Segment Disclosures, Internal Capital Markets, and Firm Value: Evidence from SFAS No. 131

Using the adoption of SFAS 131 as an exogenous change in disclosure quality of segment information, this study examines the impact of SFAS 131 on internal capital market efficiency and firm value. It finds that diversified firms that changed their segment definitions on adopting SFAS 131 (i.e., "change firms) experienced greater improvement in capital allocation efficiency in internal capital markets in the post-SFAS 131 period relative to the pre-SFAS 131 period than did a control sample of diversified firms that did not change their segment definitions (i.e., "no-change firms). This result holds in a battery of tests designed to correct for the endogeneity in firms' reporting choices following SFAS 131, suggesting that disclosure quality improves monitoring and therefore investment efficiency. In addition, this study finds that proprietary costs moderate the impact of SFAS 131 on firm value. Specifically, change firms experienced a greater increase in firm value in the post-SFAS 131 period relative to the pre-SFAS 131 period than did no-change firms except for a subsample of firms with high proprietary costs, suggesting that SFAS 131 reduced agency costs but also eroded competitive advantages.