Incentives for Diversification and the Structure of the Conglomerate Firm

In this paper, we examine the proposition that both the structures of conglomerate firms and their merger activities evidence a systematic attempt to diversify income sources and reduce the volatility of firms' profits. We test whether firms that are active in one line of business are more likely to be involved in another, the lower is the correlation between returns to the two activities, and whether, ceteris paribus, the likelihood of merger depends inversely on the correlation of cash flows to the principal activities of thecandidates for merger. We conclude that firms do act as if their goals include firm-level diversification.