Resource Allocation within Firms and Financial Market Dislocation: Evidence from Diversified Conglomerates
University of Chicago - Booth School of Business
University of Chicago - Booth School of Business and NBER
March 4, 2013
Chicago Booth Research Paper No. 13-39
Fama-Miller Working Paper
When external capital markets are stressed they may not reallocate resources between firms. We show that resource allocation within firms' internal capital markets provides an important force countervailing financial market dislocation. Using data on U.S. conglomerates we empirically verify that firms shift resources between industries in response to shocks to the financial sector. We estimate a structural model of internal capital markets to separately identify and quantify the forces driving the reallocation decision and illustrate how these forces interact with external capital market stress. The frictions in internal capital markets drive a large wedge between productivity and investment: the weaker (stronger) division obtains too much (little) capital, as though it is 12 (9) percent more (less) productive than it really is. The cost of accessing external capital funds quadruples during extreme financial market dislocations, making resource allocation within firms significantly cheaper. The estimated model allows us to simulate the propagation of the 2007/2008 financial market dislocation. The counterfactual out of sample simulated data is remarkably consistent with the actual data and shows that improved resource allocation in internal capital markets offset financial market stress during the recent financial crisis by 16% to 30% relative to firms with no internal capital markets.
Number of Pages in PDF File: 51
Keywords: Theory of Firm, Firm Boundaries, Conglomerates, Diversification, Discount, Internal Capital Markets, Crisis
JEL Classification: D92, E22, G01, G3, L21, L25working papers series
Date posted: January 31, 2013 ; Last revised: February 11, 2014
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