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Business Groups, the Financial Market and Modernization

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  • Raja Kali

Abstract

Business groups are an important aspect of the industrial organization of many developing countries. This paper develops a theory suggesting that they may be organizations that facilitate modernization in the presence of financial market constraints. An important function of the stock market is the diversification of risk that comes with specialized, productive technology. But in the face of serious information problems a well functioning stock market may fail to emerge, relegating the economy to a low productivity-poverty trap. Bilateral links between a firm and a group of others may be a more cost-effective way to achieve risk-sharing. Such business groups may be feasible when a full-fledged stock market is not. As modernization takes place, either because information problems become less severe or more firms enter the economy, business groups actually expand in size before being abruptly rendered obsolete by the stock market. This is consistent with empirical results from a number of emerging economies.

Suggested Citation

  • Raja Kali, 2000. "Business Groups, the Financial Market and Modernization," William Davidson Institute Working Papers Series 325, William Davidson Institute at the University of Michigan.
  • Handle: RePEc:wdi:papers:2000-325
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    Keywords

    technology choice; diversification; business groups; stockmarket;

    JEL classification:

    • O14 - Economic Development, Innovation, Technological Change, and Growth - - Economic Development - - - Industrialization; Manufacturing and Service Industries; Choice of Technology
    • O16 - Economic Development, Innovation, Technological Change, and Growth - - Economic Development - - - Financial Markets; Saving and Capital Investment; Corporate Finance and Governance
    • O17 - Economic Development, Innovation, Technological Change, and Growth - - Economic Development - - - Formal and Informal Sectors; Shadow Economy; Institutional Arrangements
    • P0 - Economic Systems - - General
    • L00 - Industrial Organization - - General - - - General

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