Gautier, Axel and Heider, Florian (2001) What do internal capital markets do?: redistribution vs. incentives. Discussion paper, 386. Financial Markets Group, London School of Economics and Political Science, London, UK.
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In this paper we explain the apparent diversification discount of conglomerates without assuming inefficent-cross subsidisation through internal capital markets. Instead we assume that an internal capital market efficiently redistributes scare resources across a conglomerates divisions between successive production periods. The need for redistribution arises from the fact that resources may sometimes be produced by divisions which happen to be succesful in an earlier production stage but which do not have the best investment opportunities in future production stages. In contrast to the existing literature we consider explicitly the incentive problem between corporate headquarter and divisional managers using a standard Moral-Hazard framework. We show that although a complete incentive contract can be written bi-laterally between headquarter and divisional managers, the redistribution of resources across divisions creates additional agency costs in a conglomerate. Moreover, assuming that no complete contract can govern interim redistribution policy by the headquarter, we show how the agency problem with divisional mangers constrains headquarters interim redistribution to be ex ante inefficient.
|Item Type:||Monograph (Discussion Paper)|
|Additional Information:||© 2001 The Authors|
|Library of Congress subject classification:||H Social Sciences > HF Commerce
H Social Sciences > HG Finance
H Social Sciences > HB Economic Theory
|Journal of Economic Literature Classification System:||G - Financial Economics > G3 - Corporate Finance and Governance > G31 - Capital Budgeting; Fixed Investment and Inventory Studies
L - Industrial Organization > L2 - Firm Objectives, Organization, and Behavior > L23 - Organization of Production
G - Financial Economics > G3 - Corporate Finance and Governance > G34 - Mergers; Acquisitions; Restructuring; Corporate Governance
|Sets:||Research centres and groups > Financial Markets Group (FMG)
Collections > Economists Online
Departments > Economics
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