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Policy Study

Public Enterprise Reform and Privatization in Korea : Lessons for Developing Countries

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  • 저자 임원혁(林源赫)
  • 발행일 2003/12/31
  • 시리즈 번호 2003-04
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요약 A Corporate Governance Perspective on Public Enterprises. In its broad sense, corporate governance may be defined as the entire set of institutions, both inside and outside the firm, through which the objectives of the company are set and executed and the performance of the firm is monitored.  From a corporate governance perspective, incentive schemes and objectives under public vs. private provision may be analyzed as follows.  For public provision, the objective is “public interest,” defined through a political process; whereas, for private provision, the objective is profit.  However, for both public and private provision, the most effective incentive mechanism for managers is to link managerial rewards to performance, based on clearly defined objectives.
The essence of public enterprise reform prior to privatization is to establish this type of effective incentive mechanism by implementing the following set of actions: (1) Minimize political interference, especially in personnel and pricing decisions; (2) Clarify the firm’s objectives, using performance indicators whenever possible; (3) Increase managerial autonomy to meet these objectives; (4) Evaluate managerial performance; (5) Link reward to performance.
Privatization makes a fundamental break from this approach and changes the objective of the firm from “public interest” to “profit.”  As such, a decision to privatize a public enterprise should be based on a judgement that the firm’s “public interest” function has been exhausted or can be replaced by other means such as direct fiscal subsidies.  There should also be an additional judgment that the introduction of the profit motive through privatization is likely to lead to increased consumer welfare through substantive competition and regulation.  Privatization will risk a serious backlash if it leads to a destruction of firm value through “tunneling” or other acts of malfeasance, or gives rise to monopoly rent due to the lack of competition or the capture of regulatory bodies.  As the effectiveness of privatization crucially depends on the existence of competitive and efficient markets, privatization should be part of a comprehensive program of market-oriented reform.

Public Enterprise Reform and Corporate Governance Improvement

In Korea, the most important reform measure adopted before the full-fledged privatization of public enterprises was the Government-Invested Enterprise (GIE) Administration Basic Act of 1983.  Through this Act, the government introduced a German-type dual board at each GIE, establishing a supervisory board made up of non-standing directors (except the CEO) and a virtual executive board staffed with internally promoted executive officers.  The supervisory board included representatives from the supervisory ministry and the Economic Planning Board.   The separation of internally promoted executive officers and non-standing outside directors was designed to reduce the “parachute appointment” of outsiders to executive positions, which had weakened the morale of employees at public enterprises.  In addition, the 1983 Act streamlined various controls to increase managerial autonomy, and established an inter-ministerial council to evaluate public enterprise performance and link reward to performance.  Based on the efficiency principle, a set of performance indicators devised by experts had the effect of checking managers as well as bureaucrats and politicians from pursuing their narrowly defined private interests.  This reform was widely regarded as a success (Shirley 1989).
As the Korean economy was progressively liberalized and the “public interest” argument for public enterprises was weakened, privatization began to surface as a realistic policy option in the late 1980s.  Yet due to bureaucratic inertia as well as general concern about the increasing concentration of economic power in the hands of the chaebol, or Korea’s family-based business groups, the government exercised a great deal of caution in pushing ahead with privatization prior to the 1997 economic crisis.  The government took measures to improve the corporate governance of public enterprises, and partially sold its shares in public enterprises while retaining control.
Representative of the government’s cautious approach was the 1997 Act on the Managerial Structure Improvement and Privatization of Public Enterprises.  This Act aimed at improving managerial efficiency and pushing ahead with privatization while preventing further concentration of economic power.  It imposed a shareholding cap of 7 percent to prevent the chaebol from acquiring controlling interests, and envisioned an Anglo-Saxon style corporate governance structure, involving active participation by institutional investors with significant but non-controlling interests.  Although the 1997 Act provided an alternative to chaebol-dominated privatization, it had serious shortcomings as it was accompanied neither by a credible program to sell government shares nor by a plan to separate regulatory and industrial policy objectives from the business objectives of public enterprises.  In fact, Korea implemented a comprehensive program of privatization only after the outbreak of the economic crisis at the end of 1997.

Privatization and Remaining Challenges

The economic crisis added a new sense of urgency to privatization policy, as the sale of highly regarded public enterprises was viewed as a means of generating hard currency and securing foreign investors’ confidence in Korea.  The implementation of institutional reforms to reduce moral hazard, improve corporate governance, and enhance competition also supported the privatization drive.
As the crisis put a serious dent in the chaebol’s claim for superior efficiency, most of the privatization plans for large-scale public enterprises were drafted with a view toward establishing Anglo-Saxon style corporate governance.  In fact, the privatization of POSCO, KT, and KT&G proceeded along this line.
In addition, there was an increased awareness of the importance of competition and regulation in the process of privatization.  In particular, the sale of co-generation facilities in Anyang and Bucheon without an appropriate transformation of regulatory policy led to significant hikes in heating bills and subsequent consumer complaints.  Through this experience, the government learned an expensive lesson that the introduction of the profit motive through privatization should be accompanied by substantive competition or regulation if it is to lead to improved consumer welfare.
This lesson should not be lost on policymakers.  Of the eleven public enterprises targeted for privatization in 1998, only three remain public enterprises, in electric power, gas, and district heating sectors-all network industries where competitive market design and regulation are of crucial importance.  In order for privatization to improve efficiency and consumer welfare, it should be a component of a comprehensive program to enhance the operation of market forces.

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