Conglomerates, Liquidity Shocks, and Innovation-Led Growth

Abstract

I develop a dynamic model of how internal capital markets in conglomerates respond to liquidity shocks when affiliated firms vary in innovation potential. A two-stage framework defines cutoff rules for when the conglomerate should liquidate low-productivity firms, coerce intermediate types into short-termist strategies, or preserve high-potential firms for long-horizon R&D. Embedding these margins into an endogenous growth model, I show how the optimal policy evolves: early in development, coercion preserves liquidity while sustaining broad innovation; as the economy nears the frontier and short-term returns decline, the optimal strategy shifts toward binary reallocation between liquidation and long-termism. I characterize two policy failures: a "coercion trap," where short-termism persists too long, and a "liquidation fallacy," where viable firms are discarded prematurely. The framework provides microfoundations for dynamic reallocation in conglomerate systems and offers policy insights for crisis-era restructuring.