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BOK Working Paper No.2016-20, Development of Corporate Vulnerability Index and a Connection with Corporate Insolvency

Economic Research Institute (+82-2-759-5366) 2016.12.25 3792

Title : Development of Corporate Vulnerability Index and a Connection with Corporate Insolvency
Authors : Young Jun Choi(BOK)




It has been usually taken into account that higher debts of a company tend to increase the risk of insolvency. In the case of Korea, the debt to equity ratio seems to have been stable after the Asian financial crisis thanks to the regulatory effort of reducing companies’ debt to equity ratio below 200%. By the way, unlike the debt to equity ratio, corporate default theories implicate that many Korean companies are highly likely to face default conditions, and the number of companies undergoing restructuring is growing much fast lately.
Based on such motivation, this paper develops a new corporate vulnerability index including several debt-related ratios and helping to capture corporate risks, and analyzes the effect of the vulnerability index on corporate insolvency. The index is calculated for the whole, marginal, chronic marginal, and default-risk companies by applying both principal component analysis and dynamic factor analysis with indicators from IMF’s CVU(Corporate Vulnerability Utility). The result shows that the vulnerability index for chronic marginal companies corresponds to the bankruptcy rate on promissory notes which represents the level of coporate insolvency, and recently the index is in a rising trend.

According to the estimation of the effect of chronic marginal companies’ vulnerability index on corporate insolvency of regular companies through the panel logit model, the probability of turing into marginal or default-risk companies from regular companies increases as the vulnerability index increases.

The implications of the results are as follows. First, swift and steady restructuring needs to be executed for stable real economy. Next, the development of comprehensive indicators by which to detect risk signs, like the corporate vulnerability index in this paper, is required to use them as sub-indicators to assess financial stability.

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