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 that faces costly external finance. The model highlights the importance of considering the intertwined nature of the different policies. Our main results are as follows: (1) risk management considerations prescribe the allocation of resources based not only on the divisions' productivity -- as in standard models of ''winner picking'' -- but also their risk; (2) firms may choose to voluntarily spin off productive divisions to increase liquidity; (3) diversification can reduce firm value especially in low liquidity states, as it increases the cost of a spinoff and hampers liquidity management; (4) with corporate socialism, liquidity is less valuable since it is less costly to replenish the firm's liquidity through a spinoff; and (5) division-level investment is set such that the ratio between marginal q and the marginal cost of investing in each division equals the marginal value of cash.
We thank Gregor Matvos and Raghu Rajan for helpful comments. Min Dai acknowledges the support of Singapore AcRF grants (No. R-703-000-032-112, R-146-000-306-114, and 146-000-311-114) and NSFC (No. 11671292). The views expressed herein are those of the authors and do not necessarily reflect the views of the National Bureau of Economic Research.