Cross-Ownership and Internal Capital Markets
23 Pages Posted: 16 Jan 2006
Date Written: December 2005
While we adopt the framework of Sharfstein and Stein (2000) in examining whether internal capital markets are more efficient than external capital markets, we also ask a different question: whether internal capital markets under one type of ownership are more efficient than those under another type and, if so, under what circumstances. Our analysis suggests that internal capital markets are more efficient under cross-ownership than under dispersed ownership if information asymmetry or other form of capital market imperfection limits the availability of funds; if the controller of business conglomerates can extract more private benefit from cash flow; or if the rent-seeking of division managers increases the wage required to keep them on the job. The theoretical prediction is consistent with the observed patterns of firm organization in underdeveloped economies.
Keywords: internal capital market, cross-ownership, efficiency, capital budget, operating budget
JEL Classification: G31, G32, L20
Suggested Citation: Suggested Citation