Corporate Governance and the Efficiency of Internal Capital Markets

This study investigates whether the governance structure of a diversified firm affects its internal capital market and the associated investment efficiencies. We propose that managers of well-governed diversified firms are more subject to the disciplinary power of shareholders and thus are less likely to undertake the inefficient capital investment between divisions. We find that the small segment investment of well-governed diversified firms has less sensitivity with regard to cash flows, but is more sensitive to growth opportunities. Our empirical results suggest that governance mechanisms play an important role in capital allocation among divisions of diversified firms.