Business groups and their internal capital markets: the foreign and Russian experience

Modern business groups have a powerful impact on the economic development of both developed and developing countries making it relevant to study the economic foundations of the success of these institutional structures. The article provides a systematization of international and national experience in the functioning of internal capital markets of business groups that can become one of most important strategic advantages of business groups by providing member companies with “exclusive” opportunities for efficient redistribution of intragroup funds. The methodological base of the study incorporates methods of systematization as well as statistical and comparative analysis. The study shows that business groups make a significant contribution to industrial production and, representing a large part of corporate sector (in terms of number of participants, industry coverage, size of assets, profits and market capitalization), play a significant role in the economic development of various countries. Internal capital markets of business groups are used to mitigate financing constraints and rescue weak member-companies, thus, help maintain and further strengthen the positions of integrated structures. Drawing on a wide range of empirical studies, the article highlights key effects of the redistribution of group financial resources in the context of three fundamental motives of controlling owners. The study demonstrates that under the current economic conditions Russian companies affiliated with business groups are imposed with more prerequisites to use internal capital markets to overcome external financing deficit. Estimated amounts of funds involved in financial transactions with related parties confirm the thesis on the growing role of Russian business groups’ internal capital markets in corporate financing activities. Results and conclusions of this paper can be applied in practice by consultants and financial managers seeking to improve the funding of companies affiliated with both Russian and foreign business groups.

Desperate House Sellers: Distress Among Developers

Using granular data on home builder housing developments from the 2006-09 housing crisis, I show that builders spread house price shocks across geographically distinct projects via their internal capital markets. Builders who experience losses in one area subsequently sell homes in unaffected areas at a discount to raise cash quickly. Financially constrained firms are more likely to cut prices of homes in healthy areas in response to losses in unhealthy ones. Firms also smooth shocks across projects only during the crisis and not during the boom. These results together suggest firm internal capital markets spread negative economic shocks across space.

The Internal Capital Markets of Global Dealer Banks

This study uncovers the existence of a trillion-dollar internal capital market that played a central role in the financing of dealer banks during the 2008 Global Financial Crisis. Hand-collecting a novel set of dealer microdata at the subsidiary level, I present the first set of facts on the evolution of interaffiliate loans between U.S. primary dealers and their (primarily foreign) siblings. First, the aggregate size of these dealer internal capital markets quadrupled from $335 billion in 2001 to $1.2 trillion by 2007. Second, 25 percent of total repurchase agreements and 61 percent of total securities lending reported on U.S. primary dealer balance sheets were sourced internally from sibling dealers by year-end 2007. Third, internal securities lending collapsed by 55 percent during the 2008 crisis. These facts suggest that incorporating internal capital market dynamics may be fruitful for future research on dealer behavior and market liquidity.

How does the internal capital market influence R&D spending? New evidence

PurposeThe purpose of this study is to examine whether and how internal capital markets mitigate financial constraints and enhance firms' willingness to engage in R&D projects.Design/methodology/approachThe study uses panel data relating to 2,095 publicly traded firms in the Chinese A-share market for the period 2007–2019. The tobit regression method is applied to explore R&D investment–cash flow sensitivity of group affiliates, while the systematic generalised method of moments and dynamic ordinary least squares models are adopted to address the endogeneity problem in the robustness test.FindingsThis study finds that firms affiliated with business groups demonstrate lower R&D investment–cash flow sensitivity than non-affiliated firms do and that R&D investments are significantly influenced by the cash reserves of other group members. In terms of financing channels, this study demonstrates that group firms use internal cash and equity financing to support other members' R&D investments, while debt financing does not influence member firms' R&D investments. In addition, this study discovers that R&D spending harms the stock and operating performance of some group members.Practical implicationsThe findings of this study enable business groups to focus on resource allocation and investment efficiency.Originality/valueAlthough prior studies indicate that internal capital markets can enhance R&D spending, few studies reveal the mechanisms through which internal capital markets benefit R&D. This study uses a unique methodology to test the ability of the internal capital market to enhance R&D spending. In addition, group firms use internal cash flow and equity financing to support partners' R&D projects.

The impact of internal and external reinsurance on insurers' performance and price

PurposeThis study is designed to investigate how the use of reinsurance affects the primary insurers' profitability and pricing on their insurance products.Design/methodology/approachThis study examines the impact of reinsurance on the insurers’ profitability using a two stage least square to control the endogeneity problem with a reinsurance variable. The study analyzes 11,894 firm-year observations between 2001 and 2009.FindingsThe study finds that the use of reinsurance in general has a negative impact on property/casualty insurers' performance. However, reinsurance obtained from affiliated firms has a positive impact on profitability, which supports the existence of internal capital markets in the insurance industry.Research limitations/implicationsThe finding of study implies that reinsurance transactions are used among affiliated insurers for not only managing underwriting risk and increasing underwriting capacity but also subsidizing capital through internal capital markets. In term of limitation, due to the availability of price data, this study uses only one insurance cycle of 9 years, albeit not weakening the findings.Practical implicationsEspecially for non-affiliated insurers, the finding suggests that they need to find an alternative way to transfer underwriting risk without having to use costly reinsurance.Originality/valueThis paper directly investigates the impact of reinsurance utilization on insurers' profitability and pricing.