[KS] KSR 2007-06:_Competition and Corporate Governance in Korea: Reforming and Restructuring the Chaebol-, ed. by Sung-Hee Jwa and In Kwon Lee

Wed Feb 14 18:19:46 EST 2007

_Competition and Corporate Governance in Korea: Reforming and Restructuring the Chaebol_, edited by Sung-Hee Jwa and In Kwon Lee. Cheltenham, UK and Northampton, MA, USA: Edward Elgar, 2004. 304 pp. ISBN-13 978-1-84376 912-5 (hardback). 

Reviewed by David Hundt 
Deakin University
david.hundt at deakin.edu.au <mailto:david.hundt at deakin.edu.au>   

It is now ten years since the International Monetary Fund intervened and provided emergency loans to the Republic of Korea (hereafter Korea) in return for a wide-ranging restructuring package. The main targets of the reform agenda were the chaebols, the diversified business groups that are responsible for a substantial share of Korean economic activity. While technically referring to any family-owned business group, the term “chaebol” is most commonly used in reference to the biggest groups. The Hyundai, Daewoo, Samsung, LG and SK Groups are much bigger than other chaebols, are active in a more diverse range of industries, employ family-based management systems, and have participated in national development projects. Unable to repay their debts after the collapse in the Korean currency in 1997, the chaebols were impelled to enter the Big Deal process, whereby they were expected to swap assets and merge business units.

The volume under review seeks to evaluate the reform package, paying particular attention to measures aimed at improving how firms are managed (corporate governance) and the restructuring process. Editors Sung-Hee Jwa and In Kwon Lee are based at the Korea Economic Research Institute, a think tank established by the Federation of Korean Industries, the main chaebol lobby group. The volume attempts to make the case for the reform of economic institutions alongside chaebol enterprises. Drawing on neo-institutional theorists such as Douglass North, the volume argues that institutions act as incentive structures that reward productive forms of economic behaviour. Consequently the “fit” between institutions and firms is crucial to economic outcomes (p. xiv).

The first two chapters investigate the evolution of the chaebols. Sung-Hee Jwa provides a historical overview of development policies. The chaebols’ expansion was attributable to their involvement in sectors that the government earmarked as national priorities, such as steel, petrochemicals, cars, construction and shipbuilding. Jwa argues that policy shifted in the 1980s from “government-led discrimination” in favour of those economic actors who could act as the engine for growth to “government-led egalitarianism,” whereby the government sought to reduce the economic concentration of the chaebols (pp. 17-20). For instance the government steered more loans towards non-chaebol enterprises and smaller chaebol groups. Since the financial crisis, the government has intensified efforts to make the chaebols focus on “core competencies” through Big Deals. Jwa argues that both types of government intervention are flawed. He instead calls for “market-led discrimination,” whereby markets rather than governments reward and punish private firms.

Ha-Joon Chang’s and Hong-Jae Park’s chapter promises an “alternative perspective” on chaebol policy, and indeed their tenor varies from other contributors. They take issue with the criticism levelled at the chaebol model’s high degree of diversification, low level of profits, and high leveraging. For instance the chaebols’ low profits reflect Korea’s relatively high interest rates and commensurately high interest payments (pp. 27-28). Many of the chaebols alleged sins, such as high debt-to-equity ratios, are commonly found in other countries. Chang and Park thus reject calls for measures such as mandatory caps on debt-to-equity ratios that would alter the chaebol model’s dynamic of high lending and investment. The chapter notes briefly that the chaebols have abused their economic and political power (pp. 42-45), before concluding with a call for a more consensual state-business relationship.

The section dealing with corporate governance and chaebol reform begins with Inhak Hwang’s and Jung-Hwan Seo’s depiction of the chaebol governance structure as being “controlling-shareholder managerialism.” The founding family tends to own and manage a given chaebol group. This centralised and familial style of management deters internal discipline and oversight; meanwhile, institutional investors, minority shareholders and banks have failed to play an external disciplinary role. The accumulated ills of chaebol corporate governance peaked just prior to the financial crisis (pp. 80-83). The authors suggest that corporate governance be enhanced through greater discipline via the market.

Sung Wook Joh focuses on the monitoring performance of creditors and capital suppliers. The financial crisis revealed that banks did not prevent the highly indebted chaebols from borrowing even more capital. Indeed Joh suggests that chaebol-affiliated firms increased their debt levels even faster than non-affiliated firms. Impediments to effective monitoring included difficulties in removing incompetent shareholder-managers, misplaced confidence that the chaebols would repay their debts, government appointment of senior bank executives, and non-transparent accounting practices (pp. 103-08). Joh calls for improved accounting and managerial practices, the privatisation of state-owned banks, the creation of more independent corporate boards, and the removal of regulations that limit competition.

Dong-Won Sohn and Jin-Yeong Kim depict the emergence of the chaebols as a rational response to an immature institutional setting. A relatively small number of business leaders monopolised financial resources, encouraging close links between the chaebols and banks. The chaebol founders also relied on relatives to serve as senior managers (pp. 120-21). The IMF reforms sought to end this highly personalised style of management. Corporate governance reforms have strengthened the rights of minority shareholders and encouraged the creation of “arms-length” relationships between the chaebols and banks. Sohn and Kim recommend that the Korean corporate governance reform follow the Japanese model of “relations-based” capitalism rather than the American “market-based” system. Banks and the chaebols would jointly monitor private sector activity. They also suggest that greater competition in the banking sector would avoid Japan’s experience of non-performing loans (pp. 138-39).

The third section of the volume focuses on restructuring policy. Jae-Woo Lee argues that the Big Deal process, with its emphasis on paring back the chaebols to a set of core competencies, was flawed because it did not account for “transaction costs” (the costs of economic exchange). Transaction costs determine the optimal size of a firm in a given industry (“economies of scale”). The chaebols owe their very existence to transaction costs, Lee argues, because it was cheaper to conduct economic exchanges-of physical, human and financial resources-within a chaebol group than in a normal market environment. Rather than arbitrarily seeking to reduce the number of firms in an industry, Lee argues that the government should aim to reduce transaction costs and thus make intra-chaebol transactions less attractive (pp. 173-75). With the maturation of markets during the past few decades, the costs of economic exchange have fallen. This explains the wave of de-mergers and the subsequent emergence of smaller, leaner chaebols.

In Kwon Lee examines the eight industries designated for Big Deals. Excess capacity appears to have existed in the auto, aerospace, railway vehicle and power generation sectors, but not in semiconductors, petrochemicals, oil refining and electronics (p. 199). The possession of excess capacity is a rational tactic on the part of oligopolists in that the threat to raise output can deter new entrants during periods of growing demand and also in the future, when market conditions are uncertain. Excess capacity is also a useful bargaining chip in negotiations with banks. For these reasons, Lee argues, government intervention is ineffective because it cannot control the two main causes of excess capacity: sudden changes in aggregate demand and strategic interaction among oligopolists (i.e. entry deterrence). Entry deregulation would be a more effective means of sanctioning chaebols (p. 210).

The final section of the volume investigates the ways in which the chaebols operate. Hicheon Kim, Robert E. Hoskisson, Laszlo Tihanyi and Jaebum Hong explain how diversified firms evolve in response to abnormal market conditions. Conglomerates may compensate for the inadequacy of markets, but the degree of value they create depends on the fit between strategy and structure. At least until the 1970s, the chaebols created positive synergies in fields such as project management, procurement of technology, and the design of new plants and construction. However, changes in development policy and market conditions in the 1980s reduced the importance of the chaebols’ internal markets to the national economy. The authors argue that the chaebols’ style of management has failed to match the changes in market conditions, again bringing in to question the fit between Korean firms and their institutional environment (pp. 243-44).

Ji-Hwan Lee’s and Costas Markides’ chapter finds the core competencies policy to be not only flawed but destructive to the Korean economy. Lee and Markides assert that the government should not determine which portfolio of goods a firm produces; this is for firms to decide in accordance with their holdings of strategic assets and core competencies. While diversification is problematic if a firm’s business lines are too diverse to create positive synergies, “strategic relatedness” between even superficially divergent business units may allow a firm to access resources more quickly than its competitors (pp. 257-58). Thus measures such as capping debt-to-equity ratios at 200 percent might resolve the financial aspect of restructuring (i.e., what level of loans the chaebols should carry), but not the portfolio issue (in which sectors they use their funds).

Upon reviewing the volume, I found the most notable shortcoming to be a lack of editorial guidance. Most chapters cover broadly similar ground, including discussion of material that the editors should have accounted for in the introductory chapter. A succinct summary of policy recommendations, perhaps in a concluding chapter, would also have been welcome. One reason for these organisational problems is that chapters 3, 7 and 8 have been published elsewhere as journal articles. As a result, the volume reads more as a collection of essays on the broad topic of chaebol restructuring rather than a unified body of work.

The volume also relies excessively on the language of economics to discuss a multidisciplinary set of issues. It is interesting, for instance, to note that no authors employ the term “developmental state” in their analyses, with only a single reference to the transition from a development to a regulatory policy approach in the 1980s (p. 232). Several authors mention this key period without fully explaining its significance in the transition from the dirigiste phase of Korean development. One telltale allusion is to the “non-economic” considerations for bailouts (p. 94). The overall effect is to provide a highly clinical discussion of the evolution and operation of the chaebols without an adequate treatment of the cut and thrust of state-business relations. Hyundai chairman Chung Mong-koo’s conviction for embezzlement in early 2007 exemplifies the longstanding tensions that permeate these relations. While the volume may well be correct in arguing that the government was heavy handed in reforming the chaebols, the case of Daewoo indicates that the chaebols were incapable of reforming themselves. The anti-chaebol sentiment should be seen in the context of the broader interrogation of conservative institutions and symbols, including the National Security Law and the U.S. alliance, during the past decade.

Despite these reservations I recommend this volume on the basis of its empirical research into the Korean chaebols. Used judiciously, it can complement other volumes from the social sciences that investigate the multifaceted phenomenon of Korean economic development.

Citation:
Hundt, David 2007
Review of _Competition and Corporate Governance in Korea: Reforming and Restructuring the Chaebol_, edited by Sung-Hee Jwa and In Kwon Lee_ (2004)
Korean Studies Review 2007, no. 6
Electronic file: http://koreaweb.ws/ks/ksr/ksr07-06.htm <http://koreaweb.ws/ks/ksr/ksr07-06.htm> 