Transcript Chaebols

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% respectively on
average for 10 largest chaebols.
• Convoluted cascades or Stock pyramiding
without Dual-class shares.
Convoluted Cascades 1
- One Way
• Stock Pyramiding
49
Owner
51
49
49
51
51
A
B
C
Cash flow right : 51, 26.0, 13.3. 51/198.
Convoluted Cascades 2
- Circular
Owner
51-a
☎ Owner
≥49 + a
49
49
51
A
B
a
51
C
49
Formational Background
• Chaebols are exactly the outcome of
Korean development policies.
• Firm-Specific Subsidies under Sovereign
Debt Guarantee and Credit Rationing
• Performance-based selection of
companies to subsidize.
Firm-Specific Subsidies
• Scarcity of entrepreneurial capabilities
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
commercial 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
entrepreneurs and business projects.
• Sovereign debt guarantee was an
effective 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
examination of business plans at first.
• Number of projects to develop far
exceeded that of capable entrepreneurs.
• Subsequent selection reflected fully the
previous performances. Performancebased 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 rentseeking.
Periodic Industry Restructuring
• No matter how carefully the selections
had been made, failures always occurred.
• South Korean government led the
entrepreneurs with good performance
record, with additional subsidies, to take
over troubled projects, whenever 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 enterprises as
possible with limited personal 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 annual
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 enterprise in
acquisition of other enterprises.
* Green field investment is excluded.
* Unfair handicap on domestic firms in
M&A market.
• Implementation of this policy had been
on and off.
Chaebols’ Internal Trading
• Discriminatory Trading of Intermediate
Inputs
• Discriminatory Trading of Financial Assets
• Mutual Assistance, Antitrust Issue.
• Tunneling and Evading Inheritance Tax
Internal Trading of x
U
s
OU
p
D
p
p
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
redistributing 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 attains the
highest dividend!
• It is x, not s, which matters competition,
and joint profit maximization is by no
means anti-competitive.
Internal Trading
U
100
D
0
u = 5%
0
d = 20% 100
Asset Trading
• U provides fund, D makes investment.
• Asset Trading at price lower than normal:
U donates its corporate funds to D.
• Lending : no donation.
• u>d
u<d
Lending
Donating trade (tunneling)
Anti-Competitive?
Chaebol
Non-Chaebol
U
D
Discriminatory
Internal Trading
N
Illegitimate Funding v. Market Competition
Competition v. Competitors
Penalizing the Victim
• Korean competition law views unfair
internal trading as an undue extension 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 sufferers.
Issues of Sub-Contracting
• Sub-contracting is a mode of contracting
with some structural hierarchy.
• Small and Medium-Sized suppliers of
parts and components are formally
independent, but are subject to tight
control of the (Chaebol group) buyers.
• Out-sourcing for cheap wages.
Chaebols Stifle New Ventures
• 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 DecisionMaking
• The owner’s Emperor-like management
had driven reckless expansion for many
Chaebols until 1997 economic crisis.
• There was no inherent mechanism in
Chaebol system which effectively
controls the behavior of owner, who
holds 5% cash-flow right but exercises
40% voting right on average.
Corporate Governance Issue
• How to control the owner from
Tunneling and Uncontrolled Reckless
Decision-Making?
• Insiders System? – The Owner selects
Directors and Auditors.
• Outsiders System? – No Hostile TakeOver may intimidate 40% Voting Right.
Governance 2
• All the controversies about Chaebol boils
down to transparency and corporate
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 intensive
state subsidies.
• People provided the subsidies, suffering
from long labor and low wages.
• “Chaebols earning must be redistributed
to the people.”
Justice 2
• State subsidies had been awarded for
the sake of establishing enterprises that
would be globally competitive and
provide people with many solid jobs.
• “As Chaebols had successfully fulfilled
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 control
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 disappears.
• After certain level of Development, Solid
Governance Scheme will be necessary.