A Flight to Q?: Firm Investment and Financing in Korea Before and After the 1997 Financial Crisis

Abstract

We examine investment behavior among exchange-listed Korean manufacturing firms before and after the 1997 financial crisis using firm-level panel data. We start with the standard Q-theory of investment, and then augment it by allowing for a sales accelerator and the possibility of cash constraints, categorizing firms based on their age, size and affiliation to the industrial conglomerates (i.e., chaebols). We find that Tobin's Q is a key and robust determinant of firm-level investment in a pooled sample for the period from 1992 to 2001, but that it became more important for small firms and less important for chaebol-affiliated firms after the crisis. Investment by chaebol firms also became more sensitive to the availability of internal cash balances after the crisis. We interpret this as reflecting a shift in the Korean economy to a stronger market orientation after the crisis and to a business climate in which the quality of potential projects became more important relative to capital market imperfections in determining the destination of investment funds.