Diversification by young, small firms: the role of pre-entry resources and entry mistakes

Abstract

We investigate the determinants of young, small firm diversification by using longitudinal linked employer-employee data. We focus particularly on the role played by the sharing of managerial and qualified human resources, as well as market uncertainty and entry mistakes. We find that a small but significant proportion of young, small firms diversify in their first years. Firms with a greater proportion of managers and qualified human resources are more likely to diversify early, lending credence to the resource-based view of diversification. Firms entering volatile markets are more likely to diversify earlier as well, suggesting that entry mistakes and escape from uncertain, Schumpeterian environments also influence diversification. The inspection of survival patterns of diversified firms sheds further light on the importance of these two determinants of diversification.

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Notes

  1. 1.

    Of course, corporate diversification may result simply from a purely financial rationale (Lewellen 1971), but that is unlikely to be the case for a young, small firm.

  2. 2.

    QP has been used in a wide variety of works studying firms, entrepreneurs, and workers (e.g., Amaral et al. 2011; Baptista et al. 2012, 2013).

  3. 3.

    Although data are available after 2000, changes in industry classification have made it nigh impossible to find correspondences between SIC sector classifications before and after 2000. Furthermore, after 2000, the level of aggregation increased (five instead of six digits), thus making the detection of diversification moves by firms a fundamentally different process. It was therefore chosen to circumscribe the analysis to the period ending in 2000.

  4. 4.

    We are therefore considering diversification both through internal growth and through external acquisition.

  5. 5.

    Cox survival models were also estimated for survival of diversifiers vs. non-diversifiers considering the timing of diversification and various firm and industry-level covariates. Results are available from the authors upon request.

  6. 6.

    We measure firm size using the logarithm of the total number of employees. We follow Pashigian (1969) in computing the MES as the sum of average firm sizes in all industry size classes, weighted by the proportion of employment accounted for by firms in each size class.

  7. 7.

    In order to check whether firms diversifying at birth behave differently from other firms, a binary choice model (Logit) for diversification at birth was estimated using the same variables as the hazard models (measured in the birth year). Results were very similar to the hazard models, so the analysis presented here pools all firms together.

  8. 8.

    Table 2 shows that the standard deviation of yearly firm growth rates is over 730%.

  9. 9.

    Our data does not register events in which a diversified firm specializes, i.e., disinvests from one of its lines of business. All disinvestment events correspond to firm closures.

  10. 10.

    We do not consider diversification in the 12th year as the data is left-censored and we would not be able to assess survival after that.

  11. 11.

    Indeed, necessity is also recognized in the literature an ex ante determinant of entry (see, for instance, van der Zwan et al. (2016)).

  12. 12.

    Studies of technology-based diversification at a more micro-level include, for instance, Pavitt et al. (1989), Kim and Kogut (1996), Gambardella and Torrisi (1998), Giarratana (2004), and Stern and Henderson (2004).

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Acknowledgements

The authors are indebted to the Portuguese Ministry of Labour and Social Solidarity for the access to the data used in the paper, and to participants in RENT, Academy of Management, and Strategic Management Society conferences for useful comments.

Funding

Support for this research was provided by Fundação para a Ciência e a Tecnologia (FCT) through the Carnegie Mellon-Portugal Program (CMU-PT/Etech/0036/2008 and CMUP-ERI/TPE/0028/2013).

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Baptista, R., Karaöz, M. & Leitão, J.C. Diversification by young, small firms: the role of pre-entry resources and entry mistakes. Small Bus Econ 55, 103–122 (2020). https://doi.org/10.1007/s11187-019-00142-z

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Keywords

  • Diversification
  • Start-ups
  • Small business
  • Firm resources
  • Uncertainty
  • Entry mistakes

JEL Classification

  • L22
  • L26
  • M13