MULTIDIMENSIONAL SIGNALING AND DIVERSIFICATION

This article offers a new explanation of why firms diversify. I presen t a model in which a firm has private information about both its own c ost and the demand function of the market on which it competes with an other firm. I show that diversification can be used by the informed fi rm to signal private information in order to obtain competitive advant ages. This provides an important motive for a firm to diversify, The s ignalling explanation of diversification is consistent with some empir ical observations. A phenomenon called natural signalling is also stud ied in the model where both signals and private information are multid imensional.