Internal Capital Market in Emerging Markets: Expropriation and Mitigating Financing Constraints

Abstract

This paper studies internal capital market in emerging market business groups using Chinese data. We focus on two aspects of the internal capital market that are less prominent in the developed markets: a cross-financing to get over severe financing constraints that are often prevalent in emerging market economies, and the rampant expropriation of minority shareholders under the weak corporate governance environment. We document the existence and interaction of both in China and discuss the implication of the efficiency of internal capital markets in emerging market. We found that the internal capital market is the least inefficient when weak corporate governance induce more tunneling activities and there is no big need for mitigating financing constraints. On the other hand, when the corporate governance is relatively stronger and firms have a pressing need to use the internal capital market to mitigate financing constraints, the efficiency of the internal capital market is the highest.