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KIM Yong-Ki

Last 10 Years' Corporate Governance Reform in Retrospect

KIM Yong-Ki

Apr. 25, 2007

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Since the 1997 financial crisis, economic reform has occurred in four major areas: corporate governance, financial sector, labor market, and state-owned enterprises. Of all these areas, corporate governance reform has been a key concern.

Government officials and some scholars have argued that "global standards" exist in the area of corporate governance practices. According to their claims, firms' adherence to these standards would solve many problems related to chaebol horizontal expansion, blamed as a main cause of the 1997 crisis. In addition, some others maintained that the "Korea discount (stock prices in Korean public firms failing to reflect those firms' real value)" would vanish if the standards were met.

While there is some truth to this line of reasoning, it is an argument that has gone too far. Indeed, some people equate "global standards" with accepted practices in Anglo-American-style corporate governance. Once this unquestioned assumption is taken out, however, it is hard to say their argument still hold.

The Anglo-American corporate governance model is characterized by several special features: widely dispersed share ownership, corporate control by professional managers, board of directors composed of a majority of outside appointees, and existence of active M&A market. Among others, the most important characteristic of the model is that it puts the shareholder interest as the first priority. In order to align the interest of CEOs with that of shareholders, the corporations endow their CEOs with stock options and other performance-based incentives.

Korea's efforts to adopt Anglo-American practices, however, have turned out unexpected results. While the stated purpose of these reforms was to enhance corporate performance, promote growth and maintain economic stability, reforms seem to have done more damage than good. Rather, it produced an unexpected outcome, i.e., sluggish corporate investment in plants and equipment, and myopia in corporate management.

Why has reform failed to deliver as promised? It seems to me that the reason lies in the fact that we did not consider the special context of the Korean economy. We simply tried to plug in imported market institutions, such as corporate governance-related regulations and practices, with little regard to how they would fit in Korea's context.

One key example can be found in strengthening of market discipline over firms, an essence of US and UK corporate governance practices. Most public companies in the US and the UK have highly dispersed shareholding structures, giving rise to diverging incentives between management and shareholders. In fact, only one sixth of UK publicly traded firms has a dominant shareholder with ownership of more than 25 percent controlling shares. In the US, the comparable figure is less than one-twelfth. However, dispersed ownership seen in the US and the UK is an exception rather than the rule.

Ownership of firms in continental Europe is exceedingly concentrated: 93.6 percent of public firms in Belgium have dominant shareholders whose holdings top the 25 percent threshold. The comparable figure for Austrian firms is 86.0 percent; 82.5 percent for Germany's; and 80.4 percent for the Netherlands'. In these countries, there is no public voice calling for wholesale adoption of Anglo-American corporate governance practices.

Back to the issue of corporate governance reform in Korea, it is very important to remind of the fact that corporate ownership in Korea's public companies is similar to that in European countries. Dominant shareholders control corporations and monitor their CEOs.

As a result of such differing ownership structures, corporate governance reform trying to emulate the Anglo-American practices has largely failed. By strengthening the power of outside shareholders, conflict between the largest shareholder, in many cases represented by the group's family and affiliates, and the second largest shareholders, typically foreign investors, has intensified. Some private equity funds, who can easily establish a paper company in tax havens, could use a loophole in regulations. There are examples showing amply that current regulations discriminate against domestic investors in favor of foreign counterparts.

For example, the Securities Trade Law prohibits exercising a voting right higher than 4 percent in selecting audit committee members of big public companies. The intention of this regulation is to protect the right of minority shareholders from abuse of major shareholders. A private equity fund called Sovereign divided its shares into five paper companies, all with less than 4 percent shares of SK Corporation. As a result, it exerted all its rights of 14.99 percent in the proxy fight for electing the audit committee members in the 2004 annual shareholders meeting.

In contrast, the major shareholder group consisting of affiliated companies supporting the SK Corporation's management could not exercise all of its voting rights because two of the affiliates had more than 4 percent voting rights. Such incidents, exemplified by some private equity funds, have caused political backlash against all foreign investors. Looking back the last 10 years, it is important to remember that one size doesn't always fit all.

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