A Reexamination of Tunneling and Business Groups:New Data and New Methods

The last decade of corporate governance research has been focused in large part on identifying what leads to superior or deficient corporate governance in emerging economies. We propose that firms' corporate governance and firms' strategic business activities within an industry are interlinked. By conducting a simultaneous economic analysis of business strategy and corporate governance, scholars can better discern the quality of a firm's governance. We look at one of the most rigorous extant methodologies for detecting "tunneling," or efforts by firms' controlling owner managers to take money for themselves at the expense of minority shareholders. We find that, in contrast to prior views, Indian business groups are not, on average, engaging in tunneling (expropriation), but are on average exhibiting good corporate governance, especially in light of the markedly different business strategies they typically undertake. Moreover, unlike many past conceptions of business groups from financial economics, sociology, and strategy, we find evidence for a knowledge-based "recombinative capabilities" view of business groups-that such groups have done the most to invest in R&D and other skills necessary to combine inputs in ways that lead to greater added value. Further, our finding that Indian business groups have grown larger and more diversified since liberalization and since broad-based corporate governance reforms were implemented, goes expressly against the prediction of prior schools of thought about business groups. We argue that the conventional wisdom about tunneling and business groups will need to be questioned and reformulated in light of the new data, methodology, and findings presented in this study.