A q Theory of Internal Capital Markets

We propose a tractable model of dynamic investment, division sales (spinoffs), financing, and risk management for a multi-division firm facing costly external finance. Our main results are: (1) within-firm resource allocation is based not only on the divisions’ productivity—as in standard “winner picking” models—but also their risk; (2) firms may choose to voluntarily spin off productive divisions to increase liquidity; (3) diversification can reduce firm value in low liquidity states, as it hampers liquidity management; (4) corporate socialism makes liquidity less valuable; (5) division investment is determined by the ratio between marginal q and marginal value of cash.