Business Groups in Emerging Markets - Substitutes for Missing Institutions

Abstract: Business groups in emerging markets perform better than
unaffiliated firms. We study how business groups can substitute
some functions of missing institutions, for example, enforcing
contracts. In a two period model, there is no contract enforcement
in the first period. The firms within the business group are
connected to each other by a vertical production structure,
resulting in externalities due to double marginalization, and an
internal capital market. Our model derives the sequencing of
investments and the credit contract offered by the headquarters
that solve the ex post moral hazard problem. Thus, the business
group's organizational mode and the financial structure facilitate
relational contracting.