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Internal Versus External Capital Markets

Robert H. Gertner, David S. Scharfstein and Jeremy C. Stein
The Quarterly Journal of Economics
Vol. 109, No. 4 (Nov., 1994), pp. 1211-1230
Published by: Oxford University Press
Stable URL: http://www.jstor.org/stable/2118361
Page Count: 20
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Internal Versus External Capital Markets
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Abstract

This paper presents a framework for analyzing the costs and benefits of internal versus external capital allocation. We focus primarily on comparing an internal capital market with bank lending. While both represent centralized forms of financing, in the former case the financing is owner-provided, while in the latter case it is not. We argue that the ownership aspect of internal capital allocation has three important consequences: (1) it leads to more monitoring than bank lending; (2) it reduces managers' entrepreneurial incentives; and (3) it makes it easier to efficiently redeploy the assets of projects that are performing poorly under existing management.

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