Diversification and tunneling: Evidence from Indian business groups

We provide evidence suggesting an important yet largely unexplored motive for the diversified structure of emerging economy business groups is to facilitate expropriation of minority shareholders by controlling insiders through tunneling. Using firm level panel data from India, and defining the core firm of a group as the one with the largest asset base, we find that the relatedness of the activity of a group affiliate to the activity of the core firm is correlated with the wedge between control and cash flow rights of insiders as well as with the opacity in insider ownership. Firms with ownership-control wedge lower and ownership opacity higher relative to a group's core firm are more likely to be in activities unrelated to that of the core firm. Our findings are strengthened by evidence of tunneling in the same direction, from affiliates with wedge equal to or higher than that of the core firm to affiliates with wedge lower than that of the core firm. Taken together this suggests an expropriation motive for diversification: affiliate firms are located away from a business group's core firm to serve as destination points for funds tunneled from the group's core. Journal of Comparative Economics 39 (3) (2011) 349-367. Sam M. Walton College of Business, University of Arkansas. AR 72701, USA; HEC Montreal, 3000, chemin de la Cote-Sainte-Catherine, Montreal (Quebec) H3T 2A7 Canada; Indira Gandhi Institute of Development Research, Gen. Vaidya Marg, Goregaon (E), Mumbai 400 065, India. (C) 2011 Association for Comparative Economic Studies Published by Elsevier Inc. All rights reserved.