Internal Capital Allocation and Firm Performance

Abstract

We introduce a novel concept of the activeness of internal capital allocations across industries. We derive a measure of this activeness and use it to compare the performance of firms with different capital allocation styles. We find that firms that actively change their capital allocation across industries have a lower average industry-adjusted profitability than firms that follow passive strategies. Moreover, we find that active firms obtain lower valuation and lower excess stock returns in subsequent periods. Our findings suggest that conglomerate firms that actively allocate resources across industries do not do so efficiently, and that the stock market does not fully incorporate the information revealed through the internal capital allocation process.

Keywords: internal capital allocation, firm performance, stock return

JEL Classification: G31, L25