Financial Reporting for Conglomerates : An Economic Analysis

Donald F. Turner defines the “area of conglomerate mergers as all acquisitions other than (1) acquisition by a producer of the stock or assets of a firm producing an identical product or close substitute and selling it in the same geographical market—the simple horizontal merger, and (2) acquisition of the stock or assets of a firm that buys the product sold by the acquirer or sells a product bought by the acquirer—the simple vertical merger. The area ranges from the pure conglomerate, in which there are no discernible economic relationships between the business of the acquiring and the acquired firm, through a variety of what may be called mixed conglomerates, involving horizontal or vertical economic relationships other than those characteristic of the simple mergers just described.” Turner , “Conglomerate Mergers and Section 7 of the Clayton Act,” Harvard Law Review, LXXVIII:7 (May 1965), 1315. See also “S.E.C. Begins Asking Companies to Disclose Contributions Major Lines Make to Profits,” Wall Street Journal, April 4, 1967, p. 3.

Williamson Oliver E. , “Managerial Discretion and Business Behavior,” American Economic Review, LII (Dec. 1963), 1032–1057.

Peterson Shorey , “Corporate Control and Capitalism,” Quarterly Journal of Economics, LXXIX (Feb. 1965), 1–25.

Baumol William , Business Behavior, Value and Growth (New York: Macmillan Company, 1959). See also Monsen R. Joseph Jr. Downs Anthony , “A Theory of Large Managerial Firms,” Journal of Political Economy, LXXIII (June 1965), 221–236.

Mennis Edmund A. , “Different Measures of Corporate Profits,” Financial Analysts Journal, XVIII: 5 (Sept.-Oct. 1962), 69–78. Part of this difference is explained by the fact that the income measurement process for tax purposes deviates from logical procedures used to approximate income in accordance with economic and accounting considerations. See also Mennis , “Measuring Aggregate Corporate Profits,” in Profits in The Modern Economy, eds. Stevenson Harold Nelson J. R. (Minneapolis: University of Minnesota Press, 1967), pp. 41 ff.

See SEC Form S-1, Form 10, and Form 10-K, Item 4, to compare the present reporting requirement with that which is being proposed by the SEC.

We have discussed this problem elsewhere: Cramer Iwand , “A Proposal For Conglomerate Disclosure: The Contribution Form Income Statement,” Business Horizons, XI:2 (April 1968), 49–59.

Consolidated Financial Statements, Accounting Research Bulletin 51 (New York: American Institute of Certified Public Accountants, 1959).

It has been suggested that accounting procedures should be modified so that disclosure of information on which management and investment decisions are based assumes primacy. Carl Nelson favors disclosure of detailed engineering and budget data in addition to historic revenue and cost figures, and Pearson Hunt indicates that the investor might be interested in the current and expected value of his stock. Nelson , “An Accountant's View of Profit Measurement” and Hunt, “Profits From The Investor's Point of View,” in Profits in The Modern Economy, eds. Stevenson Nelson (Minneapolis: University of Minnesota Press, 1967), pp. 73–81 and 82–88, respectively.

“Profit is, at best, a crude measure of effectiveness and efficiency for several reasons: (1) monetary measures do not exactly measure either all aspects of outputs or all inputs …; (2) standards are not accurate; and (3) at best, profit is a measure of what has happened in the short-run, whereas we are presumably also interested in the long-run consequences of decisions.” Anthony Robert N. , “Note on Responsibility Centers,” in Management Control Systems: Cases and Readings, by Anthony John Dearden Vancil Richard F. (Homewood, Ill.: Richard D. Irwin, Inc., 1965), pp. 165–171.

Adapted from a model developed by Sharpe William F. , “Capital Asset Prices: A Theory of Market Equilibrium Under Conditions of Risk,” Journal of Finance, XIX:3 (Sept. 1964), 425–442.

Ibid.

For precisely the same reason, it is impossible to determine the cost of capital separately for each of the subsidiaries or divisions, although in some exceptional cases traditional accounting practice assumes this to be the case: If capital acquired through a particular financing method is exclusively related to a project under construction, the financing costs are capitalized and accorded asset status because of the presumed ability to associate such financing specifically with the project. There is little reason to assume that this practice reflects anything but an occasionally convenient fiction. E.g., Kohler E. L. , “The Development of Accounting for Regulatory Purposes by the Federal Power Commission,” Significant Essays in Accounting, eds. Moonitz Maurice Littleton A. C. (Englewood Cliffs, N.J.: Prentice-Hall, 1965), p. 405.

Sharpe , p. 439.

Turner, pp. 1329 ff; and Narver John C. , Conglomerate Mergers and Market Competition (Berkeley: University of California Press, 1967), pp. 65 ff. See also Beckmann Martin J. , “Some Aspects of Returns to Scale in Business Administration,” Quarterly Economic Journal, LXXIV:3 (August 1960), 264–271.

Coase R. H. , “The Nature of the Firm,” A.E.A. Readings in Price Theory, eds. Stigler G. J. Boulding K. E. (Chicago: Richard D. Irwin, Inc., 1952), pp. 331–351 (reprinted from Economica, n.s., IV [1937], 336–405.

This point was made in the Procter and Gamble-Clorox case. For a discussion, see Narver , pp. 79 ff.

Narver , pp. 8 ff.

Schrader William J. , A Critical Evaluation of Income Measurement by “Products” and “Periods” (University Park, Pa.: Center for Research, College of Business Administration, Pennsylvania State University, 1959).

Dantzig George B. , Linear Programming and Extensions (Princeton: Princeton University Press, 1963), pp. 448–470.

Komai J. , Mathematical Planning of Structural Decisions (Amsterdam: North Holland Publishing Co., 1967), pp. 343–369.

The application of the decentralized planning model to decision making in the divisionalized firm was explicitly suggested by Baumol William J. Fabian Tibor , “Decomposition, Pricing for Decentralization and External Economics,” Management Science, XI (Sept. 1964), 1–31.

Ibid., 12 ff.

Dantzig , pp. 448 ff.

Biggs Barton M. , “Day of Reckoning,” Barron's, April 3, 1967, pp. 3–7.