Business group affiliation and product market competition

Literature on internal capital markets has shown the importance of internally generated funds (i.e. funds from cash-rich establishments) in overcoming financial constraints at the firm level. Likewise, business groups may flourish on account of cash-rich divisions. This paper studies the effect that business groups have on market concentration, entry, and survival of recent entrant firms.

Using the market share of business group firms as a proxy for the influence of business groups on product market competition, the paper finds:

1. that business groups decrease market concentration, measured by the four-firm concentration ratio or the Herfindahl-Hirschman Index, in the later case especially in mature industries;

2. that there is a U-shaped relationship between entry and the market share of business groups, especially in young industries, meaning that entry decreases until business group firms reach a given market share and increases afterwards;

3. there is no statistically significant relationship between the presence of business groups and the survival of new firms in the market, which is better explained by industry-level variables such as profitability and capital intensity;

4. that cash held by incumbent firms in the market discourages entry, particularly in mature industries, while cash held by the business groups of entrant firms promotes entry.

These findings suggest that business group firms strongly compete until achieving a desirable market share, and are more likely to enter a market if their business group is more cash rich.

Click here to go to the paper by Tiago Pinho Pereira and Miguel Sousa.