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10.1177/0149206305279895ARTICLEJournal of Management / December 2005Hoskisson et al. / Refocusing in Diversified Business Groups

Diversified Business Groups andCorporate Refocusing in Emerging Economies

Robert E. Hoskisson*Department of Management, W. P. Carey School of Business, Arizona State University, Tempe, AZ 85287-4006

Richard A. JohnsonMichael F. Price College of Business, University of Oklahoma, Norman, OK 73019-4006

Laszlo TihanyiDepartment of Management, Mays Business School, Texas A&M University, College Station, TX 77843-4221

Robert E. WhiteDepartment of Management, W. P. Carey School of Business, Arizona State University, Tempe, AZ 85287-4006

As emerging economies have improved their economic institutions, the performance of manylarge business groups has been reduced because such groups acted as market-substitute mecha-nisms. Consequently, business groups have become increasingly involved in refocusing activities.The authors develop a framework in which such refocusing is explained as an attempt to balanceoverall transaction costs faced by groups with organization-specific costs in order to improvegroup performance. They examine external and internal factors that might lead to the initiation ofrefocusing and also explain why different ownership structures may affect the direction of thatrefocusing (e.g., related vs. unrelated diversification).

Keywords: business group; restructuring; refocusing; emerging economy; ownershipstructure

*Corresponding author. Tel: 480-965-2286; fax: 480-965-8314.

E-mail address: [email protected]

Journal of Management, Vol. 31 No. 6, December 2005 941-965DOI: 10.1177/0149206305279895© 2005 Southern Management Association. All rights reserved.

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Corporate refocusing, a type of asset restructuring in which the firm both reduces its num-ber of businesses and makes changes to its diversification strategy, is particularly challengingin emerging economies (Carrera, Mesquita, Perkins, & Vassolo, 2003; Hoskisson, Eden, Lau,& Wright, 2000). From the practitioner’s point of view, refocusing in these countries ofteninvolves governmental institutions, shifts in regulations, and constant changes in the market-place (Wright, Filatotchev, Hoskisson, & Peng, 2005). From the researcher’s point of view,emerging economies tend to exemplify less-than-perfect market institutions and businessenvironments with scarce factor resources relative to developed economies (Wan, 2005; Wan& Hoskisson, 2003). Nonetheless, because of their recent rapid development, relatively largepopulation bases, and increased share in world trade, emerging economies have becomeincreasingly important. Understanding corporate refocusing in the emerging economy con-text is particularly relevant owing to the limited applicability of previous theories that evolvedfrom empirical research in developed markets. Furthermore, the study of refocusing in emerg-ing economies provides additional evidence on the variance in organizational behavior in dif-ferent business systems around the world (Djankov, Glaeser, La Porta, Lopez-de-Silanes, &Shleifer, 2003).

In this article, we center our examination of corporate refocusing on an important attributeof many emerging economies: local firms’ affiliations with diversified business groups.Although business groups exist in some developed economies such as Sweden (Collin, 1998)and Japan (Aoki, 1990), they differ primarily in the amount of government control over suchgroups, with developed economy business groups having less direct government control(Collin, 1998). Business groups are generally composed of legally independent firms that arebound by formal ownership and informal social ties to take coordinated actions (Khanna &Rivkin, 2001). For example, the Tata Group, which was founded by Jamsetji Nusserwanji Tatain 1868 as a private trading firm and is currently India’s largest business group, includes 91firms in a wide range of industries. The group covers the chemicals, communications, con-sumer products, energy, engineering, information systems, materials, and services industries.The group’s revenue was $14.25 billion or about 2.6% of India’s GDP in 2003-2004. Tata’smember companies employ about 220,000 people and export their products to 140 countries.However, as India’s economy has developed, Tata executives have sought to refocus its mem-ber businesses to “build a more focused company without abandoning the best of Tata’s manu-facturing tradition” (Kripalani, 2004). Over a 10-year period, Tata has refocused from 250businesses to its current set.

The existence of business groups such as Tata in emerging economies is often theorized toresult from imperfections of local labor, capital, and product markets (Leff, 1976). Priorresearch suggests that firms in emerging economies may be better off as parts of diversifiedbusiness groups because of the relatively high transaction costs prevalent in underdevelopedinstitutional environments (e.g., Khanna & Palepu, 2000). High overall transaction costs arethe results of undeveloped capital, consumer, and labor market institutions, as well as ineffi-cient transportation and telecommunications. Thus, business groups can act as intermediariesbetween economic actors and imperfect markets by potentially filling institutional voids(Caves & Uekusa, 1976). By integrating arguments from institutional and transaction cost the-ories, we argue that market-oriented institutional changes affect the overall transaction costsin an economy. As the underlying transaction costs are reduced because of these changes,

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large diversified business groups have an increased incentive to restructure (refocus) so as notto incur excessive organization costs. We offer a number of propositions regarding factors thatmight hinder or spark a business group to respond to the underlying incentive to refocus itsbusiness portfolio.

In particular, we provide an overview of external factors, including external shocks, exter-nal control mechanisms, variance in country policy toward institutional development, marketpower and competition, and cultural factors. The discussion of these external factors will helpto clarify the potential variations in the level of business group refocusing due to differences inenvironmental factors (Boisot & Child, 1996). We also examine internal factors that mayaffect the timing or likelihood of refocusing, including poor performance, leadership issues,and organizational culture and trust.

Finally, we examine how different ownership arrangements might affect the direction ofrefocusing. Although most prior empirical work has considered the business group as a homo-geneous organizational form, this assumption has serious limitations. For example, priorresearch has identified significant variations in business group ownership, including dominantfamily, bank, and government ownership positions, as well as groups partly controlled bynonbank financial institutions or foreign ownership (La Porta, Lopez-de-Silanes, & Shleifer,1999). Family ownership of diversified business groups is prominent in many emerging econ-omies across Latin America (Hoskisson, Cannella, Tihanyi, & Faraci, 2004), Taiwan (Chung,2001), India (Ramaswamy, Li, & Veliyath, 2002), and elsewhere. Banks with a strong owner-ship position in a business group are often found in those countries whose capital markets arenot fully developed, such as the Philippines (Unite & Sullivan, 2003). Other business groupsare partly controlled by developmental financial institutions (e.g., George & Prabhu, 2000).Partial foreign ownership of groups can take place through investment by large internationalfirms engaging in foreign direct investment. Unlike banks or families that have an ownershipstake in business groups, foreign owners are usually less embedded in the social network ofthe group. In contrast, governments often play a more central role in emerging countriesthrough their ownership interests in local business groups (Kornai, Maskin, & Roland, 2003).We offer propositions regarding how these ownership positions might influence the directionand type of refocusing undertaken and their impact on overall organizational costs.

Background

Corporate Restructuring and Refocusing

Corporate restructuring has been a very popular strategy during the past 25 years. Theimpact of these activities has been felt in almost every sector of the U.S. and European econo-mies. Corporate restructuring encompasses multiple forms of change that we can separate intothree categories: asset restructuring, financial restructuring, and organizational restructuring(Johnson, 1996). Asset restructuring involves the sale or spin-off of businesses within the cor-porate portfolio leading to a refocused (predominantly lower) level of diversification(Markides, 1996). Financial restructuring encompasses leveraged buyouts (LBOs), stock

Hoskisson et al. / Refocusing in Diversified Business Groups 943

repurchases, and leveraged recapitalizations, whereas organizational restructuring entailsreorganizations within the firm that do not involve the sale or disposal of assets.1

In the current study, we are examining corporate refocusing. Corporate refocusing (John-son, 1996), downscoping (Hoskisson & Hitt, 1994), and dediversification (Markides, 1996)describe activities designed to reduce the number of businesses within the firm. This reductionin the businesses within the portfolio often involves a change in corporate diversification strat-egy (Hoskisson & Johnson, 1992). For example, the sale or spin-off of multiple businessesmay lead to a new portfolio that emphasizes a set of related or unrelated businesses. Thus, cor-porate refocusing represents asset restructuring that leads to a smaller firm with a concomitantchange in diversification strategy (Hoskisson, Johnson, & Moesel, 1994).

Emerging Economies and Corporate Refocusing

Emerging economies constitute about 20% of the global economy and 80% of the world’spopulation today. This group of countries has been receiving growing attention in the past twodecades because of their increasing share in world trade and foreign direct investment andtheir rising numbers owing to the collapse of the socialist system around the world (London &Hart, 2004). There is no uniform classification of countries as emerging economies, however.The term emerging economies originated from the International Finance Corporation (IFC), amember of the World Bank Group, in the early 1980s to distinguish those middle-incomeemerging markets where foreign financial institutions were allowed to buy securities. Inrecent years, the meaning of emerging economies has expanded to countries that were previ-ously labeled as developing countries. According to recent World Bank classifications,emerging economies in 2003 fell in the gross national income (GNI) range of $756 to $9,265per capita (World Bank, 2004). Because this relatively broad income classification includessome countries with little economic progress and others with inefficient socialist economicsystems, researchers tend to include additional qualifications when they study firm strategiesin emerging economies.

Emerging market economies from an institutional theory point of view are characterized bygovernment policies promoting the development of market-friendly institutions and byaccompanying relatively fast economic growth rates (Hoskisson et al., 2000; Wright et al.2005). Although there are substantial differences in the backgrounds of emerging economies,such as those of China, the Czech Republic, Malaysia, and Thailand, there are important simi-larities in their recent institutional development. According to neo-institutional economists,institutions in general are “the underlying determinant of the long-run performance of econo-mies” (North, 1990: 107). By building well-functioning market institutions, emerging econo-mies may be able to reduce their market imperfections and lower their cost of transacting(North, 1990).

Emerging economies traditionally suffer from deficiencies in areas such as transportationand telecommunications (Wan & Hoskisson, 2003), making it more costly for firms in thoseeconomies to transact with other firms. As a result of inefficient distribution systems, importrestrictions, and a lack of necessary capital, key raw materials are often unavailable to firms. Inaddition, necessary human resources, such as competent research scientists or well-trained


managers, are typically in short supply because of underdeveloped systems of education. Theaforementioned factors all contribute to increased transaction costs faced by firms.

Besides this lack of basic factor resources, the underdevelopment of necessary marketinstitutions greatly affects local firms conducting business in emerging economies (Wan,2005). Missing market institutions in these countries can include transparency in economicreporting; a stable currency; a stable government; liquid, well-functioning equity and lendingmarkets to fuel expansion and growth (cf. Hoskisson, Johnson, Yiu, & Wan, 2001); and astrong legal system to provide aggressive enforcement of property rights and a brake onopportunism, graft, and corruption (Devlin, Grafton, & Rowlands, 1998).

As emerging economies develop better market institutions, the cost of transacting maydrop substantially. Lower levels of transaction costs coupled with reduced uncertainty provideseveral advantages for local firms. Local firms in general may be able to benefit fromimproved access to capital and other resources. Clearer ownership structures and improvedcapital market allocation open the doors to foreign direct investment. At the same time, how-ever, institutional reforms may present new threats to local firms in emerging economies. Fre-quent changes in government policies are a general source of environmental uncertainty(Ramamurti, 2000). Governments in emerging economies, for instance, tend to implementextensive privatization policies, leading to an inflow of new competitors and widespreadfinancial distress for firms that are unwilling or unable to change (Megginson & Netter, 2001).Thus, although the overall level of transaction costs may be lower as market institutionsdevelop, the increased number of entrants likely results in increased competition for localfirms.

Although emerging economies appear to present dynamic environmental conditions for alllocal firms, the propensity to refocus in this setting may be different among local firms owingto differences in their ownership structures (La Porta et al., 1999). Firms in emerging econo-mies, for example, are often parts of diversified business groups. Recent research indicatesthat, when faced with environmental challenges, business groups’ refocusing responses maydiffer from those of independent firms (Hoskisson, Cannella, et al., 2004). We argue that therefocusing of business groups in emerging economies represents a unique trade-off betweentransaction and organizational costs. To fully understand business group refocusing, we mustfirst examine the origins of business groups and their role in emerging economies.

Emerging Economies and theRole of Diversified Business Groups

Business groups are the dominant form of business organization in many emerging econo-mies (Ghemawat & Khanna, 1998; Khanna & Palepu, 2000). For instance, the largest 2,800business groups in the People’s Republic of China contribute approximately 60% of China’sindustrial output (State Statistical Bureau, People’s Republic of China, 2000). In Korea, the 30largest business groups comprise 40% of the country’s economic activity (Chang & Hong,2000). Three major discipline-based explanations have been given as to why business groupsare so prevalent in emerging economies. These are the political economy, the sociological, andthe economic viewpoints.


The political economy viewpoint emphasizes the role of government in establishing busi-ness groups. This view suggests that governments can actively encourage the formation ofbusiness groups by providing access to capital such as loan guarantees in order to facilitateeconomic development (Amsden, 1989; Guillén, 2000). Governments can also passivelyencourage business group formation when high levels of government corruption are present.In such circumstances, businesses with preferential access to government officials may find itlucrative to diversify in order to leverage government favor across multiple industries (Evans,1979; Ghemawat & Khanna, 1998).

The explanation of business groups by economic sociologists highlights the importance ofinterpersonal relationships (Strachan, 1976). According to this perspective, business groupsare “collections of firms bound together in some formal and/or informal ways” (Granovetter,1994: 454). Much of the work in this stream has suggested that business groups grew some-what naturally out of family, clan, and other interpersonal relationships. For example, Fields(1995) studied the similarity between business groups and extended families, complete withpatriarchs, inheritance rules, and mechanisms of discipline and control. More recently,Keister’s (1998) research focused on the ability of interlocking boards of directors amonggroup-affiliated firms to facilitate information flow within Chinese groups.

The third view of business groups is based on institutional economics (e.g., Leff, 1976,1978). According to this view, firms seek to overcome deficiencies in emerging economyresource markets and institutional frameworks by banding together into diversified businessgroups. Such business groups can provide internal capital, labor, material, and technologymarkets, allowing their member firms to transact more efficiently (Chang & Choi, 1988;Khanna & Palepu, 1997, 2000). Lacking a strong external capital market in emerging econo-mies, large businesses in more mature industries often lack a satisfactory mechanism to investtheir cash in additional rent-generating activities. At the same time, smaller firms in rapidlygrowing industries have difficulty in obtaining the necessary funding needed to develop newproducts and to extend into new markets. However, when both the mature and the growingfirm are placed together under the umbrella of a business group, the more mature firm can pro-vide the capital needed by the smaller firm (Guillén, 2000). Such cross-subsidies can boost theoverall performance of business group–affiliated firms.

In contrast to research on refocusing in developed economies, empirical research on busi-ness group refocusing in emerging economies tends to highlight the impacts of externalforces, including institutional changes (Ghemawat & Khanna, 1998; Hoskisson et al., 2001).In a study of business group refocusing in French civil law countries (which included emerg-ing as well as developed country business groups), Hoskisson, Cannella, and colleagues(2004) found that deregulation and increased competition led to increasing levels of refocus-ing among independent firms but decreasing levels of refocusing among group-affiliatedfirms. The authors also reported that increased country development led to significantly morerefocusing among group-affiliated than among independent firms.

Although many of the institutional and economic challenges that contributed to the preemi-nence of the business group continue to exist to a substantial degree, most emerging econo-mies have made substantial improvements in their economic systems during the past severaldecades (Hoskisson et al., 2000). Paradoxically, these improvements have often been detri-mental to the performance of business groups because previous market-substitute mecha-


nisms internal to business groups have become unnecessary or outdated. For example, Khannaand Palepu (2000), in studying business groups in Chile, found that, as market institutionsdeveloped, business group affiliation performance benefits “atrophied” over time. As a resultof these external pressures, business groups have become increasingly involved in refocusingactivities (Hoskisson et al., 2001). In the following section, we develop a framework in whichthe refocusing of emerging economy business groups is explained as an attempt to balancetransaction and organizational costs, to achieve an appropriate balance of diversificationwithin the group, and to facilitate overall business group performance.

Institutional Changes andDiversified Business Groups

One of the most significant changes taking place in emerging economies is the changingrole of government intervention. Governments of most emerging economies in recent yearshave started to liberalize foreign trade and foreign direct investment (Sougata, 2003). Suchliberalization typically diminishes the asymmetries in foreign trade and direct investment,exposes local firms to foreign competition, and decreases the ability of local firms to obtainpreferential government treatment (Guillén, 2000). In addition to trade liberalization, wide-spread privatizations have been implemented in many countries to further improve economicefficiency (Megginson & Netter, 2001; Ramamurti, 2000). The increased opportunities pre-sented by developing market institutions, on one hand, and the growing environmental com-plexity that has resulted from greater competition, decreased government involvement, andprivate owners, on the other hand, have provided incentives to local firms in emerging econo-mies to refocus their operations (Guillén, 2000). When institutions change in emerging econo-mies, refocusing on a set of core businesses may be appropriate for groups to sustain theircollective competitive advantage.

We argue that institutional changes focusing on market development affect the overalltransaction costs in an economy as well as the organization costs experienced by businessgroups. The notion of institutional change provided by neo-institutional economists is particu-larly pertinent in considering the underlying level of overall transaction costs as marketsdevelop in emerging economies. North (1990) suggested that the overall costs of transactionsin an economy exhibit a significant sensitivity to the market institutions in a country’s environ-ment. Such institutions constitute constraints as well as incentives for economic actors in theirmarket exchange (Peng, 2003; Wan, 2005). If legal infrastructure is not in place to protect con-tractual relationships, transaction costs may be high, and firms will be less likely to engage ineconomic transactions. Under these conditions, business groups may act as substitute mecha-nisms for missing market institutions, including government bureaucracy (Keefer & Knack,1997), legal enforcement (Clague, 1997), and societal trust levels (Fukuyama, 1995). If, how-ever, intellectual and property rights protections improve; capital, labor, and product marketsmature; and market intermediaries arise, business groups become less important. Under theseconditions, business group refocusing may become a distinct possibility. Ultimately, thiswould mean that the scope of business groups’ diversification would be reduced, potentiallyleading to increased efficiency (Kim, Hoskisson, Tihanyi, & Hong, 2004).


Similarly, a diversified business group would experience different organizational costsdepending on the level of diversification (Hill & Hoskisson, 1987). The inner workings of abusiness group typically resemble the multidivisional (M-form) structure (Chu, 2001). TheM-form structure, which facilitates the span of control for managing a set of diversified busi-nesses, is characterized by a central corporate office and semiautonomous divisions or subsid-iaries (Williamson, 1975). The M-form structure has more hierarchical control and coordina-tion than holding company forms involving legally independent firms. Thus, theorganizational challenges for managing diversified business groups might be similar to thosefacing diversified M-form firms in that organization costs would increase as the number ofaffiliated firms increases.

The proposed relationships between business group diversification and transaction andorganizational costs are illustrated in Figure 1. The downward-sloping transaction cost curve(TC1) represents the overall transaction costs in an economy produced by the legal infrastruc-ture and the available market institutions. The upward-sloping curve (OC1) represents theaverage organizational costs in a country that a diversified business group experiences to con-duct internal transactions. The overall cost from the given set of market institutions would berealized at the intersection of the transaction cost and organizational cost curves, where thecombined transaction and organization costs are the lowest. Thus, the overall optimal com-bined transaction and organization costs would be realized at Point A in Figure 1. This wouldbe the set point for the average level of diversification based on these costs for business groupsin an emerging economy.

Institutional Transition, Transaction Costs,and Pressure to Refocus

As Figure 2 illustrates, when market institutions have evolved such that there is better legalprotection for transactions, more capital available in the market, better financial intermediar-ies, and a more developed product market, overall transaction costs are lowered in the emerg-ing economy. This lower level of transaction costs is illustrated by curve TC2. The new loweroverall transaction cost level decreases the need for internal group markets and broad levels ofdiversification in diversified business groups. As such, the optimal level of diversification inthe overall economy would be lowered for these business groups (Point B). Accordingly, therewould be an incentive for refocusing to lower the level of diversification. In effect, the largeunrelated diversified business groups would no longer be as necessary as substitutes for mar-ket institutions. Thus, the continued development of institutions exerts pressure on largebusiness groups to reduce their levels of diversification.

External and Internal FactorsThat Influence Refocusing Activity

Although lower overall transaction costs create an incentive to refocus, business groupsmay not initiate refocusing immediately. Several important external and internal factors cantrigger the refocusing decisions of business groups. We explain below the most relevant exter-



Costs

Business Group Diversification

Transaction Costs

Organization Costs

A B

TC 1

TC 2

OC 1

Figure 2Potential for Business Group Refocusing

With Institutional Changes (Improvements)


Transaction Costs

Organization Costs

Costs

A

OC 1

TC 1

Figure 1Costs and Business Group Diversification

nal and internal circumstances that may either lead groups to initiate or may hinder refocusing.External factors include (a) external shocks, (b) external control mechanisms, (c) variance incountry policy toward developing market-oriented institutions, (d) market power and compe-tition, and (e) country cultural factors. Internal factors include (a) poor performance, (b) lead-ership, and (c) organizational culture and trust. We discuss the importance of these factorsbelow and develop propositions to summarize the logic offered.

External Shocks

The need for refocusing of business groups may not only be due to institutional changessuch as the development of more market-based systems in emerging economies. Variousshocks or crisis events in many emerging economies have dramatically increased the pressurefor business groups to refocus (Khanna & Palepu, 1999). For example, the Asian currency cri-sis that began in 1997 (Haggard, 2001) and the decline of the Soviet Union and its movetoward market reforms (cf. Filatotchev, Buck, & Zhukov, 2000) have all affected refocusing invarious ways.

Although the Asian financial crisis began in 1997, its aftereffects are still present andencourage reform (Haggard, 2001). The crisis itself led to dramatic decreases in currency val-uation even in resilient economies such as Hong Kong and Singapore. As currency values fell,so did the value of corporations operating in these countries (Bruton, Ahlstrom, & Wan, 2001).Likewise, unemployment rose and currency reserves fell. The decline made it very clear thatthere were widespread problems with macroeconomic institutions, ineffective firm strategies,and mismanagement. There can be no question that profound structural changes are takingplace in Southeast Asia today. Increases in foreign competition from China and India, the pres-ence of global competitors, and the recent deregulation of many sectors in the economy haveled to the need to adapt to these new environmental contexts through refocusing to new busi-ness models that are more effective. However, it has taken the currency crisis to sparkrefocusing in many firms in Southeast Asia.

Proposition 1: Business groups operating in countries with macroeconomic shocks will be morelikely to refocus than business groups operating in countries without macroeconomic shocks.

External Control Mechanisms

One fundamental difference between firms operating in developed market economies andfirms operating in emerging economies is the lack of external control mechanisms to disci-pline inefficient managers in the latter. The market for corporate control is not developed to theextent that it can help to resolve inefficiencies. Thus, takeovers are largely absent in manyemerging economies (although this is beginning to change). This is important becauseresearch in developed economies suggests that takeovers can spark refocusing activities(Berger & Ofek, 1999).

Part of the reason the market for corporate control is less active is the high degree of politi-cal power retained by large business groups. This may lead to government protection from


takeover attempts. Second, shareholder rights have not been protected to the extent necessaryto facilitate change. Accordingly, shareholders may worry about losses in such exchanges.Third, the market for corporate control is an adversarial process characterized by winners andlosers, conflict, and loss of face. In societies such as those in Southeast Asia that emphasizeharmony, reciprocity, and the preservation of face, adversarial processes are often ignored orshunned (Carney, 2004). The lack of an active market for corporate control, adequate share-holder protection, and cultural biases against adversarial processes serve to reduce the amountof refocusing and may help entrench managers of business groups (Bruton et al., 2001;Filatotchev et al., 2000).

Proposition 2: Business groups operating in countries with a more active takeover market will bemore likely to refocus than business groups operating in countries with a less active takeovermarket.

Variance in Country Policy TowardDeveloping Market-Oriented Institutions

One of the primary objectives for economic reform in Eastern Europe, the former SovietUnion, and China was to increase productivity by dismantling the centrally planned econo-mies present in those countries (Filatotchev et al., 2000). Through the use of large-scale privat-ization of state-owned enterprises, local governments hoped that such removal of major con-straints on managerial action coupled with improved managerial incentives would allowwidespread refocusing of newly privatized firms. However, there have been significant varia-tions among the privatization policies of different countries owing to their path-dependentinstitutional development (Boisot & Child, 1996; Nee, 1992; Xin & Pearce, 1996).

In the case of Russia, the centralized planning system was replaced through mass privatiza-tion by means of vouchers issued to all adult citizens. As government ownership declined,decision making and overall control of independent firms became decentralized (Filatotchevet al., 2000). In China, however, control is still very centralized despite the privatization pro-cess (Carney, 2004). Part of the reason for this may be political; Chinese state-owned enter-prises (SOEs) are burdened with social welfare responsibilities. As such, the difficulty inimplementing a large-scale privatization program is seriously undermined by the role of thestate in economic exchange. However, Blanchard and Shleifer (2001) argued that in transitioneconomies, where weak institutions fail to support economic growth, a strong central govern-ment could play an important role. Accordingly, the refocusing that has taken place in Chinahas been more orderly, with less employment displacement.

Alternatively, much of the refocusing activity in Russia has involved downsizing (e.g., lay-offs) (Djankov & Murrell, 2002; Filatotchev et al., 2000). Given that most of the firms areeither single-business or vertically integrated firms, widespread asset refocusing through sell-offs is not entirely feasible. The lack of institutional development and resulting limited foreigninvestment are hindering change in Russia (Hitt, Ahlstrom, Dacin, Levitas, & Svobodina,2004). Filatotchev and colleagues (2000) found that financial institutional shareholdings werepositively related to downsizing, but managerial ownership was negatively related. Their


results suggested that managerial ownership is serving to entrench management potentially tothe detriment of firm productivity.

Research has suggested that privatization, on average, is positively related to refocusing(Djankov & Murrell, 2002). Djankov and Murrell (2002) evaluated more than 100 studies in ameta-analysis on privatization and reported that increased private ownership leads to morerefocusing. Interestingly, results for privatization in the Commonwealth of Independent States(those states formerly associated with the Soviet Union) are insignificant, whereas results inSoutheast Asia have been positive. They also found that state ownership in traditional state-owned enterprises is less effective than all other ownership types except worker owners in pro-moting refocusing. Therefore, the level of privatization may affect the degree of businessgroup refocusing.

Proposition 3: Business groups operating in countries that implemented mass privatization policieswill be more likely to refocus than business groups operating in countries that implemented grad-ual privatization policies.

Market Power and Competition

Another factor that can influence the decision of whether to undertake refocusing activityis the degree of market power the business group has. As noted by Carney (2004), macro-institutional change often involves distributional struggles (such as potential entry into a par-ticular market space) that mobilize coalitions of actors to defend their shared interests. In thecase of Southeast Asia, business groups often form an elite group of politically connectedfirms that may have the power to perpetuate their positions in the face of increased deregula-tion and competition (Carney, 2004; Haggard, 2001). Thus, business groups may be able toforestall refocusing activity, relative to independent firms (Hoskisson, Cannella, et al. 2004)when faced with deregulation and increased competition from both foreign and domesticfirms (Kim et al., 2004). Independent firms may not benefit from the same level of marketpower, political connectedness, or the support of a group of businesses that reduce businessrisk (Tan & See, 2004).

Proposition 4: More powerful business groups will generally be slower to refocus than less powerfulbusiness groups or independent firms.

Country Cultural Factors

One of the principal external factors that may affect refocusing in emerging economies iscultural differences. For example, Southeast Asian and U.S. firms operate under two differentbasic cultural models. In the United States, the prevailing culture is one of confrontation.Examples include the active market for corporate control, willingness to dismiss CEOs, anddownsizing. Alternatively, firms in Southeast Asian countries operate more within a contextof consensus or cooperation. Preservation of face, harmony, reciprocity, and decision making


based on consensus require different sets of rules and relationships (Xin & Pearce, 1996). Ineffect, the prevailing culture fosters the use of relational norms or contracting that serve as asubstitute for market-based forces (Nee, 1992). Tan, Luo, and Zhang (1998) argued that fearof failure may lead to less risk taking and avoidance of uncertainty. A culture that does not sup-port risk taking or market-based forces may experience less proactive change.

Interestingly, these cultural differences may be changing over time. Fisher, Lee, and Johns(2004) examined business turnarounds in Australia and Singapore, dismissal of the CEO, andownership change and found that as the regulatory climate and market institutions improved,cultural differences did not have the same impact they did prior to the aforementionedimprovements. This suggests that less-developed economies may adopt refocusing strategiesmore similar to Western countries as their institutional infrastructures advance.

Proposition 5: Business groups operating within countries that emphasize relational norms or con-tracting will be less likely to refocus than business groups operating in countries that do notemphasize relational norms.

Poor Performance

As noted above, there are a number of internal factors that may lead to refocusing. Priorresearch in developed economies (Johnson, 1996) has suggested that poor performance maybe one such factor. This may occur directly, as happened following the Asian financial crisiswhen groups in many of the affected countries came under strong pressure to refocus theiroperations to improve performance (Haggard, 2001). Alternatively, poor performance mayindirectly result in refocusing, such as when it leads to a takeover attempt and a firm refocusesto try to avoid the takeover (Markides, 1996).

Proposition 6: Business groups exhibiting poor performance are more likely to refocus than businessgroups exhibiting strong performance.

Changes in Leadership

Poor performance may also lead indirectly to a leadership change and to subsequent refo-cusing. Bruton and colleagues (2001) have noted that poor performance in Asian firms has ledto increased CEO dismissal. The new CEO, then, is more likely to undertake refocusing effortsto stem the decline in performance. When market institutions have evolved and overall trans-action costs are lowered in the country economy, a leadership change may more readily allow afirm to respond to the pressure for reducing level of diversification. In this regard, as noted ear-lier, privatization through voucher or “giveaway” schemes is highly unlikely to influencestrong changes if the leadership in the organization follows the mentality from the previouscentral planning regime (Filatotchev, Wright, Uhlenbruck, Tihanyi, & Hoskisson, 2003). In anemerging economy, because a change in mind-set may be necessary, a change in leadershipcan be important to trigger appropriate refocusing activities. Recently, Berger and Ofek (1999)


found that refocusing in developed economies was much more likely, relative to a controlgroup of firms, when there was top management (CEO) turnover. As a result, a change in lead-ership can be important to trigger appropriate refocusing activities.

Proposition 7: Business groups with higher top management team turnover are more likely to refocusthan business groups with low levels of top management team turnover.

Level of Organizational Trust

The level of organizational trust may be another important internal predictor of refocusingactivity (Bromiley & Cummings, 1995). Relational contracting refers to personalizedexchanges governed by tacit commitments that serve to maintain the continuing relationship(Ring & Van de Ven, 1992). Components of relational contracting are present in reputation(Khanna & Palepu, 1997), social capital (Uzzi, 1997), and guanxi (Xin & Pearce, 1996). Rela-tional norms and contracting are generally fostered by trust between firms, groups, and indi-viduals (Ring & Van de Ven, 1992). Empirical evidence demonstrates that in some social set-tings, humans exhibit trustworthy behavior (Bromiley & Cummings, 1995). As noted byBromiley and Cummings, the presence of trust within the organization may serve to reducetransaction costs. Specifically, internal costs related to monitoring, enforcement, comprehen-sive contracts, and control systems may be reduced.

Within the context of business groups in emerging economies, one can make a similar argu-ment. With increased trust, the costs of controlling multiple businesses in the business groupand the costs of making, monitoring, and enforcing implicit and explicit contracts within thebusiness group should be reduced. Therefore, firms with higher levels of trust within the orga-nization may operate with an organizational culture characterized as having lower organiza-tional costs. Conversely, business groups operating with a culture of lower trust would exhibithigher organizational costs. Thus, if these organizational costs (internal costs) are greater thanthe transaction costs associated with market-based transactions (external costs), then it may bemore efficient to refocus the business group.

Proposition 8: Business groups that exhibit lower levels of trust are more likely to refocus than busi-ness groups exhibiting higher levels of trust.

Ownership Influences and the Outcomes of Refocusing

Once a decision is made to refocus, the outcome of refocusing activity is shaped by theinterests of dominant owners. For example, owners are likely to have a strong influence on thetype of diversification strategy and associated organization structure that would be imple-mented. Two dominant forms of strategy we will consider here are unrelated and related diver-sification strategies. The most efficient organizational structure associated with the unrelateddiversified strategy is the competitive M-form structure, whereas the related diversified strat-egy is most efficiently paired with the cooperative M-form structure (Hoskisson, Hill, & Kim,1993). Competitive M-form organizations are characterized by significant divisional auton-


omy and accompanying decentralization of strategic control such that divisional managers areaccountable for division performance. As such, the evaluation of divisions is primarily basedon objective financial criteria, and cash flow is allocated among divisions from headquarterson a competitive basis.

Alternatively, in firms using the cooperative M-form structure, coordination between divi-sions is necessary to realize economies of scope through transferring skills and sharingresources among divisions (Hill, Hitt, & Hoskisson, 1992). Coordination between divisions isfacilitated through incentive systems of divisional managers, which are linked to corporate, orgroup, as well as divisional performance. Markides and Williamson (1996) found that thecooperative M-form is more effective than the competitive M-form at realizing synergiesinherent in related diversification. However, the cooperative M-form is more expensive tomanage and thus, as firms move toward relatedness in the cooperative M-form structure, theyexperience increased organizational costs (Jones & Hill, 1988).

For instance, Kim and colleagues (2004) outlined two large Korean chaebols’ (LG andHyundai) refocusing efforts in response to improved institutional infrastructure. LG reducedits size as well as its level of diversification (although it still has a large unrelated component)and pursued a competitive M-form structure. Alternatively, Hyundai Motor Group sold offbusinesses and refocused into a related-diversified group of firms similar to a cooperative M-form.

If, as our model suggests, business groups decide to employ more focused strategies suchas related diversification or vertical integration, then new organizational structures would berequired. As the M-form literature suggests, more cooperative M-form structures would benecessary (Hill et al., 1992). Concomitantly, this would drive up organizational costs in orderto facilitate coordination between related businesses in diversified business groups. We illus-trate this condition in Figure 3. The increase in organizational costs to implement more coop-erative M-form structures in business groups is represented by curve OC2.

Various ownership structures may provide incentives or disincentives to focus on one or theother of these diversification strategies and structural positions and thus may influence thenature of the refocusing taken by a particular business group. Much of the previous researchfrom developed economies has classified basic ownership patterns into two groups, insidemanager-dominated groups and outside owner-dominated groups. This same research hasalso suggested that one or the other ownership structure tends to dominate the decision makingregarding refocusing (Hoskisson & Turk, 1990). However, these prior studies may underesti-mate the different incentives associated with a larger variety of ownership groups. This isespecially true for the different ownership patterns associated with business groups in emerg-ing economies (Ramaswamy et al., 2002). Even in the context of the United States or othermore developed countries, research has demonstrated that different owners are related to dif-ferent corporate-level strategies (David, Kochhar, & Levitas, 1998; Hoskisson, Hitt, Johnson,& Grossman, 2002).

In the finance literature, Brickley, Lease, and Smith (1988) have likewise developed athree-part classification of owners in the United States. Pressure-sensitive owners are suscep-tible to the influences of power exercised by firm managers. However, pressure-resistant own-ers tend to have clear profit and growth objectives for the firm, relatively independent from thegoals of the firm’s management. The group of pressure-indeterminate owners plays a passive


role in some situations and a marginally active role in others. David and colleagues (1998)suggested that mutual and pension fund investors are pressure-resistant in that they can inter-vene in decision making “without fear of retribution.” However, banks cannot easily followthe same course because much of their income is tied to interest derived from lending to targetfirms (Hoskisson et al., 2002). Thus, type of owner as well as amount of ownership will beimportant considerations in examining the motivation of owners in business groups refocus-ing in emerging economies. We offer propositions regarding the different incentives of ownersconcerning the desired type of refocusing as depicted in Figure 4.

Family Ownership

Dominant family ownership of a business group often implies control by an extended fam-ily even if they do not own a 50% majority (Chang, 2003; Chung, 2001; Ramaswamy et al.,2002). For example, Malaysian-based YTL Corporation was founded in the 1920s as a timberbusiness. Today the firm is run by the grandson of the founder and includes real estate, powergeneration, and information technology businesses (Kennedy, 2002). In groups with a strongfamily ownership position, the descendants of group founders control group-affiliated firmsthrough both equity stakes and complex legal structures (Chang, 2003). In such groups, it iscommon for each of the group affiliates to be led by a different family member.

Similar to research on emerging markets, research by Palmer, Friedland, Jennings, andPowers (1987) suggests that large diversified corporations in the U.S. context are much slower


Costs


Transaction Costs

Organization Costs

A B

OC 1

OC 2

TC 1

TC 2

Figure 3Potential for Business Group Refocusing With Increases in Organizational Costs

to adopt decentralized strategies for fear of losing power or hierarchical control. Accordingly,their research indicates that family-owned firms were less likely to adopt the multidivisionalstructure, which became prominent in the 1950s and 1960s among large U.S. corporations.Similarly, large diversified business groups in emerging economies such as Korea have main-tained family control and usually more centralized control of operations even though thegroups were quite diversified (Kim et al., 2004). Chang (2003) suggested that concentratedownership may create an incentive for the family owners to expropriate wealth from the sub-sidiary businesses of a large diversified business group.

Bertrand, Mehta, and Mullainathan (2002) suggested that the relationship between owner-ship and wealth appropriation may be attributable to “tunneling.” This refers to transferringresources from firms in which a controlling family holds relatively small cash flow rights to abusiness group subsidiary in which the family owns substantial cash flow rights. In this way,firms can expropriate value from minority shareholders (Bergstrom & Rydqvist, 1990). Inbusiness groups in emerging economies, it is likely that the refocusing choice would be a veryconstrained type of diversification such as related constrained or vertical integration. Throughstrategies such as vertical integration, where there are significant internal sales to the businessgroup, transfer-pricing strategies can be employed that may facilitate tunneling. In fact,Chang’s (2003) research suggests that performance drives ownership and not the other wayaround. In other words, families pursue ownership in firms that are highly profitable inside thebusiness group, ostensibly to allow better and more profitable resource transfers for family useas well as growth of the business group. Research in finance (Claessens, Djankov, Fan, &Lang, 2002) also suggests that this type of ownership can lead to managerial entrenchment.

With regard to refocusing strategies, family-owned business groups would likely movetoward related constrained diversification or vertical integration when a refocusing opportu-


Ownership Type Related Refocusing Unrelated Refocusing

Family

Developmental

Financial Institutions

Foreign

Bank

Government

Figure 4Ownership Incentives for Refocusing

nity presents itself through changes in the institutional environment. For example, Thailand’sCentral Group, controlled by the Chirathiwat family, refocused operations after the 1997financial crisis by closing more than 120 subsidiaries and outsourcing many noncore opera-tions (Polsiri & Wiwattanakantang, 2004).

Proposition 9: Compared to other ownership positions in emerging economies, a business group witha dominant family ownership position is more likely to adopt a narrowly scoped diversificationstrategy with a highly related group of businesses.

Developmental Financial Institutions

Developmental financial institutions (DFIs), similar to pension fund investors, might alsohave specific influences given their ownership positions in diversified business groups. Forexample, the World Bank has a subsidiary DFI called the International Financial Corporation,which has an $8 billion budget to invest in privatization programs (George & Prabhu, 2000).Countries also have DFIs, which may specialize in financing specific industries (e.g., agricul-ture) or firm size (e.g., small businesses). For example, the Industrial Development Bank ofIndia has an asset base of $10 billion and offers a broad scope of services to facilitate invest-ment (George & Prabhu, 2000). These institutions are often “pressure resistant” in the classifi-cation proposed by Brickley and colleagues (1988). Accordingly, they are likely to activelyprovide suggestions to the management of the business group, which would help the groupavoid wealth-destroying strategies, such as tunneling, found to be associated with broaderfamily ownership (Chang, 2003).

Because DFIs are large block shareholders, they are likely to provide monitoring behaviorssimilar to active institutional investor shareholders in developed economies (Gillan & Starks,2003). David, Hitt, and Gimeno (2001) suggested that institutional shareholders are often vig-ilant in guarding against opportunistic managerial and other owner behavior that would resultin wealth-destroying tunneling. In general, however, because institutional investors have adiversified portfolio, they would want firms to be more focused (Hoskisson et al., 1994;Hoskisson & Turk, 1990), but without the tunneling associated with family ownership(Hargis, 1998). This would indicate that they would support refocusing leading to reduced lev-els of diversification for business groups in emerging economies.

Proposition 10: Compared to other ownership positions in emerging economies, a business groupwith a strong developmental financial institution ownership position is more likely to adopt a nar-rowly scoped diversification strategy with a moderately related group of businesses.

Foreign Ownership

Large foreign investors would likely be “pressure resistant” as well because they have aunique relationship with the managers of the business group. They may form joint ventures (orequity alliances) with local companies through large block ownership positions, and, there-fore, they may closely monitor the venture. Also, because they may have significant under-


standing of the business and they do not fear retribution from a client relationship as a bankwould, they have both better information and motivation to closely monitor strategic behaviorof the business group. For instance, through a merger with International Steel Group, MittalSteel Company (based in the Netherlands) has become the world’s most global steel producer.Mittal has been buying large steel operations in Eastern Europe and in other emerging marketcountries and consolidating and refocusing the older operations and building more efficientfacilities (Reed & Arndt, 2004). Unlike banks, families, or governments that can control busi-ness groups, foreign owners are usually less embedded in the social network of the group. Assuch, the proportion of ownership controlled by foreign investors would likely have a negativeimpact on unrelated diversification similar to developmental financial institution ownership.

Accordingly, the refocusing that might be done when an opportunity arises would mostlikely result in a narrowing of the scope of the firm. However, the impact of foreign ownershipin regard to strategy and structure would depend more on the particular strategy desired ratherthan an emphasis on narrow versus broad levels of diversification. Thus, the incentive wouldbe to generally refocus more narrowly but do it in a way that tends to support the particularstrategy of the joint venture. For example, if the joint venture intended to foster vertical rela-tionships as in a buyer-supplier arrangement, then the particular diversification strategy wouldfollow from this strategic intent. If the joint venture was created to produce technologicallyadvanced products, then perhaps a more related and cooperative diversification strategy wouldlikely be pursued.

Proposition 11: Compared to other ownership positions in emerging economies, a business groupwith a strong foreign ownership position is more likely to adopt a narrowly scoped diversificationstrategy with a moderately related group of businesses.

Bank Ownership

Compared to family, DFI, and foreign ownership, bank ownership might provide an incen-tive for diversified business groups to refocus their portfolio of businesses in a different man-ner. In a group with a strong bank ownership position, the focal bank may provide and facili-tate resource allocation among group member firms. Although such banks may provide helpand support during times of financial distress (Aoki, 1988; Hoshi, Kashyap, & Scharfstein,1990), Brickley and colleagues (1988) classified banks and banking companies as “pressure-sensitive investors.” This is due to the relationship they have with firms in which they may alsoinvest. In large part, they are dependent on these firms for their income and the interest theyderive off loans provided to client corporations. They also receive fees by providing servicesto customer firms. Often banks are associated with large diversified networks as well and mayeven be partially owned by a business group (Hoskisson et al., 2001). In emerging economies,such banks may be closely associated or partly owned by the families connected with thesebusiness groups. Such banks may also be closely associated with the government and may nothave experienced significant competition in the banking environment.

Because the largest firms in emerging economies tend to be associated with businessgroups, banks may gravitate to establishing client relationships with these large diversifiedbusiness groups (Ramaswamy et al., 2002). Connection to these large business groups allows a


bank to increase its portfolio in which to receive interest from loans and fees for services pro-vided. Business with diversified business groups reduces transaction costs and facilitates rela-tionship-type banking. Accordingly, if there is significant bank ownership in large diversifiedbusiness groups, it is likely that refocusing would result in more unrelated-type strategies(Ramaswamy, Li, & Petitt, 2004). In turn, unrelated diversification would broaden the numberof businesses through which a bank might create business. At the very least, banks would beless likely to either pressure large client business groups to sell off businesses or encouragethem to refocus their operations.

Proposition 12: Compared to other ownership positions in emerging economies, a business groupwith a strong bank ownership position is more likely to adopt a broadly scoped diversificationstrategy with a mix of related and unrelated (related-linked) groups of businesses.

Government Ownership

Although bank ownership is expected to be associated with refocusing that maintains highlevels of unrelated diversification, the association between government ownership in a privat-ized business group and refocusing favoring unrelated diversification may be even higher.Andrews and Dowling (1998) suggested that the government seldom tracks the performanceof firms in which the government has a substantial ownership position. Ramaswamy and col-leagues (2002) found that government ownership did not have an influence on Indian busi-ness groups and thus concluded that the government might be classified as a pressure-indeterminate investor (Brickley et al., 1988). Thus, government ownership may lower moni-toring intensity, resulting in a diversification pattern that is more haphazard and unrelated.

However, business groups in some countries might have political motives for consciouslyfavoring unrelated diversification. For instance, Chinese business groups that are newlyformed and have significant government ownership might pursue unrelated diversificationand avoid refocusing in order to employ as many individuals as possible (Dharwadkar,George, & Brandes, 2000; Thomsen & Pedersen, 2000). Employment in most previously cen-trally planned economies is associated with social welfare issues such as housing, medicalbenefits, and even educational opportunities. Refocusing often reduces head count, and busi-ness groups that have significant government ownership and large employee bases might bepolitically motivated to pursue the objective of maintaining low unemployment versus pursu-ing other types of refocusing (Hoskisson, Yiu, Bruton, & White, 2004). Thus, groups con-trolled by the government (whether it be local or central government) are likely to have sizablediversified operations and resist refocusing efforts that would reduce employment levels(Hoskisson et al., 2001). However, as institutions change in an economy such as China, otherownership influences, especially foreign investment and mutual fund investment, mightreduce the emphasis on unrelated diversification.

Proposition 13: Compared to other ownership positions in emerging economies, a business groupwith a strong government ownership position is more likely to adopt a broadly scoped diversifica-tion strategy with an unrelated group of businesses.


Conclusion

As described in this article, refocusing in emerging economy business groups is likely toreduce the overall level of diversification in such groups, given the movement towardincreased market-oriented institutions in emerging economies. An important question forfuture research is to address whether the business group organizational form will disappear aseconomic development continues. As noted in the introduction, business groups continue toexist even in developed economies. Perhaps, as the Tata Group in India, business groups willadapt through refocusing to meet new environmental circumstances (Kripalani, 2004). Indeveloped economies, “institutional voids” may continue to exist allowing business groups toserve an appropriate function (Khanna & Palepu, 2000). The path dependence of institutionaldevelopment may also create differences among countries such that business groups continueto survive. Collin (1998) and Gerlach (1997) argued that business groups continue to exist inSweden and Japan because of distinctive political, cultural, and sociological differences inthese countries.

It is hoped that this review will provide a foundation for research on the refocusing of diver-sified business groups as these groups seek to develop more efficient strategies and structuresthat are matched to the institutional environment of their countries of origin. Future research isneeded to not only understand the overall external and internal organization costs and theeffects of various ownership arrangements but also to better understand the idiosyncraticexternal and internal organizational issues that may foster or hinder refocusing activities andthe strategic direction that refocusing takes. Although we have offered a number of importantfactors that might be considered in future research, there may be others that will emerge asresearch proceeds.

Note

1. Corporate restructuring as defined here from the point of the view of the strategy literature is focused on portfolioreorganization and has little to do with actual changes in organizational structure. Although we talk about changes inorganization structure, they are associated with changes necessary to implement a particular type of diversificationstrategy (related versus unrelated). For more on the specific structure types discussed in our article, see Hoskisson,Hill, and Kim (1993).

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Biographical Notes

Robert E. Hoskisson is the W. P. Carey Chair and a professor of strategic management in the Department of Manage-ment at Arizona State University’s W. P. Carey School of Business. He received his Ph.D. from the University of Cali-fornia, Irvine. His research topics focus on large diversified business groups, corporate governance, corporate innova-tion strategies, corporate and international diversification strategy, acquisitions and divestitures, strategies inemerging economies, privatization, and cooperative strategy.

Richard A. Johnson is a professor of management and currently holds the Puterbaugh Chair in American Enterprisein the Price College of Business at the University of Oklahoma. He received his Ph.D. from Texas A&M University.His current research interests include international diversification, corporate refocusing in domestic and internationalfirms, corporate governance, international entrepreneurship, and initial public offers.

Laszlo Tihanyi is an associate professor of management in the Mays Business School at Texas A&M University. Hereceived his Ph.D. from Indiana University. His research interests include international strategies, corporate gover-nance in multinational firms, and organizational adaptation in emerging economies.

Robert E. White is pursuing a Ph.D. in strategic management at Arizona State University. His research interestsinclude corporate governance, business groups, and corporate political activity.


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