The Dark Side of Internal Capital Markets Ii: Evidence from Diversified Conglomerates

38 Pages Posted: 27 Jun 2000 Last revised: 11 Nov 2022

See all articles by David S. Scharfstein

David S. Scharfstein

Harvard Business School - Finance Unit; National Bureau of Economic Research (NBER)

Date Written: January 1998

Abstract

This paper is an empirical examination of capital allocation in a sample of 165 diversified" conglomerates in 1979. I find that divisions in high-Q manufacturing industries tend to invest" less than their stand-alone industry peers, while divisions in low-Q manufacturing industries tend" to invest more than their stand-alone industry peers. This sort of socialism in which investment tends to get equalized across divisions is particularly pronounced in a" conglomerate's smaller divisions. It is also more pronounced in firms in which management has" small equity stakes suggesting that agency problems between corporate headquarters and" investors are at the root of the problem. By 1994, only 53 (32%) of these firms continue to be" free-standing diversified conglomerates. Fifty-five (33%) choose to sell off unrelated divisions" and focus on one core business. These firms tend to sell their smaller divisions do, their investment behavior changes relative to 1979: it more closely resembles that of their" stand-alone industry peers. The remaining 57 (35%) firms were acquired or (in two cases)" liquidated.

Suggested Citation

Scharfstein, David S., The Dark Side of Internal Capital Markets Ii: Evidence from Diversified Conglomerates (January 1998). NBER Working Paper No. w6352, Available at SSRN: https://ssrn.com/abstract=226103

David S. Scharfstein (Contact Author)

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