Friends with Benefits: The Role of Internal Capital Markets During Financial Stress

Business Groups continue to be a major contributor to the Indian economy and hence their influence on economic performance has intrigued researchers. It has often been argued that the unique business structure of group firms, leads to the formation of an internal capital market that renders the member firms certain advantages compared to their stand-alone counterparts. Firms in a business group can invest in each other’s business ventures and help other member firms in meeting their obligations. Therefore, during times of crisis, group-affiliated firms are likely to have better chances of surviving. Our study examines this hypothesis by deploying an empirical framework to show how the benefits of internal capital markets to group-affiliated firms amplify during an economic downturn. The results show that when economic conditions are challenging, group-affiliated firms have lesser chances of facing financial stress as opposed to stand-alone firms. Further, the study provides evidence that the intra-firm transfer increases during the crisis and that the reliance on trade credit and external loan tend to reduce for group-affiliated firms vis-à-vis stand-alone firms during the crisis.