Financially Interlinked Business Groups*

Maitreesh Ghatak and Raja Kali

Journal of Economics & Management Strategy, 2001, vol. 10, issue 4, 591-619

Abstract: 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.

Date: 2001
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