Financially Interlinked Business Groups*
Maitreesh Ghatak () and
Journal of Economics & Management Strategy, 2001, vol. 10, issue 4, 591-619
Financial interlinkage, in the form of cross-holding of equity and debt between firms, characterizes business groups in many countries. We suggest that such financial interlinkage can be viewed as a way to solve credit rationing caused by asymmetric information. If firms possess better information about each other than a bank, then business groups can be a mechanism to induce firms to sort on the basis of this information. Banks can offer a menu of contracts that vary in the extent of financial interlinkage to induce firms to self-select on the basis of the equilibrium composition of the business groups they can form. Copyright (c) 2001 Massachusetts Institute of Technology.
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