472 V. Maksimovic and G. Phillips
- On balance, industry case studies and econometric analyses of firm growth suggest
that internal capital markets are efficient in reallocating resources. - Even controlling for productivity, main and peripheral segments of diversified firms
are treated differently. Main divisions grow faster, are less likely to be cut back in
recessions, and less likely to be sold.
In our review of the evidence and econometric results, we have come to the con-
clusion that diversified firms predominantly behave like value maximizers given their
productivity and internal capital markets facilitate the efficient transfer of resources.
The evidence is broadly consistent with firms making endogenous value-maximizing
choice of organizational form and allocating resources across industries consistent with
a neoclassical model of resource allocation.
However, there is a large part of the literature that reaches different a conclusion,
that conglomerate firms usually misallocate resources. Given the latest evidence, we are
unable to reach this conclusionfor the majorityof conglomerate firms. However, there
is some evidence that conglomerate firms that are busted up had investment patterns that
varied from the neoclassical model. In addition, other puzzles do remain. In particular,
the differences in growth patterns of main and peripheral divisions of diversified firms
still have to be explained.
The conclusion that internal capital markets do not, on average, promote resource
misallocation does not imply that firms are not subject to agency problems. Managers
may allocate resources efficiently, but then expropriate the shareholder value created
using those resources. Similarly, diversified firms may overpay for acquisitions that
increase the firm’s total value added from manufacturing activities.
More generally, the empirical literature on internal capital markets is an excellent case
study of the importance of specifying the underlying benchmark model, paying attention
to strengths and weaknesses of alternative data sources, and addressing econometric
issues such as sample selection and measurement error. Seemingly reasonable choices
at any of these steps are fully capable of leading to different results. As a result, the area
remains of active interest to researchers.
Appendix A. Neoclassical model of resource allocation across industries
In this appendix we illustrate how demand shocks affect the relative resource alloca-
tion and output of efficient and inefficient producers in an industry and also efficient
and inefficient segments within a multi-industry setting. The exposition is based on the
working paper version ofMP (2002)and complements the discussion in Section3.5.
We begin by analyzing how firms change capacity in response to demand shocks in
a single industry and then generalize the model to multiple industries. We also discuss
how these predictions differ from those of agency models in the literature.
A.1. Shocks and growth in a single industry
We first analyze the relative growth rates and the flow of assets between differing pro-
ductivity over the business cycle in a single industry. Accordingly, in this subsection we