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The purpose of this paper is to examine the relationships among choice of industry diversification, capabilities and business group performance, as well as to point out the potential concern about endogenous role of industry diversification.

Using data from the top 100 business groups in Taiwan from TEJ database. This study uses Heckman’s two-step estimation procedure and contingency model to achieve unbiased results and examine our hypotheses.

The results of this study find that if business groups’ marketing or operational capabilities are strong they should adopt a high level of diversification strategy and if business groups’ R&D capability is strong they should adopt a low level one. The results of this study also show that the endogenous problem of industry diversification exists, and needs to be considered. Moreover, our finding confirms the importance of capability–strategy fit, which, in turn, can achieve better performance.

On average, high industry diversification groups perform better than low industry diversification groups after controlling for endogeneity issues. Business groups can achieve better performance if their strategy choices match the capabilities they encounter. Managers should pay attention to strategy-capability fit issues. Specifically, they should review their organizational capabilities as well as check their strategies within firms.

This study is one of the first that attempts to explore the endogenous role of diversification strategy choices, and empirical examine strategy-capability fit on business group performance.