KDI - Korea Development Institute - RESEARCH - Research Areas

Summary

Policy Study KOR Analysis of the Effect of Management Education and Consulting on Small Business Owners

This study examines the impact of management education and consulting on small businesses in Korea. It focuses on whether such support improves business performance (employee numbers and sales amounts) and reduces the likelihood of financial delinquency (payments overdue by more than 90 days). The analysis compares these outcomes to those of businesses that did not receive such support. Through propensity score matching, a control group was selected to closely resemble the treatment group, and the Difference-in- Difference method was then employed to assess the impact.

The results indicate no significant differences in employment growth or delinquency rates between businesses that received this support and the control group. However, an exception was observed in the wholesale and retail sectors, where supported businesses experienced a notable increase in sales relative to their counterparts.

To effectively enhance business performance through management education and consulting, broadening the expertise of instructors and consultants is crucial for meeting the diverse needs of different businesses. Furthermore, diversifying the content and methodologies of these services could offer business owners a wider range of options, potentially leading to a greater impact and improved efficacy of the support provided.

Summary

Policy Study KOR The Effects of the Exception to Limited Liability on Firm’s Investment

This paper analyzes the impact of exceptions to the shareholders' limited liability principle, which exists only in Korea, on corporate activities. The paper constructs a model of a firm to examine the effect of the exceptions to the limited liability principle on corporate investment activities. It shows that the violation of limited liability increases the firm's expected corporate bankruptcy costs, thereby reducing investment. In the empirical analysis, the paper examines whether firms with the largest shareholder's stake exceeding 50%, which is the condition that the limited liability is exempted, decrease investment. The results show that corporate investment is very concentrated in observations that the largest shareholder's stake did not exceed 50%. The investment decreases sharply in the cases of the largest shareholder's stake exceeding 50%. The results of this study provide implications on how exceptions to the limited liability principle in Korea affect corporate investment activities.

Summary

KDI FOCUS Remedies to Korean SOE Debt Problem

□ Benefitting from implicit government guarantees, Korean state-owned enterprises (SOEs) can readily expand their debt at an interest rate as low as sovereign bonds regardless of their ability to repay. In this scenario, Korean SOEs stand vulnerable to ‘double moral hazards’: SOEs have little incentive to improve their financial structure, and the government has a large incentive to assign popular but unprofitable projects to SOEs. In recognition of this, the government should formally acknowledge SOE debt as the ‘national guaranteed debt’ in order to ensure official supervision and regulation. In addition, the government needs to improve SOE debt structure by introducing capital regulation and bail-in bonds.

- KNOC slipped into a state of capital shortfall in 1H 2020.

- In the era of low birth rates and population aging, the financial structure of other SOEs expects a deteriorating trend to persist as well.

- This study reveals that ‘implicit guarantees’ by the government lead to heavier debt for SOEs and recommends remedies to improve the Korean SOE debt problem.

- Compared to their counterparts in the major countries, Korean SOEs have exceptionally high levels of debt.

- For financing public projects, Korea is more reliant on SOE debt than on its government debt.

- Korea’s public enterprises raise debt mainly by issuing bonds.

- Unlike bank loans requiring collateral, SOEs can issue bonds only with good credit ratings, which makes it an accessible tool to expand the debt.

- Public corporations on the brink of default can still debt-finance at a large scale at an interest rate as low as government bonds, thanks to the possibility of sovereign support.

- Owing to implicit guarantees by the government, SOEs can benefit from an interest rate lower than private ones in issuing bonds, and the resulting discount rate effect is around four trillion won per year.

- No matter how weak their fundamentals are, Korea’s public enterprises can borrow money at an interest rate 0.20%p lower than leading domestic private companies.

- Implicit guarantees by the government could lead to double moral hazard on the sides of public enterprises and government.

- First, public enterprises lack incentives to better know their fundamentals.

- Second, occasionally the government assigns infeasible projects to SOEs and mandates their execution by debt financing at a low-interest rate.

- Consequently, public enterprises end up accumulating debt on the one hand and debt capacity exhausted on the other.

- Government-guaranteed obligations need to incorporate SOE debt predominantly incurred by their bond issues, and there should be a fee for the service of a riskbased guarantee.

- Capital regulation on SOEs should be introduced to maintain financial soundness systematically.

- The disciplines on SOEs should be restored by introducing bail-in bonds where creditors share losses in case of emergencies.

Summary

Policy Study KOR Analysis of Market Discipline at the Capital Market: The Case of Korea

This paper analyzes how the size of firms, unrelated to inherent credit risks, influences firms’ access to capital markets. Specifically, we theoretically and empirically whether credit rating agencies (CRAs) unduly give favors to large-sized companies and conglomerates than small and mid-sized companies when CRAs evaluate default risks of these companies on their debts. In a simple theory model in a Bayesian persuasion framework, we find that CRAs have an incentive to generously underestimate default risks on the large-sized firms when these firms raise capital from bond markets more often than small and mid-sized firms, and thus become a very important client to CRAs. However, the bond buyers rationally infer the default risks on these large-sized companies with high credit rating, and thus charges a higher risk premium than they would to small and mid-sized companies conditional on the same financial conditions. Using a financial dataset in Korea, we document that the interest rates of bonds issued by mid-sized companies are in fact lower on average than those issued by large-sized companies. We further find that mid-sized companies are less likely to receive a high credit rating than the large-sized companies. These findings suggest that CRAs unfairly treat companies willing to issue bonds based on their sizes, thereby possibly distorting credit market structures.

Summary

Policy Study KOR Investment and Business Cycles: focusing on Investment Dispersion

This study empirically verifies that the form of the adjustment cost function serves as an important mechanism in investment decision-making after confirming that the investment dispersion of Korean companies is pro-cyclical and can affect economic fluctuations. Specifically, it is revealed through empirical analysis using corporate financial data rather than a macroeconomic model that the investment adjustment cost function generally assumed in macroeconomics is asymmetric and irreversible in the Korean economy. In particular, since the substitution effect of the marginal value-to-cost of a one-unit investment in inter-temporal investment decision-making is affected by the additional adjustment cost from the sale of equipment assets, and not the investment in equipment assets, it is empirically proven to lead to an expansion of investment dispersion. This ultimately shows, albeit indirectly, that investment dispersion can affect economic fluctuations as the investment adjustment cost function influences the decision-making in investment. What is implied here is that the adjustment cost function is not merely a deep parameter that fits the dynamics of economic fluctuations in a macroeconomic model, but it could be a macro policy variable that can be endogenized through economic policy.

Summary

Policy Study KOR A Study on Financial Constraints of Korean Companies: Focusing on the Effectiveness of Policy Financing

This study analyzes financial constraints on business firms to enhance the effectiveness of policy financing. The importance of policy finance lies in its capacity to improve the efficiency of resource allocation in society overall by providing finances to firms unable to furnish capital from private financial markets due to a market failure. From a corporate viewpoint, market failures are business conditions faced with financial constraints, which mean difficulties obtaining necessary funds, despite good opportunities present in the market. Accordingly, it is expected that adequately identifying firms' financial constraints would boost the effectiveness of policy financing.

The study first constructed an index to measure the severity of corporate financial constraints based on business size and operation years. To verify the suitability of the index, the author examined whether firms less vulnerable to financial constraints would lower their debt ratio using the 2012 corporate tax cuts for medium-sized firms. Corporate tax reduction brings down corporate debt further as the supply curve of capital is elastic for firms without financial constraints. As a group of firms without such restrictions had a more significant drop in debt after the tax cut, the analysis confirmed that the new index successfully reflected the severity of financial constraints to a certain extent.

Furthermore, the study analyzed the Business Restart Funds operated by the Korea SMEs and Startups Agency to determine whether it is feasible to use financial constraints to better policy financing in its effectiveness. The analysis revealed that firms with severe financial constraints measured by the index ramped up investment after receiving policy funds, providing insights on generating more effective outcomes depending on the selection of beneficiary firms in executing policy financing.

Summary

Research Monograph KOR Strengthening the Financial Soundness of Korean SOEs

Korean SOEs have the highest debt level in the world, and it is expected that low birth rates and an aging population will raise it even further. Due to an implicit guarantee that the government will repay SOE debt if the SOEs are not able to repay the debt by themselves, SOEs are able to expand their debt with ease. However, the existing guarantee system needs to be improved. The vast majority of bonds issued by SOEs are not included in the “official” guaranteed debt category, placing them in the blind spot of the government’s official management and control. Even if classified as such, no regulatory actions are being taken to impose guarantee fees, among others, that are essential for improving the efficiency and soundness of guaranteed debt.

This study highlights the problem of implicit guarantees based on existing theoretical frameworks and shows, through empirical analysis, that existing government rules and regulations and market discipline have been ineffective in solving the problem although the implicit guarantees can actually have a significant effect on the financing of SOEs. Based on these results, this study formulates and suggests a SOE-customized bail-in system and the risk-adjusted guarantee fee system as a way to maintain the balance between publicness and financial soundness.

Summary

Research Monograph KOR A Study on Public Sector Debt

This report consists of two independent and interrelated studies pertaining to the debt of state-owned enterprises (SOE).

Chapter 1 analyzes the impact of SOE debt on the financial soundness of the government. First of all, we review the current status of public sector debt by examining data and previous studies on various categories such as local government, public institutions (including SOEs), financial institutions, etc. The results reveal that Korea’s relative size of non-financial SOE debt to GDP is much higher than that of major foreign countries, and the ratio of SOE debt to sovereign debt is also very high, indicating that the role of SOEs in Korea’s public sector is significant. On the other hand, we conclude that regulations on the financial status of SOEs is relatively insufficient. Therefore, the regulating system needs to be improved for future public debt management and control of public institutions.

Based on these findings, we develop a general equilibrium model that explicitly considers SOE debt for analyzing its effects on fiscal soundness and the macroeconomy. The results vary depending on whether the debt growth of SOEs is a temporary shock or is accompanied by the economic inefficiency of SOEs. If the debt shock is merely temporary while the efficiency of SOEs is maintained, the fiscal sustainability is hardly affected. Government subsidies increase slightly, but it has little impact on the economy's fiscal soundness and macroeconomic variables. However, if both debt growth and economic inefficiency occur simultaneously, it can shrink the economy’s fiscal space and reduce private consumption and the growth rate, thereby worsening social welfare. Accordingly, it is necessary to improve management and supervision functions on debt growth and efficiency of SOEs to the extent of the regulations on the debt of central and local governments.

Taking into consideration the distinctive traits of public enterprises, Chapter 2 (Should this be Chapter 2) analyzes the problem of 'moral hazard' (in terms of economically inefficient behavior rather than illegal action) arising from the government's tacit guarantees on their debt. In general, Korean public enterprises become financially indebted through the issuance of bonds. These bonds are recognized as safe assets in the market because participants share a strong but implicit belief that when a debt defaults, the government will repay it on their behalf. In the banking sector, it has become a well-known fact since the global financial crisis that moral hazard occurs when the discrepancy between management fundamentals and funding conditions widens. However, unlike banks, public enterprises’ decisions on large-scale investments are determined not by their management executives but by the government, meaning that moral hazards may differ.

Chapter 2 examines the effect of moral hazard in implicit guarantees, using a theoretical model that takes into account situations in which the government assigns policy projects to public enterprises for operation. The analysis shows that implicit guarantees by the government on public enterprise-issued bonds incur moral hazard not only for the public enterprises themselves, but also for the government―which, in turn, boomerangs back to the public enterprises as a larger moral hazard. Once a policy project is assigned, the employees of the public enterprise are guaranteed a salary under the payment guarantee (salary guarantee effect), even when they fail. There is even less incentive to work harder as public enterprises can issue bonds at an interest rate similar to that of government bonds (low cost financing effect) without making any special efforts towards the success of the project.

Additionally, the government will be unable to meet the participation constraints of employees in public enterprises if it ignores profitability when assigning projects in order to maximize political interests. However, with implicit guarantees, the aforementioned effects of a basic salary guarantee and low-rate procurement serve to increase the utility of employees and, thereby, relax the participation constraints, resultantly making it easier for the government to force public enterprises to take on political-oriented policy projects―this is a moral hazard on the government side. Also, such a ‘forced’ policy project could damage the business environment in public enterprises, thus exacerbate the moral hazard of employees. This double moral hazard may diminish the social welfare of the general public.

Based on the analysis, this study suggests the following policy directions for the government's implicit guarantees. First, guarantees should not be provided in general situations. Second, guarantees should only provided in exceptional cases wherein sufficient funds cannot be raised from the bond market while the project is needed for its considerable social contribution.

Summary

Policy Study KOR R&D Tax Credit Analysis: Focusing on Financing

This paper studies R&D tax credit focusing on corporate external financing ability. It analyzes theoretically and empirically how external financing ability of a firm can affect the effects of R&D tax credit. I set up a q-theory type of model that analyzes a firm maximizing its value by choosing optimal R&D spending. The model shows that in case of costly external financing, firms could not increase their R&D as R&D tax credit rate gets high. Empirical evidence corroborates the argument. By taking advantage of introducing a new R&D tax credit bracket for medium size firms in 2009 Korea, I run diff-in-diff analysis. I show that listed firms, which have easy accessibility to external capital market, increased R&D more than non-listed firms after introducing the new tax credit bracket.

This paper implies that reducing firms’ financing costs is crucial for improving the effects of R&D tax credit. Direct subsidy on R&D might not be desirable because moral hazard might arise. Easing on flow of capital to R&D active firms is appropriate by enhancing financial market.

Summary

KDI FOCUS The Sale of Treasury Stocks and Protection of Management Rights

□ Treasury stocks play a vital role in retaining, protecting and transferring management rights in large enterprises. However, the sale of treasury stocks is essentially identical to the issuance of new shares in economic nature. Therefore, using treasury stocks to protect management rights could obscure the equal treatment of shareholders. Even if such practices are permitted for policy purposes, the government needs to put other measures into place to protect general and minority shareholders from the damages that may arise.

- The sale of treasury stocks and the issuance of new shares are the same in economic nature since both increase stock trade volume and seek outside funding.

- Within the legal system, the difference between the sale of treasury stocks and issuance of new shares seems to have been created intentionally during the legislative process. As a result, controlling shareholders are able to use treasury stocks to defend their management rights.

- Although identical economic natures do not necessitate identical regulations, policy considerations can be rationalized if the positive economic impact from the protection of management rights, through the sale of treasury stocks, is significant.

- It is often the case that having a single managing executive to control two companies is more economically efficient, in terms of business synergy and reduced transaction costs.

- Affiliated companies that are mobilized to help the controlling shareholder protect his/her management rights could suffer from a loss in efficiency, for instance lost opportunities for better investments.

- Unlike general and minority shareholders, because controlling shareholders take into account the control premium when deciding on the sale of treasury stocks, the gains are highly likely to be focused on them, creating losses for the others.

- The controlling shareholders’ decision to sell treasury shares to white knights could generate losses for general and minority shareholders since it is a ‘rushed sale,’ while the controlling shareholders reap the benefits of maintaining the control premium.

- Selling treasury shares to affiliated companies is mostly aimed at strengthening management control by increasing the holding stake and restructuring the entire group.

- If it is difficult to expect certain business synergies, the sale will not be welcomed by the purchasing company’s general and minority shareholders.

- In the mid- to long-run, the current laws and systems need to be revised so that the transaction of treasury stocks fits the economic nature.

- Even if the current laws and systems are maintained, regulations that could generate losses for general and minority shareholders need to be overhauled as soon as possible.

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