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Incentives in Internal Capital Markets: Capital Constraints, Competition, and Investment Opportunities

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Author Info
Roman Inderst () (INSEAD, LSE, CEPR)
Christian Laux () (Goethe University Frankfurt, CFS)
Abstract

We examine the effect of competition for scarce corporate financial resources on managers' incentives to generate profitable investment opportunities. Operating an active internal capital market is unambiguously beneficial only if divisions have the same level of financial resources and the same investment potential. Otherwise, managers' incentives may be lower and an internal capital market may decrease firm value even though headquarters allocates capital efficiently. We analyze under which conditions the operation of an internal capital market is more likely to add value, and we derive implications for the boundaries of firms, for a potential conglomerate discount or premium, and for the role of incentive pay for division managers. Ordering information: This article can be ordered from https://pubs3.rand.org/cgi-bin/rje/pdf.cgi.

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Publisher Info
Article provided by The RAND Corporation in its journal RAND Journal of Economics.

Volume (Year): 36 (2005)
Issue (Month): 1 (Spring)
Pages: 215-228
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Handle: RePEc:rje:randje:v:36:y:2005:1:p:215-228

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Web page: http://www.rje.org

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Related research
Keywords: Capital Budgeting; Investment Policy; cost of capital Firm Organization and Market Structure: Markets vs. Hierarchies; Vertical Integration; Conglomerates Firm Value; Firm; Firms; Investment;

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Find related papers by JEL classification:
G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Investment Policy
L22 - Industrial Organization - - Firm Objectives, Organization, and Behavior - - - Firm Organization and Market Structure

Cited by:
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  1. Oliver Hart & Bengt Holmstrom, 2008. "A Theory of Firm Scope," NBER Working Papers 14613, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  2. Claudia M. Buch & Iris Kesternich & Alexander Lipponer & Monika Schnitzer, 2009. "Financial Constraints and the Margins of FDI," Discussion Papers 272, SFB/TR 15 Governance and the Efficiency of Economic Systems, Free University of Berlin, Humboldt University of Berlin, University of Bonn, University of Mannheim, University of Munich. [Downloadable!]
    Other versions:
  3. Antoine Renucci, 2008. "Access to financing, rents, and organization of the firm," Post-Print halshs-00365983_v1, HAL. [Downloadable!]
  4. Claudia M. Buch & Iris Kesternich & Alexander Lipponer, 2009. "Financial Constraints and the Margins of FDI," IAW Discussion Papers 54, Institut für Angewandte Wirtschaftsforschung (IAW). [Downloadable!]
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