Ch. 8: Conglomerate Firms and Internal Capital Markets 427
a conglomerate’s Tobin’sqand its comparableqcomputed in the manner described
above.
Lang and Stulz measure diversification in two ways. As their principal measure they
count the number of the business segments that each firm reports in the Business Infor-
mation File of Compustat. They use segment information from the Business Information
File to compute two Herfindahl indices of diversification for each firm: an index com-
puted from by using segment sales data and a second index computed from data on
assets per segment.
Lang and Stulz main statistical tests consist of annual cross-sectional regressions for
the period 1978 to 1990. They first regress firms’ Tobin’sqs on a constant and four
dummy variables,D(j),j = 2 ,...,5. Thejth dummy variable takes on the value
1 if the conglomerate has more thanjsegments in different SIC codes. Thus,D(j)
can be interpreted as the marginal contribution toqof diversifying fromj−1toj
segments. In a second round of tests they replace Tobin’sqas the dependent variable
by the conglomerate discount, computed using comparables as above.
Across the annual cross-sectional regressions, Lang and Stulz consistently find that
the coefficient ofD( 2 )is negative and significant, indicating that a two-segment firm
sells at a discount both to single-segment firms in general, and to “comparable” single-
segment firms, as defined above. There is much less evidence for the existence of a
marginal effect of diversification on the discount for a larger number of segments. Lang
and Stulz also show that a substantial portion of the discount remains even after control-
ling for differences in size and in the extent to which the firm faces financial constraints,
as proxied, followingFazzari, Hubbard and Peterson (1988), by whether or not it pays
dividends.
In addition, Lang and Stulz investigate whether the discount can be explained by
differences in the propensity of single-segment and diversified firms to invest in re-
search and development. Since the firm’s balance sheet does not fully capture in-
vestment in R&D, the Tobin’sqs of firms that engage in a great deal of R&D are
going to be overstated relative to those of firms that engage in less R&D. If it were
the case that single-segment firms were relatively R&D intensive, this relative valu-
ation effect could explain the conglomerate discount. Lang and Stulz find that this
is not the case. Thus, Lang and Stulz conclude that the diversification discount that
they find cannot be explained by “reporting biases or subtle advantages of diversified
firms”.
The existence of a conglomerate discount naturally leads to the question: Are multi-
segment firms worth less than single-segment firms because they diversify, or do less
valuable firms choose to diversify?^4 The evidence from summary statistics is not clear-
cut. Lang and Stulz find that single-segment firms that diversify have lowerqs than
single-segment firms that do not choose to diversify. However, the industry-adjustedq
(^4) It is also possible that the decision to diversify is not causally related to the discount. This possibility is
discussed below.