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Diversification, propping and monitoring: Business groups, firm performance and the Indian economic transition

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  • Raja Kali

    ()
    (Sam M. Walton College of Business)

  • Jayati Sarkar

    ()
    (Indira Gandhi Institute of Development Research)

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    Abstract

    The industrial landscape of many emerging economies is characterized by diversified business groups. Given the well-known costs of diversification, their prevalence in emerging economies is a puzzle that has not been completely resolved. While there is evidence that business groups in emerging economies confer diversification benefits on group affiliated firms by substituting for missing institutions and markets, whether such benefits persist over the economic transition as institutions and markets develop is unclear. We investigate this issue in the context of the wide-ranging transformation of the Indian economy over the past decade. We find that business group affiliation continues to generate higher market valuation vis-…-vis standalone firms ten years into the transition, but diversification is not the source of these benefits. Instead, we find that propping through profit transfers among firms within a group and better monitoring through group level directorial interlocks explains the higher market valuation of business group affiliated firms. The effect of propping and directorial interlocks on firm value depends on the equity stakes of the controlling shareholders. Propping appears to be the source of group affiliation benefits in firms with below median cash flow rights of the controlling shareholders, while director interlocks are the primary source of the group effect for firms where the controlling shareholders have above median cash flow rights.

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    Bibliographic Info

    Paper provided by Indira Gandhi Institute of Development Research, Mumbai, India in its series Indira Gandhi Institute of Development Research, Mumbai Working Papers with number 2005-006.

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    Length: 48 pages
    Date of creation: Nov 2005
    Date of revision:
    Handle: RePEc:ind:igiwpp:2005-006

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    Keywords: business groups; diversification; propping; monitoring; concentrated ownership;

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    References

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    1. Claessens, Stijn & Fan, Joseph P.H. & Lang, Larry, 2002. "The Benefits and Costs of Group Affiliation: Evidence from East Asia," CEPR Discussion Papers 3364, C.E.P.R. Discussion Papers.
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    Cited by:
    1. Lensink, Robert & van der Molen, Remco, 2010. "Does group affiliation increase firm value for diversified groups?: New evidence from Indian companies," Journal of Empirical Finance, Elsevier, vol. 17(3), pages 332-344, June.

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