The Role of Intra-Conglomerate Equity Investment: Evidence from Korean Business Groups

Abstract

This paper demonstrates that group-affiliated firms have financial attributes that are different from those of stand-alone firms and suggests that these differences are consistent with ex-post consequences of receiving equity investment (EI) in business groups. Therefore, intra-group EI serves as an important driver of these differences. The paper verifies the results by considering the case of Korea's EI regulation. EI recipients invest more, but are less profitable than firms receiving no such investment. Group-affiliated firms reduce their dividend payout and short-term debt after receiving EI. Finally, recipients increase capital investment when they perceive their EI to be persistent, and those receiving massive EI use funds differently from those receiving normal EI. The results suggest that massive EI may involve ownership-related intentions, not financial support.

Keywords:

• Internal capital market
• equity investment
• business group
• profitability
• payout
• matching method

JEL CLASSIFICATION:

• G3

Acknowledgments

This paper has been developed from an earlier version under the title of “Equity Investment and Recipient’ Financial Decision in Business Group.” Doyeon Kim gratefully acknowledges support from the Yeungnam University research grant.

Notes

1. Villalonga (2004a, 2004b) reports that diversified firms have a premium when the BITS classification method is used, but are undervalued when the Compustat classification method is employed. This may be because Compustat segments are pooled together to avoid disclosing which segments are most profitable.

2. In Korea, according to the External Audit of Stock Companies Act, firms with a book value exceeding KRW 7 billion (approximately $7 million) should engage outside auditors even when they are not publicly traded.

3. Huang (2011) suggests that the pecking order hypothesis is broadly supported by evidence from the East Asian economy.

4. For further details on Korea's EI regulation for business conglomerates, see Figure 1. For example, the regulation is applied to all affiliated firms in the top 30 business conglomerates. In January 2002, the threshold changed from the top 30 business groups to all firms, whose total assets exceed KRW 5 trillion (about $5 billion) except for financial institutions.

5. Investment in fixed assets peaks at the year of EI reception and shrinks sharply immediately thereafter, but grows back eventually (see Figure 3).

6. In various aspects, studies have provided support for the argument that there are notably distinct differences in decision-making between chaebol groups and non-chaebol ones (e.g. Park et al., 2011).