Ch. 8: Conglomerate Firms and Internal Capital Markets 455
Lamont’s (1997)interpretation has been queried bySchnure (1997). Schnure exam-
ines the cash positions of the 26 oil companies over the period 1985–1986 and finds little
evidence that they faced cash constraints. For example, more than half the oil compa-
nies in the sample repurchased stock in 1986, many increased dividends and the cash
holdings of the sample increased substantially in 1986. This suggests that the relation
between the oil price shock and the investment by non-oil segments of oil companies
is more complex than the simple transmission of a negative shock via internal capital
markets.^28
Khanna and Tice (2001)examine the responses of discount retailers in response to
Wal-Mart’s entry into their local markets in the period between 1975 and 1996. Prior to
Wal-Mart’s entry most markets had several incumbent discount retailers. Khanna and
Tice identify 24 stand-alone incumbent discount retailers and 25 incumbent discount
divisions of diversified firms. They examine the effect of organizational form by study-
ing the incumbents’ responses to Wal-Mart’s entry while controlling for factors such as
productivity and size.
Khanna and Tice find that conditional on staying in a market following Wal-Mart’s
entry, diversified firms invest more than focused firm and their investment in more sen-
sitive to their own productivity levels than that of focused firms. They find evidence that
diversified firms transfer funds away from failing discount divisions. Moreover, diversi-
fied firms appear to be quicker in deciding whether to stay and compete with Wal-Mart
or to exit the market.
Some caveats are in order. The diversified firms in Khanna and Tice are for the most
part retailers, albeit with non-discount divisions. Thus, their study addresses the effect
of capital markets in related diversification. The discount retailing divisions of diver-
sified firms tend to be more productive than the stand-alone firms with which they are
compared, raising the possibility of self-selection in the decision to become diversified.
However, overall Khanna and Tice conclude that internal capital markets work well for
these firms and that the competitive responses of diversified firms are more efficient
than those of focused retailers.
Campello (2002)examines the internal capital markets in financial conglomerates
(bank holding companies) by comparing the responses of small subsidiary and indepen-
dent banks to monetary policy. These conglomerates are not diversified across different
industries. The advantage of examining diversification within an industry is that it is
easier to control for differences in their investment opportunities. Campello finds that
internal capital markets in financial conglomerates relax the credit constraints faced by
smaller bank affiliates and that internal capital markets lessen the impact of Fed policies
on bank lending activity.
Guedj and Scharfstein (2004)contrast the research and development strategies and
subsequent performance of small biopharmaceutical firms with those of more mature
(^28) The model inRajan, Servaes and Zingales (2000)suggests that the relative decline in the investment
opportunities in oil have made the oil segment less willing to acquiesce to uneconomic transfers to other
segments.