Institutions & Long term Performance of diversification: chaebols in Korea Keun Lee School of Economics Seoul National University Co-authors: Keonbeom Lee (Korea Institute of Finance) and Mike Peng (Ohio State University)
A diversification puzzle Diversification discount: Developed economies Diversification premium: Emerging economies Diversification discount in emerging economies: A number of more recent studies Puzzle: Is diversification premium found in emerging economies likely to hold over time? Institutional transitions in South Korea (1984-96)
An institution-based theory Unrelated product diversification (conglomeration) strategy is driven at least in part by institutional frameworks (Guillen 2000; Khanna & Palepu 1997; Kogut et al. 2002; Peng 2003; Wan & Hoskisson 2003) H1: During a period when external capital, product, and labor markets are less transparent, open, and competitive, there is a diversification premium
Extending the theory Institutional transitions call for strategic changes H2: When external markets are more transparent, open, and competitive, there is a reduction in diversification premium over time H3 (a stronger form of H2): When (1) external markets are better developed and (2) organi-zational size and complexity are on the rise, there is a diversification discount over time
Methodology: “Chop shop” method Estimating the value of a conglomerate by “chopping” it up via an examination of the value of divisions relative to the value of stand-alone firms competing with these divisions Value of the firm = sum of the values of the divisions Excess value of the firm = difference betw. the actual and the imputed value. The imputed value = hypothetical value of a group-affiliated company, assuming that it was operated as a stand-alone business. Eg) value destruction of diversification = a negative excess value.
Methodology : Chop shop First calculate the industry median of value to sales ratio (value to EBIT ratio) for the stand-alone companies in each industry. (firm value = sum of the market value of equity and the book value of debt) Imputed value of a group-affiliated company = multiplying this median (or mean) ratio to the actual sales revenues or EBIT. Imputed value: Use the two alternative variables: sales revenues and earnings-before-income taxes (hereafter EBIT).
Methodology : regressions 1 Regressions to check: The value premium, due to other firm-specific characteristics than the group-induced diversification. Excess Value = A0 + A1 * Group dummy + A2*time + A3*time*group dummy + A4 * Log (Sales) + A5 * (EBIT/ Sales) + A6 * (Capital Expenditure/Sales) + A7*(debt/equity) + A8*firm age + error term Tried other measure of diversification: 1) no. of the member firms 2) Entropy indext of diversification
Methodology : regressions 2 To identify the impact of particular institutional transitions In regressions, to Add: β1 * Group dummy + β2 * Institutional variables + β3 * Institutional variables * group dummy
Findings 1984-96: 84 chaebol groups and 751 firms (305 group affiliated firms and 446 independent firms H1: Supported (Overall there is premium during the entire 1984-96 period) H2 and H3: Supported (Diversification premium gradually drops, and then replaced by diversification discount during 1994-96) Robustness checks based on three measures of diversification are supportive Premium decline can be linked to institutional transitions in capital, product, and labor markets
Discussion Theoretically, longitudinally extending the institution-based theory of corporate diversification: Premium does not hold over time, even in emerging economies Empirically, first study to document both premium and discount in emerging economies Practically, re-evaluate the claim that conglomeration is “good” for firms in emerging economies In conclusion: Institutions matter, and institutional transitions matter a great deal for diversification strategies
Future directions Probe into related vs. unrelated diversification