Disappearing internal capital markets: Evidence from diversified business groups in Korea

This paper examines how the onset of a financial crisis affects the operation of internal capital markets among firms within a diversified business group. We find that active internal capital markets within Korean business groups (chaebols) attenuate the financial constraints of the group-affiliated firms, allowing them to make efficient capital allocations during the early 1990s. However, these markets barely function after the financial crisis of 1997. Instead, we observe public debt markets serving as a substitute for internal capital markets. Our results suggest that chaebol firms’ coordinated attempts to achieve healthier financial structures in the wake of the crisis have taken place at the expense of investment efficiency.