The dynamics of related diversification: Evidence from the health insurance industry following the affordable care act

Research Summary We provide a theory of when relatedness will encourage both diversifying entry and post-entry exit. Our formal model reveals two channels through which resource sharing in combination with firm capabilities affects diversifying entry and post-entry exit. 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. Post entry, unfavorable shocks in the new segment 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 from 2013 to 2017. Managerial Summary When would factors that favor related diversifiers' entry into a new business segment also encourage their exit post-entry? Using data on U.S. health insurance firms' entry into and exit from the Affordable Care Act (ACA) market from 2013 to 2017, we find that more related diversifiers (i.e., insurers offering Medicaid), especially the low capability ones, are more likely to enter ACA. However, facing cost shocks in the new segment, more related diversifiers, especially the low capability ones, are more likely to exit than less related diversifiers (i.e., insurers offering no Medicaid). This is consistent with our formal model that predicts a selection at entry that favors related diversifiers due to expected synergies and an adverse selection post-entry against low capability related diversifiers.