Levels of Unrelated Diversification and Firm Performance: A Conceptual Description of an S-Shaped Hypothesis

Abstract

This study reconceptualizes the so far inconclusive relationship between unrelated diversification and financial performance by explaining how coordination costs can shape the amount of free cash flow and related agency problems at different levels of unrelated diversification. The study builds upon the notion that coordination requirements and associated coordination costs will vary at levels of unrelated diversification to regulate the amount of free cash flow managers will have at their disposal at each level of unrelated diversification. Based on the agency costs associated with free cash flow, we conceptualize that at different stages of unrelated diversification, the degree of managerial misuse of free cash flow can create different performance implications of the unrelated diversified firm to explain a proposed S-shaped relationship.