Does Diversification Affects the Efficiency of Firmss Financing? Theory and Evidence from the Euro Area

Abstract

The paper investigates firms’ financing behavior, contrasting samples of members of active internal capital markets (ICM) and comparable stand-alone peers, in terms of cost of capital, capital structure, and the speed of adjustment towards preferred capital structure. Univariate results document that ICM participants exhibit lower costs of capital, higher financial leverage ratios than their counterparts, and both ICM and stand-alone firms tend to have preferred target leverage ratios. Regression results document that both ICM members and single-segment firms, adjust dynamically their financial leverage towards their preferred targets at different speeds. Findings suggest that ICM membership mitigates incentive and informational problems.