Mis-Allocation within Firms: Internal Finance and International Trade
61 Pages Posted: 25 Mar 2020
Date Written: March 2020
We develop a novel theory of mis-allocation within firms (rather than between firms) due to managers' empire building. We introduce an internal capital market into a two-factor model of multi-segment firms. We show that more open markets impose discipline on competition for capital within firms, which explains why exporters exhibit a lower conglomerate discount than non-exporters (a fact that we establish). Testing our model with data on US companies, we establish that import competition reduces mis-allocation within firms. A one standard deviation increase in Chinese imports lowers the conglomerate discount by 32% and over-reporting of costs by up to 15%.
Keywords: China shock, Conglomerate discount, Internal Capital Markets, multi-product firms, trade and organization
JEL Classification: D23, F12, G30, L22
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