448 V. Maksimovic and G. Phillips
Fig. 4. Ability by segment. Model with no common managerial ability across industries.thus contains the average of productivity by segment number (x-axis) for firms with a
given number of segments (y-axis).
Figure 4thus illustrates the case in which the assignment of firm ability is inde-
pendent across industries in which the firm produces. The figure shows how average
firm talent in the economy varies by the number of segments a firm operates in and by
segment rank. As predicted, the figure shows that within firms the main segments of
conglomerates have higher productivity than peripheral segments. As we go across the
number of segments in which a firm operates equally ranked segments at first become
more productive and then less productive. The drop-off in productivity occurs because
it is very unlikely that any single firm is productive in all ten industries. Thus, firms that
choose to produce in many industries are likely to have mediocre ability in all of them.
In this simulated example, no firms in the sample produce in all the industries. A simple
OLS regression on the simulated data shows that firms’ mean productivity is positively
and significantly related to their focus, measured by the Herfindahl index, and size.
These relations between focus and productivity are obtained even without assuming the
existence of agency costs.
InFigure 5, we allow ability in each segment to have a firm-specific component, so
that a firm which highly productive in one industry is likely to be highly productive in
other segments. As inFigure 4, the height of the graph (z-axis) gives the managerial
abilityandequivalently the size of the firm in that industry in which the firm produces.
Each row of the figure thus contains the average of productivity by segment number
(x-axis) for firms with a given number of segments (y-axis).
InFigure 5, we still see that the main segments are more productive than the periph-
erals. However, now equally ranked segments are more productive in firms that operate
in more segments. Firms that choose to operate in many segments are on average more
productive. Interestingly, a simple OLS regression shows that firms’ mean productivity