Financial constraints and negative spillovers in business groups: Evidence from Korea

• We examine the negative spillover in the business group.
• We find that the firms' financial constraints negatively affect other affiliates.
• We show that governance and credit structure affect the negative spillover.
• Overall, group structure is a key factor in understanding negative spillovers.

We examine the negative spillover from one group-affiliated firm to other group-affiliated firms in the same business group, using credit rating downgrade announcement data in Korea. We hypothesize that the existence of controlling shareholders and internal capital markets is a major cause of the negative spillover. We find that the financial constraints of a group-affiliated firm negatively affect the value of other group affiliates. Furthermore, we show that both the parent–subsidiary relationship and the credit rating difference between a downgrade firm and its group-affiliated firms affect the extent of negative spillover. In addition, our robustness test results support the argument that the internal capital market within a business group is a key factor in understanding negative spillovers.