Corporate diversification and innovation: Managerial myopia or inefficient internal capital markets?

Abstract

Which is more innovative: the decentralized, diversified firm, or the centralized, more narrowly focused firm? The economics and finance literatures argue that diversified firms have innovation advantages as their operating units have access to an internal capital market. In contrast, the strategy and entrepreneurship literatures argue that managers of these firms suffer from “managerial myopia,” discouraging them from investing in projects with long‐term, uncertain payoffs. We take a fresh look at the relationship between innovation and diversification using a comprehensive sample of diversified and nondiversified firms and a novel approach that teases out the mechanisms influencing the relationship between diversification and innovation. Consistent with conceptual and empirical work in strategy, we find a robust negative correlation between diversification and R&D intensity, suggesting that diversification reduces innovation by discouraging investment. However, our analysis suggests that internal capital market inefficiencies, rather than managerial myopia, is responsible for this observed negative relationship.

Corporate Dividend Policy, Managerial Overconfidence, Myopia, and Investor Irrationality: A Complex Concoction

“…Chatjuthamard, Ongsakul, and Jiraporn (2022) study the interaction between managerial myopia, corporate complexity and hostile takeover activity. Klein and Wuebker (2020) consider the interaction between managerial myopia, corporate diversification, and innovation. Denis (2019) analyses the interaction between managerial myopia and corporate governance.…”

Agribusiness diversification and technological innovation efficiency: A U‐shaped relationship

“…First, AD has the advantage of boosting the formation of an efficient internal capital market within an agribusiness firm (Kuppuswamy & Villalonga, 2016), which can mitigate financial constraints in R&D activities and contribute to TIE (Hsieh et al, 2010; Xiang, 2021). According to the internal capital markets theory (Shin & Stulz, 1998), subsectors of a diversified agribusiness firm have access to an internal capital market, which can provide optimal financing channels, such as internal cash flow and equity of other business units (Klein & Wuebker, 2020). Dickler et al (2022) provided empirical evidence confirming that compared to single‐business firms, multibusiness firms have more flexibility to reallocate firm resources across businesses in their portfolio.…”

“…Dickler et al (2022) provided empirical evidence confirming that compared to single‐business firms, multibusiness firms have more flexibility to reallocate firm resources across businesses in their portfolio. In contrast to external capital markets, corporate financial resources can be pooled and reallocated within the firm at high capital allocation efficiency levels because the general headquarters of diversified agricultural enterprises can make full use of information advantages and residual control rights (Klein & Wuebker, 2020). Ren et al (2021), Xiang (2021), and Tan et al (2018) find evidence that the internal capital market is conducive to stimulating R&D investments.…”