The Effect of Internal Capital Markets on Corporate Investment: Evidence from the Asian Financial Crisis

Abstract

This paper provides new evidence on the relationship between internal capital markets and corporate investment by exploiting an exogenous event and an unique empirical setting. Specifically, we compare the changes in investment of Korean business group (e.g., chaebol) firms with non-chaebol Korean firms in the aftermath of the 1997 Asian financial crisis. Korean chaebol provide a unique setting for the study of internal capital markets, since they comprise a large number of legally independent firms in several different industries, which are ultimately controlled by a family owner. Our empirical methodology employs a difference-in-differences matching estimator to ensure that chaebol firms (those in the treated group) and non-chaebol firms (those in the control group) are as similar as possible in all observable dimensions other than chaebol membership. The results shown that chaebol firms invest significantly more than non-chaebol firms in the aftermath of the crisis. This difference in investment behavior is specific to the Asian crisis period and does not hold for other, normal periods. In addition, we show that chaebol firm post-crisis investment is positively associated with variables that proxy for the availability of internal capital markets, including industry diversification within a chaebol and chaebol liquidity. The greater post-crisis investment of cheabol firms is not associated with postcrisis declines in profitability. Overall, our results suggest that Korean Chaebol were able to use their internal capital markets to mitigate the negative effects of the Asian crisis on corporate investment.