The Right Way to Restructure Conglomerates in Emerging Markets

Western financial institutions, consultants and academic advisors alike have often urged the breakup of the large, diversified business groups that dominate the private sector in many emerging economies. But a rush to dismantle these groups would be a mistake, say HBS Professors Tarun Khanna and Krishna Palepu.
by Tarun Khanna & Krishna Palepu

Western corporate strategies have long been held up as role models for businesses in emerging markets. The reaction to recent financial crises in Asia and Latin America has only served to reinforce this practice. The multilateral financial institutions, consultants, and academics that advise businesses and governments in emerging economies have all been pressing for a closer convergence of first- and third-world business models for the private sector. The details differ, but the advice boils down to the same thing in virtually every emerging economy: dismantle the diversified business groups that dominate the private sector. These include huge conglomerates such as the chaebol in Korea, the Tata Group in India, and the Koc Group in Turkey. The arguments for restructuring conglomerates are simple. Selling off assets could quickly reduce the huge debt some of these groups have built up. More fundamentally, though, breaking up these mammoth organizations could reduce their gross inefficiencies and promote greater entrepreneurship. Implicitly or explicitly, then, the Western financial community is encouraging business groups in emerging economies to unbundle their assets in the same way that companies in advanced economies did in the 1980s.

Although well intended, this advice is flawed. Behind the recommendation that business groups should be broken up to create more focused and efficient companies lies the notion that well-functioning markets can be mandated into existence. But our research, conducted in a broad range of emerging economies including those of Chile, India, and South Korea, demonstrates that even with the best intentions, it takes longer than a decade to build the kind of institutions that can support well-functioning markets for capital, management, labor, and international technology.

Rushing to dismantle the business groups that now fill these institutional voids could do more harm than good. It would simply reinforce the inefficiency of the private sector and may intensify social distress, which emerging economies are extremely ill equipped to handle. It also poses practical problems. For instance, how easy is it to estimate a reliable breakup value for a business group in the middle of a fire sale and in the absence of a well-developed market for asset sales?

But if dismantling business groups is not a sensible option, what should industry leaders and governments do instead? We believe the answer is to encourage business groups in the short term to pursue alternative internal reforms that improve their performance and their ability to substitute for market institutions. Governments in developing countries must focus on building up those market institutions in the long term. The dismantling of business groups will, we believe, follow naturally once those institutions are in place. Increasing competition will force the business groups to restructure themselves.

Of course, that's not to say the government plays no role in business reform. Any initiative to develop emerging economies must acknowledge that the business groups themselves may want to maintain the status quo. Those groups wield considerable economic and political power that can be used not only to block immediate attempts at dismantling them but also to stifle the longer-term development of markets and to work at cross-purposes with the government. But the government should focus on forcing only those reforms that are vitally necessary to build independent market institutions.