Adoptions and Eliminations of Economic Profit Plans and Internal Capital Markets Efficiency

46 Pages Posted: 3 Mar 2013

See all articles by Dobrina Georgieva Jandik

Dobrina Georgieva Jandik

University of St. Thomas

Tomas Jandik

University of Arkansas - Sam M. Walton College of Business

Anil K. Makhija

Ohio State University (OSU) - Department of Finance

Date Written: March 1, 2013

Abstract

Internal capital markets of diversified firms have been associated with inefficient allocation of investment funds across divisions, leading to value losses. Utilizing a sample of diversified firms that adopted or eliminated Economic Profit Plans (EPPs) between 1990 and 2009, we show that adoptions of those plans (that reward profitability, but penalize excessive capital investment) mitigate investment distortions and lead to value gains. Following the adoption of EPPs, diversified firms start allocating investment funds based on growth opportunities of their divisions. EPP adopters lower their divisional investment levels, especially in segments with below-average growth opportunities. The overall investment allocation efficiency improves, and the diversification discount diminishes after the adoption of EPPs. However, EPPs appear to be used only as temporary tools for assessing corporate performance. The plans are adopted primarily by firms expected to immediately generate plan bonuses for management, and they are frequently eliminated by firms with bad accounting performance, and low managerial bonuses. The study contributes to the literature on organizational efficiency, internal capital markets and on the importance of measures based on economic profits or residual income.

Keywords: internal capital markets, economic profit plans, diversification, investment efficiency

JEL Classification: G32, G34

Suggested Citation

Jandik, Dobrina Georgieva and Jandik, Tomas and Makhija, Anil K., Adoptions and Eliminations of Economic Profit Plans and Internal Capital Markets Efficiency (March 1, 2013). Available at SSRN: https://ssrn.com/abstract=2227224 or http://dx.doi.org/10.2139/ssrn.2227224

Dobrina Georgieva Jandik

University of St. Thomas ( email )

1000 LaSalle Ave.
Minneapolis, MN 55403
United States

Tomas Jandik (Contact Author)

University of Arkansas - Sam M. Walton College of Business ( email )

WCOB 302
Fayetteville, AR 72701
United States
479-575-6147 (Phone)

Anil K. Makhija

Ohio State University (OSU) - Department of Finance ( email )

2100 Neil Avenue
Columbus, OH 43210-1144
United States
614-292-1899 (Phone)

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