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Keywords:

  • Business group;
  • Holding company;
  • Loop;
  • Circular shareholdings;
  • Systematic risk;
  • Idiosyncratic risk;
  • Risk sharing;
  • Cost of equity capital;
  • Korea
  • G34

Abstract

This paper examines the effects of a series of regulatory changes that facilitated business groups in Korea to switch from a complex circular shareholding or “loop” structure to a more simplified and transparent pure holding company structure. Since these changes are likely to affect intra-group dynamics of member firms in terms of their interdependence, we focus on changes in risk characteristics and how they are reflected in initial announcement returns. Using a business group-level sample, we find that pure holding companies at the apex exhibit a significant decrease in beta subsequent to structural change, which is reflected in positive market reactions at the initial announcement. For other subsidiary member firms, however, we do not observe such patterns. On the other hand, idiosyncratic risk and volatility of operating performance significantly increase for both holding companies and subsidiaries following the switch. These results suggest that such structural changes alleviate business and financial interdependence among member firms, and that the benefits, if any, mostly accrue to (the shareholders of) the apex holding companies.