Integration and corporate investment

This thesis consists of three chapters that broadly investigates, theoretically and empirically, the effect of firm boundaries and organizational processes on internal resource allocation and corporate investment. In the first chapter, I develop an equilibrium model of internal competition for corporate resources and show that managers of integrated firms exaggerate the quality of their projects to get funding. Moreover, I show that the problem gets worse with increased integration and puts an endogenous limit on the amount of value-enhancing redistribution that can be achieved in an integrated firm. I then argue that the control rights that come with asset ownership enable a firm to set "the rules of the game" and mitigate negative managerial behavior through organizational processes such as rigid capital budgets, job rotation, centralization and hierarchies. These results point to a comparative advantage that a firm has over other financial intermediaries in allocating resources. In the second chapter, I empirically explore the effect of integration on the allocation of resources. Specifically, I find that integrated firms use stale information in their investment decisions. In addition, they have more rigid capital budgets and consequently are less responsive to investment opportunities than non-integrated firms. Using a novel approach to identify related segments, I find that the effects are stronger for diversified integrated firms that are engaged in unrelated lines of business. These empirical findings lend support to the theory developed in Chapter 1.