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This paper aims to examine the relationship between diversified investment and the operation of the internal capital market, and then further investigate the impact of corporate governance mechanism on the relationship between them. Using a sample of group-affiliated firms listed on the Shanghai and Shenzhen Stock Exchanges in China, from 2010 to 2017, we find that the operation of internal capital market Granger-causes the diversified investment and both of them have a non-linear relationship. Moreover, we also find that four factors of corporate governance mechanism (the type of ownership, the fraction of independent directors, managerial ownership, and whether the CEO is also the chairman of the board) have different moderating effects on the relationship between diversified investment and the operation of internal capital market. In addition, we conclude that the internal capital market plays a central role in the diversified investment strategy and improving corporate governance mechanism helps strengthen the relationship between diversified investment and the operation of the internal capital market.

Diversified Investment Strategy and the Operation of Internal Capital Market: The Moderating Effect of Corporate Governance Mechanism