The performance of conglomerates or multi-industry firms, corporations composed of unrelated businesses, presents a paradox to researchers in strategic management. On one hand, the preponderance of the empirical research, beginning with Richard Rumelt's ground-breaking study, Strategy, Structure and Economic Performance, and including dozens of follow-up papers, has found a negative relationship between unrelated diversification and firm performance. On the other hand, a number of multi-industry firms, perhaps General Electric and 3M first among them, are frequently held out as examples of the best-managed companies in the world. We fill a gap in our knowledge of contemporary conglomerates by assessing their performance over a twelve-year period. The burdens of size, complexity and bureaucracy in long-lived multi-industry firms were anticipated to result in below-average performance. Instead, our findings clearly identified a group of firms that out-performed performance referents like Business Week's Global 1000 medians, means, top-quartile measures, and the mean of the market-to-book ratio. Most surprisingly, nearly all of the successful firms were based either in the United States or in Great Britain, strongly suggesting that select organizations are able to meet and exceed the undeniable managerial demands of the conglomerate firm, rather than rely on protected or lax markets.
THE CONGLOMERATE PARADOX
The conglomerate- a corporation composed of unrelated businesses- evokes memories of decades past, a way of managing large firms which is now largely discredited. Indeed, if the conglomerate receives any attention today, it is most often held up strictly as an example of how not to arrange the holdings of large firms. The reasons for derision are legion. They begin with the massive number of studies of the relationship between diversification and performance, beginning with Rumelt (1974) and reviewed in Ramanujam and Varadarajan (1989), Hoskisson and Hitt (1990) and Datta et. al. (1991), the preponderance of which found a negative relationship between unrelated diversification and performance. Reasons also include the limited ability of top management to generate value from the relationships among divisions; the difficulty of interested observers, such as analysts and shareholders, to understand the complex operations and performance of firms; and the often destructive empire-building that has motivated the CEO's of some conglomerates. This last complaint about multi-industry firms links well with research finding that the size of the firm is the only highly influential and significant indicator of top-management pay. A recent meta-analysis, Tosi et. al. (2000), found that firm size accounted for more than 40% of the variance in total CEO pay, while only 5% of this variance was explained by firm performance. The quickest way to build up the base of the firm, of course, is through acquisitions, often unrelated to a firm's existing operations.
Despite the opinions and efforts of detractors, a number of conglomerates continue to exist, even in the most competitive markets in the world. Intriguingly, the firms are often household names, like General Electric, Honeywell, and 3M. These are companies that also happen to be connected by many of the same observers with superior management and top performance.
How do we reconcile the contradictions presented by the modern conglomerate, or multi-industry firm, as many are now given to calling themselves? The first issue is to get a better grasp on the number of conglomerates present on the global business landscape. The second issue is to size-up the performance of multi-industry firms, by using commonly used measures and by making comparisons with companies that employ related diversification or a single-business focus.
OUR SAMPLE AND MEASURES
To complete our analysis, we used a common source of business press data and rankings, the Business Week Global 1000. The firms in the sample included the largest 1000 firms in the developed world, as measured by market capitalization. The data compiled in the Business Week list come from two widely respected sources, Morgan Stanley International and COMPUSTAT. The sample formed a parallel set from 1988 until 1999.
The years under review are notable for a number of reasons. First, they included a sizeable stock-market contraction, in 1987, and a long period of expansion. Second, international barriers to trade and investment fell throughout the period, diminishing the value of conglomerates as a source of capital and expertise. Third, the focus period contained large increases in international competition, and in some industries, rising consolidation. Connected to the trend, public policy underwent transformation, with a major facet being the liberalized oversight of mergers and acquisitions (M&A). As Shleifer and Vishney (1991) found, M&A's in the 1960's and 1970's were used to build many large multi-industry firms; the activities of the 1980's tore them down, returning assets to much more focused configurations. Finally, inflation fell throughout the examination period, in a general trend in the major industrialized economies.
In total, 99 multi-industry firms appeared on the Global 1000 list over the 12-year span of the study. But, not all of the companies were true conglomerates with a dedicated corporate strategy. For example, Corning was a member of the list in 1996, but was actually undergoing a period of strategic transition. As well, adjustment to the larger sample was necessary for another reason: the administrative burden of unrelated diversification suggests that the longer the period of its use, the more likely it will have a deleterious effect on performance. Therefore, the focus of the study was on firms sustaining the use of unrelated diversification for a minimum five continuous years of use, in the hope of isolating a group of higher-performing firms.
The working hypothesis was that no higher-performing firms would be identified. The reasons are linked to issues both internal and external to the firms. Internally, the lack of divisional synergies, and the cost of bureaucracy were expected to weigh heavily on multi-industry firms. Externally, the pressures already described reduced the size of the sample and may threaten to destroy it completely. Moreover, the internationalization of business has perhaps decreased the opportunities for conglomerates only to developing markets. (For a description of the value and strategies of conglomerates in developing economies, see Khanna and Palepu (1997, 1999).)
Fifty-eight of the firms in the full multi-industry sample did not appear for five continuous years, leaving 41 multi-industry firms in our sample. The group represents the largest firms in the world by market capitalization that have been using, or have used, unrelated diversification over the longest period. The average number of years by which the sample firms exceeded the five-year cut-off was 3.58. Only four companies occupied a place on the list for the minimum five years, while ten appeared as multi-industry firms for the entire 12 years being studied. In all, 23 organizations appeared on the list eight or more years. The sample is also broadly international in scope, with over 11 different countries represented as the firms' home bases. (Appendix 1 offers summary statistics of the sample companies.)
Performance was operationalized as a multiple measure. The first three measures are common accounting-based parameters- return-on-equity, return-on-assets and return-on-sales. All three measures, or their constituent parts, are included in the Business Week Global 1000 list, following standardized methods of calculation. The second type of performance measure is a hybrid measure, the market-to-book ratio, which allows insight into market perceptions of the value added by management to the underlying assets of the firm.
Data were prepared for analysis in three simple steps....