Market Frictions and the Competitive Advantage of Internal Labor Markets

We show that frictions in labor and capital markets can be a source of competitive advantage for a¢ liates of corporate groups over standalone …rms in environments where bene…ts from internal markets’‡exibility are high. We argue that the advantage of ‡exibility in changing labor inputs is related to how di¢ cult it is to change capital inputs. We predict that if substituting labor with capital is di¢ cult, the group advantage of ‡exibly changing labor would be stronger in countries with high levels of …nancial development. Consistent with this prediction, we …nd a stronger competitive advantage for group a¢ liates in countries with rigid labor markets, but ‡exible capital markets. In these environments, group a¢ liates are more prevalent and they outperform standalone …rms in terms of growth and pro…tability. Keywords: corporate groups, competitive advantage, market frictions, internal labor markets, worker mobility JEL Classi…cation: J08, J40, L22, M51