Conglomerate Firms, Internal Capital Markets, and the Theory of the Firm

This article reviews the conglomerate literature, with a focus on recent papers that have cast strong doubt on the hypothesis that conglomerate firms destroy value on average when compared to similar stand-alone firms. Recent work has shown that investment decisions by conglomerate firms are consistent with value maximization; conglomerate firms trade at an average premium relative to single-segment firms when value weighting; and the valuation premia and discounts, both for conglomerates and single-segment firms, are driven by differences in the production of unique differentiated products. A profit-maximizing theory of the firm that considers how firms select their organizational structure can explain these recent findings and much of the large variation in findings in the conglomerate literature. We also review the literature showing how market imperfections create additional benefits and costs for internal capital markets and a potential for managerial distortions.