Firm boundaries matter: Evidence from conglomerates and R&D activityby Amit Seru

Journal of Financial Economics


Strategy and Management / Economics and Econometrics / Finance / Accounting


Firm boundaries matter: Evidence fro and R&D activity$

Amit Seru n

University of Chicago Booth School of Business, United States a r t i c l e i n f o a b s t r a c t

This paper examines th corporate Research and Development (R&D) activity. I exploit a quasi-experiment involving failed mergers to generate exogenous variation in acquisition outcomes of target firms. A difference-in-differences estimation reveals that, relative to failed targets, firms acquired in diversifying mergers produce both a smaller number of innovations and also less-novel innovations, where innovations are measured using patent-based metrics. on of resources? research in eco). A large body of urce allocation in ms to shed light peting views on this aspect. On the one hand, Alchian (1969), Wiliamson control over the capital allocation process, may do a better

Contents lists available at ScienceDirect journal homepage: www.e

Journal of Financ

Society), Batten and European Summer Symposium (Gerzensee) for their

Rodkey fellowships at Michigan and Kauffman and Gould Foundation at

Booth. Shu Zhang and Ram Chivukula provided outstanding research

Journal of Financial Economics 111 (2014) 381–4050304-405X/$ - see front matter & 2013 Elsevier B.V. All rights reserved. in directing investments than the external capital markets. On the other hand, the “dark side” view of internal capital markets argues that problems of corporate socialism are more prevalent in conglomerates making assistance. This is a substantially revised version of the paper that was previously circulated as “Do Conglomerates Stifle Innovation”? n Corresponding author.

E-mail address:, and Stein (1997), among others, have put forth the view that conglomerates, by virtue of exerting centralized helpful comments and suggestions. I am indebted for help with data to:

Industrial Research Institute, Rakesh Bordia, Khamir Mehta, Noah Stoffman and Shyam Venkatesan. I acknowledge funding from the Rackham andDo firm boundaries affect the allocati

This question had spawned significant nomics since it was raised in Coase (1937 work has focused on comparing the reso conglomerates relative to stand-alone fir on this issue. Theoretically, there are com charyya (Chair), Uday Rajan and John DiNardo for their guidance and advice. I thank Michael Barclay, Nick Bloom, Rebecca Eisenberg, Thomas Hellmann,

Steve Kaplan, E. Han Kim, Joshua Lerner, David Matsa, Holger Muller, Paige

Oiumet, David Robinson, David Scharfstein, Antoinette Schoar, Enrique

Schroth, Jeremy Stein, Noah Stoffman, Rene Stulz, Vikrant Vig, Luigi Zingales, the editor, an anonymous referee and seminar participants at Arizona State,

Boston College, Colorado, Chicago, HBS, LBS, Michigan, NYU, Ohio State,

Rochester, Toronto, UBC, Wharton, Yale and conference participants at

American Finance Association, American Economic Association (Econometric1. Introduction ☆ This paper is based on my dissertation. I thank Amy Dittmar, Charles

Hadlock, Vikram Nanda, Rosemarie Ziedonis and especially Sugato Bhatta-Article history:

Received 4 October 2007

Received in revised form 19 August 2010

Accepted 13 September 2010

Available online 14 November 2013

JEL classification:









Theory of firm




IncentivesThe treatment effect is amplified if the acquiring conglomerate operates a more active internal capital market and is largely driven by inventors becoming less productive after the merger rather than inventor exits. Concurrently, acquirers move R&D activity outside the boundary of the firm via the use of strategic alliances and joint ventures. There is complementary evidence that conglomerates with more novel R&D tend to operate with decentralized R&D budgets. These findings suggest that conglomerate organizational form affects the allocation and productivity of resources. & 2013 Elsevier B.V. All rights reserved.e impact of the conglomerate form on the scale and novelty ofm conglomerates ial Economics them less efficient in resource allocation (Rajan, Servaes, and Zingales, 2000; Scharfstein and Stein, 2000).

Estimating the effects predicted by these theories has proven challenging. On the one hand, there is a broad brush approach that argues that efficiency of conglomerates can be compared to stand-alone firms by examining their relative market values. This approach has, however, been criticized as being indirect and tainted by endogeneA. Seru / Journal of Financial Economics 111 (2014) 381–405382ity bias which is hard to account for.1 The other, more direct approach, has been to examine the productivity differences across organizational forms to make assessment about resource allocation (Maksimovic and Philips, 2002; Schoar, 2002). In this paper, I extend the latter by focusing on one activity and demonstrating that a causal link exists between R&D productivity differences and organizational form. By doing so, I hope to provide evidence that firm boundaries can matter for allocation of resources.

I choose to focus on innovative activity following the argument made in Wiliamson (1985) that “… in the presence of asset specificity, uncertainty, and opportunistic behavior—differences in internal organization may impact innovative behavior ...” The intuition behind this idea is simple. Novel research projects are especially characterized by significant informational asymmetries between researchers and outside evaluators. This may provide researchers in divisions leeway to manipulate the information they transmit to corporate bosses, especially if they are faced with the possible threat of reallocation of resources by corporate headquarters. Recognizing this problem, high-level managers may be reluctant to embark on novel projects in the first place. Thus, it is precisely those organizations that attempt to exploit the efficiencies of a centralized resource allocation process that may end up fostering mediocrity in their divisional