Behind Samsung's Bright Lights

Wild success, but how much does one family's tight control cost shareholders?

In many respects, Samsung Group is one of Korea Inc.'s leading lights. It is the country's largest conglomerate, with businesses in everything from insurance to industrial chemicals accounting for 20% of Korea's exports. And its flagship, Samsung Electronics Co., has transformed itself from a second-tier producer of TVs and appliances into a design powerhouse and the world's undisputed king of memory chips.

When it comes to corporate governance, though, Samsung doesn't shine quite so brightly. Sure, Korea's chaebol, or conglomerates, aren't as murky as they were a few years back. But continuing problems were highlighted on Oct. 4 when a Seoul court convicted two Samsung executives of breach of trust for helping pass control of the group from Chairman Lee Kun Hee to his children -- at the expense of other shareholders. The two were given suspended jail sentences but are appealing the decision. Lee family members haven't been charged with any wrongdoing in the affair and declined to comment for this story.

The two defendants were Park Ro Bin and Her Tae Hak, the current and former CEOs of Samsung Everland, an unlisted company that operates Korea's largest theme park. The court found them guilty of allowing Lee's children to buy 64% of their company in 1996 for less than $10 million -- an amount prosecutors said was 9% of the market value. Everland controls unlisted Samsung Life Insurance, which in turn owns 7.3% of crown jewel Samsung Electronics. That stake plus other holdings gives the Lee family control of 16% of Samsung Electronics -- enough to call the shots at the company. "Samsung is both the pride of Koreans and a reminder of the primitive capitalist system in the country," says Kim Sang Jo, a Hansung University economist who heads a shareholder activist movement.

Funny thing is, Samsung Electronics is one of Korea's most transparent companies. Foreign investors own 54% of its shares, and they have shown confidence in the elder Lee and CEO Yun Jong Yong. "The management is very focused," says Chen Gu, an analyst at DuPont Capital Management (DD ), a Delaware money manager that owns $80 million in Samsung Electronics shares. She says that in the long term, the group is better off with strong leaders such as Lee and Yun, who can invest in the future without fretting over quarterly results.

That system, though, creates plenty of potential for abuse. Lee and his family hold less than 5% of shares in the group's companies but wield near-absolute influence through a web of cross-holdings. Lee vets all key appointments, including the CEOs of 61 member companies, which means that loyalty to the family and the promotion of its interests can easily take precedence over the welfare of other shareholders.


Other chaebol, meanwhile, have done a better job of cleaning up their act. LG, for instance, two years ago set up a holding company that oversees LG Electronics and 16 other affiliates. That has boosted transparency by clarifying ownership, though even LG isn't exactly a paragon of corporate virtue: When credit-card issuer LG Card Co. ran into financial problems last year, other group companies ponied up nearly $900 million to bail it out.

The slow progress of chaebol reform means the "Korea discount" lives on. That's the drag on Korean share prices because of concerns that profits might be milked by controlling shareholders (as well as worry over the political risks posed by North Korea). Korean shares trade at an average of 9.3 times their projected 2006 earnings, 30% below the Asian average and the lowest multiple in the region, Merrill Lynch & Co. (MER ) says. "If Samsung Electronics moved its headquarters to New York and listed there, its shares would probably trade at double the current price," says one foreign fund manager who asked not to be identified. That's not likely to happen. Still, Samsung -- and even the Lee family -- would be well served if the group were to stay right where it is but make its governance as good as its world-beating products.

By Moon Ihlwan in Seoul, with Lauren Young in New York

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