ISSN (Print) - 0012-9976 | ISSN (Online) - 2349-8846
Reader Mode
-A A +A

Evaluating Institutional Disruption

Financial Sector Governance and Pharmaceutical Innovation in India

Sumit Majumdar ( teaches technology strategy at the University of Texas at Dallas.

In India, from the late 1960s to the early 2000s, a consortium of three premier financial institutions gave projects long-term loans based on tangible assets. The consortium was abandoned in 2001. A transition away from the institutional logics of consortium financing is associated with a rise in the research and development activity of pharmaceutical firms. Changes in financial sector rules impacted Indian firms’ capability transformation. Management research needs to consider institutional logics changes in assessing the influence of financial factors on firms’ capabilities creation.

The insights of P D Kasbekar were important and very useful for a section in this paper on the structure and recent history of the finance sector in India. Kasbekar (1921–2008) had held important positions in the financial governance of India: chief secretary, Government of Maharashtra; Controller of Capital Issues; and Chief Controller of Imports and Exports. Kasbekar served as private secretary to Minister of Finance C D Deshmukh and after retirement, as director of the National Institute of Bank Management. The section on institutional logics changes is based on details graciously provided by a former chairman of the State Bank of India; a former executive trustee of the Unit Trust of India; several former executive directors of the Industrial Development Bank of India, the Industrial Credit and Investment Corporation of India, and the Reserve Bank of India; and other senior financial sector executives. All of them had extensively participated in the various activities subsequently described.

The international organisation Médecins sans Frontières (Doctors without Borders) has called India the pharmacy for the developing world (Chaudhuri 2012). India’s pharmaceutical industry is growing in double digits. It has a substantial foreign presence and 20% of the global generics market by volume. In terms of overall global volume, the Indian industry ranks third; it ranks 14th by value. The Indian bulk drugs industry has a share of 9% of the global market, and India’s pharmaceutical exports have grown annually at 20% in the first decade of the 21st century (Government of India 2012).

This paper reports a study examining the impact of changing institutional logics in the financial sector in motivating research and development (R&D) by India’s pharmaceutical firms. Specifically, the study evaluates how—over the 15-year period from 1991–92 to 2005–06—changes in the institutional logics of banks’ consortium financing practices has affected firms’ R&D activities.

The activities of reconfiguring firms’ key resources are vital (Teece 2007). Because it enhances capabilities, R&D is important. Equally, an active financial sector helps promote growth (Bencivenga and Smith 1991). Finance is a key resource in influencing R&D (Hall 2002) and firm growth. The financial sector can be based on banks or equity markets (Zysman 1983). In India, banks have dominated firms’ financing (Majumdar and Sen 2010).

Institutional frameworks define firm behaviour (North 1990). Institutions provide incentives for regularity of firm behaviour, with strategies being influenced by such incentives, and institutional constraints influence investments in technology (Parente and Prescott 2002). Institutions influence strategic decision-making by their logics and shape behaviour via effects on individuals’ abilities (Thornton and Ocasio 2008).

How consortium financing, a key institutional feature ofIndia’s financial environment, has affected Indian pharmaceutical firms’ R&D activities has not been researched. The growth of the pharmaceutical sector and a continuouslyexpanding global footprint of Indian firms makes Indian pharmaceutical firms an important laboratory for advancing management research in empirically testing how institutional logics changes impact R&D and firms’ capability transformation.

Across the disciplines that make up the field of social science and management research—such as strategic management and finance—the financing of R&D has been taken seriously. This paper evaluates how financial contingencies have changed the R&D behaviour of Indian pharmaceutical firms. This specific topic has seen no diffusion in the field of social science research. The study frames the issue in a way as to appeal to a generic audience. Hence, a new and important topic that scholars may not have completely evaluated in detail is brought into the domain of social science research.

The paper makes a conceptual contribution. The theoretical analysis is cast in the institutional logics literature. The institutional logics argument—now emerging as a major source of explanations for numerous episodes of strategic change in firms—is utilised in detail to anchor explanations as to why Indian firms’ capability building behaviour should have changed.

Conceptual Background

This background considers the development of R&D capabilities, financing as an internal contingency, the role of institutional logics, and features of leverage.

Developing R&D capabilities: A key activity of firms is response to change (Teece and Pisano 1994); and strategic adjustments occur in rapidly changing environments (Teece et al 1997). Triggers for capability development are contingent on environment changes (Zahra et al 2006). As environments change, firms sense situations to seize opportunities (Teece 2007). Such changes affect dynamiccapabilities, as sense-making leads firms to engage in R&D, to serve new markets (Teece 2007). The conduct of R&D activities is a capability-enhancement process (Helfat 1997). This idea predicates a role for R&D-based competences in creating new products and processes to respond to changing market circumstances (Teece and Pisano 1994). The conduct of R&Dactivities is a core attribute of firms (Helfat 1997). R&D outcomes change the nature of outputs a firm generates, as many markets may have different expectations, and R&D-based products and processes are required for firms to respond to changing marketcircumstances.

Financing as an internal contingency: Given the context dependency for capabilities (Teece 2007), relevant factors influencing capability development are internal and external contingencies (Barreto 2010). Of these, raising funds is an important contingency. Therefore, the issues of whether to have debt and how much and what happens as a result of borrowing is of importance (Brown et al 2009; Majumdar 2011).

Corporate finance issues influence firms’ innovativeness (Opler and Titman 1993). Firms reluctantly invest in R&D(Hall 2002), and R&D is affected by financing issues. R&D spending is incurred on overhead and employment costs to create intangible assets. Outcomes of R&D are uncertain, and these uncertainties can be high, signalling risk. High-capital-intensity firms that are low on relative levels of intangible assets will face lower bankruptcy risks as their tangible assets can be collateralised for loans (Brealey and Myers 2003).

For firms engaging in higher levels of R&D, the presence of high intangible assets may lead external financiers to seek control of firms’ operations (Hart 1995), and innovative firms may choose to fund projects via internal rather than external resources (Himmelberg and Petersen 1994; Brown et al 2009). Such technology-intensive firms favour lower leverage (Lang et al 1996). In the strategic management literature, debt levels and technology intensities are found to be negatively related (Balakrishnan and Fox 1993; Vincente-Lorente 2001; O’Brien 2003).

Role of institutional logics: Institutional changes alter institutional logics and motivate firms differently, as searching for outcomes impact incentives. Altered institutional logics lead to changes in interpretations of environmental contingencies (Ocasio and Joseph 2005), new approaches in addressing contingencies (Rao et al 2003), and resource reconfigurations (Teece et al 1997). The institutional logics approach incorporates a framework as to how institutions, via underlying logics, shape the actions of firms (Thornton and Ocasio 2008). Each institutional order has a logic in guiding the principles providing individual firms motive.

Institutional logics encompass assumptions about what is meaningful as firm actions (Glynn and Lounsbury 2005; Thornton et al 2012). These assumptions influence responses to environmental stimuli (Almandoz 2014). Institutional logics lead to attributes fitting together, thereby permitting firms to develop strategy (Glynn 2008). Two broad types of effect—period effect and replacement effect—have been examined (Dunn and Jones 2010). In a period effect, an exogenous shock brings in a new dominant logic and separates a stable period of beliefs from another. The empirical research on institutional logics has covered several empirical contexts, such as architects’ practices (Jones and Liven-Tarandach 2008); banks (Almandoz 2014); financial organisations (Haveman and Rao 1997; Lounsbury 2002, 2007; Marquis and Lounsbury 2007); medical education (Dunn and Jones 2010); and restaurants (Rao et al 2003). The replacement effect posits that changes lead to a replacement of one dominant logic for another (Lounsbury 2002; Rao et al 2003).

Features of leverage:1 Debt has two characteristics. Debt holders have the right to a fixed income stream from the issuers of debt. Second, debt holders have the right to repossess collateral, which are the tangible assets of the firm, if the actions of managers take the firm to bankruptcy. Equity holders are not assured of a fixed income stream, and they cannot repossess collateral.

Firms borrow from two types of lenders: banks and financial institutions—which are often called private lenders, though not in an ownership sense—and the public-at-large, which subscribes to corporate bonds, debentures, and fixed deposits and is called arm’s-length lenders (Rajan 1992). Banks and other private lenders can efficiently monitor firms relative to arm’s-length investors (Diamond 1991). Commercial bank lending may motivate R&D (Bougheas 2004) because borrower relationships generate a monitoring advantage (Fama 1985).

Another distinction is private debt, categorised as debt from banks and non-bank private debt (James 1987). This distinction is important because banks are regulated in specific ways by the monetary authorities; and, since banks raise deposits from the general public, they need to adhere to specific reporting practices. Non-banking financial institutions are not subject to the liquidity and reporting requirements of banks.

A parallel can be drawn between banks, venture capital firms, and private equity firms. The nature of regulations that banks face is different vis-à-vis venture capital and private equity firms. In the case of venture capital and private equity firms, there is no regulation, other than self-regulation, and these entities have different risk profiles relative to regulated banks.

Institutional Context2

Many institutional contingencies have shaped Indian firms’ strategic decision-making (Das 2002). Corporate finance issues are important in India (Majumdar and Sen 2007); and the nature of rules and regulations governing the process of fundraising from banks, as well as the process of obtaining funds from domestic or overseas locations, are critical (Majumdar 2010). These institutional characteristics of India’s financial system have been all-encompassing and important in influencing firms (Majumdar and Sen 2010).

Firm leverage: In India, firms borrow using several debt instruments. Two major types of debt are short-term unsecured borrowings from commercial banks and long-term borrowings from term-lending institutions. Together these account for over 70% of all corporate borrowings. Debt is either monitored or arm’s-length (Rajan 1992). Bank borrowings and institutional borrowings are monitored debt (Majumdar and Sen 2007). The distinction between bank borrowings and borrowings from financial institutions arises because of the nature of regulations Indian banks are subject to and because of the control over interest rates banks face.

In the Indian case, non-bank private debt is provided by financial institutions. This debt is long-term and secured. The differences are important because bank debt, which is short-term, is subject to the requirement of the credit and monetary policies of the Reserve Bank of India (RBI)—India’s central bank—because of the operation of the cash reserve ratio (CRR) as well as the statutory liquidity ratio (SLR). Additionally, banks are governed by the Banking Companies Act, 1949. As a result, funds available for lending are constrained, and banks have to charge higher rates of interest. Bank loans are substantially unsecured and, therefore, more expensive than loans from financial institutions, which are based on collateral, and carry a discount relative to uncollateralised debt (Majumdar and Sen 2010; Rajan and Winton 1995).

Institutional background: Institutional issues have influenced Indian firms and outcomes (Das 2002). A fundamental transformation in institutional logics occurred in 1991 when the command-and-control policy regime, the licence raj, was replaced by a market-oriented regime. The primary change was in the approach to industrial policy—free entry into industries was permitted. An outcome was a significant rise in entrepreneurship and industrial investment. The change that occurred in 1991 was a period effect, when one exogenous shock altered the ways of doing business. Yet, other specific institutional reforms did not occur simultaneously. Reforms—for example, in capital market rules, foreign exchange rules, taxation rules, and fundraising rules—did not happen in 1991, or they occurred later, or are still outstanding. This analysis does not examine the impact of the post-1991 period effect; it examines a “replacement of institutional logics” effect, when some key rules related to the financing of firms in India changed a decade later. The next section contains the discussion as to how the financial sector evolved in India and how financial sector institutional practices, rules, and regulations affected firms’ innovative behaviour.

Financial sector—structure and recent history: The Indian capital market dates to the colonial period. The first stock market in India was established in 1857 in Bombay (now Mumbai). During the colonial period, Indian firms successfully popularised debentures as a source of financing (Roy 2000). After independence in 1947, strict control was placed on the pricing and new issues of capital, including corporate bonds. This was done via the office of the Controller of Capital Issues, a unit in the Department of Economic Affairs of the Ministry of Finance, which controlled the quantity and price of both debt and equity that companies could issue (Majumdar and Sen 2010).

In 1969 commercial banks making short-term working capital loans to industry were nationalised. Commercial banks in India are still mainly state-owned (Sarkar and Agarwal 1997) but barriers to entry have been relaxed for private banks since 1991, and there has been entry of domestic and foreign-owned private banks. In spite of state ownership of these banks, their ownership has been “quasi-private.” This is for two reasons. First, all nationalised banks in India have had long histories operating as private banks, often being part of business groups. The Central Bank of India was part of the Tata Group; the United Commercial Bank was part of the Birla Group; and even the largest state-owned bank, the State Bank of India, was privately owned until 1955 and was called the Imperial Bank of India.

Second, commercial banks are supervised by the RBI, India’s central bank, which is traditionally independent from the government. Commercial banks—subject to RBI jurisdiction and monetary policy canons—are constrained in their amount of lending; their loans are more expensive than that of financial institutions. Control rights over Indian commercial banks have remained with banking executives rather than with the Ministry of Finance. After a period of social control of banking between 1969 and 1991, there were reforms in the Indian financial sector, which allowed banks to set interest rates on their own and to engage in lending without major restrictions on who they lent to (Sen and Vaidya 1997).

Institutional Logics Change

The institutional debt market has accounted for a substantial portion of long-term industrial finance in India (Majumdar and Sen 2007), levels of average corporate debt being at least double the levels of corporate equity and, in some cases, substantially greater. Fundamental changes happened within the debt market, however, only in 2000–01. That change was the abandonment of consortium financing for long-term loans that had continued after commercial banks were first nationalised in 1969.

With respect to institutional borrowing, these loans have been essentially provided by term lending institutions; these are long-term loans that are secured on the assets bought with these loans. Term lending institutions were established de novo by the government after independence. The Industrial Finance Corporation of India was set up in 1948. A major quasi-private sector financial institution, the Industrial Credit and Investment Corporation of India, was established in 1955 with the support of the World Bank. In establishing this unit, the government’s blessing was paramount. Eventually, government holdings in this financial institution were over 80% through a variety of indirect means. These institutions have been two major suppliers of long-term loans to Indian industry (Bidani et al 1998). The Industrial Development Bank of India was set up in 1964 as a statutory corporation under a special act. After 1964, it was given the primary coordination role in the provision of industrial finance for development. The three institutions—the Industrial Development Bank of India, the Industrial Finance Corporation of India, and the Industrial Credit and Investment Corporation of India—subscribed to all loans over a certain minimum sum in the ratio of, respectively, 50%, 25% and 25%. Each institution was at liberty to bring projects to the appraisal forum, and joint appraisal would ensure that sanction norms were being maintained (Arora 1992). Occasionally, other financial institutions—such as the Life Insurance Corporation of India, the General Insurance Corporation of India, and the Industrial Reconstruction Corporation of India—would participate in the projects, and they would be allocated a share of the loan that they would advance the firms from their funds.

In 1969–70, after the first phase of the nationalisation of commercial banks, the practice began of consortium financing via senior executives’ meetings and inter-institution meetings. At regular senior executives’ meetings among the executive directors of these institutions—held at least twice a month and, in some cases, more often, if there were a large number of projects to be discussed—the complete project details would be discussed. These details would include items related to strategic, operational, technological, and financial matters. Financial institutions would extensively debate firms’ plans and seek the inputs of their technical specialists in comprehensively auditing the projections of entrepreneurs and firms. The institutions could seek changes to the plan and its projections before sanctioning a loan. By their charter, financial institutions were to advance funds for the long-term creation of industrial assets in India; typically, therefore, institutions sanctioned loans based on the firms’ investment plans to create tangible assets that could be collateralised.

In theory, a consortium structure for institutional decision-making would encourage risk-sharing so that the impact of R&D uncertainties would be minimised. Nevertheless, the culture of consortium financing activities was such that if intangible assets were to be created by the concerned firms based on the sums obtained as loans, loan sanctions would be extremely difficult, if not absolutely impossible, to obtain.

Similarly, at inter-institution meetings held at the level of the chairperson and managing director of the concerned institutions—monthly at first and quarterly later—the bigger picture record of loan sanctions among member financial institutions was reviewed. Difficult cases of project sanctions were brought to the attention of executives at the inter-institution meetings for review and sanction. Again, given the financial institutions’ mandate to advance long-term funds based on tangible asset cover, the creation of intangible assets was not supported at the top level.

This paper hypothesises that the practice of consortium financing slowed down in the mid-1990s as the Industrial Credit and Investment Corporation of India converted itself into a private scheduled commercial bank, more interested in providing loans for working capital financing, housing, and automobiles. Later, the Industrial Development Bank of India converted itself into a scheduled commercial bank, with a small presence in the commercial loans market and a larger presence in its primary long-term lending area (Reserve Bank of India 2005). This organisational conversion had involved a fundamental change in the charter of the Industrial Development Bank of India, necessitating parliamentary legislation, since it was a statutory corporation originally established under an act of Parliament.

In 2000–01, the institutions formally abandoned the practice of consortium financing via senior executives’ meetings and inter-institution meetings. Thus, the practice of consortium financing continued for over 30 years. It was the last major restriction remaining from the erstwhile command-and-control regime. Until then, firms financed by these institutions were not encouraged to create intangible assets in intellectual property via R&D activities. Accordingly, it is hypothesised that a negative relationship would be noted between the presence of consortium financing and firms’ undertaking of R&D activities.


To test the impact of the institutional change on R&D, data drawn from the RBI database on financial accounts of non-government public limited companies for pharmaceutical sector firms are used.

Sector data: The data relate to public limited companies according to the definitions of the Companies Act, 1956. The RBI public limited company data represents about 85% of the paid-up capital for eighty-six 3-digit industries (Feinberg and Majumdar 2001). The data are standardised into a common format across companies and time (Augustine 2009). To construct the panel, data on pharmaceutical firms for the period 1991–92 to 2005–06 are used. The total number of firm-year observations over the 15 years is 1,229. The data set contains details of all public limited companies in India’s pharmaceutical sector. Data coverage is akin to that of an annual firm census.

Before 1972, foreign firms used patent rights to prevent Indian companies from manufacturing. As a result, the industry was undeveloped (Chaudhuri 2012). In 1972, product patent protection for pharmaceuticals was abolished. This abolition gave firms in India an incentive to undertake at least process R&D, so as to enhance their manufacturing dynamic capabilities (Feinberg and Majumdar 2001), and transformed the industry. Indian firms developed cost-efficient processes and emerged as major global players. The companies in the data set would have been beneficiaries of this industry transformation.

To comply with the requirements under the Agreement on Trade Related Aspects of Intellectual Property Rights (TRIPS), drug product patent protection was introduced in January 2005. This protection would have influenced firms in India to undertake R&D (Chaudhuri 2005), as would have the expiration of overseas patents. Hence, Indian companies—such as Dr Reddy’s Laboratories, Lupin Laboratories, Sun, and Zydus Cadilla—focused on R&D activities to enjoy opportunities forthcoming from the expiration of patents of several blockbuster drugs overseas (Government of India 2012).

Variables: The dependent variable has been the firms’ ratio of R&D expenditure to sales (R&D). The primary explanatory variable has been a dummy variable with the value of one for a yeardenoting whether financing by a consortium of development finance institutions (Consortium Funding) was in existence or not, or 0 otherwise. Two variables control for the composition of debt in Indian pharmaceutical firms: Bank Borrowing, or the share of firms’ borrowings from commercial banks; and Institutional Borrowing, or the share of firms’ borrowings fromfinancial institutions.

Additional controls are necessary. The variables chosen are based on those identified in the literature (Lall 1983). In the innovation management literature (Cohen and Klepper 1996) an important variable is size of firms (Size); it has been measured as the natural log of sales. The variable Capital Intensity, measured as the ratio of net fixed assets to total assets, accounts for industry-specific effects impacting on undertaking R&D as well as the relative importance given by the firms to tangible versus non-tangible assets.

The share of wages to sales (Wage Share) controls for relative expenditures on human assets; a large ratio could constrain discretionary R&D spending. A ratio of firms’ foreign earnings to sales (Foreign Earnings) measures the externally generated resources that can provide additional sources of research funding as well as motivate firms to engage in higher levels of R&D for the global market. The ratio of firms’ imports to sales (Imports) is a control variable because firms that acquire inputs from overseas would be able to generate innovations more productively.

Variables are introduced to control for firms’ financial characteristics. Leverage extent is important, and the ratio of debt to equity (Debt Equity) is introduced as a control. A variable calculated as the ratio of profits retained to total net profits earned in the year (Retention Rate) is incorporated as a control. A variable, the ratio of cash to total assets (Cash), accounts for liquidity.

Estimation: Estimations are carried out on the premise that for institutional changes occurring in India, given India’s complex institutional history (Bhagwati 1993), there would be a selection process, with multiple dependencies. Thus, a concern is the endogeneity of an institutional variable (Aoki 2001). The endogeneity is tackled using the approach described in the treatment effects literature (Abbring and Heckman 2008). Given institutional change, the next issue is its impact and the question of how much causality can be imputed to such a change.

The transition away from consortium financing would have involved behavioural changes; and it would have been a major treatment experienced by Indian firms, given the nature of assumptions underlying financing. In this study, the treatment effects approach is applied in assessing how an institutional change has influenced firms’ behaviour. A treatment effect is the average causal effect of a variable on an outcome variable, and the idea behind the approach is that a transition from one state to another is equivalent to a treatment that firms receive.

A treatment effects model considers the Consortium Funding variable as a covariate influencing R&D after it has been modeled as a dummy endogenous variable influenced by certain exogenous instruments. The rationale is that Consortium Funding can represent a treatment that firms have undergone. The decision to change the rules by financial institutions will be conditioned by heterogeneous factors since self-selection into treatment is at play when major revamping programmes within a country, like the change of rules, are decided.

Treatment effects models (Rubin 1974; Heckman et al 1998; Hirano et al 2003) are important. The treatment effects approach permits a natural experiment condition (Angrist 1998) to be assessed in establishing cause and effect (White 2011), where a response function embodies the effect of interest after the causal impact of an institutionally mandated policy. A response function could be any strategic behaviour or performance variable; in the specific case of this study, it is firms’ R&D levels. In a dynamic panel, there are multiple observed treatment histories and outcomes for the same firm and for all other firms (White 2011). Some treatments may be labelled 0 in the periods that they were not implemented and then be labelled 1 continuously for all subsequent contiguous periods. It is not necessary that treatments occur in contiguous time periods.

Treatment effects models are estimated to account for the potential selection bias that may affect India’s finance sector transition away from consortium financing. The Consortium Funding variable, capturing the shift in the procedures for financing, is a 0 or 1 dummy variable for which initial parameters are estimated. In respect of instrument choice, an issue relating to the parameter being identified by the instrument is one of relative independence (White 2011). Perfectly independent instruments meeting exclusion criteria are never available; hence, other considerations arise. The macroeconomic variables used as instruments are the share of manufactured exports in India’s total exports (Manufactured Exports) and the ratio of net domestic capital formation (Capital Formation) to the gross domestic product (GDP) of the economy.


The first facts displayed are the ratio of annual R&D to sales for the pharmaceutical firms studied (Figure 1). These show a growth trend, rising to 1.45% of sales in 2005–06 from 0.65% of sales in 1991–92. Given global pharmaceutical revenues of over $800 billion and annual R&D spending by pharmaceutical firms of about $80 billion (Government of India 2012)—an R&D-to-sales ratio of 10%—the absolute and relative sums spent in India are low. The trend is one of a rise. These indicate the enhancement of dynamic capabilities by Indian pharmaceutical firms after the liberalisation of 1991.

A set of regressions of the R&D, Bank Borrowing, Institutional Borrowing, and Debt Equity variables indicate that R&D has significantly increased over time; borrowings from banks have remained stable; borrowings from financial institutions have decreased significantly over time; and leverage has decreased significantly over time. These results indicate changes in financing patterns for India’s pharmaceutical firms (Table 1).

In the first set of regression results (Table 2), four modelresults are given. The likelihood ratio statistics for all of these models denote that it has been appropriate to use the treatment effects approach. In Model A, the results relate just to the Consortium Funding variable, which is negative and significant (p < 0.01), as hypothesised.

Indian firms are highly leveraged; for example, the average of the Debt Equity ratio variable for the pharmaceutical firms studied has been 4.69, and banks and financial institutions have accounted for the borrowings. For the firms studied, Bank Borrowing has accounted for 55.18% of the total borrowings, and Institutional Borrowing has accounted for 11.38% of the total borrowings. It is necessary to include Bank Borrowing and Institutional Borrowing as controls and evaluate the status of the impact of the Consortium Funding variable after such inclusion. The results are in Model B; again the Consortium Funding variable is negative and significant (p < 0.01).

In Model C, the Bank Borrowing and Institutional Borrowing variables are excluded while all other control variables are included. In Model D, the Bank Borrowing and Institutional Borrowing variables are included with the other control variables. While the magnitude of the Consortium Funding variable reduces in size, it stays negative and significant, at p < 0.01. Across the four specifications, the Consortium Funding variable is negative and significant, and these results are consistent.

The Consortium Funding variable is a time dummy picking up a structural break in institutional policy in India. Possibly this time break could be picking up a variety of other effects so that causality between the impact of the elimination of financial consortia and firms’ capability building, via R&D activities, would be impossible to establish. The causality would be confounded by other factors; and the teasing out of the specific effect of the removal of consortium funding practices on firms’ R&D motives would be difficult.

Secondary results and causality establishment: A way to ensure that the causality between the R&D and Consortium Funding variables is firmly established, based on treatments effects modelling, is to introduce a time variable as an additional control. Hence, the results in Table 3 include a Time variable to pick up time trends. The Time variable soaks up other institutional effects. Such institutional effects would have impacted firms’ R&D spending patterns. If in the presence of the Time variable the impact of Consortium Funding is not washed out, and the Consortium Funding variable stays negative and significant, this result indicates causality between R&D and Consortium Funding.

The four models used in the primary analysis as given in Table 2 are re-run with the addition of the Time variable. These secondary results (Table 3), Models A to D, show that the Consortium Funding variable stays negative and significant (p <0.01) across the four specifications. The magnitude of the variable stays consistent with the magnitudes noted in the primary specifications. The Time variable is either insignificant, or positive and significant—hence picking up the temporal growth in R&D spending by Indian pharmaceutical firms. These results suggest the existence of a causal relationship between R&D and Consortium Funding. In other words, the elimination of a formal consortium approach to lending by India’s major financial institution led pharmaceutical firms to engage in dynamic capability building by increasing their R&D expenditure.

Prior research has established that regulatory changes in foreign exchange legislation have influenced R&D by Indian pharmaceutical firms (Majumdar 2012). Foreign exchange legislation has been an important institutional factor, codified as the Foreign Exchange Regulation Act, 1973 (FERA). In 1999, FERA provisions were replaced with those of the Foreign Exchange Management Act (FEMA). The results have shown that the transition from FERA to FEMA motivated pharmaceutical firms to undertake R&D.

A variable FEMA—coded as 1, denoting the presence of a changed foreign exchange regime, and 0 otherwise—is also introduced as a time-variant control in the estimation; the results are in Models E and F. The FEMA variable can also soak up other time-variant influences, thereby further isolating the causal impact of Consortium Funding on R&D. The results of models E and F indicate that Consortium Funding remains negative and significant after the addition of FEMA as anadditional variable. The FEMA variable is positive and significant.

Overall, the impact of this particular institutional feature on R&D activities of Indian pharmaceutical firms was negative and significant. Its repeal is associated with a positive and significant impact on R&D. The average across the 10 models of the estimate is −0.854; the size of this average estimate implies that Indian pharmaceutical firms have increased R&D spending by 80% after the consortium financing process was withdrawn. The impact is substantial—R&D spending averaged just over 1% of sales for all firms over time—and it would have raised the R&D-to-sales ratio to around 2% of sales; globally, though, the spending ratio for the pharmaceutical sector is about 10% of sales.

The results are consistent with a bankruptcy costs view of lenders’ predilections to not engage in lending activities with firms that have high levels of intangible assets. Firms with such assets and their lenders can face higher bankruptcy cost risks as assets cannot be adequately valued or collateralised. Even though a consortium structure has an insurance effect—permitting financial sector firms to pool their risks, share in possible losses, and absorb uncertainties inherent in R&D programmes—the risk-averse administrative culture of India’s financial institutions has not permitted this to happen.


The results—which have been robust to the inclusion of important variables capturing other important effects that influence R&D spending by firms, and after stripping out time and other effects—are of considerable overall significance. The magnitude of the impact of the Consortium Funding variable—it shifted in the estimation from 0 to 1—has been large and significant across all the specifications reported for the entire time period (Tables 2 and 3). Capability spending levels as measured by the ratio of R&D to sales have increased substantially. In other words, controlling for other influences, the fundamental regime shift has caused firms in the pharmaceutical sector—which is sensitive to the quantum of R&D activities undertaken—to enhance R&D activities and augment dynamic capabilities substantially.

Theories of firm behaviour are particular to historical environments as each firm’s context is unique (Dosi and Marengo 2007) and historical contingencies generate contextual variations. Firms reconfigure capabilities to meet performance goals (March 1991) and remain viable (Lewin and Volberda 1999); and their decision to reconfigure is related to contextual changes. A variety of institutional arrangements is feasible. Hence, the behaviour of individual firms in a national setting evolve along different paths at various times due to institutional variations (North 1994).

Institutions, government policies, and regulations collectively affect the quantum and quality of business activities in an economy (Reagan 1985; Williamson 2000; Ostrom 2005). Many of these impact on innovation. The finding established in this study is significant for management research. The presence of the right types of institutions causes positive capability investment outcomes. In India, the post-1991 reformsperiod had generated entrepreneurship. As institutional logics changed, several changes to industrial and trade policies were made, resulting in “period effects.” Yet, specific rules relating to Indian firms’ strategies for financing and engagement in capability building were not overhauled till 2000–01. A “replacement effect” explains why, since the overhaul of financing rules, the outcomes from such an institutional overhauling process are significant. Thus, financial sector institutionallogics, and the changes made to them, are material in transforming firms’ fortunes.

The transition away from consortium funding enhanced the freedom of firms. When financial institutions coordinated their approach, finances were available only where tangible assets were available as collateral—even though a consortia approach could have had an insurance effect in mitigating R&D-associated risks. This policy constrained access to financial resources and inhibited intangible capability building via R&D. Once firms were provided freedom from consortium funding processes, and financial institutions did not have to coordinate among themselves to sanction loans, both firms and financial institutions could engage in a greater degree of risk-taking in generating resources. This has boosted the R&D-to-sales ratios of pharmaceutical firms. Thus, changes in institutional logics have significantly impacted Indian firms’ motivations to build capabilities.

The global importance of the Indian pharmaceutical industry is increasing. There is dynamic demand growth, allied with an expanding global market footprint of Indian firms, and they have to enhance capabilities to tackle emergent global opportunities. Firms need to increase R&D; they must be provided institutional incentives appropriate to conduct R&D activities, such as those relating to financial sector contingencies. Additional institutional changes relating to firm financing can foster continuous capability transformation.


Based on a panel of several Indian pharmaceutical firms evaluated for a period of 15 years, this paper examines the impact of changes in finance sector institutional logics, rules, and processes on the levels of R&D undertaken. An important andinfluential financial sector process from the late 1960s to the early 2000s was the long-term financial institutions’ use of consortium funding approaches was to advance project finance to firms to build their capacity and capabilities. During this period, the presence of this feature had a sharply negativeimpact on firms’ predilections to engage in R&D activities. The levels of R&D spending in India’s pharmaceutical sector firms are low in absolute terms and in comparison to global R&Dlevels observed for the sector. But the abandonment of this particular financial sector institutional feature in 2000–01 led to a substantial positive impact on firms’ desire to engage in R&D activities, leading to large increases in their R&D spending ratios. The institutional logics change has provided firms
incentives to transform their capabilities and knowledge assets. Thus, changing financial sector institutional logics have had a significant impact on capability transformation and innovation performance of pharmaceutical sector firms in India.


1 This discussion is adapted from Majumdar (2010) and Majumdar and Sen (2010).

2 This section is adapted from Majumdar (2010, 2011, 2012) and Majumdar and Sen (2010).


Abbring, J H and J J Heckman (2008): “Dynamic Policy Analysis,” Econometrics of Panel Data, 3rd ed, L Matyas and P Sevestre (eds), Dordrecht:Kluwer.

Almandoz, J (2014): “Founding Teams as Carriers of Competing Logics: When Institutional Forces Predict Banks’ Risk Exposure,” Administrative Science Quarterly, Vol 59, No 1, pp 442–73.

Angrist, J (1998): “Using Social Security Data on Military Applications to Estimate the Effect of Voluntary Military Service on Earnings,” Econometrica, Vol 66, pp 249–88.

Aoki, M (2001): Towards a Comparative Institutional Analysis, Cambridge, MA: MIT Press.

Arora, K K (1992): Development Banking in India, New Delhi: Atlantic Publishers and Distributors.

Augustine, V C (2009): “Reserve Bank of India Surveys on Corporate Statistics,” The Use of Surveys by Central Banks, IFC Bulletin No 30,Irving Fisher Committee on Central Bank Statistics, Bank for International Settlements, pp 95–99.

Balakrishnan, S and I Fox (1993): “Asset Specificity, Firm Heterogeneity and Capital Structure,” Strategic Management Journal, Vol 14, pp 3–16.

Barreto, I (2010): “Dynamic Capabilities: A Review of Past Research and an Agenda for theFuture,” Journal of Management, Vol 36, No 1, pp 256–80.

Bencivenga, V R and B D Smith (1991): “Financial Intermediation and Endogenous Growth,” Review of Economic Studies, Vol 58, No 2, pp 196–209.

Bhagwati, J (1993): India in Transition: Freeing the Economy, Oxford University Press: Oxford.

Bidani, S N, P K Mitra and P Kumar (1998): Bank Finance for Industry: Working Capital and Term Loans, New Delhi: Vision Books.

Bougheas, S (2004): “Internal vs External Financing of R&D,” Small Business Economics, Vol 22, pp 11–17.

Brealey, R and S Myers (2003): Principles of Corporate Finance, 6th ed, Irwin-McGraw-Hill: New York.

Brown, J R, S M Fazzari and B C Petersen (2009): “Financing Innovation and Growth: Cash Flow, External Equity and the 1990s R&D Boom,” Journal of Finance, Vol LXIV, No 1, pp 151–85.

Chaudhuri, S (2005): The WTO and India’s Pharmaceuticals Industry: Patent Protection TRIPS and Developing Countries, New Delhi: Oxford
University Press.

— (2012): “Multinationals and Monopolies: Pharmaceutical Industry in India after TRIPS,” Economic & Political Weekly, Vol 12, pp 46–54.

Cohen, W M and S Klepper (1996): “A Reprise of Size and R&D,” Economic Journal, Vol 106, pp 925–51.

Das, G (2002): India Unbound, New York: Profile Books.

Diamond, D (1991): “Monitoring and Reputation: The Choice between Bank Loans and Directly Placed Debt,” Journal of Political Economy, Vol 99, pp 688–721.

Dosi, G and L Marengo (2007): “On the Evolutionary and Behavioral Theories of Organizations: A Tentative Roadmap,” Organization Science, Vol 18, pp 491–502.

Dunn, M B and C Jones (2010): “Institutional Logics and Institutional Pluralism: The Contestation of Care and Science Logics in Medical Education, 1967–2005,” Administrative Science Quarterly, Vol 55, pp 114–49.

Fama, E (1985): “What’s Different about Banks?” Journal of Monetary Economics, Vol 15, pp 29–39.

Feinberg, S and S K Majumdar (2001): “Technology Spillovers from Foreign Direct Investment in the Indian Pharmaceutical Industry,” Journal of International Business Studies, Vol 32, No 3, pp 421–38.

Glynn, M A (2008): “Beyond Constraints: HowInstitutions Enable Identities,” Handbook ofOrganizational Institutionalism, R Greenwood, C Oliver, K Sahlin-Andersson and R Suddaby (eds), Thousand Oaks, CA: Sage, pp 413–30.

Glynn, M A and M Lounsbury (2005): “From the Critics’ Corner: Logic Blending, Discursive Change and Authenticity in a Cultural Production System,” Journal of Management Studies, Vol 42, No 5, pp 1031–55.

Government of India (2012): Report of the Working Group on Drugs and Pharmaceuticals, New Delhi: Planning Commission.

Hall, B H (2002): “The Financing of Research and Development,” Oxford Review of Economic Policy, Vol 18, No 1, pp 35–51.

Hart, O (1995): Firms, Contracts and Financial Structure, Oxford: Oxford University Press.

Haveman, H and H Rao (1997): “Structuring a Theory of Moral Sentiments: Institutional and Organizational Coevolution in the Early Thrift Industry,” American Journal of Sociology, Vol 102, pp 1606–51.

Heckman, J J, H Ichimura and P Todd (1998): “Matching as an Econometric Evaluation Exercise,” Review of Economic Studies, Vol 65, pp 261–94.

Helfat, C E (1997): “Know-How and Asset Complementarity and Dynamic Capability Accumulation: The Case of R&D,” Strategic Management Journal, Vol 18, No 5, pp 339–61.

Helfat, C E, S Finkelstein, W Mitchell, M Peteraf, H Singh, D Teece and S G Winter (2007): Dynamic Capabilities: Understanding Strategic Change in Organizations, Oxford: Blackwell.

Himmelberg, C and Petersen B (1994): “R&D and Internal Finance: A Panel Study of Small Firms in High-Tech Industries,” Review of Economics and Statistics, Vol 76, pp 38–51.

Hirano, K G, G Imbens and G Ridder (2003): “Efficient Estimation of Average Treatment Effects Using the Estimated Propensity Score,” Econometrica, Vol 71, pp 1161–89.

James, C (1987): “Some Evidence on the Uniqueness of Bank Loans,” Journal of Financial Economics, Vol 19, pp 217–35.

Jones, C and R Livne-Tarandach (2008): “Designing a Frame: Rhetorical Strategies of Architects,” Journal of Organizational Behaviour, Vol 29, pp 1–25.

Lall, S (1983): “Determinants of R&D in an LDC: The Indian Engineering Industry,” Economics Letters, Vol 13, pp 379–83.

Lang, L H P, E Ofek and R M Stulz (1996): “Leverage, Investment and Firm Growth,” Journal of Financial Economics, Vol 40, pp 3–29.

Lewin, A and H W Volberda (1999): “Prolegomena on Co-Evolution: A Framework for Research on Strategy and New Organizational Forms,” Organization Science, Vol 10, No 5, pp 519–34.

Lounsbury, M (2002): “Institutional Transformation and Status Mobility: The Professionalization of the Field of Finance,” Academy of Management Journal, Vol 45, pp 255–66.

— (2007): “A Tale of Two Cities: Competing Logics and Practice Variation in the Professionalizing of Mutual Funds,” Academy of Management Journal, Vol 50, pp 289–307.

Majumdar, S K (2010): “Raising Debt in India: Has Foreign Ownership Been an Asset or a Liability?” Transnational Corporations, Vol 19, No 1, pp 35–54.

— (2011): “Retentions, Relationships and Innovations: The Financing of R&D inIndia,” Economics of Innovation and New Technology, Vol 20, No 3, pp 233–57.

— (2012): “Legal Regime Change and Innovation: Foreign Exchange Regulation Transformation and Pharmaceutical Sector R&D in India,” Research in Law and Economics, Vol 25, pp 75–103.

Majumdar, S K and K Sen (2007): “The Debt Wish: Rent Seeking by Business Groups and the Structure of Corporate Borrowing in India,” Public Choice, Vol 131, No 1, pp 209–23.

— (2010): “Corporate Borrowing and Profitability in an Emerging Market Economy,” Managerial and Decision Economics, Vol 31, No 1, pp 33–45.

March, J G (1991): “Exploration and Exploitation in Organizational Learning,” Organization Science, Vol 2, pp 71–78.

Marquis, C and M Lounsbury (2007): “Vive la Résistance: Competing Logics in the Consolidation of Community Banking,” Academy of Management Journal, Vol 50, pp 799–820.

North, D C (1990): Institutions, Institutional Change, and Economic Performance, Cambridge: Cambridge University Press.

— (1994): “Economic Performance through Time,” American Economic Review, Vol 84, No 3, pp 359–68.

O’Brien, J (2003): “The Capital Structure Implication of Pursuing a Strategy of Innovation,” Strategic Management Journal, Vol 24, pp 415–31.

Ocasio, W and J Joseph (2005): “Cultural Adaptation and Institutional Change: The Evolution of Vocabularies of Corporate Governance, 1972–2002,” Poetics, Vol 33, pp 163–78.

Opler, T and S Titman (1993): “Financial Distress and Corporate Performance,” Journal of Finance, Vol 49, pp 1015–40.

Ostrom, E (2005): Understanding Institutional Diversity, Princeton, NJ: Princeton University Press.

Parente, S and E C Prescott (2002): Barriers to Riches, Cambridge, MA: The MIT Press.

Rajan, R (1992): “Insiders and Outsiders: The Choice between Informed and Arm’s Length Debt.” Journal of Finance, Vol 72, pp 1367–1400.

Rajan, R and A Winton (1995): “Covenants and Collateral as Incentives to Monitor,” Journal ofFinance, Vol 50, pp 1113–46.

Rao, H, P Monin and R Durand (2003): “Institutional Change in ToqueVille: Nouvelle Cuisine as an Identity Movement in French Gastronomy,” American Journal of Sociology, Vol 108, pp 795–843.

Reagan, R (1985): “Why Is This an Entrepreneurial Age?” Journal of Business Venturing, Vol 1, No 1, pp 1–4.

Reserve Bank of India (2005): The Reserve Bank of India, 1967–81, Mumbai: Central Office.

Roy, T (2000): The Economic History of India, 185–1947, Oxford: Oxford University Press.

Rubin, D (1974): “Estimating Causal Effects of Treatments in Randomized and Non-Randomized Studies,” Journal of Educational Psychology, Vol 66, pp 688–701.

Sarkar, J and P Agarwal (1997): “Banking—The Challenges of Deregulation,” India Development Report 1997, K S Parikh (ed), New Delhi: Oxford University Press.

Sen, K and R R Vaidya (1997): The Process of Financial Liberalization in India, Delhi: Oxford University Press.

Teece, D J (2007): “Explicating Dynamic Capabilities: The Nature and Microfoundations of (Sustainable) Enterprise Performance,” Strategic Management Journal, Vol 28, pp 1319–50.

Teece, D J and G Pisano (1994): “The Dynamic Capabilities of Firms: An Introduction,” Industrial and Corporate Change, Vol 3, No 3, pp 537–56.

Teece, D J, G Pisano, and A Shuen (1997): “Dynamic Capabilities and Strategic Management,” Strategic Management Journal, Vol 18, pp 509–33.

Thornton, P and W Ocasio (2008): “Institutional Logics,” Handbook of Organizational Institutionalism, R Greenwood, C Oliver, K Sahlin-Andersson and R Suddaby (eds), Thousand Oaks, CA: Sage, pp 99–129.

Thornton, P, W Ocasio and M Lounsbury (2012): The Institutional Logics Perspective: A NewApproach to Culture, Structure and Process,Oxford: Oxford University Press.

Vincente-Lorente, J D (2001): “Specificity and Opacity as Resource-Based Determinants of Capital Structure,” Strategic Management Journal, Vol 22, pp 157–77.

White, H (2011): “Time Series Estimation of theEffects of Natural Experiments,” Journal of Econometrics, Vol 135, pp 527–66.

Williamson, O E (2000): “The New Institutional Economics: Taking Stock, Looking Ahead,” Journal of Economic Literature, September, Vol 38, pp 595–613.

Zahra, S, H Sapienza and P Davidsson (2006): “Entrepreneurship and Dynamic Capabilities: A Review, Model and Research Agenda,” Journal of Management Studies, Vol 43, pp 917–55.

Zysman, J (1983): Governments, Markets and Growth: Financial Systems and the Politics of Industrial Change, Ithaca: Cornell University Press.

Updated On : 7th Dec, 2018


(-) Hide

EPW looks forward to your comments. Please note that comments are moderated as per our comments policy. They may take some time to appear. A comment, if suitable, may be selected for publication in the Letters pages of EPW.

Back to Top