The Dark Side of Internal Capital Allocation: The Case of Korean Chaebols

In this paper, we first briefly survey the theories of internal capital markets and then provide an empirical analysis of the efficiency of internal capital allocations among the chaebols in Korea. Our analysis of equity investment flow among the subsidiaries of the top 30 chaebols from 1997 to 2001 suggests that the chaebols' inter-affiliate equity investment during this period cannot be justified by sound economic rationale, and reveals the dark side of internal capital allocation. Furthermore, we find that a strong positive relationship does not exist between equity investment and real investment. In conclusion, the internal capital allocations among the chaebols have continued to be inefficient and therefore, the argument to loosen restrictions on inter-affiliate equity investments to increase real investment cannot be justified.