Asia Pac J Manag (2015) 32:551–569

DOI 10.1007/s10490-015-9408-1

Business expansion and firm efficiency in the commercial

banking industry: Evidence from the US and China

Feng Wang & Minxue Huang & Zhigang Shou

Published online: 24 March 2015

# Springer Science+Business Media New York 2015

Abstract Despite a consensus that business expansion drives firm effectiveness, extant
literature has neglected the exact relationship between business expansion and firm
efficiency. Using secondary data from the US and Chinese banking industries, this
study explores two efficiencies of exploratory expansion (i.e., investing in new busi-
ness, outside the scope of the firm’s existing business) and exploitative expansion (i.e.,
expanding target markets in the existing business)—profitability and marketability. The
empirical results reveal that exploratory expansion decreases profitability but increases
marketability. Meanwhile, exploitative expansion has no significant effect on profit-
ability, but it can increase marketability. Furthermore, the study reveals that Chinese
banks are likely to benefit more from exploratory expansion, whereas US banks would
benefit from exploitative expansion.

Keywords Exploratory expansion . Exploitativeexpansion . Profitability . Marketability .

US and Chinese banking industry

Business expansion is a corporate strategy to create competitive advantages and

increase revenues through new product offerings or new markets or both (Bang &
Joshi, 2008; Mishina, Pollock, & Porac, 2004). As a critical form of organizational
change (Beck, Brüderl, & Woywode, 2008), business expansion has attracted attention
from both scholars and practitioners, who recognize that a firm can implement two key
strategies: exploratory expansion or exploitative expansion. With an exploratory

F. Wang
School of Business Administration, Hunan University, Changsha 410082, China
e-mail: fwang@hnu.edu.cn

M. Huang : Z. Shou (*)

Economics and Management School, Wuhan University, Wuhan 430072, China
e-mail: mkshou@whu.edu.cn
M. Huang
e-mail: huangminxue@whu.edu.cn
552 F. Wang et al.

expansion, the firm invests in a new business beyond the scope of its existing core
business (Bang & Joshi, 2008; Fang, Palmatier, & Steenkamp, 2008; Rajagopalan &
Spreitzer, 1996; Zhou & Wu, 2010). It might maintain or abandon its existing business
while entering a new business arena. For example, as IBM moved into service markets,
it largely abandoned its PC business. In a banking context though, a bank can readily
enter into new business areas, such as investment banking, while still retaining and
benefiting from its traditional loan business. Exploitative expansion instead is a strategy
by which a firm expands its target market throughout its existing business settings,
mainly by enriching its existing product lines in an attempt to satisfy a broader scope of
customer segments (Bang & Joshi, 2008; Fang, Palmatier, & Grewal, 2011; Zhou &
Wu, 2010). Thus a bank with a primary focus on its corporate loan service might begin
to provide personal and mortgage loan services too.
Prior studies address the impacts of business expansion on sales growth, short- and
long-term revenues, and firm value (e.g., Beck et al., 2008; Fang et al., 2008; Klarner &
Raisch, 2013; Kim, Dobrev, & Solari, 2003; Mishina et al., 2004). However, no
empirical research investigates the impact on firm efficiency, which is distinct from
firm effectiveness and its emphasis on absolute outcomes. Rather, firm efficiency refers
to the conversion ratio by which multiple inputs become outputs (Charnes, Cooper,
Lewin, & Seiford, 1994). The most efficient firms gain maximal outcomes by investing
minimal investments. Although business expansion can improve outcomes, leading to
greater effectiveness (Fang et al., 2008; Klarner & Raisch, 2013), the financial out-
comes might not outweigh the required investments, which implies inefficiency and the
potential failure of business expansion. To evaluate the success of business expansion,
we thus must consider its relationship with firm efficiency.
Do exploratory expansion and exploitative expansion increase firm efficiency?
Following Luo (2003) and Seiford and Zhu (1999), we consider efficiency in terms
of the firm’s profitability and marketability. Profitability is the extent to which minimal
investments (e.g., labor, capital) transform into maximal profits and sales. It thus
evaluates a firm’s efficiency for profit generation in the marketplace. Marketability
instead is the extent to which financial performance translates into market capitalization
and stock prices, such that it reflects the firm’s efficiency in terms of value creation in
the stock market. Profit represents current revenues, whereas firm value usually reflects
investors’ perceptions about the firm’s future performance. Therefore, profitability and
marketability represent short-term and long-term advantages, respectively. In turn,
organizational learning theory (Argote, 1999) suggests that exploratory expansion
involves risky learning activities. The related learning costs likely diminish current
profits, but learning should foster future gains, by increasing future sales and decreasing
the volatility of future cash flows (Srivastava, Shervani, & Fahey, 1998). Thus, we posit
that exploratory expansion decreases profitability but increases marketability. In con-
trast, an exploitative expansion strategy focuses on using existing knowledge, which
creates synergy, enhances knowledge utilization, and fosters future gains (Markides &
Williamson, 1996; Vargo & Fahey, 2004). We postulate that exploitative expansion
improves both profitability and marketability, by decreasing learning costs and increas-
ing synergy and future cash flows.
To test these predictions and measure profitability and marketability, we use data
envelopment analysis (DEA), a linear programming and nonparametric frontier method
that does not require subjective weights for multiple inputs and outputs (Charnes,
Business expansion and firm efficiency in the commercial banking 553

Cooper, & Rhodes, 1978; Charnes et al., 1994). Empirically, we integrate data from
78 US and 14 Chinese publicly traded banks during 2003–2009. The results of
this analysis reveal that exploratory expansion decreases profitability but in-
creases marketability; exploitative expansion has no significant effect on profit-
ability but could increase marketability. We also find that Chinese banks likely
benefit from exploratory expansion, whereas US banks would benefit more from
exploitative expansion.
In the next section, we introduce the research background and develop our
hypotheses. We then present our empirical study of the US and Chinese com-
mercial bank industries, which leads into a discussion of our results. Finally, we
outline the contributions and limitations of this study, as well as some research
directions.

Research background

Business expansion strategies: Exploratory and exploitative

Firms often adjust their organizations by introducing new products, markets, processes,
or other innovations (e.g., Battilana & Casciaro, 2013; D’Aunno, Succi, & Alexander,
2000; Tidd & Bessant, 2011; Zhou, Tse, & Li, 2006). Business expansion is a critical
type of organizational change that implies a shift in niches, due to new products and
new markets (Beck et al., 2008). Many studies have investigated the effectiveness of
business expansion, such as Kim et al.’s (2003) analysis of the effect of expanded
product niche width on firm failure; Gary’s (2005) investigation of the financial
outcomes of related diversification; Fang et al.’s (2008) research into the effect of
service transition on firm value; and Klarner and Raisch’s (2013) study of how change
pace influences shareholder value. But they have neglected efficiency. Therefore, in
contrast with existing studies of effectiveness, we focus on the influences of business
expansion on firm efficiency.
Following organizational change and strategic management literature, we introduce
two business expansion strategies: exploratory and exploitative. The former entails
investments in a new business arena, outside of the scope of the existing business
(Bang & Joshi, 2008; Fang et al., 2008; Zhou & Wu, 2010). For example, in the
commercial banking industry, loans represent a traditional, existing business; new
business expansions might include settlement, agency, investment, or commission
services. An exploitative expansion instead aims to improve the firm’s revenue by
expanding the target market for its existing business (Bang & Joshi, 2008; Fang et al.,
2011; Zhou & Wu, 2010). A commercial bank that had only provided service for
corporate customers might conduct an exploitative expansion by developing personal
retail and residential mortgage loans too.

Firm efficiency: Profitability and marketability

Classic production theory posits that efficiency represents a conversion ratio, from
economic inputs (e.g., labor, capital) to outputs (e.g., sales, profits). Firm efficiency as a
conversion ratio encompasses multiple inputs to outputs (Charnes et al., 1994). As Luo
554 F. Wang et al.

and Homburg (2007) emphasized, evaluations of firm efficiency thus should include
multiple inputs and multiple outputs, rather than using single, cost-based indicators
(e.g., return on assets, return on equity).
Most management-oriented efficiency studies evaluate profitability in the
marketplace, which refers to the extent to which a firm investing minimal labor
and capital resources generates maximal profit and sales. But marketability
efficiency is critical as well, because the real value of a firm is defined by the
stock market (Luo, 2003), and this measure represents the extent to which the
firm can transform its financial performance into value in the stock market.
Unlike profitability, marketability reflects investors’ expectations of future per-
formance, and it is difficult for managers to manipulate. Therefore, we consider
both profitability and marketability.
Seiford and Zhu (1999) and Luo (2003) proposed a two-stage production
process that evaluates profitability in the marketplace and marketability in the
stock market (see Fig. 1). In the first stage, labor and firm total assets represent
inputs, and sales and profits are outputs. Profitability efficiency then is the
conversion ratio for these multiple inputs to the multiple outputs, such that it
represents the firm’s competitive advantage as profit generation in the market-
place. In the second stage, outputs from the first stage (sales and profits) become
inputs, and the new outputs are stock prices and market capitalization in the
stock market. Here, marketability efficiency is the conversion ratio for these
multiple inputs to the multiple outputs, and it reflects the firm’s competitive
advantage in terms of its increased market value in the stock market.
To measure profitability and marketability, DEA offers a valid metric with
several advantages (Charnes et al., 1978; Charnes et al., 1994). First, DEA can
evaluate multiple inputs and multiple outputs, as well as provide a single
efficiency score for each firm. Second, as a linear programming and nonpara-
metric frontier method, DEA does not require any subjective weights for the
multiple inputs and outputs. For this study, we used the output-oriented model, to
ensure the maximization of outcomes (Charnes et al., 1978). Assume there are n
firms, each of which is a decision-making unit, and there are m input factors and
s output factors. The input and output vectors are xj =(x1j,x2j,⋯,xmj) and yj =(y1j,
y2j,⋯,ysj), respectively, and the production set is:

n  Xn Xn o

T ¼ ðX ; Y ÞX ≥ j¼1
λ j X j ;Y ≤ j¼1
λ j Y j ; j ¼ 1; 2; ⋯; n ð1Þ

Net Interest Market

Total Assets
Revenue Capitalization
Shareholders’ Equity Operating Revenue Market Price
Profitability Marketability
Personnel Expenses Net Profit P/B Ratio

Fig. 1 Two-stage production process of banks: Profitability and marketability

Business expansion and firm efficiency in the commercial banking 555

Thus, firm efficiency can be calculated by:

X m Xm 
− þ
max θ* ¼ θ þ ε i¼1
s i þ i¼1
s r
X
n
s:t: λ j xi j þ s−i ¼ xi0 ; i ¼ 1; 2; ⋯; m;
j¼1
ð2Þ
X
n
λ j yr j −sþ
r ¼ θyr0 ; r ¼ 1; 2; ⋯; s;
j¼1
λ j ; s−i ; sþ
r ≥0

where s−i ,s+r are slack variables; ε is the minimum; and θ is the firm efficiency score,
which ranges between 0 and 1. If the firm’s efficiency equals 1, all its output slacks are
0, the firm is said to be efficient, and it represents a best practices firm.

Hypotheses development

Effects of business expansion on profitability

To discuss whether and how exploratory and exploitative expansions influence profit-
ability and marketability, we use Fig. 2 as a framework.
Adopting an exploratory expansion means that a firm enters new business, beyond
the scope of its existing business. Based on organizational learning theory (Argote,
1999; Slater & Narver, 1995), we posit that this strategy should decrease the firm’s
profitability, in three ways. First, organizational learning involves knowledge acquisi-
tion, dissemination, and interpretation (Argote, 1999). Adopting an exploratory expan-
sion, the firm would acquire and learn new knowledge and skills, which is costly
(Slater & Narver, 1995). According to March (1991), a firm’s costs of learning worsen
its financial position in the short term, and then result in declining profitability.
Second, soon after adopting an exploratory strategy, the firm usually must address
conflicts across its new and existing business (Fang et al., 2008). Because it requires
new knowledge dissemination among departments during the organizational learning

Business Expansion Firm Efficiency

Strategy

Exploratory -
Profitability
Expansion +

Exploitative + n.s.
Marketability
Expansion +
Fig. 2 Effects of exploratory and exploitative expansions on profitability and marketability
556 F. Wang et al.

process, this strategy likely induces coordination costs across the newly varied business
areas (Zhou & Li, 2007). These coordination costs also decrease firm profitability (e.g.,
same revenue, more costs).1
Third, a firm is a bundle of resources, and every firm suffers from resource
constraints (Barney, 1991; Chen & Chu, 2012; Newbert, 2007; Zhan & Chen, 2013).
After acquiring and disseminating new knowledge, the firm must transform and
interpret the new knowledge, which requires resources. Thus, the resources available
to existing businesses may diminish. With insufficient investment, the profits from the
existing business also could decline (Fang et al., 2008), which lowers firm profitability.
Therefore:

Hypothesis 1 An exploratory expansion strategy decreases the firm’s profitability.

A firm that adopts an exploitative expansion instead deepens the product offerings
associated with its existing business, in an attempt to satisfy a broader scope of
customer demands across segments. Accordingly, such an expansion should increase
the firm’s profitability. First, an exploitative strategy involves the use of existing
knowledge in the current business. During the organizational learning process, the firm
can interpret and recall its already existing knowledge (Slater & Narver, 1995). Thus,
this strategy enables it to use proprietary know-how and indivisible physical assets
recurrently, which should decrease firm learning costs.
Second, with a broad range of customer segments (e.g., corporate, personal, and
residential mortgage loans), the firm can exploit shared knowledge and resources, such
as its brand reputation, customer service experience, or R&D competence (Clark,
1988), across the segments. This sharing helps the firm create synergy, which enhances
knowledge utilization and further improves the returns on its investment (Markides &
Williamson, 1996). Therefore:

Hypothesis 2 An exploitative expansion strategy increases the firm’s profitability.

Effects of business expansion on marketability

Unlike profitability, which focuses on short-term performance, marketability reflects

shareholders’ expectations of future firm value and accounts for both current and future
gains. According to theory pertaining to the marketing-finance interface (Srivastava
et al., 1998), shareholders emphasize marketability and evaluate it on the basis of their
anticipated future cash flows and volatility. If shareholders perceive that the firm’s cash
flows are likely to increase and the volatility of its cash flows might be attenuated in the
future, their perceptions of marketability increase.
An exploratory expansion should increase marketability by improving shareholders’
confidence in increasing, stable cash flows. First, when a firm develops new product
offerings by learning new knowledge and skills, it gains greater opportunities to
conduct cross- or up-selling among current customers. Improving the lifetime value

1
We thank an anonymous reviewer for suggesting this point.
Business expansion and firm efficiency in the commercial banking 557

of current customers sends shareholders a signal that the firm can increase its future
cash flows (Rust, Lemon, & Zeithaml, 2004).
Second, shareholders address firm signals in the stock market (Luo,
Homburg, & Wieseke, 2010; Srivastava et al., 1998). Because of the new
knowledge and skills that the firm has created, an exploratory expansion
strategy signals that the firm is an innovator and is able to create new value
appropriations. So shareholders may believe the firm is likely to stay ahead of
its competitors, with greater capabilities for resisting competitive attacks
(Rubera & Kirca, 2012). In turn, shareholders should trust the stability of the
firm’s cash flows more. Therefore:

Hypothesis 3 An exploratory expansion strategy increases the firm’s marketability.

Although an exploitative expansion also increases marketability, it relies on a

different path to improve shareholders’ confidence in future cash flows and
stability. First, an exploitative expansion aims to enlarge the firm’s target
markets by introducing broad product offerings in an existing business field,
which should send to shareholders a signal that potential revenue will increase
through a customer breadth effect (Fang et al., 2011; Zhou & Wu, 2010). For
example, a commercial bank that already sells corporate loans could enrich its
product line by adding personal or residential mortgage loans. These broadened
loan segments encourage shareholders to believe that the bank has more sources
of future cash flows.
Second, the enlarged market scope helps smooth out demand uncertainties in the
firm’s existing business (Gary, 2005). For example, if demand for corporate loans
dropped, an expanded residential mortgage loan business could compensate for that
drop. This substitutive effect minimizes the volatility of cash flows and thereby
improves shareholders’ confidence in the firm’s value. Therefore:

Hypothesis 4 An exploitative expansion strategy increases the firm’s marketability.

Effects of business expansion on marketability in emerging and developed economies

Although both exploratory and exploitative expansion strategies might improve firms’
marketability, their outputs inherently are determined by their social context (Barreto,
2010). We therefore consider how the effect of business expansion on marketability
might vary across developed and emerging economies.
Emerging economies often experience massive transitions in their social, legal, and
economic institutions, so dynamism and unpredictability characterize these markets
(Keister, 2009; Zhou et al., 2006). To be competitive, firms in these economies need to
gather real-time information from the changing environment and seize on its emergent
opportunities. Eisenhardt and Martin (2000) argued that an exploratory strategy creates
new knowledge and improves the firm’s abilities to respond to market dynamism,
whereas an exploitation strategy focuses on existing knowledge. This existing knowl-
edge even might be a disadvantage if the firm over-generalizes from its past
experience and neglects new opportunities (Argote, 1999). Thus, compared with
558 F. Wang et al.

an exploitative expansion, an exploratory expansion should be more appropriate

in emerging markets.
In addition, the overall industry structure in emerging economies is unclear
and immature (Hoskisson, Eden, Lau, & Wright, 2000), such that huge latent
opportunities and values remain to be identified and created. A firm moving
into new areas can reap first-mover advantages and differentiate itself clearly
from competitors in the existing area (Rubera & Kirca, 2012; Zhou & Li,
2007). In contrast, an exploitation strategy cannot provide reputation effects,
because a firm that adopts this strategy is not a first mover in the new market,
nor does it enjoy the advantages of preemptive domination of emerging distri-
bution channels. Therefore, shareholders likely value exploratory expansion
over exploitative expansion in emerging economies, and we posit:

Hypothesis 5 In an emerging economy, an exploratory expansion strategy leads to

higher marketability than does an exploitative expansion strategy.

Markets in developed economies instead feature less dynamism and growth

(Keister, 2009), so it is more difficult for a firm with an exploratory strategy to
capture market opportunities. In contrast, the firm’s abilities to exploit its
existing business likely generate stable cash flows (Eisenhardt & Martin,
2000). Therefore, shareholders’ confidence should be triggered by exploitative
rather than exploratory expansion in developed economies. Because the industry
structure is stable and mature, market leaders in different business areas already
possess competitive advantages they can use to maintain their market positions.
A firm adopting an exploratory expansion confronts powerful extant competi-
tors in the new business areas, so the efficiency of this type of expansion may
appear doubtful to shareholders. Diversification in existing areas promises
greater gains, because firms can exploit their existing competitive advantages
more efficiently in familiar business areas (Beck et al., 2008; Gary, 2005).
Thus, compared with exploratory expansion, exploitative expansion should
improve shareholders’ confidence in firms in developed economies, resulting
in higher marketability.

Hypothesis 6 In a developed economy, an exploitative expansion strategy leads to

higher marketability than does an exploratory expansion strategy.

Empirical study

Research context

We focus on the US and Chinese commercial banking industries to investigate

our research question, for several reasons. First, the banking industry per se is
important for the development of national economies, and because of the global
financial and economic crisis, the market environment is increasingly uncertain
for banks, especially those in emerging countries. Second, both exploratory and
exploitative strategies are prominent for banks. Increasing competition in
Business expansion and firm efficiency in the commercial banking 559

traditional loan businesses has led some banks to develop new businesses and
attempt to provide one-stop banking to their customers; others have diversified
their loan business to include both corporate and private loans. Third, as the
Chinese banking industry undergoes massive changes, in accordance with the
rapid transitions of Chinese social and economic institutions, many Chinese
banks are taking lessons from US banks. Fourth, by integrating data from
developed and emerging economy, we help validate the findings and derive
suggestions for managers and policy makers.
Our data came from the Fitch-IBCA BankScope database, which provides
financial statements for banks worldwide (Miller & Parkhe, 2002). We included
only large, publicly listed banks with assets in excess of $1 billion (Luo, 2003;
Miller & Noulas, 1996). The final data set, which spans 2003–2009, consists of
78 US and 14 Chinese banks. The 14 banks represented all the publicly listed
banks in China before 2009; the assets of the 78 US banks accounted for 82 %
of the total assets of US banks, so the sample appears representative of these
banking industries.

Measurement and data sources

Table 1 contains the constructs and measures for this empirical study.

Exploratory expansion Banks earn revenues through interest and non-interest income.
Interest revenues stem from a commercial bank’s loan business. Similar to Fang et al.
(2008), we measured the effort a bank devotes to new business, beyond its traditional
loan business, as the percentage of revenues generated from non-loan business, com-
pared with total revenues in a given year, to represent the new business ratio. From year
t - 1 to t, exploratory expansion thus equals the change in the new business ratios
calculated for each year.

Exploitative expansion A bank’s loan business consists of four segments: corpo-

rate and commercial, personal and retail, residential mortgage, and other loans.
In a given year, we collected the amount of loans in each segment. To capture
the breadth of the four segments, following Zwillinger (1996), we measured
entropy across the segments. Thus for bank i in year t, loan business entropy
would be defined as follows:

8
>
>
>
<  
X
4
Loann Loannit
Entropyit ¼ − Ln it if Loanit > 0 ; ð3Þ
>
> Loanit Loanit
>
: n¼1
0 if Loanit ¼ 0
4
where Loanit ¼ ∑ Loannit . We preferred to measure entropy, rather than vari-
n¼1
ance, because it is independent of the total amount of loans. Entropy is
maximal when loans are evenly distributed across all four segments but mini-
mal if all loans are concentrated in a single segment. Thus, from year t − 1 to
560 F. Wang et al.

Table 1 Variables and measures

Variables Measures

Dependent variables
Profitability A linear programming-based ratio of multiple outputs
(net interest revenue, operating revenue, net profit)
to multiple inputs (total assets, shareholder equity,
personnel expenses). In the final estimation equation,
the measure is the change from t-1 to t.
Marketability A linear programming-based ratio of multiple outputs
(market capitalization, market price, P/B ratio) to
multiple inputs (net interest revenue, operating revenue,
net profit). In the final estimation equation, the measure
is the change from t-1 to t.
Independent variables
Exploratory expansion From year t-1 to t, the change in the percentage of revenues
from non-loan business compared with total revenues
Exploitative expansion From year t-1 to t, the change in entropy across four loan
segments: corporate and commercial, consumer and retail,
residential mortgage, and other loans
Control variables
Market share The market share of total loans for each bank. In the final
estimation equation, the measure is the change from t-1 to t.
Deposit/total asset ratio The percentage of deposits to total assets. In the final estimation
equation, the measure is the change from t-1 to t.
Employee The number of employees (log-transformation). In the final
estimation equation, the measure is the change from t-1 to t.
Tier 1 capital ratio The percentage of Tier 1 capital. In the final estimation equation,
the measure is the change from t-1 to t.
Bad loan ratio The percentage of bad loans to total loans. In the final estimation
equation, the measure is the change from t-1 to t.
Current ratio The current assets divided by current liabilities. In the final
estimation equation, the measure is the change from t-1 to t.
ROAA dynamism The standard deviation of return on average assets across the
prior 3 years. In the final estimation equation, the measure
is the change from t-1 to t.
Country 1 = US bank; 0 = Chinese bank
Year A set of dummy variables for different years to control for
unobserved time-specific factors

t, exploitative expansion reflects the change between the entropies measured in

each year.

Bank efficiency The measures of profitability and marketability efficiency relied on the
DEA approach, which assesses the relative efficiency of a firm in converting its
multiple inputs into multiple outputs. For each year, we calculated the efficiency of
each bank in both developed and emerging markets (Luo, 2003; Seiford & Zhu,
1999). Figure 1 depicts the two-stage production process and the multiple inputs
and outputs.
Business expansion and firm efficiency in the commercial banking 561

To calculate profitability with DEA, we used three annual inputs 2: total assets,
shareholder equity, and personnel expenses. Total assets summed total current assets
and fixed assets; shareholder equity represented the sum of share capital, shareholders’
reserves, retained earnings, treasury stock, and other equity; and personnel expenses
referred to the costs of employees. The output variables for this DEA were net interest
revenue, defined as the difference between interest payments on assets and interest
payments on liabilities; operating revenue, or the sum of net sales and other revenues;
and net profit, equal to the profit for each period after distributing preferred dividends
and subtracting operating and non-operating expenses, but before the ordinary divi-
dends distribution.
To calculate marketability with DEA, we used the three outputs from the profitabil-
ity stage as inputs. The outputs in turn were market capitalization, which was equal to
the share price times the number of shares outstanding at year end; market price, or the
stock price at year end; and the price-to-book value ratio, equal to the average of high
and low ratios, as calculated by the market price divided by the book value per share.

Control variables We controlled for market structure, bank size, operating risk,
and years. First, we calculated the market share of the total loans held by each
bank. Second, to control for the effect of bank size, we used three variables:
deposit/total asset ratio, which equaled the bank’s deposits divided by its total
assets; Tier 1 capital ratio, or Tier 1 capital divided by total assets; and a simple
count of the number of employees. Third, for operating risk, we chose to control
for the bad loan ratio, because bad loans influence bank efficiency. Fourth, to
evaluate whether the bank had enough resources to pay its debts, we calculated
its current ratio, equal to its current assets divided by its current liabilities. Fifth,
for dynamism in bank growth, we calculated the standard deviation of the return
on average assets across the prior 3 years. Sixth, we created a dummy variable,
equal to 1 for US banks and 0 in all other cases. Seventh, a set of dummy
variables for different years controlled for unobserved time-specific factors that
might affect bank efficiency. Table 2 contains the descriptive statistics and
correlations for all measures.

Model estimation

The cross-sectional, time-series data set creates several issues for the model estimation.
First, we controlled for observable and unobservable heterogeneity. With regard to
observable heterogeneity, we included bank-level covariates to rule out these alternative
explanations. For bank-specific unobservable heterogeneity, we modeled the impact of

2
To test for robustness and enhance confidence in our results (Luo & Homburg, 2007), we reran the DEA with
different combinations of inputs and outputs: DEA1 used the whole array of efficiency scores in our study;
DEA2 split the efficiency scores for US and Chinese banks and then ran the DEA programming separately;
DEA3 lagged the inputs for one year; and DEA4 included the inputs and outputs that were common across
Luo’s (2003) and Seiford and Zhu’s (1999) studies. For profitability, the correlations were as follows: DEA1-
DEA2 is .768; DEA1-DEA3 is .882; and DEA1-DEA4 is .775. For marketability, the correlations were as
follows: DEA1-DEA2 is .916; DEA1-DEA3 is .920; and DEA1-DEA4 is .790. The significant, high
correlations affirmed the robustness of the DEA programming results.
 562

Table 2 Descriptive statistics and correlations

Mean SD 1 2 3 4 5 6 7 8 9 10

1. Profitability .63 .21

2. Marketability .57 .27 .16*
3. New business ratio 33.79 23.57 .02 .06
4. Existing business entropy .80 .27 −.22*** .16*** .45***
*** **
5. Market share 2.17 5.35 −.35 .12 .03 .15***
** ***
6. Deposit/total asset ratio .75 .19 −.13 −.02 −.52 −.13** −.01
7. Employee 8.56 1.64 −.57*** .03 .32*** .26*** .78*** −.24***
8. Tier 1 capital ratio 11.38 8.73 .29** .11* .33*** −.02 −.10* −.51*** −.08*
*** ** *
9. Bad loan ratio 2.09 4.64 .04 −.36 −.07 −.11 .04 .08 .03 −.08*
* *** *** * ** *** ***
10. Current ratio .25 .65 .11 .18 .45 .09 .12 −.52 .21 .85*** −.04
*** *** ***
11. ROAA dynamism .42 .68 .03 −.24 .19 −.01 −.06 −.29 .04 .46*** .46*** .43***

*
p < .05; ** p < .01; *** p < .001
F. Wang et al.
Business expansion and firm efficiency in the commercial banking 563

business expansion on changes in efficiency from time t − 1 to time t (Luo et al., 2010).
Second, we created a time lag between the measures of the independent variables and
bank efficiency to eliminate the potential for reverse causality (Boulding & Staelin,
1995). Third, we also assessed multivariate multicollinearity by examining the variance
inflation factors. The values ranged from .361 to 4.463, so multicollinearity was not a
serious issue.
Fourth, because profitability and marketability are censored, with upper and
lower bounds, we could not use traditional ordinary least square regressions.
Following Luo and Homburg (2007), we instead employed a two-limit Tobit
model. From time t − 1 to time t, we censored the progress of firm efficiency to
fall between −1 and 1. Let yi,t* denote the latent progress of profitability
(marketability) of bank i from time t − 1 to time t, as given by:
yi;t * ¼ X ’ i;t−1 β þ εi;t
¼ β0 þ β1 Exploratory Expansioni;t−1 þ β2 Exploitative Expansioni;t−1
þ β 3 ΔMarket Sharei;t−1 þ β 4 ΔDeposit Ratioi;t−1 þ β5 ΔEmployeesi;t−1
ð4Þ
þ β6 ΔTier 1 Capital Rati oi;t−1 þ β7 ΔBad Loan Rati oi;t−1
þ β8 ΔCurrent Rati oi;t−1 þ β9 ΔROAA Dynamis mi;t−1
þ β10 Country þ β 11e14 Year Dumm yt þ εi;t ;
where εi,t indicates the normally distributed residuals with zero mean and σ2
variance. For time-variant control variables, Δ represents the difference between
the two time periods. Because the progress of profitability and marketability
ranges from −1 to 1, we needed to control for sample censoring, and we
specified the observed efficiency as follows:
yi;t ¼ −1 if yi;t * ≤ −1 ðlower bound Þ;
yi;t ¼ yi;t * if − 1 < yi;t * < 1 ; ð5Þ
yi;t ¼ 1 if yi;t * ≥ 1 ðupper bound Þ :
Then the log-likelihood function can be specified as:

X
N h 0
. i  
l ðβ; σÞ ¼ logf yi;t −xi;t−1 β σ  l ci < yi;t < ci ð6Þ
i¼1
n h 0
. i h 0
. io
−log F ci −xi;t−1 β σ − F ci −xi;t−1 β σ

where; ci ¼ −1; ci ¼ 1

Analysis results

Model 1 included only the control variables. With Model 2, we tested the main effects
of business expansion strategies. A comparison of the log-likelihood values and Akaike
information criterion supported the statistical and empirical importance of the chosen
expansion strategy, as we report in Table 3.
With regard to profitability, the exploratory expansion exhibited a negative
influence (β = −.002, p < .01), in support of H1, but the exploitative expansion
564 F. Wang et al.

Table 3 Effects of business expansion strategy on profitability and marketability

Profitability Marketability

Model 1 Model 2 Model 3 Model 4

Coefficient (S.E.) Coefficient (S.E.) Coefficient (S.E.) Coefficient (S.E.)

Main effects
Exploratory expansion −.002 (.001)** .004 (.001)**
Exploitative expansion −.010 (.062) .316 (.138)*
Control variables
Δ_Market share .015 (.004)*** .023 (.005)*** −.003 (.018) −.010 (.015)
Δ_Deposit asset ratio .358 (.132)**
.286 (.126)**
−.359 (.254) −.241 (.246)
Δ_Employee −.017 (.027) .014 (.027) −.103 (.071) −.105 (.066)
Δ_Tier 1 capital ratio .010 (.002)*** .005 (.003) −.008 (.005) −.009 (.006)
Δ_Bad loan ratio .023 (.003)*** .044 (.004)*** .002 (.012) .000 (.012)
Δ_Current ratio −.029 (.073) .001 (.048) .001 (.076) .028 (.074)
Δ_ROAA dynamism .031 (.017) .009 (.016) −.012 (.028) .008 (.028)
Country −.044 (.019)* −.100 (.023)*** −.047 (.040) −.033 (.044)
Year = 2005 .010 (.020) .003 (.018) .138 (.034)*** .163 (.034)***
Year = 2006 −.033 (.017) −.016 (.017) .146 (0.032)*** .140 (.033)***
Year = 2007 −.030 (.016) −.018 (.015) −.212 (.030) ***
−.217 (.030)***
Year = 2008 −.007 (.016) −.022 (.016) .270 (.029) ***
.279 (.029)***
Intercept .083 (.019)***
.125 (.021)***
−.077 (.040) *
−.088 (.042)*
Log-Likelihood 356.384 366.726 124.721 135.497
Akaike information criterion −1.934 −2.094 −.644 −.716

*
p < .05; ** p < .01; *** p < .001

had no significant effect on the progress of profitability (β = −.010, p = .870), so

we cannot confirm H2. This result might reflect the varied influences of an
exploitative expansion: On the one hand, it focuses on the use of existing
resources, which should reduce the firm’s operational costs, but on the other
hand, it involves costly activities, such as attracting new customers. In the short
term then, exploitative expansion does not appear to offer an economical
strategy.
For marketability, we found that an exploratory expansion positively influenced the
progress of marketability (β = .004, p < .01), as did an exploitative expansion (β = .316,
p < .05). That is, we found support for both H3 and H4.
Noting their different social contexts and the potential influences on their bank
efficiency, we ran separate DEA for the 78 US banks and the 14 Chinese banks. As we
show in Table 4, we compared the relative effect sizes of exploratory and exploitative
expansion by standardizing the two independent variables. Among Chinese banks,
exploratory expansion positively influenced the progress of marketability (β = .188, p <
.05), but exploitative expansion had no significant effect. We applied a t-test to compare
the difference between these two coefficients (Cohen, Cohen, West, & Aiken, 2002).
The t-test result (∣β1-β2∣ = .143, p < .05) indicated that the effect of exploratory
Business expansion and firm efficiency in the commercial banking 565

Table 4 Effects of business expansion strategy in the US and Chinese banking industries

Marketability

Model 5 Chinese banks Model 6 US banks

Coefficient (S.E.) Coefficient (S.E.)

Main effects
Exploratory expansion .188 (.089)* .003 (.015)
Exploitative expansion .045 (.047) .044 (.112)***
Control variables
Δ_Market share .128 (.120) −.006 (.019)
Δ_Deposit asset ratio −1.002 (4.311) −.536 (.266)*
Δ_Employee .012 (.559) −.257 (.065)***
Δ_Tier 1 capital ratio −.025 (.026) −.012 (.006)*
Δ_Bad loan ratio −.009 (.027) −.001 (.014)
Δ_Current ratio 1.081 (.701) .093 (.081)
Δ_ROAA dynamism .067 (.539) −.017 (.032)
Year = 2005 .047 (.037)
Year = 2006 .160 (.035)***
Year = 2007 −.045 (.033)
Year = 2008 .026 (.033)
Intercept −.096 (.048)* .005 (.027)
Log-likelihood 5.298 122.124
Akaike information criterion .496 −.689

*
p < .05; ** p < .01; *** p < .001

expansion was significantly greater than that of exploitative expansion. For US banks,
exploratory expansion had no significant effect on marketability, but exploitative
expansion positively influenced its progress (β = .044, p < .001). The t-test result
(∣β1-β2∣ = .041, p < .01) indicated a significantly greater effect of exploitative
expansion than of exploratory expansion. Thus, exploratory expansion generated
higher marketability for Chinese banks, in support of H5, whereas exploitative expan-
sion generated higher marketability for US banks, in support of H6.

Discussion

With a foundation in organizational learning and the market-finance interface, we

investigate whether and how exploratory and exploitative expansion strategies influ-
ence firm profitability and marketability. Empirical findings from the US and Chinese
banking industries indicate that exploratory expansion decreases profitability but in-
creases marketability. Meanwhile, exploitative expansion has no effect on profitability,
yet it can increase marketability. We also find that Chinese banks are likely to benefit
from exploratory expansion, whereas US banks should pursue exploitative expansion.
566 F. Wang et al.

Contributions

This study accordingly makes two main contributions. First, to the best of our knowl-
edge, no prior organizational change research has considered the effects of a business
expansion strategy on firm efficiency. Yet business expansion is a critical form of
organizational change, and current literature affirms that organizational changes can
improve firm effectiveness—for example, technology change increases profits (Zhou
et al., 2006) and service transitions increase firm value (Fang et al., 2008). But
organizational change also might lead to increased risks and costs. Thus, it is critical
to determine whether an expansion strategy is efficient. We take an integrated perspec-
tive in our attempt to answer this question; in particular, we complement Fang et al.’s
(2008) work by testing the efficiency of both exploratory expansion and exploitative
expansion strategies. In addition, we apply Seiford and Zhu’s (1999) and Luo’s (2003)
approach to assess profitability and marketability efficiency using DEA, a mathematical
programming technique. In turn, this study helps enrich understanding of the conse-
quences of a particular type of organizational change strategy.
Second, research into the banking industry emphasizes bank efficiency, and various
studies propose different measures of efficiency, such as the effects of bank size, market
share, bad loans, and ownership structure on profitability (e.g., Berger & DeYoung,
1997; Berger & Humphrey, 1997; Grigorian & Manole, 2006) or the effect of geo-
graphical location on marketability (Luo, 2003). However, as Berger and Humphrey
(1997) and Luo (2003) noted, two key questions have been neglected: (1) Do bank
changes matter? and (2) What are some other drivers of marketability? We offer some
initial responses to these questions by using an integrated database that includes the
United States, the largest developed market in the banking industry, and China, which
is the largest emerging market. This integrated database not only confirmed the
robustness of our findings but also provided boundary conditions for our answers to
these two pressing questions.
The findings also have managerial implications. To date, Chinese banks have remained
overly focused on traditional loans, earning more than 80 % of their revenues from interest
(China Construction Bank, 2010). But according to our findings, Chinese banks could
benefit significantly from an exploratory expansion strategy. This study suggests Chinese
banks should reduce their reliance on traditional business and develop new businesses,
such as commissions, trading, and even insurance, which would allow them to increase
their competitive advantages and earn long-term benefits. In contrast, because US banks
appear more likely to benefit from exploitative expansion, they should allocate more
resources to activities to attract new target markets, rather than to new business.
Overall, neither exploratory nor exploitative expansion has a positive effect on a
firm’s profitability, whereas both can improve a firm’s marketability. Therefore, short-
term efficiency may be not a good indicator of the success of a business expansion
strategy. Instead, firms need to use long-term efficiency measures if they want to
determine the success of their organizational change strategy.

Limitations and future research directions

This study contains several limitations. First, we used secondary data from the banking
industry to test our hypotheses; it might be insightful to use data from other industries,
Business expansion and firm efficiency in the commercial banking 567

to confirm the validity of our findings. Second, in classifying the two types of
expansion strategies, we discussed how firms allocate and use their resources, but we
largely ignore the underlying drivers that might lead firms to adopt one of the two
strategies over the other. Further research should address these potential drivers, as well
as other possible consequences. Third, data limitations prevented us from identifying
whether the banks in the sample used new brands in their exploratory expansions. If a
bank applies an existing brand to new products and services, the brand’s reputation
could exert an effect, but no such influence is possible if the bank uses a totally new
brand. Further research should gather appropriate data to determine in which settings
and to what extent brand reputation affects the role of brand strategy.

Acknowledgments The authors acknowledge the financial support from National Natural Science Founda-
tion Grant of China (71402049, 71172210) and Program for New Century Excellent Talents in University of
Ministry of Education of China.

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Business expansion and firm efficiency in the commercial banking 569

Feng Wang (PhD, Wuhan University) is Assistant Professor of Marketing at the School of Business
Administration, Hunan University. His research focuses on product innovation, social media, and strategic
change. He has published in journals such as Journal of Marketing.

Minxue Huang (PhD, Wuhan University) is Professor of Marketing at the Economics & Management
School, Wuhan University. His research focuses on Internet marketing and ecommerce. He has published in
journals such as European Journal of Marketing, Journal of Business-to-Business Marketing, and Online
Information Review.

Zhigang Shou (PhD, Wuhan University) is Professor of Marketing at the Economics & Management School,
Wuhan University. His research focuses on trust, marketing channel, and B2B market. He has published in
journals such as Journal of Business Research and Industrial Marketing Management.
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