Business Groups

Fundamentals

In a review of extant theories explaining the emergence and existence of BGs, Guillen captured three predominant views. The first, which dominates the literature, is the economists’ view, based on institutional and transaction cost theories. In this view, BGs emerge in the absence of well-functioning markets or institutions as a strategic response to factor market imperfections in developing economies. Performing the role of missing institutional intermediaries in capital, labor, and product markets, BGs fill the institutional voids by generating their own internal markets for these factors. The second view, primarily advocated by economic sociologists, is that BGs are a manifestation of different social and cultural patterns prevalent in some economies. Consequently, the organizational form of BGs is isomorphic with the social structure surrounding them. In addition to this, the social network perspective emphasizes the benefits that firms realize by virtue of being embedded in an enduring network such as a BG in terms of uncertainty reduction, contract enforcement, and opportunity identification. The third explanation for the emergence of BGs is presented by political or development economists. According to this view, some states or nations actively encourage a few entrepreneurs and facilitate them with incentives to enter new industries, thus creating business groups.

BGs serve the role of strategic networks providing member firms with access to information, knowledge, resources, markets, and technologies. They also provide superior access to the political power structure facilitating BG firms with a richer pool of opportunities. Studies show that BGs also have a positive impact on firm innovation in emerging economies and facilitate a firm’s expansion into new geographic markets. In addition to all these benefits, BGs are known to confer some costs on affiliated firms. Most BGs are also characterized by pyramidal ownership structures in which one or more family firms control a set of firms, which in turn control a set of more firms, and so on. Hence, BG firms tend to suffer from conflicts of interests between controlling (typically, family) and minority shareholders. Some BGs have been shown to engage in “tunneling,” or moving profits from firms in which they have low cash flow rights to those in which they have higher cash flow rights. There is no firm agreement on whether the net benefit of belonging to a BG is positive or negative.

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