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Efficiency or bounded rationality? Drivers of firm diversification strategies in Vietnam

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Abstract

Considering the case of diversified firms within a developing/transition country such as Vietnam, this paper investigates diversification relatedness while taking into account both firm- and industry-specific components. The high volatility of the dynamics of diversification observed in Vietnam suggests the hypothesis that firms decide to enter into new industries following a trial and error process, initiated by boundedly rational herding behaviors, i.e., firms follow the most commonly observed business combinations. Using a survivor-based (SB) measure of relatedness, we test the hypothesis of boundedly rational behavior. We find that both the probability of exit and the different performance measures (Return on sales and Total factor productivity) are not or are negatively correlated with SB-related diversification. This is in contrast to what has been observed in developed countries. However, using the SIC distance approach, we obtain the expected positive relationship between performance and relatedness in diversified firms. The conflicting result between these two relatedness indices therefore suggests there has been a trend in follow-up among inexperienced firms that imitate the direction and intensity of the diversification of dominating players within the industry (herd behavior). However, diversified firms gain experience over time and choose more efficient business combinations in subsequent entries. When we use the classical SIC-based approach, we find that greater diversification raises profitability, but only to an optimum relatedness point, beyond which the positive effect fades away. To control for the endogeneity of diversification relatedness and the serial correlation in error terms, we adopt an instrumental-variable two-stage least-squares estimation approach (IV-2SLS) with GMM treatment.

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Notes

  1. White test for the presence of heteroskedasticity: χ 2(115) = 1649; p-value = 0.000

  2. Test for serial correlation: FROS(1, 11557) = 7.952, p-value = 0.0048; FTFP (1, 11557) = 10.568, p-value = 0.000

  3. Durbin-Wu-Hausman test: SIC-based index χ 2(1) = 6.755; p-value = 0.00935; SB index: χ 2(1) = 10.267; p-value = 0.00135

  4. The detailed list of diversified firms may be obtained from the authors.

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Author information

Authors and Affiliations

  1. RMIT International University, 702 Nguyen Van Linh Blvd, Hochiminh City, Vietnam

    Hien Thu Tran

  2. Department of Economics, University of Bologna, Piazza Scaravilli, 2, 40126, Bologna, Italy

    Enrico Santarelli

  3. Department of Economics and Management, University of Trento, Via Inama, 5, 38122, Trento, Italy

    Enrico Zaninotto

Authors
  1. Hien Thu Tran
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  2. Enrico Santarelli
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  3. Enrico Zaninotto
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Correspondence to Enrico Santarelli.

Additional information

Two anonymous reviewers provided comments and suggestions on previous versions of this paper. Enrico Santarelli acknowledges financial support from the University of Bologna (RFO2011)

Appendices

Appendices

Table 5 Description of variables
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Table 6 Review of diversification measures
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1.1 Appendix 3 – The survivor-based (SB) index of relatedness

Let the population of the diversified firms consist of K firms, each active in two or more industries i. Let Z ik  = 1 if a firm n is active in the industry i. The number of industries participated in by a firm k is \( {m}_k={\displaystyle \sum_i}{Z}_{ik} \), and the number of diversified firms present in the industry i is \( {n}_i={\displaystyle \sum_k}{Z}_{ik} \). Let C ij be the number of diversified firms active in both industries i and j, such that \( {C}_{ij}={\displaystyle \sum_k}{Z}_{ik}{Z}_{jk} \). In other words, C ij is a count of how often industries i and j are actually combined within the same firm. C ij will be larger if industries i and j are related, but it will also increase with n i and n j . To avoid the effect of the sizes of the industries i and j, the number C ij is compared with the number of expected combinations if diversification patterns were random. The random diversification hypothesis can be represented as a hypergeometric distribution function \( \Pr \left({X}_{ij}=x\right)=\frac{\left({}_x^{n_i}\right)\left({}_{n_j-x}^{K-{n}_i}\right)}{{}_{n_j}^K} \) where x is the number of firms active in both industries i and j, and n i and n j are drawn independently and randomly from a population of K irms. The mean and variance of X ij are, respectively, \( {\mu}_{ij}=E\left({X}_{ij}\right)=\frac{n_i{n}_j}{K} \); \( {\sigma}_{ij}^2={\mu}_{ij}\left(1-\frac{n_i}{K}\right)\left(\frac{K}{K-1}\right) \). Then, the weighted average SB relatedness of the target industry i to all other industries in the firm is then defined as \( S{B}_i=\frac{{\displaystyle \sum }S{R}_{ij}{s}_j}{{\displaystyle \sum }{s}_j} \), wherein \( S{R}_{ij}=\frac{C_{ij}-{\mu}_{ij}}{\sigma_{ij}} \) is a standdized measure of how much the actual number of combinations exceeds the expected combinations under the random diversification hypothesis, and s j is the sales of aiversified firm in indus j.

Table 7 Means, standard deviations, and correlation coefficients of independent variables
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Table 8 Robustness check - Profitability of diversified manufacturing firms
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Tran, H.T., Santarelli, E. & Zaninotto, E. Efficiency or bounded rationality? Drivers of firm diversification strategies in Vietnam. J Evol Econ 25, 983–1010 (2015). https://doi.org/10.1007/s00191-015-0408-6

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