Monday, November 07, 2005

How 1+1+1+1 Can Equal Less Than 4 - New York Times

This was in yesterday's NY Times. It is another supporting article for the diversification discount.

How 1 1 1 1 Can Equal Less Than 4 - New York Times:

"over the long haul, conglomerates, on average, perform worse in the stock market than the typical focused company. One likely cause is that they tend to do a poor job of allocating capital among their various divisions. Of course, if those units were separate publicly traded companies, the market itself would be making the allocation decisions. And it stands to reason that the overall market is a better administrator in this regard than the average corporate manager."

A study conducted by David S. Scharfstein, a finance professor at the Harvard Business School, offers evidence of inefficient capital allocation among widely diversified companies. Professor Scharfstein found that managers of conglomerates generally felt compelled to invest something in all of their divisions, regardless of the divisions' growth potential - a phenomenon that he calls intrafirm "socialism." Because of it, conglomerates tend to invest too much in divisions with low growth potential and too little in those with high potential."

"Professor Scharfstein's research was conducted for the National Bureau of Economic Research; a copy of his study is at [ssrn]."

Yet another example of a perfectly timed article. Just today in class we were speaking of the problems with internal capital markets!

1 comment:

Pat said...

That discount makes sense - empire building benefits managers (gives them something to do) but hurts stockholders who can diversify easily on their own themselves.