Diversification and Performance: Linking Relatedness, Market Structure, and the Decision to Diversify

53 Pages Posted: 29 May 2015 Last revised: 16 Jun 2015

See all articles by Ron Adner

Ron Adner

Dartmouth College - Strategy & Management Area; Dartmouth College - Tuck School of Business

Peter B. Zemsky

INSEAD - Strategy; Centre for Economic Policy Research (CEPR)

Date Written: June 03, 2015


An extensive empirical literature in strategy and finance studies the performance implications of corporate diversification. Two core debates in the literature concern the existence of a diversification discount and the relative importance of industry relatedness and market structure for the performance of diversifiers. We address these debates by building a formal model in which the extent of diversification is endogenous and depends on the degree of industry relatedness. Firms' diversification choices affect both their own competitiveness and market structure. We find a non-monotonic effect of relatedness on performance: while greater relatedness increases the competitiveness of diversified firms, it can also spur additional diversification, thereby eroding market structure and performance. In this way, our theory also elucidates how heterogeneity in firm scope strategies can emerge even when firms are initially identical. We use the model to generate data and show how the negative effect of relatedness on market structure can give rise to spurious inference of a diversification discount in cross-sectional regressions. We extend our model to show how increases in relatedness can lead to both entry and exit dynamics. A second extension investigates the conditions under which resource endowments make firms more or less likely to diversify.

Keywords: corporate strategy, diversification discount, horizontal scope of the firm, formal foundations of strategy, resources

JEL Classification: C70, D21, G34, L1, L22, M10

Suggested Citation

Adner, Ron and Zemsky, Peter B., Diversification and Performance: Linking Relatedness, Market Structure, and the Decision to Diversify (June 03, 2015). Strategy Science, Forthcoming, INSEAD Working Paper No. 2015/39/STR, Tuck School of Business Working Paper No. 2611335, Available at SSRN: https://ssrn.com/abstract=2611335 or http://dx.doi.org/10.2139/ssrn.2611335

Ron Adner (Contact Author)

Dartmouth College - Strategy & Management Area ( email )

Hanover, NH
United States

Dartmouth College - Tuck School of Business ( email )

Hanover, NH 03755
United States

Peter B. Zemsky

INSEAD - Strategy ( email )

Boulevard de Constance
77305 Fontainebleau
+33 1 60 72 4162 (Phone)
+31 1 60 74 5500 (Fax)

Centre for Economic Policy Research (CEPR)

United Kingdom

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