Diversified business groups are better equipped to cope with uncertainty

Diversified business groups can help companies withstand economic shocks, new research finds.

Belonging to a diversified business group can help companies withstand economic shocks and thrive in the face of uncertainty, according to new research from Cass Business School, Ensae-Crest in Paris, and Bocconi and Statale Universities in Milan.

Coinsurance Between Firms: The Role of Internal Labor Markets by Dr Giacinta Cestone of Cass Business School and co-authors, Professor Chiara Fumagalli, Professor Francis Kramarz, and Professor Giovanni Pica, shows that a corporate network of companies controlled by a common owner provides stability and opportunity by absorbing members of one another’s workforce, in both prosperous and difficult times.

Diversified business groups make up the largest part of many economies in continental Europe, China and India amongst others. Examples include Samsung, Virgin and Tata, which all operate in multiple regions and industries. Leading financial service organisations such as Citigroup and HSBC are also structured as groups, with a holding company controlling a collection of legal entities operating in different countries.

The research finds:

  • Diversified business groups possess their own internal labour market. Often it functions in a horizontal fashion, with workers being reallocated across member companies in response to both positive and adverse shocks.
  • When faced with growth opportunities (e.g. following a major competitor’s exit) member firms heavily rely on their group’s internal labour market to expand their workforce. This effect is particularly strong for managers, engineers and other skilled human capital.
  • When times are tough for a member firm, forcing a mass layoff or a closure, more of its displaced workers are taken up by healthier firms in the same group than return to the general job market. This is particularly true when the adverse event hits a member firm subject to higher severance payments and firing costs.
  • Importantly, following a closure or a mass layoff, the fraction of the company’s former workforce that ends up unemployed is drastically lower in group-affiliated firms than in stand-alone companies.

Dr Giacinta Cestone, Reader in Finance at Cass Business School and author of the research, said: “Internal labour markets operate as a mutual insurance mechanism across member firms in diversified business groups, allowing them to mitigate firing and hiring costs when workforce adjustments are called for. This may contribute to explaining groups’ unique ability to thrive in the face of hurdles and opportunities. Internal labour markets also appear to provide job security to corporate groups’ employees.”

In light of the authors’ results, geographically diversified groups with a presence in both UK and Continental Europe can rely on their internal labour market to respond to the hurdles of a hard Brexit. If devoid of passporting rights and access to the common market, such groups can swiftly move valuable human capital to their EU subsidiaries. Smaller UK-only based companies would not be in a position to respond as promptly to the challenge.

The research used data which covers the universe of French firms (both private and listed), providing administrative (fiscal) data on balance sheets and income statements. This is combined with an administrative database of matched employer-employee information (based on mandatory employer reports of the earnings and the position of all employees subject to payroll taxes). This information allowed the researchers to follow all French workers as they moved from one firm to another.

Funded by the AXA Research Fund and the Leverhulme Trust, this research is unique because it examines firm-level data (profits, productivity, leverage), combined with data on workers’ movements and, uniquely, each business group’s precise structure.