442 V. Maksimovic and G. Phillips
to expropriate investors. While such distortions might occur in more complex agency
models, where top management diversifies out of career concerns or to reduce risk, it is
also plausible that the distortions be caused by intra-firm conflicts.
In the classic influence cost model of intra-firm conflict,Meyer, Milgrom and Roberts
(1992)model a resource process where lower-level managers of a firm attempt to lobby
top management to increase the investment flows available to their firm. The lobbying is
costly, but in equilibrium top managers infer the true value of investment opportunities
by observing the costly lobbying. Thus, the lobbying leads to inefficiency but does not
lead to misallocation of resources.
InScharfstein and Stein (2000), managers of divisions which lack investment oppor-
tunities have a low opportunity cost of their time and therefore engage lobbying which
is creates costs for the firm as a whole. An efficient response to such lobbying might be
for the firm’s owners to bribe the managers of weaker divisions to desist. However, the
top managers of firms are themselves the agents of the firm’s owners and this affects
how they pay off the divisional managers.Scharfstein and Stein (2000)derive con-
ditions under which top management finds it optimal to bribe troublesome divisional
managers by giving them too large a share of the investment budget rather than with
cash. This occurs because top managers cannot directly expropriate the firm’s capital
budget whereas they can extract benefits from any operating funds that they would have
used to pay divisional managers. Thus, to reduce the cost of lobbying, top management
overinvests in the divisions with poor growth opportunities.^20
A central assumption of this approach is that the top management has limited power
over the divisional managers. An alternative response by top managers who do have
such power might be to change the reporting structure within these divisions or add
extraneous task which can be easily monitored to the divisional managers’ workload so
as to increase the opportunity cost of their time and thereby reduce their propensity to
lobby. Another possibility might be for the firm to sell or spin off its weaker divisions.
Rajan, Servaes and Zingales (2000)explore another implication of limited head office
power over divisions. They argue that while top management can direct capital expen-
ditures across divisions it cannot commit to a future distribution out of the value created
by the investment. The distribution of the surplus is determined through negotiations
between divisions after the surplus has been realized. The inability of top management
to commit to a distribution means that a division’s investment choices may be distorted.
A key assumption about the ex-post bargaining process between divisions is that the
divisions’ bargaining power is influenced by their initial investment decisions. As a re-
sult, it might be in the top management’s interest to initially allocate initial investment
capital in a way that will influence the outcomes of future bargaining between divisions
over the distribution of the surplus rather than to maximize value. Given a distribution
of capital across divisions, divisional managers will update their predictions about the
(^20) See alsoFulghieri and Hodrick (1997).