Three Essays on Strategic Capital Allocation

Abstract

The capital allocation process is a critical component of strategic execution for multidivisional firms. Despite this importance, strategy scholars have ceded much of the empirical work in capital allocation efficiency to the domains of finance and economics. The bulk of this research, as well as evidence from prominent field studies in strategic management, concludes that managers make significantly inefficient capital allocation decisions—a result that should be of concern to business managers and strategy scholars alike. This paper asks whether managers are truly allocating capital so inefficiently, or do they instead have a valid strategic rationale that explains their investment decisions. Building off the general framework of internal capital market efficiency from financial economics, this paper develops a new measure of strategic capital allocation. The new approach introduces a multidimensional measure to capture the strategic trade-offs between future growth and current profitability, which are faced by managers during the complex resource allocation process. In the first stage of the empirical analysis, managers are found to be allocating capital more than twice as efficiently than prior literature suggests. The second stage validates this multidimensional approach by demonstrating the predicted theoretical relationship between a strategic measure of capital allocation and firm-level value, namely, that managers appear to be capable of enhancing performance through strategic capital allocation.