Business Group Affiliation, Financial Development and Market Structure: Evidence from Europe

Abstract

This paper investigates the effect of financial development on the incentives to form business groups. We examine how this relation varies across exogenous industry conditions, legal environments, and firms' life cycle. Using a comprehensive dataset on group affiliation of European firms, we find evidence that business groups substitute imperfect financial markets via their internal capital market. Our results highlight the constructive role of business groups in economies with less developed financial markets and contribute to the debate on whether business groups should be dismantled.

Keywords: business groups, financial development, internal capital markets

JEL Classification: G32, G18, O16