Fifteen Firms on the Group's Chest
The ubiquity of conglomerates and business groups in advanced and emerging countries calls for a deep assessment of the channels through which they shape the economic environment. A new study by Chiara Fumagalli (Department of Economics, IGIER and Paolo Baffi Centre on Central Banking and Financial Regulation), Giacinta Cestone (Cass Business School), Giovanni Pica (Università di Salerno and IGIER), Nicolas Serrano-Velarde (Department of Finance and IGIER) and Xavier Boutin (European Commission) investigates the impact of group affiliation on product market competition.
In their paper entitled The Deep-Pocket Effect of Internal Capital Markets, forthcoming in The Journal of Financial Economics, Fumagalli and her co-authors make use of a unique data set on the ownership structure of French firms, provided by the French statistical institute (INSEE). Their findings indicate that, in cash-rich groups, the internal capital market allocates internal liquidity so as to alleviate the financial constraints faced by affiliated units, thereby turning them into stronger product market competitors. Consequently, entry is discouraged in markets where incumbent firms are affiliated to groups hoarding large cash reserves. The study also finds that this effect is more pronounced in environments where access to outside financing is more problematic, such as in industries with a large share of intangible assets over total assets, in industries experiencing a downturn or in innovative industries.
One policy implication that can be drawn from the analysis is that, in environments where external finance is costly to raise, the presence in a market of incumbents affiliated with cash rich groups should be seriously considered as a barrier to entry. However, the findings of this paper should not be interpreted as supporting the view that group membership is per se anti-competitive. First, the results of the paper indicate that firms backed by cash rich groups are better equipped for entering new markets. In this respect group affiliation is clearly pro-competitive. Second the results of the paper suggest that the financial slack provided to group members allows them to adopt product market strategies not available to (financially constrained) stand-alone rivals. This may well make the competitive environment tougher and, despite lower entry, benefit consumers (and total welfare) through lower prices, superior quality, and the selection of more efficient product market players.
The results of this work, by documenting that groups may significantly affect industry dynamics, call for a systematic investigation of the determinants of group formation.