Internal capital markets and investment efficiency: Evidence from Japanese industrial groups

Using a sample of 11,629 firm-years between 1993 and 1998, I examine the investment policies of firms in Japanese industrial groups. My findings indicate that internal capital markets among keiretsu firms are active. Investment at the firm level is positively correlated with cash flows from the remainder of the keiretsu. The investment of keiretsu firms is not sensitive to ex-ante proxies of growth opportunities, but rather is highly correlated with cash flow. Conversely, the investment of independent firms is positively correlated with ex-ante proxies for growth opportunities. These differences in the determinants of investment are most pronounced for firms with high cash flow levels and high growth opportunities. Not only is the investment of high cash flow, high growth opportunity firms in horizontal groups most influenced by their cash flow level, but these firms also are less valuable than their independent firm peers. The evidence is consistent with the view that the reallocation of capital within the keiretsu is not value maximizing.