The Promise of Governance

14 MARIELA M. VARGOVA, PH.D. The Promise of Governance Reform—South Korea n his inauguration speech on May 10th, the newly elected South Korean President Moon Jae-In vowed to put chaebol reform at the forefront of his political and economic agenda. “Under the Moon Jae-In administration,” he asserted, “the collusive link between politics and business will completely disappear.’ The promise of meaningful governance reform comes in the wake of the biggest political corruption scandal in Korea that saw the impeachment and the arrest of democratically elected President Park Geun-Hye on charges of “collecting or demanding $52 million in bribes”? from Samsung, one of Korea’s largest family-owned conglomerates, known as chaebol. The presidential scandal in Korea also led to the latest high- profile corporate arrest in the country. In February, Jay Y. Lee, vice chairman and acting leader of Samsung’s conglomerate empire, was arrested on accusations of bribery to former President Park and her inner circle in exchange for securing a controversial merger of Samsung Construction and Trading Corporation and Cheil Industries. While the image of a handcuffed Lee sent shockwaves across the business world, his arrest was not unprecedented. In the past, his father Lee Kun- Hee, current chairman of Samsung, was convicted twice of corruption and pardoned. Similarly, in 2007, Hyundai’s Chairman Chung Mon-Koo was found guilty of fraud and pardoned. And in 2013, SK’s Chairman Chey Tae-Won was convicted of embezzlement and later pardoned.’ The family- owned conglomerates have long dominated the economic life of modern Korean society, accounting for roughly 50% of the total share of the Korean stock market. Their close ties with the government and state bureaucracy have fueled growing public distrust and frustration with the nation’s leadership and has led to increased shareholder discontent. Korea’s Governance Practices The collusion of politics and business in Korea highlights the poor practices of corporate governance and business ethics. Corporate governance studies on Asia consistently rate Korea as lagging in governance behind leaders in the region.* Korea underperforms its peers in the areas of board independence, ethics and transparency in corporate governance. GLOBAL FORESIGHT THIRD QUAPTER 2017 Senior Vice President, Senior Sustainability and Impact Analyst 212.549.5236 [email protected] Korea, however, has not always been viewed as the laggard in Asia’s governance landscape. Right after the Asian Financial Crisis of 1997-1998, the country underwent important governance reforms that sought to quickly and significantly increase corporate board independence and the overall governance of publicly-traded Korean companies. For instance, the proportion of listed firms with at least one outside director grew from 34% in 1999, to 62.3% in 2000, to reach 94% in 2007.° In 2001 and 2003, the country’s Security Exchange Acts required large listed companies (those with about $2 billion in market capitalization) on the Korea Exchange and KOSDAQ to have at least three outside directors and for one half of their boards to be independent. In 2004, the board independence requirements were further strengthened with the stipulation that there be a majority of independent board directors for large companies. This is on par with leading international best practices in corporate governance. The Korean Commercial Code also stipulates that outside or independent directors must not be related to management while acting as fiduciaries.® This resonated with the impetus towards greater board independence to mitigate the role of corporate insiders and create new independent auditing structures within Korean corporations. In 2012, the Korean Commercial Code was revised to further enhance the board’s fiduciary duties. It required the approval of two-thirds of directors for all internal transactions and for new business dealings with third parties. If transactions or deals benefit founding families or management at the expense of minority shareholders, the approving directors will be personally liable for the losses.’ Notwithstanding these developments towards good governance, ethics controversies involving Korean chaebols surged over the past several years. A prime example is the notorious Hyundai Motor land bid in 2014 for which the company paid the excessive price of $10 billion, three times the land’s market value of $3 billion, angering investors and hurting shareholder value. According to reports, while the boards of directors of Hyundai consortium companies voted to unanimously approve the deal, the company’s outside directors were kept in the dark about the price as it was considered by management to be a confidential matter. All these instances point to a serious lapse in the HOUSE_OVERSIGHT_012092