By Sang Hyun Park
Taking the first-class seat on her plane to Seoul late last year, Cho Hyun-Ah ‘99 would not have known that an unopened bag of macadamia nuts would cost her a job and a prison sentence.
Early February, in a rare display of severity, a Seoul district court sentenced the daughter of Korean Air’s chairman to a year in prison for her tantrum over the way macadamia nuts were served to her on a plane. If this has been any indication, being rich is no longer an excuse for escaping the pains of ordinary life in South Korea. With the government’s hardened stance against the family-run conglomerates, known as chaebols, the nation is committing to more responsible forms of corporate governance. Now that restructuring is underway for the nation’s top economic players, the country will see either major improvement in its economy or catastrophic change.
The Classic Debate
Chaebols have played the leading role in the story of South Korea’s economic success. Once a war-torn nation, the country now stands as the world’s thirteenth-largest economy, owing its success to the work of industrial giants such as Samsung and Hyundai. Hand-picked by the government, family-run firms benefited from cheap loans and preferential market access, gaining enormous influence as they turned the once-fledgling economy into an export powerhouse. Just four decades after the Korean War, the country emerged as the model Asian tiger, with chaebols driving the center of this growth.
Of course, such a feat did not come without setbacks. As these family-run conglomerates grew in power, their lax corporate governance proved to be increasingly problematic. The Asian financial crisis in 1997 left the four biggest chaebols with debt five times their equity, forcing them to cut off their subsidiaries. The Daewoo Group, once the second largest conglomerate in Korea, filed bankruptcy with $50 billion worth of debt due to poor financial management. The economy achieved a narrow recovery only after a $58 billion bailout from the IMF.
Most importantly, the chaebols’ economic dominance and all-too-friendly relations with the government have perpetuated inequality within the nation. Chaebol-government collusion has allowed the conglomerates to hold most of the nation’s capital despite distributing their vast wealth to only the select part of the population that they employ. According to data compiled by CEO Score, the ten biggest conglomerates accounted for only 4% of employment in the country in 2013. As Un-Chang Chung, a former South Korean premier, once remarked, such issues constitute “a more serious matter than relations with North Korea.”
The Chaebol Problem
For decades, the country’s leadership has faced difficulty reconciling the chaebols’ vital role in the nation’s economy with the myriad problems associated with their structure. Despite restructuring efforts following the 1997 financial crises, including the appointment of outside directors and elimination of inefficient subsidiaries, the dominance of conglomerates in the nation’s economy remains largely intact. The top ten chaebols generate 80 percent of Korea’s GDP, with Samsung accounting for more than 28 percent of it alone. Meanwhile, economic polarization has long remained a pervasive problem within the nation. In addition to a shrinking middle class, poverty remains double the OECD average, while top corporate executives hold wealth in multiples of billions.
The main area of vulnerability in the Korean economy lies in the relative weakness of its domestic businesses. The manufacturing giants’ dominance in over two-thirds of the country’s business activities has deterred the growth of small and midsized companies (SMEs) and service industries. Especially in light of recent evidence of a slowing manufacturing sector and loss of market share to low-cost Chinese competitors, the need for vibrant SMEs and greater vitality in the nation’s economy is gaining increasing importance.
With the tradeoff between the nation’s growth and inequality, collusion between the government and chaebols has been a main challenge in restructuring the economy. The government’s lax regulation of the nation’s chaebols has long secured their dominance in the economy. As recently as 2008, former President Lee Myung-Bak pardoned Samsung Group chairman Lee Kun-Hee from a three-year prison sentence on charges of embezzlement and tax evasion.
Taking the hardline
Ever since the 2013 presidential elections, political consensus has gathered against the chaebols’ unsound management practices. President Park Geun Hye’s introduction of large inheritance tax bills in particular signaled a major step forward in restructuring the chaebols. By creating incentives to streamline corporate structure using holding companies, the tax bill is expected to contribute greatly to unraveling cross shareholdings and forming more transparent ownership.
The government has shown much promise in the legal front as well. The recently-passed Conglomerates Ethical Management Special Law bans members of the powerful business families from working if convicted of a crime. In February 2013, The Supreme Court confirmed a four-year embezzlement sentence for SK Holdings Chairman Chey Tae-won, marking the longest sentence for a chaebol boss. The imprisonment of Cho Hyun-ah, followed by her resignation as an executive, also came in a perfect time to demonstrate the toughened stance against criminal actions by chaebol executives.
A critical transition
Reforms targeted at chaebols will be important especially as Samsung, Hyundai, and other major conglomerates restructure to hand over power to the third-generation. Transparency will likely be a major objective in upcoming reforms with increasing market demand for accountability. In January, Hyundai failed to sell $1.25 billion shares in a logistics affiliate after failing to specify how the proceeds would be used to restructure the group. According to Park Yoo-Kyung, a director in APG Asset Management specializing in corporate governance, chaebols’ failure to provide more transparency with such details can lead to “rampant speculation in the market.”
At the World Economic Forum in 2014, President Park championed measures that will foster a “creative economy” by promoting innovation and entrepreneurship. As restructuring takes place within the vast conglomerates, it is important that the administration follows up on its promise by easing off from its manufacturing heavyweights and freeing up capital for its domestic businesses. Increased investment in R&D will help nurture the nation’s SMEs and reduce the income gap by supporting more sources of employment. Without sufficient efforts to develop its domestic businesses, however, greater restrictions on chaebols may only dwindle the nation’s overall economic output and hurt its long-run performance.
Korea’s economic future will depend on how persistently the government tackles the dual challenge of promoting better corporate governance and growing domestic businesses in years to come. With recent legal developments, Korea is well on its path to leveling its economic plane field. Yet, Korea will need to proceed with caution as it undertakes this pivotal transition. Chaebols are cornerstones to the modern Korean economy. Upcoming reforms must improve transparency, prosecute wrongdoings, and dole out profits, but one thing they must not do is permanently atrophy the giants’ formidable potential.