The effect of financial liberalization on firms' investments in Korea

Many studies suggest that firms' investments depend on the availability of internal funds. Firms face financial constraints because external funds are more costly than internal funds in an imperfect capital market. Financial liberalization plays the role of relaxing financial constraints on firms and thereby reduces the sensitivity of investments to cash flow. This paper empirically examines whether financial liberalization affects firms' investment behavior. Using panel data on Korean firms, we find that cash flow effects on investment decrease as financial markets are liberalized. In particular, small and non-chaebol firms are found to gain most from liberalization. This implies that large and chaebol firms are tending to lose their relative advantage in access to credit as liberalization proceeds.