Diversified Firms: Existence, Behaviors, and Performance
Abstract: We propose a micro-founded theory of diversified firms and offer supporting evidence. The theory suggests that diversified firms exist because they allow better deployment of factors that, because of sub-additive contracting costs, are hard to trade in fractions. Firms diversify into industries in which these factors are more productive than any alternatives available in the factor market. The theory portrays diversified firms as mechanisms that, like markets, allow specialization by enabling factors to be used on a larger scale. It identifies specific similarities in the factor demands and behaviors of the individual businesses constituting these firms and predicts that the productivity of a merged entity is below that of the acquirer, even when the merger is optimal.
