strategic management journal10

8/13/2019 Strategic Management Journal10

1/28

What Wall Street Wants Exploring the Role ofSecurity Analysts in the Evolution and Spread ofManagement Conceptsjoms_862 162..190

Alexander T. Nicolai, Ann-Christine Schulz and

Thomas W. ThomasCarl von Ossietzky University, Oldenburg

This paper discusses the role of security analysts in the dissemination of popular

management concepts, drawing on neo-institutional and management fashion theory.

Focusing on the core competence concept, we investigate whether security analysts swing with

the popularity of a management concept or serve as a corrective that secures the rationality

of managerial actions. Through our analysis, which uses data for US-based firms spanning

the period 19902002, we show that during the 1990s analysts systematically overvalued

the future earnings of refocusing firms that incorporated principles derived from the core

competence concept. Moreover, we present evidence that their valuations were positivelyinfluenced by the popularity of the core competence discourse and exhibited a systematic

bias. Our results suggest a more nuanced understanding of the dynamics underlying the

popularization processes of management concepts. In addition to the classical bandwagon-

effects discussed in neo-institutional theory, we argue that the mediating role of security

analysts and their impact on stock-market prices promote the diffusion of new management

concepts.

INTRODUCTION

Some financial history is illuminating. In the mid-1960s Wall Street engineered a wave

of conglomerate mergers with the hope that they would produce important synergies.

(The Wall Street Journal, 2000)

Now Wall Street wants . . . Boeing to be like the rest of corporate America: lean,

responsive and focused . . . (The Seattle Times, 1998)

Address for reprints: Alexander T. Nicolai, Carl von Ossietzky University Oldenburg, Fakultaet II/Institute forBusiness Administration and Business Education, Ammerlaender Heerstr. 114118, 26129 Oldenburg,Germany ([email protected]).

2009 Blackwell Publishing Ltd and Society for the Advancement of Management Studies. Published by BlackwellPublishing, 9600 Garsington Road, Oxford, OX4 2DQ, UK and 350 Main Street, Malden, MA 02148, USA.

Journal of Management Studies47:1 January 2010doi: 10.1111/j.1467-6486.2009.00862.x


2/28

Then, in the usual way, they [the conglomerates] became deeply unfashionable.

Today, they may not be back in vogue exactly; but they are certainly back in business.

(The Sunday Telegraph, 2004)

Throughout the 1960s and 1970s, it was taken for granted that the conglomerate was the

most modern organizational structure (Davis et al., 1994). However, in the 1980s the

highly diversified company was viewed more and more critically. During the 1990s

keywords such as refocusing, concentration on core competencies, and portfolio

streamlining became popular. More recently, the pendulum seems to have begun

swinging back again with business rhetoric reconverting to the particularly fertile middle

ground between focus and diversification (Harper and Viguerie, 2002, p. 30). Changes

in the corporate landscape, such as restructuring and mergers and acquisitions (M&A)

activities, can be construed in part as a result of this reversal.

This article analyses the role of capital-market actors in the promotion and popular-

ization of management concepts. Management concepts are fairly stable bodies ofknowledge about what managers ought to do and consist of a system of assumptions,

accepted principles and rules of procedure (Birkinshaw et al., 2008, p. 828). What Wall

Street wants increasingly shapes what managers believe to be appropriate forms of

management (Brancato, 1997; Davis et al., 1994; Useem, 1996) and it is, therefore,

reasonable to suggest that capital market actors have an influence on the popularization

of management concepts. Especially, the monitoring activities of security analysts

employed by investment banks, investment advisory services, and brokers may be influ-

ential ( Jensen and Meckling, 1976).

Conventional finance theory states that these analysts play . . . an important role inmaking the security markets more efficient (Moyer et al., 1989, p. 503). According to this

rational (Birkinshaw et al., 2008, p. 828) or economic view (Marcus et al., 1995, p.

119), while financial analysts suppress ineffective concepts, they foster the spread of ideas

that make organizations work more effectively. The capital market disciplines managers

(e.g. Fama and Jensen, 1983) to maximize shareholder wealth and, as a consequence, in

a free competition with fair rules, the best ideas ultimately will win out (Marcus et al.,

1995, p. 119).

However, the cyclical nature of the popularity of management concepts has led

certain authors to question whether the role of analysts is portrayed accurately from a

purely economic viewpoint. There are, for instance, some widespread claims that ana-

lysts can also foster irrational behaviour: the negative side-effects of the shareholder-

value movement or the systematic over-optimism of analysts during the dot.com wave

are often cited as examples of such behavior (e.g. Arend, 2006; Lazonick and

OSullivan, 2000). Similar claims have been made in the context of the diversification

versus refocusing debate. In particular, neo-institutionalists argue that ideas about

good management do not spread solely on the basis of rational criteria (DiMaggio

and Powell, 1983; Meyer and Rowan, 1977). From the viewpoint of neo-institutional

theory, organizations are bound by a social framework of norms, values, and assump-

tions that determine what is deemed appropriate or acceptable economic behaviour.Management fashion theory which emerged in the last decade as a widely discussed

perspective that explained the diffusion of management ideas builds on and extends

What Wall Street Wants 163

2009 Blackwell Publishing Ltd and Society for the Advancement of Management Studies


3/28

neo-institutional theory (e.g. Abrahamson, 1996; Kieser, 1997; Newell et al.,

2001).

Management fashions are commonly shared beliefs about appropriate concepts for

business management (Abrahamson, 1996). A management concept becomes a man-

agement fashion when it is taken up by a significant number of managers (Birkinshaw

et al., 2008, p. 831), who jump on the bandwagon to appear progressive and gain

support by stakeholders. One of the most influential management concepts of the 1990s

was the core competence approach, which is usually attributed to Prahalad and Hamel

(1990). These management gurus (Huczynski, 1993; Wooten et al., 2005) argued that

companies should develop their strategy and structure around their core competencies.

In practice, during that period the core competence concept was often used to justify

refocusing measures. Management fashion theorists believe that the popularity of a

particular management technique is the result of a fashion-setting process, which is

primarily shaped by business schools, management consultancies, management gurus,

and the business press, but they tend to ignore the role of the capital market.In our view, there are good reasons why management fashion theorists should

examine the role of security analysts in more detail. Drawing on neo-institutional and

management fashion literature, in the following sections we will integrate the role of

security analysts into the processes through which management concepts become

fashionable and ultimately institutionalized. In particular, we will address two main

research questions: first, is there a link between analysts valuations and the popularity

of particular management concepts? And second, if there is such a link, do security

analysts follow management fashions and help disseminate and perpetuate them?

We will empirically analyse these questions in the context of the emergence and spreadof the core competence concept and the accompanying refocusing wave that took place

in the 1990s. In particular, we will examine the forecasts of security analysts with relation

to publicly listed companies that follow management fashions, and put forward the

hypothesis that those forecasts show a systematic bias. By exploring the role of analysts

we extend the existing debate on the diffusion of popular management concepts and thus

help to shed more light on the origins and boundary conditions of management fashions.

Our study suggests an alternative understanding of the dynamics underlying the popu-

larization processes of management concepts. In addition to the classical bandwagon-

effects discussed in neo-institutional theory, here we explore how the mediating role of

security analysts and their impact on stock-market prices promote the diffusion of new

management trends in publicly listed companies.

Our topic is also of relevance to managers. In particular, the managers of publicly

listed corporations experience increasing pressure to align the strategies and structure of

their companies with the expectations of the capital market (e.g. Dobbin and Zorn,

2005). A better understanding of management fashions can help managers to decide

when it is appropriate (and when it is not) to strive to meet those expectations.

The article is organized as follows: we first discuss the role of security analysts in the

institutionalization processes of popular management concepts before we turn to a

discussion on the refocusing wave in the period 19902002 when many companiesreduced their degree of diversification. We argue that this movement can be attributed

to the core competence discourse that burgeoned in the 1990s. In our empirical study we

A. T. Nicolai et al.164



4/28

use regression analyses to quantify the association between analyst forecasts, refocusing

strategies and the core competence discourse.

THE SPREAD OF MANAGEMENT CONCEPTS AND THE CAPITAL

MARKET

Institutionalization, Management Fashions, and the Capital Market

Management concepts become institutionalized if they are adopted because actors orient

their choices to cognitive structures that are shared across societies, rather than to

rational costbenefit calculations. In particular, when the benefits of a management idea

are highly uncertain, organizations tend to base their decision of which administrative

technology to use on the decisions of other organizations (Abrahamson, 1991, p. 591).

In the neo-institutionalists view, through imitative behaviour a particular management

concept can become established, or taken for granted, regardless of whether there is anyevidence that the technique indeed enhances efficiency (Davis et al., 1994, p. 550). The

process of institutionalization is self-reinforcing. Widespread adoption increases the

legitimization of a concept, and legitimization ensures its acceptability and therefore

further dissemination.

Management fashion theory focuses on the managerial discourse that accompanies

the institutionalization and de-institutionalization of management concepts. In the

course of turning into a management fashion these concepts become an object of the

broader discourse that is shaped by the public business press and management bestsellers

(Kieser, 2002). Lean production (LP), business process reengineering (BPR), and totalquality management (TQM) are well-known examples of management fashions. The

lifecycle of these management fashions is typically characterized by a short-lived, bell-

shaped popularity curve (Gill and Whittle, 1992; Kieser, 1997). In the beginning, only a

few pioneers adopt the trend. These pioneers are joined by more and more imitators.

The growing number of followers justifies adopting the new trend, which in turn attracts

new followers. However, as the popularity of a management concept grows, it gradually

ceases to appear progressive and its appeal decreases. The first organizations begin to

abandon the technique often in favour of a new fashion, a counter-bandwagon, until

the old fashion is out and reaches the end of its lifecycle (Abrahamson and Rosenkopf,

1993, p. 489). Abrahamson (1996) proposed that the swings that are typical of manage-

ment fashions are related to technical contradictions or managerial dilemmas within

organizations. Each new management fashion stresses one side of a managerial dilemma,

until the counter-bandwagon appears which focuses on the opposite side.

Unlike management fads, which spread mainly through inter-organizational imita-

tion, fashions are propelled to a large extent through management fashion-setters outside

the organization. The rhetoric that such fashion-setters typically employ can convince

fashion-followers that a certain management concept is both rational and progressive

(Abrahamson, 1991; Kieser, 1997). The ideas and techniques of management fashion-

setters appear to be simple and clear and promise enormous improvements quantumleaps in efficiency. At the same time, they can often be ambiguous, vague, contradic-

tory, and puzzling (Giroux, 2006). Concepts like core competencies or customer




5/28

orientation are not detailed recipes for inputs, processes or structures, they are meta-

phors transmitted via rhetoric (Cornelissen, 2006; Kieser, 1997). One reason why man-

agers adopt popular management concepts is that these offer the opportunity to signal

legitimacy and innovativeness, even when there is little theoretical or practical evidence

that the implementation of the management technique will improve efficiency (see e.g.

OMahoney, 2007). For example, Staw and Epstein (2000) found that publicly listed

companies which introduced a popular management approach were more admired, and

perceived as more innovative, although this was not matched by higher economic

performance.

While the impact that scholarly research has on the popular management discourse

has been the object of controversy (Hodgkinson and Rousseau, 2009; Kieser and Leiner,

2009), there is consensus that consultants, gurus, and the business press dominate the

management fashion-setting community (David and Strang, 2006; Kieser, 1997). These

fashion-setters not only sense and satiate incipient demand for new types of manage-

ment fashions, but they also shape this demand by articulating for fashion followers thatparticular technique which matches the type they prefer (Abrahamson, 1996, p. 273).

However, the role of another authority that can define what good management is has

so far been neglected in the literature: the capital market and its representatives, such as

security analysts. What Wall Street wants has a high degree of influence on what is

regarded as an appropriate form of management practice, and in recent decades this

influence has grown (Brancato, 1997; Useem, 1996). For example, several corporate

governance reforms were launched in the last two decades (e.g. Gillan and Starks, 2000;

Karpoff et al., 1996), which increased transparency and shareholders opportunities

to monitor and control managerial actions. Rappaports (1986) concept of shareholdervalue, which may have been a fashion in itself, spread rapidly during the 1990s (Dobbin

and Zorn, 2005). Around that time, the Wall Street rule according to which sharehold-

ers accept a companys strategy or invest somewhere else lost its significance (Nicolai and

Thomas, 2004). A new phase of shareholder activism started and large shareholders in

particular intervened in the processes of strategic decision-making. As a result, executives

focused more intensely on meeting the explicit expectations of investors and analysts.

The interaction between executives and capital-market actors has continued to grow,

indicating that the latter have an increasing influence on corporate decisions and can

thus play an important role in the development and distribution of popular management

concepts. Security analysts in particular are regarded as experts in examining a com-

panys financial structure as well as its strategic prospects (Moreton and Zenger, 2005;

Zuckerman, 1999). This leads to the question of how the role of analysts can be

integrated into a theory that explains the emergence and decline of management

concepts.

The Role of Security Analysts

Security analysts are an important source of information on the valuation of firms for

players in the stock market. They conduct independent research on the competitivenessand financial situation of a company, interrogate top managers about potential prob-

lems, and elicit information on possible corrective measures (Rao and Sivakumar, 1999).




6/28

In that sense, security analysts are surrogate investors as their forecasts, when positive,

increase demand for a firms shares (Zuckerman, 1999, p. 1408). Hence, managers often

take part in meetings or conferences of analyst associations and watch closely the

periodic reports of analysts who assess a firms financial performance and issue buy, sell,

or hold recommendations (Useem, 1996; Zuckerman, 2000). Analysts not only monitor

the financial reports of firms but also promote the adoption of certain management

techniques. For example, Moreton and Zenger (2005) present empirical evidence that

managers adopt common strategies and popular management concepts, rather than

unique strategies, to attract more coverage by analysts and receive higher valuations.

In order to explore the role of analysts in the evolution and spread of popular

management concepts, we first have to discuss how security analysts can be integrated

into Abrahamsons concept of the management fashion-setting process (Abrahamson,

1991, 1996). To begin with, it is reasonable to suggest that analysts serve as mediators

between the management fashion supply (e.g. consultancies, gurus, business schools)

and the fashion demand (e.g. companies as consumers of management knowledge).Depending on the underlying theoretical assumptions, different expectations can be

developed as to how the analysts role as a mediator influences the diffusion of manage-

ment concepts. One view (A) is that analysts serve as a corrective and inhibit faddish

behaviour. This view is consistent with the efficiency market hypothesis (Fama, 1970).

Another view (B) is that analysts facilitate the spread of management concepts. Accord-

ing to this view, analysts are subject to similar socio-psychological forces as other

followers of management fashions (e.g. Zuckerman, 2000).

View A coincides with the efficiency market hypothesis and assumes that prices

faithfully reflect all available information and that agents act rationally, using all avail-able information on relevant matters to form an unbiased estimate of future dividends

and earnings (Fama, 1970). In this view, analysts should be immune to business

rhetoric, institutionalization processes, and the socio-psychological forces of manage-

ment fashions since they base their valuations on purely rational criteria. Consequently,

the primary role of analysts should be to impede the dissemination of management

fashions.

View B also accords considerable importance to analysts, as neo-institutionalists view

professionals to have a significant influence on the development of organizational

structures:

Professionals are self-interested theorists who provide recipes for successful manage-

ment, motivate public authorities to dictate or to provide incentives for approved

forms, and generate rationales for organizations adoption of new models and

practices. . . . As nascent professionals, financial analysts induce corporate managers

to respond to shareholders concerns and maximize shareholder value. (Rao and

Sivakumar, 1999, p. 32)

However, according to view B, analysts, like all individuals, are prone to errors,

misinterpretations, social influences, and personal biases. Indeed, as financial assets aresocial goods, valuation is difficult (Zuckerman, 2000). Recent advances in finance theory

suggest that the limited sense of efficiency can be explained with the help of theories that




7/28

researchers call collectively behavioural finance (Kahneman and Tversky, 1973). Most

empirical studies find that forecasts are systematically upward biased, i.e. over-optimistic

(for an overview, see e.g. Brown, 1993) and that there is a tendency among analysts to

herd (e.g. DeBondt and Forbes, 1999; Welch, 2000). Herding can be understood as the

propensity of analysts to ignore private information and orient their forecasts to those of

other analysts. This leads to systematically wrong predictions, which are coupled with

relatively low levels of forecast dispersion among the different analysts (Guedj and

Bouchaud, 2005). Herding is a well-established social phenomenon, and occurs espe-

cially in response to uncertainty (Welch, 2000). Analysts fear that they might lose their

job or reputation, or suffer some other retribution if they issue wrong forecasts. This

pressure leads them to exhibit conformist behaviour by orienting their forecasts to those

of other analysts (Phillips and Zuckerman, 2001) or following especially experienced or

highly skilled analysts so called fashion leaders (Bikhchandani et al., 1998, p. 160). If

analysts herd, i.e. display behaviour that imitates, or is in line with that of their peers, it

is reasonable to suggest that they also display imitative behaviour that is aligned with thatof the broader managerial discourse in other words, that they foster institutionalization

processes or follow management fashions. Indeed, analysts are often blamed in the

popular business literature for behaving fashionably. The new economy hype, for

example, is often attributed to the overoptimistic forecasts of herding analysts (Stiglitz,

2003). In the context of Abrahamsons (1996) framework it could be said that analysts

serve as facilitators between fashion supply and demand. If that is the case, analysts can

contribute to the dissemination of management fashions by producing incentives for

executives to adopt popular management concepts.

Views A and B are not mutually exclusive. Indeed, Abrahamson (1996) emphasizesthat the spread of management concepts is driven by technical-economic and socio-

psychological forces. In a similar way, analysts may be both rational andinfluenced by

socio-psychological factors. However, the main point of interest in this analysis is not so

much the degree of rationality but the question of whether analysts exhibit non-random,

systematic deviations from rational expectations that can be explained by neo-

institutional and management fashion theory. To discuss this point empirically, we focus

on one of the most influential management fashions of the 1990s, the core competence

concept and the corresponding refocusing trend.

THE REFOCUSING TREND IN THE 1990s

Davis et al. (1994) analysed the wave of conglomerate mergers that lasted from the 1960s

to the early 1980s. During that period, companies in the USA and in Europe followed

strategies of unrelated diversification that resulted in strongly diverse conglomerates.

There were a number of reasons for this development: in the USA, for example, there

was the CellerKefauver Act, which prohibited horizontal and vertical acquisitions. This

meant that external growth had to occur through acquisitions in unrelated industries.

Davis et al. (1994) also showed that as a result of this development, the conglomerate

became an institutionalized form (Meyer and Rowan, 1977). Eventually, it was taken forgranted that the conglomerate, or the firm-as-portfolio model, was the most modern

and efficient organizational structure (Davis et al., 1994).




8/28

The popular management discourse supported this institutionalization process. In

particular, the management fashion of portfolio matrices, as propagated by the Boston

Consulting Group, McKinsey, and Arthur D. Little, proved influential. In the USA, 45

per cent of the Fortune 500 companies applied portfolio techniques by the end of the

1970s (Haspeslagh, 1982). These techniques built upon the concept of strategic business

units and were developed for the management of companies that exhibited unrelated

diversification. These portfolio concepts implied that conglomerates were an efficient

organizational structure. This perception changed dramatically in the 1980s. During the

so-called raider wave, a large number of US companies became the targets of hostile

takeovers and were broken up into individual business units (Bhagat et al., 1990). The

mean degree of diversification decreased and the highly diversified company went out of

fashion corporate conglomerates became de-institutionalized (Davis et al., 1994,

p. 548). This trend was accompanied by a transformation in business rhetoric, which

discredited the firm-as-portfolio model, particularly in the second half of the 1980s. Davis

et al. (1994) write:

No clear-cut alternative has arisen to replace the firm-as-portfolio-model, but broad

outlines indicate that the logic defining what is appropriate to bring within a single

organizational boundary has gone from being exceptionally broad (the conglomerate)

to strikingly narrow. (Davis et al., 1994, p. 563)

Prahalad and Hamels (1990) core competence concept and related approaches can be

seen as such alternatives to the firm-as-portfolio model that Davis et al. (1994) were not

yet able to discern at the beginning of the 1990s. As mentioned earlier, managementfashions often arise as a counter-bandwagon to a previously predominant business

rhetoric (Abrahamson and Rosenkopf, 1993). Prahalad and Hamels (1990) core com-

petence concept is deemed to be a classic example of a management fashion (Carson

et al., 2000). The central message is that companies should develop strategy and struc-

ture around their core competencies. They should strive for competence leadership

(Carson et al., 2000, p. 84) rather than product leadership and should abandon the

tyranny (Carson et al., 2000, p. 86) of product-oriented strategic business units. Over

the 1990s, the core competence approach developed into one of the most influential

management concepts (Rigby and Bilodeau, 2007), and Prahalad and Hamel rapidly

advanced to the status of management gurus.

Prahalad and Hamels (1990) somewhat ambiguous argumentation does not neces-

sarily demand for a reduction of market segments and corporate diversification.

However, management fashions are often implemented in a simplified and modified way

(Benders and van Veen, 2001). This applies also to the core competence concept, which

is often used in practice as a means of justifying de-diversification. The business press

generally uses the term core competence as a synonym for focusing on core activities.

Managers do the same, and even in the academic discourse the core competence concept

is regarded as evidence for the efficiency-increasing effect of de-diversification (e.g.

Deutsch, 1997; Varadarajan et al., 2001; Zuckerman, 2000). Kanter (1991) used similarterminology in the early 1990s to describe the new ideal of the focused business, which

follows the imperative of maximizing the core business competence. Anecdotal




9/28

evidence from the business press suggests that Wall Street also valued the benefits of

refocusing:

The . . . new management fashion is to focus on your core competencies: the things

that you and you alone can do better than anyone else. J. P. Morgan, an

investment bank, has constructed an index measuring a companys focus on a scale of

1100. American companies that decided to clarify their business (jargon breeds

jargon) by focusing on the one thing they did best outperformed the market by 11 per

cent in the next two years; firms that diversified underperformed by about 4 per cent.

(The Economist, 1996, p. 67)

In a similar vein, many analysts exerted pressure on diversified companies to refocus

(Useem, 1996). Typical examples are: Disney has been under pressure recently from

Wall Street to sell nonstrategic assets and revive its core business (The New York Times,

1999, p. C1); How well the firm [MailWell] rebounds will depend on whether it can selllabel and printed office-product businesses and concentrate on its core business, said

Michael Plancey, an analyst with Merrill Lynch Global Security (The Denver Post, 2001,

p. K1).

In order to illustrate the lifecycle of the discourse on core competence or core business

(see Figure 1) we used a bibliometric approach (e.g. Abrahamson and Fairchild, 1999).

To measure the extent of the discourse, we counted the number of articles published on

the subject of core competence in the ABI/Inform database from 1990 to 2002 (for

limitations of this method, see Benders et al., 2007). We chose ABI/Inform, because the

database is one of the most comprehensive business databases and focuses mainly on

0

200

400

600

800

1000

1200

1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002

No.ofartic

les(adj.)

Year

Core business Core competence

Figure 1. Adjusted numbers of articles on core competence and core business




10/28

business press and scholarly journals on management. First, we searched electronically

all articles contained in the ABI/Inform database, looking for the word strings core

competence, core competency, core competences, or core competencies in the body

text of each article. In addition, we counted separately the number of articles listed under

core business as the term is used by the business press and managers as a synonym for

core competence (Nicolai and Dautwitz, 2009). Then, to correct for the overall growth

of the total number of articles in the database, we applied the approach of Abrahamson

and Fairchild (1999) and adjusted the number of articles by multiplying the number of

core competence articles by the ratio of the total number of articles indexed in the year

1990 to the total number of articles in that specific year.

Figure 1 shows that the core competence discourse had passed the zenith of its

popularity by the end of the 1990s. This became apparent not only quantitatively but

also qualitatively. Since 2000, business rhetoric has changed yet again. For example,

leading consulting firms such as McKinsey or the Boston Consulting Group see again a

trend towards diversification. As recently as 2002, McKinsey consultants asked are youtoo focused? (Harper and Viguerie, 2002); likewise, the Boston Consulting Group called

for an end to the myth of focusing (Heuskel, 2002). Since 2000, the fashion of core

competence orientation and the importance of refocusing has lost its popularity.

HYPOTHESES

The management fashion approach is based on the assumption that managerial dis-

course has an influence on the dissemination of management concepts. Therefore, we

expect the refocusing trend to follow the pattern of the popularity of the core competencediscourse, which had its peak in the late 1990s. It should be noted, however, that the

refocusing trend can also be explained by traditional finance theory. Agency theorists

argue that conglomerates are the classic example of the agency problem ( Jensen

and Meckling, 1976). Although there are mixed empirical results concerning the

diversificationperformance relationship (Berger and Ofek, 1995; Datta et al., 1991;

Hadlock et al., 2001; Servaes, 1996), many finance theorists question the benefits of

diversification, and the link between diversification and value destruction is made in

virtually every finance text (Martin and Sayrak, 2003, p. 38). While diversification may

not be in the shareholders interest, there are incentives for salaried managers to increase

a companys product range. Growth through diversification increases their job security,

income, and status (Amihud and Lev, 1981; Baumol, 1967). A series of developments in

the capital market over the last 20 years is likely to have helped reduce the agency

problem. These include the stronger disciplining effect of the market for corporate

control, the growing importance of active institutional investors, and the increasing

concentration of ownership and diverse corporate governance reforms (e.g. Jensen,

1993; Useem, 1996). From the point of view of agency theorists, such events reduce the

chances of top-management behaving opportunistically and increase the pressure to

correct over-diversification (e.g. Berger and Ofek, 1999; Hoskisson et al., 2005). There-

with, agency theorists offer an elaborate explanation for the refocusing trend.While both management fashion theory and agency theory help to explain why

analysts supported refocusing strategies in the 1990s, they lead to fundamentally different




11/28

expectations with regard to the direction that the bias of analysts forecasts take. If we

follow the fashion theory and assume that analysts are part of the management fashion

community, we can infer that the management discourse should influence their mental

models and consequently their forecasts. This means that we expect analysts not to be

immune to fashionable management concepts. As discussed above, analysts are prone

to personal biases and imitative behaviour (view B). If analysts follow fashions this can be

expected to have an influence on the accuracy of their forecasts and, more significantly,

on the direction in which they are likely to err.

Abrahamson (1996, p. 274) proposed that the popularity of a management concept is

related to technical contradictions or managerial dilemmas within organizations.

Management fashions stress one side of a managerial dilemma, causing receptivity for

management concepts that stress the other side. This enables the emergence of a

counter-bandwagon and explains the dynamics of pendulum swings that are typical of

management fashions (Abrahamson, 1996). The diversification versus refocus question

resembles such a dilemma. There are many good reasons for diversifying (e.g. marketpower, synergies, etc) as there are many good reasons for focusing (e.g. specialization

advantages) (Datta et al., 1991; Markides, 1996). In particular, changes in federal anti-

trust policy (e.g. CellerKefauver Act) and in tax policy, as well as recent increases in

competition, as a result of globalization, have generated trends that support or prevent

the conglomerate form (Davis et al., 1994; Zuckerman, 2000). In addition, the original

aim of risk reduction via diversification was replaced by the perception that such diver-

sification is more efficiently accomplished in public capital markets (Amihud and Lev,

1981). Stating that analysts follow management fashions does not imply that they simply

ignore those good reasons and are instead exclusively influenced by socio-psychologicalforces: a management fashion influences the interpretative process by which those

reasons and counter-reasons are balanced. When the dissemination of a management

concept gains momentum we expect the virtues of one side of a managerial dilemma to

be overvalued.

Thus, unlike traditional approaches in finance, the management fashion approach can

explain systematic forecast errors that are not in the analysts interest (view B). Since the

core competence discourse associates refocusing strategies with progressiveness and

efficiency we can argue that in the 1990s analysts overestimated the benefits of refocusing

and underestimated the benefits of diversification strategies. And as evidence indicates

that analysts underreact to negative information, but overreact to positive information

(Easterwood and Nutt, 1999, p. 1777), we expect the following outcomes:

Hypothesis 1a: Refocusing activities were associated with a systematic overvaluation of

future earnings by security analysts during the 1990s.

Hypothesis 1b: Diversifying activities were associated with a systematic undervaluation

of future earnings by security analysts during the 1990s.

According to traditional approaches in finance, the errors of analyst forecasts shouldbe time-independent. However, in light of management fashion theory, history

matters. Management fashions pass through different stages throughout their lifecycles




12/28

(Abrahamson, 1991, 1996). With the growing diffusion of management concepts their

legitimacy increases (Kieser, 1997). When it reaches the peak, a fashion is at its most

persuasive. Therefore, one can assume that with the further dissemination of a concept,

and as it gains momentum its positive influence on the analysts forecasts increases

because its legitimacy increases. The decline of the popularity of a management concept

starts when it is no longer perceived to be progressive and modern and instead becomes

the object of increasing criticism. At that point, the diffusion rate and the impact of the

fashion start to decrease. The concept is worn out and management fashion-setters

denounce the fashion and propagate a new one (Kieser, 1997). On the basis of the above,

we can therefore state:

Hypothesis 2: The popularity of the core competence discourse is positively associated

with the overvaluation of refocusing firms by security analysts.

METHODOLOGY

Data Sources and Sample Selection

We obtained data from three different sources for the period 19902002. Data on US

firms and segment data were drawn from the Compustat North America database and

the Compustat Industry Segment (CIS) database. To search systematically for refocusing

and diversifying firms we gathered segment data. A popular source for this information

is the CIS database. This database is compiled from corporate annual reports and 10-K

reports to the Security Exchange Commission (SEC). According to FASB No. 14 and

SEC Regulations S-K, US-based firms are required to report segment information forsegments whose sales, assets, or profits exceed 10 per cent of the total amount. In line

with other studies (e.g. Berger and Ofek, 1999), we used the CIS database, which reports

segment information for all active Compustat firms. Analyst forecasts were obtained

from the Institutional Brokers Estimate System (I/B/E/S).

The analysis of our hypotheses requires the identification of a sample that includes

refocusing and diversifying firms. We combined two measures to operationalize refocus-

ing and diversifying activities: the change in the number of reported business segments

measured on the four-digit SIC level (e.g. Chang, 1996; John and Ofek, 1995) and the

entropy measure of diversification, proposed by Jacquemin and Berry (1979), which has

been widely used in strategy research (e.g. Chang and Hong, 2000; Hill et al., 1992). The

entropy measure is best suited to measuring continuous changes in diversification and

has good convergent and discriminant validity with categorical measures (Chatterjee and

Blocher, 1992; Chatterjee and Singh, 1999). This method allowed us to capture a

companys entry or exit into a new business segment (on the four-digit level) and to

ensure that this activity had a significant impact on the overall diversification degree of

the company.

We identified the sample using multi-level screening: first, we computed the number

of reported segments and the entropy measure of diversification for all the firms in the

CIS database. The total diversification measure was calculated across n business seg-ments as the sum of a firms proportion of sales Pimade in each segmentiand weighted

by the logarithm of the inverse of its share (Palepu, 1985):




13/28

total diversification= ( )=

P Pi ii

n

ln .11

(1)

Industry segments are defined at the four-digit SIC level. Unlike other diversification

measures, the entropy index considers not only the number and the relative importanceof the segments in which a firm operates, but also the degree of relatedness among the

various segments. Therefore, total diversification can be decomposed into a related

element and an unrelated element. Related diversification captures the distribution of

sales by business segments within an industry group, while unrelated diversification

captures distribution across industry groups.

Hence, it is assumed that the business segments can be aggregated into m industry

groups. The segments across groups are expected to be less related to one another than

within groups. Then, the unrelated diversification is calculated in the same manner as the

total diversification, except that here we define Pjas the proportion of sales in industry

groupjand calculate it at the two-digit SIC level:

unrelated diversification= ( )=

P Pj jj

m

ln .11

(2)

We supposed that diversifying companies should denote a significant increase in their

unrelated diversification, while refocusing firms should denote a significant decrease.

Hence, we defined as refocusing firms all companies which reported a decrease in the

number of segments measured on the four-digit SIC level over a specific period and alsoa decrease in their unrelated diversification of at least 0.3 between the same years. In

using this definition we followed Berger and Ofek (1999), except that we replaced the

Herfindahl index with a more rigorous measure of unrelated diversification. This pro-

cedure resulted in a sample of 1040 refocusing observations. We identified diversifying

firms in an analogous manner: a firm diversifies its business if the number of segments

rises and the unrelated diversification increases by 0.3. In our study, this resulted in 1408

diversifying firms.

In accordance with other studies, our second step was to restrict the analysis to

manufacturing firms (e.g. Chang, 1996; Chatterjee and Singh, 1999; Grant et al., 1988),

which form by far the biggest proportion of industries in our sample. That reduced the

number of observations to 452 refocusing and 593 diversifying firms. Concentrating on

manufacturing firms helps to pursue comparisons of corporate diversity and accounting

measures. The accounting conventions used by banks, insurance, and oil companies

differ from those employed by manufacturing firms. Moreover, we found matching pairs

for most manufacturing firms, unlike in other industries.

Our empirical methodology requires comparisons of analysts valuations of refocusing

and diversifying firms to valuations of firms with no M&A activity. Accordingly, we

constructed a matched control sample with firms of similar size and complexity. Follow-

ing Berger and Ofek (1999), we used a matched-control firm for each diversifying orrefocusing company. For a matched control to qualify as such, the following two require-

ments had to be fulfilled: first, the observation had to be made in the same year for both




14/28

the matched-control and the refocusing or diversifying firm, but should not exhibit any

changes in the number of reported segments. Second, the matched firm should be

of similar size and complexity as the refocusing or diversifying firm. Accordingly, we

identified for each diversifying and each refocusing firm all companies with a maximum

deviation of sales and total diversification of 70 per cent. This resulted in multiple

matches. We selected the match that had the smallest deviation in the diversification

degree and in sales, the diversification degree being the dominant criterion (e.g. Hyland

and Diltz, 2002).

Finally, we had to eliminate from the sample those firms for which forecasts andaccounting data were not available. This led to a sample of 276 companies, 34 of which

implemented a refocusing strategy, 104 implemented a diversifying strategy, and the

remaining 138 were control firms. The main reason for the reduction of the sample size

was the availability of forecast data.

Table I shows the sales and diversification variables for the strategy sample (refocus

and diversify) and the matched-control sample. The average diversification degree is

roughly the same while the average size measured by sales is slightly different. This small

deviation can be attributed to the dominance of the diversification criterion. Further-

more, a mean difference test shows that differences between the samples are not signifi-

cant. We can conclude that our matched-control sample qualifies as such.

Table II indicates that the corporate refocusing and diversifying programmes repre-

sent substantial restructurings. It presents the unrelated diversification and the number of

segments before as well as after the implementation of the strategy. The results show that

the mean number of reported segments dropped from 4.41 to 2.85 for the refocusing

firms and doubled for the diversifying firms while the mean unrelated diversification

dropped from 0.41 to 0.38 for refocusing firms and increased from 0.01 to 0.68 for

diversifying firms.

To test Hypothesis 2 we had to generate a different sample. As we wished to analyse

the influence of the management fashion discourse on analyst valuations of refocusingfirms, we had to concentrate solely on refocusing firms. Therefore, we used the original

refocusing sample of 1040 firms. From these we eliminated those firms for which we did

Table I. Comparison of descriptive statistics between strategy and

control samples

Strategy sample Control sample Difference

n =138 n =138 (t-statistic)

Total diversification

Mean 0.75 0.74 0.01

Std. dev. 0.32 0.30 ( -0.33)

Median 0.68 0.68

Total sales

Mean 4591.88 3091.06 1500.82

Std. dev. 9448.24 5487.30 ( -1.61)

Median 1356.96 1361.80




15/28

not have forecasts and accounting data. This led to a smaller sample of 74 refocusing

firms that is analysed by means of regression techniques in the following section.

Variables

One of the main objectives of our empirical analyses was to assess whether refocusing

firms were overvalued by security analysts while diversifying firms were undervalued(Hypotheses 1a and 1b). To test these hypotheses we estimated the parameters of the

following econometric Model I:

analyst surprise refocusing diversifying forit it it = + + +a b b b 0 1 2 3 eecast dispersionfirm size leverage time effect

it

it it t + + +b b b4 5 6 ++ eit. (3)

The dependent variable is the mean relative forecast error denoted as analyst sur-

prise, which is based on the absolute value of the difference between the firms forecasted

and actual earnings, divided by the actual earnings:

analyst surpriseitijt it h

it hj

J

J

x x

x=

+

+=

1

1

(4)

where xijt is thej-th analyst forecast issued at timetover the horizonhof thei-th firms

earnings-per-share andxit+his the actual value at t +h. The analyst surprise for firmifor

periodtcan take positive as well as negative values. Positive values indicate an overes-

timation of the actual earnings-per-share and negative values an underestimation. Since

analyst forecasts are estimates, the realized analyst surprise will mostly differ from zero.We restricted the forecast data to a forecast horizon of roughly three years. This we did

for two reasons: first, we wanted to eliminate the influence of the forecast horizon on the

Table II. Firm diversification levels before and after refocusing or diversification

Variable Refocusing firms Diversifying firms

Before

refocusing

After

refocusing

Before

diversification

After

diversification(t-1) (t) (t -1) (t)

Unrelated diversification

Mean 0.41 0.38 0.01 0.68

Std. dev. 0.50 0.30 0.10 0.26

Median 0.48 0.00 0.00 0.63

Number of segments

Mean 4.41 2.85 1.59 3.69

Std. dev. 1.96 1.11 1.20 2.05

Median 4.00 2.00 1.00 3.00




16/28

accuracy of prognoses, taking into account that a shorter horizon leads to more accurate

forecasts; and second, it is appropriate that analysts should value the firm strategically

by giving long-term predictions. Additionally, we restricted the analyst surprise to the

interval [-1; 4] to adjust for outliers. This skewed interval is due to the skewed distribution.

Among the independent variables, the main variables of interest are the refocusing

and the diversifying ones. Both are dummy variables, and are set to 1 if the company

is refocusing or diversifying, and set to 0 otherwise. The dummy variables of companies

in the control sample take a zero value in both cases. Other attributes that could

influence analyst surprise are firm and forecast characteristics, and year-related effects

(e.g. Garca-Meca and Snchez-Ballesta, 2006). The first variable that we include here is

forecast dispersion. Previous studies indicate that forecast dispersion is negatively related

to analysts forecast errors (Lang and Lundholm, 1996). The dispersion is often used as

a proxy for uncertainty and a lack of consensus among analysts about future earnings

(Barron et al., 1998). For each firm, forecast dispersion is measured by the standard

deviation of forecasts. We assume a positive association.Second, we controlled for firm size, which is one of the most common variables studied

in research on forecast errors (e.g. Duru and Reeb, 2002; Gu and Wu, 2003). In most

studies, it is found to be negatively associated with analyst forecast error, although it

potentially has two different, and opposite, effects (Garca-Meca and Snchez-Ballesta,

2006): larger firms are more complex and thus indicate a greater forecast error; on the

other hand, more predisclosure information is available for such firms, which may

actually lead to a lower forecast error. We quantified firm size by the logarithm of the

total assets, expecting the coefficient of size to be negative (e.g. Beckers et al., 2004;

Brown, 1997).Third, following Zhang (2006), we suggested that leverage is positively related to

analyst surprise. Leverage is measured by the debt-to-total-assets ratio and can capture

the degree of financial distress. A higher ratio indicates a possible overuse of leverage,

and consequently potential problems with meeting debt payments. In such a high-risk

environment, analyst forecasts tend to overestimate future earnings. Additionally, we

also controlled for year-specific effects using a set of time dummy variables as the

degree of forecasting difficulties varies across time periods (e.g. Duru and Reeb,

2002).

Subsequently, we wanted to test whether analysts, who cover refocusing firms, are

directly influenced by the core competence discourse. To check this hypothesis

(Hypothesis 2) we estimated the parameters of the following modified econometric

Model II:

analyst surprise fashion discourse forecast dispersit t= + +a b b0 1 2 iionfirm size leverage

it

it it it + + +b b e3 4 . (5)

The strategy variables were removed as we examined only refocusing firms. Instead,

in (5) we included a fashion discourse variable, which represents the core competence

discourse during the period. The discourse was quantified using a bibliometric approach(Abrahamson and Fairchild, 1999). We measured the extent of the discourse by counting

the number of articles listed under core competence, core competency, core compe-




17/28

tences, or core competencies in the ABI/Inform database from 1990 to 2002 and

adjusted that number for database growth. We expected that the discourse would be

positively associated with analyst surprise.

EMPIRICAL RESULTS AND DISCUSSION

Descriptive Statistics

The calculation of the entropy measure of total diversification for all US firms in the

database during the 1990s shows a noticeable decline of the average diversification

degree until 1997. While total diversification was 0.16 in 1990, it has been in constant

decline ever since. In 1997 total diversification was decreased to 0.11. If one restricts the

sample to companies with minimum sales of at least $100 million this trend becomes

even more obvious (see Figure 2).

Total diversification decreased from 0.28 in 1990 to 0.18 in 1997. This trend is mainlydue to the decline of unrelated diversification, indicating that during that period a

significant proportion of business segments that were not part of the core business was

eliminated. Moreover, the overall refocusing trend in the beginning of the 1990s was

replaced by a diversification trend in the late 1990s. One can conclude from the data that

this refocusing wave followed the pattern of the core competence discourse during the

same period.

Table III summarizes various descriptive statistics of different variables for the three

sample groups: refocusing, diversifying, and control firms. Additionally, we tested for

Figure 2. Development of total diversification (DT), related diversification (DR), and unrelated diversifica-tion (DU) of US Firms, 19902002 (sales> $100 million)




18/28

differences between refocusing firms and diversifying firms. Here, we report the

t-statistics and the Wilcoxon rank sum statistics for the mean and median difference

significance tests between refocusing and diversifying firms.

The calculations show that analysts generally overestimated future corporate earnings,

as the mean of analyst surprise is positive in all cases. This finding is consistent with most

empirical studies, indicating a tendency towards over-optimistic behaviour among

analysts (for an overview, see e.g. Brown, 1993). An even more interesting point is that

analysts overestimated the earnings of refocusing firms by 72 per cent on average and ofdiversifying firms by 67 per cent, but those of the control sample only by 54 per cent.

This discrepancy of 5 percentage points between refocusing firms and diversifying firms,

Table III. Descriptive statistics of the dependent and independent variables and mean difference tests

between refocusing and diversifying firms during the 19902002 period

Variable Refocusing

firms

Diversifying

firms

Differences between

refocusing and

Control

firms

(n =

34) (n =

104) diversifying firms a

(n=

138)

Analyst surprise

Mean 0.72 0.67 0.05 (0.26) 0.54

Std. dev. 0.98 0.96 0.93

Median 0.37 0.27 0.10 (0.44) 0.19

Total diversification

Mean 0.64 0.79 -0.14* (-2.29) 0.74

Std. dev. 0.28 0.33 0.30

Median 0.65 0.69 -0.04 (-1.89) 0.68

Unrelated diversification

Mean 0.38 0.68 -0.29*** (-5.52) 0.44Std. dev. 0.30 0.26 0.35

Median 0.48 0.63 -0.15*** (-3.86) 0.53

Forecast dispersion

Mean 0.22 0.13 0.09* (2.39) 0.19

Std. dev. 0.27 0.17 0.41

Median 0.14 0.05 0.09* (2.04) 0.48

Number of analysts

Mean 5.59 4.60 0.99 (0.80) 3.85

Std. dev 5.69 6.46 4.89

Median 4.00 2.00 2.00 (1.75) 2.00

Firm size (total assets)Mean 7.98 6.84 1.14*** (3.29) 6.78

Std. dev. 1.40 1.79 1.77

Median 8.32 6.80 1.51*** (3.37) 7.00

Leverage

Mean 0.27 0.26 0.00 (0.12) 0.25

Std. dev. 0.18 0.17 0.18

Median 0.27 0.26 0.01 (0.14) 0.24

Notes: a t-statistics and z-scores in parentheses.

* p< 0.10; ** p< 0.05; *** p< 0.01.




19/28

as well as the discrepancy of nearly 20 percentage points between the refocusing and

control samples, gives a first hint that refocusing is probably associated with systematic

overvaluation by analysts.

An equally noteworthy finding is that the average values of the control variables

indicate the following relationships. First, refocusing firms are significantly larger than

diversifying firms. The differences in mean and median are statistically significant at the

1 per cent level. Second, refocusing firms are covered on average by more analysts than

diversifying firms. Third, on average, forecast dispersion among refocusing firms is

higher than among diversifying firms, suggesting a higher level of uncertainty and lack of

consensus among analysts covering refocusing firms. The values for the control sample

exhibit no noticeable deviation from the two main samples. Only the lower numbers of

analysts and total assets indicate that firm size is as already mentioned somewhat

smaller.

Table IV presents a Pearson correlation matrix for the independent and dependent

variables of the whole sample. We found that refocusing and diversifying strategies are

associated with higher analyst surprise and that firm size is negatively associated with

analyst surprise. Moreover, analysts tend to issue more optimistic forecasts for firms with

a higher debt-to-assets ratio. The correlations also show that there will be no serious

problem with multicollinearity in the regression analyses.

Quantitative Results

We estimated the parameters of the econometric Models I and II using maximum

likelihood estimation (MLE) techniques. To take into account the effect of left and right

truncation of the dependent variable, we applied the Truncated Regression Model as

suggested by Greene (2003, p. 760). OLS would here produce biased and inconsistent

results (Davidson and MacKinnon, 1993). We ran a BreuschPagan test to check for

heteroscedasticity. The null hypotheses of homoscedasticity could be rejected in all casesat a 0.01 significance level. Table V displays the estimated coefficients of the maximum

likelihood regression and the reported Wald z-tests in which robust White standard

Table IV. Correlation coefficients matrix (Pearson) for the dependent and independent variables

1. 2. 3. 4. 5. 6. 7.

1. Analyst surprise

2. Refocusing 0.043. Diversifying 0.05 -0.29***

4. Forecast dispersion 0.07 0.06 -0.10*

5. Number of analysts -0.09 0.08 0.04 0.36***

6. Firm size -0.19*** 0.22*** -0.05 0.27*** 0.40***

7. Leverage 0.09* 0.02 0.03 0.06 0.02 0.21***

8. Fashion discourse 0.11 -0.07 0.04 0.25*** 0.03 0.19*** -0.08

Notes: * p< 0.10; ** p< 0.05; *** p< 0.01.




20/28

errors (White, 1980) were used to take into account heteroscedasticity. The chi-squaredtests show that the models are statistically significant in both cases.

The first column of Table V shows the results of estimating Model I. The main

variables of interest in the reported regression results demonstrate the hypothesized

effect. The coefficient of the refocusing variable is positive (b1 =0.66) and significant atthe 5 per cent level, indicating that analysts systematically overvalued the future earnings

of refocusing firms. On the basis of these results, we find that our Hypothesis 1a is

confirmed: security analysts overvalued refocusing activities during the 19902002

period. This result supports our proposition that analysts indeed take corporate strategies

into consideration in their firm valuations, and that during that particular period they

had a positive attitude towards refocusing activities.

The coefficient of the diversification dummy does not differ significantly from zero,

implying that analysts did not systematically underestimate the future earnings of diver-

sifying firms during the 1990s. This means that Hypothesis 1b has to be rejected.

Nevertheless, we can conclude from these results: (1) that, as a matter of principle,

analysts did not differentiate between diversifying firms and firms that did not show

M&A activity during that period; and (2) that a counter-movement (a refocusing trend

after the diversification trend) does not inevitably lead to the underestimation of the

original strategy (diversification).

Regarding the control variables, the estimated coefficients of Model I are with theexception of forecast dispersion significantly different from zero: firm size has a

negative impact on analyst surprise (b4 = -0.24, p< 0.01), indicating that larger firms are

Table V. Regression of the analyst surprise on the hypothesized variables, after controlling for other

determinants: results of the maximum likelihood estimation (truncated regression model)

Model I Model II

Coefficient Wald z-score Coefficient Wald z-score

Intercept 1.45*** 3.04 2.00*** 2.66

Hypothesized variables

Refocusing 0.66*** 2.54

Diversifying 0.16 1.05

Fashion discourse 2.24* 1.80

Control variables

Forecast dispersion 0.44 1.55 0.74** 2.17

Firm size -0.24*** -4.35 -0.26*** -2.56

Leverage 1.10*** 2.55 -0.62 0.55

Year effect Yesa

Number of observations 276 74

Wald chi-squared 36.99*** 10.60**

Log pseudo-likelihood -336.67 -96.93

Standard error of estimate 1.04 1.11

Notes: a Coefficients are jointly significant (chi-squared = 20.18) at the 0.05 level.

* p< 0.10; ** p< 0.05; *** p< 0.01.




21/28

more transparent to observers and likely to gain greater access to private information.

This finding is consistent with most empirical studies (for an overview, see e.g. Garca-

Meca and Snchez-Ballesta, 2006). The significantly positive influence of leverage

(b5 =1.10, p< 0.01) can also be explained. A higher debt-to-assets ratio may indicatefuture problems with meeting debt payments: analysts tend to issue more optimistic

forecasts when uncertainty regarding future earnings increases, which is also confirmed

in several empirical studies.

Model II introduces the influence of the core competence discourse on the analyst

surprise of refocusing firms. The results of our estimation are reported in the second

column of Table V. We find evidence that the discourse variable is positively associated

with analyst surprise at the 10 per cent level (b1 =2.24). Thus, we find our Hypothesis 2confirmed: the popularity of the core competence discourse is positively associated with

the overvaluation of refocusing firms by analysts. This result suggests that analysts

covering refocusing firms were likely to be influenced by the core competence discourse

during the 1990s. Consequently, we can assume that analysts play an important role inthe management fashion-setting process, although we cannot directly derive from these

results what role they play, i.e. whether analysts act as originators, facilitators, or media-

tors of such a fashion.

Regarding the control variables in this model, the coefficient estimates differ signifi-

cantly from zero, with the exception of the leverage variable. We find that higher forecast

dispersion (b2 =0.74, p< 0.05) is associated with a higher overestimation of futureearnings.

Limitations

A weakness of this study is the definition of refocusing and diversifying measures, as these

are dependent on the use of the SIC-based entropy measure. The main disadvantages of

this measure are as follows. First, the entropy measure is based on the SIC system.

Unfortunately, the distance between SIC numbers cannot be interpreted as a measure of

relation (Montgomery, 1982). Although four-digit categories within broader two-digit

groups could be expected to be more similar than four-digit categories from different

two-digit groups, one cannot interpret numerical differences on an interval or ratio scale.

Thus, there arises the problem that segment groups, which are normally highly related,

are separated by the SIC system. Second, the extent of diversification in segment

financial reporting is smaller than the true extent of diversification, which is due to the

fact that segment reporting requires only segments with a sales proportion of at least 10

per cent. This reporting convention results in a total maximum of ten reported segments.

Third, as segments are self-reported, the definition of a segment is flexible. Firms can

combine two or more vertically related activities into one segment or change segments

without changing their operations (Martin and Sayrak, 2003).

Because of the described problems with the SIC-based diversification measure, we ran

qualitative checks on the refocusing and diversifying firms, in addition to the quantitative

analysis by two independent coders. As part of those checks, we searched the LexisNexisdatabase using the following strings: name of company, years of transaction, core

business, and refocus in the case of a refocusing measure, and diversify in the case of




22/28

a diversification measure. The strategy was confirmed by means of a randomly chosen

sub-sample in 70 per cent of the cases of refocusing firms and 50 per cent of the cases of

diversifying firms. We did not find any counter-evidence that the remaining 30 per cent

of the refocusing firms were actually not refocusing. We also found no counter-evidence

in roughly 30 per cent of diversifying firms, which indicates that our measure is reliable

in spite of the aforementioned weaknesses. Moreover, these additional qualitative tests

showed that diversifying measures often indicated a vertical or horizontal integration and

thus a related diversification or an extension of the core business, rather than a classic

diversification with unrelated product lines. This result is possibly one of the reasons why

Hypothesis 1b was not confirmed: namely, that the future earnings of diversifying firms

were not underestimated.

Although our findings show that the capital market fostered the core competence

fashion, they still fall short of specifying the exact causal influences within the man-

agement fashion-setting community. Some of our findings support the view that the

capital market not only disseminates but also co-produces fashions. In the 1980s man-agers faced pressure from security analysts and investors to de-diversify even before the

core competency fashion appeared. This was due to different reasons, which were

largely independent of the broader managerial discourse. Generally, the opinion that

investors, rather than companies, should diversify was held by many financial market

professionals at that time and is also supported by the standard financial textbooks (e.g.

Brealey et al., 2006). In the United States, during the raider wave, conglomerates

became the target of hostile takeovers. One important reason for that development

was the emergence of new forms of financing (such as junk bonds), which, however,

were not accompanied by new management techniques. Zuckerman (2000) putsforward another argument why analysts favoured focused companies early on: security

analysts tend to specialize in particular industries. Diversified companies with business

lines in several industries are not easily understood, which hinders attempts to value

their shares. As a result, analysts give diversified companies a poorer valuation, which

means that the managers of such firms face pressure to refocus so that their stock can

be more easily appraised. Given that the valuations and opinions of the relevant finan-

cial market professionals preceded the described shift in business rhetoric, it is reason-

able to suggest that a reciprocal relationship exists between the two: analysts influence

the popular managerial discourse and the discourse influences the valuations of ana-

lysts. If consultants or management gurus take up ideas that are already in the air,

they are not, as past research has suggested, the sole or main originators of manage-

ment fashions.

CONCLUSION AND IMPLICATIONS

To date, the academic debate on the diffusion of management concepts has not put

much emphasis on the role of capital market actors. It has focused primarily on the role

of management consultants and gurus as originators of management fashions. This

study tries to bridge this gap and sheds light on the influence of security analysts on theevolution and spread of popular management ideas. Our analyses of the core compe-

tence concept show, that in the period covered by this study, analysts overestimated the




23/28

future earnings of refocusing firms and that their valuations were positively influenced by

the managerial discourse during the same time. These findings suggest that security

analysts indeed play an important role in the dissemination of popular management

concepts and can even act as facilitators or co-producers of such trends.

In that respect, our study extends management-fashion theory in various ways. We

show that professional observers of the capital market, such as analysts, are an impor-

tant part of the management-fashion community. Thus, contrary to the purely ratio-

nal view, it is unlikely that the capital market serves as a corrective mechanism that

limits the dissemination of popular management concepts with unclear performance

implications.

Previous studies have analysed how technical (market) pressures contribute to the

de-institutionalization of organizational forms or to fashion downswings (e.g. Davis et al.,

1994). However, our analysis suggests that it is exactly the qualified, unemotional, i.e.

non-faddish, reasoning that enables capital market actors to define appropriate beha-

viour and contributes to the institutionalization of new practices. This finding leads to theproposition that capital-market-oriented companies may be more susceptible to popular

management concepts than, for example, family-business firms. In the last three decades

family-owned companies like Tata in India, Haniel in Germany, or Loews in the USA

stayed relatively unaffected by the popular management discourse and have been fol-

lowing diversifying strategies.

Moreover, our findings help to resolve the classic neo-institutionalist question of why

management practices spread even when they may be inefficient. As it emerges from our

study, financial analysts play a special role in institutionalization processes (see Figure 3).

Not only can they induce publicly listed corporations to adopt institutionalized practices(Rao and Sivakumar, 1999) but they also increase stock market valuations (e.g. DeBondt

and Thaler, 1990; Lys and Sohn, 1990), which in turn are used to evaluate the efficiency

of popular management concepts. In other words, performance data, such as stock

market returns, may be subject to the same bandwagon pressures as the management

concepts under investigation (ONeill et al., 1998).

Positive stock market reactions, however, have a direct effect on qualitative reasoning

about what constitutes norms of good management in the broader managerial discourse

that surrounds the process of institutionalization. This effect enhances significantly the

Figure 3. The role of security analysts in the institutionalization process of new management concepts (MC)




24/28

acceptability of a management concept and introduces a second source of legitimacy

to the neo-institutional literature, which has hitherto not been discussed. Neo-

institutionalists focus on the widespread adoption of a concept via inter-organizational

imitation, which serves as a source of legitimacy (DiMaggio and Powell, 1983). By

contrast, our study highlights the legitimacy-enhancing effect of performance data and

the mediating role of capital markets in the adoption and popularization of management

concepts.

Another implication of our findings is that analysts can mislead top managers into

overestimating the virtues of popular strategies. It should be noted that fund managers,

rating agencies, investment banks, and analysts have a strong and increasing influence on

corporate strategy and structure, and managers are subject to growing pressure from

shareholders and their representatives to apply strategies that have become established as

legitimate solutions to managerial problems. These groups monitor managers, aiming

to force them into the path of shareholder-value maximization and to impede deviant

managerial actions (Marris and Mueller, 1980). Deviations from this strategic directionare primarily interpreted as a conflict of interests between shareholders and salaried

managers. However, an optimal strategic path is not exogenously given, but emerges in

the course of a sense-making process within the managerial discourse. Against the

backdrop of our findings, the question arises whether the capital market impedes sub-

optimal managerial actions, or rather, deviant behaviour in general. Indeed, homogeni-

zation processes of corporate strategies are often attributed to the influence of the capital

market (Fligstein, 1990). This effect promotes faddish behaviour and restricts a manag-

ers chances of pursuing unique strategies. As corporate strategies become ever more

homogenous because of imitative behaviour, competitive advantages are in increasingdanger of becoming eroded. Whereas agency theorists stress the benefits of tighter

control over management, our analysis, which is based on fashion theory, highlights also

the possible disadvantage of the capital markets increasing influence on corporate

strategy and structure.

Nevertheless, one cannot deduce from our study that managers should ignore the

demands of security analysts and other financial market actors. If they ignored these

demands, they would run the risk of damaging corporate reputation. As mentioned

earlier, Staw and Epstein (2000) have shown that analysts and external executives

attribute a higher reputation to firms that adopt widely accepted management tech-

niques, although adopting such techniques is not necessarily associated with higher firm

performance. However, there are various possible ways of responding to institutional

pressures to adopt management concepts. As Oliver (1991) states, managers could

choose from among various possible strategic responses to institutional pressure, which

range from passive conformity to proactive manipulation. One possibility, for example,

is the concealment tactic, which means concealing non-conformity under a facade of

acquiescence (Oliver, 1991, p. 154). Indeed, there is evidence that some corporations are

committed to the core competence strategy, but at the same time define their core

competencies as broadly as possible so that there is still enough room for diversifying

their business lines (Sikora, 2001). Our study suggests that companies should adopt thisleveraged strategy particularly at times when a concept is at the height of fashion and

the applause from Wall Street is the loudest.




25/28

REFERENCES

Abrahamson, E. (1991). Managerial fads and fashions: the diffusion and rejection of innovations.Academyof Management Review, 16, 586612.

Abrahamson, E. (1996). Management fashion.Academy of Management Review, 21, 25485.Abrahamson, E. and Fairchild, G. (1999). Management fashion: lifecycles, triggers, and collective learning

processes.Administrative Science Quarterly, 44, 70840.Abrahamson, E. and Rosenkopf, L. (1993). Institutional and competitive bandwagons: using mathematical

modeling as a tool to explore innovation diffusion. Academy of Management Review, 18, 487517.Amihud, Y. and Lev, B. (1981). Risk reduction as a managerial motive for conglomerate mergers.Bell

Journal of Economics, 12, 60517.Arend, R. (2006). Bursting bubbles: what the internet could have meant to strategic management aca-

demia.Journal of Management Inquiry, 15, 37282.Barron, O. E., Kim, O., Lim, S. C. and Stevens, D. E. (1998). Using analysts forecasts to measure

properties of analysts information environment. The Accounting Review, 73, 42133.Baumol, W. J. (1967).Business Behavior, Value, and Growth. New York: Harcourt, Brace and World.Beckers, S., Steliaros, M. and Thomson, A. (2004). Bias in European analysts earnings forecasts. Financial

Analysts Journal, 60, 7485.

Benders, J. and van Veen, K. (2001). Whats in a fashion? Interpretative viability and managementfashions.Organization, 8, 3353.

Benders, J., Nijholt, J. and Heusinkveld, S. (2007). Using print media indicators in management fashionresearch.Quality and Quantity, 41, 81529.

Berger, P. G. and Ofek, E. (1995). Diversifications effect on firm value. Journal of Financial Economics, 37,3965.

Berger, P. G. and Ofek, E. (1999). Causes and effects of corporate refocusing programs. The Review of Financial Studies, 12, 31145.

Bhagat, S., Shleifer, A. and Vishny, R. (1990).Hostile Takeovers in the 1980s: The Return to Corporate Specialization.Brookings Papers on Economic Activity: Microeconomics, 172.

Bikhchandani, S., Hirshleifer, D. and Welch, I. (1998). Learning from the behavior of others: conformity,fads, and informational cascades. Journal of Economic Perspectives, 12, 15170.

Birkinshaw, J., Hamel, G. and Mol, M. J. (2008). Management innovation. Academy of Management Review,33, 82545.

Brancato, C. K. (1997). Institutional Investors and Corporate Governance: Best Practices for Increasing Corporate Values.Chicago, IL: Irwin.

Brealey, R. A., Myers, S. C. and Allen, F. (2006). Corporate Finance. New York: McGraw Hill.Brown, L. D. (1993). Earnings forecasting research: its implications for capital markets research.International

Journal of Forecasting, 9, 295320.Brown, L. D. (1997). Analysts forecast errors: additional evidence. Financial Analysts Journal, 53, 818.Carson, P. P., Lanier, P. A., Carson, K. D. and Guidry, B. N. (2000). Clearing a path through the

management fashion jungle: some preliminary trailblazing.Academy of Management Journal, 43, 114358.Chang, S. J. (1996). An evolutionary perspective on diversification and corporate restructuring: entry, exit,

and economic performance during 19819. Strategic Management Journal, 17, 587611.

Chang, S. J. and Hong, J. (2000). Economic performance of group-affiliated companies in Korea: intra-group resource sharing and internal business transactions. Academy of Management Journal, 43, 42948.Chatterjee, S. and Blocher, J. D. (1992). Measurement of firm diversification: is it robust?. Academy of

Management Journal, 35, 87488.Chatterjee, S. and Singh, J. (1999). Are trade-offs inherent in diversification moves? A simultaneous model

for type of diversification and mode of expansion decision. Management Science, 45, 2541.Cornelissen, J. P. (2006). Metaphor and the dynamics of knowledge in organization theory: a case study of

the organizational identity metaphor. Journal of Management Studies, 43, 683709.Datta, D. K., Rajagopalan, N. and Rasheed, A. M. A. (1991). Diversification and performance: critical

review and future directions. Journal of Management Studies, 28, 52958.David, R. J. and Strang, D. (2006). When fashion is fleeting: transitory collective beliefs and the dynamics

of TQM consulting. Academy of Management Journal, 49, 21533.Davidson, R. and MacKinnon, J. G. (1993). Estimation and Inference in Econometrics. New York: Oxford

University Press.Davis, G. F., Diekmann, K. A. and Tinsley, C. H. (1994). The decline and fall of the conglomerate firm in

the 1980s: the deinstitutionalization of an organizational form. American Sociological Review, 59, 54770.




26/28

DeBondt, W. F. M. and Forbes, W. P. (1999). Herding in analyst earnings forecasts: evidence from theUnited Kingdom.European Financial Management, 5, 14363.

DeBondt, W. F. M. and Thaler, R. H. (1990). Do security analysts overreact?. The American Economic Review,Papers and Proceedings of the Hundred and Second Annual Meeting of the American Economic Association, 80, 527.

Deutsch, C. H. (1997). Clearing out the kitchen sink: conglomerates learn to pick their spots. New YorkTimes, 29 July, C14.

DiMaggio, P. and Powell, W. (1983). The iron cage revisited: institutional isomorphism and collectiverationality in organizational fields. American Sociological Review, 48, 14760.

Dobbin, F. and Zorn, D. (2005). Corporate malfeasance and the myth of shareholder value. Political Powerand Social Theory, 17, 17998.

Duru, A. and Reeb, D. M. (2002). International diversification and analysts forecast accuracy and bias.TheAccounting Review, 77, 41533.

Easterwood, J. C. and Nutt, S. R. (1999). Inefficiency in analysts earnings forecasts: systematic misreactionor systematic optimism?. The Journal of Finance, 54, 177797.

Fama, E. F. (1970). Efficient capital markets: a review of theory and empirical work. The Journal of Finance,25, 383417.

Fama, E. F. and Jensen, M. C. (1983). Separation of ownership and control. Journal of Law and Economics,26, 30125.

Fligstein, N. (1990).The Transformation of Corporate Control. Cambridge, MA: Harvard University Press.Garca-Meca, E. and Snchez-Ballesta, J. P. (2006). Influences on financial analyst forecast errors: a

meta-analysis. International Business Review, 15, 2952.Gill, J. and Whittle, S. (1992). Management by panacea: accounting for transcience. Journal of Management

Studies, 30, 28195.Gillan, S. L. and Starks, L. T. (2000). Corporate governance proposals and shareholder activism: the role

of institutional investors. Journal of Financial Economics, 57, 275305.Giroux, H. (2006). It was such a handy term: management fashions and pragmatic ambiguity. Journal

strategic management journal10

Documents