In Press - AMJ

HOME COUNTRY ENVIRONMENTS,CORPORATE DIVERSIFICATION STRATEGIES,

AND FIRM PERFORMANCE

William P. WanThunderbird

Global Business Department15249 N. 59th Ave

Glendale, AZ 85306-6000Phone: (602) 978-7395Fax: (602) 843-6143

E-mail: wanw@t-bird.edu

Robert E. HoskissonUniversity of Oklahoma

Michael F. Price College of BusinessManagement Division

Norman, OK 73019-4006Phone: (405) 325-3982Fax: (405) 325-1957

E-mail: rhoskiss@ou.edu

_______________

The authors would like to thank Bert Cannella, Javier Gimeno, Dan Wood, Daphne Yiu, Laszlo Tihanyi, AmyHillman, Associate Editor Harry Barkema, and the three anonymous reviewers for their valuable comments duringvarious phases of this research. The first author acknowledges the financial support provided by the Center ofInternational Business Studies at Texas A&M University.

2

HOME COUNTRY ENVIRONMENTS,CORPORATE DIVERSIFICATION STRATEGIES,

AND FIRM PERFORMANCE

ABSTRACT

This study reexamines the relationships between corporate diversification strategies and firm

performance and suggests that these relationships are related to home country environments. We

examined two environmental aspects: factors which facilitate transformational activities and

institutions which foster transactional activities. Using a sample of firms from six Western

European countries, we found support for the paper’s central proposition that home country

environment is an important component in the study of corporate diversification strategies.

3

Research on corporate diversification has made significant contribution to the field of

strategic management in the past decades (Hoskisson & Hitt, 1990). With few exceptions,

however, most prior studies have assumed away the country environmental differences in which

the diversification strategies are adopted. In product diversification research, recent theories and

empirical studies are mostly grounded in the corporate refocusing, or downscoping, experiences

of the United States in the past two decades (Hoskisson & Hitt, 1994). However, there is

evidence that even firms in the United States might have benefited from unrelated diversification

in the 1960s when conglomerates enjoyed efficient internal capital markets in the absence of a

matured external capital market (Hubbard & Palia, 1999). Such benefits began to diminish in the

1970s along with economic and regulatory improvements in the 1970s and 1980s (Markides,

1992). Contextual differences become even more salient when we attempt to apply extant

theories and findings across countries. For example, diversified business conglomerates have

dominated many economies throughout the world (Khanna & Palepu, 1997), while in the United

States they have decreased as a significant form. As such, our knowledge about the product

diversification strategies pursued by firms in other countries is limited.

More recently, the topic of international diversification has also captured the attention of

corporate diversification researchers (e.g., Hitt, Hoskisson, & Kim, 1997; Tallman & Li, 1996).

Despite its significant contribution, this line of research likewise has its theoretical and empirical

focus predominantly centered on firms located in a few countries, mainly the United States or

Japan, and seldom examined firms located in other countries (Tallman & Shenkar, 1990).

Although extant research has generally supported a positive relationship between international

diversification and performance (e.g., Geringer, Beamish, & daCosta, 1989; Hitt et al., 1997), the

applicability of such theoretical arguments and findings across countries has yet to be adequately

4

examined in the diversification literature. More research is necessary to illuminate if firms

located in different country environments can also benefit from international diversification.

The focus of this study is to explore how country-level environmental contexts affect the

relationships between corporate diversification strategies and firm performance. Primarily

drawing upon arguments developed in institutional economics (e.g., Clague, 1997; North, 1990),

we seek to reexamine the relationships between corporate diversification strategies and firm

performance between dissimilar types of home country environments. Hirsch and Lounsbury

(1996) advocated, in general, the use of institutional economics in studying organizational

differences and our research meets this request. This study advances the current theories of

corporate diversification by explicitly incorporating the importance of home country

environmental contexts and recognizing that different contexts embody diverse levels of

environmental munificence (Castrogiovanni, 1991; Dess & Beard, 1984). In this study, we define

munificence in terms of more tangible production factors, such as physical infrastructure,

available to firms (labeled factors) and less tangible institutional support, such as judiciary

efficiency, which facilitates transactions (labeled institutions). Firms draw on their home country

environments’ factors and institutions to help produce goods or services and to exchange inputs

and outputs with others. We reconceptualize various corporate diversification strategies as

strategic actions to facilitate the substitution or utilization of factors and institutions for

enhancing firms’ competitive advantages. Accordingly, we suggest that certain diversification

strategies are more likely to be associated with superior performance in certain home country

environments. By bringing home country environment to the foreground, this study extends the

corporate diversification literature by providing a fresh approach to understand various corporate

diversification strategies from a comparative country environmental perspective. Furthermore,

5

our study contributes to the corporate diversification literature by explaining the performance

implications of both product and international diversification strategies largely conceptualized

from an institutional economics perspective (North, 1990). More specifically, by juxtaposing

product and international diversification strategies, premised on a common set of rationales

within an integrative conceptual framework, our study seeks to provide an explanation for the

apparent “paradoxical” relationship between corporate diversification strategies and firm

performance across dissimilar home country environments (e.g., Geringer et al., 2000).

We tested our conceptual framework on a sample of firms from six Western European

countries. Western Europe represents a new setting for extending the knowledge of corporate

diversification beyond the traditional country environmental contexts. Although Western

European countries are, for the most part, developed countries, there are persistent, notable

variations in the degrees of economic success and socio-political developments among them,

allowing us to examine the hypothesized performance differences of diversification strategies

due to country-level environmental munificence dissimilarity. Also, focusing on Western Europe

minimizes a host of undue exogenous influences, such as regional economic shocks or remote

geographic locations that limit international diversification, thereby enabling us to interpret the

findings more clearly within the framework of country environmental context variation.

HOME COUNTRY ENVIRONMENTS

Over the decades, it has been widely accepted that differences in economic prosperity

between countries are largely attributable to differential amounts of production factors

(Hirschman, 1983). Institutional economists, most notably North (1990), contend that without

the institutions, or “the rules of the game,” that prescribe a country’s incentive structure and

economic specialization, complex inter-firm transactions would become too costly to complete

6

and business dealings would be restricted to known parties (Clague, 1997; Greif, 1993). North’s

(1990) approach, although sharing with Williamson’s (1975) perspective in the importance of

transactions, emphasizes the central role of the larger environment in constraining the relative

optimality of firms’ actions. Hirsch & Lounsbury state that North “conceived long-run economic

change as the accretion of innumerable short-run decisions by political and economic

entrepreneurs acting in an interested way, but whose individual choices reflect their subjective

modeling of the environment” (1996: 872). The environment’s opportunity set is determined by

production factors and institutions and firms seek to capture profitable opportunities defined by

the opportunity set (North, 1990). Because opportunity sets differ across countries, firm’s

optimal actions would accordingly diverge. In essence, an institutional economics perspective

recognizes that, in addition to the production factors traditionally emphasized in classical

economics, institutions represent important elements in influencing business activities (Clague,

1997; Eggertsson, 1990).

Premised on the insights from institutional economics, this study conceives home country

environments as consisting of factors and institutions. Factors are used to produce goods or

services (transformational activities) whereas institutions are for the exchange of inputs and

outputs with other firms (transactional activities). By and large, factors, which are comprised of

endowed, advanced, and human factors, are more tangible in nature. Endowed factors refer to the

endowments largely inherited from the natural environment. Countries that possess an abundant

supply of endowed factors are in a better position to create wealth. For example, in tracing the

industrial success of the United States, Wright (1990) highlights the importance of natural

resource abundance. Advanced factors generally refer to a country’s physical infrastructure,

capital goods accumulation, and financial resources. For example, the importance of physical

7

infrastructure is shown by Aschauer’s (1989) study that productivity decline of the United States

in the 1970s was precipitated by declining rates in infrastructure investments. Human factors

refer to labor quality such as the population’s education attainment. Human factors help generate

innovative ideas and facilitate a country’s absorptive capacity with regard to new product ideas

and are found to relate to a country’s economic growth (Barro, 1991).

On the other hand, institutions, which refer to political, legal, and societal institutions, are

less tangible. Political institutions are primarily related to the credibility and effectiveness of the

bureaucratic infrastructure (Bergara, Henisz, & Spiller, 1998) and represent the foundation for

business transactions. Legal institutions spell out the formal rules whereby business transactions

may take place. In addition, the effectiveness of legal enforcement, such as the existence of an

efficient judiciary system, is equally important. Adequate legal institutions enable firms to

engage in complex transactions with anonymous parties, thus facilitating production

specialization (Greif, 1993). Societal institutions generally refer to a country’s general level of

trust, cooperative norms, and its intensity of associational activities (Knack & Keefer, 1997). For

example, Grief’s (1993) study shows that societies with higher levels of trust have enhanced

impersonal business transactions. Cooperative norms constrain self-interested economic actors to

work for collective benefits (Knack & Keefer, 1997). A dense network of civic associations,

such as cultural groups, helps nurture trust and cooperation in the society and instill in the

participants “habits of cooperation, solidarity, and public-spiritedness” (Putnam, 1993: 89-90).

In many respects, our conceptualization of home country environments parallels that of the

environmental munificence literature (e.g., Castrogiovanni, 1991; Dess & Beard, 1984). The

environment has long been viewed as providing firms with means for growth and competition

(Thompson, 1967). While environments can be conceptualized in many ways, environmental

8

munificence is regarded as one of the most important aspects in explaining strategic behaviors

and outcomes (Castrogiovanni, 1991). Past studies in the munificence literature have found

environmental munificence as an important component influencing firm strategies and outcomes,

such as organizational structure, stakeholder satisfaction, organizational innovation, and

decision-making (e.g., Goll & Rasheed, 1997; Yasai-Ardekani, 1989). In focusing on the

capacity of factors and institutions at the macro environmental level, our study views

environmental munificence as the availability of crucial factors and institutions in the home

country environment. In this exploratory study, we maintain that the complex relationships

between diversification strategies and firm performance are critically determined by country-

level environmental munificence. In order to test our hypotheses in the least complicated way,

we distinguish only between more munificent and less munificent home country environments,

but not hybrid situations of more munificent factors but less munificent institutions and vice

versa. In the hypotheses that follow, we elaborate how the performance implications of firms’

diversification strategies are related to country-level environmental munificence.

HOME COUNTRY ENVIRONMENTS AND CORPORATE DIVERSIFICATION

Because the munificence level of home country environments differs, representing diverse

sets of opportunities and constraints for firms, the factors and institutions that firms need or can

utilize are likely to differ across such environments. Firms need factors and institutions for

successful competition. High levels of factors help upgrade firms’ value chains, thus expanding

the potential to achieve higher levels of transformational efficiency. In additional to production,

firms need to engage in business exchanges. High levels of institutions contribute to transactional

efficiency by allowing firms to conduct business with unfamiliar but more efficient parties

(Greif, 1993; North, 1990). Without sufficient institutions in place, firms would have to engage

9

in tedious transactional processes such as contract negotiation or dispute resolution. To a

significant extent, firms’ actions and success are thus determined by country-level environmental

munificence in factors and institutions. In low levels of environmental munificence, firms would

maintain a significant competitive advantage over their competitors by pursuing strategic actions

that enable them to substitute those factors and institutions that are lacking in the home country

environment. In high levels of environmental munificence, firms would benefit from pursuing

strategic actions that allow them to fully utilize the factors and institutions available in the home

country environment for improving their competitiveness. As a departure from the extant

literature, we contend that it is at this point where various corporate diversification strategies

come into play in different home country environmental contexts. We reconceptualize various

diversification strategies as different strategic actions to substitute or utilize factors and

institutions for competition, in response to the home country environment’s opportunity set.

Viewed in this light, home country environment constitutes a crucial context whereby firms that

adopt the appropriate diversification strategies would achieve superior performance.

We examine how home country environments may influence the performance implications of

various corporate diversification strategies (product, outbound international, and inbound

international). Product diversification refers to a firm’s diversification into more than one

product market. With respect to international diversification, outbound international

diversification and inbound international diversification are distinguished. Outbound

international diversification refers to a firm’s diversification into foreign environments, either by

itself or by allying with other firms. Firms also cooperate with foreign firms without operating in

another country. Inbound international diversification refers to a firm’s international cooperative

activities for improving its business operations or its competitiveness at home. In the hypotheses

10

that follow, we discuss the performance implications of various diversification strategies

between more munificent and less munificent home country environments.

Product Diversification

In more munificent home country environments, firms often enjoy a more abundant supply of

factors and institutions. Hence pursuing strategic actions to substitute factors and institutions is

much less beneficial. A healthy supply of institutions enables firms to enjoy specialization

benefits facilitated by the availability of market transaction mechanisms (Clague, 1997). For

example, adequate contract enforcement mechanisms increase firms’ willingness to deal with

efficient, albeit perhaps less familiar, transacting parties (Eggertsson, 1990). Well-developed

societal institutions such as cooperative norms and societal trust facilitate the ease of inter- and

intra-organizational cooperation (Putnam, 1993). Because firms are less concerned with

opportunistic behaviors, they are less restricted in the types and numbers of exchange partners,

thus allowing them to deal with the most efficient buyers or sellers (Greif, 1993). Efficient

capital allocation mechanisms, such as credit screening, are also in place to match capital owners

with efficient capital users. Stringent anti-trust enforcement and efficient government

bureaucracy promote fairer, more intense competition, ensuring a high degree of market

participation (Bergara et al., 1998; Knack & Keefer, 1997). Because abundant factors and

institutions provide firms with plenty of opportunities to constantly challenge one another’s

competitive positions and facilitate new market entry (Specht, 1992), giving rise to more intense

competition, firms are compelled to devote significant amounts of attention to increase product

competitiveness. As such, higher levels of product diversification, requiring managers to monitor

a wide variety of businesses, may deplete a substantial portion of managers’ information-

processing capacities, and, accordingly, represent a less desirable strategy (Hill & Hoskisson,

11

1987). Corporate governance mechanisms, which are likely to be more prevalent, also

discourage empire building and lead firms to be more focused (Walsh & Seward, 1990).

In this light, the critical success factors in these environments would largely hinge on a firm’s

ability to best utilize the factors and institutions that are more readily available. With competitive

success primarily a function of transformational efficiency, firms would find it particularly

beneficial to pursue lower levels of product diversification to stay focused and attain more

specialized product market expertise. Because the sources of competitive advantage in these

environments rest on continuous improvements in the value chain, specialized capabilities in

certain transformational activities, leading to patents or consumer loyalty, constitute significant

barriers to entry. In this light, lower levels of product diversification, which place great emphasis

on developing unique, critical capabilities, are likely to lead to higher levels of firm performance.

Hypothesis 1a: In more munificent home country environments, product diversification isnegatively related to firm performance.

In less munificent environments where factors and institutions are lacking, firms would find

it beneficial to pursue higher levels of product diversification to create substitutes for factors and

institutions. A diversified corporate structure can create substitutes for lack of factors in the

environment. For instance, internal financial economies may compensate for inadequate external

capital markets, by allocating funds among internal business units more efficiently (Hill &

Hoskisson, 1987). Besides, higher levels of product diversification increase a firm’s overall

attractiveness as a borrower. Due to higher degrees of information asymmetry and more costly

default resolution procedures in these environments, lenders are prone to transact with large,

diversified firms to lower default risks. Moreover, although talents generally are in shorter

supply in these environments, diversified firms, because of their reputation and business scope,

can attract more talents and develop robust internal labor markets to develop talents to their best

12

use among different types of businesses (Khanna & Palepu, 1997). Additionally, diversified

firms, because of their size and financial capability, can afford to build common facilities, such

as transportation networks, by spreading the high costs among their many business units.

The existence of a diversified corporate structure may also compensate for lower levels of

institutions in these environments. For example, opportunistic behaviors can be more efficiently

monitored and sanctioned by hierarchical authority (Williamson, 1975). Besides, frequent

business dealings within the diversified firm may elicit greater amounts of trust or cooperative

norms among sub-units (Gulati, 1995). By arranging corporate divisions to deal with one another

frequently, diversified firms can reduce transaction costs. Furthermore, the government in these

environments usually assumes a more active role in the economy. Facilitated by their scope and

influence in many sectors of the economy, diversified firms are more likely to foster close ties

with the government, allowing them to enjoy idiosyncratic state favors. Their unique, flexible

capabilities in establishing government relationships often are not tightly restricted to any

specific product market, thus allowing them to virtually “reproduce” themselves across many

different businesses (Whitley, Henderson, Czaban, & Lengyel, 1996). Rather than improving

transformational efficiency, these firms thus can extend their competitive advantages mainly by

erecting institutional barriers to entry across many product markets, such as changing “the rules

of the game” through lobbying (Hillman & Hitt, 1999). Accordingly, higher levels of product

diversification are likely to be associated with better performance in these environments.

Hypothesis 1b: In less munificent home country environments, product diversification ispositively related to firm performance.

Outbound International Diversification

Outbound international diversification has the potential to provide firms with a variety of

benefits. This diversification strategy allows a firm to leverage its capabilities across geographic

13

markets, maximizing monopolistic advantages. Instead of being solely dependent on its home

country, a firm can lower its overall risk exposure by operating in foreign countries (Kim,

Hwang, & Burgers, 1993). Moreover, outbound international diversification allows a firm to gain

additional scale or scope economies and accumulate valuable international experience for

additional expansion (Johanson & Vahlne, 1977), to share core competencies across

multinational operations, or to reconfigure its value chain more optimally (Porter, 1990).

Accordingly, past studies have generally found that outbound international diversification is

positively related to firm performance (e.g., Grant, 1987). In more munificent home country

environments, firms would find it particularly beneficial to fully utilize the factors and

institutions in the country environment by engaging in outbound international diversification. As

such, firms may rely on the skills gained in their country environments to develop superior

competitive advantages to operate in foreign markets. Besides, their competitive edge is

sharpened by intense rivalry and sophisticated demand at home (Porter, 1990). Abundant

institutions would enable firms to acquire or develop advanced knowledge while adequate

intellectual property protection safeguards firms from losing their unique skills, thus ensuring an

adequate “appropriability regime” to encourage innovation (Teece, 1986). The level of market

competition is also enhanced due to active enforcement of anti-trust regulations, resulting in “the

survival of the fittest.” Inefficient firms are more likely to be acquired by efficient ones through

an active external market for corporate control (Walsh & Seward, 1990). Building on a solid

home base, firms in these environments are likely to be potent global competitors (Porter, 1990).

Hypothesis 2a: In more munificent home country environments, outbound internationaldiversification is positively related to firm performance.

In less munificent environments, firms may still prefer to pursue higher levels of outbound

international diversification, either to realize better returns, seek foreign inputs, or simply to find

14

more favorable business locations. However, redeployment flexibility of firms’ competitive

advantages (Anand & Singh, 1997) determines if a firm may optimally transfer its skills and

capabilities across countries. Dominant firms in more munificent country environments can more

easily transfer their capabilities such as marketing skills or technologies to the international arena

(Porter, 1990). However, most firms in less munificent environments often lack globally

redeployable capabilities to successfully compete in foreign markets. For instance, insufficient

factors limit these firms’ ability to develop world-class technologies. Relatively lax anti-trust

enforcement implies that many product markets are dominated by less innovative incumbent

firms because challenges from new entrants are usually less severe and frequent. Dominant firms

are likely to compete largely based on institutional advantages, such as creating social ties with

the government or limiting entry through regulatory constraints (Hillman & Hitt, 1999).

Although these firms may be dominant at home, sometimes even with near-monopolistic status,

their institutionally based competitive advantages are in many respects localized in nature and

likely to dissipate in foreign countries. As such, outbound international diversification is unlikely

to lead to higher levels of performance in these environments and may even have detrimental

effects on performance as these firms are likely to be outcompeted in the global market.

Hypothesis 2b: In less munificent home country environments, outbound internationaldiversification is negatively related to firm performance.

Inbound International Diversification

The benefits of inbound international diversification are well recognized in the literature

(e.g., Contractor & Lorange, 1988). With better knowledge and technologies, multinational firms

may improve the productivity of host country firms (Blomstrom, Kokko, & Zejan, 2000). It is

often suggested that host countries’ primary gains from foreign firms come from skill or

technology spillovers to host country firms, which can result from personnel training by foreign

15

firms or simply observation by host country firms (Caves, 1996). By forming cooperative

ventures with foreign partners, host country firms would have better access to unique sets of

skills and capabilities for improving their competitive position. In return, host country firms may

contribute specific local knowledge or utilize social connections to help deal with local

distribution or government agencies. Furthermore, cooperative partners may share risks with

each other, especially when they need to reduce exposures to risky projects or to compete with

more powerful competitors. Despite the benefits of cooperation with foreign partners, research

has noted the associated hazards (e.g., Hitt, Tyler, Hardee, & Park, 1995; Inkpen & Beamish,

1997). Porter (1990) views international alliances as inherently unstable, involving significant

coordination costs, difficulty in aligning incongruent strategic goals, as well as the risk of

creating a new competitor. Likewise, Inkpen and Beamish (1997) suggest that because of shifts

in partners’ bargaining power, international joint ventures are hardly stable relationships. As

such, cooperation with partners from foreign countries may have inherent pitfalls.

Understood within the conceptual framework of this study, the relative costs and benefits of

inbound international diversification may depend on home country environments. In more

munificent home country environments, inbound international diversification is less likely to

yield superior benefits because a larger number of firms have access to factors to develop

capabilities that are superior, or at least compare favorably, to foreign firms. As such,

contributions by most foreign firms would generally be less valuable. Due to well-developed

institutions in the environment, firms may obtain the needed knowledge by conveniently

transacting or allying with many domestic firms, rather than engaging in complex collaborative

activities with less familiar foreign firms that may mainly look for host country guidance or even

have hidden strategic intents (Hitt et al., 1995). Firms would be better off, as well as incur less

16

risk, in focusing on utilizing the factors and institutions in their home country environments to

help them develop or obtain necessary skills and capabilities. On a relative basis, the increased

benefits may not be large enough to compensate for the significant costs of inbound international

diversification. Moreover, when the foreign firms possess competitive advantages that can

overcome the difficulty of competing in these environments, host partners’ local knowledge and

connections would be less attractive because existing institutions, such as efficient legal system,

would facilitate foreign entry. On the other hand, foreign firms that do not possess superior

capabilities would be quite cautious in allocating substantial investments entering these

munificent but highly competitive environments. Unless the host firms contribute substantial

assistance to their foreign partners, the cooperative ventures may not be very fruitful. To the

extent that managing these alliances or dealing with many foreign partners imposes a burden on

management or diverts managers’ attention away from intense domestic competition, as

evidenced by the joint venture between Dresser and Komatsu (Hitt et al., 1995), inbound

international diversification could even hurt performance.

Hypothesis 3a: In more munificent home country environments, inbound internationaldiversification is negatively related to firm performance.

On the other hand, firms in less munificent environments are likely to find inbound

international diversification particularly attractive. Foreign firms that possess superior

capabilities have the incentives and abilities to enter these environments to tap into local demand

or engage in export processing because host country firms, unmatched in competitive

capabilities, would find it difficult to mount meaningful defense (Caves, 1996). Despite their

potential advantages, foreign firms may still be hindered by a host of local hurdles, such as less

effective government bureaucracy, and at the same time compete with other potent foreign

entrants. It is beneficial for foreign firms to overcome the liability of foreignness by utilizing

17

local partners to avoid institutional barriers (Zaheer & Mosakowski, 1997). Local partners can

also help build up foreign firms’ first mover advantages to discourage other potential foreign

entrants or to influence local regulatory process to solidify their footholds (Sarkar, Cavusgil, &

Aulakh, 1999). This creates opportunities for local firms to attract collaboration with foreign

partners to compete with other domestic firms. As these local firms learn from their foreign

partners, their competitiveness is likely to gradually increase as well.

Although firms in these environments often lack the capabilities to exit from its environment

and pursue outbound international diversification, inbound international diversification

represents a “virtual” exit to ally with outside parties to acquire quality skills and technologies

(Hirschman, 1970). Through such access to more capable foreign partners, these firms are able to

substitute for the inadequacy in factors and institutions in their environments. In addition, firms

pursuing inbound international diversification may neutralize the threats from foreign entrants by

turning some of them into partners while at the same time, becoming better equipped to counter

the attacks from other competing foreign entrants. Although the difficulty of managing

international alliances still exists (Inkpen & Beamish, 1997), it is likely that the benefits would

outweigh the costs of inbound international diversification for firms in these environments.

Hypothesis 3b: In less munificent home country environments, inbound internationaldiversification is positively related to firm performance.

Interactions

To compete globally, firms need to have superior advantages that allow them to compensate

for operating in less familiar countries. In Dunning’s (1992) eclectic approach, the basic

condition for a firm to successfully expand overseas is the possession of ownership-specific

advantages. In more munificent home country environments, competition among firms is intense

because abundant supplies of factors and institutions allow a larger number of firms to compete

18

in the market. To compete in an intensely competitive marketplace, a firm must develop and

sustain its competitive advantages by continuously improving its products, meeting the challenge

of competitors, and satisfying high customer expectations (Porter, 1990). As argued earlier, to

develop competitive advantages in these more competitive environments, firms have to stay

focused on developing product market expertise. Over-diversification has negatively affected the

competitiveness of many U.S. firms in the past decades and resulted in a series of downscoping

efforts to focus on the firms’ core businesses (Hoskisson & Hitt, 1994). Accordingly, although

outbound international diversification is likely to increase firm performance in these

environments in general, higher levels of product diversification would negatively affect firms’

abilities to develop global competitive advantages.

Hypothesis 4a: In more munificent home country environments, the interaction betweenproduct diversification and outbound international diversification is negatively related tofirm performance.

Inbound international diversification is likely to be beneficial to firms in less munificent

environments because firms can draw on and learn from foreign partners’ expertise (e.g.,

Contractor & Lorange, 1988). Firms that are more diversified in these environments are also

hypothesized to achieve better performance as they have the abilities to create substitute

institutions and factors to facilitate their operations. In most cases, foreign partners would also

prefer to cooperate with these diversified firms because of their connection and influence in, as

well as market knowledge of, the environment (Zaheer & Mosakowski, 1997). To the extent that

diversified firms cooperate with foreign partners, their ability to dominate the market would

become even stronger. Often backed by the host government, these firms also possess the

bargaining power to request their foreign partners to transfer valuable knowledge or

technologies, further contributing to their competitiveness and hence performance. As such,

19

pursuing higher levels of inbound international diversification and product diversification is

likely to be particularly beneficial in these environments.

Hypothesis 4b: In less munificent home country environments, the interaction betweenproduct diversification and inbound international diversification is positively related tofirm performance.

METHODS

There were two stages in constructing the sample. The first stage determined a sample of

countries, from which a sample of firms was constructed in the second stage.

Country Sample

The country sample was drawn from Western European countries. To adequately measure

environmental munificence, we used a larger number of variables as compared to most previous

studies (see Table 1). Following similar procedures used by studies premised on institutional

economics arguments in the fields of management (e.g., Bergara et al., 1998), international

business (e.g., Meyer, 2001), and economics (e.g., Knack and Keefer, 1997), we first

standardized the variables and then summed and averaged them to proxy the three components of

factors (endowed factors, advanced factors, and human factors) and institutions (political

institutions, legal institutions, and societal institutions), respectively. Then an average of the two

sets of components was taken to obtain factors and institutions correspondingly. A great majority

of the variables were obtained from the World Competitiveness Report, supplemented with

additional sources, and dated in the early 1990s. If the same variable is available for the 1980s,

an average was taken. As for societal institutions, additional description is needed. We used 3

items in the World Values Surveys, obtained from the Inter-University Consortium for Political

and Social Research: These 3 items are widely used and validated in a number of previous

studies in the disciplines of sociology and economics (e.g., Curtis, Grabb, & Baer, 1992; Knack

& Keefer, 1997; La Porta, Lopez-de-Silanes, Shleifer, & Vishny, 1997a).

20

----- Insert Table 1 about here -----

To examine the groupings of 16 West European countries, we used a number of classification

procedures. Please see the Appendix for details and a validity analysis. More munificent home

country environments include Denmark, France, Germany, Netherlands, Norway, Sweden,

Switzerland, and U.K. Less munificent home country environments include Austria, Belgium,

Finland, Ireland, Italy, Portugal, Spain, and Turkey. In order to obtain more accurate data on

international diversification, we narrowed the sample size to three countries in each group. The

countries selected had to meet the following criteria: (1) availability in the Worldscope database;

(2) unambiguous group classification; and (3) different types of countries within the contexts. In

accordance with the first criterion, Turkey was eliminated. Austria, Belgium, and Finland were

also eliminated as their groupings were not totally unambiguous. Sweden, France, and U.K. were

selected for the first group (more munificent environments) and Ireland, Italy, and Portugal for

the second group (less munificent environments). Because the countries within each group differ

in other respects such as cultural heritage, thus minimizing possible confounding effects due to

systematic differences in other country variables, one can more confidently interpret the

empirical results within the conceptual framework of this study. In the first group, there is a

diverse mix of attributes such as location and cultural heritage. In the second group, Italy and

Portugal can be argued to differ less. However, the only other option is Spain, which is also a

Southern European country, sharing Latin cultural heritage with Italy and Portugal. Finally, these

two groups of countries rendered an adequate firm sample size to test the hypotheses.

Firm Sample

Firms covered in the 1999 Worldscope database were used for the initial sample. For France

and U.K., the initial sample was constructed on the largest 300 firms ranked by sales. Financial

21

statement data were collected from Worldscope November CDs of 1996 to 1999. We used a

three-year average for the financial variables to avoid annual fluctuations in the accounting data.

Geringer et al (2000) suggest in their diversification study that a one-year lag is most appropriate

for reflecting a typical planning cycle. Therefore, our study also had a one-year lag between the

independent and control variables and the dependent variables. The total number of firms in the

final base sample is 722. For more munificent environments, the base sample contains 499 firms

(France: 177; Sweden: 115; UK: 207). For less munificent environments, the base sample

contains 223 firms (Ireland: 40; Italy: 133; Portugal: 50).

Operationalization of Variables

Performance. Returns on assets (ROA) was used as firm performance measure in the current

study. In addition, we also used earnings before interest and taxes divided by assets (EBIT) as an

indicator of firm performance. Because taxation rules as well as capital structure are likely to

differ among countries, EBIT can be considered to be a useful performance measure in cross-

country studies. The use of accounting-based performance measures facilitates comparing results

with most previous diversification studies (e.g., Hitt et al., 1997). Although market-based

performance measures may indicate the stock market’s perception of future performance, their

use is premised on the assumption of stock market efficiency, which is likely to differ between

more munificent and less munificent environments, and thus are less appropriate for our study.

Product diversification. Because many firms do not have segment revenues consistently

reported in Worldscope, the entropy measure of diversification could not be calculated. Because

Worldscope lists each firm’s 4-digit Standard Industry Classification (SIC) codes in order of

revenues (with a maximum of 5 SIC codes), following Gedajlovic and Shapiro (1998), we used

the imputed weighted diversification measure to calculate a firm’s level of product

22

diversification. Gedajlovic and Shapiro (1998) found a high correlation between the weighted

measure and the Herfindahl based measure (0.84) and the simple count measure (0.80),

respectively. Following these studies, this diversification measure was calculated as follows:

Degree of Diversification = Σ Pi * dij

where i = a firm’s primary market segmentj = a firm’s secondary market

dij = 0 if the firm operates in only one 4-digit industry = 1 if j is in the same 3-digit industry as i = 2 if j is in the same 2-digit industry as i

= 3 if i and j are in different 2-digit industries Pi = a weight imputed to each industry, assumed to decline geometrically.

Outbound international diversification. Because many firms do not have country or regional

segment revenues consistently reported in Worldscope, an entropy measure could not be

calculated. Some researchers use the total number of foreign countries where the firm had

subsidiaries or the total number of foreign subsidiaries as a proxy for outbound international

diversification (Barkema & Vermeulen, 1998). We used the number of foreign countries where

the firm had subsidiaries or cooperative ventures as the proxy for the level of outbound

international diversification, as joint ventures/strategic alliances have become increasingly

prevalent. The data were collected from Moody’s International Manual and Lexis-Nexis.

Inbound international diversification. Analogous to outbound international diversification,

the number of countries, as represented by the foreign partners of the firm’s cooperative

ventures, was recorded. We used Lexis-Nexis and Moody’s International Manual to search for

cooperative ventures for each firm in the sample. We ran a correlation test between a country

count measure and a cooperative venture count measure for Sweden and Ireland, respectively.

The correlations are 0.895 (p < .0001) for Sweden and 0.903 (p < .0001) for Ireland. The results

indicate that there is a high correlation between the two measures.

23

Control variables. Leverage was measured as total liabilities over total sales. We used total

sales as the denominator to avoid artificial correlations with the dependent variables, ROA and

EBIT. Sales growth was used to capture demand conditions facing a firm as well as product

cycle effects because firms operating in high-growth industries are likely to enjoy higher levels

of performance (Gedajlovic & Shapiro, 1998). It is measured as a percentage change in annual

sales. Because blockholders are especially prevalent among Western European firms, we used

the number of owners who had 5% or more ownership in the firm to control for the effects of

blockholders. Firm size was used to control for scale economies and captured by total sales in

U.S. dollars (logarithm). We used a 3-year average exchange rate to avoid artificial firm size

differences that may result from significant changes in exchange rates in one particular year.

Because performance may be influenced by diversification mode (Hitt et al., 1997), we

controlled for acquisition amounts (logarithm). The numbers were converted to U.S. dollars in

the same way as that for total sales. Using dummy variables, industry effects were controlled for

the six industry classes classified by Worldscope: industrial, transportation, banking, utility,

insurance, and other financial, with industrial as the reference group in the statistical models.

Worldscope’s classification is based on the firm’s primary business activity. In addition, a firm’s

performance may be influenced by systematic differences between individual countries (e.g.,

Thomsen and Pedersen, 2000). Accordingly, we used two sets of dummy variables to control for

such country effects, one for more munificent and one for less munificent countries.

RESULTS

Each model was tested using OLS regression. The means, standard deviations, and

intercorrleations for the variables used for the two groups of country environments are separately

presented in Table 2. There was no multicollinearity problem because no variance inflation

24

factor is greater than 10 and the mean of all the variance inflation factors was not considerably

larger than 1 (Chatterjee & Price, 1991). The standard errors reported below are

heteroscedasticity-consistent White’s (1980) standard errors.

----- Insert Table 2 about here -----

As Hypothesis 1a predicted, in more munificent environments, there is a statistically

significant negative relationship between product diversification and performance (p < .05 for

ROA and EBIT - see Models A and B in Table 3). As Models C and D in Table 3 show, product

diversification is positively related to performance (p < .05 for ROA and EBIT) in less

munificent environments (Hypothesis 1b). Hence, both Hypothesis 1a and Hypothesis 1b are

supported. As shown in Models A and B in Table 3, the coefficients of outbound international

diversification are positive and statistically significant (p < .10 for ROA; p < .01 for EBIT).

Hypothesis 2a is supported. These results suggest that firms in more munificent environments are

able to reap higher levels of performance when they engage in foreign operations. Hypothesis 2b

states that there is a negative relationship between outbound international diversification and

performance in less munificent environments. The coefficients of outbound international

diversification in both models, as reported in Models C and D in Table 3, are statistically not

significant. Hypothesis 2b is not supported. The coefficient of inbound international

diversification in Model A in Table 3 (for ROA) is statistically not significant but is statistically

significant in Model B (p < .10 for EBIT). Accordingly, Hypothesis 3a, which predicted a

negative relationship between inbound international diversification and performance in more

munificent environments, is partially supported. Hypothesis 3b states that inbound international

diversification is positively related to performance in less munificent environments. However,

the statistical results, as shown in Models C and D in Table 3, do not support Hypothesis 3b.

25

----- Insert Table 3 about here -----

With respect to the hypothesized interactions, the main effects that were used to form the

product terms in all the regression models presented below were centered (Aiken & West, 1991)

and the centered main effects were then used to form the product terms. Accordingly, variance

inflation factors indicated no problem of multicollinearity. The product terms (product

diversification X outbound international diversification), as presented in Models A and B in

Table 4, are statistically significant and negative (p < .05 for ROA; p < .01 for EBIT).

Hypothesis 4a, which states that in more munificent environments, there is a negative

relationship between performance and the interaction between product diversification and

outbound international diversification, is therefore supported. Hypothesis 4b states that in less

munificent environments, the interaction between product diversification and inbound

international diversification is positive. The product terms (product diversification X inbound

international diversification) reported in Models C and D in Table 4 are statistically significant

and positive (p < .01 for ROA and EBIT). Therefore, Hypothesis 4b is also supported.

----- Insert Table 4 about here -----

DISCUSSION

By and large, the empirical results lend support to the central proposition of this study that

home country environment is an important component in the study of corporate diversification.

As predicted, product diversification was negatively related to performance in more munificent

environments but positively related to performance in less munificent environments. The results

suggest that the negative effects found in prior United States sample studies may be largely

conditioned by the country environmental context. In regard to outbound international

diversification, firms in more munificent environments improve performance when they

26

diversify internationally. However, for firms in less munificent environments, although outbound

international diversification does not hurt performance, it does not provide substantial benefits

because most firms in these environments lack global competitiveness. As for inbound

international diversification, the results indicate that such a strategy may not always be

beneficial, as often expected, because the associated costs may nullify the possible benefits. For

less munificent environments, our results may suggest that the benefits of inbound international

diversification are difficult to realize than is commonly assumed. Furthermore, we hypothesized

and found that high product diversified firms in less munificent environments reap more benefits

from inbound international diversification. The overall results imply that the benefits of this

strategy seem to be limited to high product diversified firms, which usually are more dominant

and influential in these environments. We also found that high product diversified firms in more

munificent environments perform worse when they diversify internationally. Our overall

findings indicate that focused firms in these environments enjoy the benefits of outbound

international diversification whereas high product diversified firms suffer from such a strategy.

Lacking superior product market capabilities, high product diversified firms would find it

difficult to compete globally.

The empirical results held for a number of robust checks and alternative specifications. In

particular, we used the number of 2 digit SIC codes as a proxy for unrelated product

diversification and the results were consistent. Some studies have found that moderate levels of

product diversification generate more benefits, but other findings are mixed (e.g., Lubatkin,

1987). We tested for a symmetrical- or inverted U-shaped relationship for more munificent

environments but no such relationship was found. Firms may not easily realize the benefits

unless there is complementary internal control mechanism or managerial information capacity

27

(Hill & Hoskisson, 1987; Jones & Hill, 1988). Similarly, no symmetrical- or U-shaped

relationship was found for less munificent environments. We used the number of regions, instead

of countries, as a proxy for outbound international diversification and the results were generally

consistent. We also tested but did not find the presence of a curvilinear relationship between

outbound international diversification and performance. We examined if the interaction between

product and outbound international diversification would alleviate the negative impact of product

diversification, but similar to Tallman and Li’s (1996) findings, no significant effect was

detected. This outcome lends additional support to our finding that high levels of product

diversification in more munificent environments are harmful to firms’ global competitiveness.

Links with Extant Literature

Past literature in corporate diversification has paid insufficient attention to how home country

environments are related to corporate diversification. Instead of relying on fragmented

knowledge based on each individual country and possibly reaching incomplete or sometimes

even inappropriate conclusions, we adopted a comparative approach in this exploratory study

examining if the relationships between diversification strategies and performance are linked to

home country environmental contexts. The empirical findings provide support for our study’s

central proposition. Premised on the insights of institutional economics that business activities

are contingent on the levels of a country’s factors and institutions, our approach explicitly

incorporates the home country environmental context in the study of corporate diversification,

hence providing a valuable reference point for research from a cross-country perspective.

Furthermore, our study contributes to the corporate diversification literature by developing a

common set of rationales to explain the performance implications of both product and

international diversification strategies. This signifies that product and international

28

diversification strategies can be understood as strategic actions to substitute or utilize countries’

factors and institutions. In addition to the findings that various diversification strategies have

heterogeneous performance implications between dissimilar home country environments, we

hypothesized and found clear evidence that highly product diversified firms in more munificent

environments do not seem able to develop world-class competitiveness and their performance

suffers as a result of global operations. On the other hand, not all firms in less munificent

environments reap the benefits of inbound international diversification. Our study indicates that

only powerful, diversified firms may capture such benefits. In this regard, our study, by adopting

a cross-country, integrative perspective, was able to uncover the complex but important linkage

between product and international diversification strategies. Future research is likely to benefit

from continuing in this direction. Additionally, this study also broadens the geographic scope in

the study of diversification beyond the more traditional settings such as the United States or

Japan. However, instead of replicating past findings on new empirical settings, we adopt an

institutional economics perspective and build on extant arguments in the diversification literature

to suggest a fresh conceptual approach to study corporate diversification, one emphasizing the

significance of the home country environmental context. The explicit incorporation of the home

country environmental context, although introducing increased complexity into our received

knowledge in corporate diversification, is an important addition to the literature.

In a related vein, the perspective adopted here is broadly in line with some recent suggestions

in the resource-based literature that external, contextual factors are important in determining the

relevance or productivity of firms’ resources (e.g., Miller & Shamsie, 1996). As such, the

distinction of contextual environments based on the concept of munificence (Castrogiovanni,

1991) may hold promise for research, from the resource-based view, investigating how internal

29

firm resource development may be conditioned by environmental munificence. Accordingly, this

study may have implications for research on the resource-based view examining if the value of

firm-level resources may to a certain extent be externally determined (Priem & Butler, 2001).

Limitations and Suggestions for Future Research

Although our focus in this study is exploratory in nature, we found significant performance

differences among diversification strategies between dissimilar home country environments.

Future studies may investigate additional classifications of country environments to advance our

knowledge in this area. For instance, research on hybrid country environments with abundant

factors but inadequate institutions or vice versa would be interesting extensions. Additional

studies can explore if different kinds of factors and institutions would provide complementary or

conflicting influence upon one another. Such an examination can further illuminate how complex

country environmental variables influence the relationships between diversification strategies

and performance. Moreover, although Western Europe represents an appropriate testing ground

for this study, future studies would find it fruitful to extend the arguments developed in this

study to other parts of the world where more potential contrast between country environments

may exist. Our study primarily explored how country-level environmental munificence affects

the performance outcomes of diversification strategies. Future research might attempt to unravel

how specific factors and/or institutions influence firm strategies and performance. Furthermore,

we used broader proxy measures to capture the munificence level of the macro-environments.

Although the country-level measures used in our study are more comprehensive than prior

studies in this area, finer-grained measures will be able to more fully capture these country-level

variables, as well as to shed additional light on their direct influence. Moreover, future efforts in

creating an index on factors and institutions for a large number of countries, thus allowing the

30

use of additional statistical methods such as factor analysis, would be beneficial for the further

development of this line of research. Following most prior diversification studies, we used

dummies to control for industry effects. However, industry dummies may not fully partial out

industry effects as many firms operate in multiple industries. Future studies on business-level

strategies, focusing on single-business firms, would be able to address this aspect. Although our

study controlled for the effects of blockholders, prior studies (e.g., Thomsen and Pedersen, 2000)

found that ownership types affect performance differentially. Future research may benefit by

further teasing out the individual effects of various types of ownership.

Accordingly, our approach may have a potential link to the topic of international corporate

governance. Market-based governance structures help ensure firm efficiency by allowing a

separation of ownership and management. Adequate institutions, such as well-developed control

mechanisms, in more munificent environments may allow firms to transact with the most

efficient counterparts. Non market-based governance structures, such as family ownership, may

exist in response to low levels of environmental munificence. In further developing our

approach, future research on international corporate governance may build an integrated

conceptual framework for explaining the co-existence of different forms of governance

structures across home country environments. Another fruitful extension is to integrate our

approach with other macro-environmental frameworks, such as Murtha and Lenway’s (1994)

taxonomy of national systems of interest intermediation, and further examine the performance

implications of diversification strategies. This may broaden our approach’s theoretical scope to

explain the strategic behaviors of international entrants and cooperative partners.

Our approach may also improve understanding regarding the topic of international entry.

Previous literature in this area has largely focused on nationality or cultural symmetry as a key

31

country-level determinant of international entry decision (e.g., Kogut & Singh, 1988). Our

approach suggests that the matching of country environmental characteristics may also represent

a crucial element. For example, firms from countries with unstable political institutions but

abundant factors may have the incentives and abilities to enter environments where inward

foreign investments are particularly welcome. Such a matching of factors and institutions may

thus represent another important consideration in future international entry research.

Furthermore, research on corporate innovation and entrepreneurship may find our approach

useful. For example, in less munificent environments, firms may find it risky to develop core

competencies based on product innovation because appropriability regime is weaker (Teece,

1986). Moreover, human capital may be swayed to choose rent-seeking occupations, such as in

government bureaucracy or military, instead of pursuing entrepreneurial activities (Murphy,

Shleifer, & Vishny, 1991). Without adequate factors and institutions that foster innovative start-

ups, incumbent firms would dominate the business topography. As our research shows, although

these incumbent firms are dominant in less munificent environments, many of them are unlikely

to be potent global competitors. Despite intense competition in more munificent environments,

firms in these environments are more likely to be world-class companies. In this light, the theory

and evidence of this study may have important implications for corporate innovation and

entrepreneurship, particularly from a cross-country, comparative perspective.

In summary, we suggested and found that the relationships between corporate diversification

strategies and firm performance differ between home country environments. Our study highlights

the crucial importance of incorporating the home country environment into the study of

corporate diversification, and possibly in other strategy topics as well. Given the potential

32

importance of the conceptual approach developed in this study, further theoretical advancement

and empirical studies using this approach are likely to be fruitful.

REFERENCES

Aiken, L. S., & West, S. G. 1991. Multiple regression: Testing and interpreting interactions.

Newbury Park, CA: Sage.

Anand, J., & Singh, H. 1997. Asset redeployment, acquisitions and corporate strategy in

declining industries. Strategic Management Journal, 18: 99-118.

Aschauer, D.A. 1989. Is public expenditure productive? Journal of Monetary Economics, 23:

177-200.

Barkema, H.G. & Vermeulen, F. 1998. International expansion through startup or acquisition: A

learning perspective. Academy of Management Journal, 41: 7-26.

Barro, R. 1991. Economic growth in a cross-section of countries. Quarterly Journal of

Economics: 407-444.

Bergara, M.E., Henisz, W.J., & Spiller, P.T. 1998. Political institutions and electric utility

investment: A cross-nation analysis. California Management Review, 40: 18-35.

Blomstrom, M, Kokko, A., & Zejan, M. 2000. Foreign direct investment: Firm and host

country strategies. New York: St. Martin Press.

Castrogiovanni, G. J. 1991. Environmental munificence: A theoretical assessment. Academy of

Management Review, 16: 542-565.

Caves, R.E. 1996. Multinational enterprise and economic analysis (2nd ed.). Cambridge,

England: Cambridge University Press.

Chatterjee, S., & Price, B. 1991. Regression analysis by example (2nd ed.). New York: John

Wiley & Sons.

33

Clague, C. 1997. Introduction. In C. Clague (Ed.), Institutions and economic development:

Growth and governance in less-developed and post-socialist countries. Baltimore, MD:

Johns Hopkins University Press.

Contractor, F.J., & Lorange, P. 1988. Why should firms cooperate: The strategy and economics

basis for cooperative ventures. In F. Contractor and P. Lorange (Eds.), Cooperative strategic

in international business: 3-30. Lexington, MA: Lexington Books.

Curtis, J.E., Grabb, E.G., & Baer, D.E. 1992. Voluntary association membership in fifteen

countries: a comparative analysis. American Sociological Review, 57: 139-152.

Dess, G. G., & Beard, D. W. 1984. Dimensions of organizational task environments.

Administrative Science Quarterly, 29: 52-73.

Dunning, J.H. 1992. Multinational enterprises and the global economy. Reading, MA:

Addison-Wesley.

Eggertsson, T. 1990. Economic Behavior and Institutions. Cambridge: Cambridge University

Press.

Gedajlovic, E. & Shapiro, D.M. 1998. Management and ownership effects: Evidence from five

countries. Strategic Management Journal, 19: 533-553.

Geringer, J.M., Beamish, P.W., & daCosta, R.C. 1989. Diversification strategy and

internationalization; Implications for MNE performance. Strategic Management Journal,

10: 109-119.

Geringer, J.M., & Tallman, S., & Olsen, D.M. 2000. Product and international diversification

among Japanese multinational firms. Strategic Management Journal, 21: 51-80.

Goll, I., & Rasheed, M. 1997. Rational decision-making and firm performance: The moderating

role of environment. Strategic Management Journal, 18, 583-591.

34

Gould, D.M. & Gruben, W.C. 1996. The role of intellectual property rights in economic growth.

Journal of Development Economics, 48: 323-350.

Grant, R.M. 1987. Multinationality and performance among British manufacturing companies.

Journal of International Business Studies, 22: 249-263.

Greif, A. 1993. Contract enforceability and economic institutions in early trade: The Maghribi

traders coalitions. American Economic Review, 83: 525-548.

Gulati, R. 1995. Does familiarity breed trust? The implications of repeated ties for contractual

choices in alliances. Academy of Management Journal, 38: 85-112.

Hill, C.W.L., & Hoskisson, R.E. 1987. Strategy and structure in the multiproduct firm. Academy

of Management Review, 12: 331-341.

Hillman, A.J., & Hitt, M.A. 1999. Corporate political strategy formulation: A model of approach,

participation, and strategy decisions. Academy of Management Review, 24: 825-842.

Hirsch, P.M., & Lounsbury, M.D. 1996. Rediscovering volition: The institutional economics of

Douglas C. North. Academy of Management Review, 21: 872-884.

Hirschman, A.O. 1970. Exit, voice and loyalty. Cambridge, MA: Harvard University Press.

Hirschman, A.O. 1983. Essays in trespassing: Economics to politics and beyond. Cambridge,

England: Cambridge University Press.

Hitt, M.A., Hoskisson, R.E., & Kim, H. 1997. International diversification: Effects on the

innovation and firm performance in product-diversified firm. Academy of Management

Journal, 40: 767-798.

Hitt, M.A., Tyler, B.B., Hardee, C., & Park, D. 1995. Understanding strategic intent in the global

marketplace. Academy of Management Executive, 9: 12-19.

Hoskisson, R.E., & Hitt, M.A. 1990. Antecedents and performance outcomes of diversification:

A review and critique of theoretical performance. Journal of Management, 16: 461-509.

35

Hoskisson, R.E., & Hitt, M.A. 1994. Downscoping: How to tame the diversified firm.

New York: Oxford University Press.

Hubbard, R.G, & Palia, D. 1999. A reexamination of the conglomerate merger wave in the

1960s: An internal capital markets view. Journal of Finance, 54: 1131-1152.

Inkpen, A.C. & Beamish, P.W. 1997. Knowledge, bargaining power, and the instability of

international joint ventures. Academy of Management Review, 22: 177-202.

Johanson, J. & Vahlne, J. 1977. The internationalization process of the firm: A model of

knowledge development and increasing foreign commitments. Journal of International

Business Studies, 8: 23-32.

Jones, G.R., & Hill, C.W.L. 1988. Transaction cost analysis of strategy-structure choice.

Strategic Management Journal, 9: 159-172.

Khanna, T, & Palepu, K. 1997. Why focused strategies may be wrong for emerging markets.

Harvard Business Review, 75: 3-10.

Kim, W.C., Hwang, P., & Burgers, W.P. 1993. Multinationals’ diversification and the risk-return

trade-off. Strategic Management Journal, 14: 275-286.

Knack, S., & Keefer, P. 1997. Does social capital have an economic payoff: A cross-country

investigation. Quarterly Journal of Economics, 112: 1251-1288.

Kogut, B., & Singh, H. 1989. The effects of national culture on the choice of entry mode.

Journal of International Business Studies, 19: 411-432.

La Porta, R., Lopez-de-Silanes, F., Shleifer, A., & Vishny, R.W. 1997a. Trust in large

organizations. American Economic Review Papers and Proceedings: 333-338.

La Porta, R., Lopez-de-Silanes, F., Shleifer, A., & Vishny, R.W. 1997b. Legal determinants of

external finance. Journal of Finance, 52: 1131-1150.

36

La Porta, R., Lopez-de-Silanes, F., Shleifer, A., & Vishny, R.W. 1998. Law and finance. Journal

of Political Economy, 106: 1113-1154.

Lubatkin, M. 1987. Merger strategies and stockholder value. Strategic Management Journal, 8:

39-53.

Malos, S.B. & Campion, M.A. 2000. Human resource strategy and career mobility in

professional service firms: A test of an options-based model. Academy of Management

Journal, 43: 749-760.

Markides. C.C. 1992. Consequences of corporate refocusing: Ex ante evidence. Academy of

Management Journal, 35: 398-412.

Meyer, K.E. 2001. Institutions, transaction costs, and entry mode choice in Eastern Europe.

Journal of International Business Studies, 32: 357-367.

Miller, D., & Shamsie, J. 1996. The resource-based view of the firm in two environments: The

Hollywood film studios from 1936-1965. Academy of Management Journal, 39:519-543.

Murphy, K.M., Shleifer, A., & Vishny, R.W. 1991. The allocation of talent: Implications for

growth. Quarterly Journal of Economics, 106: 503-530.

Murtha, T.P., & Lenway, S.A. 1994. Country capabilities and the strategic state: How national

political institutions affect multinational corporations’ strategies. Strategic Management

Journal, 15: 113-129.

North, D.C. 1990. Institutions, institutional change and economic performance. New York:

Cambridge University Press.

Porter, M.E. 1990. The competitive advantage of nations. New York: Free Press.

Priem, R.L., & Butler, J.E. 2001. Is the resource-based “view” a useful perspective for strategic

management research? Academy of Management Review, 26: 22-40.

37

Putnam, R.D. 1993. Making democracy work: Civic traditions in modern Italy. Princeton, New

Jersey: Princeton University Press.

Sarkar, M.B., Cavusgil, S.T., & Aulakh, P.S. 1999. International expansion of

telecommunication carriers: The influence of market structure, network characteristics, and

entry imperfections. Journal of International Business Studies, 30: 361-382.

Specht, P.H. 1992. Munificence and carrying capacity of the environment and organization

formation. Entrepreneurship: Theory & Practice, 17: 77-86.

Tallman, S., & Li, J. 1996. Effects of international diversity and product diversity on the

performance of multinational firms. Academy of Management Journal, 39: 179-196.

Tallman, S.B. & Shenkar, O. 1990. International cooperative venture strategies: Outward

investment and small firms from NICs. Management International Review, 30: 299-315.

Teece, D.J. 1986. Profiting from technological innovation: Implications for integration,

collaboration, licensing and public policy. Research Policy, 15: 785-805.

Thompson, J.D. 1967. Organizations in action. New York: McGraw-Hill.

Thomsen, S., & Pedersen, T. 2000. Ownership structure and economic performance in the largest

European companies. Strategic Management Journal, 21: 2000.

Walsh, J.P., & Seward, J.K. 1990. On the efficiency of internal and external corporate control

mechanisms, Academy of Management Review, 15: 421-458

White, H. 1980. A heteroscedasticity-consistent covariance matrix estimator and a direct test for

heteroscedasticity. Econometrica, 48: 817-838.

Whitley, R., Henderson, J., Czaban, L, & Lengyel, G. 1996. Trust and contractual relations in an

emerging capitalist economy: The changing trading relationships of ten large Hungarian

enterprises. Organization Studies, 17: 397-420.

Williamson, O.E. 1975. Markets and hierarchies. New York: Free Press.

38

Wright, G. 1990. The origins of American industrial success, 1879-1940. American Economic

Review, 80: 651-668.

Yasai-Ardekani, M. 1989. Effects of environmental scarcity and munificence on the relationship

of context to organizational structure. Academy of Management Journal, 32: 131-156.

Zaheer, S., & Mosakowski, E. 1997. The dynamics of the liability of foreignness: A global

study of survival in financial services. Strategic Management Journal, 18: 439-464.

TABLE 1Country Environment Variables Used for Country Classification

Components Variables Data SourcesFactors Endowed

Factorsnatural resources; active labor supply (laborforce + urban population); energy sources(coal + oil + gas)

World CompetitivenessReport; United Nations data

AdvancedFactors

capital & technology investments (machinery& equipment investments + research &development expenditures); capital market(stock market + debt market + venture capitalmarket); physical infrastructure (roads + airtransport + railroads + port access +telecommunications + distribution systems +power)

World CompetitivenessReport; United Nations data;La Porta et al (1997b)

HumanFactors

education enrollment (secondary education +higher education); education quality (teacher-pupil ratio); research & developmentpersonnel

World CompetitivenessReport; United Nations data

Institutions PoliticalInstitutions

political transparency; fiscal policy (inflation+ government debt); bureaucratic corruption

World CompetitivenessReport; International CountryRisk Guide (c.f., La Porta etal., 1998)

LegalInstitutions

rule of law tradition; legal development(antitrust regulation + intellectual propertyprotection); judiciary system efficiency

World CompetitivenessReport; International CountryRisk Guide (c.f., La Porta etal., 1998); Gould & Gruben(1996)

SocietalInstitutions

society general trust; civic norms ofcooperation; associational intensity

World Values Survey

39

TABLE 2Descriptive Statistics and Correlations

More Munificent Home Country EnvironmentsMean S.D.1 N2 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16

1 ROA 0.04 0.05 498 2 EBIT 0.08 0.06 490 .93 3 France 0.35 0.47 499 -.36 -.35 4 Sweden 0.23 0.42 499 .09 .04 -.40 5 Transportation 0.05 0.22 499 -.09 -.08 -.01 .07 6 Banking 0.04 0.20 499 .09 .09 -.08 -.03 -.04 7 Utility 0.07 0.26 499 -.19 -.26 .14 -.08 -.06 -.05 8 Insurance 0.02 0.15 499 -.08 -.11 .02 -.02 -.03 -.03 -.04 9 Other Financial 0.05 0.22 499 .03 .02 -.09 .21 -.05 -.04 -.06 -.0310 Firm Size 14.49 1.83 499 -.13 -.16 .17 -.33 -.02 .13 .46 .23 -.1211 Leverage 3.84 42.16 499 .00 -.00 -.02 .07 .19 -.01 .05 .00 .00 .0312 Sales Growth 15.23 66.83 499 -.07 -.05 -.07 .04 .06 -.01 -.03 .01 -.00 -.01 -.0413 Blockholders 1.68 1.29 499 .00 -.01 -.16 .37 .00 -.12 -.15 -.09 .11 -.37 .03 .0014 Acquisition 4.93 5.51 499 .29 .32 -.54 -.18 -.07 .14 -.14 -.03 -.12 .11 -.05 -.04 -.1115 Product Diversification 1.03 0.41 499 -.05 -.05 .09 -.06 .02 .06 -.26 .00 -.10 .01 .00 -.12 .01 .0016 Inbound International Diversification 0.59 1.24 499 .01 .00 -.04 -.07 .00 .23 .04 -.05 -.09 .34 .11 -.03 -.10 .19 -.0117 Outbound International Diversification 9.64 12.62 499 .05 .06 .02 -.03 -.03 -.02 -.00 -.04 -.14 .35 -.01 -.07 -.07 .18 .05 .29

Correlations >= .09 or <= -.09 are significant at p < .05.

Less Munificent Home Country EnvironmentsMean S.D.1 N2 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16

1 ROA 0.02 0.04 223 2 EBIT 0.06 0.05 210 .91 3 Ireland 0.18 0.38 223 .13 .04 4 Portugal 0.22 0.42 223 .03 .01 -.25 5 Transportation 0.02 0.13 223 -.05 -.06 .02 .00 6 Banking 0.04 0.19 223 .10 .15 -.09 -.04 -.02 7 Utility 0.19 0.40 223 -.20 -.29 -.13 -.01 -.06 -.09 8 Insurance 0.05 0.22 223 -.05 -.15 .00 -.07 -.03 -.04 -.11 9 Other Financial 0.04 0.21 223 -.15 -.08 -.04 -.06 -.02 -.04 -.10 -.0410 Firm Size 13.59 2.23 223 -.10 -.09 -.19 -.32 -.07 .03 .50 .18 -.0611 Leverage 3.93 13.72 223 -.24 -.21 -.05 -.04 -.01 -.03 .19 -.02 .32 .0612 Sales Growth 25.72 139.86 223 -.02 -.02 .00 -.02 -.02 -.02 -.03 -.00 .33 .01 .0013 Blockholders 1.22 1.53 223 .14 .10 .65 .07 -.03 -.07 -.09 -.01 -.00 -.29 -.06 .0014 Acquisition 1.85 3.87 223 .22 .20 .62 -.07 -.06 -.09 .05 -.01 -.10 .00 -.03 -.00 .4215 Product Diversification 0.99 0.42 223 .12 .14 .00 -.37 .02 .01 -.14 .01 -.00 .18 -.06 .02 -.22 -.0516 Inbound International Diversification 0.68 1.53 223 .03 .08 -.11 -.03 .02 .06 -.04 -.02 -.08 .32 -.04 -.04 -.13 -.01 .0917 Outbound International Diversification 4.13 6.96 223 .06 .15 .02 -.18 -.07 .01 -.11 -.01 -.11 .36 -.08 -.04 -.05 .16 .10 .68

Correlations >= .13 or <= -.13 are significant at p < .05.

1 standard deviation2 number of observations

U.K. is the country reference group for more munificent home country environments and Italy is the country reference group for less munificent home country environments.Industrial is the industry class reference group.Due to missing data on the two dependent variables (ROA and EBIT), the number of observations in the empirical models is slightly different from the base samples.

40

TABLE 3Main Effects

More Munificent Less Munificent Home Country Environments Home Country Environments

Model A Model B Model C Model DDependent Variable ROA EBIT ROA EBIT

ProductDiversification

-0.010*(0.005)

-0.015*(0.007)

0.014*(0.007)

0.018*(0.009)

Outbound InternationalDiversification

0.3 X 10-3+

(0.2 X 10-3) 0.5 X 10-3**(0.2 X 10-3)

0.3 X 10-3

(0.4 X 10-3) 0.1 X 10-3

(0.5 X 10-3)Inbound InternationalDiversification

-0.002(0.002)

-0.003+

(0.002) 0.9 X 10-3

(0.002)-0.6 X 10-3

(0.002)Leverage 0.4 X 10-4**

(0.1 X 10-4) 0.5 X 10-4**(0.2 X 10-4)

-0.4 X 10-3*(0.2 X 10-3)

-0.4 X 10-3*(0.2 X 10-3)

Sales Growth -0.8 X 10-4*(0.3 X 10-4)

-0.9 X 10-4**(0.3 X 10-4)

0.1 X 10-6

(0.1 X 10-4)-0.9 X 10-5

(0.2 X 10-4)Blockholders -0.004+

(0.002)-0.006*(0.002)

0.003(0.003)

0.007+

(0.004)Firm Size -0.002

(0.002)-0.004+

(0.002) 0.2 X 10-3

(0.002) 0.002(0.002)

Acquisition 0.6 X 10-3

(0.5 X 10-3) 0.001+

(0.6 X 10-3)0.003*0.001

0.005**0.002

Transportation -0.023**(0.008)

-0.026**(0.008)

-0.017(0.012)

-0.021(0.017)

Banking 0.012(0.009)

0.014(0.012)

0.019*(0.009)

0.031*(0.013)

Utility -0.033**(0.007)

-0.058**(0.009)

-0.020**(0.006)

-0.049**(0.009)

Insurance -0.027**(0.009)

-0.057**(0.011)

-0.015**(0.005)

-0.050**(0.009)

Other Financial -0.001(0.013)

-0.001(0.014)

-0.019(0.019)

0.011(0.020)

France - Ireland -0.040**(0.006)

-0.042**(0.008)

-0.014(0.015)

-0.046*(0.021)

Sweden – Portugal -0.002(0.007)

-0.001(0.008)

0.004(0.006)

0.002(0.009)

Constant 0.098**(0.027)

0.182**(0.035)

0.005(0.022)

0.013(0.030)

N 498 490 223 210R2 0.21 0.25 0.20 0.27F-statistic 8.56** 10.44** 3.36** 4.90**Standard errors are in parentheses.

+ p < .10 * p < .05

** p < .01

Significance tests are two-tailed for control variables and one-tailed for hypothesized effects.

41

TABLE 4Interaction Effects

More Munificent Less Munificent Home Country Environments Home Country Environments

Model A Model B Model C Model DDependent Variable ROA EBIT ROA EBIT

ProductDiversification

-0.010*(0.005)

-0.016*(0.007)

0.015*(0.007)

0.019*(0.009)

Outbound InternationalDiversification

0.3 X 10-3*(0.2 X 10-3)

0.6 X 10-3**(0.2 X 10-3)

0.4 X 10-3

(0.4 X 10-3) 0.1 X 10-3

(0.5 X 10-3)Inbound InternationalDiversification

-0.002(0.002)

-0.003+

(0.002)-0.6 X 10-4

(0.001)-0.001(0.002)

Product Diversification xOutbound International Diversification

-0.7 X 10-3*(0.4 X 10-3)

-0.001**(0.5 X 10-3)

Product Diversification xInbound International Diversification

0.006**(0.002)

0.010**(0.003)

Leverage 0.5 X 10-4**(0.1 X 10-4)

0.6 X 10-4**(0.2 X 10-4)

-0.4 X 10-3*(0.2 X 10-3)

-0.4 X 10-3*(0.2 X 10-3)

Sales Growth -0.8 X 10-4*(0.3 X 10-4)

-0.9 X 10-4**(0.3 X 10-4)

0.6 X 10-6

(0.1 X 10-4) 0.7 X 10-5

(0.2 X 10-4)Blockholders -0.004*

(0.002)-0.006*(0.002)

0.003(0.003)

0.007(0.004)

Firm Size -0.002(0.002)

-0.004+

(0.002)-0.2 X 10-3

(0.002) 0.002(0.002)

Acquisition 0.6 X 10-3

(0.5 X 10-3)0.001+

(0.6 X 10-3)0.003**0.001

0.005**0.002

Transportation -0.022**(0.008)

-0.025**(0.008)

-0.016(0.012)

-0.018(0.017)

Banking 0.012(0.009)

0.014(0.012)

0.020*(0.009)

0.034*(0.013)

Utility -0.031**(0.007)

-0.055**(0.009)

-0.019**(0.006)

-0.046**(0.008)

Insurance -0.026**(0.009)

-0.056**(0.011)

-0.015**(0.005)

-0.049**(0.009)

Other Financial -0.2 X 10-3

(0.013)-0.7 X 10-3

(0.014)-0.019(0.019)

-0.012(0.020)

France - Ireland -0.035**(0.006)

-0.043**(0.008)

-0.014(0.015)

-0.049*(0.021)

Sweden – Portugal -0.003(0.007)

-0.012(0.008)

0.004(0.006)

0.001(0.009)

Constant 0.095**(0.029)

0.178**(0.036)

0.018(0.022)

0.003(0.028)

N 498 490 223 210R2 0.22 0.25 0.20 0.29F-statistic 8.23** 10.11** 3.28** 4.83**Standard errors are in parentheses.

+ p < .10* p < .05

** p < .01Significance tests are two-tailed for control variables and one-tailed for hypothesized effects.

42

APPENDIX: Country Environment Classification Procedures and Validation

To first examine the groupings of 16 West European countries, we added up factor andinstitutions components and used a split half (and median spilt) criterion. The first group (moremunificent home country environments) includes Denmark, France, Germany, Netherlands,Norway, Sweden, Switzerland, and U.K. The second group (less munificent home countryenvironments) includes Austria, Belgium, Finland, Ireland, Italy, Portugal, Spain, and Turkey.Using a mean spilt criterion, Austria, Belgium, Finland group with Denmark, France, Germany,Netherlands, Norway, Sweden, Switzerland, and U.K. In addition, we performed cluster analysisto classify these countries. We clustered the countries on factors and institutions and used threeclustering algorithms: average linkage, centroid, and median. The two groups identified from theclustering outcomes are equivalent to those of using a mean split criterion.

In general, we also followed Malos and Campion’s (2000) clustering validation procedures.First, The viability of the clustering results was supported by significant mean differencesbetween the two groups of countries, both for factors and institutions as well as for the sixcomponents. Second, we also used a set of validation variables to test the mean differencesbetween the two groups of countries. The results are also reported in the table below. Third, werandomly deleted 4 countries. The cluster groupings of the remaining countries remainedunchanged. Lastly, we performed discriminant analysis on the two clustering variables, withcluster membership as the class variable; the canonical correlation (0.928) is highly significantsupporting our clustering results.

Tests of Mean Differences of Clustering and Validation Variables

More MunificentHome Country Environments

Less MunificentHome Country Environments

Mean Mean t

Factors 0.577 -1.270 8.634**

Endowed factors 0.262 -0.576 2.769**Advanced factors 0.470 -1.033 6.754**Human factors 0.423 -0.931 4.775**

Institutions 0.405 -0.889 5.700**

Political institutions 0.477 -1.050 5.410**Legal institutions 0.509 -1.120 5.688**Societal institutions 0.227 -0.498 2.022*

Validation variables:Euromoney country creditrisk ratings

0.467 -1.028 3.838**

Hall & Jones country rating 0.541 -1.191 5.547**Heinz political risk rating 0.334 -0.736 2.234*Gwartney et al economicfreedom index

0.298 -0.655 1.917*

Human Development Index 0.470 -1.033 3.632**GDP Per Capita 0.503 -1.106 4.189***p < .05; ** p < .01; One-tailed tests.

43

William P. Wan is an assistant professor of management at Thunderbird, The AmericanGraduate School of International Management. He received his Ph.D. degree in strategicmanagement from Texas A&M University. His current research interests include corporatediversification, international strategy, and corporate governance.

Robert E. Hoskisson currently holds the Rath Chair in Strategic Management at the Michael F.Price College of Business at the University of Oklahoma. He received his Ph.D. degree from theUniversity of California, Irvine. His research topics focus on corporate and internationaldiversification strategy, corporate governance, acquisitions and divestitures, privatization andcooperative strategy.