Research On Internal Capital Market Efficiency And Capital Budgeting Behavior

For a long time, Capital Budgeting (CB) emphasizes on the estimating of future revenue flow and the determining of a reasonable discounted rate, these makes capital budgeting seem like a capital pricing process. It concerns a research field about how to improve the CB practice and enhance the economic analysis function to the CB process and result. And how to use modern main financial economic theory, which have been deeply developed into the internal of the firm and built up two theory aspects: asymmetry information and agency cost. As a result, CB decision process can reflect the firm organization, managerial behavior and corporation financial characteristic. The Internal Capital Market (ICM) emerged as a research concept during the 70s in the 20 century with the aim to explain the M-form enterprise's efficiency. Even though it has been ignored by the mainstream financial research field for a long time, its main idea is very useful to explain the capital allocation mechanism. This paper starts with the reviews and the summarizing on the research status of CB, and ICM, emphasizes the CB as the ICM's core function. Then according to this fundamental research setup, this paper takes a study on the CB's dynamic value model and ICM's CB incentive mechanism design. Then it's followed by an empirical testing about the CB in a condition of ICM.By having completed this research , this paper gets the following main meaningful and innovative contributions.Firstly, it makes up a formal ICM's structure-Conduct- Performance analysis framework,and gives a clearly definition of Internal Capital Market and its relation with capital budgeting.And it builds up a integrated analysis framework of its operation and control process which combines corporation strategy , corporation governance and risk control process,so thatmanagers can master the relation between improving ICM's efficiency and grasping investment opptunity . These frameworks will contribute to the normative and positive research of ICM.Secondly, based on information asymmetry and agency cost theory,this paper builds up a dynamic model with financial constraints for capital budgeting, and uses GMM method to estimate the financial constraint (FC) and agency cost (AC), thus conducts an Advanced-NPV CB method in the NPV practice.Thirdly, According to CB rent , adverse selection and moral hazard, the paper constructs a complete internal capital market contract model and conducts some propositions. These propositions show that the capital budgeting rent is a martingale by control internal capital market rationally.The last contribution of the paper is to have an empirical research to test China ICM efficiency. Based on FHP empirical model which has been widely used during 90s in the 20 century, this paper use it to test ICM' s income result and its efficiency. The empirical result shows that China companies can improve ICM efficiency by releasing financial constraint and controlling agency cost. But ICM' s long- time contribution to the company is negative (which is also named diversification discount).These two results show the agency cost in China companies is significant, furthermore, by using seasonal budgeting data, this paper tests and shows that China companies have a special agency cost—budgeting soft-onstraint.