The Role of Capital Markets to Enhance Allocative Efficiency of Korean Corporate Sector
The growth rate of Korean economy has exhibited downward trend after the Asian economic crisis and the global financial crisis. Economic growth driven by capital and labor input has slowed down, and the decline in the number of the economically productive population due to low fertility rate and aging population, has been considered one of the major reasons for economic slowdown of the Korean economy.
This report examines the aggregate productivity of corporate sector in Korea and total factor productivity of individual companies in Korea since 2000’s, focusing on the trend of aggregate productivity of each of corporate subgroups based on age, size, growth and financial health, and the allocative efficiency among those subgroups. In particular, this report provides detailed analysis on scale-up and marginal firms, which are considered crucial to enhance allocative efficiency of corporate sector. Further, this report discusses potential intermediary role of capital markets to improve allocational efficiency through price discovery and risk taking.
Based on the estimated total factor productivity of individual firms, both statistical breakdown of aggregate productivity and model-based misallocation analysis are conducted. Specifically, ADOPD(Augmented Dynamic Olley-Pakes Decomposition), a variant of Olley-Pakes decomposition is employed for statistical time-series of aggregate productivity change, and Hsieh-Klenow(2009, HK hereafter) model for misallocation analysis. In addition, congestion effect analysis is conducted on the marginal firms which have negative effect on aggregate productivity by taking up scarce input in the economy.
Results of the analysis are as follows. Allocative efficiency of corporate sector in Korea deteriorated from 2015 to 2018, mainly because highly productive firms had underutilized productive resources. Also misallcation in both capital and labor market worsened, and misallocation in product market had stronger negative effect than input market on the aggregate productivity.
As for allocative efficiency among subgroups of firms based on firm characteristics such as age, size, growth, and marginality, HK analysis reveals that allocational efficiency among age and size subgroups deteriorated, but ADOPD analysis does not show significant change among the size subgroups. In order to examine subgroups based on growth, a scale-up is defined as a firm with average three year sales growth rate of more than 20%. Both ADOPD and HK analyses show that allocative efficiency between scale-ups and other firms significantly worsened, implying that scale-ups underutilized productive resources. Also, when a marginal firm is defined as one with interest coverage ratio below one for three consecutive years, allocative efficiency between marginal firm subgroup and other firms worsened. However, redefining a marginal firm by lifting the requirement of three consecutive years, allocative inefficiency largely disappeared, Finally, assuming misallocation for scale-up and marginality were corrected counter-factually, efficiency gains of scale-ups were found to be larger than those of marginality.
Regarding the congestion effect analysis for marginal firms, the increasing proportion of marginal firms had a negative effect on the corporate sector in general, reducing employment and capital expenditure. In particular, low margin structure of marginal firms under ultra-low interest environment plays a significantly negative effect on value-added and aggregate productivity by distorting competition structure. Negative effect of marginal firms on aggregate productivity was larger when marginal firms are redefined, incorporating current low interest environment than when the traditional measure based on interest coverage was used, implying the need for developing a new measure that better reflects the characteristics of marginal firms for policy and regulatory supervision about corporate restructuring.
Capital markets are essential channel to redirect capital to productive firms. One of outstanding characteristics of productive firms is that in many cases these firms face financial friction. Capital markets are the most suitable provider of capital for those types of firms due to the existence of professional investors and risk capital that makes it possible to provide capital under asymmetric information, investment risk and lack of collateral.
In order for capital markets to fully support scale-up, it is necessary that scale-up funds become larger, venture debt market grow, a private sector fund of funds be introduced, and structured secondary transactions of limited parter interests flourish. Especially structured secondaries make it possible to extend the life of existing funds as well as providing exits for existing limited partners of the funds.
Among various ways for corporate restructuring through capital markets, M&A and distressed debts are likely the primary instruments, considering current capital market environment in Korea. So far, the market for distressed debt has not been fully developed in Korea, therefore, policy makers need to apply a bifurcated approach to corporate restructuring. In other words, policy makers need to promote distressed debt market for the long run, and meanwhile policy makers should have professional private sector investors such as private equity or debt funds play a major role in the short run via government sponsored funds, Specifically, in order for capital markets to fully support corporate restructuring in the short run, it is necessary that more government sponsored debt funds be established, more structured secondary transactions flourish as in scale-up, more operation experts be available, and a new forewarning indicator for corporate restructuring initiative be developed.