REASONS FOR CONGLOMERATION: EMPIRICAL ANALYSIS OF MANAGEMENT RESPONSES IN CHILE JORGE TARZIJÁN* JOSÉ RIVERA*

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1 REASONS Revista ABANTE, FOR CONGLOMERATION Vol. 3, Nº 2, pp (octubre 2000) 203 REASONS FOR CONGLOMERATION: EMPIRICAL ANALYSIS OF MANAGEMENT RESPONSES IN CHILE JORGE TARZIJÁN* JOSÉ RIVERA* ABSTRACT This paper is intended to contribute to the understanding of the motivations behind the diversification decisions of the Chilean economic groups. With this objective we surveyed the largest such groups in Chile. Our results show that the most important reasons for diversification for the top management of the Chilean business groups are managerial synergies (board of directors), financial synergies, information synergies and some specific operational synergies such as economies of scope in research and development. Also, most of the respondents stated that the diversification decisions of their firms or business groups have increased the multimarket contact with other companies or groups, influencing the strategies and diversification of competitors. The relationship between the degree of diversification of a group and its stated reasons for diversification are also analyzed. Significant differences in the motivations for diversification exist, depending on the group's actual level of diversification. Specifically, variables such as multimarket contact and access to the capital market are more important in more diversified groups. We also analyze the relationship between the size of a group and its stated reasons for diversification. There appear to be no significant differences between the answers of the management of bigger and smaller conglomerates. However, there is a positive correlation between the size of the groups and their level of diversification. Keywords: Conglomerates, Corporate Structures, Emerging Markets, Diversification Decisions JEL Classification: L11, L22, G32, G34 * Escuela de Administración, Pontificia Universidad Católica de Chile. We would like to thank Matko Koljatic, Pablo Marshall and Eduardo Walker for their valuable comments. Jaime Echenique and Alejandra Salinas provided excellent research assistance. We also thank the Vicerrectoría Académica of the Pontificia Universidad Católica de Chile for providing financial support for this research. Any remaining errors are our responsibility. jtarzija@faceapuc.cl, jrivera@faceapuc.cl

2 204 REVISTA ABANTE, VOL. 3, Nº 2 RESUMEN Este artículo intenta contribuir a la comprensión de las motivaciones para las decisiones de diversificación de los grupos económicos chilenos. Con este objetivo, encuestamos a los grupos económicos más importantes del país. Nuestros resultados muestran que las razones más significativas para las decisiones de diversificación para la alta administración de tales grupos son sinergias de management (especialmente a nivel de miembros del directorio), sinergias financieras, sinergias de información y algunas sinergias operacionales específicas tales como economías de ámbito en investigación y desarrollo. Además, la mayoría de los encuestados mencionó que las decisiones de diversificación de sus firmas o grupos han aumentado el contacto multimercado con otras compañías o grupos influenciando, de esta manera, las estrategias y diversificación de los competidores. También se analiza la relación entre el nivel de diversificación de un grupo y las razones que éste ha mencionado para su diversificación. Hay algunas diferencias significativas entre sus razones para diversificar en función del nivel real de diversificación del grupo. Específicamente, variables tales como el contacto multimercado y el acceso al mercado de capitales resultaron más importantes en grupos más diversificados. La relación entre el tamaño de un grupo y las razones que mencionaron para diversificarse no muestra diferencias significativas entre grupos de distinto tamaño. Sin embargo, sí hay una correlación positiva entre el tamaño del grupo y su nivel de diversificación. Although there is a vast literature that advises the pursuit of diversification strategies in related lines of businesses, we still find an important number of conglomerates, mainly in emerging markets, that follow unrelated diversification strategies. This apparent contradiction makes us question the probable reasons for it. In a previous paper by Tarziján (1999), the main theoretical reasons for conglomeration are revieiwed and discussed; in this paper we report and analyze the results of a survey of the top management of Chilean wherein we asked about their reasons for diversification. The basic idea behind this paper is the following: There is a set of reasons frequently stated in the literature that may explain diversification under the assumption that management's objective is to maximize value creation. Assuming these reasons are correct, we asked managers about the importance of each of them in their actual diversification decisions. We

3 REASONS FOR CONGLOMERATION 205 believe that analyzing the relationship between the theoretical and the actual reasons for diversification will be an important contribution to this literature. The analysis was done on Chilean conglomerates during the first half of the year Chile is a good country to undertake this kind of study for several reasons: i) There exist an important number of business conglomerates, ii) These conglomerates have different sizes and different degrees of diversification, iii) A regulatory agency (Superintendencia de Valores y Seguros) issues an official list of conglomerates (or economic groups) and their constituent firms. 1 From the theoretical reasons outlined in our previous paper, the most important reasons for diversification according to the upper management of the Chilean economic groups are managerial synergies, financial synergies, better information and some specific operational synergies such as economies in research and development. Also, most groups recognized that the diversification decisions of their firms or economic groups have increased the multimarket contact with other companies or groups influencing the strategies and diversification of competitors. Among the least important reasons to diversify, from the management's point of view, are some operational synergies such as those from marketing, distribution and employees other than high management and to obtain market power. We also analyze the relationship between size and diversification for groups and their stated reasons for diversification. We did not find significant differences between the answers of the management of bigger and smaller conglomerates, althought we did find some significant differences in the motivations to diversify, depending on the actual level of diversification of the group. Specifically, variables such as multimarket contact and access to the capital market are more important in more diversified groups. I. THEORETICAL CONSIDERATIONS A key part of a firm or business group's corporate strategy is its choice of the businesses in which to compete. In its corporate strategy plan, the firm or business group must decide whether it will pursue a related or an unrelated portfolio of businesses while in a narrower sense, it has to decide the specific businesses, both in terms of product variety and geographic scope, in which to participate. 1 Conglomerates in Chile are called economic groups in legal terms and we are using both expressions interchangeably.

4 206 REVISTA ABANTE, VOL. 3, Nº 2 Despite an important literature that suggests a superiority of related over unrelated diversification strategies (e.g. Rumelt (1974), Bettis (1981), Wernerfelt and Montgomery (1984), Lang and Stulz (1994), Berger and Ofek (1995) and Servaes (1996)), a significant number of business groups follow strategies of unrelated diversification. According to Khanna and Rivkin (2000), business groups (generally diversified) are deeply woven into the social and economic fabric of most emerging economies. The reasons behind the formation of business groups are an open question. In this paper we try to help in the understanding of these reasons. In a previous paper (Tarziján, 1999) we reviewed the main value creation reasons for diversification. Some of these reasons are operational synergies (e.g. economies of scale and scope), managerial synergies, transactions cost saving, financial synergies (mainly risk diversification, asset liquidation opportunities and tax savings), market power, creation and development of internal capital markets and multimarket contact. The non-value maximizing reasons (agency theoretical) are a second set of reasons frequently used to explain the diversification decisions of firms. The basic premise behind these reasons is that managers, as agents, may not act in their principal s interest but rather pursue their own self-interest. Under this scenario, managerial decisions may result in diminished shareholder s wealth. Our analysis focuses on the reasons for value creation. Khanna and Palepu (1999), argued that in emerging markets there are a variety of market failures, caused by information and agency problems that may explain the existence of economic groups as a value creation type of organization. Information problems may affect access to external funding (e.g. because of lack of monitoring) and the operation of markets when there are information asymmetries between a manager and a potential employee regarding the value of her human capital. Despite the frequently cited theoretical reasons for diversification, much needs to be done in order to truly understand what is behind the minds of the managers who make corporate strategy decisions. To help in this understanding we surveyed the management of the main Chilean business groups, asking them about their main reasons for diversification. We believe that the analysis of the relationship between the main theoretical value creation reasons for diversification and the actual reasons given by the senior management of the main companies in the groups should give us additional insight concerning the motivations of the diversification decisions for Chilean economic groups.

5 REASONS FOR CONGLOMERATION 207 II. METHODOLOGY AND DATA There is not a consensus definition of what a conglomerate or economic group is. In general, an economic group is defined based on a series of economic and social ties that delineate them. 2 In Chile, there exists an official list of groups and their constituent firms issued by a regulatory agency (Superintendencia de Valores y Seguros or SVS) which devotes a considerable effort to gather information on group membership. In this paper we consider the business groups as defined by that regulatory agency. For the Chilean regulatory agency, the term economic group has a formal definition: 3 A business group is the collection of entities that present links in their property, administration or responsibility with creditors, in such a way that it can be presumed that the economic and financial actions of their members are guided by the common interest of the group, or subordinated to it, or that there are common financial risks in the loans that they contract or in the securities that they issue. The data for this study was collected by a mail survey to the executives of the main companies of the 40 largest Chilean economic groups. The composition of each group was obtained from the aforementioned (SVS) and the size of each group was determined based on its consolidated asset value (Gonzalez, 1999, Lefort and Walker 2000a). Questionnaires were sent only to the President and Vice-President of the board of Directors and to the top level management of the largest three companies of each group and, to the holding firm of the group, whenever appropriate. We sent a maximum of three letters per company. Each respondent signed the questionnaire, thereby assuring that the person who returned it was the true respondent. Of the 40 business groups, responses were obtained from at least one top manager or chairman of the board for 15 of them (38 percent of response rate in terms of groups). For the remaining 25 economic groups no answer was received and therefore we can only speculate about their reasons for not responding. In terms of people, we sent letters to 110 managers and boards of Directors and got answers from 26 of them (24 percent response rate). Whenever we got more than one answer per group we averaged 2 See Khanna and Rivkin, This translation is taken from Lefort and Walker (2000b).

6 208 REVISTA ABANTE, VOL. 3, Nº 2 them up. In general, answers from different people of the same group were fairly similar. The questionnaires were sent during the first half of year The answers were received within a time span of 2,5 months. Despite that the sample may seem incomplete, it is important to keep in mind that the main Chilean economic groups were very well represented in the sample since we have answers from the largest 5 groups and from 9 out of the 10 largest economic groups. In terms of asset value, our respondents owned 77 percent of the asset value of the Chilean economic groups as reported by the SVS. Therefore our response rate in terms of asset value under management is unusually high. Moreover, 67 percent of the respondents are at the very top management level (president, vice presidents and general managers) while the other 33 percent percent are Divisional managers (finance, strategic planning or finance managers), assuring the credibility of the information provided. In Table 1 that follows are summarized the main descriptive statistics of the sample. TABLE 1 DESCRIPTIVE STATISTICS OF THE SAMPLE Mean Median S. D. Max Min Number of Respondents Groups 15 n. a. n. a. n. a. n. a. Book value of assets of Respondents (MM US$): 3,744 2, Rate of Answers in terms of asset value* 77% n. a. n. a. n. a n. a. Number of Answers by Group Herfindal Index of Respondents** *: Equals the assets under management of the 15 respondents groups over the assets of 40 main Chilean economic groups. **: The theoretical value of this index varies from 1 (nil diversification) to 0 (full diversification). n. a.: Not applicable We requested managers to rank the importance of each variable in their group's diversification decisions on a 1 to 7 scale with 7 meaning strongly agree, 1 meaning strongly disagree and 4 being the midpoint. In this section we also compare the means and medians obtained for each question to analyze if there are statistically significant differences between each pair of questions with a reasonable confidence level. If they are different we can rank the importance of each variable with a high level of statistical

7 REASONS FOR CONGLOMERATION 209 confidence. We performed two tests to check the statistical significance of the difference in means. The first test is the paired sample test, which assumes normality of the variables. Since we can not be sure about normality in a sample of 15 observations we also perform a non-parametric test (Wilcoxon) which does not need the assumption of normality. Most of the questions in the survey are related with the relationship between operational synergies, managerial synergies, financial synergies, market power, internal capital markets and multimarket contact and the diversification decisions of firms. Related with operational synergies we tested the desire to obtain economies in R&D and technology, marketing and promotions, employees (different from management), distribution processes and systems, administrative processes such as accounting, financial control, purchasing and budgeting. Regarding managerial synergies we tested economies related with the sharing of board members. We also tested variables related with market power, financial synergies, internal capital markets and multimarket contact. The next section presents the main results for each variable. III. RESULTS This section presents the results obtained from the survey. We first present the results for each family of variables and then compare both the relative importance of each variable inside a family and the relative importance of each family of variables. 5 A. Operational Synergies (other than managerial) To obtain operational synergies is probably the reason most frequently given by managers when asked to explain diversification decisions. They arise when more than one business share some imperfectly divisible factor of production that once acquired to produce one good becomes available at a lower cost for the production of other goods ( economies of scope ) or 5 As will be seen, examples of families of variables are economies of scope, managerial synergies, market power and financial synergies.

8 210 REVISTA ABANTE, VOL. 3, Nº 2 to produce a larger amount of the same good ( economies of scale ). A.1 Economies of Scope Tables 1 shows the importance of economies of scope, as evaluated by the management of groups, for different production factors. The last 4 columns in the table show the significance of the difference in means between each pair of variables using the Paired Sample Test. The numbers heading each of the last four columns correspond to each of the variables numbered in the rows of the table. For example the * in the third row of the column headed with (2) indicates that the means of Administrative processes and Marketing are different at the 85 percent confidence level. TABLE 1 MOST OF THE BUSINESSES OF YOUR COMPANY OR GROUP SHARE... Mean Median S.D. (1) (2) (3) (4) 1)R&D and Technology )Administrative Process )Marketing *, # * 4)Distribution Processes )Employees **, ## **, ## **, ## **, ## Average of scope economies (n =6): 4.6 *: means are different at an 85 percent of confidence using the Paired Sample Test **: means are different at an 95 percent of confidence using the Paired Sample Test #: means are different at an 85 percent of confidence using the Wilcoxon (non parametric) Test ##: means are different at an 95 percent of confidence using the Wilcoxon (non parametric) Test From the results of Table 1, we see that the most important sources of economies of scope for the groups' diversification decisions are R&D and technology together with administrative processes such as accounting, budgeting, purchasing and financial control while the least important source of economies of scope is employees. The overall mean for the operational synergies related with economies of scope showed in table 1 is 4.6. This result indicates that although somewhat important, these operational econo-

9 REASONS FOR CONGLOMERATION 211 mies are not, on average, a very important variable in the diversification decisions of firms. A.2 Economies of Scale Table 2 shows the importance of economies of scale, as evaluated by the management of the groups for different production factors. TABLE 2 THE DIVERSIFICATION PROCESS HAS ALLOWED, INSIDE EACH BUSINESS, THE ACHIEVEMENT OF... Question Mean Median S.D. (1) (2) (3) (4) (5) 1)Economies in R&D )More efficiency in use of people )Other savings inside the group )Better prices in purchasing )Reduced Production Costs *, # # 6)Economies in marketing **, ## **, ## **, ## *,# Average of scale economies (n =6): 4.6 *: means are different at a 90 percent of confidence using the Paired Sample Test **: means are different at a 95 percent of confidence using the Paired Sample Test #: means are different at a 90 percent of confidence using the Wilcoxon (non parametric) Test ##: means are different at a 95 percent of confidence using the Wilcoxon (non parametric) Test As in the case of scope economies, scale economies do not appear, on average, as a very important explanation for the diversification decisions of firms. The most important resources for creating of economies of scale are, according to the high management opinion, R&D, people and other resources. It should be noticed that it is not inconsistent that in table 1 we conclude that the sharing of employees was not an important explanation for the diversification decisions while in Table 2 efficiency in the use of people appears important. The difference is that while employees may not be an important source of economies of scope (i.e. managers do not consider important to share employees among the different businesses of a group) they may consider it a source of economies of scale in the sense

10 212 REVISTA ABANTE, VOL. 3, Nº 2 that employees may be an important variable to increase efficiency inside each business. B. Managerial (Board of Directors) Synergies We also checked the importance of Managerial Synergies, specifically at the Board of Directors level. The easiest way to visualize managerial synergies is to think of it as economies of scope obtained in the board of directors teams. Table 3 summarizes the results obtained in this case: TABLE 3 MOST OF THE BUSINESSES OF YOUR COMPANY OR GROUP SHARE... Mean Median S.D. Same board members in different companies of the group This result shows that managerial synergies are an important reason behind the diversification decisions of the groups and is consistent with the findings of Lefort and Walker (2000 a) who found that board members tend to have a seat, on average, in more than one board of the same conglomerate and that the average number of seats of any one board member increases with the size of the conglomerate. The average result presented in Table 3 is the single highest result obtained for the whole questionnaire, indicating that if one key variable must be named to explain diversification decisions, managerial synergies would be the one probably chosen. A possible explanation for this result is that interlocking directors help in the transfer of information among group firms, being more useful when alternative information sources are more disperse. Common boards also help in keeping control of the firms and enhance the fidelity of the board members to the group because when the same directors work for different firms in the group they became more dependent on it.

11 REASONS FOR CONGLOMERATION 213 C. Financial Synergies and Creation and Development of Internal Capital Markets Questions were also asked about variables linking financial synergies and internal capital markets with diversification decisions. Tables 4 a, b and c summarized the results obtained for these variables. Specifically, in table 4 a) we present the results for questions regarding the financing of groups in terms of both quantity and price. A hypothesis is that business groups may be able to get a larger amount of funds than the sum of the funds that may be raised separately by individual business units. A probable reason for this is that since business groups are assumed to choose projects and to assign money more efficiently than individual project managers, banks and other providers of funds may relax some of their credit constraints. Table 4b) presents the result for the question testing potential information advantages from belonging to a group. A hypothesis behind this latter question is that because of capital market imperfections, there is an asymmetry in information between managers group and outside investors in favor of the insiders since they will have better information about the relative performance of their individual business units, for example, because monitoring is more expensive for external investors. As a result, the group may be more efficient than external fund providers in the allocation and reallocation of funds among its different business units through an internal capital market. Table 4c) shows the results for the question linking corporate incentives and diversification. A hypothesis is that a diversification process may be motivated by the possibility of having better incentives at the corporate or group level rather than at the firm or business unit level. The idea behind this is that by giving incentives at the corporate or group level the managers of the corporation should be motivated to maximize corporate or group profits rather than business unit profits as will be the case if incentives are placed at the business unit level. The results for these variables are shown below.

12 214 REVISTA ABANTE, VOL. 3, Nº 2 C.1 Financial Synergies: TABLE 4 THE DIVERSIFICATION PROCESS OF YOUR GROUP HAS BEEN FACILI- TATED AND MOTIVATED BY... (a) 1)To obtain more financial resources than sum of individual business 2)To obtain better financing conditions than individual business units Information (b) 3)The existence of better information regarding the performance of business units inside the group than outside (c) 4)The possibility of better incentives to improve resource allocation among business at the corporate level than at the individual level Mean Median S.D. (1) (2) (3) Mean Median S.D. (1) (2) (3) Mean Median S.D. (1) (2) (3) *, **, **, # ## ## *: means are different at a 90 percent of confidence using the Paired Sample Test **: means are different at a 95 percent of confidence using the Paired Sample Test #: means are different at a 90 percent of confidence using the Wilcoxon (non parametric) Test ##: means are different at a 95 percent of confidence using the Wilcoxon (non parametric) Test The results obtained in this section are an indication that improvement in information flows that may result from a diversification process and obtaining better conditions in financial markets are relevant variables to explain the diversification decisions of most groups according to their top management. Moreover, these results show that the possibility of a better incentive strategy is not, according to the management s opinion, an important variable in explaning the diversification decisions of business groups. The medians obtained for the questions included in tables 4 a and b show, even more clearly, the high importance of financial and information synergies in the diversification decisions of economic groups.

13 REASONS FOR CONGLOMERATION 215 C.2. Market Power Market power may be a source of value creation because of companies potential ability to influence the competition level of a market through its effect on variables such as prices, quantities and the behavior of competitors. The questions more directly related with market power and their results are shown in Table 5 below: TABLE 5 THE DIVERSIFICATION DECISIONS OF THE GROUP HAS ALLOWED... Mean Median S.D. (1) (2) 1)To affect prices of products sold )To affect the quantities sold **, ## 3)To improve sales conditions **, ## **, ## Average for Market Power 3,9 *: means are different at a 90 percent of confidence using the Paired Sample Test **: means are different at a 95 percent of confidence using the Paired Sample Test #: means are different at a 90 percent of confidence using the Wilcoxon (non parametric) Test ##: means are different at a 95 percent of confidence using the Wilcoxon (non parametric) Test The results for each of the questions showed in Table 5 are an indication that obtaining market power does not appear to be an important variable to explain the diversification decisions of the Chilean business groups. It should be noted that this result may be biased for the potential difficulty of the top management teams in recognizing market power as a potential reason for diversification. Next, Table 6 tested whether there are statistically significant differences between the average results obtained for each of the categories of variables analyzed up to this point.

14 216 REVISTA ABANTE, VOL. 3, Nº 2 TABLE 6 MEAN COMPARISON BETWEEN TABLES USING DE PAIRED SAMPLE T- TEST AND THE WILCOXON TEST. (1) (2) (3) (4) (5) (6) 1)Scope Economies 2)Scale Economies 3)Managerial Synergies **,## **,## 4)Financial Synergies *,# *,# 5)Information Advantages *,# 6)Incentives **,## *,# **,## 7)Market Power **,## **,## **,## **,## **,## *: means are different at a 90 percent of confidence using the Paired Sample Test **: means are different at a 95 percent of confidence using the Paired Sample Test #: means are different at a 90 percent of confidence using the Wilcoxon (non parametric) Test ##: means are different at a 95 percent of confidence using the Wilcoxon (non parametric) Test From the results in Table 6 we may conclude that the main variables that explain the diversification decisions of the main Chilean economic groups are, according to their managers, Managerial Synergies, Financial Synergies and Information Advantages. C.3. The Importance of Being Present in Different Markets (a proxy of multimarket contact) Closely related with market power is the concept of multimarket contact. Two firms or business groups are said to be in multimarket contact when they compete simultaneously in more than one market. Multimarket contact may affect firms incentives to compete. 5 Next, we present the results for this variable. 5 See Bernheim and Winston (1990) for a very good explanation of the concept. Tarziján (1999) applies this concept as a potential reason for conglomeration in emerging markets.

15 REASONS FOR CONGLOMERATION 217 TABLE 7 THE DIVERSIFICATION PROCESS OF YOUR GROUP HAS ALLOWED YOU TO... (%) Yes Some times Not Compete with other firms in more than one market Affect the strategies of competitors Affect the diversification decisions of competitors Affect the geographic diversification of competitors As can be seen in Table 7, the most frequent answer regarding the consequences of multimarket contact is that it has affected the competitors strategies. In fact, 80 percent of the groups recognized that the multimarket contact provided by their diversification decisions has affected the strategies of competitors at least some times. This interesting result is in line with the strategic management and industrial organization literature that stresses the importance of multimarket contact in determing the firms strategies. Moreover, the result obtained in this section shows that in a relatively small economy such as Chile, diversification processes allow firms to compete simultaneously with other companies or economic groups in more than one market. It should be noticed that the desire of being present in different markets can not only be due to multimarket contact but to other reasons as well. For example, it can give additional advantages to the group in the form of, for example, more political power or access to better information. The advantage in information will be especially relevant in markets where there is a big information gap between the insiders of a company (i.e. management) and the outsiders (typically, minority shareholders and bondholders). In these markets, an economic group may prefer to invest directly in different markets as controlling shareholder in order to have better access to information avoiding being subject to an eventual wealth expropriation that may arise in an asymmetric information context when they invest as minority shareholders. C.4. (Other) Financial Synergies Regarding some of the other questions related with financial synergies, 73.3 percent of the groups answered that achieving risk diversification is an

16 218 REVISTA ABANTE, VOL. 3, Nº 2 important result of their diversification processes while the saving on taxes appears irrelevant in the diversification decisions of 93 percent of the groups. That risk diversification is an importast reason for diversification may be justified based on the existence of either transaction costs or agency reasons. Since markets are imperfect, transaction costs may justify that controlling shareholders create diversified firms since diversification at the shareholders level may be more expensive than firm or business group diversification. 6 On the other hand, diversification decisions may also be justified on grounds of agency theory arguing, for example, that diversification reduces the risks of managers because of the lower probability of having a very low level of total earnings if one business performs poorly. C.5. Future of the Diversification Process Regarding the future of their diversification process, a clear majority of the groups (67 percent) believe that the diversification of their groups should continue but into businesses related with the group's current business. Only one group believes that they should expand their diversification to non related business. These results are in line with most of the current strategy and finance literature that advises the pursuit of related diversification strategies. Moreover, 67 percent of the groups mentioned the increase in group size as a favorable result of the diversification decisions while 83.3 percent of them stated that goup executives motivate their diversification decisions. Although this paper does not intend to analyze on agency theoretical reasons, these results may shed some light about the possibility of agency being behind the diversification decisions of the groups. The sole increase in size as a diversification reason is one of the classical examples of an objective function possibly different from maximizing shareholder value. C.6. Relationship between Reasons for Diversification and Degree of Diversification of an Economic Group An interesting issue is to analyze whether there is a relationship between the degree of diversification of a business group and the answers given by 6 Here we refer to transaction costs in a wider sense including costs of being subject to hold up (due to opportunistic behavior of other parties) and cost of monitoring contracts and behaviors (Williamson, 1989).

17 REASONS FOR CONGLOMERATION 219 them about the importance of each variable in explaining their diversification decisions. In order to perform such an analysis, we first compute the diversification of each of the respondent groups based on their Herfindahl index. This index is defined as: Where: IH j = n i= 1 α 2 i IH j = Herfindahl Index for Group" j" α = assets in economic sector "i" as a percentage of j n = number of sectorsin which group " j" has investments the total assetsof group" j" To compute the Herfindahl Index for each group we first took the companies controlled by a group from the list issued by the SVS. We then went to the financial statements submitted to that Superintendencia for each public company of that group ( Ficha Estadística Codificada Uniforme, FECU) and computed the assets under control per group adding up the assets of all the companies belonging to a group. We then divided the assets of each company into different economic sectors as informed by the same companies and added up the assets under control per group in each economic sector. From here, we obtained the percentage invested by each group in each economic sector and compute its Herfindahl Index. Table 8 below summarizes the main descriptive statistics related with the size and the diversification of the groups in the sample. TABLE 9 DESCRIPTIVE STATISTICS ASSOCIATED WITH THE SIZE OF THE SAMPLE GROUPS (N = 15) Mean Median S.D. (Mean) Maximum Minimum Size (US$MM) 3, , Diversification

18 220 REVISTA ABANTE, VOL. 3, Nº 2 The diversification of a group increases as the Herfindahl index decreases. Once we have the diversification index and the answers of each group, we compute correlation coefficients between the variables explaining diversification decisions and the actual diversification of each group to see if there is a significant relationship between them. Negative values for the coefficient of correlation mean that the variable becomes more important as the diversification degree increases. To check the significance of the correlation coefficients we used the Pearson correlation test under the assumption of normality and the Kendall s tau test and the Spearman s rho test for the non-parametric case. In table 9 we summarized the main results obtained for the variables that were found significant. As can be seen, the results obtained under the parametric and the not parametric assumptions were very similar. TABLE 9 CORRELATION COEFFICIENTS AND SIGNIFICANCES: The diversification of your group has Normal Kendall Spearman Affected strategies of others Coefficient Significance Affected geographic diversification Coefficient Significance Allowed access to capital markets Coefficient Significance Allowed efficiencies in marketing Coefficient Significance Allowed to pursue of related diversification Coefficient Significance Note: A significance of 0.04 means that the hypothesis that the correlation coefficient is zero is rejected with 96 percent of confidence. From table 9, the following conclusions can be drawn. a) There is a statistically significant (at 95 percent of confidence level) positive relationship between the groups' degree of diversification and the variables related with multimarket contact. The coefficient for affect strategies of others was (significatively different from 0

19 REASONS FOR CONGLOMERATION 221 with 96 percent of confidence) and to affect geographic diversification was (significatively different from 0 with 98 percent of confidence). A negative coefficient of correlation means that the variable is more important as more diversified is the group. These results show that, according to the top management of the groups, their diversification processes have allowed them to compete with other firms in more than one market simultaneously and to affect the strategies of competitors to a larger extent when the groups are more diversified. This result is expected since the importance of multimarket contact should increase with the diversification degree of a group. b) Advantages in access to capital markets were more important as more diversified are the groups (correlation coefficient of 0.47 which is significantly different from 0 with 96 percent of confidence). This result is consistent with what we expected since banks may prefer to lend to more diversified corporations to reduce the total risk of the loan. This reason becomes even more important when groups may guarantee loans with assets from different economic sectors that, by definition, have different level of risks. c) Efficiencies in marketing and advertising activities were found to be positively correlated with the degree of diversification of the group (correlation coefficient of 0.37, which is significantly different from 0 with 92 percent of confidence). This result means that sharing of advertising and marketing becomes more important as the diversification of the group lowers, which is reasonable since sharing these activities may make more sense in related businesses. d) The correlation coefficient between the degree of diversification of the group and the desire to have a future diversification policy towards related diversification is 0.5 (different from 0 with 97 percent confidence) meaning that more diversified groups prefer to move to a more related diversification strategy. This result is important since it shows that more diversified groups do not want to increase their diversification, meaning that in the managers' minds, there may be something like a maximum tolerable diversification level.

20 222 REVISTA ABANTE, VOL. 3, Nº 2 For the other variables analyzed, no significant relationships were found at least at the 90 percent confidence level, between the diversification degree of each group and the answers given by the group. C.7. Relationship between Reasons for Diversification and Group Size Another interesting question is related with the possible relationship between the size of the groups (in terms of value of assets under control) and their reasons to diversisify. We performed similar tests to the ones explained in the previous section and also did test of rankings where we ranked the groups to see if there was a statistically significant correlation between their rankings and their answers. We did not find a significant relationship between these variables. C.8. Relationship Between Size and Diversification Table 10 below shows that there is a significant negative correlation between the size of the group and its diversification. 7 This means that, on average, the diversification of the group increases with its size. Although it is difficult to determine the cause and effect of this relationship it seems reasonable to think that in a relatively small economy such as Chile, a larger size will be closely related with a higher level of diversification since the possibilities of expanding in a specific economic sector are limited. This is one of the reasons why some Chilean economic groups have followed strategies of international expansion. TABLE 10 Kendall Spearman Size Herfindahl Index Coefficient Significance This relationship was significant only at the non parametric level.

21 REASONS FOR CONGLOMERATION 223 IV. CONCLUSIONS The objective of this paper is to contribute to the understanding of the diversification decisions of conglomerates. With this purpose we surveyed the main Chilean economic groups regarding the importance of different variables for explanining of their diversification decisions. The survey was done based on the theoretical reasons for diversification reviewed in a previous paper by Tarzijan (1999). This study contributes providing empirical survey-based backup to some of the frequently stated reasons for diversification. According to the results of the survey, the most important reasons for diversification for the top management of the Chilean business groups are managerial synergies, financial synergies, better information and some specific operational synergies such as economies in research and development. Also, most of the respondents stated that the diversification decisions of their firms or business groups have increased the multimarket contact with other companies or groups influencing the strategies and diversification of competitors. Among the least important reasons for diversification, from the management point of view, were some operational synergies such as those from marketing, distribution and employees different from high management and to obtain market power through its effects on the prices and quantities sold in the market. We also analyze the relationship between the size and the diversification of a group and its stated reasons for diversification. We did not find significant differences in the answers of the management of bigger and smaller conglomerates, but we found some significant differences in the motivations for diversification depending on the actual level of diversification of the group. Specifically, variables such as multimarket contact and some financial synergies are more important in more diversified groups. We also found some positive relationship between the size of the Chilean groups and its diversification level. This relationship may be due to the limited size of the market which inhibits the potential growth for a group if it pursues focused strategies in the local market. We may speculate that the high relevance of variables related with financial synergies, multimarket contact and managerial synergies found in this paper depend on the degree of development of the Chilean financial

22 224 REVISTA ABANTE, VOL. 3, Nº 2 markets (which is not comparable with a market such as the USA or to most of the European Community country markets), the relatively small size of the Chilean product markets and an eventual scarcity of managerial talent. While this study may have important managerial implications, it also has several limitations. First, the rate of answers to the questionnaire is relatively low. However, the rate of answer as a function of the asset value under control of the Chilean conglomerates is high. Second, the questionnaire itself is somewhat biased and limited since it is basically based on our previous paper. Third, the answers can be biased by political correctness, in the sense that managers may not be motivated to reveal agency theoretic reasons. Further research efforts can be made in order to identify the exact reasons about why firms diversify. This paper has proposed some reasons and contrasts them with the opinion of the main executives of the economic groups. However, the questionnaire was limited and the number of answers we got back does not allow refined statistical tests. Moreover, additional research is needed to analyze the relationship between the reasons for diversification and the type and mode of diversification followed by the economic groups. Another interesting question for future research is how these answers may change in different countries with different characteristics (size, development of financial markets, etc.).

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