Conglomerate Performance Using the Capital Asset Pricing Model

W HILE many aspects of conglomerate firms have been studied, empirical tests of their performance remain limited. Most of the studies to date test aspects of mergers generally. ' Professor Eamon Kelly (1967) compared a sample of 21 firms which grew 20 per cent or more by acquisitions during the period from 1946 to various terminal dates through 1963, with firms of similar size and products but with growth mainly internal (Kelly, 1967). He found no significant difference in profitability between the two groups. Gort and Hogarty (1970) also examined a number of general aspects of mergers. Their statistical analysis indicated that the stockholders of acquired firms gained on the average, while the owners of acquiring firms lost on the average. They found that mergers have an approximately neutral effect on Ithe aggregate worth of firms that participated in them (Hogarty, 1970). Reid's studies (1968) included data evaluating a sample of conglomerate firms for the decade ending in 1961. He utilized three measures which he characterized as reflecting the interests of managers, and three reflecting the interests of stockholders. Reid concluded that more actively merging firms and firms that diversified to a greater extent in their merging activity scored higher on the criteria related to managers' interests and lower on criteria related to stockholders' interests. Lorie and Halpern (1970) studied the performance of 117 mergers taken from the Federal Trade Commission listing for 1954-1967 of all mergers in manufacturing and mining in which the acquired firm had assets greater than 10 million dollars. In the Lorie and Halpern study, the focus was particularly on the possibility of "deception of investors. " The mergers which they studied, therefore, were ones in which the shareholders of the acquired company received relatively complex instruments such as convertibles or warrants.2 The investment return to, stockholders of the acquired firms was analyzed on various bases measured in the period six months prior to the merger to two years after the merger. In general, the investment return performance to stockholders of the acquired firms was superior to the market performance of broad market indexes for comparable periods of time. For example, the mean rates of return for the 12and 14-month periods subsequent to the mergers were 9.34 per cent and 9.52 per cent, respectively, while corresponding rates for the market index were 7.73 per cent and 7.38 per cent. Hogarty (1970) analyzed the success of 43 mergers by the criteria of post-merger investment performance (capital gains plus dividend returns) adjusted by an Investment Performance Index (IPI) for the industry of the acquiring company. Using measurements including reinvestment of dividends, he classified 14 failures (F), 24 ambiguous (A), and 5 successes (S). For an IPI of 10 per cent, a failure was defined as a return of 9 per cent or less, a success was a return of 11 per cent or more, and the ambiguous category represented returns between 9 and 11 per cent. Not assuming reinvestment of dividends, the distribution was 3 S, 19 A and 21 F. Hogarty found these Received for publication April 5, 1971. Revision accepted for publication June 21, 1972. * This study was supported by the Research Program in Competition and Business Policy, UCLA. We appreciate the helpful suggestions of the reviewer. ' The 1171-page special edition of the Spring 1970 St. John's Law Review on conglomerate mergers contains no article with empirical data on the comparative performance of conglomerate firms. Two empirical articles in the volume deal with other aspects of performance. The S. E. Boyle paper analyzes the premerger growth and profitability characteristics of acquired companies. The paper by T. F. Hogarty reviews earlier historical studies of the success of mergers generallv. 2 Since this kind of "funny money" (Lorie and Halpern's term) was alleged to be characteristic of conglomerate mergers, their sample of firms is presumed to be of "conglomerates. " However, no formal criteria for selection were emnlnved .