Abstract

http://ssrn.com/abstract=938274
 
 

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Firm Diversification and Equilibrium Risk Pooling: The Korean Financial Crisis as a Natural Experiment


Robert T. Masson


Cornell University

Heather Tookes


Yale University - Yale School of Management; Yale University - International Center for Finance

Taejong Um


Samsung

February 2008


Abstract:     
We use the Korean Financial Crisis as a natural laboratory for examining interactions among firm diversification, equilibrium capital structure and tail probability events. When the crisis hit in 1997, several major firms, including a large number of highly leveraged conglomerates (Chaebols), experienced bankruptcies. In a simple model, we show how diversified Chaebols are able to obtain higher levels of equilibrium debt than non-Chaebol firms (ceteris paribus) due to protective effects of cosigners. In the event of an unanticipated shock, the model predicts a systematic change in relative bankruptcy risks of Chaebol firms. To examine this implication, we first estimate a model of equilibrium debt determination for a sample of Korean manufacturing firms for the years 1991-1994. We then introduce a new empirical methodology that allows us to decompose equilibrium debt into demand, supply and Chaebol-specific factors. To improve our understanding of the mechanisms driving the widespread failures, we use decomposed debt to estimate a bankruptcy prediction model for the post-crisis period. Our main finding is that benefits from shared risks may, in fact, lead to shared vulnerability: The primary cause of bankruptcies of Chaebol firms was not idiosyncratic leverage, but instead leverage systematically related to their greater equilibrium access to debt during normal times.

Number of Pages in PDF File: 34

Keywords: Asian Financial Crisis, Korean Chaebols, Firm Diversification, Bankruptcy

JEL Classification: G33, G32, G00

working papers series





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Date posted: October 20, 2006 ; Last revised: March 21, 2008

Suggested Citation

Masson, Robert T. and Tookes, Heather and Um, Taejong, Firm Diversification and Equilibrium Risk Pooling: The Korean Financial Crisis as a Natural Experiment (February 2008). Available at SSRN: http://ssrn.com/abstract=938274 or http://dx.doi.org/10.2139/ssrn.938274

Contact Information

Robert T. Masson
Cornell University ( email )
Ithaca, NY 14853
United States
Heather Tookes (Contact Author)
Yale University - Yale School of Management ( email )
135 Prospect Street
P.O. Box 208200
New Haven, CT 06520-8200
United States
Yale University - International Center for Finance ( email )
Box 208200
New Haven, CT 06520
United States
Taejong Um
Samsung ( email )
Seoul
Korea
Feedback to SSRN


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