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Article
2024
The economics of capital allocation in firms: Evidence from internal capital markets
The economics of capital allocation in firms: Evidence from internal capital markets
Abstract (English)
We analyze a unique chief financial officer (CFO) survey data set to examine
capital allocation in firms. Top management is aware of agency and information problems
at the divisional level and organizes the budgeting process to counteract managerial oppor-
tunism, employing systems of interconnected measures, including layers of approval, divi-
sional budgets, reporting requirements, and compensation schemes. When making funding
decisions, top management relies heavily on top-level nonfinancial information, such as the
assessment of divisional managers’ abilities. However, substantial parts of the capital bud-
get do not require top management approval as firms trade off the benefits and costs of
decentralization, thereby deviating from the traditional paradigm of decentralized project
initiation but centralized project approval. Even firms with active internal capital markets
tilt capital allocation toward relatively even distributions, reflecting the use of capital alloca-
tion as a credible communication device. We also find that within-firm agency problems
may result in capital rationing, that is, divisions’ restricted access to internal capital. CFOs
also believe that integrating multiple businesses into an internal capital market results in
tangible financial benefits, predominantly lower costs of capital and higher debt capacities.
Thus, our findings also support coinsurance arguments suggesting that internal capital
markets may improve access to external financing.
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Published in
Management science (2024).
https://doi.org/10.1287/mnsc.2021.02755.
ISSN: 1526-5501
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English
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Classification (DDC)
650 Management and public relations
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Sustainable Development Goals
BibTeX
@article{Hoang2024,
url = {https://hohpublica.uni-hohenheim.de/handle/123456789/16906},
doi = {10.1287/mnsc.2021.02755},
author = {Hoang, Daniel and Gatzer, Sebastian and Ruckes, Martin et al.},
title = {The economics of capital allocation in firms: Evidence from internal capital markets},
journal = {Management Science},
year = {2024},
}