Korea's Chaebol Syndrome Persists

Hyundai's troubles have tempered the arrogance of the country's dynastic family businesses, but many of their bad habits die hard

With its charismatic chairman, Chung Mong Koo, behind bars, Hyundai Motor appears deeply troubled. The probe into alleged financial improprieties by the 68-year-old tycoon took such a high toll that the company had to postpone the announcement of its quarterly financial results. The Hyundai Motor group, which includes Kia Motors, says it also has indefinitely put on hold plans to build new factories in the U.S. and the Czech Republic.

The shock waves running through the group are a testament to the near-absolute influence of Chung, the oldest surviving son of the company's founder. "The chairman's sudden removal has serious implications for the future of the company," says Hyundai spokesman Oles Gadacz. Vice-Chairman and co-CEO Kim Dong Jin will assume operational control, but the company lacks the "coordinating force" needed for important initiatives, Gadacz says.


  The overreaching power of the chairman also highlights the weak role of the board of directors at Hyundai, Korea's No.2 conglomerate, or chaebol. "It simply wouldn't make any sense for such important investment decisions to be affected by the probe if the company had a credible board," says Nam Dae Woo, an independent board director at SK Corp., the flagship of Korea's fourth-largest chaebol, SK Group.

Indeed, Chung's arrest on Apr. 28 calls into question the extent and nature of economic reforms Korea Inc. has carried out in recent years. Korean businesses and the government have been pitching global investors on the idea that the country takes transparency and improved corporate governance seriously.

State prosecutors, however, charge that wasn't the case at Hyundai. They say Chung inflicted damage worth more than $400 million to the group through irregular deals aimed at benefiting his family at the expense of other shareholders. Prosecutors also charged him with embezzlement for raising some $140 million in illegal funds used to pay political bribes. Neither the Chungs nor their lawyers were available for comment.


  What's really disturbing about Korea Inc. is that this kind of behavior isn't limited to Hyundai. In a report released on Apr. 6, shareholder activist group People's Solidarity for Participatory Democracy (PSPD) said a study of 250 companies belonging to the 38 largest family-run conglomerates showed a quarter of them had records of irregular deals aimed at enriching the family at the expense of public shareholders in the past 10 years. "The problem is widespread," says Kim Sang Jo, head of PSPD's Economic Reform Center.

Chaebol representatives counter the report doesn't fully take into account business reasons for the deals. Given the difficult business environment due to high oil prices and the rising Korean currency, PSPD is making irresponsible claims that could damage the credibility of Korean companies, says Yang Se Young, general manager at the Federation of Korean Industries, a chaebol lobby group.

No one would doubt that Korea's chaebol have come a long way in the past decade. In theory, at least, corporate governance has improved. Companies including Hyundai, Samsung, and LG are global brands that make top-quality products. The growth-at-all-cost mantra has weakened, and the priority is now on profits rather than market share.


  Hyundai, for instance, has filled four of its seven board seats with outside directors, and its audit committee consists solely of outsiders. Similar changes have been implemented at most chaebol. But the founding families continue to wield outsized influence. "The Hyundai case shows the chaebol haven't fundamentally changed," laments Jun Sung In, a Hongik University economist with expertise in commercial codes.

The most common method for transferring money to founding families is what activists call a usurpation of corporate opportunities. A family establishes an unlisted company, in many cases in the name of the chosen heir of the chaebol chieftain, with guarantees of lucrative deals from profitable affiliates. Such a newly created company prospers on revenues generated by those intra-group deals. Then the heir can list the company to realize profits by selling its shares. With the profits, he then buys shares in the flagship company to assume control.

An example is Glovis Co., Hyundai's auto-shipping arm. Chairman Chung and his son, Eui Sun, set up Glovis in 2001 with just a tad more than $5 million, but exclusive shipping contracts from Hyundai and Kia gave the company a profit of $82 million on sales of $1.6 billion in 2005. Activists say if the Chung family hadn't created Glovis, profits from shipping Hyundai and Kia vehicles would have benefited all shareholders.


  Glovis was listed on Korea's stock exchange last December, and it's now worth $1.3 billion, although its share price has plunged 28% since its chief executive was arrested in connection with the bribery investigation in March. Chung and his son now own 60% of Glovis -- after the December initial public offering and the earlier sale of a 20% stake to a Norwegian shipping company for more than $100 million.

That adds up to a stunning return on a $5 million investment, although the prosecution against Chung prompted the family to announce it would give up ownership of Glovis. The prosecutors say they also plan to indict the son, age 35, who serves as Kia's president, in connection with irregular deals.

Another way chaebol families ensure the passage of control to the next generation involves share deals with hefty discounts. A Korean court last year convicted two executives from Samsung Group, the country's largest chaebol, for arranging convertible bonds that allowed Samsung Chairman Lee Kun Hee's children to buy 64% of a holding company at less than one tenth of the market value. Samsung apologized for the issue and pledged donations to unspecified Korean charities to make up for the estimated $137 million in gains, though the children kept the shares in the company.


 Shareholder activists welcome the arrest of Chung. "The government is sending a strong message to chaebol companies that they are getting serious about enforcing the law," says Lee Ji Soo, a lawyer at the Center for Good Corporate Governance, a private watchdog group in Seoul. "This will have positive repercussions."

Korea's powerful chaebol are a legacy of the military dictators who offered low-interest loans to a select group of businessmen charged with leading the country's rapid industrialization following the Korean War. The country has grown out of dictatorship to become a democracy. Now, it's looking to its chaebol chieftains to improve their governance.

Before it's here, it's on the Bloomberg Terminal.