Your browser does not support the PubReader view.
Go to this page to see a list of supporting browsers.
Seoul Journal of Economics
[ Article ]
Seoul Journal of Economics - Vol. 15, No. 2, pp.321-368
ISSN: 1225-0279 (Print)
Print publication date 31 May 2002
Received 29 Aug 2002 Revised 07 Feb 2003

The Dark Side of Internal Capital Allocation: The Case of Korean Chaebols

Dong Gull Lee ; Keonbeom Lee
Senior research fellow, Korea Institute of Finance, Bankers' Building, 4-1, Myong-Dong 1-Ga, Chung-Ku, Seoul, 100-021, Korea, Tel: +82-2-3705-6276, Fax: +82-2-3705-6285 dglee@kif.re.kr
Research fellow, Tel: +82-2-3705-6355, Fax: +82-2-3705-6345 kblee@kif.re.kr

JEL Classification: G32, G38, L22, L40

Abstract

In this paper, we first briefly survey the theories of internal capital markets and then provide an empirical analysis of the efficiency of internal capital allocations among the chaebols in Korea. Our analysis of equity investment flow among the subsidiaries of the top 30 chaebols from 1997 to 2001 suggests that the chaebols' inter-affiliate equity investment during this period cannot be justified by sound economic rationale, and reveals the dark side of internal capital allocation. Furthermore, we find that a strong positive relationship does not exist between equity investment and real investment. In conclusion, the internal capital allocations among the chaebols have continued to be inefficient and therefore, the argument to loosen restrictions on inter-affiliate equity investments to increase real investment cannot be justified.

Keywords:

Internal capital market, Inter-affiliate equity investment, Diversification

Acknowledgments

Earlier versions of this paper were presented at the 10th Seoul Journal of Economics International Symposium (Seoul, August 2002), the 11th Conference on the Theories and Practices of Securities and Financial Market (Kaohsiung, December 2002), and the seminar at the Korea's Official Pool of International Economists & Regional Experts (Seoul, November 2002). We thank seminar participants and Keunkwan Ryu for helpful discussions.

References

  • Alchian, Armen. “Corporate Management and Property Rights.” In Henry Manne (ed.), Economic Policy and the Regulation of Corporate Securities. Washington, DC., 1969.
  • Allen, Frankin, and Gale, Douglas. “Welfare Comparison of Intermediaries and Financial Markets in Germany and the US.” European Economic Review 39 (No. 2 1995): 179-209. [https://doi.org/10.1016/0014-2921(94)00095-H]
  • Amihud, Yakov, and Lev, Baruch. “Risk Reduction as a Managerial Motive for Conglomerate Mergers.” Bell Journal of Economics 12 (No. 2 1981): 605-17. [https://doi.org/10.2307/3003575]
  • Bebchuk, Lucian, Kraakman, Reinier, and Triantis, George. Stock Pyramids, Cross-Ownership, and Dual Class Equity: The Creation and Agency Costs of Separating Control from Cash Flow Rights. NBER Working Paper 6951, 1999. [https://doi.org/10.3386/w6951]
  • Berger, Philip, and Ofek, Eli. “Diversification's Effect on Firm Value.” Journal of Financial Economics 37 (No. 1 1995):39-65. [https://doi.org/10.1016/0304-405X(94)00798-6]
  • Chandler, Alfred. Scale and Scope. Belknap and Harvard University Press, 1990.
  • Choi, J. “Corporate Structure and Market Competition.” In POSRI (ed.), The Big Enterprises in Korea. Seoul, 1995 (in Korean).
  • Claessens, Stijn, Djankov, Simeon, Fan, Joseph, and Lang, Larry. Diversification and Efficiency of Investment by East Asian Corporations. World Bank Policy Research Working Paper 2033, 1998. [https://doi.org/10.2139/ssrn.147467]
  • Claessens, Stijn, Djankov, Simeon, Fan, Joseph, and Lang, Larry. Corporate Diversification in East Asia: The Role of Ultimate Ownership and Group Affiliation. World Bank Policy Research Working Paper 2089, 1999.
  • Coase, Ronald. “The Nature of the Firm.” In O. Williamson, and S. Winter (eds.), The Nature of the Firm: Origins, Evolution, and Development. Oxford University Press, 1998 (1937).
  • Comment, Robert, and Jarrell, Gregg A. “Corporate Focus and Stock Returns.” Journal of Financial Economics 37 (No. 1 1995): 67-87. [https://doi.org/10.1016/0304-405X(94)00777-X]
  • Denis, David, Denis, Dian K., and Sarin, Atulya. “Agency Problems, Equity Ownership, and Corporate Diversification.” Journal of Finance 52 (No. 1 1997): 135-60. [https://doi.org/10.1111/j.1540-6261.1997.tb03811.x]
  • Diamond, Peter. “Financial Intermediation and delegated monitoring.” Review of Economic Studies 51, 1984. [https://doi.org/10.2307/2297430]
  • Fauver, Larry, Houston, Joel, and Naranjo, Andy. Capital Market Development, Legal Systems and the Value of Corporate Diversification: A Cross Country Analysis. University of Florida Working Paper, 1999.
  • Franks, Julian, and Mayer, Colin. “Corporate Ownership and Control in the U.K., Germany, and France.” The Bank of America Journal of Applied Corporate Finance 9 (No. 4 1997): 30-45. [https://doi.org/10.1111/j.1745-6622.1997.tb00622.x]
  • Freixas, Xavier, and Rochet, Jean-charles. Microeconomics of Banking. Cambridge: MIT Press, 1997.
  • Gertner, Robert, Scharfstein, David, and Stein, Jeremy. “Internal versus External Capital Markets.” Quarterly Journal of Economics 109 (No. 4 1994): 1211-30. [https://doi.org/10.2307/2118361]
  • Gurley, John, and Shaw, Edward. “Financial Aspects of Economic Development.” American Economic Review 45 (No. 4 1955): 515-39.
  • Harris, Milton, and Raviv, Artur. “The Theory of Capital Structure.” Journal of Finance 46 (1991): 297-355. [https://doi.org/10.1111/j.1540-6261.1991.tb03753.x]
  • Hoshi, Takeo. “The Economic Role of Corporate Grouping and the Main Bank System.” In Masahiko Aoki, and Ronald Dore (eds.), The Japanese Firm: The Sources of Competitive Strength. Oxford University Press, 1994. [https://doi.org/10.1093/acprof:oso/9780198288152.003.0012]
  • Hyun-Han, Shin, and Stulz, Rene M. “Are Internal Capital Markets Efficient?” Quarterly Journal of Economics 113 (No. 2 1988): 531-52. [https://doi.org/10.1162/003355398555676]
  • Jensen, Michael. “Agency Costs of Free Cash Flow, Corporate Finance, Takeovers.” American Economic Review, 1986.
  • Korean Fair Trading Commission (KFTA). Internal Data Base for the Large Business Groups.
  • Khanna, Tarun, and Palepu, Krishna. Emerging Market Business Groups, Foreign Investors and Corporate Governance. NBER Working Paper 6955, 1999. [https://doi.org/10.3386/w6955]
  • Lamont, Owen. “Cash Flow and Investment: Evidence from Internal Capital Makets; Journal of Finance 52 (No. 1 1997): 83-109. [https://doi.org/10.1111/j.1540-6261.1997.tb03809.x]
  • Lang, Larry, and Stulz, Rene. “Tobin's q, Corporate Diversification, and Firm Performance.” Journal of Political Economy 102 (No. 6 1994): 1248-80. [https://doi.org/10.1086/261970]
  • Lee, Keonbeom. Diversified Business Groups and Diversification Value in Developing Countries. KIF Working Paper 2001-04, 2001.
  • Lewellen, Wilbur. “A Pure Financial Rationale for the Conglomerate Merger.” Journal of Finance 26 (No. 2 1971): 521-37. [https://doi.org/10.1111/j.1540-6261.1971.tb00912.x]
  • Lins, Karl, and Servaes, Henri. “International Evidence on the Value of Corporate Diversification.” Journal of Finance 54 (No. 6 1999): 2215-39. [https://doi.org/10.1111/0022-1082.00186]
  • Meyer, Margaret, Milgrom, Paul, and Robers, John. “Organizational Prospects, Influence Costs, and Ownership Changes.” Journal of Economics and Management Strategy 1 (No.1 1992): [https://doi.org/10.1111/j.1430-9134.1992.00009.x]
  • Park, Sang-Su, and Jin, Tae-Hong. “An Empirical Study of Chaebol's Management Efficiency.” Security and Finance Studies 2 (No.1 1996): 1-28 (In Korean).
  • Rajan, Raghuram, and Zingales, Luigi. “Power in the Theory of the Firm.” Quarterly Journal of Economics 113 (No. 2 1998a): 387-432. [https://doi.org/10.1162/003355398555630]
  • Scharfstein, David. The Dark Side of Internal Capital Markets II: Evidence From Diversified Conglomerates. NBER Working Papers 6352, 1998. [https://doi.org/10.3386/w6352]
  • Scharfstein, David, and Stein, Jeremy. The Dark Side of Internal Capital Markets: Divisional Rent Seeking and Inefficient Investment. Mimeograph, MIT, 1997. [https://doi.org/10.3386/w5969]
  • Servaes, Henri. “The Value of Diversification during the Conglomerate Merger Wave.” Journal of Finance 51 (No. 4 1996): 1201-25. [https://doi.org/10.1111/j.1540-6261.1996.tb04067.x]
  • Shin, Hyun-Han, and Stulz, Rene M. “Are Internal Capital Markets Efficient?” Quarterly Journal of Economics 113 (No. 2 1998): 531-52. [https://doi.org/10.1162/003355398555676]
  • Stein, Jeremy. “Internal Capital Markets and the Competition for Corporate Resources.” Journal of Finance 52 (No.1 1997): 111-33. [https://doi.org/10.1111/j.1540-6261.1997.tb03810.x]
  • Weinstein, David, and Yafeh, Yishav. “Japan's Corporate Groups: Collusive or Competitive? An Empirical Investigation of KEIRETSU Behavior.” Journal of Industrial Economics 43 (No. 4 1995): 359-77. [https://doi.org/10.2307/2950549]
  • Williamson, Oliver. Markets and Hierarchies: Analysis and Antitrust Implications: A Study in the Economics of Internal Organization. Free Press, 1975.