Abstract
The literature has focused on synergistic benefits or coordination costs in driving diversifying entry. A remaining puzzle that remains inadequately explained is the high levels of entry and exit by related diversifiers. We build on the existing literature to outline a formal model of the entry and exit decisions followed by an empirical test of the key implications of the model. We first observe a selection effect at entry: Facing business opportunities in a new segment, low capability firms from a more related segment expect to benefit from more synergies and are therefore more likely to enter than firms with similar capability but from less related segments. Second, we observe a reverse selection effect conditional on entry. Unfavorable shocks post entry in the new segment will tighten the survival criteria and drive some more related but low capability firms out. These predictions are supported using data on U.S. health insurance firms’ entry into and exit from the Affordable Care Act market during 2013 to 2017.
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