Exploitation of the Internal Capital Market and the Avoidance of Outside Monitoring

40 Pages Posted: 7 Nov 2013 Last revised: 30 Jul 2015

See all articles by Brandon N. Cline

Brandon N. Cline

Mississippi State University

Jacqueline L. Garner

Georgia Institute of Technology - Scheller College of Business

Adam S. Yore

University of Missouri at Columbia - Department of Finance

Date Written: October 17, 2013

Abstract

Internal capital markets (ICMs) provide firms an alternative to costly external financing; however, they also provide an avenue to avoid the monitoring associated with issuing external capital. We argue that firms operating inefficient internal capital markets will avoid outside financing. Consistent with this view, conglomerates that cross-subsidize divisions or engage in value-destroying investment avoid external capital market oversight by refraining from issuing both debt and equity. We further show that firms issuing bonds while engaging in value-destroying investment experience yield spreads that are, on average, 46 basis points higher than that of other diversified firms. They similarly experience yield spreads that are 18 basis points higher when they issue syndicated loans. Value-destroying conglomerates also witness SEO announcement returns that are, on average, 1% more negative than firms operating more efficient internal capital markets.

Suggested Citation

Cline, Brandon N. and Garner, Jacqueline L. and Yore, Adam S., Exploitation of the Internal Capital Market and the Avoidance of Outside Monitoring (October 17, 2013). Journal of Corporate Finance, Vol. 25, No. 1, 2014, Available at SSRN: https://ssrn.com/abstract=2350514 or http://dx.doi.org/10.2139/ssrn.2350514

Brandon N. Cline

Mississippi State University ( email )

Mississippi State, MS 39762
United States
662.325.7477 (Phone)
662.325.1977 (Fax)

Jacqueline L. Garner (Contact Author)

Georgia Institute of Technology - Scheller College of Business ( email )

800 West Peachtree St.
Atlanta, GA 30308
United States

Adam S. Yore

University of Missouri at Columbia - Department of Finance ( email )

403 Cornell Hall
Columbia, MO 65211
United States
573-884-1446 (Phone)

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