Divisional Managers and Internal Capital Markets




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    • Ran Duchin is at the Foster School of Business, University of Washington. Denis Sosyura is at the Ross School of Business, University of Michigan. We gratefully acknowledge the helpful comments from an anonymous referee, an Associate Editor, John Graham (the Coeditor), Cam Harvey (the Editor), Kenneth Ahern, Joey Engelberg, Ted Fee, Cesare Fracassi, Byoung-Hyoun Hwang, Roni Kisin, John Matsusaka, Oguzhan Ozbas, Mitchell Petersen, conference participants at the 2011 Society for Financial Studies (SFS) Cavalcade, the 2011 Financial Intermediation Research Society (FIRS) Annual Meeting, the 2011 Geneva Conference on Financial Networks, the 2011 SunTrust-FSU Spring Conference, the 2010 Financial Research Association (FRA) Annual Meeting, and seminar participants at Hebrew University, Michigan State University, Northwestern University, Ohio State University, Tel-Aviv University, the University of Michigan, the University of New South Wales, the University of Queensland, the University of Technology – Sydney, and the University of Sydney. This research was conducted when Ran Duchin was at the Ross School of Business at the University of Michigan.


Using hand-collected data on divisional managers at S&P 500 firms, we study their role in internal capital budgeting. Divisional managers with social connections to the CEO receive more capital. Connections to the CEO outweigh measures of managers' formal influence, such as seniority and board membership, and affect both managerial appointments and capital allocations. The effect of connections on investment efficiency depends on the tradeoff between agency and information asymmetry. Under weak governance, connections reduce investment efficiency and firm value via favoritism. Under high information asymmetry, connections increase investment efficiency and firm value via information transfer.