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

Abstract

This paper examines several dimensions of the financing behavior of subsidiary of diversified firms and of their comparable single-segment firms. To investigate this, we use two balanced panels of 636-euro area firms each, over the 2004-2017 period. Our empirical analysis document that subsidiary firms are, on average, 6.07 percent more leveraged and exhibit a 2.80 percent lower cost of capital than their comparable stand-alone peers. Both types of firms have preferred target capital structures proxied by the medians of their industry leverage ratios. Results also document that stand-alone firms adjust their capital structures to their preferred leverage ratios at an 8.71 percent higher speed than ICM members. The paper contributes to the literature providing evidence on the role of incentives and informational asymmetries on firms financing behavior.

Keywords: cost of capital, financial leverage targets, speed of adjustment, internal capital markets

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