Affiliated Firms and Financial Support: Evidence from Indian Business Groups

Abstract:     
We investigate the functioning of internal capital markets in Indian Business Groups. We document that intra-group loans are an important means of transferring cash across group firms and that such transfers are typically used to support the financially weaker firms. Groups significantly increase the extent of loans when member firms are hit with a negative earnings shock. Consistent with a support motive, loans tend to be made on favorable terms - typically at zero interest - and loan inflows significantly reduce the bankruptcy probability. Loans are not, in general, used to fund investment opportunities or to tunnel resources. Evidence suggests that an important reason for support may be to avoid group firm default and consequent negative spillovers to the group. The first bankruptcy in a group is followed by a significant drop in the amount of external finance raised, a discontinuous drop in investments and profits, and an increase in the bankruptcy probability of other healthy firms in the group. Moreover, consistent with spillovers on account of negative information, we find that consequences are more severe for firms with closer managerial links to the bankrupt firm.

Number of Pages in PDF File: 51

Keywords: Reputation, business groups, spillovers

JEL Classification: G30, G34

Accepted Paper Series