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RFS Advance Access originally published online on August 11, 2003
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Rev Fin 2003; 16:1167-1201
© 2003 the Society for Financial Studies

Cross-Subsidies, External Financing Constraints, and the Contribution of the Internal Capital Market to Firm Value

Matthew T. Billett
University of Iowa

David C. Mauer
Southern Methodist University

email: matt-billett{at}uiowa.edu

Address correspondence to David C. Mauer, Edwin L. Cox School of Business, Southern Methodist University, Dallas, TX 75275-0333, or e-mail: dmauer{at}mail.cox.smu.edu.

Abstract

We examine the link between the excess value of a diversified firm and the value of its internal capital market. Subsidies to small financially constrained segments with good relative investment opportunities significantly increase excess value, while transfers of resources from segments with good relative investment opportunities significantly decrease excess value. Of interest is that subsidies to small financially constrained segments with poor relative investment opportunities also significantly increase excess value. However, there is little evidence that this result depends on the diversity of a firm's investment opportunities. We conclude that financing constraints drive the relationship between the internal capital market and firm value.


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