Do business groups drive poor allocative efficiency in emerging markets? Using a recent large-scale highway development project in India, we study the relationship between internal capital markets and efficiency of capital allocation in Indian business groups. We show that there was significant capital reallocation across member firms within the group which allowed group affiliated firms to respond faster than standalone firms in response to upgraded connectivity. This capital reallocation was financed externally with group firms crowding-out financing from the economy thereby imposing financial constraints on standalone firms. These firms also showed lower profitability and appear to misallocate capital following access to the road network. Our evidence is consistent with busin...[ Read more ]

Do business groups drive poor allocative efficiency in emerging markets? Using a recent large-scale highway development project in India, we study the relationship between internal capital markets and efficiency of capital allocation in Indian business groups. We show that there was significant capital reallocation across member firms within the group which allowed group affiliated firms to respond faster than standalone firms in response to upgraded connectivity. This capital reallocation was financed externally with group firms crowding-out financing from the economy thereby imposing financial constraints on standalone firms. These firms also showed lower profitability and appear to misallocate capital following access to the road network. Our evidence is consistent with business groups in developing countries driving poor allocative efficiency and inhibiting growth of independent firms because of lack of finance.