Debt, Maturity, and Corporate Governance: Evidence from Korea

ABSTRACT

Using a unique survey data set, I examine how corporate governance practices of listed Korean firms can affect debt ratio and debt maturity structure. I find that firms with poor governance tend to have a higher debt ratio (especially short-term debt ratio) than firms with good governance. I also show that the documented relationships between corporate governance and debt ratio and between corporate governance and debt maturity are not significantly different between chaebol (Korean business group) and non-chaebol firms. These findings suggest that (short-term) debt financing can be used as a monitoring tool to mitigate agency problems because financial intermediaries monitor the managers of the borrowing firms. This study contributes to the corporate governance literature by providing evidence that debt capital, especially short-term debt, can be used as a complementary monitoring tool for poorly governed firms in an emerging economy.

KEY WORDS:

• corporate governance
• debt capital
• debt maturity structure
• emerging market

Notes

1. Tang and Wang (2011) show that corporate governance has a positive effect on firm liquidity in Chinese firms.

2. Jiraporn and Gleason (2007) find an inverse relationship between leverage and shareholder rights. They argue that firms with poor shareholder rights carry more debt, which mitigates agency problems.

3. Although Harvey et al. (2004) argue that in emerging markets, family groups typically control the banks and can use them for their own purposes, in Korea, banking and commerce have been separated by the Korean Banking Act.

4. Gonenc et al. (2007) argue that business groups usually have internal capital markets which play an important role for their existence, especially in an emerging market.

5. Zheng et al. (2012) argue that firms located in countries with high uncertainty avoidance, high collectivism, a high power distance, and high masculinity tend to use more short-term debt. Harford et al. (2008) investigate the relationship between boards and firms’ leverage decisions. They argue that firms with strong boards tend to have a high short-term debt ratio. Shyu and Lee (2009) further find a negative association between excess control rights and short-term debt in family controlled firms. Bektas and Kaymak (2009) find positive relationships between the age, size, and asset tangibility of firm and bank-debt ratio.

6. I also use the subindexes of the CGI as an independent variable. CGI-Payout is defined as the corporate governance index without a payout score.

7. The Korea Investors Service (KIS) rates the credit rating of firms on a scale of one to ten, with one indicating “extremely strong” and ten indicating “extremely vulnerable.”

8. In Panel A of Table 2, the mean (median) differences of total debt to total assets among three groups are statistically significant at the 5 percent or 10 percent level. The mean (median) differences of debt maturity among three groups are statistically significant at the 1 percent level.

9. Low-CGI group is in the bottom fiftieth percentile, and high-CGI group is in the top fiftieth percentile, of CGI score.

10. In a multivariable analysis, I use the percentage of total debt to total assets and debt maturity because the coefficients of CGI and its interaction with the chaebol dummy are too small.

11. It is widely documented that the market-to-book ratio is negatively related to total debt to total assets (Baker and Wurgler 2002; Hovakimian et al. 2004). However, Chen and Zhao (2006) show that the empirical basis of this debate—that is, the negative relationship between the market-to-book and leverage ratios—is not robust. They argue that firms with high market-to-book ratios tend to have a high degree of leverage because firms with higher market-to-book ratios are likely to face lower borrowing costs. Grossman and Hart (1982) argue that financial leverage can be negatively associated with the fixed-asset ratio. They find that firms with a low fixed-asset ratio (or a low level of collateral value) tend to have serious agency problems due to information asymmetry. Thus, firms with a low fixed-asset ratio have more incentives to increase their leverage because the financial intermediaries play a role in mitigating the agency problems. Using a Korean sample, Lee and Lee (1999) also find a strong and negative relationship between financial leverage and the fixed-asset ratio. They argue that firms with a high fixed-asset ratio are likely to have greater fixed (operating) costs than variable (operating) costs and that this is likely to increase their operating risk and bankruptcy risk. Thus, they argue that firms with a high fixed-asset ratio tend to have low levels of financial leverage due to the high levels of operating risk and bankruptcy risk.

12. In untabulated results, I further control for the tax rate, which could affect the dependent variable (i.e., total debt/total assets). In addition, I use the volatility of operating income (before interest deductions) over total assets and operating income (before interest deductions) to total assets instead of stock return volatility and ROA, which can be endogenously determined. These results are consistent with the view that poorly governed firms are more likely to increase their ratio of total debt to total assets than are well-governed firms.

13. In Model 5 of Table 3, the coefficient on disclosure is −0.048 (p < 0.01), but the interaction term between disclosure and the chaebol dummy is 0.054 (p < 0.05). These results show that chaebol firms with higher disclosure scores tend to have a higher ratio of total debt to total assets. I believe that firm disclosure is related to the cost of debt.

14. For another robustness test, I control for asset maturity, which can affect debt maturity. I also use the volatility of operating income (before interest deductions) over total assets and operating income (before interest deductions) to total assets instead of stock return volatility and ROA. I control for the asset maturity, the volatility of operating income (before interest deductions) over total assets, and operating income (before interest deductions) to total assets, together. These results show that there is a significant and positive relationship between the CGI and debt maturity.

15. I think that although, due to lower cost of (short-term) debt financing, chaebol firms possess greater (short-term) debt capacity than non-chaebol firms (Ferris et al. 2003; Gul and Kealey 1999), chaebol firms may have less or indifferent incentive to use (short-term) debt because they have better corporate governance than non-chaebol firms. The untabulated results show that mean and median values of CGI for chaebol firms are significantly higher than those of CGI for non-chaebol firms.

16. The Hausman specification test gives a χ2 of 334.07 (p = 0.000) when total debt to total assets is used as a dependent variable. In addition, when I use debt maturity as a dependent variable, the test gives a χ² of 71.18 (p = 0.000).

17. These results suggest that the effect of the CGI on the total debt to total assets of chaebol firms shown in column 2 of Table 3 may be weak and vulnerable.

18. In untabulated results, I use an equal-weighted corporate governance index (EW_CGI) which is the equal weighing of the sub-CGI indexes similar to Gompers et al. (2003). The results show that the negative association between the CGI and total debt to total assets and the positive association between the CGI and debt maturity remain intact when I use the EW_CGI instead of the (unequal-weighted) CGI.

19. I also conduct a dynamic system generalized method of moments (GMM) approach to mitigate endogeneity problems. These results for the dynamic system GMM consistently show that firms with bad governance systems tend to increase their total debt to total assets and have more incentives to use short-term debt than firms with good governance systems.

20. I thank a reviewer for suggesting these insightful approaches to address endogeneity problem.