Closing inefficient affiliates: evidence from Korean conglomerates

Abstract

In the wake of the financial crisis, the Korean government and creditor banks announced a ‘blacklist’ of 55 firms to be forced to exit the market. This article examines the effects that the closed affiliated firms had on stock market values of the Korean business groups (chaebols). We find that the announcement had an immediately negative effect on the remaining affiliates. The announcement's adverse effect became worse as firms had more affiliates in the ‘blacklist’ and had more investment from them, after controlling for various firm characteristics. These results suggest that the corresponding chaebols had financially weak firms besides those in the ‘blacklist’, or that the affiliates could not recover their investment when the blacklisted firms were closed.

Acknowledgements

We thank Charles Calomiris, Michael Riordan, Raphael Thomadsen and seminar participants at Asian Finance Association Columbia University and Korea University for their helpful comments and suggestions. We are also grateful to the KDI School for providing financial support.

Notes

¹The value-maximizing process can be generated as a result of either cross-subsidized predatory pricing or enhanced mutual forbearance.

²In a similar way, Gourlay and Seaton (2004) examine the role of governance factors in determining the probability and intensity of market diversification in the United Kingdom, and Menendez-Alonso (2003) examines whether a diversification strategy has a real influence on a firm's capital structure.

³The separation differs from a spin-off in that the selected firms were forced to exit the market rather than staying alive as in a spin-off.

⁴Lee et al. (2005) find evidence that poorly performing firms with less investment opportunities invest more than well-performing firms with better growth opportunities through cross-subsidization among firms in the same chaebol group during the pre-crisis perio d in Korea.

⁵Meyer et al. (1992) argue that the prospect of organizational decline and layoffs creates additional influence costs in multiunit organizations that would be absent if there were no prospect of layoffs and that would be lessened or eliminated in focused organizations. Following their view, the remaining affiliates would be better off after the ‘blacklist's’ announcement because of the absence of such influence cost.

⁶The ratio of assets can also measure the degree of shock. However, the asset size was not available for some firms that are not listed in the KSE, and thus the asset ratio cannot be constructed in this study.