Internal Information Quality and Capital Allocation within Conglomerates

48 Pages Posted: 22 Nov 2017 Last revised: 7 Dec 2017

See all articles by David P. Weber

David P. Weber

University of Connecticut - Department of Accounting

Kexin Zheng

University of Connecticut - Department of Accounting

Date Written: November 17, 2017

Abstract

Theoretical research on internal capital markets suggests an important role for internal information quality in the capital allocation process within conglomerates. Direct empirical evidence, however, has been sparse, largely because informational frictions inside firms are difficult for researchers to observe and measure. We leverage public reporting on internal control effectiveness mandated by the Sarbanes-Oxley Act of 2002 and recent developments in the accounting literature to provide evidence that the quality of the internal information environment is positively associated with the efficiency of internal capital allocation. We find that firms with internal control weaknesses allocate internal capital less efficiently than firms without weaknesses, and that allocation efficiency improves following the remediation of control weaknesses, to a level similar to firms without weaknesses. We document similar results using other recently developed proxies for internal information quality, suggesting that our inferences are not confined to internal control issues, but rather are related to internal information quality more generally. We also show that internal information quality plays a particularly important role for firms with diverse operations and during periods of economic expansion, when misallocation due to agency and information frictions tends to otherwise be more severe.

Keywords: internal information quality, internal capital markets, conglomerates

JEL Classification: G31, G32, M4, M15

Suggested Citation

Weber, David P. and Zheng, Kexin, Internal Information Quality and Capital Allocation within Conglomerates (November 17, 2017). University of Connecticut School of Business Research Paper No. 17-11. Available at SSRN: https://ssrn.com/abstract=3074629 or http://dx.doi.org/10.2139/ssrn.3074629

David P. Weber (Contact Author)

University of Connecticut - Department of Accounting ( email )

School of Business
Storrs, CT 06269-2041
United States

Kexin Zheng

University of Connecticut - Department of Accounting ( email )

School of Business
Storrs, CT 06269-2041
United States

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