Supply Chain within Business Groups: Do Families Prefer Upstream or Downstream Firms?

This study investigates how the intra-group supply chain may affect controlling families’ direct ownership in business group member firms. Previous literature suggests that profitable firms are directly owned by the controlling shareholders and are located at the top of the pyramidal structure. However, profitability may not be exogenous, but rather endogenously generated through related party transactions. Specifically, suppliers within the business group may enjoy guaranteed profits through exclusive sales contracts with other member firms. Based on a sample of large business groups in Korea, we find that suppliers are more likely to be located in the upper part of the pyramid. This pattern is more pronounced in relatively smaller groups, but disappears in the top five business groups. Our findings suggest that the incentive of controlling shareholders to expropriate corporate opportunities may be an important factor in structuring business groups.