Big Business Reform Set to Take Off Again in South Korea

Big Business Reform Set to Take Off Again in South Korea
REUTERS/Kim Hong-Ji
What you need to know

South Korea’s newly elected President Moon Jae-in emphasized the importance of chaebol reform during his campaign

In 1988, the heads of South Korea’s major business conglomerates (known as "chaebols") were questioned by lawmakers regarding corruption allegations linked to their relationship with then-president Chun Doo-hwan. Almost 30 years later, their children — who inherited their senior positions — were summoned to the parliamentary hearing into former President Park Geun-hye. This tragic déjà vu proves that collusion between South Korea’s government and business elites remains intact. Samsung’s Vice Chairman Lee Jae-yong, grandson of the corporation’s founder, was heavily interrogated at the hearing and is now behind bars for seeking undue favors from Park and her close friend Choi Soon-sil.

Observers of the Park scandal have raised doubts over the effectiveness of current chaebol regulation. Anti-chaebol sentiment has since gained momentum and is providing a strong impetus for resuming a chaebol reform process. South Koreans believe that the Park scandal could have been prevented if the chaebols were subject to proper governance and fair competition.

Two major concerns dominate reform discussions: chaebol families’ pursuit of self-interest, often at the expense of general minority shareholders, and the concentration of economic power. Although these issues are related, the former is a governance issue that concerns the potential conflicts of interest between controlling shareholders and minority shareholders, while the latter a conventional competition issue often resulting in an abuse of superior bargaining position and a distortion of market competition.

The core problem related to governance is that owner families exercise great influence on the company with little ownership. Important decisions tend to be made by leaders of the owner family, rather than by professional CEOs. The families are frequently criticized for taking illegal actions when it comes time for succession, often aimed at avoiding heavy inheritance tax while maintaining the control over the group.

Owner families also tend to take a little responsibility for management failures, and internal supervision from corporate boards does not really work to address this. An analysis of CEO turnover in South Korean firms revealed that unlike professional CEOs, the tenure of owner family CEOs is not dependent on firm performance and that the presence of outside directors does not seem to improve the link between tenure and performance.

Concerns about the concentration of economic power include unequal contractual relationships between subcontractors and chaebols, the prevalence of collusion among large chaebols, and the abuse of internal transactions. That is, chaebols are criticized for choosing to make easy profits by cutting costs through unfair terms of trade with subcontractors or by participating in collusion, rather than exerting innovative efforts to create new demand. Also, it is commonly believed that subsidizing affiliated firms by providing favorable terms of trade allows owner families to avoid inheritance tax. Although having potential procompetitive effects by, for example, improving transaction efficiency, favoring chaebols’ own subsidiaries can harm fair competition. The interest of minority shareholders can also be violated if their potential efficiency-enhancing effects are minimal.

Acknowledging the current chaebol problems, some regulators have begun to formulate measures to improve the system. For instance, Park’s impeachment has provided new momentum for passing the Korean Commercial Act amendment bill, which will protect general and minority shareholders’ rights and enhance board independence. If enacted, the law will allow minority shareholders to file suit in cases of illegal subsidiary management, require firms to have electronic voting systems and cumulative voting systems, and impose restrictions on the voting rights of large shareholders at the time of audit committee member elections. Not all of these measures are desirable — for example, cumulative voting and voting restrictions imposed on large shareholders can distort decision-making. But efforts to create an environment in which self-regulation practices of firms work effectively are important. To this end, both internal and external supervision must be strengthened. The system requires board independence and monitoring efforts from all stakeholders, where institutional investors and markets for corporate controls can play an important role.

There is another approach being considered that specifically aims to reduce the discrepancy between ownership and control. The discrepancy can result in the misalignment of interests between controlling and minority shareholders. The South Korean government has employed various types of shareholding regulations. Some of those measures are controversial. But circular shareholdings can hardly be rationalized by efficiency motives and are no longer allowed by law. Now we need to think about an effective way to lead firms to resolve existing circular shareholdings.

South Korea’s newly elected President Moon Jae-in emphasized the importance of chaebol reform during his campaign. His landslide victory suggests that reform is strongly supported by South Koreans. But future regulatory reform efforts must improve the effectiveness of the existing regulation apparatus before adding anything new. For better implementation, the role of the Korean Fair Trade Commission is important and its capacity should be strengthened. Above of all, chaebols must realize that for their own long-term prospects, they must work to improve their governance structure and make fair profits through innovation.

The News Lens has been authorized to republish this article from East Asia Forum. East Asia Forum is a platform for analysis and research on politics, economics, business, law, security, international relations and society relevant to public policy, centered on the Asia Pacific region.

TNL Editor: Edward White