Diversification and Tunneling: Evidence from Indian Business Groups∗

We provide evidence suggesting an important, yet largely unexplored motive for the diversification of emerging-economy business groups is to facilitate tunneling by controlling shareholders. Using firm-level data on Indian business groups, we find that the distance of an affiliate firm from a business group’s core is related to the wedge between control and cash flow rights of insiders and the opacity in its ownership structure. Firms with ownership-control wedge lower and ownership opacity higher than a group’s core firm are more likely to be in activities distant from the core. We also find evidence of tunneling in the same direction, from firms low in the business group pyramid to firms high in the pyramid. Taken together, this suggests an expropriation motive for diversification in Indian business groups: 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