THE JOURNAL OF FINANCE • VOL. LXVIII, NO. 2 • APRIL 2013
Divisional Managers and Internal Capital Markets
RAN DUCHIN and DENIS SOSYURA ABSTRACT
Using hand-collected data on divisional managers at S&P 500 ﬁrms, we study their role in internal capital budgeting. Divisional managers with social connections to the CEO receive more capital. Connections to the CEO outweigh measures of managers’ formal inﬂuence, such as seniority and board membership, and affect both managerial appointments and capital allocations. The effect of connections on investment efﬁciency depends on the tradeoff between agency and information asymmetry. Under weak governance, connections reduce investment efﬁciency and ﬁrm value via favoritism. Under high information asymmetry, connections increase investment efﬁciency and ﬁrm value via information transfer.
DIVISIONAL MANAGERS PLAY AN important role in theories of internal capital markets. The bright-side view posits that internal capital markets beneﬁt from stronger control rights and superior information provided by divisional managers, which enable the CEO to make better allocation decisions.1 The darkside view holds that internal capital markets suffer from agency motives of divisional managers and the CEO, who pursue private interests.2 The importance of divisional managers in the theoretical literature is also supported by
Ran Duchin is at the Foster School of Business, University of Washington. Denis Sosyura is at the Ross School of Business, University of Michigan. We gratefully acknowledge the helpful comments from an anonymous referee, an Associate Editor, John Graham (the Coeditor), Cam Harvey (the Editor), Kenneth Ahern, Joey Engelberg, Ted Fee, Cesare Fracassi, Byoung-Hyoun Hwang, Roni Kisin, John Matsusaka, Oguzhan Ozbas, Mitchell Petersen, conference participants at the 2011 Society for Financial Studies (SFS) Cavalcade, the 2011 Financial Intermediation Research Society (FIRS) Annual Meeting, the 2011 Geneva...