The Drivers and the Stock Market Assessment of Internal Capital Market: Evidence from Business Groups in Korea

Using actual equity transactions between member firms in Korean business groups, we examine the effect of firm characteristics on transaction magnitude and the stock market's response to investment in the internal capital market (ICM). On the acquiring firm's side, financial slack is positively associated but controlling shareholder ownership is negatively associated with transaction magnitude. Profitability (leverage) of the issuing firm is negatively (positively) associated with transaction magnitude. Growth of the firms involved in the transaction does not affect the transaction magnitude or the stock market's response. The stock market responds negatively to diversification and large cash of the acquiring firm. Our findings suggest that idle cash of a firm with high ownership of minority shareholders is the source of funds in ICM, and such funds are directed to poorly performing affiliated firms, which are under the influence of the same controlling shareholder.