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DISSERTATION
University of Kentucky
2002
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OWNERSHIP CONCENTRATION, VERTICAL INTEGRATION. AND ITS
DETERMINANTS IN THE KOREAN CORPORATION:
HOW DOES CHAEBOLS ORGANIZATION AFFECT OWNERSHIP
CONCENTRATION AND VERTICAL INTEGRATION
DISSERTATION
By
Dong Kwan Kang
Lexington, Kentucky
Lexington, Kentucky
2002
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UMI Number: 3047784
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OWNERSHIP CONCENTRATION, VERTICAL INTEGRATION. AND ITS
DETERMINANTS IN THE KOREAN CORPORATION:
HOW DOES CHAEBOLS ORGANIZATION AFFECT OWNERSHIP
CONCENTRATION AND VERTICAL INTEGRATION
By
Lexington, Kentucky
Co-Director of Dissertation
d .
. Co-Cffrec
irector o f Dissertation
S ' /*-3> ( 01 .
Data
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ACKNOWLEDGEMENTS
The following dissertation benefited from the assistance and direction of several
people. First, I really appreciate my Dissertation Chair, Dr. John Garen and Co Director
Dr. Frank Scott, who provided sensible, constructive, and informative advices and
dissertation finally. Next, I wish to thank all Dissertation Committee, Dr. Mark Berger,
Also, I desire to thank Dr. Young Yong Kim, professor of Chun-Nam National
University who had encouraged me continually and supplied the data and comments. I
would like to thank Dr. Seung Chul Ahn, Professor of Young-Nam University, Dr.
Yunbai Kim, professor of Gatton School, and Dr, Seung Hahn Koh who encouraged me
with love and friendship to finish this work. In addition, I wish to thank all members of
Kentucky-Korean Tennis Club Association, who have been sharing friendship with
respect.
Lastly, I wish to thank my family for providing me with endless love and
support. My father, Sung Suk Kang, and my mother, Soon Chun Ahn, inspired me to
achieve Ph.D and had supported me until I finished it. This dissertation is absolutely for
them. I would like to thank to my brother, Iel Kwan Kang, who has been taking care of
our parent instead of me. My sister, Joo Sil Kang, and her husband, Jae Geun Lee,
daughters, Davina (So-Dahm) and Jenella (So- Lin), who are sound and healthy and
always make me cheerful and happy. My wife, Jung Hee Suh, provided on-going support
in
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with lovely smile. She was always there for me with love. It is really hard to express
myself to her for many thanks, but if I have to do, I would say, Go-Mah-Wa, Sah-
Lahng- Hae!
iv
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TABLE OF CONTENTS
Acknowledgement....................................................................................................... in
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4.3 Determinants of Ownership Concentration.......................................... 74
Capital Resources.................................................................... 76
Control Potential...................................................................... 77
The Finns Age........................................................................ 77
Organizational Form................................................................. 79
4.4 Empirical Modeling and Results.......................................................... 81
Modeling.................................................................................. 81
Regression Results.................................................................... 88
4.5 Conclusion............................................................................................ 93
References................................................................................................................... 140
Vita.............................................................................................................................. 145
vi
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LISTOF TABLES
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LIST OF FIGURES
viii
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ABSTRACT OF DISSERTATION
University of Kentucky
2002
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OWNERSHIP CONCENTRATION, VERTICAL INTEGRATION. AND ITS
DETERMINANTS IN THE KOREAN CORPORATION:
HOW DOES CHAEBOLS ORGANIZATION AFFECT OWNERSHIP
CONCENTRATION AND VERTICAL INTEGRATION
ABSTRACT OF DISSERTATION
By
Dong Kwan Kang
Lexington, Kentucky
Lexington, Kentucky
2002
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ABSTRACT OF DISSERTATION
management and vertical integration at the group level, are of crucial importance in
industrial organization theory because of their strategic significances. These features are
related to agency cost theory and transaction cost theory, respectively. Using these two
concentration) and organizational form (degree of vertical integration), how the chaebols
structure affects the determinants of ownership concentration and vertical integration, and
how ownership concentration and vertical integration affect a firms performance in the
that among determinants, firm size and the firms age are significantly and negatively
while instability and debt-equity ratio are significantly and positively related with inside
ownership concentration. However, firm size and instability are positively and
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ownership concentration to performance demonstrates that ownership concentration is a
important role in the decision to adopt vertical integration. In addition, the chaebol firms,
which are vertically integrated at the group level, are found less integrated at the firm or
plant level integration than non-chaebol firms. Interestingly, the estimate reveals that
vertical integration at the firm level is significantly but negatively related to the firms
performance: the more integration at the firm level, the worse the performance. However,
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Chapter One: Introduction
1.1 Purpose
Over four decades after the Korean War, Korea has achieved a truly remarkable
economic growth, from one of the poorest countries to one of the leading developing
countries.1 The Korean business groups, the chaebols, have served not only the most
important role of achievement in the development and growth of the Korean economy but
also have been leading the Korean economy. Consequently, the chaebol is one of the most
prominent structures of the Korean economic area. However, it is not easy to define
chaebol exactly. It may be defined as a business group that consists of many formally
independent firms, but under single administrative and controlled by main shareholders,
such as owners, their family members or relatives in many diversified business area.2 There
were 32 chaebols composed of 509 affiliated firms named first as a big business group
by the Anti Trust & Fair Trade Law in 1987.3 According to the Anti Trust & Fair
Committee, total assets of big-30 chaebols composed of 616 affiliated firms in 1994 were
250 U.S. billion dollars and total asset of big-5 chaebols was 138.6 billion dollars, which is
69.5 % of total assets of big-30 chaebols. Total sales of big-30 chaebols were 169.3 billion
1 Korean economy growth of GNP per capita is remarkable: the GNP per capita was
changed from $100 to $2000 in two decades between 1965 to 1985 same as Japan
achieved in two decades between 1950 to 1970. Korea was accepted as a member of
OECD in 1996.
2 According to Yoo and Lee (1987), to be a chaebol, two conditions should be
satisfied: it should be owned by family members or relatives: and it should have diversified
into several business operation. Most Korean Chaebols satisfy these two conditions.
3 The decision of a chaebol (or a big business group) by The Fair Trade Committee
had depended on its total assets (over 400 billion Won) until the law was changed in 1993.
According to the new law, only 30 chaebols are appointed as a big business group by the
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dollars and those of big-5 chaebols were 112.3 billion dollars, which is 66.3% of total
amount of big-30 chaebols. The value added amounts by big-30 chaebols were 13.15% of
Western conglomerate, the chaebol has some distinguishable features in ownership and
integration at a group level. The inspiration of this dissertation stems from these
especially the Korean big business group, the chaebol. These two distinguishable features
transaction cost, which stems from opportunistic behavior and bounded rationality.
On one hand, the chaebols affiliated firms maintain relatively higher ownership
concentration though they are much larger, so ownership is not separated from
the Western enterprise; consequently, the owner is a non-active decision maker. However,
the owner in the Korean corporation is an active decision maker as the largest shareholder.
In the case of the chaebols affiliated firms, they are bounded by ties of fractional
ownership (e.g., cross subsidy). In the economic point of view, the owner-management
system is associated with managers shirking problems. That is, monitoring by the owners
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(the insider shareholders) seems to be more efficient than that by the main bank (Japan) or
than that by the market and the border (American and Western). This ownership structure
may be also a safeguard from the hostile takeover and less affected by the fluctuation of
business circumstance. This ownership structure in the Korean private corporations raise
several questions; what factors determine this ownership structure, how ownership
concentration is related to performance, and whether the chaebols ownership structure are
effective to the fluctuation of business circumstance. Seeking the answer to these questions
On the other hand, the chaebols affiliated firms are integrated at a group level
rather than at a firm or plant level, and diversified into many industries. This chaebols
organization form has been resulted by intermediate market failure after the Korean War
(1950-53), capital market failure by the government intervention in financial markets, and
industrial policies. Though each affiliated firm is formally independent (Korean Commerce
Law prohibits holding companies), it is a subsidiary in reality and one of the divisions in
multi-market structure at the group level. Upward integration at the group level in the
chaebol is adopted as a market strategy to reduce the increased transaction costs by the
while downward integration, such as a general trading company and department stores in
the chaebols, can be interpreted as efforts to seek economies of scale as well as transaction
cost economies from certainty and asset specificity. Under this transaction cost theory, my
paper aims to investigate what the determinants of organizational form (degree of vertical
integration) are, how the chaebols organizational form affect vertical integration at the
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firm or plant level, and how vertical integration affect the firms performance in the
concentration and vertical integration in theory, which will reflect Korean business
From corporation revolution in the 1930s in U.S., Berle and Means (1932) draw
attention to separation of ownership from control. They suggest that small professional
managers who may not even have ownership of the assets increasingly centralize owners
nominal property rights of large corporations. That is, the actual power of decision-making
in open corporations has been transferred into the hands of the manager. Thus, the goal of
the owner may deviate from the goal of the manager. Agency costs stem from this
deviation between the owner and the manager. From this phenomenon, the agency cost
was formalized (i.e., Jensen and Meclding, 1976). The incongruence of goals between the
owner (the principal) and the manager (the agent) was an important motif of this theory,
increasing insiders ownership was presented as one solution for eliminating agency costs
However, Demsetz and Lehn (1985) insisted that firms for which ownership
matters select their optimal structure and, therefore, there is no significant and positive
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resources and control potential in their study. To reflect Korean business environments,
Arm age, debt, and organizational structure are considered as the determinants of
into two parts, inside and outside ownership concentration. Furthermore, the chaebols
organization is considered as one of the determinants in order to capture the possibility that
it alters the effect on stability: a dummy variable is adopted to measure the effect of
organizational form. The top-30 chaebols firms actually have less ownership
concentration than other firms in inside ownership, but have relatively higher inside
The findings from the empirical estimates are that: 1) firm size and uncertainty are
Demsetz and Lehns (1985) view, whereas firm size is significantly and positively related
related with outside ownership concentration, 2) the firms age is significantly and
negatively related with inside ownership concentration while the firms age is significantly
but positively related with outside ownership concentration, 3) debt ratio does not show
any relationship with ownership concentration, and 4) the dummy variable reports that
chaebols actually have less inside ownership concentration than other firms, and the
comparison to their assets or equities stems partly from chaebol membership reducing the
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positive effect of instability on ownership concentration.
separable interface. However, there is a cost of using the price mechanism.1 Thus, firms
stages of homogeneous production process in a firm, the firm can eliminate or at least
reduce transaction costs from the separating process in many firms. Therefore, the
theory started with Coase (1937) and was further developed by Williamson (1975, 1985).
Coase distinguished ex-ante transaction costs such searching, bargaining, and contracting
costs from the costs of production and the costs of organization. In addition to ex-ante
transaction costs, Williamson considered possible ex-post costs of contractual hazards such
developed Coases insights by taking into account two concepts from human nature,
form) that provides a safeguard from bounded rationality and opportunism because of
better possibilities for control with organizations relative to the market. This governance
form is determined by the level of specialized assets and uncertainty. Thus, asset specificity
and uncertainty are treated as main determinants of vertical integration in theory (e.g.,
Coase, 1937, Williamson, 1975, 1985, Klein, Crawford, and Alchian, 1978) and empirics
(e.g., Monteverde and Teece, 1982, Masten, 1984, Joskow, 1987, Liberman, 1991). To
reflect the Korean business circumstance, the role of an organizational form is considered
as a determinant of vertical integration using a dummy variable; the chaebols firms are
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vertically integrated at the group level rather than the him or plant level, so that the firm
that is vertically related with its affiliated firms would be less likely integrated at the firm
or plant level. The empirical measurement shows that 1) the role of asset-specificity and
uncertainty to vertical integration is important and 2) the role of the organizational form is
the expectation that the delegated authority will act in the principals behalf. However,
the altruistic behavior of the manager causes agency costs, so one solution is increasing
Transaction costs are particularly significant when the market exchange relates to
specialized assets and uncertainty. These costs relate, for instance, the costs of searching
for the desired inputs, negotiating supply contracts, monitoring and enforcing these
contracts, and the risk associated with unforeseen changes in supply conditions. One
solution is vertical integration to diminish these costs by dealing more efficiently with
ownership concentration or/ and vertical integration do affect the firms performance
positively. Vertical integration at firm level is negatively and significant related with the
firms performance: the more integration in the firm level the worse performance. In
addition, the group level integration is not related with performance at all. On the other
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performance in the case of Korean private companies. The estimation shows both a
1J Organization of Dissertation
The rest of this paper is organized into five chapters in addition to an introduction
Chapter 2 provides the theoretical basis for this paper. The objectives of this
chapter are to review theories and empirics about the determinants of ownership and
vertical integration. The reviews include (1) ownership, its determinants, and performance
adopted basic theoretical model is refined to reflect the Korean business environment. In
addition, this chapter introduces all data sources and statistic values of dependent and
independent variables.
Chapters 4, S, and 6 are about empirical estimates and results based on the
ownership concentration in the Korean business corporation and tests the theoretical model
empirically whereas Chapter 5 explores what determinants of vertical integration are, how
the chaebols are organized in its structure, and how chaebols' structure (vertical integration
explores the effects of ownership concentration and vertical integration on the firms
performance.
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Chapter Two: Literature review
2.1 Introduction
The objectives of this chapter are to review theories and empirics about ownership
and vertical integration. This review is organized into two parts in addition to an
introduction and a conclusion: (1) ownership, its determinants, and performance and (2)
The first part is the review of ownership. In the context of corporate governance,
have been changed; the symbol of ownership rights in open corporations is represented
by shareholdings, but normal property rights and the actual power of decision-making are
transferred into the hands of a management group while the shareholders position has
been changed from active decision maker to passive recipient of dividends and
appreciation because widely dispersed ownership cannot exercise any influence over the
firms activities. By extension, it is presumed that managers run the business for the
shareholders best interest. However, this perspective has not been without challengers
who argue that shareholders are not indistinguishable and that the firms performance
depends on the distribution of share ownership among manager and others (McConnell
and Servaes, 1990). The agency cost theory was formalized from this phenomenon, i.e.,
the conflict between the mangers and the shareholders. Jensen and Mecklings (1976)
study shows why insider ownership matters with the firms performance. They presume
that increasing insiders ownership is one solution for eliminating agency costs and, in
turn, predicting better performance. However, the empirics have not supported the view
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that greater inside ownership improves performance; that is, the direction of casualty
between ownership concentration and a firms value are not consistent. As a result,
variable, and the firm size and the control potential, for example, are introduced as main
economies. Transaction cost theory provided a new approach to look inside the black box
of the firm. The existence of organizations cannot be explained in the context of classical
and neo-classical economy. Coase (1932) explains the existence of the firm with two
reasons, the costs of using the price mechanism (for instance, costs of discovering what
the relevant prices are) and higher contract costs. A more complete model for the
existence of organizations was developed and refined by later organizational theorists and
economists, such as Klein, Crawford, and Alchian (1978), Williamson (1975,1985, and
1995), and Ouchi (1979, 1980). Klein, Crawford, and Alchian (1978) described a firm as
organizations exist. The explanations of transaction cost theory begin under two basic
criticized for negligence of the important role of the market system (Robins, 1983) and
10
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these criticisms, transaction cost theory has undeniable authority to answer the
vertical integration was the most direct examination of the firms existence. Two main
aspects, transaction specific investment and uncertainty, are considered the most
also show that the relationships among them are consistently positive. In addition,
transaction cost economies is expected to provide better performance by getting rid of the
bounded rationality and the tendency towards opportunism faced by the market
mechanism. However, the empirics do not show a positive relationship between vertical
Blair (1995) mentions that ownership generally means the right to possess or
dispose of assets, the right to use assets in any way not specifically prohibited by law or
proscribed by prior contract, the right to claim the proceeds from the sales of asset or the
returns generated by assets, and the responsibility for bearing certain risks associated
with the right of possession and the control of assets. The right of possession and the
control of physical assets are customarily bundled together with the right to receive
benefits from assets and the responsibility for bearing risk associated with its misuse or
with a decline in its value. However, in the context of corporate governance, the meaning
publicly traded corporations, normal rights that constitute ownership of real property
11
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have been unbundled and parceled out to numerous participants in the company9' (Blair,
1995). As consequence, owners nominal property rights and the actual power of
decision-making in open corporations have been transferred into the hands of the
executive group. In addition, the shareholders have become passive property owners
whose major concern is the size of the dividends and/or the current market price of their
shares.
This phenomenon was first described by Adolf A. Berle Jr., and Gardiner C.
Means in their classic, The Modem Corporation and Private Property, first published in
1932. Berle and Means (1932) found that the limitation of capital supply by the owners,
associated with the corporation revolution in massive products, resulted in the dispersion
of ownership and, in turn, in the separation of ownership from management. Berle and
Means historical evidence shows that individual stockholdings in 169 of the 200 largest
transferred into the hands of a management group from those who hold a majority of the
ownership rights (equity securities). That is, the symbol of ownership rights is transferred
into the hands of the management group such as the executive group or board of directors
who may not own equity or stock while the stockholders position has changed from an
The agency cost theory was formalized by Jensen and Meckling (1976) from this
phenomenon. The conflict between shareholders and managers comes basically from the
there are two objectives of a principal (owners) and an agent (managers who are hired to
12
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run the business for the principals interest) and that owners usually seeks profit
pecuniary benefit maximization, such as their salaries, job securities, size of office and
staff, and so on. In addition, suppose that, in contrast to the agent, the principal does not
have good information about profit possibilities that result from the agents decision.
That is, because of asymmetric information between the principal and the agent, there
Therefore, the principal would try to set devices, including monitoring, bonding, and ex
post readjustments in order to induce the agent to make a decision that the principal
prefers. The costs of monitoring, bonding, and the residual losses from slippage are
agency costs. Jensen and Meckling insist that these agency costs may decrease by
increasing the agents ownership because the interests between two objectives, the
principal and the agent, would converge: It is likely that the most important conflict
arises from the fact that as the managers ownership claim falls, his incentive to devote
significant effort to creative activities such as searching out new profitable ventures
performance would be positive. That is, the higher degree of ownership concentration will
decrease the problems of managers shirking and thus greater profitability will be possible.
However, this theory fails to explain why the large modem corporations are in the
hand of managers. Jensen and Meckling view the firm as a set of contracts between two
objectives of agent and principal with each objective motivated by its self-interest.
When management and risk bearing [ownership] are viewed as naturally separate factors
of production, looking at the market for risk bearing from the viewpoint of portfolio
13
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theory tells us that risk bearers are likely to spread their wealth across many firms and so
recipient, so that the incongruence of interests between the principal and the agent was an
important motif of agency cost theory. Increasing insiders' ownership was presented as
one solution for eliminating agency costs and, in turn, achieving better performance.
However, the empirics have not supported this expectation. This will be described in the
next section in detail and discussed about the new views of the relationship between
between ownership concentration and a firms value (or a firms performance) because
1 Therefore, Fama and Jensen (1983) insisted that the problem of separation of
ownership and management could be controlled by decision systems that separate the
management (initiation and implementation) and control (ratification and monitoring) of
important decisions at all levels of the organization. They state, Devices for separation
decision management and decision control include (1) decision hierarchies in which the
decision initiatives of lower level agents are passed on to higher level agents, first from
ratification and then for monitoring, (2) boards of directors that ratify and monitoring the
organizations most important decisions and hire, fire, and compensate top-level decision
managers, and (3) incentive structures that encourage mutual monitoring among decision
agents. (p. 328)
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simple theoretical arguments alone cannot explain clearly the relationship. Formalization
of the relationship between ownership and a firms value, therefore, has been persistently
disputed in the empirics. The relations can be explained with three hypotheses; (1) the
convergence-of-interest hypothesis (i.e., Jensen and Meckling, 1976) that predicts that the
larger inside ownership concentration should be associated with the higher market value
of the firm or higher firms performance, (2) the entrenchment hypothesis (i.e., Morck,
Shleifer, and Vishny, 1988) that predict that the market value or the performance of the
firm can be adversely affected for some ranges of high ownership concentration because
(i.e., Demsetz, 1983 and Demsetz and Lehn, 1985) that expects that ownership does not
relate with performance (profitability) because firms for which ownership matter will
as profit possibilities and different interests between two objectives, i.e., the agent and the
principal, bear agency costs. These agency costs include the costs of monitoring by the
principal, and of bonding by the agent plus of the residual loss incurred by the agent.
Jensen and Meckling suggest that agency costs could be reduced (but not wholly) by
increasing the agents ownership. As a consequence, agency cost hypothesis predicts that
an increase in the agents ownership would generate higher performance; the increased
the agents ownership induces two objectives, the principal and the agent, to converge
However, Demsetz (1983) and Demsetz and Lehn (1985) insist that the ownership
structure of the firm does not relate with the firms performance (profitability). Demsetz
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and Lehn (1985) state, A decision by shareholders to alter the ownership structure of
their firm from concentrated to diffuse should be a decision made in awareness o f its
consequences for loosening control over professional management. The higher cost and
reduced profit that would be associated with this loosening in owner control should be
ownership if shareholders choose to broaden ownership. It means that firms for which
ownership matter will have selected their optimal structure of ownership already, so the
significant positive result. This is called the optimal structure hypothesis. Their test,
using 511 U.S. firms from 1976 to 1980 shows what they expected: no significant
positive relationship and no support to the Berle and Means and Jensen and Mecklings
view.
In addition, Prowse (1992), Weinstein and Yafeh (1998), and Miwa and
a linear model with 734 firms from 1979 to 1984, Prowse found no significant
relationship between ownership concentration and accounting profit rates for either the
Japanese keiretzu or non-keiretzu firms; the coefficients of profit rate in both keiretzu and
profitability is also found in the both cases. In addition, Weinstein and Yafeh discovered
using a linear model with 686 firms from 1977 to 1986. Miwa and Ramseyer also
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made sense to regress profitability on ownership. They confirm the essential logic of
Demsetz and Lehn (optimal structure hypothesis) using a database of 637 large firms
On the other hand, Morck, Shleifer, and Vishny (1988), McConnell and Servaes
(1990), Hermalin and Weisbach (1992), and Holdemess, Kroszner, and Sheehan (1999)
Morck, Shleifer, and Vishny (1998) suggest that the relationship between
ownership and corporate value is non-monotonic, so that Demsetz and Lehn (1985) failed
specification that does not capture an important non-monotonic relation. They estimate a
piece-wise linear regression in which the dependent variable is Tobins q, defined as the
ratio of the market value of a firms securities to the replacement costs of the firms plant
and inventories, and the primary independent variable as the portion of shares of insider
owners. Using a sample of 371 Fortune 500 firms for 1980, they find that Tobins q rises
first as the insider ownership increases up to 5%, then falls as the insider ownership
increases to 25%, and lastly, rises slightly with more than 25% insider ownership. This
study implies that effective managerial control of the firm occurs at 25%, the point at
relationship between Tobins q and the structure of equity ownership for a sample of
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1,173 firms for 1976 and 1,093 firms for 1986. They found a significant curvilinear
relation between Tobins q and the fraction of common stock owned by corporate
insiders. Whereas Morck, Shleifer, and Vishny found that Tobins q increased up to 5 %
level of ownership and then decreased, McConnell and Servaes found that the curve
slopes upward until insider ownership reaches approximately 40% to 50% and then
In addition, Hermalin and Weisbachs (1991) estimations with 142 NYSE firms
and CEO stock ownership but their results are different from those of Morck et al and
McConnell and Servaes; Tobins q and CEO stock ownership is positive between 0% and
1%, negative between 1% and 5%, positive between 5% and 20%, and negative after that.
Moreover, Holdemess, Kroszner and Sheehan (1999) found a similar result using
1,236 U.S. firms from 1935 and 3,759 from 1995; Tobins q and director stock ownership
are positive between 0 % and 5%, but negative from 5% to 25%. After that, the
On the other hand, some economists insist that the agency problem can be reduced
(but never be zero) by expected future salary of the agent (Kaplan, 1994), by dividends
(Easterbrook, 1984), by the managerial labor market (Fama, 1980), or by the threat of an
outside takeover. For instance, the compensation policy induces the manager to choose
actions close to shareholders interest (i.e., maximum profits). Kaplan (1994) found that
cash compensation for top executives in Japan and the U.S are highly related with the
firms performance. A 100 % increase in stock returns is associated with a 9.5 % increase
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in salary and bonus, and a 100% increase in sales is associated with a 24.7 increase on cash
compensation, whereas a 100 % increase in stock returns and in sales growth are associated
with a 15.4 % and a 23.3 % increase in cash compensation, respectively. Jensen and
Murphys (1990) study, however, show that the sensitivity of managers salary to firm
performances is low (3.25 dollars increase in salary to the 1,000 dollars increase in the
value of the corporation) and the results are inconsistent with the implication of formal
optimal structure hypothesis supporters insist that firms for which ownership matters
will have selected their optimal ownership structure already, while convergence-of-
interest and entrenchment hypothesis supporters insist that the firm value is a function of
the structure of equity ownership. However, the empirics do not show a consistent
On one hand, Berle and Means (1932) study gave economists notice of
ownership, a steady reduction in the power and interest of the stockholder, and a gradual
enhancement of managerial authority. On the other hand, Jensen and Mecklings (1976)
between ownership concentration and a firms value. However, it was a question about
19
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policy associated with, for example, a dividend and capital structure and management
performance in private corporations, until Demsetz and Lehn (1985) consider the degree
and Lehns understanding of the relationship between ownership and performance is that
firms for which ownership matters will have selected their optimal ownership structure
the value-maximizing size of a firm because the larger is the competitively viable size,
ceteris paribus, the larger is the firms capital resources and generally, the greater market
value of a given fraction of ownership. The higher price of a given fraction of the firm
given degree o f control generally requires a small share of the firm the larger is the firm.
Both these effects may imply greater diffuseness of ownership the larger is a firm. This
may be termed the risk-neutral effect of size on ownership. In addition, normal risk
aversion implies that a shareholder would increase his ownership proportion of a firm
Empirical tests (Demsetz and Lehn, 1985 and Prowse, 1992) show a negative
relation between firm size and ownership concentration. In the Demsetz and Lehn study,
using a sample of 511 U.S. corporations in the late 1970s, the size of a firm, as measured
by the market value of equity, is negatively related to ownership concentration and the
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estimated coefficient is statistically significant at the 5% level. In addition, Prowses
study, using a sample of Japanese firms in the mid 1980s, reveals the same result; firm
size, as measured by market value of equity, is positively and significantly related with
ownership concentration in the non-keiretzu firms and positively but not significantly in
keiretsu firms.
(1985) call it control potential," which means the wealth gain achievable through more
the markets for corporate control nor the managerial labor market operate costlessly. If
these markets are perfectly operated, then control potential would play no role in
stable prices, stable technology, stable market share, and so forth are firms in which
postulate that control potential is likely correlated with environmental noise. The tighter
control will pay off to the owner if a firm faces more noise in its environment.
structures. Empirical tests by Demsetz and Lehn (1985), Levy (1984), and Prowse
(1992) show a positive relationship with ownership concentration. Demsetz and Lehn
used three proxy variables for stability: 1) a firms specific risk, as measured by the
standard error of estimate calculated from the market model,2 2) the standard deviation
2 The capital asset pricing model (CAPM) describes the relationship between the
security and market returns. Specially, the market model holds that returns on an
individual security are linearly related to an index of market returns. This concept divides
a security's expected excess return into two parts: 1) market related and 2) non-market-
related returns. This can be expressed simply:
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o f monthly stock market rates of returns, and 3) the standard deviation of yearly income.
They found positive relationships between ownership concentration and these proxy
variables of stability. However, this positive relationship between ownership and business
environment is contrary to the viewpoint o f portfolio theory that risk bearers are likely to
spread their wealth across many firms and so not be interested in directly controlling the
management of any individual firm; Common stock allows residual risk to be spread
across many residual claimants who individually choose the extent to which they bear
risk and who can diversify across organizations offering such claims. Other things being
equal, portfolio theory implies that such unrestricted risk sharing lowers the cost of risk-
A question, why do organizations exit,3 may sound odd in classical and neo
classical economic theories, which explain that the economy is operated by the decentralized
system of prices (i.e., an invisible hand) without any planned centralized system (i.e., a
and neo-classical economics, the rise and existence of the centralized system cannot be
explained because these theories define a firm as a technological black box, which would try
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to maximize its profits under the given prices of labor and capital that were set by market
conditions. In addition, these theories assume that individuals will act in their own self-
interests and that simple transactions happen on-the-spot1and are conducted freely. Over
history, however, the market environment in which transactions took place became
increasingly uncertain and more complex, so that simple trust in relationships with
attempt to connect between two assumptions, the allocation of resources in a firm and the
allocation in the market price mechanism. Coase mentioned, The purpose of this paper
is to bridge what appears to be a gap in economic theory between the assumption that
resources are allocated by means of the price mechanism and the assumption that this
Coase puts a distinguishable mark of a firm and tried to develop a theory of the
firm that is both realistic and tractable; Outside the firm, price movements direct
Within a firm, these market transactions are eliminated and in place of the complicated
who directs production. It is clear that these are alternative methods of co-ordinating
production (p.388). Therefore, he assumed that distinguishing mark of the firm is the
supersession of the price mechanism because of (1) costs of using the price mechanism
(costs of discovering what the relevant prices are); the market transaction cost can be
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eliminated and the complications of market exchange can be avoided in the firm and 2)
higher contract costs that may be saved by making a long term contract or integration for
supply of the intermediate goods or services instead of a successive short term contract.
However, by Coases (1972) own admission, The Nature of A Firm was much cited
but little used because of Coases failure to explain precisely about which transactions
will be left to the markets and which will be internalized within firms. A more complete
model of the costs using the price mechanism to manage economic exchange was
Williamson (1975,1985, 1995), Klein, Crawford, and Alchian (1978), and Ouchi (1980).
the existence of the governance system and a study how trading partners protect themselves
Transaction cost theory starts from two basic behavioral assumptions: bounded
rationality and opportunism. These relationships between human factors and environmental
factor are shown in Figure2-1. Bounded rationality means the limits of cognition. Without
cognitive limits, all exchange could be conducted through planning; Bounded rationality
is the cognitive assumption on which transaction cost economies relies. This is a semi
complexity that would specify all possible contingencies in an economic exchange. On the
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Figure 2-1: Market Failure Framework
Market Failure Framework
Human factors Environmental Factors
Bounded Rationality < > Uncertainty/ Complexity
Opportunism < > Small Numbers
Adopted from Williamson (1975)
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other hand, opportunism comes from bounded rationality faced by unforeseeable future
For instance, bilateral monopoly between a buyer and a seller arises because benefits
from trade between them are increased by specific asset investments that are specialized to
their trade (Williamson called it asset specificity). Such specific asset investments give
rise to appropriable quasi-rents; the higher level of specific asset investment will increase
the threat of opportunism. That is, the asset specificity causes the quasi-rent value, and, in
turn, the quasi-rent creates additional incentives for opportunism. While traditional
economic theory assumes simply that economic actors behave out of self-interest,
transaction cost economies assumes the possibility of self-interest with guile. This
[opportunism] includes but is scarcely limited to more blatant forms, such as lying,
stealing, and cheating. Opportunism more often involves subtle forms of deceit. Both
active and passive forms and both ex ante (e.g., adverse selection) and ex post (e.g.,
moral hazard) types are included... More generally, opportunism refers to the incomplete
which economic actors are in a position to exploit some vulnerability of a firm causes
contract costs that may be saved by making a long-term contract or integration for supply
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Vertical control, i.e., a hierarchical governance mechanism, is Williamsons answer
(198S) for these bounded rationality and opportunism problems. The hierarchical
in transaction or exchange of goods and services. In general, if there exists higher risk in the
transaction because of uncertainty and/or a higher level of specific asset investment, markets
and contracts (or other forms of a market governance system) are less likely and the
hierarchical forms of governance are more likely. Though the hierarchical form of
reduce uncertainty and complexity stemmed from bounded rationality and the tendency
towards opportunism faced by the market governance mechanism. Of course, the marginal
benefit from the hierarchical governance mechanism should be greater than or at least equal
to the marginal cost of bounded rationality and the tendency towards opportunism.
insist that cultural and social forces have important roles in organization (Ouchi, 1979,
1980; Wilkins and Ouchi, 1983; Smircich, 1983; DiMaggio and Powell, 1983;
Granovetter, 1985; Scott, 1987: Hall, 1996). Culture is usually defined as social or
normative glue that holds an organization together (Smircich, 1983). It expresses the
values or social ideas and the beliefs that organization members come to share. These
values or patterns of belief are manifested by symbolic devices such as myths, rituals,
stories, legends, and specialized language.4 In this point of view, transaction cost theory
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underestimates the role of social and cultural forces in economic activity. Granovetter
(1985) points out that transactions are embedded within networks of social relationships
and influenced by expectations that are formed by the history of relationships. Therefore,
abstract transaction dimensions such as asset specificity and uncertainty do not alone
determine the governance arrangements. Close friends, for example, may trade co
The clan is considered an alternative mode for transaction that adopts the
however, it requires relatively high levels of goal congruence and the sharing of some
general paradigm that helps participants determine collective interest (Wilkins and
Ouchi, 1983). Ouchi (1980) extended the transaction cost framework to describe this
principally when it is difficult to determine the value of the goods or service. Such
which views organization as the social process by which individuals come to accept a
shared definition of social reality, (3) as a class of element, which views organization as
pertaining to a distinctive set of elements that can account for the existence, and (4) as
distinct societal spheres, which views organization as both symbolic-cognitive and
normative- system and behavioral system. In addition, organization is considered as a
process of isomorphism (DiMaggio and Powell, 1983): Coercive isomorphism stems
from the influence of political power and the problem of institutional legitimacy, mimetic
isomorphism results from standard response to uncertainty, and normative isomorphism
is associated with professionalization, which means the collective struggle of members of
an occupation to define the condition and methods of their work and to establish a
cognitive base and legitimating for their occupational autonomy. Organization of Korean
chaebol can be explained with DiMaggio and Powells view: the centralized capital
resource in domestic as well as foreign loan (i.e., capital market failure) after military
revolution (1959) is one of example of coercive isomorphism whereas instability of
political situation and resource market after Korean War are the examples of mimetic
isomorphism.
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difficulties can arise from the underlying nature of the goods or service or from a lack of
trust between the parties. To solve these problems, he suggested a clan form. This
form focuses on the socialization of individuals into an organization. This form can be
efficient when the objectives of individuals are congruent but performance evaluations
are not ambiguous.s For instance, Japanese firms rely to a great extent upon hiring
inexperienced workers, socializing them to accept the companys goals as their own, and
compensating them according to length of service, number of dependents, and other non
to control or direct their employees, since the employees natural (socialized) inclination
is to do what is best for the firm. It is also unnecessary to derive explicit, verifiable
related criteria that are relatively inexpensive to determine (Ouchi, 1980, p. 132). The
clan, then, can be efficient in governing transactions under conditions of relatively high
hierarchical structure may cause some costs such as attenuated incentives, lower quality,
and bureaucratic distortions. Thus, The lower the appropriable specialized quasi-rents,
the more likely that transactions will rely on contractual relationships than common
ownership. And conversely integration by common or joint ownership is more likely, the
higher the appropriable specialized quasi-rents of the assets involved (Klein, Crawford,
and Alchian, 1978). The problems, bounded rationality and opportunism, can be
s Z-organizations such as Hewlett-Packard and Intel are more like clans than
bureaucracies and markets because they foster close interchange between work and social
life. (Ouchi, 1981) In addition, Korean chaebol and Japanese keiretzu are considered as
clans.
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mitigated by various contracts. Various contractual agreements may be employed where
both spot markets and complete vertical integration are relatively costly methods for
may not be costly when specific asset investments are not substantial. Long-term
Exclusive dealing and requirements contracts also economize on search costs and at least
partially address certain externalities that arise with pure spot market exchange of
that are largely designed to alleviate simultaneous opportunistic inclinations on the part
In sum, despite criticisms6 of transaction cost theory, transaction cost theory has
undeniable authority to answer the fundamental question of why firms exist. Transaction
cost theory provides a new approach to look inside the black box of the firm for
organization theorists.
6 Transaction cost theory (TCT) is criticized with these points: (1) TCT focuses on
cost minimization because minimizing transaction costs is relatively little benefit in case
of exist of well developed markets and no specific assets with regard to uncertainty
(Robins, 1983); and TCT neglect the role of social relationships in economic transaction
(Granovetter, 1987)
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application of transaction cost theory to vertical integration was the most direct
examination of the question why do organizations exist? In this section, I will review
Asset Specificity
asset specificity. Coases article (1932) explains the nature of the firm versus market in
terms of vertical integration. Work by economists (e.g., Williamson, 1975, 1985 and
based on asset specificity and avoidance of opportunism. Asset specificity means that
investments in assets between a buyer and a seller (or between a downstream firm and an
upstream firm) are specialized, so that the gains from trade between them (i.e., a bilateral
monopoly relationship) rather than the others are profitable. However, the existence of
specific assets often leads to possibilities of a hold up situation in which one party is in
example of opportunistic behavior and the amount, which can be exploited, is the
appropriable quasi-rent. Therefore, opportunistic behavior may occur when one party can
take advantages of its position with respect to another party, as either a buyer or seller.
Therefore, the two assets together (a hierarchical governance mechanism) are worth more
if they are owned by one party than if they are separately owned, and this is the
mechanism can reduce the tendency towards opportunism faced by the market
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governance mechanism in association with asset specific investment. Of course, the
marginal benefit from the hierarchical governance mechanism should be greater than or
Asset specificity takes a variety of forms such as site specificity, physical asset
specificity, human asset specificity, and dedicated specificity. (For more detail, see
relationship. For example, physical proximity of contracting firms in the coal market
(e.g., Joskow, 1985 and Spiller, 1985) and the average distance shipped (e.g., Levy,
1985) are used for the proxy variables of site specificity. Second is physical asset
R&D (e.g., Levy, 1985 and MacDonald, 1984) and sunk cost (e.g., Joskow, 1985;
MacDonald, 1984; and Lieberman, 1991) are used as proxy variables. The third is human
The last is dedicated specificity, referring to investments that are dedicated assets (e.g.,
Joskow, 1987) that involve expanding an existing plant on behalf of a particular buyer. In
sum, the predicted effect of asset specificity on vertical integration is positive when a
Uncertainty
may lead to change in efficient modes of cooperation and gains from cooperation may
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increase or decrease. When there is no integration, and assets are separately owned,
owners of assets will then bargain over responses to changed market circumstances and
over the division of gains or losses from these same circumstances because all complex
contracts are incomplete. Writing a contract with enough specificity to avoid any
Therefore, hold up may occur in the case that one firm can take advantages of its
position with respect to another firm, as either a buyer or a seller. Such re-negotiation on
the contract over hold up is costly and time consuming. Even if a contract could be
written with sufficient specificity, enforcement would be difficult. For instance, in many
of the cases where appropriative quasi-rent is possible, time is important, so that the delay
associated with litigation over a contract breach might itself impose substantial costs on
the firm. Therefore, the best solution is ownership that is the right to control the use of
Evidence
Empirical evidence shows that these two determinants are positively and
importantly related with the degree of vertical integration. The following explanations of
Armour and Teece (1980) regressed the number of primary production stages in
the U.S. petroleum industry from 1954 to 1975 on measures of asset specificity such as
expenditure amounts of basic and applied materials and R&D costs. They found positive
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Table 2-1: Empirics in Vertical Integration and Its Determinants
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relationships between them with at least the 10 % significance level. Monteverde and
Teece (1982) also found that the percentage of in-house production has a positive
relationship with asset specificity such as transaction specific skills, specific items, and
system effects. The result of the probit model, using data of 133 auto components,
supported the view that transaction cost considerations surrounding the development and
organizational boundaries.
Based on a probit model, Masten (1984) tested the dichotomous choice between
internal and external procurement of supplies. The results support the contention that
the aerospace system; specificity and complexity of items are positively and highly
industry with the logit model. As expected, integration was associated with increasing
these factors. Contrary to the transaction cost model, neither frequency of transactions
nor the interaction of specificity and environmental uncertainty was significantly related
to integration. The transaction cost model improves significantly upon the fit of a simple
Levy (1985) analyzed the relationship between the degree of vertical integration
(the ratio of value added amount to sales) and asset specificity and uncertainty,
respectively, using ordinary least regressions with 69 firms. He found that R&D intensity,
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firm size, sales fluctuation, and systematic risk (P) are positively and significantly related
backward integration and two views of uncertainty and the threat of supplier retaliation,
respectively; that is, the extent to which integration relieves the uncertainty of supply for
a firm facing a variable demand function and the threat that existing suppliers will
retaliate if such vertical integration is attempted. The multiple regression results provided
the evidence that buyers would be discouraged from backward vertical integration if both
determining the duration of coal contracts negotiated between coal suppliers and electric
utilities. Using multiple regressions with 277 observations of coal contracts by coal
burning electricity generating plants, the results provided strong support for the view of
transaction cost economies; annual contract quantities are significantly and positively
related with physical, site, and dedicated asset specificities. That is, the buyers and sellers
make longer commitments to the terms of future trade at the contract execution stage, and
rely less on repeated bargaining, when specifically related investments are more
important.
John and Weitz (1988) used survey data of 87 industrial firms with sales over $50
million. The model explained about 28 % of variation in sale volume through the direct
channel. They found that human specific asset (salesmen skill), environmental
uncertainty and behavioral uncertainty are positively related with the degree of vertical
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The study of Lieberman (1991) confirmed that transaction costs and demand
manufacturing sectors. Using 34 organic chemical products of the U.S. in 1980, he uses a
logit model of firms, backward integration choices; zero/one dummy for each
downstream integration as a dependent variable on sunk costs, input costs and a number
of upstream suppliers as independent variables. The results show that sunk costs, input
costs, and a number of upstream suppliers have a significantly positive relationship at the
In sum, the transaction cost theory focuses on two aspects, transaction specific
investment and uncertainty, which are the most important determinants of vertical
Theoretically, it is acceptable if the hierarchical governance mechanism can get rid of the
the marginal benefit from the hierarchical governance mechanism is greater than or equal
to the marginal cost of the tendency towards opportunism. In addition, many empirics
support that vertical integration with regard to transaction cost economies has positively
system for better performance. First of all, as mentioned above, vertical integration
generates transaction cost economies by getting rid of the tendency towards opportunism
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with asset specific investment and uncertainty in demands and/or supplies is expected to
(Alchian and Demsetz, 1972) and inventory scheduling between stages are other benefits
The cost function is said, for instance, to be stricdy sub-additive if for any multiple of
outputs qi, q:...... qn. the summation of each cost of q, are greater than summation cost of all
qt. That is, sub-additive means that it costs less to produce the various outputs together than
to produce them separately. For example, integrated production of steel enables the metal to
remain hot from the blast furnace to carbon bum-off to rolling and drawing. Costly
reheating at each stage is eliminated. Finally, vertical integration may get benefits from
higher entry barriers, which results in market power (e.g., Stigler, 1957; Comanor, 1967;
and Williamson, 1979). If a firm wants to enter into a new industry, it needs a condition that
the firm can operate under or equal to the minimum efficient scale that the other firms do.
However, vertical integration may not pay off when the negative effects from
integration outweigh the positive ones; too much vertical integration may reduce
flexibility to market condition once vertical integration is set up (Harrigan, 1983). It may
incentives and bureaucratic distortion. As a firm gets larger, there may be decreasing
returns to the entrepreneur function, that is, the costs of organizing additional transactions
within the firm may rise Coase (1937, p. 340). Williamson (1973) also states a similar
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explanation: spans of control can be progressively extended only by sacrificing attention
capacity limits are exceeded (p. 323). Vertical integration itself also gives rise to another
opportunistic behavior by labor unions; if two firms are vertically integrated, then the
unions bargaining power in the integrated firm will be increased because of the increase of
relationship between vertical integration and performance. Data on net profit margins,
investment-to-sales ratios, and returns on investment for businesses with differing levels
find out the relationships. He finds that profit margins are modest up to a V/S of 60%, but
from that point, profits rise consistently with increasing integration. In addition,
investment intensity in his study increases along with vertical integration while return on
investment decreases up to level of 60% and then increases with vertical integration.
Therefore, the study demonstrates clearly how rising investment requirements offset the
higher profit margins associated with intensified vertical integration. If integration can
between vertical integration and performance. They tried to find the relationship between
transaction cost economies and the Korean business groups, the chaebols. They considered
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the structure of a chaebol group as a relational structure,7 showing both vertical
reduces transaction costs arising from market failure.8 Therefore, they expected that the
chaebols affiliated firms would be superior in economic performance. They divided the
Korean top-30 business groups into three types. The first type includes the top 4 business
groups, Hyundai, Samsung, Lucky-Goldstar, and Daewoo, which show the characteristics of
a conglomerate and a multi-divisional structure. The second type includes the next 20
business groups that have multi-divisional structure, and the third type includes the
remaining 6 business groups that do not have multi-divisional structure. They obtained
empirical evidence that group affiliated firms show superior economic performance; the
business group with strategy and structure of the first type has superior economic
performances.
cost economies in theory, vertical integration does not show a consistent positive
and performance cannot be accurately assessed without an appreciation of the factors that
lead transactors to adopt one form of organization over another (Masten, 1993). The co
existence and stability of varied governance forms are more evidence that vertical
7 Many other concepts of chaebols organization are introduced. One set structure,
department style structure, octopus arms structure and fleet structure are examples.
These concepts are different relational structure basically because all these concepts
come from only chaebols appearances (diversification into many industries) whereas the
concept of relational structure came from the insight of vertical and horizontal
relationship among affiliated firms in a chaebol.
8 Williamson (1975) viewed vertical integration and conglomerate as intermediate
market and financial market failure respectively.
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because, under certain specifiable conditions, they are the most efficient means for an
equitable meditation of transactions between two parties. In a similar manner, market and
clan organizations exist because each of them, under certain conditions, offer the lowest
2.4 Conclusion
vertical integration.
raised a question about property rights between a principal (ownership) and an agent
problem about the direction of causality between ownership concentration and a firms
value because the empirics did not support the theoretical explanation that the firms
explanations about ownership structure were given; whereas the optimal structure
hypothesis describes that firms for which ownership matters will have selected their
optimal structure already, the entrenchment hypothesis expresses that the firms value is a
Under the view of the optimal structure hypothesis, ownership was treated as an
endogenous variable instead an exogenous variable. Demsetz and Lehn (1985) first
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ownership concentration is value-maximizing size of the firm because the larger the
competitively viable size, ceteris paribus, the larger the firms capital resources and
generally, the greater market value of a given fraction of ownership. The second possible
determinant is control potential, which means the wealth gain achievable through more
On the other hand, transaction cost theory, which answers the fundamental
question of why firms exist, has undeniable authority despite of criticisms of it. This
theory provides a new approach to look inside the black box of the firm. Transaction cost
theory starts from two basic behavioral assumptions: bounded rationality and opportunism.
Williamsons answer for these bounded rationality and opportunism problems was a
application of transaction cost theory to vertical integration was the most direct
examination of the question of why firms exist. Over the years, the determinants of
vertical integration associated with transaction cost economies were focused on specific
the primary determinant of vertical integration is asset specificity, which causes the
quasi-rent value. In turn, the quasi-rent creates additional incentives for opportunism,
forces re-negotiation on the contracts because even the best contracts are not perfect,
which may subject the firm to a hold up problem. It is costly and time consuming.
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Therefore, the gain of the right to control the use of assets within a firm (vertical
integration) is a solution for the hold up" problem. Empirical tests show evidence that
these two determinants of vertical integration have positive and important relationships
a sensible strategy with regard to transaction cost economies, but in the empirics vertical
integration does not show a consistent relationship with performance. The co-existence
and stability of varied governance forms are evidence that vertical integration is
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Chapter Three: Methodology
3.1 Introduction
and vertical integration and the firm's performance. One model is set up for estimating
the determinants of ownership concentration and vertical integration in Korean firms with
particular interest in seeing if Chaebols affiliation firms make any differences once other
factors are controlled for. In the case of the model for the determinants of ownership
concentration, a basic equation is employed from Demsetz and Lehns (1985) regression
model, which is refined to reflect the differences in the Korean business environment.
Another model is set up for investigating both ownership concentration and vertical
integration effect on the firms performance. All models will be estimated using ordinary
least squares or weighted least squares to solve the problem of heteroscedasticity arising
when using cross-sectional data. The rest of this chapter will describe data and mean
Y =X fi +SC,
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where Y stands for each dependent variable such as ownership concentration and the
From this form, the basic equation for the determinants of ownership
concentration is:
where OWN stands for the ownership concentration, SIZE represents a firms size,
represents a firms age, and CHAEBOL is a dummy variable to capture the effect of
belongs to the chaebols group, then CHAEBOL would be equal to 1 and the others
would be 0.
The basic equation for the determinants of vertical integration will be:
where VI means the degree of vertical integration, SPECIFICITY stands for the firms
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On the other hand, estimation of an equation o f the model for the firms
PROFIT means firm performance, which is measured by the ratio of a firms net
income to its total assets or total equity. As mentioned above, VI and OWN stand for the
for economic factors that affect the firms performance such as advertisement intensity,
Empirical analysis will be conducted using the firm level data obtained primarily
Association (KJLCA) in 1996. Categorizing the top-30 or 100 chaebols and the data of
these chaebols affiliated firms and their products are collected from Annual Report o f
Korean Companies 1996 published by Korea Investors Services Inc. (KISI), Investment
Analysis o f the Listed Companies 1996 published by Kyobo Securities Inc. (KSI), and
The original sample of 446 listed manufacturing firms (of 663 total listed firms)
in the Korean stock market is collected. Table 3-1 shows that sale amounts o f total
industry, all listed companies and sample companies, which covers from SIC IS to SIC37,
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Table 3-1: Total Sales in All Industry, the Listed Firms, and Sample Data of 1995
___________ Unit: billion Korean Won
SIC A ll11 Listed Firms^ Sample FirmsJ)
15: Foods & Beverage 26,234 12,624(48%) 10,967(42%)
16: Tobacco Products 3,448 0( 0%) 0(0%)
17: Textiles 19,330 12,967(67%) 8,475(44%)
18: Wearing Apparel and Fur Articles 10,558 1,809(17%) 1,514(14%)
19: Tanning & Dressing of Leather 5,353 1,201(22%) 556(10%)
20: Wood and Products of Woods 3,069 495(16%) 495(16%)
21: Pulp, Paper, Paper Products 9,438 3,606(32%) 2,150(23%)
22: Publishing, Printing, & Recording 6,839 238(03%) 50(01%)
23: Coke, Refined Petroleum Products 16,305 12,118(74%) 12,090(74%)
24: Chemicals and Chemical Products 33,128 15,639(47%) 13,840(42%)
25: Rubber and Plastic Products 13,908 3,212(23%) 2,658(20%)
26: Non-Metallic Mineral Products 15,164 5,957(39%) 5,359(35%)
27: Basic Metals 30,546 20,340(67%) 10,459(34%)
28: Assembling Metal Products 16,686 971(06%) 620(04%)
29: Machinery and Outfits 30,107 7,355(24%) 5,963(20%)
30: For Office & Calculating 5,169 1,457(28%) 1,353(26%)
31: Electrical Machinery & Apparatus 12,316 3,726(30%) 3,495(28%)
32: TV & Communication Equipment 44,600 36,799(83%) 32,808(74%)
33: For Medical, Precision and Optical 3,767 180(05%) 73(02%)
34: Motor Cars and Trailer 34,528 24,493(71%) 16,967(49%)
35: Other Transport Equipment 10,948 3,720(34%) 1,416(13%)
36: Furniture 6,993 1,286(18%) 427(06%)
37: Recycling 451 0( 0%) 0
Total 358,888 170,195(47.4%) 131,735(36.7%)
Sources: (1) Report of Mining and Manufacturing Survey (Whole Country) of 1997
published by National Statistical Office (Republic of Korea).
(2) Annual Report of Listed Companies of 1996 published by Korea Listed Companies
Association.
Note: (%) in the third and forth column shows the percentage to total industry in sales
amount.
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All listed companies cover 47.4% of all industries' sales amount and the sample
companies cove 36.7% of them. From all listed companies, some are excluded as
follows:
3) The companies that listed after 1991 in the Korean stock market, because 60-
month stock price data are needed for the data of beta index, standard errors
from the capital asset pricing model, and the standard deviation of monthly
4) The companies for which five-year annual data from 1991 to 1995 for
fixed costs, sales amounts, overhead costs, advertisement and R&D costs are
unavailable.
After excluding all of the above cases, the sample for estimation decreases to 341.
Included manufacturing industries are as follows: Food & Beverages (47), Textiles (44),
Wearing Apparel (13), Leather, Handbags & Luggage & Footwear (12), Wood & Wood
Products (4), Pulp & Paper Products (26), Publishing & Printing (3), Chemicals &
Chemical Products (81), Refined Petroleum Products (6), Rubber & Plastic Products (14),
Non-Metallic Mineral Products (25), Basic Metal Industries (36), Fabricated Metal
Products (13), Computer & Office Equipment (8), Image, Communication & Sound
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Equipment (54), Electric Machine & Converter (18), Automobiles & Trailers (26), Other
Transport Equipment (4), Medical, Precision & Optical Instruments (3), and Furniture
(9).
The Anti-Monopoly and Fair Trade Act, first promulgated in 1981, describes a
family or associates. The companies in the group are affiliated firms. There are
company. However, Korean law strictly and explicitly bans holding companies in any
form. Thus, Samsung and Hyundai chaebol groups, as they are most commonly
perceived, do not exist legally. Categorizing top-10, top-30, top-50, or top-100 chaebols by
the rank of total assets has been done for analysis of chaebol effects on economic sectors
among economists. When the Fair Trade Committee (FTC) named a chaebol as a big
business group in 1987, there were 32 chaebols with 509 affiliated firms. The FTC had
named 53 big business groups in 1990, 61 big business groups in 1991, 78 big business
groups in 1992 according to the total assets (over 400 billion Korean Won2). Since 1993,
the FTC has named only 30 chaebols as big business groups by the rank of its total assets.
Table 3-2 shows the value-added amounts of total industries, top-30 chaebols, and
gross national product (GNP) of 1994. The gross total industry product was 90.9 percentage
of the GNP and the gross top-30 chaebols product was 14.6 percentage of the GNP in 1994.
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Table 3-2: Value Added by Total Industries and Top-30 Chaebols in 1994 of Korea (In
Billion U.S. Dollars, %)
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The value-added amount of top-30 chaebols is 45.894 billion dollars (except the security
and finance industry), which is 13.15% of the total value-added amounts of all industries. In
addition, this table shows the top-30 chaebols dominate in the principle economic sectors,
The data o f top-30 chaebols and their affiliated firms are collected from Annual
Report o f Korean Companies 1996 published by KJSI and the data of top-100 chaebols
and their affiliated firms are collected from Investment Analysis o f the Listed Companies
1996 published by KSI, and Korea Company Yearbook 1996 published by APII. These
In addition, the other dummy variables are considered in association with vertical
relationships among affiliated firms. For instance (see Table 3-3), on one hand, Doosan
Corp. does foreign exporting and domestic distribution of Doosan chaebols productions.
Thus, it has a backward vertical relationship with the other affiliated firms, such as
Oriental Brewery Co. that produces beer and wines. On the other hand, Oriental Brewery
Co. has a backward relationship with Doosan Glass Co. (bottles), Sam-Hwa Crown &
Closure Inc. (bottle lids), Doosan Farm Co. (hops and grapes), while it has a forward
relationship with Doosan Corporation. Doosan Glass, Sam-Hwa Crown & Closure, and
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Table 3-3:Vertical Relationship Among Affiliated firms of Doosan Chaebol
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Doosan Continental Can Mfg. have a forward vertical relationship with Oriental Brewery
Co. Therefore, these companies would be less willing to integrate vertically at the plant
or firm level because they are vertically related at the group-level.
The data of top-100 chaebols, their affiliated firms, and their products are
collected from Investment Analysis o f the Listed Companies 1996 by KSI, Annual Report
o f Korean Companies o f 1996 by KISI, and Korea Company Yearbook 1996 by APII.
part or all of the inputs of a firms processes (forward vertical relationship) and a
part or all o f the outputs of a firms processes is employed as the input of its
variable, indicating back and forward integration (BF), is equal to one, and zero
otherwise.
part or all of the inputs of a firms processes (forward vertical relationship), but a
part or all of the outputs of a firms processes is not employed as the input of its
otherwise.
its affiliated firms processes, but a part or all of the outputs of its affiliated firms
processes is not employed as a part or all the inputs of a firms processes, then the
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dummy variable, indicating back integration (BACK), is equal to one, and zero
otherwise.
Ownership Concentration
are collected instead of, for instance, the percentage of top 3 or 5 shareholders.
shareholdings that totals the percentage shareholdings of an owner, his family, especially
addition, the percentage shareholdings of institutions (OWN2) are collected to test the
determinants, such as firm size and business stabilities. All data are collected from
All these data are transformed into a log form because this transformation is
Where j is 1 and 2 which stands for inside ownership concentration (LNOl) and outside
3 The especially related persons mean persons who became a new family member by
marriage. A son-in-law and a daughter-in-law are examples.
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Degree of Vertical Integration
integration, is used widely in empirical literature and mainly for cross sectional data (e.g.,
Adelman, 1955; Tucker & Wilder, 1977; Buzzell, 1984; and Levy, 1985). A value-added
method explains that the more stages of production and distribution combined within a
firm, the higher the ratio of value-added to the sales. The value-added method is
the items of value-added. This method is corrected by subtracting net profit from value-
added (the adjusted value-added measurement). Another problem is that the degree of
successive stages of each firms production flows, and different market circumstances in
supply and demand faced by each firm. For instance, if a material-supply market for a
firm is competitive, and in turn transaction costs are very low, the firm will be less likely
VIa -(V a lu e added - N et Incom e-Incom e Tax)/(Sale - Net Incom e-Incom e Tax)
Ave.VIj and STD.VIj represent the average and the standard deviation of the
degree of vertical integration in the j-th industry, respectively. The data of value-added
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amounts, net incomes, taxes, and sales are collected from the Annual Report o f Listed
Firm Size: The average of five-year annual data for assets (ASSET), equities (EQ), and
debt (DEBT) are collected for proxy variables for firm size. All these data from 1991 to
1995 are collected from the Annual Report o f Listed Companies by KLCA (1996).
Uncertainty: The data of stock prices, profits, and overhead costs are collected from the
Annual Report o f Listed Companies by KLCA (1996) to measure the stability of business
environments. The 60-month data of month-end-prices of stock from 1991 to 1995 are
collected to create the standard deviation of monthly rates of returns (STD) and standard
errors (SE) from the capital asset pricing model. In addition, yearly data of profits from
1991 to 1995 are collected for the standard deviation of the annual ratios of profit to
assets (STDINC).
Firm Age: The data of firm ages are collected from the Annual Report o f Listed
Asset Specificity: Sunk cost (SUNK) is adopted for physical asset specificity, referring to
intensity (ADI) are employed as the proxy variables for asset specificity, referring
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specific intangible assets and product differentiation. The data are collected from the
Annual Report o f Listed Companies published by KLCA (1996). The annual costs of
advertising and R&D are divided by the sales amount to figure out the intensity of
advertising (A D I) and R&D (RDT). Then the five-year annual data of advertising and
R&D are averaged. The depreciating assets in the fixed assets are divided by total assets
to create sunk costs (SUN K) each year from 1991 to 1995 and the five-year annual data
of sunk costs are averaged. All these variables are represented by the unit of percentage.
Uncertainty: From the Annual Report o f Listed Companies by KLCA (1996), the five-
year annual data of overhead costs and sales amounts and the 60-month data of month-
end-prices of stock from 1991 to 1995 are collected to capture uncertainty due to a
volatile supply, demand market conditions, and stock prices. From these data, the
following variables are created: the beta (BETA=fi) of the capital asset pricing model and
the standard deviation of a monthly return on a stock (STD) for 60 months from 1991 to
1995.
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Performance and Economic Variables
Profit is calculated into two ways to test the firms performance: the ratios of the
average annual rate o f net incomes after taxes from 1991 to 1995 both to assets (IA) and
to equities (IE). The data of advertising intensity (ADI), R&D intensity (RDI), assets
(LNASSET), and the ratio of debt to assets (LEVER) are collected for the performance
The means, the standard deviations, maximum, and minimum values of dependent
and independent variables are computed by using 341 listed companies; data are
categorized into four parts, top-30 chaebols, top-100 chaebols, non-chaebols, and other
Ownership Concentration: Table 3-5 shows that the ownership concentration of non
chaebol firms is higher than that of chaebols affiliated firms: the percentage of non
chaebols ownership is 4.51% and .53 % higher than that of top-30 chaebols and top-100
chaebols in OWN1, respectively. The higher percentage may reflect the matter of firm
size. OtVNl seems to have a negative relationship with firm size (ASSET or EQUITY).
firms shows a slightly lower level than that in non-chaebols; this lower level gives an
expectation that a group level integration may decrease a willingness to organize either a
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Table 3-4: Variables and Their Descriptions
Variables Descriptions
Via (Value Added-Profit - Taxes)/(Sales-Profit- Taxes) of 1995
VIS Standardized Degree of vertical integration; VI = (Vljj-Ave.VIj/ Std. VIj)
IA(%) Average annual rate of net income after tax to asset from 1991 to 1995
IE (%) Average annual rate of gross income to stockholders' equity from 1991 to
1995
OWN1 (%) Shares (%) of owner & owners family and affiliated firms of 1995
OWN2 (%) Shares (%) of institutions of 1995
LNOl Log [OWN 1/(100-0WN1)]
LN02 Log [OWN2/( 100-OWN20]
BETA Systematical risk on investment from CAPM for 60 months (1991 -1995)
SE (=p) Standard error of estimate from CAPM for 60 months (1991 -1995)
STDINC Standard deviation of annual ratio of net profit to asset from 1991 to 1995
STD Standard deviation of monthly rate of return on the stocks of 60 months
(1991-95)
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Table3-5: Means, Standard Deviations, maximum, and Minimum Values of All Variables
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firm or a plant level integration.
Asset Specificity: R&D intensity (RDl) and sunk cost (SUNK) in chaebols affiliated firms
are much higher than those in non-chaebol firms; RDI is twice as high in top-30 chaebols
affiliated firms (7.09%) than in non-chaebol firms (3.21%) and SUNK is 8.51% higher in
top-30 chaebols affiliated firms (40.85%) than in non-chaebols firms (32.34%). On the
other hand, advertisement intensity (ADI) is lower in top-30 (1.19%) and top-100 chaebols
(1.53%) affiliated firms than in non-chaebols firms (1.99%). This lower percentage may
be explained by recognition of firms; for instance, chaebols firms are broadly recognized
by the public, so that they may not have to advertise as much as non-chaebols do.
comparison between chaebols affiliated firms and non-chaebols firms. Both the
standard deviation of 5-year net profits (STDINC) and the standard error (SE) from the
capital asset pricing model for 60 months in chaebols affiliated firms are higher than those
in non-chaebols firms; however, the standard deviation of overhead costs (STDCS), the
standard deviation of monthly rate of return on stock, and the systematic risk on investment
(BETA) in the chaebols affiliated firms are lower than those of non-chaebols firms.
Firm Size: Assets vary from 35.85 to 8,238.32 in top-30 chaebols, from 19.77 to 8,238.32
in top-100 chaebols, and from 5.19 to 1,128.80 billion Korean Won in non-chaebols.
However, top-30 chaebols affiliated firms are 12.3, 9.6, and 13.8 times higher in assets,
equity, and debt, respectively than are non-chaebols firms, but the difference of ownership
concentration between chaebols affiliated firms and non-chaebols firms is only 4.51%.
That is, chaebols affiliated firms have relatively higher ownership concentration though
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Performance: This table shows that the performance of non-chaebols firms is higher
than that of top-30 and top 100 chaebols affiliated firms: non-chaebols are 1.10% and
.64 % higher in IA than top-30 chaebols and top-100 chaebols, respectively and 1.35%
and .47% higher in IE than top-30 chaebols and top-100 chaebols, respectively. Non
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Chapter Four: Ownership Concentration and Its Determinants
4.1 Introduction
private corporations, using a sample o f the listed firms in the Korean stock market o f the
early 1990s. Many questions arise with regard to the ownership structure of Korean
private companies. Who are the main shareholders and how is ownership concentrated?
Are the main shareholders active decision makers or passive recipients of dividends and
ownership structure of chaebols affiliated firms different from that of the others that do
ownership concentration between chaebols and non-chaebols differ? These questions are
Ownership generally means the legal right of possession, control, use, and
disposition of physical assets. Thus, the owner has the right to receive benefits from
assets and the responsibility for bearing risks associated with decision-making in their
use. However, this general meaning of ownership is different from ownership in the
consequence, the owners nominal property rights and actual power of decision-making
in the corporation have been replaced by the executive group. While retaining ownership,
the role of shareholders has changed from active decision makers to passive recipients of
different from that in Japanese keiretzu or Western corporations; the owner is an active
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decision maker as well as a large shareholder in Korea. In addition, the owner or the
members of his family hold the most important positions. In an economic point of view,
these positions are very important with respect to problems of managers shirking. That is,
monitoring by the owner (insider shareholder) seems to be more efficient than that by the
main bank as is common in Japan or than that by the market and the board, which is the
common practice in the U.S. This separation of ownership and control in the modem
corporation is a part of the ongoing debate concerning the firms performance. This
debate will be joined later in Chapter 6. My primary concern in this chapter, however, is
The main determinants of ownership concentration in the literature are the market
business circumstances, a firms age, debt, and organizational form are considered
it is taken for granted that ownership concentration diffuses with the lapse of time.
Though the firms age may not be a determinant in countries where corporations have
concentration in countries such as Korea, where financial markets are undeveloped and
the determinants, also. The shortage of capital resources for new investment can be
solved not only by issuing new shares but also issuing bonds or borrowing. Loans or
bonds' usually do not affect ownership concentration directly, so that chaebols as well as
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the other firms preferred using them to issuing new shares. Moreover, organizational
and so on, owners ownership is expected to fluctuate less against the uncertainty of
business circumstances.
First, I will map out the ownership structure of Korean private corporations. Next,
financial markets, and the organizational form in the chaebol. Then, the empirical tests
follow.
It is quite different from the typical ownership structure in U.S. or Japanese corporations,
the actual power of decision-making has come to rest on management members such as
the executive group or board of directors who may not own equity or stocks, whereas the
stockholders remain in the position of residual income claims. However, ownership is not
2.1 define a multi-market form as an organizational form that is expanded and diversified
by participating from raw materials to the final product market, so the product processes
are related among a group's companies. Thus, it is different from a conglomerate form
that is organized by merging and/or acquiring.
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and his family. Therefore, the owner, as a large shareholder, is still the active decision
maker while common shareholders are simply the recipients of dividends and
appreciation.3 In addition, the owners family or relatives are widely positioned in the firms
not only as managers but also as main shareholders. This tendency is common in small and
middle sized firms as well as in chaebols. According to the research by the Korean stock
exchange (1997), 422 firms in 485 listed manufacturing firms are run by owners, relatives,
may stem from the capital structure that is an adaptive vehicle shaped in reaction to
influences and constraints from internal and external economic factors. In addition to
social standing of a top manager. Instead o f remaining like those who own only the largest
fraction of shareholdings, an owner wants to run the business directly. That is, not only
pecuniary benefits but also the social respectability from leadership or the opportunity to
deploy resources to suit his personal preferences are associated with non-separation. This
may come from the cultural background o f Confucianism, which focuses on ones social
standing and fame rather than wealth. In addition, it is very important with regard to
(1997, p. 64), 44 percent of upper-level managers who worked in chaebols responded that
inheritance of the family business was the most important reason for hiring family
3 Hereafter, I use the owner as a person who is a main inside shareholder as well as an
active decision maker, whereas the shareholders is defined as the outside shareholders
and passive recipient.
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members. Twenty-one percent responded that an easy way of controlling management was
the reason.
Second, the legal and regulatory environment of Korean business is different from
those of the U.S. and Japan. It can be explained with a view of DiMaggio and Powells
(1983) coercive isomorphism, which stems from the influence of political power. After
the Korean military revolution in 1959, the roles of both commercial and specialized
banks became a means of political financial distribution. Approvals of the annual budget
controlled by the hands of a new military regime. Furthermore, the new regime governed
foreign loan capital as well as foreign investment. In addition, the commercial law
result, the financial markets were fully under the control of the government; the banks
were not closely associated with the corporations as the long-term shareholders by the
market system but as the financial distributors in lieu of the government. Banks had only
government. Therefore, Korean banks are unlike Japanese banks, which are closely
related to Japanese corporations as the steady and long-term shareholders, monitors, and
investors to a greater extent in a corporation. In the case of the U.S., commercial banks
have been prevented by law from holding any corporate stock in their accounts (Prowse,
1992).
After centralizing capital resources of domestic and foreign loans, the new
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the lack of legitimacy of military revolution. For economic development, the larger
businesses such as chaebols were selected as the new regimes partners because the new
regime believed that the larger businesses had an advantage in economies of scale.
Therefore, loans were made predominantly to chaebols at low rates. In addition, the
system because the government believed that to move ahead swiftly with the
bottom-up decision-making processes and ultimate authority on the decision lay with
the owner-managers, so that if the decision were made by them everyone would march in
that direction.4 Furthermore, Article 200 of the Security Exchange Law of Korea, which
states that outside shareholders could not hold more than 10 % of voting stock, protected
Third, there exists a unique business group, chaebol. in the Korean private
business world, which is characterized by a group of firms that are diversified vertically
different from that of the other firms that do not belong to such chaebol groups.
Generally, the larger shareholders in a chaebol are the owners (including his family,
4 Therefore, chaebol may be called a clan form because chaebols shows relatively high
level of goal congruence though consensus is not achieved through a bottom up
decision process.
s It was revised in 1997 and a new article allowed for the outsiders to hold shares without
limitation.
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According to the Fair Trade Committee (FTC), the average percentage of
ownership in the top-30 chaebols with 652 firms in 1995 is 43.8%. This ownership
divides into two parts, direct ownership (10.5%) that belongs to the owner and his
family and indirect ownership that belongs to the affiliated firms (32.8 %). (See Table
4-1).
Table 4-2 shows how the ownership of all listed Korean companies breaks down
among various sectors from 1980 to 1995. During this period, the number of listed
companies increased 2.0 times (352 to 721 firms) but the capital stock of them increased
19.9 times (1.96 trillion to 38.05 trillion Won). This table shows that the percentage of
ownership by financial institutions in Korea has increased (from 8.2 % in 1980 to 25.5 %
in 1995) while the percentage of that by non-financial institutions and households has
decreased (from 30.0% to 18.7% and from 56.7% to 37.4% respectively) during this
period. Increased foreign ownership in 1995 stems from opening domestic financial
These data, constituting the percentage of shares in the various sectors of the U.S.
and Japan in Table 4-2, are adopted from Prowse (1992) in a standard of comparison in
the same table. They are categorized into four parts: all corporations, households,
foreigners, and others of the U.S., Japan, and Korea of 1984. Then, all corporations are
divided into two parts, financial and non-financial institutions, and financial institutions
are classified into three parts, commercial banks, insurance companies, and other
financial companies.
Korea (12.7%) is lower than those in the U.S. (26.6%) and Japan (43.3%).
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Table 4-1: Ownership in Top-30 Chaebol
Year Owner (%)=A Affiliated firm (%)=B A+B
1990 13.7 31.7 45.4
1991 13.9 33.0 46.9
1992 12.6 33.5 49.1
1993 10.3 33.1 43.4
1994 9.7 33.1 42.8
1995 10.5 32.8 43.8
Fair Trade Committee (1996)
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Table 4-2: Percentage o f Outstanding Corporate Equity Held by Various Sectors in Korea,
U.S., and Japan in 1984
Sector o f Ownership 1980 1985 1990 1995 1984
Korea U.S.A* Japan*
All corporation 27.6 45.1 40.8 44.2 43.8 37.7 67.3
Financial Institutions 8.2 15.1 25.2 25.5 12.7 26.6 43.3
Commercial Banks 5.9 7.1 7.3 11.2 6.6 .2 20.5
Insurance Na 0 5.5 5.7 0 4.6 17.7
Others Na 8.0 12.4 8.6 6.1 21.8 5.1
Non Financial Inst. 19.4 30.0 17.8 18.7 31.1 11.1 24.0
Foreigners 2.0 2.0 1.7 10.1 2.2 4.2 5.0
Households 56.9 52.5 46.0 37.4 53.7 58.1 26.7
Others 14.5 .4 10.3 8.3 .2 .0 1.0
Note: Source from Choosik (Stock), 1996 and * is adopted from Prowse (1992)
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The percentage of shareholdings by commercial banks (6.6%) shows much higher
than that of the U.S. (.2%) but lower than that of Japan (20.5%) because, as mentioned
above, commercial banks are not allowed to hold more than 5% of voting stock of a
corporation in the U.S., while the legal and regular environment of Japanese financial
Korea may reflect the inter-investment or interlocked ownership structure among the
multi-market firms such as chaebols. For example, in the 30 big chaebols in Korea, the
average of inter-investment among the affiliated firms is 26.8% of total assets in 1995.
Households in Korea and the U.S. hold a higher portion of shares but there exists a major
Table 4-3 shows how ownership is concentrated in the various shareholders of the
Korean corporations: it reports who is the largest shareholder in the corporation. Data
includes all manufacturing and non-manufacturing (except financing) sectors in the 578
listed companies from the Annual Report o f Listed Companies in 1995. It is categorized
into four parts: Owner, Institutions, Individuals, and Others. Owner stands for the
average percentage of owners and their families total possessions of stocks: ownership is
highly concentrated to Owner, which is 19.22% in the top-30 chaebols and 25.04 % in all
corporations with more than or equal to 1% of total shares show 10.83%. Individuals who
are the households (but not as an insider shareholder) and have more than or equal to 1%
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Table 4-3: Ownership Concentration in Korea of 1995
Types Chaebols All Listed firms
Owner 19.22 25.04
Institution 15.91 10.83
Individuals 4.60 7.72
Other 60.26 56.40
Note: Data are collectedfrom Annual Report o 'Listed Companies in 1995.
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The accumulation of total percentage in the large shareholders of Owner, Institutions, and
Individuals is 43.60%. Others indicate small shareholders who have less than 1% of total
Figure 4-1 explains how ownership in chaebols is concentrated. For instance, the
owner of the Hyundai chaebol is Chungs family (Joo-young Chung is a founder as well
as chairman of Hyundai chaebol) who are the largest shareholders of Hyundai Heavy Ind.
(69.2%), Hyundai Auto Corp. (6.3% by the owner and 10.3% by Hyundai Heavy Ind.),
and Hyundai Industry Development Corp. (40.5%). These three firms are the biggest
Hyundai Corp. Ltd., Hyundai Engineering, and Hyundai Development Corp. are three big
shareholders of Korean Aluminum Industry. They have 21%, 5.3% and 4.8% of total
common stocks, respectively. Korea Aluminum Ind. has 50% of shares of Hyundai
Electrical Engineering Ltd. In reality, the Chung family has only 1.12% of total
shareholdings (direct ownership), while his affiliated firms possess 48.88% of total shares
There may be many visible and invisible factors that affect the ownership structure.
Generally, capital resources and control potential (stability of business circumstances) are
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Figure 4-1: Ownership Structure o f Hyundai Chaebol
Hyundai
Engineering
Ltd.
5.3
Hyundai
Auto
6.3 Corp.
7.3
Hyundai 5.2
Industry
40.5 Development 4.8
Corporation
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concentration to reflect Korean business environments. However, the effects of the
into two parts: inside shareholders (Ownl) and the big outside shareholdings by
institutions (Own2) instead of top-five or ten shareholders. Ownl includes the total
possessions (%) of stock by an owner and his family plus the affiliated firms; Own2
includes the total possessions (%) of stock by financial and non-financial corporations
that have more than or equal to 1% of total shares. In addition, Own 12 is used as a
Capital Resources
There is a constraint for inside shareholders to supply capital resources for a new
investment or the expansion of business lines. That is, if an owner as the inside
shareholder cannot increase the share of ownership prorata, ownership concentration will
fall. Additional capital can be raised with newly issued shares, but a reduction of insiders'
ownership (e.g., Ownl) will be reduced, ceteris paribus. However, outside shareholders
capital resources for new investment can be obtained not only by issuing new shares but
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also by issuing bonds or borrowing. Whereas the reduction of insider ownership
concentration occurs with issuing new shares unless inside shareholders increase the
share of ownership prorata, debt does not affect ownership concentration directly. That is
to say, if the inside shareholder does not wish to reduce his ownership, he will prefer debt
rather than issuing new shares.6 The high debt ratio under non-separation of ownership
and management in Korean corporations may be explained with this reason. Most big
debt-holders are financial institutions in Korea, which are under control of the government
and are used as a window of political financial distribution. A good relationship with the
continually with lower interest rates. However, the higher the ratio of debt to equity is,
the higher the required interest payment on the debt, the higher bankruptcy cost, and, in
turn, the less stability in running the business is expected. Therefore, these side effects of
debt decrease the owners willingness to increase the ratio of debt to equity. Overall, the
effects of debt such as higher interest payments and bankruptcy costs though debt does
6 However, this explanation may not be adopted in the case the place o f ownership and
management are separated or that the financial market is well operated by a market
system because debt is more related to financial stability rather than ownership
concentration. Theoretically, the greater the ratio of debt to equity is, the higher the
required interest payment on the debt, and the higher bankruptcy cost is expected to be.
Therefore, the optimal debt ratio should be lower as long as the marginal benefit from
using debt is less than marginal cost of debt and bankruptcy.
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Control Potential
According to Demsetz and Lehn (1985), control potential is defined as the wealth
owner. They assume that neither the markets for corporate control nor the managerial
labor market operate costlessly. If these markets were perfectly operated, then control
potential would play no role in explaining the ownership structure. Firms that transact in
markets characterized by stable prices, stable technology, stable market shares, and so
forth are firms in which managerial performance can be monitored at relatively low cost.
In addition, they postulate that control potential is likely correlated with environmental
noise. The tighter control will pay off to the insider owner if a firm faces higher noise in
concentrated if the business environment is not stable. However, portfolio theory explains
that risk bearers such as big outside shareholders are likely to spread their wealth across
many firms if they are not members of the board and do not engage in monitoring as well.
the inside as well as outside shareholders such as Ownl and Own2 are expected to be
ambiguous.
The age of the firm may be one of the possible determinants in the case of the
early stage of business history, like Korean private business. In the view of the firm
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the lapse of time. A firm needs to develop new technology, expand its business, or enter
into new business lines in order to survive changing business environment as time goes
by. Therefore, issuing new stock is needed for these businesses unless the owner can
concentration. Berle and Means (1968) show how the ownership concentration had been
dispersed and ownership was separated from management with the firm development in
the early 1900s of U.S. business. However, the age of a firm does not seem to be a
revolution, i.e., the diffusion in ownership and the separation of ownership and
short business history: the average of the established year in the listed firms is 1966.8 and
the average year listed is 1983.4. Therefore, I control for the firms age and expect a
Organization Form
Organizational form may affect ownership concentration in the case of the Korean
from that of the other firms. Table 4-4 shows that the affiliated firms in the chaebol show
lower owner concentration but they are much larger; percentage of ownership in top-30,
top-100, and non-chaebol firms are 21.13%, 25.11%, and 25.65%, respectively whereas
the assets of top-30, top-100, and non-chaebol firms are 1,097.72, 523.28,, and 88.93
billion Korean won, respectively and the equities of top-30, top-100, and non-chaebol
firms are 301.42, 150.81, and 31.45 billion Korean Won, respectively.
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Table 4-4: Mean Values of Ownership, Assets, and Equity in Top-30, 100 Chaebols, and
Non-Chaebols in the Listed Corporadons of 1995
Chaebols Stockholdings Stockholdings Assets Equity
by Owner by Institutions (Billion S) (Billion $)
Top-30 21.133 14.323 1,097.72 301.42
Top-100 25.111 13.055 523.28 150.81
Non 25.645 8.005 88.93 31.45
Average 25.354 10.759 326.43 96.72
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However, chaebols have relatively high ownership concentration in comparison to their
assets or equities. Top-30 chaebols are about 12 and 10 times larger than non-chaebols in
assets and equities, respectively while there is only less than 4.51 percent difference
between top-30 and non- chaebols in ownership concentration. In sum, chaebols are
expected to have lower ownership concentration because they are much larger than non
chaebols are.
from its stable ownership structure; they have advantages in credit, capital flow,
reciprocal pledges, and higher quality of information on the market. Though each
affiliated firm is legally independent, it is operated as a part of a chaebol and under single
common administrative and financial control. That is, the affiliated firms of chaebols are
bound by ties of fractional ownership and reciprocal or joint investments among them
(see Figure 4-1). Therefore, ownership concentration in the affiliated firms is more stable
to the fluctuation of business circumstances than that in the others if other things are
equal.
Modeling
* O rganizational Form + e ,
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This model explains ownership concentration by firm size, listed years in Korean
concentration into three parts: (1) inside ownership concentration (%) including an
owner, his family, and affiliated firms {OWNI), (2) outside ownership concentration (%)
including only ownership that is greater or equal to 1% of the total shares (OWN2) by
{OWNI2=OWNl +OWN2). LNOl, LN02, and LN012 are the transformed log forms of
ASSET, EQUITY and DEBT are proxy variables for firm size. They stand for the
average of total assets, equity, and debt from 1991 to 1995, respectively. These variables
are expected to have negative relationships with inside ownership concentrations (LNOl).
However, the decreased amount of inside ownership may increase outside ownership
YR stands for a time period as a listed company (J7?=1995 - the listed year). The inside
ownership (LNOl) is likely to decline with time, so that YR is expected to have negative
coefficients in the LNOl equation, but not necessarily in the LN02 equation.
SE, STD, and STDINC are employed as proxy variables for environmental
stability. They stand for the standard error of the regression of the firm's monthly returns
on stock regressed on the market portfolio returns for 60 months, the standard deviation
of monthly stock market rates of return, and the standard deviation of annual firm income
ambiguous; control potential theory by Demsetz and Lehn(1985) explains that these
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variables will show a positive relationship with inside ownership while portfolio theory
explains that risk bearers are likely to spread their wealth across many firms if they are
not members of the board and do not engage in monitoring as well. With considering the
circumstances that outside owners usually do not influence management in most Korean
negative and significant, it can be interpreted that owners prefer debt rather than issuing
new shares in order to protect their ownership concentration from diffusing. For the
Dummy variables such as DUM30 and DUM100 for top-30 chaebols and top-100
chaebols and non-chaebols. DUM30 and DUM100 are expected to have negative signs
because chaebols are much larger than non-chaebols. In addition, interaction dummy
variables are considered in order to capture the possibility that chaebols alter the effect on
stability; SE30 is SE*D(JM30 and SE100 is SE*DUM100. Affiliated firms are operated
as a part of a chaebol and under single common administrative and financial control and
are bound by ties of fractional ownership and reciprocal or joint investments among
them. This gives advantages in capital flow and reciprocal pledges, so that chaebols can
maintain relatively stable with fluctuation of business circumstance than in the others if
other things are equal. Hence, the coefficients of interaction dummy variables are
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Table 4-5: Variables and Their Descriptions
Variables Descriptions
OWNl (%) Shares (%) of owner & owners family and affiliated firms of 1995
OWN2 (%) Shares (%) of institutions of 1995
OWN12(%) OWN1+OWN2
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expected to have negative signs if SE has a positive sign, vice versa. Descriptions of all
Table 4-6 shows means and standard deviations o f all variables in top-30, top-
100, non-chaebols, and all firms. Firm size in top 30 and top-100 as well as non-chaebols
is variable. Table shows that the ranges o f assets in top 30 chaebol, top-100 chaebols, and
non-chaebols are from 35.8 to 8,238.3, from 19.8 to 8,238.3, and from 5.2 to 1,128.8
billion Won and the range of equities of top-30 chaebols, top-100 chaebols, and non
chaebols are from 6.3 to 2,444.6, from 4.2 to 2,444.6, and from 2.1 to 845.3 billion Won,
respectively. However, the average of asset and equity are quietly different among them.
That is, top-30 and top-100 chaebols are 12 and 6 times higher, respectively than non
chaebol firms are. Though there are big differences in asset and equity among top-30,
between chaebols affiliated firms and non-chaebol firms is only 4.51% and .51%,
respectively while. OWN2 of non-chaebols is 6.32% and 5.05% lower than that of top-30
chaebols and top-100 chaebols. Mean values of the stability variables do not show
consistent difference between chaebols affiliated firms and non-chaebol firms; non
chaebols show lower values in the standard deviation of 5-year net profits (STDINQ and
the standard error (SE) from the capital asset pricing model for 60 months, but a higher
Table 4-7 shows the correlation matrix among variables. The statistical
significance test revealed that the true correlations among variables are very significant;
the null hypothesis that there is no linear relationship between each pair of random
variables is rejected against the alternatives that the true correlation is a positive
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Table 4-6: Mean and Standard Deviation Values
Variables Top-30 Chaebol Top-100 Chaebol Non-Chaebol All Data
Mean Maximum Mean Maximum Mean Maximum Mean Maximum
(S.D) Minimum (S.D) Minimum (S.D) Minimum Minimum
OWNl 21.133 51.80 25.111 51.80 25.645 62.80 25.354 62.8
(%) (12.653) 4.30 (12.565) 2.40 (11.888) 4.3 (12.247) 2.4
OWN2 14.325 59.80 13.055 68.50 8.005 68.2 10.759 68.5
<%) (13.000) 0 (12.129) 0 (9.654) 0 (11.448) 0
LNOl -1.487 .072 -1.231 .072 -1.174 .523 -1.205 .524
(.797) -3.102 (.766) -3.705 (691) -3.102 (732) -3.705
LN02 -2.221 .389 -2.294 .760 -2.875 .746 -2.558 .760
(1.330) -4.615 (1.256) -4.615 (1.244) -4.615 (1.282) -4.615
YR 15.211 29 14.732 39 10.245 33 12.698 39
(7.218) 5 (7.759) 4 (6.101) 5 (7.299) 4
ASSET 1,097.72 8,238.32 523.28 8,238.32 88,93 1,128.80 326.425 8,238.32
(1547.3) 35.85 (1020.81) 19.77 (142.98) 5.19 (790.26) 5.19
EQUITY 301.42 2,444.6 150.81 2,444.6 31.45 283.35 96.719 2,444.64
(444.28) 6.29 (289.83) 4.16 (38.11) 3.06 (223.64) 3.06
DEBT 796.29 5,793.6 372.45 5,793.6 57.48 845.27 229.705 5,793.67
(1121.8) 24.79 (742.78) 7.12 (108.61) 2.13 (575.401 2.13
LEVER 349.31 1,257.7 276.04 1257.75 189.448 1421.88 236.682 1421.88
(226.54) 74.56 (181.83) 30.27 (156.03) 23.64 (175.73) 23.64
SE .06495 .07614 .0629 .0761 .0603 .07648 .0617 .07647
(.0070) .04724 (.0070) .0451 (007) .04402 (.007) .04402
STD 3.5041 4.358 3.5835 4.613 3.761 5.155 3.664 5.155
(.332) 2.796 (.368) 2.796 (.403) 2.877 (.391) 2.796
STDINC 26775.0 1048523 11328.0 1048523 1688.1 53589.6 6946.26 1048523
(12488) 224.47 (77059) 107.36 (49615) 40.599 (57132) 40.599
DUM30 1 .3548 0 .194 1
(.479) (396) 0
DUM100 1 1 0 .545 1
(498) 0
Obs. 66 186 152 341
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Table 4-7: Correlation Matrix
.105 .995 .945
i*
LEVER -.017 .045 .004 .145 -.037 .184
YR -.148 .289 .049 .231 .228 .228
SE .017 .087 .073 .330 .329 .325
STD .075 -.078 .000 -.248 -.248 -.244
STDINC .037 -.040 -.003 -.055 -.067 -.049
DUM30 -.189 .128 -.026 .477 .448 .482
DUM100 -.037 .226 .129 .274 .266 .293
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(or negative) linear association at a .5% significance level for all pairs. This table shows
that inside ownership concentration (LNOl) and the other independent variables move as
expected but do not show higher correlation coefficients at all. In addition, institutions
ownership concentration (LN02) and the other independent variables show the expected
Regression Results
Table 4-8 reports the estimates of inside ownership concentration (LNOl) based
on the model. Due to a heteroskedasticity problem, the equations are weighted by asset.
Equation 1 reports the estimate results: the p-values of two-tail significance test are .00%
for ASSET, 1.54% for YR, 44.66% of LEVER, and 1.89% of SE. All signs are as
predicted and are significant except LEVER. The sign and significance of ASSET and SE
are consistent with the views of Demsetz and Lehn (1985) that inside ownership will be
diffused, as a firm is getting larger and that the tighter control will pay off to the inside
owners if the firm face higher noise in its environment. Equations 2 and 3 report the
estimates with entering different proxies of stability such as STD and STDINC. They are
positive as predicted, but not significant at all. Equations 4 and 5 reveal the estimates
with entering different variables of firm size such as equity (EQUIYT) and debt (DEBT).
The results are similar to Equation 1. All signs are as predicted. The significant and
positive signs of ASSET and SE are also consistent with the views of Demsetz and Lehn
(1985). Equations 6 and 7 show the estimates added with dummy variables to capture the
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Table 4-8:Determinants o f Ownership concentration (LN Ol)
Variables 1 2 3 4 5 6 7 8 9
Concept -1.8572 -1.1253 -1.0387 -1.7942 -1.869 -1.8619 -1.7910 -1.9532 -24615
(5.196)* (2.900)*(1100)* (5.02)* (5.23)* (5.21)* (-5.01)* (5.03)"* (4.78)*"
ASSET -2.361*10* -1.977*10*
-1.985*10*
(-4.53) * (3.80)* (3.07)*
EQ -7.604*10* -5.795*10* -7.887*10* -5.212*10* 7.083*10*
(4.13)"* (2.87)*" (4.19) * (232) (3.69)*
DEBT -3.314*10*
(4.62)_*
YR -.0137 -.0108 -.0109 -.0135 -.0138 -.0135 -.0144 -.0141 -.0146
(2.43) (1.91)* (1.97) (2.38)" (2.48) (2.41)" (2.49) (2.47) (2.53)
LEVER 1.707*10* 1.522 10* 1.573*10* -.529*10* 2187*10* 2171*10* 1.719*10* 2180*10* .029*10*
(.762) (.670) (.696) (.236) (.972) (.921) (.034) (.924) (.001)
SE 13.9586 13.2925 14.0019 14.2655 13.0293 15.8249 24.2023
(2.36)* (2.236)" (2.37)" (2.41)" (2.19)" (2.44) (2.83)*"
STD .0235
(.229)
STDINC 4.721 *107
(.054)
SE3Q -9.3684
(60)
SE100 -20.9282
(181)*
DUM30 -.2463 .3429
(2.14)" (.345)
DUM100 .0656 1.3468
(.774) (1.88)*
Adj. R-sq. .0713 .056 .056 .062 .073 .072 .061 .070 .067
F-statistic 7.525* 6.047* 6.035* 6.645*" 7.734 * 6.288* 5.429"* 5.289* 5.100*"
Note: () shows absolute value of t- statistics and*, **, and *** for the significance level
at a 10%, 5%, and 1%, respectively.
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Equation 6 shows that the signs o f all variables are as predicted and significant at least at
a 10% level: 0.42% for EQUITY, 1.81% for YR, 36.59% for LEVER, and 1.51% for SE.
and non-chaebols. In Equation 7, all signs are as predicted except DUM100. EQUITY,
YR, and SE are significant at least at a 5% level while DUM100 and LEVER are
insignificant. Equations 8 and 9 report the estimates of the interaction variables such as
SE30 and SE100 to capture the possibility that chaebols alter the effect on instability.
Equations 8 and 9 report that the interaction variables such as SE30 in Equation 8 have
negative signs, but are not significant at all. In addition, the coefficient of DUM30 in
Equation 8 has a high standard error and a low significance level in spite of that fact that
SE100 and DUM100 are significant at the 10% significance level, but DumlOO reveals
not an expected sign. These symptoms stem from higher correlation between interaction
dummies and dummy variable and lower variation in SE; SE30 and DUM30 or SE100
and DUM100 are highly correlated (rSE3o, dum 3o = -993 and T s e io o , d u m io o = -986) and
variation of SE is very low (SE=.0617 and s.d. of SE=.007). That is, these indicate that
In short, Table 4-8 reveals that the results are consistent with Demsetz and Lehns
outcomes, which explain that firm size and business environment are two main
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On the other hand, the estimates with outside ownership concentration (LN02)
are reported in Table 4-9. It shows the opposite signs to inside ownership concentration
level and the others coefficients are opposite signs to LNOl but are insignificant.
Equations 1, 2, and 3 reveal that SE, STD, and STDINC are positive coefficient signs. It
seems to support the portfolio theory that risk bearers such as outside big shareholders are
likely to spread their wealth across many firms, but the coefficients of those variables are
not significant at all. As EQUITY or DEBT is entered into the regression in place of
ASSET in Equations 4 and S, the results show the same signs as ASSET is entered, but
all variables except YR are not significant at all. YR reveals positive signs and is
significant at a 1% level in all equations of Table 4-9. Thus, it is consistent with the view
outsiders is inevitable with the lapse of time. . Equations 6 and 7 show the estimates
concentration between chaebols and non-chaebols. Equation 6 shows that all coefficients
are not significant, except YR; the coefficient of DUM30 shows a positive sign, but are
not significant. However, the coefficient of DUM100 in Equation 7 shows a positive sign
between chaebols and non-chaebols. Equations 8 and 9 report the estimates of the
interaction dummies such as SE30 and SE100 to capture the possibility that chaebols
alter the effect on instability. Equation 8 shows that both interaction dummies and
DUM30 are significant at the 5% level, but SE30 is positive while DUM30 is negative. In
Equation9, SE 100 are positive and significant at the 10% level whereas DUM100 is
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Table 4-9: Determinants o f Ownership Concentration with LN02 (n=341)
(Independent Variable=LNQ2, n=341)
Variable 1 2 3 4 5 6 7 8 9
Concept -3.1373 -2.6898 -3.1752 -3.1520 -3.1355 -3.0672 -3.1314 -2.4031 -2.0550
(5.02)*** (4.00)**8 (21.69)* (5.07)* (5.02)*" (4.92)*" (-5.08) * (3.57)* (2.32)"
ASSET .744*104 -.566M04 -8.743*104
(.806) (.627) (.780)
EQUIT -2.493*10-7 -2.275*107 -7.195*10-7 4.017*10-7 -5.714*10-7
(.778) (.058) (.214) (1.04) (181)
DEBT -1.029*1O4
(.818)*"
YR .0496 -.0491 -.0494 -.0495 -.0497 -.0496 -.0438 -.0537 -.0442
(5.06)*** (5.14) * (5.14)* (5.03)* (5.08)* (5.06)*" (4.40)* (5.45)* (4.46)*
LEVER -1.479*1(h* - . I ^ I O 4 -1.500*10 4 -n o e v o 4 -.1.613*104 -3.162*104 -3.342*10 4 -3.226-104 -3.061'104
(.377) (.296) (.383) (.283) (412) (.769) (.849 (.791) (779)
SE -.6428 -.5231 -.6215 -1.7419 -2.1702 -13.0885 -20.1068
(.062) (.051) (.060) (1.68) (212) (1.167) (1.36)
STD .1315
(761)
STDINC -3.153*10-7
(.390)
SE30 68.1672
(2.31)
SE100 33.5791
(1.69)*
DUM30 .3085 -3.9785
(1.54) (2.31)
DUM100 .4107 -1.6460
(.2.81)* (1.34)
Adj. R- .074 .076 .074 .074 .074 .078 .093 .093 .098
sq.
F-stat 7.815* 7.964* 7.826 * 7.798* 7.816"* 6.736*" 7.951 * 6.754"* 7.137*
Note: () shows t-statistics and *, **, and *** stand for the significance level at a 10%,
5%, and 1%, respectively.
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negative, but not significant. In addition, the coefficients of DUM30 and DUM100 in
Equations 8 and 9 reveal big changes with an opposite sign. These symptoms also stem
SE. That is, these indicate that interaction dummies are not very meaningful.
4.5. Conclusion
in the Korean private business sector. First, I divided ownership concentration into inside
shareholders' ownership percentages were used for dependent variables. It may cause a
problem because the standpoints between outside and inside shareholders may be
different. Demsetz and Lehn (1985) insisted that business environment would affect
shareholders who do not participate in management, they would spread out their
shareholdings in accordance with the portfolio theory if they expect that the business
environment is unstable; that is, outside ownership concentration would have a negative
relationship with instability. Therefore, the empirics without differentiating from inside to
Korean business circumstances, three other variables were added in two main
determinants of ownership concentration. One is debt because debt does not cause
diffusion of insider ownership directly but bears capital cost, i.e., interest, which is
considered one of the production costs. The second one is the firm's age. According to
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the corporation revolution theory, inside ownership is likely to decrease with time.
that of the developed countries corporations. Most corporations in Korea had been
established since World War II and Korean stock market was opened in 1956 (the
average o f the listed period is only 12.8 years). Thus, inside ownership is predicted to be
likely to decrease with time. Lastly, in order to estimate the difference of stability effect
between chaebols and non-chaebols, an interaction dummy was adopted. Each of the
affiliated firms is operated as a part of a chaebol and under single common administrative
and financial control and is bounded by ties of fractional ownership and reciprocal or
1) Firm size affects inside as well as outside ownership concentration. In the case
concentration and firm size. This is consistent with Demsetz and Lehns (1985) and
Prowses (1992) findings in the U.S. and Japan, respectively. In addition, outside
ownership concentration shows a positive relationship with firm size, but not
necessary.
inside ownership concentration. This result is consistent with Demsetz and Lehns view
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be unstable. On the other hand, instability variables reveal negative relationships with
outside ownership concentration but the coefficients were not significant at all. That is,
the portfolio theory failed in explaining that risk bearers such as outside shareholders are
3) The firms age shows a negatively significant determinant in the Korean case.
This result, a negative relationship between the firms age and insiders ownership
concentration, is consistent with Berle and Means view, i.e., corporation revolution
theory. On the other hand, the firms age reveals a positively significant determinant of
ownership concentration than other firms, but have relatively higher inside ownership
concentration in comparison to their assets or equities. Part of this is thought that chaebol
SE=0.007). That is, these indicate that interaction dummies are not very meaningful.
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Chapter Five: Vertical Integration and Determinants
5.1 Introduction
in Korea is defined as a big business group that consists of many formally independent
vertically integrated at a group level rather than at a firm level or a plant level1 and
diversified into related businesses. Though each affiliated firm is formally independent
Three important economic factors may affect the present chaebols multi-market
structure. The first one is market imperfection, which may be a common phenomenon in
fully depended on foreign aid and agricultural products. Moreover, the Korean War
(1950-53) destroyed for the most part infrastructure. Thus, domestic markets, especially
raw and intermediate input markets, were unstable as well as imperfect; there were the
Increased transaction costs2 from these problems led chaebols to participate in various
business lines; the chaebol coordinated a variety of resources and tried to become much
more self-sufficient. That is, vertical integration might be an inevitable strategy in order to
eliminate higher transaction costs and uncertainty caused by unstable and imperfect
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markets.
The second factor is related to the industrial policy of the Korean government.
After the military coup detat of 1959, an active government insisted on an export
promotion and nurturing policy for economic development and rearranged faltering
businesses. The export promotion policy led chaebols to participate in various light
industries. The government provided various kinds of supports such as subsidies, bounties
on export, and low rate domestic loans to exporting business groups. In addition, the
nurturing policy for heavy and chemistry industries in the 1970s led them to join those
industries. This policy gave full benefits to the established corporations, such as chaebols,
because the government thought they had economies of scale and experience in business.
Furthermore, the government rearranged faltering businesses in the 1970s and readjusted the
heavy industries with over-capacity in the 1980s. It also offered an opportunity for chaebols
markets after the military coup detat in 1959. Commercial banks were nationalized;3
therefore, the approval of annual budgets and the appointment of top managements came
under the control of the government. Of course, the government tightly controlled the
group firm enables the circulation of funds in a group to maintain stable capital flows and
the smooth shift of funds to those showing higher profits; the conglomerate contains a
miniature capital market substituting the capital allocation function of the market. The
3 Until the 1960s, the intermediary role of commercial banks was of little significance
because of negligible savings of the nation. The primary purpose of financial institutions
was to channel aid funds to rehabilitation projects and fanners (Nam and Lee, 1995).
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multidivisional organization forms a pool of funds from affiliated firms and reallocates
group level, stems from these three economic factors and may affect differently the
determinants of vertical integration between chaebols affiliated firms and the other
integration determinants are. In the first section, the structure of Korean business groups
will be described. This section will explain why the chaebol has the multi-market form at
the group level and why the effects of determinants on vertical integration may be
different between the chaebols affiliated firms and the other independent firms (non
market strategy to reduce the increased transaction costs by the uncertainties of market
chaebols, can be interpreted as efforts to seek economies of scale and scope as well as
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Figure 5-1: Organizational Structure (Hyundai Group)
Chairman
Affiliated Firms
Sales/Export
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is organized centering on the chairman of the chaebol group. The chaebol operates an
office of planning and coordination, a president meeting, a self-audit inspection team, and
a general board of directors. The office of planning and coordination (sometimes called
the secretarial office) operates to determine all decisions, to take care of problems faced
by all affiliated firms, and to advise the chairman of all possible information. It is a think
tank.
The regular president meeting is a path of communication for the initiation of new
all employees. The general board members usually consist of inside members of the
group, and the chairman is the president of the board. All these systems are centralized on
and governed by the chairman; therefore, all authority is concentrated toward the
chairman.
Figure 5-2 shows another view of organization. It shows how chaebols are
vertically integrated at the group level. The Hyundai chaebol group, for instance, entered
almost all industries from the supply of raw materials to sales of final goods and services:
47 affiliated firms of the Hyundai group participate in the 10 out of 15 industries (by two-
digit standard industrial classification: SIC). Hyundai shows a multi-market form that
includes characteristics of vertical integration (that is, operating several stages of the
production process at the group level) and of conglomerate (that is, diversifying all
industries). For instance, in the case of a manufacturing sector in the Hyundai chaebol,
Hyundai Engineering & Construction Co., Ltd. is vertically related with Inchun Iron &
Steel Co. Ltd. (e.g., reinforcing bar), Hyundai Construction Equipment Services Co., Ltd.
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Hyundai
Resource Hyundai Heavy Industry
Development Co. Hyundai Mipo Dockyard
Hyundai Woods Industries Co., Ltd Hyundai Corporation
Hanmoo Shopping
Keum-Kang Development
Alaska Hyundai Department
Development Hyundai Petrochemical
Hyundai Production
Diamond Advertise
Kepico
Hyundai Auto Service
Hvundai Motor America
Hyundai Auto Co.
Hyundai Precision Co. Ltd
woods, fliers, logs), Koryeo Industrial Development, Co. Ltd. (e.g., cements), Hyundai
Aluminum Industry Co., Ltd. (e.g., window sashes), Hyundai Elevator Co., Ltd. (e.g.,
elevators and escalators), Hyundai Pipe Co., Ltd. (e.g., plumbing pipes) and so
on. Hyundai Auto is integrated forward to Hyundai Corporation (e.g., sales and export of
cars) and Hyundai Auto Service (e.g., auto repair and parts sale), and is integrated
backward to Kepico (e.g., auto parts), Hyundai Precision Co. Ltd. (e.g., auto frame),
Hyundai Electronic Co. Ltd. (e.g., auto electric parts), and so on. On one hand, Hyundai
(department and retails) are integrated forward to the affiliated firms that produce
consumer goods. Alaska Development (e.g., development of oil and wood in Alaska),
Hyundai Resource Development (e.g., development wood in Russia), Hyundai Oil (e.g.,
oil importing and refining) and Hyundai Aluminum (e.g., aluminum, metal, and non-
metal importing) are integrated backward to the affiliated firms that use the raw material
goods. On the other hand, transportation firms (e.g., Suneel Shipping and Hyundai
(e.g., Hyundai Marine & Fire Insurance for fire insurance and retirement allowances,
Kangwon Bank, Hyundai Security, and Hyundai Auto Finance), R&D institutions (e.g.,
Diamond Advertise and Seoul Production) are universally related with all Hyundai
chaebol's affiliated firms. Therefore, the affiliated firms have more advantage supplying
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upstream product goods, receiving information of downstream firms, improving capital
Table 5-1 shows how the top-30 chaebols are diversified by industry. The degrees
of diversification are calculated based on the Berry Index, the Entropy Index, and the
2
Diversification Index. The Berry Index defines 1- S . , where S is Xi/X, Xi is sales
amounts of i-th industry of a chaebol and X is total amounts of the sales of the chaebol. If
2 2
a chaebol specializes in a certain industry, then S. will be 1. Therefore, the closer S. is to
1, the closer the Berry Index will be to 0, which means that the chaebol is less diversified.
If the chaebol is more diversified the Berry Index will be close to 1. The Entropy Index
defines -ISi* In (S), where In (S) is a log form of S . If the chaebol specializes in a
certain industry, the Entropy Index will be 0 because In (S) is 0. The Diversification
Index defines 1-XL/X, where XL is the largest sales amount of an industry in the chaebol.
If the chaebol is less diversified, the closer the Diversification Index will be to 0, and if
the chaebol is more diversified, the closer Diversification Index will be to 1. Among
(construction) show a less diversified index while Hyundai, Samsung, LG, Ssangyong,
Table 5-2 shows diversification index as for subgroups of 135 chaebols.4 They are
calculated according to sale and asset amounts. Diversification I is 1- XL/X, where XLis
the largest sales or assets of a firm and X is the total sales or assets of a chaebol.
4 Data of 132 chaebols are collected from the Annual Report o f Korea Companies,
1995, published by Korea Investors Services Inc.
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Table5-1: Index o f Diversification in Big 30 Chaebols (1994)
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Table5-2: Diversification o f 135 Chaebols in 1994
Diversification I Diversification II
Sales Assets Sales Assets
Big 30 Chaebols .606 .702 9.789 11.497
Big 50 Chaebols .542 .629 7.319 8.503
Big 3 0 - 135 Chaebols 391 .429 2.073 2.284
Big 135 Chaebols .447 .502 4.016 4.588
Notice: Diversification II=(l-X[/X)*#of firms and Diversification 1=1- XL/X.
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Diversification II is another index that is multiplied by the number of affiliated
companies in a chaebol to Diversification I. Both indexes show that the bigger the
Asset-specificity
associated with transaction cost economies were tested based on this conception. In
specificity (Coase, 1937; Williamson, 1975, 1985; Klein, Crawford, and Alchian, 1978;
and Alchian and Demsetz, 1972). Asset-specificity generates quasi-rent value that is
more easily captured through vertical integration. Therefore, the predicted effect of asset-
specificity is positive; it can be hypothesized that a firm is more likely to integrate when
1984) and sunk cost (e.g., Monteverde and Teece, 1987; Joskow, 1985; MacDonald,
Uncertainty
from bounded rationality (Williamson, 1975 and 1985). Without bounded rationality,
economic actors could write contracts of unlimited complexity that would specify all
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possible contingencies in an economic exchange; this complicates writing and enforcing
contingent claim contracts since the environment shifts in unforeseen ways (Anderson
and Schmittlein, 1984). The change of market environment forces contract re-negotiation
(even the best contracts are not perfect), which may lead to the adaptation o f vertical
integration to eliminate either the revising costs for formal agreements or the contracts
between two parties. In addition, if uncertainty is higher in the present and future
Organizational Form
As mentioned above, chaebols are vertically integrated at the group level; each of
the affiliated firms, which are legally independent, is operated as a part of a chaebol and
these affiliated firms are universally integrated at the group level under a single common
administration and financial control. Therefore, the affiliated firms have more advantage
supplying upstream product goods and services, improving capital flow, and coordinating
R&D and advertisement. These are not a firms but rather a groups specific assets,
making the affiliated firms substitute group-level integration for firm or plant-level
integration. As a result, the affiliated firms are expected to be less likely to integrate at
the firm or plant level; the affiliated firms tend to integrate at the group level rather than
at the firm or plant level. Therefore, a firm would be less likely to integrate at the firm or
plant level if the firm were vertically related with its group.
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5.4 Empirical Modeling and Results
Modeling
organization.
integration, is used widely for the cross sectional data (Adelman, 1955; Tucker & Wilder,
1977; Buzzell, 1984; and Levy, 1985). The value-added method explains that the more
stages of production and distribution are combined within a firm, the higher the ratio of
problematic in measuring the degree of vertical integration. One problem is that profit is
included in the items of value-added, which are net profit, income taxes, depreciation,
rents, labor expense, pension and retirement expense and interests. This method is
corrected by subtracting net profit from the value-added, using the adjusted value-added
measurement. Another problem is that the degree of vertical integration by the value-
added method may be biased because of different successive stages in production flows
and different market circumstances in supply and demand faced by each industry.
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Therefore, the data is required to be standardized. An adjusted ( VIa) and a standardized-
Ave.VIj and STD.VIj represent the average and the standard deviation of the
R&D, advertising intensity (e.g., Levy, 1985 and MacDonald, 1984), and sunk
costs (e.g., Monteverde and Teece, 1987; Joskow, 1985; MacDonald, 1984; and
Lieberman, 1991) are employed as the proxy variables for asset-specificity. R&D (RDI)
and advertising expenses (ADI) are used primarily in a firms producing differentiated
goods that require asset specific investment. Therefore, the firm that spends the
significant amount of R&D and advertising will have more specific investment assets.
Other specific investments are measured by sunk costs (SUNK) and a percentage
of main production (DIV). The higher the specialized investment, the more likely those
transactors will rely on common ownership rather than a contractual relationship because
If uncertainty is higher in the present and future markets, then vertical integration
variable, using a proxy variable, such as beta (BETA) from the capital asset pricing
model (e.g., Levy, 1984) and the standard deviations of monthly returns on the stock
(STD) for 60 months, from 1991 to 1995. These variables capture uncertainty due to
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systematical risk on investment and stock price, respectively.
Vertical integration at the group level rather than the firm or plant level in
firm that is vertically integrated at the group level is predicted to be less likely to
integrate at the plant or firm level because of nearly non-opportunistic behavior and non
contractual problems among the affiliated firms. Dummy variables are used to capture
otherwise
part or all of the inputs of a firms processes (forward vertical relationship) and a
part or all of the outputs of a firms processes is employed as the input of its
variable for the firm, indicating back and forward integration (BF), is equal to
part or all of the inputs of a firms processes (forward vertical relationship), but a
part or all of the outputs of a firms processes is not employed as the input of its
variable for the firm, indicating forward integration (FWD), is equal to one, and
zero otherwise.
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S) If a part or all of the outputs of a firms processes is employed as the input of
its affiliated firms processes, but a part or all of the outputs of its affiliated firms
processes is not employed as a part or all the inputs of a firms processes, then the
dummy variable for the firm, indicating back integration (BACK), is equal to one,
All these variables are described at Table 5-3 while Table 5-4 summarizes the
standard deviations, means, maximum, and minimum values of variables. The degree of
vertical integration in chaebols shows a slightly lower level than that in non-chaebols;
intensity (RDI) and sunk cost (SUNK) in chaebols are much higher than those in non
chaebol firms; RDI is twice as high in top-30 chaebols (6.396%) than in non-chaebols
(3.247%) and SUNK is 8.51 % higher in top-30 chaebols (40.849%) than in non-chaebols
(32.338%). On the other hand, advertisement intensity (ADI) is lower in top-30 (1.198%)
and top-100 chaebols (1.502%) than in non-chaebols (2.202%). This may be explained by
recognition of firms; chaebol firms are broadly recognized to the public, so that they may
not have to advertise as much as non-chaebols do. In addition, the percentage of main
product (DIV) is lower in top-30 (50.56%) and top-100 chaebols (53.76%) than in non
chaebol (54.55%). In the case of uncertainty variables, the standard deviation of monthly
rate of returns on stock (STD), and the systematical risk on investment (BETA) in
chaebols are lower that those of non-chaebols are. In addition, this table shows that
chaebols are highly integrated at the group level; 96.9% (BF+BACK+FWD) of top-30
chaebols are vertically related whereas only 28.4% of non-100 chaebols are vertically
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Table 5-3: Variables and Their Descriptions
Variables Descriptions
VIa Adjusted degree of vertical integration; (Value-added - Net profit)/(Sales-Net
profit) of 1995
Vis Standardized degree of vertical integration; (VIj-Ave.VIj)/ STD.VIj of 1995
ADI (%) Advertising intensity; 5-year (1991-95) annual average of advertising costs to
total sales
RDI (%) R&D intensity, 5-year annual (1991-95) average of advertising cost to total
sales
SUNK(%) Sunk costs; Fixed Costs/ Total Assets; 5-year (1991-95) annual average
DIV(%) Diversification; Sales amounts of main product/ Total Sales of 1995
BETA The systematical risk on investment from CAPM for 60 months (1991-95)
STD The standard deviation of monthly rate of returns on the stock of 60 months
(1991-95)
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TableS-4: Means and Standard Deviations o f Chaebols and Non-chaebols firms in the
listed firms of 1995
Variab Big 30 Big 100 Non All Manufacturing Firms
les Chaebol Chaebol Chaebol Mean Max Min
Via 23.419 24.814 25.104 24.084 47.188 .683
(8.828) (8.425) (8.962) (9.030)
VIS .76715 .81999 .85848 -.121 3.447 -3.292
(.241) (.257) (279) (267)
ADI 1.198 1.502 2.022 1.739 14.994 0
(1.798) (2.504) (3.6780 (3.088)
RDI 6.396 4.489 3.247 4.087 52.122 0
(1.086) (8.151) (6.102) (7.774)
SUNK 40.8492 36.7026 32.338 34.736 77.437 5.706
(11.644) (13.666) (21.342) (13.244)
DIV 50.5593 53.7602 54.5546 24.389 100.00 4.50
(24.600) (24.647) (24.148) (13.244)
BETA .87746 1.0087 1.1551 1.072 2.209 .003
(.3167) (.3134) (.3487) (340)
STD 3.5041 3.5835 3.7262 3.664 5.156 2.796
(.332) (.368) (398) (391)
DUM30 .194 1 0
(396)
DUMIO .545 1 0
0 (498)
BF .43076 .17460 .00658 .0997 I 0
(.4990) (.3806) (.300)
BACK .32307 .35978 .16447 .273 1 0
(.4712) (.4812) (.3719) (.446)
FWD .21538 .25396 .11842 .194 1 0
(.4143) (.4364) (.2791) (.396)
Obs. 66 189 152 341
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related to one another. This implies that bigger chaebol groups are more highly integrated
significance tests revealed that the true correlations among variables are very significant;
the null hypothesis of no linear relationship between each pair of random variables is
rejected against the alternatives; the true correlations are positive (or negative) linear
associations at a .5% significant level for all pairs. Generally, this table shows that
correlations among all variables are low, except among DUM30, DUM100, and BF.
Regression Results
Regression results with the standardized degree of vertical integration {Vis) are
represented in Table 5-6. Among asset-specificity variables, ADI, SUNK, and D IV show
important determinants of vertical integration but RDI does not; both advertisement
intensity {ADI) and sunk costs {SUNK) show the significant level at 1% in all equations
with the predicted positive signs; sales of main production {DIV) shows generally
significant at a 5% level with the predicted sign; and research and development intensity
integration. The coefficients of BETA show the predicted positive signs and are
coefficients of STD also show the predicted positive signs and are significant at least at a
dummies, DUM30 and DUM100, show the expected signs, and DUM30 is significant at
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Table 5-5: Correlation Matrix
Via Vis ADI RDI SUNK DIV BETA STD D3& D10& BF BACK
Vis .888
ADI .317 .245
RDI -.026 -.056 .034
SUNK .182 .124 -.271 -.025
DIV -.001 .089 -.198 -.250 .066
BETA .102 .081 .124 -.202 -.235 .045
STD .085 .108 .059 -.167 -.156 .050 .590
D30 -.104 -.129 -.087 .190 .242 -.071 -.282 -.198
DI00 -.007 -.044 -.074 .103 .183 -.018 -.246 -.228 .447
BF -.082 -.112 -.048 .164 .150 -.144 -.295 -219 .531 .304
BACK -.036 -.073 -.089 .046 .134 .003 -.047 .008 .067 .215 -.204
FWD -.040 -.047 -.009 .017 -.061 -.049 -.014 -.097 .023 .149 -.163 -.283
Note: D30J=DUM30, and D100J=DUM100
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Table 5-6: Determinants o f Vertical Integration in All Listed Firms with Ms
Variables 1 2 3 4 5
Concept -2.3193 -.5034 -2.1213 -2.2557 -1.8926
(4.057)*** (5.357)*** (3.826)*** (3.949)*** (3.276)***
ADI .1087 .1077 .1071 .1085 .1037
(6.024)*** (5.937)*** (5.988)*** (6.013)*** (5.771)***
RDI -.0014
(.197)
SUNK .0172 .0174 .0195 .0177 .0193
(4.124)*** (4.099)*** (4.609)*** (4.185)*** (4.584)***
DIV .0055 .0057 .0052 .0056 .0045
(2.443)** (2.571)** (2.351)** (2.542)** (2.019)**
STD .3049 .2527 .2300
(2.202)** (1.842)* (.1.648)
BETA .2653 .2914
(1.655)* (2.089)**
DUM30 -.3508
(-2.533)**
DUM100 -.0693
(-.631)
BF -.4734
(-2.436)**
BACK -.2961
(-2.288)**
FWD -.1932
(-1.340)
Adj. R-sq. .1186 .11.50 .1352 .1325 .1357
F-statistic 10.158*** 12.043*** 11.617*** 10.241*** 8.625***
Note: () shows t-statistics and *, **, and *** stand for the significance level at a 10%,
5%,
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a 1% while D UM 100 is insignificant. The coefficient of D U M 30 in equation 3 is lower
than that of DUM 30. The negative sign in D UM 30 means that a group level integration
is likely to decrease the willingness of a firm or plant-level integration. The other dummy
variables, BF, BACK, and FWD, disclose the expected negative signs, and B F and
B A C K are significant at least at a 5% level. These coefficients suggest that backward and
forwardly integrated firms (BF) among the affiliated firms are less willing to integrate at
the firm or plant level, and back ward integrated firms (BA C K ) also are less willing to
The regression results with the adjusted degree of vertical integration (Via)
instead Vis are reported in Table 5-7. The results with Via are very similar to them with
Vis, except the variables of D IV and BACK. This table shows that A D I and SU N K are
important determinants of vertical integration but the others such as R D I and D IV are
not. That is, both advertisement intensity (ADI) and sunk costs (SUNK) show a 1%
significant level with the predicted coefficient signs in all equations whereas research and
development intensity (RDI) and sales of main production (DIV) are of the expected
vertical integration with Via. The coefficients of BETA show the predicted positive signs
and are significant at a 1% and 10% level in equations 1 and 5, respectively. The
coefficients of STD also show the predicted positive signs and are significant at least at
10% level in equations 2, 3,and 4. DUM 30 shows the expected sign and is significant at a
5 To avoid correlation problems among DUM30, DUM100, and BF, these variables
are not used together. The estimates with together also revealed that DUM30 is negative
and insignificant, and DUM100 is positive and insignificant.
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Table5-7: Determinants o f Vertical Integration In All Listed Firm with Via
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5 % level. However, DUM100 does not show statistical significance in equation 4. The
other dummy variables, BF, BACK, and FWD, report the expected negative signs; only
integrated firms (BF) at the group level are less willing to integrate at the firm or plant
level.
5.5 Conclusion
affects firm-level integration and what the vertical integration determinants are as well.
First section described the structure of Korean business groups; chaebols have a
multi-market form at the group level, which would affect a firm or plant level vertical
1937; Williamson, 1975, 1985; Klein, Crawford, and Alchian, 1978; and Alchian and
It is consistent with earlier findings by, for instance, Levy (1984). However, a
integration is found while Tucker and Wilder (1977) and Levy (1984) find a
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significant relationship.
and the standard deviation of stock prices are used as the proxy variables. The
vertical integration.
integration. The estimates show that top-30 chaebols affiliated firms are less
form, which has a multi-market form with group-level integration and is operated
under the single common administration and finance control. Therefore, group-
level integration substitutes for the firm-level integration (the degree of vertical
integration: VI). In addition, the estimates shows that backward and/or forward
integrated firms at the group level are less willing to integrate at the firm or plant
level.
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Chapter Six: Performance with Ownership Concentration and Vertical
Integration
6.1 Introduction
property rights between a principal and an agent, which is called the principal-agent
problem. This problem, in turn, raises another question about the direction of casualty
between ownership concentration and the firms value. Namely, the higher ownership
relationship vigorously. For instance, the entrenchment hypothesis (i.e., Morck, Shleifer,
and Vishny, 1988) states that the market value or the performance of the firm is adversely
entrenchment behavior. In addition, Demsetz (1983) and Demsetz and Lehn (198S) argue
that the ownership structure of the firm does not relate with the firms performance
(profitability) because the firm for which ownership matters will have selected its optimal
On the other hand, the application of the transaction cost theory to vertical
integration was the most direct examination for better performance because vertical
market governance mechanism. That is, vertical integration is associated with asset-
specific investment and certainty in the markets, which may provide better performance.
However, empirical research into the effects of vertical integration on the firms
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performance does not show a vigorous positive relationship because of the negative
effects from vertical integration. For instance, vertical integration reduces flexibility.
Once vertical integration is set up, it is difficult to adjust to variable markets or economic
circumstances. Therefore, too much integration harms strategic flexibility (e.g., Harrigan,
1983). In addition, it may cause other costs, such as inefficiency in functioning all
As a firm gets larger, there may be decreasing returns to the entrepreneur function, that
is, the costs of organizing additional transactions within the firm may rise (Coase, 1937,
p. 340). Moreover, the co-existence of various governance forms is further evidence that
vertical integration may not guarantee higher performance; the firm may have selected its
optimal vertical integration already (e.g., Demsetz, 1983, Demsetz and Lehn, 1985).
concentration and the vertical integration effect on the firms performance in the Korean
private corporation, and to compare my research to other studies in the literature, which
tested.
Modeling
6-1) P R O F IT = P0 + * Ownership + e
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6-3) PROFIT = P0+P, * Ownership +p* Vi +6*CHAEBOL + e
concentration and performance, whereas Equation (6-2) will test whether or not the
performance. This estimate will include the other economic factors as well as chaebol
dummies.
and the degree of vertical integration, are summarized in Table 6-1. Performance as a
dependent variable is calculated as the ratio of net income to assets (IA) and to equity
(IE), which is the average annual rate of net income after tax to assets and equity from
1991 to 1995, respectively. Research and development intensity (RDI = R&D/Sales) and
advertising intensity (ADI = Advertisement/Sales) are used for proxies for intangible
capital (e.g., Harris and Raviv, 1991 and Levy, 1985). Also, the advantages of R&D and
advertisement are primarily differentiating goods and services and may generate entry
barriers. Their effects on the firms performance are usually expected to be positive. The
firms size (LNASSET=\o% [assets]) usually reflects two important roles: economies or
diseconomies of scale and entry barriers. The economies of scale comes from simply
management. The entry barrier by the firm size stems from setup costs that must be
incurred at a minimum efficient scale by all entrants. A ratio of debt to equity (LEVER)
performance.
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Table 6-1: Variables and Their Descriptions
Variables Descriptions
IA(%) Average annual rate of net income after tax to asset from 1991 to 199S
IE (%) Average annual rate of net income after tax to stockholders' equity from
1991 to 1995.
Via (Value Added - Profit After Taxes)/(Sales - Profit After Taxes) of 1995
Vis Standardized Degree of vertical integration; VI =( Via - Ave. Vial Std. Via)
OWN1 (%) Shares (%) of owner & owners family and affiliated firms of 1995
OWNISQ OWNl*OWNl
OWN2 (%) Shares (%) of institutions of 1995
OWN2SQ OWN2*OWN2
OWN12 OWN1+OWN2
OWN12SQ OWN12*OWN12
LNOl LogfOWN1/(1OO-OWN1)]
LN02 Log[OWN 2/(100-OWN2)]
LN012 Log[(OWN 1+OWN 2)/( 1OO-OWN1-OWN2)]
LNASSET A Log form of Assets; a 5-year annual average (million Won) of assets from
1991-95.
ADI (%) Advertising intensity, a 5-year (1991-95) annual average of advertising costs
to total sales
RDI (%) R& d intensity, a 5-year (1991-95) annual average of R&D costs to total
sales
LEVER(%) The Ratio of Debt to Asset of 1995
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Table 6-2 shows the statistics of the means, the standard deviations, and
maximum and minimum values. The performance of non-chaebol firms is much better
cases of IA and IE. Also, this table displays that chaebols affiliated firms are lower in
both inside ownership concentration (OW NI and L N O I) and the degree of vertical
integration {VI a and VIJ, but have a higher outside ownership concentration {OW N2 and
L N 0 2 ) and higher vertical integration at the group level {BF, BACK, and FWD) than in
non-chaebols.
Table 6-3 sums up the correlation matrix among independent and dependent
variables. This table reports lower correlations among variables except for a correlation
between IA and LEVER, which is -.439. Both I A and IE show positive correlations with
correlated with the degrees of vertical integration {V ia and Vis). The statistical
significance tests report that the true correlations among variables are significant; the null
Regression Results
integration on performance with LA, excluding other economic factors. Equations from 1
Equation 1 in Table 6-4 shows that insider ownership (O W N I) is linearly related with IA.
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Table6-2: Means and the Standard Deviations
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Table 6-3: Correlation Matrix
00
LNASSET .066 -.013 .256
LEVER
-.439 1 -.288 .085 -.061 .304
LNOI .152 .052 .035 -.288 -.185 -.016
k>
LN02 .023 .099 -.005 .200
1
-.008 .046
o
OWNI .142 .044 .023 -.255 -.163 -.023 .974 -.239
OWN2 .037 .111 -.013 -.004 .159 .033 -.179 .874
VI, -.188 -.112 .317 -.026 -.054 .159 .064 .012
Vis -.132 -.083 .245 -.057 -.082 .122 .058 -.008
DUM30 -.185 -.094 -.087 .189 .566 .314 -.189 .129
DUM100 -.166 -.041 -.074 .103 .544 .246 -.039 .226
BF -.080 -.021 -.048 .046 .453 .149 -.202 .108
BACK -.035 -.009 -.090 .017 .201 .080 .053 -.062
FWD .019 .048 -.009 .017 .025 .008 .015 .128
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convergence-of-interest hypothesis. In Equation 2, OWNI also has a curvilinear
In equation 2, the coefficients of OWNI and the square of OWNI (OWN1SQ) are
significant at a 1% level with a positive sign and a 5% level with a negative sign,
respectively, which means that profit is an increasing and then decreasing function of
some higher ownership ranges. The turning point of profit to ownership concentration
occurs at 38.29%; 34 out of 341 samples are under this range. Therefore, the estimates
some lower ranges and a negative relationship at some higher ranges. Equation 3 reports
that outsiders ownership concentration (OWN2) is positively but not significantly related
with performance. OWN2 and OWN2SQ in Equation 4 show a negative and a positive
sign, respectively, and both are not significant. Also, F-statistic is very low (1.066).
Equation S and Equation 6, respectively. Equation 7 shows that the coefficient of inside
(LNOI) is positively but not significantly related with performance. Equations 8 and 9
show a different performance between chaebols and non-chaebols. Both DUM30 and
DUM100 show negative signs and are significant at a 1 % level, which means that the
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Table 6-4:Own^rship Concentration and Performance with IA
Independent Variable, LAprofit/asset (n341).
U lU V pV l 1UVI1I
Var. 1 2 3 4 5 6 7 8 9
Concept 15263 .7680 1.3299 1177 1.3950 1.0056 1889 1.5689 1.6408
(6.12)"* (1.68) (4.54)- (1104)- (4.94)'" (1048)" (8.721) (5.28) (5.44)
0WN1 .023* .0919 .0259 .0217 .0267
(165)"* (156)- (186)"' (141)" (199)
0WN1SQ -.0012
(-1.979)"
OWN2 .0125 -.0182 .01641 .0201
(1.280) (-.845) (1 W (104)"
0WN2SQ .0006
(1.29)
0WN12 .0202 .0436
(178) (1.72)'
0WN12S -.0003
Q (-.962)
LN01 .4497
(198)-
LN02 .0882
(1.02)
DUM30 -.90541
(3.28)
DUM100 -.7567
(-3.45)
R-sq .0173 .025 .0191 .0038 .0193 .0191 .0203 .0467 .0498
F-stat. 6995* 5.463'" 4.323" 1.066 7.704 4.314" 4.534" 6.552 6941
0 shows t-statistics and *, **, and *** stand for the significance level at
' tote:
a 10%, 5%, and 1%, respectively.
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Table 6-5 reports the estimates of ownership concentration on performance, IA,
including other economic variables. This table displays that both advertisement intensity
(ADI) and debt ratio {LEVER) are the expected signs and significant at a 1% level in all
equations. However, firm size (LNASSET) and R&D intensity {RDI) are positive, but
concentration such as O W N I and LNOI are positive and significant at least at a 1% level
in Equations 1,2,3, and 4 while OWN2 and LN O I are not significant at all. OW N12, and
LN O I2 show that their coefficients are positive and significant at 1% level in Equations 5
and 6. Vertical integration such as Via and 17s are also significant at a 1% and 5% level,
respectively, but show negative signs in all equations, which means that the higher
integration the worse performance. The coefficient of top-30 chaebols dummy {DUM30)
in Equations 7 shows a negative sign and is insignificant whereas the coefficient of top-
100 chaebols dummy {DUM I00) in Equation 8 shows a negative sign and is significant
at a 5%. The coefficients of BF, BACK, and FWD in Equation 9 do not show a constant
sign and are insignificant, which indicates that the group level integration does not affect
the firms performance. In sum, Table 6-5 reports that ownership concentration is
positively and significantly related with the firms performance {IA) and vertical
integration is negatively and significantly related with the firms performance {IA). In
addition, the chaebols affiliated firms, which are related vertically at the group level,
show worse performance than non-chaebols do. Among other economic variables, only
advertisement intensity and debt-equity ratio are significantly related with the firms
performance, respectively: though research and development (R&D) and firm sizes
display that they are positively related with the firms performance, but not significantly.
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Table 6-5: Performance (IA) with Ownership Concentration and Vertical Integration
Independent Variable = IA (profit/assets), n=341
1 2 3 4 5 6 7 8 9
c 2.7928 1.7491 4.5497 3.4142 4.1358 3.0784 2.1231 1.8391 2.5914
(2.74) (1.77)' (4.29) (3.45) (4.19) (3.09) (1.90)' (1.64) (Z29)
ADI .1314 .1126 .1299 .1110 .1308 .1318 .1272 .1250 -.1301
(4.07) (3.52) (4.03) (3.47) (4.06) (4.09) (3.93) (3.87) (3.98)
RDI .0074 .0063 .0099 .0096 .0060 .0055 .0090 .0077 .0079
(571) (473) (7 54) (643) (463) (.424) (.689) (594) (.591)
LNASSE .0345 .0428 .0372 .0461 .01522 .0171 .0992 .1275 .0553
T (.411) (502) (.441) (539) (.184) (.206) (1.05) (1.33) (561)
LEVER -.0049 -.0051 -.0049 -.0051 -.0049 -.0049 -.0047 -.0048 -.0049
(8.50) (8.73) (8.54) (8.77) (8.426 (8.47) (7.99) (8.29) (8.74)
OWN1 .0273 .0266 .0267 .0293 .0273
(3.35) (3.21) (3.26) (3.58) (3.28)
0W N 2 .0149 .0143 .0158 .0181 .0148
(1.73)' (164) (1.83)' (2.07)" (1.70)'
LN01 .4999 .4840
(3.62) (3.47)
LN 02 .1243 .1160
(1.62) (1.50)
0W N 12 .0215
(3.31)
L N 012 .4277
(3.44)
Via -.0425 -.0432 -.0418 -.0422 -.0440 -.0417
(3.80) (3.87) (3.74) (3.77) (3.92) (3.75)
Vis -.2392 -.2441
(2.48r (-2.54)"
DUM30 -.4407
(1.47)
DUM100 -.4639
(2.00)"
BF -.1662
(.411)
BACK -.0576
(-.227)
FWD .0021
(.007)
R-sq .2565 .2384 .2602 .2415 .2576 .2557 .2591 .2805 .2502
F-stat 17.76 16.20 28.08 16.47 20.66 20.47 15.87 16.18 11.35
Note: () shows absolute t-statistics and *, **, and *** stand for the significance level at a
10%, 5%, and 1%, respectively.
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Table 6-6 summarizes the estimates of ownership concentration and vertical
integration on performance using IE. These estimates are very similar to Table 6-5 in some
cases; (1) the coefficients of ADI and LEVER show the expected positive signs and
significant at a 1% level in all equations; (2) the coefficients of RDI show a negative sign
and are insignificant in all equations; (3) the group level integration (BF, BACK, and
FWD) does not affect the firms performance; (4) inside (OWN1 and LNOI) as well as
outside ownership concentration (OWN2 and LN02) have positive coefficients that are
significant at least at a 10% level; and (4) the coefficients of 17a and Vis report negative
signs and are significant at a 1% and 10% level, respectively in all equations.
LNASSET using IE show a positive relationship with performance and are significant at
least at 1% level in all equations. In addition, top-30 chaebols dummy (.DUM30) shows a
negative sign in Equation 7 and is significant at a 10% level whereas top-100 chaebols
Overall, Table 6-6 reports that inside and outside ownership concentration is
positively and significantly related with the firms performance (IE), whereas vertical
integration is negatively and significantly related with the firms performance (IE). In
addition, top-30 chaebols affiliated firms, which are related vertically at the group level,
6.3 Conclusions
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Table 6-6: Performance (IE) with Ownership Concentration and Vertical Integration
133
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Whenever a principal (an owner) delegates authority to an agent (a manager) with the
expectation that the delegated authority will act in the principals behalf, it is called a
potential problems because the interests of the agent may be different from those of the
principal whom the agent is supposed to represent. One solution is increasing ownership
Transaction costs are particularly significant when the market exchange relates to
specialized assets and uncertainty. These costs relate, for instance, the costs of searching for
the desired inputs, negotiating supply contracts, monitoring and enforcing these contracts,
and the risk associated with unforeseen changes in supply conditions. One solution is
vertical integration to diminish these costs by dealing more efficiently with bounded
rationality, complexity, and tendency towards opportunism faced by the markets. Therefore,
concentration or/ and vertical integration do affect the firms performance positively.
1) Vertical integration at firm level is negatively and significant related with the
firms performance: the more integration in the firm level the worse performance.1 In
1Some factors may explain why the higher vertical integration at the plant or group-level
does not have an advantage in performance in the Korean case. The poor quality intra
firm trade may be one example: reciprocal support may take place even under a
circumstance where a supplier company is not able to compete with the rivals in price
and quality. The accounting problem is another example: the accounting data may not be
correct by omitting some profits or by transferring profits on purpose to the other
affiliated firms in the group company. In addition, the co-existence of various governance
forms is further evidence that the vertically integrated firm may not guarantee higher
performance; the firm will have selected its optimal vertical integration already. Lastly,
134
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addition, the group level integration (BF, BACK, and FWD) is not related with
performance at all.
performance in the case of Korean private companies. The estimation shows both a linear
they may misuse the theory of transaction cost economies as the market strategy. As
mentioned earlier, too much vertical integration may cause problems, such as inefficiency
in functioning all varying scales of operations as well as attenuated incentives and
bureaucratic distortion.
135
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NOTE TO USERS
13 6 -1 3 9
UMI*
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Vita
Signature
145
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