The efficiency of internal capital markets: Evidence from the Annual Capital Expenditure Survey

Does firm diversity result in an efficient or inefficient allocation of capital? Are diversified firms “value creating” or “value destroying”? We apply a panel data model to examine the relationship between firm diversity and firm value using both COMPUSTAT and the Annual Capital Expenditure Survey (ACES) data. Our main empirical result confirms that firm diversity is negatively related to the efficiency of investment (firm value), which is consistent with the majority findings of recent studies. However, once we distinguish between capital expenditure for structures and equipment, we find that while firms do inefficiently allocate capital for equipment, they efficiently allocate capital for structures. These results suggest that when the decision has long-lasting repercussions, headquarters will, more often than not, make the correct choice.