Performance Effects of Diversification : Theory and Evidence on Importance of Nature of Information

Let diversification structure refer to the choice between a diversified or focused organizational structure. Suppose performance of diversified firms within an industry Θ is a sufficient statistic for aggregate firm-level performance of diversified firms across industries Θ and Ω. Denote industry Θ the dominant industry. The formal theoretical model in this study provides rigorous evidence that efficacy, or otherwise of diversification cannot be robustly inferred in context of performance effects of diversification structure; rather only can be inferred in context of responses of focused and diversified firms to arrival of a positive shock within investment opportunity sets of a dominant industry that is characterized by `soft' information. Using the context of venture capital markets, empirical findings validate predictions of the formal theoretical model, show performance effects of diversification structure are not substitutes for performance effects of arrival of a positive shock to investments within a dominant industry that is characterized by soft information. With respect to feasibility of interactions between ability and diversification structure, empirical findings provide evidence that, at any given point in time, high ability agents have capacity for arrival at inferences, as to which of diversified or focused strategies best facilitate superior aggregate firm-level performance in future periods. In this respect, empirical findings show performance effects of changes to diversification structure that are evidence for demonstrations of ability do not coincide with, and strictly dominate performance effects of corresponding changes that are induced by life cycle progressions of venture capitalists' risk preferences