Firm aging and internal capital markets

Abstract

Internal capital markets (ICMs) can induce diversified firms to misallocate capital across divisions, thereby causing overinvestment in unpromising opportunities at the expense of more promising ones. This study highlights the role of age-based organizational rigidity in generating this phenomenon. Our analysis of Japanese firms reveals a robust inverse association between allocative efficiency and firm age. This relationship is particularly salient when a firm has assets decreasing its flexibility and when the incongruence of divisional interests in capital allocation is large. Moreover, this effect is not attributable to interfirm differences in external capital access, agency costs, or organizational members' traits. These results suggest that age-based rigidity plays a central role in lowering older firms' allocative efficiency. We also find that despite this adverse effect of aging on capital allocation, diversification mitigates the decline in growth opportunities for older firms.