Internal Capital Markets, Non-Cash Divestitures and Managerial Incentives

Abstract

Management compensation contracts are postulated to alleviate the principal-agent conflict in widely-held firms. This paper studies the efficiency of managerial incentives in internal capital markets. The incentives, measured as stock option delta and stock option vega, are estimated based on the entire holdings of manager’s stock and stock options including all the new and previously made grants. Consistent with the finance theory, I find that in internal capital markets the incentives are designed and administered in a sub-optimal way. Moreover, I find that a break-up does not constitute a solution to the agency conflicts that arise inside a complex firm. To the contrary, the evidence suggests that a break-up may be used as a vehicle to derive private benefits of control. This last result contradicts the theoretical predictions found in Scharfstein and Stein (2000).