The economic crisis and efficiency change: evidence from the Korean construction industry

Abstract

This article gauges and analyses different types of efficiency in the Korean construction industry for the period 1996 to 2000, which includes the country's economic crisis. We also identify several important factors of the efficiency change and provide some managerial implications for the reason why most Korean construction firms had failed to maintain or enhance efficiency during this period. The results show that efficiency measures decreased significantly during the sample period and that there are large differences over the period before and after the economic crisis. Unlike many other industries, the low level of cost efficiency of the construction industry is mainly due to allocative inefficiency (inappropriate mix of input factors) rather than technical inefficiency. The low level of allocative efficiency, together with the strong relationship between institutional investors and efficiency, implies that the agency problem between managers and owners had prevailed in the Korean construction industry, and that construction firms could increase efficiency by minimizing agency costs. The study also implies that firms having failed in decreasing the leverage ratio, disposing unproductive assets and increasing the receivables overdue turnover could not avoid the efficiency decrease.

Notes

¹ To identify whether a given scale inefficient firm is operating with IRS or DRS, we also estimate a frontier under the assumption of nonincreasing returns to scale (NIRS). If VRS technical efficiency is equal to NIRS technical efficiency, the firm is characterized by DRS, and if VRS technical efficiency is not equal to NIRS technical efficiency, the firm is characterized by IRS.

² To estimate a NIRS frontier, the problem is solved again with the following constraint: .

³ There can be a critique that the cross-subsidization may underestimate the factor price. The cross-subsidization is likely to be present in most of our sample firms, since most of them belong to a larger web of corporate subsidiaries. However, because the data for inside transactions are not available, it is almost impossible to identify what extent the cross-subsidization exists in each firm. However, since the cross-subsidization can be common among most in our sample, we believe our main results will not be significantly affected.

⁴ For the agency problems of free cash flow, see Jensen (1986).

⁵ See Stulz (1990) for a theoretical argument.

⁶ For example, see Schleifer and Vishny (1986). Managerial entrenchment: the case of manager-specific investments, Journal of Financial Economics, 25, 123–39. For empirical studies supporting the monitoring function of institutional investors, see Agrawal and Knoeber (1996). Firm performance and mechanisms to control agency problems between managers and shareholders, Journal of Financial and Quantitative Analysis, 31, 377–97; Kochhar and David (1996). Institutional investors and firm innovation: a test of competing hypotheses, Strategic Management Journal, 17, 73–84; Abrahamson and Park (1994). Concealment of negative organizational outcomes: an agency theory perspective, Academy of Management Journal, 37, 1302–34.

⁷ To see the effect of factor prices, we reported and discussed only the results on cost and allocative efficiency.