Using profits to re-estimate efficiency of internal capital markets

Abstract

Internal capital markets (ICM) are fundamental to conglomerates and business groups across developed and developing economies. ICM can be opportunistic or benevolent, but its efficiency assessment remains a pressing question. We focus on measuring the profit efficiency of giver firms using a novel methodology based on data envelopment analysis (DEA). We also explore heterogeneity across group firms based on ownership and governance. Overall, ICM investments are efficiency-reducing, more so for firms with higher outsider ownership. Monitoring reduces inefficiency. These findings have strong methodological, policy, and financing implications and call for caution from lenders and investors of diversely held group firms.