Download this Paper Open PDF in Browser

A Theory of Socialistic Internal Capital Markets

39 Pages Posted: 25 Mar 2005  

Antonio E. Bernardo

University of California, Los Angeles (UCLA) - Finance Area

Jiang Luo

Hong Kong University of Science & Technology (HKUST) - Department of Finance

James J. D. Wang

City University of Hong Kong (CityUHK) - Department of Economics & Finance

Date Written: January 21, 2005

Abstract

We develop a model of a two-division firm in which the strong division has, on average, higher quality investment projects than the weak division. We show that the firm optimally biases its project selection policy in favor of the weak division and this bias is stronger when there is a greater spread in average project quality. The cost of such a policy is that the firm sometimes funds an inferior project but the benefit is that it motivates the manager of the strong division to set (and meet) more aggressive cash flow targets.

Keywords: Internal capital markets, conglomerates, project selection

JEL Classification: G31

Suggested Citation

Bernardo, Antonio E. and Luo, Jiang and Wang, James J. D., A Theory of Socialistic Internal Capital Markets (January 21, 2005). AFA 2006 Boston Meetings Paper. Available at SSRN: https://ssrn.com/abstract=683727 or http://dx.doi.org/10.2139/ssrn.683727

Antonio E. Bernardo

University of California, Los Angeles (UCLA) - Finance Area ( email )

Los Angeles, CA 90095-1481
United States
310-825-2198 (Phone)
310-206-5455 (Fax)

Jiang Luo

Hong Kong University of Science & Technology (HKUST) - Department of Finance ( email )

Clear Water Bay, Kowloon
Hong Kong

James J. D. Wang (Contact Author)

City University of Hong Kong (CityUHK) - Department of Economics & Finance ( email )

83 Tat Chee Avenue
Kowloon
Hong Kong
+85 2 2788 8814 (Phone)
+85 2 2788 8806 (Fax)

Paper statistics

Downloads
59
Abstract Views
1,246