Business groups as hierarchies of firms: determinants of vertical integration and performance

We explore the nature of Business Groups, that is network-like forms of hierarchical organization between legally autonomous …rms spanning both within and across national borders. Exploiting a unique dataset of 270,474 headquarters controlling more than 1,500,000 (domestic and foreign) a¢ liates in all countries worldwide, we …nd that business groups account for a signi…cant part of value-added generation in both developed and developing countries, with a prevalence in the lat- ter. In order to characterize their boundaries, we distinguish between an a¢ liate vs. a group-level index of vertical integration, as well as an entropy-like metric able to summarize the hierarchical complexity of a group and its trade-o¤ between exploitation of knowledge as an input across the hierarchy and the associated communication costs. We relate these metrics to host country institu- tional characteristics, as well as to the performance of a¢ liates across business groups. Conditional on institutional quality, a negative correlation exists between vertical integration and hierarchical complexity in de…ning the boundaries of business groups. We also …nd a robust (albeit non-linear) positive relationship between a group’s hierarchical complexity and productivity which dominates the already known correlation between vertical integration and productivity. Results are in line with the theoretical framework of knowledge-based hierarchies developed by the literature, in which intangible assets are a complementary input in the production processes. JEL Classification: L22, L23, F23, L25, D24, G34