Abstract
Using novel data on European firms, this paper examines the effect of business group affiliation on
innovation. We find that business groups foster the scale and novelty of corporate innovation. Group
affiliation is particularly important in industries that rely more on external finance and have a higher
degree of information asymmetry. We also find that the innovation of affiliates is less sensitive to
operating cash flows. We interpret our results as supporting the â??bright side' of business group
internal capital markets and explain how legal boundaries between group affiliates mitigate the
inefficiencies found in internal capital markets of US conglomerates.
Keywords: business groups, innovation, internal capital markets
JEL Classifications: G34, L22, L26, and O32
This paper was produced as part of the Centre's Productivity and Innovation Programme. The Centre
for Economic Performance is financed by the Economic and Social Research Council.
Acknowledgements
We express our special gratitude to Patrick Bolton, Francisco Perez-Gonzalez, Mark Schankerman
and John Van Reenen for numerous helpful discussions. We are also grateful for valuable comments
from Nick Bloom, Steve Bond, Bjorn Jorgensen, Tarun Khanna, Daniel Paravisini, Tano Santos,
Catherine Thomas, Manuel Trajtenberg, Daniel Wolfenzon, Yishay Yafeh and seminar participants at
Columbia University (GSB), Hebrew University, London Business School Transatlantic Conference,
London School of Economics, NBER, and Oxford University. We thank Liat Oren for invaluable
assistance with the programming of the ownership algorithm, Hadar Gafni for excellent research
assistance, and the Institute for Fiscal Studies, especially Rachel Griffith and Gareth Maca ...