| The theoretical literature emphasizes that internal capital markets play an important role in the allocation of capital when costly monitoring exists in combination with information and incentive problems, where an internal capital market consists of all agents and mechanisms within a firm that influence the intra-firm allocation of capital. For U.S. firms, approximately 75% of capital expenditure funding comes from internal operations. This suggests that internal capital markets heavily influence investment efficiency at both the firm and macro levels. In theory, internal capital markets may either enhance or reduce firm value. For example, Stein (1997) develops a model in which an internal capital market creates value in the presence of binding capital constraints through the pooling of capital resources and investment projects from multiple divisions and then allocating capital to its best use. The internal capital market imposes soft rationing on divisions with poorer investment opportunities in order to cross-subsidize divisions (i.e., to shift additional capital to a division) with better investment opportunities. Alternatively, it is argued that internal capital markets win inefficiently subsidize poorly performing divisions if agency problems between headquarters (the central authority of an internal capital market) and managers of poorly performing divisions are severe (Myer, Milgrom, and Roberts, 1992; and Scharfstein and Stein, 1997).;The two primary objectives of this research are to provide further evidence concerning the value effects of internal capital market cross-subsidization, and to investigate the impact of a firm's scope of international operations on the firm's internal capital market efficiency. Spinoffs provide the empirical setting for this study because a spinoff breaks up an existing internal capital market and we can observe the capital expenditures of the subsidiary before and after the spinoff distribution. |
