The structure and formation of business groups: Evidence from Korean Chaebols

Abstract

In this paper we study the determinants of business groups’ ownership structure using a unique dataset of Korean chaebols, and a set of new metrics of group ownership structure. We find that chaebols grow vertically (that is, pyramidally) as the family uses well-established group firms (“central firms”) to set up and acquire firms that have low profitability and high capital requirements. Chaebols grow horizontally (that is, using direct family ownership) when the family acquires firms that are highly profitable and require less capital. We also provide direct evidence that the low profitability of firms owned through pyramids is partly due to a selection effect: the profitability of new group firms in the year before they are added to the group predicts whether they are added to pyramids or controlled directly by the family. The relationships between pyramids, profitability, and capital intensity that we uncover do not appear to be due to the separation between ownership and control induced by pyramids. Finally, we find that the selection of low-profitability firms into pyramids causes the group’s central firms to trade at a discount relative to other public group firms. Taken together, these results suggest that controlling families optimally design the ownership structure of the group in a manner that is consistent with theory.