IDEAS home Printed from https://ideas.repec.org/p/btx/wpaper/1217.html
   My bibliography  Save this paper

The Deep-Pocket Effect of Internal Capital Markets

Author

Listed:
  • Xavier Boutin

    (European Commission)

  • Giacinta Cestone

    (Cass Business School, CSEF, and ECGI)

  • Chiara Fumagalli

    (Universita Bocconi (Department of Economics), CEPR, CSEF, and Paolo Ba Centre)

  • Giovanni Pica

    (Universita di Salerno, CSEF and Centro Luca D'Agliano)

  • Nicolas Serrano-Velarde

    (Oxford University Centre for Business Taxation)

Abstract

This paper provides evidence that incumbent and entrant firms' access to business group deep pockets affects entry patterns in product markets. Relying on a unique French data set on business groups, this paper shows that entry in manufacturing industries is negatively related to the cash hoarded by incumbent-affliated groups, and positively related to entrant groups' cash. In line with theoretical predictions, we find that the impact on entry of group cash holdings is more important in environments where financial constraints are pronounced and in more financially dependent sectors. The cash holdings of incumbent and entrant groups also affect the survival rate of entrants in the 3 to 5 year post-entry window. Overall, our findings suggest that internal capital markets operate within corporate groups and affect the product market behavior of affliated firms by mitigating financial constraints.

Suggested Citation

  • Xavier Boutin & Giacinta Cestone & Chiara Fumagalli & Giovanni Pica & Nicolas Serrano-Velarde, 2012. "The Deep-Pocket Effect of Internal Capital Markets," Working Papers 1217, Oxford University Centre for Business Taxation.
  • Handle: RePEc:btx:wpaper:1217
    as

    Download full text from publisher

    File URL: http://www.sbs.ox.ac.uk/sites/default/files/Business_Taxation/Docs/WP1217.pdf
    Download Restriction: no
    ---><---

    Other versions of this item:

    References listed on IDEAS

    as
    1. Heitor Almeida & Murillo Campello, 2006. "Financial Constraints, Asset Tangibility, and Corporate Investment," NBER Working Papers 12087, National Bureau of Economic Research, Inc.
    2. Bronwyn H. Hall, 2010. "The Financing of Innovative Firms," Review of Economics and Institutions, Università di Perugia, vol. 1(1).
    3. Gordon M Phillips & Vojislav Maksimovic, 1999. "Do Conglomerate Firms Allocate Resources Inefficiently?," Working Papers 99-11, Center for Economic Studies, U.S. Census Bureau.
    4. Nina Pavcnik, 2002. "Trade Liberalization, Exit, and Productivity Improvements: Evidence from Chilean Plants," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 69(1), pages 245-276.
    5. Sharon Belenzon & Tomer Berkovitz, 2010. "Innovation in Business Groups," Management Science, INFORMS, vol. 56(3), pages 519-535, March.
    6. Stein, Jeremy C, 1997. "Internal Capital Markets and the Competition for Corporate Resources," Journal of Finance, American Finance Association, vol. 52(1), pages 111-133, March.
    7. Kovenock, Dan & Phillips, Gordon M, 1997. "Capital Structure and Product Market Behavior: An Examination of Plant Exit and Investment Decisions," The Review of Financial Studies, Society for Financial Studies, vol. 10(3), pages 767-803.
    8. Vojislav Maksimovic & Gordon Phillips, 2002. "Do Conglomerate Firms Allocate Resources Inefficiently Across Industries? Theory and Evidence," Journal of Finance, American Finance Association, vol. 57(2), pages 721-767, April.
    9. Marianne Bertrand & Paras Mehta & Sendhil Mullainathan, 2002. "Ferreting out Tunneling: An Application to Indian Business Groups," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 117(1), pages 121-148.
    10. Gopalan, Radhakrishnan & Nanda, Vikram & Seru, Amit, 2007. "Affiliated firms and financial support: Evidence from Indian business groups," Journal of Financial Economics, Elsevier, vol. 86(3), pages 759-795, December.
    11. Vojislav Maksimovic & Gordon Phillips, 2008. "The Industry Life Cycle, Acquisitions and Investment: Does Firm Organization Matter?," Journal of Finance, American Finance Association, vol. 63(2), pages 673-708, April.
    12. Bolton, Patrick & Scharfstein, David S, 1990. "A Theory of Predation Based on Agency Problems in Financial Contracting," American Economic Review, American Economic Association, vol. 80(1), pages 93-106, March.
    13. Cleary, Sean & Povel, Paul & Raith, Michael, 2007. "The U-Shaped Investment Curve: Theory and Evidence," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 42(1), pages 1-39, March.
    14. Vojislav Maksimovic & Gordon Phillips, 2005. "The Industry Life Cycle and Acquisitions and Investment: Does Firm Organization Matter?," Working Papers 05-29, Center for Economic Studies, U.S. Census Bureau.
    15. Hajivassiliou, Vassilis & Savignac, Frédérique, 2007. "Financing constraints and a firm's decision and ability to innovate: establishing direct and reverse effects," LSE Research Online Documents on Economics 4774, London School of Economics and Political Science, LSE Library.
    16. Philippe Aghion & Thibault Fally & Stefano Scarpetta, 2007. "Credit constraints as a barrier to the entry and post-entry growth of firms [‘Dualism and macroeconomic volatility’]," Economic Policy, CEPR, CESifo, Sciences Po;CES;MSH, vol. 22(52), pages 732-779.
    17. Antoine Faure- Grimaud & Roman Inderst, 2005. "Conglomerate Entrenchment under Optimal Financial Contracting," American Economic Review, American Economic Association, vol. 95(3), pages 850-861, June.
    18. Gerard Hoberg & Gordon M. Phillips, 2011. "Conglomerate Industry Choice and Product Differentiation," NBER Working Papers 17221, National Bureau of Economic Research, Inc.
    19. Rajan, Raghuram G & Zingales, Luigi, 1998. "Financial Dependence and Growth," American Economic Review, American Economic Association, vol. 88(3), pages 559-586, June.
    20. Takeo Hoshi & Anil Kashyap & David Scharfstein, 1991. "Corporate Structure, Liquidity, and Investment: Evidence from Japanese Industrial Groups," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 106(1), pages 33-60.
    21. Klapper, Leora & Laeven, Luc & Rajan, Raghuram, 2006. "Entry regulation as a barrier to entrepreneurship," Journal of Financial Economics, Elsevier, vol. 82(3), pages 591-629, December.
    22. Heitor Almeida & Murillo Campello, 2007. "Financial Constraints, Asset Tangibility, and Corporate Investment," The Review of Financial Studies, Society for Financial Studies, vol. 20(5), pages 1429-1460, 2007 12.
    23. Weinstein, David E & Yafeh, Yishay, 1995. "Japan's Corporate Groups: Collusion or Competitive? An Empirical Investigation of Keiretsu Behavior," Journal of Industrial Economics, Wiley Blackwell, vol. 43(4), pages 359-376, December.
    24. Lamont, Owen, 1997. "Cash Flow and Investment: Evidence from Internal Capital Markets," Journal of Finance, American Finance Association, vol. 52(1), pages 83-109, March.
    25. Raghuram Rajan & Henri Servaes & Luigi Zingales, 2000. "The Cost of Diversity: The Diversification Discount and Inefficient Investment," Journal of Finance, American Finance Association, vol. 55(1), pages 35-80, February.
    26. Houston, Joel & James, Christopher & Marcus, David, 1997. "Capital market frictions and the role of internal capital markets in banking," Journal of Financial Economics, Elsevier, vol. 46(2), pages 135-164, November.
    27. R. Glenn Hubbard, 1998. "Capital-Market Imperfections and Investment," Journal of Economic Literature, American Economic Association, vol. 36(1), pages 193-225, March.
    28. Federico Cingano & Fabiano Schivardi, 2004. "Identifying the Sources of Local Productivity Growth," Journal of the European Economic Association, MIT Press, vol. 2(4), pages 720-742, June.
    29. Marianne Bertrand & Antoinette Schoar & David Thesmar, 2007. "Banking Deregulation and Industry Structure: Evidence from the French Banking Reforms of 1985," Journal of Finance, American Finance Association, vol. 62(2), pages 597-628, April.
    30. Hyun-Han Shin & René M. Stulz, 1998. "Are Internal capital Markets Efficient?," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 113(2), pages 531-552.
    31. Steven M. Fazzari & R. Glenn Hubbard & Bruce C. Petersen, 1988. "Financing Constraints and Corporate Investment," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 19(1), pages 141-206.
    32. Luigi Zingales, "undated". "Survival of the Fittest or the Fattest? Exit and Financing in the Trucking Industry," CRSP working papers 336, Center for Research in Security Prices, Graduate School of Business, University of Chicago.
    33. David S. Scharfstein & Jeremy C. Stein, 2000. "The Dark Side of Internal Capital Markets: Divisional Rent‐Seeking and Inefficient Investment," Journal of Finance, American Finance Association, vol. 55(6), pages 2537-2564, December.
    34. Rafael La Porta & Florencio Lopez‐De‐Silanes & Andrei Shleifer, 1999. "Corporate Ownership Around the World," Journal of Finance, American Finance Association, vol. 54(2), pages 471-517, April.
    35. Julian Franks & Colin Mayer & Stefano Rossi, 2009. "Ownership: Evolution and Regulation," The Review of Financial Studies, Society for Financial Studies, vol. 22(10), pages 4009-4056, October.
    36. Murillo Campello, 2002. "Internal Capital Markets in Financial Conglomerates: Evidence from Small Bank Responses to Monetary Policy," Journal of Finance, American Finance Association, vol. 57(6), pages 2773-2805, December.
    37. Giacinta Cestone & Chiara Fumagalli, 2005. "The Strategic Impact of Resource Flexibility in Business Groups," RAND Journal of Economics, The RAND Corporation, vol. 36(1), pages 193-214, Spring.
    38. Naveen Khanna & Sheri Tice, 2001. "The Bright Side of Internal Capital Markets," Journal of Finance, American Finance Association, vol. 56(4), pages 1489-1528, August.
    39. Campello, Murillo & Graham, John R. & Harvey, Campbell R., 2010. "The real effects of financial constraints: Evidence from a financial crisis," Journal of Financial Economics, Elsevier, vol. 97(3), pages 470-487, September.
    40. Jean-Pierre Benoit, 1984. "Financially Constrained Entry in a Game with Incomplete Information," RAND Journal of Economics, The RAND Corporation, vol. 15(4), pages 490-499, Winter.
    41. Olley, G Steven & Pakes, Ariel, 1996. "The Dynamics of Productivity in the Telecommunications Equipment Industry," Econometrica, Econometric Society, vol. 64(6), pages 1263-1297, November.
    42. repec:bla:jfinan:v:53:y:1998:i:3:p:905-938 is not listed on IDEAS
    43. Stijn Claessens & Simeon Djankov & Leora Klapper1, 2000. "The Role And Functioning Of Business Groups In East Asia And Chile," Abante, Escuela de Administracion. Pontificia Universidad Católica de Chile., vol. 3(1), pages 91-107.
    44. Khanna, Naveen & Tice, Sheri, 2000. "Strategic Responses of Incumbents to New Entry: The Effect of Ownership Structure, Capital Structure, and Focus," The Review of Financial Studies, Society for Financial Studies, vol. 13(3), pages 749-779.
    45. Matsusaka, John G. & Nanda, Vikram, 2002. "Internal Capital Markets and Corporate Refocusing," Journal of Financial Intermediation, Elsevier, vol. 11(2), pages 176-211, April.
    46. Duchin, Ran & Ozbas, Oguzhan & Sensoy, Berk A., 2010. "Costly external finance, corporate investment, and the subprime mortgage credit crisis," Journal of Financial Economics, Elsevier, vol. 97(3), pages 418-435, September.
    47. Giacinta Cestone & Chiara Fumagalli, 2005. "The Strategic Impact of Resource Flexibility in Business Groups," RAND Journal of Economics, The RAND Corporation, vol. 36(4), pages 193-214, Winter.
    48. Campello, Murillo, 2003. "Capital structure and product markets interactions: evidence from business cycles," Journal of Financial Economics, Elsevier, vol. 68(3), pages 353-378, June.
    49. Timothy Dunne & Mark J. Roberts & Larry Samuelson, 1988. "Patterns of Firm Entry and Exit in U.S. Manufacturing Industries," RAND Journal of Economics, The RAND Corporation, vol. 19(4), pages 495-515, Winter.
    50. Luca Enriques & Paolo Volpin, 2007. "Corporate Governance Reforms in Continental Europe," Journal of Economic Perspectives, American Economic Association, vol. 21(1), pages 117-140, Winter.
    51. Chevalier, Judith A, 1995. "Capital Structure and Product-Market Competition: Empirical Evidence from the Supermarket Industry," American Economic Review, American Economic Association, vol. 85(3), pages 415-435, June.
    52. Tarun Khanna & Yishay Yafeh, 2007. "Business Groups in Emerging Markets: Paragons or Parasites?," Journal of Economic Literature, American Economic Association, vol. 45(2), pages 331-372, June.
    53. Matías Braun & Borja Larrain, 2005. "Finance and the Business Cycle: International, Inter‐Industry Evidence," Journal of Finance, American Finance Association, vol. 60(3), pages 1097-1128, June.
    54. Perotti, Enrico C. & Gelfer, Stanislav, 2001. "Red barons or robber barons? Governance and investment in Russian financial-industrial groups," European Economic Review, Elsevier, vol. 45(9), pages 1601-1617, October.
    55. Chevalier, Judith A, 1995. "Do LBO Supermarkets Charge More? An Empirical Analysis of the Effects of LBOs on Supermarket Pricing," Journal of Finance, American Finance Association, vol. 50(4), pages 1095-1112, September.
    56. Sharon Belenzon & Tomer Berkovitz & Patrick Bolton, 2009. "Intracompany Governance and Innovation," NBER Working Papers 15304, National Bureau of Economic Research, Inc.
    57. Richmond D. Mathews & David T. Robinson, 2008. "Market Structure, Internal Capital Markets, and the Boundaries of the Firm," Journal of Finance, American Finance Association, vol. 63(6), pages 2703-2736, December.
    58. Stein, Jeremy C., 2003. "Agency, information and corporate investment," Handbook of the Economics of Finance, in: G.M. Constantinides & M. Harris & R. M. Stulz (ed.), Handbook of the Economics of Finance, edition 1, volume 1, chapter 2, pages 111-165, Elsevier.
    59. Kovenock, Dan & Phillips, Gordon, 1995. "Capital Structure and Product-Market Rivalry: How Do We Reconcile Theory and Evidence?," American Economic Review, American Economic Association, vol. 85(2), pages 403-408, May.
    60. Phillips, Gordon M., 1995. "Increased debt and industry product markets An empirical analysis," Journal of Financial Economics, Elsevier, vol. 37(2), pages 189-238, February.
    61. Hopenhayn, Hugo A, 1992. "Entry, Exit, and Firm Dynamics in Long Run Equilibrium," Econometrica, Econometric Society, vol. 60(5), pages 1127-1150, September.
    62. Marianne Bertrand & Sendhil Mullainathan, 2001. "Are CEOs Rewarded for Luck? The Ones Without Principals Are," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 116(3), pages 901-932.
    63. Robert Z. Lawrence, 1991. "Efficient or Exclusionist: The Import Behavior of Japanese Corporate Groups," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 22(1), pages 311-341.
    64. Peter MacKay & Gordon M. Phillips, 2005. "How Does Industry Affect Firm Financial Structure?," The Review of Financial Studies, Society for Financial Studies, vol. 18(4), pages 1433-1466.
    65. Maksimovic, Vojislav, 1990. "Product Market Imperfections and Loan Commitments," Journal of Finance, American Finance Association, vol. 45(5), pages 1641-1653, December.
    Full references (including those not matched with items on IDEAS)

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Giacomo Rodano & Emanuele Tarantino & Nicolas Serrano-Velarde, 2012. "Bankruptcy Law and the Cost of Banking Finance," Working Papers 1218, Oxford University Centre for Business Taxation.
    2. Stein, Jeremy C., 2003. "Agency, information and corporate investment," Handbook of the Economics of Finance, in: G.M. Constantinides & M. Harris & R. M. Stulz (ed.), Handbook of the Economics of Finance, edition 1, volume 1, chapter 2, pages 111-165, Elsevier.
    3. Giacinta Cestone & Chiara Fumagalli, 2003. "Winner-Picking or Cross-Subsidization? The Strategic Impact of Resource Flexibility in Business Groups," CSEF Working Papers 93, Centre for Studies in Economics and Finance (CSEF), University of Naples, Italy.
    4. Amess, Kevin & Banerji, Sanjay & Lampousis, Athanasios, 2015. "Corporate cash holdings: Causes and consequences," International Review of Financial Analysis, Elsevier, vol. 42(C), pages 421-433.
    5. Sertsios, Giorgo, 2020. "Corporate finance, industrial organization, and organizational economics," Journal of Corporate Finance, Elsevier, vol. 64(C).
    6. Joseph P. H. Fan & Li Jin & Guojian Zheng, 2016. "Revisiting the Bright and Dark Sides of Capital Flows in Business Groups," Journal of Business Ethics, Springer, vol. 134(4), pages 509-528, April.
    7. Kabbach-de-Castro, Luiz Ricardo & Kirch, Guilherme & Matta, Rafael, 2022. "Do internal capital markets in business groups mitigate firms' financial constraints?," Journal of Banking & Finance, Elsevier, vol. 143(C).
    8. Ljungqvist, Alexander & Chen, Donghua & Lu, Haitian & Jiang, Dequan & Zhou, Mingming, 2015. "State Capitalism vs. Private Enterprise," CEPR Discussion Papers 10423, C.E.P.R. Discussion Papers.
    9. Ushijima, Tatsuo, 2005. "Internal capital market and the growth and survival of Japanese plants in the United States," Journal of the Japanese and International Economies, Elsevier, vol. 19(3), pages 366-385, September.
    10. Khosa,Amrinder & Ahmed,Kamran & Henry,Darren, 2019. "Ownership Structure, Related Party Transactions, and Firm Valuation," Cambridge Books, Cambridge University Press, number 9781108492195, September.
    11. Domenico Scalera & Alberto Zazzaro, 2009. "Do Inter-Firm Networks Make Access to Finance Easier? Issues and Empirical Evidence," Mo.Fi.R. Working Papers 25, Money and Finance Research group (Mo.Fi.R.) - Univ. Politecnica Marche - Dept. Economic and Social Sciences.
    12. Kim, Sehoon, 2020. "Disappearing Discounts: Hedge Fund Activism in Conglomerates," MPRA Paper 100876, University Library of Munich, Germany.
    13. Becker Bo & Sivadasan Jagadeesh, 2010. "The Effect of Financial Development on the Investment-Cash Flow Relationship: Cross-Country Evidence from Europe," The B.E. Journal of Economic Analysis & Policy, De Gruyter, vol. 10(1), pages 1-49, May.
    14. Stefan Erdorf & Thomas Hartmann-Wendels & Nicolas Heinrichs & Michael Matz, 2013. "Corporate diversification and firm value: a survey of recent literature," Financial Markets and Portfolio Management, Springer;Swiss Society for Financial Market Research, vol. 27(2), pages 187-215, June.
    15. Gatzer, Sebastian & Hoang, Daniel & Ruckes, Martin, 2015. "Internal Capital Markets and Diversified Firms: Theory and Practice," EconStor Preprints 169432, ZBW - Leibniz Information Centre for Economics.
    16. George, Rejie & Kabir, Rezaul, 2008. "Business groups and profit redistribution: A boon or bane for firms?," Journal of Business Research, Elsevier, vol. 61(9), pages 1004-1014, September.
    17. Campello, Murillo, 2006. "Debt financing: Does it boost or hurt firm performance in product markets?," Journal of Financial Economics, Elsevier, vol. 82(1), pages 135-172, October.
    18. Shan Ge, 2022. "How Do Financial Constraints Affect Product Pricing? Evidence from Weather and Life Insurance Premiums," Journal of Finance, American Finance Association, vol. 77(1), pages 449-503, February.
    19. Almeida, Heitor & Wolfenzon, Daniel, 2006. "Should business groups be dismantled? The equilibrium costs of efficient internal capital markets," Journal of Financial Economics, Elsevier, vol. 79(1), pages 99-144, January.
    20. George, R. & Kabir, M.R. & Douma, S.W., 2004. "Business Groups and Profit Redistribution : A Boon or Bane for Firms," Other publications TiSEM 065c6a3e-5b9a-40b7-9843-5, Tilburg University, School of Economics and Management.

    More about this item

    Keywords

    Business Groups; Cash Holdings; Internal Capital Markets; Entry;
    All these keywords.

    JEL classification:

    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
    • G38 - Financial Economics - - Corporate Finance and Governance - - - Government Policy and Regulation
    • L41 - Industrial Organization - - Antitrust Issues and Policies - - - Monopolization; Horizontal Anticompetitive Practices

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:btx:wpaper:1217. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Dongxian Guo (email available below). General contact details of provider: https://edirc.repec.org/data/sbsoxuk.html .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.