The Role of Internal Capital Market Synergies in the Context of Credit Cycles
Speaker
Abstract
| Many studies find that diversification, on average, destroys value. Still, diversified firms are prevalent in our global economy, suggesting that diversification can be beneficial. Unlike other empirical studies that examine the aggregate impact of diversification, our interest is in the cross-sectional variation in diversified firm values. Specifically, we examine how firms can benefit from internal capital market synergies by using the internal capital market to alleviate the costs associated with external financing. We find that firms can create value by reducing their external finance dependence through their internal capital market. More importantly, we show that diversified firms can benefit from combining segments from industries with different levels of excess cash flows but only in high volatility market conditions or in weak macroeconomic conditions. Consistent with Stein’s (1997) theory we show that in normal market conditions when firms can raise funds easily and at low cost (especially large diversified firms with access to public debt market), firms are less likely to manage their internal capital markets efficiently, resulting in a potential value loss due to cross subsidization and agency conflicts. |
| Contact information: |
| Hao Jiang |
