This paper investigates investment efficiency of business groups in Korea. Business groups can centralize knowledge and group resources, which reduces the cost of entering a new industry. In view of Tobin’s q , the adjustment costs of investment of business group firms are lower than those of independent firms. The empirical results show that the adjustment costs of business group firms are lower than those of independent firms, and that the output-capital ratio of business group firms is greater than that of independent firms. The results suggest that business group firms contribute to lowering the adjustment cost and to increasing investment, which, in turn, contribute to the growth of the Korean economy.
One of the economic obstacles facing a developing country is its lack of capital for investment. In addition to the uncertainties associated with investment, adjustment costs affect investors in new industries [
A Korean business group, which is called as chaebol, is a family-owned corporate entity comprising a group of firms across various industries ranging from textiles to chemicals, electronics, motor vehicles, ship building, and, most importantly, construction.1 Amsden [
The knowledge and inputs of a business group are shared across business group affiliates. This results in economies of scope. Chandler [
The adjustment costs of investment are reduced in a new industry by sharing the knowledge embodied in the capital goods of extant industries. Such sharing of knowledge increases the impact of the investment in a new industry. This paper examines the extent to which business groups occupy a favorable position compared with other potential entrants in a new industry in terms of the adjustment costs of investment.
Section 2 proposes adjustment costs of investment, and demonstrates that a firm’s rate of investment is an increasing function of Tobin’s q. Section 3 presents the estimates of the adjustment costs for business groups and compares them with those of independent firms. Finally, section 4 concludes this paper.
Let us assume a continuum of industries
where bs denotes a share of the per capita fixed capital in total capital stocks.
It should be noted that the final good s is not produced until firm i completes the investment in the fixed capital good required for the good s. The adjustment costs need to be considered for the installation of the fixed capital good s. The spillover effects of the investments of the preceding industries reduce the adjustment costs of the investments for the next industry.
It is commonly accepted that the adjustment costs are an increasing convex function of the rate of investment [
Following Uzawa [
where Zis is firm i’ s rate of investment in industry s:
In particular, we express the effective unit of capital good s in the logarithmic form of
Note that the adjustment cost is
The assumption that the effective units of capital increase as the rate of the investment increases implies that the adjustment costs operate in the direction opposite to that of the conventional increasing cost assumption. Equation (4) tells that the higher the requirement of this fixed capital good (that is, higher b), the higher the adjustment costs of the investments and the lower the effective unit of investment. Conversely, the lower the required fixed capital good, the higher the effective units of a capital good (i.e., the lower its adjustment cost).
It should also be noted that the effective unit of capital good s
During structural change, different sectors of an economy experience inherent adjustment costs. Entrance into a new sector involves the fixed costs of investments, such as managerial and administrative operations, the marketing of products, the collection of information, and basic knowledge about the production of good s. A business group can centralize knowledge about resources across industries. It shares the knowledge embodied in the fixed capital good s of its preceding industries.
Ventura [
In this paper, the Korean business group plays the role of exploring the AK technological frontier. At the constant factor prices of a small open economy, it is more advantageous for the business group to expand the scope of its operations across capital-intensive industries than to follow the capital-deepening path with a pre-existing firm in a given industry.
A firm’s profit,
We assume that the prices of the final good sand investment good s are given. The price of the final goods is
An investment is constrained by both the amount of the loan, with an interest rate of
Capital accumulates according to the usual dynamic equation:
A constant, δ, is the rate of depreciation on a unit of a capital good. The accumulation of capital continues as far as it succeeds in its venture into a new industry. However, the accumulation of capital is limited due to the adjustment costs for the forthcoming investments in a new industry.
In this context, the goal of a firm is to maximize profits according to profit Equation (5), subject to the capital accumulation Equation (6).
s.t.
The total profit flow and value of capital stock in the maximization problem is expressed in the form of the following Hamiltonian function in a present-value discounted form:
where
The necessary conditions for this model are:
The value
Next, we consider the first-order condition for the capital stock on the second row of the Equation (11). This yields a demand for the following rate of investment:
where q(.) is Tobin’s q defined as:
If we substitute the λ of Equation (10) for the q of Equation (12), we can find that Tobin’s q is a monotonically decreasing function of the adjustment cost function
This section presents the results of an empirical test regarding the relationship between a firm’s investment demand and the adjustment costs of its investments. Our incorporation of the definition of Tobin’s q allows us to present the investment demand function in a form appropriate for the regressions using the following equation:
where I is investment, K is capital stock, and q is Tobin’s q.4
We empirically investigated whether business group firms have an advantage over independent firms with regard to investment decisions using data from 131 firms for 1980-2008. All sample firms were manufacturing businesses registered with the Korean Stock Market during the period. Of the 131 sample firms, 31 are included in business groups, and the remaining 100 firms are independent firms.
Data regarding output, labor input, investment, capital, and stock prices at the firm level were derived from the Korea Information Service Financial Analysis System (KIS-FAS) Database. Price indices, which were used to obtain constant values, were obtained from the Bank of Korea website homepage (www.bok.or.kr).
The sample was divided into two groups to compare the investment effects of business group firms with those of independent firms, and the time was also divided between the period before and that after the financial crisis, because the investment behavior of Korean firms changed after the 1997 financial crisis. After the financial crisis, Korean firms successfully improved the financial structure through debt restructuring, and the performance of Korean firms improved. In particular, the profits of business group firms showed greater improvement than did those of independent firms [
In terms of the average value of capital stock, the size of business group firms was much greater than that of independent firms. During the entire period under evaluation, the prices of the average capital stock of business group and independent firms were 2176.7 and 225.5 billion Korean Wons, respectively. The average capital stock of business group firms cost about 10 times as much as that of independent firms.
Our model assumes that the production function of a business group firm conforms to AK technology, whereas that of an in dependent firm is characterized by diminishing returns. In this case, the output-capital ratio (A) of business group firms is greater than that of independent firms.
The relationship between a firm’s investment and Tobin’s q was examined with the regression model described in Equation (13). In this case, a panel data regression model with a year fixed effect was used. The regression results are presented in
It should be noted that the coefficient, β1, is an estimator of the coefficient b in equation (11), where b is the fixed investment share in Equation (1). We calculated a business group firm’s investment advantage over that of an independent firm. Note that the effective rate of capital is defined as
As we can see in
The results presented in
Investment | Capital Stock | z(=I/K) | A | |||||
---|---|---|---|---|---|---|---|---|
Business group | Independent | Business group | Independent | Business group | Independent | Business group | Independent | |
Before Crisis | 154.3 | 16.0 | 1108.9 | 180.1 | 0.19333 | 0.11618 | 1.16244 | 1.15888 |
After Crisis | 368.2 | 14.7 | 3438.7 | 279.0 | 0.08771 | 0.06311 | 1.07460 | 1.01829 |
Whole Period | 252.5 | 15.4 | 2176.7 | 225.5 | 0.14492 | 0.091856 | 1.12218 | 1.09444 |
Note: 1) The variables of Investment and Capital stocks are the 2005 constant values. Units are one billion Korean Won. 2) z: rate of investment = I/K, A: output/capital ratio. The values of z and A are the simple averages of each firm’s z and A for each group.
Firm | Intercept | R2 | ||
---|---|---|---|---|
Before Crisis | Business group | 0.08791** (1.99) | 0.108166*** (2.83) | 0.0663 |
Independent | −0.00203 (0.09) | 0.088447*** (4.58) | 0.0372 | |
After Crisis | Business group | 0.00730 (0.39) | 0.074009*** (6.44) | 0.1227 |
Independent | 0.04701*** (4.18) | 0.039600*** (4.98) | 0.0340 | |
Whole Period | Business group | −0.00036 (0.01) | 0.081475*** (5.50) | 0.2237 |
Independent | 0.03652*** (2.70) | 0.052345*** (6.08) | 0.0817 |
Note: 1) The values in ( ) are t-values. ** and *** indicate that the coefficients are statistically significant at the 5% and 1% level, respectively. 2) β1 is equal to the value of b in Equation (13).
Period | Fixed Capital Advantage (FCA) | Adjustment Cost Advantage (ACA) | Adjusted ACA |
---|---|---|---|
Before Crisis | 22.3 | −23.7 | −28.9 |
After Crisis | 86.9 | −11.9 | −22.3 |
Whole Period | 55.6 | −19.1 | −29.7 |
Note: 1) Negative ACA values mean that the adjustment costs of business group firms were lower than those of independent firms. 2) Adjusted ACA was calculated from ACA*(1 + FCA/100).
capital investment share of business group firms was greater than that of independent firms,5 and that this advantage increased after the financial crisis. This was expected given that the fixed capital stock of business group firms increased at a faster rate compared with independent firms.
Next, we calculated the adjustment costs of the investment of each group. We calculated adjustment cost, −ln(z), using the values of z in
According to the adjustment cost advantage (ACA) values in
The adjustment cost of an investment is related to the fixed capital stock. The adjusted ACA, which considers the fixed capital advantage of business group firms, can be calculated with the following equation: ACA (1 + FCA). The values of the adjusted ACA in
As assumed in the model, the empirical results show that the adjustment cost of business group firms is lower than that of independent firms. This result suggests that the Ak technology of a business group contributes to lowering its adjustment costs relative to those of independent firms.
This paper investigates investment efficiency of business groups in Korea. Business groups can centralize knowledge and group resources, which reduces the cost of entering a new industry. The growth of Korean business groups is sustained by their high investment rates. Since the adjustment cost of investment is low for a firm of business group, a business group can enter a new industry more easily than an independent firm. In this respect, a Korean business group acts as a conduit for structural change in the Korean economy.
As assumed in the model, the empirical results show that the output-capital ratio of business group firms is higher than that of independent firms, and that the adjustment cost of business group firms is lower than that of independent firms. This result suggests that the lower adjustment cost of business group contributes to increasing investment in Korean economy.
Finally, the higher output-capital ratio of business group is based on the presumption that the spillover effects of foreign technology are not exhausted. However, as the developmental stage of Korean business group reaches the level at which its technological distance from that of the world frontier is narrowed, the growth of Korean business group must rely on their own innovative strategies.
This work was supported by the National Research Foundation of Korea Grant funded by the Korean Government (NRF-2014S1A2A2027622). The theoretical model of this paper was given by Shin-Haing Kim.
Taegi Kim, (2016) Adjustment Costs and Investment Efficiency of Business Groups in Korea. Modern Economy,07,697-703. doi: 10.4236/me.2016.76073