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The Dark Side of Internal Capital Markets: Divisional Rent‐Seeking and Inefficient Investment
Author(s) -
Scharfstein David S.,
Stein Jeremy C.
Publication year - 2000
Publication title -
the journal of finance
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 18.151
H-Index - 299
eISSN - 1540-6261
pISSN - 0022-1082
DOI - 10.1111/0022-1082.00299
Subject(s) - rent seeking , compensation (psychology) , great rift , agency (philosophy) , investment (military) , microeconomics , capital (architecture) , agency cost , business , bargaining power , subsidy , economics , market economy , labour economics , monetary economics , finance , shareholder , psychology , archaeology , epistemology , astronomy , politics , political science , psychoanalysis , law , history , corporate governance , philosophy , physics
We develop a two‐tiered agency model that shows how rent‐seeking behavior on the part of division managers can subvert the workings of an internal capital market. By rent‐seeking, division managers can raise their bargaining power and extract greater overall compensation from the CEO. And because the CEO is herself an agent of outside investors, this extra compensation may take the form not of cash wages, but rather of preferential capital budgeting allocations. One interesting feature of our model is that it implies a kind of “socialism” in internal capital allocation, whereby weaker divisions get subsidized by stronger ones.