A Q Theory of Internal Capital Markets

We propose a tractable model of dynamic investment, spinoffs, financing, and risk management for a multi-division firm facing costly external finance. Our analysis formalizes
the following insights: (1) within-firm resource allocation is based not only on the divisions' productivity - as in "winner picking" models - but also their risk; (2) firms may voluntarily spinoff productive divisions to increase liquidity; (3) diversification can reduce firm value in low-liquidity states, as it increases the cost of a spinoff and hampers liquidity management; (4) corporate socialism makes liquidity less valuable; (5) division investment is determined by the ratio between marginal q and marginal value of cash.