Mr. K

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martes, mayo 03, 2005

About the Chaebol in Korea

Seven years have passed from the painful moment of my country. However, this vivid memory is still alive in my heart and has become a motive of my further study. When I read your publications to get some information for my interview, I gained some idea from them and decide to write this paper to show myself more. From this paper, I hope you understand my motive and idea.

When I read about the aggregate statistics based on net flows and the filtering technique, I realize these could be applied to analyze the financial systems of large conglomerate business groups, called as the Chaebol in Korea. The aggregate statistics and filtering technique could eliminate cross-transactions, identify the clear capital structure, and provide accurate financial conditions of a Chaebol and its affiliate companies. Moreover, I think this approach would be helpful for valuing small venture companies and their projects when making financial decisions.

Economic Crisis of Korea
In November 1997, less than a year after its accession to the OECD, Korea experienced a severe financial crisis. An inefficient and distorted financial sector and a corporate sector burdened with high levels of short-term debt were at the core of the economic crisis in Korea.

A major shock to the Korean economy occurred with the bankruptcy of five large conglomerate business groups, the Chaebols. The failure of these Chaebols revealed problems with low profitability and excessive leverage ratios in the corporate sector and faulty corporate governance in Korea. During the economic crisis, the Korean currency depreciated sharply, the Korean Stock Price Index plunged, and market interest rates surged.

Since December 1997, the Korean government has embarked on a comprehensive program for economic reform and recovery, and taken significant steps to accelerate the liberalization of capital market and foreign exchange transactions.

Problems in the Chaebol
First, the high growth, excessive debt, and high financial risk were the basement of the Chaebol. Since 1960s, the Korean economy had shown rapid growth with the investments backed through heavy external debt financing. By continuous input strategy of Korea on financial resources, the Chaebols could have achieved a remarkable advancement in the major industrial sectors competing in the world markets. However, the excessive financial leverage of the Chaebols led to the massive bankruptcy of Chaebols and their affiliate companies, including many other independent companies.

Secondly, most of the Chaebols earn rates of return that are less than their cost of capital. This poor performance and low efficiency of corporate assets reflects not only inefficient use of corporate resources, it also shows the transfer of corporate assets to affiliate companies by the controlling owners. This indicates the wide spread practice of transfer corporate assets in the past from one company to another within a conglomerate business group, the Chaebol.

Finally, by the mutual loan guarantee practices, the Chaebols were able to successfully obtain massive loans from the banks, and consequently they had excessively high leverage. Since the loan guarantee is a contingent liability, it incurs an implicit cost to the guarantors without any guarantee fees or compensation. Therefore, a loan guarantee was a useful indirect way of transferring corporate wealth of the guarantor company to the guarantee recipient. The prevailing practice of mutual loan guarantees in the past was a useful way for Chaebols to mobilize bank loans and transfer corporate wealth from one company to another.

Various challenges have been taken in an effort to reduce excessive financial leverage of the Chaebols, to enhance the global standards of business practices in financial systems of the Chaebols, and to prevent the opportunistic behavior by controlling Chaebol owners. Since the economic crisis in 1997, the top 30 largest Chaebols were subjected to produce combined financial statements for their conglomerate group, the affiliate companies of these Chaebols were required to reduce their debt to equity ratios to 200%, and loan guarantees among affiliate companies within a Chaebol were prohibited.

However, the transfer of corporate assets and the mutual events between affiliate companies of a Chaebol still have made it difficult to look into accurate financial conditions of a Chaebol and its affiliate companies. I believe that the aggregate level of financing and event studies based on net flows would be an effective approach in analyzing the capital structure and forecasting future financial conditions of them. The reason that the aggregate level of studies based on net flows is comprehensive in providing complete coverage of the Chaebol and its affiliate companies is that it will remove mutual events among them and show transparent flows between the Chaebol and external financial institutions.

With the idea I gained from your publications, I am considering these procedures to analyze accurate financial conditions and capital structure of the Chaebol and its affiliate companies. (See Figure 1)

1. By some filtering techniques, I will identify and extract all unusual events from a Chaebol and its affiliate companies over certain period. Between affiliate companies of a Chaebol, this will find mutual events such as loans, transactions or investments.

2. I will find the aggregate financing patterns of a Chaebol including its affiliate companies by the filtered financing flows. This aggregate statistical figure will show the capital structure of a Chaebol.

3. I will combine extracted events with the aggregate level of financial flows of a Chaebol. I will value each event and examine its effects, and then I will forecast the future financial condition of a Chaebol.

4. Moreover, to analyze each financial condition of affiliate companies, I will separate the aggregate level of data and allocate to each affiliate company. This approach will bring clear overviews on its financial condition and steady businesses without any unusual events including mutual relationships with other affiliate companies.

5. To the financial condition of an affiliate company, I will apply extracted events of it. Then, on the basis of its capital structure and financial flows, I will measure risks of each event, and forecast future financial condition and future value of an affiliate company of after events.

With my current abilities and knowledge in finance, I am not sure how much my idea is acceptable and my procedures are reasonable. After receiving the interview arrangement email from Saïd Business School, I just started reading your publications. However, your publications were very interested and I would like to have more opportunity to study and to hear from you about them. Whatever the quality of this paper is, I have done my best and I take pride in my idea which I gained from your publications. It was really my pleasure to have a chance to read your publications. I am sure you publications will be helpful for my future study on the corporate finance and the international finance.

Additionally, I would like to share my experience with you. Your publication, “A New Test of Capital Structure,” presented me with good understanding of the pecking order theory and trade-off theories. However, I believe small venture companies have additional reasons in seeking new equity finance before their debt capacity is exhausted.

From “A New Test of Capital Structure,”
New equity issuance is concentrated on small loss making firms that have high levels of leverage. New equity issues are associated with companies that would have difficulty raising debt finance while debt finance is raised by large profitable companies, which do not need to issue equity.

Small venture companies are usually in the state of new investment and loss-making. Although products are developed and initial marketing takes place, companies would remain unprofitable for a while. During this period, companies should use external finance, and they have to choose either debt or new equity. In this sense, most Korean small venture companies prefer financing from the new equity market though debt is the dominant source of external finance for a small venture company.

The use of debt finance requires the guarantee and collateral. Generally in Korea, creditors or financial institutions require the loan guarantee from CEO and other directors of companies while their lending is backed by collateral on average 150%. Although considering the high concentration of ownership in small venture companies, the required risk and collateral is too big to accept for CEOs. Thus, I believe, CEOs or CFOs of small venture companies try to seek first new equity finance rather than debt finance even though they are not listed in the stock market.


J. Corbett, J. Edwards, T. Jenkinson, C. Mayer, and O. Sussman, “A Response to Hackethal and Schmidt (2003), Financing Patterns: Measurement Concepts and Empirical Results”, 2004.

Mayer, C. and O. Sussman, “A New Test of Capital Structure”, Oxford Financial Research Center Working Paper, 2003.

Mayer, C., "Financing the New Economy: Financial Institutions and Corporate Governance", Information Economics and Policy, Vol.14, 2002.


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