Corporate capital allocation: a behavioral perspective
Article first published online: 27 OCT 2011
Copyright © 2011 John Wiley & Sons, Ltd.
Strategic Management Journal
Volume 32, Issue 13, pages 1465–1483, December 2011
How to Cite
Bardolet, D., Fox, C. R. and Lovallo, D. (2011), Corporate capital allocation: a behavioral perspective. Strat. Mgmt. J., 32: 1465–1483. doi: 10.1002/smj.966
- Issue published online: 27 OCT 2011
- Article first published online: 27 OCT 2011
- Accepted manuscript online: 28 SEP 2011 09:19AM EST
- Manuscript Revised: 31 AUG 2010
- Manuscript Received: 24 DEC 2008
- partition dependence;
- naïve diversification;
- capital allocation
Previous research on capital investment has identified a tendency in multibusiness firms toward cross-subsidization from well-performing to poorly performing divisions, a phenomenon that has previously been attributed to principal-agent conflicts between headquarters and divisions (Stein, 2003). In this paper, we argue that cross-subsidization reflects a more general tendency toward even allocation over all divisions in multibusiness firms that is driven, at least in part, by the cognitive tendency to naïvely diversify when making investment decisions (Benartzi and Thaler, 2001). We observe that this tendency also leads to partition dependence in which capital allocations vary systematically with the divisions and subdivisions into which the firm is organized or over which capital is allocated. Our first study uses archival data to show that firms' internal capital allocations are biased toward equality over the number of business units into which the firm is partitioned. Two further experimental studies of experienced managers examine whether this bias persists when participants are asked to allocate capital to various divisions of a hypothetical firm. This methodology eliminates the possibility of agency conflicts. Nevertheless, allocations varied systematically with the divisional and subdivisional structure of the firm and with a centralized or decentralized capital allocation manner. Copyright © 2011 John Wiley & Sons, Ltd.