Henry M. Seggerman President International Investment Advisers

There is always a lot of grumbling about “backsliding” in Korean corporate governance, how the chaebols have re-asserted their economically destructive behavior patterns, due to sagging will to reform on the part of the government. You hear this complaint from foreign investors as well as from Korean shareholder activists.

I’d agree we are seeing zero progress in two areas lately: inheritance transfers and circular shareholdings. Back taxes were imposed on a couple of inheritance deals, but we need to see dozens of these fraudulent transactions nullified before the value-destroying practice can really be halted. As for circular shareholdings, it was quite strange a few weeks ago to hear the regulators bring this up as evidence of chaebol abuse for the first time, only to announce that they had no intention of dealing with it.

As we approach the ten-year anniversary of Korea’s 1997 Financial Crisis, I would like to take this opportunity to point out the enormous progress that has in fact been made in this time period, acknowledging that some homework does remain incomplete. In general, I believe successive Korean administrations have succeeded in substantially reducing the unchecked power of Korea’s top chaebol. Everything here admittedly is old news, but I think it is worthwhile to enumerate these accomplishments as we reach this ten-year milestone.

Samsung. Samsung Electronics spending five trillion won of shareholder money to start up an auto company was certainly the most egregious example of failure to focus on core competence to date. The government wisely forced Samsung to get out of the auto business and it sold Samsung Motors to Renault.

Korea’s campaign finance laws are very restrictive, and big business does not have options such as political action committees. Thus, it has been a long-standing tradition for candidates to squeeze all the big chaebol for secret cash contributions, normally expected to be drawn from slush funds funded by manipulating “campaign stocks,” as well as by outright embezzlement. Though campaign finance reform is still needed, the Korean government did take the step of a symbolic prosecution of Samsung’s Chairman Lee, Gun-hee for campaign contributions solicited by candidates from the group eight years earlier. Unfortunately, none of the candidates who solicited and benefited from these secret contributions are serving long prison terms, but we can at least be thankful that the value-destroying practice has been impeded going forward.

LG. The Taiwanese had achieved great success in the foundry business, so Korea had good reason to fear overcapacity when the Taiwanese entered the memory chip business aggressively. This made LG’s move into semiconductors completely insane, only worsened by the paper-thin financial underpinnings for LG Semiconductor. Although the forced merger with Hyundai Electronics in DJ Kim’s fabled “Big Deal” did not eliminate LG Semiconductor’s staggering debt, it certainly prevented a no-holds-barred memory chip price war in Korea, which would have been quite harmful to its economy and stock market.

More recently, LG was the first of the Big Four to adopt the holding company structure promoted by the Korean government. Although LG Corp. took this opportunity to extort from LG Electronics a precedent-setting “brand royalty” based on a percentage of total sales, the LG group was at least setting an example of transparent ownership, with no cross shareholding and no circular shareholding whatsoever. Hopefully, the other chaebol will follow this example.

Hyundai. Before the crisis, Hyundai was the largest chaebol, an octopus-like structure with tentacles in innumerable business sectors. While tensions amongst JY Chung’s sons simmered on their own, we can certainly credit the government with strongly pushing for disaffiliation after the death of the founder, leading to the break-up of the old behemoth into much smaller groups, each with a far better focus on a core competence. There were teething pains, especially with several secret residual loan guarantees made by Motors affiliates to Hynix, but the new structure eventually stabilized.

Hyundai has always had more power to have its way with the Korean government than the other chaebol, and bribery has a long tradition in Korean business, most notably in the construction sector, where exacting approvals are always required. Nonetheless, the government had the courage to prosecute Chung, Mong-koo for construction bribes, and one hopes the corrupt government regulators who solicited and were in fact the beneficiaries of these bribes will be serving long prison terms soon.

SK. Going into the Asian currency crisis, the SK group certainly had some rather notorious baggage, the graft-tinged Roh I acquisition of Korea Mobile Telecom, which led to one of Korea’s finest tech monopolies being abused as the group’s cash cow for a number of years. But a watershed event took place in 1999. The Tiger Fund’s Julian Robertson and PSPD’s Jang, HaSung teamed up in a very successful Board revolt at SK Telecom. The result of this was special committees with real outside Director majorities being given actual veto power over the most flagrantly unfair internal financial transactions. Whilst the vast majority of Korea’s so-called outside Directors are slavishly beholden to management, and whilst SK Telecom’s special committees never really brought the hammer down on management, the simple fact of their existence is a disincentive to further value destruction.

Four years following this, there was more discipline for SK’s errant controlling shareholders, as Chey, Tae-won was sentenced to a three-year prison term for various frauds and transgressions in the trillion-won SK Global collapse. Many months later, a Roh II judiciary let him off the hook, but the initial sentence certainly sent a clear message to corporate Korea, as did the prosecutions of Lee, Gun-hee and Chung, Mong-koo.

Daewoo. Before WorldCom went bust, Daewoo was the biggest bankruptcy in the history of the world, with a staggering eighty trillion won in bad debts. Though viewed as a huge cataclysm, Daewoo’s collapse had no effect on 1999’s surging stock market or the creditworthiness of corporate Korea. Essentially, the Korean government and its command-economy banking system scheduled the event, completely purged the founding family from management, indicted the Chairman, and efficiently stabilized any affiliates with viable business activities. For nearly ten years prior to its demise, Daewoo exemplified the “too big to fail” syndrome in Korea, with many key affiliates running debt-to-equity ratios above 1,000% and government-directed “Policy Loans” shoveled into the gaping maw on demand. With two assured years of robust economic growth and the fastest-rising stock market in the world, the Korean government just decided enough was enough, and snuffed out Daewoo just by not rolling over any more loans.

I concentrated here on the Big Five chaebol to demonstrate the magnitude of heavy lifting which has been done already. However, it’s important also to acknowledge how much change we have seen in the mid- and small-sized chaebol, as well, for example with SsangYong and Hanjin.

It is easy to say that “ Korea has come a long way” since the 1997 Asian currency crisis. But why not also say “ Korea came a long way” in the 25 years before the crisis? Don’t forget, in 1972, Korea’s per capita GDP was below North Korea’s, about the same level as Uganda. The 10,000% economic growth in those years would not have been possible without “Policy Loans,” the “Iron Triangle,” and all the smoke-and-mirrors tricks devised by the chaebol and their cronies in the government and the banks. In 1997, The Asian currency crisis forced Korea to enter the real world and abandon these tricks, but no one can deny that they engendered explosive economic growth for the prior 25 years.