This paper presents a theory of pyramidal ownership and family business groups. The authors argue that pyramidal ownership arises not to separate cash flow from voting rights, as traditionally believed, but because it allows families to access retained earnings of existing firms and share new firm profits with minority shareholders of the original firm. This structure is attractive when external financing is costly and the family is expected to divert a large fraction of new firm profits. The model explains why pyramids can coexist with dual-class shares and why pyramidal structures are more common than dual-class shares globally. It also shows that pyramidal structures are used to create business groups, where a family controls multiple firms. The model is consistent with empirical evidence showing that pyramidal firms often have small deviations between ownership and control. The authors also show that pyramidal structures can lead to higher diversion of profits, and that firms with low security benefits are more likely to be set up in pyramids. The model also addresses the issue of whether new firms should be set up as independent entities or as divisions within existing firms. The authors find that pyramidal structures are more likely to be used when firms have high investment requirements and/or low profitability. The model is also consistent with the idea that pyramidal structures are more common in countries with poor investor protection. The authors conclude that pyramidal structures are not equivalent to direct ownership with dual-class shares, but rather provide a way for families to maximize internal financing and share security benefits of new firms. The model also shows that pyramidal structures can lead to overinvestment in firms, which is a version of the free cash flow problem. The authors also show that pyramidal structures can be optimal even when the family has the ability to use dual-class shares. The model is consistent with empirical evidence on pyramidal business groups and provides a new explanation for their existence.This paper presents a theory of pyramidal ownership and family business groups. The authors argue that pyramidal ownership arises not to separate cash flow from voting rights, as traditionally believed, but because it allows families to access retained earnings of existing firms and share new firm profits with minority shareholders of the original firm. This structure is attractive when external financing is costly and the family is expected to divert a large fraction of new firm profits. The model explains why pyramids can coexist with dual-class shares and why pyramidal structures are more common than dual-class shares globally. It also shows that pyramidal structures are used to create business groups, where a family controls multiple firms. The model is consistent with empirical evidence showing that pyramidal firms often have small deviations between ownership and control. The authors also show that pyramidal structures can lead to higher diversion of profits, and that firms with low security benefits are more likely to be set up in pyramids. The model also addresses the issue of whether new firms should be set up as independent entities or as divisions within existing firms. The authors find that pyramidal structures are more likely to be used when firms have high investment requirements and/or low profitability. The model is also consistent with the idea that pyramidal structures are more common in countries with poor investor protection. The authors conclude that pyramidal structures are not equivalent to direct ownership with dual-class shares, but rather provide a way for families to maximize internal financing and share security benefits of new firms. The model also shows that pyramidal structures can lead to overinvestment in firms, which is a version of the free cash flow problem. The authors also show that pyramidal structures can be optimal even when the family has the ability to use dual-class shares. The model is consistent with empirical evidence on pyramidal business groups and provides a new explanation for their existence.