Ending 'Too Big to Fail': Government Promises vs. Investor Perceptions
Review of Finance, Forthcoming
40 Pages Posted: 22 Oct 2012 Last revised: 17 Jun 2014
Date Written: February 8, 2014
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: Suggested Citation