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Evolution of Organizational Scale and Scope

Author

Listed:
  • Arnoud W.A. Boot

    (University of Amsterdam)

  • Todd T. Milbourn

    (Washington University in St. Louis)

  • Anjan V. Thakor

    (University of Michigan Business School)

Abstract

This paper examines the determinants of organizational scale and scope, with applications to various industries, including financial services. We build a model in which new opportunities arise for firms, but the skills needed to exploit them effectively are unknown. Early investments in these new opportunities expand scope and allow firms to learn the skills needed to make more efficient production decisions later on. The value of early scope expansion is thus increasing in the strategic uncertainty about the skills needed for future success in exploiting new opportunities. The disadvantage of early scope expansion is that it requires irreversible investments before actual demand is known. This demand uncertainty means potential losses since the investment cannot be recovered when demand does not materialize. Thus, early entry into a new activity involves a tradeoff, and this tradeoff works in favor of early entry under two conditions. First, there must be sufficiently high strategic uncertainty about the skills needed for success in the new activity. Second, the firm 's existing operations must be sufficiently profitable to give it the necessary "deep pockets" to absorb the potential loss of the capital invested early if there is no demand. This perspective allows us to link the optimality of scope expansion to the degrees of competition in the firm's existing activities as well as the new activity, and the development of the capital market. Moreover, to the extent that a scale-expanding merger "deepens" the firm's pockets, scale expansion will facilitate scope expansion and thus precede it.

Suggested Citation

  • Arnoud W.A. Boot & Todd T. Milbourn & Anjan V. Thakor, 2002. "Evolution of Organizational Scale and Scope," Tinbergen Institute Discussion Papers 02-060/2, Tinbergen Institute.
    • Handle: RePEc:tin:wpaper:20020060
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    File URL: https://papers.tinbergen.nl/02060.pdf
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    References listed on IDEAS

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    3. Myers, Stewart C. & Majluf, Nicholas S., 1984. "Corporate financing and investment decisions when firms have information that investors do not have," Journal of Financial Economics, Elsevier, vol. 13(2), pages 187-221, June.
    4. Clark, Jeffrey A, 1996. "Economic Cost, Scale Efficiency, and Competitive Viability in Banking," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 28(3), pages 342-364, August.
    5. David S. Scharfstein, 1998. "The Dark Side of Internal Capital Markets II: Evidence from Diversified Conglomerates," NBER Working Papers 6352, National Bureau of Economic Research, Inc.
    6. Stein, Jeremy C, 1997. "Internal Capital Markets and the Competition for Corporate Resources," Journal of Finance, American Finance Association, vol. 52(1), pages 111-133, March.
    7. Bengt Holmstrom & Steven N. Kaplan, 2001. "Corporate Governance and Merger Activity in the United States: Making Sense of the 1980s and 1990s," Journal of Economic Perspectives, American Economic Association, vol. 15(2), pages 121-144, Spring.
    8. Berger, Allen N. & Hunter, William C. & Timme, Stephen G., 1993. "The efficiency of financial institutions: A review and preview of research past, present and future," Journal of Banking & Finance, Elsevier, vol. 17(2-3), pages 221-249, April.
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    Cited by:

    1. Rémi Contamin & Valérie Prémilleux & Asma Ben Salem, 2005. "Consolidation bancaire paneuropéenne : un point d’étape," Revue d'Économie Financière, Programme National Persée, vol. 78(1), pages 47-63.

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