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Corporate Borrowing and Financing Constraints


  • Inderst, Roman
  • Mueller, Holger M


This Paper adopts an optimal contracting approach to internal capital markets. We study the role of headquarters in contracting with outside investors, with a focus on whether headquarters eases or amplifies financing constraints compared to decentralized firms where individual project managers borrow separately. If projects differ in their ex post cash-flows, headquarters makes greater repayments to investors than decentralized firms, which eases financing constraints. Effectively, headquarters then subsidizes low-return projects with high-return projects' cash. On the other hand, headquarters may, by pooling cash flows and accumulating internal funds, make investments without having to return to the capital market. Without any capital market discipline, however, it is harder for outside investors to force the firm to disgorge funds, which tightens financing constraints ex ante. Both the costs and benefits of internal capital markets are endogenous and arise as part of an optimal financial contract. Our results are consistent with empirical findings showing that conglomerate firms trade at a discount relative to a comparable portfolio of stand-alone firms.

Suggested Citation

  • Inderst, Roman & Mueller, Holger M, 2001. "Corporate Borrowing and Financing Constraints," CEPR Discussion Papers 2784, C.E.P.R. Discussion Papers.
  • Handle: RePEc:cpr:ceprdp:2784

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    References listed on IDEAS

    1. Schnitzer, Monika, 1999. "Expropriation and control rights: A dynamic model of foreign direct investment," International Journal of Industrial Organization, Elsevier, vol. 17(8), pages 1113-1137, November.
    2. Grossman, Gene & Helpman, Elhanan, 1999. "Incomplete Contracts and Industrial Organization," CEPR Discussion Papers 2280, C.E.P.R. Discussion Papers.
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    8. Hoekman, Bernard & Saggi, Kamal, 1999. "Multilateral disciplines for investment-related policies," Policy Research Working Paper Series 2138, The World Bank.
    9. Bond, Eric W & Samuelson, Larry, 1986. "Tax Holidays as Signals," American Economic Review, American Economic Association, vol. 76(4), pages 820-826, September.
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    Cited by:

    1. 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.

    More about this item


    Diversification Discount; Internal Capital Markets; Theory Of The Firm;

    JEL classification:

    • G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Fixed Investment and Inventory Studies
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
    • G34 - Financial Economics - - Corporate Finance and Governance - - - Mergers; Acquisitions; Restructuring; Corporate Governance


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