Essays on developing economy business groups

Abstract

Business groups are a set of legally independent ?rms engaged in diversi?ed business lines controlled by a central authority and linked by complex socio-economic ties. Previous studies in the context of westem conglomerates observed that over-diversi?cation leads to poor perfonnanccs. However, af?liation to diversi?ed business groups in developing economies has been observed to result in better market valuations.Hence, the existence of diversi?ed business groups as a prevalent organizational form in devloping economies has challenged the conventional wisdom of the Anglo-Saxon world. This has created a substantial interest in academia about these developing economy my diversi?ed business groups Business group literature uses multiple lenses to exlain the emergence and existence of business groups. However, empirical ?ndings are ambiguous and fail to reach a consensus. This dissertation, using an 18-year panel data of the Indian corporate sector, investigates three speci?c issues: business group heterogeneity in value creation potential for member ?nns; effects of group level diversi?cation and diversi?cation strategies on af?liate perfomiances; and effects of group af?liation on capital structure and cost of debt ?nancing of member firms.Business groups create as well as destroy value for member ?rms. Institutional void theorists argue that over time, the value-creating potential of business groups will erode out. They consider the existence of business groups as an anachronism that will disappear during institutional transitions. However, business groups have typically 'de?ed predictions of their imminent demise'. In First Essay we explore whether size of a business group create value for a?iliate ?rms during institutional transitions. We hypothesize that the size of a business group is an important determinant of value-creating potential during institutional transitions in developing economies. Contrary to institutional void theory, we argue that large business groups ensure preferential access to different factor markets for member ?rms rather than mimicking missing market institutions within the group. The nature of institutional transitions in developing economies has opened up the opportunity to grow for large business groups and we ?nd that affiliation to large business groups is bene?cial for member ?rms. In contrast,smaller business groups fail to cope with the institutional transitions as costs of affiliation to a small business group outweigh the bene?ts. Our empirical evidence also reveals the existence of heterogeneity even within individual business groups.Prior literature anticipated that with the growth of well-functioning capita markets in developing economies, the value premium assosiated with business groups have successfully used market-oriented institutional reforms to accelerate their growth through aggresive diversification strategies. Hence, second Essay explores whether business group diversification creates value for affiliated firms during institutional transitions. Our cost-benefit analysis leads us to hypothesize an inverted U-shaped relationship between business group diversification and affiliated firm performance during institutional transitions. Considering institutional transitions as a two-stage process, we also find that aggressive diversification strategies have a significant positive impact on affiliate performances in the initial phase of institutional transitions, before financial deregulations in developing economies business group affiliated firms enjoyed preferential access to capital from the state controlled financial systems. It was anticipated that institutional transitionsin developing economies from bank-based financial systems to well-functioning equity market systems will change the scenario for business groups. Third essay exploresa whether business group affiliated firms will still enjoy superior access to capital markets compared to unaffiliated firms. Existing literature has observed that business groups reduce the bankruptcy probabilityof weaker firms through intra-group cross investments. Financial transactions and mutual co-insurance between group affiliated firms lead to positive externalities for recipients of fiance. Our findings indicate that the positive effects of group affiliation on leverage remained consistent. We find that group affiliation enhances the firm's access to deficit financing. We also observed that group affiliation leads to higher costs of debt financing, mainly for firms affiliated to smaller business groups. Our empirical evidence also indicates a U-shaped relationship between costs of debt financing and firm's leverage.Finally, we explore the dynamics of the Indian corporate sector for the last two decades, especially in the manufacturing sector. The Indian economy is still dominated by Indian business houses and SOEs. SOEs or business group affiliated firms are significantly larger in size than stand-alone firms, though stand-alone firms are larger in numbers. Our sub-sample analysis of business group firms reveals a significant turnover of ranking in the list of top 25 business groups. We also find that leading business groups dominate the overall Indian corporate sector with a high concentration of wealth.