428 V. Maksimovic and G. Phillips
of diversifiers prior to diversification is not lower than that of non-diversifiers. Thus, the
conglomerate discount is not explained by the low performance of firms that choose to
become diversifiers.^5 However, not all findings they report are statistically significant or
point in the same direction.
Thus, Lang and Stulz show the existence of a conglomerate discount. However, they
judge their evidence to be “less definitive on the question of the extent to which diver-
sification hurts performance”. They find that the evidence is consistent with notion that
firms diversify because they face diminishing returns in their industries. Lang and Stulz
argue that to establish whether this is the case requires a more detailed disaggregated
analysis and an explicit model.
Berger and Ofek (1995)confirm the Stulz and Lang result that there exists a con-
glomerate discount in the range of 13–15% of firm value for the period 1986–1991.
They also investigate further potential causes of the discount. They find that the dis-
count is smaller when the firm is not too diversified and all the segments are in the same
2-digit SIC code. They also find evidence that cross-subsidization and overinvestment
contribute to the discount, and more limited evidence that diversified firms obtain tax
benefits.
Berger and Ofek compute the estimated value of each segment in three related ways
using a valuation approach similar to the multiples approach of Lang and Stulz. Berger
and Ofek multiply each segment’s assets, sales or earnings, reported in the Compustat
industry segment database, by the corresponding median valuation multiple. The in-
dustry median is obtained by matching the segment to all the single-segment firms with
sales above $20m in the most refined SIC code that contains at least five such firms. The
valuation multiples are the ratios of the single-segment firms’ total value (as proxied by
the market value of equity and book value of debt) to the its reported assets, sales or
earnings.^6
Berger and Ofek also investigate whether diversified firms destroy value by over-
investing in unprofitable industries. Their measure of over-investment is the ratio of
the sum of a conglomerate’s capital expenditures and depreciation in 3-digit SIC code
industries whose median Tobin’sqin the bottom quartile, to the conglomerate’s to-
tal sales. They find that overinvestment so defined is associated with a loss of excess
value.
Next, Berger and Ofek investigate whether cross-subsidization can explain the con-
glomerate discount. They regress the firm’s excess value on an indicator which takes a
value of one if the firm has a segment with a negative cash flow and zero otherwise.^7
The coefficient of this negative cash flow dummy is negative for diversified firms and
(^5) Graham, Lemmon and Wolf (2002)reach the opposite conclusion. Their study is discussed below.
(^6) Berger and Ofek do not use the conglomerate discount directly as their dependent variable, but the natural
logarithm of the ratio of the actual firm value to the imputed value obtained by multiplying the reported
accounting value by the appropriate multiplier. This number they term excess value.
(^7) To compute excess value they estimate separate multiples in each industry for segments that have positive
cash flows and those that do not.