Thursday, September 06, 2012

Diversified Firms in Emerging Markets

Harvard Professor Tarun Khanna has conducted extensive research on large business groups (conglomerates) in emerging markets.  He has found that the so-called conglomerate discount doesn't exist in many emerging markets.  Why?  Khanna argues that institutional voids exist in these countries.   Capital, labor, and product markets are not very efficient.  Therefore, large organizations and their management teams fill these "voids" in those countries.  In other words, the conglomerate serves a useful function, because it does what the efficient labor, product, and capital markets do in more developed countries. 

On the other hand, in more advanced economies like the United States, unrelated diversification makes much less sense.  Investors, for instance, can diversify risk quite inexpensively on their own; they don't need a CEO to diversify into many unrelated units to reduce risk.   That type of strategic move proves far more expensive than simply having the investor buy an index fund to achieve risk diversification.  

A new paper by Venkat Kuppuswamy, George Serafeim, and Belén Villalonga examines this concept in more detail.  They look at capital, product, and labor market efficiency in 38 countries over a 15 year period.   They find that the value of corporate diversification does indeed fall as capital and labor markets get more efficient.   However, they did not find a significant effect for product market factors.   In sum, corporate strategy should look different as we move across the globe, and not just because of cultural differences.  Fundamental differences in the institutional environment call for different approaches to corporate strategy as we move from more advanced economies to emerging markets. 


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Robert Cameron said...

No question that this is true. In the West, conglomerates are discounted in valuations, whilst in emerging markets they are not.
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