rm reference 2- dimensions of international diversification-their joint effects on firm performance

7/31/2019 RM Reference 2- Dimensions of International Diversification-Their Joint Effects on Firm Performance

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Dimensions of International Diversification:Their Joint Effects on Firm Performance

Lee Li

Gongming Qian

ABSTRACT. This study assesses the joint effects of country diversifi-

cation, regional diversification, and product diversification on firm per-formance. Findings from this study suggest that their joint effects arecurvilinear. At low levels of regional diversification, product diversifi-cation has a positive effect on firm performance, but the effect turns neg-

ative at high levels of regional diversification. Similarly, with lowregional diversification, country diversification has a positive effect on

firm performance,but the effect becomes negative with high regional di-versification. At low levels of country diversification, product diversifi-

cation has a negative effect on firm performance. However, the effectmay not necessarily turn positive at high levels of country diversifica-tion. [Article copies available for a fee from The Haworth Document DeliveryService: 1-800-HAWORTH. E-mail address: Website: 2005 by The Haworth

Press, Inc. All rights reserved.]

KEYWORDS. Country diversification, regional diversification, prod-uct diversification

Lee Li is Associate Professor, School of Administrative Studies, Atkinson Facultyof Liberal & Professional Studies, York University, Canada. Gongming Qian is Asso-ciate Professor, Department of Management, The Chinese University of Hong Kong,Hong Kong, Peoples Republic of China.

Address correspondence to: Lee Li, School of Administrative Studies, AtkinsonFaculty of Liberal & Professional Studies, York University, 4700 Keele Street, To-ronto, Ontario M3J 1P3, Canada (E-mail: [email protected]).

Journal of Global Marketing, Vol. 18(3/4) 2005Available online at http://www.haworthpress.com/web/JGM 2005 by The Haworth Press, Inc. All rights reserved.

Digital Object Identifier: 10.1300/J042v18n03_02 7
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International diversification has become increasingly common in thelast decade and has great impacts on diversified firms performance(Delios and Beamish 1999). Internationaldiversification canbe definedas expansion across borders of global regions and countries into differ-entgeographic locations,or markets (Hill et al. 1992). Conceptually, in-ternational diversification provides firms with benefits but at high costs(Tallman and Li 1996). The theory of multinationals suggests that inter-national diversification provide diversified firms with the potentials toexploit more market opportunities, to spread market risks, and to seekless expensive inputs and less price-sensitive markets (e.g., Buckleyand Casson 1976). However, transaction cost theory suggests that inter-national diversification incur heavy costs, including market entry costs,

costs of coordination among business units in different countries, andinformation-processing costs (Williamson 1985). Under certain condi-tions, these costs may surpass the benefits (e.g., Sambharya 1995).

The key issue is howto determine such conditions. Existing literaturesuggests that two determinants, i.e., multinationality and product diver-sification, have great impacts on these costs and the benefits (e.g., Hittet al. 1997; Tallman and Li 1996). The impacts of these two determi-nants have been tested a number of times with conflicting results. Forexample, Grant (1987) suggested that multinationalism should conferadvantages over non-multinational firms. Ramaswamy (1993) wentfurther and found that interactions between different measures of inter-national diversification had more significant effects on firm perfor-

mance. However, Michael and Shaked (1986) indicated that this mightnot be the case. Hitt and colleagues (1997) showed that product diversi-fication positively moderated internationalizing firms performance butFranko (1989) saw the opposite.

The reason for these mixed results, we argue, is that the impacts ofthese two variables are more complex than has been theoretically ar-gued and empirically tested. Multinationality and product diversifica-tion themselves are variables rather than constants. Different levels ofmultinationality and product diversification have different impacts oninternational diversification. Moreover, multinationality and productdiversification may interact between themselves and the interactionsalso affect firms international diversification. Based on such expecta-tion,we designed this research to examine the model shown in Figure 1.

We drew on the extent theory from several disciplines (i.e., corporatestrategies, international diversification, and foreign investments) andspecific theoretical domains (i.e., multinational theory, transaction cost

8 JOURNAL OF GLOBAL MARKETING


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theory, and organizational learning theory) to build the conceptualframework.

Our model departs fromtheextant internationaldiversification litera-ture in two significant ways. First, it differentiates two distinct dimen-sions of multinationality, i.e., country diversification and regionaldiversification. We believe diversification across countries within a re-gion incurs much lower costs than diversification across regions. Assuch, the term multinationality is too general to explain the costs andbenefits associated with international diversification. The extant inter-national diversification literature does not make such differentiation.Second, the model developed in this paper aims to capture the complex-

ities of the interactions between three dimensions at different levels.Most of existing studies focus on one or two variables and overlook thevariations of the variables. We believe our papers contributions onthese two fronts can help explain the mixed findings in the existing liter-ature.

THE CONCEPTUAL FRAMEWORKAND ITS THEORETICAL BASES

As the framework in Figure 1 suggests, we classify international di-versification into three dimensions and propose their joint effects (be-tween these dimensions) on firm performance.

International diversification consists of three dimensions, i.e., prod-uct diversification, country diversification, and regional diversification.Product diversification can be defined as the expansion into product

Lee Li and Gongming Qian 9

ProductDiversification

H3a,b

H1a,b

CountryDiversification

H2a,b

RegionalDiversification

FirmPerformance

FIGURE 1. Joint Effects of Diversification Dimensions on Firm Performance


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markets new to a firm (Saloner et al. 2001). Since Rumelts (1974) sem-inal study of qualitative type of product diversification, several method-ologies have been used to assess its effects on firm performance,including Standard Industrial Classification (SIC) categories (Palepu1985) and typology variables and SIC code-based entropy variables(Hoskisson et al. 1993). However, the findings have been contradictory(Hitt et al. 1997). The discrepancies may result from unlike measures orfrom nonlinearities in the relationship between product diversificationand firm performance (Tallman and Li 1996).

Country diversification is defined as expansions into individual for-eign countries. Regional diversification is defined as expansion into dif-ferent global regions or areas, such as North America or Western

Europe. Country diversification and regional diversification are two re-lated but different concepts. Here, we firstuse anexample (there are twofirms: Firm A and Firm B) to illustrate the difference. The former hasbusiness operations in 40 countries which are located in two differentworld regions while the latter diversifies in only six countries whichspread across five different regions. Firm A has high levels of countrydiversification but low levels of regional diversification. In contrast,Firm B has low levels of country diversification but high levels of re-gional diversification. A differentiation between country and regionaldiversification is necessary and important. High levelsof country diver-sification may not necessarily be risky or costly if a firm restricts its op-erations in a particular region where most of countries share similardemand patterns and cultures. In contrast, low levels of country diversi-

fication can be riskyor costly if a firm spreads its limited markets acrossdifferent regions which are different in terms of psychic distance, com-petition intensity, demand patterns, and consumer cultures.

We draw mainlyon three relevant theories (i.e., multinational theory,transaction cost theory, and organizational learning theory) to developthe analytical framework. The theories have been widely employed inthe existing literature. Multinational theory relies on foreign direct in-vestment and internalizationperspectives to explain international diver-sification. Foreign direct investments provide the potential to transfercompetitive advantages across country borders and minimize factorcosts, e.g., labor costs, capital charges (Grant 1987). Internalization, onthe other hand, offers an optimal means to overcome market imperfec-tions across different countries (Buckley and Casson 1976). However,

foreign direct investments and internalization may incur transactioncosts, such as coordination costs, communication costs, exit costs, andthe costs of losing flexibility (Williamson 1985). Transaction cost the-



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ory assesses various costs incurred in the transactions across countryborders. However, transaction cost theory overlooks the fact that thesecosts maybe reducedwhen firms increase their country-specificknowl-edge and the market penetration competencies. Organizational learningtheory, on the other hand, focuses on the development of managerialcompetencies to manage complexities and uncertainties of internation-alization. Such process is time-dependent and firm-specific. As such,the process is a unique path shaped by learning mechanisms, includingpractice, codification, mistakes, and pacing (Eisenhardt and Martin2000). However, organizational learning does not address directly theimpacts of external factors which are out of firms control. Our studywill integrate these theories to explain and assess corporate diversifica-

tion and its relationship to firm outcomes. The relationship is more fullyexplicated in the arguments that follow, and testable hypotheses areproposed.

CONCEPTUAL FRAMEWORK

Product Diversification and Country Diversification

At low levels of country diversification, product diversification willvary negatively with firm performance. Multinational theory indicatesthat low country diversification constrains firms operational scale, asfirms restrict their operation in certain countries (Grant 1987). Low

country diversification limitsmarket opportunitiesandgrowth potentialfor each product line within a diversified firm as low country diversifi-cation limits market size (Delios and Beamish 1999). Diversified firmscan hardly achieve large volume with low country diversification. Con-sequently, they can hardly spread R&D costs and promotion costs ofeach product line over a large volume and thus suffer high costs (Habiband Victor 1991). In other words, diseconomies of scale lead to high op-eration costs of each product line.

Organizational learning theory suggests that firms can hardly accu-mulateproduct expertiseand competition knowledge with limited oper-ational scale (Morck and Yeung 1991). A firm that diversifies into anew product line generally knows less about the new product than com-petitors. Limited sales volume associated with limited market size re-

tards the market followers process to swiftly catch up and surpassmarket leaders in terms of R&D capabilities, production efficiencies,and promotion competencies (Saloner et al. 2001). Moreover, limited



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product expertise and competition knowledge restricts diversifiedfirms capabilities to achieve synergies between product lines. Withlimited product expertise and competition knowledge, they can hardlytransfer or share knowledge-based resources between product lines(Eisenhardt and Martin 2000).

Increasedcountry diversificationbeyond a certain degree will reducethe costs of product diversification. Multinational theory suggests thatwide country diversification provides opportunities for each productline in various markets. In other words, each product line can achievereasonable volume across various countries. Large volume leads toeconomies of scale (Porter 1985). With wide country diversification,firms can also amortize investments in critical functions such as R&D

and brand image over a broader base (Hitt et al. 1997). Moreover, widecountry diversification increases the flexibility and spreads the risks foreach product line. A particular product lines failure in certain countriescan be compensated by its success in other countries.

Wide country diversification provides the opportunities for multina-tional manufacturers to exploit market imperfections (e.g., differencesin capital charges and labor costs) by performing many activities inter-nally (Buckley and Casson 1976). In addition, wide country diversifica-tion helps a firm to build up its internal capital market (Hill et al. 1992).This facilitates the allocation of financial resources between differentbusinesses and helps the firm to overcome sharp fluctuations in finan-cial needs. Moreover, firms with internal capital markets may have in-formational advantages, as external sources of capital have a limited

ability to know what is specifically taking place inside a large organiza-tion (Hitt et al. 1997).

Wide country diversification exposes a firm to a rich array of envi-ronments. Organizational learning theory suggests such exposure todifferent environments speed up the firms learning process as the firmhas to transfer, integrate, and createknowledge-based resources to man-age uncertainties associated with different environments (Sambharya1995). Managers who look after various countries can gain detailedproduct management and country-specific knowledge. This builds andmaintains firm-specific capabilities and speeds up the innovation pro-cess, as the firm can combine different skills and knowledge to developinnovations and new products (Ettlie 1998). Innovation enhances thecompetitiveness of each product line (Porter 1985). Moreover, opera-

tion across different countries forces firms to integrate, build and recon-figure their internal and external competencies to address differentenvironments (Teece et al. 1997). Such capabilities are the important



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source of sustained competitive advantages (Eisenhardt and Martin2000). Therefore, we propose:

Hypothesis 1a: At low levels of country diversification, perfor-mance should vary negativelywith the degree of productdiversifi-cation.

Hypothesis 1b: At high levels of country diversification, perfor-mance should vary positively with the degree of product diversifi-cation.

Regional Diversification and Country Diversification

Countries that are located in the same region or area, such as NorthAmerica, Western Europe, or Greater China (Mainland China, HongKong, and Taiwan), may share similar cultures, demands or competi-tion intensity. Similarity is defined in a relative rather than absolutesense. In other words, differences between two countries located in dif-ferent regions will be much more substantial than those between twocountries in the same region. If a firm diversifies into various countrieswithina region, it enjoys increasedmarket opportunitiesand growth po-tential but at the same time avoids a great diversity of customer cultures,demands, and competition intensity.

Relative similarity between countries in a region has great strategicimplications for diversified firms. Transaction cost theory suggests that

such similarities reduce coordination costs, distribution costs, manage-ment costs, information searching costs, and information processingcosts, as the similarities reduce both managerial, technological, and co-ordination complexities and facilitate communications between busi-ness unites located in different countries (Williamson 1985).

Multinational theory suggests that similar market environmentswithin a region help firms make it possible for diversified firms to stan-dardize their products and rationalize production in theparticular region(Tallman and Li 1996). As countries in the same geographic area sharemany similar market characteristics, customers there may accept simi-lar product features. Standardization saves costs as it provides econo-mies of scale and scope (Hitt et al. 1997). Moreover, it makes it easierfor the firm to exploit the synergies between countries. Core competen-

cies developed in one country can be applied to similar countries in thesame region (Tallman and Li 1996). It is also easier to transfer resourcesor assets, such as brand image, between countries in the same region.



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Organizational learning theory suggests that similar environmentswithin a region facilitate learning and reduce uncertainties (Habib andVictor 1991). Knowledge gained through trial-and-error process in onecountry can be applied to similar countries in the same region. Businessunits in different countries of the same region can share cutting-edgeproduct knowledge and marketing knowledge. In addition, knowl-edge-based resources accumulated from similar environments can becombined and integrated relatively easily to create new competencies(Eisenhardt and Martin 2000).

If a firm diversifies widely in different world regions/areas, it has todeal with unknown cultures, new competitors, and strange and complexenvironments that are characterized by different sets of political, eco-

nomic, and legal factors (Sambharya 1995). Transaction cost theory ar-gues that the cultural diversity arising from operations in differentmarketplaces brings with it numerous problems of communication, co-ordination, control, and motivation (Kogut and Singh 1988). Differentcultures, levels of economic development, levels of competition inten-sity, and customer needs across regions/areas make it difficult for a firmto standardize its product and distribution management. Hence, it mustadapt its marketing mix to fit different regions/areas, which will incurgovernance and management costs (Van Raaij 1997). An increasedpsy-chic/cultural distance between the firms homecountry and its locationsin different world regions/areas negatively influences cross-border ad-ministration costs (Geringer et al. 2000). As such, continued regionalexpansion contends with the increasingly difficult prospect of manag-

ing a multicultural, multi-location workforce that serves distinctly dif-ferent customer markets, and navigating through a maze of formidableconstraints imposed by the sheer number of locations in which opera-tions are established (Gomes and Ramaswamy 1999). Consequently,managerial constraints increase with multi-regional operations (Grant1987). It is true that diversified firms can enhance their competencies tomanage the managerial complexities and reduce administration coststhrough learning process. However, such learning process takes timeand can be too slow when diversified firms face threats from formidablecompetitors.

Organizational learning theory suggests that institutional andculturalfactors are formidable barriers to the transfer of marketing knowledgeand product knowledge between regions (Kogut and Singh 1988). The

organization will become too complex when a firm has an increasedproportion of foreign businesses located in a great number of differentregions, and learning is hampered by information overload (Delios and



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Beamish 1999). Such large complex operations across different regionscan hardly survive competition in high-velocity markets where changesfrequently along unpredictable and nonlinear paths (Eisenhardt andMartin 2000). The centralized system is too slow in responding to mar-ket changes as information flow between hierarchy layers within thefirms is hardly efficient (Hitt et al. 1997). Decentralized system can beproblematic as well. Decentralization will lead to resource waste. Asbusiness units in different regions can hardly share resources, they haveto duplicate and repeat same functions or activities in different regions(Sambharya 1995). Moreover, decentralization may trigger off civilwars between business unites in different regions. Therefore, we pro-pose:

Hypothesis 2a: At low levels of regional diversification, perfor-mance should vary positively with the degree of country diversifi-cation.

Hypothesis 2b: At high levels of regional diversification, perfor-mance should vary negativelywith the degree of country diversifi-cation.

Product Diversification and Regional Diversification

Low levels of regional diversification exposes a firm to similar envi-ronments but, at the same time, may not necessarily restrict the firms

market opportunities if the firm diversifies into variouscountries withina particular region. Low levels of regional diversification minimize thedisadvantages of product diversification, as the environmental similari-ties reduce the costs of coordination between product lines (Geringer etal. 2000). More importantly, low levels of regional diversification pro-vide opportunities for firms to exploit synergies between product lines(Hitt et al. 1997). Environmental similarity makes it easier for differentproduct lines to share resources or assets, such as R&D capabilities andmarketing competencies (Porter 1985). International expansion withina region, on the other hand, brings strategic benefits. Some productlines, which may not survive at home market due to small home marketsize, may become successful when they enter overseas markets, as indi-vidual small markets can add up to a reasonable volume. In addition,

each product line can increase its returns by exploiting its unique assets,such as brand equity, patents, or unique processes, across a great num-ber of similar markets (Delios and Beamish 1999). International expan-



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sion within a region increases the profit stability of each product line(Habib and Victor 1991). If a product line fails in a particular country,its success in other countries may compensate the losses and thus rescuethe product line. Low levels of regional diversification do not increasemanagers information asymmetries and information overload whenvolume rises rapidly (Hitt et al. 1997). Organizational learning theorysuggests that low regional diversification mayfacilitate product diversi-fication (Morck and Yeung 1991). Increased operations, which resultfrom operations in various countries, lead to increased knowledgespillover between product lines (Saloner et al. 2001). With low environ-mental uncertainties, firms become increasingly confident and aggres-

sive. Consequently, they tend to learn and diversify into differentproduct segments in an effort to exploit unexplored market opportuni-ties or achieve economics of scope.

When firms diversify into various different regions, they have to dealwith great varieties of environments and experience high complexitiesand managerial constraints. Product diversification may dilute firmsfocus (Geringer et al. 2000). Such lack of focus, combined with highlevels of complexities and managerial constraints, may make diversi-fied firms vulnerable to cost competition from formidable competitors(Porter 1985). High governance costs associated with product diversifi-cation may overwhelm the scope of economies of multiple markets(Tallman and Li 1996). In addition, high levels of regional diversifica-

tion can also lead to diseconomies of scale. When firms diversify intodifferent regions, they have to adapt products, promotion, and prices ofeach product line to fit different markets, such adaptation increases theoperation costs of each product line and thus reduce their competitive-ness.

Organizational learning theory suggests that the complexities result-ing from the combination of product diversities and market diversitieswill hinder a firms learning (Kogut and Singh 1988). In order to man-age complexities and constraints, diversified firms usually have to usemultidivisional structure. Each division has to look after a different setof markets. High market diversities and product diversities make it dif-ficult for individual divisions to share, transfer, and integrate informa-

tion and knowledge-based resources, as they individually deal withsubstantially different environments (Hitt et al. 1997). Therefore, wepropose:



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Hypothesis 3a: At low levels of regional diversification, perfor-mance should vary positively with the degree of product diversifi-cation.

Hypothesis 3b: At high levels of regional diversification, perfor-mance should vary negatively with the degree of product diversifi-cation.

METHOD

Research Sample

The sample for this study was drawn from the largest U.S. firms onthe Fortune 500 list. There are two reasons for selecting the largestfirms. First, the history of both of their product and international diver-sification is much longer (Didrichsen 1972; Koptis 1979). Many ofthem have operated in multiple and disparate product and internationalmarkets (Geringer et al. 2000; Hitt et al. 1997).Second, these firms havemore financial resources to carry out both product and international di-versification. However, these diversified firms need to constantly strug-gle to balance their total diversification endeavors in both the differentproduct markets and country or geographic areas to optimize their over-all performance (Sambharya 1995). We used both company-level dataincluding annual reports and 10-k fillings, and other data sources such

asMoodys Industrial Manuals and World Investment Report.1 We se-lected only those firms that have nontrivial product diversification andare competing in international markets. To smooth annual fluctuationsin the accounting data, we used a five-year average for the 1993 through1997 period for each variable in the study. The initial base sample con-sists of all firms in the Fortune 500 listing in independent existenceover this period. Because there were some missing data on many firms,however, it is necessary to make some adjustments to the original database, leaving the present sample of 167 firms, for which all of the requi-site data for 1993-97 was available.2

Dependent Variable

Performance (PERF). Three accounting-based measures were ini-tially considered as possible indicators of firm performance: return onassets (ROA), return on sales (ROS) and return on equity (ROE). They



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have been commonly employed in strategic management research (Hittet al. 1997; Qian and Li 2002; Tallman and Li 1996). ROA and ROSwere employed only because ROE is more sensitive to capital structuredifferences (Hitt et al. 1997).3 These measures indicate how much netincome is earned from each dollar of assets and sales per revenue. Theywere measured as the after-tax profit (before extraordinary items) di-vided by total assets and total sales.

Diversification Variables

Product Diversification (PD). As in prior studies (e.g., Hitt et al.1997; Palepu 1985; Riahi-Belkaoui 1996; Sambharya 1995), the en-

tropy measure of product diversificationwas employed to measure totalproduct diversification. As this index recognizes the degree of related-ness among various product segments and allows the decomposition oftotal product diversification into two additive components (i.e., relatedand unrelated production diversification), it has become increasinglypopular in strategic management research (Hill et al. 1992; Hitt et al.1997).4 Given a firm operating in n industry segments, the entropymea-sure of product diversification is defined as:

PD ==

P In(1 / P )m

i

i

i

1

where Pi is the sales attributed to segment i and In(1 / Pi) is the weightgiven to each segment within the same two-digit industry group. Thismeasure considers both the number of segments in which a firm oper-ates and the proportion of total sales each segment represents.

Country Diversification (CD). In previous studies, the degree of coun-try diversification was measured by the scale of foreign operations ormultinationality, such as foreign sales in a host country as a percentageof total sales (Geringer et al. 1989; Grant et al. 1988), foreign assets in ahost country as a percentage of total assets (Daniels and Bracker 1989;Ramaswamy 1993), and number of foreign employees in a host countryas a percentage of total employees (Kim et al. 1989). Moreover, in recentyears, some researchers (e.g., Dunning 1996; Gomes and Ramaswamy1999; Ietto-Gilles 1998; Sullivan 1994) combined sales, assets, and em-

ployment to construct multidimensional index. Following this recentdevelopment, we calculated the multidimensional index as the averageof the abovethree ratios and used it tomeasure country diversification.



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CD = + +(FATA FSTS FETE) / 3

Where FATA is the foreign assets as the percentage of a firms totalassets; FSTS is the foreign sales as the percentage of a firms total sales;and FETE is the foreign employees as the percentage of a firms totalemployees.

Regional Diversification (RD). Again, we used the entropy approachto measure regional diversification strategy. It is defined as:

RD ==

P In(1 / P )1

m

i

i

i

where Pi is the sales attributed to global market region i and In(1 / Pi) isthe weight given to each region. The advantage of using the entropymeasure of regional diversification is that it considers both the numberof global market regions in which a firm operates and the relative im-portance of each global market region to total sales (Hitt et al. 1997).According to the World Bank (2001), there are ten global regions/areasin the world, which serve as the criterion to classify the geographic dis-tribution of a firms sales.5

Control Variables

Following previous studies (e.g., Geringer et al. 2000; Tallman and

Li 1996), we included several control variables, including firm size,leverage, R&D, industry and country effects. Firm size representsphysical and financial resources (Ito and Rose 1998). Therefore, it isfrequently used as a proxy for competitive positioning (e.g., econo-mies and diseconomies of scale) within an industry (Johnson et al.1997). Although the sample firms were all derived from Fortune 500list, they might still differ in size. To control for the size difference, wemeasured it by the natural logarithm of total sales. Firm leverage,operationalized as the percentage of long-term debt to total capital(debt plus equity), was used to control for the potential effect ofnon-capital financing on firm performance.R&D, an important deter-minant of firm profitability, was measured using the firms annual ex-penditure on R&D investment divided by revenues.Effect of industry

participation was included a control variable. Since these firms oper-ated in 13 industries, the question is that homogeneity existed acrossindustry groups. Different industries, however, have different struc-



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tural characteristics which may involve different degree of risks andthe capital may also have different perception of risks involved (Bettisand Hall 1982; Porter 1985), it is therefore important to control for theindustry differences. As in previous studies (e.g., Hitt et al. 1997;Tallman and Li 1996; Markides 1995), we classified firms intotwo-digit SICcategories on the basis of sales revenue and introducedthe industry dummy variables to measure industry effect. Accord-ingly, there are 13 industries in which these firms operated. Countryeffectwas used to control for external environments given that exter-nal environments differ from country to country (Barkema andVermeulen 1998). The size and growth of a local market may influ-ence firms internationalization and performance (Zejan 1990). Fol-lowing previous studies (e.g., Barkema and Vermeulen 1998; Gomes-Casseres 1990; Zejan 1990), two variables were used: the growth ofthe market, measured by the growth in GNP; and the level of develop-ment of the host country, measured by GNP per capita.

Regression Model

We pooled our cross-sectional and time series data to take advantageof the greater degrees of freedom offered by pooling, and to captureboth the dynamic information of time series and the variation due tocross-sections (Lu and Beamish 2000). A panel data should potentially

be very informative about the parameters to be estimated (Qian 1997).If we use a pure cross-sectional analysis, we are unlikely to get an unbi-ased estimator of the causal relationships between variables (Woold-ridge 2000).

We used fixed effects models with the lagged dependent variable inthe regression specification, and tested the hypotheses proposed in thestudy. A model (T = 5 in our study) with observed explanatoryvariablesis expressed as:

PERF d94 d95 d96 d97 PERF (PD CD) +1 2 3 4 5 1 1= + + + + + +

22 2(PD CD ) (PD RD) (PD RD (CD RD) +

CD RD

+ + +

3 4 5

6

2

)

( ) + + + +Control Group I Control Group II it i

where:



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d94, d95, d96 and d97 = dummy variables for T5 in the study (theydo not change across firms);PERF

1 = laggeddependentvariable (performance in thepreviousperiod);

ai = an unobserved effect;

mit = idiosyncratic error;Control Group I = all individual diversification variables; andControl Group II = all of the variables shown in the above Control Vari-ables.

We tookai to be a group specific constant term in the regression

model. In fixed effects models, the variable ai captures all unobserved,time-constant factors that affect the dependent variable. Meanwhile,lagged dependent variable was used in regression analysis.6 As the re-gression contains any lagged values of the dependent variable, regres-sion models will no longer be unbiased or consistent (Greene 1997).Using a lagged dependent variable (PERF

1) in the model provides asimple way to account for historical factors that cause currentdiffer-ences in the dependent variable that are difficult to account for in otherways (Wooldridge 2000). When applied to our case in the study, firmswith high historical profitability rates may spend more on corporate (ei-ther product or international or both) diversification (Grant 1987; Grantet al. 1988).

RESULTS

Table 1 provides descriptive statistics and intercorrelations for allquantitative variables in the study.7 Preliminary analysis revealed lowintercorrelations among these variables, which suggested that multi-collinearity was not a serious problem. To further check its tenability,however, we made other regression diagnoses (e.g., VIFs) to detectwhether or not there was severe multicollinearity. This was done bylooking at the extent to which a given explanatory variable could be ex-plained by all of the other explanatory variables in the equation. The re-sults suggested no problem with multicollinearity as the VIF values forall independent variables were comparatively low [(VIF(i) < 2].

Our another concern was autocorrelation and heteroscedasticity intheequation because we pooled our cross-sectional and time seriesdata.Since the time period in our study was only five years, it normally did



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TABLE1.Means,Stan

dardDeviationandCorrelationsfor

theQuantitativeVariables

Variables

Means

s.d.

1

2

3

4

5

6

7

8

9

1.Profitability

5.434

4.026

2.Productdiversification

1.347

1.253

0.160*

3.Countrydiversification

0.473

0.261

0.192**

0.111

4.Regionaldiversification

0.365

0.182

0.187**

0.093

0.102

5.Firm

size

7.684

8.233

0.075

0.114

0.081

0.092

6.R&D

intensity

7.139

4.057

0.293***

0.155*

0.164*

0.155*

0.147*

7.Firm

leverage

0.728

0.494

0.081

0.060

0.029

0.033

0.045

0.025

8.GNPgrowth

0.091

0.175

0.133

0.071

0.101

0.094

0.036

0.071

0.023

9.GNPpercapita

1.316

3.192

0.113

0.064

0.088

0.080

0.027

0.059

0.017

0.049

10.Profitability(lagged1)

4.979

3.877

1.507*

0.121

0.117

0.111

0.092

0.069

0.033

0.085

0.053

*p

rm reference 2- dimensions of international diversification-their joint effects on firm performance

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