The Degree of Risk Reduction in Diversification

Topics: Systemic risk, Risk, Management Pages: 2 (646 words) Published: June 8, 2012
According to Roberts (2004, p214), diversification is when several businesses are combined under one ownership for the singular aim of reducing risk. The combination of all the businesses is less risky than individual businesses standing alone. According to Chandler (1959), there are three types of diversification: 1. Full line – company manufacture, market and control supplies of its single line of product, that is, the company has manufacture business unit, market business unit and a unit that takes care of supplies. 2. Multi line – involves company dealing in multiple line of products each unit producing its own particular product. 3. Continuing product turnover – company continuously and systematically develop new products out of research. In the view of Roberts (2004), managers of the different businesses in a firm allow information to flow easily among the businesses which can eventually result in an efficient allocation of capital among the businesses in the firm. Human capital can also be developed when there is diversification (Roberts, 2004). Example of a company where this is seen is General Electric. Also, expansion in multi line diversification allows superior managers to create more value to the firm because they will now have better access to bigger resources (Roberts, 2004 p217). This was seen in the case of ITT, this allows for complete utilization of resources in a firm. In the view of Rugman (1976), there is reduction in risk in making profit incurred by multinational companies with foreign operation than a similar company that sells its products only in one national market. Also, Rugman (1976) demonstrated in his works that there is a relationship between the stable earnings observed by firms that are diversified with ratio of foreign to total operations. In the views of Westerfield (1974), diversification will only reduce variance of profit flows of portfolios that are not market...
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