Business groups and internal capital markets: the recovery of the Mexican economy in the aftermath of the 1995 crisis

In the second half of the nineties, the Mexican economy experienced a severe financial crisis. However, as the initial panic subsided, Mexico started to show promising signals of macroeconomic recovery. Not only did the economy rebound within a year but also grew steadily afterward, averaging an annual rate slightly above 5% during 1996–2000. In this article, it is suggested that the business group structure helped in the recovery of the economy. The collapse of the banking system, and the interruption of financing flows through the domestic financial markets, was overcome by a change in the firms’ capital structure. Firms, when possible, started to depend more on trade credit, and the internal capital market of business groups created a financial cushion that kept the economy working. In order to offer a rationale for the Mexican experience, a theoretical model is presented where it is shown that moral hazard problems are reduced within a business group as long as affiliated firms in the nontradable sector surrender control rights during periods of crisis. Copyright 2007 , Oxford University Press.