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Market Structure, Internal Capital Markets, and the Boundaries of the Firm




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    • Mathews and Robinson both are at Duke University's Fuqua School of Business. We thank Jeremy Stein (the editor), an anonymous referee, as well as Kenneth Ayotte, Mike Barclay, Utpal Battacharya, Patrick Bolton, Bruce Carlin, Thomas Hellmann, Naveen Khanna, Marc Martos-Vila, John Matsusaka, Giovanna Nicodano, Gordon Phillips, Paul Povel, Manju Puri, Avri Ravid, Michael Riordan, and Merih Sevilir. We also received helpful comments from seminar participants at Columbia, Duke, Indiana, North Carolina State, Maryland, University of Southern California, the 3rd Annual Olin Corporate Governance Conference, the RICAFE–2 First Conference at the London School of Economics, the 17th Annual Conference on Financial Economics and Accounting, and the 2007 Western Finance Association Annual Meeting. Any errors are our own.


We study how the creation of an internal capital market (ICM) can invite strategic responses in product markets that, in turn, shape firm boundaries. ICMs provide ex post resource flexibility, but come with ex ante commitment costs. Alternatively, stand-alones possess commitment ability but lack flexibility. By creating flexibility, integration can sometimes deter a rival's entry, but commitment problems can also invite predatory capital raising. These forces drive different organizational equilibria depending on the integrator's relation to the product market. Hybrid organizational forms like strategic alliances can sometimes dominate integration by offering some of its benefits with fewer strategic costs.