Incentives in Internal Capital Markets: Capital Constraints, Competition, and Investment Opportunities

Roman Inderst and Christian Laux

RAND Journal of Economics, 2005, vol. 36, issue 1, 215-228

Abstract: We examine the effect of competition for scarce corporate financial resources on managers' incentives to generate profitable investment opportunities. Operating an active internal capital market is unambiguously beneficial only if divisions have the same level of financial resources and the same investment potential. Otherwise, managers' incentives may be lower and an internal capital market may decrease firm value even though headquarters allocates capital efficiently. We analyze under which conditions the operation of an internal capital market is more likely to add value, and we derive implications for the boundaries of firms, for a potential conglomerate discount or premium, and for the role of incentive pay for division managers.

Keywords: Capital Budgeting; Investment Policy; cost of capital Firm Organization and Market Structure: Markets vs. Hierarchies; Vertical Integration; Conglomerates Firm Value; Firm; Firms; Investment (search for similar items in EconPapers)
JEL-codes: G31 L22 (search for similar items in EconPapers)
Date: 2005
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Citations: View citations in EconPapers (31)

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Persistent link: https://EconPapers.repec.org/RePEc:rje:randje:v:36:y:2005:1:p:215-228

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