This study examines the relative importance of year, industry, corporate, business unit, and transient industry effects on Taiwan business unit profitability between the years 1994 and 2000. Consistent with previous studies, our results indicate that in Taiwan business unit effects are considerably more important to profitability than other effects. When compared to the United States, we find that transient industry effects are more important to profitability in Taiwan, inasmuch as Taiwan manufacturing faced changes in its management environment when industrial investment transferred to Mainland China during the 1990s. This transfer resulted in a rapid change in Taiwan's industry structure that affected profitability. Our findings suggest that Taiwanese firms cannot control the structural factors of industry within the rapidly changing management environment. This may indicate that the competitive advantages of the business unit have a relatively larger influence on firm profitability in Taiwan than in the U.S.
JEL Classification: L10
Keywords: Profitability; Industry effects; Corporate effects; Variance components analysis
Thus far, there has been over twenty years of research into the relative importance of industry and corporate effects on firm profitability. Schmalensee's (1985) study was the first published work addressing this issue. Schmalensee used the variance decomposition method to decompose the total variance of business unit profits in the 1975 Federal Trade Commission (FTC) database. He found industry structure to be the most important influence on firm profitability. Subsequent studies by Rumelt (1991), Roquebert et al. (1996), and McGahan and Porter (1997a, 2002) also explored profit variance by decomposing the variance of business-unit profits into components associated with year, industry, corporate, and business-specific effects. Although the databases and statistical techniques used by the aforementioned researchers were not exactly identical, their results appeared to indicate that both industry and business unit effects had a large influence on business unit profitability, and that business effects were more important than industry effects. On the other hand, the influence of the corporate effects on business unit profitability varied subject to the different statistical and sample screening methods adopted.
Prior relevant studies into this top focused on the advanced countries, especially the United States, whereas those empirical studies that incorporated data of developing countries have been scarce. (1) McGahan and Porter (2002: 849) suggested that "the most direct opportunities for further research reside in exploring new data on the accounting profits of firms in other parts of the world apart from the U.S. in order to yield insight on questions about the relationships between the national economic environment and industrial performance." Taiwan is still considered a developing country at present. In recent years, labor-intensive manufacturing such as the textile and plastic products industries continue to be transferred westward to Mainland China in order to reignite and sustain development in stagnant industrial sectors. As these industries mature with gradual decreases in technological advantages and global competitiveness, they are replaced by new high technology industries such as the semi-conductor industries and other such information and electronics industries. This indicates that the management environment of Taiwan's manufacturing has recently experienced significant changes. Based on the figures published by the Directorate-General of Budget, Accounting and Statistics of Executive Yuan, R.O.C., Taiwanese manufacturing as a proportion of the Gross Domestic Product (GDP) declined from approximately 33.3 percent in 1991 to approximately 25.6 percent in 2001. (2) In the rapidly changing industrial environment, Taiwanese firms cannot control the structural factors of industry. …