Business Groups in India

The business group as an organizational form is one of the many special business structures that exist in the global economy. Literature aimed at understanding whether group-affiliated firms function differently from standalone companies, more so with respect to basic corporate finance decisions like investing, financing and reporting has stayed scarce. It is in this context that we, through three observed essays based on India, aim to understand and provide answers to some unresolved questions related to how group-affiliated firms differ from standalone firms when making corporate finance determinations.

Business groups in India are a predominant economic force particularly and have been so historically. About 31 per cent of firms in India belong to business groups but this 31 per cent accounts for nearly 59 per cent of total assets held by all firms in India. This emphasises the economic significance of business groups in India context and makes it imperative to understand how they work. Also, since India’s financial liberalization in 1991 and especially since Goldman Sachs identified India as one of the four most significant economic powers among the emerging countries in 2001, Indian capital needs have become increasingly important to the international investor. According to estimations by a PricewaterhouseCoopers (PwC) report, India is slated to become the third-largest economy in the world by 2030, from its 2013 rank often. This makes India an essential market to study.

Thus, within the Indian context, the first chapter explores corporate reporting decisions at business groups. The Satyam fraud in 2008, which is India’s biggest corporate scam ever, concerned not just large scale manipulations of reported formations but also elaborate and complex transactions between multiple companies held by family members of Satyam’s Chairman like Maytas. This flashed an interest in examining earnings manipulation within business groups where inner capital markets remain a necessary evil. It is in this context that we examine if and why group-affiliated firms decide to use more real earnings management to raise reported figures in the first essay. Our analysis reveals that group-affiliated firms engage in extremely higher real earnings management than standalone firms. We then peer accruals-based earnings management constraints and reputation concerns as potential reasons for firms opting to manage real earnings. While these reasons are found to inspire all firms to manage real earnings more, they fail to explain the higher real earnings management at group-affiliated firms. Additionally, an analysis of internal capital markets within business groups reveals that group-affiliated firms invest in group firms through internal capital markets and then use real earnings management to shield the work of such investment from other stakeholders. The shielding helps assure a rising stock returns momentum.

Having found proof of group-affiliated firms engaging in higher real earnings administration, in the next essay we focus on how such companies shield their reporting misdemeanours over longer periods. In the second essay, we explore whether firms proactively make reserves by understating conveyed figures over long periods in expectation of real earnings management requirements and then remove these reserves to inflate reported figures, as and when required. We study the association between being unconditionally conservative and engaging in more real earnings management and how organizational structure impacts this association. Unconditionally conservative firms are found to engage in more real earnings management. Our results additionally reveal that business groups engage in more conservatism-based real earnings management than standalone firms. Moreover, real earnings management at unconditionally conservative business group firms is found to be inefficient, compared to standalone firms where real earnings management is commonly found to be more efficient.

Since the first two essays in this view help identify costs at business groups, the third essay explores whether exterior stakeholders can see through some of the misdeeds and segregate the good group-affiliated firms from the bad firms. Within this context, we explore the effect of additional disclosure requirements, i.e., ownership and governance-based regulations, on a firm’s capital restraints as measured by its investment-cash flow sensitivity. We further examine whether this sensitivity is affected by taking in agency costs, due to group collaboration and insider ownership. Investment cash flow acuity is found to decrease after mandatory disclosures increase, in special for those firms that had limited access to external capital earlier. Group-related firms are found to have lower investment-cash flow sensitivity before regulation, which increases after regulation when reached to standalone firms. On further analysis of only group-affiliated firms, this increase in sensitivity is found restricted to only firms with high insider privilege that perform poorly in the future.

Overall, this thesis helps understand further how corporate decision making varies in business groups from that at standalone firms. It determines why business group firms manage earnings by manipulating real activities and also provides evidence on how accounting policies that are meant to be attentive can be misused. The view also shows how regulations in low enforcement regions like India and other arising countries can be useful in separating efficient firms from opportunistic ones, therefore, lowering business costs.