Does the agency problem exist in Korean banking industry?

Abstract

In this paper, we empirically examine whether the agency problem exists in Korean banking industry. Banking industry may be a very special type of industry where government regulations are prevailing and market discipline may function less effectively than in other industries. Investors and even bankers themselves may believe that regulators will not let them fail because it can cause much bigger damage to the economy especially when banking regulations are very loose. Therefore investors would not have great incentives to monitor the behavior of banks, and bank managers could pursue riskier strategies than the firms in other industries do without worrying about the possible loss of their jobs due to the bad performance and reputation of their management. But when regulations are very tight bank managers would realize that closing down and bankruptcy of the bank is not hard to occur, and therefore, they would act in a more conservative and risk aversive manner, which is the case where the agency problem arises. From the analysis of the panel data, we find consistent evidences that the agency problem does not appear to exist in Korean banking industry before 1998 period, when regulations are very loose, which is consistent with our presumption. We find positive associations between the level of outside share ownership and risk-taking for the period of pre-1998. But this association becomes weaker for the post-regulation period 1998-2005. As the regulations become tighter, agency problem becomes bigger which will be the loss, anyway, of firm‟s cash flow, while the regulations may have some effectiveness in bringing more safety of the industry. Thus, regulators and the firms in financial industry need to develop better systems to minimize the costs associated with agency problem when making regulatory reforms.