The Effect of Asset Revaluation on the Cost of Debt: Evidence from Korea

During the 2007-2010 financial crisis, the Korean government allowed asset revaluation, which was to be introduced with the adoption of the IFRS, earlier than scheduled, in an attempt to strengthen firms’ financial position. As a result of this allowance, many firms introduced asset revaluation which increased the size of assets and stockholders’ equity. This paper studies whether asset revaluation during that period had an impact on firms’ cost of debt. More specifically, using the firm-years listed on the Korea Exchange during the recent financial crisis, we examine the changes in the cost of debt as proxied by credit ratings and bond spreads. We find that, on average, asset revaluation has no effect on the cost of debt. The positive effect of asset revaluation is limited to credit rating for highly-leveraged firms. Our findings suggest that bond rating agencies are sensitive to the likelihood of a debt covenant violation while bond market investors do not interpret asset revaluation as a fundamental improvement of the firm’s financial condition. Our results imply that asset revaluation can be marginally effective in mitigating the effects of the financial crisis.