Organizational Form and Access to Capital: The Role of Regulatory Interventions

Abstract

We examine the impact of a regulation that requires only disclosure of ownership information and no real change of firm fundamentals, on a firm’s access to capital. As a first of its kind corporate governance regulation across the globe, Clause 35 of the Securities Exchange Board of India required firms to classify shareholders into insiders and outsiders only, with no other structural changes. Using a large sample of publicly traded firms in India, a market characterized by weak enforcement and concentrated ownership, we find that prior to the regulation and as expected from literature, group-affiliated firms exhibited better access to capital (lower investment-cash flow sensitivity) than standalone firms. However, this reverses after the regulation, i.e., group-affiliated firms face more financial constraints (higher investment-cash flow sensitivity). This increase in sensitivity is restricted to only group firms with higher insider ownership, especially for firms which have no compensating mechanisms (weaker governance/monitoring) or perform poorly in the future. In essence, we find that regulation exclusively requiring information disclosure has been effective in reallocating capital more efficiently to firms with fewer agency problems.

Keywords: Financial Constraints; Agency; Mandatory Disclosures; Efficiency; Business Groups; Insider Ownership; Emerging Markets

JEL Classification: D82; G30; G31; G32; G38; M48