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Seoul Journal of Economics
[ Article ]
Seoul Journal of Economics - Vol. 20, No. 4, pp.419-445
ISSN: 1225-0279 (Print)
Print publication date 30 Nov 2007
Received 03 Aug 2007 Revised 05 Dec 2007

Corporate Leverage, Bankruptcy, and Output Adjustment in Post-Crisis East Asia

Se-Jik Kim ; Mark R. Stone
School of Economics, Seoul National University, Seoul 151-746, Korea, Tel: +82-2-880-4020 skim@snu.ac.kr
International Monetary Fund mstone@imf.org

JEL Classification: G33, E22, E23

Abstract

This paper posits that different levels of corporate leverage help explain the very wide range of output adjustment across East Asia in response to the 1997-98 crisis. A general equilibrium model is presented where leverage and output are linked by low investment and capital sales triggered by the threat of bankruptcy. In the model developed here, highly leveraged firms facing a cutoff of capital inflows, which are threatened by bankruptcy, respond first by eliminating investment and then by selling their capital goods - at a discount - to try to stay afloat. Lower investment and wasteful capital sales shrink the aggregate capital stock, trigger deflationary pressures, and contract overall output. In contrast, less leveraged firms, which are not threatened by bankruptcy, would not have to respond by lowering investment and raising costly capital sales. Therefore, a higher corporate leverage may induce a greater output contraction during the crisis. The available data are consistent with the assumptions and predictions of the model.

Keywords:

Corporate leverage, Bankruptcy, Crisis, Output adjustment

Acknowledgments

We are grateful to Eduardo Borensztein, Chris Browne, Lorenzo Giorgianni, and Jeanne Gobat for helpful comments, and Ned Rumpeltin for excellent research assistance. We gratefully acknowledge the financial support from the Advanced Strategy Program (ASP) of the Institute of Economic Research, Seoul National University.

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