SAMSUNG ELECTRONIC CORPORATION: GOVERNANCE OF CHAEBOLS
Copyright: Prof. Florencio Lopez-de-Silanes
Professor Florencio Lopez-de-Silanes and Rakhi Kumar, Yale MBA02 prepared this case as the basis for class discussion rather than to illustrate the effective or ineffective governance of an organization.
Prof. Florencio Lopez-de-Silanes INTRODUCTION
Case: Samsung Electronics
Prior to the Asian currency crises, South Korea was an investment destination for several institutional investors and emerging market funds. Throughout the early nineties the country experienced an economic boom. South Korean conglomerates, locally know as chaebols, had diversified into various industries from cars to microchips. Samsung Electronics Corporation (Samsung Electronics), a rising star in the Samsung Chaebol was considered to be a high growth company. However, in 1997, the Asian currency crises magnified the problem of the Chaebol structure and highlighted the need for governance reforms. By 1999, a shareholder rights activist in South Korea - Prof. Hasung Jang had taken up the cause of minority shareholders of Samsung Electronics. With the help of foreign institutional investors, he planned to fight for governance reforms in South Korea. As a corporate governance specialist, Samuel Smith, had been contracted by a large foreign institutional investor to help reform Samsung Electronics.
KOREAN CHAEBOLS: Establishment, growth and structure.
In order to accelerate economic growth in the 1970’s, the Korean government formulated industrial policies that encouraged investment in heavy and chemical industry (HCI). Funded largely by government-controlled banks, affluent families took advantage of the liberal policies and set up companies in these industries. By the end of the 1970’s approximately 80 percent of fixed investment in the manufacturing sector was in HCI businesses. Between 1962 and 1982, annual growth averaged 8.4%, although by the end of the 1970’s production efficiency in priority sectors was falling. As a result, there was excessive investment in the HCI industries and little allocation efficiency in the capital markets1. Due to over investment in the HCI industry and small domestic markets, companies began diversifying into unrelated businesses, giving birth to the Korean Chaebols.
Government intervention in resource allocation proved to be very costly. Enterprises that had access to preferential policy loans or tax incentives tended to expand their businesses The Institute for International Economics - Financial Services Liberalization in the WTO: Case Study of South Korea 1
Prof. Florencio Lopez-de-Silanes
Case: Samsung Electronics
rapidly without careful appraisal of investment projects. Since the government largely made lending decisions, creditor banks had little incentive for credit evaluations or loan monitoring. As a result, firms were heavily leveraged and borrowed from informal credit markets as they were usually pressed for working capital. This structural weakness put the economy on the verge of a financial crises in early the 1970s and then again in the 1980s2. However, public purse bailing out of large enterprises became the norm and people were made to believe that chaebols were too big to fail.
When the government decided to open up the South Korean economy, many of the protective measures that local companies had enjoyed during the developmental era were removed. Companies that had expanded into unrelated businesses found that they no longer had access to government capital. Initially, banks were also not interested in financing these projects, nor did they have the expertise to evaluate these new high-risk businesses. Hence, business groups started creating their own group wide internal capital markets. Transfer pricing, cross-shareholdings and cross-guarantee of debts were some of the mechanisms employed by chaebols to fund expansion. They pooled any funds available...