The Dark Side of Internal Capital Markets: Divisional Rent-Seeking and Inefficient Investment

40 Pages Posted: 27 Jun 2000 Last revised: 3 Apr 2008

See all articles by David S. Scharfstein

David S. Scharfstein

Harvard Business School - Finance Unit; National Bureau of Economic Research (NBER)

Jeremy C. Stein

Harvard University - Department of Economics; National Bureau of Economic Research (NBER)

Date Written: March 1997

Abstract

We develop a model that shows how rent-seeking behavior on the part of division managers can subvert the workings of an internal capital market. In an effort to stop rent-seeking, corporate headquarters will be effectively forced into paying bribes to some division managers. And because headquarters is itself an agent of outside investors, the bribes may take the form not of cash, but rather of preferential capital budgeting allocations. One interesting feature of our model is a kind of socialism' in internal capital allocation, whereby weaker divisions tend to get subsidized by stronger ones.

Suggested Citation

Scharfstein, David S. and Stein, Jeremy C., The Dark Side of Internal Capital Markets: Divisional Rent-Seeking and Inefficient Investment (March 1997). NBER Working Paper No. w5969. Available at SSRN: https://ssrn.com/abstract=225748

David S. Scharfstein (Contact Author)

Harvard Business School - Finance Unit ( email )

Boston, MA 02163
United States
617-496-5067 (Phone)
617-496-8443 (Fax)

HOME PAGE: http://www.people.hbs.edu/dscharfstein/

National Bureau of Economic Research (NBER)

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Cambridge, MA 02138
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Jeremy C. Stein

Harvard University - Department of Economics ( email )

Littauer Center
Cambridge, MA 02138
United States
617-496-6455 (Phone)
617-496-7352 (Fax)

HOME PAGE: http://post.economics.harvard.edu/faculty/stein/stein.html

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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