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The IUP Journal of Applied Finance
Hidden Leverage in Conglomerates: An Unintended Systemic Risk
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A business with interests in more than one sector of the economy can be run as a single company with multiple divisions as a conglomerate or with several independently run companies as a conglomerate. In India, conglomerates are large and diverse family-owned businesses. The firms affiliated to them hold large market shares in their respective sectors. On average, they tend to be larger than the unaffiliated firms. Through the act of setting up independent firms, shadow leveraging takes place through seemingly arm’s length relationships. Considerable effort is made to obfuscate the nature of the association between firms to obviate the accounting requirements for disclosure of consolidated accounts. This paper tries to establish that firms affiliated to a conglomerate are far more leveraged than their unaffiliated counterparts. Regulators and market participants are focused narrowly on their specific jurisdictions. Since the leverage is moved to unlisted and unregulated market segments, the systemic risk arising from them remains largely unexplored. Regulators need to be aware of this systemic risk and alter regulations to introduce greater disclosures from such groups.

 
 
 

Debt plays a crucial role in growth of a firm. It also acts as a check against exuberance by entrepreneurs. According to agency theory, debt is a useful governance mechanism for curbing the tendency of managers to overinvest in firm growth. The periodic interest payments reduce managerial discretion over internal funds. Further, the threat of bankruptcy provides them with strong disincentives against wasteful expenditure. In small traditional Indian businesses, debt was associated with risk. Many family-run business houses in India even today shun it despite the many advantages it offers; tax deductibility being the most important. Perusal of the history of Indian industry reveals the fact that it is intricately linked to the evolution of family-run businesses, that started off as local focused ones, into large diversified conglomerates. This is not to deny the existence of independent business houses that are run by professional managements or to belittle their role in any way.

Industrial and Financial Conglomerates (FCs) tend to be family-owned and hold large market shares of businesses in most market segments. There are other firms that are unaffiliated to such groups but could either be focused in a particular market segment or be running large diversified businesses as divisions within the firm. The primary objective is to establish the hypothesis that firms belonging to conglomerates are more leveraged than those that are not affiliated to groups. In other words, the idea is to bring to the fore, shadow leveraging that takes place through the act of setting up separately incorporated firms (as part of the group) through seemingly arm’s length relationships.

 
 
 

Applied Finance Journal,Industrial and Financial Conglomerates (FCs), Family-owned and hold large market shares, Emerging Market Economies, Complex Conglomerate Ownership Structure.