Ending 'To Big To Fail': Government Promises vs. Investor Perceptions

Review of Finance, Forthcoming

AFA 2010 Atlanta Meetings Paper

40 Pages Posted: 23 Mar 2009 Last revised: 17 Jun 2014

See all articles by Todd A. Gormley

Todd A. Gormley

Washington University in St. Louis

Simon Johnson

Massachusetts Institute of Technology (MIT) - Entrepreneurship Center; National Bureau of Economic Research (NBER)

Changyong Rhee

Asian Development Bank

Date Written: February 8, 2014

Abstract

Can a government credibly promise not to bailout firms whose failure would have major negative systemic consequences? Our analysis of Korea’s 1997-98 crisis, suggests an answer: No. Despite a general “no bailout” policy during the crisis, the largest Korean corporate groups – facing severe financial and governance problems – could still borrow heavily from households by issuing bonds at prices implying very low expected default risk. The evidence suggests “too big to fail” beliefs were not eliminated by government promises because investors believed that this policy was not time consistent. Subsequent bailouts confirmed the market view that creditors would be protected.

Keywords: Financial Development, Political Economy, Crisis

JEL Classification: E44, G18, K00, N20, P16, P17

Suggested Citation

Gormley, Todd A. and Johnson, Simon and Rhee, Changyong, Ending 'To Big To Fail': Government Promises vs. Investor Perceptions (February 8, 2014). Review of Finance, Forthcoming; AFA 2010 Atlanta Meetings Paper. Available at SSRN: https://ssrn.com/abstract=1364891 or http://dx.doi.org/10.2139/ssrn.1364891

Todd A. Gormley (Contact Author)

Washington University in St. Louis ( email )

One Brookings Drive
Campus Box 1133
St. Louis, MO 63130-4899
United States
(314) 935-7171 (Phone)

HOME PAGE: http://www.gormley.info

Simon Johnson

Massachusetts Institute of Technology (MIT) - Entrepreneurship Center ( email )

United States
617-253-8412 (Phone)
617-258-6855 (Fax)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Changyong Rhee

Asian Development Bank ( email )

6 ADB Avenue, Mandaluyong City 1550
Metro Manila
Philippines

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