External Governance and Internal Resource Allocation
41 Pages Posted: 27 Feb 2017 Last revised: 12 Oct 2018
Date Written: October 6, 2018
Internal capital markets are important determinants of investment and economic growth in the modern economy. We exploit a regulatory experiment impacting external governance and microdata on multinationals’ foreign operations to test whether external governance disciplines internal resource allocation. Firms treated with stronger external governance shift 30% more capital toward foreign subsidiaries with strong recent performance. Subsidiaries that receive capital experience no subsequent decline in productivity, suggesting the reallocation is productive. Our results provide new evidence on the scope and potential benefits of external governance and demonstrate the importance of cross-border spillovers of capital markets regulation.
Keywords: external governance, investment, internal capital markets
JEL Classification: D22, G23, G28, G34, M5
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