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Corporate Leverage, Bankruptcy, and Output Adjustment in Post-Crisis East Asia

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Authors
Kim, SeJik; Stone, Mark R.
Issue Date
2007
Publisher
Seoul Journal of Economics
Citation
Seoul Journal of Economics 20 (No. 4 2007): 419-446
Keywords
Corporate leverage; Bankruptcy; Output adjustment
Abstract
This paper posits that different levels of corporate leverage
help explain the very wide range of output adjustment across
East Asia in response to the 1997-98 crisis. A general
equilibrium model is presented where leverage and output are
linked by low investment and capital sales triggered by the
threat of bankruptcy. In the model developed here, highly
leveraged firms facing a cutoff of capital inflows, which are
threatened by bankruptcy, respond first by eliminating
investment and then by selling their capital goods - at a
discount - to try to stay afloat. Lower investment and wasteful
capital sales shrink the aggregate capital stock, trigger
deflationary pressures, and contract overall output. In contrast,
less leveraged firms, which are not threatened by bankruptcy,
would not have to respond by lowering investment and raising
costly capital sales. Therefore, a higher corporate leverage may
induce a greater output contraction during the crisis. The
available data are consistent with the assumptions and
predictions of the model.
ISSN
1225-0279
Language
English
URI
http://hdl.handle.net/10371/1393
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College of Social Sciences (사회과학대학)Institute of Economics Research (경제연구소)Seoul Journal of EconomicsSeoul Journal of Economics vol.20(4) (Winter 2007)
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