Firm Diversification and Equilibrium Risk Pooling: The Korean Financial Crisis as a Natural Experiment
Robert T. Masson
Yale University - Yale School of Management; Yale University - International Center for Finance
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.
Number of Pages in PDF File: 34
Keywords: Asian Financial Crisis, Korean Chaebols, Firm Diversification, Bankruptcy
JEL Classification: G33, G32, G00
Date posted: October 20, 2006 ; Last revised: March 21, 2008