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

Download or read book Exploitation of the Internal Capital Market and the Avoidance of Outside Monitoring written by Brandon N. Cline and published by . This book was released on 2015 with total page 40 pages. Available in PDF, EPUB and Kindle. Book excerpt: 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.