Ch. 8: Conglomerate Firms and Internal Capital Markets 449
Fig. 5. Ability by segment. Model with common managerial ability across industries.is again positively and significantly related to their focus, measured by the Herfindahl
index, and size, albeit less so than with no common firm talent.
While the simple model makes predictions about the distribution of firms’ production,
this distribution of production across industries depends on the distribution of ability.
However, ability is hard to measure. As a result, the predictions on the distribution of
segment size and productivity industries do not directly differentiate the model from
other models which predict that firms inefficiently expand into industries outside their
core competence. To differentiate the neo-classical from other views, it is necessary
to obtain predictions about the firm’s responses to exogenous shocks to the industry
environment. We discuss this below.
More recently, Gomes and Livdan (2004) embed and calibrate the model in
Maksimovic and Phillips (2002)in a dynamic setting.^23 They show explicitly that for
the parameter values they select the calibrated model is consistent withLang and Stulz’s
(1994)findings on the diversification discount. They can also reproduceSchoar’s (2002)
finding that expanding focused firms are less productive after diversification than non-
expanding focused firms.
(^23) Gomes and Livdan (2004)argue that the models differ in certain respects. However, these differences do
not affect any of the main intuitions. In essence, the differences come down to technical assumptions that
ensure the existence of an equilibrium in which some firms specialize and others do not. Maksimovic and
Phillips’ implicitly assumes that a firm that chooses to produce in two industries has higher costs than would
two identical firms that together produce the same output as the diversified firm but that areconstrainedto
specialize in one industry each. By contrast, Gomes and Livdan assume that there is a fixed cost to producing
in any industry. Both assumptions serve to counterbalance the assumption of diminishing returns to scale in
each industry which both papers make, and which would otherwise make diversification more attractive.