0. The 6th Asian Roundtable on Corporate Governance Youngjae Lim
Implementation and Enforcement in Corporate Governance
Youngjae Lim
Korea Development Institute
Korea
Theme I
Various experiences to ensure effective implementation – allocation of responsibilities and institutional frameworks
Seoul, Korea
2-3 November 2004
The views expressed in this paper are those of the author and do not necessarily represent the opinions of the OECD or its Member countries or the World Bank
Korea Development Institute

1. Korean Regulatory Agencies Enforcing Corporate Governance
Financial Supervisory Service: regulating banking, securities and insurance
Regulating listed companies in the securities market
Staffs are not government officials => Remuneration, recruitment, and training differ from those for the government officials.
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2. Korean Regulatory Agencies Enforcing Corporate Governance
Fair Trade Commission: Regulating Chaebols
Regulating private (unlisted) subsidiaries belonging to business groups
In many countries, private companies are not the target of regulation since the public investors to protect are not involved: high cash-flow right and high control right
But, in Korean business groups, unlisted subsidiaries’ behavior has important implications on the public investors of the listed subsidiaries belonging to the same business groups: low cash-flow right and high control right
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3. Role of Regulatory Agencies regarding the Implementation of Corporate Governance
Internal monitoring system: board of directors, audit committee, or minority shareholders’ rights
External monitoring system (market pressure): potential shareholders in the capital market, institutional investors, hostile takeovers
Regulatory agencies of the government: infrastructure for the external monitoring system to work
Financial Supervisory Service, Fair Trade Commission, Prosecutors, or Courts
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4. Evaluate how the external monitoring system works as of 2003 in Korea
Evaluating the Independence and Effectiveness of Financial Regulatory Agency in Korea
“Developing and Measuring an Evaluation Index for Market Reform” KDI Report, 2003
Chapter 4. “Capital Market Transparency and Investor Protection: A Comparative Law Perspective” by Ok-riak Song and Taeyoon Sung
Since the 1997 financial crisis, Korea has introduced many changes in financial regulatory systems to improve the enforcement of corporate governance.
Evaluate these reform efforts from the perspectives of institution building and actual practices
Evaluate how the external monitoring system works as of 2003 in Korea
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5. Index of the External Monitoring System in Korea
Sub-index: transparency index and accountability index
Transparency index: whether relevant information is distributed to shareholders (both current and potential)
Accountability index: how shareholders (both current and potential) place their pressures on the current management (hostile takeovers, etc.)
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6. Index of the External Monitoring System in Korea
Contents of Transparency index
(1) Information-related legal system: distribution of relevant information in a timely and effective manners
(2) Enforcement system: independent and efficient supervision for (1)
Regulatory agencies
Civil enforcement (civil liabilities regarding external auditors or class action suit)
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7. Index of the External Monitoring System: Literature
Bernard S. Black, The Legal and Institutional Preconditions for Strong Securities Market, UCLA Law Review 48: (2001) [Black]
CLSA, CG Watch: Corporate Governance in Asia (April, 2003) [CLSA]
ISS, Corporate Governance Quotient Rating Criteria [ISS]
Rafael La Prota, Florencio Lopez-de-Silanes & Andrei Shleifer, What Works in Securities Laws?, Working Paper (October, 2002) [LLS]
Partrick S. McGurn, Keeping Score: Rating Governance in the Post-Enron World, Strategic Investor Relations 7-10 (fall, 2002)  
OECD, Questions for Rating Corporate Governance
Standard & Poor's Corporate Governance Service, Company Corporate Governance Score: Abbreviated Criteria and Methodology (February, 2002) [S&P] (w/ Questions)
World Bank / IMF, Template for Country Assessment of Corporate Governance (July, 2000) [World Bank]
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8. 1-2. Transparency (Enforcement system)
Evaluating Institution Building*
1-1. Transparency (Information-related legal system)
0.8750
0.7857
0.6250 1
U.S.
0.8571
Korea
External audit system
Disclosure items
Disclosure system
1-2. Transparency (Enforcement system)
0.9444
0.7222
0.8333 1
U.S.
0.6667
0.5
Korea
Civil enforcement
Effectiveness of regulatory agencies
Independence of regulatory agencies
* As of August, 2003
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9. 1-2. Transparency (Enforcement system)
Evaluating Practices in Korea (Experts Survey)*
1-1. Transparency (Information-related legal system)
0.7857
0.5
0.6250
0.8750
Institution building
0.53
0.47
Practices
External audit system
Disclsure items
Disclosure system
1-2. Transparency (Enforcement system)
0.7222
0.39
0.6667 1
0.5
Institution Building
0.19
0.51
0.47
Practices
Civil enforcement
Effectiveness of regulatory agencies
Independence of regulatory agencies
* As of August, 2003; Accountability index (practices, 0.45; institution building,0.9027)
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10. Institution Building: Independence of regulatory agencies
(Example)
Institution Building: Independence of regulatory agencies
Korea : Members of the FSS can serve for three years ans can be reappointed once (Financial Supervisory Service Act Article 6, Clause 1). However, only the appointed members namely Chair and Vice Chair of the FSS are guaranteed of their position (0 point)
U.S. : members of the SEC can serve their position for five years (Securities Act of 1934, Article 4, Clause (a)). There is no precedent of SEC members being dismissed during their terms (1 point)
Dismissal of
regulatory agency
members

11. OECD’s 2nd Principles of Corporate Governance
Regulating Corporate Governance of Business Groups: Fair Trade Commission In Korea
OECD’s 2nd Principles of Corporate Governance
Question: Which regulatory agency should enforce the corporate governance of business groups?
Private (unlisted) companies belonging to business groups
Chaebols’ ownership structure in Korea
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12. Chaebols’ Ownership Structure
Chaebol’s controlling shareholder owns only a small fraction of equities by cross-shareholding or by pyramiding (Controlling Minority System).
The separation between control and cash-flow rights can distort incentives.
The dispersed ownership also has agency costs but the market for corporate control would discipline the controller (or the management).
The CMS insulates the controller from the market for corporate control.
=> The agency costs cannot be constrained.
Concentrated ownership => Internalizing costs
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13. Public Policy toward the Cross-shareholding Structure
The first best policy
Completing market discipline (legal protection of minority shareholders, reputation)
Removing (free) private benefits of control
The second best policy
Minimizing the destruction of firm value
Still the transfer of values from minority shareholders to controlling shareholders
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14. Ownership Structure of SK Group
Note: Author's estimation based on various business reports and audit reports (as of December 2001)
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15. Korea Development Institute

16. Korea Development Institute

17. Korea Development Institute

18. Controlling Shareholder
Table Inside Ownership for the 30 Largest Chaebols
(unit: %)
41.8
41.1
49.5
43.6
42.2
Total
35.2
36.6
44.1
35.7
33.7
Affiliated Companies
2.3
3.0
3.4
4.8
Family
3.3
1.5
2.0
3.1
3.7
Controlling Shareholder
2000
1999
1998
1997
1996
Inside Owners
Source: Press releases by the Korean Fair Trade Commission
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19. Measuring the ownership structure of Korean chaebols
La Porta, Lopez-de-Silanes, Shleifer, and Vishny (2002)
South Korea: 20 large listed firms
cash-flow right: 18 %, control right: 24 %
Calculating for the 11 largest chaebol groups
cash-flow right: 14%, control right: 41%
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20. Explaining the differences of measurement in the literature
Large listed companies: usually investing companies => small wedges
Other subsidiaries: usually invested companies => large wedges
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21. Explaining the differences of measurement in the literature
Private (unlisted) firms
Usually, not the target of policies
No public investors to protect
high cash-flow right and high control right
But, Korean business groups: (very) low cash-flow right and high control right
Public investors to protect
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22. Private firms belonging to Korean business groups
Public investors in the investing large listed companies
Corporate veil between investing and invested companies => Public investors in the investing companies do not have any shareholder rights.
the target of policies: unresolved issue
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23. A ceiling on equity investment ratio
The Monopoly Regulation and Fair Trade Act: Regulation on Chaebol subsidiary’s holding of other companies’ shares
A ceiling on equity investment ratio
all individual subsidiaries for large Chaebols except for financial companies (NBFI)
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24. Ownership Structure of Samsung Group
Estimated from the business and audit reports as of December 2001
Samsung Group had 63 companies under the control. The 19 companies in the figure account more than 80% of total assets.
Controlling shareholders own only four companies directly: Samsung Everland (28.82%), Samsung Life Insurance (4.54%), Samsung Electronics (2.0%), Samsung General Trading (1.42%). Among the four companies, Samsung Life Insurance plays the most important role in entrenching controller’s minority control.
Korea Development Institute

25. Ownership Structure of Samsung Group
Note: Author's estimation based on various business reports and audit reports (as of December 2001)
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26. Pubic policy toward financial companies’ fiduciary duty
Investment trust companies or insurance companies can exercise their voting rights for controlling shareholder.
Fiduciary duty regulation is needed as a prudential regulation
Frequent and prompt disclosures on the portfolios of financial companies are also needed.
Korea Development Institute

27. Pubic policy toward financial companies’ fiduciary duty
The KMRFTA allows Chaebol-affiliated financial companies to exercise their voting rights in such cases as: (a) appointment or dismissal of officers, (b) alteration of the articles of companies, and (c) merger of the said affiliated company with another company, or transfer of the whole or part of business to another company.
Korea Development Institute

28. Pubic policy toward financial companies’ fiduciary duty
The KMRFTA allows Chaebol-affiliated financial companies to exercise their voting rights in such cases as: (a) appointment or dismissal of officers, (b) alteration of the articles of companies, and (c) merger of the said affiliated company with another company, or transfer of the whole or part of business to another company.
Korea Development Institute