Internal capital markets (ICM), a fundamental aspect of business groups, can be used benevolently and opportunistically. This article investigates the profit efficiency of ICMs comprising firms of Indian business groups and the impact of insider ownership and governance on the net and operating profit efficiency of investing (giver) firms of ICMs. This work adopts a two-stage ‘Variable Return’ to ‘Scale-Semi-Oriented Radial Measure Data Envelopment Analysis (VRS-SORM-DEA)’ and regression-based methodology for profit efficiency analysis. This facilitates the individual efficiency measurement of all the firms engaged in ICM transactions. Incorporating the VRS-SORM DEA exhibits higher advantages than the conventional DEA model in dealing with the variables with negative data prevalent in profitability evaluation. Also, the disaggregation of the net and operating profit efficiency facilitates more accurate measurement and eliminates the influence of operating profit on the net profit. The analysis indicates that giver firms have lower average profit efficiencies than taker firms, especially for giver firms with weaker governance and monitoring. However, investments made by the giver firms are more efficient when the firm has a higher proportion of insider ownership. These results have both policy and financing implications. This paper highlights the need for transparency mandates from regulators and caution from lenders and investors of diversely held group firms when assessing the type of group firm and the resulting impact of ICMs.
