Internal Capital Markets and Return Predictability in Complex Ownership Firms

Abstract

Using global cross-firm ownership data, we find that both stock returns and cash-flow news of ownership-linked firms predict focal firm’s returns for all four types of ownership structures: subsidiary−parent, parent−subsidiary, subsidiary−subsidiary, and parent−parent. These results are observed only after the establishment of cross-firm ownership links and are not subsumed by focal firm or industry momentum, or alternative inter-firm relations, including customer−supplier links, strategic alliances, common boards, and shared analyst coverage. Our findings are best explained by mispricing due to an active internal capital market – a mechanism unique to complex ownership network firms.

Keywords: Capital expenditure, Cash-flow surprises, Earnings surprises, Investor inattention, Limits to arbitrage

JEL Classification: G15, G32, M41