Corporate Debt and Outsourcing in India

The structure of firms' activities, as to whether they should be undertaken internally or performed wholly or partially with the help of external firms, has been important. The issue of outsourcing has generated interest among academics and practitioners. Simultaneously, how firms' capital structures influence behaviour is important, because the divergent goals and preferences of different providers of capital can manifest themselves in the form of differences in strategies pursued by firms. This article uniquely evaluates whether variations in Indian firms' capital structures, and more specifically, the quantity and type of debt chosen by firms, have influenced firms' outsourcing decisions. Governance mechanisms in Indian organizations have been unique when compared to that elsewhere, with government playing a big role in the financing of firms since banks and financial institutions are, in the main, government-owned. Also, the legal environment is unique and different from those in advanced economies. The link between capital structure and strategy, thus, can become quite unusual in India. The evaluation is based on a large sample of firms for which debt data were available. The main finding noted is that as the proportion of funds borrowed by Indian firms from commercial banks and financial institutions rise, these firms engage in greater levels of outsourcing and are less inclined to vertically integrate. In the presence of financing by government-owned banks and financial institutions, industry has been able to engage in strategies that may not be compatible with asset and property rights protection and performance enhancement. This is due to the collective action problem banks and financial institutions may face in monitoring lenders. As far as corporate debentures are concerned, where debentures rise as a proportion of borrowings, firms continue to engage in outsourcing. Possibly they can ignore the pressures from bondholders, who in India have not yet had a significant presence as the corporate debt market in India is still relatively under-developed and inadequate as a source of funds. By that same logic, firms can ignore pressures from fixed deposit holders to adopt performance-enhancing or property rights protecting strategies. Yet, fixed deposit holders show an ability to influence firms to lower outsourcing as their presence in the debt structure of firms enhances. This may be not due to fixed deposit holders' influencing abilities but because the relative costs of fixed deposits are high, with interest rates on fixed deposits five to ten percentage points more than that for other debt. The enhancement of fixed deposits in firm' debt profiles will cause margin pressures. To obviate these, firms may resort to potentially cost-saving integration strategies.