The Economics of Capital Allocation in Firms: Evidence from Internal Capital Markets

Daniel Hoang (), Sebastian Gatzer () and Martin Ruckes ()
Additional contact information
Daniel Hoang: Department of Corporate Finance, Institute for Financial Management, University of Hohenheim, 70599 Stuttgart, Germany
Sebastian Gatzer: Institute for Finance, Karlsruhe Institute of Technology, 76131 Karlsruhe, Germany
Martin Ruckes: Institute for Finance, Karlsruhe Institute of Technology, 76131 Karlsruhe, Germany

Management Science, 2025, vol. 71, issue 8, 6392-6425

Abstract: We analyze a unique chief financial officer (CFO) survey data set to examine capital allocation in firms. Top management is aware of agency and information problems at the divisional level and organizes the budgeting process to counteract managerial opportunism, employing systems of interconnected measures, including layers of approval, divisional budgets, reporting requirements, and compensation schemes. When making funding decisions, top management relies heavily on top-level nonfinancial information, such as the assessment of divisional managers’ abilities. However, substantial parts of the capital budget do not require top management approval as firms trade off the benefits and costs of decentralization, thereby deviating from the traditional paradigm of decentralized project initiation but centralized project approval. Even firms with active internal capital markets tilt capital allocation toward relatively even distributions, reflecting the use of capital allocation as a credible communication device. We also find that within-firm agency problems may result in capital rationing, that is, divisions’ restricted access to internal capital. CFOs also believe that integrating multiple businesses into an internal capital market results in tangible financial benefits, predominantly lower costs of capital and higher debt capacities. Thus, our findings also support coinsurance arguments suggesting that internal capital markets may improve access to external financing.

Keywords: capital budgeting; internal capital markets; agency problems; information asymmetry; corporate investment; diversification; coinsurance (search for similar items in EconPapers)
Date: 2025
References: Add references at CitEc
Citations:

Downloads: (external link)
http://dx.doi.org/10.1287/mnsc.2021.02755 (application/pdf)

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:inm:ormnsc:v:71:y:2025:i:8:p:6392-6425

Access Statistics for this article

More articles in Management Science from INFORMS Contact information at EDIRC.
Bibliographic data for series maintained by Chris Asher ().