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Business Groups and Risk Sharing around the World

Tarun Khanna, Yishay Yafeh


Researchers commonly assume that business groups, a ubiquitous organizational form in emerging markets, permit affiliated firms to share risk by smoothing income flows and by reallocating money from one affiliate to another in times of distress. This view has received support in the literature on Japanese keiretsu. To examine the generality of these findings worldwide, we amass a new data set on business groups in 15 emerging markets, and couple this with historical and modern data from Japan. Our results, using multiple estimation techniques, corroborate the existing evidence on risk sharing within the Japanese keiretsu. In addition, in some emerging markets such as Brazil, Korea, Taiwan and Thailand, we find evidence suggesting that group affiliation is associated with a 20 – 30 percent reduction in the standard deviation of operating returns. We also find evidence of substantial “liquidity smoothing” in India, although data constraints prevent us from knowing the extent to which this phenomenon is widespread. However, risk reduction by business groups is far from a universal phenomenon -- the magnitude of the effect is small in most of the other countries in our sample, even though it is sometimes statistically significant. Tests of two-dimensional first-order-stochastic-dominance suggest that the Japan result – that group affiliated firms have both lower levels of operating profitability and lower standard deviations of operating profitability – does not generalize to most emerging markets. Finally, we find no correlation between the extent of income smoothing provided by groups and measures of capital market development. We conclude that the provision of risk sharing, to compensate for under-developed capital markets, is probably not the most important reason for the ubiquity of business groups around the world.

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