south korean chaebols national hero as well as public enemy
TRANSCRIPT
South Korean Chaebols
National hero as well as public enemy
Structure of Corporate Sector in South Korea
• Business groups (Chaebols) : A group consists of 20+- large enterprises controlled by a single agent, the owner.
• Independent large enterprises • SME sector : Numerous small and
medium sized enterprises.※ Public enterprises.
The Dominance of Chaebols
• Top 30 Chaebols produce directly 10% of annual GDP in terms of value added since 2000.
• They control innumerably many SMEs in the form of subcontracting.
• Corporate sector of the South Korean economy is dominated by chaebols.
Ownership Structure
• Controlling Minority Structure : For each firm in the group, the owner’s cash flow right is 5%, while her/his voting right is 40% on average.
• Recent data revealed owner’s cash flow and voting right as 1% and 60% respec-tively on average for 10 largest chae-bols.
• Convoluted cascades or Stock pyramid-ing without Dual-class shares.
Convoluted Cascades 1- One Way
• Stock Pyramiding 49 49 49
Owner 51 51 51 A B C Cash flow right : 51, 26.0, 13.3.
51/198.
Convoluted Cascades 2 - Circular
49 49Owner 51 51-a A B
a 51☎ Owner C ≥49 + a 49
Formational Background
• Chaebols are exactly the outcome of Korean development policies.
• Firm-Specific Subsidies under Sover-eign Debt Guarantee and Credit Ra-tioning
• Performance-based selection of com-panies to subsidize.
Firm-Specific Subsidies
• Scarcity of entrepreneurial capabili-ties invited the development policy of firm-specific subsidies.
• Government selected out a few number of promising entrepreneurs and subsidized them intensively.
※Inviting MNCs.
Firm-Specific Subsidies 2
• Foreign-loan-based development strategy adopted sovereign guarantee for commer-cial loans.
• This practice continued until the mid-1980s. (Domestic saving exceeded investment in 1986 for the first time in Korean history.)
• Sovereign guarantee was virtually business license in modern manufacturing.
• All the Industry-Specific Subsidies became virtually firm-specific.
Why Sovereign Guarantee?
• Financial market was not able then to successfully select out promising en-trepreneurs and business projects.
• Sovereign debt guarantee was an ef-fective signal to international lenders.
• Later commercial banks induced bank loans directly to allocate the fund to selected companies.
Selection Procedures
• Selection was made after careful ex-amination of business plans at first.
• Number of projects to develop far exceeded that of capable en-trepreneurs.
• Subsequent selection reflected fully the previous performances. Perfor-mance-based selection.
• Government preferred old faces with good performance records to new faces.
Controversial Issues
• Continued favor only to a fixed few raised the issue of equity.
• Japanese MITI also selected strategic auto producers to subsidize, but the successful ones such as Toyota and Honda were those not selected!
• Possibility of corruption from rent-seeking.
Periodic Industry Restructur-ing
• No matter how carefully the selec-tions had been made, failures always occurred.
• South Korean government led the en-trepreneurs with good performance record, with additional subsidies, to take over troubled projects, when-ever they were found.
Restructuring 2
• In a word, government encouraged entrepreneurs, proven to be capable, to undertake as many business projects as they can.
• Cascade ownership structure enabled owners to control as many enter-prises as possible with limited per-sonal funds.
Problems
• Economic concentration?• Reckless expansion? • Anti-Competitive behaviors? - monopoly, oligopoly or collusions? - abusing dominant market power!• Corporate governance (“Emperor-like
owner”)!
Economic Concentration
• Top 30’s VA amounts to 10% of an-nual GDP.
• Their total profit assumes at most 2% (=10X0.2) of GDP.
• Top 30 owners’ share: below 0.1% (2%X0.05) of GDP.
Reckless Expansion
• Economies of Scale and Scope. ※GE : Samsung = 5 : 1 as of 2008
• Scale and diversification is the very source of competitive advantage of modern enterprises.
Delimiting Expansion
• Impose restriction on the total amount of investment of Chaebol en-terprise in acquisition of other enter-prises.
* Green field investment is ex-cluded. * Unfair handicap on domestic firms in M&A market.• Implementation of this policy had
been on and off.
Chaebols’ Internal Trading
• Discriminatory Trading of Intermedi-ate Inputs
• Discriminatory Trading of Financial Assets
• Mutual Assistance, Antitrust Issue.• Tunneling and Evading Inheritance
Tax
Internal Trading of x
U OU s p p p
D OD
Intermediate Input Trading 1
• D and U are two member companies of a Chaebol group.
• D buys an intermediate input x from U at price s.
• D(x,s) = R(x) – sx, U(x,s) = sx – C(x)• The joint profit U(x,s) + D(x,s) = R(x)
- C(x) is free of s.• The owner’s share is O(x,s) =u U(x,s) + d D(x,s)
Intermediate Input Trading 2
• Choose (x,s) to maximize O(x,s) =u U(x,s) + d D(x,s)= d[U(x,s) + D(x,s)]+ (u-d)[sx – C(x)] If u < d holds, then lower s until you
get sx = C(x) or U(x,s) = 0. • O(x,s) =u U(x,s) + d D(x,s) = u[U(x,s) + D(x,s)]+ (d-u)[R(x) – sx]If u>d holds, then set s to have D(s,x)
= 0.
Intermediate Input Trading 3
• The internal price s is simply redis-tributing profit between U and D.
• The owner maximizes the joint profit R(x) – C(x) first, then tunnels profit to the member company where he at-tains the highest dividend!
• It is x, not s, which matters competi-tion, and joint profit maximization is by no means anti-competitive.
U 100 u = 5% 0
D 0 d = 20% 100
Internal Trading
Asset Trading
• U provides fund, D makes invest-ment.
• Asset Trading at price lower than normal: U donates its corporate funds to D.
• Lending : no donation.
• u > d Lending u < d Donating trade (tunneling)
Anti-Competitive?
Chaebol Non-Chaebol
U Discriminatory Internal Trading D NIllegitimate Funding v. Market Competi-
tionCompetition v. Competitors
Penalizing the Victim
• Korean competition law views unfair internal trading as an undue exten-sion of aid to member companies, and blames it to be anti-competitive.
• Competition authority imposes fine to the company who extended the aid.
• But the general stockholders of the penalized company are the only suf-ferers.
Issues of Sub-Contracting
• Sub-contracting is a mode of con-tracting with some structural hierar-chy.
• Small and Medium-Sized suppliers of parts and components are formally independent, but are subject to tight control of the (Chaebol group) buy-ers.
• Out-sourcing for cheap wages.
Chaebols Stifle New Ven-tures
• Seek for promising ventures• Propose to take-over• If the venture refuses, then scout a
core member familiar with the core competence of the venture.
• The original venture is squeezed out of business.
Uncontrolled Reckless Decision-Making
• The owner’s Emperor-like manage-ment had driven reckless expansion for many Chaebols until 1997 eco-nomic crisis.
• There was no inherent mechanism in Chaebol system which effectively controls the behavior of owner, who holds 5% cash-flow right but exer-cises 40% voting right on average.
Corporate Governance Issue
• How to control the owner from Tun-neling and Uncontrolled Reckless De-cision-Making?
• Insiders System? – The Owner selects Directors and Auditors.
• Outsiders System? – No Hostile Take-Over may intimidate 40% Voting Right.
Governance 2
• All the controversies about Chaebol boils down to transparency and cor-porate governance issue.
• General stockholders, who owns 95% of cash-flow rights, must be able to expand their voting right to an equivalent level.
Justice Issue
• Chaebols are an outcome of inten-sive state subsidies.
• People provided the subsidies, suffer-ing from long labor and low wages.
• “Chaebols earning must be redis-tributed to the people.”
Justice 2
• State subsidies had been awarded for the sake of establishing enter-prises that would be globally compet-itive and provide people with many solid jobs.
• “As Chaebols had successfully ful-filled the original sake while many others failed to do so, the share of Chaebol owners is legitimate and just.”
Inheritance of Owner Status
• Stock pyramiding ownership structure is a very effective means for an owner with limited amount of personal fund to con-trol a maximum number of companies.
• The founding owners had been selected carefully, monitored by performances, and awarded with their position of owner by government policy in face of shortage of entrepreneurial talent.
Inheritance 2
• Now Korean economy no longer suffers from the shortage of entrepreneurial talent.
• The second generation owners had never gone through the tough process of performance based selection, as their fathers had done.
• Cash-flow right 5% is certainly their due share, but how about voting right 40%?
Conclusion
• Incipient Stage of Industrialization : The Owners are devoted to build their personal Industrial Empires, No Tunneling actually occurred.
• As the economy grows up, the need of Chaebol ownership system disap-pears.
• After certain level of Development, Solid Governance Scheme will be necessary.