Chasing Their Tails: Why Do Firms Subsidize Underperforming Business Units?
33 Pages Posted: 12 Sep 2014
Date Written: 2014
Firms repeatedly fail to exit from underperforming lines of business. To explore the managerial motives of exit delay, this paper joins theory on scope economies and real options with a theory of internal capital market efficiency. I show that economies of scope, along with characteristics of the firm’s chief executive officer (CEO), play a significant role in the managerial decision to delay exit from an underperforming line of business. In the final stage of the analysis, I present evidence that managers may be overestimating the scope economies and option values behind their investment decisions, and that these decisions may also be subject to an escalation of commitment.
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