Corporate governance and internal capital markets

We exploit an exogenous shock to corporate ownership structures created by a recent tax reform in Germany to explore the causal link between corporate governance and internal capital markets. We find that firms with more concentrated ownership are less diversified and have a less active but more efficient internal capital market. Our findings provide direct evidence in support of Scharfstein and Stein's (2000) model, which suggests that internal capital misallocations are partly a result of poor corporate governance. We also provide evidence of a channel through which the benefits of ownership concentration outweigh its costs.