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Joon Yeol Lew

Diversification, Ricardian rents and Tobin’s q Montgomery, C. A. & Wernerfelt , B. (19 88 ) Rand Journal of Economics , Vol.19, No.4, ( Winter ): 623 - 632. Joon Yeol Lew. Introduction. Research Question

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Joon Yeol Lew

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  1. Diversification, Ricardian rents and Tobin’s qMontgomery, C. A. & Wernerfelt, B.(1988)Rand Journal of Economics, Vol.19, No.4,(Winter): 623-632 Joon Yeol Lew

  2. Introduction • Research Question • What is the relationship between Ricardian rents and multimarket activity (diversification) in large firms? • Definition • Diversification Distance • The extent to which the critical factors in the entering market differ from those in the firm’s current scope • the market in which the excess factor will yield the highest rents is the closest market.

  3. Theory & Hypotheses • Theoretical Background • Diversification (e.g., Caves, 1971; Penrose 1959; Williamson, 1985) • diversification is the result of excess capacity of productive factors • with market failure (high transaction costs or imperfect mobility) • Heterogeneity of factors (which has excess capacity) • Factors are vary in their specificity • Ricardian rents: diversification is prompted by excess capacity in rent-yielding factors • transfer of excess factors may involve Ricardian rent loss • utilize excess factor into closer market, in order. • The more distant the diversification, the less marginal rent • The more specific a factor is, the less nearby markets it has. • The more specific the factor is, the more loss of rent in diversification

  4. Hypothesized relationships • Main Hypothesis More widely diversified firms earn lower average rents, ceteris parivus.

  5. Data • Observations • Random sample of 167 firms (246 original) by Lindenberg and Ross (1981) • Variables and Data Source

  6. Diversification measure Diversification measure Concentric index (Cave et al. (1980) Where, mij = the percentage of firm i’s sales in industry j (4-digit SIC code) mil = the percentage of firm i’s sales in industry l (4-digit SIC code) rjl = 0, if j and l are the different 4-digit industries within the same 3 digit industry 1, if j and l are the different 3-digit industries within the same 2 digit industry 2, if j and l are the different 2-digit industries The more distant, the more weight(rjl)

  7. Model &Results

  8. Conclusions • Large firms earn decreasing average rents as they diversify more widely. • The farther they must go to use their factors, the lower the marginal rents they extract. • Limitations • Alternative explanations • Firms with available cash undertake diversification even when marginal rents become subnormal. • Model Assumptions: • Costless disposal of excess capacity • No natural economies of scope • Sample of only large, successful firms.

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