Evolution of Business Groups in Israel: Their Impact at the Level of the Firm and the Economy

The paper, which is based on a newly constructed and unique database, examines the emergence, ownership structure, diversification, evolution and economic activity of business groups in Israel whose development over the years occurred against the background of government activity in the business sector and the financial markets, the rapid expansion of the economy, geopolitical shocks and the extremely unusual replacement of the ruling elites. Using panel data on 650 public companies from 1995 to 2006, we identify twenty major business groups controlling about 160 listed companies and close to a half of total stock market capitalization, while the 10 largest groups' segment of the market capitalization is among the largest in the western world and amounts to 30 percent. These groups are family-controlled and highly diversified across different industries with common pyramidal structure of ownership: roughly 80 percent of all group-affiliated companies belong to business pyramids. Business groups are dominant especially in the financial sector, where half of banks and insurance companies are group-affiliated. Finally, using both stock market-based measures (Tobin's Q), and accounting measures of profitability (e.g. ROA), we find that group affiliation has no significant impact on accounting profitability, but it is associated with lower market valuation. In part, this seems to be due to conflicts between controlling and minority shareholders; and in part, this may reflect the fact that in a developed economy, where external markets are well-developed, business groups have no advantage in allocating resources internally. The reasons for their existence appear to have more to do with prestige, political ties, family considerations and other factors than with economic efficiency.