Asian Review of Financial Research

pISSN: 1229-0351
eISSN: 2713-6531

Past Issues

Past Issues

Asian Review of Financial Research / August 2014 Vol. 27 No. 3

The Effect of House Prices on Mortgage Prepayment in Korea : A Two-Factor Structural Approach

Young Ho Eom;Youngha Han;Jaehoon Hahn

Asian Review of Financial Research :: Vol.27 No.3 pp.383-422

Abstract
The Effect of House Prices on Mortgage Prepayment in Korea : A Two-Factor Structural Approach ×

We estimate a two-factor structural mortgage valuation model using data on pool-level termination rates for fixed-rate mortgage loans issued by the Korea Housing Finance Corporation (KHFC) between 2004 and 2008. Our model is a modified version of that proposed by Downing, Stanton, and Wallace (DSW, 2005), in which borrowers rationally decide when to prepay and default in response to changes in house prices as well as interest rates. DSW (2005) find that incorporating house price movements into the model significantly improves its ability to match historical prepayment data over Stanton's (1995) one-factor (interest rate only) model. In DSW (2005), house price changes are modeled to affect borrowers' termination behavior only when prices decline by increasing the value of default option, but this particular specification does not bode well for our Korean sample period, during which house prices did not experience substantial or sharp declines. Consequently, we modify DSW's (2005) two-factor model so that house price movements influence termination behavior when prices increase as well as when prices decline. In contrast to the structural model used in this paper, previous empirical research on mortgage prepayment in Korea has mostly used statistical models, in which termination behavior is modeled as a function of a set of exogenous variables such as interest rates and house prices that represent the factors affecting prepayment and default. While such statistical approach may produce estimated prepayment rates that are closer to the historical data, its out-of-sample forecasting power is likely to be low, and the model is not suitable for pricing mortgage-backed securities. The structural approach taken in this study, on the other hand, models prepayment and default as a rational borrower's optimal responses to the changes in interest rates and house prices that represent the model's state variables. Such structural models should perform better out of sample than statistical models, and they can be used in the valuation of mortgage-backed securities. The mortgage prepayment data used in this study are from 34 pools of fixed-rate mortgage loans (called Bogeumjari loans) issued by the KHFC. The sample period is from June 2004 to December 2010, and the prepayment rates at the pool-level, as published monthly by the KHFC, are used. The empirical results show that both interest rates and house price changes significantly affect prepayment rates. In particular, house prices and prepayment rates have a positive association, consistent with Park and Bang (2011) and Choi and Kim (2011), who use statistical models. In addition, incorporating house price movements into the model improves its performance in matching historical prepayment rates, compared to the model in which only interest rate movements are considered. The results of Davidson and MacKinnon's (1981) J-test selecting between non-nested models show that the two-factor specification that includes house prices and interest rates is better for estimating prepayment rates than the one-factor (interest rate) specification. Moreover, we find that the two-factor model produces prepayment forecasts that are closer to the historical data than the one-factor model in an out-of-sample test. In a structural model, mortgage terminations (prepayment or default) are the result of borrowers' optimizing behavior, and house price movements can affect the borrowers' termination behavior as follows. When house prices fall, the value of the default option implicitly held by the borrower increases. And the movements in the value of the default option significantly affect the value of the borrower's prepayment option and therefore, the likelihood of prepayment. However, we find that prepayment rates decrease with declining house prices. The house prices in Korea experienced some declines during our sample period, but not by any substantial degree. Our finding of lower prepayment rates in times of declining house prices is similar to Mattey and Wallace (2001), who find that weak house prices tend to depress refinancing and prepayments. When house prices increase, so does the collateral value of the houses and the value of the borrower's equity, which influences the likelihood of prepayment if, for example, the borrower wants to cash out some of the increase in equity. This argument is consistent with the higher prepayment rates during times of increasing house prices found in this paper. More specifically, the period of increasing house prices in our sample is from late 2006 to early 2007, which coincides with rising interest rates. Despite the rising interest rates and penalties for prepayment, prepayment rates during that period increased in close association with rising house prices, suggesting that both interest rates and changes in house prices significantly affect mortgage prepayment rates in Korea.

Download PDF Export Citation
The Effect of House Prices on Mortgage Prepayment in Korea : A Two-Factor Structural Approach ×
  • EndNote
  • RefWorks
  • Scholar's Aid
  • BibTeX

Export Citation Cancel

Credit Ratings and Equity Returns

Taekyu Kim;Jungsoon Shin

Asian Review of Financial Research :: Vol.27 No.3 pp.423-455

Abstract
Credit Ratings and Equity Returns ×

Given the numerous studies showing that firm size and book-to-market (BM) ratio are significant variables in explaining the cross-section of equity returns, size and BM effects have become the most notorious anomalies in asset pricing. Chan, Chen, and Hsieh (1985) and Chan and Chen (1991) argue that a default factor explains much of the size effect, and Fama and French (1992, 1993) show that the BM effect may be due to firms' financial distress risks. As small firms with high BM ratios are likely to suffer from financial distress, the positive relationship between financial distress risk and equity returns may provide a rational risk-based explanation for size and BM effects. However, much of the research indicates that financially distressed stocks earn abnormally lower returns. In this study, we investigate the relationship between financial distress risk, proxied by corporate bond credit ratings, and equity returns in the Korean stock market. Dichev (1998) examines the relationship between bankruptcy risk and subsequent equity returns and finds that higher distress risk is not rewarded by higher returns. The result appears to be inconsistent with a distress factor explanation of size and BM effects. Griffin and Lemmon (2002) explore the relationship between BM ratio, distress risk, and stock returns, and document that stock returns are lower for firms with low BM ratios and high distress risk. Their study is consistent with the “overreaction hypothesis” associated with the BM effect, and the “underreaction hypothesis” for the distress effect, implying that the BM effect is not likely to be explained by the distress risk factor. Vassalou and Xing (2004) argue that firms with higher default likelihood indicators earn higher returns. They present their analysis as a risk-based explanation of the BM effect. However, Da and Gao (2010) show that their results are driven by penny stocks and first-month reversals. Campbell, Hilscher, and Szilagyi (2008), Garlappi, Shu, and Yan (2008), and Da and Gao (2010) also confirm the negative relationship between distress risk and equity returns. The finding that stocks with high distress risk are not compensated by high returns in the stock market suggests an anomaly called “the financial distress anomaly” or “the financial distress risk puzzle.” There are several ways to measure a firm's default risk to examine the relationship between distress risk and stock returns. First, a logit model can be used to measure a firm's distress risk (Ohlson, 1980; Shumway, 2001; Chava and Jarrow, 2004). Griffin and Lemmon (2002), Campbell et al. (2008), and Chava and Purnanandam (2010) adopt the hazard rate estimation methodology. The second approach is based on Merton's (1974) call option pricing model. Vassalou and Xing (2004) and Kim and Park (2010) use the call option approach to measure a firm's distress risk. The third measure is the credit ratings announced by credit rating agencies. Avramov, Chodia, Jostova, and Philipov (2009) investigate the relationship between the credit ratings provided by Standard & Poor's and stock returns. In this study, we use credit ratings to measure firms' distress risk. The empirical results are summarized as follows. First, as credit ratings deteriorate, the average excess returns on the credit rating-sorted quintile portfolios decrease. The average monthly excess returns on the best (worst) rating quintile are 1.187% (-1.789%). The Capital Asset Pricing Model, Fama-French three-factor, and Carhart four-factor alphas for the credit rating quintiles also decline with the credit ratings. The return on the long-short portfolio holding stocks to the best rating quintile and shorting stocks to the worst rating quintile is significantly negative (-2.976%). These relationships hold after controlling for firm size, BM ratio, and momentum. Second, we run Fama-MacBeth regressions to examine the relationship between credit ratings and the cross-section of equity returns, and document that the coefficient on the credit rating variable is significantly negative. This finding implies that the credit rating is a significant factor in determining the cross-section of stock returns. For robustness checks, we confirm the negative relationship between distress risk and equity returns after removing downgraded firms and penny stocks from the sample. Finally, we report that market betas and loadings on the HML and SMB factors do not decrease as credit ratings decline, implying that a rational risk-based explanation is unlikely to account for abnormally low returns on stocks with bad credit ratings. Our empirical results do not support the conjecture that distress risk may be behind size and BM effects, due to evidence that distress risk is negatively related to equity returns. Kim and Park (2011) argue that default risk is positively related to stock returns in the Korean stock market. This study challenges them based on the “financial distress anomaly” in the Korean stock market.

Download PDF Export Citation
Credit Ratings and Equity Returns ×
  • EndNote
  • RefWorks
  • Scholar's Aid
  • BibTeX

Export Citation Cancel

The Short- and Long-Term Performance of Venture-Backed IPO Kosdaq Firms and the Roles of Venture Capitals in Korea

Sekyung Oh;Hyung-Ho Han

Asian Review of Financial Research :: Vol.27 No.3 pp.457-491

Abstract
The Short- and Long-Term Performance of Venture-Backed IPO Kosdaq Firms and the Roles of Venture Capitals in Korea ×

It is well known that venture capitals perform the certification role that reduces the underpricing of IPO firms by alleviating the information asymmetry between insiders and public investors. However, previous Korean studies suggest that the certification role played by Korean venture capitals is not supported—in contrast to the findings of foreign studies. It is also known that venture capitals perform the management support role that accommodates the growth of venture-backed firms and enhances the value of their portfolio companies—a direction explored by few in Korea. In this study, we analyze the short- and long-term performance of IPO firms and the certification and management support roles of venture capitals in a sample of 263 venture-backed IPOs and 213 non-venture-backed IPOs in the Kosdaq market from 2002 to 2012. Specifically, abnormal returns (AR) or cumulative abnormal returns (CAR) can be affected by the early sale of venture capitals' equity stakes after IPO, so we test their roles by dividing venture-backed IPO firms into two groups: one in which equity shares are sold early and the other in which they are not sold by venture capitals after IPO. The results of previous domestic studies on these issues are not reliable due to a limited data sample problem, and the restrictions inherent in not considering important changes such as the determination method of first day opening price and the lock-up period in Korea. As early sales of venture capitals' equity stakes can negatively affect the CAR of venture-backed IPOs, and the certification and management support roles played by venture capitals, we divide venture capitals into two groups based on whether they sell their equity stakes early or not. We then test for differences in the roles between the two groups. We find that Korean venture capitals perform the certification role after controlling the variables affecting the short-term performance of IPO firms and that the role strengthens as their equity stakes in IPO firms increase, based on the regression results for first day AR and one month CAR. However, the certification role played by venture capitals is not observed among venture-backed IPO firms whose equity stakes are sold early by venture capitals after the IPO. To analyze the effect that the equity sale of Korean venture capitals has on their certification role further, we divide venture-backed IPO firms into three groups: firms in which equity shares are sold by venture capitals immediately after IPO, those in which equity shares are sold by venture capitals within a month from the second day after IPO, and those in which equity shares are not sold at all by venture capitals within a month after IPO. The regression results show that for the second group, the certification role cannot be found at the 5% significance level and for the other groups, the certification role is not statistically significant. Our analysis of the regression results on three-year buy-and-hold average returns (BAHRs) show that Korean venture capitals do not perform the management support role after controlling the variables affecting the long-term performance of IPO firms. The long-term performance of venture-backed IPO firms decreases as the equity stakes of venture capitals increase. We also test whether the early equity sales of venture capitals prompt the underperformance of venture-backed IPO firms by dividing them into three groups again. The regression results show that as venture capitals sell more their equity shares of venture-backed IPO firms immediately or within a month from the second day after IPO—their BHARs decrease. In contrast, for venture-backed IPO firms in which equity shares are not sold by venture capitals, the BHARs increase as expected, although not with statistical significance. The results suggest that it is very difficult to anticipate the management support role of Korean venture capitals because they sell their equity stakes early (137 out of 263 portfolio companies). This implies that Korean venture capitals are trying to exit as early as possible through the IPOs of their portfolio companies instead of accommodating long-term, win-win growth. Korean President Park Geun-hye's new government is concentrating its efforts on nurturing innovative small and medium-sized companies under the slogan, “Creative Economy.” Hence, the role of venture capitals as a main financing source and value creator for venture firms is more crucial than it has ever been. However, as this study shows, if the management support role is not adequately performed, venture capitals' involvement will be limited to providing funding assistance. Therefore, more research on how to develop the management support role played by Korean venture capitals is needed for “Creative Economy” to be successful. The myth that the long-term performance of venture-backed IPO firms is worse than that of non-venture-backed IPO firms in Korea must be investigated further.

Download PDF Export Citation
The Short- and Long-Term Performance of Venture-Backed IPO Kosdaq Firms and the Roles of Venture Capitals in Korea ×
  • EndNote
  • RefWorks
  • Scholar's Aid
  • BibTeX

Export Citation Cancel

Analysis on Dysfunction of the Backdoor Listing in Korea

Joon-Seok Kim;Youngkyu Park;Seokhoon Lee

Asian Review of Financial Research :: Vol.27 No.3 pp.493-528

Abstract
Analysis on Dysfunction of the Backdoor Listing in Korea ×

In a backdoor listing, often called a “reverse merger,” an unlisted or “pearl” company obtains listed status by acquiring management control of a listed or “shell” company. Such backdoor listings provide unlisted companies with synergistic mergers and acquisitions (M&A) opportunities and the benefits of being listed. However, the reality is that the companies using this method are often involved in unfair trading scandals that harm investors, or become insolvent shortly after listing. For example, NeosemiTech was delisted in an accounting fraud scandal and issued an audit opinion of rejection on August 23, 2010, less than a year after its backdoor listing through its merger with Mono Solar, a KOSDAQ listed company. This backdoor listing practice raises many theoretical and regulatory issues because backdoor listings integrate aspects of both IPO and M&A. Adjei, Cyree, and Walker (2008) investigate the characteristics of companies using reverse mergers and Gleason, Rosenthal, and Wiggins III (2005) study the characteristics and performance of reverse mergers. In Korea, the research focuses on the factors affecting the choice between backdoor listing and IPO, the market reaction to backdoor listing, and the performance of the companies listed through reverse mergers (e.g., Kim and Lee, 2009; Choi and Lee, 2006; Park, Park, and Pae, 2009; Yun and Kang, 2009). While the literature documents the aforementioned typical features of backdoor listing, we focus on the deterioration of backdoor-listed companies—one of the most noted stylized facts in the literature that has barely been explored. In addition, our study is the first of its kind in the backdoor listing literature to investigate the corporate governance of shell companies as well as the financial characteristics of shell and pearl companies. In this study, we conducted an empirical analysis using 104 backdoor and 189 regular listing cases from July 2006 to June 2010 in the KOSDAQ market. Similar to the results of previous studies, backdoor listing was preferred over regular listing by companies that were smaller, had lower net profit margins, or were subject to information asymmetry. This held true regardless of whether the pearl companies met the quantitative listing requirements in the KOSDAQ market. Second, the shell companies were more likely to be businesses that could easily merged due to their smaller size, lower ownership of the largest shareholders, and poor performance. Third, an analysis of the public disclosures revealed that compared to firms that undertook regular listing, backdoor-listed firms reported the following cases more often: violation of regulations, changes in governance structure, and delisting. Backdoor-listed firms were also more likely to experience distress shortly after the listing, when the shell company's largest shareholders had a low ownership share and the shell company saw frequent changes in its corporate governance, or when the pearl company experienced higher profits just before the listing. Fourth, high positive excess return was observed around the date when the backdoor listing was disclosed and negative excess return occurred after the designated date. The cumulative excess return before and after backdoor listing was high for the shell companies that violated regulations before a reverse merger, implying that the investors positively evaluated the reverse merger's effect on the governance reorganization of the shell company. However, the cumulative abnormal return after the designated date was lower for the pearl companies that recorded higher profits right before backdoor listing, which shows that pearl companies sometimes window dress before backdoor listing. The findings in this study demonstrate that backdoor listing is likely to occur with a shell company that is small in size, has relatively lower ownership by the largest shareholders, exhibits poor performance, and whose business is irrelevant to that of the pearl company. Often, the motive for the backdoor listing is the acquisition of listed status rather than the creation of synergy, resulting in a high probability that pearl companies choose backdoor listing because they fail to meet the quantitative or qualitative requirements for a regular listing.. We found that backdoor listed companies that merged with shell companies under weak corporate governance experienced investor protection- related problems or delisting more frequently, emphasizing the importance of examining qualitative requirements during the backdoor listing process. Hence, our study ascertains that the qualitative inspection system for backdoor listing introduced in September 2010 is appropriate.

Download PDF Export Citation
Analysis on Dysfunction of the Backdoor Listing in Korea ×
  • EndNote
  • RefWorks
  • Scholar's Aid
  • BibTeX

Export Citation Cancel

Controlling Shareholders and the Choice of Bank Loans

Yu Kyung Lee;Eun Jung Lee;Joon Chae

Asian Review of Financial Research :: Vol.27 No.3 pp.529-565

Abstract
Controlling Shareholders and the Choice of Bank Loans ×

In this study, we investigate the relationship between the ownership of controlling shareholders and the proportion of bank loans in total debt. According to the literature, when the ownership of controlling shareholders is large enough, it incentivizes the controlling shareholders to pursue their private interests. If it is low, however, outside investors and other stakeholders, including the governance system of the company, prompt the managers of the company to maximize the firm value (Demsetz, 1983; Fama and Jensen, 1983; Morck et al., 1988). Thus, there is anon-linear relationship between the ownership of controlling shareholders and the firm value that is, until a certain level of executive ownership is reached, it increases the firm value, but if it exceeds a critical level, the firm value decreases due to controlling shareholders' pursuing their private interests (Stulz, 1988; Morck et al., 1988; McConnell and Servaes, 1990; Kim, 1992). According to the theories that controlling shareholders behave differently based on their ownership, in this study, we test whether there is a non-linear relationship between the ownership of controlling shareholders and different debt capital choices. We empirically confirm that the ownership of controlling shareholders has a non-linear relationshipwith the proportion of bank loans in total debt. Specifically, the controlling shareholders whose ownership is below (above) a certain level prefer (accept fewer) bank loans. We also consider the firm characteristics and the level of monitoring when investigating the relationship between the ownership of controlling shareholders and debt capital choices. Our analysis shows that a firm in financial distress seems to avoid the use of bank loans even when the ownership of controlling shareholders is low. We argue that the controlling shareholders of a firm in financial trouble are more likely to follow their private interests and evade the tight monitoring of the banks providing the loans (Johnson et al., 2000; Lin et al., 2013). Our investigation also addresses how a company's age affects the relationship between the ownership of controlling shareholders and debt capital choices. If a firm is older and the ownership of controlling shareholders is high (low), a bank loan (public debt) is preferred. To analyze the effect that monitoring has on debt capital choices, we use several important proxies for monitoring, such as the ownership of foreign investors, institutional ownership, and the presence of multiple large shareholders. The test shows that foreign investors seem to effectively monitor firms, such that when foreign ownership is large enough, the improved monitoring encourages firms to take more bank loans (Baek et al., 2004; Shin et al., 2004). When there are multiple large shareholders, the ownership of controlling shareholders is positively related to the proportion of bank loans in total debt, even over the critical level of controlling shareholder ownership. We interpret this result as follows. Multiple large shareholders can monitor a firm and its controlling shareholders (Maury and Pajuste, 2005), which prompts the firm to use more bank loans despite the fairly large ownership of controlling shareholders. Finally, we implement additional analyses for robustness checks. We investigate the endogeneity between a firm's ownership structure and its debt capital choices using a causal analysis. The investigation verifies our hypothesis that although the ownership of controlling shareholders affects debt capital choices, the latter does not affect the former. In addition, our results hold with different methods of inference, such as clustered error estimation or Fama and MacBeth's (1973) method. Therefore, we confirm our hypothesis that a firm with less ownership of controlling shareholders takes more bank loans than one with more ownership. This study contributes to the literature in the following ways. First, we apply Panano and Roell's (1998) theory on the decision between IPO and block sales of equity to debt capital choices. They argue that controlling shareholders consider the benefits and costs of IPO compared to the injection of new equity capital through other large shareholders. The cost of IPO is the listing cost and the benefit is less monitoring by diverse minority shareholders after the IPO. We apply this theory to debt capital choices and empirically verify it. Second, we expand on Lin et al. (2013) by including the ownership of controlling shareholders as a main variable in our investigation. Lin et al. use a wedge in their study and find a linear relationship between it and debt capital choices, whereas we find a non-linear relationship between the ownership of controlling shareholders and debt capital choices. Third, we consider the level of monitoring in our main investigation. Extant studies include a firm's characteristics, but not the level of monitoring, in this vein of research. Fourth, the Korean financial market is one of the best testing platforms from which to observe controlling shareholders' behavior, especially the pursuit of private interests, as most companies have concentrated ownership structures and are included in conglomerates known as “Chaebols.”

Download PDF Export Citation
Controlling Shareholders and the Choice of Bank Loans ×
  • EndNote
  • RefWorks
  • Scholar's Aid
  • BibTeX

Export Citation Cancel

1
Export citation