Asian Review of Financial Research

pISSN: 1229-0351
eISSN: 2713-6531

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Asian Review of Financial Research / January 2014 Vol. 27 No. 4

Efficiency and Tunneling of Intra-Group Transactions between Korean Large Business Groups and Medium Business Groups

Yoon A Lee;Kang Heum Yon

Asian Review of Financial Research :: Vol.27 No.4 pp.567-601

Abstract
Efficiency and Tunneling of Intra-Group Transactions between Korean Large Business Groups and Medium Business Groups ×

This study analyzes the efficiency of internal business transactions by comparing the effect of intra-group sale and purchase transactions on business performance, using listed companies that engaged in transactions between sales-related subsidiaries from 2005 to 2010 as subjects. We classify large and medium business groups based on whether a business group is on the mutual investment restriction list, which the Fair Trade Commission announces annually, and compare the transaction behavior difference and efficiency of the transaction effect. To directly review the change in the transaction performance of companies whose affiliations have changed from large to medium business groups due to changes in the large-size, business-group designation criteria, we perform an additional panel analysis using a business-group affiliation change dummy variable (CHANGE). By analyzing business performance using business-group designations that are related to government regulations, we investigate the effectiveness of the current regulatory policies. The main empirical analysis is based on a model that applies an affiliation dummy variable (GROUP). Our analysis compares the transaction efficiency between subsidiaries for each business-group designation. When the variables included in the regression model are considered to be corporate characteristic variables that can interact as factors to determine the size and behavior of the transactions between subsidiaries, it is possible for the internal transaction ratios (SR, PR, SPR) to become endogenous explanatory variables. Hence, we use the results of the two-stage least squares estimation method to control the endogeneity problem. We use the average value of the internal transaction ratio of industry, the number of business group-affiliated subsidiaries, and industry correlation as the instrumental variables for estimating the internal transaction ratio variables. The results are as follows. First, according to the regression analysis of the effect of sale and purchase transactions between subsidiaries on firm performance, the transactions between subsidiaries of a large business group subject to regulations have a significant, positive impact on business performance, and thus support the efficient-transactions hypothesis. In contrast, we find a significant negative correlation between the intra-group transaction ratio and firm performance in unregulated, medium-sized business groups. This evidence is consistent with the tunneling and inefficiency hypothesis, which supposes that large Korean business groups have used transactions with affiliates to illegally transfer owner's wealth and management rights. Interestingly, we can confirm that the inefficiency of unfair internal transactions is observed in medium business groups rather than in large business groups. This is contrary to common belief and the findings of previous studies on Korean Chaebol firms. Second, according to the results of the analysis of the intra-group transactions effect before and after the point of regulation change based on using a business-group affiliation change dummy variable, the transactions between subsidiaries of a company for which the affiliation has changed from a large business group to an unregulated medium business group have a significant negative impact on firm performance. We interpret this result as follows. The change in affiliation of a regulated business group to a non-regulated business group has a significant negative impact on the effect of transactions between subsidiaries. This study contributes to the literature on business groups by comparing the firm performance between two groups, before and after regulation change. In summary, differences in the efficiency of transactions between subsidiaries are revealed based on their affiliation with a large business group and the change of affiliation to a medium business group. In other words, the efficiency of internal business transactions depends on whether the firm belongs to large business group or not, and the business group's regulation designations are very important. The findings of this study thus provide the following suggestion for government policies: rather than the ex-ante, uniform method for regulating transactions between subsidiaries based on the large business group designation system, institutional supplementation is needed in the form of an ex-post regulation method based on the expansion of the target range for regulation and judgment of appropriateness. If restriction is uniformly applied to all transactions between subsidiaries based on the large business group designation system, it may constrict even efficient business management activities. Hence, the appropriateness judgment criteria for evaluating the efficiencies of individual transactions between subsidiaries are needed, and rather than the method of regulating ex-ante internal transactions outright, ex-post regulation based on the actual content of individual internal transaction is desirable. It is necessary to adjust a range of regulated firms and to complement monitoring systems for unfair trade practices, based on ex-post evaluations.

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The Information Content of Japanese Asset Sales

Sanglae Lee

Asian Review of Financial Research :: Vol.27 No.4 pp.603-630

Abstract
The Information Content of Japanese Asset Sales ×

This study examines the voluntary asset sales that took place in Japan from 2000 to 2007. Asset sales increased rapidly after the introduction of a new stock swap and transfer scheme under the Commercial Code Revision in the late 1990s. The unwinding of cross shareholding also forced managers to sell underperforming divisions to maximize shareholder wealth. The study investigates the effect of asset sales announcements and analyzes the motivation for asset sales. In particular, it verifies that information asymmetry influences asset sales. Based on asymmetric information, management can observe the performance of each division, but markets can only observe the total performance of a diversified firm. Hence, markets are likely to underestimate a firm's value. When firms are undervalued, they not only resort to selling overvalued assets for funds, but they also receive a proper evaluation by providing clearer financial information on undervalued assets. This suggests that the announcement of asset sales is positively related to the stockholder's wealth and mitigates the information gap. The results are as follows. This study uses 262 voluntary asset sales and a market model to investigate the announcement effects. We find that the announcement of asset sales is significantly positive for abnormal returns of 1.09% per day (-, +1). This suggests that asset sales convey information on corporate fundamental values if the management has access to complete information and attempts to evaluate the wealth of existing shareholders. In addition, we analyze the relationship between the cumulative abnormal return (CAR) and motivation of asset sales. Hite et al. (1987) suggest that management only operates assets for which they have a comparative advantage and sells inefficient assets. This is the so-called efficient hypothesis of asset sales. John and Ofek (1995) report that returns are higher, and the firm experiences increased operating performance, when asset sales lead to a more focused firm. This is called the focus hypothesis. However, Lang et al. (1995) argue that asset sales are used to raise capital and show that announcement returns depend on the use of the proceeds, and positive returns only occur when proceeds are paid out to creditors or shareholders. They call this the financing hypothesis. The main empirical results are not consistent with the above three hypotheses. First, to test the financing hypothesis, the entire sample is classified into two subsamples: the payout sample (54 asset sales) and there investment sample (146 asset sales). The abnormal returns of payout firms are not significantly different than those of reinvestment firms. This result is not consistent with the financing hypothesis, which asserts that an agency problem, through management's discretion, affects asset sales return. Second, we find that the sample has 118 focused asset sales and 82 non-focused asset sales. The CAR (-1, 1) of focused firms is 0.17%, which is 1.35% lower than that of the other firms, but the difference is not significant. This result also does not support the focus hypothesis. Third, according to the efficient hypothesis, management who inefficiently operate their assets will transfer it to others who may operate it more efficiently. We use Tobin's q as a proxy variable representing firm efficiency. Tobin's q for sellers is not lower than that of buyers. In addition, the median CAR of the buyer is significantly negative. These results are not consistent with the hypothesis that the positive effect of asset sales is due to improved efficiency. Fourth, we find that the degree of information asymmetry of asset sales firms is significantly higher than that of matching firms. We identify matching firms using the methodology developed by Barber and Lyon (1996). The degree of information asymmetry significantly decreases after asset sales. This suggests that information asymmetry is related to asset sales. Furthermore, in cross-sectional regressions of CAR (-3, +3), the coefficient of information asymmetry is significantly positive, whereas the coefficients of the debt-pay dummy and focus dummy are non-significantly negative. This also supports the notion that information asymmetry influences asset sales. The results of the other control variables are as follows. Firm size is not related to the announcement effect. Tobin's q is significantly positive and market return is significantly negative, suggesting that positive market response is due to the availability of information on which firms are undervalued. The coefficients of ROA and leverage are statistically insignificant, which does not support the findings of Hite et al. (1987) and Lang et al. (1995). Finally, we analyze whether asset sales are associated with investments and find that the sensitivity of investments and the proceeds of asset sales are positive and statistically significant. This is consistent with the view that firms improve their market value using asset sales that reduce information asymmetry.

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Informed Trading before Analyst Recommendation Changes

Tae-Jun Park;Kyojik Roy Song

Asian Review of Financial Research :: Vol.27 No.4 pp.631-668

Abstract
Informed Trading before Analyst Recommendation Changes ×

Analyst reports, which contain views on whether to buy or sell particular stocks for clients, usually include earnings forecasts, long-term growth forecasts, and /or stock recommendations. In general, analysts' stock recommendations fall into one of five categories: strong buy, buy, hold, sell, or strong sell. Analysts revise their recommendations by upgrading or downgrading them when needed. The recommendation changes are commonly regarded as useful information and lead to changes in stock prices. Investors expect analysts to provide objective, unbiased, and accurate equity research reports based on the best of their knowledge. However, the literature has accumulated evidence that sell-side analysts' forecasts are tainted and not objective. Sell-side analysts working for investment bank shave pressure to provide optimistic recommendations on firms that can provide business to the investment banks. Analysts working in brokerage houses also have pressure to provide optimistic recommendations to attract trading revenues because upgrades attract more business than downgrades due to restrictions on short selling. Consistent with this conflict of interest, previous literature has found that analysts affiliated with investment banks and brokers produce more optimistic earnings and are more likely to give buy recommendations. In addition, if some investors have access to the contents of upcoming analysts' reports in advance, then they can take advantage of the superior information contained in those reports. Irvine, Lipson, and Puckett (2007) test the “tipping hypothesis” based on data on initial recommendations and document that brokerage firms provide the contents of affiliated analyst reports to important clients who generate large trading commissions before the information becomes public. We extend this line of research by examining the daily trading data on Korean stock recommendation changes from 2001 to 2010. The advantage of using Korean data is that we can obtain the daily trading volume by investor types for all stocks traded on the Korean Stock Exchange (KSE) and on the Korea Securities Dealers Automated Quotation (KOSDAQ). Our sample consists of 1,708 upgrades and 2,035 downgrades for 223 unique industrial firms. By analyzing investors' trading data on the recommendation changes of analysts, we examine whether information asymmetry exists among different groups of investors, individuals, domestic buy-side institutions, and foreign investors. Unlike individual investors, institutions frequently communicate with brokerage firms, investment banks, and asset management firms to acquire information, which makes it possible for them to access analysts' reports. In addition, institutions are more capable of acquiring and processing information than individuals. We thusconjecture that domestic buy-side institutions are better informed than individuals on upcoming recommendation changes. We also investigate whether foreigners have an informational advantage compared to domestic investors on the upcoming recommendation changes. Previous studies provide inconclusive evidence that foreigners perform better than domestic investors in trading stocks. Using Korean data, Choe, Kho, and Stulz (2005) find no evidence that foreign investors perform better than domestic institutions. Our analysis shows that stock prices increase before analysts' recommendation upgrades, whereas upcoming downgrades do not cause stock prices to decrease before the information release. We then analyze the standardized trade imbalance (STI) to examine the difference in trading activities by individuals, domestic institutions, and foreigners before recommendation changes. Over the period of days -5 to -1, the STI by domestic buy-side institutions is 0.43 before upgrades and -.35 before downgrades, and the STIs are significantly different from zero at the 1% confidence level. However, the STIs by individuals and foreigners before recommendation changes are not statistically different from zero. These results indicate that domestic buy-side institutions buy (sell) stocks in anticipation of an upgrade (downgrade), whereas individual investors and foreign investors do not trade stocks based on information. We also find that trade imbalances by the institutions are positively related to abnormal returns over days 0 to 5 after the announcements of recommendation changes. This evidence is consistent with our argument that domestic buy-side institutions take advantage of their superior information on analyst recommendation changes over the short-term. Our paper adds to the literature by providing evidence of the short-term informational advantage of domestic buy-side institutions over other investors on analysts' recommendation changes based on high-frequency data from Korea. The evidence shows that domestic institutions predict the direction of analysts' recommendation changes and reflect this information in their stock trading, which is indirectly consistent with Irvine, Lipson, and Puckett's (2007) finding. We also contribute to the growing literature on foreign investors' trading in emerging markets. We find that foreign institution trading is not characteristic of analysts' recommendation changes and does not predict stock returns. This shows that foreign institutions do not have an informational advantage compared to local institutions on specific events.

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An Empirical Study on Creditor Concentration in Multiple Banking Relationships

Soo-Young Hwang;Jung-Jin Lee

Asian Review of Financial Research :: Vol.27 No.4 pp.669-708

Abstract
An Empirical Study on Creditor Concentration in Multiple Banking Relationships ×

It is generally observed that firms maintain relationships with multiple banks. Although most studies investigating the phenomenon of multiple banking relationships assume more or less equal borrowing weights among the banks, in practice creditor concentration or asymmetry in borrowing occurs, by which we mean that a firm tends to concentrate its borrowing on one main bank and to fill the remaining loan necessity from other arm's-length lenders. A firm can benefit from establishing a close, long-term relationship with a single bank. For example, studies report evidence that a close relationship improves accessibility to funds and reduces the cost of capital and collateral requirements (Petersen and Rajan, 1994; Berger and Udell, 1995). However, the downside of a close relationship with a single bank is the tendency that a firm may find itself in a disadvantageous position for loan bargaining with the bank, which has acquired monopolistic information concerning the firm's true credit worthiness. This is called the‘hold-up problem', which can be a significant constraint, at least for informationally-opaque firms. According to von Thadden (1992), multiple banking relationships may be a solution to the hold-up problem because they create competition among banks, and thus prevent one bank from extracting the monopolistic rent when offering the loan. Multiple banking relationships are reported to reduce bankruptcy probability and the costs resulting from actual bankruptcy, and thus limit a firm's potential financial distress. Finally, multiple relationships may reduce a firm's liquidity problems by spreading the risks of liquidity problem of banks themselves. However, the negotiations for loan renewals are more complicated for multiple banking relationships, and when a firm fails and is liquidated, the liquidating value of the firm may be reduced due to the possible failure of coordination among banks (Bolton and Scharfstein, 1996). Considering the above discussion, we assert that creditor concentration (or asymmetric borrowing) with multiple banking relationships allows a firm to overcome the hold-up problem, as well as the possible failure in coordination among many banks. In other words, creditor concentration is a strategic solution for a firm to strike a balance between a single long-term relationship and multiple bank relationships. This paper investigates the influence of variables related to firm, bank, and market characteristics on the degree of creditor concentration in the Korean bank loan market. We use a data set from firms registered on the KISVALUE system of the NICE Information Service from 2006 to 2011. We use a Heckman selection model, and three proxies for measuring the degree of creditor concentration are included in the analysis: the Herfindahl-Hirschman Index (HHI), the largest financing share (CR1), and the Share of Inequality Index (SII). In the first stage of analysis, we estimate a probit for the probability of multiple banking relationships. In the second stage, we estimate the determinants of the degree of concentration, which is conditional on borrowing from multiple lenders. In this study, we find evidence of stronger creditor concentration for firms with more opaque information, more liquidation value of assets, and lower leverage. In addition, creditor concentration intensifies when a firm is more profitable and less risky. Regarding main banks'characteristics, we find that variables, such as bank size, capital adequacy, and bank ROA, do not significant explain creditor concentration. However, the number of employees to total loans, which can be viewed as a proxy for monitoring costs, is negatively related to creditor concentration. Market conditions are found to influence creditor concentration: there is evidence of stronger creditor concentration during boom times, which seems to be related to the tendency of firms to disperse loans to avoid the liquidity problem during recessions. In addition, a weaker creditor concentration is found in more competitive banking environments, during which banks offer better loan conditions, resulting in more dispersed loans among banks. We divide the sample into SMEs and large firms to examine asymmetric bank borrowing patterns. We find that SMEs display highly concentrated borrowing for the firms with more opaque information, higher liquidation value of assets, lower leverage, more profitable business, and better credit rating. These results are similar to those from the previous analysis of the full sample. However, the relations are weak for large firms, which have weak incentives to make strategic decisions on borrowing allocations because they have various alternative financing sources instead of bank loans, such as issuing stocks or bonds. Next, we analyze whether there is any difference in firms' borrowing behavior during the financial crisis. The impact of firm and market characteristics on the degree of concentration in borrowing during the financial crisis is weaker than that during the normal period. We conjecture that the firms' strategic decisions are limited by the banks because of their strict lending attitude during the financial crisis. Taken together, these results indicate that creditor concentration is attributed to firms' strategic decisions on balancing the holdup problem of relationship lending with the coordination failure of multiple lending. In particular, SMEs behave more strategically relative to large firms. In this way, creditor concentration allows the borrower to retain some of the benefits of long-term relationship lending as well as to enjoy the insurance effect against liquidity risks originating from the relationship lender.

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An Empirical Study on Distress Risk Premiums Implicit in the Term Structure of Korean Corporate CDS Spreads

Jungmu Kim;Yuen Jung Park;Changjun Lee

Asian Review of Financial Research :: Vol.27 No.4 pp.709-748

Abstract
An Empirical Study on Distress Risk Premiums Implicit in the Term Structure of Korean Corporate CDS Spreads ×

We investigate the term structures of corporate credit default swap (CDS) spreads in the Korean market based on Pan and Singleton's (2008) model. To this end, we first consider an algorithm of numerical methods to calculate the theoretical price of CDSs. Specifically, we consider the finite difference method (FDM) and Monte Carlo simulation, and then, we examine the time efficiency and accuracy of the FDM. Monte Carlo simulation might be an accurate way to calculate the model price but it is time-consuming and not appropriate for estimating the term structure in our empirical study. In contrast, our analysis shows that the FDM meets our empirical goal in terms of error and speed. In particular, we use the Crank-Nicholson FDM with a 120×120 grid in our empirical analysis, as it performs relatively well in terms of speed and accuracy. Next, by employing the suggested FDM, we estimate the default probability implicit in the term structure of the CDS spreads for 19 domestic firms over the sample period from 2006 to 2012. We use the ML estimation for our econometric framework, and we estimate the 1-year, 3-year, and 5-year CDS spreads by assuming that the spread of CDSs maturing in three years is observed without error. Our estimation reveals that investors require a significant amount of premiums for bearing the risk of future variation in intensity, defined as the distress risk premium (DRP), when they invest in CDSs. We verify the argument in several ways. First, the ML estimates based on the Q-measure are very different from those based on the P-measure. The ML estimates imply that investors view the intensity dynamics more negatively under the Q-measure than under the P-measure. This result in the Korean corporate CDS market supports the finding of Pan and Singleton (2008) in two emerging sovereign markets. To take a deeper look at the significant difference between the Q- and P-dynamics of intensity, we next compute and examine the default probabilities within five years with the estimated parameters and implied intensity under both the Q- and P-measures. The results show that the Q-probability of default is much higher than its P-counterpart, implying that investors require premiums by adding more probability on real default probability. Finally, we directly calculate the amount of DRP to see how much it accounts for CDS spreads. In doing so, we follow the methodology first suggested by Pan and Singleton (2008) and then employed by Longstaff, Pan, Pedersen, and Singleton (2011) and Díaz, Groba, Lafuente, and Serrano (2013). There are two steps involved in obtaining the DRP. We first calculate the “pseudo- CDS” spread, denoted CDSP using expectations under the P-measure instead of the Q-measure to evaluate the model's spread. Then, the DRP is obtained from the difference between the market CDS spread and pseudo-CDS spread. The results show that, on the average, the DRP accounts for 42% of the CDS spreads observed in the market. We also find that the DRP varies over time as the economy state changes, and particularly, it soars during the recent financial crisis. To explain our empirical finding that the DRP accounts for a substantial portion of the CDS spread and varies over time, we further investigate what determines the DRP and what drives it to change. To this end, we analyze the principal components of the cross-section of the DRPs. Our investigation shows that the first principal component explains about 97% or more of DRP variation, which implies that Korean companies' DRPs are associated with investors' appetites for the market-wide risk. To find what drives the first principal component, we regress the first principal component on a couple of domestic and global financial variables, which serve as proxies for the market risk premium. Specifically, the Volatility Index (VIX) is used as a proxy for a global variable of risk premium, and equity market risk premium, term premium, credit premium, and sovereign distress risk premium are examined as proxies for domestic risk premiums. The result shows that the VIX is statistically significant and has a striking power to explain the time-variation of the first principal component of corporate DRP. Among the domestic variables, equity market risk premium, term premium, and credit premium are statistically significant. However, sovereign distress risk premium (DRP implied in the Korean sovereign CDS spread) subsumes the explanatory power of the other domestic variables when added to the multiple regression. This finding indicates that sovereign DRP is the most important determinant of the co-movement of corporate distress risk premiums among the domestic variables. To control the endogeneity problem, the sovereign distress risk premium is orthogonalized to all other premiums, including VIX, the equity market risk premium, the term premium, and the credit premium. We then regress the first principal component of corporate DRPs on the orthogonalized sovereign DRP. This experiment shows that the orthogonalized sovereign DRP is statistically significant and explains the first principal component of corporate DRPs. This finding implies that sovereign DRP has additional information that is not contained in other risk premium proxies.

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