Granville and Coates analysis of North American heavy manufacturing

Question

Granville and Coates’ analysis of North American heavy manufacturing found that companies operating across multiple industries generate more value, and therefore are valued more highly, than clusters of smaller, more specialized companies that have the same overall scope as the larger diversified corporation if considered together. Granville and Coates conjectured that the added premium reflects reduced earnings volatility: diversified firms can spread risk across multiple largely independent lines of business, reducing investors’ stochastic exposure to firm-specific shocks. After several scholars published remarkably parallel findings from other economic sectors, theoretical economists began in earnest to explore whether more general laws might be at work.

Those investigations were barely underway when Campa and Kedia shocked the field with their analysis of just-in-time and short-turnover supply chains, in which diversified corporations, almost without exception, were valued lower than the sum of the valuations at which their component operations would have been traded as separate corporate entities. Campa and Kedia called this pattern “the diversification discount”; they hypothesized that the companies’ discounted valuations were direct consequences of logistical inefficiencies born of diversification itself, such as cross-subsidization of underperforming divisions by more profitable ones or knots of intra-corporate conflicts that made it effectively impossible for the company to boost any component of its valuation without a diminution in another one.

Villalonga  et al , by contrast, looked further back, unpacking the motivational factors behind companies’ original diversification initiatives. They found in most cases that shortfalls in market valuation predated the companies’ acquisitions of further lines of business, reflecting fundamental inefficiencies that were already deeply embedded in the less-diversified companies’ core business operations. Noting a near-ubiquitous pattern of declining efficiency leading up to each company’s acquisition of new lines of business, Villalonga  et al  argue against the use of the term “diversification discount”, making a compelling case that companies often—perhaps even usually — diversify in an attempt to run away from, or at least to reduce the relative footprint of, dysfunctions too thoroughly entrenched to root out.   1 
 1. The passage does NOT mention any scholarly hypotheses indicating that the valuation of a diversified company can be

A. lower than the combined valuation of its component businesses considered separately, as a result of diversification
B. lower than the combined valuation of its component businesses considered separately, not as a result of diversification
C. higher than the combined valuation of its component businesses considered separately, as a result of diversification
D. higher than the combined valuation of its component businesses considered separately, not as a result of diversification
E. All of the above are mentioned.

2 
 2. The hypotheses put forward by Campa and Kedia to explain the discounted valuations of diversified companies assume that

A. the companies were not losing value in the time leading up to their acquisition of additional lines of business
B. the diversified companies attempted to raise the valuations of all of their component businesses simultaneously
C. many of the intra-corporate conflicts apparent after diversification had roots in the structure or operations of the original company
D. those companies’ diversification did not reduce their investors’ exposure to earnings volatility 
E. the underperforming divisions subsidized by diversified companies’ other divisions were not the companies’ original lines of business

3 
 3. The primary purpose of the passage is to

A. argue, with counterevidence, that early hypotheses about the valuations of diversified corporations are flawed
B. demonstrate that the cost or benefit to a corporation of acquiring additional lines of business is mainly a function of industry-specific conditions
C. present contrasting sets of research findings with possible explanations for each
D. show, through examples, that researchers analyzing the same data with the same methods can reach opposing conclusions
E. summarize the original research behind a theory and the later findings that led to a refinement of that theory

4 
 4. It can be inferred that Villalonga et al object to the use of the term “diversification discount” primarily because

A. a company’s acquisition of additional lines of business may not, in fact, decrease the overall degree of risk faced by its investors
B. it wrongly implies that diversified corporations tend to be undervalued by the market
C. that name suggests a causal relationship that does not hold in most instances of the phenomenon being named
D. the named phenomenon does not obtain for all corporations that diversify their business
E. the term Implies the existence of a significant correlation between two variables that are in fact largely independent

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vasu1104 · Answer

passage 1= analysis of granville and coates about diversified companies and their valuation. it ends with saying that there are other studies from other economic sectors. 
 passage 2= campa and kedia shocked others with their analysis and made contrasting comment than G & C. they said that reduction in valuation was direct result of logistical inefficiency born of diversification itself.  
 passage 3= study by V focused on motivational factors behind original diversification initiatives. they argue that inefficiency was already existed in less diversified companies. V is also agaisnt the word diversification discount based on the notion that declining efficiency being present leading up to the acquisition.

Q=1 
 A. its mentioned in passage 2 by C and K. 
 B last passage says that it was already embedded in less diversified companies core business.
C mentioned in passage 1 by G and C.
D only one left. so is the ans.

Q=2 
 C and K are saying that diversified corporation were valued lower than their component operations would have been traded as separate entities. they also gave reason behind such things in the form that logistical inefficiency.

A yes. because they are saying that reduction is because of logistical inefficiency that means operations became much more complex after acqusation and they were not losing money beforehand. so when we negate this, it breaks theri hypothesis
B no. this is completely out of scope.
C its not talking about any corporate conflicts.
  D completely irrelevant. 
 E passage doesnt talk about their original line of business or stuff like that.

Q=3. 
 A no, all theories are different so cant say they are exposing the flaws of earlier theory.
B irrelevant as passage is not concerned with cost or benefit of acquisation. reject.
C perfect. each theory has its own explanation and reasoning behind it
D no as the first passage says that they used different economic factors. so reject.
E no refinement of original theory.

RonPurewal · Answer

Official Explanation:

1. The passage does NOT mention any scholarly hypotheses indicating that the valuation of a diversified company can be

A. lower than the combined valuation of its component businesses considered separately, as a result of diversification
B. lower than the combined valuation of its component businesses considered separately, not as a result of diversification
C. higher than the combined valuation of its component businesses considered separately, as a result of diversification
D. higher than the combined valuation of its component businesses considered separately, not as a result of diversification
E. All of the above are mentioned.

This question asks about the specific examples that the author explicitly mentions in the passage. The solution is ultimately going to be a matter of searching the text for the required types of hypothetical explanations—and selecting the choice corresponding to the type of example that you DON’T find (or selecting the last choice, if you find all four types)—but if you have a rough “table of contents” from your initial reading, telling you  what kinds  of information are located  where , then that hunt should be much more efficient.

Valuations of diversified companies that are  lower  than those of the separate components combined are discussed in the second and third paragraphs, so let’s look in those two paragraphs for the types of hypotheses listed in choices A and B:

• A: The hypotheses of Campa and Kedia satisfy this description. (The passage explicitly confirms that Campa and Kedia’s hypothetical explanations were “consequences of logistical inefficiencies born of diversification itself”—in other words, results of diversification.)

• B: Villalonga  et al , as discussed in the final paragraph, attribute the lowered valuations of certain diversified corporations to structural problems that existed previously, and hypothesize that the diversification itself is “an attempt to run away from, or at least reduce the relative footprint of” those problems.

Both are present.

Valuations of diversified companies that are  higher  than those of the separate components combined are discussed in the first paragraph, so let’s look there for the types of hypotheses listed in choices C and D.

Only one hypothesis is listed for Granville and Coates in this paragraph: the reduction of investor exposure to economic shocks by spreading risk across the greater variety of lines of business. This is a direct result of the acquisition of those additional lines of business—i.e., a direct consequence of diversification—so this is the type of hypothesis listed in choice C.

The passage therefore does NOT mention any hypothesis of the kind listed in choice D, making  D the correct answer .

2. The hypotheses put forward by Campa and Kedia to explain the discounted valuations of diversified companies assume that

A. the companies were not losing value in the time leading up to their acquisition of additional lines of business
B. the diversified companies attempted to raise the valuations of all of their component businesses simultaneously
C. many of the intra-corporate conflicts apparent after diversification had roots in the structure or operations of the original company
D. those companies’ diversification did not reduce their investors’ exposure to earnings volatility 
E. the underperforming divisions subsidized by diversified companies’ other divisions were not the companies’ original lines of business

According to the second paragraph, Campa and Kedia blamed the shortfall in the valuations of diversified corporations on “logistical inefficiencies born of diversification itself, such as cross-subsidization ... or intra-corporate conflicts”. In other words, Campa and Kedia hypothesize that these problems newly arise in corporations that have subsumed their full current range of diversified lines of business. They assume, in other words, that the less diversified, pre-acquisition corporations were NOT valued lower than they would otherwise have been because of these same problems.

In terms of intra-corporate conflicts, therefore, Campa and Kedia are assuming that no such conflicts existed among the divisions of the original (pre-diversified) corporation to the detriment of its value back then. Choice C appears to touch on this idea, but states the opposite of what Campa and Kedia assume.

In terms of poorly performing divisions being subsidized by their high-performing counterparts, Campa and Kedia are taking for granted that those underperforming businesses are among the diverse components newly acquired by the corporation. If the underperforming units—whose underperformance is the underlying cause of the loss of valuation—were core parts of the company before diversification, then the original company’s valuation would have already been similarly penalized (perhaps even more severely, if there were no subsidies available from better-performing divisions); in other words, the problem in this case would have been pre-existing, not “born of diversification itself”.

Campa and Kedia must therefore be assuming that the underperforming divisions that receive subsidies from other components of the company are among the newly acquired lines of business.  The answer is E.

Choices A and D are factors about which Campa and Kedia assume nothing. They assume—in fact, they explicitly state—that  the problems responsible for the valuation “penalty” on diversified companies  do not trace back any further than the diversification itself, but they do not go so far as to preclude  any  losses, including those due to normal market fluctuations (as choice A would require if assumed). Choice D, in addition to being unnecessary to Campa and Kedia’s theory, is probably false (if additional lines of business are introduced, then the presence of those extra investment options most likely  does  insulate investors against risk); what Campa and Kedia  do  assume is that the lowering of valuation by the factors they cite  outweighs  any gains in valuation that might result from reduced risk.

3. The primary purpose of the passage is to

A. argue, with counterevidence, that early hypotheses about the valuations of diversified corporations are flawed
B. demonstrate that the cost or benefit to a corporation of acquiring additional lines of business is mainly a function of industry-specific conditions
C. present contrasting sets of research findings with possible explanations for each
D. show, through examples, that researchers analyzing the same data with the same methods can reach opposing conclusions
E. summarize the original research behind a theory and the later findings that led to a refinement of that theory

To piece together the primary purpose, let’s summarize the contents of the passage at the per-paragraph level, in a sort of rough “table of contents”.

¶1:
• Studies: Diversification (add’l lines of business) —> Valued HIGHER than sum of parts
• Possible explanation

¶2:
• Studies: Diversification (add’l lines of business) —> Valued LOWER than sum of parts
• Possible explanations

¶3:
• Other possible explanations for the phenomenon in ¶2
• Differ on whether the issues are new (upon diversification) or pre-existing

Packing this up even more compactly—to get it into approximately the same length as the answer choices presented here—we have studies with contrasting/opposite findings, and then potential (hypothetical) explanations for each set of findings.

That’s choice C.

Choice A is incorrect because the studies showing lower valuations after diversification do not contradict those showing higher valuations; in other words, the specifics in paragraphs 2 and 3 are not “counterevidence” to those in paragraph 1. (They would only be counterevidence if both sets of studies were done on the same companies over the same mergers and acquisitions. There is nothing to suggest any overlap; in fact, the author explicitly notes that the Campa and Kedia study covered a different industry than did the Granville and Coates study.)

None of the hypotheses advanced in the passage to explain the offset of diversified corporations’ valuations in  either  direction—either over or under the sum of valuations of their component businesses considered independently—attribute any of those effects to industry-specific particulars, so choice B is unsupported.

Choice D, like choice A, relies on the notion that Campa and Kedia studied the same set of businesses over the same timeframes as Granville and Coates did. This is false, as discussed above under choice A.

Choice E is wrong because showing that the  exact opposite  of a theory’s predictions can  also  happen (for other reasons) is not a “refinement” of the original theory.

4. It can be inferred that Villalonga  et al  object to the use of the term “diversification discount” primarily because

A. a company’s acquisition of additional lines of business may not, in fact, decrease the overall degree of risk faced by its investors
B. it wrongly implies that diversified corporations tend to be undervalued by the market
C. that name suggests a causal relationship that does not hold in most instances of the phenomenon being named
D. the named phenomenon does not obtain for all corporations that diversify their business
E. the term Implies the existence of a significant correlation between two variables that are in fact largely independent

“Villalonga  et al  argue against the use of the term ‘diversification discount’ “ is the main clause of the sentence describing the work of Villalonga  et al  (at the end of the passage), so their objection to that term must lie at the heart of their main conclusion/thesis. We can therefore answer this question by understanding the main point that Villalonga  et al  made, and then specifically honing in on why that point makes the term “diversification discount” fundamentally a misnomer (or otherwise inappropriate as presently used).

Villalonga  et al ’s main point is that most companies that underwent diversification (= acquisition of additional lines of business) already had depressed valuations before they diversified. In other words, while there may be a significant  correlation  between corporate diversification and depressed valuation, in most cases the diversification itself cannot possibly have  caused  the companies’ valuations to go down, because the depressed valuation came first.

This reversed causation is the only possible basis for Villalonga  et al ‘s objection to the term “diversification discount”. According to Villalonga  et al , that name implies that “diversification” is the cause and “discount” the effect—a relationship that does not, in fact, obtain for most of the companies that they studied.  This is choice C.

Choice A is incorrect because the “discount” in this case is a relative decrement in corporate valuation, not a reduction in investors’ risk exposure.

By pointing out the pre-existing inefficiencies that often motivate companies to diversify, Villalonga  et al  show that those companies  should  be valued below the sum of the average market values of their parts, and therefore that those companies are  properly  valued—not undervalued as choice B says—at a “discount”.

Choice D is unfounded because the term “diversification discount” only applies to those diversified corporations whose valuations are, in fact, discounted from the theoretical sum of their parts. (The same is true across other names of this type. For instance, the term “midlife crisis” only describes the mental health of individuals who experience personal crises in middle age; the use of this term in no way implies that  all  middle-aged persons experience such crises.)

Finally, choice E is just factually incorrect, because there IS a significant correlation between diversification and depressed market valuation among the companies examined by Villalonga  et al ; it’s the  direction of cause and effect  that Villalonga  et al  are saying is mischaracterized by the term.

egmat · Answer

Passage Overview: 
This passage presents  three  contrasting research findings about how diversification affects corporate valuations. Granville & Coates found a  diversification premium  (higher value). Campa & Kedia found a  diversification discount  (lower value caused by diversification). Villalonga et al found that the lower valuations predated diversification, meaning diversification wasn't the cause.

Question 1:  The passage does NOT mention any scholarly hypotheses indicating that the valuation of a diversified company can be...
 Type:  Specific Detail (negative/EXCEPT).  Correct Answer: D. 
The trick is to match each choice to a hypothesis in the passage. Choice A (lower, due to diversification) matches Campa & Kedia's  diversification discount . Choice B (lower, not due to diversification) matches Villalonga et al, who showed shortfalls 'predated the companies' acquisitions.' Choice C (higher, due to diversification) matches Granville & Coates'  diversification premium . That leaves  Choice D (higher, not due to diversification)  — no scholar in the passage argues that diversified companies are valued higher for reasons unrelated to diversification.   D is the one NOT mentioned.

Question 2:  The hypotheses put forward by Campa and Kedia assume that...
 Type:  Inference.  Correct Answer: A. 
Campa & Kedia claimed discounted valuations were 'direct consequences of logistical inefficiencies born of diversification itself.' This assumes the value loss started with diversification — meaning the companies were not already losing value before they diversified. This is exactly what Villalonga et al later challenged by showing that 'shortfalls in market valuation predated the companies' acquisitions.' So Campa & Kedia's hypothesis only works if you assume the companies were fine before diversifying.  Watch out for Choice C, which describes Villalonga et al's finding, not an assumption of Campa & Kedia.

Question 3:  The primary purpose of the passage is to...
 Type:  Primary Purpose.  Correct Answer: C. 
The passage presents  three  sets of findings — a premium (paragraph  1 ), a discount (paragraph  2 ), and a reinterpretation of the discount (paragraph  3 ) — along with explanations for each. The author doesn't argue one side is correct (eliminating A), doesn't focus on industry-specific conditions (eliminating B), doesn't claim they used the same data/methods (eliminating D), and doesn't describe a 'refinement' of one theory (eliminating E).  Choice C — 'present contrasting sets of research findings with possible explanations for each' — captures all three paragraphs perfectly.

Question 4:  Villalonga et al object to  'diversification discount'  primarily because...
 Type:  Inference.  Correct Answer: C. 
The term  'diversification discount'  implies that diversification causes the lower valuation. But Villalonga et al found that valuation shortfalls 'predated the companies' acquisitions of further lines of business' — the discount existed before diversification happened.   So the term wrongly suggests a causal relationship (diversification causes lower value) that doesn't hold in most cases.    Choice C captures this precisely: 'that name suggests a causal relationship that does not hold in most instances.'   Watch out for Choice B — the passage doesn't say the companies are undervalued by the market, just valued lower than the sum of their parts.

Answers: Q1 — D, Q2 — A, Q3 — C, Q4 — C

Adit_ · Answer

4/4. Quite a tricky passage and took quite a bit of time too.

For the 2nd one if option E was negated then the whole point of his argument of diversification discount fails.

Granville and Coates analysis of North American heavy manufacturing

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Granville and Coates analysis of North American heavy manufacturing

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