(Nijenrode Studies in Economics 3) Herman Daems (Auth.) - The Holding Company and Corporate Control-Springer US (1978)

THE HOLDING COMPANY AND CORPORATE CONTROL
NIJENRODE STUDIES IN ECONOMICS
Volume 3
Advisory Board
Professor R. E. Caves, Harvard University, Cambridge (Mass.), U.S.A.

Professor K. D. George, University College, Cardiff, United Kingdom
Professor E. Heusz, University of Marburg, West Germany.
Professor H. W. Lambers, Erasmus University, Rotterdam, The Netherlands
Professor W. G. Shepherd, University of Michigan, Ann Arbor, Michigan,
U.S.A.
Professor T. Wilson, University of Glasgow, Glasgow, United Kingdom
Board of Editors
Professor A. P. Jacquemin, University of Louvain, Belgium

Professor H. W. de Jong, University of Amsterdam, The Netherlands
L. Prins, Nijenrode, Instituut voor Bedrijfskunde, Breukelen, The Netherlands
The holding company
and corporate control
Herman Daems
European Institute for Advanced Studies in Management and UFSAL
c:Jvfartinus cfJVijhoff Social Sciences Division

CLeiden IGfJoston 1978
ISBN-13: 978-1-4613-4058-4 e-ISBN-13: 978-1-4613-4056-0
001: 10.1007/978-1-4613-4056-0
© 1977 by H. E. Stenfert Kroese B.V. Leiden, the Netherlands.

Softcover reprint of the hardcover 1st edition 1977
No part of this book may be reproduced in any form, by print, photoprint, microfilm or any other
means, without written permission from the publisher.
to Marielle
ACKNOWLEDGMENTS
Writing a foreword for a book, a task which implies that the writer's job is
finished and the reader's about to begin, is a very pleasant one and an excel-
lent opportunity to acknowledge the people and institutions who have contrib-
uted to my research and thinking over the years.
First of all I would like to thank Professor Herman van der Wee of
K.U. Leuven who, besides conceiving the original idea for this work, has
consulted me all along. He became a very good friend and counsellor. I also owe
a special word of gratitude to Professor Alfred D. Chandler Jr. of Harvard
University. He not only taught me everything I know about the modern business
institution but also gave me generous opportunities to pursue my research
interests at Harvard. Jacqueline Corluy-Janssen deserves additional credit for
her efficient support in collecting, sorting and re-calculating the original data
banks and for repeatedly helping me to meet deadline crises. It was Professor Jan
Lindemans, President of UFSAL in Brussels, who kindly allowed me to take
time off from my teaching duties to finish this research and start a new project.
And I have to thank Professors Alexis Jacquemin of UCL and John van
Waterschoot of K. U. Leuven for their sincere interest in my work and for their
friendly encouragement.
Institutions as well as people have contributed to this research. The list is long
so I will mention only two that have been particularly helpful. The Harvard
Graduate School of Business Administration repeatedly offered me fellowships
and grants and provided an outstanding intellectual environment in Cambridge
from which I benefitted enormously during my long stays there. The European
Institute for Advanced Studies in Management in Brussels has been a crucial aid
in shaping my research. It also gave me a friendly and hospitable base to which it
was a pleasure to return when I needed some shelter.
Although people and institutions contributed much, it was my lovely wife and
children, always willing and prepared to give the highest priority to my wildest
projects, who did most to help me finish this study.
Herman Daems
CONTENTS
Acknowledgements VII
Herman Daems
I. INTRODUCTION I
l. Research subject and objectives / 1
2. What is a holding company? / 2
3. Previous literature and the contribution of this study / 4
4. Plan of the study / 6
II. A POWERFUL INSTITUTION I 7
l. Introduction / 7
2. The history / 7
3. The main characteristics of the Belgian holding company system 16
4. International comparison and the reasons for the stability and viability of the holding
company / 23
5. Managerial organization of control / 34
6. Concluding remarks / 36
III. HOLDING COMPANIES AND FINANCIAL INTERMEDIATION:

THEORY I 37
l. Introduction / 37
2. The basic model: capital-as set-pricing in a two-parameter world 37
3. The case for and against security substitution by holding companies / 43
4. Conclusion / 47
IV. HOLDING COMPANIES AND SECURITY SUBSTITUTIONS:

EVIDENCE I 49
I. Introduction / 49
2. The statistical methodology 50
3. The sample / 54
4. The empirical results 55
5. Conclusion / 63
CONTENTS
V. HOLDING COMPANIES AND CORPORATE CONTROL I 65
1. Introduction I 65
2. A methodology for measuring the control influences of the holding companies I 66
3. Concentration of corporate power in the Belgian economy I 74
4. The market for corporate control in Belgium I 85
5. Concentration of corporate power and competition I 88
6. Conclusion I 90
VI. FOUNDATIONS FOR A THEORY OF HOLDING COMPANY

BEHAVIOR I 93
1. Introduction: the holding companies' problem I 93

2. Control for the pure sake of control or power I 94
3. Financial and economic benefits to control I 98
4. Conclusion I 121
VII. HOLDING COMPANIES, INVESTMENT STRATEGY AND ECONOMIC

GROWTH I 123
1. Introduction I 123
2. The retardation of the Belgian economy, revisited I 124
3. Industrial structure and economic growth I 130
4. Conclusion I 135
VIII. GENERAL CONCLUSION I 137

I. INTRODUCTION
1. Research subject and objectives
This study focuses on an economic institution, the large industrial holding

company, which continues to hold a prominent if not a strategic position in the
resource allocation process in many industrialised market economies. Powerful
multicompany combines like the famous Japanese zaibatsu and the less familiar
but equally powerful European industrial groups rely on the institution of the
holding company to tie their intermarket control network together. Two general
questions arise from this situation: first, what factors account for the viability
and growth within a market setting of those institutions which internalise
allocation decisions and, second, what effect do such institutions have on
resource allocation? These questions provide the framework in which the proper
research subject can be most adequately introduced.
Before doing so, it is crucial to point out that the holding company institution,
as analyzed in subsequent chapters, should not be confounded with the legal
constructs, bearing the same generic name and flourishing in fiscal paradises,
whose sole function is to organise tax evasion across national boundaries. The
institution, as studied here, is the large holding company through which
industrial groups manage multicompany systems. Such multicompany systems,
operating an intermarket network by means of holding companies, continue to
be more typical for Europe and Japan than for the United States where, for
legal reasons, but also because of managerial efficiency, the multicompany
system built around the holding company institution was rather short-lived and
the giant integrated multiunit enterprise rose to dominance 1 instead.
Multicompany systems and holding companies, therefore, must be analyzed in a
European setting. Particularly in Belgium, but also in France 2 , intermarket
combines and holding companies continue to occupy a crucial position in the
1. Alfred D. Chandler, Jr. (1977).

2. Francois Morin (1974).
2 INTRODUCTION
more basic sectors of the economy. Because of the remarkable stability of the
Belgian holding company structure, it was preferred to concentrate the analysis
of the holding company institution on the Belgian experience. However, an
analysis with particular reference to the Belgian intermarket c0mbines and
industrial holding companies does not imply a loss of generality. Indeed, the
theoretical, empirical and historical analysis of the holding company institution
and of the intermarket combines in subsequent chapters is sufficiently general,
we believe to provide analytical insight into the function and conduct of other
intermarket groupings and multifirm systems like the Japanese zaibatsu and the
American conglomerate.
The research objectives ofthis study, then, are: first, to determine the economic
and financial conditions which allowed the holding company institution to
remain remarkably stable over time; second, to define the economic function of
this controversial institution; third, to find new yardsticks for measuring the
holding companies' impact on Belgian finance capitalism; and, fourth, to
develop new foundations for a theory of the holding company and of corporate
control.
2. What is a holding company?
The large Belgian holding companies are best defined as financial institutions
which manage a portfolio of stocks in order to control the companies in which
they hold a share of the equity capital. The crucial term in this definition is the
concept of controL It is the struggle for corporate control which distinguishes the
holding company from other financial institutions, such as the mutual funds.
A precise definition of a holding company, then, requires a precise operational
definition of the concept of corporate control. What does control mean? What is
the purpose of control? What benefits are derived from the control function and
why is control desirable? Since Belgian holding companies are mainly financial
institutions, their activities are mainly directed towards control over the capital
management function. An operational definition of control must, therefore,
show the influence the holding company exerts on capital management. Control
over a company is best defined, then, as having the control instruments
(representation on the board of directors or a 'substantial' share of equity
capital) needed to monitor capital management in a company.
The large Belgian holding companies are used to control a complex in-
termarket combine. Very often the operating enterprises under control are not a
part of the portfolio of the 'mother' holding company but are indirectly
controlled through an intermediate layer of subholding companies. This
WHAT IS A HOLDING COMPANY? 3
technique of indirect participation permits the 'mother' holding company to

control a pyramid of companies. If the control threshold, i.e., the minimum
share of equity capital necessary to control a company, is equal to A ( < 1), the
'mother' holding company, with a capital base of K, is able to control th~ first
layer of companies with equity capital at least equal to }, -1 K. But this is not a
limit to the holding company's control influence. Indeed, when the first layer of
companies is composed of other holding companies, the 'mother' holding
company can control A- 2 K assets. In principle, there is no limit to the span of
control, and nothing would prevent one company from controlling the whole
asset structure of an economy. This is, of course, a naive view. It does not take
into account that A, the control threshold, can vary because of the actions of
competing groups. The phenomenon of widespread control influence has
occurred nevertheless, making it difficult to otherwise present a clear picture of
the strong position of the holding companies and of the multicompany
combines.
Consequently, the holding companies are institutions for organising and
structuring the corporate control market. These institutions are able to gain and
hold such control because they issue securities to buy and hold 'substantial'
blocks of stocks (controlling interest) in operating companies and other holding
companies. Very often these subsidiaries are among the largest corporations of
the Belgian economy; nearly all are listed on the Brussels Stock Exchange.
The Belgian holding companies are thus financial institutions which issue
financial claims in order to hold claims in other companies. They offer the
Belgian saver a substitution of securities: the securities of the controlled
companies substituted for the holding companies' own securities. In doing so the
holding companies, within a capital market setting, act as financial in-
termediaries between savers and investors for long-term financial assets. Instead
of buying a stake in company assets directly, the savers buy them indirectly
because they invest in holding company securities. It is clear, therefore, that the
Belgianfinancial holding companies need a capital market setting to function on a
large scale because they require the funds of the Belgian savers to finance their
controlling interests.
By acting as a financial intermediary in the capital market, the holding
company becomes similar to a closed mutual fund. The basic difference is that
holding companies strive for control over corporate decision-making.
F our research problems emerge from this brief review of the holding company
institution. First, what economic and financial conditions allow holding
companies to intermediate in the capital market? Second, why is corporate
control desirable for the investor? Third, why do the capital market and the
financial investors support or accept the substitution of securities and the
4 INTRODUCTION
functioning of the holding companies? Fourth, what is the effect of the

functioning of the financial holding companies on capital accumulation and
allocation in the Belgian economy?
3. Previous literature and the contribution

of this study
It is surprising how little attention non-Marxian economists have paid to the

economic analysis of the holding company, the key institution through which
European and Japanese combines manage and control their multicompany
systems. In the early decades of this century the topic received more scholarly
interest on both sides of the Atlantic when the holding companies, and with them
the multicompany systems, had just risen to highest dominance in the United
States, Germany, France, the United Kingdom, Japan and Belgium. Soon after
the 1930s, however, scholarly interest faded away; the study of holding
companies, and, for that matter, the whole field of institutional economics,
drifted off to the back benches of non-Marxian economic thought. Indeed, until
very recently, institutional economics 3, the study of the allocative effect of
nonmarket arrangements, had lost the leading position it once held to the
modem high-powered study of market allocation.
During the heighday of interest in the functions and conduct of holding
companies, German scholars of all ideologies were especially productive; with
their seminal publications on intercompany connections and concentration, they
laid the early foundations for studying industrial organisation in Europe. 4 In
the United States, scholarly attention to the holding company was stimulated by
public concern over the concentration of economic power and by the desire of
American lawmakers to devise legal measures for public control. 5 This early
German and American literature 6 , however, did not fully distinguish be-
tween the economics of mass-production and mass-marketing by giant fully-
integrated multiunit firms and the economic theory of intermarket groups and
multicompany systems. As will become clear in later chapters, such a distinction,
between the large modem firm and the multicompany combine, is crucial for a
correct understanding of the function and conduct of large holding companies.
3. For examples of a recent revival of theoretical interest in institutional economics, see A. M.

Spence (1975) and the Spring 1975 issue of The Bell Journal of Economics. See also the contributions
ofO. E. Williamson (1975).
4. R. Liefmann (1897), (1920), (1927). R. Hilferding (1910).
5. 1. C. Bonwright and G. C. Means (1932).
6. For a British contribution see A. J. Simons (1927).
PREVIOUS LITERATURE AND THIS STUDY 5
The early confusion about the two institutions is understandable however. In the
decisive years between the l880s and World War I the holding companies, in
some instances, played a transitory role and paved the way for the coming of the
giant enterprise. In other instances, they did not perform this transitory fUr'...:tion
but remained a stable institution instead. It is important to note that this
transition from holding company to giant enterprise took place only when the
holding company was used to control an intra-market multicompany system
and/or when anti-trust legislation threatened the survival of the combine.
Obviously, the latter is only relevant for the United States, which pioneered anti-
trust policy in 1890 and refined it in 1914. In Europe, where holding companies
were used primarily to link together intermarket combines and industrial
groupings, the multicompany systems were not in a transitory stage nor were
they threatened - nor could they easily have been threatened - by anti-trust
legislation: because of the intermarket character of the European combines, such
legislation hardly existed or was difficult to implement.
Unfortunately, early confusion about the nature of the holding company has
always hampered the development of a complete theory of holding companies.
Another reason why the previous literature has not been able to develop such a
theory is the failure of economists to come to grips with an essential concept in
any definition of a holding company, the concept of corporate control.
Economists, instead, have tended to formulate the theory of corporate control
within the framework of market power and have explained the struggle for
control with the allure of monopoly profits. In later chapters it will be argued
that such an approach must fail because it ignores the essential characteristic of
every battle over corporate control: conflicting interest among 'rival decision-
makers' and the consequent lack of unanimity.
The major contribution of this study, it is hoped, lies in the explicit
formulation of the foundations of a theory of holding company behavior and of
the theory of corporate control. It will also present new and original evidence
about the functioning of Belgian holding companies in a capital market setting.
Perhaps the most important difference between this study and previous literature
in the field is our deliberate omission of yet another directory of all financial
groups and all holding companies, induding their respective subsidiaries.
Instead oflooking at the particularities of names and faces, we have tried to see
through them to the structural aspects of the holding company phenomenon.
6 INTRODUCTION
4. Plan of the study
The study is organized in such a way that the reasons for the eyistence and
stability of the large Belgian holding companies become gradually more clear.
The economic impact of the holding company institution is estimated in Chapter
2 and it is argued that the historical stability of the Belgian holding company can
be explained by the industrial structure of the Belgian economy. The holding
company is next analyzed as a financial intermediary: empirical evidence is
presented to discuss the efficiency of the security substitution by the holding
companies. Chapter 5 uses original data to review the concentration of corporate
power in the Belgian economy and briefly discusses the efficiency of the corporate
control market. The results once more illustrate the overwhelming influence of
the holding companies on corporate control and raise doubts about the efficiency
of the corporate control market. Chapter 6 is the crucial chapter, developing as it
does the possible foundations for a theory of corporate control and holding
company behavior. It will be demonstrated that control over corporate decision-
making is desirable because capital markets are incomplete. 7 Finally, in Chapter
7, the two aspects of the holding company, financial intermediation and struggle
for corporate control, are combined in order to test whether different investment
strategies are being pursued. No definitive answers will be presented in this
chapter, but there is some evidence that these strategies probably dit not, as is
generally believed, slow down the Belgian economy in the 1950s.
7. Capital markets are incomplete when all contingent policies are not priced.
II. A POWERFUL INSTITUTION
1. Introduction
Very much like the zaibatsu in Japan, the financial and industrial groupings or
combines are the most typical institutions of European and Belgian capitalism.
These combines use powerful holding companies to knit their control system
together. This chapter illustrates the crucial role of the holding companies, and,
for that matter, the industrial combines, in the accumulation and allocation of
capital in the Belgian economy. By issuing stocks to obtain funds for buying
controlling interests in large industrial corporations and banks, the holding
companies have become the most influential financial intermediaries in the
Belgian capital market. The history of the holding companies and international
comparison suggest that such institutions could act as viable financial in-
termediaries because of the relatively high demand for external funds in the
Belgian economy. Finally, it is argued in this chapter that the managerial control
structure of the Belgian and European industrial and financial combines is
fundamentally different from the American conglomerate and that even with the
Japanese zaibatsu which is much more like the Belgian-type financial combine,
essential differences exist in the control systems.
2. The history
It is instructive to take a brieflook at the history and the evolution of the holding
company in the Belgian economy because it teaches us something about the
reasons for the institution's remarkable stability, about its origin and function in
the Belgian economy and permits a neat comparison with similar structures and
institutions in other nations.
1. This part is based on data provided by Durviaux (1947), van der Valk (1932), Chlepner (1930),
Baudhuin (1944), Levy-Leboyer (1964) and Societe Generale de Belgique (1972), R. J. Morrison
(1967), R. Cameron (1965, 1966, 1967, 1973).
8 A POWERFUL INSTITUTION
The beginning
The holding company emanates from the oldest financial institution in the
Belgian economy, the mixed bank or 'la banque mixte'. In fact its origin goes
back to 1882 when a bank called 'Societe Generale des Pays Bas pour favoriser
l'industrie nationale', was founded, which name was changed into 'Societe
Generale de Belgique' later on, when the Belgian State was founded. The
financial intermediary, an institutional innovation in the financial history of the
industrial world, was designed to overcome the large imperfections in the
accumulation and allocation of financial capital. 2
The imperfections in the market for industrial capital were caused by several
factors. The rapid industrialisation of the southern part of Belgium during the
nineteenth century concentrated on three capital-intensive industries: mining,
iron and steel, and railroads. All these sectors had a huge need for long-
term financial resources which could not be obtained from the family wealth of
the entrepreneurs. Furthermore, large initial capital outlays and high pay-back
ratios prevented the use of retained earnings as a financial source. The
insufficient instruments for mobilizing personal savings for venture capital, the
availability of investment opportunities in real estate and foreign government
securities and the public distrust of risky industrial projects created a real
opportunity for an institution to coordinate and control the flow of long-term
funds. It was the bank's intention, and that of most of its few but agressive
competitors, to mobilize savings and to use them for financing industrial
projects. The banks started with a policy of granting long-term loans but
financed these assets with short-term deposits and the issue of bank notes. When
economic conditions worsened with the downturn of the business cycle in 1838
and 1848, the public, alarmed by the economic and political situation, withdrew
its deposits and cashed in the bank notes. Since bank assets were immobile -
because of their long-term character and because most of the claims could not be
fulfilled by the bank's industrial debtors due to the economic crises - banks had
to accept stocks in exchange for the bad industrial debts, and in 1850 they were
forced to stop issuing bank notes. The real mixed bank emerged: an institution,
which issued long-term claims to hold long-term industrial assets and which at
the same time engaged in the typical activities of a commercial bank. Its crucial
challenge was to balance its industrial and commercial banking activities so as to
preserve its liquidity as a commercial bank. The industrial banking activity of the
mixed bank can be described as follows. Directly or indirectly through a
2. R. Cameron (1972).
THE HISTORY 9
financial subsidiary it holds a controlling interest in a number oflarge industrial

corporations, mainly in basic industries. The mixed bank helps these companies
financially to carry out their industrial activities and investment projects by
providing them with funds in current account. In many cases the bank.:. have
gone beyond their purely financial management and have offered their industrial
subsidiaries technical expertise, commercial guidance in foreign markets and a
protected source of basic materials.
After World War I
The whole industrial banking activity and the mixed bank character of the
Belgian financial system showed a dramatic growth after World War I and
brought the system rapidly to its present structure. The demolition of industrial
capital and the complete exhaustion of business inventories created a huge
demand for economic activity and financial resources. The mixed banks,
stimulated by the high demand for funds 3 and by increased competition in the
banking sector, launched an agressive policy by financing long-term business
projects in current accounts or by subscribing to and floating new issues of equity
capital. This crucial but risky move was supported by a sweeping wave of bank
mergers and industrial reorganizations. Nearly all banks of that time must be
considered mixed; only a very small minority of the banks was purely
commercial. To reduce the risk of large portfolio immobilisations and probably
also to increase their influence within the business community, the banks started
to found financial institutions. In these institutions, the immediate forerunners
of the present-day holding companies, the banks took a controlling interest and
entrusted them with part of their portfolio investments. Tables 1 and 2,
calculated from data from earlier work on the Belgian banking system 4 clearly
illustrate the phenomena prevailing at the time: rapid expansion of the demand
for funds after World War I and an increasingly important role of the mixed
banks and the holding companies in subscribing to the public issues of
corporations. Furthermore, a large part of the new issues went to financial
institutions for expansion of their own resources (see Table 1).
The most striking illustration of the use of current accounts to finance the
rapid economic expansion is found in column III of Table 2. Aithough the ratio
between long-term commitments in industrial securities of controlled corpo-
rations and net worth reflects an apparently sound and prudent policy, the real
3. This increased demand for funds already started before the First World War.
4. Durviaux (1947) and van der Valk (1932).
Table 1. Subscription by banks to public issues of securities by corporations 1874--1932.
I II III IV V
in million BFa in % in % in% in %
_e
1874 146 16.43 c 7.94g
1879 44 1.61 1.61
1882 156 11.53 5.76 10.54
1887 105 6.66 0.4 5.61
1892 99 12.12 1.31 1.31
1899 805 17.39 7.2 12.69
1911 603 22.22 4.56 12.47
1919 1,618 b 25.89 d 3.76f 20.32h

1923 2,370 31.77 5.65 27.02
1929 11,985 37.39 41.6 7.88 36.19
1932 2,120 25.74 8.8 1.37 4.74
Sources: Calculated from data provided by Durviaux (1947) .

• Durviaux p. 88. b Durviaux p. 141. c Durviaux p. 88. d Durviaux p. 142. e Durviaux p. 90. f
fDurviaux p. 146. 8 Durviaux p. 90. hDurviaux p. 142.

I: Public issue of securities by corporations.
II: Of which issued by financial institutions, Durviaux (1947), p. 138
III: Of which subscribed by banks.
IV: Share of holding companies in subscription.
V: Share of mixed banks in subscription, includes IV.
situation was less favourable. This is clear from a study of the ratios of column V
in Table 2, which take into account the long-term character of the current
accounts. This suggests that short-term funds were used to finance long-term
projects.
The banking legislation of 1935
The economic conditions of the early 1930s were disastrous for this strategy of
financing, through current accounts, long-term projects with largely short-term
funds. When two of the larger but newer mixed banks went bankruptS as a result
of their risky financial policies and of the decline in economic activity and the
deflationary government policies which eroded the value of bank assets, the
public started to withdraw their deposits. The mixed banks, concerned as they
were about their liquidity, had difficulties in mobilising their current accounts,
5. Bank van de Arbeid and Caisse Centrale de Credit du Boerenbond.

THE HISTORY 11
Table 2. Financial structure of the Belgian banking system, 1870-1940.
I II III IV V
1870 80.47 85.31

1880 67.64 9'.1.32
1890 68.78 l3l.04
1900 79.85 146.87
1910 80.16 159.52
1913 20.46 18.85 33.85
1920 12.38 26.55 4l.83 70.96 347.11
1921 16.46 29.46 37.40
1922 15.01 32.14 36.82
1923 12.65 25.06 45.54
1924 12.40 22.31 47.75
1925 16.66 22.56 45.65
1926 16.83 19.04 47.17
1927 18.97 15.08 46.37
1928 18.16 15.55 46.67
1929 17.63 15.20 47.12
1930 19.60 16.83 45.76 65.89 281.52
1931" 20.12 20.18 46.40
1932 17.65 22.71 39.69
1933 17.82 22.33 36.51
1934
1935 16.71 2l.41 3l.00
1936 15.37 26.28 27.21
1937 16.04 24.82 28.82
1938 15.42 19.90 30.61
1939 l3.80 21.33 30.97
1940 19.37 24.89
Sources: • Durviaux (1947), p. 203, 204, 205.

I: Share of commercial portfolio in total bank assets, van der Valk (1932), p. 56.
II: Share of industrial and government securities in total bank assets.
III: Share of debit accounts in total bank assets.
IV: Ratio of industrial portfolio to net worth, calculated from Appendix in Durviaux (1947).
V: Ratio of industrial portfolio and debit-accounts to net worth and outstanding long-term bonds,
Durviaux (1947).
business, sharply hit by the depression, could not fulfill its financial obligations
and was on the brink of bankruptcy. The government intervened and passed
Royal Decrees 6 and legislation 7 which not only curbed the pressing economic
problems but also initiated a structural change in the Belgian financial system.
6. August 22, 1934.
7. July 9, 1935.
The basic intentions of the 1935 banking legislation were to abolish the mixed
bank system and to separate banking from business interests. Banks were not
permitted to hold industrial securities on their own account and the number of
interlocking directorates that banks could have with business was drastically
reduced. At that time the large modern holding companies were formed in
Belgium. The control relationship between the banks and the holding compa-
nies, instruments for reducing the banks' financial risk and for expanding their
control, was now abruptly reversed. The holding company - now more than a
purely financial device - rapidly became a crucial financial institution in charge
of the former bank portfolio, and it gained a controlling interest in the banks
themselves.
As was the case in so many nations, the 1920s and 1930s were strategic years
for shaping Belgian capitalism. The system emerged from these two interwar
decades with what were to become its typical characteristics. Mostly because of
the industrial banking activities of the mixed banks, financial groups were
formed comprising the largest Belgian industrial corporations. These powerful
groups, which were much like the Japanese zaibatsu, have been 'monitored'
through the holding company institution and they have led to an increased
concentration and centralisation of capital management. The main sectors of
their activities are the basic industries, mining, iron and steel, heavy transporta-
tion equipment and electrical energy. Their foreign investments were concentrated
in the former Belgian colony, now Zaire, to secure the basic materials for their
domestic companies. The former mixed banks have aggressively contributed to
the reorganisation of Belgian industry during the formative interwar years.
Smaller units were forced to merge and increased size was actively sought,
creating more oligopolistic and monopolistic markets. Since this phenomenon
of concentrated market structures is typical of most industrial nations, it is not
clear whether the holding companies and mixed banks were a cause or an
instrument in the industrial concentration. Indeed, international comparisons of
market structures seem to suggest that technological and sectorial characteristics
are very important to explain industrial concentration. 8
After World War II
Since the decisive interwar years the holding company structure has not
undergone radical changes. Indeed, the institution for coordinating and con-
trolling capital management has demonstrated a noticeable stability in its
8. Pryor (1972).
THE HISTORY 13
structure, actIvIty and investments. Although it should be added that the

political and economic upheavals surrounding the independence of the former
colony in the very early 60's, the founding of the European Common Market in
1958, the increased competition from American and British companies in f'Jreign
and domestic markets and finally the changes in the political, economic and
social domestic situation, have not left the holding company structure wholly
untouched.
Recently, the government moved to gain more insight into the intricate
holding company structure by imposing the large incorporated holding compa-
nies to register with the Banking Commission (Bankcommissie-Commission
Bancaire) and to provide classified information about their direct and indirect
holdings. 9
In 1972 the Belgian government brought the holding companies to the
standing Conference on Economic Expansion and Employment in an effort to
coordinate the investment programmes of the holding companies' subsidiaries
with the objectives of the five-year indicative and contractual economic
planning. More legal actions and reforms can be expected in the future since
some representatives and senators of the major political parties have submitted
proposals to the Belgian parliament to extend the scope of the 1967 Decree
mentioned above.
9. The government's decision resulted in the Royal Decree no. 64 of November 10, 1967 which
obliges the holding companies to register with the Banking Commission, created under the 1935
Banking Legislation. The companies have to appoint, in accord with the Banking Commission, one
or more auditors selected from the members of the Institute for the Industrial Auditors or from the
list of bank auditors. The appointment of the auditors by the holding companies should receive the
prior approval ofthe Banking Commission. The auditors have to report to the Banking Commission
on the financial accounts of the holding companies and about the structure of, and changes in, their
portfolio investments. The holding companies have to provide information about their own
investment projects and the projects of their subsidiaries to the Bureau of Economic Planning,
whenever the Bureau desires to receive that information. For statistical purposes it is important to
know that the Decree defines a holding company as a company under Belgian law which holds
controlling interests, 'de jure' or 'de facto' in one or more Belgian orforeign subsidiaries and when these
holding companies: le) have publicly issued securities directly or indirectly through their subsidiaries;
2e) have a total portfolio investment of over 500 million BF.
Article I of the Decree further stipulates that the financial character of the holding company is
sufficiently evident if the value of the portfolio is more than half the total assets. This Decree is also
applicable to the Belgian holding companies of foreign financial groups.
The definition as given in the Royal Decree no. 64 does not distinguish between industrial holding
companies, which in general have only fully owned subsidiaries, and financial holding companies,
which nearly always hold a controlling interest with a minority ownership. Since the Royal Decree
took effect, 31 holding companies have registered with the Banking Commission excluding
Brufina and Cofinindus which merged to form with the Soc. Lambert the Bruxelles-Lambert
company; excluding the Compagnie d'Anvers which disappeared after being taken over by
Petrofina; and excluding the Eurotremer which merged with the Soc. Generale de Belgique.
Holding companies based on the definition of the Banking Commission are listed in Table 3.
.j:>.
Table 3. Financial data about large belgian holding companies, 1971-1975
-
Assets Net Worth 1 Portfolio 2 Net Profits Deposits of Market
1971 1975 1971 1975 1971 1975 1971 1975 subsidiaries value
1971 1973
1. Soc. Generale de
Belgique 15,127 22,515 8,570 9,589 8,236 12,565 816 1,309 4,731 16,131
2. Traction et Electricite 8,506 14,381 3,326 6,369 5,605 9,651 304 640 n.a. 6,637
3. Electrobe1 9,160 9,386 5,351 5,652 5,680 6,948 500 724 2,030 8,145 :>
4. Sofina 7,147 7,854 5,767 6,079 6,324 6,640 555 528 107 6,789 '"t1
5. Cie Brussel-Lambert 0
~
a) Lambert Mij 5,108 13,704 2,709 6,206 3,549 6,261 325 125 215 9,928 ttl
::t'
b) Brufina 2,208 1,621 1,323 104 152 >rj
c) Cofinindus 1,787 1,423 1,545 88 227 c::

r
6. Glaverbel-Mecaniver n.a. 8,073 n.a. 6,154 n.a. 6,221 n.a. -870 n.a. 6,942 ....
7. Financiere Eternit 3,479 4,517 3,223 3,539 3,154 4,011 272 328 24 n.a. Z
8. Cobepa 3,451 4,241 3,233 3,683 1,907 3,832 126 205 n.a. 3,175 ....'">-l
>-l
9. Electrorail 2,695 3,323 2,321 1,998 2,565 2,725 129 172 157 1,985 c::
10. Contibe1 3,7474 5,407 2,433 4 1,722 2,780 4 2,676 1484 268 3404 n.a. j
0
11. Finoutremer 2,017 2,952 1,735 2,357 1,735 2,464 136 134 n.a. 1,621 Z
12. Almanij 1,752 2,533 905 1,232 1,063 1,871 136 278 32 5,107
13. Financiere du Ruau 934 2,135 414 1,843 377 1,814 37 235 n.a. 1,504
14. Electrafina 1,5524 1,658 1,4264 1,491 1,4874 1,620 115 4 146 n.a. 1,600
15. Socfin 815 1,305 681 1,215 635 1,130 16 74 n.a. 355
16. C.D.1. 666 2,196 444 1,254 341 1,099 10 137 n.a. 1,206
17. Tabacofina 1,869 1,884 1,035 1,097 1,049 1,016 99 94 453 1,756
18. Ibel 257 1,206 240 844 190 879 21 100 n.a. 700
19. Cie Generale Condo
d'Eau 2,490 1,694 2,175 1,445 757 826 20 28 43 672
20. Cie Grands Lacs 720 1,173 355 804 458 664 26 59 n.a. 382
Assets Net Worth! Portfolio 2 Net Profits Deposits of Market
1971 1975 1971 1975 1971 1975 1971 1975 subsidiaries value
1971 1973
21. Soc. Generale de la

Viscose 379 531 326 333 325 488 42 83 n.a. 686
22. UFI 327 n.a. 282 n.a. 279 n.a. 25 n.a. n.a. n.a.
23. Cie Nationale a
Portefeuille 225 222 189 173 153 187 12 20 17 225
24. BDIC 733 804 604 713 727 695 46 78 n.a. 589
Source: The list of holding companies was selected from the list of the Banking Commission. Holding companies with an industrial background such as
Petrofina, the largest Belgian industrial company, and Union Miniere were excluded. ...,
The financial data for 1971 were compiled from balance sheet date published by Le Receuil Financier 1972. The data for 1975 were taken from Belgian II:
t!1
Business.
II:
....
Notes: '"o...,
1. Net worth equals total assets minus liabilities. ::0
2. Book value of portfolio investments. ><:
3. Number of shares outstanding times market price per share based on information provided by Informa.
Data in this column should not be compared with the financial data reported in the other columns.
4. The data concern 1972.
Vl
-
Finally, in 1976, as a result of the worst economic recession since the 1930s,
political pressure was applied to the government to remold the Nationale
Investeringsmaatschappij (National Investment Company NIM-SNI), a
government-controlled credit institution, which subsequently becllme a public
holding company. Because of its limited resources the new institution should not
be compared with the famous Italian public holding company, IRI, or the British
National Enterprise Board. The newly-created public holding company does not
intend to compete with the large private holding companies for control over
capital accumulation and allocation - and even if it had such plans would not be
able to do so. It is consequently doubtful whether this new public institution will
have any significant impact on the fundamental structure of Belgian capitalism.
In this brief historical review the holding company is shown as a highly stable
institution whose main historical function has been to control and organise the
flow of capital in the Belgian economy.
3. The main characteristics of the Belgian holding com-

pany system
On the following pages the historical description given above is complemented

by an outline of some essential characteristics of the holding company system
and of Belgian financial capitalism since the Second W orId War.
Size
In order to measure size, balance sheet data were compiled about a sample of
some of the largest Belgian holding companies. These data are given in Table 3.
The list of companies was selected from the annual publications of the Banking
Commission. Those companies were excluded from the analysis which in our
opinion are of a predominantly industrial character. 10 This was the case with
Petrofina, the largest Belgian industrial company, and Union Miniere, both of
which appear on the official list of the Banking Commission because they fit the
purely legal definition ofa holding company. In 1971 the relative size of these 25
companies was enormous. The total book value of assets under their control is 77
billion BF of which 51 billion BF or 67.7 percent are invested in participations in
10. In a previous study, Daems (1975), these companies were included. We now feel that those size
figures were too much influenced by the extremely large size of Petrofina and Union Miniere.
However, the figures given below are considerable underestimations of the real influence of the
holding companies in Belgium because some of the smaller holding companies have been omitted.
THE BELGIAN HOLDING COMPANY SYSTEM 17
other companies. The total net worth 11 of the holding companies in our sample
amounted to 50.8 billion BF.
The National Bank estimates that the total net worth of the 15,938
corporations developing the larger part of their business activities in Belgiur.J. can
be valued at 582.6 billion BF in 1971. 12 This suggests that for the 25 holding
companies in our sample, fewer than 0.2 percent of the total number of
corporations probably accounted for 8.7 percent of total net worth.13 In the
same year all Belgian corporations with business mainly in Belgium together
showed a total net profit of 43.8 billion BF;14 with profits up to 7.3 billion BF the
holding companies' share in this total was 9.4 percent.
These figures permit a quick but rough comparison of profit rates. The average
rate of profit, net profits over net worth, for all Belgian corporations is 7.5
percent. The holding companies score a slightly higher rate of 8 percent. The
performance difference, however, is not significant and might be attributable to
rounding off. Using these aggregate financial statistics it is possible to arrive at a
rough estimate of the direct influence of the holding companies on corporate
control in the Belgian economy. Indeed, according to estimates of the National
Bank the value of domestic and foreign shares totalled 433.9 billion BF in
Belgium in 1971.15
Since the book value of the portfolio investments of the holding companies is
probably around 52.2 billion BF,16 it seems safe to conclude that the holding
companies hold at least 12 percent of all risky assets in the Belgian economy. If
we further assume that the minimum participation to control a company is 50
percent it would seem possible that the holding companies control at least 24
percent of all capital in the form of shares. What this represents in terms of assets
can only be guessed at.
It is instructive to compare these results with the financial holdings of the
public sector. The central government and local authorities together with the
semi-state enterprises, hold 35.7 17 billion BF in shares or 8.2 percent of the total
433.9 billion BF invested in risky assets in Belgium. The investment by the public
sector in these financial assets is strongly concentrated in the semi-state
11. Net worth equals assets minus liabilities.

12. Nationale Bank van Belgie (1973), p. 111.
13. It is important to realize that all these figures contain double countings. If the securities of a
company are held by a holding company, part of the value of these securities is counted at least twice.
This suggests that the figures are lower bound estimates of the real size of the holding companies.
14. See footnote (12) in this chapter.
15. Nationale Bank van Belgie (1974), Table XII, lb.
16. See Table 3, this chapter.
17. Nationale Bank van Belgie (1974), Table XII, lb.
enterprises which account for 83.4 percent of all share capital held by the public
sector. 18
It should be borne in mind that the rough financial statistics presented above
do not attempt to measure the aggregate influence ofthejinancial proups in the
Belgian economy. Indeed the statistics do not reveal the indirect impact which
the financial groups (through some smaller holding companies, banks and
insurance companies and through some industrial companies) have on Belgian
capitalism.
Holding companies and the capital market
The strategic position of the holding companies in the Belgian economy becomes
even clearer as soon as we study the influence of these financial institutions on the
capital market. Indeed, the holding companies are among the most active users
of share capital and are among the favourites of the Belgian investment
community.
Evidence on the use of share capital by the holding companies is given in Table
4. The data show that the financial holding companies have been among the
more active issuers of share capital during the last 15 years.
Holding companies issue shares to hold shares and other financial claims in
industrial and financial companies. Consequently, an important substitution of
securities is taking place. It is not possible to provide direct statistical data on the
acquisition of risky financial assets by the holding companies, but aggregate data
exist which enable us to obtain a rough measure of security substitution in the
Belgian economy. In order to show the striking characteristics of Belgian
capitalism as clearly as possible, we have added some data about the acquisition
of share capital by type of investor in the u.S.A.
The structure of net acquisitions differs radically between the U.S.A. and
Belgium. American households during the period 1961-1964 were large net
sellers of shares, which were then bought by the institutional investors, insurance
companies and pension funds. The non-financial enterprises had no net influence
on the structure of net acquisitions. In Belgium however, households were net
investors in stocks, but they were lagging far behind the non-financial enterprises
(including the holding companies) which took more than half the net acqui-
sitions. It is clear that a substantial substitution of securities has taken place in
the Belgian economy. It is furthermore interesting to note that the traditional
institutional investors such as insurance companies and pension funds have a
18. See footnote 17, this chapter.

Table 4. Public issues of shares per sector, 1958~1973.
Sectors 1958-1963 1964-1968 1969-1973
in m.B.F. in % in m.B.F. in % in m.B.F. 1.J.l%

Food 337 1.76 23 26
Insurance 5 13 775 1.9
Banks 1549 8.12* 4857 16.79* 2959 7.28*
Construction 831 4.35 46 0.15 41
Savings and loans associations 107 0.56 515 1.78 668 1.64
Mining 18
Real estate 208 0.71 287 0.7
Corporations under the Decree
of June 19, 1964 40 0.13 65
Metals 166 0.87 509 2.04 413 1.01
Gas + electricity 3532 18.52* 7697 26.55* 2289 30.23*
Glass 122 0.64 461 1.59
Distribution 1400 7.34* 170 0.58 1006 2.47
Chemicals 498 .2.61 5243 18.75* 912 2.24
Oil 1510 7.92* 1827 6.31* 2608 6.41*
Textiles 222 1.16 113 0.39
Electrical + electronics 207 0.71 295 0.72
Paper 10
Plantations 46
Steel 2659 13.49 1738 6* 640 1.57
Mixed corporations 116
Holding Companies 1179 6.18* 2632 9.10 2827 6.95*
Transportation 30
Tramways and electricity trusts 189 0.99 442 1.52 1435 3.53
Foreign 3640 19.09* 1989 6.87* 13107 32.24*
Other 1124 5.89* 33 139
Total 19,061 28,920 40,645
Source: Calculated from yearly data provided in the annual reports of the Banking Commission.
*More than 5%.
fairly modest effect on the secuntIes market. These data do not reflect a
temporary situation, but are a reflection of the fundamental structure of the
Belgian capital market.
This substitution of securities which permits the holding companies to
organise and control the flow of capital to industry and enables them to broaden
their control over corporate capital, raises a number of interesting questions.
What are the financial conditions allowing of this substitution? Why does the
investment community support the substitution? Indeed, it can be argued that
Table 5. International comparison of net acquisitions of securities issued by non-financial en-

terprises, by type of investor, 1961-1964. (accumulated flows in %)
BELGIUM U.S.A.
shares bonds shares
Non-financial investors
Households 20.9 c - 269.0
Non-financial enterprises' 56.1
Public sector 0.8
Foreign sector 8.9
Subtotal 86.7 - 269.0

Financial intermediaries
Monetary institutions 0.8
Savings and loans associations
Insurance and pension funds 3.2 7.2 + 283.3
Other 2b 85.7
Subtotal 13.2 369.0

TOTAL 100 100
Source: B. Snoy (1970).

a. This category includes the holding companies.
b. Nationale Investeringsmaatschappij (N.l.M.).
c. The breakdown into shares and bonds is not available.
the substitution of securities must cost the Belgian saver some part of his
dividend income. In order to estimate this cost, let us assume that a Belgian
industrial company pays a dividend. Because of the holding company structure
and the substitution of securities the dividend is received by the holding company
which in turn declares a profit after subtracting its operating costs and
management fees and bonus.
From Table 6 it can be concluded that the substitution of securities by the
holding companies costs at least 34.8 million BF or 1.46 percent of portfolio
revenues.
Was this cost, in which the additional taxes to be paid, have not been taken
into account, offset by benefits in the form of superior management or
diversification which would otherwise not have been available to the Belgian
economy? This problem will be dealt with in later chapters of this study.
More information about the influence of the holding companies is obtained
when one studies capital market valuation data and turnover of securities at the
Belgian stock exchange. At the end of December 1973 the total market value of
all corporations listed on the Brussels stock exchange was slightly over 424
Table 6. Estimated cost of the Belgian financial holding companies in 1971.
(in 000.000 BF)
1. Revenues from portfolio investments 237;.7

2. Net profits' 2440.6
3. Bonus and management fees (Tantiemes) 97.7
4. Available for shareholders b (2)-(3) 2342.9

5. Cost of the holding companies (without taxes) (1)-(4) 34.8
Source: See the starred companies in Table 3.

a. Profits of the current year; transfers of profits from previous years were excluded.
b. Retained earnings are, in principle, available to the shareholder.
Table 7. Average market valuation by sector, 1970-1973.
(End of year, values in %)

Insurance 3.6 Coal-mining 0.7
Banks 11.2 Glass 2.7
Holding companies 13.1 Construction 2.7
Real estate 0.6 Textiles 0.4
Transportation 0.7 Plantations 0.2
Trusts (electricity) 4.7 Food 0.7
Electricity, gas and water 14.6 Breweries 0.3
Electronics 0.6 Sugar 0.1
Steel 2.7 Other 2.7
Metals 1.2 Paper + Printing 0.5
Non-ferrous metals 7.8 Oil 15.1
Chemistry 9.5 Distribution 2.3
Source: Monthly bulletin Statistique et Indices, Brussels Stock Exchange, December 1970, 1971,
1972, 1973.
billion BF. 19 The market value of the largest holding companies (see Table 3)
was roughly 76.1 billion BF, or 17.9 percent of the total market value. Ifwe limit
ourselves to the financial holding companies, i.e. to those companies classified as
holding companies by the Commission of the Brussels Stock Exchange,20 we
perceive a similar picture. Table 7 gives the structure of market valuation at the
19. As argued above, this total figure contains double countings owing to the security substitution.
20. This list is not identical with the list drawn up by the Banking Commission, which showed the
master list for Table 3, although there is some overlapping. The remaining companies on the Stock
Exchange list are too small to fall within the jurisdiction of the Royal Decree 64 of 1967, and are not
compelled to register with the Banking Commission.
Brussels Stock Exchange. The financial holding companies rank third among the
larger sectors. This suggests that, compared with the industrial sector of the
Belgian economy, the holding companies rely rather considerably on the public
for finance. It would be wrong to conclude from this that the holding companies
are controlled by the small investors. Most of the controlling interests in the
holding companies are held either by financial interest groups (Societe Generale
and Almany) or by wealthy families (Electrorail and Bruxelles-Lambert).21 It
seems, however, safe to argue that without the financial support of the public the
holding companies could not function. This argument is the crucial point in later
chapters.
Not only do the holding companies account for a large part of market
valuation but the securities of the holding companies are also very actively
traded in Brussels. From July 1972 to June 1973 the total volume in Belgian
shares was 5,461,676, the holding companies of the Banking Commission list
showed a volume of930,291 shares or 17.0 percent of total turnover in Belgian
shares. 22
Furthermore, the group ofjinancial holding companies was always among the
three most actively traded sectors over the last five years.
Table 8. Turnover at Brussels stock exchange by sector, 1970-1974
1970 1971 1972 1973 1974

in %a rank b in %a rank b in %a rank b in %a rank b in %a rank b
Banks 11.9 2 12.5 3 15.3 2 9.7 1 13.9 1

Holding Companies 10.9 3 13.2 2 20.3 1 7.1 2 9.4 2
Electricity, Gas
and Water 8.9 4 13.9 1 7.7 3 4.2 5 7.0 3
Oil 14.2 1 4.3 8 3.0 10 3.9 6 3.2 6
Distribution 4.4 10 9.1 4 3.7 9 3.5 7 1.7 13
50.3 53.0 50.0 28.4 36.2
Source: Monthly Bulletin, Statistique et Indices.

a. Part of total capital traded in the 'au-comptant' market in Belgian shares and industrial bonds;
data relate to December.
b. Rank of the sector among all sectors.
21. See Crisp, Courrier Hebdomadaire no. 556 June 9, 1972.

22. Calculated from data provided by the Kredietbank (1973).
STABILITY AND VIABILITY OF HOLDING COMPANIES 23
From the foregoing data the holding companies emerge as strategic financial
institutions in the Belgian economy. They playa dominant role in the ac-
cumulation and allocation of capital and they rely rather strongly on the
savings of private investors for financing their activities.
Diversification
Although some of the holding companies on the list of Banking Commission are
industrial holding companies which have concentrated their holdings in a
specific industrial sector, other holding companies have taken controlling
interests in several sectors of the Belgian economy. Table 9, using data contained
in the Receuil Financier of 1972, represents an attempt to shed some light on the
degree of portfolio diversification.
The evidence presented in Table 9 is not perfect and only indicates whether the
holding company held shares of a particular sector; it gives no indication of the
relative importance of that investment in the portfolio ofthe particular holding
company. The sectorial classification is the one used by the Stock Exchange
Commission. Table 9 does not provide information on the industrial holding
companies, such as Tabacofina (tobacco industry), Verreries Mariemont,
Glaverbel-Mecaniver, Glaceries Saint-Roch (glass industry). Even from these
imperfect data it is clear that holding companies are diversifiers, a characteristic
which has been used to explain why these companies, as a group, were among the
favoured investments of the small investors. We shall return to this argument in
detail later.
4. International comparison and the reasons for the stabi-

lity and viability of the holding company
The holding company, being an instrument to organise corporate control and to

structure the flow of capital, has gained a crucial position in Belgian capitalism.
In order to understand more precisely what economic and financial conditions
contribute to the stability and viability of the holding company, it is necessary to
compare briefly the historical experience of the holding company structure in
different nations.
In the U.S.A., the holding company flourished in the last decade of the
nineteenth century. Technological developments in many consumer-oriented
mass markets led to a very rapid growth of productive capacity. The relative
over-supply and the buyers market drove price downwards and producers were
~
Table 9. Portfolio diversification of some holding companies, 1971-1972
'"Q.l o:l
'" o:l
-'"
!>Il <;:)
!=l "0 S
o
.~ .... !=l
!=l '" !=l
Q.l o:l '" ;::l
lo .....o:l .....U
Q.l u ..... » U 0 '" .'3o §'" o
U !>Il o:l t:: ~ .~ oS l:: ~ iG
o Q.l .>=:
!=l
cIj r.IJ
!=l
._
ti
C1J .~ 8 $ ~ .~ !>Il E] .~ Q.l .... .... ....
!=l '" IZI .- ~ "'l:j 'r)
~~::s!"a
'"!=lC. .....'"'" !=l ..... !=l 0 ~
Q.l
o:l
!>Il ] 8-
2'5 5b
'" o:l 0 Q.l o:l Q.l Q.l
e t) 1) Q) ;3 d S ·s ~ Q.l Q.l 0 ] o ~ ~ 0 +-l cIj ._ .~ E;
.... ::l
.sil:)::C~ ~ E-< ~~Vl::EZU ~6 UE-<p..~ il:)tn Op..O o~
>
'"d
1. Alrnanij x x x o
2. Cobepa x x x x x x x x x ~
tIl
3. Finoutremer ~
x x x x x x x x x x x "rj
4. Electrobel x x x x x x x x x x x x er<
5. Bruxelles-Lambert x x x x x x x x x x ......
6. Nationale Ii Portefeuille x x Z
CIJ
7. Electrorail x x x x x x
...,
x x ......
...,
8. Coppee de Develop. Ind. x x x x e...,
9. BDIC x x x x ......
10. Sofina x x x x x x x x x o
11. Electrafina x x x x x
z
x
12. Soc. Generale de Belgique x x x x x x x x x x x x x x x x x
13. Soc. Generale Viscose x x
14. Traction et Electricite x x x x x x x x
15. Union Miniere x x x x x
16. Socfin x x x x x x
17. Ibel x x x x x x x x x
Source: Compiled from data contained in Receuil Financier (1972).

caught in a severe price war. Numerous efforts to form cartels, as in oil and sugar,
failed, because there was no viable way to reduce or to utilise available capacity
efficiently. The holding company structure was an excellent instrument for
implementing control and for coordinating capacity utilisation in ~sveral
autonomous companies. The holding company rose and flourished for a short
time in the American economy because of instabilities and disequilibria in
product markets. Soon, however, the holding company structure disappeared;
its loose organisational structure did not permit a close coordination of the daily
operations in production and marketing. The holding company was superseded
by the large industrial corporation with a modern organisation, an adminis-
trative structure and a control system. Although holding companies continue to
exist in the present-day American economy, they are not typically characteristic
of American capitalism, which - although some disagreement exists 23 - is
managerial capitalism and not financial capitalism. 24
The evolution of the holding company in Belgium and in some other West-
European nations appears then to have been markedly different from the
American experience. Financial intermediaries such as banks and holding
companies have played a much larger role in financing the economic develop-
ment of Western Europe. 25 It is crucial for an understanding of the financial
intermediation in Europe to speculate, without going into great detail,
about the historical reasons for these remarkable differences between the U.S.
and Western Europe.
The stability hypothesis
In this section a hypothesis is developed which explains the stability of finance

capitalism in the Belgian economy and consequently contributes to a better
understanding of why holding companies were able to gain and hold a strategic
position in capital management. The basis for the theory is the testable
proposition that financial intermediaries such as the holding companies which
issue shares to hold shares in other corporations, arose and remained viable
because the demand for external long-term capital was relatively high
(Proposition A). Earlier theoretical and empirical work by Gurley and Shaw, by
23. Jean-Marie Chevalier (1970).

24. In recent years some of the smaller commercial banks in the U.S.A. have come under the
influence of bank holding companies. The activities of these companies are confined to the banking
sector. Such holding companies are not comparable to the large Belgian holding companies. See R.
D. Johnson and D. R. Meinster (1975).
25. For a very important contribution on this subject, see A. Gerschenkron (1966).
Raymond Goldsmith and by others advanced and defended a similar position. 26

Gurley and Shaw have developed a framework to describe how the spending
units or deficit units in the economy (mostly the business sector and the
government) attract external savings from surplus units. It ha~ also been
observed that an expansion in external finance stimulated financial interme-
diation, i.e. the substitution of primary or direct securities for indirect securities.
There are still two undetermined elements in the Gurley and Shaw framework;
first, what factors influence the demand for external long-term finance, and
second, why are primary securities substituted for indirect securities? It has been
argued that the demand for external finance' ... depends on the extent to which
deficits and surpluses rotate by period among spending units .. .'.27 Such
reasoning is flawed, because there is no explanation for what determines the
rotation of deficits among spending units. Consequently, we need a theory for
understanding the demand for external finance in general and the demand for
external long-term funds in particular. At present, moreover, no sound theory
for explaining the substitution of primary long-term securities for long-term
indirect securities exists. Indeed, institutions for financial intermediation in the
long-term financial market are very difficult to explain within the framework of
traditional economic theory. It has been repeatedly demonstrated that every
function of such a financial institution, be it portfolio diversification, the
collection of information, or professional investment analysis, could be perfor-
med at lower cost in a perfect financial market. The only reason why financial
intermediaries are viable in the long-term securities market is that fundamental
imperfections exist in the financial market which can only be circumvented by
creating a new institution. Here we also need some new theory to explain what
these imperfections are and why there was more financial intermediation in the
long-term financial market. 28
It will be shown that the demand for external finance depends on the industrial
structure. The more this industrial structure is biased towards the basic
industries the higher the demand will be for external capital (Proposition B). A
sector is called more basic than another if the ratio of sales to productive capital
(turnover) is lower than in another sector. A theoretical proof of proposition B
follows from the following model. Assume a company with productive assets
equal to K. (We make a distinction between financial assets and productive
assets. Indeed, many corporations hold financial assets above the amount they
need to conduct the operations of their main business activity efficiently. Such
26. Gurley and Shaw (1956). Raymond Goldsmith (1958), David Ott (1961), Rondo Cameron
(1965).
27. David Ott, op.cit., p. 123.
28. See Chapters 2 and 3 of this study.
financial assets may be accumulated for a variety of reasons, such as financial

control over other companies, dividend and earnings stabilization, corporate
taxation, etc.). With the above-mentioned amount of productive capital K the
company realizes a volume of sales equal to S. Productive assets are finav';;ed by
equity capital E, long-term debt D and commercial credit L, the latter being
dependent on sales S. Then, the following accounting identity holds:
K(S) == E + D + L(S)
or
K(S) - L(S) == E + D == V [1]
When the company decides on an expansion plan of sales, L1S, which leaves the
profit rate n intact, it needs to expand its productive assets K. Hit is furthermore
assumed that the turnover ratio p is constant, it follows that:
1
K=-S.
P
Assume also that commercial credit L increases automatically with sales and that
it is proportionally related to sales by the following equation:
L=aS.
Using [1] it is easy to show that an expansion in S implies:
L1K - L1L == L1V

or
1
-L1S - aL1S == L1V [2]
P
Let L/K = 6, the share of short-term liabilities or commercial credit in total

productive assets, [2] can be rewritten as:
[3]
In order to determine the volume of external savings required to finance the

expansion we should subtract from the left-hand side of [3] the portion of L1 V
which is generated internally. Assuming a constant rate of net profit n, total

assets after expansion equal to K l' and the dividend payout ratio equal to d, it
follows that the demand for long-term external finance amounts to:
[4J
where
Given a uniform rate of profit and identical dividend policies, firms in a more
basic sector (lower p) with a smaller capacity for commercial credit and with a
smaller sales volume will need more external savings to finance the same
expansion plan as firms in a less basic sector (higher p).
It is important to note that the need for external finance may be lower than
estimated in [4]. If the firm accumulated financial assets in previous periods, or if
profits were exceptionally high and income taxes created a strong preference for
retaining earnings within the company, the firm could sell off some of its
financial holdings to finance its programme of expansion. Such may well be the
case during the course of a business cycle, which implies that data on external
finance should be collected over a sufficiently long period, so as to correct for
deviations over a short period of time caused by business cycle phenomena.
Next we need to explain why the industrial structure of a particular economy
may be more biased towards such basic industrial sectors as mining, steel and
iron, and heavy transportation equipment (all with a low p) and why the sectors
of the mass-produced consumer durables (with a high p) may account for a
smaller share in industrial output. It is conceivable that the more the distribution
of income is unequal in a particular economy, the more the industrial structure
will be biased towards the basic sectors, if, of course, the natural endowments of
the economy are such that it can supply the basic industries with raw materials
(Proposition C).
Finally, financial intermediation in the long-term financial market will be
more developed if the distribution of wealth is more unequal (proposition D). A
theoretical proof of proposition D is rather complex. The crux of the matter is
that large investors (those who supply such a large amount of savings that they
can expect to influence corporate decision-making effectively) will want an
institution to control the companies in which they invested their savings. This
argument is developed in chapter 6. These were the four crucial propositions of
the stability hypothesis for which we shall next try to find supporting evidence.
No propositions were included to explain the inequality in the distribution of
income and wealth. To explain this inequality we would have to elucidate the
whole economic and social history of Europe.
Some preliminary evidence
At present it is not possible to present sufficient evidence to prove or refute the

stability hypothesis developed above.
For each of the above-mentioned propositions the evidence now available is
given below. For reasons oflogical exposition the order of the propositions was
slightly altered. Since the 1920s and 30s were crucial years for shaping the basic
structure of the holding company system, supporting evidence is sought in these
years.
Proposition C: The industrial structure of Belgium (Europe) was more biased

towards the basic industrial sectors because of the obvious advantages of
location and the unequal distribution of income. The industrial development in
Belgium, France and Germany, at any rate before World War II, was mainly
concentrated in the basic industries: mining, steel and iron, and heavy trans-
portation equipment. The most developed consumer goods industries were
textiles and the food sector. In complete contrast with the developments in these
industries is the very modest development in the mass-produced consumer
durables sector. Historical research, unfortunately, has not brought forward
comparable statistics on the industrial structure of the large West-European
nations in the 1920s and 30s. As a consequence, we have to find support for our
reasoning in less precise statistics and the description provided by economic
historians.
Table 10 illustrates clearly that at least one important European nation was
lagging behind the U.S.A. in one consumer durables market, namely electrical
appliances.
More evidence about the less developed state of the consumer durables market in
Europe is provided by the number of registered cars.
Since the 1930s the automative market has expanded more rapidly in Europe
than in the U.S.A., but it is nevertheless a fact that the size of the automotive
market remained much smaller in Europe. Not only was the size of the
automotive market smaller, but also the demand for intermediate products by
the car manufacturers was relatively smaller in Europe than in the U.S.A. In
Great-Britain only 8.2 percent of total iron and steel production was used for
manufacturing cars; in the U.S.A., however, between 17 and 53 percent of iron
and steel consumption was used by the automotive industry. The European
Table 10. Electrical appliances in use in selected countries, about 1932 (per 10,000 people).
U.S.A. France
Irons 1,580 850

Percolators, kettles 490 200
Heaters, radiators 280 85
Stoves 180 8
Water heaters 7
Vacuum cleaners 740 120
Source: see for source note D. Landes (1969), Table 38.
Table II. Registered motor vehicles in Europe and in the U.S.A., 1905, 1913, 1930 and 1938 (in
thousands).
1905 1913 1930 1938
Europe 81" 426" 5.182 8.381

U.S. 79 1.215 26.532 29.443
Source: See Table 41 in D.D. Landes (1969).

a. U.K., Germany and France only.
economy, from its early industrial beginnings until World War II, was much
more concentrated on the basic and capital goods industries and on some non-
durable consumer goods sector than the U.S. economy, and those consumer
durables which were sold in Europe were often manufactured by American
companies. The industrial structure of the American economy was indeed
shaped by these industrial sectors, which at high volume and speed were
producing the modern durable consumer goods for the affluent domestic mass
market. 29 The reason for this crucial difference in industrial structure is probably
the less equal income distribution and the less affluent and smaller consumer
market in Europe than in the U.S.A. The relative over-supply of labour in
Europe before World War II depressed wages and created high unemployment,
which drastically reduced the size of the consumer market.
Proposition B: The demand for external finance is higher in an economy where the
industrial sector is more basic. This difference observed in industrial structure
has important consequences for the structure of the demand for funds to finance
industrial capital. Indeed, as was argued above, the basic industries have a large
29. A. D. Chandler (1977).

demand for funds to finance fixed assets, which, in relation to sales, are
proportionally greater in the basic industries than in the consumer durables
sector. Therefore, the basic and capital goods industries had to appeal to the
capital market to attract external funds, which, because of the nature 01' these
businesses, will tend to be in the form of equity capital. It is not easy to provide
direct statistical evidence for the argument developed above. The following
pieces of indirect evidence seem to be available. Some of it is widely accepted by
scholars.
In Belgium the family-controlled company held out longer in the consumer
goods sectors than in the basic industries. The reason might be that in those
industries family wealth could provide the necessary initial funds and internal
funds were sufficient to finance the modest expansion.
Direct evidence of the larger need for external funds in Europe after World
War II is presented in Table 12.
From a careful analysis of the sources and the uses of funds provided in Table 12
we come to the remarkable conclusion that the capital markets are relatively
more important in Belgium and France than in the U.S.A. and Germany.
Indeed, a large part of the funds used by the private non-financial enterprises
comes from external sources. Share issues accounted for a high 8.2 percent of
total funds in Belgium and a low 1.3 percent in the U.S.A. Several questions
come to mind immediately in connection with these significant differences in the
financial flows to industry between the U.S.A., where managerial capitalism is
dominant, and some European countries where finance capitalism is paramount.
We may argue that the data presented in Table 12 reflect a temporary
disequilibrium between the demand for funds to finance gross fixed asset
formation and the possibility of the companies to generate internal funds. This
argument does not lend itself to an acceptance of the structural nature of the
differences between the U.S.A. and some continental European countries;
instead, it points to the relatively higher level of capital formation in France and
Germany than in the U.S.A. as the major reason for the phenomenon. Therefore,
the fundamental challenge to the validity of the argument developed on the
previous pages about the influence of the industrial structure on the demand for
external funds and on the stability of finance capitalism in Belgium and some
other European nations is to show that the data in table 12 do not only hold for
the early 1960s, but are also valid in the long run. As far as we know, no
systematic data on the pre-war period were available to clarify the issues.
In an effort to complement these data a consolidated statement of sources and
uses of funds was constructed for 34 Belgian corporations over the period
1920-1930. The companies all belong to the 100 largest corporations in 1920 and
1930. The results are given in Table 13 and support the hypothesis that the
Table 12. International comparison of sources and uses offunds by private non-financial enterprises
1960-64 (in percentages).
Belgium France Germany USA

(1961-64) (1961-64) (1960-64) (1961-64)
1. Sources
11. Internal
111 Net Savings 17.4 26.5
112 Depreciation 40.5 41.4
Total 57.9 52.3 67.6 69.7

12. External
121 Shares 8.2 6.2 4.1 1.3
122 Bonds 1.7 3.7 2.1 5.3
123 Direct Foreign Inv. 8.3 34.6 3.6
124 Bank Credit 10.8 18.2 5.2
125 Other 13.1 4.4 18.5
Total 42.1 44.5 32.4 30.3

13. Statistical Adjustment 3.2
TOTAL SOURCES 100.0 100.0 100.0 100.0

2. Uses
21. Gross Capital Formation
211 Fixed assets (Gross) 77.7 77.6 79.4 69.5
212 Inventory changes 11.4 7.7 7.3 5.8
Total 89.1 85.3 86.7 75.3

22. Financial assets
221 Bonds, shares 5.9 5.0
222 Foreign investments 1.9
223 Cash and other liquid
assets 1.7 9.7
224 Other 1.4
Total 10.9 14.7 13.3 20.3

23. Statistical Adjustment 4.4
TOTAL USES 100.0 100.0 100.0 100.0
Sources: Compiled from data contained in O.E.C.D., Capital Markets Study, IV, Utilization of
Savings, Paris, 1967. For Germany, Table 3, p. 210. For U.S.A., Table 6, p. 518. For France, p. 164.
For Belgium, data were taken from B. Snoy (1970).
ST ABILITY AND VIABILITY OF HOLDING COMPANIES 33
Table 13. Consolidated statement of sources and uses of funds 1920-30.
Uses Sources
Net fixed capital formation 65.9% External funds 67.7%

Portfolio investments 19.0% New shares 24.5%
Working capital 15.1% Bonds 33.8%
(short-term assets minus Other long-term debt. 9.4%
short term liabilities
Internal funds 32.3%
Total 100% Total 100%
Source: Balance sheet data for 34 Belgian non-financial corporations.

Note: The research work of Noel Pauwels is gratefully acknowledged.
demand for external long-term funds was relatively high in the Belgian economy
during the interwar years.
Proposition D. Financial intermediation in the long-term securities market
increases if the distribution of wealth is unequal. No precise data are available at
present about the historical distribution of wealth in the Belgian economy, but it
is generally accepted that wealth was and is highly concentrated.
Conclusion
The basic argument of the stability hypothesis can be restated as follows. The
demand for external capital by the basic industries and the relatively large
influence of these sectors in the industrial structure explain why holding
companies were able to playa larger role in the economic development of
Belgium than their American counterparts could do in their economic
environment.
Since the financial intermediaries, because of capital market imperfections
and the historical concentration of wealth, could coordinate and control the
accumulation and allocation of wealth, they became the obvious suppliers of
funds to industry in Belgium and in Europe. In exchange for the funds, they
obtained control over the industrial sector. The institutions for organising
corporate control in Belgium, such as the holding companies, were consequently
financial institutions and they flourished, because they were the only ones to
meet the financial demands of the basic industries. These institutions were viable
and became strategic in the European setting in view of the relatively high
demand for external funds by the companies in the basic industries. 30
After World War II, when the structure of industry in Europe - under the
influence of a more affluent mass oarket - changed more towards the consumer
durables sectors, the holding companies probably lost some of their overall grip
on the European industry to the American multinational companies. European
managerial capitalism may be in the making, but it still has a long way to go to
erase the long historical roots of finance capitalism.
5. Managerial organization of control
Although it is tempting to compare the large Belgian holding company, because

of its typical characteristics described above, with the American conglomerate
and the Japanese zaibatsu, the comparison is misleading. The typical American
conglomerate generally holds close to lOO percent of the equity capital of a
subsidiary. Only exceptionally will the holding company, directly and indirectly,
hold such a large percentage of the equity capital of its subsidiary.31 The
conglomerate pursues a fairly well-defined corporate policy through a divisional
organisation. The subsidiaries are managed as a division by the corporate
headquarters, which uses formal and standardised reporting mechanisms and
uniform control systems to implement corporate policy and to evaluate
divisional performance. The holding company conducts an ill-defined corporate
policy through a loose organisation, which might be too flattering a term to
describe the real system. The directors of the holding company preside over or
are members of the board of the subsidiary. Often the directors have built up their
careers in the subsidiary under their present control; this may provide them with
a strong technical background, but it sometimes prevents them from making the
hard economic and financial strategic decisions concerning their company.
There is nothing in the holding company comparable to the staff functions of the
30. Some of the previous literature about the holding companies comes close to making the opposite
argument as the one advanced here. Revue Nouvelle (1972), Joyce, (1964), A.B.V.V. (1956), suggest
that the financial groups confined their investment activity to the basic and capital goods industries,
because such groups do not want to invest in modern consumer durables sectors; they are too
conservative and lack the entrepreneurial drive. Although this explanation for the holding
company's investment strategies might contain some truth, it surely cannot explain the existence and
the historical stability of the holding company structure. For more details about this point see
Chapter 7.
31. See the annual reports of the Societe Generale de Belgique, the largest financial holding company.
MANAGERIAL ORGANIZATION OF CONTROL 35
conglomerate's head office. 32 Uniform control systems such as standardised

accounting practices are not utilized, which should make it much more difficult
to coordinate the operations of the subsidiaries and to evaluate performance.
There is nothing like the open and agIessive image-building which is being
practised by the American conglomerate and the Japanese zaibatsu. Neither are
uniform corporate symbols used, nor are subsidiaries announced as 'XYZ
another division of ABC'. From the point of view of organising control it
appears therefore that the large Belgian holding company, probably by a lack of
agressive competition, has not followed the organisational innovation in-
troduced by American management and continues to rely more on trustworthy
people than on efficient organisation. The holding company structure is
probably the poorest way in a modern economy to organise control, which
apparently is the central business of the large Belgian holding company. Finally,
it is very important to realise that the conglomerate movement is an industrial
phenomenon which was innovated by industrial corporations in search of
unrelated diversification on the basis of transferable managerial talents. The
holding company is largely afinancial phenomenon. For practical reasons then,
it is not feasible to compare the Belgian holding company with America's newest
business institution, the conglomerate. Analytically, however, it might be
instructive to use some of the theoretical reflexions about the capital manage-
ment function performed by the conglomerate, as will be done later on.
Comparisons with the American conglomerate are bound to be misleading,
because fundamental differences exist in managerial organisation of control.
Would a comparison of the Belgian holding company and industrial combine
with the control techniques of the Japanese zaibatsu be more fruitful? Hadley 34
mentions four control techniques frequently used by Japanese zaibatsus
common ownership, personnel, credit and centralized buying and selling. The
last-mentioned control function is performed by the famous and aggressive
Japanese trading companies. The large Belgian holding company only uses three
of the four control techniques, i.e. common ownership, personnel and industrial
credit. No centralised buying or selling exists, and no trading companies are used
to sell the products or buy the material inputs for the subsidiaries of the holding
company. Again, it must be concluded that the managerial organisation of
corporate control is ill-developed and weak in the Belgian holding company.
32. Nevertheless, some subsidiaries perform R&D activities for other subsidiaries belonging to the
same financial group. A good example is Traction et Electricite which is the engineering and
research subsidiary of the Societe Generale de Belgique.
32. Hadley (1970), p. 28.
6. Concluding remarks
Several important conclusions vnerge from the foregoing description of the

history and the role and functioning of the large Belgian holding company.
There is first the remarkable stability of the holding company institution.
Roughly 150 years ago the institution was doing what it does today, issuing
publicly financial claims to hold claims in companies with the objective of
monitoring these companies financially and otherwise, if necessary. Second, it is
crucial to remember that most of the holding companies are incorporated, with
shares publicly and often actively traded on the Brussels Stock Exchange. The
holding companies' subsidiaries too are incorporated and are among the largest
Belgian industrial and financial corporations. The large Belgian holding
companies, as a consequence, are neither purely financial devices for organising
tax evasion across national boundaries, as is the case with many so-called
holding companies in Europe's fiscal paradises; nor are they solely financial
instruments for managing family wealth, since they manage capital from small
savers as well. Third, not all of the holding companies hold diversified
portfolios; some are specialised in certain industries, such as glass, petrol,
electricity and tobacco, but in general all of them operate in basic and more
traditional capital-intensive industries, leaving the newer industrial sectors as
chemicals and mass-produced consumer durables to foreign groups or to joint
ventures with other financial groups.
In this synthesis the large Belgian holding company is shown as a financial
institution that plays a crucial and strategic role in organising, coordinating and
controlling the accumulation, allocation and flow of capital within a market
setting, since the shares of both the holding company and its subsidiary are
publicly traded. The real challenge, then, lies in the explanation of the economic
and financial conditions that contribute to the stability and viability of this much
debated institution within a capital market setting. In the next two chapters
attention is foc'used on the role of the holding company as a financial
intermediary.
III. HOLDING COMPANIES AND FINANCIAL
INTERMEDIATION: THEORY
1. Introduction
Holding companies are instruments for structuring and organizing control over
corporate decision-making. Such institutions permit large investors to influence
corporate policies, but they can only function when small investors support the
institution by supplying capital. Indeed, as was demonstrated in Chapter 2,
holding companies issue shares to hold shares in other companies and a security
substitution is consequently taking place in the Belgian capital market. The basic
question we shall deal with in this chapter is to find the conditions under which
small investors (those who cannot influence corporate decision-making) will
accept the substitution of securities. Previous writers on the subject have argued
that, because holding companies have interests in different companies in different
sectors, they are able to present a diversified portfolio to the small investor. In line
with recent developments in capital market theory it will be shown that such a
reasoning is flawed and that only in imperfect capital markets will small investors
find it profitable to buy holding company securities for diversifification.
The theory is directly testable and performance measures of holding company
securities can be constructed. In this chapter, however, we will limit ourselves to
the theoretical developments. Statistical tests are presented in Chapter 4.
2. The basic model: Capital-asset-pricing in a two-

parameter world 1
In order to evaluate the performance of a particular security correctly and to

estimate the effect of diversification on such an asset, an explicit theory of capital-
asset-pricing was formulated in the relevant literature. A major difficulty in
1. The literature on capital-asset-pricing is abundant. For a review of this literature, covering the
fundamental developments, and a bibliography see M. Jensen (1972). The reader who is familiar with
the capital-asset-pricing model can turn to section 3 without loss of the general argument.
38 HOLDING COMPANIES AND FINANCIAL INTER MEDIA TION
developing such a positive theory is the existence of risk and uncertainty. A

methodology should be developed to measure this risk and it must be shown how
security markets with rational investors will price risk and uncertainty.
Let us assume that I rational iii vestors exist in an economy with J risky assets.
No riskless asset exists. The rates of return fj on the J assets are joint normally
distributed with expected returns E(fj) and the variance-covariance matrix is
given by the general element ajh' All investors agree on the joint probability
distribution and base their investment decisions (because of the above assump-
tions about the probability distribution) on two parameters, the expected rate of
return and the portfolio variance.
Let xij be the proportion ofi's portfolio invested in assetj. The expected return
E(fpJ on investor i's portfolio is given by
E(fpJ = L xijE(f) [1J

j
where by definition L xij = 1

j
Individual i's portfolio risk is given by the variance of the portfolio's rate of
return.
a;i = L L xijxihahj [2J

j h
where a;i stands for portfolio variance and a hj is the covariance of rates of returns
on asset h with rates on asset j.
It is useful to rewrite [2J as follows:
api = L xijPjpPj [3J

j
where Pjpi = [cov (fj , fpJJ/a pPj is the correlation coefficient of asset j 0n the
portfolio returns. It is important to realize that the risk of asset j, if it is in a
portfolio, is not equal to the standard deviation of that asset, but only a fraction of
the asset's standard deviation or total risk. The real measure of risk of an asset (i.e.
systematic risk) is the covariance of that asset with the portfolio divided by the
portfolio's standard deviation. By combining assets in a portfolio the investor
need not bear the full risk of asset j, but only the asset's systematic risk;
consequently, he should not demand a financial compensation for the full risk of
assetj.
Employing this effect of diversification on portfolio risk the investor can select
THE BASIC MODEL 39
a portfolio (xi!' ... , xij) such that for a given portfolio return E(rpi ) the portfolio
risk is minimal. Such a portfolio is efficient. The investor's portfolio selection
problem is nothing more than a constrained minimization problem for which the
Lagrangean is written as:
L = (J;i + 2Ai(E*(rp;) - L xijE(~)) + 2,u;(1 - L xij) [4J

j j
First order conditions for a minimum require:
L Xih(Jhj - AiE(I~) - Ili = 0 forj=(l, ... ,J) [5J

h
E*(Fpi ) = LXijE(F) [6J

j
[7J
Under appropriate assumptions a unique solution exists for the (J + 2)

equations [5J, [6J and [7]. Consequently, it is possible to derive the individual
demand equations for assets. Before deriving the equilibrium market prices from
these equations let us define Wi as investor i's share in total wealth W of the
economy. For a givenj, multiply equation [5J by Wi and sum over all investors.
Define y = L willi' J = L Willi and Sh = L WiX ih' the share of assetj's valuation in
i i i
total market valuation W
LSh(Jhj - yE(f) - J = 0 [8J

h
Since L Sh(Jhj = cov (Fj> Fm)' where Fm = L S/h,the rate of return on the total
h h
market, it is possible to rewrite (8) as:
[9J
Equation [9J defines the equilibrium rate ofretmn and the price of assetj. If[9J is
multiplied by Sj and summed over j, it is easy to verify that [10J holds.
(J2 J
~=E(F )+- [1OJ
y m y
40 HOLDING COMPANIES AND FINANCIAL INTERMEDIATION
Let [cov(rj , rm)]/u! = Pi' where u! is the variance of the market's rate of return;
then it follows after substituting [10] in [9], and rearranging terms that:
[11]
Equation [11] gives the equilibrium expected rate of return on asset j. The
meaning of Pj is fairly easy to discover. It is well-known that total market risk is
equal to a weighted average of market's covariances with the individual assets.
u! = :L Sj cov (ri' rm)

j
The fJ's are therefore a scaled measure of assetj's risk in the market portfolio. The
real or systematic risk of an asset is consequently given by Ppm. This analysis
shows that in equilibrium the expected rates of return depend linearly on Pj , being
the measure of risk.
Next, the meaning of the term - (J/y) should be determined. Let us assume that
one builds up a portfolio ()j of all assets traded in this capital market. The
expected rate of return on this portfolio is given by [12].
[12],
where :L()jPj = pz is equal to the portfolio's covariance with the market divided
j
by the market's variance, i.e. the portfolio's risk. If we assume that Pz = 0 it
follows that:
[13]
So the term - (J/y) is the return on a portfolio with a zero beta. There are an
infinite number of portfolios satisfying the conditions:
THE BASIC MODEL 41
and
The portfolio is selected such that there is minimum variance. The solution of a
simple, constrained minimization problem will enable us to find the portfolio
(Oi, ... , OJ).
In sum, E(fo) is the rate of return on a minimum-variance zero-beta portfolio.
Since all other zero-beta portfolios have the same return E(ro), but higher
variance, the minimum-variance zero beta portfolio is an efficient portfolio.
Some economists will rightly feel uncomfortable with the rather technical
interpretation of the - (Jjy) term as the return on the minimum-variance-zero-
beta portfolio. Indeed, the interpretation is too mathematical and lacks a 'real-
world' content. Although much of the very recent literature does not develop this
point, it seems possible to attach a more profound economic interpretation to the
[-(Jjy)J or E(ro) term.2 Although most writers, including F. Black, who first
derived a modified version of equation [11J in a different way, state that they are
working with a two-period model, they are really developing the theory as we did
above, i.e. within a timeless or one period world. 3 So what is really missing in the
derivation of [11 J is the investor's justified demand to receive a compensation for
his abstinence of present consumption. The model with J risky assets misses a
theory of interest rates. A glance at the specification of the constrained
minimization problem [4J suggests that - (Jjy) can be interpreted as a weighted
average of the I investor's marginal rate of substitution of present consumption
for future consumption under all possible states of the world. 4 Such a reasoning
suggests that E(ro) is nothing else than the market's price for abstinence under
uncertainty. E(ro) is consequently a generalized interest rate and provides a
substantial broadening of the theory of interest. Stated differently E(ro) is the
premium for abstinence in a two parameter uncertain world.
The foregoing analysis makes it possible to rewrite equation [11 J and to give it
a more precise interpretation.
[14J
or
[15J
2. D. Mayers (1973).
3. F. Black (1972).
4. See also footnote 2, this chapter.
The LHS of [14] or [15] is the excess return on assetj, i.e. the premium for risk
received in addition to the premium for abstinence. This excess return is equal to
the amount of asset j's risk (fJp m) multiplied by the price of risk
the return per unit of risk.

We have then found a solution to the two problems mentioned at the beginning
of this chapter. A measure of the amount of risk associated with a particular asset
was obtained, and the market price of risk was determined.
Equation [14] permits the individual investor (and the researcher) to evaluate
whether an asset is correctly priced in the capital market.
When
[16]
and IX > 0, the asset is undervalued, or

IX < 0, the asset is overvalued, or
IX = 0, the asset is rightly valued.
The IX coefficient of [16] is consequently a theoretically sound performance

measure.
Before making an analysis of the effect of diversification on holding company
securities, we shall illustrate how the model developed above would differ if a
riskless asset was available.
In case of the existence of a riskless asset the RHS of [14] is zero, because such
an asset has no risk by definition (fJ F = 0, F being the index of the riskless asset).
Consequently, there is no reason why the investor would expect a premium for
risk on such an asset. The only premium on the riskless asset is the reward for
abstinence as can be seen from [17].
[17]
This being assumed, the expected return on assetj is equal to:
[18]
In sum, this section has presented some important results about the measurement
and pricing of risk in a two-parameter world. It was possible to derive explicit and
testable hypotheses about asset-pricing and efficient portfolios.
SECURITY SUBSTITUTION BY HOLDING COMPANIES 43
3. The case for and against security substitution by hold-

ing companies
Previous writers on the subject and prospectuses of holding companies em-

phasized that small investors were benefiting from the holding companies'
diversified portfolios. They argued, again without an explicit theory, that holding
company securities were interesting to the investor, because he could hold a
diversified portfolio, and consequently earn an extra return on those securities.
Using the theory of the foregoing section, it is possible to test the theoretical
soundness of such a proposition.
In a perfect capital market, rational investors will be holding efficient
portfolios and expected returns on asset/s will be given by equation [14]. Let us
assume that a holding company forms a portfolio (hi' ... , hj)' Assuming that the
holding company does not charge a management fee, the expected return on such
a portfolio is given by:
E(fH) = L hjE(~) = (1 - L. h/J)E(fo) + L h/JjE(fm)

j j
or by:
[19]
when
Equation [19] is exactly what an individual investor could have expected on his
own ifhe wanted to duplicate the holding company's portfolio. In perfect capital
markets there is no case for the substitution of securities by the holding
companies. Investors will be indifferent betw~en 'private' diversification and
'institutional' diversification. It should be stressed here again that there is also no
guarantee that the portfolio held by the holding companies is efficient in the risk-
return space.
This result about the neutrality of institutional diversification on asset-pricing
in perfect capital markets is well-known and has received considerable attention
in recent financial literature. The point was most provocatively advanced by Jan
Mossin: 5
5. Jan Mossin (1973) p. 79. See also: Levy, H. and Sarnat, M. (1970).
... The principal explanation of (or defense for) conglomerate mergers is that they allow
firms to diversify and thus spread out risk. However, with an efficient security market there
is no need for an individual company to diversify, since stockholders can obtain precisely
the same effect by diversifying their own portfolios (which is just what they do if they act
rationally). Dismaying as the idea may seem to a particular company's board of directors,
the market doesn't give a damn for the legal entity called the company; it is the real side of
the economy that matters, not how ownership is organized. 6
The reasoning implies that no financial rationale exists for small investors to
support the institutional substitution of securities in an active manner. One
economist, however criticised the foregoing theory.
Wilbur G. Lewellen 7 has argued that diversified firms have a larger debt
capacity because the default risk on debt payments is lower in a diversified firm
than in an undiversified one. Is this argument valid for the explanation of security
substitution by the holding companies? Strictly speaking it is not, because the
central assumption of Lewellen is that companies are fully merged and form a
judicial entity. This is obviously not the case with the holding companies. The
subsidiaries of these companies are indeed legal entities on their own.
Nevertheless, it might be argued that the debt capacity of the subsidiaries is
larger, because other companies of the same group can provide financial
guarantees to the debtors. But what will be the reaction of stockholders and
debtors of these other companies which are providing the guarantees? As yet no
complete theoretical development of this argument has been worked out and it
will not be attempted here.
So far we have shown that in perfect capital markets no case exists for financial
intermediation by holding companies. Such a case may exist in imperfect
markets. 8 In the absence oftransaction and information costs, rational investors
will not find it difficult to hold diversified portfolios, although then they have to
manage several different kind of stocks. If however transaction costs are high and
information is not freely available, investors may be forced to specialise in a very
limited number of stocks.
Let us assume that every investor is forced to specialize in only two assets, one
riskless and one risky. For simplicity's sake put J = 3. Expected rates of return
are E(il)' E('2) and variances (J~, (J~. The alternatives available to the investor are
given in Figure 1, assuming that he can lend or borrow at a riskless rate rr Since
we assume that all investors hold homogeneous beliefs and are mean-variance
utility maximizers, it is clear that all will try to hold portfolios on line II.
6. This last proposition is only true for small investors, as will be shown in Chapter 6.
7. W. G. Lewellen (1971).
8. See also H. Levy and M. Sarnat (1972).
SECURITY SUBSTITUTION BY HOLDING COMPANIES 45
Consequently, the price of asset 1 will drop, expected return will rise and risk will
decline. Market pressure on asset 2 will drive up its price, will lower return and
increase risk. In equilibrium all assets will be on one line through r F as indicated
in Figure 2.
Figure 1
Figure 2
Equilibrium relations for expected return can be derived from Figure 2.
or
[20J
The results indicate that returns are linearly dependent on risk, but risk is
measured, contrary to our earlier results, by the standard deviation of the asset
returns and not by systematic risk. In an economy where investors are forced to
remain specialists in a very limited number of securities, equilibrium returns will
consequently depend on standard deviation and not on the p's as is the case if
investors are 'diversifiers'. The empirical implication of this result is obvious.
How will the picture change when a holding company organises a security
substition? Such a holding company combines assets 1 and 2 and substitutes the
formerly independent securities for its own securities. The portfolio constructed
by the holding company will probably not be efficient in the mean-variance sense,
because the holding company maximizes different objectives. Figure 3 illustrates
what will happen to equilibrium in the market.
The small investors (i.e. the investors who cannot influence policy) will profit
from the functioning of the holding companies in an imperfect market. If
investors are specialists, a case for security substitution and financial in-
CONCLUSION 47
termediation by holding companies exists. H. Levy and M. Sarnet came to a

similar conclusion but the derivation of their argument is not complete, since they
neglected to bring forward the effects on asset pricing. 9
4. Conclusion
Security substitution and financial intermediation by holding companies are

important characteristics of the Belgian financial markets. In this chapter the
theoretical conditions are studied which make substitution viable in security
markets and we have tried to indicate the benefits of security substitution for
small investors. In perfect capital markets where rational investors hold
efficiently diversified portfolios, there is no reason for 'institutional'
diversification. The more so since 'institutional' diversification and security
substitution are expensive, because management fees must be paid to the
managers of the holding companies. ! 0
By reducing default risk, 'institutional' diversification, may, however, affect
debt capacity and optimal financial leverage of the financial group.!! A major
complication arises with this explanation of institutional diversification, because
the controlled subsidiaries are legal entities and could, in principle, transfer cash
flow on a temporary basis only.
There is a real benefit if transaction and information costs prevent the small
investors from diversifying efficiently. In that case holding companies can
improve the wealth position of the small investors.
Whether markets are perfect or imperfect and whether holding companies
have a superior or poorer performance, are empirical questions. This chapter has
provided the necessary specifications to test these hypotheses in the next chapter
of this study.
9. See footnote 8, this chapter.

10. See also Table 6, Chapter 2.
11. This hypothesis is, in principle, testable. An international comparison ofleverage ratios in those
industries where Belgian holding companies are most active, is one way of testing the hypothesis. The
reader is also referred to the data contained in Table 3. Many of the holding companies
hold deposits of their subsidiaries. Those deposits can be used by the holding company in other
companies to create a safety block in case of insufficient cash flow.
IV. HOLDING COMPANIES AND SECURITY
SUBSTITUTION: EVIDENCE
1. Introduction
It is a typical, but controversial, characteristic of the Belgian economy that large

holding companies control a substantial part of the crucial savings/investment
process. Indeed, the holding companies issue shares in the securities market in
order to finance their controlling interests in large industrial and financial
corporations, some of which have their shares publicly traded in the stock
market. It is consequently a real challenge for the economist to explain why such
a security substitution and financial intermediation is taking place in the Belgian
capital market.
Financial intermediation can easily be explained in the short- and medium-
term financial markets and in particular long-term markets such as the
mortgages market. Indeed, because of transaction-, information-, monitoring-
and management-costs, it is uneconomical for deficit- and surplus-units to settle
their short- and medium- term financial liabilities and claims outside the banking
and financial system. A financial institution is indeed an efficient instrument to
economise on the costs associated with allocating scarce financial resources in a
short period of time through markets. 1 But it is hard to see immediately what
benefits can be obtained from the intermediation which is organised by the
holding companies in the long-term securities market. Here, it is useful to make a
distinction between those investors who can influence corporate decision-
making, henceforth referred to as large investors, and small investors who cannot
affect corporate decision-making because they are price-takers in the asset
market and because they are outvoted, on an individual basis, in the general
assembly. It will be demonstrated later that large investors can gain from an
institution such as the holding company which permits them to monitor
corporate decision-making, because it allows them to enforce their corporate
policy preferences. In order, then, to reduce the risks of holding large controlling
1. For asimilarline of reasoning see the recent contribution ofG. 1. Benston and C. W. Smith (1976).
50 HOLDING COMPANIES AND SECURITY SUBSTITUTION
interests, the large investors incorporate holding companies and issue holding
company securities which are sold to the small investors. It has been demon-
strated above that in perfect and efficient capital markets with rational investors,
capital-asset prices will be such ~hat small investors are indifferent about the
security substitution which is organised by the large investors through the
holding companies. Under these conditions there is no reason why small
investors would prefer to buy institutional portfolio diversification from the
holding companies.
When capital markets, however, are imperfect because of transaction- and
portfolio-management costs, small investors want to economise on the number
of shares they hold. Under these circumstances, investors might benefit from
'institutional' diversification. The security substitution which is being organised
by the holding company, then, enables the small investor to economise on
transaction and monitoring costs and permits him to diversify his portfolio
holdings with a smaller number of securities. The substitution of securities can be
called an efficient substitution when the holding company's portfolio is efficient
in a mean-variance sense.
In this chapter we present the empirical evidence. Using the capital-asset-
pricing model developed in the foregoing chapter we evaluate financial perfor-
mance of holding company securities in the Brussels capital market and test
whether holding companies have reduced diversifiable risk, i.e. whether the
security substitution is efficient in the mean-variance sense. Finally, we provide a
first and rather rough empirical test of capital-asset pricing and market efficiency
in the Brussels stock market.
2. The statistical methodology2
It was argued above that the welfare efficiency of security substitution in the long-
term financial market by holding companies depends on the efficiency and
perfection of the capital market. An efficient capital market is a market where all
available information about a security is reflected in its price. Consequently in an
efficient market the prices of stocks behave randomly. A market is called perfect
when investors are price-takers and when no transactions of information costs
2. After this section was completed I became aware of Roll's fundamental critique of the statistical
tests of the capital-asset-pricing paradigm (Roll, 1976). If his critique, which is the sole dissident
opinion in the whole field of finance to date, is indeed correct, the statistical methodology used in the
paper should be handled with care. Further scientific contributions in the field of finance will clarify
this issue. For the time being it does not seem unreasonable to continue relying on the more
traditional statistical methodology of the capital-asset-pricing model.
THE STATISTICAL METHODOLOGY 51
are to be paid. As shown in Chapter 3, efficient and perfect capital markets imply
that expected rates of return on assets are given by equation [1].
[lJ
where Pi is the relative risk measure of j in the market portfolio (provided this
portfolio is mean-variance efficient),
'i' 'm'
'0' stand for the stochastic returns on assetj, on the zero-beta minimum
variance portfolio, and on the market portfolio. E is the expected value operator.
When a 'really' riskless asset exists with a rate of return equal to r F , it can be
shown that E(fo) = r F . 3 In the literature this modified equation is known as the
Sharpe-Lintner-Mossin model and will henceforth be referred to as the variant of
equation [1].
Equation [lJ, however, is an ex-ante equilibrium relationship and cannot be
tested directly. A test is nevertheless possible when assumptions are made about
the stochastic processes generating the rates of return. Several hypotheses can be
formulated about the stochastic return-generating process. The process can
follow a one-factor or a two-factor model. Black, Jensen and Scholes 4 in a
pioneering paper showed that two-factor-models explain the rates of return on
American stock exchanges better than one-factor-models. Elsewhere, however, it
was demonstrated that for the Brussels stock exchange a one-factor model
appears to capture the return-generating process fairly well. 5 In this study, then,
we limit ourselves to a one-factor return-generating process.
Assume that the rates of return on all risky assets j ('1"'" 'i' ... , 'n) are n-
variate normally distributed. 6 It then follows from well-known theorems in
multi-variate statistics that Pi and any linear combination of (P1 , • .• , Pi' ... , Pn ) are
bi-variate normal. 7
The return,m on the market portfolio is such a linear combination of (1\, ... , 'i'
... , Pm) and consequently and 'i 'm
follow a bi-variate normal distribution. Bi-
3. See Chapter 2.
4. Black, Jensen and Scholes (1971).
5. Daems (1975).
6. The statistical derivation which is given here is only one of the many approaches possible. This one
is the least co=on in the literature and was therefore singled out. For other derivations see Blume
and Friend (1973), p. 21 and Fama (1976).
7. For a proof, see M. G. Kendall and S. Stuart (1969), p. 380.
variate normality implies that the conditional distribution of fj given fil' is normal
with mean: 8
This allows us to write the stochastic return generating process of f j , conditional

on r m , as:
[3]
where ej is normally distributed with zero mean and finite variance.

After rearranging [3] the ex-post testable equation [4] is found:
[4]
To see the testable implications it is useful to rewrite the variant of equation [1] as
follows: 9
where !Xj = 0, implies that assetj is correctly valued,

> 0, implies that asset j has a superior performance
!Xj
and !Xj < 0, implies that asset j has an inferior performance.
Substituting [4] in [3] it becomes obvious how the ex-ante equilibrium relation
can now be written in an ex-post observable relation [5]:
[5]
Assuming that Pj is fairly constant over the relevant period oftime, the time-series
version of the ex-post equilibrium relation can be written as:
[6]
If the Brussels stock exchange is efficient, the time-series regression of equation

[6] should provide no evidence of serial correlation in Gjt' Such a finding would
lead us to support the hypothesis of random behaviour in stock prices. Efficiency
8. See Mood and Graybill (1963), p. 202.

9. See also Chapter 2.
THE STATISTICAL METHODOLOGY 53
and perfection would also require the estimated aj to be insignificantly different

from zero. 10 Such a result would lead us to conclude that it is not possible to
reject the hypothesis that assets are not correctly valued.
The rate of return on government se.:urities, henceforth denoted by l"gt is
probably in a period of a stable rate of inflation the closest approximation of the
rate of return r Ft on a 'really' riskless asset. So by assuming that r Ft = rgt' it is
possible to use a time series of rates of return on government securities as a very
close proxy of rFt' the reward for abstinence. Consequently, our results depend on
fluctuations in the rate of inflation.
A more direct test of perfect capital markets can be obtained from a cross-
sectional version of the equilibrium relationship. Equation [7J postulates that
average excess returns on an asset j depend linearly on Pj' the measure of risk.
[7J
Where rj and r F are average rates of return over the sampling period. If capital
markets are perfect the estimates of 61 and 62 should be such that 61 = 0 and
62 = rm - rpo In that case small investors will be indifferent about security
substitution by the holding companies. This would not be the case when equation
[7J does not hold but equation [8J does.
[8J
Indeed, equation [8J implies that excess returns depend on the security's total
variance which includes diversifiable risk. If such a result was found, it would
provide evidence that the capital market is segmented and that investors,
probably because of imperfections, specialise in certain securities. The small
investors will consequently profit from the security substitution by the holding
companies. We are then interested in testing whether the holding companies
contribute to an efficient substitution, i.e. whether their securities have less
diversifiable risk. The degree of diversifiable risk contained in a security is
measured by the correlation coefficient between security returns and market
returns. It is consequently possible to evaluate the degree of diversifiable risk by
studying the coefficient of determination R2 of the regression equation [6]. The
larger R2, the smaller the amount of diversifiable risk contained in a single
security. Securities with low amounts of diversifiable risk permit the investor to
economise on the number of securities to be held in his portfolio and save him
portfolio management costs.
10. Estimated coefficients of (Xj and Pj are noted as &j and ~.

Before presenting the empirical results we describe the sample used in the
empirical tests.
3. The sample
Most previous studies of the Belgian capital market generally used fairly small
samples. Two large commercial banks, Kredietbank and Generale Bankmaat-
schappij, systematically collect data, but those data banks were either not
available or were not suitable for our research.
We, therefore, decided to construct a new and a large data bank of monthly
stock market data. The period covered in the research ran from the end of
December 1963 till the end of December 1973. The sample was constructed in
three parts. The first and largest part of the sample consisted of the securities
included in the Kredietbank's stock market index (KB-index). This index in 1968
contained 75 securities; the market value of the index is probably around 80 per
cent of total market value. 11 The second part is a random selection of 25
securities from the remaining securities on the list of the over-the-counter market
in Brussels. The third part is composed of the holding companies which were on
the Banking Commission's list of holding companies and which were not yet
included in part 1 or 2 of the sample. The total size of the sample was 115
securities, which is probably large enough to account for over 90 per cent of total
market valuation in the Brussels's over-the-counter market. A list of the
securities contained in our sample can be found in Appendix C of Daems
(1975).12 Monthly rates of return were then computed for the sampled securities
over the period January 1964 till December 1973. These rates of return were
adjusted for cash dividend payments, for stock dividends, for stock splits and for
subscription rights to new offerings. The rates were calculated using formula [9J:
[9J
where r i . t rate of return of security j in period t

Pi . t price of security j at the end of month t
Pi •t - 1 price of security j at the end of month t - 1
11. Vernieuwing van de aandelenbeursindex van de Kredietbank, Weekberichten van de Kredietbank 23°
Jaargang no 12,23 maart 1968.
12. I am very grateful to the staff of 1nforma S.A. and to the staff of the Echo de la Bourse for kindly
providing me a with complete collection of the Echo de la Bourse and for offering the facilities to copy
the lists.
THE EMPIRICAL RESULTS 55
Dj,t dividend, if any, during month t

k.J, t coefficient 13 for adjusting previous financial data in case of stock
splits, rights offering or stock dividend in period t. (The coefficient
= 1 when no adjustment is nt:eded).
Formula 19] assumes that investors are price-takers in the capital market,
otherwise the investor who presently is not trading in security j could not use the
rate of return r.J, t as an estimate of the rate of return which he could obtain when
he started trading in security j. Indeed when the investor's actions influence the
price of security j, formula [9] is not an exact evaluation ofthe return onj. This
might well be the case for some securities in our sample since some of the sampled
securities have extremely low yearly trading volumes.
None of the existing stock market indices could be used to calculate the market
rate of return r m' because these indices only capture the changes in market
valuation and ignore dividends. In order to correct for this deficiency we decided
to construct a new index of returns on the market portfolio, For every month a
weighted average was calculated of the returns on the individual securities:
The weights in the aforementioned formula are the number of shares outstanding
of security j at time t (nj,t) divided by the total sum of shares in the market. 14
Finally the rate of return on government securities, the best approximation of
r Ft during a period of stable inflation, was taken to be the rate of return on one-
month Treasury Bills. 15 Since those rates are expressed in yearly values they were
divided by 12 to approximate the monthly rates.
4. The empirical results

Financial performance of holding and non-holding companies: time-
series tests
The total period of 120 months was divided in two equally long sub-periods
running from January 1964 till December 1968 for the first sub-period and from
13. Data about the coefficient were obtained from the publication of Informa S.A. Memento des
Valeurs and from Cours Extremes.
14. This weighing procedure is not theoretically correct (see Chapter 2), but it has intuitive appeal.
Indeed the number of shares outstanding might proxy better for the public availability of the security
than the share of security j in total market valuation.
15. See N ationale Bank van Belgiii.
January 1969 till December 1973 for the second sub-period. For every security
where a complete set of data existed for the sub-period under consideration,
regressions were run using the specification of equation [6]. Table 1 summarises
the important results.
Although it appears that holding companies, on the average, score higher
performance measures (a j ) than non-holding companies, upon closer inspection
it can be seen that the difference between H (holding companies) and NH (non-
holding companies) is not significant and that performance measures for both
groups are not significantly different from zero. Further evidence for this
conclusion is found in the t-values for the arestimate. Only a small fraction of
securities in both groups have a performance measure which is significantly
different from zero. It is concluded therefore that securities on average are
correctly priced and no performance differences between groups can be detected.
The estimates of the ~'s are in most cases significantly different from zero, which
provides evidence of the joint distribution of the monthly rates of returns.
The estimates of R2 show that the individual securities of the NH-group carry
substantial amounts of diversifiable risk which can only be reduced by forming
diversified portfolios. There is, however, definite proof that the securities of the
Table 1. Average performance measures of holding- and non-holding companies.
1964-68 a 1969-73 b
(J'j NH -0.00054 (0.0114) 0.00015 (0.0089)

H 0.00135 (0.0063) 0.00154 (0.0063)
% of taj > 1.684 c NH 15.2% 17.1%
H 10.5% 18.7%
Pj NH 0.89159 (0.5498) 0.87689 (0.3354)
H 0.9567 (0.3352) 0.94673 (0.1783)
% of tpj > 1.684 c NH 80.0% 93.9%
H 100.0% 100.0%
R2 NH 0.1572 (0.1374) 0.2369 (0.1543)
H 0.2783 (0.1135) 0.4089 (0.1407)
F-value for differences
between R2 for NH and H 12.545 d 16.762d
Source: Own calculations based on specification [6].
Standard deviations in parenthesis.

a the sample contained 85 non-holding companies and 19 holding companies
b the sample contained 82 non-holding companies and 20 holding companies
c t-values larger than 1.684 indicate that the corresponding estimates are significantly different from
zero at the 5 per cent level.
d significant at 1 per cent level.
holding company group contain less diversifiable risk and such securities might
consequently reduce the number of different securities an investor must hold in
order to construct an efficient portfolio. The F-values in the bottom row of Table
1 support this contention. It is concluded therefore that holding company
securities are a way to economise on transaction- and portfolio-management
costs.
Durbin-Watson statistics indicated that for all securities, except one, the
hypothesis of no serial correlation among residuals could not be rejected. 16 For
the one exception, the test was inconclusive. The stability over time of the
performance measure &j and of ~ can be studied by calculating the correlation
between the estimated parameters in the first sub-period with the corresponding
estimates in the second period. The correlation coefficient for the & is rather low,
Ra = - 0.2248, which lends further credit to the hypothesis that the observed a's
are random and do not show a systematic over- or undervaluation of securities.
The measure of risk fJ is not very stable over time as is exemplified by the
correlation-coefficient Rp = 0.4603.
To test the dependence of the performance measure &j, on the risk measure~,
regressions were run using two alternative specifications. The results are reported
in Table 2.
The results do not support the contention that the performance measures are
biased and indicate that a one-factor model, which is being used here, is an
adequate representation of the return-generating process. The R2 are very low for
Table 2. Dependence of performance measures on risk measure.
For 1964--68" For 1969-73 b
!X j = 0.002534 -0.003015Pj !X j = -0.00131 + 0.00190Pj

(0.00212) (0.00203) (0.00262) (0.00275)
R2 = 0.0210 R2 = 0.0048
!X j = 0.002847 (1 - Pj) !X j = - 0.001311 (1 - Pj)
(0.00199) (0.00261)
R2 = 0.0191 R2 = 0.0007
Source: Own calculations.
Standard deviations of estimates in parenthesis:

a number of observations 104.
b number of observations 98.
16. All these D.W. statistics are above 1.45, the appropriate Du value.
both periods, but this is either proof of the weak dependence of &j on ~ or due to
the measurement errors contained in the ~'s. These measurement errors could be
reduced by forming portfolios, but at the present stage we do not possess
sufficient data. Only for the first suu-period do the results suggest that the risk
measure has a weak influence on the performance measure.
Test of the perfection of the capital market: cross-sectional tests
It was demonstrated above that in perfect capital markets, i.e. markets without
transaction costs and with rational investors, the excess returns on a security
should depend on the systematic risk (measured by /3) and should not be
influenced by the total variance of the security returns. If the latter was the case it
could be argued that because of market imperfections, investors are specialising
in very few securities. 1 7 Those investors could consequently benefit from the
security substitution by the holding companies.
The regression results ofthe cross-sectional tests can be found in Table 4. The
conclusions appear to be very important. The R2 are low, but this is not abnormal
and it is due to the fact that we did not use portfolios of securities to estimate the
cross-sectional specifications. The data on the excess returns consequently
contain a substantial amount of random noise. The SER 2 variable is a substitute
for unsystematic risk and SER is equal to the standard error of regression of the
time-series regression for that particular security. The crucial equations for a test
of the capital-asset-pricing model are, equations [1] and [4]. According to the
theory developed above, the intercepts should be zero and the slope should equal
the average difference rm - rg. From Table 3 it is clear that the intercepts are not
significantly different from zero.
In Table 4 the hypothesis that the slopes are different from rm - rg is tested. It is
not possible to reject the hypothesis that the coefficients of ~ in the cross-
sectional test are different from rm - ra.
Do the foregoing empirical results provide evidence that the capital-asset-pricing
model explains differential rates of return of common stocks in the Brussels
capital market rather well? At first sight they do. Indeed, the measure of
systematic risk influences excess returns and the coefficient of this measure is not
significantly different from the excess rate of return on the market portfolio. It
also appears that the original Sharpe-Lintner-Mossin model explains rates of
returns well. However, before accepting these results as definite proof of the
validity of the capital-asset-pricing model, we need to discuss the potential draw-
17. See Chapter 3, section 3.

Table 3. Cross-sectional tests of the influence of systematic and unsystematic risk on stock prices.
1964-68
number of observations = 104
0.0025 - 0.0029 Pi
(0.0021) (0.0020)·
R2 = 0.0197
-0.0023 + 0.4936 SER 2
(0.0013)* (0.1629)***
R2 = 0.0826
0.0022 - 0.0059Pj + 0.6741 SER 2
(0.0020) (0.0020)***(0.1692)***
R2 = 0.1528
1969-73
number of observations = 98
[4J iJ - 1'g = -0.0013 + o.oon Pj

(0.0026) (0.0028)**
R2 = 0.0650
[5J iJ - 1'g = 0.0031 + 0.54813 SER 2
(0.0013 )**(0.2560)*
R2 = 0.0456
[6J iJ - 1'g = -0.0032 + o.oonpj + 0.5442 SER 2
(0.0027) (0.0027)** (0.2485)**
R2 = 0.1099
Standard errors in parenthesis.

* to-value significant at 5% level.
** to-value significant at 1%level.
*** to-value significant at 0.5% level.
Table 4. Crucial test of capital-asset-pricing model.
t-value for difference between

coefficient of P standard error r m - rg coefficient of fJ and I"m - rg
1964-68 -0.0029 0.002048 0.00009 -1.459

1969-73 o.oon 0.00278 0.00527 0.6942
Source: Table 3.
backs in our measurement technique and methodology. Indeed, several criti-

cisms can be raised against the empirical results. First, the /1's used in the cross-
sectional tests are measured /1's, which will deviate from the real [J's. Second, ifthe
conclusion is accepted that the onl.,' measure of risk accounting for differential
rates of return is the p-measure, how then is this conclusion to be reconciled with
the seemingly contrary results reported in equations [2J, [3J, [5J, and [6J of
Table 3? Third, the stochastic generating process was assumed to be a linear one-
factor generating process, which necessarily implies that the rate of return
depends linearly on p. Is such an assumption valid? In the following paragraphs
we have tried to answer some aspects of these criticisms.
The measurement errors in Ii

It is well known from econometric theory that if the independent variable in a
simple regression contains random errors, the slope of the regression will be
downward biased and the intercept will be upward biased. Both estimates will
also be inconsistent. 18 Since the [J's, the independent variable in the cross-
sectional tests, were obtained from time-series estimations, it is likely that a fairly
large degree of measurement error is contained in the [J's. The degree of bias
which such an error in the /1's creates in the estimated coefficients of the cross-
sectional tests can be measured using the following argument.
The cross-sectional tests are based on equation [10J, which is the same as
equation [7J except for the fact that the real P's have been replaced with the
measured jJ's.
[1OJ
[l1J
If it is further assumed, as is done in equation [llJ, that the measured /1's are
equal to the real [J's plus a stochastic factor, then it easily follows that the
estimated ()1 will in probability limit converge to: 19
[12J
18. See J. Johnston (1963) p. 149-150, but also M. H. Miller and M. Scholes (1972) p. 60.
19. See J. Johnston (1963) p. 50.
a=
where is the variance of the measurement error in the fJi , and a~ is the variance
of the measured /1's.
Assuming that the square of the average standard error of the fJ estimates
a=
obtained from the time series regression is an estimate of and that the variance
of fJ is an estimate of a~, it is possible to work out equation [12]. The results are
reported in Table 5.
Table 5. Estimate of bias in the slope of the cross-sectional tests.
1 _a_
2
"
a 2 ap2 a p2
"
1964-68 0.0976 0.2708 0.64
1969-73 0.0510 0.1011 0.49
The measurement errors in the fJ's appear to be rather serious for an unbiased and
consistent estimation of the slope coefficient of the risk measure. Especially for
the second sub-period is the bias considerable and would lead us to reject our
earlier conclusions for the period 1969-1973.
Unbiased and consistent estimates can be obtained from the cross-sectional
regressions if an instrumental variable is used instead of the fJ/s. Tests were run
using the /1's of the other sub-period as an instrumental variable. Because the
intertemporal covariance between the /1's is quite low, the estimated coefficients
are rather wild. 20 Pooling of the individual stock data in portfolios might be
helpful. 21 At the moment there is insufficient data available to perform such an
analysis.
Systematic versus unsystematic risk
The capital-asset-pricing model demonstrates that in perfect and efficient

markets differential rates of return depend on systematic risk fJi" It is only when
capital markets are segmented because of transaction costs that excess rates of
return depend on unsystematic risk SER2. In such segmented markets holding
companies can provide a financial benefit to the small investors because the
financial institution enables them to overcome the market segmentation. Table 3
20. See J. Johnston (1963).

21. E. Fama and 1. MacBeth (1973).
presented evidence that fJj , the measure of systematic risk, had an influence on
average rates of return, but we also found that unsystematic risk SER 2
intervened. 22 Is it possible to draw any conclusions from these apparently
conflicting results?
The first characteristic of equations [1] and [3], and [4] and [6] in Table 3 is
that the estimated coefficients of Pj remain relatively stable and that the
corresponding standard errors are unchanged. Such results are already an
indication that SER 2 cannot be a complete proxy measure for p. 23 Indeed, if such
were the case, the multicolinearity between SER 2 and fJ would lead to
substantially larger standard errors of estimates. 24 Nevertheless some de-
pendence of fJ on SER 2 was present in our sample - as is clear from Table 6.
Table 6. Dependence of systematic risk on unsystematic risk.
1964-68 Pj = 0.7647 + 30.4423 SER 2

(0.0589) (7.6013)
R2 = 0.1359
1969-73 Pj = 0.8863 + 0.55278 SER 2
(0.04658) (9.3021)
R2 = 0.0001
Another and perhaps a more powerful explanation of the dependence of the

excess rates of return on unsystematic risk SER 2 comes from the fact that the
distribution of individual rates of return is skewed to the right, so that
exceptionally high positive returns occur for some stocks. Those skewed
distributions simultaneously lead to high average returns and to high standard
errors of regression in the time-series regressions. Even if ex-ante no dependence
exists between expected rates of return and unsystematic risk, it might creep in ex-
post in the above described way.25 Again the only way to deal satisfactorily with
these problems is to pool individual rates of return to form portfolios of securities.
22. See equation [2J, [3J, [5J, [6J Table 3.

23. This would explain the results of equations [2J and [5J in Table 4.
24. See J. Johnston (1963).
25. M. H. Miller and M. Scholes (1972), p. 66-70.
CONCLUSION 63
linearity of the cross-sectional return-risk relation
In order to test the linearity of equatiOll [12J regressions were run using the
following specification.
Table 7 clearly demonstrates that there is no reason to reject the linearity

hypothesis.
Table 7. Linearity of the return-risk relation*
1964-68 rj - rg = 0.0030 -0.0053Pj +0.001113;

(0.0044) (0.0077) (0.0029)
R2 = 0.0222
1969-73 rj - I'g = 0.0033 -0.0025Pj +0.0047 13;
(0.0089) (0.0191) (0.0097)
R2 = 0.0522
* Based on a slightly different sample than the one used before. Only those stocks were included for
which data were available over the whole period 1964-73.
The foregoing critical analysis, although certainly not complete, forces us to

refrain from making definite statements about the validity of the capital-asset-
pricing model. It seems safe to conclude, however, that with the present data bank
of rates of return, it is not possible to reject the capital-asset-pricing hypothesis.
The Brussels' stock market appears to be a rather efficient and perfect market.
For the small investor there should consequently be relatively little difference
between 'institutional' diversification by the holding company and 'home-made'
diversification. The results so far suggest that the small investors do not need the
holding companies to enable them to hold diversified portfolios.
5. Conclusion
Some earlier writers have argued that the holding companies present lucrative
investment opportunities to the small investors, because such institutions hold
diversified portfolios. The argument received full support from the management
of the holding companies. In chapter 3 it was demonstrated that from a
theoretical point of view their argument is flawed. In this chapter we were able to
prove, using a large sample of returns on common stocks, that no performance
difference can be detected between the securities ofthe holding companies and of
the non-holding companies. The Brussels stock market appears to be fairly
perfect and efficient, and as such provides no reason for 'institutional'
diversification. As financial intermediaries, the holding companies are not able to
improve the financial position of the small investors, who not only are price-
takers in the asset market but also do not possess the control instruments to wield
a direct influence. The only possible advantage which the holding company
securities have to offer is that they carry less diversifiable risk. Because of this last
characteristic the investor can reduce the number of securities he has to hold in
his portfolio in order to diversify efficiently. The economic rationale for the
existence of such powerful financial institutions in the Belgian economy is not to
be found in the financial intermediation and security substitution which is being
organised by the holding companies. In the next chapter we turn to another more
fundamental aspect of the holding companies, the control over corporate
decision-making.
V. HOLDING COMPANIES AND CORPORATE
CONTROL
1. Introduction
The holding company system arose and remained viable in the Belgian economy
because the institution during the decisive interwar years was able to coordinate
and to control the supply of external long-term funds to industry, which, due to
its historical bias towards the basic industrial sectors, had a relatively high
demand for external capital to supplement its modest propensity to generate
funds internally. As financial intermediaries, the holding companies continue to
hold a strategic position in the accumulation and allocation of savings, but it has
been demonstrated above that, theoretically and empirically, the financial
intermediation and security substitution organised by such companies does not
improve the financial position of the small investor. The economic rationale for
the existence of the large holding companies and industrial combines, if any
exists, must consequently be sought in the struggle for control over corporate
wealth and corporate strategic decision-making. In this chapter we want to
present new evidence about this second and more fundamental aspect of the
holding companies, the concentration of corporate control. It is the aim of this
chapter to measure the control influence of the holding companies at the firm
level. The first section develops the methodology for measuring control at the
firm level, while in other sections the measuring technique is applied to the
Belgian situation.
Although the analysis is based solely on Belgian data, the results, so we
believe, are relevant for the study of industrial organisation and concentration in
general. Ideally, industrial concentration, the discretionary control over re-
source allocation in the hands of a few decision-makers should be studied by
analysing the concentration of decision-making power in decision units. Such
decisions units may control resource allocation in several plants or judicial
entities. The question, then, that counts for concentration and competition is not
how production and legal structures are organised but how discretionary power
over economic decision-making is organised. It is the real side that matters for
66 HOLDING COMPANIES AND CORPORATE CONTROL
allocation and allocative efficiency - not the legal side. An in-depth analysis of
industrial concentration consequently implies not only a proper specification of
the relevant market, a problem that rightly preoccupies scholars of industrial
organisation, but also a search ~eyond the directly observable and 'visible'
economic units such as plants and judicial entities, in order to delimit the
relevant decision-making centers with greater accuracy.
Conventional measures of concentration, however, focus on what could be
called 'visible' concentration. Indeed, these measures only estimate various
statistical parameters of skewed-ness of the frequency distribution of firms or
plants by size of industry sales, assets or employment. The critical assumption
underlying such concentration measures is that the basic units of analysis, plants
or firms operating in the sector or relevant market, are independent economic
decision-makers. If the assumption of independence is not fulfilled as it is in
many European nations and in Japan, it will consequently not be possible to
estimate real concentration consistently and to compare concentration and
competition cross-sectionally or internationally.
Interlocking directorships, holding companies, industrial combines, trusts,
joint ventures and cartel agreements are the chief institutions contributing to the
'invisible' concentration of corporate power. In this chapter, then, evidence is
presented about the specific contribution of the holding companies to con-
centration and about the sectoral structure of the control liabilities between
firms. This latter finding is of general importance because it provides a very
detailed insight in the sectoral structure of interlocks and the results cast doubt
upon Stigler's well-known conclusion that interlocking directorships had no
noticeable effect on competition among firms. 1
2. A methodology for measuring the control influences of

the holding companies
Through their investments, the holding companies have actively cultivated a

controlling interest in several industrial and financial companies. This struggle
for corporate control by the holding companies has challenged many researchers
and research centres to collect data on the wide-spread influence of such financial
institutions on corporate decision-making. The literature on Belgian holding
companies abounds with attempts to sketch out the concentration of power in a
systematic way.
1. Stigler, G. J. (1968), p. 261.

THE CONTROL INFLUENCES OF HOLDING COMPANIES 67
The literature
The oldest study, which at the moment 01 its publication aroused a lively public
debate, was undertaken by the Socialist Labour Union, ABVV-FGTB.2 The
primary purpose of the ABVV-FGTB report was political. By pointing to the
high concentration of power in private hands, the labour union intended to stir a
fundamental reform of Belgian capitalism. N~vertheless the study deserves
credit for being the first to try to analyze the grip of a few financial groups on
corporate wealth. In a way it is disappointing that the Belgian economists
have missed the opportunity to initiate this kind of research. Its contri-
bution might have helped to work out a precise methodology for mea-
suring concentration of power over corporate assets. Indeed the ABVV-
FGTB study, as was the case with most of the more recent studies, sketches the
degree of concentration by giving a description of the direct and indirect
portfolio holdings. A company is said to be in the control sphere of a particular
financial group or holding company when the group or company holds a
controlling interest - an exact definition cannot be given - and/or has a
representative or representatives on the board of directors of the subsidiary. For
every financial group, the ABVV-FGTB report focuses on financial groups and
not on the holding companies through which the powerful financial groups
operate; a list is given of the subsidiaries under direct and indirect control.
Although this method gives the reader a fairly detailed impression of the span of
control of the holding company, the methodology does not permit a test of some
important hypotheses. Is concentration of corporate power increasing or
decreasing over time? How does the Belgian situation differ in terms
of corporate power from other industrial nations? How different is the
concentration sector-by-sector? What factors explain the concentration; i.e.
what characteristics increase the likelihood that a particular industrial or
financial company is under control of a financial group or holding company?
Such questions, vital for a better understanding of the holding company
structure, cannot be answered with an imprecise methodology which does not try
to quantify the degree of concentration.
Most of the later studies have followed, with some minor improvements, the
methodology of the ABVV -FGTB report. Pierre J oye 3 in his book Les Trusts en
Belgique has given a very detailed and impressive list and description of all the
control linkages in the Belgian economy. It is clear that his work has the same
2. Algemeen Belgisch Vakverbond A.B. V. V., Federation Generale des Travailleurs Beige, F. G. T.B.
(1956).
3. P. Joye (1964).
methodological drawbacks as the study discussed above. Furthermore his

reliance on partial and fragmentary information sometimes deceives him into
erroneous conclusions. 4 The most respected and scholarly publication on the
subject of the dominance of the financial groups over corporate control is the
Morphologie des groupes financiers. 5 The study gives a careful analysis of the
span of control of the financial and industrial groups. Flow charts were used to
disentangle the control influences. The results shed light on the hierarchical
structure of Belgian capitalism, but they also leave the reader with a sense of
confusion. Indeed, because ofthe descriptive nature ofthese results it is difficult to
learn something from thos'e charts about the questions raised above. Moreover it
is nearly impossible to develop an international comparison on the basis of the
control charts, and it will be close to impossible to test theories of holding
company behaviour.
Finally, two innovative recent studies should be mentioned here. Michel
Devroey6 significantly improved the traditional Berle-and-Means 7 metho-
dology by more closely studying the influence of different decision-makers,
professional managers, family-owned firms and financial groups on the decision-
making process in the large Belgian companies. Devroey's research does not deal
directly with concentration of power, but his methodology, based on a
meticulous dissection of corporate decision-making, might be helpful in measur-
ing the real span of control of the holding companies. The major drawback,
however, is that this kind of research is highly time-consuming and, since the
interview technique is used, the results are bound to be limited in time and space.
The second recent study was done by Cuyvers and Meeusen. 8 This re-
search, however, is limited to the interlocking directorships between 30 hold-
ing companies in the Belgian economy.9 The methodology used by Cuyvers
and Meeusen is particularly interesting because they developed a mathematical
technique to detect cliques in the control structures. Again the concentration
4. P. J oye (1964) argues that the holding companies and financial groups stimulate the use of internal
savings but from our empirical research it is clear that during Joye's period of analysis (the past
World War II era), internal sources were less used. It is also not clear how he squares his contention
with the fact that the US, a nation dominated by managerial capitalism, is using relatively fewer
external sources of capital than the Belgian economy.
5. The study is published by Crisp. The first edition appeared in 1962, the second in 1967, and a
updated version was published in 1972.
6. M. Devroey (1973).
7. A. A. Berle and G. C. Means (1937),
8. Cuyvers, L. and Meeusen, W. (1976).
9. In our research the total population of Belgian corporations listed on the Brussels Stock
Exchange was studied.
phenomenon itself is not studied. Only the boundaries of the financial groups,
the 'cliques', in the Cuyvers' amd Meeusen terminology, are studied. 10
A new methodology
It is a real challenge, then, to develop a methodology for measuring the influence

of the holding companies over corporate wealth. In thinking about this
methodology we had two objectives in mind: first, the measure of concentration
should be quantitative, and second, the measure should be simple but ought
nevertheless to catch the essential features of the control influence. The rationale
behind our wish to have a quantitative measure of control was that most
statistical techniques for testing hypotheses require quantitative data, that an
international comparison would be easier and that the time pattern of con-
centration of power might be easier to construct. The only technique which
fulfilled both goals, those of being both a quantitative methodology and a simple
measure, is the study of interlocking directorates. As will become clear, in the
second section we have gone beyond the usual applications 11 of the technique of
measuring interlocking directorates and we have undertaken modest attempts to
test the significance of our results. For a correct understanding of our new results
on the dominance of the holding companies over corporate control it is crucially
important to study in detail the methodology used.
Let us assume that five companies, A, B, C, D, E, exist in an economy. Each
company has a board of directors (beheerraad-conseil d'administration) of 3
directors. Assume also that some directors of a particular company hold
positions in other companies as indicated by the two-pointed arrows in Figure 1.
Figure 1. postulates that the first position in companies A and E is held by the
same director, the second position is held by the same director in companies A
and D and there exists one director holding the four third positions in A, B, C and
D. A very first measure to estimate average concentration of power in this
hypothetical economy is to count the number of positions p and the number of
directors d. The ratio p/d gives an estimation of the average number of
positions held by one director and is a rough index of concentration. It will be
argued later that this measure might be biased by the size distribution, in terms of
assets, of the companies. In our hypothetical example p = 15 and d = 10 which
10. In the future it might be interesting, when adequate computer programs become available, to use
the Cuyvers' and Meeusen' methodology on our larger data ban1e
II. The study of interlocking directorships is not new to economics; c.f. P. C. Dooley (1969), Y.
Futasugi (1973), D. Bunting and J. Barbour (1971), Cuyvers L. and Meeusen W. (1976), U.S. Federal
Trade Commission, U.S. House of Representatives (1951), Committee on the Judiciary (1965).
Figure 1. Hypothetical Structure of Interlockings.
puts p/d = 1.5. More detail about the concentration of power at the directors
level can be obtained by studying the distribution of positions over the available
directors. From such analysis it follows that the director holding position no. 3 in
companies A, B, C and D has 4 positions, or 26.6% of all positions in the
hypothetical economy. The study of the Lorenz curve might therefore clarify
some basic factors.
So far we have focused on the directors; we now turn to the companies. A
company is said to be interlocked with another company when it has a director in
common with this other company. Company A is interlocked 5 times with 4
companies; Band C are interlocked 3 times; D has 4 interlockings and E interlocks
only I time. Companies A and D have a two-fold interlocking; all other inter-
lockings are simple. Dispersion r of a company is defined as the number of com-
panies with which A is interlocked. This concept of dispersion is new in this con-
text and was not used in earlier studies. Concentration can now be studied in
several ways, as is necessary because every method has its drawbacks. First, the
concentration can be studied by analysing the number of interlockings per com-
pany i. Since this statistic depends on the number of positions in the board of
directors of the particular company, it might be useful to design other measures.
Second, the ratio of interlockings of company j over the number of positions is on
its board scales the first measure of concentration (i/p). Third, the ratio of
interlockings over dispersion permits a test showing whether the concentration is
directed towards particular companies (i/r). In previous studies the second and
third measures were completely overlooked; they are introduced here so as to
capture the concentration of power over corporate wealth more closely. More
ratios will be discussed in the next paragraph, when the new data on the Belgian
economy are presented.
The relevance of the new methodology
Two major points can be raised against the use of the technique of measuring
interlocking directorates in order to estimate the concentration of corporate
power. The first point emphasises the fact that interlocking directorates form
only a part of the way through which a holding company can influence capital
management and business decision-making in a company. The second point
probes for the factors, such as the size-distribution of the assets and of the board
of directors, that could bias the ratios mentioned above.
The first criticism, i.e. that interlocking directorates are only a partial measure
of control influence, against the relevance of the proposed measuring technique
for estimating the real corporate power of the holding companies is serious but
can be dealt with adequately. The criticism has point, which can be seen from the
following reasoning. If, for instance, the holding company has only one director
but holds a large share of the equity capital of the controlled company, the real
power of the holding company might be much larger than estimated by our
proposed methodology. Another situation might occur when the holding
company does not use its own directors but relies on trusted persons and/or
family ties to influence the decision-making process in its subsidiary. Only a
meticulous search for the personal and family ties in the small managing circles
of Belgian financial capitalism might clarify this issue. However anyone who has
undertaken this kind of research is a ware that it is only a matter of time before the
results will be labelled fraud and subjective. A final comment in the same line
deserves attention. Some American scholars have doubts about the power of the
board of directors and they argue that the real decision-making power has
shifted to the professional management group, which is not only responsible for
daily operations but also for strategic planning. 12 If this should be the case in the
Belgian economy, which is by no means certain,13 our methodology would
greatly overestimate the real power obtained from the interlocking directorships.
The following counter-argument seems plausible against the foregoing,
mainly empirical, remarks. If the holding company is going to have a significant
impact on corporate decision-making - which is more than the power of
approval - the very least the institution must have in order to implement its
12. Berle, A. A., and Means, G. C. (1932) also J. K. Galbraith (1967).

13. See M. Devroey (1973).
power is a representative on the board of directors. Such power over the

subsidiary might in reality be larger than would appear from the measurement
through the interlocking directorates; but it certainly cannot be less, unless the
board is stripped of its sovereignt),. However, evidence exists which points to the
fact that this is not the case in Belgium. 14 According to this line of reasoning it
follows that our methodology provides an estimate of the lower bound of the
concentration of power. We have tried to apply this principle of the lower bound
consistently, as will become clearer when the sample is described in the next
paragraph. This also implies that the real concentration of power is greater than
our results suggest.
A second line of criticism probes for the theoretical assumptions underlying
the measurement. Although vitally important for a correct interpretation of the
statistical results, the potential theoretical drawback of the methodology was
completely ignored in the two articles which have recently dealt with the
subject. 15 Let us assume an economy with n companies j and assets k i per
company. If companies appoint their directors rationally, i.e. if only so many
directors are appointed as are necessary to manage assets efficiently within the
constraints imposed by corporate law, then the demand for positions Pj can be
written in a simplified way as follows:
[1J
The total demand for director positions in the economy is given by the sum over i
of[1J:
P = ak + nb [2J
where P = L Pi the total number of positions in the economy and
k = L k i , total assets.
i
From equation [2] it is clear that the number of director positions in an economy
which manages its assets efficiently within corporate law 16 depends upon the
number of companies in the economy. A reorganisation, caused by a change in
the number of companies which in turn implies a change in the size distribution
of companies, will lead to a reduction in the demand for director positions. If, as
14. See M. Devroey (1973).

15. P. C. Dooley (1969), D. Bunting and J. Barbour (1971).
16. Corporate law in Belgium obliges every corporation to have at least 3 directors.
traditional static economic theory indicates, we further assume an equal rate of

profit in the different companies and an equal share per company of director
renumerations in total profit, then the total number d of available directors will
be defined by the financial and managerial qualifications necessary to become a
director and by the income level necessary to compensate for the financial and
managerial expertise provided by the directors. This income level is under the
above-mentioned assumptions proportional to k. Since k is exogeneously given,
and, given the assumption of an ideally organised economy, d, the total number
of directors, will be defined independently from the number of positions
demanded in the economy.17 The aggregate measure of concentration pld
depends consequently on the number n of companies and on the size-distribution
of companies.
This is easily seen when [2] is divided by d, which is exogeneously given.
L=a~+~b [3J
d d d
Two conclusions follow from [3]. First, international comparisons of the
concentration of power, using the average number of positions per director,
might be flawed, even for countries of comparable size, when the number of
companies and consequently the distribution of corporate wealth over the
companies is radically different in the two economies. 18 The same remark is true
when time series are analysed.
Second, when corporate wealth of the economy is managed efficiently, as was
postulated in the foregoing theory, the smaller companies should have more
interlockings than the larger companies. Indeed, directors of small companies
will need more positions to be fully employed and to have a full salary. This
implies a negative influence of kj' the size of company j, on the average number
of interlockings i)pj per director. Equation [4J provides one possible specifica-
tion. 19
17. Proof follows easily from the following argument. Let n be the rate of profit and d the share of
director bonuses in profit. Then dnk is available for distribution among directors. Let w be the
nd
market-price per director for director-services. Then the number of directors is given by d = - k.
Since k and all other parameters are exogeneously given d is given. w
18. From equation [3 ] it is also clear thatinternationalcomparisons of concentration based on the
ratio p/d will be meaningless when the ratio kid differs from country to country. Such differences
might be caused by differences in managerial efficiency of the directors and/or differences in director
bonuses.
19. There is no a priori reason why equation [4] should be linear in the assets kj" Indeed, it is not
possible to give an exact theoretical derivation of the general specification of [4] without making
explicit assumptions about the distribution function of the k/s. There can, however, be no doubt about
i.
the sign of the influence of kj on --L.
Pj
[4J
It is consequently possible to design a rough statistical test of the significance of

the results of the concentration of power. If interlocking directorates exist in an
economy because of economies in director management then the regression
results of [4] should not show a significant positive influence of size, as measured
by assets, on average number of interlockings. A significant positive relation
would be evidence that interlocking directorates are used to gain control over
corporate wealth. In the following pages the data on interlocking directorates
are presented and it will be argued that they indeed provide significant evidence
for the control influence of the holding companies and that consequently these
data are not biased by the size distribution of companies.
3. Concentration of corporate power in the Belgian

economy
In this section the methodology ofintedocking directorates is utilised to measure

concentration of corporate power.
The sample
In order to obtain as clear a picture of the concentration of corporate power as

possible the sample consisted of 385 Belgian corporations quoted on the Brussels
stock exchange in 1967. Data about directorships were taken from an annual
financial directory, Financie1e Studies 20 which records the members of the board
of directors per company and lists alphabetically the persons holding a
directorship. The year 1967 was chosen to allow for a comparison of the results
on interlocking directorates with the data for the U.S., which were compiled by
Peter C. Dooley for 1965. 21 Furthermore it seems unlikely that the particular
year chosen effects the results since concentration has a structural characteristic.
Finally, we were not so much interested in providing an up-to-date list of who is
20. Financie'le studies published by the Kredietbank 1967, Brussels. This publication is a translation
into Dutch from the Memento des valeurs published by lnforma. Both publications, although
carefully prepared, contain some minor errors, which we could not correct. It seems reasonable to
assume that such errors do not bias the basic results which, as well be shown soon, are clear and
significant.
21. P. C. Dooley (1969).
CORPORATE POWER IN THE BELGIAN ECONOMY 75
who in Belgian industry with names and faces, but rather in the structure of
interlockings and of concentration.
As argued above the study consistently tries to measure a lower bound of the
concentration of corporate power. Fol~9wing this principle the research was
limited to the interlocking directorates of the members of the board and excluded
the members of the council of commissioners and auditors. It is fully recognised
that in doing so we probably underestimated the real concentration of corporate
power. It was also not always possible to distinguish between directors and
honorary directors; we therefore included both in the study. This has practically
no influence on our results, and it more closely represents the real control
influence.
Aggregate measures of concentration of corporate power
Before turning to an analysis of interlocking directorates at the firm level we

present aggregate measures of the concentration of corporate power in the
Belgian economy. Table 1 shows that the 385 sampled corporations with book
value of assets amounting t0 22 1,153.9 billion BF, offered a total of 3,533
positions which were held by 2,184 directors. The average concentration ratio
was consequently 1.61. From Dooley's data for the United States we calculated
the average number of positions held by one director to be only 1.26. Corporate
power consequently appears to be more concentrated in Belgium than in the
U.S.A.
The distribution of directors by the number of positions they hold provides
further evidence for the high degree of concentration of corporate power. A very
small percentage (0.6 percent) of directors held 5.7 percent of all positions and
were responsible for 34.9 percent of all interlockings. In the U.S.A. on the
contrary, no directors had more than 7 positions. The Gini-coefficient of
concentration is 0.25 for Belgium and 0.18 for the U.S.A. The calculated total
number ofinterlockings is much lower in the U.S. than in Belgium. Indeed the
average number of interlockings per corporation is 19.5 in Belgium and 9.9 in
the U.S.A.
Two fundamental questions arise here. First, do the foregoing statistics
provide sufficient proof that corporate power is more concentrated in Belgium's
financial capitalism than in North America's managerial capitalism? Indeed, it
has been argued above that this comparison between the 250 largest American
companies and the Belgian corporations might be flawed because of the
22. Based on balance sheet data contained in Le Recueil Financier (1967).

-.l
Table 1. International comparison of the distribution of directorships. 0"\
Belgium 1967 U.S. 1965

Number of Number of Number of Theoretical Number of Number of Theoretical
positions held directors positions number of directors positions number of :r:
by one director interlocks interlocks 0
t""'
(1) (2) % (3) = (1) x (2) % (4) % (5) % (6) = (5) x (1) % (7) % ....t:I
Z
1 1586 72.6 1586 44.8 0 0 2603 82.2 2603 64.9 0 0 0
(j
2 321 14.6 641 18.1 321 8.5 372 11.7 744 18.5 372 30.0 0
3 130 5.9 390 11.0 390 10.3 123 3.8 369 9.2 369 29.7 a::'C
4 57 2.6 228 6.4 342 9.0 49 1.54 196 4.8 294 23.7 :>
5 25 1.1 125 3.5 250 6.6 13 0.4 65 1.6 130 10.4 Z
21 0.9 126 3.5 8.3
;;
6 315 5 0.1 30 0.7 75 6.0 tI:>
7 10 0.4 70 1.9 210 5.5 :>
8 11 0.5 88 2.4 308 8.1 z
t:I
9 5 0.2 45 1.2 180 4.7 (j
10 3 0.1 30 0.8 135 3.5 0
:;tI
11 5 55 1.5 275 7.3 'C
12 1 12 0.3 66 1.7 0
:;tI
13 2 26 0.7 156 4.1 :>
--l
14 2 28 0.7 182 4.8 tI1
30 5.7 0.8 5.5 34.9 (j

15 2 0.7 210
0
16 1 16 0.4 120 3.1 Z
--l
17 17 0.4 136 3.6 :;tI
18 0
t""'
19 19 0.5 171 4.5
2184 3533 3767 3165 4007 1240
Source: For Belgium, based on our own data and.ca1culations; for USA, see Dooley (1969).
CORPORA TE POWER IN THE BELGIAN ECONOMY 77
differences in corporate size. The smaller size of the Belgian companies and the
larger size of our sample, 385 companies, can indeed lead to biased results since
in perfectly managed economies the smaller companies have more interlockings
than the larger. Consequently we will try to show that interlockings are
positively, and not negatively, correlated with size. 23
Second, what elements and what institutions are responsible for or are the
sources of the concentration of corporate power in the Belgian economy?
Evidence will be deVeloped showing that the large holding companies, the
electrical utilities and trusts, and some of the larger industrial corporations
contribute most to the concentration of corporate power as measured by our
methodology.
The dependence of interlocking directorships on size
In this paragraph we will try to prove that interlocking directorships (i), being a
substitute measure for the concentration of corporate power, are positively
related to size (k j ), which consequently would lead us to argue that the aggregate
concentration statistics are significant.
Interlockings were measured as described in an earlier section of this chapter;
their size was estimated on the basis of total book value of assets in million BF as
reported in the I.e Receuil Financier of 1967. Regression equation [5J reports the
cross-sectional statistical results. Standard deviations of the estimated para-
meters are given in parenthesis below the parameters. 24 The banking and
insurance sectors were excluded since their assets could not be adequately
measured in terms of book value of assets:
ij = 14.794 + 0.0039kj [5J

(1.251)** (0.00035)**
R2 = 0.25 F = 123.24
23. The finding that interlockings in Belgium are positively related to size does not necessarily
provide sufficient proof that corporate power in Belgium is more concentrated than in the U.S. The
result, however, certainly lends support to the hypothesis that within Belgian capitalism, the
interlocking directorships are not caused by a particular distribution of asset sizes but are a
significant characteristic of the Belgian economy.
24. Double-starred coefficients indicate a significance level at 1%.
Although the coefficient of determination is low, which could be expected in a

cross-sectional test, the results show that k j has a significant positive influence on
ij at the 0.01 confidence level. The results might be biased because interlockings
were not scaled over the size of th~ companies. Companies with more directors
are more likely to have more interlockings. In the next regression equation
interlockings per company were divided by the number of directors in the board:
i.
-L = 1.6329 + 0.00012kj [6J
Pj
(0.0923)** (0.000025)**
R2 = 0.05 F = 22.86
Again the explanatory power of the specification is low but no doubt can exist
about the significance of the size effect on the scaled measure of interlocking
directorships. In an attempt to improve R2, regressions were run on a more
completely specified model. Regression equation [7] is the fully specified form of
[5J and regression equation [8] the corresponding specifications of [6].
ij = 10.628 + 0.0038kj + 22.529Jj + 23.79h j - l1.513sj

(2.186)** (0.0003)** (3.214)** (5.079)** (2.965)**
R2 = 0.40 F = 62.636
i.
-L = 1.0493 + 0.00012kj + 2.022Jj + 2.446h j - 0.714s j
Pj
(0.1511)** (0.00002)** (0.2222)** (0.4203)** (0.205)**
R2 = 0.34 F = 48.26
where i j = number of interlockings per company

Pj = number of directors per company
k j = assets per company
Jj = share of portfolio investments in assets per company
hj = share of interlockings with financial holding company
Sj = share of single interlockings.
These statistical results, which demonstrate a remarkable stability, 2 5 suggest the

idea that large companies have more interlocking directorships than small
companies. The high degree of concentration in corporate power in the Belgian
economy thus arises from structural characteristics of Belgian capitalism and is
not caused by the smaller size of the Belgian economy. We now turn to a more
fundamental analysis of the factors and institutions that are responsible for such
a high degree of concentration.
The sources of high concentration
In an attempt to explain the concentration of corporate power we will first study

the average number of interlockings per company at the sectoral level. The
sectoral classification of companies was taken from the Stock Exchange
Commission in Brussels.
Table 2. Average number ofinterlockings per company by sector.
larger ( + ) or smaller ( - ) than sample average"

A. Insurance companies 7.66
B. Banks 15.00
C. Holding companies 35.60 +
D. Real estate 12.28
E. Transportation 37.90 +
F. Trusts 66.57 +
G. Utilities 57.00 +
H. Electrical + electronics 45.50 +
I. Steel 18.33
J. Metal and mechanical 10.22
K. Non-ferrous metals 31.93 +
L. Chemicals 16.04
M. Mining 13.62
N. Glass 26.36 +
O. Construction 13.61
P. Textiles 3.63
Q. Plantations 21.84 +
R. Food 8.23
S. Other 9.81
T. Distribution 10.61
Source: Own calculation

• weighted average of all sectors 19.5.
25. Please compare the coefficient of k j respectively in [5J and [7J and in [6J and [8].
Table 2 shows that 8 sectors contribute much to the overall degree of

concentration in Belgium. The sectors are the financial holding companies,26
transportation, the electricity and gas trusts, the utilities, electrical equipment,
lion-ferrous metals, the glass sector and the plantations in Africa. All these
sectors belong to the more traditional and basic capital goods industries. Such
results provide evidence for the theory that the phenomenon of interlocking
directorships is more characteristic for some sectors (mostly the capital-intensive
capital goods industries) than for others (the consumer goods industry). Before
probing for the reasons to explain this finding, some more detailed data will be
presented about the interlockings at the firm level.
Table 3. Distribution of companies by number of interlockings per sector.
N umber of interlockings between

Sectors· 0-10 11-20 21-30 31-40 41-60 61-80 81-100 101+
in%
A 66.7 33.3
B 33.3 22.2 44.5
C 22.7 18.2 13.6 18.2 6.8 9.1 4.5 6.8
D 57.1 21.4 7.1 14.3
E 36.4 18.2 9.1 27.3 9.1
F 14.3 14.3 14.3 14.3 14.3 28.6
G 25.0 8.3 8.3 25.0 25.0 8.3
H 25.0 25.0 25.0 25.0
I 55.6 27.8 5.6 5.6 5.6
J 68.6 17.1 8.6 2.9 2.9
K 18.8 25.0 25.0 6.3 6.3 12.5 6.3
L 52.4 19.0 4.8 9.5 9.5 4.8
M 58.6 17.2 6.9 13.8 3.4
N 9.1 36.4 36.4 9.1 9.1
0 54.8 19.4 12.9 9.7 3.2
P 95.5 4.5
Q 47.4 5.3 15.8 15.8 10.5 5.3
R 76.7 10.0 10.0 3.4
S 75.7 5.4 5.4 10.8 2.7
T 53.8 38.5 7.7
Total 52.6 15.8 10.4 8.3 4.7 3.6 2.6 2.1
Source: Own calculations

a For meaning of alphabetical classification see Table 2.
26. Note that the definition of holding company is based on the Stock Exchange classification, which
is not identical with the Banking Commission's.
CORPORATE POWER IN THE BELGIAN ECONOMY 81
Table 3 gives the distribution, per sector, of companies by number of

interlockings. The distribution for the whole sample illustrates that a large
number of companies have very few interlockings: 52.6 percent of all sampled
companies had interlockings between 0 and 10. A marked difference appears
when the global distribution is compared with the sectoral distributions for the
sectors C, F, G, H, I, K, Nand Q. For all these sectors the distribution shifts
more towards the higher interlockings. Again it is noteworthy that all these
sectors are more traditional and basic: none of them is in the consumer goods
industries. These results substantiate the earlier finding that specific sectors are
responsible for the high degree of concentration of corporate power, and show
that within those sectors some companies account for the larger part of the total
interlockings of the sector.
What factors or institutions, then, account for the orientation of the
interlocking directorships towards certain companies in certain sectors? Table 4
contains the answer. Indeed the table records the control interrelations among
sectors in the Belgian economy for the first time. Two major findings can be
deducted from this symmetric matrix. The interlockings within each sector itself
and those between all sectors and the sector of the financial holding companies
are consistently among the most important sectoral control interrelations. This
can be seen in Table 4 when the pattern of the encircled cells in the matrix is
studied. Cells have been encircled to indicate that the sectors mentioned in the
horizontal rows were most and second most interlocked with the sectors
mentioned in the column. From this crude analysis it is clear that the financial
holding companies 27 are, together with the intrasectoral interlockings, the main
source accounting for the concentration of corporate power. Since these holding
companies have always invested in the basic and more traditional industries, it
could be expected that these sectors appeared so highly interlocked in Table 2.
The intra-sectoral interlockings can probably be best explained by two factors:
(a) the wish to organize and structure competition in product markets, and (b)
the specific managerial know-how necessary to run the particular sector
efficiently. These results might support the view that the characteristics of each
sector are the main determinants which explain interlocking directorships. In
order to illustrate the correctness of the foregoing reasoning more clearly
regressions were run in an attempt to explain the interlockings per company by
proportion of interlockings with the holding company sector. The results have
already been presented in equations [7J and [8]. The coefficients of the II-factor
are positive and significant and prove that the holding company sector is the
main source for the concentration of corporate power. Another way to measure
27. Stock Exchange Commission's definition.

Table 4. Matrix of inter- and intra-sectoral control linkages in the Belgian economy, 1967. 00
tv
Sectors A B C D E F G H I J K L M N 0 P Q R Rl R2 S Sl S2 T Total
Insurance A 0 6 1 4 0 0 0 0 0 0 3 2 1 3 0 0 1 0 0 1 0 0 0 23
Banks B 6 14 20 4 0 5 11 0 7 12 9 9 6 6 9 I 120 1 0 0 4 2 0 2 135 II:
Holding companies C 1 20 398 50118 70 112 42 77 61 14 65 48 49 85 19 17 10 9 17 49 7 5 21 1567 0
r'
Real estate D 4 4 50 16 1 6 7 4 2 4 12 9 5 o 10 0 17 1 2 2 5 1 o 10 172 t:l
Transportation E 0 o 118 1 94 33 53 12 2 19 23 6 2 20 6 0 19 0 1 1 3 1 0 3 417 Z
Trusts F 0 5 70 6 33 62 110 22 14 20 19 26 24 13 12 0 7 0 0 1 11 1 3 7 466 Cl
()
Utilities G 1 11 112 7 53110 142 33 21 21 39 25 25 12 29 0 15 1 0 2 14 1 4 6 684 0
Electrical + electronics H 0 0 42 4 12 22 33 0 5 13 7 9 10 6 6 0 5 1 1 1 1 1 1 2 182 a::'"tj
Steel I 0 7 77 2 2 14 21 5 42 38 25 18 28 9 14 1 3 4 1 1 13 1 1 3 330 >
Metal and mechanical J o 12 61 4 19 20 21 13 38 54 18 7 9 11 35 5 7 2 1 0 13 5 0 3 358 ~
tr:I
Non-ferrous metals K 0 9 114 12 23 19 39 7 25 18 102 12 34 10 46 1 16 1 2 2 12 1 0 6 511 en
Chemicals L 3 9 65 9 6 26 25 9 18 7 12 40 27 22 16 2 13 2 4 0 12 5 2 3 337 >
Mining M 2 6 48 5 2 24 25 10 28 9 34 27 114 19 13 4 Z
1 4 4 0 10 5 0 1 395 t:l
Glass N 1 6 49 o 20 13 12 6 9 11 10 22 19 56 19 4 7 6 0 2 9 8 0 1 290 ()
Construction 0 3 9 85 10 6 12 29 6 14 35 46 16 13 19 72 2 10 6 5 3 13 3 2 3 422 0
~
Textiles P 0 1 19 0 0 0 0 0 1 5 1 2 4 4 2 32 1 0 0 0 4 1 0 3 80 '"tj
0
Plantations Q 0 7 120 17 19 7 15 5 3 7 16 13 1 7 10 1 86 8 4 14 43 3 0 9 415 ~
Food R 1 1 10 1 0 0 1 4 2 1 2 4 6 6 0 8 6 4 1 2 1 1 5 68 >
...,
Breweries Rl 0 0 9 2 1 0 0 1 1 2 4 4 0 5 0 4 4 18 0 7 1 0 5 99 tr:I
()
Sugar Rz 0 0 17 2 1 1 2 1 1 0 2 0 0 2 3 0 14 1 o 24 6 0 0 3 80 0
Other S 1 4 49 5 3 11 14 11313 12 12 10 9 13 4 43 2 7 6 36 2 5 8 283 Z
...,
Paper Sl 0 2 7 1 1 1 1 1 1 5 1 5 5 8 3 I 3 1 I 0 2 4 0 2 56 ~
Oil Sz 0 0 5 0 0 3 4 1 1 0 0 2 0 0 2 0 0 1 0 0 5 0 0 0 24 0
r'
Distribution T 0 2 21 10 3 7 6 2 3 3 6 3 1 3 3 9 5 5 3 8 2 o 32 138
7532

Pnrirl"'lpA (>plh:. lnrlir!ltp th~t (!p("tnr in thp hnrl'7nnt<::ll rrnIT';:; UTPrp rr1nd <;InA (!PI"I'\nA tnnd intprlnl"'.....prl Ul'ith (!pr-tnr 1n (>",I11'l'n"
the role of the financial holding companies is to calculate what direct effect their
disappearance would have on the overall concentration of corporate power in
the Belgian economy.
It is possible to estimate this direct effect by deducting from the horizontal row
totals in Table 4 (excluding row C) the interlockings with the holding company
sector. When the financial holding companies are eliminated, the total number of
interlockings in the Belgian economy would fall from 7532 to 4796. With the
expulsion of the holding company, the average concentration ratio drops from
19.5 interlockings per company to 14.02.
Thus far it has been shown that the holding companies, financial institutions
for the control over corporate wealth, are a main source for the concentration of
corporate power. It can further be shown that the control influences in the
Belgian economy have a wide span and are tight. A first way to study the span of
control is to calculate dispersion (r), the number of companies with which a
given company is interlocked.
Equation [9] shows that larger companies have a more widely spread control
influence, which is also the case when a company is more interlocked with the
holding company sector and its portfolio investments (a sign of holding
company activity) are larger in relation to total assets and the tighter control.
rj = 5.163 + 0.002kj + 11.66~ + 13.05hj - l.31s j [9]

(1.1962)** (0.0001)** (1.758)** (3.326)** (1.622)
R2 = 0.35 F = 50.2**
A second way to approach the span of control is to study sectoral control

diversification. For the ten most interlocked companies control diversification
ratios were calculated. A two-sector diversification ratio for a given company is
defined as the proportion of interlocking directorates with the two most
important sectors in term of interlockings, for that company. The four-sector
diversification ratio is based on the four most important sectors. The group of the
10 most interlocked companies, presented in Table 5, appears to have a widely
spread influence over corporate wealth since even the four-sector diversification
ratio is well below 100 percent.
In order to study the tightness t of the control influences in the Belgian
economy, inter10ckings per company were divided by dispersion. The tightness
ratio of a company measures the average number of interlockings this company
has with other companies. The findings of equation [10] are similar to the results
obtained from the study of dispersion.
tj = 1.519 + 0.00003kj + 0.2957Jj + 0.6882h j - 0.6674s j [lOJ

(0.083)** (0.000012)** (0.122)** (0.2316)** (0.1130)**
R2 = 0.140 F = 15.01
It is clear that control links between the highly interlocked companies are
considerable and that control over corporate decision-making is consequently
tight, under the definition given to that concept in this study.
Summary of findings
This section has presented new quantitative evidence about the concentration of
corporate power in the Belgian economy. It was found that the results are
significant and are not biased by the size distribution of Belgian corporations.
Larger companies interlock more, and the main source for the interlocking
directorships are the financial holding companies, which have focused their
activities upon the basic and capital-intensive industries. Another source for the
concentration of corporate power is the intra-sectoral control linkages. It has
been demonstrated further that the dispersion of control links in the Belgian
economy is wide and that control over corporate decisionmaking is tight.
Table 5. Diversification of control influence, 1967.
Name of company N° of inter- Sector a Two-sector b Four-sector C

lockings diversification diversification
ratio ratio
1. Electrobel 161 F 45.3 67.0

2. Societe Generale
de Belgique 158 C 29.1 46.2
3. ACEC 127 H 38.5 58.2
4. Traction et Electricite 122 F 41.8 60.6
5. Intercom 118 G 43.2 72.3
6. Cockerill 115 I 36.5 55.6
7. Auxilacs 103 C 52.4 71.8
8. Commerce et Industrie 103 C 31.0 55.3
9. Interbrabant 99 G 48.8 69.9
10. Cofimines 92 C 56.5 76.0

a For meaning of codes used see Table 4.
b percent of interlockings in two largest sectors.
C percent of interlockings in four largest sectors.
THE MARKET FOR CORPORATE CONTROL 85
4. The market for corporate control in Belgium 28
The foregoing section outlined the influence of the holding company structure
on the organisation of corporate control in Belgian capitalism. It was found that
the holding companies' principal business is to manage and to monitor other
industrial and financial companies financially. Since there are so many large
holding companies in the Belgian economy and since these institutions contri-
bute so much to the concentration of corporate power, it is interesting to study
whether an active market for corporate control has originated, i.e. whether
controlling interests in subsidiaries are often sold or traded in exchange for other
interests. Some economists 29 have argued that the existence of such a market for
corporate control is a necessary condition for an efficient functioning of
capitalism, and that in managerial capitalism, it provides a balance against the
growing independence of non-owner managers. Such a market would indeed
eliminate inefficient management groups.
Although a careful search through publicly available secondary material, such
as annual reports and newspaper articles might be helpful in bringing forward an
exact picture of the size of the corporate control market in Belgium, it is doubtful
whether we would find a lot of activity in this market for control. Most students
of Belgian capitalism agree that among the holding companies and their
respective financial groups only a modest degree of competition exists to take
over or to change control influence over companies. The only recent exception
of a major battle for control is the so-called' Affaire Sofina'. Two large groups,
the Societe Generale de Belgique and the group Lambert contested the control
over Sofina, a financial institution with controlling interests in the electricity and
engineering sector. The skirmish was won by the former.
Another indication of the rather weak competition in the corporate control
market is provided by take-over bids, a technique which has only become more
popular since the 1960s. The annual reports of the Banking Commission contain
data on take-over bids, which were brought to the attention of the Commission.
In 1970, 11 bids were placed, in 1971, 15, in 1972,9, in 1973, 18 and 11 in 1974.
From this source the holding companies do not appear to be very active in the
take-over bids. A study of the Kredietbank 30 showed that most take-over bids
during the period 1959-1969 were undertaken in the hope of achieving a
28. For a theoretical analysis of the market for corporate control see Chapter 6.
29. See H. G. Manne (1965).
30. Ret openbaar aanbod tot aankoop of omruiling van aandelen in Belgie, Weekberichten, 20
February 1970, Kredietbank, Brussel. Waardebepaling van ondernemingen bij overname in Belgie,
Weekberichten, 17 January 1975, Kredietbank, Brussel.
200.0.0.
10.0.0.0.
1.000
100
1952 1955 1960 1965 1970 1972

Figure 2. Merger activity in Belgium. (Data from N.I.S.).
geographical diversification or a rationalisation of production. In only one case,

the above-mentioned' Affaire Sofina', was the explicit purpose of the bid to gain
control over the company, purely for the sake of control. Further evidence for
our point of view is found in R. Witterwulghe's study of take-over bids. 31 He
found that in 40 out of 52 take-over bids during the period 1964-1972 did
the bidder offer to buy shares in a company where he already was holding a
controlling interest. Only 12 take-over bids were directed towards a company
which was not presently under control of the bidder. 32
Another but less direct way to study the size of the corporate control market is
to analyse merger activity. Figure 2 and Figure 3 give an outline of corporate
mergers since 1952. It is not possible, however, to show whether merger activity
was influenced by the actions of the holding companies. To my knowledge a
detailed case-by-case study of mergers in Belgium is lacking. Some multiple
regressions were run to test whether mergers could be explained by expanding
31. R. Wtterwulghe (1973).

32. R. Wtterwulghe (1973). Table 1, p. 110.
THE MARKET FOR CORPORATE CONTROL 87
250
_ _ number of mergers
______ index of industrial production
200
150
100
50
o r-.--.-.--.-.--.-,--r-.--.-,--r-.--.-,--r-.--.-,--r-
1952 1955 1960 1965 1970 1972
Figure 3. Merger activity in Belgium in number of mergers and index of industrial production,
1952-1972.
markets, by business cycles or by capital market indicators. The results are

reported in Appendix B but they are not statistically significant. Do such results
suggest that the measuring technique is poor, that the specification is weak or
that other i.e. non-economic factors explain merger activity in Belgium? More
research is needed to clarify the issue.
The conclusion is fairly simple. The market for corporate control, although
existing, is probably rather small in Belgium. It seems doubtful then that,
because of its small size, the market for corporate control is able to sanction
inefficient management.
5. Concentration of corporate power and competition
In this section the general implications of the empirical results for the degree of
competition are briefly discussed. Tbis discussion may at first sight seem
superfluous in the light of Stigler's argument that it is ' ... unnecessary to
examine the (more) basic question: would the existence of many interlocking
directorates lead to a decrease of competition?' 33 Indeed, if bis contention is true
the relevance of our results for economics would be very small, although it may
be large for the study of social structures.
Stigler based his conclusion on a small piece of sketchy evidence and on a
theoretical argument. Referring to the extremely small number of interlocking
directorates in four British industrial sectors (aircraft, boots and shoes, tyres and
cement), Stigler concluded that interlocking directorships had no noticeable
effect upon corporate directorates. To the contrary, from the empirical results
reported above, it is clear that interlocking directorates have a profound impact
on corporate directorates in the Belgian economy and that intra-sectoral
linkages together with control linkages with the large holding companies are the
main sources of 'invisible' concentration. These findings, based on a large sample
of corporations, are clearly at variance with the evidence reported by Stigler.
Whether the Belgian case is a representative example of other continental
European economies remains to be shown empirically, but common sense
suggests that such may well be so. In that case, 'invisible' concentration
organised by holding companies and industrial combines may playa large role in
shaping competition in Belgian markets. Empirical studies about the inter-
dependence of concentration and competition in Belgium should consequently
include holding companies and industrial combines as main factors affecting
competition in Belgian markets.
Stigler not only based his argument on empirical evidence, but he also relied
on the contention that: interlocking directorates are a clumsy technique, even
when one desires to coordinate the activities of two firms. Therefore, I would not
expect their presence or absence to have a significant relationship to the extent of
competition among firms.'34 Stigler may well be right that interlocking
directorships are a clumsy management technique. Tbis will be especially true in
those sectors where products are non-homogeneous because of quality differen-
tials, advertising, packaging and branding. The managerial coordination
required to gain market power in such a sector is so complex that it might be
33. G. J. Stigler, (1968), p. 261.

34. G. J. Stigler (1968), p. 261 footnote.
CORPORA TE POWER AND COMPETITION 89
impossible to use the institution of interlocking directorates to realize a close

coordination of marketing activities. A good concrete example of an industrial
sector where such close managerial coordination is vitally important is the
consumer durables sector. In this sector interlocking directorates and financial
ties will not effect competition much because of their clumsiness in dealing with
purely managerial tasks.
However, in sectors where products and technologies are rather homo-
geneous, as in the case in the more basic industries, interlocking directorates may
well provide an apt instrument for the coordination of capacity planning and
utilisation, of pricing policies and of geographical market segmentation. In those
sectors interlocking directorships are probably used as an efficient substitute for
or a complement to a cartel agreement, which in a sense is an even poorer
coordination instrument for managing market power than an interlocking
directorate. To conclude the discussion of Stigler's argument it seems more than
likely that in the Belgian economy and probably in other continental European
economies as well, interlocking directorates and invisible concentration do effect
competition. It is also plausible to argue that the effect of invisible concentration
on competition depends on the industrial characteristics of the sector.
Finally, the empirical findings reported earlier underscore yet again the now
familiar fact that holding companies, suppliers of long-term financial funds,
contribute most to the concentration of corporate power. It is, however, not
entirely clear - at least not from a purely theoretical point of view - why the
influence of the supplier of financial resources is so paramount. The unique
position held by holding companies is unmatched by any other economic group
of suppliers of services and resources to the firm. In standard neo-classical
economic theory, there is no theorem to explain why the position of the financial
group should be so dominant. In the next chapter it will be demonstrated that
large holding companies gain from the concentration of corporate power
because it enables them to force their policy preferences upon corporate policy.
The desire for corporate control- as will become clear later is largest when
capital markets are incomplete (in the Arrow-Debreu sense) and fundamental
differences exist among investors about future events and policy preferences
which cannot be reconciled by the market mechanism and the price system. The
argument again suggests that capital holders will want to monitor their capital
investments in those sectors where fundamental differences in opinion exist
about alternative corporate policies such as in energy, steel and raw materials, all
basic industrial sectors.
90 HOLDING COMPANIES AND CORPORATF CONTROL
6. Conclusion
In this chapter new evidence has been presented about the concentration of
corporate power in the Belgian economy. The evidence is of general importance
because it brings forward the basic structure of what was called 'invisible'
concentration. Indeed, for the first time a complete picture is presented of the
inter- and intra-sectoral control linkages. The findings, based on a precise
analytical methodology, demonstrate that holding companies and intra-sectoral
control linkages contribute most to the concentration of economic power.
It remains to be shown in the next chapter why holding companies and large
investors struggle for control over corporate wealth and corporate decision-
making.
APPENDIX A: THE 54 MOST INTERLOCKED COMPANIES, 1967
Number of Sector"
interlockings
1 Electrobel 161 F
2 Societe Generale de Belgique 158 C
3 ACEC 127 H
4 Traction et Electricite 122 F
5 Intercom 118 G
6 Cockerill-Ougree Providence 118 G
7 Auxilacs 103 C
8 Commerce et l'Industrie 103 C
9 Interbrabant 99 G
10 Cofimines 92 C
1198
11 Sofina 92 F
12 Ebes 92 G
13 Metallurgie Hoboken 89 K
14 Verlica-Momignies 86 N
15 Grands Lacs 85 C
16 Sogefor 84 G
17 Pays Charleroi et Extensions 83 E
18 Carbochimique 81 L
19 Cie Maritime Beige 78 E
20 Cominiere 75 C
770
CONCLUSION 91
21 Uce-Linalux-Hainaut 75 Q
22 Union Miniere 70 K
23 Ruzizi 70 Q
24 Sibeka 70 K
25 Cie Financiere du Katanga 67 C
26 Fagaz 67 G
27 Liege-Seraing et Extensions 67 E
28 Sogelec 66 G
29 Bruxelloise de Developpement 65 C
30 Tramways Bruxellois 63 E
680
31 Electrorail 61 C
32 Socol 61 0
33 Agricom 57 R
34 Cotonco 57 S
35 Overpelt-Lommel 55 K
36 Electrische Tramwegen Gent 53 E
37 Mercantile Marine 52 J
38 Esmalux 51 G
39 PRB 51 L
40 Brufina 50 C
548
41 Laura en Vereniging 48 M
42 Union Financiere Anvers 45 C
43 CFE Entreprises 44 0
44 Belref 42 0
45 Metallurgique Hainaut-Sambre 42 I
46 Belectric 42 F
47 Financiere des Caoutchoucs 41 C
48 Cimoutremer 41 0
49 Kasai 41 .Q
50 Fininter 40 C
426
51 Lacourt 40 C
52 Brugeoise et Nivelles 40 J
53 Cometain 40 K
54 Andre Dumont 40 M
160
TOTAL 3.782
Source: Based on own calculations

asectoral classification is the one used by the Stock Exchange Commission, for code see Table 17 in
Chapter 1.
APPENDIX B: MERGER ACTIVITY IN BELGIUM, 1953-72
In an effort to explain merger activity in Belgium we undertook several statistical tests.

The main objective was to find if expanding markets, economies of scale, business cycles,
and/or capital market conditions could be used to explain merger activity. The regression
results are reported below. The specification is log-linear; hence, the estimated coefficients
must be interpreted as elasticities. Standard errors are in brackets below the estimated
parameters.
MERGNO = 7.599 + 0.187 VOL + 0.757 INDEX - 9.969 GNP + 11.273 PROD
(11.496) (0.495) (1.081) (5.954) (6.166)
R2 = 0.55 D.W. = 2.136
MERGCP = 9.606 + 0.206 VOL + 2.586 INDEX - 17.278 GNP + 19.203 PROD
(26.818) (1.154) (2.522) (13.889) (14.386)
R2 = 0.45 D.W. = 2.29
MERGNO = log. of number of mergers, (source NIS').

MERGCP = log. of mergers in million BF, (source NIS ').
VOL = Yearly trading volume Brussels Stock Exchange, (source NBB b ).
INDEX = Index of share prices Brussels Stock Exchange, (source NIS').
GNP = Gross National Product, (source NIS').
PROD = Index of Industrial Production, (source NIS').
These results provide evidence of the difficulty of attempting to advance an explanation
for merger activity in Belgium. Gross national product, as a proxy measure for expanding
markets, and the index of industrial production, as a proxy for economies of scale (but
also for the business cycle) are the only variables that appear to have a significant
influence on mergers.
a. NIS, NationaaI Instituut voor de Statistiek.

b. NBB, Nationale Bank van BeIgie.
VI. FOUNDATIONS FOR A THEORY OF
HOLDING COMPANY BEHAVIOR
That the search for control over corporate wealth has a decisive impact on the
demand for financial assets remains an uncontested dogma for most observers of
the financial arena. Reports about fights for corporate control score headlines
regularly in national and international financial newspapers and stir up lively
public debate. There is also evidence that some iuvestors, both large and small,
prefer to allocate part of their resources to hold controlling interest in corporate
assets. Such investors probably forego other opportunities in order to gain
corporate control; therefore, they pay a price for control. Until recently, however,
most neo-classical economic theorists have either ignored the influence of this
desire for control on resource allocation or they have tried to demonstrate that
the problem is irrelevant.
In this chapter then, we will try to determine why corporate control - the
central business of a holding company - is a desirable good for an investor and
what influence the search for control might have on the demand for corporate
assets and on asset-pricing. Although the chapter will provide the foundation for
a much-needed theory of corporate control, it is not meant to develop a complete
theory of holding company behaviour. Such a theory must provide answers to
the key questions raised in the introduction to this book. What does corporate
control mean? What is the purpose of control? What benefits are derived from the
control function and why is control desirable?
1. Introduction: the holding companies' problem
The holding companies' problem can be specified along the following lines. Let us
assume that N risky assets are available offering uncertain rates of return and that
borrowing and lending in a riskless asset is possible. Let Zi represent the
proportion held in asset i. The holding company must now decide how to allocate
its wealth over the assets. For the sake of simplicity, we define control as owning a
share of the equity capital of a company larger than or equal to )" the control
94 HOLDING COMP ANY BEHAVIOR
threshold. It will be, assumed that Ais the same for all assets and is exogeneously
defined by an institutional arrangement like corporate law. It will of course be
necessary to remove this restriction in future refinements ofthe theory. Indeed, if
the demand for assets depends on the desire for control, it is logical that A is
endogeneously defined in a general equilibrium framework. If Zi ?> A, the holding
company is said to have acquired control over asset i, i.e. it has obtained the
instruments needed to influence corporate decision-making. In order to derive
the composition of the portfolio and the demand for assets by the holding
company, we need to specify the objective function of the holding company. A
major complication in specifying the objective function stems from the fact that
holding companies are financial intermediaries which issue shares in order to
hold controlling interests. Consequently the holding companies' portfolio
decisions are directly influenced by the willingness of the savers to accept the
security substitution. In order to avoid this complication, which will be analysed
more carefully later on, we assume that the holding company is a 'control-
investor', i.e. a private, non-incorporated investor looking for control over the
assets he holds.
To specify the objective function of the 'control-investor' is not easy. Three
alternative specifications are possible: first, the maximization of expected utility
offuture wealth, second, the maximization of control influence and third, a trade-
off between the expected utility of future wealth and control.
The first alternative implies that control over corporate decision-making has a
positive effect on the distribution of the investor's future wealth. Indeed, if this
was not the ,case, the specific portfolio-problem of the 'control-investor' would
disappear, and would coincide with the portfolio-problem of a 'normal' investor.
Neither type of investor would then care about controlling interests because, by
definition, they would have no utility for control (unless, of course, the
distribution of returns was made a function of the z/s, a not implausible situation
since a controlling interest might entitle the investor to benefits not available to
others). The third section in this chapter will bring forward the returns which can
be expected, in theory, from such a controlling interest. Meanwhile, the other
alternative specifications, in which control is seen as a desirable good in itself, will
be scrutinized.
2. Control for the pure sake of control or power
As argued above, three alternative assumptions about the nature of the control-
investor's objective function are possible. For the moment we will analyze only
those two objective functions, the second and third alternatives, which implicitly
CONTROL FOR THE SAKE OF POWER 95
assume that no economic or financial benefits accrue to the control-investor.

The second alternative puts all emphasis on control motivation and posits the
'control-investor' as simply a capitalist in search of power. It is this aspect of
holding companies which has been most emphasized in the popular literature.
Although the impact of such a motivation on allocation has never been worked
out, some of the consequences of control maximization were touched upon in the
introduction to this study. If the 'control-investor' has an initial wealth of Wo' he
can control A- 1 Wo assets. When his controlled companies hold controlling
interests in other companies, the 'control-investor' is able to expand his control
influence over A- 2 Wo assets. This reasoning suggests that no limit exists to the
control influence of the 'control-investor' when indirect participations or
pyramids are allowed. The analysis is slightly exaggerated and naive, however,
since it would permit one capitalist to control the whole asset structure of the
economy.
Let us assume for simplicity's sake that the creation of financial pyramids is
prohibited, or that no corporation is allowed to hold corporate securities. The
investor striving for maximum control is faced with the same problem as the
wealth maximizers of the first alternative, i.e. over what asset to take control? If
no borrowing or lending is possible he will take control over A-1 Wo assets. But
what happens when borrowing and lending are possible? How much will the
'control-investor' borrow or lend to finance his control participations?
The non-borrowing non-lending case is not as simple as we suggested either.
When A is different from company to company and/or the size distribution of
companies is unequal, the whole specification breaks down. What is it that is
maximized? Total assets controlled or number of companies under control? This
suggests that the objective function selected or implicitly assumed in most
previous studies of holding companies is extremely naive. Control for the pure
sake ofcontrol does not lead to a solution of the portfolio selection problem. Control
must be desirable because of the potential returns to the control function. 1
Some of the issues raised under our naive specification ofthe objective function
of a control-investor can be resolved by specifying a utility function with two
arguments - future wealth and control - as was suggested in alternative three.
This accounts for the problem of how to allocate funds over the available projects
and it also offers a justification of the price paid for control. Note that we retain
the assumption about the non-existence of an economic or financial benefit to
control, made earlier in the discussion of alternative 2.
1. One of the very first attempts to integrate the desire for control over corporate wealth with non-
marxian economic theory is given by W. W. Cooper (1949).
96 HOLDING COMPANY BEHAVIOR
In order to simplify matters the utility function is written in an additive form. 2
n
U(W(8), Z, ... , Zn) = f(W(8)) +L g(Z') [1]
i= 1
Where W(8) is final wealth in state of the world 8
f(W(8)) utility for wealth!, > 0 f" < 0

:1 g ::12g
g(Zi) utility for control in asset i _u_>O
::1
U
---;--z < 0.
UZ i UZ i
and Zi is the proportion invested in asset i.

Ideally one would like g(Zi) = 0 if Zi < A. This, however, causes the total utility
function to be discontinuous. Again, for simplicity's sake, both components of the
utility function are assumed to be continuous and differentiable. Let Pi be the
price of the jlh asset, f;( 8) the return on the jlh asset in state of the world 8, rF the
return on the riskless asset and B be the amount of money invested in the riskless
asset.
Final wealth is given by:
W(8) = (1 + rF)B + L ziPi(l + f;(O)) [2]

i= 1
Taking into account the budget-restriction:
Wo = B +L ZiPi
i= 1
[2] can be rewritten as
n
W(O) = Wo(1 + rF ) + L ziPi(fi(O) - ;OF) [3]
i= 1
2. In a recent article in the Journal of Finance A. Melnik and M. A. Pollatschek (1973) tried to take a
similar approach but applied it rather awkwardly. One of their 'conclusions' is the obvious statement
that, ' ... whenever the utility of acquiring a company is greater than the utility of owning an
equivalent amount of other stocks (but without control), the acquiring firm will liquidate its other
holdings in order to gain control over that company (p. 1271). Moreover the writers fail to integrate
the possibility that investors can borrow to acquire a controlling interest.
CONTROL FOR THE SAKE OF POWER 97
If h«()) is the 'control-investor"s probability function over the states of the world,
it is possible to derive the 'control-investor"s demand function for participations
in the different assets by finding a solution to the following maximization
problem:
MaxE(U) = MaxI: UCW«()))h«())

e
for for
where E is the expected value operator.

The first-order conditions for a maximum are given by:
aE(U) _ ag
-a- = E[f'(W)P;Cr; - r F )] +a = 0 for all i,
~ ~
or
E[f'(W)P;(f; - r F )] = ;g for all

Zi
i. [4]
Equation [4] states that the 'control-investor' is willing to trade return for
control. He will do so until the marginal utility gained from control is equal to the
marginal utility lost from return. The result suggests that a 'control-investor' will
invest more in asset i than an 'ordinary' investor, i.e. an investor with no utility for
control. Indeed where a normal investor will invest until EU' CW)P;(r; - r F)] = 0,
a 'control-investor' will continue to invest beyond this optimal point. This suggests
that in an economy dominated by 'control-investors' the demand for risky assets
will be higher than in a 'normal' economy. Stock-market prices will be inflated by
the actions of the 'control-investors', and expected returns on risky assets will be
lower, possibly leading to an export of financial capital by small investors to
'normal' economies i.e. economies not dominated by 'control-investors'.
Although such results and hypotheses are attractive, their major drawback is that
they are not directly testable. Indeed a valid test would require a cross-sectional
comparison of stock prices and rates of return across different stock markets.
But, although it is possible to adjust for the differences in risk across different
stock markets,3 it is not possible to differentiate stock markets on the basis of the
relative influence of 'control-investors'.
Another way to test the theory might be to derive some properties of the
3. See B. Solnik (1973).

individual demand equations from the equilibrium conditions given in equation

[4]. Whether such a derivation is possible without explicitly specifying the
underlying utility functions, however, is highly doubtful. A test of the theory
about the demand functions of the 'control-investor' would therefore be nothing
more than a test of the underlying utility functions.
In this section portfolio decisions by the 'control-investor' were studied under
the assumption that no benefit accrued to the control function. Control was
desirable for the pure sake of power over corporate decision-making. Next we
will analyse the more realistic situation in which control is an instrument for
obtaining financial returns otherwise not available.
3. Financial and economic benefits to control
The theory developed in the foregoing section assumed that control over
corporate wealth was desirable only for the sake of being in control or having
power. In this section control is studied as an instrument for capturing excess
financial returns. The fact that an investor holds a controlling interest in an asset
enables him to exercise a right over the financial returns and permits him to earn
an excess return. The fundamental question then becomes: what economic and
financial conditions permit the existence of an excess benefit or return? Such
conditions may arise in product-markets or in factor-markets, or in both at the
same time. We will start the analysis with a study of the possible excess returns
accruing to the investor who holds controlling interest in a company because of
specific conditions in product-markets.
Benefits to control because of imperfections in product-markets
It is possible to earn an excess return by coordinating price and output decisions

between several companies. 4 Four cases can be distinguished. Whether they will
direct us toward an explanation of the existence of holding companies will be
discussed later on.
4. Much of the literature on mergers and conglomerates is useful for our analysis. The only serious
difficulty is that theories of merger activity explain why some firms fully merge and completely
reorganize their management structures, but ignore the firms which do not fully merge but come into
the control-sphere of other companies. The latter is the case with the holding company. See also later
in this chapter.
FINANCIAL AND ECONOMIC BENEFITS TO CONTROL 99
Case I: Coordination in a single market

By coordinating price and output decisions among competing companies in the
same product market, a 'control-investor' can effectively organise a monopoly
and earn an excess return on invested capital. The result is well known and
needs no further comment.
Case II: Coordination in many markets

Let us assume that two monopolists are operating in two different but
interrelated industries. 5 The demand functions faced by these companies are
given by:
q1 = 11 (P1' P2) (demand function firm 1)
That both product-markets are interrelated is exemplified by the specification of

the demand functions. No external economies or diseconmnies in production
exist implying that cost functions are independent. Profits for firm 1 and 2 are
given by:
Both firms assume that the other's prices will not change and both will maximize
profits by setting prices where:
(firm 2) [S.b]
If (Pt, pi) is a solution for the system of equations, the individual firms and both
industries will be in equilibrium if new entries are prohibited.
Owners of both firms, however, would profit from a coordination of both
5. Forsimilarmode1sseeM.J. Bailey (1954),J. Markham (1973), T. Naylor andJ. Vernon (1969) and
K. Palda (1969).
firms' pricing policies. Suppose a 'control-investor', holding controlling interest

in both companies, suggests that management maximize joint profits.
Such an investor, undoubtedly supported by his fellow capitalists, would urge the
two firms to set prices where:
[6.a]
[6.b]
Equations [6.a] and [6.b] show that the non-coordinated pricing policies found
in [5.a] and [5.b] are sub-optimal because both firms ignored the effect their
decisions had on each other's profits. Equilibrium prices (pr*, pi*) are a solution
of system [6.a and b]. It follows from comparing systems [5.a and b] and [6.a and
b] that policies (pr, pi *) - i.e. the coordinated solution - earn more profits when
industries are demand-interrelated.
When commodities are complementary products, it is well known that the
following holds: oq2/0P1 < 0 and oqdoP2 < O. The non-coordinated solution
[pr, pi] would lead to negative partial derivatives for the joint profit function
because (P2 - C;(q2)) > 0 and (P1 - C~(ql)) > O. Both firms are too small and
are selling their products too expensively. The 'control-investor' could earn an
extra income by suggesting that management reduce prices and expand output.
Not only would joint profits increase but also profits of individual firms. All
stockholders of both firms will support the change in policy advocated by the so-
called 'control-investor'.
When commodities are substitutes, it follows that Q2/0P1 > 0 and oQ1/0P2 > o.
The 'control-investor', again with the full consent of the co-owners, will order a
reduction in output and an increase in prices. Indeed, the non-coordinated
solution (pr, pi) leads to positive partial derivatives with respect to PI and P2 of
the joint profit function. Without coordination, firm sizes are too large to earn
the maximum return on total capital in both industries. The 'control-investor's
action will effectively reduce competition between the companies and all
stockholders will benefit. Finally, when commodities are independent, oQl/0P2
= 0 and oQ2/0PI = O. No extra profit can be earned by coordinating the activities
of both companies and there is no economic reason for inter-company control
linkages.
Comments about the relevance of this theorizing to an understanding of the

holding company will be presented later on; here we are limiting ourselves to a
further exploration of the foregoing model.
It might be argued that no explicit inter-company control linkages are needed
to bring the firms to the optimal solution (Pi*, pi*). Indeed 'intelligent' firms,
facing a variable sum game might come to this conclusion without the need for
consultation with each other. They would automatically take into account the
effect of their decisions on each other's profits and act accordingly. In reality,
however, the coordination problem might be so complex that it would dis-
courage the companies from considering such a tacit coordination of their
production plans.
Since all companies in the foregoing theory were monopolists, it does not make
much sense to analyse the social desirability and the allocative efficiency of the
resource allocation. But it is worth noting that the actions of a 'control-investor'
lead, in one situation, to a socially desirable output: when companies sell
complementary products, a coordination of pricing policies results in a higher
output at a lower price.
Government intervention to set prices in both industries would remove the
incentive for inter-company control linkages. But stockholders of both firms
might then find it profitable to form a lobby that would suggest the 'right' prices
to the government.
Case I I I: Coordination of externalities

Let us assume that two firms are producing in two independent industries.
Demand functions are independent and revenues are given by:
(firm 1)
(firm 2)
Cost functions illustrate the existence of externalities in production. Profits are

given by:
(firm 1)
(firm 2).
Both producers ignore the effects of their output decisions on each other's profits
and assume that the o~her company's output will not change. Under these rather
naive assumptions, profits are maximized when output plans are fixed at:
[7.a]
[7.b]
The uncoordinated equilibrium (qf, q~) is a solution of [7.a and b]. Stockholders,
however, would urge a coordination of production plans to take the exter-
nalities into account. A 'control-investor' with controlling interest in both com-
panies will enforce a maximization of joint profits.
The coordinated equilibrium (qf*, q~*) is obtained as a solution ofthe system of

first-order conditions for a maximum of joint profits.
[8.a]
[8.b]
Coordinated production plans lead to more superior results than uncoordinated

plans because the firms, acting independently, do not consider the 'real' marginal
cost curves. The 'control-investor' will profit by imposing these real marginal cost
curves. When there are external economies for both firms, the 'control investor',
once more unanimously supported by all stockholders, will order an expansion
of output because 8C z/8ql < 0 and 8C 1 /8qz < o. The existence of external dis-
economies, 8C z/8ql > 0 and 8Cd8qz > 0, will lead to a reduction of firm sizes.
Thus far, all results have indicated that stockholders of both companies are in
full agreement with the policies advocated by the 'control-investor'. An interest-
ing situation arises when only one company experiences externalities. In this case
of asymmetric externalities, the owners of the firm responsible for the externality
will not agree to the joint maximization policies of the 'control-investor'. To
understand this more precisely, assume 8C z/8ql = 0 and 8C 1 /8qz > 0 (firm 2
impose external diseconomies on firm I). The 'control-investor' will order firm 2
to internalize all its costs, implying a reduction of output. Stockholders of firm 2
will oppose the move since profits would thereby decrease. If the control influence
of the 'control-investor' is based on a majority position, he need not worry about
bribing co-owners. If it is not, a bribe might be necessary (although illegal

between companies which are legally independent).
From the point of view of public policy it is interesting to observe that
allocative efficiency is improved by the action of the 'control-investor', and even
more so when product-markets are already price-regulated. The conclusion is
surprising although not unknown in the literature. Indeed, in the case of
externalities, financial concentration, ceteris paribus, leads to improved allo-
cative efficiency.
Case I V: Coordination of vertical integration 6

Assume company 1, a monopolist, obtains material inputs from company 2, a
monopolist in a producer goods market. In order to produce one unit, firm 1
needs IX units of firm 2's product. Total output Q of firm 2 can be decomposed in
two components: first, output produced for use as input in firm 1 (= IXql) and
second, products sold to other firms Q2' Demand functions are independent and
are given by:
(firm 1)
(firm 2)
where Q = Q2 + IXQ1'
Revenues per company are given by:
If each firm acts independently, it will maximize its own profit function.
(firm 1)
(firm 2)
First-order conditions for maximization of individual profit functions lead to

optimal output policies (Qi, Q*), a solution of [9.a] and [9.b].
6. See for similar developments A. Jacquemin (1975), M. L. Greenhart and H. Ohta (1976), among
others.
[9.a]
[9.b]
It is crucial to note that firm 1 pays a monopoly price (i.e. a price larger than
marginal costs) for its inputs. Output in the final markets is restricted because of
the monopolistic market structure in the intermediate product-markets. The
'control-investor' can gain by ordering firm 1 to expand production until
marginal revenue is equal to its marginal costs plus firm 2's marginal costs times
the technical coefficient IX. Such a policy will automatically maximize joint
profits.
First-order conditions for a maximum are given by:
The uncoordinated policies (q'J', Q*) lead to positive partial derivatives of the
joint profit function. The coordinated policies (q'J'*, qi*) imply an expansion of
output in the two sectors (an expansion of output in firm 1 stimulates an
expansion in firm 2). This coordination would not be necessary if resource
markets were perfect or perfectly regulated. Under both hypotheses, input prices
would equal marginal costs and the 'control-investor' would not be able to
improve allocative efficiency.
How will stockholders react to the new production plans of the 'control-
investor'? Before tackling this question, it is important to realize that the 'control-
investor' is indifferent to the matter ofthe transfer price for the inputs. Indeed, the
price that company 1 pays in excess is an extra profit for company 2. The 'control-
investor' is also unconcerned about profits being transferred from one company
to the other. 7 His main concern is that company I uses its marginal costs to decide
7. This implies, of course, that both companies are subject to the same corporate taxes, which may not
be the case ifthey operate in different countries or if one company, because of its regional location or
the nature of its activities, can benefit from government subsidies.
on its production plans and ignores the transfer prices. This is not the case with
the other investors. After new production plans are irreversibly implemented,
stockholders of company 1 would prefer to hold transfer prices as low as possible
- certainly no higher than the marginal costs of company 2. Stockholders of
company 2, on the contrary, would prefer the highest possible transfer prices and
certainly no lower than the price company 2 can obtain for its product in the
market.
Although owners of both firms will agree ex ante to cooperate on the change in
production plans, a conflict of interest will arise ex post between stockholders of
company 1 and company 2. The situation is aggravated by the fact that a
reconciliation with the point of view of the stockholders of company 1 would
imply price-discrimination. 8
In the case of vertical relations between companies it seems better, if the
government does not regulate prices, to fully merge the companies. The 'control-
investor' does improve allocative efficiency, but too much room remains for
financial abuse. An integrated firm is preferable and would effectively eliminate
the need for financial superstructures, like the holding company. Furthermore,
an integrated firm's managerial efficiency would be superior, i.e. able to
coordinate and control production more closely.
Conclusions
In the foregoing four cases 9 we sought the reasons why control linkages between
companies might exist. 10 It was shown that economic conditions in some
product-markets (monopolization, demand-interrelated products, externalities
and vertical integration) cause multi-company coordination to become
profitable. The appeal of the results of the foregoing theories is that, at least in
principle, they can be tested. Such tests could be based on the table of inter-
sectoral control linkages reported in Table 4, Chapter 5. Some of the features of
Table 4 support our theoretical reasoning; the intra-sectoral control linkages and
the interlocking directorships with the large electrical utilities (the important
suppliers of inputs, energy, to industry) came out very clearly. More detailed tests
would require price and output data per sector and might be helpful in explaining
8. For a similar theoretical analysis of Japanese zaibatsus, see R. Caves and M. Uekusa, 'Industrial
Organization', chapter 7, in Asia's new giant: How the Japanese economy works, H. Patrick and H.
Rosowsky, Eds., The Brookings Institution, Washington, D.C., 1976, p. 492.
9. A fifth case, economies of scale, was excluded because of its irrelevance to holding companies and
industrial combines. Indeed, obtaining production economies of scale in separate units is impossible.
Marketing and distribution economies are probably unattachable because no central trading
company exists in the Belgian combines.
10. It is this aspect of concentration activity which was completely ignored in the literature on
mergers.
the structure of interlocking directorships. But do the foregoing models explain

the large impact of holding companies on the concentration of corporate power,
i.e. do product-market conditions explain the existence of holding companies?
Superficially, the answer is yes. The portfolios of the Belgian holding companies
show that vertically-interrelated companies are under the control influence. So
are companies in the same or in complementary industries. 11
However, in explaining the existence of holding companies with models that
search the return on the control function in the more efficient coordination of
pricing and production policies, the major flaw is that these models do not
explain why coordination fails to lead to a full merger. Fully-merged companies
would have a better organizational form for managing the close coordination
of prices and outputs than the loose holding company, which, in contrast to
its Japanese counterpart, has not developed control instruments for marketing
and production planning. 12 This is not to say that the holding company cannot
take the initiative in coordinating prices and production plans more profitably in
several companies. But there is no fundamental reason why the holding company
should keep the companies legally separated and not bring the subsidiaries to a
fully-merged company more efficiently able to implement the required coordi-
nation. 13 The more so because Belgian anti-trust legislation has been overtly
permissive. It seems safe to conclude that product-market conditions alone cannot
fully explain the struggle for control over corporate assets and, ipso facto, the
stability and viability of the holding companies. These conditions only suggest
that the holding company can be useful as a transitory institution for gradually
organising the merger of economically-interrelated companies.
Additional support for this argument comes directly from the theory de-
veloped above. In most cases studied, stockholders were unanimous about the
decisions to be taken since all owners would benefit from the new policies. There
is consequently no reason why a 'control-investor' would continue to pay a pricefor
the right to exercise the control-function. Therefore the control-function is not a
desirable economic good and a market for corporate control is hard to explain on
the basis of product-market imperfections.
11. Banks which typically belong to every multi-company combine, are of course 'suppliers' of a
product (financial services) that is needed as an input in every company.
12. See especially Chapter 2.
13. Belgian fiscal legislation does not appear to provide a rationale for keeping companies legally
separated.
Benefits to control because of incomplete capital markets 14
It was found above that imperfections in product-markets could not fully explain
the existence of holding companies, financial institutions for control over
corporate decision-making. We will now investigate the conditions in the capital
market which would bring forward the desire to control corporate assets.
If investors unanimously agree on corporate policies to be pursued, there is no
economic rationale for the fight for control and the creation of specialised
institutions for control over corporate wealth. The basic issue, therefore, is to
determine the conditions under which stockholders' unanimously consent to
corporate policies. In order to do so, we have enlarged upon some very recent
work by P. A. Diamond, J. E. Stiglitz, H. Leland, S. Ekern, R. Wilson, M. King
and others. 1s We will first develop the basic model and then turn to its
implications for capital-asset pricing in an economy dominated by 'control-
investors' or holding companies.
The basic model
Let us assume that I consumer-investors (1, ... , i, ... ,1) face a two period (1,2)
consumption-investment decision in an economy in which assets (1, .. . ,j, ... , J)
exist. In period 2, K states (1, ... , k, ... , K) of the world are possible. Let R be the
(J x K) matrix of state-dependent returns. Consequently Rjk is the return on asset
j in period 2 when state k occurs. The matrix of state-dependent returns is fully
known to all investors and has the highest possible rank, implying that when
J ~ K, as is subsequently assumed, assets are linearly independent projects, i.e.
they are genuinely different. Every row vector of returns (R jl' ... , R jk) depends on
a policy-variable Xj' the functional relation between returns and policy-variables
is known to all investors. 16 Let Pj be the price of asset j. Every investor i has a
subjective probability function hk over the states of the world, implying that
L hk = 1. The ith investor's utility function is given by Ui ( C 1 i' C 2i ), where Cti is i's
k
14. The meaning of the term 'incomplete capital markets' will become clear below.
15. See P. A. Diamond (1967), J. E. Stiglitz (1972), H. Leland (1974), S. Ekern (1973), S. Ekern and R.
Wilson (1974), M. King (1974), L. Gevers (1974), S. Ekern (1975), N. Nielsen (1974).
16. As Niels C. Nielsen rightly observes in Nielscen (1974): 'the assumption that the returns on a
specific project depend solely on the policy-variable of that project and are independent of the other
projects' policy-variables implies that firm j's decisions directly influence the future supply in the
capital market. Hence, the firm is not a price-taker in the asset market and the market is not perfectly
competitive'. We feel that this assumption is fully justified and might provide a reasonable
representation of a 'real' world (whatever this may be).
consumption in period t. Let zij be the share of asset j held by investor i.

Consumption in period 2 in state of the world k is consequently given by:
C 2 ;k = I.ZijRjk
k
Initial wealth of investor i is given by:
Wu = Cu + I. zijPj [1OJ
j
where Cl ,; and zij represent the initial endowments of investor i. The investor is a
price-taker in the asset market and assumes that management has selected the
policy variables (Xl"'" XJ) which will not be changed. The investor will
maximize expected utility by selecting a portfolio of holdings (zo, ... , ziJ) subject
to the budget constraint (10). Maximization of the Lagrangean:
L( C u' zit' ... , ZiJ, A;} = I. (V;( C 1i' C 2 ;)hk) + A/Wli - C li - I. zijPj)
k j
leads to the following first-order conditions, the individual demand equations for
assets:
for C li ~ (:~; 'hk) = A;
~(:~;Rj~k)=A;Pj j=(l, ... ,J) [12J
for A; Cli + L Z;jPj = C Ii + I. zijPj

j j
The J equations of [12J can be rewritten as:
[13J
where
The W;k'S have a precise economic meaning. They are investor i's marginal rate of
substitution of consumption in period 1 for consumption in period 2 in state of
the world k.
If J = K, the number of assets is equal to the number of states of the world - a

condition known in the literature as the Arrow-Debreu world with complete
markets - the inverse of R exists and a unique solution can be found for the Wik'S
from the J equations of system [13]. Such a solution depends entirely on asset
prices (Pl' ... , PJ ) and on the matrix of state-dependent returns. Since all investors
are assumed to be price-takers in the capital market and have full information
about the R matrix, the W ik coefficients for investor i are equal to every other
investor's W hk coefficients. Consequently, in the case of complete markets, the
asset market is able to price every contingency and equation [13] will be exactly
the same for all investors. System [13] can be rewritten as:
which is now independent of investor j's typical characteristics. This result does
not hold when markets are incomplete; indeed, for J < K, there are less assets
than states of the world. The solution of system [13] will be different for every
investor and the marginal rates of substitution are not necessarily equalized
among investors. Consequently, in a condition of incomplete markets, it is not
possible to price all contingencies in the capital markets.
These results about the feasibility of pricing contingent consumption bundles
in capital markets have important consequences for the possibility of unanimous
decisions by investors on policy changes. Before a closer analysis of unanimity
among investors, we will derive the equilibrium asset price in an economy. The
equilibrium asset price for j is easily found when, for investor i, we multiply
equation [13] by zij" Summation over j leads quickly to:
LZijL WikR jk = LZijPj

i k i
Since in equilibrium LZij = 1, after rearranging terms; we find:
LRjkL.ZijWik = P j [13.a]
k i
Equation [13.a] states that the value of one unit of return on assetj in state of the
world k is equal to a weighted average of the marginal rates of substitutions of all
investors. This important result suggests that the price of an asset is not only
influenced by the share of in vester i's investment in assetjbut also by his marginal
rate of substitution. An investor who strongly prefers to substitute consumption
in a particular state of the world for present consumption will have a large
influence on the price Pj'
When complete markets exist [13.a] simplifies to [13.b]:
[13.b]
Individual appraisals are now equalized by market forces. With these results in
mind, we now turn to an analysis of unanimity.
Let us assume that the management of company j intends to change its policy
variable Xj' after an equilibrium is reached in the capital market. How would
stockholders react to such a proposal? A rational stockholder would study the
influence of such a policy change on his expected utility. Equation [14] gives the
partial derivative of expected utility with respect to a change in x j"
aE(U) au. au. ( az.. )

- a x = LZij ac' Rjdik + L ar' L ax'] Rjk !;k [14]
j k 2i k ~2i k j
Using equations [12], [13] and the substitution W ik = Ai- 1 (auJac 2i )!;k' it is pos-
sible to rewrite [14] as follows:
aE(U) _ 1"
-a--Xj
- Zi/ i £... WikR ' + Ai1"
Io
k
iJZij
£... -a P
jk
j Xj
j [15]
The effect of a change in j's policy on investor i can be decomposed into two
components. The first term in the RHS of [15] is the income-effect; it describes
the effect of the proposed change on income. The second term is the portfolio-
effect (or substitution-effect). It measures how investor i would like to change his
portfolio after the policy change is announced by company j's management. If the
sign of [15] is independent of investor i's characteristics, then all investors will
concur in corporate decision-making and will support or resist policy changes
unanimously.
A major difficulty in determining the sign of [15] is the sign of the portfolio-
effect. Indeed, it is not possible to explicitly derive the signs of the partial
derivatives azu/iJx j , without specifying the underlying utility function. This is
easily verified by taking the derivative with respect to Xj of [13]. To avoid the
difficulty of specifying a particular utility function we assume, as most authors do,
that, after the change in corporate policy is announced, stock markets remain
closed and stockholders are prohibited from trading shares in companies. 1 7 This
rather heroic assumption permits us to rewrite [15] as:
17. S. Ekern and R. Wilson (1974), H. Leland (1974). For a thorough discussion of these assumptions,
see M. King (1974) and N. Nielsen (1974).
Four different cases are possible.
I. A policy change has the same effect on returns in all contingencies

When Rjk has the same sign for some states of the world and equals zero for the
remaining states, all investors will agree in their evaluations of the proposed
change. Indeed, assuming Rjk > 0 for all k, [16] is positive for all owners of the
firm (investors holding long positions in assetj) because all W ik are positive. All
investors will support the policy proposal unanimously. The reverse will be true
when, because of the change in policy, returns decrease in all possible states of the
world. Stockholders will unanimously resist a detrimental policy.
The foregoing result once more underscores a very familiar conclusion:
stockholders prefer their companies to operate as efficiently as possible and they
unanimously resist inefficient management. This also implies that stockholders
prefer more monopolization than less monopolization.
The conclusion is clear. Stockholders are unanimous in their evaluation of
improvements in efficiency when such improvement lead to higher returns in all
contingencies. But what will happen when the company is operating at maximum
efficiency and when policy changes have different effects on returns in different
states of the world?
II. Complete markets

In an Arrow-Debreu world with complete markets it is possible to rewrite [16] as
follows:
[17]
Equation [17] has the same sign for every investor. If [17] is positive for one
stockholder, all other stockholders will agree to the change in policy by
expanding Xj. Consequently, unanimity exists under complete markets. Indeed,
because R is a square, non-singular matrix, the J projects span the entire space of
state-dependent returns. Every new policy proposed by management was already
available to the investors, and was priced in the stockmarket. When markets are
complete, stockholders will agree about the policies to be pursued. But what
happens when complete markets do not exist?
III. Incomplete markets with unanimity

If the company proposes a change in policy which does not change the set of
available state-dependent returns, stockholders will support or resist the pro-

posed change unanimously. The set of available state-dependent returns is not
altered by a proposal when the state-dependent returns of the proposed policy
belong to the sub-space of state-dependent returns spanned by the original J
linearly-independent vectors of returns. Proof of this proposition follows easily.
Because the set of state-dependent returns is not altered it is possible to write:
Substituting this expression in [16] and taking into account [13], it follows that:
[18]
Since [18] has the same sign for all investors, stockholders will approve or
disapprove of the proposed policy unanimously. Writing independently, P. A.
Diamond, H. E. Leland and M. King have shown that the set of state-dependent
returns is not altered when the returns can be written as:
[19]
According to [19] returns are a linear function of the stochastic term g(k). The
derivative of [19] with respect to the policy variable Xj leads to:
[20]
It is sufficient that another asset h exists to be able to rewrite [20] as:
or
implying that
The system of two equations in two unknowns has a unique solution for Yh and Yj
when the two projects are linearly independent. The existence of Yh and Yj proves
the theorem that return vectors with linear stochastic terms do not alter the set of
state-dependent returns.
Do the foregoing theorems have an economic interpretation? In some specific
real world cases, yes, the theorems and the specification in [19 ] apply. For ex-
ample, price-taking firms facing random prices with non-stochastic costs would
meet the assumptions of the theorems. In general however, it is unlikely that
many real-world economic situations would fulfil our rather strong theoretical
assumptions.
IV. Incomplete markets without unanimity

In general it will not be possible to find unanimous evaluations of policy changes.
Indeed when new policy proposals alter the available set of state-dependent
returns, stockholders will disagree about the actions proposed. Some will want to
control corporate decision-making in order to force their preferences on the
management. Such control is desirable, not because of product-market conditions,
but because of uncertainty, difference of opinion about the likely occurence of some
events and because of incomplete markets.
Conclusions in explaining the existence of holding companies
It was argued above that, under rather strong assumptions, all investors
unanimously approved or disapproved proposed changes in corporate policy. In
such circumstances holding company's policy would merely reflect the desires of
all individual investors, who would be indifferent to the existence of the holding
company. The owners of the holding company would not receive an excess return
above what they would receive without this financial institution. Consequently,
under these limiting assumptions, there would be no reason for the existence and
stability of the holding company. The capitalists, the owners, can agree as a group
about the policies to be pursued and do not need control institutions to
implement their policy proposals. There is no reason to pay a price for control.
If, however, the conditions for unanimity are not fulfilled, stockholders will
compete among each other to gain control over corporate assets. By forming
holding companies and coalitions, some stockholders can implement a more
desirable corporate policy and achieve a higher expected utility. If capital
markets re-open after new policies are announced, or when capital markets are
incomplete and new policies alter the set of state-dependent returns, the
competition for corporate control among capitalists will become an economic
necessity. Control over corporate assets enables the holding company to
implement those policies which are most desirable to its owners.
We believe the foregoing argument provides the fundamental reasons why

holding companies exist. Consequently, it is important to probe for the effect this
financial institution has on capital-asset pricing.
The effect of holding companies on capital-asset pricing
Although this subject, the effect of control motivations on asset pricing and
capital allocation, is the essence of financial capitalism, it has been completely
ignored, to our knowledge, in the literature to date. Nevertheless it is possible to
derive some elementary propositions using the theoretical framework developed
above.
Let us assume an economy with one large investor (index i = 1) and I - 1
small investors and j risky assets. The large investor has the exclusive right to
decide the corporate policy of asset 1. He may have obtained this power because
he is so wealthy that his initial endowments z11 give him a controlling interest in
company 1. Asset j's policy U #- 1) is exogeneously defined and cannot be
changed by any of the investors. The large investor's decision problem can be
specified as follows: maximize expected utility for c11' present consumption, for
Zlj' the portfolio holdings and for the policy variable Xl' subject to the budget
constraint. The Lagrangean is given by:
+ Al (ell +'L,ZljPj-Cll-'L,ZljP)
j j
First-order conditions for a maximum require:
[21.a]
j=(l, ... ,J) [21.b]
[21.c]
ell + LZ 1jP j - c ll - LZ 1jP j =0 [21.d]

j j
Before discussing the important conclusions to be drawn from the large investor's
individual demand equations for risky assets, we should justify the assumptions
made in deriving equation [21.c].
It could be argued that the large investor is not completely free to change his
share z 11 in company 1, and that his share should be larger than the control
threshold, i.e. the minimum share required to control company 1 legally. This is
not necessarily true. Indeed, the large investor could hold a controlling interest
equal to the control threshold simultaneously with a short position in the same
asset, by issuing holding company securities. The investor could create as many
layers of sub-holding companies as are necessary to obtain the desired net
position in asset 1. (What would happen if the large investor did not have this
opportunity to create sub-holding companies will be discussed later on). The large
investor is assumed to be a price-taker in the capital market but he realizes that a
change in policy would effect the price of asset 1.
Given the foregoing assumptions, it is possible to study the meaning of the
system of equations [21]. The crucial equation is [21.c]. The large investor,
although he possesses complete control over company 1, cannot ignore the effect of
his policies on asset-pricing. The economic rationale is obvious: every decrease in
asset-prices decreases the wealth position of the large investor, making it more
difficult for him to buy diversification in the other assets and to allocate resources
efficiently over the two periods. The large investor, however, will not maximize
asset-prices because, by doing so, he could lose too much expected utility.
How will asset-prices in an economy dominated by holding companies differ
from asset-prices in an economy in which small investors prevail? If this
important question cannot be answered easily, it does not seem at all possible to
answer the following question. In the absence of a dominant large investor, what
policy will be selected by the general assembly of stockholders and what
coalitions will be formed among these stockholders? Without explicit answers to
these questions it is impossible to compare asset-prices in economies with or
without holding companies. Further refinements of the theory are necessary to
develop this point. 18
Nevertheless it is possible to compare the foregoing results with the situation in
which the large investor is not allowed, or is not able, to create holding companies
and sub-holding companies. In this case, the large investor must hold a share in
company 1 at least equal to the control threshold in order to dominate corporate
decision-making. Let z1' 1 be the minimum participation in asset 1 required to
18. In Nielsen (1974) it is shown that, under general conditions, no uniquely supported objective
function for the firm exists. This implies that stockholders will not concur in decision-making under
these conditions, and coalitions will be formed to impose preferences. Hence concentration in
corporate decision-making power will come forward.
s' s
x2
1
·'-......X 1
1
s' s
l-z:
Figure 1
control the company. The demand curves for asset 1 are given in Figure 1. For
every policy (x~, xi, ... ) another demand curve is drawn.
IT all shares are traded on the capital market, as is the case when the large
investor can create holding companies, 19 the inelastic supply curve is given by SS.
The large investor will then select the policy which maximizes his expected utility.
Such a policy will not necessarily lead to share-price maximization.
Suppose the large investor is not allowed or is unable to create holding
companies. 20 The supply curve will shift to the left, to S'S', and the large investor
will select a policy which might not be the same as the one previously pursued. It
seems that, with no possibility of creating holding companies, stock market
prices will be higher and assets will be overvalued. This result, however, depends
on the elasticity of the demand curves and on the policies pursued by the large
investor.
It is also possible to compare our results with decision-making in a centrally-
planned, public-ownership economy. Let us assume that I individuals have
19. The shares of company 1 which do not come on the market are substituted for holding company
securities which are traded on the market.
20. Many family enterprises would fit this assumption.
utility functions for consumption now and in the future. The central-planner has
an amount C of goods for present consumption and I risky projects. Each
individual has his own subjective probability estimate about the K states of the
world. By selecting for each individual a level of present consumption and a
portfolio, and for the economy as a whole a policy vector (Xl' ... , X), the central-
planner tries to achieve a Pareto-optimal allocation. In doing so he will try to
improve the position of one individual without worsening the positions of the
others. Suppose the planner starts with individual 1, he will maximize l's utility
without changing the utility levels (U) of the other individuals. The Lagrangean
is given by:
L= L U1(C 11 , Lz 1jR jk )!lk - L fli(L UJ;k - 0) +

k j i *1 k
+ 2(C - L C) + L v/l- LZij)

i j i
and first-order conditions for a maximum require:
[22.a]
au.
fli L
k
ac ' hk =
1i
2 for i = (2, ... ,1) [22.b]
for all j [22.c]
for i = (2, ... ,1) [22.d]

and for allj
[22.e]
for allj
[22.fJ
for all j [22.g]
Eliminating 2, Vj and fli between [22.a], [22.b], [22.c] and [22.d], we find a
familiar expression (see equation 13):
for allj and i i= 1
where
The most interesting equation, however, is [22.e] forj = 1. Eliminating Abetween

[22.a] and [22.b] gives us an expression for f.ii' and substituting this result in
[22.e] leads, for j = 1, to:
ZljL W1kR~k = L Zi1 L WikR~k [23]

k i= 1 k
The LHS of [23] is formally equal to [21.c], but the RHS of [23] is not equal to
the derivative of the price of asset 1 with respect to the policy variable Xl' This last
corollary follows from studying the equilibrium price relations as given in [13.a].
It is clear that the central-planner, an abstract concept, pursues a different
policy than the control-investor, another abstract concept. The former's policy,
being Pareto-efficient, will be socially more desirable than the latter's. This
striking result derives from the fact that the holding company obtains higher
expected utility for itself by lowering the utility levels of other investors.
The conclusion to be drawn from this analysis is important. Thefunctioning of
holding companies in an economy leads to different corporate policies than the
policies advocated by central-planners. This is not only valid for the corporate
poljcies of the holding company the most salient institution of financial
capitalism, but also, as was shown earlier, for decision-making in 'traditional'
capitalism based on family enterprises.
Benefits to control because of non-linear sharing
In the foregoing pages, it was shown that the fundamental reasons why holding
companies exist should be sought in incomplete and imperfect capital markets.
Control is desirable because it offers the holding company and the large investor the
opportunity to select the policy which best fits their preferences. A further benefit to
control might arise from the fact that the group of investors holding a controlling
interest can appoint the company directors. These directors receive a manage-
112
Figure 2
ment fee and emoluments. Consequently it could be argued that the group of
investors holding a controlling interest earn an extra return on capital. 21
What happens then is that returns are not linearly shared among investors: a
group holding a majority position might receive a relatively larger share of return
than the minority group. In the following paragraphs we will study the effect of
non-linear sharing-rules on asset-prices.
Let us assume that only two investors exist in an economy withj assets. Initial
wealth of both investors is given by WI and W2 • Borrowing and lending is possible
at a riskless rate r. Both investors select mean-variance efficient portfolio's. The
sharing rule is given by J(ZI) for investor 1 and 1 - J(Z2) for investor 2. Figure 2
gives an idea of the shape of the sharing-rule. If investor 1 holds a share of less
than 1/2 in assetj, he will receive less than his proportional share: if he holds more
he will receive proportionally more.
The budget equation of investor i is given by:
W; = L,ZijPj + Bi i = (1, 2)
j
where Bi is the amount of funds borrowed.

21. Although this argument is frequently advanced in the popular literature about holding
companies, it is not completely correct. True, the investors supply supervision and management
expertise to the holding company as well as capital. But since the market for directors is probably
imperfect, fees for management will be too high. It is this excess in fees which provides the extra return
on capital.
Terminal wealth for investor i in state of the world k is equal to:
r;k = L.Ji(Zi)R jk + rBi

j
where
and
and
Eliminating B between the budget equation and terminal wealth leads to:
r;k = L. (J;Czi)Rjk - Zi/'P) + rW;

j
Assuming that both investors agree on the probability distributions, expected

terminal wealth is equal to:
Ei = L. (Ji(Zi)E(R) - zijrP) + rW;

j
where E(R) is the expected value of R j .

Variance of terminal wealth is defined as:
V; = L L. Ji(Zi)Ji(Zik)O'jk
h j
where O'jk is the co-variance of returns.

Define Ui (Ei' V;) as the utility function of investor i.1t represents a preference:
ordering over the mean and the variance. Maximization of Ui (Ep V;) for zij
requires:
or
[24]
where - (d VjdE;) = Yi the rate of substitution of mean wealth for risk.

CONCLUSION 121
Summing [24J over i and taking into account
Yl + Y2 = Y
and
we find:
-y(b'(zl)E(R) - rP) + 2b'(zijn:::O"jh = 0 [25J

h
It is easy to show that L 0" jh = cov (R j ' R M) where R M = L R j. All this permits
h j
us to solve [25J for Pj.
[26J
Asset-prices in this two-investor economy will depend directly and explicitly on

the respective holdings. In a 'normal' economy b'(z;) = 1. If both investors hold
nearly the same holdings, prices will be high. If one investor holds a very large
share and the other a very small one, asset-prices will be very low.
4. Conclusion
The literature on holding companies looked to product-market imperfections for

the main reason for the high degree of financial concentration in Belgian
capitalism. Some writers argued, without relying on an explicitly formulated
theory, that the struggle for monopoly profits and exploitation explained the
struggle for power and stimulated the creation of financial institutions like
holding companies. Other writers interpreted the holding company pheno-
menon as a means of coordinating policies in different companies and providing
subsidiaries with managerial and technological expertise. Both groups of
scholars point to conditions in product-markets to explain the existence of
financial superstructures. In the foregoing chapter it was shown that such
reasoning, if not flawed, only partially explains the Belgian-type holding
company. Since stockholders want their companies to earn as much as possible,
they approve unanimously all action that, through coordination of price and
production policies, increases profits. Under these circumstances, stockholders
act as a homogeneous group (or class) with a common interest. No economic or

financial incentive exists for them to hold a controlling interest in one or several
companies and to pay a price for control. In fact, all stockholders would want to
merge companies able to profit from intercompany coordination, especially
when public policy towards mergers is flexible and no tax incentives exist. These
fully-merged companies would be much better equiped for the profitable
coordination of activities than the loose holding company structure, which lacks
managerial instruments for coordination. The holding company could, at best,
serve as an interim organisation for preparation of the merger.
Fundamentally, holding companies exist in financial capitalism because
capitalists have conflicting interests. Contrary to what is always claimed by
Marxists, such investors do not form a homogeneous group. Conflicts of interest
arise among them because of uncertainty, differences in beliefs about the likely
occurence of some events and because of incomplete markets. Even if companies
maximize profits as much as possible in all states of the world, investors will
disagree about policies to be pursued. 22 Control over corporate decision-making
is therefore a desirable good and investors will be willing to pay a price for the
right to exercise control and to select the policy variables. The financial
institution ofthe holding company, as an invention of financial capitalism meant
to structure the corporate control market, permits the large investors to
implement their policy preferences and diversify their wealth at the same time.
It was also proved, however, that the holding company is not completely free in
its choice of policy but must consider the effect of its policies on asset-prices. Is it
possible to provide a direct test of the foregoing theory? No, not at its present
stage. One promising track, however, would be a detailed study of the theoretical
effects of holding companies on asset-prices. An international comparison of
rates of return on assets might then provide an interesting test of the theory. In
some instances above we were able to show that asset-prices will be higher (and
rates of return lower) in a concentrated economy, but the results were not general
enough to merit a complex international comparison. 23
22. The reader who finds it difficult to accept the mathematical proof of this proposition may find it
easier to test our reasoning against the following example. Assume that several fishermen, all equally
experienced, are co-owners of one fishing net. All the fishermen have a subjective probability
distribution over the location of a fish shoal in a lake. One fisherman, however, strongly believes that
he has prior information which permits him to locate the shoal offish exactly. Such an individual will,
to a certain extent, be willing to pay a price for the right to throw out the fishing net.
23. Some financial newspapers have suggested that the Brussels stock market is too expensive, i.e.
rates ofreturn on its stocks are lower than in the rest of the world. Is this because of the existence of
holding companies? Maybe not, because the Brussels stock market is also less riskier. A very recent
study by Bruno Solnik (1973) could not find a significantly poorer performance by the Brussels
market.
VII. HOLDING COMPANIES, INVESTMENT
STRATEGY AND ECONOMIC GROWTH
1. Introduction
In previous chapters it was argued that holding companies playa crucial role in
capital accumulation and allocation. The institution was seen as stable and
viable because it can organize and coordinate the flow of external venture capital
to the capital-intensive basic industrial sectors. In exchange for capital, the
financial groups took a prominent and strategic position from which the holding
companies can control corporate wealth and capital management in certain
sectors of the Belgian economy. In this chapter the two main characteristics of
the holding company (supply of capital and control over capital management)
are combined in order to study the investment strategy of the institution and the
effect of such a strategy on economic growth. Indeed if financial groups merely
supply capital in exchange for control or merely provide external funds for their
controlled subsidiaries - which, for reasons discussed earlier, are mostly located
in capital-intensive capital goods industries - then the investment strategy of the
holding companies is interest-inelastic and, as such, would lead to a bias in the
industrial structure of the economy because of capital immobilities and
distortions in the supply of funds. 1 Such a conservative investment strategy
might reduce the rate of growth of the economy and it endangers full
employment in the long-run.
In a first section we will review the literature dealing with this subject. The
basic argument these studies developed runs as follows: the marked retardation
of the Belgian economy in the 1950's was due to its archaic industrial structure, a
.:::ondition which led to a concentration of industrial output on slow-growing
1. A similar argument is developed in the periodical of the National Bank, Tijdschrift voor
Documentatie en Voorlichting, NBB, April 1967 XLII deel no. 4.
Translated: 'The relationship between the large banks and the industrial or financial groups
(holding companies) might immobilize the financial circuits, in the sense that the banks prefer to
finance the subsidiaries of the group. It is however difficult to prove that the dependence of the banks
on the holding companies has really distorted the distribution of funds.' p. 436.
124 INVESTMENT STRATEGY AND ECONOMIC GROWTH
basic industrial sectors. Since the financial groups and holding companies
dominated these slow-growing industrial sectors, e.g., mining and transpor-
tation equipment, it is argued that the financial groups and holding companies
were responsible for the retardation of Belgian economic growth.
In a second section doubts will be raised about the empirical validity of the first
part of the hypothesis: that the industrial structure is responsible for economic
retardation. Using the generally accepted but nevertheless deficient metho-
dology of shift-and-share analysis, we will measure the retarding effect of
allocative inefficiencies.
The chapter does not attempt to provide a definitive answer to the question of
the influence of the holding companies' investment strategy on employment and
economic growth. Such an analysis should be undertaken, but it would require
more statistical data about investment than are presently available.
2. The retardation of the Belgian economy, revisited
There can be no doubt about the weak performance of the Belgian economy
during the first fifteen years after World War II. Table 1 illustrates this weakness
in an international perspective.
Table 1. International comparison of growth of output, investment and exports, 1953-1970
Average annual growth rates

Belgium EEC OECD Europe
1959 1970 1959 1970 1959 1970
1953 1959 1953 1959 1953 1959
GNP 2.5 4.9 5.3 5.5 4.4 5.0

Gross fixed investment 2.3 6.0 7.7 7.0 6.8 6.7
in manufacturing 2.9 8.7
in total plant and equipment 2.2 7.5 7.7 8.5 7.3 7.7
Merchandise exports (volume) 6.4 8.8
Merchandise exports
(value) 6.5 12.1 12.6 12.1 7.7 10.7
Source: Bleu, OECD Economic Surveys, June 1972, Paris, Table 9, p. 37.
Two elements are worth retaining from this table. In the 1950s the performance of
the Belgian economy was significantly below international averages. The 1960s
saw a marked improvement and the economy reached international perfor-
mance standards doubling all performance ratios. What accounts for this curious
THE RETARDATION OF THE BELGIAN ECONOMY 125
phenomenon of retardation followed by rapid acceleration? Four reasons are

commonly cited in the literature. First, the industrial structure of the Belgian
economy was unfavourably biased towards its slow-growing industrial sectors.
Second, the small size of the Belgian economy and the protectionistic policies of
other European nations hindered the development of new sectors and reduced
aggregate demand. Third, the economic policies of the early 1960s created a
more favourable economic environment and pushed Belgian economic perfor-
mance upwards to international standards. Fourth, capital equipment was
significantly older and less efficient than in neighbouring countries.
Since the meagre economic developments in the 1950s have been linked so
often to the higher degree of capitalistic concentration in Belgium and to the
presence of holding companies there, it is necessary to detail the arguments that
were used to support the first three reasons, which are commonly cited to explain
this poor development.
Industrial structure
The available literature overwhelmingly resorts to the traditional industrial

structure of the Belgian economy in explaining the low rate of growth in the
1950s. Nearly all writers of the period accepted this reasoning. Without
scrutinizing the empirical evidence in detail, they turned quickly to the
description of the reasons for the stability of such a traditional industrial
structure in the Belgian environment. 2 These scholars suggest that the invest-
ment strategy of Belgian entrepreneurs caused the composition of industrial
output to remain unfavourable to the promotion of growth. This argument is
little more than a disguised version of the well-known entrepreneurial failure
theory, used over and over again by economic historians to explain every
ratardation, in every period, in every nation of the world. Nevertheless, in regard
to Belgium, the argument has received impressive support. Indeed, in a recent
study, the OEeD states:
This unfavourable composition of output tended to be perpetuated, in part because of a
general reluctance on the part of business interests to engage extensively in new activities.
To some extent, this was simple inertia and misinterpretation of the likely duration of the
crises striking certain industries. But it was also related to the fact that Belgium, because
of its small size, lacked the pool of technical and managerial know-how and the capability
generally of companies big enough to undertake large scale production of new products
utilising new techniques. 3
2. See the above ~ited literature on the financial groups, but also, A. Lamfalussy (1961).
3. Bleu, OEeD Economic Surveys, June 1972, Paris, p. 36.
Similar ideas can be found in nearly every study. In its own, the socialist labour
union, the ABVV, said:
'The largest responsibility for this situation [the weak performance ofthe economyJlies with
the financial groups and holding companies because in our so-called 'free' economy and by
the lack of a Government plan for economic expansion and social progress, these groups
are responsible for the expansion of the large companies and as a consequence for the
growth of the economy'. 4
Undoubtedly the best study of the 1950s period is Alexander Lamfalussy's

book 'Investment and growth in mature economies'. 5 Lamfalussy is the only
index net profit 1957 1948 =100

3
2
5
200
100
9 8
o 100 2O<i index gross fi xed
-?-- assets 1957
1948 = 100
Figure 1. Comparison of Profit rates and Gross Fixed Asset Formation, 1957.
4. ABVV (1956), p. 266.

5. A. Lamfa1ussy (1961).
THE RET ARDA TION OF THE BELGIAN ECONOMY 127
scholar to present evidence about the structure of investment, as summarized in

Table 2 and Figures 1 and 2, and he pioneers a theory meant to explain the
defensive nature of the investment strategies of Belgian entrepreneurs. Although
average profits were low or losses were occurring in the textiles, rolling stock and
railway equipment, and coal mining sectors, new investment was nevertheless
taking place. Figure 1 focuses special attention on this phenomenon, proving
that capital output ratios increased or remained fairly stable, even for those
sectors in which dis-investment could be expected, i.e. coal mining and textiles.
Lamfalussy calls these investments defensive because they were undertaken 'as a
protective device in stagnating or declining markets, when competition is active,
when the lowering of costs becomes a matter of survival rather than of
expansion'.6 Lamfalussy includes steel and food among the sectors where
defensive investment is dominant. Indeed, in the steel and food sectors, the
normal rate of profit (the rate of interest plus a premium for uncertainty proper
to individual industries)1 is slightly above the average profit rate, suggesting
index output 1957 1948 =100
200
100
a 100 200 index gross fixed

-+-- ossets 1957
1948 = 100
Figure 2. Comparison of Output Expansion and Gross Fixed Asset Formation, 1957.
6. A. Lamfa1ussy (1961) p. XVI.

7. A. LamfaJussy (1961) p. 132.
......
tv
00
Table 2: Profit rates, gross fixed asset formation and related data for selected industries, 1957
Z
Average Index' Index' Index' Change Labour' Share of -<m
CIl
rates Net gross Output Capital- Produc- sector in ...,
of profit fixed III output tivity total a:::
m
profit in 1957 Assets 1957 ratios 1957 Industries ...,Z
in % in 1957 in 1957 output CIl
1953 in % ...,
::c
...,>
1. Chemicals 11.3 200 178 167 107 159 4.8 m
2. Cement 11.3 260 188 142 118 169 2.0 Cl
><:
3. Electrical Engineering and
Electronics
>
10.0 270 210 170 123 133 1.8 Z
Ij
4. Electricity and Gas 8.7 198 163 154 106 143 4.6
m
5. Steel 7.0 250 143 150 84 140 6.1 (")
6. Food and beverages 6.3 220 146 141 104 135 16.7 0
Z
7. Textiles 3.7 66 125 142 92 152 10.0 0
8. Rolling stock and railway equipment 3.2 (losses) 149 n.a. n.a. n.a. 1.0 a:::
.....
(")
9. Coal mining -3.1 (losses) 144 111 130 130 13.1
Cl
::c
Source: Compiled from data contained in A. Lamfalussy (1961). 0
• Index 1948 = 100. ...,~
b does not include government subsidies. ::r:
THE RETARDATION OF THE BELGIAN ECONOMY 129
again that non-profit motives guide investment. Lamfalussy argues convinc-

ingly that, under certain conditions these defensive investment strategies, from
the point of view of individual wealth-maximization by the entrepreneurs, are
rational.
'The general conclusion is that if (a) the life span of capital goods is long, if (b) the
entrepreneur's planning horizon is short, and if (c) the break-up value of the assets is
substantially lower than their profit-value, a fall in the rate of profit below the normal level
will induce no dis-investment at all.'s
Having shown empirically that these defensive strategies were rational

responses to economi~ conditions in certain sectors, Lamfalussy jumps to the
conclusion that such strategies reduce the rate of growth of the economy .
. . . the widespread nature of defensive investment prevented capital flowing from

declining (or stationary) to expanding industries and therefore slowed down the overall
growth of Belgian industry as compared with the rapid development that took place in the
neighbouring continental countries. 9
Alexander Lamfalussy consequently comes to the same conclusion as the

aforementioned OEeD study lO and sees investment strategy as a major element
in causing the Belgian economy to grow more slowly than other economies. It is
nevertheless interesting to note that he does not single out the holding company
structure as responsible for the defensive nature of investment strategies.
Economic and technological conditions in the sectors are the main factors in
shaping investment strategy. In this respect, one should remember that food and
textiles, two sectors employing defensive strategies, have never been under the
control of the financial groups and holding companies.
Although the literature on recent Belgian economic history holds, without
sufficient empirical proof, that the industrial structure was the main cause for
deflationary conditions in Belgium in the 1950s other explanations have also
been advanced.
The size of the Belgian economy
The business community in general and holding companies in particular have

never agreed that entrepreneurial failure caused the economic retardation of the
8. A. Lamfalussy (1961) p. 83.
9. A. Lamfalussy (1961) p. 153.
10. See Footnote 3, this chapter.
1950s. They argued, again without clear empirical evidence, that the small size of
the domestic market and the deadly pressures of neighbouring countries'
protectionistic policies on export demand prevented Belgian entrepreneurs from
launching more expansionary investment strategies. 11 They then explained the
recovery of the 1960s by the broadening of Belgian export markets after the
Treaty of Rome. In the second section of this chapter, rough evidence is
presented which shows that size cannot have retarded the Belgian economy in the
1950s since, in the same period, other small economies were able to develop
rapidly.
Economic policies of the 19605
A third institutional element which is said to have pulled the Belgian economy
out of its low performance syndrome was a radical change in economic policy
that began in 1959. Economic Expansion Laws were then passed, and have since
been broadened with Regional Development Laws, which allowed the govern-
ment to actively stimulate industrial investment. Subsequently, a dramatic
increase of foreign direct investment in fast-growing industrial sectors such as
chemicals, oil refining and metal products contributed to a structural change in
the industrial sector and exports. This, again, seems to support the hypothesis
that deficient investment policies alone were responsible for the low performance
of the 1950s. It appears that Belgium was only able to become one of the rapidly
developing nations of western Europe after foreign multinationals altered the
structure of Belgian industry. Faced with this evidence it is risky to argue, as will
be done in the next section, that the structural deficiencies of Belgian industry
may not have been very relevant to the poor economic development of the 1950s.
3. Industrial structure and economic growth
Most students of recent Belgian economic history argue that conservative

investment policies of the 1950s reinforced Belgium's traditional industrial
structure; which, because of its heavy concentration on slow-growing sectors,
prevented the economy from growing at international standards. This section
presents new evidence, based on shift-and-share analysis, about the actual
influence of structural characteristics on the low performance of the Belgian
economy. The results suggest that structural characteristics alone cannot explain
11. Societe Geoerale de Belgique (1972).

INDUSTRIAL STRUCTURE AND ECONOMIC GROWTH 131
the retardation of the economy, which could mean that the (so-called)
conservative investment strategies of Belgian entrepreneurs were not solely
responsible for retardation.
Table 3 describes the evolution of the Belgian industrial structure and Table 4
compares this structure with that in comparable countries such as The
Netherlands, Denmark and Norway. These nations were preferred over all the
EEC or OECD-Europe countries because the size of the Belgian economy and
the size of its domestic market is substantially smaller than the other member-
nations of EEC or OECD-Europe.
Table 3. Industrial structure of the Belgian economy.
in %and in 1963 prices

1953 1960 1970
Mining and quarrying 10.48 6.2 2.52

Manufacturing 68.24 73.69 76.39
Construction 17.21 16.62 13.96
Electricity, Gas and Water Distribution 4.05 3.47 7.12
Source: Calculated from National Accounts.
Table 4: International comparison of industrial structure in European nations, 1953: in % and in

current prices.
"0 '"
I':i ;>,
~ ..:;l
S cd ....
;>,
cd
I':i
cd
::s S Il)
Il)
S
()
..<:: ~ ::s
]l I':i ...... .... cd ....
Il) Il) Il) 0 .... Il)
t:O 0 Z Z IJ.. 0
Mining and quarrying 10.38 0.48 5.75 4.18 4.64 8.17

Manufacturing 68.68 73.96 72.06 70.51 79.76 77.49
Construction 16.24 20.93 16.83 20.37 12.59 11.13
Electricity, Gas and Water Works 4.69 4.61 5.34 4.92 2.99 3.19
Source: Calculated from OEeD Statistics of National Accounts, 195~1, p. 65, 83, 91, 99,147 and
157.
Note: The minor differences in the data reported for Belgium in this table and Table 3 are due to
the use of a different source.
Tables 3 and 4 amply demonstrate the strongly traditional nature of Belgian

industry. Mining and quarrying take a large share of total industrial product and
the manufacturing industries, together with the fast-growing sectors, contribute
less than in other countries. Structure does seem, therefore, to explain the low
performance of the Belgian 1950s economy. Indeed, all the other small nations in
Table 5 grew more rapidly than Belgium.
Table 5: Average annual growth rate of GNP in European nations 1953-60.
Belgium 2.9
Denmark 3.9
Netherlands 5.1
Norway 3.2
Sweden 3.9
OECD Europe 4.8
EEC 5.7
Source: see source note Table 4.
In order to explicitly test the hypothesis that the Belgian economy grew slowly
because of its traditional structure, the following argument has been developed.
The growth (g) of total industrial product is a weighted average of sectoral
growth rates (g;) where the weights (s;) are the respective shares of each sector in
total industrial product.
By changing the weights (s) it is possible to test whether a different structure

would have resulted in a higher rate of growth (g).12 Using the real weights of
1960 and 1970, as reported in Table 4, it is possible to estimate the hypothetical
rate of growth of industrial output under the assumption that the Belgian
economy would have achieved a more modern industrial structure earlier in its
postwar economic history. Table 6 summarizes the calculation and reports the
striking results.
A radically different structure of output could not have altered the rate of growth
of industrial product in the Belgian economy. Since this rate of growth explains
only part of the rate of growth of the entire economy, industrial structure cannot
explain the total retardation.
International comparisons lead to a similar result. The difference between the
rate of growth of industrial product in a foreign country gF and in Belgium g can
be written s follows:
4
g = L sigi
i= 1
4 4
gF - g = L SiFgiF - L Sigi
i= 1 i= 1
12. By industrial structure is meant the relative shares s, of the sectors in total product.
INDUSTRIAL STRUCTURE AND ECONOMIC GROWTH 133
Table 6: Real and hypothetical rates of growth of industrial product.
Real growth
ratio's (1960/53)
(I) (2) = (3) = (4) =

(1) x weights (1) x weights (I) x weights
53" 60 b 70 e
Mining and quarrying 0.7373 0.0773 0.0457 0.0186

Manufacturing 1.3464 0.9188 0.9922 1.0285
Construction 1.2040 0.2072 0.2001 0.1681
Electricity Gas and Water
Works 1.0680 0.0433 0.0371 0.0760
1.2466 1.2751 1.2912
Rate of growth of total Real Hypothetical Hypothetical
industrial product 3.2% 3.5% 3.7%
Source: Own calculations based on Table 1-21 (see source note to Table 4).
a see Table 3 column (I)
b see Table 3 column (2)
C see Table 3 column (3)
4
adding and subtracting L sigiF leads to:
i= 1
4 4
gF - g = L s;(giF - gJ + L giF(SiF - SJ [1]
i= 1 i= 1
The first term in the RHS of[1] explains the difference between a foreign country
and Belgium by the difference in their sectoral growth rates. The second term
measures the effect of structural differences on industrial performance. Shift-and-
share analysis contains an arbitrary element: there is no a priori reason to prefer
this specification to that obtained by adding and subtracting to the RHS of
4
equation [1] the term L siFgi. The latter would produce a different estimate of
i::;;: 1
the structural effect and the growth effect. Indeed, instead of weighing the
differences in structures with the foreign sectoral growth rates, the new formula
calls for a weight based on Belgian sectoral growth rates. Since such growth rates
are lower in Belgium, our estimation procedure is an upper bound for the
structural effect. Table 7 summarizes the calculation.
It is worth nothing that the growth effect dominates the structural effect in every
comparison. The Belgian economy was lacking in growth in every industrial sector
Table 7: International comparison of industrial performance.
Real growth ratio's of sectors (1953-1960) in constant 1954 prices.

Mining and Manuf. Constr. Gas and Total
Quarrying Electricity
Belgium 0.7307 1.3162 1.2445 1.3292 1.2414

Denmark 1.3043 1.4089 1.2201 1.8120 1.3853
Norway 1.1683 1.3243 0.9093 1.6809 1.2538
Germany 1.1258 1.8304 l.5606 1.8805 1.7423
Industrial Structure in 1953 (prices 1954)
Belgium 0.1087 0.6784 0.1637 0.0490
Denmark 0.0047 0.7371 0.2147 0.0432
Norway 0.0385 0.7096 0.2047 0.0494
Germany 0.0839 0.7691 0.1134 0.0335
Differences between industrial performance in several countries and Belgium

Denmark
Real difference 0.1439
Growth effect" 0.1448
Structural effect" - 0.0012
Estimated difference 0.1436
Norway
Growth effect a 0.0153
Structural effect" - 0.0027
Germany
Growth effect" 0.4704
Structural effect" 0.0305
Source: Table 4 and the source note, and own calculations (see source note to table 4).
'See text for explanation.
and its poor performance is only partly explained by structural deficiencies. One
should remember that our estimation procedure is an upper bound for the real
structural effect.
It could be argued that the structural deficiences were caused, not so much by
the composition of industrial output over the four industrial sectors included in
the analysis (mining and quarrying, manufacturing, construction and electricity,
CONCLUSION 135
gas and water works), but by the composition of output in the manufacturing
sector alone. Tests similar to those above were carried out on the structure of the
manufacturing sector but again, the results did not indicate a significant
influence of structure on performance. Over the period 1953-1960 the value
added in the manufacturing sector expanded at a rate of 4.3 percent. If the
composition of output in 1953 had been what it became in 1960, the rate of
growth would have climbed to 4.5 percent and, if 1970 structural weights are
used, to 4.7 percent. Both hypothetical performance measures are far below the
6.4 percent rate of growth of value added in the manufacturing sector in the
period 1960-1970. Therefore the empirical conclusion remains unshaken: the
industrial structure of the economy alone cannot explain the phenomenon of
economic retardation in Belgium in the 1950s.
Before accepting as empirical 'truth' the controversial conclusion that
structural deficiencies explain only a small part of economic retardation in the
1950s, the methodology used should be carefully scrutinized. Shift-and-share
analysis is crude and it ignores the inter-sectoral linkages. Indeed, it can be
argued that developments in a particular sector might, through backward
linkages, pull the whole economy out of its relative stagnation. The compre-
hensive answer to such a fundamental criticism can -only come from a sectoral
model. Whether such a model would yield radically different results, however, is
doubtful. Indeed, fast-growing modern industrial sectors, such as petro-
chemicals, have rather modest backward linkages and it seems unlikely that they
could stimulate the economy by themselves.
Another fallacy of shift-and-share analysis is its complete neglect of the
market-setting. A different industrial structure is only possible in an economy in
which a set of prices exists that will support the output structure. However, while
calculating our hypothetical ratios of growth we completely ignored the
question of whether the price-structure of 1953 could support a more modern
industrial structure.
In sum, two basic criticisms can be levelled against the methodology used:
neglect of the growth potential of inter-industry linkages and neglect of relative
prices and demand. However, the results obtained were so clear that further
refinements in methodology would not substantially alter the general
conclusion.
4. Conclusion
In Chapters 2 and 5 it was demonstrated that holding companies had a sizeable

impact on capital management in the Belgian economy. Because the holding
l36 INVESTMENT STRATEGY AND ECONOMIC GROWTH
company is a financial institution for corporate control, its investment strategy

can pursue different objectives. These strategies effect the industrial structure of
the economy and could lead to a structural weakness and an economic
retardation. However, as tested in the foregoing pages, using shift-and-share
analysis, it was impossible to detect how industrial structure significantly
influenced the economic retardation of the 1950s in Belgium.
It is a major drawback of this chapter that it undertook no direct analysis of
investment strategy at the holding company level and at the level of the firm.
Such an analysis, indeed, is difficult to undertake. It requires not only a mass of
comparable micro-data which is presently unavailable and unlikely to be
developed in the near future, but a precisely specified theory that takes into
account the fundamental differences between investment incentives in the basic
industrial sectors and in other industrial sectors. This last distinction is crucially
important since, as demonstrated earlier, the industrial activities of holding
companies and financial groups are very much concentrated in certain industrial
sectors.
A promising area of research may emerge from a substantial broadening of the
studies carried out to detect performance differences between owner-controlled
and manager-controlled firms. The broadening of these studies not only calls for
a comparison of rates of return but for an analytical comparison of investment
and financing decisions. It is obvious that industrial factors must be taken into
account more thoroughly than they were in the aforementioned studies.
VIII. GENERAL CONCLUSION
Nearing the end of this study, it is time to reflect on whether the goals we set for
ourselves at the beginning of our research have been reached. The general
objective was to gain an understanding of why economic institutions, non-
market instruments for allocating, coordinating and monitoring, became so
dominant in modern market economies. The specific objective was the study of
conditions that explain the existence, stability and viability of the large Belgian
holding company, the financial institution through which "complex multicom-
pany systems control an intermarket network.
It was demonstrated that the holding company arose and remains a viable
institution because it is able to coordinate and control the flow of new equity
capital to Belgian industry, which, because of its traditional concentration on the
capital-intensive basic industries, has a relatively high demand for external
funds. In exchange for the supply of capital, the holding companies seized
control over corporate wealth. Holding companies, then, by substituting
securities, act as financial intermediaries. It was theoretically and empirically
demonstrated, however, that small investors - those investors who cannot
change corporate policies - are indifferent about security substitution in the
Belgian capital markets and, hence, that financial intermediation cannot be the
prime reason why holding companies continue to flourish in a capital market
setting.
It was then shown that holding companies have a substantial influence on the
concentration of corporate power in the Belgian economy. For the first time, a
matrix was developed which illuminated intra- and intersectoral control
linkages between the largest Belgian corporations.
These observations led us in Chapter 6 to tackle a fundamental question: why
is control over corporate decision-making desirable for the investor, i.e., why is
such an investor willing to pay a price for control? Control over corporate
decision-making was shown to be desirable for the large investor because, in the
absence of complete capital markets (for a definition of a complete capital
market see Chapter 6) and in the presence of non-trivial corporate policies, large
l38 GENERAL CONCLUSION
investors will want to gain control in order to impose those corporate policies
which would fit their preferences best. This theory of corporate control should be
further developed. It not only offers an excellent starting point for studying
financial capitalism, the corporate control market and the pricing of capital
assets in economies with skewed distribution of wealth, but such a theory is also
useful in providing a theoretical foundation for public regulation and
intervention.
If the holding companies only supply capital in exchange for control, does
such a policy lead to investment strategies which retard economic development?
The question was touched on in the closing chapter of this study but, contrary to
what has been argued in the literature, no convincing evidence was found of such
a structural retardation.
The foregoing arguments are this study's main original contributions to the
further analysis of financial and managerial capitalism. Clearly, other important
questions remain unresolved and some of them should receive more and urgent
attention in the near future. Let us, then, briefly discuss one of these questions.
The first and the most important has to do with shaping a public policy toward
the large holding companies. There are two principles which could serve as
guidelines for the design of such a policy. The first principle is regulation of the
holding companies, i.e., the creation of a legal code which regulates their actions
and activities. The second principle is intervention, i.e., the creation of public
initiatives to take over holding company activities. The discussion about these
fundamental principles becomes confused very often because ideology creeps in
too early. This is particularly the case in Belgium. Before starting such a
discussion, therefore, it is vital to supply a meaningful interpretation of the
principle of regulation and intervention. Such an interpretation can only come
from answers - and from a fact-finding methodology - to the following
questions: what will be the objective of regulation and what will be regulated?;
what will be the objective of public intervention and how will such intervention
be organised? If, for example, the government decides to directly intervene in the
industrial and financial sector by creating a public holding company, what is the
objective which is being pursued? Is this objective a decrease in the concentration
of corporate power?, an expansion of economic activity?, full employment?,
regional development and/or a radical reorganisation of industrial relations? It
is clear that direct intervention need not be an efficient and effective principle for
all these objectives - although it might for some. How, then, will public
intervention be organised: by creating new industrial initiatives?, by buying
controlling interests in companies?, or by nationalisation? All these questions
are of utmost importance and should be studied theoretically and empirically
by professional economists espousing different ideologies.
GENERAL CONCLUSION 139
This study is a modest beginning in a field which professional economists in

and outside Belgium have ignored for too long. In the near future more such
studies need to be undertaken, analytical, empirical and comparative studies, of
the effect resource allocation has on economic institutions in general and
multicompany systems and holding companies in particular. A revival of
institutional economics, the study of non-market arrangements for allocating
resources, is urgently needed. Such a revival would certainly broaden the scope
of knowledge of the field of industrial organisation.
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THE HOLDING COMPANY AND CORPORATE CONTROL

NIJENRODE STUDIES IN ECONOMICS

Professor R. E. Caves, Harvard University, Cambridge (Mass.), U.S.A.

Professor A. P. Jacquemin, University of Louvain, Belgium

c:Jvfartinus cfJVijhoff Social Sciences Division

© 1977 by H. E. Stenfert Kroese B.V. Leiden, the Netherlands.

II. A POWERFUL INSTITUTION I 7

III. HOLDING COMPANIES AND FINANCIAL INTERMEDIATION:

IV. HOLDING COMPANIES AND SECURITY SUBSTITUTIONS:

V. HOLDING COMPANIES AND CORPORATE CONTROL I 65

VI. FOUNDATIONS FOR A THEORY OF HOLDING COMPANY

1. Introduction: the holding companies' problem I 93

VII. HOLDING COMPANIES, INVESTMENT STRATEGY AND ECONOMIC

VIII. GENERAL CONCLUSION I 137

1. Research subject and objectives

This study focuses on an economic institution, the large industrial holding

1. Alfred D. Chandler, Jr. (1977).

2. What is a holding company?

technique of indirect participation permits the 'mother' holding company to

functioning of the holding companies? Fourth, what is the effect of the

3. Previous literature and the contribution

It is surprising how little attention non-Marxian economists have paid to the

3. For examples of a recent revival of theoretical interest in institutional economics, see A. M.

4. Plan of the study

financial subsidiary it holds a controlling interest in a number oflarge industrial

After World War I

Table 1. Subscription by banks to public issues of securities by corporations 1874--1932.

1919 1,618 b 25.89 d 3.76f 20.32h

Sources: Calculated from data provided by Durviaux (1947) .

fDurviaux p. 146. 8 Durviaux p. 90. hDurviaux p. 142.

The banking legislation of 1935

5. Bank van de Arbeid and Caisse Centrale de Credit du Boerenbond.

Table 2. Financial structure of the Belgian banking system, 1870-1940.

1870 80.47 85.31

Sources: • Durviaux (1947), p. 203, 204, 205.

After World War II

structure, actIvIty and investments. Although it should be added that the

c) Cofinindus 1,787 1,423 1,545 88 227 c::

21. Soc. Generale de la

3. The main characteristics of the Belgian holding com-

On the following pages the historical description given above is complemented

11. Net worth equals assets minus liabilities.

Holding companies and the capital market

18. See footnote 17, this chapter.

Table 4. Public issues of shares per sector, 1958~1973.

Sectors 1958-1963 1964-1968 1969-1973

in m.B.F. in % in m.B.F. in % in m.B.F. 1.J.l%

Total 19,061 28,920 40,645

Table 5. International comparison of net acquisitions of securities issued by non-financial en-

Subtotal 86.7 - 269.0

Subtotal 13.2 369.0

Source: B. Snoy (1970).

Table 6. Estimated cost of the Belgian financial holding companies in 1971.

(in 000.000 BF)

1. Revenues from portfolio investments 237;.7

4. Available for shareholders b (2)-(3) 2342.9

Source: See the starred companies in Table 3.

Table 7. Average market valuation by sector, 1970-1973.

(End of year, values in %)

Table 8. Turnover at Brussels stock exchange by sector, 1970-1974

1970 1971 1972 1973 1974

Banks 11.9 2 12.5 3 15.3 2 9.7 1 13.9 1

50.3 53.0 50.0 28.4 36.2

Source: Monthly Bulletin, Statistique et Indices.