Working Paper: CEPR ID: DP15341
Authors: Min Dai; Xavier Giroud; Wei Jiang; Neng Wang
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.
Keywords: internal capital markets; multidivision firms; risk management; corporate socialism
JEL Codes: D92; G3; L25
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Risk management considerations (G52) | Resource allocation (D45) |
| Higher risk divisions (C46) | Resource allocation (D45) |
| Firms' liquidity needs (G33) | Decision to spin off divisions (L22) |
| Cash flow needs (D25) | Decision to spin off divisions (L22) |
| Diversification (G11) | Firm value (G32) |
| Corporate socialism (P16) | Firm value (G32) |
| Corporate socialism (P16) | Underinvestment (G31) |
| Division-level investment decisions (G11) | Investment decisions (G11) |