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A Theory of Socialistic Internal Capital Markets

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  • Bernardo, Antonio E
  • Luo, Jiang
  • Wang, James J.D.

Abstract

We develop a model of a two-division firm in which the “strong” division has,on average, higher quality investment projects than the “weak” division. We show that the firm optimally biases its project selection policy in favor of the weak division and this bias is stronger when there is a greater spread in average project quality. The cost of such a policy is that the firm sometimes funds an inferior project but the benefit is that it motivates the manager of the strong division to set (and meet) more aggressive cash flow targets.

Suggested Citation

  • Bernardo, Antonio E & Luo, Jiang & Wang, James J.D., 2005. "A Theory of Socialistic Internal Capital Markets," University of California at Los Angeles, Anderson Graduate School of Management qt29x1966g, Anderson Graduate School of Management, UCLA.
    • Handle: RePEc:cdl:anderf:qt29x1966g
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    References listed on IDEAS

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