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Conglomerate discount

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

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Conglomerate discount

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  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 1980’s

  4. 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

  5. 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

  6. 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

  7. 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

  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 don’t allocate analysts from each market segment to study conglomerate firm

  9. Papers on Conglomerate Discount • 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.

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