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A Study of Indonesia, Republic of Korea, Malaysia,Philippines,andThailand
Edited by: Juzhong Zhuang SeniorEconomist RegionalEconomicMonitoringUnit AsianDevelopmentBank David Edwards AssistantChiefEconomist ProjectEconomicEvaluationDivision AsianDevelopmentBank Ma. Virginita A. Capulong SeniorSectorAnalyst AgricultureandSocialSectorsDepartment(West) AsianDevelopmentBank
© Asian Development Bank 2001 Allrightsreserved. ThispublicationwaspreparedundertheAsianDevelopmentBanksregionalTechnical Assistance 5802: A Study on Corporate Governance and Financing in Selected DMCs. The views expressed in this book are those of the authors and do notnecessarilyreflecttheviewsandpoliciesoftheAsianDevelopmentBank,or itsBoardofDirectorsorthegovernmentstheyrepresent. The Asian Development Bank does not guarantee the accuracy of the data includedinthispublicationandacceptsnoresponsibilityforanyconsequencesfor theiruse. Use of the term country does not imply any judgment by the authors or the AsianDevelopmentBankastothelegalorotherstatusofanyterritorialentity . ISBN 971-561-323-3 Publication Stock No. 100800 Published and printed by theAsian Development Bank P.O. Box 789, 0980 Manila, Philippines
List of Tables List of Figures Foreword Preface Abbreviations 1 Indonesia 1.1 Introduction 1.2 OverviewoftheCorporateSector 1.2.1 HistoricalDevelopment 1.2.2 TheCapitalMarket 1.2.3 The Banking Sector 1.2.4 ForeignCapital 1.2.5 GrowthandFinancialPerformance 1.2.6 LegalandRegulatoryFramework 1.3 CorporateOwnershipandControl 1.3.1 CorporateOwnershipStructure 1.3.2 ManagementandInternalControl 1.3.3 ExternalControl 1.4 CorporateFinancing 1.4.1 FinancialMarketInstruments 1.4.2 PatternsofCorporateFinancing 1.4.3 CorporateFinancingandOwnershipConcentration 1.5 TheCorporateSectorintheFinancialCrisis 1.5.1 CausesoftheFinancialCrisis 1.5.2 ImpactoftheFinancialCrisisontheCorporateand BankingSectors 1.5.3 Responses to the Crisis 1.6 Summary, Conclusions, and Recommendations 1.6.1 SummaryandConclusions 1.6.2 Policy Recommendations References vi ix x xi xii 1 1 3 3 4 5 7 8 15 17 17 25 30 32 32 34 35 36 36 39 42 45 45 48 51
2 Republic of Korea 2.1 Introduction 2.2 OverviewoftheCorporateSector 2.2.1 HistoricalDevelopment 2.2.2 Rise of the Large Business Groups (Chaebols) 2.2.3 RoleoftheCapitalMarketandForeignCapital 2.2.4 GrowthandFinancialPerformance
53 53 55 55 60 62 65
iv 2.3 CorporateOwnershipandControl 2.3.1 PatternsofCorporateOwnership 2.3.2 InternalManagementandControl 2.3.3 ShareholderRights 2.3.4 ControlbyCreditors 2.3.5 TheMarketforCorporateControl 2.3.6 ControlbytheGovernment 2.3.7 EmployeeParticipationinCorporateGovernance 2.4 CorporateFinancing 2.4.1 Overview of the Financial System 2.4.2 PatternsofCorporateFinancing 2.4.3 FinancialStructure,Diversification,andCorporate Performance 2.5 TheCorporateSectorintheFinancialCrisis 2.5.1 WeaknessesinCorporateGovernance 2.5.2 TheRoleofGovernmentIntervention 2.5.3 ManifestationsofWeakCorporateGovernanceand GovernmentIntervention 2.5.4 ShortcomingsinMacroeconomicPolicy 2.6 Responses to the Crisis and Policy Recommendations 2.6.1 CorporateRestructuringActivities 2.6.2 PolicyMeasuresforCorporateReform 2.6.3 Policy Recommendations References 3 The Philippines 3.1 Introduction 3.2 OverviewoftheCorporateSector 3.2.1 HistoricalDevelopment 3.2.2 GrowthandFinancialPerformance 3.2.3 LegalandRegulatoryFramework 3.3 CorporateOwnershipandControl 3.3.1 PatternsofCorporateOwnership 3.3.2 CorporateManagementandShareholderControl 3.3.3 TheRoleofCreditorsinCorporateControl 3.4 CorporateFinancing 3.4.1 TheFinancialMarketandInstruments 3.4.2 PatternsofCorporateFinancing 3.4.3 OwnershipConcentration,FinancialLeverage,and Performance 3.5 TheCorporateSectorintheFinancialCrisis 3.5.1 TheFinancialCrisis:CausesandManifestations 3.5.2 ImpactoftheCrisisontheCorporateSector 3.5.3 Responses to the Crisis 74 74 94 103 105 108 110 111 113 113 118 128 130 132 134 134 137 139 139 143 148 153 155 155 156 156 158 167 171 171 186 198 199 199 202 209 210 210 212 214
v 3.6 Summary, Conclusions, and Recommendations 3.6.1 SummaryandConclusions 3.6.2 Policy Recommendations References 216 216 219 226
4 Thailand 4.1 Introduction 4.2 OverviewoftheCorporateSector 4.2.1 HistoricalDevelopment 4.2.2 DevelopmentofCapitalMarkets 4.2.3 GrowthandFinancialPerformance 4.2.4 LegalandRegulatoryFramework 4.3 CorporateOwnershipandControl 4.3.1 PatternsofCorporateOwnership 4.3.2 CorporateManagementandControl 4.3.3 ExternalControl 4.4 CorporateFinancing 4.4.1 OverviewoftheFinancialSector 4.4.2 PatternsofCorporateFinancing 4.5 TheCorporateSectorduringtheFinancialCrisis 4.5.1 ImpactoftheFinancialCrisisontheCorporateSector 4.5.2 Responses to the Crisis 4.6 Summary, Conclusions, and Recommendations 4.6.1 SummaryandConclusions 4.6.2 Policy Recommendations References
229 229 230 230 233 235 239 240 241 244 248 252 252 257 261 261 264 270 270 273 277
1992-1997 Table 1.20 ROE of the Banking Sector. 1992-1995 Table 1. Indonesia Table 1.14 Banking Sector Outstanding Loans. 1996-1999 Table 1. Republic of Korea Table 2. 1997 Table 1. 1990-1997 Table 1. 1993-1997 Table 1.8 OwnershipConcentrationofPubliclyListedCompanies.11 CharacteristicsoftheBoardofCommissioners Table 1. 1992-1999 Table 1.1 Listed Firms with Positive Economic V alueAdded. 1992-1997 Table 1.4 Growth Performance of Publicly Listed Companies by Sector.4 Development of the Stock Market.vi List of Tables 1. 1992-1998 Table 2.10 Anatomy of the Top 300 Indonesian Conglomerates. 1992-1997 Table 1. 1985-1998 6 7 9 11 12 14 14 18 19 21 26 27 28 32 33 34 36 39 40 41 41 54 56 61 63 .12 CharacteristicsoftheBoardofDirectors Table 1. 1996-1998 2.3 GrowthandFinancialPerformanceofPubliclyListed Companies.7 Growth Performance of the Top 300 Conglomerates.18 GDP Growth by Sector.15 V alue of Stocks Issued and Stock Market Capitalization.19 DER and ROE of Publicly Listed Companies by Sector.2 KeyMacroeconomicIndicators Table 2.13 Presence of Board Committees in Listed Companies Table 1.3 Subsidiaries of the 30 Largest Chaebols Table 2.1 Growth of the Banking Sector. 1996-1998 Table 1.9 OwnershipConcentrationofPubliclyListedCompanies by Sector. 1988-1996 Table 1. 1993-1999 Table 1.16 FinancingPatternsofPubliclyListedNonfinancial Companies. 1992-1999 Table 1.6 GrowthandFinancialPerformanceofState-Owned Companies. 1986-1996 Table 1.17 DER of Listed Companies by Degree of Ownership Concentration Table 1. 1992-1997 Table 1.5 Financial Performance of Publicly Listed Companies by Sector.2 Foreign Capital Flows.21 Nonperforming Loans by Type of Bank. 1990-1998 Table 1.
1990-1997 InternationalComparisonofRatiosofOrdinaryIncome toSalesinManufacturing GrowthandFinancialPerformanceofSelectedIndustries GrowthandFinancialPerformanceofListedCompanies.6 Table 2. 1997 Ownership Concentration ofAll Listed Firms. 1993-1997 64 66 66 68 70 71 72 73 75 78 80 82 82 83 84 85 86 87 90 91 120 121 122 126 126 127 .10 Table 2.29 Table 2.11 Table 2. 1985-1998 GrowthandFinancialPerformanceoftheNonfinancial Corporate Sector. 1990 and 1997 Ownership Composition of Listed Nonfinancial Firms by Size. 1988-1997 FinancingPatternsoftheNonfinancialCorporateSectorby Industry Financing Patterns of Listed Companies.7 Table 2. 1994-1997 Cross-Payment Guarantees of the Top 30Chaebols.8 Table 2.28 Table 2.19 Table 2.30 Private Capital Flows to Korea. 1988-1997 OwnershipConcentrationofListedNonfinancialFirms by Industry. 1997 Ownership Composition of Listed Nonfinancial Firms by Control Type.20 Table 2.18 Table 2. 1988-1997 Features of the 30 Largest Chaebols GrowthandFinancialPerformanceofthe30Largest Chaebols.5 Table 2. 1999 InternalShareholdingsofthe30Largest Chaebols. 1987-1997 FlowofFundsoftheNonfinancialCorporateSector. 1993-1997 The Top 30 Chaebols Debt-to-Equity Ratio.12 Table 2.14 Table 2. 1988-1997 FinancingPatternsoftheNonfinancialCorporateSector. 1988-1997 Ownership Concentration of the Survey Sample of 81 Listed Firms.15 Table 2. 1992-1997 OwnershipConcentrationofListedNonfinancialFirms. 1997 Ownership Composition of Listed Firms in Selected Countries. 1995-1997 Ownership Composition of Listed Companies. 1997 OwnershipConcentrationofListedNonfinancialFirms by Firm Size.16 Table 2.26 Table 2.22 Table 2.9 Table 2.24 Table 2.13 Table 2.17 Table 2. 1994-1998 Financing Patterns of the Top 30 Chaebols. 1988-1997 Ownership Composition of Listed Nonfinancial Firms by Industry. 1985-1997 GrowthandFinancialPerformanceofListedCompanies by Size.25 Table 2.vii Table 2.21 Table 2.23 Table 2.27 Table 2.
1 Public Companies Registered.21 OwnershipConcentration.viii Table 2.SectorOrientation.7 GrowthandFinancialPerformanceoftheCorporateSector by Industry. 1992-1996 Table 3. 1989-1997 Table 3.5 GrowthandFinancialPerformanceoftheCorporateSector by Control Structure. 1989-1997 Table 3.9 OwnershipConcentrationatCriticalLevelsofControl Over Publicly Listed Companies.10 Composition of Top Five Shareholders of Philippine Publicly Listed Companies by Sector.11 TotalandPerCompanySales.3 TheCorporateSectorandGrossDomesticProduct.32 Table 2. 1989-1997 Table 3. 1997 Table 3. 1988-1997 Table 3. 1988-1997 Table 3. The Philippines Table 3. Thailand Table 4.19 Financing Patterns by Firm Size. 1997 Table 3. 1990-1999 Table 3.20 Financing Patterns by Industry.13 ADB Survey Results on Shareholder Rights Table 3. 1978-2000 Table 4. 1988-1997 Table 3. 1989-1997 Table 3.1989-1997 Table 3. 1983-1997 Table 3.22 Foreign Investment Flows. 1988-1997 Table 3.14 Philippine Stock Market Performance.8 Ownership Composition of Philippine Publicly Listed Companies by Sector.2 Public Offerings of Securities.16 CorporateFinancing PatternsbyOwnershipType. andAffiliated Banks of Selected Business Groups. 1992-1999 .1 GDP Growth of SoutheastAsian Countries.12 Control Structure of the Top 50 Corporate Entities.6 GrowthandFinancialPerformanceoftheCorporateSector by Firm Size. 1990-1998 131 137 138 158 159 160 161 163 164 166 173 175 176 180 184 191 201 203 204 205 206 207 208 209 212 235 236 3. 1997 Table 3.000 Companies. 1997 Table 3.4 GrowthandFinancialPerformanceoftheCorporateSector by Ownership Type.17 Composition ofAssets and Financing of the Publicly Listed Sector.2 Growth and Financial Performance of the Top 1.Profitability andFinancial . 1995-1998 4. 1997 Table 3.15 Financing Patterns of the Corporate Sector.18 Financing Patterns by Control Structure. 1988-1997 Table 3. Flagship Company. 1986-1998 Nonperforming Loans of General Banks. 1985-1997 Number of Firms with Dishonored Checks. Leverage Table 3.33 Net Profit Margins of Chaebols.31 Table 2. 1988-1997 Table 3.
15 Table 4. Ownership Concentration.16 Table 4. 1990-1998 StatisticalRelationshipsbetweenCorporateProfitability. 1985-1996 Average Key Financial Ratios by Company Size.2 Figure 3.4 Table 4. 1985-1999 237 238 239 241 242 243 251 252 256 258 259 260 261 262 264 List of Figures Figure 1. 1990-1996 External Debt. and Company Size Top-Five Shareholder Composition of Publicly Listed Companies in Thailand. 1992-1999 Common-Size Statements for Companies Listed in SET.1 Figure 1.9 Table 4. 1990-1996 Financial Ratios of Listed Companies by Ownership Concentration.17 StatisticalHighlightsoftheStockExchangeofThailand.10 Table 4. 1992-1999 Offerings of Debt Securities.2 TheSuhartoGroup TypicalInternalOrganizationalStructureofaPublicly Listed Company in Indonesia CorporateControlStructure:TheCaseofAyalaCorporation CorporateControlStructure:theCaseofLopezGroup 24 25 195 197 .12 Table 4. 1993-1999 Key Financial Ratios of Publicly Listed Companies. 1990-1998 Merger and Acquisition Activities.8 Table 4. 1986-1999 NumberofNewlyRegisteredandBankrupted/Closed Companies.3 Table 4. 1985-1996 Top-Five Ownership Concentration of Publicly Listed Companies in Thailand. 1990-1996 Common-Size Statements of Public Companies by Ownership Concentration.6 Table 4.5 Table 4.11 Table 4. 1990-1996 Financial Ratios of All Listed Firms.1 Figure 3. 1993-1999 Size and Composition of the Thai Financial Sector. Leverage.14 Table 4.ix Table 4.13 Table 4.7 Table 4.
Corporate governance has become a major policy concern in the wake of the Asian financial crisis. Weak governance structure, poor investment, and risky financingpracticesofthecorporatesectorintheaffectedcountriescontributedto their sharp economic recession in 1997-1998. The weaknesses in corporate governanceandfinanceunderminedthecapacityofthesecountriestowithstandthe combined shocks of depreciated currencies, massive capital outflows, increased interestrates,andlargecontractionindomesticdemand. Tohelpunderstandcorporategovernanceissuesandtheirimpact,aswell astoidentifyneedsforinterventionsinaddressingpolicyandinstitutionalweaknesses, the Economics and Development Resource Center of theAsian Development Bank (ADB) undertook a regional study on corporate governance and finance in selected developing member countries. The countries covered are Indonesia, Republic of Korea, Malaysia, Philippines, and Thailand. This book presents the major findings of the study. The policy recommendations will supportADBs financialsectorworkinitsdevelopingmembercountries.
Arvind Panagariya ChiefEconomist
Corporate Governance and Finance in EastAsia presents the findings of a regionalstudyofcorporategovernanceandfinanceinselecteddevelopingmember countries of theAsian Development Bank (ADB). The study attempts to identify theweaknessesincorporategovernanceandfinanceincountriesmostaffected by the 1997Asian financial crisis, and recommends policy and reform measures to address the weaknesses. The study covers Indonesia, Republic of Korea, Malaysia, Philippines, and Thailand. The findings of the study are presented in two volumes. Volume One,A ConsolidatedReport,presentsaframeworkforanalyzingcorporategovernance and finance, summarizes the major findings of the five country studies, and provideskeypolicyrecommendationsforstrengtheningcorporategovernanceand improving the efficiency of corporate finance inADB member countries. Volume Two,CountryStudies,collectsfourcountryreports.Wewouldliketothankcountry experts Saud Husnan of Gadsab Mada University, Indonesia; Kwang S. Chung andYen Kyun Wang of Chung-Ang University, Republic of Korea; FazilahAbdul Samad of University of Malaya, Malaysia; Cesar G. Saldaña of PSR Consulting, Inc., the Philippines; and Piman Limpaphayom of Asian University of Science and Technology, Thailand, for their efforts and cooperation in conducting the countrystudies.CesarG.Saldañaalsoprovidedusefulinputstothepreparation oftheconsolidatedreport. The volumes benefited extensively from constructive comments from ADBstaffandofficialsoftheministriesoffinance,centralbanks,securitiesand exchangecommissions,stockexchanges,andcorporaterestructuringagenciesof theeightADBmembercountriesthatparticipatedinthestudysfinalizationworkshop in Manila, on 18-19 November 1999. Our deep appreciation goes to Jungsoo Lee, former Chief Economist, and S. Ghon Rhee, former Resident Scholar, for their strong support at various stages of the study; Manabu Fujimura, for his efforts in organizing the finalizationworkshop;MarceliaGarcia,MarinieBaguisa,Ma.ReginaSibal,andRosanna Benavidez, for their administrative support and assistance; and JosefYap, Leah Sumulong, Graham James Dwyer, Judith Banning,andLynetteMallery, for their editorialassistanceandadvice.
ADB AGM AGSM AMU APEC B BDC BIBF BIS BOC BOD BSDC BSP BUN CB CDRAC CEO CP CRA DER ESOP EVA FDI FSC GAAP GATT GDP GNP HCI IBRA IDFR IEFR IFS IMF IPO IPP JSX NBFI NEFR NPL OECD OTC Asian Development Bank annualgeneralmeeting annualgeneralshareholdersmeeting assetmanagementunit Asia-Pacific Economic Cooperation baht Bond Dealers Club BangkokInternationalBankingFacility BankforInternationalSettlements board of commissioners boardofdirectors BangkokStockDealingCenter BangkoSentralngPilipinas(CentralBank) Bank Umum Nasional convertiblebond CorporateDebtRestructuringAdvisoryCommittee chiefexecutiveofficer commercialpaper CorporateRestructuringAgreement debt-to-equityratio employee stock ownership plan economicvalueadded foreigndirectinvestment Financial Supervisory Commission generallyacceptedaccountingprinciples GeneralAgreementonTariffsandTrade grossdomesticproduct grossnationalproduct heavyandchemicalindustries IndonesianBankRestructuringAgency incrementaldebtfinancingratio incrementalequityfinancingratio InternationalFinancialStatistics InternationalMonetaryFund initialpublicoffering investmentprioritiesplan JakartaStockExchange nonbankfinancialinstitution newequityfinancingratio nonperformingloan OrganisationforEconomicCo-operationandDevelopment over-the-counter
xiii P PCO PD PICPA PLDT PSE PTB ROA ROE Rp RSA SBL SCS SEA SEC SET SFR SMC SSS SOC TIE TQ W US peso planningandcoordinationoffice PresidentialDecree PhilippineInstituteofCertifiedPublicAccountants Philippine Long Distance Telephone Co. Philippine Stock Exchange principaltransactionsbank returnonassets returnonequity rupiah Revised SecuritiesAct singleborrowerlimit shareofacontrollingshareholder Securities and ExchangeAct Securities and Exchange Commission StockExchangeofThailand self-financingratio SanMiguelCorporation Social Security System State-ownedcompany timesinterestearned Tobins Q won UnitedStates
Note: In this volume, $ refers to US dollars, unless otherwise stated.
The currency crisis that began in mid-1997 in Thailand spread quickly to Indonesia and the rest of Southeast Asia. Initially, Indonesia’s monetary authority tried to defend the domestic currency, the rupiah, by widening the intervention band, while maintaining its managed floating system. From 5 to 8 percent in June 1997, when the currency crisis hit Thailand, the band was widened to 12 percent on 11 July 1997 when the crisis started spilling over to Indonesia. After resisting pressure for a short period, the rupiah fell by 6 percent against the dollar on 21 July 1997, the biggest one-day fall in five years. Finally, the Indonesian monetary authority realized that the system could not cope with the continuing pressure on the currency, as the risk of losing all foreign exchange reserves to prop up the rupiah was too high. On 14 August 1997, the monetary authority decided to adopt a free floating exchange rate system. The currency fell further because of strong demand for dollars. As the rupiah weakened, nervous lenders refused to refinance maturing loans, investors cut down and then reversed the flow of funds, borrowers tried to obtain dollars before the rupiah fell further, and individuals joined the chase for dollars. At that time, several banks ran out of dollar notes. From Rp4,950 to the dollar at the end of December 1997, the exchange rate fell to more than Rp15,000 at the height of the crisis in June 1998, although it later stabilized at about Rp9,000. At that exchange rate, it is estimated that half of Indonesian corporations became technically insolvent. The crisis also exacerbated an already deepening political turmoil. The financial crisis devastated the Indonesian economy. In 1998, gross domestic product (GDP) contracted by 13 percent and the inflation
Associate Professor, Faculty of Economics, Gadsab Mada University, Yogyakarta, Indonesia. The author wishes to thank Juzhong Zhuang, David Edwards, both of ADB, and David Webb of the London School of Economics for their guidance and supervision in conducting the study, the Jarkata Stock Exchange for its help and support in conducting company surveys, and Lea Sumulong and Graham Dwyer for their editorial assistance.
In many instances. On the other hand. and responses to the financial crisis.2 presents an overview of the Indonesian corporate sector. followed by finance (-26. Foreign debt reached more than $100 billion. All sectors.5 percent. When the crisis hit the country. contracting by 36. these controlling families had political connections that allowed their companies to enjoy special privileges. except utilities. the Indonesian economy seemed to be in generally good shape. Foreign creditors. The construction sector was the worst hit. This study reviews the Indonesian corporate sector’s historical development. Vol. II rate reached 58. The study also identifies family-based companies and corporate groups. In this setup.3 looks at patterns of corporate ownership and control. short-term loans were used to finance long-term investments. However. patterns of ownership and control. highly leveraged companies. and . the controlling families of corporate groups often established banks to provide funds to affiliated nonfinancial companies. placed a high premium on these political connections in assessing the chances of being repaid. Section 1. or Thailand. prior to the financial crisis. Although as a percent of GDP the stock of outstanding foreign debt owed directly by the private sector was smaller than that of the Republic of Korea. the currency composition and term structure of corporate foreign indebtedness were causes for concern.6 percent) and trade (-18 percent). and analyzes their importance to the corporate sector in Indonesia. To facilitate even easier access to credit. These banks were allowed to operate even if they violated minimum capital adequacy requirements.5 percent. The scale of the financial crisis exposed weaknesses of the country’s corporate sector. patterns of financing. particularly those with large foreign loans. The highly concentrated and family-based ownership structure of corporate groups and companies resulted in a governance structure where corporate decisions lie in the hands of controlling families. this left the Indonesian economy extremely vulnerable. how it has affected corporate financial performance and financing. Malaysia. and how it contributed to the crisis. Section 1. posted negative growth. regulatory framework. no doubt.2 Corporate Governance and Finance in East Asia. It analyzes the weaknesses of corporate governance in Indonesia. were the ones most affected. These were already contributing to high levels of nonperforming loans (NPLs) in the Indonesian banking sector several years before the 1997 crisis erupted. Economic growth reached more than 7 percent per year and the inflation rate was kept at single digit levels. Lending activities of affiliate banks that were not sufficiently backed by owners’ equity and the reliance by foreign lenders on the strength of political connections paved the way for risky investments.
only 40 companies replied—39 are private companies and one state-owned company (Bank BNI). Not all items in the questionnaires were answered by the respondents. It also examines the statistical relationship between corporate performance and corporate governance characteristics. medium. Subsequently. Section 1.2. However.6 summarizes the major findings of the study and suggests recommendations to improve governance in the Indonesian corporate sector. With the relatively liberal laws governing foreign and domestic private investments introduced by the New Order Government in 1967 and 1968. This section reports the results of an Asian Development Bank (ADB) survey on corporate management and control practices in Indonesian publicly listed companies. Despite the oil revenues. and tobacco industries.and large-scale companies were dominated by state-run industrial concerns. and its response. Section 1. while Chinese and indigenous entrepreneurs ran some large businesses in trading. a gradual shift in public investment away from manufacturing took place. the windfall from oil and gas revenues was an important factor that allowed the Government to promote industrial development via import substitution.Chapter 1: Indonesia 3 profiles the corporate sector’s governance characteristics. 1.2 1. . textiles.4 analyzes corporate financing patterns. Up until the mid-1960s. how it was affected by the crisis.2 Section 1. The industries that emerged were highly import-dependent and reliant on tariff protection.1 Overview of the Corporate Sector Historical Development The marked permeability between the State and business in Indonesia goes back to the country’s struggle for independence. 2 Survey questionnaires were sent to 280 companies listed in the Jakarta Stock Exchange. substantial volumes of private investment entered the scene. In the early 1970s.5 examines the corporate sector during the financial crisis in terms of its role. in the course of the fight for nationhood from 1942 to 1950. The Government became directly involved in industry as a result of the nationalization of Dutchowned shipping firms and oil companies.
II the currency needed to be devalued periodically under a managed floating exchange rate system to avoid large current account deficits. the Indonesian industrial sector was quite diverse. there were also many rapidly growing large-scale companies and business groups or conglomerates. While most of the companies were small. investors were reluctant to supply funds to the stock market because they did not know whom to trust and the mechanisms that could protect small investors and shareholders against expropriation by controlling shareholders were underdeveloped. Second. the stock exchange was also unattractive to companies trying to raise capital as they could borrow from state banks at very low interest rates. which dominated their respective sectoral outputs and markets. the Government shifted its industrial policy toward the promotion of labor-intensive exports. and related products) had shares in total exports that were rapidly increasing.4 Corporate Governance and Finance in East Asia. But these proved counterproductive because they limited the potential for capital gains to prospective investors. In 1992. By 1987. The equity market remained largely unappealing due to a number of factors. Third. Last. Export credits with low interest rates were granted to industries that were intensive in the use of local labor and raw materials. During this period. the dilution of corporate ownership. In the 1980s. But until the end of 1988. the value of manufactured exports overtook the value of oil and gas exports for the first time. many founding owners of companies were reluctant to go public and dilute their corporate ownership. the Capital Market Executive Agency and National Investment Trust tried to attract small investors to the stock market by setting prices and preferring small orders in initial public offerings (IPOs). the number of firms quoted in the stock market was only 24. Regulations in the banking sector led to equities having higher risk but lower returns than bank deposits. even when new shareholders do not threaten the control exercised by the original owners. exports of nonoil products (particularly textiles and footwear. and employed the bulk of the industrial labor force. wood. Generally speaking.2 The Capital Market The Government reactivated the stock exchange in 1977. mostly nonbank financial institutions and stockbrokers. First. A number of underwriters emerged. Partly as a result of various government policies. Vol. 1. a distinct industrial elite started to emerge.2. produced consumer goods. These were families with strong links to the political elite of the New Order. potentially subjects companies to greater regulatory scrutiny. .
Thus. Conglomerates carried out 210 out of 257 IPOs.3 The Banking Sector Despite the development of the stock market. the banking sector has undergone many reforms. priority credits still enjoyed subsidized interest rates and funding from the Central Bank. Since 1977. state-owned banks were still among the biggest. Through the years. The banking sector.1 shows that from 1994 to 1998. . Table 1. more significant reforms were introduced.2. six SOCs had issued equities in the market. the legal infrastructure that was supposed to guide the evolution of the banking sector was not backed by effective enforcement. companies could no longer enjoy low-interest credit from state banks. private domestic banks dominated the sector in terms of number and total assets. the number of private domestic banks increased. Consequently.5 trillion. These included the opening of the banking industry to new entrants. the liberalization of the banking industry allowed banks to determine lending rates for nonpriority loans. the capital market played an increasing role in raising long-term funds needed by the corporate sector. Partly as a result of these reforms. the number of listed companies in the stock exchange increased substantially. Interest rate regulations on state banks and credit ceilings in general were removed. with a total value of more than Rp8 trillion. However. During this period. reduced restrictions on foreign exchange transactions. The Government also abolished the practice of setting prices for IPOs and removed restrictions on price movements in the secondary market. which up to then was channeling oil revenues to priority sectors. to date. The development of the Indonesian stock market also provided a vehicle for the privatization of state-owned companies (SOCs). began to face competition. However. with a total value of Rp16. But in terms of assets per bank.Chapter 1: Indonesia 5 At the end of 1988. The initial banking sector reform was introduced in 1983. Further reforms along the same direction and affecting state-controlled banks came in the 1990s. The dominance of state banks started to erode. and increased access of domestic banks to international financial markets. 1. which were previously constrained to 4 percent per day. The Government also allowed foreign investors to buy up to 49 percent of listed shares. from 24 in 1988 to more than 300 in 1997. However. the banking sector has been and still is the major source of credit for the corporate sector. the controlling shareholder of these SOCs is still the State. In 1988.
and Bank Umum Nasional (BUN) have failed and the first two are now under management of the Indonesian Bank Restructuring Agency (IBRA).5 528. Vol.6 7 7.8 10 19.2 161 214.8 31 10.5 165 308.6 34 14. Bank Danamon. the 10 largest were all affiliated with major business groups. The deregulation of the banking industry and the liberalization of the capital account created a variety of new sources of financing for the corporate sector.8 166 248.0 234 1994 104.2 10 14.9 248.3 27 51.1 Growth of the Banking Sector. .4 239 222 208 173 Assets and liabilities were concentrated in the top 10 banks.9 31 9. Bank Danamon (ranked 7th).1 10 47.9 27 113.8 27 200. The other banks among the top 10 were state banks.7 351.9 10 11.5 7 9. BCA. Of these. 1993-1999 Type of Bank State-Owned Banks Assets (Rp trillion) Number of Banks Foreign Banks Assets (Rp trillion) Number of Banks Joint Venture Banks Assets (Rp trillion) Number of Banks Regional Government Banks Assets (Rp trillion) Number of Banks Private National Banks Assets (Rp trillion) Number of Banks Total Assets (Rp trillion) Number of Banks Source: Bank Indonesia.8 10 37. But the banking system proved incapable of performing its intermediation function.3 30 7. Both BCA and BUN have shareholders linked to the former President Suharto.7 27 37.4 789.5 7 7 7 5 15.4 10 35. and Bank International Indonesia (ranked 9th).3 201. private domestic banks among the top 10 in 1997 included Bank Central Asia (BCA) (ranked first and linked to the Salim group). banks could earn profits even when they did not gather and process information about risk.3 10 17.9 291.6 Corporate Governance and Finance in East Asia. Among private domestic banks. while BUN has been closed down by the Government.6 164 144 130 92 387.1 240 1995 122.9 304.8 29 6.9 39 18.9 762. Because regulation was weak.5 27 88. II Table 1.6 7 12.8 391.4 34 12.5 27 66. 1993 100.8 27 147.6 240 1996 1997 1998 1999 141. In terms of assets.
November 2000. IMF.59 billion in 1996.4 Foreign Capital The years of rapid industrial growth attracted a large amount of foreign direct investments (FDIs).81 3.15) — = not available.2 Foreign Capital Flows. Most FDIs came in through joint ventures with business groups having strong political connections. foreign investment also had a strong presence in the services and infrastructure sectors. But FDIs were only one form of foreign capital inflows to Indonesia. September 2000.40) (0. textiles. FDI flows were strong.09 1. In 1994.00 2. 1.01 (2.01) (0. Successive policy deregulation facilitated FDIs in various light manufacturing industries.10 5.88 4.11 3.48 1. Between 1990 and 1996.33 (13.87 7. such as metal goods. Joint BIS-IMF-OECD-World Bank Statistics on External Debt.2. initially from Japan and the Republic of Korea.50 (0. foreign creditors were eager to provide financing to Indonesia.78 2.74 5. Indonesia received capital inflows averaging about 4 percent of GDP. .09) 1.09) (0. In effect. the Government allowed foreign investors to own 100 percent of an Indonesian company. Although these inflows were not nearly as large as those received by Thailand (10 percent of GDP) and Malaysia (9 percent of GDP). Net FDI flows increased to $5. there was a phenomenal growth in direct borrowings by Indonesian corporations. they still amounted to a large sum for the economy to absorb. when the financial crisis hit Indonesia.Chapter 1: Indonesia 7 Foreign and domestic banks defaulted on their responsibility of deciding where capital should go and ensuring that it was used in the most effective way. In the 1990s. Table 1. especially through bank loans. there was an explosion of credit for which the probability of repayment was based on little but blind faith in the sustainability of rapid growth and on the presumption that political connections were as good as government guarantees against bankruptcy of borrowers. as shown in Table 1. Source: IFS CD-ROM. and footwear.63) (1. except in certain strategic sectors. Until the onset of the crisis.2. Increasingly.59 4.88) — — — — — — 8. From the mid-1980s until July 1997. 1990-1998 ($ billion) Type of Flows Net FDI Net Portfolio Investment Foreign Bank Loans 1990 1991 1992 1993 1994 1995 1996 1997 1998 1.
and conglomerates. Vol. participation in the Indonesian stock market was exclusive to domestic investors. In September 1997. Private borrowers preferred foreign loans since these were relatively cheaper. especially the short-term ones. foreign investors began to dominate daily trading. In the 1990s. . Due to data constraints. Consequently. plus 4 percent for the depreciation of the rupiah. The Government relaxed this restriction in 1988. the analysis focuses only on publicly listed companies. total corporate debt reached nearly $118 billion. In November 1998. The private sector left foreign loans unhedged because the depreciation of the rupiah had never reached more than 4 percent annually since the 1986 devaluation under the managed floating system. II Up until the late 1980s. the average borrowing rate for dollar loans was 9 percent. allowing foreign investors to buy up to 49 percent of stocks of a publicly listed company. more than 50 percent of total Indonesian private debt and 60 percent of total foreign exchange debt were owed to 175 foreign banks and other foreign financial institutions. of which two thirds were rupiah-denominated. Between 1989 and 1992. an interesting question is whether standard measures of corporate profitability and performance also indicated the same. the average foreign ownership of listed companies was 21 percent. state-owned companies (SOCs). Capital account liberalization permitted the inflow of foreign capital that fueled the credit boom in the country. This is lower than the average borrowing rate of 18 percent for loans in domestic currency. but declined to an average of 25 percent during 19951997. This increased to 30 percent by the end of 1993. increasing the total trading value from Rp8 trillion in 1992 to Rp120. foreign banks became a significant source of financing for the corporate sector. Domestic corporate debt was about $50 billion equivalent. the limit on foreign portfolio investment was removed and foreign investors were allowed to buy up to 100 percent of shares of a listed Indonesian company.8 Corporate Governance and Finance in East Asia. The following section looks at the growth and financial performance of the corporate sector. with the onset of the Asian crisis. The excessive dollar borrowings made the corporate sector vulnerable to sudden currency fluctuations.4 trillion in 1997. The external corporate debt owed to foreign commercial banks was $67 billion. From 1987 to 1996.5 Growth and Financial Performance While it was obvious that the term structure and currency composition of debt suggested problems in the run-up to the crisis.2. By the end of 1997. 1.
5 34.2 7. 1994.0 12.0 1.1 percent in 1997 when the crisis began to buffet Indonesia.6 48. b Asset turnover is defined as sales over assets. but turned negative in 1997.1 4.0 11. 1992-1997 (percent) Item Growth Indicators Sales Growth Share of Value Added in GDPa Asset Growth Financial Indicators Debt-to-Equity Ratio Return on Equity Return on Assets Asset Turnoverb 1992 — 3.2 1995 37. 174 firms. 226 firms. averaging 3.4 1997 7.8 220. Source: JSX Monthly (several publications).5 34.6 24.5 37.9 37.3 shows the growth and financial performance of Indonesian publicly listed companies.3 Growth and Financial Performance of Publicly Listed Companies.6 1994 50. total sales of listed companies grew at an annual average rate of 31 percent. 1993. 248 firms.7 — 250. In 1997. ranging from 220 to 250 percent between 1992 and 1996. publicly listed companies as a group contributed less than 10 percent to GDP. Asset turnover was above 30 percent until 1996.4 38.5 3.0 12.7 percent in 1997. the average DER increased to 310 percent from 230 percent the . Despite such rapid growth.1 220.1 0. 1996. a Value added was assumed to be 30 percent of total sales. Table 1.0 6.7 — = not available.6 percent in 1997.5 240.8 6.Chapter 1: Indonesia 9 Publicly Listed Companies Table 1. Net profits grew at an annual rate of more than 20 percent from 1992 to 1996.7 3. 1995.4 31.8 230. The debt-to-equity ratio (DER) was high compared to those of listed companies in Malaysia and the Philippines.6 3. Return on assets (ROA) was also relatively stable during 1992-1996.4 1996 18. 246 firms. but declined to 0. while total assets grew at 43 percent. although the contribution increased over time. During 1992-1997. 250 firms.0 12.8 percent between 1992 and 1996. The growth of listed companies was sustained by continuing investments.9 310. Average return on equity (ROE) of listed firms was 11.3 3. When the crisis battered Indonesia in 1997. Note: The number of firms is not identical for each year. there were 204 firms.0 64.3 6.0 3. but fell to 24.2 30. but dropped to 1. and 1992.4 percent.4 1993 45.0 10.0 33.
the mining sector had the highest ROE. and services.7 percent during 1992-1996. in terms of growth of sales and assets. The finance sector’s contribution to GDP. helped in part by the relatively strong demand for consumer goods. the mining sector ranked first. due mainly to the domination of the International Nickel Company of Canada. But the sector’s ROE fluctuated a lot. When interest rates increased. The same applied to the trade sector. followed by agriculture (Table 1. and services. basic industry and chemicals. and property. it appeared that the performance of listed companies was quite satisfactory prior to the crisis. This sector was less affected by the crisis. still posting a positive but lower ROE. Overall. finance. ROE fell drastically because the sector had one of the highest DERs. miscellaneous industry. when the property sector was booming during 1993-1997. real estate. the companies in the sector did not operate with a high leverage. and trade. Also. ROA of all sectors dropped in 1997. Vol. trade.2 in 1997. which operated in nickel and copper mining in 1992 and 1993. the mining sector had the lowest DER. miscellaneous industry. Before the crisis. and building construction. However. In terms of share of value added to GDP. property. meanwhile. investment. with ROE falling to -11.5 presents the financial performance of listed companies by sector.3 percent between 1992 and 1996. only two sectors (mining and finance) showed a consistently increasing trend from 1992. averaging 17. real estate. Table 1. indicating its reliance on equity to support growth. investment. although asset turnover was slow. and trade) even posted . The finance. From 1995. Meanwhile.64 percent in 1997. the banks eagerly provided credit to property development companies. Four sectors (basic industry and chemicals. This indicates that a substantial part of corporate debt was denominated in dollars and unhedged. the property sector was severely affected by the crisis. For instance. the fluctuation in nickel and copper prices contributed to the oscillation of ROE. The Jakarta Stock Exchange (JSX) classified listed companies into nine sectors: agriculture. consumer goods. property. averaging 21. II previous year. the dominant sector was the finance sector. Most companies in the sector that had unhedged dollar-denominated loans suffered exchange rate losses when the rupiah weakened.10 Corporate Governance and Finance in East Asia. increased from 0. During those years. The consumer goods sector ranked second in terms of ROE. infrastructure. mining. The ROE levels suggest that high leverage enabled listed companies to achieve high returns on equity. In terms of sales and asset levels in 1997.73 percent in 1992 to 1. and building construction sectors had the highest DERs because companies in these sectors found it easy to obtain credit from banks.4).
Industry Consumer Goods Industry Prop.2 14.6 135.2 35.6 0. and Bldg.2) 0.4 43.7 90.7 54.5 28.9 54.1 0.0 (192.9 0. Investment.1 0.2 0.4 1. Investment.0 24. and Services Net Profit Growth Agriculture Mining Basic Industry and Chemicals Misc.3 0.9 36.5 23.1 0.5) 49. Investment.3) 53. Constn. and Services Asset Growth Agriculture Mining Basic Industry and Chemicals Misc.3 31. Industry Consumer Goods Industry Prop.1 0.0 31.9 64.4 1993 155.3 0.6 0.5 1.7 112. and Bldg.1 1.7) (27.6 (0.9 8.1 1.7 17.2 0.8 32. Constn.5 1.6 51.0 43.6) 25.9 31.. and Services Share of Value Added in GDP Agriculture Mining Basic Industry and Chemicals Misc.1 (41.6 22.5 95.4 103.5 (8.2 41.9 59.5 68.4 21.9 123.2 41.6) 119.7 28.6 133. Real Estate.8) (12. Investment.1 16.0 16.1 23.6 0.4) 6.Table 1.0 64.1 0.3 31.8 1.1 — 39.9 53.8 28.0) 46. and Bldg.7 133.7) (113.1 32.6 0.8 50.5 1.0 (20. 1992 — — — — — — — — — — — — — — — — — — — — — — — — — — — 0.4 31.3 0.9 54.8 66.9 14.3 17.3) 39. Real Estate.6 (41.4 44. Infrastructure Finance Trade.7 24.8) 0.7 0. Real Estate.4 30.6) 19.5 61.4 Growth Performance of Publicly Listed Companies by Sector.9 0.7 1995 51. and Bldg.0 0.1 67. Infrastructure Finance Trade.8 27.5 0.6 1.2 5.3 92.8 (76.2 11.7 0.1 28.7 40.9 25.5 (11.0 68. Real Estate.0 0. Source: JSX Monthly (several publications).7) 17.3 1.0 1.4 38.8 62.1 1.5 0.4) 8.1 1. Industry Consumer Goods Industry Prop.5 13.6 15.3 (203.6 1994 (75.0 (28.5 92.0 22.7 — — 11.0 0.1 42.7) 26.1 35..0 18.6 24.4 170..9 . Industry Consumer Goods Industry Prop.5) 6. Constn.1 0.5 53..4 64. Infrastructure Finance Trade.1 1.6 85.6 83.8 0.1 71.4 (149.9 (7.7 21.0 0.8 29.7 62.2 13.9 1.6 28.5) 13.3 340.4 1.4 0. Constn. and Services — = not available.4 1.3 51.0 1996 1997 58.1 0.0 0.1 0.0 0.8 51. 1992-1997 (percent) Indicator/Sector Sales Growth Agriculture Mining Basic Industry and Chemicals Misc.5 9.3 0.8 1.4 30.7 (82.7 34. Infrastructure Finance Trade.5 45.2 59.7 — 36.3 0.4 77.1 0.1 (11.8 24.7 43.1 0.6 26.
1 10.8 168.6 13.4) (1.2 6.8 3.0 110.9 38.4 46.0 9.2 23.0 3.5 4.4 35.0 130. Industry Consumer Goods Industry Prop.3 17.0 650.1 9.0 70.3 18.4 35.1 11.5 19.0 39.4 71. Industry Consumer Goods Industry Prop.7 5.8) 8.9 14. Investment.0 190.4 1.5 7.4 17.6 19.6 8.2) 15.9 38.0 (0.1 1994 80. Industry Consumer Goods Industry Prop.2 1993 130.0 150.3 0.0 170. Constn.2 30.6) 36.0 180.0 50.6 8.9 87.6 18.6 13.1 6. Real Estate.3) 5.0 120.0 180.0 120.4 5.3 7.7 61. and Services Return on Equity Agriculture Mining Basic Industry and Chemicals Misc.0 650.0 110.6 (2.3 17.9 42.0 100.0 150.0 100.6 1.. Investment.0 8.0 14.9 40..0 46. Industry Consumer Goods Industry Prop.3 64.4 79.0 11.0 66.0 210.0 160.8 5.0 110.0 80. 1992-1997 (percent) Indicator/Sector Debt-to-Equity Agriculture Mining Basic Industry and Chemicals Misc.7 4.4 20.2 111.8 9.8 44. Infrastructure Finance Trade.7 12.5 4.1 7.8 8.7 9. and Bldg.1 10.4 6.1 4.5 5.5 11.5 13.0 3.0 220.1 4. 1992 20.6 (11.0 180.0 160.2 11.5 Financial Performance of Publicly Listed Companies by Sector.7 4.7 8.4 6.3 1.0 190.9 7.0 70.9 4.2 53.0 700.5 17.7 26. and Services Return on Assets Agriculture Mining Basic Industry and Chemicals Misc.7 13.0 60.7 4.1 (5.4 .0 100.0 70.0 17.7 5.9 10.1 65.0 12.3 38.9 29.8 20.7 8.0 630.1 13.0 110.3 73.1 63.7 10.2 15. and Services Source: JSX Monthly (several publications).0 140.0 19.2 7.2 (4. Constn.2 3.0 120.7 71.0 110.0 140.0 80.1 (3.4 13.0 86.0 110.4 46.1 8. Infrastructure Finance Trade.8 25. Constn.2 7.3 13. Real Estate.4 4.8 479.3 7.1 89. Real Estate. Investment.0 1997 230.0 120.5 14.2 39. and Bldg.0 8..1 3. and Services Asset Turnover Agriculture Mining Basic Industry and Chemicals Misc.1 4.0 380.2 13.8 11.9 41.2 3. Real Estate.0 15.7 1.7 12.5 56. Infrastructure Finance Trade.0) 7.8 16.8 67.6) 18.2 8.Table 1.0 680.8 81.8 11.6 23.0 560.1 1.6 74. and Bldg.0 69.6 14.7 10.0 160.7 1.0 110..0 190.3 33.1 2.7 10. Investment. Infrastructure Finance Trade.0 90.1 1996 100.5 43.5 1995 80.7 46.2) 7. Constn.7 (3.0 150.4 13.0 100.1 10.0 80.3 5.8 382. and Bldg.7 12.9 17.1 9.
The Department of Mining and Energy ranked first in terms of sales of SOCs under its control. between 1993 and 1995. and basic industry and chemicals sectors had relatively stable ROA before the crisis. By 1995.7 percent in 1990 to 6 percent in 1996. State-Owned Companies At the end of 1995. The DER was slightly higher than for listed companies.Chapter 1: Indonesia 13 negative ROA.4 percent the following year. the Department of Finance supervised 30 SOCs. These growth rates were low compared to those for listed companies during the same period.3 trillion. Just like private companies. SOCs diversified into many businesses. the SOCs’ value added as a percentage of GDP ranged from 6 to 8. which collectively had the largest assets. SOCs’ sales growth fluctuated during 1990-1996. While asset turnover rates of publicly listed 3 4 SOCs are those in which the State has at least a 51 percent equity interest. increasing from 21. much lower than that of companies listed in the stock exchange. Only the agriculture sector showed an increase in ROA in the couple of years before 1997. insurance (11 companies). the ratio decreased from 8. respectively. The finance and miscellaneous industry. but dropped dramatically to 4. The sectoral distribution of 165 SOCs is as follows: nonfinancial (143 companies). Taken together. there were 165 state-owned companies (SOCs)3 in Indonesia. and finance company (four companies).6 to 8.7 to 7 percent for publicly listed companies. However.1 percent in 1992 to 28. Assuming a fixed ratio of value added to sales. registering an average annual rate of 10 percent. there were 58 SOCs with subsidiaries and affiliates. SOCs actively operated in various sectors4 under the supervision of “technical” departments. . Six SOCs were listed in the Jakarta Stock Exchange. the subsidiaries and affiliates number 459 with total assets of Rp343.1 percent in 1993. ROA had been at high levels from 1992 to 1995.6). This was due to large sales by the National Oil Company (Pertamina). growth of net profits and assets was erratic. but it continuously declined from 370 percent in 1992 to 250 percent in 1995. indicating SOCs’ declining contribution to GDP. banks (seven companies). Similarly. Trade had the highest ROA of 39.8 percent between 1992 and 1995 (Table 1.3 percent in 1995. For instance. SOCs’ ROE ranged from 6. Asset turnover rates were lower relative to those of publicly listed companies.7 percent. This was relatively high compared to the 3. averaging 24 and 31 percent.
In 1997.7).4 13.6 Growth and Financial Performance of State-Owned Companies. 1992-1995 (percent) Indicator Growth Indicators Sales Growth Share of Value Added in GDPa Assets Growth Financial Indicators Debt-to-Equity Ratio Return on Equity Return on Assets Asset Turnoverb — = not available.766 business units. the contribution of conglomerates to GDP increased from 12.7 1994 (9. II companies consistently declined over time.8 21.6 28.8 11.6 1995 25.1 310. these conglomerates owned 9.0 6.5 3.1 32.14 Corporate Governance and Finance in East Asia.4 1993 16. Table 1.3 250.5 percent in 1995. a Value added was assumed to be 30 percent of total sales.1 trillion in 1990 to Rp234 trillion in 1997.7 Growth Performance of the Top 300 Conglomerates. Their total sales increased from Rp90.7 13.0 28.8 12. SOCs’ asset turnover rates showed a downward trend from 32. 1990-1997 (percent) Item Sales Growth Share of Value Added in GDPa 1990 1991 1992 1993 1994 1995 1996 1997 — 17.4 percent in 1992 to 28. mostly private companies. Source: Indonesian Data Business Center.2 18.2 — 370.1 6. Table 1.6 28.6) 260.0 8.7 (2. Vol.1 19.1 30. a Value added was assumed to be 30 percent of total sales.1) 5.8 percent in 1990 to 13. Assuming a constant ratio of value added to sales.7 16.0 8.3 30.0 17. but dropped to 11.1 12.4 13.4 7. b Asset turnover is defined as sales over assets.0 7.0 12.6 percent in 1994. but climbed to 30.2 — = not available.0 24. .4 16.3 12.4 percent in 1994.4 13. 1992 — 7.5 Conglomerates This study used available data on the top 300 conglomerates in Indonesia.2 percent in 1997 (Table 1. Source: Indonesian Data Business Center.2 23.
For instance. The 1995 law requires limited liability companies to set up two boards: the board of commissioners (BOC). and the accountant. shareholders lose control. By international standards. the decision to use certain company assets as collateral for bank credit might need BOC approval. and the attendance should at least be two thirds of total shareholders. except in strategic issues stated in the law. and consolidations. The BOC. the decision to amend the company charter should be approved by two thirds of shareholders present in the meeting. commissioners.6 Legal and Regulatory Framework During the 1990s. a member company might sign a disadvantageous contract with another company where the same controlling shareholder has a higher stake. The law mandates the BOC and BOD to work for the best interests of the company and not just of the shareholders. is the only shareholder mechanism for monitoring and controlling the BOD. In general. A chairman heads the BOC while a chief executive officer (CEO) heads the BOD. For mergers.2. tasked with supervising the firm. The law also holds the directors and commissioners jointly responsible for decisions made by the company. For instance. The actual responsibilities of BOCs vary by company and are stipulated in the company’s charter. The law replaced an earlier statute that was based on the Dutch system. however. tasked to provide direction to the company. The meeting decides on important issues. The law also specifies that the highest “institution” in the limited company is the shareholders’ meeting.Chapter 1: Indonesia 15 1. The Corporate Law The Corporate Law of 1995 governs the establishment and operation of limited liability companies in Indonesia. the Government promulgated a number of laws and regulations to protect investors. and declaration of bankruptcy. The BOD undertakes operating decisions while the BOC participates in strategic decisions and operations review. . the legal and regulatory framework of the corporate sector was far from adequate. such as the appointment (or replacement) of directors. If the BOC does not perform well. The company charter details the issues that need shareholder meeting approval. The law explicitly requires approval during the meeting of decisions on strategic issues such as amendment of the company charter (articles of incorporation). an approval needs the majority (50 percent plus one) vote. acquisitions. and the board of directors (BOD). mergers. as representative of shareholders. For example. This guards against shady intercompany dealings within a group of companies.
(xiv) mandatory disclosure of intercompany affiliation such as affiliated lending or guarantees. (xvi) independence of auditing. It regulates the requirements of investment companies. delineating the tasks and responsibilities of the Capital Market Supervisory Agency. (ii) proxy voting. such as custodian banks and the securities registration bureau. investment advisors. A tender offer is also required for acquisitions of up to 20 percent of listed shares. The law provides the following rights to or protection of shareholders: (i) access to regular and reliable information free of charge. The law is supplemented by Government regulations. Controlling shareholders have no vote on the matter. some listed companies sell no more than a small proportion of shares to the public in order to retain the freedom of the founders to make strategic decisions. (xvii) mandatory independent board committee. (viii) the right to make proposals at the shareholders’ meeting. insider trading (including market rigging and manipulation) investigation. (vi) one share one vote. transparency requirements. (xv) mechanisms to resolve disputes between the company and shareholders. and administrative and legal punishment.16 Corporate Governance and Finance in East Asia. and (xviii) severe penalties for insider trading. consolidations. and other supporting agencies. securities companies. Because of such requirements. (x) mandatory shareholders’ approval of major transactions. It also regulates reporting and auditing procedures. An important rule is the requirement for independent shareholders’ approval for arrangements that might lead to conflicts of interest. . (xii) mandatory disclosure of connected interests. and the attendance should at least be three fourths of total shareholders. investment managers. (ix) mandatory shareholders’ approval of interested transactions. Vol. (iii) proxy voting by mail. underwriters. and bankruptcy. (xiii) mandatory disclosure of nonfinancial information. the decision should be approved by three fourths of the shareholders present. (v) preemptive rights on new share issues. (vii) the right to call an emergency shareholders’ meeting. decrees of the finance minister. II acquisitions. The Capital Market Law The Capital Market Law (1995) regulates companies listed in the stock exchange. (xi) mandatory disclosure of transactions by significant shareholders. brokers. and guidelines promulgated by the head of capital market supervision. Examples in the area of corporate governance are guidelines for situations that can potentially lead to conflicts of interest and for acquisitions of substantial shares of listed companies. (iv) cumulative voting for directors.
The two most important elements of ownership structure are concentration and composition.1 Corporate Ownership Structure Quality of corporate governance is closely related to corporate ownership structure (see discussions in the Consolidated Report of this study). the viability of a project). Discussions on corporate ownership cover listed companies and conglomerates. the Banking Law (1992). A new bankruptcy law was passed in August 1998. capital adequacy. Banking Laws Affecting the Corporate Sector Some elements of the banking law also affect the corporate sector. Unsecured creditors could proceed against a debtor in default based on loan covenants and through the legal process of collection against the latter’s assets. families. It reveals characteristics of controlling shareholders. or financial institutions. for instance. The old bankruptcy law based on the Dutch system was biased in favor of debtors and made it almost impossible for creditors to seek court resolution when debtors defaulted.3 Corporate Ownership and Control This section looks at the ownership structure of the corporate sector and reports the results of an ADB survey on corporate management and control of publicly listed companies.Chapter 1: Indonesia 17 Bankruptcy Law Despite loan covenants. However. Banking regulations also set lending limits. . whether they are individuals. It aimed to protect creditors by providing easier and faster access to legal redress. 1.. etc. amended in October 1998. 1. creditors of unsecured loans are unprotected when borrowers fail to meet their obligations. For instance. The court can declare the debtor bankrupt upon the request of at least two creditors and default on one loan. Ownership concentration is usually measured by the proportion of shares owned by the top one. states that a bank is not allowed to provide credit without collateral. holding companies. five. the collateral could take the form of nonphysical assets (e. A Commercial Court was also set up to deal with bankruptcy cases.3. or 20 shareholders. net open positions.g.
0 1.3 1995 47. The pattern of ownership concentration changed little over this period. This is because a few companies in the transportation sector issued high proportions of shares to the public. and 0.18 Corporate Governance and Finance in East Asia. consumer goods.5 16. the controlling shareholders usually act as standby buyers.9. and Berlian Laju Tankers (liquid bulk maritime transportation services) issued 48.7 1996 48.1 4.5 Average 48. and basic industry and chemicals sectors than in others. mining.8. The percentage owned by each of the five largest shareholders was 48. 2. Table 1.0 0. the founder usually continues to own the majority of shares through a . 13.1 1.6 13. respectively. When a company goes public.9 Source: The Indonesian Capital Market Directory. issued 93. This is partly due to the prevailing practice of raising equity through rights issues in Indonesia.7 3.5 1997 48. When a company makes a rights issue.5 72.0 67.1 0.6 3. Vol. Table 1. about two thirds of publicly listed companies’ outstanding shares were owned by corporations that were directly or indirectly controlled by families. Zebra Nusantara (taxi services).8 Ownership Concentration of Publicly Listed Companies.0 4. for instance.9 14.9 2.6 percent. This preserves the pro rata share of existing shareholders.0 2. Data from the Indonesian Capital Market Directory (various publications) show that between 1993 and 1997. the five largest shareholders owned 68. II Publicly Listed Companies Table 1.8 68. On average.5 12.9 percent of total outstanding shares.9 2.8 1.4 2.6.9 0.5 percent.6 68.4 percent.1 13. 1993-1997 (percent) Shareholder Rank First Largest Second Largest Third Largest Fourth Largest Fifth Largest Total 1993 50.2 1.2 11. ownership widely held by the general public is highest in the infrastructure and transportation sector (not shown in the table). 3.7 1994 48. Meanwhile.6 3.8 shows average proportions of shares owned by the five largest shareholders of publicly listed companies during 1993-1997.0 0.8 68.2 67.6.9 shows that ownership by the largest shareholder in 1997 was more concentrated in the agriculture.6 4. Rig Tenders Indonesia (shipping services) issued 51.
4 11.3 14. The findings suggest that the concentration of corporate control in the hands of few families is a major determinant of the evolution of an inefficient legal and judicial system.9 Ownership Concentration of Publicly Listed Companies by Sector. In terms of capitalization. Constn. Util.1 1.4 1. Thus the founder keeps the proportion of shares necessary to retain control over management of the listed firm.1 1. (1999) also found.9 1.7 1. These figures suggest that ultimate control of the corporate sector rests in the hands of a small number of families.1 2.9 3. and corruption. on the other. is strong.7 4. Table 1. Real Estate.4 54. Industry Consumer Goods Industry Prop. the rule of law. 1997 (percent) Sector Agriculture Mining Basic Industry and Chemicals Misc. the top family controls 16.3 2. Legal and regulatory developments may have been impeded by the concentration of corporate wealth in .6 8.2 10.7 percent of the market. First Second Third Fourth Fifth Biggest Biggest Biggest Biggest Biggest 54.1 11.3 0.2 2. and only 0.4 44.2 0. Investment.1 1.Chapter 1: Indonesia 19 fully-owned limited liability company (Perseroan Terbatas).4 4.7 9. and Transportation Finance Trade. and Services Average Source: The Indonesian Capital Market Directory.1 0.7 13.9 44.6 9. which shows that in 1996.0 5.3 0. In fact.6 percent were widely held.6 1.1 0. in a cross-country study..4 6.2 This is confirmed in Claessens et al. as well as the existence of corruption.9 50. and Bldg.1 2. (1999).1 13..6 2.5 1.1 1.3 36.8 14.7 6.1 2.2 15.6 0.6 percent of total market capitalization while the top 15 families control 61.3 48. that the correlation between the share of the largest 15 families in total market capitalization. Infrastructure. and the efficiency of the judicial system. on the one hand.9 0. Claessens et al.5 58. Indonesia has the largest number of companies controlled by a single family.5 4. Most of the five largest owners of Indonesian publicly listed companies are limited liability companies rather than individuals. two thirds (67.9 44.1 percent) of Indonesian publicly listed companies were in family hands.2 46.
However. Vol. the onset of the crisis negated this development. II the small number of families and the tight links between companies and the Government. nonindigenous groups owned a larger proportion of the top 300 Indonesian conglomerates. Sundanese. Family control is said to have positive effects in that it allows group members in conglomerates to make strategic decisions quicker. the Government allowed foreign investors to buy up to 100 percent of listed shares. But these benefits are few and often dubious compared to the high costs of concentration. From 193 in 1988. foreign ownership increased to 21 percent. ethnicity. and family origin. resulting instead in a decline in the proportion of foreign investor ownership. it rose to 30 percent. In 1993. or other ethnic groups. . However. During 1988-1996. Batak.42 percent in December. accounting for 64 percent of total conglomerate sales in 1988-1996. their number increased to 5 In 1997. with all its regulations. In September 1997. but later declined and steadied at around 25 percent. the legal system is less likely to evolve in a manner that protects minority shareholders. and Padang. was able to create a favorable environment for business development.55 percent in August to 25. This may indicate that the New Order Government.10 shows the anatomy of the top 300 conglomerates in terms of year of establishment. The nonindigenous businesspeople are usually Chinese. If the role of a limited number of families in the corporate sector is so large and the Government is heavily involved in and influenced by business. When the Government allowed foreign investors to buy up to 49 percent of listed shares in 1988. most were established during the New Order Government. the proportion of foreign ownership declined from 27. conglomerates established before 1969 dominated in terms of sales. Coordination is easier because informal communication channels exist.20 Corporate Governance and Finance in East Asia. The corruption and regulatory problems generated by high ownership concentration by families in Indonesia are likely to overwhelm its benefits. numbering 162 in 1988 and 170 in 1996. there is a dichotomy between corporations owned by indigenous and nonindigenous businesspeople. In Indonesia. political affiliation.5 Conglomerates Table 1. Indian. Among the top 300 conglomerates. Indigenous businesspeople include the Javanese.
7 106.7 28.1 46.2 33.4 22.4 37.0 58. the number of mixed groups declined from 86 in 1988 to 68 in 1996.3 36.3 101.2 76.2 30.6 34.8 Source: Indonesian Business Data Centre.0 58.1 179. sales of the Bakrie group before it went public in 1990 were only Rp369.1 87.4 trillion in 1996.2 159.4 15.9 35.6 54.0 28.9 42.4 18.4 81.1 58.2 23.7 24.9 77.9 14.1 42.8 68.1 percent of total .5 106.3 20.7 40.3 80.6 77.8 36.1 52.4 52. its sales reached Rp1.2 29.8 49.4 32.4 86.5 120.7 89.0 31.3 43. For instance.0 116.4 48.6 114.4 68.6 95.0 44. Meanwhile.8 57.8 38.7 95.8 25.5 22.7 64.9 73.1 41.2 12.6 12.4 31. more than five times its 1988 level.8 28. Their total sales also increased from Rp38.9 billion.4 57.6 17.8 12.4 19.2 48. due to their “go public” activities.3 120.9 13. 1988-1996 Item Number of Groups Year of Establishment Before 1946 1946-1968 1969 Forward Ethnicity Mixed Nonindigenous Indigenous Political Affiliation Nonofficial Official-Related Origin Family Nonfamily Sales (Rp trillion) Year of Establishment Before 1946 1946-1968 1969 Forward Ethnicity Mixed Nonindigenous Indigenous Political Affiliation Nonofficial Official-Related Origin Family Nonfamily 1988 1989 1990 1991 1992 1993 1994 1995 1996 13 125 162 86 193 21 260 40 176 124 13 125 162 83 196 21 259 41 175 125 13 123 164 80 196 24 260 41 171 129 13 120 167 76 199 25 260 40 174 126 13 118 169 76 198 26 262 38 172 128 12 122 166 71 201 28 263 37 171 129 12 122 166 69 205 26 262 38 172 128 11 120 169 71 204 25 260 40 177 123 10 120 170 68 204 28 259 41 175 125 9. In 1996.7 49.8 30. Conglomeration Indonesia 1997.4 16.9 trillion.9 47. 204 in 1996.0 18.4 69.Chapter 1: Indonesia 21 Table 1.9 137.5 21.1 21. While they supplied 20.3 134.0 15.1 25.1 103.1 33.6 trillion in 1988 to Rp137.4 59.4 59.1 46.4 31.10 Anatomy of the Top 300 Indonesian Conglomerates.
compared with the less than Rp700 billion of a nonofficial-related conglomerate. Banks owned by groups or conglomerates typically act as a “cashier” that provides credit to companies within the group. most of the 16 liquidated banks had violated the legal lending limit set by the central bank. But only a handful of these companies are listed in the market. The contraction in the number and economic contribution of mixed groups may be an indication of increasing social polarization along ethnic lines. Some of them later became public companies by listing in the stock market. Average sales of official-related conglomerates were substantially greater than nonoffficial-related ones during 1988-1996. Bambang Rijadi Soegomo. Djuhar Soetanto. But listed companies within conglomerates were few. collectively controlling . Conglomerates were also classified into nonofficial. Only about 13 percent were formed by official or ex-official families. In 1996. Political alliances between entrepreneurs and officials have often led to the violation of regulations meant to promote prudent business practices in the banking industry.2 trillion. or have resulted from alliances between entrepreneurs and officials. Vol. Most of the top 300 conglomerates were established by ordinary citizens.22 Corporate Governance and Finance in East Asia.7 percent in 1996. banks that had to be closed down included Bank Surya (owned by Sudwikatmono) and Bank Andromeda (owned by Bambang Trihatmodjo). In 1996. In 1997 and 1998. Official-related groups have owners (or founders) who are or are allied with former or current government officials (or their families). and Fast Food (restaurants). owns four groups with many subsidiaries and affiliate companies. their contribution declined to 13. II sales in 1988. Out of 174 companies. and Wisnu Suhardhono of Apac-Bhakti Karya. More recent alliances were between Bambang Trihatmodjo (former President Suharto’s son) and Johannes Kotjo. average sales of official-related conglomerates reached Rp1. there were 175 groups that originated from a family business. The high NPLs accumulated by banks within official-related groups could be partly attributed to this practice. Prudential credit analysis tends to be ignored. The well-known official-business alliances are those between Sudwikatmono (former President Suharto’s cousin) and Soedono Salim. and Ibrahim Risyad of the Salim group. Indocement Tunggal Prakarsa (cement industry). 117 are jointly owned by the family and 57 are owned by individual family members. for instance. The Suharto family is the largest stockholder in Indonesia. which is the largest conglomerate in Indonesia. The Salim group.and officialrelated groups. Bank Indonesia. including Indofood Sukses Makmur (food industry). In November 1997.
for instance. It is generally believed that there are cross-holdings between financial and nonfinancial companies and among nonfinancial firms. management. In 1996. besides Suharto himself. as well as other relatives and business partners. but those of the entire group.Chapter 1: Indonesia 23 assets worth $24 billion (Claessens et al. The BOC chairperson often represents the controlling party of the company. Cross-Shareholdings Cross-shareholding is one way to enhance corporate control and occurs when a company down the chain of control has some shares in another company within the same chain. In so doing. or someone very close to and trusted by the controlling shareholders.. many of whom. The Salim Group is also in part controlled by the Suharto family. continue receiving some kind of protection and special treatment. The family controls 417 listed and unlisted companies through a number of business groups led by the Suharto children. While the source of the . Indofood Sukses Makmur (food industry) was owned by Indocement Tunggal Prakarsa (cement industry). The families retain control of the companies through ownership. and hence. Semen Cibinong. Some of the groups related to officials have a unique share ownership structure. He or she could either be the biggest shareholder. Although they are not actively involved in the daily operations of the companies. with no restrictions. served in some government function (see Figure 1. The officials (or their family members) often own a small portion of shares given to them freely by controlling shareholders. Both are listed companies and members of the Salim group. Cases in point are the Bank Papan Sejahtera and Bank Niaga. which were liquidated or recapitalized after being acquired by the Tirtamas group that owns a listed cement company. Indonesian law allows cross-shareholdings. or both. If the family members cannot actively manage the companies as directors. Cross-holdings between financial and nonfinancial firms potentially create more serious problems. they maintain their position as commissioners. the controlling shareholders are able to maintain their special relationship with officials. But it is difficult to obtain data on cross-shareholding among firms.1). they still control the work of the directors. This is because cross-owned banks had to consider not only their own interests. families mostly manage the groups and make strategic decisions themselves. 1999). Although some groups employ professional managers.
Who Controls East Asian Corporations? Financial Economics Unit. Lang. (Feb. World Bank. 1999). and Larry H. Financial Sector Practice Department.Figure 1.1 The Suharto Group Usaha Mulia Group (cousin Hasim) Cemen Cibinong Hanurata Group Suharto Family Citra Lamoro Group (daughter Mbak Tutut) Bank Yama Bob Hasan Group (Mohamad Hasan) Gatari 22 firms with control over 20% Citra Marga Persda Tollroad Trias Sentosa Bank Central Indomobil Mercu Buana Group (step brother Probo) 11 firms with control over 20% Kedaung Indah 14 firms with control over 20% Kedaung Group (Agus Nursalim) 18 firms with control over 20% Tirtamas 21 firms with control over 20% 262 firms with control over 20% Salim Group (friend Soedono) Sempati Air Humpuss Group Bank Utamar 17 firms with control over 20% Bimantara Group (son Bambang) TPI Andromed Tripolita 8 firms with control over 20% Kabelindro Kiani Murmi Sakti Source: Stijn Claessens. . Simeon Djankov. P.
the BOC has the right to obtain any information concerning the firm. As the owners’ representatives. and. The typical structure of a publicly listed company in Indonesia is shown in Figure 1. Shareholders are at the top of the organization. both controlling and minority.Chapter 1: Indonesia 25 problem is inconclusive. including the boards. The BOD leads the company and makes strategic and operational decisions.2 Typical Internal Organizational Structure of a Publicly Listed Company in Indonesia Shareholders Board of Directors Board of Commissioners M a n a g e r s Employees The succeeding discussions examine some aspects of the internal management and control system in practice in Indonesian listed companies. one possibility is that legal lending limits had been violated. The managers execute the BOD’s decisions and lead employees in their departments. This is based on the Dutch system. 1. if necessary. seek an audience with directors. management and managerial compensation.3. Figure 1. role and protection of minority shareholders. request a shareholders’ meeting. Therefore. the directors. the BOC supervises the work of directors. The discussions are based on the ADB survey of 40 companies listed in the Jakarta Stock Exchange.2 Management and Internal Control A company’s internal organizational structure determines how shareholders control management.2. and accounting and auditing procedures. .
Corporate Governance and Finance in East Asia, Vol. II
Board of Commissioners and Board of Directors Table 1.11 presents a summary of some characteristics of the BOC. The table reveals that 29 out of 40 companies surveyed did not have independent commissioners. Although 23 companies reported that commissioners were elected based on professional expertise, nine companies reported that selection was based on relationships with controlling shareholders, and another nine reported that commissioners were the company’s founders. Table 1.11 Characteristics of the Board of Commissioners
Number of Firms Responded 11 29 23 9 9 10 22 7 27 7 8 8 30 6 4
Questions Presence of Independent Commissioners a. Yes b. No Basis for Electing the Board of Commissioners a. Professional expertise b. Relationship with controlling shareholders c. As founders of the company Procedure in Electing the Board of Commissioners a. Nominated by the management and confirmed by the AGM b. Nominated by significant shareholders and confirmed by the AGM c. Nominated and elected by shareholders during the AGM Basis for Electing the Chairman of BOC a. Professional expertise b. Shareholdings c. As founders of the company d. Relationship with controlling shareholders Relationship between the Chairman and CEO a. Not related by blood or marriage b. Related by blood or marriage c. No answer
Note: Since companies could answer more than one alternative, the total does not necessarily add up to 40 for each question. Source: ADB Survey.
In most companies (22 out of 40), members of the BOC were nominated by significant shareholders and confirmed at the annual general meetings (AGMs). A nominee that was not supported by significant shareholders
Chapter 1: Indonesia
was unlikely to be chosen as a commissioner. Most companies (27 out of 40) elected their BOC chairman based on professional expertise. The majority of firms (30 out of 40) also reported no relationship between the chairman and CEO either by blood or marriage. A similar picture is obtained for the BOD (Table 1.12). Most companies (30 out of 40) reported not having independent directors. Professional expertise was an important basis in electing directors for 29 companies. Relationships with controlling shareholders and founders of the company were the basis for selecting directors in 11 companies. Table 1.12 Characteristics of the Board of Directors
Number of Firms Responded 10 30 29 7 4 13 22 6 29 3 7 8
Questions Presence of Independent Directors a. Yes b. No Basis in Electing Board of Directors a. Professional expertise b. Relationship with controlling shareholders c. As founders Procedure in Electing Board of Directors a. Nominated by the management and confirmed by the AGM b. Nominated by significant shareholders and confirmed by the AGM c. Nominated and elected by shareholders during the AGM Basis in Electing the Chief Executive Officer a. Professional expertise b. Shareholdings c. As founders of the company d. Relationship with controlling shareholders
Note: Since companies could answer more than one alternative, the total does not necessarily add up to 40 for each question. Source: ADB Survey.
Twenty-two out of the 40 respondents elected their directors through nomination by significant shareholders and confirmation by the AGM. Most companies (29 out of 40) selected the CEO based on professional expertise, although some companies based it on relationships with controlling shareholders.
Corporate Governance and Finance in East Asia, Vol. II
Management and Managerial Compensation The Corporate Law mandates the BOD to lead the company and make strategic and operational decisions, and the BOC to supervise the work of the directors. The BOC also reviews the results of operations and participates in strategic decision making. This indicates some overlapping functions for the BOC and the BOD, which is confirmed in the ADB survey. This overlapping of responsibilities, particularly in making strategic decisions, may result in conflicts. However, since the BOC appoints members of the BOD and determines their remuneration, the BOC is in a strong position to dominate the BOD. Twenty-five out of 40 firms indicated that the CEO makes important decisions after consulting the chairman of the BOC. In carrying out their tasks, the majority of firms reported not having committees to assist the BOD and BOC, as shown in Table 1.13. Only a few companies have nomination, remuneration, and auditing committees, most of which were set up between 1995 and 1997. In 1995, Bank Indonesia required commercial banks to have an auditing committee. Table 1.13 Presence of Board Committees in Listed Companies
Type of Committee Nomination Committee Remuneration Committee Auditing Committee None Total
Source: ADB Survey.
BOD 5 5 5 23 38
BOC 1 1 3 35 40
Most firms reported terms of appointment of three to five years for the BOD and BOC. In some companies, the term differs for commissioners and directors. Although the term is for three to five years, in 13 out of 40 companies, the directors and commissioners have been in service for more than five years. Results of the ADB survey show that in 18 companies, the CEO is given fixed compensation plus a profit-related bonus. In 14 companies, only fixed compensation is given. For the BOC chairman, 10 companies
Chapter 1: Indonesia
provide fixed compensation plus profit related bonus, while 14 companies provide fixed compensation only. Role and Protection of Minority Shareholders Indonesian law requires publicly listed companies to have at least 300 shareholders to help ensure share liquidity and dispersed ownership. The highest number of shareholders is found in Bank BNI (a state-owned bank), reportedly having 27,568 shareholders. Small companies simply comply with the minimum shareholder number requirement. Most companies reported that their shareholders enjoy all mandated rights and protection, except those on proxy voting by mail, cumulative voting for directors, and the independent board committee. A company charter (articles of incorporation) stipulates the quorum requirement during annual meetings, which is usually two thirds of total shareholders. The ADB survey showed that more than 67 percent of shareholders attended the last annual meeting in most companies. While proxy voting is allowed, proxy votes accounted for less than 10 percent of shareholders on average. Brokerage companies and management were the usual proxies. A change in the company charter requires a two-thirds majority vote by shareholders. The ADB survey revealed that in the last three years, only one management proposal (i.e., director’s fee) was rejected during the AGM. This is not surprising because management usually seeks prior approval of proposals from controlling shareholders. Accounting and Auditing Procedures Thirty-five out of 40 respondents in the ADB survey claimed to have substantially followed international accounting standards even prior to the financial crisis. Accounting authorities, however, can easily change acceptable accounting methods. After the crisis, for instance, the Indonesian Accountants Association recommended that potential foreign exchange losses be reported as losses at the end of the accounting year. Later, the association allowed companies to choose between declaring it in the profit and loss statement at the end of the accounting year or in the balance sheet. All companies in the survey reported the presence of an independent auditor, which is usually an international audit company. Most companies have been associated with their independent auditors for more than five years. Shareholders appoint the external auditor during the AGM.
Corporate Governance and Finance in East Asia, Vol. II
Control by Creditors The control of creditors over a debtor company rests on assets used as collateral for loans. Unsecured creditors resort to the legal process when problems arise. Based on the ADB survey, each company was associated with an average of five creditors, the majority of which were banks. Some companies were associated with an excessively large number of creditors, reaching up to 30. Most of the companies have been dealing with their institutional creditors for less than three years. Although the banking law requires collateral for bank loans, some creditors did not enforce the requirement. Only 10 companies reported that they were required to provide collateral by all creditors. Twelve companies claimed having creditors that did not ask for collateral. Twenty-five out of 32 companies reported having renegotiated loans with creditors in the last five years, mostly after the Asian crisis. This indicates that many companies experienced serious difficulties in repaying debts as a result of the crisis. But most of these companies stated they would possibly borrow from the same creditors, indicating their relatively strong bargaining position. The majority of firms (22 out of 29) also said that creditors had no influence in management decision making. In 1998, the Bankruptcy Law was passed to protect creditors and the Commercial Court was set up to deal with bankruptcies. This paved the way for unsecured creditors to proceed against a debtor in default based on loan covenants and through the legal process of collection against the debtor’s assets. However, enforcement of the law was a disappointment to those who hoped that it would put corporate restructuring and the settlement of corporate debts on a running start. Only 17 cases had been filed with the court by late November 1998. Just two companies had been declared bankrupt, and three suits were dismissed by the Commercial Court. The Government’s political will and support are still very much needed in order to set up a well functioning Commercial Court. Long and hard work is required to restore creditors’ confidence in Indonesia’s legal system. The Market for Corporate Control Between 1992 and 1997, there were 40 cases of acquisition and takeover of Indonesian companies. Most of these, however, were internal acquisitions (i.e., acquisition of a company in the same group). Only five cases were
the Government took over NPLs and put them under IBRA management. it was common for the Government to invest in certain private companies. which was acquired by Yopie Wijaya in 1995. who was acquiring his second commercial bank. restrictions on market entry. with the minister’s approval. For instance. Most Indonesian state companies are 100 percent owned by the Government. Before the financial crisis. This used to be a common practice in companies associated with the Suharto regime. 6 7 Later in March 1999. They then replaced the BOD and later sold the bank. appointment of management.6 In this case.Chapter 1: Indonesia 31 external acquisitions. Wijaya and his friends bought shares of the bank on several occasions until they gained control. the owner of Tirtamas group. A more recent case was the acquisition by Nutricia (the fourth largest baby food firm in the world) of PT Sari Husada (another baby food firm) in 1998. Since the NPLs reached up to Rp300 trillion. to Hashim Djojohadikusumo. or direct subsidies. In April 1999. the bank was liquidated. A study by Connie Tjandra (1993) shows that internal acquisitions were often initiated for tax shelter purposes. IBRA found itself tasked with managing large amounts of assets in the private sector. Bank Niaga was under a recapitalization program. Control by the Government Government control could be in the form of state ownership. State ownership for listed SOCs ranges from 25 to 35 percent. . The bank was reported to have high NPLs and had broken the legal lending limit. except for publicly listed SOCs. the takeover brought significant losses to Djojohadikusumo when share prices plunged7 during the crisis. The BOD and BOC of PT Sari Husada were allowed to complete their terms before they were replaced. Another case was the takeover of Bank Niaga in 1997 by Djojohadikusumo. One famous takeover was Bank Papan Sejahtera. the acquiring interest was apparently seeking economic profits. The Government appoints the BOD and BOC of these firms. In these two latter cases. the acquiring parties were trying to obtain operating synergies because they had companies in the same industry. at a large profit. In the massive restructuring of the banking sector that commenced after the crisis. a state-owned insurance company may invest its funds in a private firm. However. The Government is thus able to appoint some officials to be members of the private firm’s BOD or BOC.
6 4. because of the restrictions discussed below.9 234.6 6.0 93. bank credit surged from Rp122. stocks. bank loans were the only instruments available to the corporate sector for short term (working capital) or long term (investment) financing.3 9. and others offered by nonbank financial institutions or finance companies. equities became available to the corporate sector.3 66.4.1 Corporate Financing Financial Market Instruments Prior to 1977.9 378.4 86.9 153. new instruments have been introduced to the corporate sector.7 112. 1992-1999 (Rp trillion) Type of Bank State-Owned Banks Foreign Banks Regional Govt Banks Private National Banks Total Source: Bank Indonesia.5 42.3 14.5 7. Bank loans.14 Banking Sector Outstanding Loans. the share of private national banks in outstanding total loans increased to 44.9 trillion in 1992 to Rp487.5 108. . jointly providing almost 90 percent of loans until 1997. However. Table 1. 1992 1993 1994 1995 1996 1997 1998 1999 68.6 48. remain the major financing instrument for the corporate sector. including bonds.7 122.6 3.2 6.4 24.6 percent in 1997.3 60. From 34.4 trillion in 1998.6 292.0 6.4 225.6 150. Private national banks and state-owned banks were the biggest domestic creditors. however.1 Equities In 1977. Vol.2 5. Since then.2 71.9 150.3 111.4 percent in 1992.3 188.5 80.0 3. this market was not well developed. when the Government reactivated the stock exchange.7 50.0 168. Bank Credit As shown in Table 1.8 193.2 27.32 Corporate Governance and Finance in East Asia.1 220. When the Government liberalized the banking industry at the end of 1988 (which allowed for higher interest rates). II 1.14.4 1.4 56.7 18.0 487. Data from Bank Indonesia show that from 1994 to 1997. companies considered alternatives to bank loans. private national banks overtook state banks as the dominant credit source.
In 1988. During the 1990s. limiting loans to a maximum of 15 times equity and foreign loans to five times the equity. the activities of finance companies were not covered by regulations on prudential practices in the banking sector (e.6 123.1 10. the stock market has gained a bigger role in corporate sector financing (Table 1.5 1995 35.3 percent in 1990 when the stock market was liberalized and foreign investors were allowed to purchase up to 49 percent of listed firms’ shares. and net open position). Prior to 1995. i. .0 70.7 14. offering services such as leasing.4 207. Most banks therefore set up subsidiary finance companies to circumvent banking regulations. the Government issued regulations to supervise and promote prudential practices in finance companies.7 percent in 1997.0 206.Chapter 1: Indonesia 33 Some companies went public. legal lending limit.. funds raised in the stock market were less than 5 percent of the credit disbursed by the banking sector. 1992-1999 (Rp trillion) Item Stocks Issued Outstanding (As % of Outstanding Bank Credit) Market Capitalization Source: Bank Indonesia. when foreign investors were not yet allowed to purchase listed shares.5 333.g. 1992 1993 11. The ratio of funds raised by finance companies to credit disbursed by the banking sector has been increasing from about 5 percent in 1992 to 13 percent in 1996. Overall. It gradually increased again starting in 1991.6 310. allowed to accept deposit accounts from the public.15 Value of Stocks Issued and Stock Market Capitalization.15).7 15. capital adequacy ratio.0 15. thus increasing the role of the capital market in raising long-term funds.8 48.. credit cards.9 1999 76.7 9.2 16. but dropped to 8 percent in 1991 when the Government tried to stabilize an overheating economy.6 301. In 1995.1 1994 26. however.9 406. The ratio reached 8.e. and consumer credit. They were not.5 Financing by Finance Companies Finance companies first emerged at the end of 1980.1 17.6 859.6 91. shooting up to 18.4 1996 1997 1998 50. finance companies were increasingly used as channels for the inflow of foreign loans. Table 1. factoring.1 18.
0 1991-1996 16. In terms of composition.6 100.7 22. PACAP Research Center. otherwise it would be classified as a loss in the banks’ books.5 (0.0 3.6 12.3 (0.16 shows financing sources of Indonesian publicly listed nonfinancial companies estimated by using flow-of-funds analysis. 1996.3 16.5 11.3 14. have been popular in Indonesia since 1990.6 8. Table 1. which are unsecured negotiable promissory notes with a maximum maturity of 270 days. In the second half of the 1980s.6 23. Source: Author’s estimates based on the Pacific-Basin Capital Markets (PACAP) Databases. Bank Indonesia prohibited banks from underwriting issues of commercial papers but allowed them to act as paying agents. This is in contrast to the lower share of borrowings during the same period.1) 23.2 Patterns of Corporate Financing Table 1.4 13. they were not rated by a rating agency. 1.8 percent. Vol.8 17. at 81 percent of total borrowings.4 8.9 16.0 39.8 7.6 100.2 26.0 100.1) 23.16 Financing Patterns of Publicly Listed Nonfinancial Companies.5 — 26. averaging 26. Banks could invest only in commercial papers that were rated by the Indonesian Rating Agency (which was set up only in 1995 to rate debt instruments). II Commercial Papers Commercial papers.5 21. Thus in November 1995.4.5 percent and 36.0 — = not available. .0 1986-1996 17. publicly listed nonfinancial companies had high proportions of equity and internal finance (retained earnings). respectively.34 Corporate Governance and Finance in East Asia. short-term borrowings were greater than long-term debts. 1986-1996 (percent) Financing Source Internal Borrowings Short-Term Long-Term Debentures/Equity Debentures Equity Trade Credit Others Total 1986-1990 36.4 23. While banks had some exposure to these instruments.3 37.
Bank loans also surged when the banking sector was liberalized in 1988. respectively. The results indicate that firms with higher ownership concentration tend to have a higher DER. They also do not want to dilute corporate control and are more likely to finance growth with debt. Hence. Indosat and Telekom. The high share of equity financing was due to the surge in capital market activity following the 1988 reforms. Most corporate charters require commissioners to approve debt issues or sign debt agreements. Of the various financing sources. corporate debts accounted for 39. . This amount doubled in 1997. with longterm debts increasing rapidly. 1.9 trillion in 1996. while Semen Cibinong’s losses reached Rp2. Corporate debts grew over time. Large shareholders are inclined to undertake risky projects intended to generate high returns using borrowed funds. These liabilities grew significantly because corporate expansion was largely financed by debt. Two telecommunications companies. Indofood registered losses of almost Rp1. which managed to post significant profits due to low exposure to dollar-denominated loans. reaching Rp229.2 trillion (mostly foreign exchange losses). as evidenced by an average DER of 230 percent during 1992-1996 that rose to 310 percent in 1997.4 trillion in 1993 to Rp112. the pattern changed. The analysis of ownership patterns in Section 3 indicated that founders (the controlling party) or the five biggest owners held at least 50 percent of total shares. that ownership concentration may be associated with heightened risk-taking by companies.1 trillion. which was masked by the rapid growth in investments. The corporate sector invested heavily from 1991 to 1993 and slowed down its investment spending a few years before the 1997 crisis.9 trillion. the corporate sector’s high leverage. also suffered from foreign exchange losses but managed to post profits of Rp0.3 Corporate Financing and Ownership Concentration It has been suggested. was due largely to a rapid rise in long-term debts. except Semen Gresik (an SOC). For instance. Note that the corporate sector’s high leverage existed side by side with sizable equity capital raised from the capital market. Many companies suffered big losses in 1997 due to their high exposure to dollar loans. All companies in the cement industry suffered from foreign exchange losses. in the context of Indonesia and some other countries.6 trillion and Rp1.17 compares the DER of listed firms by degree of ownership concentration.2 trillion. rising from Rp54. Table 1.4.3 percent during 1991-1996.Chapter 1: Indonesia 35 In the 1990s.
and high ownership concentration among families with political affiliation. aided . II However. to maintain control of the company. This section highlights those that were seen to have contributed significantly to the crisis in Indonesia: inadequacy of the regulatory framework under the financial liberalization. Table 1. As a result.0 1.5.358. the borrowings swelled. Inadequate Financial Regulatory Framework Liberalization of financial markets increased the corporate sector’s access to domestic and foreign private capital. since commissioners represent the controlling party.1 The Corporate Sector in the Financial Crisis Causes of the Financial Crisis Many intertwined factors led to the crisis. Between 1987 and 1996.17 DER of Listed Companies by Degree of Ownership Concentration (percent) Item Mean Standard Deviation DER of Firms with High DER of Firms with Low Ownership Concentration Ownership Concentration 699. decisions on debt are made with the implicit endorsement of owners. 1. heavy reliance of companies on bank credits to finance investments. the private sector borrowed heavily in unhedged dollars. ultimately.0 351. the free capital flow system allowed private companies to borrow dollars offshore without any restriction.36 Corporate Governance and Finance in East Asia. Source: Author’s estimates. Controlling parties rely on external financing to maintain their equity share and. The low cost of foreign loans and the relatively stable exchange rate created a false sense of security for corporations. Vol.0 386.56 significant at the 10 percent level. The availability of bank credit brought by the rapid rise in the number of banks and the free capital flow system led to a credit boom. In addition. The test of the difference between the two means found the t-value of 1.5 1.0 Notes: Firms with high ownership concentration have more than 50 percent of shares owned by the top five shareholders.
e. However. . A director at Bank Indonesia revealed that in 1995.Chapter 1: Indonesia 37 by the lack of an existing mechanism to supervise and monitor foreign transactions. However. The large supply of foreign funds. conglomerates set up finance companies and used these as channels for the unfettered inflow of foreign loans in lieu of banks. many firms became highly leveraged. It is not known if these regulations had an effect on nonbank intermediaries. Heavy Reliance on Bank Credits to Finance Investments Companies relied heavily on bank loans to finance rapid corporate expansion because internal financing was insufficient and the capital market was not developed. The Government later specified the legal lending limit and the net open position that banks had to follow. They were. The banks served as a “cashier” that provided easy credit to nonfinancial companies within the group. large amounts of credit were directed to the companies within the group. This often led to the violation of prudential credit management practices. It was only in 1995 that some regulations on the activities of finance companies were contemplated. those with high DERs) established their own banks. This left them vulnerable to interest rate surges as well as sudden currency fluctuations in the case of dollar loans. to circumvent these banking regulations. There was also a smaller demand for equity compared to external debt financing since controlling shareholders preferred the latter to maintain their control of the companies. after all. did finance many viable ventures. only created to serve the companies to which they lent. It also meant that the cashier bank had neither the independence nor the incentive to exercise ex ante and ad interim monitoring of borrowers.. Conglomerates that had difficulty in getting loans (i. Decisions to borrow in dollars made sense to many borrowers because dollar loans were cheaper than rupiah loans. The supervising agency was caught unprepared. It was doubly difficult to exercise supervision when groups with political clout owned the banks. and the negative net open position (short position in dollars) continuously rose to precarious levels. The removal of entry barriers in the banking sector caused the number of private national banks to soar from only 65 in 1988 to 144 in 1997. averaging about 4 percent of GDP. As a result. substantial amounts were also funneled into projects that guaranteed repayment mainly on the strength of borrowers’ close political connections. the level of corporations’ foreign debt could not even be ascertained. A lot of short-term foreign funds were used to finance long-term investment projects. In the process.
or both. but on the basis of who the borrower was. Aside from the fact that many of these loans were channeled through banks and corporations of politically connected families. In early 1998. High Ownership Concentration High concentration of corporate ownership (particularly by families) led to poor financing and investment practices. where private banks are usually in the hands of big businesses. and in the process maintain control of the company. there was also almost universal confidence that the economic growth would continue indefinitely. of which $64. $35 billion of Indonesia’s foreign debt owed to private foreign banks was about to mature in less than one year. as they had done so in the years before the crisis.5 billion was owed directly by corporations. most often to people who were close to the ruling regime. Vol. total private sector foreign debt stood at $72.38 Corporate Governance and Finance in East Asia. II By mid-1997. Controlling shareholders also prefer to use debts to finance expansion so as not to dilute their ownership. Since the Government could not afford to undertake these projects.5 billion. In many cases. Corporations were certain that they could roll over short-term loans when these fell due. and investing shares among nonfinancial companies within the group and in other groups’ companies. . There were cases where banks and borrowing companies were controlled by the same groups or families with strong political connections. Projects involving massive capital investments and long-term operating deals (in telecommunications. Families retain control by keeping the majority percentage of outstanding shares. Family-controlled corporations were generally structured as a complicated web of affiliates and associated companies. contracts were granted to the private sector. politicians. banks did not lend on the basis of the soundness of the project. They enhance their control over companies through cross-shareholdings. Collusion between big businesses and the political elite was widespread in Indonesia. This fact was usually not disclosed in financial statements. They ensure that commissioners represent their interests and maintain close relationships with the chairperson. toll roads. by setting up their own banks. and power generation) require huge capital. The ultimate control of the corporate sector rests in the hands of a small number of families who own groups of companies. This was often the case in the banking industry. partly because they used nominee accounts to register ownership rather than set up a holding company.
8 7. and Business Services Other Services GDP 1996 3. The average DER was found to be 1.0 2. 1996-1999 (percent) Sector Agriculture. when all sectors.2 (1.4) 2.8 1997 1. 53 companies reported negative equity of Rp6.3 Source: Central Bureau of Statistics (Biro Pusat Statistik. Livestock.6) (0. and Restaurants Transport and Communications Financial.4 7.7) 2.3 12. The consumer goods industry reported the lowest ROE.8 0. BPS).6 13.8) (11. real estate. Forestry.0) 1999 2.8) (13. and building construction.4 5.7) (2. Hotels.Chapter 1: Indonesia 39 1. and Fisheries Mining and Quarrying Manufacturing Electricity. followed by property. Most sectors showed significant increases in leverage.1) (26. much higher than the 307 percent registered in December 1997.52 trillion.5.4) (0.18 shows that growth in most sectors significantly fell in 1997. This continued in 1998.0 3.58 trillion (meaning their losses were greater than the paid-up capital).9 3. followed by the finance and trade sectors. Real Estate. posted negative growth rates. Sectors with lower ROE generally had higher DER.6 4. The construction sector was the worst hit.6 (36.2 Impact of the Financial Crisis on the Corporate and Banking Sectors Impact on the Corporate Sector Table 1.8 8. DER and ROE were calculated per sector. Only 86 companies reported profits. Using the financial statements as of 30 June 1998 of 161 publicly listed companies. Table 1. and Water Supply Construction Trade. and 128 companies reported a total loss of Rp46.0 5.3 11. except utilities.1 (1.4 7. as shown in Table 1.6 8.24 trillion for the first six months of 1998. indicating a rapid rise in . The JSX Monthly reported that total losses of 214 listed companies amounted to Rp39.370 percent.1 6.18 GDP Growth by Sector. Gas.7) (8.1) 1.6 12.1 5.2 8.6) (3.5) (18.7 1998 (0.7 6.0) (15.19.
Financial and banking analysts estimate that by September 1998.0 177. II Table 1.097. interest expenses rose as credit rates increased from 20 percent in early 1998 to 40 percent in mid-1999.2 (4.0 108.0 111. as shown in Table 1.1 30. The table also reveals that although private national banks dominated the banking sector in terms of assets and credits.7) 6.0 635.0 697.4) 18.0 105.2) (264.395.0 1. a Actual data for 1st semester only.4) 8.1 (5.0 177. but annualized to approximate full year values.0 1998 186.6) 15. foreign exchange losses came about with the use of unhedged foreign debt.0 1997 234.0) 10. rupiah values of dollar-denominated debts due to the weakening of the local currency and the rapid decline in equity because of losses. 1996-1998 (percent) DER Sector Agriculture Mining Basic Industry Miscellaneous Industry Consumer Goods Industry Property Infrastructure Finance Trade/Services Average 1996 104.0 2.7 1.370. Second.1 (92.8) 36. from only 8.8 17.0 97. The huge losses suffered by most companies were caused by three factors. private banks posted negative ROEs in the same year. losses in operation were due to declines in sales and increases in the cost of imported inputs.1 1.0) (78.4 (6.1 (3.1 (124.0 219.0 158.6 (11.2 13.625.0 229.0 65.0 307.5 percent in April 1998. This figure further increased to 47.40 Corporate Governance and Finance in East Asia. and would have kept on increasing if interest rates had not declined.0 191.0 92. Source: JSX Monthly. . the NPL ratio had reached more than 60 percent.0 a ROE 1996 1997 1998a 14.9 12.7 percent in July 1998. Impact on the Banking Sector Table 1. Vol.0 193. several publications. small foreign banks enjoyed the highest profits. First. Third.0 2.1) 7.0 631. the NPL ratio rose to 25.0 72.5 8.0 163.4 5.8 (373.271.0 205.0 1.21.2 23.6) (115.19 DER and ROE of Publicly Listed Companies by Sector.1) Note: DERs were calculated for only 161 companies (out of 214) that had positive equity.20 reveals that the banking sector’s ROE decreased significantly in 1997. As the rupiah weakened and interest rates increased.0 864. Mostly suffering from a liquidity squeeze.0 108.0 12.8 percent in 1996.0 1.3 7.
6 — 1. 227/1998 and October No. Source: Infobank.24 (4.2 1.45 21.25 22.Chapter 1: Indonesia 41 Table 1.3 361.86 11.21 Nonperforming Loans by Type of Bank.5 31.8 187. In July 1998.68 1996 1997 8.0 — 4.81 13.91 21.84 27.1 30.30 5.9 — 11. 1992 7.1 274.1 13.38) 11.8 8. however.5 128.44 15.47 20. 230/1998.24 15.69 14.50 9. 1992-1997 (percent) Type of Bank State-Owned Banks Foreign Banks Joint Venture Banks Regional Development Banks Private National Banks Total — = not available.6 6.8 11.7 106.0 — 32.5 2.9 Regional Foreign and Development Joint Venture Banks Banks — 9.34 16.2 10.7 — 1.7 Item Total Loans Dec 1996 July 1997 Dec 1997 July 1998 NPLs Dec 1996 July 1997 Dec 1997 July 1998 NPL Ratio (%) Dec 1996 July 1997 Dec 1997 July 1998 Total 331.0 129.5 222.28 5.3 445. private national banks overtook State-owned banks when their NPL ratio jumped to 57. coupled with negative spreads (deposit rate was higher than the credit rate).07 13.8 3. 1996-1998 (Rp trillion) State-Owned Banks — 140.7 29. State-owned banks initially had the highest NPL ratio.2 8.9 11.2 — 8.2 — 19.4 7.3 22.8 14.2 37.43 10.20 ROE of the Banking Sector.73 30.5 57. July No.3 Private National Banks — 179.7 — = not available.1 1.9 297.06 20.1 47.09 (11.20) Table 1.6 — 4.45 — 1993 15.15 20. Source: The National Banking Association. .37 19.07 1994 14.72 16.9 percent.67 8.7 4.70 1995 7.6 — 13.09 11.2 48.89 27. put pressure on the banking sector.2 8. The high and increasing NPLs.39 13.5 34.2 47.0 622.12 15.1 198.
Total amortization payments due on foreign debt in 1998 were placed at $32 billion (before restructuring). assembling the legal and policy framework to facilitate corporate restructuring. Unfortunately. few companies were in a position to resume interest payments. and Ciputra (property business).4 trillion of domestic debt and $6. by mid-September 1998. In November.5. Semen Cibinong (cement industry) became the first Indonesian company to resume paying part (25 percent) of the interest on its $1. such as Garuda (a national flag carrier). However.000 eligible firms had signed up for the scheme. a number of prominent companies. The scheme encourages negotiation between creditors and debtors. II 1. companies were not servicing their debts. By end-November. the committee launched the Jakarta Initiative. IBRA was formed to offer Mexican-style resolution for private sector foreign debt. the scheme failed.000/$1) in debt from domestic commercial banks. Astra International (automotive). have been subject to restructuring deals under the initiative.42 Corporate Governance and Finance in East Asia. a more comprehensive scheme to tackle domestic and foreign corporate debt. While the process of restructuring was in progress. none of the 2. Another option that companies could take under the Jakarta Initiative was debt restructuring via debt-to-equity swaps. Vol. particularly in terms of debt resolution. about 80 percent of which was private. The committee was tasked to ascertain the level of private corporate sector debts and arrange negotiations between debtors and creditors.3 Responses to the Crisis Corporate Restructuring Measures At the end of 1997. One premise of the initiative was that creditors should agree to a standstill for a certain period (creditors would desist from exercising their claims on a distressed company’s assets) to allow debtors to operate normally after obtaining fresh financing. Aside from being described as overly complicated.7 percent ($64. the corporate sector had more than Rp600 trillion ($75 billion at Rp8. The scheme offered a hedging facility against rupiah devaluations for restructuring agreements. More than two thirds of private debt was short-term and the average maturity of all private debt was estimated to be only 18 months. On 9 September 1998. Corporate debt accounted for 46. Since September 1998.7 billion of foreign exchange debt. In addition.2 billion debt. the Government and private sector formed a committee to help corporates deal with the crisis. Thus. only a . In June 1998.6 billion) of Indonesia’s total external debt in March 1998. the Jakarta Initiative Task Force had conducted negotiations for 52 companies with Rp2.
Astra International. Standard Chartered. limitations will be imposed on the ability of secured creditors to foreclose on their collateral during bankruptcy proceedings (as is provided for in the bankruptcy laws of most other countries). Debtors. focused on its core business of car and motorcycle manufacturing and sold off its subsidiaries in semiconductors. A Commercial Court was set up to handle corporate restructuring and debt settlements. with the requirement that adequate compensation and protection will be provided to such creditors during that period. Bank Bali agreed on a debt-to-equity swap with its creditor. Procedural rules are also being introduced to ensure certainty and transparency in the proceedings. who fail to reach agreements with creditors in out-of-court workouts under the Jakarta Initiative or fail to gain the requisite creditor support for the workout plan can resort to the Commercial Court. Protection against insider and fraudulent transactions taken by a debtor prior to the adjudication of bankruptcy will be enhanced. as well as general commercial disputes.e. mining.Chapter 1: Indonesia 43 few companies reached agreement with their creditors on this. Rabobank and Citibank. In the banking industry. Some listed companies with relatively “rich” shareholders decided to replace their loans with additional equity through rights issues and privileged subscription (limited offering). for equity infusion. Bank Niaga also negotiated with some of its creditors. some companies attempted to restructure their businesses on their own. Qualified professionals from the private sector will act as receivers and administrators in the management of estates of companies in bankruptcy or reorganization. The Commercial Court can be asked to hold off creditors and impose strict guidelines on the negotiating process . the companies’ financial performance deteriorated. Meanwhile. When credit from the banking sector became unavailable and interest rates increased significantly. a publicly listed company operating in the automotive industry. plantations. i. and sell noncore businesses or nonoperating assets.. lay off workers. especially in preventing unjustifiable delays in the adjudication of bankruptcy. For instance. Bankruptcy Reform The Bankruptcy Law was passed in August 1998. Astra International (automotive industry) and Bakrie Brothers (a holding company in several sectors) explored this option. Moreover. consolidate business units. forcing them to cut costs. aiming to modernize the bankruptcy system and promote the fair and expeditious resolution of commercial disputes. under which the latter would become one of the bank’s shareholders. and mining equipment.
(ii) the resolution of nonviable private banks. and recapitalization of state banks. . companies were allowed to sell shares only by issuing stock rights. the Government did not impose restrictions nor did it attempt to regulate capital flows. In the longer term. the measure had only a minimal impact. II to achieve liquidation of the company. The Government. the Capital Market Supervisory Agency allows companies to offer additional shares directly to the public. the Court’s early record has been a disappointment. The significance of a sound bankruptcy system cannot be understated as it provides a backdrop for negotiations in the workout and restructuring process against which parties often gauge their legal rights. with only 17 cases filed as of November 1998. collusion. Some companies simply decided not to pay their loans knowing that it would be difficult for creditors to take the case to court. in consultation with IMF and the World Bank. Banking Sector Reforms The Government’s banking sector reform strategy is focused on (i) government-assisted recapitalization programs for potentially viable private banks. since the market reflects the condition of the economy. reform. To push bankruptcy reforms. Rather. The Agency also allowed companies to buy back up to 10 percent of outstanding shares to improve the condition of the stock market. The Government has also been concerned with the issue of capital controls. There will be changes in the implementation of the bankruptcy law. it is envisaged that the Commercial Court will play a central role in modernizing the commercial legal system. Vol. including procedures for handling operational issues and processing bankruptcy cases. Realizing that they undermine investors’ confidence.44 Corporate Governance and Finance in East Asia. The bias in favor of debtors has retarded the pace of corporate restructuring. Previously. However. legislation against corruption. Capital Market Reform In the capital market. and (v) a strengthened banking supervision system. (iv) measures to recover liquidity support previously extended to troubled banks by Bank Indonesia. (iii) the merger. However. and nepotism (anti-KNN) was signed in 1999. is also reviewing the Bankruptcy Law. The Court has also declared only two companies bankrupt. the monitoring system for foreign exchange transactions will be strengthened to improve transparency and better assess the credit exposure of the corporate and banking sectors.
Conclusions. The four state banks (BDN. BBD.6. The importance of this legislation may need to be emphasized. Bank Indonesia has announced a recapitalization program for potentially viable private banks. and Bapindo) will be merged into one bank named Bank Mandiri. It has also drafted regulations to remove obstacles for converting debt to equity. The Company Law at present can be interpreted as severely limiting the scope for debt-equity swaps. Liquidity support given to troubled banks should be repaid in four years. merged.1 Summary. was enacted in 1999. depositors will be fully protected by the Government. improvement of rules and prudential regulations. 1. the Government has drafted a regulation providing tax neutrality for mergers and removing other tax disincentives for restructuring. A new central banking law. providing Bank Indonesia with substantially enhanced autonomy. regulations will need to be issued to permit debt-toequity swaps in the context of corporate restructuring plans. the Government established IBRA to supervise problem banks. and Recommendations Summary and Conclusions Corporate Ownership and Structure Most of Indonesia’s top conglomerates were established as family businesses. In October 1998. Some 175 groups that originated from family businesses controlled . The Bank Indonesia 21st package includes recapitalization. the Government required banks to be audited by international external auditors. Other Regulatory Reforms To push corporate restructuring further. Parliament approved amendments to the banking law that were geared toward strengthening the legal powers of IBRA and its AMU. or sold (after transferring NPLs to the AMU). The merger process will be finished within two years. and follow-up action on bank restructuring. However. Banks deemed ineligible for recapitalization will be closed. To obtain a clearer picture of the banking sector. The agency set up an Asset Management Unit (AMU) to directly manage problem loans of banks under its supervision. To overcome these problems.Chapter 1: Indonesia 45 In 1997. In particular. BEII. it is doubtful whether pure holding companies are able to enter into swaps.6 1.
7 percent. meanwhile. corporate debts grew over time. The restructuring and resolution of financial distress may. But because foreign creditors were reluctant to lend long term. On the one hand. The free capital flow system permitted the inflow of foreign capital to fuel the credit boom in the economy. when barriers to entry in the banking sector were lifted. The financial crisis created opportunities for addressing the inefficiencies in the legal and judicial system that supported corruption. not all of the conglomerate-affiliated companies are publicly listed. These banks also obtained cheap offshore funds. however. families control 67. However. banks were unwilling to provide credit to highly leveraged companies. However. conglomerates set up finance companies to bring in cheap foreign loans as these companies were not adequately regulated. As a result. Therefore. thus. Companies relied heavily on bank credit.1 percent of publicly listed companies in Indonesia. Foreign creditors. while a single family controlled 16. When the Government regulated the legal lending limit and the net open position of banks. conglomerates set up their own banks to serve as “cashiers” providing credit to companies within groups. Vol. Financing Patterns Controlling shareholders opted to use debts to finance expansion. put a significant amount of corporate assets of conglomerates in the hands of creditors or the Government. Among those listed in the Jakarta Stock Exchange. This study reveals that Indonesian listed companies with higher ownership concentration had higher levels of leverage. lacked the information necessary to allow them to assess projects’ risks and chances for success. II 53 percent of total assets of the top 300 Indonesian conglomerates. On average. the majority remains family-controlled.6 percent of the total stock market capitalization in 1996 and the top 15 families controlled 61. These figures show the extent of power wielded over the corporate sector by a small number of families. Rapid growth in investments masked the corporate sector’s increasing leverage. Indonesian companies borrowed short term. retain ownership control of companies.46 Corporate Governance and Finance in East Asia. allowing them to maintain their equity shares and. Companies preferred to borrow in dollars because interest rates of foreign loans were lower than for domestic loans and the exchange rate was relatively stable. this financing pattern supports the claim that family-based controlling shareholders relied on excessive borrowing to finance corporate expansion .
the high domestic interest rates that prevailed from 1998. financed by issuing nearly $80 billion worth of bank restructuring bonds.370 percent in 1998. followed by the property sector. The problem was in the maturity structure of its dollar-denominated debt and high debt-to-equity ratios in some sectors.21 trillion in 1996. The financial crisis led to the closure of several dozen banks. NPLs rose and capital adequacy ratios fell. the corporate sector was in quite good shape in terms of growth and profitability. the consumer goods industry was the worst hit.1 percent in 1997 to -124. As the rupiah weakened and interest rates increased. Impact of the Financial Crisis Prior to the crisis. and registered a net loss of Rp39. although at a declining rate. The Government and the private sector responded with measures to mitigate the negative effects. ROE dropped from 1. When the crisis hit Indonesia. Responses to the Crisis The impact of the financial crisis on the corporate sector was serious. facilitate debt restructuring.Chapter 1: Indonesia 47 without diluting their control. To restructure the corporate sector. Sales of conglomerates as well as those of publicly listed companies were increasing. corporate-initiated debt restructuring . the highly leveraged companies. the Government initiated corporate debt restructuring measures (Mexican-style foreign debt resolution and the Jakarta Initiative). and strengthen prudential regulations and supervision of the financial sector. Net profits of publicly listed companies had consistently been growing at an average rate of 20 percent each year. and the rapid decline in equity due to losses. The Government introduced reforms to improve bankruptcy procedures. were the most adversely affected. Meanwhile. Total profits of publicly listed companies dropped to Rp3.1 percent in 1998. DER increased to 307 percent in 1997 and further surged to 1. particularly those with large short-term foreign loans. At the height of the crisis. it also reflects the failure of the financial sector to channel funds to the corporate sector efficiently due to weak prudential regulation and supervision. Bank Indonesia extended emergency loans to many banks.1 trillion in 1997 from Rp13.24 trillion in the first half of 1998. On the other hand. The significant increases in leverage indicate a rapid rise in the rupiah value of debts due to the revaluation of dollar-denominated debts.
Amendments should include (i) empowering minority shareholders by raising the majority percentage of votes required on critical corporate decisions and mandating minimum representation of minority shareholders on the board. Vol. (ii) delineating the functions of the board of directors and commissioners. In particular. the legal system is less likely to evolve in a manner that will allow it to protect minority shareholders. the regulatory environment was not prepared to supervise the increasing number of banks and nonbank . and protecting creditors’ rights. but inadequate protection to minority shareholders from the dominance of large shareholders. Improving the Legal and Regulatory Framework for Bank Supervision After the liberalization of the financial sector.48 Corporate Governance and Finance in East Asia. Most companies claim to have adopted international standards of accounting and auditing procedures. Specific recommendations include protecting the rights of minority shareholders. The Corporate Law should be reviewed and amended in the context of pervasive control by large shareholders. improving the legal and regulatory framework for bank supervision. If the role of a limited number of families in the corporate sector is so large and the Government is either heavily involved in or influenced by business. and (iii) strengthening transparency and disclosure requirements. 1. but it is not clear whether in practice these standards are in place. cost cutting and business consolidation) and acquisitions by creditors or foreign investors through debt-to-equity swaps and equity infusions..g.6. minority shareholders have not been able to oppose controlling shareholders’ decisions to invest in unprofitable projects financed by unhedged foreign currency debts.2 Policy Recommendations The Government should introduce measures to address the weaknesses in corporate governance identified in this study. Protecting Minority Shareholders’ Rights The Corporate Law provides sufficient rights and protection for all shareholders. II measures included internal business restructuring (e. The Government should ensure that all laws and regulations are effectively enforced.
the Republic of Korea and Thailand were more successful in getting foreign creditors to collectively solve their problems during the crisis. Protecting Creditors’ Rights To protect creditors’ rights. with necessary legal sanctions for violations. it is likely that future private financial flows for the corporate sector will continue to conform to a short-term structure. Further. orderly restructuring.Chapter 1: Indonesia 49 financial institutions. This is a significant factor in . the Court has been slow and ineffective in processing bankruptcy suits. the banking regulatory framework was inadequate in regulating banks’ dealings with affiliated nonfinancial companies. Banks should be required to provide data on such transactions and charged penalties for noncompliance. The regulatory framework was also weak in supervising and monitoring foreign transactions. the Government lost monitoring and control powers over foreign fund flows. When finance companies were used to channel offshore loans in lieu of commercial banks. Because these banks are neither easily convinced nor compelled to submit their claims to the jurisdiction of Indonesian commercial and bankruptcy courts. In the first place. With credit being coursed through the domestic banking system rather than directly to numerous local corporations. the Indonesian corporate sector directly owes an inordinate amount and a greater portion of its loans to foreign banks. The ownership of banks (including finance companies) by shareholders of nonfinancial companies undermined the capability of these banks to conduct prudential credit management. recapitalization. The tendency of foreign creditors to lend short term is a problem that must be confronted once private capital flows to Indonesia recover. The Government should also continue strengthening the monitoring system for foreign exchange transactions. The Central Bank needs to monitor and control dealings by banks within business groups and improve enforcement methods to prevent circumvention of prudential regulations. Consequently. One way is to set limits on lending activities by banks to affiliated nonfinancial companies. it has been difficult to implement standstills. a new bankruptcy law was passed in the aftermath of the crisis and a Commercial Court was set up to deal with bankruptcy cases. in contrast to the Republic of Korea and Thailand. most of banks’ NPLs resulted from credit to companies within the same group. However. Because foreign creditors are faced with more information asymmetries than domestic creditors. and liquidation of corporate assets.
Only when creditors have the confidence that their rights are protected will they resume financing companies. Vol. II explaining the greater depth of the crisis in Indonesia. . The Bankruptcy Law should thus be reinforced and creative means should be introduced to avoid a prolonged and costly paralysis of corporate activity and financing. despite the smaller level of capital inflows (as a percentage of GDP).50 Corporate Governance and Finance in East Asia.
The Impact of Acquisition to Shareholders Wealth: Comparison Between Internal and External Acquisition. Indonesian Business Data Centre. and Larry H. Unpublished thesis MMUGM. University of Maryland. Economy of Indonesia. Forest. and M. Corporate Governance: Responsibilities. Claessens. 1995. The Private Debt Anatomy. P. Who Controls East Asian Corporations? Financial Economics Unit. Manuscript. JSX Monthly Statistics. Wright. John Wiley and Sons. The Economist Intelligence Unit. 14 May 1999. Bank Indonesia. 1997.. Institute for Economic and Financial Research. and Remuneration. Risks. World Bank. 1998. John Wiley and Sons. Center for International Business Education and Research. various publications. Indonesia: Sustaining Manufactured Export Growth. . Embassy of Indonesia. various publications. Indonesian Capital Market Directory 1992-1998. Indonesian Business Data Centre.Chapter 1: Indonesia 51 References ADB Programs Department (East). Indonesia Country Report. Conny Tjandra Rahardja. 1997. Working Paper #58. Indonesia Country Profile. Jakarta Stock Exchange. 1999. K. Lang. Keasey. Stijn. 1998. Economic and Financial Statistics. various publications. Letter of Intent of the Government of Indonesia to the IMF. Financial Sector Practice Department. Jonathan. Michael Krill. and Richard Turtil. 1995. 1996. Indonesian Central Bureau of Statistics. The Economist Intelligence Unit. 1999. Embassy of Indonesia Homepage. 1996. P. Large and Medium Manufacturing Statistics. Conglomeration Indonesia: Regeneration and Transformation into World Class Corporate Entities. Yogyakarta. Indonesia: An Emerging Market. various publications. Asia in Crisis: The Implosion of the Banking and Finance System. F. Delhaise. Maryland. Simeon Djankov.
A national consensus is emerging that a democratic system based on free market principles should be firmly established to promote more intense competition in every sector of the economy. the Republic of Korea. and David Webb of the London School of Economics for their guidance and supervision in conducting the study. The country’s winners would then emerge based only on economic efficiency. . Korea) in November of that year. Department of Economics.2 Republic of Korea Kwang S. It had been the norm in Korea to conduct business based on political and administrative favoritism rather than on competitive merits. Further. internal control mechanisms. 1 Professors. Chung and Yen Kyun Wang1 2. The extent of inefficient investment can be seen from the fact that more than 70 percent of listed firms had negative economic value added (EVA) before the crisis while those with positive EVA declined (Table 2. Inefficient investment coupled with excessive financial leverage was found to be at the root of the economic crisis at the corporate level. both of ADB. the Korea Stock Exchange for its help and support in conducting company surveys. Business managers and controlling shareholders were maximizing firm size at the expense of profits. the Government and business sector had good reason to reflect on the causes of the crisis. markets. and Graham Dwyer for his editorial assistance. Chung-Ang University. Poor corporate governance and political and government intervention in the business and financial sectors are widely viewed as contributory factors.1 Introduction The economic crisis that began in Thailand and swept through Asia starting in the summer of 1997 hit the Republic of Korea (henceforth. This has been the crux of the corporate governance problem in Korea. Seoul. David Edwards. or capital market discipline. banks as major creditors had governance problems of their own and failed to monitor or exercise the control rights generally afforded to lenders via loan agreements. and curtailing of morally hazardous behavior that has been prevalent among economic decision makers. a practice that was not checked by creditors. timely exit of poor performers from the market.1). As the Korean currency. and corporates were sent reeling. The authors wish to thank Juzhong Zhuang.
accountability of controlling shareholders and boards of directors. This broad perspective can help clarify the ongoing reform efforts of businesses and the Government. Copeland. June 1999.5 Note: The EVAs are calculated as: EVA = NOPAT – WACC. Weaknesses in the overall corporate governance system in Korea had many ramifications. Source: Korea Stock Exchange. aiming to identify the areas in need of further reform and to provide policy recommendations for improved corporate governance. II Table 2. capital market discipline. . The total number of respondents was 81 out of about 550 nonfinancial firms listed on the Exchange.1 1998 490 164 33. Dividend payments were at less than 2 percent annually as opposed to the double-digit interest rates in the past decades. where NOPAT is the net operating profit after taxes and WACC is the weighted average cost of capital multiplied by invested capital.4 1993 513 174 33. Self-dealings by controlling shareholders—crosssubsidization and cross-guarantees among member firms within a chaebol (a conglomerate/large business group)—and the lack of transparency hindered the development of an efficient capital market capable of mobilizing low-cost equity funds. 1992-1998 Item Total Number of Firms Firms with Positive EVA Percentage of Firms with Positive EVA 1992 508 180 35.1 Listed Firms with Positive Economic Value Added. Many firms left some questions unanswered. Government reform goals for the corporate sector include enhancement of corporate transparency. and improvement of bankruptcy procedures. which distributed and collected the questionnaire. Koller. Vol. and J Murrin (1995). and individual companies. Restructuring efforts have focused on reduction in the degree of business diversification and in the financial leverage of large-sized firms.1 1996 561 163 29. This study collects and analyzes data on the Korean economy. T. This study also reviews the legal and 2 The survey was conducted mainly through the Korea Stock Exchange. especially chaebols. A survey was conducted for the nonfinancial listed companies using a questionnaire developed by the Asian Development Bank (ADB)2 to supplement official data.1 1997 518 104 20.9 1994 531 165 31. Inefficient investment undermined the competitiveness of Korean firms in the global marketplace.1 1995 560 163 29.54 Corporate Governance and Finance in East Asia. the corporate sector. The EVAs are the same as the economic profit as explained in T.
creditors. 3 The review of historical development of the Korean economy draws substantially from the book by Sohn. Section 2. Section 2. and naturally adopted an import substitution policy.6 discusses responses of the Government and the business sector and explains in detail their reform and restructuring efforts. The evolution of the modern Korean economy can be divided into four periods.2. clothing.1 Overview of the Corporate Sector Historical Development3 The development of the Korean corporate sector is closely related to the progress of the economy.4 contains analyses of corporate financing and its relationship to performance. Import Substitution: 1948-1961 The Korean War (1950-1953) devastated Korea’s industrial capacity. and other necessities domestically.Chapter 2: Korea 55 regulatory framework for the corporate sector and reform measures taken after the crisis. Major economic indicators for some of these periods are shown in Table 2. reviewing government policies responsible for the development of the modern corporate sector. This chapter is composed of six sections.2. The Government tried to produce food. which account for a substantial portion of the Korean economy. and employees and their role in shaping corporate governance practices. the Government relied heavily on aid from the United States (US) and United Nations to alleviate poverty and high inflation. In the period 19481961. It traces the country’s economic development. It reviews such elements as shareholders’ rights. Yang. and Yim (1998). It then presents recommendations for further reform in corporate governance and financing.2 presents an overview of the corporate sector.2 2. Section 2. the import liberalization rate was below 7 percent and the average tariff rate was in the range of 25 to 30 percent. 2. Section 2. From 1948 to 1961. the board of directors system. Section 2.3 identifies characteristics of corporate governance by analyzing the ownership structures and control patterns of listed companies and the largest chaebols.5 describes the state of the corporate sector in the financial crisis and draws on the results of the foregoing sections to outline the causes of the crisis. . corporate control by the Government.
102.855.4 10.0) (297. the Government redirected the policy focus away from import substitution to an export-led manufacturing-based economy.2 1.7 37.8 12. the Government called for an unprecedented average annual economic growth rate of 7. and inconsistent economic policies.2 1980-1989 8.1 35.5 250.1a 21. IMF.5) 8. II Table 2. The Government tried .1 15.7c 11.4 1990-1997 7.0 27.56 Corporate Governance and Finance in East Asia. unless otherwise indicated) Indicator GNP Growth Rate Inflation Rate Savings Rate Investment Rate Manufacturing/GDP Interest Rate on Time Depositse Exchange Rate (won/$) Export Growth Rate Import Growth Rate Trade Balance (million $) Current Account (million $) Capital Account (million $) 1962-1971 1972-1979 8.1 — = not available.4 24.7 30. e For maturities of one year or more. c Refers to 1989.8 24. Export Drive: 1962-1971 Between 1962 and 1971.8 15.4 29.1 percent with moderate rates of inflation and introduced a series of reform packages aimed at developing key industries. However.6 11.4 (1.9 — — 21.1d 9. a Refers to 1971. and large current account deficits.265.2 Key Macroeconomic Indicators Annual Average (percent.1 29. the Government was not successful in solving the problems of slow growth.332.2 314.0 41.1 9. In 1961 it devalued the won from W65 to W130/dollar and announced its first Five-Year Economic Development Plan (1962-1966).2 452. high unemployment and inflation.2 31.2 757.2 30.3 8. In the Plan.9) 1. b Refers to 1979. Source: Bank of Korea.8 (8. lack of strong drive.5) (1.753. International Financial Statistics. Vol.9b 15.8 (724.4 29. Economic Statistics Yearbook.447.9 794.949. d Refers to 1997. Large amounts of aid in the form of agricultural goods from the US kept prices of local goods low and discouraged efforts to increase agricultural production.0) 492.2 32.5 38. largely because of political instability. and implementing new budget and tax measures. modernizing the industrial structure. This goal required very high savings and investment rates.9) (7.7 14.2 6.
In 1964. The exchange rate system was a kind of crawling peg until 1974. Bank deposits increased rapidly. a modest improvement over the 4. due to continuous current account deficits. the Government tried to provide exporting firms with a free trade environment. and maximizing mobilization of domestic savings on the other.5 percent. But the liberalization trend turned out to be short lived as current account deficits continued. The positive list system for imports was replaced with a negative list that indicated only those items that could not be imported. These were considerably liberalized in 1967 when Korea joined the General Agreement on Tariffs and Trade (GATT). the Government changed the multiple and fixed exchange rate system to a unitary floating exchange rate system. The well-educated. Exports increased sharply from $41 million in 1961 to $2. the Government undertook important economic reforms in two areas: the foreign exchange rate and the interest rate.4 percent. Also. and almost doubled the foreign exchange rate from W130/dollar to W256/dollar to enhance the international competitiveness of exports. The average growth rate of the economy from 1960 to 1964 was 5.3 percent average between 1954 and 1959. the growth of gross domestic product (GDP) raised domestic savings. In 1971. Korea normalized political and economic relations with Japan to encourage inflows of Japanese capital that could finance big development projects. In 1965 the interest rate on one-year deposits doubled from 15 to 30 percent. boosting internal investment resources. resulting in high real interest rates. which laid a solid foundation for a steady growth path. During the first five-year plan period. The Government abolished temporary direct subsidy measures and introduced a new comprehensive export promotion system. This change raised the import liberalization rate from 9.2 billion in 1972. In 1963-1964. and cheap labor force was well utilized by the export-led growth strategy.3 percent to 60. . The interest rate reform enabled banks to allocate large funds to the industrial sector and reduced the high inflationary pressure that had built up in the economy. channeling funds from curb markets into the banking sector. imports of consumer goods and luxury items were highly restricted. but tariff rates were raised to 40 percent in the 1960s. up from 30 percent in the late 1950s. However.Chapter 2: Korea 57 to meet its targets by borrowing large amounts of foreign capital on the one hand. but the average growth rate for 1965-1969 shot up to 10 percent. the import liberalization rate was 55 percent. while the average tariff rate was 39 percent. abundant. During this period.
becoming a seed of the economic crisis in 1997. investing a total of $9. By promoting HCIs. The Government targeted six industries—steel. There were three reasons for the switch: first. It promoted HCIs by supplying massive capital for construction and development. electronics. faced the danger of bankruptcy. The Government took emergency measures. the Government felt that continuous trade deficits arising from increasing intermediate and capital goods imports could be prevented by developing import substitution industries. shipbuilding. These included rescheduling business debts.6 billion between 1973 and 1981 into these sectors. The Government encouraged a variety of business projects. and chemicals—as future core industries. machinery (including automobiles). and giving low interest rate loans to banks from the central bank. and allocating virtually unlimited amounts of credit at below-market rates while controlling the financial system. The HCI promotion policy was much more comprehensive than past economic development plans. One industrial policy adopted during the heavy and chemical industrialization drive was administered credit rationing. less developed countries forced Korea to adjust its industrial structure. and assigned them to specific chaebols. In 1972. The Government has since used similar emergency rescue measures for large businesses and banks almost once every 10 years. It included a detailed construction and investment schedule over a 10-year time frame and mandated coercive implementation. These practices contained an implicit government guarantee that large businesses and banks could never fail.58 Corporate Governance and Finance in East Asia. II Heavy and Chemical Industry Promotion: 1972-1979 In the Third Five-Year Economic Development Plan (1972-1976). this new strategy had the Government explicitly allocating credit only to those firms deemed vital to HCIs in the form of below-market interest rates . the Government changed its industrial policy emphasis from light industries to heavy and chemical industries (HCIs). where preferential export credit was given to almost every exporter. Unlike the previous system. Vol. reducing or exempting debts of farmers and fishermen. it tried to substitute imports and export high value-added HCI products. This strategy formally took off with the announcement of the HCI Promotion Plan in June 1973. Third. nonferrous metal. announcing rescue packages for businesses and banks. the domestic economy was stagnant and many businesses. the emergence of competition of other low-wage. Second. in the face of a world economic slump. overburdened with debts and high interest rates. the Government felt the need to strengthen the defense industry.
However. Firms that followed the Government expanded greatly. Korea recorded current account surpluses and rapid economic growth due to the “three lows”: low value of the US dollar. especially between 1979 and 1985. the Government restructured some large businesses through forced liquidation and M&As. and the large excess capacity of HCIs. various measures to increase competition were taken. however. The plan of the 1970s was thought to be successful in the long run. faced with high inflation. Cheap credit and distorted prices resulted in overexpansion in the HCIs. Meanwhile. fiscal expenditure maintained zero growth. The growth rate of the money supply was reduced drastically. The industrial and trade policy resulted in high inflation in the 1970s and serious excess capacity problems by 1979. since during the second half of the1980s many of the promoted firms became world-class competitors and exporters. In 1986-1989. with many turning into the now well-known chaebols. including denationalization of banks.2). Meanwhile. and the won depreciated by 20 percent with the adoption of a Basket-Currency Gliding System in 1980. Such an approach gave the Government increased control over the economy. This required industrial restructuring by the Government. coupled with political uncertainty due to the assassination of President Park in 1979. low . Gross national product (GNP) growth rates on average were higher in the 1972-1979 compared to 1962-1971 (Table 2. The incentives available became more market-based. a heavy foreign debt burden. the Government adopted comprehensive measures to promote economic stabilization.Chapter 2: Korea 59 through state-controlled banks. imports were further liberalized while tariff rates were lowered. and their utilization ratios were very high. Evaluations of HCI promotion policies are mixed. In order to improve economic efficiency. exacerbated the overcapacity problem. including forced liquidations and mergers and acquisitions (M&As). such as widespread underutilization of capacities of HCIs and related plants. The severe world recession caused by the second oil shock. met increased difficulty. price controls were abolished. light manufacturing and service industries were weakened by disadvantages such as a lack of credit. The two important ones were import liberalization and deregulation of the financial sector. as it had to control only a few large chaebols. Economic Liberalization and Globalization: 1980-1997 In 1979. New start-up firms. the policy wasted substantial amounts of resources in the short and medium terms. Macroeconomic policies became hostages of the industrial strategy.
Vol. The Government tried to adjust economic policies and regulations to meet global standards. which gradually widened. 46. the importance of chaebols was increasing. The official rate fluctuated within a band.2. the import liberalization ratio reached 98.9 percent. 4. with the 30 largest in the total economy in 1997 standing as follows: value-added. further increasing its pace of import liberalization. the Government committed itself to further liberalization of the goods and capital markets. whose business activities are controlled by an identical person. and low oil prices. and total workforce. while continuous and large current account surpluses saved Korea from the foreign debt problem. The birth of chaebols can be traced to the selling of Japanese colonial properties that were reverted to the Korean Government after World 4 The historical review of chaebols draws substantially from the paper of Lee and Lee (1996). total debts. . but it chose to liberalize gradually. By joining the Organisation for Economic Co-operation and Development (OECD) in December 1996.” A large-scale business group is called a chaebol.3 percent. Korea began participating in many multilateral trade negotiations during the Uruguay Round. Korea became a signatory country to the International Monetary Fund (IMF) Article VIII.9 percent. The most important element characterizing chaebols is the concentration of ownership. total assets. 45. 2. The low value of the dollar led to a low won and high yen. 13. 47. Korea abolished remaining direct subsidy systems for export activities as well as some traditionally managed trade systems. where particular individuals and their family have de facto control of the management of all subsidiary companies of groups. II world interest rates. Industrial and trade policies were modified to be consistent with WTO. Korea adopted a market average exchange rate system. In 1993.60 Corporate Governance and Finance in East Asia. In 1988. total sales. and declaring that it would follow Article XI of GATT. Meanwhile. and acceded to the World Trade Organization (WTO) in 1994.2 Rise of the Large Business Groups (Chaebols)4 The Korean Fair Trade Act defines a business group as “a group of companies. joined the Asia Pacific Economic Cooperation (APEC) Group in 1993. in which the official rate for the day would be based on the interbank transaction volume-weighted average of rates of the previous business day.1 percent and average tariff rates 8.1 percent.9 percent. In 1990. giving up its foreign exchange controls related to the current account.2 percent.
In this sense.1 20.3 shows that the number of subsidiaries of the 30 largest chaebols increased considerably since 1993. the ownership and management of a chaebol’s subsidiaries are not separate. of Subsidiaries per Chaebol 20. However. This galvanized the fast growth of chaebols. From the standpoint of the Government. Since the Government controlled most business activities. This policy contributed greatly to the expansion of chaebols. Large-scale companies owned by the Japanese were sold to individuals under preferential terms and later enjoyed a relatively favorable position for accumulating capital. Subsidiary companies of chaebols are subject to “fleet-type management” in that they are controlled by the overall managerial system of chaebols.5 20. Important managerial decisions are made primarily by owners. 1993-1996 Year 1993 1994 1995 1996 No. One reason for this controlling power is inter-company shareholding among subsidiaries.3 Subsidiaries of the 30 Largest Chaebols.Chapter 2: Korea 61 War II. of Subsidiaries 604 616 623 669 Average No. The Government provided financial and fiscal incentives to chaebols and trading companies with relatively abundant financial resources. Since the 1960s. the Korean Government has set the national goals of economic development and offered all kinds of support and incentives to achieve them. the number of subsidiaries declined drastically due to corporate restructuring.when the Government put a great deal of emphasis on development of the HCIs. In the mid-1970s. and they are aided and supported by one another. reaching 669 in 1996. Table 2. after the financial crisis. financial assistance. large-scale businesses and chaebols were thought to be appropriate actors because they could meet the huge investment requirements of these industries.8 22. it was more effective to deal with a small number of companies to secure tangible outcomes. Chaebols are also excessively diversified. . The Government provided subsidies. Chaebols have a history of substantial concentration of ownership. chaebols that maintained a close relationship with the political authorities were able to grow fast. Table 2.3 Source: The Fair Trade Commission. and tax breaks to key industries to promote exports and industrial upgrading.
For example. and were allowed extra depreciation charges for tax purposes. they can reduce uncertainties and dilute risks through sharing of information and diversification. if a chaebol has an unsound financial structure but strong financial links through mutual payment guarantees among their subsidiaries. Under this law. However. This law was in effect until 1987 when it was partly absorbed into the Capital Market Development Act. Another law that contributed to the development of the stock market was the Act to Expedite the Going Public of Corporations of 1972. diversification can make chaebols stable through the portfolio effect. the Government’s efforts to develop the stock market culminated in the Capital Market Development Act of 1968.3 Role of the Capital Market and Foreign Capital In the 1960s. which may ultimately lead to the decline of social efficiency. The law also allowed employees of listed firms to get 20 percent of the subscription rights in offerings of new shares. They had to meet certain requirements in terms of firm size. including the “economies of organizational size” inherent in multi-product and multiplant firms. the Government reviewed the financial performance of companies and recommended (or ordered) selected ones to go public. profitability. Related to this is the tendency of chaebols to assist unprofitable firms at the expense of profitable ones. . 2. On the other hand. Since chaebols are engaged in many different businesses. The law also contained provisions to afford tax and other benefits to firms that went public and to impose tax-related penalties on those that refused to comply with government recommendations. years since establishment. chaebols can benefit from synergies.62 Corporate Governance and Finance in East Asia. Meanwhile. Diversification may raise chaebol profitability but could also work to eliminate more efficient competitors because bigger chaebols have a higher capability to enforce unfair methods of competition. listed companies enjoyed corporate tax rates that were 10 to 20 percentage points lower than those imposed on privately held firms. internalization of the market that could enhance the internal efficiency of a chaebol may close the market to other firms. II Theoretically. Vol. etc. the bankruptcy of one or a few marginal subsidiaries could lead to a chain of bankruptcies for the entire chaebol. there are many negative assessments of organizational structures and practices of chaebols. In the early years after the enactment of the law.2. This could ensure their stable growth and enhance their investment abilities. in addition to the usual economies of scale.
570 95.6 Year 1985 1989 1990 1994 1995 1996 1997 1998 Source: Monthly Review (Securities Supervisory Board) and the Financial Supervisory Service.1 Market Capitalization (W billion) 6.9 34.6 747.4 40. Because of government policies and the booming economy. Third.4 654.7 934. of Listed Firms 342 626 669 699 721 760 776 748 Stock Price Index 138.1 16.4 Development of the Stock Market. This reversal in policy reflected declining stock prices and was generally maintained until the outbreak of the economic crisis in 1997. the stock market grew rapidly during the 1980s. Also that year.0 965.5 406.Chapter 2: Korea 63 During the 1980s and 1990s. the number of firms listed on the Korea Stock Exchange almost doubled in the five-year period from 1985 (342 firms) to 1990 (669 firms). was established to invest in domestic shares beginning in September 1985. the Government attempted to stabilize the stock market by limiting IPOs and share issues by listed companies.2 44. .9 918. The Korea Fund. Inc. Second.476 79. the Government announced measures to increase the demand for shares by providing tax and financial incentives to individual investors.0 79. The policy to expand the size of the stock market.. Beginning 1990. a country fund. however.151 117.0 49. in 1986 the Government imposed limits to bond issues on firms that were recommended to go public but refused.1 30.020 151.217 141. First. especially those paying small or no dividends. The aggregate Table 2.370 70.989 137.9 833. the Government announced the gradual opening of the capital market to foreign investors in January 1981. mainly by increasing the supply of shares by initial public offerings (IPOs) and seasoned issues.798 Market Capitalization as a Ratio to GDP (%) 8. continued until 1989. several important policy measures were implemented to promote the development of the stock market. 1985-1998 No.4. Korean firms were allowed for the first time to issue in international financial markets equity-related securities such as convertible bonds (CBs) and depository receipts. As shown in Table 2. In this regard.
338 4. and stayed at the 30-40 percent level up to 1996.5 shows net FDI—inward investments by foreigners less outward investments by Koreans—in the period 1985-1998. The relative size of the stock market diminished to 44 percent in 1990.287 (340) 73. Korean companies borrowed substantial amounts of foreign capital due to the excess of investments over savings and chronic current account deficits—except in the period 1986-1989.924 (1.785 (1.085 2.017) 1.382 Permit basis.953 10.942) 42.352 471 3.742 (3.239 19.59 percent in 1998 and to more than 50 percent in the early months of 1999.255 2.553 8.126 (1.542) (1. currency and deposits.870) (1.150 5.944) 8.339) (9.183 12.149 13. The growth in the number of listed firms also slowed in the 1990s. and other liabilities.001 4. Bank of Korea.642 21. . due to declining stock prices. However.326 1.440 1.737 (333) (297) (607) (2) 218 2.875 21.450 24.858 4.64 Corporate Governance and Finance in East Asia. II market value of all listed firms represented only 8 percent of GDP in 1985. and 1993.910) 2.123 3.650 (1.453 (2.86 percent of GDP in 1997.413) 56.583 25 10. Source: Balance of Payments.5 Private Capital Flows to Korea. Vol. The number shrank for the first time in 1998 to 748 firms from 776 the previous year. foreign direct investment (FDI) has been very small relative to GDP and compared to other East Asian countries.714 1. The reasons for the decline include increases in bankruptcies and mergers involving listed companies since the outbreak of the economic crisis.546 (2.571 2.2 percent by 1989.658) (3. The aggregate market value of listed shares bottomed at 16.347 3. trade credits.141 4. Table 2.817 16.433) (9.455) 13. Table 2. but increased sharply to 79.296) (6.534) 1.868 (518) (418) 63 1.264) (3. Other investments include loans.694) 2. 1985-1998 ($ million) Year Net FDIa Portfolio Investments Other Investmentsb Of Which Loans Trade Credits 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 Total a b 313 (9) 696 809 147 (808) (115) (311) (832) (2.800 (7.008) (3.852) (2. but rose again to 34.500 7.414) 5.
The same categories will be analyzed in later sections. but between 1988 and 1993. following the sharp depreciation of the won. but dropped in 1996 and were negative by 1997. Japan’s was consistently higher. other net private capital inflows amounted to $130 billion during 1985-1998. (ii) listed firms. portfolio investments amounted to $73. 2. and (iii) chaebols.7 billion and loans $42. Of this. In addition to FDI. The debt-to-equity ratio (DER) averaged 311 percent for the period 1990-1996 and peaked at 424.4 Growth and Financial Performance This section looks at the performance of (i) the aggregate corporate sector. increasing to 76 percent in 1997.2. Table 2.7 compares the ratio of ordinary income to sales of Korea’s manufacturing sector with those of Japan. The Aggregate Corporate Sector The aggregate corporate sector in this study excludes the financial sector.9 billion.Chapter 2: Korea 65 Complicated government regulations.China. the growth rates of equity and sales dropped sharply in 1996 and 1997. Net private capital inflow. excluding FDI. However. weak incentives for attracting FDI. Large amounts of outward investment by Koreans in the mid-1990s arose out of increased liberalization of foreign exchange regulations. The ratio is generally in the same range for Japan and Korea. The contribution of the corporate sector to GDP was 73. increased substantially in 1994-1996 due to accelerated liberalization of capital movements (Table 2. and sales of the aggregate sector during this period were very high (Table 2. and US. Between 1986 and 1989.2 percent in 1987. Taipei.5).6 percent in 1997. The dismal performance of the Korean corporate sector compared to the . Corporate sector net proft margins increased from 1993 to 1995. and high production costs were the main reasons for low FDI in Korea. Profit rates of Korean firms were relatively low compared to those of Taipei. equity. This indicates that a substantial proportion of debt was denominated in dollars. The growth rates of total assets. Korea had substantial current account surpluses and experienced net private capital outflow. Return on equity (ROE) and return on assets (ROA) showed similar patterns. This would lay the foundation for evaluating the effect of corporate governance on performance.6).China and the US.
6 424.1 2.4 2.9 4. Ordinary income = operating income + nonoperating income (from financial activities) – nonoperating expenses (from financial activities).4 2.0 10.3 14.6 318.3 21.8 8. .5 7.4 — 6.9 8.8 21. Table 2.3) 5.2 13.6 1.8 3. Note: Ratio of ordinary income to sales = (ordinary income/sales).0 13. Net profit margin = ratio of net income to sales.3 11.3 6.1 2. Source: Bank of Korea.3 335.3 17.4 2. 1990-1997 (percent) Growth Performance Year Total Assets Equity Sales Financial Performance Net Profit Margin DER ROE ROA 1990 1991 1992 1993 1994 1995 1996 1997 23.9 18.6 1.0 8.5 1.4 19.3 3.0 305.8 1.7 1.2) (0.0 6.7 International Comparison of Ratios of Ordinary Income to Sales in Manufacturing (percent) Year Korea US Japan Taipei.0 7. ROE = return on equity (ratio of net income to stockholders’ equity).3 308.6 (4.5 2.5 1.4 1.9 16. Source: Bank of Korea.9 2.7 15.3 21.1 — — — = not available.1 6.0 4.1 2.2 1.5 3.3 312.9 3.6 3.9 2.3 — 3.7 3.4 1.6 Growth and Financial Performance of the Nonfinancial Corporate Sector.5 4.6 4.5 0.2 18.Table 2.7 3.9 13.9 16. Financial Statement Analysis Yearbook.7 4.7 4.2 19.5 1. Financial Statement Analysis Yearbook.5 (0.0 (0.9 3.0 3.9 2.0 13.8) 297.China 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 2.2 13.7 4.8 22.9) DER = debt-to-equity ratio.1 5.9 5.7 2.0 0.4 4.6 2.5 4.2 1.9 5. ROA = return on assets (ratio of net income to total assets).4 10.1 8.6 9.2 1.8 1.6 13.4 1.3 1.7 325.7 15.9 5.9 18.2 9.8 2.
In most years. . ROEs. Profit rates of most industries are also quite low.6). with equity in wholesale and retail trade even contracting.4 percent.and small-scale firms (Table 2. The superior performance of listed firms in terms of sales growth may be due to large firms’ easy access to credit and the inclusion of financial firms in the listed firms category. the sales growth of listed firms was higher than that of the aggregate sector (see Table 2. and transport sectors recorded negative profit rates in 1997. The other financial ratios follow the general pattern of the aggregate corporate sector. this may be an indication of the bias toward large firms in terms of access to credit. The growth performance of large firms for the 1988-1997 period was better than that of medium. A comparison of performance by firm size reveals some interesting results. This may be related to its having the lowest DER. while their average net profit margin was lower than that of medium firms. It is notable that the construction sector’s profit rate began its decline in 1995. a year ahead of the other industries. Net profit margins. However. with the wholesale and retail trade sector and the construction sector having the highest figures. sales of listed firms grew 18. Profit rates of different industries also mirrored the downward trend of the aggregate corporate sector prior to the crisis.10). All sectors experienced a sharp decline in equity and sales growth in 1997. and steam supply industry. construction. the exception being the electricity. Again. Small listed firms were hardest hit by the financial crisis.8).Chapter 2: Korea 67 other three economies can be attributed to the emphasis on growth in sales and market shares rather than on profits. both ROA and ROE were lower for the listed firms compared to the latter. but higher than that of small firms. followed by mediumsized firms and large ones. This preference of Korean firms has its roots in the structure of corporate governance. However. Growth rates of total assets are generally high. the average ROE was lowest for large firms.5 percent while the aggregate sector recorded only 13. trade. gas. Listed Companies The number of listed firms increased from 334 in 1985 to 775 in 1997 (Table 2. The profit margin of listed firms was generally higher than that of the aggregate corporate sector. The manufacturing. In 1997. and ROAs of all listed firms declined substantially in 1996 and turned negative in 1997.9). Performance followed similar patterns across different industries (Table 2.
6 17.9 16.8 526.5 5.5 5.0 5.4 12.0 254.3 1.3 2.5 1.6 5.8 24.8 24.4 2.4 0.5 306.8 1.9 538.6 0.4 5.Table 2.6 6.8 35.6 1.4 3.8 302.4 1.3 14.8 562.5 (1.6 2.1 0.3 8.0 5.8 22.2) 6.0) 1.1 10.4 .1 22.4 10.8 3.3 15.0 16.5 3.5 19.6 14.1 (0.7 9.8 7.2 0.4 2.5 (5.4 2.8 345.6 655.5 473.0 22.0 2.2 423.1 17.4 5.6) 3.9 16.9 5.0 1.3 15.0 1.1 0.7 0.5 1.3) (1.7 22.9 428.0 15.8 12.5 1.0 2.4 14.0 9.4 (0.3 8.3 8.5 270.3 15.6 3.2 7.7) 2.7 (3.0 18.2 6.2 5.3 10.3 18.2 5.7 30.1 1.8 17.2) (0.3 15.5 432. Renting.2 16.8 2.8 10.5 (0.2 20.6 24.2 12.2 24.1 7.0) 0.0 24.1 16.8 23.2) 15.7 317.0 16.5 338.5 13.1 20.9 16.8 32.8 0.7 294.0 1.5 6.4 4.4 740.2 (1.6 0.2 315.8 10.2 5.8 1.8 34.1 290.8 14.4 10.3 11.7 514.0 2.2 15.3 8.3 14.0 19.1 0.4 1.7 (0.0) 0.0 37.4 15.0 3.2 241.1) 0.9 13. and Business Activities 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 Average 11.0) 4.7 17.3 285.2 6.1 1.0 22.8 2.1) (3.9 (0.8 2.9 31.9 29.0 21.0 18.0 (0.8 14.7 16.8 22.0 (0.8 16.3 13.5 1.6 15.5 6.2 25.5 286.5 4.6 16.0 23.3 11.4 474.5 14.6 3.9 25.0 1.5 1.0 1.0 1.9 340.0 15.3 2.7 21.1 28.5 239.3 25.6 375.5 27.2 0.2 18.8) 0.4 2.6) (6.5 569.1 21.9 (0.8 Real Estate.4 291.5 23.0 245.8 12.4 350.4 9.4 458.2 16.1 27.9 19.6 318.9 0.0 (4.2 0.4) 0.6 14.5 483.1 1.2 20.9 9.4 10.5 28.1 396.5 1.0 12.4 5.4 17.4 0.1 296.0 1.8 13.9) 1.6 12.4 348.9 3.5 16.8 Growth and Financial Performance of Selected Industries (percent) Growth Performance Year Assets Equity a Financial Performance NPM b Sales DER ROE ROA Manufacturing 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 Average 13.9 10.2 36.7 1.8 0.9 1.1 2.8 3.6 14.4 10.3 1.0 7.9 2.5 30.5) 0.1 1.5 Construction 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 Average 18.0 2.6 7.3 288.7 4.7 228.8 461.9 10.1 2.7 10.6 17.3 10.0 22.2) 22.1) 3.7 7.7 5.2 2.9 14.8 16.6 11.0 24.7 520.1 (0.3 31.6 12.9 (0.9 2.8 16.6 1.4 2.8 616.
7 19.5 482.6 34.6 — — — — — 17.6 9. and Communication 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 Average 15.8) (12.9 10.6 2.5 30.4 21.6 6.7 20.6 3.3 8.7) (4.6 19.4 0.9 456.5 14.3 — — — — — 10.5 307.0 2.1 2.7 7.3 1.8 111.8 0.9 17.6 16.3 4.0 1.0 2.4 7.0) 1. b NPM denotes net profit margin.2 14.9 9.3) 4. Storage.6 0.6 512.0) 1.3 3.2 698.4 1.2 18.4 2. Source: Calculated using data from Bank of Korea.3) 15.7 187.1 11.6 9.1) 5.6 (2.9 8.1 21.1 4.5 12.0 14.3 4.8 12.6 20.3 (2.7 — — — — — 14.3 2.3) 11.0 13.4 14.7 0.3 112.6 8.7 2.5 14.2 15.6 19.4 — — — — — 448.7 2.1 15.2) 9.3 23.6 8.9 9.9 4.3 4.4 3.2) 13.6 172.0 5.8) 1.1 (0.5 47.6 (2.4 16.7 14.3 524.9 1.1 8.4 0.5 117.062.3) (1.1 16.1 323.4 3.1 1. a New equity does not include capital surplus. Financial Statement Analysis Yearbooks.8 0.8 (Cont’d) Growth Performance Year Assets Equitya Sales NPMb Financial Performance DER ROE ROA Wholesale/Retail Trade 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 Average — — — — — 31.6 6.1) (0.0 21.5 26.9 (11.7 7.0 (15.0 106.2 18.4) (1.9 6.2 11.4 6.4 12.4 169.9 332.4 30.4 2.Table 2.6 1.5 15. Gas.2 1.5 344.0 89.9 3.2 143.8 3.5 4.4 341.1) (0.3 9.3 125.7) 0.3 17.3 18.8 11.9 12.4 15.4 (2.8 3.9 17.5 8.4 6.0 14.5 11.5 0.6 12.3 12.1) 1.2 3.7 116.2 10.1 11.6 18.0 98.6 1.3 18.1 3.4 0.6 8.3 740.2 18.8 14.3 543.9 10.8 529.6 6.6 4.4 367.2 10.9 18.8 4.2 2.9 12.2 14. and Steam Supply 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 Average 12.7 12.8 8.8 14.2) 0.2 122.5 14.4 12.9 8.1 6.0 5. .1 14.0 7.0 1.8 7.7 16.6 12.8 9.4 9.5) 22.1 12.9 4.5 11.7 510.0 1.7 11.8 6.9 7.5 13.2 90.6 15.7 — = not available.5 16.2 — — — — — 2.4 1.6 4.3 0.9) (8.8 12.0 921.4 13.4 11.3 8.4 3.3 1.5 612.1 (2.5 539.8 15.4 633.5 2.5 14.5 (2.1 17.4 7.3 34.7 0.8 6.5 462.2 10.5 15.4 10.6 — — — — — 0.9 (10.1 15.7 11.7 15.6 21.6 9.7 11.0 Transport.9 321.3 19.9 18.2 7.9 Electricity.4 (0.6 14.1 15.1 (11.4 1.0) (0.3 0.0 (1.
Performance of Chaebols This section uses available data on the top 30 chaebols.0 18. 1998.5 19.8 5.5 ROA 0.9 Source: Constructed using data from Korea Investors Service.8 6.2 9.6 (1.9 Growth and Financial Performance of Listed Companies.3 2. Vol.7 Net Profit Margin 0.6 1. the largest chaebol. Chaebols have been the most important actors and engines of growth in the Korean economy.9 6. Generally.1 1.4) 1.4 2.9 0. the growth of sales of the top 30 chaebols exceeded that of the aggregate corporate sector (compare Tables 2.9 1. In 1995. In 1997. Hyundai Group.4 1.2 6.9 2. followed by the top 6-10 (Table 2. it is the chaebols’ large firms that are listed.3 15.6 23.5 0. It should also be noted that when the financial crisis struck in 1997.3 percent).6 22. and net profits (46.5 19.2 0. The top five chaebols registered the highest growth rates.1 6.12). of Firms 334 351 386 503 626 669 680 681 687 698 715 754 775 Sales Growth 10.9 2.3 4.4 0.1 1.9 11.2 2.9 percent).4 1. The number of Hyundai member companies rose to 57 in 1997. and close to half of total assets (46.4 22.6 2. unless otherwise indicated) Financial Performance Year 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 Average No. The smallest group had 16 members in 1995. of which four were listed.5 5.5 ROE 3.7 1.3 20.0 0. had 46 member companies.3 0.3 (0. the 30 largest chaebols accounted for 13.4 1.11).0 3. The criteria for selection of largest chaebols have changed a few times.1) 4.70 Corporate Governance and Finance in East Asia.7 (5. of which 16 were publicly listed (Table 2. the top 11-30 chaebols experienced a decline of . debts (47. Kis-Fas.8 24. sales (45. but the number of designated groups has been fixed at 30 since 1993.12).9 percent).8 0.2 9.6 0. II Table 2.7) 0.9 21.1 percent of the economy’s total value added (excluding the financial sector).9 26. Between 1993 and 1997.7 percent) of the corporate sector.7 1.6 and 2. 1985-1997 (percent.6 3.
8 6.4 3.9 1.0 4. .6) 0.9 2.8) 6.6 9.0 6.6 7.2) (1.9 22.7 (1.3 11.5 17.2 0.4) 1.4 3.3) 5.5 5.6 0.8 17. Source: Korea Investors Service.6 2.6 0.5 2.3) 0.5) 1.2 1.9 6.8 3.5 0.9 (0.6 (0.9 0.0 1. Kis-Fas.4 Medium Small Large Medium Small ROA Growth Performance Large 17.6 13.0 19.7 2.4 1.2 Small 13.8 0.2 2.1 0.5 (1.2) (1.8 0.7 18.9 2.0 1.6 2.6 8.2 2.4 5.8 7.9 6.10 Growth and Financial Performance of Listed Companies by Size.3 9.3 15.2 (0.4 1.Table 2. 1998.9 1.9 0.0 1.9 3.9 5.6 6.0 16.1 2.0 (4.6 3.8 10.6 2.9 0.3 3.9 25.4 6.8) 1.5 5.5 Net Profit Margin Year Large Medium Small 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 Average 2.7 2.6 1.9 2.6 (1.3 Medium 14.0 17.2) 0.3 15.9) (6.8 (5.7 3. Others are medium firms.9 14.3 (0.0 1.8 0.2 7.0) 1.8 1.8 6.7 (1.1) 5. 1988-1997 (percent) ROE Large 9.2 13.2 12.1 2.2 13.1 8.4 11.5 25.6 1.2 10.5 3.1 1.6 1.2 Note: Large firms have a capital base greater than W15 billion and small firms smaller than W5 billion.8 16.4 2.2 3.5) 1.0) 0.3 (0.6 5.3 1.1 11.0 15.8 0.0 10.5 1.4 16.3 6.7 (0.7 4.7 1.6 3.
995 2.313 14.158 1. .853 1997 53.090 6.967 7.951 3.774 7.929 12.677 3.177 — 6.309 14.398 — 2.129 2.935 2.364 5.924 2.455 22.743 40.423 5.457 14.640 4. of Member Companies 1995 46 55 49 25 32 23 24 16 31 28 27 26 18 21 16 17 16 16 14 19 22 19 24 11 14 8 8 11 18 16 1997 57 80 49 30 46 25 24 28 31 30 26 25 21 — 19 18 18 17 24 24 24 6 8 2 15 — 7 — 18 — No.756 5.147 5.303 3.445 4.346 3.956 3.180 2.475 2.574 3.996 1.501 13.433 3.11 Features of the 30 Largest Chaebols Total Assets (W billion) Name Hyundai Samsung LG Daewoo Sunkyung Ssangyong Hanjin Kia Hanwha Lotte Kumho Doosan Daelim Hanbo Dong-A Halla Hyosung Dongkuk Jinro Kolon Tongyang Hansol Dongbu Kohap Haitai Sammi Hanil Keukdong New Core Byucksan 1995 43.287 10.990 2.486 6.458 6.246 11.370 6.427 9.651 38.927 16. of Listed Companies 1995 16 14 11 9 5 11 9 5 8 4 4 9 5 2 4 3 2 7 4 4 4 6 8 2 5 2 2 2 0 4 — = not available.117 4.376 35.873 2.597 351.798 — No.599 — 2.131 3.158 7.395 31.Table 2.690 3. Source: Fair Trade Commission.761 31.910 3.766 3.
2 0.5 19.4 (2.Table 2.3 27.9 24.5) (0.1 (2.0 2.4 30.0) 12.9 3.6 25.2 0.2 (2.6 19.1) (0.7 15.7 15.5 27.4) (0.6 1.0 0.0 2.8 Assets 12.2 1.3 9. 1993-1997 (percent) Growth Rates Year Top 1-5 1993 1994 1995 1996 1997 Top 6-10 1993 1994 1995 1996 1997 Top 11-30 1993 1994 1995 1996 1997 Top 30 1993 1994 1995 1996 1997 Sales 12.1) (0.1) 0.3 19.7 4.4 0.4 12.4 38.1 (3.1) (1.2 11.12 Growth and Financial Performance of the 30 Largest Chaebols.5) (0.6 (0.7 13.8 0.3 1.3 0.7 1.3 15.7 0.9 20.7 10.5) (0.0 1.7) ROE 5.3 3.0) 3.4 26.2) (2.4) 1.2 3.3 16.0 6.5 32.0 17.1 2.1 27.9 17.5 20.5 2.5 (0.2 (16.1 (1.1) 0.8 18.2) (0.3 14.9 20.0 31.4) (14.0 2.3 11.9 3.1 10. .3) 0.6 Financial Performance Net Profit Margin 1.2 20.7 10.2 (5.2) 1.6 4.0 19.6 18.0) ROA 1.8 27.2 0.3 0.3 1.2 (2.1 19.0 0.5 5.9 1.7) Source: Bank of Korea.9 18.
7 percent growth in total assets.13). Attempts to rectify the corporate structure were halfhearted and it was only after the onset of the crisis that many of the most serious reforms were instituted. The Commercial Code stipulates the basic governance framework and applies to all corporations. internal and external control mechanisms. 2. and vulnerable balance sheets. except for 1995. and the companies that are under the control of the largest shareholder. Vol. and access to credit.” This “identical person. Ownership patterns. resulted in the chaebols’ excessive leverage. The absence of a well-developed equity market and the provision of subsidized credit.1 Patterns of Corporate Ownership The ownership of most Korean listed firms is highly concentrated. 2.95 percent. There has been a wide range in DER among chaebols. technology.” in Korea’s legal and regulatory framework.3 Corporate Ownership and Control This section looks at the key aspects of corporate governance in Korea.3.765 percent (Table 2. includes the largest shareholder. Only the top five chaebols registered a positive net profit margin in 1997. II 2 percent in their sales and a very low 4. . In general. However. and government intervention interacted through a set of laws and regulations to bring about the existing structure. the average DER of the 30 largest chaebols reached 519 percent. from 190 to 3. However. chaebols had a higher average DER than the corporate sector as a whole. loopholes and inconsistent policies spawned strategic behavior and agency problems. weak corporate control. 5 While “ownership concentration” can be defined and measured differently in different contexts. a pyramidal structure of corporate ownership is prevalent. the net profit margin of the aggregate sector exceeded that of the top 30 chaebols. The ROE of the top 30 chaebols was consistently higher than that of the aggregate corporate sector. By the end of 1997. his/her relatives.5 Founding families are mostly still the largest shareholders and. and led to a high concentration of ownership. Their worst year was 1997 when ROE hit -15. The better showing of the top five chaebols was a direct result of their dominance in human resources. in this instance. it refers to the degree of concentration and shareholdings in the hands of an “identical person. The financial performance of the top 11-30 chaebols deteriorated during 1993-1997.74 Corporate Governance and Finance in East Asia. coupled with weak corporate governance. more important.
5 2.2 2.441.4 622. Kohap 25.2 328. Doosan 13.7 416.4 192. Hyundai 2. Samsung 3. LG 4. Daelim 16. Kumho 12. Sammi 27.4 175.8 312. Byucksan 1996 1.8 336.7 621. Hyundai 2.5 464. Hansol 23.0 486. Daewoo 5.0 370. Sunkyung 6. Jinro 20. Newcore 30.7 267.1 477. Hanbo 15.13 The Top 30 Chaebols’ Debt-to-Equity Ratio.244.7 620.5 337.5 3. Daelim 14.6 409.2 423. Ssangyong 7.3 297.5 383. Halla 17.2 924. Dongah Construction 16.2 471.1 3.0 506.0 436.3 328.1 674. Hanil 28. LG 4.1 278. Kumho 12.6 .6 936.9 321. Kia 9.855.6 2. Dongbu 24. Hanwha 10. Sunkyung 6. Hyosung 18. Samsung 3. Jinro Debt-to-Equity Ratio 376.1 190. Dongkuk Steel 19.7 688.2 292. Hyosung 18.Table 2. Kolon 21. 1995-1997 (percent) Chaebols 1995 1. Doosan 15. Dongah 14. Daewoo 5.065.7 354.4 205.6 516. Hansol 17. Ssangyong 7.9 751. Hanjin 8.1 385. Tongyang 22. Hanjin 8.764. Dongkuk Steel 19. Kukdong Construction 29. Kia 9. Lotte 11.5 343. Hanwha 10.8 313.3 315.2 346. Haitai 26.3 572.4 556.0 218. Lotte 11. Halla 13.
Anam 27.8 338. Kolon 19. Hanil 28.3 676.6 590.1 433. Newcore 28.8 468.9 490.1 375. Keopyong 29. Hansol 16.0 419.0 907.4 1.7 1.4) 513.3 347.6 424.6 416.Table 2. Saehan Average of All Chaebolsa 1995 1996 1997 Average of All Industries Excluding Financial Sectorb 1995 1996 1997 Debt-to-Equity Ratio 317.3 1. Keopyong 29. Miwon 30. Kohab 18.6 Sources: aFair Trade Commission.9 578.5) 404. Newcore 26.600.0 505.5 386. Dongbu 23. Daesang 27. bBank of Korea.9 1. Jinro 23. Anam 22. Kolon 21.9 465.5 (893. Hanwha 9. Hyundai 2. Tongyang 24. Haitai 25.6 478.0 305. LG 5.5 323. Haitai 25.214.5 1. Halla 13.8 347.8 590.498.8 658. Dongkuk Steel 20.1 359.5 576. Lotte 12.7 370.3 399.5 519. Shinho 26.1 472. Hyosung 17. Daelim 14. Shinho 1997 1.8 647. Dongbu 21. Daewoo 4.784.13 (Cont’d) Chaebols 20. Kohab 22.9 216. Hanjin 7. Ssangyong 8. Tongyang 24.9 472. .5 261.6 335.5 (1.8 399. Samsung 3. Kumho 10. Dongah 11. Doosan 15. SK 6. Kamgwon Industrial 30.501.8 307. Financial Statement Analysis Yearbook.1 438.225.7 944.
and then steadily declined after 1993.7 percent by 1997. The percentage of shares owned by “other corporations. Thus. that is.. but their shares declined to 21. the percentage of holdings by individuals slipped to 60. The pattern of distribution changed little through 1992-1997. Theoretically. and insurance companies increased during the period. the incentive effect once again dominates. However. The controlling shareholders of chaebols hold comparatively smaller percentages of shares. an increase in their ownership may bring their ownership incentives to converge with those of the minority shareholders. and state-owned companies and securities companies declined. including investment trust companies. the entrenchment effect and problems of agency may be more pronounced in chaebols than in independent firms.” foreigners. The holdings of financial institutions. resorting to extensive use of pyramiding to maintain control. the ownership structure can bring about an incentive effect. managerial entrenchment becomes more likely. fluctuated widely during the period.” followed by banks. However. 10 to 30 percent). including banks and other financial firms. large ownership can also bring about the entrenchment effect. Beyond that range. When managerial holdings are reinforced by artificial control mechanisms such as pyramiding. the Government. the extent of ownership by these individuals declined gradually after 1988. Among listed nonfinancial companies. i. The reduction can be .Chapter 2: Korea 77 When controlling shareholders hold a very small percentage of the shares. while those owned by banks.6 percent by 1997. Most non-chaebol listed firms in Korea are believed to have ownership concentrations within the 10-30 percent range.1 percent.e. Securities companies reduced their holdings over this period of falling stock prices as the size of investment trust companies’ stock portfolios declined. the individual owners—the portfolio investors as well as the controlling shareholders and their family members—formed the largest shareholder group (Table 2. the entrenchment effect outweighs the incentive effect.14). From 69. an entrenched manager is insulated from market pressure and can pursue personal goals without the fear of being replaced. the year the stock market was in a frenzy due to buying sprees. with a given range of managerial shareholdings (for instance. The next important group was “other corporations. Composition of Ownership Among listed companies. individuals were also the largest shareholder group. Financial institutions owned as much as 28 percent of the total corporate shareholdings in 1992.
2 9.3 18.8 5.6 9. a The State covers the Government and state-owned companies.4 13.0 5.3 1.9 2.3 1994 521 1. of Firms The Statea Banks.2 17. merchant banks.9 4.4 18.7 9.5 6.7 6.4 Insurance Firms Other Corporations Foreigners Individuals 39.Table 2.9 26.6 36.14 Ownership Composition of Listed Companies.3 17.5 62.0 4.1 18.1 8.8 4.5 4.1 2.6 8.8 59.4 14.6 12. etc.8 1995 548 2.3 5. investment trust companies.9 19.0 8.5 1989 498 0.8 5.5 12.6 16.5 60.0 60.7 8.2 4.4 6.1 11.2 8.2 5.2 5. c Data from Korea Stock Exchange.1 3.9 1.0 7.5 1992 508 2.0 27.8 2.1 21.6 19.7 14.7 4.6 22. .1 8.4 34.2 1.2 9.6 9.5 7.1 10.6 20. d Constructed from data files of the Korea Listed Companies Association.b A.0 28.9 17.2 8.3 17. and finance companies.4 5.2 1993 511 2.7 3.0 9.9 15.7 1990 531 0. etc. 1988-1997 (percent) Financial Institutions Securities Firms Total 28.5 6.0 5.9 36.2 18.9 2.3 8.3 18.5 1.7 59.6 16.1 1.8 2. All Listed Companiesc 1992 681 1993 687 1994 698 1995 715 1996 754 1997 775 9.6 16.6 13.1 4.5 7.3 1.1 21.1 68.8 17.7 18.5 1.9 37.8 69.3 39.” includes commercial banks.6 2.5 Note: Ownership is based on number of shares.4 13.1 17.6 1991 505 0.2 7.8 17.8 59.9 1.1 60.0 59.2 3.2 B.3 26.4 5.7 9.2 2.7 7. Listed Nonfinancial Companiesd 1988 406 0.9 5.4 1997 551 1.6 Year No.3 2. b “Banks. mutual savings.3 5.3 1996 570 2.5 18.5 16.1 18.
with the Government continuing to hold a sizable share in the Korea Electric Power Corporation. One minor difference is that the percentage of shareholdings by corporations is slightly higher in large-sized firms. When independent companies are distinguished from firms affiliated with the 30 largest chaebols. Foreigners gradually increased their equity shares in 1992 when direct purchases by them were first permitted. Corporate holdings averaged 16 percent throughout 1988-1997. as distinguished from individual and foreign investors.8 percent of listed shares in 1997. indicating their increased investments particularly in the service industries with high growth rates. The holdings of other corporations are mainly equity investments in affiliate companies. of some banks. financial institutions had more shares in the manufacturing sector than in primary industries. government ownership in nonfinancial companies was remarkably smaller and more concentrated. indicating their heavier reliance on inter-firm financing investments. In general.18). This trend can be explained by government ownership. Over the years. Institutional investors. the Government acquired an even bigger share in several banks as part of its program to bail out these distressed institutions. and small companies. held 26. the holdings of institutional investors were expected to increase significantly with the Government’s introduction of US-type investment companies in 1998 and . a more detailed breakdown of the data on majority shareholdings in the next section shows significant differences in the two groups’ composition and level of majority shareholdings.17). However. In most instances. The ownership distribution in listed nonfinancial firms. the Government was the sole owner. there appears to be no significant difference in the overall shareholding patterns between the two groups (Table 2. This is low compared with those in Japan. electricity. In 1998. categorized into large. Individuals held the majority of the shares in all industries except in telecommunications. Compared with its holdings in all listed companies. UK. The Government’s and state-owned institutions’ (including some banks) ownership was generally small except in the power sector. other corporations’ holdings shifted toward service industries.15). and service of motor vehicles (Table 2. Before such liberalization. and US (Table 2. did not vary significantly (Table 2. medium.16). However. foreign holdings were derived from purchases through country funds and direct capital investments. whether partial or absolute.Chapter 2: Korea 79 ascribed to prudence in staying away from the stock market—as part of their risk management strategy—as the stock market was in doldrums throughout the 1990s.
7 63.7 1.5 4.5 7.0 9.3 38.6 — — 2.5 — 1.3 7.0 Industry 1990 Fishing and Fish Farms Mining Food Products and Beverages Wearing Apparel and Fur Articles Wood.7 14.0 0.9 1.9 60.0 20.2 0.2 2.0 2.5 0.4 14.9 66.8 8.4 62.4 5.1 1.7 22.4 — 0.. 1990 and 1997 (percent) Financial Institutions The Statea — — 0.b Securities Firms Insurance Firms Other Corporations Foreigners — — 0.8 73.8 7.3 13.0 9.1 65.6 11.2 17.1 0.5 — — 0.1 10. Etc.9 55.5 19.9 23.4 8.3 2. and App.6 1.2 54.3 0. Gas.8 7. Elecl Mach.6 18.7 20.2 64.4 56.2 1.3 0. Rubber.8 3.9 4.7 17.6 3.3 10.1 0.4 56.3 9.9 8.3 2.2 1.5 85.9 19.5 — 0.9 0.8 Individuals 83.4 8.0 10.1 0.4 1.0 1. and Plastics Basic Metal Fabricated Metal and Machinery Office and Computing Machinery Electronics.9 16.2 — 0.7 2.9 52.Table 2.8 7.1 8.9 42. Paper.3 1.5 0.15 Ownership Composition of Listed Nonfinancial Firms by Industry.3 62.7 64.2 7.7 22.1 7.7 20.5 0.7 2. and Printing Chemicals.2 9.2 9.8 7.7 14.0 — 0.8 3.8 1.9 15.9 1.2 0.0 — 39.4 2.1 27. and Steam Supply Precision and Optical Instruments Other Manufacturing Construction Service of Motor Vehicles Wholesale and Retail Trade Transport Telecommunications Other Business Activities Nonmetallic Mineral Products Average .8 7.7 2.5 17.3 57.5 0.6 24.4 7. and Printing Pulp.1 19.6 8.3 6.9 59.4 1.5 3.0 8.3 1.4 8.5 6.1 88.2 — — 0.8 6.2 0.5 12.4 0.2 0.7 59.1 8.4 Banks.1 0.2 22.0 9. Motor Vehicles Electricity.0 9.8 5.7 29.2 9.3 0.7 6. Paper.3 4.1 4.9 10.0 7.6 5.3 11.
6 7.9 20.9 5. etc.1 3.0 5.7 1.3 6.6 1.9 57.8 2. Note: Ownership is based on number of shares.8 0.3 65.4 45.0 4.2 0.3 6.4 68.6 6.4 4.4 43.8 12. mutual savings.” includes commercial banks.5 3. merchant banks.1 6.5 3.9 0.4 76.6 75.8 5.0 7. Paper.1 2. Paper.4 6.0 43.3 60.6 59.2 49.5 4.5 3.9 6. and Printing Chemicals.2 6.1 25.1 18. Rubber.6 2.6 0.8 3.2 3.9 2.9 2.4 2.5 0. and Plastics Basic Metal Fabricated Metal and Machinery Office and Computing Machinery Electronics.7 19.2 1.4 3.7 5.1 9.2 4.5 3. and App.6 2.8 6.1 2.9 6.8 2. . Elecl Mach.7 4. Source: Constructed from data files of the Korea Listed Companies Association.6 14.6 2.9 18.9 5.6 60.3 2.5 — 2.8 2.4 4.4 9.4 0.9 1.7 6.5 1. Gas.9 78.9 69.1 54.2 23.1 4.4 1.2 5.6 6.0 6.6 18.4 20. a The State covers the government and state-owned companies.1 1.2 0. and finance companies.1 9.5 6.3 15.6 0.6 3.4 2.2 8.1 — 0.3 1. b “Banks.4 16.0 60.7 23.6 20.2 4.7 2.0 1.8 54.4 58.2 4.0 6.8 5.8 11.0 3.6 — = not available. and Printing Pulp.7 2.6 5.9 1.1997 Fishing and Fish Farms Mining Food Products and Beverages Wearing Apparel and Fur Articles Wood.8 57.5 12.0 8.7 17.9 20.0 11.3 31.9 2.5 7.3 0.2 1.9 7.8 27.2 13.4 1.2 7.4 1. Motor Vehicles Electricity.9 7.4 58.4 — 1. and Steam Supply Precision and Optical Instruments Other Manufacturing Construction Service of Motor Vehicles Wholesale and Retail Trade Transport Telecommunications Other Business Activities Nonmetallic Mineral Products Average 1.7 2.1 — 1.1 1.9 2.3 1.2 4.7 2.1 3. investment trust companies.8 0.9 1.3 57.5 4.8 4.3 8.4 2.78 81.5 59.3 7.5 5.2 5.5 63.
4 21. of Firms Large Medium Small Total 211 208 80 499 a Large firms have a capital base greater than W15 billion and small firms smaller than W5 billion.1 6. Securities Firms Insurance Firms 2.7 6.7 1.8 1. Others are medium firms.1 2.9 5.16 Ownership Composition of Listed Nonfinancial Firms by Size.1 Banks. c “Banks.5 8.4 61. merchant banks.4 2.7 8.6 16.c Securities Firms Insurance Firms Other Corporations Individuals 58.4 4.8 4.7 Control Type No.5 6.7 0.” includes commercial banks.8 60.9 2.5 16.0 6. Source: Constructed from data files of the Korea Listed Companies Association.4 Firm Sizea No.8 2.3 Banks. b Table 2.5 18. mutual savings.0 1. of Firms Independent Firms Affiliates of 30 Largest Chaebols Total 316 117 433 Source: Constructed from data files of the Korea Listed Companies Association.17 Ownership Composition of Listed Nonfinancial Firms by Control Type. and finance companies.4 1.5 62. The State covers the government and state-owned companies.3 6. 1997 (percent) The Stateb Foreigners 4.4 5.4 17.8 4.6 60.5 4.4 5.8 6.9 4. . investment trust companies.5 2. etc.Table 2.7 Foreigners 4.7 4. etc.0 Other Corporations 16. 1997 (percent) The State 1.4 61.5 Individuals 60.8 3.2 1.1 8.5 19.4 2. etc.
including those of the largest shareholder.1 financial institutions’ establishment of corporate pension fund accounts. minority shareholders.3 6.Chapter 2: Korea 83 Table 2.3 54. At the moment. The more popular open-end investment companies (mutual funds) were expected to come into existence by the end of 1999 with the Government’s deregulation of the capital market. his/her family members. only closed-end investment companies and traditional investment trust companies are allowed. In 1997. The majority shareholder group’s shareholdings in listed nonfinancial firms steadily declined from 1990 to 1996.5 45. for example. investors (Table 2. defined as those holding less than 1 percent of shares. Concentration of Ownership The analysis of ownership concentration in this section focuses on shareholdings of the majority shareholder. This has had profound implications for corporate governance and the market for corporate control in Korea. Among nonfinancial listed firms. Institutional Investors 42.4 26. the majority shareholder group in all listed companies consists of the corporate.7 16. corporations held 70 percent of the controlling blocks of shares. 1997 (percent) Country Japan Korea Taipei.3 47.20).1 8. the majority shareholder group on average held 23-30 percent of outstanding shares in the period 19881997 (Table 2.China United Kingdom United States Source: Stock Exchange of Korea.8 56. Generally.8 9.1 percent and appear to be similar to the proportion of foreign holdings in the four other countries.6 39.18 Ownership Composition of Listed Firms in Selected Countries.6 Individuals 23.19). But these may . while family members accounted for only 30 percent. Foreign holdings of Korean shares were 9. rather than the individual. and other shareholders who do not belong to either the minority shareholders or the majority shareholder group. and the companies under the control of the largest shareholder.8 10.6 Foreigners 9.5 20.
19 Ownership Concentration of All Listed Firms.6 22.3 2.8 72.7 Note: The majority shareholder includes the largest shareholder.1 4.1 32.1 5.0 66.1 14.7 7.4 7.0 29.0 25.4 5.0 22.1 37.2 2.2 2.0 69.0 2.6 5.1 28. . Other shareholders are those who do not belong to either the minority shareholders or the majority shareholder group.9 7.1 23.2 Minority Shareholders Subtotal 71.4 3.5 43.3 18. and the companies under the control of the largest shareholder. 1992-1997 (percent) Majority Shareholders Corporation 15.7 16.9 33.9 6.6 73.9 2.1 15.3 30.0 Year Corporation Individual 1992 1993 1994 1995 1996 1997 41.6 2.7 6.0 4.1 5. his/her family members.6 46.1 21.3 Subtotal 5.8 Individual Subtotal Other Shareholders Corporation 3.0 1.9 3.7 44.Table 2.9 Individual 2.6 26.7 18.2 26. Minority shareholders are those holding less than 1 percent of shares.8 8. Source: Stock Exchange of Korea.8 73.9 32.
7 18. have been underestimated because it was widely believed that the largest shareholder often had hidden shares registered in the names of relatives and subordinates of the company. The percentage of shares held by minority owners (with less than 1 percent of outstanding shares) was highest for large firms at more than 55 percent (Table 2.4 28. Besides.0 58. the Government has retained a large number of shares.6 11. the majority owner held more than 20 percent of an average firm.9 48.Chapter 2: Korea 85 Table 2. It was highest in medium-sized firms before 1993 and.5 13.1 50. hiding shares offers no additional tax or other benefits.5 60. The shareholders that held more than 1 percent but did not belong to the majority group held about 20 percent on average. ownership was relatively diffused due to government regulation.9 12.6 57.0 22.5 12.8 25. Meanwhile.8 Majority Shareholders 27.8 54.3 62. in the small firms.3 25. rubber and plastics. which held less than 1 percent of a company’s outstanding shares as of 1997.9 Other Shareholders 18. Ownership concentration tended to be lower in large compared to medium and small listed firms. minority shareholders.22).8 12. utility companies have a relatively higher degree of ownership concentration with the majority shareholder owning nearly 45 percent of an average company (partly because these companies were owned solely by the Government before their privatization [Table 2.0 20. In most industries.4 Source: Constructed from data files of the Korea Listed Companies Association. .21]). Across industry. collectively owned less than 50 percent of an average firm.9 27.8 28.4 23.8 57. The practice of hidden shares seems to have been less prevalent in recent years. Majority ownership is also high in the chemicals.20 Ownership Concentration of Listed Nonfinancial Firms.9 29. 1988-1997 (percent) Year 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 Minority Shareholders 53. and mining categories.6 58.9 25.5 23. thereafter.2 15. In such cases. In telecommunications.
1 19.3 39.2 48.5 20.5 52. Rubber. Elecl Mach.4 11.8 21.0 30.6 38.9 44.2 20. Motor Vehicles Electricity.5 16.0 21.6 19.4 Industry Fishing and Fish Farms Mining Food Products and Beverages Wearing Apparel and Fur Articles Wood.5 41.5 21.8 55..21 Ownership Concentration of Listed Nonfinancial Firms by Industry. Gas.9 10.2 22.5 44.8 24.0 51.8 51.7 27.8 29.7 29.2 37.7 17.3 19.2 19.6 34.2 46.7 24.8 31.5 19.8 44. and Printing Pulp.1 49. and Printing Chemicals.6 53. and Plastics Basic Metal Fabricated Metal and Machinery Electronics.7 26.3 26.7 36. Paper. and App.5 23.6 50.8 25.2 34.2 23.0 39. 1997 (percent) Number of Firms 3 2 43 49 12 16 90 39 31 71 34 8 9 49 40 15 1 10 29 551 36.1 43.4 16.9 26. and Steam Supply Other Manufacturing Construction Wholesale and Retail Trade Transport Telecommunications Other Business Activities Nonmetallic Mineral Products Total Source: Constructed from data files of Korea Listed Companies Association. .2 26.5 47.Table 2.6 25.1 17.8 41.0 54.9 Minority Shareholders Majority Shareholders Other Shareholders 12.7 21. Paper.4 53.
2 55.3 55.2 52.8 50.2 50.5 28.1 48.7 22.5 10.6 55.2 32.5 33.2 18.2 Majority Shareholders 26.0 26.9 16.0 59.8 52.4 47.2 21.3 27.3 26.3 21.9 60.0 55.9 56. 1988-1997 (percent) Year Small 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 Medium 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 Large 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 No.5 51.3 19.7 28.2 26.5 12.4 30.6 31.7 16.9 21.22 Ownership Concentration of Listed Nonfinancial Firms by Firm Size.6 24.5 21.Table 2. of Firms 66 81 72 76 80 67 78 102 134 115 148 197 219 212 210 217 216 216 215 215 165 213 220 217 218 217 227 230 231 221 Minority Shareholders 53.0 66.3 25.9 53.9 23.8 17.6 27.9 22.6 65.7 14.0 24.7 57.4 30. .8 52.8 56.9 17.1 27.5 Other Shareholders 19.1 58.2 56.9 12.9 28.5 12.1 20.2 21.4 51.4 30.7 31.2 12.7 15.8 11.6 59.5 27.9 26.2 21.9 55.8 62.8 27.7 57.5 26.5 19.6 15.4 29.1 15.4 21.2 11.6 62.6 11.2 Source: Korea Listed Companies Association.5 49.7 17.1 16.8 28.5 19.
the firm destroys value. One of the merits of pyramiding. They analyzed firms in which controlling shareholders participate as managers. This type of inter-firm investment. TQ increases as the SCS increases. Kim (1992) and Kim. Hong. which can then pass the equity capital to a third. Hong. TQ is below 1. II Ownership Concentration and Financial Performance J. If SCS is below the range of 20-25 percent. called “pyramiding”— commonly (though incorrectly) known as “indirect cross-shareholding”— is prevalent in Korea. 1988). thus a firm creates value. Then TQ declines until SCS reaches 45 percent and increases until it reaches 50 percent. If SCS is above 20-25 percent. one company from a chaebol group could obtain debt payment . Kim (1992) found the relation between TQ and SCS to be nonlinear. Where direct cross-shareholding is not allowed. Inter-Firm Investments and Pyramiding in Chaebols The Commercial Code imposes limits on direct cross-shareholding. thus a firm destroys value. H. often at terms unfair to one of the transacting parties. and the shareholding of a controlling shareholder (SCS) as the degree of ownership concentration. This refers to the situation wherein Company A holds shares of Company B and simultaneously Company B holds shares of Company A. it means the firm creates value. which is the company holding more than 40 percent of outstanding shares of its subsidiary. The study by Kim. and Kim (1995) studied the empirical relationship between the degree of ownership concentration and financial performance in Korea. if TQ is lower than 1. from the standpoint of the controlling shareholder. If SCS reaches 10 percent. The pattern of the relationship between SCS and TQ is similar between Korean and US firms (Mork. one company can still place equity investments in another. J. although turning points in the value of firms are different. Shleifer. The Code prohibits a subsidiary company from owning shares of its parent company. is effective control of a certain group of companies even with a smaller investment. TQ was calculated by dividing the market value of a firm by the substitution price of its assets. Vol. Both studies used Tobin’s Q (TQ) for the value of a firm as an index of financial performance. and Vishny. If TQ is higher than 1. For example. TQ is above 1. In Korea.88 Corporate Governance and Finance in East Asia. TQ has a maximum value. H. affiliated companies have been able to conduct inter-firm transactions. If SCS is below 10 percent. and Kim (1995) reached a similar conclusion. The relationship between TQ and SCS shows a similar pattern.
neither the investors nor the relevant government authorities were active in monitoring such unfair dealings between firms. Among chaebol affiliated firms. Thus. or about four firms each. 59 parent companies collectively had investments in 759 firms. and about 11 percent were domestic financial institutions. The extent of pyramiding can be seen in some of the previous tables. But the controlling power of the owners also stems from inter-company shareholdings of the subsidiaries. the top 30 chaebols’ shareholding by subsidiaries was 34. the average shareholding of the controlling owners and their families was 8. 59 were parent firms with one or more subsidiaries. This also partly explains why chaebols frequently opted to expand by establishing new firms rather than placing investments internally. In the case of the 30 largest chaebols. The top five shareholders of the chaebol-affiliated firms consisted of one individual and 3. although they are likely to be insignificant. together owning an average of 37. together owning an average of 38.Chapter 2: Korea 89 guarantees from other members of the group at no cost. not individuals. In Table 2. Of the 81 respondents.14. corporations hold about 20 percent of the outstanding shares of all listed nonfinancial firms. or about five subsidiaries each. the top five shareholders consisted of 2. Among the 81 listed firms in the ADB survey.23.5 percent of shares. or an average of 13 firms per company. Until recently. These shares should be added to the control block although the financial institutions belonging to the 30 largest chaebols are prohibited from exercising their voting rights in the member firms of the chaebol. 62 percent (16 out of 26) had a corporation as the largest shareholder. standalone setups. Twenty-two of the 81 respondents were independent.9 percent of shares. For the same year.5 percent as of 1997.4 corporations. Thus. Partial results are shown in Table 2. The fact that corporations. Only six firms (or 13 percent) indicated that their subsidiaries also owned shares in themselves. financial institutions that are subsidiaries of a chaebol also hold shares in its member firms. there are instances of direct cross-shareholding in Korean firms. If we define the internal shareholdings of a . For the whole sample. In many instances. Among the subsidiaries or firms receiving investments. 34 percent were foreign companies.5 percent. dominated the majority shareholder group in chaebol-affiliated companies is consistent with the results of the ADB survey conducted for this study. together having a total of 292 domestic subsidiaries. 53 percent were domestic nonfinancial firms. and 319 foreign subsidiaries.5 corporations and two individuals. for example. firms linked through partial equity investments could enjoy the advantage of consolidation without an actual formal consolidation or merger of operations taking place.
5 38.7 39.5 4.7 0.0 3.9 29.8 18. A few companies reported less than five largest shareholders.7 37. b The chaebol affiliated firms are those belonging to one of the 30 largest groups.0 21.1 22.1 3.23 Ownership Concentration in the Survey Sample of 81 Listed Firms.7 19.Table 2.5 31.0 1.5 18.4 11.6 34.5 2.0 1.4 18.0 17.1 1.5 2.8 8.3 26. .6 3.8 Note: The survey was conducted during the period January through May 1999 and included nonfinancial listed firms only.0 13.2 25.8 38.4 38.5 2.8 31.9 21.5 4.4 25.7 5.4 2.8 37.6 16.9 5.6 3. 1999 Five Largest Shareholders No.6 3.5 1.5 24.5 2.4 21.0 2.4 42.0 3.9 34.2 37. a Number of shareholders.3 12. of Firms Largest Shareholder’s Holdings (%) Compositiona Individuals Firms Shareholdings (%) Individuals Firms Total Classification Total Sample Non-Chaebol Affiliated Largest Shareholder is Largest Shareholder is Largest Shareholder is Chaebol Affiliatedb Largest Shareholder is Largest Shareholder is Largest Shareholder is CEO an Individual a Firm CEO an Individual a Firm 81 55 31 10 14 26 3 7 16 20.4 1.
Chicago.7 9. Lee.5 percent. C. “The Ownership Structure and Family Control in Korean Conglomerates: With Cases of the 30 Largest Chaebols.4 13.” In Korean Managerial Dynamics. Many attempts have been made by researchers to identify the typical patterns of ownership structures in chaebols. it appears that the chaebol families have had a strong desire to expand their business bases. the average internal shareholding ratio of the top 30 chaebols was at least 43 percent.2 33. Thus it can be inferred that their strategy in designing the ownership structure of their business groups was to minimize the financial resources required to maintain their grip on the management of the member firms while maximizing their control.” Paper presented at the Annual Conference of Financial Management Association.2 12. H.6 33. Internal shareholdings in some chaebols also include shares owned by nonprofit organizations operated by the controlling family. 79-95. Family holdings include shares owned by the family members and by parties considered to be under the influence of the family. Lee. “Japanese Zaibatsu and Korean Chaebols. 1987-1997 Type of Shareholding Internal Shareholdings Family Member Companies Source: Korea Fair Trade Commission. Jae Woo.7 1992 46. pp. The relatively high internal holdings of the 30 largest chaebols were due partly to the fact that many of the chaebols’ firms are still privately held.2 1994 42. 1987 56. 15 October 1998.8 33. Tamio.5 34.6 Later studies by Lee (1997) and Lim (1998)7 find similar patterns. . 1998.4 10. Table 2. Chung and H. 1997.0 8.4 1993 43. As of 1997.1 1997 43. the controlling families owned 8. Table 2.24 Internal Shareholdings of the 30 Largest Chaebols. The family and member companies’ shareholdings have been declining over time. Hattori (1989) identified three patterns based on data in the early 1980s.2 15.8 40.4 1990 45.Chapter 2: Korea 91 chaebol as the shareholdings of the controlling family and the member companies of the group. 1989. the ownership patterns can be described as follows.24 shows the average internal shareholdings in the 30 largest chaebols.5 Judging from the historical record.7 31. New York: Praeger. 6 7 Hattori. Ungki Lim.5 percent and member companies. “Is the Fair Trade Policy Fair?” Korea Economic Research Institute. 34. Based on these studies. edited by K.
Most of its member firms were acquired by. there is no controlling shareholder. Hyundai Motors acquired Kia Motors via an international auction. Sun Hong Kim. it had 18 listed and 39 private companies.” A family owns a substantial portion of shares of member firms and becomes the controlling shareholder of each. Chaebol Reforms Various measures have been taken to improve the transparency of chaebols with regard to accounting.” Under this type of ownership pattern. Investments between the lower level subsidiaries are rare. The Hyundai Group exemplifies this. is an example of this type. and subsidiaries’ equity participation. As of 1997. holdings of the nonprofit foundation. other firms.” shows a simple pyramidal structure. A nonprofit foundation under the family’s control is the largest shareholder of one of the base companies. Vol. II The first (Type A) is called “direct family ownership. The Hanjin Group. The fourth type (Type D) is “management control. investments made by the base companies. or merged into. It consists of seven listed and 24 privately held firms. which then make investments in the subsidiaries. The family itself holds shares in some subsidiaries. The Kia Group was about the only management-controlled group but was out of existence by 1999. The Hanwha Group can be classified as such a company. called the “indirect control via base company. and his management team exercised full control over the group without much interference from major investors. consisting of eight listed and 16 privately held firms as of 1997. For example. Its controlling family holds shares in three base companies through which they exercise control over the other member firms. and business activities. The third (Type C) is “indirect control via complex shareholding. financial.92 Corporate Governance and Finance in East Asia. One of the . The controlling family has sizable investments in two base companies and smaller investments in many others. subsidiaries have extensive investments in other subsidiaries. The two base companies have investments in three other base companies. the family controls the group’s member companies by its own shareholdings. Also. Thus. But the former chief executive officer (CEO).” Here the family directly controls a base company and a nonprofit foundation. which in turn hold shares in some of the other subsidiaries. Kia Motors was the base company and had such strategic shareholders as Ford Motors of the US and Mazda of Japan. The second (Type B). Here the family is the controlling shareholder of one or more strategic base companies that have enough equity participation in the subsidiaries. completely dissolved under financial distress.
Cross-guarantees are believed to constitute a form of wealth transfer from financially strong members to weak ones. bankruptcy reorganization. The Fair Trade Act was amended in 1998 to allow pure holding companies to be established under restrictive conditions. A third disallows multiple layering of holding companies. This was the reason why chaebols chose to employ pyramidal structures. The Fair Trade Act was also revised in February 1998 to prohibit cross-guarantees of debt among members of a chaebol. the act did not have any important provisions except the standard clauses prohibiting monopolization of an industry through business combinations. These conditions are aimed at restricting excessive pyramiding and expansion of chaebols. The first serious attempt to deal with this issue was the introduction of the Monopoly Regulation and Fair Trade Act of 1980 (hereinafter. At this early stage. there are reports that some top chaebols are studying the feasibility of transforming their organizational structure. the Fair Trade Act). only operating holding companies were allowed to be established. Existing guarantees had to be resolved by March 2000. This limit was also applicable to banks and insurance companies. These amendments prohibited holding companies and direct cross-shareholding. They hindered early exits (liquidation. and limited the amount of total investments made by a member firm of a chaebol in other firms to less than 40 percent of its net assets. following the amendment of the law. The limit on investments was reduced to 25 percent in 1994 and completely eliminated by 1997. However. thus hurting the shareholders of stronger firms.Chapter 2: Korea 93 pronounced purposes of government intervention in the corporate sector has been to prevent concentration of economic power in the hands of a few large chaebols. Another is that the holding company should own more than 50 percent of the shares of a nonlisted subsidiary company and more than 30 percent of a listed company. . The Government is also considering whether to allow consolidated taxation for pure holding companies. An operating holding company is defined by the Fair Trade Act as one whose investment in others does not exceed 50 percent of its total assets. Initially. Until the end of 1998. Also. the Credit Management Regulation rules were amended to prohibit financial institutions from requiring guarantees from affiliated firms when extending new loans. The prohibition of holding companies was also abolished in 1999. One condition requires that the DER of the holding company should not exceed 100 percent. It remains to be seen whether they will adopt the holding company structure in the future. direct control of the management of chaebols was attempted through amendments of the act in 1986 and 1990.
which put together the accounts of all members of a chaebol. planned for capital raising and allocation on a groupwide basis. even though they were legally independent with their own board of directors and the outside shareholder groups were not identical. the Commission has strengthened its investigative activities to eradicate cross-subsidization and wealth transfer activities among group members. who is universally called the “group chairman. The 30 largest chaebols are now required to publish “combined” financial statements. Chaebols maintain that the restructuring headquarters will exist only for a limited period. chaebols dismantled their “planning and coordination offices” or “chairman’s offices” under pressure from the Government.) of nonviable member firms and helped afford a disproportionate advantage to chaebols in obtaining favorable bank loans because (it was generally believed) the Government would not let large chaebols go bankrupt. unlike the regular consolidated statements that only cover those firms that are related through direct equity participation. The Fair Trade Commission has been deeply involved in promoting managerial transparency by exercising its power to investigate and levy penalties on “unfair internal transactions” among member firms of chaebols. Some chaebols operated “group management boards” attended by top executives (presidents or chairpersons) of larger member firms. Despite chaebols’ decision to dismantle the chairman’s offices. Since the economic crisis. II etc. usually in the rank of a company president.” The group chairman operated through these offices and treated the individual member firms as if they were the divisions of a single legal entity. but the larger and stronger ones still operate their newly named “restructuring headquarters” under the control of the group chairperson. until urgent restructuring is complete.3. and transferred funds generated by one firm to another. The chairman’s office had its own chief executive officer. The office established strategies for the group as a whole. there have been no significant changes. 2. and the capital market was almost nonexistent until the recent reform . These offices were legally informal and functioned as the headquarters of chaebols. In 1998. Vol. Their operating costs were borne by the member companies rather than by the controlling shareholder.2 Internal Management and Control Monitoring of corporate management by shareholders. The staff of these organizations were employees of member firms. Some chaebols have disintegrated or shrunk in size. It also acted as the secretariat for the unofficial “presidential meeting” of the member firm presidents.94 Corporate Governance and Finance in East Asia. boards of directors.
Thus. There are many reasons for this. especially chaebols. the representative director was also the chairperson of the board. Even where the largest shareholder is not the representative director. Meanwhile. Legal provisions to protect investors were limited. However. With few exceptions. only the Government could play an effective role in monitoring corporations. as the major creditors. he or she generally approves major decisions made by the management. Directors are elected at the general shareholders meeting for a term not exceeding three years. the creditors did not declare defaults. or at least acts as the de facto CEO. creditors were not active in monitoring debtor firms and relied mainly on guarantees and collateral. except for banks. As of 1997. The board elects one or more representative directors from among the board members. the concept of fiduciary duty of managers was not well established. Even when the covenants were violated. . Board of Directors General Characteristics of the Boards Under the Commercial Code. Professionalism in management was not well developed and managers were content with receiving orders from controlling shareholders. but some large ones have two or more. this was complicated by the prevailing attitude that large companies. Banks. This policy managed to hamper any monitoring initiatives from the capital market. Most companies have one representative director. and takeover codes were not accommodative to active monitoring. corporations should have a board of directors consisting of at least three members. the controlling shareholder is officially the representative director and the CEO. were too big to fail. control is not separate from ownership. The Government’s policy and securities law provisions to protect control rights of the incumbent management had been in place until the early 1990s. In most listed companies. Loan agreements and debt indentures did not include strict covenants.Chapter 2: Korea 95 efforts. had their own governance problems. Under such circumstances. This implies that the typical agency problems in Korean corporations stem from conflicts of interest between inside (the largest) and outside (minority) shareholders. the controlling shareholder (or a member of the controlling group) was the legally registered representative director in 354 out of 551 nonfinancial listed firms. in most Korean firms.
The rules further require that the number of outside directors be not less than a quarter of the size of the board by the annual shareholders meeting in 1999. . With the boards consisting only of insiders. the attendance rate of outside directors. it has been common practice that candidates for directorship are handpicked by the controlling shareholder/CEO from among the senior managers and are automatically approved at the general shareholders meeting. Most of the outside directors in those days were the controlling shareholders of chaebols or executives of affiliated companies. the stock exchange recently amended the listing rules to require that companies disclose a detailed profile of the candidate and the person who made the nomination. there is concern that newly elected outside directors still lack independence from the management or the controlling shareholder. all of whom were managers. almost all companies succeeded in adopting cumulative voting. Despite the qualification requirements. the listing rules restrict the eligibility of independent outside directors to those who have no family ties with the managers and no significant business transactions with the company. The Commercial Code was also revised in 1998 to introduce cumulative voting for the election of directors. cumulative voting is not mandatory and a company can exclude itself from its application by amending its charter. The exchange is also expected to recommend company charters to have provisions that allow for information demanded by outside directors to be promptly supplied to them. companies have to disclose in their annual reports the frequency of board meetings. other than the representative director(s). Recent Reform Efforts on the Board System In 1997. and their positions (accept or reject) on matters voted on in board meetings. In the 1999 annual shareholders meetings. the listing rules of the Korea Stock Exchange were revised to require that listed companies have one or more “independent outside directors” by the 1998 annual shareholders meeting. Moreover. However. However. were supposed to be outside directors.96 Corporate Governance and Finance in East Asia. In order to address this concern. members of the board. II When the Commercial Code first introduced the corporate board system in the 1960s. A few large companies had more than 50 directors. they were virtually under the full control of the CEOs and in practice functioned only as management councils without any decision-making power—at least until 1998. Further. Vol.
Where the two were separate. he or she held 6. a blue-ribbon committee. was established under the auspices of the Ministry of Finance and Economy and the Korea Stock Exchange. which had extended financial support in their recent recapitalization efforts. an audit committee. Among the firms with no outside directors. Almost all (92 percent) of the respondents had one or more outside directors and 70 percent were elected after the Asian financial crisis. These results are in accordance with the new listing rules introduced in 1998. On average. Directors were most frequently elected because of their professional expertise (74 percent of the respondents marked this answer). they had a parent/child relationship in 20 percent of the cases. although some banks recently have established board committees.2 percent and the CEO 14. This is because most banks.4 directors. 88 percent had plans to hold elections in the near future. Among others. having no controlling shareholders. The Securities and Exchange Act will require large listed firms with W2 trillion or more in total assets to adopt the audit committee system. this committee adopted the Code of Best Practice in Corporate Governance. ADB Survey Results on Boards The ADB survey results confirm the above assessments and provide early indications on the effects of the reforms.9 percent on average.Chapter 2: Korea 97 The committee structure of the board as found in the US has not yet been adopted by listed companies.1 percent of outstanding shares of a listed company. In September of the same year.1 percent and outside directors 1. Meanwhile.5 percent of the shares. Where the chairperson was not the CEO. The controlling shareholder of some banks is the Government. The Commercial Code is being amended to allow a choice between the audit committee system and the current internal auditor system. the chairperson of the board was also the CEO and on average held 10. and a nominating committee. the Corporate Governance Reform Committee. the OECD principles of corporate governance were the minimum standard for the Korean Code of Best Practice. Directors were also chosen on the basis of their relationship with the controlling . In March 1999. the Korean Code recommends that large listed firms should have at least three independent directors. The average board had 8. In 78 percent of the responding firms. are required to have a majority of outside directors. who would comprise at least 50 percent of the boards. inside directors owned 16.
II shareholder (30 percent). The board or the management then determines compensation packages for individual directors. and fixed fees plus performance-related pay. the term of appointment of directors and board chairpersons is three years. Most frequently. Members of controlling shareholder families or their trusted company personnel often act as directors for multiple chaebol firm boards. and shareholding (10 percent). the management nominated director candidates (64 percent of the directors). Vol. Less frequently.2 years on average. one person was sitting on nine boards and this person was the CEO of a chaebol firm. compensation for directors must be approved by the annual shareholders meeting for each fiscal year. Chairpersons of the board were elected on the basis of professional expertise (33 percent of the firms). in 23 percent. The reason for this high frequency of interlocking directorship is that many listed firms belong to chaebols. the board had no committees. Some directors were nominated by significant shareholders (18 percent) or introduced (and elected) at the shareholders meeting. in some firms. The survey results indicate that boards determine remuneration packages for chairpersons in 42 percent of the firms. the package for the chairperson is directly proposed at the annual shareholders meeting either by the board (31 percent of the firms) or by the management (9 percent). In most firms. The general practice is that shareholders approve the upper limit on the total amount to be paid to all directors. This rather long tenure must be due to their status as controlling shareholders in most firms. The current chairperson has been in office for 6. In 91 percent of the sample firms. Remuneration for chairpersons include only fixed fees in 76 percent of the sample firms. In some instances. As discussed earlier. relationship with controlling shareholders (21 percent). a total of 562 directors were sitting on two or more corporate boards. However. In 1997. among the 81 sample firms. In one case. the management determines the remuneration. About five directors per firm have been in office for more than one term. election of directors was based on shareholdings (7 percent) and status as founder (7 percent). the board had a nomination and an audit committee. most firms just began to elect a small number of outside directors to meet a new requirement in the listing rules and thus have no experience in the AngloAmerican type of board processes.98 Corporate Governance and Finance in East Asia. including stock options. According to the Commercial Code. . founders of the company acted as the chairperson (22 percent). In 13 percent. These were established only recently. In a very small number of firms.
In 20 percent. In the survey. In cases where CEO is not the largest shareholder and chairperson. who is not the chairperson. it was proposed by CEO and approved by the board. CEO generally has the ultimate power to decide on corporate affairs. In 21 percent of cases. CEO simply follows the orders of the chairperson. CEO decides on important matters after consulting the chairperson in the majority (55 percent) of the firms. Ensuring that a company serves the public interest is considered a less important responsibility of CEO. decides on important matters on his/her own in 13 out of the 44 firms. In the 25 firms where CEO was not the chairperson of the board. in which there is no controlling shareholder. The firms in the survey consider steady growth of a company and maximization of the shareholder value as the most important responsibilities of CEO. The remuneration package was proposed by the board (and approved by the annual general meeting) in 56 percent of the firms. According to the survey. 86 percent of the firms answered positively when asked whether the largest shareholder was CEO. fixed salary plus net profit-related bonus in 9 percent.Chapter 2: Korea 99 Management CEO In the survey sample.2 years. CEOs generally maintain their positions for a long time because they are frequently the founders or largest shareholders of their firms. In a handful of sample firms. and in another 21 percent CEO bought shares in the market. and fixed salary plus performance-related pay including stock options in 13 percent. . the payment is about five times the CEO’s annual salary. CEO is also the founder in 52 percent of the firms. It indicates that CEO. A smaller number of firms consider maximization of a company’s market share and looking after the interests of such stakeholders as creditors and employees as very important. shareholding in three firms. CEOs have been in their positions for an average of 9. CEO is entitled to a large sum in cases his/ her contract is terminated before its expiration. In such cases. the survey tells a slightly different story than is generally believed in Korea. he or she does not enjoy much power. In 4 percent of the cases. he or she was selected on the basis of professional expertise in 15 firms. When CEO is not the chairperson. compensation is by fixed salary in 74 percent of the firms. CEO was given shares by the family. In less than 20 percent of the firms. However. These results show that the incentive compensation scheme for professional CEOs is not well developed in Korean firms. and was appointed by the Government in five firms.
II Senior Executives In the past. disclosure. in particular. and .100 Corporate Governance and Finance in East Asia. Transparency and Disclosure Accounting Standards The Financial Supervisory Commission (FSC) was established in April 1998 to take charge of supervising the financial markets and institutions. The bonus is supposed to be linked to company performance. About 40 percent of the listed companies had amended their charters to introduce incentive stock options by the 1999 shareholders meetings. Senior managers were even often called directors although they were not official members of the board. in practice) allocates the unsubscribed portion of new shares issued in rights offerings to executives. from IMF and the World Bank. executives sometimes have the opportunity to buy company shares at favorable prices because the board of directors (CEO. (ii) establishment of accounting standards for financial institutions. One area has been to enhance the reliability of financial statements of corporations in line with internationally accepted standards. but in practice is fixed and understood as part of a fixed salary. Vol. it was common for all senior executives to be elected as directors at the shareholders meeting. However. Usually CEO suggests the maximum amount of all the directors’ compensation at the shareholders meeting to get approval and then sets the base salary and bonus for individual executives. The commission has played an active role in introducing new rules on corporate governance. This action was in response to calls by international investors and. The term of appointment of executives did not have any real meaning because they had to leave the company if and when the controlling shareholder demanded. Penalties for fraudulent financial reports were increased. but as of March 1999 only 27 firms actually had given stock options to their executives or employees. Reforms in accounting standards since May 1998 have proceeded in several areas: (i) revision of financial accounting standards that are primary sources of the Korean Generally Accepted Accounting Principles. and accounting standards. Korean firms have rarely used shares for executive compensation. Incentive stock options have become a popular compensation method since the Securities and Exchange Act was amended in 1996 to allow the issuance of stock options to managers and other employees.
Internal and External Auditing The Commercial Code requires a corporation to have at least one internal auditor elected at the general shareholders meeting. The internal auditors are supposed to play the role of the audit committee found in the board of directors in US corporations without being members of the board. 41 percent of the companies believed that they have followed some international accounting standards. Those that never adopted international standards show their willingness to do so once the Government introduces international standards. however. Notwithstanding a regulation limiting the votes of the largest shareholder to a maximum of 3 percent of the outstanding voting rights in selecting an internal auditor. but 49 percent confessed that they have not followed international standards at all. they cannot be expected to discharge this responsibility because the representative director selects the internal auditor and can force him or her to resign. In practice. In the ADB survey.Chapter 2: Korea 101 (iii) establishment of accounting standards for “combined” financial statements of chaebols. The new rules also require financial institutions to recognize realized losses and allowances for potential losses arising from guarantees in the current year’s financial statements. The primary sources of reference in the revision were International Accounting Standards and US Accounting Standards. financial institutions must report their securities holdings at market value and recognize 100 percent of unrealized holding gains or losses in the current year’s income statement. the internal auditor is considered to be a subordinate of the . Korean listed companies with subsidiaries are required to compile consolidated balance sheets. The revised accounting standards apply to the firms subject to external auditing for the fiscal year starting on or after January 1999. Most of the companies following all or some of the international standards in the past adopted such standards before the crisis started. Thus. Consolidated reporting was introduced before the outbreak of the crisis. The new accounting standards for financial institutions adopt the mark-to-market basis to account for securities. Only 10 percent of the respondents have followed all international accounting standards. The External Audit Act and its Decree require financial statements of corporations with total assets of W7 billion or more to be prepared and audited according to the financial accounting standards and working rules set by FSC. Under the Commercial Code. they also have the power and duty to monitor the activities of executive directors.
But this problem can be mitigated if auditors function under the umbrella of the board. If the status of internal auditors is elevated to that of independent board members. as a monitor of management in the Korean (and also the Japanese) system. the Korean Code of Best Practice also recommends that large firms adopt the audit committee structure with two thirds of its members consisting of independent directors. there were many cases where external auditors failed to detect omissions and false numbers in financial statements of listed firms. External auditors are selected for a term of three years. If the company changes its external auditor for reasons that are not listed in the relevant regulation. Vol. Responsibilities of the External Auditors Committee include recommending a selection to the annual shareholders meeting and ensuring that external auditors conform to new transparency standards. and creditors selects it. underdeveloped market discipline for accounting firms. The Securities and Exchange Act will also be revised to require an audit committee for large listed companies with total assets equal to or exceeding W2 trillion.102 Corporate Governance and Finance in East Asia. . Listed and registered corporations must publish financial statements audited by external accounting firms. the relevant laws and regulations were changed after the Asian crisis to require at least one of the internal auditors to be full time and to recommend that listed firms have outside (independent) auditors. This is because the auditor. The general organizational/social culture in Korea abhors conflict and may also have hindered effective functioning of internal auditors. Big Korean accounting firms are affiliated with US accounting firms. In the ADB survey. does not have the power to hire and fire the managers. Accepting these arguments.6 years. this problem will largely disappear. The current external auditors have been associated with the surveyed companies for an average of 4. however. The internal auditor in the Korean corporate system can be argued to be inferior to the Anglo-American audit committee and the German supervisory board. and lack of strong professional ethics in the accounting profession. The Commercial Code will be revised to allow corporations to choose from the two options: the internal auditor or the board audit committee system. II controlling shareholder/CEO. The problem of misconduct on the part of the external auditor was caused partly by weak penalties on wrongdoing. About 100 listed firms will be subject to this requirement. outside directors. then the Securities and Futures Commission can appoint a new one. Previously. In order to increase independence. but since 1998 a committee consisting of internal auditors. In the past. almost all firms affirmed that the external auditor is independent from the company. the board of directors had the power to appoint an external auditing firm.
Approval of mergers and major divestitures.77 percent of the shares. However. charter amendments. A total of 326 shareholders per firm. No companies have so far introduced voting by mail. Internet. About one fifth of the listed firms issued nonvoting preferred shares. representing 62.93 percent of the shareholders but 26. The above results indicate that. the Depository is instrumental in getting resolutions passed. the Depository is subject to “shadow voting. in general. for some firms.3 Shareholder Rights Voting Rights and Practices Under the Commercial Code.” The survey shows that the Korea Securities Depository holds 69. The Korea Securities Depository can exercise the voting rights of shares left thereto by the investors (beneficial owners) if the owner of the share does not indicate his or her intention to vote personally. corporations cannot issue common shares without voting rights.53 percent of the total shareholdings.” Companies can increase the number . voting by the Depository can influence the outcome of votes because an “ordinary resolution” of the general shareholders meeting requires a majority of the votes attending and one quarter of total votes outstanding. and dismissal of directors and internal auditors require a “special resolution. About 100 shareholders per firm voted by proxy at the last annual general meetings (of the 40 firms answering the relevant questions). A “special resolution” requires two thirds of the votes attending and one third of total votes outstanding.Chapter 2: Korea 103 2. small shareholders do not attend the annual meeting and that. the only purpose of allowing the Depository to vote was to help listed companies to meet the quorum requirement for the general shareholders meeting. Under the Commercial Code. These voters represented only 5. One common share should have one vote. respectively. Citizens’ coalitions sometimes solicit proxies in order to file lawsuits against a management.21 percent of total shares issued. or telephone. amendments of the articles of incorporation require a “special resolution.3. attended the last annual general meeting. This shows that a relatively larger number of shareholders send in their proxies. Thus. The Depository represented 20 percent of the shares attending the meetings. or 10. However.” meaning that it should divide its votes in accordance with the accept/reject ratio of votes cast by other shareholders attending the shareholders meeting. The securities companies and banks are the second and third. The management is the most important proxy. Preferred shares can be nonvoting and issued up to one quarter of the total number of shares.79 percent of the shareholders.
Shareholder Protection Before the economic crisis. Shareholders have preemptive rights. mergers and acquisition plans.01 percent. and for access to unpublished accounting books and records. II of votes required for a resolution to amend the articles. or block charter amendments considered harmful to minority shareholders. In February 1998 and again in March. the board of directors decides on issues of shares within the limit of the authorized capital. It also attended the shareholders meeting of several companies to present the views of outside shareholders. However. Various measures have since been taken to improve investor protection. Those that are most likely to be rejected relate to election of directors. Due to the changes in rules for investor protection.104 Corporate Governance and Finance in East Asia.5 percent. was able to force a change in the charter of SK Telecom. dividend proposals. As an example. and major investment projects (only five firms answered this question). Proposals put forward by management are rarely rejected at the general meetings. Changes in the authorized capital require an amendment of the articles of incorporation.0 percent. In four out of 62 respondents. The amendment included a provision requiring the company management to get prior approval of shareholders to undertake major investments and raise capital in international markets. the Securities and Exchange Act was revised to lower the representation requirement for shareholder derivative suits from 1 to 0. from 3 to 1. Only two out of 62 respondents to this question have had cases in which proposals were rejected. the requirement was lowered from 1 to 0. The company also agreed to the right of the fund . laws and regulations were generally very loose in protecting the rights of minority shareholders. but these can be waived by an amendment of the articles of incorporation. The charges included self-dealing by a controlling shareholder and unfair subsidization of affiliated companies by a chaebol firm. Vol. an institutional investor based in the US. the Tiger Fund. This citizens’ coalition actively contacted the management of selected companies and negotiated measures to protect shareholders. demand changes in business policy. For recommendations for dismissal of directors and internal auditors. an activist citizens’ coalition has brought shareholder derivative suits against several large listed firms. This coalition also attempted to cooperate with domestic and foreign institutional investors to find their way into general shareholders meetings. the annual general meeting passed a resolution that was not proposed by the management nor the board of directors but rather by shareholders.
After the economic crisis. but it was not entirely clear whether they had the duty of loyalty as well. Before the amendment. Banks have played some limited role in monitoring the investment activities of chaebols. loans to directors.Chapter 2: Korea 105 to recommend two directors to the corporate board. As for bond issues. For further protection of investors. underwriting securities firms acted also as trustees. managers were considered to be subject to the duty of care. This has strengthened the accountability of controlling shareholders as de facto CEOs. bond indentures are only a few pages long compared to a few dozen pages found in advanced bond markets. In fact. . The covenants in loan agreements and bond indentures were very loose. there was the usual conflict of interest problem and the trustee did not have the incentive to strictly enforce the covenants. These have to be disclosed under the Securities and Exchange Act or approved by shareholders under the Commercial Code and other laws. Thus. simple. creditors did not interfere with the management of a debtor. affiliated lending or guarantees. In 1974.3. the Government had for some time pushed for the enactment of class action suits on false statements and omissions in disclosure materials.4 Control by Creditors Role of Creditors in Corporate Monitoring Traditionally. and not strictly enforced. The laws and regulations of the country protect shareholders from interested transactions. However. Banks themselves were poorly governed and bank managements had little incentive to monitor borrowers. The Code has also been amended to state more clearly the fiduciary duty (of care and loyalty) of the management. This was one of the most significant developments with respect to shareholder activism in the Korean capital market. The Commercial Code has a new clause that regards the controlling shareholder as a de facto director if he or she uses personal influence to affect business decisions of the management. it now appears that it has backed away from its earlier efforts to introduce legislation on class action suits. the Government introduced the Credit Management Regulation system whereby chaebols were required to seek the approval of their main banks prior to undertaking large investments. 2. controlling shareholders have become more susceptible to liability claims by other (minority) shareholders. and transactions with major shareholders. mergers and acquisitions.
In 1994 the approval requirement was abolished. there have been concerns that the Government might use the system to intervene in the management of the business groups. a main bank is charged with collecting and analyzing financial information of the firm and delivering its opinion on various applications and matters requiring consultation among lenders to the firm. Under the system. creditors now have a bigger say in court proceedings for receivership and composition. The firms subject to the system are required to get the approval of the main bank prior to purchasing real estate. II acquisitions. Emphasis on the monitoring role of banks has been growing since the beginning of the Asian crisis.106 Corporate Governance and Finance in East Asia. However. The 10 largest business groups are required to select no more than three core companies in consultation with their respective main banks. the main banks should review the feasibility and financing plans of projects undertaken by the core companies and monitor their financial conditions and prospects. this proposal has only a slim chance of being accepted by the Government or legislature. and purchases of real estate. including. In turn. Besides the setting up of an “External Auditors Committee” by firms. The objective of the system is to improve the financial condition of the largest business groups and promote the soundness of bank management. Some proponents argue that creditors should have the right to send their representatives to boards of directors of borrowers. The view that is more popular among theorists is that creditors would pursue goals that are not in harmony with value maximization and the decision-making role should be bestowed on the shareholders as residual claimants. 11 banks. On the other hand. However. Vol. ADB Survey Results on Borrowing and Lending Practices The ADB survey shows that a typical nonfinancial company is associated with various types of creditors. The main bank should also monitor and restrict extension of loans to the controlling shareholder and other firms in the group. recently banks have been increasingly interested and successful in electing former bank officers as outside directors of firms that underwent workout processes. In 1996. 10 nonbank . Purchase of real estate should be financed by equity capital and not by borrowed funds. on average. as discussed earlier. the main bank system was introduced and has been applied to the 51 largest business groups to which banks extended more than W250 billion in loans and payment guarantees.
Breakdown of loan guarantors is as follows: about 40 percent of loans are without any guarantees. penalty was involved in rescheduling. payments were usually rescheduled through negotiation without any penalty. With respect to the types of loans. The borrower’s relationship with most banks has lasted for more than five years. A few creditors exercise influence through covenants relating to major decisions by the company. 16 percent . or creditors filed for receivership. or through their shareholdings. while a third think that creditors have weak influence. Among the creditors. most frequently in the form of loan guarantees and less frequently by arrangement of guarantees by a third party. whereas seven of the 17 nonfinancial corporations are. in order of importance: affiliated companies. More than half of the firms think that creditors have no influence on their management and decision making. banks are most likely to require collateral. Most firms feel that requirements for collateral have been tightened since the crisis started. and purchase or supply of raw materials. The assistance came from. renegotiation took place after the crisis. For a small number of firms. subsidiaries. For more than half of such firms. mutual guarantee agreements. 35 percent are guaranteed by the company itself (by collateral and purchase of guarantee insurance). and 17 nonfinancial corporations. holding companies.Chapter 2: Korea 107 financial institutions (NBFIs). Relationships with affiliated companies providing guarantees or collateral include ownership of each other’s shares. Creditors usually exercise their influence through covenants relating to the use of loans. and other financial institutions. Most of the 43 firms with renegotiation experience were able to borrow from the same creditors afterwards. One tenth of the firms received assistance from the Government in loan applications. controlling shareholders. NBFIs infrequently ask for collateral. About 60 percent of the firms have experienced renegotiation of loan repayment with creditors during the last five years. Most of the financial institutions are not affiliates of the borrowing company. About half of the respondents received assistance from other sources in the form of loan guarantees and/or provision of collateral. Only a few feel that creditors have very strong influence. collateral is more likely to be required of loans for working capital than for fixed investments. holding shares of another company by both the borrower and the guarantor. The typical company has also maintained its relationship with five of the 10 NBFIs for more than five years. collateral was taken away. When loans could not be repaid on time.
major creditors. the lead creditor banks formally signed Capital Structure Improvement Plans with chaebols. the Korean Government maintained a policy of protecting the incumbent management of listed companies. the Corporate Restructuring Coordination Committee (CRCC) will provide arbitration. In cases where the creditors are unable to reach an agreement on a workout plan. 4 percent by subsidiaries. Under a contract signed between the creditors and the debtor. The new ways through which creditors. Third. Vol. are summarized below. II by other affiliated companies. This committee was set up in accordance with the provisions of the CRA. First. Separate from but emulating the CRA. and in continued monitoring of debtors.5 The Market for Corporate Control Government Policy Toward Hostile Takeovers Until 1994. 2. banks and other institutional lenders are playing more important roles than ever before.108 Corporate Governance and Finance in East Asia. have been the driving forces for restructuring activities of the largest 64 chaebols. the main vehicle for implementing the workout concept (or the London Approach) is the Corporate Restructuring Agreement (CRA) signed by 210 financial institutions in July 1998. Representative of the policy was the stipulation under the Securities and Exchange Act that no one can accumulate more than 10 percent of the voting shares of a listed company . including commercial and merchant banks. the delegation has the right to approve wide-ranging financial activities of the firm. Second.3. the creditor banks will send a delegation composed of bank officers to the workout firm to oversee its management. This agreement will provide guiding principles in coordinating diverse interests among creditor institutions and promoting cooperation. will get involved in the restructuring and workout processes. Role of Creditors in the Corporate Restructuring Process In the current process of business restructuring and workouts of an unprecedented number of firms under financial distress. The leading creditor banks will continuously monitor the progress in implementing the signed Plans. In this connection. and 1 percent by the Government. 2 percent by holding companies. especially banks. Behind these new strengthened roles of creditors is the newly set-up FSC. a Lead Creditor Council Agreement was signed for restructuring the top five chaebols.
However. an acquirer of shares wishing to own more than 25 percent of the issued shares was required to make a tender offer to buy at least 50 percent). As far as institutional arrangements are concerned.Chapter 2: Korea 109 unless he or she obtains prior approval of the Securities and Exchange Commission. The policy to protect the incumbent owners/managers was formally dropped when the Securities and Exchange Act was amended in 1994 to abolish the 10 percent limit. It was generally believed that the securities authority would use its power to review and order revisions of the tender offer statement to halt any hostile takeover attempt. The incumbent controlling shareholders used various tactics such as issuing privately placed CBs. Publicly issued CBs require three months before their owners can convert them to shares. Privately placed CBs cannot be converted into shares in one year. more than half of these attempts failed. Korea does not have the mandatory takeover rules applying to those who amass more than 30 percent of the shares outstanding (until 1998. Takeover Activity As soon as the Act was amended. it can be safely stated that Korea now has one of the most accommodating capital markets with respect to hostile takeovers in the region. Between 1994 and 1997. turning to white knights. In the early 1990s the Government shifted its policy toward freer activities in the market for corporate control. For takeover defense. but were completely eliminated in 1998. The shareholders already owning more than 10 percent at the time the company went public were exceptions to the rule. A company cannot issue new shares to a third party without first amending the corporate charter. listed firms rely mainly on shareholdings by the largest shareholder. Poison pills cannot be used mainly because companies cannot distribute stock options as dividends to shareholders. and announcing competitive tender offers by the controlling shareholder. hostile takeovers by tender offers began to appear in the capital market. Companies have also utilized share repurchases. Unlike the UK. a total of 13 hostile takeover attempts occurred. Limits on acquisitions of shares of a Korean firm by a single investor were gradually increased over a six-year period beginning in 1992. Unlike Germany. corporations cannot limit the voting rights of large shareholders to a given maximum. In one case. the outside shareholders did not want to sell shares because the share price went above the offer price due to a share repurchase by the target and anticipation of a competitive bid from a third party. Stock purchases by tender offer were also exempted. The reasons for failure are diverse. .
6 Control by the Government State-Owned Enterprises Government ownership of listed companies is very limited. 172 firms (or 22 percent of listed firms) belong to the 30 largest chaebols. in which the Government still holds the largest ownership. Many of the takeover targets in the past did not have a controlling shareholder (group). was newly listed. an electric power company. Another reason is that many listed firms belong to chaebols. Vol. Some had two or more large shareholders who had joint control of the firm but could not cooperate. the Government became the largest shareholder of several commercial banks through equity participation purporting to recapitalize them out of financial distress. the limit will be eliminated when it is fully privatized in two years. For the others. Hostile takeovers in Korea will be rare in the future. As of February 1999. 2. a steel company. Golden parachutes are almost unknown in Korea because the total amount of director compensation has to be voted on at the general shareholders meeting each year. except for the banks. Currently the limit is 3 percent. are designated as public companies. some firms have included a supermajority provision for the dismissal of directors and provided for a staggered board. It is harder now to find such firms. One reason is that the percentage of inside shareholdings (by the controlling shareholder group and the firms under its control) for an average listed firm is very high (26.110 Corporate Governance and Finance in East Asia. it is not certain whether the Government will ever fully privatize them and whether it will hold a golden share in the case of a complete sale of Government-held shares. In their charters. The Government-owned listed companies. and a bank had government ownership. Korea Telecom.3. Charter amendments have also been employed by some firms to limit the maximum number of directors. As of the end of 1997.7 percent on average as of the end of 1997 for nonfinancial listed firms). which are allowed by the Securities and Exchange Act to set the limit on the ownership of shares by one single shareholder. Firms affiliated with a large group are generally regarded as difficult targets as the other members of the group will come to the rescue or act as white knights. For the steel company. In 1998. II The Securities and Exchange Act was revised in 1998 to abolish the 10 percent limit on share repurchases and the Government simultaneously eliminated the limit on foreign ownership of shares of listed firms. In 1999. .
Even where employees hold . The Government’s right to send public officials to the boards was eliminated. was amended in 1997 to introduce a board structure consisting of a majority of nonexecutive directors. Control Over Private Companies One of the pronounced purposes of government intervention in the corporate sector has been to prevent concentration of economic power in the hands of a few large chaebols (see 2. went into effect in 1998 to prevent them from absorbing too much of the funds available in the market. each of the 10 largest chaebols was allowed to raise funds no more than 4 percent of the total market capitalization of the member firms. But this rule. controlled the total amount of corporate bonds issued per month and allocated amounts to individual corporations. more state-owned corporations became subject to this new board structure. The Government has frequently imposed restrictions on the use of capital markets by large companies. There were also limits on the amount raised and the number of issues per year. which limits the total amount of bonds issued by the five largest chaebols. Labor is not represented in corporate boards. which was introduced in 1996. especially those belonging to chaebols. 2. Meanwhile. It was abolished before the economic crisis but another regulation.3.Chapter 2: Korea 111 The Government used to appoint a few public officials to the boards of state-owned corporations. nominated by the minister in charge of the company in question. the Government. is being applied to the 51 largest business groups to which the banks extended more than W250 billion in loans and payment guarantees.1).7 Employee Participation in Corporate Governance Employee participation in corporate governance is very limited. the main bank system. and approved by the Chairperson of the Planning and Budget Commission. as applied to four large corporations. The nonexecutive directors are now recommended by a committee. In addition. only qualified firms could issue new shares. There is no active debate or discussion going on about this potentially difficult issue.3. Further. This was aimed at limiting the supply of bonds thereby stabilizing interest rates. The objective of the system was to improve the financial condition of the chaebols and to promote the soundness of bank management. For example. Beginning in 1999. administering through a self-regulatory committee of the securities industry.
Collective bargaining is. Two thirds of the respondents had an organized union. Vol. Employee stock ownership plans became popular in 1974 when the Government allowed tax and financial benefits for stock purchases by employees. employees of listed firms issuing shares through rights offerings are entitled to 10 percent of the rights. 2. they delegate their voting rights to plans’ representatives. At the national level.1 in 1997. carried out at the enterprise level. in principle. there are two federations of labor unions. and development of the company. these firms have to offer 20 percent of the shares being issued to their employees at the public offer prices. and 66 percent manual workers. and 2. of which 2 percent were senior managers. Employees of companies have had the opportunity to buy shares of their employing businesses at favorable prices. Under the Capital Market Development Act of 1968. Under the Labor Management Council Law. operation. In these firms. The percentage of shares held by the employee stock ownership plans in listed companies was 1. II shares of their companies through employee stock ownership plans. 32 percent technicians and professional staff. Local unions in the same industry have established industrial labor federations. the council meetings have been superficial. About half of these firms considered the influence of the union on the management of the company to be weak.9 in 1980. Trade unions are organized on an enterprise basis. union members account for 54 percent of the employees. which were generally much lower than estimated values. This practice may be due to the fact that employees are typically submissive to their employers and that their total shareholdings are minimal. the subscription rights given to employees when a company goes public and when a listed company issues shares were increased to 20 percent of the new shares. but 27 percent of them felt that it was strong. employers are required to meet with representatives of labor unions at least once every three months. the management usually consults the union on major issues relating to the management. . The typical collective bargaining agreement has a one-year duration. The respondents of the ADB survey had 2.112 Corporate Governance and Finance in East Asia. In 1987.654 employees per firm on average. In actuality. The union had no influence on the management in 17 percent of the firms.5 in 1990. This law is not intended for wage negotiations but for employers to seek cooperation and productivity increases from workers. Under another law enacted in 1972 to induce private companies to go public. The relevant regulation was amended recently in order to facilitate voting by individual employees. In 70 percent of the firms with organized unions.
Chapter 2: Korea 113
Corporate Financing7 Overview of the Financial System
The foundation of the modern financial system in Korea was laid during the early 1950s. Specialized banks were established during the 1960s to facilitate capital mobilization and strengthen financial support for underdeveloped or strategically important sectors. Most NBFIs were introduced during the 1970s to diversify financing sources, promote the development of the money market, and attract funds into the organized market. From the early 1980s, several commercial banks and NBFIs were added as part of a series of broad measures to spur financial liberalization and internationalization. These measures coincided with a shift from a government-oriented economic policy toward a market-oriented stance. Recently, the Korean financial system has been undergoing substantial changes through a comprehensive financial reform program. This program was agreed upon by the Korean Government and IMF upon the signing of a financial aid package. At present, financial institutions in Korea may be divided into three categories by function: the central bank (the Bank of Korea); banking institutions, including commercial and specialized banks; and NBFIs, including development, savings, investment, insurance, and other institutions. Corporations raise funds through direct loans from the banks and NBFIs, and by transactions with the public through the money market, stock market, and bond market. Banks To a certain extent commercial banks have engaged in long-term financing in addition to their short-term banking operations. They still tend to depend heavily on borrowings from the Bank of Korea to cover persistent shortages in their own loanable funds, although the ratio of these borrowings to their total sources of funds has decreased. Commercial banks in Korea may, as in most countries, engage in a wide range of business. In addition to their core activities, they also handle such businesses as guarantees and acceptances, own-account securities investment, and receipt and disbursement of Treasury funds as agencies of the Bank of Korea. Specific authorization is required for each area of nonbank business they engage in: such as trust ac7
The authors gratefully acknowledge the help of Prof. Bong-Han Yoon who contributed several sections of this part.
114 Corporate Governance and Finance in East Asia, Vol. II
counts, credit card business, and some aspects of securities business. Specialized banks, which function as deposit money banks alongside commercial banks, conduct a similar range of business in addition to their own areas. From the early 1980s, banking institutions moved into a number of new business areas and developed a variety of innovative products to raise their competitiveness against NBFIs, and to meet the growing and diversified demand for financial products. Examples are credit cards, sale of commercial bills discounted by themselves, factoring business, trust business, certificates of deposit (CDs) business, and sale of cover bills. They also entered such security businesses as sales of government, public, and corporate bonds under repurchase agreements; the acceptance, discount, and sale of trade bills; and lead underwriting and over-the-counter sales of government and public bonds. In the early 1980s, the trust business, which had been limited to Bank of Seoul and Trust Company, was opened to all banks. Nonbank Financial Institutions NBFIs can be broadly classified into the following categories: (i) development institutions comprising the Korea Development Bank and the ExportImport Bank of Korea; (ii) savings institutions including the trust accounts of banking institutions, mutual savings and finance companies, credit unions, mutual credit facilities, and postal savings; (iii) investment companies comprising investment trust companies and merchant banking institutions; and (iv) contractual institutions such as insurance companies and pension funds. In addition, there are various nonbank institutions that handle specialized lending such as leasing, factoring, credit cards, consumer loans, housing loans, and venture financing without receiving deposits. NBFIs have increased their share of total funds supplied since the 1980s as they have been permitted greater freedom in management and operations. The market share of banking institutions in terms of Korean won deposits dropped sharply from about 71 percent in 1980 to 30 percent in 1997; while that of NBFIs increased from 29 percent to 70 percent during the corresponding period. Differences in regulatory treatment accounted for the greater freedom in management for the NBFIs. They were allowed relatively greater flexibility in their management of assets and liabilities and, most important, were permitted to apply higher interest rates on their deposits and loans. Evenness in regulatory treatment concerning such interest rates has, however, largely been achieved following the completion of a four-stage plan for deregulation of interest rates from 1991 to 1997.
Chapter 2: Korea 115
Money Market The money market is composed of the call market and a wide range of other short-term financial markets including those for Treasury Bills, Monetary Stabilization Bonds (MSBs), negotiable CDs, repurchase agreements (RPs), commercial papers (CPs), trade bills, and cover bills. The beginning of the organized money market in Korea dates from when MSBs and Treasury bills were first issued in 1961 and 1967, respectively. However, the money market remained underdeveloped until the early 1970s when the Government took a series of measures designed to channel curb market funds into financial institutions and to systematically organize the short-term financial market. In 1972, with the passage of the Short-Term Financing Business Act and the establishment of investment and finance companies, the sale of papers issued by nonfinancial business firms and investment and finance companies was initiated. This was a first step toward the formation of an advanced money market. In 1974, negotiable CDs (large-value time deposits at banks) were introduced. In addition, call transactions, which had previously taken place between individual banks, were put on a systematic basis. In 1977, the Korea Securities Finance Corporation initiated repurchase agreements with securities companies involving bonds on a shortterm basis. Various new financial instruments, including CPs, were introduced in the early 1980s. Since 1985, there has been a sharp increase in the outstanding balance of money market instruments. This is chiefly due to product innovation and expansion in the number of financial institutions handling such instruments. The volume of money market transactions expanded from W7,995 billion in 1985 to W44,201 billion in 1990, and W98,100 billion in 1995 (as of the end of June). Stock Market Activity in the primary (new issues) stock market was extremely brisk during the period 1986 through 1989. The value of shares sold in IPOs and in rights offerings by listed companies grew 48 times from W294 billion in 1985 to W14,176 billion in 1989. But the stock market sagged in 1990, resulting in a decline in IPOs and seasoned issues. The composite stock price index declined substantially during 1990-1992 due to continued labormanagement disputes and a slowdown in economic growth. Though the market recovered temporarily from 1993 to 1995, it again went into a slump
116 Corporate Governance and Finance in East Asia, Vol. II
after 1996 until the index hit 350 in December 1997 with the onset of the financial crisis. A new stock market was organized in April 1987 to provide a new means of trading stocks for small- and medium-sized companies and venture businesses not eligible for listing on the Korea Stock Exchange. A corporation satisfying less stringent criteria can register with the Korean Securities Dealers Association under the sponsorship of at least two securities companies. This market, named KOSDAQ, is not exactly an over-thecounter (OTC) market in that, unlike the National Association of Securities Dealers Automated Quotations (NASDAQ) in the US, there are no active dealers for registered shares. Still, investors are assured of a certain degree of liquidity of the shares registered at the KOSDAQ. Though the KOSDAQ is still in its infancy, it has been showing a great potential for growth by providing liquidity to shares of small and large firms before they are eventually listed on the Korea Stock Exchange. Despite the considerable growth and good performance of the Korean stock market, many problems were exposed with the onset of the financial crisis in 1997. The major problems may be identified in the following areas: (i) corporate disclosure system; (ii) reliability of accounting information; (iii) protection of small shareholders; and (iv) inactive takeover markets. Bond Market Public and corporate bonds are issued in the Korean bond market. Public bonds include government and other bonds that are issued by provincial and municipal governments, government-owned enterprises, and government-owned financial institutions. All public bonds are implicitly or explicitly guaranteed by the central Government. Corporate bonds are those issued by private companies under the Commercial Code. The value of listed public bonds became larger than listed corporate bonds in 1986 and remains to be so. The secondary bond market consists of the exchange and the OTC market. However, as in most other countries, the OTC market has dominated trading in bonds. Almost all of the bond transactions still take place on the OTC market despite government efforts to develop a separate exchange market for bonds. Most corporate bonds were issued as guaranteed bonds where the payment of principal and interest is guaranteed by financial institutions. Nonguaranteed bonds or debentures accounted for only 15 percent of the
Chapter 2: Korea 117
total issued in 1997, although their proportion reached 30 percent in 1995. This implies that most bonds were issued according to similar conditions regardless of the financial standing of the issuing company and that the bond rating system has not been well developed in Korea. However, all of this is changing. Bond rating agencies are now applying tighter criteria. Banks have strengthened their credit reviews in extending debt payment guarantees because of tighter regulatory and market pressures on their own financial conditions. Most securities companies have all but stopped extending guarantees. One of the dramatic changes in the bond market after the IMF bailout is that most corporate bonds are now issued on a nonguaranteed basis. The proportion of nonguaranteed bonds accounted for 69 percent of the total offerings of corporate bonds in 1998. This is in contrast with the prebailout period, when the proportion of guaranteed bonds was more than 80 percent of the total offerings. One problem for the corporate bond market is that most bonds are issued with maturities of less than four years. The maturity of corporate bonds should be lengthened to generate stable longterm funds for corporations. Financial Deregulation Discriminatory government regulations in the financial sector were prevalent during the 1970s. Entry into financial industries such as commercial banking, investment banking, securities brokerage, merchant banking, and insurance was strictly controlled. Ownership of commercial banks and their internal governance structures were controlled for many decades. These factors resulted in a serious structural imbalance in the financial industry. It diminished the role and profitability of banks while encouraging growth of NBFIs. In addition, the capital structure of business firms worsened and the unorganized money market rapidly expanded. In order to reduce government intervention and to restore the balanced development of the financial market, interest rate deregulation was initiated in June 1981. A significant advance occurred in December 1988, when most of the lending rates of banks and NBFIs were liberalized. Only interest rates on long-term deposits were regulated to avoid excessive competition among financial institutions. Interest rates on remaining deposits were gradually deregulated. However, in 1989, when interest rates rose rapidly and macroeconomic conditions deteriorated, the Government again placed extensive control over interest rate movements, including window guidance. In August 1991, the Government announced the Four-Stage
In June 1993. flow of funds analysis was used to examine patterns of financing of the aggregate corporate sector. The Government handed over its controlling stakes in four commercial banks to private hands in 1981-1983. It included such important issues as interest rate deregulation. the Korean Government announced its Financial Liberalization and Market Opening Plan. mutual savings. On the basis of flows of funds. as a first step toward liberalization of capital account transactions. opting to bring in the plan step-by-step to avoid market dislocation from a sudden shift in the system. entry barriers to banks and NBFIs were lowered in an attempt to promote competition. and the 30 largest chaebols. depreciation.5 percent in November 1981. II Interest Rate Deregulation Plan. was liberalized drastically in 1998 after the financial crisis.2. and organization of commercial banks. The Government adopted a cautious approach. . Since 1985. finance companies. implementing the first stage in November 1991. Also. The Government began to considerably deregulate foreign exchange in 1987 due to the shift of the current account into surplus in 1986 (see 2. Vol. which resulted in the establishment of a number of new banks.2 Patterns of Corporate Financing Corporate Financing Practices In this section. Moreover. the Government simplified various directives and instructions regulating personnel management. development of the money market. the Government announced a plan in 1981 that substantially improved foreign investors’ access to the domestic capital market.118 Corporate Governance and Finance in East Asia. Meanwhile. revision of the credit control system.1). The plan was launched partially to accommodate US demands for comprehensive structural deregulation and market opening of the financial sector. Korean firms have been allowed to issue CBs in international financial markets. the following measures can be constructed: Self-financing ratio (SFR) is the ratio of change in internal funds to change in total assets. In addition. With the privatization of nationwide commercial banks. listed companies. and liberalization of foreign and capital transactions. the required reserve ratio was substantially lowered from an average of 23 percent in 1979 to 3.4. the business scope of financial institutions was greatly widened from the early 1980s. 2. etc. The capital market. Some policy loans were also abolished. especially the domestic bond market. budget. Internal funds include retained earnings. short-term finance companies.
particularly in the short term. 1994. Incremental debt financing ratio (IDFR) is the ratio of change in total borrowings to change in total assets. The corporate sector used . Securities finance became a more important source from 1988 onwards. and 1997. on average. particularly in the 1990s in response to the liberalization of the capital market.25 shows the flow of funds of the nonfinancial corporate sector in Korea during 1988-1997. In securities finance. comprising internally generated capital (retained earnings. but it remained less than 10 percent of total financing. but do not include capital surplus (asset revaluation allowance and the excess of current value over issue value of stock). the proportion of foreign borrowings in total finance rose steadily. Equity capital represents the shareholders’ commitment to the business. The share of external financing. depreciation. and government transfers.Chapter 2: Korea 119 and net capital transfers from the Government. This means that internal funds after dividend payment were insufficient to finance growth in total assets. including all sources other than retained earnings. It measures the degree of financing growth in total assets by additional equity. Table 2. The SFR averaged 28. except for the stock market boom of 19871988.4 percent in the precrisis period 1988-1997. and allowances) and new equity capital. Incremental equity financing ratio (IEFR) is the ratio of change in stockholders’ equity to change in total assets or 1-IDFR. financing by corporate bonds and CPs was more significant than by new equity. In 1988 when the stock market boomed. Meanwhile.25. Before 1988. The use of additional debt to finance growth increases financial risks as the company may not be able to pay interest during periods of recession or high interest rates. Additional equity capital used to finance growth reduces the financial cost and the financial risk of investment. was 71 percent during the period. capital surplus. It measures the degree of financing growth in total assets by additional debts. Financing Patterns of the Aggregate Corporate Sector Table 2. New equity financing ratio (NEFR) is the ratio of change in equity (stocks issued + equity other than stocks) to change in total assets. depreciation. the proportion of borrowings from NBFIs fell to its lowest value at 4 percent.26 shows the four measures of corporate financing calculated from Table 2. This high proportion deprived Korean businesses of flexibility during recession periods due to high financial costs. the corporate sector’s most important source of external finance was bank borrowings. except in 1991.
9 9.3 10.0 11.1 12.4 71.5 0.6 4.7 15.3 30.3 3.1 0.0) 12.7 10.5 2.1 2.1 — 27.6 3.7 — — — — 9.3) 11.7 11.1) 4.6 Sources of Funds Internal Financinga External Financing Bank Borrowings Banks Nonbanks Merchant Banks Insurance and Others Securities Natl.6 0.3 2.6) 5.1 2.6 9.1 0.8 8.6 0.2 10.3 1.1 72.2 2.7 6.3 6.4 (0.7 1989 1990 1991 1992 1993 1994 1995 1996 22.4 0.1 3.8 1.2 34.2 13.6 14. which is the excess of current value over issue value of stock.0 0.6 10.1) 6.7 2.4 10.6 77.7 8. a Includes retained earnings.0 3.3 16.1 1.1 1.6 3.4 2.7 2.3 25.8 0.3 1.25 Flow of Funds of the Nonfinancial Corporate Sector.5 0.1 3.9 0.5 9.4 27.3 6.2 26.6 25. depreciation.1 (0.5 13.3 27.0 9.4 0.2 (0.3 6.2 1.6 4.0 0.7 32.7 13.2 14.9 10. and Flow of Funds.7 (0.8 15.6 11.7 12. Source: Understanding Flow of Fund Accounts.0 — — — — 8. Bank of Korea.9 2.0 (0.2 — 28.7 4.7 10.7 1.6 4.1 10.7 10.1 1.8 30.0 3.4 11.9 34. 1994.1 23.3) 15.4 2. .0 1.2 15.1) 4.5 2.6 2.8 1.4 3.4) 13.6 8.7 4.0 5.1 8.4 27.7 73.2 0.7 8.3 1.4 2.9 73.8 17.8 (0.6 11.7 71.7) 11. 1988-1997 (percent) 1988 43.7 1.7 7.2 13.2 5.9 10.8 1.8 1.6 9.3 72.6 5.5 29.4 27. Bank of Korea.9 72.6 0.1 3.0 9.9 6.0 1997 26.3 — — — — 8.5 16.6 0.1 36.9 28.2 6.0 70.6 (0.1 27.8 4.8 27.4 — 28.0 2.Table 2.7 14.7 14.5 0.0 10.0 3.8 -2.4 1.4 1.2 6.4 2.4 8.8 — 26.6 1.1 17.9 38. and Public Bonds Commercial Paper Corporate Bonds Stock Issuesb Equity Other than Stock Foreign Loans Foreign Current Bonds Trade Credit Direct Investment Others Others Government Loans Business Credit Other Financial Debts — = not available.0 17.6 9.8 56. b Includes capital surplus.4 21.4 15.2 — — — — 9.1 (1.5 16.8 1.3 3.0 22.3 — 30.0 16.4 (2.5 2.4 9.1 — — — — 12.3 5.7 2.5 2. and net capital transfers from the Government.
SFR peaked at 44 percent.1 26.4 percent. additional equity to finance 12.2 percent of the growth in total assets.1 39.8 10.1 17.1 12. Across industry.7 40. . There were significant time trends.4 percent.5 percent.2 37.7 30. and Flow of Funds. dropping to 26. 1994. Incremental financing from equity was 40.4 percent (Table 2.5 68.6 62. higher than the aggregate 40.2 IDFR 36. was financed by additional debts. average SFR was 37.9 46.4 NEFRa 20. Its IEFR and NEFR dropped to 23.9 22.7 percent in 1997.4 12. NEFRs.6 percent.Chapter 2: Korea 121 Table 2.8 28. higher than the aggregate 28.3 60.7 40.1 53.0 57. and the total debt ratio was much higher in 1996 and 1997 at 62. Source: Calculations from Understanding Flow of Fund Accounts. and IEFRs were declining.9 60.6 percent and 1.5 and 76.5 12. 45.5 31. indicating a high financial risk position.0 5.0 27.4 27. Bank of Korea.6 percent. Bank of Korea.4 IEFR 63.3 percent in 1997. Lower income diminished the industry’s equity position toward crisis year 1997. On average.7 9.9 28. It dropped to 28 percent the following year. In periods of high economic growth such as in 1988.3 73. respectively.0 11. NEFR registered 20.6 percent over the 10-year period.3 11.5 percent in 1997.3 27.8 percent of its total asset growth through debts. but plunged to 5.27).26 Financing Patterns of the Nonfinancial Corporate Sector.7 26. the corporate sector relied heavily on external financing for its expansion. in the manufacturing sector.8 62.7 40. IEFR ranged from 32 percent to 64 percent of asset growth during the boom years.9 percent by 1997 when net profit margins were negative. Manufacturing financed 54. respectively.6 26.4 37.3 12. an average of 59. IDFR reached 73.0 42.1 percent in 1988 during the stock market boom.6 Excludes capital surplus.2 percent of incremental asset growth was financed by equity. 1988-1997 (percent) Year 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 Average a SFRa 43. While SFRs. The balance. declining to 26.3 59.7 28.3 59. but also continuously fell.
5 7.4 46.2 percent in 1993.5 1.6 53. It had the highest average SFR in 1988 at 31.7 percent in 1996. and low total debt and short-term borrowing ratios. with the total debt ratio much higher in 1995-1997 at 82 to 84 percent.9 percent.6 36.4 63. Since 1992.8 4.6 3. large firms showed more cyclical patterns in these financing ratios than small.6 4. These sectors had relatively low equity financing ratios and high total debt ratios in financing asset growth between 1988 and 1997.9 IDFR 34. the proportion of short-term borrowings in total financing has been high.3 28. gas.4 45.9 percent of asset growth. from 17.2 21. II The construction industry showed the most cyclical pattern in annual asset growth.122 Corporate Governance and Finance in East Asia.9 6. their average SFR was higher.6 54.8 percent in 1990. Total debt financed an average 74.27 Financing Patterns of the Nonfinancial Corporate Sector by Industry (percent) Year Manufacturing 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 Average SFRa 50. one year ahead of the other industries. then increased to 20.6 45.7 47. On the other hand. Financing patterns of the wholesale.and medium-sized firms.0 42. In 1997. Table 2.7 47. the utilities (electricity.5 NEFRa 9.0 30.1 percent of total asset growth for the period. which decreased to 8.8 percent in crisis year 1997. this dropped further to 15.4 54. Equity financed an average 25.3 52.6 62.6 37. Categorized according to company size. and hotels sector and realty/renting/business activities sector were similar. storage. and communication sector had relatively high incremental equity ratios.2 62.1 29.0 42.0 3.5 23.2 3.0 57. Since large firms were more profitable. the two sectors also had low equity financing ratios and high debt financing ratios.5 76.6 37.7 37.6 53. explaining partly the collapses of several construction companies in 1995. Vol.2 .7 37. and steam) and the transportation. and fell to about 10 percent in 1997.4 47.8 50.4 37.4 3.8 IEFR 65. retail.2 5.
4 28.5 1993 22. Storage.8 25.3 4.0 .9 15.7 41.9 20.1 19.8 1991 51.8 29.6 2.6 37.8 54.0 4.7 1989 26.5 76.8 4.0 68.6 14.27 (Cont’d) Year SFRa NEFRa IDFR 53. Household Goods.9 1992 56.5 1.1 66.0 31.1 69.7 15.8 76.9 Construction 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 Average 31.5 12.2 4.0 34.5 20.8 70.2 5. and Communication 1988 64.9 1989 63.6 8.3 47.2 3.2 Average 53.3 84.6 37.0 82.1 25.2 74.0 1.2 18.9 1. Hotels 1988 33.9 1.7 78.8 81.6 9.9 1993 63.7 6.2 29.6 4.3 19.5 87.6 8.2 46.4 1995 53.1 Trasport.6 9.2 1995 16.5 70.9 47.9 Average 19.4) 2.9 2.7 7.4 IEFR 46.7 53.0 3.0 1990 50.0 17.4 2.5 21.9 9.2 10.1 70.9 52.0 60.2 23.6 73.1 59.7 Wholesale/Retail Trade.7 1997 8.4 62.7 15.8 9.7 1994 53.3 1996 16.5 23.9 30.3 10.2 70.8 1994 15.3 7.6 71.1 1991 14.0 65.9 80.7 80.9 29.0 1992 24.5 29.9 33.0 40.7 42.9 1.3 (9.6 7.5 1996 42.Table 2.2 20.0 0.2 8.0 10.6 1997 29.3 57.9 16.8 2.0 1990 12.4 26.0 74.5 62.1 84.3 21.3 8.1 4.7 78.3 4.8 74.2 25.
Long.2 63. and Steam Supply 1988 118. a Excludes capital surplus.8 17.8 1990 19.5 22.3 62.and mediumscale firms.0 43.6 7. Gas.4 47. Source: Calculated using data from Bank of Korea.0 21.1 34.7 18.27 (Cont’d) Year SFRa NEFRa 6.8) (35.8 Average 22. The large firms had a higher proportion of external financing in 1996-1997.6 1.9 28.1 54.3 85.1 71.4 1995 62.4 1994 72.1 1991 56.3 3. however.6 52.9 Average 75.8 36.4 5.9 45.7 69.0 1.9 29.7 70. Financial Statement Analysis Yearbooks.4) 3.0 46.6 1997 23.1 1989 34.4 7.3 29.4 1.9 IDFR 31.3 81.6 1990 82.6 1991 18.1 42. Renting.8 1993 11.5 77.7 37.3 Electricity.9 57.3 92.0 (0.6 1989 118. Higher growth in total assets and sales and easier access to debts by large firms could be reasons for this.0 0. and Business 1988 51.6 Real Estate. The trend was reversed in 1996-1997. when large firms had much lower equity financing ratios and higher debt financing ratios than small. SFR = self-financing ratio.7 1994 8.4 (107.8 135.0 1992 51.4 0. Vol.0 0.124 Corporate Governance and Finance in East Asia.5 8.3 207.3 7.0 1997 24.2 1992 18.0 67.7 1996 18.6 1995 17.and short-term borrowings of these firms shot up in that period.9 65. IEFR = incremental equity financing ratio.0 33.1 1993 55.0 79.1 0.0 56. .1 35.0 53. NEFR = new equity financing ratio. II Table 2.6 IDFR = incremental debt financing ratio.9 64. Their average IEFR was also higher and IDFR smaller.4 1996 45.3 31.7 14.4 0 0 0 0 1.8) 7.1 70.4 IEFR 69.
8 percent. They were able to borrow easily from banks by issuing corporate bonds and CP. The average IEFR of the top 30 chaebols of 29. at an average 70.6 percent.29). but higher than that of listed companies. All of the top 30 chaebols relied heavily on short-term borrowings. Financing Patterns of Chaebols For chaebols.7 percent for all listed companies. The largest borrowers were the top 11-30 chaebols. the top 11-30 chaebols had the highest guarantees commitments at 207. Another key feature of corporate finance in Korea is the widespread use of loan guarantees among the top 30 chaebols. Group-member firms borrowed less. They had easier access to bank loans and the markets for corporate bonds and CPs than nonlisted companies. External financing reached 94.3 and 89.30).7 percent. The average IEFR and IDFR were 10. In 1997. the NEFR of the top 30 chaebols plunged while the debt ratio increased substantially. about the same as that of the corporate sector as a whole.4 percent. the top 6-10 chaebols. the lowest ratio of 58. for listed companies.6 percent of total asset growth.1 percent of their equity capital. Cross-payment guarantees have been declining since 1993 and reached 91. respectively.9 percent. the average SFR was 28.28). and using cross-payment guarantees among affiliated companies. compared with 89. the IDFR of listed companies increased to 93. In 1997.5 percent is lower than that of the corporate sector in general. and higher than that of listed companies (Table 2.3 percent of their equity capital in 1997 (Table 2. Many firms affiliated with the top 30 chaebols saw loan guarantees turn into their own debts because of defaults in debt payments. In 1996-1997.8 percent of their total finance in 1997. 91. The proportion of their short-term financing averaged 72. . Their shortterm borrowings accounted for 86. 153.9 percent.Chapter 2: Korea 125 Financing Patterns of the Publicly Listed Firms The average SFR of listed companies in 1994-1997 was much lower than that of the corporate sector as a whole (Table 2. The debt financing ratio of listed companies was high since they relied more on external financing. The chaebols’ drive to expand their empires resulted in heavy borrowings.7 percent. and the top five chaebols. and were large borrowers.2 percent. compared with the entire corporate sector’s 35 percent and 65.5 percent and their total external financing.
3 5.3 IDFR 57. Korea Federation of Industries.1 8.9 7.Table 2.2 10.2 23.3 28.7 13.5 8.9 6.4 1.28 Financing Patterns of Listed Companies. 1994-1997 (percent) SFRa 41.4 12.29 Financing Patterns of the Top 30 Chaebols. Table 2.4 88.2 1. Source: Calculated using data of Seung No Choi. 1994-1998 (percent) SFRa IDFR 85.5 8.6 IEFR 42.2 36.6 61.1 1.6 70.9 NEFRa IEFR 14.8 76.2 NEFRa 1.3 1.4 29. Source: Calculated from data obtained from data files of the Korea Listed Companies Association.8 22.3 Year 1994 1995 1996 1997 Average a Excludes capital surplus. Largest Business Groups in Korea.5 2.4 38.3 86.5 91.7 12.7 1.8 89. .1 93.5 Year 1994 1995 1996 1997 Average a Excludes capital surplus.5 2.6 1.6 11.6 0.
Second. .9 — — — 1996 105. poor financial and corporate governance resulted in overlending by banks. Korean firms preferred debt financing (bank and nonbank borrowings). Fourth.3 200. in order of ranking.9 153. 1993-1997 (as percentage of equity capital) Rank Top Top Top Top 30 Chaebols 5 Chaebols 6-10 Chaebols 11-30 Chaebols 1993 469. bond issues. bond issues. Factors Influencing Corporate Financing Choices Until recently. rights issues. especially in the 1970s when real interest rates of bank loans were negative. the Government provided implicit guarantees on bank lending and large businesses. and underdevelopment of the stock market. the Korean economy was plagued with high inflation.3 64.9 — — — 1994 258.0 1997 91. Source: Fair Trade Commission and the Federation of Korean Industries.1 — — — 1995 161.3 58. chaebols could easily borrow funds from banks and NBFIs by using cross-payment guarantees. Few firms ranked loans from NBFIs as their first preference. And fifth.1 — = not available. and reserves and retained earnings.Chapter 2: Korea 127 Table 2. more than half of bank loans were priority loans with low interest rates. and extended loans based on cross-payment guarantees. Controlling shareholders usually tried to avoid dilution in their shareholdings for fear of losing control. so that the firms engaged in lobbying to gain access to them. and loans from NBFIs. Further. Financial institutions did not strictly screen their loan projects and monitor their debtors. company preferences in financing investment projects before the crisis were. the Government applied high tax rates on net profits of corporations. Firms now prefer internal funds and new equity capital. This change implies that firms now give more attention to financial risks. According to the ADB survey. These are followed by loans from banks. First. loans from banks. This attitude appears to have changed after the crisis because reserves and retained earnings and rights issues became the preferred financing choices. Interest payments on debts were considered a loss when calculating taxes.30 Cross-Payment Guarantees of the Top 30 Chaebols. Third.7 150. There were several reasons for this.0 207. inefficient investment and excessive diversification of corporations.
II In seeking external financing. Only a few firms sought foreign loans because domestic loans were not available. in order of importance. Korea now provides a better environment for financial risk management. This preference has changed little after the crisis. According to the survey. and Corporate Performance Corporate Performance and Financial Structure Many chaebols were vulnerable to unfavorable cyclical shocks such as the business downturn at the end of 1995 and the terms of trade shock in 1996. the majority (60 percent) of the firms responding to the ADB survey look first for nonaffiliated financial institutions. These survey results indicate that many companies were not very attentive to exchange rate risks (and possibly to financial risks in general). For these firms. and futures and other financial derivatives. even with a heavy debt burden. Among the responding companies that had foreign currency denominated loans. The percentage of foreign currency denominated loans hedged against exchange rate risks was 21. Diversification. in selecting financing sources.3 Financial Structure. firms give their first consideration to minimization of transaction and interest costs.128 Corporate Governance and Finance in East Asia.5 percent at the end of 1997. ensuring the liquidity of the company. Few companies felt that hedging was too costly or was unnecessary as the exchange rate was considered fixed. 2. some (36 percent) thought that a hedging facility was not available or not working properly. Other factors include. and reduction in tax burden. they survived for two to three . maintenance of the existing ownership structure. more than half (53 percent) hedged against exchange rate fluctuations.4. Among those that never hedged against exchange rate risks. Nonetheless. About half of the respondents of the ADB survey borrowed foreign currency denominated loans from foreign banks. and others (29 percent) expected the local currency to appreciate in value. A futures exchange launched in 1999 trades foreign exchange options. the percentage of foreign currency denominated debt in the portfolio was 14. The most important reasons why they chose to borrow foreign currency denominated loans were that terms of foreign loans were more favorable and/or these loans were considered cheaper.36 percent on average for these companies. Vol. many firms (or 42 percent) never considered hedging.
They were also higher than those of the top five chaebols until 1991. Table 2. the ratios of nonchaebols were remarkably higher than those of the top 670 chaebols during the entire period. But since 1992. the top five chaebols’ ratios were much higher. Interest coverage ratios of non-chaebols were higher than those of the top 6-70 chaebols during the entire period. The extremely high leverage and the ability of chaebols to survive for several years with huge debts are evidence of poor internal governance of both the corporate and financial institutions. They were also higher than those of the top five chaebols until 1992. as well as lax financial supervision (Nam et al.13).Chapter 2: Korea 129 years before collapsing at the time of the 1997 financial crisis (2. The ratios of the top five chaebols were similar to those of the top 6-70 chaebols until 1991 when the top five chaebols’ ratios shot up.. These findings indicate that independent firms have had a lower leverage and performed better financially. the ratios of independent firms were higher than those of the top five and top 6-70 chaebols during the entire period. the top five chaebols and the top 6-70 chaebols had similar ratios. Among the main findings were the following. However. Those firms whose interest payment coverage ratios are below 1 are likely to go bankrupt. 1999). Nam et al.3. . In order to determine the relationship between financing patterns and corporate performance.2. (iv) In terms of EBITDA to total assets. except in 19931995 when semiconductor prices were extraordinarily high. The ratios of the top 6-70 chaebols were lower than those of the top five chaebols. but the ratios of independent firms were much lower. except in 1991. (ii) In terms of net income to total assets. Operating earnings are earnings before interest payments and taxes plus depreciation and amortization (EBITDA). (i) In terms of total borrowings to total assets. the trend was reversed in 1993 when the interest coverage ratios of the top five chaebols exceeded those of the independent firms. (iii) Interest payment coverage ratios are calculated as operating earnings over interest expenses. (1999) compared the financial positions of 504 chaebol affiliates and non-chaebol independent firms during the period 1986-1998.
The differences in the degrees of diversification among the three groups are substantial. had a significant role. debt guarantees for free. Indicators such as increasing debt-to-equity ratios. Their subsidiaries. except in the recession years of 1996-1997. larger research and development expenditure. In terms of the net profit margin (the ratio of net profits to sales revenue). The diversification of the top five chaebols remained at about the same level within the period. and lowest in the top 3172 chaebols. then declined to levels lower than those of the top five in the years of economic downturn 1993-1997. the top five chaebols outperformed the top 6-30 chaebols for most of 1985-1997. however. The diversification of chaebols under workout was much lower than that of the top 6-30. II Corporate Performance and Diversification As a chaebol further diversified into nonrelated areas. net profit margins of the top 31-72 chaebols were always higher than those of the top 6-30. the top 6-30 and 31-72 chaebols gradually increased their diversification beginning 1990. too. had easier access to credit than the top 31-72 chaebols. and easier access to cheap credit. But the net profit margins of the top 31-72 chaebols were higher than those of the top five in 1985-1992. The degree of diversification of chaebols that fell into default. second highest in the top 6-30. and composition was lower than that of the top 6-30 but higher than that of the top 31-72 chaebols on average. Factors related to weak corporate governance were closely intertwined with shortcomings in macroeconomic policy and vulnerabilities in the financial sector.130 Corporate Governance and Finance in East Asia.31). This indicates that excessive diversification and inefficient investment of the top 30 chaebols resulted in relatively low net profit margins (Table 2. its profit rate declined. Chaebols have been subsidizing new or low-profit industries by transferring resources from high-profit industries through inside dealings. The more diversified top five chaebols performed better than the less diversified top 6-30 because they were better established in most business areas and have superior personnel and technology. court receivership. Vol. the degree of diversification was highest in the top five chaebols. or outright transfer of resources due to poor corporate governance practices. 2. During 1985-1997. Meanwhile. Government intervention.5 The Corporate Sector in the Financial Crisis This section looks at the various causes of the crisis in 1997. rising nonperforming loans (NPLs) and falling .
6) 0.6) (12.3) 0.2) (0.4 (2.7) (0.8) 0.1) 1.9 1.3) 0.5 0.1 1.8 (0.2 1.4 1996 0.5 1.2 1.9 0.6 0.1 0.0) (4.3) 12.7) (0.7 1.9 1.5) (2.3 (3.9 1.1) 2.8 0.7 1.1 0.6 (10.3) 0.3) (0.3 1.1 1.4) (2.6 1.1 1.3 0.0 1987 1.7 (1.0 4. Beyond the Limit.2 (0.6) 0.1 (4.2 4.9) (8.8 3.4 0. .3 1.7 1.2 (0.5) 0.5 (0.1) (1.1 0.7 0.4 0. Court Receivership.2) 1.1 1.7) 0.6 1.3 1.9 8.1) 1.4 0.6 0.2) (4.7 0.5 1.2) 1.8 3.7 (4.3 1.4) (0.3) 1.5) (2.6 1.9 0.5 1.2 (17.8 0.0) (0.2) (0.2) (13.4 0.8) (20.4 1.5 (6. Management Research Institute.8 1.3 1.8) (1.2 1.1 0.8 0.9 (0.4 1.2 (1.1) 0. p.8) 0.4) (4.4) (1.2 0.2 (0.3) 1.1 (1.3 1.0) (0.11.8) (4.4) (6.4 1.5 2. Background and Task of Structural Adjustment.0 6.8) 1.6 1989 1.6) (0.1 0.3 0.8 (0.6 0.8) 0.0 0.3) 0.6 (0.9) 2.3 3.3) 0.4 (0.3 0.0 1.5 1.6 (0.8) 1997 0.6 5.0) 0.2) (4.9) 2.1 1. 1985-1997 Item Top 5 Hyundai Samsung LG Daewoo SK Top 6-30 Top 31-72 Default.8 1990 0.4 (0.9 0.0 1992 1994 1.4 (1.4 (1.2) 0.3 1.0) (3.1) — = not available.6 0.5 4.5 (0.6 1.3) (1.6 0.4 (0.1 0.6) (20.0 1.0) 0.31 Net Profit Margins of Chaebols.3 1.4 2.3 0.7 1.5) (1.9 0.6) 0.2) 1.1) (5.7 2.2) (3.3) (0.5) (0.5) (7.1 (3.4) (1.7 0.6 0.3 (0.2) 2.1 4.0 (7.6 0.3 1.3 0.7 0.1 (4.9) 0.3) 0.2) 2.2 1.8) (11.5 (0. and Reconciliation Kia Jinro Hanbo Sammi Newcore Haitai Chungku Kukdong Daenong Halla Workout Target Kuhpyong Kangwon-sanup Pyuksan Sinho Tongil Kohap Sinwon Anam Donga 1985 1.1 0.1) 0.2 1.5 1.4) (1.0 0.7) 0.3) 0.8) 0.0 (2.8 0.2 1.8 1.4 (1.2) (13. Source: Whan Whang.7 (0.7 3.9) 2.8 (0.3 (0.Table 2.8) (0.8) 0. 1998.6) (12.3 1.6) (0.0) 0.1) (1.4 1.1 2.1 (0.2 (0.6 3.8 0.1 0.6 1.9) (1.7) (1.5 (4.0 (0.1) 2.2 1995 3.1) (6. Chung Ang University.7 0.3 1.8) (1.9) (9.8) (3.8) (37.1 1.7 — (0.3 (0.1 (9.3) (12.1 0.9 1.2) (4.7 0.3 (0.6 7.5 (0.7 (0.6 0.6) 0.8) 2.1) (2.1 1.
132 Corporate Governance and Finance in East Asia. a firm’s board of directors had the power to appoint an external auditor. 2. Internal and External Control Concentration of ownership has been and will be the major obstacle to the independence of the board of directors from management. and creditors should select (recommend) the external auditor. The hold was tightened by the practice wherein candidates for directors were handpicked from among the managers by the controlling shareholder. The most serious problem among most Korean listed firms has been that a controlling shareholder acting as CEO could never be replaced. and to the development of the market for corporate control. outside directors. Until 1997. after the crisis. Until 1997. the recently adopted Code of Best Practice in Corporate Governance recommends the strengthening of the board system. Thus. a committee composed of internal auditors. Meanwhile. Ownership concentration also had ramifications on corporate transparency. internal auditors cannot be expected to perform their function independently of management. the controlling shareholder or CEO generally selects the internal auditor despite a legal provision limiting the votes of the largest shareholder to a maximum of 3 percent. Along with government policies to protect the status quo. the independence and objectivity of the external auditor were often questioned. II corporate profitability were signs that the Korean economy had reached the edge of a slippery slope. Now.1 Weaknesses in Corporate Governance Concentration of Ownership and Entrenched Management Concentration of ownership has been the root cause of many problems related to corporate governance. But in 1998. They were then almost automatically elected at the general shareholders meeting. . the boards of all listed companies were composed of insiders only. this has led to entrenched management. The Code of Best Practice recommends board audit committees for large listed firms and the Commercial Code is being amended to introduce the audit committee system as an alternative to the internal auditor system. the Korea Stock Exchange introduced listing rules requiring that listed firms elect “independent outside directors” to comprise not less than a quarter of the board members. Thus. Vol. Moreover. A remote trigger in the Thai crisis was all that took to push the economy over the edge.5.
Banks did not function as monitors of corporate management although they were shareholders as well as the most influential creditors. There were no effective monitoring mechanisms for its management. restrictions of voting rights of shares of institutional investors. and some differences in Korea’s generally accepted accounting principles from international standards. Meanwhile. as well as institutions. however. a large issuance of preferred stocks with no voting rights. when a large diversified chaebol. prevalent window dressing practices. Traditionally. as a whole. Many of the takeover targets in the past did not have a controlling shareholder. In this situation. Diversification can reduce chaebols’ risks through the portfolio effect. the Government maintained a policy of protecting the incumbent management of a listed company. individuals. hostile takeovers in Korea will likely be rare in the future. Under the direction of the controlling shareholder. Representative of the policy was the stipulation under the Securities and Exchange Act that no one other than founders could accumulate more than 10 percent of the voting shares of a listed company unless he or she obtained prior approval of the Securities and Exchange Commission. and restrictions on hostile takeovers. However. The purpose was to increase the size of the stock market by having financially sound private firms go public with an assurance that they would not be taken over. usually a member of the founding family. participated in the stock market as short-term traders rather than long-term investors. Another reason is that firms affiliated with a chaebol are generally regarded as difficult targets as the other members of the group will come to the rescue or act as a white knight. profitable firms within a chaebol tended to subsidize unprofitable firms. regulatory and practical difficulty in implementing proxy voting. One reason is that the percentage of inside shareholdings for an average listed firm is very high. Many changes were introduced to promote M&A in the 1990s. Dominance of Chaebols A chaebol is tightly controlled by the largest shareholder. corporate accounting information was not reliable due to the lack of independence of external auditors. These internal dealings made strong firms weak and helped marginal firms survive. has an unsound capital structure and .Chapter 2: Korea 133 There had been some devices to protect management so that companies could indulge in business activities without fear of takeover. These included restrictions of shareholdings of institutional investors.
although their subsidiaries had better quality workforce and easier access to cheap credit than the top 31-72 chaebol affiliates.134 Corporate Governance and Finance in East Asia. prevalence of rent-seeking and morally hazardous behavior by economic decision makers. and internal funds. Financing preferences changed drastically after the crisis. the intervention later resulted in the accumulation of adverse side effects: underdeveloped product. Such problems may eventually cause ripples through the entire economy. The new preference ordering is as . share issues. bond issues. II strong financial links among its member firms through investments and cross-guarantees. the authorities did not properly check on banks’ lending practices—banks did not screen the lending projects and evaluate the creditworthiness of corporations properly. 2. However. as the latter are well established in most business areas. and a high degree of inefficiency in the economy. the financial distress of one or a few marginal firms can lead to a chain of bankruptcies across the entire chaebol. 2. Profitability of the top 6-70 chaebol firms has been lower than that of the top five chaebol firms.3 Manifestations of Weak Corporate Governance and Government Intervention Preference of Debt Over Equity Financing in the Precrisis Period Before the crisis. Net profit margins of the top 31-72 chaebols were higher than those of the top five or of the top 6-30.5. while (non-chaebol) independent firms had much lower borrowing ratios. This effectively becomes an exit barrier for chaebols and would justify the intervention and support of the Government.2 The Role of Government Intervention Strong government intervention in the early stages of economic development was useful for overcoming inefficiencies in financial and capital markets and for managing high investment risks. The Government’s supervision and regulation of financial institutions were poor. Further. Vol. the typical chaebol firm had an extremely high DER. financing choices of listed firms in order of preference were bank loans. capital.5. and other individual markets. The Government and the Bank of Korea did not have accurate information on the extent of transactions that corporations and financial institutions had abroad. As mentioned earlier. This indicates that too much diversification and overinvestment in the top 30 chaebols resulted in relatively low net profit margins.
the Government and the Bank of Korea defended the currency. The poor state of corporate governance in the banking and financial sectors was responsible for overlending by banks and NBFIs through perfunctory screening of loan applications. as evidenced by occasional. which is far higher than the average ratio of around 400 percent for nonfinancial listed firms. At the end of 1996. Nonpolicy loans were also considered to be cheap because of interest rate regulations. overseas borrowing became difficult and higher interest rates were charged on foreign borrowing. As of the end of 1997.Chapter 2: Korea 135 follows: internal funds.5 billion. bank loans. The financing choice of listed firms was also influenced by the underdevelopment of the stock market. total foreign debt amounted to $157. which were the most important financing source until 1987. The high proportion of foreign debt led to a mismatch problem where borrowers were unhedged against foreign exchange risk. However. consisted of high proportions of policy loans. After the financial crisis erupted in Indonesia and Thailand. The ratio of external debts to GDP reached 48 percent at the end of 1998. signaling a bearish speculative move on the won. the size of the stock market was not adequate to digest all the potential supply of new shares to finance the rapid growth of corporations. The lending practices of banks. Bank loans. won/dollar nondeliverable forward rates increased rapidly. Other factors also contributed to this preference. In the international financial market. The preference for debt finance also led to a relatively large foreign debt. In November 1997. This change implies that firms are now more attentive to financial risk and inefficient investment financed by external funds is less likely to recur in the future. Implicit guarantees by the Government on bank loans to large businesses. share issues. . the exchange rate (won/dollar) increased sharply and the financial crisis erupted in Korea. The foremost reason why listed companies preferred debt financing over issues of new shares lies in the largest shareholders’ desire to keep control of the management by preventing dilution of their ownership. were advantageous to chaebols because they were in an “ideal” position to meet the loan requirement through cross-guarantees among their member firms. the top 30 chaebols showed a DER of 519 percent. large-scale bailouts of financially distressed firms. 63 percent of which was short-term. which generally required guarantees or collateral. and bond issues. Although the ratio of stock market capitalization to GDP in Korea was not very different from those in the Philippines and Thailand. reducing foreign exchange reserves to a dangerous level. obviously contributed to overlending and aggravated the situation.
especially chaebols. Before the crisis. the NPL ratio8 of banks and other financial institutions began to increase. reaching highs of 6 percent in 1997 and 8.000 in September 1998 (Table 2. In 1997 they became negative. . The banks and merchant banks lent to large businesses.136 Corporate Governance and Finance in East Asia. were low in 1996 and 1997. the ratios of net profits to sales. a large number of construction companies failed due to the recession in the real estate market and decline in real estate prices. and returned to about 1. The number of insolvent companies increased rapidly in 1991 and doubled to more than 11. then 20.000 during January-September of 1998. Fixed loans are those for which interest is not received for six months or longer. excluding the financial sector. Financial Sector Vulnerability Because of financial losses in the corporate sector. Vol. Moreover. Doubtful loans are those for which interest is not received for six months or longer. Following the “three months” definition. nine out of the 30 top chaebols failed.6 percent in June 1998. and estimated losses. the NPL ratio reached 7. According to the “six months” definition. they are defined as loans for which interest payments are overdue by three months or more. starting 1 July 1998.1 percent in 1996.32). Further.200 in 1997.000 per year starting 1992. total assets. and shareholders’ equity of all industries. and there is no collateral. and there is collateral. decelerated from March 1998. Overlending and inefficient investment were also a result of moral hazard due to implicit government guarantees and “too big to fail” legacies to large businesses. The bank supervisory 8 NPLs of banks comprise fixed (substandard) and doubtful loans.000 from December 1997 to February 1998. without strictly evaluating the creditworthiness of businesses and the profitability of projects. Meanwhile.7 percent in 1997. and the pursuit of growth through excessive diversification and inefficient investment. They utilized mutual payment guarantees among their affiliates and believed that they would never fail. However. regardless of whether it is caused by large personal holdings of the controlling shareholder or by pyramiding. has given rise to various types of self-dealings by the controlling shareholder. legal and other barriers prevented the exit of financially nonviable firms. The Government could hardly help them because of the number and magnitude of business failures. These were the definitions until 30 June 1998. The inevitable result of inefficient investment was a fall in corporate profits. The monthly number reached more than 3. the NPL ratio of commercial banks increased rapidly from 4. II Inefficient Corporate Investment and Low Profitability Ownership concentration among Korean firms. It jumped to 17.
985 Services 3. Policymakers thought that economic growth would resolve the NPL problem without the need for corrective action.255 13. and continuous and large current account deficits. In 1990-1993. As a result they had largely overvalued currencies. 2. The current account deficits in terms .386 5.210 1. authorities were not too concerned about the high NPL ratios at Korean banks in 1997 simply because the high and rising ratios had precedents.856 7. Compared to ROAs and ROEs of domestic branches of foreign banks. Source: Bank of Korea.759 6.417 Others 152 132 108 97 88 161 326 252 274 302 553 861 952 Note: 1998 figures cover only January-September.517 2. low efficiency.457 2.502 11.472 2.553 3. Exchange rates were virtually pegged to the US dollar in all troubled Asian countries.114 811 706 696 866 1.China.Chapter 2: Korea 137 Table 2.238 4. 1986-1998 Year 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 Total 4.647 8.657 3.265 6.131 1.769 9.754 3.69 20. Meanwhile. This was mainly due to the high ratios of NPLs.992 11.544 2.589 171.244 3.859 3. and Taipei.33).107 6. This speculation was said to be one of the causes of the financial crisis in Korea.4 Shortcomings in Macroeconomic Policy The macroeconomic framework also contributed to the crisis in 1997.855 6. European countries.637 6.32 Number of Firms with Dishonored Checks.751 1.259 2.250 2.053 5.850 3.5.133 3. those of domestic banks were lower in the 1990s. The difference between the Korean and Western definitions of NPLs left foreign investors with suspicions that the size of NPLs in Korea might be much larger than the government-announced magnitude. ROEs and ROAs of Korean and Japanese banks were low compared with those of the US. the ratio reached 7-8 percent.890 4.673 Construction 380 354 242 195 294 585 1.135 1. and large government-directed loans. and declined to 4-6 percent in 1994-1996 (Table 2.573 3.159 10.027 Manufacturing 1.979 8.
520 194. and Indonesia -3.6 percent (1995).077 NPL Ratio (%) 8. The main result of the rigid labor market was a “high-cost and lowefficiency” economy. which led to large corporate losses. Thailand -8. II Table 2. although per capita income in Korea was much lower. Source: Bank of Korea.4 5.6 Fixed loans are those requiring collateral and for which interest is not received for six months or longer.652 29.6 percent (1995). the terms of trade deteriorated 12 percent in 1996 and 11 percent in 1997. and 30 percent in 1996.192 Doubtful (B)b 952 1. In 1997. Korea -4.221 8.929 11. It was estimated that the Korean won was overvalued by 20 to 30 percent from 1989 to 1997. Land prices and real estate rents were also high compared to trading partners.562 18. b Doubtful loans are collateral-free loans for which interest is not received for six months or longer.827 289.639 1.8 percent (1996).176 7. Related to this.China.190 9. Businesses served as a social safety net. of percentage of GDP were as follows: Malaysia -8.266 10.310 6.584 2.600 10. because of the rigid labor market.705 160.8 5.484 11.556 118.1 6. the ratio of short-term debt to foreign reserves was very high. even in times of economic slowdown. Vol.China. In addition to the overvaluation of the won.170 1.736 8. judging from the real effective exchange rate indexes using unit labor cost indexes as a deflator and 1985 as a base year. the hourly wage rate in the Korean manufacturing sector was higher than in Singapore or Taipei. The pegged currency also encouraged foreign borrowing as investors believed that the exchange rate would remain stable.649 375.537 10.430 12.2 4. 1990-1998 (W billion) Year 1990 1991 1992 1993 1994 1995 1996 1997 1998 a Total Loans 90.237 Estimated Loss (C) 958 920 840 816 213 385 490 490 648 NPL (A+B+C) 7.116 1. . Mass layoffs became legally possible only after the economic crisis.1 percent (1995).874 22.475 143.138 Corporate Governance and Finance in East Asia.0 7.739 241.33 Nonperforming Loans of General Banks.954 9.997 9.0 8. Meanwhile large businesses could not legally lay off workers.0 7.832 337.160 11. Real interest rates in Korea had been two to three times higher than those of Japan or Taipei.584 Fixed (A)a 5.1 7.910 1.390 12.
A guideline informally promulgated by FSC required the 30 largest chaebols to lower their DER of 412. Measures have been taken by several chaebols to streamline operations and improve incentives of managers and employees. the immediate objective centered on restoring the international investment community’s confidence in the Korean economy. has been actively utilizing its influence to motivate institutions to coordinate debtor firms’ restructuring activities. . and subsidizing money-losing units. the excessive amount of debt of Korean corporations had to be reduced to a sustainable level.6 percent as of the end of June 1998 to no more than 200 percent by the end of 1999. embarked on their own restructuring programs and/or implemented restructuring demands of the creditor banks. Nonviable firms and financial institutions. They have also been urged to divest themselves of strategically ill-fitting businesses and sell equity holdings of attractive business units to foreign firms to reduce debts. ‘Voluntary’ Restructuring Chaebols have been under pressure from the Government to abolish their informal group headquarters to increase the managerial independence of member firms.Chapter 2: Korea 139 2. Other firms experiencing financial distress were subjected to workout procedures through negotiations between debtors and creditor institutions. However. although efforts to lay off thousands of blue-collar employees at Hyundai Motors encountered fierce opposition from labor and ended up in mediation after intervention by politicians from the ruling coalition.1 Responses to the Crisis and Policy Recommendations Corporate Restructuring Activities Restructuring activities in the corporate and financial sectors of the Korean economy were aimed at enhancing their long-term viability and competitiveness. had been forced into bankruptcy proceedings or merged into healthier entities. The FSC—later called the Financial Supervisory Service (FSS)— which is in charge of prudential regulation of financial institutions. They have been pressured to stop such practices as providing loan guarantees. Ailing banks needed to be recapitalized after the huge amount of NPLs was disposed. which were laden with huge amounts of debt and were on the verge of bankruptcy. Downsizing by curtailing employment has been prevalent.6 2. Corporations. To achieve this.6. including banks.
140 Corporate Governance and Finance in East Asia. FSC directed banks to appraise the long-term viability of client firms showing symptoms of failure. This number was at 779 firms in April and grew to 1. The process of voluntary debt recontracting by creditors was prolonged because Korean lending organizations lacked experience and expertise when it involved a multitude of creditors. In their first review. the creditor . More than 59 percent of potential buyers were foreign firms. banks and other creditors were reluctant to absorb losses realized by debt compositions. The reasons are manifold. Korean firms have been slowly stepping up their restructuring since the latter half of 1998 as the economy began to show signs of recovery. The data also show that about 24 percent of acquisition negotiations ended up in actual deals. More important. while only 14 percent of the negotiations were completed from the beginning of the crisis up to April 1998. the number of potential sellers decreased somewhat from 2. In many cases. they were reluctant to allow recontracting for fear of further deterioration in the capital adequacy ratio. sellers could not find buyers as almost all domestic firms struggled to raise cash for debt reduction and for working capital needs while there was a severe credit crunch following the outbreak of the crisis. II Divestitures to raise cash for debt reduction and to focus on core businesses have not proved to be easy. potential foreign buyers waited for the price of acquisition targets to come down further. Locally.281 in April to 2.045 in October. On the other hand. Vol.138 by the end of October. Noticing this disincentive. Internationally. or to agree on debt-equity swaps demanded by potential purchasers as a precondition for the deal. Involuntary Exits The Government has been involved in the restructuring process mainly through its supervisory capacity over banks. It was frequently observed that the negotiating parties could not agree on a price due to large discrepancies in valuation. A debtor whose liquidation value was estimated to be greater than its going concern value was subject to “exit”—meaning the creditors would altogether stop lending and not allow renewal of the existing debt. because liquidation of debtor firms would exacerbate the banks’ already weak balance sheets. Data collected by the Korean Chamber of Commerce and Industry show that the number of potential domestic and foreign buyers in the M&A market increased by about 50 percent over the six-month period from April to October 1998. Banks did not have the incentive to force financially nonviable firms to liquidate.
and 12 were sold off to other firms. by their creditors. By the end of 1998. was allocated to the six largest banks for them to employ outside experts as advisors. The plans were put into action immediately following finalization. The creditor banks and the advisory groups also drafted such plans for the top 6-64 chaebols. write-offs. These chaebols submitted plans for restructuring to improve their respective capital structures. A portion of the Technical Assistance Loan of $33 million. Among the sell-offs. and 16 non-chaebol corporations that had been selected as possible workout candidates. Based on these plans. the creditor banks drafted their own restructuring plans with assistance from outside advisory groups led by foreign investment banks. A second round of review to select more firms for exit was conducted by the Major Creditors’ Council organized for each of the top five chaebols. .Chapter 2: Korea 141 banks selected 55 firms as targets for exit. FSC has been monitoring the processes from a prudential regulation standpoint. 24 were liquidated. 11 were merged into other group members. creditor banks completed evaluation of the financial status of 35 subsidiaries belonging to 13 chaebols. interest reductions. More than 200 financial institutions signed the Corporate Restructuring Agreement to carry out corporate workouts with the top 6-64 chaebols. and/or conversion of debt into equity have been applied to those firms that are considered to be viable in the long run and have voluntarily entered into negotiations with creditor banks. not only for the design of corporate workout programs but also their implementation. workouts are being applied to non-chaebol firms identified as financially weak. Negotiations were then held between the chaebols and the creditors’ councils to finalize the financial structure improvement plans. Upon completion of the evaluation. Corporate Workouts Workouts in the forms of debt rescheduling. three filed for courtsupervised bankruptcy reorganization. Among the 55 firms selected. the results thus far have not entirely been as desired. The workout plans were completed for most firms by early 1999. These included 20 firms from the top five chaebols and 32 from the top 6-30 chaebols. provided by the World Bank. two were acquired by newly organized employee stock ownership plans. but viable. Also. Although the intention of the Government and the banks was to effect immediate liquidation of these selected firms.
aircraft. First. the Government has been urging the largest chaebols to strike “big deals” or business swaps among themselves to consolidate overlapping manufacturing facilities. Big Deals Ever since the outbreak of the economic crisis. labor union demands of the seller were not acceptable to the transacting parties. Foreign investment—in the form of acquisition of controlling interests. In the case of automobiles. automobiles. However. Thus. In one case. In another. On 3 September 1998. Big deals would.142 Corporate Governance and Finance in East Asia. Foreign Acquisitions Confidence in the Korean economy depends critically on the lowering of the level of corporate debt. inducement of foreign direct investments was considered to be the most effective means of achieving that end. Big deals have been elevated to the status of the most important means of effective corporate restructuring. enable chaebols to streamline their overly diversified operations and focus on several core business areas. II creditor banks and the corporations will devise detailed workout programs based on the rehabilitation plans submitted by the corporations. The less than satisfactory state of foreign capital infusion in the early days stems from a number of factors. Vol. Hyundai Motor Corporation won the international auction of Kia Motors in its third bidding and Daewoo Motors agreed to acquire Samsung Motors. This figure contrasts sharply with the total of $700 million for all of 1997. As of April 1999. some of the acquisition agreements have been discarded for various reasons. and equity participation—reached about $8. and petrochemicals. it is hoped.5 billion on agreement basis during the 10-month period after December 1997. purchase of divested assets. railroad cars. Restrictions on foreign ownership of land were also abolished. most of the big deals have entered their final stages of negotiation. Korea adopted and implemented policies to open its capital market completely. oil refineries. chaebols did announce their agreements on big deals in seven industries excluding the automobile industry. the foreign buyer demanded specific protections against adverse developments in the business environment. These deals could eliminate excess capacity in such industries as semiconductors. power plant facilities. vessel engines. In the early days after the outbreak of the crisis. uncertainty over the future .
(iii) to reduce financial leverage.6. In effect.2 Policy Measures for Corporate Reform Goals and Policy Measures for Reform in the Corporate Sector Based on their assessments of what caused the economic crisis in Korea and what needs to be done to overcome it. Sixth. foreign buyers usually employed discounted cash flow methods of valuation while local sellers often put greater emphasis on replacement costs of assets. Fifth. (ii) to remove cross-guarantees of loans among group members. legal procedures pertaining to corporate rehabilitation and bankruptcy filings were simplified to expedite rulings on the exit of nonviable firms and to ensure better representation of creditor banks in the resolution process for court receivership or court-supervised composition. (iv) to focus on a small number of core businesses. the Government and chaebols reached an agreement on the goals of restructuring and reform efforts. With this in mind. Not only does this represent progress in terms of an improved institutional framework for market competition. some of the potential acquirers demanded terms that were unreasonable or unacceptable from the sellers’ point of view. the widespread practice of cross-guarantees of loans and the lack of corporate transparency could potentially give rise to contingent liabilities to the buyer and this has posed a bottleneck problem to the speedy consummation of deals.Chapter 2: Korea 143 course of the Korean economy remains high. 2. As set forth in the agreement. The presence of . the improved procedures stipulated in the Bankruptcy Reorganization Act and the Composition Act reduced what had previously been legalistic exit barriers. foreign buyers were concerned with the inflexibility of the labor market. many of the potential buyers believed that prices asked by sellers were still too high and there would be opportunities to buy assets on fire sales in the future. and (v) to improve the accountability of controlling shareholders and the board. Second. these goals were: (i) to enhance managerial transparency. Seventh. but it also has important implications with respect to corporate workouts. many of the businesses that Korean firms put on sale did not prove to be attractive to foreign firms. Overhaul of Bankruptcy Procedures In February 1998. Fourth. local creditor banks were reluctant to absorb losses arising from debt compositions and debt-equity swaps that were necessary in deals involving insolvent sellers. Third.
In the past this stage usually extended for as long as two to three years. if a final reorganization plan is not worked out within one year from the date of the court order placing a firm in receivership. etc. (ii) legal changes have been made so that domestic accounting practices conform to international standards.01 percent in May 1998. . and economics professions should be organized to provide for expeditious proceedings in court. thereby preventing abuses by controlling shareholders/managers of financially distressed firms. October 1998. The purpose of this rule is to shorten the reorganization planning period. First. Fifth. the maximum grace period on loans to the firm being reorganized was shortened to 10 from 20 years. The court can refuse to accept the application for composition if it finds it inappropriate considering the size of corporate assets. (v) all listed companies are required to appoint outside directors beginning 1998 9 This and the following two subsections draw on the Ministry of Finance and Economy. Korea’s Economic Progress Report. a “Management Committee. accounting.” comprised of experts in the legal. the court may annul its previous decision and force the firm into immediate liquidation.144 Corporate Governance and Finance in East Asia. (iv) restrictions on institutional investors’ voting rights were eliminated in June 1998. the right to revoke court receivership is allowed to the creditors. Also. the new rules made it clear that a court receivership order is available only when the going concern value of the firm under consideration is greater than its liquidation value. Improving Transparency and Corporate Governance9 Transparency and accountability in corporate governance will be promoted by the following measures: (i) consolidated financial statements are required beginning 1999. The changes in the reorganization procedures can be summarized as follows. II an expeditious exit scheme is expected to better induce negotiation for workouts between creditor banks and corporations. Vol. the changes in the institutional setting for corporate reorganization will enable creditors and debtors to promptly respond to the development of financial problems. Also. The creditors can form a “Creditors Committee” among themselves to allow them to participate in the decision processes in court. (iii) the representation requirement for shareholder derivative suits was drastically relaxed from 1 percent to 0. Fourth. Third. the Composition Act was amended to narrow the eligibility of applying for court-supervised composition. Second. number of creditors.
Foreigners are now able to invest in local bonds and short-term money market instruments without any restrictions. financial institutions could no longer require cross-debt guarantees. A recent case in point is the penalty imposed by the Fair Trade Commission on chaebol subsidiaries found to be involved in unfair transactions among group members.Chapter 2: Korea 145 (as of the end of May 1998. (iii) hostile mergers and acquisitions by foreigners were fully liberalized in May 1998. including financial subsidization. (ii) full liberalization of foreign exchange transactions was legislated and will be put into effect in two stages. beginning on 1 April 1999. (vi) bankruptcy laws were revised in February 1998 to facilitate the exit of insolvent firms. According to the law. Capital Market Liberalization Since 1998. administrative procedures for FDI will be dramatically simplified and made transparent. an additional nine industries will be opened or further liberalized. various supporting measures. which was passed in August 1998. only 31 out of 1. crossdebt guarantees totaling about W10 trillion—about 30 percent of the total guarantees among the 30 largest chaebols—were dissolved. (v) by the end of May 1999. Korea has rapidly liberalized the capital market by adopting the following measures: (i) the ceiling on foreign equity ownership was completely eliminated in May 1998. and (viii) as of 1 April 1998. either partially or fully. Measures for improving standards in corporate governance are already effecting a generally more open corporate culture and greater transparency in business practices.148 industries remain closed. (iv) during April and May 1998. the Korea Trade and Investment Agency (KOTRA) will provide a one-stop service with respect to FDI. to FDI). In addition. 514 listed companies had appointed 677 outside directors). 21 industries were further liberalized or newly opened to FDI (now. (vii) by the end of March 1998. These new standards are and will continue to be strictly enforced. and (vi) all current laws related to FDI have been streamlined and incorporated into a single legal framework represented by the Foreign Investment Promotion Act. As for promotion. Existing cross-debt guarantees should be completely eliminated by the end of March 2000. Foreign Investment Promotion Act The Foreign Investment Promotion Act was put into effect in November 1998. including tax exemptions and reductions. have been instituted for FDI: .
the Korean Government is strengthening prudent regulations and market monitoring. the Government intends to supplement these measures with a sound macroeconomic policy in order to secure more effective protection against systemic risks. Also. as well as building an early warning system. Capital Market Augmentation Bond Market The Government recently introduced a policy plan to deepen Korea’s bond market. The law allows rental cost exemptions and reductions for FDI. including infrastructure and tax support. The primary aims of the law are the liberalization of the capital account and the development of the foreign exchange market. These bonds will be issued . It aims to establish a benchmark by consolidating various government bonds. Three-year government bonds will be used to establish a benchmark. The location of the FIZ will be determined at the request of foreign investors. however. such as the high-tech industry. Liberalization of Foreign Exchange Transactions In September 1998 the Foreign Exchange Management Act was replaced by the Foreign Exchange Transaction Act. are not risk-free. Various local taxes will also be exempted or reduced for eight to 15 years at the discretion of local governments. These liberalization measures. will be provided to foreign firms in the FIZ. To minimize potential risks. Vol. II (i) (ii) (iii) Tax exemption and reduction: Corporate and income taxes will be exempted or reduced for FDI in target industries.146 Corporate Governance and Finance in East Asia. Low cost rental facility: National and public real properties will be rented to foreign-invested firms for up to 50 years. The majority of government bonds to be issued in the next two to three years will carry a maturity of three years. Various support measures. Free Investment Zone (FIZ): A free investment zone will be developed to accommodate large-scale FDI. for 10 years (full exemption for the first seven years and 50 percent tax reduction for the remaining three years).
Twenty-five domestic financial institutions. Mutual funds (or open-end investment companies) will be allowed starting 2001. Prior to the introduction of this system. Investment Companies Korea has developed an institutional framework for closed-end investment companies so that they function as a key instrument for long-term financing. and the demand for longerterm bonds increases in the future. but it will also help improve financial institutions’ risk management. and is promoting joint ventures between foreign and domestic agencies.6 trillion in these funds: W0. It is now easy for private investors. It also opened the credit rating service market to foreign competition. Moody’s signed a joint venture contract with Korea Investors Service. a debt restructuring fund and three balanced funds (funds that invest in both equity and debt) were established in September 1998. Related legislation was put into effect in September 1998. both domestic and foreign.6 trillion for the debt restructuring fund. to establish closed-end investment companies. According to the law. In order to promote a greater market demand for government bonds.Chapter 2: Korea 147 monthly. invested a total of W1. To ensure transparency and efficiency of the fund operations. These are expected to operate for the next three years. financial institutions . The Government established specific qualification criteria and selected the primary dealers in 1999. commercial banks were allowed to carry out dealing operations for government bonds starting in October 1998. but may be extended as required. the Government will correspondingly expand the issuance of government bonds that have a maturity of five years or more. Asset-Backed Securities A new law providing for asset-backed securities (ABS) was passed in September 1998. they will be managed by foreign investment management companies. a primary dealers system will be introduced for healthy financial institutions. with only minor standard exceptions. As a pilot program. including the Korea Development Bank. and W1 trillion divided equally between the three balanced funds. This law will not only provide an effective institutional environment for the disposal of NPLs. In August 1998. If interest rates stabilize at a low level. No qualification requirements are being imposed on investors who are sponsoring new mutual funds.
B investing in C. However.g. and other unfair internal transactions among affiliated companies should be stopped primarily by improving rules on corporate governance rather than by boosting the Government’s policing role. Selfdealings. and C investing in D. In principle. considering that there is no other effective way to limit circular investments among chaebol affiliates (e. However. there is another view that placing a maximum limit on interfirm investments. The corporate governance structure cannot be expected to function efficiently if this issue is not addressed. II and qualified public corporations. It would be more desirable for the market-oriented measures to be put into place and strictly enforced. Vol. 2. On the other hand. Direct controls of interfirm investments and/or pyramidal ownership structures will not be persuasive. cross-subsidization. For instance. The Government has restored a previously abolished regulation that imposes a ceiling on the total amount that a chaebol company can invest in other firms.. this regulation may not be effective in curtailing pyramidal structures. which is the case for many chaebols. as stipulated by the government measure. can utilize ABS.3 Policy Recommendations Poorly performing markets and the resulting lack of market discipline justified the government intervention in recent corporate and financial restructuring activities. etc.) and the level of interfirm investments is very high. As markets become more efficient. A investing in B. Policies aiming to improve the corporate governance system should take into account the high ownership concentration often created by pyramiding. this can only be a temporary measure. There must be stronger rules to control agency problems. the role of the board of directors as the internal control mechanism must loom large in corporate governance. foreign business corporations with good credit standing are now also permitted to issue ABS. such as the Korea Asset Management Corporation (KAMCO). is inevitable. the government intervention will have to be refocused so that it only sets the rules of the game in the marketplace. One way of strengthening independence of the boards is to require that listed companies accept nominations for directors by institutional . when the limit is binding.148 Corporate Governance and Finance in East Asia. unless the limit is tight and binding. then the regulation will inhibit efficient investment of firms.6. However. More important. greater efforts to improve corporate governance are preferable to regulation of interfirm investment. A good governance system is essential for the healthy growth of corporations and financial institutions.
Further.Chapter 2: Korea 149 investors or their trade associations. Companies could also invite nominations from such organizations as the Korea Listed Companies Association or citizens’ coalitions that have been active in monitoring corporate management through proxy solicitations. and also negligence of external (independent) auditors actionable. pp. 1997). thereby helping to strengthen board independence and enlisting boards’ more active involvement in monitoring corporate management. governance. One action that has yet to be taken is the introduction of an act to facilitate class action suits against corporate directors and internal and external auditors for their wrongdoings. 23-26. One way of motivating institutions to do this is to 10 M. There has recently been a general shift in individual investor preference from direct personal stock trading to investing in traditional investment trust companies and the newly introduced (closed-end) investment funds. Institutional investors will play an increasingly important role in corporate governance. Class action suits are an efficient means for corporate monitoring. The Securities and Exchange Act will then require large listed companies to switch to a board audit committee system from an internal auditor system. the Korea Stock Exchange could incorporate provisions of the Code of Best Practice in Corporate Governance in its listing rules. and other committees. The Corporate Board. Proposed: A Governance Monitor. . various measures have been implemented to promote investors’ rights. using audit. September/ October 1997. More effective measures to protect investors will enhance corporate transparency and also the accountability of directors to shareholders. it will have to include making self-dealings by directors and officers. Latham. 1997. Since the economic crisis. and requiring that all directors hold shares of their companies. The Government can prompt institutional investors to contribute more to good corporate governance by paying greater attention to corporate affairs. Each listed firm should be required to disclose the extent of its compliance with the Code in its annual report. Listing rules may recommend that all or large listed companies adopt an audit committee.10 Other means to improve independence of the boards include mandating that independent outside directors form the majority. The annual shareholders meetings could also elect reputable “monitoring companies” to recommend director candidates (Latham. If and when the law is introduced. The Government has already announced that it intends to amend the Commercial Code to introduce Anglo-American type audit committees as an alternative to the current internal auditor system.
the Government will have to come up with appropriate policy measures to solve these problems. important pension funds including public employee funds and teacher funds seem to have their own governance problems because their top management and portfolio management policies are controlled by the Government. Another concerns whether the court-appointed receiver should be given the power to convene board and shareholder meetings and also to replace directors and officers with court approval. such as the Korea Investment Trust Association. possibly. more drastic in nature. is to restrict ownership of investment trust companies and NBFIs by the five largest chaebols and. . and impose stronger penalties on violations of the rules on portfolio investments. An efficient means to control problems arising from ownership of financial institutions by industrial capital is to strengthen the accountability and fiduciary duty of the very management of these institutions. etc. by all nonfinancial companies (or “industrial capital”). securities companies. Shareholdings concentrated in investment companies and other institutional investors pose a serious dilemma. These guidelines would recommend shareholder activism and faithful discharge of fiduciary duties by actively participating in shareholder voting. Vol. objecting to certain defensive measures proposed by the management. an audit committee. strengthening incentive compensation schemes for executives. Also. insurance companies. Rights of minority shareholders should also be strengthened for these institutions. The Government recently proposed the revision of bankruptcy-related laws. and compliance officers. could prepare such guidelines. The Government can also lower the limits on investments in affiliated companies.150 Corporate Governance and Finance in East Asia. and other NBFIs are subsidiaries of chaebols— especially the five largest ones. Measures that are being implemented or introduced will require that the management of institutional investors be closely monitored by a board consisting of a majority of independent outside directors. strengthen its supervisory activities. Application of more stringent bankruptcy-related rules to firms in financial distress will effect greater discipline over corporate management. reviewing independence and expertise of candidates for outside directors. and thus cannot be expected to be actively involved in monitoring portfolio firms. Many of the larger investment trust companies. In the coming years. The institutions’ respective trade associations. One issue that is being debated is the necessity of the court ordering a firm into bankruptcy once it is found to be nonviable during deliberation on composition or receivership. II provide comprehensive guidelines for their actions in matters related to corporate governance. Another measure.
and introducing disincentive schemes for excessive borrowings. the limit on ownership of bank shares will have to be eased so that strategic investors (shareholders) can act as true effective monitors of bank management. Such measures include providing an effective corporate governance system. The current obligatory system of disclosure that emphasizes “hard” . the banks have great leverage over the management of debtor firms. Banks should adopt strong incentive compensation schemes for management. private firms. the elimination of implicit guarantees for financial support to chaebols. The Government should substantially reduce the proportion of policy loans from bank loans. large firms. For this. Banks need to play a bigger role than they do at present in monitoring corporate investment and management. and stop unfair internal transactions. to concentrate instead on a small number of core businesses. Bank boards also need to be made more independent from management. such as application of higher interest rates by banks to chaebols with higher DERs. and financial institutions. therefore are vulnerable to economic shocks. the important issues to be addressed are: (i) improvement of the corporate disclosure system. In turn. bank managers should be made accountable to shareholders but not to the Government. An effective policy package is needed for chaebols to dispose of marginal firms with low profitability at the earliest date. The public and corporations should be taught or fully informed of the best practices in corporate governance. This means that the Government can control the banks and. and (iii) a good corporate governance system to protect investors. and thus full-scale education programs should be developed. and consistently show low profit rates. (ii) provision of reliable accounting information. In order to minimize government intervention in bank and corporate management. which could provide alternative sources of long-term corporate finance. through them. lessening the degree of double taxation of dividends (or further reducing personal income taxes on dividends). The Government needs to sell off at the earliest feasible dates the bank shares that it acquired in the course of recapitalizing banks.Chapter 2: Korea 151 There still exist widespread concerns that the Government will continue to exercise a great deal of discretionary power over banks. Many concepts regarding good corporate governance are still new to a lot of market players in Korea. The Government should put more efforts into developing the capital market. To facilitate the development of the Korean stock market. Many corporations are burdened with excessive debt and. reduction of protection of domestic markets and entry barriers. Chaebols are overly indebted. excessively diversified into nonrelated business areas.
especially among business people. Maintaining current account surpluses for a considerable period is needed to pay back foreign debts. and bureaucrats. data on quotations and trading volumes. no economic reforms will be effective. The establishment of a Corruption Prevention Institute will be helpful in this regard. These should be lengthened to make them a source of stable long-term funds. on a real time basis. Without successfully addressing this problem. Currently. II information on past performance needs to be transformed into a system in which corporations voluntarily announce “soft” information on future prospects. At the same time. and labor productivity should be considered. . The network should cover not only the exchange market but also OTC transactions of investors and dealers. Policies are needed to help develop more reliable services by bond rating agencies. and measures to reduce corruption. the information system of the bond market should be better organized to transmit. Vol. politicians. More effective punitive means need to be devised to penalize both corporations in violation of disclosure rules and the officers in charge. Prevalent corruption. penalties on violations of disclosure rules are not effective enough to have a significant impact. In determining optimal exchange rates. The function of securities companies as dealers of bonds should be improved. Future research could include causes of corruption. Another problem with the corporate bond market is that most bonds are issued with maturities of less than four years. wage rates. profitability of export industries and real effective exchange rates that account for changes in nominal exchange rates. is considered to be one of the major causes of the economic crisis. The development of the OTC bond market requires a well-developed dealer system.152 Corporate Governance and Finance in East Asia. reasons for different degrees of corruption in various countries. One of the significant changes in the bond market after the economic crisis is that most corporate bonds are now issued nonguaranteed and on the basis of credit quality of the issuer. Overvaluation of exchange rates should be avoided in order for export and import-substitution industries to stay internationally competitive.
Financial Studies. I. C. Corporate Restructuring. W. Lee (eds. H. KERI.Chapter 2: Korea 153 References Bank of Korea. Lee. various issues. H. W. pp. Center for Free Enterprise. 1995. H. Chon. 1995. 1997. I. S. Jae Woo. Korea’s Chaebol. Proposed: A Governance Monitor. 1997. W. Korea Economic Research Institute. Cho. various issues. International Financial Statistics. Y. N. Hattori. M. T... 1999. 23-26. in Korean Managerial Dynamics. Kim. Hong. 7995. Is the Fair Trade Policy Fair? Korea Economic Research Institute. 1997. S. KERI. Understanding Flow of Fund Accounts. International Monetary Fund. Bank of Korea. S. and H. Japanese Zaibatsu and Korean Chaebols. KERI. and K. S. Survey of Facility Investment Plan. edited by K. Determinants of Diversification of Korean Business Groups. 1996. The Corporate Board. September 1997. various issues. September/October 1997. Kang. Jua. Latham. Choi. An Empirical Evidence on Value of a Firm and Ownership Structure. Hong Moon Sa. Kim. C. Cho. D. Kim. A Study on the Relationship between Ownership Structure of a Firm and Value of a Firm. 1998. Bank of Korea. Bibong Publishing Co. Korea’s Large Conglomerates. Korea Economic Research Institute. pp. Korean Managerial Dynamics. pp. K. New York: Praeger. Economic Statistics Yearbook. New York: Praeger. D. Market Concentration and Diversification of Business Groups. Ju Hyun. Evolutionary Chaebol. Financial Studies. 1998. and J. Kwon. 1994. 1996. Lee. Chung and H. September 1998. Chung. September 1998. 1992. C. W. S. Financial Statement Analysis Yearbook. S. 1989. . Maeil Daily Economic Newspapers. K. Tomio. various issues. 1996. Lee. 1997.. Korea Development Bank. 1989. and 1998 issues. Korea’s Financial System. Chon. H. H.). 1993. Bank of Korea. 79-95.
S. H. September 1998. C. January 1995. 1998. Korea’s Trade and Industrial Policies: 1948-1998. Korea’s Economic Progress Report. Capital Liberalization. U. Ungki.. Nam. K. Chicago. Beyond the Limit. 1996. W. KIEP Working Paper 98-05. and J. Whang. Chung Ang University. S. S. K. Ministry of Finance and Economy. Vol. Business Groups in Korea: Characteristics and Government Policy. Korea Institute for International Economic Policy. Yang. 2nd Sangnam Forum.. 1999. March 1999. Yim. and H. I. November 1996. II Lee. 1999. October 1998. Corporate Governance in Korea. Korea Finance Institute. 1996. Korea Institute for Industrial Economics and Trade.. Kim. Y. A New Trade and Industrial Policy in the Globalization of Korea. I. S. 1998. 1998. 1998. The Ownership Structure and Family Control in Korean Conglomerates: With Cases of the 30 Largest Chaebols.154 Corporate Governance and Finance in East Asia. 23. Lim. Management Research Institute. Lim. Real Exchange Rate and Policy Measures. Lee. Y. H. Lee. October 1998. Sohn. 1995. Background and Task of Structural Adjustment. Joh. Whan. J. Kim. Yonsei University. The Pattern of Ownership Structure and their Characteristics in Korean Conglomerates: With Cases of the 30 Largest Chaebols. K. Korea Institute for International Economics and Trade. C. Y. Seoul. Ungki. . Korea Development Institute and World Bank. J. Conference on Corporate Governance in Asia: A Comparative Perspective. Wang. KIET Occasional Paper No. Kang. Annual Conference of Financial Management Association. J. and J.
the Philippine nonfinancial corporate sector had managed its borrowing risks relatively well by largely avoiding imprudent use of debts and risky investments. and government subsidies were tackled during that period. Roble. Denise B. Serrana. Inc. When the Asian crisis erupted in 1997. From 1993 to 1996. PSR Consulting. Inc. for their research assistance. the Philippine Stock Exchange for its help and support in conducting company surveys. about a decade before the recent Asian crisis. in particular Francisco C. Companies of other Asian countries were already using these markets to finance investment and growth. The author wishes to thank Juzhong Zhuang. . the Philippines.1 Introduction In recent years. the Philippine economy and corporate sector were in a relatively sound financial position. the PSR Consulting. Issues such as State ownership of businesses. This has come about following a political and economic upheaval from 1983 to 1987. 1 Principal. Saldaña1 3. David Edwards. state-sanctioned monopolies. and David Webb of the London School of Economics for their guidance and supervision in conducting the study. allowed the Government and the corporate sector to gradually access foreign debt markets after a long absence. after the completion of debt negotiations with the IMF and Paris Club. staff. both of ADB. The Asian financial crisis revealed that. overall. The Government pursued the privatization of various state-owned corporations as part of its financial rehabilitation programs sponsored by the World Bank and the International Monetary Fund (IMF). The lifting of the debt moratorium in 1991. the Philippine corporate sector has played a leading role in the government’s efforts to get the country on track toward sustainable economic development. and Lea Sumulong and Graham Dwyer for their editorial assistance. Pineda.. aiming at eventually limiting the Government’s role to economic policy setting and allowing the private sector to conduct most economic activity. and Liza V. healthy profits from the previous five years and new equity raised through successful initial public offerings (IPOs) in a robust stock market allowed the corporate sector to accelerate investments and borrowings.3 The Philippines Cesar G.
the corporate sector showed structural weaknesses similar to those in neighboring Asian countries. Investments of large corporate groups tend to focus on obtaining market shares and industry dominance. Corporate financing relies excessively on bank loans. Banks have significant presence as members of affiliated business groups. regulatory framework. Government interventions under the notion of “master planning” for economic and social development characterized the 1970s and early 1980s. therefore. It analyzes the impact of corporate governance on company financial performance and financing.2. the Government overvalued the local currency and imposed high import tariffs. This study reviews the Philippine corporate sector in terms of its historical development. The highly concentrated and family-based ownership of corporate groups has resulted in governance structures that depend largely on internal control systems. But protectionist policies made labor relatively more expensive and. patterns of ownership. Vol. Sugar refining and textile mills are examples of industries that floundered in the 1980s because of government import substitution policies. The Board of Investments (BOI) was created to draw up an investment priorities . nationalist sentiments led to policies that favored import substitution and heavy government intervention in business. and on the financial crisis. The policy was crafted by the martial law regime at that time. patterns of financing. Companies were profitable because of protection from foreign competition. yet they did not risk new capital required for modernizing and expanding manufacturing capacity. An industrial elite. 3. Companies finance long-term investments with short-term debt. companies were necessarily large and capital-intensive. To implement these policies.1 Overview of the Corporate Sector Historical Development During the 1950s and 1960s. on family-based and controlled conglomerates. emerged to influence industrial policies. control by internal and external governance agents. composed mostly of families previously in trading businesses.156 Corporate Governance and Finance in East Asia. their growth could not be sustained. While new manufacturing industries were successfully established. and responses to the financial crisis. II Still.2 3. which leads to their easing of due diligence and monitoring standards when lending to group members. usually with the acquiescence of bank creditors. These early industrialists naturally opposed any initiative to reduce tariffs.
Reforms in policies. Starting in 1981. Nevertheless. In 1991. the Government continuously revised the enabling law of BOI so that incentives were reduced in number.Chapter 3: Philippines 157 plan (IPP) to encourage private sector investments by offering tax and other incentives. including the reduction of tariffs.. BOI incentives retained a strong bias in favor of capital-intensive enterprises and domestic-oriented industries.e. Foreign ownership was allowed only in industries with high technological and market barriers. and import licensing requirements. The Government signaled through the IPP its intent to shape the future industrial landscape. and orientation toward domestic markets. i. dominance by large companies. made less associated with capital investments. the legislative body passed the Foreign Investment Act (FIA). the top three companies accounted for a disproportionately large share of total sales and assets. the Government narrowed the range of tariff rates by commodity categories and reduced the average tariff rate from 28 to 20 percent. Probably the most significant effects of tariff protection and biases for capital intensity were the corporate sector’s high degree of concentration. the State took over the generation and distribution of electricity. Following government initiatives in the control of the infrastructure and utilities sectors. organizing industries into sectors and picking “winners. The high industrial concentration led to practices of price leadership and output restrictions and the rise of industry lobby groups—common features of an oligopolistic . Better access to cheaper imported raw materials improved the competitiveness of local manufacturers. clearly shifted economic management toward reliance on markets rather than on decisions by bureaucrats in the Government. quantitative restrictions. and initiated the development of alternative energy sources in response to the oil crises. Quantitative restrictions and tariff protection of preferred industries remained firmly in place. advance notice of areas where the country disallowed or restricted foreign investment. The 1980s were marked by a peaceful transition of political power. Exports were not competitive because of the high costs of imported materials. In many industries. In the early 1990s. and oriented toward exports. The FIA allowed foreign equity investment in many areas and at the same time provided a transparent. the “pioneer” industries identified in the IPP. assumed ownership of the largest petroleum refining company. It limited the bureaucratic cost and discretion that accompanied the necessary approvals of foreign investments.” No strategic industry could take off without the Government’s participation in its management and operations.
2.5 percent per year (Table 3.7 8.5) 3.2 7.9 (1.2 Source: ADB. only to be unsettled by the crisis of 1997. II market. Vol.8 4. .5 9.8 percent growth in fixed 2 The SEC-BusinessWorld Annual Survey of the Top 1.2 Korea. The Philippines substantially lagged behind other countries from 1990 to 1995 (Table 3.2).000 Corporations covers financial and nonfinancial companies.6 7.4 4.8 8.7) (10.5 8.1 5.0 (0. only nonfinancial companies were used.5) 5.3 2.2 Growth and Financial Performance Performance of All Companies The analysis of corporate performance in this section used financial data from the Securities and Exchange Commission (SEC)-BusinessWorld Annual Survey of Top 1.2 9.1). Its growth rate began to catch up with others in 1996. 1990-1999 (percent) Year 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 Indonesia 9.9 7.2 Thailand 11. which was taken as a representation of the Philippine corporate sector. This rate of growth was sustained by a comparable 18. Table 3.5 (7.2) 0.7 (13.2) 4.000 Philippine companies grew 17.9 5.8 5.1 GDP Growth of Southeast Asian Countries. With economic reforms introduced in the 1980s and 1990s.1 4.0 8. net sales of the top 1.9 6.3 8.3 9.6) 0. In this section.4 Philippines 3.7 Malaysia 9.0 (6.000 corporations.7) 10.158 Corporate Governance and Finance in East Asia.1 8. of 9. A comparison of the Philippines’ economic performance in terms of real gross domestic product (GDP) growth with selected countries in Southeast Asia places the succeeding review of the corporate sector’s performance in context.5 8.2 8. Key Indicators of Developing Asian and Pacific Countries 2000.7 5.1 5. Rep.2 7.0 8.2 During 1988-1997.3 7.8 8.3 9. however.8 10.8 5. competition from liberalized imports had somewhat reduced oligopolistic tendencies and concentration in many industries. 3.2 (0.0 7.
3 60 10.6 75 6.6 290.0 148.2 Average 146 12.225.5 446.4 776.2 27.5 1.3 382.9 3.4 3.2 Growth and Financial Performance of the Top 1.8 741.7 443.341.647.1 51.4 898 1.6 18.1 468.9 2.6 900 1.7 218. 1988-1997 1989 5184.108.40.206 862.6 35.1 6. .6 954.2 378.2 2.8 22.7 238.7 903 0.1 54 11.9 629.5 64.2 2.332.978.8 4.1 4.4 602.2 4.1 1.2 136.2 Indicators 1988 Growth Indicators (P billion) Net Sales Net Income Fixed Assets Total Assets Total Liabilities Stockholders’ Equity Retained Earnings 464.3 107 13.1 Other Indicators No.4 63.1 1.1 72.9 96.7 73 6. return on assets (ROA) = net income/total assets.8 26.5 119 12.2 900.4 555.9 480.5 14.9 898 1.893.3 121 12.6 102 16.6 149 12.5 1.4 Financial Ratios (%) Leverage ROE ROA Turnover Net Profit Margin 222 14.3 898 1.4 861.561.781.3 68 7.9 149 6.9 952.3 46.8 6.7 1.5 1.6 1. net profit margin = net income/net sales. turnover = net sales/total assets.Table 3.3 941.6 144.1 5.2 707.4 8.131.1 181 11.394.5 72 7.5 570.0 1.6 109 12.6 5.4 188.5 508.8 618.7 1.317.5 192.8 77 7.9 896 2.697.1 714. of Companies Sales per Company (P billion) 899 0.3 306.5 4.209. Source: SEC-BusinessWorld Annual Survey of Top 1.177.2 Compound Growth (%) 17.1 197 14.1 881.4 1.2 1.4 260.5 Leverage = total liabilities/stockholders’ equity.9 1.6 426.9 617.7 28.6 896 0.8 902 1.1 73 5.5 193.9 78 6. return on equity (ROE) = net income/ stockholders’ equity.7 20.4 411.0 900 1.5 887 0.000 Companies.8 411.2 338.1 95.1 66 12.000 Corporations in the Philippines.512.5 51 4.1 33.1 615.191.0 1.8 5.6 1990 1991 1992 1993 1994 1995 1996 1997 1.
Assuming Table 3. 1988-1997 Top 1. indicating that the corporate sector’s exposure to foreign currency-denominated loans was not as significant as in other countries. The growth rates of corporate sales for the period 1988-1997 exceeded those of the country’s GDP for the same period (Table 3. for the 10-year period.697 1.000 Corporations in the Philippines.5 17. respectively. Asset growth was funded by debt that grew at an average of 20.5 Ratio of Estimated Value Addeda to GDP (%) 17.000 Companies Year 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 Average Growth (%) a GDP (P billion) 799 925 1.5 Value-added is assumed to be 30 percent of net sales. leverage increased from 109 percent in 1996 to 149 percent in 1997. Total assets grew at an average annual rate of 22.3). and by equity that grew at a higher average annual rate of 26.000 companies averaged 7.352 1.178 1.4 20.9 percent for the period. but the extent of the increase was not as dramatic as in other Asian countries. various years. Net profit margins for the top 1.3 The Corporate Sector and Gross Domestic Product.394 1. This is high compared with developed countries but compares favorably with other Asian countries.979 17.693 1.248 1. Further. Net income consistently increased from 1988 to 1996 and declined only in the crisis year 1997.9 21.8 percent per year.9 23.3 percent.172 2.6 percent and 5. Vol.8 17.4 24.1 Net Sales (P billion) 465 519 630 741 862 954 1. Sources: ADB.427 13.7 percent. Key Indicators of Developing Asian and Pacific Countries 1999.160 Corporate Governance and Finance in East Asia.8 19.474 1. The data suggest no evidence of excessive borrowing in the run-up to the crisis in 1997. Return on equity (ROE) and return on assets (ROA) averaged 12. and the SEC-BusinessWorld Annual Survey of Top 1.906 2.5 16. . The debt-toequity ratio ranged from 222 percent in 1988 to 102 percent in 1994. These rates of return are high compared with other Asian countries.077 1.2 percent.1 19. II assets.
0 28.0 4.9 22.5 GovernmentOwned 4.5 23 4. and industry reveals further structural characteristics of the growth and financial performance of the corporate sector.Chapter 3: Philippines 161 a constant ratio of value added to sales.0 5.0 Net Income 19.7 22.2 103 5. Performance by Ownership Type The Philippine corporate sector can be categorized into four groups based on ownership: (i) publicly listed.9 158 13.3 11.9 17.3 27.1 12. (ii) foreign-owned. corporate control structure.8 2.1 Financial Ratios (%) Leverage 89 ROE 15.8 No.5 Other Indicators Share of Sales (%) 17. size. and (iv) privately owned. . 1988-1997 Indicators Publicly Listed Privately Owned Rate.7 2.8 percent of the corporate sector’s total sales between 1988 and 1997. these figures suggest a significant and increasing contribution of the corporate sector to GDP. of Companies 73 Sales per Company (P billion) 2.9 196 1.8 ForeignOwned 21.9 26.2 9.6 Total Assets 29.3 9. Averaging 42.8 3.000 Corporations in the Philippines. privately owned companies constituted the largest group (Table 3. A study of company performance by ownership type.1 ROA 8.5 Retained Earnings 30.5 Source: SEC-BusinessWorld Annual Survey of the Top 1.0 31.5 27.4 Fixed Assets 19.4 28.0 5.0 142 22.4 Stockholders’ Equity 32. The foreign-owned companies were the Table 3.3 146 6. various years.3 42.8 22.3 22.4 Growth and Financial Performance of the Corporate Sector by Ownership Type.4).8 Growth Indicators (Compound Annual Growth Net Sales 20.3 22.0 Turnover 53 Net Profit Margin 15. %) 17.1 22 10.8 14.4 Total Liabilities 26. The premise is that these variables have a direct bearing on corporate performance and growth. (iii) Government-owned.4 190 5.8 606 0.
8 percent for foreign-owned companies and 20 percent for publicly listed companies during 1988-1997.000 companies in 1997. However. the highest net profit margin of 15. and the second lowest asset turnover. selling an average of P4. and low return on investment is the norm.3 percent. Only 84 of the 221 public companies listed on the Philippine Stock Exchange (PSE). Publicly listed companies had the lowest leverage at 89 percent. while there were few of them. the second best ROE and ROA.2 percent and ROA of 9. Privately-owned and Government-owned companies grew at slower rates.1 billion per company in 1997. these companies were comparatively large. compared with P2. they generated the highest return on investments.75 billion per company for foreign-owned companies.5 percent. It should also be added that the profit margin of Government-owned companies is distorted by the presence of holding companies such as the Philippine National Oil Company. or 38 percent. II second largest at about 27. The privately-owned companies were only about one third of the average size of per company sales of the publicly listed companies. a level high by Western standards but at par with those of other Asian countries.5 percent average growth rate of the entire corporate sector. . Publicly listed companies had a minor though steadily increasing share in total sales. With an average leverage ratio of 142 percent. the asset base is large.162 Corporate Governance and Finance in East Asia. The government-owned companies had the highest leverage at 190 percent but lowest ROA and ROE because these are primarily public utilities and companies in the energy sector where turnover is low. with an average ROE of 22. reflecting the significant presence of holding companies as the gross revenues of holding companies flow through to operating income. But by being most efficient in employing assets. The compound annual sales growth rate was 21. exceeding the 17. Bases Conversion Development Authority.000 list. meaning that the remaining 62 percent were relatively small in sales and assets. and government-subsidized agencies such as the National Food Authority and Local Water Utilities Administration. followed by publicly listed ones. Their ROA and ROE were both more than twice as high as those of government-owned companies.9 percent. Governmentowned companies in the top 1. Vol. The privately-owned companies had a high average leverage ratio of 158 percent. although small in number. were among the top 1. registered the largest per company sales at about P9 billion in 1997. but lower than those of foreignowned and publicly listed companies. These were mostly large public utilities. foreign-owned companies borrowed more than publicly listed ones.
various years.0 25. But the conglomerates were larger measured in sales per company.1 124 5.3 No.8 Growth Indicators (Compound Annual Growth Rate.0 55.6 26. 1988-1997 Indicators Group Member Independent 18.4 24.5).8 ROA 8.3 Total Liabilities 30. a company can be a member of a conglomerate or independent. had a lower leverage ratio.1 Source: SEC-BusinessWorld Annual Survey of Top 1.7 2.3 Financial Ratios (%) Leverage 98 ROE 15.0 22. medium. of Company 159 Sales per Company (P billion) 2.7 Total Assets 32.1 Retained Earnings 32. Table 3. compared with 32.8 6.3 percent for the conglomerates.000 Corporations in the Philippines.7 Stockholders’ Equity 34. and achieved higher returns on invested assets than independent companies (Table 3. and small companies. the corporate sector is divided into large.2 Net Income 21. %) Net Sales 20.2 23.3 Other Indicators Share in Sales (%) 32.Chapter 3: Philippines 163 Performance by Control Structure By control structure. Performance by Firm Size By firm size.6 715 0. grew faster.2 Fixed Assets 25. The independent companies contributed about 56 percent of corporate sales on average during the period 1988-1997.0 166 15.0 Turnover 67 Net Profit Margin 12. Sales and resources of the . depending on assets and sales.5 Growth and Financial Performance of the Corporate Sector by Control Structure.
9 89 1.6 Growth and Financial Performance of the Corporate Sector by Firm Size.3 Source: SEC-BusinessWorld Annual Survey of Top 1. various years.8 percent of the total number of companies in the list (Table 3. %) Net Sales 15.1 No.5 12. defined in this study as the next 200 largest companies in the top 1.1 ROA 5.5 25.9 32.6 36.4 billion in 1997.4 Total Liabilities 18.0 730 0. Table 3.6 31. However. Large companies accounted for 56. Sales per company in this group averaged P13. while small companies.4 28.1 4.164 Corporate Governance and Finance in East Asia.9 Financial Ratios (%) Leverage 158 ROE 13. for this study.1 81 9.9 Retained Earnings 13. which. 1988-1997 Indicators Large Medium 19.2 29.2 Stockholders’ Equity 18. Medium-sized companies also performed better in terms of ROE.1 percent of the total sales of the corporate sector.0 156 16. averaging 16 percent. sales of mediumsized companies grew faster than large companies.5 Growth Indicators (Compound Annual Growth Rate. although they comprised only 8.1 25. Medium-sized companies.7 Net Income 1. averaged a far less P3 billion in per company sales.5 73 6.2 Other Indicators Share in Sales (%) 56.000 list. indicating that they deployed resources more efficiently than large and small companies.2 25.6 Small 19.000 list.3 Fixed Assets 15.6 49.0 32.5 128 10. .3 Turnover 65 Net Profit Margin 8.5 Total Assets 18.0 7.000 Corporations in the Philippines.7 44. averaged only P920 million in per company sales during the same year.6 47. are defined as the largest 100 companies in the top 1. Vol.9 26. of Companies 79 Sales per Company (P billion) 7. referring to the remaining companies in the list.6). II Philippine corporate sector are highly concentrated among the large companies.
averaging 10. and construction. Poor returns appear to have been caused by the low profit margin at 6. reflecting to some extent a “bubble” phenomena in the former two sectors. with their ROE dropping to 3. at 156 percent. Performance by Industry This study also looked at corporate performance by industry.7. assets. from 14. as indicated by the negative annual growth.6 percent.2 percent for large ones. ROE dropped from 10. But small companies’ leverage was significantly lower. profits. and the construction sectors than for the manufacturing. compared with 9. Net income declined from P54. specifically those industries least and most affected by the financial crisis.1 billion in 1996 to P4. The sector showed consistent growth in sales.4 percent in 1997 from 11. utilities.5 percent for medium-sized companies and 8. and utilities and services sectors.7 billion and P35. Large. are shown in Table 3. Medium-sized companies apparently enjoyed efficiencies associated with economies of scale and made more productive use of their assets. Mediumsized companies’ leverage level was slightly lower. Manufacturing companies represented more than half of the corporate sector in number in the period 1988-1997 and accounted for about 82 percent of total sales. but lower than that of construction. For small companies. but suffered its largest decline in net profits in 1997. of net income. at 128 percent for the period.8 billion in .2 billion in 1997 for this sector.8 percent.1 percent. net income.7 percent a year earlier. The growth and financial performance of selected industries.7 percent in 1996 to 8. and equity up to 1996. The Asian financial crisis affected large companies most severely. and utilities and services sectors. at -12. ROE dropped to 7. unlike their counterparts in other Asian countries.. showed the lowest ROE.and medium-sized companies did not substantially increase their leverage in years running up to the crisis in 1997. manufacturing. The leverage ratio of the manufacturing sector was higher than that of the real estate and property sector. net income.8 percent in 1997. Growth of sales. The real estate and property sector also suffered significantly in sales. at 158 percent on average during 1988-1997. and assets was much higher for the real estate and property. especially during the period 1994-1996. although the largest in number.e.Chapter 3: Philippines 165 Small companies. and profitability in 1997 when the crisis started.8 the previous year. i.7 percent in 1997 for medium-sized companies. Sales revenue and net income declined from P76. real estate. Leverage was the highest for large companies.
1 10.7 Net Income (12.9 2. Its knock-on effect on the economy was small as it accounted for less than 3 percent of the top 1.9 17.6 Financial Ratios (%) Leverage 142 181 ROE 13.7 28.6 69 16.2 8.7 192 9.8) 17. of Company 454 17 Sales per Company (P billion) 1.7 Growth and Financial Performance of the Corporate Sector by Industry.4 Source: SEC-BusinessWorld Annual Survey of Top 1.3 55.1 2.5 12.2 45.000 Corporations in the Philippines.0 23.2 12.2 37.4 19.4 16. it does not appear to have been excessively exposed to foreign currency-denominated loans. Vol. The sector’s buildup in equity during the stock market boom of 1994-1996 may have cushioned the impact of the crisis.4 percent.3 Fixed Assets 20.7 Indicators Manufacturing Construction 27.9 billion and P24.7 52.9 5. 1988-1997 Utilities Real Estate and and Services Property 39.8 48.3 20.7 ROA 5. But the impact of the Asian crisis on the real estate and property sector was much smaller than that on the manufacturing sector.7 billion in 1997. the sector’s ROE dropped from 15.0 Turnover 112 24 Net Profit Margin 5.7 10.166 Corporate Governance and Finance in East Asia.8 Stockholders’ Equity 21. and was also much more limited compared with the property sectors in other Asian countries.3 Retained Earnings 17. .4 Total Assets 19.6 Total Liabilities 18. 1996 to P56.1 24 42.0 31 0.9 23.7 percent to 10.4 3. various years. With a modest increase in total liabilities and leverage level of less than 100 percent in 1997.9 2.2 28 0.7 19. II Table 3.6 No.0 25. %) Net Sales 16.0 21. respectively.000 companies’ total sales on average during 19881997.8 41.5 Other Indicators Share in Sales (%) 82.6 Growth Indicators (Compound Annual Growth Rate.7 83 2. As a result.3 5.
the ownership of Filipino citizens in the corporation is not less than the legally required percentage of capital stock. (iii) principal office. The currency devaluation bloated the foreign currency-denominated loans of these companies. (iv) term of existence. nationalities. and restrictions. For publicly listed companies. nationalities. the Code requires a corporation 3 A company’s articles of incorporation should include: (i) corporate name. Amendments to the articles of incorporation require approval by a majority of the board of directors and a two-thirds vote of outstanding capital stock. Two other pertinent laws are Presidential Decree (PD) 902-A. Corporation Code of 1980 Supplanting the old Corporation Law of 1906. which regulates banks and nonbank financial institutions except insurance companies. contains some provisions affecting corporations’ dealings with banks. Under the Code. unlike in neighboring countries hit by the Asian crisis. Overall. and the Insolvency Law. (ii) purpose of the corporation. and residences of incorporators and directors. and recognized rules on corporate practices. privileges. and amount of authorized capital stock. One month after registration. par value. reaching up to 313 percent in 1997. and amount subscribed and paid by each. (v) number of directors (not less than five nor more than 15). and residences of original subscribers. administrative regulations. . It provides the basic constitutional structure for the organization. the Corporation Code of 1980 is a compilation of important juridical rulings. which is also the organic law governing the operations of SEC.3 which serve as the company’s declaration that the minimum percentage of authorized capital required by law has been subscribed and paid-up. and dissolution of corporations. The articles of incorporation may also include other matters such as waiver of preemptive right and classes of shares such as founders’ or redeemable shares describing their rights.Chapter 3: Philippines 167 The utilities sector had the second highest leverage during 19881997 at 181 percent on average. the leverage of all four industries was low. and (viii) names. The General Banking Law. (vi) names.2. It specifies the minimum information to be indicated in the articles of incorporation. (vii) number. which was based on American corporate law.3 Legal and Regulatory Framework The Corporation Code of 1980 is the main law governing the corporate sector. operation. 3. the Revised Securities Act (RSA) and PSE’s public listing requirements also apply.
place. A majority of the outstanding shares of shareholders must vote to authorize amendments to the bylaws. officers. or officers. supervision (regulatory). (iii) qualifications. However. and public policy. and control (adjudicative) of all corporations. uniform.168 Corporate Governance and Finance in East Asia. the corporation’s articles of incorporation. (v) manner of election or appointment and term of office of all officers other than directors. duties. and (vii) manner of issuing certificates in the case of stock corporations. PD 902-A also granted SEC the exclusive jurisdiction to hear and decide cases involving: (i) complaints about devices or schemes employed by the board of directors and officers amounting to fraud and misrepresentation that may be detrimental to the interest of the public or shareholders. PD 902-A expanded SEC’s mandate to include absolute jurisdiction. manner of voting. shareholders may delegate this power to the board of directors by a two-thirds vote of outstanding capital stock. among shareholders. and (iv) petition of corporations to be declared in a state of suspension of payments in cases when their assets cover all debts but they cannot pay these debts when they fall due. (vi) penalties for violation of the bylaws. (iv) time for holding annual election of directors and manner of giving the election notice. and should not impair vested rights. . and between the corporation and the State concerning its franchise or right to exist. and manner of calling and conducting regular or special meetings of the directors and shareholders. and reasonable. In 1976. (iii) controversies in the election or appointments of directors and officers of corporations. (ii) controversies arising out of intra-corporate relations. II to adopt a code of bylaws or rules for its internal governance. and forms of proxies and manner of voting them. Vol. To be valid. Securities and Exchange Commission: PD 902-A SEC is the government agency responsible for implementation of the Corporation Code. directors. Its mandate is to supervise corporations in order to encourage investments and protect investors. 4 Some of the items that a corporation may provide in its bylaws are the following: (i) time. (ii) required quorum in shareholders’ meetings. between the shareholders and the corporation.4 Philippine corporate law distinguishes between management decisions that require only a majority vote of the board and major decisions that require a two-thirds majority vote of shareholders. and compensation of directors. must be general. and employees. It implements rules and regulations that protect minority shareholders from possible fraud and misbehavior by controlling shareholders. In addition. the bylaws must be consistent with the law.
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The last item of PD 902-A is the special jurisdiction granted to SEC over applications by corporations for “suspension of payments” to creditors, a role of the regular courts that was originally part of the Insolvency Law. Under this authority to approve applications for suspension of payments, SEC has the power to appoint rehabilitation receivers or management committees for petitioning corporations. A presidential writ issued in 1981 placed SEC under the supervision of the Ministry of Finance, but in 1998, control of the agency was returned to the Office of the President. Insolvency Law The Insolvency Law is designed to effect an equitable distribution of insolvent debtors’ properties among their creditors. It permits debtors to be discharged from their liabilities to enable them to start afresh with property set apart for them from assets to be used as payment to creditors. The regular courts have jurisdiction for insolvency proceedings including suspension of payments for individual debtors. A debtor can petition the court to suspend payment of debts or to be discharged from liabilities and debts by voluntary or involuntary insolvency proceedings. Revised Securities Act: Law on Securities Dealing Like its predecessor, the 45-year-old Securities Act, the RSA was patterned after several US securities acts. The RSA is primarily designed to prevent the exploitation of investors through the sale of unsound or fraudulent securities. For this purpose, the law requires full and accurate disclosure of all material facts concerning the issuer and the securities it proposes to sell, and prohibits misrepresentations, manipulations, and other fraudulent practices in the sale of securities. To enforce these regulations, the law requires the registration of securities. The registration requirement covers full and accurate disclosure of the character of the securities to be sold to the public, including detailed information regarding past dealings between the issuer and its directors, officers, and principal shareholders. Public Listing Rules of the Philippine Stock Exchange PSE is the country’s facility for secondary trading of shares of publicly listed companies. In 1998, SEC, which originally supervised PSE, granted the exchange the status of a “self-regulated” organization. Thus, PSE now
170 Corporate Governance and Finance in East Asia, Vol. II
has the authority, within general guidelines set by SEC, to set rules and regulations for PSE members and listed companies. The general requirements for maintenance of listed status include submission of financial reports that conform with generally accepted accounting principles (GAAP) and regulations established by PSE, and compliance with laws relating to securities and exchange regulations, board resolutions, and agreements executed with the agency. Violations of PSE requirements are subject to sanctions, including delisting. PSE is responsible for ensuring that listed companies follow the exchange’s rules of disclosure and fair treatment of investors. It has the power to impose sanctions on any company that fails or erroneously discloses material information that affects the rights and benefits of investors and misrepresents information in its application, prospectus, financial statements, or reports. In the area of corporate governance, PSE requires corporations to resolve, and, where possible, eliminate arrangements within groups of companies and own-company dealings that can lead to conflicts of interest. Upon complaints by minority investors, PSE can review the deals in question, using such criteria as benefits to the company, adequate disclosure to shareholders, and internal control procedures to ensure fair and reasonable terms. Banking Laws Affecting Corporations Some aspects of banking laws affect the governance of corporations. The important ones concern: (i) the capacity of officers of corporations to assume positions as members of the board of directors of banks, (ii) limits on ownership of banks by nonfinancial corporations, (iii) limits of lending by banks to corporations, and (iv) rules on lending to directors and other insiders. The General Banking Law governs the regulation of the establishment, management, and operations of banks. As the highest policymaking body of the banking system, the Monetary Board prescribes the qualifications of bank directors and reviews the qualifications of those appointed as bank directors and officers. It could disqualify anyone found, for whatever reason, unfit for the position. There are no other restrictions on corporate officers to be appointed as members of the board of directors of banks. A corporation, including its wholly or majority-owned subsidiaries, can own common shares of banks up to a maximum of 30 percent of banks’ voting stock. In the event that the corporation is majority-owned by one person or by relatives, the limit is 20 percent of banks’ voting shares.
Chapter 3: Philippines 171
Regulations on the single borrower limit (SBL) put a ceiling on the maximum amount that a bank can lend to a debtor. SBL rules limit the total liabilities of any borrower of a commercial bank to 15 percent of the bank’s unimpaired capital and surplus, and an additional 15 percent for “adequately secured loans,” to a maximum 30 percent (“unimpaired capital and surplus” refers to the total paid-in capital, surplus, and undivided profits, net of valuation reserves of a bank). SBL limits exclude risk-free loans such as Government-guaranteed loans and loans secured by cash deposits. Total corporate liabilities include all liabilities of the debtors and their majorityowned subsidiaries. The Monetary Board may prescribe the consolidation of the liabilities of subsidiaries with the parent corporation under certain conditions. Central Bank (Bangko Sentral ng Pilipinas [BSP]) regulations do not prohibit loans by the bank to its directors, officers, shareholders, and other related interests, known as DOSRI. However, they are subject to certain prudential requirements under banking laws, as follows: (i) a director or officer of a bank can only borrow or become a guarantor, endorser, or surety for loans from the bank with the written approval of all other directors of the bank (i.e., excluding the director concerned); (ii) the amount of outstanding credit accommodations that a bank extends to its shareholders shall be limited to an amount equal to the sum of their unencumbered deposits and book value of their paid-in capital contributions; and (iii) loans and advances given to officers in the form of fringe benefits shall not form part of liabilities under DOSRI.
Corporate Ownership and Control Patterns of Corporate Ownership
The historical development of Philippine corporate ownership is rooted in the country’s colonial past, the industrial policies of the Government, and the recent emergence of industrialists and an entrepreneurial class. During the Spanish and American period up to World War II, a small number of families acquired land and owned large businesses. These families built and preserved their businesses over several generations. Many of them became controlling shareholders of family-based corporations and business groups that are major players in the present-day Philippine corporate sector. Ownership is a key element in corporate control and governance. Public listing rules of PSE require that a minimum of 10 to 20 percent of
172 Corporate Governance and Finance in East Asia, Vol. II
outstanding shares, depending on the size of the company, be available for trading in the stock exchange. As companies usually only issue the minimum required number of shares, large blocs of controlling shareholders often dominate corporate decision making in publicly listed companies. Public investors and minority shareholders are not in a position to influence management. Moreover, the presence of large controlling shareholders makes takeovers by other companies difficult. For these reasons, the resolution of conflicts between the interests of controlling shareholders, minority shareholders, public investors, and creditors in Philippine companies depends very much on the effectiveness of internal control systems. Ownership Concentration of Listed Companies This study measures ownership concentration in terms of shareholdings by the top one, five, and 20 shareholders.5 Table 3.8 shows that the top shareholder owned 40.8 percent of the market value of an average nonfinancial company. The shareholding of the top shareholder varied across sectors. It was highest for the property sector at 54.8 percent, followed by holding companies (as a sector) at 53 percent. One shareholder held majority control of an average company in these two sectors. The average shareholding of the largest shareholder was less than 25 percent only in sectors with large market capitalization, such as power and energy, and transportation, and in sectors with high risks, such as oil exploration and mining. These figures suggest that for publicly listed companies, a single shareholder often has substantial or even dominant control. Combined, the holding of the top five shareholders in an average company was about 65.3 percent for the nonfinancial sector and 59.2 percent for the financial sector. The five largest shareholders held majority control over an average Philippine publicly listed company, except in three sectors—transportation; food, beverage, and tobacco; and oil exploration. Ownership by the five largest shareholders was on average most concentrated among holding companies (78.4 percent), and in construction (74 percent), property (69.8 percent), manufacturing and trading (68.4 percent), and communications (67.3 percent).
The study derived ownership data for 194 (169 nonfinancial) companies out of 221 (190 nonfinancial) listed on the Philippine Stock Exchange as of 1997. Shareholdings by the top one, five, and 20 shareholders were estimated for each company and averaged by using the market capitalization of each company as a weight.
Chapter 3: Philippines 173
Table 3.8 Ownership Concentration of Philippine Publicly Listed Companies by Sector, 1997
Sector Financial Institution Banks Financial Services Average Shareholdingb Nonfinancial Company Communication Power and Energy Transportation Services Construction and Other Related Products Food, Beverage, and Tobacco Holding Companies Manufacturing, Distribution, and Trading Hotel, Recreation, and Other Services Property Mining Oil Average Shareholdingb
Top 1 26.9 41.3 27.2 35.4 21.5 23.8 47.7 22.7 53.0 37.4 28.9 54.8 23.4 19.9 40.8
Top 5 59.2 63.2 59.2 67.3 55.4 48.4 74.0 44.1 78.4 68.4 55.3 69.8 56.0 45.1 65.3
Top 20a 76.4 65.8 76.2 76.9 72.1 69.2 86.2 69.7 86.0 42.6 68.0 74.5 51.9 64.3 75.9
Information on the top 20 shareholders is not available for five holding companies, 10 manufacturing companies, and two property companies. b Weighted by market capitalization. Source: PSE databank.
The shareholding of the 20 largest shareholders in an average company was 75.9 percent for the nonfinancial sector and 76.2 percent for the financial sector. In 12 out of 13 sectors, the top 20 shareholders owned more than 50 percent of the voting shares of an average company. In 10 out of 13 sectors, the top 20 shareholders held more than a two-thirds majority control of an average company. Ownership Concentration at Critical Levels of Control PSE listing rules require that a minimum of 10 to 20 percent of outstanding shares of a company be issued to the public, depending on its size. An interesting question is whether in reality Philippine publicly listed companies issue enough shares to be truly widely held or whether they barely meet this minimum requirement. The answer to this can be gleaned from an
In 111 companies. minority shareholders are unlikely to be able to influence the strategic and operating decisions of a company without the support of one or more large shareholders. or about 30 percent of the total. including pure holding companies. Vol. which are mostly privately owned and controlled by family-based shareholder blocs. a single shareholder held operating control of a company. Individuals did not constitute a significant shareholder group among the top five shareholders. holding only an average of 2. the top five shareholders owned more than 50 percent of the voting shares. II analysis of the number of companies in which the top one. controlling an average of 52. a single owner owned more than 80 percent of outstanding shares. Through these. In 21 companies. In four of 11 nonfinancial sectors. or almost 75 percent of the total. or 14 percent of the total. The shares of publicly listed companies are thinly traded and illiquid. and 20 shareholders? In Table 3.2 percent of outstanding shares of publicly listed companies. nonfinancial corporations held majority control. or 3 percent of the total. large and family-based shareholders pool the family’s ownership over many . the top 20 shareholders collectively owned a majority of a company’s shares. 66 percent (signifying strategic control).174 Corporate Governance and Finance in East Asia. Nonfinancial corporations with controlling shareholdings are likely to be holding companies. In 76 companies. and share prices are sensitive to movements of foreign funds. five.1 percent of publicly listed companies in the Philippines in 1997. There are advantages to establishing pure holding companies. Composition of Ownership of Publicly Listed Companies Another important issue concerning corporate ownership is the composition of the controlling shareholders. Parent companies usually spin off operating units into new companies that they continue to control as affiliates. With such high levels of ownership concentration. a single shareholder held two-thirds majority control.9 shows that in 44 companies. The largest group is nonfinancial corporations. In 116 companies. the top five controlling shareholders were classified into eight groups. The limited volume of shares issued to the public is one of the causes of the underdevelopment of the Philippine stock market. Who are the top one. or 80 percent (only nominally publicly listed) of outstanding shares. or 20 shareholders owned more than 50 percent (signifying operating control). the top five shareholders held more than two-thirds majority control of a company.10. or 51 percent of the total. or 78 percent of the total. Table 3. five. In four companies.
1997 % of Firms with Top Shareholders Controlling more than 50% of Shares Top 1 30 40 50 20 31 — 14 24 30 90 80 86 72 73 50 57 72 74 100 87 93 36 82 100 100 80 78 20 13 43 8 14 — — 8 14 70 60 57 48 49 50 14 52 51 Top 5 Top 20a Top 1 Top 5 Top 20a 90 80 86 36 76 100 71 76 72 % of Firms with Top Shareholders Controlling more than 66% of Shares % of Firms with Top Shareholders Controlling more than 80% of Shares Top 1 — 13 7 — 2 — — — 3 Top 5 40 33 50 28 27 50 — 28 30 Top 20a 60 67 64 20 47 50 43 36 45 Sector Communication Construction Food. and two companies in the property sector. Beverage. and Tobacco Manufacturing.9 Ownership Concentration at Critical Levels of Control Over Publicly Listed Companies. Distribution. 10 manufacturing companies. . and Trading Holding Power Transportation Property Total — = not available. a Data for top 20 shareholders were not available for five holding companies. Source: PSE databank.Table 3.
5 12.5 13.1 a Weighted by market capitalization. Distribution.6 2.9 6.1 1.4 1.5 2.0 0.2 1.0 7.8 66. and Tobacco Holding Companies Manufacturing. Source: PSE Databank.1 0.5 0.0 2.2 3.7 0.1 7.6 18.0 0.7 0.7 0.0 1.0 1.6 0.6 0.4 29.3 0.6 1.8 21.4 0.7 0.8 0.0 0. and Other Services Property Mining Oil Average Shareholdinga 33.1 5.0 1.9 52.7 0.0 0.6 0.1 9.8 0.2 0.0 0.2 59.9 0.9 0.2 0.5 4.6 0.3 0.10 Composition of Top Five Shareholders of Philippine Publicly Listed Companies by Sector.7 3.0 0.4 2.5 0.0 5.3 5.2 3.4 5.Table 3.6 2.1 8.0 1.0 0.0 5.6 0. and Trading Hotel.6 33.7 1.2 3.3 0.3 0.0 10.3 0.7 3.0 2.3 1.0 0.0 1.2 0.0 4.7 67.3 5.6 12.0 0. .0 5.3 12.6 0.8 11.2 3.0 1.0 0.8 0.5 26.3 2. Recreation.0 45.0 0.1 6.4 19. Beverage.1 0.0 0.6 9.3 1.4 8.0 1.6 5.6 0.0 5.5 4.3 26.0 0.7 0. 1997 (percent) Nonfinancial Investment Nominee Commercial Company Trust Fund Company Individual Bank Government Securities Broker Insurance Company Sector Financial Company Banks Financial Services Average Shareholdinga Nonfinancial Company Communication Power and Energy Transportation Services Construction and Other Related Products Food.2 10.9 36.5 53.3 37.2 5.0 0.0 1.0 0.2 0.2 0.
7 percent of shareholdings).Chapter 3: Philippines 177 companies and share in the risks and profits of the group. They can also better manage their income taxes because income from affiliated companies passes through a holding company. Holding companies as a sector had the largest market capitalization in PSE in 1997. The investment funds’ presence in these sectors ranged from 8. Because of limited ownership by institutional investors. These are mainly the Social Security System (SSS) and the Government Service Insurance System (GSIS). Investment trust funds were the most important institutional investors. The Philippine capital market did not have an active analyst community comparable to those in more developed capital markets.2 percent shareholding by the financial institutions was even inflated to some extent because securities brokers held trading portfolios for their clients rather than long-term investments. The 7.2 percent in 1997. accounting for P258.6 billion or 26. Insurance companies were very minor investors in the stock market because prudential regulations prevent them from investing significant amounts even in equities of large companies. and insurance companies (0. The financial institutions among the top five shareholders of nonfinancial corporations are investment trust funds (with 4. commercial banks (1. Holding companies were themselves 66 percent owned by other nonfinancial corporations.6 percent of market capitalization in 1997. securities brokers (1. with an average of only 7.5 to 12.3 percent).1 percent). Privately-owned pure holding companies own a majority of shares and exercise control of publicly listed holding and operating companies through a multilayered pyramid structure. respectively. . As a group.7 percent of market capitalization of the nonfinancial publicly listed companies. Such advantages have contributed to the popularity of holding companies among publicly listed companies.1 percent). and San Miguel Corporation (SMC) in food and beverages. Funds of SSS and GSIS consist mainly of compulsory contributions from members of the country’s private sector and government workforce. while still allowing the public to own minority shares. This complex layering of ownership masks the identity of individuals or families that actually own and control operating companies. there was no real market for investment information. These include Philippine Long Distance Telephone Company (PLDT) in telecommunications. Petron and MERALCO in power and energy. These institutions keep a stock portfolio mostly in shares of a few companies with large capitalization and high liquidity in select industries. financial institutions did not have a significant ownership in nonfinancial corporations.
Family-based groups have larger companies since their total sales were about 33. All major industries were represented.000 corporations’ sales. liberalized the regulations on entry of foreign bank branches and foreign ownership of local banks. remain in force to control excessive lending of banks to insiders. This could further increase the concentration of ownership and expand the scope of own-group lending by these larger banks. This is significant considering that there were only 31 local commercial banks in the country in 1997. The Central Bank deregulated interest rates and foreign exchange. using data on the Philippines’ top 1. identified the companies belonging to each of these groups. However. about three fourths. Corporate financing depends on intermediation by banks. Commercial banks hold the largest share. including SBL and DOSRI rules. suggesting that business groups are common in all major markets. and tracked the financial performance of each company from 1992 to 1997. so far limiting their involvement to selected products. Foreign banks have a growing presence but have not necessarily increased the supply of credit to the corporate sector. Prudential regulations.178 Corporate Governance and Finance in East Asia. Banks that are members of business groups have an advantage in raising funds from the internal capital market of the group. To understand the ownership and governance characteristics of family-owned business groups.4 percent of the top 1. . Large shareholders and their families own these banks directly or through their controlled companies. A common feature of corporate ownership of a business group is the centrality of a commercial bank. Vol. the Central Bank’s reforms are probably changing the conduct but not necessarily the structure of the banking system.11). II Family-Based Ownership and Business Groups The Asian Development Bank (ADB) survey of publicly listed companies conducted for this study reveals that about one third of responding companies started out as family businesses. and increased the capital requirements for all types of banks. More than three fourths of the respondents are either a parent or subsidiary (about 70 percent of these are domestic nonfinancial companies). suggesting that most publicly listed companies are parts of business groups.8 percent of total companies in number. the study put together a list of prominent business groups. of the financial resources in the country.000 companies.6 The total sales of these groups in 1997 were estimated at P806 billion (Table 3. Most family businesses that went public did so because they wanted to raise capital and to gain the prestige associated with being a public company. Some 20 financial institutions were affiliated with these groups. The process identified a total of 238 companies belonging to 39 business groups from the SEC-BusinessWorld Annual Survey of the Top 1. many companies in family-owned groups are not publicly listed. a nonfinancial company that owns a commercial bank has better access to loans at favorable rates and terms.000 Corporations in the Philippines. but they comprised only 23. Still.7 6 7 The study used publicly available shareholder information and published reports. including 16 commercial banks. For this reason.
In terms of sales. Cojuangco. the study used the four largest business groups—Ayala. Family-based business groups are most dominant in sectors such as manufacturing. or an average of about 12 per group. including business groups and independent companies.6 percent of the total sales of the top 1. The main constraint may be the availability of family members that could be drawn for top management positions. Lopez. Commercial banks are often affiliated to a particular business group. the nonfinancial sector was real estate (60. the two were closely related through their affiliations to business groups. Gokongwei. Interlocking Relationship between Financial and Nonfinancial Firms Although financial institutions as a whole did not own directly significant proportions of shares of nonfinancal corporations in the Philippines. for each of these groups. Commercial banking contributed about 40 percent of group profits for the Ayala group and Gokongwei group. it was manufacturing (36. broadcasting (49. To show this.000. and for the Henry Sy group. 25 out of the 50 top corporate entities were familybased groups. the principal owner of SMC.2 percent). Foreign-owned companies mainly serve the export markets. the top 10 family-based business groups had only 119 companies in the top 1.000 companies. a substantial proportion of group profits came from its financial subsidiaries. In the meantime. These corporate entities accounted for 53.4 percent of the group’s 1997 profits). namely. For the Ayala group. and more than 20 percent for the Lopez group and Henry Sy group. with the exception of Banco de Oro. for the Lopez group. Lopez. construction. Together. In terms of number of companies. the biggest private company in the Philippines.8 percent). Also.12). the largest family-based business group was the Ayala Corporation Group. which was majority-owned by the Henry Sy group. retail merchandising (69. ranged according to their sales (Table 3. and Ayala. It is also noteworthy that. in most . the three largest entities were family-based groups. with 27 affiliated companies in the top 1.000 corporations in 1997.Chapter 3: Philippines 179 Compared with other Asian countries. The significance of family-based business groups in the Philippine corporate sector is immediately evident in the 50 largest corporate entities. an average group in the Philippines has fewer member companies. nonfinancial companies contributed about 36 to 60 percent of total profits for these groups. real estate. and banking. Significantly.1 percent). In 1997. the largest was the Eduardo Cojuangco group. for the Gokongwei Group. as discussed in previous sections. and Henry Sy—as examples.
3 15. 17. 11. and Affiliated Bank of Selected Business Groups. 15. power. food. 13. and dairy products Investments. Sector Orientation.2 1. and mining Management. 3. food. 9. and personal care prods Shipping.0 13. 6. and car manufacturing Car manufacturing and real estate Food and telecommunications Department store and real estate Airlines. 14. Consunji 4 3 Food and dairy products Construction and mining 10.5 49. of Affiliated Companies Total Sales (P billion) 123. Real estate. 5.4 10.0 Average Sales Per Company (P billion) 6.9 2. 8.3 2.5 47. 7. 2.3 3.4 . and packaging Power distribution and mass communications Real estate. Eduardo Cojuangco Lopez Family Group Ayala Corp.Table 3.2 16.6 7. construction. beverages.5 2. 4.1 4.4 48.5 17. 1997 Business Group 19 15 27 12 12 9 4 6 11 4 8 9 5 4 5 6 Major Sector Orientation Estimated No.5 44. and tobacco Telecommunications Cement and construction materials Pharmaceutical and distribution 12.5 13.6 3. coconut oil.7 98.9 3.2 1.11 Total and Per Company Sales.5 6.0 26.5 26. 16. telecom. Group George Ty John Gokongwei Henry Sy Lucio Tan Ramon Cojuangco Family Group Del Rosario/Phinma Group Zuellig Group First Pacific/ Metro Pacific Group Aboitiz Family Group Jose Concepcion/RFM Group Alfonso Yuchengco Andres Soriano Family Group George Go Wilfred Uytengsu/ General Milling Group David M. Beverages. real estate.3 11. and tourism Credit card 18. agriculture.1 4.4 6.5 46. Flagship Company. beverages. 10.0 5.8 84.1 2.0 17. and food Food.6 2.6 3.
2 1. 24. 22. Enrile/JAKA Group Jaime Gow Guoco Group Jose Go Jardine Davies Gerardo Lanuza Alfredo C. 35. 25.1 0.0 5. P.9 6. .9 1.8 6. and various company annual reports.1 1.7 0.3 2.8 Jollibee Foods Luis Lorenzo Family Group Alcantara Family Group Bienvenido Tantoco Elena Lim Andrew Gotianum Brimo Family Group Andrew Tan J.9 1.7 1.2 6.3 7.4 3. Cruz Jose Luis Santiago Keppel Group Robert John Sobrepeña/ Fil-Estate Group Total Real estate Sources: PSE Databank.0 0. 29. mining.6 3.7 0.7 3. 28.9 7.4 5. 4 238 1. 21. 23.8 1.7 4.000 Corporations (1997).0 1. SEC-BusinessWorld Annual Survey of Top 1.6 5.2 4.4 3. and real estate Retail merchandising Ceramics and real estate Department store and real estate Cement and sugar central Real estate and securities trading Bookstore. 34.9 0.9 0.4 1. 38.9 1.6 Fast food Beverages and agro-industrial products distribution Cement and wood products Retail merchandising Electronic appliances Real estate Mining Real estate Telecommunication. 33.1 805. 20.6 2.3 2. 39. 32. distribution.1 1. 26. 31. 37. 27.1 2.8 1.7 0. 36.6 0.5 2.8 1.5 8.19. and real estate Department store Mining Construction Telecommunication Shipyard and power 4 7 5 2 4 4 3 2 5 7 5 5 2 3 2 3 2 2 2 2 8.0 2. Ramos Gaisano Family Group Felipe Yap Felipe F. 30.
9.Table 3. and Affiliated Bank of Selected Business Groups. 7.11 (continuation) Total and Per Company Sales. 15. 19. 11. 3. Group George Ty John Gokongwei Henry Sy Lucio Tan Ramon Cojuangco Family Group Del Rosario/Phinma Group Zuellig Group First Pacific/Metro Pacific Group Aboitiz Family Group Jose Concepcion/RFM Group Alfonso Yuchengco Andres Soriano Family Group George Go W. 2. 6. Eduardo Cojuangco Lopez Family Group Ayala Corp. Consunji Jollibee Foods Luis Lorenzo Family Group Alcantara Family Group Large Large Medium Medium Medium Large Large Large Medium Large Medium Medium Medium Medium Medium Medium Medium Medium Medium Small Small San Miguel Corporation MERALCO Ayala Corporation Toyota Motors Robinson Shoe Mart Philippine Airlines Phil. 14. 4. Long Distance Telephone Phinma Zuellig Pharmaceutical Metro Pacific William Gothong and Aboitiz Swift Foods/RFM House of Investment Anscor Equitable Card Network Inc. 17. Alaska Milk Corporation DM Consunji. 5. 13. 12. Flagship Company. Sector Orientation. 8. 16. 21. Jollibee Foods Corporation Pepsi Cola Products Alsons Cement . Uytengsu/General Milling Group David M. Inc. 18. 20. 1. 10. 1997 Business Group Size Classa Flagship Company Affiliate Bankb UCPB PCIBank BPI Metrobank/Global Bank PCIBank Banco de Oro Allied Bank Bank of Commerce Asian Bank PDCP Bank Union Bank Consumer Bank (Savings Bank) RCBC Asian Bank Equitable Banking Corp.
medium = P1. Fil-Estate Development Inc. 38. 34. 26. a b Size class is measured in terms of sales: Large = greater than P4. 29. Enrile/JAKA Group Jaime Gow Guoco Group Jose Go Jardine Davies Gerardo Lanuza Alfredo C. 36.48 billion. F. . Inc.65 billion. 35. Ramos Gaisano Family Group Felipe Yap Felipe F. PT&T Corp. 23. 30. 24.48 billion.. Sources: PSE Databank. Kepphil Shipyard Inc.000 Corporations (1997). 28. P. 37. 27.65 billion to P4. and various company annual reports. unless otherwise indicated.East-West Bank International Exchange Bank Ecology Bank (Savings Bank) Dao Heng Bank Orient Bank International Exchange Bank International Exchange Bank Philbanking Corp. 33. SEC-BusinessWorld Annual Survey of Top 1. Keppel-Monte Bank Bienvenido Tantoco Elena Lim Andrew Gotianum Brimo Family Group Andrew Tan J. 25. Refers to commercial banks. 39. Cruz & Co. Cruz Jose Luis Santiago Keppel Group Robert John Sobrepeña/Fil-Estate Group Medium Medium Small Medium Medium Small Small Small Small Medium Small Medium Small Small Small Small Small Small Rustans Solid Group Filinvest Philex Mining Megaworld Properties Jaka Investment Corporation Uniwide Corporation Guoco Ceramics Ever Gotesco Republic Cement PhilRealty National Bookstore Gaisano Department Store Lepanto Consolidated Mining F. 22. small = less than P1. 31. 32.
17. banking. telecommunication. beverages.8 22. and telecommunications Department store and banking Airlines.5 15.5 17. 13.1 17. and real estate Banking. 14.0 38.8 84.0 24. 23. 22. 8.4 48.2 49.5 26.0 37. food. 12.6 26. Fujitsu Computer Products Corp. 1997 Sales (P billion) Control Structure Major Industrial Orientation 123.2 Business Group Business Group Business Group Government. 7.6 18. 4. and mining Gold and other precious metal refining . car manufacturing. Texas Instruments (Phils. 15. food.8 53. power. and car manufacturing Power Refined petroleum products Refined petroleum products Banking. Aboitiz Family Group Jose Concepcion/RFM Group Alfonso Yuchengco Philippine Associated Smelting and Refining Corp.5 77.Table 3. Del Rosario/PHINMA Zuellig Group Toshiba Information Equipment (Phils. Beverages. 19. construction. 10. Philippine National Bank Mercury Drug Corp. 5.and Foreign Jointly Owned Business Group Business Group Business Group Government-Owned Publicly Listed/Foreign-Owned Foreign-owned Business Group Business Group Business Group Business Group Business Group Foreign-Owned Foreign-Owned Business Group Business Group Foreign-Owned Privately-Owned Publicly Listed/Foreign-Owned Privately-Owned Business Group Corporate Entity 1. Petron Corporation Pilipinas Shell Petroleum Corporation George Ty John Gokongwei Henry Sy Lucio Tan Ramon Cojuangco Family Group Caltex (Philippines) Inc. and personal care products Shipping.12 Control Structure of the Top 50 Corporate Entities. 24. 11. Inc. and bank Real estate. agriculture. beverages. and tobacco Telecommunications and banking Refined petroleum products Radar equipment and radio remote control apparatus Cement and construction materials Pharmaceutical and distribution Electronic data processing equipment and accessories Electronic data processing equipment and accessories Bank Drugs and pharmaceuticals goods retailing Real estate. 3. 6. Eduardo Cojuangco Lopez Family Group Ayala Corporation Group National Power Corp. coconut oil. food. Inc. and food Food. and dairy products Investments. of the Phils.).2 16.5 46. 2. First Pacific/Metro Pacific Group 21.5 44. 18. 16. 9.5 47.3 15. and packaging Power distribution. bank. 20. mass communications.).1 60.4 19.7 98.
48. Luis Lorenzo Family Group United Laboratories Development Bank of the Philippines Alcantara Family Group Bienvenido Tantoco Elena Lim Brimo Family Group Andrew Tan Total Share in Top 1. including biological products Bank Cement and wood products Retail merchandising Electronic appliances Mining Real estate Sources: SEC-BusinessWorld Annual Survey of Top 1.0 11. 32. National Steel Corporation National Food Authority Phil. 37.9 6.0 5.7 10. PSE Databank. Inc.9 14.7 13. 50.000 Corporations (1997).3 13.9 7. 35. and tourism Banking Radar equipment and radio remote control apparatus Operation of rolling mills Palay. corn (unmilled).25. 44. real estate.6 1. 30.1 9. 47. Uytengsu/General Milling Group David M. and apparatus for line telephony and line telegraphy Tobacco products wholesaling Cigarettes Radar equipment.6 Foreign-Owned Foreign-Owned Foreign-Owned Business Group Foreign-Owned Business Group Privately-Owned Government-Owned Business Group Business Group Business Group Business Group Business Group La Suerte Cigar and Cigarette Factory Land Bank of the Philippines Procter and Gamble Philippines Andres Soriano Family Group George Go Hitachi Computer Products (Asia) Corp. Philip Morris Philippines. 39.0 12.A. Corp. radio and remote control apparatus Fast food Bank Beverages and distribution of agro-industrial products Drugs and medicines. 34.000 Companies Sales (%) Cigarettes Bank Soap and detergents Management.5 8.8 9.2 7.3 8. Inc.4 10. 27. 41.9 7.7 10. Consunji Uniden Philippines Laguna. Jollibee Foods Citibank N. 45.5 8. Inc. 29. 49. 26. . 40. 31. 43. 28.5 10.0 13. 42.6 9.290 53. 33.4 8.6 12. 36. Amusement and Gaming Corporation Mitsubishi Motors Phils. 9. EAC Distributors Inc. 14. 46. and other grains wholesaling Other amusement and recreational activities Motor vehicles Food and dairy products Construction and mining Television and radio transmitters..8 6. and various company annual reports.8 Privately-Owned Government-Owned Foreign-Owned Business Group Business Group Foreign-Owned Government-Owned Government-Owned Government-Owned Foreign-Owned Business Group Business Group Foreign-Owned 38. W. Philips Semiconductors Phils.
corporate mergers or consolidations. Shareholders limit the broad power of the board by ratifying their decisions on critical corporate affairs. issuance of stocks. issuance of corporate bonds. sale or disposition of a substantial portion of corporate assets. such as amendments of the articles of incorporation. Actual control of the banks was still held by the groups.186 Corporate Governance and Finance in East Asia. to the corporation and its shareholders for damages caused if they agree to unlawful corporate acts. Vol. although public investors held a majority of shares. removal of directors. amendments in the bylaws.3. Shareholders have the right under the Code to file derivative suits against directors and officers and other third parties to redress any wrongdoing committed against the corporation for which the board refuses to sue or to remedy. approval of management contracts.8 The Board of Directors As the representative of shareholders in a company. and declaration of cash dividends. jointly and individually. II publicly listed commercial banks affiliated to these groups. investments of corporate funds in other companies or purposes. 8 The ADB survey of corporate governance practices was conducted in the first semester of 1999 using a questionnaire prepared by Juzhong Zhuang of the Asian Development Bank. A total of 44 companies responded to the survey (out of about 221 financial and nonfinancial listed companies). the board of directors plays a crucial role in corporate governance. voluntary dissolution. appointment and compensation of senior executives. these were dispersed shareholdings. However. The Corporation Code holds members of the board of directors liable. The Philippine Corporation Code mandates the board of directors to exercise its control over a corporation. 3. shareholder voting in general meetings and legal protection of their rights. and financial disclosure. The review is based on an ADB survey of listed companies in the Philippines conducted in 1999 for this study. . They are likewise liable if they pursue financial interests that conflict with their duty as directors. Of course. accounting and auditing. business groups had only minority ownership. This section reviews practices of corporate management and shareholder control in Philippine publicly listed companies. determination of compensation to board members.2 Corporate Management and Shareholder Control The main mechanisms by which shareholders control corporate management are the board of directors.
The ADB survey results show that a chairperson is compensated either by a fixed fee (52 percent of respondents).7 percent). In a few cases. the average number of years of holding office was 6. or percentages of shareholdings (28. appointed by the Government. protecting shareholder interests. The majority of respondents indicated that board directors and chairpersons were elected mainly on the basis of either relationship with major shareholders (31. or representatives of creditors. In practice. . or the Government without approval by shareholder general meetings. Financial compensation is another means by which shareholders can motivate boards and board members to manage companies in their interests. Such a short tenure may to some extent suggest that large shareholders want to keep their board members under close control. or a per diem for meetings (18 percent). But professional expertise is also an important criterion (28. The average stipulated term of office of the chairperson and members of the board for most responding companies was one year. a fixed fee plus performance-related bonuses (30 percent).Chapter 3: Philippines 187 actual practices of board functions and the role of shareholders may diverge somewhat from the legal framework. board directors were the founder of a company. More than half of respondents indicated that board directors were elected during the shareholder general meetings. appointing senior management.6 for board chairpersons and 7.9 percent). This can partly be explained by the fact that many family-based large shareholders control companies through holding companies in which they have majority ownership. Board chairpersons in a substantial number of responding companies did not own significant amounts of shares in their personal capacities. Respondents of the ADB survey ranked the following as the most important responsibilities of the board: making strategic decisions. According to the ADB survey.7 percent). in a descending order. But half of respondents indicated that they also had board directors directly nominated by controlling shareholders or management. with a maximum of 36 percent. The longest was 27 years for board chairpersons and 14 years for board directors. Making day-to-day management decisions was not regarded as an important board responsibility. The ADB survey shows that the number of board directors ranged from six to nine among the responding companies. and determining remuneration for board directors and senior management. ensuring that a company follows legal and regulatory requirements.5 for board members. a typical chairperson owned 3 to 5 percent of outstanding shares of a company on average.
or management (15 percent). It is also not clear whether the outside directors were elected before or after the financial crisis. Senior Executives The Corporation Code does not specify the role and responsibilities of senior executives. namely. Unlike in Western corporate models. But the independence of these outside directors is often doubtful. Companies may set up special board committees to strengthen due diligence procedures. The nomination committee searches and reviews candidates for key management positions. In some companies. or amount of shareholding (15 percent). This suggests that large shareholders control CEOs by means other than shareholdings. the parent company or company bylaws (21 percent). the chairperson of the board was also the chief executive officer (CEO). The audit committee selects external auditors. Ninetythree percent of the respondents had one or more outside directors. . II Compensation for the chairperson was determined either by the board (54 percent of respondents). and reviews the findings of external audits. In the ADB survey. The ADB survey shows that in 41 percent of the responding companies. Vol. audit. the CEO 9 The three most common board subcommittees are the compensation. There was no case found in the ADB survey where a minority shareholder invoked such a provision of the Corporation Code. relationship with controlling shareholders (35 percent). owners brought prominent political or civic leaders into their boards with the intention of improving the visibility of the corporation rather than improving the quality of board decisions. CEOs apparently cannot increase their shareholdings because family-based owners restrict the number of shares available to management. A CEO that was not the chairperson of the board was selected on the basis of professional expertise (42 percent of respondents).188 Corporate Governance and Finance in East Asia. When the CEO was not the chairperson. however. negotiates the audit fees and scope of audits. About half of the active committees were audit committees and the other half nomination committees. The Corporation Code prohibits the removal of any director without cause if that act would deprive minority shareholders of representation in the board. The compensation committee reviews and recommends remuneration plans of key officers and employee stock option plans.9 In practice. These committees were established only recently. by tenure and compensation. only 35 percent of responding companies have set up board committees. large shareholder-dominated companies often view such committees as unnecessary formalities. and nomination committees.
shareholders may exercise appraisal rights. Second. . Only one respondent indicated that its CEO was entitled to a substantial amount of compensation. Third. (iii) invests in another company for a purpose different from that of the corporation. A substantial number of respondents also considered looking after interests of other stakeholders and the general public as among the important responsibilities of the CEO. (ii) disposes of or mortgages a substantial portion or all of corporate properties and assets. Fifth. shareholders enjoy a number of rights and protection. The “golden parachute” was apparently not a common feature of CEOs’ compensation packages. The average service length of CEOs was 5. first. the Corporation Code allows cumulative voting for directors.. The longest service rendered was 27 years. Companies are not allowed to issue shares with different voting rights. and (iii) involvement of directors in businesses that compete with the company. Shareholder Rights and Protection Under the Corporation Code.2 years. The majority of responding companies compensated their CEOs by using a fixed salary plus a performance-related bonus. of directors representing minority shareholders. to help ensure the representation of minority interests in the board. and prohibits the removal. equal to three years’ pay. the Corporation Code requires that the following types of transactions involving potential conflict of interest between shareholders and management be reviewed and approved by the board: (i) dealings of a company with directors or officers. the rights to demand payment for shares of those who do not agree with the board’s decisions when a company (i) amends the articles of incorporation. without cause.Chapter 3: Philippines 189 was not related to the chairperson by blood or marriage in all of the cases except one. shareholders have preemptive rights to maintain their proportionate ownership of a company under any financing plan that may be undertaken by the company.e. Fourth. Among others. An overwhelming 70 percent of respondents said a CEO who was not the chairperson of the board could make key decisions only after consulting the chairperson or the entire board. including electronic means. or (iv) enters into a merger or consolidation with another corporate entity. They can vote through proxy. (ii) contracts with companies linked through interlocking directorship. But about 27 percent viewed it to be ensuring steady growth of the company. if the CEO’s contract was preterminated. i. About 60 percent of respondents of the ADB survey considered maximizing shareholder values as the CEO’s most important responsibility.
Last. Being appointees of controlling shareholders. in the Philippines. potential buyers are required to make a tender offer to minority shareholders at a price equal to the offer it is making to controlling shareholders. Those who did were usually offered below-market values for their shares. a shareholder could file a derivative suit against a director to redress a wrongdoing. The company was dissolved before indictment. there were often no real discussions of board proposals or actions. However. Sixth. Regardless of the amount of shares held. no one has been successfully prosecuted for insider trading. SEC proceedings were costly and time-consuming. there are no requirements for disclosing such transactions to shareholders under the Corporation Code. it is doubtful whether this legal protection for shareholders will achieve what it intends to in practice. In cases of derivative suits against directors for wrongdoings or actions against insider trading. the Revised Securities Act has strict provisions designed to deter insider trading. the Corporation Code allows a company to waive this in the article of incorporation upon registration or in a subsequent amendment. In the case of preemptive rights.190 Corporate Governance and Finance in East Asia. II shareholders are allowed to inspect a company’s stock and transfer books. that of Interport Resources Corporation. minority shareholders were often vulnerable to the expropriation of their interests by controlling shareholders and management. Vol. Dissenting minority shareholders did not necessarily have recourse to a third party for an objective appraisal of their shares. But an action by the regular court on a petition by the company’s owners/officers prevented SEC from pursuing the investigation. In practice. board members are likely to be under pressure to approve transactions that benefit controlling shareholders to the detriment of minority shareholders. There was only one case. During annual general meetings where minority shareholders could exercise their rights. because of the dominance of large controlling shareholders. There was little chance that a proposal from minority shareholders could ever get approved. In the past. hostile takeovers are not common because in most companies ownership is concentrated . Consequently. in cases of corporate takeovers. Few minority shareholders actually exercised their appraisal rights. because of poor compliance and enforcement as well as some loopholes in corporate laws. where SEC made substantial progress in investigation. An effective market for corporate control may provide some protection for minority shareholders against the expropriation of their interests by the incumbent management. Although transactions involving potential conflict of interest need to be reviewed and approved by the board.
Nevertheless.8 30.13 ADB Survey Results on Shareholder Rights Percentage of Respondents Shareholder Rights One Share One Vote Proxy Voting by Mail Preemptive Rights on New Share Issues Prohibition of Loans to Directors Mechanisms to Resolve Disputes with Company Independent Audit Mandatory Independent Board Committees Severe Penalty for Insider Dealings Source: ADB Survey of Philippines Publicly Listed Companies.2 43. 1999. Table 3. a company that is widely held but has a large shareholder.4 percent of shareholders but 58 percent of outstanding shares.2 69. representing about 24 percent of outstanding shares.522 shareholders each. demonstrates the feasibility of developing a market for corporate control if publicly listed companies were widely held.6 30. An average of about 4.8 92.4 No 0.0 63. An average of 327 shareholders per company attended the last annual meeting and they represented about 63 percent of total shares. The ADB survey provides further evidence on shareholder rights. Nominees held about 45 percent of the outstanding shares.2 7.Chapter 3: Philippines 191 in a few controlling shareholders and families.7 43. About 333 shareholders per company voted by proxy. appointed either by the board or shareholders during the annual general meetings. and their activism in the corporate sector. the successful hostile takeover by First Pacific Group of PLDT.900 shareholders per company did not vote during the last annual general meeting.13 summarizes rights that the shareholders of the responding companies enjoyed. The responding companies had on average 43. Yes 100.4 70.6 Independence of Auditing The ADB survey revealed that all the responding companies had an independent auditor. The brokers or securities companies were the most important proxy voters. followed by management and banks. representing 3.8 56.0 51.0 36. About 93 percent of the respondents contracted . Table 3. protection.3 56.0 48.
with the longest being 50 years. intra-company receivables and payables. The Code grants a shareholder the right to inspect business records and minutes of board meetings. or the accounting standard of a specific developed country (for example. and an analysis of financial statements. Vol. long-term leases. the US GAAP). financial reporting standards allow room for interpretation by independent auditors. Because of such long relationships.192 Corporate Governance and Finance in East Asia. Disclosure and Transparency The disclosures required by the Corporation Code are achieved through shareholders’ inspection of a company’s books and an “information statement” that companies should regularly issue to shareholders. In practice. the information statement transmitted to every shareholder should contain the audited financial statements. Meanwhile. On average. Nevertheless. II their annual audit to an international auditing firm. the agency also requires reports on important details about their operations and management. In two celebrated cases. An auditor can choose among three alternative sets of GAAP. More than 20 percent of the respondents have been dealing with their auditors for 20 years or more. independent auditors are likely to be quite familiar with the operations and financial aspects of their clients. a hostile takeover case). SEC requires all registered companies to periodically submit reports for the purpose of updating their respective registration statements filed at the agency. The accounting profession in the Philippines is considered fairly developed and Manila is a known regional center for accounting expertise. the responding companies have been associated with their present auditors for 13 years. . Most major international auditing firms operate in the Philippines. These different versions of GAAP. the international accounting standard. as practiced in the Philippines). a management discussion of the business. investments in subsidiaries. revaluation of fixed assets. From publicly listed companies. the local standard (i. intangible assets. namely. a bankruptcy case) or hid a large amount of liabilities and losses (PLDT. imposing penalties on violators.. Nevertheless. and consolidation policy. vary in their evaluation of some major accounts such as securities and other liquid assets. foreign currency-denominated liabilities. a preferred independent auditing firm either reported assets that did not exist (Victorias Milling Corp. independent audits do not guarantee the absence of questionable accounting practices.e. there are many cases of poor financial reporting by large companies.. although closely related.
which are controlled by large shareholders with public investors in a minority position. Publicly available financial information was often of low quality. Corporate Control by Controlling Shareholders As in many other Asian countries. large shareholders can use their control to transfer wealth from a company in a business group where they have low cash flow rights to another where they have high cash flow rights.g. which are closely held by large shareholders and family members. Such expropriation is due to gaps between control rights and cash flow rights that pyramiding structures of business groups centered on holding companies create. marketing. They allow risk pooling and can achieve economies of scale in management. because of the highly concentrated ownership of Philippine corporations. and financing. e. accounting for 27 percent of the total stock market capitalization that year. The popularity of holding companies in the Philippine corporate sector is evident: with a market capitalization of P258.6 billion. Laws of many Southeast Asian countries allow the establishment of pure holding companies (with the exception of Korea up to 1999). When control rights exceed cash flow rights. Even for widely held public companies. arguably. “Selective public listing” is a strategy of many business groups for channeling funds from public investors to member companies. Controlling shareholders usually select member companies that require large .. However. which are usually controlled by holding companies. as large shareholders had no need for financial statements to monitor their companies and management that were under their own control. they also make it easier for controlling shareholders to expropriate interests of minority shareholders. sometimes did not penalize independent auditors for poorly prepared audited financial statements. Holding companies enable controlling shareholders to collectively own shares of other companies in a business group and to centralize the group’s management.Chapter 3: Philippines 193 Many small. namely SEC and the Philippine Institute of Certified Public Accountants (PICPA). Pure holding companies can be privately owned. controlling shareholders in the Philippines usually exercise their corporate control through the setting up of business groups. from a minority-controlled to a majority-owned subsidiary. and publicly listed. Family-based controlling shareholders use them as vehicles for controlling business groups.and medium-sized businesses did not have quality financial statements. the authorities. they formed the largest group of corporate entities in the Philippine stock market in 1997.
namely. especially its management. The first three companies are publicly listed while the fourth.194 Corporate Governance and Finance in East Asia. minority control at 42. It is majority-owned by Mermac. and a passive minority investment at 15 percent in Honda Cars (Philippines). Controlling shareholders gain additional leverage in management control over minority-owed companies. Ayala Corporation. of Cebu Holdings (a publicly listed government-owned company). Ayala Land fully owns Makati Development Corporation and holds a minority stake. Ayala Corporation is a publicly listed pure holding company. In cases of minority ownership. Ayala Corporation then holds a sufficient number of shares to achieve various degrees of control in two types of holding companies and two types of operating companies. Vol.6 percent of Globe Telecom. Public investors collectively hold a minority of 41 percent. financing.and minority-controlled operating companies are also holding companies.. . the parent company plays an active role in management. an active minority share at 44. They are operating companies but at the same time have majority or minority share ownership in other operating companies. and customers. II equity investment for public listing. They may have a representative in the board. The stylized features of control structure of business groups in the Philippines can be illustrated by using a leading Philippine family-based conglomerate.1 percent of Ayala Land. active minority or passive minority holdings. Honda Cars (Philippines). controlling shareholders of a parent company hold these shares as “strategic investments” that they could increase or reduce depending on business opportunities. Ayala Corporation’s majority. a family-owned pure holding company. Inc. Minority-owned companies may also need access to resources of the group. with 59 percent of shares.4 percent of Bank of the Philippine Islands. In an active minority-owned operating company. controlling shareholders of the parent company do not participate in management. These investments can be classified according to the role of the controlling shareholders in the management of the invested company. controlling shareholders of the parent company may eventually increase their shares to a majority position. is privately owned. This is most evident when a minority-owned company transacts with other members of the group where the controlling shareholders hold majority control. In a passive minority-owned operating company. Selective public listing combined with use of pure holding companies to own and control member companies lead to various organizational structures of business groups. at 47. Some holding companies are not pure holding companies. Depending on the performance of the company. as an example (Figure 3.1).2 percent. It has a majority control at 71.
Inc. (58.96%) Privately-Held Pure Holding Company Public Investors (41. Inc. (47.06%) <50% >15% &<50% Active MinorityOwned Pure Operating Company Globe Telecoms (44. (15%) MinorityControlled Operating and Holding Company Bank of the Philippine Islands (42. Inc.1 Corporate Control Structure: The Case of Ayala Corporation Family Members 100% Mermac.44%) >50% MajorityControlled Pure Operating Company Makati Development Corporation (100%) <50% MinorityControlled Pure Operating Company Cebu Holdings.Figure 3.. .04%) <50% Ayala Corporation >50% Publicly Listed Pure Holding Company >50% MajorityControlled Operating and Holding Company Ayala Land (71.2%) >50% MajorityControlled Pure Operating Company BPI Family Savings Bank (100%) <50% MinorityControlled Pure Operating Company Note: Data as of 31 December 1998.6%) <15% Passive MinorityOwned Pure Operating Company Honda Cars Phils.
76%)] [39.44%] = [42. and Larry H.5%] / [(88.3% x 5.44%] / [25%] = 1.8%] 5.196 Corporate Governance and Finance in East Asia. Expropriation of Minority Shareholders: Evidence from East Asia.5%] [39. Simeon Djankov. Lang. H. 1999b. and a minority-controlled holding company. The Separation of Ownership and Control in East Asian Corporations. [control right] [control rights via Ayala Corporation] = [cash flow right] [cash flow rights via Ayala Corporation] = [42. [control right] [cash flow right] = = = = = [sum of control rights via Benpres and First Holdings] [sum of cash flow rights via Benpres and First Holdings] [1. see the World Bank research papers by Stijn Claessens.7 times 12 . 1998.2). a privately owned company. Rockwell Land. however. Being in the public utilities sector. Generally.64% +37.10 The Ayala family’s control rights over BPI was 1. First Philippine Holdings Corporation. defined as control by large shareholders of an operating company through minority ownership by several companies.7 times its cash flow rights by virtue of the double layer pyramid structure of the Ayala group. MERALCO. P.64%) + (37. they exercise far greater control (two to five times more) than they are entitled to by virtue of their ownership rights.3% x 1.7 times its cash flow rights by virtue of its cross-holdings via Benpres and First Holdings. Lang: 1999a.12 These examples show that even when large shareholder groups are minority shareholders. Simeon Djankov. and First Philippine Industrial Corporation are indirectly held by a majoritycontrolled holding company. P. Who Owns and Controls East Asian Corporations? 11 Ibid.5% x 14. companies in the Lopez Group are large and minority-controlled. The Lopez Family owns a significant portion of shares of these companies if these indirect shareholdings are summed up and attributed to the beneficial owners. and Larry H. is illustrated in the Lopez Group (Figure 3. indirect shareholdings do not appear to be a prevalent practice in the Philippine corporate sector. Diversification and Efficiency of Investment by East Asian Corporations. Vol.98% x 42.44%] / [58. II Bank of the Philippine Islands owns 100 percent of the BPI-Family Savings Bank. See also Stijn Claessens.14%] / [1. and 1999c. The situation offers large shareholders tremendous incentive to move resources 10 For details.7 times Ibid. Joseph P. Benpres Holdings. Fan.11 The Lopez family’s control rights over MERALCO was 5.14%] / [6. The control of companies through indirect corporate shareholdings.
5% Operating Company MajorityControlled Operating Company Rockwell Land Corporation 24.7% 62.64% MinorityControlled 14.5% First Philippine Industrial Corporation 50% 50% Note: Data as of 31 December 1998.76% Operating Company MinorityControlled 24.Figure 3. Inc.3% 11. Privately-Held Pure Holding Company 88. .5% Minority-Controlled Publicly Listed Pure Holding Company First Philippine Holdings Corporation Benpres Holding Corporation Majority-Controlled Publicly Listed Pure Holding Company Manila Electric Company 1.2 Corporate Control Structure: The Case of Lopez Group Public Investors Family Members Lopez.
while 80 percent reported that creditors with which they had renegotiated loans were still willing to lend to them. Suspension of Payments of Debts Under PD 902-A.3. 3. the data suggest. The controlling shareholders could also use the resources of minority-owned subsidiaries to engage in overexpansion and empire building investments. Most responding companies had dealt with their commercial bank creditors for more than five years and nonbank creditors for only about two years. Control by Creditors According to the ADB survey. Vol. SEC could suspend the rights of a creditor to demand payment from a borrower in accordance with the terms of the loan . The average company. accessed nonbank creditors for specific purposes but dealt with commercial banks on a long-term basis. Sixty-one percent of respondents indicated that creditors usually asked for collateral for all types of loans. The survey results also revealed that creditors did not intervene in the management of borrowing companies and wanted to maintain business relationships with corporate borrowers even when they were in trouble. Some 85 percent of respondents believed that creditors had no influence or only weak influence on corporate management.198 Corporate Governance and Finance in East Asia. and (ii) how the legal framework protects creditor interests and rights. However. whether for working capital or capital expenditure. it was not common for creditors to take legal action against debtors or foreclose on those assets held as collateral in cases of default. a publicly listed company dealt with an average of eight banks and six nonbank financial institutions. Most respondents (81 percent) indicated that they had renegotiated with their creditors on loan repayment when they faced liquidity problems.3 The Role of Creditors in Corporate Control This study examines the role of creditors in corporate control by looking at (i) how corporate borrowers perceive the control power of their creditors. Only a minority of respondents (18 percent) indicated that they had faced adverse creditor actions such as a collection lawsuit or foreclosure of collateral. II from their subsidiaries to their majority-owned publicly listed holding company or elsewhere up the pyramid.
including the rehabilitation of the corporation. There are two modes of suspension of payments under PD 902A. Markets for equity and debt instruments are small and there are serious structural problems that discourage large. The second mode is for suspension of payments with the appointment of a management committee (Mancom) or rehabilitation receiver. PD 902-A granted SEC blanket powers to intervene and adjudicate claims. There are no legal or practical limits to the time period of suspension of payments. under which. could take an indefinite period. The corporation continued to be under rehabilitation receivership as of June 1999. SEC could intervene to avoid asset dissipation. a real estate-based business group. bank credit is the main source of corporate financing. it is not clear whether the corporate borrower’s assets are of sufficient value to cover its liabilities. The borrower will propose a rehabilitation plan to SEC. the litigation process. This explains why creditors invariably oppose any move by borrowers to file for suspension of payments at SEC. Under such circumstances. which determines the viability of the rehabilitation plan and appoints a Mancom or a rehabilitation receiver to implement the proposal if approved.Chapter 3: Philippines 199 agreement.. Consequently. Publicly listed companies do not represent a cross section of the Philippine corporate . a company’s assets are of sufficient value to cover all of its debts. profitable companies from going public. An impending conflict between the two parties could result in dissipation of assets of the company due to creditors’ action to liquidate the company’s assets they hold as collateral. Commercial banks hold about three fourths of the resources of the financial system. Under this mode. the borrower requests to defer payments for a certain period to enable it to generate the necessary liquidity.4 3. In practice. Inc. SEC and the court required that the creditors of BF Homes. The law on suspension of payments envisions resetting the corporation’s business for a temporary period to prevent its irreversible collapse. 3. For example. The first mode is for simple suspension of payments. wait for 14 years from the time the company petitioned for suspension of payments in 1984.4.1 Corporate Financing The Financial Market and Instruments The Philippine financial market has remained underdeveloped compared with other countries in the region.
only 84 had sales large enough to be placed in the top 1. is far ahead of the flock. inflation. Philippine companies were less leveraged. II sector. The Government financed its chronic fiscal deficits by issuing short-term Treasury bills.g. The corporate sector raised a substantial amount of . Of the 221 companies listed in the Philippine Stock Exchange in 1997. especially short-term debt. The market capitalization of the Philippine stock market in August 1997. Even in the real estate sector. Equity instruments include common stocks. Korea) ($143 billion). In part. From the 1970s up to the early 1990s. the Republic of Korea (henceforth. about the size of Thailand’s. The ratio of market capitalization to GDP over the last 15 years put the development of the Philippine stock market at par with other developing markets in the region (e. They invested in only a few large companies whose shares were relatively liquid. while interest rates were at high levels and volatile.4 billion (or $59 million using the average exchange rate). Korea and Thailand).7 billion. most listed companies are controlled by their five largest shareholders. but not to the same extent as it did in other Asian economies. Equity financing through IPOs was active. however.14 shows that the average volume of daily trading in 1997 stood at P2. Most companies invested only in projects that met hurdle rates as high as 20 to 30 percent and had short payback periods. and Indonesia ($61. Interest rates. The crisis affected the Philippine corporate sector.000 companies. Foreign funds were wary of the Philippine stock market because of its limited liquidity. companies expanded only at a moderate pace. this is because. The Philippine stock market is not a liquid market. less exposed to foreign debt. Table 3. the minimum required to qualify as a public corporation. Rising stock prices during the Ramos administration reflected to some extent the business optimism. As a result. Foreign portfolio investments also remained small. compared with Malaysia ($186 billion). The period 1993-1997 was one of lower inflation and declining lending rates.. and convertible securities. the country experienced double-digit inflation. Vol. and less engaged in risky investments.5 billion). Malaysia. the collapse of the stock market during the Asian financial crisis suggested that the earlier stock price surge in part reflected the “bubbles” common to other stock markets in the region. preferred stocks. and fiscal management were among interrelated factors explaining the underdeveloped state of the Philippine financial market. However. Most publicly listed companies issue only up to 20 percent of total shares to the public. The stock market was depressed up to the early 1990s. was one of the smallest in the region at $47.200 Corporate Governance and Finance in East Asia. compared with other economies.
1 0.088.0 0.9 114.3 Market Capitalization (year end.8 1.9 2.0 0.4 9.Table 3.2 925.351.9 682.3 2.5 571.445.386.3 — = not available.5 16. 1983-1997 Daily Trading Volume (P million) — — — — 129.5 1. .4 728.7 2.5 26.906. Note: Combined transactions of Makati and Manila Stock Exchanges are not available for the years 1983 to 1986.171.0 1.1 5.2 297.7 41.4 Ratio of Market Capitalization to GDP 0.7 391.3 59.7 207.6 1.2 61.3 4.3 314.5 72.1 0.2 1.5 12.2 57.0 2.3 0.251.4 1.9 1.1 524.1 88.2 3.3 0.0 161.7 1.248. P billion) 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 19.6 1.9 12. P billion) Gross Domestic Product (current prices.1 0.5 Year 369.1 0.7 0.0 0.121.6 261.421.8 1.8 102.2 59.14 Philippine Stock Market Performance.2 0.2 1.686.077.2 ($ million) — — — — 6.8 799.3 158.9 608. Source: PSE databank.8 1.515.373.9 2.8 0.5 1.692.474.545.2 0.
6 billion. by virtue of their large stakes in the financial system. tight regulations. Because existing shareholders wanted to retain their proportionate control over their companies. Debt securities include commercial papers and corporate bonds.2 Patterns of Corporate Financing The study looked at retained earnings. The picture of the financial system that emerges is thus one of limited capital markets. However. issuing companies had to undergo a process of review and credit rating by the Credit Information Bureau Inc. Vol. of which 85 percent was raised from 1993 to the first half of 1997. From 1988 to 1997.. and inventory financing. Only a few large companies floated commercial papers because of the limited market. Corporate bonds are another type of debt securities. and the dominance of large commercial banks. asset-backed credits. about 127 companies went public with a total value of offerings of about P134. are in a position to provide such discipline. by volatile interest rates and the absence of a secondary market. Few companies offer preferred stocks because the Philippine tax system does not allow tax deductibility of dividends on preferred stocks. corporate bond issuing was even more limited. and debt as sources of corporate financing by using flow of funds analysis. sells these commercial papers through brokers. However. which buy commercial papers either for their own account or for their clients. the rights issue was a popular way of raising equity capital.202 Corporate Governance and Finance in East Asia. lack of competition among financial institutions. and high transaction costs. Only the commercial banks. 3. a strong regulatory system for bank supervision is imperative. II equity capital through IPOs during the stock market boom from 1993 to the first half of 1997. because business groups often own large commercial banks. moreover. Debt instruments include negotiated credits and debt securities. include bank credits. which ultimately influences the pricing of commercial paper issues. This is because only companies with strong capitalization and predictable cash flows such as public utility companies can issue bonds. The measures used in the analysis are: . new equity.4. Negotiated credits. which were the principal source of corporate financing in the Philippines. which in most cases is an affiliate of the issuing company. leases. The underwriter. Under SEC regulations. The largest buyers have been commercial banks. discounting of receivables. Capital markets cannot provide the market discipline that corporate investors need. The corporate bond market was stunted.
5 0.3 0.9 0. during this period.2 0.3 0. On the other hand.2 0.6 0.4 0.000 Corporations in the Philippines from 1988 to 1997. 1988-1997.1 0.8 0.3 0. .3 0. It measures a company’s capacity to finance asset growth by equity capital.4 0. As shown in Table 3.1 Average 1.5 0.1 0.2 0. it is one minus IDFR.5 0.5 0.0 0. It measures a company’s capacity to finance asset growth by internally generated funds.2 0. It measures a company’s capacity to finance growth in fixed assets by internally generated funds.3 0.6 0.9 0. the average SFRF was high at 109 percent. New equity financing ratio (NEFR): ratio of changes in stockholders’ equity (excluding retained earnings) to changes in total assets. All Companies Financial flows data were derived from the SEC-BusinessWorld Annual Survey of Top 1.5 0.5 0.6 0. the SFRT was low at Table 3.5 2.000 Corporations in the Philippines.0 0.1 0.4 0. Incremental equity financing ratio (IEFR): ratio of changes in shareholders’ equity inclusive of retained earnings to changes in total assets.8 0. Incremental debt financing ratio (IDFR): ratio of changes in total liabilities to changes in total assets.4 0.1 0.Chapter 3: Philippines 203 (i) (ii) (iii) (iv) (v) Self-financing ratio of fixed assets (SFRF): ratio of changes in retained earnings to changes in fixed assets.3 0. Self-financing ratio of total assets (SFRT): ratio of changes in retained earnings to changes in total assets.4 0.4 0.4 0.2 0.15.4 1. Retained earnings were sufficient to finance the entire growth of fixed assets in the corporate sector.5 0. 1989-1997 Financing Indicators SFRF SFRT NEFR IDFR IEFR 1989 1990 1991 1992 1993 1994 1995 1996 1997 1.15 Financing Patterns of the Corporate Sector.1 0. It measures a company’s reliance on borrowings in financing asset growth.3 0.5 Source: SEC-BusinessWorld Annual Survey of Top 1.9 0. By definition.8 0.9 0.5 0.5 0.7 0.
This was mainly caused by the declining contribution from retained earnings.0) 0. suggesting that there was a deterioration of financial performance in the Philippine corporate sector in the years running up to the crisis.3 0. 1989-1997 Financing Indicators SFRF SFRTa NEFR IDFRa IEFRa a Publicly Listed 1.5 Foreign-Owned 1.6 0. As a result. 1988-1997.2 (0.5 0. It can also be observed that the relative importance of stockholders’ equity (including retained earnings and new equity investment) was declining and that of debts increasing in financing the growth of the corporate sector from 1991 to 1997. Vol.2 0. 1991. There were significant year-to-year variations. when it financed 45 percent of it. The corporate sector used new equity to finance 32 percent and new debts to finance 49 percent of growth in total assets. privately.5 Privately-Owned 0. Companies financed fixed assets from internal sources in hard times.3 0. . except in 1991. reflecting the capital flight caused by political instability in the early 1990s. the SFRF was higher.8 0. the level of corporate leverage increased.000 Corporations in the Philippines.204 Corporate Governance and Finance in East Asia.16.and foreign-owned. Corporate Financing by Ownership Type As shown in Table 3. and 1997. Source: SEC-BusinessWorld Annual Survey of Top 1. implying that internal funds were far from sufficient to finance growth in total assets. for all three types of companies—publicly listed. The corporate sector consistently relied on debt and new equity to finance asset growth throughout the period. debts were the most important source of financing. In periods of an economic crunch such as in 1989. Total assets grew by 23 percent that year. internal funds were not a significant source of financing growth in total assets. Retained earnings were the least important.16 Corporate Financing Patterns by Ownership Type.1 a Excludes negative balances.9 0.3 0.3 0. except for foreignowned companies that had a negative new equity financing ratio.7 0. II only 19 percent. with debt providing 93 percent of the financing requirements. In 1997. On Table 3. In all the years. retained earnings declined and few new equity investments flowed into the corporate sector.
9 16.1 9.9 100.5 27.4 2.0 100. 1988-1997.0 8. contributing 90 percent of growth in total assets.7 13.0 1995 1996 13.17 Composition of Assets and Financing of the Publicly Listed Sector.9 12.7 4.7 2.8 46. This financing pattern supports the earlier finding that foreign-owned companies had the highest leverage among the three types of companies.7 2.9 38.2 12.0 1994 19.3 11.17.7 23.0 9.0 53.0 13. especially bank loans. Foreign-owned companies relied more heavily on debt financing.2 51.0 38.5 12.6 43.8 51.8 0.5 0.4 100. publicly listed companies relied more on new equity financing than privately.8 38.8 17.3 48.9 16.0 1993 14.2 100.0 6.5 16.3 12.9 4. The sector built up its short-term debts.8 3.4 100.3 12.9 24.0 12.2 3.4 3.1 13. A breakdown of the financial structure of publicly listed companies measured in balance sheet items is shown in Table 3.0 9.1 15.8 26. It presents a composition analysis of assets and financing sources for the period 1992-1996.4 43.1 49.8 39.3 4.9 16.3 12.4 2.8 100.4 10.4 100. .4 12.1 50.8 16.3 13.1 7.3 10.2 3.5 9.8 0.4 41. compared with 47 percent for publicly listed companies and 55 percent for privately-held firms.0 10.7 100.7 13.3 51. significantly Table 3. 1992-1996 (percent) 1992 Assets Cash and Temporary Investment Accounts Receivable Inventory Other Current Assets Total Current Assets Investment Fixed Assets Other Assets Total Assets Liabilities and Equity Accounts Payable Short-Term Loans Other Current Liabilities Total Current Liabilities Long-Term Debt Other Long-Term Debt Other Long-Term Liabilities Total Liabilities Stockholders’ Equity Total Liabilities and Stockholders’ Equity 14.6 48.5 41.2 100.0 9.6 37.9 3.4 100.8 3.1 10.and foreign-owned companies.8 4.0 Source: SEC-BusinessWorld Annual Survey of Top 1.000 Corporations in the Philippines.6 26.3 10.9 0.0 10.Chapter 3: Philippines 205 average.6 0.6 48.7 7.0 9.2 42.
Further. indicating that many publicly listed companies were likely to be in a tight liquidity position. On average. compared with an average of 54 percent for independent companies.3 0.5 0.13 was at 1. the current ratio. the average SFRF of business groups was higher compared with that of independent companies.3 0. group companies usually financed their investment in member companies by equity rather than debt. II in 1996 and became more vulnerable to the financial crisis in 1997. The traditional measure of liquidity.18 Financing Patterns by Control Structure. Group companies were generally more profitable than independent companies.9 0. the easier access to external credit.6 Independent Company 0.1 0. 1989-1997 Financing Indicators SFRFa SFRTa NEFR IDFRa IEFRa a Group Member 1.3 0. For these two reasons.206 Corporate Governance and Finance in East Asia. Corporate Financing by Control Structure Conglomerates have certain advantages in financing because of the opportunities offered by the internal capital markets. The normal standard liquid position is a current ratio of 2 or higher.000 Corporations in the Philippines.2 0.18. As shown in Table 3.5 0. Vol. group companies were less reliant on debt financing than 13 Defined as total current assets divided by total current liabilities. and economies of scale in fund raising. Group companies financed an average of 45 percent of growth in total assets by debt. 1988-1997. retained earnings financed 113 percent of growth in fixed assets and 23 percent of growth in total assets from 1989 to 1997 for business groups. for independent companies. respectively. as opposed to 94 and 30 percent.45 in 1996.5 Excludes negative balances Source: SEC-BusinessWorld Annual Survey of Top 1. The SFRF for independent companies would have been even lower if the highly profitable foreign-owned companies were excluded. . Table 3. their inherent ability to pool risks.
5 0.2 0. The lower SFRF for large companies may be caused by their larger outlays for growth in fixed assets.08 and SFRT of 0. 1988-1997.19).76 for small companies and 0.55 was substantially higher than the small companies’ 0. There was also increased reliance on debt financing. Source: SEC-BusinessWorld Annual Survey of Top 1. averaging 61 percent of growth in total assets. The corresponding ratio was 0.2 0.6 0.000 Corporations in the Philippines.8 0. Large firms consistently increased their reliance on debts from 1994 to 1997. These results support the earlier finding that the leverage of business groups was lower than that of the independent companies from 1988 to 1997.06. On average.4 Small 0. medium-sized companies used more debts. These years were 1991 with 110 percent. with an average of 3. equity financed 42 percent of incremental asset growth. The medium-sized companies’ high debt financing ratio was due mainly to three years of complete reliance on debt to finance growth.50 (Table 3. Corporate Financing by Industry The manufacturing sector had an average SFRF of 1. Large companies’ IDFR of 0. and 1997 with 131 percent.47.3 0.19 Financing Patterns by Firm Size. With assets growing at a fast pace during this period. 1993 with 96 percent.3 0.6 0.9 0. Table 3. compared with 55 percent for large companies and 47 percent for small ones. 1989-1997 Financing Indicators SFRFa SFRTa NEFR IDFRa IEFRa a Large 0.5 Excludes negative balances.Chapter 3: Philippines 207 independent companies.5 Medium 3.20).88 for large companies (Table 3.2 0. Corporate Financing by Firm Size SFRF was highest for medium-sized companies.3 0.1 0. Excluding .
debt financed about 78 percent of asset growth in real estate. SFRF for the sector averaged 0. Since the real estate boom coincided with that of the stock market.4 0.4 0.5 0. while SFRT averaged only 0.20 Financing Patterns by Industry. many of the leading real estate companies successfully went public during that time. 1988-1997. Up to 1997. the total debt ratio was much higher in 1996 at 0.6 0. achieving an average SFRF of 3.6 0. the incremental equity ratios of the industry were high. . Low incomes diminished the equity financing position of the manufacturing industry toward the crisis year.6 0. with an SFRF as low as 0. Source: SEC-BusinessWorld Annual Survey of Top 1. when debts declined. Table 3. The utilities sector showed weaknesses in internal fund generation in 1989-1994. The real estate industry financed its growth by substantial equity funds. the manufacturing industry financed 57 percent of its total asset growth by debt.32.47 two years later.4 Construction 0. Incremental equity financing amounted to an average of 44 percent of total asset growth.7 0.208 Corporate Governance and Finance in East Asia.4 0. During the crisis year.000 Corporations in the Philippines. Excluding 1997 when fixed assets declined.1 0.58 and SFRT of 0.79 and in 1997 at 0. Equity financed the rapid expansion in the industry’s assets in the period 1994 to 1997. Its SFRF and SFRT were volatile because of chronic losses and reduction in fixed and total assets.27.4 3.5 0.91.3 0.5 (0.3 0. increasing to 0. ranging from 41 to 118 percent. 1989-1997 Financing Indicators Manufacturing SFRFa SFRTa NEFR IDFRa IEFRa 1.29. The situation improved beginning 1994. Total liabilities increased partly as a result of the local currency devaluation and financed all of asset growth for the year. The construction sector was a heavy user of debt financing.2) 0. Equity financed an average of 62 percent of total asset growth.04.3 0. The effects of the crisis of 1997 were adverse. the industry generated internal funds. In the eight years preceding the crisis. Vol.5 Utilities and Real Estate Services and Property 0. The sector had the highest leverage among all industries that year.3 0. While this level is considered prudent. II 1991.6 a Excludes negative balances.
the coefficient of the ownership concentration measure in all the three regressions is positive and statistically significant.421 0.21. Profitability. while if it fails. and Performance Previous studies on corporate governance have often associated ownership concentration with heightened risk-taking by companies. As shown in Table 3.008 5. knowing that if an investment turns out to be successful they could capture most of the gain. and the Failure of Internal Control Systems. Journal of Finance 48: 831-880. Using the PSE database.4. Source: Author’s estimates based on the PSE databank.009 5.004 3. and financial leverage are all positively and significantly related to the degree of ownership concentration.Chapter 3: Philippines 209 3. ROE. ROE. Financial Leverage. Exit. the degree of ownership concentration.00056 1. and Financial Leverage Dependent Variable Item Coefficient of Ownership Concentration T-statistics Adjusted R-squared F-statistics ROE 0. ROA.287 0. ROE = return on equity. alternatively.14 Large shareholders may borrow excessively to undertake risky projects. Three regressions were run with the shareholding of the largest five shareholders as an independent variable and ROA. more profitable.21 Ownership Concentration. 1992-1996.00125 2. 14 See for example Michael Jensen (1993).130 ROA 0. was regressed against measures of profitability and of financial leverage. The Modern Industrial Revolution.3 Ownership Concentration. Large shareholders may also overuse financial leverage to avoid diluting ownership and control. ROA = return on assets. These results suggest that companies with higher ownership concentration tend to be more highly leveraged and.860 Leverage = the ratio of total assets to total equity.00036 2. ownership concentration = the total shareholdings of the top five shareholders. and leverage.769 0. measured by the percentage of shareholdings of the largest five shareholders. . creditors bear the consequences. as the dependent variable. at the same time.230 Leverage 0. Table 3.
foreign investments in the country have been low. Manufactures accounted for about 85 percent of exports. the country was less dependent on foreign private capital.5 billion in 1996 and grew at an average of 48 percent per annum from 1992 to 1996. Vol. Compared to other East Asian crisis-affected countries. more than half (52 percent) of exports were semiconductors. and agriculture at 21 percent. The structure of the economy may be understood by looking at its sectoral composition and export competitiveness. with a narrow exporting industry base. Historically.5 3. but its share had been declining by 4 percent per year since 1995.” The Government’s judgment that economic fundamentals were strong was based on stable growth rates.” that is. Net investment inflows were $3. and intermediate goods. Commercial and industrial activities in the country were largely oriented to domestic markets. In sum. In 1997. The costs of an economic correction brought about by the regional financial crisis were thought probably to be low due to the sound structure of the real economy and the strong position of the financial sector. industry at 34 percent. their growth gathering momentum only beginning in 1992. raw materials. After a . with commodities accounting for the balance. Garments was the second largest export sector at about 9 percent.1 The Corporate Sector in the Financial Crisis The Financial Crisis: Causes and Manifestations A devaluation of the local currency signaled the arrival of the financial crisis in 1997. The export sector had a very narrow breadth. the country’s GDP growth pace indicated that it did not have a “bubble economy. notably remittances of overseas workers.210 Corporate Governance and Finance in East Asia. an overexpansion of capacities. which averaged 4. The country experienced balance of payments surpluses but these were due to transfers. the economy still showed vestiges of its import-dependent and substituting character. II 3. Net trades in goods and services averaged a deficit of 4.5.5 percent per year from 1992 to 1997. Exports were growing at about 20 percent per year in the three years preceding the crisis. Although much lower than those of other Asian countries. The largest contributors to GDP were services at 43 percent. About 80 percent of imports were capital goods (particularly power generating and telecommunications equipment). The Government explained that the country had “sound economic fundamentals” but that the problems were caused by “contagion. the growth in foreign investments fueled that of the manufacturing and services sectors in the years preceding the crisis. Because of limited local capital.8 percent of GDP from 1995 to 1997.
fueled also by successful IPOs during the stock market boom of 1993-1996. unlike their counterparts in the region. an average inflation rate of 7. Economic performance during 1992-1997 was characterized by an average growth rate of real gross national product (GNP) at 3. assets grew at a compound annual rate of about 31 percent. and a relatively healthy banking system. Financial institutions called on their shortterm loans and shortened the maturity of existing loans. the Government restructured its debts into longer tenors with a maximum of 25 years. average ROE was 13.8 percent. . the country and the corporate sector had no access to foreign currency debts from the international financial market.3 percent. the Government sought stability and achieved this in 19921997. Eventually. an average Treasury bill rate of 13. adjustments were focused on the quantity and quality of the banking system’s corporate loans. in turn. After hovering in the range of 100 to 127 percent. In the Philippines. while sales grew by only 20 percent per year. Closer analysis. a positive balance of payments from 1992 to 1996. Since the regional financial crisis was triggered by the loss of confidence in some East Asian economies by foreign creditors and investors. resulting in stability in the short-term debt to reserves ratio. the discipline of the loan moratorium and the restructuring of the country’s loans to long-term maturity kept this ratio below 100 percent up to September 1997. Total debts were only 52 percent of assets or 108 percent of equity. The corporate sector was in a relatively stable financial condition around the time of the crisis. From 1993 to 1997.5 percent. Profitable operations since 1992 had allowed it to build equity. The adverse impact of the crisis in most Asian countries was proportional to the amount of short-term foreign debts relative to net international reserves.6 billion as of March 1997. however. Prudent fiscal management and controls on foreign borrowings were part of the adjustments required by IMF and foreign creditors. Five years of stable growth before the crisis enabled the country to build its net international reserves to $10. shows that investments of the corporate sector were growing at a faster rate than sales revenues in the years immediately preceding the crisis. the ratio of short-term debts to international reserves dipped below 100 percent beginning June 1998. which. The Central Bank conserved international reserves by allowing the local currency to float within a wider trading margin. The lessons from debt restructuring became the basis for the Government’s economic policies.1 percent.Chapter 3: Philippines 211 long period of debt moratorium and restructuring that started in 1983 and ended in 1991. a government fiscal surplus from 1994 to 1997. depended on the quality of the corporate sector’s investments. From 1988 to 1996. During this time.
Vol.” 3. It financed 26 percent of corporate capital growth. the other immediate impact of the crisis was that on foreign investment flows. Net foreign investments more than doubled from 1995 to 1996 but declined by 78 percent in 1997 (Table 3. In sum.2 Impact of the Crisis on the Corporate Sector Aside from the foreign exchange adjustment. Debts financed a large part of this expansion. II The corporate sector indeed overexpanded after 1993 like its counterparts in the region. It rose to $2.22 Foreign Investment Flows.47. In 1997. net FDI remained stable at more than $1 billion. Net foreign portfolio investment amounted to $1. . These patterns in investment and financing are similar to those of other countries in the region.22. 1995-1998 Item Net Foreign Investments ($ million) Foreign Direct Investment (FDI) Foreign Portfolio Investment Net Capital Increase by Corporations (P million) Net FDI as a Percentage of Corporate Net Capital Increase (%) 1995 1.0 1998 739 555 328 69. or 114 percent of net foreign direct investment (FDI). precisely. 1997 = 29.300 1.7 Note: Peso-dollar exchange rates used are: 1995 = 25.303 23.212 Corporate Governance and Finance in East Asia.22).71.06.485 145. The debt level of the Philippine corporate sector in 1997 was low by Asian standards but still high by developed country standards.609 1.101 billion or 196 percent of net FDI in 1996. 1998 = 41. but to a lesser degree. mitigated the effects of the pullout and liquidation of investments in the aftermath. Foreign investments in the Philippines have not been as high as the inflows to other Asian countries—and this.650 32.073 (406) 121.5.074 2. growing by about 34 percent per year from 1994 to 1997. 1996 = 26.749 26.0 1996 3. It is understandable then that the effect of the Asian financial crisis on the Philippines was correspondingly that of a negative “contagion.101 92. Sources: Bangko Sentral ng Pilipinas and SEC.718 30. Table 3.517 1. the country’s economic and corporate sector growth in 1994 to 1997 appeared to have been part of a positive “contagion” effect of optimism by investors and creditors about the region. Most of this leverage happened during the boom years in the region.4 1997 762 1. Data for 1998 cover only January-August. But portfolio investment amounting to $406 million flew out of the Philippines.5 billion in 1995.
Loan calls.2 to 28. By October 1998.3 percent of assets. in turn. with commercial banks holding P2. ranged from 11 to 13 percent from 1993 to July 1997.513 billion. The real problem of the corporate sector during the crisis was the rise in interest rates. Lending rates were well above the 20 percent level from July 1997 to March 1998. Although corporate borrowers were not highly leveraged. depended on the liquidity and capital position of commercial banks. the corporate sector became vulnerable to loan calls and high interest rates. albeit at current market interest rates. Because of weak internal fund generation. the commercial banking sector’s capital remained strong at 17. they could not initiate a large reduction of their loans because these in part financed long-term growth in assets. The banking system was able to absorb the impact of the crisis primarily because of its strong capital position. sparking a rise in interest rates on corporate loans. Bank spreads over Treasury bill rates increased in 1997 but were within the range experienced in the past. The resources of the financial system that year totaled P3. The interest rates on Treasury bills. lending rates also came down.369 billion. By March 1988. Average bank lending rates climbed to their peak of 25. Loans outstanding of commercial banks declined by the first quarter of 1998. they were willing to restructure and renegotiate existing loans by corporate borrowers. With the increase in borrowings and reduced liquidity. Because commercial banks were strongly capitalized.7 percent in January 1998. Manufacturing reduced its loans outstanding by 11 percent from October 1997 levels. new borrowings financed asset growth. Net profit margins were at a 10-year low at 4.2 percent in November 1997. which held about 75 percent of the assets of the financial system in 1997. Companies deferred investments in new fixed assets. ROE at 6. then rose to a high of 22.9 percent.Chapter 3: Philippines 213 Corporate financial performances and conditions deteriorated during 1997. suggesting that commercial banks required a higher premium at about the height of the crisis but not beyond. in varying degrees for each sector. the sectors with the highest outstanding loans had reduced their credit exposures. and leverage increased to 149 percent compared with 109 percent in 1996. A number of small banks closed but they represented less than 1 percent of the financial system’s total resources. The combined effects of shrinking demand and high interest rates reduced the corporate sector’s demand for loans.2 percent was barely above inflation rate. meanwhile. When the Treasury bill rates eased in March 1998. and the wholesale and . Bank loan pricing was based on the bellwether 91-day Treasury bill rates rather than inflation.
the aggregate effect of the crisis on NPLs was of a magnitude comparable only to the country’s last major banking crisis in 1984-1986.3 percent in December 1997. 3.214 Corporate Governance and Finance in East Asia. But the Philippine banking system had gone through worse crises in the past. the fiscal position. The Central Bank adopted other measures to strengthen the financial system. through the Bankers’ Association of the Philippines. as with its counterparts in other Asian countries. including (i) a regulatory limit of 20 percent on banks’ loans to the . loans outstanding of the real estate sector increased by 11 percent from June 1997 to June 1998.5-6 percent. This allowed the Central Bank to convince the banks. II retail trade sector. thereby reducing overall intermediation costs. single-digit NPL ratios began only since 1989. In March 1997.3 Responses to the Crisis Government Responses The Government’s policy and regulatory responses to the crisis focused on monetary and credit issues. was a problem sector. These peaked at 14. set limits on overbought/oversold foreign exchange positions of banks.9 percent of bank loan portfolios.5. and set up a hedging facility for borrowers with foreign currency-denominated loans. the ratio increased to a high of 11.6 percent in June 1998. This “voluntary agreement” partly explains why the loan spreads of banks were within the range of recent experience. These figures show that adjustment problems were industry-specific and that the real estate industry. As for nonperforming loans (NPLs). However. The Central Bank introduced regulations on foreign exchange trading to control speculation and nondeliverable forward contracts. Still. The move retained the liquidity position of banks but lowered their cost of reserves. and the financial system. to reduce their lending spreads over the 91-day Treasury bill rates from 3-8 percent to 1. by 12 percent. The Central Bank also moved to control inflation and bring down domestic interest rates by reducing the statutory reserve requirement by 3 percentage points and raising the liquidity reserve ratio by the same amount. The latter measure was especially beneficial to companies with unhedged foreign currency loans from commercial banks.5 percent by September 1998. The pattern indicates that real estate loans were of substandard quality but banks had contained the problem by mid-1998. real estate loans averaged 11. and its experience of low. and subsequently went down to 13. Vol.
PAL. the Asian crisis opened a unique opportunity for foreign investors. the corporate sector dealt with the crisis as any company facing a recession and drying up of credit would—companies cut costs by reducing staff.6 percent growth in 1999. Publicly listed Philippine companies could also be restructured through takeovers by local and foreign investors. Average Treasury bill rates have cooled since mid-1998. The acquiring company. bank loan rates have also come down. A 40 percent devaluation of the Philippine peso lowered the purchase price of PLDT to foreign investors. came up with a rehabilitation plan by May 1999 that was found acceptable to all parties. With its weakened financial position. The economy avoided a recession in 1998 and achieved 3. The real estate portfolio of commercial banks also declined and was well below the Central Bank’s regulatory ceiling by March 1998. changing technologies. the Government kept inflation below 10 percent. (v) improving disclosure requirements on the financial position of banks. which was privatized with the Lucio Tan group gaining control and the Government retaining minority ownership.Chapter 3: Philippines 215 real estate sector. was known to have a policy . Responses of the Corporate Sector The corporate sector’s financial position. took more action. the country’s flag carrier. Financially strong companies were able to survive the crisis by effecting such internal restructuring. its accessibility to foreign capital. (ii) shortening the period for classifying unpaid loans as past due from three months to one month. The policy directions and actions taken by the Government appear to have ushered in recovery. In the case of PLDT. subcontracting and outsourcing. Takeovers in the past involved cooperative negotiations between purchasers of a target company and family-based large shareholders. and (vi) issuing guidelines on duties and responsibilities of banks’ boards of directors for improved quality of bank management. (iv) increasing banks’ capital requirement by 20 percent for universal banks (banks with expanded licenses) and 40 percent for ordinary commercial banks. consolidating business units. (PAL). Large companies with heavy loan exposures such as Philippine Airlines Inc. In response to calls for lower bank intermediation costs. the largest telecommunications setup in the Philippines. and giving up noncore businesses. First Pacific Corporation. and the legal framework for reorganization and liquidation conditioned its response to the crisis. (iii) fixing loan loss provisions of 2 percent of the gross amount of loan portfolio on top of individually rated bad loan accounts. With prudent monetary management.
A second method was to purchase the shares of other large minority shareholders. eventually took over PLDT and announced a restructuring plan for the entire group of companies. Although considered the prime industrial company in the Philippines. at a premium over the market price to reflect the value of management control. In a legal process that ended in his takeover of management.6. When Cojuangco took over. is whether there are sufficient safeguards to prevent controlling shareholders from . SMC had lagged behind other groups of companies such as Ayala Corporation in financial performance for some years. First Pacific. however.1 Summary. One mode was the outright purchase of shares in the open market. the Cojuangcos. using some or all of these means. and Recommendations Summary and Conclusions The Philippine corporate sector has been shaped by the country’s economic and industrial development policies. controlling shareholders can capture these profits by excluding public investors from ownership.6 3. A third method was to make a formal tender offer to PLDT’s controlling minority shareholders. II of investing to control companies that are dominant players in their industries. the Soriano family. SMC is another widely-held company managed by a minority shareholder. By itself. Vol. When companies are highly profitable. Conclusions. First Pacific could have acquired sufficient shares to take control of PLDT in three ways. Ownership is highly concentrated and a few dominant players control major industries. he restructured the company toward its core brewery business and sold off local and foreign subsidiaries. concentrated ownership of companies is not equivalent to weakness in corporate governance.216 Corporate Governance and Finance in East Asia. Eduardo Cojuangco was able to assert his ownership of shares taken over by the Government during the transition of power in 1986. The question. the stock price of PLDT was buoyant during the takeover period. It may even solve agency problems that a separation of control and ownership could precipitate because large shareholders have an incentive to closely oversee management. PLDT’s large minority shareholders such as the SSS and First Philippine Fund publicly announced their willingness to offer their entire holdings in a block sale at a premium. 3. Its stock price and returns to shareholders had stagnated. Consequently. Corporate governance is conditioned by the high ownership concentration of these large companies.
Privately-owned companies. By ownership structure. influenced by industry characteristics. an underdeveloped capital market. This study analyzed trends in corporate performance and financing in relation to corporate governance from 1988 to 1997. the most numerous in the corporate sector. companies that are members of family-based conglomerates had higher returns and lower leverage than independent companies. and the lack of market for corporate control. ownership of banks by business groups. were the least profitable. By control structure. With large shareholders in control. Forming business groups appears to be a viable means of competing because this allows for more efficient organization and utilization of resources of large controlling shareholders. foreign companies were the most profitable but highly leveraged. an ineffective insolvency system. The financing pattern of the corporate sector was influenced by the tight financial conditions prevailing in the country up to 1992. with the real estate and public utilities industries standing out for their pronounced cyclical patterns. The five largest shareholders have majority control of an average publicly listed company. passive independent auditing. By size. to some extent. Leverage was within Asian norms but above developed country standards. while the largest 20 shareholders control more than 75 percent of shares. Financial institutions are not significant shareholders. The Philippine corporate sector was relatively efficient in investing and financing compared with other countries affected by the Asian crisis. medium companies showed higher profitability than large and small ones. Publicly listed companies had the highest profit margins and lowest leverage among the local companies. Returns to capital exceeded inflation rates. minority shareholders need to be protected by external control mechanisms. Business groups occupied seven of the top 10 and 25 of the top 50 largest corporate entities in the Philippines in 1997. Ownership of publicly listed companies is highly concentrated. The corporate sector consistently relied on internally generated funds and equity before resorting to borrowings.Chapter 3: Philippines 217 expropriating the wealth of minority shareholders through aggressive and risky investment. Corporate governance should be viewed in the context of an increasing presence and growth of large shareholders-centered conglomerate business organizations. Analysis of corporate financing by ownership . Performance was. oligopolistic market structures. The result is that corporate governance depends only on internal controls. This study points out weaknesses in external control mechanisms such as weak legal protection for minority shareholders.
the amount of pressure from stock market investors and PSE (for publicly listed companies in the group). statistical analysis of company-level data revealed significant relationships between corporate performance and corporate governance. The extent of governance problems depends on internal control policies of the controlling shareholders. with the foreign-owned companies found to rely more on borrowed funds. Such structures result in control by large shareholders through disproportionately smaller investments in equity ownership. as typified by the Ayala Group. II type gave similar results. selective public listing of companies in the group. and the extent of supervision of outside institutions such as independent auditors and SEC. The difference between management control and ownership rights is usually substantial. Publicly listed companies were responsive to investors’ requirements for prudent use of debts. superior profitability. Companies whose large shareholders have higher degree of control tend to borrow more but generate better returns. Ownership concentration was positively related to both returns and leverage. ROE. The positive relationship between financial leverage and ownership concentration is consistent with the hypothesis that controlling shareholders prefer to use debt financing in order to avoid ownership dilution. Larger disparities in control over cash flow rights imply higher incentives for large shareholders to (i) expropriate wealth of shareholders not belonging to the controlling group and (ii) invest in empirebuilding and high-risk projects. Even in cases where the group owned only a minority share of a commercial bank. Internal financial markets operated by business groups allowed them to optimize their financial resources at lower external debt levels. Large. and sustained growth. and centralized management and financing. . family-based shareholders gain control by such means as the setting up of holding companies. After controlling for industry effects. ROA. Vol. A commercial bank is an important part of most business groups. Family-based business groups have focused their investments in industries where their superior financing capacities and political/social influence give them unique advantages. Large companies owned or controlled by business groups tend to dominate their industries.218 Corporate Governance and Finance in East Asia. A business group is an effective business organizational model for achieving leadership in industries. Business groups with pyramiding structures heighten the issue of corporate governance. and leverage were all positively related to the degree of ownership concentration. the bank usually accounted for a large share of each group’s net profits. The pyramid model is useful for centrally managing smaller companies.
with recently restructured public debt. The crisis caused a tightening of credit to the corporate sector and a spike in interest rates. Promoting a Broader Ownership of the Corporate Sector The highly concentrated ownership of the publicly listed corporate sector should be a concern of SEC and PSE.Chapter 3: Philippines 219 The financial crisis came when the Philippine economy was in a relatively strong financial position. low inflation. decisions by large sharehold- . the government budget in surplus. rather than the banks that lent millions of pesos. This law is flawed in concept because it supplants a market-based credit agreement with a political process.6. Under the new Securities Regulation Code enacted in 2000. The Central Bank responded by improving the liquidity of the system and by establishing conditions for bringing down interest rates on bank loans. A number of large debtors petitioned SEC for rehabilitation under procedures set by PD 902-A. Specific actions recommended are described below. Still. adversely affecting companies’ operations and financial position. SEC’s quasijudicial functions. strong capital position built on IPOs in a buoyant stock market. There are systemic risks involved in highly concentrated ownership. are to be removed and transferred to courts. As the crisis wore on in 1998. there were sharp rises in the number of bankruptcies and petitions for debt relief. The Central Bank imposed strict limits on real estate lending. including suspension of payments. The corporate sector accessed the foreign debt market only in the mid-1990s because of the country’s long-drawn debt moratorium. That is. The corporate sector was also in good financial condition with rich internal cash flows accumulated from a number of profitable years. 3. and sound overall creditworthiness. resulting in the banks’ accelerated restructuring of troubled debts in this sector. a strong international reserves position. For example. decide on the financial future of a troubled debtor. and a market-oriented policy environment. SEC officials. mostly by highly leveraged companies and speculative investors in real estate.2 Policy Recommendations The Government should address weaknesses in corporate governance identified in this study by introducing reforms in the policy and regulatory framework and promoting the development of markets. there was a sharp rise in borrowings and decreasing productivity of investments a few years before the crisis in a pattern similar to that of Asian crisis countries.
they serve to curb the powers of controlling shareholders. Vol. inadequate disclosures. and (iii) increase the minimum required percentage of outstanding shares for public listing in the stock exchange from the present 10-20 percent. This may limit current practices of appointing prominent individuals and family members as directors. The adjustment should be made over a fixed period of time. depending on the size of the company. SEC should strengthen disclosure requirements by issuing specific guidelines on minimum disclosures required for related party transactions. insider information. Increasing the Statutory Accountability of Directors and Strengthening the Board System The Government should clarify statutory fiduciary responsibilities of the board of directors. II ers often cause wide volatility in stock prices and invite reaction from creditors. The following recommendations involve amendments to the Corporation Code that will improve transparency of ownership and address the current high level of ownership concentration in Philippine business: (i) require disclosures of underlying ownership of shares held by nominees and holding companies. To help ensure this. Another measure would be to impose a statutory limit on the number of directorships that one can accept. To strengthen the board. It has suffi- . and self-dealing. PSE Listing Rules should specify criteria and a selection process that will help ensure that the nominees for the position are truly independent and qualified. Strengthening Minority Shareholder Rights An issue that concerns minority shareholders is whether they have instruments—legal or ethical—that can prevent controlling shareholders from expropriating their wealth through risky investment and financing. the PSE Listing Rules require the appointment of a minimum number of independent directors in the board of publicly listed companies. to 25 percent.220 Corporate Governance and Finance in East Asia. This will enable SEC to enforce prudential requirements on management of companies and enable minority shareholders to pursue grievances against their boards. Clear legal accountability is a precondition for successful shareholder activism. (ii) require disclosure of material changes in ownership. Because independent directors tend to adopt the perspective of minority shareholders in board decisions.
g. (iv) require banks to follow international financial accounting. Because ownership is generally concentrated in five shareholders. For example. officers. directors. the board will be compelled to initiate a thorough discussion of the merits of the proposed related-party deals that will require the participation of minority shareholders. fit and . Impose severe penalties for any attempt by banks to circumvent this regulation. raising the current two-thirds majority to a three-fourths majority. (ii) set strict limits on lending by banks to affiliated companies. current rules allow boards of directors to approve own-dealings or related party transactions by simple majority. The Government should improve its prudential supervision system to ensure that banks perform their role as external control agents of their corporate debtors. the board can easily muster the needed majority to approve the deal. in particular. The following recommendations aim to further improve banking regulations and supervision in the Philippines: (i) limit shareholdings of nonfinancial companies in banks.Chapter 3: Philippines 221 cient case history that can be used as a basis for tightening its disclosure requirements. and related interests. prudential measures and regulations. e. and (v) closely monitor. By requiring sufficient disclosure and a 75 percent majority vote on such decisions. and disclosure standards. or prohibit cross-guarantees by companies belonging to affiliated groups. reporting. They need legal empowerment such as higher majority voting requirements. Finally. the Corporation Code should be amended to impose sufficiently stiff penalties for self-dealings that patently expropriate the wealth of other shareholders.. limit. in areas of supervisory functions of the central bank. Improving Financial Regulation and Strengthening Implementation The Asian crisis demonstrated the need to strengthen banking regulation. It is encouraging that the newly enacted 2000 Banking Laws have introduced changes along these lines. Minority shareholders have failed to use traditional venues such as the annual general shareholders’ meetings to discipline controlling shareholders that expropriate their wealth. (iii) adopt international standards of capital adequacy and ensure that banks comply with these standards. and of banks in nonfinancial companies in order to avoid connected lending.
This investor profile has a “missing middle”—long-term investors who intend to participate in longterm growth of a company and who also trade shares depending on company performance. Managements find that their investment and financing decisions affect stock prices and become aware of their responsibility to create shareholder value. Institutional investors impose market discipline by voting on strategic corporate decisions. By supporting the establishment and operation of institutional investors. This way. The other is the addition of provisions in the Corporation Code to facilitate class action suits against corporate directors. and lending to DOSRI. Reforming the Legal and Regulatory Framework for Investment Funds and Venture Capital Owners of Philippine publicly listed companies consist of controlling shareholders and investors that hold trading portfolios. SEC appears to be taking a primarily regulatory posture in the operation of investment funds. One is improved transparency and disclosure on specific items that potentially involve expropriation of wealth of minority shareholders. Other investors benefit from the information that analysts produce for these institutional investors as information technology makes their output a public good. Presently. institutional investors can be a driving force in providing market discipline to management. Investment and venture capital funds meet this description. Promoting Shareholder Activism Promoting shareholder activism to encourage small shareholders to actively monitor management is an approach that has not been tried out in the Philippines. The current law should expand class action suits to include management and . In developed capital markets. institutional investors lead public investors in providing market signals to companies. The absence of institutional investors indicates that the legal and regulatory basis is inadequate. Two measures should be adopted to promote shareholder activism. II proper rule. management. SEC and PSE can help ensure that these external control agents provide market discipline even in companies controlled by large investors. and external auditors. foreign ownership of banks. Vol. transparency. an active financial analyst community can begin to form. If institutional investors are present. Its priority is to protect prospective fund investors from unscrupulous fund managers.222 Corporate Governance and Finance in East Asia.
Philippine Government Treasury bonds should provide bellwether rates for corporate bonds in the way that they have for short-term bank debts. And by issuing Government Treasury securities in longer tenors. SEC should allow minority shareholders to be represented by activist groups. guarantees. and Credit Information Bureau that can be the starting point of this effort. and the external auditors. It should develop a medium-term yield curve for the corporate debt market by strengthening the Government bond market. Placing the means for prosecuting in the hands of minority shareholders may instill more discipline in controlling shareholders. Promoting Competition in Product Markets The Government should pursue industrial development policies that promote competition through the elimination of subsidies. The Government should enhance the securities markets as an alternative source of corporate financing and pursue aggressive development of the local debt securities markets. Promoting the corporate bond market requires that the Government develop trading systems and services of credit risk rating of corporate issuers. the Government could develop the market for future issues of corporate bonds. Companies are likely to remain dependent on bank financing if the authorities do not strictly enforce prudential lending regulations. information disclosures. Legal provisions for class action suits should cover self-dealing by directors. Securities market development efforts should coincide with strict regulation of the commercial banking sector. and dividend decisions. where the threat of class action suits alone is sufficient to encourage quality decisions and behavior from management.Chapter 3: Philippines 223 auditors. There are existing institutions such as Dun and Bradsreet. entry . compensation contracts. Expanding Debt Securities Financing The Philippine corporate sector relies on bank loans because controlling shareholders do not want to dilute their control by issuing equities. These groups have an incentive to gather technical expertise. SEC should take steps to simplify the process of class action suits and provide an avenue for out-of-court settlements similar to practices in the US. leadership. and broad-based political and popular support to pursue possible cases involving expropriation of minority shareholders’ wealth. their directors and management. The present provision on class action suits is inadequate because shareholders view the process as ineffective and expensive.
and provide quality basic services should also be heightened.and medium-scale companies can become more competitive relative to large companies. Improving External Audit Standards and Information Disclosure Effective external control in corporate governance requires accurate and timely information about companies. The resulting absence of a strong investor base makes share prices vulnerable to manipulation or insider trading by large shareholders. so that small. and publicly listed companies trade barely the minimum number of shares required for public listing. The Government should also continue to improve infrastructure. Little attention is given to the conditions that make those regulations effective in the US corporate sector but not present in the Philippines. II and exit barriers. Efforts to reduce graft and corruption. Vol. PSE should campaign for top-tier companies to go public and work with SEC in encouraging publicly listed companies to expand their share offerings to the public. The increase in percentage of public holdings may be gradually implemented to enable the companies to adjust. there is a need to increase the supply of quality securities from top-tier local companies in the Philippine stock market. Many of the problems associated with auditing and disclosure stem from the tendency of SEC and PICPA to be satisfied with replicating what their counterparts in the US require by way of audit standards and disclosures. SEC should require that a larger percentage of publicly listed companies’ shares be sold to the public. Many large companies remain privately owned. improve enforcement of the rule of law. and various other forms of protection. Audited financial statements contain basic information about a company’s financial position and performance. Another problem is the orientation of external auditors to the interest of large shareholders rather than public investors. Lack of liquidity deters institutional investors.224 Corporate Governance and Finance in East Asia. The Government’s competition policies should aim to facilitate the free entry and exit of domestic and foreign companies and regulation of anticompetitive practices. PSE and SEC need to build a liquid and efficient market. Increasing the Supply of Quality Equities in the Stock Market To promote the capital market as an external control agent in corporate governance. Current disclosure requirements of SEC are not rigorous enough for public investors. Penalties for poor conduct of auditing by independent .
Chapter 3: Philippines 225 auditors and the mechanism for imposing them are weak. Reforming the legal framework for suspension of payments. SEC and PICPA need to formulate more specific disclosure standards. The law is obviously not in line with the Government’s policy of allowing market mechanisms to work and not intervening in private sector business. and liquidation of troubled companies should be made a priority of the Government. Although the new Securities Regulation Code enacted in 2000 has removed some of SEC’s quasijudicial functions. . suspension of payments and private damage actions. Improving the Legal Framework for Suspension of Payments. it creates a moral hazard problem. and Liquidation. The law on suspension of payments replaces a market-oriented solution with a political process. PD 902-A has not accomplished any successful rehabilitation of a petitioning company since its implementation. violators were made to pay only nominal penalties. reorganization. and implement those standards and penalties rigorously. Instead. and transferred these to courts. For that matter. the new law needs to be effectively implemented and enforced. Reorganization. review the system of penalties on professionals involved in a company’s violation of disclosure rules. including the resolution of intracorporate disputes. SEC and PICPA have not publicly penalized any auditor company that violated disclosure requirements or failed to submit audited financial statements. In spite of the many well-known cases of poorly audited financial statements that resulted in losses for investors.
Journal of Finance 2 (1). and Atulya Sarin. Joseph P. David J. Journal of Political Economy 93 (6). Stijn Claessens. . Tokyo: Institute of Developing Economies. Harold. Quarterly Journal of Economics. Who Owns and Controls East Asian Corporations? Discussion Paper 2054. Emilio. 1999. World Bank. XXIX. Stijn. and Kenneth Lehn. Stijn. II References Abonyi. Joseph P. edited by Toida Mitusuru and Daisuke Hiratsuka. Dennis Gromb. Burkart. and Corporate Diversification. Stijn. Dennis. Claessens. Simeon Djankov. and Clifford Holderness. Fan. Simeon Djankov. Fan. 1998. Simeon Djankov. Discussion Paper. H. and Larry H. Journal of Financial Economics 25: 371-395. World Bank. Lang.. Ownership Structure and Corporate Performance in East Asia. Simeon Djankov. The Philippines: Onward to Recovery. George. Monitoring and the Value of the Firm. March. Key Indicators of Developing Asian and Pacific Countries 1998. World Bank. July. and Larry H. 1989. Lang. Expropriation of Minority Shareholders in East Asia. Thailand’s Corporate Financing and Governance Structures: Impact on Firms’ Competitiveness. Antonio. H. Claessens. 1998a. Denis. 1998. P. Diversification and Efficiency of Investment by East Asian Corporations. and Larry H. 1994. Private Benefits from Control of Public Corporations. Bangko Sentral ng Pilipinas. Working Paper. Jr. and Simeon Djankov. Manila: Asian Development Bank. 1997. Agency Problems. 1997. Stijn. Equity Ownership. Philippine Macroeconomic Prospects: The Next Ten Years. Pedro. P. Thailand: From Financial Crisis to Economic Renewal. Claessens. 1988. Diane K. October.. Institute of Southeast Asian Studies. and Fausto Panunzi. 1985. Lang. and Larry H. 693-728. P. 1999. P. Claessens. Demsetz. Fan. The Structure of Corporate Ownership: Causes and Consequences. Lang. Lang. Michael. Claessens. World Bank. Joseph P. Working Paper. Asian Development Bank. Simeon Djankov. Large Shareholders. 1999. and Larry H. Joseph Fan. M. Vol. May. World Bank. Vol. The Separation of Ownership and Control in East Asian Corporations. H. Stijn.226 Corporate Governance and Finance in East Asia. Alba. Barclay. 1998c. 1998b. P. Conference on Thailand’s Dynamic Economic Recovery and Competitiveness. Working Paper 2088. Asian Industrializing Region in 2005.
Euromoney Books. David S. Internal versus External Capital Markets. Prowse.. Michael.). Joseph C. The Market for Corporate Control: A Scientific Evidence. Franco. Journal of Financial Economics 11: 5-50. World Bank. Exit. Michael. The Modern Industrial Revolution. and John Moore. and Artur Raviv. Hart. Prowse. Modigliani. 1977. Harris. Stuart. Jensen. 1986. Oliver. Agency Costs of Free Cash Flow. Quarterly Journal of Economics 106: 33-60. 1993.. Financial Intermediation and Delegated Monitoring. 1983. Corporation Finance. 1976. and Merton Miller. Gestner. . 1990. Michael. Jensen. Agency Costs and Ownership Structure. Jensen. Stephen. November. Corporate Structure. Review of Economic Studies 51: 393-414. 1995. 1991. F. Journal of Financial Economics 5: 147-175. Hoshi. Journal of Finance 45: 321-350. 1994 and Investment Guide 1997. Journal of Finance 48: 831-80. Journal of Financial Economics 3: 305-360. Stephen. Stein. American Economic Review 76: 323-29. Michael. Debt and Seniority: An Analysis of the Role of Hard Claims in Constraining Management. Milton. 1995. Takeo. and the Theory of Investment. Lufkin. 1984. Douglas. 1998. Journal of Financial Economics 27: 4366. The Quarterly Journal of Economics.Chapter 3: Philippines 227 Diamond. International Corporate Governance. 1994. Corporate Governance: Emerging Issues and Lessons from East Asia. Philippine Stock Exchange Fact Book 1997. and Richard Ruback. Theory of the Firm: Managerial Behavior. 1958. Scharfstein. and William Meckling. Liquidity and Investment: Evidence from Japanese Industrial Groups. Determinants of Corporate Borrowing. Myers. 1990. and the Failure of Internal Control Systems. and David Scharfstein. Corporate Finance and Takeovers. American Economic Review 48 (3): 261297. and Jeremy C. Anil Kashyap. American Economic Review 85: 567-85. Institutional Investment Patterns and Corporate Financial Behavior in the United States and Japan. Robert H. 1990. Capital Structure and the Information Role of Debt. The Cost of Capital. Jensen. and David Gallagher (eds.
1992. Some Conceptual Issues in Corporate Governance and Finance. 1997. Washington.228 Corporate Governance and Finance in East Asia. Webb. Asian Development Bank. Stephen. Shleifer. Journal of Finance LII. 1997. 1. March. Journal of Political Economy 94: 461-88. November. Jeremy C. How Do Large Corporations in Developing Countries Finance their Growth? Corporate Financial Structures in Developing Countries. Credit. Technical paper No. 1996. May. II Prowse. Andrei. World Bank. Washington. Stein. Journal of Money. East Asia: The Road to Recovery. No. DC. Journal of Finance 91: 1121-1139. and Robert W. . Shleifer. 1991. 1985. No. Stiglitz. and Robert W. David. Vol. The Structure of Ownership in Japan. Internal Capital Markets and the Competition for Corporate Resources. DC. Mimeograph. Andrei. 1998. 2. Joseph E. Vishny. 1. Singh. IFC/WB. Ajit. A Survey of Corporate Governance. Large Shareholders and Corporate Control. Vishny. and Banking Lecture 17. 1998. Journal of Finance L11: 737-783. Credit Markets and the Control of Capital.
In the prelude to the 1997 crisis. As a result. and Philippines all depreciating significantly. short-term private debt obligations grew to about 60 percent of total private sector debts. The crisis in Thailand stemmed directly from unsound macroeconomic policies and imbalances.4 Thailand Piman Limpaphayom1 4. the Stock Exchange of Thailand for its help and support in conducting company surveys. Thai corporations were collectively overexposed to exchange rate risks. with Thai corporations overutilizing short-term foreign currency-denominated loans. The corporate sector also contributed significantly to the crisis. and David Webb of the London School of Economics for their guidance and supervision in conducting the study. The majority of these debts were not properly hedged. 1 Associate Professor. heralding not only a financial crisis in the country. with the currencies of Indonesia. Thailand. For the period 1994-1996. It was inefficient in financial intermediation. magnified the impact of these problems on the economy when the crisis hit. .1 Introduction In May to July 1997. and Lea Sumulong and Graham Dwyer for their editorial assistance. Faculty of Business. the Thai Government conceded and adopted a floating exchange rate regime. but also the stalling of East Asia’s “economic miracle. David Edwards. The banking system. Korea). Malaysia. Thailand’s crisis exposed similar vulnerabilities in other East Asian economies. had been plagued with prudential problems for a long time. both of ADB. But it also laid bare weaknesses in both the financial and corporate sectors. poorly regulated and sheltered from competition. The fixed exchange rate policy. Instead of serving as a buffer between the large inflow of foreign capital and the corporate sector. annual short-term capital inflows to Thailand were equivalent to 7-10 percent of gross domestic product (GDP). The author wishes to thank Juzhong Zhuang. Chonburi. Republic of Korea (henceforth. coupled with financial liberalization and deregulation in the absence of an effective regulatory and supervisory system. the Thai baht came under pressure from speculative attacks. the banking system merely validated the financial risks.” After mounting an aggressive defense of the currency. Asian University of Science and Technology.
its growth and financial performance. This study examines these and other factors that might have weakened corporate sector governance in Thailand.2 4. as well as its legal and regulatory framework. Vol. and a family-based corporate ownership structure. The First and Second Plans (1961-1971) Under the first two plans.230 Corporate Governance and Finance in East Asia. II There is now a consensus that weak governance was partly responsible for the corporate sector’s poor financing and investment practices.2 discusses the development of the Thai corporate sector under the National Economic and Social Development Plans. Import tariffs on machinery and heavy equipment were removed.5 discusses how the corporate sector contributed to the financial crisis and looks at its impacts. while new industries were encouraged to reduce the need for imports.3 looks at corporate ownership patterns that resulted in inadequate protection for minority shareholders and weak corporate governance in Thailand. lack of transparency and adequate disclosure. Section 4. The study then considers policy recommendations with emphasis on corporate governance improvement. Key factors that led to weak corporate governance include the ineffectiveness of the regulatory framework. . Section 4.2. 4. with government policy providing support but avoiding direct interference. focusing mainly on the companies listed in the Stock Exchange of Thailand (SET). The National Economic and Social Development Board was created to plan the country’s economic and social development. Section 4.4 provides an overview of Thailand’s financial markets and examines patterns of corporate financing and investment in the years prior to the 1997 crisis.1 Overview of the Corporate Sector Historical Development The corporate sector has long been considered the engine of Thailand’s economic growth. The country initiated national economic development planning in 1961 when the economy was growing rapidly. To protect domestic industries. the Government implemented major infrastructure projects and modified its tax policy to encourage capital investment and savings. Section 4. the Government increased tariffs on products that could be produced locally.
Fourth. remaining high until 1981. the Government borrowed $6. especially foreign aid from the United States.4 percent of GDP.6 percent per year. however.3 percent in 1974. averaging 1. External factors. and reduced current account deficits. The focus shifted to export promotion. The average budget deficit reached an all-time high of $2. the current account registered a surplus in 1986.Chapter 4: Thailand 231 During this period. leaving the Government no choice but to resort to overseas borrowings. including a weakening of the dollar. The Third. lower than anticipated due to a worldwide economic recession. But the sustained importation of heavy machinery and equipment resulted in large trade deficits. and automobile assembly) emerged. textiles. Industrial sector growth was also rapid and many industries (tires.4 billion from overseas and increased taxes on numerous items. As a result. The results were increased exports. and increases in world food and oil prices. Unemployment. the value of the baht remained stable.5 percent in 1973 and 24. Inflation levels were low. The Government decided to embark on restructuring measures in the Fifth Plan (1982-1986) to rehabilitate the ailing economy. Inflation reached 15. helped offset these deficits. The Government had to shift emphasis to restoration of economic stability. Thus. processed steel. . However. the government’s debt burden escalated. Consequently. using tax policy to control prices of consumer goods and implementing several price control measures to curb inflation. the industrial sector grew at a faster rate than the agricultural sector. The decline in imports was steady. became a major problem as domestic investment declined.15 billion per year or 4. Budget deficits also increased throughout the Fourth Plan. it proceeded with its development plan for the industrial sector. To close the fiscal gap. an improved trade balance. Budget deficits remained a major problem during the Fifth Plan. resulted in increases in the current account deficit. canned foods. with the devaluation of the baht in 1984 a major step in this direction. gross national product grew by about 7 percent per year. At the same time. and Fifth Plans (1972-1986) An economic downturn at the end of the Second Plan led to an adjustment in policies. Average growth for the period was 4 percent per year. with the agricultural sector the major contributor. chemicals. In the wake of lower world oil prices and the rapid growth in income from the tourism and travel industry. including luxury goods. capital inflows. however.
Private sector investment grew at an average annual rate of 7 percent. from only $31 billion in 1992. with private foreign debt reaching $92 billion by the end of 1996. By 1995. Growth rates during 1987-1991 ranged from 9. Europe.2 and 13. and Hong Kong. China—went to export-oriented manufacturing industries. rather than to productive activities. an oversupply of housing emerged. Most of the FDIs—originating mainly from Japan. . property development. The manufacturing sector became a dominant force in the economy. The exchange rate was steady at around B25 to the dollar. better than the 5.2 percent per year.6 percent target of the Seventh Plan. compared with the 14. compared with the 8. respectively. Thailand became a debtor’s market.6 percent.5 to 13. the Government successfully balanced the budget and even settled its foreign debt of $4 billion before this was due. The country’s high ratings in the international capital market. averaging 10. Vol. Average annual growth in real GDP was 8 percent. The Seventh Plan (1992-1996) The economy’s performance from 1992 to 1996 generally met the targets of the Seventh Plan. Growth of exports and imports averaged 14.8 percent. while exports expanded considerably.5 percent. On top of its predominantly “borrowed” nature. Thailand’s rapid growth up to the mid-1990s made the country one of the world’s fastest-growing economies. the bulk of domestic investments went to speculative ventures such as real estate. With loans increasingly becoming expensive and hard to come by due to a lending squeeze by the central bank and high interest rates. The country also attracted a large amount of foreign direct investments (FDIs). Singapore. Inflation was 4. From 1989. United States. combined with its liberal financial policies.7 and 11. increasing its share in total export value from 42 to 76 percent. II The Sixth Plan (1987-1991) Industrial sector productivity improved gradually during the Sixth Plan period. reaching an annual inflow of $2 billion in 1991.8 percent.232 Corporate Governance and Finance in East Asia.4 percent targets. invited a deluge of capital seeking profitable investments. and the stock market.2 percent target. Key to this growth performance was the government’s adoption in 1993 of an aggressive program for attracting foreign capital to finance domestic investments. the property sector began to collapse in 1996. lower than the target of 8. compounded by a slump in property sales.
its policy had always been to protect domestic banks.8 percent in 1995 to 1. Its most crucial role was to help mobilize funds to support Thailand’s industrialization and economic development. the capital markets didn’t play a significant role until 1975. Before the capital market emerged. prepared a comprehensive report entitled “A Capital Market in Thailand. the establishment of the Securities Exchange of Thailand (SET) was legislated and trading began on 30 April 1975.2. 58 on the Control of Commercial Undertakings Affecting Public Safety and Welfare.3 percent in 1996. SET officially became “the Stock Exchange of Thailand” in 1991.2 Development of Capital Markets Although the corporate sector has long been the government’s main tool for economic development. Exports went into a tailspin. the corporate sector’s main source of funding was the banks. placing all publicly listed companies under regulation. In May 1974. In 1969.” extending its control and regulatory powers to the finance and securities companies operating freely at the time. a policy that held throughout the first six economic development plans. Sidney M. on account of an overvalued baht that weakened export competitiveness. the Government passed the Public Limited Company Act. the Bank of Thailand and . The country had a current account deficit of about 8 percent of GDP in 1995 and 1996. The deficits caused the Government to rely on even more external borrowing. Robbins recommended an overhaul of the existing informal stock market established earlier by a group of local brokers in favor of a centrally regulated institution. A series of increases in customs and excise taxes on luxury imports did little to stem rampant consumer spending. Under the 1962 Commercial Banking Act. the Government amended the “Announcement of the Executive Council No. Robbins. And because the Government considered the banking system vital to the development of the economy. many companies considered the Act too restrictive and a hindrance to growth. In his report. In 1972. However.Chapter 4: Thailand 233 Toward the end of the Plan period. a former Chief Economist from the US Securities and Exchange Commission. which raised the debt service ratio. Foreign banks were barred from competing directly with domestic banks.” which later became the master plan for the development of the Thai capital market. In 1978. Included in the Second Plan (1967-1971) was a proposal to establish the country’s first authorized and regulated securities market. 4. which was amended in 1979 and 1985. with growth shrinking from 23. the signs of an economy about to falter were there.
Thailand’s capital market entered a new era with improved legislation and regulation. there were 29 commercial banks (15 domestic and 14 foreign banks) in Thailand. With the liberalization of financial markets. In the 1990s.234 Corporate Governance and Finance in East Asia. the financial and banking laws were generally ineffective. Earlier. The Public Company Act of 1992 relaxed some of the rules and restrictions contained in the original laws. creating a moral hazard problem—the perverse expectation that imprudent bank behavior would be rewarded with forbearance and bailout.” The Government also granted financial institutions overly generous bailouts. Externally. However. At the end of the Sixth Plan. and the General Agreement on Tariffs and Trade (GATT) meeting in Uruguay had the liberalization of financial services on its agenda. Thailand discarded controls on foreign exchange transactions and capital flows—a turning point for the Thai corporate sector. The resulting availability of funds propelled the corporate sector’s growth through the early part of the 1990s. and new financial instruments. The banks and finance companies operated at insufficient levels of reserve capital and were overexposed in high-risk businesses such as real estate. The pressure dovetailed with the Government’s intention to make Bangkok one of the financial centers of the region. the Government was under international pressure to deregulate the financial sector. while the Securities and Exchange Act (SEA) the same year sought to improve capital market supervision. The regulatory measures were inadequately designed and poorly enforced. to cater specifically to its . increased financial market activities. While the Bank of Thailand had the regulatory power to influence business practices. Laws were enacted to stimulate growth of the corporate sector. the World Bank had recommended such a move. it usually relied on “moral suasion. A number of internal and external factors contributed to the Thai Government’s acceptance of the IMF’s Article VIII agreement. II the Ministry of Finance had full authority to supervise all commercial banks. Economic growth had been rapid and domestic savings could not keep up with the pace to support investments. Financial deregulation and liberalization allowed the country to attract foreign savings and investments that helped finance the growth of the economy. The introduction of these two laws came just after the Government’s signing of Article VIII of an Agreement with the International Monetary Fund (IMF) in May 1990 to deregulate and liberalize financial markets. Thai banks gained access to a variety of funding sources from around the world. Vol.
The result was a corresponding growth and development in Thailand’s capital markets. 4.9 261. the country became recognized as an economic development model for other emerging economies. 1978-2000 Number Registered of Capital Companies (B billion) 5 6 245 5 13 129 22 194 42 661 1.9 1. with B1.3 83.2 11. Forestry.394.5 111. Hunting.101.4 trillion in registered capital and B791 billion in paid-up capital.2 Type of Business Agriculture.9 16. and Restaurants and Hotel Transport.1 Public Companies Registered. Gas. and Communication Financing. The majority of the companies are in manufacturing.5 791. Real Estate.6 23. The stock market boom from 1991 until the financial crash of 1997 reflected international investors’ response to Government policies. Storage. Social and Personal Service Total Note: The data for 2000 is as of October 2000.5 50. finance.3 trillion have been registered with the authority (Table 4. The manufacturing sector is a far second with registered capital of B350 billion and paid-up capital of Table 4. In terms of capital.6 1.9 34. Insurance.1 78. .1 trillion and paid-up capital of B1. Financial deregulation and liberalization were key to realizing that vision. Thailand.1). The Bangkok International Banking Facility (BIBF) was thus established to facilitate international borrowings and encourage capital flows as a means of financing the current account deficit. about 661 companies with total registered capital of B2.2. and wholesale/ retail trade and restaurant/hotel sectors. and Water Construction Wholesale and Retail Trade.3 Growth and Financial Performance Since the 1978 enactment of the Public Limited Company Act.6 2.6 350. Worldwide.1 30. and Business Service Community.0 Paid-up Capital (B billion) 1.0 110. Source: Department of Commercial Registration.291.0 21. in that order.0 19. Ministry of Commerce. and Fishing Mining and Quarrying Manufacturing Electricity. however.Chapter 4: Thailand 235 fast-growing neighbors. the financial sector is the largest.
Market capitalization.4 277.8 1995 64.4 34.2 Public Offerings of Securities. allowed Thai financial institutions and corporations to obtain funds overseas.8 billion.6 174. Domestic and offshore debt issues reached B54. Vol.6 7. With the enactment of the SEA of 1992 that brought suppliers of finance services and their clients together.2).5 1.5 — — 56.5 39.7 billion in 1996. respectively. reached .9 31.1 599.1 286. moreover.6 — = not available. While a rebound was apparent beginning in 1998. The signing of Article VIII with the IMF. After the passage of the SEA of 1992.8 151.7 5.4 96. Securities and Exchange Commission of Thailand. These peaked at B89. Source: Key Capital Market Statistics.7 27.3 22.3 1996 1997 65. 1992-1999 (B billion) Type of Securities Equity Debt Instrument Domestic Offering Offshore Offering Hybrid Instrument Domestic Offering Offshore Offering Total Funds Raised 1992 1993 1. The stock market also became an invaluable source of funds for corporations.6 8.1 — — — 6.0 20. reducing the value of offerings to a little more than a quarter of the previous year’s level.2 25. The 1997 crisis battered the primary market for securities.7 136.7 9.3 194. The number of listed companies and securities steadily increased until 1996 (Table 4. the capital market became instrumental in the rapid growth and development of the corporate sector.0 1994 82. Table 4.3 31.7 billion and B27. II B261 billion. from only B20.2 40.1 54.0 0.5 1. The development of the corporate sector closely followed the development of capital markets.7 7.8 — 26.236 Corporate Governance and Finance in East Asia.2 12. the year before the crisis struck. Debt market activities also increased significantly with the establishment of the Bond Dealers’ Club (BDC) in 1994. reaching a precrisis peak in 1996 (Table 4. meanwhile. The preeminence of the financial sector is a direct result of financial deregulation and liberalization.3).6 39.2 5.5 billion and B1 billion the previous year.3 6.9 37. this was due to the recapitalization of commercial banks in compliance with the new loan provisioning requirement.1 2.4 51.8 201.9 1998 1999 15. the value of public offerings rose steadily.
pulled down by active public offering activities. their share rising from 17 percent in 1993 to 43 percent in 1997.301 3.Chapter 4: Thailand 237 Table 4. in the end.360 1. return on equity (ROE). and gross profit margin. While the decline in gross profit margin was not as sharp. the companies could not generate enough net returns from their assets and equity. had been on the rise throughout the 1980s. gross profit margin rose until 1991 before falling in 1992.1 by 1996.268 2.565 2. the average times interest earned (TIE) was down to 5. not all public companies are listed on the SET.281 832 373 356 482 Due to listing requirements and other reasons. its high point in 1995 at B3. From 10. Foreigners accounted for an increasing proportion of SET’s turnover value. resulting in their inability to fulfill debt obligations.303 930 855 1. as measured by return on assets (ROA). however.114 1.325 3. Source: Securities and Exchange Commission of Thailand.535 1.683 1. The trend reversed in 1995. The upward trends for ROE and ROA continued through 1989.4). was the ominous deterioration in the key financial ratios of publicly listed companies. 1993-1999 Item Number of Listed Companies Number of Listed Securities Market Capitalization (B billion) Turnover Value (B billion) SET Index a 1993 1994 1995 1996 1997 1998 1999 a 347 408 389 494 416 538 454 579 431 529 418 494 392 450 3. But instead of shifting to a low gear. The plunge in profitability and asset turnover—from 117 percent in 1985 to 65 percent in 1996 for the latter—cast doubts on the .560 1. The financial leverage of all companies declined until 1994. Meanwhile. Throughout the 1990s.6 trillion.5 at its peak in 1987. ROE similarly fell from 21.193 2. Side by side with this surge of financing for corporate growth. when long-term debt grew as Thai corporations began to borrow heavily to finance growth. By the early 1990s.4 percent in 1996.3 percent in 1989 to 3. Corporate profitability. ROA dipped from 10.3 Statistical Highlights of the Stock Exchange of Thailand. the highly liquid financial system continued offering cheap funds to sustain corporate sector investments.610 1.201 2. then stalled in 1990. however. The key financial ratios of all companies listed on SET bear this out (Table 4. corporate profitability had been declining.4 percent to 5. the averages for all three profitability ratios took a downswing all the way until 1996.133 1.8 percent.
0 145. Severely affected by global competition throughout the decade. which was particularly significant in the two years preceding the crisis.7 54.238 Corporate Governance and Finance in East Asia. these companies opted for debt.7 5.6 125.7 21.4 3.3 4.2 10.1 242.6 Year 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 Source: Pacific-Basin Capital Markets Database compiled by the University of Rhode Island.8 5. practice of heavy borrowing. clothing.4 47.2 215. The downtrend in corporate profitability.7 35.9 14.7 LongTerm Debt to Asset Assets Turnover (%) (%) 14.4 51.8 11. resulting in higher collateral values for borrowers.7 59.4 Key Financial Ratios of Publicly Listed Companies.9 7.7 12. and footwear had the lowest at 11 percent.5 63.5 52. but was most severe in building and furnishing material industries as a result of the downturn in the real estate market.8 8. Vol.8 5.9 8.7 27.7 20.9 77.1 52.0 125.4 12.4 9.2 10.1 114.0 7. II Table 4. which fell from 16 percent in 1991 to just under 6 percent in 1996.2 49.3 8.1 16.4 4.7 80.2 27.6 41. It has also been argued that family-based controlling shareholders borrowed excessively to avoid diluting their control over their corporations.5 30. Among the crisis-hit countries.1 60. Overall.0 139.3 12.5).4 5.4 24.6 168. was felt across industries. They were generally more efficient in managing their assets and .7 5.2 27.5 38.9 7.9 39.7 5.9 66.0 117.4 119.9 51.4 12.2 35.4 26.7 12.8 25.5 9.8 151. large companies (where size is reckoned in terms of assets or sales) were more profitable than small companies in terms of ROE (Table 4.2 10.4 7.2 6.6 12. Despite the availability of the equity market.7 12.7 27.5 50.1 120. Korea and Thailand had the highest debt-to-equity ratios.1 16.4 34.9 140.9 144.7 4. the textiles.8 88.6 7.8 51. US.2 161.4 139. Thailand’s ROE.7 15. A major reason for this was the rapid rise in asset prices. 1985-1996 LongTotal Term Total Return Return Gross Debt Debt Debt on on Profit Times to to to Assets Equity Margin Interest Equity Equity Assets (%) (%) (%) Earned (%) (%) (%) 3.3 91.8 14. Hotels and travel showed the highest ROE of 15 percent while textiles. clothing.1 9.8 54.6 27.6 138. and footwear industries also experienced losses.1 44.4 18.0 63.4 28. was also distinct in the region.7 34.6 36.4 7.0 3.9 27.4 44.5 15.5 51.7 12.2 64.3 10.0 29.
5 6.1 25.8 6.3 25.3 52.7 10.6 7.1 6.4 Legal and Regulatory Framework Before 1992.4 116.2 10.5 94.3 135. During the 1990s. However.8 10. 1985-1996 Company Size by Assets Company Size by Sales Item Return on Assets (%) Return on Equity (%) Gross Profit Margin (%) Times Interest Earned Total Debt-to-Equity (%) Long-Term Debt-to-Equity (%) Total Debt-to-Assets (%) Long-Term Debt-to-Assets (%) Asset Turnover (%) Small Medium Large 6. weaknesses became evident.7 Source: Pacific-Basin Capital Markets Database compiled by the University of Rhode Island. capital despite the higher gross margins of small companies. Cumulative voting.3 49.4 52.9 13.3 49. measured by total asset turnover.7 14.0 83. They also tended to use more financial leverage than small companies as their total DERs show. also deteriorated.7 6. although the performance of listed companies in the late 1980s was strong.6 6.2. 4. it was thought.2 134. US.6 10.3 43.3 23.3 176.1 Small Medium Large 5.6 12.6 5. the overall activities of listed companies. could lead to a high turnover in the board. the law disallowed cumulative voting. The argument was that having a Board of Directors whose members represented different groups of investors would create conflicts and hamper management effectiveness.8 142. There were also concerns that the provisions governing the criminal prosecution and penalties of directors and management were harsh and inappropriate.2 121. some rules and regulations of this particular law were believed to be too restrictive and were discouraging companies from going public. the Public Limited Company Act of 1978 and its amendments regulated Thai publicly listed companies.6 31.1 5.3 164.0 48.8 62.3 15.5 7.5 87. For instance. total asset turnover declined after 1989. In sum.5 Average Key Financial Ratios by Company Size.2 18. which would be disruptive to company management.Chapter 4: Thailand 239 Table 4. by the 1990s.0 20. Increasingly heavy borrowings rendered the sector even more vulnerable to lower profitability and sales.8 6. .6 30.8 26.1 29. Although stable in the 1980s.6 30.6 61.8 47.2 12.4 8.1 13.9 20.3 88.
relaxed the contentious provisions of the 1978 Public Limited Company Act. a feature that is believed to have impaired the effectiveness of existing regulatory mechanisms in the corporate sector.3 Corporate Ownership and Control Ownership and control of corporations in Thailand are highly concentrated. Vol. The legal and regulatory framework for the corporate sector also includes provisions related to insolvency.2 The market for corporate control was not active and did not give managers strong incentives to perform efficiently. and external monitoring and control of corporations were also weak. . However. the exit of these provisions appears to have contributed to the 1997 financial crisis. coupled with weak corporate governance.5. The Public Company Act of 1992. and the punishment for management misconduct was also lightened considerably. The provision discouraged original family owners from registering their companies. from holding more than 50 percent of total outstanding shares and other shareholders from holding more than 10 percent of outstanding shares individually. The law prohibited the largest shareholders. 2 ADB survey questionnaires were sent to all Thai listed companies in early 1999. The protection of minority shareholders was inadequate under the Public Company Act of 1992. An Asian Development Bank (ADB) survey conducted for this study shows. as a group. the new legislation removed a number of incentives that would have kept public companies prudent and diligent in their operations. for instance. that creditors had generally little influence on the management of corporations. played an important role in bringing about the financial crisis. The original company owners welcomed the changes and the number of publicly listed companies subsequently rose to more than 600.240 Corporate Governance and Finance in East Asia. Cumulative voting was made optional. II Another issue was the proportion of shareholding by top shareholders. As it turned out. As the succeeding sections point out. adopted to promote the development of publicly listed companies. but not all questions were answered. Fortysix companies responded. the limit on shareholdings by the largest shareholders was increased from 50 to 70 percent of total outstanding shares. This will be discussed in Section 4. concentrated ownership. 4.
9 52. Indonesian.9 4.4 10.9 26. This implies that the top five shareholders enjoyed full control over the outcomes of shareholder meetings.8 11.4 5.0 7. In the past.4 26.1 4.9 54.8 5.1 Patterns of Corporate Ownership A World Bank study covering nine Asian countries finds that firms in Japan and Taipei. with the top three shareholders accounting for almost 50 percent (Table 4.9 52. Source: Comprehensive Listed Company Information Database.6 4. In contrast. China firms have the highest single shareholder ownership concentration at 35. these companies obtained funding solely from banks or from their own retained earnings. respectively.Chapter 4: Thailand 241 4.5 Average for 1990-1998 period. and 28.7 7. and minority shareholders to stake their claim in the control and regulation of these companies.7 12.0 53.2 11. on average. there were only slight variations in the pattern.1 11. one would expect the public.6 28.3 7. Ownership Concentration Between 1990 and 1998. the top five shareholders of each of publicly listed Thai companies held. with the largest shareholder on average controlling 10.1 5.6 57.4 26. .1 7.3 5.2 4. 1990-1998 Averagea 1990 1991 1992 1993 1994 1995 1996 1997 1998 1st Largest 2nd Largest 3rd Largest 4th Largest 5th Largest Top Five a 28.3 7.1 3. Ownership was most concentrated in the packaging.3 percent and 18.2 56.6 Top-Five Ownership Concentration of Publicly Listed Companies in Thailand.4 percent of outstanding shares.0 3.1 percent of control rights.6 68. creditors. 56. But with their increased reliance on new varieties of equity and debt instruments.China have the least concentrated ownership. this was not the case. Unfortunately. Across industries.4 6.5 28.3 11. Most large Thai corporations listed on SET started out as family businesses.5 9.6).0 3.3 28.3 16.7 6.9 6.0 7. Thai.9 3.3 percent. Table 4.9 3.1 12.0 56.8 32.2 4. The Public Company Act of 1992 allowed ownership and control of these companies to remain with the founding families even as they became increasingly dependent on nonfamily resources.4 26.6 27.7 percent.9 percent of shares of a company.0 5. 33.7 11. and Hong Kong.9 55.4 6.1 5.4 4.1 5. Stock Exchange of Thailand.9 11.3.9 52.2 4.
owning 26.037 0. founding families maintain effective control of entire groups. * Denotes significance at the 10 percent level.169*** 0.022*** 0. Company size is significantly related to ROE and leverage.001*** 0. Other industries had their top five shareholders controlling at least 55 percent of outstanding shares.034*** 0.001 0. Based on a regression analysis. year. Leverage.800 0.029 3.001) 0.116) Debt-to-Equity (1.115 9. there is no statistically significant relationship between ownership concentration (measured by percentage of shares owned by the top five shareholders) and profitability of Thai publicly listed companies (Table 4.005** 0.080 6. Vol.090 0.8). It is the practice of Thai corporate founding families to set up holding companies to own shares in affiliated companies or subsidiaries. *** at the 1 percent level. These are consistent with the hypothesis that companies with more concentrated ownership tend to engage in higher debt financing because their controlling owners do not want to dilute their control by bringing in new equity holders.7 Statistical Relationships between Corporate Profitability. Table 4. Source: Author’s estimation based on the Pacific-Basin Capital Markets Database compiled by the University of Rhode Island.533)*** Debt-to-Assets (0.058* ROE (0.031 3.003 0. as measured by debt-to-equity and debt-to-asset ratios. ** at the 5 percent level. Composition of Controlling Shareholders Affiliated corporations comprise the largest group among the top five shareholders of publicly listed companies. with a top-five ownership concentration of at least 60 percent. Through these holding companies.7 percent of outstanding shares on average (Table 4. results show a significant positive relationship between ownership concentration and financial leverage. and building and furnishing industries. Ownership Concentration. and Company Size Item Intercept Top Five Ownership Concentration Company Size Adjusted R-Squared F-Statistic ROA 0. including those that are publicly listed .647 Note: The regression included dummy variables for industry. On the other hand.072) (0. II agribusiness. US.242 Corporate Governance and Finance in East Asia.7). and ownership types.
4 1.0 19. .8 1.1 1. In 1994.9 15. operates five of the most successful shopping malls in Thailand. In addition.8 23.5 2. Individual family members also hold a significant amount of outstanding shares. Established in 1980 with a registered capital of B300 million. averaging about 18. a joint venture among three families.Chapter 4: Thailand 243 Table 4.6 5.1 4. individual members of the Chirathivat family aggregately hold 25. 1990-1998 Year 1990 1991 1992 1993 1994 1995 1996 1997 1998 Average Company 28.3 20.7 Bank 2.5 1.4 1.4 22.5 0. founding families and their relatives maintain control of many companies by jointly holding on to the most significant chunk of shares.2 7.7 1.2 5.2 1.2 1.9 7.0 17. a company listed in the real estate sector of SET.2 18. a NBFIs denotes nonbank financial institutions.3 27.6 1.6 1.5 0.9 18.6 28. the company. one of the founding members.1 0.5 0.3 0.7 — 1. with 29. The roster of its major shareholders as of December 1997 illustrates the typical ownership concentration of a publicly listed company in Thailand.1 1.4 1.6 1. Although holding companies set up affiliate firms. The top 10 shareholders include a holding company owned by the Tejapaibul family.9 19. These individuals usually hold important management positions in concerned companies.8 Top-Five Shareholder Composition of Publicly Listed Companies in Thailand.9 6.8 28. Stock Exchange of Thailand.3 1.0 18.7 0. unlike in Japan where crossshareholding is common.3 27.3 percent of outstanding shares. This practice is illustrated by Central Pattana. in SET. The largest shareholder is Central Holdings Company.9 0. the company increased its registered capital and became a public company listed in SET.6 percent of outstanding shares.5 NBFIsa 6.5 26.0 3.5 1. The ADB survey indicated that listed companies held shares in an average of 11 companies.7 5.3 1.5 percent.6 25. Source: Comprehensive Listed Company Information Database. including finance and investment companies. Typically.4 20. the affiliate firms rarely hold shares of their parent companies.8 0. owned by the Chirathivat family.3 — = not available.5 5.3 1.5 Government Other 0.5 Individuals 13.3 27.
Together. Vol. where the top three shareholders are the Ministry of Finance. For example. only one tenth of listed companies have commercial banks on their top-five shareholder list. 3 Discussions in this section are based on results of company surveys by SET and ADB. they exercise limited influence in operations because of the restricted size of their shareholdings.5 percent of total outstanding shares. 4. they account for 80 percent of total outstanding shares. has the Ministry of Finance as its only large shareholder with 92. these shareholders are able to control the company. Only a handful of companies have the Government among their large shareholders. the Government’s role in public companies is expected to decline. .5 percent of total outstanding shares of listed companies. commercial banks account for only 1.2 Corporate Management and Control3 Board of Directors The Public Company Act of 1992 stipulates the appointment process. By owning 62 percent of voting shares. In such cases. on average.. Across industries. qualification. II another of the company’s founding members. duties. The Government holds.244 Corporate Governance and Finance in East Asia. Although the list of top shareholders of publicly listed companies includes financial institutions. the predominance of individual family members and holding companies in the top shareholder list remains valid. Another example is Bangchak Petroleum Plc. About half of listed companies have nonbank financial institutions such as finance and investment companies in their top-five shareholder list. Nonbank financial institutions hold an aggregate 5. the Petroleum Authority of Thailand. There was a trend of rising government shareholdings throughout the period 1990 to 1998. In effect. Moreover. the Government owns the majority of the shares. On average. with the envisioned privatization master plan. 1. Thai Airways International Plc. the top 10 shareholders consist predominantly of members of founding families and their holding companies. However. and responsibilities of directors of public companies. and a state bank. roles.3. holdings by individual family members and holding companies account for at least 50 percent of outstanding shares of an average listed company. Except in the hotel and travel service sector.9 percent of outstanding shares.1 percent of total outstanding shares of listed companies. both conducted in 1999.
Some companies (36 percent) had five to six main board members holding seats in their executive boards. directors may be imprisoned or fined.Chapter 4: Thailand 245 Directors are required to meet minimum qualifications specified under the SEA of 1992 and the Listing Rules issued by SET. A survey by SET found that the majority (58 percent) of the 202 responding companies held their board meetings every quarter. Although 28 percent of the chairpersons came from the ranks of independent outside directors. Generally. Nineteen companies stated that selection was based on professional qualifications. while 15 percent of respondents went beyond the requirement. meanwhile. Almost all companies (98 percent) exceeded the minimum required five members in their Board of Directors. but not in 22 others. the ADB survey found that 31 companies (out of 46 responding) required outside directors to be present at all board meetings. while 30 percent of respondent companies held board meetings monthly. If found in violation of these provisions. In their business conduct. The ADB survey indicated. In addition. that only in two of the 46 responding companies were the chair of the boards elected based on the extent of their shareholdings. an executive board consists of senior management and some main board members. directors shall be elected at the annual general shareholders’ meetings (AGSMs). Many companies have a formal policy on corporate governance and business ethics. In five other companies. Unless stipulated in public companies’ articles of association. Meanwhile. Most companies (83 percent) satisfied SET’s requirement of having two independent board members. Chair of the Board and Chief Executive Officer The SET survey showed that about 73 percent of listed companies had a separate executive (management) board. directors are required to act with care and honesty for the company’s best interest. The appointment of the chief executive officer (CEO) needed approval during the AGSM in 11 of the responding companies. Three companies indicated that the CEO and the chair were close relatives. the majority (71 percent) had board chairs who were also members of top management teams. . selection was based on relationships with controlling shareholders. directors could be compelled to compensate the company for damages arising from their misconduct. and to comply with the laws and articles of association.
and CEO The majority of company respondents to the SET survey provided similar compensation packages to internal and external directors. In 25 companies. Half of the companies in the SET survey had a separate remuneration committee. In one company. The SET survey found that the majority of listed companies (81 percent) still have no separate audit committee. the majority of the companies (77 percent) did not have outside directors as members of their remuneration committees. However. Audit Committees and Accounting Standards Since January 1999. the remuneration packages had to be approved during AGSMs. SET’s attempts to bring accounting practices to international standards have included requiring listed companies to consolidate all liabilities— including those on off-balance sheets—in their financial statements beginning June 1998. The directors’ compensation was determined largely by the Board of Directors except in 19 percent of the companies surveyed where a remuneration committee was in charge. The ADB survey indicated that 18 of the 46 responding companies compensated their chairpersons using a fixed-fee schedule. Three companies allowed their management to determine the chair’s compensation package. with 41 firms admitting the use of services of international auditing firms. these were attributed to variations in the extent of duties and responsibilities assumed by those directors. Also. Vol. II Compensation of Directors. Chair. Fourteen other companies had profit-related incentive schemes in addition to fixed fees. not an independent assignment.246 Corporate Governance and Finance in East Asia. Where different. These committees were mainly responsible for determining compensation for senior and regular staff. Companies already with audit committees did not have independent outside directors as audit committee members. however. Directors with managerial responsibility or those related to major shareholders cannot be members of such audit committees. the work of this committee was often considered part of the executive board’s responsibilities. while 19 companies observed only some of them. all listed companies have been instructed to establish audit committees to be responsible for examining the quality and reliability of company financial statements. Twenty-five of the 46 respondents to the ADB survey declared adherence to all relevant international standards. All respondents confirmed the use of external auditors. the auditor is not .
At least 28 responding companies had the following . (i) No standards are enforced in the content and timing of notices for shareholder meetings. Relationships between firms and external auditors are generally long-term. The Act. shareholders have access to reliable information at no cost. remuneration. most responding companies have rules and regulations intended to protect shareholders. SEC. with 13 companies allowing proxy voting through mail. In the majority of these companies (38 out of 46 respondents). (ii) The prudential role of outside directors is limited by the noncompulsory character of their participation in key decision-making bodies such as the audit. (iv) The roles and responsibilities of the major government agencies regulating shareholder rights—the Ministry of Commerce. although recently. or other financial instruments. stipulates the proper conduct of shareholder meetings. According to the ADB survey. as well as the registration and holding of shares. shareholders can claim compensation in cases of negligence or dishonesty by management. likewise. Proxy solicitation tends to be abused to the extent that shareholders are inadequately informed about matters to be taken up in shareholder assemblies. Minority Shareholders and their Rights Many different rights and entitlements of shareholders are laid out in the Public Company Act of 1992. and the Bank of Thailand— are not clearly defined. The majority of the companies (85 percent) require the appointment of external auditors during annual general meetings. While safeguards are in place. there are also significant gaps in the system of shareholder protection. However. the institutional machinery is not fully responsive to complaints about violation of shareholder rights. As a result. SET’s rules and regulations closely follow this Act. Shareholders are also entitled to call emergency meetings and present proposals at AGSMs.Chapter 4: Thailand 247 independent from the company. there is the danger that top management may be capable of unduly influencing the board’s decisions. (iii) Because the chair is frequently also part of the top management team. Forty-four companies indicated that they had proxy voting in place. For instance. the corporate sector lacks a strong self-regulatory body to compel compliance with these standards. averaging about 14 years. debentures. SET. The Act also holds directors liable for any damage to shareholders. and executive committees. the Securities and Exchange Commission (SEC) and SET were actively prosecuting violating firms. including false statements to conceal information about the financial condition and operations of the company during the sale of shares.
and mandatory disclosure of related interests and significant shareholders’ transactions.3. it would be difficult for minority shareholders to gather the shares needed to take action. Almost 82 percent of shareholders. The SEA of 1992 and the listing rules also contain provisions for the protection of shareholders against transfer pricing. Banks would be obvious candidates to implement these mechanisms. While stimulating the growth of the sector. the only group of shareholders that can exercise rights is the top five shareholders. however. In theory. Written law and its enforcement diverge partly because of a provision that shareholders who take action against erring directors must have at least 5 percent of the total number of shares. and insider trading. Only a small number of shareholders attended the latest AGSMs.248 Corporate Governance and Finance in East Asia. In practice. But the exercise of these rights requires even higher shareholding levels. they comprised only 8 percent of total shareholders. In effect. on average. II mechanisms in place: mandatory shareholder approval of major transactions and interested or related party transactions. and call an extraordinary session. . minority shareholders may also appoint an outside inspector to examine the company’s operations and financial condition. did not vote in previous AGSMs. such protection has been insufficient. given their importance in providing finance and their stake in companies. takeover of the company. But with the ownership concentration of Thai companies. These problems appear to be partly a result of the relaxation of the rules and regulations in the original Public Limited Company Act of 1978. representing only about 28 percent of shareholdings. 66 percent of total outstanding shares.3 External Control Control by Creditors The fact that insider control in Thai companies is very strong should compel a search for alternative external control and monitoring mechanisms. Although the attendees held. On paper. 4. the new Public Company Act of 1992 inadvertently weakened the governance of public companies by diminishing minority shareholder rights. The ADB survey results reveal that the proposals presented by management were rarely rejected during the general meetings. minority shareholders are assured adequate legal protection. Vol. The difficulty minority shareholders have in exercising their rights can be seen from the ADB survey results.
Under a weak bankruptcy system. while loans for fixed investment were also more likely to be supported by collateral. Seven of the companies responding to the ADB survey indicated that all their creditors required collateral. such as that seen in Thailand before the crisis. One tempering mechanism that could inhibit the excessive use of borrowing is the threat of losing control in the event of bankruptcy. Normally. as the ADB survey confirmed. when insiders want to expand their company’s operations without losing control. borrowers seldom lose control to creditors even when they default and become insolvent.Chapter 4: Thailand 249 Historically. Apparently. Only three companies thought otherwise. The old bankruptcy law in Thailand also made it difficult for creditors to obtain payment against bankrupt borrowers. Actual bankruptcy proceedings took more than five years on average. Debtors had many handles to stall the bankruptcy process. The impact of the financial crisis on credit eligibility and supervision requirements has been significant. Thailand has relied on commercial banks and finance companies to channel funds to private enterprises. which could cause a delay by at least a year. Most companies reported that banks were more likely to require collateral. a company’s reputation and its long-term relationship with creditors sufficed in many instances. the majority believed that creditors had little influence on company management and decision making. however. Only 28 of the responding companies in the ADB survey indicated that their creditors required such feasibility studies. Fifteen of the 20 companies that had to renegotiate loan repayment with creditors in the last five years did so after the crisis. other than losing control. However. Among 16 companies in the ADB survey whose loan applications in the last three years were rejected. In the end. while 18 said none of their creditors required collateral. For 20 of the 46 responding companies. including procedural disputes. 17 indicated that only some of their creditors had such a requirement. There were many options. to solve debt repayment problems. they resort to borrowing. Eleven companies stated that creditors usually exercised whatever influence they had on management through covenants regarding the use of loans. 11 experienced rejection after the crisis started. . creditors’ collateral requirements were tightened after the crisis. creditors do not always require project feasibility studies or business plans in granting loans. Leverage allows the assets and operations of the company to grow without diluting corporate control. The presence of collateral usually diminishes banks’ incentives for screening project feasibility and monitoring project implementation.
before the extent to which the bankruptcy framework has been strengthened becomes clear. The company has 21 days to evaluate the tender offer and submit a report to SEC and all shareholders. the minimum tender offer was reduced to 10 percent and some procedural modifications have also been introduced. The second category is the tender offer.9). The dearth of tender offers before the crisis suggests that the Thai capital market did not offer a venue for imposing market discipline on corporate management. of shareholders: (i) all shareholders must receive tender offers.250 Corporate Governance and Finance in East Asia. According to the SEA of 1992. Since the introduction of the Public Limited Company Act of 1978. however. a person who acquires more than 5 percent of issued shares must file a report with SEC one day after the date of acquisition. The situation remained sluggish in 1997 at nine tender offers and a further decline in total offered value. The Market for Corporate Control The SEA of 1992 was the first legislation that stipulated rules and regulations regarding the market for corporate control. II The financial crisis has presented a unique opportunity for reinventing the framework for corporate bankruptcy and for creating regulatory and judicial precedents. In 1996. with a significantly lower total tender offer value of B8. SEC was later made responsible for regulating corporate takeovers. and failed to provide managers with strong incentives to perform efficiently. The first category is the acquisition of shares in the open market. Recently. only a limited number of successful mergers of public companies have taken place. its main role is to ensure transparency and fairness. which is a general offer made to shareholders of a company to acquire at least 25 percent of outstanding shares. Although merger and acquisi- .3 billion. there were 41 cases of tender offers.3 billion (Table 4. with a total tender offer value of B42. Vol. In this case. It will take years. there were only six tender offers. Such efforts would serve to strengthen external discipline on controlling owners. whether directly or indirectly. there are two categories of merger and acquisition activities with associated regulatory measures. and (iii) tender offers will be effective 30 days after the report has been filed with the SEC. (ii) an advertisement regarding the tender offer must be placed in major newspapers for at least three consecutive days. The market for corporate control has not been active in Thailand. In 1994 and 1995. if the purchase of shares implies a change in the directors or business activities. There are detailed requirements regarding such notification. SEC has no authority to either approve or reject tender offers.
Because of the current crisis. tion activities increased after 1997.7 11. Even when companies offer ESOPs. Twenty-nine firms indicated that employees held shares of their companies.0 55.9 3. Employee Participation in Corporate Governance There has been little.7 Purchase Value Number of % of Tender Offer Value Companies 84.0 B billion 4.Chapter 4: Thailand 251 Table 4.8 8 27 14 6 9 13 23 Tender offer value refers to the minimum offer value. but the average shareholding is smaller than 1 percent of total outstanding shares.8 81. Provident funds for government workers and workers in public enterprises have been established only recently.6 17. employees are even less willing to accept common shares as a form of compensation or benefit. Pension funds are perhaps even weaker in Thailand. not with a view to becoming involved in actual management.1 84.1 75.3 60. employees regard the plans as monetary incentives.1 58.3 6.9 Merger and Acquisition Activities. but employees have never been represented in the board of directors since their shareholdings are minimal. trading by mutual funds in SET represented less than 10 percent of total trading. While the Thai mutual fund industry compares well to those in other developing countries in the region.5 6. . 1993-1999 Year 1993 1994 1995 1996 1997 1998 1999 a Tender Offer Valuea (B billion) 5. The number of domestic institutional investors rose after the mutual fund industry was established in 1991. Since 1994. they have mostly been concerned with short-term gains. employee participation in corporate governance in Thailand.2 6.2 7.3 11.2 8.4 23.2 6. Source: Securities and Exchange Commission of Thailand. But instead of opting for an active role in the market for corporate control. it remains small. if any. Eleven of the 46 responding companies in the ADB survey offer ESOPs.1 19. most of these were forced mergers or related to rescue packages. Few companies offer employee stock option plans (ESOPs).
15 of which were domestic banks.325.0 8. II 4. Thai Bond Dealing Centre.0 SET Market Capitalization 1.4 1.4 Year 1992 1993 1994 1995 1996 1997 1998 1999 Source: Stock Exchange of Thailand.3 5.775.430.6 1.564.372.5 trillion.4 519. Bangkok Bank Ltd. The total values of loans from financial institutions and commercial banks were consistently larger than the market capitalization of SET.268.2 262.0 3.8 941.5 4. total assets of commercial banks amounted to B5.1 6. The bond market played only a marginal role in corporate financing. .5 5.10) shows that Thailand is a highly bank-dependent economy.0 339.1 5.3 1.906. and Bank of Thailand.5 6.133.485. Vol.477.912. the next four largest banks accounted for 63 percent.825.8 3.171. accounted for 28 percent of the banking sector’s total assets.4 3. Competition from foreign banks was limited as they were not allowed to engage in full branch operations.4 220.127.116.119.161. The share of domestic banks in the banking system’s total assets was 80 percent.6 6. Many large commercial banks had affiliates among the 93 finance companies that served the high-risk market.0 424.4.5 Outstanding Loans from Commercial Banks 2.663.390. although its role increased in the wake of the crisis.669.1 3.4 4. The Banking System Until recently.360.6 2. In 1996.300.119. 1992-1999 (B billion) Outstanding Loans from All Financial Institutions 2.252 Corporate Governance and Finance in East Asia.10 Size and Composition of the Thai Financial Sector.3 546..037. the banking sector was highly concentrated.1 7.1 Corporate Financing Overview of the Financial Sector A breakdown of the Thai financial sector for the period 1992-1999 (Table 4.5 4.1 3. there were 29 commercial banks.1 Domestic Debt Securities Outstanding 215.9 2. Table 4. The country’s largest bank.2 2.559.
Some 347 companies were listed in the same year with a total market capitalization of B3. Despite the worldwide market crash in 1987. Banks under the BIBF scheme were allowed to mobilize funds from abroad and lend to Thai companies in foreign currency. The Equity Market During the first few years of its operations. Benefiting from rapid economic and industrial growth. Licenses were granted to 15 Thai banks.8 in 1998. SET immediately recovered due to the strength of the Thai economy. was set up by 74 members with an initial capital of B500 million. BIBF banks also enjoyed tax incentives on their operations and profits.2 trillion. In the following years. Turnover value reached B2. banking.3 trillion. Stock prices tripled in the next three years until the market experienced its first crash as a result of the Gulf Crisis in 1990. reaching 355. The number of listed companies also quadrupled between 1981 and 1993. the Government established the BIBF to expand the banking sector and reduce the borrowing costs of Thai companies. Easy access to commercial bank loans by family business groups. 12 existing foreign banks. Many company founders did not want to release even a small portion of corporate ownership and refused to go public. The Government removed controls on capital and dividend repatriation in 1991. finance. the stock market entered its first boom period in 1986. the market rose steadily and reached a record high in the fourth quarter of 1993. and property have accounted for the bulk of trading volumes. and almost all capital account transactions were deregulated. Banking activity peaked in the mid-1990s. due to their close ties. an over-the-counter market. hardly any progress was made in lowering the cost of domestic financial intermediation or in developing new financial instruments for corporations. In 1993. and 20 new foreign banks. owning 70 percent of the country’s second largest bank. the liberalization of interest rates and capital account transactions stimulated a credit expansion through short-term borrowings in foreign currency. In 1995. BSDC is a nonprofit. also made it unattractive to raise capital from the equity market. SET is organized into 32 major industries. the SET index declined. SET was not very active. self-regulatory organization under the .Chapter 4: Thailand 253 The Government was also a major figure in the banking system. After that. The lack of supply of quality shares was a big problem for SET at that time. the Bangkok Stock Dealing Center (BSDC). Through the years. In contrast. Because borrowers carried the exchange rate risk.
5 percent and collectively owning at least 30 percent of paidup capital. the BSDC was dissolved in 1999. Authorized companies were those with a minimum of 200 shareholders owning collectively at least 25 percent of paid-up capital. approved by SET. so now only listed companies are traded in SET. Listed companies were those that had (i) paid-up capital of at least B20 million. but dropped the following year to B122 million. Before 1993. securities deposit center. Its main role is to serve as a secondary market for unlisted companies trying to raise capital. The SEA of 1992 installed the legal and regulatory framework for Thai capital markets. The primary market is supervised by SEC. It separated the primary and secondary markets to promote more flexible and effective supervision of both. In 1998. Vol. In 1996. Turnover value was B1. however. SET. The company should then appoint a financial adviser. securities can be traded in the secondary markets.254 Corporate Governance and Finance in East Asia. Only one security was listed in BSDC in 1995 and two more in 1996. among other functions approved by SEC. The allocation procedure is nondiscretionary. Company applicants must have an established history of operating under substantially the same management. with each facing different listing requirements. . According to the SEA of 1992. each holding no more than 0. and (ii) a minimum of 300 shareholders. lottery drawing must be used to ensure fairness. If approved by SEC and the SET Board of Governors. there were two kinds of companies in SET—“listed” and “authorized” companies. II jurisdiction of SEC. which has a legal mandate to examine a company’s financial status and operations before allowing it to issue securities to the public. The listing application should be submitted concurrently to SEC and SET. stock trading can commence within five days. financial projections. turnover value was negligible and the BSDC Index remained flat throughout 19961998. to assist in the public offering process. and securities registrar. Proposed changes in capital must be submitted for approval to SET accompanied by a detailed memorandum outlining the use of proceeds. Consequently. which consist of SET and BSDC. also acts as a clearinghouse. In July 1990. If the issue is oversubscribed. SET’s primary functions are to serve as a center for the trading of listed securities and to provide the essential systems needed to facilitate securities trading. After initial public offerings.8 billion in 1996. SET established new requirements for initial public offerings. A company wishing to qualify for listing in SET must file an information booklet (prospectus) with SEC and SET. the two classifications were merged. and pro forma balance sheet and income statements.
In 1996. However. the Bank of Thailand assumed responsibility for regulating the bond market. The proportion of domestic convertible debt instruments increased until 1995. Beginning 1961. The Thai bond market was also smaller than that of Malaysia (56 percent of GDP) and the Philippines (39 percent of GDP) in that year. To gain some perspective of the size of the bond market in Thailand. Companies generally issued short-term debt instruments like promissory notes or bills of exchange. the market for these bonds has been slow owing to the change in the Government’s original policy of requiring the use of state-guaranteed bonds as legal reserves.11). at about 11 percent of the total value of outstanding loans extended by commercial banks and 20 percent of total equity market capitalization. it represented only 9 percent of GDP. Investors had limited knowledge of debt instruments. and the Government did not issue new bonds during 1990-1997. compared to 110 percent in the US and 74 percent in Japan in the same year. The bond market in Thailand started in 1933.Chapter 4: Thailand 255 The Bond Market The Thai bond market has played a marginal role in corporate financing until recently. Upon its founding in 1942. the first bond rating agency in Thailand. the year the Ministry of Finance first issued government bonds to finance infrastructure projects and economic development. while secured debt instruments accounted for just above 10 percent. which encouraged limited companies and public companies to issue debt instruments. The recent financial crisis. A turning point of the corporate debt market was the enactment of the SEA of 1992. was also instrumental to the growth of the corporate debt market. . The corporate sector played a limited role in the bond market in the early years because of the complicated rules and regulations in effect at that time. the Government issued more bonds to finance industrial development projects and perennial deficits. led to the renewed issuance of Government bonds to finance the resurgent budget deficit and support cash-strapped financial institutions. A breakdown of domestic offerings of corporate debt securities from 1992 to 1996 shows that unsecured debts accounted for about 60 percent. however. Four years after the passage of the SEA. The budget surpluses of the 1990s eliminated the need for new bond issuance. State-owned enterprises became active issuers of bonds since 1993 because the Government constrained their borrowings (Table 4.9 billion. it accounted for a small share of the entire financial sector. The Thai Rating Information Services. the size of the corporate debt market rose to B132. in 1994.
The decline in total domestic debt offerings in 1996 can be ascribed to the increase in offshore convertible debts.7 0.7 — — 40.6 — 0.3 — — 3. II Table 4.3 46.8 191.3 13.1 59. this had climbed to B200.5 — — 32.7 5. By 1995.1 12.0 17.1 107.3 6.5 138.2 45.0 0. Vol.7 132.1 — — — 29.3 22. The domestic debt market declined after 1994 because corporations could borrow offshore at lower costs.4 110.1 21.6 billion.4 7.9 329.5 55.3 — 14.9 30.3 8.4 — 26.1 141.0 5.3 3.3 50.5 43. 1992-1999 (B billion) Item Government Bonds Treasury Bills State Enterprise Bonds Guaranteed Nonguaranteed Other Government Bonds Corporate Bonds Domestic Secured Unsecured With Warrant Convertible Short-Term Offshore Secured Unsecured With Warrant Convertible Total 1992 1993 1994 1995 1996 1997 1998 1999 — — — — — — 400.1 55. turnover value had reached B51.5 37.8 31.8 Source: Securities and Exchange Commission of Thailand and the Thai Bond Dealing Centre.8 2.0 60.0 333.5 — — — — 1.9 20. BDC was established in November 1994 by 50 securities companies based on the provisions of the SEA of 1992.1 6.0 7.8 47. by the end of 1997.0 33. Total offshore debt offerings peaked in the run-up to the financial crisis.1 — — 6.7 90.3 29.11 Offerings of Debt Securities.7 0.2 43.7 5.1 121.4 — — — 1.2 28.6 19.5 billion.8 167.256 Corporate Governance and Finance in East Asia.5 — 39. a surge attributed to capital inflows encouraged by high returns on Thai bonds.1 315. total offshore debt offerings had plunged by 68 percent to a mere B28.4 billion.1 10.2 — — 50.8 55.3 46.4 57.6 — — 0.7 — — — — — 4. The club was considered the first organized secondary bond market in Thailand to serve as the wholesale market for debt securities.3 140. A sharp rise in unsecured offshore debt offerings can be noted all the way through 1996.1 8.0 — 5.1 289.2 2. The following year.7 7.1 61.0 281.0 — 5.0 — 26.9 37.5 — 0.9 0. the year the crisis unraveled and the baht was floated.0 27.7 821.9 40.2 89. However.4 49.5 10.4 — 9.0 86.5 5. then declined substantially in 1996 and 1997.7 — — — — — — — 77.0 26.7 95.2 57.7 538.7 28.9 5.9 37.1 41.5 — — — 3. .2 39.
the use of debentures remains minimal even though the trend was generally upward until the 1997 crisis. Turnover fell further to B72. Companies in construction and property development seemed unable to generate internal funds. In addition.1 billion in 1998. In the same year.2 billion as a result of the default of debentures due to the Asian crisis. Retained earnings accounted for about 30 percent of total equity financing. Thailand’s publicly listed companies rely mainly on loans from commercial banks and financial institutions to finance their growth. BDC was renamed “the Thai Bond Dealing Centre” following its status upgrade to a bond exchange. Longterm loans accounted for about 20 percent of total liabilities. The average for all industries was only 22 percent. Equity financing remains an important part of listed companies’ long-term financing. The overall trend is consistent with the decline in profitability observed in the analysis of corporate sector performance earlier.4. 4. overall asset quality and liquidity of listed Thai companies deteriorated throughout the period. For the construction industry. From 1990 to 1996.Chapter 4: Thailand 257 compared with investment in equities. they also had a relatively small proportion of equity and .2 Patterns of Corporate Financing An examination of financing patterns among Thai companies listed in SET shows that on the asset side. In any case. Construction and property development industries tended to have high proportions of long-term loans and debentures. a trend most apparent in the leap between 1991 and 1992. judging by their relatively low levels of retained earnings. steadily easing up between 1990 and 1996. The closure of 58 finance companies affected the BDC significantly since half of its members were suspended as a result. Across industries. and marketable securities holdings. listed companies experienced liquidity problems with declining reserves of cash and marketable securities during the period 1990 to 1996 (Table 4. these comprised 31 percent.12). At lower than 5 percent of total liabilities. The ratio of net working capital to total assets decreased from a peak of 31 percent in 1993 to 28 percent in 1996. significant variations can be noted. with equity levels remaining high despite an increase in debt. The proportion of accounts receivable also declined steadily. while for the property development industry. cash balances. In 1997. turnover value plummeted to B106. short-term loans accounted for more than 40 percent of total liabilities. these accounted for 33 percent of total liabilities. There was also little change in the trend in retained earnings within the seven-year period.
2 3.8 21.8 20.0 14.0 100.8 9.0 100.8 7.0 12.8 19.8 37. 1990-1996 (percent) Item All Years 1990 1991 1992 1993 1994 1995 1996 2.9 20. were highly leveraged.9 6.2 45.9 38.4 2.4 43.0 100.9 18.8 8.1 50.0 100.8 17.4 48.6 100.6 38.5 1.5 43.2 1.0 100.2 42.0 10.2 17.6 10.3 14.2 22.9 14.2 17.3 49.9 49. and low) also underscores that companies with high ownership concentration had high levels of long-term loans (Table 4.2 1.9 12. The level of total liabilities for the group characterized by high ownership concentration .8 46.9 2.6 50.8 10.9 16.1 7.9 17.6 36.3 2.7 18.9 14.6 0.2 15.9 50.6 22.3 1.7 17.3 48.0 100.1 13.2 43.0 6.8 35.0 7.6 2.1 17.9 10.9 14.2 34.7 50.7 36.2 2.0 100.3 1.0 100. Vol.13). medium.4 7.6 12.7 52.2 12.4 6.9 3.0 Assets Cash Marketable Securities Accounts Receivable Inventories Other Current Assets Total Current Assets Net Fixed Assets Other Assets Total Assets Liabilities and Equity Accounts Payable Short-Term Loans Other Current Liabilities Total Current Liabilities Long-Term Loans Debentures Other Liabilities Total Liabilities Capital Stock Paid-In Capital Retained Earnings Total Equity Total Liabilities and Equity Source: Pacific-Basin Capital Markets Database compiled by the University of Rhode Island.6 11.258 Corporate Governance and Finance in East Asia.6 14.7 1.2 16.8 3.5 1.7 7.6 8.6 0.5 37.8 25.4 49.0 1.8 14.6 0.3 38.2 16.2 17.7 0.9 14.9 0.0 13.2 2.5 9.0 100. II Table 4.6 15.9 43.8 6.0 15.2 2.6 51.3 34.9 17.1 36.9 15.4 8.4 49.3 6.1 2.6 100.9 40.3 12.6 0.5 1.5 14.3 50.7 16.6 21.2 1.1 5.9 14.5 0.7 16.0 100.3 14.8 1.2 35.0 48.2 17.3 18.9 6.0 100.3 17.5 9.12 Common-Size Statements for Companies Listed in SET.3 34.0 100.2 43. US.4 21.7 14.3 21.4 17.1 49.3 18.2 2.6 6.6 13.0 10. compared with the 44 percent general average.0 51.4 14.7 9. Printing and publishing companies had lower financial leverage than companies in other industries.0 100.1 18.0 2. The agribusiness industry relied more heavily on short-term loans at 56 percent of the industry’s total liabilities.3 25.4 17.6 18.8 37.5 11.7 15.8 9. Analysis of common-size statements by ownership concentration (based on the levels of top-five ownership concentration classified as high.0 100.8 34.
1 44.0 Source: Pacific-Basin Capital Markets Database compiled by the University of Rhode Island.9 50.6 2. was 53 percent of total assets compared with 49.8 37.5 21.3 1.8 13.2 11.0 14.5 13.0 100.6 100.Chapter 4: Thailand 259 Table 4.7 percent for medium ownership concentration companies and 49.13 Common-Size Statements of Public Companies by Ownership Concentration. US. common equity accounted for a smaller proportion of total assets (47 percent) than companies with lower ownership concentration.0 100.1 49.9 2.0 6.6 47.6 22.9 7.7 12. This is consistent with the observation that majority shareholders try to maintain their control by utilizing debt as a major source of funds. .5 11.0 6.4 37.9 21.5 18.9 0.0 41.2 45.0 Medium 2.4 50.4 1.3 16.4 18.0 19.4 35.4 3.6 0.9 100.1 18.9 36.3 1.3 8.4 49.2 22.7 17.2 0.5 100.4 13.0 Low 1. For the high ownership concentration group.9 16. 1990-1996 Degree of Ownership Concentration Item Assets Cash Marketable Securities Accounts Receivable Inventories Other Current Assets Total Current Assets Net Fixed Assets Other Assets Total Assets Liabilities and Equity Accounts Payable Short-Term Loans Other Current Liabilities Total Current Liabilities Long-Term Loans Debentures Other Liabilities Total Liabilities Capital Stock Paid-In Capital Retained Earnings Total Equity Total Liabilities and Equity High 2.3 35.6 9.0 16.6 15.3 100.2 8.2 14. Companies with medium ownership concentration tended to have a higher proportion of short-term loans.8 12.5 percent for low ownership concentration companies.4 7.0 7.1 53.8 13.6 14.1 36.7 19.
Short-term debt accounted for most of the increase. The financing patterns indicate that companies with high ownership concentration were more highly leveraged than companies with medium and low concentration.8 151.1 144.7 28.8 5.1 16. After the crisis. these firms more easily increased their leverage.7 66.0 28. Vol. US.9 63.7 34.1 in 1996.1 52.8 51. it would seem that firms with concentrated ownership and associated links to the banking system have easier access to debt financing.4 5.6 41.3 31.14 Financial Ratios of All Listed Firms.7 percent in 1996. An overall picture of SET-listed companies’ financing and investment patterns in the 1990s shows a steady rise in the use of financial leverage (Table 4. 1990-1996 Ratio Times Interest Earned Total Debt to Equity (%) Long-Term Debt to Equity (%) Total Debt-to-Assets (%) Long-Term Debt-to-Assets (%) Net Working Capital-to-Assets (%) Operating Capital-to-Assets (%) 1990 1991 1992 1993 1994 1995 1996 8. II Results from the ADB survey reveal that Thai companies preferred to use reserves and retained earnings as their first choice of financing.3 61.7 12.4 7.2 49. bond issues.9 7.1 64.14).9 14.2 68. Public companies relied more on short-term debt financing in the period before the financial crisis.4 12. thus rendering them more vulnerable.8 65. however.7 12. followed by bank loans.6 125.7 34. .0 50.4 44.7 11.3 Source: Estimated from the Pacific-Basin Capital Markets Database compiled by the University of Rhode Island.6 7.0 145. Such deterioration of financial positions during the period was a common feature of listed companies.7 5. Generally. The TIE ratio declined from its peak of 7.15.4 51.9 140. More important.260 Corporate Governance and Finance in East Asia.5 38. and rights issues. The direct relationship between the degree of leverage and the degree of ownership concentration is apparent in Table 4.1 31. especially from 1994 to 1996.2 35. While further detailed investigations are necessary.8 percent in 1990 to 52. As a result.1 16. minimization of transaction and interest costs.5 52.6 138.8 65. Table 4.1 31.0 25.1 23.9 51. was the headlong deterioration of firms’ ability to meet their interest payment obligations.7 in 1994 to 5. however. bond issues overtook loans from commercial banks as the second preference. the choice of financing is determined by the company’s liquidity considerations.1 44.4 139. The ratio of total debt to total assets increased from 50. and maintenance of the existing ownership structure.
however.4 percent to 46 percent during the same period. 1990-1996 Degree of Ownership Concentration Ratio Times Interest Earned Total Debt to Equity (%) Long-Term Debt to Equity (%) Total Debt-to-Assets (%) Long-Term Debt-to-Assets (%) Net Working Capital-to-Assets (%) Operating Capital-to-Assets (%) Low 6.5 126.5 percent of external debt in 1996 (Table 4. The composition and term-structure of this debt.5 4.5.0 64. the proportion of short-term debt increased from 15. This decline was accompanied. continued to slide from 1985 to 1997.16). The proportion of nondebt-creating capital flows.15 Financial Ratios of Listed Companies by Ownership Concentration.3 Source: Estimated from the Pacific-Basin Capital Markets Database compiled by the University of Rhode Island.4 27.8 Medium 7. The corporate sector contributed significantly to the crisis because of its rising levels of leverage.7 percent from 1991 to 1996.8 14. The proportion of external debt as a percentage of GDP consequently increased from 42.5 34. peaking in 1994 at 84 percent. unhedged foreign exchange liabilities.8 29. From only 34 percent in 1986. is even more telling.4 52.5 percent between 1985 and 1990 to 8.6 30. 4.8 percent in 1986 to 52 percent in 1995.2 percent in 1986 to 251.9 percent in 1997. and a preponderance of short-term debt liabilities.4 13. private debt accounted for 84. From 45 percent of total net capital movements in 1985.1 High 6.2 49. Their average annual growth rate declined from 28.6 11. Nonbank private debt increased from 27.4 63.1 The Corporate Sector during the Financial Crisis Impact of the Financial Crisis on the Corporate Sector The financial crisis came after a period of rapid growth in the Thai economy. debt-creating capital inflows rose to 65 percent in 1990. US. such as direct equity and portfolio investment.8 66.Chapter 4: Thailand 261 Table 4.5 148. by a remarkable growth in the proportion of debt-creating capital inflows in the wake of the development of the debt market and the establishment of the BIBF.8 49. Additionally. .8 28.3 42.2 124. on the other hand.
9 29.8 3.5 14.1 0.8 12.7 13.9 43.2 0.Table 4.8 3.0 3.9 10.6 Total 18.8 108.2 32.1 64.8 0.9 1.9 35.5 4.6 18.3 16.2 10.0 Long-Term Short-Term BIBF Commercial Bank Long-Term Short-Term 0.2 15.1 5.16 External Debt.1 95.6 1.9 11.7 109.2 0.4 15.0 8.7 2.1 22.9 7.3 2. 1986-1999 ($ billion) Private Nonbank Long-Term Short-Term 3.7 23.5 4.0 21.5 12.0 11.9 3.1 Source: Bank of Thailand.3 0.9 13.9 6.4 5.7 20.1 34.3 0.3 0.1 0.0 4.3 20.4 3.8 31.3 3.8 13.9 4.6 Government Year Long-Term Short-Term 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 12.4 18.3 3.7 0.1 0.3 37.5 16.9 6.2 0.3 0.3 0.7 1.3 0.6 — 0.3 7.6 7.9 100.9 3.6 52.4 2.0 11.1 0.5 12.4 10.9 5.2 2.3 0.9 1.1 23.8 10.9 31.2 2.7 24.5 1.1 12.3 — — — — — — — 6.1 2.9 10.0 6.9 0.2 14. .7 10.0 13.3 10.4 — — — — — — — 1.1 30.3 12.3 0.3 105.2 2.0 0.5 19.
Due in part to liquidity problems on the one hand. The severity of the impact of the crisis on the corporate sector was apparent from (i) the decline in the volume of public offerings. It hit a 10-year low in the second quarter of 1998.6 billion from the 1996 level of B201 billion. the number of newly registered companies dropped to a 10-year low in 1998. and (iii) bankruptcies. leaving domestic investors with large capital losses. Aside from the problem of NPLs. The ADB survey conducted for this study confirms this: 35 of the 46 respondents indicated that they took out foreign-denominated loans mostly from foreign banks. reaching 45 percent of total outstanding credit in December. Meanwhile. according to the Bank of Thailand. based on the three-month past due definition. At the end of 1994. The value of public offerings sank in 1997 to B56. from its peak in 1995. closures. the SET Index stood at 1. the numbers of bankruptcies and company closures reached all-time highs in 1998 (Table 4. If lending rates remained high. NPLs spiraled from 12 percent in the second quarter of 1997 to almost 40 percent in the third quarter of 1998.360. The proportion of NPLs as a percentage of outstanding loans demonstrates the liquidity problem experienced by the corporate sector. the index declined to 1. nonfinancial companies also experienced severe liquidity problems as a result of the baht’s devaluation. On average. Trading volume has since been thin. trading activity at SET had been on the downturn. Similarly. suggesting that serious investors have not returned to the market. large Thai companies had actively borrowed at low interest rates from foreign financial institutions. and drastic decline in the number and capital of newly registered companies. The effects of the crisis were felt across all industry sectors. After that. foreign currency-denominated debts constituted 55 percent of their total debt portfolio. (ii) the rise in the nonperforming loan (NPL) ratio and consequent tightening of credit even for viable firms.17). SET’s dismal performance is indicative of the extent of the setback suffered by the Thai capital market. exposing the companies to disaster when the baht started tumbling on 2 July 1997. the liquidity problems faced by the corporate sector are likely to continue for some time. Most of these foreign debts were not properly hedged. banks would be recording more of such NPLs. and poor business confidence on the other. With easy access to foreign funds. Foreign investors retreated from the market. outstanding credit also declined throughout the second half of 1998. .Chapter 4: Thailand 263 This shows that although banking and finance companies suffered most because of their short-term exposure.6 in December 1996.281 in December 1995 and to 831. Even before the crisis.
IMF required Thailand to meet a set of performance criteria and implement various restructuring measures.17 Number of Newly Registered and Bankrupted/Closed Companies.792 7.677 Bankrupted/Closed 2.134 31. But when assistance from other sources did not materialize.096 22. It also explains the higher dividend yield ratio.312 25.288 35.264 Corporate Governance and Finance in East Asia. The price-to-earnings (P/E) ratio deteriorated from 19.218 3. As part of the assistance package. A steady price decline over the past few years has dragged down the ratio of market price to book value. Ministry of Commerce.066 19.334 4.797 4.904 20.052 36.407 28.5 at the end of 1994 to 12 in 1996 and further to 6.409 6.201 24.095 14.2 billion for balance of payments support and buildup of the country’s reserves. 4.915 37.080 9.695 3.902 3.112 9. 1985-1999 Year 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 Newly Registered 10.5. the Thai Government was lukewarm to the idea of obtaining IMF assistance because of the requirements and conditions attached to the financial package.2 Responses to the Crisis Initially. Thailand. II Table 4.925 12.224 4. The IMF financial package was a credit facility of $17.933 25. . The first Letter of Intent was cosigned by the Minister of Finance and the Governor of the Bank of Thailand on 14 August 1997.307 4.410 37. The increase of the P/E ratio in 1998 was mostly a result of a decrease in earnings for most listed companies. the Government was left with no choice.410 5.105 4.6 in 1997.977 Source: Department of Commercial Registration.777 11. Vol.
loan provisioning. and if necessary. Securities. Strict loan classifications. drawn up with World Bank and ADB assistance. follow through with a civil or bankruptcy suit. Under the old bankruptcy laws. Regulatory Response by the Government The IMF program. Creditors could negotiate to reschedule debt repayments.Chapter 4: Thailand 265 The terms of the agreement required the Government to maintain tight monetary and fiscal policies. The Government required all remaining financial institutions to recapitalize and instituted closer monitoring measures to ensure full compliance with this requirement. Several changes in the banking and financial policy environment have been effected in line with the restructuring program. creditors seldom succeeded in obtaining payment against bankrupt borrowers. For example. also aimed at institutionalizing legal and regulatory reforms. The old law allowed only creditors to file bankruptcy suits. The Financial Sector Restructuring Authority was established in October 1997 to address the problems of 58 finance companies that were suspended in 1997. They could seek civil action through the courts and could also use criminal sanctions to enforce debt repayments. and income recognition were implemented. As it turned out. Many believed that the process was inefficient. increase profitability. and Credit Foncier Businesses. By invoking procedural loopholes. debtors could drag out the process for many years. There were many options for solving debt repayment problems. only two companies emerged intact from the suspension. In early 1998. and did not recognize debtor-initiated bankruptcy declarations. While no definition for “insolvency” could be found in the bankruptcy law. These include repeal of the Commercial Bank Act. and worked on revisions to the Secured Transaction Law. and the Act Regulating the Finance. and restore solvency. The assets of the other companies were liquidated by auctions. The Government also passed the Bankruptcy Act and Foreclosure Act Amendments. IMF relaxed these key conditions. however. it was widely interpreted as “having debts more than assets.” Creditors thus bore the burden of proving a debtor’s insolvency before the courts. The Bank of Thailand also improved banking standards. secured creditors had to obtain the court’s approval before starting proceedings . the Civil and Commercial Code. The core of the IMF conditionalities was the restructuring of the banking and financial sector to regain investor confidence.
Companies need . the main purpose of which is to assist in the rehabilitation process so that a company can repay its debt and still retain its assets while remaining in business. The reorganization process is successful if (i) the debts shall have been discharged. The original Bankruptcy Act dealt only with liquidation and composition. Under the old Bankruptcy Act. Chapter 11 is the main tool in restructuring bankrupted companies in the US. In 1999. a remedy beneficial to borrowers and creditors is made possible through a business reorganization that should improve the borrower’s debt position and ensure its continued operations. the company shall be declared bankrupt and liquidation of assets shall follow. and expensive process. If the process fails to revive the business. the amended law limits the rights of secured creditors. To make matters worse for creditors. In Thailand. The amendment added reorganization provisions to the Bankruptcy Act of 1940. and (iv) the debts shall have been settled within a five-year period. The amended legislation also includes voluntary bankruptcy as a new feature. For one. (iii) shareholders regain their legal rights. Foreign secured creditors had to go through the motions of establishing that their country of domicile granted Thai creditors similar rights. There are other potential problems. the National Assembly passed an amended Bankruptcy Act and approved the establishment of special bankruptcy courts. which means that a debtor could continue in business while the reorganization program was being implemented. Chapter 11 cases account for only 5 percent of bankruptcy suits in the US but consume 90 percent of the courts’ time. thereby allowing court-supervised corporate restructuring.266 Corporate Governance and Finance in East Asia. Vol. The model for Thailand’s amended bankruptcy law was the US Chapter 11. it covers only the court-supervised reorganization of distressed companies. (ii) management of the company reverts to the borrower. but it is a complicated. any new loan to a company extended after the creditor discovered the insolvency would not be eligible for repayment. creditors always had to contend with the threat of disruptions in a delinquent borrower’s business. the judges and court officers have yet to learn and master the new bankruptcy procedure. II for the recovery of debt through the realization of any collateral. The new law is designed to prevent bankruptcy due to temporary liquidity problems by allowing an insolvent debtor to file a reorganization plan with the court. time consuming. In effect. Enforcement of the new law is bound to be ponderous and lengthy. The amended law also introduced the concept of automatic stay. But more important.
The amendment also remedies the slow process of executing or disposing of assets in a public auction.” The Foreclosure Act Amendment was likewise passed in 2000. namely “liabilities exceed assets. The result. the test for insolvency still uses the balance sheet criterion. shall have the power to call the extraordinary general meeting. The proposed amendment also includes a provision for the company to reimburse minority shareholders for expenses related to calling such a meeting. after determining the legitimacy of the request. only tangible assets were the norm. the court. the Bankruptcy Amendment will just prolong the problems of nonviable borrowers. Consequently. There have been proposals to lower the minimum shareholdings required for a minority group to request the board of directors to call an extraordinary general meeting at any time. Procedural delays give borrowers an advantage because they can refuse to pay back their loans even though they can meet their obligations. The minimum shareholding requirement is too high for any individuals or groups of minority shareholders to take action against controlling shareholders. questions have been raised regarding the appropriateness of the 1992 Act. however. Under the new law. minority shareholders’ rights are not adequately protected. which aims to increase liquidity in the domestic economy by allowing businesses to use both tangible and intangible assets in securing credit.” as opposed to the more appropriate criterion of “ability to pay when the debt falls due. SEC also examined the possibility of an amendment to the Public Company Act of 1992.Chapter 4: Thailand 267 to solve the problems (e. The new foreclosure law cuts short the procedures required under the Civil and Commercial Code for petty or simple cases dealing with mortgage defaults: (i) submission by the drafting committee of a default judgment bill within a week. In the past. Minority shareholders also have to absorb the costs related to their actions because the 1992 Act does not allow them to be reimbursed by the company. corporate governance) that caused the bankruptcy in the first place. In case the board of directors does not comply. Without the necessary corporate restructuring. the 1992 Act relaxed some of the original restrictive rules and regulations to encourage public company registration.g. Most important. Still pending Parliament approval is the amendment to the Secured Transaction Law.. The amendment seeks to revise old rules and procedures that tended to delay foreclosure proceedings. Replacing the Public Limited Company Act of 1978. has not been satisfactory. . The proposed new law seeks to expand the type of assets that a borrower can use as collateral. and (ii) processing of default cases within four to six months of filing of a court claim.
The proposal clearly delineates duties of care and loyalty for directors of public companies. the controlling shareholders have the exclusive domain to appoint or exercise management. subject only to approval by the board of directors. minority shareholders are likely to be wary of increasing their equity without corresponding control mechanisms at their disposal. The 1992 Act also allows directors to engage in business activities that may directly or indirectly affect the company. vis-a-vis the minority shareholders. they face the prospect of being unable to compete for the scarce funds available in the equities market. Otherwise. The regulators are drafting a proposal to amend the provisions on related transactions. But because this is the assumption embedded in the regulation. who are also the managers. In the absence of such a stock market boom now. without cumulative voting. it will probably be expensive because of the higher risk that comes with weak accountability mechanisms. Where equity will come forward. This may be true in countries where publicly traded companies are widely held. In addition. Because of high ownership concentration. which. there are few provisions in the Act that deal with related or connected transactions that potentially reduce shareholders’ value. it permits directors. The only reason Thai investors placed their money in stock issues despite these legal cracks was the rapid increase in stock prices in the 1990s.. Vol. and determine voting results on virtually any matter. disrupts the company’s management and decision making. this is not so in publicly traded companies in Thailand.268 Corporate Governance and Finance in East Asia. The radically changed circumstances after 1997 offer the possibility that firms and their controlling shareholders will be under greater pressure to concede to the exercise of minority rights. with the approval of the board. The proposal for the amendment of the Public . in turn. claiming that it creates fragmentation in the board of directors. the main problem is overlooked. to borrow from the company without consideration to the fairness of the transaction or transparency of the approval process. The 1992 Act only prescribes—not requires—the use of the cumulative voting procedure. Consequently. Directors enjoy unusual protection under the 1992 Act in that they can be pardoned by shareholders in the annual general shareholders’ meeting for any violation of fiduciary duties. i. Most companies decide against cumulative voting. II Another issue is the assumption in the 1992 Act that there is a separation of ownership and control functions. The textbook separation between owners who sit in the company’s board and professional managers who run the company does not apply in Thailand.e. But as demonstrated. the dominance of controlling shareholders. However. minority shareholders have no chance of being represented in the board.
Cases for which negotiations were unsuccessful. However.147 cases (B1. Commercial banks initiated 74 percent of these cases.6 trillion) have agreed to cooperate with CDRAC’s restructuring process. As of November 2000. In response. will be settled by the courts. where bankruptcy procedures are swift and effective. In addition.068 cases involving B475 billion are undergoing restructuring. the number of cases has abated. Within three months. a Corporate Debt Restructuring Advisory Committee (CDRAC) was established in 1998 to map out debt restructuring measures in support of efficient negotiations between the private sector and financial institutions.767 cases involving outstanding credit of B2. personal consumption. although since then.764 debt restructuring cases involving B1. 322. and manufacturing sectors.1 trillion of outstanding credit. Another 77. Some 82 percent of these cases have been successfully restructured.1 trillion in outstanding credit. The reason is that bankruptcy law amendments appear to facilitate settlements outside the court.Chapter 4: Thailand 269 Company Act of 1992 includes a recommendation to require all public companies to use cumulative voting to ensure that the board of directors consists of representatives from all groups of shareholders. the court had more than 80 cases for disposition. CDRAC’s target debtors comprised 10. Corporate Debt Restructuring and Bankruptcy The 1997 crisis led to a severe liquidity problem in the economy. the mere threat of external control alters the incentives faced by managers and controlling shareholders significantly. as well as those that did not cooperate with CDRAC’s restructuring process. Equally important is the contribution of effective and reliable bankruptcy procedures for improved corporate governance. This point is crucial because compared with . accounting for B1. By October 2000. Another 5 percent of cases (B70 billion) are undergoing restructuring negotiations. and procedures for debt restructuring.8 trillion had been completed.6 trillion. In particular. accounting for B1. with the majority of the debtors coming from the commerce. the Government introduced debt restructuring-related measures to help resolve bad debts. only 7. Considerable progress has been achieved on this front. contributing to the unprecedented rise in the corporate sector’s bad debt. The first bankruptcy court in Thailand opened on 18 June 1999. methods. Reforms in bankruptcy procedures should be seen not only in the context of crisis resolution. The Bank of Thailand issued guidelines in 1998 encouraging financial institutions to specify their own policies.
The . Vol. Emphasis was on the structure of corporate governance and patterns of corporate ownership and financing of publicly listed companies. to push companies to harmonize their accounting with international standards. The exchange has already required that listed companies’ quarterly reports be directly comparable with annual statements.270 Corporate Governance and Finance in East Asia. and promoted key industries through incentives. Such improvements in disclosure standards are part of the efforts of SET and SEC. Conclusions. Examination of corporate ownership. a time span that includes the onset of financial liberalization—the turning point of Thai economic development in the last decade—and represents the decade preceding the Asian financial crisis of 1997.6 4. The economic development of Thailand took off with the implementation of a series of National Economic and Social Development Plans beginning with the first medium-term plan for 1961 to 1966. II Malaysia. and performance during this period helps understand the causes of the crisis.6. The study covers the period 1985 to 1996. 4. behavior. and Recommendations Summary and Conclusions This study has provided an overview of the corporate sector and governance in Thailand. the Government protected certain corporate sectors through tariffs and regulation. Thailand is coming from a situation where excessively high leverage became the norm because firms could obtain finance without having to concede a measure of control to outsiders. The banking industry played a key role in the early stages of economic development because it represented the only avenue for funding Thai corporations. Financial information from listed companies will also soon be required to conform to International Accounting Standards. Philippines. despite the weakness of their disciplinary powers. Reforms through SET and Improved Disclosure The financial crisis prompted SET to introduce a range of improvements to its operation and regulation. It required listed companies to establish their own audit committees by the end of 1999. For this reason.1 Summary. the Thai Government managed its economy with the corporate sector as the main engine of growth and development. and even Indonesia. Weak bankruptcy procedures were part and parcel of the perverse set of incentives that led firms to build up unsustainable levels of debt. In the next three decades.
On average. Thai companies were vulnerable to exchange rate risks. the increase in long-term debt more than compensated for the drop. One of the major findings is the high ownership concentration among Thai companies listed on SET. Consequently. . At the same time. Subsequently. During 1992-1997. The impact of the crisis was felt across all industries. Minority shareholders. This implies that the control of an average Thai company is typically in the hands of a few persons (founders or their associates) who own a majority of total outstanding shares. the number of listed companies in SET fell from 454 in 1996 to 392 in 1999. foreign debt in the Thai corporate sector increased continuously. One of the principal causes of the crisis was the excessive use of foreign debt by the corporate sector. the profitability of publicly listed companies abruptly declined and their financial leverage increased. After 1992.000 from the previous year’s level. Because most of these debts were not hedged. the numbers of bankruptcy cases and company closures reached alltime highs. the overall pattern of ownership concentration seems to have been stable for the past 10 years. Profitability increased throughout the 1980s but began to decline in the first half of the 1990s. The study examined the impact of ownership structure on corporate governance and financing patterns. Meanwhile. the overall corporate sector was seriously affected. The number of newly registered companies in 1997 dropped by almost 10. even after the development of capital markets.Chapter 4: Thailand 271 importance of bank financing continued throughout the 1990s. Although there was a decline in short-term foreign debt. At the onset of the 1997 financial crisis. In 1992. the top five largest shareholders hold about 56 percent of total outstanding shares. In 1995 and 1996. Nonbank private corporations accounted for most of the increase. The SEA of 1992 also marked the beginning of an active bond market in Thailand. Financial liberalization apparently encouraged companies to borrow overseas to finance investments that were not productively employed. Although there are some variations across industries. the corporate sector entered a new era with the enactment of two major pieces of legislation. the number and value of public offerings of securities accelerated. reaching its peak in 1996. at a time when most of them were already experiencing declining profits and high leverage. there was a marked increase in the number of public corporations. The financial performance of the corporate sector remained satisfactory up to the years before the outbreak of the financial crisis. the Public Company Act of 1992 and the SEA of 1992. the devaluation of the baht that began on 2 July 1997 affected the financial condition of Thai corporations.
Among the five largest shareholders of Thai companies listed on SET. With financial institutions playing limited roles in the capital market. An analysis of the corporate ownership structure in Thailand suggests that founders and management continue to own and control publicly listed Thai companies. through the use of holding and affiliated companies. commercial banks hold only about 2 percent of total outstanding shares while nonbank financial institutions hold about 6 percent.272 Corporate Governance and Finance in East Asia. foreign and domestic. the existing legal and regulatory framework suggests otherwise. Institutional investors in Thailand. are not active. II although larger in number. Recently. there is a clear lack of outside monitors for these publicly listed but family-controlled companies. All these. they have little influence over management decision making and control. The key laws. Thus. In the past. Most foreign institutional investors invest only on a short-term basis and aim for short-term trading profits. The investing public holds the rest of the outstanding shares. The absence of external market controls on the management of publicly listed corporations is dangerous. along with a highly concentrated ownership structure. hold only a small portion of total outstanding shares. Financial institutions hold a very small proportion. The highly concentrated ownership structure weakens the protection of minority shareholder rights. The rules in both Acts governing . Vol. These laws stipulate rules and regulations concerning the activities of all public companies. averaging 46 percent. the mutual fund industry has entered the picture but with limited roles and activities. the government pension fund was the only major institutional investor. The implications of ownership structures that are concentrated to such a high degree are serious. It remains to be seen how reforms in bankruptcy procedures—including the increased threat of creditor control—could shift the incentives of controlling shareholders toward greater acceptance of equity finance and its consequent accession of control to new shareholders. publicly listed and unlisted companies in Thailand are equally subject to the consequences of the risk-taking behavior of controlling owners. Consequently. holding companies and affiliated corporations hold the largest proportion at 27 percent of total outstanding shares. The Government holds about 1 percent of total outstanding shares but these holdings represent majority shares of a few companies. protect the interests of all shareholders of public companies. the Public Company Act of 1992 and the SEA of 1992. Nominally. Individuals and insiders hold the second largest proportion at about 19 percent. contribute to the lack of external controls on the corporate sector through the capital markets.
6. Consequently. but is significantly related to financing patterns. the Public Company Act of 1992 allows shareholders to act only when they hold a minimum proportion of shareholdings. Certain provisions. The ownership structure of Thai listed companies also significantly affects company behavior. . Rather. In view of this. because there is no separation between ownership and management. an aim that can be achieved mostly through legal reforms. The second issue involves the protection of shareholder rights. the main challenge is in protecting minority shareholders from the possibility of expropriation by the majority. before the crisis. Specifically. the high ownership concentration of many listed Thai companies inhibits the effectiveness of these provisions. However. 4. The third issue involves creating external market controls through better regulation and development of the capital markets. In this third area. It appears that founding family members use debt extensively to finance investments because they want to preserve control of their firms. these companies tend to become overleveraged. the main challenge is not how the board can control management to maximize shareholder value. moreover. making them vulnerable to economic shocks. a requirement impossible to meet due to the concentrated shareholdings of founding family members and management. because there are shared interests between the controlling shareholders and key management personnel. laws did not provide minority shareholders sufficient safeguards in cases of transactions involving companies where the controlling shareholders had related interests. Ownership concentration appears to have little impact on corporate profit performance. posed formidable barriers in the minority shareholders’ exercise of their rights. For instance. The first issue involves the development of a comprehensive supervisory framework and the strengthening of the capacity of supervisory agencies. the degree of ownership concentration has a statistically significant positive relationship to the degree of financial leverage. The Government has been moving to amend the Public Company Act of 1992 to increase minority shareholders’ protection in this regard.Chapter 4: Thailand 273 minority shareholders’ participation in decision making and in initiatives against management conform to international standards.2 Policy Recommendations There are three major policy issues and recommendations that could improve corporate governance in Thailand. For example. key reforms that will strengthen the regulation of financial institutions.
unified supervisory agency or a permanent regulatory division consisting of supervisory units from the three agencies. this is a problem in Thailand. three major government organizations (the Ministry of Commerce. If this were the situation. the supervisory system is fragmented and not as effective as it should be. Under the current system. the principal shareholder typically plays a key role in management and often serves as the chief executive officer. and after the enactment of the SEA in 1992. in 1975. In this setting. with control delegated to professional managers. It is important that the roles and responsibilities of each agency are clearly defined to the public. . SET was mandated to supervise listed companies. II encourage market competition. Consequently. voting only on major decisions.274 Corporate Governance and Finance in East Asia. Protection of Shareholder Rights The common assumption is that publicly traded corporations are widely dispersed in terms of ownership. activate the market for corporate control. The owners of a firm rely on a board of directors to supervise the managers. The Government must develop an overall framework for corporate sector supervision and redefine the regulatory jurisdiction of each agency along functional lines. he/she often has the decisive vote. the key issue in corporate governance would then be to ensure that managers act in the best interests of the shareholders. and increase the participation of institutional investors are imperative. Once the roles and responsibilities are clearly defined. SEC was established as another supervisory agency. the Ministry of Commerce had the sole supervisory responsibility. in most of Thailand’s publicly traded firms. Vol. There is also supposed to be separation of ownership and control. The board therefore plays a pivotal role. The best approach may entail establishing a single. Development of a Comprehensive Supervisory Framework There is a need for the Government to establish a comprehensive supervisory framework for the corporate sector. This is due to the historical development of the Thai corporate sector: before 1975. the supervisory agencies also need to be empowered to enforce the laws. Only then will these agencies be able to act promptly and effectively. SET. If the principal shareholder is in fact chair of the board. As in other crisis economies in the region. In reality. the key issue in corporate governance is how to prevent insiders from expropriating assets of minority shareholders. and SEC) are involved in corporate supervision.
Through an amendment in the Public Company Act. and a prohibition of connected transactions by directors or management. Current laws allow a high degree of ownership concentration and provide inadequate safeguards against possible conflict-of-interest transactions and their impact on minority shareholders. SEC is exploring the possibility of amending the law toward this direction.Chapter 4: Thailand 275 There is a need to recognize the unique ownership structure in Thailand and its effects on corporate investment and financing behavior. The Ministry of Commerce is conducting a study on proposed amendments to the Public Company Act of 1992. Since the Asian financial crisis. Some of the legal reforms under consideration concern settling conflictof-interest situations with significant effects on minority shareholders. accountability. This includes prescribing ways to empower minority shareholders without disrupting the company’s operations. the Government can change the shareholding limit for controlling shareholders. This move is expected to be unpopular among founding family members and original owners. The first recommendation involves the repeal of current legislation to allow minority shareholders to have greater influence over management decision making. There is also a need for legislation dealing with nominee or holding companies because they are the institutional means that founding family members use to maintain control. The slow improvement in the legal framework has likewise obstructed progress in this area. The Government does not have an effective way of monitoring the financial activities of these companies even as it is widely believed that a large amount of funds is being channeled through them. The second recommendation is to dilute ownership concentration through the use of regulatory power. The current ownership structure leads to ineffective corporate governance and inadequate protection of minority shareholders. regulators must increase transparency and step up enforcement. Both SET and SEC are taking an active stance in improving the transparency and efficiency of Thai capital markets. But weaknesses in accounting and auditing practices have been inhibiting the development of capital markets. SEC has been trying to lay the foundations of good corporate governance by espousing fairness. requiring cumulative voting for the election of directors. Because these holding companies control a number of large public companies in Thailand. they should be monitored and regulated. and . there has been much progress in this area. The situation prompts two specific recommendations. transparency. To ensure a level playing field. increasing penalties for directors engaged in misconduct.
The promotion of active roles for domestic institutional investors should also improve corporate governance in Thailand. while a strong domestic debt market will also offer protection from foreign exchange risk. The Bank of Thailand’s enforcement of prudent lending practices among Thai financial institutions. The same goes for improvements in the bankruptcy system. In the stock market. the power of the capital market to discipline inefficient management is almost nonexistent. However. Further. Because the financing of Thailand’s corporate sector is predominantly bank-based and will remain so for a long while yet. Capital Market Development and Regulation Another important issue concerns the development of capital markets. Vol. will lead to the emergence of a reference yield curve. There will be no incentive for companies to raise capital in the equities market if they can obtain funds at a lower cost elsewhere. it is important to explore reforms that can lead to the enhanced role of banks in monitoring enterprises. The variety of debt instruments available to the corporate sector and investors should be increased and longer-term sources of bond finance actively promoted. a well-developed secondary market will pave the way for market disciplinary forces to act against poorly managed companies. The first step is to establish an active secondary Government bond market.276 Corporate Governance and Finance in East Asia. especially in the area of connected lending. aimed at ensuring that banks finance only creditworthy projects. Thailand should develop a strong public debt market to supplement the banking system in financing corporate investments. . it will be difficult to improve corporate governance in Thailand. Accounting standards have also been under review. the SEC’s disposition toward a largely voluntary approach for adoption of these characteristics has resulted in uneven compliance among public companies. In an environment of highly concentrated ownership. which. there is a need to increase market disciplinary power through market competition. will incidentally close off easy sources of finance for companies that have been practicing regulatory arbitrage. One way the Government can improve the current situation is to require publicly listed companies to trade a higher proportion of outstanding shares in the secondary market. II responsibility among companies. for instance. A well-developed domestic debt market will provide corporations with an alternative to bank financing. in turn. Without a strong and efficient capital market. This may not be possible without reforms in the banking sector itself.
The Thai Bond Dealing Centre. Department of Commercial Registration Database. 1998. Bank of Thailand. Bank of Thailand Quarterly Bulletin. Fact Book. Kingston. 1995-1999. 1997. The University of Rhode Island. The Securities and Exchange Commission of Thailand. Ministry of Commerce. Key Capital Market Statistics. The Stock Market in Thailand. PACAP-Thailand Database. Bank of Thailand Monthly Bulletin.Chapter 4: Thailand 277 References Annual Report. 1995-1999. 1997. 1997-1999. US. The Securities and Exchange Commission of Thailand. Thailand. . The Stock Exchange of Thailand. The Stock Exchange of Thailand. 1995. The Stock Exchange of Thailand. Thai Accounting Standards. Pacific-Basin Capital Markets Research Center. Bond Market Development in Thailand. 1995-1999. Bank of Thailand.
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