1. 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)

2. 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 ( )

3. 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

4. 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

5. 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.

6. 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).

7. 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

8. 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

9. Findings
: 84 chaebol groups and 751 firms (305 group affiliated firms and 446 independent firms
H1: Supported (Overall there is premium during the entire period)
H2 and H3: Supported (Diversification premium gradually drops, and then replaced by diversification discount during )
Robustness checks based on three measures of diversification are supportive
Premium decline can be linked to institutional transitions in capital, product, and labor markets

10. 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

11. Future directions
Probe into related vs. unrelated diversification