Corporate Governance and Internal Capital Markets

by Belen Villalonga, for The Harvard Law School Forum at Harvard Law School, Febraury 16, 2010.

In our paper, Corporate Governance and Internal Capital Markets, which was recently published on SSRN, my co-author, Zacharias Sautner, and I take advantage of a unique opportunity for a natural experiment provided by a recent tax change in Germany to explore the link between corporate governance and internal capital markets. In 2002, the prevailing 52% corporate tax on capital gains from investments in other corporations was repealed, thus eliminating a significant barrier to changes in ownership structures. The tax repeal affected most large shareholders in German corporations since, in addition to companies, banks, and other financial institutions that are commonly organized in corporate form, most wealthy individual and family shareholders in Germany hold their shares through intermediate corporations (La Porta, López de Silanes, and Shleifer (1999); Franks and Meyer (2001); Faccio and Lang (2002)). Indeed, the tax change gave rise to a significant reshuffling of corporate ownership structures. This exogenous shock allows us to overcome or at least mitigate concerns about the endogeneity of ownership in estimating its effect on internal capital markets.

The significant change in ownership structures that resulted from the German tax reform offers an additional advantage from an econometric point of view: It creates a longitudinal variation that is unusual in ownership studies and which, combined with the already-large cross-sectional variation in German ownership structures, allows us to identify the effects of ownership changes and structure with much greater statistical power than what could be obtained from U.S. data. Moreover, because German corporations disclosed segment information during our sample period, we are able to compute measures of diversification and internal capital market efficiency similar to those used by other researchers on U.S. data…(continue reading)

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