Tuesday, July 13, 2004

The inefficiency of internal capital markets: another part of the diversification discount ?

SSRN-Corporate Diversification and Internal Capital Markets: Evidence from the Turkish Business Groups by Halit Gonenc, Ozgur Berk Kan, Ece Karadagli:

Gonenc, Kan, and Karadagli make use of an interesting data set to give more confirmation to the view that external capital markets are more efficient than internal capital markets. They "compare the performance of firms affiliated with diversified business groups with the performance of unaffiliated firms." They find that "having a group affiliated bank affects the accounting performance measures of the group firms positively, but the market value of the group affiliated firms negatively, supporting the misallocation of capital hypothesis." This missallocation is often cited as a partial cause of the diversification discount.

One interpretation of the findings that accounting performance improves, but that stock performance does not, would be that internal markets rely more on accounting data and therefore investment is tailored to, and performance geared to, maximize the accounting returns.

Several interesting aspects to this paper:

* "unaffiliated firms use cash type seasoned equity offerings more heavily" "this supports the idea that unaffiliated firms are more bound to external markets."

* The paper focuses on 200 Turkish firms. This is important as prior research would suggest that if internal markets have an advantage it would be found in countries with capital markets less developed than the US, UK, European, and Japanese markets.

CITE: Gonenc, Halit, Kan, Ozgur Berk and Karadagli, Ece C., "Corporate Diversification and Internal Capital Markets: Evidence from the Turkish Business Groups" . EFMA 2004 Basel Meetings Paper. http://ssrn.com/abstract=500163

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