Crises as Opportunities for Growth: The Strategic Value of Business Group Affiliation

In many markets around the world, a substantial fraction of publicly listed firms are members of family-controlled business groups. Despite widespread concerns over their corporate governance impacts, family business groups have continued to expand, with no end to their dominance in sight. For example, from 2002 to 2012, a period which includes the Global Financial Crisis (GFC), the total annual sales as a percentage of GDP of the top 10 largest family business groups in South Korea increased from 53% to 80%, with two-thirds of the gain occurring after this crisis. While previous studies suggest that groups exploit their economic and political influence to perpetuate their market dominance over nongroup affiliated firms, little is known about the conditions under which groups are able to expand their market power and strengthen their competitive positions over time.

In our paper titled Crises as Opportunities for Growth: The Strategic Value of Business Group Affiliation, which is available on SSRN, we investigate whether business groups exploit crises to expand their economic power. Our study is motivated by the surprising lack of empirical evidence that links internal financing benefits of group affiliation to their product market positions. This is despite the large body of evidence in the industrial organization literature documenting that financially strong firms have a “deep pockets” advantage which enable them to capture market share from their financially constrained rivals. In a similar vein, we argue that the internal capital markets (ICMs) of business groups provide their affiliates with a clear strategic advantage during crisis periods, allowing them to capture market share from standalone rivals with limited access to external capital.

While past studies have analyzed the impact of group ICM activity on corporate investment levels during financial crises, their conclusions are mixed and none have focused on the longer-term strategic product market outcomes of such activity. Groups in several countries are found to use their ICMs during crisis period to reallocate capital to financially constrained firms with valuable investment opportunities. Our study explores whether there is also a strategic element underlying such choices. Business groups do not operate in a competitive vacuum, but rather strategically interact with their rivals. Such considerations can also explain how a business group utilizes its ICM during a financial crisis. Analyzing this aspect of a group’s behavior is important because it allows us to uncover a new explanation for the continued dominance of family business groups, namely exploiting crises as an opportunity to achieve product market dominance over their standalone rivals.

Our study recognizes that a group’s success in utilizing internal capital during crises to expand its long-term market power depends critically on how effectively its rivals can respond to such competitive threats. This is likely to vary across countries depending on the resilience of external capital markets following crises. In developed capital markets, standalone firms can effectively respond to a group’s competitive threats by quickly regaining access to external finance when capital markets return to normal. If groups anticipate this response, then their incentive to use their deep pockets to realize a competitive advantage can be seriously diminished. In contrast, for groups in emerging markets, any competitive gains they achieve during a crisis period can more easily be defended and built upon in the long run. This is because standalone firms can find it difficult to claw back product market share losses due to chronic restrictions on access to external finance that persist in developing countries even after capital market conditions return to their pre-crisis levels.

Using the 2008—2009 GFC as our setting, we analyze the strategic responses to this crisis with a comprehensive sample of family business groups from 45 countries around the world. Given our coverage of both developed and emerging capital markets, the GFC is an ideal external financial shock as it effectively closes the external capital markets in the short run to virtually all firms around the world. Such conditions amplify a group’s ICM advantage and allows us to observe its effects more clearly on product market performance. In normal times, it is significantly more difficult to identify these same effects because the competitive benefits of deep pockets are likely to occur at a more incremental pace (or perhaps not at all), and thus are difficult to disentangle from other factors that could explain group dominance, such as unobservable controlling family skill levels or favorable government policies.

We find that family group firms significantly increase their product market shares from the pre- to post-crisis period relative to similar standalone firms. This result, however, is observed only in emerging markets. Consistent with the notion that external capital markets in developed countries recover more quickly after a crisis, which seriously diminishes the competitive advantage of employing group ICMs, we detect no significant difference in market share gains between group-affiliated and standalone firms over the pre- to post-crisis period for developed markets.

We further investigate whether groups deploy internal capital to industries where affiliated firms can realize the most valuable competitive gains. We argue that the crisis provides a strategic opportunity for group affiliates to establish their dominance in highly competitive industries, where in normal times, making such product market inroads can be too costly. Our analysis confirms that product market gains are largely attributable to group firms operating in industries with high pre-crisis levels of competition. We also find variations in market share gains across industry segments within group affiliated firms. In segments where the group firm is not an industry leader, the market share gains are more pronounced than in segments where the group firm has already achieved market dominance.

Next, we examine the channels through which groups in developing countries use their ICMs during crises to improve product market performance. First, we find in emerging markets that groups cut their capital expenditures by less than standalone firms, especially for firms operating in young or competitive industries. Second, we find that product market expansion events such as new product releases, entry into new markets, and production increases occur more frequently for group firms than their standalone rivals in the aftermath of the GFC. Third, we find that groups in emerging markets engage in frequent inorganic expansions through acquisitions during the crisis period. Importantly, we document that all these strategic initiatives to improve their product market positions translate into higher stock returns from the pre- to post-crisis period.

Overall, our findings suggest that by exploiting strategic opportunities presented by financial crises, groups not only insulate their affiliates from external market shocks, but they also use these shocks as opportunities to enhance their competitive positions. While a group’s crisis period ICM advantage is beneficial to its minority shareholders, the same cannot be said about their overall economic impact, especially in emerging markets. Despite decades of strong domestic economic growth and financial globalization reforms, countries classified as emerging markets continue to lag behind developed markets in many respects including equity trading activity, capital raising, financial intermediaries and institutional investor development, and they remain generally under-represented in international investors’ portfolios. Business groups may contribute to perpetuating these persistent differences, as their ICM activity during crisis periods can limit the growth and development of new independent firms, in part by weakening the demand for financial intermediaries’ services.

The complete paper is available for download here.