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

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David S. Scharfstein

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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.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 6352.

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Date of creation: Jan 1998
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Handle: RePEc:nbr:nberwo:6352

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Find related papers by JEL classification:
G3 - Financial Economics - - Corporate Finance and Governance
G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Investment Policy

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  1. 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. [Downloadable!] (restricted)
  2. Servaes, Henri, 1996. " The Value of Diversification during the Conglomerate Merger Wave," Journal of Finance, American Finance Association, vol. 51(4), pages 1201-25, September. [Downloadable!] (restricted)
  3. David S. Scharfstein & Jeremy C. Stein, 1997. "The Dark Side of Internal Capital Markets: Divisional Rent-Seeking and Inefficient Investment," NBER Working Papers 5969, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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