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Working Paper

Corporate Restructuring in Korea : Policy Issues before and during the Crisis

  • 저자 유승민(劉承旻)
  • 발행일 1999/02/01
  • 시리즈 번호 9903
요약 Restructuring Corporate Korea under crisis is an on-going
process which began less than a year ago and is in fact a
continual evolution so long as the business environment changes.
Thus it is too early to make a definite judgment on the future
of Korean industries and chaebols. Although many of the
uncertainties arise from volatile market variables which do not
allow any reliable predictions, there are still many
government-made instabilities. The present situation of crisis
tends to justify stronger government interventions, valid or not,
since the government is believed to be the only player who can
mobilize the resources needed to fix the problems in financial
and corporate sectors.

One irony is that the tradition of state predominance in the
Korean economy, which has been at the root of many problems
of Korea Inc., is now being reinforced during the crisis, possibly
turning Korea into another state-run economy (see the Asian
Wall Street Journal, August 25, 1998). The point is that a proper
role of the government is called for in order to overcome the
crisis, but the inertia of erroneous government intervention, once
developed, cannot be easily removed when the economy no
longer needs it.

The debate in Korea on the role of the state vis-a-vis the
market highlights this concern over any excessive (or too
hands-off) intervention by the government coupled with
overkilling (or blindly believing) market mechanisms in dealing
with the crisis. Neither government intervention nor market
mechanisms are in itself an objective, the real issue being which
is the most cost-efficient way of restructuring Corporate Korea.
A dichotomized approach may be necessary in dealing with
corporate restructuring versus financial restructuring in that the
former should resort more to market principles while direct
intervention by the government is inevitable in the initial stage
of financial restructuring, although intervention in financial
restructuring should as much as possible work to reinforce
markets and be as consistent in its treatment of all players as
possible. Indeed, in the process of recapitalizing and cleaning
the balance sheets of financial institutions, many banks are to be
nationalized or placed under stronger state control.

A similar trend of de facto nationalization, however, is likely
to occur in the corporate sector either through direct
nationalization of ailing corporations or the so-called bank-led
corporate restructuring. This trend itself will not present a
problem if Corporate Korea can be successfully restructured to
become healthier and stronger. Rather, a key concern is: Does
the Korean government have the will and ability to successfully
micro-manage corporate restructuring under its own initiative? If
the answer is no, then the government may have to limit its
role to providing proper monetary and fiscal policies and
institutional innovations to induce corporate restructuring, and
leave the initiative in the hands of corporations themselves,
shareholders, and commercially oriented creditors.

In what follows, we try to make a few cautions and
suggestions regarding the current government efforts toward
corporate restructuring:

Breaking up chaebols? Isn't it a risky over-reaching?

Finally, we need to address one of the most fundamental
issues in the corporate restructuring of chaebols: that is, should
chaebols be dismantled and can they be? Although the scope of
this issue goes far beyond corporate governance, its essence lies
within corporate governance. We first note that all of the
improvements in regulatory framework and law enforcement with
respect to corporate governance will significantly affect chaebols'
governance as the corporate managers, controlling shareholders
and inside directors are, under more transparent accounts, better
monitored and checked by shareholders, outside directors and
creditors, and face more credible threats of being forced to lose
their jobs or compensate any damages.

However, to the extent that chaebols' concentrated
ownership structure leaves the corporate control of Chongsu
uncontestable (see Appendix Table 6), all of these changes in
corporate governance-related policies will not be effective in
replacing inefficient management of chaebol companies with a
better management, either from within the corporate organization
or through the market for corporate control. This regulatory
impotence in replacing chaebols' old management with a new
and efficient one, is the starting point of the debate on breaking
up chaebols.

In Korea's academic circle, dismantling chaebols seems to
carry dual meanings: (a) to separate ownership, control and
management, implying a result that the present controlling
shareholders lose, in some way still unknown to most of us,
their absolute and uncontested power over the entire subsidiaries,
and (b) to dismantle business groups; that is, to make individual
subsidiaries stand free and independent of anything except their
own shareholders and/or stakeholders. As dismantling chaebols
has never been officially and openly mentioned by the President
himself, nor his aides, its exact meaning in a real world context
is still unknown, and the time may not be ripe yet for any
serious discussions on dismantling chaebols. One of the few
exceptions is the following comments made by Kim Won-Kil,
Member of the National Assembly and Chairman of the Policy
Committee, the ruling National Congress for New Politics, on
August 20, 1998 at a seminar on the 2nd Nation-Building: "The
purpose of restructuring Korean economy is to enhance
international competitiveness by dismantling chaebol system
which have long dominated national economy with the privileges
chaebols enjoyed under a financial system lacking autonomy."
Recently, however, domestic press has begun to point out the
possibility that the current administration may indeed pursue a
policy of dismantling chaebols (see the Dong-A Daily, October
26, 1998 and the Seoul Daily, October 17 and October 27, 1998).

Nevertheless, policy changes in Korea are sometimes so
abruptly, confidentially and covertly decided that we had better
be prepared to answer questions associated with this old and
fundamental issue of dismantling chaebols. In fact, as we look
back upon the series of new chaebol regulations that have been
adopted and implemented under the Kim Dae Jung administration
-- those regulations or policies regarding corporate governance,
chairman's office, debt payment guarantees, intra-group
transactions, the so-called Big Deals, designation of the so-called
exit firms, etc., -- we may infer that the combined effects of
some of these regulations, desirable or not, amount to de facto
chaebol dismantling. For instance, strengthened regulations of
intra-group transactions, including debt payment guarantees,
would imply that chaebols no longer need to maintain a group
structure if every transaction among their subsidiaries has to be
carried out as if it occurred in the market, because one of the
very reasons why chaebols internalize their transactions is
simply that they gain by doing so.

It is not clear at this point in time if the new chaebol
regulations are purposely aiming at dismantling chaebols, though
their accumulated and long-term effects will undoubtedly be
close to what we can envisage under the same name of chaebol
dismantling. The true answer may depend upon what will be the
new policies or regulations, if any, that will be added from now
on to the above list of existing regulations. If chaebol
dismantling is what the Kim Dae Jung administration is really
after, then it can be predicted that in the near future the
government will come up with various measures that will
generate important momentum in breaking up Korean chaebols.
A recent document released by the Financial Supervisory
Commission is one such example which alludes to the possibly
of dismantling chaebols. See the Financial Supervisory

Thus, a new list of regulations aimed at dismantling
chaebols may include: (a) separating ownership, control and
management through debt-equity swaps, and stringent law
enforcement -- civil, commercial and criminal -- on any tax
evasion, insider stock trading, bribery, misappropriations,
embezzlement, neglect of fiduciary duties, etc. by controlling
shareholders (Chongsu) and his or her family members; (b)
curbing intra-group shareholdings by introducing a new
regulation into the Commercial Code, the Securities Exchange
Law or the Monopoly Regulation and Fair Trade Act; (c) further
strengthening corporate governance-related regulations. Some of
these regulations will require new legislation, while many others
are made possible either through tighter enforcement of existing
laws and regulations or through strengthened control over
chaebols through newly nationalized or state-controlled banks.

Regarding the question of whether or not dismantling
chaebols is feasible at all in Korea, we unfortunately do not
have a clear understanding of the political will and resolution of
top power elites to overhaul Korea's political economy in this
way. A more important question for the Korean economy,
however, would be whether or not dismantling chaebols is the
best way for efficiency reasons in the short as well as longer
term to restructure Corporate Korea. Specifically, we are
interested in three questions: If chaebols are dismantled, what
are the alternative ways of corporate organization in Korea?
How can we be assured that the new models of corporate
organization are better for the national economy? Arent there
any transaction costs inevitable in this transition, and if so, can
we neglect them?

To be sure, chaebols were the creation of Park Chung Hee's
growth paradigm, and it is fair to say that chaebols have had
the good, the bad and sometimes even the ugly aspects, like any
other big businesses in the history of capitalist market
economies. It is easy to blame chaebols for having caused the
crisis, but to find a subsititute paradigm will not be an easy job.
If the argument for dismantling chaebols is only based upon the
popular observation that chaebol-dominated economic structure
has caused the present crisis, which many Koreans mistakenly
named the IMF crisis, then a real danger exists with the idea of
dismantling chaebols. Doing so would mean that any strengths
of chaebols will disappear altogether. Every model of corporate
governance and organization around the world is not free from
the so-called historical path dependency, Roe(1993) argues that
depending on what kind of laws and regulations the state
imposes upon business firms, the nature of corporate governance
can be greatly affected. The development of laws and
regulations in turn is determined by social, economic and
political forces, and in this sense, the concept of historical path
dependency is critical in shaping the corporate governance of
each country. and the Korean chaebols are no exception in this
regard. Though it is still uncertain when the present crisis will
be over and Korea takes another path of sustainable
development, it will make an history when it eventually ends,
and chaebols are expected to change immensely along this
evolutionary trajectory of crisis. The eventual outcome of this
longer-term evolution may be quite close to what those
self-proclaimed reformists want to achieve right away when
they argue for dismantling chaebols. A critical difference
however, lies in the time horizon and whether it is an
evolutionary or revolutionary process.

A recommendation on policy choices for corporate restructuring
to enhance competitiveness:

What are the basic policy directions if corporate
restructuring means only increasing competitiveness rather than
dismantling chaebols? The first thing the Korean government
should do under the present government-made uncertainties is to
assure chaebols that it will not use political and coercive power
to dismantle them. When chaebols are assured that the
government's real intention lies in restructuring for
competitiveness, not for dismantling them, then a significant
portion of uncertainties will be removed and chaebols' decision
making will speed up. Even if the real intention of the
government lies in dismantling chaebols, it needs to be made
public and more transparent in order to avoid unnecessary
uncertainties, though such a move will invite friction and
confrontations between chaebols and the government.

Second, the government should redirect, on a comprehensive
and integrated basis, the current package of policies and
regulations on corporate restructuring in a more
incentive-compatible way. One of the most serious fragilities in
corporate and financial restructuring in Korea is that the
incentives are too weak for the corporations and the banks to
restructure sufficiently (see Lieberman and Mako, 1998). This
implies that the government should resort more to
incentive-compatible, market-oriented solutions rather than to a
bureaucrat-made, incentive-incompatible recipe. It also implies
that any public money available for corporate and financial
restructuring can be used to augment the incentives to
restructure. Public money can be used to recapitalize or purchase
non-performing loans from those banks who are successful in
corporate workouts, etc. In order to align the private incentives
of corporations with the interests of the national economy, the
threats of competition and bankruptcy should be the starting
point of chaebol policy. Regulatory innovations in such important
issues as corporate governance, financial reform, and bankruptcy
procedures will be essential in order to render these threats
workable and credible. Finally, a new model of
government-bank-business relationship should be developed to
replace previous incestuous ties. The government should
understand why muddling through is the equilibrium choice of
corporations and banks when incentives are given in that way.

Third, the government need not be rash and should learn
that corporate restructuring takes time. Furthermore, it should
realize that there are clear limitations to what even the best
government can do for restructuring business corporations. The
government also needs to understand, instead of grumbling at
the slow pace of chaebol restructuring, that business is by
nature opportunistic. However serious the crisis may be, we
cannot simply replace corporate managers by bureaucrats or
politicians. Efforts should be maintained not to break the nutshell
of corporate organization, unless corporations go bankrupt and
need to come under court protection or out-of-court settlement.
Also, policy innovation should be directed at inducing
restructuring within the nutshell by the corporations themselves.

Fourth, the current economic difficulties in Korea call for not
only an efficienct bankruptcy procedure but also an innovative
mix of policies to minimize both social costs of corporate
bankruptcies in the short run and nationalization of the private
sector in the longer run. There is no argument with the
proposition that insolvent corporations be dealt with under an
efficient and fair bankruptcy procedure, as is clearly the case
with Kia, Hanbo, and so many other insolvencies. But we note
at the same time that being viable or non-viable is in itself a
function of a variety of market variables including interest rates,
exchange rates, wage rates, profitability, asset prices, and so on.
Under this situation, the issue of insolvency should not be
exaggerated with only partial numerical evidence. The
government needs to be cautious in dealing with those
corporations falling in the grey area between outright insolvency
and solvency.

With these basic directions in mind, a few recommendations
could be made to redirect the current policies toward corporate

First, instead of enforcing the 200% debt-equity ratios by
the end of 1999, the Korean government needs to reasonably
assume that chaebols' financial status will not improve until
they find a way-out whereby escaping their present mountain of
debts. As we discussed in Section 3.3.2, there are indeed many
theoretical ways of reducing corporate debts, but the problem is
that almost none are effective under the current situation. We
believe that a proper mix of monetary and fiscal policies, coupled
with progress in financial restructuring, will be helpful in
making the now ineffective ways of reducing debts begin to
work. The option of government-directed debt-equity swaps,
now a policy fashion in Korea, should then be selectively applied
mainly to those viable but insolvent corporations. However,
debt-equity swaps will remains a possible option if both the
creditor and debtor agree.

Second, the government needs to withdraw its overreached
hands in the so-called Big Deals among chaebols. If chaebols
are coerced into Big Deals and some of the deals fail, then
chaebols would try to extract compensation, leading to legal
disputes in the future. It needs to make clear that there be
neither coercion nor preferential subsidies for any deals among
private corporations, except for normal regulatory innovations in
the Tax Law, Securities Exchange Law, Commercial Code,
Foreign Capital Inducement Act, and regulations of land
acquisitions. 'Excessive or duplicative facilities', if any, will be
handled by corporations themselves under the governance of
shareholders and creditors. Corporate decision-makers are, and
should be, aware that any failure to restructure their capacities
and business portfolios would invite harsh penalties in the
markets first and in bankruptcy procedures next.

Third, the government also needs to align its regulations of
intra-group transactions to be more consistent with the
objectives of competition and tax laws, unless it wants to
dismantle chaebols. The government needs to admit that
intra-group transactions among chaebol subsidiaries are
otherwise an issue to be addressed not by the government but
by shareholders and creditors under more transparent corporate
accounts. The government needs to acknowledge that
intra-group or intra-firm reallocation of resources can be an
efficient way of internalizing the process of industrial
restructuring. In the special case of debt payment guarantees,
outright regulations may be preferable to market solutions, but
the government should be prepared to make a transition from
regulation to market-based solutions in the near future.

Fourth, an innovation in bankruptcy procedures is critical
and urgent as we see the inefficiencies of both court protection
and out-of-court settlement. The government needs to consider
adopting the principle of 'exit by business group' instead of
'exit by individual subsidiaries' during the interim period of
crisis as we take into account the complex financial ties among
chaebol subsidiaries and the inherent difficulty of cutting those
ties. Although 'exit by individual subsidiaries' sounds appealing
theoretically, 'exit by business group' may be a more plausible
option in reality. The threat of bankruptcy is then applied not
only to individual subsidiaries but to the entire group.

Fifth, regulatory innovations in corporate governance-related
issues seem to be moving in the right direction. The only
remaining issue is a matter of the extent and speed with which
the government should carry out its regulatory measures. This
is an area where the government needs to take caution. It
should speed up regulatory improvements for accounting
transparency, shareholder rights, board of directors, and pure
holding companies, but cautiously introduce class action suits.

All in all, it is predicted that more than half of Korea's 30
largest chaebols will either disappear or come under new
management during and after the crisis (see Appendix Table 9).
This strongly implies that Korean economy is awaiting another
round of concentration, following the earlier one in the 1970s and
1980s. Many of the failing chaebols will be acquired by
surviving stronger chaebols including the top five (like Hyundais
acquisition of Kia Motors), though there will be some to be
acquired by foreign capital. Thus, Korea's industrial
organization after the crisis will likely consist of a number of
small and medium-sized companies, some independent large
companies, chaebols who will have survived the crisis, plus
foreign multinationals and newly privatized, former state-owned
giants under professional management and with widely dispersed
ownership. Another key element of Korea's industrial
organization will depend upon whether or not chaebols own and
control some of the nations commercial banks and become
similar to pre-war Japanese zaibatsu (see Mathews, 1998), which
is still an open issue in Korea. To many, allowing chaebols to
run banks is seen as a disaster as we consider the present level
of prudential regulations in Korea.
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