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:
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.
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.