Capital Markets and Firm Organization: How Financial Development Shapes European Corporate Groups

This paper investigates the e¤ect of country-level …nancial development on the formation of corporate groups. Since cross-country regressions are hard to interpret in a causal sense, we use exogenous industry measures to investigate a speci…c channel through which …nancial development may a¤ect group a¢ liation: internal capital markets. Using a comprehensive …rm-level dataset on European corporate groups in 15 countries, we …nd that countries with less-developed …nancial markets have a higher percentage of group a¢ liates in more capital-intensive industries. This relationship is more pronounced for young and small …rms and for a¢ liates of large and diversi…ed groups. Our …ndings are consistent with the view that internal capital markets may, under some conditions, be more e¢ cient than prevailing external markets, and that this may drive group a¢ liation even in developed economies. Keywords: corporate groups, …nancial development, internal capital markets JEL Classi…cation: G32, G18, O16