A financial crisis is often triggered by negative external factors in the credit market. In case of the recent global financial crisis, the trigger was the sudden collapse of Lehman Brothers. Hence, it can be a reasonable notion to reflect the cost of externality on a fair deposit insurance premium in order to absorb consequential market distortion. This is akin to correcting the market distortion by taxing air pollution. Pedersen and Roubini (2008) is the first paper to address this issue by proposing the idea as a viable way to restore financial stability. In this paper, we reframe Merton’s (1974) credit risk model based on a general equilibrium context and price the systematic risk for deposit insurance which is considered to be the cost of the negative externality. For that purpose, we make use of the general equilibrium models such as Cox, Ingersoll and Ross (1985), Ahn and Thompson (1988) and Bates (1991). The model assumes that the return dynamics on the firm value process follows a geometric Brownian motion. This kind of stochastic dynamics is made possible by an economy’s random technological change over time. Park, Ahn and Kim (2009) has derived the risk-neutral dynamics for the firm value process using the Ahn and Thompson’s model (1988). The risk-neutral dynamics allows us to price a risky debt in a general equilibrium setting. Applying Ito’s lemma to the equilibrium relationship between the firm (asset) value and its debt value, we derive an equilibrium return dynamics on the debt. From this equilibrium return dynamics, we obtain an equilibrium relationship between the asset risk premium and the debt risk premium for a firm. Particularly, we show that the systematic risk premium depends upon the following variables: 1) the relative riskiness of debt (deposit) to asset, 2) asset beta, and 3) the investor’s relative risk aversion. The relative riskiness of debt to asset is largely associated with the bank’s financial risk represented by the leverage (debt to asset) ratio. The asset beta is determined by the asset return covariance with the economy’s total wealth. According to Merton (1977), the fair deposit insurance premium per dollar is defined as a present value of the expected default loss (per dollar deposited) under Martingale (Q) measure. Deposit insurance premium is, henceforth, computed as a sum of the present value of the expected loss to depositors from their bank default and its systematic risk premium; the risk-neutral default probability under Q measure accounts for the risk premium beyond its expected default loss. The expected default loss is, in turn, estimated using the classical logit model. In order to estimate the debt premium, we impute the firm asset return (unobservable) from its stock return (observable) by employing the iterative procedure used by Vassalou and Xing (2004). This procedure is similar to the KMV’s procedure outlined in Crosbie (1999). The procedure is based on the Merton’s notion (1974) that a firm’s stock is, as a matter of fact, a call option on the firm’s asset with the book value of the firm’s liability being the strike price. We first estimate the stock return volatility from the daily stock prices and use it as an initial value for the asset return volatility. Using the Merton’s relationship, we compute daily asset values for each trading days. We then compute the asset return volatility for the next iteration. The procedure is repeated until it converges. A striking difference of our model from the traditional option based model such as Merton (1977) and Marcus and Shaked (1984) is that our model allows us to estimate the expected default loss and the systematic risk premium explicitly and separately. Our model also differs markedly from that of Cooper and Davydenko (2004),which derives a relationship between the equity risk premium and the debt risk premium, in that ours is, in nature, a general equilibrium model while theirs is not. An empirical analysis is done for the Korean commercial banks and the mutual savings banks and is compared to the results obtained by the prior studies such as Marcus and Shaked (1984), and Duffie, Jarrow, Purnanandam and Yang (2003). Our model generally produces a higher premium than what one would obtain from the Marcus and Shaked’s (1984), which tends to underestimate it. We, furthermore, find that the expected default losses are higher for the mutual savings banks than the commercial banks, but the systematic risk premia are the opposite. We think that the commercial banks tend to be more procyclical as evidenced by their higher beta coefficients. The systematic risk premia varied over the business cycle, and reached the peak in the year of 2008. They are negatively related to the degree of financial stability. We recommend that the deposit insurance premia should be charged at the rates reflecting the differences in the systematic risk premia.

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The Korean fund market has experienced a tremendous growth in the past several years. Especially, the growth in the equity type fund has been phenomenal; for instance, its balance grew from 6.5 trillion won in March 2005 to 127.7 trillion won as of November 2008. While low interest rate and steady growth trend in the world stock market have driven the increase in the market size, the introduction of systematic monthly fund investment method, which is virtually the dollar cost averaging investment, has also played a significant role. In fact, since its introduction, fund distributors often advise individual investors in favor of the dollar cost averaging method, asserting that it generates higher returns with lower risks compared to the lump sum investment strategy; accordingly, many individual investors have participated in equity-type fund investment. This study aims to compare the performance of the lump sum (LS) investment strategy and dollar cost averaging (DCA) investment strategy in the Korean mutual fund market to check whether the DCA method really outperforms the LS method. Thus far numerous debates have followed over which of these two investment strategies is better since Constantinides (1979) which suggests that the LS investment strategy outperforms the DCA investment strategy. Prior to his paper, it was generally accepted that DCA is better than LS due to the dollar cost averaging effect. However, many theoretical and empirical researches since Constantinides (1979) have suggested that LS actually outperforms DCA. Most of the literature on this issue, regretfully, has been solely based on theoretical analysis or simulation methods only. Even empirical analysis has relied on hypothetical accounts rather than actual investment accounts. In this regard, this paper is different from the past literature in that we used not only the conventional simulation methodologies, but also individual investors’ actual account data to effectively compare the performance of LS and DCA investment strategies. The data for this paper are comprised of: i) KOSPI stock index and bond yields from January 1988 to December 2008 for the historic simulation; ii) KOSPI stock index and bond yield from January 2001 to December 2008 for Monte Carlo simulation; and iii) 36,890 individual accounts (of which 22,449 using DCA strategy and 14,441 using LS strategy) from December 2004 to November 2008 for the real investor data analysis. Our major findings are as follow. First, the historic simulation shows that LS investment strategy provides better return for short-term investment horizon (1 year) while DCA investment strategy outperforms for the long-term investment horizon (3 year and 5 year). This result holds robust whether we use simple return, Sharp measure, or Jensen’s alpha to measure the fund account performance. The Monte Carlo simulation shows similar results: the LS investment strategy gives better return for the 1 year investment horizon. For the 2 year investment horizon both strategies are comparable while DCA starts to outperform LS when the investment horizon is longer than 3 years. Second, we use individual fund investment account data to compare DCA and LS strategies and find that DCA outperforms LS during our study period which is divided into bullish period and bearish period. We find that the marginal effect of DCA on the risk adjusted return (Jensen’s alpha) is positive even after controlling for the market conditions. It is also found that DCA becomes a better investment strategy than LS when the investment term is longer and the investment capital is larger. Third, we compared two different methods to close down DCA investment account. Fund investors with DCA account can either choose automatic sell-off when their monthly saving contract matures or wait to select the better time to sell-off his or her fund even after the contract term expires. We find that investors who choose different sell-off time other than automatic contract expiration time do not perform better, and this indicates that investors as a group do not have ability to choose better investment exit time. Finally, we conduct the sensitivity analysis for the fund investment in response to the changes in the stock prices. We find that both fund purchase and fund sell-off are sensitive to stock price movements. Both purchase and sales of fund increase when the stock price (KOSPI index) rises, and they decrease when the stock price falls. Between the purchase and sales, fund purchase activity is more sensitive to the stock price movements than fund sales activity is while LS investors are more sensitive than DCA investors are. Our study result suggests that individual equity type fund investors are better off when they invest with DCA strategy and for a longer time horizon. This paper makes a meaningful contribution to the fund and investment literature as it is the first paper to examine the actual investors’ account to compare the DCA and LS fund investment methods. Nonetheless, we acknowledge that some part of the result may be sensitive to the study period.

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This paper analyzes the role of controlling shareholders in corporate wage decisions. Even though existing theories have argued for the positive role of controlling shareholders who own substantial portions of voting shares, there have not been many theoretical or empirical papers that specifically identify or confirm their roles in corporate management. If any, existing papers analyze the relationship between managerial ownership and firm value or firm performance. However, the causal relationship is not easily testable, and the results are indeterminate. This is partly due to the endogeneity problem between ownership and firm value in addition to the mixed effects of managerial ownership on firm value. In theory, larger managerial ownership positively affects firm value by aligning the incentives of managers with those of outside shareholders, but managers would also hold larger numbers of shares if they find the shares of their companies are undervalued. Such an endogeneity issue makes it extremely difficult to test empirically the effect of managerial ownership on firm value. In addition, a larger size of managerial ownership entrenches managers, which has a negative effect on the firm value, leading to indeterminate conclusions on the issue. In this paper, we identify wage bargaining as a corporate decision process in which managers or controlling shareholders can get involved. We set up a theoretical model to predict the relationship between managerial ownership and wage decision, and empirically test the hypotheses based on the model. We use a cooperative bargaining model in which a controlling shareholder or a manager who represents the share holder bargains with employees to decide on employees’ wage. Unlike other production factors such as financial capital or intermediate materials to be out- sourced from competitive factor markets, wage provides a good candidate for confirming the role of controlling shareholders in corporate management since wage is negotiable in the bargaining process between the firm and its employees. We derive theoretical predictions on the effect of controlling ownership and the personal benefits controlling share holders gain from controlling the wage of the firm’s employees. As a result, we could empirically confirm the disciplinary role of controlling ownership in wage decision in firms. The theoretical model predicts that controlling ownership is negatively correlated with the wage of employees as long as the profitability of the firm is not too high or employees’ stock ownership is large enough. This is because the relative importance of cash flow rights of a controlling shareholder increases with his stock ownerships while the relative importance of his private benefit of control decreases. Our intuition dictates that the more shares the controlling shareholder owns, the higher wage will be incurring more cost to his share value, providing an incentive for him to lower the wage. Thus, the condition of low profitability is needed since the controlling shareholder may concede too much in a wage bargaining if he has too much to lose when the profitability of the firm is very high and the bargaining fails. The condition for the reasonable level of employees’ ownership also implies that employees also need to have something to lose if the bargaining fails. Empirical analyses confirm the theoretical predictions and show that there is a negative relationship between the two variables. We also show in the theoretical model that the size of the private benefit of control is positively correlated with employees’ wage. We conjecture that controlling shareholders concede to the employees in the wage bargaining since the private benefit can be lost if the bargaining fails. The data used in this paper for empirical analyses is obtained from the TS-2000 of KLCA, and covers the listed companies on the Korea Stock Exchange during the years from 1999 to 2002. The empirical analyses confirm the theoretical predictions and show that there is a negative relationship between controlling ownership and wage level. When we include an interaction variable between low profitability dummy variable and controlling ownership, the coefficient is negative and significant at the 1% significance level. The result confirms our conjecture that the monitoring role of controlling shareholders will be stronger when the firm does not perform well. When we divide the sample firms based on their employees’ ownerships and profitability, we again confirm our theoretical results that the monitoring role of controlling shareholders would be stronger in those companies with higher employees’ ownership and lower profitability. The over all results suggest that a professional manager with lower stock ownership would collude with his employees and allow them higher wages in order to secure his control over his firm. The paper also shows that the disciplinary role of a controlling shareholder is more prominent when the performance of the company is poorer. On the other hand, any increase in the ownership by employees or their participation in a labor union tends to have an increasing effect on their wage level. The theoretical and empirical results of the paper enhance our understanding of the role of a controlling shareholder as a monitor of corporate management.

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The Korean stock markets include the KOSPI market (main board), the KOSDAQ market (new market), and the FreeBoard (organized OTC stock market). Originally, the first organized OTC stock market in Korea was the Third Market, which was founded in March 2000, specifically for the purpose of providing liquidity for stocks which could not meet the listing requirements for the regulated markets (the KOSPI and the KOSDAQ markets), particularly venture-related growth stocks; or which had been delisted from the regulated markets. Except for the first couple of years, however, the Third Market suffered from illiquidity arising mainly from regulatory inadequacy and the IT bubble. Hence, the Third Market did not fulfill the goals for which it was created. The Korean government decided to revamp the Third Market under its “Plan to Support Finance and Tax for Developing the Venture Industry;” in July 2005, the Third Market was replaced by FreeBoard, market rules were strengthened, and some tax benefits were added. However, the tax benefits fell short of the tax benefits provided to the regulated markets, and FreeBoard retained an archaic trading mechanism, in which orders are usually matched only if they are identical in both price and quantity. In this paper, we examine how effectively FreeBoard (including the Third Market, the predecessor of FreeBoard) has served three particular roles as the organized OTC stock market in Korea. The roles examined are: providing liquidity and market quality, providing financing, and bridging the OTC and regulated markets. First of all, FreeBoard’s creation of liquidity and market quality are examined through microstructure analysis. The latest microstructure theory uses trade-execution costs (or pricing errors) to measure a stock market’s quality in general. Hasbrouck (1993) and Bandi and Russell (2006) are representative of the research. In this paper, we utilized the Full-Information Transaction Cost (FITC) in Bandi and Russell as the main analytical frame. In addition, as a robustness check, we used Hasbrouck’s measure for pricing errors. We analyzed these estimates and other market statistics to measure the market quality of the FreeBoard in comparison to the KOSDAQ market. Next, we evaluated FreeBoard’s role of providing finance to unlisted firms by analyzing the total amounts of equity and bond financing raised by companies. Finally, we undertook a market macrostructure analysis to examine FreeBoard’s role of bridging the OTC and regulated markets. The analysis of the connection between the OTC and regulated markets compares the changes in market liquidity and volatility resulting from a listing transfer from the regulated markets to the FreeBoard or vice versa. Until recently, there has been very limited academic research concentrating on the OTC stock markets. However, the development of IT relating to stock trading and the increasing liquidity of the OTC markets has recently enabled the collection of OTC trading data, and several research projects are being carried out internationally, especially in the U.S. Compared to other papers focusing on Korea, this is the first paper to use FreeBoard’s intraday data to test its functional efficiency and economic significance. Other international papers have conducted analysis for the “one-way” bridging function from the NYSE and Nasdaq down to the OTCBB and Pink Sheets (Easley, O’Hara and Pompilio (2005) and Harris, Panchapagesan and Werner (2008)). This is the first paper to conduct a complete analysis of the OTC market’s “two-way” bridging function, both from the regulated markets down to the OTC, and from the OTC up to the regulated markets, in order to investigate the significance of the OTC market’s macrostructure. The sample period is from March 2000 to December 2007. We used intraday trade execution data for all stocks listed (registered) on both the Third Market and FreeBoard. We found the following results. •Market statistics of the firms listed on the FreeBoard are qualitatively very low and its market quality measured by FITC (or Hasbrouck’s pricing errors) is much lower than those of the KOSDAQ market. Hence, the FreeBoard does not provide adequate liquidity or market quality, and thus does not provide an attractive new investment opportunity for investors. • Few public offerings have been made since the inauguration of the market, so FreeBoard has not significantly facilitated financing for unlisted and unregulated firms. • In the case of stocks moving from regulated markets down to the FreeBoard, liquidity dried up and volatility increased substantially. In contrast, for stock transferring from the Free- Board up to the KOSDAQ market, both liquidity and volatility improved tremendously. In the latter case, perhaps surprisingly, the stock prices decline slightly; our interpretation is that the prices were too high on Freeboard since the greater liquidity suggests that pricing on KOSDAQ should be more efficient than it is on FreeBoard. Taken together, these results imply that FreeBoard’s market efficiency is very low. Our results also show that the functional gap between FreeBoard and the KOSDAQ market is huge, thereby exacerbating the inefficiency in the macrostructure of the Korean stock markets. Moreover, our results indicate that FreeBoard’s archaic trading mechanism has been the essential cause of inefficiency on FreeBoard and should be improved immediately.

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This paper re-examines the learning CAPM, a new version of conditional CAPM, developed by Adrian and Franzoni (2005). While acknowledging its firm foundation, we argue that the learning CAPM is likely to be exposed to endogeneity problems. In other words, the regressors are possibly correlated with the disturbance terms due to the omitted risk factors and errors-in-variable problems from the imperfect proxy for the unobservable market portfolio. Kim (2006) shows that the conventional Kalman filter provides an econometrician with invalid inference about the parameters if one ignores the endogeneity problems and provides new approach to circumvent endogeneity problems. In this paper, we test whether the proposed model can account for the Fama and French 25 size and book-to-market sorted portfolios. To test the joint significance of pricing errors, we use the root mean squared error (RMSE) where it gives equal weight to each portfolio as well as the composite pricing error (CPE) of Campbell and Vuolteenaho (2004) in which it gives less weight to the volatile portfolio. The main findings of this paper are summarized as follows. First, Hausman’s (1978) specification test shows that there is a substantial correlation between the market portfolio and disturbance terms, which justifies the application of Kim’s (2006) two-step approach. We reject the null hypothesis of no correlation between the regressors and the disturbance terms in seventeen out of twenty-five portfolios. Second, our specification partly explains the size and value premium. While the time trends of the estimated market betas of the one from the Kalman filter ignoring endogeneity problems and our specification are very similar, the average market betas are considerably different. For example, the estimated average market beta of small-value portfolio by Kim’s (2006) approach is 1.62, whereas it is 1.05 when inferred from the Kalman filter ignoring endogeneity problems. It means that while the market betas of small-value stocks are underestimated if we ignore the endogeneity problems, the introduction of long-run market beta correctly estimates the true riskiness of small-value stocks. In addition, with Kim’s (2006) approach, the estimated average market beta of large-growth portfolio is 0.94, while it is 1.62 for small-value portfolio. Therefore, the proposed model explains why investors' expected return from small-value stocks is higher than that from large-growth stocks. Under our framework, small and value stocks earn more than big and growth stocks just because they are riskier than big and growth stocks. Third, the overall performance of our specification is better than that of the one from the Kalman filter ignoring endogeneity problems. The RMSE is reduced by about 28%. More importantly, the CPE drops by about 49%. Thus, the learning CAPM incorporating the endogeneity problems can better account for the size and value premium. However, our specification is not fully able to explain the value premium since the pricing errors of value portfolios are still significantly positive. Therefore, it seems that we are still missing some important determinants that explain the stock return patterns. Adrian and Franzoni (2005) develop a new type of conditional CAPM by incorporating the long-run changes in factor loadings as well as the contemporaneous changes in market betas. In their model, the long-run market beta plays a crucial role in explaining the size and value premium. Franzoni (2004) documents that the market betas of small and value stocks have decreased substantially in the second half of twentieth century. Based on the reduction in betas of small and value stocks, they argue that the high level of market betas from the past affect today’s market betas. The slow-learning of investors caused by the introduction of the long-run mean of market betas makes them larger than the OLS estimates. However, we argue that the regressors of the learning CAPM are very likely to be correlated with the disturbance terms. It is because : (1) there might be omitted risk factors such as SMB and HML of Fama and French (1993) which can explain most of the CAPM-related anomalies(size and value premium); and (2) there might be the errors-in-variable problems from the imperfect proxy for the unobservable market portfolio. Kim (2006) documents that the correct inference of Kalman filter strongly depends on the assumption that the regressors are uncorrelated with the disturbance terms. His simulation study shows that the conventional Kalman filter provides an econometrician with invalid inference about the parameters if one ignores the endogeneity problems. He derives a Heckman-type (1976) two-step approach to circumvent endogeneity problems and shows that one can obtain the consistent estimates of the hyper-parameters and correct inference of the time-varying factor loadings with the proposed two-step approach. Therefore, we apply Kim’s (2006) two-step approach to infer the time-varying market betas under the learning CAPM of Adrian and Franzoni (2005).

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In the Korean stock market, investors must wait, on average, for about 3 weeks after subscription day to trade initial public offering (IPO) stocks. At subscription day, the underwriting firms receive orders for the IPO stocks from various investor groups such as employees of the issuing firm, institutional and individual investors. This results in creating time lapse, or non-trading period between subscription and listing day in Korea. This is quite different from the IPO process in the U.S. Such non-trading period may be a risk factor on the IPO investments. Because investors cannot trade the IPO stocks during the non-trading period, they cannot gain the trading profits when positive information for an IPO stock is obtained and vice versa. This paper examines how the existence of non-trading period affects the IPO underpricing as a new risk factor that can increase the expected losses of the IPO investments in the Korean stock market. To answer this research question, we first define non-trading period effect as the upper bound of dis- count rate for the offering price or the expected losses that can occur during the non-trading period. We then measure an option value of the non-trading period effect with option pricing model and analyze the effect of the option values on the IPO underpricing. Longstaff (1995) provided an option pricing model to estimate losses by implementing restrictions on stock trade. Assuming a perfect timer who knows the optimal selling point of the IPO stocks, a variant of Longstaff model is applied to estimate the maximum expected losses resulting from the restriction on trading IPO stocks as option values. To estimate the option value, we should measure the volatility of each IPO stocks. But that is impossible because IPO stocks have no past return data. As a proxy for the volatility of an IPO stock, we used the average of volatilities of the matching firms. Matching firms, which had to be listed at least 3 years prior to the listing day of the concerned IPO stock, were selected within the same industry of the IPO stock. Using the data of 602 IPO stocks listed in Korea exchange (KRX) with KOSPI and KOSDAQ boards from February, 2000 to July, 2007, we first analyzed the degrees of IPO underpricing using various initial return measures. We found that the IPO underpricing in the Korean stock market was very high and sustainable. The average initial return at listing day (= closing price of listing day/offering price -1) was 57.60%. And the averages of the other 3 initial returns, the average of holding period returns (HPR) and cumulating abnormal returns (CAR) calculated for 20 trading days and HPR from listing day to first negative stock return day after the listing day, were higher than the average returns at the listing day. The amount of initial returns at listing day is more than double the amount of that in the U.S market, which was reported by Ritter and Welch (2002). We found the evidence that non-trading period effect is one of the important factors which determine the IPO underpricing. The option values for non-trading period effect were 11.98% of the offering price on average, which is about 21% of the initial returns at the listing day. And the IPO underpicing increases as the option value of the IPO stock increases. When the 602 IPO stocks were divided into five groups by their option values, the average initial returns of the highest group fell in the range of 25~49%, significantly higher than those of the lowest group, and the highest group always showed higher initial returns among subsamples before and after the abolition of the market making rule and among those of listed markets, KOSPI or KOSDAQ. These results are consistent with the results of the regression analysis. Various factors were controlled to evaluate the effect on the initial returns of IPO stocks. The factors considered were the change of the market making rule, market returns before and at the listing day, and other IPO-related characteristic variables -IPO amount, competitive rate of subscription, firm age, ROA, leverage ratio, etc. The option value for non-trading period effect was significantly and positively related with initial returns of IPO stocks in all models. However, the effects of the non-trading period on the IPO underpricing decreased after the abolition of the market making rule. Previous papers suggested that the expected losses of underwriting firms resulting from the IPO regulations such as compulsory market making rule or put-back option rule are the main cause for the IPO underpricing. Above and beyond this cause, this paper suggests that the expected losses of investors during non-trading period are another important cause for the IPO underpricing in the Korean stock market.

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In this paper, we investigate how the ownership structure of a firm is related to its corporate policy on payouts. Previous literature has identified several goals that may guide firms’ payout policies such as signaling firm value or lowering agency costs. Some of these studies argue that firms may distribute their cash or engage in share repurchase programs in order to send a signal to the market that either they are undervalued or their future value will be higher. Other researches claim that firms might lower their agency costs by adopting a payout policy to lower free cash flows. The focus of our study is to investigate whether the ownership and the control rights of controlling shareholders are linked to corporate payout decisions. It has been widely recognized that there can be a discrepancy between the ownership rights (also known as cash flow rights) and the control rights of controlling shareholders. In the case of Korea, ownership by affiliated firms can contribute to such differences. Many Korean firms have subsidiaries that are interconnected through interlocking ownership and internal capital markets. Considering the corporate ownership structure, we measure control rights through all the cash flow rights of controlling shareholders and the voting rights of all subsidiaries. Thus, the control rights include all the shares under the influence of the controlling shareholders. First, we examine payout policies for all publicly traded firms in the Korean Stock Exchange between 1998 and 2005. For share repurchases, we collected information on corporate decisions to engage in open market share repurchases as well as to allocate resources to trust funds that specialize in treasury stocks. Since all publicly traded firms are required to disclose their decisions on share repurchases, we collect information on the announcement dates, the amounts, and the methods of share repurchases. In addition, for corporate decisions to distribute cash to shareholders, we use the annual information of cash dividends reported in their financial statements. We empirically test the determinants and effects of payout policy using the announcement information and the financial data of publicly traded firms. Based on empirical results from previous studies, we have controlled for other explanatory factors such as firm size, capital structure, volatility, market to book ratio, cash holding, free cash flow, and chaebol dummy. In addition to these explanatory factors, we also examine how ownership and control rights affect payout decisions. Overall empirical results in this paper can be summarized in three parts. First, we find that firms of which controlling shareholders have greater ownership and control rights are more likely to choose to pay cash dividends to their shareholders controlling for other factors. In contrast, firms with lower ownership and control rights are more likely to adopt share repurchase programs. These results are strong and statistically significant. Thus, our findings support the hypothesis that ownership structure affects corporate decisions to adopt payout policy. Second, we test whether firms with weak ownership rights are engaged in larger scale share repurchase programs. Specifically, we examine factors affecting the number of shares that a firm buys back or the proportion of firm resources allocated buying back shares. After controlling for the aforementioned explanatory factors, we find that firms with weaker ownership and control rights are more likely to both buy more shares and spend proportionately more resources, compared to firms with stronger ownership and control rights. Third, we examine the effects of payout policy on firm value. In particular, we investigate how announcements by firms to buy shares affect their stock returns. Under the efficient market hypothesis, investor decisions in the market are believed to reflect all information available in stock prices. Thus, the changes in stock prices reflect how the market evaluates the payout decisions of firms. We find that stock prices decline after the announcement of share repurchases by firms whose controlling shareholders have weaker ownership. This result is different from the positive stock returns shown in many earlier studies of share repurchases that did not examine ownership structure. Our result suggests that investors in the market perceive a negative consequence of share repurchases by firms with weak ownership structure and consequently, firm value declines. Taking into account all the results in this study, we conclude that a firm’s payout policy depends on ownership structure. Moreover, firms with weak ownership structures tend to adopt share repurchase programs at the cost of other shareholders.

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This study examines a large sample of M&As conducted in Korea since the financial crisis in late 1990s in order to investigate how announcement returns to acquiring firms differ among various types of acquisitions. We adopt the term ‘acquisition types’ inclusively: the legal procedures, intended goals, payment methods, and acquirer’s financial characteristics such as firm size. We try to get the sufficient sample size by including ‘acquisition of business’ and ‘acquisition of stock’, as well as ‘merger’ in our sample M&A firms. However, we exclude from our sample the backdoor listings that are fundamentally different from ordinary M&As in order to enhance the sample homogeneity. Most of existing empirical studies fail to distinguish backdoor listings from ordinary M&As in sample selection. In our preliminary analysis, the announcement returns of backdoor listings are estimated to be larger by more than twice the size of ordinary M&As. Based on the final sample of 396 acquisitions announced and completed by non-financial companies listed in the Korea Exchange (KRX) from January 2000 to June 2008, acquiring firms’ short-run stock performance (CARs) during the announcement period is examined to see if the market’s initial reaction is affected by such facts as: whether the transaction is a merger or acquisition; whether the acquisition is a diversifying or affiliated one or not; and whether the acquiring firm is large or small. Abnormal returns are measured using both the market adjusted and the market-model adjusted approaches, whose outcomes are basically similar. We perform our analysis both in a univariate setting and in a multivariate framework in which we control for other factors that may affect acquirer announcement returns. Our major findings are as follows. First, acquiring shareholders consistently earn positive abnormal returns for as long as 10 days prior to the announcement date, i.e., the date of decision by a board of directors. However, stock prices behave efficiently, showing seldom abnormal returns after the announcement date. Consequently, their CARs(-5, 1), on average, amount to 5.9%, statistically significant at the 1% level. The positive announcement effects on acquiring firms are more evident in domestic studies than those in foreign studies while the results are consistent with the empirical evidences of existing domestic studies. Furthermore, shareholders of firms in acquisitions of businesses earn positive abnormal returns (CARs(-5, 1)) of 11.1%, while those in abnormal returns to mergers and stock acquisitions are only 5.3%. The difference between these two is statistically significant. Second, acquirers of diversifying acquisitions significantly outperform in shareholders’ abnormal returns relative to acquirers of non-diversifying acquisitions. Although it has been commonly argued that non- diversifying acquisitions increasing the concentration of core business are more likely to create firm value, our empirical evidence supports the opposite. Our result seems to indicate that the stock market of the current decade values highly developing a new business area for the future growth through diversifying acquisitions. Third, acquirers of non-affiliated mergers significantly outperform in shareholders’ abnormal returns relative to those of affiliated mergers, both the acquirer and the target owned by the same major shareholder. The result is consistent with existing empirical findings, suggesting that affiliated mergers are usually initiated by corporate headquarters which have intention to remedy their ailing subsidiaries through mergers with better performing subsidiaries. Accordingly, shareholders of acquiring firms, namely well-performing subsidiaries, react negatively to the announcement of affiliated mergers. Fourth, we find the size effect on M&A transactions, which implies that announcement returns are inversely related with the acquirers’ firm size when measured in total assets and the market value of equity. The size effect is significant and robust in all the variations of regression models. However, the acquiring firm’s financial ratios measured prior to the year of merger completion such as free cash flow, debt ratio, book to market ratio, and profit margin do not have any significant effects on announcement returns. The targets’ financial data such as firm size and operating performance are not meaningfully related with the acquiring shareholders’ returns either. Lastly, it is commonly expected that announcement returns of acquisitions with stocks are less than those of cash acquisitions since acquiring firms would pay for their acquisitions with stocks when those stocks are overvalued and cash when they are undervalued. Although the extant foreign literature documents significant relations between the form of acquisition payment and announcement returns, we find no evidence that the method of payment conveys information about the acquirer’s firm value. Typically in Korea, all stock-financed acquisitions correspond to mergers as the legal forms of acquisitions, whereas all cash-financed acquisitions are of acquisitions of either stocks or businesses. Thus, it is possibly conjectured that the effect of payment methods is veiled by the legal forms of acquisitions.

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Two dominant theories explaining firms’ different level of cash holdings are the static trade-off model and the pecking order theory. According to the former, a firm holds cash and cash equivalent assets when the subject firms’ managers can easily enjoy the incentives from the transactions of such assets and the precautionary motive outweigh the cost and benefit of cash holdings. In contrast to the static trade-off model, the pecking order theory asserts that the level of firm’s cash holdings is determined passively and that the optimal level of cash holdings does not exist since a firm first expends on the profitable investment opportunities and then pays off the debt and accumulates cash holdings with what is left (Myers and Majluf (1984)). Most empirical studies have also placed emphasis on the static trade-off model and the pecking order theory. Both models exhibit exceedingly similar results that smaller-sized firms tend to increase the level of cash holdings, implying a greater degree of information asymmetry existing in a subject firm especially when its investment and R&D expenditures are projected to be high. Higher expenditures subsequently lead to higher future capital requirement and higher possibility of liquidity shortage owing to more volatility in past cash flows (Opler et al. (1999), Gong (2006)). On the other hand, as Myers and Rajan (1998) have mentioned, managers in a firm with a higher possibility of an agency problem due to the separation of ownership and management are likely to have an incentive to hold more cash assets. This is because cash and its equivalents are the easiest types of assets with which managers can exercise their discretional power.. Conversely, at a firm with more transparent corporate governance, on the other hand, its management has less incentive to hold more cash assets as a way to expand his/her discretional power since, then, such firm closely monitors management’s transactions, which reduces the possibility of the agency problem. As such, based on the previous studies, we examine whether the agency theory, as well as the static trade-off model and pecking order theory, is also a significantly influential factor in deciding the level of cash holdings for Korean companies. Most studies consider only partial elements of corporate governance such as ownership structure including shareholding ratios of management, or institutional investors and foreign investors as proxy variables for the possibility of agency problem. Unlike those preceding studies, we use a unique data set of the firm-level corporate governance scores on an annual basis as a proxy variable for the degree of agency problem. The data are being provided by the Korea Corporate Governance Service (KCGS) every year, following the evaluation of listed firms’ ownership structures and governance structures. In addition, we provide an empirical evidence on how the agency problem affects a firm’s level of cash holdings based on our analysis of 2,541 sample firms listed in the Korea Stock Market between 2002 and 2006. We collect an individual firm’s annual financial statement data, stock price data, and composite data with respect to Korean business groups (aka. chaebols) from KisValue II and FnDataGuide. The annual ratio of average cash holdings to total assets ranges from 9.34% to 10.42%. We also consider the standardized score of shareholder protection, board of directors, corporate disclosure (transparency), auditing organization, and earnings distribution which altogether constitute the total corporate governance score. By controlling various factors of the static trade-off model and the pecking order theory, we find that firms with sound corporate governance, especially those that enforce strong shareholder protection rules, tend to reduce the level of cash holdings. Moreover, we also undertake various robustness tests to control for the effects of endogeneity problems of corporate governance and the characteristic of panel data. Furthermore, we provide additional evidence reinforcing our results and the agency theory. We conclude that chaebols show lower levels of cash holding ratios than non-chaebols do, if all else equal. The tendency of the lower the level of cash holdings the better corporate governance the firm has is found more apparent in chaebol firms than in non-chaebol firms. Further, as the level of cash holdings of the other group-affiliated firms increases, the firm’s cash holding ratio becomes lower, implying that the static trade-off model and the pecking order theory have less influence on the cash holdings due to the existence of internal capital markets within Korean chaebol groups. In other words, internal capital markets within chaebols indeed have a substantial impact on the group-affiliated firms and allow them to maintain lower level of cash holdings than those of non-chaebols, all else equal. Overall, this paper provides the evidence strongly supportive of the agency theory and shows that differences in the intensity of agency problem across firms play an important role in explaining the different levels of firms’ cash holdings.

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This paper analyzes the firm-bank relationship from a borrower (firm)’s perspective using the data of Korea’ s listed firms and banks in transaction relationships (say related banks). For the analysis, I use a number of related banks or the of dependence of a firm on the main bank as measurements of firm-bank relationship. Further, the more related bank means that the firm has many ties with banks, which implies the firm can make new relationship with new bank easily. However, each tie is weak in the strength. In the other hands, the more dependence on the main bank means that the firm has the deeper relationship with the main bank. The firm characteristics for the analysis are classified into four categories. The first includes the information asymmetries on the borrower. Firm size, firm history and proportion of tangible assets among total assets are used to capture the information asymmetries. In particular, the firm with bigger size or longer history might have lower information asymmetries in the loan market. The more tangible asset of a firm, often hold as a mortgage in the loan contract, also could decrease the information asymmetries in loan market. The second category includes the performance and the risk of the borrower. ROA and the interest expenses-sales ratio capture the performance and the risk of the firm respectively. The firm showing better performance or with lower risks has less trouble to make a new relationship with new banks. However, these variables does not indicate the depth of relationship between a firm and banks. The third includes the characteristics regarding the growth and investment of a firm. Growth rate in sales and average growth rate in sales for recent five years are used to capture the growth characteristic of a firm. Further, investment activity of a firm is measured by the increase in tangible asset divided by total asset of a firm. Since the firm with fast growth and intensive investment is more likely to have the higher information asymmetries in the loan market, the firm might have trouble to raise funds from banks except the main bank. Therefore, we expect that the growth and investment of a firm are loosely related to the depth of relationship with banks. The fourth is the financial soundness, which is important factor to determine the firm-bank relationship. The financially sounder firm can raise funds easily from only limited numbers of banks. Thus, the sounder financial status of a firm implies the deeper relationship with banks. Since the paper analyzes the firm-bank relationship in the firm’s perspective, I control the characteristics of banks for the analysis using variables like ROA and size of main bank. To control the effects of firm’s dependency on the bank loan, size of bank loans of a firm divided by total liabilities is used. Furthermore, year and industry dummies are included to control the effects of macro economic condition or industry characteristics. The result of empirical analysis shows that borrower with lower information asymmetries is easier to find new relationships with banks and has lower dependency on the main bank. Tuning to the performance and risk of a firm, the firm showing better performance or with lower risks is easier to find new relationship with banks and has lower dependency of the main banks. However, a firm with fast growth and intensive investment is more likely dependent on the main bank to raise funds. Also the result suggest that a firm with the sounder financial status has the smaller number of related banks and the higher dependence on the main bank. In summary, borrower with lower information asymmetries, better performance, and lower risks is more likely to have multiple ties with banks than growth-oriented (or investment-oriented) firms. However, the dependency on the main bank is stronger in growth-oriented (or investment-oriented) firms. In addition, the financial soundness make strengthen the relationship between the borrower and the main bank. It is a common belief that the alleviation of information asymmetry in the loan market can improve the intermediary role of banks. Also the strengthening of main bank stimulates the growth or investment of small-medium enterprise. Moreover, financial soundness of firms is crucial to strengthen the firm-bank relationship and enhance the intermediary role of banks. The analysis in this paper using Korean data empirically supports these common beliefs. However, this paper has several limitations to be improved in future researches. The empirical results are obtained from the recent Korean data, and the time-span of data is not sufficient. Therefore, more rigorous studies are required to generalize the result of this paper. Further, although simple test of correlation among variables shows that endogenous problem is negligible, still the endogenous problem could exist.

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