On the Financial Efficiency and Control in Business Groups

Abstract

I present a theory of how capital structure and control structure co-vary in business groups. A controlling party of a business group adopts the pyramidal structure with excess internal capital to overcome restrictions on external financing imposed by control benefits. External financing capacity of the pyramid is maximal when highly leveraged parent firms are financially supported by the dividends of low-leveraged subsidiaries, which further promotes the pyramid. In contrast, business groups without this control constraint are horizontal and highly leveraged, facilitating the maximization of security cash flow benefits. These predictions are empirically confirmed for Korean family business groups.

Keywords: Control benefits, internal capital, capital structure, dividends, pyramid, horizontal structure, chaebols

JEL Classification: G32, G34