Literature Review: Corporate Diversification Policy

Corporate diversification is a field of research that has become quite a viable topic for many researchers around the world. However, various gaps continue to be witnessed in regard to the focus of the topics pursued in a number of the researches. This literature review section is concerned with the review of literature related to the topic. This review of the literature will mainly place focus on summarizing previous theoretical and empirical research that has been conducted in relation to corporate diversification and policy. In addition, this review of the literature will be used to identify the ways, how current theory developed by various studies can be expanded in the future. This expansion aims at providing new evidence on the topic under discussion.

Review of Past Literature (Empirical)

The majority of the studies conducted have adopter various definitions of corporate diversification. Weiss (2013) reveals that a corporate diversification policy entails the manner and approach in which businesses take the initiative to particulate in industries that may or may not be related to their core business. Wan, Hoskisson, Short, and Yiu (2010) in their study define corporate diversification policy as a kind of growth strategy that allows a company to expand its activities and enter new business activities. Ooi, Hooy, and Som (2014) bring out the view that corporate diversification strategy details the way that allows the companies to be able to determine the areas they have the capacity to invest in and make desirable profits while enjoying sustainable growth with less risk. Corporate diversification can be divided into two main types: related and unrelated. Nazarova (2015) defines related corporate diversification as the strategy that occurs, when companies operate in multiple industries or businesses, which usually can be linked to the current business of the companies. Unrelated corporate diversification usually takes place, when a company pursues numerous different businesses or industries that have no linkages among them. Some researchers have developed the belief that the operations of diversifying corporates must be in synergy for the process of diversification to succeed. Iqbal, Hameed, and Qadeer (2012) expound on this fact by postulating that corporate diversification is one of the main business growth parts that a business entity must take. The main drawback of all the discussed definitions of corporate diversification is that they are limited in terms of defining various ways how the companies are able to diversify. Consequently, this field of research can be extended in the future, as the definition of corporate diversification should go beyond merely mentioning the process as a way the companies can enter new businesses and should include various ways corporate diversification can take place. In fact, such an extension will be essential for the provision of new evidence as it relates various means and methods companies use to conquer new businesses and industries.

The research has been conducted to explore the motives of the companies to adopt corporate diversification policy. La Rocca and Staglianò (2012) in their study assert that one reason, why many companies have adopted this diversification policy, is to receive benefits from current market in terms of higher returns and minimum risk. Actually, this fact is in line with the main financial objective to get maximum profit with lower level of risk. In their research, Iqbal, Hameed, and Qadeer (2012), establish that companies tend to embrace the diversification policy, when they are able to enjoy higher benefits from putting in place an effective organizational fit compared to the costs of reduced specialization. The same motive is reiterated by Ooi, Hooy, and Som (2014) in their study, when they affirm that firms tend to diversify, when the benefits of diversification overcome the associated costs. This focus is supported until the opposite takes place (Ooi, Hooy, & Som, 2014). The study by Nazarova (2015) also assesses various motives of the firms to accept corporate diversification policy. In tandem with this understanding, the study explicates three significant factors that motivate firms to diversify their activities. Thus, three key factors include search for market power, the solution to agency problems, and the utilization of many existing resources with the aim of taking control of the market through an illustrative competitive advantage. Raei, Tehrani, and Farhangzadeh (2015) posit that firms, which have diversified their activities, have the ability to create positive spillovers. The reason for such a situation is the fact that the value of resources in a given industry increases because of investment in another industry. Babenko (2014) finds that the motive behind company diversification consists in internal capital markets; this fact implies that diversified firms come about, when the financial market imperfections push managers towards allocation of funds in a more efficient manner in comparison to the external capital market. All the motives have a strong basis, which clearly demonstrates that the firms are constantly willing to tap into the opportunities presented to them in their environments as they seek to grow. However, much room remains, when it comes to identification of the motives that influence the decision of firms to diversify. In particular, more research can be carried out with regard to the factors that push these motives forth. In this regard, there is a need for new information to be developed, when it comes to the factors that fuel the motives among the companies.

Raei, Tehrani, and Farhangzadeh (2015) assert that, as diversified firms continue to be central to the current evolving economy, the value provided by corporate diversification has become a kind of enigma that requires to be a solution. Thus, this fact illustrates a gap in the research that needs to be expanded in the future by providing new evidence on this topic. Further, Wang and McLee (2011) in their research find that one controversial issue that has emerged is the question that relates the usage of premium or discount for diversification of companies and firms. Wan et al. (2010) have explored this issue and they remark that various scholarship efforts have been devoted primarily towards finding an answer to the question whether companies need to consider premium or discount as a means of diversifying. This fact presents a way current research can be expanded in future in order to obtain new information in relationship to this topic.

Corporate diversification policy has been a preoccupation of various research studies as a means that can help a firm to create value. While some scientists concluded that corporate diversification is closely linked to value creation, some studies have discredited this fact and asserted that diversification works to destroy value instead. Wang and McLee (2011) present this opinion in their study, where they assert that diversification is a threat to the multi-businesses and multi-national companies, which have built their portfolios on the basis of success of certain brands and areas of business. This current research can be expanded further, as not all the companies have reported a depreciation in their value. Therefore, this research expansion can look into identification of specific  factors that distinguish the level of success and failure that resulted from creation and  destruction of value.

Theoretical Approach to Corporate Diversification Policy

In fact, many theories have been utilized in past research to explain corporate diversification policy. At the same time, it is also essential to note that some of these theories of explanation of diversification in this context can also be perceived to present theoretical motivations for company diversification. Doaei, Anuar, and Ismail (2014) advance the agency theory that relates this fact. The agency theory is perceived to be a negative theory. The reason for the negative view is the fact that it promotes diversification at the expense of the owners of the company. Ooi, Hooy, and Som (2014) illustrate this phenomenon, when they assert that management of diversifying firms act with the intent of maximizing their own benefits even at the expense of the interests of shareholders. Weiss (2013) shares the same notion in the assertion that managers diversify with the purpose of increasing their power and prestige. In the end, corporate diversification will serve to increase their compensation, secure their investment and reduce their employment risk in terms of job loss and protection of professional reputation.

Another essential theory that has been used to explore the concept of corporate diversification policy is. Wan et al. (2010) advance this theory and postulate that the transaction cost theory looks into the possibility to undertake a transaction at a lower cost in the market or within the hierarchy of the firm. Weiss (2013) also explores this theory and states that it entails the negotiation, monitoring, and enforcement costs, which come about as a consequence of the transaction between two or more additional parties. In fact, these transaction costs serve as a motivation for the companies to diversify. Wan et al. (2010) further explore this theory and point out that diversification would emerge as a non-value maximization strategy  in theoretical environments with no transaction costs. The reason for such a situation is the fact that resources could easily be purchased in the market. However, transaction costs appear due to the market insufficiencies that forces integration.

The resource-based theory has also been used by some studies to explain diversification of companies. Doaei, Anuar, and Ismail (2014) exploit this theory and explain that it is usually perceived as a positive theory, as its outcomes are beneficial to a diversifying company. According to the study by Babenko (2014), this theory places more value on such resources as capabilities in specialized human capital, technological knowledge, and managerial expertise. Doaei, Anuar, and Ismail (2014) assert that these resources have high value, as they are difficult to imitate or substitute. Thus, they can be used to create value for a company, as they can be used under different circumstances that allows the development of a competitive advantage (Doaei, Anuar, & Ismail, 2014).

The analysis of the theoretical motives that influence diversification of the firms concludes that the current theory needs to be expanded. The researchers should look at the notion of corporate diversification from different angles and explore the spheres of the topic in more detail. Thus, the expansion needs to direct to the sphere of the motives for corporate diversification since the current reasons are insufficient to offer a clear picture.

Conclusion

This literature review has served to demonstrate the level of research findings regarding the topic of corporate diversification policy. Most of the information provided is quite useful as it demonstrates the rapid development of this topic. Rapid development also implies that more and more companies are reaping benefits from diversification that further increases interest in the topic. At the same time, various existing gaps in the theory of corporate diversification cannot be ignored. These gaps have been detected from both empirical and theoretical analysis provided on the topic. Thus, many spheres remain undeveloped, when it comes to understanding the place of corporate diversification policy in growth of firms and their expansion to new ventures.

Related Free Review Essays