Abstract

We provide a rationale for the use of pyramidal ownership (the control of a firm through a chain of ownership relations) that departs from the traditional argument of separating ownership and control. With a pyramidal structure a family uses a firm it already controls to set up a new firm. This allows the family to access the entire stock of retained earnings of the firm it controls and to share the security benefits of the new firm with the other existing shareholders of the original firm. Therefore, pyramids are more attractive when internal funds are important (e.g., due to the poorly functioning capital markets) and when the security benefits of the new firm are low; conditions that we show hold in an environment with poor investor protection. We also analyze the creation of family business groups (a collection of multiple firms under the control of a single family). Business group flourish when external markets are poorly developed because, in such cases, internal resources from the existing firms provide the family with a financing advantage vis-a-vis other competing entrepreneurs. Thus, the model predicts that in countries with poor investor protection family business groups should be common and they should be organized as pyramids. Because our model departs from the traditional argument for pyramids as a device to separate ownership and control, it can differentiate between pyramids and dual class shares even in situations in which the same deviation from one share-one vote can be achieved with either method. Unlike the traditional argument, our model is consistent with recent empirical evidence that some pyramidal firms are associated with small deviations between ownership and control. We also argue that pyramids can be an efficient organizational structure for the family if the availability of internal funds is sufficiently important, even though pyramids are associated with high levels of cash flow diversion. Other predictions of the model are consistent with systematic and anecdotal evidence on pyramidal business groups.

Citations