DP14478 Mis-allocation Within Firms: Internal Finance and International Trade

Author(s):	Sebastian Doerr, Dalia Marin, Davide Suverato, Thierry Verdier
Publication Date:	March 2020
Date Revised:	March 2020
Keyword(s):	China shock, Conglomerate discount, Internal Capital Markets, multi-product firms, trade and organization
JEL(s):	D23, F12, G30, L22
Programme Areas:	Financial Economics, International Trade and Regional Economics
Link to this Page:	cepr.org/active/publications/discussion_papers/dp.php?dpno=14478

We develop a novel theory of mis-allocation within firms (rather than between firms) due to managers' empire building. We introduce an internal capital market into a two-factor model of multi-segment firms. We show that more open markets impose discipline on competition for capital within firms, which explains why exporters exhibit a lower conglomerate discount than non-exporters (a fact that we establish). Testing our model with data on US companies, we establish that import competition reduces mis-allocation within firms. A one standard deviation increase in Chinese imports lowers the conglomerate discount by 32% and over-reporting of costs by up to 15%.