The impact of the regulatory environment and corporate level diversification on firm performance.

Abstract

The strategic choice perspective views adaptation as a process determined by management occurring within a controllable environment (Child, 1972). In response to this view many studies have been conducted investigating the importance of management's role in shaping a firm's direction. Several of these studies suggest that the external environment constrains the range of strategic options (Hambrick and Lei, 1985; Venkatraman and Prescott, 1990). Alternatively, other studies have shown that managers are important variables of firm performance (Day and Lord, 1988; Thomas, et al., 1991). However, while these studies have focused on a variety of settings, research investigating the role of strategic management in regulated industries is sparse (Ramaswamy et al., 1994; Russo, 1992; Shaffer, 1995). The majority of studies conducted on government regulation have focused on economics or government policy. Issues such as the impact of regulation on market structure (Vietor, 1991) and the role of government in obtaining social objectives (Bryer, 1982) have fallen under these headings. However, this stream of research is dominated by analysis of industry level phenomenon. Thus, very little is known about the influences of government regulation on firm level behavior and performance. While studies of strategy performance relationships have been conducted (Ramaswamy et al., 1994; Snow and Hrebeniak, 1980), the relationship of corporate-level strategy and performance has yet to be examined in a regulated environment. The extent to which regulation plays a major role in both domestic and international business requires that more research be aimed at understanding the strategic implications of operating in regulated industries (Ramaswamy et al., 1994). Furthermore, research is needed that focuses on what happens when regulated firms diversify outside of the regulated environment. As regulated firms diversify domestically and internationally the relationship between the firm and the environment may change drastically. For example, utilities diversifying into unregulated markets will face competitive forces unlike those within the regulated environment. Thus, the study of how regulated firms perform when diversifying outside the regulated environment is important and may assist managers in choosing strategies at the corporate level. The present study addresses this gap in the literature by examining the relationship between the regulatory environment, level of diversification outside the regulated environment, and performance of regulated electric utility companies. A review of the diversification literature is provided along with a review of literature regarding how regulation influences a firm's behavior. A research hypothesis based on the relationship between the regulatory environment and corporate strategy, and its effects on performance is then presented followed by the methodology used to test the hypothesis. Finally, results are explained and a discussion is provided to address the theoretical and managerial implications of this study. LITERATURE REVIEW Over the past twenty years, beginning with the work of Rumelt (1974), there have probably been more empirical studies of diversification and corporate performance than in any other area of strategic management. Much of this work has focused on the relationship between relatedness of diversification and performance with results being somewhat inconsistent (Dess et al., 1995). For example, Rumelt (1974) found related diversification to be the most profitable, while Michel and Shaked (1984) found unrelated diversification leads to better performance. Other studies by Varadarajan and Ramanujam (1987), Hoskisson (1987), and Simmonds (1990) also found related diversification to be associated with better performance. However, the work of Dubofsky and Varadarajan (1987) suggests that unrelated diversifiers perform better based on market based measures. …

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