Ch. 8: Conglomerate Firms and Internal Capital Markets 433
The firms classified as single segment in BITS are smaller than the firms classified as
single segment in COMPUSTAT. If as, suggested byMaksimovic and Phillips (2002)
size is positively correlated with productivity, then the premium that Villalonga finds
using BITS data may be occurring because she is implicitly comparing conglomerates,
which are larger, with unproductive small single-segment firms.
Finally, several interesting results showing that alternative measures of diversification
may affect the interpretation of current results are obtained byDenis, Denis and Yost
(2002). They examine global diversification over time. These firms are not necessarily
diversified industrially. They document that global diversification results in average val-
uation discounts of the same magnitude as those for industrial diversification. Analysis
of the changes in excess value associated with changes in diversification status reveals
that increases in global diversification reduce excess value. One possible implication
of their results that is consistent withMaksimovic and Phillips (2002)is that as firms
expand they take on less profitable projects but ones that still may have positive NPV,
thus reducingratiomeasures of excess value.
Denis, Denis and Yost (2002)also find that firms that are both globally and industri-
ally diversified do not suffer a diversification discount on average, suggesting that global
diversification may in this case benefit firm value. This result is driven by the latter half
of the sample period, in which firms that are both globally and industrially diversified
are valued at a premium relative to single segment, domestic firms. Their results imply
that the value and costs of diversification may change over time.
2.3. Self-selection and the endogeneity of the decision to become a conglomerate
The early research on the conglomerate discount relied on the comparison of con-
glomerates’ divisions with a control sample of comparables using single-segment firms
chosen using heuristic criteria described above. The implicit assumption was that con-
glomerate and single-segment firms faced the same investment opportunities and were
of similar ability.
This way of selecting comparables raises issues on two grounds. First, it ignores po-
tentially observable differences between the divisions and the matching single-segment
firms that might affect valuation. Second, the heuristic matching procedures implicitly
assume that firms become conglomerates randomly, and not as argued byMaksimovic
and Phillips (2002), because they differ in material ways from firms that remain single-
segment. If the decision to diversify is not random, and is instead based on information
observed by the firm but not by the researcher, then the estimation procedure must take
into account the endogeneity of the decision.^15
The underlying hypothesis in the discount literature is that the value of firmiat timet
relative to its comparables,Vitis a linear function of a set of control variablesXitand
(^15) For early discussions of this endogeneity in the context of corporate finance decisions, seeEckbo, Maksi-
movic and Williams (1991)andPrabhala (1997). Chapter 2in this volume (Li and Prabhala, 2007) contains a
much more comprehensive discussion of selection issues in this type of research.