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Corporate Governance in Korea – Has Korea learned from the crisis?

Corporate Governance in Korea – Has Korea learned from the crisis?

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Published by André Feldhof
Bad corporate governance was one of the main reasons why the Asian financial crisis in 1997 hit Korea so hard. Interlocking shareholding between the business conglomerates ("chaebols") shielded many companies from international market pressure. This paper shows that Korea learned from the crisis and that it successfully reformed its corporate governance system.
Bad corporate governance was one of the main reasons why the Asian financial crisis in 1997 hit Korea so hard. Interlocking shareholding between the business conglomerates ("chaebols") shielded many companies from international market pressure. This paper shows that Korea learned from the crisis and that it successfully reformed its corporate governance system.

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Published by: André Feldhof on Jul 30, 2012
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Corporate Governance in Korea – Has Korealearned from the crisis?
 André Feldhof Course: Corporate GovernanceCourse Coordinator: Prof. Harm SchepelDate: 30 April 2012
 
2
IntroductionDuring much of the second half of the 20
th
century, large industrial conglomerates, or 
chaebols,
were at the forefront of economic development in South Korea
1
(hereafter:Korea). However, during the Asian financial crisis in 1997, several of them rapidlydescended into bankruptcy, leaving the economy in turmoil
2
. Many scholars havesubsequently blamed the severity of the financial crisis in Korea on poor corporategovernance (CG)
3
. It has been argued that the close-knit governance of the
chaebols
was responsible for the crisis
4
. Most corporations were essentially owned andadministered by a circle of wealthy families and state-controlled banks
5
. They benefited from information advantages over minority shareholders and were able toexpropriate them and the firm of their resources
6
. Shleifer & Vishny (1997) havefurthermore argued that the legal system in Korea did not restrict these
chaebol 
activities: “In many countries […], the law protects investors better than it does inRussia, Korea, or Italy”
7
. Minority shareholders could not challenge businessdecisions and foreign investment was heavily restricted.Partly due to obligations that came with a loan from the InternationalMonetary Fund (IMF), the government committed itself to a reform of the Korean CGsystem
8
. Jung & Chung (2003) hold that the government implemented “sweepingreforms” of its CG system
9
, putting Korea on its way on its way to achieving “world-class corporate governance standards”
10
. This paper sets out to show that Korea hasindeed learned a lesson from the financial crisis and that it has successfully reformedits CG system. To make this argument, the paper is structured as follows. The first part discusses models of CG and establishes the aspects that define a strong CGsystem. The second part gives a brief overview over the Korean economy and focuseson the CG issues that led to the crisis. The third part analyzes the adaptation measurestaken by the Korean government and discusses whether, based on the model

1
Solomon, Solomon & Park, 2002, p. 32
2
Joh, 2003, p. 292
3
Johnson, Boone, Breach & Friedman, 2000, p. 143; Joh, 2003, p. 288; Alguira, Kabbach de Castro, Lee & You,2011, p. 15; Choi, Park & Yoo, 2007, p. 942
4
OECD, 1998, p. 89
5
Solomon, Solomon & Park, 2002, p. 30
6
Baek, Kang & Park, 2004, p. 270
7
Shleifer & Vishny, 1997, p. 742
8
Jung & Chung, 2005, para 4
9
Jung & Chung, 2003, para 39
10
Jung & Chung, 2005, para 31
 
3
established before, they can be called successful. The paper concludes that Korealearned from its mistakes before the crisis and successfully implemented a new CGsystem.1. Corporate Governance models – what makes a strong CG system?Shleifer and Vishny (1997) argue that CG is concerned with the resolution of agency problems in a corporation
11
. Thus, a company manager’s interests do not necessarilyoverlap with the interests of a shareholder. A large shareholder’s interests do notnecessarily overlap with the interests of a minority shareholder. CG gives investors alegal mechanism to make sure that their investment is used in a way that earns them a profit
12
. Putting it in other words, Shleifer and Vishny (1997) suggest that CG isconcerned with the separation of ownership and control
13
.There are different models of CG which all have their individual merit.Shleifer and Vishny (1997) assert that the US model, the UK model, the Germanmodel and the Japanese model are the best in the world, but all of them have their  particular features
14
. The US and UK models place more importance on legal protection of shareholders, while the German and the Japanese models are morefocused on long-term shareholding, large investors and finance through banks
15
. Thethree systems may be converging over time, however: There is a “growing popularityof large shareholders in the United States, the emergence of public debt markets inJapan, and […] increasing bank-bashing in Germany”
16
. What can be assumed ascommon for all of them is that they try to safeguard three aspects: First, they allowcompanies to attract external funding. Second, they protect shareholders againstexpropriation through managers. Third, they protect small shareholders againstexpropriation by large shareholders. These three aspects shall be explained in detail below, and they will guide the subsequent analysis.Firstly, CG allows corporations to attract finance. In Japan and Germany, bank lending has a particular importance, reinforced by the fact that the bank providing a

11
Shleifer & Vishny, 1997, p. 737
12
Shleifer & Vishny, 1997, p. 738
13
ibid.
14
Shleifer & Vishny, 1997, pp. 737f 
15
Shleifer & Vishny, 1997, pp. 769f 
16
Shleifer & Vishny, 1997, p. 773

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