Resource Allocation within Firms and Financial Market Dislocation
The Harvard Law School Forum on Corporate Governance and Financial Regulation 2013-05-01
Do firm boundaries mediate the effect of shocks to the financial intermediation sector? When the functioning of the intermediation sector is impaired – as was the case in the recent financial crisis – shocks can be transmitted to the broader economy since funds may not flow to highest value use without incurring significant cost. This issue has been extensively explored in the credit channel literature (e.g., Kashyap and Stein ; Bernanke and Blinder [1988; 1992], and Bernanke and Gertler ). However, unlike what is assumed in this literature, firms may be able to reallocate resources internally – for instance, between divisions in different industries – to ameliorate the effect of financial shocks. If so, external credit market conditions will impact the nature of resource allocation inside firms and between industries differently than they would in an economy with no internal capital markets. Diversified firms constitute a large part of economies around the world; therefore, resource allocation within firms can be of significant importance. In this paper we propose that firms shift resources between industries in response to shocks to the financial sector. We estimate a structural model to quantify the forces driving this reallocation decision, and show that these forces dampen shocks to the financial sector in economically significant ways.