Corporate Governance Trends Analyzed

Why did the SK Corporation, worth 47 trillion won, suffer an affront when Sovereign Asset Management attempted to enhance its corporate governance with a mere 170 billion won, or 0.3 percent of its corporate value? Why did Hyundai Group and KCC go through a management feud? And why did Doosan Group have to suffer a “War of Brothers?” All these incidents happened because the families owning the companies lacked corporate management power, and thereby were unable to defend their management control.

A team led by Professor Chang Deok-jin of Seoul National University has expressed numerical trends in Korean company losses of corporate governance after the Asian financial crisis by analyzing investment practices from 1997 to 2003.

Less owner holdings and diversified shares-

The team used the concept of ratios from zero to one in order to show how many shares corporate owners maintain.

Since 1997, the average ratio of the top 29 Korean companies was 0.431 in 1997, 0.371 in 1998, 0.419 in 1999, 0.372 in 2000, 0.373 in 2001, 0.359 in 2002, and 0.377 in 2003, a gradual fall with some variations.

In other words, ownership shareholding is decreasing, and the shareholders themselves are becoming more diverse due to the government’s regulations on ownership and inheritance.

At the end of 2003, the top five conglomerates with strongest corporate governance were Hyundai Development Company (0.888), KCC (0.798), Shinsegae (0.758), Hyosung (0.754), and Daesang Corp. (0.630). The bottom five groups were SK Corp. (0.053), Doosan (0.097), Hanhwa (0.105) Hyundai Heavy Industries Corp. (0.125) and Hyundai Motor Company (0.135).

Samsung Group, the largest Korean company, ranked seventh from the bottom among 29 companies.

29 corporations, four groups-

The team plotted a graph of corporate governance with investment relations among subsidiaries as an axis.

It plotted data from 29 corporations into four quadrants, with corporate governance as the Y axis and investment relations as the X axis.

The investment relations axis shows how much corporate governance an owner has in terms of subsidiary shareholding. The more complex an investment structure is, and the more indirectly an owner holds his subsidiaries’ shares, the higher the corporation score between zero and one.

TK Corporation, KCC and Shinsegae are in the first quadrant, which is characteristic of companies in the 1980s. They have complex corporate investment structures and their owners have strong management control. They are not exposed to takeover bids from other companies.

Korea Iron and Steel Corp., Hyundai Department Store, Oriental Chemical Industries, and CJ are in the second quadrant, which means their owners have high share ownership, but that they have separate affiliate companies. Their share ownership is high in one or two core affiliates, and these core affiliated companies have many shares of other subsidiary companies. They bear a resemblance to corporate governance of holding companies.

The third quadrant is a corporate management risk-zone that includes Samsung, SK, Hyundai, Hanwha, and Doosan. These companies have small total share proportions and relatively simple investment structures, leaving them open to management attacks from other corporations. In addition, they are likely to be on a shaky ground if their owner families feud over management control.

LG Group belongs to the third quadrant, but it has relatively stronger corporate governance numbers since it is transitioning to a holding company after spinning off LG Cable in 2003

Not many companies are in the fourth quadrant. They have weak corporate governance and complex investment structures.

Hyundai threatened-

A squabble over management control in November 2003 clearly showed how vulnerable a company can be when an owner family loses corporate governance.

KCC almost took over Hyundai Group with over 40 percent of Hyundai Elevator, the holding company of Hyundai Group.

Chang’s team explains that because Hyundai Group had weak corporate governance since the 1997-98 Asian financial crisis, the group came under attack by KCC thanks to its owner’s strong corporate governance.

The Hyundai Group’s corporate governance ratio decreased from 0.37 in 1997 to 0.10 in 2001, while the KCC owner’s ranked second among 29 groups in 2003 with a 0.79 ratio.

“The Korean method of controlling a company efficiently with relatively small assets became an Achilles heel. These groups became vulnerable to other companies’ bids to control them with changes in the management environment,” said Chang.

Changes to the holding company system are needed-

Most conglomerates have trouble maintaining management control and inheriting companies. They try to enhance corporate governance through separating companies and converting to the holding company system,

All eyes are on the conglomerates in the third quadrant over how they will bolster corporate governance. They have to have the financial capabilities to invest on a large scale.

Also, they may be violating trade laws when they invest in their affiliates. To enlist the support of small investors like SK did, they should promise transparent management.

“The current system limits corporate efforts to strengthen corporate governance. At a time when there is more foreign money than local funding, the government should come up with a long term roadmap which can help companies make the switch to holding company structures,” said Chang.

“Some will remain the same, while global companies like Samsung will take the lead in separating their affiliates,” said Professor Chang Ha-sung of Korea University.

Kwang-Hyun Kim Se-Jin Jung kkh@donga.com mint4a@donga.com