Korea is going through a rapid metamorphosis as the market reform process moves into high gear. Shareholder rights are near the top of the agenda for frustrated investors. In the past, few would dare challenge the direction of Korea’s massive conglomerates, its chaebols. The management teams of these all-powerful companies did what they liked and virtually ignored shareholders. However, they are now being dragged kicking and screaming into a new era.
In a landmark case for minority shareholder rights earlier this year, Seoul District Court ordered Lee Chol-Soo, former president of Korea First Bank (KFB), and three other executives, to pay $32.3 mn in compensation for losses incurred by poor management. Shareholders claimed management was responsible for bringing KFB to the verge of bankruptcy through bad loans to the now bankrupt Jinro Group, Kia Group and Hanbo Steel. Over 150 shareholders took part in the suit filed on their behalf by the People’s Solidarity for Participatory Democracy (PSPD), an organization designed to protect minority shareholders. In a first for Korea, a derivative suit (where compensation goes directly to the company) was also filed by 61 of the shareholders.
In the sights
‘What made the First Bank situation unpalatable was that the bank’s chairman went ahead with loans to Hanbo Steel in spite of knowing that the company was on the brink of collapse,’ says Joo Young Kim, the PSPD’s lawyer. ‘The bank lent a huge amount to Hanbo, and it is alleged that the chairman received bribes from the steel company. Shareholders realized the illicit connection between the chaebols and the bank and they were very angry.’
Leading shareholders into battle is Dr Jang Ha-Sung, a Korea University economist who has rallied against the abusive power of the chaebols. Jang waged his war in the press at first but has now moved on to the courts. Armed with an aggressive group of lawyers and accountants, PSPD founder Jang is forcing chaebols through the litigation hoop. KFB was his first target, Samsung is still in litigation, and Hyundai and Daewoo are being scrutinized.
‘Our organization has campaigned against the chaebols for two years,’ says Jang. ‘We have filed numerous suits in court. But since most of the media is under the influence of the chaebols, it is difficult to get our message to the domestic and foreign investment community. Chaebols have the power to buy articles in exchange for advertisements and pressure the media into not allowing us to put in our own advertisements. As investors are kept in the dark it makes it difficult to gather the necessary shareholders to file suits against the companies.’
Acting on behalf of the chaebols is the Korean Listed Companies Association (KLCA), a non-profit organization composed of 760 listed companies and 20 associated members. Formed in 1973, the KLCA was established to facilitate relations between investors and listed companies. Improving corporate disclosure and IR is part of the KLCA mission.
‘Minority shareholders are more active than ever,’ says Jin-Seok Suh, executive vice chairman at KLCA. ‘Third parties like the KLCA and the PSPD are very eager to push shareholder rights and some companies are impressed by this activity. They are willing to serve shareholders at annual meetings and on their web sites.’
Push needed
Still, the PSPD believes that change will not be a natural progression. The chaebols must be pushed hard if the reform is to gather momentum. One of the first to buckle under PSPD pressure was telecoms giant SK Telecom, Korea’s largest provider of mobile phone services. Just days before its March annual meeting, SK Telecom announced that it would bow to shareholder demands to implement safeguards against alleged mismanagement. Faced with a proxy proposal from institutional investors controlling 10 percent of the stock (TEI Fund plc, The Korea Fund, Oppenheimer Global Fund and Oppenheimer Variable Accounts Funds) the company accepted investor demands.
‘This was an accomplishment for the minority shareholder campaign because the chaebol actively reformed itself in response to minority shareholder demands. We hope this is the start of a trend,’ says Kim. ‘However, the majority of chaebols are trying to defeat our attempts to bring transparency into the management process. They think shareholder activism will hurt management efficiency and drive companies out of the market. They are worried foreign investors will take over their management positions. It’s a hard battle because the chaebols control everything.’
The prime incentive for shareholder complaints against SK Telecom was the allegation by South Korea’s Fair Trade Commission (FTC) that SK Group, parent of SK Telecom, was using the cellular phone giant to subsidize struggling affiliates. It’s a fairly common chaebol practice which has come under greater criticism in recent years.
In this case, the effect on SK Telecom’s bottom line was devastating. Overall, the mobile telecom company has shown sharply increased sales costs and decreased profits since becoming part of the SK Group in 1994. Over the past year, SK Telecom’s net income declined 41.9 percent despite a 31.2 percent increase in net sales.
One of the largest chaebols under fire from the PSPD is Samsung, long known for milking cash from profitable companies and pumping it into other subsidiaries or business experiments. The saga began in March when Samsung Electronics issued W60 bn ($43 mn) in private convertible bonds, of which Samsung Group chairman Lee Kun-Hee’s son Lee Jae-Yong purchased W45 bn and Samsung purchased W15 bn. Although it was a private issue and the company could sell the bonds to designated individuals, the PSPD contends Samsung violated shareholder’s right to purchase the shares and diluted their voting power for the sole purpose of using the convertible bonds to pass on management power to the chairman’s son. In addition, the conversion price was set lower than market price at the date of issue.
One day to go
The PSPD received a temporary injunction against the conversion or sale of the convertible bonds. However, the day before the court ruling Samsung Electronics went ahead and converted the bonds to shares. The PSPD tried to nullify the issue of new shares and have a temporary injunction against the disposition of listing Lee Jae-Yong’s shares. Although the injunction is still in place, the Suwon District Court ruled against the nullification of the newly issued shares and the PSPD is appealing.
In addition, during a Samsung Electronics shareholder meeting, the PSPD told investors that Samsung Electronics is secretly funding Samsung Motors through an overseas corporation called Pan-Pacific. The PSPD claims that in 1994-95 the company supplied $106 mn of the $1.8 bn Samsung Group used for its controversial foray into the auto industry.
Samsung Motors is in deep financial trouble and its problems are a threat to the entire group. The PSPD wants the company to present a plan for recovering its investment and is pressing for similar information on Samsung’s foreign investments. This includes the $720 mn sunk into money-losing computer maker AST Research in Irvine, California.
Outside influence
According to Jenny Chin-Pak, global analyst at Institutional Shareholder Services (ISS) in Maryland, the surge in Korean shareholder rights gained momentum after last December’s $60 bn bail-out of the country by the IMF. Korea’s debt problem was key to the bail-out: some $23.4 bn is owed to domestic and overseas banks, accounting for 267 percent of equity.
This debt overhang is even more expensive to service now that local interest rates have skyrocketed and banks are balking at making more loans. The country’s 22 banks have recorded their worst performances ever this year, with combined net losses of $5.16 bn in the first half of 1998, according to Korea’s Banking Supervisory Authority.
In effect, it is the debt issue that brought Korea to the verge of default and forced a major restructuring of its economy. ‘The IMF bail-out set the ball rolling for many things in Korea, among them the shareholder rights movement,’ says Chin-Pak. ‘It wasn’t until the Asian financial crisis that people began questioning what was really wrong with the chaebols. The IMF provided the monetary incentive for reform measures and that meant that shareholders could challenge management at some of the badly performing companies.’
Government boost
Shareholders have also been bolstered by the government’s own program. The recent election of President Kim Dae-Jung has brought about a major change in the handling of chaebol affairs. One important aspect of this is the realization that foreign investment is absolutely crucial if the economy is going to prosper over the longer term.
After returning from an Asia-Europe Meeting in London this spring, Kim voiced the need for foreign investment. ‘We must have foreign investment to solve our crisis,’ he stated. Foreign investors can now buy up to one-third of a company’s shares without board approval (excluding defense and other strategic industries), while the individual foreign investment ceiling was lifted completely.
‘Management teams are getting the message that they must handle shareholders better and become more accountable,’ says Pak. ‘They can no longer rely on government intervention and self-financing. As foreign investors take bigger stakes in Korean companies, management is under increased pressure to conform to western standards of corporate governance. This is reinforced by the government’s acknowledgement that its financial recovery is dependent on foreign investment.’
Tax penalties
On top of its pro-foreign investment policy, the government has taken other steps to reform the chaebols. These include: the imposition of tax penalties on excessive borrowing and debt payment guarantees; filing of consolidated financial statements by chaebols for fiscal 1999; and the lowering of minimum shareholding ratios from 0.05 percent to 0.01 percent, which allows more shareholders the ability to file suits against companies.
The current reforms open the door to more western standards of business, including investor relations, corporate disclosure and transparency. However, none of this sits well with the chaebols, who have enough on their plate dealing with severe financial headaches.
The chaebols’ power is still overwhelming, however, and their domain of influence extends to the courts as well as the government. As an example of some of the problems which lie ahead, 22 subsidiaries of Korea’s top 30 chaebols have already violated the government’s cross-payment guarantee limit by extending debt guarantees to sister companies in excess of 100 percent of their entire net worth.
‘The government has made impressive efforts to improve the investment regime and increase transparency, but of course, overall reform will be gradual,’ says Rob Patalano, client manager at Merit Communications, Burson-Marsteller’s partner in Seoul. ‘During the worst of the economic crisis, people encouraged change, yet since the economy has stabilized, businesses have tended to revert to their old ways.’
Private funds
Meanwhile, the PSPD continues to forge ahead in filing suits against chaebols. The organization uses funds received from private citizens to fund court cases and further its lobbying effort. Currently, the PSPD is pressuring the government not to allow chaebols to institute holding companies. In addition, it is working with the government to allow minority shareholders to file class action suits in the year 2000. This will make companies more accountable since shareholders will be paid any compensation deemed appropriate by the courts.
‘My wish is that foreign institutional investors delegate their shares to us so that we can continue to bring companies like Samsung to court,’ says Jang. ‘That would send a very strong signal to the chaebols. Although we risk being blamed for bringing in the foreign ‘invaders’ to Korea, we are willing to take that risk. We would conduct the legal battle, and investors need not fear that this would restrict their liquidity since all we need is 0.01 percent of shares to bring the chaebols to court. That is a very minor price considering the potential return.’
Nonetheless, minority shareholders have a long way to go to reform Korean companies. In March this year, Daelim Tradings’ annual meeting turned violent as a number of shareholders were prevented from voting. Baek Kwang Hoo, a business executive who owns 2.9 percent of the ceramics and tableware manufacturer, claimed Daelim refused to allow him to vote on behalf of shareholders who collectively own 23.8 percent of the company. Baek has secured at least 30.1 percent of Daelim’s 2.1 mn outstanding shares from minority shareholders compared to the 14.3 percent owned by Daelim chairman Lee Jae Woo and his allies.
‘Despite all this progress, I do not see any real change in management psyche,’ says Jang. ‘Although court rulings and reforms have made them aware of the problems, we still have a long way to go before we see any real changes for minority shareholders. One of the biggest obstacles is the minimal support from the shareholders themselves. Most are short-term investors. Since Korean companies are not transparent, investors see no benefit in keeping shares for the long term. Therefore the main engine for change must be foreign investors.’
