Cross Subsidies, External Financing Constraints, and the Contribution of the Internal Capital Market to Firm Value

43 Pages Posted: 25 Oct 1998

See all articles by Matthew T. Billett

Matthew T. Billett

Indiana University - Kelley School of Business - Department of Finance

David C. Mauer

affiliation not provided to SSRN

Date Written: May 2001

Abstract

This paper examines the link between the value of a diversified firm and the value of its internal capital. We construct measures of the value of internal capital market transactions based on the dollar flow of subsidies and transfers across segments, the relative investment opportunities of segments, and the likelihood that a segment receiving a subsidy would face external financing constraints if it were a stand-alone firm. We find that specific components of a diversified firm's internal capital market are important determinants of its excess value. Subsidies to small financially constrained segments with good relative investment opportunities significantly increase excess value, while transfers of resources from segments with good relative investment opportunities significantly decrease excess value. Surprisingly, subsidies to small financially constrained segments with poor relative investment opportunities also significantly increase excess value, albeit to a lesser extent than the subsidies to constrained segments with good relative investment opportunities. We conclude that financing constraints drive the relationship between the internal capital market and firm value.

JEL Classification: G32, G31, D20

Suggested Citation

Billett, Matthew T. and Mauer, David C., Cross Subsidies, External Financing Constraints, and the Contribution of the Internal Capital Market to Firm Value (May 2001). Available at SSRN: https://ssrn.com/abstract=134188 or http://dx.doi.org/10.2139/ssrn.134188

Matthew T. Billett (Contact Author)

Indiana University - Kelley School of Business - Department of Finance ( email )

1309 E. 10th St.
Bloomington, IN 47405
United States
812-855-3366 (Phone)

David C. Mauer

affiliation not provided to SSRN

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