Influence and Inefficiency in the Internal Capital Market
43 Pages Posted: 1 Feb 1999
Date Written: September 2005
Abstract
I model inefficient resource allocations that result from influence activities by division managers in M-form organizations. Division managers distort private information about relative investment opportunities and skew capital budgets in their favor. Corporate headquarters faces a tradeoff between the cost of attaining an accurate private signal and the value of the information the signal provides. To mitigate influence activities, headquarters incorporates implicit investment contracts into capital budgeting processes that alter the sensitivity of investment to private signals (possibly distorted) and public signals (not distorted, but noisy). The contracts lead to inefficient resource allocations relative to first-best and this inefficiency is most pronounced in firms with more influential managers, lower private costs of influencing, and greater uncertainty in investment opportunities. Several predictions of the model are consistent with existing evidence.
Keywords: influence activities, capital budgeting, divisional investment
JEL Classification: G31, G32
Suggested Citation: Suggested Citation
Do you have negative results from your research you’d like to share?
Recommended Papers
-
Tobin's Q, Corporate Diversification and Firm Performance
By Larry H.p. Lang and René M. Stulz
-
The Cost of Diversity: The Diversification Discount and Inefficient Investment
By Raghuram G. Rajan, Henri Servaes, ...
-
The Cost of Diversity: The Diversification Discount and Inefficient Investment
By Raghuram G. Rajan, Henri Servaes, ...
-
Cash Flow and Investment: Evidence from Internal Capital Markets
-
The Dark Side of Internal Capital Markets: Divisional Rent-Seeking and Inefficient Investment
-
Internal Capital Markets and the Competition for Corporate Resources
-
Explaining the Diversification Discount
By José Manuel Campa and Simi Kedia
-
Explaining the Diversification Discount
By José Manuel Campa and Simi Kedia