Power Plays: Intra-Firm Corporate Connections and Firm Value

Abstract

We study the role played by personal connections between divisional managers and the CEO on the allocation of resources within large corporate organizations. Connections can work to improve the flow of information within the organization (information hypothesis) or enhance the bargaining power of the connected divisional managers at the expense of the other managers (power hypothesis). Using data on a large sample of multi-segment US corporations from 1996 to 2004, we provide evidence in favor of the latter. We show that the segments run by connected managers receive more investment and exhibit lower sensitivity to their own cash flow short-falls (and more sensitivity to the other segments' cash-flow). At the firm-level, having more connected managers presiding over more productive segments improves the transfer of resources by preventing transfers to the less productive segments. Having more connected managers in charge of more productive segments is associated with a lower conglomerate discount. We also find evidence that the market uses the CEO-manager connections as a signal about the quality of governance of the firm.