Impact of Business Portfolio Diversification on Construction Company Insolvency in Korea

Abstract

This study aims to conduct an empirical analysis of the impact of diversification on construction company insolvency through a vector error correction model (VECM). The study focuses on a series of structural changes in the Korean construction industry as well as on the fluctuation process of construction business portfolios. This study calculated the diversification index to subrogate diversification level and used it as an analytical variable. The gross domestic product (GDP), Korea Composite Stock Price Index (KOSPI), construction investment, and interest rate are used as analytical variables representing macroeconomic variables. Finally, the expected default frequency (EDF) is calculated to indicate the level of construction company insolvency and used as its proxy variable. The analysis results differed from what was previously understood about Korea. EDF fluctuation was in a positive direction owing to the impact of diversification and had a response of approximately 0.032% in Q10. Moreover, the EDF fluctuation relative to the impact of construction investment amount was also in a positive direction and had a response of approximately 0.02% in Q10. Normally, higher diversification results in a greater increase in firm value, and a better construction economy results in enhanced firm management. However, the results showed otherwise. This difference is apparently attributable to limited diversification in terms of the types of projects and project lifecycle in the Korean construction industry. To effectively generate diversification strategies under these conditions, Korean construction firms should focus on diversification in terms of project lifecycle, specifically seeking higher value project development, engineering, and consulting work in the short term, or seeking to enter the asset management field to pursue long-term operating profits. Moreover, these firms can enhance technical skills and business abilities in the civil engineering and plant fields for diversification in terms of the types of projects in the long term.