Resource Allocation within Firms and Financial Market Dislocation: Evidence from Diversified Conglomerates

Matvos, Gregor; Seru, Amit

doi:10.1093/rfs/hhu005

Cited by 172 publications

(134 citation statements)

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“…Despite this difference in reporting standards, our results are consistent with those in recent papers that examine the operation of internal capital markets in times of market turmoil and distress. This literature shows that U.S. conglomerates' internal capital markets step in during periods of industry distress or market disruption and improve resource allocation (Kuppuswamy and Villalonga (), Gopalan and Xie (), Matvos and Seru ()). A unique contribution of our paper is to provide direct evidence on how internal capital markets work in business groups.…”

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confidence: 99%

Internal Capital Markets in Business Groups: Evidence from the Asian Financial Crisis

Almeida

Kim

2015

The Journal of Finance

277

135

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This paper examines capital reallocation among firms in Korean business groups (chaebol) in the aftermath of the 1997 Asian financial crisis, and the consequences of this capital reallocation for the investment and performance of chaebol firms. We show that chaebol transferred cash from low-growth to high-growth member firms, using cross-firm equity investments. This capital reallocation allowed chaebol firms with greater investment opportunities to invest more than control firms after the crisis. These firms also showed higher profitability and lower declines in valuation than control firms following the crisis. Our results suggest that chaebol internal capital markets helped them mitigate the negative effects of the Asian crisis on investment and performance.The literature on internal capital markets focuses mostly on multisegment firms (conglomerates), which are common in the United States. A "business group"-a group of legally independent firms under common ownershipshares many of the features of U.S.-type conglomerates. In particular, both have internal markets that can allocate capital among member firms and divisions. While the importance of internal capital allocation within conglomerates has probably decreased in the United States as a result of financial development, the role of groups may still be significant in countries with weak institutions and less developed financial markets (Khanna and Palepu (2000), Morck, Wolfenzon, and Yeung (2005), Khanna and Yafeh (2007)). Notwithstanding the potential importance and ubiquity of groups in emerging markets (Claessens et al. (2002), Faccio and Lang (2002)), however, there is surprisingly little direct evidence on the efficiency of their capital allocation.In this paper, we study capital allocation in Korean business groups (chaebol), focusing on an event that is likely to have exacerbated the impact of chaebol * Chang-Soo Kim (corresponding author) is at Yonsei University. Hwanki Brian Kim and Heitor Almeida are at the University of Illinois at Urbana-Champaign. We thank three anonymous referees, Michael Roberts, Ran Duchin, Miguel Ferreira, Antonio Gledson de Carvalho, Radha Gopalan, David Reeb, Mara Faccio, Patrick Behr, and participants at Hong Kong University, Purdue University, Bocconi University, the 2012 SBFIN conference, the 2012 LUBRAFIN conference, the Washington University 2011 Corporate Finance Conference, and the HKUST 2011 Finance Symposium for comments and suggestions. We also thank Igor Cunha, Jiyoon Lee, Yunhee Cho, Sunghoon Joo, and Myeongwoo Kang for excellent research assistance. The authors do not have any conflicts of interest, as identified in the Disclose Policy. DOI: 10.1111/jofi.12309 2540The Journal of Finance R internal capital markets on resource allocation, namely, the Asian crisis of 1997. The 1997 Asian crisis was a truly unprecedented and unexpected event that greatly affected Asian economies. Important sources of external finance (such as bank loans and bonds) became more costly or virtually impossible to access i...

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Internal Capital Markets in Business Groups: Evidence from the Asian Financial Crisis

Almeida

Kim

2015

The Journal of Finance

277

135

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“…Matvos and Seru () estimate a structural model of internal capital markets to disentangle and quantify the various forces driving the resource reallocation decision.…”

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Capital and Labor Reallocation within Firms

Giroud¹,

Mueller

2015

The Journal of Finance

184

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We document how a shock to investment opportunities at one plant ("treated plant") spills over to other plants within the same firm, but only if the firm is financially constrained. To provide the treated plant with resources, headquarters withdraws capital and labor from other plants, especially from plants that are relatively less productive, not part of the firm's core industries, and located far away from headquarters. As a result of the resource reallocation, aggregate firm-wide productivity increases. We do not find any evidence of capital or labor spillovers among plants of financially unconstrained firms. * Giroud is with the MIT Sloan School of Management and NBER; Mueller is with the NYU Stern School of Business, NBER, CEPR, and ECGI. We thank Michael Roberts (the editor), two anonymous referees, our discussants Owen Lamont (NBER) and Hyunseob Kim (UNC Junior Faculty Roundtable), and seminar participants at the NBER Corporate Finance Summer Institute, Micro@Sloan Conference, UNC Junior Faculty Roundtable, University of Chicago (Booth), Massachusetts Institute of Technology (Sloan), New York University (Stern), Harvard Business School, London Business School, London School of Economics, Duke University (Fuqua), Cornell University (Johnson), Washington University in St. Louis (Olin), University of Maryland (Smith), University of British Columbia (Sauder), Dartmouth College (Tuck), University of Utah (Eccles), Arizona State University (Carey), Georgia Institute of Technology (Scheller), INSEAD, HEC Paris, Stockholm School of Economics, City University (Cass), University of Florida (Warrington), University of Western Ontario (Ivey), Bentley University, WU Vienna, and Humboldt University for helpful comments. The research in this paper was conducted while the authors were Special Sworn Status researchers of the U.S. Census Bureau at the New York and Boston Census Research Data Centers. Any opinions and conclusions expressed herein are those of the authors and do not necessarily represent the views of the U.S. Census Bureau. All results have been reviewed to ensure that no confidential information is disclosed. 1Electronic copy available at: http://ssrn.com/abstract=2436552There is a close link between the theory of internal capital markets and the theory of the firm. Accordingly, headquarters can create value by actively reallocating scarce resources across projects. In particular, headquarters' control rights enable it to take resources away from some projects and give them to other, more deserving ones (Alchian (1969), Williamson (1975), Stein (1997)). By contrast, an external lender, such as a bank, does not possess the authority to reallocate resources across borrowers.This fundamental idea-that headquarters can create value by actively reallocating scarce resources-is testable. Stein (1997, p. 112) formulates the "efficient internal capital markets hypothesis" as follows:"Thus, for example, if a company owns two unrelated divisions A and B, and the appeal of investing in B suddenly increases, ...

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“…Kuppuswamy and Villalonga (2015) find that diversified firms use their internal capital more efficiently during the financial crisis (smarter money effect). Additionally, using diversified conglomerates data, Matvos and Seru (2014) demonstrate that some firms reallocate resources internally to significantly mediate the effect of financial shock. However, Mitton (2002) focuses on the East Asian financial crisis of 1997-1998 and finds that, while diversification can offer the benefit of improving capital allocation, this benefit could virtually disappear in a time of crisis as investment opportunities diminish.…”

Section: Ownership Structures Under Extreme Economic Conditionsmentioning

confidence: 95%

The Effect of Diversification under Different Ownership Structures and Economic Conditions: Evidence from the Great Recession

Liebenberg

Lin

2019

JRFM

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The effect of corporate diversification on firm performance has been extensively documented in the literature. In the general finance literature, Kuppuswamy and Villalonga (2015) studied the diversification effect during the 2007–2009 financial crisis and found that diversification adds value in the presence of external financing constraints. Motivated by this finding, we investigate whether a similar effect applies to insurance firms and we develop hypotheses for their different ownership structures (stock vs. mutual insurers; and group vs. non-group affiliated insurers). Using a sample of property-liability insurers over a period of 2004 to 2013, we find that the effect of diversification on performance is contingent on ownership structures and economic conditions. The diversification effect for stock insurers and insurers affiliated with a group is not significantly affected by economic conditions. However, the diversification effect for mutual insurers and non-affiliated insurers is reversed during the financial crisis. More specifically, diversified firms with these kinds of ownership structures perform better than focused firms during normal economic conditions, but their performance was significantly worse during the financial crisis. Our results are robust to alternative measures of performance and diversification, and to corrections for endogeneity. Our study contributes to the diversification literature by showing how the effect of diversification varies with ownership structure under different economic conditions and the results shed light on the specific circumstances in which diversification can improve or reduce performance.

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Resource Allocation within Firms and Financial Market Dislocation: Evidence from Diversified Conglomerates

Cited by 172 publications

References 72 publications

Internal Capital Markets in Business Groups: Evidence from the Asian Financial Crisis

Internal Capital Markets in Business Groups: Evidence from the Asian Financial Crisis

Capital and Labor Reallocation within Firms

The Effect of Diversification under Different Ownership Structures and Economic Conditions: Evidence from the Great Recession

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