Foreign Currency Debt Financing, Firm Value, and Risk: Evidence from Korea Surrounding the Global Financial Crisis

• Date: 01 February 2016
• Published date: 01 February 2016
• DOI: http://doi.org/10.1111/ajfs.12123

Foreign Currency Debt Financing, Firm

Value, and Risk: Evidence from Korea

Surrounding the Global Financial Crisis*

Sung C. Bae**

College of Business Administration, Bowling Green State University

Hyeon Sook Kim

School of Business, Chungnam National University

Taek Ho Kwon

School of Business, Chungnam National University

Received 31 July 2015; Accepted 28 December 2015

Abstract

We examine the valuation effect of foreign currency (FC) debt financing, relative to local cur-

rency (LC) debt financing. Employing extensive data from Korean firms during 2002–2012,

we document strong evidence that firms using FC debt financing have significantly lower val-

ues than firms using LC debt financing. Even during the pre-global financial crisis period

when the LC value appreciated, we find no evidence of a higher firm value associated with

FC debt financing. Further analyses on the possible causes of the negative association of FC

debt and firm value reject the conjecture of higher firm risk resulting from the usage of FC

debt but lend empirical support for the inefficiency in hedging by Korean firms. While the

heavy usages of currency derivatives by Korean firms with FC debt financing lead to lower

firm risk, such usages fail to generate higher firm values mainly due to their inefficient and

improper hedging with currency derivatives. Our empirical results remain robust to different

model and sample specifications.

Keywords Foreign currency debt financing; Local currency debt financing; Firm value; Firm

risk; Hedging; Korean firms; Global financial crisis

JEL Classification: F31, G15

*The authors acknowledge helpful comments from Daniel P. Klein, Mingsheng Li, Anthony

Loviscek, Ji Yeol Jimmy Oh, and session participants at the 2015 CAFM meeting in Seoul,

Korea on the earlier version of the paper. This work was supported by the Korea Grant of

the National Research Foundation funded by the Korean Government (NRF-2011-327-

1300258). The usual disclaimer applies

**Corresponding author: Sung C. Bae, Department of Finance, College of Business Administra-

tion, Bowling Green State University, Bowling Green, OH 43402, USA. Tel.: 419-372-8714, Fax:

419-372-2527, email bae@bgsu.edu.

Asia-Pacific Journal of Financial Studies (2016) 45, 124–152 doi:10.1111/ajfs.12123

124 ©2016 Korean Securities Association

1. Introduction

Over the past decades, foreign currency (FC, hereafter) debt financing has made a

significant contribution to the growth of business firms in emerging economies.

The usage of FC debt, however, has also affected these firms’ operations negatively.

The Asian financial crisis in 1997 reaffirmed that the usage of FC debt could bring

in significant risk to borrowing firms. Although the usage of FC debt declined after

the Asian financial crisis, it started to increase again, reaching the highest level dur-

ing the global financial crisis in 2007. Furthermore, since the global financial crisis,

there has been a big increase in FC bond issuance by emerging market firms.

According to the Bank for International Settlements, firms other than banks in the

emerging markets have issued $692 billion in international bonds during the post-

crisis period. Whether the increase in FC debt around the global financial crisis has

brought in a positive or negative effect on firm value and other firm characteristics

is an important piece of information for both investors and corporate managers,

and is the main issue explored in our paper.

A small number of existing studies have examined firms’ usage of FC debt but

offered limited and inconclusive evidence on the effect of FC debt financing on firm

value. In a study of Asian firms during the Asian financial crisis of 1997–1999,

Allayannis et al. (2003) find that all debt including FC debt brought a negative

effect on firms’ performance such as return on assets, earnings coverage ratio, and

borrowing risk. Ghosh (2008) documents similar evidence for Indian firms during

1995–2004. He further shows that firms participating in the international debt mar-

kets reveal more pronounced negative effects. In a study of United Kingdom firms,

Clark and Judge (2009) do not find conclusive evidence on the positive effect of FC

debt on firm value. They note that this inconclusive evidence is mainly due to many

constraints accompanying the management of foreign exchange risk using FC debt.

In contrast, Harvey et al. (2004) show that the usag e of FC debt in 18 emerging

market countries during 1995–1996 led to better firm performance in terms of

CAR. They attribute their findings to the high standards of financial disclosure that

these firms must satisfy for foreign creditors, suggesting that FC debt in emerging

markets is an effective mechanism to reduce firms’ agency costs.

As noted above, the current literature on the usage of FC debt lacks co nvincing

and conclusive evidence on the valuation effect of FC debt financing. Moreover, while

a few studies focusing on emerging economies have investigated FC debt financing

surrounding the 1997 Asian financial crisis and for the period of the depreciation of

local currencies (LCs hereafter) in the late 1990s and early 2000 (Allayannis et al.,

2003; Ghosh, 2008), little research has been done for emerging market firms sur-

rounding the 2007 global financial crisis or for more recent appreciation of LCs.

1

Our

1

As indirect evidence, Bleakley and Cowan (2008) and Endr

esz and Harasztosi (2014) show

that during the global financial crisis, firms using more FC debt significantly reduce their

investments, compared to firms using less FC debt due to the balance sheet effect of FC debt.

Foreign Currency Debt Financing, Firm Value, and Risk

©2016 Korean Securities Association 125