The Dark Side of Relatedness: Resource Characteristics, Hierarchical Failure, and Organizational Form

Abstract: Theory suggests that corporate diversification can create value by exploiting economies of scope or creating efficient internal capital markets. Because resources can normally be shared over a limited set of activities, and because internal capital markets suffer from information and incentive problems, most researcher argue that closely related diversification should outperform unrelated or conglomerate diversification. However, the empirical evidence is mixed. We argue that the same factors giving rise to scope economies—in particular, the ability to deploy resources across multiple products or activities—lead to divisional rent-seeking under conditions of asymmetric information. In other words, there is a “dark side of relatedness.” We provide an integrated, comparative-institutional explanation for diversification based on resource characteristics and transaction costs, showing how resource flexibility and information costs drive the benefits and costs of alternative organizational forms.