Conglomerate discount

1
Conglomerate discount

• Corporate Restructuring
• Tim Thompson

2
Arguments based on fundamentals

• Conglomerates are good
• Williamson (1975), with superior inside
  information, diversified firms can allocate
  capital better than the market
• Stein (1997), can fund winners and abandon losers
  more efficiently than market, agency costs
  mgr/shareholder

3
Conglomerates are bad

• Morck, Schleifer and Vishny (1990)
• Look at bidder returns to announcements of
  acquisitions
• Bad past performing managers incur larger
  negative abnormal returns at the announcement of
  acquisitions, relative to good performers
• Avg bidder return in related acquisition is
  positive, avg bidder return in unrelated
  acquisition is negative, stat. insig, but seems
  signif in 1980s

4
Conglomerates are bad, contd.

• Jensen (1988), agency costs of free cash flow
  argument for forming conglomerates
• Comment and Jarrell (1995)
• Herfindahl index of focus
• Increasing focus correlated with abnormal
  positive stock returns
• diversified firms dont have more debt, dont
  rely less on cap mkt and are targets more often

5
Berger and Ofek

• Estimated conglomerate discount
• Took sample of conglomerate firms (segments in
  different 4-digit SIC codes)
• Calced Value to Sales, Assets, EBIT ratios for
  companies, same industries as conglom segs
• Used median comp ratio to value segments of
  conglomerate
• Summed to calc imputed value of conglom

6
Berger and Ofek, contd.

• Calculated ratio of market value of conglom to
  imputed value
• Average 13-15 value discount for congloms
  relative to single-segment competitors
• Value loss greater when segments not in same
  2-digit SIC code
• Value loss related to overinvestment relative to
  peers and cross subsidization

7
Divisional managers incentives

• Incentives of management may be enhanced with
  stock, options, SARs, etc.
• In diversified firm, often dont have divisional
  stock (carve outs and target shares are rare)
• Conglomerate stock may not set up appropriate
  payoff for risk taking

8
Stock market explanations

• Market cannot understand multi-division firm and
  attach a correct multiple to its earnings or cash
  flow
• RJR/Nabisco, Phillip Morris/Kraft argument
• Companies dont allocate analysts from each
  market segment to study conglomerate firm

9
Papers on Conglomerate Discount

• Berger, Philip and Eli Ofek (1995).
  Diversifications Effect on Firm Value, Journal
  of Financial Economics.
• Berger, Philip and Eli Ofek (1996). Bustup
  Takeovers of Value-Destroying Diversified Firms,
  Journal of Finance.
• Comment, Robert and Gregg Jarrell (1995).
  Corporate Focus and Stock Returns, Journal of
  Financial Economics.
• Jensen, Michael (1986) The Agency Costs of Free
  Cash Flow, Corporate Finance and Takeovers,
  American Economic Review.
• Stein, Jeremy. (1997) Internal Capital Markets
  and the Competition for Corporate Resources,
  Journal of Finance.
• Williamson, Oliver (1975). Markets and
  Hierarchies, Free Press.