Financial Economics

WEB–APPENDIX I

CONGLOMERATES AS A MEANS OF OVERCOMING CAPITAL MARKET IMPERFECTIONS

Conglomerates are assemblies of firms whose products are unrelated to each other. Hence, the perfect capital market argument applies in the sense that conglomerates ought not to be able to create economic value in a such a market because they only create portfolios that investors could create on their own (see the homemade diversification argument in the discussion of mergers in Web-Appendix H). Moreover, the arguments of possible monopoly power cannot be applied because by definition a combination of unrelated firms does not create market power. Nonetheless, the imperfect information and managerial incentive arguments discussed in this book can still be used to rationalize conglomerate activity. But what are the other arguments supporting conglomerates based on market imperfections?

Managerial efficiency of the conglomerate form is sometimes cited as a reason conglomerates might create economic value. Perhaps this argument takes its most telling form in asserting the superiority of internal financial management relative to that of the capital markets, for certain kinds of transactions. Management of conglomerates may better be able to allocate investment capital to their divisions than can financial markets to separate companies, for the reasons that management might have better operating information and supervisory capability than do investors. Hence, conglomerate management might be in a better ...