Introduction: The Political Economy of Corporate Restructuring

Abstract

SOAS (DKS 338.8 / 842 508) The financial crisis that swept through Asia in 1997-98 had many roots, but one that has received increasing attention is the nature of the Asian business group (Pomerleano 1998; Claessens, Djankov and Lang 2000b; Rajan and Zingales 1998; Johnson et al. 2000; Johnson and Mitton 2001). These highly diversified, family-owned conglomerates have been the entrepreneurial engine of Asia's rapid growth over the last three decades. But at the same time they exhibited a number of troubling weaknesses, from high leveraging to weak corporate governance, lack of transparency and outright corruption. 1 In no country in the region is this ambivalence about the business group more pronounced than Korea. Influential accounts of Korea's growth have put the Korean groups, or chaebol, at the very center of the country's economic transformation (Amsden 1989). Yet the chaebol's close and collusive ties with the government, increasing dominance of Korea's economy and oligopolistic practices also made them politically controversial (Cho 1990). These perceptions only strengthened with the financial crisis, for which many Koreans held die chaebol directly responsible. 1 After highlighting major features of the chaebol as a corporate form, we discuss internal governance problems that arise from the chaebol's ownership and control patterns. In particular, we emphasize that the chaebol form consists of subsidiaries rather than divisions. This multi-subsidiary structure may be exploited to advance the interests of the founder's family at the expense of other stakeholders (as well as efficiency) when countervailing legal measures are not available. Although the pre-crisis literature typically presumed the chaebol were characterized by concentrated ownership, we note that important changes have taken place in ownership patterns since the early 1980s. 2 We also show that the external dimension of the chaebol's corporate governance has undergone significant change as well. Democratization and liberalization increasingly shifted the balance of power from the government to the chaebol, but expectations for implicit government protection from bankruptcy continued to operate and distorted the resource allocation process (Hahn 2000). At least by the mid-1990s, the efficiency advantage of the chaebol was more presumed than real, and systemic risks were building up as Korea was caught between the old developmental state model and a market economy. 2 Theoretical Approaches to the Chaebol The efficiency model The principal-agent model Political economy approaches The Chaebol and the 1997 Crisis The Political Economy of Crisis Management '5'he Political Economy of Structural Reform The short-run corporate restructuring effort did not precede the initiation of structural reforms; indeed, the new administration appeared more clear in its intentions with respect to these structural measures than it was with the financial restructuring program just outlined. These reforms focused squarely on corporate governance (see Chapters 6 and 12). Although they appeared to emanate from a consultative process between the president and the major chaebol leaders, Mo and Moon argue in Chapter 6 that the extent of private sector input to the process was probably minimal. The extensive legislative and regulatory program that evolved in the early months of 1998 predominantly reflected the preferences of the new administration, with input from the international financial institutions. 21 22 The five principles of corporate restructuring agreed on January 13, 1998 included enhancing transparency in accounting and management, resolving mutual debt guarantees among chaebol affiliates, improving firms' financial structure through a reduction of debt-equity ratios, streamlining business activities, and strengthening the accountability of chaebol bosses. On the occasion of Kim Dae-jung's National Liberation Day speech of August 15, 1999 - the high tide of the administration's skepticism about the chaebol-he announced three more principles, including regulation of the chaebol's control of non-bank financial institutions and inter-subsidiary equity investments, and prevention of irregular inheritance and gift-giving among chaebol owners. 22 Myeong-Hyeon Cho provides a detailed overview of these reforms in Chapter 12. His analytic starting point is what we have called the entrenchment problem: the difficulty of controlling owner-managers who have relatively low stakes in the firm but exercise control through in-group ownership. Many of the reforms clearly targeted this problem. Even more directive measures focused on the financial structure of the chaebol group and sought to cut through long-standing corporate practices that expropriated minority shareholders' value or shifted risk to the public sector (see section 2 above). 22 Cho's evaluation of the reforms is generally positive, particularly with respect to the reform of accounting procedures, transparency and disclosure, and shareholder rights. But Cho highlights a number of areas where owner-managers continue to evade effective oversight. For example, while the crisis led to a decline in the founding family's stake in its companies - a development Joh and Kim find adversely affects performance (Chapter 5) - the stake controlled by affiliated firms actually increased, potentially worsening entrenchment problems. Boards of directors have become more accountable, but questions remain about whether "outside" directors really enjoy independence. 22 Despite the importance of internal corporate governance mechanisms, the overall legal and market environment in which the chaebol function - including external corporate governance mechanisms - will probably have a greater influence on firm behavior in the long run. One of the most important of these environmental factors is the role of foreign direct investment in the economy. Korea has historically had a low level of foreign investment, but the Kim Dae-jung government dramatically accelerated the gradual opening process that had begun under his predecessors. 22 Mikyung Yun argues in Chapter 10 that concerns about the anticompetitive effects of foreign direct investment cannot be altogether dismissed; increasing foreign investment may simply trade concentrated domestic ownership for concentrated foreign ownership. However, Yun argues that such concentration may simply be the result of competitive processes. In a setting in which the market for corporate control is so weakly developed, opening the country both to more foreign investment and to cross-border mergers and acquisitions is likely to have a salutary effect on chaebol management and performance. In three case studies, she traces some mechanisms through which this might occur, including the effects of joint venture partnerships on internal corporate governance and the transfer of managerial technology. 22 23 The incentives to corporate restructuring are also powerfully affected by foreclosure and bankruptcy laws. If these laws or their implementation are weak, firms have incentives to delay restructuring debt and operations and even repayment. Reform of the bankruptcy process and clear enforcement of bankruptcy and foreclosure laws are important not only for managing actual firm failures, but also for providing incentives to creditors and debtors to reach out-of-court settlements. 23 Compared with Southeast Asian countries, bankruptcy procedures were somewhat stronger in Korea when the crisis hit. Implicit government guarantees against the bankruptcy of large chaebol, however, made these procedures less applicable than they appeared. When deciding whether to give a bankrupt firm a second chance, the law also effectively required the court to look beyond the firm itself and to consider the broader ramifications of the firm's failure for the local and national economy. 23 Using firm-level productivity data, Youngjae Lim shows in Chapter 9 that Korean bankruptcy procedures were biased toward rehabilitation rather than liquidation, even when the latter was warranted. Firms accepted into the rehabilitation-oriented bankruptcy procedures typically had lower than average productivity and continued to exhibit below-average productivity well after the initiation of the rehabilitation program. Even firms in structurally depressed industries, with little hope for a turnaround, were allowed to prolong their lives. 23 Since the crisis, the bankruptcy law has undergone two rounds of major reform in order to correct this bias and to expedite the process itself. It remains to be seen whether these changes, combined with corporate governance and financial sector reforms, will be sufficient to facilitate the orderly exit of nonviable firms. 23 The final component of the external environment that we examine is competition policy. In Chapter 11, Kwangshik Shin makes a strong argument that the fundamental problem posed by the chaebol is not conglomerate size, ownership concentration, nor even their propensity for "unfair" competition. Nonetheless, Shin shows that these perceptions have guided Korean competition policy and given it its particularly interventionist and directive character. Beginning with the Chun Doo Hwan administration, successive Korean governments initiated "chaebol policies" that attempted to impose various direct controls of investment policies" and financing behavior on the large groups. These policies typically had little success in mitigating the problems they purported to address, particularly the level of concentration in the economy. 23 24 Shin argues that the chaebol created competition problems not because of conglomerate size per se but because of two broader problems. First, the combination of industrial policy, trade protection, limitations on foreign direct investment and a variety of formal and informal barriers to entry and exit shielded the cha