DP2935 Internal Capital Markets, Cross-Subsidization and Product Market Competition

Author(s): Giacinta Cestone, Chiara Fumagalli
Publication Date: September 2001
Keyword(s): business groups, conglomerate discount, cross-subsidization, internal capital markets, product market competition
JEL(s): G30, L13, L20
Programme Areas: Financial Economics, Industrial Organization
Link to this Page: www.cepr.org/active/publications/discussion_papers/dp.php?dpno=2935

This Paper analyses the interaction between internal capital market allocations and product market competition. It is argued that diversification and divestiture are both rational responses to anticipated changes in the competitive environment. Diversification is the optimal response to an anticipated toughening of competition, whereas divestiture may encourage competitors to adopt collusive pre-commitments. Moreover, thanks to the ability to shift resources across units, a diversified business group can consolidate its market power across industries. Our results yield empirically testable predictions relating the stock-market reaction to diversification announcements and the diversification premium to product market factors.