Diversification, Financial Leverage and Conglomerate Systematic Risk

Of the many conglomerate studies to date, some have dealt with the risk-return performance of conglomerates in the context of the capital asset pricing model [2, 7, 10, 14], others have considered the motives for the formation of conglomerates [4, 5, 6, 13], and still others have examined the operating characteristics of conglomerates [9, 12, 15]. Within the last group, Weston and Mansinghka [15, p. 928] argued that the primary motivation for conglomerate formation is defensive diversification, “…defined as diversification to avoid adverse effects on profitability from developments taking place in the firm's traditional product market areas.” Another motivation is provided by Levy and Sarnat [4] and Lewellen [5] who demonstrated that the only economic gain from a purely conglomerate merger may be the increased debt capacity resulting from the combination of entities having imperfectly correlated earnings streams.