The Deep Pocket Effect of Internal Capital Markets by Chiara Fumagalli, Xavier Boutin, Giacinta Cest

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The Deep Pocket Effect of Internal Capital
Marketsby Chiara Fumagalli, Xavier Boutin,
Giacinta Cestone, Giovanni Pica and Nicolas
Serrano-Velarde

• discussion by Francesco Columba

The usual disclaimer applies. The opinions are
those of the discussant only and in no way
involve the responsibility of the Bank of Italy.
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Summary I

• Role of financial strength in industry entry
• Literature examined the role of individual firm
  deep pockets and the effect of group-affiliation
  per se
• Access to groups deep pockets, opposed to own
  financial resources, is a source of market power
  for firms? Yes, according to the authors
• First finding liquid wealth owned by affiliated
  subsidiaries in other markets is negatively
  related to entry in the incumbents market
• But endogeneity is a major concern. Unobserved
  factors (eg group efficiency) could be driving
  simultaneously entry in a market and group cash
  holdings in other markets.
• To address endogeneity the authors adopt a
  theory-driven empirical approach and test two
  predictions from Cestone and Fumagalli (2005)

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Summary II

• First prediction tested entry deterrence of
  group deep pockets stronger when group-affiliated
  incumbents have a more difficult access to
  external finance
• Finding industries where firms hold less
  collateralizable assets entry is more sensitive
  to group liquidity and less sensitive to
  incumbent liquidity
• Second prediction tested entry-deterring effect
  of group deep pockets boosted by the intensity of
  internal resource reallocation within the group
• Finding group deep pockets have a larger effect
  on entry in markets where within group capital
  market is more active (activity measured by
  intra-group lending, group diversification,
  financial intermediaries)
• Contribution to deep pocket literature (financial
  muscle as competitive advantage) disentangling
  group financial strength from firm one and to
  internal capital markets literature analyzing
  business groups instead of multidivisional firms.
• Overall results are against perfect capital
  market hypothesis

Rome, October 21, 2009
discussion by Francesco Columba
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Relevance of internal capital markets

• Own funding in normal times matters, and its
  interaction with prodcut market competition may
  inform the competitive behavior of multimarket
  firms and groups
• During times of financial distress internal
  resources relevance may be magnified.
• As the debate on the existence of financial
  frictions (and on pro-cyclicality of the
  financial sector) underlines, during crises
  access to external finance may have a prohibitive
  price or be impossible at all as markets dry up
  or disappear. Access to internal resources
  becomes even more a strategic factor
• According to the authors after a shock hits one
  of the sector within groups winner-picking
  (cash-poor groups) may coexist with
  cross-subsidization (cash-rich groups). What
  happens if the shock is not idiosyncratic to a
  sector?

Rome, October 2, 2009
discussion by Francesco Columba
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empirical design

• Basic entry equation
• Information set of entrant refers to one-year
  lagged variables
• Exogeneity of cash holdings of the rest of the
  group in other markets to shocks to market i.
  What if common shocks? Behavior along the cycle?
• Group deep pockets and external capital markets
• Is the proxy of ease of access to external
  capital market (tangibles/assets) robust ? What
  if a deleveraging process develops due to
  funding and liquidity problems?
• Is it the relevant one for access to securities
  and stock markets, to bank finance?
• Rating? Relationship lending?
• Group deep pockets and internal capital markets
• 3 measures of ICM intensity intra-group loans,
  number of financial intermediaries, group
  diversification
• Data
• Foreign owned groups

Rome, October 2, 2009
discussion by Francesco Columba
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results

• Basic equation
• effect of business group total cash on entry
  deterrence is smaller than that of incumbent
  total cash
• Deep pockets and access to external finance
• results using sub-sampling coherent with
  prediction but conditional on accuracy of proxy
  of ease of access to credit
• proxy measured at market level not at firm level
• Deep pockets and ICM activity proxied from
• intra-group loans
• financial intermediaries
• diversification
• more direct proxies, financial flows?

Rome, October 2, 2009
discussion by Francesco Columba
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Issues

• Determinants of cash accumulation within a group
  drivers of groups cash holdings decisions. Is
  endogeneity tackled?
• Dynamics? Is the cash flow held to pick up
  opportunities or to do corporate hedging? Or to
  support needy firms (socialist equilibrium)?
• Welfare implications?
• Liquidity measures? Is access to external finance
  controlled for? Relationship lending?

Rome, October 2, 2009
discussion by Francesco Columba
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Policy implications

• potential threat to entry posed by the deep
  pockets of the group incumbent is affiliated
  with.
• detrimental effect to be traded off with
  efficiency gains from group deep pockets and the
  financial slack provided
• Cash-rich groups may have a pro-competitive
  effect favoring entry in opposition to
  incumbents predatory strategies

Rome, October 2, 2009
discussion by Francesco Columba
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