Risk Management of Business Groups: Capital Reallocations during a Financial Crisis

Abstract

Korean business groups, chaebol, reduced cash-flow volatility in the aftermath of the 1997 Asian financial crisis by reducing (increasing) investment in member firms with high (low) cash-flow volatility, which was accompanied by active capital reallocations through equity investments from high- to low-cash-flow-volatility member firms. Consequently, chaebol reduced aggregate cash-flow volatility to a greater extent than otherwise similar stand-alone firms. The negative cash-flow volatility--investment association was stronger amongchaebol with greater dependence on external financing or higher cross-member-firm variability in cash-flow volatility. Our results are consistent with internal capital markets being an effective means of risk management for chaebol in times of high external financing costs and robust to alternative explanations.

Keywords: Risk management, business group, capital reallocation, investment, financial crisis

JEL Classification: G30, G32