The Bright Side of Internal Capital Markets


  • Naveen Khanna,

  • Sheri Tice

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    • Khanna is from the Eli Broad College of Business, Michigan State University and Tice is from the A.B. Freeman School of Business, Tulane University. The authors thank Tim Adam, George Constantinides, John Doukas, Ted Fee, Rick Green (the editor), Charlie Hadlock, Jun-Koo Kang, Bob Korajczyk, David Lesmond, Vik Nanda, Mitchell Petersen, Todd Pulvino, Paola Sapienza, Sheridan Titman, an anonymous referee, and participants at the 2001 American Finance Association Meetings, the 2000 EFMA meetings and the Eleventh Annual Financial Economics and Accounting Conference at the University of Michigan for their suggestions. Tice gratefully acknowledges research support from the J.F. Jr. and Jessie Lee Seinsheimer Faculty Research Fellowship at the A.B. Freeman School of Business.


We examine capital expenditure decisions of discount firms in response to WalMart's entry into their markets. Before WalMart's entry, focused incumbents and discount divisions of diversified incumbents are similar in size, geographic dispersion, and firm debt levels. However, discount divisions of diversified firms are significantly more productive. After WalMart's entry, diversified firms are quicker to either exit the discount business or stay and fight. Also, their capital expenditures are more sensitive to the productivity of their discount business. Internal capital markets function well, as transfers are away from the worsening discount divisions. It appears diversified firms make better investment decisions.