Ch. 8: Conglomerate Firms and Internal Capital Markets 475
In a multi-period setting firms don’t need to acquire all their capacity in each period.
After the first period, they have an endowment of capacity form the previous period.
Thus, they need only make marginal adjustments to capacity in response to changes
ina. Firms can choose to use all their capacity to produce, to sell some capacity and
use the remainder to produce, or to buy more capacity and produce. Capacity may be
purchased from and sold to other firms operating in the same industry, or from sources
outside the industry. The net capacity adjustments they make follow fromRemark 1.
A.2. Cross-segment effects and the growth of conglomerates
As discussed above, when a positive demand shock occurs in industry 1 more productive
producers increase their market share. When the productive producer is a conglomerate
which operates both in industry 1 and industry 2 this increase in production in industry 1
creates a negative externality for this producer in industry 2. Thus, the conglomerate
producer becomes a relatively less aggressive competitor in industry 2. By contrast,
producers in industry 1 that are sufficiently less productive reduce capacity in industry 1
by selling capacity to the more productive firms.^42 This reduction in capacity reduces
their control costs and creates a positive externality for the producers in industry 2. As a
result, the less productive producers in industry 1 that also operate in industry 2 become
more aggressive competitors in industry 2 and grow faster than they otherwise would in
that industry. Thus, we can observe that:
Remark 3.Given a distribution of managerial talent, a positive price shock in indus-
try 1 provides incentives for: (a) Conglomerates that are more productive producers
in industry 1 relative to industry competitors to reduce their focus on industry 2 and
increase their focus on industry 1 (b) Conglomerates that are marginally productive
producers in industry 1 to reduce their focus on industry 1 and increase their focus on
industry 2.
We illustrate case (b). This is easiest to show if we assume that there exist some firms
in each industry which are single-segment. We use the suffixssto indicate that the firm
is single-segment. For simplicity, all single-segment firms in both industries have the
same technology.
We assume that of the total number of firmsna fraction,λc, are conglomerates and
operate in both industries. Assume that all conglomerates have identical abilitiesd 1 c
andd 2 c. An equal number of single-segment firms operates in both industries, so that
the fraction of thenfirms operating in each industry as single-segment firms isλss,
(^42) Note that “sufficiently” depends on the elasticity of supply of capacity into the industry. If supply is fixed
(β=0), then it is sufficient thatd<1. In a more general model it would not be necessary for the sale of
capacity to occur in industry 1 in order for the less productive firms to become more aggressive competitors
in industry 2. It would be sufficient for the less productive producers to grow more slowly in industry 1 than
the more productive producers following a positive price shock.