The purpose of this study is to investigate how the foreign outside blockholders affect a firm's investment policy. Since the Asian financial crisis, Korean corporation’s total investment has been decreasing. To name a few, they are structural obstacles to investment (Jeon, Kim, and Ha, 2005), increase in the cost of capital caused by decrease in debt ratio (Jeon, 2006), market and policy uncertainty (Lee, 2004), and increase in foreign ownership. The structural obstacles include the decreases in profitable investment opportunities, the globalization of production bases and Chinese growth, and weakened entrepreneurial momentum. This study particularly focuses on how foreign blockholders influence firms’ investment decisions. If, for instance, foreign investors have only short-term interest under the limitation of information asymmetry, they are not likely to be interested in firms’ long-run investment policies while demanding high dividend payout to recoup their investment as early as possible. The sharp increase in foreign ownership ratio may also create the market environment inductive to more hostile M&As in Korea. Therefore, it has been argued that firms had to spend a lot of cash to repurchase their own shares in the capital market, thereby decreasing investments. As such, this study analyzes the effects of foreign shareholders on firms’ investment policy from the view point of the theory of financial constraints under information asymmetry. Myers and Majluf (1984) argue that the firms with financial constraints have under-investment problems and prefer inside financing to outside capital, when there is an information asymmetry between inside managers and outside investors. Fazzari, Hubbard, and Petersen (1988) and Agca and Mozumdar (2008) also show that as the degree of information asymmetry (financial constraints) is mitigated, the investment-cash flow sensitivity decreases, while the investment of firms increases. Thus, this study argues that if the foreign investors are not disadvantaged by more information asymmetry than domestic shareholders are, they are more likely to play leading roles in increasing the investment of firms by facilitating the firms’ access to capital under reduced financial constraints. On the other hand, if the foreign shareholders suffer more information asymmetry than domestic shareholders do, they may be interested in short-term performance and demand higher dividend payout to the shareholders, consequently leading to the decrease of corporate investment. The previous studies with regards to this issue have shown conflicting results. Park (2004) and Sul (2006) argue that as foreign ownership increases, the corporate investment in facilities decreases. In contrast, Bin and Cho (2005), Lee (2005), Bae and Hwang (2006) show that the increases in foreign ownership do not directly affect firms’ investments in facilities. Kim (2003), Park and Lee (2006), Cho and Sul (2006) show that the foreign ownership is positively related with the R&D investments. However, Lee (2006) argues that the foreign shareholders do not necessarily affect firms’ investment in R&D. This study is different from the previous literature in that this analysis uses both fixed assets and R&D as the variables affecting firms’ investment decision. In addition, we conduct our studies on a separate pool of domestic and foreign outside blockholders who have more than 5% ownership from the rest of blockholders. Further, this study looks into whether and how domestic and foreign outside blockholders affect investment-cash flow sensitivity. Finally, we use the financial variables of all the non-financial companies listed in Korea exchange for the period of year 2000 through 2008. All the data are collected from the annual reports provided in the DART system of Financial Supervisory Service and KIS-value data base. After deleting some outliers having 1% extreme financial variables, 391 firms’ variables are used for this study. The static panel analysis is employed because this model considers the time series and cross-sectional characteristics as follows: INVit = α + βMajorownit - 1 + x' it - 1 r + uit , where INVit is the investment level of a firm i and year t as a dependent variable. Firms’ investments in both facilities and R&D are used as dependent variables, separately. Majorouwn it-1 is the ownership of major shareholders, and x it - 1 reflects control variables including cash flow, cost of capital, profitability, inside ownership, firm size, and growth rate. The results of our analysis are summarized as follows: Firstly, the panel analysis of the investments in plant and equipment as a dependent variable shows that outside foreign shareholders often end up decreasing the investment-cash flow sensitivity of firms by increasing the firms’ financial constraints. This result implies that outside foreign shareholders in the end play positive roles in reducing information asymmetry. Secondly, the panel analysis of firms’ R&D investment shows that more outside foreign shareholders’ involvement increases R&D investment significantly more than that of outside domestic blockholders; in short, foreign shareholders bring about the effect of decreasing investment-cash flow sensitivity of firms while tightening capital constraints. These observations imply that outside foreign investors play important roles in mitigating the information asymmetry problem while increasing the investments in R&D more than domestic blockholders do. That is, the foreign investors have contributed to the increase in the investments by making firms’ capital financing easier through the mitigation of information asymmetry. Some limitations in this study may arise due to some potential measurement errors of the firm size and retained earning/equity, used for the proxies of information asymmetry.

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The 2007~2009 global financial crisis has highlighted the danger of systemic risk, largely caused by interconnectedness and externality among financial institutions. Generally, systemic risk is a difficult concept to define and measure accuately, making it even more challenging for policy makers to effectively address the issue. Although no clear consensus has been established on a formal definition of systemic risk, it usually denotes the risk related to all the potential results followed by the collapse of a whole financial system, consisting of many interacting financial institutions. In order to effectively prevent such systemic risk, it is necessary to first develop a reliable method to measure such risk. The previous studies on the systemic risk can be divided into two structural approaches: using contingent claims analysis (Lehar, 2005, Gray, Merton, and Bodie, 2008, and Gray and Jobst, 2009) and reduced- form approaches focusing on the statistical tail behavior of financial institutions’ asset returns (Adrian and Brunnermeier, 2009, and Chan-Lau, 2010). In this paper, we propose a new method to gauge systemic risk: the conditional probability of default (CoPD), which is derived from the joint probability distributions of banks’ asset returns. In order to obtain CoPD, we first estimate the joint probability distributions of asset returns and the default points of banks in the system. Since the market values of bank assets are unobservable, we estimate asset returns using stock prices and debt maturity structures following Merton (1974) and Crosbie and Bohn (2003). To maximize the consistency between asset values and asset volatilities, we estimate them using the recursive exponentially weighted moving average algorithm developed by Lee (2010). In doing so, we assume that a bank is in default if the market value of its assets is less than the default point, which is estimated based on the debt maturity structure of banks. We define CoPD as a default probability of a bank, conditional on other banks being in default. The difference between CoPD and unconditional PD, CoPD, contains useful information on systemic risk.CoPD denotes the change in default probability of bank i when bank j goes bankrupt. The stronger the interdependence between bank i and bank j gets, the higher CoPD becomes. This method allows us to develop systemic risk indicators which measure how much the default possibility of banks increases when other banks in the system go bankrupt. The systemic risk indicator (SRI) can be calculated based on the n×n CoPD matrix, whose element CoPD denotes the difference between CoPD and unconditional PD  . The overall systemic risk may be captured by the mean value of all off-diagonal elements in the matrix. SRI measures the increase in default probability of a bank on average when a bank in the system falls default. If there are no direct and indirect connections between banks, SRI approaches 0. The stronger the interdependence within the banking system gets, the higher SRI will be. In order to measure how much the default probabilities of other banks increase when the bank goes bankrupt, we also develop the systemic importance indicator (SII) of each individual bank as well as the systemic vulnerability indicator (SVI), which are supplementary information of the systemic risk indicator. We may calculate SII as the column mean of the CoPD matrix. On the other hand, the systemic vulnerability indicator of an individual bank measures how much the default probability of the bank increases when other banks go bankrupt. Thus, SVI can be calculated as the row mean of the CoPD matrix. Meanwhile, Adrian and Brunnermeier (2009) have proposed a popular systemic risk measure: CoVaR, which may evaluate the systemic risk contribution of an individual bank. However, this method entails some serious measurement errors on tail dependence. The concept of tail dependence generates a measure for extreme co-movements in the lower and upper tail of asset return distributions, respectively. A reliable systemic risk measure must correctly capture the lower tail dependence among the involved banks. Simulation results suggest that CoVaR underestimates the systemic risk if lower tail dependence is significant, whereas it overestimates the systemic risk if upper tail dependence is strong. The Monte-Carlo experiments show that CoPD can accurately address the problem with CoVaR on tail dependence. The CoPD may also reflect the information about the financial strength of banks. In this study, we calculate the systemic risk indicators for six Korean domestic banks by applying our method. The empirical results show that the systemic risk indicator of the Korean banking system had remained stable for a long period of time after the 2003 credit card crisis until the sub-prime mortgage crisis broke out (2007~2009). Since then the systemic risk of the Korean banking system has dramatically increased again. Secondly, large banks’ systemic importance is considerably high, while low-capital banks are systemically vulnerable. Finally, the BIS capital ratio and the FX liquidity ratio have changed in the opposite direction of the systemic risk indicator with a lead of two or three quarters.

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This paper presents a selective survey of the recent empirical research on exchange rates and foreign exchange markets in Korea. This paper focuses on four basic areas: purchasing power parity and real exchange rates, nominal exchange rate dynamics, foreign exchange market efficiency and market microstructure, and corporate finance issues of exchange rates including foreign exchange risk hedging. First of all, we introduce empirical studies that investigate whether the won/dollar exchange rate satisfies the purchasing power parity relationship in the long run and examine the determinants of short-run fluctuations in the won/dollar real exchange rate. Then, we introduce research about nominal exchange rate dynamics and exchange rate forecasting. Research based on the asset market approach is presented including those investigating the effect of “news” on nominal exchange rates. In addition, empirical studies about foreign exchange markets covering diverse topics such as market efficiency, foreign exchange market intervention and the market microstructure approach are discussed. Finally, studies that measure the foreign exchange exposure and identify the factors that determine the foreign exchange exposure of Korean firms are introduced together with studies that investigate the effect of foreign exchange risk on the return from international portfolio investment.

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Finance is unique in that researchers question even the integrity of managers. Researchers in other disciplines in management sciences consider managers to be agents with good intentions. They focus on supplying good instruments for managers to put into practice, failing to question the intent of managers. But researchers in corporate finance equipped with agency theory question the more fundamental problems and ask what if managers are bad or if managers are plagued with agency problems? These kinds of questions are the topics of corporate governance. Researchers in corporate finance who have a way of seeing things differently have brought and will bring many spectacular achievements in both the academic and practical world. This paper reviews the empirical literature on the corporate governance issues in the Korean capital market setting, where corporate governance issues are important because Korea’s chaebols, family-owned conglomerates, are blamed for minority shareholder expropriation via unlawful inheritances and accounting fraud with all the success in international markets. This survey focuses on the effectiveness of internal governance and external markets to monitor and control managers. The topics covered in the following four sections are: (1) The effect of corporate governance structure on corporate policy, (2) Corporate governance and firm value, (3) Market discipline, and (4) Determinants of governance structure. Finally, the discussion and conclusion are presented in the last section.

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Behavioral finance encompasses research that gives up the traditional assumptions of expected utility maximization with rational investors in an efficient market. It is defined as the application of psychology to financial decision making and financial markets. Based on this definition, our review essay summarizes recent work of behavioral studies in Korean capital markets along with some pioneering papers in the behavioral finance literature. In Korea, behavioral studies are in their early stages of development. First, we start with discussion of the limits of arbitrage as a foundation of behavioral finance. We discuss the limits of arbitrage to explain why Friedman’s (1953) paradigm of arbitrage may not eliminate pricing errors in capital markets. Second, the prospect theory of Kahneman and Tversky (1979) and its related empirical results are reviewed. Third, empirical results related to overreaction and underreaction are addressed. Fourth, investors’ trading behaviors and return patterns as influenced by psychological biases are discussed. In conclusion, we address several areas to explore as promising research fields. First, experimental investigation with psychologists is warranted. Second, regional anomalies need be explored from behavioral perspectives. Investors’ behavior across cultures is also an interesting topic in behavioral finance. Third, collaborative work with other business areas is needed. Finally, corporate behavioral finance has much room for further investigation.

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This paper reexamines the relation between firm value and classified boards. The previous studies on large-sample data document a negative relation between classified boards and firm value. Event study evidence also shows a positive market response to the elimination of classified boards and a negative announcement effect for the new adoption of classified boards. These results, however, posit a puzzle why then a majority of the U.S. firms maintains this seemingly suboptimal board structure. We attempt to resolve this puzzle. After correcting for the influence of omitted variables and self-selection bias, we find no evidence that such negative relation exists at all. If there is any, we find that classified boards actually enhance firm value. The result explains why classified board structure prevails till recent years. Further, we show that the valuation effect of classified boards is conditional on a firm’s information costs. For firms with high monitoring costs, the market perceives that classified boards hurt firm value. However, for firms whose information problem is less severe, the adoption of classified boards is not viewed as detrimental to firm value. This suggests that there are some firms whose organizational structures do not fit with classified boards even though classified boards are value-enhancing for a majority of firms.

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As fund markets have experienced a tremendous growth internationally, a lot of studies on the performance of funds have been conducted in recent years. At the same time, academic interest to investigate the impact of managerial skills on a fund’s performance has also grown. However, due to the short history and the lack of data on the Korean fund market, only a few studies have actually been conducted on the performance of the Korean active fund market. In this study, therefore, we analyze whether and to what extent the performance of Korean funds is influenced by the skill of managers or simply by luck. For this investigation, the bootstrap simulation method is applied. Previous studies traditionally use the persistence test to find out whether the performance of a fund is based on a manager’s skill. These studies test whether a past winner continues to show good performance. Since this performance test is based on the short-term performance of funds, we cannot rule out the possibility of the intervention of noise. To solve this problem, recent studies, such as Kosowski, Timmermann, Wermers, and White (2006) and Fama and French (2010) use the bootstrap simulation. Thus, we have decided to apply this methodology to the active fund market in Korea. A simulation run produces a random sample within the period of 95 months, from February 2001 to December 2008. We examine 3,000 simulation runs. Using this method, we derive a distribution of excess returns of funds compared to a return of a benchmark portfolio under the assumption that managers are unskilled. Comparing the distribution from the simulation and the real distribution of excess returns of funds, we are able to estimate if real excess returns are extreme cases under the simulation distribution. In addition, we divide our sample into two groups : one group of funds in the early 2000s and the other group of funds in the late 2000s. We also subdivided the sample into two groups as long- and short-term groups funds that have existed for 5 or more years and those that have existed for less than 1 year, respectively. Fund groups are also sorted out according to the size. In fact, the sample funds are ranked based on their size: if a fund’s size is below the median value, the fund is included in the small-size group while the rest is included in the large-size group. While most previous studies have focused on the fund performance itself or the characteristics affecting the performance, our study aims to investigate the impact of fund managers’ skills on the fund performance in the Korean active fund market. As far as we are aware, our study is the first study of its kind to ever show also the effect of the herding phenomenon among managers on the possibility of the linkage of fund performance and the skill of managers. Furthermore, we use the methodology that can reduce biases such as survivorship bias and incubation bias, which could appear in the examination of funds. Our major findings are as follows. First, real excess returns exist in a narrow range as compared to the simulation distribution of excess returns, which are derived under the assumption of unskilled managers. This finding suggests that Korean fund managers possess even levels of fund managing skills, neither too superior nor too inferior compared to one another. Second, fund performance is more highly influenced by managers’ skill among the funds that belong to the late 2000s group than those of the early 2000s group. This finding suggests that the fund managers’ skill has improved over the years. Third, the performance of funds is more likely to be affected by managers’ skill in the long-term fund group than in the short-term fund group. This finding implies that fund managers’skill is more likely to affect the performance of funds that are running on a long-term basis. Fourth, the performance of funds based on managers’ skill seems similar between a small-size group and a large-size group. At this point, it is important to observe a notable feature of Korea’s fund market that is an extremely narrow range of the distribution of real excess returns especially compared to that of the corresponding U.S. market. To identify some potential causes of this difference, we investigate whether the herding phenomenon can be found among fund managers. If managers copy one another in making investment decisions regardless of their access to private information, indeed, the performance among funds is highly likely to be similar. For this investigation, we apply the LSV herding measure developed by Lakonishok, Shleifer, and Vishny (1992). Using this measure, we find that managers in the Korean active fund market herd one another more strongly than in the U.S fund market. We also find that when mangers herd severely, then the effect of managers’ skill on the performance of funds is expectedly very limited. This finding suggests that the stronger the herding phenomenon is, the less relevant the skill of fund managers is in the fund performance.

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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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