Asian Review of Financial Research

pISSN: 1229-0351
eISSN: 2713-6531

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Asian Review of Financial Research / January 2016 Vol. 29 No. 4

Capital Structure and Employee Pay : Evidence from Korea

Jaeouk Kim;Ji-Woong Chung

Asian Review of Financial Research :: Vol.29 No.4 pp.437-472

Abstract
Capital Structure and Employee Pay : Evidence from Korea ×

This study examines the relationship between employee pay and the capital structure of publicly listed firms in Korea. Consistent with Hanka (1998) and Hovakimian and Li (2011), we find that higher leverage is associated with lower average employee pay. However, our findings contrast with the theory of Berk, Stanton, and Zechner (2010) and the theory of the compensating wage differential. When firms add more debt to their balance sheet, the probability of bankruptcy increases and their employees face a greater risk of unemployment. Studies have suggested that workers bear significant economic and psychological costs from involuntary unemployment. In this context, the economic theory of Berk et al. (2010) predicts that firms compensate for this risk by increasing employee pay to increase the leverage related to higher average wages. However, in contrast to Berk et al. (2010), several studies have documented a negative correlation between leverage and employee wages. Hanka (1998) and Hovakimian and Li (2011) find that increased leverage is associated with lower employee pay. They interpret this as being a result of the risk shifting from shareholders and managers to employees. In addition to the risk-shifting motive, Perotti and Spier (1993) argue that firms use leverage as a bargaining tool against labor, especially when in financial distress. Moreover, Benmelech, Bergman, and Enriquez (2012) find that firms tend to renegotiate employee wages downward when they are under financial distress. Thus, from this perspective, higher leverage is associated with lower average employee pay among firms that are in financial difficulty. In summary, studies that predict a negative relationship between leverage and wages have suggested that increased leverage imposes disciplinary effects on labor by reducing employee wages. In our empirical analysis, we estimate panel fixed effect models that control for the time-invariant heterogeneity among firms and general time trends. In firm fixed effect regressions controlling solely for leverage, we find that leverage is associated with lower average employee pay. Moreover, in regressions that control for other firm characteristics, we find that higher leverage is associated with lower average employee pay. The Fama and MacBeth (1973) regressions deliver the same results. These findings suggest that the disciplinary effect of leverage is more pronounced than the compensating effect of higher bankruptcy risk. As our sample period covers the periods before and after the 2008 global financial crisis, we test whether the global financial crisis had any significant effects on the relationship between leverage and wages. We conduct the same regression analyses for the pre- and post-financial crisis periods (2003~2007, 2010~2015), and our empirical results suggest that the negative relationship between leverage and wages significantly intensified after the financial crisis. Moreover, the negative relationship between leverage and wages was only significant for the post-crisis period. This result confirms that the disciplinary effect of leverage was more pronounced after the financial crisis. We also consider industry heterogeneity and the labor market conditions in our analysis of the variation in the leverage-wage relationship. We expect employees' wage levels to vary significantly among different industries, especially technology firms and non-technology firms (Chemmanur, Cheng, and Zhang, 2013). We examine the variations across industries and markets by conducting comparative analyses of KOSPI and KOSDAQ firms, and firms in the technology industry and those in other industries classified according to the KSIC code. We find that the leverage-wage relationship is significantly more negative among non-technology firms. We also predict that the disciplinary effect of leverage is stronger in industries with lower unionization and shortage rates, as employees in these industries have less bargaining power against the firms. Consistent with our prediction, we find that the negative relationship between leverage and wages is strengthened in industries with lower unionization and shortage rates. In summary, among Korean public firms, we find that higher leverage is associated with lower employee pay. This result substantiates the view that debt disciplines labor. However, our findings do not support the theory of Berk et al. (2010) that firms compensate for increased unemployment risk by increasing wages to gain greater leverage. In addition, we find that after the financial crisis (2008~2009), the negative relationship between leverage and wages increased significantly. Our findings suggest that the disciplinary effect of debt was significantly pronounced after the financial crisis. We also examine the effects of the labor market conditions and industry heterogeneity on the leverage-wage relationship. Consistent with our prediction, the negative relationship between leverage and wages is significantly strengthened among firms in non-technology industries and those belonging to industries with lower unionization and shortage rates. One limitation of our study is that we cannot fully control for the endogeneity of leverage. We expect that future research will mitigate this problem. Our evidence contributes to the growing body of literature connecting labor economics and corporate finance and to the research on the relationship between leverage and wages by providing additional evidence to support the disciplinary effect of debt.

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Transmission of Systemic Risk Through Latent Leverage Channel

Myeong Hyeon Kim,Baeho Kim

Asian Review of Financial Research :: Vol.29 No.4 pp.473-494

Abstract
Transmission of Systemic Risk Through Latent Leverage Channel ×

This paper examines the mechanism of systemic risk propagation through system- wide latent leverage channel. We focus on the hidden leverage-induced asset value dynamics in the financial markets, intertwined with balance-sheet components of the banking system. We propose a latent leverage index by estimating smooth transition regression models based on the intrinsic element of the financial system, off-balance-sheet transaction, and cross-border activities of the Korean commercial banking system. We find that a shock to the latent leverage index impacts the macroeconomy with the lag of three quarters. This finding provides an important policy-oriented implication for macroprudential supervision of banking system.

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Dividend Policy and Permanence of Earnings

Sungmin Kim;Yongwon Jang

Asian Review of Financial Research :: Vol.29 No.4 pp.495-519

Abstract
Dividend Policy and Permanence of Earnings ×

This paper investigates the effect of permanence of firm's earning on the dividend policy of Korean firms. We decompose earnings into a transitory component and a permanent one, employing the approach of Beveridge and Nelson (1981). We focus on the relation between dividends and permanent earnings. Lee (1996) presented the empirical results that dynamic dividend behavior was more accounted for primarily by changes in permanent earnings rather than current earnings, using aggregate time-series data for the Standard and Poor's composite Stock Price Index. We use firm-level panel data and test hypothesis that Korean firm's dividend decisions also depend more on permanent earnings rather than transitory earnings. We find that the permanent earning has a significantly positive relationship with dividend and the coefficient estimate of permanent earnings is larger than that of transitory earnings. Future more, we use cash flows as earnings variable and find the similar results. There is a significantly positive relationship between permanent cash flows and dividends. And the marginal effect of permanent cash flows on dividends is significantly larger than that of transitory cash flows on them. These empirical results show that Korean firms take into consideration of permanence of earnings more in making their dividend decisions.

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Mergers and Acquisitions in the U.S. Insurance Industry

Bum J. Kim,Sojung C. Park

Asian Review of Financial Research :: Vol.29 No.4 pp.521-545

Abstract
Mergers and Acquisitions in the U.S. Insurance Industry ×

The challenging market condition for insurance carriers has become intense so that insurance companies look for all the feasible options for survival including consolidation with other insurance carriers, agent and broker networks and even non-insurance financial institutions. Using event study methodology, our study investigates whether the mergers and acquisitions of US insurers create value and there is strategic advantage for insurance carriers to consider cross-industry consolidations. We analyze all within-border mergers and acquisitions during 2003~2012 where either or both of the acquirer and target are US insurance carrier. We find that insurance mergers and acquisitions have positive valuation effects on acquiring firms, especially for the cross-industry mergers and acquisitions.

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