PDF Ebook Conglomerate Firms and Internal Capital Markets
The large literature on conglomerate firms began with the documentation of the conglomerate discount. Given conglomerate firm production represents more than 50 percent of production in the United States, this discount has represented a large economically important puzzle for the U.S. economy. For corporate finance, the primary question about diversification is “When does corporate diversification affect firm value?” And, “When it does, how does it do so?” Early literature came to the conclusion that the conglomerate discount was the result of problems with resource allocation and internal capital markets. Recent literature has found that self-selection by firms with different and changing investment opportunities can explain the discount and also explain resource allocation.
In this chapter we survey the large literature on corporate diversification in corporate finance. For corporate finance, the primary question about diversification is “When does corporate diversification affect firm value?” And, “When it does, how does it do so?” By a diversified firm in corporate finance, we usually mean a firm that operates in more than one industry, as classified by the Standard Industrial Code (SIC).
This question arises naturally as part of the larger problem of determining how the boundaries of firms should be set. Coase (1937) argues that they are set at the point at which the costs of carrying out transactions within a firm equal those of carrying them out in the open market or in another firm. Thus, for corporate diversification to be of interest, it must be that the cost of carrying out transactions within the firm are affected if it contains more than one industry within its boundaries. Implicit in this belief is that industries differ materially in the skills and resources which are required to operate efficiently in, and that this diversity of operating environments affects the cost of performing transactions within the firm. These costs could be due to financial externalities across industries, such as improved risk sharing within the firm, or real externalities that could arise due to the use of a shared factor of production, such as the attention of the firm’s decision makers.
Diversification is also of interest to researchers because data on most intra-firm decisions is in general hard to acquire. By contrast, some data on how firm revenues and capital expenditures are distributed across the industries is available, which makes the research on diversification a good starting point for studying the more general problem of setting firm boundaries.
Contents
1. Introduction
2. The Conglomerate Discount
- 2.1 Documenting the Discount: Early Research
2.2 Initial Caveats: The Data
2.3 Self-selection and the Endogeneity of the Conglomerate Decision
3. Theory Explaining the Conglomerate Discount and Organizational Form
- 3.1 Benefits of Internal Capital Markets
3.2 Conglomerates and Organizational Competencies
3.3 Diversification and the Failure of Corporate Governance
3.4 Diversification and the Power within the Firm
3.5 Neoclassical Model of Conglomerates and Resource Allocation
4. Investment Decisions of Conglomerate Firms
- 4.1 Investment – Cash Flow Sensitivity
4.2 Industry Studies
4.3 Efficient Internal Capital Markets
4.4 Bargaining Power within the Firm and Differential Investment Opportunities
4.5 Investment under a profit – maximizing neoclassical model
4.6 Mergers and Acquisitions, Divestitures and Spinoffs
- 4.6.1 Diversified Firms and the Market for Assets
4.6.2 Spinoffs
5. Conclusions: What Have We Learned?
6. Appendix: Neoclassical Model of Resource Allocation across Industries
7. References
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PDF Ebook Conglomerate Firms and Internal Capital Markets
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