Internal versus External Capital Markets

Abstract

This paper presents a framework for analyzing the costs and benefits of internal vs. external capital allocation. We focus primarily on comparing an internal capital market to bank lending. While both represent centralized forms of financing, in the former case the financing is owner-provided, while in the latter case it is not. We argue that the ownership aspect of internal capital allocation has three important consequences: 1) it leads to more monitoring than bank lending; 2) it reduces managers' entrepreneurial incentives; and 3) it makes it easier to efficiently redeploy the assets of projects that are perfotming poorly under existing management.

Business groups and profit redistribution: A boon or bane for firms?

“…The benefits emanate from the bright side of the operations of the internal capital market where groups can help firms that have difficulties in obtaining financing from the external capital market (Gertner, Scharfstein and Stein, 1994;Stein, 1997;. Groups can allocate resources efficiently to more deserving firms by transferring funds away from slow growing, cash generating firms to those that are expanding rapidly but need new funds.…”

Mergers, Spinoffs, and Employee Incentives

“…If an employee generates an innovation, the allocation of the surplus from the development of the innovation is determined (as in Zwiebel, 1996a and1996b) at the interim date by intra-firm bargaining between the firm and the employee, before the second stage of the project is performed. 7 The outcome of bargaining between the employee and the firm depends on their relative bargaining power and on each party's outside option. We assume that each firm's outside option while bargaining with its employee is limited by the fact that the firm cannot replace its current employee with a new one from the general labor market population, but it can only hire an employee from a rival firm in the same product market.…”

Internal Capital Market Efficiency of Belgian Holding Companies

“…In 1991, the disclosure law became applicable to all firms listed without exception. 15 To construct the database, we select all Belgian listed companies that report to be a holding company.…”

“…However, through pyramidal structure, a mother company can achieve much control over the subsidiary with only a small indirect shareholding. For example, if a holding company A holds 50 percent in a subsidiary A1 and 20 percent in a subsidiary A2, and if A1 holds 30 percent in A2, the sum of direct and indirect shareholding of A2 is 35 percent, but the 15 The disclosure law was adopted in 1989, and before this date, the Belgian corporate ownership was a black box, no data were available and little was known about it. Some firms, under condition, were not obliged to disclose their ownership data.…”