This study applied the methodology used by Schmalensee and Rumelt—who analyzed the extent to which corporate headquarters, individual business units, and industry factors each influence the profitability of individual business units within diversified firms in the United States—to affiliate companies belonging to Korean business groups (chaebols). The variance in affiliate profitability was decomposed into business group effects, affiliate firm effects, and industry participation effects. The results revealed that, unlike in the United States, the business group effect was substantial in Korea. This demonstrates that in the Korean business environment, where capital markets are imperfect and factor markets are underdeveloped, business groups serve the function of overcoming market imperfections through internalization. However, the business group effect was found to be larger among smaller business groups ranked below the top 30 than among the top 30 large-scale business groups.