A q Theory of Internal Capital Markets

Xavier Giroud, Min Dai, Wei Jiang and Neng Wang

No 15341, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: We propose a tractable model of dynamic investment, division sales (spinoffs), financing, and risk management for a multi-division firm that faces costly external finance. The model highlights the importance of considering the intertwined nature of the different policies. Our main results are as follows: (1) risk management considerations prescribe the allocation of resources based not only on the divisions' productivity -- as in standard models of ''winner picking'' -- but also their risk; (2) firms may choose to voluntarily spin off productive divisions to increase liquidity; (3) diversification can reduce firm value especially in low liquidity states, as it increases the cost of a spinoff and hampers liquidity management; (4) with corporate socialism, liquidity is less valuable since it is less costly to replenish the firm's liquidity through a spinoff; and (5) division-level investment is set such that the ratio between marginal q and the marginal cost of investing in each division equals the marginal value of cash.

JEL-codes: D92 G3 L25 (search for similar items in EconPapers)
Date: 2020-10
New Economics Papers: this item is included in nep-cfn
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Working Paper: A q Theory of Internal Capital Markets (2020)
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