Diversification of Korean housebuilding firms: The pattern and motives between 1980 and 1995

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Habitat International 31 (2007) 277–290 www.elsevier.com/locate/habitatint

Diversification of Korean housebuilding firms: The pattern and motives between 1980 and 1995 Youngha Cho Department of Real Estate Management and Construction, Oxford Brookes University, Headington Campus Gipsy Lane, Oxford OX3 0BP, UK

Abstract The Korean housebuilding industry made rapid growth during the 1980s and 1990s and the industry has been restructured. One of its outstanding characteristics has been the diversification of housebuilding firms. The objective of this paper is to examine the impact of government regulations on the restructuring of the Korean housebuilding industry. The extent and pattern of diversification were examined via an analysis of the period 1980–1995, and the motives for diversification were investigated using interviews and empirical modelling. The results show that Korean housebuilding firms were diversified into both related and unrelated businesses during the rapid growth period. The conclusion is that building firms tended to diversify into other businesses in order to use resources more efficiently. In particular they extended their activities into counter-cyclical businesses in order to compensate for business loss due to tight government regulation. The diversification is seen as a survival strategy under a regulated environment as well as a long-term growth strategy. r 2007 Elsevier Ltd. All rights reserved. Keywords: Housebuilding industry; Diversification; Regulation; Korea

Introduction The Korean housebuilding industry grew steadily in line with the economic development of the country during the 1970s, and then grew rapidly after the mid-1980s. Since the 1980s the Korean government has intervened in the private housing sector more frequently through the introduction of various restrictions, including sale price control, residential land development regulations and public allocation of residential land. Significant structural changes took place in the industry in the 1980s and 1990s (during this period of rapid growth). Of particular note is the dominance of large firms: until the mid-1980s the housebuilding industry consisted of a multitude of small firms1 as seen traditionally in other countries (Buzzelli, 2001; Gillen, 1994). The emergence of large firms came about in Korea several decades later than in other developed countries. For example, the housebuilding boom of the UK came in the 1920s and 1930s (Ball, 1983; Jackson, 1991) and in Tel.: +44 1865 483941; fax: +44 1865 483927. 1

E-mail address: [email protected] Firms with less than 10 employees.

0197-3975/$ - see front matter r 2007 Elsevier Ltd. All rights reserved. doi:10.1016/j.habitatint.2007.07.002

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the 1950s and 1960s for the USA (Grebler, 1973). Since the mid-1980s, when the Korean government initiated a mass construction plan for housing (‘The Construction Programme for Two Million Dwellings’), large housebuilders have dominated the industry.2 Another main change is the increasing trend towards diversification, both by those already in the market and those which entered it after the 1980s, into a range of businesses not related to their own industry (Kim & Park, 1996). It is noticeable that this pattern of diversification pursued by housebuilding firms was rather different from the spatial diversification observable in other countries (Ball, 2006). Many commentators argue that the structure of housing supply side may be influenced by the nature of regulation (Ball, 2003, 2006; Barker, 2004; Malpezzi, 2005). This argument seems to fit with the observation that the restructuring of the industry took place when the Korean government intervened extensively in the industry in the 1980s and 1990s with various regulations, in particular with the mass construction plan (1988–1992). This paper attempts to investigate the impact of government regulations on the housebuilding industry, focusing on the phenomenon of diversification among Korean housebuilding firms during the rapid growth period. The Asian economic crisis, which started in late 1997, has brought about subsequent reform of the housebuilding industry. In order to avoid the irregular shocks which the Asian economic crisis brought to the industry, the period of study for this paper focuses on the rapid growth period between 1980 and 1995. A brief overview of the regulatory policies during the housebuilding boom is presented before the extent and pattern of diversification among Korean housebuilding firms between 1980 and 1995 is examined. Then, the motives for diversification, in particular, the reasons for the outward diversification, are investigated assisted by evidence from the literature, interviews and empirical modelling. An analysis and conclusion are provided at the end of the paper. Korean housebuilding industry: its growth and government intervention Rapid economic growth in the 1970s and the 1980s resulted in the population of Korea becoming concentrated in large cities, especially in Seoul and its metropolitan area. This increased the demand for housing in these areas, whilst higher household income also increased the level of affordability. The result throughout the 1970s and 1980s was a housing shortage. The housing shortage3 increased from 17.5% in 1960 to 30.2% in 1985. House price inflation was as critical as the shortage problem itself: the price of housing rose almost fivefold during the 13 years of 1975–1988, while the nation’s Gross Domestic Product grew less than threefold in real terms (KRIHS, 1990). What made the housing shortage worse was a lack of land available for development. Approximately 70% of Korea’s total land is natural ‘greenery area’ including mountains, hills and rivers, and there has been a tight limit on residential land development since 1980, i.e. green belt was designated around large cities. Only a small percentage of the total land was designated as developable (KRIHS, 1998). During the 1970s and the early 1980s, the government’s housing policy exercised control over the excess demand for housing and the sale price of houses in Seoul. In the mid-1980s, the government decided to expand the supply of new houses to alleviate the chronic housing shortage, particularly in the region of the capital. This resulted in the mass construction plan for housing, 1988–1992, ‘The Construction Programme for Two Million Dwellings’. To successfully implement the programme, the key steps were: to increase the supply of developable land; expand housing finance; and remove various regulations restricting residential development. As a result, after the rate of investment in housing increased to around 8% of GNP for the period 1988–1995, and the average number of new dwellings to between 500,000 and 600,000 per year, compared with about 200,000 in the 1970s and 1980s (KRIHS, 1998). The main goal of the Korean housing policy during the mass construction period was to achieve residential stability by increasing the supply of new dwellings at affordable prices to those genuinely in need of housing. In the process, the government directly intervened in the housing and land markets and introduced new regulations such as a public allocation system for developable land and a revised house size 2

Approximately 70% of new housing has been built by large building firms. It is defined as the difference between the number of households requiring a dwelling unit and the existing housing stock (Barker, 2004; KRIHS, 1990). 3

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distribution.4 At the same time, other regulations such as house price controls and existing residential land development regulations were revised. Residential land development regulations (public land development) The process of residential land development has changed over time in Korea. In particular, since the mass construction period, private developers have not been allowed to take part in land development and the Korean government has played a key role as a developer. The rationale of the government’s intervention was to prevent private developers from collecting a large windfall gain from land development, and to convert the permitted gains to provide infrastructure for the site. The government could also speed up the process of largescale residential development at a time of acute shortage. In particular, since large plots of land with multiple ownership could be extremely difficult to assemble and purchase, the government’s expropriation rights made it easy to amalgamate them and proceed with a major development programme. The process of public land development during the mass construction plan period can be summarised as follows. Firstly, the Ministry of Construction and Transport (MOCT) estimated the amount of land needed for residential development, as well as for infrastructure, then ensured that the necessary total area of land was rezoned and developed. The ministry also approved land-use conversion applications, and issued exceptional permits to public-sector agencies, e.g. the Korea Land Corporation (KLC), the Korea National Housing Corporation (KNHC) and local governments (Kim & Kim, 1999). Once these bodies had purchased the necessary amount of undeveloped land at valued prices, they serviced them with infrastructure and had them rezoned as residential and commercial sites. Consequently, large-scale land development projects were virtually monopolised by the public sector (Hannah, Kim, & Mills, 1993). More than 60% of total residential land provided since 1980 has been developed by the government. From the mass construction period (1988–1992) onwards, nearly all the residential land in the capital region has been provided by public land development (KRIHS, 1990). Public allocation of developable land Since 1989 the Korean government has also been involved in the allocation of developable land. The public allocation of land operated as a subsequent policy of public land development. Once a public body such as the KLC, KNHC or local government provided the site with infrastructure and re-zoning services, the developable land was sold to the housebuilding firms through the Housebuilding Firms’ Association. The association allocated the developable site to their member firms according to a set of rules known as a random lottery process. The opportunity to participate in a particular building project depended on whether the housebuilding firm was chosen via the random lottery process. Private housebuilding firms criticised these regulations for land development, since they created uncertainty and unexpected outcomes for their businesses. However, once any firm won the lottery (giving it the chance to buy the developable site), the sale of the houses/apartments to be built was guaranteed, as the supply of housing was far below demand. House price control (house price ceiling) Imposing a house price ceiling was aimed primarily at preventing speculation, and then stabilising house prices by government control of the sale price of newly built dwellings. This was applied to any new building project providing 20 or more dwellings. The price controls applied in practice only to apartment dwellings.5 The reason for this was that for single-family dwellings and row houses (similar to town houses in the UK), the developers suffered only a moderate profit loss if they opted for a project comprising less than 20 single family dwellings in order to avoid price control. On the other hand, the profit for developers of apartments declined substantially if they built less than 20 apartments (Kim & Kim, 1999), mainly because of economies of scale. 4 Until 1998, the government mandated land development projects to allocate at least 70% of developed residential sites to dwellings smaller than 85 m2 in net floor space, and 30% to those smaller than 60 m2. 5 For-sale dwelling which is the most dominant house type in Korea since the mid-1980s.

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Table 1 Trends under house price ceiling system (unit: 10,000 won per pyong)

Less than 85 m2 Over 85 m2 (25.7 pyong) Increase ratio per year (%)

1977

1978

1979

1980

1981

1982

1985

1988

55

68

78

90

105

–

23.6

14.7

15.4

16.7

105 134 0 27.6

115 134 3.1 0

126.8 134 3.3 0

Source: Ministry of Construction and Transportation. 1 pyong ¼ 3.3 m2.

From the mid-1980s, as the majority of new construction consisted of apartments, price controls have had farreaching implications for the profits of housebuilding companies. Table 1 summarises the changes over time. From 1977 to 1981, the sale price per dwelling was controlled at a constant level regardless of size. Since 1977 the ceiling price has been adjusted every year by points between 14.7% and 27.6% above the previous year’s price. After 1982, the price for large dwellings (over 85 m2) was set at a fixed price whilst the price for smaller dwellings (less than 85 m2) was adjusted. After the introduction of the mass construction plan in 1988 the government modified the price ceiling method.6 This was intended to stimulate housing supply by giving building firms more profit from a building project. Typically a price ceiling discourages the supply of the goods upon which it is imposed. However, this was not the case with price control on new apartments in Korea (Kim, 1997; Kim & Kim, 1999). The fundamental reason was that the supply of housing was conditioned by the availability of developable land. Even though the Korean government controlled land development, once a firm could participate in a development project, sale of the new apartments was guaranteed in such a seller’s market. In conclusion, the institutional structure of housing supply in Korea in the 1980s and 1990s was very similar to social housing schemes in European countries, in which social housing landlords became major land developers from the 1920s onwards, and also undertook the development function in new housing, whilst overwhelmingly hiring private building contractors to build actual structures (Ball, 2003). Diversification of Korean housebuilding firms Structural change in the housebuilding industry may be driven by the property market cycle and regulatory changes rather than by technological factors, scale and scope economies and international trade pressures common in many manufacturing sectors (Ball, 2003). The regulations relating to the land development process may have played an important part in restructuring the industry in Korea, especially in the mid-1980s when there was a long-term shortage of available land. The general hypothesis of this paper is that government regulations did affect the diversification of the housebuilding firms during the high growth period. This section analyses the extent of the Korean building firms’ diversification and investigates how the pattern changed during the high growth period, using secondary data. Definition of diversification and data source Firstly, it needs to be decided how to measure diversification. Using the companies’ annual reports published by the Korea Stock Exchange, the range of businesses in which the firms were involved each year was traced and the businesses classified according to the Korean Standard Industry Classification (KSIC). Housebuilding is one of its 4-digit categories under the construction umbrella. This study defined related business as those under the same 4-digit category, whilst unrelated business was outside the 4-digit category. 6 The house price ceiling was adjusted by construction cost in such a way that the cost increases in land, labour, and building materials could be indexed for inclusion in the ceiling price, as well as interest and normal profit. The ceiling price per dwelling was adjusted every year till the late 1990s by points between 5% and 15% against those of previous years.

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Low

Cell A: Firms with Very Low Diversity

Cell B: Related Diversified Firms

High

Cell C: UnrelatedDiversified Firms

Cell D: Firms with Very High Diversity

Low

High

281

Direction of diversification Fig. 1. Two-dimensional conceptualisation of diversification in firms. Source: Varadarajan and Ramanujam (1987, p. 383), revised.

There are a number of diversification indices widely used in other research, such as the Herfindal, Gort and Gravity indices (Gollop & Monahan, 1991). To use these existing diversification indices, it is necessary to have access to revenues or sales data for each business in which the companies are involved. The main reason for not using those indices was because the relevant data for each business in which the chosen Korean building firms were involved were not accessible. Whilst sales figures for housebuilding businesses were obtainable at the 4-digit category level, for construction and other businesses only total sales figures at the 2-digit level were available. As an alternative, a four-cell matrix was used, as seen in Fig. 1. This matrix distinguishes between diversification into those areas closely related to a firm’s primary activity and those not closely related and does not require data on revenues or sales of each business segment, although it still provides insights into both the extent of diversification (high/low), and its direction (predominantly related/predominantly unrelated) (Varadarajan & Ramanujam, 1987). To measure the extent and pattern of diversification, the top 200 housebuilding firms, based on volume of sales, were selected for four different years (1980, 1985, 1990 and 1995). These years represent the high growth period of the industry before the Asian financial crisis, which may have brought an irregular shock to it. Due to the availability and inconsistency of data for each firm, the numbers in the samples in each year vary.7 These top 200 firms were then divided into two groups. Type I firms were those which either originated as part of a larger construction company, operating across all fields of construction, or those whose main business was something else, such as construction material manufacturing or a hotel, but which became involved in housebuilding later, especially in the mid-1980s.8 They were the common M-form type of construction companies, described and analysed by Williamson (1985). The Korean government encouraged them to participate in the mass construction programme in order to activate the plan successfully. Type II firms were those whose original main activity was housebuilding. Diversification: the extent and the pattern According to the KSIC classification, as a whole only 5% of the sample firms in 1980 were involved in one or more businesses unrelated to housebuilding, but the proportions steadily increased over the survey period (22.3%, 46.5% and 51.1% in 1985, 1990 and 1995, respectively). In 1995, half of the 51% were operating completely unrelated businesses, such as the supply of timber, the sale of motor vehicles, hotel and restaurant businesses, broadcasting, and financial institutions, as well as related businesses such as civil engineering, plant 7

Numbers in the sample.

Type I firm Type II firm Total

8

1980

1985

1990

1995

21 85 106

51 71 122

40 102 142

79 64 143

There are only two firms originally from the manufacturing sector and two hotel businesses.

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cell D

cell C

cell B

cell A

2.47

100%

6.17 29.41 11.11

80%

56.25

40.00

5.88

60%

25.00

40%

18.75 47.06

20%

20.00

12.50 80.25

17.65

1980

1985

15.00

12.50

0% 1990

1995

Cell A: Firms with low diversity Cell B: Firms diversified into related business Cell C: Firms diversified into unrelated business Cell D: Firms with very high diversity Fig. 2. Diversification pattern of Type I firms (large).

cell D

100%

cell C

2.47

4.35

6.17

8.70

cell B

cell A

31.25

15.38

11.11

80%

26.09

60%

30.77

25.00

40%

12.50

20.51

31.25

33.33

20% 80.25

60.87

0% 1980

1985

1990

1995

Fig. 3. Diversification pattern of Type I firms (small).

hire and property development. The wide range of diversification differs from the scope of building firms observed in other countries (Ball, 1988; Casson, 1987; Grebler, 1973; Hasegawa & Shimizu Group, 1988). In the UK, for example, there was some diversification into other industries such as material production, the manufacture of temporary buildings and plant merchandising in the 1970s and 1980s (Hillebrandt & Cannon, 1990). However, the main activities to attract investment by UK building firms were generally buildingrelated,9 and their business was associated with backward integration. (Casson, 1987). Figs. 2–5 show the extent and pattern of Korean housebuilding firms’ diversification between 1980 and 1995. This classifies firms in cell A as those with very low diversity; in cell B are those which diversified into related business; in cell C are those which diversified into unrelated business and in cell D are those with very high diversity. The extent and pattern of diversification are found to differ according to the type and size of firms. Type I firms show a great degree of diversification. This is not surprising, because type I firms started their businesses in other fields, then later entered the housebuilding industry. Fig. 2 shows the changes of large, type I firms over time. The proportion in cell B increased greatly between 1980 and 1985, whereas the proportion in cells C and D increased significantly only after 1985. In general, the extent of diversification has slowed down since 1990, and it is important to stress that the proportion in cell D 9

Such as concrete fabrication and aggregates where there are liable to be economies of scale, general plant hire, piling, road surfacing, timber trading, builders’ materials, various forms of property development and managerial services.

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100%

0.00

cell C

cell B

283

cell A

0.00 24.14

12.00

19.51

42.50

80% 10.34

26.83

60% 17.24

27.50

40% 29.27

20.00

20%

88.00

48.28

24.39

10.00

0% 1980

1985

1990

1995

Fig. 4. Diversification pattern of Type II firms (large).

cell D 0.00

100%

cell C

0.00

3.57

12.00

3.57

cell B

cell A 4.88 12.82

80%

24.39 28.21

32.14

60% 21.95

20.51

40% 20% 88.00

60.71

38.46

48.78

0% 1980

1985

1990

1995

Fig. 5. Diversification pattern of Type II firms (small).

decreased after 1990. Fig. 3 shows the case of small, type I firms. These display a lower degree of diversification than the larger firms, though the patterns are similar. Figs. 4 and 5 show the cases of type II firms whose main business was originally housebuilding. For both large and small firms the extent of diversification steadily increased from 1985, showing that the proportion of cells B–D firms increased continuously after 1985. Small firms appear less diversified than large firms, but the diversification patterns are similar. However, it should be noted that in 1995 large firms of type II showed a higher level of diversification than those of type I. The four-cell diversification matrix clearly shows the changing pattern of diversification in Korean housebuilding firms. It shows that diversification continued to increase after 1985 during the high growth period and that type II firms, in particular, whose main business was originally housebuilding, steadily diversified into a range of other businesses even after 1990. This is quite different from the pattern observed in other countries where large housebuilding firms either tended to concentrate on housebuilding and diversify geographically, as in the UK, or were typically a subsidiary of multi-divisional construction enterprises, as in many other European countries (Ball, 2006). Motives for diversification Over the past 20 years, diversification has received a huge amount of scholarly attention. A solid body of theory has emerged to explain a firms’ behaviour and executives’ motives with respect to diversification (Ansoff, 1957, 1987). The basis for the theory is in the positive relationship of two key factors: heterogeneous large diversified firms and growth theory (Penrose, 1959). This section gives an overview of the major

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perspectives on the motives for diversification, followed by further investigation into the motives in the context of the housebuilding industry. Evidence from the literature A number of individual perspectives on the motives for diversification have been developed for different industries. The major view stresses market-power. According to this, firms tend to achieve a monopoly position through strong market power in order to gain more profit. Large diversified conglomerates may exercise power in several anti-competitive ways such as ‘cross-subsidisation’, ‘mutual forbearance’ and ‘reciprocal buying’ (Montgomery, 1994). This view emphasises a positive relationship between market share and firms’ market power. According to Martin (1993), if a conglomerate pursues profit maximisation by maintaining inter-dependency within the group in response to competitors, a structural relationship between market share and the firm’s market power would be formed. The importance of large diversified business groups, the so-called Chaebol, has been emphasised in accounts of the Korean economy. The economic development plan pursued by the Korean government in the 1960s gave preferential treatment to larger firms by channelling to them foreign and domestic loans with lower interest rates at a time of high inflation (Jeong & Masson, 1990). The 30 largest business groups accounted for 40% of the total output of the manufacturing sector in 1982 (Chang & Choi, 1988) and, in particular, the 10 largest business groups had diversified into finance, trade, construction and other non-manufacturing industries (Jeong & Masson, 1990). In this context, the diversification of the Korean housebuilding firms during the high growth period seems to have been not particularly industry-specific, but a growth strategy common to most industries in Korea. Some studies in Korea have proved that fast growing firms have the capacity to invest in both related businesses or new businesses. A clear positive relationship between the growth ratio of sales in an industry and entry into other industries was observed (Jun, 1996; Song, 1994). However, this view seems not entirely persuasive as a motive for diversification in the housebuilding industry. Considering the varieties of regulation on the housing supply side, such as land development regulation, restrictions on allocation of developable land, and sale price regulation, even large building firms would not have been able to build market power for higher profit by using the price mechanism or established negotiation skills in the market. The second main motive given for diversification is risk-pooling, based on the presumption that any firm or investor is risk-averse. Diversification is regarded as a portfolio decision which spreads resources or funds over a number of available businesses. Hills and Hansen (1991) found that the degree of risk was positively related to the level of diversification. If firms perceived high risk in their main business, they tended to diversify into other businesses in order to spread the total risk. This can also be explained as an agency theory, which states that managers pursue risk-averse strategies as a way of reducing a firm’s overall risk (Amihud & Lev, 1981; Jensen & Meckling, 1976; Shleifer & Vishny, 1989). These writers emphasise that acquisition of other firms may be carried out as a form of managerial prerequisite, intended to decrease risk associated with managerial human capital, and that their consequences may be regarded as an agency cost. Housebuilding may be considered a risky business; production and land purchase decisions have to be made on the basis of forecasts of highly uncertain prospects, and sometimes based on irrational price behaviour in the housing market (Ball, 2006). The M-form of larger construction conglomerates, observed from the 1950s to the 1990s in the UK housebuilding industry, is an example of firms achieving financial benefits by unrelated diversification. However, this is rarely the case now in the UK building industry and large UK housebuilders are pursuing risk-pooling strategies of geographical diversification by operating different housing markets (Ball, 2003). In the Korean context, house price control brought a very limited level of profit to developing building sites, and the restrictions on land development and the allocation method obviously created a degree of uncertainty; regulations therefore could be considered as a risk factor to the industry as a whole. According to this view, many building firms were able to diversify their operations so that they could survive the lottery-like allocation of developable land by generating money in other business area. Another comprehensive view is the resource view, which emphasises that breadth of diversification is a function of firms’ resource stocks. It suggests that if a firm has large resources, it tends to diversify in order to

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use these resources more efficiently. In other words, residual resources may be the rationale for diversification. Several studies (Caves, 1971; Gorecki, 1975; Teece, 1982) support this view with evidence that a firm’s resources have a positive relationship with the level of diversification. A study by Harvey (1985) on capital switching in the built environment also supports this view. It emphasises large capitalist firms’ active and efficient involvement in the transformation and construction of the built environment. The basic idea of the study is that those who have the professional and intellectual skills to shape space materially and effectively can acquire a certain power, and switch their specialised knowledge into profit. This resource view seems to be the most plausible in terms of the politico-economic context of Korea, where more institutional support was given to large-scale companies by government and it can be seen from the evidence in the previous section that large building firms consistently showed a higher degree of diversification. However, it must be emphasised that the three different views are not mutually exclusive, but rather complementary. All views aim at ‘further growth’ by achieving profit maximisation as a short-term goal. Evidence from interviews A series of in-depth interviews were carried out in 1997 in order to find what motivated Korean building firms to diversify, and the executive’s strategic rationale for diversification. The top 35 firms, based on size of annual turnover, were contacted with the support of the Korean Housebuilding Firms Association. However, only 24 firms were willing to participate in the interview process. The interviews used semi-structured questionnaires; the interviewees were either senior managers in charge of the housebuilding business or managing directors of the chosen firms. When the main reason for diversification was asked, the majority of interviewees (18 out of 24) stated instantly that it was government regulation. Another 3 interviewees gave a rather general reason—for further growth—and 2 more stated they could get cost efficiency from related diversification, especially material manufacturing. The first group particularly blamed land development regulation and the public allocation of developable land as a causal factor, creating business uncertainties which could grow into a significant risk to the whole business. Had a building firm not been chosen in the allocation process, regulation would actually mean a barrier to entry. For this group, diversification may be explained as a risk-pooling strategy in case the worst should happen: that is, in case they were never chosen by the lottery method during the housebuilding boom period. The last two groups responded with specific reasons for further growth, including efficient use of resources, and they also emphaised that unrelated business also had a synergy effect, diminishing the risks resulting from the regulations. Service businesses such as the hotel business and the restaurant business would be a good counter-cyclical to help them continue their operation and survive a housebuilding downturn. They expressed strong agreement with the first group about the negative effect of government regulations on the housebuilding industry. The building firms commonly argued that government involvement meant that they could not expect any profit at the land development stage. Profit from the housebuilding business could be obtained only from the construction process. However, the sale price ceiling regulation obviously affected their profitability. Accordingly the housebuilding firms were strongly against these regulations; they could not achieve an appropriate level of profits at either stage, i.e. neither in land development nor in actual construction. The Korean government countered these arguments, emphasising that they provided housebuilding firms a ‘business opportunity’ by providing land ready to be used. The government’s main argument was that the land development process is often more capital-intensive than actual housebuilding and carries potentially higher risks (Ball, 2003). Government also argued that building firms could save time at the stages of obtaining planning permission and assembling the building plots. However, this argument was obviously applicable only to those chosen to take part in building projects via the lottery method. Yet many housebuilding firms seemed not to think of diversification as a strategic issue, as observed in Casson’s study (1987) of UK construction firms’ diversification. The diversification in Korean building firms seems likely to have been a decision taken for survival. If the building firms operated in businesses other than

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housebuilding in these uncertain business circumstances, they would be likely to survive for some time, even when they did not earn adequate profits from housebuilding. In answer to a separate question, 13 out of the interviewed companies (24) said they were considering further diversification in the near future. It was hard to find out what the main motives for this diversification were. The interviews clearly indicated that the government regulation of the industry created a good deal of business uncertainty; building firms could not predict whether they would be chosen to take part in the housebuilding programme from year to year. These circumstances may have affected the changing pattern of diversification in the 1980s and 1990s. However, diversification was not a simple strategy which every building firm could undertake. Only those which had the capacity and resources for further investment would be able to implement such a decision. Following the Asian economic crisis that began in late 1997, housing supply actually dropped by about 50% compared to the previous 10 years and the housebuilding industry has undergone subsequent reform. The Asian shock is considered one of the most extreme events experienced by housebuilding firms. The majority of small firms were bankrupted. A follow-up survey undertaken in December 2005 with the help of the Korean Housebuilding Firms Association, revealed that among the type II firms in 1995 (total 64) classified as diversified firms (26), 25 survived the outbreak of economic crisis. Less diversified companies found it harder to survive. Only 29% of the less diversified firms (11 out of 38) were continuing to do business by 2003. It proved that large firms are more likely to survive sharp housing market downturns than smaller builders: they have the capabilities to understand and manage project information flows, uncertainties and risks; the management skills to tackle the risks; and sufficient capacity, especially financial assets, to see them through (Ball, 2006). It was also found that 80% (21 out of 26) of those classified as more diversified were listed among the 100 top housebuilders, and 35% (10 out of 26) were listed within the 50 top housebuilders in 2003. This follow-up analysis supports the original study results: diversification may be a survival strategy for building firms facing uncertainties as well as a growth strategy. Evidence from modelling Empirical modelling was undertaken in parallel with the interviews. It aimed to examine which factors were the most influential predictors of Korean building firms’ diversification. The three motives from the literature discussed above were considered for modelling. A logistic regression model, a form of regression used when the dependent variable has a nominal value and the independent variables are of any type, was designed.10 This model also estimates the probability of a certain event occurring, here taken to be the probability of becoming a diversified firm against being a less diversified firm (Field, 2000). Data sources and explanatory variables The same sample firms were used as for measuring the extent of diversification. The samples were divided into two categories; 1 ¼ diversified firms and 0 ¼ less diversified. Those defined as cell A and cell B firms in the four-cell matrix in Fig. 1 were classified as ‘less diversified firms’, whereas cell C firms and cell D firms were classed as ‘diversified firms’. For the estimation, only type II firms—those which were originally housebuilders—were included in the analysis, because the main aim of this study is to investigate the role of regulations on diversification out from housebuilding. Type I firms were excluded from the modelling, as these had already diversified into the housebuilding business. Table 2 summarises the three types of independent variable discussed in the literature, along with operational definitions and expected relations with the dependent variable (which is the diversified firm). As market power variables, market share in the housebuilding business (MHS) and growth ratio of sales 10

In its simplest form, the logistic regression model when there are several predictors, forms as below; P(Y) ¼ 1/(1+eZ) where Z ¼ b0+b1X1+b2X2+?+bnXn+ei P(Y) is the probability of Y occurring, e is the base of natural logarithms, and the other coefficients form a linear combination much the same as in simple regression. Z is identical to the linear regression equation in that there is a constant (b0), a predictor variable (X1) and a coefficient attached to that predictor (b1).

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Table 2 Operational definition of variables Variables

Definition of variables

Independent variable DV

1:Diversified firms 0: less diversified

Risk pooling variables DEBT PROF FC Market power variables MSH GROWTH Resource variables LTASSETa LEMPLOYa CASS FASS LPEYEARa a

Operational definition

Expected relations

Debt ratio Profitability ratio Financial cost to total assets

Total debt/capital  100 Ordinary profit/total assets  100 Total financial cost divided by total debts (financial cost per debt)

+  +

Market share in housebuilding

The ratio of each firm’s housebuilding business sales to total housebuilding sales (sales/sales in prior year1)  100

+

Growth ratio of sales Total assets Number of employees Ratio of current assets to total assets Ratio of fixed assets to total assets Years in housebuilding business

Total assets Total number of employees Current assets divided by total assets Physical fixed assets divided by total assets Total number of years in housebuilding business

+ + + + + +

Used as log form.

(GROWTH) were used. It was assumed that firms having a high market share and a high growth ratio of sales in the housebuilding industry tended to diversify into other businesses in order to achieve market power in the industry. There were very limited choices of risk variables from available public data. Debt ratio (DEBT) and financial cost (FC) were used. A high debt ratio may be a business index, indicating the insecurity of a business. Financial cost means the cost of using funds from any external capital market. Korean housebuilding firms tended to have high dependency on external funding (institutional or non-institutional), which accrues high financial costs. A firm’s high financial costs imply possible financial difficulty for the firm and a firm might diversify to spread the risks. Profitability in the housebuilding business (PROF) was chosen, assuming that if a firm had a low profitability, it might try to diversify into other businesses to compensate for those low profits. It was expected that the profitability variable would show a negative relation to a firm’s diversification. It has to be noted that profitability might alternatively be used as a market power variable. High profit in the housebuilding business could be a good reason for seeking market power in the industry. Resources were widely defined, including factors a firm has purchased in the market; services the firms created from those factors; and specialist knowledge the firm accumulated through time. As resource variables, total assets (ASSET) and number of employees (EMPLOY) were used. ‘Flexibility of resources’ was also used in the model, including the key indicators of ratio of current assets to total assets (CASS) and ratio of fixed assets to total assets (FASS) as Chatterjee and Wernerfelt (1991) suggest. Also the total number of years in the housebuilding business (PEYEAR) was used as an asset which the firm accumulated over time. The ten variables in Table 2 were expected to be positively related to a firm’s diversification, except among the risk variables profitability variable (PROF). The model was estimated using data from 1995, when the extent of diversification was its highest. As the model was designed to investigate the motives for diversification, not its consequences, time lags for the independent variables were used in the estimation process. This was based on results from the interviews, showing diversification was normally achieved between 3 and 5 years after the firms began to consider the idea. All independent variables were used as average values for the previous three years (1992, 1993 and 1994). The financial data required in the analysis was obtained

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from the sample firms’ Annual Reports published by the Korean Stock Exchange. All variables were discounted with a GNP deflator index based on 1995, in order to reflect price changes during the analysis period. The binary logistic regression model was estimated by the SPSS statistical package. Estimation results Table 3 shows the results of the diversification model—how the diversified firms differed from those less diversified. The success of the logistic regression can be assessed by looking at best-fit measures, such as the model chi-square as an indicator of model appropriateness and the Wald statistic to test the significance of individual independent variables. Model chi-square appears significant at the 1% significance level and the explanation power of the model is 0.31, reasonably high in empirical model estimates in social science. The odds ratios shown in Table 3 imply the odds of being in the highest-coded case of the dependent variable (here, being diversified) when the independent variable increases by one unit. Total asset (LTASSET), and business period (LPEYEAR) among resource variables are significant as motives for diversification. This means that as the total asset increases by one unit, the odds of being a diversified firm are multiplied by 7.12 and as the lifetime of a firm increases by one unit, the odds of being diversified increase 3.03 times. The market power variable (GROWTH) also appears significant, but only at 10% significance level. The odds ratio is 1.3, which means that as the growth ratio of sales increases by one unit, the likelihood of diversification increases about 1.3 times. No variable among the risk avoidance variables appears influential in the model. Profitability in housebuilding (PROF), however, appears as negative to diversification, as was expected, but is still not significant. Having considered the significance levels and the size of odds ratios, the resource motive appears to be the most influential factor in explaining the diversification of Korean housebuilding firms. It means that if a firm has large resources, it is more likely to diversify into other businesses in order to use its resources more efficiently in the market or in another market. Moreover, if a firm has been in the housebuilding business for a long time, it might be more likely to extend its business into other related businesses. However, it is important to be cautious in using these results, as the variables used in the empirical modelling were limited to only those publicly available. A more detailed modelling, given further data availability, would be beneficial for more sophisticated analysis.

Table 3 Modelling of motives of diversification: 1995 B

S.E.

Wald

Odds ratio

Constant Risk avoidance variables DEBTR PROF FC

3.49

4.23

0.68

0.03

0.02 5.16 0.01

0.02 6.25 0.10

1.54 0.68 0.03

0.97 0.06 1.02

Market power variables MSH GROWTH

0.15 0.17*

1.06 0.03

0.02 2.44

1.17 1.30

Resource variables LTASSET LEMPLOY CASS FASS LPEYEAR

2.66** 1.06 0.03 0.02 1.96**

1.04 1.65 0.02 0.10 1.22

3.49 0.42 0.65 0.03 2.58

7.12 2.91 1.02 1.02 3.03

2 log likelihood Model chi-square R2

123.19 35.49*** 0.31

*po0.10, **po0.05, ***po0.01.

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Analysis and conclusions This study clearly indicates that Korean building firms actively diversified both into related and unrelated businesses in the 1980s and 1990s. Above all, the diversification of type II firms (those who were originally housebuilders) has increased rapidly since 1990. This means that Korean housebuilding firms diversified into other businesses in line with rapid growth in their core business. This is a different motive to that observed in other modern housebuilding industries where housebuilding firms are traditionally specialised, and tend to widen their business scope geographically, especially for risk-pooling benefits. The results of the interviews indicate that government regulations in the housebuilding industry had generated a good degree of uncertainty. Land development regulation and the public allocation of developable land during the study period clearly gave building firms a sense of deprivation of profits, as larger profits are usually expected from land development than from a building site because of higher risks in the land market (Ball, 2003). There are unavoidable sunk costs and transaction costs, such as monitoring and searching costs in the initial stages of diversification. However, if the risk perceived from uncertain circumstances was higher than the additional investment costs, the diversification decision would be a reasonable strategy, among others. Uncertain circumstances may lead building firms to pursue flexibility rather than efficiency. The empirical evidence shows the level of diversification increased, in particular, during 1988–1992, when government regulations were very strict. It may be said that regulation facilitated the diversification of Korean housebuilding firms. The logistic regression model was rather less supportive of the risk variables, showing debt ratio (DEBTR) and financial costs (FC), defined as uncertainty measures, to be insignificant. The model gave more support to the resource motive, and the market power explanation to a lesser extent. A firm’s assets and lifetime variables were found to be the most influential factors in their diversification. This means that those which had enough resources, manpower, and which retained specialist knowledge from long business experience were most able to diversify into other businesses. Their resources might have been the rationale for their diversification. It may be concluded that the regulatory circumstances in the 1980s and 1990s might have encouraged building firms to rethink their current business strategy and to seek the possibility of other business, as the interviews indicated. It suffices to say that pervasive regulations on the supply side made housebuilding firms respond to the changing environment. The diversification pattern observed in the high growth period proved to be one example of this. However, not every building firm could implement the decision to diversify. Only those which had the capacity to invest their resources in other businesses were capable of diversifying into other businesses (as the logistic regression model indicates). Government regulations, in particular the government intervention in the land development and allocation processes, are claimed to have affected the governance structure of the industry. The houebuilding firms played the role of building contractor rather than of developer, with the function of traditional land development taken over by the government. It was also found from the interviews that building firms tended to diversify into cash-rich businesses and counter-cyclical businesses, as those businesses would help them to continue operating during housebuilding downturns and be able to compensate for business loss from core activities. It may be concluded that the diversification of Korean housebuilding firms was a short-term survival strategy under a highly regulated environment rather than a long-term growth plan. This study has shown how Korean building firms responded to the government’s regulatory environment during the high growth period between the mid-1980s and mid-1990s, focusing on their diversification. Further study on the Korean housebuilding industry following the Asian financial crisis would be beneficial for understanding how diversification levels have been affected by these new circumstances. References Ansoff, H. I. (1957). Strategies for diversification. Harvard Business Review, 35(5), 113–124. Ansoff, H. I. (1987). Corporate strategy. London: Penguin. Amihud, Y., & Lev, B. (1981). Risk reduction as a managerial motive for conglomerate mergers. Bell Journal of Economics, 12(2), 605–617. Ball, M. (1983). Housing policy and economic power: The political economy of owner occupation. London: Methuen.

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