Scope, Scale, and Concentration: A New Perspective on the 21st-Century Firm

The Evolution of Firm Scope and Measurement Challenges

Recent discussions on corporate concentration have relied on traditional industry classifications that often fail to capture the evolving nature of firm scope and competition. Historically, firm scope has been measured using Compustat segment data, which relies on broad industry classifications and managerial reporting discretion. However, this traditional method falls short in capturing the true breadth of modern firms, particularly as they expand into related product markets rather than diversifying into entirely new industries.

In our recent paper, “Scope, Scale, and Concentration: The 21st-Century Firm,” published in The Journal of Finance, Gerard Hoberg and I introduce a novel methodology to measure firm scope using natural language processing (NLP) techniques, specifically doc2vec. This advanced text analysis method allows us to extract rich textual information from firms’ annual reports, offering a more granular, data-driven approach to measuring firm scope. By analyzing firms’ 10-K filings, we can quantify the industries they truly operate in based on how they describe their businesses, providing a significantly more detailed and accurate measure than conventional business segment data.

One of the most striking findings of our study is that when measured using our text-based scope methodology, industry concentration in the U.S. has not increased over the past 40 years. This contradicts conventional wisdom, which suggests that industries have become more concentrated, often using measures like the Herfindahl-Hirschman Index (HHI) based on standard NAICS or SIC codes. Traditional concentration metrics fail to account for the growing scope of firms, which our method captures. When we adjust for firm scope using text-based HHI measures, we find that horizontal concentration has remained stable over time, challenging the dominant narrative of rising corporate dominance.

This finding has broad policy implications. Current antitrust discussions often assume that increasing firm size and a shrinking number of public firms indicate growing monopoly power. However, our results suggest that what is actually happening is an expansion in firm scope within competitive markets rather than an increase in monopolistic control. This distinction is crucial for policymakers considering new merger guidelines and regulatory interventions.

The Power of Textual Data and NLP in Measuring Firm Scope

Our findings reveal that firms have expanded their operational scope by nearly 60% over the past 30 years, largely through acquisitions and R&D investments rather than by adding formal business segments. Unlike traditional conglomerates, these firms do not increase the number of reportable segments in financial statements but instead operate more flexibly across multiple closely related product spaces.

By employing textual analysis, we confirm that firms have leveraged synergies across related industries while maintaining streamlined organizational structures. This expansion of scope, however, remains hidden in conventional databases like Compustat, which continue to categorize firms based on broad, often outdated industry classifications.

How Firms Increase Scope: Investments and Acquisitions

Our study also examines the strategies firms use to expand their scope. We find that firms that increase their scope are more likely to engage in acquisitions, invest in research and development, and expand into related markets. Interestingly, we do not find a significant link between scope expansion and capital expenditures. This suggests that firms are increasingly relying on innovation and asset redeployment rather than traditional investment in physical infrastructure to grow their market reach.

Moreover, we find that firms with higher scope have higher market valuations, indicating that investors recognize the benefits of scope expansion. An increase in firm scope from the 25th percentile to the 75th percentile is associated with a substantial increase in firm valuation, as measured by the market-to-book ratio. This suggests that investors reward firms that strategically expand their operations into complementary markets while maintaining operational efficiency.

Financing Scope Expansion: The Role of Equity and Debt

Another key insight from our research is that firms expanding their scope tend to finance their growth through equity rather than debt. This preference for equity financing is consistent with the nature of scope expansion, which often involves investment in intangible assets such as intellectual property, technology, and brand positioning—assets that do not provide the same collateral value as tangible assets. This financing strategy differentiates modern multi-industry firms from traditional conglomerates, which historically relied on debt to fund diversification efforts.

Implications for Market Concentration and Competition Policy

Our findings call for a reassessment of traditional industry concentration measures and their implications for antitrust policy. As firms continue to evolve, so too must our methods of analyzing competition and firm behavior in the economy. Policymakers need to recognize that increasing firm size does not necessarily equate to reduced competition, especially when firms expand their scope in ways that enhance market efficiencies rather than limit consumer choice.

Additionally, our research suggests that regulatory bodies should consider scope expansion when evaluating mergers and acquisitions. Rather than focusing solely on traditional industry concentration metrics, regulators should examine how a firm’s expansion into related markets impacts overall competition dynamics.

Conclusion

Our research highlights the critical role of textual analysis in understanding modern corporate structures and market dynamics. By using NLP techniques such as doc2vec, we provide a more precise, data-driven approach to measuring firm scope and demonstrate that market concentration has not increased when accounting for firms’ expanded scope. These findings challenge the conventional wisdom on corporate concentration and offer new insights into how firms strategically expand in today’s competitive landscape.

As firms continue to leverage synergies across related industries and use innovation-driven strategies to expand, understanding the nuances of firm scope will be increasingly important for investors, regulators, and policymakers alike. Our study not only provides a new way to measure firm scope but also highlights the need for more sophisticated approaches in assessing market competition and corporate strategy in the 21st century.

The full paper can be accessed at: https://onlinelibrary.wiley.com/doi/epdf/10.1111/jofi.13400