Khanna & Yafeh (2007)

American Economic Association
Business Groups in Emerging Markets: Paragons or Parasites?

Author(s): Tarun Khanna and Yishay Yafeh
Source: Journal of Economic Literature, Vol. 45, No. 2 (Jun., 2007), pp. 331-372
Published by: American Economic Association
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Journal of Economie Literature
Vol XLV (June 2007), pp. 331-372
Business Groups in Emerging Markets:

Paragons or Parasites?
Tarun Khanna and Yishay Yafeh*
Diversified business groups, consisting of legally independent firms operating across

diverse industries, are ubiquitous in emerging markets. Groups around the world
share certain attributes but also vary substantially in structure, ownership, and other
dimensions. This paper proposes a business group taxonomy, which is used to formu
late hypotheses and present evidence about the reasons for the formation, prevalence,
and evolution of groups in different environments. In interpreting the evidence, the
authors pay particular attention to two aspects neglected in much of the literature: the
circumstances under which groups emerge and the historical evidence on some of the
questions addressed by recent studies. They argue that business groups are responses
to different economic conditions and that, from a welfare standpoint, they can some
times be "paragons" and, at other times, "parasites." The authors conclude with an
agenda for future research.
1. Introduction multiple (often unrelated) industries, which

are bound together by persistent formal
(e.g., equity) and informal (e.g., family)
Diversified business
groups are ubiquitous(or corporate)
in emerging ties. Varying degrees of participation by
markets (e.g., Brazil, Chile, China, India, outside investors characterize many busi
Indonesia, South Korea, Mexico, Pakistan, ness groups around the world. Table 1 sug
Thailand, and many more) and even in gests that, in all countries for which data
some developed economies (e.g., Italy, are available, the fraction of firms classified
Sweden). These groups typically consist of by domestic sources as group affiliated is
legally independent firms, operating in substantial, ranging from about a fifth in
Khanna: Harvard Business School. Yafeh: Hebrew University (Tokyo), Yonsei University (Seoul), the CEPR
University, CEPR, and ECGI. We are very grateful to the European Summer Symposium in Financial Markets
Editor, Roger Gordon, to two anonymous referees, and to (Gerzensee), the Bank of Israel and the Copenhagen
Kee-Hong Bae, Sea-Jin Chang, Chi-Nien Chung, Stijn Business School for many helpful comments and sugges
Claessens, Arturo Condo, Mariassunta Giannetti, Gustavo tions. Khanna is particularly grateful to his coauthors,
Herrero, Umit Izmen, Raja Kali, Eugene Kandel, Jun Geoffrey Jones, Yasheng Huang, Jan Rivkin, and, espe
Koo Kang, Bahattin Karademir, Luc Laeven, Woosung cially, Krishna Palepu for many stimulating conversations.
Lee, Dani Maman, Ishtiaq Mahmood, Gerry McDermott, We also thank Shai Harel, Liora Johnpoor, and Hyunjee
Noel Maurer, Randall Morck, Aldo Musacchio, Ramana Kim for excellent research assistance. Financial support
Nanda, Giovanna Nicodano, Kris Samphantharak, Andrei from the Division of Research at Harvard Business School
Shleifer, Jordan Siegel, Daniel Wolfnezon, Bernard (Khanna) and the Krueger Center at the Hebrew
Yeung, and seminar participants at Hitotsubashi University (Yafeh) is gratefully acknowledged.
331
332 Journal of Economie Literature, Vol. XLV (June 2007)
TABLE 1
Group Affiliation around the World
Years Number Number (Median size Median Median Median Median

of of firms of group of group ROA of ROA of standard standard
data affiliated affiliated affiliated unaffiliated deviation deviation
firms firms)/ firms firms of ROA, of ROA,
(Median size (percent) (percent) group unaffiliated
of affiliated firms
unaffiliated firms (percent)
firms) (percent)
Argentina 1990-97 25 11 5.5 3.9 7.8*: 3.7 4.9**
Brazil 1990-97 108 51 2.5 3.3 1.8* 4.1 5.1
Chile 1989-96 225 50 18.7 5.9 2.2* 4.4 4.1.
India 1990-97 5446 1821 4.4 11.7 9.6* 4.6 4.4*

Indonesia 1993-95 236 153 2.8 7.3 7.8 1.9 2.5*
Israel 1993-95 183 43 5.0 6.3 3.9* 2.1 2.6
South Korea 1991-95 427 218 3.9 4.8 5.1 1.9 2.6*
Mexico 1988-97 55 19 2.3 8.2 6.1 3.1 2.6
Philippines 1992-97 148 37 3.4 7.3 4.0 2.5 2.9
Taiwan 1990-97 178 79 2.0 5.1 6.2 1.7 2.3**
Thailand 1992-97 415 258 2.3 2.9 4.4* 4.3 4.9**
Turkey 1988-97 40 21 1.0 24.6 26.3 6.2 9.1
Prewar Japan 1932-43 58 17 6.8 5.5 6.4 4.4 7.1
Notes: The table shows summary statistics on group risk and operating performance for twelve emerging mark
as well as for prewar Japan. Firm numbers, as well as statistics on firm size (total assets) and median return o
assets (ROA), are all based on the year for which we have maximal coverage for the country in question. In p
war Japan, group affiliation refers to affiliation in the largest three zaibatsu only. Significance levels for the com
parisons of medians are based on Wilcoxon signed-rank tests. Firms with profit rates above 100 percent or b
-100 percent are excluded from the analysis. * and ** denote a difference between group-affiliated and other
firms that is significant at the 5 percent and 10 percent levels, respectively. See Khanna and Yafeh (2005) for
sources and for more information on the sample and variable definitions.
Chile to about two-thirds in Indonesia. Thesome groups there is considerable vertical

table also indicates that, in virtually all
integration and intragroup trade; in others,
emerging markets, group affiliated firms less. Some groups are deeply involved in
banking and financial services, whereas oth
tend to be relatively large and economically
important. ers are not. Some of this diversity is illustrat
But groups around the world vary consid ed in table 2, which displays partial data on
erably in form: some are extremely diversi the extent of group diversification, vertical
fied whereas others are more focused. In integration, and involvement in financial
Khanna and Yafeh: Business Groups in Emerging Markets 333
services in nine emerging markets.1 Groups American conglomerates each group firm is
in Chile, for example, are far more diversi an independent entity, and the equity stake
fied than groups in South Korea, which, in of outside investors can vary across group
turn, are more diversified than groups in firms. Why are diversified entities in the
Taiwan; groups in the Philippines are far United States organized as conglomerates
more vertically integrated than groups in rather than business groups? Is the answer
India and far more involved in financial serv related to economic and financial develop
ices than groups in Thailand. Moving from ment? Or is it perhaps due to differences in
structure to ownership and control, some the rule of law, social structure, or political
business groups are vertically controlled economy? Is it due to unique historical devel
("pyramids"), whereas others are horizontally opments in the United States? The study of
linked through cross shareholdings. The business groups in emerging markets could
extent of family involvement also varies con potentially offer some answers.
siderably across groups. Finally, in certain The present paper attempts to make three
contributions to the literature on business
countries, business groups are a politically
important force, enjoying close relations with groups. The first is motivated by the view
the government; in others the relations that the diversity of business groups around
between groups and governments tend to be the world is due to the diversity of the
more turbulent. underlying conditions leading to their for
The ubiquity and diversity of business mation. This approach is at the basis of a
groups make the study of this institution fas novel taxonomy of business groups along
three dimensions:
cinating. Conceptually, this hybrid organiza
tional form between firm and market can (1) Group structure: the extent of horizontal
shed new light on the theory of the firm and diversification; the extent of vertical inte
its boundaries. Empirically, the ubiquity of gration; and the extent of involvement in
the financial sector.
business groups outside the United States
and the United Kingdom makes them rele (2) Group ownership and control: the
vant to a variety of fields within economics, extent to which the group is pyramidal
including industrial organization, corporate in structure; the extent to which it is
finance, development and growth, and even family controlled.
open-economy macro to the extent that it (3) Group interaction with society: the
deals with financial crises. In addition, the nature of the interaction between busi
comparative study of business groups in ness groups and the state; the extent of
emerging markets may shed new light on monopoly power wielded by groups.
some economic phenomena in developed This taxonomy is used to derive six testable
economies. For example, although many hypotheses about the reasons for the forma
business groups are highly diversified, unlike tion of business groups, their prevalence in
different economic environments, and the
welfare implications associated with their
1 Group diversification is measured by the number of
two-digit industries in which the group operates. Vertical
presence. In general, the framework in
integration is measured as follows: Group firms are classi which economic agents form business groups
fied into two-digit I SIC industries and, for each pair of in response to the economic and institutional
firms (x, y), we observe the fraction of inputs from x's
industry to y's and vice versa. We then record the higher
environment within which they operate is in
value for each pair and average over all pairs in the group the spirit of work by Masahiko Aoki (2001) or
to obtain the group's vertical integration index.
Involvement in financial services is measured as the frac
Avner Greif (2006), who emphasize that
tion of all group assets in group financial firms. See Tarun
institutions should be analyzed within a par
Khanna and Yishay Yafeh (2005) for further details on ticular economic context. Because groups
these measures. arise for different reasons and in different
TABLE 2
Group Heterogeneity around the World
Country Group Group vertical Group assets in

diversification integration financial firms
Brazil 1.4 0.04 N/A
Chile 5.1 0.06 0.24
India 4.2 0.04 0.05
Indonesia 2.1 0.04 0.45
South Korea 1.7 0.04 N/A
Mexico 2.7 0.02 0.05
Philippines 3.1 0.08 0.60
Taiwan 1.6 0.02 0.01
Thailand 3.5 0.04 0.35
Notes: Group diversification is measured as the number of two-digit industries in which the group oper
ates. Group vertical integration is the average input-output coefficient across all pairs of firms within the
group (see footnote 1), and involvement in financial services is measured as the fraction of all group assets
in group financial firms. See Khanna and Yafeh (2005) for data sources and for more information on the
sample and variable definitions.
environments, we argue that their impact onis plagued by lack of data on group origin.
social welfare is ambiguous, even though Another example of novel data in this paper
much of the existing literature suggests that is preliminary evidence supporting the view
they are uniformly welfare-reducing: groupsthat groups do not only respond to their envi
may sometimes play a positive role by makingronment but also shape and influence it.
up for underdeveloped economic institu Although econometric evidence on this point
tions, but they can also be detrimental tois almost entirely absent, historical evidence
social welfare because of rent seeking orin several countries is supportive of this view
monopoly power. There is therefore no clear This dynamic effect of groups on their eco
verdict on the extent to which groups shouldnomic environment is sometimes socially
be viewed as "paragons" or "parasites," and welfare-enhancing, and sometimes not.
the answer is likely to vary across countries, The third contribution of the present study
groups, and possibly time periods. is to question some of the conventional wis
The second contribution of the presentdom in the literature. For example, groups,
we argue, are not purely rent-seeking organ
study is the presentation of new stylized data
and evidence on several facets of businessizations as some of the literature has por
groups which go beyond the existing litera trayed them. Nor should groups be equated
ture. In particular, we present comparablewith pyramids, and pyramids are not always
data on the origins and emergence of busithe, or even a, way of disenfranchising
ness groups around the world. This is keyminority shareholders.
because group membership should generally The literature on business groups in eco
be viewed as endogenous and because mostnomics and finance has focused primarily on
of the empirical literature on business groupstwo themes. The first regards business
groups as diversified entities, and studies the overview by Khanna (2000) on emerging mar
relations between this feature and various kets and by Yafeh (2003) on Japan. There are
questions in industrial organization and cor also two complementary, concurrent surveys
porate finance. The second, more recent, that readers should consult?Granovetter
research theme on business groups follows (2005) reviews the economic sociology litera
Andrei Shleifer and Robert W. Vishnys ture, and Randall Morck, Daniel Wolfenzon,
(1997) survey on corporate governance and and Bernard Yeung (2005) discuss pyramidal
subsequent work by Rafael La Porta et al. groups and corporate governance.
(1997, 1998). Studies in this line of research The rest of the paper is organized around
regard business groups, especially their the taxonomy of business groups around the
pyramidal forms, as a favorite setting for the world: section 2 focuses on dimensions relat
study of conflicts of interests between con ed to the structure of business groups; in
trolling and minority shareholders; the lat section 3 we examine dimensions related to
ters expropriation is often referred to as ownership and control; section 4 focuses on
"tunneling." Beside diversification and tun two dimensions of the interaction between
neling, a small number of economic studies business groups and society; and the con
emphasize rent seeking and the sometimes cluding section, section 5, delineates a
close relations between business groups and future research agenda. All sections contain
the governments of the countries in which one or more hypotheses derived from the
they operate. An even smaller number of taxonomy of business groups, which are fol
studies attempt to relate groups to monopoly lowed by subsections presenting the existing
power and imperfect competition. evidence.
Outside economics and finance, groups
have attracted a lot of academic interest in
2. Structure and Form of Business Groups
sociology, where they are viewed as networks
of social, not only economic, significance 2.1 Structure of Business Groups:
(e.g., Michael L. Gerlach 1992; Mark Diversification
Granovetter 2005; Gary G. Hamilton 1997;
Lisa A. Keister 2004; Marco Orr?, Nicole Prevailing managerial theories advocate
Woolsey Biggart, and Hamilton 1997). that companies should discover their source
Studies of business groups are also common of competitive advantage and remain true to
in business history, where the unit of analysis it. This "conventional wisdom" is not based
is typically the history of one group (e.g., John on unambiguous theoretical predictions: cor
G. Roberts 1973 on the house of Mitsui; porate diversification can be beneficial to
Richard M. Steers 1999 on the Hyundai shareholders if a firm has certain resources
group, and many more) or on groups in a sin that can be profitably deployed outside the
gle country (e.g., Alice H. Amsdens 1989 industry in which it operates, such as entre
study of South Korea and its chaebol groups preneurial skills, technology, etc. In addition,
or Gita Piramals 1998 study of Indian busi when equity markets function poorly, it may
ness houses). Although extensive, the litera be possible to lower risk through diversifica
ture on business groups leaves many tion across industries. In contrast with these
interesting questions unanswered. positive arguments for diversification, there
The present papers builds on our own ear are also theoretical foundations for the view
lier surveys of business groups?a short that diversification can be harmful if it is
driven by managerial objectives such as
2 The term "tunneling" has become popular following
"empire building" or risk aversion, or if it
Simon Johnson, La Porta, Florencio Lopez-de-Silanes, and
Shleifer (2000) who trace its origins to the expropriation of leads to agency problems among division
minority shareholders in the Czech Republic. managers (e.g., Raghuram Rajan, Henri
Servaes, and Luigi Zingales 2000; David S. unnecessary or even harmful in developed
Scharfstein and Jeremy C. Stein 2000). economies do not exist or are underdevel
Empirically, the common view in the United oped in poorer countries. Capital markets are
States, that diversification "destroys share incomplete and may be plagued with infor
holder value," has been supported by evi mational and other problems, making risk
dence on the relative performance of firms reduction through diversification and the use
focused on a small number of industries in of internal capital markets relatively efficient
comparison with diversified firms?which in comparison with poorly regulated external
suggests that, in the United States, the costs markets. Labor markets may also lack institu
associated with diversification typically tions training skilled labor and management,
exceed the benefits.3 making diversified business groups, where
The ubiquity of diversified (and often fair trained personnel can be used for a variety of
ly successful) business groups in many coun tasks across many group firms, a possible sub
tries outside the United States is therefore in stitute for these institutions.
sharp contrast with the prevailing conven
2.1.1 Evidence on Groups and the
tional wisdom. Why then is diversification in
Diversification Discount in
the form of business groups so common in
Emerging Markets
emerging markets? Leaving aside (for now)
the question why the typical institutional A starting point in the discussion of the
mechanism for diversification is conglomer validity of Hypothesis 1 is the question
ates in the United States and business whether or not a diversification discount
groups in emerging markets, the following exists in emerging markets. The general
hypothesis offers one possible explanation: answer seems to be that the diversification
discount tends to be lower in environments
Hypothesis 1: Diversified business groups
should be more common in economies with where markets, including, but not limited to,
less developed market institutions. financial markets, are less developed, in line
with Hypothesis 1. In some cases, diversified
Hypothesis 1 is based on the conjecture
entities are even traded at a premium rather
that corporate focus need not necessarily be a
than a discount. For example, Larry Fauver,
good strategy in environments less economi
Joel Houston, and Andy Naranjo (2003), who,
cally developed than the United States, where
following U.S. studies, rely on stock market
the benefits of diversification may exceed data, find that the diversification discount is a
the costs. The main reason is that some of
the institutions that make diversification feature of high income countries, with devel
oped (financial) markets and institutions. By
contrast, in low-income countries, there is no
3 See surveys by Cynthia A. Montgomery (1994) and market discount?and sometimes there is
John D. Martin and Akin Sayrak (2003). The association of
diversification with a loss of firm value in modern U.S. data even a premium?for corporate diversifica
is sometimes called the "diversification discount." This dis tion. Qualitatively similar results are reported
count is interpreted as evidence of a causal link (corporate by Stijn Claessens et al. (2003), who use both
diversification is the cause of the reduction in shareholder
wealth) in studies such as Yakov Amihud and Baruch Lev stock market and accounting variables to
(1981); Morck, Shleifer, and Vishny (1990); Larry H. P. measure the value of diversification. They
Lang and Rene M. Stulz (1994); Philip G. Berger and Eli find a diversification premium in the relative
Ofek (1995); and Robert Comment and Gregg A. Jarrell
(1995). Several more recent studies have cast some doubt ly poor countries in East Asia (Indonesia, the
on the causal interpretation of the diversification discount, Philippines, or Thailand) and a diversification
focusing on the endogeneity of the decision to diversify and
on measurement problems of both performance and diver 4 For earlier formulations of this hypothesis, see
sification; see, for example, Jose Manuel Campa and Simi Khanna and Krishna Palepu (1999a, 2000b, and 2000c).
Kedia (2002); Judith Chevalier (2004); Belen Villalonga An even earlier descriptive reasoning is due to Nathaniel
(2004a) and (2004b); and Toni M. Whited (2001). H. Leff(1976, 1978).
discount in the richer countries in the region firms within certain diversified groups, for
(e.g., Hong Kong or Taiwan). Although both example, in Brazil, Israel, and the Philippines,
Fauver, Houston, and Naranjo (2003) and outperform their non-group affiliated peers,
Claessens et al. (2003) refer to multisegment the relative performance of firms affiliated
firms in general, not specifically to corporate with diversified groups cannot be easily relat
groups, there is some time series evidence on ed to economic development, to the often
business groups indicating that the relative cited differences in legal origins across
advantage of groups declines as market insti countries (La Porta et al. 1997, 1998) or to
tutions develop. For example, Khanna and measures of financial development. Indeed,
Palepu (2000c) document the declining country-specific institutional characteristics,
(stock market and accounting profitability especially those associated with financial mar
based) group premium over a decade associ kets,5 suggest that it is hard to find common
ated with economic reform and development institutional features among the countries
of market institutions in Chile. Keonbeom where group firms seem to do relatively well:
Lee, Mike Peng, and Keun Lee (2001) contract enforcement is relatively efficient in
observe that companies affiliated with the Israel and poor in the Philippines (Brazil is in
South Korean business groups, the chaebol, between). Similarly, among the countries
used to be traded at a premium until the early where group firms are characterized by low
1990s?but the premium turned into a dis risk and low return, South Korea ranks rela
count starting around 1994 (see also Stephen tively high in contract enforcement and
P. Ferris, Kenneth A. Kim, and Pattanaporn Argentina relatively low.6 We conclude that
Kitsabunnarat 2003). A number of other diversified business groups are sometimes
studies discussed below concur and claim associated with good performance of affiliated
that in recent years the relative performance firms, but the relation between the costs and
of group affiliated companies in South Korea benefits of diversification on the one hand,
has not been very good, although this aggre and economic and institutional development
gate statistic masks considerable variation on the other, is probably more complex than
between some groups which have done very what Hypothesis 1 suggests. The ambiguity of
well (e.g., Samsung) and some group that the results implies that in emerging markets
have done very poorly (e.g., Daewoo). too, there are certainly cases of diversified
Table 1, where unconditional risk and groups which destroy shareholder value in
returns characteristics of diversified business line with the evidence on the United States.
groups around the world are displayed, sug Ignoring the ambiguity of the evidence in
gests a more nuanced picture, which casts table 1, leaving aside sample selection issues,
some doubt on the view that the benefits of and assuming that a causal interpretation can
diversification are higher in institutionally be assigned to the correlation between diver
underdeveloped emerging markets. Although sification and performance, the particular
See, for example, the World Bank, Doing Business

data set, http://rru.worldbank.org/DoingBusiness, featur of an entire conglomerate and its performance, whereas in
ing information on the duration and cost of bankruptcy the literature on emerging markets the unit of analysis is
procedures as well as on the efficiency of contract typically an individual group firm, which resembles a "line
enforcement. of business" activity in U.S. data (see Khanna and Palepu
Although table 1 displays unconditional statistics, 2000b).
multivariate regressions generate a similarly ambiguous Comparisons of group versus nongroup firms are
picture; see Khanna and Jan W. Rivkin (2001) and Khanna plagued with selection issues, the most obvious one being
and Yafeh (2005). the assumption that group affiliation is exogenous, or at
An important distinction between the literature on least historically predetermined. Another selection prob
emerging market groups and the literature on conglomer lem is related to the choice of groups to list some but not
ate diversification in the United States is that U.S.-based all companies. This makes comparisons based on listed
studies typically look at the relation between the diversity firms potentially biased.
reason(s) why diversification may be optimal earliest studies of diversified groups in South
in (at least some) environments with relative Korea, find that group-affiliated firms were
ly underdeveloped institutions is not clear. more profitable than other South Korean
We examine several possible explanations. companies in the 1980s, but several more
recent studies on the South Korean chaebol
2.1.2 Evidence on Groups, Diversification
report relatively poor performance of group
and Internal Capital Markets
affiliated companies in the 1990s (although
Historical observations on the U.S. econo some groups have continued to do very well).
my suggest that capital markets may be the One interpretation of this pattern is that, as
underdeveloped institution driving the the South Korean economy became more
empirical correlation between diversifica mature and financial markets more liberalized
tion and shareholder value in different envi in the 1990s, the advantage of business groups
ronments. There is evidence suggesting that in accessing capital was gradually eroded.
the "diversification discount" may have been Nevertheless, other explanations for this pat
smaller in the United States in earlier peri tern, not related to underdeveloped institu
ods when financial markets (more than other tions (capital or other) are certainly possible:
institutions?) were less developed. This For example, South Korea faced a severe cri
might suggest that, in such an environment, sis in 1997-98, for which some observers
raising capital in an internal capital market blamed business groups. In the aftermath of
of a diversified entity might have been more the crisis, the governments approach toward
efficient than communicating with external the big business groups underwent deep
potential providers of capital, primarily changes, and this may have affected the abili
because of information problems. ty of group-affiliated firms to generate profits.
But are internal capital markets the main In addition, the fact that the founding gener
reason why diversified business groups are ation of owners-managers had to turn over the
formed in underdeveloped countries? And if keys to the second generation, typically within
so, are information problems in financial mar the family, may also have had adverse effects.
kets the crucial factor? Direct evidence on It is very difficult to disentangle the impact of
these questions is scarce. A series of studies these different forces; the focus on one eco
on business groups in South Korea is indirect nomic force or another in the existing litera
ly supportive of the underdeveloped financial ture seems to be somewhat arbitrary.10
markets version of Hypothesis 1: Sea-Jin More evidence on the conjecture that the
Chang and Unghwan Choi (1988), one of the performance of diversified business groups is
9 J. Bradford De Long (1991), for example, argues that
firms that were part of the J. P. Morgan group (had profitable in the 1980s. Among the studies documenting
Morgan men on their boards) were traded at a premium the poor performance of members of South Koreas busi
in the early decades of the twentieth century (although ness groups in the 1990s, Terry L. Campbell and Phyllis Y.
causality is hard to infer from this). Moving to the 1960s, Keys (2002) report lower profits (but higher sales growth)
John G. Matsusaka (1993) and Robert Glenn Hubbard for group-affiliated firms and relate this finding to inade
and Darius Palia (1999) report that acquisitions of compa quate corporate governance: executive turnover, they
nies in industries unrelated to the bidder's core industry argue, is not closely related to performance. Ferris, Kim,
were not penalized by U.S. financial markets at that time. and Kitsabunnarat (2003), who use stock market data, find
Furthermore, Hubbard and Palia (1999) emphasize that that chaebol-affiliated firms currently trade at a discount
the returns to bidders tended to be especially high when and suggest that this may be due to low profits, overin
the acquired target firms were financially constrained. vestment, or inefficient cross-subsidization within the
10 Chang and Choi (1988) interpret their finding of groups. Similar arguments on overinvestment, typically
superior performance of group firms as evidence that the financed by (often state-subsidized) debt, are made by
group structure enhances efficiency through effective Dong Gull Lee and Lee (2002) and by Jeong-Pyo Choi and
management and lower transaction costs, not necessarily Thomas G. Cowing (1999). Other studies, such as Keun
in financial markets. They do not test this hypothesis Lee, Keunkwan Ryu, and Jung Mo Yoon (2000), attribute
against other possible explanations that may have made the the poor performance of chaebol firms to low productive
biggest and most diversified South Korean groups relatively efficiency, presumably also due to overexpansion.
related to internal capital markets (and imper mutual insurance or risk sharing among
fections in external capital markets) can be group firms. They find that risk sharing is a
found in studies estimating investment-cash characteristic of business groups only in a
flow sensitivities for group and non-group small number of emerging markets, most
firms (in the spirit of Steven M. Fazzari, notably South Korea, and to a lesser extent
Hubbard and Bruce C. Petersen 1988; Takeo Thailand and Taiwan. They do not find a
Hoshi, Anil Kashyap, and Scharfstein 1991; clear relation between the extent of group
and Hyun-Han Shin and Stulz 1998). Shin diversification and the prevalence of within
and Young S. Park (1999) apply this method group risk sharing, and neither do they find
ology to South Korean business groups, and any evidence that risk sharing is more com
Enrico C. Perotti and Stanislav Geifer (2001) mon where external financial markets are
to Russian financial-industrial groups (FIG), less developed. This study is therefore incon
and find that individual group firms are not sistent with Hypothesis 1 with respect to the
very sensitive to their own cash flows when provision of insurance in environments
making investment decisions; they are, how where the availability of state-contingent
ever, sensitive to the cash flows of the rest of claims is very limited.12
the group suggesting the existence of an
internal capital market which transfers 2.1.3 Evidence on Group Diversification for
resources across firms. The welfare implica Reasons Unrelated to Capital Markets
tions of this internal capital market are, how
ever, ambiguous: on the positive side, a group There is some evidence supporting a ver
can include a main bank (or a cash cow) and sion of Hypothesis 1 in which diversification
provide funding to affiliated firms too small or is beneficial in emerging markets for rea
opaque to have easy access to outside finan sons unrelated to financial markets.
cial markets. This should be particularly valu Imperfections in labor markets (both for
able when the protection of creditors and skilled employees and for executives), limit
accounting standards are weak, so that arms ed enforcement of contracts, inadequate
length lending will be limited. The very limit rule of law and other institutional deficien
ed evidence in the literature is insufficient to cies may give rise to business groups that
evaluate this conjecture: Shin and Park (1999) generate these public goods for the benefit
argue that internal capital markets within the of group members. In line with this argu
South Korean chaebol are actually inefficient ment, Hyundai, for example, established a
(supporting too much investment by group training center for technical personnel to be
firms with weak investment opportunities), used by the entire group, as well as an
whereas Perotti and Geifer (2001) do not take applied research institute.13
a stand on the efficiency of such transfers in
Russia. Overall, these studies provide mixed Khanna and Yafeh (2005) document also some
evidence on the validity of Hypothesis 1. degree of risk sharing in India through within-group
Another approach to evaluate whether transfers. For more on risk sharing in Indian business
diversified groups emerge in response to cap groups, see Radhakrishnan Gopalan, Vikram K. Nanda,
and Amit Seru (forthcoming) who discuss group assis
ital market imperfections is that of Khanna tance to firms in distress, and Vijaya B. Marisetty and
and Yafeh (2005), who test the extent to Marti G. Subrahmanyam (2006) who discuss the survival
probability of group firms after going public.
which diversified groups make up for under
13 See also Khanna and Palepu (1997) on the Tata
developed financial markets by providing group in India, and Chang (2003a) on human resource
management in South Korean business groups. Greif and
Eugene Kandel (1995) discuss the underdevelopment of
11 See also Krislert Samphantharak (2003) who uses a contract enforcement institutions in Russia in the early
different methodology to discuss internal capital markets 1990s, which may have precipitated the emergence of
in Thai business groups. financial-industrial groups.
Diversified groups may be efficient if they enhanced profitability. Their survey evi
make up for missing institutions related to dence suggests that this was primarily due to
the process of entrepreneurship: new ven group advantages in product and labor
tures initiated by business groups rely not (rather than capital) markets.
only on capital infusion from the group, but At present, the precise identification of
often also on the group brand name and the sources of group advantage remains an
implicitly on its reputation, providing a guar empirical challenge. Studies such as Khanna
antee that is scarce in emerging 'markets and Palepu (2000b) and (2000c), who find
(Noel Maurer and Tridib Sharma 2001). that in India and in Chile the relation
There is also an internal (within-group) mar between diversification and profitability
ket for talent. In this sense, some business among business groups is nonlinear (beyond
groups are perhaps closer to private equity a certain level diversification is associated
firms than to conglomerates. Geoffrey Jones with higher profits), can be interpreted in
(2000) makes this point in relation to British many ways. One way forward is perhaps to
trading houses in the early twentieth centu exploit variations in the nature of market
ry: one of the primary functions of these imperfections across different countries.
early groups (which, like many venture capi This is difficult if types of market imperfec
tal funds today, were often organized as part tions are positively correlated (e.g., where
nerships) was "identifying opportunities and capital markets are underdeveloped, labor
placing potential British investors in touch markets may also be so), but some interest
with them" (pp. 50-51). It may be possible ing examples can nevertheless be found. For
to argue that, in India today, Tata Industries example, diversification in Chile, where
comes close to this view of a business group financial markets are fairly developed and
as a quasi-venture capitalist, albeit with the rule of law is relatively good, is unlikely
longer investment horizons than typical to be due to the same mix of reasons that led
American private equity funds (Khanna and to the emergence of diversified groups in
Palepu 2005). Another Indian group, Birla, Suhartos Indonesia. Another related possi
helped found and finance new firms, which bility is to try and disentangle various rea
were later spun-off using the entrepreneur sons for the existence of diversified groups
ial talent of its employees. The process of by looking at changes in their activities and
"spawning" new companies by established scope in response to shocks (Pankaj
business groups may potentially be impor Ghemawat and Khanna 1998). For example,
tant in emerging markets where it is proba a business group whose primary function is
bly difficult to start de novo.14 to form an internal capital market is likely to
Khanna and Palepu (1999a) use survey shrink or disappear in response to financial
data to in order to try and identify sources of market development, whereas other groups
benefits from affiliation with a diversified would not. Not much research has been car
group. Their analysis, which is based on ried out along these lines.15
intragroup confidential information, indi Despite the ambiguity of the results in this
cates that in both Chile and India group section, our impression is that there is some
activity increased during periods following tentative evidence suggesting that, at least
extensive liberalization and pro-market under some circumstances, groups can make
reforms, and in a way which apparently
15 Chi-nien Chung and Ishtiaq Mahmood (2006), for
14 See Paul Gompers, Josh Lerner, and Scharfstein example, document a trend of increasing diversification
(2005) for a discussion of entrepreneurial spawning in the over the last three decades in Taiwanese business groups,
United States. In this context, diversification may be the which coincided with a period of deregulation. They do
result of within-group entrepreneurial activities rather not provide a full explanation for this trend, and suggest
than their cause. that tax considerations may be involved.
up for underdeveloped institutions in both costs between unrelated parties. Under such
capital and labor markets (Khanna and circumstances, intragroup trade, within the
Palepu 1997; Khanna 2000). Although it is context of long-run relationships supported
difficult to draw firm conclusions from this, by family and other social ties, may be rela
one possible implication might be that the tively cheap and efficient. This argument is
profit maximizing level of diversification summarized in the following hypothesis:
(and perhaps also the level of diversification Hypothesis 2: The presence of business
which maximizes social welfare) may be groups, the extent of their vertical integra
higher for companies (or groups) operating tion, and the volume of intragroup trade,
in emerging markets than it is for American should all be higher in environments with
firms. It is not clear, however, why the busi underdeveloped legal and judicial institu
ness group form (rather than a fully owned tions, where contracting is costly.
conglomerate) is the most popular way to
attain this level of diversification in many 2.2.1 Evidence on Groups, Vertical
less developed economies. One possibility is Integration, and Contracting Costs
that, from the point of view of controlling
Surprisingly, we are not aware of any direct
shareholders, the group structure is prefer
evidence testing this prediction?which is
able, and only a unique historical event pre
similar to the Coase-Williamson arguments
vents the existence of business groups in the on the boundaries of the firm?in the context
United States as well?diversified American
of business group structure.16 Data on the
groups were common through the mid-1930s
volume of intragroup trade are not readily
until tax policies introduced by President
available, and the rudimentary data on verti
Roosevelt induced either the integration of
cal integration in table 2 are ambiguous
groups into conglomerates or the spin off of
controlled subsidiaries (Morck 2005; we (probably in part due to the dubious quality of
the available data). On the one hand, vertical
return to this historical episode below). A
integration among groups in the Philippines
possible rationale for the superiority and pre
is high, in line with the poor institutional
dominance of the group form in emerging
infrastructure in that country. But the extent
markets is that the group structure insulates
of vertical integration in relatively uncorrupt
the controlling shareholder from institutional
Chile is higher than in Indonesia, suggesting
investor pressure and takeovers, and bestows
that there may be other explanations besides
undisputed control and economic influence
contracting costs which may account for this
with limited capital investment. The group
variation. One possibility is that vertical inte
form may be preferred also because of legal
gration serves primarily as a means to obtain
considerations, especially in relation to cor
monopoly power or alleviate the double
porate liability and the ability of the control
monopoly problem, rather than as a tool to
ling shareholder to choose not to bailout
overcome contracting difficulties (although
ailing group firms (Giovanna Nicodano
the existence of contracting difficulties and
2003). By contrast, the conglomerate form
may be more appropriate than a business 16 Daron Acemoglu, Johnson, and Todd Mitton (2005),
group for the purpose of tax reducing income who use firm (not group) level data, argue that, control
smoothing across divisions. ling for financial development and industrial structure,
there is no relation between contracting costs and a verti
2.2 Structure of Business Groups: The cal integration index across countries. A recent working
paper by Joseph P. H. Fan et al. (2006) reports prelimi
Extent of Vertical Integration nary evidence of more vertical integration in Chinese
Limited contract enforcement, weak rule provinces with weak protection of property rights in com
parison with other provinces. There is no distinction in
of law, corruption, and an inefficient judicial this study between vertical integration within a single firm
system should all lead to high transaction and integration within a business group.
opportunities to exercise monopoly power development should explain business group

may be correlated). This view is corroborated involvement in financial services, in addition
by the CEO of the Indonesian group Astra to country-specific government regulations.
International who described in a private
interview the motivation for the vertical inte 2.3.1 Evidence on Group Involvement in
Financial Services
gration strategy of his group as driven by the
pursuit of monopoly power rather than by the Historically, British multinational business
inadequacy of contracting institutions. The groups in the early twentieth century were
food production within the Thai CP Group heavily involved in financial services over
has been considerably vertically integrated, seas, in line with Hypothesis 2 on high finan
but again, the stated purpose was not con cial contracting costs in these environments
tracting difficulties. In addition, there seems (Jones 2000). Chilean business groups were
to be considerable variation in the extent of also involved in finance prior to the liberal
vertical integration across groups within the ization and financial development of the
same country, suggesting that group and 1980s. Large Indonesian groups typically use
industry-specific factors play a role which is a group-specific financial institution, a fea
sometimes more important than country-spe ture that became more pronounced when
cific institutional factors. The more system their capital needs increased: Astra
atic evidence on vertical integration provided International, for example, was in process of
by Chang (2003a) is consistent with this view: expanding its automobile assembly lines in
he constructs group and industry-specific 1970s when it started acquiring banks and
measures of vertical integration for South expanding into other financial services. In
Korea and finds it to be considerable in the Turkey, almost all banks are group-affiliated
largest groups and in certain industries (e.g., (B. Burcin Yurtoglu 2000). The contempo
automobiles). He argues that vertical integra rary cross sectional evidence on group
tion may have been an efficient strategy in the involvement in financial services and finan
past (in line with Hypothesis 2), but it cial development provided in table 2 sug
involves considerable difficulties today. gests, however, that there is considerable
variation in group involvement in financial
2.3 Structure of Business Groups:
Involvement in the Financial Sector services even among countries where finan
cial contracting is presumably costly, perhaps
Group involvement in banking, insurance because of regulatory differences.
and other aspects of the financial system Beyond the prevalence of group involve
may be related to transaction costs consider ment in the financial sector, the fragmentary
ations similar to those driving vertical inte existing evidence on the performance of
gration. A variation of Hypothesis 2 may group-affiliated financial institutions is, to
apply to this context as well: contracting some extent, consistent with the view that
costs, institutional quality, and financial group involvement in this sector makes up
for its underdevelopment. Maurer (1999)
For example, the Turkish group Eczacibasi is fully ver
and Maurer and Stephen Haber (2006)
tically integrated in its core pharmaceutical business, but emphasize the positive roles of related lend
other Turkish groups exhibit much less vertical integration. ing within Mexican business groups in the
18 Robert C. Feenstra, Deng-Shing Huang, and
Hamilton (2003) and Feenstra and Hamilton (2006) also period 1888-1913, when contracting institu
provide evidence showing that South Korean business tions were in their infancy.19 By contrast, La
groups, especially the very large ones, are more vertically
integrated (and more horizontally diversified) than
Taiwanese groups. They propose a model with multiple 19 See also Naomi R. Lamoreaux (1994) for a positive
competitive outcomes, rather than differences in transaction view of related lending by New England Banks in the late
costs, to explain these differences. eighteenth and early nineteenth centuries.
Porta, Lopez-de-Silanes, and Guillermo quacy of some of the regulatory institutions in

Zamarripa (2003) document the negative many emerging markets, generates an envi
sides of "related lending" in contemporary ronment in which "tunneling" (the expropria
Mexican groups. In the early 1980s, Chilean tion of minority shareholders) can become a
groups were implicated in a financial crisis common feature of the economy:
and the associated failure of the first wave of
Hypothesis 3: (a) Pyramidal groups
privatization in that country, allegedly should be particularly common in countries
because of related lending. A conceptual with poor investor protection and inade
difficulty in the discussion of this issue is the quate rule of law. (b) These countries should
endogeneity of financial underdevelopment, have under-developed equity markets
which may actually be due to group influ because investors will demand a discount
ence; this makes the relation between busi
when buying shares of companies affiliated
ness group involvement in financial services with a pyramidal group.
and the development of these services com
plex. These issues are related to the recent 3.1.1 Evidence on Pyramids, Tunneling, and
literature on the political economy of Financial Development
finance, where investor protection and The literature on pyramidal groups and
financial system institutions are modeled as conflicts of interest between majority and
endogenous outcomes of political processes minority shareholders is discussed in great
(see Morck, Wolfenzon, and Yeung 2005). detail in Morck, Wolfenzon, and Yeung
(2005). Their reading of the evidence is con
3. Ownership and Control of Business sistent with Hypothesis 3: family-controlled
Groups pyramidal business groups in countries where
minority shareholders are not well protected
3.1 Pyramidal versus Other Groups
are associated with the expropriation of small
We now turn to variation in ownership and shareholders, and this adversely affects finan
control characteristics in business groups cial development. In line with Hypothesis
around the world. Perhaps the most impor 3, tunneling has become the main focus of
tant distinction in this category is between much of the recent literature on business
pyramidal and other organizational struc groups: table 3, which summarizes many of
tures. This is because of the strong link in the the existing studies on groups in South Korea,
literature, dating back to Adolf Berle and illustrates how the initial research interest in
Gardiner Means (1932, book 1, chapter 5), groups as diversified entities has been nearly
between pyramids and the expropriation of completely replaced by studies of conflicts
minority shareholders: in pyramidal groups between majority and minority shareholders.
there is typically a large divergence between In what follows we raise a number of concep
the large shareholder s "control rights" (which tual issues related to the literature on
are often very high) and "cash flow rights" pyramidal groups and tunneling.
which are typically much smaller (e.g., First, how many of the business groups
Lucian Arye Bebchuk, Reiner Kraakman, around the world are actually vertically
and George G. Triantis 2000; Marcello controlled pyramids and where are they locat
Bianchi, Magda Bianco, and Luca Enriques ed? Despite the centrality of this question,
2001). This, in combination with the inade
Hypothesis 3 focuses on equity finance; this logic

20 See also Chang (2003a), chapter 5, on related lend seems somewhat less applicable to debt finance, which is
ing in South Korea, and Robert Cull, Haber, and Masami discussed below.
Imai (2006) for a discussion of conditions under which See also Heitor Almeida and Wolfenzon (forthcoming)
related lending has positive effects. for a theoretical discussion of these issues.
TABLE 3
Studies on Business Groups in South Korea
Study Main Argument, Sample Size, Category Listed Groups as Information

Sample Period Firms Pyramids? about
Only? Families?
Yes
Groups as diversified
Chang and Choi Business groups with multidivisional No reference No specific
entities
(1988) structure show superior economic information
performance because of reduced
transaction costs. 63 group affiliated
and 119 independent firms, 1975-84.
Shin and Park Internal capital markets in the chae Groups as diversified Yes No reference No specific
(1999) bol alleviate financing constraints, entities information
but are associated with inefficient
allocation of funds. 123 group affiliat
ed firms and 194 independent firms,
1994-95.
Choi and Cowing Group firms exhibited relatively low Groups as diversified Yes No reference No specific
(1999) profit rates before 1989; firms affili entities information
ated with the largest groups appear
to have somewhat higher growth
rates and lower variation in profit
rates compared with unaffiliated
firms. 91 group affiliated firms and
161 independent firms, 1985-93.
Chang and Hong Group firms benefit from group Groups as diversified Listed or No reference Reference to
(2000) membership through sharing intangi entities statutorily Samsung and
ble and financial resources with other
member firms. Various forms of
audited Hyundai
companies
internal business transactions, such as
debt guarantees, equity investments
and internal trade are extensively
used for the purpose of cross-subsi
dization. 1,248 companies, associated
with 317 business groups, 1996.
Bae, Kang, and When a chaebol-affiliated firm makes Corporate Listed on Assumed No specific
Kim (2002) an acquisition its stock price typically governance/pyramids/ the KSE information
falls. Minority shareholders of the tunneling
acquiring firm lose, but controlling
shareholders benefit because the
acquisition enhances the value of
other firms in the group. Consistent
with tunneling. 107 mergers, 87
firms, 1981-97.
Campbell and Corporate governance problems Corporate Listed on No reference No specific

Keys (2002) among the top chaebol may have governance/pyramids the KSE information
exacerbated the recent financial cri tunneling
sis. 356 firms, 1993-99.
Chang and Hong Business groups play an important Groups as diversified Listed or No reference Samsung
(2002) r?le m developing countries by cir entities statutorily mentioned
cumventing market inefficiencies; audited
these effects tend to be smaller in
companies
large business groups, and to
decrease over time. 1,666 companies
affiliated with 368 business groups,
_1985-96._
(continued)
TABLE 3 (continued)
Study Main Argument, Sample Size, Category Listed Groups as Info, about
Sample Period Firms Pyramids? Families?
Only?
Simultaneous nature of relationship
Chang (2003b) Corporate Yes Significant Quite a bit of
between ownership structure and reference to reference to
governance/pyramids/
performance in a sample of group
tunneling this issue the family
affiliated public firms. Performance issue
determines ownership structure but
not vice versa: controlling share
holders use insider information to
increase their direct and indirect
equity stakes in more profitable
firms and transfer profits to other
affiliates through intragroup trade.
419 chaebol-affiliates, 1986-96
Ferris, Kim, and Chaebol-affiliated firms suffer loss Groups as diversified
Yes No reference Reference to
Kitsabunnarat of value relative to nonaffiliated entities this issue; no
(2003) firms. This may be due to: (1) pur specific
suit of profit stability rather than information
profit maximization; (2) overinvest
ment in low performing industries;
(3) cross-subsidization of weaker
members of their group. 759 chae
bol firm-year observations and
1,316 independent firm-year obser
vations, 1990-95.
Joh (2003) Tunneling by controlling sharehold- Corporate Listed or Reference to No specific

ers when their cash flow rights are governance/pyramids/ otherwise this issue information
low. 5,829 firms, 1993-1997. tunneling "registered"
Companies
Kim and Lee Performance during crisis is related Corporate Listed on Reference to General ref
(2003) to agency problems. 590 firms, May governance/pyramids/ the KSE this issue
1997-August 1998. tunneling
Corporate Listed on Reference in
Baek, Kang, and Change in firm value during crisis Control by
Park (2004) is a function of firm-level differ
governance/pyramids/ the KSE the model family mem
ences in corporate governance tunneling bers among
measures. 644 firms, November other vars.
1997-December 1998.
Lim and Kim Highly leveraged groups with a Groups as diversified Listed and Reference to Reference to
(2005) high proportion of nonmanufactur entities + corporate unlisted this issue this issue; no
ing business tend to have direct governance/pyramids/ specific
ownership. Larger groups with a tunneling information
high proportion of nonvoting shares
tend to have pyramidal structure.
Groups with focused business lines
tend to have larger family stakes.
669 firms, 1995.
Notes: This table summarizes many of the English language journal articles on the South Korean chaebol. The litera
ture exhibits a pronounced shift in recent years from a positive (or at least mixed) view of groups as diversified enti
ties to a clear impression that groups are undesirable. The table also illustrates some strong trends in the
economics-finance profession, as reflected in the recent focus on tunneling and conflicts between controlling and
minority shareholders. Features of corporate groups which were praised in some of the early studies when South
Korea was doing well (e.g., centralized control) have been reinterpreted more recently as potential weaknesses, which
are detrimental to small shareholders. Finally, the table demonstrates the tendency to focus on listed or quasi-listed
(audited) firms (because of data constraints), the limited use of information on group structure and on familial and
other possible intragroup contracts, and the absence of a dynamic perspective.
the answer is less clear-cut than it should be. cross shareholding, making the decision
La Porta, Lopez-de-Silanes, and Shleifer whether or not it should be considered a
(1999), who do not focus specifically on busi pyramid difficult (Chul-Kyu Kang 1997).
ness groups, find that widely held firms are Second, in much of the literature, the link
rare outside the United States and the between pyramidal groups and the expropria
United Kingdom. By contrast, concentrated tion of minority shareholders is an unques
family ownership, often exercised through tioned axiom. This is unwarranted: the
pyramids and other mechanisms that enable empirical evidence on the prevalence and
control in excess of cash flow rights are quite severity of profit tunneling from minority
common around the world. This view is sup shareholders within pyramidal groups is far
ported by Fabrizio Barca and Marco Becht s from clear-cut, although there is certainly
(2001) description of ownership and control anecdotal evidence on incidents of tunneling
of European firms (see also Mara Faccio and in Europe (Johnson, La Porta, Lopez-de
Lang 2002), and by the evidence in Silanes, and Shleifer 2000), and more system
Claessens, Simeon Djankov, and Lang atic evidence from pyramidal Indian business
(2000) and Claessens et al. (2002) on the groups (Marianne Bertrand, Paras Mehta, and
ownership and control of Asian firms. But Sendhil Mullainathan 2002) and South
even within this general framework, there Korean business groups (Kee-Hong Bae, Jun
seems to be considerable cross-sectional Koo Kang, and Jin-Mo Kim 2002; Sung Wook
variation. Khanna and Catherine Thomas Joh 2003; Jae-Seung Baek, Kang, and Inmoo
(2004) study business groups in Chile, Lee 2006). But even these convincing studies
where, they argue, pyramidal equity ties of tunneling raise a number of unanswered
characterize less than half of all group firms. questions. For example, Bertrand, Mehta, and
According to Roberto Barontini and Mullainathan (2002) find that Indian firms
Lorenzo Caprio (2005), unlike Claessens et located lower within pyramidal groups are less
al. s (2002) description of Asian firms, a sensitive to industry-specific shocks to their
wedge between cash flow and control rights profitability than are firms located in upper
in family-dominated firms in Continental levels. They interpret this result as evidence
Europe is far more commonly associated that positive shocks to firms in lower levels of
with dual shares than with pyramidal struc the pyramid are siphoned off to firms in upper
tures. By contrast, Chang (2003a) argues levels of the group pyramid, an activity which
that in South Korea pyramidal structures are serves the interests of controlling sharehold
common, Piruna Polsiri and Yupana ers, but not of minority shareholders holding
Wiwattanakantang (2006) estimate (without an equity stake in the tunneled firms only
providing precise data) that about half of the This interpretation is plausible for positive
business groups in Thailand are pyramidal, shocks (additional profits are taken away by
and Yurtoglu (2000) discusses the preva the controlling shareholders), but it is less self
lence of pyramids in Turkey. Some pyrami evident why tunneling would make firms
dal groups can also be found in other located in low levels of the group pyramid less
countries such as Indonesia, Malaysia and sensitive to negative shocks.
Mexico. Part of the difficulty in mapping Bae, Kang, and Kim (2002) examine acqui
pyramidal groups steins from the fact that sitions of often ailing companies by other
business group structures are often more group firms within the South Korean chaebol
complex than textbook pyramids, making a groups and find that within-group takeovers
dichotornous classification of groups into rarely raise the value of the bidder, but do
pyramids and nonpyramids difficult. The raise the value of other group members.
Samsung group, for example, involves both They also provide some examples (from the
vertical pyramidal control and horizontal LG group, for instance) showing how such
takeovers benefited controlling shareholders Indonesia) control premia are low.

at the expense of minority shareholders. Very Furthermore, in some European countries
closely related methodologically is a study by (e.g., Austria or the Czech Republic) the
Baek, Kang, and Lee (2006) whose focus is value of controlling blocks is much higher
on private securities offerings within South than in the chaebol-dominated South Korean
Korean groups, rather than on takeovers. economy (see Dyck and Zingales 2004).
They find that some of these securities are Beside the caveat that not all groups are
offered to other group members at prices pyramids and the fact that some of the
that are very far off from their true values, empirical results on tunneling are open to
and document negative stock price responses more than one interpretation, even where
to such deals. But the tunneling interpreta groups are pyramidal in structure, reputation
tion favored in these studies is not the only and other safeguards might preclude minori
possible one; some intragroup takeovers and ty shareholder exploitation. Martin Holmen
securities placements may also constitute and Peter H?gfeldt (2005), for example, dis
efficient mutual insurance or risk sharing, as pute the equation of pyramids and tunneling
Khanna and Yafeh (2005) document for in present-day Sweden, where there is ade
South Korea. Furthermore, An Buysschaert, quate investor protection. Historically, tun
Marc Deloof, and Marc Jegers (2004) report neling did not seem to be a major concern for
a positive price response to within-group British investors in the early twentieth centu
equity sales in a small sample of pyramidal ry, who were eager to invest money in multi
Belgian groups, suggesting that these trans national trading groups with certain
actions are not always interpreted as harmful pyramidal characteristics; affiliation with one
to minority shareholders. of the family-controlled British merchant
Moving to historical evidence from the houses was apparently viewed as a stamp of
Japanese prewar zaibatsu groups, Morck and certification, rather than as a reason for fear
Masao Nakamura (2005) argue that the of expropriation (Jones 2000, chapter 6).
growth patterns of some of the Japanese pre More recent evidence in Yan-Leung Cheung,
war zaibatsu reflected the importance attrib P. Raghavendra Rau, and Aris Stouraitis
uted to private benefits of control by some (2006), who document tunneling in Hong
large shareholders. Julian Franks, Colin Kong (often through "connected transac
Mayer, and Hideaki Miyajima (2006) disagree tions" between related parties), suggests that
and do not find much evidence of tunneling tunneling is not especially common in
in the major zaibatsu groups; instead, they pyramidal groups. Morton Bennedsen and
argue that small shareholders were happy to Kasper Meisner Nielsen (2006) provide evi
invest in their shares in the stock market dence that in Europe dual class shares
dominated financial system of prewar Japan. destroy more value than pyramids. In other
Another proxy used in the literature to words, not all pyramids are associated with
measure tunneling is control premia, which tunneling, and tunneling is not restricted to
are generally higher in countries where pyramidal organizations.
minority shareholder protection is poor Finally, much of the literature pays only
(Tatiana Nenova 2003; Alexander Dyck and scant attention to the participation constraints
Zingales 2004). Yet the relation between con of investors in these pyramidal schemes.
trol premia, minority shareholder rights and
pyramidal business groups is less than 23 It is interesting to note that these pyramidal business
straightforward. South Korea, for example, is groups did not operate within the United Kingdom, only
overseas. This may support the view that business groups
found to have a high control premium in make up for underdeveloped institutions.
both studies, yet in certain other countries 24 Shleifer and Wolfenzon (2002) is a notable exception.
where business groups are dominant (e.g., See also Morck, David A. Stangeland, and Yeung (2000).
Why, on a routine basis, do investors continue 3.2 Family versus Nonfamily Groups
to invest in situations where their investment
Another dimension related to ownership
is likely to be expropriated? It is, perhaps,
and control in the taxonomy of business
possible to argue that na?ve investors in
groups around the world has to do with role
emerging markets invest in business groups
of family considerations in the presence,
prone to tunneling because of inexperience or
evolution and performance of groups:
inadequate human capital; we find this
implausible. Another possibility is that the Hypothesis 4: (a) Family-controlled
feasible alternatives available to investors are groups are likely to be more common in
extremely limited, although this claim proba countries with inadequate rule of law, where
bly did not apply historically to British transactions with outsiders are costly, (b)
investors in merchant houses. An explanation Family considerations influence the forma
that we find more plausible is that group rep tion, structure and performance of family
utation for fair treatment of minority share controlled groups; in some cases, groups
holders is an important consideration (see may continue to exist for family-related soci
Armando Gomes 2000 for a related theoreti etal reasons, even when they no longer
cal model). This could be group reputation enhance economic efficiency.
for risk sharing (or assistance to poorly per 3.2.1 Evidence on Groups and Families
forming companies) which reduces the Evidence on the relation between fami
default risk of group-affiliated companies, a
feature which investors may find attractive lies, the prevalence of business groups and
even if they know that they are exposed to a economic institutions is provided by La
certain risk of expropriation by controlling Porta, Lopez-de-Silanes, and Shleifer
shareholders. A more formal mechanism is (1999) who document higher presence of
proposed by Faccio, Lang, and Leslie Young family firms (not necessarily groups) in envi
(2001) who find that some groups, especially ronments where contracting is difficult.
in Europe, are known to pay higher dividends Kathy Fogel (2006), using data on the
and thus compensate investors for the risk of largest business groups and individual com
expropriation. Finally, it is possible that at panies in over forty countries, also suggests
least some part of the alleged tunneling may that family ownership is more common in
in fact represent returns to some core asset, economies with poor institutions. One read
with the investing public s participation con ing of these findings is that kinship and
other social ties facilitate economic transac
straints being satisfied. This asset can be a
socially productive one, such as some core tions (Granovetter 2005) and, more general
entrepreneurial ability, or a socially detrimen ly, that business groups are networks whose
tal lobbying capability (e.g., Faccio 2006). At prevalence facilitate the creation of "trust,"
present, the literature provides very few which makes up for incomplete contracts and
answers to these questions. imperfect rule of law. Fogel (2006), by con
trast, claims that family ownership and con
trol is the cause of economic and institutional
' Somewhat related to this discussion is the phenome
non of foreign investors who are reluctant to invest in
underdevelopment.
In addition to these two international
Indian groups (Khanna and Palepu 2000a) or, more gener
ally, in firms with concentrated family ownership in emerg comparisons, there are a number of studies
ing markets with poor investor protection (Christian Leuz,
Karl V. Lins, and Francis E. Warnock 2006). This could be documenting the prevalence of family
construed as evidence of tunneling which is, for some rea controlled business groups in specific
son, more acceptable to domestic investors than to foreign
ers (see also Susan Perkins, Morck, and Yeung 2006).
However, these studies do not measure the extent to which 26 Morck, Stangeland, and Yeung (2000) make a similar
pyramidal structures in particular deter foreign investment. point.
countries. For Taiwan, Chung and it is not clear from these studies why family
Mahmood (2006) document considerable assets cannot be divided into independent
family equity stakes and involvement in companies without the group structure.
management in 1988, followed by a rapid There is also no clear evidence in this liter
decline in the 1990s, which was accompa ature?much of which is centered on East
nied by an increase in the use of pyramids in Asia?on whether or not family oriented
order to maintain family control. In groups are more prevalent in East Asia
Singapore, Lai Si Tsui-Auch (2006) suggests (where there is a special cultural emphasis
that about a third of the top business groups on the family) than in other regions; there
are family controlled (the rest are govern are certainly non-Asian countries with
ment linked). Family equity stakes are often extensive family involvement in business
above 50 percent, (without much change groups: in Mexico, for instance, there is con
between 1996 and 2002), and family involve siderable family influence in all of the eight
ment in management is extremely high: in largest groups.
nine of the top ten business groups the Beyond pure family ties, the sociology lit
chairman is a family member; in all but one erature regards groups as network struc
of these firms, so is the CEO. In Malaysia, tures serving primarily social and cultural
Edmund Terence Gomez (2006) estimates purposes, rather than seeking to achieve
that thirty-five of the top fifty business economic objectives. Granovetter (2005)
groups in 1997 were family owned, but the uses the mixed evidence on the perform
number has declined since the East Asian ance of group firms to suggest that consid
financial crisis; as in Singapore, other large erations other than economic efficiency may
groups are typically government linked. be at play The importance of noneconomic
Claessens, Djankov, and Lang (2000) dis functions of business groups is reinforced,
cuss family firms as an important feature of he argues, by the enormous variation in
Asian companies more generally, and Jones structure of business groups around the
(2000) regards historical British trading world, which is likely to reflect societal, cul
houses operating in Asia as well-functioning tural, institutional, and other norms going
family-controlled groups. beyond standard economics. Factors such as
Not only is the evidence on the preva inheritance customs (e.g., primogeniture or
lence of family controlled groups limited, other), kinship structure, and even national
there is also very little research on the ideology and pride, may all play a role in
extent to which considerations affecting shaping corporate groups in different envi
family firms influence the growth and ronments. Cultural edicts on how economic
behavior of business groups. Some research exchange should be arranged, rather than a
on this question originates from an exten rational response to missing markets or eco
sive literature within (economic) sociology, nomic institutions, may account for differ
which views business groups as a family ences in the structure of groups between,
organization, whose objective is tied to the for example, South Korea and Taiwan
social milieu (Orr?, Biggart, and Hamilton (Hamilton and Feenstra 1997; Hamilton
1997). Diversification, for example, may be 1997).
interpreted as a way to manage family Moving from sociology to economics,
assets?firms are merely asset holders for issues raised by the literature on family
lineage interests (Hamilton 1997), although firms (primarily in the United States) such
as succession, differences between founder
controlled firms and successor-controlled
27 See also Xiaowei Luo and Chung (forthcoming) on
family and other social ties and group performance in ones, the importance of family control ver
Taiwan.
sus family management, the tendency to use
debt finance and the link between all these the appointment of senior officers (The
and performance seem highly relevant for Marker, August 17, 2006). Commonwealth
understanding the link between families of Australia (1995) emphasizes family
and business groups. A recent working related issues as determinants of group
paper by Bertrand et al. (2004) is the first to structure in Indonesia, and describes fam
examine these issues systematically in the ily ties and inheritance customs in ethnic
context of Thai business groups dominated Chinese business groups in several other
by ethnic Chinese families. Using elaborate East Asian countries. There is also consid
data on seventy groups, they show that the erable evidence on the link between fami
group structure is related to family history lies in business group structure and
and evolution, for example, to the number performance in South Korea. Chang
of male sons of the founder or to the num (2006) documents the rapidly declining
ber of brothers he had. Bertrand et al. equity stakes of the founding families of
(2004) also attempt to relate diversification Hyundai and SK, whereas in other large
groups family stakes were historically
and growth to family considerations, and to
link group performance to intrafamily smaller but have remained stable. Chang
feuds.29 and Shin (2005) show that group firms
The relation between family considera with large family stakes in South Korea do
tions and business group structure is not outperform other members of the
apparently not specific to Thailand. same group, in contrast with what one
Piramal (1998), for example, provides would expect if extensive tunneling took
anecdotes describing how intergenera place on behalf of the controlling families.
tional considerations influence the struc Euysung Kim (2006) studies the relation
ture of business groups in India. In between family ownership and total factor
Israel, where contracting institutions and productivity and finds a positive relation
the rule of law are considered highly devel for group firms.
oped, two tycoons, controlling two of the In addition to the influence of family
largest business groups, admitted recently considerations on group structure and per
that family considerations affected the formance, the tendency of many groups to
number of companies in their groups and use debt rather than equity finance may be
related to family ownership, reflecting a
desire not to dilute control (Chang 2003a
discusses this in the context of the South
28 See Morck, Wolfenzon, and Yeung (2005) for further
discussion of this literature.
Korean chaebol). Thus, in contrast with the
29 See also Polsiri and Wiwattanakantang (2006) for possible negative effects of business groups
information on the extensive involvement of families in
on equity markets, many groups are large
the ownership and management of business groups in
Thailand. borrowers and important bank clients. It is
The decision of Williamson Magor Group to not clear, however, if this tendency is more
acquire Union Carbide India in 1994 was apparently
prompted by the Khaitan family's worry about its off
spring's habits. "Worried that their son ... was spending
too much time in their stable of three hundred horses,
Shanti (Khaitan) persuaded her husband to make an 31 On the relation between performance of South
offer.... Deepak (Khatian) needed to settle down, and Korean groups and the equity stakes of insiders or family
she was convinced that a big company like Union members, see also Chang (2003b), Woochan Kim,
Carbide would be just the right ticket." Similarly, Youngjae Lim, and Taeyoon Sung (2004), and Ungki Lim
Kasturbhai Lalbhai, a cotton textile magnate, made four and Chang-Soo Kim (2005). Keister (2004) compares
large investments the period 1929-35, of which three family and business group structure in South Korea and
were designed to sustain his nephews' careers, and the China, and Amsden (1989) and Eun Mee Kim (1997) dis
fourth was to avoid disgracing the family name by bailing cuss the importance of families in South Korea business
out an errant family member. groups more generally.
pronounced in family-controlled groups to address this issue). Furthermore, the equi

than in stand alone family firms.32 ty contracts that are visible to the public
We regard the family-firms line of research observer and the social scientist might not be
on groups as highly promising, both with the most meaningful contracts in systems
respect to the prevalence of family-controlled where relationship contracting predominates
groups in different environments, and with (Khanna and Thomas 2004).
respect to the interaction between family
considerations and group performance and 4. Interactions Between Business Groups
efficiency. Contrasts between business groups and Society
that are single-family controlled and those
that are either government controlled (in 4.1 Business Groups, Politics, and
Singapore or in China) or are controlled by
Governments
multiple families (e.g., LG in South Korea for This part of the taxonomy focuses on the
at least part of its history or some joint ven nature of the interaction between business
tures between the Ko? and Sabanci groups in
groups, governments, and politics.33
Turkey) would be particularly interesting.
Because business groups have enjoyed close
Analyzing groups from this perspective is,
ties to their governments in many countries,
however, difficult for two main reasons.
it is not surprising that the political economy
First, while all of the studies discussed in this
section focus on the link between families literature on groups has often viewed gov
ernment-supported business groups as rent
and firm performance, performance might
seeking "parasites." Influential papers such
also affect the stability of the familial contract
as Jagdish N. Bhagwati (1982) or Anne O.
and thereby the structure of families. Krueger (1974), while not directly studying
Bertrand et al. (2004) take a first step in
groups, have been used in support of argu
addressing this issue when they treat the
ments on rent-seeking through the power
number of male offsprings as an endogenous
exercised by incumbent businesses, typically
outcome. Second, in many cultures, it is not
at all clear that "what one sees is what one family-based business groups. Indeed, the
interaction between groups and the state has
gets" with regard to the family assets. In other
received much attention over the past few
words, the best assets of the family might not
decades, to the extent that an impression
be the publicly listed parts (Bertrand et al.
that all groups are deeply politically involved
2004 and Khanna and Palepu 1999a attempt
has been generated:
32 On various other aspects of debt finance in business

groups, see Bianco and Nicodano (2006) or Ronny Manos, Korean chaebol were extremely heavily leveraged (Mark
Victor Murinde, and Christopher J. Green (2004). Note L. Clifford 1994; Chang 2003a), a feature that made them
also that leveraged business groups share some attributes especially vulnerable during the Asian crisis of 1997-98.
with leveraged buyout (LBO) organizations in the United But the parallel between business groups in emerging
States (we are grateful to George P. Baker and Krishna markets and American LBO organizations should not be
Palepu for suggesting the analogy; George P. Baker and taken too far. Debt from Indian institutional investors or
Montgomery 1994 compare LBOs with American con from government-controlled financial institutions in South
glomerates). As in LBOs, each business group affiliate is Korea would hardly have the disciplining character of debt
organized as a separate legal entity, with its own fiduciary from American capital markets in the heyday of LBOs.
responsibilities, its own board, and its own disclosure Another striking difference is that LBO organizations in
regime. Just like LBO associations that finance individual the United States were forced to liquidate their invest
purchases with heavy leverage, business groups often ments within a defined time period. This led to an inde
launch new ventures with financial support from financial pendent measure of the value of each business (in order to
intermediaries. In India, for example, a typical new ven sell it), and to a powerful incentive structure, quite differ
ture of the past few decades was launched with very little ent from that prevailing in the case of a business group in
equity capital from the entrepreneur (just as in an LBO) an emerging market.
and a lot of (equity and) debt from domestic institutional 33 See a related discussion in Morck, Wolfenzon, and
investors. There is also extensive evidence that the South Yeung (2005).
Hypothesis 5: Business groups are emerged as an outcome of certain govern

formed with government support, expand ment economic policies (Daniel Maman
and diversify with government nurturing, 2002), and the rise of the "oligarchs" in
and their performance is a function of their Russia is yet another recent (and very
rent-seeking ability and opportunities. extreme) example of the emergence of
In general, there is substantial evidence groups under the auspices of the govern
supporting the first part of the hypothesis? ment (Sergei Guriev and Andrei Rachinsky
business groups in emerging markets are
2005).
very often, though not always, formed with Tables 4 through 7 present a comparative
government support. But as the groups perspective on the origins of business groups
evolve and (some of) the countries develop, around the world. Table 4 confirms that gov
the relations between groups and govern ernment support is an important factor in
ments become far more complex so that the formation of business groups in many
there is considerable variation in this dimen environments. Nevertheless, even within
sion across groups and countries. countries where groups generally enjoyed
government support some groups emerged
4.1.1 Evidence on the Origins of Groups: with little or no government favors (e.g.,
The Role of Governments Samsung, see table 5 on prewar Japan and
In many countries, the very appearance of table 6 on South Korea).34 Table 7 suggests
the business group phenomenon was that the vast majority of business groups
strongly influenced by government policies. began as family dominated corporations,
The Japanese prewar zaibatsu groups often with close ties to the government.
emerged as a result of a government privati 4.1.2 Evidence on the Relations between
zation program in the early 1880s, and
Mature Groups and Governments
expanded and diversified their activities in
response to government contracts awarded While in most countries groups emerged
under preferential terms (Eleanor M. with at least some degree of government sup
Hadley 1970). The South Korean business port, often in the context of development
groups, the chaebol, enjoyed close ties to oriented mercantilist policies, the relations
the government of General Park; the gov between mature groups and the state can
ernment controlled the allocation of credit vary considerably In some circumstances,
and foreign currency, and the chaebol groups continue to enjoy close ties with the
enjoyed preferential access to these and authorities. Raymond Fisman (2001) pro
other resources (e.g., Clifford 1994; Kim vides convincing econometric estimates of
1997; Chang 2003a). The privatization poli the value of political connections enjoyed by
cies of Prime Minister Mahathir's govern business groups in Indonesia during the
ment in Malaysia enriched certain ethnic Suharto regime (see also Leuz and Felix
Malay-owned business groups dramatically Oberholzer-Gee 2006). Gomez (2006,
(Gomez and K. S. Jomo 1999). The Salim Appendix table 6.1) delineates the extensive
group in Indonesia had family ties with
President Suharto and expanded, as did
other Indonesian groups, with the assistance 34 Nevertheless, Kang (1997) argues that Samsung's
diversification was, at least partially, driven by an attempt
of government-granted monopolies and to maximize rents from the governments preferential
licenses. Keister (1998 and 2004) describes interest rate policies.
35 Table 7 is based on detailed web-based and archival
how the government actively encouraged
research by Hyunjee Kim for which we are very grateful.
the formation of business groups in China
Examples of groups that were not family controlled even
and protected them from foreign competi early in their development exist in Chile (Nicol?s Majluf
tion. In Israel, family-owned groups et al. 1995) and in China (Keister 1998).
TABLE 4
The Comparative Origins of Business Groups: Historical Comparisons by Country
State-backing (general) Privatization-related Ethnic Policies and Family issues
State protection (through tariffs and Family ties have always been at
non-tariff barriers and through target the center of groups and groups
ing of priority sectors) benefited today are still owned and some
Brazil groups, as did extensive state financ times run by the families that cre
ing. In the 1990s protection decreased ated them decades ago.
(although there is still some state
backing in the form of technology and
research grants and support).
Government encouraged the forma

tion of many business groups and pro
tected them from foreign competition
because they were regarded as essen
tial for development. However, gov
China ernment sentiment waxed and waned
(since the depending on the fortune of business
1980s) groups in neighboring countries, par
ticularly South Korea. In addition, the
People's Liberation Army has histori
cally been involved in several business
ventures, many of which are organ
ized as business groups.
Some groups benefited from the con Some groups benefited

Chile solidation policies following the crises from privatization dur
of 1970s and 1980s. ing the Pinochet regime.
A limited role of the state combined Family groups evolved, typically as
with a historically homogeneous dis a result of the success of specific
Costa tribution of land and coffee plants. firms, especially in commodities.
Rica However, government protection of
some sectors (e.g., sugar, meat, rice)
led to the growth of certain groups.
Industrial holding companies Voucher privatization

emerged out of former Communist led to the creation of
planning units, sometimes with 15?30 large, diversified invest
horizontally and vertically linked ment funds, often indi
Czech plants and subsidiaries. These compa rectly run by banks,
which control linked
Republic nies were voucher-privatized and
restructured using government subsi enterprises.
dies. The remaining shares were
bought at discount by the new man
agement team and consortia of Czech
banks.
Favored entrepreneurs formed Some entrepreneurs Clusters of business groups

groups during the License Raj of the who formed groups formed around ethnic, religious
1960s and 1970s (although other benefited from the and social communities, for exam
groups date back to the early twenti transfer of assets for ple, the Marwaris of Rajasthan
India eth century). This was despite the merly held by the formed businesses in Bengal and
existence of de jure legislation that British to Indians dur elsewhere; the Gujeratis in the
was anti-big business (e.g., the ing the Independence West, the Chettiars in the South,
Monopolies and Restrictive Trade movement (de facto etc.
Practices Act). privatization).
(continued)
TABLE 4 (continued)
Some groups run by members of the The Salim group Suharto viewed the involvement
Suharto family. Others, such as the received assets seized by of his children in business groups
Indonesia Salim group, were granted monopoly the army. as a way of righting the Pribumi
(under over mills. Close government Chinese imbalance in the top
Suharto) involvement in business. State-spon ranks of the business community
sored cement and other monopolies (although most groups are identi
benefited groups. fied as ethnic-Chinese, including
the state-supported Salim group).
State backing of preferred groups in Privatization?transfer

Israel the early decades after independence. of some government
assets to families and
new groups in the 1990s.
Government credit and protection of

some groups in early postwar years
Italy (eg-> tne Pesenti family who owned
Pirelli). Some government-controlled
groups as well.
Preferential credit and protection Sale of assets formerly

from foreign competition to entrepre controlled by the
neurs following government guide Japanese and of state
lines, especially with political contacts assets to some favored
South to General Park. The government, groups and entrepre
Korea through its control of the financial
(1960?90) system, often encouraged group
diversification, mergers and consolida
tion (acquisition of ailing firms and
groups), and investment in certain
industries.
Preferential credit to businessmen Privatization (of colonial Prime Minister Mahathir supports
with close ties, including members of assets and of failed gov Bumiputeras (indigenous Malay)
Mahathir's family. Political parties ernment investments)? entrepreneurs in the privatization
Malaysia processes. Some ethnic Chinese
(under explicitly involved in business. buyers have political
Consolidation has often been used as contacts and state groups operate in Malaysia and
Mahathir)
a remedy to salvage distressed firms, patronage. across its borders (to diversify
particularly by grouping companies political risks).
under favored Malay entrepreneurs.
Until the mid 1980s, the government The privatization periodFamily ties are crucial for busi
supported business groups by pro (mostly 1988 to 1994) ness groups in Mexico. The
tecting many sectors through tariffs benefited many businesslargest industrial conglomerates in
and trade restrictions, as well as by groups which bought thecertain regions are still run by the
granting discretionary concessions national phone companyfamilies who started the business
(for example, in media, mining, and (and was granted a es in the mid-nineteenth century,
Mexico other sectors), as well direct and indi
monopoly for five years)often with very strong ties to the
rect subsidies to certain goods and and banks. Some new government.
industries (e.g., sugar). Groups also groups were created fol
enjoyed monopolies, state-induced lowing the privatization
consolidation and certain protectionof the 1990s.
from FDI. Since 1973, groups and
conglomerates have enjoyed certain
special tax incentives.
(continued)
TABLE 4 (continued)
The government of the Somozas Concentration in family groups,

(father and son) controlled directly a inherited from colonial times.
large number of industries. At the
Nicaragua end of the Sandinista government
many firms were bankrupt and a few
groups acquired them, leading to
consolidation
Pakistan Foreign exchange licenses given pri
(starting marily to rich families. Combined
around with restrictions on imports.
1960)
Some (limited) government support Industry-led financial
of industry-led FIGs which evolved industrial groups (FIGs)
with the collapse of Communism; emerged early in the pri
much more support of the bank-led vatization process. Bank
Russia FIGs which enjoy (enjoyed?) political led FIGs emerged later,
clout, lobbying power for various in relation to auctions
privileges (e.g., restrictions on for initiated by President
eign investors), and influence the Yeltsin favoring (some)
media. buyers; state assets sold
at low prices to
"Oligarchs."
Government-linked business groups Ethnic Chinese, who felt threat
established in the 1960s and 1970s in ened by the government formed
gapore orc[er to make economic investments private, family controlled groups,
jointly with private investors. diversifying across industries and
borders to reduce risk.
During Apartheid, major groups

were associated with the whites;
In the postapartheid period, the
adoption of Black Economic
South Empowerment policies induced a
Africa transfer of assets from whites to
blacks, and the formation of con
glomerates by select black entre
preneurs, some of whom had
political contacts to the ANC.
Not much government support and
encouragement; family groups formed
Taiwan endogenously (but benefited from
certain tax advantages starting in the
1960s).
Some groups originated in the 1940s; Groups are often dominated by
politicians and military officers often ethnic Chinese, some of whom
Thailand involved in business groups; restricted operate in neighboring countries
competition in many sectors favors as wel
groups.
(continued)
TABLE 4 (continued)
Between 1923 and 1980 some groups Relatively larger busi The nineteenth century business
ness groups are the
were supported through preferential elite was mostly composed of eth
input prices, low-cost credits, tax favored participants in nic minorities and foreign
rebates, foreign exchange licenses, the privatization of state investors. With the founding of
import licenses, government con owned enterprises, espe the new Turkish Republic in
tracts, as well as through export-spe cially those with strong 1923, the economic agenda
cific measures allowing business political ties. Smaller stressed creating an indigenous
Turkey groups to establish large export com family groups participate business class: bureaucrats, mer
panies in the 1980s. The government in the privatization chants, and professionals were
also encouraged diversification and efforts of smaller state encouraged to become entrepre
internationalization of business groups assets.
via various economic incentives. (But
several group-owned banks were
taken over by the government after
the bank crisis in 2001.)
Some "political merchants" received

Nine- state credit and grants. Ailing govern
teenth ment businesses privatized and sold to
Century the zaihatsu. Government contracts
Japan encouraged group growth around
major wars.
Sources (in English): Brazil?Leff (1978), Suzingan and Villela (1997), and Musacchio (2004); Chile?Khanna
and Palepu (1999a, 2000c); China?Keister (2004); Costa Rica?private communication with A. Condo; Czech
Republic?McDermott (2002); India?Khanna and Palepu (1999a, 2000b, 2005) and Piramal (1998);
Indonesia?Commonwealth of Australia, Chapter 8, Schwarz (1994), Kompass Indonesia (1996) and Fisman
(2001), Hanani (2006); Israel?Maman (2002); Italy?Aganin and Volpin (2005), Amatori (1997); Malaysia
Gomez and Jomo (1999) and Gomez (2006); Mexico?G?mez-Galvarriato (forthcoming); Nicaragua?Strachan
(1976); Pakistan?White (1974); Russia?Johnson (1997) and Guriev and Rachinsky (2005); Singapore?Tsui
Auch (2006); South Africa?McGregor (1998); Taiwan?Hamilton (1997) and Chung (2001); South Korea?
Amsden (1989), Clifford (1994) and Chang (2003a); Thailand?Bertrand et al. (2004), Tara Siam (1996-97),
Polsiri and Wiwattanakantang (2006); Turkey?Mango (2004), Yaprak et al. (2004), and Karademir et al. (2005);
Prewar Japan?Morikawa (1992).
(For Latin America, a general Spanish source is America Econ?mica, 1997).
and close ties between business groups and president in 1993), a Turkish business group
the government in Malaysia (see also has launched a political party, allegedly so
Johnson and Mitton 2003). In India, some that their representation in government can
business groups were able to receive favor confer political immunity on them (Andrew
able treatment from the "License Raj" in cer Mango 2004), and in Malaysia some business
tain periods (Dwijendra Tripathi 2004). groups are centered on political parties (e.g.,
There are yet more extreme examples of the Malay political party UMNO or the
symbiosis between business groups and the Chinese political party MC A; see Gomez
government: each of the two major Japanese and Jomo 1999 and some discussion in
zaibatsu, Mitsui and Mitsubishi, virtually Commonwealth of Australia 1995). Pramuan
controlled one of the major parties in the Bunkanwanicha and Wiwattanakantang
Japanese parliament in the 1910s. More (2005) describe Thai business tycoons who
recently, some owners of South Korean chae enter politics in order to win various govern
bol seemed to entertain political aspirations ment concessions, and in Singapore there
(e.g., Chairman Chung of Hyundai ran for are still some fully government controlled
TABLE 5
The Comparative Origins of Business: Group-Specific Origins in Nineteenth Century Japan
Origin Growth and Relations with the State
Mitsui* Dates back to 1673 (dry goods); "political Historically close ties with various governments.
merchants" who provided financial services Growth and diversification through acquisitions and
to the Tokugawa regime since the late seven through establishment of new businesses, in part
teenth century. through government privatization and contracts.
Mitsubishi* Founded by a former Samurai after the Meiji Initial investment in shipping enjoyed government
Restoration. protection, subsidies, loans etc. Subsequent growth
and diversification patterns broadly similar to
Mitsuis.
Sumitomo* Dates back to the late sixteenth century, with Diversified from mining into trading, finance and
ties to the Tokugawa regime. industry. Again, diversification and growth through
both acquisitions and through the establishment of
new businesses, with government support.
Yasuda* "Political merchants" from the Meiji Less diversified than the other big groups, more
Restoration period. Mainly provided finan focused on banking and finance. Again, both acqui
cial services (including the establishment of sitions and new businesses as mechanisms of
the third national bank in 1876). growth.
Asano Around 1870; no previous political ties. Initial fortune out of various investments. Growth
through cooperation with a separate financial insti
tution.
Fujita Origin: supplier of goods and engineering An internal family feud led to the dissolution of this
works to the new government (with contacts group and its reorganization as the Kuhara zaihatsu
to major figures in the Meiji government). in 1905.
Furukawa Formed in 1874, related to old wealth from Mostly in mining and utilities, e.g., established the
the Ono family. first hydroelectric power plant in 1890. Characterized
by more vertical integration (e.g., in copper extrac
tion and production) than diversification.
Okura Merchant (groceries) before the Meiji Growth mainly through acquisitions. Despite sub
Restoration; converted into gun production stantial operations overseas, government contracts
in the 1860s and then into overseas trading remained a major source of income.
starting 1873.
1 This refers to the Japanese term seisho which is defined by Morikawa (1992, p. 3) as "traders and financiers
who used their ties to powerful political figures to obtain government favors, enabling them to earn substantial
profit in return for providing goods and services to the state. Government patronage took the form of subsidies,
grants and monopolies or special privileges, favorable credit arrangements, and sales of state enterprises at nomi
nal prices."
Source: Morikawa (1992). * denotes the big four zaihatsu groups.
business groups (Temasek, for example, transformation?e.g., when the Chinese

which controls Singapore Airlines). Communist Party took power in 1949?and
But governments and business groups do in an ongoing sense when groups struggled
not always operate symbiotically. First, in the face of an inimical state?e.g., India's
there are a number of historical examples socialist government in the few decades
when governments harmed, rather than following Indian independence; indeed
assisted, business groups. This has hap Khanna and Palepu (2005) point out that
pened both in times of wrenching societal the turnover in leading Indian groups
TABLE 6
The Comparative Origins of Business Groups: Group-Specific Origins in Present-Day South Korea
Origin Growth and Relations with the State
Hyundai Mr. Chung (the founder) started hy Together with Daewoo, one of General Park's favored groups
providing mechanical services to in the 1970s, when Hyundai cooperated with the government s
the American army; later estab policy of investment in heavy and chemical industries.
lished contacts with the Syngman Obtained licenses and government finance as well as preferen
Rhee regime. tial tax treatment and protection from imports. Growth
through both acquisitions and entry into new industries.
Allegedly, Hyundai and other big groups used government
contacts to improve their competitive positions, occasionally
by acquiring assets of ailing groups and by winning major gov
ernment contracts. Mr. Chung was General Park's "informal
construction minister" and a personal friend.
Daewoo Mr. Kim (the founder) was the son Close relations with the government, which transferred to
of General Park's teacher. Group Daewoo the Okpo shipyard and some assets in the auto
established in 1967. industry previously owned by GM. Government-induced
investments in heavy industry. Expansion mainly through
acquisitions. Strong international orientation (overseas invest
ments).
Samsung Mr. Lee (the founder) established Samsung was relatively large already in the 1950s; made polit
the company in 1938, using some ical "donations" and established contacts in government. But
inherited wealth. Acquisition of relations with the state were turbulent in comparison with the
assets left by the Japanese in 1945. other major groups: General Park forced Samsung to
"donate" some of its assets soon after taking power, and for a
while the group was virtually excluded from most government
contracts. Instead, growth fostered through cooperation with
foreign firms; relative focus on electronics. Growth and diver
sification in 1960s through both acquisitions and establish
ment of new businesses.
LG Founded as a trading company in mostly in electronics and chemicals; benefited from
Growth
1947. government development plans in the 1960s; related diversifi
cation strategy.
SK Founded in 1957; close ties with Much of its growth driven by acquisition of privatized state
the government since inception. assets (including property left by the Japanese), through close
ties to the government, including the marriage of the
founder's son to the daughter of President Roh.
Source: Clifford (1994) and Chang (2003a).
across the past sixty years is far too high to to social ties between the office holder and
be consistent with entrenchment and close senior managers. Furthermore, even with
group-government ties. In Pinochets in the same group, different affiliates may
Chile, after the fall of Allende s Socialist either be favored or punished depending
government in 1973, pro-free-market and on their CEO or Chairman's social ties to
antiownership concentration policies were the current political regime. In the United
adopted, which were sometimes antibusi States, Morck (2005) and Morck and
ness groups. In South Korea, Jordan Siegel Yeung (2005) describe how President
(2006) shows that political regime changes Roosevelt took policy measures against
lead to differences in the particular firms business groups (see table 4 for other
that receive government favors according examples).
TABLE 7
The Comparative Origins of Business Groups: Initial Control Structure of Business Groups
Family Others
Indonesia Nearly Complete Some state involvement
Malaysia High (90+ percent) State involvement and

some foreign investment
Thailand High (80 percent) Some state involvement
Turkey Nearly Complete N/A
Mexico High (90 percent) Some state involvement
Sources: The table is based on detailed archival, web-based, and interviews by Hyunjee Kim. ISI
Emerging Markets Database, One Source Database, Hoovers Database, Datamonitor Company
Report, websites and annual reports. Data refer to the largest firms within the largest groups in each
country. Family control is defined as having the founding family holding at least 20 percent of the
equity during the first decade after the group was founded. In Malaysia, for example, over 90 percent
of the group firms examined satisfy this criterion.
Even where governments were not hostilethat loses favor with the authorities because
of its excessive influence.
toward business groups, the relationship
between them often changed over time, as
4.1.3 The Welfare Implications of Close Ties
groups became stronger and more inde
between Groups and Governments
pendent. This seems to have been the case
in Japan in the 1930s (Franks, Mayer, and The prevailing assumption in much of the
literature is that government support of
Miyajima 2006) and in South Korea starting
in the 1980s (Amsden 1989; Clifford 1994;groups is socially harmful. Despite the nega
Kim 1997; Chang 2003a; Chung H. Lee,tive implications of government favors of the
Lee, and Kangkook Lee 2002), where the type described above, there may also be a
expression the "Republic of Samsung" isbright side: business groups may have
sometimes used. In post-1997 South Korea, helped governments orchestrate a "big
push" in several sectors simultaneously
the government has actively tried to weaken
the chaebol albeit with limited success in(arguably in prewar Japan, see, for example,
view of their power and influence (although
Kazushi Ohkawa and Henry Rosovsky 1973).
Eduardo Borensztein and Jong-Wha Lee In other cases, governmental favoritism
2002 provide evidence that group firms losttowards business groups controlled by an
ethnic minority may have helped preserve
their preferential access to capital following
the crisis). The overall conclusion from this
evidence is that as business groups accumu
late political and economic influence, the The changing relations between groups and govern
nature of their relations with government ment may be related also to changes in the ownership
structure of business groups over time. For example, in
tends to change?from government proIndonesia or Mexico, foreigners often hold very signifi
t?g?s to a strong lobby with often captured
cant equity stakes in business groups firms?many group
firms among the largest business groups in Indonesia,
regulators (in line with phenomenon ofMexico, and South Africa have foreign ownership of 20
"entrenchment" emphasized by Morck, percent or more. This may affect the nature of ties
Wolfenzon, and Yeung 2005) or to a sectorbetween groups and politicians.
social equilibrium, as in Malaysia. The private sector and the government, without
appropriate counterfactual against which considering additional constituencies. For
this government policy should be judged example, Aldo Musacchio (2004) argues that
may well be race riots and chaos. Similar the rise of business groups (and concentrat
government-directed transfers are currently ed ownership) in Brazil coincided with the
being attempted in South Africa, under the rising power of organized labor, with the
label of Black Economic Empowerment, government playing only a background role.
with groups forming around emergent suc Yasheng Huang (2003) discusses the general
cessful black entrepreneurs in the post suppression of the indigenous private sector
Apartheid regime?again, the overall in China. This analysis, along with Keister s
economic value of such a policy is not easy to (2004) study of the forced formation of busi
gauge.37 ness groups in China, suggests that the gov
Social welfare might be enhanced by group ernment favors business groups formed by
government liaisons if, for instance, the rela the state but discriminates against business
tion between groups and governments groups formed by private entities.
supports tax collection and fiscal policy. Do In some countries, the government might
governments favor groups because it is easy to itself be in transition, affecting the formation
collect taxes from them? If so, this would be and evolution of business groups. In
reminiscent of medieval rulers who parti Czechoslovakia, for example, newly formed
tioned their territories into fiefdoms con groups reflected new networks of compa
trolled by quasi-independent lords who could nies, as power shifted from the Communist
rule them as they saw fit as long as they paid government to the regime that replaced it
their taxes to the government. This issue has (Gerald A. McDermott 2002; see also David
rarely been addressed in the literature. Stark 1996 on post-Communist corporate
Hidemasa Morikawa (1992) notes that taxes networks in Hungary).
collected from the Japanese zaibatsu during
4.1.4 Evidence on the Political Ability of
World War II were substantial. By contrast,
Morck (2005) describes how the U.S. tax Groups to Shape their Environment
authorities felt that collecting taxes from busi Can business groups use their political
ness groups was especially difficult because of clout to shape their business environment?
tunneling, and so supported (perhaps even This central question has no systematic
initiated) President Roosevelt's attack on busi answer in the existing literature. Historically,
ness groups. Chang (2003a) suggests that groups have often invested in market
South Korean groups shift funds so as to supporting infrastructure and launched new
reduce their tax liability. Mihir A. Desai, Dyck, industries?the Japanese zaihatsu are a good
and Zingales (forthcoming) argue that ineffi example. There are also claims that business
cient corporate governance structures associ groups in Mexico exerted influence in favor
ated with the expropriation of the rights of of free trade with the United States from
minority shareholders are likely to be associat which the groups were hoping to benefit.
ed also with tax evasion (expropriation of the Kim (1997) argues that the South Korean
governments rights). Clearly, more systematic groups lobbied for liberalization in the
evidence on this issue from various countries 1980s, and Anusha Chari and Nandini Gupta
would be of interest. (2006) show that in India industries with
Analytically, it might not always be sensi
ble to study just the interaction between the Somewhat related is a historical anecdote from early
twentieth century British India, when the Birla group sup
ported and financed indigenous Indian businesses and
The relevant legislation is the broad-based Black entrepreneurs as an alternative to the British-dominated
Economic Empowerment Bill, no. 53, of 2003. business scene (Piramal 1998; Tripathi 2004).
high presence of group-affiliated firms were 4.2 Business Groups and Monopoly Power
more likely to be associated with liberaliza
tion of foreign entry in the early 1990s than There are good theoretical reasons to sus
industries dominated by state owned pect that business groups may wield consid
firms.39 By contrast, groups may resist cer erable market power. They may, under some
tain political reforms, improvements in circumstances, drive their rivals out of mar
minority shareholder protection or antitrust kets, or prevent entry, due to their "deep
legislation?this seems to be the case in pockets," "first mover advantage," and ties to
South Korea in recent years (Chang 2003a). the government. "Multimarket contact" (B.
Morck, Wolfenzon, and Yeung (2005) argue Douglas Bernheim and Michael D.
that "entrenchment" through political clout Whinston 1990) between diversified busi
is often used by business groups to restrict ness groups competing with each other
entry and competition. Rajan and Zingales repeatedly in many sectors may facilitate col
(2003) also express concern about the ability lusion. And business groups may bundle
of business incumbents (not specifically together different group products in order to
groups) to curtail competition and free extract more rents from distributors and
financial markets. The ability of groups to ultimate buyers. It is not clear, however, if
shape their environment may also be related these considerations are the rationale
to attempts by business groups in many behind the formation of business groups.
countries to gain influence on the media Hypothesis 6: (a) Business group forma
(Bhattin Karademir and Ali Danisman 2006 tion should involve horizontal mergers, ver
describe this for the case of Turkey). tical foreclosure, entry deterrence, and other
Two conclusions emerge from this discus mechanisms designed to increase market
sion. First, political economy explanations
for the formation and effectiveness of power, (b) Monopoly power should be
reflected in high profit rates, (c) Group pres
groups, beyond the traditional focus on gov ence should be especially pronounced in
ernment favors, should receive more atten
environments where monopoly rents can be
tion. Second, it might be fruitful to view the extracted such as industries and countries
relations between groups and the state as the with trade barriers and weak antitrust
equilibrium outcome of a game, in the spirit enforcement.
of work by Aoki (2001) and Greif (2006).
4.2.1 Evidence on Business Groups and
These games are typically complex, and their
application to a particular context is not Monopoly Power
always straightforward. Nevertheless, con The theoretical conjectures associating
ceptually, the result of such a government business groups with monopoly power
business group game might well be rent enjoyed popular support in the past, albeit
seeking and cohabitation, but it might also without rigorous empirical tests. The view
be an uneasy coexistence, quite distinct from that business groups harm competition dates
the outcome of groups currying favor with back to the Great Depression in the United
the state.40 States. Morck (2005) argues that President
Roosevelt sought to dissolve America s groups
(by taxing intercorporate dividends) partly on
This is in some contradiction to Tripathi (2004),
these grounds. One of the primary objectives
who argues that the Bombay Club (of Indian industrial of the postwar American occupation reforms
ists) lobbied for restricted entry of foreign multinationals. in Japan was the dissolution of the prewar zai
40 It would be interesting to model the relation
batsu, which was driven by strong views on
between ties with the government and the business group
structure, in contrast with politically connected firms their anticompetitive effects and the resulting
operating in one industry. social tension that may have contributed to
the rise of militarism in Japan (Hadley 1970; deterrence. Other anecdotes refer to collu
Yafeh 1995). Ginette Kurgan-Van Hentenryk sion across ethnic Chinese business groups in
(1997) suggests the Belgian business groups East Asia (Commonwealth of Australia
facilitated the cartelization of the Belgian coal 1995). Ahmed Mushfiq Mobarak and
industry in the interwar period. Purbasari (2005) provide more systematic
Nevertheless, despite the plausibility of evidence?they show how politically con
arguments on groups and monopoly power, nected Indonesian business groups used their
the literature on the industrial organization influence during Suharto's reign to win exclu
effects of business groups has not developed sive import licenses conferring protection
much. The theoretical relation between group from imports, market power, and competitive
affiliation and entry deterrence is explored advantage relative to their rivals, leading to
formally in an interesting recent study by increased concentration. There is also fairly
Giacinta Cestone and Chiara Fumagalli systematic evidence on changes in the relative
(2005). They show that internal capital mar size and rankings of business groups over
kets are not always advantageous to group time, which could be interpreted as evidence
affiliated firms when they try to deter entry; of competition or erosion of monopoly
under certain conditions they may actually be power?the list of top ten business groups has
"softer" than stand-alone firms. There changed dramatically over the past three
seems to be scope for many more theoretical decades in India and Taiwan, but has
analyses of groups and industrial organization. remained very stable in South Korea and
Empirical evidence on the hypothesis that Thailand. It is not clear, however, why
business groups restrict competition is sur groups in some countries wield less power to
prisingly scarce. Casual observation suggests restrict entry than groups in other countries.
that not all groups enjoy high profit rates and Overall it is surprising that no attempts have
monopoly rents (table 1). The few studies been made to use modern NEIO (New
directly testing the monopoly power of busi Empirical Industrial Organization) tech
ness groups use not very recent data from niques to assess the market power of business
developed economies: David Encaoua and groups in emerging markets.
Alexis Jacquemin (1982) investigate French
industrial groups arid find little evidence of 5. Directions for Future Research
their having any market power (although the
This final section outlines general directions
econometric techniques used in empirical for future research in view of what we believe
industrial organization have evolved signifi we know, and what we would like to know,
cantly since then); David E. Weinstein and about business groups in emerging markets.
Yafeh (1995) argue that (in the 1980s) Japans
bank-centered groups competed aggressively 5.1 Origin and Formation of Business
against each other rather than colluded. Groups
Although there are no similar studies for The formation of business groups remains
emerging markets, there are occasional largely unexplained. Because of this lacuna,
descriptions of the intense rivalry between
the South Korean chaebol. These are not for 42 In India, only three of the top ten groups in 1969
mally substantiated, and even if true, do not were included in the list of top ten groups in 1997.
Taiwan is similar to India in this respect: only three of the
necessarily preclude anticompetitive entry top ten groups of 1973 appear on the list for 2002. By
contrast, in South Korea, six of the top groups in 1972
41 See also Antoine Faure-Giimaud and Roman were among the top ten groups in 1996, and in Thailand
Inderst (2005) who discuss related issues in the context of too, six of the top ten groups in 1979 appeared on the list
conglomerates with internal capital markets. Feenstra and of top ten business groups in 1997 (Khanna and Palepu
Hamilton (2006) also discuss monopoly power of business 2005; Chung and Mahmood 2006; Chang 2003a; Polsiri
groups in a different context. and Wiwattanakantang 2006, respectively).
selection effects may render comparisons of heterogeneity of the Chinese community.

groups and nongroup firms invalid. We view The empirical support for this claim, howev
this as an important direction for both theo er, is suspect because of other systematic dif
retical and empirical future research. ferences in the background of Chinese and
The existing theoretical literature on the Indian entrepreneurs in Singapore. More
formation of business groups consists of no sophisticated empirical analyses of the differ
more than a handful of models. Raja Kali ential origins of business groups are likely to
(1999) studies the endogenous formation of be valuable.
business networks in response to limited Somewhat related conceptually is the idea
contract enforcement by the legal system; to use within-country variation in the struc
Maurer and Sharma (2001) also focus on ture and development of business groups to
imperfect property rights. Maitreesh Ghatak draw some conclusions on the forces that lead
and Kali (2001) and Kali (2003) emphasize to their formation. For example, it appears
imperfect information in capital markets as that the Chinese government pursued liberal
another possible motive. Almeida and ization primarily in regions where it was weak
Wolfenzon (forthcoming) offer a theoretical (the south), and not in the northeast (e.g.,
explanation for the formation of pyramidal Beijing) where the Communist Party had its
groups which is based on the ability of con pre-1949 stronghold. Is it the case then that
trolling shareholders to access the cash flows state-sponsored groups created by fiat are
of all group firms so as not to rely on under developing primarily in the northeast?
developed external financial markets. A par Variation in group presence across Indian
ticularly intriguing theoretical direction (also provinces might shed light on the relation
related to underdeveloped financial mar between the formation of business groups
kets) would relate the formation of groups to and issues related to ethnic identity and per
risk attitudes: are groups a mutual insurance haps also to "trust." For example, is it possible
arrangement attracting risk-averse economic to map the presence of certain ethnic groups
agents? Se-Jik Kim (2004) is the only existing in certain regions (e.g., Marwaris in Rajasthan
model along these lines. and, by migration, in Bengal; Chettiars in the
Existing empirical studies of the formation south) to the formation and development of
of groups are often based on small data sets groups along similar ethnic lines? Indian busi
and employ empirical techniques that are not ness groups offer an opportunity to take
fully convincing. For example, Chung (2001, advantage of the variation over time in the
2006) examines the origin and evolution of processes that led to the formation?some
groups in Taiwan, distinguishing between groups, like the Tatas and Birlas were created
reasons related to market forces, culture, and by indigenous entrepreneurs during the time
societal institutions, but the relative empiri of the British Empire; a second wave, like the
cal importance of these factors is hard to dis Goenkas and the Khaitans, were the product
entangle. Tsui-Auch (2005) documents a of the postindependence (1947) transfer of
tendency among ethnic Chinese entrepre assets from the British to Indians; a third set
neurs in Singapore to form diversified busi originated during India's "License Raj" of the
ness organizations (in comparison with 1960s and 1970s. Can these different circum
ethnic Indian entrepreneurs), and attributes stances be related to group structure?
this interesting observation to the cultural
5.2 Evolution and Dynamics of Business
Groups
' The empirical evidence in Kaivan Munshi and Mark
Historical and dynamic (over a long period
Rosenzweig (2005) on informal mutual insurance institu
tions in India, and in Ran Abramitzky (2005) on the Israeli of time) perspectives of business groups can
Kibbutz may offer some useful related insights. enrich our understanding of this institution
in several ways. First, it would be interesting "history matters"), and on the raison d'?tre
to compare the validity of cross-sectional of group formation and development.
explanations for the ubiquity and perform
5.3 Longevity of Business Groups
ance of business groups with time-series
based perspectives (Jones and Khanna Although there is no systematic evidence
2006)?do groups evolve in a fashion that is on the question whether or not the longevi
consistent with missing institutions, risk shar ty of group affiliates exceeds that of other
ing, tunneling, use of a scarce resource, etc.? wise comparable, unaffiliated firms, in many
The Japanese prewar zaibatsu provide an countries, very long-lived groups can be
obvious opportunity to carry out such an found. In some cases, groups have survived,
analysis because of the wealth of information without a substantial change in structure,
about their activities and development, pro over a long period, starting in an era when
viding over five decades of data. Another the country was poor, all the way to prosper
possibility is the shorter, but more recent his ity (e.g., Sweden). This is related to the
tory of the South Korean chaebol. There impression that, if groups ever dissolve, this
are other interesting examples: Maurer and tends to conincide with dramatic changes in
Sharma (2001) study the evolution of nine government policy4 Can groups ever die
teenth century Mexican business groups peacefully? We are not sure. One of the few
(which, in their view, was a response to limit examples of such a process is provided by
ed contract enforcement); Khanna and Jones (2000), who describes the demise (or
Palepu (2005) study the evolution of business refocus) of British trading houses during
groups in India (which, they argue, fits the recent decades in response to a changing
view of groups as a substitute for underde environment (rise of diversified institutional
veloped institutions; see also Jones 2000 on investors in London, decolonization abroad,
historical British groups); and Alexander decline in trade in raw materials, etc.).
Aganin and Paolo Volpin (2005) study the Morck et al. (2005) show that Canadian pyr
evolution of Italian groups (focusing on amids died peacefully in the mid twentieth
investor protection and political issues). century due to market crashes, inheritance
Many more historical studies with explicit taxes, and other factors, but new groups
hypotheses in mind, especially with compet arose to replace them in the later decades of
ing hypotheses whose testable implications the century. There is also some recent evi
can be contrasted in time-series data, could dence on the on-going, gradual decline of
shed further light on the evolution of cross shareholding in Japanese corporate
groups, on path dependence (ways in which groups (Mitsuaki Okabe 2002; Yafeh 2003;
Miyajima and Furniaki Kuroki forthcoming).
44 Morikawa (1992) is the most detailed English-lan By contrast, recent evidence suggests that
guage study of these groups with a plethora of information
the business group phenomenon in much of
on their origins, evolving relations with the government,
growth and diversification patterns, controlling families,
human resource management, and more. He tends to 46 For a brief discussion of the history and survival of
interpret the zaihatsu growth and diversification history in the Wallenberg group, the largest in Sweden, over the
a Chandlerian tradition of efficient management and use past 150 years, see the Economist, Oct. 14, 2006, p. 94.
of internal resources. The evidence he provides, however, 4 For example, President Roosevelt deliberately
is not really set up in a way that enables testing competing attempted to dismantle American big businesses during
hypotheses about the reasons for the existence and growth the Great Depression (Morck 2005; Morck and Yeung
of these groups. 2005), which may explain why he could muster the neces
45 Chang (2003a) argues that, much like the Japanese sary political will. The American occupation authorities
zaihatsu in the late nineteenth century, South Koreas forcefully dissolved the Japanese zaihatsu after World War
business groups developed under the auspices of a devel II (Yafeh 1995). The South Korean government attempt
opment-oriented government, but gradually became ed to curb the power of the major chaebol following the
independent and pursued a growth strategy that reflected Asian financial crisis of 1997-98 (Khanna and Palepu
their resources and competitive advantages. 1999b; Chang 2003a) with limited success.
East Asia did not disappear following the and Wolfenzon (2006) argue that because of
1997 crisis, although some groups did col negative externalities (on the ability of non
lapse and others were forced to restructure. group firms to raise finance) business groups
For example, Chung and Mahmood (2006) do not realize the full cost of their presence
show that Taiwanese groups became more (and presumably will not dissolve on their
diversified both across industries and across own even when it is optimal to do so).
countries following the crisis; they also
5.4 Counter)actuals to Business Groups
became more pyramidal in structure. Tsui
Auch (2006) examines both government When considering the welfare conse
owned and privately owned groups quences of groups, it is unclear what the
controlled by ethnic Chinese in Singapore, appropriate counterfactual should be:
finding certain gradual changes toward against what alternative should groups be
increased focus but much continuity. Gomez evaluated? The ideal is a well functioning
(2006) documents significant weakening of market economy, but in reality the world
Malaysian groups with the demise of their consists of distant second-bests. In the
patrons, Prime Minister Mahathir and other absence of groups, would there be other
politicians in Malaysia, like Daim and Anwar. forms of networks? Would market-support
Polsiri and Wiwattanakantang (2006) ing institutions emerge spontaneously? Is
describe the restructuring of Thai business there a way to infer the appropriate counter
groups and Alberto Hanani (2006) of factual from recent policy interventions
Indonesian groups. None of these studies (e.g., in South Korea or China)? Almeida
suggests that, despite the crisis and the ensu and Wolfenzon (2006), who evaluate the
ing changes, the dissolution of business welfare implications of business groups as a
groups in any of these countries is imminent. function of measures of efficiency of exter
Are there cultural or societal reasons that nal financial markets, provide an interesting
would prevent corporate structure in emerg starting point for addressing this issue. Also
ing markets from self-evolving into a more relevant is the model of Vojislav Maksimovic
focused structure as the country develops? and Gordon Phillips (2002), who suggest
What is the role of government in this that conglomerates are an efficient equilibri
process? Is it advisable, or even possible, for um outcome to certain business opportuni
the state to forcibly dismantle groups, as has ties, whereas for others standalone firms are
been attempted in South Korea? Even if better suited. The equivalent for business
groups have run their course, is it clear that groups would be that groups are an efficient
the desired policy is to try and dissolve them outcome for certain situations in which the
(Khanna and Palepu 1999b)? Is a policy of appropriate counterfactual is not necessarily
benign neglect more desirable (as in India)? stand alone firms but some other, not well
Is it clear that when the social costs of cor specified, outcome. Also related is the obser
porate groups exceed their social benefits, vation in Maurer and Haber (2006) that,
private costs to group owners will also when restrictions were imposed on related
exceed private benefits? Can groups involv lending within Mexican business groups in
ing substantial inefficiencies persist for a 1997, the result was a large decline in the
long time? If so, is it because of a weak cor size of the credit market, not the emergence
porate control environment? Because of of a competitive equilibrium in which all
social reasons (e.g., families who diversify to firms could access loans on equal footing.
accommodate disparate interests of the next Conceivably, the relevant counterfactual
generation)? These are complex theoretical to business groups may change with eco
issues. At present, we are aware of only one nomic development?in early stages, in the
study that tries to address them: Almeida absence of groups, the plausible feasible
366 Journal of Economie Literature, Vol XLV (June 2007)
alternative may well be underdevelopment existence of unanswered puzzles. Part of the

and limited market institutions. In more difficulty stems from the vast differences
advanced economies, in the absence of busi across countries, groups, and time periods,
ness groups, perhaps superior capital, labor, and part from the multiple effects that
and other market institutions would develop; groups tend to have. Progress is likely to
this conjecture has never been tested. result from casting a broader net for relevant
data; this includes paying attention to histor
5.5 Groups and Macroeconomic Crises
ical data and evidence, using group origin as
Some studies relate corporate governance a relevant variable, and exploiting time
in business groups to the financial crisis in series variation. To us, business groups con
East Asia (e.g., Giancarlo Corsetti, Paolo tinue to be a fascinating topic for research,
Pesenti, and Nouriel Roubini 1999; Johnson, still posing many interesting questions with
Peter Boone, Alasdair Breach, and Eric implications for a variety of important issues
Friedman 2000; Mitton 2002; Byungmo Kim in economics and finance.
and Lee 2003; Baek, Kang, and Kyung Suh References
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American Economic Association

Business Groups in Emerging Markets: Paragons or Parasites?

Business Groups in Emerging Markets:

Diversified business groups, consisting of legally independent firms operating across

1. Introduction multiple (often unrelated) industries, which

Years Number Number (Median size Median Median Median Median

Argentina 1990-97 25 11 5.5 3.9 7.8*: 3.7 4.9**

Brazil 1990-97 108 51 2.5 3.3 1.8* 4.1 5.1

Chile 1989-96 225 50 18.7 5.9 2.2* 4.4 4.1.

India 1990-97 5446 1821 4.4 11.7 9.6* 4.6 4.4*

Philippines 1992-97 148 37 3.4 7.3 4.0 2.5 2.9

Taiwan 1990-97 178 79 2.0 5.1 6.2 1.7 2.3**

Thailand 1992-97 415 258 2.3 2.9 4.4* 4.3 4.9**

Turkey 1988-97 40 21 1.0 24.6 26.3 6.2 9.1

Prewar Japan 1932-43 58 17 6.8 5.5 6.4 4.4 7.1

Chile to about two-thirds in Indonesia. Thesome groups there is considerable vertical

Country Group Group vertical Group assets in

Chile 5.1 0.06 0.24

India 4.2 0.04 0.05

Indonesia 2.1 0.04 0.45

South Korea 1.7 0.04 N/A

Mexico 2.7 0.02 0.05

Philippines 3.1 0.08 0.60

Taiwan 1.6 0.02 0.01

Thailand 3.5 0.04 0.35

See, for example, the World Bank, Doing Business

opportunities to exercise monopoly power development should explain business group

Porta, Lopez-de-Silanes, and Guillermo quacy of some of the regulatory institutions in

Hypothesis 3 focuses on equity finance; this logic

Study Main Argument, Sample Size, Category Listed Groups as Information

Campbell and Corporate governance problems Corporate Listed on No reference No specific

Joh (2003) Tunneling by controlling sharehold- Corporate Listed or Reference to No specific

takeovers benefited controlling shareholders Indonesia) control premia are low.

pronounced in family-controlled groups to address this issue). Furthermore, the equi

32 On various other aspects of debt finance in business

Hypothesis 5: Business groups are emerged as an outcome of certain govern

State-backing (general) Privatization-related Ethnic Policies and Family issues

Government encouraged the forma

Some groups benefited from the con Some groups benefited

Industrial holding companies Voucher privatization

Favored entrepreneurs formed Some entrepreneurs Clusters of business groups

State-backing (general) Privatization-related Ethnic Policies and Family issues

State backing of preferred groups in Privatization?transfer

Government credit and protection of

Preferential credit and protection Sale of assets formerly

State-backing (general) Privatization-related Ethnic Policies and Family issues

The government of the Somozas Concentration in family groups,

During Apartheid, major groups

State-backing (general) Privatization-related Ethnic Policies and Family issues

Some "political merchants" received

Origin Growth and Relations with the State

business groups (Temasek, for example, transformation?e.g., when the Chinese

Origin Growth and Relations with the State

Source: Clifford (1994) and Chang (2003a).

Indonesia Nearly Complete Some state involvement

Malaysia High (90+ percent) State involvement and

Thailand High (80 percent) Some state involvement

Turkey Nearly Complete N/A

Khanna & Yafeh (2007)

Khanna & Yafeh (2007)

Khanna & Yafeh (2007)