Product Market Competition and the Ownership Choice of Business Groups: Evidence from Korean Chaebols

ABSTRACT

This study investigates the effect of product market competition on the ownership choice of controlling shareholders in the Korean business groups known as chaebols. We find that member firms in more competitive markets have less disparity between the control and cash flow rights of controlling shareholders. The adjustment in ownership due to product market competition is implemented mainly through an adjustment in the ownership of affiliates rather than in the direct ownership of controlling shareholders. The disciplinary effect of product market competition is observed only in member firms with lower market power in their own industries. The result implies that product market competition works as a disciplinary mechanism that reduces the incentive of chaebols’ controlling shareholders to pursue the private benefits of control.

KEY WORDS:

• business group
• controlling shareholder
• disparity
• private benefit of control
• product market competition

JEL CLASSIFICATION CODES:

• G30
• G32.

Acknowledgments

This article is a revised version of one part of the corresponding author’s Ph.D. dissertation. We are grateful for the helpful comments of referees. In addition, we thank Hyung Cheol Kang (University of Seoul) for providing the detailed data about ownership chains in Korean chaebols.

Funding

Kyung Suh Park appreciates the financial support of the Korea University Business School and the AICG.

Notes

^1. In order to remove the concern that the sample period covers only the years before the global financial crisis, we compare the main variables before and after the crisis. However, no significant shift in product market competition and ownership disparity is observed. In addition, when we control for a limited number of variables, we find that the relationship between product market competition and ownership disparity remains unchanged after the global financial crisis.

^2. This criterion is also used in Almeida et al. (2011) and Kim, Lim, and Sung (2007).

^3. For detailed descriptions of ownership data and the methods of calculation in this study, please see Table 1 of Kim, Lim, and Sung (2007), figure 1 of Almeida et al. (2011) and http://groupopni.ftc.go.kr.

^4. As proxies for product market competition, these variables measure market size and margin rate. Such measures would matter if a firm, regardless of its nationality, enters an industry. Thus, the two measures reflect the competitive pressures in the foreign market. Although such measures of competition may be insufficient to reflect perfectly the competitive pressures in foreign markets, we believe that there is no better measure in the literature to check robustness.

^5. Profitability is measured by the average ROA for the past 3 years in order to reflect their trends. We assume that this approach is a good proxy for expected profitability, which is a more relevant factor in controlling shareholders’ decisions about direct ownership. The assumption is based on studies that also employ such a measure to act as a proxy for expected profitability (Almeida et al. 2011; Kim, Lim, and Sung 2007). Moreover, we include sales growth and the past 3 years’ standard ROA deviation in order to reflect expected profitability based on a firm’s cash flow generation pattern in the empirical model. In an unreported result, we use the ROA of the same fiscal year to control the effect of a firm’s profitability on disparity. The finding confirms a similar result.

^6. In Table 1, every firm with ownership data is included; however, firms without controlling shareholders, such as public firms, are excluded because the analysis of their ownership structure is not appropriate in this study. Nonetheless, Table 3 provides the summary statistics of the final sample that includes both types of firm. Thus, the number of sample firms in Table 1 and in Table 3 differs.

^7. The current definition of cash flow rights is the sum of the direct ownership held by controlling family members; thus, the definition ignores the ultimate cash flow rights that such family members hold through affiliated firms (i.e., the product of ownership stakes through ownership chains). Consequently, the possibility exists that ownership disparity in this study may be overestimated. In order to rule out such a possibility, when we consider the ownership chains, we employ a stricter measure of disparity. This measure is used in Almeida et al. (2011) and Kim, Lim, and Sung (2007) as a dependent variable. We also rerun the regressions. We find that the prior results continue to hold. However, because the goal of this study is to examine the effect of the external environment on a firm’s ownership structure, rather than to obtain substantial monetary benefit from cash flow rights and private benefits from control rights, we use the measure that is more intuitive and easier to understand.

^8. Khanna and Palepu (2000) and Stein (1997) find that business group firms with internal product and capital markets could support each other; thus, they face less external financial constraint. Accordingly, group member firms could be less affected by the regulatory effect of a competitive threat. In order to examine whether the effect of a competitive threat is influenced by the size of internal product and capital markets, we include an interaction variable between product market competition and the dummy variable of internal market size (the number of affiliated firms). The interaction variable takes a value of 1 when the number of affiliates is more than the median and 0 otherwise. The result shows that the coefficient of the interaction variable is not significant, implying that the size of internal markets does not have a significant effect on the relationship between product market competition and ownership disparity.

^9. Please see Wooldridge (2002).

^10. Reflecting a suggestion from a referee, we additionally use alternative measures for product market competition. These measures are the number of market participants in an industry and the concentration ratio measured by the market share of the top four players. We find that the results are consistent with our existing results, thereby suggesting their robustness.