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

Raja Kali () and Jayati Sarkar ()
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Raja Kali: Sam M. Walton College of Business
Jayati Sarkar: Indira Gandhi Institute of Development Research

Indira Gandhi Institute of Development Research, Mumbai Working Papers from Indira Gandhi Institute of Development Research, Mumbai, India

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.

Keywords: business groups; diversification; propping; monitoring; concentrated ownership (search for similar items in EconPapers)
JEL-codes: G15 G34 (search for similar items in EconPapers)
Pages: 48 pages
Date: 2005-11
New Economics Papers: this item is included in nep-cwa and nep-fin
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (9)

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