NBER

Raghuram Rajan, Henri Servaes, Luigi Zingales

Bibliographic Information

NBER Working Paper No. 6368
Issued in January 1998
NBER Program(s):CF

A non-technical summary of this paper is available in the September 1998 NBER Digest.  You can sign up to receive the NBER Digest by email.

Published: Journal of Finance, Vol. 55, no. 1 (2000): 35-80. citation courtesy of

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Abstract

In a simple model of capital budgeting in a diversified firm where headquarters has limited power, we show that funds are allocated towards the most inefficient divisions. The distortion is greater the more diverse are the investment opportunities of the firm's divisions. We test these implications on a panel of diversified firms in the U.S. during the period 1979-1993. We find that i) diversified firms mis-allocate investment funds; ii) the extent of mis-allocation is positively related to the diversity of the investment opportunities across divisions; iii) the discount at which these diversified firms trade is positively related to the extent of the investment mis-allocation and to the diversity of the investment opportunities across divisions.

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