The value of flexibility in m ulti‐business firms

Research Summary Whether diversified firms have advantages over their single-business counterparts is the focus of much research in strategic management. Indeed, there is sparse evidence that corporate advantage exists, on average. We explore one potential driver of corporate advantage—that multi-business firms have more flexibility than single-business firms to cope with uncertainty, because they can internally redeploy resources across businesses. Using Compustat data, we show that uncertainty increases the relative advantage of multi-business firms, a finding robust to controls for endogeneity. Consequently, the paper provides important insight and evidence around when corporate advantage might obtain. Moreover, we find that growth option value is accentuated in the presence of switching flexibility. Finally, multi-business firms with redeployment experience and businesses with more inversely correlated returns benefit more from uncertainty. Managerial Summary Multi-business firms have a flexibility advantage over single-business firms as they can reallocate firm resources from one business unit to another depending on inducements. What is the impact of this flexibility on firm value? In this paper, we test whether such a flexibility advantage translates into greater economic returns in more volatile markets. We expect that resource redeployment creates value if it amplifies business-specific positive shocks while alleviating business-specific downturns. Consistent with this argument, we find empirical evidence that with increasing stock market volatility, multi-business firms benefit significantly more in terms of firm value than their single-business counterparts. In particular, in highly volatile stock markets, monthly adjusted returns are 2.3 times higher for multi-business firms than for single-business firms.