The East Asia Crisis and Corporate Finances: The Untold Micro Story

Abstract

Empirical findings about corporate finance support Krugman's view that crony capitalism lay at the core of Asia's recent financial crisis. Implicit government guarantees and poor banking supervision led to poor decisions about credit allocation in Asia's banking-dominated financial systems.

Explanations of what caused the Asian crisis have focused on macroeconomic factors. Pomerleano offers a complementary perspective focusing on corporate distress and corporate finance.

He presents key ratios for companies in various countries. Using global benchmarking, he imposes a consistent cross-border analysis of financial risk and performance. He provides a statistical review of corporate financial practices and performance in Hong Kong, Indonesia, the Republic of Korea, Malaysia, the Philippines, Taiwan (China), and Thailand - benchmarked against corporate financial data for other countries in Latin America and for four industrial countries: France, Germany, Japan, and the United States.

One common pattern emerges from the analysis: unsustainable rapid (and probably excessive) investment in fixed assets financed by excessive borrowing in some Asian countries (for example, Indonesia, Korea, and Thailand).

The result of the East Asian investment spending spree was poor profitability, reflected in low and declining returns on equity and capital.

At the core of the corporate crisis were financial excesses that violated prudent financial practices and eventually led to the inevitable financial distress.

The empirical findings support Krugman's view: that crony capitalism lay at the core of the crisis. Crony capitalism was manifested in poor policies - implicit government guarantees and poor banking supervision - that led to poor decisions about credit allocation in the banking-dominated financial system.

Preliminary findings also suggest vast differences in economic value-added among countries (both industrial and developing). In an era of increasing capital mobility, corporations are not adhering to global standards in creating shareholder value.

The implications for enhanced regulation and supervision of the financial system are unmistakable. The recent introduction of improved loan classification systems and capital adequacy norms are encouraging first steps toward better regulation and supervision. But they must be supplemented by an improved regulatory framework and better enforcement.

This paper is a product of the Development Prospects Group, Office of the Senior Vice President, Development Economics. The author may be contacted at [e-mail].