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Resource Allocation within Firms and Financial Market Dislocation: Evidence from Diversified Conglomerates

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  • Gregor Matvos
  • Amit Seru

Abstract

When external capital markets are stressed they may not reallocate resources between firms. We show that resource allocation within firms' internal capital markets provides an important force countervailing financial market dislocation. Using data on US conglomerates we empirically verify that firms shift resources between industries in response to shocks to the financial sector. We estimate a structural model of internal capital market to separately identify and quantify the forces driving the reallocation decision and how these forces interact with external capital market stress. The frictions in internal capital markets drive a large wedge between productivity and investment: the weaker (stronger) division obtains too much (little) capital, as though it is 12 (9) percent more (less) productive than it really is. The cost of accessing external capital funds quadruple during extreme financial market dislocations, making resource allocation within firms significantly cheaper. The estimated model allows us to simulate the propagation of the 2007/2008 financial market dislocation. The counterfactual out of sample simulated data is remarkably consistent with the actual data and shows that improved resource allocation in internal capital markets offset financial market stress during the recent financial crisis by 16% to 30% relative to firms with no internal capital markets.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 17717.

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Date of creation: Dec 2011
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Publication status: published as "Resource Allocation within Firms and Financial Market Dislocation: Evidence from Diversified Conglomerates," (with Amit Seru), Review of Financial Studies, Accepted.
Handle: RePEc:nbr:nberwo:17717

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  1. Patrick Bajari & C. Lanier Benkard & Jonathan Levin, 2007. "Estimating Dynamic Models of Imperfect Competition," Econometrica, Econometric Society, vol. 75(5), pages 1331-1370, 09.
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  3. Hovakimian, Gayané, 2011. "Financial constraints and investment efficiency: Internal capital allocation across the business cycle," Journal of Financial Intermediation, Elsevier, vol. 20(2), pages 264-283, April.
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  8. Nicholas Bloom, 2007. "The Impact of Uncertainty Shocks," NBER Working Papers 13385, National Bureau of Economic Research, Inc.
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Cited by:
  1. Strebulaev, Ilya A. & Whited, Toni M., 2012. "Dynamic Models and Structural Estimation in Corporate Finance," Foundations and Trends(R) in Finance, now publishers, vol. 6(1–2), pages 1-163, November.

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