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.