Business Groups
or
The Riddle of the Great
Pyramids
Randall Morck
Globes – Israeli Business Conference, Tel Aviv, December 2010
1
Business Groups
Economics textbooks are about large US & UK firms, which are
1. Widely held – no controlling shareholder
2. Freestanding – listed firms neither control nor are controlled
by other listed firms
Many (most?) large firms in most other countries belong to
business groups, which are
1. Pyramidal
2. Controlled by wealthy families or tycoons
Family Firm
>50%
>50%
A1
A2
>50%
>50%
B1
B2
>50%
>50%
C1
D1
D2
<50% in
each
>50%
D3
<50% in
each
>50%
C3
>50%
D4
<50% in
each
>50%
D5
<50% in
each
D6
<50% in
each
>50%
<50% in
each
>50%
C5
>50%
D7
B4
>50%
C4
>50%
>50%
B3
>50%
C2
>50%
>50%
D8
<50% in
each
>50%
D9
<50% in
each
>50%
C6
>50%
D10
<50% in
each
Public Shareholders
>50%
D11
<50% in
each
>50%
C7
>50%
D12
<50% in
each
>50%
D13
<50% in
each
C8
>50%
D14
<50% in
each
>50%
D15
<50% in
each
>50%
D16
<50% in
each
2
How LSE Nearly Destroyed the World
Rosenstein-Rodan, Paul. 1943. Problems of Industrialisation of Eastern
and South-Eastern Europe. Economic Journal 53(210/1) 202-11.
 Pervasive & huge coordination problems slow growth
A business needs public goods
No single business can pay for
education
Needs suppliers & customers
Economies of scale often different
Needs complementary sectors
(externalities)
Economies of scale different
Especially for ‘hard to trade’ goods
Hold up problems everywhere
Especially for ‘hard to trade’ goods
Quality control problems
Irrational to produce quality
intermediate goods

3
Solution: A Big Push
 Rosenstein-Rodan, Paul. 1943. Problems of Industrialisation of
Eastern and South-Eastern Europe. Economic Journal 53(210/1) 20211.
Central planning is the solution!!
State provides public goods
State captures externalities in taxes
State-owned enterprises formed as
needed to fill in economic gaps
Customers, suppliers, & producers &
users of complementary goods set
up & expanded in proper sequence
Extensive taxes & subsidies
Tax optimally scaled sectors to
subsidize needed, but inefficiently
scales sectors
The state can supervise quality control
4
How LSE Nearly Destroyed the World
 Rosenstein-Rodan, Paul. 1943. Problems of Industrialisation of
Eastern and South-Eastern Europe. Economic Journal 53(210/1) 20211.
Why the private sector can’t do it
“Financial markets and institutions are
inappropriate to the task of
industrialization of a whole country.
“They deal with too small units, and do
not account for externalities
“Capital goes to individual firms
“There has never been a [private
sector] scheme of planned
industrialisation comprising a
simultaneous planning of several
complementary industries”
5
How LSE Nearly Destroyed the World
 Rosenstein-Rodan, Paul. 1943. Problems of Industrialisation of
Eastern and South-Eastern Europe. Economic Journal 53(210/1) 20211.
How the private sector can do it!
Pyramidal business groups are
precisely “a [private sector] scheme of
planned industrialisation comprising a
simultaneous planning of several
complementary industries”
Pyramidal business groups are
Highly diversified
Coordinate the establishment of
new firms using capital from
existing one
Rife with cross subsidizations
Public goods – e.g. Turkish universities
6
A Common Theme …
“LG My father and I started a cosmetic cream factory in the
late 1940s. At the time, no company could supply us with
plastic caps of adequate quality for cream jars, so we had to
start a plastics business. Plastic caps alone were not
sufficient to run the plastic molding plant, so we added
combs, toothbrushes, and soap boxes. This plastic business
also led us to manufacture electric fan blades and telephone
cases, which in turn led us to manufacture electrical and
electronic products and telecommunications equipment.
The plastics business also took us into oil refining, which
needed a tanker shipping company. The oil refining company
alone was paying an insurance premium amounting to more
than half the total revenue of the largest insurance company
in Korea. Thus, an insurance company was started. This
natural step-by-step evolution through related businesses
resulted in the Lucky-Goldstar (LG) group as we see it today.”
Koo Cha-Kyung, Chair
Kim and Lee (2007)
American Pyramids
8
1930s America
Pyramidal business groups prominent in news & on Capitol Hill
 Shareholders rights activists fret about vast separation of
ownership from control, entrenched insiders, self-dealing
 IRS auditors complain of transfer pricing
 FTC economists complain of hidden monopolies
 Newspapers warn of systemic governance risk
 Roosevelt’s “New Dealers” suspicious of concentrated
political power, hereditary elites, …
Family Firm
>50%
>50%
A1
A2
>50%
>50%
B1
B2
>50%
>50%
C1
D1
D2
<50% in
each
>50%
D3
<50% in
each
>50%
C3
>50%
D4
<50% in
each
>50%
D5
<50% in
each
D6
<50% in
each
>50%
<50% in
each
>50%
C5
>50%
D7
B4
>50%
C4
>50%
>50%
B3
>50%
C2
>50%
>50%
D8
<50% in
each
>50%
D9
<50% in
each
>50%
C6
>50%
D10
<50% in
each
Public Shareholders
>50%
D11
<50% in
each
>50%
C7
>50%
D12
<50% in
each
>50%
D13
<50% in
each
C8
>50%
D14
<50% in
each
>50%
D15
<50% in
each
>50%
D16
<50% in
each
9
Worthy of Eternal Life
Hereditary governance
Tax avoidance
Market power
Systemic risk
Political influence
Big Push growth
10
Roosevelt’s New Deal
‘35



‘36

Securities & Exchange Act enforces
transparency, self-dealing exposed
Intercorproate dividend tax at 10% of
regular rate
No capital gains tax on property from
complete liquidation of a controlled
subsidiary
Public Utilities Holding Co. Act “Death
Sentence Clause” bans pyramids > 2 layers
high in public utilities industries



‘37


‘40
Bank & Cheffins (2010) dissent, prob. wrongly
Sokolinski (2010) is best work on the subject
Intercorproate dividends tax at 15% of
regular rate
No capital gains tax on any assets from
complete liquidation of subsidiary
Investment Companies Act regulates listed
companies with extensive shareholdings in
other listed companies as investment
companies
Source: Morck (2005).
11
Decline of Equity Control Blocks in the US
12
What Happened in the UK?
’68
 LSE Takeover Rule
If you buy 30% of any listed
firm, you must buy 100%
 Postwar Labour governments
British reaction to
something “not cricket”
Source: Tripe Soup, by Andy Farnsworth. Copyright
© 1999 - 2007 Google
capitalized large trade-based
pension funds
 Their lobbying led to the LSE
takeover rule
 Active M&A eroded pyramids
 Either incumbent control
block holder or raiders must
buy 100%
 Pyramids largely gone by
1970s
 Such measures won’t work
absent active M&A
Franks, Meyer, and Rossi (2005)
13
Elsewhere
 Big Push in effect in “developing” world
 Business group firms are star performers in India, Chile, …
 Business groups after a Big Push
 Dismantled in US & UK (& Japan)
 Tied with regulation to various degrees in W. Europe, Canada,
Australia …
 Failure to launch in Latin America
 Repeated “almost successful” aborted economic takeoffs
 Just as takeoff imminent, lobbying stalls further development?
 Completed development would obviate the advantage of


business groups?
Latin America “land of the future, … forever?”
Saving Capitalism from the Capitalists, by Rajan & Zingales
 Recent successful Big Push economies
 Public policy issue in Hong Kong, Korea, Singapore, Taiwan,
Israel …
14
?
15