This paper examines capital reallocation among firms in Korean business groups (chaebol) in the aftermath of the 1997 Asian financial crisis, and the consequences of this capital reallocation for the investment and performance of chaebol firms. We show that chaebol transferred cash from low-growth to high-growth member firms, using cross-firm equity investments. This capital reallocation allowed chaebol firms with greater investment opportunities to invest more than control firms after the crisis. These firms also showed higher profitability and lower declines in valuation than control firms following the crisis. Our results suggest that chaebol internal capital markets helped them mitigate the negative effects of the Asian crisis on investment and performance.The literature on internal capital markets focuses mostly on multisegment firms (conglomerates), which are common in the United States. A "business group"-a group of legally independent firms under common ownershipshares many of the features of U.S.-type conglomerates. In particular, both have internal markets that can allocate capital among member firms and divisions. While the importance of internal capital allocation within conglomerates has probably decreased in the United States as a result of financial development, the role of groups may still be significant in countries with weak institutions and less developed financial markets (Khanna and Palepu (2000), Morck, Wolfenzon, and Yeung (2005), Khanna and Yafeh (2007)). Notwithstanding the potential importance and ubiquity of groups in emerging markets (Claessens et al. (2002), Faccio and Lang (2002)), however, there is surprisingly little direct evidence on the efficiency of their capital allocation.In this paper, we study capital allocation in Korean business groups (chaebol), focusing on an event that is likely to have exacerbated the impact of chaebol * Chang-Soo Kim (corresponding author) is at Yonsei University. Hwanki Brian Kim and Heitor Almeida are at the University of Illinois at Urbana-Champaign. We thank three anonymous referees, Michael Roberts, Ran Duchin, Miguel Ferreira, Antonio Gledson de Carvalho, Radha Gopalan, David Reeb, Mara Faccio, Patrick Behr, and participants at Hong Kong University, Purdue University, Bocconi University, the 2012 SBFIN conference, the 2012 LUBRAFIN conference, the Washington University 2011 Corporate Finance Conference, and the HKUST 2011 Finance Symposium for comments and suggestions. We also thank Igor Cunha, Jiyoon Lee, Yunhee Cho, Sunghoon Joo, and Myeongwoo Kang for excellent research assistance. The authors do not have any conflicts of interest, as identified in the Disclose Policy. DOI: 10.1111/jofi.12309
2540The Journal of Finance R internal capital markets on resource allocation, namely, the Asian crisis of 1997. The 1997 Asian crisis was a truly unprecedented and unexpected event that greatly affected Asian economies. Important sources of external finance (such as bank loans and bonds) became more costly or virtually impossible to access i...