Business Group Affiliation, Ownership Structure, and the Cost of Debt

Abstract

This paper examines the relation between business group affiliation and the cost of debt capital. The co-insurance effect associated with business groups can reduce the cost of debt, while the expropriation by controlling shareholders can raise the cost of debt. We find that firms affiliated with major Korean business groups (i.e., chaebols) enjoy a substantially lower cost of public debt than do independent firms, consistent with the co-insurance argument. We also find that the effect of group affiliation on the cost of debt is stronger for firms with poor credit quality and with opaque financial statements, and when the economy is in downturns. These findings are consistent with the notion that the value of co-insurance increases with the uncertainty about the future payoffs of debtholders. Our study highlights that the role of business groups is distinct from and incremental to the role of ownership structure in the debt market.