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Contract Enforcement and Firm Organization: Evidence from the Indian Textile Industry
Working Paper

Published By

CDDRL Working Papers

October 2009

Using new field-level and international survey evidence we highlight one channel via which weak legal institutions may lower Indian productivity and growth. We provide evidence that top executives in Indian firms are highly centralized and do not delegate functional responsibility and decision making to middle-management. Case-study evidence and large-scale firm surveys suggest executives fear that managers will misappropriate firm assets given the opportunity to do so, in part because the weak legal system is unlikely to successfully punish the culprits and recover the assets. As a result, firms' growth potential is limited because of the limited time and attention of the top executives. This can help explain why Indian firms are smaller on average than those in the US or Europe. It can also explain why there is less reallocation of capital and labor from low productivity to high productivity firms in India, since otherwise-successful firms find it harder to grow. As a result, weak legal institutions may play a potentially important role in reducing aggregate productivity and growth in India.

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