Horizontal diversification and vertical contracting: Firm scoe and asset ownership in taxi fleets

Building on research suggesting that diversification taxes managerial resources while simultaneously creating new opportunities for the firm, this paper proposes and tests a theory of efficient organizational adaptation following diversification. Focusing on organizational systems as nexuses of contracts, we show how coordination can be improved following diversification by shifting asset ownership to agents. We find support for this proposition using novel microdata on taxi firms from the Economic Census, which shows that firms respond to the need for coordination between business units, following diversification, by shifting away from leasing vehicles to drivers toward contracting with drivers who own their own vehicles. We then investigate a deeper implication of the theory, that if changes in (vertical) asset ownership are efficiency improving responses to (horizontal) diversification, then horizontal and vertical organizational changes should exhibit complementarities in firms' production functions. We find that firms are indeed more productive when they realign their asset ownership contracts more fully following diversification. The empirical tests control for firm fixed effects and are robust to controls for the joint determination of diversification, asset ownership and productivity. We interpret the evidence as providing support for a theory of efficient organizational adaptation in response to the challenges of diversification.