Do Internal Capital Markets in Business Groups Reduce Financial Constraints?

22 Pages Posted: 23 Feb 2016 Last revised: 24 Nov 2016

See all articles by Guilherme Kirch

Guilherme Kirch

Universidade Federal do Rio Grande do Sul (UFRGS)

Luiz Ricardo Kabbach-Castro

Universidade de São Paulo (USP); Universidad de Navarra

Date Written: September 1, 2016

Abstract

We develop a simple model of investment in business groups subject to moral hazard. Our model suggests that productivity and pledgeable income are the drivers of resources in the internal capital markets of these groups. This prediction can be use to explain on the grounds of efficiency some results that have been interpreted in the literature as evidence of "socialist" cross-subsidization in business groups. One important implication of our model is that group firms with strong financial conditions (high pledgeable income) tend to be favored by the internal capital market while group firms with weak financial conditions (low pledgeable income) tend to give support to it. This is in sharp contrast with the hypothesis that internal capital markets in business groups can overcome the failures of external finance markets. However, this doesn't mean that internal capital markets are detrimental to economy. Finally, we derive novel empirical implications from our model that can be object of future empirical works.

Keywords: Internal Capital Markets, Business Groups, Financial Constraints, Corporate Governance, Efficient Capital Allocation

JEL Classification: G31, G32, L22

Suggested Citation

Kirch, Guilherme and Kabbach-Castro, Luiz Ricardo, Do Internal Capital Markets in Business Groups Reduce Financial Constraints? (September 1, 2016). Available at SSRN: https://ssrn.com/abstract=2736265 or http://dx.doi.org/10.2139/ssrn.2736265

Guilherme Kirch (Contact Author)

Universidade Federal do Rio Grande do Sul (UFRGS) ( email )

Rua Washington Luiz, 855
Porto Alegre, RS, 90010-460
Brazil
+55 51 33083836 (Phone)

HOME PAGE: http://www.ea.ufrgs.br

Luiz Ricardo Kabbach-Castro

Universidade de São Paulo (USP) ( email )

Brazil
+551633738642 (Phone)
+551633739425 (Fax)

HOME PAGE: http://www.ceef.prod.eesc.usp.br

Universidad de Navarra ( email )

Campus Universitario
Pamplona, Navarra 31009
Spain
683623704 (Phone)

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