Mis-Allocation within Firms: Internal Finance and International Trade

Abstract

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