Internal Capital Markets And Corporate Refocusing

USC Finance & Business Econ. Working Paper No. 01-6

53 Pages Posted: 17 Oct 2001  

John G. Matsusaka

University of Southern California - Marshall School of Business; USC Gould School of Law

Vikram K. Nanda

University of Texas at Dallas - School of Management - Department of Finance & Managerial Economics

Date Written: April 2000

Abstract

This paper develops a theory of organization based on the benefits and costs of internal capital markets. A central assumption is that the transaction cost of raising external funds is greater than the cost of internal funds. The benefit of internal resource allocation is that it gives the firm a real option to avoid external capital markets (and the associated deadweight transaction costs) in more states of the world than single-business firms. The cost is the internal resource flexibility exacerbates an over investment agency problem. The optimal focus is determined by trading off the benefit of the option against the cost of over investment. In this context, we show how the relative efficiency of integration and separation depends ultimately on assignment of control rights over cash flow. Testable implications are derived for the level of divisional investment, the sensitivity of divisional investment to cash flow, and the diversification discount.

JEL Classification: G30

Suggested Citation

Matsusaka, John G. and Nanda, Vikram K., Internal Capital Markets And Corporate Refocusing (April 2000). USC Finance & Business Econ. Working Paper No. 01-6. Available at SSRN: https://ssrn.com/abstract=008212 or http://dx.doi.org/10.2139/ssrn.8212

John G. Matsusaka

University of Southern California - Marshall School of Business ( email )

Department of Finance & Business Economics
Los Angeles, CA 90089
United States
213-740-6495 (Phone)
213-740-6650 (Fax)

USC Gould School of Law

699 Exposition Boulevard
Los Angeles, CA 90089
United States
213-740-6495 (Phone)

Vikram K. Nanda (Contact Author)

University of Texas at Dallas - School of Management - Department of Finance & Managerial Economics ( email )

2601 North Floyd Road
P.O. Box 830688
Richardson, TX 75083
United States

Paper statistics

Downloads
881
Rank
19,851
Abstract Views
3,818