We develop a profit-maximizing neoclassical model of optimal firm size and growth across different industries based on differences in industry fundamentals and firm productivity. In the model, a conglomerate discount is consistent with profit maximization. The model predicts how conglomerate firms will allocate resources across divisions over the business cycle and how their responses to industry shocks will differ from those of single-segment firms. Using plant level data, we find that growth and investment of conglomerate and single-segment firms is related to fundamental industry factors and individual segment level productivity. The majority of conglomerate firms exhibit growth across industry segments that is consistent with optimal behavior. SEVERAL RECENT ACADEMIC PAPERS and the business press claim that conglomerate firms destroy value and do a poor job of investing across business segments. 1 Explanations for this underperformance share the idea that there is an imperfection either in firm governance ~agency theory! or in financial markets ~incorrect valuation of firm industry segments!. These studies implicitly assume that the conglomerates and single-industry firms possess similar ability to compete, and that they differ mainly in that conglomerates

This paper argues that the documented discount on diversified firms is not per se evidence that diversification destroys value. Firms choose to diversify. We use three alternative econometric techniques to control for the endogeneity of the diversification decision, and find evidence supporting the self-selection of diversifying firms. We find a strong negative correlation between a firm's choice to diversify and firm value. The diversification discount always drops, and sometimes turns into a premium. There also exists evidence of self-selection by refocusing firms. These results point to the importance of explicitly modelling the endogeneity of the diversification status in analyzing its effect on firm value.

Corporate governance in the United States changed dramatically throughout the 1980s and 1990s. Before 1980, corporate governance—meaning the mechanisms by which corporations and their managers are governed—was relatively inactive. Then, the 1980s ushered in a large wave of merger, takeover and restructuring activity. This activity was distinguished by its use of leverage and hostility. The use of leverage was so great that from 1984 to 1990, more than $500 billion of equity was retired on net, as corporations repurchased their own shares, borrowed to finance takeovers, and were taken private in leveraged buyouts. Corporate leverage increased substantially. Leveraged buyouts were extreme in this respect with debt levels typically exceeding 80 percent of total capital. The 1980s also saw the emergence of the hostile takeover and the corporate raider. Raiders like Carl Icahn and T. Boone Pickens became household names. Mitchell and Mulherin (1996) report that nearly half of all major U.S. corporations received a takeover offer in the 1980s. In addition, many firms that were not taken over restructured in response to hostile pressure to make themselves less attractive targets. In the 1990s, the pattern of corporate governance activity changed again. After a steep but brief drop in merger activity around 1990, takeovers rebounded to the levels of the 1980s. Leverage and hostility, however, declined substantially. At the same time, other corporate governance mechanisms began to play a larger role,

We analyze several hundred firms that expand via acquisition and0or increase their number of business segments. The combined market reaction to acquisition announcements is positive but acquiring firm excess values decline after the diversifying event. Much of the excess value reduction occurs because our sample firms acquire already discounted business units, and not because diversifying destroys value. This implies that the standard assumption that conglomerate divisions can be benchmarked to typical stand-alone firms should be carefully reconsidered. We also show that excess value does not decline when firms increase their number of business segments because of pure reporting changes. DOES CORPORATE DIVERSIFICATION destroy value? Several recent papers attempt to answer this question by comparing the market value of firms that operate multiple lines of business to the value of a portfolio of stand-alone firms operating in the same industries as the conglomerate’s divisions. Lang and Stulz ~1994! use this approach and find that multisegment firms have low

I use the Business Information Tracking Series (BITS), a new census database that covers the whole U.S. economy at the establishment level, to examine whether the finding of a diversification discount is an artifact of segment data. BITS data allow me to construct business units that are more consistently and objectively defined than segments, and thus more comparable across firms. Using these data on a sample that yields a discount according to segment data, I find a diversification premium. The premium is robust to variations in the sample, business unit definition, and measures of excess value and diversification. THE DIVERSIFICATION DISCOUNT has been the subject of an active debate in corporate finance during the past few years. 1 On the one hand, Lang and Stulz (1994), Berger and Ofek (1995), and Servaes (1996) find that diversified firms trade at an average discount relative to single-segment firms. This finding has often been interpreted as evidence that diversification destroys value. 2 On the other hand, several studies show that the discount is only the product of sample selection biases. Villalonga (1999) and Campa and Kedia (2002) find that diversified firms traded at a discount prior to diversifying. More generally, diversifying and nondiversifying firms differ systematically in multiple characteristics. When the selection bias is corrected for, the diversification discount

This essay surveys the body of research that asks how the efficiency of corporate investment is influenced by problems of asymmetric information and agency. I organize the material around two basic questions. First, does the external capital market channel the right amount of money to each firm? That is, does the market get across-firm allocations right, so that the marginal return to investment in firm i is the same as the marginal return to investment in firm j? Second, do internal capital markets channel the right amount of money to individual projects within firms? That is, does the internal capital budgeting process get withinfirm allocations right, so that the marginal return to investment in firm i’s division A is the same as the marginal return to investment in firm i’s division B? In addition to discussing the theoretical and empirical work that bears most directly on these questions, the essay also briefly sketches some of the implications of this work for broader issues in both macroeconomics and the theory of the firm.

Using a sample of over 1000 firms from seven emerging markets in 1995, we find that diversified firms trade at a discount of approximately 7 % compared to single-segment firms. Diversified firms are also less profitable than single-segment firms, but lower profitability only explains part of the discount. We find a discount only for those firms that are part of industrial groups, and for diversified firms with management ownership concentration between 10 % and 30%. The discount is most severe when management control rights substantially exceed their cash flow rights. Our results do not support internal capital market efficiency in economies with severe capital market imperfections. 1 Our paper examines the costs and benefits of corporate diversification in emerging markets. We use the Worldscope database to study seven emerging markets (Hong Kong, India, Indonesia, Malaysia, Singapore, South Korea, and Thailand) and compare the value of diversified and focused firms within each country. Given the greater level of information asymmetry and other market imperfections in these economies, corporate diversification could impact firm value in two ways. One hypothesis is that the use of internal capital markets could lead to higher values for diversified firms. Our second hypothesis is that minority shareholders can be more easily expropriated in diversified firms, which implies a lower

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Bankers ’ Association for providing us with the data set employed in this paper, to Cristiano Zazzara and Marco Pellegini for their help in acquisition, translation, and understanding of this publicly available data set, and the Bank for International Settlements (BIS) for provision of data on stock

for their outstanding research assistance and professional management of the two-year-long data collection process.