The 6th Asian Roundtable on Corporate Governance

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The 6th Asian Roundtable on Corporate
Governance Implementation and Enforcement in
Corporate Governance Youngjae Lim Korea
Development Institute Korea Theme I Various
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
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Korean Regulatory Agencies Enforcing Corporate
Governance

• Financial Supervisory Service regulating
  banking, securities and insurance
• Regulating listed companies in the securities
  market
• Staffs are not government officials gt
  Remuneration, recruitment, and training differ
  from those for the government officials.

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Korean Regulatory Agencies Enforcing Corporate
Governance

• Fair Trade Commission Regulating Chaebols
• Regulating private (unlisted) subsidiaries
  belonging 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

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Role of Regulatory Agencies regarding the
Implementation of 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

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Evaluating the Independence and Effectiveness of
Financial Regulatory Agency in Korea

• 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

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Index of the External Monitoring System 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.)

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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)

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Index of the External Monitoring System
Literature

• Bernard S. Black, The Legal and Institutional
  Preconditions for Strong Securities Market, UCLA
  Law Review 48781-855 (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 Works 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 Governance Score Abbreviated
  Criteria and Methodology (February, 2002) SP
  (w/ Questions)
• World Bank / IMF, Template for Country
  Assessment of Corporate Governance (July, 2000)
  World Bank

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Evaluating Institution Building
As of August, 2003
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Evaluating Practices in Korea (Experts Survey)
As of August, 2003 Accountability index
(practices, 0.45 institution building,0.9027)
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(Example) Institution Building Independence of
regulatory agencies

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

• OECDs 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

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Chaebols Ownership Structure

• Chaebols 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.
• gt The agency costs cannot be constrained.
• Concentrated ownership gt Internalizing costs

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Public Policy toward the Cross-shareholding
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

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Ownership Structure of SK Group
Note Author's estimation based on various
business reports and audit reports (as of
December 2001)
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• Table Inside Ownership for the 30 Largest
  Chaebols

(unit )
Source Press releases by the Korean Fair Trade
Commission
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Measuring the ownership structure of Korean
chaebols

• 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

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Explaining the differences of measurement in the
literature

• Large listed companies usually investing
  companies gt small wedges
• Other subsidiaries usually invested companies gt
  large wedges

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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

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Private firms belonging to Korean business groups

• Public investors in the investing large listed
  companies
• Corporate veil between investing and invested
  companies gt Public investors in the investing
  companies do not have any shareholder rights.
• the target of policies unresolved issue

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The Monopoly Regulation and Fair Trade Act
Regulation on Chaebol subsidiarys holding of
other companies shares

• A ceiling on equity investment ratio
• all individual subsidiaries for large Chaebols
  except for financial companies (NBFI)

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Ownership Structure of Samsung Group

• 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 controllers
  minority control.

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Ownership Structure of Samsung Group
Note Author's estimation based on various
business reports and audit reports (as of
December 2001)
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Pubic policy toward financial companies
fiduciary duty

• 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.

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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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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.