Business Groups and Tunneling: Evidence from Private Securities Offerings by Korean Chaebols

Abstract

Using a comprehensive sample of equity-linked private securities offerings by Korean firms from 1989 to 2000, we examine whether such offerings can be used as a mechanism for wealth transfer between issuers and acquirers. For deals involving issuers and acquirers in the same business group (chaebol), the announcement returns for chaebol-affiliated issuers with good past performance are lower than those for other types of issuers if the price discount is larger. In contrast, this deal leads to more value creation for chaebol-affiliated acquirers than other types of acquirers. Furthermore, well-performing chaebolaffiliated acquirers experience a larger wealth loss than other types of acquirers if they buy securities from poorly performing issuers in the same chaebol. We also find that chaebol firms with good past performance tend to sell private securities at a low price to their member firms. This evidence is consistent with tunneling within business groups. The widespread use of pyramid ownership structures and cross-holdings among firms belonging to a business group allows controlling shareholders to exercise full control over a firm despite holding a relatively small portion of its cash flow rights. 1 This divergence between ownership and control raises concerns of tunneling -that controlling shareholders of the business group have strong incentives to siphon resources out of firms to increase their wealth (Johnson, La Porta, Lopez-de-Silanes, and Shleifer, 2000). Although tunneling creates a severe agency problem between controlling and minority shareholders and imposes a serious friction on the efficient functioning of a capital market, systematic evidence of its existence is scarce. One notable exception is the study of Bertrand, Mehta, and Mullainathan (2002), who use a sample of 18,600Indian firms during the period 1989 to 1999 to examine tunneling in pyramidal ownership structures of business groups. They show that the ultimate owners of the pyramids have strong incentives to divert resources from firms low down in the pyramid towards ones high up in the pyramid. In a similar vein, Bae, Kang, and Kim (2002) find that minority shareholders of firms within the top 30Korean business groups typically lose out from their acquisitions, but that the controlling shareholders gain from the same deals. These results are consistent with the existence of tunneling among firms belonging to business groups.In this paper, we extend this literature by providing direct evidence of tunneling among group firms. To gain a better understanding of tunneling from a different perspective than those found in the existing literature, we analyze the valuation effect and the pricing of equity-linked private securities offerings by Korean firms from 1989 to 2000. Our objective is to examine the extent to which firm value is related to the controlling shareholder's incentive to carry out tunneling. Unlike previous studies, we focus on the financing decisions of group-affiliated firms, not on their investment decisions. We s...

Banks and Corporate Decisions: Evidence from Business Groups

“…This paper's bank perspective is also an extension of the literature on agency in business groups, which has emphasized agency conflicts between managers/controlling shareholders and minority shareholders, but less between debtholders and shareholders. This perspective reconciles the contradictory findings regarding Japanese business groups, as some studies found beneficial effects of business groups due to agency reduction (Hoshi et al, 1990;Prowse, 1990), while others found pernicious effects due to tunneling (Bae et al, 2002(Bae et al, , 2006Morck and Nakamura, 2005;Jiang et al, 2010). In the bank perspective, the former results are based on banks' heyday in Japan, when there were many opportunities for interests to align between banks and firms, while the latter results are based on banks' decline, when conflicts were more prevalent than alignments.…”

Board Structure and Intragroup Propping: Evidence from Family Business Groups in Hong Kong

“…Empirical analyses find that board size is positively related to the level of private benefits available to insiders in US firms (Boone et al, 2007). A large body of literature shows that group member firms are conducive to self-dealing transactions and that controlling families have strong incentives and enjoy plentiful channels to divert wealth from or between their member firms for their own private benefit (Johnson et al, 2000;Bae, Kang, and Kim, 2002;Bertrand, Mehta, and Mullainathan, 2002;Morck, Wolfenzon, and Yeung, 2005;Baek, Kang, and Lee, 2006;Cheung, Rau, and Stouraitis, 2006;among others). It is reasonable to conjecture that boards with larger size function more effectively to discourage controlling families from undertaking intragroup propping activities, which may harm the interests of minority shareholders of member firms from which resources are siphoned off.…”

Family Control and Expropriation at Not‐for‐Profit Organizations: Evidence from Korean Private Universities

“…Johnson, La Porta, Lopez-de-Silanes, and Shleifer (2000) coin the term "tunneling" to describe the actual expropriation activities by controlling families and provide many examples of tunneling around the world. Atanasov (2005), Bae et al (2002), Bae, Baek, Kang and Liu (2012), Baek et al (2004), Baek, Kang, and Lee (2006), Bertrand et al (2002), Cheung, Rau, andStouraitis (2006), andJoh (2003) provide evidence of tunneling using data from Korea, India, Hong Kong, and Bulgaria. One common theme of these papers is that the control-ownership disparity is a good proxy for the risk of expropriation by controlling shareholders and that the disparity measure well captures the extent of actual expropriation, so that high control-ownership disparity is associated with poor firm performance and valuation.…”

“…6. Numerous studies have documented evidence that the disparity between control and cash flow rights by controlling families is associated with greater expropriation risk and thus poor firm performance (Atanasov, 2005;Bae et al, 2002Bae et al, , 2012Baek et al, 2004Baek et al, , 2006Bertrand et al, 2002;Cheung et al, 2006;Claessens et al, 2000Claessens et al, , 2002Joh, 2003;La Porta et al, 2002;Lemmon & Lins, 2003;Mitton, 2002). 7.…”