Essays in corporate finance

Abstract

This dissertation presents three essays in Corporate Finance. In the first essay, I study managerial incentives in internal capital markets. In particular, I develop a two-tiered agency model to study division managers' incentives within internal capital markets. Division managers try to influence the external capital market's assessment of the firm and the internal capital market's assessment of their divisions in order to increase their level of funding. I show that, as the number of divisions increases, the external capital market's assessment of the firm becomes a public good for division managers, and the internal capital market replaces the external capital market in the provision of managerial incentives. I also show that, while diversified firms have an advantage in allocating resources, this may come at the expense of managerial incentives. Based on the analysis, the paper relates the value of diversification to characteristics of the firm, the industry, the external capital market, and the internal capital market. In the second essay, I propose a model of entrepreneurship in which investors decide whether to become venture capitalists or to form firms and entrepreneurs decide whether to join a firm or seek financing in the venture capital market. The venture capital market allows better matching between investors and entrepreneurs, but this comes at the cost of adverse selection. The model suggests that as a sector matures, innovation takes place first within firms, then in ventures backed by venture capitalists backed ventures, and finally within firms again.

(cont.) In addition, I analyze the relationships between the venture capital market and investors' diversity, investors' scope of expertise and entrepreneurial incentives. The third essay, which is co-authored with Andres Almazan, examines how the trading activities of institutional investors can help to mitigate agency conflicts in corporations. The access of institutional investors to privileged information produces an adverse selection effect that reduces the trading activity of institutional investors and generates a free-rider problem that affects the intensity with which institutional investors wish to "vote with their feet". We also study ownership implications, incentives to acquire information and the interaction of the Wall Street Rule with other mechanisms of governance (i.e. capital structure).