Financial Decisions by Business Groups in India: Is It ‘Fair and Square’?

Abstract

Using a large sample of business-group-affiliated firms in India, we investigate whether corporate financial decisions that create internal capital markets are influenced by the extent of insider ownership. We hypothesize that insiders want to control more capital, motivated either by opportunism or efficiency.We distinguish opportunism from efficiency based on whether sales decrease or increase in the year after financial decisions are taken. We find that as insider ownership increases, a firm (i) transfers less capital into the group when sales increase in the following year, (ii) pays out less dividends when sales decrease in the following year and (iii) receives less capital from the group if it is struggling. This indicates that insiders act in an efficient manner when transferring capital across firms within the group. However, when deciding whether to return capital to investors, they retain resources even when future performance does not improve and thus act opportunistically.

Keywords: Internal capital markets, Opportunism vs. efficiency, Business groups, Dividends, Cash flow rights

JEL Classification: G15, G34