WPS3975

# **Financing Firms in India**<sup>∗</sup>

**Franklin Allen Rajesh Chakrabarti** Finance Department Finance Area The Wharton School College of Management University of Pennsylvania Georgia Institute of Technology <u>allenf@wharton.upenn.edu rajesh.chakrabarti@mgt.gatech.edu</u>

## **Sankar De**

Centre for Analytical Finance Indian School of Business Hyderabad 500 019, India <u>Sankar_De@isb.edu</u>

**Jun “QJ” Qian Meijun Qian** Finance Department Finance Department Carroll School of Management Carroll School of Management Boston College Boston College <u>qianju@bc.edu qianme@bc.edu</u>

## **Abstract**

We examine the legal and business environments, financing channels and governance mechanisms of various types of firms in India, and compare them to those from other countries. Despite its English commonlaw origin, strong legal protection provided by the law and a democratic government, corruption within India’s legal system and government significantly weakens investor protection in practice. External financing of firms has been dominated by non-market sources of financing, while the characteristics of listed firms are similar to those from countries with weak investor protection. Our evidence, including results based on a survey of smalland medium-scale private firms, shows that alternative financing channels provide the most important source of funds. We also find that informal governance mechanisms, such as those based on reputation, trust and relationships, are more important than formal mechanisms (e.g., courts) in resolving disputes, overcoming corruption and supporting growth.

## **Keywords:** India, law and finance, institutions, informal mechanisms, SME sector.

## **_JEL_ Classifications:** O5; K0; G0

## World Bank Policy Research Working Paper 3975, August 2006

_The Policy Research Working Paper Series disseminates the findings of work in progress to encourage the exchange of ideas about development issues. An objective of the series is to get the findings out quickly, even if the presentations are less than fully polished. The papers carry the names of the authors and should be cited accordingly. The findings, interpretations, and conclusions expressed in this paper are entirely those of the authors. They do not necessarily represent the view of the World Bank, its Executive Directors, or the countries they represent. Policy Research Working Papers are available online at http://econ.worldbank.org._

> ∗ We appreciate helpful comments from Asli Demirgüç-Kunt, Mihir Desai, Nandini Gupta, Ravi Jagannathan, Rohan Williamson, Marc Zenner, and seminar/session participants at the Chinese University of Hong Kong, Stockholm School of Economics, Gothenberg University, Wharton and the Darden-World Bank conference on emerging markets.  For assistance with collecting financial data and conducting firm surveys, we wish to thank Sankar De’s associates at the Centre for Analytical Finance (CAF), Indian School of Business.  Gaurav Khurana and Narender Khurana contributed to our survey work in New Delhi.  Deepika Luke (CAF) and Richard Fu (Georgia Tech) provided extensive research assistance, and P. G. Shinde (Centre for Monitoring Indian Economy) contributed economic and financial data. Sankar De gratefully acknowledges financial support from the Goldman Sachs Foundation, and the other authors thank their respective institutions and the Wharton Financial Institutions Center for financial support.