New perspectives on capital allocation

This dissertation consists of three essays. The first essay compares capital investment behavior in multi- and single-business companies in order to assess the efficiency of internal capital markets. I analyze archival field data from a cross-sectional sample of business units belonging to U.S. companies and identify a number of empirical regularities that do not accord with a rational account of internal capital markets. First, I find that multi-business firms invest more intensively in cash-needy unprofitable businesses than single-business firms. Second, I find that single-business firms invest more intensively in cash-needy profitable businesses than multi-business firms. Finally, I find no evidence that the higher level of investment on cash-needy unprofitable businesses in multi-business firms results in a higher success rate in making those businesses profitable over time. I suggest a number of potential explanations for these empirical patterns.;In the second essay, I investigate the effect on capital investment of the relative size of a business with respect to the size of the rest of its corporation. I find that capital expenditures (normalized by assets) are higher when a business is smaller relative to the rest of its firm, holding everything else constant. This result agrees with the finance literature that claims that internal capital markets are inefficient in allocating capital. Moreover, it provides evidence that managers at the top of the corporation might be biased toward even allocations to all their businesses. I suggest a cognitive behavioral account to explain this phenomenon, namely, that managers experience a "naive diversification" bias that leads them to put "too much" in smaller businesses and "too little" in bigger ones, after controlling for investment opportunities and overall size. The conclusions of this essay are relevant to how organizational structure affects investment behavior.;In the third essay, I explore the role of a cognitive bias known as naive diversification in organizational capital allocation decisions by managers. The essay advances a methodology for cleanly demonstrating a counter-normative bias toward even allocation. I use archival data to show that firms' internal capital allocations are biased toward equality over the number of business units into which the firm is partitioned. In three further experimental studies, I show that this bias persists in a simplified experimental setting in which social/political and incentive-based mechanisms can be ruled out.