Corporate Grouping, Resource Allocation Processes, and Protection of Minority Shareholders

This paper analyzes the influence of ownership structure on investment allocation decisions in a hierarchical corporate group. Such a group is characterized by an inbuilt conflict of interests since the controlling shareholder's objectives do not necessarily coincide with those of minority shareholders, the latter being only interested in the maximization of the value of the firm in which they have invested. The purpose of this paper is to derive a formal theoretical model to explain the intuitive fact that the actions of the controlling shareholder, taken in the interest of the entire group, may sometimes damage some of the subsidiaries. Resource allocation processes in both a group and a multidivisional firm are analyzed and compared. Conditions on the (integrated) group's ownership are established which make the multidivisional form preferable for minority shareholders. The effects of changes in ownership structure on both the underlying and market values of the group's member firms are also analyzed. The analysis here developed provides a simple analytical framework to investigate how the decisions of groups' controlling investors affect the investment of minority shareholders, and is intended as a first step toward a proper understanding of business groups' internal functioning.