Ending "Too Big to Fail": Government Promises vs. Investor Perceptions
Todd A. Gormley
University of Pennsylvania - The Wharton School
Massachusetts Institute of Technology (MIT) - Entrepreneurship Center; National Bureau of Economic Research (NBER)
Asian Development Bank
NBER Working Paper No. w17518
Can a government credibly promise not to bailout firms whose failure would have major negative systemic consequences? Our analysis of Korea's 1997-99 crisis, suggests an answer: No. Despite a general "no bailout" policy during the crisis, the largest Korean corporate groups (chaebol) – facing severe financial and governance problems – could still borrow heavily from households through issuing bonds at prices implying very low expected default risk. The evidence suggests "too big to fail" beliefs were not eliminated by government promises, presumably because investors believed that this policy was not time consistent. Subsequent government handling of potential and actual defaults by Daewoo and Hyundai confirmed the market view that creditors would be protected.
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Number of Pages in PDF File: 56working papers series
Date posted: October 22, 2011
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