Competition, diversification and systematic risk
I have started to pay attention to the systematic measure of risk since the year of 2017, such as the theoretical paper (Feinstein, Rudloff, and Weber 2017), which may potentially explore the risk measure via integrating multiple departments. Owing to my supervisor and colleague Jose Miguel and Jose Luis at the University of Granada, for briefly introducing their work about this, a popular idea was kept by myself that how exactly you measure the systematic/general risk for the entire company with multiple businesses. Naive thinking on this could be a weighted summation of all the risks of single businesses. Still, as our knowledge, it will go wired if we do not carefully consider the dependence/association across multiple businesses, even if the weights are controlled by these dependencies.
Then till this year 2020, the outbreak of COVID-19 affects all the aspects. Besides the numerous lives lost, the depression of economics would come after that. At least in China, during the state-wide lock-down, it is easy to imagine that lands of small companies could not survive for this period. So do those in other countries and districts. Inspired by several Weibo (Sorry for my short memory, one of those could come from 木遥 probably), the main idea of which talks about the power of the competitive market, for instance, the level of the competitive market reflects that of the efficiency of local authorities to the governance of the corona-virus, and the other is that single sales channel, such as retail or wholesale/B2B, leads to the shortage shock among toilet paper and meat1. The former one may cause the interest of sociologists and economists to study the efficiency of free/competitive market to the governance in view of China’s evidence.
Motivation
The latter one reminds me of the association to the systematical measure of risks, and also it could be akin to the classical Mean-Variance theory in risk management. In other words, the shortage of toilet paper and/or meat in the supermarkets or groceries may result from the imbalance of the supply and demand in the retail, since the companies in these domains are solid on their retail sales channels and have no flows from other channels, such as B2, which currently has affluent supply with no demand due to the lock-down situation. The reason for the ‘no-flow’ situation is the barriers in various channels.
In short, one company conducting a single business (sales channel) is the consequence of a less competitive environment and thus stays in a high-risk position systematically. So I am just curious whether the following statement holds or not:
The less diversification resulting from the less competitive market is in higher systematic risk.
The front part of this statement is so fascinating to me. Besides its connection to some orthodox Economic theories, it may let me re-think the classical case in the textbook: pouring out milk during the depression – classically considered as the action of the Price war. Now it happens again, not only milk but also some vegetable,2 which would witness more explanations
Back to the front part, even it is a causal-and-effect problem and must be complicated if imported DAGs, some observations may be useful. A recent work (Ljubownikow and Ang 2020) gives a cool empirical result:
“… higher competitive intensity is associated with less related diversification and more unrelated diversification…”
The related/unrelated diversification also naturally describes the dependence level of the multiple businesses, which hints the association with the structure of the systematic measure of risk. Therefore, this new consideration of the systematic measure of risk would make a difference in corporate risk management.
Model
Yet, if the normative study of Economics is temporarily ignored, the second part of our statement would be easy to check in a simple framework referring to Ljubownikow and Ang (2020) as well: the association among competition, diversification, and systematic risk. The stylized facts of this work would be a good start to some intuition of further normative studies.
References
Feinstein, Zachary, Birgit Rudloff, and Stefan Weber. 2017. “Measures of Systemic Risk.” SIAM Journal on Financial Mathematics 8 (1): 672–708.
Ljubownikow, Grigorij, and Siah Hwee Ang. 2020. “Competition, Diversification and Performance.” Journal of Business Research 112: 81–94.
