Power Struggles, Tunneling Incentives, and Investment Efficiency in Diversified Business Groups

Abstract

Unlike conglomerates in the U.S., where investment ows may be distorted due to power struggles (Rajan, Servaes, and Zingales (2000)), we nd that diversi ed business groups in India, on average, invest e ciently. Our analysis controls for the possibility of tunneling (Bertrand, Mehta, and Mullainathan (2002)). Overall, our results suggest that investment decisions in diversi ed business groups are consistent with the E cient Internal Capital Markets Hypothesis. We also nd that the presence of relational contracts in business groups mitigates the adverse e ects of tunneling incentives, consistent with the internal governance argument in Acharya, Myers, and Rajan (2011).