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Diversified business groups better placed to withstand Brexit challenges

Corporate networks of companies controlled by a common owner are better able to respond to both adverse and positive shocks

by Amy Ripley (Senior Communications Officer)

Consider a UK-based group running two companies active in different sectors. One unit sourcing vital inputs from the EU, the other completely shielded from the impact of Brexit, even possibly benefitting from a weaker pound. How is this diversified group going to manage its workforce in the aftermath of Brexit? How will more focused competitors cope with the shock? A recent paper by Dr Giacinta Cestone of Cass Business School may have some of the answers.

Insurance Between Firms: The Role of Internal Labor Markets shows that corporate networks of companies controlled by a common owner are better able to respond to both adverse and positive shocks when compared to their stand-alone rivals. This is because, the paper shows, groups actively run internal labour markets: they reallocate workers across member firms (subsidiaries) whenever these face shocks.

Diversified business groups essential to large European economies

Diversified business groups make up the largest part of many economies in Europe, China and India amongst others. Examples of such groups 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 network of legal entities operating in different countries.

The research shows that when business conditions deteriorate in a sector, groups move workers away from their adversely hit units, towards better performing units active in growing sectors. The flip side of this story is that group subsidiaries facing an unexpected growth opportunity seem to expand faster than their stand-alone competitors. Indeed, “group subsidiaries draw on the skilled human capital of their affiliates rather than undergoing a costly search and hiring process on the external job market.”

Internal labour markets help organisations adapt to complex challenges

Dr Cestone said the research confirmed that internal labour markets are vital for organisations’ ability to adapt to complex challenges.

“From a human capital management perspective, diversified groups are better placed to cope with a major shock like Brexit, that will severely hit some sectors while possibly benefitting others. Focused, stand-alone companies do not enjoy the same flexibility to manage their workforce: in the presence of labour market frictions, their ability to adjust to Brexit can be limited.”

“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,” she added.

Internal labour markets may provide job security for skilled employees

Dr Cestone also noted that internal labour markets within UK-based groups may provide some job security to their most skilled employees. Geographically diversified groups with a presence in both UK and Continental Europe will swiftly move the most skilled human capital to their EU subsidiaries when their UK operations are devoid of frictionless access to the Common Market. However, less skilled employees are not likely to enjoy the same type of employment insurance.

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.

The data covers the universe of French firms (both private and listed), comprising balance sheets and income statements. A database of matched employer-employee information (based on mandatory employer reports of the earnings and the position of all employees subject to payroll taxes) allowed the researchers to follow all French workers as they moved from one firm to another.

Read the report

The report is published in the ECGI Working Paper series and can be read here.

Report authors:

  • Dr Giacinta Cestone, Cass Business School
  • Professor Chiara Fumagalli, Bocconi University
  • Professor Francis Kramarz, CREST (ENSAE), Paris
  • Professor Giovanni Pica, Università della Svizzera Italiana (USI)
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