Stand-alone Firms Research Articles

Internal Capital Markets and R&D Investment: Evidence from Korean Chaebols

ABSTRACT This study examines how internal capital markets (ICMs) within business groups affect the financing of research and development (R&D) investments, focusing on Korean chaebols. We find that, on average, chaebol-affiliated firms exhibit lower R&D investment – cash flow sensitivity than standalone firms do. We also find that an affiliated firm’s R&D expenditure is significantly positively associated with the net amount of equity capital received from other affiliates but not significantly related to its own cash flow. These findings indicate that ICMs effectively mitigate affiliated firms’ R&D financing constraints. We further find that this financing constraint mitigation is more pronounced during financial crises and for high-tech firms. Finally, we find that, for chaebols, greater ICM effectiveness leads to better innovative performance. Overall, our study highlights the importance of ICMs for promoting corporate innovation via the reduction of R&D financing constraints.

Corporate diversification, investment efficiency and the business cycle

I document the time-varying investment efficiency of conglomerates compared with single-segment firms. I find that, during recessions, conglomerates have higher Q-sensitivity of investment than do stand-alone firms, in contrast to the relationship during expansion periods. I also find that conglomerates, with the benefits from internal capital markets, exhibit increased dependence of investment on internal capital during recessionary periods, while stand-alone firms significantly increase cash retention and deviate their investment from its optimal level more severely. I examine the effect of the degree of diversification and find consistent evidence on investment efficiency and deployment of internal capital. I also provide evidence that conglomerates with stronger governance do not improve investment efficiency during recession, which suggests that agency costs cannot fully explain the changes in investment of conglomerates.

Does market competition foster related party transactions? Evidence from emerging market

We examine the impact of market competition on related party transactions (RPTs). Using a sample of 12,794 firm-year observations from listed Indian firms, we find that market competition has a positive impact on the usage of RPTs, and this effect is greater in firms that have a low level of monitoring and profitability. We find that firms in a competitive environment engage in a greater amount of business RPTs in comparison to non-business RPTs. Business group firms in competitive industries use RPTs significantly more than standalone firms. We also find that in a competitive market, RPTs are positively related to firm value.

Cross-Subsidization in Conglomerate Firms: Evidence from Government Spending Shocks

AbstractExploiting demand shocks from changes in federal government spending, we examine how the organizational structure of a firm affects its investment behavior. Government spending shocks affect the investment of government-dependent conglomerate segments less than matched stand-alone firms. Investment also increases in lower government-dependent segments when other segments within the same firm experience positive demand shocks, indicating cross-subsidization between segments. We further show that this cross-subsidization leads to worse operating performance and increases the diversification discount. Our findings are robust after addressing the endogeneity of government spending.

Related Party Transactions and firm value: the role of governance mechanism

The research on Related Party Transactions (R.P.T.s) shows that the impact of R.P.T.s is context dependent and there is no consensus on the findings of available studies. This study aims to examine the impact of R.P.T.s on firm value in Indian context and the interaction effect of governance mechanism on the relationship between R.P.T.s and firm value. A sample of 2,294 firms consisting of 685 group affiliated firms and 1,609 standalone firms for a period of 2014–2021 has been selected and panel data regression method has been applied for testing the hypotheses. The empirical findings of the study support the transaction efficiency hypothesis that R.P.T.s in India do not expropriate the interest of minority shareholders and these transactions enhance efficiency of the firm by reducing transaction cost, enforcing optimal business contracts and effectively allocating resources between affiliated firms. The findings of the study also provide significant contribution to the literature by examining the interaction effect of governance mechanism on the relationship between R.P.T.s and firm value.

Common Owner, Uncommon Value: Business Group Ownership and Firm Growth Opportunities

Recent research on business groups has traced their continued growth, despite widespread institutional changes, to their inherent characteristics such as diverse business portfolio and multi-entity structure. We add to this stream of work by focusing on the third important characteristic of business groups, viz., their ownership structure. In sharp contrast to the prevailing view that business group core owners use their control to expropriate minority shareholders in weak institutional environments, we focus on their value adding potential in strengthened institutional environments. We argue that higher levels of controlling ownership positively influence all key drivers of opportunity pursuit by firms, viz., motivation, firm-specific knowledge, and controllability, and hence a firm’s growth opportunities. More significantly, we highlight the common nature of business group ownership that distinguishes them from controlling owners of standalone firms. We argue that this common characteristic together with control enables business group owners to orchestrate resource and information transfer across affiliate firms and importantly leverage their accumulated expertise of making decisions to positively influence growth opportunities of affiliate firms. We test our arguments on a sample of Indian firms during the time period 2001-2019 and find significant support. Our work adds to business group research by investigating a defining yet understudied characteristic of business groups—common ownership. By demonstrating their value adding role, we complement the emerging body of work that looks beyond institutional environment-based explanations for the existence of business groups. Our work also has significant implications for the nascent competence-based view in ownership research.

Propensity to Propose and Pay Dividend: Does Firm Characteristics Matter?

The study assesses the impact of firm characteristics on the propensity to propose dividends and pay a dividend as proposed. This study uses a dataset of 4011 listed Indian non-financial firms over 15 years, spanning 2004–2005 to 2018–2019. Firm characteristics are observed to be important determinants of firms’ propensity to propose dividends and pay as proposed. With respect to a propensity to propose dividends, firms’ size, profitability, market-to-book ratio (MBR), capital expenditure, cash holding, ownership concentration, and group affiliation are found to have positive coefficients, whereas earning volatility, leverage, free cash flow (FCF) and illiquidity are found to have negative coefficients. On the contrary, with respect to a propensity to pay dividends as proposed, the study observes that size, profitability, MBR, and ownership concentration have negative coefficients, and leverage, FCF, illiquidity, and group affiliation have positive coefficients. The results are consistent for both group and stand-alone firms. These findings have practical significance for the investors since investors are likely to be more concerned about the payment of dividends as proposed rather than the mere promise to pay dividends.

Organizational structure and tax avoidance: multinational evidence from business group affiliation

ABSTRACT We investigate the relation between business group affiliation and tax avoidance for publicly traded firms in a global setting. Overall, we find that publicly traded business group firms exhibit greater tax avoidance than stand-alone firms. This evidence is consistent with prior findings on Japan and Korea and suggests that the business group form allows ultimate owners to shift income between entities to lower their tax payments. However, we find that the effect is restricted to firms in countries with developed economies and with code law traditions. In emerging market, code law countries we do not observe a significant difference in tax avoidance, and in countries with common law systems we find that business group firms exhibit lower tax avoidance than stand-alone firms. Thus, our evidence suggests that the extent of a country’s economic development and legal origin combine to affect the ability of business groups to facilitate tax avoidance for public companies.

Does mandatory CSR expenditure regulation matter to promoters? Empirical evidence from India

PurposeThis paper aims to examine the relation between promoter ownership (PO) and corporate social responsibility (CSR) expenditure in India, the first country to legally mandate the CSR spending.Design/methodology/approachThis paper applies panel regression to examine the impact of PO on actual and excess CSR expenditure because panel regression has lesser multicollinearity problems and has the benefit of controlling for individual or time heterogeneity mostly present in cross-section or time series data. The results are robust to testing the CSR expenditure decision (to engage or not to engage in CSR) by using the binary choice logit model.FindingsBased on the agency theory, this study shows a nonlinear relation between PO and CSR expenditure, which suggests that promoters start extracting private benefits of control at the expense of outside shareholders and engage in lesser CSR expenditure only when their ownership crosses a threshold level of 52% approximately. This study further shows that the nonlinear relation between PO and CSR expenditure is more pronounced for firms that are more prone to agency problems, for business group firms than standalone firms and for firms not following the Companies Act 2013 CSR mandate.Practical implicationsThe findings shed light at the idea of how promoters’ incentive alignment should be proposed and followed to encourage a firm’s social investment activities.Originality/valueFirst, this study argues that the relation between PO and CSR expenditure is nonlinear in nature, by showing that the impact of PO on CSR expenditure is adverse only at higher level of PO. Second, this study’s richer data set on CSR expenditure not only allows the authors to analyze the relation for actual CSR spending by the firms but also helps to examine the excess spending made over and above the mandatory spending, as directed by the Companies Act, 2013.

Economic policy uncertainty and investment-cash flow sensitivity: evidence from India

PurposeThis study examines the impact of economic policy uncertainty (EPU) on the investment-cash flow sensitivity (ICFS) of Indian manufacturing firms.Design/methodology/approachThis study uses the fixed-effect method to investigate the effect of EPU on ICFS from 2004 to 2019.FindingsThis study finds that EPU increases ICFS, which is more (less) during the crisis (before and post-crisis) period. The authors also find that the effect of EPU on ICFS is more for smaller, younger and standalone (SA) firms than the larger, matured and business group affiliated (BGA) firms. This study also reveals that EPU reduces corporate investment (CI). Further, the authors find that cash flow is more significant for the investment of financially constrained firms and the negative effect of EPU is more for these firms.Research limitations/implicationsThis study considers the Indian manufacturing sector. Therefore, this study can be extended by analyzing the relationship between EPU and ICFS for the service sector.Practical implicationsFirst, this study can be useful for corporates, academicians and government bodies to understand the effect of EPU on ICFS and CI. Second, this study will help corporates to focus on internal funds to finance corporates' investment during the crisis period because EPU increases the cost of external finance which may increase ICFS and reduce CI. Third, lending agencies, investors and stakeholders should also focus on the firm's nature, ownership, size and age because these factors play a crucial role to reduce or increase the negative effect of EPU on ICFS. Fourth, the Government should make appropriate policy measures in terms of concessional interest rates to increase the easy availability of external finance for SA, small size, and young firms to reduce the negative effect of EPU on CI because these firms are considered as more financially constrained firms.Originality/valueThis study adds new inputs to the current literature of EPU in several ways. First, this study is one of the main studies focused on the relationship between EPU and ICFS (CI). Especially in emerging countries like India, examining this relationship extends previous research. Second, this study also examines the impact of EPU on ICFS for BGA, SA, small, large, matured and young firms as well as crisis and non-crisis periods. Third, this study uses the sample of the Indian manufacturing sector which has emerged the qualities to become a global manufacturing hub and attracting global investors. Therefore, examining the effect of EPU on ICFS for these firms will be more interesting.

Organizational form and access to capital: The role of regulatory interventions

We examine how regulatory nudges mandating only disclosure of ownership information and no structural change impact a firm’s access to capital based on its organizational form. As a first of its kind, Clause 35 in India (characterized by weak enforcement and concentrated ownership) only required classifying shareholders into insiders and outsiders. Pre-regulation, group-affiliated firms exhibited lesser financial constraints than standalone firms. This reverses post-regulation, especially for group firms with higher insider ownership. More so for those with weaker compensating mechanisms or poorer future performance. In essence, regulation exclusively requiring information disclosure has been effective in reallocating capital more efficiently to firms with fewer agency problems.

The Decision to Go Public and Business Group Affiliation: Evidence from India

Using a comprehensive sample of Indian stock market listings from 2000 to 2014, we examine the effect of business group (BG) affiliation on the decision to go public. Supporting the internal capital markets hypothesis, we find that BG firms are less likely to go for initial public offerings (IPOs). Compared to stand-alone firms, BG firms that go public are older and less profitable. Further, this article elucidates the dynamics of the decision to go public within BGs (with multiple unlisted eligible affiliates in their portfolio) as extant models fail to explain the same adequately. We examine the relative importance of reputation, capital raising, and control considerations on the decision to go public. We find that the affiliate that invests in other group affiliates’ financial assets is more likely to be taken public. Affiliates that are net receivers of intragroup support are less likely to list. BG’s reputation has a positive impact on the choice of the affiliate to list. JEL Classifications: G30, G32

Does Business Group’s Conscious of Social Responsibility Enhance its Investment Efficiency? Evidence from ESG Disclosure of China’s Listed Companies

Business groups are industry exemplars whose investment decisions and social responsibility commitments are important for future sustainable development. We use data from China’s listed firms from 2012 to 2018 to investigate the effects of ESG-related disclosure on corporate investment efficiency by comparing the heterogeneity in ESG-related disclosure between group-affiliated firms and standalone firms, as well as between member firms within groups at different pyramid levels. We find that (1) group-affiliated firms are more willing to disclose ESG information than independent ones, and compared with lower-level pyramid member firms, higher-level pyramid member firms have a higher propensity of ESG disclosure; (2) over-investment for group-affiliated firms and under-investment for higher-level pyramid member firms are all moderated by their higher propensity for ESG disclosure. That is, corporate disclosure of ESG information significantly promotes investment efficiency; (3) by grouping the sample firms according to analyst attention and industry external financing dependence, respectively, we find that the promotion effect of ESG disclosure on corporate investment efficiency is more significant when the firms are followed by fewer analysts, or when firms belong to industries with higher external financing dependence. Our findings suggest that ESG disclosure plays an important role in driving a firm’s investment toward desirable levels.

Does group affiliation impact financial constraints? Evidence from India

PurposeThis study aims to primarily investigate two vital questions: First, the authors examine whether group-affiliated firms are more (less) financially constrained vis-à-vis standalone firms. The authors estimate working capital investment (WCI) to cash flow sensitivity to understand the nature of financial constraints. Second, the authors further investigate the impact of working capital level on firm values and risks between group-affiliated and standalone firms.Design/methodology/approachThis paper uses balanced panel data set from the year 2012–2019. The authors employ propensity score matching to ascertain comparable firm attributes from business group and standalone firms. This process yields 280 firms (140 in each group) after controlling the firm heterogeneity between these two groups. All the models are estimated using fixed-effect regression.FindingsThe authors find that group affiliated firms are less financially constrained than standalone firms. The results show that WCI to cash flow sensitivity is higher in standalone firms vis-a-vis group-affiliated firms, implying that standalone firms are more financially constrained than group-affiliated firms. Second, the authors find that firm values are more sensitive to working capital level in standalone firms versus group-affiliated firms. Furthermore, the authors document that the risk of the standalone firms is less sensitive to working capital level than that of group-affiliated firms.Originality/valueMost recent studies exploring the role of group affiliation in financing constraints have not controlled for heterogeneity among group-affiliated firms vis-à-vis standalone firms, which may arise due to variation in firm characteristics. Unlike prior studies, this research design ascertains comparable firm attributes between business group and standalone firms, implying firms belonging to these two groups differ by the exogeneous affiliation (business group and standalone firms). The authors document that group-affiliated firms are less financially constrained than standalone firms controlling firm-level heterogeneity between group-affiliated and standalone firms. To the best of the authors' knowledge, no such work has been previously done in general (specifically in India).

How do business group affiliated firm in emerging markets outperform standalone firms? A knowledge-based view

PurposeThis study seeks to understand how business group-affiliated firms perform in emerging markets. Previous studies identify that in spite of changes in the competitive landscape, seemingly counter-intuitively, business group affiliates outperform their standalone counterparts in emerging markets. This study adopts a knowledge-based view to resolve this apparent paradox.Design/methodology/approachThis study uses a problematization methodology to qualitatively analyze the strategic decisions of Indian business group-affiliated firms. This study cross-validates their analysis with the empirical results available in published academic and practitioner articles.FindingsPrevious studies explain this outperformance paradox based on assumptions that include filling institutional voids, access to strategic resources and leveraging political connections. By questioning these assumptions, this study identifies an alternative explanation that is based on affiliates’ ability to adopt a strategic approach that balances knowledge capital acquired through international expansion and innovation.Practical implicationsThe findings have important implications for managers of business group-affiliated firms in emerging markets, as well as for those in developed markets seeking to compete or collaborate in emerging markets.Originality/valueThis study provides a framework for managers of business group affiliates to identify suitable pathways to higher levels of competitive advantage.

Dissecting Conglomerate Valuations

ABSTRACTWe develop a new method to estimate Tobin's Qs of conglomerate divisions without relying on standalone firms. Divisional Qs differ considerably from those of standalone firms across industries, over time, and in their sensitivity to economic shocks. The differences are explained by intraconglomerate covariance structures and access to internal capital markets that mitigate external financing frictions. Consequently, the Qs capture variation in the allocation of assets in the economy: within firms through internal capital markets and across focused and diversified firms through diversifying acquisitions. Overall, our method provides opportunities to study the economic mechanisms that explain corporate diversification.

Does economic policy uncertainty affect trade credit and firm value in Korea? A comparison of chaebol vs. non-chaebol firms

This paper investigates how economic policy uncertainty (EPU) affects trade credit and firm value of business group-affiliated firms (chaebol firms) and stand-alone firms (non-chaebol firms) in Korea over the period 1994–2019. We find a robust negative relationship between EPU and trade credit for all Korean firms using alternative measures of EPU and trade credit. We also find evidence that small chaebol firms, being presumably more financially constrained in the post-Asian financial crisis period, tend to respond more fiercely to changes in EPU and curtail their trade credits in greater amounts compared to large chaebol firms and non-chaebol firms. Further analysis suggests that cutting trade receivables during periods of high EPU increases firm value, especially for small chaebol firms; however, this relationship is non-linear. Accordingly, trade receivables cutbacks during periods of elevated EPU only increase firm value up to a certain point, beyond which it leads to value erosion. Taken together, our findings confirm the intuitive projection that under Korea’s unique market settings, different chaebol groups respond differently to impending policy uncertainties.

CEO's age and investment‐cash flow sensitivity

This study examines the impact of Chief Executive Officer's (CEO's) age on investment‐cash flow sensitivity (ICFS) for Indian firms from 2005 to 2018. Using system generalized method of moments (GMM), this study finds that young (older) CEOs increase (reduce) ICFS. This study finds that the effects of CEO's age on ICFS become more (less) stronger for standalone (group‐affiliated) firms and during crisis (noncrisis) periods. Further, the individual effect of older (young) CEOs is negatively (positively) associated with the corporate investment, and this effect is not significant for standalone firms and during the crisis period. Overall, this study adds new insights to the existing finance literature.

The side effect of business group membership: How do business group isomorphic pressures affect organizational innovation in affiliated firms?

Literature suggests that business groups help affiliated firms overcome market failure, which is common in emerging economies, thus serving as a source of competitive advantage. This paper discusses how and when affiliated firms pay for these advantages. Specifically, we propose that affiliated firms, compared with stand-alone firms, bear unique institutional isomorphic pressures from business groups. Using information technology industry samples from the World Bank’s Enterprise Surveys, we find that affiliated firms underperform on organizational innovation more than stand-alone firms. In addition, we find that the main effect is strengthened when the business group size is large and the affiliated firm CEO’s industrial experience level is low. Moreover, the main effect is the strongest when an affiliated firm is embedded into a large business group the CEO of which has a low industrial experience level. Our findings contribute to a comprehensive understanding of the impact of business group membership.

David versus Goliath: The Relation between Auditor Size and Audit Quality for U.K. Private Firms

We examine the relation between auditor size and audit quality for a sample of U.K. private firms. Private firms prioritize tax considerations over reducing information asymmetry in their financial reporting. We find that Big 4’s private clients exhibit higher levels of discretionary accruals and lower precision of accrual estimates than non-Big 4’s private clients. Although Big 4 auditors are less tolerant of income-increasing earnings management, they leave more room for downward earnings management and their private clients are able to engage in greater tax avoidance. These results are stronger for standalone firms than for business groups as the latter’s greater demand for stakeholder communication motivates Big 4 auditors to increase audit quality. Collectively, our evidence suggests that Big 4 auditors adjust audit quality in a more competitive segment of the audit market where client firms generally perceive the benefit from tax minimization to outweigh the cost of reduced earnings informativeness.