Reallocation of Corporate Resources and Managerial Incentives in Internal Capital Markets
By Sandro Brusco, Fausto Panunzi. Social Science Research Network, 2005
142 citations recorded by the source corpus.
One distinguishing feature of internal capital markets is their ability to reallocate funds in favour of the most profitable divisions (winner-picking). Yet, diversified firms often trade at a discount with respect to their focused counterparts. The literature has tried to explain the apparent misallocation of resources with lobbying activities or power struggles. We show that the diversification discount can be explained even in a model where resources are efficiently allocated ex post. When managers obtain utility from the funds under their purview, moving funds across divisions may diminish their incentives. The ex ante reduction in managerial incentives can more than offset the increase in firm value due to the ex post efficient reallocation of funds. If headquarters have some commitment power, it is in general optimal to commit not to reallocate at least a fraction of funds. As a result, the investment in a given division is (optimally) more sensitive to the division's cash flow than to other divisions' cash flow, as confirmed by the empirical studies on internal capital markets. Our theory complements the view that links the diversification discount to the inefficient functioning of internal capital markets.
Subfields: Accounting, Economics and Econometrics
View Paper: https://www.semanticscholar.org/paper/2177a9fcb26ebf3cb1a2114712b9f7a87c3c879a
Citations in the corpus
- The Positive Effects of Biased Self-Perceptions in Firms (2007, unknown): “This may heighten the incentive of other division managers to be productive (although we should also point out that the competition for resources may have an opposite effect on endogenous incentives, as shown by Brusco and Panunzi (2005)).”
- Strategic Alliances and the Boundaries of the Firm (2008, unknown): “The model is closely related to recent internal capital markets models (see Stein (1997), Stein (2002), and Brusco and Panunzi (2000)).2 The closest theoretical work is probably Fulghieri and Sevilir (2003), which studies a spectrum of organizational alternatives available for the efficient…”
- A Theory of Firm Scope (2010, unknown): “First, there is an overlap with the literature on internal capital markets; see particularly Stein (1997, 2002), Scharfstein and Stein (2000), Rajan, Servaes and Zingales (2000), Brusco and Panunzi (2005), and Inderst and Laux (2005).”