The large Korean business groups are often called chaebols which are composed of a variety of juridically independent, but jointly controlled firms that usually operate in various industries. Until the IMF bailout at the end of 1997, they had a tendency to diversify their business portfolios into unrelated industries. As a result, the average number of businesses in which the 30 largest chaebols engaged has increased from 18.3 in 1993 to 20.0 in 1997 at the two-digit SIC level. The five largest chaebols, Hyundai, Samsung, Daewoo, LG, and SK operate in about 30 different industries. 

The chaebols' diversification behavior has always been under public criticism and has generated heated discussions about government policy with regard to its impact on corporate performance and allocative efficiency. The first argument says that the chaebols pursue a (excess) diversification strategy in order to build a 'corporate empire' at the expense of shareholder value. Recently, the strategy is believed to have caused the subsequent bankruptcies of many chaebols including Hanbo, Kia, Jinro, Sammi, and Halla. About allocative efficiency, chaebol diversification is blamed for the increase in overall economic concentration and the distortion in resource allocation created by their anticompetitive behavior, such as cross-subsidies. Taking these views into account, the government has restricted chaebol diversification, and now, under the rubric of 'chaebol reform' strongly urges the chaebols to restructure their business portfolios and focus on core businesses.

While the chaebols and their diversification behavior are always subject to public debate, there exist few empirical findings in this field. As such, this book constructs an extensive panel data on the diversification behavior of 72 chaebols during 1985∼1997 and uses this data to examine the relationship between diversification and allocative efficiency. More specifically the book deals with three different issues: the nature and future prospects of the chaebols (Chapter 2); the diversification procedure and characteristics of the 72 groups during 1985∼1997 (Chapter 3); and the relationship between diversification, market structure, and aggregate concentration (Chapter 4).

The main arguments contained in each chapter can be summarized as follows. In Chapter 2, we rely on a comparative approach to economic organization to understand the nature of the chaebols. They should not be  considered simply as Korea-specific organizations. In other countries as well there exist business groups comprising juridically independent firms tied into pyramidal control system similar to the chaebols. But business groups in each country may have different characteristics as far as governance structure and their relationship with the government are concerned. Thus, we perceive the chaebols as containing two distinct properties: the Korea-specific governance structure, and the general nature of the business group as a hybrid form between market and hierarchy. After conceptualizing the chaebols this way, we attempt to explain their evolutionary process in the context of regulatory policies and institutions supporting corporate activity, such as property rights protection, social trust, and so on. Chapter 2 also explains how the recent changes in the business environment will affect the business scope and organizational form of the chaebols in the future. 

The third chapter measures the Berry-Herfindahl and Entropy indices of diversification of the 72 groups during 1985∼1997. They are measured  using six different statistics such as sales, assets, and employment at both the firm level and the industry level. We find that there are no significant differences among various measures. Table 1 summarizes some features of the chaebols' diversification behavior by group size and shows that in general the larger the group size, the larger the diversification level and the lower the relatedness among business portfolios. Table 1 also indicates that the Big 5 groups had already reached a high level of diversification in the 1980s, while the relatively small groups have aggressively expanded their level of diversification during that period.

The extensive panel data provided in this study will help us rigorously examine the implications of diversification on chaebol performance. We leave the complete empirics to the next research topics. Instead, here we limit the pooled regression analysis to two sub-samples: the 14 groups out of 72 that went bankrupt since 1997 and the 9 groups that are under the so-called workout program. The empirical work on the bankrupt groups shows with statistical significance that the diversification level is inversely related to the profit rate, which may suggest that over-diversification is the cause of the troubles faced by these groups. For the sample of 'workout' groups, however, we find that debt-equity ratios and total asset sizes are the factors contributing most to the decrease in the profit rate, while diversification improves performance.

Diversification Index of the 72 Chaebols By Group

Finally in Chapter 4 we use the method suggested by Clarke & Davies (1983) and examine the relationship between diversification, market structure, and aggregate concentration. The overall change in aggregate concentration during 1985∼1997 is about 36%. This change is decomposed into (a) the change in aggregate diversification, 13.4% pt.; (b) the change in the shares of individual industries, 19.8% pt.; and (c) the change in market concentration, 0.3% pt.

The study also shows that during the 1980s diversification was the main cause for the increase in aggregate concentration while both reductions in the share of oligopolistic industries and market concentration worked as countervailing forces. During the 1990s, however, chaebol diversification activities have stagnated and the increasing share of oligopolistic industries has become the major force behind the increase in aggregate concentration. one may infer from these facts that change in overall diversification levels has a negative relationship with change in market concentration. Table 2 shows that this conjecture is valid, and the correlation coefficients are relatively high and statistically significant. on the other hand the correlation between change in diversification and aggregate concentration is low and statistically insignificant. This finding seems surprising since we know that diversification increases the amount of economic resources under the control of chaebols and thereby aggregate concentration. Because market structure has a strongly negative relationship with diversification, however, this outcome is consistent with our model in which aggregate concentration is affected by market structure as well as diversification.

Correlation Coefficients of Diversification vs. Market Structure,  and Diversification vs. Aggregate Concentration

Note: each number in the parenthesis denotes the p-value.