Does Internal Capital Market Affiliation Matter for Capital Allocation? An Empirical Analysis

Abstract

The paper examines the capital allocative behavior of internal capital market (ICM) members and their comparable single-segment firms in the euro area. Results indicate that the ICM members exhibit lower relationship between investment and the availability of internal funds, lower impact of financial flexibility, and lower levels of underinvestment and overinvestment behavior, than their peers. Results document that headquarters’ monitoring and managerial discretion, cost of capital, financial flexibility, informational asymmetries and asset lumpiness appear to be significant determinants of investment behavior.

Keywords: capital allocation, investment-cash flow sensitivity, internal capital markets, financial flexibility, asset lumpiness

JEL Classification: C33, C81, D25, G31, L22