korea development institute 0 the 6th asian roundtable on corporate governance implementation and...

Korea Development Institute 1

The 6th Asian Roundtable on Corporate Governance

Implementation and Enforcement in Corporate Governance

Youngjae LimKorea Development Institute

Korea

Theme IVarious experiences to ensure effective implementation – allocation of

responsibilities and institutional frameworks

Seoul, Korea

2-3 November 2004

The views expressed in this paper are those of the author and do not necessarily represent the opinions of the OECD or its Member countries or the World Bank


Financial Supervisory Service: regulating banking, securities and insurance

Regulating listed companies in the securities market

Staffs are not government officials => Remuneration, recruitment, and training differ from those for the government officials.

Korean Regulatory Agencies Enforcing Corporate Governance


Fair Trade Commission: Regulating Chaebols Regulating private (unlisted) subsidiaries belongi

ng to business groups In many countries, private companies are not the

target of regulation since the public investors to protect are not involved: high cash-flow right and high control right

But, in Korean business groups, unlisted subsidiaries’ behavior has important implications on the public investors of the listed subsidiaries belonging to the same business groups: low cash-flow right and high control right

Korean Regulatory Agencies Enforcing Corporate Governance


Internal monitoring system: board of directors, audit committee, or minority shareholders’ rights

External monitoring system (market pressure): potential shareholders in the capital market, institutional investors, hostile takeovers

Regulatory agencies of the government: infrastructure for the external monitoring system to work

Financial Supervisory Service, Fair Trade Commission, Prosecutors, or Courts

Role of Regulatory Agencies regarding the Implementation of Corporate Governance


“Developing and Measuring an Evaluation Index for Market Reform” KDI Report, 2003

Chapter 4. “Capital Market Transparency and Investor Protection: A Comparative Law Perspective” by Ok-riak Song and Taeyoon Sung

Since the 1997 financial crisis, Korea has introduced many changes in financial regulatory systems to improve the enforcement of corporate governance.

Evaluate these reform efforts from the perspectives of institution building and actual practices

Evaluate how the external monitoring system works as of 2003 in Korea

Evaluating the Independence and Effectiveness of Financial Regulatory Agency in Korea


Sub-index: transparency index and accountability index

Transparency index: whether relevant information is distributed to shareholders (both current and potential)

Accountability index: how shareholders (both current and potential) place their pressures on the current management (hostile takeovers, etc.)

Index of the External Monitoring System in Korea


Contents of Transparency index (1) Information-related legal system: distribution

of relevant information in a timely and effective manners

(2) Enforcement system: independent and efficient supervision for (1)

Regulatory agencies

Civil enforcement (civil liabilities regarding external auditors or class action suit)

Index of the External Monitoring System in Korea


• Bernard S. Black, The Legal and Institutional Preconditions for Strong Se

curities Market, UCLA Law Review 48:781-855 (2001) [Black] • CLSA, CG Watch: Corporate Governance in Asia (April, 2003) [CLSA] • ISS, Corporate Governance Quotient Rating Criteria [ISS]• Rafael La Prota, Florencio Lopez-de-Silanes & Andrei Shleifer, What Wor

ks in Securities Laws?, Working Paper (October, 2002) [LLS] • Partrick S. McGurn, Keeping Score: Rating Governance in the Post-Enron

World, Strategic Investor Relations 7-10 (fall, 2002) • OECD, Questions for Rating Corporate Governance • Standard & Poor's Corporate Governance Service, Company Corporate G

overnance Score: Abbreviated Criteria and Methodology (February, 2002)

[S&P] (w/ Questions) • World Bank / IMF, Template for Country Assessment of Corporate Gover

nance (July, 2000) [World Bank]

Index of the External Monitoring System: Literature


1-2. Transparency (Enforcement system)

0.94440.7222

0.8333

1

1

U.S.

0.6667

1

0.5

Korea

Civil enforcement

Effectiveness of regulatory agencies

Independence of regulatory agencies

* As of August, 2003

1-1. Transparency (Information-related legal system)

0.87500.7857

0.6250

1

1

U.S.

0.6250

0.8571

0.8750

Korea

External audit system

Disclosure items

Disclosure system

Evaluating Institution Building*

18


1-2. Transparency (Enforcement system)

0.72220.39

0.6667

1

0.5

Institution Building

0.19

0.51

0.47

Practices

Civil enforcement

Effectiveness of regulatory agencies

Independence of regulatory agencies

* As of August, 2003; Accountability index (practices, 0.45; institution building,0.9027)

1-1. Transparency (Information-related legal system)

0.78570.5

0.6250

0.8750

Institution building

0.53

0.47

Practices

External audit system

Disclsure items

Disclosure system

Evaluating Practices in Korea (Experts Survey)*

18

• Korea : Members of the FSS can serve for three years ans can be reappointed once (Financial Supervisory Service Act Article 6, Clause 1). However, only the appointed members namely Chair and Vice Chair of the FSS are guaranteed of their position (0 point)

•U.S. : members of the SEC can serve their position for five years (Securities Act of 1934, Article 4, Clause (a)). There is no precedent of SEC members being dismissed during their terms (1 point)

Dismissal of regulatory agency

members

(Example)Institution Building: Independence of regulatory agencies (Example)Institution Building: Independence of regulatory agencies


OECD’s 2nd Principles of Corporate Governance Question: Which regulatory agency should enforce

the corporate governance of business groups? Private (unlisted) companies belonging to business

groups Chaebols’ ownership structure in Korea

Regulating Corporate Governance of Business Groups: Fair Trade Commission In Korea


Chaebol’s controlling shareholder owns only a small fraction of equities by cross-shareholding or by pyramiding (Controlling Minority System).

The separation between control and cash-flow rights can distort incentives.

The dispersed ownership also has agency costs but the market for corporate control would discipline the controller (or the management).

The CMS insulates the controller from the market for corporate control.

=> The agency costs cannot be constrained. Concentrated ownership => Internalizing costs

Chaebols’ Ownership Structure


The first best policy Completing market discipline (legal protection of minority shareholders, reputation) Removing (free) private benefits of control

The second best policy Minimizing the destruction of firm value Still the transfer of values from minority shareholders to controlling shareholders

Public Policy toward the Cross-shareholding Structure


Note: Author's estimation based on various business reports and audit reports (as of December 2001)

Ownership Structure of SK Group


11

1

1

2

1

2

1

111

2

2 22

1

22 2

2

1

2

22

2

2

22

2

1

2

22

2

2

22

2 2

2

2

2

2

22

22

2

2

2

1

2

1

22

2

2

2

2

2

2

2

2

0.2

.4.6

.81

votin

g rig

ht

0 .2 .4 .6 .8 1cash-flow right

Samsung Group, Year 2002


1

22

11

1

1

1

1

2

1

2

2

1

2 2

1

2

1

1

2

2

1

2

2 2

2

22

2

2

2

1

1

2

2

2

2

1

222

22

2

1

1

2

2

2

0.2

.4.6

.81

votin

g rig

ht


LG Group, Year 2002


1

1

1

2

2

2

1

2222

1

2

2

1

2

2

1

1

2

2

2

2

2

2

2

222222

2

22

22

22

2

1

2

22

2

2

22

2

2

2

2

2 2

2

2

2

11

2

0.2

.4.6

.81

votin

g rig

ht


SK Group, Year 2002


• Table Inside Ownership for the 30 Largest Chaebols

41.841.149.543.642.2Total

35.236.644.135.733.7Affiliated Companies

2.33.03.44.84.8Family

3.31.52.03.13.7Controlling Shareholder

20001999199819971996Inside Owners

Source: Press releases by the Korean Fair Trade Commission

(unit: %)


La Porta, Lopez-de-Silanes, Shleifer, and Vishny (2002)

South Korea: 20 large listed firms

cash-flow right: 18 %, control right: 24 %

Calculating for the 11 largest chaebol groups cash-flow right: 14%, control right: 41%

Measuring the ownership structure of Korean chaebols


Large listed companies: usually investing companies => small wedges

Other subsidiaries: usually invested companies => large wedges

Explaining the differences of measurement in the literature


Private (unlisted) firms Usually, not the target of policies No public investors to protect high cash-flow right and high control right

But, Korean business groups: (very) low cash-flow right and high control right

Public investors to protect

Explaining the differences of measurement in the literature


Public investors in the investing large listed companies

Corporate veil between investing and invested companies => Public investors in the investing companies do not have any shareholder rights.

the target of policies: unresolved issue

Private firms belonging to Korean business groups


A ceiling on equity investment ratio all individual subsidiaries for large Chaebols excep

t for financial companies (NBFI)

The Monopoly Regulation and Fair Trade Act: Regulation on Chaebol subsidiary’s holding of other companies’ shares


Estimated from the business and audit reports as of December 2001

Samsung Group had 63 companies under the control. The 19 companies in the figure account more than 80% of total assets.

Controlling shareholders own only four companies directly: Samsung Everland (28.82%), Samsung Life Insurance (4.54%), Samsung Electronics (2.0%), Samsung General Trading (1.42%). Among the four companies, Samsung Life Insurance plays the most important role in entrenching controller’s minority control.

Ownership Structure of Samsung Group


Ownership Structure of Samsung Group

Note: Author's estimation based on various business reports and audit reports (as of December 2001)


Investment trust companies or insurance companies can exercise their voting rights for controlling shareholder.

Fiduciary duty regulation is needed as a prudential regulation

Frequent and prompt disclosures on the portfolios of financial companies are also needed.

Pubic policy toward financial companies’ fiduciary duty


The KMRFTA allows Chaebol-affiliated financial companies to exercise their voting rights in such cases as: (a) appointment or dismissal of officers, (b) alteration of the articles of companies, and (c) merger of the said affiliated company with another company, or transfer of the whole or part of business to another company.


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