The Bright Side of Internal Capital Markets

Abstract

We examine capital expenditure decisions of discount firms in response to WalMart's entry into their markets. Before Wal-Mart's entry, focused incumbents and discount divisions of diversified incumbents are similar in size, geographic dispersion, and firm debt levels. However, discount divisions of diversified firms are significantly more productive. After Wal-Mart's entry, diversified firms are quicker to either "exit" the discount business or "stay and fight." Also, their capital expenditures are more sensitive to the productivity of their discount business. Internal capital markets function well, as transfers are away from the worsening discount divisions. It appears diversified firms make better investment decisions.

The deep-pocket effect of internal capital markets

“…25 Remember that we treat all firms of the same group that operate in the same market as a single unit.…”

Conglomerate Entrenchment under Optimal Financial Contracting

“…In a similar spirit, Khanna and Tice (2001) document that diversified retail firms were quicker to react following Wal-Mart's entry into a local market, e.g., by shutting down their discount business. 3 The extant theoretical literature on predation and entrenchment focuses on the more vulnerable financial structure of new entrants (e.g., Telser (1966), Benoit (1984)).…”

Informed Headquarters and Socialistic Internal Capital Markets*

“…The intuition is that any other putative equilibrium allocation H 6 = 1 would motivate type H to deviate from the equilibrium strategy and raise allocations to the more pro…table division A without having further negative e¤ects on managers'e¤ort levels. 14 Using this …nding, H's incentive compatibility constraint, condition (14), simpli…es to: 14 Any putative equilibrium allocation^ H 6 = 1 would yield a strictly smaller payo¤ than a putative out-of equilibrium strategy H = 1 considering even most "favorable" o¤-equilibrium beliefs to sustain an equilibrium, namely < 2 We now analyze type L's incentive-compatibility constraint. A type L headquarters would never want to imitate H since H = 1 makes managers believe that headquarters is type H inducing them to do nothing, which immediately lowers productivity in period 2 by eI 2 : At the same time, H clearly makes L's period 1 investment weakly less e¢ cient than any other allocation.…”