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Multidimensional Signalling and Diversification

Yongmin Chen ()

RAND Journal of Economics, 1997, vol. 28, issue 1, 168-187

Abstract: This article offers a new explanation of why firms diversify. I present a model in which a firm has private information about both its own cost and the demand function of the market on which it competes with another firm. I show that diversification can be used by the informed firm to signal private information in order to obtain competitive advantages. This provides an important motive for a firm to diversify. The signalling explanation of diversification is consistent with some empirical observations. A phenomenon called natural signalling is also studied in the model where both signals and private information are multidimensional.

Date: 1997
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Handle: RePEc:rje:randje:v:28:y:1997:i:spring:p:168-187