Business Group Affiliation, Internal Labor Markets, External Capital Markets, and Labor Investment Efficiency

• Author: Boochun Jung,S. Ghon Rhee,Ilhang Shin,Dongyoung Lee
• Date: 01 February 2019
• Published date: 01 February 2019
• DOI: http://doi.org/10.1111/ajfs.12245

Business Group Affiliation, Internal Labor

Markets, External Capital Markets, and

Labor Investment Efficiency

Boochun Jung

School of Accountancy Shidler College of Business, University of Hawaii at Manoa, United States

Dongyoung Lee

Desautels Faculty of Management, McGill University, Canada

S. Ghon Rhee

Department of Financial Economics and Institutions, University of Hawaii at Manoa, United States

Ilhang Shin*

College of Business & Economics, Gachon University, Republic of Korea

Received 3 November 2017; Accepted 21 November 2018

Abstract

We examine how business group affiliation affects a firm’s labor investment decisions. Using

data from 2002 to 2014, we find that Korean business group- (chaebol-) affiliated firms make

more efficient labor investments than nonaffiliated firms. The positive relation between chae-

bol-affiliated firms and labor investment efficiency is attributed to the mitigation of underin-

vestment in labor. Moreover, chaebol affiliates have higher labor productivity than stand-

alone firms. We further show that both labor sharing among affiliated firms and their easy

access to external financing lead to more efficient labor investments for chaebol firms, com-

pared to stand-alone firms.

Keywords Labor investment efficiency; Hiring efficiency; Business group; Chaebol; Employ-

ment; Internal labor markets; External capital markets

JEL Classification: G31, G34, J24, J46

1. Introduction

The most valuable of all capital is that invested in human beings. —Alfred Marshall

*Corresponding author: Accounting College of Business and Economics, Gachon University,

1342 Seongnamdaero, Sujeong-gu, Seongnam-si, Gyeonggi-do, 13120, Republic of Korea. Tel:

+82-31-750-5529, Fax: +82-31-750-5152, email: jayshih00@gachon.ac.kr.

Asia-Pacific Journal of Financial Studies (2019) 48, 65–97 doi:10.1111/ajfs.12245

©2019 Korean Securities Association 65

This study investigates whether firms affiliated with business groups are more or

less efficient than stand-alone firms in labor investment decisions. Labor investment

is the primary source of corporate innovation (Chang et al., 2006) and intangible

knowledge-based resources (Chang and Hong, 2002). The examination of labor

investment efficiency is particularly important in emerging markets, because labor-

intensive industries are more prevalent in those markets than in developed coun-

tries. However, relatively little is known about the potential role of business group

affiliation in labor investment decisions in such an emerging market setting.

While the finance literature is replete with theoretical models on internal labor

markets, there is limited empirical evidence of the labor market efficiency of con-

glomerate firms of emerging economies. In their review of internal labor market

studies, Baker and Holmstrom (1995, p. 255) note that there are “too many theo-

ries, too few facts” and call for further empirical research on internal labor markets.

On the one hand, internal market and institutional void theories (Leff, 1978 ;

Khanna and Palepu, 1997, 1999, 2000) posit that business groups in emerging

economies develop efficient labor markets internally to cope with the lack of insti-

tutions governing external labor markets.

1

On the other hand, classic agency theory

(Jensen, 1986, 1993) suggests that the more powerful firms within a business group

tend to overinvest in their own projects at the expense of other affiliated firms,

resulting in a misallocation of economic and human resources (Glaser et al., 2013).

Given the different theories and lack of empirical evidence, it is an open empirical

question whether business group-affiliated firms make more efficient investments in

labor.

We focus on Korean business conglomerates, known as chaebols, for several rea-

sons. First, in 2016, public expenditures on labor markets in Korea (as a percentage

of gross domestic product) were 0.7%, which was among the lowest among the

Organization for Economic Co-operation and Development (OECD, 2018) coun-

tries. This, in turn, implies that private sector firms, such as chaebols, should play a

more critical role in shaping labor markets. Chung (2015) notes that though the 30

largest chaebols recruited more than one million employees as of late 2014, policy-

makers generally demand that chaebol firms increase hiring to help solve unemploy-

ment problems for young job seekers, given the country’s economic dependency on

large conglomerates. Second, an International Monetary Fund country report,

1

According to Khanna and Palepu (1999, p. 129), “business groups also substitute for labor

market institutions. There are only a handful of business schools in countries like Korea,

India, and Chile, and demand for management talent far exceeds the supply. But large com-

panies such as Korea’s Samsung Group can create their own internal market for managers.

Samsung uses the diversity of its business activities to expose its managers to a wide variety

of situations. By virtue of its size and importance, Samsung also can recruit world-class fac-

ulty to lead its in-house training programs. The company’s training center invests heavily in

knowledge management so all Samsung Group companies can benefit from the insights and

experience of Samsung executives, especially those who have been posted overseas.”

B. Jung et al.

66 ©2019 Korean Securities Association

published in February of 2018, states that South Korea stands out from other

OECD countries for having a relatively high share of temporary workers.

2

In 2016,

25.5% of total employment accounted for temporary workers in South Korea,

whereas 15.8% was the average in all OECD countries. Non-regular (or temporary)

jobs are more concentrated in smaller business entities that are less likely to be affil-

iated with chaebols. These temporary jobs are associated with less vocational train-

ing, thus leading to lower productivity growth. Third, despite low levels of

ownership, controlling shareholders (e.g., founding family, owner-managers) in

chaebol firms can exercise significant decision-making power over hiring by allocat-

ing human resources across member firms (Chang, 2003). While divergence

between ownership and control might lead to agency problems in labor allocation,

controlling shareholders’ direct monitoring of and access to private informati on

about member firms’ profitable opportunities allow for more efficient investments

in human capital. Last, Korea is one of the few countries in which detailed data on

firm-level union and business group affiliation are publicly available for a large

sample of publicly traded firms (Kim and Yi, 2006). Given a clear definition of

business group affiliation and data availability on labor unions in Korea, chaebols

provide an ideal setting in which to test the efficiency of internal labor markets.

3

To measure labor investment efficiency, first we regress firms’ net hiring (per-

centage change in the number of employees) on various economic determinants of

the expected level of labor investment. The residuals constructed from the regres-

sion indicate the extent of deviation from the predicted level of labor investment

based on various firm fundamentals. Specifically, positive residuals indicate overin-

vestment in labor (i.e., labor investment that is higher than the level predicted from

economic fundamentals), while negative residuals indicate underinvestment in

labor. Thus, the absolute values of the residuals represent labor investment ineffi-

ciency as a whole. Second, we estimate how business group affiliation is associated

with labor investment efficiency, controlling for firm characteristics that may affect

the efficiency of labor investment.

Using data from 2002 to 2014, we find that chaebol firms hire more efficiently

than non-chaebol firms.

4

This finding is driven by a reduction in underinvestment

in labor rather than a decrease in overinvestment in labor, suggesting that business

groups maintain an adequate level of employment for their member firms to miti -

gate underinvestment problems. These results do not support policymakers’ request

2

The report is available at https://www.imf.org/~/media/Files/Publications/CR/2018/cr1841.a

shx.

3

In 2015, Korea was also ranked third to last in collective bargaining coverage (11.8%)

among OECD countries, followed by Turkey (6.7%) and Lithuania (7.1%), whereas the aver-

age value of collective bargaining coverage was 32.6% in OECD countries. Data are available

at https://stats.oecd.org/Index.aspx?QueryId=80973.

4

Chaebol firms are member companies affiliated with business groups, while non-chaebol

firms in this study are stand-alone firms.

Business Group Affiliation and Labor

©2019 Korean Securities Association 67