Working Paper: NBER ID: w5639
Authors: Hyunhan Shin; René M. Stulz
Abstract: This paper investigates the divisional investment policies of diversified firms. We find that investment of the smallest division of diversified firms is significantly related to the cash flow of the other segments. We then show that the smallest division's investment is more sensitive to the cash flow of the other divisions for firms where one expects aggregate investment to be related to cash flow also, namely low q firms and firms with high leverage. This and other evidence we provide is consistent with what we call the bureaucratic rigidity hypothesis. This hypothesis states that relative allocations of investment funds in diversified firms are sticky. We fail to find support for the view that diversified firms allocate more funds to divisions in industries with better investment opportunities
Keywords: diversification; investment policy; internal capital markets; bureaucratic rigidity; free cash flow
JEL Codes: G31; G32
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Cash flow from other divisions (G39) | Investment of the smallest division (G11) |
| Cash flow of the largest division (G39) | Investment of the largest division (G31) |
| Performance of the largest division (L25) | Investment of the smallest division (G11) |
| Bureaucratic rigidity hypothesis (D73) | Stickiness in capital allocation (G31) |
| Internal capital market inefficiencies (G19) | Investment decisions (G11) |
| Free cash flow hypothesis (G19) | Investment of the smallest division (G11) |