Mis-allocation Within Firms: Internal Finance and International Trade
69 Pages Posted: 9 Mar 2020 Last revised: 1 Oct 2021
Date Written: October 1, 2021
This paper develops a novel theory of capital mis-allocation within firms that stems from managers' empire building and informational frictions within the organization. Introducing an internal capital market into a two-factor model of multi-segment firms, we show that international competition imposes discipline on managers and reduces capital mis-allocation across divisions, thereby lowering the conglomerate discount. The theory can explain why exporters exhibit a lower conglomerate discount than non-exporters (a new fact we establish). Testing the model's predictions with data on US companies, results suggest that Chinese import competition significantly reduces managers' over-reporting of costs and improves the allocation of capital within firms.
Keywords: Multi-Product Firms, Trade and Organization, Internal Capital Markets, Conglomerate Discount, China Shock
JEL Classification: F12, G30, L22, D23
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