Power struggles, tunneling incentives, and investment efficiency in diversified business groups
Description
Unlike conglomerates in the United States—where investment flows may be distorted due to internal power struggles (Rajan, Servaes, and Zingales, 2000)—we find that diversified business groups in India, on average, allocate investments efficiently. Our analysis controls for the possibility of tunneling (Bertrand, Mehta, and Mullainathan, 2002) and examines investment flows at both the firm and group levels. At the firm level, our findings are consistent with the Efficient Internal Capital Markets (EICM) Hypothesis: investment flows are aligned with value-maximizing opportunities, and incentives for distortions arising from power struggles appear limited. Furthermore, we find that investment flows in the “right direction” increase with diversity in resource-weighted opportunities among group firms that control larger resource bases, suggesting that efficiency considerations are most prominent where they matter most. However, we also observe evidence of tunneling behavior: investments tend to flow from group firms in which controlling families hold lower cash flow rights to firms where they hold higher cash flow rights. Notably, this pattern is primarily observed among group firms with low growth opportunities, consistent with the Tunneling Hypothesis. In contrast, among firms with high growth potential, investment allocation remains aligned with the EICM framework. We further find that the presence of relational contracts within business groups mitigates the adverse effects of tunneling incentives, supporting the internal governance argument proposed by Acharya, Myers, and Rajan (2011). Overall, our results suggest that, at the group level, potential distortions arising from power struggles and tunneling are outweighed by efficiency considerations. Consequently, investment decisions within diversified Indian business groups are largely consistent with the Efficient Internal Capital Markets Hypothesis.
Copyright Date
January 2012
Publication Date
1-1-2012
Keywords
Power struggles, Tunneling, Internal capital markets, Business groups, Diversity
Conference
World Finance Conference, 17-18 December, 2012, Shanghai
