Are Internal Capital Markets Efficient?

Abstract

Using segment information from Compustat from 1978 through 1992, we find that investment by a segment of a diversified firm depends on the cash flow of the firm's other segments. The investment by segments of highly diversified firms is larger and less sensitive to their cash flow than the investment of comparable single-segment firms. We document that diversified firms treat segments alike when they should not. In particular, the sensitivity of a segment's investment to the cash flow of other segments does not depend on whether its investment opportunities are better than those of the firm's other segments.

JEL Classification: G31, G32