Do Financial Constraints Affect Internal Capital Markets?

Although business groups occupy strong positions in Russia, existing studies on Russian group-affiliated companies are insufficient yet to provide a thorough understanding of how the internal capital markets of business groups operate and influence corporate activities. The purpose of this paper is to assess the impact of the internal capital markets on the investments of Russian group-affiliated companies. What motivates the use of internal capital markets? Does the reallocation of intragroup funds help mitigate financing constraints of group members and facilitate their investments? To find relevant answers we apply the generalized method of moments (GMM) to estimate investments models based on data for 514 Russian companies affiliated with 48 business groups over the period from 2014 to 2018. Following the existing studies based on both Q model of investment and the Euler equation model, we analyze the relationship between subsidiaries’ investments and such factors as lagged investments, sales, leverage, asset profitability and liquidity as well as the size of both subsidiaries and their groups. The results reveal that leverage and profitability of business groups positively influence the investment activity of subsidiaries. These findings support our hypotheses that the internal capital markets of Russian business groups are active and help mitigate the financial constraints of affiliated companies. Meanwhile, we find that subsidiaries’ investment activity is negatively related to their asset profitability which is typical for tunneling or propping practices followed by controlling shareholders. The results also show some evidence of the positive relationship between subsidiaries’ cash flows and investments, demonstrating that the internal capital markets in Russia do not eliminate the financial constraints of group-affiliated companies. The findings on the internal capital markets of Russian business groups described in this paper may be useful for managers seeking for mechanisms to increase the financial resource availability for large and medium companies in the context of sanctions, macroeconomic instability and yet not sufficiently developed financial markets in Russia.

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Corporate Financial Constraints and Internal Capital Markets: Evidence from Emerging Countries

Accounting and Finance Research ◽

10.5430/afr.v6n1p25 ◽

2016 ◽

Vol 6 (1) ◽

pp. 25 ◽

Cited By ~ 1

Author(s):

Mine Ugurlu ◽

Ayse Altiok-Yilmaz ◽

Elif Akben-Selcuk

Keyword(s):

Capital Markets ◽

Financial Constraints ◽

Trade Credit ◽

Business Groups ◽

Emerging Countries ◽

Internal Capital Markets ◽

Financing Constraints ◽

Positive Relation ◽

Internal Capital ◽

Cash Flow Sensitivity

This paper investigates whether the internal capital markets of business groups mitigate the financial constraints of affiliated firms,and affect their financing policies.It aims to extend the evidence on internal capital markets to emerging countries where financing constraints are prevalent, and adds to the literature on trade credit by revealing that the distressed group-affiliated firms rely less on trade credit than their non-affiliated counterparts despite the positive relation between trade credit and distress. Group firms that have high investments in prior periods use less trade credit in the subsequent periods than non-affiliated firms. The study rests on panel data regressions covering 3906 firms from six emerging countries for the 2006-2012 period. The findings indicate that the Q-sensitivity of the investments of affiliated firms is lower than that of their unaffiliated counterparts in all countries and that the investment cash flow sensitivity of affiliates is lower in five countries, strongly indicating that group-affiliated firms are financially less constrained. The distressed group firms use significantly lower leverage than distressed unaffiliated firms despite the positive relation between distress and leverage. Group firms in high–Q industries invest less than unaffiliated firms. This paper contributes to the existing literature on internal capital markets by expanding the scope to emerging countries where market imperfections and financing constraints are more pronounced, and provides strong evidence for the role of business groups, prevalent in most emerging countries, in mitigating the constraints on the investments and financing choices of the group-affiliated firms.

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