The Trade-Off Between Ex-Post and Ex-Ante Efficient Capital Allocation in Internal Capital Markets and Organizational Form

30 Pages Posted: 26 Nov 2007

See all articles by Jason Sturgess

Jason Sturgess

Queen Mary University of London

Date Written: January 13, 2007

Abstract

This paper examines the efficiency of internal capital markets. I develop a model in which headquarters allocates capital ex-post efficiently to the stronger division and find that this can be ex-ante inefficient. Reallocating capital ex-post to the stronger division reduces ex-ante incentives which can only be restored through monetary compensation. This decreases future investment and may result in the internal capital market being sub-optimal compared with two stand-alone divisions. I show how these effects are particularly important for two types of firm. Finally, ex-ante incentives can be restored by an ex-post inefficient social capital allocation rule, which I show to be optimal.

Keywords: capital allocation, internal capital markets, agency

JEL Classification: G31, G34, L22

Suggested Citation

Sturgess, Jason, The Trade-Off Between Ex-Post and Ex-Ante Efficient Capital Allocation in Internal Capital Markets and Organizational Form (January 13, 2007). Available at SSRN: https://ssrn.com/abstract=1032544 or http://dx.doi.org/10.2139/ssrn.1032544

Jason Sturgess (Contact Author)

Queen Mary University of London ( email )

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