Revisiting Internal Capital Market Efficiency: A Strategic View

The empirical literature on internal capital markets (ICM) implicitly has assumed that capital allocations are efficient when headquarters shift more capital to divisions operating in industries with more attractive investment opportunities. In this study, we challenge this one-size-fits-all industry-comparing logic, arguing that it overlooks the role of firm-specific idiosyncrasies in shaping capital allocation decisions. We introduce firm-specific industry effects (FSIE) as a novel firm-level construct that captures the extent to which the performance of a firm’s divisions is driven by industry factors rather than firm-level characteristics. This measure reflects the relevance of industry trends for a firm’s capital allocation decisions and, consequently, the extent to which the firm is expected to strategically—that is, purposefully and with the aim of creating value—conform to (or deviate from) industry-comparing logics of capital allocation. Our empirical results show that FSIE is associated with firms’ conformity to such a logic of capital allocation. A post hoc analysis further demonstrates that the value-creating effect of such a conformity depends on the extent to which it is systematically driven by FSIE. Specifically, firm value is associated with conformity to the industry-comparing logic of allocation only when such a conformity systematically covaries with FSIE. These findings suggest that the prevailing literature on ICM may have overestimated inefficiency and value destruction in multi-business firms by overlooking how firm idiosyncrasies affect capital allocation strategies. More broadly, our study highlights the importance of considering FSIE in understanding when industry-level characteristics provide a relevant basis for corporate-level decisions.

Supplemental Material: The online appendix is available at https://doi.org/10.1287/stsc.2022.0053.