Aspects and Macroeconomic Implications of The Increasing Share of Business Groups

Abstract

■ In recent years, stand-alone firms, mainly SMEs, have changed their ownership structure to inflate the share of business groups while those who have shifted exhibit lower total factor productivity compared to those that have remained stand-alone. ○ Firms shifting to business groups showed higher input growth than stand-alone firms but a relatively low growth of value-added, hinting at a gradual decline in total factor productivity. ○ Business groups have lower entry and exit rates than their independent counterparts as is their total factor productivity at the time of market entry and exit. ○ The growing share of business groups in the Korean economy suggests that there could be a negative blow to market dynamics and efficiency of resource allocation.

■ However, despite the potential inefficiency in resource allocation of the overall economy, firms transition into business groups because it is the optimal decision for them as individual business entities. ○ When firms form a business group, they can expect: 1) lower costs via internal transaction; 2) risk sharing against external shocks; 3) more access to production factors; 4) increased private gains for controlling shareholders as they take advantage of the distortion in the ownership and governance structures; and 5) “Peter Pan Effect”1) in which firms are turned into subsidiaries (or parent) so as to maintain SME status (continued government support). ○ The fact that changes in ownership structure occur mostly among SMEs and that there exist inefficiencies in resource allocation and weakness in market dynamics implies that there may be a fallacy of composition in which stand-alone firms make the optimal decision to form a business group, which unfortunately does not lead to the optimization of the overall economy.

■ To that end, a competitive market environment must be created to enhance the efficiency of resource allocation and market dynamics and also stronger incentives to enable the growth from SMEs into middle-standing enterprises and higher. ○ Market competition and financial services should be reinforced to help highly productive stand-alone firms to grow more rapidly, without forming business groups. ○ Possibilities must be removed for dominant shareholders seeking private gains and of business groups being formed via distorted structures for incentives such as subsidy and tax benefits.