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

34 Pages Posted: 20 Oct 2006 Last revised: 21 Mar 2008

Robert T. Masson

Cornell University

Heather Tookes

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

Taejong Um

Samsung

Date Written: 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.

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

JEL Classification: G33, G32, G00

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: https://ssrn.com/abstract=938274 or http://dx.doi.org/10.2139/ssrn.938274

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

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