Business groups and the impact of industry relatedness on firms' borrowing costs

Purpose - This study analyzes whether industry relatedness between a corporate borrower and its group peers significantly affects that firm's borrowing cost. Design/methodology/approach - A regression analysis is run on bank-loan data of a sample of Indonesian companies for 2010–2020. The main variables of interest are the natural logarithms of the borrowing firm's number of affiliates classified within either similar 2- or 4-digit GICS industries, and the Caves weighted index of these firms' related diversification. This index measures how firms in a group are diversified in relation to the borrower. The dependent variable is the all-in credit spread, stated in basis points, over the LIBOR or similar benchmark, as of the loan issuance date. Findings - Findings support the industry-relatedness hypothesis and contradict the risk-reduction hypothesis and show that banks charge lower loan spreads on a borrowing firm that either operates within a similar industry as its affiliate or diversifies into related sectors or industries. Consistent with the co-insurance-effect hypothesis, the results also underline the importance of the parent and first-layer firms as supporting instead of the tunneling vehicles within business groups. These conclusions hold even after segregating the sample and using the loan maturity as the dependent variable. Originality/value - This study uses a unique diversification measurement based on the borrowing firm's sector or industry, relative to other group members, and offers new insights on business group diversification and bank loan costs.