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This paper aims to examine the relationship between diversified investment and the operation of the internal capital market, and then further investigate the impact of corporate governance mechanism on the relationship between them. Using a sample of group-affiliated firms listed on the Shanghai and Shenzhen Stock Exchanges in China, from 2010 to 2017, we find that the operation of internal capital market Granger-causes the diversified investment and both of them have a non-linear relationship. Moreover, we also find that four factors of corporate governance mechanism (the type of ownership, the fraction of independent directors, managerial ownership, and whether the CEO is also the chairman of the board) have different moderating effects on the relationship between diversified investment and the operation of internal capital market. In addition, we conclude that the internal capital market plays a central role in the diversified investment strategy and improving corporate governance mechanism helps strengthen the relationship between diversified investment and the operation of the internal capital market.INDEX TERMS Diversified investments, internal capital markets, corporate governance mechanism, business groups, affiliated firms.

Based on the monitoring effect of creditors, this paper examines the relevance between group's internal capital market and cash holdings. We find that the groups have become the economic pillar organization in China, but groups' internal capital markets generally exist the inefficient phenomena. We further find that the group's members on average have more cash holdings than independent companies and the moderating effect of bank debt's intervention can strengthen the negative relevance between internal capital market and cash holdings. Our findings suggest that groups should follow the pace of economic reform to enhance efficiency of internal capital market and reduce cash holdings by the way of appropriate bank debt.

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