Financial Frictions, Internal Capital Markets, and the Organization of Production

This paper evaluates the role of internal capital markets in business groups for allocating capital to its most productive use. A quantitative model in which business groups arise endogenously as substitutes for imperfect credit markets explains several stylized facts about establishment size distribution and cross-firm productivity differences. The impact of internal capital markets on economic development is positive: shutting down business conglomeration in the model calibrated to the Canadian economy would lead to a 3 percent reduction in output per capita. These losses are higher in economies with less developed financial markets. (Copyright: Elsevier)