Does Internal Capital Market Membership Matter for Financing Behavior? Evidence from the Euro Area

Abstract

The paper examines firms’ financing behavior of internal capital market (ICM) members and their comparable single-segment firms in the euro area, in terms of capital structure, cost of capital, and the speed of adjustment towards preferred capital structure. Results indicate that both ICM members and single-segment comparable firms have preferred target capital structures proxied by industry’s leverage ratio median, and that subsidiary firms are significantly more leveraged and exhibit lower cost of capital than their counterparts. Results also document that ICM members adjust dynamically their capital structures to their preferred leverage ratios at a slower speed than stand-alone firms. Findings suggest that ICM membership mitigates incentive and informational problems.

Keywords: cost of capital, financial leverage targets, speed of adjustment, internal capital markets, bias-corrected estimators

JEL Classification: C33, C81, D25, G32, L22