Internal capital markets and CEO power

Abstract

This paper examines the relationship between the organizational hierarchy at the highest management level and the allocation of internal financial resources within a firm. A measure of CEO influence is devised that reflects the extent of CEO power over decisions in the firm. I find that diversified firms where decisions are heavily polarized towards the CEO allocate their resources less efficiently than firms where decisions are made by a coalition of top executives. This finding suggests that a diversified firm headed by one powerful CEO is subject to higher effects of rent-seeking behavior and internal power struggles from lower level management than is a coalition of executives making investment decisions. The implications of this finding are consistent with the argument that the diversification discount is a consequence of agency problems existing between layers of management within the firm.