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Reallocation of Corporate Resources and Managerial Incentives in Internal Capital Markets

32 Pages Posted: 13 Sep 2002  

Sandro Brusco

SUNY at Stony Brook University, College of Arts and Science, Department of Economics

Fausto Panunzi

Bocconi University - Department of Economics; European Corporate Governance Institute (ECGI); Centre for Economic Policy Research (CEPR)

Multiple version iconThere are 2 versions of this paper

Date Written: May 2002

Abstract

Diversified firms often trade at a discount with respect to their focused counterparts. The literature has tried to explain the apparent misallocation of resources with lobbying activities or power struggles. We show that diversification can destroy value even when resources are efficiently allocated ex post. When managers derive utility from the funds under their purview, moving funds across divisions may diminish their incentives. The ex ante reduction in managerial incentives can more than offset the increase in firm value due to the ex post efficient reallocation of funds. This effect is robust to the introduction of monetary incentives. We apply our model to the analysis of the optimal reallocation policy and to the effect of the asymmetry among divisions. In general it is optimal for headquarters to commit not to reallocate at least a fraction of funds. As a result, the investment in a given division is more sensitive to the division's cash flow than to other divisions' cash flow. Asymmetries in size and growth prospects increase the diversification discount.

JEL Classification: D2, L1, L2

Suggested Citation

Brusco, Sandro and Panunzi, Fausto, Reallocation of Corporate Resources and Managerial Incentives in Internal Capital Markets (May 2002). CESifo Working Paper Series No. 735. Available at SSRN: https://ssrn.com/abstract=318773

Sandro Brusco (Contact Author)

SUNY at Stony Brook University, College of Arts and Science, Department of Economics ( email )

Stony Brook, NY 11794
United States

Fausto Panunzi

Bocconi University - Department of Economics ( email )

Via Roentgen 1
20136 Milan
Italy
+39 02 5836 5327 (Phone)
+39 02 5836 5343 (Fax)

European Corporate Governance Institute (ECGI)

c/o ECARES ULB CP 114
B-1050 Brussels
Belgium

HOME PAGE: http://www.ecgi.org

Centre for Economic Policy Research (CEPR)

77 Bastwick Street
London, EC1V 3PZ
United Kingdom

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