The 6th Asian Roundtable on Corporate
Governance
Implementation and Enforcement in Corporate
Governance
Youngjae Lim
Korea Development Institute
Korea
Theme I
Various 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
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Korean Regulatory Agencies Enforcing Corporate
Governance
 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.
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Korean Regulatory Agencies Enforcing Corporate
Governance
 Fair Trade Commission: Regulating Chaebols
 Regulating private (unlisted) subsidiaries
belonging 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 cashflow right and high control right
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Role of Regulatory Agencies regarding the
Implementation of Corporate Governance
 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
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Evaluating the Independence and Effectiveness of
Financial Regulatory Agency in Korea
 “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
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Index of the External Monitoring System in Korea
 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.)
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Index of the External Monitoring System in Korea
 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)
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Index of the External Monitoring System: Literature
•
Bernard S. Black, The Legal and Institutional Preconditions for
Strong Securities 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
Works 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 Governance Score: Abbreviated Criteria and Methodology
(February, 2002) [S&P] (w/ Questions)
•
World Bank / IMF, Template for Country Assessment of Corporate
Governance (July, 2000) [World Bank]
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Evaluating Institution Building*
1-1. Transparency (Information-related legal system)
Korea
0.7857
U.S.
0.8750
Disclosure system
0.8750
1
Disclosure items
0.8571
1
External audit system
0.6250
0.6250
1-2. Transparency (Enforcement system)
Korea
0.7222
U.S.
0.9444
Independence of regulatory agencies
0.5
1
Effectiveness of regulatory agencies
1
1
0.6667
0.8333
Civil enforcement
* As of August, 2003
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18
Evaluating Practices in Korea (Experts Survey)*
1-1. Transparency (Information-related legal system)
Disclosure system
Practices
0.5
Institution building
0.7857
0.47
0.8750
0.53
0.6250
Disclsure items
External audit system
1-2. Transparency (Enforcement system)
Practices
0.39
Institution Building
0.7222
Independence of regulatory agencies
0.47
0.5
Effectiveness of regulatory agencies
0.51
1
Civil enforcement
0.19
0.6667
* As of August, 2003; Accountability index (practices, 0.45; institution building,0.9027)
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(Example)
Institution Building: Independence of regulatory agencies
• Korea : Members of the FSS can serve for three years ans
Dismissal of
regulatory agency
members
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)
Regulating Corporate Governance of Business
Groups: Fair Trade Commission In Korea
 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
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Chaebols’ Ownership Structure
 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
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Public Policy toward the Cross-shareholding Structure
 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
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Ownership Structure of SK Group
Note: Author's estimation based on various business reports and audit reports (as of December 2001)
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1
Samsung Group, Year 2002
.8
22 2
2 22
22
22
22
2 2
2
2
2
2
2
2
2
22
2
2
22
2
2
2
2
.6
2
2
22
22 2
2
2
2
22
.4
2
11
.2
1
111
1
111
1 1
1
0
1
0
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.2
.4
.6
cash-flow right
.8
1
15
1
LG Group, Year 2002
2 22
2
2 2
2
2
222
2
.8
2
2
.6
2
1
.4
2222
2
2
1
1
1
1
11
1
1
1
.2
1
1
22
2
1
1
2
0
1
0
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.2
.4
.6
cash-flow right
.8
1
16
SK Group, Year 2002
.8
1
222 2 2 2
2
2
22
2
.6
2
22
2
2 2
2
.4
.2
2
2
2
2
2
2
2
2
2
1
2
2 1
122 21
1
1
2
2
2
211
1
1
0
1
2
0
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.2
.4
.6
cash-flow right
.8
1
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• Table Inside Ownership for the 30 Largest Chaebols
(unit: %)
Inside Owners
1996
1997
1998
1999
2000
Controlling Shareholder
3.7
3.1
2.0
1.5
3.3
Family
4.8
4.8
3.4
3.0
2.3
Affiliated Companies
33.7
35.7
44.1
36.6
35.2
Total
42.2
43.6
49.5
41.1
41.8
Source: Press releases by the Korean Fair Trade Commission
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Measuring the ownership structure of Korean chaebols
 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%
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Explaining the differences of measurement in the
literature
 Large listed companies: usually investing
companies => small wedges
 Other subsidiaries: usually invested companies =>
large wedges
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Explaining the differences of measurement in the
literature




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 cashflow right and high control right
 Public investors to protect
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Private firms belonging to Korean business groups
 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
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The Monopoly Regulation and Fair Trade Act:
Regulation on Chaebol subsidiary’s holding of other
companies’ shares
 A ceiling on equity investment ratio
 all individual subsidiaries for large Chaebols
except for financial companies (NBFI)
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Ownership Structure of Samsung Group
 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.
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Ownership Structure of Samsung Group
Note: Author's estimation based on various business reports and audit reports (as of December 2001)
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Pubic policy toward financial companies’ fiduciary duty
 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.
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Pubic policy toward financial companies’ fiduciary duty
 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.
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Pubic policy toward financial companies’ fiduciary duty
 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.
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