1. Introduction
In the last decade, corporate diversification across industries has attracted a great
deal of attention by financial economists and management scholars. Research on the
diversification discount such as Berger and Ofek (1995) and Lang and Stulz (1994) shows
that diversified U.S. firms trade at a significant discount relative to specialized firms.
Active debate is still going on as to whether diversification itself is responsible for the
discount (Martin and Sayrak, 2003). Recent studies such as Campa and Kedia (2002) and
Villalonga (2004a) suggest that, once the endogeneity of diversification status is accounted
for, diversification is not detrimental to firm value. Nevertheless, the fact that a staggering
number of U.S. firms have divested unrelated businesses to refocus on the areas of their core
strength suggests that managing a large diversified corporation successfully is not an easy
task (Markides, 1995; Comment and Jarrell, 1995). Organizational economists provide a
number of reasons to suspect that large complex organizations like diversified firms might
underperform small rivals organized more simply (e.g. Milgrom and Roberts, 1988;
Rotemberg and Saloner, 1994; Scharfstein and Stein, 2000).
The wave of corporate refocusing appears to have hit the other side of the Pacific in
the late 1990s. Nowadays, the business press is full of articles reporting Japanese
companies, even those long considered the bluest of blue, actively slashing unprofitable
businesses. As Figure 1 illustrates, the number of publicly announced divestitures in Japan
indeed increased dramatically in the wake of corporate restructuring wave in the late 1990s.
However, the diversification strategy of Japanese firms was once espoused as economically
sound by many observers. For instance, in an influential Harvard Business Review article,
Prahalad and Hamel (1990) drew heavily on Japanese companies to illustrate the importance
of nurturing a firm’s core...