Motives to Diversify Motives to Diversify In some instances, managers may be motivated to diversify their companies even if there are no incentives and a lack of resources should constrain any inclination toward diversification. Managers' motives for diversification include: Reduction of managerial risk Diversification may enable managers to reduce employment risk (the risks related to the loss of their jobs or a reduction in compensation) because by diversifying the company (by adding a number of additional businesses) managers may be able to diversify their employment risk if profitability does not decline significantly as a result of the diversification. Desire for increased compensation Diversification also may enable managers to increase their compensation because of positive correlation between diversification, company size, and executive compensation. This positive correlation may exist because diversification generally results in an increase in the complexity and size of the overall company, and large companies are more difficult to manage. As a consequence, managers of large companies generally are compensated more highly than are managers of small companies. Managers may be motivated to increase overall company diversification even when the incentives and resources are absent. If this happens, internal and external governance mechanisms generally come into play to discourage diversification that is motivated solely by managerial self-interest. Unfortunately, these mechanisms are not perfect and may give incentives to managers to take strategic actions (to reduce the level of company diversification) that are counter-productive (resulting in lower-than-expected performance). For example: Spin-off companies may not realize productivity gains. Business units that are spun off may have unrecognized interdependent linkages with business units that remain in the company. Ultimately, the appropriate level of diversification should be determined by the market and by individual company resources and capabilities. One signal that the company may be overdiversified is when operating diversified businesses reduces rather than improves the overall performance of the company. Therefore, diversification strategies can be used to enhance a company’s strategic competitiveness and enable it to earn above-average returns. However, positive outcomes from diversification are possible only when the company achieves the appropriate level of diversification, given its resources, capabilities, and core competencies, and taking into account the external environmental opportunities and threats. |