Pyramidal ownership and the creation of new firms

We study the role of pyramidal ownership in the creation of new firms using a comprehensive panel of manufacturing firms in Europe. Pyramidal ownership structures are used to supply inside funds to new firms that are unable to raise enough external financing, namely, those with large investment requirements and low pledgeable cash flows. They are also used to finance more capital-intensive new firms, those that rely more on expensive labor, and those whose projects pay off late. New firms that need more inside funds are set up through pyramidal ownership links to parent companies with more resources. Our results suggest that pyramids arise because they provide a financing advantage in setting up new firms when the pledgeability of cash flows to outside financiers is limited. This financing advantage is pervasive in many countries, it exists regardless of whether new firms are set up by business groups or by smaller organizations, and is an important underpinning of entrepreneurial activity