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Corporate Governance in Korea

Executive SummaryKorea has made rapid and significant progress in corporate governance since its economic

crisis in the late 1990s. While this progress is set to be maintained, however, further

improvements are still needed. The Korean government has placed strong emphasis on raising

standards of corporate governance. This is complemented by recent improvements in the legal

and institutional framework in Korea, active discussion by (and pressure from) civic groups,

and significant efforts by leading companies to improve their governance systems.

Furthermore, the inauguration of the h ighly reform-oriented Roh Moo -hyun administration isexpected to add momentum for continuing improvements.

Nevertheless, corporate governance in Korea remains based on the combined “owner-

manager” principle, and the functioning of governance systems and regulation is still not

effective. Disagreement over the appropriateness of specific governan ce reform proposals

amongst the corporate sector, led by the chaebols, on one side, and civic groups along with

government on the other side, has also slowed the pace of change. Even individual companies

that have independently streamlined their governance systems and policies still need to make

significant improvement in specific practical areas.

On the positive side, access by enterprises to capital markets is good, as the restructuring of the

banking industry has been implemented successfully even du ring Korea’s fast econom icrecovery since its foreign exchan ge crisis. At the same time, the opacity of corpo rate o wnership

structures and the attitudes of controlling shareholders are key areas that need attention.

Efforts by the government, based on recommendations made by international organizations

including the IMF, have enabled regulations and systems related to corporate governance to be

brought close to international standards. Although regulatory agencies are undergoing

integration, overlapping jurisdictions and resulting inefficiencies remain. The information

infrastructure in Korea is reasonably developed, with accounting and auditing standards close

to international standards, backed by relatively wide disclosure and satisfactory access.

The financial crisis tha t hit Asia in th e late 1990 s uncovered serious deficiencies in the Korean

economy. These included: inappropriate supervision of the government-led financial system;

indiscreet, “fleet”-type management by Korea’s chaebol; and improper management decisions

made by controlling shareholders. While progress has been made, Korea has failed to fully

Analyst:

Calvin R Wong, Hong Kong

(852) 2533-3501

For important information

on Corporate GovernanceScores, please see the last

page of this report.

July 3, 2003

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Standard & Poor’s • Corpora te Governance Score 2

implement principles of market competition during the process of economic liberalization, and

has failed to create a fully transparent economic environment.

Continued efforts by market participants to seek legal and institutional reforms and improve

efficiency following the economic crisis have helped Korea to record economic recovery at a

rate faster than any other Asian country in the aftermath of the crisis. In corporate governance,

significant improvement has been made during a relatively short period. However, the speed of

fundamental change in corporate ownership structures remains slow and the lack of a stronggovernance culture points to weakness of governance standards at individual enterprises.

Success in Korea’s implementat ion of stronger corpo rate governance practices will depend on

the degree to which structural reform of the corporate sector, including the chaebol, will

succeed in the future.

Current Corporate Governance IssuesFollowing the 1997-98 financial crisis, Korean corporate governance has improved

systematically. Nevertheless, systematic changes are not enough to ensure fundamental changes

in corporate culture, business ethics, and among interest groups involved in policy making.

Discussion on potential improvements in corporate governance practice is continuing while

interest groups argue for their own agendas.

Reform of the chaebol is challenging the effort to improve corporate governance in Korea

while the cou ntry is struggling to r esolve the following key issues:

• Class action suits;

• Ceilings on conglomerates’ equity investments;

• Corporate governance in public companies; and

• Strengthening the rights of shareholders and directors or external directors.

Class action suits.

With a draft bill pending in the Korean legislature, the debate between the government (as well

as) civil bodies and the business sector is still under way. The former gro up claims the

introduction of class action suits would boost the rights of minority shareholders and

transparency in the management of companies. In turn, the business sector argues that theimplementation of such a legal system is premature in Korea and could impede corporate

restructuring.

Ceiling on large corporations’ equity investments.

Under the Mon opoly Regulation and Fair Trade Act, large corporations are allowed to ow n up

to 25% equity in their subsidiaries. However, the effect of the ceiling is questioned because of

various exceptions allowing business groups to exceed the ceiling. One interest group is calling

for an overhau l in the relevant laws and r egulations while the business sector insists the ceiling

is undermining the growth potential of large corporations.

Corporate governance in public companies.

The government is reviewing the possibility of promoting privatized public companies to

impose corporate governance as efficiently as in the private sector. The government is

considering the use of stakes in companies owned by the government, banks or other

institutional investors, including pension funds and other funds, to improve corporate

governance in public companies.

Strengthening rights of shareholders and directors or external directors.

Issues on expanding directors’ authority, specifying directors’ commitm ents required to fulfill

their duty to shareholders, and defining external directors’ limited responsibility are being

discussed. Furthermore, the approval of shareholders for new share issues, transactions with

related parties, and the ban on excluding application of the articles of incorporation for

cumulative voting are being considered.

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July 3, 2003 • www.standardandpoors.com 3

Market infrastructureKorea’s political environment is characterized by the high geopolitical threat from the North

Korean regime, a rapidly developing system of democracy, a government which exerts a

significant amount of influence over the country’s economic activities, and a lack of autonomy

in the private sector as a result of such government influence.

Tensions between South and North Korea remain high, despite the “Sunshine Policy” pursuedby the former President Kim Dae-Jung. A series of actions taken by North Korea has

heightened fears of a conflict on the Korean peninsula. Although the possibility of a war

between South and North Korea is considered low, the North’s closed political system makes

its future response unpredictable.

Korean enterprises in general follow a typical ownership and control form where the founders

and their successors and other interested parties manage businesses as majority shareholders.

This type of structure has the benefit of enabling quick and unified decision-making. At the

same time, the structure does not protect the interests of minority shareholders, and hinders

approp riate monitoring and control of ma nagement. It also creates problems relating to

management succession an d the role of family members versus professional man agers.

Macroeconomic stability.Korea’s foreign currency sovereign credit rating has returned to the level recorded prior to the

economic crisis of 1997, an indication of the extent of its economic recovery. Standard &

Poor’s foreign currency rating is ‘A-’, with a stable outlook. The upward trend in the credit

rat ing reflects Korea’s ability to effectively deal with external shocks, its more flexible labor

market, stronger financial liquidity, and restructuring initiated by the Korean government.

Nevertheless, there are several factors constraining further improvement in Korea’s ratings,

including the unfinished restructuring in the private sector and the military threat from North

Korea.

Korea’s remarkable growth has been quoted as a model case for developing countries.

However, the 1997 economic crisis disclosed structural weaknesses, particularly the need for

greater liberalization to support a growth -centered p olicy, and the importan ce of adoptingprinciples of market competition and creating a transparent economic environment.

Ownership structure.

The level of corporate ow nership, standing at more th an 93 % by the private sector as of 2001,

indicates that Korean enterprises are privately owned in general.

Following the election of Roh Moo-hyun, the basic policy on the privatization of major public

enterprises is expected to be maintained. However, the new administration will reexamine

these policies for sectors of major public interest, such as transport and power.

Ownership structures of Korean enterprises are based on the conglomerates known as chaebol.

As of January 2003, there were 43 business groups and 728 subsidiaries subject to restrictions

on mutual contributions. The relative importance to, and influence of these enterprises on, the

Korean economy is absolute.

Korean enterprises in general are governed by a controlling shareholder and manager system

under which controlling shareholders and managers act as owner and representative based on

a high internal equity ratio resulting from mutual investment. In other words, the controlling

shareholders exclusively control enterprises as managers, with ownership and control not

separated. Table 1 shows that ownership concentration of leading chaebol (controlling

shareholders and their affiliates) has diminished somewhat from 1999-2001. But ownership

concentration remains substantial at 45% .

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Standard & Poor’s • Corporate Governance Sc ore 6

directors provided that certain stock-listed corporations (with total assets greater than W2

trillion) or KOSDAQ-registered corporation s as prescribed by Presidential Decree shall have

not less than three non-executive directors. But it shall make the number of non-executive

directors not less than half the total number of directors. Regulations are also available for the

nominating committee to review non-executive director candidates.

Regulations on qualification of non-executive directors. The Securities and Exchange Law does not prescribe detailed qualification requirements fornon-executive directors, bu t prescribes only passive limitations creating criteria, wh ich prevents

certain people from becoming non-executive directors. The provisions related to the

disqualifications o f non-executive directors, as stipulated in the Securities and Exchan ge Act,

are outlined in considerable detail. The Korea Listed Companies Association established

“service standards for non-executive directors” in November 2000. This standard, established

on the premise that improved corporate governance strengthens corporate competitiveness and

maximizes corporate value, contains comprehensive guidelines regarding the function and legal

status of non-executive directors, basic authorities and duties, and remuneration.

However, due to the fact that the will of the management is strongly reflected in the

nomination and appointment of non-executive directors, there is a limit on the extent to which

many non-executive directors are truly independent of company management.

Audit committee regulations.

The Commercial Code contains relatively detailed provisions governing auditors and the audit

committee. The composition of the audit committee shall consist of at least three directors.

According to the provisions of the Code, the directors engaged in the company business shall

not exceed one-third of the total members of the committee. To guarantee the independent

operation of th e audit committee, the Code also prescribes that the chairman of the audit

committee of securities companies must be a non-executive director (Paragraph 2, Article 54-6,

Securities and Excha nge Law).

2. Shareholders’ meetings.

Notice of shareholders meeting.

Shareholders must be notified, in writing or by electronic documents, of any general meetingsat least two weeks prior to such meeting.

Proxy rights.

Shareholder may have proxies to exercise the voting rights on their behalf. In this case, the

proxy shall submit a document proving power of representation at the general meeting.

Voting procedures.

There are no specific provisions within the Commercial Code regarding voting procedures and

third party verification of voting results. In general, a system where motions are passed when

no objections are heard is used to decide most agenda items at shareholder meetings.

3. Minority shareholder rights.

Regulations on minority shareholders’ rights can be considered to have made significantprogress during the past few years in that the minimum shareholding requirements for

exercising important rights have been significantly lowered. The legally guaranteed major

rights of minority shareholders are as in Table 2.

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(FSS) as its executive body. Mon etary po licy is the responsibility of the M onetar y Board of the

Bank of Korea.

MOFE has the authority to set the principles and the basic directions of economic policy. The

main d uties of the Financial Supervisory Commission include the generation of policies for

financial industry supervision, oversight o f the FSS, and the development of guidelines for

financial sector restructurings. The main purpose of the Securities and Futures Commission is

to perform duties mandated by the FSC such as investigation into unfair trade in the securitiesand futures markets, business related to corpor ate accounting standards and audits, and t he

management and supervision of the securities futures markets.

The FSS was established by the FSC and t he Securities and Futu res Commission to regulate

financial institutions and their functions, inspect the institutions’ financial status, and to order

corrective measures as required.

The MOFE, the Bank of Korea, and the FSC carry rights to mutually request the submission of

related materials. Business cooperation between the regulatory bodies seems to be smooth.

However, because some business areas overlap, the efficiency of the overall regulatory bodies

still needs to b e improved.

Self-regulatory bodies.The self-regulatory bod ies include t he Korea Stock Exchange (KSE), the Korea Securities

Dealers Association, which supervises the KOSDAQ market, and the Korea Listed Companies

Association.

The Korea Securities Dealers Association established the KOSDAQ Market. The purpose is to

perform duties related to market operations, including listed company disclosure, the execution

of transactions, and market actions such as the suspension of trading.

The KSE was established to form fair p rices for securities and to prot ect investors. It d iscloses

corporate information, monitors unfair transactions, and examines trading. In case the KSE

discovers an unfair act through its own monitoring system, KSE is obliged to report to the

Financial Supervisory Commission, which has right to take punitive actions.

The Korea Listed Companies Association is a nonprofit corporation established under the

Securities and Exchange Law to handle matters related to securities. Its main duties include

recommending improvement to the system related to securities firms, listed companies, and

training. In addition, for use as a reference by listed companies seeking to appoint non-

executive directors, it distributes a list of persons registered in the manpower bank and

recommends candidates for non-executive directors. The Korea Corporate Governance Service

(KCGS) has also been established and supported by the KSE to provide analytical services to

enhance corporate governance awareness among listed Korean companies.

Enforcement of the law.

The FSS’ investigative function is limited, because direct investigative rights with respect to

financial institutions are maintained by the Securities and Futures Commission operating underthe control of the FSC. However, actual investigative rights may be exercised through business

association with the Securities and Futures Commission.

The punitive measures that may be taken by the FSS include the cancellation of business

licenses or registration for certain institutions, suspension of all or part of a business, closure of

business, suspension of part or all of branch business, and the issuance of warnings. Judicial

action may be ta ken by indicting related persons to face prosecution. During 2000 and 2001,

there were only two cases of partial business suspension, four cases of reprimand and/or

institutional warning, and nine cases of other punitive actions taken by the Financial

Supervisory Services. This indicates the relatively minimal level of its practical enforcement

activities.

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In case a violation is discovered during the process of examining trading or of monitoring

members, the KSE may directly punish, or otherwise take other appropriate measures against,

relevant members or related persons, pursuant to the KSE’ Articles of Incorporation and

service regulations. However, the punishment shall be limited to suspension of trading for a

specific period, imposing fines in an amount not exceeding W1 billion or instructing violators

to b e more careful in future. In general, KSE report s such cases to the Financial Supervisory

Services instead of tak ing its own investigation and pu nitive actions.

Informational Infrastructure

The Financial Supervisory Commission has the final authority in setting, amending, and

interpreting the Korean Accounting Standards (KAS) and the Korean Standards on Auditing.

In 1998, the Financial Supervisory Commission introduced major amendments to the then

Korean Financial Accounting Standards and an old version of the Korean Standards on

Auditing, in an effort to make them compatible with international standard s. At the time,

those amendments were issued based on International Accounting Standards (IAS).

Meanwhile, the Financial Supervisory Commission revised Korea Sub-Standards on Auditing,

supplemental schedules of the Korean Standards on Auditing, in 1999 by adopting

International Standard s on Auditing.

Korean accounting standards.

The KAS consist of 91 articles and is supported by supplementary rulings. The Korea

Accounting Institute (KAI) has issued 10 stat ements of KAS based on IAS and has prepared

more than 20 d raft standards and exposure drafts.

In the process of formulating Korean accounting standards, KAI, once it decides IAS inputs are

not sufficient for use in Korea, refers to accounting standard s generally accepted in th e U.S.

When the business environment in Korea precludes the application of both standards, KAI

comes up with exclusively independent standards.

Korean standards on auditing.

The Korean Institute of Certified Public Accountants (KICPA) has set Korean Standards on

Auditing, described through 35 articles and Korean Sub-Standards on Auditing, which it

believes are consistent with the International Standards on Auditing.

Public auditors and requirements for independent audits.

A total of 6,439 CPAs were registered with KICPA as of December 2002. Among them, 4,954

members were working as auditors.

Four international accounting firms and six other local firms, which are member firms of the

world’s largest accounting firms, make up the mainstream accounting firms in Korea. In total,

there are 57 accounting companies, nine of which ha ve more than 100 CPAs, and 3,375 CPAs

are working at all accounting firms combined. Remaining members of KICPA are working in

private practices.

The External Audit Act requires financial statements of resident companies to be audited if

their total assets reached a minimum of W7 billion in the immediate preceding fiscal year. The

financial audit is to be conducted by a qualified CPA or audit teams of accounting firms.

Auditors in turn are responsible for submitting the audit report to their client company, the

Securities and Futures Commission and KICPA within the deadline.

Comparison with international accounting standards.

Consolidated accounts.

KAS are generally deemed to comply with IAS. For instance, both account ing rules specify the

same kind of financial information for disclosure requirements. But the former demands

individual financial statements for key financial data while the latter requires consolidated

financial statements. KAS does not have a clause regarding joint venture accounting.

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Operating data in addition to financial data.

KAS does not specify that the disclosure of financial statements should be accompanied by

operating information of the company. However, the disclosure of operating data is essential

for a company to go public, although it is not required under KAS.

Segment data.

Standards for the definition of operating segments and reporting requirements set out in

Korean Accounting Standard s Interpretation 50-87 are consistent with International

Accounting Standards. But the requirements for reportable segments differ, making a

distinction that KAS does not impose the equity method of accounting for a reportable

segment on which the company’s investment is concentrated.

Method of asset valuation.

Aside from the circumstances under which revaluation of assets is allowed, the way changes in

depreciation methods are interpreted and the level of disclosure necessary for related party

transactions, there is no significant difference in the way Korean accounting standards and

international accounting standards t reat revaluation of assets.

KAS complies with IAS in many ot her aspects: definition of incom e, expense, profit/loss, cash

flow statement, and all real and contingent liabilities. As for the accounting for related party

transactions, KAS is more detailed by pr oviding examples and sets forth different d isclosurerequirements from IAS in t erms of coverage.

Required timing of disclosure.

All residents companies are required to file financial statements with the Securities and Futures

Commission to comply with the Commercial Code and publish their balance sheets in a major

newspaper under the External Audit Act. Financial statements include a balance sheet, income

statement, cash flow statement, and statement of appro priations of retained earnings approved

in the general meeting of shareholders.

All compa nies with stocks listed on either KSE or KO SDAQ under the Securities and Excha nge

Law are required to disclose audited financial reports on a quarterly basis.

Under th e Securities and Exchange Law, listed companies shall meet the periodic disclosure

requirements by filing their audit reports and financial reports. In addition, these companies

are also subject to prompt reporting of any material events that may affect investors’ decisions

in making their investment.

A regulatory system for fair disclosure was implemented in November 2002.

Ease of access to financial statements.

All companies are required to keep their audited financial statements as well as the audit report

and make them available for their shareholders and creditors, if any of them seek access to the

financial information during normal business hours.

The Financial Supervisory Service offers financial statements and au dit reports of comp aniessubject to the External Audit Act through its web site (dart.fss.or.kr). Other financial activities

of these companies, such as buy-back or d isposal of shares, M& A plans and purchase of new

businesses are also posted.

(This report was prepared w ith contributions from National Information & Credit Evaluation

(NICE) of Korea.)

References

An, Ye-Hon g, “Cur rent Corp orate Governance and Directions for Its Improvement”, Th e

Bank of Korea Financial System Review (August 19 99)

Cho, Jang-yeon, Byung-min Kang, and Kyung-soon Kim, Position Report on Korean

Accounting Standards (6th September 2002)

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Jang, Ha-sung, “Th e Korea Discount and Corpora te Governance” (November 2001)

Kim, Kak-jung, “ Evaluation of Recommendations for Corpor ate Go vernance Improvement”

(October 2000)

Kim, Yong, “A Study on Corporate Governance Since the 1997 Economic Crisis” (February

2002)

Kim, Yong-youl, “Corporate Governance Features Necessary for Developing an Advanced

Economy” (July 2000)

Lee, Sun, “ Present and Future Corporat e Governance in Korea” (March 2000 )

Lee, Young-Kee, “ Korean Corpo rate Go vernance in an Era of Global Competition” (April

1999)

OECD, “ OECD Corp orate Governance Guidelines” (1999)

Park, Se-Hyun, “A Study on Corporate Governance in Korea: Problems and Improvements”

(August 2002)

Seo, Jung-hwan, “Chaebol Ownership and Corporate Governance: Structures, Changes and

Implications” (March 20 02)

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Corporate Governance Score (‘CGS’) reflects Standard & Poor’s assessment of a company’s corporate

governance practices and policies and the extent to which these serve the interests of the company’s

financial stakeholders, wi th an emphasis on shareholders’ interests. These governance practi ces and policies are

measured against Standard & Poor’s corporate governance scoring methodology, which is based on a synthesis

of i nternational codes, governance best pract ices and guidelines of good governance practice.

Companies with the same score have, in the opinion of Standard & Poor’s, similar company specific governanceprocesses and practices overall, irrespective of the country of domicile. The scores do not address specific legal,

regulatory and market environments, and the extent t o whi ch these support or hinder governance at the company

level, a factor which may affect the overall assessment of the governance risks associated with an individual

company (see below ‘Country Factors’).

GovernanceWatchA ‘GovernanceWatch’ designation may be used to highlight the fact that identifiable governance events and

short-term t rends have caused a CGS to be placed on review . GovernanceWatch does not mean that a change to

the CGS is inevitable. GovernanceWatch is not intended to include all CGSs under review, and changes to the

CGS may occur without the CGS having first appeared on GovernanceWatch.

Country FactorsAlthough Standard & Poor’s publishes country governance analyses from time to time, it is important to note that

Standard & Poor’s does not currently score individual countries. However, consideration of a country’s legal,

regulatory and market environment is an important element in the overall analysis of the risks associated with

the governance practices of an individual company. For example two companies wit h the same Company Scores,but domiciled in countries with contrasting legal, regulatory and market standards, present different risk profiles

should their governance practices deteriorate i.e. in the event of deteriorati on in a specific company’s governance

standards, investors and stakeholders are likely to receive better protection in a country with stronger and better

enforced laws and regulations. However, in Standard & Poor’s opinion, companies with high corporate governance

scores have less governance related risk than companies with low scores, irrespective of the country of domicile.

For a full explanation of Standard & Poor’s crit eria for measuring corporate governance standards, please refer

to the latest edition of “ Corporate Governance— Criteria & Methodology ” .

Corporate Governance Scores

Published by Standar d & Poor’s, a Division of Th e McGraw -Hill Compan ies, Inc. Executive offices: 1221 Avenue of the Americas, New

York, NY 100 20. Editorial offices: 55 Water Street, New York, NY 1004 1. Subscriber services: (1) 212-438-72 80. Copyright 2002 b y The

McGraw -Hill Companies, Inc. Reproduction in wh ole or in part proh ibited except by permission. All rights reserved. Informat ion has been

obtained by Standar d & Poor’s from sources believed to be reliable. However, because of the possibility of human or mechanical error b y our

sources, Standa rd & Poor’s or others, Standard & Poor’s does not guarantee the accuracy, adequacy, or completeness of any information and

is not responsible for any errors or omissions or the result obtained from the use of such information. Ratings are statements of opinion, notstatements of fact or r ecommendations to b uy, hold, or sell any securities.

A CGS is articulated on a scale of CGS 1 (low est) to CGS 10 (highest).

CGS 10 and CGS 9 — a company that, in Standard & Poor’s opinion, has very strong corporate governance

processes and practices overall. A company in t hese scoring categories has, in Standard & Poor’s opinion, few

weaknesses in any of t he major areas of governance analysis.

CGS 8 and CGS 7 — a company that, i n Standard & Poor’s opinion, has strong corporate governance

processes and practices overall. A company in these scoring categories has, in Standard & Poor’s opinion,some weaknesses in certain of the major areas of governance analysis.

CGS 6 and CGS 5 — a company that, i n Standard & Poor’s opinion, has moderate corporate governance

processes and practices overall. A company in these scoring categories has, in Standard & Poor’s opinion,

weaknesses in several of t he major areas of governance analysis.

CGS 4 and CGS 3 — a company that, in Standard & Poor’s opinion, has weak corporate governance processes

and practices overall. A company in these scoring categories has, in Standard & Poor’s opinion, significant

weaknesses in a number of t he major areas of governance analysis.

CGS 2 and CGS 1 — a company that, in Standard & Poor’s opinion, has very weak corporate governance

processes and practices overall. A company in these scoring categories has, in Standard & Poor’s opinion,

significant weaknesses in most of the major areas of analysis.

Important Note

A CGS is based on current information

provided to Standard & Poor’s by the

company, its officers and any other sources

Standard & Poor’s considers reliable. A CGS

is neither an audit nor a forensic

investigation of governance practices.

Standard & Poor’s may rely on audited

information and other information provided

by the company for the purpose of the

governance analysis. A CGS is neither a

credit rating nor a recommendation to

purchase, sell or hold any interest in a

company, as it does not comment on market

price or suitability for a particular investor.

Scores may also be changed, suspended orwithdrawn as a result of changes in, or

unavailability of such information.

A

july 3, 2003

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