Group Therapy

By filling gaps in the infrastructure of emerging economies, business groups can both foster and deter entrepreneurship in various ways. Peter K. Jacobs explores the research of HBS associate professor Tarun Khanna in this article from Working Knowledge.
by Peter Jacobs

Look beyond the United States and Great Britain and you are likely to find networks of companies, from Latin America's grupos to India's business houses and Japan's keiretsu, helping to form the world's economies. For HBS associate professor Tarun Khanna, studying business groups and their role in emerging markets has been part of a larger effort to understand how local business environments influence company strategy.

Thus far, strategy scholars have emphasized the importance of industry and firm-specific characteristics in affecting company choices. But, Khanna observes, location matters as well, since the economic environments of emerging markets such as Chile, Costa Rica, or Mexico vary so greatly. Since business groups are such an integral part of most economies, understanding how these networked organizations function also becomes important.

Khanna has been studying the causes and consequences of group affiliation for several years now, often with HBS professor Krishna G. Palepu. His current research, much of which is set in Latin America, focuses on several important aspects of business groups: their effect on entrepreneurial activity in emerging markets; the ways they undertake coordinated action despite the fact that they are often composed of very diverse units; and the role families play in these organizations.

Court systems, contract law, stock markets, accounting standards, and other elements that facilitate entrepreneurship and growth are often weak, archaic, or entirely missing.
— Tarun Khanna

Regarding his work on entrepreneurship with Professor Palepu, Khanna notes that "it is important to recognize that emerging economies, unlike those of developed nations, typically lack many of the essential supporting institutions we tend to take for granted in the United States. Court systems, contract law, stock markets, accounting standards, and other elements that facilitate entrepreneurship and growth are often weak, archaic, or entirely missing."

By providing substitutes for these kinds of gaps in a nation's infrastructure, Khanna explains, business groups can help foster entrepreneurship in a variety of ways. They can supply seed capital for budding entrepreneurs, when such capital is exceedingly scarce. Groups are also able to provide a variety of support activities and assist in the distribution and marketing of goods and services. And if an entrepreneur decides to sell the business, one group or another is often a willing and able buyer, a valuable "exit" option when public capital markets are underdeveloped. Perez Companc S.A., for example, is an Argentina-based group founded in 1946 whose activities span the borders of several South American nations. Its operations in numerous energy-related industries have done much to improve the economic infrastructure of that continent's emerging countries.

On the other hand, the close connections of some groups to a nation's power structure may serve as effective barriers to entry, preventing the flourishing of de novo entrepreneurship and stifling growth. "Through our ongoing work in Argentina and Brazil, as well as in several countries in Asia and Africa," Khanna says, "we want to determine when groups enhance entrepreneurship and when they deter it."

With assistance from the Instituto de Altos Estudios Empresariales (IAE), a leading graduate school of business and management in Buenos Aires, Khanna and HBS professor Pankaj Ghemawat have surveyed several aspects of the strategy and structure of business groups in Argentina. Their research on the role of the families controlling these groups focuses on the mechanisms of family intervention in company management that are effective in creating value.

In another project with HBS assistant professor Jan W. Rivkin that utilizes data on all publicly traded companies in Chile, Khanna has discovered that family ties in that country are so prevalent that they are not as useful as interlocking directorates and pyramidal equity structures in delineating business group boundaries. Furthermore, stock returns of group affiliates move in tandem even after equity relationships among them have been accounted for, suggesting that a variety of formal and informal mechanisms tie the fortunes of group affiliates together.

Although Khanna says there is still much to learn about business groups and how they affect economic development, the findings he and his colleagues have unearthed so far have important implications for leaders in three distinct areas. First, he points out, it is inappropriate for managers in developing countries to assume they can simply transfer American concepts and systems to their own economic settings and expect them to work the same way. For example, highly diversified organizations may work poorly in advanced economies like the United States, but they sometimes deliver superior value in certain emerging markets, where their scope allows them to leverage their own resources to compensate for deficiencies in the economic support system. Cash needed for investment purposes in one company in a grupo, for instance, can be internally generated by other parts of the organization. This can enhance value creation, especially when external capital markets are poorly functioning.

Second, Khanna's research suggests that the economic development that should be the overriding priority of policymakers in emerging markets cannot be achieved rapidly nor by government decree. After all, it took the United States a century to achieve its present level of development. Although a country like Bolivia, for example, might commit at some point to building a gleaming new stock exchange, the notion that this will translate quickly into smoothly functioning financial markets, in the absence of enabling institutions and intermediaries, is unrealistic.

Finally, agencies and multinational companies that operate in emerging economies should realize that the business environment they encounter in one developing country is likely to differ substantially in the next. Markets in Latin America and other emerging regions are not, in fact, cut from the same cloth.

Today, business groups thrive in many Latin American countries, while governments in other parts of the world respond to their presence in many different ways. Although some nurture their growth, others neglect them, and still others attempt to banish them entirely, wary of them as centers of concentrated power and wealth. While curtailing business groups may sometimes be politically expedient, the leaders of developing nations will provide a greater service in the long run, Khanna argues, by focusing instead on building the infrastructure required by an advanced economy.

About the Author

Peter Jacobs is a freelance business writer based in Wellesley, Mass. He can be reached at