Agency Problems and Overinvestment in the Korean Chaebol Firms

This article provides an alternative interpretation of the cause of the 1997 economic crisis in Korea, based on principal-agency relations in the capital and labor markets. It shows that the state should have intervened in the Korean economy not only to make markets but also to complement market failure. In this article the authors argue that the retreat of state intervention implied the retreat of state regulation of the market as well. We suggest that this retreat rather than moral hazard or rent seeking activities of the chaebol is the main cause of the crisis. More concretely, the retreat of state regulation of the market since the late 1980s has worsened and revealed the latent principal-agency problems of the capital and labor markets in the economy. Therefore the deregulation of the capital and labor markets transformed the possibility of overinvestment into actuality. Our interpretation suggests that neither the restoration of the developmental state nor the full implementation of market mechanism will solve the structural problems of the Korean economy. Instead a new kind of "democratic regulation of the market" should be the immediate agenda for the economy.