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The purpose of this paper is to investigate how Korean conglomerates (chaebol) have rapidly ascended to international prominence. The success of Korean chaebol firms seems to be associated with internal market transactions. Just as Japanese keiretsu firms succeeded by utilizing a bank‐centred financing system, Korean chaebol firms devised an internal financing system such as payment guarantees and collateral provisions in a restrictive regulatory environment.

This study examines the effects of such internal market transactions on the technical efficiency of chaebol firms using a stochastic frontier function for a panel data set of 1,675 firms from 1992 to 1998.

The study has found that chaebol firms have achieved a net gain in technical efficiency by utilizing internal market transactions as a way of mitigating liquidity constraints. Thus, the chaebol's role as an internal capital provider has given Korean conglomerates a competitive advantage in product pricing and capital financing, which is the main source of the success of Korean chaebol firms.

What is new in the paper is that the positive effects of the Korean chaebol on the Korean economy have outweighed the negative effects of the chaebol. The paper has provided empirical evidence that the chaebol played a major role in transforming the Korean economy from an agricultural economy to an IT‐led economy. The main value of the paper may be found in its attempt to analyze the technical efficiency of Korean large business groups using a stochastic frontier production approach. The paper will appeal to readers who are interested in the driving forces of rapid economic growth in a developing economy.