[Seri column]Korean-style corporate governance

Since the 1997 financial crisis, economic reform has occurred in four major areas: corporate governance, the financial sector, the labor market and state-owned enterprises. Of all these areas, corporate governance reform has been the key concern.
Government officials and some scholars have argued that “global standards” exist in the area of corporate governance practices. According to their claims, firms’ adherence to these standards would solve many problems related to horizontal expansion at jaebeol (business conglomerates), blamed as a main cause of the 1997 crisis. In addition, some others maintained that the “Korea discount” (stock prices in Korean public firms failing to reflect those firms’ real value) would vanish if the standards were met. While there is some truth to this line of reasoning, it is an argument that has gone too far. Indeed, some people equate “global standards” with accepted practices in Anglo-American-style corporate governance. Once this unquestioned assumption is taken out, however, it is hard to say their argument still holds.
The Anglo-American corporate governance model is characterized by several special features: widely dispersed share ownership, corporate control by professional managers, a board of directors composed of a majority of outside appointees, and the existence of an active M&A market. Among others, the most important characteristic of the model is that it puts the interests of the shareholder as the first priority. In order to align the interests of CEOs with those of shareholders, corporations endow their CEOs with stock options and other performance-based incentives.
Korea’s efforts to adopt Anglo-American practices, however, have turned out unexpected results. While the stated purpose of these reforms was to enhance corporate performance, promote growth and maintain economic stability, reforms seem to have done more damage than good. Rather, they produced sluggish corporate investment in plants and equipment, and myopia in corporate management.
Why has reform failed to deliver as promised? It seems to me that the reason lies in the fact that we did not consider the special context of the Korean economy. We simply tried to plug in imported market institutions, such as corporate governance-related regulations and practices, with little regard to how they would fit in a Korean context. One key example can be found in the strengthening of market discipline over firms, a characteristic of U.S. and U.K. corporate governance practices. Most public companies in the United States and Britain have highly dispersed shareholding structures, giving rise to diverging incentives between management and shareholders. In fact, only one-sixth of U.K. publicly traded firms have a dominant shareholder with ownership of more than 25 percent. In the United States, the comparable figure is less than one-twelfth. However, the dispersed ownership seen in the U.S. and the U.K. is the exception rather than the rule.
Ownership of firms in continental Europe is exceedingly concentrated: 93.6 percent of public firms in Belgium have dominant shareholders whose holdings top the 25 percent threshold. The comparable figure is 86.0 percent in Austria, 82.5 percent in Germany and 80.4 percent in the Netherlands.
Back to the issue of corporate governance reform in Korea, it is very important to remember the fact that corporate ownership in Korea’s public companies is similar to that in European countries. Dominant shareholders control corporations and monitor their CEOs.
As a result of such differing ownership structures, corporate governance reform trying to emulate the Anglo-American practices has largely failed. By strengthening the power of outside shareholders, conflict between the largest shareholder, in many cases represented by the group’s family and affiliates, and the second-largest shareholders, typically foreign investors, has intensified. Some private equity funds, which can establish paper companies in tax havens, could use a loophole in regulations. There are examples showing that current regulations discriminate against domestic investors in favor of their foreign counterparts.
For example, the Securities Trade Act prohibits exercising a voting right higher than 4 percent in selecting audit committee members of big public companies. The intention of this regulation is to protect the rights of minority shareholders from abuse by major shareholders. A private equity fund called Sovereign divided its shares into five paper companies, all with less than 4 percent shares of SK Corporation. As a result, it exerted all its rights of 14.99 percent in the proxy fight for electing the audit committee members in the 2004 annual shareholders meeting.
In contrast, the major shareholder group consisting of affiliated companies supporting the SK Corporation’s management could not exercise all of its voting rights because two of the affiliates had more than 4 percent voting rights. Such incidents, exemplified by some private equity funds, have caused political backlash against all foreign investors. Looking back over the last 10 years, it is important to remember that one size doesn’t always fit all.

*The writer is a research fellow at the Public Policy Research Division, Samsung Economic Research Institute. Inquiries on this article should be addressed to seriyongki.kim@sam sung.com.

by Kim Yong-ki