It was a kind of financial coup almost unknown in South Korea. On Apr. 14, a Monaco-based private equity fund called Sovereign Asset Management announced that it had quietly bought up the single largest stake -- 14.99% -- -in SK Corp., Korea's top oil refiner and a flagship of SK Group, the country's third-largest conglomerate. The ultimate aim of the move was transparent: Sovereign hoped eventually to cash in on what it saw as a company worth much more than its low stock valuation. But Sovereign's media-shy New Zealand-born principals justified the investment in terms that ring loud gongs in South Korea these days. In a press release, the fund stated its goal was to turn SK Corp. into "a role model for corporate governance and shareholder value for Korean business."
That theme has dominated discussion of Korean business for much of the past five years. Even as South Korea grew to become an important player in global technology and consumer electronics, complaints mounted from investors, especially foreign ones, that Korean companies were poorly governed. It's a country where family dynasties rule over giant conglomerates by breaking them up into dozens of opaque subcompanies that control each other through complex cross-shareholdings. Corporate decision-making is a private affair among chaebol kingpins and their family and political friends. And, until very recently, boards were closed to outsiders. But slowly and steadily, good governance has been asserting itself in Korea, and the Sovereign Asset Management share grab is the latest sign of that change. It came just weeks after the scion of SK Group, Chey Tae Won, was hauled off to jail flanked by plainclothes policemen and charged with illegally manipulating shares in SK companies to assure he maintained control. The stock price of SK Corp. plunged as a result, and Sovereign took advantage by snapping up its block of shares.
Shortly after Chey's arrest, new President Roh Moo Hyun made clear that his government is serious about chaebol reform and about improving corporate governance across the board. The probe into Chey and SK Group came in the last days in office of President Kim Dae Jung, who had done much to rein in out-of-control corporate chieftains during his five years in office, but had been criticized for waffling and delay in his last years. His successor, Roh, has pledged to pick up where Kim left off. "Reforms must continue," Roh said in a speech to the National Assembly in April. "The days of keeping two sets of corporate accounting books are over."
The pressure for reform is more than an internal Korean matter: It's the price of Korea's enormous success in global business. Spurred by the almost ruinous financial crisis of 1997-98, South Korea quickly found its footing and transformed its economy, churning out computers, cell phones, liquid crystal display screens, broadband equipment, and dozens of other tech products in high demand in the West. Soon some of its companies became the darlings of foreign investors. Foreigners now own more than a third of the shares in the companies listed on the Seoul stock exchange. And the foreign share of three of South Korea's biggest companies -- Samsung Electronics Co., Kookmin Bank, and Pohang Iron and Steel Co. -- now tops 50%.
Those foreign shareholders are among the loudest crying for corporate reform. And one can read their displeasure in Korea Inc.'s numbers. Price-earnings ratios of widely held Korean stocks are mostly in the single digits, far below those of their global peers. Indeed, valuations are so low that Korean companies are a temptation not just to "value" investors like Sovereign, but to manufacturing corporations eager to expand in Asia. "They look like good investment candidates if you are confident you can improve transparency and accountability," says Kim Joo Young, head of the Center for Good Corporate Governance in Seoul.
Kim and other shareholder activists have already made their mark. On May 5, a joint survey by the Asian Corporate Governance Assn. and CLSA, a brokerage and banking investment arm of France's Crédit Lyonnais, declared South Korea most improved in its Asia corporate governance ranking for this year. Yet overall the Koreans still rank fifth (after Singapore, Hong Kong, India, and Taiwan), and the study concludes corporate shenanigans persist in the country. "Much of the improvement in corporate governance in Korea is a function of a stricter, improved regulatory framework," says François Roy, chief analyst of the association. "It would be a large leap of faith to suggest that a focus on corporate governance and shareholder value has permeated right though the corporate culture of Korea."
But some companies have made big strides. One star highlighted in the report was KT Corp., Korea's biggest phone and broadband company. Privatized in May, 2002, it's now one of the few companies in Asia with an independent chairman of the board. It also pins bonus payouts to share price and financial performance. Three other Korean companies are among the CLSA's Top 10 in Asia, including Kookmin Bank and Korea Tobacco & Ginseng Corp., both privatized in recent years.
Samsung Electronics has also come a long way. Since 2001, it has filled half its 14 board seats with outside directors. Three are foreigners nominated by foreign investors, who own a combined 51% of the company. Its audit committee is made up of outside directors. "Samsung Electronics has demonstrated one of the most improved corporate governance practices in Korea," says James Paterson, head of CLSA's research in Korea. The same cannot be said, however, of Samsung Group, the chaebol with which the electronics company is affiliated.
As for Sovereign, it's not yet clear how it will use the $150 million investment in SK Corp. to open it up. The secretive investment firm has pursued similar deals in other emerging markets. In the 1990s, it bought stakes in several Russian companies, including gas producer Gazprom and national electricity group UES. Opinion is mixed in Moscow financial circles on Sovereign's track record in improving governance.
As the largest shareholder in SK Corp., Sovereign has secured a foothold in SK Telecom Co. -- one of Asia's most profitable mobile telecom carriers -- because the refinery holds a 20.85% stake in that sister company. Some foreign investors are salivating at the prospect that turmoil might somehow spring SK Telecom loose as an autonomous company. The brokerage arm of Deutsche Bank issued a report recently saying SK Telecom's share price would probably double if it became independent.
In the past, Korean regulators often ignored the kinds of games that dominated SK Group and got Chey arrested. That's changed. Kang Chul Kyu, chairman of the watchdog Korea Fair Trade Commission, doesn't object to the Sovereign deal and castigates SK. "SK Group was running against the current," he says. "The name of the game now is transparency in management and fair competition." Kang needs to make up for time lost in the administration of ex-President Kim Dae Jung. Early on, Kim won applause around the world for his corporate reforms. He required big companies to appoint outside directors, forbade the common practice of stronger companies guaranteeing debt payments for weaker affiliates, and introduced a voting system designed to protect minority shareholders' rights. But often these were not implemented.
Now, the spotlight is on Kang. He has pledged to look into the business practices of the top six chaebol -- including the Samsung, LG, and Hyundai groups -- by June to determine if they've been engaging in irregular intragroup transactions. "Any complaints of violations made by civic groups and any suspected foul play will be thoroughly investigated," he vows. Probes are under way of alleged financial manipulations by the Dougbu and Hanwha Groups.
The chaebol, however, are bracing for battle. Even as Chey is being tried on charges of share manipulation and $1.2 billion in accounting fraud, chaebol-funded lobbying groups are raising a hue and cry over fears that Sovereign may launch a hostile takeover. The Federation of Korean Industries, which represents chaebol interests, is calling the Sovereign deal a "leakage of national wealth" -- tapping a suspicion of foreigners that goes back hundreds of years. The hard-hitting tactics are no surprise: The chaebol have long appealed to popular nationalist sentiment whenever their corporate fiefdoms come under attack.
In fact, SK's recent financial troubles stem directly from a chaebol victory in a similar tug-of-war back in 1998, when they successfully pressured the government to lift restrictions on share investments between affiliates, citing threats of foreign takeover. In the absence of any meaningful corporate oversight, Chey's clan strengthened its grip on an expanding universe of companies, all of them linked in some way or another to SK Corp. or SK Telecom. The number of SK affiliates ballooned to 60 from 39 in 2000 by bringing smaller companies into the fold. Intragroup investments jumped to $8.67 billion in 2001, from $916 million in 1997, according to the Fair Trade Commission. The number of these transactions dropped off only after the government reimposed restrictions in 2001. An SK spokesman says the chaebol was investing in numerous startups.
It's a big mess that obviously needs cleaning up. But there are signs that Korea's once-silent shareholders are ready to use the SK scandal as the rallying cry for a new drive to improve governance. Activist groups, led by People's Solidarity for Participatory Democracy, have a big agenda. They want a tightening of cross-shareholding restrictions, a strengthening of the role of outside directors, legal reforms that allow class actions, and creation of a firewall between manufacturers and their main banks.
To be sure, the current, flawed model hasn't held back corporate dynamos like Samsung and LG, which rely on all-powerful CEOs. But the norm in Korea is far less instructive. When all-powerful chaebol chieftains make mistakes, the whole country pays a price in terms of destroyed shareholder value. Without independent board members and audit committees to check abuses, shareholders have no way of knowing on what basis management is making decisions that affect their investment. Dynastic rule is no replacement for good governance. "The probability of having outstanding managers and visionaries in two generations in a row will be close to nil," reckons HSBC Securities Korea strategist Lee Jeong Ja.
To attract new capital and bid up share prices to levels that truly reflect underlying value, Korea needs to abandon its byzantine ways once and for all. The solution is for Roh's government to carry out governance reforms that show the chaebol heads who is really the boss -- the shareholder.
By Moon Ihlwan in Seoul