Transcript Conglomerate discount Corporate Restructuring Tim Thompson Arguments based on fundamentals • Conglomerates are good – Williamson (1975), with superior inside information, diversified firms can allocate capital better.

Conglomerate discount
Corporate Restructuring
Tim Thompson
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
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 1980’s
Conglomerates are bad, cont’d.
• 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 don’t have more debt, don’t
rely less on cap mkt and are targets more often
Berger and Ofek
• Estimated conglomerate discount
– Took sample of conglomerate firms (segments
in different 4-digit SIC codes)
– Calc’ed 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
Berger and Ofek, cont’d.
• 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
Divisional managers’ incentives
• Incentives of management may be enhanced
with stock, options, SAR’s, etc.
• In diversified firm, often don’t have
divisional stock (carve outs and target
shares are rare)
• Conglomerate stock may not set up
appropriate payoff for risk taking
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 don’t allocate analysts from
each market segment to study conglomerate
firm
Papers on Conglomerate
Discount
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Berger, Philip and Eli Ofek (1995). “Diversification’s 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.