The costs of refocusing: Evidence from hedge fund closures during the financial crisis

Abstract

However, refocusing can also reduce economies of scale and scope, and will often impose direct operational costs associated with the refocusing event itself. Although recent research has acknowledged that refocusing may impose costs on firms (Alaix, 2014; Feldman, 2014;Wiedner & Mantere, 2018), there are major conceptual and empirical gaps in our knowledge about refocusing costs.Conceptually, there is a lack of clarity surrounding where refocusing costs come from, which limits our ability both to fully characterize the implications of an important corporate strategic decision (i.e., scope reduction) and to advise managers on how to mitigate these costs. As such, in this paper, we argue that there are two broad mechanisms that drive refocusing costs. First, refocusing may destroy synergies, whereby businesses are no longer able to share overlapping activities and operations. Second, refocusing may create adjustment costs, whereby the common management activities that underpin the functioning of the entire organization are temporarily impaired. We therefore characterize and investigate the mechanisms driving refocusing costs along two dimensions: the degree of relatedness between the business that has been removed and its sister divisions, and the duration of time over which refocusing costs persist.Empirically, testing theories about refocusing is challenging because selection effects make it difficult to measure refocusing costs. When managers choose to refocus, the benefits of doing so typically outweigh the costs, obscuring a researcher's ability to observe such costs by looking at performance data. Thus, one possible interpretation of the finding that endogenous refocusing is associated with an improvement in operating performance is that although the benefits of refocusing outweigh the costs, some costs of refocusing are present whenever managers choose to refocus. Employing some simple notation to clarify what "costs" means, we denote the gross benefits of refocusing (GB) as the operational gains associated with a reduction in firm scope, and the gross costs of refocusing (GC) as any associated cost that offsets the gross benefits of refocusing. Thus, the net implications of refocusing (NET) are GB − GC. If managers only choose to refocus when there are net benefits of refocusing, meaning that NET = GB − GC > 0, one will not be able to measure GC by studying the relationship between refocusing and performance, even if GC > 0.A key empirical question then becomes how to measure the costs of refocusing. Notably, when exogenous factors force managers to reduce the scope of the firm, it means that the equilibrium conditions for positive net performance implications of refocusing do not hold. Thus, when exogenous refocusing takes place, one might expect there to be net costs of refocusing-in other words, NET = GB − GC < 0-and, therefore, refocusing should be associated with a decrease in operating performance. Thus, we test our theory of refocusing costs by inferring the net costs of refocusing from decreases in...

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