Management Papers

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Journal Article

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Strategic Management Journal





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The resource-based view on firm diversification, subsequent to Penrose (1959), has focused primarily on the fungibility of resources across domains. We make a clear analytical distinction between scale free capabilities and those that are subject to opportunity costs and must be allocated to one use or another, thereby shifting the discourse back to Penrose's (1959) original argument regarding the stock of organizational capabilities. The existence of resources and capabilities that must be allocated across alternative uses implies that profit-maximizing diversification decisions should be based upon the opportunity cost of their use in one domain or another. This opportunity cost logic provides a rational explanation for the divergence between total profits and profit margins. Firms make profit-maximizing decisions to increase total profit via diversification when the industries in which they are currently competing become relatively mature. Due to the spreading of these capabilities across more segments, we may observe that firms' profit-maximizing diversification actions lead to total profit growth but lower average returns. The model provides an alternative explanation for empirical observations regarding the diversification discount. The self-selection effect noted in recent work in corporate finance may not be indicative of inferior capabilities of diversifying firms but of the limited opportunity contexts in which these firms are operating.

Copyright/Permission Statement

This is the peer reviewed version of the following article: Levinthal, D. A. and Wu, B. (2010), Opportunity costs and non-scale free capabilities: profit maximization, corporate scope, and profit margins. Strat. Mgmt. J., 31: 780–801., which has been published in final form at doi: 10.1002/smj.845 This article may be used for non-commercial purposes in accordance with Wiley Terms and Conditions for Self-Archiving


corporate diversification, firm capabilities, opportunity cost, diversification discount, industry dynamics, resource-based view of the firm



Date Posted: 27 November 2017

This document has been peer reviewed.