Exploitation of the internal capital market and the avoidance of outside monitoring |
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| Institution: | 1. Mississippi State University, Department of Finance and Economics, P.O. Box 9580, Mississippi State, MS 39762, United States;2. Northern Illinois University, Department of Finance, DeKalb, IL 60115, United States;1. UQ Business School, The University of Queensland, Australia;2. Department of Accounting and Finance, University of Strathclyde, Glasgow, Scotland, United Kingdom;3. School of Management , Xi''an Jiaotong University, China;1. Department of Finance, Florida State University, Tallahassee, FL 32306-1110, United States;2. Department of Finance, Ming Chuan University, Taipei City, Taiwan;1. Indian Institute of Management Calcutta, Diamond Harbour Road, Joka, Kolkata 700104, India;2. Lubin School of Business, Pace University, One Pace Plaza, New York 10038, USA |
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| Abstract: | Internal capital markets (ICMs) provide firms an alternative to costly external financing; however, they also provide an avenue to avoid the monitoring associated with issuing external capital. We argue that firms operating inefficient internal capital markets will avoid outside financing. Consistent with this view, conglomerates that cross-subsidize divisions or engage in value-destroying investment avoid external capital market oversight by refraining from issuing both debt and equity. We further show that firms issuing bonds while engaging in value-destroying investment experience yield spreads that are, on average, 46 basis points higher than those of other diversified firms. They similarly experience yield spreads that are 18 basis points higher when they issue syndicated loans. Value-destroying conglomerates also witness SEO announcement returns that are, on average, 1% more negative than firms operating more efficient internal capital markets. |
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