Recent global financial crisis has raised some critical questions about the current status of the financial system, including management of systemic risk at both macro and micro level, integrity of the financially regulatory regime, and the overall quality and mechanism of financial infrastructures. Among many other salient issues especially for the academia in the analysis of the cause of the crisis, the asymmetry in an incentive compensation system within the financial industry in particular has been singled out as one of the serious issues to be addressed because the asymmetry in incentive compensation only creates incentives for risk-taking while it fails to penalize financial managers when bets turn sour. Raghuram Rajan (2008) refers to this risk-taking incentive as “It’s heads I win, tails you lose.” However, the incentive for risk-taking can account for only a necessary condition for a financial crisis, not a sufficient condition. Even risky investments, as long as they are diversified, for example, can hardly make financial markets unstable. In fact, it seems more likely to take the combination of investors’ both incentives to take excessive risky investments and herding behavior to ignite a financial crisis. This paper, therefore, theoretically investigates the effect of the asymmetry in incentive compensation for fund managers on their herding behavior in investment, based on the canonical model of Bikhchandani, Hirshleifer and Welch (1992, hereafter abbreviated as BHW). Without a rigorous examination, indeed, it is very difficult to accurately assess the effect as to whether it is positive or negative. For example, if fund managers sufficiently take into account their predecessors’ activities in their decisions, they are likely to discount the informational value of those activities and the possibility of information cascade will be, therefore, lower. On the contrary, if the effect of the incentives for individual fund managers to take risky investments is greater than that of the depreciation of the informational value of the predecessors’ investment activities, the asymmetry in incentive compensation can precipitate the information cascade and herd behavior in investment. Thus, our theoretical model analyzes the effect of asymmetry in incentive compensation for fund managers on their herding behavior by introducing asymmetric costs related to investment decision. In other words, these costs could be regarded as the opportunity costs in investment decision. In fact, these costs play key roles in our model; if these costs are assumed to be less than half like in our model, fund managers anticipate higher rates of return than that in the benchmark case by making decision of riskier investment than the market portfolio. This means that the opportunity costs in the model are relatively lower than those in the benchmark case. It is, thus, important to note that if these costs are assumed to be just half, as in a benchmark case, they are the opportunity costs when fund managers make any investment decisions that show the same risk with the market portfolio. All other fundamental assumptions are similar to the BHW (1992). We have shown the following theoretical results. First, with asymmetric incentive compensation in which fund managers’ gains for success are larger than their losses for failure, the fund managers are more likely to be optimistic compared to the case of symmetric incentive compensation. Second, with asymmetric incentive compensation, wrong up-cascades are more likely to occur and less likely to stop, compared with wrong down-cascades. In our model, a wrong cascade is defined as information cascades occurring in the opposite direction of ex-post investment state. On one hand, a wrong up-cascade is a cascade where ex-post investment state is bad while investment decision has been made by individual fund managers. On the other hand, a wrong down-cascade is a cascade where ex-post investment state is good while investment decision has not been made by individual fund managers. Third, with asymmetric incentive compensation, wrong up-cascades start earlier than the case with symmetric incentive compensation does. These theoretical results imply that fund managers are, in fact, likely to hold too optimistic approach to their investment with asymmetric incentive compensation. Our findings further imply that the asymmetry in the incentive compensation scheme may exacerbate wrong cascades and herd behavior in investment, thus causing the financial system to be more unstable. Therefore, it is necessary to consider this asymmetry carefully in designing in order for the fund managers’ incentive compensation scheme to generate desirable effects. Since the recent global financial crisis, regulatory reforms or provisions of best practice of compensation scheme for prudent risk management have been widely discussed at both international and domestic levels. For example, the Financial Stability Board has proposed principles for sound compensation practice and its implementation standards, focusing on governance structure, pay structure and risk alignment, disclosure of compensation scheme, and supervisory issues. The Korean government is also preparing policy measures related to the compensation practice in order to curb risk-taking in financial institutions, which is along the lines with the recommendation of Financial Stability Board. Our findings imply that regulatory authorities should consider more appropriate compensation schemes that reduce this asymmetry such as deferring incentive pay so that it is better linked to long-term performance.

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This paper investigates whether the effect of internal corporate governance on the corporate dividend and investment decisions differs depending on the level of product market competition. Many existing literatures have argued that good internal corporate governance leads to increased dividend for investor protection. However, these arguments appear to have overly generalized the realities of complex process of corporate managerial decision making. As long as the purpose of good corporate governance is to increase firm value by inducing an effective operation of corporate resources, shareholders would want not only to receive higher dividends, but also to allow managers to invest in good projects so as to enhance long-term firm value. This paper, therefore, investigates the managerial decisions on dividend payout and investment, the two most important financial decisions with substitutional characters, and how these decisions are being affected by both the competitive and non-competitive product market environments. As far as we are informed, this is the first paper of its kind which analyzes the impact of interaction between internal corporate governance and product market competition on managerial decisions, especially on the dividend payout and investment decision. In a competitive product market in general, as managers are subject to higher default risks and turnover sensitivity to performance, potential agency problems (e.g., overinvestment) tend to decrease. In this context, we hypothesize that in competitive product markets, shareholders permit managers to reduce dividend and increase investment for the purpose of enhancing firm value. On the other hand, in non-competitive product markets where an overinvestment problem still exists, shareholders are likely to be reluctant to follow managers' investment decisions and may ask for higher level of dividend payment instead. As such, we conjecture that in a competitive product market good internal corporate governance induces managers to expand investment expenditure and reduce dividend, and our claim is well supported by the following existing literatures. In competitive product markets: (i) as managers assume higher default and predatory risk, potential overinvestment problems can be reduced (La Porta et al., 2000); (ii) firms have more incentives to increase their market shares by investing in new products rather than in non-competitive product markets (Fellner, 1951; Scherer, 1980); (iii) managers are more likely to be enticed to maximize the productivity sensitivity to investment by minimizing the cost (Nickell, 1996). In sum, in a competitive product market, good internal corporate governance disciplines the managers to use internal capital more on valuable investment than on dividend payout. On the other hand, in a non-competitive product market, managers are more likely to over-invest, and shareholders are more likely to oppose a manager's investment decision and ask for higher level of dividend. The sample of our paper consists of 581 companies listed on the Korea Stock Exchange for the fiscal years from 2004 to 2008. We have chosen to examine the Korean economy so as to avoid estimation bias by controlling for any noisy effect of other external disciplinary mechanisms. The Korean economy is known for its competitive product markets while external corporate governance components such as managerial labor market and market for corporate control require further improvement. As we are investigating the interaction of product market competition and internal governance, we want to remove any external noise other than the product market competition, and the data from the Korean firms allow us the convenience, providing clearer relationship between external and internal governance. In our empirical test, we investigate how internal corporate governance actually affects dividend policies and investment decision making in both competitive and non-competitive product market environments, using interaction variables between internal corporate governance index and competition dummy variables. Additionally, we divide the samples into two groups of firms: those which belong to business groups (chaebol) and stand-alone firms, while carrying out the same analysis for both groups. As firms in business groups have internal capital market that mitigates financial constraint, they are less exposed to the discipline of product market competition than stand-alone firms are. Therefore, in a competitive product market, only stand-alone firms benefit from good internal corporate governance as a way to increase the investment. The empirical results are as follows: in general, good internal corporate governance leads to higher investment and a lower level of dividend or share repurchase in competitive product markets than in non-competitive industries. On the other hand, in non-competitive product markets where managers' overinvestment problem is not properly controlled, good internal corporate governance leads to a higher level of dividend or share repurchase and less investment expenditure. The results are consistent with our hypothesis. We also check to find out whether these findings are influenced by the financing capability of firms by implementing the same analysis to both categories of sample firms, chaebol or independent firms. In the competitive product market, while chaebol firms with good internal corporate governance do not increase investment expenditure, stand-alone firms with good internal corporate governance significantly increases investment expenditure. The result shows that chaebol firms are not affected by product market competition in their investment decision since they have internal product and capital markets. On the other hanThis paper investigates whether the effect of internal corporate governance on the corporate dividend and investment decisions differs depending on the level of product market competition. Many existing literatures have argued that good internal corporate governance leads to increased dividend for investor protection. However, these arguments appear to have overly generalized the realities of complex process of corporate managerial decision making. As long as the purpose of good corporate governance is to increase firm value by inducing an effective operation of corporate resources, shareholders would want not only to receive higher dividends, but also to allow managers to invest in good projects so as to enhance long-term firm value. This paper, therefore, investigates the managerial decisions on dividend payout and investment, the two most important financial decisions with substitutional characters, and how these decisions are being affected by both the competitive and non-competitive product market environments. As far as we are informed, this is the first paper of its kind which analyzes the impact of interaction between internal corporate governance and product market competition on managerial decisions, especially on the dividend payout and investment decision. In a competitive product market in general, as managers are subject to higher default risks and turnover sensitivity to performance, potential agency problems (e.g., overinvestment) tend to decrease. In this context, we hypothesize that in competitive product markets, shareholders permit managers to reduce dividend and increase investment for the purpose of enhancing firm value. On the other hand, in non-competitive product markets where an overinvestment problem still exists, shareholders are likely to be reluctant to follow managers' investment decisions and may ask for higher level of dividend payment instead. As such, we conjecture that in a competitive product market good internal corporate governance induces managers to expand investment expenditure and reduce dividend, and our claim is well supported by the following existing literatures. In competitive product markets: (i) as managers assume higher default and predatory risk, potential overinvestment problems can be reduced (La Porta et al., 2000); (ii) firms have more incentives to increase their market shares by investing in new products rather than in non-competitive product markets (Fellner, 1951; Scherer, 1980); (iii) managers are more likely to be enticed to maximize the productivity sensitivity to investment by minimizing the cost (Nickell, 1996). In sum, in a competitive product market, good internal corporate governance disciplines the managers to use internal capital more on valuable investment than on dividend payout. On the other hand, in a non-competitive product market, managers are more likely to over-invest, and shareholders are more likely to oppose a manager's investment decision and ask for higher level of dividend. The sample of our paper consists of 581 companies listed on the Korea Stock Exchange for the fiscal years from 2004 to 2008. We have chosen to examine the Korean economy so as to avoid estimation bias by controlling for any noisy effect of other external disciplinary mechanisms. The Korean economy is known for its competitive product markets while external corporate governance components such as managerial labor market and market for corporate control require further improvement. As we are investigating the interaction of product market competition and internal governance, we want to remove any external noise other than the product market competition, and the data from the Korean firms allow us the convenience, providing clearer relationship between external and internal governance. In our empirical test, we investigate how internal corporate governance actually affects dividend policies and investment decision making in both competitive and non-competitive product market environments, using interaction variables between internal corporate governance index and competition dummy variables. Additionally, we divide the samples into two groups of firms: those which belong to business groups (chaebol) and stand-alone firms, while carrying out the same analysis for both groups. As firms in business groups have internal capital market that mitigates financial constraint, they are less exposed to the discipline of product market competition than stand-alone firms are. Therefore, in a competitive product market, only stand-alone firms benefit from good internal corporate governance as a way to increase the investment. The empirical results are as follows: in general, good internal corporate governance leads to higher investment and a lower level of dividend or share repurchase in competitive product markets than in non-competitive industries. On the other hand, in non-competitive product markets where managers' overinvestment problem is not properly controlled, good internal corporate governance leads to a higher level of dividend or share repurchase and less investment expenditure. The results are consistent with our hypothesis. We also check to find out whether these findings are influenced by the financing capability of firms by implementing the same analysis to both categories of sample firms, chaebol or independent firms. In the competitive product market, while chaebol firms with good internal corporate governance do not increase investment expenditure, stand-alone firms with good internal corporate governance significantly increases investment expenditure. The result shows that chaebol firms are not affected by product market competition in their investment decision since they have internal product and capital markets. On the other hand, in the case of stand-alone firms who face higher level of financial constraint, interaction between product market competition and internal corporate governance plays an important role in the process of corporate investment decision. d, in the case of stand-alone firms who face higher level of financial constraint, interaction between product market competition and internal corporate governance plays an important role in the process of corporate investment decision.

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We provide the first comprehensive review of the market microstructure literature on the Korean financial markets, published in the five leading Korean journals from 1990 to mid-2010. We also offer some perspective on the literature for investors, exchange officials, policy makers, and regulators and provide a roadmap for future research endeavors. This paper includes the following five main categories: (1) micro aspects of the microstructure world: orders and trades, basic market quality, price discovery, and trading mechanisms; (2) trading protocols: rules and regulations related to trading; (3) market transparency; (4) market macrostructure; (5) expansion of market microstructure to the fields of investments and corporate finance. We find that the current status of the Korean market microstructure research is as follows. The research in the Korean market microstructure has been disproportionately concentrated into the two categories of micro aspects and trading protocol. However, most of them were conducted during the 1990s, which has limited the perspectives on the academic and policy implications by periods, subjects, and trading protocols. The research on the categories of transparency and market macrostructure is very limited, even though these areas contain features of Korean markets that are unique among world markets. The research of market microstructure combined with investments has been fairly active, whereas that combined with corporate finance is at its inception.

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This paper reviews the hypotheses and empirical evidence that have been proposed to explain IPO activities and pricing behavior in Korea. The paper particularly reviews empirical evidence and explanations related to the three patterns associated with Korean IPOs: underpricing, hot issue markets, and long-run underperformance. Explanations for underpricing can be grouped under two broad categories: deliberate underpricing and behavioral approaches. The first category can be divided into two subcategories: asymmetric information and price stabilization. While the first subcategory attempts to explain underpricing in the efficient market framework and consider it as a part of the costs associated with IPOs, the last subcategory turns to one of the services that underwriters use to provide price stabilization. While the hypotheses based on asymmetric information are well established and supported by the literature, the significant variation in the degree of underpricing over time together with the poor long-term performance makes many researchers doubtful whether information-based theories could be enough to explain the large initial returns. Some researchers thus turn to behavioral explanations which put more emphasis on the effect of investors’ irrational behavior or sentiment on stock prices. Evidence suggests that no hypothesis can dominantly explain large initial returns. Thus the hypotheses reviewed here are not mutually exclusive and a given hypothesis can be more relevant to some IPOs than to others.

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There have been fundamental changes in corporate dividend policy over the last several decades. Firms decide whether to pay out the corporations’ earnings to shareholders as dividends and share repurchases or to keep the profits as retained earnings for future investments. Corporate payout policy is a complicated financial decision- making process that considers future growth opportunities and corporate governance, as well as financing conditions in markets. Determining the payout amount is crucial for corporate finance managers since it is directly related to firm value. Korean corporations’ payout policy has changed dramatically since the Asian financial crisis in 1997.Until the Asian financial crisis, the Korean stock market had not experienced the appropriate conditions to test the various hypotheses based on dividend theory because firms did not have an optimal dividend policy based on their needs and capabilities to maximize firm value. However, after 1997, the paradigm shift in the business environment brought about shareholder-value maximization management, transparency enhancement in corporate governance, and investor-favorable regulation changes, making the Korean stock market more qualified for sophisticated empirical tests of payout policy. This paper reviews the empirical evidence on dividends and stock repurchases over the last three decades in Korea that consider market imperfections such as tax, information asymmetry, and agency costs. Also this paper covers the major survey results on dividend policy.

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We examined in this paper whether the impact of liquidity on the expected stock return varies according to a firm’s payout policy. We used the daily relative spread as the proxy for illiquidity and treated it by the means of linear spline functions in order to measure the change of its impact on the expected return in each sub-range specified by those functions. KRX market data excluding the financial sector were used for the analysis during the sample period from 1999 to 2008. We had the following results. First, we found clear convexity for the stock-repurchasing portfolios when we checked the influence of liquidity on the expected return using the 2SLS regression including instrumental variables to control the potential endogeneity of the dummy variables indicating payout choice. The slope of the relative spread jumped precipitously to the sub-range [0.0044, 0.0070). On the other hand, mere concavity existed for the cash-dividend portfolios. The slope of the relative spread was nearly horizontal, and its statistical significance was also pretty low. This result supports the proposition that the relationship between the relative spread and the expected return could be convex for the repurchasing firms. If so, this would be due to the tax effect, proposed by Gottesman and Jacoby (2006) who modify the Amihud and Mendelson (1986) proposition that the relationship between them is concave piecewise- linear. Second, the robustness test using Heckman’s (1976) two-step estimation also confirmed the result above. The slope of the relative spread soared sharply in the same sub-range as above for the stock-repurchasing portfolios, although its statistical significance somewhat decreased overall. Therefore, we found the relationship between the relative spread and the expected return convex irrespective of the estimation methods; one method stresses the control of the endogeneity while the other emphasizes sample selection correction. Third, we also carried out a probit regression analysis to examine which of the stock’s attributes influences payout decisions. As a result, we found that the more liquid the stock is, the more likely stock repurchases are preferred over cash dividends. Further, the smaller the share of the largest shareholder is, the larger the share of foreign investors become, or the younger the age of the firm, the more likely stock repurchases are adopted as the firm’s payout policy. This conclusion was robust when i) we divided the sample into 4 groups according to the possible combinations of whether each payout policy was chosen or not; and ii) we retested the result using the multinomial logit regression model in which we controlled for the additional financial variables. Thus, we found liquidity is a critical factor in deciding payout policy, and every exogenous variable (the share of the largest stockholder, that of foreign investors, and the age of the firm) influences the choice of the payout policy. These variables were used to control for endogeneity and to correct sample selection. Existing studies thus far have focused on the overall positive relation between the relative spread and the expected return. For instance, recent studies like Park and Eom (2008) and Yun, Ku, Eom, and Hahn (2009) merely confirmed that liquidity is an additional pricing factor in explaining the excess return of the stock. This paper differs from these in that it explores the curvature as well as the direction of the coefficient of the relative spread by applying the spline regression function in examining the relationship between them, which has turned out to vary according to the payout policy, the typical financial decision making initiated by the management of the firm. Thus, we attempted to make an integrated approach that combines payout policy as a corporate finance issue with asset pricing as the essence of investments. This paper’s finding is unique in the respect that it is internationally the first confirmation of Gottesman and Jacoby (2006)’s proposition. From the results, we can also expect that firms may exert more efforts to enhance the liquidity of their stocks when they adopt stock repurchases as their payout policy. As stocks are very sensitive to liquidity change, they can improve the market value by reducing the required rate of return of their stocks. In this context our results can be extended to the study under the market microstructure framework in which we can discuss how the market mechanism should be constructed to boost the liquidity so as to help stock-repurchasing firms level up their firm value. To follow up, it will be very interesting to see whether those repurchasing firms indeed take actions to increase the liquidity of their stocks and what measures they actually use to accomplish that aim. This will require more research.

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Although initial public offerings (IPO) are one of the most important issues in corporate finance, academic research in this area has been rather minimal. The absence of academic interests can be accounted by the prevalent assumption in the market that IPO is just a standard procedure toward a firm’s growth. The view was not challenged until the early 1990s when Pagano (1993) and Zingales (1995) presented their seminal works. Then a recognition has been built that entrepreneurs actually make a conscious decision whether to go public by evaluating the benefits and costs of going public. Further, it is difficult to collect detailed information such as accounting and ownership data for private firms. For this paper, we analyze the determinants of IPOs using a large database of the private firms that meet the listing requirements of the Korea Exchange (KRX). In doing so, we basically follow the approach of Pagano et al. (1998) by comparing the ex ante and ex post characteristics of IPO firms with those of private firms. First, our main variable in the analysis is the ownership structure which differentiates the paper from the existing ones. As the prior and post IPO ownership structure would be one of the main concerns of the controlling shareholders, we conjecture that owners when designing the sale of new shares will definitely have the final ownership structure in mind. Second, this paper focuses on firms that are controlled by their founders, or the founders’ families since they are the ones who are most likely to face the tradeoff between the benefits and costs of going public. Accordingly, family firms account for 95.3% of our sample. In this study, we hypothesize that (1) the probability of an IPO increases with the ownership by the controlling family, but decreases with the ownership by member firms in a business group, and (2) this relationship is stronger for non-chaebol firms than for chaebol-affiliated firms. These hypotheses are built upon the common understanding that less diversified owners are more likely to resort to the IPO, since they have more to gain from diversifying their investments. We test the hypotheses by studying 491 non-financial firms that went public through the KOSPI market of the KRX during the period of 1987 through 2005. To investigate the determinants of Korean IPOs, the characteristics of these IPO firms are compared with those of non-IPO firms that still met the listing requirements of the KRX but chose to remain private. In addition, we investigate what types of changes resulted from going public especially in their financial characteristics and the ownership structures . We also analyze the determinants of changes in the ownership by the controlling family over the three years before and after the IPO. Our findings are summarized as follows. ∙ Ex ante determinants of an IPO: From a logit model of the probability of going public, we find that firms are more likely to go public in the following cases: if the median market- to-book ratio of listed firms in the same industry is higher; and if the ownership by the controlling family is higher while the ownership by member firms in the same group is lower. We also find that these results are stronger for non-chaebol firms than for chaebol firms. The overall results support our hypotheses that controlling shareholders decide to go public in order to diversify their own wealth and maximize the proceeds by carefully timing the IPO. ∙ Ex post consequences of an IPO: By examining the dynamics of firm characteristics before and after the IPO through a regression framework of Chemmanur et al.(2010), we find that the following firm characteristics notably decline after the IPO: profitability, sales growth, investment, leverage, the industry market-to-book ratio, family ownership, and the ownership by affiliated firms. The ex post effects of the IPO complement our results for the ex ante analysis. Subsequent to the IPO, investments in tangible assets also decrease while investments in affiliated firms’ equity increase, especially for non-chaebol firms. This result implies that the proceeds from the IPO are not used for future investments, but to diversify the business group or secure control over the group of a controlling shareholder. ∙ Determinants of the changes in ownership by the controlling family: Finally, we run each regression for the two separate periods before and after the IPO to examine the determinants of changes in the ownership by controlling families. For the periods prior to the IPO, the ownership by a controlling family is positively related to the investments in affiliated firms’ equity. After the IPO, this relationship is no longer significant, and family ownership increases with the Tobin’s Q. These results suggest that controlling shareholders maximize their private benefits by securing their control over business groups before the IPO, but pursue higher investment value after an IPO when the control issue tends to be less important.

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The intertemporal relation between risk and return has long been an important topic in asset pricing literature. Most asset pricing models postulate a positive relationship between a stock portfolio’s expected returns and risk, which is often modeled by the variance or standard deviation of the portfolio’s returns, claiming that idiosyncratic risk has no significant effect on returns. However, no agreement has been met about the existence of such a trade-off for stock market indices. While return volatility is an intuitively appealing measure of risk, the difference approaches used by previous researchers suggest that no clear consensus has emerged regarding its relevance. Yet, whether investors require a larger risk premium on average for investing in a security during times when the security is more risky remains an open question. This paper, therefore, makes a contribution by exploring the relationship between return and risk as proxied by firm-volatility, comprised of both systematic and idiosyncratic volatility. As for the predictability of stock market returns, Goyal and Santa- Clara(2003) propose a new approach to test the presence and significance of a time-series relationship between risk and return for the aggregate stock market. They find a positive relation between the equal-weighted average stock volatility and the value-weighted portfolio returns. They also show that the lagged volatility of market returns has no predictive power for the expected return on the market. Bali, et al.(2005), on the other hand, find that Goyal and Santa-Clara’s empirical results based on the equal-weighted average stock risk are not robust across different stock portfolios and sample periods. That is, their conclusions do not hold when either the more natural value-weighted measure of average stock risk or the more robust median stock volatility is used in predictive regressions. Ang, Hodrick, Xing and Zhang(2006) further suggest that volatility of market return is a priced cross-sectional risk factor based on their observation that US stocks with high lagged idiosyncratic volatility earn very low future average returns, and these assets are indeed mispriced when applying the Fama-French model. Their results of the negative relationship between idiosyncratic volatility and expected returns are surprising for two reasons. First, the difference in average returns across stocks with low and high idiosyncratic volatility is rather large. Second, their findings cannot be explained by either exposure to aggregate volatility risk or other existing asset pricing models. On the other hand, in order to capture the time-varying property of idiosyncratic risk, Fu(2009) uses the exponentially generalized autoregressive conditional heteroskedasticity (EGARCH) models and out-of-sample data to estimate expected idiosyncratic volatilities, and find that idiosyncratic risk is positively related to expected returns. Views on the relationship remain divergent: asset pricing theory implies that expected returns should be positively related to model-implied systematic volatility; various theoretical studies suggest that idiosyncratic volatility should be positively related to expected returns; and several empirical studies suggest that idiosyncratic volatility has explanatory power for the cross-section of expected returns. As such, this paper examines the explanatory power of idiosyncratic volatility estimated by three asset pricing models(CAPM, Fama-French 3 factor model, and Alternative 3 factor model suggested in Yun, et al.(2009)), and total volatility, a model-free quantity, for the cross-section of stock returns. Total volatility is the sum of systematic volatility relative to some asset pricing model and idiosyncratic volatility relative to the same model. As a result, no significant link between expected returns and idiosyncratic volatility in Korea stock market (KOSPI) data is traced while some cross-sectional evidence for a negative relationship between total volatility and expected return is detected. In addition, the portfolios of lower volatility stocks achieved a higher expected return than those of higher volatility stocks. We could ascertain that the effect is driven mainly by systematic volatility by applying AHXZ(2006)’s method. We also investigate the implications of the findings above for asset pricing and construct a total volatility factor via the factor mimicking portfolio for total volatility. Following the Fama and French(1992, 1993) model, we construct the factor mimicking portfolio as the zero cost portfolio which is long for the quintile of stock with lowest total volatility and short for the quintile with highest total volatility. We estimate the factor price of total volatility risk using the Fama and MacBeth(1973) procedure for individual stocks in our data. During the research period, the factor price of total volatility risk is positive and significant, indicating that the variation in systematic risk has notable implications for asset pricing. We also conclude based on the multi-factor models of risk that aggregate volatility should be a cross-sectional risk factor. Our finding is that the total volatility has a negative cross-sectional relationship with expected returns of individual stocks. Moreover, when we decompose the total volatility factor into systematic and idiosyncratic components, we find that the factor price of total risk is positive while that for idiosyncratic is insignificant. This negative relationship corroborates the results from the past research in option pricing that has shown a negative price of risk for systematic volatility, by reassuring that stocks with high past exposure to innovations in aggregate market volatility earn low future average returns.

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What is the economic role of the bankruptcy court(judge)? The general answer is that it serves to play key roles in valuation, distribution, and procedure. Yet, the bankruptcy courts are often considered passive and procedural participants in bankruptcy game literature. Indeed, the mainstream themes are more often focused on the optimal bankruptcy law than the court’s strategic role with primary emphasis on the workout negotiation game between the debtor firm and its creditors in the shadow of the bankruptcy law. This paper, therefore, examines the game between the bankruptcy court and the firms that file for bankruptcy protection (Chapter 11). The adopted model is a dynamic game under incomplete information. The perfect Bayesian equilibrium concept is used to refine the resulting equilibriums. By doing so, we construct that the player’s movement is determined according to the sequential rationality and the Bayesian consistency, thereby disallowing empty threats in the process. In this paper, for simplicity, the creditors are assumed to be made of only one class of passive participants; when the firm is liquidated, they receive the proceeds first, and when the firm is reorganized, they are given new equity. The debtor firm chooses between self-liquidation and filing for bankruptcy protection. The self-liquidation leaves something for the debtor firms, but the ex-post liquidation leaves nothing because of bankruptcy costs which reduce the liquidation value. The bankruptcy court maximizes the social welfare which is the sum of the debtor firm’s and the group of creditors’ gains. The court is assumed to have the authority to set the recovery ratio and to reject the petition. Here, the recovery ratio means the ratio between the original debt amount and the value of new equity that is paid to the creditors when the firm is reorganized. In the case of rejection, the firms are assumed to be liquidated(Chapter 7). The judicial intervention or discretion means the strategic decision of the court in the corporate bankruptcy game. There are two types of firms: good firms and bad firms. Good firms’ going concern value is higher than the liquidation value; vice versa for bad firms. The proportion of the two types of firms is determined by nature. The firms know their own type but that information is not verifiable to a the third party. The court only knows the ex-ante probability distribution of the firm types. Therefore, there is a possibility that the two types are pooled, and the court cannot distinguish between them, which leads to the pooling equilibrium. Sometimes, however, the bankruptcy court has strategic measures to prevent the bad firms from filing for bankruptcy protection, which leads to the separated equilibrium. Based on the recovery ratio set by the bankruptcy court, which subsequently becomes common knowledge, the bankrupt firms decide whether to file for bankruptcy protection. Sometimes, the firm type can be publicly revealed as a good or bad one before the court decision is made. In that case, generally good firms are reorganized and bad ones are liquidated. The court can also decide whether to reorganize the firm or reject the petition. If rejected, the firm is liquidated, and the proceeds are paid to the creditors. Because of the bankruptcy costs, the ex-post liquidation leaves nothing for the debtor firms. Reorganization means the debt-equity swap, i.e., the new equity claim, claim is given to the creditors according to the preset recovery ratio. Using the above game structure, this paper provides the following implications. First, the bigger the difference between the expected going-concern value and the liquidation value, the more important the strategic role of bankruptcy court becomes. On the contrary, when the expected going concern value and the liquidation value are the same (or similar), the strategic role of the bankruptcy court does not make any difference. In that case, it does not matter whether the firm is reorganized or liquidated. Second, when the going-concern value is higher, the court decision should be made favorable to the reorganization. This policy implication is especially important when systemic bankruptcy occurs. In that case, many good firms could go bankrupt due to the externality of macroeconomic shocks. Third, when the liquidation value is higher, the court should set the recovery ratio higher and take more selective approach when reviewing the petitions. These measures could help discern the opportunistic behaviors of bad firms. Fourth, when the bankruptcy law is pro-debtor, the strategic role of bankruptcy court gains more importance. In this paper, we can interpret the lower recovery ratio as the proxy for the pro-debtor law. When the recovery ratio is deemed low, the court should reject the petition more often than when the ratio is high. Fifth, the better the court’s information capability is, the higher the social welfare becomes. This result suggests that the court and judges should improve their expertise. This also implies that any legal uncertainties can produce significant impacts on the overall process of corporate bankruptcy.

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This paper reviews 30 years of empirical research on asset pricing models in the Korean stock markets. The validity of the Capital Asset Pricing Model (CAPM) has been seriously challenged in Korea as in the other countries. The overall empirical results in Korea show, as they do in other countries, that the static CAPM fails to explain for stock returns in Korea. Contrary to the prediction of the CAPM, firm characteristic variables such as firm size, book-to-market, and earnings-to-price ratio have significant explanatory power for average stock returns in the Korean stock markets. Because of these CAPM-anomalous phenomena, various asset pricing models such as the types of Arbitrage Pricing Theory (APT), the Consumption-based Capital Asset Pricing Model (C-CAPM), and the types of the Intertemporal Capital Asset Pricing Model (I-CAPM) have been introduced and tested in the literature. The Fama and French(1993) three-factor model is arguably acceptable in explaining Korean stock returns. This paper also provides some explanations of various testing methodologies used in the literature for asset pricing models and discusses the related econometric issues.

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