Debates on Korean Chaebol (Conglomerates) –

Acknowledgements of its Contributions

vs.

Attacks on its Concentrated Power Dong Hyeon Jung

Dept. Of East Asian Studies

University of Delhi

4th Asian Leadership Conference (Chosun Ilbo)

Asia’s Next Challenge: Good Growth, Smart Welfare March 26-27, 2013

Appreciating Chaebol Criticizing Chaebol

Focal points: 1. Need even more chaebols to compete each other – prime mover of success 2. Golden-egg bearing Geese; chaebol regulation is poisoning them 3. Initiated technology & development of man-power 4. Say people are unhappy because of the dinosaur-like chaebol – no other than populist rhetoric

1. Unfair deals in favor of inter-affiliates, undue

inheritance, collusive ties with government, monopoly 2. Group-wide control by Owner- managers with only fractional equity, heading real estate

speculations

Feedback from the floor Before debate - Appreciated 47 vs. Critic: 53 After debate - 50 vs. 50

Chang, Chaebol killer

• The Korean debater against Chaebol, Chang Ha-sung, teaches at Korea University and he, as a prominent leader of a NGO, has borne brilliant fruits in reforming the chaebols’ long-lasted misconducts

• Particularly, in protecting minority share holders’ interests, by urging the government and chaebol to establish fair institutional governance and leading campaigns to enact the “Law of class-action suit” and “Law of representative election system of outside directors” of the chaebol – those are remarkable landmarks in Korean economic history

• He gained his nick name “Chaebol Killer”

Definition of Chaebol

• Economists define Korean Chaebol in various ways but what is common in every definition is that it is a big business conglomerate, comprising a large number of diversified affiliate companies, controlled by an emperor-like owner chairman whose power exceeds his legal authority over the group-wide operation

• Government-chaebol cooperation was essential to the subsequent economic growth and an astounding growth rate began in the early 1960s

Growth of Chaebol

• That is to say, Korean chaebol were able to grow because of two factors—foreign loans and special favors given by the government

• Preferential interest rates, tax deductions, government assurances for repayment, import quotas under preferential exchange rates, supporting and subsidizing exports were the main devices

• The General trading firm had been one of the most remarkable export machines

• After 1987, chaebol began to go global (as labor disputes and real-income rose steeply): now many of them gained global brand

Govern ment

General Trading Firm

General Trading Firm

Support on contest basis

Small producers

EXPORT

General Trading Firms & Export

Collect various kinds of products for export

-Global marketing -Tech assistance

276

3749

1873

1616

322 234

235 144 121 88 85

0

500

1000

1500

2000

2500

3000

3500

4000

19861987198819891990199119921993199419951996

Num

ber

of

outb

reaks

YEAR

Labor Disputes

Source: Business Management 20years in Korea P. 26

-1

7,4 8,3

11,6

18,3

10,7

6,9

8,8

5,8

-5

0

5

10

15

20

1981 1985 1987 1988 1989 1990 1991 1992 1993

Rise of Real Income (1981-1993)

Source: Korea Labor Institute, Labor Statistics, 1997

Distinctive features of chaebol

1. Diversified subsidiaries under the control of a family (1,565 affiliates controlled by 43 chaebols in 2012)

2. Had grown on indebtedness to finance their expansion to industrial banks and independent banks and their own financial subsidiaries (high debt-equity ratio)

3. Creating fictitious capital by Cross-Share-Holding: the owner-manager holds only a very small portion of equities in their listed companies, but exerts absolute power over the group-wide management and decision-makings

Distinctive features of chaebol

4. The owner-managers are assisted by a “Control tower”: it controls the interrelationship among affiliates to extract maximum profit, and take role as a conduit to serve the interest of the controlling family (Sometimes, even at cost of outside investors, Hanwha & SK)

5. Chaebols are not allowed to own banks(Law for separate

finance from industry enacted in 1982) unlike the Japanese Keiretsu, who have historically given the affiliated companies almost unlimited access to credit through their affiliated banks as well as non-banking financial companies

6. Concentration of economic power

A

Typical Type of Chaebol Structure

B C D

2007(a)

20i08 2009 2010 2011 2012(b)

Increase (C=b-a)

Rate of increase (c/a)

Hyundai Heavy

7 9 15 16 21 24 17 242.90%

POSCO 23 31 36 48 61 70 47 204.30

LG 31 36 52 53 59 63 32 103.20

Hanjin 25 27 33 37 40 45 20 80.00

Lotte 44 46 54 60 78 79 35 79.50

SK 57 64 77 75 86 94 37 64.90

Hanhwa 34 40 44 48 55 53 19 55.90

Hyundai Motor

36 36 41 42 63 56 20 55.60

GS 48 57 64 69 76 73 25 52.10

Samsung 59 59 63 67 78 81 22 37.30

Total 364 405 479 515 617 638 274 75.3

Increased Affiliates of the 10 largest Chaebol

Secretary Financial HQ Strategic HQ Knowledge HQ

CONTROL TOWER (Samsung)

1960S 1970-80S 1990S-Currency Crisis

Currency crisis- present

• Secretarial assistance to chairman • Conveying the orders to the affiliates • Follow-up the orders

• Monitoring the over-all management • Performance assessment • Study on relevance of new Investment • Stimulate efficiency

• Investment planning • Long-term planning of the group • Optimum resource allocation • Garnering & rewarding CEOs

• Control & support the restructuring • Diffuse knowhow- Initiating training & innovation • Group-wide orchestration for synergy increase

Concentration Deepening

• Samsung, Hyundai Motors, SK, LG (4 largest, survey in 2013)

1. - Profits: 79.8% out of the 30 largest combined

(2011: 58.3%, 2012; 61.4%)

- Fifth to tenth: 16% (Lotte, POSCO, Hyundai Heavy Industry, GS, Hanjin, Hanwha)

11th to 30th: 4.3%

2. - Turnouts: 53.2%

(2009: 49.6%)

Profits of the 30 largest chaebols during the past 5 years

Source: Fair Trade Commission

yyy The percentages of each groups’ profits

The turn-outs of each groups The changes in percentages

The Number of affiliates and its changes

The taxation on 10 largest chaebols Out of total corporate tax revenues

Unit: 10 billion won

2009 2010 2011

Source: The National Tax Service

The changes of Debt-Equity ratios of each group

How chaebols were favored

• “…The founder of LG group was ordered to build a cable factory. He preferred to build a textile factory…. He was summoned by Colonel Yo Wonsik, Chairman of Military Junta’s Commerce and Industry Committee, and was ordered to build the cable factory. He was also ordered to conclude a foreign loan contract for the construction within one week. …

• Ironically, this unwilling option of a cable factory laid the foundation of the Chaebol LG

• This was one example of what Park Chung Hee later termed as “surgical operation” , which he imposed on many prominent entrepreneurs”

(Quoted from Kim Hyung-A, Korea’s Development under Park Chung Hee, p. 83)

Governance: Share-holdings of the chairmen and Internal-holdings

• The 10 largest chaebols (1012)

• The internal share holding (inside stakes): 55.7%

• The shares held by the Chairmen: 2.13% (Samsung 0.95%, SK 0.6%)

• The shares held by family members of the chairmen: 2.05% • The shares held by the families in total: 4.28%

• Internal holding = family holdings + cross-holdings + others

( confidant-officers, affiliated non-profit, organizations, reacquired stocks)

• On this ground, the chaebols are often condemned that they

control more than they deserve

Co. A 200

Co. B 100

+100 +50

Co. C 100 +

100 + 50

Co. D 30 + 30

+ 30

Cross-share Holding and its Effects

With 200, the Owner-manager controls 790

A 200

B 100+100 (held by public)

C 100 + 100

D 30 + 30

Cross (Circular)-share Holding and its Effects

With 200, the Owner-manager controls 660 A enjoys 50% of control and 25% of dividends

Cross-Share-Holding of Samsung (Fair Trade Commission, July, 2012)

The Outcome of Cross-share-holding

• Establishment of chaebol: Those efficient firms expanded diversified investments and made a business group under the founders’ control - these business groups constitute chaebol

• The more efficient, the faster the groups grew – Concentration of economic power of a few leading groups like Samsung, Hyundai etc. has been accelerated

• The chaebol founders practiced wholehearted devotion for the growth of the groups with support of the government

• The diversification and concentration of chaebol were thus, at its initial stage, aided and abetted by the government

Why Chaebols are Denounced ?

• In general, the social anti-chaebol feeling runs quite deep

• Domestic debates have been mostly focused on the negative aspects of chaebols: excessive concentration, the collusion between government and chaebols or the lack of transparency as ethical background, unfairness of owner-managers’ running the group affiliates with small stakes, and its imbalance against SMEs (small and medium sized businesses)

1. Chaebols’ concentration of economic power

2. Unwarranted tax evasion

Why Chaebols are denounced ?

3. The owner-managers control of the group extends beyond their possession of equity (enlarging inside stakes by cross-share holding), and the large number of minority share-holders do not have any effective means to monitor and discipline the arbitrary and dogmatic management. Theoretically, this type of governance may magnify the agency problems and sometimes may hurt the value of the public shareholdings

4. Excessive imbalance in growth between chaebol and SMEs – chaebols are clobbering SMEs and reducing them to bare bones

Why chaebols are denounced?

5. Unlawful internal trading (inter-affiliate deals with favors)

6. Excessive diversified management

7. Lack of transparency (infringing the interests of minor share holders)

8. People believe that too little of chaebols’ growth is trickling down to the public and SMEs

9. Lack of rule of law in favor of chaebol (acquittal with money, guilty with no money)

10. Encroaching into SME’s territories (bakeries etc.)

Many criticisms are far-fetched

• Some of the charges against the chaebol are true but some of them are far-fetched

• At the fledgling stage of Korean growth, government favors helped them grow fast, but now it is the consumers who make the chaebol strong

• Too-big-to-fail and collusive ties between business and government were by-products of government-guided development model and served as one of the major causes of economic crisis in late 1990s

• But the economic reforms and increased foreign investments during and after crisis redressed them

Owner-manager

CEO-Hired Professional Managers

Checked by the Market & Outsiders

Change of Corporate Governance

Control (training, recruit, evaluation, reward) Long-term strategy, support reforms

Performance

Disclose the performances to the Public

Monitoring (Law & Rule, System, Public Opinion)

Monitoring (Law & Rule, System, Public Opinion)

Concentration: The most controversial issue

• Classical theory blames monopoly (oilgopoly) on the ground that monopolized producers neglect the technological innovation because they can control the prices

• Aggregate concentration does not necessarily lead to the increase of market concentration

• Domestic market shares of chaebols are often oligopolistic and highly concentrated but, in global markets, they become only one of the many suppliers

Concentration & Innovation

• But competition in innovation looms much larger today than in the past. Only gigantic firms can afford the huge amount of R&D investments for innovation

• 80-90% of profits of Samsung Electronics and Hyundai Motors, who represent champions of monopoly in Korea, come from global markets – a good example that many of the criticisms are far-fetched

Powerful ownership enables bold decision-making

• A big difference between Japanese big business and Korean chaebol: Any plan that doesn’t ensure the obvious profit is not likely to be endorsed by ruling council in Japan; even risky investment decisions evident of lowering profit have been made in Korean chaebol with powerful owner-managers

• Bold decisions based on long-term perspective are made promptly: Samsung’s success is an exemplary

• The chairman Lee Keun-hee’s philosophy is “Serve consumers with quality” and encourages the top managers not to worry about the losses, assuring them if any losses made because of the efforts to improve quality that would be covered by his private funds

• Very famous anecdotes of Samsung: newly produced 150 thousand mobile phones were burned on March 9, 1993,

at the Lee’s order, of when a minor defect was discovered • In May, 2012, 100 thousand Galaxy S3 model were

unloaded from the plane bounded for a foreign market • All products of the model produced by the time were

destroyed, because a slight defect on the cover was checked

• Anyone who finds a defect at process is authorized to stop the operation

* Such decisions could be made only under the powerful chaebol governance

• By virtue of this, Samsung overpowered Japanese electronics manufacturers - at the turning point from analogue to digital in around 1990

Samsung Sony Panasonic Sharp

Turnout 201.1 76.2 84 28.4

Operating profit

29.1 1.5 1.6 -1.8

Samsung & Japanese Electronics Trillion won

•Samsung: achievement of 2012 •Japanese: From March, 2011 to March 2012 (estimation) • Yen was denominated in won, calculated by the rate of March 14, 2013 • Source: weekly Biz, March 16, 2013

Cross-share holding: a hot button

• Despite all these merits of chaebol, people believe the concentration of a few largest chaebols is excessive

• The managerial machine that accelerate the concentration is the cross-share-holding: it has been a hot button of the chaebol controversy

Cross-share-holding

• According to a study, banning the controversial cross-shareholding practice could cause GDP to slide 2 percent (Oh Jung-guen Korea Univ., Cross shareholding wins friends)

• Banning cross-holding may lead a loose control of a owner-manager: possibly lose merits of Korean governance mentioned before

• Slackening the control of group may face a possibility of it being taken over by rivals or corporate raiders (Hostile M&As: SK was driven to the brink by the Sovereign, the Monaco based speculative fund, and KT&G attacked by Ichan & Co., a corporate raider in Wall Street)

The cross-share-holding banned recently

• The new Korean government banned 62 chaebols the cross-share-holding as of April 1, 2013

• Many experts worry this would demoralize entrepreneurship, leading to loss of growth momentum – Chaebol issue in Korea today is a dilemma

• The outcome remains to be seen

Illegal or unwarranted wealth inheritance: another controversial issue

• The number of kids with stock holdings exceeding 100 million won (US$88,400) exceeded the 100 mark for the first time in April as owners of large businesses take steps to pass on their wealth to their children, data showed on April 12, 2013

• According to the data compiled by Chaebol.com, an information provider on large conglomerates, 102 children under 12 held sizable shares in listed companies as of the end of April, up from 87 kids a year earlier (Korea herald)

• The National Tax Service said on Thursday that it has collected an additional 278.3 billion won ($246.3 million) from 11 entrepreneurs who have transferred property to their children via overseas tax evasion (Joongang Daily)

Common sense is often hazardous to prosperity

• The objective economy has its own mechanism of operation which often go against what the ordinary people expect

• The public often believe the rich people deserve higher taxation and it helps the national economy grow stronger and healthier. But what happens in reality is adversary

• 97.5 % of corporate tax during Indira Gandhi’s rule in India was proved to be disastrously self-defeating, making so many loopholes & leading the businessmen not doing their best

Common sense is often hazardous to prosperity

• French President Hollande’s pledge to raise the taxation on rich to 75% induced an exodus of the super riches from France to Belgium, Russia and Switzerland – if the tax law ever exercised it, it would have driven even much of the investments out

• Former Korean President Roh’s threatening on rich drove quite a chunk of Korean money over to the US and other countries

• The 60% of inheritance tax in Korea is exorbitant: as many economists argue, unreasonable heavy taxation is like a punishment for the talented and hard worker

• Therefore, the temptation to avoid tax would never stop as long as the rate stays unreasonably high

• Reasonable tax rate and exercising rigorous law enforcement rather than the high rate with lots of loophole would be better choice

Diversification proved to be conducive to growth

• Empirical studies prove that diversifications haven’t

harmed healthy management. Out of reviewing 14 emerging economies, a research found out that diversification had been conducive to growth. (Tarun Khanna & J. W. Ravikin, 2001, Korean business 20 yrs, 194, footnote 10)

• To some extent, diversification was an effective response to the rapidly growing businesses

• Diversification helps the owner-mangers launch a new investment project with little capital of his own as well as reducing the threats of being taken-over (Korean business 20 yrs, 185)

Rule of Law: A Fundamental Role of State

• Lack of Rule of law (not guilty with money, guilty with no money) is not entirely the chaebols’ fault – it is the responsibility of the government ( judiciary), not the chaebol

• Fair and rigorous enforcement of law is one of the most crucial premises of sound growth and development: powerful entrepreneurs are not saints nor philanthropists, they may want to enjoy political or judiciary perks

• It may be a turning point now: The owner-managers of SK (3rd largest) & Hanhwa Group (10th) were sentenced guilty for embezzlements and they have been jailed – interpreted as an end of get-out-of-jail-free cards for Korean tycoons

• They were indicted for the embezzlements of company money, using the affiliates as vehicles

Paradox of being competitive: dwindling Trickle-Down-Effect

• After economic crisis of 1997-98, Korean firms underwent extensive restructuring and have become competitive considerably

• Became competitive through being more efficient, and enlarging global outsourcing, employing less domestic workers

• As a result, trickle-down-effect has been dwindled, since employment is the major channel of the trickling-effect

• In 2000, the export increase of a billion $US created 15 more job employments, but in 2008, less than 10 jobs, 40% decline

• The turnout of Samsung Electronics doubled in the years of 2005-2011, but the employment increased only 25%

Frustrated by reduced social mobility

• Polarization of the society makes the ladder of the social status steep and difficult to climb up, leading the poor parents deadly frustrated for limited opportunities (to enter the universities of good reputation)

• According to KDI (Korea Development Institute), the children of parents whose monthly income is one thousand US dollars higher, gain 21 more points in scores of TOEIC than the other lower income-groups, and the young employees whose TOEIC score is 100 points higher are paid about 1,500 US dollars more monthly

• The frustration outpours as resentment against the super riches, namely, chaebol and their families, grow because they are gaining ever more income and wealth by the improved efficiency

Gap between chaebol and SMEs

• The outcries that chaebols are clobbering SMEs and reducing them to bare bones – it is true, but only to some extent, because not every chaebol is that bad

• Depriving of SME’s trailblazing achievements and high-handedness of chaebol employees against SME deserve a censure

• The children of some chaebols opened shops like bakeries or caffe at downtown Seoul, and that fueled anti-chaebol climate and enraged the public

• People believe it is nothing more than time-killing hobbies for chaebol families, but it is a matter of life or death to the mom-and-pop store owners

Chaebol shouldn’t be blamed for everything

• Chaebol children’s start-ups of bakery-like small business were the most stupidest decisions the Korean chaebol ever made – it embroiled the chaebol into social uproar and outrages

• Apart from these, many of the other attacks on chaebol in relation to the SMEs go overboard

• Concerning ruthless cutting down the SMEs’ delivery prices, reducing them to bare bones: tough and obstinate unions have to be blamed for this also

• Many of the troubles that SMEs are facing are to be blamed on the government agencies and related red tapes with unnecessary paper works, rather than chaebols

• The new president Park Ken-hye named them “thorns beneath the fingernails”

Chaebol shouldn’t be blamed for everything

• Many people claim that government must break up chaebol system, believing SMEs do not grow and prosper because of chaebol

• DID is a supplier to Samsung Display in Asan, mid-west of Korea – its employees increased from 400 in 2009 to 1,300 in 2012

• In the region around Asan & Chunan, the primary suppliers to Samsung Display increased 3,205 in 2004 to 30,300 in 2012. These increases were due to the growth of Samsung Display

• A good example that shows big business and SMEs are complementary

Who are to be blamed?

• The productivity of big business has risen 9.3% during the period of 1995-2010

• Their production abroad increased 6.7% in 2005 to 16.7% in 2010, leading 2% decreases of employment each year (largely due to militant unions and wage rise)

• In contrast, the rate of productivity of SMEs against big business lowered from 49% in 1990 to 27% in 2010

• The average wage of SME is a little more than half of the big firms (McKinsey, 2nd Report)

• Who should be blamed for low productivity of SMEs, chaebol or SMEs themselves?

• Class action law suit & Punitive damages to protect the SMEs against big business are being enacted

Conclusion-many criticisms are far-fetched

• Korean companies largely grew on management by the chaebol founders, Korean economic success and gaining today’s global status would not have been possible if not for bold investments and proactive entrepreneurship from chaebol owners

• Contribution to the prosperity, technological innovation, particularly the management based on long-term vision, adversary ideas to increase investments at downturns, daring decisions to enter into newly emerging industries have been chaebols’ merits

Conclusion

• Quick decision-making, acumen, the enterprising drive of family control and their wholeheartedly dedicated entrepreneurship also helped build Korea’s economic success

• Their achievements and commitments must be appreciated despite criticism of their sometimes unfair business practices

• Some people at the floor of the debate mentioned at the first this presentation might have been sympathetic with this over-all picture of the Korean chaebol, and lead them to shift from critics to appreciating

Conclusion

• In fact, the debates over Korean chaebol have been largely emotional rather than theoretical and the debates have surfaced vibrant at the times of presidential elections when populism flourishes

• The theoretical focus has to be placed on competitiveness and inspiring entrepreneurship based on rule of law, rather than populous complaints

• However any measures or systems that help chaebol, using the concentrated power as leverage, to pursue rent-seeking activities must be starkly denied , such as trades with affiliates with unreasonable favors

• At the same time, chaebol owners must be aware that corporate performance is but one of many qualities demanded today, because social aura has changed from growth-seeking to fair distribution, and chaebols are demanded to play their part in this regard

If chaebol closes down, would SMEs prosper?

• The Question: If some chaebols should close down as punishments for their blunders, would SMEs prosper by filling up the gap left by them?

• The perception both about chaebol and SME must be renewed

• SMEs play an important role in generating employment and, more importantly, entrepreneurial opportunities

• The paradigm of approach to SMEs must be also shifted from “protection” to “boosting competitiveness”

True proactive schemes for SME

• Toward creating innovation system, connecting firms, universities and research institutions, which help upgrade traditional sectors and lead to the development of new sectors, eventually promoting and selling their products around the world

• The more urgent need is devising some schemes to give the adventurous and creative young talented second or third opportunities to start up again in case of failures rather than protective subsidies