Business Group Heterogeneity and Affiliation Effect: Evidence from Korean Chaebols
Business groups exist in many countries around the world. More recently, the emergence of powerful “tech conglomerates” such as Google or Amazon has revived concerns regarding the accumulation of economic power by such business structures. Business groups have raised substantial attention among scholars with the key question of the effect of business group membership on firm behavior and performance. We contribute to this literature by developing a novel identification strategy that reveals the variation of the affiliation effect across groups.
Business Groups and the Effect of Affiliation
The academic literature defines business groups as legally independent firms linked together by economic and social ties. Affiliates of the same group often coordinate activities to follow a common purpose or serve a group-level strategy. Business group membership provides affiliates with numerous competitive advantages relative to standalone firms. Hence, resource-based theory highlights the ability of business groups to pool and allocate resources across affiliates depending on needs or opportunities. Business groups also benefit from their size by lobbying and gaining substantial market power. Scholars document business groups’ dark sides in contrast with their bright sides. Unlike multidivisional firms, affiliated firms are rarely fully owned by the group’s controlling shareholder, who often uses complex ownership structures to influence group affiliates. Consequently, conflicts of interest can occur between the group’s controlling and minority shareholders of affiliated firms. Business groups’ accumulation of market power raised competition concerns, leading some countries to introduce regulatory measures aiming at dismantling business groups.. By contrast, business groups continue to prosper and dominate economically in other countries, such as South Korea.
Korean business groups, also called chaebols, developed after the Korean War and contributed to the remarkable post-war industrialization. Throughout the 20th century, chaebols accumulated substantial economic and political power. Competition concerns led to the creation of the Korea Fair Trade Commission (KFTC), which is in charge of closely monitoring chaebols. Samsung Group is currently the largest chaebol. The group’s control is still in the hands of the founding family. While Western consumers know Samsung for smartphones, TVs, and home appliances, the group is active in various industries, including financial services, hospitality, and heavy industry.
In the literature, business groups are often considered homogeneous entities. However, empirical observations contradict such simplification as groups differ from each other in terms of size, diversification, or financial policy. Because the main theories associate the effect of affiliation with group features, we hypothesize that the effect of affiliation varies across groups. To test this hypothesis, we developed a novel empirical approach based on three analysis levels. First, we follow common practice and estimate the average effect of affiliation. Such an approach assumes the homogeneity of business groups. Second, we categorize business groups based on group-level characteristics such as size, diversification, financial condition, and performance. This approach partially relaxes the assumption of homogeneity as it allows the variation of the effect across categories (e.g., largest vs. smallest business groups). In the last stage of our analysis, we estimate the effect of affiliation for each single business group to capture the effect associated with group-specific characteristics.
Evidence from Korean Chaebols
To test our hypothesis, we exploit the uniqueness of the Korean framework. The prevalence of business groups and wide data availability characterize Korea. The KFTC annually discloses the list of the largest business groups and their affiliated firms. Our empirical analysis is based on a sample of Korean-listed firms from 2007 to 2019. Among the 1785 sample firms, 257 belong to a business group.
We start our investigation by examining the performance effect of affiliation. On average, business group affiliation is associated with a valuation premium. The benefits of business group membership in terms of resource availability and visibility can explain this premium. Indeed, further investigation shows that investors tend to pay a higher premium for affiliation with large, well-performing, and strong chaebols. The valuation premium contrasts with the lower profitability associated with affiliation. However, such a negative effect is consistent with the profit-smoothing strategy reported in the existing literature. In addition, our results reveal that the negative effect on operating performance is limited to a small number of chaebols.
We extend our analysis to financial and investment decisions. While market forces likely drive the performance effect, groups controlling shareholder preferences might have a stronger impact on corporate policies. Regarding financing, business group membership is associated with lower cash holdings and debt. Further analysis shows that large, well-performing, robust business groups drive these average effects. We also observe a heterogeneity of effects between groups consistent with the discretionary power of the controlling shareholder on financial decisions. Business groups follow a conservative payout policy, in line with prior findings. However, our empirical strategy reveals that a limited number of business groups drive the negative association between affiliation and payout. Finally, the analysis of the affiliation effect on investment illustrates the relevance of our approach. Indeed, the model, ignoring business heterogeneity, fails to identify any significant association between business group membership and capital investment. Nevertheless, such an association exists at the group level but is negative for some groups and positive for others. This large heterogeneity explains the absence of an average affiliation effect on investment.
Our work contributes to the literature on business groups, specifically Korean chaebols. Consistent with empirical and theoretical literature, our analysis shows that business group membership significantly affects affiliates’ performance and behavior. However, our novel identification strategy sheds new light on the effect of affiliation by revealing its heterogeneity across groups. Hence, while market forces tend to drive the performance effect of affiliation, our results regarding corporate policies suggest the role played by controlling shareholder preferences and discretionary power.
Our findings highlight the limitations of a simple model that ignores group characteristics and heterogeneity. Such a simplistic approach might lead to wrong conclusions by hiding variations in the effect of affiliation across groups. In our analysis, the case of investment perfectly illustrates this risk. While a simplistic approach concludes that affiliation does not affect investment, many groups follow specific investment strategies.
Our results call for considering business group heterogeneity to better understand affiliates’ performance and behavior. In addition to the academic contribution, our findings have implications for practitioners and policymakers. Accounting for group characteristics and features could improve the accuracy of analyst forecasts, and policymakers might also consider differences in affiliation effects to refine regulation and monitoring of business groups to improve the competition framework.
Romain Ducret holds a Ph.D. in Finance and is a research and teaching assistant at the Department of Management of the University of Fribourg (Switzerland).
Dušan Isakov is a Full Professor of Corporate Finance and Governance at the Department of Management of the University of Fribourg (Switzerland).
This post is adapted from their paper, “Business Group Heterogeneity and Firm Outcomes: Evidence from Korean Chaebols,” available on SSRN.