Governance overhaul

Consensus is in the mold as investors try to find a compromise between Western model of shareholder capitalism and high efficiency of Korea’s chaebol system

By Cho Jin-seo

Sons and daughters of Korea’s big business families might feel content when they heard the news that Rupert Murdoch, the global media tycoon, is appointing his 38-year-old son as his successor.

It is common for Korean children to take over their fathers’ businesses however small their actual shareholdings are. And Murdoch’s case from now on will become a good excuse for those chaebol families that Western corporate governance culture, which is thought to be superior in management textbooks, may be not much different from Asia’s in reality.

The financial crisis of 2008 and 2009 to a large degree undermined the legitimacy of “shareholder capitalism,” which was most famously advocated by former GE boss Jack Welch. Instead, the fall of many American firms and the rise of many Chinese, Indian and Korean firms have made many believe that Asian corporate governance culture may not be that bad after all.

Just look at the performance of Korean stocks in recent years, chaebol families may say. The KOSPI has now recovered most of the damage inflicted during the global financial crisis and is back at its all-time high. Meanwhile, main indices in advanced economies such as the U.S., Japan, and Hong Kong are below their pre-crisis level. This leads to the question of whether their "good" corporate governance model is really relevant to shareholder returns.

Breach of social trust

To many global investors, at least on the surface, bad corporate governance culture is one reason for the so-called “Korea Discount” - that Korean stocks are undervalued because of incompetent and selfish chaebol leaders and inadequate and insufficient regulations by the government.

In January, Mark Mobius, a veteran fund manager at Franklin Templeton Investments, told a local newspaper that the main reason of the Korea discount was not the bellicose regime of North Korea but the opaque governance structure of chaebol.

CLSA, a French-owned equity broker, was even more critical. In a joint report titled Corporate Governance Watch, which was released in October 2010, CLSA and the Asian Corporate Governance Association (ACGA) rated Korea at the bottom of the league in Asia along with India and the Philippines. The top places were unsurprisingly taken by the former British colonies of Hong Kong and Singapore.

Moreover, the report said that the situation has worsened since Lee Myung-bak became president.

“Korea’s corporate governance development over the past three years has clearly stalled and, in some areas, backtracked,” said Charles Lee, the advocacy manager of ACGA.

“This result is not surprising because President Lee Myung-bak, a conservative who came to power in early 2008, is unabashedly pro-big business and has relegated corporate governance to near the bottom of the government’s policy priorities,” the report says, noting the president himself was once the CEO of a Hyundai subsidiary.

The evidence of unethical governance is everywhere at chaebol. The heads of three largest conglomerates ― Samsung, Hyundai Motor, and SK ― had been caught for corporate crimes such as tax evasion and embezzlement. The charge is usually that they illegally used corporate assets to enrich their private wealth or to pass on the wealth to their children without paying tax.

The case of Hyundai-Kia Automotive Group is the typical example of such “tunneling” of profits between subsidiaries. The group has been subcontracting most of its logistics processes to Glovis, a company owned by the chairman’s son. And the son, Chung Eui-sun, was suspected of using his growing assets at Glovis to increase his influence within the group. Some minor shareholders and NGOs have been furious with this breach of shareholder trust, accusing Hyundai’s board of directors of neglecting its fiduciary duty.

The problem of nepotism and the society’s leniency toward those found guilty is not confined to big firms. Park Yoon-bae, a shareholder activist who gained stardom after attacking the management of Taekwang Group last year, laments that “90 percent of Korean firms, big or small, are not free from such illegalities.”

Efforts are made

Regardless of such pessimism, there are clear signs that both the government and corporations are trying to fix the situation, albeit slowly. Last Thursday, President Lee convened a meeting of government agencies under the title of “fair society.” At it, the National Tax Service said it would crack down harder on improper wealth transfers and inheritance at chaebol families. Even the previously pro-chaebol media reported favorably on this announcement.

Courts have also made moves in recent months against corporate crimes. For example, a March 22 order to Hyundai-Kia Automotive Group Chairman Chung Mong-koo that he should pay the company 82.6 billion won ($74 mil) for his dubious dealing with Glovis. Both Chung and the plaintiffs (minor shareholders) accepted the verdict.

There are efforts being made from the market side as well. In recent years, so-called socially responsible investment (SRI) funds have been sprouting up in the equity market. SRI consultancies and advisory firms have also been established.

Big investors such as the National Pension Service (NPS) also began to introduce SRI planning in some of their investments. The NPS alone is believed to operate a 2.4 trillion won ($2.16 billion) SRI fund in Korea, and it vows to increase the amount.

Are chaebol always wrong?

Another trend in the equity market is that investors no longer see Korea’s corporate governance as necessarily bad, as witnessed in the recent stock price rises of Hyundai and Samsung stocks.

A motor industry analyst, who asked for anonymity, said that the advocates of American-style shareholder activism are simply naive, as they are detached from the reality of business.

“I do not want to be seen as a chaebol advocate. But the reality is that managing a big business is not that easy,” he said. “In the end, firms speak with their financial performance. If their behavior is really bad for the firm, then numbers will show it.”

The analyst then points to the fact that the share price of Kia Motors, where the embattled Chung Eui-sun is the CEO, has grown more than 10 times since January 2009.

“If the market think Chung is a bad manager for the firm, than how can they justify this jump? What is really important for firms, and for the national economy, is motivating and rewarding the entrepreneurship of business managers. In this respect, public opinion is not always right.”

A similar market response was seen on Samsung Group in recent months. On December 3, the group promoted Lee Jae-yong, the son of chairman Lee Kun-hee, to president at Samsung Electronics, the group’s flagship business. His rapid rise in the corporate hierarchy of Samsung over the past few years has been frequently criticized. Nevertheless, the firm’s stock price on that day rose to a then historic high. The firm also had a record profit last year.

A road ahead

Both the advocate and critics of the chaebol system agree on the need for more transparent governance at top management. Because of the closed nature of Korean corporate governance, foreign investors are often afraid of making long-term investment decisions regardless of their financial performance on paper, said Charles Lee, the manager at ACGA.

“If one day chaebol change their attitude toward minor shareholders and bring transparency to their governance structure, then foreign investors will surely welcome them,” he said.

Ryu Young-jae, the chief of Sustinvest, a firm specialized in SRI investment, says that having a better governance structure usually raises the firm's value. He cites a paper by Olaf Weber of the University of Waterloo and colleagues.

The research shows that the financial performance of 151 global SRI funds has on average outperformed the MSCI World Index, the global equity benchmark, during the period of 2002 and 2009 - by 40 percent for the bullish period between April 2003 and May 2007.

Ryu says that institutional investors, especially the pension funds, need to adopt an “engagement” approach in order to take the maximum benefit of the SRI investment. The concept is different from shareholder activism that it does not aim to fight against the management or to make a noise. They rather need to pursue a peaceful partnership with management in order to raise the long-term stock price of the firm, he says.

One weakness of the current SRI investment model is that it does not separate the various factors of responsible management, Lee of the ACGA says. For example, Samsung Electronics is often the top pick of domestic SRI funds, even though its governance does not impress investors. This is because of the “Greenwashing” - the firm spends big money in dealing with environmental issues, so that its environmental friendliness can more than compensate for its weak ratings in governance.

The path to corporate governance reform in Korea is to be a long, tedious process. NPS chairman Jun Kwang-woo said last month that though the pension fund is becoming more active in the SRI investment, it does not want a radical approach on the issue.

“We need to give more weight to firms that improve the citizens’ lives,” he said.

A simple but perceptive rule. But in reality, fund managers will struggle on the concept of good and bad corporate governance when stock prices of firms with good and bad governance structure are on the rise hand in hand. Now seems to be such time.