Evolution of the Costs and Benefits of Business Groups

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Evolution of the costs and benefits of business groups:
Korean chaebols with pre-crisis discount and post-crisis
premium
Keun Lee,*, Ji Youn Kim a, Oonkyu Leeb
a

b

School of Economics, Seoul National University, Seoul Korea
Techno-Economics and Policy Program(TEPP), Seoul National University, Seoul, Korea

___________________________________________________________________________ Abstract
We examine Korean chaebols to analyze the long term evolution of the costs and benefits associated with a diversified business group. We find that Korean chaebol-affiliated firms have shown some dramatic changes in the costs and benefits along the three time periods (1984-1988, 1990-1995, and 2001-2003). Korean chaebol-affiliated firms did not suffer a value loss relative to non-affiliated firms in the 1980s and did so in the 1990s, but in the post-crisis period, they are rather experiencing value gains. Chaebol-affiliated firms’ value loss/gains hold even after controlling for the relatedness of the diversification present within the chaebol. To identify the causes of this dramatic changes, we checks whether chaebol firms: (1) pursue profit stability rather than profit maximization, (2) over-invest in low performing industries, (3) cross-subsidize the weaker members of their group, and (4) possess greater debt capacity and consequently enjoy lower tax burdens. Overall, in the 1980s chaebol firms has enjoyed various advantages including taxes but did not invest much excessively, but in the 1990s their performance decreased due to substantial over-investment, despite several advantages still holding. Now, after restructuring after the financial crisis, they (survived chaebols) have emerged as very profitable firms with less over-investment despite no longer tax advantages which show that they have become more transparent than before. JEL classification: G32; G34

Keywords: Chaebol; Business groups; Value loss/gain
___________________________________________________________________________ * Corresponding author. Tel.: +82-2-880-6367; kenneth@snu.ac.kr (Keun Lee).

1. Introduction

Business groups are found in numerous economies, including India (Bertrand, Mehta, and Mullainathan 2002; Ghemawat and Khanna 1998), Chile (Khanna and Palepu 2000b; Khanna and Palepu 1999b), Hong Kong (Au, Peng, and Wang 2000), and China (Peng 2000; Keister 1998), in addition to Japan and Korea where the Chaebols and the Keiretsu, respectively, have been symbols of economic growth. Since early works such as Leff (1978) and Goto (1982), there has been a surge of literature on the subject (Kock and Guillen 2001; Peng, Lee and Tan 2001; Khanna 2000; Khanna and Palepu 2000a, 1999a, 1997; Feenstra and Hamilton 1995; Guillen 2000; Granovetter 1994; Powell and Smith-Doerr 1994; Joh 2003 LaPorta, Lopez-De-Silanes and Shleifer, 1999, Shin and Park, 1999). While performance comparisons between group firms versus stand-alone firms have been the central topic of academic research, the results have never been conclusive. For example, in earlier studies of the Japanese keiretsu, group affiliation is viewed as beneficial as Hoshi, Kashyap, and Scharfstein (1990, 1991), Prowse (1992) and Ferris, Kumar, and Sarin (1995) find that keiretsu affiliations lead to reductions in agency, bankruptcy, and monitoring costs as well as liquidity constraints. However, later studies of keiretsu such as Weinstein and Yafeh (1998), Morck and Nakamura (1999), and Kang and Stulz (2000), report significant costs to group membership due to the presence of an affiliated bank. The studies on the Korean business groups have also shown diverging results although they are somewhat different from Japanese keiretsu. 1 Korean chaebols are large corporate groupings of firms that operate in unrelated industries, and they have become dominant during the mid-1960s (Jung, 1989), and contributed significantly to Korea’s economic growth (Yoo and Lee, 1987). An earlier work by Chang and Choi...
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