Market Segmentation under Regulation and Rent Dissipation: Based on Trans-regional Operation of Chinese Business Groups

Abstract

By examining the trans-regional operation of Chinese business groups, this paper studies the rent formed by regional market segmentation and its dissipation process. For local interests, Chinese local governments restrict inter-regional circulation of resources, and thus create regional market segmentation. Nowadays, the Chinese market is becoming increasingly integrated, but the problem of segmentation still cannot be ignored. Prior studies show that regional market segmentation forms barriers and brings costs to firms, so in pursuit of long-term development, firms have to resort to export trade while avoiding domestic markets. However, in practice, trans-regional operation is fairly common for firms. Although market segmentation entails huge costs, firms enter regional markets in various ways. What are firms’ benefits from trans-regional operation? Where do these benefits come from? These are the main research questions of this paper. We believe that regional market segmentation caused by local governments increases the transaction costs that firms bear, hence non-exclusive rents are formed. Firms can realize abnormal returns in the commodity market if they can avoid regulation related to market segmentation. For business groups, remote subsidiaries help to co-ordinate the interests of local governments and the groups, so it is probably a low-cost approach to overcome market segmentation. With market accesses acquired through remote subsidiaries, business groups can lower the costs of goods sold, approach the market, expand sales and eventually increase profits, but in the meantime, the groups need to pay rent-seeking costs such as non-productive expenditures and extra taxes to establish and maintain remote subsidiaries. To empirically test the benefits and costs of overcoming market segmentation, we first calculate the inter-provincial degree of market segmentation using the relative price method, and then business groups’ degree of overcoming market segmentation. Empirical results show that business groups that overcome market segmentation enjoy larger sales volume and higher gross profit margin, but need to invest in more non-productive expenditures and pay more taxes. Their financial performances are improved on the whole. In further analyses, we show that state-owned groups are less motivated to participate in rent-seeking competition, so by overcoming market segmentation, the performances of private business groups improve more than those of state-owned business groups. Fierce competition drives producers’ surplus to zero, so the fiercer the market competition is, the more improvements are there in the groups’ financial performances after overcoming market segmentation. To address the potential endogeneity problem, we examine the impacts of entrance into and exit from segmented markets on business groups’ financial performance. This paper contributes to market segmentation literature by revealing the micro-level mechanism of the efficiency loss. Specifically, firms need to pay non-productive expenditures and extra taxes to gain rents formed by market segmentation. Therefore, eliminating local protectionism would advance the benign development of both firms and the overall economy. Additionally, this paper supplements the literature related to business groups with an in-depth analysis on the benefits and costs of trans-regional operation, and references for business decisions are provided.