Trade credits are offered by suppliers in the form of allowances for buyers to postpone their payments. Trade credits are non-market-based bilateral debt contracts between buyers and sellers, and these contracts incur higher costs of debt than market-based short-term financing sources such as bank financing and commercial paper. Trade credit financing is generally assumed to be more expensive than bank financing, as trade credit is commonly requested by credit-constrained borrowing firms. Another prevailing assumption is that reliance on trade credit financing tends to increase with the degree of credit rationing on financially constrained firms following adverse macroeconomic shocks. In the fields of corporate finance and financial intermediation, the question of how firms choose their financing sources has become increasingly important for researchers. Clearly, different sources involve different kinds of risk, and choices are made under conditions of information asymmetry in financial markets. In line with traditional research in this area, this paper examines how firms conduct trade credit financing in response to both macroeconomic and microeconomic factors, and it tests the substitutability and complementarity of bank financing and trade credit financing. The existing literature on trade credit financing suggests two main views on trade credit channels, namely the “substitution view” and the “complementarity view.” The substitution view posits that trade credit is a substitute for market-based, short-term financing sources such as bank revolving lines or commercial paper. Reliance on trade credit is more likely when the borrowing firms are constrained in their access to these market-based, short-term financing sources. Under such constraints, firms commonly turn to substitute sources of financing, such as trade credit. In this sense, trade credit and market-based financing are substitutes, and we can expect that trade credits will be more commonly used by firms under financial distress or in times of economic shocks, e.g., financial crises. The complementarity view holds in situations where the supply of trade credit and the access to bank financing or capital market funding are linked. When financial intermediaries are more effective in screening and monitoring the borrowing firms, financial intermediaries can provide financing directly to firms operating in capital markets. However, when the suppliers are more efficient in screening and monitoring, or in enforcing debt contracts, it may be optimal for these financial intermediaries to offer financing to the suppliers, who then relend to the purchasing firms. Such efficiency may arise if the suppliers have proprietary information about the purchasing firms, if they can threaten to suspend future deliveries, or if their opportunity costs for any repossessed inventory are higher than the costs of financial intermediaries. In some sense, non-financial suppliers act as “agents” for financial intermediaries. The main question raised in this paper is why financially vulnerable firms rely more on trade credit financing, even when seemingly cheaper sources of financing (such as bank revolving lines and commercial paper) are available in the short-term debt markets. In particular, our paper investigates how financial vulnerabilities and macroeconomic shocks operate in both separate and combined ways to affect firms’ choices for trade credit financing. This paper uses CP spread as a measure of credit crunches in short-term debt markets. In addition, the 2008~2009 global financial crisis is used as a natural event study factor, which represents an example of an extreme macroeconomic shock to both domestic and overseas financial markets. The effects of both CP spreads and macroeconomic shocks on trade credit financing are estimated. The empirical results show that adverse macroeconomic shocks increase trade credit financing, which is measured by accounts payable relative to sales. These results imply that trade credit financing may offset the contraction of bank financing, which can be triggered by adverse macroeconomic shocks and credit crunches in the Korean economy. In other words, trade credit financing can function as a financing instrument that can absorb macroeconomic shocks, thereby serving to maintain business operations and enable the management of working capital. Our paper also examines the effects of various firm-level financial vulnerabilities on trade credit financing. Following previous studies, we consider financial vulnerability factors, including the Whited-Wu index and the dividend payout ratio, both of which indicate the degrees of financial constraint. We also consider the modified Altman Z score and the default likelihood Indicator, both of which indicate the degree of financial distress. The empirical results show that financial vulnerability factors increase firms’ reliance on trade credit financing. Overall, our paper’s findings indicate that under conditions of macroeconomics shock, financially vulnerable borrowing firms are inclined to increase their reliance on trade credit financing. This evidence supports the hypothesis that trade credit financing serves as an alternative source of short-term corporate debt financing for financially vulnerable firms that are facing credit crunches. Our results suggest that trade credit financing plays a key role in helping firms to flexibly maintain their business operations and manage working capital under conditions of financial constraint or distress, such as those following macroeconomic shocks. Moreover, this paper provides evidence that the interactive effects of macroeconomic shocks and financial vulnerabilities tend to stimulate trade credit borrowing (i.e., accounts payable relative to sales). This pattern implies that firms are commonly forced into reliance on trade credit financing when adverse macroeconomic circumstances render them financially vulnerable.

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We examine the effects of a fund manager replacement on fund performance, risk, and money flows using data from January 2004 to March 2015. We define a fund as either a positive performance (PP) fund or a negative performance (NP) fund depending on whether it belongs to the upper 50% or lower 50% based on its performance in the previous year. We then compare the effects of manager replacement between the two groups. First, we find that the performance of an NP fund improves after the fund manager replacement, while that of a PP fund decreases. This phenomenon becomes more pronounced for the +2 year period compared with the +1 year period. This result implies that while it is feasible to find a qualified manager to replace a manager whose performance is below average, it is difficult to find a better manager to replace one whose performance is above average. Therefore, manager replacement can be a positive event for investors in an NP fund and a negative event for investors in a PP fund. However, investors should understand that it takes some time for fund performance to change, as the fund performance of a PP fund remains better than that of an NP fund for +1 year after the manager replacement. The improved performance of the NP fund and decreased performance of the PP fund become significant from the +2 year period after the fund manager replacement. Second, the risk level of the NP fund decreases after the manager replacement, whereas that of the PP fund remains virtually the same. We find that both the standard deviation of excess return and the one factor beta of the NP fund are higher than those of the PP fund for the -1 year period. We conjecture that this is because poorly performing fund managers take more risks to recover their inferior performance. This result is consistent with the U.S. market findings of Brown et al. (1996). The risk level of the NP fund decreases significantly after the fund manager replacement, whereas no significant change occurs for the PP fund. Third, we find a significant change in the style of the fund that survives more than two years after the manager replacement, with the fund manager replacement slowly contributing to the fund style change. Comparing the styles before and after the manager replacement, we find that the PP fund has a higher coefficient for the SMB and PR1YR factors and a lower coefficient for the HML factor. This implies that PP fund managers prefer small and medium-sized stocks, growth, and momentum. The meaningful style change is not found for the +1 year period for either the PP fund or NP fund, as it may require some time to change the fund portfolios and style. However, for the +2 year period, we find a significant style change for the NP fund; its negative SMB coefficient increases and its negative HML coefficient decreases, which means the proportion of large and value stocks increases in its portfolio. Fourth, after controlling for the various factors that may affect the fund money flows, we find no significant change in the new money flows before and after the fund manager replacement. We find that the money flows for both the NP and PP funds are negative for the +1 year period, although statistically significant so only for the NP fund. We use a number of control variables to check whether the inferior fund performance or the fund manager replacement causes the negative money flow for the NP fund. We use past performance, the excess return standard deviation, turnover, fund size, and management fee as control variables and run the regression on the new money flow for the fund manager replacement. Our regression results show that the fund manager replacement has no significant effect on the fund money flows. This indicates that important information such as the fund manager replacement is not delivered efficiently to fund investors in the Korean market. Therefore, we recommend that fund management companies and regulatory agencies establish practical methods to promptly deliver crucial information such as fund manager replacements to fund investors to protect the investors’ rights. This study is the first to examine the effects of fund manager replacement on fund performance and risk in the Korean market. However, fund manager research in Korea carries some limitations. We collect the fund manager replacement data from fund rating companies since 2004; therefore, the study period is rather short and can be period dependent. Furthermore, many fund management companies do not specify the name or responsible fund manager, but instead use the chief investment officer’s name or multiple manager names to identify the head manager of a fund. We hope future research on this topic will resolve the limits of our study and deliver further findings on the effect of fund manager replacement on fund performance.

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In this study, we investigate the determinants of credit ratings for companies affiliated with the Korean Chaebols. After controlling for endogeneity, we find that the average credit ratings for Chaebol-affiliated firms are significantly higher than those of non-Chaebol-affiliated firms. Next, we estimate the critical control threshold centrality and position established by Almedia et al. (2011) and apply those measures to the credit ratings of affiliated firms. The results show that affiliated firms with lower centrality measures tend to have higher credit ratings and that the relationship is not linear, suggesting that controlling shareholders use central firms to provide firms that have lower centrality with operational and financial support, that is, propping. Firms with lower centrality have higher credit ratings during a group-wide boom. This suggests that propping is more likely to emerge during an economic boom.

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Starting with the capital asset pricing model (CAPM), a variety of systematic risk factors have been suggested. The performance of equity funds investing primarily in equities is evaluated using these risk factors and serves as the basis for judging a fund manager’s ability. Jensen (1968) evaluates fund performance using the CAPM; Carhart (1997) relies on a four-factor model that includes Fama and French’s (1993) three factors and Jegadeesh and Titman’s (1993) momentum factor; Pastor and Stambaugh (2002a, 2002b) include industry factors; and Barber, Huang, and Odean (2016) include Fama and French’s (2015) profitability and investment factors. As more systematic risk factors are considered, fund performance can be evaluated more precisely, and the systematic risk factor explaining the fund’s abnormal returns can be found. However, Barber, Huang, and Odean (2016) demonstrate that fund investors are most sensitive to CAPM alpha and that more sophisticated investors use more systematic risk factors to assess fund performance. In other words, sophisticated investors may be aware that equity funds are not likely to have abnormal returns in excess of their benchmark returns. Based on Barber, Huang, and Odean (2016), this study reassesses equity fund performance using more information about the fund’s market excess returns, which are most easily accessible to fund investors. This approach enables us to indirectly evaluate fund performance from the perspective of sophisticated investors and identify risk factors that explain the market excess returns of equity funds. Fama and French (2010) argue that the cross-sectional average alpha of U.S. mutual funds is close to zero, while only very extreme performance groups have a significant alpha. Thus, extreme performance is due to luck, not the fund manager’s skill. This study attempts to identify the systematic risk factors that explain extreme performance using market excess return distribution. It examines whether the significance of fund performance changes when more systematic risk factors are used. When equity funds do not earn higher returns than the benchmark returns, performance changes insignificantly and idiosyncratic risk explains the extreme performance when more systematic risk factors are considered. For example, when Fama and French’s (1993) three factors completely explain the performance of a fund with significant market excess returns during the analysis period, a fund investor who evaluates performance using the three-factor model judges the fund managers as having no skill. In addition, fund managers use a widely known strategy in the market rather than adopting various investment strategies. In other words, style investing strategies that do not rely on the three factors do not exceed the market returns on average. This study uses the CAPM, Fama and French’s (1993) three-factor model, and Fama and French’s (2015) five-factor model. This study investigates the effects of idiosyncratic risk on fund performance. Highperforming funds with high idiosyncratic risk are overestimated when only return data are used. Therefore, this study reevaluates the performance using Bayesian inference, which considers the idiosyncratic risk. The Bayesian inference is measured by the weighted average of the actual return data and the prior distribution. The effect of the prior distribution is stronger when the idiosyncratic risk of the actual returns is high. I examine the Bayesian alpha rank of the market excess return groups to see whether a change in performance rank occurs. The absolute value of the Bayesian alpha decreases compared with the OLS alpha due to the effect of prior distribution, but the performance rank does not change if the fund alpha is due to the fund manager’s ability, as all of the funds have the same prior distribution. However, funds with a high idiosyncratic risk have a significant effect on prior distribution, leading to a significant change in performance rank. I use Jones and Shanken’s (2005) Bayesian inference method, which includes the information that the cross-sectional average alpha of the fund is zero. This study identifies several results. First, the average abnormal returns of both the net and gross returns are zero, and the distribution of the returns is close to normal. Second, although performance is ranked according to the market excess returns, only the top 1% (top 4%) of the funds in net returns (gross returns) indicates significant performance. This result indicates that during the analysis period, fund returns are mostly explained by market returns, and extreme returns are due to idiosyncratic risk. Third, the three-factor model completely explains the extremely high returns. Thus, fund managers increase systematic risks (three factors), which are well known in the market. In other words, style investing strategies other than the three factors do not exceed market returns on average during the analysis period. Fourth, the performance rank of the high-performing funds with high idiosyncratic risk changes drastically when Bayesian inference is used. In particular, the effect of Bayesian inference is stronger in the boom market periods, which have a high idiosyncratic risk. Thus, a fund manager’s skill does not result in extreme performance. These findings are empirical and based on fund managers, fund investors, and the development of the fund industry. Although investors’ interest in equity funds weakened after the global financial crisis, the exchange traded fund (ETF) market is growing rapidly. The ETF market is expected to pursue various investment styles while following the market returns with low fund fees.

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Given the wide variety of equity funds in the public offering market, fund investors find it difficult to select funds that match their investment preferences. Therefore, equity fund investors pay greater attention to funds that are recommended by sales professionals from banks or securities companies. They rely on brokers’ recommendations when selecting equity funds instead of conducting rigorous analysis. Therefore, brokers’ fund recommendations carry great importance from the perspective of investor protection. However, due to the limitations of data collection, research on this topic has not yet been conducted in Korea. Analysis of fund recommendations would have valuable implications for investor protection. Studies of equity funds have paid much attention to overall fund performance, fee structures, or the role of fund distributors (e.g., Won, 2009; Kim, 2011; Kho and Baek, 2013). However, although performance analysis of fund recommendations is important, research has paid little attention to the topic. To the best of our knowledge, no study has considered the real performance of recommended funds in Korea, as fund brokers do not voluntarily disclose data related to fund sales or the return performance of recommended funds. As each broker sells tens of funds, it is difficult to estimate the return performance of the funds of each broker. However, fund evaluation companies have recently begun to build data on funds recommended by each vendor, so analysis of the performance of recommended funds is possible. We empirically analyze the determinants of brokers’ fund recommendations and the performance of recommended funds in two ways. First, we analyze the factors that determine brokers’ fund recommendation decisions. Second, we analyze the future performance of the recommended funds. To confirm our findings, we use propensity score matching to compare the performances by matching recommended and non-recommended funds with similar characteristics. To investigate possible conflicts of interest in the fund recommendations, we focus on the levels of fees and commissions and the relationships between brokers and fund managers. We pay attention to the possibility that the seller, in recommending a fund to a customer, acts on behalf of the seller or affiliated fund manager rather than prioritizing the customer’s benefit. The results of this study are as follows. Funds with front-end loads and/or funds of asset management firms with no affiliated brokerage companies are more likely to receive recommendations from brokers. Furthermore, funds of large asset management companies receive more recommendations than those of medium or small management companies. In addition, new funds with short operating periods are selected as recommended funds, and new funds from affiliate management firms are more likely to be recommended. The performance of those recommended funds turns out to be inferior. Based on the results of analysis of the profitability of broker-recommended funds, we find that recommended funds do not perform better than funds that are not recommended by brokers. This result does not support the general perception that brokers have fund-selection ability. However, no evidence supports the view that the inferior performance of broker-recommended funds is caused by the self-interest of the broker who pursues the profit of a subsidiary asset management company. Recommended funds of affiliated asset management companies record better performance than those of non-affiliated companies. In particular, when the seller recommends a newly launched fund of the affiliated management company, its return performance is better. Thus, we conjecture that the inferior performance of a recommended fund is not due to the broker’s intention to subsidize an affiliated asset management company. This result suggests that a broker, through an information transfer from affiliated fund managers, plays a role in mitigating the information asymmetry of newly launched funds. It also supports the view that the affiliate broker analyzes the newly launched fund more accurately. Our study shows that broker-recommended funds generally exhibit inferior return performance. This result suggests that fund sellers are required to improve their fund selection ability to enhance the protection of fund investors. Sellers must improve their fund analysis capabilities through internal research and workforce reinforcement. Our study has some limitations in the sense that it covers a relatively short period due to the insufficient accumulation of fund recommendation data. Further research should be conducted to review the robustness of the analytical results over a wider analysis period after equity fund data are accumulated more broadly.

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Until recently, the loan portfolios of savings banks in Korea have tended to concentrate on project financing with higher risks than the conventional loan portfolios of commercial banks. However, these concentrated loan portfolios and other disruptive behaviors led to massive bankruptcies among savings banks in 2011. In the past, many savings banks have experienced a similar bankruptcy process, largely due to the expansion of saving banks’ assets through mergers, high risk project financing loan projects, the illegal acts of large shareholders and executives, and the increasing loan concentration of high risk lenders. In particular, the concentration of real estate-related loans became a major management risk factor for savings banks in the 2000s, particularly in the deteriorating operating environment caused by the collapse of the real estate market after the global financial crisis. Furthermore, saving banks’ dependence on high-risk loans, such as project finance loans and unsecured personal loans, has intensified in recent years. This is a major factor in the failure of Korean savings banks in the event of external economic shocks. However, due to the limited data collection issue, only a few empirical studies have considered the relationship between the loan concentration ratio of savings banks and bank insolvency. The backdrop to the 2011 insolvency crisis of the savings banks is their large-scale growth and organizational change into a business group, which progressed rapidly up until 2010. Although mergers between savings banks were limited before December 2005, savings banks were already experiencing financial distress at that time due to the household credit crisis in 2003. The number of large savings banks with an asset size of over 1 trillion Korean won increased from 6 in June 2005 to 29 by the end of 2010. As of June 2010, 31 subsidiaries had been opened by 11 savings bank groups. The expansion and integration of these savings banks led to aggressive top-line expansion strategies, including high-risk lending operations and expansions. Over the 2011 to 2017 period, the average total assets of savings banks declined between 2011 and mid-2014 due to the failure of 31 savings banks after 2011, but the assets of the remaining savings banks rapidly increased after 2014. Research on savings bank credit concentration has been limited due to the lack of data, and most recent studies have analyzed only commercial banks or specific types of loans. Beck and Jonghe (2013) described the positive effects of loan concentration on commercial banks. The authors argued that commercial banks accumulate sufficient knowledge and experience in the field by focusing on loans to specific sectors over many years. This suggests that banks improve their ability to inspect and supervise loans and can reduce potential risks by identifying and addressing credit-related issues in a timely manner. Tabak, Fazio, and Cajueiro (2011) also argued that the concentration of lending to specific sectors in Brazilian banks shows that banks can enhance supervision, increase expertise in those areas, and lower bank risk while improving profitability. In this paper, we empirically examine the impact of concentrated loan portfolios on bank failures using the methodology of logistic regression. Our analysis shows that for saving banks the more concentrated the loan portfolio and the larger the number of mega loans (i.e., loans above 1 billion won), the higher the likelihood of failure. We also find that the more loans to relatively high risk borrowers and to borrowers with lower credit ratings in both the corporate and household sectors, including project financing and unsecured personal loans, the higher the probability of failure. However, mortgages with relatively good collateral turn out to have a significant negative relationship with savings bank insolvency.

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Shareholder activism in public pension funds, asset management firms, and foreign hedge funds have led to an increasing number of calls for dividend payouts, so listed firms on the Korean Stock Exchange should urgently prepare an optimal dividend policy for raising corporate value in the mid- to long-term. However, developing such a policy has not previously been discussed or analyzed. In this study a method of deriving the optimal dividend policy of a firm to maximize its value is suggested. Based on the arguments (Fama and Babiak, 1968; Marsh and Merton, 1987; Lee, 1996, etc.) that cash dividends rely on permanent earnings and on the empirical findings (Fama and French, 1998; Pinkowitz, Stulz, and Williamson, 2006 and etc.) that cash dividends contribute to an increase in corporate value, the effect of cash dividends, which are driven by the permanence of earnings, on corporate values is analyzed. In the Beveridge-Nelson method earnings are divided into permanent and temporary earnings. Empirical results show that as the proportion of cash dividend relative to permanent earnings increases, corporate value increases significantly. Second, it is possible to derive the optimal level of dividend for a company, as the proportion of cash dividend relative to the permanent earnings is nonlinear and takes a reverse U form. Specifically, we find that corporate value increases with the cash dividend proportion of permanent earnings up to the point of 41.47%, and it decreases as the percentage increases beyond this point. These results imply that domestic firms must realize their optimal dividend policy by considering the persistence of earnings, and that institutional investors need to monitor whether a firm’s dividend policy at a micro level is aimed at achieving its optimal dividend level, which can maximize its shareholder value.

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A stop-loss strategy is an investment strategy that automatically sells a stock that is suffering a loss when its price reaches a stop price. It is well known that investors actively use these strategies to protect against downward risk in the face of (ultra-) short-term volatility and drastically dropping stock prices. Since a stop-loss strategy uses algorithms to determine when the stock should be sold, investors do not have to follow the market constantly. Therefore, investors can control their behavioral biases and prevent losses in advance, and in practice this strategy is generally known to be useful in improving returns on investment. However, according to Kaminski and Lo (2014), the stop-loss strategy has different effects depending on the return-generating process the stocks follow. If stock returns follow a momentum or a regime-switching process, then a stop-loss strategy can increase portfolio profits and/or reduce volatility. However, if they follow a random-walk or a mean-reverting process, then a stop-loss strategy can lower portfolio profits. This paper analyzes the performance and effectiveness of stop-loss strategies in the Korean stock market by analyzing a general stop-loss strategy and a specific stop-loss strategy. For the general stop-loss strategy, we use the one studied by Lei and Li (2009). For the specific stop-loss strategy, we use the Active Risk-Management Phase 3 of the Korea National Pension Service (NPS). We analyze the effects of the general stop-loss strategy on the stocks listed on the KOSPI and KOSDAQ markets from July 1996 to June 2016. We use block bootstrapping to compare the performances of the stop-loss strategy to the buy-hold strategy, and calculate the efficiency of the stop-loss strategy by calculating the stop-loss premium. To analyze the specific stop-loss strategy embedded in the NPS’s Active Risk-Management Phase 3, we analyze the NPS’s investment universe from January 2011 to December 2017. We compute the cumulative rate of returns after the entry of the Active Risk-Management Phase 3 under an algorithm simulation. Ever since the 2008 global financial crisis, the Korean stock market, like other leading global markets, has experienced ultra-short-term volatility and sudden liquidity droughts in the absence of any material news. Stop-loss orders are a basic risk-management tool under these circumstances. Despite these structural market conditions, the Korea Exchange (KRX) does not offer stop orders or stop-loss orders to investors. Therefore, it is important to determine whether stop-loss strategies can help control the downside risk to investors. This study also addresses how the interaction between the structural conditions of the Korean stock market and the implementation of mandatory stock trading under the risk-management rules affect the investment strategy of the NPS, which is a timely and important topic. The results of our analyses are as follows. First, in terms of performance, we cannot confirm that a general stop-loss strategy is statistically superior to a buy-hold strategy, or vice versa. However, in terms of risk management, a general stop-loss strategy is more effective at reducing volatility than a buy-hold strategy. Second, 75% of the stocks that enter Phase 1 exit and return to a normal status within fourteen trading days. Phase 1 only involves enhanced monitoring of the stock, and stop-loss orders are not applied to these. When a stock enters Phase 2, a report is generated, but no specific action is mandated. Once a stock enters Phase 3, NPS is mandated to consider placing a stop-loss order. We find that in Phase 2 it is beneficial to observe whether the stock return becomes positive or remains stable over the ensuing 2~3 months (60 trading days) or 4~5 months (120 trading days). If the return continues to be positive or stable, NPS should continue to hold the stock and not place a stop-loss order. However, if the return remains negative in Phase 2, it is desirable to sell the stock without waiting for it to enter Phase 3. If a stock enters Phase 3 and NPS still holds it, it is desirable to sell the stock and to invest the sales proceeds in safe assets, and then repurchase the stock if and when it meets the re-entry threshold. Third, as the cumulative return after entering Phase 3 is often negative for up to 240 trading days, the stop-loss strategy does not seem to hurt returns by realizing transitory losses. Any possible increase in volatility, which results from the introduction of static VI or the increase of the price limit, does not appear to adversely affect the stop-loss strategy. Fourth, we find that the general stop-loss strategy in the Korean stock market does not improve performance. However, in the case of active risk management of NPS, it is desirable to sell the stocks prior to or on entering Phase 3. The difference between the two results appears to be largely due to the differences of the specific parameters of the stop-loss strategies. In the end, the effectiveness of stop-loss strategies critically depends on matching the parameters of the strategy to the conditions in the Korean stock market.

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Since the Korean currency crisis of 1997, Korean firms have followed the compensation system used in the U.S. With this shift, pay for executives has risen sharply and the pay multiple has increased. We investigate the effect of this increased pay multiple on the overall operating and stock performance of Korean firms. Our data comprise 15,438 firm-year observations in 1,745 non-financial firms listed on two Korean stock markets from 2004 to 2016. Researchers in the field of human resource management find that relative pay has greater relevance than absolute pay in shaping the behaviors or attitudes of lower-level employees. Accordingly, we conjecture that enlarged pay multiples have a negative effect on Korean firms, as Korea has a relatively more egalitarian culture and a less elaborate evaluation system. In addition, relative deprivation theory posits that employees feel deprived when they perceive that their executives are overpaid. Employees may accept that high pay for an executive is deserved if that executive has high managerial ability. However, the employees may feel that executives with low managerial ability are paid too much. We therefore estimate the managerial ability of executives by adopting the method suggested by Demerjian, Lev, and McVay (2012), and we divide our sample firms into high and low managerial ability groups. We hypothesize that the effects of pay multiple on firm performance differ according to whether the firms have high or low managerial ability. Our empirical results are as follows. First, pay multiple negatively affects the overall operating and stock performance of most Korean firms. This finding implies that most employees think their executives’ pay is unjustifiably high, and it should be reduced. This sentiment seems to support relative deprivation theory. Second, the negative impact of pay multiple occurs only in the low managerial ability group. In the high managerial ability group, increased pay multiples have a positive effect. This finding indicates that employees in firms with low-ability managers feel deprived because of their executives’ excessive pay, whereas employees in firms with high-ability managers accept that their executives’ increased levels of pay are deserved. Third, the squared terms of pay multiple have negative coefficients. In other words, the negative effect of pay multiple becomes greater as pay multiple increases in the low managerial ability group. Meanwhile, this result indicates that the positive effect of pay multiple changes negatively as pay multiple increases in the high managerial ability group. In quintile analyses, we confirm that this non-linearity applies for both high and low managerial ability groups. In general, the negative effect becomes greater for each higher quintile of pay multiple in the low managerial ability group. We find that there is an inverted U-shaped relationship between pay multiple and firm performance in the high managerial ability group, which implies the existence of the optimal pay multiple. Fourth, we use an instrumental variable to check for potential endogeneity due to reverse causality between pay multiples and firm performances. Our empirical results are robustly confirmed. Finally, we further analyze various sub-samples of manufacturing and non-manufacturing firms, chaebol and non-chaebol firms, and Korea Stock Exchange (KSE) as compared to KOSDAQ firms. We obtain consistent results for all of the subsamples. In summary, we show that pay multiple has a negative effect on firm performance. However, this negative effect only occurs in low managerial ability firms, where the negative impact becomes more significant as the pay multiple grows larger. These findings are consistent with relative deprivation theory. This paper examines executive-employee pay multiples, rather than pay gaps among executives or employees. By linking the pay multiple to firm performance, we show that it is important to adopt a pay structure that includes both executives and employees. Furthermore, we contribute meaningful evidence concerning relative deprivation theory by analyzing how managerial ability is related to the relationship between pay multiple and firm performance. Our findings indicate that to enhance firm performance, executive pay structures need to reflect managerial ability.

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In this paper, I analyze household portfolios with and without household debts, each of which is supposedly subject to distinct financial target according to household characteristics and financial status, respectively. Four issues were identified through the 2011~2013 Household Financial Survey. First, households with debts have more financial assets in addition to real assets than those without debts, which include stocks, bonds, insurance, and mutual funds. Households with debts also own more real estate and durables such as automobiles and real assets, which is statistically significant. This result implies that households with debts invest aggressively in asset allocation and in specific assets, unlike those without debts. Second, disposable income is a main interest variable and reduces the share of financial assets at a low level but increases the share at a high level, irrespective of household debts. In contrast, At a low level, the net worth increases real assets, whereas it decreases at a high level. Thus, we conclude that households tend to diversify the portfolio risk of real assets through financial markets. Third, as previously found, household debts reduce household financial assets but reinforce the holdings of real assets, which is also prevalent in the sample of households with excessive debts. Finally, in terms of generations, middle-aged and older households with debts are more likely to prefer stocks, and significantly more likely than younger households.

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