Tuesday, May 08, 2007

Financial and Industrial Capital, the Chaebol, and the GNP

Here's a very interesting story about one area of agreement between the right wing presidential candidates as well as some particular types of economic nationalists: this is the issue of Chaebol ownership of financial institutions such as banks and other lending bodies. Traditionally, a separation of finance and industry is considered necessary to avoid 'moral hazard' issues that could lead to economic crises. Obviously, for the writers of this blog, the economic areas that we usually discuss issues such as moral hazard are mostly in terms of workplace and societal relations, but for mainstream economists these issues are mostly confined to who owns what. It should be no surprise then that the right wing (and occasionally some former left wing nationalists as well) have come out in support of the chaebol's right to own banks.

Now, some of the chaebol's complaints about reverse discrimination against Korean firms are legitimate in terms of the way in which parts of the banking system were preferrentially sold off to foreign speculative funds to whom Korea's restrictions on voting rights and ownership of financial and non-financial firms did not apply, but it should be remembered that the crucial exception that was made here was between foreign and domestic capital and not between foreign capital vs. the chaebol. A key distinction to keep in mind. The chaebol and the right here are mainly turning a criticism of what was a genuinely bad policy move into something that suits their interests in a way that would give them even more control over resources than they have now.

Jeon Seong-in, a professor of Hongik University, makes an astute comment in the article:
"They are plainly talking about transferring bank ownership to the conglomerates.'' "(The so-called presidential hopefuls) worry about the future of domestic financial industry and cite Lone Star Funds, but this problem was not caused because Lone Star represents foreign capital, but because a bank fell into the hands of a non-financial company. They may have correctly recognized a problem, but it is as if they have come up with the wrong solution. ''

I think this is the right step towards a larger debate on what to do about financial sectors as a whole, at the moment the banking sector is overwhelmingly foreign owned, but even where the government owns banks it runs them in the same way, investing in mostly speculative ventures like mortgage and consumer credit -- though they have now begun privatizing Woori bank which they own the majority stake in at the moment. Here one needs a critique of financial capital and what it does, not simply foreign vs. domestic capital. What could the government do to better allocate funds that create jobs, that don't go to environmentally wasteful investments or corrupt firms, and in way in which the public has more than a modicum of democratic input. Some people think that projects like the Ha Soon fund are the answer here, based upon investment in companies with strong shareholder rights, but I am also skeptical about this too. I would rather see money go to firms that respect their unions and workers or to other redistribution enhancing institutions rather than simply a firm with a good relation to its shareholders. Anyways, that's just my opinion.


  1. Here's a more conventional look into the problem regarding different financial systems from a different perspective, closer to some statist analyses.

    Last 10 Years' Corporate Governance Reform in Retrospect
    KIM Yong-Ki Apr. 25, 2007

    Since the 1997 financial crisis, economic reform has occurred in four major areas: corporate governance, financial sector, labor market, and state-owned enterprises. Of all these areas, corporate governance reform has been a key concern.

    Government officials and some scholars have argued that "global standards" exist in the area of corporate governance practices. According to their claims, firms' adherence to these standards would solve many problems related to chaebol horizontal expansion, blamed as a main cause of the 1997 crisis. In addition, some others maintained that the "Korea discount (stock prices in Korean public firms failing to reflect those firms' real value)" would vanish if the standards were met.

    While there is some truth to this line of reasoning, it is an argument that has gone too far. Indeed, some people equate "global standards" with accepted practices in Anglo-American-style corporate governance. Once this unquestioned assumption is taken out, however, it is hard to say their argument still hold.

    The Anglo-American corporate governance model is characterized by several special features: widely dispersed share ownership, corporate control by professional managers, board of directors composed of a majority of outside appointees, and existence of active M&A market. Among others, the most important characteristic of the model is that it puts the shareholder interest as the first priority. In order to align the interest of CEOs with that of shareholders, the corporations endow their CEOs with stock options and other performance-based incentives.

    Korea's efforts to adopt Anglo-American practices, however, have turned out unexpected results. While the stated purpose of these reforms was to enhance corporate performance, promote growth and maintain economic stability, reforms seem to have done more damage than good. Rather, it produced an unexpected outcome, i.e., sluggish corporate investment in plants and equipment, and myopia in corporate management.

    Why has reform failed to deliver as promised? It seems to me that the reason lies in the fact that we did not consider the special context of the Korean economy. We simply tried to plug in imported market institutions, such as corporate governance-related regulations and practices, with little regard to how they would fit in Korea's context.

    One key example can be found in strengthening of market discipline over firms, an essence of US and UK corporate governance practices. Most public companies in the US and the UK have highly dispersed shareholding structures, giving rise to diverging incentives between management and shareholders. In fact, only one sixth of UK publicly traded firms has a dominant shareholder with ownership of more than 25 percent controlling shares. In the US, the comparable figure is less than one-twelfth. However, dispersed ownership seen in the US and the UK is an exception rather than the rule.

    Ownership of firms in continental Europe is exceedingly concentrated: 93.6 percent of public firms in Belgium have dominant shareholders whose holdings top the 25 percent threshold. The comparable figure for Austrian firms is 86.0 percent; 82.5 percent for Germany's; and 80.4 percent for the Netherlands'. In these countries, there is no public voice calling for wholesale adoption of Anglo-American corporate governance practices.

    Back to the issue of corporate governance reform in Korea, it is very important to remind of the fact that corporate ownership in Korea's public companies is similar to that in European countries. Dominant shareholders control corporations and monitor their CEOs.

    As a result of such differing ownership structures, corporate governance reform trying to emulate the Anglo-American practices has largely failed. By strengthening the power of outside shareholders, conflict between the largest shareholder, in many cases represented by the group's family and affiliates, and the second largest shareholders, typically foreign investors, has intensified. Some private equity funds, who can easily establish a paper company in tax havens, could use a loophole in regulations. There are examples showing amply that current regulations discriminate against domestic investors in favor of foreign counterparts.

    For example, the Securities Trade Act prohibits exercising a voting right higher than 4 percent in selecting audit committee members of big public companies. The intention of this regulation is to protect the right of minority shareholders from abuse of major shareholders. A private equity fund called Sovereign divided its shares into five paper companies, all with less than 4 percent shares of SK Corporation. As a result, it exerted all its rights of 14.99 percent in the proxy fight for electing the audit committee members in the 2004 annual shareholders meeting.

    In contrast, the major shareholder group consisting of affiliated companies supporting the SK Corporation's management could not exercise all of its voting rights because two of the affiliates had more than 4 percent voting rights. Such incidents, exemplified by some private equity funds, have caused political backlash against all foreign investors. Looking back the last 10 years, it is important to remember that one size doesn't always fit all.

    The writer is research fellow at the Public Policy Research Division, Samsung Economic Research Institute. Inquiries on this article should be addressed to seriyongki.kim@samsung.com.

  2. I am confused to write a comment after the last one above. And I forgot all I wanted to say :) Well, to my mind, the capital of the world (for many reasons) is Japan. Do not try to talk round me.

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