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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
Korea Development Institute 2
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
Korea Development Institute 3
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
Korea Development Institute 4
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
Korea Development Institute 5
“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
Korea Development Institute 6
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
Korea Development Institute 7
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
Korea Development Institute 8
• 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
Korea Development Institute 9
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
Korea Development Institute 10
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
Korea Development Institute 12
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
Korea Development Institute 13
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
Korea Development Institute 14
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
Korea Development Institute 15
Note: Author's estimation based on various business reports and audit reports (as of December 2001)
Ownership Structure of SK Group
Korea Development Institute 16
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
Korea Development Institute 17
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
0 .2 .4 .6 .8 1cash-flow right
LG Group, Year 2002
Korea Development Institute 18
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
0 .2 .4 .6 .8 1cash-flow right
SK Group, Year 2002
Korea Development Institute 19
• 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: %)
Korea Development Institute 20
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
Korea Development Institute 21
Large listed companies: usually investing companies => small wedges
Other subsidiaries: usually invested companies => large wedges
Explaining the differences of measurement in the literature
Korea Development Institute 22
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
Korea Development Institute 23
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
Korea Development Institute 24
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
Korea Development Institute 25
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
Korea Development Institute 26
Ownership Structure of Samsung Group
Note: Author's estimation based on various business reports and audit reports (as of December 2001)
Korea Development Institute 27
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
Korea Development Institute 28
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.
Pubic policy toward financial companies’ fiduciary duty
Korea Development Institute 29
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.
Pubic policy toward financial companies’ fiduciary duty