WSJ on Conglomerates
| Peter Klein |
Industrial conglomerate ITT announced in January a split into three more focused companies, one concentrated in hotels and gaming, one in education (technical training centers), and a slimmed-down ITT Corporation containing the remaining manufacturing businesses. This is the second major restructuring for ITT, once the poster child of the conglomerate movement of the 1960s and early 1970s.
The Wall Street Journal’s article of 13 January contains a nice graphic on the firm’s history, including a picture of Harold Geneen, the quintessential “management by the numbers” CEO (click to enlarge). It also includes ruminations on the conglomerate form more generally, about which I have a continuing research interest. Yale’s Jeffrey Sonnenfeld says conglomerates represented “an unholy mix of opportunistic investment bankers, misguided consultants and the vanities of CEOs.” A companion article puts it this way: “Conglomerates blossomed five decades ago, when favorable interest rates made it relatively easy to boost revenue and stock prices with serial acquisitions. But they fell out of favor when the stock increases slowed and investors began to question whether promised efficiencies would materialize.”
But this is not quite right. In fact, the research literature finds little evidence that conglomerate growth was fueled mainly by cheap credit and rising stock prices. Acquisitions were made largely with stock, rather than debt, and there is no clear evidence that acquirers were systematically overvalued relative to targets. The main problem, is is often the case in popular writing on diversification, is the failure to distinguish among different types of conglomerates. Some of them made economic and financial sense, some of them didn’t. (For a more balanced overview and introduction to the topic, I suggest Bhide 1990 and Berlin 1999.)
NYU’s Richard Sylla notes that diversification through the conglomerate form makes little sense for investors, who can do it themselves by holding diversified portfolios. This is true, of course, but shows only that conglomeration is not an efficient means of reducing portfolio risk. To add value, conglomerates must exploit some kind of economies of scope, such as internal-capital-market efficiencies — a challenge, to be sure, but hardly impossible.