Charles Mbugua Njoroge
The study on the linkage between corporate diversification and performance has attracted much scholarship within the fields of strategy and finance yet continues to yield with mixed results. Sources of the confusion in previous studies on diversification and performance are both methodological and theoretical. Among the theoretical issues identified are those that pertain to identification of independent variables, moderator variables and outcome variables. Most studies have relied on a single theoretical framework modelling diversification and performance through a single equation model ignoring the whole process before the diversification decision is reached. This has led to inadequate model specification with results losing validity and generalizability. Methodological issues raised pertain to heavy reliance on cross-sectional studies and models that suffer from difficulty of capturing contingencies such as in a theory of diversification. Other issues regard measurement of both diversification and performance constructs. Previous studies have largely ignored antecedents to diversification: this omission could possibly explain some of the contradiction in results. Availability of resources/capabilities, institutional issues, transaction costs and agent behaviour are some of the factors that affect a firm’s diversification decision. Even when antecedents to diversification have been considered, empirical research efforts were largely based on the explanatory elements of resource-based view. The framework proposed in this study draws on literature from the resource-based view, transaction cost economics, institutional economies and agency theory so as to enhance our understanding of antecedents to diversification. It is premised on the view that antecedent factors motivate a firm to undertake diversification. Excess resource endowments in the face of high transaction costs may induce a firm to diversify into related activities. Absence of well-developed institutions induce firms to undertake unrelated diversification to replicate the market structures that would have been provided by well-developed institutional environment. The firm governance system while not a source of competitive advantage may lead to prevalence of agency costs which affect optimality condition when faced with choice of diversification strategy. This research study is an attempt to offer an alternative view by specifying additional elements in a model of diversification and performance comprising of antecedent factors (resources, transaction costs, institutional structure and firm governance) as the independent variable, diversification strategy that results is the intervening variable and firm performance the dependent variable. It is based on the proposition that antecedent factors affect the performance outcomes of diversification. This study will enhance understanding in corporate diversification and holds promise to provide some additional insight in resolving the unsettled issues in the debate on diversification-performance linkage.