Business groups as knowledge-based hierarchies of firms

We provide the first worldwide overview of the patterns of hierarchical differentiation across Business Groups (BGs), highlighting the coexistence of different hierarchical shapes. We show how the different shapes can arise as optimal hierarchical structures in a knowledge-based model of BGs when subsidiaries’ operations involve problem-solving under parents’ supervision. The optimal choice of hierarchical structure is driven by production efficiency and two dimensions of problem-solving: efficiency related to supervising knowledge creation and handling associated communication across subsidiaries. We check the consistency of the model’s predictions with the empirical patterns. The model successfully passes the consistency test (JEL D23, L23, F23, L25, G34)