This action might not be possible to undo. Are you sure you want to continue?
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
3 Subsidiaries of the 30 Largest Chaebols Table 2. 1990-1998 Table 1. 1997 Table 1. 1992-1999 Table 1. 1992-1997 Table 1.11 CharacteristicsoftheBoardofCommissioners Table 1. 1993-1999 Table 1.21 Nonperforming Loans by Type of Bank. 1992-1995 Table 1. 1992-1998 Table 2.5 Financial Performance of Publicly Listed Companies by Sector. 1992-1997 Table 1. 1986-1996 Table 1.6 GrowthandFinancialPerformanceofState-Owned Companies.15 V alue of Stocks Issued and Stock Market Capitalization.20 ROE of the Banking Sector. Republic of Korea Table 2. 1996-1998 2. 1992-1999 Table 1.1 Listed Firms with Positive Economic V alueAdded.4 Growth Performance of Publicly Listed Companies by Sector.14 Banking Sector Outstanding Loans.13 Presence of Board Committees in Listed Companies Table 1.9 OwnershipConcentrationofPubliclyListedCompanies by Sector.4 Development of the Stock Market. 1996-1998 Table 1.2 Foreign Capital Flows.8 OwnershipConcentrationofPubliclyListedCompanies.vi List of Tables 1. 1993-1997 Table 1. 1992-1997 Table 1.10 Anatomy of the Top 300 Indonesian Conglomerates. 1990-1997 Table 1.16 FinancingPatternsofPubliclyListedNonfinancial Companies.1 Growth of the Banking Sector.18 GDP Growth by Sector.17 DER of Listed Companies by Degree of Ownership Concentration 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 .7 Growth Performance of the Top 300 Conglomerates.19 DER and ROE of Publicly Listed Companies by Sector. Indonesia Table 1. 1996-1999 Table 1. 1992-1997 Table 1. 1988-1996 Table 1.3 GrowthandFinancialPerformanceofPubliclyListed Companies.2 KeyMacroeconomicIndicators Table 2.12 CharacteristicsoftheBoardofDirectors Table 1.
24 Table 2.26 Table 2.28 Table 2. 1988-1997 Ownership Composition of Listed Nonfinancial Firms by Industry.27 Table 2.13 Table 2. 1995-1997 Ownership Composition of Listed Companies.22 Table 2.17 Table 2.25 Table 2. 1990-1997 InternationalComparisonofRatiosofOrdinaryIncome toSalesinManufacturing GrowthandFinancialPerformanceofSelectedIndustries GrowthandFinancialPerformanceofListedCompanies. 1987-1997 FlowofFundsoftheNonfinancialCorporateSector.15 Table 2. 1997 Ownership Composition of Listed Nonfinancial Firms by Control Type.12 Table 2. 1988-1997 OwnershipConcentrationofListedNonfinancialFirms by Industry.vii Table 2.8 Table 2. 1988-1997 FinancingPatternsoftheNonfinancialCorporateSectorby Industry Financing Patterns of Listed Companies.29 Table 2. 1985-1998 GrowthandFinancialPerformanceoftheNonfinancial Corporate Sector. 1994-1998 Financing Patterns of the Top 30 Chaebols. 1997 OwnershipConcentrationofListedNonfinancialFirms by Firm Size.23 Table 2. 1993-1997 The Top 30 Chaebols Debt-to-Equity Ratio.16 Table 2.9 Table 2. 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 .11 Table 2.10 Table 2.7 Table 2. 1988-1997 Features of the 30 Largest Chaebols GrowthandFinancialPerformanceofthe30Largest Chaebols. 1985-1997 GrowthandFinancialPerformanceofListedCompanies by Size.19 Table 2. 1994-1997 Cross-Payment Guarantees of the Top 30Chaebols. 1988-1997 FinancingPatternsoftheNonfinancialCorporateSector.6 Table 2. 1992-1997 OwnershipConcentrationofListedNonfinancialFirms.14 Table 2. 1999 InternalShareholdingsofthe30Largest Chaebols.18 Table 2. 1988-1997 Ownership Concentration of the Survey Sample of 81 Listed Firms.30 Private Capital Flows to Korea. 1997 Ownership Concentration ofAll Listed Firms.5 Table 2. 1997 Ownership Composition of Listed Firms in Selected Countries.20 Table 2.21 Table 2. 1990 and 1997 Ownership Composition of Listed Nonfinancial Firms by Size.
5 GrowthandFinancialPerformanceoftheCorporateSector by Control Structure. 1989-1997 Table 3. The Philippines Table 3. 1989-1997 Table 3.7 GrowthandFinancialPerformanceoftheCorporateSector by Industry. 1989-1997 Table 3.2 Public Offerings of Securities.19 Financing Patterns by Firm Size.9 OwnershipConcentrationatCriticalLevelsofControl Over Publicly Listed Companies. 1992-1996 Table 3.14 Philippine Stock Market Performance. 1989-1997 Table 3. 1997 Table 3.13 ADB Survey Results on Shareholder Rights Table 3. 1997 Table 3. 1997 Table 3. 1988-1997 Table 3.3 TheCorporateSectorandGrossDomesticProduct.21 OwnershipConcentration. Leverage Table 3.20 Financing Patterns by Industry.31 Table 2.6 GrowthandFinancialPerformanceoftheCorporateSector by Firm Size.32 Table 2.10 Composition of Top Five Shareholders of Philippine Publicly Listed Companies by Sector. 1978-2000 Table 4. andAffiliated Banks of Selected Business Groups.17 Composition ofAssets and Financing of the Publicly Listed Sector.1 GDP Growth of SoutheastAsian Countries. 1990-1999 Table 3.000 Companies. 1988-1997 Table 3. 1988-1997 Table 3. 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. 1992-1999 .viii Table 2.22 Foreign Investment Flows.15 Financing Patterns of the Corporate Sector.16 CorporateFinancing PatternsbyOwnershipType. 1997 Table 3.Profitability andFinancial . 1988-1997 Table 3.1 Public Companies Registered.18 Financing Patterns by Control Structure.33 Net Profit Margins of Chaebols. 1983-1997 Table 3.11 TotalandPerCompanySales. Thailand Table 4. Flagship Company. 1985-1997 Number of Firms with Dishonored Checks.1989-1997 Table 3. 1995-1998 4. 1988-1997 Table 3.4 GrowthandFinancialPerformanceoftheCorporateSector by Ownership Type.2 Growth and Financial Performance of the Top 1. 1986-1998 Nonperforming Loans of General Banks. 1988-1997 Table 3.8 Ownership Composition of Philippine Publicly Listed Companies by Sector.12 Control Structure of the Top 50 Corporate Entities.SectorOrientation. 1997 Table 3.
1992-1999 Offerings of Debt Securities.6 Table 4.14 Table 4.5 Table 4. 1990-1996 External Debt.12 Table 4.ix Table 4.9 Table 4. 1993-1999 Size and Composition of the Thai Financial Sector.1 Figure 3. 1985-1999 237 238 239 241 242 243 251 252 256 258 259 260 261 262 264 List of Figures Figure 1.2 TheSuhartoGroup TypicalInternalOrganizationalStructureofaPublicly Listed Company in Indonesia CorporateControlStructure:TheCaseofAyalaCorporation CorporateControlStructure:theCaseofLopezGroup 24 25 195 197 . and Company Size Top-Five Shareholder Composition of Publicly Listed Companies in Thailand. 1986-1999 NumberofNewlyRegisteredandBankrupted/Closed Companies.11 Table 4.4 Table 4. 1990-1996 Financial Ratios of All Listed Firms.16 Table 4.7 Table 4. 1993-1999 Key Financial Ratios of Publicly Listed Companies.2 Figure 3.13 Table 4.8 Table 4.1 Figure 1. Leverage. 1985-1996 Top-Five Ownership Concentration of Publicly Listed Companies in Thailand.10 Table 4. Ownership Concentration.17 StatisticalHighlightsoftheStockExchangeofThailand. 1990-1996 Common-Size Statements of Public Companies by Ownership Concentration. 1990-1998 StatisticalRelationshipsbetweenCorporateProfitability. 1985-1996 Average Key Financial Ratios by Company Size. 1992-1999 Common-Size Statements for Companies Listed in SET. 1990-1996 Financial Ratios of Listed Companies by Ownership Concentration.15 Table 4.3 Table 4. 1990-1998 Merger and Acquisition Activities.
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.
how it has affected corporate financial performance and financing. Section 1. particularly those with large foreign loans. Foreign debt reached more than $100 billion. regulatory framework. In this setup. However. These banks were allowed to operate even if they violated minimum capital adequacy requirements. except utilities.2 Corporate Governance and Finance in East Asia. these controlling families had political connections that allowed their companies to enjoy special privileges. It analyzes the weaknesses of corporate governance in Indonesia.5 percent.3 looks at patterns of corporate ownership and control. posted negative growth. This study reviews the Indonesian corporate sector’s historical development. Section 1. 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. 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. were the ones most affected. Foreign creditors. the controlling families of corporate groups often established banks to provide funds to affiliated nonfinancial companies. the currency composition and term structure of corporate foreign indebtedness were causes for concern. the Indonesian economy seemed to be in generally good shape.5 percent. On the other hand. Economic growth reached more than 7 percent per year and the inflation rate was kept at single digit levels. this left the Indonesian economy extremely vulnerable. To facilitate even easier access to credit. patterns of financing. and . and how it contributed to the crisis. contracting by 36. The scale of the financial crisis exposed weaknesses of the country’s corporate sector. In many instances. placed a high premium on these political connections in assessing the chances of being repaid. The study also identifies family-based companies and corporate groups. and responses to the financial crisis. short-term loans were used to finance long-term investments. or Thailand.2 presents an overview of the Indonesian corporate sector. The construction sector was the worst hit.6 percent) and trade (-18 percent). All sectors. followed by finance (-26. Malaysia. These were already contributing to high levels of nonperforming loans (NPLs) in the Indonesian banking sector several years before the 1997 crisis erupted. no doubt. Vol. highly leveraged companies. II rate reached 58. When the crisis hit the country. and analyzes their importance to the corporate sector in Indonesia. patterns of ownership and control. 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.
the windfall from oil and gas revenues was an important factor that allowed the Government to promote industrial development via import substitution. 1. Despite the oil revenues. Not all items in the questionnaires were answered by the respondents. Up until the mid-1960s.2. This section reports the results of an Asian Development Bank (ADB) survey on corporate management and control practices in Indonesian publicly listed companies. substantial volumes of private investment entered the scene. 2 Survey questionnaires were sent to 280 companies listed in the Jakarta Stock Exchange. Section 1. and tobacco industries. how it was affected by the crisis.Chapter 1: Indonesia 3 profiles the corporate sector’s governance characteristics.and large-scale companies were dominated by state-run industrial concerns. Subsequently.5 examines the corporate sector during the financial crisis in terms of its role. textiles. With the relatively liberal laws governing foreign and domestic private investments introduced by the New Order Government in 1967 and 1968. The industries that emerged were highly import-dependent and reliant on tariff protection. a gradual shift in public investment away from manufacturing took place.2 Section 1. while Chinese and indigenous entrepreneurs ran some large businesses in trading. In the early 1970s. Section 1. The Government became directly involved in industry as a result of the nationalization of Dutchowned shipping firms and oil companies. However. It also examines the statistical relationship between corporate performance and corporate governance characteristics.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. and its response. .4 analyzes corporate financing patterns. only 40 companies replied—39 are private companies and one state-owned company (Bank BNI).6 summarizes the major findings of the study and suggests recommendations to improve governance in the Indonesian corporate sector. medium.2 1. in the course of the fight for nationhood from 1942 to 1950.
produced consumer goods. Vol. 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. In 1992. II the currency needed to be devalued periodically under a managed floating exchange rate system to avoid large current account deficits.4 Corporate Governance and Finance in East Asia. Last. and employed the bulk of the industrial labor force. Second. By 1987. During this period. These were families with strong links to the political elite of the New Order. Partly as a result of various government policies. which dominated their respective sectoral outputs and markets.2 The Capital Market The Government reactivated the stock exchange in 1977. there were also many rapidly growing large-scale companies and business groups or conglomerates. and related products) had shares in total exports that were rapidly increasing. potentially subjects companies to greater regulatory scrutiny. 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). Third. the Indonesian industrial sector was quite diverse. the number of firms quoted in the stock market was only 24. the dilution of corporate ownership. the Government shifted its industrial policy toward the promotion of labor-intensive exports. even when new shareholders do not threaten the control exercised by the original owners. Export credits with low interest rates were granted to industries that were intensive in the use of local labor and raw materials.2. 1. A number of underwriters emerged. But until the end of 1988. In the 1980s. 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. Regulations in the banking sector led to equities having higher risk but lower returns than bank deposits. wood. exports of nonoil products (particularly textiles and footwear. The equity market remained largely unappealing due to a number of factors. But these proved counterproductive because they limited the potential for capital gains to prospective investors. mostly nonbank financial institutions and stockbrokers. While most of the companies were small. the stock exchange was also unattractive to companies trying to raise capital as they could borrow from state banks at very low interest rates. Generally speaking. First. a distinct industrial elite started to emerge.
the banking sector has undergone many reforms. priority credits still enjoyed subsidized interest rates and funding from the Central Bank. more significant reforms were introduced. The initial banking sector reform was introduced in 1983. The Government also allowed foreign investors to buy up to 49 percent of listed shares. with a total value of more than Rp8 trillion. However. the controlling shareholder of these SOCs is still the State. the legal infrastructure that was supposed to guide the evolution of the banking sector was not backed by effective enforcement.1 shows that from 1994 to 1998. Table 1. companies could no longer enjoy low-interest credit from state banks. Interest rate regulations on state banks and credit ceilings in general were removed. However. Through the years. which were previously constrained to 4 percent per day. During this period. These included the opening of the banking industry to new entrants.2. began to face competition. Partly as a result of these reforms. six SOCs had issued equities in the market. In 1988. Thus. from 24 in 1988 to more than 300 in 1997.Chapter 1: Indonesia 5 At the end of 1988. The banking sector. the number of listed companies in the stock exchange increased substantially. the liberalization of the banking industry allowed banks to determine lending rates for nonpriority loans. Conglomerates carried out 210 out of 257 IPOs.3 The Banking Sector Despite the development of the stock market. the number of private domestic banks increased. However. 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. the banking sector has been and still is the major source of credit for the corporate sector.5 trillion. The dominance of state banks started to erode. Further reforms along the same direction and affecting state-controlled banks came in the 1990s. which up to then was channeling oil revenues to priority sectors. . But in terms of assets per bank. state-owned banks were still among the biggest. to date. Consequently. and increased access of domestic banks to international financial markets. private domestic banks dominated the sector in terms of number and total assets. Since 1977. 1. with a total value of Rp16. The development of the Indonesian stock market also provided a vehicle for the privatization of state-owned companies (SOCs). the capital market played an increasing role in raising long-term funds needed by the corporate sector.
Vol. Because regulation was weak. private domestic banks among the top 10 in 1997 included Bank Central Asia (BCA) (ranked first and linked to the Salim group).9 291.0 234 1994 104.4 10 35.3 201. and Bank Umum Nasional (BUN) have failed and the first two are now under management of the Indonesian Bank Restructuring Agency (IBRA). II Table 1.4 34 12.9 248. while BUN has been closed down by the Government.7 351.1 10 47.8 31 10.8 29 6.9 762.2 161 214.5 7 7 7 5 15. banks could earn profits even when they did not gather and process information about risk. Of these.5 165 308.4 239 222 208 173 Assets and liabilities were concentrated in the top 10 banks. and Bank International Indonesia (ranked 9th). But the banking system proved incapable of performing its intermediation function.5 528.1 240 1995 122.9 39 18.8 27 200.8 10 37.5 27 88.6 7 7.6 164 144 130 92 387.9 304. Bank Danamon (ranked 7th).3 30 7. Among private domestic banks.1 Growth of the Banking Sector. .8 10 19.6 Corporate Governance and Finance in East Asia. 1993 100. The other banks among the top 10 were state banks.9 10 11.4 789.9 27 113.6 7 12. 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.3 10 17. 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.9 31 9. BCA. Bank Danamon. the 10 largest were all affiliated with major business groups.3 27 51. Both BCA and BUN have shareholders linked to the former President Suharto.6 34 14.8 166 248.2 10 14.8 27 147. In terms of assets.5 7 9.7 27 37.5 27 66.6 240 1996 1997 1998 1999 141.8 391.
59 billion in 1996.01) (0.63) (1.09 1.2. Successive policy deregulation facilitated FDIs in various light manufacturing industries.2 Foreign Capital Flows.2.74 5. FDI flows were strong. as shown in Table 1. especially through bank loans.00 2. .09) 1. the Government allowed foreign investors to own 100 percent of an Indonesian company. Joint BIS-IMF-OECD-World Bank Statistics on External Debt. and footwear. Between 1990 and 1996.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.88) — — — — — — 8.4 Foreign Capital The years of rapid industrial growth attracted a large amount of foreign direct investments (FDIs). Indonesia received capital inflows averaging about 4 percent of GDP. In 1994. they still amounted to a large sum for the economy to absorb. Although these inflows were not nearly as large as those received by Thailand (10 percent of GDP) and Malaysia (9 percent of GDP).50 (0.81 3. Source: IFS CD-ROM. initially from Japan and the Republic of Korea. In effect. November 2000. 1990-1998 ($ billion) Type of Flows Net FDI Net Portfolio Investment Foreign Bank Loans 1990 1991 1992 1993 1994 1995 1996 1997 1998 1. Increasingly. textiles.15) — = not available.59 4. Net FDI flows increased to $5.78 2. In the 1990s.48 1. there was a phenomenal growth in direct borrowings by Indonesian corporations. IMF. such as metal goods. From the mid-1980s until July 1997. But FDIs were only one form of foreign capital inflows to Indonesia. foreign creditors were eager to provide financing to Indonesia. 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. Until the onset of the crisis. Most FDIs came in through joint ventures with business groups having strong political connections. except in certain strategic sectors.33 (13. foreign investment also had a strong presence in the services and infrastructure sectors.40) (0.11 3. September 2000.01 (2.88 4. Table 1. 1.87 7.09) (0.10 5. when the financial crisis hit Indonesia.
the average foreign ownership of listed companies was 21 percent. and conglomerates. By the end of 1997. Due to data constraints. Consequently.4 trillion in 1997. 1. allowing foreign investors to buy up to 49 percent of stocks of a publicly listed company. state-owned companies (SOCs). This is lower than the average borrowing rate of 18 percent for loans in domestic currency. increasing the total trading value from Rp8 trillion in 1992 to Rp120. but declined to an average of 25 percent during 19951997. Between 1989 and 1992. 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.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. plus 4 percent for the depreciation of the rupiah. In September 1997. Vol. 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. especially the short-term ones. the average borrowing rate for dollar loans was 9 percent. II Up until the late 1980s. In November 1998. the analysis focuses only on publicly listed companies. The following section looks at the growth and financial performance of the corporate sector.8 Corporate Governance and Finance in East Asia. . This increased to 30 percent by the end of 1993. with the onset of the Asian crisis. of which two thirds were rupiah-denominated. foreign banks became a significant source of financing for the corporate sector. an interesting question is whether standard measures of corporate profitability and performance also indicated the same. The excessive dollar borrowings made the corporate sector vulnerable to sudden currency fluctuations.2. Domestic corporate debt was about $50 billion equivalent. 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. From 1987 to 1996. The external corporate debt owed to foreign commercial banks was $67 billion. foreign investors began to dominate daily trading. total corporate debt reached nearly $118 billion. Capital account liberalization permitted the inflow of foreign capital that fueled the credit boom in the country. participation in the Indonesian stock market was exclusive to domestic investors. In the 1990s. The Government relaxed this restriction in 1988. Private borrowers preferred foreign loans since these were relatively cheaper.
9 37. b Asset turnover is defined as sales over assets.3 shows the growth and financial performance of Indonesian publicly listed companies. Net profits grew at an annual rate of more than 20 percent from 1992 to 1996.0 12.0 12. but turned negative in 1997. The growth of listed companies was sustained by continuing investments.7 — = not available.8 6.1 0.6 percent in 1997.0 10. 174 firms.7 percent in 1997.2 1995 37.4 1997 7.6 48. total sales of listed companies grew at an annual average rate of 31 percent.0 12. Asset turnover was above 30 percent until 1996. 250 firms. although the contribution increased over time.6 1994 50.8 220.5 3.4 31.3 Growth and Financial Performance of Publicly Listed Companies. and 1992.8 percent between 1992 and 1996. 1994.5 34.5 240. 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. but declined to 0. The debt-to-equity ratio (DER) was high compared to those of listed companies in Malaysia and the Philippines. there were 204 firms.3 6. Source: JSX Monthly (several publications). 246 firms.2 7.0 6. while total assets grew at 43 percent.7 — 250.0 1.4 38. 226 firms. Table 1. the average DER increased to 310 percent from 230 percent the . Average return on equity (ROE) of listed firms was 11.9 310.6 24. ranging from 220 to 250 percent between 1992 and 1996. publicly listed companies as a group contributed less than 10 percent to GDP. When the crisis battered Indonesia in 1997. Note: The number of firms is not identical for each year. 1996.Chapter 1: Indonesia 9 Publicly Listed Companies Table 1.3 3. 248 firms. but dropped to 1.8 230.6 3.1 220. 1995. but fell to 24.0 33.5 34.1 4.7 3. Return on assets (ROA) was also relatively stable during 1992-1996. a Value added was assumed to be 30 percent of total sales.0 3. During 1992-1997.2 30. In 1997. 1993.4 1993 45. averaging 3.4 1996 18.1 percent in 1997 when the crisis began to buffet Indonesia.4 percent. Despite such rapid growth.0 64.5 37.0 11.
73 percent in 1992 to 1. mining. real estate. indicating its reliance on equity to support growth. But the sector’s ROE fluctuated a lot. it appeared that the performance of listed companies was quite satisfactory prior to the crisis. The ROE levels suggest that high leverage enabled listed companies to achieve high returns on equity. The consumer goods sector ranked second in terms of ROE. The same applied to the trade sector. the mining sector ranked first. Overall. real estate. and trade.64 percent in 1997. finance. increased from 0. ROE fell drastically because the sector had one of the highest DERs. and building construction sectors had the highest DERs because companies in these sectors found it easy to obtain credit from banks. In terms of share of value added to GDP. due mainly to the domination of the International Nickel Company of Canada. the banks eagerly provided credit to property development companies. only two sectors (mining and finance) showed a consistently increasing trend from 1992. and property. Most companies in the sector that had unhedged dollar-denominated loans suffered exchange rate losses when the rupiah weakened. when the property sector was booming during 1993-1997. averaging 17. the property sector was severely affected by the crisis. During those years. The finance. property.10 Corporate Governance and Finance in East Asia. investment. still posting a positive but lower ROE. II previous year. infrastructure. although asset turnover was slow. For instance. Table 1. miscellaneous industry. investment. Also. The Jakarta Stock Exchange (JSX) classified listed companies into nine sectors: agriculture. and services. Before the crisis.7 percent during 1992-1996. property. with ROE falling to -11.3 percent between 1992 and 1996. the dominant sector was the finance sector. When interest rates increased. followed by agriculture (Table 1. This sector was less affected by the crisis. the mining sector had the highest ROE. the fluctuation in nickel and copper prices contributed to the oscillation of ROE.5 presents the financial performance of listed companies by sector. consumer goods.2 in 1997. The finance sector’s contribution to GDP. meanwhile. the mining sector had the lowest DER. trade. and trade) even posted . Four sectors (basic industry and chemicals. which operated in nickel and copper mining in 1992 and 1993. Meanwhile. averaging 21. This indicates that a substantial part of corporate debt was denominated in dollars and unhedged.4). miscellaneous industry. Vol. However. and services. in terms of growth of sales and assets. From 1995. helped in part by the relatively strong demand for consumer goods. basic industry and chemicals. and building construction. ROA of all sectors dropped in 1997. In terms of sales and asset levels in 1997. the companies in the sector did not operate with a high leverage.
6 15.4 1993 155.1 1. and Services Share of Value Added in GDP Agriculture Mining Basic Industry and Chemicals Misc.5 9.5) 13.4) 6.1 16.7) (27.7 54.5 61. and Services Net Profit Growth Agriculture Mining Basic Industry and Chemicals Misc. and Bldg.8) 0.3 51.7) 17.2 14.7 0.8 51.7 24.2 0.5 28. Investment.9 14.1 1.5 53.1 (41.4 43.2) 0. Real Estate.8 0.1 1. and Bldg.9 (7.6 133.1 — 39.7 112. and Services Asset Growth Agriculture Mining Basic Industry and Chemicals Misc.8 27.1 0.4 77.7 17.4 170.3 0.9 0.3 17.0 1.9 1.0 31.2 11.3 (203. Real Estate.9 54.2 41.2 35.1 71.2 5. Investment.1 42. Infrastructure Finance Trade. Industry Consumer Goods Industry Prop.1 23.6) 119.4 1.9 25.5 92.8 24.8 29.9 .0 68.5 23.8 50.5) 49.4 64. Industry Consumer Goods Industry Prop.7) (113. Industry Consumer Goods Industry Prop.6 0.0 0. Constn. Real Estate.0 22.4 1.1 1.3 31.9 36.9 53.. Constn.3 0. and Bldg. Industry Consumer Goods Industry Prop.5 13.5 68.0 16.1 0.1 0.7 21..1 35.8 66.2 59.3 340.6 85.5 0.8 62.1 0.4 1.0 0.3 31. Investment.6 26.0 0.9 59.6 83.5 (11.3 0. Constn.7 (82.6 24.4 0.1 0.1 0.6 28. Infrastructure Finance Trade.5 45.1 32.6 (0.6 0. 1992-1997 (percent) Indicator/Sector Sales Growth Agriculture Mining Basic Industry and Chemicals Misc.4 (149.8 (76.8 28.1 67.4 30.3) 39.9 31.7 40..1 28.1 1.0 (192.9 0.5) 6.1 0. 1992 — — — — — — — — — — — — — — — — — — — — — — — — — — — 0.1 0. Source: JSX Monthly (several publications).0 64.6 135. Infrastructure Finance Trade.6 1.5 (8.5 0.4 21. and Bldg.7 34. Infrastructure Finance Trade.3) 53.9 8.7 28. Constn.2 13.4 30.8 32.7 43.7 — 36.1 0. and Services — = not available.0 (20.3 0.4 38.3 0.7 133.4 44.7 — — 11.1 0.0 24.6 0.9 54.4 103.5 95.7 1995 51.3 1.8 1. Investment.0 43.4 Growth Performance of Publicly Listed Companies by Sector.7 62.3 92.6 1994 (75.2 41.0) 46.6) 19.9 123.1 (11.8 1.6 22.4) 8.8) (12.7) 26.0 (28.7 0.0 0.6 (41.7 90.6 51.2 0.5 1.0 0.5 1. Real Estate.Table 1.5 1.0 0.0 1996 1997 58.6 0..4 31.0 18.9 64.6) 25.
9 87.8 81.2 13.6 23. Constn.0 1997 230.0 170.0 140.6 (11.8 9.0 80.0 (0.5 17.7 1.4 .8 5.8 11.1 8. Real Estate.8 44.8 20.3 64.0 180.7 12.3 7.3 73.0 3.0 66. Infrastructure Finance Trade.7 26.0 190.4) (1.0 110.8 16. and Bldg.9 10. 1992-1997 (percent) Indicator/Sector Debt-to-Equity Agriculture Mining Basic Industry and Chemicals Misc.8 382.7 71.7 4.0 120. Real Estate.0 50.5 14.4 46.0 630.1 4.3 7.9 40.0 180.0 17.0 110.0 46. Infrastructure Finance Trade.7 10.0 39. Industry Consumer Goods Industry Prop.0 12. Industry Consumer Goods Industry Prop.4 46.4 13.7 5.2 7.2 30.0 110.0 110.9 4. and Services Return on Equity Agriculture Mining Basic Industry and Chemicals Misc.1 10.6 74. Constn.1 1994 80.0 100.0 90.0 3. Constn.3 17.3 18.0 70. Investment.0 150.7 10.0 8.0 190.9 17.0 60. Constn.0 110.5 1995 80.9 29. and Bldg.7 12.2 11.5 4.6 18.1 4.7 10.6 8. and Services Source: JSX Monthly (several publications).5 4.0 160.5 Financial Performance of Publicly Listed Companies by Sector.4 5.0 100.0 160.7 9.9 42.1 (5.0 80.1 65.3 0.5 56.4 6. 1992 20.5 11.0 210.0 69.3 1.6 14.0 19.5 5.2) 15.3 13.0) 7.0 120.1 89.1 (3.4 17. and Bldg.Table 1.8 25.0 150.2 53.6 (2.7 (3.0 120.3 17.0 70.2) 7.2 3.0 140.1 63.6 13.5 43.3 38.1 4.0 110.4 35.2 3. Infrastructure Finance Trade. Real Estate.0 120.2 39.2 15.0 680.1 9. and Services Asset Turnover Agriculture Mining Basic Industry and Chemicals Misc.4 20.7 8. Industry Consumer Goods Industry Prop.4 35.7 8.4 71.2 (4.8 11.9 14.0 650.1 3.1 7.7 4.3 33. Investment..9 41.7 13.2 1993 130.1 6. Industry Consumer Goods Industry Prop.3 5.4 13.7 46.7 12.1 1.1 2.0 220.2 7.4 4.1 10.1 10.8) 8.8 479.0 560.0 160.8 67.7 61. and Services Return on Assets Agriculture Mining Basic Industry and Chemicals Misc.1 13.6 1.6) 36.0 130.1 1996 100.0 110.9 38. Investment.0 100.0 11.0 70.0 15. Investment.4 79.7 1.4 6.7 5.0 100.0 80.0 14.8 3.4 1. and Bldg..0 150.2 6.0 700.3) 5.8 168.0 190.2 8.0 9.9 38.0 86..6 13.0 650.0 8.5 19.2 111.6 19.5 13.6) 18.5 7.8 8..1 11.9 7. Infrastructure Finance Trade.1 9.7 4.0 380. Real Estate.6 8.2 23.0 180.
which collectively had the largest assets.3 trillion.1 percent in 1993. but it continuously declined from 370 percent in 1992 to 250 percent in 1995. For instance. between 1993 and 1995.7 percent in 1990 to 6 percent in 1996. This was relatively high compared to the 3. The DER was slightly higher than for listed companies. the SOCs’ value added as a percentage of GDP ranged from 6 to 8. registering an average annual rate of 10 percent. ROA had been at high levels from 1992 to 1995. While asset turnover rates of publicly listed 3 4 SOCs are those in which the State has at least a 51 percent equity interest.4 percent the following year. The finance and miscellaneous industry. Six SOCs were listed in the Jakarta Stock Exchange. but dropped dramatically to 4. averaging 24 and 31 percent.6).1 percent in 1992 to 28. State-Owned Companies At the end of 1995. respectively. SOCs’ ROE ranged from 6. there were 58 SOCs with subsidiaries and affiliates. and basic industry and chemicals sectors had relatively stable ROA before the crisis. indicating SOCs’ declining contribution to GDP. Only the agriculture sector showed an increase in ROA in the couple of years before 1997.7 to 7 percent for publicly listed companies. However. SOCs diversified into many businesses. SOCs’ sales growth fluctuated during 1990-1996. the subsidiaries and affiliates number 459 with total assets of Rp343.Chapter 1: Indonesia 13 negative ROA. Taken together. Asset turnover rates were lower relative to those of publicly listed companies. and finance company (four companies). Trade had the highest ROA of 39. the Department of Finance supervised 30 SOCs. Just like private companies.6 to 8. much lower than that of companies listed in the stock exchange. . there were 165 state-owned companies (SOCs)3 in Indonesia. This was due to large sales by the National Oil Company (Pertamina). the ratio decreased from 8. The Department of Mining and Energy ranked first in terms of sales of SOCs under its control. Similarly.3 percent in 1995. increasing from 21. insurance (11 companies). banks (seven companies).7 percent. The sectoral distribution of 165 SOCs is as follows: nonfinancial (143 companies).8 percent between 1992 and 1995 (Table 1. By 1995. These growth rates were low compared to those for listed companies during the same period. SOCs actively operated in various sectors4 under the supervision of “technical” departments. growth of net profits and assets was erratic. Assuming a fixed ratio of value added to sales.
1 30.5 percent in 1995. Table 1. Vol.4 13. a Value added was assumed to be 30 percent of total sales.7 16.1 310.0 8.2 percent in 1997 (Table 1.6 28.1) 5. Assuming a constant ratio of value added to sales. a Value added was assumed to be 30 percent of total sales.4 percent in 1994.3 250. SOCs’ asset turnover rates showed a downward trend from 32.7 1994 (9.2 — 370.766 business units. II companies consistently declined over time.7 (2.0 12. .0 17.7 13.2 — = not available.7 Growth Performance of the Top 300 Conglomerates.3 12.6 percent in 1994. b Asset turnover is defined as sales over assets. mostly private companies.2 23.4 16.8 11. Source: Indonesian Data Business Center.4 13.0 24.2 18.1 trillion in 1990 to Rp234 trillion in 1997.4 percent in 1992 to 28. but climbed to 30.8 21.4 7.6 1995 25. Their total sales increased from Rp90.1 19.0 6.0 8. the contribution of conglomerates to GDP increased from 12. 1990-1997 (percent) Item Sales Growth Share of Value Added in GDPa 1990 1991 1992 1993 1994 1995 1996 1997 — 17.8 percent in 1990 to 13. In 1997.6 28.1 6. 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.6) 260. 1992 — 7.14 Corporate Governance and Finance in East Asia.4 1993 16. Source: Indonesian Data Business Center.5 3.0 28.4 13.0 7. these conglomerates owned 9.7). but dropped to 11. Table 1.6 Growth and Financial Performance of State-Owned Companies.3 30.1 12.1 32.8 12.5 Conglomerates This study used available data on the top 300 conglomerates in Indonesia.
The law replaced an earlier statute that was based on the Dutch system. the legal and regulatory framework of the corporate sector was far from adequate. In general. acquisitions. and the accountant. and the attendance should at least be two thirds of total shareholders. For example. The actual responsibilities of BOCs vary by company and are stipulated in the company’s charter. and declaration of bankruptcy. as representative of shareholders. The law also specifies that the highest “institution” in the limited company is the shareholders’ meeting. The law explicitly requires approval during the meeting of decisions on strategic issues such as amendment of the company charter (articles of incorporation). By international standards. For instance. is the only shareholder mechanism for monitoring and controlling the BOD. The meeting decides on important issues. . and the board of directors (BOD). A chairman heads the BOC while a chief executive officer (CEO) heads the BOD. the decision to amend the company charter should be approved by two thirds of shareholders present in the meeting. The Corporate Law The Corporate Law of 1995 governs the establishment and operation of limited liability companies in Indonesia. a member company might sign a disadvantageous contract with another company where the same controlling shareholder has a higher stake. shareholders lose control. however.Chapter 1: Indonesia 15 1. The company charter details the issues that need shareholder meeting approval. For instance. an approval needs the majority (50 percent plus one) vote. The law mandates the BOC and BOD to work for the best interests of the company and not just of the shareholders. tasked with supervising the firm. The BOD undertakes operating decisions while the BOC participates in strategic decisions and operations review. commissioners. except in strategic issues stated in the law. such as the appointment (or replacement) of directors. mergers. tasked to provide direction to the company. The 1995 law requires limited liability companies to set up two boards: the board of commissioners (BOC). the decision to use certain company assets as collateral for bank credit might need BOC approval. The BOC. For mergers. If the BOC does not perform well. The law also holds the directors and commissioners jointly responsible for decisions made by the company. the Government promulgated a number of laws and regulations to protect investors.2.6 Legal and Regulatory Framework During the 1990s. and consolidations. This guards against shady intercompany dealings within a group of companies.
(x) mandatory shareholders’ approval of major transactions. (xvii) mandatory independent board committee. A tender offer is also required for acquisitions of up to 20 percent of listed shares. (vii) the right to call an emergency shareholders’ meeting. It also regulates reporting and auditing procedures. brokers. The law is supplemented by Government regulations. decrees of the finance minister. (xiii) mandatory disclosure of nonfinancial information. underwriters. consolidations. (xi) mandatory disclosure of transactions by significant shareholders. Controlling shareholders have no vote on the matter. (v) preemptive rights on new share issues. investment managers. transparency requirements. It regulates the requirements of investment companies. (ix) mandatory shareholders’ approval of interested transactions. (xii) mandatory disclosure of connected interests. insider trading (including market rigging and manipulation) investigation. An important rule is the requirement for independent shareholders’ approval for arrangements that might lead to conflicts of interest. and (xviii) severe penalties for insider trading. and other supporting agencies. II acquisitions. 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. and bankruptcy. (xiv) mandatory disclosure of intercompany affiliation such as affiliated lending or guarantees. (ii) proxy voting. (viii) the right to make proposals at the shareholders’ meeting. securities companies.16 Corporate Governance and Finance in East Asia. and administrative and legal punishment. (iii) proxy voting by mail. 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. The law provides the following rights to or protection of shareholders: (i) access to regular and reliable information free of charge. Vol. The Capital Market Law The Capital Market Law (1995) regulates companies listed in the stock exchange. and the attendance should at least be three fourths of total shareholders. (iv) cumulative voting for directors. (xv) mechanisms to resolve disputes between the company and shareholders. such as custodian banks and the securities registration bureau. Because of such requirements. delineating the tasks and responsibilities of the Capital Market Supervisory Agency. . (vi) one share one vote. and guidelines promulgated by the head of capital market supervision. (xvi) independence of auditing. the decision should be approved by three fourths of the shareholders present. investment advisors.
Banking Laws Affecting the Corporate Sector Some elements of the banking law also affect the corporate sector. the viability of a project). for instance. It aimed to protect creditors by providing easier and faster access to legal redress. A new bankruptcy law was passed in August 1998. whether they are individuals. It reveals characteristics of controlling shareholders.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.3. For instance. The court can declare the debtor bankrupt upon the request of at least two creditors and default on one loan. . net open positions.Chapter 1: Indonesia 17 Bankruptcy Law Despite loan covenants. 1. However. Banking regulations also set lending limits. families. capital adequacy.1 Corporate Ownership Structure Quality of corporate governance is closely related to corporate ownership structure (see discussions in the Consolidated Report of this study). etc. the Banking Law (1992). amended in October 1998. holding companies.. five. states that a bank is not allowed to provide credit without collateral. 1. 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. Ownership concentration is usually measured by the proportion of shares owned by the top one. or 20 shareholders.g. A Commercial Court was also set up to deal with bankruptcy cases. The two most important elements of ownership structure are concentration and composition. or financial institutions. creditors of unsecured loans are unprotected when borrowers fail to meet their obligations. the collateral could take the form of nonphysical assets (e. Discussions on corporate ownership cover listed companies and conglomerates. 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.
and Berlian Laju Tankers (liquid bulk maritime transportation services) issued 48.6 4.9 percent of total outstanding shares. When a company goes public. The percentage owned by each of the five largest shareholders was 48.9 Source: The Indonesian Capital Market Directory.0 4. Vol.5 72.8 shows average proportions of shares owned by the five largest shareholders of publicly listed companies during 1993-1997.5 12. and 0.9.0 1. 13.0 0.0 2. II Publicly Listed Companies Table 1.1 1. and basic industry and chemicals sectors than in others.7 1996 48.2 11.9 14.6 percent.4 percent.1 13.8 Ownership Concentration of Publicly Listed Companies. 3.6 3.8 68.1 0. Zebra Nusantara (taxi services). mining.8.2 67.9 2.5 1997 48. The pattern of ownership concentration changed little over this period.7 1994 48. the five largest shareholders owned 68. This is partly due to the prevailing practice of raising equity through rights issues in Indonesia.6 13.0 67.4 2. issued 93.2 1.7 3. Meanwhile.5 percent.5 16.9 shows that ownership by the largest shareholder in 1997 was more concentrated in the agriculture. for instance.9 0. This is because a few companies in the transportation sector issued high proportions of shares to the public. 1993-1997 (percent) Shareholder Rank First Largest Second Largest Third Largest Fourth Largest Fifth Largest Total 1993 50.6 68. Data from the Indonesian Capital Market Directory (various publications) show that between 1993 and 1997.1 4. On average. Table 1.18 Corporate Governance and Finance in East Asia. the founder usually continues to own the majority of shares through a . Rig Tenders Indonesia (shipping services) issued 51.8 1.6 3.6. This preserves the pro rata share of existing shareholders.5 Average 48.9 2. respectively. When a company makes a rights issue.6.8 68. ownership widely held by the general public is highest in the infrastructure and transportation sector (not shown in the table).0 0. Table 1. 2. consumer goods. about two thirds of publicly listed companies’ outstanding shares were owned by corporations that were directly or indirectly controlled by families. the controlling shareholders usually act as standby buyers.3 1995 47.
These figures suggest that ultimate control of the corporate sector rests in the hands of a small number of families.1 1.2 46.6 1.6 percent were widely held.1 1.7 1.3 14.1 13.9 0.4 6.3 2.5 58.8 14.3 48.1 percent) of Indonesian publicly listed companies were in family hands.6 2.2 15.. (1999) also found.1 1.9 44. 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. Real Estate.4 54. Table 1.1 0. and Bldg.9 1.4 44.6 9.9 3.2 10. Claessens et al. Industry Consumer Goods Industry Prop.0 5.1 1.1 11. Legal and regulatory developments may have been impeded by the concentration of corporate wealth in . the rule of law.. In terms of capitalization. (1999).6 8. and corruption. In fact. 1997 (percent) Sector Agriculture Mining Basic Industry and Chemicals Misc.9 Ownership Concentration of Publicly Listed Companies by Sector.6 0.3 0.4 4. is strong.1 2. Util. two thirds (67.4 11. as well as the existence of corruption.1 0.7 6. the top family controls 16.7 percent of the market.9 50. Most of the five largest owners of Indonesian publicly listed companies are limited liability companies rather than individuals. which shows that in 1996.2 2. in a cross-country study.2 This is confirmed in Claessens et al.4 1. Indonesia has the largest number of companies controlled by a single family. Infrastructure.7 4. and the efficiency of the judicial system. that the correlation between the share of the largest 15 families in total market capitalization.Chapter 1: Indonesia 19 fully-owned limited liability company (Perseroan Terbatas). Constn.3 36. on the other. Investment.9 44. and Transportation Finance Trade. on the one hand.3 0.2 0. Thus the founder keeps the proportion of shares necessary to retain control over management of the listed firm.1 2.6 percent of total market capitalization while the top 15 families control 61. and only 0. First Second Third Fourth Fifth Biggest Biggest Biggest Biggest Biggest 54.5 1.7 13.1 2.5 4.7 9. and Services Average Source: The Indonesian Capital Market Directory.
Indian. Family control is said to have positive effects in that it allows group members in conglomerates to make strategic decisions quicker. 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. and Padang. This may indicate that the New Order Government. However.20 Corporate Governance and Finance in East Asia. In 1993. The nonindigenous businesspeople are usually Chinese. Vol. accounting for 64 percent of total conglomerate sales in 1988-1996. During 1988-1996. In September 1997. and family origin. In Indonesia. foreign ownership increased to 21 percent. the onset of the crisis negated this development. The corruption and regulatory problems generated by high ownership concentration by families in Indonesia are likely to overwhelm its benefits. Sundanese. ethnicity.42 percent in December. or other ethnic groups. with all its regulations. II the small number of families and the tight links between companies and the Government. the Government allowed foreign investors to buy up to 100 percent of listed shares.10 shows the anatomy of the top 300 conglomerates in terms of year of establishment. Indigenous businesspeople include the Javanese. the legal system is less likely to evolve in a manner that protects minority shareholders. But these benefits are few and often dubious compared to the high costs of concentration. most were established during the New Order Government. the proportion of foreign ownership declined from 27. Among the top 300 conglomerates. political affiliation. Coordination is easier because informal communication channels exist. their number increased to 5 In 1997.5 Conglomerates Table 1. conglomerates established before 1969 dominated in terms of sales. .55 percent in August to 25. When the Government allowed foreign investors to buy up to 49 percent of listed shares in 1988. there is a dichotomy between corporations owned by indigenous and nonindigenous businesspeople. numbering 162 in 1988 and 170 in 1996. but later declined and steadied at around 25 percent. Batak. resulting instead in a decline in the proportion of foreign investor ownership. was able to create a favorable environment for business development. However. nonindigenous groups owned a larger proportion of the top 300 Indonesian conglomerates. it rose to 30 percent. From 193 in 1988.
1 41.10 Anatomy of the Top 300 Indonesian Conglomerates.7 24.Chapter 1: Indonesia 21 Table 1.1 103.5 120.0 58.6 77.0 15.4 15.7 49.4 18.4 68.8 12.4 22.6 54.1 46.6 12.3 80.8 68.1 58.5 21.9 42.7 95.9 14.3 101.4 32.3 134.6 95.8 30.2 23.0 31.8 38.0 58.3 43.1 87.1 21. While they supplied 20. due to their “go public” activities. For instance.0 18.7 40.3 120. In 1996.8 36.2 30.3 36.4 86.1 percent of total .9 73.9 47.4 59. Their total sales also increased from Rp38.9 77.2 33.4 59.8 25.2 12.2 159.8 57.8 28.7 64.4 19.4 69.7 89.8 Source: Indonesian Business Data Centre.6 trillion in 1988 to Rp137.6 34.0 116.1 179.4 trillion in 1996. sales of the Bakrie group before it went public in 1990 were only Rp369.1 52.5 106.3 20.6 114.9 35.0 28.2 76.5 22.7 28.4 57. Conglomeration Indonesia 1997.9 137.4 81.4 31.9 billion.2 48.4 16.1 33.1 42.8 49.1 46. 204 in 1996.7 106.1 25.6 17.4 52. more than five times its 1988 level.2 29.0 44. 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 9.4 37. its sales reached Rp1. Meanwhile.4 48.4 31. the number of mixed groups declined from 86 in 1988 to 68 in 1996.9 trillion.9 13.
More recent alliances were between Bambang Trihatmodjo (former President Suharto’s son) and Johannes Kotjo. Most of the top 300 conglomerates were established by ordinary citizens. Political alliances between entrepreneurs and officials have often led to the violation of regulations meant to promote prudent business practices in the banking industry. But only a handful of these companies are listed in the market. In 1997 and 1998. The Salim group. Djuhar Soetanto. Conglomerates were also classified into nonofficial. Indocement Tunggal Prakarsa (cement industry). collectively controlling . In November 1997. average sales of official-related conglomerates reached Rp1. which is the largest conglomerate in Indonesia. or have resulted from alliances between entrepreneurs and officials. The high NPLs accumulated by banks within official-related groups could be partly attributed to this practice. But listed companies within conglomerates were few.22 Corporate Governance and Finance in East Asia. Out of 174 companies. and Fast Food (restaurants). Official-related groups have owners (or founders) who are or are allied with former or current government officials (or their families). most of the 16 liquidated banks had violated the legal lending limit set by the central bank. Bambang Rijadi Soegomo. for instance. and Ibrahim Risyad of the Salim group. there were 175 groups that originated from a family business. II sales in 1988. compared with the less than Rp700 billion of a nonofficial-related conglomerate. owns four groups with many subsidiaries and affiliate companies. The well-known official-business alliances are those between Sudwikatmono (former President Suharto’s cousin) and Soedono Salim. In 1996.2 trillion. 117 are jointly owned by the family and 57 are owned by individual family members. Only about 13 percent were formed by official or ex-official families. banks that had to be closed down included Bank Surya (owned by Sudwikatmono) and Bank Andromeda (owned by Bambang Trihatmodjo). The Suharto family is the largest stockholder in Indonesia. Average sales of official-related conglomerates were substantially greater than nonoffficial-related ones during 1988-1996. Banks owned by groups or conglomerates typically act as a “cashier” that provides credit to companies within the group. and Wisnu Suhardhono of Apac-Bhakti Karya.and officialrelated groups. Bank Indonesia. In 1996. Some of them later became public companies by listing in the stock market.7 percent in 1996. Vol. Prudential credit analysis tends to be ignored. The contraction in the number and economic contribution of mixed groups may be an indication of increasing social polarization along ethnic lines. including Indofood Sukses Makmur (food industry). their contribution declined to 13.
If the family members cannot actively manage the companies as directors. Semen Cibinong. He or she could either be the biggest shareholder. In so doing. The family controls 417 listed and unlisted companies through a number of business groups led by the Suharto children. The families retain control of the companies through ownership. Indonesian law allows cross-shareholdings. The BOC chairperson often represents the controlling party of the company. Both are listed companies and members of the Salim group. 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. families mostly manage the groups and make strategic decisions themselves. but those of the entire group. they maintain their position as commissioners. This is because cross-owned banks had to consider not only their own interests. they still control the work of the directors. 1999). for instance. Some of the groups related to officials have a unique share ownership structure.1). Cases in point are the Bank Papan Sejahtera and Bank Niaga. as well as other relatives and business partners. While the source of the . Although they are not actively involved in the daily operations of the companies. or both. In 1996. Cross-holdings between financial and nonfinancial firms potentially create more serious problems. Although some groups employ professional managers. The Salim Group is also in part controlled by the Suharto family. with no restrictions..Chapter 1: Indonesia 23 assets worth $24 billion (Claessens et al. many of whom. continue receiving some kind of protection and special treatment. management. and hence. which were liquidated or recapitalized after being acquired by the Tirtamas group that owns a listed cement company. The officials (or their family members) often own a small portion of shares given to them freely by controlling shareholders. besides Suharto himself. served in some government function (see Figure 1. the controlling shareholders are able to maintain their special relationship with officials. or someone very close to and trusted by the controlling shareholders. It is generally believed that there are cross-holdings between financial and nonfinancial companies and among nonfinancial firms. Indofood Sukses Makmur (food industry) was owned by Indocement Tunggal Prakarsa (cement industry). But it is difficult to obtain data on cross-shareholding among firms.
Lang. (Feb. and Larry H. Financial Sector Practice Department. World Bank. . Simeon Djankov. P. Who Controls East Asian Corporations? Financial Economics Unit.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.Figure 1. 1999).
and accounting and auditing procedures. role and protection of minority shareholders. if necessary. The BOD leads the company and makes strategic and operational decisions. management and managerial compensation. Therefore. and. request a shareholders’ meeting. The discussions are based on the ADB survey of 40 companies listed in the Jakarta Stock Exchange. The typical structure of a publicly listed company in Indonesia is shown in Figure 1. This is based on the Dutch system.Chapter 1: Indonesia 25 problem is inconclusive.2 Management and Internal Control A company’s internal organizational structure determines how shareholders control management. the BOC has the right to obtain any information concerning the firm. Figure 1. seek an audience with directors. both controlling and minority. including the boards. the directors. 1.3. As the owners’ representatives.2. the BOC supervises the work of directors. Shareholders are at the top of the organization.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. .
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
restrictions on market entry. to Hashim Djojohadikusumo. In April 1999. the acquiring parties were trying to obtain operating synergies because they had companies in the same industry. Before the financial crisis. Another case was the takeover of Bank Niaga in 1997 by Djojohadikusumo. The Government appoints the BOD and BOC of these firms. In the massive restructuring of the banking sector that commenced after the crisis. the bank was liquidated. a state-owned insurance company may invest its funds in a private firm. Bank Niaga was under a recapitalization program. the takeover brought significant losses to Djojohadikusumo when share prices plunged7 during the crisis. or direct subsidies. 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. The Government is thus able to appoint some officials to be members of the private firm’s BOD or BOC. 6 7 Later in March 1999. For instance. who was acquiring his second commercial bank. Since the NPLs reached up to Rp300 trillion. Most Indonesian state companies are 100 percent owned by the Government. The bank was reported to have high NPLs and had broken the legal lending limit. The BOD and BOC of PT Sari Husada were allowed to complete their terms before they were replaced.Chapter 1: Indonesia 31 external acquisitions. One famous takeover was Bank Papan Sejahtera. the owner of Tirtamas group. at a large profit. In these two latter cases. State ownership for listed SOCs ranges from 25 to 35 percent. with the minister’s approval. This used to be a common practice in companies associated with the Suharto regime. it was common for the Government to invest in certain private companies. A study by Connie Tjandra (1993) shows that internal acquisitions were often initiated for tax shelter purposes. They then replaced the BOD and later sold the bank. Control by the Government Government control could be in the form of state ownership. except for publicly listed SOCs.6 In this case. the Government took over NPLs and put them under IBRA management. appointment of management. Wijaya and his friends bought shares of the bank on several occasions until they gained control. the acquiring interest was apparently seeking economic profits. . IBRA found itself tasked with managing large amounts of assets in the private sector. which was acquired by Yopie Wijaya in 1995. However.
however.4 24.4 225.8 193. and others offered by nonbank financial institutions or finance companies. 1992 1993 1994 1995 1996 1997 1998 1999 68. remain the major financing instrument for the corporate sector.0 93.3 9. 1992-1999 (Rp trillion) Type of Bank State-Owned Banks Foreign Banks Regional Govt Banks Private National Banks Total Source: Bank Indonesia. equities became available to the corporate sector. jointly providing almost 90 percent of loans until 1997.5 108.5 7. private national banks overtook state banks as the dominant credit source. including bonds.2 27.14 Banking Sector Outstanding Loans.1 Equities In 1977.3 111.3 66.4 56.1 220.2 6.9 trillion in 1992 to Rp487.4 percent in 1992.9 378.6 percent in 1997.6 150. Since then. companies considered alternatives to bank loans. Vol. bank credit surged from Rp122. the share of private national banks in outstanding total loans increased to 44.0 3.7 18.6 3.4.9 234. Bank Credit As shown in Table 1.6 4.9 150.0 6.2 71.6 48. Data from Bank Indonesia show that from 1994 to 1997. When the Government liberalized the banking industry at the end of 1988 (which allowed for higher interest rates).7 112. However.9 153.6 6. .4 86.5 42.3 14. stocks.2 5.4 1. bank loans were the only instruments available to the corporate sector for short term (working capital) or long term (investment) financing. Table 1.14. From 34.3 188.3 60. II 1. because of the restrictions discussed below.4 trillion in 1998.7 122.0 487. Private national banks and state-owned banks were the biggest domestic creditors. new instruments have been introduced to the corporate sector.32 Corporate Governance and Finance in East Asia. Bank loans.1 Corporate Financing Financial Market Instruments Prior to 1977. this market was not well developed.0 168. when the Government reactivated the stock exchange.6 292.7 50.5 80.
. limiting loans to a maximum of 15 times equity and foreign loans to five times the equity. Most banks therefore set up subsidiary finance companies to circumvent banking regulations. and consumer credit.Chapter 1: Indonesia 33 Some companies went public.8 48.6 123. capital adequacy ratio.6 301. shooting up to 18.4 1996 1997 1998 50.e.0 206.1 10.7 percent in 1997. 1992-1999 (Rp trillion) Item Stocks Issued Outstanding (As % of Outstanding Bank Credit) Market Capitalization Source: Bank Indonesia. legal lending limit.4 207.g.7 14.3 percent in 1990 when the stock market was liberalized and foreign investors were allowed to purchase up to 49 percent of listed firms’ shares. but dropped to 8 percent in 1991 when the Government tried to stabilize an overheating economy.9 1999 76. The ratio reached 8. 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 1996.15 Value of Stocks Issued and Stock Market Capitalization. factoring.7 15. In 1995.6 859. offering services such as leasing. During the 1990s.7 9.9 406. Overall.5 1995 35. finance companies were increasingly used as channels for the inflow of foreign loans. the activities of finance companies were not covered by regulations on prudential practices in the banking sector (e.0 15.1 1994 26. i.0 70. Prior to 1995. and net open position).5 Financing by Finance Companies Finance companies first emerged at the end of 1980. allowed to accept deposit accounts from the public. when foreign investors were not yet allowed to purchase listed shares. They were not. funds raised in the stock market were less than 5 percent of the credit disbursed by the banking sector.6 91.1 18. It gradually increased again starting in 1991. . however. 1992 1993 11. thus increasing the role of the capital market in raising long-term funds..2 16.5 333.1 17. Table 1. the Government issued regulations to supervise and promote prudential practices in finance companies. credit cards.6 310. In 1988. the stock market has gained a bigger role in corporate sector financing (Table 1.15).
otherwise it would be classified as a loss in the banks’ books.16 Financing Patterns of Publicly Listed Nonfinancial Companies. 1996. While banks had some exposure to these instruments.7 22.6 100. Table 1.5 percent and 36. they were not rated by a rating agency.3 37. Bank Indonesia prohibited banks from underwriting issues of commercial papers but allowed them to act as paying agents.2 26. respectively.6 23. In the second half of the 1980s. This is in contrast to the lower share of borrowings during the same period.16 shows financing sources of Indonesian publicly listed nonfinancial companies estimated by using flow-of-funds analysis. Vol. 1986-1996 (percent) Financing Source Internal Borrowings Short-Term Long-Term Debentures/Equity Debentures Equity Trade Credit Others Total 1986-1990 36.5 (0. short-term borrowings were greater than long-term debts.0 100. .6 8.8 17. II Commercial Papers Commercial papers.0 1991-1996 16. which are unsecured negotiable promissory notes with a maximum maturity of 270 days.6 12.5 21.0 3. 1.3 16.1) 23.0 1986-1996 17.6 100. Thus in November 1995. at 81 percent of total borrowings.4 8.4 13.9 16. averaging 26.5 11.0 39.5 — 26.3 (0. In terms of composition. PACAP Research Center.2 Patterns of Corporate Financing Table 1.34 Corporate Governance and Finance in East Asia. publicly listed nonfinancial companies had high proportions of equity and internal finance (retained earnings).1) 23.4 23.3 14. 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). have been popular in Indonesia since 1990.4. Source: Author’s estimates based on the Pacific-Basin Capital Markets (PACAP) Databases.0 — = not available.8 7.8 percent.
These liabilities grew significantly because corporate expansion was largely financed by debt. except Semen Gresik (an SOC).Chapter 1: Indonesia 35 In the 1990s. Bank loans also surged when the banking sector was liberalized in 1988. 1. corporate debts accounted for 39.2 trillion (mostly foreign exchange losses). in the context of Indonesia and some other countries. Indosat and Telekom. All companies in the cement industry suffered from foreign exchange losses. was due largely to a rapid rise in long-term debts. that ownership concentration may be associated with heightened risk-taking by companies.2 trillion. Most corporate charters require commissioners to approve debt issues or sign debt agreements.4. which managed to post significant profits due to low exposure to dollar-denominated loans. Indofood registered losses of almost Rp1.3 Corporate Financing and Ownership Concentration It has been suggested.9 trillion in 1996. 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.6 trillion and Rp1. the corporate sector’s high leverage.17 compares the DER of listed firms by degree of ownership concentration. They also do not want to dilute corporate control and are more likely to finance growth with debt. This amount doubled in 1997. Corporate debts grew over time. Hence. . Table 1. which was masked by the rapid growth in investments. The results indicate that firms with higher ownership concentration tend to have a higher DER.3 percent during 1991-1996. The corporate sector invested heavily from 1991 to 1993 and slowed down its investment spending a few years before the 1997 crisis. as evidenced by an average DER of 230 percent during 1992-1996 that rose to 310 percent in 1997. Large shareholders are inclined to undertake risky projects intended to generate high returns using borrowed funds.4 trillion in 1993 to Rp112. Note that the corporate sector’s high leverage existed side by side with sizable equity capital raised from the capital market. Of the various financing sources. The high share of equity financing was due to the surge in capital market activity following the 1988 reforms. rising from Rp54. For instance. also suffered from foreign exchange losses but managed to post profits of Rp0. Two telecommunications companies. respectively. while Semen Cibinong’s losses reached Rp2.9 trillion. reaching Rp229. Many companies suffered big losses in 1997 due to their high exposure to dollar loans. with longterm debts increasing rapidly.1 trillion. the pattern changed.
and high ownership concentration among families with political affiliation. Controlling parties rely on external financing to maintain their equity share and.1 The Corporate Sector in the Financial Crisis Causes of the Financial Crisis Many intertwined factors led to the crisis. aided . The low cost of foreign loans and the relatively stable exchange rate created a false sense of security for corporations. Table 1.56 significant at the 10 percent level.0 Notes: Firms with high ownership concentration have more than 50 percent of shares owned by the top five shareholders. 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. the free capital flow system allowed private companies to borrow dollars offshore without any restriction. The test of the difference between the two means found the t-value of 1.0 351. Vol. Inadequate Financial Regulatory Framework Liberalization of financial markets increased the corporate sector’s access to domestic and foreign private capital. As a result. since commissioners represent the controlling party.36 Corporate Governance and Finance in East Asia. the borrowings swelled. heavy reliance of companies on bank credits to finance investments.5 1. Between 1987 and 1996. ultimately. to maintain control of the company.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 699.0 1. decisions on debt are made with the implicit endorsement of owners. Source: Author’s estimates. II However.0 386. 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.5.358. the private sector borrowed heavily in unhedged dollars. In addition. 1.
It was only in 1995 that some regulations on the activities of finance companies were contemplated. The banks served as a “cashier” that provided easy credit to nonfinancial companies within the group.e. those with high DERs) established their own banks. did finance many viable ventures. after all. Decisions to borrow in dollars made sense to many borrowers because dollar loans were cheaper than rupiah loans. It is not known if these regulations had an effect on nonbank intermediaries. As a result.Chapter 1: Indonesia 37 by the lack of an existing mechanism to supervise and monitor foreign transactions. 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. only created to serve the companies to which they lent. conglomerates set up finance companies and used these as channels for the unfettered inflow of foreign loans in lieu of banks.. A lot of short-term foreign funds were used to finance long-term investment projects. substantial amounts were also funneled into projects that guaranteed repayment mainly on the strength of borrowers’ close political connections. averaging about 4 percent of GDP. The Government later specified the legal lending limit and the net open position that banks had to follow. It was doubly difficult to exercise supervision when groups with political clout owned the banks. It also meant that the cashier bank had neither the independence nor the incentive to exercise ex ante and ad interim monitoring of borrowers. However. and the negative net open position (short position in dollars) continuously rose to precarious levels. many firms became highly leveraged. 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. However. large amounts of credit were directed to the companies within the group. . In the process. A director at Bank Indonesia revealed that in 1995. Conglomerates that had difficulty in getting loans (i. This often led to the violation of prudential credit management practices. The supervising agency was caught unprepared. to circumvent these banking regulations. They were. 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. The large supply of foreign funds. This left them vulnerable to interest rate surges as well as sudden currency fluctuations in the case of dollar loans. the level of corporations’ foreign debt could not even be ascertained.
II By mid-1997. and investing shares among nonfinancial companies within the group and in other groups’ companies. of which $64.5 billion was owed directly by corporations. In many cases. $35 billion of Indonesia’s foreign debt owed to private foreign banks was about to mature in less than one year. In early 1998. partly because they used nominee accounts to register ownership rather than set up a holding company. 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. Controlling shareholders also prefer to use debts to finance expansion so as not to dilute their ownership. Vol. This was often the case in the banking industry. as they had done so in the years before the crisis.38 Corporate Governance and Finance in East Asia. contracts were granted to the private sector. Since the Government could not afford to undertake these projects. but on the basis of who the borrower was. by setting up their own banks. Collusion between big businesses and the political elite was widespread in Indonesia. . most often to people who were close to the ruling regime. Family-controlled corporations were generally structured as a complicated web of affiliates and associated companies. toll roads. High Ownership Concentration High concentration of corporate ownership (particularly by families) led to poor financing and investment practices. and in the process maintain control of the company. banks did not lend on the basis of the soundness of the project. Corporations were certain that they could roll over short-term loans when these fell due. total private sector foreign debt stood at $72. Aside from the fact that many of these loans were channeled through banks and corporations of politically connected families. Families retain control by keeping the majority percentage of outstanding shares. or both.5 billion. and power generation) require huge capital. politicians. where private banks are usually in the hands of big businesses. They enhance their control over companies through cross-shareholdings. there was also almost universal confidence that the economic growth would continue indefinitely. This fact was usually not disclosed in financial statements. The ultimate control of the corporate sector rests in the hands of a small number of families who own groups of companies. They ensure that commissioners represent their interests and maintain close relationships with the chairperson.
5.6) (3. Most sectors showed significant increases in leverage.18 GDP Growth by Sector.0 2.52 trillion. Forestry. Using the financial statements as of 30 June 1998 of 161 publicly listed companies.19.8 1997 1. and Restaurants Transport and Communications Financial.3 12.8) (13.1) 1.5) (18.7) 2.3 11.6 12.8 7. and 128 companies reported a total loss of Rp46. much higher than the 307 percent registered in December 1997. 53 companies reported negative equity of Rp6.0 3.1) (26. The average DER was found to be 1.0) 1999 2. Real Estate. and Water Supply Construction Trade.370 percent.4 7.0 5.8 8.Chapter 1: Indonesia 39 1. posted negative growth rates. indicating a rapid rise in . The JSX Monthly reported that total losses of 214 listed companies amounted to Rp39. followed by property.7) (8.7) (2. Table 1. The consumer goods industry reported the lowest ROE. when all sectors.1 5. Only 86 companies reported profits.3 Source: Central Bureau of Statistics (Biro Pusat Statistik. DER and ROE were calculated per sector.4 7. and building construction. and Fisheries Mining and Quarrying Manufacturing Electricity.7 1998 (0. BPS). 1996-1999 (percent) Sector Agriculture.6 4.6 13.4) (0.18 shows that growth in most sectors significantly fell in 1997. real estate. Hotels. followed by the finance and trade sectors. and Business Services Other Services GDP 1996 3.4 5. as shown in Table 1. Gas.1 6. Livestock. Sectors with lower ROE generally had higher DER.2 8.1 (1.4) 2. except utilities.2 Impact of the Financial Crisis on the Corporate and Banking Sectors Impact on the Corporate Sector Table 1.8) (11.6 (36.2 (1.24 trillion for the first six months of 1998. This continued in 1998.7 6.8 0.58 trillion (meaning their losses were greater than the paid-up capital).6 8.6) (0. The construction sector was the worst hit.0) (15.9 3.
0 205. and would have kept on increasing if interest rates had not declined.0 697.0 105.0 1.0 72. Mostly suffering from a liquidity squeeze. rupiah values of dollar-denominated debts due to the weakening of the local currency and the rapid decline in equity because of losses.1) 7.6 (11. Vol.19 DER and ROE of Publicly Listed Companies by Sector.395.1 1. First.0 92.0) (78.1 (124.0 1.0 2.2 (4. Impact on the Banking Sector Table 1.1) Note: DERs were calculated for only 161 companies (out of 214) that had positive equity.0 65.1 (5.0 163.0 108.0 229.5 percent in April 1998.8 17.7) 6.40 Corporate Governance and Finance in East Asia.0 307. II Table 1.0 177. . Source: JSX Monthly.4) 18.271.9 12.0 1998 186. Third.20 reveals that the banking sector’s ROE decreased significantly in 1997. 1996-1998 (percent) DER Sector Agriculture Mining Basic Industry Miscellaneous Industry Consumer Goods Industry Property Infrastructure Finance Trade/Services Average 1996 104.0 12.2) (264.0 193. Second.2 23.8 percent in 1996.7 percent in July 1998. Financial and banking analysts estimate that by September 1998. The table also reveals that although private national banks dominated the banking sector in terms of assets and credits.6) (115.1 (3.1 30.0) 10.370. The huge losses suffered by most companies were caused by three factors.0 158.4) 8.3 7.0 864.0 1.6) 15.4 (6. As the rupiah weakened and interest rates increased. This figure further increased to 47. losses in operation were due to declines in sales and increases in the cost of imported inputs.8 (373. but annualized to approximate full year values.0 1997 234.5 8. small foreign banks enjoyed the highest profits. several publications. interest expenses rose as credit rates increased from 20 percent in early 1998 to 40 percent in mid-1999. the NPL ratio rose to 25.8) 36.0 635.0 2. private banks posted negative ROEs in the same year.0 a ROE 1996 1997 1998a 14.0 111.0 631. a Actual data for 1st semester only.0 191.0 219.097. foreign exchange losses came about with the use of unhedged foreign debt.4 5. as shown in Table 1.2 13. from only 8.0 177. the NPL ratio had reached more than 60 percent.0 97.7 1.21.1 (92.0 108.625.
24 15.1 1.6 — 13.9 Regional Foreign and Development Joint Venture Banks Banks — 9.68 1996 1997 8.1 198.86 11.20 ROE of the Banking Sector.2 — 19.45 — 1993 15.7 — 1.24 (4.37 19. 1992-1997 (percent) Type of Bank State-Owned Banks Foreign Banks Joint Venture Banks Regional Development Banks Private National Banks Total — = not available. Source: The National Banking Association.3 22.50 9.5 2.0 — 4.1 30.44 15. coupled with negative spreads (deposit rate was higher than the credit rate).2 1.73 30.2 8.07 1994 14.67 8.72 16.39 13.09 11.3 Private National Banks — 179.20) Table 1.70 1995 7.38) 11.0 — 32.6 — 4.9 11.7 4.06 20.3 361.09 (11.5 128.5 34.0 622.8 187.2 10.47 20.2 48. Source: Infobank.Chapter 1: Indonesia 41 Table 1. State-owned banks initially had the highest NPL ratio.30 5.3 445.91 21.69 14.9 — 11.1 13.8 14. put pressure on the banking sector.6 — 1.8 8.1 274.45 21. 227/1998 and October No.12 15.4 7. private national banks overtook State-owned banks when their NPL ratio jumped to 57.7 — = not available.34 16.28 5.5 57.0 129.89 27.84 27.2 37.07 13.7 106. 1996-1998 (Rp trillion) State-Owned Banks — 140.21 Nonperforming Loans by Type of Bank.2 — 8.5 31.9 percent.2 47. July No.5 222.7 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 331.81 13.25 22.1 47.2 8. In July 1998.8 11. The high and increasing NPLs.9 297.43 10. . however.7 29.15 20.8 3. 1992 7. 230/1998.6 6.
and Ciputra (property business). Since September 1998.7 billion of foreign exchange debt. By end-November. In June 1998.000/$1) in debt from domestic commercial banks.5. companies were not servicing their debts. The scheme encourages negotiation between creditors and debtors. Semen Cibinong (cement industry) became the first Indonesian company to resume paying part (25 percent) of the interest on its $1. Corporate debt accounted for 46. Aside from being described as overly complicated. II 1. few companies were in a position to resume interest payments. IBRA was formed to offer Mexican-style resolution for private sector foreign debt. On 9 September 1998. the scheme failed. the Government and private sector formed a committee to help corporates deal with the crisis. While the process of restructuring was in progress. none of the 2. Total amortization payments due on foreign debt in 1998 were placed at $32 billion (before restructuring). about 80 percent of which was private.3 Responses to the Crisis Corporate Restructuring Measures At the end of 1997. Thus.42 Corporate Governance and Finance in East Asia. 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. by mid-September 1998. such as Garuda (a national flag carrier). Another option that companies could take under the Jakarta Initiative was debt restructuring via debt-to-equity swaps. a more comprehensive scheme to tackle domestic and foreign corporate debt. Unfortunately.6 billion) of Indonesia’s total external debt in March 1998. In addition. The scheme offered a hedging facility against rupiah devaluations for restructuring agreements.4 trillion of domestic debt and $6. 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.000 eligible firms had signed up for the scheme.2 billion debt.7 percent ($64. only a . have been subject to restructuring deals under the initiative. the committee launched the Jakarta Initiative. the Jakarta Initiative Task Force had conducted negotiations for 52 companies with Rp2. In November. the corporate sector had more than Rp600 trillion ($75 billion at Rp8. Vol. particularly in terms of debt resolution. The committee was tasked to ascertain the level of private corporate sector debts and arrange negotiations between debtors and creditors. However. assembling the legal and policy framework to facilitate corporate restructuring. a number of prominent companies. Astra International (automotive).
. mining. consolidate business units. as well as general commercial disputes. Some listed companies with relatively “rich” shareholders decided to replace their loans with additional equity through rights issues and privileged subscription (limited offering). 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). Meanwhile. The Commercial Court can be asked to hold off creditors and impose strict guidelines on the negotiating process . Bank Bali agreed on a debt-to-equity swap with its creditor. Moreover.e. Astra International (automotive industry) and Bakrie Brothers (a holding company in several sectors) explored this option. with the requirement that adequate compensation and protection will be provided to such creditors during that period. Bankruptcy Reform The Bankruptcy Law was passed in August 1998.Chapter 1: Indonesia 43 few companies reached agreement with their creditors on this. forcing them to cut costs. Qualified professionals from the private sector will act as receivers and administrators in the management of estates of companies in bankruptcy or reorganization. For instance. Bank Niaga also negotiated with some of its creditors. i. 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. Standard Chartered. and mining equipment. under which the latter would become one of the bank’s shareholders. lay off workers. Astra International. a publicly listed company operating in the automotive industry. Procedural rules are also being introduced to ensure certainty and transparency in the proceedings. the companies’ financial performance deteriorated. and sell noncore businesses or nonoperating assets. 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. for equity infusion. Protection against insider and fraudulent transactions taken by a debtor prior to the adjudication of bankruptcy will be enhanced. Debtors. When credit from the banking sector became unavailable and interest rates increased significantly. Rabobank and Citibank. plantations. some companies attempted to restructure their businesses on their own. aiming to modernize the bankruptcy system and promote the fair and expeditious resolution of commercial disputes. especially in preventing unjustifiable delays in the adjudication of bankruptcy. In the banking industry.
(iv) measures to recover liquidity support previously extended to troubled banks by Bank Indonesia. II to achieve liquidation of the company. in consultation with IMF and the World Bank. There will be changes in the implementation of the bankruptcy law. the Court’s early record has been a disappointment. collusion. the Capital Market Supervisory Agency allows companies to offer additional shares directly to the public. However. Capital Market Reform In the capital market. including procedures for handling operational issues and processing bankruptcy cases. Vol. since the market reflects the condition of the economy. the measure had only a minimal impact. companies were allowed to sell shares only by issuing stock rights. Rather. (iii) the merger. The bias in favor of debtors has retarded the pace of corporate restructuring. . the Government did not impose restrictions nor did it attempt to regulate capital flows. and (v) a strengthened banking supervision system. However. it is envisaged that the Commercial Court will play a central role in modernizing the commercial legal system. with only 17 cases filed as of November 1998. (ii) the resolution of nonviable private banks. In the longer term. To push bankruptcy reforms. 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. and nepotism (anti-KNN) was signed in 1999. Realizing that they undermine investors’ confidence. legislation against corruption. Some companies simply decided not to pay their loans knowing that it would be difficult for creditors to take the case to court.44 Corporate Governance and Finance in East Asia. The Government has also been concerned with the issue of capital controls. The Government. 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. Banking Sector Reforms The Government’s banking sector reform strategy is focused on (i) government-assisted recapitalization programs for potentially viable private banks. The Agency also allowed companies to buy back up to 10 percent of outstanding shares to improve the condition of the stock market. Previously. and recapitalization of state banks. is also reviewing the Bankruptcy Law. reform.
regulations will need to be issued to permit debt-toequity swaps in the context of corporate restructuring plans. the Government required banks to be audited by international external auditors. 1. To overcome these problems. and follow-up action on bank restructuring. depositors will be fully protected by the Government. BEII. improvement of rules and prudential regulations. In October 1998. Bank Indonesia has announced a recapitalization program for potentially viable private banks. Parliament approved amendments to the banking law that were geared toward strengthening the legal powers of IBRA and its AMU. BBD. To obtain a clearer picture of the banking sector. It has also drafted regulations to remove obstacles for converting debt to equity. the Government established IBRA to supervise problem banks. was enacted in 1999. Conclusions. In particular.1 Summary.6 1. The Company Law at present can be interpreted as severely limiting the scope for debt-equity swaps. or sold (after transferring NPLs to the AMU). The four state banks (BDN. Some 175 groups that originated from family businesses controlled . and Bapindo) will be merged into one bank named Bank Mandiri. Banks deemed ineligible for recapitalization will be closed. it is doubtful whether pure holding companies are able to enter into swaps. The importance of this legislation may need to be emphasized. However. The merger process will be finished within two years.Chapter 1: Indonesia 45 In 1997. The Bank Indonesia 21st package includes recapitalization. and Recommendations Summary and Conclusions Corporate Ownership and Structure Most of Indonesia’s top conglomerates were established as family businesses. Liquidity support given to troubled banks should be repaid in four years.6. Other Regulatory Reforms To push corporate restructuring further. merged. 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. The agency set up an Asset Management Unit (AMU) to directly manage problem loans of banks under its supervision.
Companies relied heavily on bank credit. Therefore. not all of the conglomerate-affiliated companies are publicly listed. However.46 Corporate Governance and Finance in East Asia. However. The financial crisis created opportunities for addressing the inefficiencies in the legal and judicial system that supported corruption. families control 67. this financing pattern supports the claim that family-based controlling shareholders relied on excessive borrowing to finance corporate expansion . Among those listed in the Jakarta Stock Exchange. thus.1 percent of publicly listed companies in Indonesia. conglomerates set up their own banks to serve as “cashiers” providing credit to companies within groups. allowing them to maintain their equity shares and. banks were unwilling to provide credit to highly leveraged companies. This study reveals that Indonesian listed companies with higher ownership concentration had higher levels of leverage. however. corporate debts grew over time.6 percent of the total stock market capitalization in 1996 and the top 15 families controlled 61. put a significant amount of corporate assets of conglomerates in the hands of creditors or the Government. 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. The free capital flow system permitted the inflow of foreign capital to fuel the credit boom in the economy. Vol. when barriers to entry in the banking sector were lifted. the majority remains family-controlled. retain ownership control of companies. When the Government regulated the legal lending limit and the net open position of banks. II 53 percent of total assets of the top 300 Indonesian conglomerates. while a single family controlled 16. On average. The restructuring and resolution of financial distress may. These figures show the extent of power wielded over the corporate sector by a small number of families. These banks also obtained cheap offshore funds. Foreign creditors.7 percent. But because foreign creditors were reluctant to lend long term. conglomerates set up finance companies to bring in cheap foreign loans as these companies were not adequately regulated. Indonesian companies borrowed short term. meanwhile. Rapid growth in investments masked the corporate sector’s increasing leverage. lacked the information necessary to allow them to assess projects’ risks and chances for success. As a result. Financing Patterns Controlling shareholders opted to use debts to finance expansion. On the one hand.
Meanwhile. the highly leveraged companies. The Government introduced reforms to improve bankruptcy procedures. Sales of conglomerates as well as those of publicly listed companies were increasing. Impact of the Financial Crisis Prior to the crisis. the consumer goods industry was the worst hit. Total profits of publicly listed companies dropped to Rp3.21 trillion in 1996. were the most adversely affected. NPLs rose and capital adequacy ratios fell.1 percent in 1997 to -124. To restructure the corporate sector. Responses to the Crisis The impact of the financial crisis on the corporate sector was serious. although at a declining rate. The problem was in the maturity structure of its dollar-denominated debt and high debt-to-equity ratios in some sectors. ROE dropped from 1. the Government initiated corporate debt restructuring measures (Mexican-style foreign debt resolution and the Jakarta Initiative). Bank Indonesia extended emergency loans to many banks. the high domestic interest rates that prevailed from 1998.Chapter 1: Indonesia 47 without diluting their control. The financial crisis led to the closure of several dozen banks. corporate-initiated debt restructuring . followed by the property sector. and strengthen prudential regulations and supervision of the financial sector. particularly those with large short-term foreign loans. At the height of the crisis.24 trillion in the first half of 1998. and registered a net loss of Rp39.370 percent in 1998. financed by issuing nearly $80 billion worth of bank restructuring bonds. facilitate debt restructuring. and the rapid decline in equity due to losses. On the other hand. When the crisis hit Indonesia. As the rupiah weakened and interest rates increased. Net profits of publicly listed companies had consistently been growing at an average rate of 20 percent each year.1 trillion in 1997 from Rp13. DER increased to 307 percent in 1997 and further surged to 1. The Government and the private sector responded with measures to mitigate the negative effects. it also reflects the failure of the financial sector to channel funds to the corporate sector efficiently due to weak prudential regulation and supervision. The significant increases in leverage indicate a rapid rise in the rupiah value of debts due to the revaluation of dollar-denominated debts. the corporate sector was in quite good shape in terms of growth and profitability.1 percent in 1998.
but it is not clear whether in practice these standards are in place.. Protecting Minority Shareholders’ Rights The Corporate Law provides sufficient rights and protection for all shareholders. Specific recommendations include protecting the rights of minority shareholders.2 Policy Recommendations The Government should introduce measures to address the weaknesses in corporate governance identified in this study. the legal system is less likely to evolve in a manner that will allow it to protect minority shareholders. minority shareholders have not been able to oppose controlling shareholders’ decisions to invest in unprofitable projects financed by unhedged foreign currency debts. The Government should ensure that all laws and regulations are effectively enforced. cost cutting and business consolidation) and acquisitions by creditors or foreign investors through debt-to-equity swaps and equity infusions. Improving the Legal and Regulatory Framework for Bank Supervision After the liberalization of the financial sector. II measures included internal business restructuring (e. 1. Vol. 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.6.g. The Corporate Law should be reviewed and amended in the context of pervasive control by large shareholders. and protecting creditors’ rights. improving the legal and regulatory framework for bank supervision. 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. the regulatory environment was not prepared to supervise the increasing number of banks and nonbank . and (iii) strengthening transparency and disclosure requirements. (ii) delineating the functions of the board of directors and commissioners.48 Corporate Governance and Finance in East Asia. Most companies claim to have adopted international standards of accounting and auditing procedures. but inadequate protection to minority shareholders from the dominance of large shareholders. In particular.
Protecting Creditors’ Rights To protect creditors’ rights. This is a significant factor in . the banking regulatory framework was inadequate in regulating banks’ dealings with affiliated nonfinancial companies. The ownership of banks (including finance companies) by shareholders of nonfinancial companies undermined the capability of these banks to conduct prudential credit management. orderly restructuring. the Indonesian corporate sector directly owes an inordinate amount and a greater portion of its loans to foreign banks. Consequently. it is likely that future private financial flows for the corporate sector will continue to conform to a short-term structure. When finance companies were used to channel offshore loans in lieu of commercial banks. recapitalization. Further. the Government lost monitoring and control powers over foreign fund flows. In the first place. in contrast to the Republic of Korea and Thailand. with necessary legal sanctions for violations. most of banks’ NPLs resulted from credit to companies within the same group. The Central Bank needs to monitor and control dealings by banks within business groups and improve enforcement methods to prevent circumvention of prudential regulations. However. the Republic of Korea and Thailand were more successful in getting foreign creditors to collectively solve their problems during the crisis. The tendency of foreign creditors to lend short term is a problem that must be confronted once private capital flows to Indonesia recover. and liquidation of corporate assets. a new bankruptcy law was passed in the aftermath of the crisis and a Commercial Court was set up to deal with bankruptcy cases. the Court has been slow and ineffective in processing bankruptcy suits. Banks should be required to provide data on such transactions and charged penalties for noncompliance. it has been difficult to implement standstills. Because these banks are neither easily convinced nor compelled to submit their claims to the jurisdiction of Indonesian commercial and bankruptcy courts.Chapter 1: Indonesia 49 financial institutions. One way is to set limits on lending activities by banks to affiliated nonfinancial companies. The regulatory framework was also weak in supervising and monitoring foreign transactions. The Government should also continue strengthening the monitoring system for foreign exchange transactions. With credit being coursed through the domestic banking system rather than directly to numerous local corporations. Because foreign creditors are faced with more information asymmetries than domestic creditors.
despite the smaller level of capital inflows (as a percentage of GDP). 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.50 Corporate Governance and Finance in East Asia. Vol. . II explaining the greater depth of the crisis in Indonesia. Only when creditors have the confidence that their rights are protected will they resume financing companies.
Wright. Claessens. 1995. Corporate Governance: Responsibilities. Conny Tjandra Rahardja. Indonesian Business Data Centre. Yogyakarta. and Larry H. Michael Krill. various publications. Lang. University of Maryland. Bank Indonesia. Indonesia Country Profile. Keasey. and M. 1999. Risks. Center for International Business Education and Research.Chapter 1: Indonesia 51 References ADB Programs Department (East). Indonesian Capital Market Directory 1992-1998. Unpublished thesis MMUGM. Financial Sector Practice Department. Stijn. K. 1996. 1999. Institute for Economic and Financial Research. Indonesian Central Bureau of Statistics. various publications. Asia in Crisis: The Implosion of the Banking and Finance System. World Bank. various publications. Indonesia: An Emerging Market. Letter of Intent of the Government of Indonesia to the IMF. Delhaise. 14 May 1999. John Wiley and Sons. The Private Debt Anatomy. The Impact of Acquisition to Shareholders Wealth: Comparison Between Internal and External Acquisition. 1998. Who Controls East Asian Corporations? Financial Economics Unit.. Embassy of Indonesia. Embassy of Indonesia Homepage. 1997. Economy of Indonesia. and Remuneration. Working Paper #58. Jonathan. P. 1995. Indonesian Business Data Centre. Indonesia: Sustaining Manufactured Export Growth. Maryland. Jakarta Stock Exchange. Large and Medium Manufacturing Statistics. various publications. F. Conglomeration Indonesia: Regeneration and Transformation into World Class Corporate Entities. The Economist Intelligence Unit. 1998. . Economic and Financial Statistics. P. JSX Monthly Statistics. John Wiley and Sons. Indonesia Country Report. 1997. and Richard Turtil. Simeon Djankov. Forest. 1996. The Economist Intelligence Unit. Manuscript.
and corporates were sent reeling.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. Chung-Ang University. and David Webb of the London School of Economics for their guidance and supervision in conducting the study. 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. . The country’s winners would then emerge based only on economic efficiency. 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. Poor corporate governance and political and government intervention in the business and financial sectors are widely viewed as contributory factors.1). The authors wish to thank Juzhong Zhuang. markets. This has been the crux of the corporate governance problem in Korea. 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. the Government and business sector had good reason to reflect on the causes of the crisis. and Graham Dwyer for his editorial assistance. both of ADB. Korea) in November of that year.2 Republic of Korea Kwang S. internal control mechanisms. Further. Department of Economics. Seoul. It had been the norm in Korea to conduct business based on political and administrative favoritism rather than on competitive merits. the Korea Stock Exchange for its help and support in conducting company surveys. David Edwards. Business managers and controlling shareholders were maximizing firm size at the expense of profits. 1 Professors. Inefficient investment coupled with excessive financial leverage was found to be at the root of the economic crisis at the corporate level. timely exit of poor performers from the market. Chung and Yen Kyun Wang1 2. and curtailing of morally hazardous behavior that has been prevalent among economic decision makers. As the Korean currency. a practice that was not checked by creditors.
which distributed and collected the questionnaire.1 1996 561 163 29. T.1 1997 518 104 20. and J Murrin (1995). Copeland. Government reform goals for the corporate sector include enhancement of corporate transparency. especially chaebols. capital market discipline.5 Note: The EVAs are calculated as: EVA = NOPAT – WACC. . Weaknesses in the overall corporate governance system in Korea had many ramifications.1 1995 560 163 29. and individual companies. 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. This study collects and analyzes data on the Korean economy. Many firms left some questions unanswered. 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. Inefficient investment undermined the competitiveness of Korean firms in the global marketplace. Vol. A survey was conducted for the nonfinancial listed companies using a questionnaire developed by the Asian Development Bank (ADB)2 to supplement official data. aiming to identify the areas in need of further reform and to provide policy recommendations for improved corporate governance.1 1998 490 164 33. June 1999. II Table 2.1 Listed Firms with Positive Economic Value Added. The total number of respondents was 81 out of about 550 nonfinancial firms listed on the Exchange. the corporate sector. and improvement of bankruptcy procedures. The EVAs are the same as the economic profit as explained in T. 1992-1998 Item Total Number of Firms Firms with Positive EVA Percentage of Firms with Positive EVA 1992 508 180 35. Koller. Restructuring efforts have focused on reduction in the degree of business diversification and in the financial leverage of large-sized firms. This broad perspective can help clarify the ongoing reform efforts of businesses and the Government. accountability of controlling shareholders and boards of directors. Dividend payments were at less than 2 percent annually as opposed to the double-digit interest rates in the past decades. This study also reviews the legal and 2 The survey was conducted mainly through the Korea Stock Exchange. Source: Korea Stock Exchange.9 1994 531 165 31.54 Corporate Governance and Finance in East Asia.
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. It then presents recommendations for further reform in corporate governance and financing. the import liberalization rate was below 7 percent and the average tariff rate was in the range of 25 to 30 percent. Yang.2. the board of directors system.1 Overview of the Corporate Sector Historical Development3 The development of the Korean corporate sector is closely related to the progress of the economy. Section 2. creditors. It traces the country’s economic development.4 contains analyses of corporate financing and its relationship to performance. 3 The review of historical development of the Korean economy draws substantially from the book by Sohn. The Government tried to produce food. Import Substitution: 1948-1961 The Korean War (1950-1953) devastated Korea’s industrial capacity.2. The evolution of the modern Korean economy can be divided into four periods. Major economic indicators for some of these periods are shown in Table 2. and naturally adopted an import substitution policy.2 presents an overview of the corporate sector. clothing. Section 2. and Yim (1998). which account for a substantial portion of the Korean economy. In the period 19481961. reviewing government policies responsible for the development of the modern corporate sector. corporate control by the Government. 2.6 discusses responses of the Government and the business sector and explains in detail their reform and restructuring efforts. and other necessities domestically. Section 2. From 1948 to 1961. Section 2. and employees and their role in shaping corporate governance practices. . It reviews such elements as shareholders’ rights. the Government relied heavily on aid from the United States (US) and United Nations to alleviate poverty and high inflation.3 identifies characteristics of corporate governance by analyzing the ownership structures and control patterns of listed companies and the largest chaebols.Chapter 2: Korea 55 regulatory framework for the corporate sector and reform measures taken after the crisis. This chapter is composed of six sections.2 2. Section 2.
However. high unemployment and inflation. modernizing the industrial structure.2 Key Macroeconomic Indicators Annual Average (percent.1 9. Source: Bank of Korea.7 37.5) (1.8 12. the Government was not successful in solving the problems of slow growth.5) 8. d Refers to 1997.5 250. The Government tried . In 1961 it devalued the won from W65 to W130/dollar and announced its first Five-Year Economic Development Plan (1962-1966).2 757.1 15.1 percent with moderate rates of inflation and introduced a series of reform packages aimed at developing key industries. 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.4 24.9 — — 21. II Table 2. c Refers to 1989. a Refers to 1971.2 314.2 1980-1989 8.9b 15.2 452. This goal required very high savings and investment rates.1d 9. and implementing new budget and tax measures.2 6. 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 8.56 Corporate Governance and Finance in East Asia.0 27. lack of strong drive.0) 492.6 11. and inconsistent economic policies.1 29.3 8.4 10. the Government redirected the policy focus away from import substitution to an export-led manufacturing-based economy.753.8 (724.4 (1.7 14.8 15.1 — = not available.4 29.4 29. In the Plan. Economic Statistics Yearbook.2 30. International Financial Statistics. Vol.4 1990-1997 7. b Refers to 1979.447.7 30.7c 11.0 41.855.265.102.332.9 794.5 38.2 31. e For maturities of one year or more.9) (7.8 (8. Export Drive: 1962-1971 Between 1962 and 1971.1 35.8 24.0) (297.1a 21. the Government called for an unprecedented average annual economic growth rate of 7.9) 1. and large current account deficits. IMF.2 1.2 32.949. largely because of political instability.
the growth of gross domestic product (GDP) raised domestic savings.3 percent average between 1954 and 1959. due to continuous current account deficits.5 percent. This change raised the import liberalization rate from 9. and almost doubled the foreign exchange rate from W130/dollar to W256/dollar to enhance the international competitiveness of exports. but tariff rates were raised to 40 percent in the 1960s. up from 30 percent in the late 1950s. resulting in high real interest rates. while the average tariff rate was 39 percent. The exchange rate system was a kind of crawling peg until 1974. In 1964. boosting internal investment resources. During this period. imports of consumer goods and luxury items were highly restricted. Korea normalized political and economic relations with Japan to encourage inflows of Japanese capital that could finance big development projects. Also. and maximizing mobilization of domestic savings on the other.2 billion in 1972. But the liberalization trend turned out to be short lived as current account deficits continued.Chapter 2: Korea 57 to meet its targets by borrowing large amounts of foreign capital on the one hand. the Government undertook important economic reforms in two areas: the foreign exchange rate and the interest rate. which laid a solid foundation for a steady growth path.3 percent to 60. The average growth rate of the economy from 1960 to 1964 was 5. The well-educated. During the first five-year plan period. In 1971. the import liberalization rate was 55 percent.4 percent. The Government abolished temporary direct subsidy measures and introduced a new comprehensive export promotion system. and cheap labor force was well utilized by the export-led growth strategy. These were considerably liberalized in 1967 when Korea joined the General Agreement on Tariffs and Trade (GATT). The positive list system for imports was replaced with a negative list that indicated only those items that could not be imported. Bank deposits increased rapidly. In 1965 the interest rate on one-year deposits doubled from 15 to 30 percent. abundant. the Government tried to provide exporting firms with a free trade environment. Exports increased sharply from $41 million in 1961 to $2. the Government changed the multiple and fixed exchange rate system to a unitary floating exchange rate system. but the average growth rate for 1965-1969 shot up to 10 percent. 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. a modest improvement over the 4. However. In 1963-1964. . channeling funds from curb markets into the banking sector.
reducing or exempting debts of farmers and fishermen. II Heavy and Chemical Industry Promotion: 1972-1979 In the Third Five-Year Economic Development Plan (1972-1976). the Government felt the need to strengthen the defense industry.6 billion between 1973 and 1981 into these sectors. The Government targeted six industries—steel. and giving low interest rate loans to banks from the central bank. where preferential export credit was given to almost every exporter. faced the danger of bankruptcy. The Government encouraged a variety of business projects. electronics. in the face of a world economic slump. machinery (including automobiles). and assigned them to specific chaebols. the Government changed its industrial policy emphasis from light industries to heavy and chemical industries (HCIs). less developed countries forced Korea to adjust its industrial structure. This strategy formally took off with the announcement of the HCI Promotion Plan in June 1973. One industrial policy adopted during the heavy and chemical industrialization drive was administered credit rationing. These practices contained an implicit government guarantee that large businesses and banks could never fail. There were three reasons for the switch: first. investing a total of $9. Third. shipbuilding. 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 . By promoting HCIs. nonferrous metal. Unlike the previous system. 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. becoming a seed of the economic crisis in 1997. The Government has since used similar emergency rescue measures for large businesses and banks almost once every 10 years. overburdened with debts and high interest rates. announcing rescue packages for businesses and banks. the Government felt that continuous trade deficits arising from increasing intermediate and capital goods imports could be prevented by developing import substitution industries. and chemicals—as future core industries. it tried to substitute imports and export high value-added HCI products. These included rescheduling business debts. In 1972. Vol. It included a detailed construction and investment schedule over a 10-year time frame and mandated coercive implementation. the domestic economy was stagnant and many businesses. Second.58 Corporate Governance and Finance in East Asia. The Government took emergency measures. the emergence of competition of other low-wage. It promoted HCIs by supplying massive capital for construction and development.
including denationalization of banks. a heavy foreign debt burden. the Government adopted comprehensive measures to promote economic stabilization.Chapter 2: Korea 59 through state-controlled banks. In order to improve economic efficiency. various measures to increase competition were taken. price controls were abolished. The growth rate of the money supply was reduced drastically. In 1986-1989. and the won depreciated by 20 percent with the adoption of a Basket-Currency Gliding System in 1980. coupled with political uncertainty due to the assassination of President Park in 1979. and their utilization ratios were very high. New start-up firms. The severe world recession caused by the second oil shock. Macroeconomic policies became hostages of the industrial strategy. Economic Liberalization and Globalization: 1980-1997 In 1979. Meanwhile. faced with high inflation. However. Korea recorded current account surpluses and rapid economic growth due to the “three lows”: low value of the US dollar. low . Gross national product (GNP) growth rates on average were higher in the 1972-1979 compared to 1962-1971 (Table 2. the policy wasted substantial amounts of resources in the short and medium terms. Firms that followed the Government expanded greatly. This required industrial restructuring by the Government. met increased difficulty.2). since during the second half of the1980s many of the promoted firms became world-class competitors and exporters. the Government restructured some large businesses through forced liquidation and M&As. imports were further liberalized while tariff rates were lowered. The two important ones were import liberalization and deregulation of the financial sector. and the large excess capacity of HCIs. Meanwhile. Evaluations of HCI promotion policies are mixed. The plan of the 1970s was thought to be successful in the long run. Such an approach gave the Government increased control over the economy. however. Cheap credit and distorted prices resulted in overexpansion in the HCIs. light manufacturing and service industries were weakened by disadvantages such as a lack of credit. especially between 1979 and 1985. such as widespread underutilization of capacities of HCIs and related plants. The industrial and trade policy resulted in high inflation in the 1970s and serious excess capacity problems by 1979. with many turning into the now well-known chaebols. fiscal expenditure maintained zero growth. as it had to control only a few large chaebols. exacerbated the overcapacity problem. including forced liquidations and mergers and acquisitions (M&As). The incentives available became more market-based.
9 percent. .” A large-scale business group is called a chaebol. 4. Korea became a signatory country to the International Monetary Fund (IMF) Article VIII. II world interest rates. but it chose to liberalize gradually. Industrial and trade policies were modified to be consistent with WTO. In 1988. total sales. 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. The most important element characterizing chaebols is the concentration of ownership. which gradually widened.1 percent. the Government committed itself to further liberalization of the goods and capital markets. and total workforce. while continuous and large current account surpluses saved Korea from the foreign debt problem.3 percent. The official rate fluctuated within a band. and declaring that it would follow Article XI of GATT. total assets. Meanwhile. In 1993. By joining the Organisation for Economic Co-operation and Development (OECD) in December 1996. giving up its foreign exchange controls related to the current account. Korea abolished remaining direct subsidy systems for export activities as well as some traditionally managed trade systems. 45. In 1990.9 percent. where particular individuals and their family have de facto control of the management of all subsidiary companies of groups. with the 30 largest in the total economy in 1997 standing as follows: value-added. 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). 46. and acceded to the World Trade Organization (WTO) in 1994. 47. further increasing its pace of import liberalization.9 percent. and low oil prices. the importance of chaebols was increasing. whose business activities are controlled by an identical person. joined the Asia Pacific Economic Cooperation (APEC) Group in 1993.60 Corporate Governance and Finance in East Asia. 2.1 percent and average tariff rates 8. the import liberalization ratio reached 98. Vol.2 Rise of the Large Business Groups (Chaebols)4 The Korean Fair Trade Act defines a business group as “a group of companies. The low value of the dollar led to a low won and high yen. The Government tried to adjust economic policies and regulations to meet global standards. 13. Korea began participating in many multilateral trade negotiations during the Uruguay Round. Korea adopted a market average exchange rate system.2 percent. total debts.2.
when the Government put a great deal of emphasis on development of the HCIs. This galvanized the fast growth of chaebols. financial assistance. Subsidiary companies of chaebols are subject to “fleet-type management” in that they are controlled by the overall managerial system of chaebols. Table 2.3 shows that the number of subsidiaries of the 30 largest chaebols increased considerably since 1993. it was more effective to deal with a small number of companies to secure tangible outcomes. the number of subsidiaries declined drastically due to corporate restructuring. In the mid-1970s. . In this sense. Since the Government controlled most business activities.Chapter 2: Korea 61 War II. and they are aided and supported by one another.5 20.3 Source: The Fair Trade Commission. However. Since the 1960s. This policy contributed greatly to the expansion of chaebols.8 22. of Subsidiaries 604 616 623 669 Average No. chaebols that maintained a close relationship with the political authorities were able to grow fast.1 20. of Subsidiaries per Chaebol 20. and tax breaks to key industries to promote exports and industrial upgrading. The Government provided subsidies. Large-scale companies owned by the Japanese were sold to individuals under preferential terms and later enjoyed a relatively favorable position for accumulating capital. Chaebols are also excessively diversified. From the standpoint of the Government. reaching 669 in 1996. Table 2. The Government provided financial and fiscal incentives to chaebols and trading companies with relatively abundant financial resources.3 Subsidiaries of the 30 Largest Chaebols. large-scale businesses and chaebols were thought to be appropriate actors because they could meet the huge investment requirements of these industries. Important managerial decisions are made primarily by owners. after the financial crisis. One reason for this controlling power is inter-company shareholding among subsidiaries. 1993-1996 Year 1993 1994 1995 1996 No. the Korean Government has set the national goals of economic development and offered all kinds of support and incentives to achieve them. the ownership and management of a chaebol’s subsidiaries are not separate. Chaebols have a history of substantial concentration of ownership.
Under this law. II Theoretically. In the early years after the enactment of the law. if a chaebol has an unsound financial structure but strong financial links through mutual payment guarantees among their subsidiaries. etc. Another law that contributed to the development of the stock market was the Act to Expedite the Going Public of Corporations of 1972. For example. years since establishment. the Government reviewed the financial performance of companies and recommended (or ordered) selected ones to go public. the Government’s efforts to develop the stock market culminated in the Capital Market Development Act of 1968. profitability. diversification can make chaebols stable through the portfolio effect. and were allowed extra depreciation charges for tax purposes. the bankruptcy of one or a few marginal subsidiaries could lead to a chain of bankruptcies for the entire chaebol. chaebols can benefit from synergies. Since chaebols are engaged in many different businesses.62 Corporate Governance and Finance in East Asia. Meanwhile. there are many negative assessments of organizational structures and practices of chaebols. internalization of the market that could enhance the internal efficiency of a chaebol may close the market to other firms. This could ensure their stable growth and enhance their investment abilities. they can reduce uncertainties and dilute risks through sharing of information and diversification. On the other hand. which may ultimately lead to the decline of social efficiency. This law was in effect until 1987 when it was partly absorbed into the Capital Market Development Act. Related to this is the tendency of chaebols to assist unprofitable firms at the expense of profitable ones. They had to meet certain requirements in terms of firm size. including the “economies of organizational size” inherent in multi-product and multiplant firms.2.3 Role of the Capital Market and Foreign Capital In the 1960s. Vol. 2. However. in addition to the usual economies of scale. The law also allowed employees of listed firms to get 20 percent of the subscription rights in offerings of new shares. 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. 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. .
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).5 406.4 654. In this regard.6 747. The aggregate Table 2. the Government announced the gradual opening of the capital market to foreign investors in January 1981.1 Market Capitalization (W billion) 6.370 70.9 918.020 151.2 44. several important policy measures were implemented to promote the development of the stock market.6 Year 1985 1989 1990 1994 1995 1996 1997 1998 Source: Monthly Review (Securities Supervisory Board) and the Financial Supervisory Service. 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. The Korea Fund.217 141.1 30. was established to invest in domestic shares beginning in September 1985.7 934. .798 Market Capitalization as a Ratio to GDP (%) 8.9 34. mainly by increasing the supply of shares by initial public offerings (IPOs) and seasoned issues. the Government attempted to stabilize the stock market by limiting IPOs and share issues by listed companies. Third. the Government announced measures to increase the demand for shares by providing tax and financial incentives to individual investors.476 79. Second. Beginning 1990.Chapter 2: Korea 63 During the 1980s and 1990s. Also that year. in 1986 the Government imposed limits to bond issues on firms that were recommended to go public but refused. of Listed Firms 342 626 669 699 721 760 776 748 Stock Price Index 138.989 137. Inc. especially those paying small or no dividends. As shown in Table 2. 1985-1998 No. the stock market grew rapidly during the 1980s.0 965. a country fund.0 79.1 16.0 49.9 833. This reversal in policy reflected declining stock prices and was generally maintained until the outbreak of the economic crisis in 1997.4 40.4.4 Development of the Stock Market. continued until 1989. The policy to expand the size of the stock market. First. however.570 95. Because of government policies and the booming economy..151 117.
440 1.347 3. Vol. The growth in the number of listed firms also slowed in the 1990s.414) 5.875 21.86 percent of GDP in 1997. Source: Balance of Payments. due to declining stock prices. II market value of all listed firms represented only 8 percent of GDP in 1985.008) (3.326 1.694) 2. trade credits.500 7.123 3.183 12.339) (9.126 (1.924 (1.264) (3.150 5. Other investments include loans.239 19.910) 2.785 (1. currency and deposits. The aggregate market value of listed shares bottomed at 16.571 2.453 (2.852) (2.413) 56.737 (333) (297) (607) (2) 218 2. The reasons for the decline include increases in bankruptcies and mergers involving listed companies since the outbreak of the economic crisis.5 Private Capital Flows to Korea. 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 1986-1989.001 4. and stayed at the 30-40 percent level up to 1996.642 21.714 1.942) 42.450 24.2 percent by 1989.534) 1.817 16.255 2. but rose again to 34.742 (3.800 (7.296) (6. and other liabilities.5 shows net FDI—inward investments by foreigners less outward investments by Koreans—in the period 1985-1998.338 4.583 25 10.650 (1. However.455) 13. The number shrank for the first time in 1998 to 748 firms from 776 the previous year.658) (3.542) (1.64 Corporate Governance and Finance in East Asia. Table 2.59 percent in 1998 and to more than 50 percent in the early months of 1999. . 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) (2.352 471 3.953 10.944) 8. Table 2.858 4. foreign direct investment (FDI) has been very small relative to GDP and compared to other East Asian countries.017) 1.546 (2.870) (1.553 8. The relative size of the stock market diminished to 44 percent in 1990.287 (340) 73.085 2.382 Permit basis. but increased sharply to 79.433) (9. Bank of Korea. and 1993.141 4.868 (518) (418) 63 1.149 13.
but between 1988 and 1993. and (iii) chaebols.2. Return on equity (ROE) and return on assets (ROA) showed similar patterns. The contribution of the corporate sector to GDP was 73. increased substantially in 1994-1996 due to accelerated liberalization of capital movements (Table 2. weak incentives for attracting FDI. Table 2. and US.9 billion.7 compares the ratio of ordinary income to sales of Korea’s manufacturing sector with those of Japan. This would lay the foundation for evaluating the effect of corporate governance on performance. The dismal performance of the Korean corporate sector compared to the . the growth rates of equity and sales dropped sharply in 1996 and 1997. The growth rates of total assets. The debt-to-equity ratio (DER) averaged 311 percent for the period 1990-1996 and peaked at 424.5).China. Of this.6). Between 1986 and 1989. Taipei. Profit rates of Korean firms were relatively low compared to those of Taipei. 2. The same categories will be analyzed in later sections. Corporate sector net proft margins increased from 1993 to 1995. and sales of the aggregate sector during this period were very high (Table 2. but dropped in 1996 and were negative by 1997. Net private capital inflow. Korea had substantial current account surpluses and experienced net private capital outflow. and high production costs were the main reasons for low FDI in Korea.2 percent in 1987.Chapter 2: Korea 65 Complicated government regulations. However. increasing to 76 percent in 1997. The ratio is generally in the same range for Japan and Korea. The Aggregate Corporate Sector The aggregate corporate sector in this study excludes the financial sector. This indicates that a substantial proportion of debt was denominated in dollars. (ii) listed firms. other net private capital inflows amounted to $130 billion during 1985-1998. portfolio investments amounted to $73. In addition to FDI. Japan’s was consistently higher. equity. Large amounts of outward investment by Koreans in the mid-1990s arose out of increased liberalization of foreign exchange regulations. following the sharp depreciation of the won. excluding FDI.7 billion and loans $42.6 percent in 1997.4 Growth and Financial Performance This section looks at the performance of (i) the aggregate corporate sector.China and the US.
8 2.3 21.5 1.0 10.5 0.7 3.0 (0.3 3.1 2.0 4.1 2.1 — — — = not available.4 — 6.3 21.6 (4.9 13.9 8.4 2.8) 297.1 2.7 4.7 4. ROE = return on equity (ratio of net income to stockholders’ equity).7 325.7 2.8 1. Net profit margin = ratio of net income to sales.3 6.2 1.9 3. Ordinary income = operating income + nonoperating income (from financial activities) – nonoperating expenses (from financial activities).9 16.3 312.0 7.0 13.2 13.0 13.7 15.8 3.7 International Comparison of Ratios of Ordinary Income to Sales in Manufacturing (percent) Year Korea US Japan Taipei.5 2.2) (0. .9) DER = debt-to-equity ratio. Financial Statement Analysis Yearbook.9 4.1 6.9 2.6 13.0 6.9 18.9 2.1 5.2 13.5 1.4 10.5 4.6 1.6 3.4 19. 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 23.8 21.9 18.China 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 2.Table 2.7 15. Table 2.4 4.9 5.3 1.6 Growth and Financial Performance of the Nonfinancial Corporate Sector.4 1.5 (0.3 11.3 17.6 4.3 — 3.5 3.7 3.2 1.5 4.6 424. ROA = return on assets (ratio of net income to total assets).0 8.0 3.9 2.4 1. Note: Ratio of ordinary income to sales = (ordinary income/sales).6 318.3) 5.5 1.6 1.8 22.8 1.4 1.6 9.0 0.9 5.2 1. Financial Statement Analysis Yearbook.9 3.2 9.7 1. Source: Bank of Korea.4 2.3 14.2 19.3 308.9 5.8 8. Source: Bank of Korea.4 2.2 18.9 16.3 335.1 8.6 2.5 7.0 305.7 4.
Listed Companies The number of listed firms increased from 334 in 1985 to 775 in 1997 (Table 2. All sectors experienced a sharp decline in equity and sales growth in 1997.8). This may be related to its having the lowest DER.4 percent. construction. Net profit margins. and transport sectors recorded negative profit rates in 1997. Profit rates of different industries also mirrored the downward trend of the aggregate corporate sector prior to the crisis.10). with the wholesale and retail trade sector and the construction sector having the highest figures. but higher than that of small firms.9).5 percent while the aggregate sector recorded only 13. The other financial ratios follow the general pattern of the aggregate corporate sector.Chapter 2: Korea 67 other three economies can be attributed to the emphasis on growth in sales and market shares rather than on profits. In 1997. A comparison of performance by firm size reveals some interesting results. It is notable that the construction sector’s profit rate began its decline in 1995. followed by mediumsized firms and large ones. This preference of Korean firms has its roots in the structure of corporate governance. . The manufacturing. The growth performance of large firms for the 1988-1997 period was better than that of medium. the sales growth of listed firms was higher than that of the aggregate sector (see Table 2.and small-scale firms (Table 2. The profit margin of listed firms was generally higher than that of the aggregate corporate sector.6). gas. However. and ROAs of all listed firms declined substantially in 1996 and turned negative in 1997. a year ahead of the other industries. with equity in wholesale and retail trade even contracting. and steam supply industry. this may be an indication of the bias toward large firms in terms of access to credit. trade. Again. both ROA and ROE were lower for the listed firms compared to the latter. ROEs. Small listed firms were hardest hit by the financial crisis. the average ROE was lowest for large firms. Profit rates of most industries are also quite low. while their average net profit margin was lower than that of medium firms. Growth rates of total assets are generally high. However. the exception being the electricity. In most years. Performance followed similar patterns across different industries (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. sales of listed firms grew 18.
2 (1.1 10.3 1.4 458.0 245.9 16.6 655.4 474.6 0.6 5.8 3.3 11.8 17.4 740.5 286.2 24.0 18.4 5.9 5.1) (3.0) 1.3 15.1 1.8 12.2 241.8 616.3 18.8 345.5 (0.4 10.8 10.2 12. and Business Activities 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 Average 11.8 24.3 14.8 34.6 2.8 2.6 6.0 1.5 1.2) 15.8 32.5) 0.4 9.0) 4.0 3.0 22.5 5.9 29.0 1.1 1.5 432.0 2.8 1.5 5.0 24.4 2.9 14.5 483.8 16.5 1.2 5.3 15.3 10.6 14.0 15.4 2.3 15.6 14.9 25.4 5.9 340.4 3.8 562.0 (0.5 270.6 1.7 10.1 2.2 36.4 0.8 526.3 11.7 (0.6 0.4 10.7 228.2) 22.7 4.9 538.1) 3.8 0.5 13.2 423.7 0.0 5.9 16.1 396.5 4.0 7.1 0.3 8.9 2.6 7.8 Real Estate.3 1.1 1.6 17.1 28.5 (5.3 25.0) 0.0 15.8 10.5 1.2 6.5 Construction 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 Average 18.4 10.8 35.5 16.5 28.5 (1.5 14.2 0.8 14.6) 3.8 14.6 3.4 5.4 .5 3.0 254.1 296.6 17.0 2.2 7.8) 0.6 12.5 239.4 15.8 13.3) (1.9 13.4 17.8 2.6 3.5 23.5 6.5 1.4 291.6 15.6) (6.4) 0.0 1.4 1.1 2.0 2.1 1.9 2.2 315.0 2.5 30.0 19.2 5.1 21.6 12.9 10.7 7.5 306.8 22.4 2.5 1.6 375.1 22.2 0.9 428.4 12.2 6.0 22.2 25.1 (0.5 338.8 16.2 20.4 2.3 13.9 3.1) 0.2) 6.9 16.9 9.0 18.2 2.4 10.2 15.0 1.0 16.3 2.4 2.1 16.7 5.Table 2.1 (0.8 24.9 (0.4 14.1 0.6 11.5 1.0 37.1 7.0 21.4 350.0 1.7 (3.9 19.6 318.3 8.8 12.9 (0.4 348.4 1.9 10.3 8.4 (0.2 16.8 16.0 5.8 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 31.9 1.5 473.6 24.2 18.9) 1.7 22.4 0.8 1.1 0.6 14.7 16.7 317.1 290.0 1.5 19.8 3.3 10.7 514.3 285.0 23.8 23.0) 0.8 0.2 16. Renting.7 21.6 1.7 9.2 5.3 15.0 9.3 288.0 16.3 14.0 (4.5 569.3 8.9 0.7 520.0 1.6 16.7 17.0 (0.7 1.8 22.2 20.1 17.0 12.5 27.7) 2.1 20.2) (0.5 6.0 22.8 302.8 461.7 294.1 27.2 0.3 2.9 (0.7 30.4 4.3 31.8 2.0 24.8 7.
6 0.5 462.4 341.6 — — — — — 0.3 2.8) 1.4 6.1 21.9 Electricity.062.3 18.4 12.4 21.5 14.3) 11.0 21.3 (2.3 112.7 11.5 11.7 11.4 10.4 13.9 12.6 2.2 18.0 (15.8 11.5 307.6 6.6 4.2 18.1 4.6 9.4 15.3 125.3 18.6 4.6 15.5 30.5 8.0 2.3 9.1) 1.9 17.5 4.9 18.3 0.6 14.0 1.6 19.2 3.7 20.2 7. Storage.4 14.8 12.9 10.5 26.4 6.1 16.4 367. Financial Statement Analysis Yearbooks.3 19.1) 5.6 8.0 98.3 8.6 1.5 0.9 17.4 2.8 0.1) (0.3 17.7 15.7 187.1 (0.7 7.2 10.6 — — — — — 17.4 3.8 12.7 — — — — — 14.8 14.5 16. and Steam Supply 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 Average 12.6 9.2 11.0 89.2) 13.2) 0.9 12.9 (10.8 8.9 332. a New equity does not include capital surplus.3 23.9 18.2) 9.5 117.8 7.9 8.4 0.9 3.7 11.5 11.6 6.8 15.8) (12.1 6.1 15.5) 22.0 106.1 3.0 5.4 — — — — — 448.2 90.5 2.1 1.3 8.4 16.9 7.1 15. b NPM denotes net profit margin.6 12.4 2.1 11.5 539.3 1.4 12.4 (0.0 7.5 612.7 16.6 18.5 14. .9 9.6 512.2 14.3 4.0 921.8 (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 — — — — — 31.1 14.0 1.6 8.8 6.5 13.4 0.4 7.6 34.6 20.9 (11.Table 2.5 15.0 1.3 — — — — — 10.7 510.0 14.7 — = not available.4) (1.6 172.1 (2.7 2.4 3.4 7.0 (1.3 4.7 19.9 9.7 14.1 323.1 8.9 456.7) 0.3) 15.3 3.2 143.1 15.6 16.2 1. Source: Calculated using data from Bank of Korea.7 12.3 34.8 0.5 12.1) (0.0) 1.8 4.5 47.4 30.7 116.7) (4.8 9.2 14.9 1.1 2.6 8.4 3.0 14.7 0.5 344.3) (1.6 21.7 0.7 2.5 14.1 (11.2 10.3 12.6 12.9 8. Gas.4 1.4 169.4 11.6 19.6 (2.5 14.4 1.6 (2.9 4.4 9.2 698.6 9.3 0.0) 1.6 1.2 15.2 — — — — — 2.3 4.5 482. and Communication 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 Average 15.3 543.2 18.0 2.1 11.2 2.6 3.5 (2.0 5.9 6.9 4.4 633.5 15.7 7.9 10.1 12.1 17.8 6.4 (2.9 321.6 6.0 Transport.8 3.8 111.0 13.0) (0.3 740.2 10.3 1.4 0.8 3.9) (8.3 524.3) 4.2 122.4 1.8 14.8 529.
Hyundai Group.8 0.6 22.6 3.6 0.9 percent).4 0.3 percent).6 1.1 percent of the economy’s total value added (excluding the financial sector). followed by the top 6-10 (Table 2.3 4. Generally.3 20.7 (5.7 Net Profit Margin 0.5 ROE 3.70 Corporate Governance and Finance in East Asia. the largest chaebol.11).0 0.9 6. Vol.3 (0.9 11. The number of Hyundai member companies rose to 57 in 1997.9 Growth and Financial Performance of Listed Companies.1 1. II Table 2. Kis-Fas.5 0. and close to half of total assets (46.6 and 2. In 1995. It should also be noted that when the financial crisis struck in 1997.1) 4. of Firms 334 351 386 503 626 669 680 681 687 698 715 754 775 Sales Growth 10.5 19. and net profits (46.8 6.4 2.2 0.12).9 21.9 2. it is the chaebols’ large firms that are listed.7 percent) of the corporate sector. unless otherwise indicated) Financial Performance Year 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 Average No.9 0. Between 1993 and 1997.2 2.12). Performance of Chaebols This section uses available data on the top 30 chaebols.3 2. the top 11-30 chaebols experienced a decline of . 1985-1997 (percent.7 1. Chaebols have been the most important actors and engines of growth in the Korean economy. 1998.6 23.5 ROA 0.7 1.1 1.0 3.8 5. sales (45. In 1997.4 1. had 46 member companies. The top five chaebols registered the highest growth rates.2 9.9 Source: Constructed using data from Korea Investors Service. but the number of designated groups has been fixed at 30 since 1993. of which 16 were publicly listed (Table 2.6 (1.4) 1.9 1.1 6.4 1.5 5.3 0.7) 0.5 19. the 30 largest chaebols accounted for 13. the growth of sales of the top 30 chaebols exceeded that of the aggregate corporate sector (compare Tables 2. of which four were listed.9 26.2 9. The smallest group had 16 members in 1995.9 2.9 percent).4 22.3 15. debts (47.0 18. The criteria for selection of largest chaebols have changed a few times.4 1.6 2.8 24.2 6.
4 6.6 9.10 Growth and Financial Performance of Listed Companies by Size.3 11.6 6.0 1.6 3.5) 1.6 2.5 (1.3 (0.2) (1.5 3.8) 6.0 (4.2 0.5 5.2 1.8 6.6 8.6 1.6 (0.7 2.7 4.8 1.4 3.5 17.9 22.3) 5.7 (0.3 Medium 14.2 13.1 1.9 1.0 4.5 0.8 6.8 0.2 2.0) 1.Table 2.1 0. .8 16.9 2.0 19.0 1.2 Note: Large firms have a capital base greater than W15 billion and small firms smaller than W5 billion.6 (1.1 2.7 18.0 16.3 (0.4 16.3 3.2 Small 13.6 1.9 1.2 10.5 25.0) 0.4 1.4 Medium Small Large Medium Small ROA Growth Performance Large 17.2 12.9) (6.3 6.1 11.3 15.6 2.3 1.9 5.2 13.7 3.4 11.1 8.7 2. Others are medium firms.0 1.9 14.0 17.2 (0.3) 0.0 1.9 (0.6 0.8) 1.2 2.7 1.6 2.0 6.6 13.6 7.1) 5.9 0.8 10.9 0.6 0.4 2.9 6.0 15.4) 1.2) 0.9 2.0 10.5 1.4 5.9 2.5 2.8 17.9 0.9 25.9 3.7 (1.8 0.2 7.3 9.5) 1.9 6.6 5.6) 0.5 Net Profit Margin Year Large Medium Small 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 Average 2.4 3. Kis-Fas.8 0. 1988-1997 (percent) ROE Large 9.3 15.2 3.1 2.6 3.8 7.8 0.6 1.8 3.2) (1.5 5. Source: Korea Investors Service.4 1.7 (1.8 (5. 1998.
690 3. 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. .597 351.131 3.798 — No.427 9.433 3.574 3.158 7.309 14.445 4.995 2.956 3. Source: Fair Trade Commission.090 6.158 1.376 35.677 3.951 3.929 12.774 7.303 3.313 14.Table 2.370 6. 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.398 — 2.423 5.246 11.761 31.910 3.287 10.11 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 43.457 14.651 38.147 5.346 3.599 — 2.873 2.177 — 6.117 4.924 2.935 2.475 2.927 16.458 6.129 2.180 2.853 1997 53.756 5.743 40.486 6.455 22.990 2.395 31.364 5.967 7.501 13.766 3.640 4.996 1.
4) (14.3 15.1) 0.3 14.2) (2.0 2.0) 3.0 17.2 (16.8 27.1) (0.1 (2.6 4.5 32.0 31.0 0.4 26.2 (5.4) (0.2 20.9 20. 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 12.8 0.1) (1.7) Source: Bank of Korea.4 0.9 3.1) (0.9 1.2 0.8 Assets 12.5) (0.Table 2.1 (1.5 20.0 1.9 17.3 1.3 3.4) 1.2 (2.7 10.2 (2.9 20.3 19.5 5.3 1.2 0.3 0.2) (0.2) 1.5 (0.7 15.0 6.3 9.5 19.7) ROE 5.3 16.1 27.3) 0.0) 12.6 1.3 11.6 25.12 Growth and Financial Performance of the 30 Largest Chaebols.0) ROA 1.4 30.6 Financial Performance Net Profit Margin 1.4 (2.8 18.0 19.7 10.9 18.2 3. .7 15.6 19.0 2.7 13.5 2.7 1.4 12.7 4.4 38.3 27.1) 0.1 (3.2 1.0 2.5 27.5) (0.5) (0.1 2.3 0.0 0.1 19.1 10.7 0.6 (0.9 24.2 0.2 11.6 18.9 3.
In general. and led to a high concentration of ownership. chaebols had a higher average DER than the corporate sector as a whole. except for 1995. the net profit margin of the aggregate sector exceeded that of the top 30 chaebols. Their worst year was 1997 when ROE hit -15.5 Founding families are mostly still the largest shareholders and. . a pyramidal structure of corporate ownership is prevalent. 2. and the companies that are under the control of the largest shareholder.3. his/her relatives.3 Corporate Ownership and Control This section looks at the key aspects of corporate governance in Korea. II 2 percent in their sales and a very low 4. and access to credit. 2. The absence of a well-developed equity market and the provision of subsidized credit.765 percent (Table 2. loopholes and inconsistent policies spawned strategic behavior and agency problems. from 190 to 3. technology.1 Patterns of Corporate Ownership The ownership of most Korean listed firms is highly concentrated. weak corporate control. Ownership patterns. The ROE of the top 30 chaebols was consistently higher than that of the aggregate corporate sector.7 percent growth in total assets. and vulnerable balance sheets.13). Only the top five chaebols registered a positive net profit margin in 1997.” This “identical person. resulted in the chaebols’ excessive leverage.95 percent.” in Korea’s legal and regulatory framework. There has been a wide range in DER among chaebols. The better showing of the top five chaebols was a direct result of their dominance in human resources. 5 While “ownership concentration” can be defined and measured differently in different contexts. The financial performance of the top 11-30 chaebols deteriorated during 1993-1997. However. By the end of 1997. internal and external control mechanisms. coupled with weak corporate governance. The Commercial Code stipulates the basic governance framework and applies to all corporations. 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. in this instance.74 Corporate Governance and Finance in East Asia. Vol. it refers to the degree of concentration and shareholdings in the hands of an “identical person. includes the largest shareholder. more important. 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.
0 218. 1995-1997 (percent) Chaebols 1995 1. Daelim 16.2 471. Byucksan 1996 1.764. Ssangyong 7.4 205.9 751.2 292. Dongbu 24. Doosan 15.0 370. Newcore 30.5 343. Hansol 23. Halla 13. Ssangyong 7.3 572. Tongyang 22. LG 4.2 423.13 The Top 30 Chaebols’ Debt-to-Equity Ratio.5 3. Halla 17. Kia 9.Table 2. Hyosung 18.6 936. Samsung 3. Sunkyung 6.6 .8 336.5 383. Sammi 27.5 464.0 486. Hyundai 2.7 416. Kolon 21.1 385.8 313.3 315. Hanil 28. Hanwha 10. Doosan 13. Daewoo 5.9 321. Kumho 12.4 175.2 328.4 192.5 337.7 354.441.6 516.2 924.1 3.7 267.1 477. Dongah Construction 16.3 328. Samsung 3. Daelim 14. Daewoo 5. Hanjin 8.4 622.244. Dongkuk Steel 19. Hanbo 15. Sunkyung 6. Dongkuk Steel 19. Jinro Debt-to-Equity Ratio 376. Hanwha 10. Haitai 26. Hyundai 2.0 506.0 436. Dongah 14.1 278. Kohap 25.7 620.8 312.065.6 2.7 688.5 2.2 346. Kia 9. Lotte 11.6 409.4 556.1 674.855. LG 4. Kukdong Construction 29. Hansol 17. Hyosung 18. Kumho 12. Lotte 11.1 190. Jinro 20. Hanjin 8.2 2.3 297.7 621.
Kohab 18.9 1.784. Newcore 28. Ssangyong 8.8 647.501.3 399.0 305.13 (Cont’d) Chaebols 20. Tongyang 24.1 375.9 465.0 907.9 472.3 347.7 1.4 1. Financial Statement Analysis Yearbook. Hanil 28. Dongkuk Steel 20.4) 513.8 338. Dongbu 21.6 416. Daewoo 4. Haitai 25.6 Sources: aFair Trade Commission.5 1. Anam 27.6 424.8 468.8 347. Kamgwon Industrial 30.9 216.3 676. Keopyong 29.5 (893.9 490.7 370. Shinho 1997 1. Hansol 16. Shinho 26. Keopyong 29. Daelim 14.3 1. Dongah 11. Lotte 12.5 386. Kolon 19.9 578. Samsung 3.1 438. bBank of Korea.600. Dongbu 23. Newcore 26. Hyundai 2.498.5 576. Anam 22.6 335.214.1 359.8 307. Saehan Average of All Chaebolsa 1995 1996 1997 Average of All Industries Excluding Financial Sectorb 1995 1996 1997 Debt-to-Equity Ratio 317.7 944. Haitai 25. Hyosung 17.0 505. Tongyang 24.1 433. Daesang 27. Kumho 10. Doosan 15. Jinro 23. Halla 13.Table 2. Hanwha 9.8 399.8 590. Kolon 21. LG 5. Kohab 22.5 (1.225.6 478. SK 6. .1 472. Hanjin 7.5 519.5) 404.6 590.8 658.5 261.0 419.5 323. Miwon 30.
The controlling shareholders of chaebols hold comparatively smaller percentages of shares. Securities companies reduced their holdings over this period of falling stock prices as the size of investment trust companies’ stock portfolios declined.” foreigners. that is. the percentage of holdings by individuals slipped to 60. Composition of Ownership Among listed companies.1 percent. Most non-chaebol listed firms in Korea are believed to have ownership concentrations within the 10-30 percent range. The holdings of financial institutions.7 percent by 1997. including banks and other financial firms.e. From 69. However. i. and insurance companies increased during the period. Financial institutions owned as much as 28 percent of the total corporate shareholdings in 1992. the entrenchment effect outweighs the incentive effect. the entrenchment effect and problems of agency may be more pronounced in chaebols than in independent firms. and then steadily declined after 1993. individuals were also the largest shareholder group. while those owned by banks.6 percent by 1997. 10 to 30 percent). the individual owners—the portfolio investors as well as the controlling shareholders and their family members—formed the largest shareholder group (Table 2.14). Thus. an entrenched manager is insulated from market pressure and can pursue personal goals without the fear of being replaced. the incentive effect once again dominates. with a given range of managerial shareholdings (for instance. large ownership can also bring about the entrenchment effect.Chapter 2: Korea 77 When controlling shareholders hold a very small percentage of the shares. The percentage of shares owned by “other corporations. When managerial holdings are reinforced by artificial control mechanisms such as pyramiding. Beyond that range. The next important group was “other corporations. including investment trust companies. the Government.” followed by banks. and state-owned companies and securities companies declined. Among listed nonfinancial companies. but their shares declined to 21. fluctuated widely during the period. managerial entrenchment becomes more likely. the extent of ownership by these individuals declined gradually after 1988. an increase in their ownership may bring their ownership incentives to converge with those of the minority shareholders. However. the ownership structure can bring about an incentive effect.. The pattern of distribution changed little through 1992-1997. resorting to extensive use of pyramiding to maintain control. The reduction can be . the year the stock market was in a frenzy due to buying sprees. Theoretically.
2 17.1 68.3 26.1 4.1 8.2 8.6 16.3 18.3 1994 521 1.8 2.2 8.6 2.Table 2.5 1992 508 2.4 5.2 7. a The State covers the Government and state-owned companies.5 1.2 9.8 2.3 2.1 18.8 5. etc.7 7. 1988-1997 (percent) Financial Institutions Securities Firms Total 28.5 16.5 6.8 69.0 60.1 3.3 5.0 7.5 12.8 1995 548 2.3 17.5 1989 498 0.4 Insurance Firms Other Corporations Foreigners Individuals 39.0 28.6 Year No.6 12.2 1.0 27.6 13.3 1996 570 2.7 18. mutual savings.4 1997 551 1.1 60.5 Note: Ownership is based on number of shares. Listed Nonfinancial Companiesd 1988 406 0.7 9.7 1990 531 0.7 4.0 5.1 21.6 36.0 5.9 2.6 8. . merchant banks.9 19.3 17.b A.0 9.7 3.3 5.8 17.7 8.4 13.1 8.7 59.4 18.3 39.8 5.2 5.6 16.1 18.3 1.0 4.1 10.9 4.8 59.0 59. investment trust companies.6 9.9 1.2 2.1 11.5 18.8 59.0 8.6 1991 505 0.6 22.9 5.9 37.3 18.8 17.3 8.9 15. c Data from Korea Stock Exchange.4 5.5 7.1 2.5 1.2 4.1 21.4 14.4 13.4 34.2 B.5 62. of Firms The Statea Banks.5 6. All Listed Companiesc 1992 681 1993 687 1994 698 1995 715 1996 754 1997 775 9.5 4. d Constructed from data files of the Korea Listed Companies Association.5 7.7 9.9 26. and finance companies.5 60.9 2.2 9.8 4.6 9.7 6.3 1.2 1993 511 2.2 3.9 36.6 19. etc.6 16.9 17.1 1.” includes commercial banks.4 6.7 14.6 20.14 Ownership Composition of Listed Companies. b “Banks.9 1.1 17.2 5.2 18.
Compared with its holdings in all listed companies. medium. the Government acquired an even bigger share in several banks as part of its program to bail out these distressed institutions. the holdings of institutional investors were expected to increase significantly with the Government’s introduction of US-type investment companies in 1998 and . did not vary significantly (Table 2. whether partial or absolute. and small companies. This trend can be explained by government ownership. government ownership in nonfinancial companies was remarkably smaller and more concentrated.18).15). One minor difference is that the percentage of shareholdings by corporations is slightly higher in large-sized firms. indicating their heavier reliance on inter-firm financing investments. Before such liberalization. foreign holdings were derived from purchases through country funds and direct capital investments. Individuals held the majority of the shares in all industries except in telecommunications. This is low compared with those in Japan. Over the years.17). 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. When independent companies are distinguished from firms affiliated with the 30 largest chaebols.16). In general. UK. held 26. indicating their increased investments particularly in the service industries with high growth rates. with the Government continuing to hold a sizable share in the Korea Electric Power Corporation. Institutional investors. electricity. as distinguished from individual and foreign investors. In 1998. and service of motor vehicles (Table 2.8 percent of listed shares in 1997.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. other corporations’ holdings shifted toward service industries. Corporate holdings averaged 16 percent throughout 1988-1997. However. However. of some banks. financial institutions had more shares in the manufacturing sector than in primary industries. there appears to be no significant difference in the overall shareholding patterns between the two groups (Table 2. Foreigners gradually increased their equity shares in 1992 when direct purchases by them were first permitted. The Government’s and state-owned institutions’ (including some banks) ownership was generally small except in the power sector. In most instances. and US (Table 2. categorized into large. The holdings of other corporations are mainly equity investments in affiliate companies. The ownership distribution in listed nonfinancial firms. the Government was the sole owner.
9 60.5 0.3 62.1 0.3 1.2 9.3 1. Motor Vehicles Electricity.4 8.2 7.7 17.7 1.4 — 0. Elecl Mach.7 2.3 57.9 19.8 7.4 5.6 — — 2.6 11.1 65.9 66.5 4.9 1.1 27.5 0.5 — 0.5 3.8 7.2 — — 0.4 56.9 59.7 20.8 6.0 7.8 1.1 0.6 5. Paper. and Printing Pulp.Table 2.3 4.3 11.6 24.7 63.4 56.4 2.3 38.5 — 1.5 85.7 14.2 0.7 2.4 0.6 3.9 16.5 17.0 8.7 59.1 88.4 14.2 0.8 73.3 10.2 9.8 3. and Printing Chemicals. Etc.9 52.6 18.6 8.9 15.5 12.7 22.2 — 0. 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 6.3 0.9 8.0 — 0.1 0.8 3.5 19. and Plastics Basic Metal Fabricated Metal and Machinery Office and Computing Machinery Electronics.9 23.2 0.1 7.2 1.8 8.7 20.2 9.4 1.6 1.9 42.15 Ownership Composition of Listed Nonfinancial Firms by Industry.1 8.7 14.3 9.0 9.3 13. Paper.9 4.8 7..1 19.2 17.0 9.1 4.5 0. Gas.8 7.1 1.3 2. 1990 and 1997 (percent) Financial Institutions The Statea — — 0.1 0.0 9.0 0.2 0.8 5. and App.1 8.2 2.9 10.1 10.7 64.3 6.0 — 39.4 62.4 8.3 0.2 64.5 7.2 22.4 7.8 Individuals 83.0 1.3 7.5 — — 0.5 0.0 9.4 8.0 10.0 20.4 1.5 6.b Securities Firms Insurance Firms Other Corporations Foreigners — — 0.2 54.3 2.9 0.9 55.9 1.2 1.0 2.3 0.7 29.0 Industry 1990 Fishing and Fish Farms Mining Food Products and Beverages Wearing Apparel and Fur Articles Wood. Rubber.7 2.7 22.4 Banks.
8 0. Note: Ownership is based on number of shares.4 16.9 6.6 14.3 2.4 2.5 63.2 23.8 5.1 2.8 6.4 1.6 75.7 23.1 — 1.2 0. Gas.7 1.4 — 1.3 60.4 2.9 6. Motor Vehicles Electricity.3 31.3 6.8 3. mutual savings.6 2.1 6.6 18.6 6.2 4.8 4.8 12.3 57.9 0. Paper.3 65.9 2.1 3.3 7.3 1. etc.1 9.0 6.1 4.9 20.8 57. and App.1 — 0.8 5. b “Banks.5 5.4 3.4 4. Rubber.3 0.4 76.6 20.1 54.0 43.9 1.0 60.9 20. a The State covers the government and state-owned companies.4 68.7 5.9 2.5 4.3 1.1 25.4 45.0 6.2 8.8 2.3 15.6 59.5 7.5 0.4 4.2 13.2 0. investment trust companies.2 4.4 1.9 18.4 9.5 6.9 7.8 27.9 7. and Printing Chemicals. Source: Constructed from data files of the Korea Listed Companies Association.0 11.78 81.9 2.9 5.7 4.9 1. and Printing Pulp. and Plastics Basic Metal Fabricated Metal and Machinery Office and Computing Machinery Electronics.3 6.7 2.5 59.0 4.2 49.7 2.1 3.4 6.1 1.8 2.9 78.1 1.1997 Fishing and Fish Farms Mining Food Products and Beverages Wearing Apparel and Fur Articles Wood.2 5.1 2.8 2.6 6.5 3. Elecl Mach.1 18.6 2. merchant banks.6 60. 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 1.2 5.4 2.5 12.6 7.7 2.9 5.4 43.9 57.0 1.4 20.0 7.6 3.5 1.6 — = not available.7 6.2 4.8 11.5 — 2.4 0.0 3.2 6.9 2. .5 4.4 1.5 3.5 3. and finance companies.2 1.8 0.3 8.6 2.1 9.7 19.6 5.2 3.8 54.9 69.4 58.0 8.2 7.7 2.6 1.6 0.7 17.6 0.2 1.4 58.0 5. Paper.9 1.” includes commercial banks.2 4.5 3.
7 Foreigners 4. Source: Constructed from data files of the Korea Listed Companies Association.4 5.1 2.4 21.4 17. and finance companies.8 4.4 2. etc. etc. Securities Firms Insurance Firms 2.7 8.2 1.8 2.5 6.1 8. etc.0 1.0 6.6 60. 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.8 3. of Firms Independent Firms Affiliates of 30 Largest Chaebols Total 316 117 433 Source: Constructed from data files of the Korea Listed Companies Association.9 5.7 1. 1997 (percent) The Stateb Foreigners 4.1 6.4 1.8 6.0 Other Corporations 16.5 Individuals 60.4 61.7 Control Type No. 1997 (percent) The State 1. The State covers the government and state-owned companies.c Securities Firms Insurance Firms Other Corporations Individuals 58.Table 2. investment trust companies.5 18.4 5. b Table 2.5 62. mutual savings.5 8.1 Banks.17 Ownership Composition of Listed Nonfinancial Firms by Control Type.5 4.5 2.3 6.8 60.4 Firm Sizea No.9 4.7 6. .7 0.6 16.4 4.” includes commercial banks.7 4. merchant banks. c “Banks.16 Ownership Composition of Listed Nonfinancial Firms by Size.8 4.5 19.9 2.8 1. Others are medium firms.4 61.3 Banks.5 16.4 2.
defined as those holding less than 1 percent of shares.6 39.Chapter 2: Korea 83 Table 2.4 26.3 47.18 Ownership Composition of Listed Firms in Selected Countries.3 54. including those of the largest shareholder.5 20. rather than the individual. corporations held 70 percent of the controlling blocks of shares. 1997 (percent) Country Japan Korea Taipei. 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. In 1997.5 45.8 56. Generally. his/her family members.8 9. and other shareholders who do not belong to either the minority shareholders or the majority shareholder group. investors (Table 2.8 10. But these may . the majority shareholder group on average held 23-30 percent of outstanding shares in the period 19881997 (Table 2. At the moment. only closed-end investment companies and traditional investment trust companies are allowed. This has had profound implications for corporate governance and the market for corporate control in Korea. minority shareholders. Concentration of Ownership The analysis of ownership concentration in this section focuses on shareholdings of the majority shareholder.1 financial institutions’ establishment of corporate pension fund accounts.1 percent and appear to be similar to the proportion of foreign holdings in the four other countries.19).6 Foreigners 9. Among nonfinancial listed firms. Institutional Investors 42. the majority shareholder group in all listed companies consists of the corporate. Foreign holdings of Korean shares were 9. for example.20).7 16.6 Individuals 23. and the companies under the control of the largest shareholder. while family members accounted for only 30 percent.3 6.1 8.China United Kingdom United States Source: Stock Exchange of Korea. The majority shareholder group’s shareholdings in listed nonfinancial firms steadily declined from 1990 to 1996.
7 18.1 21.0 4.0 1.9 Individual 2.7 6.1 5.1 23.0 29.7 Note: The majority shareholder includes the largest shareholder.6 46. and the companies under the control of the largest shareholder.0 22.9 2.6 5.3 18.3 2.4 7.3 30. his/her family members.1 5.0 25.2 Minority Shareholders Subtotal 71.0 69.8 8.7 16.5 43.2 2.19 Ownership Concentration of All Listed Firms. Other shareholders are those who do not belong to either the minority shareholders or the majority shareholder group.1 32.9 32. .2 2.1 4.7 44.2 26.0 2.1 15.4 5.1 14.0 Year Corporation Individual 1992 1993 1994 1995 1996 1997 41. 1992-1997 (percent) Majority Shareholders Corporation 15.6 2.6 26.Table 2.6 22.7 7.9 3.8 73.1 28.0 66. Source: Stock Exchange of Korea.4 3.8 72.9 6.1 37.9 7. Minority shareholders are those holding less than 1 percent of shares.9 33.6 73.3 Subtotal 5.8 Individual Subtotal Other Shareholders Corporation 3.
21]). The shareholders that held more than 1 percent but did not belong to the majority group held about 20 percent on average. and mining categories.5 60. in the small firms.8 12. 1988-1997 (percent) Year 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 Minority Shareholders 53. Besides. minority shareholders.6 58. hiding shares offers no additional tax or other benefits. rubber and plastics.4 28.0 58. In such cases. The practice of hidden shares seems to have been less prevalent in recent years. Across industry.8 Majority Shareholders 27.2 15.3 62.20 Ownership Concentration of Listed Nonfinancial Firms.7 18. which held less than 1 percent of a company’s outstanding shares as of 1997.22). Majority ownership is also high in the chemicals. thereafter.9 29. 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 2.4 23.9 12.9 25. collectively owned less than 50 percent of an average firm.Chapter 2: Korea 85 Table 2.1 50. ownership was relatively diffused due to government regulation.6 57. 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.5 13.9 27.6 11.8 25.8 57.0 22.8 28.9 48. the majority owner held more than 20 percent of an average firm. the Government has retained a large number of shares.5 12. It was highest in medium-sized firms before 1993 and.8 54.5 23. Meanwhile. 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. In most industries.4 Source: Constructed from data files of the Korea Listed Companies Association. .0 20. In telecommunications.3 25.9 Other Shareholders 18. Ownership concentration tended to be lower in large compared to medium and small listed firms.
1 43. 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. and Printing Pulp.6 34.6 38.0 54.8 21.5 16.21 Ownership Concentration of Listed Nonfinancial Firms by Industry.3 26.Table 2.3 19. Paper. and Printing Chemicals.8 55.2 23.7 29.5 21.6 53.4 53.8 24. 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 36.2 34..0 51.1 49. and Plastics Basic Metal Fabricated Metal and Machinery Electronics.2 46.1 17.2 20.5 47. Paper.5 44.0 39.9 44.2 26. Elecl Mach.2 48. .4 16.0 21.0 30.5 52.9 26.2 19.6 19.8 29.1 19.9 Minority Shareholders Majority Shareholders Other Shareholders 12.5 41.4 11.9 10.8 51. Gas.7 24.5 23.4 Industry Fishing and Fish Farms Mining Food Products and Beverages Wearing Apparel and Fur Articles Wood.8 44.7 36.7 21.6 25.3 39.5 19.5 20. Rubber.8 41.7 27.6 50.2 37. and App. Motor Vehicles Electricity.2 22.7 26.7 17.8 31.8 25.
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.4 47.8 50.7 22.7 28.1 15.4 21.6 27.4 30.1 27.6 15.9 55.6 11.2 11.3 21.2 21.5 51.8 17.3 19.7 31.8 52.2 12.5 19.9 60.9 23.9 16.22 Ownership Concentration of Listed Nonfinancial Firms by Firm Size.5 33.2 21.0 59.8 28.7 57.7 16.8 52.5 12.2 50.3 55.8 62.3 27.5 19. .9 12.9 53.0 66.9 21.8 27.2 Majority Shareholders 26.2 26.5 Other Shareholders 19.3 26.9 26.5 12.2 52.Table 2.2 Source: Korea Listed Companies Association.0 24.6 31.0 26.5 21.1 20.5 10.1 48.6 55.4 30.6 24.4 29.2 56.2 32.9 22.8 11.9 56.5 27.5 26.1 16.9 28.2 21.7 17.7 15.3 25.4 51.2 18.7 14.6 62.4 30.7 57.5 49.8 56.0 55.6 59.1 58.9 17.6 65.2 55. 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 53.5 28.
J. II Ownership Concentration and Financial Performance J. Then TQ declines until SCS reaches 45 percent and increases until it reaches 50 percent. the firm destroys value. thus a firm creates value. The Code prohibits a subsidiary company from owning shares of its parent company. TQ was calculated by dividing the market value of a firm by the substitution price of its assets. TQ increases as the SCS increases. Hong. One of the merits of pyramiding. They analyzed firms in which controlling shareholders participate as managers. Vol. and the shareholding of a controlling shareholder (SCS) as the degree of ownership concentration. it means the firm creates value. and Vishny. This refers to the situation wherein Company A holds shares of Company B and simultaneously Company B holds shares of Company A. Inter-Firm Investments and Pyramiding in Chaebols The Commercial Code imposes limits on direct cross-shareholding. one company can still place equity investments in another. Shleifer. and Kim (1995) studied the empirical relationship between the degree of ownership concentration and financial performance in Korea. TQ is below 1. The study by Kim. Kim (1992) found the relation between TQ and SCS to be nonlinear. Where direct cross-shareholding is not allowed. Kim (1992) and Kim. TQ has a maximum value. thus a firm destroys value. often at terms unfair to one of the transacting parties. if TQ is lower than 1. H.88 Corporate Governance and Finance in East Asia. If SCS reaches 10 percent. Both studies used Tobin’s Q (TQ) for the value of a firm as an index of financial performance. If SCS is below the range of 20-25 percent. and Kim (1995) reached a similar conclusion. In Korea. which can then pass the equity capital to a third. called “pyramiding”— commonly (though incorrectly) known as “indirect cross-shareholding”— is prevalent in Korea. Hong. This type of inter-firm investment. one company from a chaebol group could obtain debt payment . TQ is above 1. For example. If TQ is higher than 1. If SCS is below 10 percent. 1988). although turning points in the value of firms are different. which is the company holding more than 40 percent of outstanding shares of its subsidiary. If SCS is above 20-25 percent. The pattern of the relationship between SCS and TQ is similar between Korean and US firms (Mork. The relationship between TQ and SCS shows a similar pattern. affiliated companies have been able to conduct inter-firm transactions. H. from the standpoint of the controlling shareholder. is effective control of a certain group of companies even with a smaller investment.
The extent of pyramiding can be seen in some of the previous tables. 62 percent (16 out of 26) had a corporation as the largest shareholder. For the whole sample. or about four firms each. together owning an average of 38. or an average of 13 firms per company. If we define the internal shareholdings of a . for example.14. financial institutions that are subsidiaries of a chaebol also hold shares in its member firms.23. Thus. the top five shareholders consisted of 2. The fact that corporations. The top five shareholders of the chaebol-affiliated firms consisted of one individual and 3. neither the investors nor the relevant government authorities were active in monitoring such unfair dealings between firms. 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. Twenty-two of the 81 respondents were independent. the top 30 chaebols’ shareholding by subsidiaries was 34. 34 percent were foreign companies.5 percent of shares. although they are likely to be insignificant. In Table 2. together owning an average of 37. 59 were parent firms with one or more subsidiaries.5 percent. the average shareholding of the controlling owners and their families was 8.9 percent of shares. corporations hold about 20 percent of the outstanding shares of all listed nonfinancial firms. firms linked through partial equity investments could enjoy the advantage of consolidation without an actual formal consolidation or merger of operations taking place. In the case of the 30 largest chaebols. or about five subsidiaries each.5 percent as of 1997. there are instances of direct cross-shareholding in Korean firms. and about 11 percent were domestic financial institutions. But the controlling power of the owners also stems from inter-company shareholdings of the subsidiaries.4 corporations. not individuals. Among chaebol affiliated firms. Only six firms (or 13 percent) indicated that their subsidiaries also owned shares in themselves. 53 percent were domestic nonfinancial firms. Partial results are shown in Table 2. standalone setups.Chapter 2: Korea 89 guarantees from other members of the group at no cost.5 corporations and two individuals. 59 parent companies collectively had investments in 759 firms. This also partly explains why chaebols frequently opted to expand by establishing new firms rather than placing investments internally. 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. Thus. Of the 81 respondents. and 319 foreign subsidiaries. Until recently. Among the subsidiaries or firms receiving investments. For the same year. Among the 81 listed firms in the ADB survey. In many instances.
9 29.5 24.0 2.9 34. b The chaebol affiliated firms are those belonging to one of the 30 largest groups.8 Note: The survey was conducted during the period January through May 1999 and included nonfinancial listed firms only. 1999 Five Largest Shareholders No.8 31.0 3.7 37.0 21.7 19.1 3.7 5.4 1.2 25.5 2. .8 18.5 2.4 21.2 37.4 42.9 5.4 11.0 1.3 26.0 3.7 0.5 31.4 18.5 38.8 38.1 22.Table 2.8 8.5 4. A few companies reported less than five largest shareholders. 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 20.5 2.0 1.4 38.6 3.23 Ownership Concentration in the Survey Sample of 81 Listed Firms.7 39.6 3.5 18.4 2.5 2.6 16.0 13.5 1.0 17.1 1.8 37.4 25.3 12.6 3.5 4.6 34. a Number of shareholders.9 21.
34. the average internal shareholding ratio of the top 30 chaebols was at least 43 percent. edited by K.” Paper presented at the Annual Conference of Financial Management Association. pp.5 percent. 6 7 Hattori. 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. Chicago. Hattori (1989) identified three patterns based on data in the early 1980s.4 10. the controlling families owned 8. New York: Praeger. Ungki Lim.4 1993 43.” In Korean Managerial Dynamics.Chapter 2: Korea 91 chaebol as the shareholdings of the controlling family and the member companies of the group. “Japanese Zaibatsu and Korean Chaebols.2 12. Lee.7 9. As of 1997. 15 October 1998.1 1997 43. 79-95.0 8. The family and member companies’ shareholdings have been declining over time. Chung and H.6 33. 1987 56. .8 33. “Is the Fair Trade Policy Fair?” Korea Economic Research Institute.6 Later studies by Lee (1997) and Lim (1998)7 find similar patterns.24 shows the average internal shareholdings in the 30 largest chaebols.5 percent and member companies. Many attempts have been made by researchers to identify the typical patterns of ownership structures in chaebols. 1987-1997 Type of Shareholding Internal Shareholdings Family Member Companies Source: Korea Fair Trade Commission.7 31.24 Internal Shareholdings of the 30 Largest Chaebols. 1997.2 15. Internal shareholdings in some chaebols also include shares owned by nonprofit organizations operated by the controlling family. Based on these studies. Family holdings include shares owned by the family members and by parties considered to be under the influence of the family. C. the ownership patterns can be described as follows. it appears that the chaebol families have had a strong desire to expand their business bases.4 1990 45. Table 2.2 33. Tamio.7 1992 46. “The Ownership Structure and Family Control in Korean Conglomerates: With Cases of the 30 Largest Chaebols. 1989.5 34. 1998.2 1994 42.5 Judging from the historical record. Table 2.4 13. Lee.8 40. H. Jae Woo. 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.
The Hyundai Group exemplifies this. Chaebol Reforms Various measures have been taken to improve the transparency of chaebols with regard to accounting.92 Corporate Governance and Finance in East Asia. The third (Type C) is “indirect control via complex shareholding. But the former chief executive officer (CEO). II The first (Type A) is called “direct family ownership. financial. The second (Type B). is an example of this type. Most of its member firms were acquired by. which in turn hold shares in some of the other subsidiaries. Vol. and business activities. One of the . consisting of eight listed and 16 privately held firms as of 1997. The Hanwha Group can be classified as such a company. The controlling family has sizable investments in two base companies and smaller investments in many others. which then make investments in the subsidiaries. Sun Hong Kim. Kia Motors was the base company and had such strategic shareholders as Ford Motors of the US and Mazda of Japan. completely dissolved under financial distress. The two base companies have investments in three other base companies. holdings of the nonprofit foundation. and his management team exercised full control over the group without much interference from major investors. As of 1997. or merged into. subsidiaries have extensive investments in other subsidiaries. The Kia Group was about the only management-controlled group but was out of existence by 1999. A nonprofit foundation under the family’s control is the largest shareholder of one of the base companies. and subsidiaries’ equity participation. It consists of seven listed and 24 privately held firms. other firms. Here the family is the controlling shareholder of one or more strategic base companies that have enough equity participation in the subsidiaries. The family itself holds shares in some subsidiaries. the family controls the group’s member companies by its own shareholdings. investments made by the base companies.” A family owns a substantial portion of shares of member firms and becomes the controlling shareholder of each. there is no controlling shareholder. Thus. Investments between the lower level subsidiaries are rare. Also. Hyundai Motors acquired Kia Motors via an international auction.” Under this type of ownership pattern.” shows a simple pyramidal structure. called the “indirect control via base company. The fourth type (Type D) is “management control. For example. it had 18 listed and 39 private companies.” Here the family directly controls a base company and a nonprofit foundation. The Hanjin Group. Its controlling family holds shares in three base companies through which they exercise control over the other member firms.
These amendments prohibited holding companies and direct cross-shareholding. bankruptcy reorganization. At this early stage. 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. only operating holding companies were allowed to be established. They hindered early exits (liquidation. Cross-guarantees are believed to constitute a form of wealth transfer from financially strong members to weak ones. Until the end of 1998. . there are reports that some top chaebols are studying the feasibility of transforming their organizational structure. The Fair Trade Act was amended in 1998 to allow pure holding companies to be established under restrictive conditions.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. One condition requires that the DER of the holding company should not exceed 100 percent. Also. Initially. This was the reason why chaebols chose to employ pyramidal structures. the Fair Trade Act). following the amendment of the law. the Credit Management Regulation rules were amended to prohibit financial institutions from requiring guarantees from affiliated firms when extending new loans. thus hurting the shareholders of stronger firms. The Government is also considering whether to allow consolidated taxation for pure holding companies. The prohibition of holding companies was also abolished in 1999. It remains to be seen whether they will adopt the holding company structure in the future. 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. These conditions are aimed at restricting excessive pyramiding and expansion of chaebols. A third disallows multiple layering of holding companies. Existing guarantees had to be resolved by March 2000. direct control of the management of chaebols was attempted through amendments of the act in 1986 and 1990. However. 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. This limit was also applicable to banks and insurance companies. the act did not have any important provisions except the standard clauses prohibiting monopolization of an industry through business combinations. The Fair Trade Act was also revised in February 1998 to prohibit cross-guarantees of debt among members of a chaebol. The limit on investments was reduced to 25 percent in 1994 and completely eliminated by 1997. The first serious attempt to deal with this issue was the introduction of the Monopoly Regulation and Fair Trade Act of 1980 (hereinafter.
) 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. usually in the rank of a company president. 2. even though they were legally independent with their own board of directors and the outside shareholder groups were not identical.94 Corporate Governance and Finance in East Asia. and transferred funds generated by one firm to another. planned for capital raising and allocation on a groupwide basis. which put together the accounts of all members of a chaebol. who is universally called the “group chairman. and the capital market was almost nonexistent until the recent reform . Some chaebols have disintegrated or shrunk in size. Their operating costs were borne by the member companies rather than by the controlling shareholder. 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. These offices were legally informal and functioned as the headquarters of chaebols. boards of directors. It also acted as the secretariat for the unofficial “presidential meeting” of the member firm presidents. there have been no significant changes. until urgent restructuring is complete. The chairman’s office had its own chief executive officer. Since the economic crisis. In 1998. II etc. Some chaebols operated “group management boards” attended by top executives (presidents or chairpersons) of larger member firms. but the larger and stronger ones still operate their newly named “restructuring headquarters” under the control of the group chairperson. Chaebols maintain that the restructuring headquarters will exist only for a limited period.3. Vol. The staff of these organizations were employees of member firms.” The group chairman operated through these offices and treated the individual member firms as if they were the divisions of a single legal entity. the Commission has strengthened its investigative activities to eradicate cross-subsidization and wealth transfer activities among group members.2 Internal Management and Control Monitoring of corporate management by shareholders. The office established strategies for the group as a whole. The 30 largest chaebols are now required to publish “combined” financial statements. chaebols dismantled their “planning and coordination offices” or “chairman’s offices” under pressure from the Government. Despite chaebols’ decision to dismantle the chairman’s offices.
The Government’s policy and securities law provisions to protect control rights of the incumbent management had been in place until the early 1990s. However. corporations should have a board of directors consisting of at least three members. Directors are elected at the general shareholders meeting for a term not exceeding three years. Meanwhile. and takeover codes were not accommodative to active monitoring. With few exceptions. There are many reasons for this. the controlling shareholder is officially the representative director and the CEO. except for banks. As of 1997. this was complicated by the prevailing attitude that large companies. Most companies have one representative director. This implies that the typical agency problems in Korean corporations stem from conflicts of interest between inside (the largest) and outside (minority) shareholders. but some large ones have two or more. Even where the largest shareholder is not the representative director. Board of Directors General Characteristics of the Boards Under the Commercial Code. Under such circumstances. In most listed companies. the creditors did not declare defaults. or at least acts as the de facto CEO. Legal provisions to protect investors were limited. as the major creditors. control is not separate from ownership. had their own governance problems. the concept of fiduciary duty of managers was not well established. in most Korean firms. Thus. he or she generally approves major decisions made by the management. the representative director was also the chairperson of the board. This policy managed to hamper any monitoring initiatives from the capital market. were too big to fail. Loan agreements and debt indentures did not include strict covenants. Banks. The board elects one or more representative directors from among the board members. only the Government could play an effective role in monitoring corporations. Even when the covenants were violated. the controlling shareholder (or a member of the controlling group) was the legally registered representative director in 354 out of 551 nonfinancial listed firms.Chapter 2: Korea 95 efforts. Professionalism in management was not well developed and managers were content with receiving orders from controlling shareholders. . creditors were not active in monitoring debtor firms and relied mainly on guarantees and collateral. especially chaebols.
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. However. With the boards consisting only of insiders. A few large companies had more than 50 directors. In the 1999 annual shareholders meetings. Moreover. Recent Reform Efforts on the Board System In 1997. were supposed to be outside directors. other than the representative director(s). almost all companies succeeded in adopting cumulative voting. 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. Despite the qualification requirements.96 Corporate Governance and Finance in East Asia. 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. However. II When the Commercial Code first introduced the corporate board system in the 1960s. members of the board. . and their positions (accept or reject) on matters voted on in board meetings. The Commercial Code was also revised in 1998 to introduce cumulative voting for the election of directors. the attendance rate of outside directors. 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. 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. Further. there is concern that newly elected outside directors still lack independence from the management or the controlling shareholder. all of whom were managers. cumulative voting is not mandatory and a company can exclude itself from its application by amending its charter. Most of the outside directors in those days were the controlling shareholders of chaebols or executives of affiliated companies. companies have to disclose in their annual reports the frequency of board meetings. In order to address this concern. 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. Vol. 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.
inside directors owned 16. This is because most banks.Chapter 2: Korea 97 The committee structure of the board as found in the US has not yet been adopted by listed companies. The controlling shareholder of some banks is the Government. he or she held 6. Where the two were separate. the Corporate Governance Reform Committee. and a nominating committee. the Korean Code recommends that large listed firms should have at least three independent directors. are required to have a majority of outside directors. who would comprise at least 50 percent of the boards. which had extended financial support in their recent recapitalization efforts. Among the firms with no outside directors.1 percent and outside directors 1. a blue-ribbon committee. Directors were also chosen on the basis of their relationship with the controlling . they had a parent/child relationship in 20 percent of the cases.2 percent and the CEO 14. Meanwhile. an audit committee. In March 1999. Directors were most frequently elected because of their professional expertise (74 percent of the respondents marked this answer). The average board had 8. On average.9 percent on average. having no controlling shareholders. ADB Survey Results on Boards The ADB survey results confirm the above assessments and provide early indications on the effects of the reforms. the OECD principles of corporate governance were the minimum standard for the Korean Code of Best Practice. the chairperson of the board was also the CEO and on average held 10.4 directors. Where the chairperson was not the CEO. Almost all (92 percent) of the respondents had one or more outside directors and 70 percent were elected after the Asian financial crisis. was established under the auspices of the Ministry of Finance and Economy and the Korea Stock Exchange. this committee adopted the Code of Best Practice in Corporate Governance. Among others. although some banks recently have established board committees. The Securities and Exchange Act will require large listed firms with W2 trillion or more in total assets to adopt the audit committee system.5 percent of the shares. These results are in accordance with the new listing rules introduced in 1998. 88 percent had plans to hold elections in the near future. The Commercial Code is being amended to allow a choice between the audit committee system and the current internal auditor system.1 percent of outstanding shares of a listed company. In 78 percent of the responding firms. In September of the same year.
In one case. including stock options. In most firms. Remuneration for chairpersons include only fixed fees in 76 percent of the sample firms. In 1997. 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. The reason for this high frequency of interlocking directorship is that many listed firms belong to chaebols. As discussed earlier. The survey results indicate that boards determine remuneration packages for chairpersons in 42 percent of the firms. In 91 percent of the sample firms. In 13 percent. the board had no committees. The current chairperson has been in office for 6. the board had a nomination and an audit committee. Less frequently. founders of the company acted as the chairperson (22 percent). Vol. the management nominated director candidates (64 percent of the directors). However. These were established only recently. In a very small number of firms. in 23 percent. . election of directors was based on shareholdings (7 percent) and status as founder (7 percent). compensation for directors must be approved by the annual shareholders meeting for each fiscal year. Most frequently. 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). and fixed fees plus performance-related pay. According to the Commercial Code. Chairpersons of the board were elected on the basis of professional expertise (33 percent of the firms). a total of 562 directors were sitting on two or more corporate boards. in some firms. Members of controlling shareholder families or their trusted company personnel often act as directors for multiple chaebol firm boards. The general practice is that shareholders approve the upper limit on the total amount to be paid to all directors. About five directors per firm have been in office for more than one term. relationship with controlling shareholders (21 percent). In some instances. Some directors were nominated by significant shareholders (18 percent) or introduced (and elected) at the shareholders meeting. among the 81 sample firms. This rather long tenure must be due to their status as controlling shareholders in most firms.2 years on average. one person was sitting on nine boards and this person was the CEO of a chaebol firm. the management determines the remuneration.98 Corporate Governance and Finance in East Asia. II shareholder (30 percent). The board or the management then determines compensation packages for individual directors. the term of appointment of directors and board chairpersons is three years. and shareholding (10 percent).
When CEO is not the chairperson. and was appointed by the Government in five firms. 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. CEO is also the founder in 52 percent of the firms. In 4 percent of the cases. It indicates that CEO. In a handful of sample firms. The remuneration package was proposed by the board (and approved by the annual general meeting) in 56 percent of the firms. who is not the chairperson. However. shareholding in three firms. compensation is by fixed salary in 74 percent of the firms. it was proposed by CEO and approved by the board.2 years. In the 25 firms where CEO was not the chairperson of the board. In the survey. CEOs have been in their positions for an average of 9. CEO simply follows the orders of the chairperson. CEO generally has the ultimate power to decide on corporate affairs. In 20 percent. 86 percent of the firms answered positively when asked whether the largest shareholder was CEO. in which there is no controlling shareholder. he or she does not enjoy much power. According to the survey. CEO decides on important matters after consulting the chairperson in the majority (55 percent) of the firms. These results show that the incentive compensation scheme for professional CEOs is not well developed in Korean firms. In such cases. decides on important matters on his/her own in 13 out of the 44 firms. 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 payment is about five times the CEO’s annual salary. and in another 21 percent CEO bought shares in the market. CEO was given shares by the family. In less than 20 percent of the firms. In cases where CEO is not the largest shareholder and chairperson. In 21 percent of cases.Chapter 2: Korea 99 Management CEO In the survey sample. Ensuring that a company serves the public interest is considered a less important responsibility of CEO. CEO is entitled to a large sum in cases his/ her contract is terminated before its expiration. CEOs generally maintain their positions for a long time because they are frequently the founders or largest shareholders of their firms. he or she was selected on the basis of professional expertise in 15 firms. fixed salary plus net profit-related bonus in 9 percent. the survey tells a slightly different story than is generally believed in Korea. and fixed salary plus performance-related pay including stock options in 13 percent. .
but as of March 1999 only 27 firms actually had given stock options to their executives or employees. Senior managers were even often called directors although they were not official members of the board. it was common for all senior executives to be elected as directors at the shareholders meeting. II Senior Executives In the past. (ii) establishment of accounting standards for financial institutions. 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. One area has been to enhance the reliability of financial statements of corporations in line with internationally accepted standards. 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. and . disclosure. However. 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. in particular.100 Corporate Governance and Finance in East Asia. but in practice is fixed and understood as part of a fixed salary. executives sometimes have the opportunity to buy company shares at favorable prices because the board of directors (CEO. Penalties for fraudulent financial reports were increased. Vol. in practice) allocates the unsubscribed portion of new shares issued in rights offerings to executives. Korean firms have rarely used shares for executive compensation. The bonus is supposed to be linked to company performance. and accounting standards. About 40 percent of the listed companies had amended their charters to introduce incentive stock options by the 1999 shareholders meetings. This action was in response to calls by international investors and. 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 commission has played an active role in introducing new rules on corporate governance. 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. from IMF and the World Bank.
they cannot be expected to discharge this responsibility because the representative director selects the internal auditor and can force him or her to resign. Those that never adopted international standards show their willingness to do so once the Government introduces international standards. 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. however. The revised accounting standards apply to the firms subject to external auditing for the fiscal year starting on or after January 1999.Chapter 2: Korea 101 (iii) establishment of accounting standards for “combined” financial statements of chaebols. the internal auditor is considered to be a subordinate of the . Korean listed companies with subsidiaries are required to compile consolidated balance sheets. 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. Only 10 percent of the respondents have followed all international accounting standards. In the ADB survey. they also have the power and duty to monitor the activities of executive directors. 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. 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. 41 percent of the companies believed that they have followed some 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. In practice. 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. Most of the companies following all or some of the international standards in the past adopted such standards before the crisis started. but 49 percent confessed that they have not followed international standards at all. Internal and External Auditing The Commercial Code requires a corporation to have at least one internal auditor elected at the general shareholders meeting. Under the Commercial Code.
But this problem can be mitigated if auditors function under the umbrella of the board. Vol. 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. Listed and registered corporations must publish financial statements audited by external accounting firms. as a monitor of management in the Korean (and also the Japanese) system. almost all firms affirmed that the external auditor is independent from the company. II controlling shareholder/CEO. 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. but since 1998 a committee consisting of internal auditors. About 100 listed firms will be subject to this requirement. Accepting these arguments. External auditors are selected for a term of three years. this problem will largely disappear. 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. The Commercial Code will be revised to allow corporations to choose from the two options: the internal auditor or the board audit committee system.102 Corporate Governance and Finance in East Asia. and creditors selects it. 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. Big Korean accounting firms are affiliated with US accounting firms. underdeveloped market discipline for accounting firms. outside directors. the board of directors had the power to appoint an external auditing firm. The problem of misconduct on the part of the external auditor was caused partly by weak penalties on wrongdoing. In the past. however. The current external auditors have been associated with the surveyed companies for an average of 4. . there were many cases where external auditors failed to detect omissions and false numbers in financial statements of listed firms. then the Securities and Futures Commission can appoint a new one.6 years. and lack of strong professional ethics in the accounting profession. In order to increase independence. If the status of internal auditors is elevated to that of independent board members. does not have the power to hire and fire the managers. In the ADB survey. Previously. 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. This is because the auditor. The general organizational/social culture in Korea abhors conflict and may also have hindered effective functioning of internal auditors. If the company changes its external auditor for reasons that are not listed in the relevant regulation.
53 percent of the total shareholdings. amendments of the articles of incorporation require a “special resolution. This shows that a relatively larger number of shareholders send in their proxies. 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. About 100 shareholders per firm voted by proxy at the last annual general meetings (of the 40 firms answering the relevant questions). However. A total of 326 shareholders per firm. Thus. 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. The Depository represented 20 percent of the shares attending the meetings.Chapter 2: Korea 103 2. representing 62. in general. corporations cannot issue common shares without voting rights.3. However. One common share should have one vote. charter amendments. These voters represented only 5. Approval of mergers and major divestitures. Citizens’ coalitions sometimes solicit proxies in order to file lawsuits against a management. the Depository is subject to “shadow voting.” The survey shows that the Korea Securities Depository holds 69. Under the Commercial Code. The securities companies and banks are the second and third.3 Shareholder Rights Voting Rights and Practices Under the Commercial Code. No companies have so far introduced voting by mail. the only purpose of allowing the Depository to vote was to help listed companies to meet the quorum requirement for the general shareholders meeting. Internet. small shareholders do not attend the annual meeting and that.” Companies can increase the number . for some firms. The above results indicate that. Preferred shares can be nonvoting and issued up to one quarter of the total number of shares.” meaning that it should divide its votes in accordance with the accept/reject ratio of votes cast by other shareholders attending the shareholders meeting.93 percent of the shareholders but 26.77 percent of the shares. or telephone. or 10.21 percent of total shares issued. A “special resolution” requires two thirds of the votes attending and one third of total votes outstanding. respectively. attended the last annual general meeting. the Depository is instrumental in getting resolutions passed.79 percent of the shareholders. About one fifth of the listed firms issued nonvoting preferred shares. The management is the most important proxy. and dismissal of directors and internal auditors require a “special resolution.
Shareholder Protection Before the economic crisis. and for access to unpublished accounting books and records. the Securities and Exchange Act was revised to lower the representation requirement for shareholder derivative suits from 1 to 0. 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. dividend proposals. Various measures have since been taken to improve investor protection. mergers and acquisition plans. and major investment projects (only five firms answered this question). Due to the changes in rules for investor protection. Only two out of 62 respondents to this question have had cases in which proposals were rejected. demand changes in business policy. Shareholders have preemptive rights. but these can be waived by an amendment of the articles of incorporation. Changes in the authorized capital require an amendment of the articles of incorporation. In four out of 62 respondents. the Tiger Fund.01 percent. the requirement was lowered from 1 to 0. an activist citizens’ coalition has brought shareholder derivative suits against several large listed firms. In February 1998 and again in March. laws and regulations were generally very loose in protecting the rights of minority shareholders. As an example. or block charter amendments considered harmful to minority shareholders. was able to force a change in the charter of SK Telecom. the annual general meeting passed a resolution that was not proposed by the management nor the board of directors but rather by shareholders. However. This citizens’ coalition actively contacted the management of selected companies and negotiated measures to protect shareholders. an institutional investor based in the US. Those that are most likely to be rejected relate to election of directors.5 percent. The company also agreed to the right of the fund .104 Corporate Governance and Finance in East Asia. from 3 to 1. The charges included self-dealing by a controlling shareholder and unfair subsidization of affiliated companies by a chaebol firm. II of votes required for a resolution to amend the articles. It also attended the shareholders meeting of several companies to present the views of outside shareholders. This coalition also attempted to cooperate with domestic and foreign institutional investors to find their way into general shareholders meetings. Vol. For recommendations for dismissal of directors and internal auditors. Proposals put forward by management are rarely rejected at the general meetings. the board of directors decides on issues of shares within the limit of the authorized capital.0 percent.
affiliated lending or guarantees. Banks themselves were poorly governed and bank managements had little incentive to monitor borrowers. Before the amendment.3. creditors did not interfere with the management of a debtor. .Chapter 2: Korea 105 to recommend two directors to the corporate board. managers were considered to be subject to the duty of care. underwriting securities firms acted also as trustees. it now appears that it has backed away from its earlier efforts to introduce legislation on class action suits. After the economic crisis. bond indentures are only a few pages long compared to a few dozen pages found in advanced bond markets.4 Control by Creditors Role of Creditors in Corporate Monitoring Traditionally. but it was not entirely clear whether they had the duty of loyalty as well. simple. The laws and regulations of the country protect shareholders from interested transactions. and not strictly enforced. However. 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. there was the usual conflict of interest problem and the trustee did not have the incentive to strictly enforce the covenants. Banks have played some limited role in monitoring the investment activities of chaebols. mergers and acquisitions. For further protection of investors. 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. The covenants in loan agreements and bond indentures were very loose. In fact. These have to be disclosed under the Securities and Exchange Act or approved by shareholders under the Commercial Code and other laws. loans to directors. Thus. the Government had for some time pushed for the enactment of class action suits on false statements and omissions in disclosure materials. 2. This has strengthened the accountability of controlling shareholders as de facto CEOs. As for bond issues. controlling shareholders have become more susceptible to liability claims by other (minority) shareholders. The Code has also been amended to state more clearly the fiduciary duty (of care and loyalty) of the management. In 1974. and transactions with major shareholders.
However. The 10 largest business groups are required to select no more than three core companies in consultation with their respective main banks. 11 banks. Besides the setting up of an “External Auditors Committee” by firms. Vol. 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. Some proponents argue that creditors should have the right to send their representatives to boards of directors of borrowers. this proposal has only a slim chance of being accepted by the Government or legislature. The objective of the system is to improve the financial condition of the largest business groups and promote the soundness of bank management. the main banks should review the feasibility and financing plans of projects undertaken by the core companies and monitor their financial conditions and prospects. 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. The firms subject to the system are required to get the approval of the main bank prior to purchasing real estate. Emphasis on the monitoring role of banks has been growing since the beginning of the Asian crisis. 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. Under the system. In turn. On the other hand. including. and purchases of real estate.106 Corporate Governance and Finance in East Asia. on average. ADB Survey Results on Borrowing and Lending Practices The ADB survey shows that a typical nonfinancial company is associated with various types of creditors. In 1996. creditors now have a bigger say in court proceedings for receivership and composition. there have been concerns that the Government might use the system to intervene in the management of the business groups. 10 nonbank . However. 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. In 1994 the approval requirement was abolished. Purchase of real estate should be financed by equity capital and not by borrowed funds. II acquisitions. as discussed earlier.
A few creditors exercise influence through covenants relating to major decisions by the company. or through their shareholdings. About half of the respondents received assistance from other sources in the form of loan guarantees and/or provision of collateral. When loans could not be repaid on time. Most firms feel that requirements for collateral have been tightened since the crisis started. subsidiaries. Most of the financial institutions are not affiliates of the borrowing company. For a small number of firms. The assistance came from. holding shares of another company by both the borrower and the guarantor. and purchase or supply of raw materials. With respect to the types of loans. collateral was taken away. For more than half of such firms. most frequently in the form of loan guarantees and less frequently by arrangement of guarantees by a third party. while a third think that creditors have weak influence. Among the creditors. and other financial institutions. banks are most likely to require collateral. holding companies. collateral is more likely to be required of loans for working capital than for fixed investments. renegotiation took place after the crisis. mutual guarantee agreements. payments were usually rescheduled through negotiation without any penalty. One tenth of the firms received assistance from the Government in loan applications. Only a few feel that creditors have very strong influence. penalty was involved in rescheduling. 16 percent . Creditors usually exercise their influence through covenants relating to the use of loans. 35 percent are guaranteed by the company itself (by collateral and purchase of guarantee insurance). whereas seven of the 17 nonfinancial corporations are. or creditors filed for receivership. The typical company has also maintained its relationship with five of the 10 NBFIs for more than five years. controlling shareholders. The borrower’s relationship with most banks has lasted for more than five years. NBFIs infrequently ask for collateral. in order of importance: affiliated companies. More than half of the firms think that creditors have no influence on their management and decision making. Breakdown of loan guarantors is as follows: about 40 percent of loans are without any guarantees. Relationships with affiliated companies providing guarantees or collateral include ownership of each other’s shares.Chapter 2: Korea 107 financial institutions (NBFIs). About 60 percent of the firms have experienced renegotiation of loan repayment with creditors during the last five years. and 17 nonfinancial corporations. Most of the 43 firms with renegotiation experience were able to borrow from the same creditors afterwards.
have been the driving forces for restructuring activities of the largest 64 chaebols. 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.108 Corporate Governance and Finance in East Asia. This agreement will provide guiding principles in coordinating diverse interests among creditor institutions and promoting cooperation. First. the Korean Government maintained a policy of protecting the incumbent management of listed companies. banks and other institutional lenders are playing more important roles than ever before. This committee was set up in accordance with the provisions of the CRA. Under a contract signed between the creditors and the debtor. a Lead Creditor Council Agreement was signed for restructuring the top five chaebols. especially banks. 2. are summarized below.3. the delegation has the right to approve wide-ranging financial activities of the firm. 2 percent by holding companies. In cases where the creditors are unable to reach an agreement on a workout plan. 4 percent by subsidiaries. Vol.5 The Market for Corporate Control Government Policy Toward Hostile Takeovers Until 1994. Behind these new strengthened roles of creditors is the newly set-up FSC. 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. Separate from but emulating the CRA. and in continued monitoring of debtors. In this connection. the lead creditor banks formally signed Capital Structure Improvement Plans with chaebols. 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 . II by other affiliated companies. Third. and 1 percent by the Government. will get involved in the restructuring and workout processes. the creditor banks will send a delegation composed of bank officers to the workout firm to oversee its management. the Corporate Restructuring Coordination Committee (CRCC) will provide arbitration. major creditors. The new ways through which creditors. including commercial and merchant banks. Second. The leading creditor banks will continuously monitor the progress in implementing the signed Plans.
it can be safely stated that Korea now has one of the most accommodating capital markets with respect to hostile takeovers in the region. In one case. The incumbent controlling shareholders used various tactics such as issuing privately placed CBs. In the early 1990s the Government shifted its policy toward freer activities in the market for corporate control. The reasons for failure are diverse. a total of 13 hostile takeover attempts occurred. hostile takeovers by tender offers began to appear in the capital market. The shareholders already owning more than 10 percent at the time the company went public were exceptions to the rule. corporations cannot limit the voting rights of large shareholders to a given maximum. Companies have also utilized share repurchases. As far as institutional arrangements are concerned. A company cannot issue new shares to a third party without first amending the corporate charter. more than half of these attempts failed. Poison pills cannot be used mainly because companies cannot distribute stock options as dividends to shareholders. turning to white knights. Korea does not have the mandatory takeover rules applying to those who amass more than 30 percent of the shares outstanding (until 1998. Between 1994 and 1997. 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). . 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. listed firms rely mainly on shareholdings by the largest shareholder. Privately placed CBs cannot be converted into shares in one year. Limits on acquisitions of shares of a Korean firm by a single investor were gradually increased over a six-year period beginning in 1992. and announcing competitive tender offers by the controlling shareholder. Takeover Activity As soon as the Act was amended. but were completely eliminated in 1998. 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. For takeover defense. 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. Publicly issued CBs require three months before their owners can convert them to shares. Stock purchases by tender offer were also exempted.Chapter 2: Korea 109 unless he or she obtains prior approval of the Securities and Exchange Commission. Unlike the UK. However. Unlike Germany.
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. 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. Another reason is that many listed firms belong to chaebols. For the others. Some had two or more large shareholders who had joint control of the firm but could not cooperate. Charter amendments have also been employed by some firms to limit the maximum number of directors. some firms have included a supermajority provision for the dismissal of directors and provided for a staggered board. 172 firms (or 22 percent of listed firms) belong to the 30 largest chaebols. the Government became the largest shareholder of several commercial banks through equity participation purporting to recapitalize them out of financial distress. As of February 1999. in which the Government still holds the largest ownership. the limit will be eliminated when it is fully privatized in two years. 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. In 1999. Many of the takeover targets in the past did not have a controlling shareholder (group). Currently the limit is 3 percent. are designated as public companies. which are allowed by the Securities and Exchange Act to set the limit on the ownership of shares by one single shareholder. except for the banks. For the steel company.3. a steel company. In 1998. As of the end of 1997.7 percent on average as of the end of 1997 for nonfinancial listed firms). Hostile takeovers in Korea will be rare in the future. 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. was newly listed. Vol. Korea Telecom. 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. It is harder now to find such firms.6 Control by the Government State-Owned Enterprises Government ownership of listed companies is very limited. In their charters. an electric power company.110 Corporate Governance and Finance in East Asia. 2. and a bank had government ownership. . The Government-owned listed companies.
which was introduced in 1996. more state-owned corporations became subject to this new board structure. went into effect in 1998 to prevent them from absorbing too much of the funds available in the market. The Government has frequently imposed restrictions on the use of capital markets by large companies. is being applied to the 51 largest business groups to which the banks extended more than W250 billion in loans and payment guarantees. which limits the total amount of bonds issued by the five largest chaebols. This was aimed at limiting the supply of bonds thereby stabilizing interest rates. administering through a self-regulatory committee of the securities industry. There is no active debate or discussion going on about this potentially difficult issue.3. The Government’s right to send public officials to the boards was eliminated. especially those belonging to chaebols. In addition. The nonexecutive directors are now recommended by a committee. Meanwhile. the Government. But this rule. 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. as applied to four large corporations. and approved by the Chairperson of the Planning and Budget Commission. It was abolished before the economic crisis but another regulation. only qualified firms could issue new shares. nominated by the minister in charge of the company in question. 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.Chapter 2: Korea 111 The Government used to appoint a few public officials to the boards of state-owned corporations. Even where employees hold . was amended in 1997 to introduce a board structure consisting of a majority of nonexecutive directors.1). controlled the total amount of corporate bonds issued per month and allocated amounts to individual corporations. 2. Labor is not represented in corporate boards.3. The objective of the system was to improve the financial condition of the chaebols and to promote the soundness of bank management. There were also limits on the amount raised and the number of issues per year.7 Employee Participation in Corporate Governance Employee participation in corporate governance is very limited. Beginning in 1999. the main bank system. Further. For example.
but 27 percent of them felt that it was strong.5 in 1990. Trade unions are organized on an enterprise basis. 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. Collective bargaining is. employees of listed firms issuing shares through rights offerings are entitled to 10 percent of the rights. the council meetings have been superficial. Two thirds of the respondents had an organized union. . Under another law enacted in 1972 to induce private companies to go public. About half of these firms considered the influence of the union on the management of the company to be weak. of which 2 percent were senior managers. and 66 percent manual workers. they delegate their voting rights to plans’ representatives. Vol. 32 percent technicians and professional staff. and development of the company. in principle. union members account for 54 percent of the employees.9 in 1980. In 1987. Local unions in the same industry have established industrial labor federations. Under the Capital Market Development Act of 1968. In these firms. carried out at the enterprise level. The typical collective bargaining agreement has a one-year duration. The relevant regulation was amended recently in order to facilitate voting by individual employees. there are two federations of labor unions. and 2. In 70 percent of the firms with organized unions. The union had no influence on the management in 17 percent of the firms. 2.1 in 1997. Under the Labor Management Council Law. Employee stock ownership plans became popular in 1974 when the Government allowed tax and financial benefits for stock purchases by employees. which were generally much lower than estimated values. operation. The respondents of the ADB survey had 2. II shares of their companies through employee stock ownership plans. the management usually consults the union on major issues relating to the management. these firms have to offer 20 percent of the shares being issued to their employees at the public offer prices. employers are required to meet with representatives of labor unions at least once every three months.112 Corporate Governance and Finance in East Asia. In actuality. This practice may be due to the fact that employees are typically submissive to their employers and that their total shareholdings are minimal. This law is not intended for wage negotiations but for employers to seek cooperation and productivity increases from workers. The percentage of shares held by the employee stock ownership plans in listed companies was 1. At the national level. Employees of companies have had the opportunity to buy shares of their employing businesses at favorable prices.654 employees per firm on average.
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
1). Vol. Internal funds include retained earnings.5 percent in November 1981. which resulted in the establishment of a number of new banks. depreciation. was liberalized drastically in 1998 after the financial crisis. finance companies. especially the domestic bond market. and liberalization of foreign and capital transactions. opting to bring in the plan step-by-step to avoid market dislocation from a sudden shift in the system. The Government began to considerably deregulate foreign exchange in 1987 due to the shift of the current account into surplus in 1986 (see 2. and the 30 largest chaebols. On the basis of flows of funds. the required reserve ratio was substantially lowered from an average of 23 percent in 1979 to 3. the business scope of financial institutions was greatly widened from the early 1980s. revision of the credit control system.2 Patterns of Corporate Financing Corporate Financing Practices In this section. The capital market. mutual savings.2. Some policy loans were also abolished. With the privatization of nationwide commercial banks. Meanwhile. In June 1993. the Government announced a plan in 1981 that substantially improved foreign investors’ access to the domestic capital market. entry barriers to banks and NBFIs were lowered in an attempt to promote competition.4. the Korean Government announced its Financial Liberalization and Market Opening Plan. budget. Also. Since 1985. Moreover. implementing the first stage in November 1991. the following measures can be constructed: Self-financing ratio (SFR) is the ratio of change in internal funds to change in total assets. Korean firms have been allowed to issue CBs in international financial markets. development of the money market. the Government simplified various directives and instructions regulating personnel management. In addition. The plan was launched partially to accommodate US demands for comprehensive structural deregulation and market opening of the financial sector. The Government handed over its controlling stakes in four commercial banks to private hands in 1981-1983. short-term finance companies. . It included such important issues as interest rate deregulation. The Government adopted a cautious approach. 2. etc. and organization of commercial banks.118 Corporate Governance and Finance in East Asia. flow of funds analysis was used to examine patterns of financing of the aggregate corporate sector. II Interest Rate Deregulation Plan. listed companies. as a first step toward liberalization of capital account transactions.
It measures the degree of financing growth in total assets by additional equity. In 1988 when the stock market boomed. Financing Patterns of the Aggregate Corporate Sector Table 2. This means that internal funds after dividend payment were insufficient to finance growth in total assets. Securities finance became a more important source from 1988 onwards. except in 1991. Incremental debt financing ratio (IDFR) is the ratio of change in total borrowings to change in total assets. 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. the corporate sector’s most important source of external finance was bank borrowings. particularly in the short term.25 shows the flow of funds of the nonfinancial corporate sector in Korea during 1988-1997. The share of external financing. but do not include capital surplus (asset revaluation allowance and the excess of current value over issue value of stock). the proportion of borrowings from NBFIs fell to its lowest value at 4 percent.25. capital surplus. This high proportion deprived Korean businesses of flexibility during recession periods due to high financial costs. The corporate sector used .4 percent in the precrisis period 1988-1997. and 1997. and government transfers. Table 2. but it remained less than 10 percent of total financing. Additional equity capital used to finance growth reduces the financial cost and the financial risk of investment. Equity capital represents the shareholders’ commitment to the business. Before 1988. the proportion of foreign borrowings in total finance rose steadily. 1994. In securities finance.26 shows the four measures of corporate financing calculated from Table 2. was 71 percent during the period. depreciation. The SFR averaged 28. Meanwhile. including all sources other than retained earnings. 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. It measures the degree of financing growth in total assets by additional debts. comprising internally generated capital (retained earnings. New equity financing ratio (NEFR) is the ratio of change in equity (stocks issued + equity other than stocks) to change in total assets. particularly in the 1990s in response to the liberalization of the capital market. on average. except for the stock market boom of 19871988. and allowances) and new equity capital. depreciation.Chapter 2: Korea 119 and net capital transfers from the Government.
0 3.4 (2.2 13.0 3.0) 12.7 32.6 4.5 2.9 73.Table 2.1 (0.3 3.6 8.8 0.6 77.5 29.0 70.6 (0.9 6. 1994.5 0.7 8.6 0.4 27.7 14.6 0.7 1.1 12.8 56.4) 13.0 0.0 3.1) 4.3 2.8 8.3 1.1 3.6 9.1 17. . and Flow of Funds. Bank of Korea.1 27.7 1.0 1997 26. b Includes capital surplus.7 2.0 9.3 — 30.2 26.1 0.4 27.0 10.7 8.4 21.8 (0.4 10.5 2. a Includes retained earnings.4 0.6 3.6 25.7 10.9 28.7 15.8 — 26.9 9.1 72.7 — — — — 9.3 72.9 34.3 30.2 — 28.5 2.3 6.4 2.7 13.2 5.7 10.1 — 27.3 5.5 0.6 3.6 Sources of Funds Internal Financinga External Financing Bank Borrowings Banks Nonbanks Merchant Banks Insurance and Others Securities Natl.7 7.9 0.6 9.4 1.7 6. and net capital transfers from the Government.7) 11.8 -2.2 34.0 — — — — 8.3) 11.8 1.3 25.0 (0.5 13.1 1.9 38.3 — — — — 8.6 11.6) 5.9 2.7 12.8 4.1 23.1 8.7 71.8 1.3 1.5 2.4 15.1 2.4 11.1 — — — — 12.0 2.4 71.6 0.0 0. Source: Understanding Flow of Fund Accounts.1 1.2 13.4 9.1 3.0 22.1) 6. Bank of Korea.0 17.1 36.8 1.7 2.4 (0.1 2.6 0.2 10.4 8.4 1.8 17.6 1. which is the excess of current value over issue value of stock.1 10.4 27.7 73.2 1.1 (1.0 1.4 2.3 10.6 4.5 9.6 14.8 1.9 10.2 — — — — 9.5 16.3) 15.0 11.7 4.8 1.3 3.3 16.5 0.3 6. 1988-1997 (percent) 1988 43.4 — 28.8 15.1) 4.2 14.6 9.3 6.1 1. depreciation.7 4.6 11.1 3.2 0.2 6.7 2.6 2.0 16.2 2.0 5.7 14.8 27.6 10.3 1.25 Flow of Funds of the Nonfinancial Corporate Sector.6 5.7 (0.4 0.2 6.1 0. 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.4 3.4 2.3 27.4 2.9 72.8 30.7 11.2 (0.7 1989 1990 1991 1992 1993 1994 1995 1996 22.7 10.5 16.2 15.0 9.6 4.9 10.
and Flow of Funds.1 percent in 1988 during the stock market boom.Chapter 2: Korea 121 Table 2. and IEFRs were declining.3 60. higher than the aggregate 28. respectively. On average.5 12.2 percent of incremental asset growth was financed by equity. in the manufacturing sector. Bank of Korea.6 percent.0 11. Across industry.8 10. Lower income diminished the industry’s equity position toward crisis year 1997. Source: Calculations from Understanding Flow of Fund Accounts.26 Financing Patterns of the Nonfinancial Corporate Sector.4 IEFR 63. declining to 26.8 62.2 37. respectively. an average of 59.27). .2 percent of the growth in total assets.6 Excludes capital surplus.3 11.5 percent in 1997.6 percent and 1. NEFR registered 20. 1988-1997 (percent) Year 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 Average a SFRa 43.3 59. but also continuously fell. IEFR ranged from 32 percent to 64 percent of asset growth during the boom years.4 percent. higher than the aggregate 40.5 percent.1 26.1 39. and the total debt ratio was much higher in 1996 and 1997 at 62.6 percent. NEFRs.4 percent (Table 2.3 percent in 1997. 45.3 27.3 59. SFR peaked at 44 percent. In periods of high economic growth such as in 1988.8 28. Its IEFR and NEFR dropped to 23. indicating a high financial risk position.3 73.4 percent.9 60.5 and 76. dropping to 26.1 53.7 28.7 40. There were significant time trends. It dropped to 28 percent the following year. The balance. was financed by additional debts.0 57.5 31.9 46.7 9.9 percent by 1997 when net profit margins were negative. the corporate sector relied heavily on external financing for its expansion.7 30.0 5.1 17.0 42.7 40.9 28. IDFR reached 73. Bank of Korea. Incremental financing from equity was 40.7 percent in 1997. but plunged to 5.4 12.4 NEFRa 20.7 40. While SFRs.2 IDFR 36.4 37. Manufacturing financed 54. 1994.6 percent over the 10-year period.7 26.1 12.8 percent of its total asset growth through debts.3 12.0 27.4 27.5 68.9 22.6 26. additional equity to finance 12. average SFR was 37.6 62.
9 percent of asset growth.4 47.7 47. with the total debt ratio much higher in 1995-1997 at 82 to 84 percent.4 3.8 percent in 1990.5 NEFRa 9.4 54. then increased to 20. the utilities (electricity. In 1997. On the other hand.6 3. Categorized according to company size.8 percent in crisis year 1997.9 6. explaining partly the collapses of several construction companies in 1995.6 4.5 7. their average SFR was higher. It had the highest average SFR in 1988 at 31.1 percent of total asset growth for the period.7 37. Since large firms were more profitable.4 37. storage.9 IDFR 34. and fell to about 10 percent in 1997.0 3.1 29.0 42.6 37.6 54.7 37. the proportion of short-term borrowings in total financing has been high. II The construction industry showed the most cyclical pattern in annual asset growth. and steam) and the transportation. the two sectors also had low equity financing ratios and high debt financing ratios. gas.9 percent. Table 2. Financing patterns of the wholesale.4 46. this dropped further to 15.6 53.0 30.5 1. Since 1992.and medium-sized firms.4 45.0 57.3 28.5 23.8 4.122 Corporate Governance and Finance in East Asia. Vol.5 76. Total debt financed an average 74.6 37.6 53. one year ahead of the other industries. These sectors had relatively low equity financing ratios and high total debt ratios in financing asset growth between 1988 and 1997.2 . large firms showed more cyclical patterns in these financing ratios than small.0 42.27 Financing Patterns of the Nonfinancial Corporate Sector by Industry (percent) Year Manufacturing 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 Average SFRa 50.2 5. and hotels sector and realty/renting/business activities sector were similar.4 63.3 52.8 IEFR 65.7 47.6 36.6 62.8 50.6 45. from 17. and low total debt and short-term borrowing ratios.2 62.2 percent in 1993. Equity financed an average 25. which decreased to 8. retail.7 percent in 1996. and communication sector had relatively high incremental equity ratios.2 21.2 3.
0 60.4) 2.5 29.5 1.5 12.1 Trasport.5 76. Storage.1 19.3 (9.3 84.6 2.7 7.9 20.0 1990 12.Table 2.9 30.0 31.4 1995 53.3 19.7 78.8 4. Hotels 1988 33.6 8.1 66.9 52.6 7.9 1.2 20.9 29.6 14.9 1992 56.4 2.7 Wholesale/Retail Trade.9 1993 63.4 62. Household Goods.3 57.1 84.8 2.2 5.0 17.9 1.1 69.8 9.3 1996 16.4 28.7 1994 53.0 1990 50.9 2.7 78.2 23.9 Construction 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 Average 31.8 25.7 15.9 1.0 4.3 7.2 1995 16.1 25.6 71.5 20.8 76.2 8.7 1989 26.2 70.6 9.6 4.8 70.6 9.5 62.5 1993 22.9 9.0 74.4 IEFR 46.6 37.2 74.9 80.3 4.9 1989 63.3 8.6 73.7 41.5 70.7 42.8 54.9 16.3 47.3 10.8 1991 51.8 29.7 15.8 74.2 18.0 40.8 81.5 87.1 70.2 25.2 46.0 10.9 33.7 1997 8.1 4.2 10.9 47. and Communication 1988 64.2 29.2 3.5 21.6 1997 29.27 (Cont’d) Year SFRa NEFRa IDFR 53.9 15.0 3.4 26.0 65.1 1991 14.7 80.6 37.0 0.5 23.1 59.0 82.6 8.2 Average 53.3 4.3 21.0 1992 24.8 1994 15.7 53.0 34.9 Average 19.0 1.0 68.7 6.2 4.5 1996 42.0 .
1 0.7 14.4 5. and Steam Supply 1988 118.7 18.8 36.1 54.6 7.5 8.8 17. Renting.1 35.7 1996 18.4 0.0 0.8 135.8) (35.9 65.1 42.1 1989 34.9 Average 75.9 28.124 Corporate Governance and Finance in East Asia. a Excludes capital surplus.1 34.0 21.5 77.0 46.4 1995 62.0 43. when large firms had much lower equity financing ratios and higher debt financing ratios than small.0 (0. Source: Calculated using data from Bank of Korea.1 1993 55.7 69. NEFR = new equity financing ratio.3 3.8 1990 19.6 1989 118.3 207.0 1. Vol.5 22.2 1992 18.6 Real Estate.0 56. however.1 1991 56. Gas.3 31.6 52.9 45.7 1994 8. and Business 1988 51.7 37. IEFR = incremental equity financing ratio.3 81.6 1990 82. .8) 7.4 (107.6 1.1 70.0 1997 24.3 92.0 53.6 1991 18.0 67.4) 3. Higher growth in total assets and sales and easier access to debts by large firms could be reasons for this.4 1.0 79.4 1996 45. The large firms had a higher proportion of external financing in 1996-1997.4 0 0 0 0 1.9 64.6 IDFR = incremental debt financing ratio.0 1992 51. Long. Their average IEFR was also higher and IDFR smaller. Financial Statement Analysis Yearbooks.8 Average 22.4 47.1 71.3 62.27 (Cont’d) Year SFRa NEFRa 6.8 1993 11.9 57.3 Electricity.0 33.6 1997 23.2 63. II Table 2.4 7. The trend was reversed in 1996-1997. SFR = self-financing ratio.9 IDFR 31.and mediumscale firms.6 1995 17.4 IEFR 69.0 0.and short-term borrowings of these firms shot up in that period.3 85.4 1994 72.7 70.3 7.9 29.3 29.
compared with 89.8 percent.5 percent and their total external financing. and were large borrowers.7 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 2.7 percent for all listed companies.30).1 percent of their equity capital.5 percent is lower than that of the corporate sector in general. and higher than that of listed companies (Table 2. Many firms affiliated with the top 30 chaebols saw loan guarantees turn into their own debts because of defaults in debt payments. The chaebols’ drive to expand their empires resulted in heavy borrowings.4 percent. for listed companies. the lowest ratio of 58. the top 6-10 chaebols. External financing reached 94. In 1997. In 1996-1997. Their shortterm borrowings accounted for 86.9 percent.28). The proportion of their short-term financing averaged 72. and the top five chaebols. The average IEFR of the top 30 chaebols of 29. respectively. The debt financing ratio of listed companies was high since they relied more on external financing. 91. and using cross-payment guarantees among affiliated companies.6 percent. They had easier access to bank loans and the markets for corporate bonds and CPs than nonlisted companies.3 percent of their equity capital in 1997 (Table 2. at an average 70.9 percent. The largest borrowers were the top 11-30 chaebols. Group-member firms borrowed less. They were able to borrow easily from banks by issuing corporate bonds and CP. the average SFR was 28. Financing Patterns of Chaebols For chaebols. the IDFR of listed companies increased to 93.2 percent. but higher than that of listed companies.29). 153. compared with the entire corporate sector’s 35 percent and 65. about the same as that of the corporate sector as a whole. the top 11-30 chaebols had the highest guarantees commitments at 207. In 1997. .8 percent of their total finance in 1997. Another key feature of corporate finance in Korea is the widespread use of loan guarantees among the top 30 chaebols.6 percent of total asset growth. the NEFR of the top 30 chaebols plunged while the debt ratio increased substantially.7 percent. The average IEFR and IDFR were 10. All of the top 30 chaebols relied heavily on short-term borrowings.3 and 89. Cross-payment guarantees have been declining since 1993 and reached 91.
1 1.5 91.5 2.2 1.6 61.3 IDFR 57.7 12. Source: Calculated from data obtained from data files of the Korea Listed Companies Association.6 IEFR 42.5 2. Table 2.4 29.3 5.3 28.6 1.4 88.2 10.5 Year 1994 1995 1996 1997 Average a Excludes capital surplus.8 89.1 8. Largest Business Groups in Korea.3 86.7 13.8 22.4 12.9 7.9 NEFRa IEFR 14. .Table 2. 1994-1998 (percent) SFRa IDFR 85. 1994-1997 (percent) SFRa 41. Source: Calculated using data of Seung No Choi.5 8.3 Year 1994 1995 1996 1997 Average a Excludes capital surplus.4 1.2 23.2 NEFRa 1.8 76.5 8.6 0.3 1.7 1.29 Financing Patterns of the Top 30 Chaebols.9 6. Korea Federation of Industries.6 70.6 11.4 38.2 36.28 Financing Patterns of Listed Companies.1 93.
3 200. Third. Interest payments on debts were considered a loss when calculating taxes. chaebols could easily borrow funds from banks and NBFIs by using cross-payment guarantees. company preferences in financing investment projects before the crisis were.30 Cross-Payment Guarantees of the Top 30 Chaebols. loans from banks. especially in the 1970s when real interest rates of bank loans were negative. Controlling shareholders usually tried to avoid dilution in their shareholdings for fear of losing control.0 207. And fifth. inefficient investment and excessive diversification of corporations.0 1997 91.3 58. Further. Source: Fair Trade Commission and the Federation of Korean Industries. There were several reasons for this. the Korean economy was plagued with high inflation. Few firms ranked loans from NBFIs as their first preference.3 64. and reserves and retained earnings. Financial institutions did not strictly screen their loan projects and monitor their debtors. and loans from NBFIs. Second.9 153. First.9 — — — 1996 105. more than half of bank loans were priority loans with low interest rates.7 150. and underdevelopment of the stock market. rights issues. This change implies that firms now give more attention to financial risks.1 — — — 1995 161. the Government applied high tax rates on net profits of corporations. This attitude appears to have changed after the crisis because reserves and retained earnings and rights issues became the preferred financing choices. the Government provided implicit guarantees on bank lending and large businesses. Firms now prefer internal funds and new equity capital. bond issues.9 — — — 1994 258. Factors Influencing Corporate Financing Choices Until recently. These are followed by loans from banks. and extended loans based on cross-payment guarantees. According to the ADB survey. . 1993-1997 (as percentage of equity capital) Rank Top Top Top Top 30 Chaebols 5 Chaebols 6-10 Chaebols 11-30 Chaebols 1993 469.Chapter 2: Korea 127 Table 2. Fourth. in order of ranking. bond issues. so that the firms engaged in lobbying to gain access to them.1 — = not available. Korean firms preferred debt financing (bank and nonbank borrowings). poor financial and corporate governance resulted in overlending by banks.
128 Corporate Governance and Finance in East Asia. the percentage of foreign currency denominated debt in the portfolio was 14. Only a few firms sought foreign loans because domestic loans were not available. For these firms. and others (29 percent) expected the local currency to appreciate in value.36 percent on average for these companies. This preference has changed little after the crisis. and reduction in tax burden. Few companies felt that hedging was too costly or was unnecessary as the exchange rate was considered fixed. According to the survey. 2. some (36 percent) thought that a hedging facility was not available or not working properly. ensuring the liquidity of the company. in selecting financing sources. The percentage of foreign currency denominated loans hedged against exchange rate risks was 21. Among those that never hedged against exchange rate risks. 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. more than half (53 percent) hedged against exchange rate fluctuations. Other factors include. Korea now provides a better environment for financial risk management. many firms (or 42 percent) never considered hedging. II In seeking external financing. Vol. they survived for two to three . firms give their first consideration to minimization of transaction and interest costs. Among the responding companies that had foreign currency denominated loans.3 Financial Structure. even with a heavy debt burden. About half of the respondents of the ADB survey borrowed foreign currency denominated loans from foreign banks.5 percent at the end of 1997. the majority (60 percent) of the firms responding to the ADB survey look first for nonaffiliated financial institutions. Nonetheless. and futures and other financial derivatives. Diversification. maintenance of the existing ownership structure.4. These survey results indicate that many companies were not very attentive to exchange rate risks (and possibly to financial risks in general). in order of importance. A futures exchange launched in 1999 trades foreign exchange options. 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 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. Those firms whose interest payment coverage ratios are below 1 are likely to go bankrupt. The ratios of the top 6-70 chaebols were lower than those of the top five chaebols. 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. However. except in 19931995 when semiconductor prices were extraordinarily high. 1999). the top five chaebols and the top 6-70 chaebols had similar ratios. These findings indicate that independent firms have had a lower leverage and performed better financially.3. They were also higher than those of the top five chaebols until 1991. the top five chaebols’ ratios were much higher. But since 1992. the trend was reversed in 1993 when the interest coverage ratios of the top five chaebols exceeded those of the independent firms.13). (ii) In terms of net income to total assets. the ratios of nonchaebols were remarkably higher than those of the top 670 chaebols during the entire period.2. . They were also higher than those of the top five chaebols until 1992. Interest coverage ratios of non-chaebols were higher than those of the top 6-70 chaebols during the entire period. Among the main findings were the following. but the ratios of independent firms were much lower. Nam et al. the ratios of independent firms were higher than those of the top five and top 6-70 chaebols during the entire period.Chapter 2: Korea 129 years before collapsing at the time of the 1997 financial crisis (2. (iii) Interest payment coverage ratios are calculated as operating earnings over interest expenses. (i) In terms of total borrowings to total assets. Operating earnings are earnings before interest payments and taxes plus depreciation and amortization (EBITDA). as well as lax financial supervision (Nam et al. Table 2. except in 1991. (iv) In terms of EBITDA to total assets. In order to determine the relationship between financing patterns and corporate performance. (1999) compared the financial positions of 504 chaebol affiliates and non-chaebol independent firms during the period 1986-1998..
Government intervention. The diversification of chaebols under workout was much lower than that of the top 6-30. and easier access to cheap credit. Vol. 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. This indicates that excessive diversification and inefficient investment of the top 30 chaebols resulted in relatively low net profit margins (Table 2. The diversification of the top five chaebols remained at about the same level within the period. II Corporate Performance and Diversification As a chaebol further diversified into nonrelated areas. larger research and development expenditure. too. rising nonperforming loans (NPLs) and falling . The differences in the degrees of diversification among the three groups are substantial. had easier access to credit than the top 31-72 chaebols. the top 6-30 and 31-72 chaebols gradually increased their diversification beginning 1990. except in the recession years of 1996-1997. Their subsidiaries. the top five chaebols outperformed the top 6-30 chaebols for most of 1985-1997.5 The Corporate Sector in the Financial Crisis This section looks at the various causes of the crisis in 1997. 2. Factors related to weak corporate governance were closely intertwined with shortcomings in macroeconomic policy and vulnerabilities in the financial sector. then declined to levels lower than those of the top five in the years of economic downturn 1993-1997. The degree of diversification of chaebols that fell into default. the degree of diversification was highest in the top five chaebols. and composition was lower than that of the top 6-30 but higher than that of the top 31-72 chaebols on average. second highest in the top 6-30.31). But the net profit margins of the top 31-72 chaebols were higher than those of the top five in 1985-1992. or outright transfer of resources due to poor corporate governance practices. In terms of the net profit margin (the ratio of net profits to sales revenue). Indicators such as increasing debt-to-equity ratios. however. Chaebols have been subsidizing new or low-profit industries by transferring resources from high-profit industries through inside dealings. had a significant role. debt guarantees for free. its profit rate declined. Meanwhile. net profit margins of the top 31-72 chaebols were always higher than those of the top 6-30.130 Corporate Governance and Finance in East Asia. During 1985-1997. and lowest in the top 3172 chaebols.
Background and Task of Structural Adjustment.3) (12.5) (1.8 3.3 1.4 (1.4 (0.9 1.3) (0.2 1.1) (5.9 1.6 0.3 1.2) 2.2 (0.0) (3.4 1.1 0.1 1.4 0.4 0.6) (0.6 0.1 (4.6) (12.5) 0.3 1.6 1.1 0.4) (1.2) (3.8) (0.2) (0.3 0.6 1.9 1.1 2.6 5.5) (2.4 1. . Management Research Institute.4) (4.6 1989 1.9) 2.2 4. 1998.4) (6.3 0.7 0.1) 2.9 0.9 0.1 1.0 1.0 1.3 (3.6) 0.1 1.5 (0.7 0.8) (20.1 0.3 0.1 0.5 4.1 1.5 (6.6 0. Court Receivership.4 (2.9) 2.6 1.0) (0.2) (4.8) (4.0) 0.1) (1.7 0.2 0.6) (0.5 (0.4) (1.2 (0. 1985-1997 Item Top 5 Hyundai Samsung LG Daewoo SK Top 6-30 Top 31-72 Default.2 1.6 0.2 1995 3.0) 0.3 1.6) 0.7 (1.8) (1.8 (0.2 (17.3 (0.1 (0.1) — = not available.1) 2.3) 0.8 0.1 1.7 (0.9 0.7 1.3) 0.1 0.5 1.7 1.3 3.4 (0.6) 0.1 0.31 Net Profit Margins of Chaebols.8 1.3 1.2 1.0) 0.2) 0.4 (1.4 1996 0.8) 1997 0.2) 2.7) (0.7 — (0.2) (13.8) 0.5 1.1) 1.8) 0.3 1.8 (0.0 (7.1 0.3) 0.3) 0.2 1.1) 1.3 0.3) 1.4) (0.8) 2.6 (0.3) 0.8) 1.3 1.0 6.2 1.6 0.6) (20.5 1.8) (11.4 1.1 (3.4 0.2) 1.8 1.5) (0.9 0.6 7.1 0. Beyond the Limit.8) 0.0 1992 1994 1.3 (0.5 2.5) (7.1 4.4) (2.3) 1.9 8.1 (1.1 (9.1) (2.2) 1.8) (3.0) (0.9) (1.5 (0.2) (13.1 (4.0 (0.8 0.4) (1. Source: Whan Whang.5 1.6) (12.4 2.5 1.7 1.2) (4.9 1. 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 1.8 1990 0.0 (2.2) (0.3 1.6 0.6) 0.2 (0.6 (0.4 1.6 3.3) 12.3 (0.0 4.9) (8.7) (0.4 0.8 0.1 1.9) 2.9) (9.5 (0.0 0.2 (0.1 0.6 1.3) 0.9) 0.3 1.3) (1.8 (0.7 0.7) (1.2) (4.8 0.8) (37.7 (0.7 2.11.0 0.8 0.7 3.2 1.7 0.8) 0.0) (4.2) 1.3 0.5 (4.3 (0.7 0.3) (0.1) (6. p.8 3.1) (1.6 0.1) 0.7) 0.2 (1.6 1.0 1987 1.7 1.7) 0.8) (1.3 1. Chung Ang University.6 (10.9 (0.5) (2.1) 0.3) 0.6 0.7 (4.1 1.4 (1.4 (0.5 0.8) 0.Table 2.3 1.
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. outside directors. 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. 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. . after the crisis. But in 1998. A remote trigger in the Thai crisis was all that took to push the economy over the edge. internal auditors cannot be expected to perform their function independently of management. Along with government policies to protect the status quo. They were then almost automatically elected at the general shareholders meeting. The most serious problem among most Korean listed firms has been that a controlling shareholder acting as CEO could never be replaced.5. II corporate profitability were signs that the Korean economy had reached the edge of a slippery slope.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. the boards of all listed companies were composed of insiders only. 2. The hold was tightened by the practice wherein candidates for directors were handpicked from among the managers by the controlling shareholder. and to the development of the market for corporate control. the recently adopted Code of Best Practice in Corporate Governance recommends the strengthening of the board system. and creditors should select (recommend) the external auditor. Until 1997. Thus. Thus. Ownership concentration also had ramifications on corporate transparency. the independence and objectivity of the external auditor were often questioned. Until 1997. a committee composed of internal auditors. Meanwhile. Vol. 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. Now. Moreover. a firm’s board of directors had the power to appoint an external auditor.132 Corporate Governance and Finance in East Asia. this has led to entrenched management.
profitable firms within a chaebol tended to subsidize unprofitable firms. Many of the takeover targets in the past did not have a controlling shareholder. and some differences in Korea’s generally accepted accounting principles from international standards. Many changes were introduced to promote M&A in the 1990s. 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. In this situation. has an unsound capital structure and . 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. however. Dominance of Chaebols A chaebol is tightly controlled by the largest shareholder. participated in the stock market as short-term traders rather than long-term investors. These included restrictions of shareholdings of institutional investors. hostile takeovers in Korea will likely be rare in the future. Banks did not function as monitors of corporate management although they were shareholders as well as the most influential creditors. Meanwhile. individuals. a large issuance of preferred stocks with no voting rights. Under the direction of the controlling shareholder. Traditionally. restrictions of voting rights of shares of institutional investors. Diversification can reduce chaebols’ risks through the portfolio effect. regulatory and practical difficulty in implementing proxy voting. as well as institutions. when a large diversified chaebol. as a whole. and restrictions on hostile takeovers. There were no effective monitoring mechanisms for its management. prevalent window dressing practices. corporate accounting information was not reliable due to the lack of independence of external auditors.Chapter 2: Korea 133 There had been some devices to protect management so that companies could indulge in business activities without fear of takeover. usually a member of the founding family. 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. One reason is that the percentage of inside shareholdings for an average listed firm is very high. However. These internal dealings made strong firms weak and helped marginal firms survive. the Government maintained a policy of protecting the incumbent management of a listed company.
As mentioned earlier. However. and a high degree of inefficiency in the economy.3 Manifestations of Weak Corporate Governance and Government Intervention Preference of Debt Over Equity Financing in the Precrisis Period Before the crisis. The Government and the Bank of Korea did not have accurate information on the extent of transactions that corporations and financial institutions had abroad. II strong financial links among its member firms through investments and cross-guarantees. Such problems may eventually cause ripples through the entire economy. bond issues. Profitability of the top 6-70 chaebol firms has been lower than that of the top five chaebol firms. capital. while (non-chaebol) independent firms had much lower borrowing ratios.5. Financing preferences changed drastically after the crisis. and internal funds. prevalence of rent-seeking and morally hazardous behavior by economic decision makers. financing choices of listed firms in order of preference were bank loans. the financial distress of one or a few marginal firms can lead to a chain of bankruptcies across the entire chaebol. The new preference ordering is as . Further. although their subsidiaries had better quality workforce and easier access to cheap credit than the top 31-72 chaebol affiliates. the intervention later resulted in the accumulation of adverse side effects: underdeveloped product. the authorities did not properly check on banks’ lending practices—banks did not screen the lending projects and evaluate the creditworthiness of corporations properly. and other individual markets. The Government’s supervision and regulation of financial institutions were poor.5. Net profit margins of the top 31-72 chaebols were higher than those of the top five or of the top 6-30. the typical chaebol firm had an extremely high DER. share issues. Vol. This effectively becomes an exit barrier for chaebols and would justify the intervention and support of the Government. as the latter are well established in most business areas. 2.2 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. This indicates that too much diversification and overinvestment in the top 30 chaebols resulted in relatively low net profit margins.134 Corporate Governance and Finance in East Asia. 2.
total foreign debt amounted to $157. The financing choice of listed firms was also influenced by the underdevelopment of the stock market. The high proportion of foreign debt led to a mismatch problem where borrowers were unhedged against foreign exchange risk.5 billion. In the international financial market. large-scale bailouts of financially distressed firms. The ratio of external debts to GDP reached 48 percent at the end of 1998. 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. won/dollar nondeliverable forward rates increased rapidly. 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. signaling a bearish speculative move on the won.Chapter 2: Korea 135 follows: internal funds. which generally required guarantees or collateral. bank loans. and bond issues. were advantageous to chaebols because they were in an “ideal” position to meet the loan requirement through cross-guarantees among their member firms. reducing foreign exchange reserves to a dangerous level. The preference for debt finance also led to a relatively large foreign debt. which were the most important financing source until 1987. In November 1997. . However. After the financial crisis erupted in Indonesia and Thailand. the Government and the Bank of Korea defended the currency. obviously contributed to overlending and aggravated the situation. The lending practices of banks. 63 percent of which was short-term. the top 30 chaebols showed a DER of 519 percent. as evidenced by occasional. Other factors also contributed to this preference. 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. overseas borrowing became difficult and higher interest rates were charged on foreign borrowing. share issues. which is far higher than the average ratio of around 400 percent for nonfinancial listed firms. the exchange rate (won/dollar) increased sharply and the financial crisis erupted in Korea. Bank loans. Nonpolicy loans were also considered to be cheap because of interest rate regulations. Although the ratio of stock market capitalization to GDP in Korea was not very different from those in the Philippines and Thailand. Implicit guarantees by the Government on bank loans to large businesses. At the end of 1996. 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. consisted of high proportions of policy loans. As of the end of 1997.
excluding the financial sector. It jumped to 17.000 per year starting 1992. The bank supervisory 8 NPLs of banks comprise fixed (substandard) and doubtful loans. The inevitable result of inefficient investment was a fall in corporate profits. decelerated from March 1998.6 percent in June 1998. a large number of construction companies failed due to the recession in the real estate market and decline in real estate prices.000 during January-September of 1998.000 in September 1998 (Table 2. II Inefficient Corporate Investment and Low Profitability Ownership concentration among Korean firms. and shareholders’ equity of all industries. were low in 1996 and 1997. and estimated losses. especially chaebols. Following the “three months” definition. they are defined as loans for which interest payments are overdue by three months or more. Moreover.200 in 1997. the NPL ratio8 of banks and other financial institutions began to increase. has given rise to various types of self-dealings by the controlling shareholder. the ratios of net profits to sales. Vol. reaching highs of 6 percent in 1997 and 8. total assets.000 from December 1997 to February 1998. nine out of the 30 top chaebols failed. and the pursuit of growth through excessive diversification and inefficient investment.32). They utilized mutual payment guarantees among their affiliates and believed that they would never fail. .136 Corporate Governance and Finance in East Asia. and there is no collateral. then 20. Fixed loans are those for which interest is not received for six months or longer. In 1997 they became negative. legal and other barriers prevented the exit of financially nonviable firms. Meanwhile. The number of insolvent companies increased rapidly in 1991 and doubled to more than 11. starting 1 July 1998. The banks and merchant banks lent to large businesses.7 percent in 1997. regardless of whether it is caused by large personal holdings of the controlling shareholder or by pyramiding. Doubtful loans are those for which interest is not received for six months or longer. and returned to about 1. Financial Sector Vulnerability Because of financial losses in the corporate sector. without strictly evaluating the creditworthiness of businesses and the profitability of projects. The Government could hardly help them because of the number and magnitude of business failures. However. the NPL ratio of commercial banks increased rapidly from 4. Further. the NPL ratio reached 7. 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. These were the definitions until 30 June 1998. The monthly number reached more than 3. Before the crisis.1 percent in 1996. and there is collateral. According to the “six months” definition.
265 6.673 Construction 380 354 242 195 294 585 1.133 3. those of domestic banks were lower in the 1990s. The current account deficits in terms . 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. 1986-1998 Year 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 Total 4. 2.850 3.210 1.107 6.131 1. Exchange rates were virtually pegged to the US dollar in all troubled Asian countries. As a result they had largely overvalued currencies. authorities were not too concerned about the high NPL ratios at Korean banks in 1997 simply because the high and rising ratios had precedents.244 3.573 3. This was mainly due to the high ratios of NPLs.69 20. Policymakers thought that economic growth would resolve the NPL problem without the need for corrective action.33).759 6.856 7.135 1.5. In 1990-1993.992 11.657 3.769 9.159 10. and large government-directed loans.472 2.255 13. Meanwhile.114 811 706 696 866 1. and declined to 4-6 percent in 1994-1996 (Table 2.238 4. This speculation was said to be one of the causes of the financial crisis in Korea.553 3.979 8. the ratio reached 7-8 percent.985 Services 3.647 8.751 1.859 3.China.250 2.386 5.637 6. Source: Bank of Korea. Compared to ROAs and ROEs of domestic branches of foreign banks.4 Shortcomings in Macroeconomic Policy The macroeconomic framework also contributed to the crisis in 1997.259 2.053 5.Chapter 2: Korea 137 Table 2.027 Manufacturing 1. and Taipei.890 4.457 2.502 11.544 2.855 6. ROEs and ROAs of Korean and Japanese banks were low compared with those of the US.32 Number of Firms with Dishonored Checks. and continuous and large current account deficits.417 Others 152 132 108 97 88 161 326 252 274 302 553 861 952 Note: 1998 figures cover only January-September. low efficiency.754 3. European countries.517 2.589 171.
8 percent (1996).170 1. Korea -4. Vol.584 Fixed (A)a 5.562 18. Related to this. and 30 percent in 1996.475 143. The main result of the rigid labor market was a “high-cost and lowefficiency” economy. In addition to the overvaluation of the won.537 10.739 241.237 Estimated Loss (C) 958 920 840 816 213 385 490 490 648 NPL (A+B+C) 7.0 7.116 1. 1990-1998 (W billion) Year 1990 1991 1992 1993 1994 1995 1996 1997 1998 a Total Loans 90. It was estimated that the Korean won was overvalued by 20 to 30 percent from 1989 to 1997. judging from the real effective exchange rate indexes using unit labor cost indexes as a deflator and 1985 as a base year.929 11.584 2.736 8.160 11.192 Doubtful (B)b 952 1.649 375.652 29.600 10. of percentage of GDP were as follows: Malaysia -8. because of the rigid labor market. the ratio of short-term debt to foreign reserves was very high.556 118.China. Source: Bank of Korea.520 194.910 1.484 11. Thailand -8.077 NPL Ratio (%) 8. b Doubtful loans are collateral-free loans for which interest is not received for six months or longer. although per capita income in Korea was much lower.190 9.1 percent (1995). Mass layoffs became legally possible only after the economic crisis. .0 7. Meanwhile large businesses could not legally lay off workers. and Indonesia -3. Businesses served as a social safety net. the hourly wage rate in the Korean manufacturing sector was higher than in Singapore or Taipei. In 1997. the terms of trade deteriorated 12 percent in 1996 and 11 percent in 1997.6 percent (1995).176 7.954 9. Land prices and real estate rents were also high compared to trading partners.China. The pegged currency also encouraged foreign borrowing as investors believed that the exchange rate would remain stable.705 160.874 22.832 337.310 6.221 8. II Table 2.138 Corporate Governance and Finance in East Asia.430 12.4 5.997 9.1 7.33 Nonperforming Loans of General Banks.639 1. even in times of economic slowdown.1 6.6 Fixed loans are those requiring collateral and for which interest is not received for six months or longer. Real interest rates in Korea had been two to three times higher than those of Japan or Taipei.2 4.8 5.6 percent (1995). which led to large corporate losses.266 10.390 12.827 289.0 8.
Other firms experiencing financial distress were subjected to workout procedures through negotiations between debtors and creditor institutions. Downsizing by curtailing employment has been prevalent. . which were laden with huge amounts of debt and were on the verge of bankruptcy.6. To achieve this. has been actively utilizing its influence to motivate institutions to coordinate debtor firms’ restructuring activities. 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. and subsidizing money-losing units. Corporations. However. Ailing banks needed to be recapitalized after the huge amount of NPLs was disposed. embarked on their own restructuring programs and/or implemented restructuring demands of the creditor banks.6 percent as of the end of June 1998 to no more than 200 percent by the end of 1999. had been forced into bankruptcy proceedings or merged into healthier entities. Measures have been taken by several chaebols to streamline operations and improve incentives of managers and employees. They have been pressured to stop such practices as providing loan guarantees.Chapter 2: Korea 139 2.6 2. ‘Voluntary’ Restructuring Chaebols have been under pressure from the Government to abolish their informal group headquarters to increase the managerial independence of member firms. the excessive amount of debt of Korean corporations had to be reduced to a sustainable level. including banks. The FSC—later called the Financial Supervisory Service (FSS)— which is in charge of prudential regulation of financial institutions. the immediate objective centered on restoring the international investment community’s confidence in the Korean economy. 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. A guideline informally promulgated by FSC required the 30 largest chaebols to lower their DER of 412.
The data also show that about 24 percent of acquisition negotiations ended up in actual deals. The reasons are manifold. the creditor . 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. because liquidation of debtor firms would exacerbate the banks’ already weak balance sheets. Locally. they were reluctant to allow recontracting for fear of further deterioration in the capital adequacy ratio. This number was at 779 firms in April and grew to 1. FSC directed banks to appraise the long-term viability of client firms showing symptoms of failure. Noticing this disincentive.138 by the end of October. banks and other creditors were reluctant to absorb losses realized by debt compositions. It was frequently observed that the negotiating parties could not agree on a price due to large discrepancies in valuation.045 in October. More than 59 percent of potential buyers were foreign firms. the number of potential sellers decreased somewhat from 2. Involuntary Exits The Government has been involved in the restructuring process mainly through its supervisory capacity over banks. while only 14 percent of the negotiations were completed from the beginning of the crisis up to April 1998. Vol. Banks did not have the incentive to force financially nonviable firms to liquidate. 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. 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. Korean firms have been slowly stepping up their restructuring since the latter half of 1998 as the economy began to show signs of recovery. potential foreign buyers waited for the price of acquisition targets to come down further. Internationally. II Divestitures to raise cash for debt reduction and to focus on core businesses have not proved to be easy.140 Corporate Governance and Finance in East Asia. In their first review. On the other hand. or to agree on debt-equity swaps demanded by potential purchasers as a precondition for the deal. 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. In many cases. More important.281 in April to 2.
by their creditors. workouts are being applied to non-chaebol firms identified as financially weak. Corporate Workouts Workouts in the forms of debt rescheduling. Upon completion of the evaluation. The creditor banks and the advisory groups also drafted such plans for the top 6-64 chaebols. the creditor banks drafted their own restructuring plans with assistance from outside advisory groups led by foreign investment banks. These included 20 firms from the top five chaebols and 32 from the top 6-30 chaebols. By the end of 1998. . write-offs. provided by the World Bank. three filed for courtsupervised bankruptcy reorganization. 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. Also. 24 were liquidated. 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. These chaebols submitted plans for restructuring to improve their respective capital structures. and 16 non-chaebol corporations that had been selected as possible workout candidates. 11 were merged into other group members.Chapter 2: Korea 141 banks selected 55 firms as targets for exit. not only for the design of corporate workout programs but also their implementation. interest reductions. two were acquired by newly organized employee stock ownership plans. Based on these plans. More than 200 financial institutions signed the Corporate Restructuring Agreement to carry out corporate workouts with the top 6-64 chaebols. Among the 55 firms selected. was allocated to the six largest banks for them to employ outside experts as advisors. The plans were put into action immediately following finalization. Among the sell-offs. The workout plans were completed for most firms by early 1999. the results thus far have not entirely been as desired. but viable. A portion of the Technical Assistance Loan of $33 million. and 12 were sold off to other firms. Negotiations were then held between the chaebols and the creditors’ councils to finalize the financial structure improvement plans. FSC has been monitoring the processes from a prudential regulation standpoint. creditor banks completed evaluation of the financial status of 35 subsidiaries belonging to 13 chaebols. Although the intention of the Government and the banks was to effect immediate liquidation of these selected firms.
Foreign investment—in the form of acquisition of controlling interests. power plant facilities. the Government has been urging the largest chaebols to strike “big deals” or business swaps among themselves to consolidate overlapping manufacturing facilities. automobiles. uncertainty over the future . inducement of foreign direct investments was considered to be the most effective means of achieving that end. the foreign buyer demanded specific protections against adverse developments in the business environment.5 billion on agreement basis during the 10-month period after December 1997. Big Deals Ever since the outbreak of the economic crisis. some of the acquisition agreements have been discarded for various reasons. aircraft. In another. However. Vol. These deals could eliminate excess capacity in such industries as semiconductors. purchase of divested assets. chaebols did announce their agreements on big deals in seven industries excluding the automobile industry. Korea adopted and implemented policies to open its capital market completely. This figure contrasts sharply with the total of $700 million for all of 1997. most of the big deals have entered their final stages of negotiation. it is hoped. Big deals have been elevated to the status of the most important means of effective corporate restructuring. As of April 1999. Foreign Acquisitions Confidence in the Korean economy depends critically on the lowering of the level of corporate debt. The less than satisfactory state of foreign capital infusion in the early days stems from a number of factors. oil refineries. vessel engines. and petrochemicals. First. labor union demands of the seller were not acceptable to the transacting parties. Hyundai Motor Corporation won the international auction of Kia Motors in its third bidding and Daewoo Motors agreed to acquire Samsung Motors. On 3 September 1998. II creditor banks and the corporations will devise detailed workout programs based on the rehabilitation plans submitted by the corporations. In one case. Restrictions on foreign ownership of land were also abolished. railroad cars. Thus. In the case of automobiles. In the early days after the outbreak of the crisis. enable chaebols to streamline their overly diversified operations and focus on several core business areas.142 Corporate Governance and Finance in East Asia. Big deals would. and equity participation—reached about $8.
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. (ii) to remove cross-guarantees of loans among group members. foreign buyers usually employed discounted cash flow methods of valuation while local sellers often put greater emphasis on replacement costs of assets. but it also has important implications with respect to corporate workouts. Fifth. (iii) to reduce financial leverage. local creditor banks were reluctant to absorb losses arising from debt compositions and debt-equity swaps that were necessary in deals involving insolvent sellers. Not only does this represent progress in terms of an improved institutional framework for market competition. these goals were: (i) to enhance managerial transparency. As set forth in the agreement. foreign buyers were concerned with the inflexibility of the labor market.Chapter 2: Korea 143 course of the Korean economy remains high. Overhaul of Bankruptcy Procedures In February 1998. Seventh. 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. 2. some of the potential acquirers demanded terms that were unreasonable or unacceptable from the sellers’ point of view. (iv) to focus on a small number of core businesses. The presence of . the improved procedures stipulated in the Bankruptcy Reorganization Act and the Composition Act reduced what had previously been legalistic exit barriers. many of the businesses that Korean firms put on sale did not prove to be attractive to foreign firms. 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. In effect.6. Second. Sixth. 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. With this in mind. and (v) to improve the accountability of controlling shareholders and the board. Third. the Government and chaebols reached an agreement on the goals of restructuring and reform efforts. Fourth.
Second. Also. Fourth. 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. the court may annul its previous decision and force the firm into immediate liquidation. (ii) legal changes have been made so that domestic accounting practices conform to international standards. (iii) the representation requirement for shareholder derivative suits was drastically relaxed from 1 percent to 0. Third.144 Corporate Governance and Finance in East Asia. a “Management Committee. thereby preventing abuses by controlling shareholders/managers of financially distressed firms. etc. the Composition Act was amended to narrow the eligibility of applying for court-supervised composition. the right to revoke court receivership is allowed to the creditors. the maximum grace period on loans to the firm being reorganized was shortened to 10 from 20 years. the changes in the institutional setting for corporate reorganization will enable creditors and debtors to promptly respond to the development of financial problems. The purpose of this rule is to shorten the reorganization planning period. Korea’s Economic Progress Report. (iv) restrictions on institutional investors’ voting rights were eliminated in June 1998. number of creditors. and economics professions should be organized to provide for expeditious proceedings in court. . (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. The court can refuse to accept the application for composition if it finds it inappropriate considering the size of corporate assets. In the past this stage usually extended for as long as two to three years.01 percent in May 1998. The changes in the reorganization procedures can be summarized as follows.” comprised of experts in the legal. The creditors can form a “Creditors Committee” among themselves to allow them to participate in the decision processes in court. Vol. First. October 1998. 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. if a final reorganization plan is not worked out within one year from the date of the court order placing a firm in receivership. II an expeditious exit scheme is expected to better induce negotiation for workouts between creditor banks and corporations. Also. accounting. Fifth.
administrative procedures for FDI will be dramatically simplified and made transparent. Foreign Investment Promotion Act The Foreign Investment Promotion Act was put into effect in November 1998. According to the law. financial institutions could no longer require cross-debt guarantees. Measures for improving standards in corporate governance are already effecting a generally more open corporate culture and greater transparency in business practices. These new standards are and will continue to be strictly enforced. (v) by the end of May 1999. including tax exemptions and reductions. and (viii) as of 1 April 1998. 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. have been instituted for FDI: . (vii) by the end of March 1998. various supporting measures. In addition. 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. either partially or fully. crossdebt guarantees totaling about W10 trillion—about 30 percent of the total guarantees among the 30 largest chaebols—were dissolved. the Korea Trade and Investment Agency (KOTRA) will provide a one-stop service with respect to FDI. only 31 out of 1. which was passed in August 1998. (iv) during April and May 1998.148 industries remain closed. 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. an additional nine industries will be opened or further liberalized. beginning on 1 April 1999. (ii) full liberalization of foreign exchange transactions was legislated and will be put into effect in two stages. Foreigners are now able to invest in local bonds and short-term money market instruments without any restrictions. (vi) bankruptcy laws were revised in February 1998 to facilitate the exit of insolvent firms. (iii) hostile mergers and acquisitions by foreigners were fully liberalized in May 1998. including financial subsidization. As for promotion. Capital Market Liberalization Since 1998. Existing cross-debt guarantees should be completely eliminated by the end of March 2000. 514 listed companies had appointed 677 outside directors).Chapter 2: Korea 145 (as of the end of May 1998. to FDI). 21 industries were further liberalized or newly opened to FDI (now.
Free Investment Zone (FIZ): A free investment zone will be developed to accommodate large-scale FDI. as well as building an early warning system. It aims to establish a benchmark by consolidating various government bonds. To minimize potential risks. Capital Market Augmentation Bond Market The Government recently introduced a policy plan to deepen Korea’s bond market. including infrastructure and tax support. II (i) (ii) (iii) Tax exemption and reduction: Corporate and income taxes will be exempted or reduced for FDI in target industries. The law allows rental cost exemptions and reductions for FDI. the Korean Government is strengthening prudent regulations and market monitoring. The location of the FIZ will be determined at the request of foreign investors. the Government intends to supplement these measures with a sound macroeconomic policy in order to secure more effective protection against systemic risks. Low cost rental facility: National and public real properties will be rented to foreign-invested firms for up to 50 years. The primary aims of the law are the liberalization of the capital account and the development of the foreign exchange market. Three-year government bonds will be used to establish a benchmark. Various local taxes will also be exempted or reduced for eight to 15 years at the discretion of local governments. These liberalization measures. The majority of government bonds to be issued in the next two to three years will carry a maturity of three years. Liberalization of Foreign Exchange Transactions In September 1998 the Foreign Exchange Management Act was replaced by the Foreign Exchange Transaction Act.146 Corporate Governance and Finance in East Asia. Vol. such as the high-tech industry. Various support measures. for 10 years (full exemption for the first seven years and 50 percent tax reduction for the remaining three years). however. are not risk-free. These bonds will be issued . will be provided to foreign firms in the FIZ. Also.
In August 1998. to establish closed-end investment companies. and the demand for longerterm bonds increases in the future.6 trillion in these funds: W0. To ensure transparency and efficiency of the fund operations. It is now easy for private investors. they will be managed by foreign investment management companies. Moody’s signed a joint venture contract with Korea Investors Service. both domestic and foreign. 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. but it will also help improve financial institutions’ risk management. the Government will correspondingly expand the issuance of government bonds that have a maturity of five years or more. a debt restructuring fund and three balanced funds (funds that invest in both equity and debt) were established in September 1998. These are expected to operate for the next three years. financial institutions . and W1 trillion divided equally between the three balanced funds. a primary dealers system will be introduced for healthy financial institutions. As a pilot program. No qualification requirements are being imposed on investors who are sponsoring new mutual funds. including the Korea Development Bank. Asset-Backed Securities A new law providing for asset-backed securities (ABS) was passed in September 1998. commercial banks were allowed to carry out dealing operations for government bonds starting in October 1998. Related legislation was put into effect in September 1998. It also opened the credit rating service market to foreign competition. In order to promote a greater market demand for government bonds. invested a total of W1. and is promoting joint ventures between foreign and domestic agencies. but may be extended as required. According to the law. If interest rates stabilize at a low level. This law will not only provide an effective institutional environment for the disposal of NPLs. The Government established specific qualification criteria and selected the primary dealers in 1999. Twenty-five domestic financial institutions. Mutual funds (or open-end investment companies) will be allowed starting 2001.6 trillion for the debt restructuring fund.Chapter 2: Korea 147 monthly. with only minor standard exceptions.
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.. On the other hand. when the limit is binding. One way of strengthening independence of the boards is to require that listed companies accept nominations for directors by institutional . cross-subsidization. such as the Korea Asset Management Corporation (KAMCO). As markets become more efficient. the government intervention will have to be refocused so that it only sets the rules of the game in the marketplace.g. More important. A investing in B. which is the case for many chaebols. Policies aiming to improve the corporate governance system should take into account the high ownership concentration often created by pyramiding. The corporate governance structure cannot be expected to function efficiently if this issue is not addressed. this regulation may not be effective in curtailing pyramidal structures. II and qualified public corporations. considering that there is no other effective way to limit circular investments among chaebol affiliates (e. There must be stronger rules to control agency problems. Vol.) and the level of interfirm investments is very high.6. 2. 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. A good governance system is essential for the healthy growth of corporations and financial institutions.3 Policy Recommendations Poorly performing markets and the resulting lack of market discipline justified the government intervention in recent corporate and financial restructuring activities. In principle. can utilize ABS. It would be more desirable for the market-oriented measures to be put into place and strictly enforced. then the regulation will inhibit efficient investment of firms.148 Corporate Governance and Finance in East Asia. B investing in C. as stipulated by the government measure. etc. and C investing in D. Direct controls of interfirm investments and/or pyramidal ownership structures will not be persuasive. Selfdealings. this can only be a temporary measure. However. greater efforts to improve corporate governance are preferable to regulation of interfirm investment. However. there is another view that placing a maximum limit on interfirm investments. For instance. 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. is inevitable. unless the limit is tight and binding. However.
thereby helping to strengthen board independence and enlisting boards’ more active involvement in monitoring corporate management. Class action suits are an efficient means for corporate monitoring. and also negligence of external (independent) auditors actionable. 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. If and when the law is introduced. September/ October 1997. the Korea Stock Exchange could incorporate provisions of the Code of Best Practice in Corporate Governance in its listing rules. 23-26. The annual shareholders meetings could also elect reputable “monitoring companies” to recommend director candidates (Latham. Proposed: A Governance Monitor. pp. The Government can prompt institutional investors to contribute more to good corporate governance by paying greater attention to corporate affairs. More effective measures to protect investors will enhance corporate transparency and also the accountability of directors to shareholders.10 Other means to improve independence of the boards include mandating that independent outside directors form the majority. governance. 1997). using audit. The Securities and Exchange Act will then require large listed companies to switch to a board audit committee system from an internal auditor system. 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. . Institutional investors will play an increasingly important role in corporate governance. Since the economic crisis. Latham. it will have to include making self-dealings by directors and officers. 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. The Corporate Board. One way of motivating institutions to do this is to 10 M. Further. and other committees. Listing rules may recommend that all or large listed companies adopt an audit committee. and requiring that all directors hold shares of their companies. 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. 1997. various measures have been implemented to promote investors’ rights.Chapter 2: Korea 149 investors or their trade associations. Each listed firm should be required to disclose the extent of its compliance with the Code in its annual report.
Another measure. Also. . Shareholdings concentrated in investment companies and other institutional investors pose a serious dilemma. and thus cannot be expected to be actively involved in monitoring portfolio firms. The Government recently proposed the revision of bankruptcy-related laws. is to restrict ownership of investment trust companies and NBFIs by the five largest chaebols and. 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. 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. These guidelines would recommend shareholder activism and faithful discharge of fiduciary duties by actively participating in shareholder voting. etc. strengthening incentive compensation schemes for executives. and impose stronger penalties on violations of the rules on portfolio investments. such as the Korea Investment Trust Association. The Government can also lower the limits on investments in affiliated companies. 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. by all nonfinancial companies (or “industrial capital”). strengthen its supervisory activities. objecting to certain defensive measures proposed by the management. and other NBFIs are subsidiaries of chaebols— especially the five largest ones. 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. reviewing independence and expertise of candidates for outside directors. Application of more stringent bankruptcy-related rules to firms in financial distress will effect greater discipline over corporate management. 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. insurance companies. and compliance officers. possibly.150 Corporate Governance and Finance in East Asia. The institutions’ respective trade associations. In the coming years. securities companies. more drastic in nature. the Government will have to come up with appropriate policy measures to solve these problems. an audit committee. Vol. Rights of minority shareholders should also be strengthened for these institutions. could prepare such guidelines. Many of the larger investment trust companies.
The Government needs to sell off at the earliest feasible dates the bank shares that it acquired in the course of recapitalizing banks. and (iii) a good corporate governance system to protect investors. and financial institutions. Such measures include providing an effective corporate governance system. which could provide alternative sources of long-term corporate finance. For this. (ii) provision of reliable accounting information. the important issues to be addressed are: (i) improvement of the corporate disclosure system. Bank boards also need to be made more independent from management. lessening the degree of double taxation of dividends (or further reducing personal income taxes on dividends). the banks have great leverage over the management of debtor firms. excessively diversified into nonrelated business areas. In turn. The public and corporations should be taught or fully informed of the best practices in corporate governance. therefore are vulnerable to economic shocks. To facilitate the development of the Korean stock market. to concentrate instead on a small number of core businesses. In order to minimize government intervention in bank and corporate management. The Government should put more efforts into developing the capital market. Banks should adopt strong incentive compensation schemes for management. such as application of higher interest rates by banks to chaebols with higher DERs. and introducing disincentive schemes for excessive borrowings. large firms. Banks need to play a bigger role than they do at present in monitoring corporate investment and management. Many corporations are burdened with excessive debt and. and stop unfair internal transactions. bank managers should be made accountable to shareholders but not to the Government. reduction of protection of domestic markets and entry barriers. through them.Chapter 2: Korea 151 There still exist widespread concerns that the Government will continue to exercise a great deal of discretionary power over banks. Chaebols are overly indebted. and thus full-scale education programs should be developed. This means that the Government can control the banks and. the elimination of implicit guarantees for financial support to chaebols. private firms. An effective policy package is needed for chaebols to dispose of marginal firms with low profitability at the earliest date. Many concepts regarding good corporate governance are still new to a lot of market players in Korea. The current obligatory system of disclosure that emphasizes “hard” . The Government should substantially reduce the proportion of policy loans from bank loans. and consistently show low profit rates. 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.
More effective punitive means need to be devised to penalize both corporations in violation of disclosure rules and the officers in charge. Policies are needed to help develop more reliable services by bond rating agencies. The function of securities companies as dealers of bonds should be improved. At the same time. Another problem with the corporate bond market is that most bonds are issued with maturities of less than four years. Without successfully addressing this problem. politicians. Overvaluation of exchange rates should be avoided in order for export and import-substitution industries to stay internationally competitive. Currently. and bureaucrats. These should be lengthened to make them a source of stable long-term funds. the information system of the bond market should be better organized to transmit. Future research could include causes of corruption. is considered to be one of the major causes of the economic crisis. II information on past performance needs to be transformed into a system in which corporations voluntarily announce “soft” information on future prospects. and measures to reduce corruption. . Vol. 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. and labor productivity should be considered. The development of the OTC bond market requires a well-developed dealer system. The establishment of a Corruption Prevention Institute will be helpful in this regard. In determining optimal exchange rates. penalties on violations of disclosure rules are not effective enough to have a significant impact. on a real time basis.152 Corporate Governance and Finance in East Asia. especially among business people. The network should cover not only the exchange market but also OTC transactions of investors and dealers. reasons for different degrees of corruption in various countries. wage rates. data on quotations and trading volumes. Prevalent corruption. profitability of export industries and real effective exchange rates that account for changes in nominal exchange rates. no economic reforms will be effective. Maintaining current account surpluses for a considerable period is needed to pay back foreign debts.
various issues. International Monetary Fund. 1998. KERI. Financial Studies. New York: Praeger. Korea Economic Research Institute. September 1997. Ju Hyun. New York: Praeger. N. Korea’s Financial System. Kim. Economic Statistics Yearbook. S. Tomio. Jua. W. Hong Moon Sa. 1996. pp. 1997. in Korean Managerial Dynamics. and H. Lee. various issues. 1992. Korean Managerial Dynamics. 1997. S. Chon. International Financial Statistics. Korea Economic Research Institute. 1996. Jae Woo. Choi. 7995. September/October 1997. Financial Studies. 1995. Kim. Korea Development Bank. Japanese Zaibatsu and Korean Chaebols. H. 79-95. various issues. Hattori. pp. Center for Free Enterprise. September 1998. Cho. Chung and H. Lee. Kang. S. K. Bank of Korea. Financial Statement Analysis Yearbook. H. edited by K. Kim.). Bibong Publishing Co. Y. C. 1989. Hong. 1998. KERI. M. I. Market Concentration and Diversification of Business Groups. and K. Corporate Restructuring. KERI. 1996. pp. W. Understanding Flow of Fund Accounts. Kwon. 1995. Chung.Chapter 2: Korea 153 References Bank of Korea. Korea’s Large Conglomerates. 1999. and J. Proposed: A Governance Monitor. H. 1993.. An Empirical Evidence on Value of a Firm and Ownership Structure. T. Determinants of Diversification of Korean Business Groups. D. and 1998 issues. Lee. The Corporate Board. Maeil Daily Economic Newspapers. S. 23-26. 1997. Latham. 1997. Bank of Korea. 1994. W. Evolutionary Chaebol. S. . A Study on the Relationship between Ownership Structure of a Firm and Value of a Firm. Bank of Korea. 1989. H. D. H. K. S. Survey of Facility Investment Plan. Cho. C.. Korea’s Chaebol. Lee (eds. W. Is the Fair Trade Policy Fair? Korea Economic Research Institute. September 1998. C. Chon.. various issues. I.
October 1998. C. H. October 1998. Whang. Lim. 1996. November 1996. March 1999. Yonsei University. Korea Institute for International Economics and Trade. 1995. KIET Occasional Paper No. Business Groups in Korea: Characteristics and Government Policy. and J. 2nd Sangnam Forum. 1999. 1998. 1998. Sohn.154 Corporate Governance and Finance in East Asia. S. Corporate Governance in Korea. I. Ministry of Finance and Economy. 1996. Real Exchange Rate and Policy Measures. S. Background and Task of Structural Adjustment.. Annual Conference of Financial Management Association. Ungki. Kang. Conference on Corporate Governance in Asia: A Comparative Perspective. Korea’s Trade and Industrial Policies: 1948-1998. I. C. September 1998. Kim. January 1995. Korea Institute for International Economic Policy. . Seoul. 1998. Y. U. Yang. Management Research Institute. and J. Y. and H. KIEP Working Paper 98-05. Joh. Korea Finance Institute. Lee. 1998. The Ownership Structure and Family Control in Korean Conglomerates: With Cases of the 30 Largest Chaebols. Kim. Vol. 1999. Capital Liberalization. Whan. Y. The Pattern of Ownership Structure and their Characteristics in Korean Conglomerates: With Cases of the 30 Largest Chaebols. Chicago. Yim. S. J. Nam. Korea Institute for Industrial Economics and Trade. J. S. II Lee.. Korea’s Economic Progress Report. H.. Chung Ang University. Korea Development Institute and World Bank. Lee. J. Ungki. Wang. A New Trade and Industrial Policy in the Globalization of Korea. K. Beyond the Limit. K. Lim. W. K. 23.
both of ADB. When the Asian crisis erupted in 1997. and Lea Sumulong and Graham Dwyer for their editorial assistance. state-sanctioned monopolies.1 Introduction In recent years. The lifting of the debt moratorium in 1991. aiming at eventually limiting the Government’s role to economic policy setting and allowing the private sector to conduct most economic activity. the Philippine nonfinancial corporate sector had managed its borrowing risks relatively well by largely avoiding imprudent use of debts and risky investments. the PSR Consulting. Pineda. 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. overall. staff. .3 The Philippines Cesar G. 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). allowed the Government and the corporate sector to gradually access foreign debt markets after a long absence. David Edwards. PSR Consulting. and Liza V. Serrana. This has come about following a political and economic upheaval from 1983 to 1987. for their research assistance. the Philippines. Inc. and government subsidies were tackled during that period. and David Webb of the London School of Economics for their guidance and supervision in conducting the study. Inc. the Philippine Stock Exchange for its help and support in conducting company surveys. Companies of other Asian countries were already using these markets to finance investment and growth.. Issues such as State ownership of businesses. 1 Principal. The Asian financial crisis revealed that. the Philippine economy and corporate sector were in a relatively sound financial position. Denise B. the Philippine corporate sector has played a leading role in the government’s efforts to get the country on track toward sustainable economic development. Saldaña1 3. Roble. after the completion of debt negotiations with the IMF and Paris Club. in particular Francisco C. The author wishes to thank Juzhong Zhuang. From 1993 to 1996. about a decade before the recent Asian crisis.
The highly concentrated and family-based ownership of corporate groups has resulted in governance structures that depend largely on internal control systems. II Still. Sugar refining and textile mills are examples of industries that floundered in the 1980s because of government import substitution policies. regulatory framework. and responses to the financial crisis. To implement these policies. An industrial elite. nationalist sentiments led to policies that favored import substitution and heavy government intervention in business. patterns of financing. their growth could not be sustained. usually with the acquiescence of bank creditors. Vol. Government interventions under the notion of “master planning” for economic and social development characterized the 1970s and early 1980s. 3.2. Companies finance long-term investments with short-term debt. Corporate financing relies excessively on bank loans. Companies were profitable because of protection from foreign competition.1 Overview of the Corporate Sector Historical Development During the 1950s and 1960s. It analyzes the impact of corporate governance on company financial performance and financing. The policy was crafted by the martial law regime at that time. which leads to their easing of due diligence and monitoring standards when lending to group members. composed mostly of families previously in trading businesses. But protectionist policies made labor relatively more expensive and. This study reviews the Philippine corporate sector in terms of its historical development. Banks have significant presence as members of affiliated business groups. the corporate sector showed structural weaknesses similar to those in neighboring Asian countries. companies were necessarily large and capital-intensive.156 Corporate Governance and Finance in East Asia. patterns of ownership. Investments of large corporate groups tend to focus on obtaining market shares and industry dominance. emerged to influence industrial policies.2 3. on family-based and controlled conglomerates. The Board of Investments (BOI) was created to draw up an investment priorities . While new manufacturing industries were successfully established. and on the financial crisis. control by internal and external governance agents. the Government overvalued the local currency and imposed high import tariffs. therefore. These early industrialists naturally opposed any initiative to reduce tariffs. yet they did not risk new capital required for modernizing and expanding manufacturing capacity.
Better access to cheaper imported raw materials improved the competitiveness of local manufacturers. Reforms in policies. and initiated the development of alternative energy sources in response to the oil crises. the State took over the generation and distribution of electricity. the top three companies accounted for a disproportionately large share of total sales and assets. the Government continuously revised the enabling law of BOI so that incentives were reduced in number. quantitative restrictions.Chapter 3: Philippines 157 plan (IPP) to encourage private sector investments by offering tax and other incentives. Exports were not competitive because of the high costs of imported materials.e. In 1991. 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. i.” No strategic industry could take off without the Government’s participation in its management and operations. Following government initiatives in the control of the infrastructure and utilities sectors. Quantitative restrictions and tariff protection of preferred industries remained firmly in place. 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 . It limited the bureaucratic cost and discretion that accompanied the necessary approvals of foreign investments. advance notice of areas where the country disallowed or restricted foreign investment. the legislative body passed the Foreign Investment Act (FIA).. In the early 1990s. including the reduction of tariffs. BOI incentives retained a strong bias in favor of capital-intensive enterprises and domestic-oriented industries. made less associated with capital investments. Starting in 1981. dominance by large companies. 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. clearly shifted economic management toward reliance on markets rather than on decisions by bureaucrats in the Government. The 1980s were marked by a peaceful transition of political power. The Government signaled through the IPP its intent to shape the future industrial landscape. In many industries. assumed ownership of the largest petroleum refining company. organizing industries into sectors and picking “winners. and orientation toward domestic markets. Nevertheless. Foreign ownership was allowed only in industries with high technological and market barriers. and import licensing requirements.
6 7. of 9.1 GDP Growth of Southeast Asian Countries.2 Korea.8 4.2 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 1.5 9.9 7.5 8.3 9.2 7.2 9.2) 0. net sales of the top 1.2).0 (0.1).7 (13.8 5.5) 5. only nonfinancial companies were used.6) 0.8 10. Key Indicators of Developing Asian and Pacific Countries 2000.7 5.9 5.9 (1. 3.000 corporations.8 8.5 percent per year (Table 3.7 8. This rate of growth was sustained by a comparable 18. The Philippines substantially lagged behind other countries from 1990 to 1995 (Table 3. 1990-1999 (percent) Year 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 Indonesia 9.0 8.000 Corporations covers financial and nonfinancial companies.0 8. competition from liberalized imports had somewhat reduced oligopolistic tendencies and concentration in many industries.1 5.000 Philippine companies grew 17.1 8.5 8.2 During 1988-1997. .7) (10.2 (0. which was taken as a representation of the Philippine corporate sector.3 2.2 Thailand 11. II market.9 6.2) 4. With economic reforms introduced in the 1980s and 1990s.3 8.4 4. only to be unsettled by the crisis of 1997. In this section.7) 10.4 Philippines 3. Vol. Rep.0 7.2 7.2 8. Table 3. Its growth rate began to catch up with others in 1996.5) 3.5 (7. 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.8 percent growth in fixed 2 The SEC-BusinessWorld Annual Survey of the Top 1.8 8.8 5.3 9.158 Corporate Governance and Finance in East Asia.2 Source: ADB.7 Malaysia 9.2. however.1 4.0 (6.3 7.1 5.
8 741.7 218.3 121 12.9 898 1.5 4.2 900.2 136.8 618.8 4.160.5 64.5 14.5 1.8 77 7.1 714.225.3 941. .4 602.000 Corporations in the Philippines.6 426.6 900 1.1 Other Indicators No.6 954.5 1.5 72 7.5 193.3 107 13.4 3.3 306.893.5 508.4 555.3 46.7 1.5 Leverage = total liabilities/stockholders’ equity. 1988-1997 1989 519.7 443.5 570.5 887 0.5 51 4.0 1.4 Financial Ratios (%) Leverage ROE ROA Turnover Net Profit Margin 222 14.4 411.1 73 5.209.6 109 12.1 33.1 54 11.9 2.7 20.4 861.5 1.8 902 1.9 617.4 8.2 378.561.Table 3.8 5.4 188.000 Companies.5 119 12.3 862.2 4. turnover = net sales/total assets.8 6.1 5.7 238.9 480.9 896 2.2 707.6 102 16.8 26.341.781.9 952. of Companies Sales per Company (P billion) 899 0.3 68 7.2 Growth and Financial Performance of the Top 1. return on equity (ROE) = net income/ stockholders’ equity.1 1.9 629.2 27.2 338.2 Indicators 1988 Growth Indicators (P billion) Net Sales Net Income Fixed Assets Total Assets Total Liabilities Stockholders’ Equity Retained Earnings 464.7 73 6.3 60 10.1 881.3 898 1.191.5 192.6 144.0 148.177.9 149 6.1 615.2 2.4 260. Source: SEC-BusinessWorld Annual Survey of Top 1.1 6.9 3.1 1.7 28.2 Compound Growth (%) 17.5 446.9 1.9 78 6.4 898 1.1 51.317.0 1.0 900 1.1 72.8 411.6 149 12.1 197 14.2 Average 146 12.1 468.2 1.1 95.697.1 181 11.1 66 12.394.6 290.7 1.8 22.123.512. return on assets (ROA) = net income/total assets.6 75 6.6 18.332.131.9 96.1 4.4 776.6 5.647.6 896 0. net profit margin = net income/net sales.978.3 382.4 1.6 1990 1991 1992 1993 1994 1995 1996 1997 1.6 1.4 63.2 2.7 903 0.6 35.
2 percent. The debt-toequity ratio ranged from 222 percent in 1988 to 102 percent in 1994.000 Companies Year 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 Average Growth (%) a GDP (P billion) 799 925 1.352 1.9 23.8 percent per year. leverage increased from 109 percent in 1996 to 149 percent in 1997.5 Ratio of Estimated Value Addeda to GDP (%) 17. The data suggest no evidence of excessive borrowing in the run-up to the crisis in 1997. Asset growth was funded by debt that grew at an average of 20. This is high compared with developed countries but compares favorably with other Asian countries.5 17.172 2.693 1.000 Corporations in the Philippines.000 companies averaged 7. Vol.6 percent and 5.1 Net Sales (P billion) 465 519 630 741 862 954 1.4 24. respectively. These rates of return are high compared with other Asian countries.5 Value-added is assumed to be 30 percent of net sales.9 percent for the period. Further. and the SEC-BusinessWorld Annual Survey of Top 1. Key Indicators of Developing Asian and Pacific Countries 1999. and by equity that grew at a higher average annual rate of 26.248 1.3).474 1. Total assets grew at an average annual rate of 22.160 Corporate Governance and Finance in East Asia.906 2. Net profit margins for the top 1. various years.8 19. Net income consistently increased from 1988 to 1996 and declined only in the crisis year 1997. Assuming Table 3.427 13.8 17. 1988-1997 Top 1. The growth rates of corporate sales for the period 1988-1997 exceeded those of the country’s GDP for the same period (Table 3. indicating that the corporate sector’s exposure to foreign currency-denominated loans was not as significant as in other countries.3 percent. Sources: ADB.3 The Corporate Sector and Gross Domestic Product.7 percent. II assets.077 1. but the extent of the increase was not as dramatic as in other Asian countries.178 1.697 1.1 19. . for the 10-year period.5 16.9 21.394 1.4 20.979 17. Return on equity (ROE) and return on assets (ROA) averaged 12.
0 28.3 27. (iii) Government-owned.3 9. .5 27.0 Turnover 53 Net Profit Margin 15. corporate control structure.7 22.4 Growth and Financial Performance of the Corporate Sector by Ownership Type.8 No.8 14. The premise is that these variables have a direct bearing on corporate performance and growth.0 4. privately owned companies constituted the largest group (Table 3.2 103 5. these figures suggest a significant and increasing contribution of the corporate sector to GDP.0 5.0 142 22.3 22.9 26.0 31.4 Stockholders’ Equity 32.1 22 10. (ii) foreign-owned.3 22. of Companies 73 Sales per Company (P billion) 2.3 42.4 28.5 GovernmentOwned 4.1 Financial Ratios (%) Leverage 89 ROE 15. and (iv) privately owned. size.8 22.8 3.8 606 0. 1988-1997 Indicators Publicly Listed Privately Owned Rate. A study of company performance by ownership type.8 Growth Indicators (Compound Annual Growth Net Sales 20.4).9 22. and industry reveals further structural characteristics of the growth and financial performance of the corporate sector.6 Total Assets 29.9 17.4 Total Liabilities 26.0 5.2 9.3 11.1 ROA 8.5 Other Indicators Share of Sales (%) 17.4 190 5. Performance by Ownership Type The Philippine corporate sector can be categorized into four groups based on ownership: (i) publicly listed.5 Source: SEC-BusinessWorld Annual Survey of the Top 1.0 Net Income 19.000 Corporations in the Philippines.5 23 4.8 percent of the corporate sector’s total sales between 1988 and 1997.8 2. Averaging 42.9 196 1.1 12. various years.5 Retained Earnings 30.4 Fixed Assets 19.Chapter 3: Philippines 161 a constant ratio of value added to sales.7 2. The foreign-owned companies were the Table 3. %) 17.8 ForeignOwned 21.3 146 6.9 158 13.
2 percent and ROA of 9. 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. and government-subsidized agencies such as the National Food Authority and Local Water Utilities Administration. exceeding the 17. while there were few of them. The privately-owned companies were only about one third of the average size of per company sales of the publicly listed companies. were among the top 1.162 Corporate Governance and Finance in East Asia. But by being most efficient in employing assets.5 percent. . selling an average of P4. The compound annual sales growth rate was 21. the asset base is large. Only 84 of the 221 public companies listed on the Philippine Stock Exchange (PSE). foreign-owned companies borrowed more than publicly listed ones. meaning that the remaining 62 percent were relatively small in sales and assets. 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. registered the largest per company sales at about P9 billion in 1997.1 billion per company in 1997.000 list. but lower than those of foreignowned and publicly listed companies. Their ROA and ROE were both more than twice as high as those of government-owned companies. Governmentowned companies in the top 1. Vol.3 percent.9 percent. However. Publicly listed companies had a minor though steadily increasing share in total sales.8 percent for foreign-owned companies and 20 percent for publicly listed companies during 1988-1997. these companies were comparatively large. they generated the highest return on investments. and the second lowest asset turnover. II second largest at about 27.75 billion per company for foreign-owned companies. Bases Conversion Development Authority. the second best ROE and ROA. compared with P2. the highest net profit margin of 15.5 percent average growth rate of the entire corporate sector. Privately-owned and Government-owned companies grew at slower rates. These were mostly large public utilities. Publicly listed companies had the lowest leverage at 89 percent. reflecting the significant presence of holding companies as the gross revenues of holding companies flow through to operating income. although small in number.000 companies in 1997. a level high by Western standards but at par with those of other Asian countries. with an average ROE of 22. With an average leverage ratio of 142 percent. and low return on investment is the norm. followed by publicly listed ones. The privately-owned companies had a high average leverage ratio of 158 percent.
the corporate sector is divided into large.3 No.1 Retained Earnings 32. grew faster.6 26.7 Stockholders’ Equity 34. Performance by Firm Size By firm size. But the conglomerates were larger measured in sales per company.0 166 15.6 715 0. The independent companies contributed about 56 percent of corporate sales on average during the period 1988-1997.3 percent for the conglomerates.0 22.3 Total Liabilities 30. compared with 32. and achieved higher returns on invested assets than independent companies (Table 3.8 6.2 23.4 24. 1988-1997 Indicators Group Member Independent 18. depending on assets and sales.2 Net Income 21.7 Total Assets 32.1 124 5. and small companies.3 Financial Ratios (%) Leverage 98 ROE 15.2 Fixed Assets 25. had a lower leverage ratio. %) Net Sales 20.0 25.8 ROA 8.1 Source: SEC-BusinessWorld Annual Survey of Top 1.000 Corporations in the Philippines.0 55. Table 3.0 Turnover 67 Net Profit Margin 12.Chapter 3: Philippines 163 Performance by Control Structure By control structure. Sales and resources of the . various years. of Company 159 Sales per Company (P billion) 2.7 2.3 Other Indicators Share in Sales (%) 32. medium. a company can be a member of a conglomerate or independent.5 Growth and Financial Performance of the Corporate Sector by Control Structure.8 Growth Indicators (Compound Annual Growth Rate.5).
6). However.5 12.2 29. Vol. %) Net Sales 15.6 31.1 No.1 25. of Companies 79 Sales per Company (P billion) 7. sales of mediumsized companies grew faster than large companies. are defined as the largest 100 companies in the top 1. Sales per company in this group averaged P13.4 billion in 1997.2 Other Indicators Share in Sales (%) 56.2 Stockholders’ Equity 18. referring to the remaining companies in the list. which.0 32.9 89 1.3 Source: SEC-BusinessWorld Annual Survey of Top 1.4 Total Liabilities 18.6 Small 19. .0 7. averaging 16 percent.7 Net Income 1.5 Growth Indicators (Compound Annual Growth Rate.1 4.8 percent of the total number of companies in the list (Table 3.0 730 0. defined in this study as the next 200 largest companies in the top 1. Medium-sized companies also performed better in terms of ROE. II Philippine corporate sector are highly concentrated among the large companies.1 81 9.5 128 10.3 Fixed Assets 15. averaged a far less P3 billion in per company sales.9 32.000 list.9 Financial Ratios (%) Leverage 158 ROE 13. while small companies.5 73 6.6 49. although they comprised only 8. indicating that they deployed resources more efficiently than large and small companies.000 Corporations in the Philippines. averaged only P920 million in per company sales during the same year.5 Total Assets 18.2 25.1 ROA 5.6 47.5 25. 1988-1997 Indicators Large Medium 19. Large companies accounted for 56. Table 3.9 Retained Earnings 13.0 156 16. various years.6 36.3 Turnover 65 Net Profit Margin 8.9 26. for this study.164 Corporate Governance and Finance in East Asia.1 percent of the total sales of the corporate sector.4 28.000 list. Medium-sized companies.7 44.6 Growth and Financial Performance of the Corporate Sector by Firm Size.
at 158 percent on average during 1988-1997. The sector showed consistent growth in sales. with their ROE dropping to 3. and utilities and services sectors.2 percent for large ones. at 128 percent for the period. ROE dropped to 7.7 billion and P35. For small companies.8 the previous year. are shown in Table 3. i.6 percent.and medium-sized companies did not substantially increase their leverage in years running up to the crisis in 1997. Medium-sized companies apparently enjoyed efficiencies associated with economies of scale and made more productive use of their assets. Poor returns appear to have been caused by the low profit margin at 6. compared with 9. and profitability in 1997 when the crisis started. net income.Chapter 3: Philippines 165 Small companies. and construction. especially during the period 1994-1996.7.8 percent in 1997.1 billion in 1996 to P4.8 billion in . 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. Sales revenue and net income declined from P76. of net income.7 percent in 1997 for medium-sized companies. unlike their counterparts in other Asian countries. but lower than that of construction. at 156 percent.e. The leverage ratio of the manufacturing sector was higher than that of the real estate and property sector. utilities. Net income declined from P54.4 percent in 1997 from 11..2 billion in 1997 for this sector. and equity up to 1996.1 percent. manufacturing. but suffered its largest decline in net profits in 1997.5 percent for medium-sized companies and 8. But small companies’ leverage was significantly lower. The growth and financial performance of selected industries. reflecting to some extent a “bubble” phenomena in the former two sectors. ROE dropped from 10. at -12.8 percent. showed the lowest ROE. Large. Mediumsized companies’ leverage level was slightly lower. averaging 10. from 14. net income. profits. although the largest in number.7 percent a year earlier. and utilities and services sectors. Performance by Industry This study also looked at corporate performance by industry. Growth of sales. assets. and assets was much higher for the real estate and property. Leverage was the highest for large companies. The Asian financial crisis affected large companies most severely. real estate. as indicated by the negative annual growth.7 percent in 1996 to 8. specifically those industries least and most affected by the financial crisis. The real estate and property sector also suffered significantly in sales. and the construction sectors than for the manufacturing.
2 28 0.9 23. 1988-1997 Utilities Real Estate and and Services Property 39.0 25. %) Net Sales 16. respectively.0 Turnover 112 24 Net Profit Margin 5. .1 10. II Table 3.4 19.1 24 42.3 Retained Earnings 17.7 percent to 10. The sector’s buildup in equity during the stock market boom of 1994-1996 may have cushioned the impact of the crisis.7 Growth and Financial Performance of the Corporate Sector by Industry.7 billion in 1997.9 2.0 21.5 12.7 192 9.6 69 16. the sector’s ROE dropped from 15.7 19. Vol.6 Financial Ratios (%) Leverage 142 181 ROE 13.8) 17.8 41.4 16.9 billion and P24.000 companies’ total sales on average during 19881997.0 23.8 48. But the impact of the Asian crisis on the real estate and property sector was much smaller than that on the manufacturing sector.3 55.8 Stockholders’ Equity 21.3 Fixed Assets 20.9 17.7 Indicators Manufacturing Construction 27. As a result.9 2.166 Corporate Governance and Finance in East Asia.3 20. With a modest increase in total liabilities and leverage level of less than 100 percent in 1997.6 Total Liabilities 18.7 10. 1996 to P56.4 percent. various years.2 12.6 Growth Indicators (Compound Annual Growth Rate.7 83 2. Its knock-on effect on the economy was small as it accounted for less than 3 percent of the top 1.2 45.4 Total Assets 19.5 Other Indicators Share in Sales (%) 82. and was also much more limited compared with the property sectors in other Asian countries.3 5.7 52.000 Corporations in the Philippines.9 5.2 8. it does not appear to have been excessively exposed to foreign currency-denominated loans.7 28.1 2.4 3.2 37.6 No. of Company 454 17 Sales per Company (P billion) 1.4 Source: SEC-BusinessWorld Annual Survey of Top 1.0 31 0.7 ROA 5.7 Net Income (12.
unlike in neighboring countries hit by the Asian crisis. (ii) purpose of the corporation. (iv) term of existence. the Code requires a corporation 3 A company’s articles of incorporation should include: (i) corporate name. Corporation Code of 1980 Supplanting the old Corporation Law of 1906.3 Legal and Regulatory Framework The Corporation Code of 1980 is the main law governing the corporate sector. and the Insolvency Law. Two other pertinent laws are Presidential Decree (PD) 902-A. the ownership of Filipino citizens in the corporation is not less than the legally required percentage of capital stock. One month after registration. The General Banking Law. and amount of authorized capital stock. 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. For publicly listed companies. the Revised Securities Act (RSA) and PSE’s public listing requirements also apply. operation. which was based on American corporate law. (v) number of directors (not less than five nor more than 15). 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. and dissolution of corporations. and residences of incorporators and directors. and recognized rules on corporate practices. The currency devaluation bloated the foreign currency-denominated loans of these companies. . (vi) names. privileges. and (viii) names. nationalities. and residences of original subscribers. which regulates banks and nonbank financial institutions except insurance companies. It specifies the minimum information to be indicated in the articles of incorporation. and restrictions. It provides the basic constitutional structure for the organization.3 which serve as the company’s declaration that the minimum percentage of authorized capital required by law has been subscribed and paid-up. administrative regulations. 3. Under the Code.2. Overall. the Corporation Code of 1980 is a compilation of important juridical rulings. (vii) number.Chapter 3: Philippines 167 The utilities sector had the second highest leverage during 19881997 at 181 percent on average. (iii) principal office. par value. which is also the organic law governing the operations of SEC. the leverage of all four industries was low. and amount subscribed and paid by each. reaching up to 313 percent in 1997. nationalities. contains some provisions affecting corporations’ dealings with banks.
However. duties. and reasonable. shareholders may delegate this power to the board of directors by a two-thirds vote of outstanding capital stock. and employees. To be valid. directors. or officers. the corporation’s articles of incorporation. In 1976. 4 Some of the items that a corporation may provide in its bylaws are the following: (i) time.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. Vol. the bylaws must be consistent with the law. (ii) required quorum in shareholders’ meetings. supervision (regulatory). (v) manner of election or appointment and term of office of all officers other than directors. II to adopt a code of bylaws or rules for its internal governance. (vi) penalties for violation of the bylaws. and between the corporation and the State concerning its franchise or right to exist. A majority of the outstanding shares of shareholders must vote to authorize amendments to the bylaws. PD 902-A expanded SEC’s mandate to include absolute jurisdiction. and compensation of directors. Its mandate is to supervise corporations in order to encourage investments and protect investors. must be general. (ii) controversies arising out of intra-corporate relations. Securities and Exchange Commission: PD 902-A SEC is the government agency responsible for implementation of the Corporation Code. officers. 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. . and control (adjudicative) of all corporations. place. and public policy. and (vii) manner of issuing certificates in the case of stock corporations. (iv) time for holding annual election of directors and manner of giving the election notice. 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. among shareholders. manner of voting.168 Corporate Governance and Finance in East Asia. In addition. and forms of proxies and manner of voting them. It implements rules and regulations that protect minority shareholders from possible fraud and misbehavior by controlling shareholders. and should not impair vested rights. between the shareholders and the corporation. and manner of calling and conducting regular or special meetings of the directors and shareholders. (iii) qualifications. uniform. (iii) controversies in the election or appointments of directors and officers of corporations.
Chapter 3: Philippines 169
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
There are advantages to establishing pure holding companies. The largest group is nonfinancial corporations. or 20 shareholders owned more than 50 percent (signifying operating control). 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. Composition of Ownership of Publicly Listed Companies Another important issue concerning corporate ownership is the composition of the controlling shareholders. the top five shareholders owned more than 50 percent of the voting shares. which are mostly privately owned and controlled by family-based shareholder blocs. five. The shares of publicly listed companies are thinly traded and illiquid. In 116 companies. In 76 companies. In 111 companies. The limited volume of shares issued to the public is one of the causes of the underdevelopment of the Philippine stock market. and 20 shareholders? In Table 3. holding only an average of 2.2 percent of outstanding shares of publicly listed companies. or almost 75 percent of the total. five. 66 percent (signifying strategic control). a single owner owned more than 80 percent of outstanding shares. controlling an average of 52. a single shareholder held operating control of a company.174 Corporate Governance and Finance in East Asia. Parent companies usually spin off operating units into new companies that they continue to control as affiliates. or 51 percent of the total.9 shows that in 44 companies. II analysis of the number of companies in which the top one. Table 3. or about 30 percent of the total. including pure holding companies. the top five controlling shareholders were classified into eight groups. or 14 percent of the total. Individuals did not constitute a significant shareholder group among the top five shareholders. the top five shareholders held more than two-thirds majority control of a company. the top 20 shareholders collectively owned a majority of a company’s shares. Nonfinancial corporations with controlling shareholdings are likely to be holding companies. In four of 11 nonfinancial sectors. large and family-based shareholders pool the family’s ownership over many . Through these. In 21 companies. and share prices are sensitive to movements of foreign funds.10.1 percent of publicly listed companies in the Philippines in 1997. or 3 percent of the total. or 78 percent of the total. Who are the top one. In four companies. a single shareholder held two-thirds majority control. or 80 percent (only nominally publicly listed) of outstanding shares. nonfinancial corporations held majority control. Vol. With such high levels of ownership concentration.
Distribution.Table 3. 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 Trading Holding Power Transportation Property Total — = not available. and two companies in the property sector. a Data for top 20 shareholders were not available for five holding companies. Beverage. Source: PSE databank. .9 Ownership Concentration at Critical Levels of Control Over Publicly Listed Companies. and Tobacco Manufacturing. 10 manufacturing companies.
6 5.3 12.3 5.7 67.6 12.3 26.6 0.0 0.0 0.6 0.4 2.8 21.7 0.2 5.6 0.1 1.9 36.5 2.4 19.6 9.2 59.0 2.7 0.4 8.3 2.1 7.7 0.0 0.0 0.0 1.0 0.0 0.5 0.6 18.0 1.4 0.10 Composition of Top Five Shareholders of Philippine Publicly Listed Companies by Sector.5 12.7 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.3 1.2 10.0 5.6 1.6 0.2 3.2 3.Table 3.5 13.0 1.5 0.0 0.2 0.6 33.9 0.0 1.4 29.6 0.5 26.7 3.1 5.1 a Weighted by market capitalization.3 0.0 45.6 2.8 66. .0 0. and Trading Hotel.3 0.0 1.1 6.8 0.9 6.2 3.5 4.0 0.6 0. Recreation.0 5.0 0.0 1.7 3.0 5.0 1.2 0.2 0.8 0.7 0.5 53.7 0.0 0.0 0.3 37.7 1.0 10.0 7.6 2.0 4. and Tobacco Holding Companies Manufacturing.3 0.0 1. Beverage.8 11.5 4. and Other Services Property Mining Oil Average Shareholdinga 33. Source: PSE Databank.2 1.1 9.9 0.3 1.0 0.0 2.9 52.1 0.3 0.2 3.8 0. Distribution.3 5.0 0.2 0.1 0.0 5.1 8.6 0.2 0.3 0.4 1.4 5.0 0.
Holding companies were themselves 66 percent owned by other nonfinancial corporations. and insurance companies (0. The investment funds’ presence in these sectors ranged from 8.5 to 12. Such advantages have contributed to the popularity of holding companies among publicly listed companies.3 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. They can also better manage their income taxes because income from affiliated companies passes through a holding company.7 percent of market capitalization of the nonfinancial publicly listed companies. commercial banks (1. . Funds of SSS and GSIS consist mainly of compulsory contributions from members of the country’s private sector and government workforce. Because of limited ownership by institutional investors. Holding companies as a sector had the largest market capitalization in PSE in 1997.6 billion or 26. and San Miguel Corporation (SMC) in food and beverages. 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. The financial institutions among the top five shareholders of nonfinancial corporations are investment trust funds (with 4. The Philippine capital market did not have an active analyst community comparable to those in more developed capital markets. financial institutions did not have a significant ownership in nonfinancial corporations. accounting for P258. The 7.1 percent). with an average of only 7.6 percent of market capitalization in 1997. These include Philippine Long Distance Telephone Company (PLDT) in telecommunications. Investment trust funds were the most important institutional investors. there was no real market for investment information. securities brokers (1. 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.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.1 percent).2 percent in 1997. This complex layering of ownership masks the identity of individuals or families that actually own and control operating companies. As a group. respectively.Chapter 3: Philippines 177 companies and share in the risks and profits of the group. These are mainly the Social Security System (SSS) and the Government Service Insurance System (GSIS).7 percent of shareholdings). while still allowing the public to own minority shares.
This is significant considering that there were only 31 local commercial banks in the country in 1997. liberalized the regulations on entry of foreign bank branches and foreign ownership of local banks. so far limiting their involvement to selected products. . 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. 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. many companies in family-owned groups are not publicly listed.7 6 7 The study used publicly available shareholder information and published reports. Corporate financing depends on intermediation by banks. the Central Bank’s reforms are probably changing the conduct but not necessarily the structure of the banking system. Some 20 financial institutions were affiliated with these groups. Vol. including SBL and DOSRI rules. the study put together a list of prominent business groups. Prudential regulations. including 16 commercial banks. More than three fourths of the respondents are either a parent or subsidiary (about 70 percent of these are domestic nonfinancial companies).178 Corporate Governance and Finance in East Asia.6 The total sales of these groups in 1997 were estimated at P806 billion (Table 3. suggesting that most publicly listed companies are parts of business groups. The process identified a total of 238 companies belonging to 39 business groups from the SEC-BusinessWorld Annual Survey of the Top 1. and increased the capital requirements for all types of banks. All major industries were represented. remain in force to control excessive lending of banks to insiders.11). However. Banks that are members of business groups have an advantage in raising funds from the internal capital market of the group. and tracked the financial performance of each company from 1992 to 1997. a nonfinancial company that owns a commercial bank has better access to loans at favorable rates and terms.000 companies.8 percent of total companies in number. The Central Bank deregulated interest rates and foreign exchange. suggesting that business groups are common in all major markets. To understand the ownership and governance characteristics of family-owned business groups. 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. Still. identified the companies belonging to each of these groups. Family-based groups have larger companies since their total sales were about 33. of the financial resources in the country.000 Corporations in the Philippines. Foreign banks have a growing presence but have not necessarily increased the supply of credit to the corporate sector. about three fourths. Commercial banks hold the largest share. For this reason.000 corporations’ sales. This could further increase the concentration of ownership and expand the scope of own-group lending by these larger banks. but they comprised only 23. using data on the Philippines’ top 1.4 percent of the top 1.
The main constraint may be the availability of family members that could be drawn for top management positions. or an average of about 12 per group. Cojuangco. It is also noteworthy that. the two were closely related through their affiliations to business groups. for the Lopez group. In 1997. Significantly.12). Also. in most . which was majority-owned by the Henry Sy group.000. the nonfinancial sector was real estate (60. Gokongwei. and for the Henry Sy group. retail merchandising (69. and Henry Sy—as examples. for each of these groups. the principal owner of SMC. with 27 affiliated companies in the top 1.000 corporations in 1997. For the Ayala group. and banking. In the meantime.4 percent of the group’s 1997 profits). as discussed in previous sections. Family-based business groups are most dominant in sectors such as manufacturing. the top 10 family-based business groups had only 119 companies in the top 1. the largest was the Eduardo Cojuangco group.8 percent). a substantial proportion of group profits came from its financial subsidiaries. for the Gokongwei Group. 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. and more than 20 percent for the Lopez group and Henry Sy group.Chapter 3: Philippines 179 Compared with other Asian countries. construction.000 companies. 25 out of the 50 top corporate entities were familybased groups. it was manufacturing (36. Foreign-owned companies mainly serve the export markets.2 percent). including business groups and independent companies. with the exception of Banco de Oro. Lopez. These corporate entities accounted for 53. the biggest private company in the Philippines. To show this.1 percent). Together. Lopez. an average group in the Philippines has fewer member companies. real estate. In terms of number of companies. In terms of sales. broadcasting (49. Commercial banks are often affiliated to a particular business group. namely.6 percent of the total sales of the top 1. Commercial banking contributed about 40 percent of group profits for the Ayala group and Gokongwei group. ranged according to their sales (Table 3. the largest family-based business group was the Ayala Corporation Group. the study used the four largest business groups—Ayala. The significance of family-based business groups in the Philippine corporate sector is immediately evident in the 50 largest corporate entities. nonfinancial companies contributed about 36 to 60 percent of total profits for these groups. the three largest entities were family-based groups. and Ayala.
0 26. and packaging Power distribution and mass communications Real estate. real estate.5 44.4 48. 2. 3. 5. Flagship Company. agriculture.3 15.5 26. beverages.5 2.8 84. 15. 7. coconut oil. food. beverages.0 13.4 6. 4.1 4.0 5. 6.5 13.11 Total and Per Company Sales.5 6. and food Food. and personal care prods Shipping.1 4. and Affiliated Bank of Selected Business Groups.4 10. and mining Management.Table 3. and dairy products Investments. food. 10.3 2. of Affiliated Companies Total Sales (P billion) 123.5 47. Consunji 4 3 Food and dairy products Construction and mining 10. 16. 1997 Business Group 19 15 27 12 12 9 4 6 11 4 8 9 5 4 5 6 Major Sector Orientation Estimated No. 9.6 7. and tobacco Telecommunications Cement and construction materials Pharmaceutical and distribution 12. Sector Orientation.1 2. and car manufacturing Car manufacturing and real estate Food and telecommunications Department store and real estate Airlines. Real estate. 13.2 1. Eduardo Cojuangco Lopez Family Group Ayala Corp. power.9 2.3 3. 11. 8.4 .5 17.3 11.7 98. telecom. 14. construction.5 46.0 Average Sales Per Company (P billion) 6.0 17. 17.6 3.9 3.2 1. and tourism Credit card 18.5 49.6 3. Beverages. 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.2 16.6 2.
31.6 0. SEC-BusinessWorld Annual Survey of Top 1.8 6.8 1.0 1.8 Jollibee Foods Luis Lorenzo Family Group Alcantara Family Group Bienvenido Tantoco Elena Lim Andrew Gotianum Brimo Family Group Andrew Tan J.9 1.9 6.5 8.3 7.6 3.7 1. 4 238 1. 23.5 2. 39.000 Corporations (1997).7 4.6 5. 34. Ramos Gaisano Family Group Felipe Yap Felipe F. 35.2 6.2 4.1 1. 27. and various company annual reports.1 0.6 2. .3 2. 28.1 805. 22. 38. and real estate Retail merchandising Ceramics and real estate Department store and real estate Cement and sugar central Real estate and securities trading Bookstore.9 0.2 1.0 5.7 0. 25. mining. P.8 1. 29. 33.9 7. 24. 30. 36.4 5.1 1. 37.3 2. Cruz Jose Luis Santiago Keppel Group Robert John Sobrepeña/ Fil-Estate Group Total Real estate Sources: PSE Databank.0 2. distribution. Enrile/JAKA Group Jaime Gow Guoco Group Jose Go Jardine Davies Gerardo Lanuza Alfredo C. 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 8.9 1.4 1.9 1.0 0.4 3.6 Fast food Beverages and agro-industrial products distribution Cement and wood products Retail merchandising Electronic appliances Real estate Mining Real estate Telecommunication.7 0.7 0.9 0. 32. 26.8 1. 21.7 3. 20.19.1 2.4 3.
1. 8. 18. Sector Orientation. 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. 19. Jollibee Foods Corporation Pepsi Cola Products Alsons Cement .Table 3. Eduardo Cojuangco Lopez Family Group Ayala Corp. 4. 11. 16. 7. 12. Alaska Milk Corporation DM Consunji. 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. Long Distance Telephone Phinma Zuellig Pharmaceutical Metro Pacific William Gothong and Aboitiz Swift Foods/RFM House of Investment Anscor Equitable Card Network Inc. 13. 10. 15. 5. 17. 6. 14. 9. 2.11 (continuation) Total and Per Company Sales. 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. and Affiliated Bank of Selected Business Groups. 21. Inc. Uytengsu/General Milling Group David M. 3. 20. Flagship Company.
Ramos Gaisano Family Group Felipe Yap Felipe F. Kepphil Shipyard Inc.48 billion.65 billion to P4. 25. medium = P1. 23. and various company annual reports. 34. 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.000 Corporations (1997). F. 39. a b Size class is measured in terms of sales: Large = greater than P4.East-West Bank International Exchange Bank Ecology Bank (Savings Bank) Dao Heng Bank Orient Bank International Exchange Bank International Exchange Bank Philbanking Corp. 27. 38. small = less than P1. SEC-BusinessWorld Annual Survey of Top 1. 35. Inc. PT&T Corp. 31. 33. Refers to commercial banks. 32. . Sources: PSE Databank.48 billion. 29. Fil-Estate Development Inc. Enrile/JAKA Group Jaime Gow Guoco Group Jose Go Jardine Davies Gerardo Lanuza Alfredo C. 30. 26. Cruz & Co. 36. 24. unless otherwise indicated.65 billion.. Keppel-Monte Bank Bienvenido Tantoco Elena Lim Andrew Gotianum Brimo Family Group Andrew Tan J. 22. 37. 28. P.
food.4 19.2 49. 9.0 24. and mining Gold and other precious metal refining . Beverages. of the Phils.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. and food Food.0 38. First Pacific/Metro Pacific Group 21. and real estate Banking.). car manufacturing. 2. Philippine National Bank Mercury Drug Corp. 14.7 98. 3. 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.8 53. beverages. 17. coconut oil. 16.5 26. 1997 Sales (P billion) Control Structure Major Industrial Orientation 123. 15.5 44. and car manufacturing Power Refined petroleum products Refined petroleum products Banking. banking.2 Business Group Business Group Business Group Government.5 77. 20.5 47.6 18.5 17. agriculture. mass communications.5 15. Eduardo Cojuangco Lopez Family Group Ayala Corporation Group National Power Corp. 23.8 84.Table 3. food. power. 6. 8. 5. 19. telecommunication. and telecommunications Department store and banking Airlines.6 26.3 15.1 17. Inc.0 37. beverages. and personal care products Shipping. Aboitiz Family Group Jose Concepcion/RFM Group Alfonso Yuchengco Philippine Associated Smelting and Refining Corp. and packaging Power distribution. and bank Real estate. bank. 11. Petron Corporation Pilipinas Shell Petroleum Corporation George Ty John Gokongwei Henry Sy Lucio Tan Ramon Cojuangco Family Group Caltex (Philippines) Inc.5 46. Fujitsu Computer Products Corp. Texas Instruments (Phils. 18. Del Rosario/PHINMA Zuellig Group Toshiba Information Equipment (Phils. food.8 22.4 48.2 16. 10. 24. 7.). and dairy products Investments.1 60. 22. 12.12 Control Structure of the Top 50 Corporate Entities. construction. Inc. 13. 4.
Jollibee Foods Citibank N. and apparatus for line telephony and line telegraphy Tobacco products wholesaling Cigarettes Radar equipment.7 10.8 6. 48. 50. 32.A.0 11.9 7. 43.7 13. Inc. 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 1.25.000 Companies Sales (%) Cigarettes Bank Soap and detergents Management.5 10. and other grains wholesaling Other amusement and recreational activities Motor vehicles Food and dairy products Construction and mining Television and radio transmitters. Consunji Uniden Philippines Laguna.3 13. 46.6 12.5 8. 44.4 10. 36. 33.. Inc. 9. 31.9 14. 47. Inc. National Steel Corporation National Food Authority Phil. . Uytengsu/General Milling Group David M. W. including biological products Bank Cement and wood products Retail merchandising Electronic appliances Mining Real estate Sources: SEC-BusinessWorld Annual Survey of Top 1.8 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 38.0 5. Amusement and Gaming Corporation Mitsubishi Motors Phils. Philip Morris Philippines. PSE Databank.0 13. 35. 41.6 1. EAC Distributors Inc.7 10. radio and remote control apparatus Fast food Bank Beverages and distribution of agro-industrial products Drugs and medicines.8 9.9 7.4 8. 34. 42. and various company annual reports.1 9.290 53. 26. Corp.6 9. 28. 14.000 Corporations (1997). 30. 45. 37. Philips Semiconductors Phils.2 7.6 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. real estate. 39.5 8. corn (unmilled).9 6. and tourism Banking Radar equipment and radio remote control apparatus Operation of rolling mills Palay. 40.3 8. 49. 27. 29.0 12.
The Corporation Code holds members of the board of directors liable. 3. The review is based on an ADB survey of listed companies in the Philippines conducted in 1999 for this study.3. and financial disclosure. to the corporation and its shareholders for damages caused if they agree to unlawful corporate acts. Actual control of the banks was still held by the groups. . the board of directors plays a crucial role in corporate governance.2 Corporate Management and Shareholder Control The main mechanisms by which shareholders control corporate management are the board of directors.186 Corporate Governance and Finance in East Asia. This section reviews practices of corporate management and shareholder control in Philippine publicly listed companies. amendments in the bylaws. removal of directors. However. The Philippine Corporation Code mandates the board of directors to exercise its control over a corporation. They are likewise liable if they pursue financial interests that conflict with their duty as directors. shareholder voting in general meetings and legal protection of their rights. and declaration of cash dividends. Of course. these were dispersed shareholdings. Shareholders limit the broad power of the board by ratifying their decisions on critical corporate affairs. Vol. jointly and individually. investments of corporate funds in other companies or purposes. business groups had only minority ownership. 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. issuance of stocks. although public investors held a majority of shares. A total of 44 companies responded to the survey (out of about 221 financial and nonfinancial listed companies). voluntary dissolution. corporate mergers or consolidations. 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. approval of management contracts. sale or disposition of a substantial portion of corporate assets. issuance of corporate bonds. such as amendments of the articles of incorporation. appointment and compensation of senior executives. II publicly listed commercial banks affiliated to these groups.8 The Board of Directors As the representative of shareholders in a company. determination of compensation to board members. accounting and auditing.
appointing senior management. The average stipulated term of office of the chairperson and members of the board for most responding companies was one year. or a per diem for meetings (18 percent).7 percent). ensuring that a company follows legal and regulatory requirements. Such a short tenure may to some extent suggest that large shareholders want to keep their board members under close control. . The ADB survey results show that a chairperson is compensated either by a fixed fee (52 percent of respondents). appointed by the Government.6 for board chairpersons and 7. But professional expertise is also an important criterion (28. The longest was 27 years for board chairpersons and 14 years for board directors.Chapter 3: Philippines 187 actual practices of board functions and the role of shareholders may diverge somewhat from the legal framework. a typical chairperson owned 3 to 5 percent of outstanding shares of a company on average. the average number of years of holding office was 6. or representatives of creditors. The majority of respondents indicated that board directors and chairpersons were elected mainly on the basis of either relationship with major shareholders (31. Making day-to-day management decisions was not regarded as an important board responsibility. More than half of respondents indicated that board directors were elected during the shareholder general meetings.5 for board members. In practice. board directors were the founder of a company. and determining remuneration for board directors and senior management. But half of respondents indicated that they also had board directors directly nominated by controlling shareholders or management. The ADB survey shows that the number of board directors ranged from six to nine among the responding companies. or the Government without approval by shareholder general meetings.9 percent). Financial compensation is another means by which shareholders can motivate boards and board members to manage companies in their interests. Respondents of the ADB survey ranked the following as the most important responsibilities of the board: making strategic decisions. Board chairpersons in a substantial number of responding companies did not own significant amounts of shares in their personal capacities. or percentages of shareholdings (28. protecting shareholder interests.7 percent). in a descending order. According to the ADB survey. 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. with a maximum of 36 percent. In a few cases. a fixed fee plus performance-related bonuses (30 percent).
The nomination committee searches and reviews candidates for key management positions. however. large shareholder-dominated companies often view such committees as unnecessary formalities. by tenure and compensation. When the CEO was not the chairperson. It is also not clear whether the outside directors were elected before or after the financial crisis. CEOs apparently cannot increase their shareholdings because family-based owners restrict the number of shares available to management. The compensation committee reviews and recommends remuneration plans of key officers and employee stock option plans. In some companies. 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.9 In practice. only 35 percent of responding companies have set up board committees. The Corporation Code prohibits the removal of any director without cause if that act would deprive minority shareholders of representation in the board. Vol. negotiates the audit fees and scope of audits. the chairperson of the board was also the chief executive officer (CEO). the parent company or company bylaws (21 percent). This suggests that large shareholders control CEOs by means other than shareholdings. and nomination committees. There was no case found in the ADB survey where a minority shareholder invoked such a provision of the Corporation Code. The ADB survey shows that in 41 percent of the responding companies. or management (15 percent). and reviews the findings of external audits. A CEO that was not the chairperson of the board was selected on the basis of professional expertise (42 percent of respondents). or amount of shareholding (15 percent). Companies may set up special board committees to strengthen due diligence procedures. These committees were established only recently. But the independence of these outside directors is often doubtful. In the ADB survey. About half of the active committees were audit committees and the other half nomination committees. the CEO 9 The three most common board subcommittees are the compensation. .188 Corporate Governance and Finance in East Asia. II Compensation for the chairperson was determined either by the board (54 percent of respondents). namely. Senior Executives The Corporation Code does not specify the role and responsibilities of senior executives. Ninetythree percent of the respondents had one or more outside directors. The audit committee selects external auditors. Unlike in Western corporate models. audit.
The longest service rendered was 27 years.. The average service length of CEOs was 5. .2 years. But about 27 percent viewed it to be ensuring steady growth of the company. About 60 percent of respondents of the ADB survey considered maximizing shareholder values as the CEO’s most important responsibility. without cause. Fourth. Fifth. equal to three years’ pay. shareholders have preemptive rights to maintain their proportionate ownership of a company under any financing plan that may be undertaken by the company. Among others. or (iv) enters into a merger or consolidation with another corporate entity. (iii) invests in another company for a purpose different from that of the corporation. the Corporation Code allows cumulative voting for directors. of directors representing minority shareholders. shareholders enjoy a number of rights and protection. (ii) disposes of or mortgages a substantial portion or all of corporate properties and assets. 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. Only one respondent indicated that its CEO was entitled to a substantial amount of compensation. to help ensure the representation of minority interests in the board. (ii) contracts with companies linked through interlocking directorship. and prohibits the removal. They can vote through proxy. i. first. 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. shareholders may exercise appraisal rights. The majority of responding companies compensated their CEOs by using a fixed salary plus a performance-related bonus. if the CEO’s contract was preterminated.e. Third. and (iii) involvement of directors in businesses that compete with the company. Second. The “golden parachute” was apparently not a common feature of CEOs’ compensation packages. Companies are not allowed to issue shares with different voting rights. 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.Chapter 3: Philippines 189 was not related to the chairperson by blood or marriage in all of the cases except one. Shareholder Rights and Protection Under the Corporation Code. 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 Revised Securities Act has strict provisions designed to deter insider trading. In the case of preemptive rights. because of poor compliance and enforcement as well as some loopholes in corporate laws. There was only one case. Vol. Regardless of the amount of shares held. SEC proceedings were costly and time-consuming. board members are likely to be under pressure to approve transactions that benefit controlling shareholders to the detriment of minority shareholders. because of the dominance of large controlling shareholders. minority shareholders were often vulnerable to the expropriation of their interests by controlling shareholders and management. The company was dissolved before indictment. An effective market for corporate control may provide some protection for minority shareholders against the expropriation of their interests by the incumbent management. in cases of corporate takeovers. that of Interport Resources Corporation. There was little chance that a proposal from minority shareholders could ever get approved. Being appointees of controlling shareholders. the Corporation Code allows a company to waive this in the article of incorporation upon registration or in a subsequent amendment. However. there were often no real discussions of board proposals or actions. Last. hostile takeovers are not common because in most companies ownership is concentrated . it is doubtful whether this legal protection for shareholders will achieve what it intends to in practice. In the past. Few minority shareholders actually exercised their appraisal rights. II shareholders are allowed to inspect a company’s stock and transfer books. But an action by the regular court on a petition by the company’s owners/officers prevented SEC from pursuing the investigation. 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.190 Corporate Governance and Finance in East Asia. In practice. Dissenting minority shareholders did not necessarily have recourse to a third party for an objective appraisal of their shares. Sixth. a shareholder could file a derivative suit against a director to redress a wrongdoing. Those who did were usually offered below-market values for their shares. there are no requirements for disclosing such transactions to shareholders under the Corporation Code. no one has been successfully prosecuted for insider trading. During annual general meetings where minority shareholders could exercise their rights. in the Philippines. where SEC made substantial progress in investigation. Although transactions involving potential conflict of interest need to be reviewed and approved by the board. Consequently. In cases of derivative suits against directors for wrongdoings or actions against insider trading.
0 48.4 70. representing about 24 percent of outstanding shares.0 63.13 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.3 56. Nevertheless.Chapter 3: Philippines 191 in a few controlling shareholders and families. The responding companies had on average 43.6 30.8 30. An average of 327 shareholders per company attended the last annual meeting and they represented about 63 percent of total shares.900 shareholders per company did not vote during the last annual general meeting. a company that is widely held but has a large shareholder. demonstrates the feasibility of developing a market for corporate control if publicly listed companies were widely held. The brokers or securities companies were the most important proxy voters. representing 3. and their activism in the corporate sector.4 percent of shareholders but 58 percent of outstanding shares.522 shareholders each. Nominees held about 45 percent of the outstanding shares. appointed either by the board or shareholders during the annual general meetings.8 56.8 92.2 7.4 No 0.0 36.2 43.6 Independence of Auditing The ADB survey revealed that all the responding companies had an independent auditor. An average of about 4.7 43. About 93 percent of the respondents contracted .0 51. Table 3. the successful hostile takeover by First Pacific Group of PLDT. Table 3. protection. followed by management and banks. Yes 100. The ADB survey provides further evidence on shareholder rights.2 69. About 333 shareholders per company voted by proxy.13 summarizes rights that the shareholders of the responding companies enjoyed. 1999.
SEC requires all registered companies to periodically submit reports for the purpose of updating their respective registration statements filed at the agency. a bankruptcy case) or hid a large amount of liabilities and losses (PLDT. vary in their evaluation of some major accounts such as securities and other liquid assets. the information statement transmitted to every shareholder should contain the audited financial statements. the agency also requires reports on important details about their operations and management. Meanwhile. the US GAAP). 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. the local standard (i. a management discussion of the business. independent auditors are likely to be quite familiar with the operations and financial aspects of their clients.. The accounting profession in the Philippines is considered fairly developed and Manila is a known regional center for accounting expertise. there are many cases of poor financial reporting by large companies.192 Corporate Governance and Finance in East Asia. Most major international auditing firms operate in the Philippines. In practice. and consolidation policy. long-term leases. the international accounting standard. II their annual audit to an international auditing firm. On average. intangible assets.e. financial reporting standards allow room for interpretation by independent auditors. Vol. or the accounting standard of a specific developed country (for example. 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. From publicly listed companies. Because of such long relationships. imposing penalties on violators. the responding companies have been associated with their present auditors for 13 years. The Code grants a shareholder the right to inspect business records and minutes of board meetings. In two celebrated cases. Nevertheless. These different versions of GAAP. intra-company receivables and payables. revaluation of fixed assets. a preferred independent auditing firm either reported assets that did not exist (Victorias Milling Corp. foreign currency-denominated liabilities.. and an analysis of financial statements. independent audits do not guarantee the absence of questionable accounting practices. investments in subsidiaries. a hostile takeover case). namely. although closely related. as practiced in the Philippines). with the longest being 50 years. Nevertheless.
as large shareholders had no need for financial statements to monitor their companies and management that were under their own control. which are closely held by large shareholders and family members. “Selective public listing” is a strategy of many business groups for channeling funds from public investors to member companies. The popularity of holding companies in the Philippine corporate sector is evident: with a market capitalization of P258. which are controlled by large shareholders with public investors in a minority position. the authorities. 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. When control rights exceed cash flow rights.6 billion. Even for widely held public companies. they also make it easier for controlling shareholders to expropriate interests of minority shareholders. Publicly available financial information was often of low quality. from a minority-controlled to a majority-owned subsidiary. namely SEC and the Philippine Institute of Certified Public Accountants (PICPA).. Controlling shareholders usually select member companies that require large . However.Chapter 3: Philippines 193 Many small. and publicly listed. Holding companies enable controlling shareholders to collectively own shares of other companies in a business group and to centralize the group’s management. Family-based controlling shareholders use them as vehicles for controlling business groups. They allow risk pooling and can achieve economies of scale in management. Such expropriation is due to gaps between control rights and cash flow rights that pyramiding structures of business groups centered on holding companies create. sometimes did not penalize independent auditors for poorly prepared audited financial statements. Pure holding companies can be privately owned. because of the highly concentrated ownership of Philippine corporations.and medium-sized businesses did not have quality financial statements. e. arguably. they formed the largest group of corporate entities in the Philippine stock market in 1997. and financing. Laws of many Southeast Asian countries allow the establishment of pure holding companies (with the exception of Korea up to 1999). which are usually controlled by holding companies. Corporate Control by Controlling Shareholders As in many other Asian countries. marketing. accounting for 27 percent of the total stock market capitalization that year.g. controlling shareholders in the Philippines usually exercise their corporate control through the setting up of business groups.
Honda Cars (Philippines).. It is majority-owned by Mermac.6 percent of Globe Telecom. Minority-owned companies may also need access to resources of the group. Public investors collectively hold a minority of 41 percent. with 59 percent of shares. II equity investment for public listing. It has a majority control at 71. . In an active minority-owned operating company. the parent company plays an active role in management. controlling shareholders of the parent company may eventually increase their shares to a majority position. Ayala Land fully owns Makati Development Corporation and holds a minority stake. namely. The first three companies are publicly listed while the fourth.2 percent. This is most evident when a minority-owned company transacts with other members of the group where the controlling shareholders hold majority control.4 percent of Bank of the Philippine Islands. They may have a representative in the board. at 47. In a passive minority-owned operating company. active minority or passive minority holdings. They are operating companies but at the same time have majority or minority share ownership in other operating companies. Depending on the performance of the company. Ayala Corporation is a publicly listed pure holding company. an active minority share at 44. a family-owned pure holding company. of Cebu Holdings (a publicly listed government-owned company). 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.1 percent of Ayala Land. financing. In cases of minority ownership. Controlling shareholders gain additional leverage in management control over minority-owed companies. especially its management. Ayala Corporation. controlling shareholders of a parent company hold these shares as “strategic investments” that they could increase or reduce depending on business opportunities. Vol. as an example (Figure 3. Inc.194 Corporate Governance and Finance in East Asia.and minority-controlled operating companies are also holding companies. These investments can be classified according to the role of the controlling shareholders in the management of the invested company. and customers.1). controlling shareholders of the parent company do not participate in management. Some holding companies are not pure holding companies. is privately owned. Selective public listing combined with use of pure holding companies to own and control member companies lead to various organizational structures of business groups. and a passive minority investment at 15 percent in Honda Cars (Philippines). minority control at 42. Ayala Corporation’s majority. The stylized features of control structure of business groups in the Philippines can be illustrated by using a leading Philippine family-based conglomerate.
04%) <50% Ayala Corporation >50% Publicly Listed Pure Holding Company >50% MajorityControlled Operating and Holding Company Ayala Land (71. Inc.06%) <50% >15% &<50% Active MinorityOwned Pure Operating Company Globe Telecoms (44..Figure 3.96%) Privately-Held Pure Holding Company Public Investors (41. Inc. . (58. (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.6%) <15% Passive MinorityOwned Pure Operating Company Honda Cars Phils.44%) >50% MajorityControlled Pure Operating Company Makati Development Corporation (100%) <50% MinorityControlled Pure Operating Company Cebu Holdings. (47.2%) >50% MajorityControlled Pure Operating Company BPI Family Savings Bank (100%) <50% MinorityControlled Pure Operating Company Note: Data as of 31 December 1998.
1999b. Diversification and Efficiency of Investment by East Asian Corporations. 1998. indirect shareholdings do not appear to be a prevalent practice in the Philippine corporate sector. however.12 These examples show that even when large shareholder groups are minority shareholders. Simeon Djankov.44%] / [58. Who Owns and Controls East Asian Corporations? 11 Ibid. Lang.5% x 14. H. is illustrated in the Lopez Group (Figure 3.8%] 5. First Philippine Holdings Corporation.5%] / [(88. and Larry H.7 times its cash flow rights by virtue of the double layer pyramid structure of the Ayala group. Simeon Djankov. Vol. defined as control by large shareholders of an operating company through minority ownership by several companies. and 1999c. The Separation of Ownership and Control in East Asian Corporations. Benpres Holdings. Lang: 1999a.7 times 12 . they exercise far greater control (two to five times more) than they are entitled to by virtue of their ownership rights. Being in the public utilities sector. [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. and Larry H. P.76%)] [39. The control of companies through indirect corporate shareholdings. see the World Bank research papers by Stijn Claessens. Generally.98% x 42.5%] [39. a privately owned company. MERALCO.7 times Ibid. See also Stijn Claessens.3% x 5.10 The Ayala family’s control rights over BPI was 1.14%] / [1. companies in the Lopez Group are large and minority-controlled. P.7 times its cash flow rights by virtue of its cross-holdings via Benpres and First Holdings. 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. The situation offers large shareholders tremendous incentive to move resources 10 For details.44%] = [42. and First Philippine Industrial Corporation are indirectly held by a majoritycontrolled holding company. II Bank of the Philippine Islands owns 100 percent of the BPI-Family Savings Bank.11 The Lopez family’s control rights over MERALCO was 5. Expropriation of Minority Shareholders: Evidence from East Asia.3% x 1.64% +37. [control right] [control rights via Ayala Corporation] = [cash flow right] [cash flow rights via Ayala Corporation] = [42.44%] / [25%] = 1. and a minority-controlled holding company.196 Corporate Governance and Finance in East Asia. Rockwell Land.2). Joseph P.64%) + (37.14%] / [6. Fan.
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. Inc.64% MinorityControlled 14. Privately-Held Pure Holding Company 88. .Figure 3.5% First Philippine Industrial Corporation 50% 50% Note: Data as of 31 December 1998.5% Operating Company MajorityControlled Operating Company Rockwell Land Corporation 24.3% 11.7% 62.76% Operating Company MinorityControlled 24.2 Corporate Control Structure: The Case of Lopez Group Public Investors Family Members Lopez.
The controlling shareholders could also use the resources of minority-owned subsidiaries to engage in overexpansion and empire building investments. 3. II from their subsidiaries to their majority-owned publicly listed holding company or elsewhere up the pyramid. Suspension of Payments of Debts Under PD 902-A. accessed nonbank creditors for specific purposes but dealt with commercial banks on a long-term basis. Most respondents (81 percent) indicated that they had renegotiated with their creditors on loan repayment when they faced liquidity problems. and (ii) how the legal framework protects creditor interests and rights. Control by Creditors According to the ADB survey. SEC could suspend the rights of a creditor to demand payment from a borrower in accordance with the terms of the loan . a publicly listed company dealt with an average of eight banks and six nonbank financial institutions. Only a minority of respondents (18 percent) indicated that they had faced adverse creditor actions such as a collection lawsuit or foreclosure of collateral. the data suggest.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. while 80 percent reported that creditors with which they had renegotiated loans were still willing to lend to them.3. Vol.198 Corporate Governance and Finance in East Asia. Most responding companies had dealt with their commercial bank creditors for more than five years and nonbank creditors for only about two years. Sixty-one percent of respondents indicated that creditors usually asked for collateral for all types of loans. However. The average company. 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. whether for working capital or capital expenditure. Some 85 percent of respondents believed that creditors had no influence or only weak influence on corporate management. it was not common for creditors to take legal action against debtors or foreclose on those assets held as collateral in cases of default.
The corporation continued to be under rehabilitation receivership as of June 1999. For example. under which. Inc. Consequently. The law on suspension of payments envisions resetting the corporation’s business for a temporary period to prevent its irreversible collapse. the litigation process. The second mode is for suspension of payments with the appointment of a management committee (Mancom) or rehabilitation receiver.1 Corporate Financing The Financial Market and Instruments The Philippine financial market has remained underdeveloped compared with other countries in the region. SEC and the court required that the creditors of BF Homes. profitable companies from going public. In practice. Under this mode. including the rehabilitation of the corporation. which determines the viability of the rehabilitation plan and appoints a Mancom or a rehabilitation receiver to implement the proposal if approved. Under such circumstances. 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. Publicly listed companies do not represent a cross section of the Philippine corporate . 3.4 3. There are no legal or practical limits to the time period of suspension of payments. it is not clear whether the corporate borrower’s assets are of sufficient value to cover its liabilities. bank credit is the main source of corporate financing. 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. Markets for equity and debt instruments are small and there are serious structural problems that discourage large. the borrower requests to defer payments for a certain period to enable it to generate the necessary liquidity.Chapter 3: Philippines 199 agreement. There are two modes of suspension of payments under PD 902A. a company’s assets are of sufficient value to cover all of its debts. Commercial banks hold about three fourths of the resources of the financial system. This explains why creditors invariably oppose any move by borrowers to file for suspension of payments at SEC. a real estate-based business group. could take an indefinite period. The borrower will propose a rehabilitation plan to SEC.4.. SEC could intervene to avoid asset dissipation. PD 902-A granted SEC blanket powers to intervene and adjudicate claims.
but not to the same extent as it did in other Asian economies. 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. Of the 221 companies listed in the Philippine Stock Exchange in 1997. Foreign portfolio investments also remained small. this is because. the minimum required to qualify as a public corporation. and convertible securities. Foreign funds were wary of the Philippine stock market because of its limited liquidity. companies expanded only at a moderate pace. The Government financed its chronic fiscal deficits by issuing short-term Treasury bills. Most publicly listed companies issue only up to 20 percent of total shares to the public. preferred stocks. inflation. Korea and Thailand). and fiscal management were among interrelated factors explaining the underdeveloped state of the Philippine financial market.. Philippine companies were less leveraged. 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. As a result.14 shows that the average volume of daily trading in 1997 stood at P2. however. compared with other economies.4 billion (or $59 million using the average exchange rate). II sector.g. 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. The corporate sector raised a substantial amount of . Equity instruments include common stocks. They invested in only a few large companies whose shares were relatively liquid. The Philippine stock market is not a liquid market. In part.000 companies. Malaysia. compared with Malaysia ($186 billion). Table 3. The stock market was depressed up to the early 1990s. Korea) ($143 billion). while interest rates were at high levels and volatile.5 billion). Rising stock prices during the Ramos administration reflected to some extent the business optimism. Vol. the country experienced double-digit inflation. The period 1993-1997 was one of lower inflation and declining lending rates.7 billion. is far ahead of the flock. only 84 had sales large enough to be placed in the top 1. less exposed to foreign debt. From the 1970s up to the early 1990s. about the size of Thailand’s. was one of the smallest in the region at $47. Interest rates. and less engaged in risky investments.200 Corporate Governance and Finance in East Asia. However. most listed companies are controlled by their five largest shareholders. The market capitalization of the Philippine stock market in August 1997. the Republic of Korea (henceforth. Equity financing through IPOs was active. The crisis affected the Philippine corporate sector. especially short-term debt. Even in the real estate sector.
515.545.5 26.2 61.2 0.9 114.14 Philippine Stock Market Performance.1 0. Note: Combined transactions of Makati and Manila Stock Exchanges are not available for the years 1983 to 1986. 1983-1997 Daily Trading Volume (P million) — — — — 129.8 1.8 0.4 9.2 1. P billion) Gross Domestic Product (current prices.445.692.3 0.2 3.3 158.686.6 261.1 0.5 1.474.6 1.7 1.121.0 0.2 297. P billion) 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 19.3 59.1 0.8 102.248.906.077.9 1.0 0.5 72.9 608.4 728.7 0.9 12.1 524.8 1.386.5 12.0 2.373. .351.421.5 Year 369.3 314.3 0.251.2 925.0 161.4 1.088.9 682.0 0.2 57.7 41.5 16.Table 3.9 2.1 88.5 1.2 0.5 571. Source: PSE databank.3 4.1 0.4 Ratio of Market Capitalization to GDP 0.1 5.0 1.3 Market Capitalization (year end.7 2.9 2.3 — = not available.2 ($ million) — — — — 6.171.2 1.8 799.3 2.7 391.7 207.2 59.8 1.6 1.
Few companies offer preferred stocks because the Philippine tax system does not allow tax deductibility of dividends on preferred stocks. moreover. and inventory financing. The underwriter.2 Patterns of Corporate Financing The study looked at retained earnings. The largest buyers have been commercial banks. lack of competition among financial institutions. Corporate bonds are another type of debt securities. asset-backed credits. Negotiated credits. which in most cases is an affiliate of the issuing company. From 1988 to 1997. Only a few large companies floated commercial papers because of the limited market. include bank credits. the rights issue was a popular way of raising equity capital. The corporate bond market was stunted. Capital markets cannot provide the market discipline that corporate investors need. which buy commercial papers either for their own account or for their clients.202 Corporate Governance and Finance in East Asia. new equity. about 127 companies went public with a total value of offerings of about P134. sells these commercial papers through brokers. which ultimately influences the pricing of commercial paper issues. Vol. Debt instruments include negotiated credits and debt securities. However. discounting of receivables. because business groups often own large commercial banks. of which 85 percent was raised from 1993 to the first half of 1997. Because existing shareholders wanted to retain their proportionate control over their companies. This is because only companies with strong capitalization and predictable cash flows such as public utility companies can issue bonds. leases.6 billion. However. and debt as sources of corporate financing by using flow of funds analysis. which were the principal source of corporate financing in the Philippines. The picture of the financial system that emerges is thus one of limited capital markets. and the dominance of large commercial banks. Debt securities include commercial papers and corporate bonds. corporate bond issuing was even more limited. by volatile interest rates and the absence of a secondary market. II equity capital through IPOs during the stock market boom from 1993 to the first half of 1997. and high transaction costs. a strong regulatory system for bank supervision is imperative. are in a position to provide such discipline.4. tight regulations. Only the commercial banks. Under SEC regulations. 3.. issuing companies had to undergo a process of review and credit rating by the Credit Information Bureau Inc. The measures used in the analysis are: . by virtue of their large stakes in the financial system.
2 0. It measures a company’s capacity to finance asset growth by equity capital.15 Financing Patterns of the Corporate Sector.8 0.4 1.4 0.9 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.5 0.5 Source: SEC-BusinessWorld Annual Survey of Top 1.8 0.1 0. On the other hand.3 0. . New equity financing ratio (NEFR): ratio of changes in stockholders’ equity (excluding retained earnings) to changes in total assets.3 0.6 0. Retained earnings were sufficient to finance the entire growth of fixed assets in the corporate sector.4 0.2 0.5 2. Incremental debt financing ratio (IDFR): ratio of changes in total liabilities to changes in total assets. It measures a company’s reliance on borrowings in financing asset growth.1 Average 1.4 0. during this period. 1988-1997. it is one minus IDFR.0 0.2 0.3 0.4 0.9 0.2 0.5 0.5 0.6 0.5 0.6 0. Self-financing ratio of total assets (SFRT): ratio of changes in retained earnings to changes in total assets.000 Corporations in the Philippines from 1988 to 1997.9 0.15.7 0. By definition.9 0.5 0.000 Corporations in the Philippines.3 0.5 0. All Companies Financial flows data were derived from the SEC-BusinessWorld Annual Survey of Top 1. It measures a company’s capacity to finance growth in fixed assets by internally generated funds.3 0.5 0. It measures a company’s capacity to finance asset growth by internally generated funds.3 0. As shown in Table 3. the average SFRF was high at 109 percent. Incremental equity financing ratio (IEFR): ratio of changes in shareholders’ equity inclusive of retained earnings to changes in total assets.1 0.1 0.4 0.8 0. the SFRT was low at Table 3.1 0.3 0.2 0.4 0.4 0.5 0.0 0.1 0.5 0. 1989-1997 Financing Indicators SFRF SFRT NEFR IDFR IEFR 1989 1990 1991 1992 1993 1994 1995 1996 1997 1.
. In all the years.2 (0. 1988-1997.3 0.2 0. Companies financed fixed assets from internal sources in hard times. There were significant year-to-year variations. and 1997. On Table 3.6 0.16. 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 1997.3 0. The corporate sector consistently relied on debt and new equity to finance asset growth throughout the period. Retained earnings were the least important. debts were the most important source of financing.3 0. implying that internal funds were far from sufficient to finance growth in total assets. This was mainly caused by the declining contribution from retained earnings. 1989-1997 Financing Indicators SFRF SFRTa NEFR IDFRa IEFRa a Publicly Listed 1. As a result.1 a Excludes negative balances. privately.9 0. the level of corporate leverage increased. with debt providing 93 percent of the financing requirements. for all three types of companies—publicly listed. In 1997.5 0.and foreign-owned. The corporate sector used new equity to finance 32 percent and new debts to finance 49 percent of growth in total assets. II only 19 percent. Vol. reflecting the capital flight caused by political instability in the early 1990s.3 0.5 Foreign-Owned 1. In periods of an economic crunch such as in 1989. 1991. when it financed 45 percent of it. Corporate Financing by Ownership Type As shown in Table 3. internal funds were not a significant source of financing growth in total assets. retained earnings declined and few new equity investments flowed into the corporate sector.16 Corporate Financing Patterns by Ownership Type.0) 0.8 0.5 Privately-Owned 0. except in 1991.204 Corporate Governance and Finance in East Asia. suggesting that there was a deterioration of financial performance in the Philippine corporate sector in the years running up to the crisis. except for foreignowned companies that had a negative new equity financing ratio.7 0.000 Corporations in the Philippines. Total assets grew by 23 percent that year. the SFRF was higher. Source: SEC-BusinessWorld Annual Survey of Top 1.
2 100.4 10. Foreign-owned companies relied more heavily on debt financing. compared with 47 percent for publicly listed companies and 55 percent for privately-held firms. contributing 90 percent of growth in total assets.1 15.9 24.6 0.3 12.9 100. 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 14.9 0.0 9.1 50. especially bank loans.9 16.9 3.7 2.9 12.17.0 8.2 42.1 13.0 Source: SEC-BusinessWorld Annual Survey of Top 1.Chapter 3: Philippines 205 average.7 13.2 51.7 7.8 26.0 38.17 Composition of Assets and Financing of the Publicly Listed Sector.0 10.0 9.9 16.8 3.1 10.0 1994 19.3 51.0 53. This financing pattern supports the earlier finding that foreign-owned companies had the highest leverage among the three types of companies.0 10.000 Corporations in the Philippines.5 41.4 100.3 4.4 43. publicly listed companies relied more on new equity financing than privately.8 46.8 39. .5 0.0 100.7 23.3 48. A breakdown of the financial structure of publicly listed companies measured in balance sheet items is shown in Table 3.8 17.4 2.3 11.4 100.9 16.4 2.1 9.4 100.6 48.0 6.3 12.6 48.3 13.9 4. The sector built up its short-term debts.0 9.8 0.8 16.0 1993 14.0 1995 1996 13.1 7.8 100.3 10.7 2.0 13.4 12.4 3. significantly Table 3. It presents a composition analysis of assets and financing sources for the period 1992-1996.8 38.2 100.and foreign-owned companies.7 13.3 10.8 4.2 12.8 51.7 100. 1988-1997.0 9.8 0.9 38.6 26.1 49.5 12.5 16.5 27.2 3.7 4.0 12.8 3.6 43.6 37.5 9.2 3.4 41.4 100.3 12.
3 0. For these two reasons. The traditional measure of liquidity. Group companies financed an average of 45 percent of growth in total assets by debt.3 0. 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.45 in 1996.1 0. II in 1996 and became more vulnerable to the financial crisis in 1997. Group companies were generally more profitable than independent companies. the easier access to external credit. Vol.18. Corporate Financing by Control Structure Conglomerates have certain advantages in financing because of the opportunities offered by the internal capital markets.5 Excludes negative balances Source: SEC-BusinessWorld Annual Survey of Top 1. As shown in Table 3.5 0. group companies usually financed their investment in member companies by equity rather than debt. Further. 1988-1997. and economies of scale in fund raising.18 Financing Patterns by Control Structure. indicating that many publicly listed companies were likely to be in a tight liquidity position.5 0. respectively. as opposed to 94 and 30 percent. The SFRF for independent companies would have been even lower if the highly profitable foreign-owned companies were excluded.3 0.206 Corporate Governance and Finance in East Asia.2 0. Table 3.000 Corporations in the Philippines. On average. for independent companies.6 Independent Company 0. 1989-1997 Financing Indicators SFRFa SFRTa NEFR IDFRa IEFRa a Group Member 1.13 was at 1. the current ratio. their inherent ability to pool risks. the average SFRF of business groups was higher compared with that of independent companies. compared with an average of 54 percent for independent companies. group companies were less reliant on debt financing than 13 Defined as total current assets divided by total current liabilities. The normal standard liquid position is a current ratio of 2 or higher.9 0. .
and 1997 with 131 percent.8 0. equity financed 42 percent of incremental asset growth.3 0. averaging 61 percent of growth in total assets. Table 3.08 and SFRT of 0.19).50 (Table 3.76 for small companies and 0.9 0.1 0.55 was substantially higher than the small companies’ 0. With assets growing at a fast pace during this period. 1993 with 96 percent. compared with 55 percent for large companies and 47 percent for small ones.06. Corporate Financing by Industry The manufacturing sector had an average SFRF of 1. 1989-1997 Financing Indicators SFRFa SFRTa NEFR IDFRa IEFRa a Large 0. There was also increased reliance on debt financing. medium-sized companies used more debts. The lower SFRF for large companies may be caused by their larger outlays for growth in fixed assets. Excluding . These years were 1991 with 110 percent.5 Excludes negative balances. Large firms consistently increased their reliance on debts from 1994 to 1997.2 0. The corresponding ratio was 0. with an average of 3.Chapter 3: Philippines 207 independent companies.5 Medium 3.20).47.6 0.2 0.2 0.4 Small 0. Large companies’ IDFR of 0. These results support the earlier finding that the leverage of business groups was lower than that of the independent companies from 1988 to 1997.6 0.3 0.19 Financing Patterns by Firm Size. 1988-1997.88 for large companies (Table 3. The medium-sized companies’ high debt financing ratio was due mainly to three years of complete reliance on debt to finance growth.000 Corporations in the Philippines. Corporate Financing by Firm Size SFRF was highest for medium-sized companies.5 0. On average. Source: SEC-BusinessWorld Annual Survey of Top 1.3 0.
5 0.4 0. Equity financed an average of 62 percent of total asset growth. 1988-1997. The real estate industry financed its growth by substantial equity funds.6 a Excludes negative balances.5 Utilities and Real Estate Services and Property 0. debt financed about 78 percent of asset growth in real estate.3 0.91. The construction sector was a heavy user of debt financing. In the eight years preceding the crisis.7 0.000 Corporations in the Philippines. Incremental equity financing amounted to an average of 44 percent of total asset growth.3 0. II 1991. SFRF for the sector averaged 0. with an SFRF as low as 0. the total debt ratio was much higher in 1996 at 0.4 0. While this level is considered prudent.04.4 0.5 (0. achieving an average SFRF of 3.20 Financing Patterns by Industry. Excluding 1997 when fixed assets declined. Its SFRF and SFRT were volatile because of chronic losses and reduction in fixed and total assets.3 0.47 two years later.6 0.58 and SFRT of 0.29. The situation improved beginning 1994. the manufacturing industry financed 57 percent of its total asset growth by debt.6 0. many of the leading real estate companies successfully went public during that time. Equity financed the rapid expansion in the industry’s assets in the period 1994 to 1997. the incremental equity ratios of the industry were high. when debts declined.5 0.6 0.208 Corporate Governance and Finance in East Asia.4 3.1 0. Source: SEC-BusinessWorld Annual Survey of Top 1. while SFRT averaged only 0. The utilities sector showed weaknesses in internal fund generation in 1989-1994. 1989-1997 Financing Indicators Manufacturing SFRFa SFRTa NEFR IDFRa IEFRa 1.27. During the crisis year.2) 0.3 0. Since the real estate boom coincided with that of the stock market. increasing to 0. Up to 1997.79 and in 1997 at 0.32. Low incomes diminished the equity financing position of the manufacturing industry toward the crisis year. ranging from 41 to 118 percent. Vol. . Table 3.4 Construction 0. Total liabilities increased partly as a result of the local currency devaluation and financed all of asset growth for the year. the industry generated internal funds. The effects of the crisis of 1997 were adverse. The sector had the highest leverage among all industries that year.
These results suggest that companies with higher ownership concentration tend to be more highly leveraged and. alternatively.008 5. as the dependent variable. Financial Leverage. more profitable. 1992-1996. ROE.3 Ownership Concentration.421 0.21. As shown in Table 3. at the same time.004 3. while if it fails. 14 See for example Michael Jensen (1993).00036 2.860 Leverage = the ratio of total assets to total equity. the coefficient of the ownership concentration measure in all the three regressions is positive and statistically significant. was regressed against measures of profitability and of financial leverage. ownership concentration = the total shareholdings of the top five shareholders. and leverage.130 ROA 0. and Financial Leverage Dependent Variable Item Coefficient of Ownership Concentration T-statistics Adjusted R-squared F-statistics ROE 0.21 Ownership Concentration.00056 1. Profitability. and the Failure of Internal Control Systems. . Exit. creditors bear the consequences. ROE = return on equity. and financial leverage are all positively and significantly related to the degree of ownership concentration. measured by the percentage of shareholdings of the largest five shareholders. Large shareholders may also overuse financial leverage to avoid diluting ownership and control.230 Leverage 0.14 Large shareholders may borrow excessively to undertake risky projects. ROE.287 0. Source: Author’s estimates based on the PSE databank. ROA = return on assets. and Performance Previous studies on corporate governance have often associated ownership concentration with heightened risk-taking by companies.009 5. Table 3.00125 2. The Modern Industrial Revolution. ROA. Three regressions were run with the shareholding of the largest five shareholders as an independent variable and ROA. Journal of Finance 48: 831-880. the degree of ownership concentration.769 0.4. Using the PSE database. knowing that if an investment turns out to be successful they could capture most of the gain.Chapter 3: Philippines 209 3.
About 80 percent of imports were capital goods (particularly power generating and telecommunications equipment). foreign investments in the country have been low. notably remittances of overseas workers. In 1997. which averaged 4. The country experienced balance of payments surpluses but these were due to transfers.5.5 billion in 1996 and grew at an average of 48 percent per annum from 1992 to 1996. an overexpansion of capacities.8 percent of GDP from 1995 to 1997. the economy still showed vestiges of its import-dependent and substituting character. In sum. The structure of the economy may be understood by looking at its sectoral composition and export competitiveness. and intermediate goods.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. After a . The export sector had a very narrow breadth. with a narrow exporting industry base. and agriculture at 21 percent. Net investment inflows were $3. 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. Because of limited local capital.5 percent per year from 1992 to 1997.” The Government’s judgment that economic fundamentals were strong was based on stable growth rates. their growth gathering momentum only beginning in 1992. more than half (52 percent) of exports were semiconductors. Garments was the second largest export sector at about 9 percent. Net trades in goods and services averaged a deficit of 4. The largest contributors to GDP were services at 43 percent. industry at 34 percent. the growth in foreign investments fueled that of the manufacturing and services sectors in the years preceding the crisis. Exports were growing at about 20 percent per year in the three years preceding the crisis. Historically. raw materials. the country’s GDP growth pace indicated that it did not have a “bubble economy. but its share had been declining by 4 percent per year since 1995. Compared to other East Asian crisis-affected countries. Vol.” that is. Although much lower than those of other Asian countries. II 3. with commodities accounting for the balance. Manufactures accounted for about 85 percent of exports. the country was less dependent on foreign private capital.210 Corporate Governance and Finance in East Asia. The Government explained that the country had “sound economic fundamentals” but that the problems were caused by “contagion. Commercial and industrial activities in the country were largely oriented to domestic markets.5 3.
6 billion as of March 1997. however. a government fiscal surplus from 1994 to 1997. resulting in stability in the short-term debt to reserves ratio. while sales grew by only 20 percent per year. Closer analysis. In the Philippines. Five years of stable growth before the crisis enabled the country to build its net international reserves to $10. 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. 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. The lessons from debt restructuring became the basis for the Government’s economic policies.3 percent. the ratio of short-term debts to international reserves dipped below 100 percent beginning June 1998. unlike their counterparts in the region. Economic performance during 1992-1997 was characterized by an average growth rate of real gross national product (GNP) at 3. Since the regional financial crisis was triggered by the loss of confidence in some East Asian economies by foreign creditors and investors. fueled also by successful IPOs during the stock market boom of 1993-1996.5 percent. in turn. an average Treasury bill rate of 13.8 percent.Chapter 3: Philippines 211 long period of debt moratorium and restructuring that started in 1983 and ended in 1991. assets grew at a compound annual rate of about 31 percent. From 1993 to 1997. shows that investments of the corporate sector were growing at a faster rate than sales revenues in the years immediately preceding the crisis. The corporate sector was in a relatively stable financial condition around the time of the crisis. the country and the corporate sector had no access to foreign currency debts from the international financial market. Prudent fiscal management and controls on foreign borrowings were part of the adjustments required by IMF and foreign creditors. and a relatively healthy banking system. adjustments were focused on the quantity and quality of the banking system’s corporate loans. After hovering in the range of 100 to 127 percent. 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. depended on the quality of the corporate sector’s investments. the Government sought stability and achieved this in 19921997.1 percent. Eventually. From 1988 to 1996. average ROE was 13. which. a positive balance of payments from 1992 to 1996. . The Central Bank conserved international reserves by allowing the local currency to float within a wider trading margin. Profitable operations since 1992 had allowed it to build equity. Total debts were only 52 percent of assets or 108 percent of equity. an average inflation rate of 7. During this time.
47.303 23.212 Corporate Governance and Finance in East Asia.101 billion or 196 percent of net FDI in 1996.5 billion in 1995. 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. 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.485 145.300 1. II The corporate sector indeed overexpanded after 1993 like its counterparts in the region. the other immediate impact of the crisis was that on foreign investment flows. In 1997. precisely.718 30.22.517 1. Most of this leverage happened during the boom years in the region. but to a lesser degree. Net foreign portfolio investment amounted to $1. Sources: Bangko Sentral ng Pilipinas and SEC.22 Foreign Investment Flows. 1998 = 41.22). mitigated the effects of the pullout and liquidation of investments in the aftermath.074 2.073 (406) 121. Foreign investments in the Philippines have not been as high as the inflows to other Asian countries—and this. or 114 percent of net foreign direct investment (FDI).06. 1996 = 26.71.7 Note: Peso-dollar exchange rates used are: 1995 = 25. In sum.650 32. The debt level of the Philippine corporate sector in 1997 was low by Asian standards but still high by developed country standards.609 1. Data for 1998 cover only January-August. .0 1996 3.4 1997 762 1. Debts financed a large part of this expansion.0 1998 739 555 328 69. These patterns in investment and financing are similar to those of other countries in the region.749 26. growing by about 34 percent per year from 1994 to 1997. net FDI remained stable at more than $1 billion.5. But portfolio investment amounting to $406 million flew out of the Philippines. Net foreign investments more than doubled from 1995 to 1996 but declined by 78 percent in 1997 (Table 3.101 92. Table 3. Vol. It financed 26 percent of corporate capital growth. 1997 = 29.2 Impact of the Crisis on the Corporate Sector Aside from the foreign exchange adjustment. It rose to $2.” 3. It is understandable then that the effect of the Asian financial crisis on the Philippines was correspondingly that of a negative “contagion.
in turn.2 to 28. Because commercial banks were strongly capitalized. they were willing to restructure and renegotiate existing loans by corporate borrowers.3 percent of assets. Loans outstanding of commercial banks declined by the first quarter of 1998. Bank loan pricing was based on the bellwether 91-day Treasury bill rates rather than inflation. The combined effects of shrinking demand and high interest rates reduced the corporate sector’s demand for loans. A number of small banks closed but they represented less than 1 percent of the financial system’s total resources. new borrowings financed asset growth. Bank spreads over Treasury bill rates increased in 1997 but were within the range experienced in the past. with commercial banks holding P2. By March 1988.2 percent was barely above inflation rate.513 billion. depended on the liquidity and capital position of commercial banks. which held about 75 percent of the assets of the financial system in 1997. The banking system was able to absorb the impact of the crisis primarily because of its strong capital position. ranged from 11 to 13 percent from 1993 to July 1997.2 percent in November 1997. the commercial banking sector’s capital remained strong at 17. suggesting that commercial banks required a higher premium at about the height of the crisis but not beyond. Companies deferred investments in new fixed assets.369 billion.9 percent. Loan calls. When the Treasury bill rates eased in March 1998. they could not initiate a large reduction of their loans because these in part financed long-term growth in assets. albeit at current market interest rates. Although corporate borrowers were not highly leveraged. lending rates also came down. The interest rates on Treasury bills.Chapter 3: Philippines 213 Corporate financial performances and conditions deteriorated during 1997. The resources of the financial system that year totaled P3. Net profit margins were at a 10-year low at 4. Average bank lending rates climbed to their peak of 25. and leverage increased to 149 percent compared with 109 percent in 1996. ROE at 6. Lending rates were well above the 20 percent level from July 1997 to March 1998. the sectors with the highest outstanding loans had reduced their credit exposures. Manufacturing reduced its loans outstanding by 11 percent from October 1997 levels. and the wholesale and . meanwhile. Because of weak internal fund generation. the corporate sector became vulnerable to loan calls and high interest rates.7 percent in January 1998. With the increase in borrowings and reduced liquidity. in varying degrees for each sector. then rose to a high of 22. By October 1998. The real problem of the corporate sector during the crisis was the rise in interest rates. sparking a rise in interest rates on corporate loans.
the aggregate effect of the crisis on NPLs was of a magnitude comparable only to the country’s last major banking crisis in 1984-1986.6 percent in June 1998. The Central Bank introduced regulations on foreign exchange trading to control speculation and nondeliverable forward contracts. the ratio increased to a high of 11. to reduce their lending spreads over the 91-day Treasury bill rates from 3-8 percent to 1. 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. II retail trade sector. In March 1997. However. was a problem sector. These figures show that adjustment problems were industry-specific and that the real estate industry. As for nonperforming loans (NPLs). real estate loans averaged 11. The latter measure was especially beneficial to companies with unhedged foreign currency loans from commercial banks.5-6 percent. Still. single-digit NPL ratios began only since 1989.3 Responses to the Crisis Government Responses The Government’s policy and regulatory responses to the crisis focused on monetary and credit issues. The move retained the liquidity position of banks but lowered their cost of reserves. The pattern indicates that real estate loans were of substandard quality but banks had contained the problem by mid-1998.9 percent of bank loan portfolios. The Central Bank adopted other measures to strengthen the financial system. This “voluntary agreement” partly explains why the loan spreads of banks were within the range of recent experience. thereby reducing overall intermediation costs. But the Philippine banking system had gone through worse crises in the past. These peaked at 14. and the financial system. 3. as with its counterparts in other Asian countries. This allowed the Central Bank to convince the banks.3 percent in December 1997. and subsequently went down to 13. Vol.5 percent by September 1998. the fiscal position. 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. and its experience of low. through the Bankers’ Association of the Philippines. and set up a hedging facility for borrowers with foreign currency-denominated loans.214 Corporate Governance and Finance in East Asia. set limits on overbought/oversold foreign exchange positions of banks.5. by 12 percent.
Responses of the Corporate Sector The corporate sector’s financial position. PAL. and the legal framework for reorganization and liquidation conditioned its response to the crisis. In the case of PLDT. the Asian crisis opened a unique opportunity for foreign investors. and (vi) issuing guidelines on duties and responsibilities of banks’ boards of directors for improved quality of bank management. (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. consolidating business units. The economy avoided a recession in 1998 and achieved 3. (iv) increasing banks’ capital requirement by 20 percent for universal banks (banks with expanded licenses) and 40 percent for ordinary commercial banks. subcontracting and outsourcing. (iii) fixing loan loss provisions of 2 percent of the gross amount of loan portfolio on top of individually rated bad loan accounts. the largest telecommunications setup in the Philippines. The acquiring company.Chapter 3: Philippines 215 real estate sector. Average Treasury bill rates have cooled since mid-1998. the Government kept inflation below 10 percent. came up with a rehabilitation plan by May 1999 that was found acceptable to all parties. With prudent monetary management.6 percent growth in 1999. which was privatized with the Lucio Tan group gaining control and the Government retaining minority ownership. its accessibility to foreign capital. (v) improving disclosure requirements on the financial position of banks. In response to calls for lower bank intermediation costs. With its weakened financial position. Financially strong companies were able to survive the crisis by effecting such internal restructuring. Takeovers in the past involved cooperative negotiations between purchasers of a target company and family-based large shareholders. was known to have a policy . Publicly listed Philippine companies could also be restructured through takeovers by local and foreign investors. A 40 percent devaluation of the Philippine peso lowered the purchase price of PLDT to foreign investors. The real estate portfolio of commercial banks also declined and was well below the Central Bank’s regulatory ceiling by March 1998. (PAL). and giving up noncore businesses. bank loan rates have also come down. the country’s flag carrier. Large companies with heavy loan exposures such as Philippine Airlines Inc. First Pacific Corporation. changing technologies. 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. took more action.
however. using some or all of these means. eventually took over PLDT and announced a restructuring plan for the entire group of companies. is whether there are sufficient safeguards to prevent controlling shareholders from . A third method was to make a formal tender offer to PLDT’s controlling minority shareholders. 3. In a legal process that ended in his takeover of management. Although considered the prime industrial company in the Philippines. the stock price of PLDT was buoyant during the takeover period. SMC had lagged behind other groups of companies such as Ayala Corporation in financial performance for some years. SMC is another widely-held company managed by a minority shareholder. Conclusions. One mode was the outright purchase of shares in the open market. First Pacific. Consequently. A second method was to purchase the shares of other large minority shareholders. the Cojuangcos. II of investing to control companies that are dominant players in their industries. controlling shareholders can capture these profits by excluding public investors from ownership. he restructured the company toward its core brewery business and sold off local and foreign subsidiaries. When Cojuangco took over. 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. Corporate governance is conditioned by the high ownership concentration of these large companies. Vol.1 Summary. Eduardo Cojuangco was able to assert his ownership of shares taken over by the Government during the transition of power in 1986.6. Its stock price and returns to shareholders had stagnated.216 Corporate Governance and Finance in East Asia. concentrated ownership of companies is not equivalent to weakness in corporate governance. When companies are highly profitable. the Soriano family. at a premium over the market price to reflect the value of management control. First Pacific could have acquired sufficient shares to take control of PLDT in three ways.6 3. and Recommendations Summary and Conclusions The Philippine corporate sector has been shaped by the country’s economic and industrial development policies. The question. Ownership is highly concentrated and a few dominant players control major industries. By itself. 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.
passive independent auditing. This study points out weaknesses in external control mechanisms such as weak legal protection for minority shareholders. Returns to capital exceeded inflation rates. influenced by industry characteristics. Financial institutions are not significant shareholders. minority shareholders need to be protected by external control mechanisms. The Philippine corporate sector was relatively efficient in investing and financing compared with other countries affected by the Asian crisis. Corporate governance should be viewed in the context of an increasing presence and growth of large shareholders-centered conglomerate business organizations. ownership of banks by business groups.Chapter 3: Philippines 217 expropriating the wealth of minority shareholders through aggressive and risky investment. Publicly listed companies had the highest profit margins and lowest leverage among the local companies. By size. Ownership of publicly listed companies is highly concentrated. companies that are members of family-based conglomerates had higher returns and lower leverage than independent companies. Privately-owned companies. Business groups occupied seven of the top 10 and 25 of the top 50 largest corporate entities in the Philippines in 1997. foreign companies were the most profitable but highly leveraged. were the least profitable. The five largest shareholders have majority control of an average publicly listed company. By ownership structure. The result is that corporate governance depends only on internal controls. Analysis of corporate financing by ownership . while the largest 20 shareholders control more than 75 percent of shares. This study analyzed trends in corporate performance and financing in relation to corporate governance from 1988 to 1997. with the real estate and public utilities industries standing out for their pronounced cyclical patterns. 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. Leverage was within Asian norms but above developed country standards. oligopolistic market structures. and the lack of market for corporate control. The financing pattern of the corporate sector was influenced by the tight financial conditions prevailing in the country up to 1992. The corporate sector consistently relied on internally generated funds and equity before resorting to borrowings. medium companies showed higher profitability than large and small ones. an ineffective insolvency system. Performance was. an underdeveloped capital market. the most numerous in the corporate sector. With large shareholders in control. By control structure. to some extent.
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. and centralized management and financing. and sustained growth. Large. the bank usually accounted for a large share of each group’s net profits. as typified by the Ayala Group. Even in cases where the group owned only a minority share of a commercial bank. The extent of governance problems depends on internal control policies of the controlling shareholders. Large companies owned or controlled by business groups tend to dominate their industries. The pyramid model is useful for centrally managing smaller companies. Such structures result in control by large shareholders through disproportionately smaller investments in equity ownership. superior profitability. 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. . with the foreign-owned companies found to rely more on borrowed funds. the amount of pressure from stock market investors and PSE (for publicly listed companies in the group). After controlling for industry effects. statistical analysis of company-level data revealed significant relationships between corporate performance and corporate governance. and the extent of supervision of outside institutions such as independent auditors and SEC. Companies whose large shareholders have higher degree of control tend to borrow more but generate better returns. and leverage were all positively related to the degree of ownership concentration. selective public listing of companies in the group. Business groups with pyramiding structures heighten the issue of corporate governance. A commercial bank is an important part of most business groups. A business group is an effective business organizational model for achieving leadership in industries. ROE. Ownership concentration was positively related to both returns and leverage. ROA. Internal financial markets operated by business groups allowed them to optimize their financial resources at lower external debt levels. Vol.218 Corporate Governance and Finance in East Asia. family-based shareholders gain control by such means as the setting up of holding companies. Family-based business groups have focused their investments in industries where their superior financing capacities and political/social influence give them unique advantages. Publicly listed companies were responsive to investors’ requirements for prudent use of debts. The difference between management control and ownership rights is usually substantial. II type gave similar results.
3. with recently restructured public debt. mostly by highly leveraged companies and speculative investors in real estate. and sound overall creditworthiness. Still. low inflation. rather than the banks that lent millions of pesos. SEC officials. decide on the financial future of a troubled debtor. The Central Bank responded by improving the liquidity of the system and by establishing conditions for bringing down interest rates on bank loans. Under the new Securities Regulation Code enacted in 2000. The Central Bank imposed strict limits on real estate lending.Chapter 3: Philippines 219 The financial crisis came when the Philippine economy was in a relatively strong financial position.6. The corporate sector was also in good financial condition with rich internal cash flows accumulated from a number of profitable years. A number of large debtors petitioned SEC for rehabilitation under procedures set by PD 902-A. a strong international reserves position. The crisis caused a tightening of credit to the corporate sector and a spike in interest rates. strong capital position built on IPOs in a buoyant stock market. there were sharp rises in the number of bankruptcies and petitions for debt relief. That is. and a market-oriented policy environment. 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. The corporate sector accessed the foreign debt market only in the mid-1990s because of the country’s long-drawn debt moratorium. There are systemic risks involved in highly concentrated ownership. This law is flawed in concept because it supplants a market-based credit agreement with a political process. For example. As the crisis wore on in 1998. are to be removed and transferred to courts. including suspension of payments. the government budget in surplus. decisions by large sharehold- . adversely affecting companies’ operations and financial position. SEC’s quasijudicial functions. resulting in the banks’ accelerated restructuring of troubled debts in this sector.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. Specific actions recommended are described below.
inadequate disclosures. It has suffi- . insider information. depending on the size of the company. Because independent directors tend to adopt the perspective of minority shareholders in board decisions. 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. This will enable SEC to enforce prudential requirements on management of companies and enable minority shareholders to pursue grievances against their boards. and (iii) increase the minimum required percentage of outstanding shares for public listing in the stock exchange from the present 10-20 percent. SEC should strengthen disclosure requirements by issuing specific guidelines on minimum disclosures required for related party transactions. Another measure would be to impose a statutory limit on the number of directorships that one can accept. the PSE Listing Rules require the appointment of a minimum number of independent directors in the board of publicly listed companies. (ii) require disclosure of material changes in ownership. To help ensure this. 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. 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. Clear legal accountability is a precondition for successful shareholder activism. Vol. The adjustment should be made over a fixed period of time. To strengthen the board. Increasing the Statutory Accountability of Directors and Strengthening the Board System The Government should clarify statutory fiduciary responsibilities of the board of directors. to 25 percent. II ers often cause wide volatility in stock prices and invite reaction from creditors.220 Corporate Governance and Finance in East Asia. they serve to curb the powers of controlling shareholders. and self-dealing. This may limit current practices of appointing prominent individuals and family members as directors.
limit. prudential measures and regulations. Improving Financial Regulation and Strengthening Implementation The Asian crisis demonstrated the need to strengthen banking regulation. 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. (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. (iv) require banks to follow international financial accounting. Finally. (iii) adopt international standards of capital adequacy and ensure that banks comply with these standards. It is encouraging that the newly enacted 2000 Banking Laws have introduced changes along these lines. The Government should improve its prudential supervision system to ensure that banks perform their role as external control agents of their corporate debtors.Chapter 3: Philippines 221 cient case history that can be used as a basis for tightening its disclosure requirements. directors. By requiring sufficient disclosure and a 75 percent majority vote on such decisions. reporting. fit and .g. They need legal empowerment such as higher majority voting requirements.. the Corporation Code should be amended to impose sufficiently stiff penalties for self-dealings that patently expropriate the wealth of other shareholders. or prohibit cross-guarantees by companies belonging to affiliated groups. and disclosure standards. For example. in areas of supervisory functions of the central bank. officers. e. and related interests. raising the current two-thirds majority to a three-fourths majority. the board can easily muster the needed majority to approve the deal. and of banks in nonfinancial companies in order to avoid connected lending. The following recommendations aim to further improve banking regulations and supervision in the Philippines: (i) limit shareholdings of nonfinancial companies in banks. Minority shareholders have failed to use traditional venues such as the annual general shareholders’ meetings to discipline controlling shareholders that expropriate their wealth. Because ownership is generally concentrated in five shareholders. Impose severe penalties for any attempt by banks to circumvent this regulation. and (v) closely monitor. in particular.
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. Presently. institutional investors can be a driving force in providing market discipline to management. If institutional investors are present. 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. and external auditors. By supporting the establishment and operation of institutional investors. institutional investors lead public investors in providing market signals to companies. II proper rule. SEC and PSE can help ensure that these external control agents provide market discipline even in companies controlled by large investors. In developed capital markets. The other is the addition of provisions in the Corporation Code to facilitate class action suits against corporate directors. Its priority is to protect prospective fund investors from unscrupulous fund managers. Two measures should be adopted to promote shareholder activism. Institutional investors impose market discipline by voting on strategic corporate decisions. The current law should expand class action suits to include management and . SEC appears to be taking a primarily regulatory posture in the operation of investment funds. This way. Other investors benefit from the information that analysts produce for these institutional investors as information technology makes their output a public good. Managements find that their investment and financing decisions affect stock prices and become aware of their responsibility to create shareholder value. and lending to DOSRI. an active financial analyst community can begin to form. management. foreign ownership of banks. 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.222 Corporate Governance and Finance in East Asia. The absence of institutional investors indicates that the legal and regulatory basis is inadequate. One is improved transparency and disclosure on specific items that potentially involve expropriation of wealth of minority shareholders. Investment and venture capital funds meet this description. transparency. Vol.
guarantees. leadership. Philippine Government Treasury bonds should provide bellwether rates for corporate bonds in the way that they have for short-term bank debts. and the external auditors. information disclosures. The present provision on class action suits is inadequate because shareholders view the process as ineffective and expensive. Legal provisions for class action suits should cover self-dealing by directors. Companies are likely to remain dependent on bank financing if the authorities do not strictly enforce prudential lending regulations. compensation contracts. 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. It should develop a medium-term yield curve for the corporate debt market by strengthening the Government bond market. These groups have an incentive to gather technical expertise. and broad-based political and popular support to pursue possible cases involving expropriation of minority shareholders’ wealth. their directors and management. the Government could develop the market for future issues of corporate bonds. Promoting the corporate bond market requires that the Government develop trading systems and services of credit risk rating of corporate issuers. where the threat of class action suits alone is sufficient to encourage quality decisions and behavior from management. and dividend decisions. Placing the means for prosecuting in the hands of minority shareholders may instill more discipline in controlling shareholders.Chapter 3: Philippines 223 auditors. Promoting Competition in Product Markets The Government should pursue industrial development policies that promote competition through the elimination of subsidies. Securities market development efforts should coincide with strict regulation of the commercial banking sector. The Government should enhance the securities markets as an alternative source of corporate financing and pursue aggressive development of the local debt securities markets. and Credit Information Bureau that can be the starting point of this effort. 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. entry . And by issuing Government Treasury securities in longer tenors. There are existing institutions such as Dun and Bradsreet. SEC should allow minority shareholders to be represented by activist groups.
Current disclosure requirements of SEC are not rigorous enough for public investors. improve enforcement of the rule of law. Little attention is given to the conditions that make those regulations effective in the US corporate sector but not present in the Philippines. and various other forms of protection. Efforts to reduce graft and corruption. and publicly listed companies trade barely the minimum number of shares required for public listing.and medium-scale companies can become more competitive relative to large companies. SEC should require that a larger percentage of publicly listed companies’ shares be sold to the public. Audited financial statements contain basic information about a company’s financial position and performance. Increasing the Supply of Quality Equities in the Stock Market To promote the capital market as an external control agent in corporate governance. The resulting absence of a strong investor base makes share prices vulnerable to manipulation or insider trading by large shareholders. PSE and SEC need to build a liquid and efficient market. Another problem is the orientation of external auditors to the interest of large shareholders rather than public investors. II and exit barriers. Improving External Audit Standards and Information Disclosure Effective external control in corporate governance requires accurate and timely information about companies. The Government’s competition policies should aim to facilitate the free entry and exit of domestic and foreign companies and regulation of anticompetitive practices. The increase in percentage of public holdings may be gradually implemented to enable the companies to adjust. Vol. Many large companies remain privately owned. and provide quality basic services should also be heightened. Lack of liquidity deters institutional investors. The Government should also continue to improve infrastructure. 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. Penalties for poor conduct of auditing by independent . there is a need to increase the supply of quality securities from top-tier local companies in the Philippine stock market.224 Corporate Governance and Finance in East Asia. so that small. 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.
. Instead. PD 902-A has not accomplished any successful rehabilitation of a petitioning company since its implementation. 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. Reforming the legal framework for suspension of payments. it creates a moral hazard problem. and Liquidation. and transferred these to courts. SEC and PICPA have not publicly penalized any auditor company that violated disclosure requirements or failed to submit audited financial statements.Chapter 3: Philippines 225 auditors and the mechanism for imposing them are weak. review the system of penalties on professionals involved in a company’s violation of disclosure rules. 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. SEC and PICPA need to formulate more specific disclosure standards. Reorganization. including the resolution of intracorporate disputes. The law on suspension of payments replaces a market-oriented solution with a political process. violators were made to pay only nominal penalties. reorganization. In spite of the many well-known cases of poorly audited financial statements that resulted in losses for investors. For that matter. Improving the Legal Framework for Suspension of Payments. suspension of payments and private damage actions. the new law needs to be effectively implemented and enforced. and implement those standards and penalties rigorously.
Dennis Gromb. and Larry H. and Simeon Djankov. 1994. July. Claessens.. October. World Bank. Journal of Financial Economics 25: 371-395. Ownership Structure and Corporate Performance in East Asia. World Bank. David J. Stijn. Large Shareholders. Jr. Private Benefits from Control of Public Corporations. Joseph P. Bangko Sentral ng Pilipinas. 1985. 1999. Simeon Djankov. and Larry H. H. Harold. Claessens. Denis. Diane K. The Separation of Ownership and Control in East Asian Corporations. 1997. Simeon Djankov. Joseph Fan. Alba. Barclay. Lang. Claessens. March. Tokyo: Institute of Developing Economies. and Atulya Sarin. Simeon Djankov. 1999. Simeon Djankov. H. World Bank. II References Abonyi. 1998b. and Larry H. May. H. M. 1998c. Joseph P. and Fausto Panunzi. Demsetz. Lang. Thailand: From Financial Crisis to Economic Renewal. Lang. Claessens. P.226 Corporate Governance and Finance in East Asia. Stijn. George. 1997. 1998. and Larry H. Manila: Asian Development Bank. Monitoring and the Value of the Firm. Equity Ownership. Philippine Macroeconomic Prospects: The Next Ten Years. Emilio. P.. Asian Industrializing Region in 2005. 1999. and Corporate Diversification. Stijn Claessens. Claessens. Quarterly Journal of Economics. Fan. 693-728. Vol. Agency Problems. edited by Toida Mitusuru and Daisuke Hiratsuka. Dennis. Pedro. and Larry H. World Bank. Who Owns and Controls East Asian Corporations? Discussion Paper 2054. P. Asian Development Bank. Michael. P. XXIX. Stijn. Joseph P. 1998a. 1989. The Structure of Corporate Ownership: Causes and Consequences. Lang. Stijn. Fan. Simeon Djankov. Expropriation of Minority Shareholders in East Asia. Working Paper 2088. Journal of Political Economy 93 (6). Working Paper. P. Discussion Paper. Thailand’s Corporate Financing and Governance Structures: Impact on Firms’ Competitiveness. . Conference on Thailand’s Dynamic Economic Recovery and Competitiveness. Burkart. 1988. World Bank. Antonio. Key Indicators of Developing Asian and Pacific Countries 1998. Journal of Finance 2 (1). 1998. and Kenneth Lehn. Institute of Southeast Asian Studies. Stijn. Vol. and Clifford Holderness. Working Paper. Lang. The Philippines: Onward to Recovery. Fan. Diversification and Efficiency of Investment by East Asian Corporations.
International Corporate Governance. and Jeremy C. 1990. Prowse. and the Failure of Internal Control Systems. The Market for Corporate Control: A Scientific Evidence. Michael. Stephen. Lufkin. Michael. and John Moore. Michael. American Economic Review 85: 567-85. 1986. Takeo. Agency Costs and Ownership Structure. Agency Costs of Free Cash Flow. Anil Kashyap. Franco. Stein. Journal of Financial Economics 5: 147-175. Jensen.).Chapter 3: Philippines 227 Diamond. F. November. Prowse. The Modern Industrial Revolution. Quarterly Journal of Economics 106: 33-60. Jensen.. American Economic Review 76: 323-29. and the Theory of Investment. and William Meckling. Capital Structure and the Information Role of Debt. Journal of Finance 45: 321-350. Euromoney Books. 1995.. and David Scharfstein. 1995. Hart. and Merton Miller. Review of Economic Studies 51: 393-414. Scharfstein. Oliver. and Richard Ruback. and David Gallagher (eds. 1990. The Cost of Capital. Myers. Journal of Finance 48: 831-80. Modigliani. 1994 and Investment Guide 1997. Corporate Governance: Emerging Issues and Lessons from East Asia. Journal of Financial Economics 27: 4366. Jensen. Michael. David S. Journal of Financial Economics 11: 5-50. Theory of the Firm: Managerial Behavior. 1983. Institutional Investment Patterns and Corporate Financial Behavior in the United States and Japan. Financial Intermediation and Delegated Monitoring. . 1977. Joseph C. Corporate Finance and Takeovers. 1991. 1990. and Artur Raviv. The Quarterly Journal of Economics. Robert H. World Bank. Corporation Finance. American Economic Review 48 (3): 261297. Philippine Stock Exchange Fact Book 1997. Jensen. 1958. 1994. Corporate Structure. Internal versus External Capital Markets. Stuart. Journal of Financial Economics 3: 305-360. Gestner. Milton. Debt and Seniority: An Analysis of the Role of Hard Claims in Constraining Management. Stephen. 1976. 1984. Harris. Douglas. 1998. 1993. Hoshi. Determinants of Corporate Borrowing. Liquidity and Investment: Evidence from Japanese Industrial Groups. Exit.
1996. II Prowse. World Bank. How Do Large Corporations in Developing Countries Finance their Growth? Corporate Financial Structures in Developing Countries. Vishny. Washington. Jeremy C.228 Corporate Governance and Finance in East Asia. Journal of Finance 91: 1121-1139. Internal Capital Markets and the Competition for Corporate Resources. Journal of Political Economy 94: 461-88. Vol. Shleifer. 1997. Journal of Finance LII. No. Large Shareholders and Corporate Control. Ajit. 1. DC. Shleifer. Journal of Money. Stephen. . 1992. The Structure of Ownership in Japan. Stein. Stiglitz. East Asia: The Road to Recovery. Andrei. David. 1. Asian Development Bank. Joseph E. Webb. 2. November. 1998. 1997. Journal of Finance L11: 737-783. and Robert W. Technical paper No. and Robert W. 1985. Washington. 1991. 1998. Andrei. Some Conceptual Issues in Corporate Governance and Finance. May. A Survey of Corporate Governance. Mimeograph. IFC/WB. and Banking Lecture 17. DC. No. Credit. Credit Markets and the Control of Capital. March. Singh. Vishny.
. the Thai baht came under pressure from speculative attacks. both of ADB. and Lea Sumulong and Graham Dwyer for their editorial assistance. and David Webb of the London School of Economics for their guidance and supervision in conducting the study. the Thai Government conceded and adopted a floating exchange rate regime.” After mounting an aggressive defense of the currency. Thailand. The author wishes to thank Juzhong Zhuang.4 Thailand Piman Limpaphayom1 4. Faculty of Business. the Stock Exchange of Thailand for its help and support in conducting company surveys. had been plagued with prudential problems for a long time. and Philippines all depreciating significantly. magnified the impact of these problems on the economy when the crisis hit. with the currencies of Indonesia. The fixed exchange rate policy. heralding not only a financial crisis in the country. The banking system. The crisis in Thailand stemmed directly from unsound macroeconomic policies and imbalances. Korea). Republic of Korea (henceforth. Malaysia. 1 Associate Professor. poorly regulated and sheltered from competition. coupled with financial liberalization and deregulation in the absence of an effective regulatory and supervisory system.1 Introduction In May to July 1997. It was inefficient in financial intermediation. Asian University of Science and Technology. Thai corporations were collectively overexposed to exchange rate risks. but also the stalling of East Asia’s “economic miracle. Chonburi. Thailand’s crisis exposed similar vulnerabilities in other East Asian economies. the banking system merely validated the financial risks. annual short-term capital inflows to Thailand were equivalent to 7-10 percent of gross domestic product (GDP). But it also laid bare weaknesses in both the financial and corporate sectors. The corporate sector also contributed significantly to the crisis. Instead of serving as a buffer between the large inflow of foreign capital and the corporate sector. short-term private debt obligations grew to about 60 percent of total private sector debts. For the period 1994-1996. with Thai corporations overutilizing short-term foreign currency-denominated loans. David Edwards. As a result. The majority of these debts were not properly hedged. In the prelude to the 1997 crisis.
The National Economic and Social Development Board was created to plan the country’s economic and social development. 4.1 Overview of the Corporate Sector Historical Development The corporate sector has long been considered the engine of Thailand’s economic growth. as well as its legal and regulatory framework.2. Section 4. Section 4. Import tariffs on machinery and heavy equipment were removed.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. Key factors that led to weak corporate governance include the ineffectiveness of the regulatory framework. Section 4. with government policy providing support but avoiding direct interference. its growth and financial performance.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. Vol. To protect domestic industries. the Government increased tariffs on products that could be produced locally. The country initiated national economic development planning in 1961 when the economy was growing rapidly. focusing mainly on the companies listed in the Stock Exchange of Thailand (SET). .2 4.5 discusses how the corporate sector contributed to the financial crisis and looks at its impacts. lack of transparency and adequate disclosure. the Government implemented major infrastructure projects and modified its tax policy to encourage capital investment and savings. and a family-based corporate ownership structure. The study then considers policy recommendations with emphasis on corporate governance improvement. The First and Second Plans (1961-1971) Under the first two plans. This study examines these and other factors that might have weakened corporate sector governance in Thailand. 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. Section 4.
Fourth. averaging 1. canned foods. Industrial sector growth was also rapid and many industries (tires. especially foreign aid from the United States. and Fifth Plans (1972-1986) An economic downturn at the end of the Second Plan led to an adjustment in policies. however. and increases in world food and oil prices. with the devaluation of the baht in 1984 a major step in this direction. the value of the baht remained stable. chemicals. But the sustained importation of heavy machinery and equipment resulted in large trade deficits. At the same time. using tax policy to control prices of consumer goods and implementing several price control measures to curb inflation. an improved trade balance. The Third. textiles.5 percent in 1973 and 24. Budget deficits also increased throughout the Fourth Plan. helped offset these deficits. including a weakening of the dollar. lower than anticipated due to a worldwide economic recession. resulted in increases in the current account deficit. External factors.4 percent of GDP.4 billion from overseas and increased taxes on numerous items. The decline in imports was steady. Inflation reached 15. gross national product grew by about 7 percent per year. Inflation levels were low.15 billion per year or 4. As a result. the current account registered a surplus in 1986. remaining high until 1981. and reduced current account deficits. In the wake of lower world oil prices and the rapid growth in income from the tourism and travel industry. became a major problem as domestic investment declined. including luxury goods. leaving the Government no choice but to resort to overseas borrowings. the industrial sector grew at a faster rate than the agricultural sector. The Government decided to embark on restructuring measures in the Fifth Plan (1982-1986) to rehabilitate the ailing economy. capital inflows.6 percent per year. and automobile assembly) emerged. Budget deficits remained a major problem during the Fifth Plan. The results were increased exports. however. the Government borrowed $6. . it proceeded with its development plan for the industrial sector. The average budget deficit reached an all-time high of $2. However. the government’s debt burden escalated. Average growth for the period was 4 percent per year. processed steel.Chapter 4: Thailand 231 During this period. with the agricultural sector the major contributor. To close the fiscal gap.3 percent in 1974. The Government had to shift emphasis to restoration of economic stability. Consequently. Thus. Unemployment. The focus shifted to export promotion.
while exports expanded considerably. better than the 5. . Growth of exports and imports averaged 14. The exchange rate was steady at around B25 to the dollar. property development. invited a deluge of capital seeking profitable investments.2 percent target. the property sector began to collapse in 1996. Inflation was 4. with private foreign debt reaching $92 billion by the end of 1996. respectively. Growth rates during 1987-1991 ranged from 9. By 1995. On top of its predominantly “borrowed” nature. The manufacturing sector became a dominant force in the economy. Singapore. and the stock market. Thailand’s rapid growth up to the mid-1990s made the country one of the world’s fastest-growing economies.6 percent target of the Seventh Plan. II The Sixth Plan (1987-1991) Industrial sector productivity improved gradually during the Sixth Plan period. and Hong Kong. averaging 10. from only $31 billion in 1992. Vol.5 percent.6 percent. 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 Seventh Plan (1992-1996) The economy’s performance from 1992 to 1996 generally met the targets of the Seventh Plan. lower than the target of 8. The country also attracted a large amount of foreign direct investments (FDIs).8 percent.232 Corporate Governance and Finance in East Asia. China—went to export-oriented manufacturing industries.5 to 13. compounded by a slump in property sales. compared with the 14. From 1989. reaching an annual inflow of $2 billion in 1991.2 percent per year. increasing its share in total export value from 42 to 76 percent. combined with its liberal financial policies. Most of the FDIs—originating mainly from Japan. the Government successfully balanced the budget and even settled its foreign debt of $4 billion before this was due. Thailand became a debtor’s market.7 and 11. an oversupply of housing emerged. rather than to productive activities. Private sector investment grew at an average annual rate of 7 percent. Europe. United States.2 and 13.4 percent targets.8 percent. With loans increasingly becoming expensive and hard to come by due to a lending squeeze by the central bank and high interest rates. the bulk of domestic investments went to speculative ventures such as real estate. Average annual growth in real GDP was 8 percent. compared with the 8. The country’s high ratings in the international capital market.
the corporate sector’s main source of funding was the banks. Robbins. However. which was amended in 1979 and 1985. the Government passed the Public Limited Company Act. In 1978. In his report. 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. Its most crucial role was to help mobilize funds to support Thailand’s industrialization and economic development. In May 1974.2 Development of Capital Markets Although the corporate sector has long been the government’s main tool for economic development. prepared a comprehensive report entitled “A Capital Market in Thailand. the capital markets didn’t play a significant role until 1975. on account of an overvalued baht that weakened export competitiveness. 4. Under the 1962 Commercial Banking Act.8 percent in 1995 to 1. placing all publicly listed companies under regulation. 58 on the Control of Commercial Undertakings Affecting Public Safety and Welfare. its policy had always been to protect domestic banks. A series of increases in customs and excise taxes on luxury imports did little to stem rampant consumer spending. And because the Government considered the banking system vital to the development of the economy. the Government amended the “Announcement of the Executive Council No. Included in the Second Plan (1967-1971) was a proposal to establish the country’s first authorized and regulated securities market.2.” extending its control and regulatory powers to the finance and securities companies operating freely at the time. many companies considered the Act too restrictive and a hindrance to growth. The country had a current account deficit of about 8 percent of GDP in 1995 and 1996. Exports went into a tailspin. a policy that held throughout the first six economic development plans. Sidney M. the signs of an economy about to falter were there.Chapter 4: Thailand 233 Toward the end of the Plan period. the establishment of the Securities Exchange of Thailand (SET) was legislated and trading began on 30 April 1975. a former Chief Economist from the US Securities and Exchange Commission. the Bank of Thailand and . Foreign banks were barred from competing directly with domestic banks. which raised the debt service ratio. Before the capital market emerged. In 1972.” which later became the master plan for the development of the Thai capital market. SET officially became “the Stock Exchange of Thailand” in 1991. In 1969. The deficits caused the Government to rely on even more external borrowing.3 percent in 1996. with growth shrinking from 23.
the financial and banking laws were generally ineffective. Thailand’s capital market entered a new era with improved legislation and regulation. the Government was under international pressure to deregulate the financial sector. The resulting availability of funds propelled the corporate sector’s growth through the early part of the 1990s. Thailand discarded controls on foreign exchange transactions and capital flows—a turning point for the Thai corporate sector. However.234 Corporate Governance and Finance in East Asia. Laws were enacted to stimulate growth of the corporate sector. and new financial instruments. Economic growth had been rapid and domestic savings could not keep up with the pace to support investments. while the Securities and Exchange Act (SEA) the same year sought to improve capital market supervision. the World Bank had recommended such a move. Earlier. The Public Company Act of 1992 relaxed some of the rules and restrictions contained in the original laws. II the Ministry of Finance had full authority to supervise all commercial banks. At the end of the Sixth Plan. Externally. it usually relied on “moral suasion. and the General Agreement on Tariffs and Trade (GATT) meeting in Uruguay had the liberalization of financial services on its agenda. In the 1990s.” The Government also granted financial institutions overly generous bailouts. creating a moral hazard problem—the perverse expectation that imprudent bank behavior would be rewarded with forbearance and bailout. A number of internal and external factors contributed to the Thai Government’s acceptance of the IMF’s Article VIII agreement. The banks and finance companies operated at insufficient levels of reserve capital and were overexposed in high-risk businesses such as real estate. 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. With the liberalization of financial markets. to cater specifically to its . The regulatory measures were inadequately designed and poorly enforced. there were 29 commercial banks (15 domestic and 14 foreign banks) in Thailand. increased financial market activities. Thai banks gained access to a variety of funding sources from around the world. The pressure dovetailed with the Government’s intention to make Bangkok one of the financial centers of the region. Vol. While the Bank of Thailand had the regulatory power to influence business practices. Financial deregulation and liberalization allowed the country to attract foreign savings and investments that helped finance the growth of the economy.
and Water Construction Wholesale and Retail Trade. Forestry.0 19. the financial sector is the largest. The result was a corresponding growth and development in Thailand’s capital markets. the country became recognized as an economic development model for other emerging economies. 4. Source: Department of Commercial Registration.1 30. Thailand.9 261. Gas.6 23. Real Estate.101. Insurance.5 111.5 50.6 350.0 Paid-up Capital (B billion) 1. Social and Personal Service Total Note: The data for 2000 is as of October 2000. Hunting.0 110.9 16. Storage.1). about 661 companies with total registered capital of B2. Ministry of Commerce.3 83. and Communication Financing. The manufacturing sector is a far second with registered capital of B350 billion and paid-up capital of Table 4.394.3 Growth and Financial Performance Since the 1978 enactment of the Public Limited Company Act.1 78.1 Public Companies Registered. .2 Type of Business Agriculture.2 11. Financial deregulation and liberalization were key to realizing that vision. In terms of capital. The stock market boom from 1991 until the financial crash of 1997 reflected international investors’ response to Government policies.3 trillion have been registered with the authority (Table 4.4 trillion in registered capital and B791 billion in paid-up capital. and Fishing Mining and Quarrying Manufacturing Electricity. 1978-2000 Number Registered of Capital Companies (B billion) 5 6 245 5 13 129 22 194 42 661 1. and Business Service Community. in that order.9 1. however. and wholesale/ retail trade and restaurant/hotel sectors. with B1.291. and Restaurants and Hotel Transport.1 trillion and paid-up capital of B1.0 21. Worldwide. finance. 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.5 791.2.6 2.Chapter 4: Thailand 235 fast-growing neighbors.9 34.6 1. The majority of the companies are in manufacturing.
9 31.1 — — — 6. Table 4.4 96. reached .1 54.5 billion and B1 billion the previous year.1 2.2). allowed Thai financial institutions and corporations to obtain funds overseas. Debt market activities also increased significantly with the establishment of the Bond Dealers’ Club (BDC) in 1994. The preeminence of the financial sector is a direct result of financial deregulation and liberalization.5 1.2 Public Offerings of Securities.7 7.6 — = not available. Vol. the capital market became instrumental in the rapid growth and development of the corporate sector.8 1995 64.2 5.3 6. reaching a precrisis peak in 1996 (Table 4.2 12.3 22.1 599. from only B20.7 136. respectively.2 25. With the enactment of the SEA of 1992 that brought suppliers of finance services and their clients together. After the passage of the SEA of 1992.5 — — 56.8 151.3 194. the year before the crisis struck.6 8.4 51.3 1996 1997 65.7 27. II B261 billion. reducing the value of offerings to a little more than a quarter of the previous year’s level.7 9.6 39.7 billion and B27. Securities and Exchange Commission of Thailand.9 37.9 1998 1999 15.7 5. the value of public offerings rose steadily. The signing of Article VIII with the IMF. this was due to the recapitalization of commercial banks in compliance with the new loan provisioning requirement.2 40.8 — 26.5 39.6 7. moreover. The number of listed companies and securities steadily increased until 1996 (Table 4.0 1994 82. The development of the corporate sector closely followed the development of capital markets. Domestic and offshore debt issues reached B54.0 20.0 0. meanwhile.4 34.4 277. Market capitalization.7 billion in 1996. The 1997 crisis battered the primary market for securities.8 201. While a rebound was apparent beginning in 1998. These peaked at B89. 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.5 1.236 Corporate Governance and Finance in East Asia.3 31.8 billion.1 286. Source: Key Capital Market Statistics.3).6 174.
in the end. was the ominous deterioration in the key financial ratios of publicly listed companies.281 832 373 356 482 Due to listing requirements and other reasons.325 3.3 Statistical Highlights of the Stock Exchange of Thailand. Corporate profitability.193 2. Foreigners accounted for an increasing proportion of SET’s turnover value. return on equity (ROE).610 1.133 1. however.303 930 855 1. and gross profit margin. Side by side with this surge of financing for corporate growth. But instead of shifting to a low gear. The key financial ratios of all companies listed on SET bear this out (Table 4.5 at its peak in 1987. pulled down by active public offering activities.Chapter 4: Thailand 237 Table 4.560 1.268 2.683 1. when long-term debt grew as Thai corporations began to borrow heavily to finance growth.3 percent in 1989 to 3. Throughout the 1990s. From 10. Meanwhile. By the early 1990s. as measured by return on assets (ROA). ROA dipped from 10.6 trillion. gross profit margin rose until 1991 before falling in 1992. the averages for all three profitability ratios took a downswing all the way until 1996. ROE similarly fell from 21. not all public companies are listed on the SET. The financial leverage of all companies declined until 1994. While the decline in gross profit margin was not as sharp. The upward trends for ROE and ROA continued through 1989.565 2.8 percent.4 percent to 5. resulting in their inability to fulfill debt obligations. however. 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. corporate profitability had been declining. their share rising from 17 percent in 1993 to 43 percent in 1997.4). the highly liquid financial system continued offering cheap funds to sustain corporate sector investments.301 3.4 percent in 1996. the average times interest earned (TIE) was down to 5.1 by 1996.360 1. The trend reversed in 1995. The plunge in profitability and asset turnover—from 117 percent in 1985 to 65 percent in 1996 for the latter—cast doubts on the . its high point in 1995 at B3. had been on the rise throughout the 1980s.114 1. then stalled in 1990. the companies could not generate enough net returns from their assets and equity.535 1.201 2. Source: Securities and Exchange Commission of Thailand.
8 54. They were generally more efficient in managing their assets and .9 39. was felt across industries.9 140.3 12.6 138. practice of heavy borrowing.2 215.7 LongTerm Debt to Asset Assets Turnover (%) (%) 14.5 30.9 14.4 5.8 25. The downtrend in corporate profitability.0 145.9 7.8 51.4 139. It has also been argued that family-based controlling shareholders borrowed excessively to avoid diluting their control over their corporations.7 21.4 7. Vol.7 12.6 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.3 8.0 3. which fell from 16 percent in 1991 to just under 6 percent in 1996.7 12.7 27.5 50.2 10.7 15. Thailand’s ROE.6 7.7 4.5).2 27.7 5.1 114.238 Corporate Governance and Finance in East Asia.1 52.9 27.4 51.5 63.4 12. Overall. 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 (%) (%) (%) 3.9 51. II Table 4.5 9.4 26.8 5. US.5 52.8 88.7 20. Among the crisis-hit countries.8 8.7 27.0 139.4 12. Hotels and travel showed the highest ROE of 15 percent while textiles.9 77. and footwear had the lowest at 11 percent.6 36.1 242. the textiles.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 4.1 9.6 168. clothing.4 3.4 Key Financial Ratios of Publicly Listed Companies.8 5.7 5.9 144. was also distinct in the region.7 54. Korea and Thailand had the highest debt-to-equity ratios.5 51.6 41.0 63.1 120. resulting in higher collateral values for borrowers.6 12.2 10.4 24.4 119.5 15. but was most severe in building and furnishing material industries as a result of the downturn in the real estate market.3 10.7 80.4 44.2 10.0 7.6 27.7 35. clothing.9 7.2 49.7 12.2 35. Severely affected by global competition throughout the decade.4 4.0 117.4 47.4 7.5 38.0 29.1 16.1 44.7 59. Despite the availability of the equity market. which was particularly significant in the two years preceding the crisis.8 11.3 91.2 64.6 125.2 6.1 60.7 34.2 27. A major reason for this was the rapid rise in asset prices.1 16.3 4.9 8. and footwear industries also experienced losses.4 34. these companies opted for debt.4 18.4 9.9 66.7 5.4 28.2 161.8 14.0 125.7 12.
US.4 52.0 20.3 176. which would be disruptive to company management. total asset turnover declined after 1989.6 6.8 6.2 134. could lead to a high turnover in the board.1 25.6 30.6 5. also deteriorated.8 62.7 10. by the 1990s. Cumulative voting. the overall activities of listed companies.6 31.4 Legal and Regulatory Framework Before 1992.3 43. During the 1990s. Although stable in the 1980s. it was thought.6 10.Chapter 4: Thailand 239 Table 4.1 13. The argument was that having a Board of Directors whose members represented different groups of investors would create conflicts and hamper management effectiveness.5 94.6 61. Increasingly heavy borrowings rendered the sector even more vulnerable to lower profitability and sales.7 14.5 6.6 7.2 10. weaknesses became evident. 4. capital despite the higher gross margins of small companies.9 13.0 83. measured by total asset turnover.4 116.1 Small Medium Large 5.8 6.5 7. some rules and regulations of this particular law were believed to be too restrictive and were discouraging companies from going public. However.6 30.3 23.2 12.3 135. the Public Limited Company Act of 1978 and its amendments regulated Thai publicly listed companies.3 25.1 6. There were also concerns that the provisions governing the criminal prosecution and penalties of directors and management were harsh and inappropriate.2 121.0 48. In sum.3 52.4 8.5 87.3 164. They also tended to use more financial leverage than small companies as their total DERs show.7 Source: Pacific-Basin Capital Markets Database compiled by the University of Rhode Island.1 29.9 20.8 142.3 49.7 6.3 49.8 26.3 15. 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 6.2.3 88. the law disallowed cumulative voting. .2 18.6 12.8 10.8 47.1 5. although the performance of listed companies in the late 1980s was strong. For instance.5 Average Key Financial Ratios by Company Size.
that creditors had generally little influence on the management of corporations. and external monitoring and control of corporations were also weak. 4. Fortysix companies responded. The original company owners welcomed the changes and the number of publicly listed companies subsequently rose to more than 600. played an important role in bringing about the financial crisis. The law prohibited the largest shareholders. the exit of these provisions appears to have contributed to the 1997 financial crisis. as a group. but not all questions were answered. . As it turned out. Cumulative voting was made optional.5. adopted to promote the development of publicly listed companies. from holding more than 50 percent of total outstanding shares and other shareholders from holding more than 10 percent of outstanding shares individually.3 Corporate Ownership and Control Ownership and control of corporations in Thailand are highly concentrated.2 The market for corporate control was not active and did not give managers strong incentives to perform efficiently. coupled with weak corporate governance. The provision discouraged original family owners from registering their companies. As the succeeding sections point out. and the punishment for management misconduct was also lightened considerably. The protection of minority shareholders was inadequate under the Public Company Act of 1992. relaxed the contentious provisions of the 1978 Public Limited Company Act. the new legislation removed a number of incentives that would have kept public companies prudent and diligent in their operations. An Asian Development Bank (ADB) survey conducted for this study shows. a feature that is believed to have impaired the effectiveness of existing regulatory mechanisms in the corporate sector. 2 ADB survey questionnaires were sent to all Thai listed companies in early 1999. The Public Company Act of 1992. concentrated ownership. for instance. This will be discussed in Section 4.240 Corporate Governance and Finance in East Asia. However. Vol. II Another issue was the proportion of shareholding by top shareholders. the limit on shareholdings by the largest shareholders was increased from 50 to 70 percent of total outstanding shares. The legal and regulatory framework for the corporate sector also includes provisions related to insolvency.
1 3. Indonesian.0 53.China have the least concentrated ownership.9 3. the top five shareholders of each of publicly listed Thai companies held.2 56.8 32.8 11.1 7. Ownership was most concentrated in the packaging.9 52.4 26.1 11.9 3.9 11.6 Top-Five Ownership Concentration of Publicly Listed Companies in Thailand.6 68.5 9. Thai. This implies that the top five shareholders enjoyed full control over the outcomes of shareholder meetings. one would expect the public.7 6.3 16. respectively.0 56.2 4. there were only slight variations in the pattern. this was not the case. with the largest shareholder on average controlling 10.0 7. . Across industries.3 7.3 percent.7 12.9 54.0 7.4 percent of outstanding shares.6 57. China firms have the highest single shareholder ownership concentration at 35.4 6. Table 4.1 5. Ownership Concentration Between 1990 and 1998.9 4.6 27.4 26.7 percent. Most large Thai corporations listed on SET started out as family businesses.1 12. on average. Source: Comprehensive Listed Company Information Database. Unfortunately.4 5.1 4.1 5. and 28.0 5.5 28.9 55.0 3.Chapter 4: Thailand 241 4.3 11. 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. In contrast.2 11.3 percent and 18. Stock Exchange of Thailand.2 4.3 7.1 5. creditors. But with their increased reliance on new varieties of equity and debt instruments.6 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. and minority shareholders to stake their claim in the control and regulation of these companies.9 52.9 26.0 3.1 Patterns of Corporate Ownership A World Bank study covering nine Asian countries finds that firms in Japan and Taipei. these companies obtained funding solely from banks or from their own retained earnings. 33. In the past.9 52.8 5.4 10.7 7.7 11.6).5 Average for 1990-1998 period.3.4 26.9 percent of shares of a company. and Hong Kong. with the top three shareholders accounting for almost 50 percent (Table 4.1 percent of control rights.6 28.9 6.4 4.2 4.4 6. 56.3 5.3 28.
7 percent of outstanding shares on average (Table 4. and building and furnishing industries. Leverage. and Company Size Item Intercept Top Five Ownership Concentration Company Size Adjusted R-Squared F-Statistic ROA 0. results show a significant positive relationship between ownership concentration and financial leverage. as measured by debt-to-equity and debt-to-asset ratios. Source: Author’s estimation based on the Pacific-Basin Capital Markets Database compiled by the University of Rhode Island. Company size is significantly related to ROE and leverage. Based on a regression analysis.005** 0. founding families maintain effective control of entire groups. including those that are publicly listed . owning 26.647 Note: The regression included dummy variables for industry.116) Debt-to-Equity (1.001) 0. * Denotes significance at the 10 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. Composition of Controlling Shareholders Affiliated corporations comprise the largest group among the top five shareholders of publicly listed companies.080 6.7 Statistical Relationships between Corporate Profitability. and ownership types.034*** 0.090 0.7).058* ROE (0.022*** 0. On the other hand. Other industries had their top five shareholders controlling at least 55 percent of outstanding shares.037 0. ** at the 5 percent level. US. 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. Vol. with a top-five ownership concentration of at least 60 percent. year. Ownership Concentration.115 9. Table 4.003 0. Through these holding companies.242 Corporate Governance and Finance in East Asia.800 0. *** at the 1 percent level. II agribusiness.072) (0. It is the practice of Thai corporate founding families to set up holding companies to own shares in affiliated companies or subsidiaries.8).169*** 0.031 3.001 0.029 3.001*** 0.533)*** Debt-to-Assets (0.
Stock Exchange of Thailand.2 18. This practice is illustrated by Central Pattana.6 25. The ADB survey indicated that listed companies held shares in an average of 11 companies.2 5.9 0.7 1.5 1. These individuals usually hold important management positions in concerned companies.4 1.5 0.8 1. Although holding companies set up affiliate firms.9 18.3 1.8 23. a company listed in the real estate sector of SET.0 3. owned by the Chirathivat family.3 1. a joint venture among three families. averaging about 18.0 19.0 17.9 19. The largest shareholder is Central Holdings Company.6 1. unlike in Japan where crossshareholding is common.4 1.4 22. the company. The top 10 shareholders include a holding company owned by the Tejapaibul family.9 7. the company increased its registered capital and became a public company listed in SET.3 27. Typically.2 7. individual members of the Chirathivat family aggregately hold 25.5 Individuals 13. including finance and investment companies.1 1.5 1.1 1. one of the founding members.7 5. in SET. In addition.5 0.5 26.6 1.1 4. 1990-1998 Year 1990 1991 1992 1993 1994 1995 1996 1997 1998 Average Company 28.8 Top-Five Shareholder Composition of Publicly Listed Companies in Thailand.2 1.3 1.5 percent. founding families and their relatives maintain control of many companies by jointly holding on to the most significant chunk of shares.3 27.6 1.3 percent of outstanding shares.2 1. with 29.0 18. Individual family members also hold a significant amount of outstanding shares.8 0. The roster of its major shareholders as of December 1997 illustrates the typical ownership concentration of a publicly listed company in Thailand.4 1. operates five of the most successful shopping malls in Thailand.5 0.5 NBFIsa 6.3 27.3 — = not available. Established in 1980 with a registered capital of B300 million.9 15.3 0. In 1994. Source: Comprehensive Listed Company Information Database.8 28.5 2. the affiliate firms rarely hold shares of their parent companies.1 0.5 5.4 20.3 20.Chapter 4: Thailand 243 Table 4. a NBFIs denotes nonbank financial institutions.7 Bank 2.9 6.5 Government Other 0. .7 0.6 5.6 percent of outstanding shares.6 28.7 — 1.
and a state bank. both conducted in 1999. Vol. Moreover. has the Ministry of Finance as its only large shareholder with 92. Except in the hotel and travel service sector. In such cases. 4. commercial banks account for only 1. the Government owns the majority of the shares. the predominance of individual family members and holding companies in the top shareholder list remains valid. qualification. these shareholders are able to control the company.. On average. only one tenth of listed companies have commercial banks on their top-five shareholder list. holdings by individual family members and holding companies account for at least 50 percent of outstanding shares of an average listed company. However.1 percent of total outstanding shares of listed companies. Thai Airways International Plc. with the envisioned privatization master plan. and responsibilities of directors of public companies. the Government’s role in public companies is expected to decline. Only a handful of companies have the Government among their large shareholders.3. the Petroleum Authority of Thailand. For example. Together. There was a trend of rising government shareholdings throughout the period 1990 to 1998. 1. II another of the company’s founding members. on average.5 percent of total outstanding shares of listed companies. Nonbank financial institutions hold an aggregate 5. 3 Discussions in this section are based on results of company surveys by SET and ADB. where the top three shareholders are the Ministry of Finance. roles. By owning 62 percent of voting shares. duties. . the top 10 shareholders consist predominantly of members of founding families and their holding companies.5 percent of total outstanding shares.2 Corporate Management and Control3 Board of Directors The Public Company Act of 1992 stipulates the appointment process. In effect. they account for 80 percent of total outstanding shares. About half of listed companies have nonbank financial institutions such as finance and investment companies in their top-five shareholder list.244 Corporate Governance and Finance in East Asia.9 percent of outstanding shares. Although the list of top shareholders of publicly listed companies includes financial institutions. The Government holds. they exercise limited influence in operations because of the restricted size of their shareholdings. Another example is Bangchak Petroleum Plc. Across industries.
an executive board consists of senior management and some main board members. If found in violation of these provisions. In five other companies. the majority (71 percent) had board chairs who were also members of top management teams. Generally. Unless stipulated in public companies’ articles of association. selection was based on relationships with controlling shareholders. Some companies (36 percent) had five to six main board members holding seats in their executive boards. that only in two of the 46 responding companies were the chair of the boards elected based on the extent of their shareholdings.Chapter 4: Thailand 245 Directors are required to meet minimum qualifications specified under the SEA of 1992 and the Listing Rules issued by SET. Meanwhile. Almost all companies (98 percent) exceeded the minimum required five members in their Board of Directors. Many companies have a formal policy on corporate governance and business ethics. directors could be compelled to compensate the company for damages arising from their misconduct. Although 28 percent of the chairpersons came from the ranks of independent outside directors. directors shall be elected at the annual general shareholders’ meetings (AGSMs). A survey by SET found that the majority (58 percent) of the 202 responding companies held their board meetings every quarter. Three companies indicated that the CEO and the chair were close relatives. while 30 percent of respondent companies held board meetings monthly. In their business conduct. Most companies (83 percent) satisfied SET’s requirement of having two independent board members. the ADB survey found that 31 companies (out of 46 responding) required outside directors to be present at all board meetings. The appointment of the chief executive officer (CEO) needed approval during the AGSM in 11 of the responding companies. The ADB survey indicated. directors may be imprisoned or fined. Nineteen companies stated that selection was based on professional qualifications. and to comply with the laws and articles of association. 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. . while 15 percent of respondents went beyond the requirement. In addition. but not in 22 others. meanwhile.
while 19 companies observed only some of them. II Compensation of Directors. 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. Chair. the work of this committee was often considered part of the executive board’s responsibilities. the auditor is not . Audit Committees and Accounting Standards Since January 1999. Half of the companies in the SET survey had a separate remuneration committee. Also. Three companies allowed their management to determine the chair’s compensation package. The ADB survey indicated that 18 of the 46 responding companies compensated their chairpersons using a fixed-fee schedule. these were attributed to variations in the extent of duties and responsibilities assumed by those directors. In one company. with 41 firms admitting the use of services of international auditing firms. Companies already with audit committees did not have independent outside directors as audit committee members. all listed companies have been instructed to establish audit committees to be responsible for examining the quality and reliability of company financial statements. the majority of the companies (77 percent) did not have outside directors as members of their remuneration committees.246 Corporate Governance and Finance in East Asia. Twenty-five of the 46 respondents to the ADB survey declared adherence to all relevant international standards. however. However. All respondents confirmed the use of external auditors. These committees were mainly responsible for determining compensation for senior and regular staff. 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. Where different. the remuneration packages had to be approved during AGSMs. not an independent assignment. and CEO The majority of company respondents to the SET survey provided similar compensation packages to internal and external directors. Vol. Fourteen other companies had profit-related incentive schemes in addition to fixed fees. In 25 companies. The SET survey found that the majority of listed companies (81 percent) still have no separate audit committee. Directors with managerial responsibility or those related to major shareholders cannot be members of such audit committees.
SET. SEC. Relationships between firms and external auditors are generally long-term. In the majority of these companies (38 out of 46 respondents). averaging about 14 years. (iv) The roles and responsibilities of the major government agencies regulating shareholder rights—the Ministry of Commerce. remuneration. As a result. For instance. At least 28 responding companies had the following . Minority Shareholders and their Rights Many different rights and entitlements of shareholders are laid out in the Public Company Act of 1992. However. the corporate sector lacks a strong self-regulatory body to compel compliance with these standards. The Act. (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. as well as the registration and holding of shares. likewise. According to the ADB survey. most responding companies have rules and regulations intended to protect shareholders. and the Bank of Thailand— are not clearly defined. (iii) Because the chair is frequently also part of the top management team. shareholders have access to reliable information at no cost. with 13 companies allowing proxy voting through mail. or other financial instruments. SET’s rules and regulations closely follow this Act. The Act also holds directors liable for any damage to shareholders. the institutional machinery is not fully responsive to complaints about violation of shareholder rights. While safeguards are in place. (i) No standards are enforced in the content and timing of notices for shareholder meetings. and executive committees. Proxy solicitation tends to be abused to the extent that shareholders are inadequately informed about matters to be taken up in shareholder assemblies. including false statements to conceal information about the financial condition and operations of the company during the sale of shares. shareholders can claim compensation in cases of negligence or dishonesty by management. the Securities and Exchange Commission (SEC) and SET were actively prosecuting violating firms. stipulates the proper conduct of shareholder meetings. The majority of the companies (85 percent) require the appointment of external auditors during annual general meetings.Chapter 4: Thailand 247 independent from the company. Shareholders are also entitled to call emergency meetings and present proposals at AGSMs. there are also significant gaps in the system of shareholder protection. although recently. there is the danger that top management may be capable of unduly influencing the board’s decisions. debentures. Forty-four companies indicated that they had proxy voting in place.
The difficulty minority shareholders have in exercising their rights can be seen from the ADB survey results. minority shareholders are assured adequate legal protection. representing only about 28 percent of shareholdings. on average. In theory. and call an extraordinary session. however. 66 percent of total outstanding shares. it would be difficult for minority shareholders to gather the shares needed to take action. On paper. did not vote in previous AGSMs. II mechanisms in place: mandatory shareholder approval of major transactions and interested or related party transactions. Although the attendees held.3. Almost 82 percent of shareholders. they comprised only 8 percent of total shareholders. the new Public Company Act of 1992 inadvertently weakened the governance of public companies by diminishing minority shareholder rights. But with the ownership concentration of Thai companies. The ADB survey results reveal that the proposals presented by management were rarely rejected during the general meetings. While stimulating the growth of the sector. and insider trading. and mandatory disclosure of related interests and significant shareholders’ transactions. . takeover of the company. the only group of shareholders that can exercise rights is the top five shareholders. given their importance in providing finance and their stake in companies.248 Corporate Governance and Finance in East Asia. such protection has been insufficient. Vol. 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. But the exercise of these rights requires even higher shareholding levels. Banks would be obvious candidates to implement these mechanisms.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. 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. Only a small number of shareholders attended the latest AGSMs. minority shareholders may also appoint an outside inspector to examine the company’s operations and financial condition. The SEA of 1992 and the listing rules also contain provisions for the protection of shareholders against transfer pricing. In practice. 4. In effect.
. Actual bankruptcy proceedings took more than five years on average. Eleven companies stated that creditors usually exercised whatever influence they had on management through covenants regarding the use of loans. the majority believed that creditors had little influence on company management and decision making. including procedural disputes. Leverage allows the assets and operations of the company to grow without diluting corporate control. For 20 of the 46 responding companies. while 18 said none of their creditors required collateral. There were many options. Only three companies thought otherwise. other than losing control. to solve debt repayment problems. they resort to borrowing. Normally. The old bankruptcy law in Thailand also made it difficult for creditors to obtain payment against bankrupt borrowers. Among 16 companies in the ADB survey whose loan applications in the last three years were rejected. The impact of the financial crisis on credit eligibility and supervision requirements has been significant. Apparently. such as that seen in Thailand before the crisis.Chapter 4: Thailand 249 Historically. Thailand has relied on commercial banks and finance companies to channel funds to private enterprises. as the ADB survey confirmed. which could cause a delay by at least a year. The presence of collateral usually diminishes banks’ incentives for screening project feasibility and monitoring project implementation. a company’s reputation and its long-term relationship with creditors sufficed in many instances. However. when insiders want to expand their company’s operations without losing control. Only 28 of the responding companies in the ADB survey indicated that their creditors required such feasibility studies. 17 indicated that only some of their creditors had such a requirement. Under a weak bankruptcy system. Most companies reported that banks were more likely to require collateral. Seven of the companies responding to the ADB survey indicated that all their creditors required collateral. borrowers seldom lose control to creditors even when they default and become insolvent. creditors’ collateral requirements were tightened after the crisis. while loans for fixed investment were also more likely to be supported by collateral. however. Debtors had many handles to stall the bankruptcy process. Fifteen of the 20 companies that had to renegotiate loan repayment with creditors in the last five years did so after the crisis. creditors do not always require project feasibility studies or business plans in granting loans. In the end. 11 experienced rejection after the crisis started. One tempering mechanism that could inhibit the excessive use of borrowing is the threat of losing control in the event of bankruptcy.
of shareholders: (i) all shareholders must receive tender offers. and failed to provide managers with strong incentives to perform efficiently. with a total tender offer value of B42. SEC has no authority to either approve or reject tender offers. The Market for Corporate Control The SEA of 1992 was the first legislation that stipulated rules and regulations regarding the market for corporate control. 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. SEC was later made responsible for regulating corporate takeovers. and (iii) tender offers will be effective 30 days after the report has been filed with the SEC. There are detailed requirements regarding such notification.9). however. the minimum tender offer was reduced to 10 percent and some procedural modifications have also been introduced. In 1996. Such efforts would serve to strengthen external discipline on controlling owners. there are two categories of merger and acquisition activities with associated regulatory measures. The market for corporate control has not been active in Thailand. The second category is the tender offer. According to the SEA of 1992. Although merger and acquisi- . a person who acquires more than 5 percent of issued shares must file a report with SEC one day after the date of acquisition.3 billion (Table 4. if the purchase of shares implies a change in the directors or business activities. whether directly or indirectly. there were only six tender offers. only a limited number of successful mergers of public companies have taken place. which is a general offer made to shareholders of a company to acquire at least 25 percent of outstanding shares. its main role is to ensure transparency and fairness. In this case.3 billion. II The financial crisis has presented a unique opportunity for reinventing the framework for corporate bankruptcy and for creating regulatory and judicial precedents. Since the introduction of the Public Limited Company Act of 1978. before the extent to which the bankruptcy framework has been strengthened becomes clear. Recently. with a significantly lower total tender offer value of B8. (ii) an advertisement regarding the tender offer must be placed in major newspapers for at least three consecutive days. In 1994 and 1995. The first category is the acquisition of shares in the open market. there were 41 cases of tender offers. It will take years.250 Corporate Governance and Finance in East Asia. The company has 21 days to evaluate the tender offer and submit a report to SEC and all shareholders. Vol. The situation remained sluggish in 1997 at nine tender offers and a further decline in total offered value.
tion activities increased after 1997. Because of the current crisis.9 Merger and Acquisition Activities. not with a view to becoming involved in actual management. trading by mutual funds in SET represented less than 10 percent of total trading. Pension funds are perhaps even weaker in Thailand.8 81.0 B billion 4. Employee Participation in Corporate Governance There has been little.6 17.0 55.1 75. employees are even less willing to accept common shares as a form of compensation or benefit.3 6. Eleven of the 46 responding companies in the ADB survey offer ESOPs. . Source: Securities and Exchange Commission of Thailand. The number of domestic institutional investors rose after the mutual fund industry was established in 1991.8 8 27 14 6 9 13 23 Tender offer value refers to the minimum offer value.4 23. it remains small.2 8. While the Thai mutual fund industry compares well to those in other developing countries in the region.2 6. but the average shareholding is smaller than 1 percent of total outstanding shares. Since 1994. most of these were forced mergers or related to rescue packages.2 7.9 3. but employees have never been represented in the board of directors since their shareholdings are minimal.7 11.1 84. they have mostly been concerned with short-term gains. 1993-1999 Year 1993 1994 1995 1996 1997 1998 1999 a Tender Offer Valuea (B billion) 5. Even when companies offer ESOPs. Twenty-nine firms indicated that employees held shares of their companies.7 Purchase Value Number of % of Tender Offer Value Companies 84. employee participation in corporate governance in Thailand.2 6.1 58.Chapter 4: Thailand 251 Table 4.3 60.1 19. Few companies offer employee stock option plans (ESOPs). employees regard the plans as monetary incentives.3 11. if any.5 6. But instead of opting for an active role in the market for corporate control. Provident funds for government workers and workers in public enterprises have been established only recently.
906.669. Thai Bond Dealing Centre.3 546. Competition from foreign banks was limited as they were not allowed to engage in full branch operations.5 Outstanding Loans from Commercial Banks 2.0 3.1 Domestic Debt Securities Outstanding 215.360. Table 4.0 8. the next four largest banks accounted for 63 percent.825..559.5 trillion.912. .325.8 3.663.119.372. The country’s largest bank.4 1. and Bank of Thailand.775.4 3.10) shows that Thailand is a highly bank-dependent economy. 15 of which were domestic banks.1 3.3 5.4 Year 1992 1993 1994 1995 1996 1997 1998 1999 Source: Stock Exchange of Thailand.5 4.161.4 4.2 262.268. total assets of commercial banks amounted to B5.6 1.5 6.10 Size and Composition of the Thai Financial Sector.0 424.4 519.230. II 4.3 1. 1992-1999 (B billion) Outstanding Loans from All Financial Institutions 2. there were 29 commercial banks.430.1 3. Bangkok Bank Ltd.485.6 2. the banking sector was highly concentrated.2 2.1 6. Vol. In 1996.979. although its role increased in the wake of the crisis.171. The Banking System Until recently.037.5 4.564.1 5.133.6 6.0 339.9 2. accounted for 28 percent of the banking sector’s total assets. Many large commercial banks had affiliates among the 93 finance companies that served the high-risk market.477. The bond market played only a marginal role in corporate financing.4.390.4 4.5 5.1 Corporate Financing Overview of the Financial Sector A breakdown of the Thai financial sector for the period 1992-1999 (Table 4.252 Corporate Governance and Finance in East Asia. The share of domestic banks in the banking system’s total assets was 80 percent.300.193.1 7. The total values of loans from financial institutions and commercial banks were consistently larger than the market capitalization of SET.0 SET Market Capitalization 1.8 941.
Many company founders did not want to release even a small portion of corporate ownership and refused to go public. Turnover value reached B2. and 20 new foreign banks. Stock prices tripled in the next three years until the market experienced its first crash as a result of the Gulf Crisis in 1990. and almost all capital account transactions were deregulated. the stock market entered its first boom period in 1986. In contrast. owning 70 percent of the country’s second largest bank. Through the years. 12 existing foreign banks. hardly any progress was made in lowering the cost of domestic financial intermediation or in developing new financial instruments for corporations. self-regulatory organization under the . SET immediately recovered due to the strength of the Thai economy. BSDC is a nonprofit. due to their close ties. the liberalization of interest rates and capital account transactions stimulated a credit expansion through short-term borrowings in foreign currency. The Government removed controls on capital and dividend repatriation in 1991. SET is organized into 32 major industries. also made it unattractive to raise capital from the equity market. the Government established the BIBF to expand the banking sector and reduce the borrowing costs of Thai companies. BIBF banks also enjoyed tax incentives on their operations and profits. Banks under the BIBF scheme were allowed to mobilize funds from abroad and lend to Thai companies in foreign currency. Licenses were granted to 15 Thai banks. In 1993. was set up by 74 members with an initial capital of B500 million. an over-the-counter market. The lack of supply of quality shares was a big problem for SET at that time. Some 347 companies were listed in the same year with a total market capitalization of B3.Chapter 4: Thailand 253 The Government was also a major figure in the banking system. the market rose steadily and reached a record high in the fourth quarter of 1993. Benefiting from rapid economic and industrial growth. Banking activity peaked in the mid-1990s. finance. The Equity Market During the first few years of its operations. In the following years. banking. reaching 355. SET was not very active. Because borrowers carried the exchange rate risk.2 trillion. Easy access to commercial bank loans by family business groups. The number of listed companies also quadrupled between 1981 and 1993.3 trillion.8 in 1998. In 1995. and property have accounted for the bulk of trading volumes. the Bangkok Stock Dealing Center (BSDC). the SET index declined. Despite the worldwide market crash in 1987. After that.
turnover value was negligible and the BSDC Index remained flat throughout 19961998. A company wishing to qualify for listing in SET must file an information booklet (prospectus) with SEC and SET. In July 1990. After initial public offerings. and (ii) a minimum of 300 shareholders. Authorized companies were those with a minimum of 200 shareholders owning collectively at least 25 percent of paid-up capital. also acts as a clearinghouse. however. each holding no more than 0. lottery drawing must be used to ensure fairness.5 percent and collectively owning at least 30 percent of paidup capital. The company should then appoint a financial adviser. SET established new requirements for initial public offerings. Before 1993. In 1998. but dropped the following year to B122 million. It separated the primary and secondary markets to promote more flexible and effective supervision of both. The primary market is supervised by SEC. Consequently. If the issue is oversubscribed. Turnover value was B1. According to the SEA of 1992. to assist in the public offering process. Vol. 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.8 billion in 1996. securities deposit center. II jurisdiction of SEC. the two classifications were merged. The allocation procedure is nondiscretionary. and securities registrar. Its main role is to serve as a secondary market for unlisted companies trying to raise capital. Proposed changes in capital must be submitted for approval to SET accompanied by a detailed memorandum outlining the use of proceeds. . Listed companies were those that had (i) paid-up capital of at least B20 million. and pro forma balance sheet and income statements. financial projections. stock trading can commence within five days. 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. Only one security was listed in BSDC in 1995 and two more in 1996.254 Corporate Governance and Finance in East Asia. The SEA of 1992 installed the legal and regulatory framework for Thai capital markets. SET. If approved by SEC and the SET Board of Governors. so now only listed companies are traded in SET. which consist of SET and BSDC. approved by SET. with each facing different listing requirements. Company applicants must have an established history of operating under substantially the same management. In 1996. among other functions approved by SEC. securities can be traded in the secondary markets. the BSDC was dissolved in 1999. there were two kinds of companies in SET—“listed” and “authorized” companies.
however. 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. which encouraged limited companies and public companies to issue debt instruments. 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. A turning point of the corporate debt market was the enactment of the SEA of 1992. it accounted for a small share of the entire financial sector. the size of the corporate debt market rose to B132. 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.11). while secured debt instruments accounted for just above 10 percent. 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. Upon its founding in 1942. Beginning 1961. Four years after the passage of the SEA. . The proportion of domestic convertible debt instruments increased until 1995. the Government issued more bonds to finance industrial development projects and perennial deficits. State-owned enterprises became active issuers of bonds since 1993 because the Government constrained their borrowings (Table 4. compared to 110 percent in the US and 74 percent in Japan in the same year. The recent financial crisis.9 billion. the Bank of Thailand assumed responsibility for regulating the bond market. A breakdown of domestic offerings of corporate debt securities from 1992 to 1996 shows that unsecured debts accounted for about 60 percent. and the Government did not issue new bonds during 1990-1997. The Thai Rating Information Services. the year the Ministry of Finance first issued government bonds to finance infrastructure projects and economic development. In 1996. the first bond rating agency in Thailand. in 1994. However. Investors had limited knowledge of debt instruments. at about 11 percent of the total value of outstanding loans extended by commercial banks and 20 percent of total equity market capitalization. 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. The budget surpluses of the 1990s eliminated the need for new bond issuance. was also instrumental to the growth of the corporate debt market. it represented only 9 percent of GDP. led to the renewed issuance of Government bonds to finance the resurgent budget deficit and support cash-strapped financial institutions.
1 141.7 90. turnover value had reached B51.0 7.9 20.8 47. total offshore debt offerings had plunged by 68 percent to a mere B28.2 — — 50.7 821. a surge attributed to capital inflows encouraged by high returns on Thai bonds. the year the crisis unraveled and the baht was floated.5 billion. The following year.1 55.1 41.0 33.5 138.9 40.0 — 5.3 6.11 Offerings of Debt Securities.5 — — — 3.9 5.1 289.7 538. By 1995.3 13.5 — 0.7 95.1 121.5 43.7 132.1 10.1 — — — 29.3 8.7 — — 40. Vol.8 167.4 — 26. Total offshore debt offerings peaked in the run-up to the financial crisis.5 37.1 315.2 89.7 0.4 — — — 1.5 — — — — 1.0 281.256 Corporate Governance and Finance in East Asia.3 50.4 — 9.1 59.1 12.4 7.3 46.7 28.5 — — 32.8 Source: Securities and Exchange Commission of Thailand and the Thai Bond Dealing Centre.5 10.6 — 0.3 — 14.2 28.0 — 26.1 6.8 55. 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 — — — — — — 400.4 57.8 191.1 21.0 17.8 2.2 45. However.0 60.2 43.4 billion.2 2.0 — 5.2 57.3 46.3 29.7 0. .5 55.4 49.8 31.0 0. The club was considered the first organized secondary bond market in Thailand to serve as the wholesale market for debt securities. The decline in total domestic debt offerings in 1996 can be ascribed to the increase in offshore convertible debts.1 107. A sharp rise in unsecured offshore debt offerings can be noted all the way through 1996.6 billion.3 — — 3.0 333.9 37.3 140.0 86.5 — 39. The domestic debt market declined after 1994 because corporations could borrow offshore at lower costs.4 110.9 37.7 5.7 7.1 61. by the end of 1997.0 27.5 5.7 — — — — — — — 77. II Table 4.1 8.9 329.7 — — — — — 4. this had climbed to B200.9 30.9 0. BDC was established in November 1994 by 50 securities companies based on the provisions of the SEA of 1992.6 19.0 26.3 3.3 22.1 — — 6. then declined substantially in 1996 and 1997.2 39.0 5.6 — — 0.7 5.
turnover value plummeted to B106. In any case. From 1990 to 1996. Thailand’s publicly listed companies rely mainly on loans from commercial banks and financial institutions to finance their growth. steadily easing up between 1990 and 1996. In 1997. overall asset quality and liquidity of listed Thai companies deteriorated throughout the period. they also had a relatively small proportion of equity and . while for the property development industry. Retained earnings accounted for about 30 percent of total equity financing. judging by their relatively low levels of retained earnings. listed companies experienced liquidity problems with declining reserves of cash and marketable securities during the period 1990 to 1996 (Table 4. Companies in construction and property development seemed unable to generate internal funds. Across industries. these accounted for 33 percent of total liabilities. Construction and property development industries tended to have high proportions of long-term loans and debentures.2 Patterns of Corporate Financing An examination of financing patterns among Thai companies listed in SET shows that on the asset side. Longterm loans accounted for about 20 percent of total liabilities.4.Chapter 4: Thailand 257 compared with investment in equities. Equity financing remains an important part of listed companies’ long-term financing. with equity levels remaining high despite an increase in debt. Turnover fell further to B72. cash balances.12). these comprised 31 percent. significant variations can be noted. a trend most apparent in the leap between 1991 and 1992. and marketable securities holdings. At lower than 5 percent of total liabilities. BDC was renamed “the Thai Bond Dealing Centre” following its status upgrade to a bond exchange. In the same year.2 billion as a result of the default of debentures due to the Asian crisis. the use of debentures remains minimal even though the trend was generally upward until the 1997 crisis. There was also little change in the trend in retained earnings within the seven-year period. The overall trend is consistent with the decline in profitability observed in the analysis of corporate sector performance earlier. In addition. The average for all industries was only 22 percent. short-term loans accounted for more than 40 percent of total liabilities. The proportion of accounts receivable also declined steadily. For the construction industry.1 billion in 1998. The closure of 58 finance companies affected the BDC significantly since half of its members were suspended as a result. The ratio of net working capital to total assets decreased from a peak of 31 percent in 1993 to 28 percent in 1996. 4.
12 Common-Size Statements for Companies Listed in SET.3 38.8 9.6 15.2 1.6 50.9 14.5 9.9 20.1 2.2 2.9 43.0 100.8 35.0 100.0 15.7 16.3 21. Vol.4 49.6 0.4 6.0 13.0 100.2 34.2 43.6 6.3 34.13).3 34.9 18.1 7.9 10.8 14.3 14.9 6.9 40.2 45.258 Corporate Governance and Finance in East Asia.6 8.4 17. 1990-1996 (percent) Item All Years 1990 1991 1992 1993 1994 1995 1996 2.6 0.8 25. and low) also underscores that companies with high ownership concentration had high levels of long-term loans (Table 4.6 13.5 9.7 18.6 11.9 17.8 8.6 22.7 17.8 21.7 0.5 43.2 16.7 50.3 25.7 14.8 1.3 12.0 12.8 46.6 10. medium.9 0.6 14.4 7.2 2.0 100. US.0 6.9 50.8 37.7 15. Analysis of common-size statements by ownership concentration (based on the levels of top-five ownership concentration classified as high.6 2.0 1.2 12.3 1.0 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.3 50.4 17.6 21.9 17.0 100.4 8.0 2.2 43.0 100.7 52.1 18.7 16.0 7.1 5.3 2.3 6.4 43.2 22.9 2.9 14.2 16.3 49.9 6.3 18.5 0.8 34.9 14.0 10.5 14.2 17.4 21.0 100. were highly leveraged.2 1. The agribusiness industry relied more heavily on short-term loans at 56 percent of the industry’s total liabilities.9 38.8 3.1 50. Printing and publishing companies had lower financial leverage than companies in other industries.6 100.4 49.6 12.0 100.0 48.2 17.7 36.7 1.3 48.2 2.5 37.0 100.9 15. II Table 4.0 100.3 1.8 37.2 2.7 7.6 100.6 36.5 1.2 17.9 3.0 10.9 14.9 49.9 16.6 0.8 19.0 100.5 11.0 14.8 9. compared with the 44 percent general average.4 48.7 9.6 51.2 42.0 100.2 17.9 12. The level of total liabilities for the group characterized by high ownership concentration .3 14.1 36.3 17.1 49.8 7.4 2.8 17.8 20.4 14.5 1.2 35.6 38.2 1.2 3.2 15.0 100.8 10.3 18.0 100.6 0.8 6.5 1.1 17.6 18.1 13.9 14.0 51.
6 22.3 100.9 100.9 36.4 1.0 7. This is consistent with the observation that majority shareholders try to maintain their control by utilizing debt as a major source of funds.6 9.4 13.0 6.6 15.1 18.2 0.4 35.3 16.2 8.0 Low 1.6 2.9 50. US. For the high ownership concentration group.6 0.5 percent for low ownership concentration companies.7 19.8 13.8 13.6 47.8 12.9 21.4 3.5 100.1 36.5 13.9 2.8 37.1 49.Chapter 4: Thailand 259 Table 4.5 18.1 53.2 14.0 41.5 21.4 37.0 14.9 16. common equity accounted for a smaller proportion of total assets (47 percent) than companies with lower ownership concentration.2 22.0 Medium 2. 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 2.0 6.4 49.3 8.0 16.0 100.1 44.4 18.2 11.7 percent for medium ownership concentration companies and 49.0 19.2 45. was 53 percent of total assets compared with 49.4 50.6 100.3 35.6 14.5 11.13 Common-Size Statements of Public Companies by Ownership Concentration.7 17.0 100.7 12.3 1.3 1.9 7. .9 0. Companies with medium ownership concentration tended to have a higher proportion of short-term loans.0 Source: Pacific-Basin Capital Markets Database compiled by the University of Rhode Island.4 7.
Vol.1 52.4 7. bond issues.8 51. The TIE ratio declined from its peak of 7.1 64.9 140.8 65.3 Source: Estimated from the Pacific-Basin Capital Markets Database compiled by the University of Rhode Island.8 percent in 1990 to 52.5 38. these firms more easily increased their leverage. Short-term debt accounted for most of the increase.4 139.7 34. 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. was the headlong deterioration of firms’ ability to meet their interest payment obligations.7 12. Generally.6 138.0 25. bond issues overtook loans from commercial banks as the second preference. however.7 5.9 7.4 5. and maintenance of the existing ownership structure.1 31.7 percent in 1996. The ratio of total debt to total assets increased from 50. US. it would seem that firms with concentrated ownership and associated links to the banking system have easier access to debt financing.2 68.8 65. The direct relationship between the degree of leverage and the degree of ownership concentration is apparent in Table 4.1 144.260 Corporate Governance and Finance in East Asia. Such deterioration of financial positions during the period was a common feature of listed companies. II Results from the ADB survey reveal that Thai companies preferred to use reserves and retained earnings as their first choice of financing.1 in 1996.14 Financial Ratios of All Listed Firms.4 51. however.8 5.9 51.6 125.1 23.1 16. thus rendering them more vulnerable. and rights issues.0 50. The financing patterns indicate that companies with high ownership concentration were more highly leveraged than companies with medium and low concentration.9 14.1 16.0 145.4 12.1 31. 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 8.7 66. minimization of transaction and interest costs. After the crisis.7 28.7 34.14).7 12.3 31. Public companies relied more on short-term debt financing in the period before the financial crisis. While further detailed investigations are necessary. the choice of financing is determined by the company’s liquidity considerations.3 61.15.0 28.2 35. .7 in 1994 to 5.2 49. Table 4. As a result.6 7.6 41.5 52.8 151.1 44.9 63. More important.7 11. followed by bank loans. especially from 1994 to 1996.4 44.
8 Medium 7.5 34.4 27. however. The corporate sector contributed significantly to the crisis because of its rising levels of leverage.5 148. 4.1 High 6.8 14.5 percent between 1985 and 1990 to 8.5 percent of external debt in 1996 (Table 4. .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.8 29. This decline was accompanied. the proportion of short-term debt increased from 15.3 42.8 49. peaking in 1994 at 84 percent. From only 34 percent in 1986.5. debt-creating capital inflows rose to 65 percent in 1990. US.4 52.2 49. From 45 percent of total net capital movements in 1985. continued to slide from 1985 to 1997. Nonbank private debt increased from 27.5 4.6 11.4 percent to 46 percent during the same period.8 28. and a preponderance of short-term debt liabilities.6 30.8 percent in 1986 to 52 percent in 1995.4 13.2 percent in 1986 to 251. 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. is even more telling. The composition and term-structure of this debt.15 Financial Ratios of Listed Companies by Ownership Concentration. such as direct equity and portfolio investment.16).2 124. on the other hand. 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. Additionally.0 64.Chapter 4: Thailand 261 Table 4.3 Source: Estimated from the Pacific-Basin Capital Markets Database compiled by the University of Rhode Island. The proportion of nondebt-creating capital flows.7 percent from 1991 to 1996. unhedged foreign exchange liabilities.9 percent in 1997. The proportion of external debt as a percentage of GDP consequently increased from 42. Their average annual growth rate declined from 28.5 126.4 63. private debt accounted for 84.8 66.
6 — 0.8 12.5 1.3 12.4 10.1 64.3 2.7 23.9 13. 1986-1999 ($ billion) Private Nonbank Long-Term Short-Term 3.0 11.8 3.0 4.1 34.8 108.2 10.3 37.6 1.3 3.8 13.0 0.4 18.4 3.Table 4.9 1.9 31.4 — — — — — — — 1.7 0.1 30.6 7.9 1.0 Long-Term Short-Term BIBF Commercial Bank Long-Term Short-Term 0.2 14.8 3.1 2.1 95.0 21.3 3.9 100.3 0.7 20.3 0.6 Total 18.1 0.3 0.0 13.5 16.5 19.7 13.0 3.6 18.5 4.8 31.6 52.2 2.2 0.9 6.3 16.3 7.9 11.3 — — — — — — — 6.4 2.1 12.9 7.9 5.7 24.1 0.9 35.3 20.7 10.0 11.6 Government Year Long-Term Short-Term 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 12.1 22.5 14.7 109.1 Source: Bank of Thailand.2 0.1 23.0 8.7 1.9 43.9 0.9 29.3 0.7 2.5 4.16 External Debt.9 4.1 0.2 2.3 0.2 2.3 0.9 3.8 10.2 0.5 12.3 0.3 105.2 32.9 3.0 6. .1 5.4 5.9 10.1 0.5 12.8 0.3 10.2 15.4 15.9 10.9 6.3 0.
(ii) the rise in the nonperforming loan (NPL) ratio and consequent tightening of credit even for viable firms. outstanding credit also declined throughout the second half of 1998. Due in part to liquidity problems on the one hand. If lending rates remained high. from its peak in 1995. 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. Aside from the problem of NPLs. Similarly. the liquidity problems faced by the corporate sector are likely to continue for some time. After that. leaving domestic investors with large capital losses. the numbers of bankruptcies and company closures reached all-time highs in 1998 (Table 4. SET’s dismal performance is indicative of the extent of the setback suffered by the Thai capital market. based on the three-month past due definition. trading activity at SET had been on the downturn. 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. closures. Even before the crisis. nonfinancial companies also experienced severe liquidity problems as a result of the baht’s devaluation. the index declined to 1.281 in December 1995 and to 831. large Thai companies had actively borrowed at low interest rates from foreign financial institutions. Meanwhile. banks would be recording more of such NPLs. With easy access to foreign funds. Foreign investors retreated from the market.6 in December 1996. suggesting that serious investors have not returned to the market.Chapter 4: Thailand 263 This shows that although banking and finance companies suffered most because of their short-term exposure. the number of newly registered companies dropped to a 10-year low in 1998. according to the Bank of Thailand. . The value of public offerings sank in 1997 to B56. The proportion of NPLs as a percentage of outstanding loans demonstrates the liquidity problem experienced by the corporate sector.17). Trading volume has since been thin. The effects of the crisis were felt across all industry sectors. On average.360. and drastic decline in the number and capital of newly registered companies. the SET Index stood at 1. foreign currency-denominated debts constituted 55 percent of their total debt portfolio. reaching 45 percent of total outstanding credit in December. NPLs spiraled from 12 percent in the second quarter of 1997 to almost 40 percent in the third quarter of 1998. and poor business confidence on the other. Most of these foreign debts were not properly hedged. exposing the companies to disaster when the baht started tumbling on 2 July 1997.6 billion from the 1996 level of B201 billion. At the end of 1994. and (iii) bankruptcies.
4.052 36. But when assistance from other sources did not materialize.777 11.410 37.080 9.915 37. The price-to-earnings (P/E) ratio deteriorated from 19.925 12.218 3.695 3.6 in 1997.904 20. . II Table 4.677 Bankrupted/Closed 2.902 3.105 4. The IMF financial package was a credit facility of $17.264 Corporate Governance and Finance in East Asia.409 6.224 4.307 4.933 25.288 35.5. Ministry of Commerce.095 14. IMF required Thailand to meet a set of performance criteria and implement various restructuring measures. The first Letter of Intent was cosigned by the Minister of Finance and the Governor of the Bank of Thailand on 14 August 1997.407 28. the Government was left with no choice. Thailand. It also explains the higher dividend yield ratio.201 24. Vol.066 19.17 Number of Newly Registered and Bankrupted/Closed Companies.2 billion for balance of payments support and buildup of the country’s reserves.334 4. As part of the assistance package.410 5.977 Source: Department of Commercial Registration.797 4. 1985-1999 Year 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 Newly Registered 10.312 25.096 22. the Thai Government was lukewarm to the idea of obtaining IMF assistance because of the requirements and conditions attached to the financial package.5 at the end of 1994 to 12 in 1996 and further to 6.112 9.2 Responses to the Crisis Initially.792 7. A steady price decline over the past few years has dragged down the ratio of market price to book value. The increase of the P/E ratio in 1998 was mostly a result of a decrease in earnings for most listed companies.134 31.
The Financial Sector Restructuring Authority was established in October 1997 to address the problems of 58 finance companies that were suspended in 1997. drawn up with World Bank and ADB assistance. only two companies emerged intact from the suspension. IMF relaxed these key conditions. the Civil and Commercial Code. also aimed at institutionalizing legal and regulatory reforms. There were many options for solving debt repayment problems. The assets of the other companies were liquidated by auctions. and worked on revisions to the Secured Transaction Law. Under the old bankruptcy laws. creditors seldom succeeded in obtaining payment against bankrupt borrowers. The Government also passed the Bankruptcy Act and Foreclosure Act Amendments. and if necessary. The old law allowed only creditors to file bankruptcy suits. loan provisioning. however. Regulatory Response by the Government The IMF program. In early 1998. it was widely interpreted as “having debts more than assets. follow through with a civil or bankruptcy suit. They could seek civil action through the courts and could also use criminal sanctions to enforce debt repayments. Strict loan classifications. While no definition for “insolvency” could be found in the bankruptcy law. and Credit Foncier Businesses. and restore solvency.” Creditors thus bore the burden of proving a debtor’s insolvency before the courts. Securities. debtors could drag out the process for many years. These include repeal of the Commercial Bank Act. The Government required all remaining financial institutions to recapitalize and instituted closer monitoring measures to ensure full compliance with this requirement. Many believed that the process was inefficient. and income recognition were implemented. The Bank of Thailand also improved banking standards. For example. The core of the IMF conditionalities was the restructuring of the banking and financial sector to regain investor confidence. Several changes in the banking and financial policy environment have been effected in line with the restructuring program. and did not recognize debtor-initiated bankruptcy declarations. and the Act Regulating the Finance. increase profitability. As it turned out. Creditors could negotiate to reschedule debt repayments. secured creditors had to obtain the court’s approval before starting proceedings .Chapter 4: Thailand 265 The terms of the agreement required the Government to maintain tight monetary and fiscal policies. By invoking procedural loopholes.
Chapter 11 cases account for only 5 percent of bankruptcy suits in the US but consume 90 percent of the courts’ time. The model for Thailand’s amended bankruptcy law was the US Chapter 11. Chapter 11 is the main tool in restructuring bankrupted companies in the US. Enforcement of the new law is bound to be ponderous and lengthy. II for the recovery of debt through the realization of any collateral. But more important. it covers only the court-supervised reorganization of distressed companies. The amendment added reorganization provisions to the Bankruptcy Act of 1940. There are other potential problems. The amended legislation also includes voluntary bankruptcy as a new feature. (ii) management of the company reverts to the borrower. Foreign secured creditors had to go through the motions of establishing that their country of domicile granted Thai creditors similar rights. For one. Under the old Bankruptcy Act. creditors always had to contend with the threat of disruptions in a delinquent borrower’s business. If the process fails to revive the business. time consuming. and (iv) the debts shall have been settled within a five-year period. the company shall be declared bankrupt and liquidation of assets shall follow. The reorganization process is successful if (i) the debts shall have been discharged. but it is a complicated.266 Corporate Governance and Finance in East Asia. In 1999. (iii) shareholders regain their legal rights. 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. In effect. the amended law limits the rights of secured creditors. the judges and court officers have yet to learn and master the new bankruptcy procedure. the National Assembly passed an amended Bankruptcy Act and approved the establishment of special bankruptcy courts. The original Bankruptcy Act dealt only with liquidation and composition. any new loan to a company extended after the creditor discovered the insolvency would not be eligible for repayment. thereby allowing court-supervised corporate restructuring. Companies need . The amended law also introduced the concept of automatic stay. and expensive process. In Thailand. 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. 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. which means that a debtor could continue in business while the reorganization program was being implemented. Vol. To make matters worse for creditors.
” as opposed to the more appropriate criterion of “ability to pay when the debt falls due. shall have the power to call the extraordinary general meeting.. the test for insolvency still uses the balance sheet criterion. In case the board of directors does not comply. Consequently. namely “liabilities exceed assets. Procedural delays give borrowers an advantage because they can refuse to pay back their loans even though they can meet their obligations. however. Replacing the Public Limited Company Act of 1978. the court. and (ii) processing of default cases within four to six months of filing of a court claim. Still pending Parliament approval is the amendment to the Secured Transaction Law. only tangible assets were the norm. corporate governance) that caused the bankruptcy in the first place. SEC also examined the possibility of an amendment to the Public Company Act of 1992. The proposed new law seeks to expand the type of assets that a borrower can use as collateral. minority shareholders’ rights are not adequately protected. the 1992 Act relaxed some of the original restrictive rules and regulations to encourage public company registration. after determining the legitimacy of the request. In the past. The result. The amendment seeks to revise old rules and procedures that tended to delay foreclosure proceedings. the Bankruptcy Amendment will just prolong the problems of nonviable borrowers. .Chapter 4: Thailand 267 to solve the problems (e. questions have been raised regarding the appropriateness of the 1992 Act. 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. The proposed amendment also includes a provision for the company to reimburse minority shareholders for expenses related to calling such a meeting. Without the necessary corporate restructuring.g. has not been satisfactory. Under the new law. which aims to increase liquidity in the domestic economy by allowing businesses to use both tangible and intangible assets in securing credit. 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.” The Foreclosure Act Amendment was likewise passed in 2000. 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. The minimum shareholding requirement is too high for any individuals or groups of minority shareholders to take action against controlling shareholders. Most important. The amendment also remedies the slow process of executing or disposing of assets in a public auction.
with the approval of the board. The 1992 Act only prescribes—not requires—the use of the cumulative voting procedure.e. But because this is the assumption embedded in the regulation. it will probably be expensive because of the higher risk that comes with weak accountability mechanisms. 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.268 Corporate Governance and Finance in East Asia. In addition.. Vol. But as demonstrated. 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. Because of high ownership concentration. i. minority shareholders have no chance of being represented in the board. Most companies decide against cumulative voting. Consequently. the dominance of controlling shareholders. The 1992 Act also allows directors to engage in business activities that may directly or indirectly affect the company. it permits directors. II Another issue is the assumption in the 1992 Act that there is a separation of ownership and control functions. vis-a-vis the minority shareholders. the main problem is overlooked. this is not so in publicly traded companies in Thailand. In the absence of such a stock market boom now. without cumulative voting. This may be true in countries where publicly traded companies are widely held. they face the prospect of being unable to compete for the scarce funds available in the equities market. 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. Otherwise. in turn. minority shareholders are likely to be wary of increasing their equity without corresponding control mechanisms at their disposal. claiming that it creates fragmentation in the board of directors. and determine voting results on virtually any matter. which. disrupts the company’s management and decision making. who are also the managers. The proposal for the amendment of the Public . The proposal clearly delineates duties of care and loyalty for directors of public companies. The textbook separation between owners who sit in the company’s board and professional managers who run the company does not apply in Thailand. there are few provisions in the Act that deal with related or connected transactions that potentially reduce shareholders’ value. the controlling shareholders have the exclusive domain to appoint or exercise management. Where equity will come forward. to borrow from the company without consideration to the fairness of the transaction or transparency of the approval process. The regulators are drafting a proposal to amend the provisions on related transactions. However. subject only to approval by the board of directors.
322.6 trillion. As of November 2000. and procedures for debt restructuring. Another 5 percent of cases (B70 billion) are undergoing restructuring negotiations. In addition. and manufacturing sectors. the number of cases has abated.6 trillion) have agreed to cooperate with CDRAC’s restructuring process.767 cases involving outstanding credit of B2. CDRAC’s target debtors comprised 10. with the majority of the debtors coming from the commerce. Commercial banks initiated 74 percent of these cases. the mere threat of external control alters the incentives faced by managers and controlling shareholders significantly. Some 82 percent of these cases have been successfully restructured. the Government introduced debt restructuring-related measures to help resolve bad debts. Another 77. 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. although since then. The Bank of Thailand issued guidelines in 1998 encouraging financial institutions to specify their own policies. In response. as well as those that did not cooperate with CDRAC’s restructuring process.1 trillion in outstanding credit. accounting for B1. Cases for which negotiations were unsuccessful. Within three months.068 cases involving B475 billion are undergoing restructuring.8 trillion had been completed. methods. This point is crucial because compared with . By October 2000. Considerable progress has been achieved on this front. Corporate Debt Restructuring and Bankruptcy The 1997 crisis led to a severe liquidity problem in the economy.1 trillion of outstanding credit. Reforms in bankruptcy procedures should be seen not only in the context of crisis resolution. the court had more than 80 cases for disposition. personal consumption. contributing to the unprecedented rise in the corporate sector’s bad debt. The first bankruptcy court in Thailand opened on 18 June 1999. where bankruptcy procedures are swift and effective.764 debt restructuring cases involving B1. only 7. Equally important is the contribution of effective and reliable bankruptcy procedures for improved corporate governance. will be settled by the courts.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.147 cases (B1. In particular. The reason is that bankruptcy law amendments appear to facilitate settlements outside the court. accounting for B1. However.
Examination of corporate ownership. Conclusions. Vol. 4. The banking industry played a key role in the early stages of economic development because it represented the only avenue for funding Thai corporations. 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. 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 1997.270 Corporate Governance and Finance in East Asia. and Recommendations Summary and Conclusions This study has provided an overview of the corporate sector and governance in Thailand. behavior. The exchange has already required that listed companies’ quarterly reports be directly comparable with annual statements. Reforms through SET and Improved Disclosure The financial crisis prompted SET to introduce a range of improvements to its operation and regulation. to push companies to harmonize their accounting with international standards. Weak bankruptcy procedures were part and parcel of the perverse set of incentives that led firms to build up unsustainable levels of debt. For this reason. and performance during this period helps understand the causes of the crisis. Emphasis was on the structure of corporate governance and patterns of corporate ownership and financing of publicly listed companies. despite the weakness of their disciplinary powers. and promoted key industries through incentives. The . Philippines. It required listed companies to establish their own audit committees by the end of 1999. II Malaysia.6.1 Summary.6 4. the Thai Government managed its economy with the corporate sector as the main engine of growth and development. In the next three decades. Such improvements in disclosure standards are part of the efforts of SET and SEC. 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. Financial information from listed companies will also soon be required to conform to International Accounting Standards. The study covers the period 1985 to 1996. and even Indonesia.
After 1992. the top five largest shareholders hold about 56 percent of total outstanding shares.Chapter 4: Thailand 271 importance of bank financing continued throughout the 1990s. Meanwhile. The study examined the impact of ownership structure on corporate governance and financing patterns. the devaluation of the baht that began on 2 July 1997 affected the financial condition of Thai corporations. Because most of these debts were not hedged. In 1995 and 1996. At the same time. 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 increase in long-term debt more than compensated for the drop. The financial performance of the corporate sector remained satisfactory up to the years before the outbreak of the financial crisis. On average. One of the principal causes of the crisis was the excessive use of foreign debt by the corporate sector. The SEA of 1992 also marked the beginning of an active bond market in Thailand. One of the major findings is the high ownership concentration among Thai companies listed on SET. the number of listed companies in SET fell from 454 in 1996 to 392 in 1999. Thai companies were vulnerable to exchange rate risks.000 from the previous year’s level. Financial liberalization apparently encouraged companies to borrow overseas to finance investments that were not productively employed. there was a marked increase in the number of public corporations. Nonbank private corporations accounted for most of the increase. at a time when most of them were already experiencing declining profits and high leverage. Subsequently. Although there are some variations across industries. the overall pattern of ownership concentration seems to have been stable for the past 10 years. the number and value of public offerings of securities accelerated. Although there was a decline in short-term foreign debt. the numbers of bankruptcy cases and company closures reached alltime highs. the profitability of publicly listed companies abruptly declined and their financial leverage increased. In 1992. reaching its peak in 1996. foreign debt in the Thai corporate sector increased continuously. Minority shareholders. . During 1992-1997. Profitability increased throughout the 1980s but began to decline in the first half of the 1990s. the overall corporate sector was seriously affected. the corporate sector entered a new era with the enactment of two major pieces of legislation. At the onset of the 1997 financial crisis. Consequently. even after the development of capital markets. The impact of the crisis was felt across all industries. The number of newly registered companies in 1997 dropped by almost 10. the Public Company Act of 1992 and the SEA of 1992.
The investing public holds the rest of the outstanding shares. Most foreign institutional investors invest only on a short-term basis and aim for short-term trading profits. Individuals and insiders hold the second largest proportion at about 19 percent. they have little influence over management decision making and control. These laws stipulate rules and regulations concerning the activities of all public companies. averaging 46 percent. All these. Institutional investors in Thailand. Consequently. are not active. foreign and domestic. the existing legal and regulatory framework suggests otherwise. the mutual fund industry has entered the picture but with limited roles and activities. commercial banks hold only about 2 percent of total outstanding shares while nonbank financial institutions hold about 6 percent. II although larger in number. The key laws. Among the five largest shareholders of Thai companies listed on SET. An analysis of the corporate ownership structure in Thailand suggests that founders and management continue to own and control publicly listed Thai companies. Recently. contribute to the lack of external controls on the corporate sector through the capital markets. holding companies and affiliated corporations hold the largest proportion at 27 percent of total outstanding shares. In the past. With financial institutions playing limited roles in the capital market.272 Corporate Governance and Finance in East Asia. the Public Company Act of 1992 and the SEA of 1992. The highly concentrated ownership structure weakens the protection of minority shareholder rights. The rules in both Acts governing . Nominally. Vol. Financial institutions hold a very small proportion. along with a highly concentrated ownership structure. Thus. hold only a small portion of total outstanding shares. The Government holds about 1 percent of total outstanding shares but these holdings represent majority shares of a few companies. The absence of external market controls on the management of publicly listed corporations is dangerous. The implications of ownership structures that are concentrated to such a high degree are serious. the government pension fund was the only major institutional investor. protect the interests of all shareholders of public companies. through the use of holding and affiliated companies. there is a clear lack of outside monitors for these publicly listed but family-controlled companies. publicly listed and unlisted companies in Thailand are equally subject to the consequences of the risk-taking behavior of controlling owners. 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.
The second issue involves the protection of shareholder rights. a requirement impossible to meet due to the concentrated shareholdings of founding family members and management. The ownership structure of Thai listed companies also significantly affects company behavior. Certain provisions. Specifically. Rather. the main challenge is not how the board can control management to maximize shareholder value. The first issue involves the development of a comprehensive supervisory framework and the strengthening of the capacity of supervisory agencies. 4. the high ownership concentration of many listed Thai companies inhibits the effectiveness of these provisions. Ownership concentration appears to have little impact on corporate profit performance. the degree of ownership concentration has a statistically significant positive relationship to the degree of financial leverage. an aim that can be achieved mostly through legal reforms. In view of this. For example. laws did not provide minority shareholders sufficient safeguards in cases of transactions involving companies where the controlling shareholders had related interests. because there is no separation between ownership and management.6.Chapter 4: Thailand 273 minority shareholders’ participation in decision making and in initiatives against management conform to international standards. before the crisis. The third issue involves creating external market controls through better regulation and development of the capital markets. The Government has been moving to amend the Public Company Act of 1992 to increase minority shareholders’ protection in this regard. key reforms that will strengthen the regulation of financial institutions. posed formidable barriers in the minority shareholders’ exercise of their rights. moreover. Consequently. because there are shared interests between the controlling shareholders and key management personnel. these companies tend to become overleveraged. However. For instance. the Public Company Act of 1992 allows shareholders to act only when they hold a minimum proportion of shareholdings. making them vulnerable to economic shocks. but is significantly related to financing patterns. It appears that founding family members use debt extensively to finance investments because they want to preserve control of their firms.2 Policy Recommendations There are three major policy issues and recommendations that could improve corporate governance in Thailand. In this third area. the main challenge is in protecting minority shareholders from the possibility of expropriation by the majority. .
As in other crisis economies in the region. The best approach may entail establishing a single. in most of Thailand’s publicly traded firms. and increase the participation of institutional investors are imperative. In this setting. If the principal shareholder is in fact chair of the board. SET. SEC was established as another supervisory agency. Consequently. Vol. in 1975. and after the enactment of the SEA in 1992. Development of a Comprehensive Supervisory Framework There is a need for the Government to establish a comprehensive supervisory framework for the corporate sector.274 Corporate Governance and Finance in East Asia. . the Ministry of Commerce had the sole supervisory responsibility. the supervisory system is fragmented and not as effective as it should be. the key issue in corporate governance would then be to ensure that managers act in the best interests of the shareholders. with control delegated to professional managers. Under the current system. voting only on major decisions. In reality. Protection of Shareholder Rights The common assumption is that publicly traded corporations are widely dispersed in terms of ownership. The owners of a firm rely on a board of directors to supervise the managers. three major government organizations (the Ministry of Commerce. This is due to the historical development of the Thai corporate sector: before 1975. unified supervisory agency or a permanent regulatory division consisting of supervisory units from the three agencies. II encourage market competition. The board therefore plays a pivotal role. this is a problem in Thailand. he/she often has the decisive vote. the key issue in corporate governance is how to prevent insiders from expropriating assets of minority shareholders. Only then will these agencies be able to act promptly and effectively. and SEC) are involved in corporate supervision. It is important that the roles and responsibilities of each agency are clearly defined to the public. Once the roles and responsibilities are clearly defined. The Government must develop an overall framework for corporate sector supervision and redefine the regulatory jurisdiction of each agency along functional lines. There is also supposed to be separation of ownership and control. the supervisory agencies also need to be empowered to enforce the laws. If this were the situation. SET was mandated to supervise listed companies. the principal shareholder typically plays a key role in management and often serves as the chief executive officer. activate the market for corporate control.
requiring cumulative voting for the election of directors. regulators must increase transparency and step up enforcement. the Government can change the shareholding limit for controlling shareholders. To ensure a level playing field. SEC is exploring the possibility of amending the law toward this direction. there has been much progress in this area. SEC has been trying to lay the foundations of good corporate governance by espousing fairness. Because these holding companies control a number of large public companies in Thailand. and . This includes prescribing ways to empower minority shareholders without disrupting the company’s operations. and a prohibition of connected transactions by directors or management. The Ministry of Commerce is conducting a study on proposed amendments to the Public Company Act of 1992. The current ownership structure leads to ineffective corporate governance and inadequate protection of minority shareholders. This move is expected to be unpopular among founding family members and original owners. Through an amendment in the Public Company Act. accountability. The second recommendation is to dilute ownership concentration through the use of regulatory power. they should be monitored and regulated. Since the Asian financial crisis. Some of the legal reforms under consideration concern settling conflictof-interest situations with significant effects on minority shareholders. 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.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 slow improvement in the legal framework has likewise obstructed progress in this area. The first recommendation involves the repeal of current legislation to allow minority shareholders to have greater influence over management decision making. Both SET and SEC are taking an active stance in improving the transparency and efficiency of Thai capital markets. transparency. increasing penalties for directors engaged in misconduct. The situation prompts two specific recommendations. 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. 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. But weaknesses in accounting and auditing practices have been inhibiting the development of capital markets.
there is a need to increase market disciplinary power through market competition. for instance. it will be difficult to improve corporate governance in Thailand.276 Corporate Governance and Finance in East Asia. A well-developed domestic debt market will provide corporations with an alternative to bank financing. aimed at ensuring that banks finance only creditworthy projects. The variety of debt instruments available to the corporate sector and investors should be increased and longer-term sources of bond finance actively promoted. In the stock market. while a strong domestic debt market will also offer protection from foreign exchange risk. especially in the area of connected lending. Capital Market Development and Regulation Another important issue concerns the development of capital markets. Accounting standards have also been under review. The first step is to establish an active secondary Government bond market. The same goes for improvements in the bankruptcy system. a well-developed secondary market will pave the way for market disciplinary forces to act against poorly managed companies. In an environment of highly concentrated ownership. The Bank of Thailand’s enforcement of prudent lending practices among Thai financial institutions. will lead to the emergence of a reference yield curve. Because the financing of Thailand’s corporate sector is predominantly bank-based and will remain so for a long while yet. . 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. Without a strong and efficient capital market. The promotion of active roles for domestic institutional investors should also improve corporate governance in Thailand. the power of the capital market to discipline inefficient management is almost nonexistent. the SEC’s disposition toward a largely voluntary approach for adoption of these characteristics has resulted in uneven compliance among public companies. Thailand should develop a strong public debt market to supplement the banking system in financing corporate investments. Further. However. II responsibility among companies. which. it is important to explore reforms that can lead to the enhanced role of banks in monitoring enterprises. Vol. will incidentally close off easy sources of finance for companies that have been practicing regulatory arbitrage. This may not be possible without reforms in the banking sector itself. There will be no incentive for companies to raise capital in the equities market if they can obtain funds at a lower cost elsewhere. in turn.
The Stock Market in Thailand. 1995-1999. 1995. 1998. Pacific-Basin Capital Markets Research Center. The Stock Exchange of Thailand. The Securities and Exchange Commission of Thailand. Department of Commercial Registration Database. The Thai Bond Dealing Centre. Ministry of Commerce. The Securities and Exchange Commission of Thailand. Kingston.Chapter 4: Thailand 277 References Annual Report. Thailand. 1995-1999. . Bank of Thailand Monthly Bulletin. 1997-1999. US. 1995-1999. PACAP-Thailand Database. The Stock Exchange of Thailand. Fact Book. 1997. Bond Market Development in Thailand. The Stock Exchange of Thailand. Thai Accounting Standards. The University of Rhode Island. Key Capital Market Statistics. Bank of Thailand. 1997. Bank of Thailand Quarterly Bulletin. Bank of Thailand.
This action might not be possible to undo. Are you sure you want to continue?
We've moved you to where you read on your other device.
Get the full title to continue listening from where you left off, or restart the preview.