Causes for changing performance of the business groups in a transition economy: market-level versus firm-level factors in China

This article investigates longitudinal changes in the relative performance of business groups utilizing data on listed companies in China over a 10-year period (1994-2003). Using a measure of firm value in the stock market and panel regression methods, this article finds the initially superior and eventually worsening performance of group-affiliated firms compared with stand-alone firms. To explain the downward performance, this article considers several alternative hypotheses, namely, institutional development, increasing competition, diversification discount, agency costs from state-ownership, and agents asset diversion behavior. This article has found certain differences in the explanatory power of each hypothesis. While the institutional development hypothesis is somewhat weak, the increasing discount for unrelated diversification as well as serious agency costs revealed in asset diversion in the business groups can better explain the longitudinal decrease in the performance of business groups. We find that while diversification still creates values, its marginal contribution has decreased over time, and that while the state-ownership variable negatively affects the values of firms in general, it is not the cause of the worsening valuation of business groups.