450 V. Maksimovic and G. Phillips
- Investment decisions of conglomerate firms
We next review the recent evidence on the conglomerate discount and conglomerate
firms’ investment decisions by examining first the investment and resource allocation
decision of existing conglomerate firms. We then review the literature on spinoffs and
divestitures of conglomerate firms.
There have been four major ways that the literature has addressed how conglomerate
firms may invest differentially. First, there has been a branch that has examined whether
conglomerate firms have differential investment—cash flow sensitivity. Second, there
have been studies examining investment allocation across projects by firms within a
single industry. The advantage of the single-industry studies is that in controls for dif-
ferences investment opportunities that might be hard to measure. Third, several studies
have examined how firms should invest when faced with differential opportunities based
on the neoclassical investment model. Fourth, studies have examined divestitures and
spin-offs for evidence of decreased agency costs after the divestiture. We review each
of these areas in turn.
4.1. Investment–cash flow sensitivity
The models of conglomerate investment relate the conglomerate firm’s investment ex-
penditures in each segment to the segment’s investment opportunities and to the state of
the firm’s internal capital market.
Neoclassical theory suggests that the firm’s level of investment should depend only
on its perceived investment opportunities measured by the firm’s marginal Tobin’sq,
where marginal Tobin’sqis the value of the investment opportunity divided by the cost
of the required investment.^24
Shin and Stulz (1998)andScharfstein (1998)use this relation between Tobin’s q
and investment to examine how a firm’s internal capital market allocates investment.
If the internal capital market is as efficient as the public market for capital we would
expect to see a similar relation between investment and Tobin’sqfor the segments of
conglomerates and for single-segment firms.
One set of tests estimates an investment equation on single-segment firms and con-
glomerates’ segments. Consider equation(4)
ij=zjγ+qjβ+ζj, (4)whereiis the firm’s capital expenditures,qis the marginal Tobin’sqandzis a vector
of exogenous explanatory variables. For single segment firms the marginal Tobin’sq
(^24) Tobin’sqis usually defined as the value of the firm (equity and debt claims) scaled by the replacement
value of the firm’s assets. In the corporate finance literature this quantity is often approximated by the ratio
of the market value of a firm’s assets (market value of equity+book value of assets−book value of equity-
deferred taxes) to the book value of assets. SeeWhited (2001).