Ferreting out Tunneling: An Application to Indian Business Groups

Owners of husiness groups are oflen accused of expropriating minority shareholders hy tunneling resources from firms where they have low cash flow rights to firms where they have high cash flow rights. In this paper we propose a general methodology to measure the extent of tunneling activities. The methodology rests on isolating and then testing the distinctive implications of the tunneling hjfpothesis for the propagation of earnings shocks across flrms within a group. When we apply our methodology to data on Indian business groups, we flnd a signiflcant amount of tunneling, much of it occurring via nonoperating components of proflt. I.