Firm Age and Valuation: Evidence From Korea

• Author: J.B.(Jong‐Bom) Chay,Heuijung Kim,Jungwon Suh
• Date: 01 October 2015
• DOI: http://doi.org/10.1111/ajfs.12111
• Published date: 01 October 2015

Firm Age and Valuation: Evidence From

Korea*

J.B.(Jong-Bom) Chay

SKKU Business School, Sungkyunkwan University

Heuijung Kim

SKKU Business School, Sungkyunkwan University

Jungwon Suh**

SKKU Business School, Sungkyunkwan University

Received 3 July 2013; Accepted 28 July 2015

Abstract

Using Korean stock market data, we document evidence that firm age is a key determinant

of firm value. Specifically, firm value (measured by the market-to-book equity ratio) has a

downward sloping relation with firm age. We also find that profitability and capital expendi-

tures decline as firms age, suggesting that firms may become less valuable with age as they

become less profitable and run out of investment opportunities. Our evidence also suggests

that firms conduct IPOs by capitalizing on a small window of opportunity for listing during

which their profitability is temporarily at its peak. Because this profitability is not sustainable,

IPO issuers experience a sharp drop in profitability, contributing to a negative relation

between firm value and age in the post-IPO period. The learning hypothesis of P

astor and

Veronesi (2003) is unable to explain the negative firm age–value relation in the Korean stock

market, given that uncertainty does not decline with age and that the negative relation is

either non-existent or very weak among dividend-non-payers.

Keywords Firm age; Market-to-book; Firm maturity; IPO window; Learning hypothesis

JEL Classification: G10, G30

1. Introduction

Conventional wisdom has it that corporations experience material changes in their

characteristics as they age. For example, there is a popular belief that firm s run out

*The authors appreciate comments and suggestions from two anonymous referees and seminar

participants at the 2013 Korea Securities Association Conference. This paper was supported by

Samsung Research Fund, Sungkyunkwan University, 2014. All errors are our own.

**Corresponding author: Jungwon Suh, SKKU Business School, Sungkyunkwan University,

Seoul 110-745, Korea, Tel: +82-2-760-0482, Fax: +82-2-760-0440, email: jungwonsuh@skku.

edu.

Asia-Pacific Journal of Financial Studies (2015) 44, 721–761 doi:10.1111/ajfs.12111

©2015 Korean Securities Association 721

of investment opportunities as they mature. Surprisingly, however, the extant lite ra-

ture rarely explicitly considers the role of firm age in shaping corporate finance

variables such as firm value. For example, while Grullon et al.’s (2002) maturity

hypothesis assumes that firms’ dividends increase as they enter the maturity stage,

their analysis does not examine firm age per se. Similarly, DeAngelo et al.’s (2006)

life-cycle hypothesis makes the same assumption but these authors do not explicitly

consider firm age. The study of P

astor and Veronesi (2003) is a rare exception in

that they consider firm age explicitly, specifically, in relation to valuation, positing

that firm value declines over a firm’s lifetime as investors learn about the firm’s

profitability (or as uncertainty resolves over time).

The purpose of the current study is to determine whether firm value has a sys-

tematic relation with age and, if so, to explore explanations for such a relation. Our

initial empirical investigation is conducted on a sample of Korean firms listed on

the Korea Composite Stock Price Index (KOSPI) market of the Korea Exchange

(KRX) over the period 2000–2011. Following P

astor and Veronesi (2003), we use

the number of years since a firm’s listing as our measure of firm age and the mar-

ket-to-book equity ratio to measure firm value. Univariate analysis suggests that

firm value has a downward sloping relation with firm age. To elaborate, the median

market-to-book tends to drop precipitously during the first several years after list-

ing. While this median increases somewhat for firms that are nine and 10 years old,

it slides thereafter. Interestingly, the negative firm age–value relation is driven by

dividend-payers because it is obtained mainly among dividend-payers. The firm

value of dividend-non-payers varies considerably across age groups, not displaying

any downward or upward trend pattern.

Among the firm characteristics we consider that could account for the negative

firm age–value relation, profitability and capital expenditures exhibit downward

sloping patterns as firms age, suggesting that the negative firm age–value relation

could be ascribed in part to declining profit and the shrinking investment opportu -

nity set that firms face as they age. On the other hand, stock returns and stoc k

return volatility do not display any particular pattern that could link them to the

negative firm age–value relation.

We also run a regression of firm value on age after controlling for previously

identified determinants of firm value, such as the contemporaneous and future

values of profitability and stock returns. In both OLS regressions (with year

fixed effects) and Fama-MacBeth regressions, the estimated coefficient on firm

age is significantly negative for the whole sample. In particular, the negative

effect of firm age on value remains significant even after controlling for prof-

itability and capital expenditures—the two firm characteristics that display down-

ward sloping relations with firm age—suggesting that there is more than

declining profitability and investment opportunities behind the negative firm

age–value relation. Our regression results also indicate that the significantly nega-

tive effect of firm age on valuation is observed for dividend-payers, but not for

dividend-non-payers.

J.-B. Chay et al.

722 ©2015 Korean Securities Association

We also examine a longer time period that spans more than 30 years from 1981

to 2011 in order to derive a more reliable conclusion and to also perform a variety

of additional robustness checks, such as controls for IPO cohort effects and firm

fixed effects.

1

Our results remain virtually unchanged for this extended sample per-

iod—that is, firm value has a significantly negative relation with age and this nega-

tive relation is more pronounced for dividend-payers than for dividend-non-payers.

These findings hold even after we exclude firms that are relatively young, so our

findings are not driven entirely by the sharp decline in firm value in the first

several years after IPOs. These findings also hold regardless of whether we drop

inactive firms as of the end of the year 2011; whether firms are affiliated with a

chaebol; or whether we control for industry fixed effects. Further, these findings

continue to hold when we account for IPO cohort effects—by adding dummy vari-

ables each of which equals 1 for firms that issue IPOs in the same fiscal year and 0

otherwise—suggesting that the negative firm value–age relation tends to be signifi-

cant for each IPO cohort (i.e., firms that enter the stock market in the same year).

Finally, our findings remain unchanged in firm fixed effects regressions, suggesting

that the negative firm value–age relation (for all sample firms or for dividend-

payers) is not just a cross-sectional phenomenon but a reflection of within-firm

variation in firm value across age.

To gain further insight into the negative firm age–value relation, we examine a

sample of firms for which firm value and key firm characteristics are available for

pre-IPO years. Interestingly, firm value tends to increase sharply several years prio r

to IPOs before it begins a downward trend. Also, profitability surges substantially

several years prior to IPOs although it declines greatly following IPOs. Hence, it

appears that the pre-IPO increase in firm value is driven by a similar pre-IPO

increase in profitability. However, accruals do not display any discernible upward

trend in the years surrounding IPO issuance; hence it does not appear that IPO

issuers engage in aggressive earnings management to make them look attractive to

investors. These findings suggest that firms conduct IPOs during which their prof-

itability is temporarily at its peak. While the high pre-IPO profitability appears to

push up the pre-IPO firm value, the rapid post-IPO decline in profitability indicates

that such high profitability is short-lived, thereby contributing to the negative firm

age–value relation in the post-IPO period.

In search of the forces that shape the negative firm age–value relation in the

Korean stock market, we consider several hypotheses. Our evidence is most consis-

tent with two hypotheses: “the firm maturity hypothesis” and “the IPO window

hypothesis.” First, the firm maturity hypothesis, as proposed by Grullon et al.

(2002) and DeAngelo et al. (2006 ), posits that firm value could decrease because

firms experience declining profit and a shrinking investment opportunity set as

they age. Indeed, our evidence shows that the downward trend in firm value in the

1

When firm fixed effects regressions are estimated for a relatively short sample period, results

are not so meaningful because we have to work with a short variation over time.

Firm Age and Valuation

©2015 Korean Securities Association 723