Chapter 6: Corporate-Level Strategy 189
diversification before 1986, they encouraged lower diversification after 1986, unless the diver-
sification was funded by tax-deductible debt. Yet, there have been changes in the maximum
individual tax rates since the 1980s. The top individual tax rate has varied from 31 percent in
1992 to 39.6 percent in 2013. There have also been some changes in the capital gains tax rates.
Corporate tax laws also affect diversification. Acquisitions typically increase a firm’s
depreciable asset allowances. Increased depreciation (a non-cash-flow expense) produces
lower taxable income, thereby providing an additional incentive for acquisitions. At one
time, acquisi tions were an attractive means for securing tax benefits, but changes rec-
ommended by the Financial Accounting Standards Board (FASB) eliminated the “pool-
ing of interests” method to account for the acquired firm’s assets. It also eliminated the
write-off for research and development in process, and thus reduced some of the incen-
tives to make acquisitions, especially acquisitions in related high-technology industries
(these changes are discussed further in Chapter 7).^91
Thus, regulatory changes such as the ones we have described create incentives or
disincentives for diversification. Interestingly, European antitrust laws have historically
been stricter regarding horizontal mergers than those in the United States, but recently
have become more similar.^92
Low Performance
Some research shows that low returns are related to greater levels of diversification.^93
If high performance eliminates the need for greater diversification, then low performance
may provide an incentive for diversification. In the Strategic Focus, Coca-Cola has not met
its growth and profit targets in its dominant business of soft drinks in recent years. As such,
it has sought to diversify into higher growth areas such as bottled water, tea, and fruit juices.
Firms such as Coca-Cola, which has an incentive to diversify, need to be careful
because often there are brand risks to moving into areas that are new and where the com-
pany lacks operational expertise. There can be negative synergy (where potential synergy
between acquiring and target firms is illusory) and problems between leaders and cultural
fit difficulties with recent acquisitions.^94 Research evidence and the experience of a num-
ber of firms suggest that an overall curvilinear relationship, as illustrated in Figure 6.3,
Figure 6.3 The Curvilinear Relationship between Diversification and PerformancePerformanceLevel of DiversificationDominant
BusinessRelated
ConstrainedUnrelated
Business