Corporate growth, financing, and risks in the decade before East Asia's financial crisis

East Asia's financial crisis has been attributed in part to the weak performance and risky financial structures of Asian corporations. In the period before Asia's financial crisis, however, analysts were not suggesting that the financial structure of many East Asian corporations would be unable to withstand the combined shocks of increased interest rates, depreciated currencies, and large drops in domestic demand. To document the basic record of corporate performance and financing structures for East Asian corporations, the authors analyze data for 5,550 firms in nine countries for the period 1988-96. They find large differences in performance and financial structure across countries. Profitability - as measured by real return on assets (ROA) in local currency -- was relatively low in Hong Kong, Japan, the Republic of Korea, and Singapore in the decade before the crisis. Corporations in Indonesia, the Philippines, and Thailand averaged high returns - roughly double those in Germany and the United States for the same period. In 1994-96, measured performance declined somewhat in several East Asian countries, especially Japan and Korea. Those differences in performance were not fully reflected in sales growth, as investment rates were high and continued to drive output growth in all countries. These stylized facts suggest that the East Asian miracle was indeed based on a vibrant corporate sector. But the combination of high investment and relatively low profitability in some countries meant that much external financing was needed. Outside equity was used sparingly - in part because stock markets were depressed (Japan) or because insiders preferred to retain control - so borrowing was heavy in most East Asian countries, and leverage increased in the years before 1996 in Korea, Malaysia, and Thailand. Risk increased as short-term (foreign exchange) borrowing became increasingly important in the 1990s, especially in Malaysia, Taiwan (China), and Thailand. In other words, it is now apparent that some of the vulnerabilities in corporate financial structures that were to become an important factor in East Asia's financial crisis already existed in the early 1990s, although they were not noted at the time.