Determination of capital structure and prediction of bankruptcy in Korea

This dissertation includes two different but highly related topics: determination of capital structure and prediction of bankruptcy.; In Chapter 2, we analyze the determination of the capital structure of Korean manufacturing firms, based on the three categories of capital structure theory and the peculiar characteristics of Korean economy. It is found that profitability and firm size are the most important factors determining debt ratios for Korean manufacturing firms for the 1991–1994 sample period. We observe a high level of extra debt capacity for Chaebol firms. It is concluded that empirical findings are consistent with the pecking order hypothesis and that financial/bankruptcy risk pooling mechanism of Chaebol groups in normal times enabled Chaebol member firms to attain a high level of debt.; In Chapter 3, we search for good predictors of bankruptcies of Korean manufacturing firms in late 1997 through mid 1998. We then investigate whether the occurrence of bankruptcy could have been well predicted ahead of time. We find from our basic logit model that total debt ratio is the best indicator of bankruptcies influenced by the 1997 financial crisis in Korea. Total debt coverage ratio becomes a significant predictor as bankruptcy approaches, whereas firm size and short-term debt coverage ratio are not good forecasters of firm failure. Findings from our basic model are supported by the extended model using Altman's variables. Bankruptcies for non-Chaebol firms are more influenced by the level of internal funds. In an analysis based on the Shannon's entropy method and rolling logit model, we infer that the market could not have predicted bankruptcies of Korean manufacturing firm ahead of time.; In Chapter 4, we examine how the risk generated by debt demand and debt supply factors affects the probability of bankruptcy, based on both a ‘competitive equilibrium model’ and a ‘credit rationing model’ with a usury constraint. We decompose the predicted debt ratio according to the demand level, firm size, and Chaebol membership and analyze the effects of these partitioned predicted debt ratios as well as the effects of the residual value of the debt ratio on the probability of bankruptcy. The possibility of a structural change in bankruptcy risk is also investigated. The implications of the empirical findings between the two theoretic debt determination models are consistent: there was such a regime change that the protective power of firm size and Chaebol membership diminished to a great extent after the crisis. The increase in the degree of the risk related to demand levels is much larger for Chaebol firm than for non-Chaebol firms.