Exploitation of the internal capital market and the avoidance of outside monitoring

Brandon N. Cline, Jacqueline L. Garner and Adam S. Yore

Journal of Corporate Finance, 2014, vol. 25, issue C, 234-250

Abstract: Internal capital markets (ICMs) provide firms an alternative to costly external financing; however, they also provide an avenue to avoid the monitoring associated with issuing external capital. We argue that firms operating inefficient internal capital markets will avoid outside financing. Consistent with this view, conglomerates that cross-subsidize divisions or engage in value-destroying investment avoid external capital market oversight by refraining from issuing both debt and equity. We further show that firms issuing bonds while engaging in value-destroying investment experience yield spreads that are, on average, 46 basis points higher than those of other diversified firms. They similarly experience yield spreads that are 18 basis points higher when they issue syndicated loans. Value-destroying conglomerates also witness SEO announcement returns that are, on average, 1% more negative than firms operating more efficient internal capital markets.

Keywords: Corporate diversification; Internal capital market; Syndicated lending; Corporate bond offerings; Seasoned equity offerings; Monitoring (search for similar items in EconPapers)
JEL-codes: G12 G14 G31 G32 G34 (search for similar items in EconPapers)
Date: 2014
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (7)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:corfin:v:25:y:2014:i:c:p:234-250

DOI: 10.1016/j.jcorpfin.2013.12.004

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