So could such a decision work in China? The answer is yes, according to my own research. I conducted a study that divides all companies included in the Shanghai and Shenzhen 300 Composite index into groups based on whether the companies are diversified, or focused, in terms of lines of business. I then compared the operational performance and stock performance for those that have more diverse business lines, with those that have more focused business revenues.

I found that, consistent with investors' preference in the West, more focused investors perform better, both in operational efficiency and stock prices, than the more diversified ones.

So why do investors prefer more focused companies?

First and foremost, many investors believe that capital markets are more efficient than average companies at allocating capital. As a result, investors prefer to see listed companies distribute cash flow back to their investors, and let them decide whether they want to go along with companies' investment plans. Given that corporate managers are influenced by agency problems and shortcomings in their own behavioral patterns, investors sometimes prefer to avoid complex businesses where internal markets play too great a role

Corporate governance can be another issue. According to research, corporate managers have the tendency to retain and squander company cash flow for their own benefit. For example, researchers found that companies with more corporate jets and sports stadiums named after them have poor corporate governance and stock performance. As the size of the company grows, there are greater resources and cash flow at the management's disposal, which concerns investors more.

Finally, if investors prefer to diversify across different sectors of the same company, specialized and divided companies would give investors more flexibility in choosing the best player within the respective industry than the choice by conglomerates.

Granted China is still going through the stage of fast economic growth, and the size of Chinese companies is bound to increase with the economy. However, it is important to point out that increasing the size of corporation does not necessarily require the parent companies to put all their subsidiaries within the same group. Flexible corporate structure, such as a parent holding company, may be more effective in increasing its asset size and market capitalization, if this is what the parent company pursues.

Several modern corporate finance tactics, such as spin-off, split-off, and carve-out, are available to Chinese companies when they consider restructuring and improving their investor relationship. Successful examples, such as the split-ups of News Corp and Marathon Oil, prove that such restructuring tools can effectively improve corporate performance, at least in the short- to medium-term.

Some SOE senior managers are concerned that splitting up a parent company may result in a decrease in its asset size or loss of corporate control. The lessons from the more developed capital markets suggest that, as long as the valuation and transaction are carried out at fair market value, the restructuring of SOEs should be able to attract increased capital from investors and improve core competence. At the same time, investors would value each business line of the company more, now that they understand the company better.

Only when the SOEs are open to such restructuring possibilities can they set up an effective monitoring mechanism over their lines of business and truly make each line strong and competitive on its own.

A successful SOE can only be built on the success of each of its own businesses and a successful Chinese economy relies on the success of each of its SOEs.

The author is deputy director of the Shanghai Advanced Institute of Finance, Shanghai Jiao Tong University. The views do not necessarily reflect those of China Daily.