A Review of the Internal Capital Allocation Literature: Piecing Together the Capital Allocation Puzzle

Abstract

Allocating internal financial capital represents a key task for managers of multidivisional corporations. This has led to a wealth of research and theorizing about capital allocation and whether or not managers allocate capital successfully. However, capital allocation research has diverged in a number of directions that reflect different and often incompatible perspectives, underlying frameworks, and outcomes. The result is a puzzle, wherein scholars have found little consistent substantive relation between capital allocation, business unit characteristics, and firm performance. Through our review, we seek to bring clarity to this puzzle by identifying problems in the literature and by offering a solution. We suggest problems in the literature stem from the disparate approaches scholars have taken when studying capital allocation, including assessments of what constitutes and prevents successful allocation. We begin by organizing these approaches into a framework that highlights key allocation strategies and the primary impediments to allocation success that scholars have used to build their models. We then suggest that managers may employ a number of allocation strategies and that scholars need to recognize that not all corporate managers employ the same strategy. We contend that a resurgence of obtrusive, qualitative, and multilevel studies may help explain why managers Acknowledgments: The authors would like to gratefully acknowledge the comments and suggestions of the coeditors of the special issue-Cathy Maritan and Gwen Lee-as well as two anonymous reviewers.

Resource Allocation and Strategy

“…Using a measure constructed to capture business unit influence based on publicly available data, the analysis finds that a greater year-to-year change in capital allocation across business units is associated with more business unit influence in the top management team of a firm. Both the Bardolet et al (2017) study and the Vieregger et al study identify capital allocation patterns and propose plausible explanations that warrant further, more detailed examination, as Busenbark et al (2017) advocate.…”

“…He goes on to argue that despite developments since the time of his original study, management theory of the resource allocation process remains wedded to a financial model of capital budgeting that poorly fits the problem facing companies and that more work is needed on the basic problem of resource allocation-a difficult undertaking given the complexity of interrelated technical, economic, and organizational forces involved and the changing environment in which they operate. Busenbark, Wiseman, Arrfelt, and Woo (2017) focus on corporate capital allocation and review the body of research on that topic. The authors' goal is to bring clarity to the questions of what the purpose of capital allocation is and what constitutes successful allocation, ultimately strengthening the link between capital allocation and firm strategy.…”

“…Busenbark, Wiseman, Arrfelt, and Woo (2017) focus on corporate capital allocation and review the body of research on that topic. The authors’ goal is to bring clarity to the questions of what the purpose of capital allocation is and what constitutes successful allocation, ultimately strengthening the link between capital allocation and firm strategy.…”

“…The other area of study is the outcomes of resource allocation. Future research can more closely link resource allocation decisions to intermediate and firm-level outcomes resulting from allocations such as corporate value creation (Maritan & Lee, 2017), competitive advantage (Leiblein et al, 2017; Maritan & Lee, 2017), firm performance (Busenbark et al, 2017), and overinvestment in activities such as R&D (Ahuja & Novelli, 2017).…”

Bringing a Resource and Capability Lens to Resource Allocation

“…One stream is focused on the resource allocation process and has developed descriptive process models of behavioral, social, and political factors driving resource allocation decisions (see Bower & Gilbert, 2005, for a review). The second stream consists of research on capital allocation in multidivisional firms that has focused on the relationship between characteristics of business units and patterns in the allocation of capital to those units by corporate management (see Busenbark, Wiseman, Arrfelt, & Woo, 2017, for a review [this issue]).…”