Korean Politics (POLI 133J) May 24 Politics and Political Economy of Chaebol Reform

1. Korean Politics (POLI 133J) May 24Politics and Political Economy ofChaebol Reform What are the issues regarding chaebol? How has Korean corporate governance changed, if at all? What are the limitations of reform? Why was reform so difficult? What made some reform possible? What are the prospects for reforms?

2. Why is Chaebol a problem?Isn’t it an engine of growth? • Economic concentration & polarization: • High profits of chaebol firms vs. low profits of SMEs • Growth without employment; Dual labor market • Trickle-down effect? • GNP’s loss in the 4-27 by-elections • Corporate governance: • Lack of transparency • Ownership & control: Dynastic succession (to third generation) • Too-Big-To-Fail • Corruption & capture (crony capitalism)

3. Theoretical Approaches to the Chaebol Efficiency model: A rational and efficient (profit-maximizing) response to underdeveloped markets for inputs & services • vertical integration: Make-or-buy decisions depend on the level of development for markets and legal institutions. • horizontal diversification: risk diversification, use of common factor of production (eg. overseas marketing info) • explains business structure rather than governance structure

4. Theoretical Approaches to the Chaebol Political economy explanation: • Chaebol as the creature of politics • Rent-seeking and political/bureaucratic corruption: Exchange of under-priced credit and political donations

5. Theoretical Approaches to the Chaebol Principal-agent model: The problem of incentive compatibility and asymmetric information between shareholders and professional managers • not relevant for Southeast Asia’s family-based business groups with high concentration of ownership • particularly acute for Korean chaebols: The founder’s family has only a small ownership stake, but exercises control by using extensive inter-subsidiary shareholdings (entrenchment problem).

6. Korean Chaebol Ownership Structure

7. Characteristics of Korean Chaebol Unrelated horizontal diversification: Octopus-like business structure High debt-to-equity ratio: Cross-debt guarantees (prohibited after the 1997 crisis) Ownership and governance structure: Absolute authority of the chairman, cross or circular shareholdings

8. Growth of chaebol under Park • Park’s desire to emulate Japanese zaibatsu • Allocation of under-priced credit through government-controlled banks • Export-oriented • Heavy and chemical industries • Chaebol reform: important political issue after democratic transition

9. YS’s failed chaebol reform Policy objectives • Internal to chaebol: separation of ownership from the management, transparent management • External to chaebol: unfair advantages vis-à-vis SMEs and foreign corporations (cross-payment guarantee, cross-investment), real name reforms • Global competitiveness: deregulation Response of the FKI • Ambiguous, inconsistent position about real name reform • Opposition to removal of cross-payment guarantee and cross-investment • Call for lower interest rates

10. DJ’s chaebol reform Agreement with four largest chaebols • Consolidated corporate balance sheets for each chaebol • Eliminate cross-investment and payment guarantees • Reduce debt/equity ratio • Specialize into key sectors • Strengthen the responsibility of the CEOs Tripartite Commission: Government, Management & Labor • Chaebol reform + labor market flexibility

11. Why did change take place? Roh, YS vs. DJ: • The gravity of economic crisis • Discredited chaebol and FKI • International pressures (IMF) • DJ’s weak connection w/ chaebol. • Tripartite Commission: burden sharing • DJ’s electoral victory represented the people’s demand for reform (cross-class coalition against chaebol) • The role of civil society: Minority shareholders movement

12. Minority Shareholders’ Movement • PSPD • Jang Ha-sung, Kim Sang-jo • To attend and raise questions at the general shareholders’ meetings. -Samsung Electronics GSM (March 1998) for 13 hours • Shareholders’ suit • To file a criminal complaint

13. How has Korean corporate governance changed if at all?  • Peter Gourevitch (2005): From 80% blockholder concentraton with zero shareholder protections to 32% concentration rate (lower than sample mean of 47%) with shareholder protections index of 37 (close to the sample mean of 45). • Transparency: substantial improvement Limitations of reform: • Ownership structure and accountability: little progress • Samsung’s slush fund scandal • Increasing chaebol concentration & polarization

14. General Concentration Ratio (1981~2006) Source: Kim, Sang-jo (2010)

15. Chaebol Concentration Ratio (1994~2007) Source: Kim, Sang-jo (2010)

16. Productivity Comparison between Small & Large Enterprises (1973-2006; LE=100%) Notes: Firm size ■ 5~19 employees        ▲ 20~49 employees ◆ 50~299 employees ★ 300~499 employees   ● more than 500 employees Source: Kim, Sang-jo (2010)

17. Ownership Structure of Top 10 Chaebols (1990~2009) Source: Kim, Sang-jo (2010)

18. Prospects for Corporate Governance Reform under Lee MB • Lee, former CEO of Hyundai companies • Pro-business or pro-chaebol? • Pro-Seomin(ordinary people) & fair society? • High foreign exchange rates & low interest rates (→high inflation) • Tax cuts for the rich & (big) corporations • Weakening of “separation of financial and industrial capital” • Elimination of the equity investment limit • Weakening of regulations on holding companies

19. Regulations on chaebol’s circular shareholdings and ownership of banks Fair Trade Act: • Cross-shareholding restriction rule for top chaebol • Equity investment sum caption rule (Top chaebol cannot invest more than 40% of net assets in group subsidiaries.): Repealed (March 2009) Separation of Financial Capital and Industrial Capital: • Banking Act: Limit on bank ownership, from 4% to 10%, but voting rights are limited to 4% (2002 revision); ownership and voting rights, up to 9% (2009 revision) • Financial Holding Companies Act: The revision bill was not passed in April 2009. • Financial Industry Structure Law: A financial company should obtain approval to acquire 5% or more of a intra-group company; 20% or more of a non-intra-group company.

21. Samsung Group and Financial Industry Structure Law • Samsung Everland, in which Chairman Lee Kunhee and his son Lee Jae-Yong hold 3.72% and 25.1% of total shares, respectively, was charged with maintaining a key position in the Group using the circular investment strategy with intra-group financial institutions. • Samsung Card owns 25.64% of the shares of Everland, which owns 13.35% of Samsung Life Insurance’s shares. Samsung Life Insurance again owns 7.24% of shares of Samsung Electronics, which owns 46.9% of total shares of Samsung Card. • Thus, Samgsung Card is in obvious violation of the FISL by owning 20% more shares of Everland than is legally allowed, while Samsung Life Insurance has an excessive holding of 2.24% of Samsung Electronics’ shares.

22. Separation of Financial Capital and Industrial Capital • Rationale: • Banks have to monitor industrial firms. • Conflict of interest between bank customers and majority shareholders of an industrial firm • Standard & Poor’s (2005), “Preventing control of the financial system by large corporations and business groups is crucial to preventing the recurrence of a financial crisis.”

23. The Politics of Chaebol Reform and New Financial Rules Pro-chaebol coalition: • Chaebol’s lobbying arm: Federation of Korean Industry • Chaebol-supported think tanks: The Institute for Free Enterprise, Samsung Economic Research Institute • Conservative media • Grand National Party Reform coalition: • Progressive NGOs: CCEJ, PSPD, Solidarity for Economic Reform • Woori Party, DLP, progressive media Conflict within the government: • Chung Un-chan, Sharing of surplus profits • GNP, Repeal of tax cuts (corporate income tax)