Risk Reduction as a Managerial Motive for Conglomerate Mergers

A conglomerate merger generally leads, through the diversification effect, to reduced risk for the combined entity. As is well known, in perfect capital markets such risk reduction will not be beneficial to stockholders, since they can achieve on their own the preferred degree of risk in their "homemade" portfolios. What, then, is the motive for the widespread and persisting phenomenon of conglomerate mergers? In this study a "managerial" motive for conglomerate merger is advanced and tested. Specifically, managers, as opposed to investors, are hypothesized to engage in conglomerate mergers to decrease their largely undiversifiable "employment risk" (i.e., risk of losing job, professional reputation, etc.). Such risk-reduction activities are considered here as managerial perquisites in the context of the agency cost model. This hypothesis about conglomerate merger motivation is empirically examined in two different tests and found to be consistent with the data.