Korea's Whining Corporate Titans

The chaebol claim that restricting their cross-holdings would open them to foreign takeovers. That just doesn't wash

By Moon Ihlwan

To hear South Korea's big businesses complain about new legislation aimed at curbing abuses on the part of conglomerates, or chaebol, one would think that Korea Inc.'s crown jewels were in danger of en masse takeover by foreign investors. Execs at Samsung Electronics, Asia's most profitable electronics company, and other chaebol warn that steps taken by President Roh Moo Hyun's Administration to improve transparency and shareholder value could make their companies vulnerable. They point out that more than 50% of many valuable companies, including Samsung, Hyundai Motor, Posco (PKX ), Kookmin Bank (KB ), and SK Corp., are now owned by foreigners, who in theory could engineer boardroom changes.

The chaebol's claim, however, is nothing but a ploy to perpetuate business practices frowned on in other mature markets. "They are simply making ridiculous demands by drumming up dreamed-up fears," laments Ha Joon, a senior activist at People's Solidarity for Participatory Democracy, which promotes shareholder rights.

The chaebol lobby is vigorously protesting a bill passed by the National Assembly in December that aims to limit the influence of the conglomerates' founding families. It will gradually lower -- from the current 30%, to 15%, in 2008 -- the voting rights of chaebol financial arms that have used customers' funds to buy shares in core group companies to guarantee the companies are run as the families desire. Starting in 2008, the financial arms will be denied any voting rights in an affiliate if the group's nonfinancial units already hold a combined 15% stake in the affiliate concerned.


  Ironically, the legislation doesn't satisfy shareholder activists, either. While they welcome moves to rein in chaebol maneuvering, they say such abuses must be completely banned to put an end to a bad corporate-governance system in Korea. The chaebol, however, are calling for repeal of the ceiling on the amount their units can invest in other affiliates.

In truth, the argument that Korean conglomerates' management rights must be protected from foreign influence is flawed. Chaebol execs say, for example, that foreign investors will pursue higher dividends at the expense of investing in longer-term projects. But any investors, whether foreign or local, with large equity holdings aren't likely to engage in practices that will drive down the share price -- and the value of their holdings. Companies grant fat dividends because they can afford to, not because they're forced to.

The International Monetary Fund supports the new legislation because better corporate governance is likely to promote, rather than hinder, investment. "Improvements in governance will reduce the 'Korea discount' on equity, thereby lowering the cost of raising capital," a recent IMF report noted. Indeed, the Korea discount is steep. Park Kyung Min, chief executive at Hangaram Investment Management, reckons the average price-earnings multiple based on 2004 estimates for companies listed on the Seoul stock exchange is 6, vs. an average of 10 for those on the Taipei stock market.


  Also fallacious is the claim that restrictions on shareholding will favor foreign -- over local -- investors. In fact, the new regulations are designed to ensure equal rights for all shareholders. Any Korean individual is free to buy shares in local companies. The restrictions simply prevent founding families from wielding far greater power than their share ownership warrants. And if foreign investors were to engage in any questionable cross-shareholding among affiliates, it's likely that the reform-minded government would take action.

Take the example of Samsung. Chairman Lee Kun Hee, the scion of the founding family, and his relatives own only 3.3% of the electronics company. Yet Samsung Life, Korea's biggest life insurer, bought a 7.2% stake in the electronics giant -- using customers' assets. Taking into account stakes held by Samsung's other affiliates, Lee's voting power tallies 20.9%, ensuring him management control.

In the run-up to the December legislation, chaebol lobby groups such as the Federation of Korean Industries had warned that Samsung and other blue chips could be targets of hostile takeovers. They trumpeted that Samsung and other well-run companies are majority-owned by foreigners -- but neglected to point out that all major foreign investors holding those stocks are pension funds or portfolio fund managers. "I have never heard of a pension fund actively pursuing a hostile takeover," says Korea University finance professor Jang Ha Sung. Indeed, Korean Finance Minister Lee Hun Jae agrees that a hostile takeover aimed at Samsung Electronics is impossible.


  The chaebol lobby is also fighting a law that will allow minority shareholders to file class actions against companies with flawed accounting practices. Citing the forward-looking spirit of the law, the chaebol seek exemption for carrying over accounting manipulations from past irregularities. True, the purpose of the new law isn't to punish past accounting wrongdoings, which were widespread, but to guarantee future transparency. Yet allowing the chaebol to delay cleaning up their act will only prolong the Korea discount.

Here's hoping that the power of the chaebol isn't great enough to overturn the new legislation and stop additional reforms. The laws don't put to rest corporate-governance concerns in Korea, but they're long-overdue, much-needed steps in the right direction.

Moon is BusinessWeek's Seoul bureau chief

Edited by Patricia O'Connell

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