CEP Discussion Paper No 833 November 2007 Innovation in Business Groups

Using novel data on European firms, this paper examines the effect of business group affiliation on innovation. We find that business groups foster the scale and novelty of corporate innovation. Group affiliation is particularly important in industries that rely more on external finance and have a higher degree of information asymmetry. We also find that the innovation of affiliates is less sensitive to operating cash flows. We interpret our results as supporting the ‘bright side’ of business group internal capital markets and explain how legal boundaries between group affiliates mitigate the inefficiencies found in internal capital markets of US conglomerates.