The Granite Tower
FEATURECOVER STORY
Korean Chaebols: The Whites and Blacks of our Society
Kim Hye Ri, Jung Woo Jae  |  dnflehdtod3@korea.ac.kr, wjtow@korea.ac.kr
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승인 2015.10.03  14:41:59
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It is often pointed out that the history of human development is the history of competition and supremacy. Historically, those that gained the upper hand and retained their superiority were those that succeeded and survived. In the same way, advancement mostly occurred solely to those who did not settle for what they already possessed, but rather to those who continuously endeavored for further benefit–even when it meant depriving others of their possessions. The same held true for the appearance of chaebols , which are massive business groups that appeared during the ingression period of modern-day capitalism.
 
   
▲ Dollars hanging on a clip which portrays chaebol’s greed. Provided by psnews.ro.
Chaebol is a Korean term that signifies the conglomerate group of major monopolistic capitalists or entrepreneurs, which is mainly composed of close family members and relatives. The expression is derived from the Japanese word zaibatsu, major corporation owners that drastically emerged during the 20th century after the Second World War. Although forces closely akin to chaebol do exist worldwide—the Lego Group of Denmark, Zhejiang of China, and Rothschild of England—this form of governing group particularly arose to wield vast power in Korean society. How, then, did Korean chaebols come about, and what influence are they exerting both socially and economically?
 
Authority of Minorities as a Universal Phenomenon
The enormous and even excessive influence of chaebols and their approximations from around the world have constantly encountered various criticisms, in that they have brought about a modern version of inequality and aristocratism. Entering the modern era, the economic status of an individual served as the main source behind these social discriminations. In the same manner, ever since chaebols monopolistically have passed their properties and assets down to their descendants, they have transformed into an attributional social position that commoners could not even dare to imagine.
   
▲ Professor Kim Soohan (Department of Sociology). Photographed by Lee Ji Hoon.
 
“Although it is natural that human beings strive to differentiate themselves from other people,” stated Professor Kim Soo Han (Department of Sociology), “The issues with regards to chaebols have transgressed from being a mere separation from others.” To elaborate, chaebols have hindered the climbing of social ladders through social activities and fixated economic activities by making it difficult for new proprietors to succeed.
 
A far more serious fact is that society at large does not recognize this modern-day hierarchy as a social problem. “Take Samsung, the largest corporation of Korea, for example; even those media critical towards chaebols consider it natural that the conglomerate Lee family inherit companies’ subsidiaries of Samsung, even when they own a mere two percent stake in that business,” Professor Kim pointed out.
 
Endless Demand for More: Striving for Surplus
Why, then, would human beings continuously crave for more materialistic value even when they already possess an affluent amount? According to Professor Kim, this matter could mainly be explained by the following two reasons: first, because society is rampant with its emphasis on size; and second, because people intrinsically desire recognition from others.
 
To begin with, the increasing importance of size within human society as a whole has pushed even the already enormous corporations to constantly venture into other fields. “In Korea, companies such as Hyundai, LG and Daewoo Electronics initiated semiconductor business not because of its profitability, but because Samsung had accomplished significant results from this precise industry,” said Kim.
 
More fundamentally, the monopolization of wealth is also concerned with the basic social drive to be praised by others. In other words, rather than simply desiring solely material value itself, wealth has served as a means toward social recognition. By placing the standard of comparison from themselves to their rivals and competitors, accumulating a vast fortune came to be a signification of acknowledgement and compensation.
 
Chaebols: A Peculiar Korean Condition?
Though conglomerate groups and family-run corporates do exist worldwide, Korean chaebols are especially regarded as a serious issue, in that they hold an intrinsic characteristic of their own, differentiating themselves from those of other countries. “The fact that chaebols have privatized profits and socialized their loss is the core factor specifying Korean conglomerates,” said Professor Choi Pae Kun (Department of Economics, Konkuk University).
 
   
▲ Professor Choi Pae Kun (Department of Economics, Konkuk University). Photographed by Lim Jae Heun.
To explain further, unlike major corporations of other countries that mainly went through independent accumulation of their capital, corporates of Korea could flourish in the virtue of the nation and its people. In the process of venturing into heavy and chemical industries during the 1970s, a significant number of banks had almost been driven to the point of insolvency, due to their massive investments of capital into these companies. Additionally, the government granted more benefits, such as a reduction of tax and control of labor costs, bearing the disadvantages that the public faced.
 
Likewise, when corporates were attacked with critical situations during the International Monetary Fund (IMF) financial crisis in 1997, the people of Korea voluntarily inaugurated a nationwide Gold Gathering Movement, wherein they offered any of their possessions made of gold in order to contribute to settling the county’s debt. “Despite these sacrifices, the profits created during the process were solely distributed among these chaebols,” Choi added. “On the other hand, Northern European countries revert their wealth back to the state by paying a notable amount of tax, in return with the investments that they previously received from the public for initiating a new business.”
 
How Korean Chaebols Achieved Their Current Status
On close scrutiny over the history of how Korean chaebols initially emerged and developed, it is asserted that chaebols were first formed during the era under the United States (U.S.) Military Government in Korea. This was the period that immediately followed Korea’s liberation from Japanese colonization, and therefore numerous policies were implemented with regards to the disposition of Japan’s vested property. During this process, approximately 2700 Japanese attributed enterprises were sold at giveaway prices. As a result, a considerable number of political privileges concerning the disposal, allocation, and bank accommodation prevailed, which was then followed by countless incidents of bribery and lobbies.
 
Notably, these primary forms of chaebols were not always from prestigious backgrounds to begin with. “It is true that owners of corporates including Hite Beer, Doosan which took over OB beer, and Dongyang Cement Corporation, were from affluent families,” explained Professor Choi. However, the disposition was also given to commoners and the former merchandizing classes as well, providing a chance to build up fortunes on their own. Examples include Sunkyung textile industry, the former version of SK Corporation, and Shinsegae Department Store, founded by Lee Byung-chull, the initial owner of Samsung Corporation.
 
In the 1950s, the postwar years after the outbreak of the Korean War, industrial development in Korea depended heavily on international aid and assistances. Consequently, Sambaek industry, signifying three-white industries — sugar, mill, and cotton manufactures — posted considerable growth. “During this era, people’s main concerns were with regards to basic needs like food and clothing,” said Choi. “The Sambaek industry was thereby a symbol to meet these needs.” Companies such as CJ Cheil Jedang, Cheil sugar-manufacturing company, and Cheil Fabric Industries of Samsung arose during this period, and formed a foothold for Samsung’s so-called tentacle business management of ruling diversified affiliates.
 
The decades of the 1960s and 1970s demonstrated both the bright and the seamy side of chaebols. While they significantly contributed to the drastic economic growth of Korea, at the same time they spawned serious social issues of collusive alliance between government and businesses. In the 1960s and 1970s, the Korean government placed its main objective on promoting domestic industries and economic advancement. In turn, the government began to foster heavy and chemical industries as a means to increase the amount of export profits, and chaebols began to receive preferential treatment in earnest, pertaining to import permission, allocation of foreign currencies and bank advance policies.
 
Chaebols: Reflection of Korean Corporate Governance Structure
Meanwhile, the prerogatives that chaebols relished carried over from the Park Junghee regime into the Chun Doo Whan regime, and are still posed as a serious social concern even to this day. It is true that chaebols constituted a severe threat on social and economic equality due to these privileges. Nevertheless, it cannot be denied that they contributed greatly toward accomplishing Korea’s economic vitalization.
 
Likewise, their success in activating domestic industry and increasing exports led to the strengthening of chaebols’ increasing domination on their corporations in the 1960s, and finally in the 1970s, the Korean conglomerate system retained its current form. This tentacle business management structure that settled in the 1970s, though heavily criticized by scholars and experts of today, emerged almost inevitably, and could even be considered to have played a positive role.
 
“During the period, the market economy was not at all settled within Korea, and companies could not just vaguely wait until it was established,” Choi said. “Therefore, as a solution to initiate heavy and chemical industries, corporates simultaneously ventured into diversified businesses despite the laybacks that they encountered.” An explicit example would be Hyundai Motors which initiated the automobile industry during that era. Since building an automobile required a great deal of complex industrial processes, including steel manufactures, glass industries, and even highways and capitals, various affiliated companies were founded as a result.
 
   
▲ Hyundai Motor Company Headquarter. Provided by sacarfan.co.za.
In addition, this form of diversified management structure proved to be both efficient and effective, as it significantly reduced the risks that corporations could easily confront. For instance, during the mid and late 1980s, when Samsung first made a foray into the semiconductor industry, the company was able to continue its business despite a heavy deficit in other industries between the years 1988 and 1989. Adding to this, the profits earned from Hyundai Engineering and Construction Company also wielded a positive influence on other subsidiaries of Hyundai to develop.
 
Abuse of Diversified Management: Circular-shareholding Structure
At present, a typical corporate governance structure of chaebol consists of a holding company and its subsidiary companies; the holding company is invested by a chaebol family at center stage, and governs numerous subsidiary companies that manage industries of various fields. Here, the relationship, or to put it another way, the investment structure between the holding company and its subsidiary companies, as well as among the affiliated companies themselves, is usually tangled and intricately connected.
 
This link, more often than not, serves as the leading cause that brings about some serious business management problems. The most common yet notable investment structure is called the cross-shareholding structure; the main method through which chaebols continue to maintain their influence on their subsidiaries.
   
▲ Professor Kim Woochan (Business School). Photographed by Lim Jae Heun.
 
“A circular-shareholding investment structure,” explained Professor Kim Woo Chan (Business School), “is when investments are arranged in a multi-level and circular way; along this structure, the final capital invested is redounded on the initial one.” For instance, say that a holding company owns three affiliates called A, B, and C. In a circular-shareholding structure, company A makes contributions to company B; then company B, in turn, contributes to company C; afterwards, company C contributes to company A once again.
 
According to Professor Kim, the emergence of this structure was due to various reasons—privatization of public enterprise, swapping businesses, separation of affiliated companies, expansion of joint investments, and so on. In the case of Lotte, which rekindled the issue of corporate structures within Korea due to their 416 loop of circular-shareholding structure, expansion of joint investment had served as the fundamental cause. That is, whenever Lotte decided to establish a new subsidiary, the existing ones invested a small portion of their profits in unison; as this investment continued on, joint investments transformed into a circular structure.
 
“As opposed to most people’s assertion that a massive amount of money be necessary to break the vicious cycle, absolutely none is needed,” Kim elaborated. This is because the solidity between the loops of Lotte’s subsidiaries is quite meager and delicate, thereby making it effortless to break the loops apart. “A bigger problem exists behind the Hyundai Motor Company, since it employs circular-shareholding as a method through which chaebols continue to increase their influence on subsidiaries,” he added.
 
Here in Kim’s words, cross-shareholding triggers the disparity between the control right and the cash flow right of a company. To put it another way, a shareholder is able to exercise an excessive amount of voting rights with little financial stake. “Chaebols as shareholders may avoid the damages that should be inflicted on themselves, even in situations where the loss was due to their misjudgment,” Kim pointed out, “and even other corporate structures besides circular-shareholding may provoke the same problem.”
 
Never-ending Expansion
To make matters worse, chaebols have recklessly expanded their business areas, even making a foray into strategic areas of small and medium businesses. For instance, female descendants of chaebol firm leaders established baking companies. Lee Boo-jin, the daughter of Samsung’s chairman Lee Kun-hee and the president of Hotel Silla, once owned Artisee, a premium bakery chain. Also, Fauchon Korea was established by the granddaughter of Lotte’s chairman, Shin Kyuk-ho.
 
The rise of such brands operated by major conglomerates posed a serious threat to small bakeries owned by small merchants whose sales had already dropped due to the emergence of large-scale bakery chains such as Tous Les Jours and Paris Baguette. “It is difficult to regulate the extension of conglomerates with economic logics,” says Professor Kim. However, so-called tunneling which is often utilized by large business groups can be a significant problem. Firms often assign major projects to their affiliates, benefiting the affiliates and damaging other small firms. In particular, top manufacturing firms in Korea such as Samsung Electronics and Hyundai Motor Company received a substantial number of components from their affiliates, Samsung SDS and Hyundai Mobis respectively.
 
   
▲ Samsung Headquarter. Provided by Gettyimages.
According to the Fair Trade Commission, 12.5 percent of chaebol business groups’ sales were derived from internal transactions between affiliates. Furthermore, some listed companies assign profitable projects to their unlisted affiliates whose major shareholders are chaebol families, unjustly benefiting heads of the chaebols.
 
“Due to the reckless diversification of conglomerates, not only small firms but also investors of the conglomerates suffer damages,” says Professor Kim Soohan. Due to chaebols’ internal transactions, barriers to entry exist for small or medium-sized firms which try to compete with the conglomerates’ affiliates. In addition, investors have to share the risk resulting from overly audacious expansion decisions made by the heads of the conglomerates.
 
Never-ending Inheritance
Regardless of the public’s view towards the merits and demerits of chaebols, it is a widely known truth that their dominance will not end in a single generation. They try to turn over their astronomical amount of wealth and all kinds of privileges to their descendants. Current heads of Korean conglomerates are mostly second or third generation chaebols who inherited large business groups from their fathers or grandfathers.
 
During the procedure of succession, most of them evaded a substantial amount of tax. For instance, Samsung’s chairman Lee Kun-hee paid only 18.1 billion won as inheritance tax by using borrowed-name bank accounts. Third generation successors have used far more deceptive strategies, utilizing financial tools such as convertible bonds. A convertible bond is a type of bond that the holder can convert into a specified number of shares of common stock in the issuing company. They often obtain shares of rather minor subsidiaries in a giveaway price and sell them after the price has increased, obtaining cash necessary to take over major subsidiaries or parent companies.
 
Employing these means, second and third generation chaebols obtain control rights of the whole business groups and take over the management. Some assert that this so-called owner management facilitates the efficiency of management and rapid decision making. On this perspective, the government has granted amnesty to many chaebols who committed frauds.
 
Nevertheless, others contend that the capacity of professional executives has been underestimated. “We have not seen a lot of professional executives who have actual power to lead,” says Professor Kim Woo Chan. Until now, professional executives have had only a limited amount of control of the firms since their role was temporarily that of workers instead of owners.
 
In other words, if they are ensured that they will stay in their positions regardless of the owners’ status, they will eventually show what they can achieve. Furthermore, though chaebeol’s successes have received spotlights, there are many cases of failure. “Samsung’s Lee Kun-hee is highly praised because of his success in the electronics industry, but he has also caused a large financial loss to the business group by making an unreasonable decision to enter the car industry,” says Professor Kim.
 
For Democratic Governance
To halt conglomerates from inhibiting balanced development and distribution of wealth, researchers and activists from various disciplines have come up with measures which differ in orientation and methods. Some have dealt with chaebol’s tyrannical business actions such as the reckless expansion of chaebol groups or unreasonable treatments toward their subcontractors. Others have studied the problems about ownership of the firms. Among them, many have focused on improving corporate governance structures to prevent only a small number of privileged shareholders from controlling the whole firm.
 
   
▲ A model of circular shareholding. Provided by freedomsquare.co.kr.
As an alternative for circular shareholding, many conglomerates have established holding companies. If several actions are limited, holding companies can improve the corporate governance structures of the firms. The 1999 amendment to the Fair-trade Act of Korea stated that the holding company must own more than 30 percent of a listed company’s shares to legally control it. Therefore, conglomerates were prevented from recklessly expanding their governance structure. Since the early 2000s, many chaebols have converted their governance structure, adopting the holding company system. For instance, LG took an initiating rule in adopting the system, thoroughly following the guideline provided by the Fair-trade Act.
 
   
▲ LG Headquarter. Provided by Gettyimages.
However, establishing holding companies could not be a cure-all for the governance structure problems. Instead, with deregulation, holding companies have paradoxically facilitated the formation of a pyramid of affiliates. Holding companies that were established later did not follow limitations included in the 1999 amendment, continuously expanding the pyramid structure. “Holding companies were rather used to enhance the control right of the major shareholders. The conversion to holding companies was a change for the worse,” says Professor Kim.
 
As a measure to reinvigorate the deadlocked reform, many researchers suggest a Mandatory Bid Rule (MBR) as another alternative. The MBR enforces an acquirer of a controlling stake in a listed company to provide the remaining shareholders with a put option of their minority stakes. The other shareholders who have a put option can request the major shareholder to purchase their shares if they want to sell. In other words, “major shareholders who have controlling rights are required to own a substantial number of shares by law,” Professor Kim describes. Now, Korean conglomerates can acquire a new firm by holding a 20 to 30 percent stake in the company. On the other hand, major shareholders in nations adopting the MBR such as United Kingdom (UK) have to solidify their controlling rights by purchasing more stocks.
 
However, the fundamental solution to the maladies caused by arbitrary decisions of a small number of major shareholders is enhancing the influence of individual shareholders. Non-executive directors should speak on behalf of the shareholders and prevent the founder and his descendants from making unreasonable decisions. Unfortunately, check and balance do not exist in current board meetings of major Korean conglomerates. “Current non-executive directors are de-facto puppets of the chaebol families,” Kim says, pointing out the non-executive directors’ lack of independence.
 
In order to reinforce the rights of individual shareholders, National Pension Service (NPS) should play a leading role. “NPS is the only shareholder that is able to actively exercise its rights,” said Professor Kim. NPS owns a substantial number of shares in major conglomerates such as Samsung, Hyundai Motors, and SK. Furthermore, unlike other large shareholders that have trade connections with the firms, NPS is free from external pressures from the firm leader. Thus, NPS can independently appoint non-executive directors and make them speak on behalf of most shareholders who do not have control rights.
 
Despite its capacity to take reformative initiatives, NPS has retained a passive attitude in major chaebol issues. Rather than speaking on behalf of minority shareholders, they have irresponsibly agreed with unreasonable decisions whose only beneficiaries were firm leaders and their families. As a result, many researchers and activists are urging NPS to change its attitude. “Major political parties unanimously pledged NPS to exercise its rights during elections, but there seems to be no progress even now,” Kim added.
 
Another key to enhancing shareholders’ rights is the improvement of the legal system. An example of necessary changes is the obligation of cumulative voting. Cumulative voting permits shareholders to vote for more than one seat to put more than one vote on a preferred candidate. If minority shareholders concentrate their votes by utilizing this rule, it increases their chances of obtaining representation in the board meeting. The rule already exists in commercial law, but because it is not mandatory, only a small number of firms have followed the rule. By enforcing the rule to all listed firms, the shareholders’ right to speak on decision making will be improved.
 
   
▲ SK Headquarter. Provided by koreabizwire.com.
For the Social Control of Greed
Though corporate governance is a significant issue, a different approach is needed to tackle yet another problem, chaebol’s reckless diversification. Since the last presidential election, there has been a social consensus on the importance of economic democracy. Many agree that the growth of small and medium-sized firms is crucial for the sustainable development of Korea. However, there are diverging opinions concerning the need for political resolution of the problem.
 
Some argue that it is unreasonable to arbitrarily regulate business activities of conglomerates for a political purpose. On the contrary, there are scholars who contend that no such thing as a perfect market exists in the real world. “After all, Korea’s current market structure itself was built under the influence of the government,” says Professor Kim Soohan. On Kim’s point of view, shattering people’s illusions about a perfect market is what Korean society should prioritize.
 
According to the Article 119 of Korean constitution, the state “may regulate and coordinate economic affairs in order to maintain a balanced growth and stability of the national economy.” Therefore, there is a justifiable cause for those who try to regulate chaebol’s business activities. “Eventually, political momentum will determine the success of economic democracy,” adds Professor Kim Soohan. In other words, whether political parties and the government come up with binding and effective measures to appropriately regulate chaebol’s greed will determine the future of Korean economy.
 
Eventually, for What?
Then, where should political leaders and voters focus when discussing reforms on chaebols as a whole? The answer lies in finding out what opponents of chaebols want. “According to a survey on 1900 Koreans, those negative toward conglomerates demand an ethical management, more contribution to public services, and mutual growth with small and middle-sized firms,” says Professor Kim Soohan.
 
Put differently, it means that corporate social responsibilities (CSR) should be the core of the reforms. At the same time, it seems obvious that the urges for democratic governance and moderate expansion are not the voices of only experts. Chaebols should restrain from enjoying freedoms without responsibilities. It is time that chaebols change from an entity of mixed blessings in Korean society to true economic leaders of the national economy.
 

 

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