NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

Ending "Too Big To Fail": Government Promises vs. Investor Perceptions

Todd A. Gormley, Simon Johnson, Changyong Rhee

NBER Working Paper No. 17518
Issued in October 2011
NBER Program(s):   CF   EFG   IFM   POL

Can a government credibly promise not to bailout firms whose failure would have major negative systemic consequences? Our analysis of Korea's 1997-99 crisis, suggests an answer: No. Despite a general "no bailout" policy during the crisis, the largest Korean corporate groups (chaebol) – facing severe financial and governance problems – could still borrow heavily from households through issuing bonds at prices implying very low expected default risk. The evidence suggests "too big to fail" beliefs were not eliminated by government promises, presumably because investors believed that this policy was not time consistent. Subsequent government handling of potential and actual defaults by Daewoo and Hyundai confirmed the market view that creditors would be protected.

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Document Object Identifier (DOI): 10.3386/w17518

Todd A. Gormley, Simon Johnson, Changyong Rhee (2014), Ending "Too Big to Fail": Government Promises vs. Investor Perceptions, Review of Finance, forthcoming

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