Microsoft Word 2007 ichrie conference Proceedings Final-Final 06-06-07. doc

HYPOTHESES 
Markides (1995) found that refocusing (reduction in diversification) in the 1980s by over-diversified firms 
is associated with profitability improvement. Stimpert and Duhaime (1997) also suggested that diversification 
beyond some point yields fewer opportunities to achieve synergies, and extensive diversification is assumed to have 
a detrimental impact on firm performance. These findings imply that there might be an optimal diversification level, 
with performance decrements to either side of that point of maximization. Hitt et al. (1997) explained the existence 
of optimal internationalization by arguing that at some point, the coordination costs would outweigh the benefits 
derived from sharing resources and exploiting market opportunities. These transaction costs, then, begin to produce 
diminishing returns to internationalization. Palich et al. (2000) also suggested a curvilinearity model to reconcile the 
conflicting theories and findings regarding the nature of such a relationship. They claimed that the marginal costs of 
diversification increase rapidly as diversification hits high levels. Therefore, we hypothesized that there is an 
optimal level of internationalization for best performance and the relationship is curvilinear. 
H1: Internationalization and performance has an inverted U shaped relationship. 
 
Although the agency cost theory suggests that leverage can improve performance; as leverage continues to 
increase, both debt cost and default risk also increase and eventually exceed the firm’s debt service capacity and 
result in default. Therefore, the relationship between leverage and firm performance is more likely to be curvilinear 
and there should exist an optimal leverage for firm performance. 
H2: Leverage and performance have an inverted U shaped relationship. 
 
In the studies of internationalization’s effect on capital structure, evidence for both positive and negative 
correlation was found. On one hand, Reeb et al. (2001) found that internationalization lowers the risk for debt 
holders and results in higher leverage. Singh and Nejadmalayeri (2004) also showed that internationalization 
supports a higher leverage and directly results in reduction of overall cost of capital. On the other hand, Low and 
Chen (2004) reported that internationally diversified corporations have lower debt ratios than domestic corporations. 
In addition to the increased coordination costs discussed in the literature review, the negative relationship between 

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