this post was submitted on 22 Aug 2023
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These weird combinations look fun but they're generally the result of having conglomerates, companies that have gobbled up a bunch of smaller, unrelated companies.
Conglomerates are tricky to pull off because managing a lot of disparate business lines. A CEO who knows all about how to market construction equipment is likely to miss that one of their other products became an iconic sex toy years ago. The big problem is that more focused companies can typically outmaneuver you in their area of focus.
Theoretically, there might be synergies that make your company more effective but normally, conglomeration is drag on the risk-adjusted rate of return on your company. It's much easier to pull off when your government has strong protectionist policies or if there are officials you can bribe to keep out the competition.
Why would a company do something that's generally bad for the company? It's generally good for the CEO. A CEO often has a very concentrated investment portfolio. Changes in the value of the company they're running can have a huge impact on their personal wealth. Conglomeration allows a single company to be a diversified asset. It does it in a way that's objectively worse for shareholders but better for the CEO.
I don't think your last sentence is congruent with what you were saying before it.
You're saying a CEO will opt for conglomeration because it either increases the value or decreases the volatility of the company because the CEO has lots of stock in the company. If that's the case, how is it bad for the shareholders, of which the CEO is a major player?
The shareholders can go and buy a diversified portfolio on their own, by investing in many companies, so they can derisk their portfolio without conglomeration.
If they already own shares of the conglomerating company, its returns will be lower (they don't care that it's less risky; they've diversified already). Similarly, the returns of the company that is now becoming part of the conglomeration will likely be reduced, which negatively affects shareholders of that company.
The benefit is really only for the people whose prospects are deeply tied to this company, and only this company... its management employees, who are compensated by the company (often in the form of stock that they can't sell till they leave, or that vests over a long time frame).
It's a bit complicated.
The CEO and the other shareholders aren't the same.
For the CEO, it's a good way to diversify since they can't diversify the normal way.
For the regular share holders it's a way to diversify but it's not as good as being able to buy and sell the individual components.
I'll skip a lot of the math but the upshot is that their Sharpe Ratio (expected return divided by risk) is higher if they do their own diversification than if they buy one company that tries to diversify within it.