Asia Pacific J Manage (2006) 23:467 483
DOI 10.1007/s10490-006-9011-6
Business group affiliation and firm performance
in a transition economy: A focus
on ownership voids
Xufei Ma & Xiaotao Yao & Youmin Xi
Published online: 14 December 2006
#
Springer Science + Business Media, LLC 2006
Abstract In a transition economy, how does business group affiliation make a difference in
firm performance? Under the broad label of institutional voids, what specific voids can
business groups fill? This paper addresses these questions by drawing on insights from
property rights theory and an institutional perspective. We argue that ownership voids, as a
subset of institutional voids, occur due to the lack of unambiguously specified ownership of
state assets in transition economies, and that business groups emerge to serve as the direct
owners of state-owned enterprises to replace such voids. Based on a sample of 1,119 publicly-
listed Chinese companies, we find that the interaction of business group affiliation and state
ownership has a significant and positive effect on firm performance. Our findings point to
business group s substitution role in filling ownership voids in China s transition economy.
. . . .
Keywords Business group Performance Property rights theory Institutional perspective
Transition economy
How does business group affiliation make a difference in firm performance? This question
has recently fascinated students of organization and strategy (Chang & Hong, 2000;
Khanna & Palepu, 2000a, 2000b; Khanna & Rivkin, 2001). One significant stream of
research, originated from institutional economics, conceives of business groups as
We thank Editors Mike Peng and Andrew Delios, the anonymous APJM reviewer, and the participants of
APJM Special Issue Conference on Conglomerates and Business Groups in Asia-Pacific for helpful
comments and suggestions on earlier versions of this paper. This research is supported by three grants from
the National Natural Science Foundation of China (No. 70472035, No. 70202003, and No. 7012001).
X. Ma ( )
Business Policy Department, NUS Business School, National University of Singapore,
1 Business Link, Singapore 117592, Singapore
e-mail: [e-mail]
:
X. Yao Y. Xi
Organization and Management Department, School of Management, Xi an Jiaotong University,
28 West Xianning Road, Xi an 710049 Shaanxi Province, China
X. Yao
e-mail: [e-mail]
Y. Xi
e-mail: [e-mail]
468 X. Ma et al.
responses to market failures and associated transaction costs (Leff, 1978). It is then well
received that business groups can serve as functional substitutes to fill the institutional voids in
emerging economies (Khanna & Palepu, 1997). However, under the well-known and broad
label of institutional voids, what specific voids can business groups fill in transition economies?
By addressing these questions, we seek to contribute to the business group literature in
two significant ways. First, we propose a new concept ownership voids to reflect the
true value of business groups in a transition economy where their role is to facilitate
economic reform and corporatization of the state-owned enterprises (SOEs) (Yiu, Bruton, &
Lu, 2005). We contend that micro-level evolution of business groups mirrors an emerging
economy s macro-level transition stage, while macro-level institutional arrangement, in
turn, affects micro-level firm performance (Peng, 2003; Peng & Luo, 2000).
We do not disagree with the insightful arguments on business groups function in
replacing institutional voids (Khanna & Palepu, 1997), but we go a step further by
considering the institutional context of transition economies, a subset of emerging
economies (Hoskisson, Eden, Lau, & Wright, 2000) experiencing institutional transitions
from centrally planned to market-based economic systems (Child, 1994; Peng & Heath,
1996; Yiu et al., 2005). Drawing on property rights theory (Alchian & Demsetz, 1972;
Barzel, 1989; Grossman & Hart, 1986) and institutional perspective (North, 1990; Peng,
2002, 2003), we see ownership voids as a subset of and complementary to the broader
notion of institutional voids. With a focus on ownership voids, we further explore how a
firm s business group affiliation impacts its performance in a transition economy.
Second, we shift the focus from examining whether business group affiliation matters to
studying how it matters to different types of firms (such as state-owned versus non-state-
owned firms), which is perhaps more meaningful. In this paper, we argue that group
affiliation is more critical to state-owned enterprises (SOEs) in China s transition economy.
This is so because business groups can be used by the government to make up for the lack
of unambiguous ownership among SOEs and to solve the consequent problems derived
from these ownership voids. For non-SOEs, such a performance improvement effect may
not exist because the ownership of these firms is relatively clear and the owners have
concrete rather than conceptual existence. In other words, business group affiliation may
matter more for SOEs in a transition economy. We believe that our emphasis on the
ownership type of firms can pave the way for future theoretical developments (Dubin,
1978; O Neil, Rondinelli, & Wattanakul, 2004; Peng, Tan, & Tong, 2004) and can serve as
an important step toward a complete picture of the role and value of business groups.
With these two objectives in mind, we choose China as the research setting to test our
hypotheses. Two compelling reasons justify this selection. China is a transition economy
having a different reform trajectory from its counterparts either in Eastern Europe or in
some other emerging economies in transition (Peng, 2003; Peng & Heath, 1996).
Meanwhile, business groups have played critical roles, received tremendous government
support, and been utilized as a tool to facilitate reform in China s ongoing institutional
transition period (Gupta & Wang, 2004; Keister, 2000; Yiu et al., 2005).
Background
Business groups in emerging economies
Having a rapid pace of economic development with government policies favoring
economic liberalization and the adoption of a free-market system, emerging economies
Business group affiliation and firm performance in a transition economy 469
are assuming an increasingly prominent position in the world (Wright, Filatotchev,
Hoskisson, & Peng, 2005). One important form of business organizations in many
emerging economies and Asian countries is business group (Ahlstrom & Bruton, 2004;
Guillén, 2000; Khanna & Rivkin, 2001). As to the definition, Khanna and Rivkin (2001)
propose that a business group is a set of firms which, though legally independent, are bound
together by a constellation of formal and informal ties and are accustomed to taking
coordinated action.
A key research inquiry in the business group literature is the relationship between group
affiliation and firm performance. Economics-based viewpoint has the dominant explanatory
power: because in emerging economies institutions are often under-developed and have led
to increased costs of doing business (North, 1990), business groups can play the
substitution role to fill the institutional voids such as the lack of intermediaries in product,
labor, and capital markets (Khanna & Palepu, 1997). Business groups are critical in
emerging economies and the ubiquity of business groups suggests that they may affect the
economic performance of group-affiliated members in these economies, either generating
benefits for or imposing costs upon members.
For example, Chang and Choi (1988) demonstrate that firms under the Korean chaebol
umbrella outperformed independent companies, and Khanna and Palepu (2000a, 2000b)
provide the evidence that group membership was associated with the superior profitability
of member firms in India and Chile. By amassing data from 14 emerging economies,
Khanna and Rivkin (2001) find that the profits of business group affiliates were higher than
otherwise comparable unaffiliated firms in six countries, though the group affiliates profits
were lower in three with no significant difference in the remaining five.
According to an institutional perspective, institutional transitions in emerging economies
are  qualitatively different from industry-specific changes in the West (Newman, 2000)
and the pace and source of these transitions have varied dramatically (Peng, 2003). Recent
work in the business group literature has begun to highlight how institutional characteristics
and the environment of transition economies intersect (Keister, 1998; 2000, 2001; Lee,
Peng, & Lee, 2007; Yiu et al., 2005).
As pointed out by Khanna and Rivkin (2001), the roots of sustained differences in group
affiliation firm performance relationship may vary across institutional contexts. The fact
that emerging economies are hardly uniform (Hoskisson et al., 2000; Khanna & Palepu,
1997; Wright et al., 2005) suggests that the value and the role of business groups may well
depend on the institutional contexts in which they are embedded (Khanna & Rivkin, 2001;
Kim, Hoskisson, Tihanyi, & Hong, 2004). Therefore, it is useful to extend the inquiry on
the business group affiliation firm performance relationship to transition economies.
Business groups in China s transition economy
Similar to many other emerging economies, China falls short in a number of ways to
provide a range of formal institutions to facilitate the functioning of markets. As a result,
business groups have emerged by filling these institutional voids and they currently
contribute approximately 60% of the nation s industrial output (Yiu et al., 2005). In an
effort to explore the distinct role played by Chinese business groups, however, we also need
to look at the unique state of China s institutional environment it is not only a fast
growing emerging market but also a transition economy (Li, Sun, & Liu, 2006; Peng &
Heath, 1996).
Indeed, China has chosen a gradualist policy, meaning that corporatization rather
than privatization of the state-owned enterprises is one of the major objectives of its
470 X. Ma et al.
economic reform (Keister, 2000; Li & Wong, 2003; Peng, 2004). Since the state embarked
on the ownership reform (Child, 1994), Chinese firms with diverse ownership types can
further be classified into two major types: SOEs and non-SOEs (Delios, Wu, & Zhou, 2006;
Peng, 2004). For Chinese listed companies, the focus of this study, they are joint-stock
companies transformed from traditional SOEs or non-SOEs (Li & Wong, 2003; Peng,
2004).
As a firm s group affiliation is concerned, if its largest shareholder is a particular
business group, the firm should be regarded as this group s affiliate. Further, consistent with
the ownership type classification, a Chinese listed company s largest shareholder is
considered as state-owned if it falls in one of the following three  state-owned categories:
government agencies, state-owned non-group enterprises, or state-owned business groups.
It is of particular interest to note that business groups in state-owned sectors are not only the
 product of policy inducement, as found in Korea s emerging economy (Chang & Hong,
2000), but also the instrument used by the Chinese government to facilitate institutional
transition and ownership reform (Ma & Lu, 2005; Yiu et al., 2005).
Theory and hypotheses development
Direct effects of group affiliation
In China, business groups are coalitions of firms from multiple industries that interact over
long periods of time and that are distinguished by elaborate inter-firm networks of lending,
trade, ownership, and social relations (Keister, 2000). This description indicates that group-
affiliated companies performance is shaped by two sets of factors: the sharing of group-
based resources/liabilities and various forms of intra-group business transactions (Chang &
Hong, 2000). We show in this section how the benefits and liabilities simultaneously
influence affiliates performance in China s transition economy.
The benefits of group affiliation An affiliated firm can share a group s reputation capital
simply by being associated with a prestigious business group (Chang & Hong, 2000; Peng,
Lee, & Wang, 2005). Group-based reputation capital may help the affiliated firms in
achieving sustained superior performance (Barney, 1991). Financial resources are also
critical to firm s performance in an emerging economy. Like many other emerging
economies, China s financial intermediaries are either absent or not fully evolved (Khanna
& Palepu, 1997). Under this situation, insider lending appears to substitute for a formal
financial system and to give firms access to otherwise scarce capital where markets are
inadequate at allocating funds (Keister, 2001). In addition, selling and purchasing of
intermediate and final goods through internal trading networks or via credit-extension
activities is prevalent in Chinese business groups (Keister, 2001). With extensive vertical
transactions internalized within the business groups, the affiliates may be more likely to
access raw material and intermediate goods (Khanna & Rivkin, 2001).
The above analysis points to the various benefits of being a business group member.
Moreover, group affiliates may have guanxi-based competitive advantages, which are still
important, even in China s transition economy (Chen & Chen, 2004; Peng & Zhou, 2005;
Tang & Xi, 2006). Within a business group, group members usually have strong and long-
term interorganizational guanxi to make use of the internalized markets less expensively but
more extensively than their non-group counterparts. Furthermore, business groups often
embrace superior political capital to receive considerable external support from the
Business group affiliation and firm performance in a transition economy 471
government (Peng et al., 2005), which may spill over to the affiliates and generate higher
financial returns. The above arguments lead us to the following hypothesis:
Hypothesis 1a In China s transition economy, a firm s business group affiliation has a
positive effect on its performance.
The costs of group affiliation Though affiliates can enjoy group-based benefits, we
acknowledge theoretical arguments and prior studies that present the other side of group
membership: affiliates may suffer from the liability of business group affiliation (Isobe,
Makino, & Goerzen, 2006). For example, belonging to business groups with a bad
reputation comes to be a liability rather than an asset to the affiliates and the affiliates
performance will be jeopardized rather than improved (Chang & Hong, 2000). Similarly,
guanxi-based lending in commercial activities is common in China s transition economy
and may temporarily mitigate the pressure of the affiliates cash flow pressure, but this also
is one of the major sources of endless  triangular debts within a Chinese business group
and will have a negative impact on the performance of the affiliates offering such lending to
other members (Peng & Luo, 2000).
In sum, these discussions suggest that group membership may be costly in China s
transition economy. Following Khanna and Rivkin s (2001) arguments on the costs of
group affiliation found in other emerging economies, we suggest a competing hypothesis:
Hypothesis 1b In China s transition economy, a firm s business group affiliation has a
negative effect on its performance.
The interaction effect of state ownership status and group affiliation
According to the institution-based view of firm (Peng, 2002), we argue that in China s
transition economy, business group affiliation s equivocal impact on firm performance may
to a large extent be attributed to the heterogeneity of ownership types, a remarkable feature
of China s institutional context. As pointed out by Boisot and Child (1996), at the society
level, China has been experiencing the transition from a planned economy to a market
economy, while at the firm level, the shift of ownership and property rights of the SOEs has
served as a major stimulus for China s economic reform.
Herein, we extend the work of Yiu and colleagues (2005) in that state-owned business
groups have been used by the government as a tool of ownership reform, an intermediary
institution to facilitate the enterprise restructuring, and an instrument to smoothen
organizational transformation in China. Building on the insights from property rights
theory, we elaborate how the interaction of a firm s group affiliation and ownership type
affects its performance.
A focus on ownership voids Property rights are the set of economic and social relations
defining the position of each individual with respect to the utilization of scarce resources
(Furubotn & Pejovich, 1974). At the macro level, the understanding of property rights refers
to the legal system, social norms, and the economic mechanism (Alchian, 1965; Alchian &
Demsetz, 1972). At the micro level, property rights theory (Barzel, 1989; Demsetz, 1983;
Grossman & Hart, 1986) attempts to answer the question of how the structure of property
rights evolves in response to individual incentives and behavioral patterns subject to
institutional arrangements. In a nutshell, this literature suggests that the right of ownership,
as a sub-category of the general concept of property rights, really matters (Peng, 2000).
472 X. Ma et al.
Prior research has suggested that ownership type can be a parsimonious and important
variable for organization and management research to explore the institutional character-
istics of emerging economies in transition (O Neil et al., 2004; Peng et al., 2004). In the
Chinese concept, SOE property is owned by the state and hence belongs to all the citizens.
Although this concept has been deeply embodied in Chinese economy for more than half a
century, its precise meaning is not clearly defined in theory and practice.
Property rights theory suggests that the owners of SOEs all the citizens of the nation in
which the SOE is situated are symbolic and actually powerless, and hence they have no
real rights to collect income generated from the property (Furubotn & Pejovich, 1974). As a
result, although the owners of Chinese SOEs are essentially the 1.3 billion citizens of
China, in reality, these owners have no incentives to manage, control, use, transfer, or sell
the property. Under this situation, ownership voids occur due to the lack of unambiguously
specified ownership of the state assets in China s transition economy (Peng, 2000).
Given these inherent ownership voids, traditional SOEs are ultimately managed and
supervised by government agents, who are not the owners of these state assets but can
claim themselves as representing the state, intervene in the firm on behalf of  all citizens,
and pursue their private benefits at the expense of the citizens (Qian, 1996; Shleifer &
Vishny, 1997). Based on the case studies of three Chinese SOEs, Steinfeld (1998) pointed
out that one of the vital problems of the SOEs is a lack of legally clear and enforceable
property rights. Consequently, it may be the innate ownership voids that are largely
accounting for the widespread SOE performance problems in China s transition economy
(Child, 1994; Peng, 2004; Shenkar & von Glinow, 1994).
Business groups as a solution Ownership voids, pertinent to transition economies, can be
regarded as a subset of the broad notion of institutional voids prevalent in emerging
economies. Similar to the business groups function in replacing institutional voids,
economic theory predicts that private enterprises if allowed to enter would step in to
substitute the ownership voids. Different from other emerging economies, the Chinese
government plays a determinant and proactive role in ownership reforms by preventing the
private sector to play a major role. There is not much privatization in China. Instead, the
state has found and implemented a tentative solution to restructure corporate ownership,
retain control in state assets, and transfer government shareholding into legal persons or
corporate shareholdings (Qian, 1996; Xu & Wang, 1999). Given that the first step needed in
dealing with ownership issues of SOEs is to clarify ownership rights, the Chinese
government is following the gradualist logic for the ownership reform (Li, 1997).
Subsequently, the actual ownership role of SOEs can be exercised by different levels of
government agencies and various forms of companies. In order to avoid the chaos caused
by shock therapies in Russia and Poland (Peng, 2003), the government has encouraged the
formation of business groups and used them to fill the ownership voids. That is, business
groups were  created to serve as the second-order but direct owners of Chinese SOEs in
the institutional transition and ownership transformation processes.
In light of business groups function of filling the ownership voids due to their
institutional traits that are distinct from those of other types of state-owned shareholdings
(i.e., government agencies or non-group SOEs), we expect business groups to play a more
important role in the corporate governance and hence to positively impact the performance
of state-owned listed companies in China s transition economy.
The clear-cut distinction between a business group and a government agency is that the
group is an economic entity with economic-oriented goals, while the government agency
has multiple agenda including both economic and political goals such as employment,
Business group affiliation and firm performance in a transition economy 473
development, and stability (Walder, 1994). Moreover, business groups are subject to hard
budget requirements, while government agencies often have the  soft budget constraint
(Kornai, 1986) contributing to the inefficiency of the business operations. Although
business groups are still state-owned, they have the autonomy and are constrained by
hardened budget to make strategic choices on key business decisions, a mission impossible
to government agencies. Consequently, the group, as the direct owner of the affiliated firm,
has greater incentive to exercise ownership power to closely monitor the managers, a
critical factor to firm performance (Demsetz, 1983; Jensen & Meckling, 1976; Shleifer &
Vishny, 1986).
As far as state-owned non-group enterprises are concerned, some of them are actually
asset management institutions. An asset management institution is a quasi-government
agency that has a mandate to prevent state assets from being lost during the transition from
state to private-ownership. With this function, our arguments can also apply to state-owned
asset management institutions.
Meanwhile, for other types of non-group firms, we can identify how business groups
have the ability to fill the ownership voids. Indeed, from the very beginning of China s
economic reform, business groups rather than any single companies were empowered to
develop their own strategic plans, set up finance companies to raise capital, and decide the
composition of the management teams of member firms (Keister, 2000; Lu & Yao, 2006).
Through learning by doing, groups have developed greater capability and more experience
than non-group enterprises to monitor subsidiary managers. Further, a group usually has
rich human capital and may be able to select more qualified directors to sit on the board of
listed companies or more competent managers to operate affiliated firms businesses
(Keister, 2000; Khanna & Palepu, 1997; Peng, 2004).
As shown in Figure 1, we contend that due to the institutional arrangements of China s
transition economy, state-owned business groups, compared to government agencies or
non-group SOEs, have direct rights to collect economic income generated from the property
of their affiliated companies. Moreover, state-owned business groups have greater
State
Ownership Voids
Government Agency Non-Group Enterprise Business Group
(Lack of incentives (Lack of capability (Filling Ownership Voids)
to fill ownership voids) to fill ownership voids)
Non-Group-Affiliated Group-Affiliated
SOEs SOEs
Figure 1 Business group s substitute role in filling ownership voids
474 X. Ma et al.
incentives and capability to closely and effectively monitor managers of the group
members, and thus can play a more critical role to fill the ownership voids for their state-
owned affiliates.
In other words, for the state-owned sectors, business groups embrace aforementioned
unique institutional traits to be more related with the institutional arrangement of China s
transition economy to facilitate property reform and control the affiliates (Peng et al., 2005).
The institution-based view of the firm (Peng, 2002) further suggests that such an
institutional relatedness will lead to superior firm performance in the corresponding
institutional context. In contrast, as the ownership of non-SOEs is better defined, the above
logic on ownership voids may not hold for these firms. Taken together, we have the
following hypothesis:
Hypothesis 2 In China s transition economy, the interaction of a firm s business group
affiliation and state ownership status has a positive effect on firm performance.
Methods
Sample and data sources
As suggested by Yiu and colleagues (2005), a single-country study appears to be a sensible
approach to examining the comparative performance of business group affiliated firms and
independent firms, as it eliminates the confounding effect of different economies.
Accordingly, we used a sample of China s publicly-listed companies. Although the
arguments in the hypotheses development section are not confined to the case of publicly
listed companies, a sample of Chinese listed companies is advantageous in at least two
ways. Given the difficulty of data collection in emerging economies (Wright et al., 2005),
on the one hand, we believe that the information of listed companies is the most consistent,
accurate, and transparent among the information available for Chinese firms. On the other
hand, the sample of Chinese listed companies consists of different types of firms (including
SOEs and non-SOEs, group-affiliated and non group-affiliated), which is a necessary
source of variance to test our hypotheses.
A listed company in China may issue five different types of shares on either the
Shanghai or Shenzhen Securities Exchanges: state shares, legal person shares, staff shares,
A shares and B shares (Li & Wong, 2003; Xu & Wang, 1999). In addition, it may issue
shares in Hong Kong (H shares) and on overseas exchanges. According to the regulations
of the China s Securities Regulatory Commission (CSRC), state shares and legal person
shares are not tradable to the stock market, A-shares are tradable but exclusively available
to domestic investors, B-shares are issued only to attract foreign portfolio investors, H-
shares are shares of mainland Chinese enterprises listed on the Hong Kong Exchange, and
staff shares can become A-shares once sold on the market.
We derived the basic sample from the official websites of the Shanghai and Shenzhen
Stock Exchanges as well as listed companies annual reports and websites. Furthermore, to
complement the necessary variables of each company, such as the shareholder identity,
equity share distribution, and product segments, we also referred to other databases
including CSMAR, Bloomberg, Datastream, and Worldscope. We consulted these data
sources when there was inconsistency or when there were missing data. By doing so, we
were able to increase the data reliability and completeness.
Business group affiliation and firm performance in a transition economy 475
We analyzed data from annual reports of Chinese listed companies in 2004. By the end
of 2004, there were 1,377 publicly listed companies in the two stock exchanges. Because
the presence of foreign shareholders would significantly influence a listed company s
corporate governance and performance in emerging economies (Khanna & Palepu, 2000b),
and because the companies having three consecutive years of net profits are eligible to issue
shares to foreign investors according to the regulations of CSRC, we only included those
having no B shares and H shares in our sample. Further, newly listed companies which
conducted their IPOs in 2004 were excluded because their performance information is
actually used for listing purposes. Finally, we obtained a sample comprising 1,119 Chinese
listed companies with their information of the year 2004.
In our study, we used two authoritative and complementary sources to identify a listed
company s group affiliation. One source is from the lists provided by different levels of State-
owned Assets Supervision and Administration Commissions (SASAC). The other source is
from China s Largest Business Groups 2004 (NSBC, 2004a), which was published by the
National Statistics Bureau of China (NSBC). This directory is the most authoritative and
publicly available source of data on Chinese business groups because NSBC is compared to
the Securities and Exchange Commission in the United States (Yiu et al., 2005).
We believe that the methods used here to identify a listed company s group affiliation are
appropriate for our study. Due to the ambiguity in definition and the relatively low capital
requirement for registration, the actual number of groups registered at all government levels
grew very rapidly in China (Nolan, 2001). In fact, most companies were just renamed as
groups in the absence of any real structural change. More importantly, many so-called
business groups have received little institutional support from the state, a critical resource to
firms in a transition economy. In other words, those not covered by our two business group
data sources can hardly be theoretically and empirically considered as  true groups.
The main source we used to identify whether a listed company s largest shareholder is
state-owned or non state-owned is a database developed by the State Information Center of
China (SIC). SIC is directly under the State Development and Reform Commission and
currently its database contains information on about 270,000 Chinese firms. This is
currently the largest official database on China s companies. The information provided
includes the identity, ownership type, detailed locations, and websites of these firms.
Dependent variable
Tobin s Q Consistent with previous studies (Wernerfelt & Montgomery, 1988; Khanna &
Palepu, 2000b) we used a Tobin s Q measure of performance. Given the difficulty of
determining the replacement value of assets in China s economy, we defined Tobin s Qas
the ratio of the sum of the market value of equity and the book value of liabilities to the
book value of a firm s assets. Tobin s Q is particularly preferred to purely accounting-based
performance measures (e.g., ROA, ROE or ROS) because the latter are easily manipulated
by listed companies in China s transition economy.
Independent and control variables
Group affiliation Following prior studies on business group affiliation (Filatotchev, Lien, &
Piess, 2005; Ramaswamy, Li, & Petitt, 2005; Wang, Huang, & Bansal, 2005), we used an
indicator variable to indicate whether a Chinese listed company is affiliated with a
particular business group. The indicator variable took a value of 1 if the listed company is
affiliated with a business group, 0 otherwise.
476 X. Ma et al.
State ownership status We also used an indicator variable to identify whether a listed
company s largest shareholder is state-owned or non state-owned (O Neill et al., 2004). The
indicator variable took a value of 1 if the listed company s largest shareholder is state-owned.
Shanghai stock exchange In principle any company going public can be listed on either
Shanghai or Shenzhen Stock Exchange, but in fact this is strongly influenced by local
governments (Li & Wong, 2003; Xu & Wang, 1999). We used a dummy variable to control
for the geographic stock exchange effect with 1 representing Shanghai Stock Exchange.
Provincial GDP per capita As pointed out by Naughton (1995), each emerging economy is
likely to be  multiple emerging markets because economic and social development stages
greatly differ by regions. We then used each province s per capita GDP as a proxy for
regional differences of these listed companies headquarters locations. This information was
from China Statistical Yearbook 2004 (NSBC, 2004b).
Years of listing Because it usually takes time for a Chinese firm to become familiar with the
operation of a publicly listed company, we controlled for years of listing, measured as the
number of years (till 2004) since a company was publicly listed.
Firm size Firm size is an important factor which may exert a strong impact on a firm s
performance (Wu & Choi, 2004). We used the natural logarithm of the listed company s
annual sales (in yuan 10,000) as our measure of firm size.
Leverage Because capital structure is found to be significantly correlated with firm
performance (Chang, 2003) and more importantly, because the debt problem (e.g.,
triangular debt) is a significant issue in China (Peng & Luo, 2000), we introduced the
leverage (i.e., the ratio of total debt to equity) as a proxy for capital structure (Lin, Er, &
Kwok, 2005).
Industry fixed effects The existing literature shows that industry effects may be determinant
to firm s market value under some conditions and may account for the majority of
explained variance of Tobin s Q (Schmalansee, 1985). Particularly, industrial influences
should be prominent in China s institutional transitions, even after China s accession to the
WTO in 2001. Therefore, we included fixed effects for industry to control for the 22
industries identified by the CSRC.
Ownership concentration This is the first of four measures of corporate governance
mechanisms that we used as additional control variables. Consistent with prior studies (La
Porta, Lopez-de-Silanes, Shleifer, & Vishny, 1998), we defined ownership concentration as
the percentage of shares held by the three largest shareholders concentration a firm.
Institutional ownership Prior research suggests that institutional ownership matters to firm
performance (Ramaswamy et al., 2005; Tihanyi, Johnson, Hoskisson, & Hitt, 2003). We
used the proportion of stock owned by institutional investors as its measure.
Managerial ownership Since managerial ownership provides the top management
incentives to be in alignment with the shareholders (Jensen & Murphy, 1990), we used a
dichotomous variable to indicate whether top management team members were holding the
company s shares. The dichotomous variable took a value of 1 if they were holding shares.
Table 1 Descriptive Statistics and Correlationsa,b.
Variables Mean s.d. 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11.
1. Tobin s Q 1.21 0.46
2. Shanghai Stock Exchange 0.62 0.49 -0.005
3. Provincial GDP per capitac 9.63 0.61 0.057 0.216
4. Years of listing 6.36 2.96 .150 -0.238 0.148
5. Firm size (sales)c 11.24 1.32 -0.276 0.047 0.208 -0.047
6. Leverage 1.61 9.71 -0.029 0.050 0.012 0.002 0.030
7. Ownership concentration 0.55 0.14 -0.138 0.072 -0.012 -0.340 0.155 -0.032
8. Institutional ownership 0.01 0.03 0.056 0.058 0.061 -0.141 0.292 -0.008 0.052
9. Managerial ownership 0.25 0.43 0.003 -0.510 -0.152 0.148 0.017 -0.051 -0.096 -0.015
10. Outside directors ratio 0.34 0.05 0.011 -0.014 0.054 -0.002 -0.045 0.050 0.012 0.005 -0.025
11. State ownership status 0.68 0.47 -0.100 -0.095 -0.002 -0.041 0.198 -0.022 0.202 0.038 0.071 -0.128
12. Business group affiliation 0.67 0.47 -0.132 0.058 0.076 -0.083 0.253 -0.062 0.236 0.075 -0.079 -0.008 0.150
a
N = 1,119.
b
Pearson correlations are significant at the 0.05 level (two-tailed test) at |0.06|.
c
Logarithm.
Business group affiliation and firm performance in a transition economy
477
478 X. Ma et al.
Outside directors ratio Corporate governance literature indicates that outside directors may
affect firm performance (Peng, 2004). We used the ratio of outside directors to board size as
the measure (Tihanyi et al., 2003).
Results
We utilized OLS regressions to test our hypotheses. Prior to the statistical analyses, we
conducted preliminary assessments to make sure our data set satisfies basic statistical
assumptions. With a reasonably large sample size of over 1,000 firms (n = 1,119), the
matrix shows no substantial problem with multicollinearity among the independent
variables and control variables (Li & Wong, 2003; Ramaswamy et al., 2005).
Table 1 presents the descriptive statistics and correlation matrix for the study s variables.
The descriptive statistics show that 67% of these 1,119 listed companies are group-
affiliated. The average Tobin s Q is 1.21.
Table 2 Results of OLS Regression Analysis for Tobin s Q of Chinese Listed Firmsa.
Variable Model 1 Model 2 Model 3
1. Constant 1.86*** (0.26) 1.81*** (0.26) 1.98*** (0.26)
2. Shanghai Stock Exchange 0.02 (0.03) 0.02 (0.03) 0.02 (0.03)
3. Provincial GDP per capitab 0.08** (0.02) 0.08*** (0.02) 0.08*** (0.02)
4. Years of listing 0.02*** (0.01) 0.02*** (0.01) 0.02*** (0.01)
5. Firm size (sales)b -0.12*** (0.01) -0.12*** (0.01) -0.12*** (0.01)
6. Leverage -0.00 (0.00) -0.00 (0.00) -0.00 (0.00)
7. Ownership concentration -0.16 (0.10) -0.13 (0.10) -0.15 (0.10)
8. Institutional ownership 2.69*** (0.48) 2.70*** (0.48) 2.71*** (0.47)
9. Managerial ownership 0.02 (0.04) 0.01 (0.04) 0.02 (0.04)
10. Outside directors ratio -0.15 (0.24) -0.15 (0.24) -0.13 (0.24)
11. State ownership status -0.02 (0.03) -0.01 (0.03) -0.15** (0.05)
12. (H1a/H1b) Business group affiliation -0.05+ (0.03) -0.19*** (0.05)
13. (H2) State ownership status × 0.22*** (0.06)
Business group affiliation
R2 0.16 0.16 0.17
Adjusted R2 0.13 0.13 0.14
F 6.50*** 6.41*** 6.73***
"R2 0.00 0.01
F for "R2 0.52 2.54***
Number of firms in sample 1,119 1,119 1,119
a
Cell entries are unstandardized coefficient estimates;
numbers in parentheses are standard errors;
coefficient estimates for industry fixed effects are not reported.
b
Logarithm.
+
p < 0.10.
*p < 0.05.
**p < 0.01.
***p < 0.001.
All two-tailed tests.
Business group affiliation and firm performance in a transition economy 479
We tested our hypotheses in three regression models. The results of these regressions are
displayed in Table 2. All models were significant.
Model 1 is the baseline model which has all the control variables. Model 2 tested the
main effect. The result presents that group affiliation had a negative effect on firm
performance and this relationship was slightly significant (p < 0.10). The F statistic for the
incremental change of R2 shows the comparison between unconstrained regression model
(Model 1) and constrained one (Model 2). The inclusion of group affiliation (Model 2) does
not explain significantly more variance in the dependent variable than Model 1, the basic
control model. Taking into consideration the individual effect and incremental change, the
results show that neither Hypothesis 1a nor Hypothesis 1b is supported.
Model 3 tested interaction between state ownership status and group affiliation. Before
the interpretation of the interaction effect, we first checked the overall change in model fit
using the F statistic to see whether the inclusion of the interaction term significantly
improved model fit. The statistical result shows that the addition of the interaction term in
Model 3 added 1 percent ("R2 = 0.01, F = 2.54, p < 0.001) to the explained variance
obtained in Model 2 (the baseline model for Model 3). In Model 3, group affiliation had a
significant and negative effect on firm performance (p < 0.001), partially supporting the
prediction of Hypotheses 1b. However, the interaction between state ownership status and
group affiliation led to better performance and this effect is statistically significant (p <
0.001). Our Hypothesis 2 receives strong support.
To gain further insight into the significant interaction effect, we constructed Figure 2
based on the results of Models 3. Figure 2 depicts the interaction between group affiliation
and the firm s largest shareholder s state ownership status. Support for H2 is shown by the
difference of Tobin s Q between group affiliates and non-group affiliates. The histograms
clearly exhibit that for state-owned companies, group affiliates have better performance
than non-group affiliates, while for non state-owned sectors, the group-affiliated firms have
worse performance than independent ones.
1.5
1.4
1.3
1.2
1.1
1
Non-state owned State-owned
Non-group affiliates Group affiliates
Figure 2 Interaction of group affiliation and state ownership status
Tobin's Q
480 X. Ma et al.
Discussion and conclusion
In this paper, we seek to add to prior research by paying much closer attention to the
institutional environment where business groups and their affiliates are embedded. To do
so, we extend the group affiliation firm performance relationship to transition economies, a
subset of emerging economies, to theoretically analyze and empirically test the role of
business groups and the value of group affiliation during institutional transitions.
In particular, we apply the property rights theory to business group research. We have
conceptualized business groups as substitutes not only for institutional voids in emerging
economies in general, but also for ownership voids in transition economies in specific.
Though business groups filling function is utilized mainly by firms as a response to market
imperfections or less munificent intuitional conditions in emerging economies, their
substitution role in transition economies is achieved as a tentative solution by governments
to corporatize the SOEs.
Thanks to this macro-level institutional arrangement, state-owned firms have had
business groups as their own unambiguous owners to exercise the property rights.
Moreover, as market-oriented organizations, business groups have the incentives and
capabilities to monitor and supervise the managers of their affiliates. In other words,
business groups role of filling ownership voids is at least as important as that of
substituting institutional voids in the state-owned sectors of transition economies.
Therefore, future research on business groups in other emerging economies and in the
Asia Pacific region may examine more specific functions of the business groups under
different institutional contexts (Ahlstrom & Bruton, 2004; Kim et al., 2004; Peng, 2002).
By and large, our hypotheses received good support in a sample of 1,119 Chinese listed
companies, which has theoretical and empirical implications. On the one hand, the most
important findings in our study are the significant interaction effect of group affiliation and
state ownership status. As predicted, group affiliation can more effectively improve
performance when this firm s largest shareholder is state-owned. These findings support our
theoretical arguments on group s role to fill ownership voids. The results indicate that
though this solution to the inefficiency problem of SOEs is probably neither optimal nor
thorough, it has worked reasonably well in China s gradualist institutional transition.
On the other hand, we found that the direct relationship between group affiliation and
firm performance is negative in the full model but not very significant in the partial model.
That is, the direct relationship is still not clear, as indicated by previous literature. Our
explanations for this phenomenon were based on the intricate networks of internal
transactions. However, the equivocal group affiliation firm performance linkage found in
this study and most prior studies further shows that the interaction effect rather than the
direct relationship is more useful or helpful in our understanding of the benefits and costs of
business group affiliation in emerging economies.
The most notable limitation in this study is that we derived our empirical results from a
sample of listed companies in China s transition economy, giving rise to the concern on the
generalizability of our findings. We believe that our findings are applicable to other
emerging economies which are experiencing institutional transitions from a planned to a
market system and where business groups are prominent. However, future research should
explore new institutional context, introduce some unexplored moderating factors, and
scrutinize other dimensions of firm performance like innovation and productivity (Carney
& Gedajlovic, 2003; Mahmood & Mitchell, 2004). Another limitation is that although the
cross-sectional analysis enabled us to precisely catch a particular point in China s
institutional transition, researchers may want to consider using a longitudinal panel design
Business group affiliation and firm performance in a transition economy 481
to tease out how specific changes in the institutional and economic environment influence
the relationship between group affiliation and firm performance (Lee et al., 2007).
Despite these limitations, this study extends the research on group affiliation firm
performance relationship to the context of institutional transitions and contributes to the
business group literature in that we go beyond well-received institutional voids argument by
highlighting the notion of ownership voids, and in that we shift the focus from testing direct
relationship to the interaction effect by examining the value of group affiliation in China s
transition economy. In light of the fact that the role of business groups and the value of group
affiliation vary across different institutional environments, organizational contexts and
ownership types, it seems imperative for scholars to use a multi-level approach and draw
upon rich insights of other research streams when investigating this fascinating topic 
group affiliation and firm performance relationship.
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Xufei Ma is currently a doctoral candidate in strategic management and international business NUS Business
School, National University of Singapore. His research interests include multinational firms' host country
strategy/structure in emerging markets, the internationalization of Chinese firms, and business groups in
China's transition economy.
Xiaotao Yao is an associate professor of strategy and organization at the School of Management, Xi an
Jiaotong University, China. His research focuses on corporate strategies, social ties/capital in China s
transition economy, the cross-level transformation mechanisms from individual social ties/capital to firm and
inter-firm strategic actions and competitive advantages, and the applicability of performance appraisal
methods across different cultures.
Youmin Xi is a professor of management at the School of Management, Xi an Jiaotong University, China.
His research concerns the strategies and structures of Chinese business groups, organizational trust, and
leadership. He currently is also highly devoted to the construction of a China-grounded management theory
by drawing on both the Western management theories and Chinese management philosophy.