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A Study of Indonesia, Republic of Korea, Malaysia,Philippines,andThailand
Edited by: Juzhong Zhuang SeniorEconomist RegionalEconomicMonitoringUnit AsianDevelopmentBank David Edwards AssistantChiefEconomist ProjectEconomicEvaluationDivision AsianDevelopmentBank Ma. Virginita A. Capulong SeniorSectorAnalyst AgricultureandSocialSectorsDepartment(West) AsianDevelopmentBank
© Asian Development Bank 2001 Allrightsreserved. ThispublicationwaspreparedundertheAsianDevelopmentBanksregionalTechnical Assistance 5802: A Study on Corporate Governance and Financing in Selected DMCs. The views expressed in this book are those of the authors and do notnecessarilyreflecttheviewsandpoliciesoftheAsianDevelopmentBank,or itsBoardofDirectorsorthegovernmentstheyrepresent. The Asian Development Bank does not guarantee the accuracy of the data includedinthispublicationandacceptsnoresponsibilityforanyconsequencesfor theiruse. Use of the term country does not imply any judgment by the authors or the AsianDevelopmentBankastothelegalorotherstatusofanyterritorialentity . ISBN 971-561-323-3 Publication Stock No. 100800 Published and printed by theAsian Development Bank P.O. Box 789, 0980 Manila, Philippines
List of Tables List of Figures Foreword Preface Abbreviations 1 Indonesia 1.1 Introduction 1.2 OverviewoftheCorporateSector 1.2.1 HistoricalDevelopment 1.2.2 TheCapitalMarket 1.2.3 The Banking Sector 1.2.4 ForeignCapital 1.2.5 GrowthandFinancialPerformance 1.2.6 LegalandRegulatoryFramework 1.3 CorporateOwnershipandControl 1.3.1 CorporateOwnershipStructure 1.3.2 ManagementandInternalControl 1.3.3 ExternalControl 1.4 CorporateFinancing 1.4.1 FinancialMarketInstruments 1.4.2 PatternsofCorporateFinancing 1.4.3 CorporateFinancingandOwnershipConcentration 1.5 TheCorporateSectorintheFinancialCrisis 1.5.1 CausesoftheFinancialCrisis 1.5.2 ImpactoftheFinancialCrisisontheCorporateand BankingSectors 1.5.3 Responses to the Crisis 1.6 Summary, Conclusions, and Recommendations 1.6.1 SummaryandConclusions 1.6.2 Policy Recommendations References vi ix x xi xii 1 1 3 3 4 5 7 8 15 17 17 25 30 32 32 34 35 36 36 39 42 45 45 48 51
2 Republic of Korea 2.1 Introduction 2.2 OverviewoftheCorporateSector 2.2.1 HistoricalDevelopment 2.2.2 Rise of the Large Business Groups (Chaebols) 2.2.3 RoleoftheCapitalMarketandForeignCapital 2.2.4 GrowthandFinancialPerformance
53 53 55 55 60 62 65
iv 2.3 CorporateOwnershipandControl 2.3.1 PatternsofCorporateOwnership 2.3.2 InternalManagementandControl 2.3.3 ShareholderRights 2.3.4 ControlbyCreditors 2.3.5 TheMarketforCorporateControl 2.3.6 ControlbytheGovernment 2.3.7 EmployeeParticipationinCorporateGovernance 2.4 CorporateFinancing 2.4.1 Overview of the Financial System 2.4.2 PatternsofCorporateFinancing 2.4.3 FinancialStructure,Diversification,andCorporate Performance 2.5 TheCorporateSectorintheFinancialCrisis 2.5.1 WeaknessesinCorporateGovernance 2.5.2 TheRoleofGovernmentIntervention 2.5.3 ManifestationsofWeakCorporateGovernanceand GovernmentIntervention 2.5.4 ShortcomingsinMacroeconomicPolicy 2.6 Responses to the Crisis and Policy Recommendations 2.6.1 CorporateRestructuringActivities 2.6.2 PolicyMeasuresforCorporateReform 2.6.3 Policy Recommendations References 3 The Philippines 3.1 Introduction 3.2 OverviewoftheCorporateSector 3.2.1 HistoricalDevelopment 3.2.2 GrowthandFinancialPerformance 3.2.3 LegalandRegulatoryFramework 3.3 CorporateOwnershipandControl 3.3.1 PatternsofCorporateOwnership 3.3.2 CorporateManagementandShareholderControl 3.3.3 TheRoleofCreditorsinCorporateControl 3.4 CorporateFinancing 3.4.1 TheFinancialMarketandInstruments 3.4.2 PatternsofCorporateFinancing 3.4.3 OwnershipConcentration,FinancialLeverage,and Performance 3.5 TheCorporateSectorintheFinancialCrisis 3.5.1 TheFinancialCrisis:CausesandManifestations 3.5.2 ImpactoftheCrisisontheCorporateSector 3.5.3 Responses to the Crisis 74 74 94 103 105 108 110 111 113 113 118 128 130 132 134 134 137 139 139 143 148 153 155 155 156 156 158 167 171 171 186 198 199 199 202 209 210 210 212 214
v 3.6 Summary, Conclusions, and Recommendations 3.6.1 SummaryandConclusions 3.6.2 Policy Recommendations References 216 216 219 226
4 Thailand 4.1 Introduction 4.2 OverviewoftheCorporateSector 4.2.1 HistoricalDevelopment 4.2.2 DevelopmentofCapitalMarkets 4.2.3 GrowthandFinancialPerformance 4.2.4 LegalandRegulatoryFramework 4.3 CorporateOwnershipandControl 4.3.1 PatternsofCorporateOwnership 4.3.2 CorporateManagementandControl 4.3.3 ExternalControl 4.4 CorporateFinancing 4.4.1 OverviewoftheFinancialSector 4.4.2 PatternsofCorporateFinancing 4.5 TheCorporateSectorduringtheFinancialCrisis 4.5.1 ImpactoftheFinancialCrisisontheCorporateSector 4.5.2 Responses to the Crisis 4.6 Summary, Conclusions, and Recommendations 4.6.1 SummaryandConclusions 4.6.2 Policy Recommendations References
229 229 230 230 233 235 239 240 241 244 248 252 252 257 261 261 264 270 270 273 277
5 Financial Performance of Publicly Listed Companies by Sector.11 CharacteristicsoftheBoardofCommissioners Table 1. 1992-1999 Table 1. 1990-1998 Table 1.3 GrowthandFinancialPerformanceofPubliclyListed Companies.3 Subsidiaries of the 30 Largest Chaebols Table 2.17 DER of Listed Companies by Degree of Ownership Concentration Table 1.21 Nonperforming Loans by Type of Bank. 1986-1996 Table 1. Republic of Korea Table 2. 1985-1998 6 7 9 11 12 14 14 18 19 21 26 27 28 32 33 34 36 39 40 41 41 54 56 61 63 .12 CharacteristicsoftheBoardofDirectors Table 1. 1992-1998 Table 2. 1990-1997 Table 1.18 GDP Growth by Sector.7 Growth Performance of the Top 300 Conglomerates.15 V alue of Stocks Issued and Stock Market Capitalization.9 OwnershipConcentrationofPubliclyListedCompanies by Sector. 1997 Table 1.13 Presence of Board Committees in Listed Companies Table 1. 1993-1999 Table 1.19 DER and ROE of Publicly Listed Companies by Sector.10 Anatomy of the Top 300 Indonesian Conglomerates. 1992-1997 Table 1.14 Banking Sector Outstanding Loans.vi List of Tables 1. 1996-1998 2.20 ROE of the Banking Sector. 1992-1997 Table 1.8 OwnershipConcentrationofPubliclyListedCompanies. 1996-1998 Table 1. 1992-1995 Table 1. 1993-1997 Table 1.2 Foreign Capital Flows.6 GrowthandFinancialPerformanceofState-Owned Companies. 1992-1997 Table 1.4 Growth Performance of Publicly Listed Companies by Sector.1 Listed Firms with Positive Economic V alueAdded. 1996-1999 Table 1. Indonesia Table 1. 1992-1999 Table 1.2 KeyMacroeconomicIndicators Table 2.4 Development of the Stock Market.16 FinancingPatternsofPubliclyListedNonfinancial Companies. 1992-1997 Table 1. 1988-1996 Table 1.1 Growth of the Banking Sector.
1985-1998 GrowthandFinancialPerformanceoftheNonfinancial Corporate Sector.25 Table 2.11 Table 2.9 Table 2. 1995-1997 Ownership Composition of Listed Companies.19 Table 2. 1985-1997 GrowthandFinancialPerformanceofListedCompanies by Size.29 Table 2.14 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 .18 Table 2.5 Table 2. 1987-1997 FlowofFundsoftheNonfinancialCorporateSector.22 Table 2.26 Table 2.10 Table 2.30 Private Capital Flows to Korea. 1990 and 1997 Ownership Composition of Listed Nonfinancial Firms by Size. 1988-1997 FinancingPatternsoftheNonfinancialCorporateSectorby Industry Financing Patterns of Listed Companies.7 Table 2.27 Table 2. 1988-1997 Ownership Concentration of the Survey Sample of 81 Listed Firms.20 Table 2.16 Table 2.6 Table 2. 1997 Ownership Composition of Listed Firms in Selected Countries. 1994-1997 Cross-Payment Guarantees of the Top 30Chaebols.17 Table 2. 1999 InternalShareholdingsofthe30Largest Chaebols.13 Table 2. 1997 Ownership Composition of Listed Nonfinancial Firms by Control Type.28 Table 2.21 Table 2. 1993-1997 The Top 30 Chaebols Debt-to-Equity Ratio.15 Table 2.vii Table 2.12 Table 2. 1997 OwnershipConcentrationofListedNonfinancialFirms by Firm Size.8 Table 2. 1992-1997 OwnershipConcentrationofListedNonfinancialFirms. 1988-1997 Ownership Composition of Listed Nonfinancial Firms by Industry.23 Table 2.24 Table 2. 1994-1998 Financing Patterns of the Top 30 Chaebols. 1997 Ownership Concentration ofAll Listed Firms. 1988-1997 OwnershipConcentrationofListedNonfinancialFirms by Industry. 1990-1997 InternationalComparisonofRatiosofOrdinaryIncome toSalesinManufacturing GrowthandFinancialPerformanceofSelectedIndustries GrowthandFinancialPerformanceofListedCompanies. 1988-1997 FinancingPatternsoftheNonfinancialCorporateSector. 1988-1997 Features of the 30 Largest Chaebols GrowthandFinancialPerformanceofthe30Largest Chaebols.
1988-1997 Table 3.31 Table 2. 1988-1997 Table 3.000 Companies.20 Financing Patterns by Industry. 1995-1998 4.21 OwnershipConcentration.viii Table 2.1989-1997 Table 3.Profitability andFinancial .9 OwnershipConcentrationatCriticalLevelsofControl Over Publicly Listed Companies.16 CorporateFinancing PatternsbyOwnershipType.SectorOrientation. 1990-1998 131 137 138 158 159 160 161 163 164 166 173 175 176 180 184 191 201 203 204 205 206 207 208 209 212 235 236 3. 1997 Table 3.12 Control Structure of the Top 50 Corporate Entities.8 Ownership Composition of Philippine Publicly Listed Companies by Sector.6 GrowthandFinancialPerformanceoftheCorporateSector by Firm Size.17 Composition ofAssets and Financing of the Publicly Listed Sector.33 Net Profit Margins of Chaebols.1 Public Companies Registered. Leverage Table 3. 1988-1997 Table 3. 1986-1998 Nonperforming Loans of General Banks.4 GrowthandFinancialPerformanceoftheCorporateSector by Ownership Type. 1997 Table 3.32 Table 2. 1989-1997 Table 3. The Philippines Table 3. Thailand Table 4.13 ADB Survey Results on Shareholder Rights Table 3.2 Public Offerings of Securities. 1997 Table 3.15 Financing Patterns of the Corporate Sector. 1988-1997 Table 3. 1985-1997 Number of Firms with Dishonored Checks. 1983-1997 Table 3. 1978-2000 Table 4.11 TotalandPerCompanySales. 1988-1997 Table 3. 1992-1999 . 1988-1997 Table 3. 1989-1997 Table 3.19 Financing Patterns by Firm Size.14 Philippine Stock Market Performance. 1990-1999 Table 3. 1997 Table 3. 1997 Table 3.2 Growth and Financial Performance of the Top 1.5 GrowthandFinancialPerformanceoftheCorporateSector by Control Structure. 1989-1997 Table 3. 1989-1997 Table 3.1 GDP Growth of SoutheastAsian Countries. 1992-1996 Table 3.7 GrowthandFinancialPerformanceoftheCorporateSector by Industry.18 Financing Patterns by Control Structure. Flagship Company.3 TheCorporateSectorandGrossDomesticProduct.22 Foreign Investment Flows. andAffiliated Banks of Selected Business Groups.10 Composition of Top Five Shareholders of Philippine Publicly Listed Companies by Sector.
9 Table 4.7 Table 4.1 Figure 3. 1992-1999 Offerings of Debt Securities.13 Table 4. 1990-1998 StatisticalRelationshipsbetweenCorporateProfitability.ix Table 4. 1985-1996 Top-Five Ownership Concentration of Publicly Listed Companies in Thailand. 1990-1996 Common-Size Statements of Public Companies by Ownership Concentration. 1990-1996 Financial Ratios of Listed Companies by Ownership Concentration. Ownership Concentration.14 Table 4. and Company Size Top-Five Shareholder Composition of Publicly Listed Companies in Thailand.12 Table 4. 1990-1998 Merger and Acquisition Activities. 1985-1996 Average Key Financial Ratios by Company Size. 1990-1996 Financial Ratios of All Listed Firms.16 Table 4.3 Table 4.10 Table 4. 1986-1999 NumberofNewlyRegisteredandBankrupted/Closed Companies.2 Figure 3. 1990-1996 External Debt.17 StatisticalHighlightsoftheStockExchangeofThailand.8 Table 4.6 Table 4.15 Table 4. 1993-1999 Size and Composition of the Thai Financial Sector. 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 .5 Table 4.11 Table 4. 1992-1999 Common-Size Statements for Companies Listed in SET.4 Table 4. 1993-1999 Key Financial Ratios of Publicly Listed Companies. Leverage.1 Figure 1.
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.
the controlling families of corporate groups often established banks to provide funds to affiliated nonfinancial companies. were the ones most affected. It analyzes the weaknesses of corporate governance in Indonesia. and . placed a high premium on these political connections in assessing the chances of being repaid. When the crisis hit the country. particularly those with large foreign loans. To facilitate even easier access to credit. The construction sector was the worst hit. and analyzes their importance to the corporate sector in Indonesia.2 presents an overview of the Indonesian corporate sector. These banks were allowed to operate even if they violated minimum capital adequacy requirements. 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. short-term loans were used to finance long-term investments. On the other hand. the currency composition and term structure of corporate foreign indebtedness were causes for concern. Section 1. contracting by 36. followed by finance (-26. how it has affected corporate financial performance and financing. Vol. This study reviews the Indonesian corporate sector’s historical development. patterns of financing.2 Corporate Governance and Finance in East Asia. 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. All sectors.5 percent. Foreign creditors. The scale of the financial crisis exposed weaknesses of the country’s corporate sector. except utilities. These were already contributing to high levels of nonperforming loans (NPLs) in the Indonesian banking sector several years before the 1997 crisis erupted. patterns of ownership and control. these controlling families had political connections that allowed their companies to enjoy special privileges. Malaysia. highly leveraged companies. Foreign debt reached more than $100 billion. The study also identifies family-based companies and corporate groups. no doubt. In this setup. 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. Economic growth reached more than 7 percent per year and the inflation rate was kept at single digit levels.6 percent) and trade (-18 percent). In many instances. posted negative growth.3 looks at patterns of corporate ownership and control. the Indonesian economy seemed to be in generally good shape. this left the Indonesian economy extremely vulnerable. However. Section 1. and how it contributed to the crisis. prior to the financial crisis.5 percent. or Thailand. II rate reached 58. and responses to the financial crisis. regulatory framework.
1.Chapter 1: Indonesia 3 profiles the corporate sector’s governance characteristics.2.1 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. while Chinese and indigenous entrepreneurs ran some large businesses in trading. With the relatively liberal laws governing foreign and domestic private investments introduced by the New Order Government in 1967 and 1968. the windfall from oil and gas revenues was an important factor that allowed the Government to promote industrial development via import substitution. in the course of the fight for nationhood from 1942 to 1950. medium. how it was affected by the crisis.and large-scale companies were dominated by state-run industrial concerns.5 examines the corporate sector during the financial crisis in terms of its role. This section reports the results of an Asian Development Bank (ADB) survey on corporate management and control practices in Indonesian publicly listed companies.4 analyzes corporate financing patterns. . The industries that emerged were highly import-dependent and reliant on tariff protection.6 summarizes the major findings of the study and suggests recommendations to improve governance in the Indonesian corporate sector. It also examines the statistical relationship between corporate performance and corporate governance characteristics. In the early 1970s. Section 1. Section 1. Up until the mid-1960s. Despite the oil revenues. and tobacco industries.2 1. The Government became directly involved in industry as a result of the nationalization of Dutchowned shipping firms and oil companies. Subsequently. textiles. However. Not all items in the questionnaires were answered by the respondents.2 Section 1. and its response. 2 Survey questionnaires were sent to 280 companies listed in the Jakarta Stock Exchange. a gradual shift in public investment away from manufacturing took place. only 40 companies replied—39 are private companies and one state-owned company (Bank BNI). substantial volumes of private investment entered the scene.
a distinct industrial elite started to emerge. By 1987. Vol. Third. the number of firms quoted in the stock market was only 24. Last. even when new shareholders do not threaten the control exercised by the original owners. These were families with strong links to the political elite of the New Order. the dilution of corporate ownership.4 Corporate Governance and Finance in East Asia. Regulations in the banking sector led to equities having higher risk but lower returns than bank deposits. Partly as a result of various government policies. But these proved counterproductive because they limited the potential for capital gains to prospective investors. A number of underwriters emerged. During this period. 1. But until the end of 1988. Second. 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).2 The Capital Market The Government reactivated the stock exchange in 1977. potentially subjects companies to greater regulatory scrutiny. there were also many rapidly growing large-scale companies and business groups or conglomerates. wood. produced consumer goods. the value of manufactured exports overtook the value of oil and gas exports for the first time. The equity market remained largely unappealing due to a number of factors. the stock exchange was also unattractive to companies trying to raise capital as they could borrow from state banks at very low interest rates. II the currency needed to be devalued periodically under a managed floating exchange rate system to avoid large current account deficits. First. 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. which dominated their respective sectoral outputs and markets.2. many founding owners of companies were reluctant to go public and dilute their corporate ownership. exports of nonoil products (particularly textiles and footwear. Export credits with low interest rates were granted to industries that were intensive in the use of local labor and raw materials. . In the 1980s. While most of the companies were small. the Indonesian industrial sector was quite diverse. the Government shifted its industrial policy toward the promotion of labor-intensive exports. In 1992. mostly nonbank financial institutions and stockbrokers. and employed the bulk of the industrial labor force. and related products) had shares in total exports that were rapidly increasing. Generally speaking.
the liberalization of the banking industry allowed banks to determine lending rates for nonpriority loans. Table 1. reduced restrictions on foreign exchange transactions. private domestic banks dominated the sector in terms of number and total assets. 1.3 The Banking Sector Despite the development of the stock market. the number of listed companies in the stock exchange increased substantially. with a total value of more than Rp8 trillion. These included the opening of the banking industry to new entrants. six SOCs had issued equities in the market. Since 1977. The Government also allowed foreign investors to buy up to 49 percent of listed shares. the banking sector has undergone many reforms. However. Interest rate regulations on state banks and credit ceilings in general were removed. the capital market played an increasing role in raising long-term funds needed by the corporate sector. which were previously constrained to 4 percent per day.2. with a total value of Rp16. which up to then was channeling oil revenues to priority sectors. Further reforms along the same direction and affecting state-controlled banks came in the 1990s. Partly as a result of these reforms. Conglomerates carried out 210 out of 257 IPOs. Consequently. In 1988. and increased access of domestic banks to international financial markets. The Government also abolished the practice of setting prices for IPOs and removed restrictions on price movements in the secondary market. However.5 trillion. The development of the Indonesian stock market also provided a vehicle for the privatization of state-owned companies (SOCs). more significant reforms were introduced. state-owned banks were still among the biggest.Chapter 1: Indonesia 5 At the end of 1988. companies could no longer enjoy low-interest credit from state banks. During this period. The initial banking sector reform was introduced in 1983. . The banking sector. the controlling shareholder of these SOCs is still the State. from 24 in 1988 to more than 300 in 1997. began to face competition. The dominance of state banks started to erode. However. But in terms of assets per bank. to date.1 shows that from 1994 to 1998. the legal infrastructure that was supposed to guide the evolution of the banking sector was not backed by effective enforcement. Thus. priority credits still enjoyed subsidized interest rates and funding from the Central Bank. Through the years. the banking sector has been and still is the major source of credit for the corporate sector. the number of private domestic banks increased.
1 240 1995 122. The other banks among the top 10 were state banks.9 27 113.2 10 14. 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. .6 Corporate Governance and Finance in East Asia.8 391. the 10 largest were all affiliated with major business groups.9 291. 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.7 27 37. Bank Danamon.8 27 147. private domestic banks among the top 10 in 1997 included Bank Central Asia (BCA) (ranked first and linked to the Salim group). II Table 1.5 27 88.5 165 308.6 7 7. 1993 100.8 29 6.8 31 10. Bank Danamon (ranked 7th).0 234 1994 104.4 10 35. But the banking system proved incapable of performing its intermediation function.5 27 66. and Bank International Indonesia (ranked 9th).4 239 222 208 173 Assets and liabilities were concentrated in the top 10 banks.6 240 1996 1997 1998 1999 141.3 10 17. Vol.7 351.1 10 47. banks could earn profits even when they did not gather and process information about risk.4 789.2 161 214.1 Growth of the Banking Sector.6 164 144 130 92 387.4 34 12.9 248.5 528. BCA.8 27 200.9 10 11.8 10 19.8 10 37.8 166 248.6 7 12.3 201. Of these.9 39 18.6 34 14. In terms of assets.9 762.3 30 7.5 7 7 7 5 15. and Bank Umum Nasional (BUN) have failed and the first two are now under management of the Indonesian Bank Restructuring Agency (IBRA). Because regulation was weak. Both BCA and BUN have shareholders linked to the former President Suharto. Among private domestic banks.9 31 9.5 7 9.9 304.3 27 51. while BUN has been closed down by the Government.
and footwear.74 5.2 Foreign Capital Flows. as shown in Table 1.09) 1. From the mid-1980s until July 1997. September 2000. Indonesia received capital inflows averaging about 4 percent of GDP.87 7.88 4.50 (0. foreign creditors were eager to provide financing to Indonesia.11 3.59 4.2. such as metal goods. Source: IFS CD-ROM. Until the onset of the crisis.09) (0. textiles.09 1. In 1994. In the 1990s. initially from Japan and the Republic of Korea.40) (0. 1. November 2000.01) (0. foreign investment also had a strong presence in the services and infrastructure sectors.33 (13.88) — — — — — — 8. Table 1.15) — = not available. Most FDIs came in through joint ventures with business groups having strong political connections.4 Foreign Capital The years of rapid industrial growth attracted a large amount of foreign direct investments (FDIs).59 billion in 1996.48 1. Increasingly. Although these inflows were not nearly as large as those received by Thailand (10 percent of GDP) and Malaysia (9 percent of GDP). Joint BIS-IMF-OECD-World Bank Statistics on External Debt. Net FDI flows increased to $5. there was a phenomenal growth in direct borrowings by Indonesian corporations. 1990-1998 ($ billion) Type of Flows Net FDI Net Portfolio Investment Foreign Bank Loans 1990 1991 1992 1993 1994 1995 1996 1997 1998 1. IMF.81 3. Successive policy deregulation facilitated FDIs in various light manufacturing industries.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. they still amounted to a large sum for the economy to absorb.2. 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. . especially through bank loans.63) (1. when the financial crisis hit Indonesia.78 2. FDI flows were strong.10 5. Between 1990 and 1996. except in certain strategic sectors.00 2.01 (2. In effect. But FDIs were only one form of foreign capital inflows to Indonesia. the Government allowed foreign investors to own 100 percent of an Indonesian company.
This increased to 30 percent by the end of 1993. 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. the average borrowing rate for dollar loans was 9 percent. more than 50 percent of total Indonesian private debt and 60 percent of total foreign exchange debt were owed to 175 foreign banks and other foreign financial institutions. of which two thirds were rupiah-denominated. with the onset of the Asian crisis. The external corporate debt owed to foreign commercial banks was $67 billion. Consequently. especially the short-term ones. In September 1997. an interesting question is whether standard measures of corporate profitability and performance also indicated the same. state-owned companies (SOCs). Due to data constraints. total corporate debt reached nearly $118 billion. The following section looks at the growth and financial performance of the corporate sector.4 trillion in 1997. the average foreign ownership of listed companies was 21 percent.8 Corporate Governance and Finance in East Asia. II Up until the late 1980s. Between 1989 and 1992. By the end of 1997. From 1987 to 1996. plus 4 percent for the depreciation of the rupiah. 1.5 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. The excessive dollar borrowings made the corporate sector vulnerable to sudden currency fluctuations. participation in the Indonesian stock market was exclusive to domestic investors. and conglomerates. but declined to an average of 25 percent during 19951997. 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.2. foreign investors began to dominate daily trading. foreign banks became a significant source of financing for the corporate sector. increasing the total trading value from Rp8 trillion in 1992 to Rp120. . Domestic corporate debt was about $50 billion equivalent. Capital account liberalization permitted the inflow of foreign capital that fueled the credit boom in the country. allowing foreign investors to buy up to 49 percent of stocks of a publicly listed company. The Government relaxed this restriction in 1988. This is lower than the average borrowing rate of 18 percent for loans in domestic currency. Vol. Private borrowers preferred foreign loans since these were relatively cheaper. In November 1998. In the 1990s. the analysis focuses only on publicly listed companies.
1 0.0 6. but turned negative in 1997. and 1992.4 38. but fell to 24.4 1996 18.5 3.3 Growth and Financial Performance of Publicly Listed Companies.7 3. Net profits grew at an annual rate of more than 20 percent from 1992 to 1996. Average return on equity (ROE) of listed firms was 11.3 6. total sales of listed companies grew at an annual average rate of 31 percent.0 12. 1994.5 240. Asset turnover was above 30 percent until 1996. ranging from 220 to 250 percent between 1992 and 1996.8 percent between 1992 and 1996.5 37. 174 firms. 248 firms.4 31.1 4.0 12. 1996.5 34. a Value added was assumed to be 30 percent of total sales.9 37. Table 1.2 30. publicly listed companies as a group contributed less than 10 percent to GDP. When the crisis battered Indonesia in 1997.6 3. 250 firms. averaging 3.0 12.0 64.6 percent in 1997. During 1992-1997.7 — = not available. 1995. Despite such rapid growth.2 1995 37.0 3.0 1. 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 dropped to 1. although the contribution increased over time.0 10.6 24. but declined to 0.1 220.2 7.4 percent. Note: The number of firms is not identical for each year.3 shows the growth and financial performance of Indonesian publicly listed companies.4 1993 45.6 1994 50. 246 firms.0 33. 226 firms.5 34.Chapter 1: Indonesia 9 Publicly Listed Companies Table 1.8 220.4 1997 7.1 percent in 1997 when the crisis began to buffet Indonesia. b Asset turnover is defined as sales over assets.6 48.3 3. The growth of listed companies was sustained by continuing investments. In 1997. 1993.7 percent in 1997.7 — 250. Source: JSX Monthly (several publications). Return on assets (ROA) was also relatively stable during 1992-1996. there were 204 firms.8 230. while total assets grew at 43 percent.0 11. The debt-to-equity ratio (DER) was high compared to those of listed companies in Malaysia and the Philippines.8 6.9 310. the average DER increased to 310 percent from 230 percent the .
real estate.3 percent between 1992 and 1996. miscellaneous industry. meanwhile. In terms of sales and asset levels in 1997. and property. Four sectors (basic industry and chemicals. averaging 17. Meanwhile. indicating its reliance on equity to support growth. the dominant sector was the finance sector. which operated in nickel and copper mining in 1992 and 1993. property. Also. and services. real estate. This indicates that a substantial part of corporate debt was denominated in dollars and unhedged. miscellaneous industry. However.64 percent in 1997. mining. property.2 in 1997. The finance. and trade) even posted . the mining sector ranked first. trade. The same applied to the trade sector. The Jakarta Stock Exchange (JSX) classified listed companies into nine sectors: agriculture. But the sector’s ROE fluctuated a lot. the companies in the sector did not operate with a high leverage. The finance sector’s contribution to GDP. although asset turnover was slow. consumer goods. II previous year. followed by agriculture (Table 1. in terms of growth of sales and assets. ROE fell drastically because the sector had one of the highest DERs.73 percent in 1992 to 1. Vol.7 percent during 1992-1996. when the property sector was booming during 1993-1997. and building construction sectors had the highest DERs because companies in these sectors found it easy to obtain credit from banks. finance. still posting a positive but lower ROE.10 Corporate Governance and Finance in East Asia. Table 1. and trade. Overall. the mining sector had the highest ROE. due mainly to the domination of the International Nickel Company of Canada. The consumer goods sector ranked second in terms of ROE. During those years. Most companies in the sector that had unhedged dollar-denominated loans suffered exchange rate losses when the rupiah weakened. infrastructure. and building construction. Before the crisis. This sector was less affected by the crisis. averaging 21. increased from 0. helped in part by the relatively strong demand for consumer goods. basic industry and chemicals. The ROE levels suggest that high leverage enabled listed companies to achieve high returns on equity. and services. the mining sector had the lowest DER. with ROE falling to -11. it appeared that the performance of listed companies was quite satisfactory prior to the crisis. the fluctuation in nickel and copper prices contributed to the oscillation of ROE.4). For instance. investment. In terms of share of value added to GDP. investment. the property sector was severely affected by the crisis. When interest rates increased. From 1995. the banks eagerly provided credit to property development companies.5 presents the financial performance of listed companies by sector. ROA of all sectors dropped in 1997. only two sectors (mining and finance) showed a consistently increasing trend from 1992.
Industry Consumer Goods Industry Prop.5 95.4 30. Constn.1 32.1 0.7) 17.2 59. and Bldg. Constn.4) 8. Industry Consumer Goods Industry Prop.7 43.4 38..6 24.0 0.8 50.9 36.6 0.5 9.3) 53.9 123.9 31.9 25.0 18.1 (11.0 43.3 17.2) 0.7) 26.2 35.. and Services Asset Growth Agriculture Mining Basic Industry and Chemicals Misc.5) 49.5) 13..9 0.8) (12.8 28. Infrastructure Finance Trade.8 (76.3 51.9 8. Real Estate.4 170.3 0.1 1.9 0.9 .1 0. Investment.4 103.2 0. and Services Net Profit Growth Agriculture Mining Basic Industry and Chemicals Misc.2 14.3 92.2 5.1 71.6 0.0 (192.0 1996 1997 58.7 34.8 24.9 53.1 67.8 1. and Services Share of Value Added in GDP Agriculture Mining Basic Industry and Chemicals Misc.6 22.1 1.9 14.5 61.4 64.5 1.8 66. Infrastructure Finance Trade.1 0.2 41.5 0.9 1.5 68.4 1.3) 39.4 (149. and Bldg.6) 25.2 41.1 0.6) 19.2 0.1 0.6 0.7) (113.4 31.8 32. and Bldg.5 1. Infrastructure Finance Trade.0) 46.7 1995 51.1 35. 1992-1997 (percent) Indicator/Sector Sales Growth Agriculture Mining Basic Industry and Chemicals Misc.8 62.5 92.5 28.5 1.4 1.0 1.7 21.4 0.1 0.1 0.3 0.4 21.3 1. Investment.3 (203.1 1. Investment.9 (7.0 0.0 0.7 133.6 0.4 1. Real Estate.6 1. Real Estate.1 (41.9 64.1 42.7 17.0 0.6 133.4 43.8 1.2 11.5 (11.1 16. Constn.6 (41.8) 0.1 28.7 112.5 (8.7 0.6 51.7 — — 11.7 90.1 — 39. Infrastructure Finance Trade.7) (27.5 53.8 29.6 26.9 54. Investment. 1992 — — — — — — — — — — — — — — — — — — — — — — — — — — — 0.7 0. Real Estate. Source: JSX Monthly (several publications).8 0.2 13.1 0.0 16.1 1.3 31.1 0.6) 119.3 0.7 24.1 0.0 0.4) 6.4 1993 155.6 28.1 23.1 1. Industry Consumer Goods Industry Prop.7 54.6 85.7 62.4 30..5 45.9 54.6 135.4 77.7 40.4 Growth Performance of Publicly Listed Companies by Sector.6 15.5) 6.8 51.5 13.3 340.7 — 36.0 (28.9 59.0 (20.0 68.6 83.4 44. and Services — = not available.0 31.3 31.5 23.5 0.0 24. Constn.0 64.6 1994 (75. Industry Consumer Goods Industry Prop. and Bldg.Table 1.7 28.3 0.6 (0.8 27.0 22.3 0.7 (82.0 0.
2 7.8 16.0 650. Industry Consumer Goods Industry Prop.4 71.4 46.3 38.0 110.4 6. Constn.1 6.1 (3.7 9.0 80.0 150.6 8.5 Financial Performance of Publicly Listed Companies by Sector.9 4.9 7.5 7.5 19.1 10.4 17.8 168.0 700.2 15.7 1.0 120.7 4.1 10.4 1.8 479.3 13.2 111.1 3.1 63.0 100.1 4.0 70.0 140.7 1.6 19.0 150.0 80.3 33. and Services Source: JSX Monthly (several publications).0 11.8 67.7 46. Investment.0 3.0 120.9 10. and Services Return on Equity Agriculture Mining Basic Industry and Chemicals Misc. Constn.8 11.4 5.1 10. Investment.0 50.7 10.2 39.5 4. and Bldg.0 14.3) 5.0 70.3 17.6 8.1 65.8 81.Table 1.6 74.7 12.6 13. Constn.9 42.0 110.0 80.0 46.7 8.4 46. Investment.5 13.0) 7.4 13.2 6.5 1995 80.2 11. Infrastructure Finance Trade.0 650.1 1994 80.7 (3.0 180.5 43.6 13.7 71.0 210..4 . 1992 20.7 8.4) (1.0 630. Real Estate.0 66.0 15.5 11.1 89.4 35. Investment.3 0.6 23.3 7.2) 15. and Services Asset Turnover Agriculture Mining Basic Industry and Chemicals Misc.1 8. Real Estate.0 220.8 44.1 11. Real Estate.9 40.1 9.3 5.0 70.2) 7. Infrastructure Finance Trade.8 11.3 18.8 8. Industry Consumer Goods Industry Prop.0 150.1 9.7 13.0 110.0 110.8 9.0 9.0 170.0 160.7 61. Infrastructure Finance Trade. Constn.0 380.7 5. and Bldg. and Bldg.0 17.0 190. 1992-1997 (percent) Indicator/Sector Debt-to-Equity Agriculture Mining Basic Industry and Chemicals Misc.0 110.5 56.8 5.0 1997 230.0 120.0 69.1 1. Industry Consumer Goods Industry Prop.0 120.2 (4.0 190.0 90.7 10.7 4.1 2.1 13..4 35.6) 36.9 41.1 4.6 (11.1 1996 100.8 3.7 10.0 100.0 160.2 7.0 60.9 17.4 4.2 3.0 8.. Infrastructure Finance Trade.0 19.0 160.2 1993 130.0 680.0 100.5 14.9 38.2 13.0 100.0 110.0 130. and Bldg.8 20.9 29.0 560.5 5.2 53.4 20.8) 8..7 12.8 382.0 12.9 14.3 64.0 3.4 6.7 12.6 (2.0 110.0 140.1 (5. Real Estate.4 13.3 73.6 1.2 23.2 3.7 5.0 86.5 4.0 180.1 4.4 79.0 (0. and Services Return on Assets Agriculture Mining Basic Industry and Chemicals Misc.3 7.2 30.6 14. Industry Consumer Goods Industry Prop.1 7.2 8.9 38.0 8.7 26.6 18.8 25.6) 18.5 17.3 1.9 87.7 4.0 190.0 39.3 17.0 180.
increasing from 21. This was due to large sales by the National Oil Company (Pertamina). By 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. averaging 24 and 31 percent. ROA had been at high levels from 1992 to 1995. and finance company (four companies).6 to 8. Similarly. Taken together. the SOCs’ value added as a percentage of GDP ranged from 6 to 8.7 percent.6). indicating SOCs’ declining contribution to GDP. growth of net profits and assets was erratic. These growth rates were low compared to those for listed companies during the same period. Six SOCs were listed in the Jakarta Stock Exchange. Just like private companies. the subsidiaries and affiliates number 459 with total assets of Rp343. Asset turnover rates were lower relative to those of publicly listed companies.1 percent in 1992 to 28.3 percent in 1995. respectively. However. between 1993 and 1995. SOCs actively operated in various sectors4 under the supervision of “technical” departments. insurance (11 companies). much lower than that of companies listed in the stock exchange.7 percent in 1990 to 6 percent in 1996. the Department of Finance supervised 30 SOCs. . banks (seven companies). SOCs diversified into many businesses.Chapter 1: Indonesia 13 negative ROA. but it continuously declined from 370 percent in 1992 to 250 percent in 1995. State-Owned Companies At the end of 1995. SOCs’ sales growth fluctuated during 1990-1996.7 to 7 percent for publicly listed companies. Only the agriculture sector showed an increase in ROA in the couple of years before 1997. The DER was slightly higher than for listed companies. there were 58 SOCs with subsidiaries and affiliates.3 trillion. The Department of Mining and Energy ranked first in terms of sales of SOCs under its control. Trade had the highest ROA of 39. The finance and miscellaneous industry. which collectively had the largest assets. This was relatively high compared to the 3. SOCs’ ROE ranged from 6. but dropped dramatically to 4.8 percent between 1992 and 1995 (Table 1. the ratio decreased from 8. and basic industry and chemicals sectors had relatively stable ROA before the crisis.1 percent in 1993. For instance. The sectoral distribution of 165 SOCs is as follows: nonfinancial (143 companies). registering an average annual rate of 10 percent. there were 165 state-owned companies (SOCs)3 in Indonesia. Assuming a fixed ratio of value added to sales.
8 percent in 1990 to 13.4 percent in 1992 to 28. the contribution of conglomerates to GDP increased from 12.1) 5.0 6.14 Corporate Governance and Finance in East Asia. a Value added was assumed to be 30 percent of total sales.8 21.3 12.6 28.1 32.0 17. Assuming a constant ratio of value added to sales.5 3.1 trillion in 1990 to Rp234 trillion in 1997. but climbed to 30.4 13. Vol.8 11.4 7.7 (2. Source: Indonesian Data Business Center.0 12.0 8.3 30.0 8.6 percent in 1994.5 Conglomerates This study used available data on the top 300 conglomerates in Indonesia.0 24.7 13.6 1995 25.0 7. b Asset turnover is defined as sales over assets.6 Growth and Financial Performance of State-Owned Companies. 1992 — 7.6) 260.2 23.1 6.2 — = not available.766 business units. these conglomerates owned 9. . II companies consistently declined over time.3 250. In 1997. a Value added was assumed to be 30 percent of total sales.1 30.4 13.2 — 370.4 percent in 1994.0 28.7).7 16.2 18.4 1993 16. 1990-1997 (percent) Item Sales Growth Share of Value Added in GDPa 1990 1991 1992 1993 1994 1995 1996 1997 — 17. Table 1. mostly private companies. Table 1.7 Growth Performance of the Top 300 Conglomerates.7 1994 (9.1 12.5 percent in 1995.4 13. 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.1 19.4 16.8 12. SOCs’ asset turnover rates showed a downward trend from 32.2 percent in 1997 (Table 1.6 28. but dropped to 11. Source: Indonesian Data Business Center.1 310. Their total sales increased from Rp90.
and consolidations. an approval needs the majority (50 percent plus one) vote. and the accountant. tasked with supervising the firm. The BOD undertakes operating decisions while the BOC participates in strategic decisions and operations review. This guards against shady intercompany dealings within a group of companies.Chapter 1: Indonesia 15 1. By international standards. a member company might sign a disadvantageous contract with another company where the same controlling shareholder has a higher stake.2. The law replaced an earlier statute that was based on the Dutch system. acquisitions. and declaration of bankruptcy. The BOC. The 1995 law requires limited liability companies to set up two boards: the board of commissioners (BOC). such as the appointment (or replacement) of directors. For example. A chairman heads the BOC while a chief executive officer (CEO) heads the BOD. If the BOC does not perform well. the decision to amend the company charter should be approved by two thirds of shareholders present in the meeting. For instance. shareholders lose control. In general. however. For instance. The company charter details the issues that need shareholder meeting approval. tasked to provide direction to the company. commissioners. The meeting decides on important issues. is the only shareholder mechanism for monitoring and controlling the BOD. The law explicitly requires approval during the meeting of decisions on strategic issues such as amendment of the company charter (articles of incorporation). and the attendance should at least be two thirds of total shareholders.6 Legal and Regulatory Framework During the 1990s. . the Government promulgated a number of laws and regulations to protect investors. mergers. The actual responsibilities of BOCs vary by company and are stipulated in the company’s charter. as representative of shareholders. except in strategic issues stated in the law. For mergers. The law also specifies that the highest “institution” in the limited company is the shareholders’ meeting. The law also holds the directors and commissioners jointly responsible for decisions made by the company. and the board of directors (BOD). The Corporate Law The Corporate Law of 1995 governs the establishment and operation of limited liability companies in Indonesia. The law mandates the BOC and BOD to work for the best interests of the company and not just of the shareholders. the legal and regulatory framework of the corporate sector was far from adequate. the decision to use certain company assets as collateral for bank credit might need BOC approval.
16 Corporate Governance and Finance in East Asia. brokers. The law is supplemented by Government regulations. consolidations. 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. 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 other supporting agencies. (xvi) independence of auditing. The Capital Market Law The Capital Market Law (1995) regulates companies listed in the stock exchange. investment managers. It also regulates reporting and auditing procedures. (xv) mechanisms to resolve disputes between the company and shareholders. (vii) the right to call an emergency shareholders’ meeting. (x) mandatory shareholders’ approval of major transactions. delineating the tasks and responsibilities of the Capital Market Supervisory Agency. and (xviii) severe penalties for insider trading. transparency requirements. A tender offer is also required for acquisitions of up to 20 percent of listed shares. securities companies. An important rule is the requirement for independent shareholders’ approval for arrangements that might lead to conflicts of interest. investment advisors. Vol. (vi) one share one vote. The law provides the following rights to or protection of shareholders: (i) access to regular and reliable information free of charge. and guidelines promulgated by the head of capital market supervision. insider trading (including market rigging and manipulation) investigation. (viii) the right to make proposals at the shareholders’ meeting. (iv) cumulative voting for directors. and the attendance should at least be three fourths of total shareholders. (xii) mandatory disclosure of connected interests. Controlling shareholders have no vote on the matter. and administrative and legal punishment. (ix) mandatory shareholders’ approval of interested transactions. underwriters. (xi) mandatory disclosure of transactions by significant shareholders. II acquisitions. (xiv) mandatory disclosure of intercompany affiliation such as affiliated lending or guarantees. and bankruptcy. decrees of the finance minister. (xvii) mandatory independent board committee. (v) preemptive rights on new share issues. It regulates the requirements of investment companies. (ii) proxy voting. (iii) proxy voting by mail. Because of such requirements. . (xiii) mandatory disclosure of nonfinancial information. such as custodian banks and the securities registration bureau. the decision should be approved by three fourths of the shareholders present.
capital adequacy. 1. It aimed to protect creditors by providing easier and faster access to legal redress. A Commercial Court was also set up to deal with bankruptcy cases.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. 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. The two most important elements of ownership structure are concentration and composition. amended in October 1998.g. Ownership concentration is usually measured by the proportion of shares owned by the top one. five. etc. 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. the Banking Law (1992). whether they are individuals. for instance. Banking regulations also set lending limits. Discussions on corporate ownership cover listed companies and conglomerates.Chapter 1: Indonesia 17 Bankruptcy Law Despite loan covenants. 1. or financial institutions. For instance.3. or 20 shareholders. A new bankruptcy law was passed in August 1998. the collateral could take the form of nonphysical assets (e. However.1 Corporate Ownership Structure Quality of corporate governance is closely related to corporate ownership structure (see discussions in the Consolidated Report of this study). states that a bank is not allowed to provide credit without collateral. . The court can declare the debtor bankrupt upon the request of at least two creditors and default on one loan. the viability of a project).. creditors of unsecured loans are unprotected when borrowers fail to meet their obligations. It reveals characteristics of controlling shareholders. families. Banking Laws Affecting the Corporate Sector Some elements of the banking law also affect the corporate sector. net open positions. holding companies.
1 0.9 0. 1993-1997 (percent) Shareholder Rank First Largest Second Largest Third Largest Fourth Largest Fifth Largest Total 1993 50.5 16.6 13.2 1. 13. The percentage owned by each of the five largest shareholders was 48. This is partly due to the prevailing practice of raising equity through rights issues in Indonesia.9 2.6 4. and 0.6 3. Zebra Nusantara (taxi services). The pattern of ownership concentration changed little over this period.5 1997 48.9 14.8 shows average proportions of shares owned by the five largest shareholders of publicly listed companies during 1993-1997.5 percent.0 4.4 percent.7 1996 48. the five largest shareholders owned 68.0 0.9.0 1. 3.4 2.3 1995 47.8 68.0 2.8. This is because a few companies in the transportation sector issued high proportions of shares to the public.7 1994 48.1 4. 2.6 percent.0 0. and basic industry and chemicals sectors than in others. about two thirds of publicly listed companies’ outstanding shares were owned by corporations that were directly or indirectly controlled by families.6 3. mining. When a company goes public.6 68. Data from the Indonesian Capital Market Directory (various publications) show that between 1993 and 1997. This preserves the pro rata share of existing shareholders.1 13.9 shows that ownership by the largest shareholder in 1997 was more concentrated in the agriculture.5 72. Table 1.1 1. When a company makes a rights issue. ownership widely held by the general public is highest in the infrastructure and transportation sector (not shown in the table).6. On average.9 2.9 percent of total outstanding shares.2 11. for instance.2 67. and Berlian Laju Tankers (liquid bulk maritime transportation services) issued 48. the controlling shareholders usually act as standby buyers.18 Corporate Governance and Finance in East Asia.5 Average 48. Vol.8 1.7 3.9 Source: The Indonesian Capital Market Directory. Rig Tenders Indonesia (shipping services) issued 51.0 67. the founder usually continues to own the majority of shares through a . issued 93.8 68.5 12. consumer goods.8 Ownership Concentration of Publicly Listed Companies. Table 1. respectively. II Publicly Listed Companies Table 1.6. Meanwhile.
3 48.3 2.6 9. Legal and regulatory developments may have been impeded by the concentration of corporate wealth in . and only 0.5 1. Indonesia has the largest number of companies controlled by a single family.4 44.7 6. and the efficiency of the judicial system.6 0. Most of the five largest owners of Indonesian publicly listed companies are limited liability companies rather than individuals.7 13.9 3. is strong.1 1. (1999). that the correlation between the share of the largest 15 families in total market capitalization. Real Estate.1 2. the top family controls 16. (1999) also found. on the other.2 2.9 44.3 14.9 44.7 4.9 0.7 percent of the market.9 Ownership Concentration of Publicly Listed Companies by Sector. Table 1. Util.3 0. Investment.2 46.1 1.8 14. two thirds (67.4 11. and Transportation Finance Trade.1 1.2 This is confirmed in Claessens et al.2 0.1 2. and corruption.1 1.9 50.5 4. Infrastructure. In fact. Industry Consumer Goods Industry Prop.4 54.9 1.6 8.2 15.1 0. the rule of law. In terms of capitalization. These figures suggest that ultimate control of the corporate sector rests in the hands of a small number of families.4 6.1 13. in a cross-country study...6 1.4 4.1 0.6 percent of total market capitalization while the top 15 families control 61.6 2.1 percent) of Indonesian publicly listed companies were in family hands. on the one hand.5 58.1 2. Constn.2 10. First Second Third Fourth Fifth Biggest Biggest Biggest Biggest Biggest 54.1 11.3 0. which shows that in 1996.6 percent were widely held.Chapter 1: Indonesia 19 fully-owned limited liability company (Perseroan Terbatas). and Bldg. as well as the existence of corruption. and Services Average Source: The Indonesian Capital Market Directory.4 1. Thus the founder keeps the proportion of shares necessary to retain control over management of the listed firm. 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.7 9. Claessens et al.7 1.3 36.0 5. 1997 (percent) Sector Agriculture Mining Basic Industry and Chemicals Misc.
political affiliation.55 percent in August to 25. Indian. the onset of the crisis negated this development.5 Conglomerates Table 1. and family origin. This may indicate that the New Order Government. their number increased to 5 In 1997. Family control is said to have positive effects in that it allows group members in conglomerates to make strategic decisions quicker. When the Government allowed foreign investors to buy up to 49 percent of listed shares in 1988. Indigenous businesspeople include the Javanese. numbering 162 in 1988 and 170 in 1996. Among the top 300 conglomerates. and Padang. Sundanese. the legal system is less likely to evolve in a manner that protects minority shareholders. Vol. was able to create a favorable environment for business development. there is a dichotomy between corporations owned by indigenous and nonindigenous businesspeople. In 1993. it rose to 30 percent. In Indonesia. ethnicity. However. resulting instead in a decline in the proportion of foreign investor ownership. From 193 in 1988. During 1988-1996. with all its regulations. or other ethnic groups. conglomerates established before 1969 dominated in terms of sales.42 percent in December. accounting for 64 percent of total conglomerate sales in 1988-1996. most were established during the New Order Government. 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. The corruption and regulatory problems generated by high ownership concentration by families in Indonesia are likely to overwhelm its benefits. In September 1997. but later declined and steadied at around 25 percent. II the small number of families and the tight links between companies and the Government. nonindigenous groups owned a larger proportion of the top 300 Indonesian conglomerates. But these benefits are few and often dubious compared to the high costs of concentration. Batak. the Government allowed foreign investors to buy up to 100 percent of listed shares. However. foreign ownership increased to 21 percent. The nonindigenous businesspeople are usually Chinese.10 shows the anatomy of the top 300 conglomerates in terms of year of establishment. . Coordination is easier because informal communication channels exist.20 Corporate Governance and Finance in East Asia. the proportion of foreign ownership declined from 27.
0 44.1 21.9 77.4 48.1 46. Meanwhile.4 32.1 percent of total .9 137.5 22.3 120.5 106. Conglomeration Indonesia 1997.1 87.4 16.7 28.9 13.8 30.0 31.0 116.2 33.7 89.3 101. sales of the Bakrie group before it went public in 1990 were only Rp369. 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 9.0 58.8 57.2 29. In 1996.6 114.2 159.3 43.9 73.9 trillion.4 18.1 41.6 12. For instance.4 59. due to their “go public” activities.2 12.5 120.7 95.9 14.8 28.6 77.4 19.8 38.2 30.1 52.9 42.10 Anatomy of the Top 300 Indonesian Conglomerates.4 31.8 Source: Indonesian Business Data Centre.2 48.0 15.2 23. 204 in 1996.4 31.4 52.6 trillion in 1988 to Rp137.1 42.8 36.7 24.0 28.1 103.4 69.4 trillion in 1996.3 36.4 22.5 21.1 58.7 40.3 134. the number of mixed groups declined from 86 in 1988 to 68 in 1996.8 12.4 37.4 59.4 86.1 46.8 68.2 76.3 20.0 18. more than five times its 1988 level.9 47.6 95. its sales reached Rp1.1 33.1 25.7 106.4 81. While they supplied 20.0 58.3 80.7 64.4 57.4 68.9 35.6 17.Chapter 1: Indonesia 21 Table 1.6 34.9 billion.4 15.8 49. Their total sales also increased from Rp38.8 25.1 179.6 54.7 49.
The high NPLs accumulated by banks within official-related groups could be partly attributed to this practice. Average sales of official-related conglomerates were substantially greater than nonoffficial-related ones during 1988-1996. II sales in 1988. The Salim group. and Ibrahim Risyad of the Salim group. Djuhar Soetanto. Only about 13 percent were formed by official or ex-official families. their contribution declined to 13. owns four groups with many subsidiaries and affiliate companies. Out of 174 companies. In November 1997. Vol. But listed companies within conglomerates were few. Indocement Tunggal Prakarsa (cement industry). 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). average sales of official-related conglomerates reached Rp1. Political alliances between entrepreneurs and officials have often led to the violation of regulations meant to promote prudent business practices in the banking industry. Most of the top 300 conglomerates were established by ordinary citizens. compared with the less than Rp700 billion of a nonofficial-related conglomerate. In 1997 and 1998. Banks owned by groups or conglomerates typically act as a “cashier” that provides credit to companies within the group. The Suharto family is the largest stockholder in Indonesia. The well-known official-business alliances are those between Sudwikatmono (former President Suharto’s cousin) and Soedono Salim. which is the largest conglomerate in Indonesia. and Fast Food (restaurants). In 1996. In 1996. or have resulted from alliances between entrepreneurs and officials. most of the 16 liquidated banks had violated the legal lending limit set by the central bank. More recent alliances were between Bambang Trihatmodjo (former President Suharto’s son) and Johannes Kotjo. Bank Indonesia.2 trillion. Prudential credit analysis tends to be ignored. Bambang Rijadi Soegomo. for instance. collectively controlling . banks that had to be closed down included Bank Surya (owned by Sudwikatmono) and Bank Andromeda (owned by Bambang Trihatmodjo). 117 are jointly owned by the family and 57 are owned by individual family members. Some of them later became public companies by listing in the stock market.22 Corporate Governance and Finance in East Asia. But only a handful of these companies are listed in the market. Official-related groups have owners (or founders) who are or are allied with former or current government officials (or their families). Conglomerates were also classified into nonofficial.7 percent in 1996.and officialrelated groups. and Wisnu Suhardhono of Apac-Bhakti Karya. there were 175 groups that originated from a family business.
management. The family controls 417 listed and unlisted companies through a number of business groups led by the Suharto children. 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).1). served in some government function (see Figure 1. with no restrictions. many of whom. But it is difficult to obtain data on cross-shareholding among firms. as well as other relatives and business partners. While the source of the . The officials (or their family members) often own a small portion of shares given to them freely by controlling shareholders. and hence. Semen Cibinong. they maintain their position as commissioners. 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. Some of the groups related to officials have a unique share ownership structure. they still control the work of the directors. In so doing.Chapter 1: Indonesia 23 assets worth $24 billion (Claessens et al. Cases in point are the Bank Papan Sejahtera and Bank Niaga. Both are listed companies and members of the Salim group. Cross-holdings between financial and nonfinancial firms potentially create more serious problems. 1999). but those of the entire group. He or she could either be the biggest shareholder. If the family members cannot actively manage the companies as directors.. the controlling shareholders are able to maintain their special relationship with officials. This is because cross-owned banks had to consider not only their own interests. The BOC chairperson often represents the controlling party of the company. continue receiving some kind of protection and special treatment. or both. In 1996. for instance. The families retain control of the companies through ownership. Indonesian law allows cross-shareholdings. which were liquidated or recapitalized after being acquired by the Tirtamas group that owns a listed cement company. besides Suharto himself. families mostly manage the groups and make strategic decisions themselves. The Salim Group is also in part controlled by the Suharto family. Although some groups employ professional managers. Although they are not actively involved in the daily operations of the companies. or someone very close to and trusted by the controlling shareholders.
1999). Lang. . World Bank.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. Who Controls East Asian Corporations? Financial Economics Unit. (Feb. Financial Sector Practice Department. and Larry H. Simeon Djankov. P.Figure 1.
seek an audience with directors. and accounting and auditing procedures. The BOD leads the company and makes strategic and operational decisions. This is based on the Dutch system. The managers execute the BOD’s decisions and lead employees in their departments. one possibility is that legal lending limits had been violated. request a shareholders’ meeting. the directors.Chapter 1: Indonesia 25 problem is inconclusive. As the owners’ representatives. Shareholders are at the top of the organization.2 Management and Internal Control A company’s internal organizational structure determines how shareholders control management. the BOC supervises the work of directors.2.2 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. the BOC has the right to obtain any information concerning the firm. role and protection of minority shareholders. 1. including the boards. management and managerial compensation. Figure 1. and. both controlling and minority.3. The typical structure of a publicly listed company in Indonesia is shown in Figure 1. if necessary. Therefore. The discussions are based on the ADB survey of 40 companies listed in the Jakarta Stock Exchange. .
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
Wijaya and his friends bought shares of the bank on several occasions until they gained control. 6 7 Later in March 1999. Another case was the takeover of Bank Niaga in 1997 by Djojohadikusumo. However. who was acquiring his second commercial bank. 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. 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. Bank Niaga was under a recapitalization program. appointment of management. Since the NPLs reached up to Rp300 trillion.6 In this case. In the massive restructuring of the banking sector that commenced after the crisis.Chapter 1: Indonesia 31 external acquisitions. Control by the Government Government control could be in the form of state ownership. State ownership for listed SOCs ranges from 25 to 35 percent. the bank was liquidated. or direct subsidies. One famous takeover was Bank Papan Sejahtera. In these two latter cases. the owner of Tirtamas group. the takeover brought significant losses to Djojohadikusumo when share prices plunged7 during the crisis. This used to be a common practice in companies associated with the Suharto regime. The bank was reported to have high NPLs and had broken the legal lending limit. Before the financial crisis. The Government appoints the BOD and BOC of these firms. In April 1999. They then replaced the BOD and later sold the bank. with the minister’s approval. which was acquired by Yopie Wijaya in 1995. at a large profit. IBRA found itself tasked with managing large amounts of assets in the private sector. For instance. The BOD and BOC of PT Sari Husada were allowed to complete their terms before they were replaced. The Government is thus able to appoint some officials to be members of the private firm’s BOD or BOC. the acquiring parties were trying to obtain operating synergies because they had companies in the same industry. Most Indonesian state companies are 100 percent owned by the Government. . except for publicly listed SOCs. the acquiring interest was apparently seeking economic profits. restrictions on market entry. the Government took over NPLs and put them under IBRA management. to Hashim Djojohadikusumo. a state-owned insurance company may invest its funds in a private firm.
equities became available to the corporate sector.4 225.1 Equities In 1977. .6 percent in 1997. new instruments have been introduced to the corporate sector.3 14.5 108.1 Corporate Financing Financial Market Instruments Prior to 1977. remain the major financing instrument for the corporate sector.0 93.9 trillion in 1992 to Rp487. 1992 1993 1994 1995 1996 1997 1998 1999 68.3 60.3 188.4 trillion in 1998.14 Banking Sector Outstanding Loans.32 Corporate Governance and Finance in East Asia.5 7.4 56.6 150.0 3. Bank Credit As shown in Table 1.7 18.14.4. Data from Bank Indonesia show that from 1994 to 1997.0 6. jointly providing almost 90 percent of loans until 1997.6 48.6 6. Table 1.7 122. Vol.4 86.5 42.3 9. Since then.3 66.7 50. because of the restrictions discussed below. bank loans were the only instruments available to the corporate sector for short term (working capital) or long term (investment) financing. private national banks overtook state banks as the dominant credit source.0 487.0 168.9 150. From 34.9 153. including bonds.9 234.1 220.2 6. however. Private national banks and state-owned banks were the biggest domestic creditors.4 1.6 3. 1992-1999 (Rp trillion) Type of Bank State-Owned Banks Foreign Banks Regional Govt Banks Private National Banks Total Source: Bank Indonesia.5 80.6 4.3 111.6 292.2 27. Bank loans. the share of private national banks in outstanding total loans increased to 44. companies considered alternatives to bank loans.4 percent in 1992.7 112.2 71. stocks.2 5.8 193.9 378. bank credit surged from Rp122. II 1. and others offered by nonbank financial institutions or finance companies. this market was not well developed.4 24. However. when the Government reactivated the stock exchange. When the Government liberalized the banking industry at the end of 1988 (which allowed for higher interest rates).
1 10. It gradually increased again starting in 1991. 1992 1993 11. In 1995.6 91.1 1994 26.7 14.Chapter 1: Indonesia 33 Some companies went public.e.6 310. and net open position). i.0 15. During the 1990s.5 1995 35. the activities of finance companies were not covered by regulations on prudential practices in the banking sector (e. In 1988. thus increasing the role of the capital market in raising long-term funds. Overall. limiting loans to a maximum of 15 times equity and foreign loans to five times the equity.9 406.5 Financing by Finance Companies Finance companies first emerged at the end of 1980. when foreign investors were not yet allowed to purchase listed shares. Most banks therefore set up subsidiary finance companies to circumvent banking regulations. . but dropped to 8 percent in 1991 when the Government tried to stabilize an overheating economy.6 301.1 18. factoring.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. They were not. offering services such as leasing.g. finance companies were increasingly used as channels for the inflow of foreign loans.0 206. the Government issued regulations to supervise and promote prudential practices in finance companies.15 Value of Stocks Issued and Stock Market Capitalization.4 1996 1997 1998 50. credit cards. 1992-1999 (Rp trillion) Item Stocks Issued Outstanding (As % of Outstanding Bank Credit) Market Capitalization Source: Bank Indonesia.7 percent in 1997.2 16.9 1999 76.7 15.. funds raised in the stock market were less than 5 percent of the credit disbursed by the banking sector.5 333.15). Table 1.4 207. allowed to accept deposit accounts from the public.1 17. The ratio reached 8.0 70.6 859. however. legal lending limit.. capital adequacy ratio.6 123. Prior to 1995. the stock market has gained a bigger role in corporate sector financing (Table 1. 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 1996.7 9.8 48. and consumer credit. shooting up to 18.
6 100.0 39.4 23.3 37. II Commercial Papers Commercial papers.1) 23.5 11.2 Patterns of Corporate Financing Table 1. Thus in November 1995.3 (0. publicly listed nonfinancial companies had high proportions of equity and internal finance (retained earnings). While banks had some exposure to these instruments. 1986-1996 (percent) Financing Source Internal Borrowings Short-Term Long-Term Debentures/Equity Debentures Equity Trade Credit Others Total 1986-1990 36. averaging 26.6 100.8 percent. In terms of composition.0 1991-1996 16. they were not rated by a rating agency.2 26. Bank Indonesia prohibited banks from underwriting issues of commercial papers but allowed them to act as paying agents.7 22. Table 1. .0 — = not available. short-term borrowings were greater than long-term debts.6 12.0 100.34 Corporate Governance and Finance in East Asia. which are unsecured negotiable promissory notes with a maximum maturity of 270 days. 1996. Source: Author’s estimates based on the Pacific-Basin Capital Markets (PACAP) Databases.5 21. 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). Vol. have been popular in Indonesia since 1990.1) 23.8 7. otherwise it would be classified as a loss in the banks’ books.0 1986-1996 17.16 shows financing sources of Indonesian publicly listed nonfinancial companies estimated by using flow-of-funds analysis.4 13.4 8. This is in contrast to the lower share of borrowings during the same period. PACAP Research Center.3 16. respectively.5 (0.5 — 26. 1.4.16 Financing Patterns of Publicly Listed Nonfinancial Companies. In the second half of the 1980s. at 81 percent of total borrowings.0 3.6 8.5 percent and 36.9 16.3 14.6 23.8 17.
Two telecommunications companies.3 percent during 1991-1996. while Semen Cibinong’s losses reached Rp2. 1.4. They also do not want to dilute corporate control and are more likely to finance growth with debt.4 trillion in 1993 to Rp112. that ownership concentration may be associated with heightened risk-taking by companies.2 trillion. Many companies suffered big losses in 1997 due to their high exposure to dollar loans. reaching Rp229.3 Corporate Financing and Ownership Concentration It has been suggested. rising from Rp54. Indofood registered losses of almost Rp1.1 trillion. The corporate sector invested heavily from 1991 to 1993 and slowed down its investment spending a few years before the 1997 crisis. the corporate sector’s high leverage. Corporate debts grew over time.9 trillion.2 trillion (mostly foreign exchange losses). was due largely to a rapid rise in long-term debts. Hence. corporate debts accounted for 39. 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. Indosat and Telekom. All companies in the cement industry suffered from foreign exchange losses. which managed to post significant profits due to low exposure to dollar-denominated loans. Table 1. Bank loans also surged when the banking sector was liberalized in 1988.17 compares the DER of listed firms by degree of ownership concentration.Chapter 1: Indonesia 35 In the 1990s. The results indicate that firms with higher ownership concentration tend to have a higher DER. the pattern changed. This amount doubled in 1997. Most corporate charters require commissioners to approve debt issues or sign debt agreements. .6 trillion and Rp1. Note that the corporate sector’s high leverage existed side by side with sizable equity capital raised from the capital market. except Semen Gresik (an SOC). with longterm debts increasing rapidly.9 trillion in 1996. as evidenced by an average DER of 230 percent during 1992-1996 that rose to 310 percent in 1997. The high share of equity financing was due to the surge in capital market activity following the 1988 reforms. also suffered from foreign exchange losses but managed to post profits of Rp0. For instance. Large shareholders are inclined to undertake risky projects intended to generate high returns using borrowed funds. Of the various financing sources. respectively. These liabilities grew significantly because corporate expansion was largely financed by debt. which was masked by the rapid growth in investments. in the context of Indonesia and some other countries.
Controlling parties rely on external financing to maintain their equity share and. heavy reliance of companies on bank credits to finance investments. Source: Author’s estimates. 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 private sector borrowed heavily in unhedged dollars. Vol. The test of the difference between the two means found the t-value of 1. decisions on debt are made with the implicit endorsement of owners. II However. Table 1.5. The low cost of foreign loans and the relatively stable exchange rate created a false sense of security for corporations. since commissioners represent the controlling party. Between 1987 and 1996. aided .0 386. and high ownership concentration among families with political affiliation. ultimately.56 significant at the 10 percent level.0 1. 1. In addition.358.5 1.0 351. Inadequate Financial Regulatory Framework Liberalization of financial markets increased the corporate sector’s access to domestic and foreign private capital.0 Notes: Firms with high ownership concentration have more than 50 percent of shares owned by the top five shareholders. the borrowings swelled.36 Corporate Governance and Finance in East Asia. 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. 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. As a result.1 The Corporate Sector in the Financial Crisis Causes of the Financial Crisis Many intertwined factors led to the crisis.
As a result. substantial amounts were also funneled into projects that guaranteed repayment mainly on the strength of borrowers’ close political connections. It was only in 1995 that some regulations on the activities of finance companies were contemplated. A director at Bank Indonesia revealed that in 1995. The supervising agency was caught unprepared. It was doubly difficult to exercise supervision when groups with political clout owned the banks. A lot of short-term foreign funds were used to finance long-term investment projects. The large supply of foreign funds. This often led to the violation of prudential credit management practices. Decisions to borrow in dollars made sense to many borrowers because dollar loans were cheaper than rupiah loans.e. those with high DERs) established their own banks. only created to serve the companies to which they lent. did finance many viable ventures. It is not known if these regulations had an effect on nonbank intermediaries. In the process. 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. to circumvent these banking regulations. The Government later specified the legal lending limit and the net open position that banks had to follow.. This left them vulnerable to interest rate surges as well as sudden currency fluctuations in the case of dollar loans. many firms became highly leveraged. averaging about 4 percent of GDP. It also meant that the cashier bank had neither the independence nor the incentive to exercise ex ante and ad interim monitoring of borrowers. 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. after all. and the negative net open position (short position in dollars) continuously rose to precarious levels. large amounts of credit were directed to the companies within the group. the level of corporations’ foreign debt could not even be ascertained. . They were. However.Chapter 1: Indonesia 37 by the lack of an existing mechanism to supervise and monitor foreign transactions. conglomerates set up finance companies and used these as channels for the unfettered inflow of foreign loans in lieu of banks. The banks served as a “cashier” that provided easy credit to nonfinancial companies within the group. However. 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. Conglomerates that had difficulty in getting loans (i.
but on the basis of who the borrower was. and in the process maintain control of the company. There were cases where banks and borrowing companies were controlled by the same groups or families with strong political connections. toll roads. politicians. Controlling shareholders also prefer to use debts to finance expansion so as not to dilute their ownership. High Ownership Concentration High concentration of corporate ownership (particularly by families) led to poor financing and investment practices. Collusion between big businesses and the political elite was widespread in Indonesia. and power generation) require huge capital. Since the Government could not afford to undertake these projects. most often to people who were close to the ruling regime. Corporations were certain that they could roll over short-term loans when these fell due. This fact was usually not disclosed in financial statements.38 Corporate Governance and Finance in East Asia. The ultimate control of the corporate sector rests in the hands of a small number of families who own groups of companies. and investing shares among nonfinancial companies within the group and in other groups’ companies. This was often the case in the banking industry. total private sector foreign debt stood at $72. .5 billion. In many cases.5 billion was owed directly by corporations. In early 1998. Family-controlled corporations were generally structured as a complicated web of affiliates and associated companies. Families retain control by keeping the majority percentage of outstanding shares. as they had done so in the years before the crisis. Aside from the fact that many of these loans were channeled through banks and corporations of politically connected families. there was also almost universal confidence that the economic growth would continue indefinitely. They ensure that commissioners represent their interests and maintain close relationships with the chairperson. Vol. partly because they used nominee accounts to register ownership rather than set up a holding company. of which $64. Projects involving massive capital investments and long-term operating deals (in telecommunications. $35 billion of Indonesia’s foreign debt owed to private foreign banks was about to mature in less than one year. or both. where private banks are usually in the hands of big businesses. banks did not lend on the basis of the soundness of the project. II By mid-1997. contracts were granted to the private sector. They enhance their control over companies through cross-shareholdings. by setting up their own banks.
19. This continued in 1998. and Water Supply Construction Trade.9 3. real estate.4 7.0) (15. and 128 companies reported a total loss of Rp46. 53 companies reported negative equity of Rp6.8 7. BPS).6 4.6) (0.Chapter 1: Indonesia 39 1. Real Estate. The JSX Monthly reported that total losses of 214 listed companies amounted to Rp39.1 (1. DER and ROE were calculated per sector.6) (3. and Restaurants Transport and Communications Financial. and building construction.8 1997 1.52 trillion. Forestry.4 5. The average DER was found to be 1.5) (18.18 shows that growth in most sectors significantly fell in 1997.3 11.6 12.6 (36.1 5. Only 86 companies reported profits.24 trillion for the first six months of 1998. The construction sector was the worst hit.58 trillion (meaning their losses were greater than the paid-up capital).8) (11. Using the financial statements as of 30 June 1998 of 161 publicly listed companies.4 7.7 1998 (0.0 3. The consumer goods industry reported the lowest ROE. Gas. posted negative growth rates. when all sectors.8 0. Most sectors showed significant increases in leverage. followed by property. indicating a rapid rise in .0 2.8) (13.370 percent.5.0 5.8 8.2 (1.1) 1.1) (26.1 6. much higher than the 307 percent registered in December 1997.3 12.7) (8. except utilities. 1996-1999 (percent) Sector Agriculture.3 Source: Central Bureau of Statistics (Biro Pusat Statistik.6 8. as shown in Table 1.18 GDP Growth by Sector.7 6. Table 1.2 8. Sectors with lower ROE generally had higher DER.7) 2.7) (2.0) 1999 2.6 13. and Business Services Other Services GDP 1996 3.2 Impact of the Financial Crisis on the Corporate and Banking Sectors Impact on the Corporate Sector Table 1.4) (0. followed by the finance and trade sectors. Livestock. and Fisheries Mining and Quarrying Manufacturing Electricity.4) 2. Hotels.
several publications.625.0 a ROE 1996 1997 1998a 14. Financial and banking analysts estimate that by September 1998. losses in operation were due to declines in sales and increases in the cost of imported inputs.0 163. as shown in Table 1.5 percent in April 1998. foreign exchange losses came about with the use of unhedged foreign debt.0 108.0 193.6) (115.0 111.8 (373. from only 8.0 1.0 92. Second. . Mostly suffering from a liquidity squeeze.0 105.1 1.0 1998 186.9 12.0 1.1 (3. The huge losses suffered by most companies were caused by three factors.0 12. but annualized to approximate full year values.4 5.1 30.0 97.5 8.7) 6.0 697.8) 36.0 65. The table also reveals that although private national banks dominated the banking sector in terms of assets and credits. This figure further increased to 47.1 (124.0 72.0 158. private banks posted negative ROEs in the same year.097.0 205. Vol.370.0 1.0 2.2) (264.0 177.40 Corporate Governance and Finance in East Asia. Third.0 229. Source: JSX Monthly.0 219.1) 7. 1996-1998 (percent) DER Sector Agriculture Mining Basic Industry Miscellaneous Industry Consumer Goods Industry Property Infrastructure Finance Trade/Services Average 1996 104.0 108.3 7. interest expenses rose as credit rates increased from 20 percent in early 1998 to 40 percent in mid-1999. First.0 635.2 (4.0 307.0 191.0) 10.0) (78.2 13.6) 15. As the rupiah weakened and interest rates increased.1) Note: DERs were calculated for only 161 companies (out of 214) that had positive equity.1 (5.395.19 DER and ROE of Publicly Listed Companies by Sector. and would have kept on increasing if interest rates had not declined.0 1997 234.2 23.6 (11.0 631. a Actual data for 1st semester only.0 2.271. the NPL ratio had reached more than 60 percent. II Table 1. Impact on the Banking Sector Table 1.0 177.0 864.7 1.8 17. the NPL ratio rose to 25. small foreign banks enjoyed the highest profits.7 percent in July 1998.4) 8.4) 18.4 (6.20 reveals that the banking sector’s ROE decreased significantly in 1997.1 (92.21.8 percent in 1996. rupiah values of dollar-denominated debts due to the weakening of the local currency and the rapid decline in equity because of losses.
1 13.70 1995 7.6 — 4.45 21.24 (4.7 29.6 6.6 — 13.30 5.34 16. State-owned banks initially had the highest NPL ratio.9 percent.68 1996 1997 8.09 (11.39 13.73 30.2 8.21 Nonperforming Loans by Type of Bank.9 297.7 Item Total Loans Dec 1996 July 1997 Dec 1997 July 1998 NPLs Dec 1996 July 1997 Dec 1997 July 1998 NPL Ratio (%) Dec 1996 July 1997 Dec 1997 July 1998 Total 331.0 622.3 22.1 47. 1992 7.09 11.8 3.8 11. 227/1998 and October No.72 16.89 27.1 1.2 8. 1992-1997 (percent) Type of Bank State-Owned Banks Foreign Banks Joint Venture Banks Regional Development Banks Private National Banks Total — = not available.45 — 1993 15.1 30.7 106. however. 1996-1998 (Rp trillion) State-Owned Banks — 140.07 13. put pressure on the banking sector.0 — 4. The high and increasing NPLs.5 57.0 — 32. In July 1998.1 274.44 15.84 27.50 9.07 1994 14.0 129.24 15.1 198.69 14.9 Regional Foreign and Development Joint Venture Banks Banks — 9.5 31.7 — = not available.9 11.3 361. .2 — 19.12 15.3 445.2 48.9 — 11. 230/1998.38) 11.7 4.86 11.20 ROE of the Banking Sector.43 10.8 8.37 19.2 47. private national banks overtook State-owned banks when their NPL ratio jumped to 57.47 20.25 22. coupled with negative spreads (deposit rate was higher than the credit rate).2 — 8. Source: Infobank.5 128.06 20. Source: The National Banking Association.Chapter 1: Indonesia 41 Table 1.3 Private National Banks — 179.81 13.6 — 1. July No.5 222.2 10.8 14.67 8.15 20.5 2.5 34.8 187.2 1.20) Table 1.7 — 1.2 37.4 7.91 21.28 5.
a more comprehensive scheme to tackle domestic and foreign corporate debt. The scheme offered a hedging facility against rupiah devaluations for restructuring agreements. such as Garuda (a national flag carrier). 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. the corporate sector had more than Rp600 trillion ($75 billion at Rp8. Total amortization payments due on foreign debt in 1998 were placed at $32 billion (before restructuring). and Ciputra (property business). However.3 Responses to the Crisis Corporate Restructuring Measures At the end of 1997. by mid-September 1998. By end-November.000/$1) in debt from domestic commercial banks. 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. II 1. The scheme encourages negotiation between creditors and debtors. Since September 1998. particularly in terms of debt resolution. Aside from being described as overly complicated. Vol. Semen Cibinong (cement industry) became the first Indonesian company to resume paying part (25 percent) of the interest on its $1. IBRA was formed to offer Mexican-style resolution for private sector foreign debt. Another option that companies could take under the Jakarta Initiative was debt restructuring via debt-to-equity swaps. Corporate debt accounted for 46. assembling the legal and policy framework to facilitate corporate restructuring. the Government and private sector formed a committee to help corporates deal with the crisis. In addition. few companies were in a position to resume interest payments. Thus. a number of prominent companies. While the process of restructuring was in progress. In June 1998.42 Corporate Governance and Finance in East Asia. have been subject to restructuring deals under the initiative. about 80 percent of which was private. In November. Astra International (automotive).5. companies were not servicing their debts.000 eligible firms had signed up for the scheme. the committee launched the Jakarta Initiative. On 9 September 1998.2 billion debt. the scheme failed. only a .6 billion) of Indonesia’s total external debt in March 1998.7 percent ($64.7 billion of foreign exchange debt. the Jakarta Initiative Task Force had conducted negotiations for 52 companies with Rp2. none of the 2. The committee was tasked to ascertain the level of private corporate sector debts and arrange negotiations between debtors and creditors.4 trillion of domestic debt and $6. Unfortunately.
and mining equipment. Bank Bali agreed on a debt-to-equity swap with its creditor. Astra International. Protection against insider and fraudulent transactions taken by a debtor prior to the adjudication of bankruptcy will be enhanced.e. i. under which the latter would become one of the bank’s shareholders. especially in preventing unjustifiable delays in the adjudication of bankruptcy. lay off workers. For instance. In the banking industry. mining. plantations. focused on its core business of car and motorcycle manufacturing and sold off its subsidiaries in semiconductors. a publicly listed company operating in the automotive industry. for equity infusion. A Commercial Court was set up to handle corporate restructuring and debt settlements. Rabobank and Citibank. Astra International (automotive industry) and Bakrie Brothers (a holding company in several sectors) explored this option. Bankruptcy Reform The Bankruptcy Law was passed in August 1998. When credit from the banking sector became unavailable and interest rates increased significantly.. forcing them to cut costs. Moreover. 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. 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). Standard Chartered. Qualified professionals from the private sector will act as receivers and administrators in the management of estates of companies in bankruptcy or reorganization. The Commercial Court can be asked to hold off creditors and impose strict guidelines on the negotiating process . some companies attempted to restructure their businesses on their own. Debtors. and sell noncore businesses or nonoperating assets. Meanwhile. Bank Niaga also negotiated with some of its creditors. consolidate business units. with the requirement that adequate compensation and protection will be provided to such creditors during that period. aiming to modernize the bankruptcy system and promote the fair and expeditious resolution of commercial disputes. Procedural rules are also being introduced to ensure certainty and transparency in the proceedings. 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). the companies’ financial performance deteriorated.Chapter 1: Indonesia 43 few companies reached agreement with their creditors on this.
reform. with only 17 cases filed as of November 1998. In the longer term. and (v) a strengthened banking supervision system. it is envisaged that the Commercial Court will play a central role in modernizing the commercial legal system. (ii) the resolution of nonviable private banks. in consultation with IMF and the World Bank. Previously. collusion. the measure had only a minimal impact. . The bias in favor of debtors has retarded the pace of corporate restructuring. Some companies simply decided not to pay their loans knowing that it would be difficult for creditors to take the case to court. Realizing that they undermine investors’ confidence. (iv) measures to recover liquidity support previously extended to troubled banks by Bank Indonesia. 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.44 Corporate Governance and Finance in East Asia. However. Rather. The Agency also allowed companies to buy back up to 10 percent of outstanding shares to improve the condition of the stock market. since the market reflects the condition of the economy. and recapitalization of state banks. legislation against corruption. including procedures for handling operational issues and processing bankruptcy cases. Capital Market Reform In the capital market. and nepotism (anti-KNN) was signed in 1999. The Government has also been concerned with the issue of capital controls. is also reviewing the Bankruptcy Law. However. 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. The Government. There will be changes in the implementation of the bankruptcy law. the Capital Market Supervisory Agency allows companies to offer additional shares directly to the public. The Court has also declared only two companies bankrupt. (iii) the merger. the Government did not impose restrictions nor did it attempt to regulate capital flows. II to achieve liquidation of the company. To push bankruptcy reforms. companies were allowed to sell shares only by issuing stock rights. Vol. the Court’s early record has been a disappointment.
Banks deemed ineligible for recapitalization will be closed. The four state banks (BDN. Conclusions. In particular. Other Regulatory Reforms To push corporate restructuring further. and Recommendations Summary and Conclusions Corporate Ownership and Structure Most of Indonesia’s top conglomerates were established as family businesses. was enacted in 1999. the Government has drafted a regulation providing tax neutrality for mergers and removing other tax disincentives for restructuring. improvement of rules and prudential regulations. 1. BEII. Some 175 groups that originated from family businesses controlled . It has also drafted regulations to remove obstacles for converting debt to equity. or sold (after transferring NPLs to the AMU). Liquidity support given to troubled banks should be repaid in four years. merged. The Bank Indonesia 21st package includes recapitalization. A new central banking law. Bank Indonesia has announced a recapitalization program for potentially viable private banks. The Company Law at present can be interpreted as severely limiting the scope for debt-equity swaps. the Government required banks to be audited by international external auditors. providing Bank Indonesia with substantially enhanced autonomy. However.6. Parliament approved amendments to the banking law that were geared toward strengthening the legal powers of IBRA and its AMU.1 Summary. and follow-up action on bank restructuring. and Bapindo) will be merged into one bank named Bank Mandiri. the Government established IBRA to supervise problem banks. The agency set up an Asset Management Unit (AMU) to directly manage problem loans of banks under its supervision. The merger process will be finished within two years. In October 1998. To obtain a clearer picture of the banking sector. regulations will need to be issued to permit debt-toequity swaps in the context of corporate restructuring plans. it is doubtful whether pure holding companies are able to enter into swaps. BBD.6 1. To overcome these problems. depositors will be fully protected by the Government. The importance of this legislation may need to be emphasized.Chapter 1: Indonesia 45 In 1997.
These banks also obtained cheap offshore funds. But because foreign creditors were reluctant to lend long term.46 Corporate Governance and Finance in East Asia. lacked the information necessary to allow them to assess projects’ risks and chances for success. not all of the conglomerate-affiliated companies are publicly listed.7 percent. Rapid growth in investments masked the corporate sector’s increasing leverage. Indonesian companies borrowed short term. conglomerates set up their own banks to serve as “cashiers” providing credit to companies within groups. Foreign creditors. while a single family controlled 16.1 percent of publicly listed companies in Indonesia. When the Government regulated the legal lending limit and the net open position of banks. corporate debts grew over time. however. The restructuring and resolution of financial distress may. conglomerates set up finance companies to bring in cheap foreign loans as these companies were not adequately regulated. II 53 percent of total assets of the top 300 Indonesian conglomerates. However. This study reveals that Indonesian listed companies with higher ownership concentration had higher levels of leverage. retain ownership control of companies. when barriers to entry in the banking sector were lifted. put a significant amount of corporate assets of conglomerates in the hands of creditors or the Government. families control 67. 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. These figures show the extent of power wielded over the corporate sector by a small number of families. On the one hand. banks were unwilling to provide credit to highly leveraged companies. meanwhile. Vol. The free capital flow system permitted the inflow of foreign capital to fuel the credit boom in the economy. On average. Financing Patterns Controlling shareholders opted to use debts to finance expansion. thus. Therefore. Among those listed in the Jakarta Stock Exchange. Companies relied heavily on bank credit. However. The financial crisis created opportunities for addressing the inefficiencies in the legal and judicial system that supported corruption. this financing pattern supports the claim that family-based controlling shareholders relied on excessive borrowing to finance corporate expansion . As a result.6 percent of the total stock market capitalization in 1996 and the top 15 families controlled 61. the majority remains family-controlled. allowing them to maintain their equity shares and.
the Government initiated corporate debt restructuring measures (Mexican-style foreign debt resolution and the Jakarta Initiative).1 percent in 1998. were the most adversely affected. On the other hand. the corporate sector was in quite good shape in terms of growth and profitability. The problem was in the maturity structure of its dollar-denominated debt and high debt-to-equity ratios in some sectors. particularly those with large short-term foreign loans. When the crisis hit Indonesia. Meanwhile. Bank Indonesia extended emergency loans to many banks. and the rapid decline in equity due to losses. the high domestic interest rates that prevailed from 1998. The financial crisis led to the closure of several dozen banks. and strengthen prudential regulations and supervision of the financial sector.370 percent in 1998. ROE dropped from 1. Sales of conglomerates as well as those of publicly listed companies were increasing. DER increased to 307 percent in 1997 and further surged to 1. financed by issuing nearly $80 billion worth of bank restructuring bonds. The significant increases in leverage indicate a rapid rise in the rupiah value of debts due to the revaluation of dollar-denominated debts. Impact of the Financial Crisis Prior to the crisis. although at a declining rate.Chapter 1: Indonesia 47 without diluting their control. Total profits of publicly listed companies dropped to Rp3. facilitate debt restructuring. As the rupiah weakened and interest rates increased. Responses to the Crisis The impact of the financial crisis on the corporate sector was serious. NPLs rose and capital adequacy ratios fell. corporate-initiated debt restructuring . and registered a net loss of Rp39.21 trillion in 1996. the highly leveraged companies. At the height of the crisis.24 trillion in the first half of 1998. the consumer goods industry was the worst hit. To restructure the corporate sector. followed by the property sector. The Government introduced reforms to improve bankruptcy procedures. The Government and the private sector responded with measures to mitigate the negative effects. Net profits of publicly listed companies had consistently been growing at an average rate of 20 percent each year.1 trillion in 1997 from Rp13.1 percent in 1997 to -124. it also reflects the failure of the financial sector to channel funds to the corporate sector efficiently due to weak prudential regulation and supervision.
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. the regulatory environment was not prepared to supervise the increasing number of banks and nonbank . but it is not clear whether in practice these standards are in place. If the role of a limited number of families in the corporate sector is so large and the Government is either heavily involved in or influenced by business. and protecting creditors’ rights. but inadequate protection to minority shareholders from the dominance of large shareholders.6. The Corporate Law should be reviewed and amended in the context of pervasive control by large shareholders.2 Policy Recommendations The Government should introduce measures to address the weaknesses in corporate governance identified in this study. Vol.. the legal system is less likely to evolve in a manner that will allow it to protect minority shareholders. The Government should ensure that all laws and regulations are effectively enforced. (ii) delineating the functions of the board of directors and commissioners. Improving the Legal and Regulatory Framework for Bank Supervision After the liberalization of the financial sector. II measures included internal business restructuring (e. In particular.g. Protecting Minority Shareholders’ Rights The Corporate Law provides sufficient rights and protection for all shareholders. minority shareholders have not been able to oppose controlling shareholders’ decisions to invest in unprofitable projects financed by unhedged foreign currency debts. Amendments should include (i) empowering minority shareholders by raising the majority percentage of votes required on critical corporate decisions and mandating minimum representation of minority shareholders on the board. Most companies claim to have adopted international standards of accounting and auditing procedures. and (iii) strengthening transparency and disclosure requirements.48 Corporate Governance and Finance in East Asia. Specific recommendations include protecting the rights of minority shareholders. 1.
most of banks’ NPLs resulted from credit to companies within the same group. and liquidation of corporate assets. The regulatory framework was also weak in supervising and monitoring foreign transactions. The ownership of banks (including finance companies) by shareholders of nonfinancial companies undermined the capability of these banks to conduct prudential credit management. The Central Bank needs to monitor and control dealings by banks within business groups and improve enforcement methods to prevent circumvention of prudential regulations. a new bankruptcy law was passed in the aftermath of the crisis and a Commercial Court was set up to deal with bankruptcy cases.Chapter 1: Indonesia 49 financial institutions. the Court has been slow and ineffective in processing bankruptcy suits. The tendency of foreign creditors to lend short term is a problem that must be confronted once private capital flows to Indonesia recover. When finance companies were used to channel offshore loans in lieu of commercial banks. In the first place. Further. This is a significant factor in . Because these banks are neither easily convinced nor compelled to submit their claims to the jurisdiction of Indonesian commercial and bankruptcy courts. with necessary legal sanctions for violations. it has been difficult to implement standstills. One way is to set limits on lending activities by banks to affiliated nonfinancial companies. the banking regulatory framework was inadequate in regulating banks’ dealings with affiliated nonfinancial companies. Consequently. it is likely that future private financial flows for the corporate sector will continue to conform to a short-term structure. the Government lost monitoring and control powers over foreign fund flows. the Indonesian corporate sector directly owes an inordinate amount and a greater portion of its loans to foreign banks. Protecting Creditors’ Rights To protect creditors’ rights. However. Banks should be required to provide data on such transactions and charged penalties for noncompliance. in contrast to the Republic of Korea and Thailand. orderly restructuring. 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. recapitalization. Because foreign creditors are faced with more information asymmetries than domestic creditors. the Republic of Korea and Thailand were more successful in getting foreign creditors to collectively solve their problems during the crisis.
Only when creditors have the confidence that their rights are protected will they resume financing companies. despite the smaller level of capital inflows (as a percentage of GDP). . Vol. II explaining the greater depth of the crisis in Indonesia. The Bankruptcy Law should thus be reinforced and creative means should be introduced to avoid a prolonged and costly paralysis of corporate activity and financing.50 Corporate Governance and Finance in East Asia.
Indonesia: An Emerging Market. 14 May 1999. 1999. Asia in Crisis: The Implosion of the Banking and Finance System. P. 1997. Conglomeration Indonesia: Regeneration and Transformation into World Class Corporate Entities. Forest. John Wiley and Sons. Embassy of Indonesia Homepage. Indonesia Country Profile. Keasey. Economy of Indonesia. Claessens. F. The Impact of Acquisition to Shareholders Wealth: Comparison Between Internal and External Acquisition. The Economist Intelligence Unit.. Corporate Governance: Responsibilities. Working Paper #58. World Bank. various publications. Unpublished thesis MMUGM.Chapter 1: Indonesia 51 References ADB Programs Department (East). Stijn. Financial Sector Practice Department. and Remuneration. Economic and Financial Statistics. The Private Debt Anatomy. Bank Indonesia. Institute for Economic and Financial Research. Simeon Djankov. Michael Krill. Large and Medium Manufacturing Statistics. and Richard Turtil. 1999. Lang. Letter of Intent of the Government of Indonesia to the IMF. The Economist Intelligence Unit. Embassy of Indonesia. University of Maryland. 1995. JSX Monthly Statistics. 1998. Wright. John Wiley and Sons. K. Manuscript. 1996. 1997. Indonesia: Sustaining Manufactured Export Growth. 1996. Who Controls East Asian Corporations? Financial Economics Unit. . Indonesian Central Bureau of Statistics. Jakarta Stock Exchange. Indonesian Business Data Centre. 1998. Jonathan. various publications. various publications. and Larry H. Maryland. Risks. Indonesian Capital Market Directory 1992-1998. Center for International Business Education and Research. Conny Tjandra Rahardja. Indonesia Country Report. Delhaise. 1995. Yogyakarta. Indonesian Business Data Centre. various publications. P. and M.
and curtailing of morally hazardous behavior that has been prevalent among economic decision makers. 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. internal control mechanisms. Chung and Yen Kyun Wang1 2. markets. and Graham Dwyer for his editorial assistance. Poor corporate governance and political and government intervention in the business and financial sectors are widely viewed as contributory factors.2 Republic of Korea Kwang S. 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. 1 Professors. Further. and David Webb of the London School of Economics for their guidance and supervision in conducting the study. The country’s winners would then emerge based only on economic efficiency. Inefficient investment coupled with excessive financial leverage was found to be at the root of the economic crisis at the corporate level. It had been the norm in Korea to conduct business based on political and administrative favoritism rather than on competitive merits. Business managers and controlling shareholders were maximizing firm size at the expense of profits. 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. Seoul. The authors wish to thank Juzhong Zhuang. timely exit of poor performers from the market. both of ADB. . Korea) in November of that year. the Government and business sector had good reason to reflect on the causes of the crisis. the Republic of Korea. a practice that was not checked by creditors. or capital market discipline. As the Korean currency. the Korea Stock Exchange for its help and support in conducting company surveys. This has been the crux of the corporate governance problem in Korea.1). Chung-Ang University. 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. Department of Economics. David Edwards.
accountability of controlling shareholders and boards of directors. II Table 2. This broad perspective can help clarify the ongoing reform efforts of businesses and the Government. Copeland. especially chaebols.1 1997 518 104 20.1 1995 560 163 29. The total number of respondents was 81 out of about 550 nonfinancial firms listed on the Exchange. T.9 1994 531 165 31.1 1996 561 163 29. This study also reviews the legal and 2 The survey was conducted mainly through the Korea Stock Exchange. Government reform goals for the corporate sector include enhancement of corporate transparency. Weaknesses in the overall corporate governance system in Korea had many ramifications. Inefficient investment undermined the competitiveness of Korean firms in the global marketplace. Source: Korea Stock Exchange. the corporate sector. 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. June 1999. and improvement of bankruptcy procedures. and individual companies. This study collects and analyzes data on the Korean economy. Many firms left some questions unanswered. A survey was conducted for the nonfinancial listed companies using a questionnaire developed by the Asian Development Bank (ADB)2 to supplement official data. 1992-1998 Item Total Number of Firms Firms with Positive EVA Percentage of Firms with Positive EVA 1992 508 180 35.1 1998 490 164 33. aiming to identify the areas in need of further reform and to provide policy recommendations for improved corporate governance. Dividend payments were at less than 2 percent annually as opposed to the double-digit interest rates in the past decades. Koller.5 Note: The EVAs are calculated as: EVA = NOPAT – WACC. The EVAs are the same as the economic profit as explained in T. .54 Corporate Governance and Finance in East Asia. which distributed and collected the questionnaire. 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. capital market discipline. Restructuring efforts have focused on reduction in the degree of business diversification and in the financial leverage of large-sized firms. and J Murrin (1995).1 Listed Firms with Positive Economic Value Added. Vol.
2 2. The Government tried to produce food. 2. and other necessities domestically. It traces the country’s economic development. Major economic indicators for some of these periods are shown in Table 2. the board of directors system. reviewing government policies responsible for the development of the modern corporate sector. It then presents recommendations for further reform in corporate governance and financing.Chapter 2: Korea 55 regulatory framework for the corporate sector and reform measures taken after the crisis. This chapter is composed of six sections.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. The evolution of the modern Korean economy can be divided into four periods. Section 2. creditors.3 identifies characteristics of corporate governance by analyzing the ownership structures and control patterns of listed companies and the largest chaebols. clothing.1 Overview of the Corporate Sector Historical Development3 The development of the Korean corporate sector is closely related to the progress of the economy. and Yim (1998). Import Substitution: 1948-1961 The Korean War (1950-1953) devastated Korea’s industrial capacity. In the period 19481961. corporate control by the Government. Section 2. the import liberalization rate was below 7 percent and the average tariff rate was in the range of 25 to 30 percent. Yang.2. which account for a substantial portion of the Korean economy. .2 presents an overview of the corporate sector. 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 The review of historical development of the Korean economy draws substantially from the book by Sohn. Section 2. From 1948 to 1961.6 discusses responses of the Government and the business sector and explains in detail their reform and restructuring efforts.4 contains analyses of corporate financing and its relationship to performance. Section 2. Section 2.2. and naturally adopted an import substitution policy. and employees and their role in shaping corporate governance practices.
4 24.2 32.4 29.332.949.9 794.7c 11.447. a Refers to 1971. Export Drive: 1962-1971 Between 1962 and 1971. In 1961 it devalued the won from W65 to W130/dollar and announced its first Five-Year Economic Development Plan (1962-1966). International Financial Statistics. II Table 2.4 29.5 38.1 29. IMF.4 1990-1997 7. the Government called for an unprecedented average annual economic growth rate of 7.1d 9.7 37.1 9. 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.1a 21. e For maturities of one year or more.265.6 11.1 — = not available. The Government tried .102. b Refers to 1979.5 250.8 (8.1 percent with moderate rates of inflation and introduced a series of reform packages aimed at developing key industries. In the Plan.8 (724.9b 15.753.9) (7. 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. d Refers to 1997. Vol. largely because of political instability.4 10.4 (1.2 314.8 15.9) 1.8 24.2 757.3 8. and implementing new budget and tax measures.0) 492.7 30. Source: Bank of Korea.2 Key Macroeconomic Indicators Annual Average (percent.56 Corporate Governance and Finance in East Asia. c Refers to 1989. the Government redirected the policy focus away from import substitution to an export-led manufacturing-based economy.2 31.2 1980-1989 8.1 15.2 6. lack of strong drive. the Government was not successful in solving the problems of slow growth.0 41.2 30.5) (1.0) (297.8 12. high unemployment and inflation. and large current account deficits. Economic Statistics Yearbook. This goal required very high savings and investment rates.7 14.0 27. modernizing the industrial structure. and inconsistent economic policies.5) 8.9 — — 21.1 35. However.855.2 1.2 452.
Korea normalized political and economic relations with Japan to encourage inflows of Japanese capital that could finance big development projects. This change raised the import liberalization rate from 9.4 percent. During the first five-year plan period. . and almost doubled the foreign exchange rate from W130/dollar to W256/dollar to enhance the international competitiveness of exports. In 1963-1964.2 billion in 1972.Chapter 2: Korea 57 to meet its targets by borrowing large amounts of foreign capital on the one hand. But the liberalization trend turned out to be short lived as current account deficits continued. boosting internal investment resources.5 percent. In 1964. the Government tried to provide exporting firms with a free trade environment. The average growth rate of the economy from 1960 to 1964 was 5. the growth of gross domestic product (GDP) raised domestic savings. However. and maximizing mobilization of domestic savings on the other. while the average tariff rate was 39 percent. but tariff rates were raised to 40 percent in the 1960s. abundant. the Government changed the multiple and fixed exchange rate system to a unitary floating exchange rate system. the import liberalization rate was 55 percent. In 1965 the interest rate on one-year deposits doubled from 15 to 30 percent. imports of consumer goods and luxury items were highly restricted. 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. channeling funds from curb markets into the banking sector. a modest improvement over the 4. the Government undertook important economic reforms in two areas: the foreign exchange rate and the interest rate.3 percent average between 1954 and 1959. which laid a solid foundation for a steady growth path. resulting in high real interest rates. The positive list system for imports was replaced with a negative list that indicated only those items that could not be imported. up from 30 percent in the late 1950s. The exchange rate system was a kind of crawling peg until 1974. The Government abolished temporary direct subsidy measures and introduced a new comprehensive export promotion system. due to continuous current account deficits. During this period. Exports increased sharply from $41 million in 1961 to $2. The well-educated. These were considerably liberalized in 1967 when Korea joined the General Agreement on Tariffs and Trade (GATT). Also. and cheap labor force was well utilized by the export-led growth strategy. In 1971. Bank deposits increased rapidly.3 percent to 60.
machinery (including automobiles). less developed countries forced Korea to adjust its industrial structure.58 Corporate Governance and Finance in East Asia. There were three reasons for the switch: first. the domestic economy was stagnant and many businesses. the Government felt the need to strengthen the defense industry. overburdened with debts and high interest rates. It included a detailed construction and investment schedule over a 10-year time frame and mandated coercive implementation. The Government took emergency measures. it tried to substitute imports and export high value-added HCI products. Third. in the face of a world economic slump. and assigned them to specific chaebols. These included rescheduling business debts. The Government has since used similar emergency rescue measures for large businesses and banks almost once every 10 years. and giving low interest rate loans to banks from the central bank. and allocating virtually unlimited amounts of credit at below-market rates while controlling the financial system. Unlike the previous system. One industrial policy adopted during the heavy and chemical industrialization drive was administered credit rationing. the emergence of competition of other low-wage. announcing rescue packages for businesses and banks. This strategy formally took off with the announcement of the HCI Promotion Plan in June 1973. becoming a seed of the economic crisis in 1997. The HCI promotion policy was much more comprehensive than past economic development plans. 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 . Second. where preferential export credit was given to almost every exporter. investing a total of $9.6 billion between 1973 and 1981 into these sectors. the Government felt that continuous trade deficits arising from increasing intermediate and capital goods imports could be prevented by developing import substitution industries. II Heavy and Chemical Industry Promotion: 1972-1979 In the Third Five-Year Economic Development Plan (1972-1976). the Government changed its industrial policy emphasis from light industries to heavy and chemical industries (HCIs). faced the danger of bankruptcy. nonferrous metal. shipbuilding. The Government encouraged a variety of business projects. electronics. It promoted HCIs by supplying massive capital for construction and development. and chemicals—as future core industries. By promoting HCIs. reducing or exempting debts of farmers and fishermen. The Government targeted six industries—steel. In 1972. Vol. These practices contained an implicit government guarantee that large businesses and banks could never fail.
faced with high inflation. including forced liquidations and mergers and acquisitions (M&As). However. Korea recorded current account surpluses and rapid economic growth due to the “three lows”: low value of the US dollar. exacerbated the overcapacity problem. Macroeconomic policies became hostages of the industrial strategy. Cheap credit and distorted prices resulted in overexpansion in the HCIs. and the won depreciated by 20 percent with the adoption of a Basket-Currency Gliding System in 1980. The industrial and trade policy resulted in high inflation in the 1970s and serious excess capacity problems by 1979. New start-up firms. including denationalization of banks. such as widespread underutilization of capacities of HCIs and related plants. Economic Liberalization and Globalization: 1980-1997 In 1979. as it had to control only a few large chaebols. fiscal expenditure maintained zero growth. met increased difficulty. and the large excess capacity of HCIs. Firms that followed the Government expanded greatly. This required industrial restructuring by the Government. Evaluations of HCI promotion policies are mixed. coupled with political uncertainty due to the assassination of President Park in 1979. The plan of the 1970s was thought to be successful in the long run. imports were further liberalized while tariff rates were lowered. a heavy foreign debt burden. since during the second half of the1980s many of the promoted firms became world-class competitors and exporters. light manufacturing and service industries were weakened by disadvantages such as a lack of credit. In order to improve economic efficiency. the policy wasted substantial amounts of resources in the short and medium terms. Meanwhile. In 1986-1989. The growth rate of the money supply was reduced drastically. especially between 1979 and 1985. the Government restructured some large businesses through forced liquidation and M&As. The incentives available became more market-based. price controls were abolished. Such an approach gave the Government increased control over the economy. the Government adopted comprehensive measures to promote economic stabilization. The two important ones were import liberalization and deregulation of the financial sector. with many turning into the now well-known chaebols.Chapter 2: Korea 59 through state-controlled banks. Gross national product (GNP) growth rates on average were higher in the 1972-1979 compared to 1962-1971 (Table 2. Meanwhile. and their utilization ratios were very high. The severe world recession caused by the second oil shock.2). low . various measures to increase competition were taken. however.
2 percent.1 percent and average tariff rates 8. 46. The Government tried to adjust economic policies and regulations to meet global standards. Vol. Korea abolished remaining direct subsidy systems for export activities as well as some traditionally managed trade systems.3 percent.9 percent. 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). In 1993.2 Rise of the Large Business Groups (Chaebols)4 The Korean Fair Trade Act defines a business group as “a group of companies. and total workforce. the importance of chaebols was increasing. and acceded to the World Trade Organization (WTO) in 1994. with the 30 largest in the total economy in 1997 standing as follows: value-added. The most important element characterizing chaebols is the concentration of ownership. further increasing its pace of import liberalization. Korea became a signatory country to the International Monetary Fund (IMF) Article VIII. the Government committed itself to further liberalization of the goods and capital markets. and low oil prices. the import liberalization ratio reached 98. Meanwhile. The low value of the dollar led to a low won and high yen. 45. 47.1 percent. Korea adopted a market average exchange rate system. whose business activities are controlled by an identical person.2. 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. By joining the Organisation for Economic Co-operation and Development (OECD) in December 1996. while continuous and large current account surpluses saved Korea from the foreign debt problem. but it chose to liberalize gradually. . Industrial and trade policies were modified to be consistent with WTO.60 Corporate Governance and Finance in East Asia. where particular individuals and their family have de facto control of the management of all subsidiary companies of groups. total sales. The official rate fluctuated within a band. and declaring that it would follow Article XI of GATT.9 percent. total debts. total assets. which gradually widened. In 1988.” A large-scale business group is called a chaebol. 2. Korea began participating in many multilateral trade negotiations during the Uruguay Round. In 1990. giving up its foreign exchange controls related to the current account. 13. II world interest rates.9 percent. joined the Asia Pacific Economic Cooperation (APEC) Group in 1993. 4.
it was more effective to deal with a small number of companies to secure tangible outcomes. The Government provided subsidies. From the standpoint of the Government. and tax breaks to key industries to promote exports and industrial upgrading. Since the 1960s. Chaebols have a history of substantial concentration of ownership. after the financial crisis.when the Government put a great deal of emphasis on development of the HCIs. In this sense. Important managerial decisions are made primarily by owners.1 20.8 22. The Government provided financial and fiscal incentives to chaebols and trading companies with relatively abundant financial resources. Large-scale companies owned by the Japanese were sold to individuals under preferential terms and later enjoyed a relatively favorable position for accumulating capital. Since the Government controlled most business activities.5 20. chaebols that maintained a close relationship with the political authorities were able to grow fast. One reason for this controlling power is inter-company shareholding among subsidiaries. and they are aided and supported by one another. Table 2. of Subsidiaries per Chaebol 20. financial assistance. Chaebols are also excessively diversified.3 shows that the number of subsidiaries of the 30 largest chaebols increased considerably since 1993.Chapter 2: Korea 61 War II.3 Source: The Fair Trade Commission. the ownership and management of a chaebol’s subsidiaries are not separate. reaching 669 in 1996. Subsidiary companies of chaebols are subject to “fleet-type management” in that they are controlled by the overall managerial system of chaebols. large-scale businesses and chaebols were thought to be appropriate actors because they could meet the huge investment requirements of these industries. Table 2. the number of subsidiaries declined drastically due to corporate restructuring. 1993-1996 Year 1993 1994 1995 1996 No. However. In the mid-1970s. the Korean Government has set the national goals of economic development and offered all kinds of support and incentives to achieve them.3 Subsidiaries of the 30 Largest Chaebols. This policy contributed greatly to the expansion of chaebols. . of Subsidiaries 604 616 623 669 Average No. This galvanized the fast growth of chaebols.
II Theoretically. However. . the Government reviewed the financial performance of companies and recommended (or ordered) selected ones to go public. 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. 2. Vol. 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. They had to meet certain requirements in terms of firm size. diversification can make chaebols stable through the portfolio effect. Another law that contributed to the development of the stock market was the Act to Expedite the Going Public of Corporations of 1972. In the early years after the enactment of the law. internalization of the market that could enhance the internal efficiency of a chaebol may close the market to other firms. Meanwhile.62 Corporate Governance and Finance in East Asia. including the “economies of organizational size” inherent in multi-product and multiplant firms. which may ultimately lead to the decline of social efficiency. Under this law. profitability. For example. listed companies enjoyed corporate tax rates that were 10 to 20 percentage points lower than those imposed on privately held firms. On the other hand. and were allowed extra depreciation charges for tax purposes. This law was in effect until 1987 when it was partly absorbed into the Capital Market Development Act. they can reduce uncertainties and dilute risks through sharing of information and diversification. if a chaebol has an unsound financial structure but strong financial links through mutual payment guarantees among their subsidiaries. the bankruptcy of one or a few marginal subsidiaries could lead to a chain of bankruptcies for the entire chaebol. Since chaebols are engaged in many different businesses. This could ensure their stable growth and enhance their investment abilities. Related to this is the tendency of chaebols to assist unprofitable firms at the expense of profitable ones. in addition to the usual economies of scale. chaebols can benefit from synergies. years since establishment. etc. there are many negative assessments of organizational structures and practices of chaebols. The law also allowed employees of listed firms to get 20 percent of the subscription rights in offerings of new shares. the Government’s efforts to develop the stock market culminated in the Capital Market Development Act of 1968.2.3 Role of the Capital Market and Foreign Capital In the 1960s.
1985-1998 No. The policy to expand the size of the stock market.7 934.. First.1 16. Third.1 Market Capitalization (W billion) 6.151 117.0 965. The Korea Fund.5 406.4 Development of the Stock Market.9 918.6 Year 1985 1989 1990 1994 1995 1996 1997 1998 Source: Monthly Review (Securities Supervisory Board) and the Financial Supervisory Service. the stock market grew rapidly during the 1980s.0 49. 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). several important policy measures were implemented to promote the development of the stock market.2 44. especially those paying small or no dividends. mainly by increasing the supply of shares by initial public offerings (IPOs) and seasoned issues. the Government announced the gradual opening of the capital market to foreign investors in January 1981. in 1986 the Government imposed limits to bond issues on firms that were recommended to go public but refused. Because of government policies and the booming economy. Beginning 1990. This reversal in policy reflected declining stock prices and was generally maintained until the outbreak of the economic crisis in 1997. Second. however.4.4 654.370 70.9 833.570 95.989 137.9 34.217 141. .476 79. was established to invest in domestic shares beginning in September 1985. The aggregate Table 2.4 40. the Government announced measures to increase the demand for shares by providing tax and financial incentives to individual investors.798 Market Capitalization as a Ratio to GDP (%) 8. 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.6 747. of Listed Firms 342 626 669 699 721 760 776 748 Stock Price Index 138. a country fund. Inc.Chapter 2: Korea 63 During the 1980s and 1990s.0 79.1 30. As shown in Table 2. the Government attempted to stabilize the stock market by limiting IPOs and share issues by listed companies. continued until 1989. In this regard. Also that year.020 151.
5 Private Capital Flows to Korea.450 24. The aggregate market value of listed shares bottomed at 16.141 4.534) 1. However.296) (6. 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) (2.944) 8.858 4.338 4.017) 1.440 1.382 Permit basis.694) 2.553 8. 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 1986-1989.571 2.183 12.658) (3.875 21.714 1. Table 2.953 10.64 Corporate Governance and Finance in East Asia.455) 13.942) 42.001 4. but rose again to 34. but increased sharply to 79.642 21.239 19. The relative size of the stock market diminished to 44 percent in 1990.287 (340) 73.86 percent of GDP in 1997.868 (518) (418) 63 1. Other investments include loans.817 16.742 (3. Bank of Korea.123 3.150 5.433) (9.2 percent by 1989. currency and deposits.500 7. Table 2.650 (1.924 (1. due to declining stock prices.255 2.5 shows net FDI—inward investments by foreigners less outward investments by Koreans—in the period 1985-1998. trade credits.59 percent in 1998 and to more than 50 percent in the early months of 1999.542) (1. foreign direct investment (FDI) has been very small relative to GDP and compared to other East Asian countries. Source: Balance of Payments.453 (2.785 (1.149 13. and stayed at the 30-40 percent level up to 1996.085 2.870) (1. The number shrank for the first time in 1998 to 748 firms from 776 the previous year.126 (1.910) 2.737 (333) (297) (607) (2) 218 2.546 (2.326 1.264) (3.352 471 3.413) 56.414) 5.008) (3. . II market value of all listed firms represented only 8 percent of GDP in 1985.800 (7. Vol. and other liabilities.347 3.339) (9.852) (2.583 25 10. The growth in the number of listed firms also slowed in the 1990s. The reasons for the decline include increases in bankruptcies and mergers involving listed companies since the outbreak of the economic crisis. and 1993.
Corporate sector net proft margins increased from 1993 to 1995. but dropped in 1996 and were negative by 1997. The ratio is generally in the same range for Japan and Korea. The debt-to-equity ratio (DER) averaged 311 percent for the period 1990-1996 and peaked at 424. This indicates that a substantial proportion of debt was denominated in dollars. Return on equity (ROE) and return on assets (ROA) showed similar patterns.4 Growth and Financial Performance This section looks at the performance of (i) the aggregate corporate sector.China. The contribution of the corporate sector to GDP was 73. excluding FDI. However. weak incentives for attracting FDI. increasing to 76 percent in 1997. The same categories will be analyzed in later sections. increased substantially in 1994-1996 due to accelerated liberalization of capital movements (Table 2. but between 1988 and 1993. portfolio investments amounted to $73.2. other net private capital inflows amounted to $130 billion during 1985-1998.6). Net private capital inflow. In addition to FDI. Profit rates of Korean firms were relatively low compared to those of Taipei. (ii) listed firms.5). and US. and (iii) chaebols. Taipei.7 billion and loans $42.6 percent in 1997. and sales of the aggregate sector during this period were very high (Table 2. Between 1986 and 1989. Japan’s was consistently higher.9 billion.China and the US. This would lay the foundation for evaluating the effect of corporate governance on performance. Korea had substantial current account surpluses and experienced net private capital outflow. Large amounts of outward investment by Koreans in the mid-1990s arose out of increased liberalization of foreign exchange regulations. Of this. The growth rates of total assets. The dismal performance of the Korean corporate sector compared to the . and high production costs were the main reasons for low FDI in Korea.Chapter 2: Korea 65 Complicated government regulations.7 compares the ratio of ordinary income to sales of Korea’s manufacturing sector with those of Japan. equity. 2. Table 2. The Aggregate Corporate Sector The aggregate corporate sector in this study excludes the financial sector.2 percent in 1987. the growth rates of equity and sales dropped sharply in 1996 and 1997. following the sharp depreciation of the won.
0 4. Financial Statement Analysis Yearbook.7 15. 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 23.1 — — — = not available.5 4. ROA = return on assets (ratio of net income to total assets).6 Growth and Financial Performance of the Nonfinancial Corporate Sector.8 2.8 3. Source: Bank of Korea.9 8.3 17. .1 2.8 1.7 1.9) DER = debt-to-equity ratio.7 3.4 2.6 424.4 — 6.4 4.8) 297.6 4.2) (0.9 5.6 1.2 13.7 4.9 16.9 5.6 3.5 7.6 318.7 325.4 10.9 3.8 22.5 1.3) 5.8 8.9 3.5 2.3 335.0 13.5 1.0 8.0 305.China 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 2.9 16.0 10.1 2.4 1.9 2.9 18.3 21.3 308.4 2.3 312.9 2.1 8.0 (0.1 6. Ordinary income = operating income + nonoperating income (from financial activities) – nonoperating expenses (from financial activities).4 1.2 1.1 5.0 7.7 4.3 6. Financial Statement Analysis Yearbook.9 13.2 13.6 13.2 9.9 18.2 1.3 21.6 2.8 1.6 (4.4 1.0 6.5 0. Source: Bank of Korea.0 13.0 3.6 1.7 2.7 4.5 4.3 — 3.2 19.7 International Comparison of Ratios of Ordinary Income to Sales in Manufacturing (percent) Year Korea US Japan Taipei.Table 2.1 2.5 1.5 3.3 1.2 18.6 9.5 (0. Net profit margin = ratio of net income to sales.9 4.4 2.4 19.3 3.3 14. Note: Ratio of ordinary income to sales = (ordinary income/sales).8 21.2 1.9 2. Table 2.3 11. ROE = return on equity (ratio of net income to stockholders’ equity).0 0.7 3.7 15.9 5.
trade. Growth rates of total assets are generally high. and steam supply industry.4 percent. but higher than that of small firms. while their average net profit margin was lower than that of medium firms. In most years.5 percent while the aggregate sector recorded only 13. with the wholesale and retail trade sector and the construction sector having the highest figures. However. and ROAs of all listed firms declined substantially in 1996 and turned negative in 1997. However. The manufacturing. and transport sectors recorded negative profit rates in 1997. The growth performance of large firms for the 1988-1997 period was better than that of medium.6).8).10). the sales growth of listed firms was higher than that of the aggregate sector (see Table 2.9).Chapter 2: Korea 67 other three economies can be attributed to the emphasis on growth in sales and market shares rather than on profits. . Profit rates of different industries also mirrored the downward trend of the aggregate corporate sector prior to the crisis. gas. a year ahead of the other industries. both ROA and ROE were lower for the listed firms compared to the latter. ROEs. Listed Companies The number of listed firms increased from 334 in 1985 to 775 in 1997 (Table 2. Net profit margins. with equity in wholesale and retail trade even contracting. This preference of Korean firms has its roots in the structure of corporate governance. Profit rates of most industries are also quite low. Performance followed similar patterns across different industries (Table 2. The profit margin of listed firms was generally higher than that of the aggregate corporate sector. All sectors experienced a sharp decline in equity and sales growth in 1997. In 1997. construction. 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. A comparison of performance by firm size reveals some interesting results. sales of listed firms grew 18.and small-scale firms (Table 2. the average ROE was lowest for large firms. the exception being the electricity. It is notable that the construction sector’s profit rate began its decline in 1995. Small listed firms were hardest hit by the financial crisis. followed by mediumsized firms and large ones. The other financial ratios follow the general pattern of the aggregate corporate sector. this may be an indication of the bias toward large firms in terms of access to credit. Again. This may be related to its having the lowest DER.
7 5.5 28.5 569.8 0.7 1.4 2.0 1.1 16.8 17.0 245.1 7.7) 2.1 10.4 15.7 16.6 15.2 5.6) (6.1 2.3 1.5 19.9 0.2 (1.4 5.6 12.3 15.0 24.6 17.4 2.3 14.8 22.8 23.1 0.9 (0.3 10.0 19.9 19.8) 0.6 1.4 14.2 6.0 1.2 0.5 6.3 2.3 285.8 16.0 254.8 14.3 15.9 5.2 20.8 16.9 16.3 8.8 16.4 10.5 Construction 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 Average 18.8 24.2 5.2 2.9 16.4 (0.5 1.6 318.2) (0.5 27.9 10.0 7.9 2.1 2.4 350.4 2.0 18.7 (3.4 10.2 12.8 10.3 13.6 14.0 1.3 10.3 15.1 20.8 345.8 24.4 5.2 0.4 458.4 474.5 1.0 21.8 13.4 0.7 30.1 22.8 12.4 10.3 8.7 17.5 13.8 34.6 375.8 302.0 3.6 14.0 1.9 (0.7 520.9 10.4 740.5 16.0 22.4 1.4 17.0 2.0 2.4 1.6 14.4 348.9 340.5) 0.2 0.6 5.8 2.8 32.0 15.2 6.5 306.4 5.6 2.9 16.5 1.7 10.8 461.7 7.2) 15.0) 0.8 0.0) 4.3 18.9 29.2 7.2 20.0 15.9 14.8 35.3 1.1) (3.8 7.2 241.9 13.0 22.5 239.2 315.5 3.7 317.9 3.7 514.6 0.5 432.1 1.0) 0.0 (0.1 27.5 1.1 396.2) 6.0 16.8 12.6 6.5 (1.7 22.8 1.0 1.5 1.7 9.1 1.4 .8 10.4) 0.0 12.8 526.8 616.6 11.6 1.2 24.1 1.9 2.1 21.1 (0.3 8.0 37.1 0.0 22.0 16.7 294.9 538.5 23.8 2.3 8.6 3.2 16.0 2.8 562.3 25.8 3.4 3.9) 1.5 4.6 3.9 25.5 483.Table 2.0 9.0 24.6 12. Renting.1 17.8 14.3 2.8 2.5 (5.5 5.5 30.7 4.8 1.5 338.3 288.2 18.6 655.5 6.4 0.9 9.5 (0.0 5.6 16.9 31.0 5.1) 0.4 4.0 1.4 2.5 473.1 290.9 (0.3 31.0 18.2 15.3 11.5 270.8 Real Estate.2 16.5 14.8 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 13.6 7.2 423.5 5.3 14.3 11.1) 3.4 9.7 21.7 228.0 2.1 0.3) (1.0 1.7 0.6 0.4 10.4 12.5 286.1 28.2) 22.1 296.1 (0.0 23.0 (0.8 3.4 291.6) 3.2 36.2 5. and Business Activities 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 Average 11.2 25.5 1.9 1.3 15.0) 1.1 1.8 22.4 2.6 17.6 24.7 (0.0 (4.9 428.
7 2.6 6.3 18. and Communication 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 Average 15.7 11.1 21.6 172.5 482.7 19.5 16.4 10.9 10.2 15.8 7.5 14.4 6.5 47.6 9. Gas.2 10.1 8.6 18.6 9.4 15.0 Transport. and Steam Supply 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 Average 12.2 — — — — — 2.2 18.4 (2.2 18.3 23.9 4.4 12.5 15.3 2.2 14.5 15.9 18.8 15.7 510.7 7.5 14.3 1. a New equity does not include capital surplus.6 19.6 9.062.4 30.3) 15.9 4.9 9.7) 0.3 740.2 1.7 12.9 18.5 612.8 12.9 1.8 0.4 11.8) (12.2 18.3 8.2 90.1 (2.6 (2.3 125.4 0.3) 11.9 6. Storage.7 — = not available.9 12.1 15.6 12.8 12.6 3.5 14.5 0.0 1.3 4.8 0.3 (2.1 2.0 13.1 323. Source: Calculated using data from Bank of Korea.6 8.7 11.8 111.6 15.4 2.6 — — — — — 0.4 6.7) (4.4 633.3 0.6 8.8 8.2 7.5 14.4 (0.5 462.8) 1.4 14.4 13.1 11.4 21.2 2.6 14.5 117.7 2.2 14.8 (Cont’d) Growth Performance Year Assets Equitya Sales NPMb Financial Performance DER ROE ROA Wholesale/Retail Trade 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 Average — — — — — 31.6 (2.7 116.9 3.5 4.0 14.0 (1.1 1.6 1.6 8.0 (15.4 2.7 — — — — — 14.6 512.1) (0.3 4.5 2.3 3. .3 18.4 367.9 12.3 34.7 0.1 15.5 12.0 7.Table 2.6 0.0) 1. Financial Statement Analysis Yearbooks.4 16.3 1.5) 22.1) 1.5 30.7 7.0) 1.1 11.0 921.5 11.2 10.7 15.5 (2.2) 13.7 20.2) 9.9 8.6 6.9 7.0 5.4 0.0 14.6 2.4 0.1 16.5 26.4 1.4 1.1 12.6 21.0 2.0 98.2 11.6 1.6 4.9 332.4 3.5 13.3 9.6 12.9 (10.6 4.1 15.4 341.6 16.8 11.0 1.0 2.2 10.4) (1.9 Electricity.3 112.3) 4.1) 5.6 19.8 6.3 — — — — — 10.3 19.6 — — — — — 17.1 (11.4 7.3 12.1 (0.7 187.3 0.8 4.9 9.2 698.8 3.7 14.9 10.2 122.8 9.1 4.4 7.1) (0.8 529.5 307.6 20.9 8.2) 0.6 34.4 12.6 6.4 3.3 17.8 6.1 3.0 89.9 17.1 6.4 3.7 0.5 11.4 1.4 169.7 11.4 9.3) (1.5 8.0 106.3 524.3 543.5 539. b NPM denotes net profit margin.4 — — — — — 448.0 21.9 17.7 16.9) (8.2 3.8 14.3 8.8 3.5 344.9 321.1 14.0 5.1 17.2 143.8 14.0) (0.3 4.0 1.9 (11.9 456.
9 1.5 0.4) 1.4 1. the top 11-30 chaebols experienced a decline of .4 1.8 0.3 percent).9 Source: Constructed using data from Korea Investors Service.5 5.6 (1.9 26. The number of Hyundai member companies rose to 57 in 1997. followed by the top 6-10 (Table 2.2 2.8 24.9 Growth and Financial Performance of Listed Companies.2 9. debts (47.7 (5. of Firms 334 351 386 503 626 669 680 681 687 698 715 754 775 Sales Growth 10.1 6.7) 0.4 0.6 and 2.12).6 1.0 18.9 21. and net profits (46.5 ROA 0. Generally.2 9.3 15. sales (45.7 Net Profit Margin 0.9 6.7 1.3 2.8 6.70 Corporate Governance and Finance in East Asia.1) 4.5 19. 1985-1997 (percent. unless otherwise indicated) Financial Performance Year 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 Average No.3 20. Between 1993 and 1997. The criteria for selection of largest chaebols have changed a few times.8 5.9 percent). but the number of designated groups has been fixed at 30 since 1993.4 1. In 1995. and close to half of total assets (46.9 2.6 2.4 2.1 1.0 0. The smallest group had 16 members in 1995. Chaebols have been the most important actors and engines of growth in the Korean economy.12).6 3. The top five chaebols registered the highest growth rates. the 30 largest chaebols accounted for 13.0 3. Kis-Fas. had 46 member companies.6 23. 1998. Vol.3 0. the growth of sales of the top 30 chaebols exceeded that of the aggregate corporate sector (compare Tables 2.9 0. of which four were listed.9 11.7 percent) of the corporate sector. Performance of Chaebols This section uses available data on the top 30 chaebols. it is the chaebols’ large firms that are listed.6 0.11).9 2. Hyundai Group. the largest chaebol.9 percent).7 1.5 ROE 3. In 1997.2 0.4 22. It should also be noted that when the financial crisis struck in 1997.2 6.6 22.1 percent of the economy’s total value added (excluding the financial sector).3 4.3 (0.1 1. of which 16 were publicly listed (Table 2.5 19. II Table 2.
8 0.2 2. .0 4.1 0.6 2.9 25.4 Medium Small Large Medium Small ROA Growth Performance Large 17.8 7.9 5.0 1.8) 6. Source: Korea Investors Service.6 (1.0 (4.9 14.8 17. Others are medium firms.5 17.Table 2.4 1.0 6.2) (1.8 3.4 2.4 3.2 2.9 (0.10 Growth and Financial Performance of Listed Companies by Size.6 3.9 2.4 3.5 5.9 1.7 4.6 6.4 16.9) (6.6 2.6 1.1 11.0 15.9 3.5 0.5 Net Profit Margin Year Large Medium Small 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 Average 2.9 0.8) 1.1 2.4) 1.1) 5.3 3.5 (1.5) 1.2 Small 13.6) 0.0) 1.8 0.9 6.0 17. 1988-1997 (percent) ROE Large 9.5) 1.7 (1. 1998.2 10.5 2.2 12.3 (0.8 6.0 1.4 5.9 6.5 5.7 3.3 6.6 9.3 1.6 2.6 7.2 1.2 13.3 (0.8 1.7 (0.2) (1.5 1.4 11.7 (1.2 Note: Large firms have a capital base greater than W15 billion and small firms smaller than W5 billion.4 6.3) 0.9 1.7 2.7 18.6 0.0 1.8 6.1 1.0 19.9 2.8 (5.5 3.9 0.6 0.4 1.3 9.2) 0.6 3.6 (0.6 1.3 Medium 14.6 5.0) 0.9 2. Kis-Fas.8 0.2 13.3 15.9 22.9 0.1 8.0 10.5 25.1 2.6 8.3 11.7 2.3) 5.3 15.8 16.0 16.8 10.6 13.8 0.0 1.7 1.2 7.2 3.6 1.2 0.2 (0.
177 — 6.690 3.798 — No.651 38.597 351.313 14. Source: Fair Trade Commission.774 7.599 — 2.180 2.929 12.873 2.457 14.951 3.395 31.131 3.486 6.924 2.423 5.935 2.158 7.370 6.309 14.996 1.927 16.766 3.246 11.129 2.501 13.990 2.287 10.967 7.677 3. .11 Features of the 30 Largest Chaebols Total Assets (W billion) Name Hyundai Samsung LG Daewoo Sunkyung Ssangyong Hanjin Kia Hanwha Lotte Kumho Doosan Daelim Hanbo Dong-A Halla Hyosung Dongkuk Jinro Kolon Tongyang Hansol Dongbu Kohap Haitai Sammi Hanil Keukdong New Core Byucksan 1995 43.433 3.346 3.158 1.Table 2.574 3.910 3.376 35.147 5.364 5.995 2.853 1997 53.475 2.756 5. 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.303 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.090 6.427 9.117 4.956 3.455 22.743 40.640 4.445 4.458 6.398 — 2.761 31.
2 1.3 0.3 27.4) (14.1 (3.2 0.7) ROE 5.2 11.2 (16.1) (1.1 (1.3) 0.0 0.9 17.7 1.4) (0.5) (0.2 (5.1 27. 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 12.6 19.7 13.8 18.5 5.6 4.3 16.1) (0.0 6.5 19.7) Source: Bank of Korea.4 38.0 31.9 3. .9 24.7 10.6 (0.6 25.5 27.3 15.5 2.9 20.2 0.9 3.7 4.2) (0.8 Assets 12.2 (2.2 20.7 15.4 0.1 19.8 0.1) (0.3 14.1 2.Table 2.9 20.3 3.7 15.4) 1.5) (0.0) ROA 1.1) 0.0 1.6 18.3 19.1) 0.2) (2.4 30.0 17.0 0.3 11.2 0.2 (2.0 2.8 27.0 19.1 10.3 1.0) 3.5 32.7 10.6 1.5 (0.0 2.9 1.3 1.3 9.5) (0.4 26.1 (2.6 Financial Performance Net Profit Margin 1.5 20.0 2.2) 1.3 0.4 12.4 (2.12 Growth and Financial Performance of the 30 Largest Chaebols.7 0.9 18.2 3.0) 12.
technology.95 percent. However.765 percent (Table 2. Ownership patterns. his/her relatives. a pyramidal structure of corporate ownership is prevalent. and government intervention interacted through a set of laws and regulations to bring about the existing structure. from 190 to 3. loopholes and inconsistent policies spawned strategic behavior and agency problems. in this instance. it refers to the degree of concentration and shareholdings in the hands of an “identical person. the average DER of the 30 largest chaebols reached 519 percent.1 Patterns of Corporate Ownership The ownership of most Korean listed firms is highly concentrated. The Commercial Code stipulates the basic governance framework and applies to all corporations.13). weak corporate control.5 Founding families are mostly still the largest shareholders and. resulted in the chaebols’ excessive leverage. 2.3 Corporate Ownership and Control This section looks at the key aspects of corporate governance in Korea. Their worst year was 1997 when ROE hit -15. By the end of 1997. The better showing of the top five chaebols was a direct result of their dominance in human resources. internal and external control mechanisms. and the companies that are under the control of the largest shareholder. The ROE of the top 30 chaebols was consistently higher than that of the aggregate corporate sector. 5 While “ownership concentration” can be defined and measured differently in different contexts. except for 1995. The financial performance of the top 11-30 chaebols deteriorated during 1993-1997. and led to a high concentration of ownership.” This “identical person. II 2 percent in their sales and a very low 4. coupled with weak corporate governance. includes the largest shareholder. 2.3. and vulnerable balance sheets.” in Korea’s legal and regulatory framework. There has been a wide range in DER among chaebols. and access to credit. Vol. Only the top five chaebols registered a positive net profit margin in 1997.74 Corporate Governance and Finance in East Asia. In general. the net profit margin of the aggregate sector exceeded that of the top 30 chaebols.7 percent growth in total assets. The absence of a well-developed equity market and the provision of subsidized credit. . However. 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. chaebols had a higher average DER than the corporate sector as a whole. more important.
2 346.3 315.9 321. Kia 9.0 436.5 337.7 267. Ssangyong 7.1 3. Daewoo 5.441.1 477.3 297.244.7 620. Daelim 14. Hanbo 15. Sunkyung 6.9 751. Hyundai 2.4 622.5 343.13 The Top 30 Chaebols’ Debt-to-Equity Ratio.7 688. Hyosung 18.2 2.6 936.2 328.1 385. Newcore 30. Hanil 28.764. Kumho 12.0 370.5 3.4 205.0 506. Samsung 3. Doosan 13. Jinro 20.6 409.Table 2. Kumho 12. Hanjin 8.5 383. 1995-1997 (percent) Chaebols 1995 1. Hyundai 2.7 416. Dongkuk Steel 19. Dongah Construction 16.1 674. LG 4.8 336. Sammi 27.5 2. Dongbu 24.0 218.6 516.5 464.0 486.4 175. Doosan 15. Hyosung 18.4 192. Hanwha 10.1 278. Sunkyung 6.7 621. Kukdong Construction 29. Halla 13. Haitai 26. Byucksan 1996 1. Samsung 3.2 292.4 556.2 423. Jinro Debt-to-Equity Ratio 376.3 572.8 312.2 471. Hansol 17. Dongkuk Steel 19.1 190. Hanwha 10. Kohap 25. Halla 17.6 .7 354.6 2. LG 4. Daelim 16. Lotte 11. Daewoo 5. Kia 9. Dongah 14. Kolon 21.855.3 328. Hanjin 8.065. Tongyang 22. Hansol 23. Lotte 11. Ssangyong 7.8 313.2 924.
1 472.0 907.8 338.8 307. Financial Statement Analysis Yearbook.501.6 590. Kamgwon Industrial 30.8 590. Hanil 28.6 478.5 (1.8 658. Dongkuk Steel 20. Anam 27.6 Sources: aFair Trade Commission.9 1.0 305. Newcore 28. Anam 22.498. Ssangyong 8.9 472. Saehan Average of All Chaebolsa 1995 1996 1997 Average of All Industries Excluding Financial Sectorb 1995 1996 1997 Debt-to-Equity Ratio 317. Hansol 16. .4) 513. Lotte 12.8 347. Dongah 11. Tongyang 24.Table 2.13 (Cont’d) Chaebols 20. SK 6.0 419.600. Newcore 26.1 375.4 1. LG 5. Daelim 14.1 359. Dongbu 21.3 1.7 1.5) 404.9 490.5 576. Daewoo 4. Haitai 25. Hyosung 17. Kohab 22.8 399.7 370. Kolon 19.3 676. bBank of Korea. Hanjin 7. Keopyong 29. Miwon 30.9 216. Samsung 3. Tongyang 24. Kohab 18.9 465. Kolon 21.225.1 438. Daesang 27. Kumho 10.5 519. Haitai 25. Hyundai 2. Shinho 1997 1.784. Dongbu 23.7 944.5 (893.6 424.9 578.8 647. Hanwha 9. Shinho 26.6 335.1 433. Halla 13.5 323.0 505. Doosan 15.5 1. Jinro 23.214.3 347.3 399.8 468.5 386. Keopyong 29.6 416.5 261.
Beyond that range. The controlling shareholders of chaebols hold comparatively smaller percentages of shares. The percentage of shares owned by “other corporations. and then steadily declined after 1993. The next important group was “other corporations. From 69.7 percent by 1997. resorting to extensive use of pyramiding to maintain control. 10 to 30 percent). fluctuated widely during the period. individuals were also the largest shareholder group. that is. the entrenchment effect outweighs the incentive effect.” foreigners. with a given range of managerial shareholdings (for instance.. Thus. Most non-chaebol listed firms in Korea are believed to have ownership concentrations within the 10-30 percent range. large ownership can also bring about the entrenchment effect. the Government. an increase in their ownership may bring their ownership incentives to converge with those of the minority shareholders. i. the incentive effect once again dominates. the entrenchment effect and problems of agency may be more pronounced in chaebols than in independent firms. and insurance companies increased during the period.” followed by banks. Among listed nonfinancial companies. the ownership structure can bring about an incentive effect.14). an entrenched manager is insulated from market pressure and can pursue personal goals without the fear of being replaced. However.Chapter 2: Korea 77 When controlling shareholders hold a very small percentage of the shares. and state-owned companies and securities companies declined. managerial entrenchment becomes more likely. the extent of ownership by these individuals declined gradually after 1988. Financial institutions owned as much as 28 percent of the total corporate shareholdings in 1992. The pattern of distribution changed little through 1992-1997. including investment trust companies. When managerial holdings are reinforced by artificial control mechanisms such as pyramiding. but their shares declined to 21. while those owned by banks. the individual owners—the portfolio investors as well as the controlling shareholders and their family members—formed the largest shareholder group (Table 2. Securities companies reduced their holdings over this period of falling stock prices as the size of investment trust companies’ stock portfolios declined. including banks and other financial firms. Theoretically. the percentage of holdings by individuals slipped to 60. The reduction can be . the year the stock market was in a frenzy due to buying sprees.6 percent by 1997.1 percent. However. Composition of Ownership Among listed companies.e. The holdings of financial institutions.
0 9.4 Insurance Firms Other Corporations Foreigners Individuals 39. of Firms The Statea Banks.0 4.5 18.8 17.8 2.3 1. Listed Nonfinancial Companiesd 1988 406 0.2 8.5 4.3 1996 570 2.2 8.7 3.2 5.5 60.2 17.6 8.5 6.1 2.6 13.2 7.5 7.2 3.Table 2.2 1993 511 2.2 5.5 12.0 8.7 4.4 14.7 7. 1988-1997 (percent) Financial Institutions Securities Firms Total 28.6 19.0 59.3 5.3 17.8 2.6 2.6 16.3 8.14 Ownership Composition of Listed Companies.4 6.6 1991 505 0.1 17.5 6.9 2.9 26.b A.6 16.2 9.7 8.2 B.1 68.7 9.0 5.2 18.8 5.8 17.4 13. merchant banks.7 59.6 20.3 39.3 5.7 9.9 37.5 1.3 2.” includes commercial banks.2 2.5 Note: Ownership is based on number of shares.1 11.3 1994 521 1.3 1.9 1. mutual savings.8 4. a The State covers the Government and state-owned companies.8 69.7 6.4 5. c Data from Korea Stock Exchange. b “Banks.1 8.4 18.6 12.9 36.9 15.4 13. and finance companies.3 18.1 8. .0 60. etc.8 59.2 9.0 7.7 14.5 7.6 9.1 4.1 21. d Constructed from data files of the Korea Listed Companies Association.4 5. etc.4 1997 551 1.2 4.1 18.4 34.1 18.6 22.0 5.1 10.7 1990 531 0.1 21.7 18.1 3.8 59.6 Year No.5 1.9 5. investment trust companies.5 1989 498 0.5 62.1 1.0 27.3 17.3 18.6 16. All Listed Companiesc 1992 681 1993 687 1994 698 1995 715 1996 754 1997 775 9.0 28.6 9.2 1.9 1.5 16.9 4.3 26.8 5.9 2.8 1995 548 2.1 60.6 36.5 1992 508 2.9 17.9 19.
held 26. UK. The holdings of other corporations are mainly equity investments in affiliate companies. government ownership in nonfinancial companies was remarkably smaller and more concentrated. Individuals held the majority of the shares in all industries except in telecommunications. When independent companies are distinguished from firms affiliated with the 30 largest chaebols.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. Over the years. and service of motor vehicles (Table 2. In most instances. whether partial or absolute. the Government acquired an even bigger share in several banks as part of its program to bail out these distressed institutions. foreign holdings were derived from purchases through country funds and direct capital investments. there appears to be no significant difference in the overall shareholding patterns between the two groups (Table 2. Compared with its holdings in all listed companies.16). In 1998. categorized into large.17). Institutional investors. other corporations’ holdings shifted toward service industries. The ownership distribution in listed nonfinancial firms. This trend can be explained by government ownership. and small companies. did not vary significantly (Table 2. The Government’s and state-owned institutions’ (including some banks) ownership was generally small except in the power sector. Before such liberalization. indicating their increased investments particularly in the service industries with high growth rates. However. This is low compared with those in Japan. Corporate holdings averaged 16 percent throughout 1988-1997. medium. the Government was the sole owner. Foreigners gradually increased their equity shares in 1992 when direct purchases by them were first permitted. of some banks. electricity. with the Government continuing to hold a sizable share in the Korea Electric Power Corporation.15).8 percent of listed shares in 1997. the holdings of institutional investors were expected to increase significantly with the Government’s introduction of US-type investment companies in 1998 and . and US (Table 2. However. financial institutions had more shares in the manufacturing sector than in primary industries. In general. as distinguished from individual and foreign investors. One minor difference is that the percentage of shareholdings by corporations is slightly higher in large-sized firms. 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.18). indicating their heavier reliance on inter-firm financing investments.
4 8.6 5.3 6.7 63.0 7.2 22.2 — 0.9 59.6 8.8 8.4 2.5 7.3 57.7 2.4 5. Etc.7 2.7 20.3 2.7 64.9 1.3 0. 1990 and 1997 (percent) Financial Institutions The Statea — — 0.b Securities Firms Insurance Firms Other Corporations Foreigners — — 0.2 2.. and Plastics Basic Metal Fabricated Metal and Machinery Office and Computing Machinery Electronics.1 0.9 55.0 9.3 9.0 — 0.8 3.2 9.8 3.4 1.6 3.7 22.3 4.1 27.9 42.4 — 0.2 1.7 20.15 Ownership Composition of Listed Nonfinancial Firms by Industry.4 0.4 62.1 0.1 8.0 9.0 10.3 1.6 11.4 8.8 7.9 19.3 13.9 66.5 0.3 0.2 54.7 14.7 1.0 2.8 7.3 0.4 14.2 9.5 17.6 24.5 0.9 0.8 7.2 17.1 0.9 15.1 8.7 2. and Printing Chemicals.7 6.1 0.5 — 1.9 16.8 7.3 1.7 29.7 17. Paper.2 7.9 1.8 5.6 18.8 73.3 38.4 7.1 65.3 7.0 9.2 64.0 8.0 20.2 1.2 0.4 56. Rubber.0 1.8 1.9 60.5 0.3 62.9 4.2 0.9 10.5 3.6 1.0 Industry 1990 Fishing and Fish Farms Mining Food Products and Beverages Wearing Apparel and Fur Articles Wood.0 — 39.7 14.9 52.5 12.1 7.5 6.4 8.7 22.4 Banks.5 0.4 1.3 10.9 8.6 — — 2. Paper. Gas.8 7. and App.5 — — 0.5 85.3 2.7 59.9 23.5 19.0 9. Motor Vehicles Electricity.5 — 0.2 0.2 9.1 10. Elecl Mach.8 6.Table 2.8 Individuals 83. 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 88.1 1.3 11.5 4.1 19.2 0.1 4.4 56.2 — — 0.0 0. and Printing Pulp.
Paper.3 6.1 3.4 0.5 59.5 1.4 58. merchant banks.4 4.1 1.1 9.4 43.6 0.7 2.2 7.9 20.3 65.1 2.2 13.6 60.4 1.8 57. Elecl Mach.4 1.6 75.6 7.2 5.4 — 1. etc.3 8.8 5.9 78.4 1. and Printing Chemicals. mutual savings.4 45.1 6.6 0. b “Banks. Paper.4 3.5 3.8 27.9 6.4 58.3 7.2 6.7 2.6 59.6 2.2 4.8 2.2 4.5 7.6 2.6 — = not available.7 1. a The State covers the government and state-owned companies.0 7.1 2.5 3. and App.9 1.2 8.1 18.7 23. and Printing Pulp. and Plastics Basic Metal Fabricated Metal and Machinery Office and Computing Machinery Electronics.4 76.1 54.2 4.8 5.5 3.0 3.6 6.2 49.9 2.2 4.2 5.8 54.5 4. and finance companies. Note: Ownership is based on number of shares.78 81. Motor Vehicles Electricity.5 6.0 4.3 57.3 1.9 2.9 7.6 20.4 20.3 0.9 5.9 20.2 1.1 — 1.5 5.3 60.4 2.2 1.8 3.6 2.9 0.4 2.8 0.3 2.4 9. investment trust companies.0 60.8 4.1 4.3 15. .9 69.8 12.4 16.0 5. Rubber. Gas.9 1.4 68.8 11.7 4.7 2.6 5.9 6.7 5.1997 Fishing and Fish Farms Mining Food Products and Beverages Wearing Apparel and Fur Articles Wood.9 18.0 1.0 43.1 1.9 2.5 3.3 1.9 1.6 6.7 6.1 — 0.5 12.0 8.1 9.6 14.0 11.4 6.6 18.5 0.2 0. Source: Constructed from data files of the Korea Listed Companies Association.7 17.7 19.8 6.0 6.5 4.9 57. 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 1.9 7.0 6.9 5.5 63.4 4.2 0.8 2.2 23.” includes commercial banks.9 2.4 2.5 — 2.1 3.3 31.6 3.8 0.6 1.3 6.2 3.1 25.8 2.7 2.
etc. 1997 (percent) The Stateb Foreigners 4.5 6. etc.9 4.5 62.1 6.8 60.7 Foreigners 4.5 4.8 1.7 1.4 61.4 4.0 1.8 6. mutual savings.3 Banks. . merchant banks. b Table 2.2 1.7 6.8 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. c “Banks.0 Other Corporations 16. investment trust companies.5 8.0 6.6 16.4 2.8 2.4 21.9 5.4 2.5 19.8 4. Others are medium firms.1 2.4 1.4 5.c Securities Firms Insurance Firms Other Corporations Individuals 58.” includes commercial banks. The State covers the government and state-owned companies.3 6.9 2.5 Individuals 60. etc.4 5.1 8.1 Banks.7 4.4 Firm Sizea No.4 17.7 0. Source: Constructed from data files of the Korea Listed Companies Association.Table 2.17 Ownership Composition of Listed Nonfinancial Firms by Control Type.8 4.5 18. 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.5 16.16 Ownership Composition of Listed Nonfinancial Firms by Size.7 Control Type No.5 2. 1997 (percent) The State 1.6 60. Securities Firms Insurance Firms 2.7 8.4 61. and finance companies.
8 56. investors (Table 2. rather than the individual. Generally. Foreign holdings of Korean shares were 9.6 39. minority shareholders. corporations held 70 percent of the controlling blocks of shares. Institutional Investors 42.19). 1997 (percent) Country Japan Korea Taipei.5 45. But these may .3 6.China United Kingdom United States Source: Stock Exchange of Korea. for example.3 54. his/her family members. 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.6 Foreigners 9. 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. Among nonfinancial listed firms. including those of the largest shareholder. the majority shareholder group in all listed companies consists of the corporate. while family members accounted for only 30 percent.6 Individuals 23.7 16. and other shareholders who do not belong to either the minority shareholders or the majority shareholder group. only closed-end investment companies and traditional investment trust companies are allowed.20). The majority shareholder group’s shareholdings in listed nonfinancial firms steadily declined from 1990 to 1996.5 20.3 47. In 1997. and the companies under the control of the largest shareholder.8 9. At the moment. the majority shareholder group on average held 23-30 percent of outstanding shares in the period 19881997 (Table 2.4 26. This has had profound implications for corporate governance and the market for corporate control in Korea.18 Ownership Composition of Listed Firms in Selected Countries.1 8.Chapter 2: Korea 83 Table 2. defined as those holding less than 1 percent of shares.8 10.1 percent and appear to be similar to the proportion of foreign holdings in the four other countries.
7 Note: The majority shareholder includes the largest shareholder.6 5.1 5.3 2.4 7. 1992-1997 (percent) Majority Shareholders Corporation 15.9 7.6 46.5 43. Minority shareholders are those holding less than 1 percent of shares.0 25.0 29.2 2.9 33.6 26.1 14.8 72.8 Individual Subtotal Other Shareholders Corporation 3.9 Individual 2.6 73. .2 26.9 6.8 73. Source: Stock Exchange of Korea.0 4.7 18.7 6.0 1.3 18.0 Year Corporation Individual 1992 1993 1994 1995 1996 1997 41.0 22.4 3. Other shareholders are those who do not belong to either the minority shareholders or the majority shareholder group.4 5.0 66.6 2.2 2.1 37.7 7.3 Subtotal 5.7 44.19 Ownership Concentration of All Listed Firms.0 2.9 2.1 5.9 32. and the companies under the control of the largest shareholder.1 23.8 8.7 16.2 Minority Shareholders Subtotal 71.Table 2.1 15. his/her family members.3 30.9 3.1 32.1 28.1 21.6 22.1 4.0 69.
6 58.5 12. The percentage of shares held by minority owners (with less than 1 percent of outstanding shares) was highest for large firms at more than 55 percent (Table 2.4 23. It was highest in medium-sized firms before 1993 and. Ownership concentration tended to be lower in large compared to medium and small listed firms. which held less than 1 percent of a company’s outstanding shares as of 1997.9 Other Shareholders 18. The practice of hidden shares seems to have been less prevalent in recent years. collectively owned less than 50 percent of an average firm.8 28. in the small firms. In telecommunications.5 23. and mining categories.3 62. thereafter. minority shareholders.8 Majority Shareholders 27.6 57.22).0 22.6 11. In most industries.4 Source: Constructed from data files of the Korea Listed Companies Association.0 58. In such cases. the majority owner held more than 20 percent of an average firm.8 57. 1988-1997 (percent) Year 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 Minority Shareholders 53.7 18.0 20.8 54.9 25. Besides. rubber and plastics.9 27.21]). ownership was relatively diffused due to government regulation. The shareholders that held more than 1 percent but did not belong to the majority group held about 20 percent on average. Across industry. 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 2.1 50. hiding shares offers no additional tax or other benefits.2 15.9 12.8 12. Majority ownership is also high in the chemicals. Meanwhile. the Government has retained a large number of shares.8 25.5 13.4 28.20 Ownership Concentration of Listed Nonfinancial Firms. 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.Chapter 2: Korea 85 Table 2. .9 29.9 48.3 25.5 60.
9 Minority Shareholders Majority Shareholders Other Shareholders 12.4 53.7 24. and App.2 20.5 16.2 19. Elecl Mach.9 44.3 19.8 21.1 49.2 48. and Printing Chemicals. .5 47.6 53.0 21.4 16.1 43. Motor Vehicles Electricity.6 25.8 24.8 25. Rubber.8 55.0 30. and Plastics Basic Metal Fabricated Metal and Machinery Electronics. and Printing Pulp.6 34.8 41.3 26.3 39.2 46.6 50. Gas.7 36.5 41.7 29.9 10.9 26.6 19.2 34.6 38. 1997 (percent) Number of Firms 3 2 43 49 12 16 90 39 31 71 34 8 9 49 40 15 1 10 29 551 36.1 17.2 23.4 Industry Fishing and Fish Farms Mining Food Products and Beverages Wearing Apparel and Fur Articles Wood.0 54. Paper.2 22.5 44. Paper.4 11.5 19.5 21.21 Ownership Concentration of Listed Nonfinancial Firms by Industry.7 26.1 19.8 51.7 17.2 26.7 21.5 20.0 39.8 31.8 44.5 52.Table 2.7 27..2 37. 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.5 23.0 51.8 29.
2 11.4 30.8 56.1 15.2 50.2 55.5 51.9 26.6 62.1 27.5 10.2 12.7 17.0 55.2 Source: Korea Listed Companies Association.1 48.5 28.9 16.5 26.8 50.2 18.5 33.9 17.1 16.8 52.9 22.2 21.6 11. 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 53.3 55.6 24.5 19.9 28.6 31.7 31.0 24.6 59.6 27.3 25.5 12.5 27.8 52.8 17.4 30.0 66.6 15.4 30.9 53.2 52.2 26.7 14.7 22. .2 Majority Shareholders 26.6 65.4 21.9 56.9 55.7 16.5 Other Shareholders 19.7 57.Table 2. 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.3 27.8 28.2 21.3 26.7 15.22 Ownership Concentration of Listed Nonfinancial Firms by Firm Size.9 23.2 21.7 57.4 29.5 21.9 21.5 12.5 49.9 60.6 55.8 27.4 51.2 32.0 26.3 19.5 19.0 59.8 11.4 47.2 56.9 12.3 21.8 62.1 58.7 28.1 20.
called “pyramiding”— commonly (though incorrectly) known as “indirect cross-shareholding”— is prevalent in Korea. one company from a chaebol group could obtain debt payment . TQ was calculated by dividing the market value of a firm by the substitution price of its assets. One of the merits of pyramiding. H. 1988). thus a firm destroys value. If SCS is above 20-25 percent. This refers to the situation wherein Company A holds shares of Company B and simultaneously Company B holds shares of Company A. is effective control of a certain group of companies even with a smaller investment. Hong. often at terms unfair to one of the transacting parties. and the shareholding of a controlling shareholder (SCS) as the degree of ownership concentration. The pattern of the relationship between SCS and TQ is similar between Korean and US firms (Mork. II Ownership Concentration and Financial Performance J. TQ is below 1. The relationship between TQ and SCS shows a similar pattern. Both studies used Tobin’s Q (TQ) for the value of a firm as an index of financial performance. H. and Kim (1995) reached a similar conclusion. This type of inter-firm investment. affiliated companies have been able to conduct inter-firm transactions. If TQ is higher than 1.88 Corporate Governance and Finance in East Asia. Vol. which can then pass the equity capital to a third. The Code prohibits a subsidiary company from owning shares of its parent company. although turning points in the value of firms are different. and Vishny. J. from the standpoint of the controlling shareholder. thus a firm creates value. For example. Kim (1992) found the relation between TQ and SCS to be nonlinear. In Korea. Kim (1992) and Kim. it means the firm creates value. TQ has a maximum value. If SCS reaches 10 percent. Where direct cross-shareholding is not allowed. TQ increases as the SCS increases. Shleifer. the firm destroys value. and Kim (1995) studied the empirical relationship between the degree of ownership concentration and financial performance in Korea. TQ is above 1. Hong. which is the company holding more than 40 percent of outstanding shares of its subsidiary. They analyzed firms in which controlling shareholders participate as managers. if TQ is lower than 1. The study by Kim. one company can still place equity investments in another. If SCS is below the range of 20-25 percent. If SCS is below 10 percent. Inter-Firm Investments and Pyramiding in Chaebols The Commercial Code imposes limits on direct cross-shareholding. Then TQ declines until SCS reaches 45 percent and increases until it reaches 50 percent.
34 percent were foreign companies.Chapter 2: Korea 89 guarantees from other members of the group at no cost. together owning an average of 37. and 319 foreign subsidiaries. neither the investors nor the relevant government authorities were active in monitoring such unfair dealings between firms. In Table 2. Among chaebol affiliated firms.5 corporations and two individuals. Twenty-two of the 81 respondents were independent. But the controlling power of the owners also stems from inter-company shareholdings of the subsidiaries. although they are likely to be insignificant. together owning an average of 38.5 percent. Only six firms (or 13 percent) indicated that their subsidiaries also owned shares in themselves. Partial results are shown in Table 2.5 percent of shares. 62 percent (16 out of 26) had a corporation as the largest shareholder. the top five shareholders consisted of 2. together having a total of 292 domestic subsidiaries. the average shareholding of the controlling owners and their families was 8. for example. the top 30 chaebols’ shareholding by subsidiaries was 34. 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.9 percent of shares. The top five shareholders of the chaebol-affiliated firms consisted of one individual and 3.23.14. dominated the majority shareholder group in chaebol-affiliated companies is consistent with the results of the ADB survey conducted for this study. or about four firms each. standalone setups. Among the subsidiaries or firms receiving investments. Among the 81 listed firms in the ADB survey. 53 percent were domestic nonfinancial firms. not individuals. and about 11 percent were domestic financial institutions. In many instances. corporations hold about 20 percent of the outstanding shares of all listed nonfinancial firms. For the whole sample. Thus. Thus. This also partly explains why chaebols frequently opted to expand by establishing new firms rather than placing investments internally.4 corporations. Until recently. If we define the internal shareholdings of a . The extent of pyramiding can be seen in some of the previous tables. or an average of 13 firms per company. or about five subsidiaries each. firms linked through partial equity investments could enjoy the advantage of consolidation without an actual formal consolidation or merger of operations taking place. 59 were parent firms with one or more subsidiaries. In the case of the 30 largest chaebols. The fact that corporations. financial institutions that are subsidiaries of a chaebol also hold shares in its member firms. Of the 81 respondents. For the same year. 59 parent companies collectively had investments in 759 firms.5 percent as of 1997. there are instances of direct cross-shareholding in Korean firms.
7 19.6 16. A few companies reported less than five largest shareholders.8 38.8 8. 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 20.7 39.6 3.7 5.9 21.4 2.5 4.4 25.6 3.5 31.7 37.4 21.5 2.1 22.8 Note: The survey was conducted during the period January through May 1999 and included nonfinancial listed firms only.8 18.5 2.5 1.4 42.5 18.4 11.0 17. 1999 Five Largest Shareholders No.3 12.4 18.6 3.8 37.1 3.2 37.0 2.5 2.3 26. a Number of shareholders.2 25.0 3.8 31.0 3.9 29.9 34.5 24.7 0.1 1.0 21.9 5.Table 2.5 2.23 Ownership Concentration in the Survey Sample of 81 Listed Firms.5 38.0 1.0 13.4 38. b The chaebol affiliated firms are those belonging to one of the 30 largest groups.0 1.6 34. .5 4.4 1.
Lee.8 33.4 13. C.1 1997 43.2 12. the ownership patterns can be described as follows. Jae Woo. 15 October 1998. As of 1997.7 1992 46.Chapter 2: Korea 91 chaebol as the shareholdings of the controlling family and the member companies of the group.7 31.24 shows the average internal shareholdings in the 30 largest chaebols. “Is the Fair Trade Policy Fair?” Korea Economic Research Institute. 1987 56. “The Ownership Structure and Family Control in Korean Conglomerates: With Cases of the 30 Largest Chaebols. 6 7 Hattori. 1998. Lee. Table 2.2 1994 42. “Japanese Zaibatsu and Korean Chaebols. Family holdings include shares owned by the family members and by parties considered to be under the influence of the family. 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.0 8. 79-95. it appears that the chaebol families have had a strong desire to expand their business bases. New York: Praeger. Based on these studies.24 Internal Shareholdings of the 30 Largest Chaebols. Chung and H. Hattori (1989) identified three patterns based on data in the early 1980s.5 percent and member companies. Table 2. 1997. pp. .4 10. 34.5 34. the average internal shareholding ratio of the top 30 chaebols was at least 43 percent.5 Judging from the historical record.7 9. H. Ungki Lim. The family and member companies’ shareholdings have been declining over time. 1989.” Paper presented at the Annual Conference of Financial Management Association.5 percent. 1987-1997 Type of Shareholding Internal Shareholdings Family Member Companies Source: Korea Fair Trade Commission. the controlling families owned 8. Chicago.2 15. Many attempts have been made by researchers to identify the typical patterns of ownership structures in chaebols.6 Later studies by Lee (1997) and Lim (1998)7 find similar patterns. 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.” In Korean Managerial Dynamics.8 40.2 33. edited by K. Internal shareholdings in some chaebols also include shares owned by nonprofit organizations operated by the controlling family.4 1993 43. Tamio.4 1990 45.6 33.
Chaebol Reforms Various measures have been taken to improve the transparency of chaebols with regard to accounting. Also. completely dissolved under financial distress. The Kia Group was about the only management-controlled group but was out of existence by 1999. The Hyundai Group exemplifies this. But the former chief executive officer (CEO). A nonprofit foundation under the family’s control is the largest shareholder of one of the base companies. Here the family is the controlling shareholder of one or more strategic base companies that have enough equity participation in the subsidiaries. and business activities. Vol. Sun Hong Kim. The two base companies have investments in three other base companies.” Here the family directly controls a base company and a nonprofit foundation. investments made by the base companies. The controlling family has sizable investments in two base companies and smaller investments in many others. is an example of this type. financial. which in turn hold shares in some of the other subsidiaries. Kia Motors was the base company and had such strategic shareholders as Ford Motors of the US and Mazda of Japan. For example. As of 1997. which then make investments in the subsidiaries. The second (Type B). subsidiaries have extensive investments in other subsidiaries. The fourth type (Type D) is “management control. or merged into. II The first (Type A) is called “direct family ownership. and his management team exercised full control over the group without much interference from major investors. Most of its member firms were acquired by. The Hanjin Group. Thus. there is no controlling shareholder.” A family owns a substantial portion of shares of member firms and becomes the controlling shareholder of each. called the “indirect control via base company. The Hanwha Group can be classified as such a company. Its controlling family holds shares in three base companies through which they exercise control over the other member firms. holdings of the nonprofit foundation.92 Corporate Governance and Finance in East Asia. and subsidiaries’ equity participation. One of the . consisting of eight listed and 16 privately held firms as of 1997. Investments between the lower level subsidiaries are rare.” Under this type of ownership pattern.” shows a simple pyramidal structure. other firms. The family itself holds shares in some subsidiaries. Hyundai Motors acquired Kia Motors via an international auction. It consists of seven listed and 24 privately held firms. the family controls the group’s member companies by its own shareholdings. The third (Type C) is “indirect control via complex shareholding. it had 18 listed and 39 private companies.
The Government is also considering whether to allow consolidated taxation for pure holding companies. direct control of the management of chaebols was attempted through amendments of the act in 1986 and 1990. 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. there are reports that some top chaebols are studying the feasibility of transforming their organizational structure. thus hurting the shareholders of stronger firms. Until the end of 1998. The Fair Trade Act was also revised in February 1998 to prohibit cross-guarantees of debt among members of a chaebol. the act did not have any important provisions except the standard clauses prohibiting monopolization of an industry through business combinations. They hindered early exits (liquidation. 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. This limit was also applicable to banks and insurance companies. only operating holding companies were allowed to be established. The first serious attempt to deal with this issue was the introduction of the Monopoly Regulation and Fair Trade Act of 1980 (hereinafter. These conditions are aimed at restricting excessive pyramiding and expansion of chaebols. Existing guarantees had to be resolved by March 2000. The Fair Trade Act was amended in 1998 to allow pure holding companies to be established under restrictive conditions. Also. An operating holding company is defined by the Fair Trade Act as one whose investment in others does not exceed 50 percent of its total assets. Initially. A third disallows multiple layering of holding companies. Cross-guarantees are believed to constitute a form of wealth transfer from financially strong members to weak ones. It remains to be seen whether they will adopt the holding company structure in the future. following the amendment of the law. However. These amendments prohibited holding companies and direct cross-shareholding.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. The prohibition of holding companies was also abolished in 1999. At this early stage. The limit on investments was reduced to 25 percent in 1994 and completely eliminated by 1997. This was the reason why chaebols chose to employ pyramidal structures. the Credit Management Regulation rules were amended to prohibit financial institutions from requiring guarantees from affiliated firms when extending new loans. One condition requires that the DER of the holding company should not exceed 100 percent. bankruptcy reorganization. the Fair Trade Act). .
unlike the regular consolidated statements that only cover those firms that are related through direct equity participation. which put together the accounts of all members of a chaebol. Despite chaebols’ decision to dismantle the chairman’s offices. the Commission has strengthened its investigative activities to eradicate cross-subsidization and wealth transfer activities among group members. and transferred funds generated by one firm to another. It also acted as the secretariat for the unofficial “presidential meeting” of the member firm presidents. The chairman’s office had its own chief executive officer. but the larger and stronger ones still operate their newly named “restructuring headquarters” under the control of the group chairperson. II etc.” The group chairman operated through these offices and treated the individual member firms as if they were the divisions of a single legal entity. Some chaebols operated “group management boards” attended by top executives (presidents or chairpersons) of larger member firms. 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.94 Corporate Governance and Finance in East Asia. who is universally called the “group chairman. usually in the rank of a company president. chaebols dismantled their “planning and coordination offices” or “chairman’s offices” under pressure from the Government.3. Some chaebols have disintegrated or shrunk in size. until urgent restructuring is complete.) 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. even though they were legally independent with their own board of directors and the outside shareholder groups were not identical. there have been no significant changes. Since the economic crisis. planned for capital raising and allocation on a groupwide basis. These offices were legally informal and functioned as the headquarters of chaebols.2 Internal Management and Control Monitoring of corporate management by shareholders. The staff of these organizations were employees of member firms. The 30 largest chaebols are now required to publish “combined” financial statements. Vol. Chaebols maintain that the restructuring headquarters will exist only for a limited period. The office established strategies for the group as a whole. Their operating costs were borne by the member companies rather than by the controlling shareholder. and the capital market was almost nonexistent until the recent reform . In 1998. boards of directors. 2.
This policy managed to hamper any monitoring initiatives from the capital market. This implies that the typical agency problems in Korean corporations stem from conflicts of interest between inside (the largest) and outside (minority) shareholders. and takeover codes were not accommodative to active monitoring. this was complicated by the prevailing attitude that large companies. As of 1997. had their own governance problems. Directors are elected at the general shareholders meeting for a term not exceeding three years. Loan agreements and debt indentures did not include strict covenants. as the major creditors. in most Korean firms. 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. only the Government could play an effective role in monitoring corporations. Professionalism in management was not well developed and managers were content with receiving orders from controlling shareholders. the representative director was also the chairperson of the board. creditors were not active in monitoring debtor firms and relied mainly on guarantees and collateral. corporations should have a board of directors consisting of at least three members. Board of Directors General Characteristics of the Boards Under the Commercial Code. With few exceptions. especially chaebols. . Most companies have one representative director. Even when the covenants were violated. except for banks. Meanwhile. There are many reasons for this.Chapter 2: Korea 95 efforts. control is not separate from ownership. Banks. were too big to fail. Thus. he or she generally approves major decisions made by the management. Legal provisions to protect investors were limited. the controlling shareholder is officially the representative director and the CEO. the creditors did not declare defaults. but some large ones have two or more. The board elects one or more representative directors from among the board members. In most listed companies. Even where the largest shareholder is not the representative director. or at least acts as the de facto CEO. the concept of fiduciary duty of managers was not well established. Under such circumstances. the controlling shareholder (or a member of the controlling group) was the legally registered representative director in 354 out of 551 nonfinancial listed firms.
The Commercial Code was also revised in 1998 to introduce cumulative voting for the election of directors. almost all companies succeeded in adopting cumulative voting. II When the Commercial Code first introduced the corporate board system in the 1960s. A few large companies had more than 50 directors. Recent Reform Efforts on the Board System In 1997. companies have to disclose in their annual reports the frequency of board meetings. Most of the outside directors in those days were the controlling shareholders of chaebols or executives of affiliated companies. and their positions (accept or reject) on matters voted on in board meetings. However. there is concern that newly elected outside directors still lack independence from the management or the controlling shareholder. 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 attendance rate of outside directors. other than the representative director(s). In the 1999 annual shareholders meetings.96 Corporate Governance and Finance in East Asia. members of the board. 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. all of whom were managers. . 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. With the boards consisting only of insiders. Further. 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. 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. However. were supposed to be outside directors. 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. 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. Moreover. In order to address this concern. Despite the qualification requirements. cumulative voting is not mandatory and a company can exclude itself from its application by amending its charter.
Among others. These results are in accordance with the new listing rules introduced in 1998. ADB Survey Results on Boards The ADB survey results confirm the above assessments and provide early indications on the effects of the reforms.1 percent of outstanding shares of a listed company. Almost all (92 percent) of the respondents had one or more outside directors and 70 percent were elected after the Asian financial crisis. The Securities and Exchange Act will require large listed firms with W2 trillion or more in total assets to adopt the audit committee system. although some banks recently have established board committees. the Corporate Governance Reform Committee. Where the two were separate. they had a parent/child relationship in 20 percent of the cases. he or she held 6. In March 1999. In 78 percent of the responding firms. the chairperson of the board was also the CEO and on average held 10. The average board had 8.1 percent and outside directors 1. which had extended financial support in their recent recapitalization efforts. inside directors owned 16. Directors were also chosen on the basis of their relationship with the controlling . a blue-ribbon committee. and a nominating committee. Among the firms with no outside directors. the Korean Code recommends that large listed firms should have at least three independent directors.9 percent on average. This is because most banks. was established under the auspices of the Ministry of Finance and Economy and the Korea Stock Exchange.2 percent and the CEO 14.5 percent of the shares. who would comprise at least 50 percent of the boards. 88 percent had plans to hold elections in the near future. On average. an audit committee.Chapter 2: Korea 97 The committee structure of the board as found in the US has not yet been adopted by listed companies. Directors were most frequently elected because of their professional expertise (74 percent of the respondents marked this answer). this committee adopted the Code of Best Practice in Corporate Governance. The controlling shareholder of some banks is the Government. the OECD principles of corporate governance were the minimum standard for the Korean Code of Best Practice. Meanwhile. having no controlling shareholders. The Commercial Code is being amended to allow a choice between the audit committee system and the current internal auditor system. are required to have a majority of outside directors.4 directors. Where the chairperson was not the CEO. In September of the same year.
In some instances. 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. Less frequently. including stock options. However. The reason for this high frequency of interlocking directorship is that many listed firms belong to chaebols. compensation for directors must be approved by the annual shareholders meeting for each fiscal year. Some directors were nominated by significant shareholders (18 percent) or introduced (and elected) at the shareholders meeting. and shareholding (10 percent). Most frequently. In most firms.98 Corporate Governance and Finance in East Asia. As discussed earlier. and fixed fees plus performance-related pay. In 1997. In a very small number of firms. the term of appointment of directors and board chairpersons is three years. 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). relationship with controlling shareholders (21 percent). The current chairperson has been in office for 6. This rather long tenure must be due to their status as controlling shareholders in most 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. the board had a nomination and an audit committee. About five directors per firm have been in office for more than one term. Vol. These were established only recently. In 91 percent of the sample firms. In one case. the management nominated director candidates (64 percent of the directors). a total of 562 directors were sitting on two or more corporate boards. According to the Commercial Code. in 23 percent. one person was sitting on nine boards and this person was the CEO of a chaebol firm. The board or the management then determines compensation packages for individual directors. II shareholder (30 percent). the management determines the remuneration. election of directors was based on shareholdings (7 percent) and status as founder (7 percent).2 years on average. among the 81 sample firms. Chairpersons of the board were elected on the basis of professional expertise (33 percent of the firms). founders of the company acted as the chairperson (22 percent). in some firms. In 13 percent. the board had no committees. The survey results indicate that boards determine remuneration packages for chairpersons in 42 percent of the firms. Remuneration for chairpersons include only fixed fees in 76 percent of the sample firms. .
Ensuring that a company serves the public interest is considered a less important responsibility of CEO. CEO simply follows the orders of the chairperson. CEO was given shares by the family. In the survey. and fixed salary plus performance-related pay including stock options in 13 percent. CEOs have been in their positions for an average of 9. In a handful of sample firms. However. 86 percent of the firms answered positively when asked whether the largest shareholder was CEO. he or she was selected on the basis of professional expertise in 15 firms. In 21 percent of cases. It indicates that CEO. shareholding in three 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. and was appointed by the Government in five firms.2 years. In less than 20 percent of the firms. The remuneration package was proposed by the board (and approved by the annual general meeting) in 56 percent of the firms. CEO is also the founder in 52 percent of the firms. who is not the chairperson. In the 25 firms where CEO was not the chairperson of the board. the payment is about five times the CEO’s annual salary. compensation is by fixed salary in 74 percent of the firms. decides on important matters on his/her own in 13 out of the 44 firms. When CEO is not the chairperson. CEO generally has the ultimate power to decide on corporate affairs. fixed salary plus net profit-related bonus in 9 percent. CEO decides on important matters after consulting the chairperson in the majority (55 percent) of the firms. CEO is entitled to a large sum in cases his/ her contract is terminated before its expiration. In 20 percent. According to the survey. In such cases. it was proposed by CEO and approved by the board. In 4 percent of the cases. the survey tells a slightly different story than is generally believed in Korea. and in another 21 percent CEO bought shares in the market. he or she does not enjoy much power. . The firms in the survey consider steady growth of a company and maximization of the shareholder value as the most important responsibilities of CEO.Chapter 2: Korea 99 Management CEO In the survey sample. In cases where CEO is not the largest shareholder and chairperson. CEOs generally maintain their positions for a long time because they are frequently the founders or largest shareholders of their firms. These results show that the incentive compensation scheme for professional CEOs is not well developed in Korean firms. in which there is no controlling shareholder.
The bonus is supposed to be linked to company performance. 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. About 40 percent of the listed companies had amended their charters to introduce incentive stock options by the 1999 shareholders meetings. 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. This action was in response to calls by international investors and. 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. 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. and accounting standards. it was common for all senior executives to be elected as directors at the shareholders meeting. in particular. executives sometimes have the opportunity to buy company shares at favorable prices because the board of directors (CEO. but in practice is fixed and understood as part of a fixed salary. from IMF and the World Bank. disclosure. The commission has played an active role in introducing new rules on corporate governance. (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. but as of March 1999 only 27 firms actually had given stock options to their executives or employees. One area has been to enhance the reliability of financial statements of corporations in line with internationally accepted standards. Vol. However.100 Corporate Governance and Finance in East Asia. and . in practice) allocates the unsubscribed portion of new shares issued in rights offerings to executives. Senior managers were even often called directors although they were not official members of the board. Penalties for fraudulent financial reports were increased. II Senior Executives In the past. Korean firms have rarely used shares for executive compensation.
Those that never adopted international standards show their willingness to do so once the Government introduces international standards. Consolidated reporting was introduced before the outbreak of the crisis. 41 percent of the companies believed that they have followed some international accounting standards. In the ADB survey. they cannot be expected to discharge this responsibility because the representative director selects the internal auditor and can force him or her to resign. The new rules also require financial institutions to recognize realized losses and allowances for potential losses arising from guarantees in the current year’s financial statements. the internal auditor is considered to be a subordinate of the . The primary sources of reference in the revision were International Accounting Standards and US Accounting Standards. however.Chapter 2: Korea 101 (iii) establishment of accounting standards for “combined” financial statements of chaebols. Only 10 percent of the respondents have followed all international accounting standards. Most of the companies following all or some of the international standards in the past adopted such standards before the crisis started. In practice. The revised accounting standards apply to the firms subject to external auditing for the fiscal year starting on or after January 1999. 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. Internal and External Auditing The Commercial Code requires a corporation to have at least one internal auditor elected at the general shareholders meeting. they also have the power and duty to monitor the activities of executive directors. but 49 percent confessed that they have not followed international standards at all. 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. Thus. Under the Commercial Code. 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. Korean listed companies with subsidiaries are required to compile consolidated balance sheets. financial institutions must report their securities holdings at market value and recognize 100 percent of unrealized holding gains or losses in the current year’s income statement. The new accounting standards for financial institutions adopt the mark-to-market basis to account for securities.
This is because the auditor. and creditors selects it. outside directors. the board of directors had the power to appoint an external auditing firm. But this problem can be mitigated if auditors function under the umbrella of the board. External auditors are selected for a term of three years. The current external auditors have been associated with the surveyed companies for an average of 4. and lack of strong professional ethics in the accounting profession. 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. Previously. 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. About 100 listed firms will be subject to this requirement. 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. Listed and registered corporations must publish financial statements audited by external accounting firms. but since 1998 a committee consisting of internal auditors. . If the status of internal auditors is elevated to that of independent board members. If the company changes its external auditor for reasons that are not listed in the relevant regulation. underdeveloped market discipline for accounting firms.6 years. The general organizational/social culture in Korea abhors conflict and may also have hindered effective functioning of internal auditors. In order to increase independence. 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. however. Accepting these arguments. as a monitor of management in the Korean (and also the Japanese) system. this problem will largely disappear.102 Corporate Governance and Finance in East Asia. does not have the power to hire and fire the managers. In the ADB survey. The problem of misconduct on the part of the external auditor was caused partly by weak penalties on wrongdoing. In the past. The Commercial Code will be revised to allow corporations to choose from the two options: the internal auditor or the board audit committee system. there were many cases where external auditors failed to detect omissions and false numbers in financial statements of listed firms. Big Korean accounting firms are affiliated with US accounting firms. II controlling shareholder/CEO. almost all firms affirmed that the external auditor is independent from the company. 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. Vol. then the Securities and Futures Commission can appoint a new one.
The Depository represented 20 percent of the shares attending the meetings. small shareholders do not attend the annual meeting and that. Internet.” The survey shows that the Korea Securities Depository holds 69. About 100 shareholders per firm voted by proxy at the last annual general meetings (of the 40 firms answering the relevant questions).3 Shareholder Rights Voting Rights and Practices Under the Commercial Code. Under the Commercial Code.Chapter 2: Korea 103 2.” meaning that it should divide its votes in accordance with the accept/reject ratio of votes cast by other shareholders attending the shareholders meeting. respectively. or telephone. the Depository is subject to “shadow voting. One common share should have one vote.3. About one fifth of the listed firms issued nonvoting preferred shares. in general. Preferred shares can be nonvoting and issued up to one quarter of the total number of shares. 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 above results indicate that.” Companies can increase the number .77 percent of the shares. Thus. Approval of mergers and major divestitures. Citizens’ coalitions sometimes solicit proxies in order to file lawsuits against a management. or 10. amendments of the articles of incorporation require a “special resolution. 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. No companies have so far introduced voting by mail. However. The securities companies and banks are the second and third. corporations cannot issue common shares without voting rights. The management is the most important proxy.53 percent of the total shareholdings. A total of 326 shareholders per firm. for some firms. attended the last annual general meeting. representing 62.93 percent of the shareholders but 26. the Depository is instrumental in getting resolutions passed.21 percent of total shares issued. However. A “special resolution” requires two thirds of the votes attending and one third of total votes outstanding. charter amendments. These voters represented only 5. This shows that a relatively larger number of shareholders send in their proxies. and dismissal of directors and internal auditors require a “special resolution.79 percent of the shareholders. the only purpose of allowing the Depository to vote was to help listed companies to meet the quorum requirement for the general shareholders meeting.
As an example. the Securities and Exchange Act was revised to lower the representation requirement for shareholder derivative suits from 1 to 0. demand changes in business policy. was able to force a change in the charter of SK Telecom. but these can be waived by an amendment of the articles of incorporation. In four out of 62 respondents. It also attended the shareholders meeting of several companies to present the views of outside shareholders. For recommendations for dismissal of directors and internal auditors. and for access to unpublished accounting books and records. The company also agreed to the right of the fund . However. the Tiger Fund. the board of directors decides on issues of shares within the limit of the authorized capital. and major investment projects (only five firms answered this question).01 percent. laws and regulations were generally very loose in protecting the rights of minority shareholders. Proposals put forward by management are rarely rejected at the general meetings. Changes in the authorized capital require an amendment of the articles of incorporation. the requirement was lowered from 1 to 0. II of votes required for a resolution to amend the articles. Only two out of 62 respondents to this question have had cases in which proposals were rejected. Shareholder Protection Before the economic crisis. This coalition also attempted to cooperate with domestic and foreign institutional investors to find their way into general shareholders meetings. dividend proposals. an activist citizens’ coalition has brought shareholder derivative suits against several large listed firms.5 percent. from 3 to 1. an institutional investor based in the US.104 Corporate Governance and Finance in East Asia. the annual general meeting passed a resolution that was not proposed by the management nor the board of directors but rather by shareholders. or block charter amendments considered harmful to minority shareholders.0 percent. Those that are most likely to be rejected relate to election of directors. Various measures have since been taken to improve investor protection. This citizens’ coalition actively contacted the management of selected companies and negotiated measures to protect shareholders. The charges included self-dealing by a controlling shareholder and unfair subsidization of affiliated companies by a chaebol firm. Due to the changes in rules for investor protection. mergers and acquisition plans. Vol. Shareholders have preemptive rights. In February 1998 and again in March. 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.
For further protection of investors. 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. mergers and acquisitions. Banks have played some limited role in monitoring the investment activities of chaebols. creditors did not interfere with the management of a debtor. In 1974. As for bond issues. bond indentures are only a few pages long compared to a few dozen pages found in advanced bond markets. 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. In fact. Banks themselves were poorly governed and bank managements had little incentive to monitor borrowers. and transactions with major shareholders. After the economic crisis. 2. This has strengthened the accountability of controlling shareholders as de facto CEOs. the Government had for some time pushed for the enactment of class action suits on false statements and omissions in disclosure materials.Chapter 2: Korea 105 to recommend two directors to the corporate board. controlling shareholders have become more susceptible to liability claims by other (minority) shareholders. The covenants in loan agreements and bond indentures were very loose. Thus. affiliated lending or guarantees. and not strictly enforced. loans to directors. These have to be disclosed under the Securities and Exchange Act or approved by shareholders under the Commercial Code and other laws. underwriting securities firms acted also as trustees. simple. it now appears that it has backed away from its earlier efforts to introduce legislation on class action suits.4 Control by Creditors Role of Creditors in Corporate Monitoring Traditionally. Before the amendment. This was one of the most significant developments with respect to shareholder activism in the Korean capital market. The laws and regulations of the country protect shareholders from interested transactions. managers were considered to be subject to the duty of care. there was the usual conflict of interest problem and the trustee did not have the incentive to strictly enforce the covenants. but it was not entirely clear whether they had the duty of loyalty as well.3. However. . The Code has also been amended to state more clearly the fiduciary duty (of care and loyalty) of the management.
Vol. 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. there have been concerns that the Government might use the system to intervene in the management of the business groups. and purchases of real estate. 11 banks. The 10 largest business groups are required to select no more than three core companies in consultation with their respective main banks. ADB Survey Results on Borrowing and Lending Practices The ADB survey shows that a typical nonfinancial company is associated with various types of creditors. The firms subject to the system are required to get the approval of the main bank prior to purchasing real estate. In turn. Purchase of real estate should be financed by equity capital and not by borrowed funds. Under the system. creditors now have a bigger say in court proceedings for receivership and composition. on average.106 Corporate Governance and Finance in East Asia. However. as discussed earlier. 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. the main banks should review the feasibility and financing plans of projects undertaken by the core companies and monitor their financial conditions and prospects. 10 nonbank . Emphasis on the monitoring role of banks has been growing since the beginning of the Asian crisis. recently banks have been increasingly interested and successful in electing former bank officers as outside directors of firms that underwent workout processes. Besides the setting up of an “External Auditors Committee” by firms. Some proponents argue that creditors should have the right to send their representatives to boards of directors of borrowers. 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. including. In 1994 the approval requirement was abolished. this proposal has only a slim chance of being accepted by the Government or legislature. In 1996. II acquisitions. The main bank should also monitor and restrict extension of loans to the controlling shareholder and other firms in the group. On the other hand. The objective of the system is to improve the financial condition of the largest business groups and promote the soundness of bank management.
and 17 nonfinancial corporations. The typical company has also maintained its relationship with five of the 10 NBFIs for more than five years. collateral was taken away. holding shares of another company by both the borrower and the guarantor. or through their shareholdings. and other financial institutions. or creditors filed for receivership. Most firms feel that requirements for collateral have been tightened since the crisis started. Among the creditors. NBFIs infrequently ask for collateral. About 60 percent of the firms have experienced renegotiation of loan repayment with creditors during the last five years. while a third think that creditors have weak influence. Creditors usually exercise their influence through covenants relating to the use of loans. When loans could not be repaid on time. subsidiaries. With respect to the types of loans. Only a few feel that creditors have very strong influence. holding companies. 16 percent . The assistance came from. controlling shareholders. banks are most likely to require collateral. For a small number of firms. The borrower’s relationship with most banks has lasted for more than five years. Most of the 43 firms with renegotiation experience were able to borrow from the same creditors afterwards. penalty was involved in rescheduling. One tenth of the firms received assistance from the Government in loan applications. About half of the respondents received assistance from other sources in the form of loan guarantees and/or provision of collateral. renegotiation took place after the crisis.Chapter 2: Korea 107 financial institutions (NBFIs). mutual guarantee agreements. 35 percent are guaranteed by the company itself (by collateral and purchase of guarantee insurance). For more than half of such firms. collateral is more likely to be required of loans for working capital than for fixed investments. Breakdown of loan guarantors is as follows: about 40 percent of loans are without any guarantees. and purchase or supply of raw materials. Relationships with affiliated companies providing guarantees or collateral include ownership of each other’s shares. whereas seven of the 17 nonfinancial corporations are. most frequently in the form of loan guarantees and less frequently by arrangement of guarantees by a third party. Most of the financial institutions are not affiliates of the borrowing company. More than half of the firms think that creditors have no influence on their management and decision making. A few creditors exercise influence through covenants relating to major decisions by the company. in order of importance: affiliated companies. payments were usually rescheduled through negotiation without any penalty.
3. Separate from but emulating the CRA. Vol. 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. II by other affiliated companies. especially banks. will get involved in the restructuring and workout processes. 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 . Third. 4 percent by subsidiaries. the lead creditor banks formally signed Capital Structure Improvement Plans with chaebols. This agreement will provide guiding principles in coordinating diverse interests among creditor institutions and promoting cooperation. In this connection. Under a contract signed between the creditors and the debtor. are summarized below. banks and other institutional lenders are playing more important roles than ever before. 2 percent by holding companies. 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. 2. including commercial and merchant banks.5 The Market for Corporate Control Government Policy Toward Hostile Takeovers Until 1994. major creditors. First. the Corporate Restructuring Coordination Committee (CRCC) will provide arbitration. Second. The new ways through which creditors. the creditor banks will send a delegation composed of bank officers to the workout firm to oversee its management. In cases where the creditors are unable to reach an agreement on a workout plan.108 Corporate Governance and Finance in East Asia. Behind these new strengthened roles of creditors is the newly set-up FSC. and in continued monitoring of debtors. This committee was set up in accordance with the provisions of the CRA. The leading creditor banks will continuously monitor the progress in implementing the signed Plans. have been the driving forces for restructuring activities of the largest 64 chaebols. the Korean Government maintained a policy of protecting the incumbent management of listed companies. and 1 percent by the Government. a Lead Creditor Council Agreement was signed for restructuring the top five chaebols. the delegation has the right to approve wide-ranging financial activities of the firm.
The incumbent controlling shareholders used various tactics such as issuing privately placed CBs. A company cannot issue new shares to a third party without first amending the corporate charter. 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. Poison pills cannot be used mainly because companies cannot distribute stock options as dividends to shareholders. Companies have also utilized share repurchases. listed firms rely mainly on shareholdings by the largest shareholder. and announcing competitive tender offers by the controlling shareholder. Stock purchases by tender offer were also exempted. more than half of these attempts failed. It was generally believed that the securities authority would use its power to review and order revisions of the tender offer statement to halt any hostile takeover attempt. . The 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. Korea does not have the mandatory takeover rules applying to those who amass more than 30 percent of the shares outstanding (until 1998. corporations cannot limit the voting rights of large shareholders to a given maximum. For takeover defense. but were completely eliminated in 1998. turning to white knights. it can be safely stated that Korea now has one of the most accommodating capital markets with respect to hostile takeovers in the region. The reasons for failure are diverse. Unlike Germany. 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). Between 1994 and 1997. 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. As far as institutional arrangements are concerned. However. In the early 1990s the Government shifted its policy toward freer activities in the market for corporate control. Takeover Activity As soon as the Act was amended. a total of 13 hostile takeover attempts occurred. Publicly issued CBs require three months before their owners can convert them to shares. Unlike the UK.Chapter 2: Korea 109 unless he or she obtains prior approval of the Securities and Exchange Commission. hostile takeovers by tender offers began to appear in the capital market. In one case. The shareholders already owning more than 10 percent at the time the company went public were exceptions to the rule.
Currently the limit is 3 percent. 2. As of the end of 1997. Vol. 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. Many of the takeover targets in the past did not have a controlling shareholder (group). . In 1998. was newly listed. and a bank had government ownership.6 Control by the Government State-Owned Enterprises Government ownership of listed companies is very limited. some firms have included a supermajority provision for the dismissal of directors and provided for a staggered board. the limit will be eliminated when it is fully privatized in two years. a steel company. 172 firms (or 22 percent of listed firms) belong to the 30 largest chaebols.110 Corporate Governance and Finance in East Asia. which are allowed by the Securities and Exchange Act to set the limit on the ownership of shares by one single shareholder. Firms affiliated with a large group are generally regarded as difficult targets as the other members of the group will come to the rescue or act as white knights. are designated as public companies. Some had two or more large shareholders who had joint control of the firm but could not cooperate. For the steel company. the Government became the largest shareholder of several commercial banks through equity participation purporting to recapitalize them out of financial distress. 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. 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. The Government-owned listed companies.7 percent on average as of the end of 1997 for nonfinancial listed firms). 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. Another reason is that many listed firms belong to chaebols. Korea Telecom. in which the Government still holds the largest ownership. In 1999. For the others. Charter amendments have also been employed by some firms to limit the maximum number of directors.3. an electric power company. Hostile takeovers in Korea will be rare in the future. In their charters. except for the banks. As of February 1999.
Meanwhile. and approved by the Chairperson of the Planning and Budget Commission. Even where employees hold . is being applied to the 51 largest business groups to which the banks extended more than W250 billion in loans and payment guarantees.3. nominated by the minister in charge of the company in question. only qualified firms could issue new shares. In addition. 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. 2. especially those belonging to chaebols. But this rule. The Government has frequently imposed restrictions on the use of capital markets by large companies. the Government. This was aimed at limiting the supply of bonds thereby stabilizing interest rates. There were also limits on the amount raised and the number of issues per year. The Government’s right to send public officials to the boards was eliminated. Further. which limits the total amount of bonds issued by the five largest chaebols. controlled the total amount of corporate bonds issued per month and allocated amounts to individual corporations. The nonexecutive directors are now recommended by a committee. as applied to four large corporations. was amended in 1997 to introduce a board structure consisting of a majority of nonexecutive directors.1). went into effect in 1998 to prevent them from absorbing too much of the funds available in the market. each of the 10 largest chaebols was allowed to raise funds no more than 4 percent of the total market capitalization of the member firms. administering through a self-regulatory committee of the securities industry. There is no active debate or discussion going on about this potentially difficult issue.7 Employee Participation in Corporate Governance Employee participation in corporate governance is very limited. more state-owned corporations became subject to this new board structure.3.Chapter 2: Korea 111 The Government used to appoint a few public officials to the boards of state-owned corporations. For example. Beginning in 1999. The objective of the system was to improve the financial condition of the chaebols and to promote the soundness of bank management. the main bank system. It was abolished before the economic crisis but another regulation. Labor is not represented in corporate boards. which was introduced in 1996.
Under the Labor Management Council Law. which were generally much lower than estimated values. Two thirds of the respondents had an organized union. In these firms. About half of these firms considered the influence of the union on the management of the company to be weak. Under the Capital Market Development Act of 1968. they delegate their voting rights to plans’ representatives. In 70 percent of the firms with organized unions. Local unions in the same industry have established industrial labor federations. II shares of their companies through employee stock ownership plans. This law is not intended for wage negotiations but for employers to seek cooperation and productivity increases from workers. the management usually consults the union on major issues relating to the management. in principle.1 in 1997. 32 percent technicians and professional staff. The respondents of the ADB survey had 2. the council meetings have been superficial. and development of the company. The relevant regulation was amended recently in order to facilitate voting by individual employees. and 66 percent manual workers. At the national level.9 in 1980. 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. Vol. Trade unions are organized on an enterprise basis. The typical collective bargaining agreement has a one-year duration. Employee stock ownership plans became popular in 1974 when the Government allowed tax and financial benefits for stock purchases by employees. 2. operation. employers are required to meet with representatives of labor unions at least once every three months. . Under another law enacted in 1972 to induce private companies to go public. union members account for 54 percent of the employees. In 1987.112 Corporate Governance and Finance in East Asia. employees of listed firms issuing shares through rights offerings are entitled to 10 percent of the rights. The percentage of shares held by the employee stock ownership plans in listed companies was 1. of which 2 percent were senior managers. The union had no influence on the management in 17 percent of the firms. This practice may be due to the fact that employees are typically submissive to their employers and that their total shareholdings are minimal. Employees of companies have had the opportunity to buy shares of their employing businesses at favorable prices. and 2. Collective bargaining is.5 in 1990. carried out at the enterprise level.654 employees per firm on average. these firms have to offer 20 percent of the shares being issued to their employees at the public offer prices. In actuality. there are two federations of labor unions. but 27 percent of them felt that it was strong.
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
implementing the first stage in November 1991.4. was liberalized drastically in 1998 after the financial crisis. the Government simplified various directives and instructions regulating personnel management. listed companies. Also. the business scope of financial institutions was greatly widened from the early 1980s. Vol. With the privatization of nationwide commercial banks.1). In June 1993. It included such important issues as interest rate deregulation. and liberalization of foreign and capital transactions. entry barriers to banks and NBFIs were lowered in an attempt to promote competition. . 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. which resulted in the establishment of a number of new banks.2 Patterns of Corporate Financing Corporate Financing Practices In this section. opting to bring in the plan step-by-step to avoid market dislocation from a sudden shift in the system. Internal funds include retained earnings. the following measures can be constructed: Self-financing ratio (SFR) is the ratio of change in internal funds to change in total assets. development of the money market.5 percent in November 1981. II Interest Rate Deregulation Plan. Since 1985. Korean firms have been allowed to issue CBs in international financial markets. flow of funds analysis was used to examine patterns of financing of the aggregate corporate sector. as a first step toward liberalization of capital account transactions. Some policy loans were also abolished.118 Corporate Governance and Finance in East Asia. the required reserve ratio was substantially lowered from an average of 23 percent in 1979 to 3. especially the domestic bond market. On the basis of flows of funds. Moreover. the Government announced a plan in 1981 that substantially improved foreign investors’ access to the domestic capital market. The capital market. the Korean Government announced its Financial Liberalization and Market Opening Plan. The Government handed over its controlling stakes in four commercial banks to private hands in 1981-1983. etc.2. The plan was launched partially to accommodate US demands for comprehensive structural deregulation and market opening of the financial sector. depreciation. The Government adopted a cautious approach. finance companies. revision of the credit control system. Meanwhile. short-term finance companies. 2. budget. mutual savings. and organization of commercial banks. In addition.
25. including all sources other than retained earnings. on average. Incremental equity financing ratio (IEFR) is the ratio of change in stockholders’ equity to change in total assets or 1-IDFR. was 71 percent during the period.4 percent in the precrisis period 1988-1997. 1994. the proportion of borrowings from NBFIs fell to its lowest value at 4 percent. In 1988 when the stock market boomed.Chapter 2: Korea 119 and net capital transfers from the Government. but it remained less than 10 percent of total financing. It measures the degree of financing growth in total assets by additional debts. Additional equity capital used to finance growth reduces the financial cost and the financial risk of investment. particularly in the 1990s in response to the liberalization of the capital market. but do not include capital surplus (asset revaluation allowance and the excess of current value over issue value of stock). 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. Meanwhile. Financing Patterns of the Aggregate Corporate Sector Table 2. comprising internally generated capital (retained earnings. 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. particularly in the short term. and 1997. and government transfers. Equity capital represents the shareholders’ commitment to the business. the proportion of foreign borrowings in total finance rose steadily. The corporate sector used . capital surplus. Table 2. Incremental debt financing ratio (IDFR) is the ratio of change in total borrowings to change in total assets. In securities finance. depreciation.26 shows the four measures of corporate financing calculated from Table 2. except for the stock market boom of 19871988. the corporate sector’s most important source of external finance was bank borrowings. depreciation. New equity financing ratio (NEFR) is the ratio of change in equity (stocks issued + equity other than stocks) to change in total assets. financing by corporate bonds and CPs was more significant than by new equity. except in 1991. The share of external financing. This high proportion deprived Korean businesses of flexibility during recession periods due to high financial costs. Before 1988.25 shows the flow of funds of the nonfinancial corporate sector in Korea during 1988-1997. The SFR averaged 28. It measures the degree of financing growth in total assets by additional equity. and allowances) and new equity capital.
0 1.7 4.1 10.1 17.5 2.6 1.8 -2.7 8.2 (0.8 4.8 1.7 7.7 1.3) 15.8 — 26.6 9.1) 4.6 11. which is the excess of current value over issue value of stock.7 2.4 1.1 1.2 0.2 26.2 — — — — 9. .0 70.8 1.4 27. a Includes retained earnings.0 11.4 (0.8 27.7 11.7 (0.9 2.0 10.8 0.8 56.6 0.6 3.1 23.2 15.6 2.5 13.6 25.3 10.4 71.0 3.2 34.4 — 28.7 14.2 5.3 25.6 11.0) 12.8 15.1 2.3 — — — — 8.2 13.6 8.0 0.0 9.2 10.2 13.4 0.5 16.6 3.4 8.6 14.4 27.3 3.1 2.2 6. and Flow of Funds.9 34.4 0.7 10.1 0.5 2.4 2.1 27.7 2.3 30.4 2.7 1.6 10.3 6.6 4.7 4.9 6.4 2.0 17.4 1.1 1.4 3.6 4.0 16.7 6.7 1989 1990 1991 1992 1993 1994 1995 1996 22. 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.7 14.0 22.6 0.9 10.1 72. and net capital transfers from the Government.4 (2. Source: Understanding Flow of Fund Accounts.1 8.7 13.7 10.0 5. 1988-1997 (percent) 1988 43.0 0.8 17.9 73.7 10.1) 6.3 6.5 29.3 — 30.Table 2.8 1.6 9.6 0. b Includes capital surplus.1 3.7 2.6 9.4 11.1 (1.8 1.4 10.8 8.4) 13.2 — 28.8 30.7 8.5 9.6 77.2 14.2 1.0 2.3 2.1 1. depreciation.4 15.7 73.5 0.8 1.4 27.9 9.9 0.0 1997 26.7 15.9 72.1 0.6 Sources of Funds Internal Financinga External Financing Bank Borrowings Banks Nonbanks Merchant Banks Insurance and Others Securities Natl.0 9.6 5.1 (0.2 2.1 36.3) 11.3 1.25 Flow of Funds of the Nonfinancial Corporate Sector.3 72.3 1.1) 4.1 3.5 16.6) 5. Bank of Korea. 1994.3 3.4 9.1 3.9 38.0 — — — — 8.4 21.6 (0.5 0.3 5.3 16.7 32.6 4.7) 11.4 2.3 6.0 3.9 28.0 (0.9 10.5 2.1 12.6 0.7 12.2 6.3 27. Bank of Korea.1 — 27.3 1.5 0.8 (0.7 71.0 3.7 — — — — 9.1 — — — — 12.5 2.
The balance.0 57. declining to 26.9 60.26 Financing Patterns of the Nonfinancial Corporate Sector. higher than the aggregate 28.2 percent of incremental asset growth was financed by equity.4 NEFRa 20. 1988-1997 (percent) Year 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 Average a SFRa 43.6 percent.6 Excludes capital surplus. SFR peaked at 44 percent.3 27. Across industry.4 37. 45.7 40.6 percent.27).4 percent (Table 2.1 17. Incremental financing from equity was 40. was financed by additional debts. dropping to 26. additional equity to finance 12. and Flow of Funds.3 11. higher than the aggregate 40.8 28.5 percent.5 68. but plunged to 5.1 39. and IEFRs were declining.9 22.1 12.9 percent by 1997 when net profit margins were negative.4 12. Manufacturing financed 54.6 percent and 1.3 percent in 1997.3 59.7 26. NEFRs.2 IDFR 36. In periods of high economic growth such as in 1988.4 percent.5 12.8 10. NEFR registered 20.7 30.4 27.4 percent.9 46. . Bank of Korea.7 percent in 1997.7 9.Chapter 2: Korea 121 Table 2. On average. Bank of Korea.5 31.3 12.5 and 76. Lower income diminished the industry’s equity position toward crisis year 1997. Its IEFR and NEFR dropped to 23.6 62. IEFR ranged from 32 percent to 64 percent of asset growth during the boom years.8 percent of its total asset growth through debts. and the total debt ratio was much higher in 1996 and 1997 at 62. in the manufacturing sector.7 28. IDFR reached 73. but also continuously fell.1 26. While SFRs.3 60. It dropped to 28 percent the following year.2 37.0 11. average SFR was 37.3 73.0 27.0 42.2 percent of the growth in total assets. indicating a high financial risk position.1 53.7 40. Source: Calculations from Understanding Flow of Fund Accounts.7 40.1 percent in 1988 during the stock market boom.4 IEFR 63.6 26.3 59. respectively.0 5.9 28.8 62. 1994.5 percent in 1997. respectively. There were significant time trends. an average of 59. the corporate sector relied heavily on external financing for its expansion.6 percent over the 10-year period.
the proportion of short-term borrowings in total financing has been high. storage. with the total debt ratio much higher in 1995-1997 at 82 to 84 percent. this dropped further to 15. from 17. the two sectors also had low equity financing ratios and high debt financing ratios.1 29.3 52.5 NEFRa 9.122 Corporate Governance and Finance in East Asia.6 37.0 3.6 4.4 45. Vol.6 53. These sectors had relatively low equity financing ratios and high total debt ratios in financing asset growth between 1988 and 1997.7 37.7 47. and hotels sector and realty/renting/business activities sector were similar.4 37. Since 1992.4 63.and medium-sized firms. which decreased to 8.9 IDFR 34. II The construction industry showed the most cyclical pattern in annual asset growth.8 percent in crisis year 1997. Table 2. large firms showed more cyclical patterns in these financing ratios than small.7 percent in 1996.0 42. retail.5 23.1 percent of total asset growth for the period. Equity financed an average 25.5 76.7 37. and fell to about 10 percent in 1997. explaining partly the collapses of several construction companies in 1995. In 1997.6 54.4 47.2 percent in 1993. their average SFR was higher.8 50.2 3. and steam) and the transportation.4 3.6 45. the utilities (electricity.8 percent in 1990.5 1.5 7. It had the highest average SFR in 1988 at 31. and communication sector had relatively high incremental equity ratios. Categorized according to company size.2 62.8 4.6 53. one year ahead of the other industries.9 percent.7 47.2 . then increased to 20.6 3. Total debt financed an average 74.2 5.6 62.0 57.9 percent of asset growth.8 IEFR 65.4 46. Financing patterns of the wholesale. gas.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. and low total debt and short-term borrowing ratios. Since large firms were more profitable.4 54.6 37.0 42.3 28.6 36.2 21.0 30. On the other hand.9 6.
2 4.0 .5 20.7 Wholesale/Retail Trade.2 5.6 37.3 (9.9 16.3 10.8 9.4 2.4 28.9 1.3 1996 16.6 7. Hotels 1988 33.2 46.27 (Cont’d) Year SFRa NEFRa IDFR 53.9 Construction 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 Average 31.3 21.9 30.1 1991 14.1 Trasport.0 4.1 4.8 74.7 1989 26.9 1992 56.6 9.3 7.9 1993 63.0 82.5 23.5 29.5 70.8 29.5 62.6 9.0 40.5 12.5 1.5 76.4) 2.9 15.5 21.7 78.0 1990 12.2 10.1 19.8 81.7 78.3 4.9 52.1 66.2 29.2 23.8 70.0 10.9 2.0 34.6 2.0 60.3 57.6 37.2 Average 53.1 59.5 1996 42.3 84.6 71.4 IEFR 46.7 80.7 42.1 69.0 1.1 70.9 1.9 80.6 14.8 1994 15.2 25.2 18.7 15.7 6.8 76.9 1.9 1989 63. and Communication 1988 64.4 62.2 74.3 4.5 1993 22.0 0.0 17.0 3.2 70.4 26.3 19.6 4.8 25.3 8.7 15.0 68.7 53.0 31.9 9. Storage.0 1992 24.9 20.8 54.6 1997 29.9 47.Table 2.9 29.0 74.4 1995 53.7 1994 53.1 25.2 3.0 1990 50.6 73.9 33.7 41.7 7.1 84. Household Goods.5 87.6 8.8 2.2 20.2 1995 16.0 65.9 Average 19.6 8.8 1991 51.3 47.8 4.2 8.7 1997 8.
7 70. Long.7 1994 8.1 1989 34.1 1991 56.8 36.4 47.2 63.4 IEFR 69.7 69. The large firms had a higher proportion of external financing in 1996-1997.4 1994 72.9 45.3 3. when large firms had much lower equity financing ratios and higher debt financing ratios than small.and mediumscale firms.7 37.3 Electricity.9 IDFR 31.8 1990 19. and Steam Supply 1988 118.2 1992 18. Financial Statement Analysis Yearbooks.4 0. II Table 2.1 35.1 1993 55.8) 7.9 29.8 135.3 29. however.0 33. Source: Calculated using data from Bank of Korea. IEFR = incremental equity financing ratio.6 52.9 Average 75.0 0.124 Corporate Governance and Finance in East Asia.and short-term borrowings of these firms shot up in that period.3 81.7 1996 18.5 8.3 7.6 1989 118.27 (Cont’d) Year SFRa NEFRa 6.6 1997 23.9 64.0 1997 24.5 77.0 67.9 65.0 21.0 79.0 0.8 1993 11.6 1995 17. .0 56.4 5.9 57.1 0.4 1. Their average IEFR was also higher and IDFR smaller.8 17. Gas. Higher growth in total assets and sales and easier access to debts by large firms could be reasons for this.4 1995 62.1 54.0 1992 51.1 71.4) 3.1 70.0 46.8) (35. NEFR = new equity financing ratio.0 53. SFR = self-financing ratio.3 85.0 1.3 92.0 43.1 34. and Business 1988 51.6 IDFR = incremental debt financing ratio. Renting.7 18.3 207.5 22.7 14.0 (0.9 28.4 (107.6 1991 18.6 Real Estate.6 7.4 7.3 62.8 Average 22.6 1. The trend was reversed in 1996-1997. Vol.4 1996 45.4 0 0 0 0 1. a Excludes capital surplus.1 42.6 1990 82.3 31.
for listed companies. at an average 70. The chaebols’ drive to expand their empires resulted in heavy borrowings. In 1997.5 percent and their total external financing.30). They were able to borrow easily from banks by issuing corporate bonds and CP. External financing reached 94.29). All of the top 30 chaebols relied heavily on short-term borrowings. the IDFR of listed companies increased to 93.3 and 89.5 percent is lower than that of the corporate sector in general.8 percent.3 percent of their equity capital in 1997 (Table 2. and were large borrowers. The average IEFR of the top 30 chaebols of 29. the average SFR was 28.4 percent. the top 6-10 chaebols.2 percent. Financing Patterns of Chaebols For chaebols. and higher than that of listed companies (Table 2. They had easier access to bank loans and the markets for corporate bonds and CPs than nonlisted companies.8 percent of their total finance in 1997. 91.28). 153.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 2.1 percent of their equity capital. In 1997.7 percent.9 percent. Group-member firms borrowed less. about the same as that of the corporate sector as a whole. Another key feature of corporate finance in Korea is the widespread use of loan guarantees among the top 30 chaebols. compared with the entire corporate sector’s 35 percent and 65. the top 11-30 chaebols had the highest guarantees commitments at 207.9 percent. In 1996-1997.7 percent for all listed companies. the lowest ratio of 58. The debt financing ratio of listed companies was high since they relied more on external financing.6 percent of total asset growth. and the top five chaebols.6 percent. Their shortterm borrowings accounted for 86. compared with 89. The average IEFR and IDFR were 10. the NEFR of the top 30 chaebols plunged while the debt ratio increased substantially. The largest borrowers were the top 11-30 chaebols.7 percent. respectively. Many firms affiliated with the top 30 chaebols saw loan guarantees turn into their own debts because of defaults in debt payments. but higher than that of listed companies. Cross-payment guarantees have been declining since 1993 and reached 91. . and using cross-payment guarantees among affiliated companies. The proportion of their short-term financing averaged 72.
1 8.6 70.6 0.8 76.2 1.9 NEFRa IEFR 14.6 IEFR 42.5 2.3 1.1 93.4 1.5 91.4 38.5 Year 1994 1995 1996 1997 Average a Excludes capital surplus.2 NEFRa 1.4 29.6 11.4 12. 1994-1998 (percent) SFRa IDFR 85.8 22. Source: Calculated using data of Seung No Choi.Table 2.3 86.2 10.6 1.5 8.8 89.1 1.5 2. Source: Calculated from data obtained from data files of the Korea Listed Companies Association.7 1.3 5.6 61.5 8.4 88. .3 28.3 Year 1994 1995 1996 1997 Average a Excludes capital surplus. Largest Business Groups in Korea.3 IDFR 57.9 6. Table 2.7 12.29 Financing Patterns of the Top 30 Chaebols.9 7.7 13. 1994-1997 (percent) SFRa 41. Korea Federation of Industries.2 36.2 23.28 Financing Patterns of Listed Companies.
so that the firms engaged in lobbying to gain access to them.3 64. bond issues. Financial institutions did not strictly screen their loan projects and monitor their debtors. This change implies that firms now give more attention to financial risks. Further.3 58. Interest payments on debts were considered a loss when calculating taxes. rights issues. especially in the 1970s when real interest rates of bank loans were negative. There were several reasons for this.9 — — — 1996 105.0 1997 91. and loans from NBFIs.3 200. Fourth.0 207. . poor financial and corporate governance resulted in overlending by banks.Chapter 2: Korea 127 Table 2. Third. more than half of bank loans were priority loans with low interest rates. Second. First. in order of ranking. And fifth. This attitude appears to have changed after the crisis because reserves and retained earnings and rights issues became the preferred financing choices. Controlling shareholders usually tried to avoid dilution in their shareholdings for fear of losing control.7 150. chaebols could easily borrow funds from banks and NBFIs by using cross-payment guarantees.30 Cross-Payment Guarantees of the Top 30 Chaebols. inefficient investment and excessive diversification of corporations. and reserves and retained earnings. and underdevelopment of the stock market. Firms now prefer internal funds and new equity capital. Factors Influencing Corporate Financing Choices Until recently. Korean firms preferred debt financing (bank and nonbank borrowings). the Government applied high tax rates on net profits of corporations. loans from banks. 1993-1997 (as percentage of equity capital) Rank Top Top Top Top 30 Chaebols 5 Chaebols 6-10 Chaebols 11-30 Chaebols 1993 469. These are followed by loans from banks. company preferences in financing investment projects before the crisis were. bond issues.9 153. According to the ADB survey. the Korean economy was plagued with high inflation.9 — — — 1994 258.1 — — — 1995 161. and extended loans based on cross-payment guarantees. Few firms ranked loans from NBFIs as their first preference. Source: Fair Trade Commission and the Federation of Korean Industries. the Government provided implicit guarantees on bank lending and large businesses.1 — = not available.
Nonetheless.3 Financial Structure. Diversification. Among those that never hedged against exchange rate risks. II In seeking external financing.4.5 percent at the end of 1997. more than half (53 percent) hedged against exchange rate fluctuations. Vol. Few companies felt that hedging was too costly or was unnecessary as the exchange rate was considered fixed. Only a few firms sought foreign loans because domestic loans were not available. they survived for two to three . ensuring the liquidity of the company. A futures exchange launched in 1999 trades foreign exchange options. The percentage of foreign currency denominated loans hedged against exchange rate risks was 21. some (36 percent) thought that a hedging facility was not available or not working properly. and reduction in tax burden. firms give their first consideration to minimization of transaction and interest costs.36 percent on average for these companies. 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. Other factors include. According to the survey. maintenance of the existing ownership structure. Korea now provides a better environment for financial risk management. many firms (or 42 percent) never considered hedging. in order of importance. 2. These survey results indicate that many companies were not very attentive to exchange rate risks (and possibly to financial risks in general). Among the responding companies that had foreign currency denominated loans. the majority (60 percent) of the firms responding to the ADB survey look first for nonaffiliated financial institutions. For these firms. 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. the percentage of foreign currency denominated debt in the portfolio was 14. and futures and other financial derivatives. even with a heavy debt burden. in selecting financing sources. About half of the respondents of the ADB survey borrowed foreign currency denominated loans from foreign banks. This preference has changed little after the crisis. and others (29 percent) expected the local currency to appreciate in value.128 Corporate Governance and Finance in East Asia.
the trend was reversed in 1993 when the interest coverage ratios of the top five chaebols exceeded those of the independent firms. the ratios of nonchaebols were remarkably higher than those of the top 670 chaebols during the entire period. (iv) In terms of EBITDA to total assets. 1999).. (ii) In terms of net income to total assets. 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. They were also higher than those of the top five chaebols until 1992. .Chapter 2: Korea 129 years before collapsing at the time of the 1997 financial crisis (2. These findings indicate that independent firms have had a lower leverage and performed better financially. the top five chaebols and the top 6-70 chaebols had similar ratios.3. Operating earnings are earnings before interest payments and taxes plus depreciation and amortization (EBITDA). but the ratios of independent firms were much lower. But since 1992. However.13). They were also higher than those of the top five chaebols until 1991. the ratios of independent firms were higher than those of the top five and top 6-70 chaebols during the entire period. (1999) compared the financial positions of 504 chaebol affiliates and non-chaebol independent firms during the period 1986-1998. except in 19931995 when semiconductor prices were extraordinarily high. In order to determine the relationship between financing patterns and corporate performance. The ratios of the top 6-70 chaebols were lower than those of the top five chaebols. as well as lax financial supervision (Nam et al. (iii) Interest payment coverage ratios are calculated as operating earnings over interest expenses. Interest coverage ratios of non-chaebols were higher than those of the top 6-70 chaebols during the entire period. except in 1991. Nam et al. the top five chaebols’ ratios were much higher. Among the main findings were the following. 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. (i) In terms of total borrowings to total assets. Table 2.2. Those firms whose interest payment coverage ratios are below 1 are likely to go bankrupt.
or outright transfer of resources due to poor corporate governance practices.31). II Corporate Performance and Diversification As a chaebol further diversified into nonrelated areas. Factors related to weak corporate governance were closely intertwined with shortcomings in macroeconomic policy and vulnerabilities in the financial sector. its profit rate declined. The differences in the degrees of diversification among the three groups are substantial. rising nonperforming loans (NPLs) and falling . Vol. In terms of the net profit margin (the ratio of net profits to sales revenue). debt guarantees for free. second highest in the top 6-30. During 1985-1997. the top 6-30 and 31-72 chaebols gradually increased their diversification beginning 1990. the top five chaebols outperformed the top 6-30 chaebols for most of 1985-1997. The diversification of chaebols under workout was much lower than that of the top 6-30. and composition was lower than that of the top 6-30 but higher than that of the top 31-72 chaebols on average.130 Corporate Governance and Finance in East Asia. the degree of diversification was highest in the top five chaebols. But the net profit margins of the top 31-72 chaebols were higher than those of the top five in 1985-1992. and easier access to cheap credit. Chaebols have been subsidizing new or low-profit industries by transferring resources from high-profit industries through inside dealings. The diversification of the top five chaebols remained at about the same level within the period. Meanwhile. 2. Government intervention. larger research and development expenditure. then declined to levels lower than those of the top five in the years of economic downturn 1993-1997. except in the recession years of 1996-1997. and lowest in the top 3172 chaebols. This indicates that excessive diversification and inefficient investment of the top 30 chaebols resulted in relatively low net profit margins (Table 2. Their subsidiaries. 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. net profit margins of the top 31-72 chaebols were always higher than those of the top 6-30. Indicators such as increasing debt-to-equity ratios. court receivership. had easier access to credit than the top 31-72 chaebols.5 The Corporate Sector in the Financial Crisis This section looks at the various causes of the crisis in 1997. however. The degree of diversification of chaebols that fell into default. too. had a significant role.
4 (0.0) 0.5 1.5 (4.1) — = not available.7) (1.9 0.7 — (0.0 0.9 0.7 0.5 (0.0) (0.4 1. .2) (3.5) (1.6 7.6 1.2 1.8) 0.4 0.6 0.0) (0.1 1.6) 0.6) (12.4) (1.4 1.2) (0.5) (2.8 0.8 3.3) 0.1 0.1) 2.2) 2. 1998.9 0.1 0.3 (3.3 1.6) (0.4 0. Source: Whan Whang.4 2.31 Net Profit Margins of Chaebols.2 (1.8) 0.4 0.0 (7.4) (0.3) 0.7) 0.4) (6.6 (0.4 0.8) 0.3 1.1 0.3) 1.3) (1.2) (4.6 0.8) 0.1 1.8 (0.0 (2.7 3.6 0.5) (2.9) (1.8) 1.3 (0.1 1.2 1.5 1.3 1.5 (0.1 1.3 (0.3 1.1 (0.Table 2.9) (9.1 0.3 0.2 1.4 1.1 1.2 (17.3) 1. Court Receivership.6 0.1 (4.1) (5.1 0.7 (0.8 0.2 (0.1 0.2) (13.7 (4.1) (1.3 1.4 1.8) (3.4 (1.7 (0.2 (0.5 1.3 1.2) 1. Background and Task of Structural Adjustment.8) (1.7 1.0) 0.0 6.8) (20.5 0.5) 0.9) 2.7 0.3) 0.6 1.2) 2.3) 0.8) (0.0 4.8 0.0 0.4 (1.6 (0.5 4. 1985-1997 Item Top 5 Hyundai Samsung LG Daewoo SK Top 6-30 Top 31-72 Default.5 1.7 1.6) (20.0 1.6 0.7 (1.3 1.2) (13.7 1.3) 0.8 1.6 5.9 1.6 1.2 1995 3.7 0.9) 0.7) 0.3 0.7 0.5) (0.9 1.6) 0.3) 12.0) (3.4) (2.2) 1.6 3.9) 2.6) 0.3 (0. and Reconciliation Kia Jinro Hanbo Sammi Newcore Haitai Chungku Kukdong Daenong Halla Workout Target Kuhpyong Kangwon-sanup Pyuksan Sinho Tongil Kohap Sinwon Anam Donga 1985 1.1) 0.6) 0.2) (0.9) (8. Beyond the Limit.1) (2.8) 2.8 (0.1 2.3 0.3 1.1 (1.6) (12.3 3.8 0.6 (10.3 1.2 1. Chung Ang University.8 1.2) (4.5 1.0 1987 1.7 0.9 1.1 (3.5) (7.1) 1.7 2.0) 0.8) 0.2) 1.7 1.8) (37.1 0.9 8.9 (0.6 1.4) (1.1) (1.0 (0.3) 0.1 (9.9) 2.1 0.8 0.5 2.1 4.3 0.4 (2.2 4.5 (0.5 (6.8 (0.6 0.2 1.1) 1.9 0.0 1.7) (0.7) (0.1 1.5 (0.1) 2.8) 1997 0.0 1992 1994 1.4 1996 0.3 0.4) (4.4 (1.8) (4.6 1989 1.1 1.3) (12.3 (0.4) (1.3 1.1 (4.1 0.8) (1.4 (0.3 1.1) 0.9 1.2 0. Management Research Institute.6 1.6 0.7 0.8 1990 0.8 3.3) (0.6) (0.6 0.8) (11.2 1.11.4 (0.2) (4.2 (0.1) (6.0) (4.2) 0.3) (0. p.2 (0.3) 0.
Thus. the boards of all listed companies were composed of insiders only. The hold was tightened by the practice wherein candidates for directors were handpicked from among the managers by the controlling shareholder. II corporate profitability were signs that the Korean economy had reached the edge of a slippery slope. Meanwhile. the independence and objectivity of the external auditor were often questioned. after the crisis. and to the development of the market for corporate control. internal auditors cannot be expected to perform their function independently of management. Until 1997. . The most serious problem among most Korean listed firms has been that a controlling shareholder acting as CEO could never be replaced. Vol. outside directors. and creditors should select (recommend) the external auditor.5. Until 1997. the recently adopted Code of Best Practice in Corporate Governance recommends the strengthening of the board system. Now. Along with government policies to protect the status quo. 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. a firm’s board of directors had the power to appoint an external auditor. 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. 2.132 Corporate Governance and Finance in East Asia. Moreover. a committee composed of internal auditors. They were then almost automatically elected at the general shareholders meeting. Thus. 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. Ownership concentration also had ramifications on corporate transparency. A remote trigger in the Thai crisis was all that took to push the economy over the edge.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. this has led to entrenched management. 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. But in 1998.
as a whole. usually a member of the founding family. 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. Many of the takeover targets in the past did not have a controlling shareholder. There were no effective monitoring mechanisms for its management. Under the direction of the controlling shareholder. a large issuance of preferred stocks with no voting rights. however. Many changes were introduced to promote M&A in the 1990s. restrictions of voting rights of shares of institutional investors. corporate accounting information was not reliable due to the lack of independence of external auditors. Meanwhile. and restrictions on hostile takeovers. One reason is that the percentage of inside shareholdings for an average listed firm is very high. regulatory and practical difficulty in implementing proxy voting. Diversification can reduce chaebols’ risks through the portfolio effect. Traditionally. individuals. These internal dealings made strong firms weak and helped marginal firms survive. Dominance of Chaebols A chaebol is tightly controlled by the largest shareholder. has an unsound capital structure and . the Government maintained a policy of protecting the incumbent management of a listed company. Banks did not function as monitors of corporate management although they were shareholders as well as the most influential creditors. However. hostile takeovers in Korea will likely be rare in the future. In this situation. participated in the stock market as short-term traders rather than long-term investors. 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. prevalent window dressing practices. These included restrictions of shareholdings of institutional investors. profitable firms within a chaebol tended to subsidize unprofitable firms. when a large diversified chaebol. 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. and some differences in Korea’s generally accepted accounting principles from international standards.Chapter 2: Korea 133 There had been some devices to protect management so that companies could indulge in business activities without fear of takeover. as well as institutions.
the intervention later resulted in the accumulation of adverse side effects: underdeveloped product. bond issues. as the latter are well established in most business areas. Profitability of the top 6-70 chaebol firms has been lower than that of the top five chaebol firms. the authorities did not properly check on banks’ lending practices—banks did not screen the lending projects and evaluate the creditworthiness of corporations properly. II strong financial links among its member firms through investments and cross-guarantees. Vol. This indicates that too much diversification and overinvestment in the top 30 chaebols resulted in relatively low net profit margins. capital.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.5. prevalence of rent-seeking and morally hazardous behavior by economic decision makers. Net profit margins of the top 31-72 chaebols were higher than those of the top five or of the top 6-30. The Government and the Bank of Korea did not have accurate information on the extent of transactions that corporations and financial institutions had abroad. Such problems may eventually cause ripples through the entire economy. share issues. the financial distress of one or a few marginal firms can lead to a chain of bankruptcies across the entire chaebol. This effectively becomes an exit barrier for chaebols and would justify the intervention and support of the Government. the typical chaebol firm had an extremely high DER. The Government’s supervision and regulation of financial institutions were poor. 2.134 Corporate Governance and Finance in East Asia. while (non-chaebol) independent firms had much lower borrowing ratios. and other individual markets. 2. However. financing choices of listed firms in order of preference were bank loans.3 Manifestations of Weak Corporate Governance and Government Intervention Preference of Debt Over Equity Financing in the Precrisis Period Before the crisis.5. and internal funds. Further. and a high degree of inefficiency in the economy. The new preference ordering is as . As mentioned earlier. although their subsidiaries had better quality workforce and easier access to cheap credit than the top 31-72 chaebol affiliates. Financing preferences changed drastically after the crisis.
reducing foreign exchange reserves to a dangerous level. 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. At the end of 1996. In the international financial market. as evidenced by occasional.5 billion. The lending practices of banks. In November 1997. The high proportion of foreign debt led to a mismatch problem where borrowers were unhedged against foreign exchange risk. Although the ratio of stock market capitalization to GDP in Korea was not very different from those in the Philippines and Thailand. Other factors also contributed to this preference. After the financial crisis erupted in Indonesia and Thailand. The preference for debt finance also led to a relatively large foreign debt. However. . overseas borrowing became difficult and higher interest rates were charged on foreign borrowing. and bond issues. 63 percent of which was short-term. signaling a bearish speculative move on the won. The financing choice of listed firms was also influenced by the underdevelopment of the stock market. total foreign debt amounted to $157. 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. the top 30 chaebols showed a DER of 519 percent. which is far higher than the average ratio of around 400 percent for nonfinancial listed firms. which were the most important financing source until 1987. As of the end of 1997. Implicit guarantees by the Government on bank loans to large businesses. 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. consisted of high proportions of policy loans. Bank loans. obviously contributed to overlending and aggravated the situation. large-scale bailouts of financially distressed firms. which generally required guarantees or collateral. share issues. bank loans. the exchange rate (won/dollar) increased sharply and the financial crisis erupted in Korea. won/dollar nondeliverable forward rates increased rapidly. were advantageous to chaebols because they were in an “ideal” position to meet the loan requirement through cross-guarantees among their member firms. the Government and the Bank of Korea defended the currency. 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. The ratio of external debts to GDP reached 48 percent at the end of 1998. Nonpolicy loans were also considered to be cheap because of interest rate regulations.Chapter 2: Korea 135 follows: internal funds.
Fixed loans are those for which interest is not received for six months or longer. without strictly evaluating the creditworthiness of businesses and the profitability of projects. It jumped to 17. Following the “three months” definition. They utilized mutual payment guarantees among their affiliates and believed that they would never fail. decelerated from March 1998. reaching highs of 6 percent in 1997 and 8. II Inefficient Corporate Investment and Low Profitability Ownership concentration among Korean firms. 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. According to the “six months” definition. and there is no collateral. were low in 1996 and 1997. starting 1 July 1998. and shareholders’ equity of all industries. Before the crisis. has given rise to various types of self-dealings by the controlling shareholder. regardless of whether it is caused by large personal holdings of the controlling shareholder or by pyramiding.6 percent in June 1998. Financial Sector Vulnerability Because of financial losses in the corporate sector. then 20. the NPL ratio reached 7.1 percent in 1996. and the pursuit of growth through excessive diversification and inefficient investment. However. legal and other barriers prevented the exit of financially nonviable firms.000 per year starting 1992. The monthly number reached more than 3. the NPL ratio8 of banks and other financial institutions began to increase. Moreover.32).200 in 1997.000 during January-September of 1998. The number of insolvent companies increased rapidly in 1991 and doubled to more than 11. they are defined as loans for which interest payments are overdue by three months or more. The bank supervisory 8 NPLs of banks comprise fixed (substandard) and doubtful loans. and there is collateral. . In 1997 they became negative. The Government could hardly help them because of the number and magnitude of business failures. total assets.136 Corporate Governance and Finance in East Asia. the NPL ratio of commercial banks increased rapidly from 4. Further. a large number of construction companies failed due to the recession in the real estate market and decline in real estate prices. The inevitable result of inefficient investment was a fall in corporate profits. Meanwhile. and returned to about 1.000 in September 1998 (Table 2. Doubtful loans are those for which interest is not received for six months or longer.000 from December 1997 to February 1998. These were the definitions until 30 June 1998. and estimated losses. nine out of the 30 top chaebols failed. the ratios of net profits to sales. especially chaebols. The banks and merchant banks lent to large businesses. Vol.7 percent in 1997. excluding the financial sector.
417 Others 152 132 108 97 88 161 326 252 274 302 553 861 952 Note: 1998 figures cover only January-September. authorities were not too concerned about the high NPL ratios at Korean banks in 1997 simply because the high and rising ratios had precedents. Compared to ROAs and ROEs of domestic branches of foreign banks.238 4.647 8. the ratio reached 7-8 percent.027 Manufacturing 1.890 4. European countries.053 5. This speculation was said to be one of the causes of the financial crisis in Korea.751 1.133 3.33).769 9. As a result they had largely overvalued currencies. those of domestic banks were lower in the 1990s.657 3.32 Number of Firms with Dishonored Checks. Meanwhile.502 11.255 13. 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.4 Shortcomings in Macroeconomic Policy The macroeconomic framework also contributed to the crisis in 1997.472 2.855 6. and declined to 4-6 percent in 1994-1996 (Table 2. The current account deficits in terms .Chapter 2: Korea 137 Table 2. This was mainly due to the high ratios of NPLs.759 6. low efficiency.259 2.107 6. and Taipei.159 10.210 1.553 3.69 20.573 3. Source: Bank of Korea.589 171. ROEs and ROAs of Korean and Japanese banks were low compared with those of the US.265 6.386 5.637 6.985 Services 3.China.250 2. In 1990-1993.992 11.850 3.457 2.5.244 3. and continuous and large current account deficits.673 Construction 380 354 242 195 294 585 1.135 1. 2.131 1.544 2.856 7. and large government-directed loans.114 811 706 696 866 1.754 3.517 2.859 3. 1986-1998 Year 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 Total 4.979 8. Policymakers thought that economic growth would resolve the NPL problem without the need for corrective action. Exchange rates were virtually pegged to the US dollar in all troubled Asian countries.
584 2.929 11.537 10.827 289.China.484 11.1 7.0 8.6 percent (1995).116 1. Land prices and real estate rents were also high compared to trading partners.China.33 Nonperforming Loans of General Banks.520 194. of percentage of GDP were as follows: Malaysia -8.237 Estimated Loss (C) 958 920 840 816 213 385 490 490 648 NPL (A+B+C) 7.1 percent (1995).192 Doubtful (B)b 952 1.910 1. Real interest rates in Korea had been two to three times higher than those of Japan or Taipei. In 1997. Mass layoffs became legally possible only after the economic crisis.997 9.8 percent (1996).138 Corporate Governance and Finance in East Asia. . Vol. Thailand -8. Korea -4.6 Fixed loans are those requiring collateral and for which interest is not received for six months or longer.390 12. and Indonesia -3.0 7. Businesses served as a social safety net.1 6. Source: Bank of Korea. even in times of economic slowdown.705 160. Meanwhile large businesses could not legally lay off workers.739 241. the hourly wage rate in the Korean manufacturing sector was higher than in Singapore or Taipei. which led to large corporate losses. b Doubtful loans are collateral-free loans for which interest is not received for six months or longer.556 118.475 143.649 375.310 6. It was estimated that the Korean won was overvalued by 20 to 30 percent from 1989 to 1997.221 8.639 1.077 NPL Ratio (%) 8. although per capita income in Korea was much lower.176 7. Related to this. 1990-1998 (W billion) Year 1990 1991 1992 1993 1994 1995 1996 1997 1998 a Total Loans 90. In addition to the overvaluation of the won.600 10. and 30 percent in 1996.562 18.266 10.0 7.170 1.652 29.190 9.4 5. II Table 2.160 11.736 8.874 22. the ratio of short-term debt to foreign reserves was very high.954 9. the terms of trade deteriorated 12 percent in 1996 and 11 percent in 1997.832 337. The pegged currency also encouraged foreign borrowing as investors believed that the exchange rate would remain stable. because of the rigid labor market.584 Fixed (A)a 5.430 12.6 percent (1995). judging from the real effective exchange rate indexes using unit labor cost indexes as a deflator and 1985 as a base year.2 4. The main result of the rigid labor market was a “high-cost and lowefficiency” economy.8 5.
To achieve this. the excessive amount of debt of Korean corporations had to be reduced to a sustainable level. Corporations.6. 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. embarked on their own restructuring programs and/or implemented restructuring demands of the creditor banks. However. 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. Other firms experiencing financial distress were subjected to workout procedures through negotiations between debtors and creditor institutions. ‘Voluntary’ Restructuring Chaebols have been under pressure from the Government to abolish their informal group headquarters to increase the managerial independence of member firms.6 percent as of the end of June 1998 to no more than 200 percent by the end of 1999. including banks. A guideline informally promulgated by FSC required the 30 largest chaebols to lower their DER of 412. and subsidizing money-losing units. has been actively utilizing its influence to motivate institutions to coordinate debtor firms’ restructuring activities. had been forced into bankruptcy proceedings or merged into healthier entities. which were laden with huge amounts of debt and were on the verge of bankruptcy.Chapter 2: Korea 139 2. Downsizing by curtailing employment has been prevalent. .6 2.1 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. They have been pressured to stop such practices as providing loan guarantees. The FSC—later called the Financial Supervisory Service (FSS)— which is in charge of prudential regulation of financial institutions. Ailing banks needed to be recapitalized after the huge amount of NPLs was disposed. Nonviable firms and financial institutions. Measures have been taken by several chaebols to streamline operations and improve incentives of managers and employees. the immediate objective centered on restoring the international investment community’s confidence in the Korean economy.
potential foreign buyers waited for the price of acquisition targets to come down further. II Divestitures to raise cash for debt reduction and to focus on core businesses have not proved to be easy. FSC directed banks to appraise the long-term viability of client firms showing symptoms of failure.281 in April to 2. or to agree on debt-equity swaps demanded by potential purchasers as a precondition for the deal. On the other hand. banks and other creditors were reluctant to absorb losses realized by debt compositions. Involuntary Exits The Government has been involved in the restructuring process mainly through its supervisory capacity over banks. 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. while only 14 percent of the negotiations were completed from the beginning of the crisis up to April 1998. Noticing this disincentive. In their first review. The reasons are manifold. Locally. the number of potential sellers decreased somewhat from 2. More important.140 Corporate Governance and Finance in East Asia. This number was at 779 firms in April and grew to 1. they were reluctant to allow recontracting for fear of further deterioration in the capital adequacy ratio. Korean firms have been slowly stepping up their restructuring since the latter half of 1998 as the economy began to show signs of recovery. 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. 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. Banks did not have the incentive to force financially nonviable firms to liquidate. Vol.045 in October.138 by the end of October. It was frequently observed that the negotiating parties could not agree on a price due to large discrepancies in valuation. 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. the creditor . because liquidation of debtor firms would exacerbate the banks’ already weak balance sheets. Internationally. The data also show that about 24 percent of acquisition negotiations ended up in actual deals. More than 59 percent of potential buyers were foreign firms. In many cases.
creditor banks completed evaluation of the financial status of 35 subsidiaries belonging to 13 chaebols. 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.Chapter 2: Korea 141 banks selected 55 firms as targets for exit. write-offs. A portion of the Technical Assistance Loan of $33 million. The creditor banks and the advisory groups also drafted such plans for the top 6-64 chaebols. Corporate Workouts Workouts in the forms of debt rescheduling. Although the intention of the Government and the banks was to effect immediate liquidation of these selected firms. two were acquired by newly organized employee stock ownership plans. not only for the design of corporate workout programs but also their implementation. 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. Based on these plans. . provided by the World Bank. the results thus far have not entirely been as desired. The workout plans were completed for most firms by early 1999. These chaebols submitted plans for restructuring to improve their respective capital structures. More than 200 financial institutions signed the Corporate Restructuring Agreement to carry out corporate workouts with the top 6-64 chaebols. by their creditors. workouts are being applied to non-chaebol firms identified as financially weak. three filed for courtsupervised bankruptcy reorganization. The plans were put into action immediately following finalization. 24 were liquidated. Among the sell-offs. but viable. Among the 55 firms selected. the creditor banks drafted their own restructuring plans with assistance from outside advisory groups led by foreign investment banks. and 12 were sold off to other firms. interest reductions. These included 20 firms from the top five chaebols and 32 from the top 6-30 chaebols. By the end of 1998. Also. was allocated to the six largest banks for them to employ outside experts as advisors. Upon completion of the evaluation. and 16 non-chaebol corporations that had been selected as possible workout candidates. 11 were merged into other group members. 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.
oil refineries. the foreign buyer demanded specific protections against adverse developments in the business environment.142 Corporate Governance and Finance in East Asia. The less than satisfactory state of foreign capital infusion in the early days stems from a number of factors. Foreign investment—in the form of acquisition of controlling interests. Big Deals Ever since the outbreak of the economic crisis. Foreign Acquisitions Confidence in the Korean economy depends critically on the lowering of the level of corporate debt. Korea adopted and implemented policies to open its capital market completely. most of the big deals have entered their final stages of negotiation. II creditor banks and the corporations will devise detailed workout programs based on the rehabilitation plans submitted by the corporations. vessel engines. Thus. aircraft. some of the acquisition agreements have been discarded for various reasons. the Government has been urging the largest chaebols to strike “big deals” or business swaps among themselves to consolidate overlapping manufacturing facilities. This figure contrasts sharply with the total of $700 million for all of 1997. In one case. enable chaebols to streamline their overly diversified operations and focus on several core business areas. chaebols did announce their agreements on big deals in seven industries excluding the automobile industry. Hyundai Motor Corporation won the international auction of Kia Motors in its third bidding and Daewoo Motors agreed to acquire Samsung Motors. These deals could eliminate excess capacity in such industries as semiconductors. First.5 billion on agreement basis during the 10-month period after December 1997. automobiles. As of April 1999. In the case of automobiles. and equity participation—reached about $8. However. Vol. Big deals would. purchase of divested assets. Restrictions on foreign ownership of land were also abolished. On 3 September 1998. uncertainty over the future . labor union demands of the seller were not acceptable to the transacting parties. In the early days after the outbreak of the crisis. Big deals have been elevated to the status of the most important means of effective corporate restructuring. and petrochemicals. it is hoped. power plant facilities. inducement of foreign direct investments was considered to be the most effective means of achieving that end. In another. railroad cars.
Not only does this represent progress in terms of an improved institutional framework for market competition. these goals were: (i) to enhance managerial transparency. In effect. As set forth in the agreement. 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. many of the businesses that Korean firms put on sale did not prove to be attractive to foreign firms. Second. 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. Fourth. the Government and chaebols reached an agreement on the goals of restructuring and reform efforts. foreign buyers were concerned with the inflexibility of the labor market. (ii) to remove cross-guarantees of loans among group members. (iv) to focus on a small number of core businesses. With this in mind. foreign buyers usually employed discounted cash flow methods of valuation while local sellers often put greater emphasis on replacement costs of assets. 2.6. Overhaul of Bankruptcy Procedures In February 1998. some of the potential acquirers demanded terms that were unreasonable or unacceptable from the sellers’ point of view. the improved procedures stipulated in the Bankruptcy Reorganization Act and the Composition Act reduced what had previously been legalistic exit barriers. local creditor banks were reluctant to absorb losses arising from debt compositions and debt-equity swaps that were necessary in deals involving insolvent sellers. (iii) to reduce financial leverage.2 Policy Measures for Corporate Reform Goals and Policy Measures for Reform in the Corporate Sector Based on their assessments of what caused the economic crisis in Korea and what needs to be done to overcome it. Sixth. Third. and (v) to improve the accountability of controlling shareholders and the board.Chapter 2: Korea 143 course of the Korean economy remains high. The presence of . Fifth. but it also has important implications with respect to corporate workouts. 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. Seventh.
. The purpose of this rule is to shorten the reorganization planning period. The changes in the reorganization procedures can be summarized as follows.01 percent in May 1998. etc. the Composition Act was amended to narrow the eligibility of applying for court-supervised composition. The court can refuse to accept the application for composition if it finds it inappropriate considering the size of corporate assets. the right to revoke court receivership is allowed to the creditors. The creditors can form a “Creditors Committee” among themselves to allow them to participate in the decision processes in court. II an expeditious exit scheme is expected to better induce negotiation for workouts between creditor banks and corporations. a “Management Committee. October 1998. accounting. In the past this stage usually extended for as long as two to three years. Second. Also. Third. Fourth. (iii) the representation requirement for shareholder derivative suits was drastically relaxed from 1 percent to 0. First. and economics professions should be organized to provide for expeditious proceedings in court. Korea’s Economic Progress Report. 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. thereby preventing abuses by controlling shareholders/managers of financially distressed firms. (ii) legal changes have been made so that domestic accounting practices conform to international standards.” comprised of experts in the legal. (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. Vol. number of creditors. Also. the changes in the institutional setting for corporate reorganization will enable creditors and debtors to promptly respond to the development of financial problems. (iv) restrictions on institutional investors’ voting rights were eliminated in June 1998. the maximum grace period on loans to the firm being reorganized was shortened to 10 from 20 years. the court may annul its previous decision and force the firm into immediate liquidation. Fifth.144 Corporate Governance and Finance in East Asia. if a final reorganization plan is not worked out within one year from the date of the court order placing a firm in receivership. 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.
21 industries were further liberalized or newly opened to FDI (now. to FDI). Foreign Investment Promotion Act The Foreign Investment Promotion Act was put into effect in November 1998. As for promotion. (ii) full liberalization of foreign exchange transactions was legislated and will be put into effect in two stages. including tax exemptions and reductions. (vi) bankruptcy laws were revised in February 1998 to facilitate the exit of insolvent firms. According to the law. In addition. which was passed in August 1998. (iv) during April and May 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. either partially or fully. including financial subsidization. the Korea Trade and Investment Agency (KOTRA) will provide a one-stop service with respect to FDI. Foreigners are now able to invest in local bonds and short-term money market instruments without any restrictions. (v) by the end of May 1999. 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. beginning on 1 April 1999. Existing cross-debt guarantees should be completely eliminated by the end of March 2000.148 industries remain closed. 514 listed companies had appointed 677 outside directors). Measures for improving standards in corporate governance are already effecting a generally more open corporate culture and greater transparency in business practices. various supporting measures. financial institutions could no longer require cross-debt guarantees. and (viii) as of 1 April 1998. an additional nine industries will be opened or further liberalized.Chapter 2: Korea 145 (as of the end of May 1998. Capital Market Liberalization Since 1998. 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. (iii) hostile mergers and acquisitions by foreigners were fully liberalized in May 1998. only 31 out of 1. have been instituted for FDI: . (vii) by the end of March 1998. crossdebt guarantees totaling about W10 trillion—about 30 percent of the total guarantees among the 30 largest chaebols—were dissolved. These new standards are and will continue to be strictly enforced. administrative procedures for FDI will be dramatically simplified and made transparent.
are not risk-free. These liberalization measures.146 Corporate Governance and Finance in East Asia. Also. The majority of government bonds to be issued in the next two to three years will carry a maturity of three years. for 10 years (full exemption for the first seven years and 50 percent tax reduction for the remaining three years). These bonds will be issued . The law allows rental cost exemptions and reductions for FDI. Low cost rental facility: National and public real properties will be rented to foreign-invested firms for up to 50 years. The location of the FIZ will be determined at the request of foreign investors. such as the high-tech industry. the Government intends to supplement these measures with a sound macroeconomic policy in order to secure more effective protection against systemic risks. will be provided to foreign firms in the FIZ. Capital Market Augmentation Bond Market The Government recently introduced a policy plan to deepen Korea’s bond market. II (i) (ii) (iii) Tax exemption and reduction: Corporate and income taxes will be exempted or reduced for FDI in target industries. as well as building an early warning system. Various local taxes will also be exempted or reduced for eight to 15 years at the discretion of local governments. Vol. however. Liberalization of Foreign Exchange Transactions In September 1998 the Foreign Exchange Management Act was replaced by the Foreign Exchange Transaction Act. the Korean Government is strengthening prudent regulations and market monitoring. including infrastructure and tax support. Free Investment Zone (FIZ): A free investment zone will be developed to accommodate large-scale FDI. It aims to establish a benchmark by consolidating various government bonds. Various support measures. Three-year government bonds will be used to establish a benchmark. The primary aims of the law are the liberalization of the capital account and the development of the foreign exchange market. To minimize potential risks.
Prior to the introduction of this system. but it will also help improve financial institutions’ risk management. According to the law. Asset-Backed Securities A new law providing for asset-backed securities (ABS) was passed in September 1998. and W1 trillion divided equally between the three balanced funds.6 trillion for the debt restructuring fund. the Government will correspondingly expand the issuance of government bonds that have a maturity of five years or more. they will be managed by foreign investment management companies. and is promoting joint ventures between foreign and domestic agencies. 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. commercial banks were allowed to carry out dealing operations for government bonds starting in October 1998. Mutual funds (or open-end investment companies) will be allowed starting 2001. Related legislation was put into effect in September 1998. Moody’s signed a joint venture contract with Korea Investors Service. with only minor standard exceptions. In August 1998. It also opened the credit rating service market to foreign competition. to establish closed-end investment companies. a debt restructuring fund and three balanced funds (funds that invest in both equity and debt) were established in September 1998. It is now easy for private investors. invested a total of W1. both domestic and foreign. No qualification requirements are being imposed on investors who are sponsoring new mutual funds. Twenty-five domestic financial institutions. As a pilot program. including the Korea Development Bank. a primary dealers system will be introduced for healthy financial institutions. and the demand for longerterm bonds increases in the future. but may be extended as required. These are expected to operate for the next three years.Chapter 2: Korea 147 monthly. If interest rates stabilize at a low level. In order to promote a greater market demand for government bonds. This law will not only provide an effective institutional environment for the disposal of NPLs. financial institutions .6 trillion in these funds: W0. To ensure transparency and efficiency of the fund operations. The Government established specific qualification criteria and selected the primary dealers in 1999.
As markets become more efficient. More important. However.. this regulation may not be effective in curtailing pyramidal structures.6. It would be more desirable for the market-oriented measures to be put into place and strictly enforced. Vol. However. can utilize ABS. In principle. However. such as the Korea Asset Management Corporation (KAMCO). foreign business corporations with good credit standing are now also permitted to issue ABS. B investing in C. then the regulation will inhibit efficient investment of firms. On the other hand. 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. is inevitable. etc. A good governance system is essential for the healthy growth of corporations and financial institutions.) and the level of interfirm investments is very high. Direct controls of interfirm investments and/or pyramidal ownership structures will not be persuasive. Selfdealings.g. For instance. Policies aiming to improve the corporate governance system should take into account the high ownership concentration often created by pyramiding. One way of strengthening independence of the boards is to require that listed companies accept nominations for directors by institutional . cross-subsidization. There must be stronger rules to control agency problems. considering that there is no other effective way to limit circular investments among chaebol affiliates (e. II and qualified public corporations. this can only be a temporary measure. when the limit is binding. greater efforts to improve corporate governance are preferable to regulation of interfirm investment. and C investing in D. 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.148 Corporate Governance and Finance in East Asia. as stipulated by the government measure. there is another view that placing a maximum limit on interfirm investments.3 Policy Recommendations Poorly performing markets and the resulting lack of market discipline justified the government intervention in recent corporate and financial restructuring activities. the government intervention will have to be refocused so that it only sets the rules of the game in the marketplace. which is the case for many chaebols. A investing in B. The corporate governance structure cannot be expected to function efficiently if this issue is not addressed. unless the limit is tight and binding. 2. the role of the board of directors as the internal control mechanism must loom large in corporate governance.
and requiring that all directors hold shares of their companies. Listing rules may recommend that all or large listed companies adopt an audit committee. 1997. various measures have been implemented to promote investors’ rights. Class action suits are an efficient means for corporate monitoring. The Securities and Exchange Act will then require large listed companies to switch to a board audit committee system from an internal auditor system. More effective measures to protect investors will enhance corporate transparency and also the accountability of directors to shareholders. 1997).Chapter 2: Korea 149 investors or their trade associations. 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. One way of motivating institutions to do this is to 10 M. 23-26. . Proposed: A Governance Monitor. pp.10 Other means to improve independence of the boards include mandating that independent outside directors form the majority. If and when the law is introduced. and other committees. The Corporate Board. Each listed firm should be required to disclose the extent of its compliance with the Code in its annual report. Since the economic crisis. and also negligence of external (independent) auditors actionable. the Korea Stock Exchange could incorporate provisions of the Code of Best Practice in Corporate Governance in its listing rules. Further. The Government can prompt institutional investors to contribute more to good corporate governance by paying greater attention to corporate affairs. 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. September/ October 1997. Latham. governance. Institutional investors will play an increasingly important role in corporate governance. using audit. The annual shareholders meetings could also elect reputable “monitoring companies” to recommend director candidates (Latham. 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. it will have to include making self-dealings by directors and officers. thereby helping to strengthen board independence and enlisting boards’ more active involvement in monitoring corporate management. 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.
Also. Application of more stringent bankruptcy-related rules to firms in financial distress will effect greater discipline over corporate management. 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. strengthen its supervisory activities. possibly. The Government can also lower the limits on investments in affiliated companies. II provide comprehensive guidelines for their actions in matters related to corporate governance. . 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. objecting to certain defensive measures proposed by the management. Rights of minority shareholders should also be strengthened for these institutions. etc. strengthening incentive compensation schemes for executives. securities companies. and impose stronger penalties on violations of the rules on portfolio investments. and other NBFIs are subsidiaries of chaebols— especially the five largest ones. could prepare such guidelines. 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. and thus cannot be expected to be actively involved in monitoring portfolio firms. The Government recently proposed the revision of bankruptcy-related laws. These guidelines would recommend shareholder activism and faithful discharge of fiduciary duties by actively participating in shareholder voting. more drastic in nature. reviewing independence and expertise of candidates for outside directors. Another measure.150 Corporate Governance and Finance in East Asia. the Government will have to come up with appropriate policy measures to solve these problems. Many of the larger investment trust companies. Shareholdings concentrated in investment companies and other institutional investors pose a serious dilemma. such as the Korea Investment Trust Association. The institutions’ respective trade associations. Vol. and compliance officers. is to restrict ownership of investment trust companies and NBFIs by the five largest chaebols and. 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. 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. an audit committee. by all nonfinancial companies (or “industrial capital”). In the coming years.
and thus full-scale education programs should be developed. which could provide alternative sources of long-term corporate finance. In turn. lessening the degree of double taxation of dividends (or further reducing personal income taxes on dividends). The Government should substantially reduce the proportion of policy loans from bank loans. The Government needs to sell off at the earliest feasible dates the bank shares that it acquired in the course of recapitalizing banks. Banks should adopt strong incentive compensation schemes for management. (ii) provision of reliable accounting information. such as application of higher interest rates by banks to chaebols with higher DERs. through them. bank managers should be made accountable to shareholders but not to the Government. For this. The current obligatory system of disclosure that emphasizes “hard” . Banks need to play a bigger role than they do at present in monitoring corporate investment and management. Such measures include providing an effective corporate governance system. reduction of protection of domestic markets and entry barriers. The public and corporations should be taught or fully informed of the best practices in corporate governance. The Government should put more efforts into developing the capital market. the important issues to be addressed are: (i) improvement of the corporate disclosure system. In order to minimize government intervention in bank and corporate management. Many corporations are burdened with excessive debt and. 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. and consistently show low profit rates. and introducing disincentive schemes for excessive borrowings. the banks have great leverage over the management of debtor firms. therefore are vulnerable to economic shocks. private firms. To facilitate the development of the Korean stock market. and financial institutions. Many concepts regarding good corporate governance are still new to a lot of market players in Korea. the elimination of implicit guarantees for financial support to chaebols. An effective policy package is needed for chaebols to dispose of marginal firms with low profitability at the earliest date. Bank boards also need to be made more independent from management. to concentrate instead on a small number of core businesses. large firms. and stop unfair internal transactions. Chaebols are overly indebted. and (iii) a good corporate governance system to protect investors. excessively diversified into nonrelated business areas. This means that the Government can control the banks and.Chapter 2: Korea 151 There still exist widespread concerns that the Government will continue to exercise a great deal of discretionary power over banks.
Maintaining current account surpluses for a considerable period is needed to pay back foreign debts. is considered to be one of the major causes of the economic crisis. Another problem with the corporate bond market is that most bonds are issued with maturities of less than four years. Overvaluation of exchange rates should be avoided in order for export and import-substitution industries to stay internationally competitive. In determining optimal exchange rates. wage rates. the information system of the bond market should be better organized to transmit. 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 bureaucrats. Currently. More effective punitive means need to be devised to penalize both corporations in violation of disclosure rules and the officers in charge. The function of securities companies as dealers of bonds should be improved. no economic reforms will be effective. on a real time basis.152 Corporate Governance and Finance in East Asia. . and labor productivity should be considered. The network should cover not only the exchange market but also OTC transactions of investors and dealers. especially among business people. profitability of export industries and real effective exchange rates that account for changes in nominal exchange rates. Future research could include causes of corruption. The development of the OTC bond market requires a well-developed dealer system. Policies are needed to help develop more reliable services by bond rating agencies. data on quotations and trading volumes. penalties on violations of disclosure rules are not effective enough to have a significant impact. Without successfully addressing this problem. The establishment of a Corruption Prevention Institute will be helpful in this regard. reasons for different degrees of corruption in various countries. Vol. These should be lengthened to make them a source of stable long-term funds. and measures to reduce corruption. At the same time. II information on past performance needs to be transformed into a system in which corporations voluntarily announce “soft” information on future prospects. politicians. Prevalent corruption.
1989. S. T. 1995. K. KERI. An Empirical Evidence on Value of a Firm and Ownership Structure.). 79-95. D. Corporate Restructuring. Choi.. KERI. 1998. H. Chon. Korea’s Chaebol. Bank of Korea. New York: Praeger. Bank of Korea. S. 1989. C. Jua. Korea Economic Research Institute. D.Chapter 2: Korea 153 References Bank of Korea. M. Kim. Chung. Determinants of Diversification of Korean Business Groups. Korea Economic Research Institute. Hattori. pp. Market Concentration and Diversification of Business Groups. Hong. September 1998. Lee. Korea’s Large Conglomerates. 1997. W. Is the Fair Trade Policy Fair? Korea Economic Research Institute. H. H. International Financial Statistics. Proposed: A Governance Monitor. C. and J. various issues. Cho. Financial Studies. KERI. Kim. S. Korea’s Financial System. I. 1996. various issues. Latham. 1997. S. Bank of Korea. Economic Statistics Yearbook. Chung and H. W. in Korean Managerial Dynamics. September 1997. Center for Free Enterprise. Bibong Publishing Co. and K. Tomio. Y. Korea Development Bank. S. various issues. Lee (eds. Evolutionary Chaebol. Hong Moon Sa. Kang. H. Japanese Zaibatsu and Korean Chaebols. Ju Hyun. Jae Woo.. Kwon. Cho. 1992. 1996. 1997. International Monetary Fund. and H. Survey of Facility Investment Plan. 1998. K. Financial Studies. pp. H. September/October 1997. 1996. September 1998.. N. 23-26. A Study on the Relationship between Ownership Structure of a Firm and Value of a Firm. . S. New York: Praeger. 7995. pp. Financial Statement Analysis Yearbook. W. Kim. various issues. C. and 1998 issues. 1997. I. Lee. Chon. Korean Managerial Dynamics. The Corporate Board. 1995. Understanding Flow of Fund Accounts. 1999. Maeil Daily Economic Newspapers. 1993. W. edited by K. Lee. 1994.
Vol. 1996. Whan. Y. Y. H. November 1996. J. A New Trade and Industrial Policy in the Globalization of Korea. Korea’s Trade and Industrial Policies: 1948-1998. Lee. J. Kim. U. 2nd Sangnam Forum. Korea Institute for International Economics and Trade. Yonsei University. and H. Lim. W. Capital Liberalization.. I. The Ownership Structure and Family Control in Korean Conglomerates: With Cases of the 30 Largest Chaebols. S. Korea Finance Institute. K. S. September 1998. Korea’s Economic Progress Report. J. Real Exchange Rate and Policy Measures. Chicago. I. Wang.154 Corporate Governance and Finance in East Asia. 1996. Background and Task of Structural Adjustment. Corporate Governance in Korea. C. C.. Yang. 23. K. Annual Conference of Financial Management Association. Kim. 1998. and J. Management Research Institute. Business Groups in Korea: Characteristics and Government Policy. 1998. Ungki. Whang. H. Korea Institute for International Economic Policy.. Lee. Conference on Corporate Governance in Asia: A Comparative Perspective. . October 1998. Yim. October 1998. The Pattern of Ownership Structure and their Characteristics in Korean Conglomerates: With Cases of the 30 Largest Chaebols. January 1995. Joh. Ungki. 1999. and J. Kang. Seoul. S. Beyond the Limit. II Lee. Y. Lim. March 1999. Korea Institute for Industrial Economics and Trade. 1998. Korea Development Institute and World Bank. Ministry of Finance and Economy. Nam. 1998. K. 1995. S. Chung Ang University. KIEP Working Paper 98-05. KIET Occasional Paper No. 1999. Sohn.
and government subsidies were tackled during that period. state-sanctioned monopolies.1 Introduction In recent years. staff. and Liza V. When the Asian crisis erupted in 1997. the Philippine economy and corporate sector were in a relatively sound financial position. . allowed the Government and the corporate sector to gradually access foreign debt markets after a long absence. From 1993 to 1996. both of ADB. The lifting of the debt moratorium in 1991. Serrana. PSR Consulting.. Roble. about a decade before the recent Asian crisis. after the completion of debt negotiations with the IMF and Paris Club. and Lea Sumulong and Graham Dwyer for their editorial assistance. in particular Francisco C. the PSR Consulting. The Asian financial crisis revealed that. 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). Saldaña1 3. the Philippine Stock Exchange for its help and support in conducting company surveys. Inc. aiming at eventually limiting the Government’s role to economic policy setting and allowing the private sector to conduct most economic activity. and David Webb of the London School of Economics for their guidance and supervision in conducting the study. David Edwards. overall. Companies of other Asian countries were already using these markets to finance investment and growth. for their research assistance. Issues such as State ownership of businesses. This has come about following a political and economic upheaval from 1983 to 1987.3 The Philippines Cesar G. 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. Pineda. Inc. 1 Principal. The author wishes to thank Juzhong Zhuang. the Philippine corporate sector has played a leading role in the government’s efforts to get the country on track toward sustainable economic development. Denise B. the Philippine nonfinancial corporate sector had managed its borrowing risks relatively well by largely avoiding imprudent use of debts and risky investments. the Philippines.
yet they did not risk new capital required for modernizing and expanding manufacturing capacity. Corporate financing relies excessively on bank loans. composed mostly of families previously in trading businesses. Companies finance long-term investments with short-term debt. usually with the acquiescence of bank creditors. their growth could not be sustained. regulatory framework. on family-based and controlled conglomerates. Vol. which leads to their easing of due diligence and monitoring standards when lending to group members. The policy was crafted by the martial law regime at that time. patterns of ownership. While new manufacturing industries were successfully established. emerged to influence industrial policies. and on the financial crisis.2 3. The Board of Investments (BOI) was created to draw up an investment priorities . It analyzes the impact of corporate governance on company financial performance and financing. To implement these policies.2. The highly concentrated and family-based ownership of corporate groups has resulted in governance structures that depend largely on internal control systems. the Government overvalued the local currency and imposed high import tariffs.1 Overview of the Corporate Sector Historical Development During the 1950s and 1960s. An industrial elite. Companies were profitable because of protection from foreign competition. nationalist sentiments led to policies that favored import substitution and heavy government intervention in business. patterns of financing. But protectionist policies made labor relatively more expensive and. companies were necessarily large and capital-intensive. the corporate sector showed structural weaknesses similar to those in neighboring Asian countries.156 Corporate Governance and Finance in East Asia. II Still. and responses to the financial crisis. therefore. Sugar refining and textile mills are examples of industries that floundered in the 1980s because of government import substitution policies. Government interventions under the notion of “master planning” for economic and social development characterized the 1970s and early 1980s. control by internal and external governance agents. 3. Banks have significant presence as members of affiliated business groups. Investments of large corporate groups tend to focus on obtaining market shares and industry dominance. This study reviews the Philippine corporate sector in terms of its historical development. These early industrialists naturally opposed any initiative to reduce tariffs.
the Government continuously revised the enabling law of BOI so that incentives were reduced in number. Better access to cheaper imported raw materials improved the competitiveness of local manufacturers. BOI incentives retained a strong bias in favor of capital-intensive enterprises and domestic-oriented industries. the legislative body passed the Foreign Investment Act (FIA). and import licensing requirements. made less associated with capital investments. In many industries. i. the State took over the generation and distribution of electricity. the “pioneer” industries identified in the IPP. 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 . the top three companies accounted for a disproportionately large share of total sales and assets. organizing industries into sectors and picking “winners. quantitative restrictions. assumed ownership of the largest petroleum refining company. Probably the most significant effects of tariff protection and biases for capital intensity were the corporate sector’s high degree of concentration. Exports were not competitive because of the high costs of imported materials. Foreign ownership was allowed only in industries with high technological and market barriers. and oriented toward exports.. 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. clearly shifted economic management toward reliance on markets rather than on decisions by bureaucrats in the Government. and initiated the development of alternative energy sources in response to the oil crises. and orientation toward domestic markets. Following government initiatives in the control of the infrastructure and utilities sectors. The 1980s were marked by a peaceful transition of political power. It limited the bureaucratic cost and discretion that accompanied the necessary approvals of foreign investments. The FIA allowed foreign equity investment in many areas and at the same time provided a transparent. Reforms in policies.Chapter 3: Philippines 157 plan (IPP) to encourage private sector investments by offering tax and other incentives. including the reduction of tariffs. The Government signaled through the IPP its intent to shape the future industrial landscape.” No strategic industry could take off without the Government’s participation in its management and operations. Quantitative restrictions and tariff protection of preferred industries remained firmly in place. Nevertheless.e. In the early 1990s. Starting in 1981. In 1991. advance notice of areas where the country disallowed or restricted foreign investment.
.3 7.6) 0.8 5. 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. competition from liberalized imports had somewhat reduced oligopolistic tendencies and concentration in many industries. Rep.7 8.9 (1.8 8. Key Indicators of Developing Asian and Pacific Countries 2000.2 (0.0 7.0 8.9 6.1).8 4. Vol.9 7.2 During 1988-1997.3 8. only nonfinancial companies were used.7 Malaysia 9. net sales of the top 1.7) 10. This rate of growth was sustained by a comparable 18.5 (7.4 Philippines 3. 1990-1999 (percent) Year 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 Indonesia 9.8 8. In this section.2 Korea.2 9.5 9.2.1 5.8 5.5 8.2 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 8.0 8.2 7. II market. Its growth rate began to catch up with others in 1996.7) (10. Table 3.1 GDP Growth of Southeast Asian Countries.158 Corporate Governance and Finance in East Asia. 3.5) 5.2) 0.8 10.000 Philippine companies grew 17. which was taken as a representation of the Philippine corporate sector.8 percent growth in fixed 2 The SEC-BusinessWorld Annual Survey of the Top 1.1 4.0 (6. With economic reforms introduced in the 1980s and 1990s. however.0 (0.2 Thailand 11.6 7.2 7.2 Source: ADB.000 Corporations covers financial and nonfinancial companies.5) 3.2 8.1 8. of 9.2).1 5.5 percent per year (Table 3.4 4.3 9.3 2. The Philippines substantially lagged behind other countries from 1990 to 1995 (Table 3.7 5.3 9.000 corporations. only to be unsettled by the crisis of 1997.9 5.7 (13.2) 4.
9 952.6 75 6.1 468.6 102 16.893.160.332.1 6.3 68 7.7 20.512.5 51 4.978.4 555.1 51.191.2 Average 146 12.5 72 7.9 898 1.2 338.6 900 1.225.8 411.6 896 0.1 33.2 Growth and Financial Performance of the Top 1.5 1.5 4.3 60 10.6 954.2 1.1 4.4 188.5 570.3 107 13.6 1.1 1.1 73 5.0 148.9 629.1 72.3 898 1.8 902 1.2 27.4 63. return on equity (ROE) = net income/ stockholders’ equity.9 2.9 1.7 218.9 3.8 26.2 4.6 149 12.781.4 1.Table 3. .7 903 0.5 192.4 861.5 14.1 95.2 2.2 900.7 73 6.8 6.9 617.9 149 6.6 18.0 1.1 1.9 96.561.1 881.000 Corporations in the Philippines.000 Companies.2 707.2 2. net profit margin = net income/net sales. 1988-1997 1989 519.1 714.0 1.1 181 11.7 1.6 35.3 306.3126.96.36.199 238.1 5.2 Compound Growth (%) 17.4 411.6 109 12.5 64.4 898 1.5 887 0.5 Leverage = total liabilities/stockholders’ equity.341.8 618.8 5.1 Other Indicators No.0 900 1.4 602.4 776.7 1. Source: SEC-BusinessWorld Annual Survey of Top 1.6 1990 1991 1992 1993 1994 1995 1996 1997 1.7 28.3 862.5 1.3 121 12.8 4.5 508.6 290.5 193.1 54 11. turnover = net sales/total assets. return on assets (ROA) = net income/total assets.2 136.8 22.1 615.9 78 6.6 426.4 3.2 378.8 741.5 1.3 941.7 443.697.1 197 14.5 119 12.177.9 896 2.6 5.1 66 12.394.2 Indicators 1988 Growth Indicators (P billion) Net Sales Net Income Fixed Assets Total Assets Total Liabilities Stockholders’ Equity Retained Earnings 464.4 8.4 Financial Ratios (%) Leverage ROE ROA Turnover Net Profit Margin 222 14.6 144.8 77 7.3 382. of Companies Sales per Company (P billion) 899 0.3 46.209.4 260.9 480.647.5 446.
and by equity that grew at a higher average annual rate of 26.077 1.1 19. .2 percent. II assets.8 percent per year.248 1.394 1. Further.8 19. 1988-1997 Top 1.7 percent. The debt-toequity ratio ranged from 222 percent in 1988 to 102 percent in 1994.697 1. The growth rates of corporate sales for the period 1988-1997 exceeded those of the country’s GDP for the same period (Table 3.5 Ratio of Estimated Value Addeda to GDP (%) 17. Key Indicators of Developing Asian and Pacific Countries 1999.172 2.3 The Corporate Sector and Gross Domestic Product. Sources: ADB.9 23.979 17.9 21.4 20.9 percent for the period.5 Value-added is assumed to be 30 percent of net sales. Asset growth was funded by debt that grew at an average of 20. various years.427 13. for the 10-year period.3 percent. indicating that the corporate sector’s exposure to foreign currency-denominated loans was not as significant as in other countries. respectively.000 companies averaged 7.906 2.1 Net Sales (P billion) 465 519 630 741 862 954 1. This is high compared with developed countries but compares favorably with other Asian countries.000 Corporations in the Philippines.5 16.8 17.178 1.3).5 17. Vol. Assuming Table 3.160 Corporate Governance and Finance in East Asia. and the SEC-BusinessWorld Annual Survey of Top 1.000 Companies Year 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 Average Growth (%) a GDP (P billion) 799 925 1. The data suggest no evidence of excessive borrowing in the run-up to the crisis in 1997. Total assets grew at an average annual rate of 22.474 1.6 percent and 5.352 1.4 24. These rates of return are high compared with other Asian countries. Return on equity (ROE) and return on assets (ROA) averaged 12. but the extent of the increase was not as dramatic as in other Asian countries. leverage increased from 109 percent in 1996 to 149 percent in 1997.693 1. Net income consistently increased from 1988 to 1996 and declined only in the crisis year 1997. Net profit margins for the top 1.
9 26.4 Total Liabilities 26.1 Financial Ratios (%) Leverage 89 ROE 15. of Companies 73 Sales per Company (P billion) 2.0 31. (ii) foreign-owned. size. The foreign-owned companies were the Table 3.3 9.8 3.2 103 5.8 606 0.8 2.8 No.8 14. A study of company performance by ownership type.5 Retained Earnings 30.Chapter 3: Philippines 161 a constant ratio of value added to sales.3 22.6 Total Assets 29.7 22.3 146 6.9 196 1.9 158 13. privately owned companies constituted the largest group (Table 3.0 4.9 22.7 2. corporate control structure.4).3 42. various years.3 22.8 Growth Indicators (Compound Annual Growth Net Sales 20. these figures suggest a significant and increasing contribution of the corporate sector to GDP. Averaging 42.0 28.5 Source: SEC-BusinessWorld Annual Survey of the Top 1.8 ForeignOwned 21.2 9.0 142 22.5 GovernmentOwned 4.3 11. Performance by Ownership Type The Philippine corporate sector can be categorized into four groups based on ownership: (i) publicly listed.0 Net Income 19.0 5. .000 Corporations in the Philippines.3 27.4 190 5. The premise is that these variables have a direct bearing on corporate performance and growth.1 ROA 8.5 23 4.4 Stockholders’ Equity 32.4 Fixed Assets 19.0 5.8 22.5 Other Indicators Share of Sales (%) 17.5 27.1 22 10.1 12.4 Growth and Financial Performance of the Corporate Sector by Ownership Type. and industry reveals further structural characteristics of the growth and financial performance of the corporate sector. and (iv) privately owned.0 Turnover 53 Net Profit Margin 15. %) 17. 1988-1997 Indicators Publicly Listed Privately Owned Rate. (iii) Government-owned.8 percent of the corporate sector’s total sales between 1988 and 1997.4 28.9 17.
With an average leverage ratio of 142 percent.2 percent and ROA of 9. compared with P2. but lower than those of foreignowned and publicly listed companies. were among the top 1.5 percent average growth rate of the entire corporate sector. and low return on investment is the norm. Bases Conversion Development Authority.1 billion per company in 1997.75 billion per company for foreign-owned companies. The privately-owned companies were only about one third of the average size of per company sales of the publicly listed companies. the second best ROE and ROA.9 percent. These were mostly large public utilities. Their ROA and ROE were both more than twice as high as those of government-owned companies.162 Corporate Governance and Finance in East Asia. However. Vol. . the asset base is large. The privately-owned companies had a high average leverage ratio of 158 percent. Privately-owned and Government-owned companies grew at slower rates. while there were few of them. Publicly listed companies had the lowest leverage at 89 percent. Only 84 of the 221 public companies listed on the Philippine Stock Exchange (PSE). meaning that the remaining 62 percent were relatively small in sales and assets. and the second lowest asset turnover. they generated the highest return on investments. The compound annual sales growth rate was 21. But by being most efficient in employing assets. II second largest at about 27. Publicly listed companies had a minor though steadily increasing share in total sales. followed by publicly listed ones. with an average ROE of 22. and government-subsidized agencies such as the National Food Authority and Local Water Utilities Administration. a level high by Western standards but at par with those of other Asian countries.3 percent.000 list. foreign-owned companies borrowed more than publicly listed ones. 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.8 percent for foreign-owned companies and 20 percent for publicly listed companies during 1988-1997. although small in number. exceeding the 17. registered the largest per company sales at about P9 billion in 1997. these companies were comparatively large. or 38 percent. 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. reflecting the significant presence of holding companies as the gross revenues of holding companies flow through to operating income.5 percent. selling an average of P4. the highest net profit margin of 15.000 companies in 1997. Governmentowned companies in the top 1.
the corporate sector is divided into large.0 25.1 124 5.0 22.1 Retained Earnings 32. and small companies. had a lower leverage ratio.1 Source: SEC-BusinessWorld Annual Survey of Top 1.3 No. various years. %) Net Sales 20.7 Total Assets 32.3 percent for the conglomerates.3 Financial Ratios (%) Leverage 98 ROE 15. of Company 159 Sales per Company (P billion) 2.3 Other Indicators Share in Sales (%) 32.2 Net Income 21.2 23.0 Turnover 67 Net Profit Margin 12.3 Total Liabilities 30.8 ROA 8.6 26.5).6 715 0. Sales and resources of the .8 6. a company can be a member of a conglomerate or independent. The independent companies contributed about 56 percent of corporate sales on average during the period 1988-1997. depending on assets and sales. But the conglomerates were larger measured in sales per company.4 24. grew faster. 1988-1997 Indicators Group Member Independent 18. compared with 32.Chapter 3: Philippines 163 Performance by Control Structure By control structure.2 Fixed Assets 25.5 Growth and Financial Performance of the Corporate Sector by Control Structure. Table 3.7 Stockholders’ Equity 34.8 Growth Indicators (Compound Annual Growth Rate. medium.0 55.0 166 15.000 Corporations in the Philippines. and achieved higher returns on invested assets than independent companies (Table 3.7 2. Performance by Firm Size By firm size.
6 47.2 29.4 billion in 1997. %) Net Sales 15.9 Retained Earnings 13.5 128 10.1 81 9.1 ROA 5.6 31.5 12. referring to the remaining companies in the list. indicating that they deployed resources more efficiently than large and small companies.1 25. averaging 16 percent. various years.6 49.9 Financial Ratios (%) Leverage 158 ROE 13. of Companies 79 Sales per Company (P billion) 7.2 Stockholders’ Equity 18.2 Other Indicators Share in Sales (%) 56.0 32. 1988-1997 Indicators Large Medium 19.5 25.000 list.164 Corporate Governance and Finance in East Asia.9 26. are defined as the largest 100 companies in the top 1.0 7.9 32.0 156 16.7 44.000 list. sales of mediumsized companies grew faster than large companies.8 percent of the total number of companies in the list (Table 3. Medium-sized companies.5 Growth Indicators (Compound Annual Growth Rate. Vol.6).6 Growth and Financial Performance of the Corporate Sector by Firm Size. Table 3.1 percent of the total sales of the corporate sector. However.000 Corporations in the Philippines.1 No.5 73 6. although they comprised only 8.6 Small 19.6 36.3 Turnover 65 Net Profit Margin 8. averaged only P920 million in per company sales during the same year. which.5 Total Assets 18. Sales per company in this group averaged P13.9 89 1. Large companies accounted for 56.4 28. averaged a far less P3 billion in per company sales.3 Source: SEC-BusinessWorld Annual Survey of Top 1.1 4.3 Fixed Assets 15.7 Net Income 1. . while small companies.2 25. II Philippine corporate sector are highly concentrated among the large companies.4 Total Liabilities 18. for this study.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.
ROE dropped from 10.7 percent in 1996 to 8. Medium-sized companies apparently enjoyed efficiencies associated with economies of scale and made more productive use of their assets. ROE dropped to 7. at 158 percent on average during 1988-1997. The leverage ratio of the manufacturing sector was higher than that of the real estate and property sector. with their ROE dropping to 3. showed the lowest ROE. compared with 9. Performance by Industry This study also looked at corporate performance by industry. Mediumsized companies’ leverage level was slightly lower. manufacturing. assets. specifically those industries least and most affected by the financial crisis.5 percent for medium-sized companies and 8. Large. are shown in Table 3. at 156 percent. from 14. averaging 10. For small companies. and the construction sectors than for the manufacturing. Poor returns appear to have been caused by the low profit margin at 6. of net income.7 percent a year earlier.7. and utilities and services sectors. The real estate and property sector also suffered significantly in sales. but lower than that of construction. and utilities and services sectors.8 the previous year. The Asian financial crisis affected large companies most severely.4 percent in 1997 from 11.and medium-sized companies did not substantially increase their leverage in years running up to the crisis in 1997. unlike their counterparts in other Asian countries.1 percent.6 percent. 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.2 billion in 1997 for this sector. at 128 percent for the period. But small companies’ leverage was significantly lower. Sales revenue and net income declined from P76. i.1 billion in 1996 to P4. Leverage was the highest for large companies. utilities.8 percent in 1997. Growth of sales.2 percent for large ones. and assets was much higher for the real estate and property. The sector showed consistent growth in sales.7 percent in 1997 for medium-sized companies. especially during the period 1994-1996. reflecting to some extent a “bubble” phenomena in the former two sectors. as indicated by the negative annual growth.7 billion and P35. Net income declined from P54. and profitability in 1997 when the crisis started.Chapter 3: Philippines 165 Small companies. profits.e. and equity up to 1996. although the largest in number.. net income. and construction. real estate.8 percent. at -12. net income. but suffered its largest decline in net profits in 1997.8 billion in . The growth and financial performance of selected industries.
7 10.7 83 2. and was also much more limited compared with the property sectors in other Asian countries. %) Net Sales 16.9 17.1 10.7 19.6 Total Liabilities 18.5 Other Indicators Share in Sales (%) 82.166 Corporate Governance and Finance in East Asia.4 19.7 percent to 10.0 Turnover 112 24 Net Profit Margin 5.6 Growth Indicators (Compound Annual Growth Rate. Its knock-on effect on the economy was small as it accounted for less than 3 percent of the top 1. . With a modest increase in total liabilities and leverage level of less than 100 percent in 1997.0 23.000 companies’ total sales on average during 19881997. II Table 3.0 21.0 25.1 2. 1996 to P56.6 Financial Ratios (%) Leverage 142 181 ROE 13.6 69 16. 1988-1997 Utilities Real Estate and and Services Property 39.4 3.9 5. it does not appear to have been excessively exposed to foreign currency-denominated loans.7 52.7 Growth and Financial Performance of the Corporate Sector by Industry. respectively.9 23.3 20. various years.2 45.5 12.9 2.3 55.3 5.2 37.8) 17.3 Retained Earnings 17.000 Corporations in the Philippines.8 41.4 percent.2 28 0.7 192 9.0 31 0.8 Stockholders’ Equity 21.6 No.8 48. The sector’s buildup in equity during the stock market boom of 1994-1996 may have cushioned the impact of the crisis. the sector’s ROE dropped from 15.7 Net Income (12. But the impact of the Asian crisis on the real estate and property sector was much smaller than that on the manufacturing sector.7 ROA 5.4 16.4 Total Assets 19.7 billion in 1997. Vol. of Company 454 17 Sales per Company (P billion) 1.7 28.9 2.2 8.4 Source: SEC-BusinessWorld Annual Survey of Top 1.7 Indicators Manufacturing Construction 27.9 billion and P24.2 12.1 24 42.3 Fixed Assets 20. As a result.
Two other pertinent laws are Presidential Decree (PD) 902-A. Overall. (iv) term of existence. (iii) principal office. reaching up to 313 percent in 1997. (v) number of directors (not less than five nor more than 15).3 which serve as the company’s declaration that the minimum percentage of authorized capital required by law has been subscribed and paid-up.Chapter 3: Philippines 167 The utilities sector had the second highest leverage during 19881997 at 181 percent on average. One month after registration. (ii) purpose of the corporation.2. It specifies the minimum information to be indicated in the articles of incorporation. . operation. nationalities. and amount of authorized capital stock. The currency devaluation bloated the foreign currency-denominated loans of these companies. and amount subscribed and paid by each. the leverage of all four industries was low. which was based on American corporate law. and restrictions. (vii) number. the Code requires a corporation 3 A company’s articles of incorporation should include: (i) corporate name. contains some provisions affecting corporations’ dealings with banks. For publicly listed companies. It provides the basic constitutional structure for the organization. and (viii) names. par value. which regulates banks and nonbank financial institutions except insurance companies. The General Banking Law. the Corporation Code of 1980 is a compilation of important juridical rulings. and recognized rules on corporate practices. 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. 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. privileges. the Revised Securities Act (RSA) and PSE’s public listing requirements also apply. (vi) names. and residences of incorporators and directors. Under the Code. 3. and residences of original subscribers. administrative regulations.3 Legal and Regulatory Framework The Corporation Code of 1980 is the main law governing the corporate sector. nationalities. the ownership of Filipino citizens in the corporation is not less than the legally required percentage of capital stock. which is also the organic law governing the operations of SEC. and dissolution of corporations. unlike in neighboring countries hit by the Asian crisis. Corporation Code of 1980 Supplanting the old Corporation Law of 1906. and the Insolvency Law.
place. and reasonable. and public policy. In addition. and should not impair vested rights. (v) manner of election or appointment and term of office of all officers other than directors. Vol. or officers. A majority of the outstanding shares of shareholders must vote to authorize amendments to the bylaws. duties. 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. manner of voting.168 Corporate Governance and Finance in East Asia. To be valid. and control (adjudicative) of all corporations. II to adopt a code of bylaws or rules for its internal governance. However. must be general. PD 902-A expanded SEC’s mandate to include absolute jurisdiction. and compensation of directors. Securities and Exchange Commission: PD 902-A SEC is the government agency responsible for implementation of the Corporation Code. and between the corporation and the State concerning its franchise or right to exist. (iii) controversies in the election or appointments of directors and officers of corporations. 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. In 1976. (iii) qualifications. the corporation’s articles of incorporation. the bylaws must be consistent with the law. directors. and forms of proxies and manner of voting them. supervision (regulatory). (iv) time for holding annual election of directors and manner of giving the election notice.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. between the shareholders and the corporation. uniform. 4 Some of the items that a corporation may provide in its bylaws are the following: (i) time. (ii) required quorum in shareholders’ meetings. and (vii) manner of issuing certificates in the case of stock corporations. (vi) penalties for violation of the bylaws. among shareholders. and employees. and manner of calling and conducting regular or special meetings of the directors and shareholders. It implements rules and regulations that protect minority shareholders from possible fraud and misbehavior by controlling shareholders. Its mandate is to supervise corporations in order to encourage investments and protect investors. (ii) controversies arising out of intra-corporate relations. shareholders may delegate this power to the board of directors by a two-thirds vote of outstanding capital stock. . officers.
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The last item of PD 902-A is the special jurisdiction granted to SEC over applications by corporations for “suspension of payments” to creditors, a role of the regular courts that was originally part of the Insolvency Law. Under this authority to approve applications for suspension of payments, SEC has the power to appoint rehabilitation receivers or management committees for petitioning corporations. A presidential writ issued in 1981 placed SEC under the supervision of the Ministry of Finance, but in 1998, control of the agency was returned to the Office of the President. Insolvency Law The Insolvency Law is designed to effect an equitable distribution of insolvent debtors’ properties among their creditors. It permits debtors to be discharged from their liabilities to enable them to start afresh with property set apart for them from assets to be used as payment to creditors. The regular courts have jurisdiction for insolvency proceedings including suspension of payments for individual debtors. A debtor can petition the court to suspend payment of debts or to be discharged from liabilities and debts by voluntary or involuntary insolvency proceedings. Revised Securities Act: Law on Securities Dealing Like its predecessor, the 45-year-old Securities Act, the RSA was patterned after several US securities acts. The RSA is primarily designed to prevent the exploitation of investors through the sale of unsound or fraudulent securities. For this purpose, the law requires full and accurate disclosure of all material facts concerning the issuer and the securities it proposes to sell, and prohibits misrepresentations, manipulations, and other fraudulent practices in the sale of securities. To enforce these regulations, the law requires the registration of securities. The registration requirement covers full and accurate disclosure of the character of the securities to be sold to the public, including detailed information regarding past dealings between the issuer and its directors, officers, and principal shareholders. Public Listing Rules of the Philippine Stock Exchange PSE is the country’s facility for secondary trading of shares of publicly listed companies. In 1998, SEC, which originally supervised PSE, granted the exchange the status of a “self-regulated” organization. Thus, PSE now
170 Corporate Governance and Finance in East Asia, Vol. II
has the authority, within general guidelines set by SEC, to set rules and regulations for PSE members and listed companies. The general requirements for maintenance of listed status include submission of financial reports that conform with generally accepted accounting principles (GAAP) and regulations established by PSE, and compliance with laws relating to securities and exchange regulations, board resolutions, and agreements executed with the agency. Violations of PSE requirements are subject to sanctions, including delisting. PSE is responsible for ensuring that listed companies follow the exchange’s rules of disclosure and fair treatment of investors. It has the power to impose sanctions on any company that fails or erroneously discloses material information that affects the rights and benefits of investors and misrepresents information in its application, prospectus, financial statements, or reports. In the area of corporate governance, PSE requires corporations to resolve, and, where possible, eliminate arrangements within groups of companies and own-company dealings that can lead to conflicts of interest. Upon complaints by minority investors, PSE can review the deals in question, using such criteria as benefits to the company, adequate disclosure to shareholders, and internal control procedures to ensure fair and reasonable terms. Banking Laws Affecting Corporations Some aspects of banking laws affect the governance of corporations. The important ones concern: (i) the capacity of officers of corporations to assume positions as members of the board of directors of banks, (ii) limits on ownership of banks by nonfinancial corporations, (iii) limits of lending by banks to corporations, and (iv) rules on lending to directors and other insiders. The General Banking Law governs the regulation of the establishment, management, and operations of banks. As the highest policymaking body of the banking system, the Monetary Board prescribes the qualifications of bank directors and reviews the qualifications of those appointed as bank directors and officers. It could disqualify anyone found, for whatever reason, unfit for the position. There are no other restrictions on corporate officers to be appointed as members of the board of directors of banks. A corporation, including its wholly or majority-owned subsidiaries, can own common shares of banks up to a maximum of 30 percent of banks’ voting stock. In the event that the corporation is majority-owned by one person or by relatives, the limit is 20 percent of banks’ voting shares.
Chapter 3: Philippines 171
Regulations on the single borrower limit (SBL) put a ceiling on the maximum amount that a bank can lend to a debtor. SBL rules limit the total liabilities of any borrower of a commercial bank to 15 percent of the bank’s unimpaired capital and surplus, and an additional 15 percent for “adequately secured loans,” to a maximum 30 percent (“unimpaired capital and surplus” refers to the total paid-in capital, surplus, and undivided profits, net of valuation reserves of a bank). SBL limits exclude risk-free loans such as Government-guaranteed loans and loans secured by cash deposits. Total corporate liabilities include all liabilities of the debtors and their majorityowned subsidiaries. The Monetary Board may prescribe the consolidation of the liabilities of subsidiaries with the parent corporation under certain conditions. Central Bank (Bangko Sentral ng Pilipinas [BSP]) regulations do not prohibit loans by the bank to its directors, officers, shareholders, and other related interests, known as DOSRI. However, they are subject to certain prudential requirements under banking laws, as follows: (i) a director or officer of a bank can only borrow or become a guarantor, endorser, or surety for loans from the bank with the written approval of all other directors of the bank (i.e., excluding the director concerned); (ii) the amount of outstanding credit accommodations that a bank extends to its shareholders shall be limited to an amount equal to the sum of their unencumbered deposits and book value of their paid-in capital contributions; and (iii) loans and advances given to officers in the form of fringe benefits shall not form part of liabilities under DOSRI.
Corporate Ownership and Control Patterns of Corporate Ownership
The historical development of Philippine corporate ownership is rooted in the country’s colonial past, the industrial policies of the Government, and the recent emergence of industrialists and an entrepreneurial class. During the Spanish and American period up to World War II, a small number of families acquired land and owned large businesses. These families built and preserved their businesses over several generations. Many of them became controlling shareholders of family-based corporations and business groups that are major players in the present-day Philippine corporate sector. Ownership is a key element in corporate control and governance. Public listing rules of PSE require that a minimum of 10 to 20 percent of
172 Corporate Governance and Finance in East Asia, Vol. II
outstanding shares, depending on the size of the company, be available for trading in the stock exchange. As companies usually only issue the minimum required number of shares, large blocs of controlling shareholders often dominate corporate decision making in publicly listed companies. Public investors and minority shareholders are not in a position to influence management. Moreover, the presence of large controlling shareholders makes takeovers by other companies difficult. For these reasons, the resolution of conflicts between the interests of controlling shareholders, minority shareholders, public investors, and creditors in Philippine companies depends very much on the effectiveness of internal control systems. Ownership Concentration of Listed Companies This study measures ownership concentration in terms of shareholdings by the top one, five, and 20 shareholders.5 Table 3.8 shows that the top shareholder owned 40.8 percent of the market value of an average nonfinancial company. The shareholding of the top shareholder varied across sectors. It was highest for the property sector at 54.8 percent, followed by holding companies (as a sector) at 53 percent. One shareholder held majority control of an average company in these two sectors. The average shareholding of the largest shareholder was less than 25 percent only in sectors with large market capitalization, such as power and energy, and transportation, and in sectors with high risks, such as oil exploration and mining. These figures suggest that for publicly listed companies, a single shareholder often has substantial or even dominant control. Combined, the holding of the top five shareholders in an average company was about 65.3 percent for the nonfinancial sector and 59.2 percent for the financial sector. The five largest shareholders held majority control over an average Philippine publicly listed company, except in three sectors—transportation; food, beverage, and tobacco; and oil exploration. Ownership by the five largest shareholders was on average most concentrated among holding companies (78.4 percent), and in construction (74 percent), property (69.8 percent), manufacturing and trading (68.4 percent), and communications (67.3 percent).
The study derived ownership data for 194 (169 nonfinancial) companies out of 221 (190 nonfinancial) listed on the Philippine Stock Exchange as of 1997. Shareholdings by the top one, five, and 20 shareholders were estimated for each company and averaged by using the market capitalization of each company as a weight.
Chapter 3: Philippines 173
Table 3.8 Ownership Concentration of Philippine Publicly Listed Companies by Sector, 1997
Sector Financial Institution Banks Financial Services Average Shareholdingb Nonfinancial Company Communication Power and Energy Transportation Services Construction and Other Related Products Food, Beverage, and Tobacco Holding Companies Manufacturing, Distribution, and Trading Hotel, Recreation, and Other Services Property Mining Oil Average Shareholdingb
Top 1 26.9 41.3 27.2 35.4 21.5 23.8 47.7 22.7 53.0 37.4 28.9 54.8 23.4 19.9 40.8
Top 5 59.2 63.2 59.2 67.3 55.4 48.4 74.0 44.1 78.4 68.4 55.3 69.8 56.0 45.1 65.3
Top 20a 76.4 65.8 76.2 76.9 72.1 69.2 86.2 69.7 86.0 42.6 68.0 74.5 51.9 64.3 75.9
Information on the top 20 shareholders is not available for five holding companies, 10 manufacturing companies, and two property companies. b Weighted by market capitalization. Source: PSE databank.
The shareholding of the 20 largest shareholders in an average company was 75.9 percent for the nonfinancial sector and 76.2 percent for the financial sector. In 12 out of 13 sectors, the top 20 shareholders owned more than 50 percent of the voting shares of an average company. In 10 out of 13 sectors, the top 20 shareholders held more than a two-thirds majority control of an average company. Ownership Concentration at Critical Levels of Control PSE listing rules require that a minimum of 10 to 20 percent of outstanding shares of a company be issued to the public, depending on its size. An interesting question is whether in reality Philippine publicly listed companies issue enough shares to be truly widely held or whether they barely meet this minimum requirement. The answer to this can be gleaned from an
II analysis of the number of companies in which the top one. the top 20 shareholders collectively owned a majority of a company’s shares. The shares of publicly listed companies are thinly traded and illiquid. Nonfinancial corporations with controlling shareholdings are likely to be holding companies. a single owner owned more than 80 percent of outstanding shares. the top five shareholders owned more than 50 percent of the voting shares. Who are the top one. In 111 companies. In 116 companies. controlling an average of 52.10.1 percent of publicly listed companies in the Philippines in 1997. or almost 75 percent of the total. or 3 percent of the total.174 Corporate Governance and Finance in East Asia. Individuals did not constitute a significant shareholder group among the top five shareholders. In four companies. In 21 companies. 66 percent (signifying strategic control). a single shareholder held operating control of a company.9 shows that in 44 companies. There are advantages to establishing pure holding companies. or 20 shareholders owned more than 50 percent (signifying operating control). Composition of Ownership of Publicly Listed Companies Another important issue concerning corporate ownership is the composition of the controlling shareholders. The largest group is nonfinancial corporations. and share prices are sensitive to movements of foreign funds. large and family-based shareholders pool the family’s ownership over many . the top five shareholders held more than two-thirds majority control of a company. or 51 percent of the total. Parent companies usually spin off operating units into new companies that they continue to control as affiliates. With such high levels of ownership concentration. or about 30 percent of the total. In four of 11 nonfinancial sectors. or 14 percent of the total. 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. which are mostly privately owned and controlled by family-based shareholder blocs. five. The limited volume of shares issued to the public is one of the causes of the underdevelopment of the Philippine stock market. five. or 80 percent (only nominally publicly listed) of outstanding shares. In 76 companies.2 percent of outstanding shares of publicly listed companies. Table 3. including pure holding companies. the top five controlling shareholders were classified into eight groups. Vol. and 20 shareholders? In Table 3. Through these. a single shareholder held two-thirds majority control. nonfinancial corporations held majority control. holding only an average of 2. or 78 percent of the total.
Table 3. Distribution. and Tobacco Manufacturing. 10 manufacturing companies. and two companies in the property sector. a Data for top 20 shareholders were not available for five holding companies. . Beverage. and Trading Holding Power Transportation Property Total — = not available. 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.9 Ownership Concentration at Critical Levels of Control Over Publicly Listed Companies. Source: PSE databank.
Recreation.5 2.2 3.0 1. and Tobacco Holding Companies Manufacturing.8 0.1 0.7 0.6 12.3 26.2 0.0 0.4 5.6 2.0 45.0 0.2 0.0 5.0 5.8 0.6 1.2 1.6 0.0 0.2 3.0 5.9 0.7 67.8 66.0 0.7 3.3 37.0 1.10 Composition of Top Five Shareholders of Philippine Publicly Listed Companies by Sector.0 0.7 0.3 2.0 1.5 26.3 0.0 1.6 2.7 0.0 1.0 0. and Trading Hotel.4 19.0 0.8 21.0 2.7 3.0 0.3 5.4 0.0 1.0 0.0 0.4 2.2 0. Distribution.1 1.0 4.0 2.3 0.6 0.9 52.2 59.0 0.1 0.3 0.2 0.5 13.2 0.6 0.8 0. .6 33.1 9. and Other Services Property Mining Oil Average Shareholdinga 33.2 5.1 8.5 12.3 1.9 36.2 10.2 3.1 5.6 0. Beverage.3 0.5 0.Table 3.0 0.3 0.6 18.5 4. 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.8 11.0 7.4 29.6 0.0 0.0 10.3 1.0 1.2 3.5 53.5 0.7 0.5 4.1 a Weighted by market capitalization.1 7.4 8.0 0.6 0.9 6.3 12.9 0.6 5.0 5.6 0. Source: PSE Databank.1 6.4 1.6 9.0 0.3 5.7 1.7 0.7 0.0 1.
The investment funds’ presence in these sectors ranged from 8. while still allowing the public to own minority shares. there was no real market for investment information.1 percent). Petron and MERALCO in power and energy.5 to 12. financial institutions did not have a significant ownership in nonfinancial corporations. Privately-owned pure holding companies own a majority of shares and exercise control of publicly listed holding and operating companies through a multilayered pyramid structure. respectively.6 percent of market capitalization in 1997.1 percent).7 percent of shareholdings).7 percent of market capitalization of the nonfinancial publicly listed companies. The 7. Funds of SSS and GSIS consist mainly of compulsory contributions from members of the country’s private sector and government workforce. Holding companies were themselves 66 percent owned by other nonfinancial corporations.Chapter 3: Philippines 177 companies and share in the risks and profits of the group.6 billion or 26. The financial institutions among the top five shareholders of nonfinancial corporations are investment trust funds (with 4. Such advantages have contributed to the popularity of holding companies among publicly listed companies. This complex layering of ownership masks the identity of individuals or families that actually own and control operating companies. commercial banks (1. These institutions keep a stock portfolio mostly in shares of a few companies with large capitalization and high liquidity in select industries.3 percent). and insurance companies (0. Because of limited ownership by institutional investors.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. securities brokers (1. These are mainly the Social Security System (SSS) and the Government Service Insurance System (GSIS). 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.2 percent in 1997. . The Philippine capital market did not have an active analyst community comparable to those in more developed capital markets. They can also better manage their income taxes because income from affiliated companies passes through a holding company. Holding companies as a sector had the largest market capitalization in PSE in 1997. accounting for P258. As a group. These include Philippine Long Distance Telephone Company (PLDT) in telecommunications. and San Miguel Corporation (SMC) in food and beverages. Investment trust funds were the most important institutional investors. with an average of only 7.
Banks that are members of business groups have an advantage in raising funds from the internal capital market of the group. The Central Bank deregulated interest rates and foreign exchange. suggesting that business groups are common in all major markets. Corporate financing depends on intermediation by banks.178 Corporate Governance and Finance in East Asia. More than three fourths of the respondents are either a parent or subsidiary (about 70 percent of these are domestic nonfinancial companies). Vol. identified the companies belonging to each of these groups. and tracked the financial performance of each company from 1992 to 1997. using data on the Philippines’ top 1. Foreign banks have a growing presence but have not necessarily increased the supply of credit to the corporate sector. Prudential regulations.4 percent of the top 1. a nonfinancial company that owns a commercial bank has better access to loans at favorable rates and terms. 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.7 6 7 The study used publicly available shareholder information and published reports.8 percent of total companies in number. the Central Bank’s reforms are probably changing the conduct but not necessarily the structure of the banking system. Family-based groups have larger companies since their total sales were about 33. including SBL and DOSRI rules. about three fourths. This could further increase the concentration of ownership and expand the scope of own-group lending by these larger banks. including 16 commercial banks. Still. and increased the capital requirements for all types of banks. many companies in family-owned groups are not publicly listed.000 Corporations in the Philippines. However. suggesting that most publicly listed companies are parts of business groups.6 The total sales of these groups in 1997 were estimated at P806 billion (Table 3.11). All major industries were represented. but they comprised only 23. .000 companies. of the financial resources in the country. 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. This is significant considering that there were only 31 local commercial banks in the country in 1997. For this reason. liberalized the regulations on entry of foreign bank branches and foreign ownership of local banks.000 corporations’ sales. so far limiting their involvement to selected products. Commercial banks hold the largest share. The process identified a total of 238 companies belonging to 39 business groups from the SEC-BusinessWorld Annual Survey of the Top 1. the study put together a list of prominent business groups. remain in force to control excessive lending of banks to insiders. Some 20 financial institutions were affiliated with these groups. To understand the ownership and governance characteristics of family-owned business groups. 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.
with the exception of Banco de Oro.12). In terms of number of companies. 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. In terms of sales. construction. Also. Lopez.4 percent of the group’s 1997 profits). the three largest entities were family-based groups. In 1997. nonfinancial companies contributed about 36 to 60 percent of total profits for these groups. it was manufacturing (36. Together.Chapter 3: Philippines 179 Compared with other Asian countries. To show this.000 corporations in 1997. the nonfinancial sector was real estate (60. Lopez. and Henry Sy—as examples. or an average of about 12 per group.2 percent). in most . as discussed in previous sections. retail merchandising (69. Gokongwei. and banking. which was majority-owned by the Henry Sy group. for the Lopez group. Foreign-owned companies mainly serve the export markets. the biggest private company in the Philippines. for the Gokongwei Group. the largest family-based business group was the Ayala Corporation Group. an average group in the Philippines has fewer member companies. In the meantime. broadcasting (49. Commercial banks are often affiliated to a particular business group. the largest was the Eduardo Cojuangco group. The significance of family-based business groups in the Philippine corporate sector is immediately evident in the 50 largest corporate entities. the two were closely related through their affiliations to business groups. Significantly. for each of these groups. including business groups and independent companies. and for the Henry Sy group. It is also noteworthy that.000. and Ayala. the top 10 family-based business groups had only 119 companies in the top 1.8 percent). Cojuangco. For the Ayala group.6 percent of the total sales of the top 1. and more than 20 percent for the Lopez group and Henry Sy group. the principal owner of SMC. 25 out of the 50 top corporate entities were familybased groups. The main constraint may be the availability of family members that could be drawn for top management positions. These corporate entities accounted for 53. Family-based business groups are most dominant in sectors such as manufacturing. Commercial banking contributed about 40 percent of group profits for the Ayala group and Gokongwei group.1 percent). a substantial proportion of group profits came from its financial subsidiaries. the study used the four largest business groups—Ayala. with 27 affiliated companies in the top 1. namely.000 companies. real estate. ranged according to their sales (Table 3.
3 2.5 6.8 84. 6.3 3. 16.5 44. 13. Real estate. 4. power. and tobacco Telecommunications Cement and construction materials Pharmaceutical and distribution 12. beverages.2 16.1 4. coconut oil.4 6.0 13.3 11.5 13.Table 3.11 Total and Per Company Sales. 9.4 10. agriculture. and mining Management.1 2.5 49.0 Average Sales Per Company (P billion) 6.5 17. 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.6 3. and personal care prods Shipping.7 98. 8.9 2. 10. telecom.4 .2 1. and dairy products Investments. Consunji 4 3 Food and dairy products Construction and mining 10. 15. beverages. Eduardo Cojuangco Lopez Family Group Ayala Corp.5 46. and tourism Credit card 18.6 7.0 26. construction.0 5. 17. food.3 15. Beverages. food. and Affiliated Bank of Selected Business Groups. Flagship Company. Sector Orientation. of Affiliated Companies Total Sales (P billion) 123.1 4.0 17. and car manufacturing Car manufacturing and real estate Food and telecommunications Department store and real estate Airlines. 5.5 2.5 26. 14.9 3. 11.5 47. 1997 Business Group 19 15 27 12 12 9 4 6 11 4 8 9 5 4 5 6 Major Sector Orientation Estimated No.4 48.6 2.6 3. real estate. and packaging Power distribution and mass communications Real estate. and food Food. 7. 2. 3.2 1.
2 6. Enrile/JAKA Group Jaime Gow Guoco Group Jose Go Jardine Davies Gerardo Lanuza Alfredo C.8 1. .7 0. 29.2 4.4 3. Cruz Jose Luis Santiago Keppel Group Robert John Sobrepeña/ Fil-Estate Group Total Real estate Sources: PSE Databank.7 1. 22.1 1. and real estate Retail merchandising Ceramics and real estate Department store and real estate Cement and sugar central Real estate and securities trading Bookstore.8 6.8 1.0 0. 20. 27. and various company annual reports.4 5. mining. 32.0 1. 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. SEC-BusinessWorld Annual Survey of Top 1. 24. 37. 33.3 7.5 2.8 Jollibee Foods Luis Lorenzo Family Group Alcantara Family Group Bienvenido Tantoco Elena Lim Andrew Gotianum Brimo Family Group Andrew Tan J. P.4 1.9 0. 4 238 1.3 2.9 1. 28.4 3. 38.6 5.1 805. 26. 30.7 0.000 Corporations (1997).6 Fast food Beverages and agro-industrial products distribution Cement and wood products Retail merchandising Electronic appliances Real estate Mining Real estate Telecommunication.1 2. 21.9 0. distribution.9 7.6 2. 36.9 1.0 5.1 1.9 1.2 1.0 2. Ramos Gaisano Family Group Felipe Yap Felipe F.1 0. 35.7 3. 34. 23.6 3.9 6.7 0.3 2. 25.7 4.6 0. 31.8 1.19.5 8. 39.
6. 19. 9. 2. 8. and Affiliated Bank of Selected Business Groups. 14. 5. Jollibee Foods Corporation Pepsi Cola Products Alsons Cement . 20. 12. 4. Long Distance Telephone Phinma Zuellig Pharmaceutical Metro Pacific William Gothong and Aboitiz Swift Foods/RFM House of Investment Anscor Equitable Card Network Inc. Inc. 18. 16. 17. 7. Eduardo Cojuangco Lopez Family Group Ayala Corp. 3. Sector Orientation. Flagship Company. 21. 15. 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.11 (continuation) Total and Per Company Sales. Uytengsu/General Milling Group David M. 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. 1. 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. Alaska Milk Corporation DM Consunji. 11. 13. 10.Table 3.
Ramos Gaisano Family Group Felipe Yap Felipe F. medium = P1. 22.East-West Bank International Exchange Bank Ecology Bank (Savings Bank) Dao Heng Bank Orient Bank International Exchange Bank International Exchange Bank Philbanking Corp. 28. 32. 24. Cruz & Co. Kepphil Shipyard Inc. 39. Inc. 35. . 26. 29.. 37. 33. P. small = less than P1. 25. Sources: PSE Databank. Keppel-Monte Bank Bienvenido Tantoco Elena Lim Andrew Gotianum Brimo Family Group Andrew Tan J. Refers to commercial banks.65 billion to P4. Enrile/JAKA Group Jaime Gow Guoco Group Jose Go Jardine Davies Gerardo Lanuza Alfredo C. SEC-BusinessWorld Annual Survey of Top 1. 27. unless otherwise indicated. 36. F. Fil-Estate Development Inc. 31. PT&T Corp. a b Size class is measured in terms of sales: Large = greater than P4. 38. and various company annual reports. 30. 34.48 billion. 23. 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.65 billion.000 Corporations (1997).48 billion.
5 44.6 26. construction.5 77. agriculture. telecommunication.5 46.2 Business Group Business Group Business Group Government. and mining Gold and other precious metal refining . and personal care products Shipping. Aboitiz Family Group Jose Concepcion/RFM Group Alfonso Yuchengco Philippine Associated Smelting and Refining Corp. coconut oil. 3. 1997 Sales (P billion) Control Structure Major Industrial Orientation 123. of the Phils.8 22.7 98.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 1.3 15. 18.1 17. mass communications. and real estate Banking. 14. 19. banking. Inc.2 16. and packaging Power distribution. 4. 10. 22. 11. Del Rosario/PHINMA Zuellig Group Toshiba Information Equipment (Phils. and dairy products Investments. and telecommunications Department store and banking Airlines. car manufacturing. and food Food.6 18. 7. beverages.0 37. food.0 24.).2 49.5 47. 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. food.1 60. 23. 5. 20. power. and car manufacturing Power Refined petroleum products Refined petroleum products Banking. 16. 17. beverages. Beverages.8 53. Petron Corporation Pilipinas Shell Petroleum Corporation George Ty John Gokongwei Henry Sy Lucio Tan Ramon Cojuangco Family Group Caltex (Philippines) Inc. 8.8 84. 9. 24.). 6. Fujitsu Computer Products Corp. First Pacific/Metro Pacific Group 21.5 26.12 Control Structure of the Top 50 Corporate Entities.Table 3. 2. food. Philippine National Bank Mercury Drug Corp.5 15. Eduardo Cojuangco Lopez Family Group Ayala Corporation Group National Power Corp.0 38.4 48.4 19. and bank Real estate. bank. 12. Inc. Texas Instruments (Phils.5 17. 13. 15.
.1 9. PSE Databank. 40. 50. and various company annual reports.A. 42.8 6.9 7.9 6. 39. Amusement and Gaming Corporation Mitsubishi Motors Phils. including biological products Bank Cement and wood products Retail merchandising Electronic appliances Mining Real estate Sources: SEC-BusinessWorld Annual Survey of Top 1.5 10. National Steel Corporation National Food Authority Phil.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. 36. 31. Philip Morris Philippines.4 8.3 8.8 9.8 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. 26. 14. 47. real estate..000 Corporations (1997). 30. EAC Distributors Inc. corn (unmilled). 46. and apparatus for line telephony and line telegraphy Tobacco products wholesaling Cigarettes Radar equipment. radio and remote control apparatus Fast food Bank Beverages and distribution of agro-industrial products Drugs and medicines.4 10.0 12. W. 43. 49.2 7. Consunji Uniden Philippines Laguna. 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 1.000 Companies Sales (%) Cigarettes Bank Soap and detergents Management.5 8. Inc.290 53.3 13.0 5. 41. 9. and other grains wholesaling Other amusement and recreational activities Motor vehicles Food and dairy products Construction and mining Television and radio transmitters. 32. 48. 34. Philips Semiconductors Phils.7 10. 27.5 8.6 1.9 14.0 13.6 9.0 11. Corp. 37. and tourism Banking Radar equipment and radio remote control apparatus Operation of rolling mills Palay. 28. Uytengsu/General Milling Group David M. Inc. Inc. 29.25. Jollibee Foods Citibank N.7 10. 45.6 12. 44. 33. 35.7 13.9 7.
appointment and compensation of senior executives. to the corporation and its shareholders for damages caused if they agree to unlawful corporate acts. The Corporation Code holds members of the board of directors liable. investments of corporate funds in other companies or purposes. business groups had only minority ownership. A total of 44 companies responded to the survey (out of about 221 financial and nonfinancial listed companies).2 Corporate Management and Shareholder Control The main mechanisms by which shareholders control corporate management are the board of directors. This section reviews practices of corporate management and shareholder control in Philippine publicly listed companies. and declaration of cash dividends. However. The review is based on an ADB survey of listed companies in the Philippines conducted in 1999 for this study. accounting and auditing. 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. II publicly listed commercial banks affiliated to these groups.3. such as amendments of the articles of incorporation. issuance of stocks. Actual control of the banks was still held by the groups. determination of compensation to board members. The Philippine Corporation Code mandates the board of directors to exercise its control over a corporation. Shareholders limit the broad power of the board by ratifying their decisions on critical corporate affairs. and financial disclosure. these were dispersed shareholdings. the board of directors plays a crucial role in corporate governance. voluntary dissolution. shareholder voting in general meetings and legal protection of their rights. corporate mergers or consolidations. 3. approval of management contracts. 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. removal of directors. issuance of corporate bonds.186 Corporate Governance and Finance in East Asia. They are likewise liable if they pursue financial interests that conflict with their duty as directors.8 The Board of Directors As the representative of shareholders in a company. amendments in the bylaws. . Of course. although public investors held a majority of shares. sale or disposition of a substantial portion of corporate assets. jointly and individually. Vol.
the average number of years of holding office was 6. According to the ADB survey. with a maximum of 36 percent. Board chairpersons in a substantial number of responding companies did not own significant amounts of shares in their personal capacities.7 percent). More than half of respondents indicated that board directors were elected during the shareholder general meetings. Such a short tenure may to some extent suggest that large shareholders want to keep their board members under close control. Respondents of the ADB survey ranked the following as the most important responsibilities of the board: making strategic decisions. 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. In a few cases. . In practice. a fixed fee plus performance-related bonuses (30 percent). or representatives of creditors. appointing senior management. appointed by the Government. ensuring that a company follows legal and regulatory requirements. or a per diem for meetings (18 percent). The ADB survey shows that the number of board directors ranged from six to nine among the responding companies. and determining remuneration for board directors and senior management. board directors were the founder of a company. Making day-to-day management decisions was not regarded as an important board responsibility. in a descending order. Financial compensation is another means by which shareholders can motivate boards and board members to manage companies in their interests.6 for board chairpersons and 7. 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. a typical chairperson owned 3 to 5 percent of outstanding shares of a company on average. But professional expertise is also an important criterion (28. The ADB survey results show that a chairperson is compensated either by a fixed fee (52 percent of respondents). The average stipulated term of office of the chairperson and members of the board for most responding companies was one year.9 percent). or the Government without approval by shareholder general meetings. The majority of respondents indicated that board directors and chairpersons were elected mainly on the basis of either relationship with major shareholders (31.7 percent).5 for board members. protecting shareholder interests. But half of respondents indicated that they also had board directors directly nominated by controlling shareholders or management. or percentages of shareholdings (28.
The nomination committee searches and reviews candidates for key management positions. Unlike in Western corporate models. and reviews the findings of external audits. The audit committee selects external auditors. In the ADB survey. or amount of shareholding (15 percent). These committees were established only recently. But the independence of these outside directors is often doubtful. A CEO that was not the chairperson of the board was selected on the basis of professional expertise (42 percent of respondents). the CEO 9 The three most common board subcommittees are the compensation. and nomination committees. The ADB survey shows that in 41 percent of the responding companies. relationship with controlling shareholders (35 percent).9 In practice. 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. About half of the active committees were audit committees and the other half nomination committees. It is also not clear whether the outside directors were elected before or after the financial crisis. Senior Executives The Corporation Code does not specify the role and responsibilities of senior executives. This suggests that large shareholders control CEOs by means other than shareholdings. namely. or management (15 percent). the chairperson of the board was also the chief executive officer (CEO). In some companies. II Compensation for the chairperson was determined either by the board (54 percent of respondents). When the CEO was not the chairperson. however. . The compensation committee reviews and recommends remuneration plans of key officers and employee stock option plans. audit. Companies may set up special board committees to strengthen due diligence procedures. There was no case found in the ADB survey where a minority shareholder invoked such a provision of the Corporation Code. large shareholder-dominated companies often view such committees as unnecessary formalities. Vol. The Corporation Code prohibits the removal of any director without cause if that act would deprive minority shareholders of representation in the board.188 Corporate Governance and Finance in East Asia. the parent company or company bylaws (21 percent). by tenure and compensation. Ninetythree percent of the respondents had one or more outside directors. CEOs apparently cannot increase their shareholdings because family-based owners restrict the number of shares available to management. negotiates the audit fees and scope of audits. only 35 percent of responding companies have set up board committees.
Chapter 3: Philippines 189 was not related to the chairperson by blood or marriage in all of the cases except one. A substantial number of respondents also considered looking after interests of other stakeholders and the general public as among the important responsibilities of the CEO. (ii) disposes of or mortgages a substantial portion or all of corporate properties and assets. 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. Companies are not allowed to issue shares with different voting rights. Among others. equal to three years’ pay. About 60 percent of respondents of the ADB survey considered maximizing shareholder values as the CEO’s most important responsibility. (ii) contracts with companies linked through interlocking directorship. Only one respondent indicated that its CEO was entitled to a substantial amount of compensation. and prohibits the removal. the Corporation Code allows cumulative voting for directors. The average service length of CEOs was 5. The majority of responding companies compensated their CEOs by using a fixed salary plus a performance-related bonus. including electronic means. to help ensure the representation of minority interests in the board. shareholders have preemptive rights to maintain their proportionate ownership of a company under any financing plan that may be undertaken by the company. Fifth. shareholders enjoy a number of rights and protection. 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. and (iii) involvement of directors in businesses that compete with the company. i. 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. Second. of directors representing minority shareholders. Shareholder Rights and Protection Under the Corporation Code. .. or (iv) enters into a merger or consolidation with another corporate entity. Fourth. But about 27 percent viewed it to be ensuring steady growth of the company. first. shareholders may exercise appraisal rights.e.2 years. The longest service rendered was 27 years. if the CEO’s contract was preterminated. Third. without cause. They can vote through proxy. The “golden parachute” was apparently not a common feature of CEOs’ compensation packages. (iii) invests in another company for a purpose different from that of the corporation.
But an action by the regular court on a petition by the company’s owners/officers prevented SEC from pursuing the investigation. because of the dominance of large controlling shareholders. 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. SEC proceedings were costly and time-consuming. In practice. that of Interport Resources Corporation. there were often no real discussions of board proposals or actions. in the Philippines. In the case of preemptive rights. There was only one case. II shareholders are allowed to inspect a company’s stock and transfer books. Regardless of the amount of shares held. a shareholder could file a derivative suit against a director to redress a wrongdoing. Few minority shareholders actually exercised their appraisal rights. the Revised Securities Act has strict provisions designed to deter insider trading. The company was dissolved before indictment. there are no requirements for disclosing such transactions to shareholders under the Corporation Code. it is doubtful whether this legal protection for shareholders will achieve what it intends to in practice. Dissenting minority shareholders did not necessarily have recourse to a third party for an objective appraisal of their shares. An effective market for corporate control may provide some protection for minority shareholders against the expropriation of their interests by the incumbent management. because of poor compliance and enforcement as well as some loopholes in corporate laws. in cases of corporate takeovers.190 Corporate Governance and Finance in East Asia. In cases of derivative suits against directors for wrongdoings or actions against insider trading. hostile takeovers are not common because in most companies ownership is concentrated . Although transactions involving potential conflict of interest need to be reviewed and approved by the board. In the past. minority shareholders were often vulnerable to the expropriation of their interests by controlling shareholders and management. During annual general meetings where minority shareholders could exercise their rights. Consequently. no one has been successfully prosecuted for insider trading. Those who did were usually offered below-market values for their shares. the Corporation Code allows a company to waive this in the article of incorporation upon registration or in a subsequent amendment. where SEC made substantial progress in investigation. Being appointees of controlling shareholders. However. Vol. There was little chance that a proposal from minority shareholders could ever get approved. board members are likely to be under pressure to approve transactions that benefit controlling shareholders to the detriment of minority shareholders. Last. Sixth.
protection.8 30. followed by management and banks.2 69. Table 3.Chapter 3: Philippines 191 in a few controlling shareholders and families.900 shareholders per company did not vote during the last annual general meeting. a company that is widely held but has a large shareholder.0 51. 1999.3 56. Nevertheless. Yes 100.6 Independence of Auditing The ADB survey revealed that all the responding companies had an independent auditor.0 48. Nominees held about 45 percent of the outstanding shares.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. The responding companies had on average 43.13 summarizes rights that the shareholders of the responding companies enjoyed. An average of about 4.4 No 0. An average of 327 shareholders per company attended the last annual meeting and they represented about 63 percent of total shares.7 43.2 43. representing 3.6 30.8 92. The brokers or securities companies were the most important proxy voters. representing about 24 percent of outstanding shares.4 70.2 7.0 63. and their activism in the corporate sector.0 36. demonstrates the feasibility of developing a market for corporate control if publicly listed companies were widely held.8 56. appointed either by the board or shareholders during the annual general meetings.522 shareholders each.4 percent of shareholders but 58 percent of outstanding shares. Table 3. About 333 shareholders per company voted by proxy. The ADB survey provides further evidence on shareholder rights. About 93 percent of the respondents contracted . the successful hostile takeover by First Pacific Group of PLDT.
From publicly listed companies. On average. long-term leases. intra-company receivables and payables. Nevertheless. investments in subsidiaries. financial reporting standards allow room for interpretation by independent auditors. intangible assets. a bankruptcy case) or hid a large amount of liabilities and losses (PLDT. and consolidation policy. a preferred independent auditing firm either reported assets that did not exist (Victorias Milling Corp. Vol. In two celebrated cases. The Code grants a shareholder the right to inspect business records and minutes of board meetings. as practiced in the Philippines). revaluation of fixed assets. SEC requires all registered companies to periodically submit reports for the purpose of updating their respective registration statements filed at the agency. with the longest being 50 years. namely. vary in their evaluation of some major accounts such as securities and other liquid assets. independent audits do not guarantee the absence of questionable accounting practices. foreign currency-denominated liabilities. The accounting profession in the Philippines is considered fairly developed and Manila is a known regional center for accounting expertise. 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. a management discussion of the business. there are many cases of poor financial reporting by large companies. These different versions of GAAP. the local standard (i. In practice. . An auditor can choose among three alternative sets of GAAP. Because of such long relationships. and an analysis of financial statements. the international accounting standard.e.. a hostile takeover case). II their annual audit to an international auditing firm. More than 20 percent of the respondents have been dealing with their auditors for 20 years or more. or the accounting standard of a specific developed country (for example. the agency also requires reports on important details about their operations and management. the US GAAP). although closely related. independent auditors are likely to be quite familiar with the operations and financial aspects of their clients. imposing penalties on violators. Most major international auditing firms operate in the Philippines. the information statement transmitted to every shareholder should contain the audited financial statements.192 Corporate Governance and Finance in East Asia. Meanwhile. Nevertheless. the responding companies have been associated with their present auditors for 13 years..
they also make it easier for controlling shareholders to expropriate interests of minority shareholders. and financing. When control rights exceed cash flow rights.g. and publicly listed.Chapter 3: Philippines 193 Many small. arguably. because of the highly concentrated ownership of Philippine corporations. They allow risk pooling and can achieve economies of scale in management. Even for widely held public companies. Corporate Control by Controlling Shareholders As in many other Asian countries. accounting for 27 percent of the total stock market capitalization that year. namely SEC and the Philippine Institute of Certified Public Accountants (PICPA). which are usually controlled by holding companies. Laws of many Southeast Asian countries allow the establishment of pure holding companies (with the exception of Korea up to 1999). Publicly available financial information was often of low quality. sometimes did not penalize independent auditors for poorly prepared audited financial statements. Controlling shareholders usually select member companies that require large . Such expropriation is due to gaps between control rights and cash flow rights that pyramiding structures of business groups centered on holding companies create. which are controlled by large shareholders with public investors in a minority position. 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. as large shareholders had no need for financial statements to monitor their companies and management that were under their own control. Family-based controlling shareholders use them as vehicles for controlling business groups. e. Pure holding companies can be privately owned.and medium-sized businesses did not have quality financial statements. However. The popularity of holding companies in the Philippine corporate sector is evident: with a market capitalization of P258. which are closely held by large shareholders and family members. they formed the largest group of corporate entities in the Philippine stock market in 1997. marketing. controlling shareholders in the Philippines usually exercise their corporate control through the setting up of business groups. the authorities. from a minority-controlled to a majority-owned subsidiary.. “Selective public listing” is a strategy of many business groups for channeling funds from public investors to member companies. Holding companies enable controlling shareholders to collectively own shares of other companies in a business group and to centralize the group’s management.6 billion.
of Cebu Holdings (a publicly listed government-owned company). with 59 percent of shares.and minority-controlled operating companies are also holding companies. They may have a representative in the board.1). These investments can be classified according to the role of the controlling shareholders in the management of the invested company. Inc. controlling shareholders of the parent company may eventually increase their shares to a majority position. Selective public listing combined with use of pure holding companies to own and control member companies lead to various organizational structures of business groups. Ayala Corporation is a publicly listed pure holding company.1 percent of Ayala Land. financing.4 percent of Bank of the Philippine Islands. . controlling shareholders of a parent company hold these shares as “strategic investments” that they could increase or reduce depending on business opportunities. 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. In an active minority-owned operating company. Ayala Corporation. The stylized features of control structure of business groups in the Philippines can be illustrated by using a leading Philippine family-based conglomerate. is privately owned. This is most evident when a minority-owned company transacts with other members of the group where the controlling shareholders hold majority control. controlling shareholders of the parent company do not participate in management. at 47. as an example (Figure 3. Some holding companies are not pure holding companies. Public investors collectively hold a minority of 41 percent. Controlling shareholders gain additional leverage in management control over minority-owed companies. II equity investment for public listing. In cases of minority ownership. minority control at 42. an active minority share at 44. 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. It is majority-owned by Mermac.194 Corporate Governance and Finance in East Asia. Honda Cars (Philippines). the parent company plays an active role in management. Ayala Corporation’s majority.. The first three companies are publicly listed while the fourth. and customers.6 percent of Globe Telecom. Depending on the performance of the company. and a passive minority investment at 15 percent in Honda Cars (Philippines). Ayala Land fully owns Makati Development Corporation and holds a minority stake. Vol. It has a majority control at 71. Minority-owned companies may also need access to resources of the group. namely. especially its management.2 percent. a family-owned pure holding company. In a passive minority-owned operating company.
04%) <50% Ayala Corporation >50% Publicly Listed Pure Holding Company >50% MajorityControlled Operating and Holding Company Ayala Land (71.96%) Privately-Held Pure Holding Company Public Investors (41. . Inc.44%) >50% MajorityControlled Pure Operating Company Makati Development Corporation (100%) <50% MinorityControlled Pure Operating Company Cebu Holdings..06%) <50% >15% &<50% Active MinorityOwned Pure Operating Company Globe Telecoms (44. (58.Figure 3.1 Corporate Control Structure: The Case of Ayala Corporation Family Members 100% Mermac.2%) >50% MajorityControlled Pure Operating Company BPI Family Savings Bank (100%) <50% MinorityControlled Pure Operating Company Note: Data as of 31 December 1998. Inc.6%) <15% Passive MinorityOwned Pure Operating Company Honda Cars Phils. (15%) MinorityControlled Operating and Holding Company Bank of the Philippine Islands (42. (47. Inc.
Generally. First Philippine Holdings Corporation.7 times Ibid. Diversification and Efficiency of Investment by East Asian Corporations. and 1999c.8%] 5. and Larry H. however. Expropriation of Minority Shareholders: Evidence from East Asia.14%] / [1.44%] / [25%] = 1.12 These examples show that even when large shareholder groups are minority shareholders. and Larry H.5%] [39. [control right] [control rights via Ayala Corporation] = [cash flow right] [cash flow rights via Ayala Corporation] = [42. Who Owns and Controls East Asian Corporations? 11 Ibid. Joseph P. is illustrated in the Lopez Group (Figure 3.44%] = [42.64% +37. II Bank of the Philippine Islands owns 100 percent of the BPI-Family Savings Bank.98% x 42. indirect shareholdings do not appear to be a prevalent practice in the Philippine corporate sector. H.3% x 1. see the World Bank research papers by Stijn Claessens.7 times 12 .11 The Lopez family’s control rights over MERALCO was 5.44%] / [58. and First Philippine Industrial Corporation are indirectly held by a majoritycontrolled holding company.64%) + (37.14%] / [6. 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.5% x 14. P.7 times its cash flow rights by virtue of the double layer pyramid structure of the Ayala group. defined as control by large shareholders of an operating company through minority ownership by several companies. Lang. [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. Lang: 1999a. Simeon Djankov. The situation offers large shareholders tremendous incentive to move resources 10 For details. companies in the Lopez Group are large and minority-controlled. Simeon Djankov. P. 1999b. Fan.2).76%)] [39. Vol. Being in the public utilities sector.196 Corporate Governance and Finance in East Asia.10 The Ayala family’s control rights over BPI was 1. and a minority-controlled holding company. Benpres Holdings. See also Stijn Claessens.3% x 5.7 times its cash flow rights by virtue of its cross-holdings via Benpres and First Holdings. a privately owned company. The Separation of Ownership and Control in East Asian Corporations. they exercise far greater control (two to five times more) than they are entitled to by virtue of their ownership rights.5%] / [(88. Rockwell Land. MERALCO. The control of companies through indirect corporate shareholdings. 1998.
Inc.7% 62. .Figure 3.76% Operating Company MinorityControlled 24. Privately-Held Pure Holding Company 88.5% First Philippine Industrial Corporation 50% 50% Note: Data as of 31 December 1998.5% Minority-Controlled Publicly Listed Pure Holding Company First Philippine Holdings Corporation Benpres Holding Corporation Majority-Controlled Publicly Listed Pure Holding Company Manila Electric Company 1.2 Corporate Control Structure: The Case of Lopez Group Public Investors Family Members Lopez.5% Operating Company MajorityControlled Operating Company Rockwell Land Corporation 24.3% 11.64% MinorityControlled 14.
Vol. Suspension of Payments of Debts Under PD 902-A. 3. Most responding companies had dealt with their commercial bank creditors for more than five years and nonbank creditors for only about two years.3. Control by Creditors According to the ADB survey. However. Some 85 percent of respondents believed that creditors had no influence or only weak influence on corporate management. 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. accessed nonbank creditors for specific purposes but dealt with commercial banks on a long-term basis. Sixty-one percent of respondents indicated that creditors usually asked for collateral for all types of loans. 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. II from their subsidiaries to their majority-owned publicly listed holding company or elsewhere up the pyramid. a publicly listed company dealt with an average of eight banks and six nonbank financial institutions. and (ii) how the legal framework protects creditor interests and rights.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. The average company. it was not common for creditors to take legal action against debtors or foreclose on those assets held as collateral in cases of default. whether for working capital or capital expenditure. SEC could suspend the rights of a creditor to demand payment from a borrower in accordance with the terms of the loan . while 80 percent reported that creditors with which they had renegotiated loans were still willing to lend to them.198 Corporate Governance and Finance in East Asia. Most respondents (81 percent) indicated that they had renegotiated with their creditors on loan repayment when they faced liquidity problems. The controlling shareholders could also use the resources of minority-owned subsidiaries to engage in overexpansion and empire building investments.
The second mode is for suspension of payments with the appointment of a management committee (Mancom) or rehabilitation receiver. The borrower will propose a rehabilitation plan to SEC. For example. Inc. the litigation process.4 3. Publicly listed companies do not represent a cross section of the Philippine corporate . a real estate-based business group. it is not clear whether the corporate borrower’s assets are of sufficient value to cover its liabilities. 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. There are two modes of suspension of payments under PD 902A. including the rehabilitation of the corporation. could take an indefinite period. a company’s assets are of sufficient value to cover all of its debts. The corporation continued to be under rehabilitation receivership as of June 1999. In practice. PD 902-A granted SEC blanket powers to intervene and adjudicate claims. 3. The first mode is for simple suspension of payments. Markets for equity and debt instruments are small and there are serious structural problems that discourage large. The law on suspension of payments envisions resetting the corporation’s business for a temporary period to prevent its irreversible collapse. wait for 14 years from the time the company petitioned for suspension of payments in 1984. the borrower requests to defer payments for a certain period to enable it to generate the necessary liquidity.1 Corporate Financing The Financial Market and Instruments The Philippine financial market has remained underdeveloped compared with other countries in the region. which determines the viability of the rehabilitation plan and appoints a Mancom or a rehabilitation receiver to implement the proposal if approved. profitable companies from going public. Consequently. This explains why creditors invariably oppose any move by borrowers to file for suspension of payments at SEC. There are no legal or practical limits to the time period of suspension of payments..Chapter 3: Philippines 199 agreement. SEC could intervene to avoid asset dissipation. bank credit is the main source of corporate financing. Under this mode. Commercial banks hold about three fourths of the resources of the financial system. under which. Under such circumstances.4. SEC and the court required that the creditors of BF Homes.
Malaysia. The crisis affected the Philippine corporate sector. preferred stocks. less exposed to foreign debt. The stock market was depressed up to the early 1990s. compared with Malaysia ($186 billion). The period 1993-1997 was one of lower inflation and declining lending rates. however.200 Corporate Governance and Finance in East Asia. and Indonesia ($61. Vol. Of the 221 companies listed in the Philippine Stock Exchange in 1997. Foreign funds were wary of the Philippine stock market because of its limited liquidity. Foreign portfolio investments also remained small. was one of the smallest in the region at $47. Philippine companies were less leveraged. Even in the real estate sector. Equity instruments include common stocks. and fiscal management were among interrelated factors explaining the underdeveloped state of the Philippine financial market. The Government financed its chronic fiscal deficits by issuing short-term Treasury bills. They invested in only a few large companies whose shares were relatively liquid. inflation. compared with other economies. the country experienced double-digit inflation. and less engaged in risky investments. Rising stock prices during the Ramos administration reflected to some extent the business optimism. companies expanded only at a moderate pace. In part.g.14 shows that the average volume of daily trading in 1997 stood at P2. while interest rates were at high levels and volatile. From the 1970s up to the early 1990s. II sector. this is because. 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.. about the size of Thailand’s. Table 3. However. but not to the same extent as it did in other Asian economies. The market capitalization of the Philippine stock market in August 1997. the minimum required to qualify as a public corporation. As a result.000 companies. most listed companies are controlled by their five largest shareholders. the Republic of Korea (henceforth.5 billion). is far ahead of the flock. Most companies invested only in projects that met hurdle rates as high as 20 to 30 percent and had short payback periods.4 billion (or $59 million using the average exchange rate). 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. Korea and Thailand). only 84 had sales large enough to be placed in the top 1. and convertible securities. Interest rates. especially short-term debt. Equity financing through IPOs was active. The corporate sector raised a substantial amount of . Most publicly listed companies issue only up to 20 percent of total shares to the public. Korea) ($143 billion).7 billion. The Philippine stock market is not a liquid market.
545.Table 3.9 1.2 1.1 0.2 0.0 0.5 16.2 61.077.1 0.7 0.3 314.9 608.2 925.5 1.0 161.9 2.8 102.1 0.2 297.7 2.686.9 114.7 207.121.0 1.2 3.171.8 1.7 391.5 26.421.3 158.2 0.8 1.088.2 1. Note: Combined transactions of Makati and Manila Stock Exchanges are not available for the years 1983 to 1986.373.8 799.8 0.8 1.251.1 0.6 261.3 0.4 9.2 59.4 Ratio of Market Capitalization to GDP 0.692.3 Market Capitalization (year end.5 1.6 1.515.1 88.2 ($ million) — — — — 6.9 682.9 2.3 4.5 12.6 1. 1983-1997 Daily Trading Volume (P million) — — — — 129. Source: PSE databank.3 0.1 5.7 1.0 0.5 72.0 0. P billion) Gross Domestic Product (current prices.248.1 524.3 2.9 12.3 — = not available.445.0 2.386.7 41.14 Philippine Stock Market Performance.3 59.4 728.474. .4 1. P billion) 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 19.5 571.906.2 57.5 Year 369.351.
and debt as sources of corporate financing by using flow of funds analysis. about 127 companies went public with a total value of offerings of about P134. However. 3. and inventory financing. and high transaction costs. which were the principal source of corporate financing in the Philippines. Capital markets cannot provide the market discipline that corporate investors need. II equity capital through IPOs during the stock market boom from 1993 to the first half of 1997. Negotiated credits. leases.202 Corporate Governance and Finance in East Asia. issuing companies had to undergo a process of review and credit rating by the Credit Information Bureau Inc.6 billion. The corporate bond market was stunted. lack of competition among financial institutions. This is because only companies with strong capitalization and predictable cash flows such as public utility companies can issue bonds. new equity. are in a position to provide such discipline. The picture of the financial system that emerges is thus one of limited capital markets. corporate bond issuing was even more limited. by volatile interest rates and the absence of a secondary market. include bank credits. Corporate bonds are another type of debt securities. Debt instruments include negotiated credits and debt securities. which in most cases is an affiliate of the issuing company. Vol. moreover. asset-backed credits. Only a few large companies floated commercial papers because of the limited market. sells these commercial papers through brokers. However. From 1988 to 1997. The underwriter. which ultimately influences the pricing of commercial paper issues.4. Because existing shareholders wanted to retain their proportionate control over their companies. Under SEC regulations. of which 85 percent was raised from 1993 to the first half of 1997. Debt securities include commercial papers and corporate bonds. The largest buyers have been commercial banks. tight regulations.. because business groups often own large commercial banks. the rights issue was a popular way of raising equity capital. by virtue of their large stakes in the financial system. which buy commercial papers either for their own account or for their clients.2 Patterns of Corporate Financing The study looked at retained earnings. discounting of receivables. Only the commercial banks. The measures used in the analysis are: . Few companies offer preferred stocks because the Philippine tax system does not allow tax deductibility of dividends on preferred stocks. a strong regulatory system for bank supervision is imperative. and the dominance of large commercial banks.
2 0.000 Corporations in the Philippines.3 0.9 0.15 Financing Patterns of the Corporate Sector.5 0. 1989-1997 Financing Indicators SFRF SFRT NEFR IDFR IEFR 1989 1990 1991 1992 1993 1994 1995 1996 1997 1.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.1 Average 1.4 0.5 0.0 0.5 Source: SEC-BusinessWorld Annual Survey of Top 1.4 0.1 0. 1988-1997.3 0. Incremental debt financing ratio (IDFR): ratio of changes in total liabilities to changes in total assets.2 0.8 0.3 0.4 0. during this period.5 0.4 0.0 0.2 0.3 0.1 0.5 0. New equity financing ratio (NEFR): ratio of changes in stockholders’ equity (excluding retained earnings) to changes in total assets.1 0. the average SFRF was high at 109 percent.5 0. On the other hand.3 0.5 2.8 0. .8 0.6 0.2 0. Self-financing ratio of total assets (SFRT): ratio of changes in retained earnings to changes in total assets. It measures a company’s reliance on borrowings in financing asset growth. Incremental equity financing ratio (IEFR): ratio of changes in shareholders’ equity inclusive of retained earnings to changes in total assets.6 0.5 0. It measures a company’s capacity to finance growth in fixed assets by internally generated funds.9 0. Retained earnings were sufficient to finance the entire growth of fixed assets in the corporate sector.3 0. As shown in Table 3.4 0.7 0.3 0.9 0. It measures a company’s capacity to finance asset growth by equity capital.15.5 0. it is one minus IDFR.4 1.5 0. By definition.9 0.1 0.000 Corporations in the Philippines from 1988 to 1997. It measures a company’s capacity to finance asset growth by internally generated funds.6 0.2 0.1 0.4 0.5 0.4 0. the SFRT was low at Table 3. All Companies Financial flows data were derived from the SEC-BusinessWorld Annual Survey of Top 1.
when it financed 45 percent of it. As a result. for all three types of companies—publicly listed.3 0. 1991. and 1997. The corporate sector consistently relied on debt and new equity to finance asset growth throughout the period. privately. .5 Privately-Owned 0. It can also be observed that the relative importance of stockholders’ equity (including retained earnings and new equity investment) was declining and that of debts increasing in financing the growth of the corporate sector from 1991 to 1997.3 0. Vol.2 0.9 0. except in 1991. Corporate Financing by Ownership Type As shown in Table 3. This was mainly caused by the declining contribution from retained earnings.6 0. Retained earnings were the least important. Total assets grew by 23 percent that year. debts were the most important source of financing.2 (0. There were significant year-to-year variations.0) 0. On Table 3. reflecting the capital flight caused by political instability in the early 1990s. retained earnings declined and few new equity investments flowed into the corporate sector.16. internal funds were not a significant source of financing growth in total assets. In all the years.and foreign-owned.3 0. Source: SEC-BusinessWorld Annual Survey of Top 1.1 a Excludes negative balances. In 1997. The corporate sector used new equity to finance 32 percent and new debts to finance 49 percent of growth in total assets.204 Corporate Governance and Finance in East Asia.8 0.16 Corporate Financing Patterns by Ownership Type. implying that internal funds were far from sufficient to finance growth in total assets. 1988-1997. II only 19 percent. suggesting that there was a deterioration of financial performance in the Philippine corporate sector in the years running up to the crisis. the SFRF was higher. the level of corporate leverage increased.000 Corporations in the Philippines.5 Foreign-Owned 1. with debt providing 93 percent of the financing requirements. 1989-1997 Financing Indicators SFRF SFRTa NEFR IDFRa IEFRa a Publicly Listed 1. except for foreignowned companies that had a negative new equity financing ratio.7 0. In periods of an economic crunch such as in 1989.3 0.5 0. Companies financed fixed assets from internal sources in hard times.
9 16.5 41. 1988-1997.8 3.0 Source: SEC-BusinessWorld Annual Survey of Top 1.0 10.and foreign-owned companies.0 1993 14.7 2.3 48.8 46.6 37.8 38.8 4.8 51. 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 14.4 100.9 24.4 100.1 10. significantly Table 3. Foreign-owned companies relied more heavily on debt financing.0 1994 19.Chapter 3: Philippines 205 average.0 10.3 12.8 26.8 0.4 2.2 100.7 7.9 4.0 38.0 12.4 10.5 16.2 42.4 100.7 23.0 9.6 0.2 3.9 3.0 6.7 100.8 3. .3 13.1 49.4 43.0 9.1 15. contributing 90 percent of growth in total assets.5 27.9 16.3 12.5 12.3 12.2 51.4 12.8 17.3 11.1 13.0 1995 1996 13.0 9.2 12.5 0.4 41.6 26.1 7.3 51.2 3.000 Corporations in the Philippines. especially bank loans.7 13. It presents a composition analysis of assets and financing sources for the period 1992-1996.9 38.8 100.9 16.0 13.3 10.17. A breakdown of the financial structure of publicly listed companies measured in balance sheet items is shown in Table 3. publicly listed companies relied more on new equity financing than privately.2 100.3 4.4 2.8 0. The sector built up its short-term debts.6 48.8 39.5 9.9 0.9 12.7 13.0 9.4 100.1 9.6 48.8 16.9 100.4 3.6 43.7 4.1 50.3 10. This financing pattern supports the earlier finding that foreign-owned companies had the highest leverage among the three types of companies.0 53.17 Composition of Assets and Financing of the Publicly Listed Sector. compared with 47 percent for publicly listed companies and 55 percent for privately-held firms.0 100.7 2.0 8.
group companies usually financed their investment in member companies by equity rather than debt.45 in 1996. Vol. The SFRF for independent companies would have been even lower if the highly profitable foreign-owned companies were excluded. their inherent ability to pool risks.18. indicating that many publicly listed companies were likely to be in a tight liquidity position. Group companies financed an average of 45 percent of growth in total assets by debt. the easier access to external credit.13 was at 1. Table 3. 1988-1997. the current ratio.206 Corporate Governance and Finance in East Asia.3 0.9 0.000 Corporations in the Philippines. On average. for independent companies.5 0. The normal standard liquid position is a current ratio of 2 or higher. compared with an average of 54 percent for independent companies. As shown in Table 3. group companies were less reliant on debt financing than 13 Defined as total current assets divided by total current liabilities.1 0. the average SFRF of business groups was higher compared with that of independent companies. Group companies were generally more profitable than independent companies.3 0. and economies of scale in fund raising.5 Excludes negative balances Source: SEC-BusinessWorld Annual Survey of Top 1.3 0. respectively. .18 Financing Patterns by Control Structure. Further. Corporate Financing by Control Structure Conglomerates have certain advantages in financing because of the opportunities offered by the internal capital markets.5 0. For these two reasons. as opposed to 94 and 30 percent. II in 1996 and became more vulnerable to the financial crisis in 1997. The traditional measure of liquidity.2 0. 1989-1997 Financing Indicators SFRFa SFRTa NEFR IDFRa IEFRa a Group Member 1. 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.6 Independent Company 0.
76 for small companies and 0.08 and SFRT of 0. Excluding . Corporate Financing by Firm Size SFRF was highest for medium-sized companies.6 0.8 0. Large firms consistently increased their reliance on debts from 1994 to 1997.55 was substantially higher than the small companies’ 0. medium-sized companies used more debts.19 Financing Patterns by Firm Size.50 (Table 3.3 0. averaging 61 percent of growth in total assets. These years were 1991 with 110 percent. The medium-sized companies’ high debt financing ratio was due mainly to three years of complete reliance on debt to finance growth. The corresponding ratio was 0.06.9 0. 1988-1997. These results support the earlier finding that the leverage of business groups was lower than that of the independent companies from 1988 to 1997.20).5 Medium 3. and 1997 with 131 percent. 1989-1997 Financing Indicators SFRFa SFRTa NEFR IDFRa IEFRa a Large 0. On average.19).1 0. Large companies’ IDFR of 0.000 Corporations in the Philippines.3 0. With assets growing at a fast pace during this period. There was also increased reliance on debt financing. equity financed 42 percent of incremental asset growth.5 0.5 Excludes negative balances.3 0. with an average of 3.2 0. Corporate Financing by Industry The manufacturing sector had an average SFRF of 1.6 0.2 0. Source: SEC-BusinessWorld Annual Survey of Top 1.47.88 for large companies (Table 3. 1993 with 96 percent.2 0. compared with 55 percent for large companies and 47 percent for small ones. The lower SFRF for large companies may be caused by their larger outlays for growth in fixed assets. Table 3.Chapter 3: Philippines 207 independent companies.4 Small 0.
In the eight years preceding the crisis.58 and SFRT of 0. Since the real estate boom coincided with that of the stock market. Excluding 1997 when fixed assets declined.27. The sector had the highest leverage among all industries that year.3 0.1 0. debt financed about 78 percent of asset growth in real estate.2) 0. Equity financed the rapid expansion in the industry’s assets in the period 1994 to 1997.4 Construction 0. the incremental equity ratios of the industry were high. The situation improved beginning 1994. the manufacturing industry financed 57 percent of its total asset growth by debt.91.04. 1988-1997. II 1991. Up to 1997. Table 3.5 0.6 0. During the crisis year.4 0. The real estate industry financed its growth by substantial equity funds.29.000 Corporations in the Philippines. Vol. SFRF for the sector averaged 0.6 0.3 0. the industry generated internal funds.6 a Excludes negative balances. 1989-1997 Financing Indicators Manufacturing SFRFa SFRTa NEFR IDFRa IEFRa 1. While this level is considered prudent.4 3. achieving an average SFRF of 3.208 Corporate Governance and Finance in East Asia.4 0. The construction sector was a heavy user of debt financing. Source: SEC-BusinessWorld Annual Survey of Top 1.5 (0.3 0. Total liabilities increased partly as a result of the local currency devaluation and financed all of asset growth for the year. Its SFRF and SFRT were volatile because of chronic losses and reduction in fixed and total assets.32.47 two years later. . while SFRT averaged only 0.20 Financing Patterns by Industry. Low incomes diminished the equity financing position of the manufacturing industry toward the crisis year. ranging from 41 to 118 percent. with an SFRF as low as 0. many of the leading real estate companies successfully went public during that time.7 0.79 and in 1997 at 0.5 0.3 0. The utilities sector showed weaknesses in internal fund generation in 1989-1994. increasing to 0. when debts declined.6 0.5 Utilities and Real Estate Services and Property 0.4 0. The effects of the crisis of 1997 were adverse. the total debt ratio was much higher in 1996 at 0. Equity financed an average of 62 percent of total asset growth. Incremental equity financing amounted to an average of 44 percent of total asset growth.
creditors bear the consequences. ROE.00125 2. These results suggest that companies with higher ownership concentration tend to be more highly leveraged and.769 0. 1992-1996.130 ROA 0. and Performance Previous studies on corporate governance have often associated ownership concentration with heightened risk-taking by companies.00036 2. while if it fails. The Modern Industrial Revolution. ROE = return on equity. ROA. and the Failure of Internal Control Systems.3 Ownership Concentration. the degree of ownership concentration.004 3. measured by the percentage of shareholdings of the largest five shareholders. . Three regressions were run with the shareholding of the largest five shareholders as an independent variable and ROA.230 Leverage 0.4. Source: Author’s estimates based on the PSE databank. ROA = return on assets.00056 1. and Financial Leverage Dependent Variable Item Coefficient of Ownership Concentration T-statistics Adjusted R-squared F-statistics ROE 0. Table 3.14 Large shareholders may borrow excessively to undertake risky projects. Using the PSE database.008 5. Exit.287 0. knowing that if an investment turns out to be successful they could capture most of the gain. at the same time. as the dependent variable.009 5. and leverage.860 Leverage = the ratio of total assets to total equity.21.Chapter 3: Philippines 209 3. ROE. Financial Leverage. 14 See for example Michael Jensen (1993). and financial leverage are all positively and significantly related to the degree of ownership concentration. more profitable. Journal of Finance 48: 831-880. As shown in Table 3. alternatively. ownership concentration = the total shareholdings of the top five shareholders. the coefficient of the ownership concentration measure in all the three regressions is positive and statistically significant. Large shareholders may also overuse financial leverage to avoid diluting ownership and control. Profitability. was regressed against measures of profitability and of financial leverage.421 0.21 Ownership Concentration.
In 1997. and agriculture at 21 percent. 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.1 The Corporate Sector in the Financial Crisis The Financial Crisis: Causes and Manifestations A devaluation of the local currency signaled the arrival of the financial crisis in 1997. the growth in foreign investments fueled that of the manufacturing and services sectors in the years preceding the crisis. the country’s GDP growth pace indicated that it did not have a “bubble economy. Net trades in goods and services averaged a deficit of 4.5. Historically. After a . In sum.5 3. The largest contributors to GDP were services at 43 percent. The structure of the economy may be understood by looking at its sectoral composition and export competitiveness.5 billion in 1996 and grew at an average of 48 percent per annum from 1992 to 1996. with a narrow exporting industry base. more than half (52 percent) of exports were semiconductors. raw materials.5 percent per year from 1992 to 1997. II 3. but its share had been declining by 4 percent per year since 1995. Commercial and industrial activities in the country were largely oriented to domestic markets. foreign investments in the country have been low.8 percent of GDP from 1995 to 1997. the economy still showed vestiges of its import-dependent and substituting character. with commodities accounting for the balance. and intermediate goods. The Government explained that the country had “sound economic fundamentals” but that the problems were caused by “contagion. industry at 34 percent. Exports were growing at about 20 percent per year in the three years preceding the crisis. their growth gathering momentum only beginning in 1992. an overexpansion of capacities. the country was less dependent on foreign private capital. Because of limited local capital. notably remittances of overseas workers. Garments was the second largest export sector at about 9 percent. Vol.” The Government’s judgment that economic fundamentals were strong was based on stable growth rates. Manufactures accounted for about 85 percent of exports. Compared to other East Asian crisis-affected countries. About 80 percent of imports were capital goods (particularly power generating and telecommunications equipment).210 Corporate Governance and Finance in East Asia. Net investment inflows were $3. Although much lower than those of other Asian countries. which averaged 4.” that is. The export sector had a very narrow breadth. The country experienced balance of payments surpluses but these were due to transfers.
In the Philippines. 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 Government restructured its debts into longer tenors with a maximum of 25 years. resulting in stability in the short-term debt to reserves ratio. Five years of stable growth before the crisis enabled the country to build its net international reserves to $10. After hovering in the range of 100 to 127 percent. adjustments were focused on the quantity and quality of the banking system’s corporate loans. shows that investments of the corporate sector were growing at a faster rate than sales revenues in the years immediately preceding the crisis. however. Economic performance during 1992-1997 was characterized by an average growth rate of real gross national product (GNP) at 3. the ratio of short-term debts to international reserves dipped below 100 percent beginning June 1998. the country and the corporate sector had no access to foreign currency debts from the international financial market. assets grew at a compound annual rate of about 31 percent.6 billion as of March 1997. Total debts were only 52 percent of assets or 108 percent of equity. From 1993 to 1997. and a relatively healthy banking system. which. The corporate sector was in a relatively stable financial condition around the time of the crisis. a positive balance of payments from 1992 to 1996.8 percent. Prudent fiscal management and controls on foreign borrowings were part of the adjustments required by IMF and foreign creditors. while sales grew by only 20 percent per year. fueled also by successful IPOs during the stock market boom of 1993-1996. During this time. unlike their counterparts in the region. a government fiscal surplus from 1994 to 1997.5 percent. 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. Eventually.Chapter 3: Philippines 211 long period of debt moratorium and restructuring that started in 1983 and ended in 1991. Profitable operations since 1992 had allowed it to build equity. average ROE was 13. . the Government sought stability and achieved this in 19921997. Closer analysis. The lessons from debt restructuring became the basis for the Government’s economic policies.1 percent. Financial institutions called on their shortterm loans and shortened the maturity of existing loans. depended on the quality of the corporate sector’s investments. an average inflation rate of 7. an average Treasury bill rate of 13. The Central Bank conserved international reserves by allowing the local currency to float within a wider trading margin. Since the regional financial crisis was triggered by the loss of confidence in some East Asian economies by foreign creditors and investors. From 1988 to 1996. in turn.3 percent.
7 Note: Peso-dollar exchange rates used are: 1995 = 25.073 (406) 121.609 1. Most of this leverage happened during the boom years in the region. It rose to $2. the other immediate impact of the crisis was that on foreign investment flows. 1997 = 29.22). Net foreign investments more than doubled from 1995 to 1996 but declined by 78 percent in 1997 (Table 3.0 1998 739 555 328 69. 1998 = 41. It financed 26 percent of corporate capital growth.” 3.749 26.485 145.517 1.71. II The corporate sector indeed overexpanded after 1993 like its counterparts in the region.101 billion or 196 percent of net FDI in 1996.5. In sum. But portfolio investment amounting to $406 million flew out of the Philippines. precisely.06.074 2. mitigated the effects of the pullout and liquidation of investments in the aftermath. growing by about 34 percent per year from 1994 to 1997. .4 1997 762 1.101 92. 1996 = 26.718 30. Data for 1998 cover only January-August. or 114 percent of net foreign direct investment (FDI). It is understandable then that the effect of the Asian financial crisis on the Philippines was correspondingly that of a negative “contagion.212 Corporate Governance and Finance in East Asia.22.5 billion in 1995. but to a lesser degree.303 23. These patterns in investment and financing are similar to those of other countries in the region. 1995-1998 Item Net Foreign Investments ($ 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 debt level of the Philippine corporate sector in 1997 was low by Asian standards but still high by developed country standards. Sources: Bangko Sentral ng Pilipinas and SEC.2 Impact of the Crisis on the Corporate Sector Aside from the foreign exchange adjustment. net FDI remained stable at more than $1 billion.22 Foreign Investment Flows. Table 3. In 1997. Vol.0 1996 3. 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. Net foreign portfolio investment amounted to $1.650 32.300 1. Foreign investments in the Philippines have not been as high as the inflows to other Asian countries—and this. Debts financed a large part of this expansion.47.
2 percent in November 1997. Although corporate borrowers were not highly leveraged. Lending rates were well above the 20 percent level from July 1997 to March 1998. Bank spreads over Treasury bill rates increased in 1997 but were within the range experienced in the past.2 percent was barely above inflation rate. lending rates also came down. they were willing to restructure and renegotiate existing loans by corporate borrowers. which held about 75 percent of the assets of the financial system in 1997.3 percent of assets. albeit at current market interest rates.7 percent in January 1998. with commercial banks holding P2. The banking system was able to absorb the impact of the crisis primarily because of its strong capital position. and the wholesale and . in turn. Loan calls. ROE at 6. the commercial banking sector’s capital remained strong at 17. When the Treasury bill rates eased in March 1998. the sectors with the highest outstanding loans had reduced their credit exposures. Companies deferred investments in new fixed assets. The resources of the financial system that year totaled P3. Net profit margins were at a 10-year low at 4. meanwhile. the corporate sector became vulnerable to loan calls and high interest rates. The combined effects of shrinking demand and high interest rates reduced the corporate sector’s demand for loans.369 billion. and leverage increased to 149 percent compared with 109 percent in 1996.2 to 28. Bank loan pricing was based on the bellwether 91-day Treasury bill rates rather than inflation. new borrowings financed asset growth. depended on the liquidity and capital position of commercial banks. ranged from 11 to 13 percent from 1993 to July 1997. By March 1988. in varying degrees for each sector. Loans outstanding of commercial banks declined by the first quarter of 1998. Average bank lending rates climbed to their peak of 25. sparking a rise in interest rates on corporate loans.9 percent. they could not initiate a large reduction of their loans because these in part financed long-term growth in assets. A number of small banks closed but they represented less than 1 percent of the financial system’s total resources. The real problem of the corporate sector during the crisis was the rise in interest rates.Chapter 3: Philippines 213 Corporate financial performances and conditions deteriorated during 1997. Because of weak internal fund generation. By October 1998. suggesting that commercial banks required a higher premium at about the height of the crisis but not beyond. With the increase in borrowings and reduced liquidity. then rose to a high of 22. Because commercial banks were strongly capitalized.513 billion. Manufacturing reduced its loans outstanding by 11 percent from October 1997 levels. The interest rates on Treasury bills.
the fiscal position.214 Corporate Governance and Finance in East Asia. and subsequently went down to 13. thereby reducing overall intermediation costs. In March 1997.3 Responses to the Crisis Government Responses The Government’s policy and regulatory responses to the crisis focused on monetary and credit issues. set limits on overbought/oversold foreign exchange positions of banks. and the financial system. single-digit NPL ratios began only since 1989. However. 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. to reduce their lending spreads over the 91-day Treasury bill rates from 3-8 percent to 1. But the Philippine banking system had gone through worse crises in the past. was a problem sector. and its experience of low. through the Bankers’ Association of the Philippines.6 percent in June 1998. The pattern indicates that real estate loans were of substandard quality but banks had contained the problem by mid-1998. The Central Bank introduced regulations on foreign exchange trading to control speculation and nondeliverable forward contracts.5-6 percent. II retail trade sector. Still. and set up a hedging facility for borrowers with foreign currency-denominated loans. This allowed the Central Bank to convince the banks.3 percent in December 1997. The latter measure was especially beneficial to companies with unhedged foreign currency loans from commercial banks. by 12 percent. including (i) a regulatory limit of 20 percent on banks’ loans to the .9 percent of bank loan portfolios. real estate loans averaged 11. This “voluntary agreement” partly explains why the loan spreads of banks were within the range of recent experience. The Central Bank adopted other measures to strengthen the financial system. 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. These figures show that adjustment problems were industry-specific and that the real estate industry.5. The move retained the liquidity position of banks but lowered their cost of reserves. loans outstanding of the real estate sector increased by 11 percent from June 1997 to June 1998. 3. as with its counterparts in other Asian countries.5 percent by September 1998. As for nonperforming loans (NPLs). These peaked at 14. Vol. the ratio increased to a high of 11.
and (vi) issuing guidelines on duties and responsibilities of banks’ boards of directors for improved quality of bank management.Chapter 3: Philippines 215 real estate sector. Financially strong companies were able to survive the crisis by effecting such internal restructuring. (iii) fixing loan loss provisions of 2 percent of the gross amount of loan portfolio on top of individually rated bad loan accounts. was known to have a policy . Average Treasury bill rates have cooled since mid-1998. Takeovers in the past involved cooperative negotiations between purchasers of a target company and family-based large shareholders. (v) improving disclosure requirements on the financial position of banks. and giving up noncore businesses. Responses of the Corporate Sector The corporate sector’s financial position. subcontracting and outsourcing. which was privatized with the Lucio Tan group gaining control and the Government retaining minority ownership. changing technologies. Large companies with heavy loan exposures such as Philippine Airlines Inc. took more action.6 percent growth in 1999. The acquiring company. The real estate portfolio of commercial banks also declined and was well below the Central Bank’s regulatory ceiling by March 1998. (ii) shortening the period for classifying unpaid loans as past due from three months to one month. With prudent monetary management. consolidating business units. In the case of PLDT. the Government kept inflation below 10 percent. 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. First Pacific Corporation. The policy directions and actions taken by the Government appear to have ushered in recovery. PAL. In response to calls for lower bank intermediation costs. (iv) increasing banks’ capital requirement by 20 percent for universal banks (banks with expanded licenses) and 40 percent for ordinary commercial banks. and the legal framework for reorganization and liquidation conditioned its response to the crisis. With its weakened financial position. 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 economy avoided a recession in 1998 and achieved 3. the largest telecommunications setup in the Philippines. the Asian crisis opened a unique opportunity for foreign investors. its accessibility to foreign capital. bank loan rates have also come down. the country’s flag carrier. came up with a rehabilitation plan by May 1999 that was found acceptable to all parties. (PAL).
Conclusions. he restructured the company toward its core brewery business and sold off local and foreign subsidiaries. Corporate governance is conditioned by the high ownership concentration of these large companies. A third method was to make a formal tender offer to PLDT’s controlling minority shareholders. Ownership is highly concentrated and a few dominant players control major industries. Its stock price and returns to shareholders had stagnated.1 Summary. 3. Vol. concentrated ownership of companies is not equivalent to weakness in corporate governance. The question.6 3. controlling shareholders can capture these profits by excluding public investors from ownership. SMC had lagged behind other groups of companies such as Ayala Corporation in financial performance for some years. 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. and Recommendations Summary and Conclusions The Philippine corporate sector has been shaped by the country’s economic and industrial development policies. Although considered the prime industrial company in the Philippines. Consequently. When Cojuangco took over. One mode was the outright purchase of shares in the open market.216 Corporate Governance and Finance in East Asia.6. First Pacific could have acquired sufficient shares to take control of PLDT in three ways. eventually took over PLDT and announced a restructuring plan for the entire group of companies. 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. the Cojuangcos. using some or all of these means. is whether there are sufficient safeguards to prevent controlling shareholders from . the Soriano family. When companies are highly profitable. A second method was to purchase the shares of other large minority shareholders. however. First Pacific. the stock price of PLDT was buoyant during the takeover period. Eduardo Cojuangco was able to assert his ownership of shares taken over by the Government during the transition of power in 1986. at a premium over the market price to reflect the value of management control. SMC is another widely-held company managed by a minority shareholder. By itself. II of investing to control companies that are dominant players in their industries. In a legal process that ended in his takeover of management.
with the real estate and public utilities industries standing out for their pronounced cyclical patterns. foreign companies were the most profitable but highly leveraged. Corporate governance should be viewed in the context of an increasing presence and growth of large shareholders-centered conglomerate business organizations. the most numerous in the corporate sector. companies that are members of family-based conglomerates had higher returns and lower leverage than independent companies. This study analyzed trends in corporate performance and financing in relation to corporate governance from 1988 to 1997. Business groups occupied seven of the top 10 and 25 of the top 50 largest corporate entities in the Philippines in 1997. Privately-owned companies. oligopolistic market structures. influenced by industry characteristics. Ownership of publicly listed companies is highly concentrated. 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. By ownership structure. an ineffective insolvency system. The five largest shareholders have majority control of an average publicly listed company. Leverage was within Asian norms but above developed country standards. With large shareholders in control. The corporate sector consistently relied on internally generated funds and equity before resorting to borrowings. an underdeveloped capital market. Analysis of corporate financing by ownership . ownership of banks by business groups. The financing pattern of the corporate sector was influenced by the tight financial conditions prevailing in the country up to 1992. while the largest 20 shareholders control more than 75 percent of shares. By size. passive independent auditing. Publicly listed companies had the highest profit margins and lowest leverage among the local companies. medium companies showed higher profitability than large and small ones. Financial institutions are not significant shareholders. minority shareholders need to be protected by external control mechanisms. Performance was. to some extent. Returns to capital exceeded inflation rates. were the least profitable. The Philippine corporate sector was relatively efficient in investing and financing compared with other countries affected by the Asian crisis.Chapter 3: Philippines 217 expropriating the wealth of minority shareholders through aggressive and risky investment. This study points out weaknesses in external control mechanisms such as weak legal protection for minority shareholders. By control structure. and the lack of market for corporate control. The result is that corporate governance depends only on internal controls.
After controlling for industry effects. statistical analysis of company-level data revealed significant relationships between corporate performance and corporate governance. Companies whose large shareholders have higher degree of control tend to borrow more but generate better returns. The pyramid model is useful for centrally managing smaller companies. Internal financial markets operated by business groups allowed them to optimize their financial resources at lower external debt levels. Family-based business groups have focused their investments in industries where their superior financing capacities and political/social influence give them unique advantages. 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. Publicly listed companies were responsive to investors’ requirements for prudent use of debts. with the foreign-owned companies found to rely more on borrowed funds. Ownership concentration was positively related to both returns and leverage. ROE. superior profitability. Even in cases where the group owned only a minority share of a commercial bank. Large. the amount of pressure from stock market investors and PSE (for publicly listed companies in the group). and the extent of supervision of outside institutions such as independent auditors and SEC. and sustained growth. . The extent of governance problems depends on internal control policies of the controlling shareholders. Business groups with pyramiding structures heighten the issue of corporate governance. as typified by the Ayala Group. selective public listing of companies in the group. the bank usually accounted for a large share of each group’s net profits. and leverage were all positively related to the degree of ownership concentration. ROA.218 Corporate Governance and Finance in East Asia. II type gave similar results. The difference between management control and ownership rights is usually substantial. and centralized management and financing. Vol. A business group is an effective business organizational model for achieving leadership in industries. family-based shareholders gain control by such means as the setting up of holding companies. A commercial bank is an important part of most business groups. Large companies owned or controlled by business groups tend to dominate their industries. 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. Such structures result in control by large shareholders through disproportionately smaller investments in equity ownership.
with recently restructured public debt. The corporate sector was also in good financial condition with rich internal cash flows accumulated from a number of profitable years. 3. 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. For example. adversely affecting companies’ operations and financial position.Chapter 3: Philippines 219 The financial crisis came when the Philippine economy was in a relatively strong financial position. mostly by highly leveraged companies and speculative investors in real estate. decide on the financial future of a troubled debtor. Under the new Securities Regulation Code enacted in 2000.2 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. are to be removed and transferred to courts. As the crisis wore on in 1998. 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. That is. SEC officials. there were sharp rises in the number of bankruptcies and petitions for debt relief.6. Still. strong capital position built on IPOs in a buoyant stock market. low inflation. A number of large debtors petitioned SEC for rehabilitation under procedures set by PD 902-A. SEC’s quasijudicial functions. decisions by large sharehold- . The crisis caused a tightening of credit to the corporate sector and a spike in interest rates. resulting in the banks’ accelerated restructuring of troubled debts in this sector. rather than the banks that lent millions of pesos. 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. Specific actions recommended are described below. including suspension of payments. the government budget in surplus. and sound overall creditworthiness. a strong international reserves position. This law is flawed in concept because it supplants a market-based credit agreement with a political process. The Central Bank responded by improving the liquidity of the system and by establishing conditions for bringing down interest rates on bank loans. The Central Bank imposed strict limits on real estate lending. and a market-oriented policy environment.
To help ensure this. This will enable SEC to enforce prudential requirements on management of companies and enable minority shareholders to pursue grievances against their boards. It has suffi- . they serve to curb the powers of controlling shareholders. inadequate disclosures. 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. the PSE Listing Rules require the appointment of a minimum number of independent directors in the board of publicly listed companies. depending on the size of the company. Another measure would be to impose a statutory limit on the number of directorships that one can accept.220 Corporate Governance and Finance in East Asia. II ers often cause wide volatility in stock prices and invite reaction from creditors. Increasing the Statutory Accountability of Directors and Strengthening the Board System The Government should clarify statutory fiduciary responsibilities of the board of directors. To strengthen the board. The adjustment should be made over a fixed period of time. Vol. 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. Clear legal accountability is a precondition for successful shareholder activism. 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. 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. and self-dealing. (ii) require disclosure of material changes in ownership. insider information. to 25 percent. This may limit current practices of appointing prominent individuals and family members as directors.
It is encouraging that the newly enacted 2000 Banking Laws have introduced changes along these lines. in areas of supervisory functions of the central bank. Minority shareholders have failed to use traditional venues such as the annual general shareholders’ meetings to discipline controlling shareholders that expropriate their wealth. e.. (iii) adopt international standards of capital adequacy and ensure that banks comply with these standards. (iv) require banks to follow international financial accounting. Finally. or prohibit cross-guarantees by companies belonging to affiliated groups. fit and . The following recommendations aim to further improve banking regulations and supervision in the Philippines: (i) limit shareholdings of nonfinancial companies in banks. For example. officers. They need legal empowerment such as higher majority voting requirements. in particular. and of banks in nonfinancial companies in order to avoid connected lending.Chapter 3: Philippines 221 cient case history that can be used as a basis for tightening its disclosure requirements. 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.g. and (v) closely monitor. the Corporation Code should be amended to impose sufficiently stiff penalties for self-dealings that patently expropriate the wealth of other shareholders. Impose severe penalties for any attempt by banks to circumvent this regulation. Because ownership is generally concentrated in five shareholders. directors. and related interests. the board can easily muster the needed majority to approve the deal. By requiring sufficient disclosure and a 75 percent majority vote on such decisions. current rules allow boards of directors to approve own-dealings or related party transactions by simple majority. and disclosure standards. reporting. prudential measures and regulations. Improving Financial Regulation and Strengthening Implementation The Asian crisis demonstrated the need to strengthen banking regulation. The Government should improve its prudential supervision system to ensure that banks perform their role as external control agents of their corporate debtors. limit. raising the current two-thirds majority to a three-fourths majority.
institutional investors can be a driving force in providing market discipline to management. SEC and PSE can help ensure that these external control agents provide market discipline even in companies controlled by large investors. Two measures should be adopted to promote shareholder activism. Institutional investors impose market discipline by voting on strategic corporate decisions. Managements find that their investment and financing decisions affect stock prices and become aware of their responsibility to create shareholder value. SEC appears to be taking a primarily regulatory posture in the operation of investment funds. 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. In developed capital markets. and lending to DOSRI. Presently.222 Corporate Governance and Finance in East Asia. Investment and venture capital funds meet this description. One is improved transparency and disclosure on specific items that potentially involve expropriation of wealth of minority shareholders. The other is the addition of provisions in the Corporation Code to facilitate class action suits against corporate directors. If institutional investors are present. 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. II proper rule. foreign ownership of banks. Its priority is to protect prospective fund investors from unscrupulous fund managers. transparency. Other investors benefit from the information that analysts produce for these institutional investors as information technology makes their output a public good. and external auditors. 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. Vol. management. The absence of institutional investors indicates that the legal and regulatory basis is inadequate. The current law should expand class action suits to include management and . By supporting the establishment and operation of institutional investors. an active financial analyst community can begin to form. This way. institutional investors lead public investors in providing market signals to companies.
and broad-based political and popular support to pursue possible cases involving expropriation of minority shareholders’ wealth. compensation contracts. where the threat of class action suits alone is sufficient to encourage quality decisions and behavior from management. Securities market development efforts should coincide with strict regulation of the commercial banking sector. These groups have an incentive to gather technical expertise. their directors and management. The Government should enhance the securities markets as an alternative source of corporate financing and pursue aggressive development of the local debt securities markets. Promoting the corporate bond market requires that the Government develop trading systems and services of credit risk rating of corporate issuers. and Credit Information Bureau that can be the starting point of this effort. Placing the means for prosecuting in the hands of minority shareholders may instill more discipline in controlling shareholders. and dividend decisions. 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. SEC should take steps to simplify the process of class action suits and provide an avenue for out-of-court settlements similar to practices in the US. leadership. Promoting Competition in Product Markets The Government should pursue industrial development policies that promote competition through the elimination of subsidies. and the external auditors. And by issuing Government Treasury securities in longer tenors. the Government could develop the market for future issues of corporate bonds. Philippine Government Treasury bonds should provide bellwether rates for corporate bonds in the way that they have for short-term bank debts.Chapter 3: Philippines 223 auditors. The present provision on class action suits is inadequate because shareholders view the process as ineffective and expensive. information disclosures. There are existing institutions such as Dun and Bradsreet. It should develop a medium-term yield curve for the corporate debt market by strengthening the Government bond market. Companies are likely to remain dependent on bank financing if the authorities do not strictly enforce prudential lending regulations. Legal provisions for class action suits should cover self-dealing by directors. guarantees. entry . SEC should allow minority shareholders to be represented by activist groups.
Current disclosure requirements of SEC are not rigorous enough for public investors. Another problem is the orientation of external auditors to the interest of large shareholders rather than public investors. 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. 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. 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. The Government’s competition policies should aim to facilitate the free entry and exit of domestic and foreign companies and regulation of anticompetitive practices. and publicly listed companies trade barely the minimum number of shares required for public listing. II and exit barriers. PSE and SEC need to build a liquid and efficient market. SEC should require that a larger percentage of publicly listed companies’ shares be sold to the public. Increasing the Supply of Quality Equities in the Stock Market To promote the capital market as an external control agent in corporate governance. and various other forms of protection. Little attention is given to the conditions that make those regulations effective in the US corporate sector but not present in the Philippines. Lack of liquidity deters institutional investors.and medium-scale companies can become more competitive relative to large companies. Penalties for poor conduct of auditing by independent . Many large companies remain privately owned. and provide quality basic services should also be heightened. Improving External Audit Standards and Information Disclosure Effective external control in corporate governance requires accurate and timely information about companies. improve enforcement of the rule of law. Efforts to reduce graft and corruption. The Government should also continue to improve infrastructure. Audited financial statements contain basic information about a company’s financial position and performance. so that small. The increase in percentage of public holdings may be gradually implemented to enable the companies to adjust. The resulting absence of a strong investor base makes share prices vulnerable to manipulation or insider trading by large shareholders. Vol.
Improving the Legal Framework for Suspension of Payments. 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. it creates a moral hazard problem. For that matter. and implement those standards and penalties rigorously. the new law needs to be effectively implemented and enforced. The law on suspension of payments replaces a market-oriented solution with a political process. In spite of the many well-known cases of poorly audited financial statements that resulted in losses for investors. . and Liquidation. Reorganization. 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. SEC and PICPA need to formulate more specific disclosure standards. suspension of payments and private damage actions. Reforming the legal framework for suspension of payments. Although the new Securities Regulation Code enacted in 2000 has removed some of SEC’s quasijudicial functions. PD 902-A has not accomplished any successful rehabilitation of a petitioning company since its implementation. review the system of penalties on professionals involved in a company’s violation of disclosure rules. violators were made to pay only nominal penalties. reorganization. and liquidation of troubled companies should be made a priority of the Government. including the resolution of intracorporate disputes. Instead.
Asian Development Bank. Fan. Stijn Claessens. Expropriation of Minority Shareholders in East Asia. The Philippines: Onward to Recovery. March. Tokyo: Institute of Developing Economies. and Larry H. Stijn. Asian Industrializing Region in 2005. and Larry H. Lang. October. Joseph P. 1998b. The Separation of Ownership and Control in East Asian Corporations. Simeon Djankov. Claessens. 1988. Working Paper 2088. Thailand: From Financial Crisis to Economic Renewal. Journal of Financial Economics 25: 371-395. P. Michael. Antonio. Simeon Djankov.. 1999. H. Manila: Asian Development Bank. Denis. Monitoring and the Value of the Firm. Journal of Political Economy 93 (6). and Kenneth Lehn. Burkart. edited by Toida Mitusuru and Daisuke Hiratsuka. Demsetz. Joseph P. Dennis. Equity Ownership. 1997. World Bank. Fan. and Larry H. and Corporate Diversification. Stijn. Diversification and Efficiency of Investment by East Asian Corporations. Private Benefits from Control of Public Corporations. and Larry H. Diane K.226 Corporate Governance and Finance in East Asia. Who Owns and Controls East Asian Corporations? Discussion Paper 2054. Vol. Stijn. World Bank. Vol. World Bank. Alba. XXIX. Thailand’s Corporate Financing and Governance Structures: Impact on Firms’ Competitiveness. May. and Fausto Panunzi. Fan. and Atulya Sarin. July. Lang. Lang. P. Lang. P. Large Shareholders. Key Indicators of Developing Asian and Pacific Countries 1998. H. M. Jr. 1994. Quarterly Journal of Economics. Conference on Thailand’s Dynamic Economic Recovery and Competitiveness. . Stijn. 1997. Discussion Paper. Philippine Macroeconomic Prospects: The Next Ten Years. Working Paper. Claessens. Simeon Djankov. Harold. Claessens. David J. H. World Bank. Pedro. George. The Structure of Corporate Ownership: Causes and Consequences. 1999. Joseph P. Simeon Djankov. Institute of Southeast Asian Studies. Barclay. Agency Problems. P. and Clifford Holderness. World Bank. Simeon Djankov. 1999. 693-728. Joseph Fan. 1998c. Claessens. Lang. Dennis Gromb. 1985. P. 1998. 1989. Claessens. Ownership Structure and Corporate Performance in East Asia. 1998. and Simeon Djankov. Bangko Sentral ng Pilipinas. Stijn. and Larry H. Working Paper. Emilio. 1998a. Journal of Finance 2 (1). II References Abonyi..
Takeo. Stuart. 1993. Corporate Finance and Takeovers. American Economic Review 48 (3): 261297. Jensen. Financial Intermediation and Delegated Monitoring.. Quarterly Journal of Economics 106: 33-60. and William Meckling. Anil Kashyap. Douglas. Internal versus External Capital Markets.Chapter 3: Philippines 227 Diamond. Stephen. Journal of Finance 45: 321-350. Capital Structure and the Information Role of Debt. Hoshi. Robert H. 1994. Agency Costs of Free Cash Flow.). Debt and Seniority: An Analysis of the Role of Hard Claims in Constraining Management. Michael. November. F. . Scharfstein. The Cost of Capital. Corporation Finance. Milton. Franco. The Modern Industrial Revolution. Gestner. Journal of Financial Economics 27: 4366. The Market for Corporate Control: A Scientific Evidence. Determinants of Corporate Borrowing. and Artur Raviv. and David Scharfstein. Jensen. Prowse. Prowse. Theory of the Firm: Managerial Behavior. Michael. Agency Costs and Ownership Structure. and John Moore. The Quarterly Journal of Economics. Exit. American Economic Review 76: 323-29. International Corporate Governance. 1984. 1991. David S. Stephen. Stein. Joseph C. 1995. 1976. Jensen. 1994 and Investment Guide 1997. and the Theory of Investment.. American Economic Review 85: 567-85. 1990. and Jeremy C. 1990. Michael. Euromoney Books. Journal of Financial Economics 11: 5-50. and Merton Miller. 1977. Journal of Financial Economics 3: 305-360. and David Gallagher (eds. 1986. 1958. Philippine Stock Exchange Fact Book 1997. Corporate Governance: Emerging Issues and Lessons from East Asia. 1998. Myers. Oliver. World Bank. and the Failure of Internal Control Systems. Institutional Investment Patterns and Corporate Financial Behavior in the United States and Japan. 1995. Lufkin. Review of Economic Studies 51: 393-414. 1990. and Richard Ruback. Michael. Hart. Modigliani. 1983. Jensen. Journal of Finance 48: 831-80. Harris. Liquidity and Investment: Evidence from Japanese Industrial Groups. Corporate Structure. Journal of Financial Economics 5: 147-175.
Stein. Vishny.228 Corporate Governance and Finance in East Asia. Singh. Webb. 1997. Ajit. World Bank. Credit. 1997. Technical paper No. 1985. DC. 1998. Joseph E. Journal of Finance 91: 1121-1139. IFC/WB. Vol. Vishny. Journal of Political Economy 94: 461-88. David. and Robert W. 1. . How Do Large Corporations in Developing Countries Finance their Growth? Corporate Financial Structures in Developing Countries. Some Conceptual Issues in Corporate Governance and Finance. Shleifer. A Survey of Corporate Governance. Asian Development Bank. March. The Structure of Ownership in Japan. 1998. Stiglitz. Journal of Finance LII. and Robert W. No. Washington. Andrei. Andrei. Washington. No. 1991. 1996. 1. Jeremy C. 2. East Asia: The Road to Recovery. Stephen. 1992. DC. Mimeograph. Credit Markets and the Control of Capital. Journal of Finance L11: 737-783. Large Shareholders and Corporate Control. Shleifer. May. Journal of Money. November. Internal Capital Markets and the Competition for Corporate Resources. II Prowse. and Banking Lecture 17.
The fixed exchange rate policy. and Philippines all depreciating significantly. But it also laid bare weaknesses in both the financial and corporate sectors. Asian University of Science and Technology. the Thai baht came under pressure from speculative attacks. The author wishes to thank Juzhong Zhuang. Thailand’s crisis exposed similar vulnerabilities in other East Asian economies. 1 Associate Professor. the Stock Exchange of Thailand for its help and support in conducting company surveys. Thai corporations were collectively overexposed to exchange rate risks. In the prelude to the 1997 crisis.” After mounting an aggressive defense of the currency. The crisis in Thailand stemmed directly from unsound macroeconomic policies and imbalances. and David Webb of the London School of Economics for their guidance and supervision in conducting the study. with Thai corporations overutilizing short-term foreign currency-denominated loans. with the currencies of Indonesia. Korea). Faculty of Business. both of ADB. coupled with financial liberalization and deregulation in the absence of an effective regulatory and supervisory system. poorly regulated and sheltered from competition. magnified the impact of these problems on the economy when the crisis hit. David Edwards. 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). As a result. short-term private debt obligations grew to about 60 percent of total private sector debts. Instead of serving as a buffer between the large inflow of foreign capital and the corporate sector. . heralding not only a financial crisis in the country. For the period 1994-1996. The banking system. It was inefficient in financial intermediation. Thailand. and Lea Sumulong and Graham Dwyer for their editorial assistance.4 Thailand Piman Limpaphayom1 4. had been plagued with prudential problems for a long time. the Thai Government conceded and adopted a floating exchange rate regime. Malaysia. Chonburi. The corporate sector also contributed significantly to the crisis. The majority of these debts were not properly hedged.1 Introduction In May to July 1997. but also the stalling of East Asia’s “economic miracle. Republic of Korea (henceforth.
2 4.1 Overview of the Corporate Sector Historical Development The corporate sector has long been considered the engine of Thailand’s economic growth. To protect domestic industries. with government policy providing support but avoiding direct interference. as well as its legal and regulatory framework. while new industries were encouraged to reduce the need for imports.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. Section 4. focusing mainly on the companies listed in the Stock Exchange of Thailand (SET). and a family-based corporate ownership structure. The study then considers policy recommendations with emphasis on corporate governance improvement. the Government implemented major infrastructure projects and modified its tax policy to encourage capital investment and savings.230 Corporate Governance and Finance in East Asia. The National Economic and Social Development Board was created to plan the country’s economic and social development.2. The country initiated national economic development planning in 1961 when the economy was growing rapidly. . Section 4.5 discusses how the corporate sector contributed to the financial crisis and looks at its impacts.2 discusses the development of the Thai corporate sector under the National Economic and Social Development Plans. Import tariffs on machinery and heavy equipment were removed. lack of transparency and adequate disclosure.3 looks at corporate ownership patterns that resulted in inadequate protection for minority shareholders and weak corporate governance in Thailand. Section 4. II There is now a consensus that weak governance was partly responsible for the corporate sector’s poor financing and investment practices. Key factors that led to weak corporate governance include the ineffectiveness of the regulatory framework. its growth and financial performance. 4. 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. the Government increased tariffs on products that could be produced locally. Section 4. Vol.
resulted in increases in the current account deficit. As a result. with the devaluation of the baht in 1984 a major step in this direction. including a weakening of the dollar. . the current account registered a surplus in 1986. The results were increased exports.15 billion per year or 4. with the agricultural sector the major contributor. Inflation reached 15.Chapter 4: Thailand 231 During this period. However. capital inflows. and automobile assembly) emerged. and reduced current account deficits. became a major problem as domestic investment declined. Budget deficits remained a major problem during the Fifth Plan. the industrial sector grew at a faster rate than the agricultural sector. But the sustained importation of heavy machinery and equipment resulted in large trade deficits.4 percent of GDP. Budget deficits also increased throughout the Fourth Plan.5 percent in 1973 and 24. textiles. remaining high until 1981. and increases in world food and oil prices. Consequently. chemicals. the Government borrowed $6.4 billion from overseas and increased taxes on numerous items. To close the fiscal gap. Fourth.3 percent in 1974. The Government had to shift emphasis to restoration of economic stability. The decline in imports was steady. Thus. however. an improved trade balance. Industrial sector growth was also rapid and many industries (tires. averaging 1. canned foods.6 percent per year. External factors. The focus shifted to export promotion. processed steel. the value of the baht remained stable. The average budget deficit reached an all-time high of $2. using tax policy to control prices of consumer goods and implementing several price control measures to curb inflation. The Government decided to embark on restructuring measures in the Fifth Plan (1982-1986) to rehabilitate the ailing economy. the government’s debt burden escalated. including luxury goods. Average growth for the period was 4 percent per year. Unemployment. The Third. leaving the Government no choice but to resort to overseas borrowings. it proceeded with its development plan for the industrial sector. In the wake of lower world oil prices and the rapid growth in income from the tourism and travel industry. Inflation levels were low. At the same time. however. and Fifth Plans (1972-1986) An economic downturn at the end of the Second Plan led to an adjustment in policies. especially foreign aid from the United States. helped offset these deficits. lower than anticipated due to a worldwide economic recession. gross national product grew by about 7 percent per year.
invited a deluge of capital seeking profitable investments. Vol. property development. The country also attracted a large amount of foreign direct investments (FDIs). With loans increasingly becoming expensive and hard to come by due to a lending squeeze by the central bank and high interest rates. The Seventh Plan (1992-1996) The economy’s performance from 1992 to 1996 generally met the targets of the Seventh Plan. compared with the 8. Private sector investment grew at an average annual rate of 7 percent. Singapore. The exchange rate was steady at around B25 to the dollar. the property sector began to collapse in 1996. The manufacturing sector became a dominant force in the economy.232 Corporate Governance and Finance in East Asia.6 percent target of the Seventh Plan. On top of its predominantly “borrowed” nature. lower than the target of 8. Thailand became a debtor’s market. with private foreign debt reaching $92 billion by the end of 1996. By 1995. The country’s high ratings in the international capital market.7 and 11.5 percent. while exports expanded considerably.4 percent targets. Most of the FDIs—originating mainly from Japan.2 percent target. Inflation was 4. reaching an annual inflow of $2 billion in 1991. respectively. compounded by a slump in property sales. the bulk of domestic investments went to speculative ventures such as real estate.2 percent per year. Key to this growth performance was the government’s adoption in 1993 of an aggressive program for attracting foreign capital to finance domestic investments. increasing its share in total export value from 42 to 76 percent. Thailand’s rapid growth up to the mid-1990s made the country one of the world’s fastest-growing economies. Average annual growth in real GDP was 8 percent. averaging 10. the Government successfully balanced the budget and even settled its foreign debt of $4 billion before this was due. United States.6 percent. From 1989. Growth of exports and imports averaged 14.8 percent. compared with the 14. Europe. .8 percent. from only $31 billion in 1992. combined with its liberal financial policies.5 to 13. II The Sixth Plan (1987-1991) Industrial sector productivity improved gradually during the Sixth Plan period. and Hong Kong.2 and 13. and the stock market. rather than to productive activities. better than the 5. China—went to export-oriented manufacturing industries. Growth rates during 1987-1991 ranged from 9. an oversupply of housing emerged.
8 percent in 1995 to 1. prepared a comprehensive report entitled “A Capital Market in Thailand. In May 1974.Chapter 4: Thailand 233 Toward the end of the Plan period. 4. A series of increases in customs and excise taxes on luxury imports did little to stem rampant consumer spending. SET officially became “the Stock Exchange of Thailand” in 1991. Exports went into a tailspin. And because the Government considered the banking system vital to the development of the economy. Before the capital market emerged. However. the capital markets didn’t play a significant role until 1975. 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. In 1972.3 percent in 1996. its policy had always been to protect domestic banks. The country had a current account deficit of about 8 percent of GDP in 1995 and 1996. In his report. the signs of an economy about to falter were there. which raised the debt service ratio.” which later became the master plan for the development of the Thai capital market. placing all publicly listed companies under regulation. Included in the Second Plan (1967-1971) was a proposal to establish the country’s first authorized and regulated securities market.2 Development of Capital Markets Although the corporate sector has long been the government’s main tool for economic development. the Government passed the Public Limited Company Act. many companies considered the Act too restrictive and a hindrance to growth. the establishment of the Securities Exchange of Thailand (SET) was legislated and trading began on 30 April 1975.2. Foreign banks were barred from competing directly with domestic banks. with growth shrinking from 23. 58 on the Control of Commercial Undertakings Affecting Public Safety and Welfare.” extending its control and regulatory powers to the finance and securities companies operating freely at the time. Robbins. the Bank of Thailand and . a policy that held throughout the first six economic development plans. Under the 1962 Commercial Banking Act. In 1969. on account of an overvalued baht that weakened export competitiveness. In 1978. the corporate sector’s main source of funding was the banks. Its most crucial role was to help mobilize funds to support Thailand’s industrialization and economic development. which was amended in 1979 and 1985. the Government amended the “Announcement of the Executive Council No. a former Chief Economist from the US Securities and Exchange Commission. Sidney M. The deficits caused the Government to rely on even more external borrowing.
The regulatory measures were inadequately designed and poorly enforced. II the Ministry of Finance had full authority to supervise all commercial banks. the Government was under international pressure to deregulate the financial sector. At the end of the Sixth Plan. With the liberalization of financial markets. Externally. and new financial instruments. while the Securities and Exchange Act (SEA) the same year sought to improve capital market supervision. The Public Company Act of 1992 relaxed some of the rules and restrictions contained in the original laws. A number of internal and external factors contributed to the Thai Government’s acceptance of the IMF’s Article VIII agreement. increased financial market activities. The pressure dovetailed with the Government’s intention to make Bangkok one of the financial centers of the region. The resulting availability of funds propelled the corporate sector’s growth through the early part of the 1990s. In the 1990s. to cater specifically to its . While the Bank of Thailand had the regulatory power to influence business practices. and the General Agreement on Tariffs and Trade (GATT) meeting in Uruguay had the liberalization of financial services on its agenda. Earlier. it usually relied on “moral suasion. The banks and finance companies operated at insufficient levels of reserve capital and were overexposed in high-risk businesses such as real estate. the financial and banking laws were generally ineffective. 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. the World Bank had recommended such a move. Economic growth had been rapid and domestic savings could not keep up with the pace to support investments. Financial deregulation and liberalization allowed the country to attract foreign savings and investments that helped finance the growth of the economy. there were 29 commercial banks (15 domestic and 14 foreign banks) in Thailand. However. creating a moral hazard problem—the perverse expectation that imprudent bank behavior would be rewarded with forbearance and bailout. Thailand discarded controls on foreign exchange transactions and capital flows—a turning point for the Thai corporate sector.234 Corporate Governance and Finance in East Asia. Thailand’s capital market entered a new era with improved legislation and regulation.” The Government also granted financial institutions overly generous bailouts. Laws were enacted to stimulate growth of the corporate sector. Vol. Thai banks gained access to a variety of funding sources from around the world.
Chapter 4: Thailand 235 fast-growing neighbors.9 34.3 83.5 791.394.1 78. finance. and wholesale/ retail trade and restaurant/hotel sectors. Financial deregulation and liberalization were key to realizing that vision.6 1.9 1. with B1.1 Public Companies Registered.0 110. The manufacturing sector is a far second with registered capital of B350 billion and paid-up capital of Table 4.5 111.5 50. Social and Personal Service Total Note: The data for 2000 is as of October 2000. Insurance.0 19. 1978-2000 Number Registered of Capital Companies (B billion) 5 6 245 5 13 129 22 194 42 661 1.4 trillion in registered capital and B791 billion in paid-up capital. and Water Construction Wholesale and Retail Trade. . Storage.291.9 16. in that order. The majority of the companies are in manufacturing.2 11.3 trillion have been registered with the authority (Table 4. Source: Department of Commercial Registration.1).0 21.2.2 Type of Business Agriculture. The stock market boom from 1991 until the financial crash of 1997 reflected international investors’ response to Government policies.3 Growth and Financial Performance Since the 1978 enactment of the Public Limited Company Act.0 Paid-up Capital (B billion) 1. Worldwide. Thailand. 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. however. Hunting. and Communication Financing.101. 4. Real Estate. Ministry of Commerce. the financial sector is the largest. and Fishing Mining and Quarrying Manufacturing Electricity. In terms of capital.6 350. and Business Service Community. about 661 companies with total registered capital of B2.1 trillion and paid-up capital of B1.6 23.6 2. Gas. the country became recognized as an economic development model for other emerging economies. Forestry. and Restaurants and Hotel Transport. The result was a corresponding growth and development in Thailand’s capital markets.1 30.9 261.
5 billion and B1 billion the previous year. Vol.7 7.7 27.1 — — — 6.1 286.3 194.2 5. this was due to the recapitalization of commercial banks in compliance with the new loan provisioning requirement. reached .3 6.2 40. Securities and Exchange Commission of Thailand. the capital market became instrumental in the rapid growth and development of the corporate sector.8 — 26.4 34.8 201.3).4 51. The signing of Article VIII with the IMF.7 9. Domestic and offshore debt issues reached B54. The preeminence of the financial sector is a direct result of financial deregulation and liberalization. The 1997 crisis battered the primary market for securities.4 277. reducing the value of offerings to a little more than a quarter of the previous year’s level. reaching a precrisis peak in 1996 (Table 4.9 31.5 1.236 Corporate Governance and Finance in East Asia.7 billion in 1996.8 billion.7 5. After the passage of the SEA of 1992. The stock market also became an invaluable source of funds for corporations.1 599.6 39. Source: Key Capital Market Statistics.6 7.2 25.6 174.6 — = not available.6 8.7 136. These peaked at B89.9 37.1 2.5 1.3 1996 1997 65. The number of listed companies and securities steadily increased until 1996 (Table 4.2 12. the year before the crisis struck.2 Public Offerings of Securities.7 billion and B27.5 39. Table 4.3 31.1 54. allowed Thai financial institutions and corporations to obtain funds overseas.0 20. meanwhile. the value of public offerings rose steadily. The development of the corporate sector closely followed the development of capital markets.2). Debt market activities also increased significantly with the establishment of the Bond Dealers’ Club (BDC) in 1994. respectively.3 22.8 151.5 — — 56. moreover.4 96.0 1994 82. II B261 billion. from only B20.9 1998 1999 15. While a rebound was apparent beginning in 1998.0 0.8 1995 64. Market capitalization. 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. With the enactment of the SEA of 1992 that brought suppliers of finance services and their clients together.
535 1. Corporate profitability.303 930 855 1. however. was the ominous deterioration in the key financial ratios of publicly listed companies. gross profit margin rose until 1991 before falling in 1992. Source: Securities and Exchange Commission of Thailand.133 1.4).3 Statistical Highlights of the Stock Exchange of Thailand. however.8 percent.610 1.268 2. not all public companies are listed on the SET. the highly liquid financial system continued offering cheap funds to sustain corporate sector investments. in the end. Foreigners accounted for an increasing proportion of SET’s turnover value. as measured by return on assets (ROA). resulting in their inability to fulfill debt obligations.4 percent in 1996. The trend reversed in 1995. then stalled in 1990. had been on the rise throughout the 1980s. the companies could not generate enough net returns from their assets and equity. 1993-1999 Item Number of Listed Companies Number of Listed Securities Market Capitalization (B billion) Turnover Value (B billion) SET Index a 1993 1994 1995 1996 1997 1998 1999 a 347 408 389 494 416 538 454 579 431 529 418 494 392 450 3. But instead of shifting to a low gear.4 percent to 5. The key financial ratios of all companies listed on SET bear this out (Table 4. ROE similarly fell from 21. return on equity (ROE). its high point in 1995 at B3.5 at its peak in 1987.193 2. The plunge in profitability and asset turnover—from 117 percent in 1985 to 65 percent in 1996 for the latter—cast doubts on the . Side by side with this surge of financing for corporate growth. ROA dipped from 10. corporate profitability had been declining.325 3. From 10.1 by 1996. the average times interest earned (TIE) was down to 5.565 2.281 832 373 356 482 Due to listing requirements and other reasons. The financial leverage of all companies declined until 1994.114 1.Chapter 4: Thailand 237 Table 4. and gross profit margin. when long-term debt grew as Thai corporations began to borrow heavily to finance growth. By the early 1990s. pulled down by active public offering activities.560 1. Throughout the 1990s.301 3.360 1. the averages for all three profitability ratios took a downswing all the way until 1996. their share rising from 17 percent in 1993 to 43 percent in 1997.3 percent in 1989 to 3.201 2. Meanwhile.683 1.6 trillion. The upward trends for ROE and ROA continued through 1989. While the decline in gross profit margin was not as sharp.
8 5.5). 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 (%) (%) (%) 3.2 161.7 27.7 12.5 63.6 41. practice of heavy borrowing. which fell from 16 percent in 1991 to just under 6 percent in 1996.7 59.1 60.2 215.4 7. the textiles.6 7.7 5.0 125.4 139. resulting in higher collateral values for borrowers.4 18.0 29.4 47.4 44.7 LongTerm Debt to Asset Assets Turnover (%) (%) 14.8 88.2 10. Severely affected by global competition throughout the decade.8 11.2 49.8 54. and footwear had the lowest at 11 percent.7 5.4 12.1 9.7 80.4 4.9 39.1 120.2 10.4 28.9 144. They were generally more efficient in managing their assets and .5 50.9 7.4 26. Thailand’s ROE. and footwear industries also experienced losses.0 63. but was most severe in building and furnishing material industries as a result of the downturn in the real estate market.5 15.0 117.8 25.7 27.9 77.7 54. which was particularly significant in the two years preceding the crisis.8 151. clothing.6 168.2 35.4 9. these companies opted for debt. was felt across industries. US.8 5.1 16.3 10.5 52. II Table 4.9 14.2 27. Overall.6 36.9 140.7 21.7 35.6 12.1 114.9 51.8 14.4 7.3 4. clothing.1 16. Hotels and travel showed the highest ROE of 15 percent while textiles.0 7.0 3.8 51.6 138.4 51.9 7.0 145.7 15. A major reason for this was the rapid rise in asset prices.9 66.2 27.4 119. was also distinct in the region.1 52. Among the crisis-hit countries.2 64.7 4.6 125.4 Key Financial Ratios of Publicly Listed Companies.6 27.9 27. Korea and Thailand had the highest debt-to-equity ratios.3 8.4 5.1 44.0 139.6 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.9 8.5 51.5 30.7 12.7 12.3 91.4 24.5 38. It has also been argued that family-based controlling shareholders borrowed excessively to avoid diluting their control over their corporations.7 12.7 34.4 3.5 9.7 20.4 12.4 34.8 8.238 Corporate Governance and Finance in East Asia.1 242. The downtrend in corporate profitability.7 5.3 12. large companies (where size is reckoned in terms of assets or sales) were more profitable than small companies in terms of ROE (Table 4. Despite the availability of the equity market.2 10. Vol.2 6.
could lead to a high turnover in the board.6 10.5 94. There were also concerns that the provisions governing the criminal prosecution and penalties of directors and management were harsh and inappropriate.8 10. .6 6.6 7.6 61.4 116. Cumulative voting.4 Legal and Regulatory Framework Before 1992.1 5.3 176.2 12. also deteriorated.1 Small Medium Large 5. However. measured by total asset turnover.5 Average Key Financial Ratios by Company Size.7 14. although the performance of listed companies in the late 1980s was strong. total asset turnover declined after 1989.4 52.3 88.5 7.3 23.3 135.0 83. the Public Limited Company Act of 1978 and its amendments regulated Thai publicly listed companies.6 5.1 6.3 49.3 15.8 47.7 Source: Pacific-Basin Capital Markets Database compiled by the University of Rhode Island.9 13.1 13.4 8. Increasingly heavy borrowings rendered the sector even more vulnerable to lower profitability and sales.8 6.5 6.8 142.3 164. which would be disruptive to company management. some rules and regulations of this particular law were believed to be too restrictive and were discouraging companies from going public.8 26. the overall activities of listed companies.2 18.2.6 30.7 10.Chapter 4: Thailand 239 Table 4.0 48. In sum.3 52.7 6. it was thought.8 62.9 20.2 10. US. During the 1990s. For instance. weaknesses became evident.0 20.6 31.1 25. 4. capital despite the higher gross margins of small companies.3 49.6 12. They also tended to use more financial leverage than small companies as their total DERs show.6 30. by the 1990s. 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 6.2 121. The argument was that having a Board of Directors whose members represented different groups of investors would create conflicts and hamper management effectiveness. Although stable in the 1980s.1 29.3 25.8 6.2 134.3 43.5 87. the law disallowed cumulative voting.
The law prohibited the largest shareholders. The protection of minority shareholders was inadequate under the Public Company Act of 1992. a feature that is believed to have impaired the effectiveness of existing regulatory mechanisms in the corporate sector. and external monitoring and control of corporations were also weak. for instance. The original company owners welcomed the changes and the number of publicly listed companies subsequently rose to more than 600. as a group. This will be discussed in Section 4. from holding more than 50 percent of total outstanding shares and other shareholders from holding more than 10 percent of outstanding shares individually. The Public Company Act of 1992. 2 ADB survey questionnaires were sent to all Thai listed companies in early 1999. the exit of these provisions appears to have contributed to the 1997 financial crisis. As the succeeding sections point out. relaxed the contentious provisions of the 1978 Public Limited Company Act.240 Corporate Governance and Finance in East Asia. coupled with weak corporate governance. II Another issue was the proportion of shareholding by top shareholders. concentrated ownership. The provision discouraged original family owners from registering their companies. . An Asian Development Bank (ADB) survey conducted for this study shows. and the punishment for management misconduct was also lightened considerably. 4. As it turned out. the new legislation removed a number of incentives that would have kept public companies prudent and diligent in their operations. However. Cumulative voting was made optional. Fortysix companies responded. the limit on shareholdings by the largest shareholders was increased from 50 to 70 percent of total outstanding shares. adopted to promote the development of publicly listed companies. but not all questions were answered.2 The market for corporate control was not active and did not give managers strong incentives to perform efficiently.5.3 Corporate Ownership and Control Ownership and control of corporations in Thailand are highly concentrated. that creditors had generally little influence on the management of corporations. played an important role in bringing about the financial crisis. The legal and regulatory framework for the corporate sector also includes provisions related to insolvency. Vol.
9 52.3.0 3.6).8 5.8 32. 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.2 56. these companies obtained funding solely from banks or from their own retained earnings. and 28.0 3.7 6.2 4.4 6. 56. creditors.2 4.3 5.6 28.9 55.4 26. Ownership Concentration Between 1990 and 1998.8 11.3 7.6 4.0 7.5 28.1 5.0 53.9 3.0 56.6 27.1 4.6 Top-Five Ownership Concentration of Publicly Listed Companies in Thailand.1 12. with the largest shareholder on average controlling 10.1 percent of control rights. Source: Comprehensive Listed Company Information Database.9 3.9 6.3 percent.1 11. This implies that the top five shareholders enjoyed full control over the outcomes of shareholder meetings.4 26.4 4.3 7. Thai. Unfortunately. In contrast.1 Patterns of Corporate Ownership A World Bank study covering nine Asian countries finds that firms in Japan and Taipei.4 26. there were only slight variations in the pattern.9 11.4 10. Indonesian.China have the least concentrated ownership.4 5.1 3.5 9. 33.1 5.9 54. 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 28.7 11.0 7.2 4. Across industries. with the top three shareholders accounting for almost 50 percent (Table 4.7 12.6 57. Table 4.3 16. the top five shareholders of each of publicly listed Thai companies held.9 52.Chapter 4: Thailand 241 4.1 5.7 7.9 52.3 28.3 percent and 18. Stock Exchange of Thailand.6 68. and Hong Kong. But with their increased reliance on new varieties of equity and debt instruments.9 26.2 11.3 11. Most large Thai corporations listed on SET started out as family businesses. In the past.9 4. one would expect the public. on average. respectively.4 6.0 5.7 percent.4 percent of outstanding shares. .9 percent of shares of a company. and minority shareholders to stake their claim in the control and regulation of these companies.5 Average for 1990-1998 period. this was not the case.1 7. China firms have the highest single shareholder ownership concentration at 35. Ownership was most concentrated in the packaging.
022*** 0.001 0. It is the practice of Thai corporate founding families to set up holding companies to own shares in affiliated companies or subsidiaries.058* ROE (0.800 0. II agribusiness.001*** 0.034*** 0.037 0. with a top-five ownership concentration of at least 60 percent. as measured by debt-to-equity and debt-to-asset ratios.003 0. Table 4.647 Note: The regression included dummy variables for industry.169*** 0. Other industries had their top five shareholders controlling at least 55 percent of outstanding shares. Company size is significantly related to ROE and leverage.533)*** Debt-to-Assets (0.7 percent of outstanding shares on average (Table 4. Source: Author’s estimation based on the Pacific-Basin Capital Markets Database compiled by the University of Rhode Island. Based on a regression analysis.090 0. ** at the 5 percent level. Leverage. *** at the 1 percent level. owning 26.031 3. and Company Size Item Intercept Top Five Ownership Concentration Company Size Adjusted R-Squared F-Statistic ROA 0. year.115 9. including those that are publicly listed . and ownership types.001) 0.242 Corporate Governance and Finance in East Asia. Through these holding companies. 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. On the other hand. Composition of Controlling Shareholders Affiliated corporations comprise the largest group among the top five shareholders of publicly listed companies. founding families maintain effective control of entire groups. Vol. and building and furnishing industries. 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.116) Debt-to-Equity (1. Ownership Concentration.029 3. US.8).005** 0. results show a significant positive relationship between ownership concentration and financial leverage.7).072) (0. * Denotes significance at the 10 percent level.080 6.7 Statistical Relationships between Corporate Profitability.
Stock Exchange of Thailand.5 Government Other 0.2 7.Chapter 4: Thailand 243 Table 4. a NBFIs denotes nonbank financial institutions.3 1.4 22. the company increased its registered capital and became a public company listed in SET.3 20. Source: Comprehensive Listed Company Information Database. the affiliate firms rarely hold shares of their parent companies.4 20.8 1. in SET.4 1. owned by the Chirathivat family.3 percent of outstanding shares. . In 1994. Typically.6 percent of outstanding shares.7 — 1. including finance and investment companies. Individual family members also hold a significant amount of outstanding shares.0 19.3 27.8 28.5 1. The top 10 shareholders include a holding company owned by the Tejapaibul family.3 27. with 29.0 18. operates five of the most successful shopping malls in Thailand. Although holding companies set up affiliate firms.2 1.2 18.1 0. one of the founding members.1 1.5 0. unlike in Japan where crossshareholding is common.5 0. a joint venture among three families. The ADB survey indicated that listed companies held shares in an average of 11 companies. The largest shareholder is Central Holdings Company.5 2.5 NBFIsa 6.9 18.9 19. In addition.6 28.5 0.3 27.3 1. This practice is illustrated by Central Pattana.9 7.7 0.6 1.6 5. The roster of its major shareholders as of December 1997 illustrates the typical ownership concentration of a publicly listed company in Thailand.6 1.8 Top-Five Shareholder Composition of Publicly Listed Companies in Thailand.1 4.9 15.9 6.7 5.3 0.0 3.5 26.7 Bank 2. averaging about 18.8 23.7 1. a company listed in the real estate sector of SET.4 1.5 5.5 Individuals 13. 1990-1998 Year 1990 1991 1992 1993 1994 1995 1996 1997 1998 Average Company 28.1 1.3 — = not available.3 1.5 1.4 1. individual members of the Chirathivat family aggregately hold 25.0 17.5 percent.8 0.6 25. These individuals usually hold important management positions in concerned companies.2 5. Established in 1980 with a registered capital of B300 million. founding families and their relatives maintain control of many companies by jointly holding on to the most significant chunk of shares. the company.9 0.6 1.2 1.
and a state bank. Moreover. By owning 62 percent of voting shares. they account for 80 percent of total outstanding shares. holdings by individual family members and holding companies account for at least 50 percent of outstanding shares of an average listed company. only one tenth of listed companies have commercial banks on their top-five shareholder list. where the top three shareholders are the Ministry of Finance. Together.5 percent of total outstanding shares of listed companies. There was a trend of rising government shareholdings throughout the period 1990 to 1998.5 percent of total outstanding shares.2 Corporate Management and Control3 Board of Directors The Public Company Act of 1992 stipulates the appointment process. For example. On average. duties. 3 Discussions in this section are based on results of company surveys by SET and ADB. and responsibilities of directors of public companies. commercial banks account for only 1. with the envisioned privatization master plan. the top 10 shareholders consist predominantly of members of founding families and their holding companies.9 percent of outstanding shares. qualification. . About half of listed companies have nonbank financial institutions such as finance and investment companies in their top-five shareholder list. the predominance of individual family members and holding companies in the top shareholder list remains valid. has the Ministry of Finance as its only large shareholder with 92. Thai Airways International Plc. 4. the Petroleum Authority of Thailand.. Only a handful of companies have the Government among their large shareholders.3. Except in the hotel and travel service sector. In such cases. both conducted in 1999. they exercise limited influence in operations because of the restricted size of their shareholdings. Another example is Bangchak Petroleum Plc. II another of the company’s founding members. However. the Government’s role in public companies is expected to decline. Nonbank financial institutions hold an aggregate 5. 1. The Government holds. Although the list of top shareholders of publicly listed companies includes financial institutions.244 Corporate Governance and Finance in East Asia. Vol. on average. roles. Across industries. In effect.1 percent of total outstanding shares of listed companies. the Government owns the majority of the shares. these shareholders are able to control the company.
Most companies (83 percent) satisfied SET’s requirement of having two independent board members. Many companies have a formal policy on corporate governance and business ethics. The ADB survey indicated. In their business conduct. while 15 percent of respondents went beyond the requirement. Meanwhile. directors are required to act with care and honesty for the company’s best interest. Three companies indicated that the CEO and the chair were close relatives. The appointment of the chief executive officer (CEO) needed approval during the AGSM in 11 of the responding companies. In five other companies. but not in 22 others. If found in violation of these provisions. . directors shall be elected at the annual general shareholders’ meetings (AGSMs). Although 28 percent of the chairpersons came from the ranks of independent outside directors. the majority (71 percent) had board chairs who were also members of top management teams. Nineteen companies stated that selection was based on professional qualifications. 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. A survey by SET found that the majority (58 percent) of the 202 responding companies held their board meetings every quarter.Chapter 4: Thailand 245 Directors are required to meet minimum qualifications specified under the SEA of 1992 and the Listing Rules issued by SET. Unless stipulated in public companies’ articles of association. selection was based on relationships with controlling shareholders. that only in two of the 46 responding companies were the chair of the boards elected based on the extent of their shareholdings. Almost all companies (98 percent) exceeded the minimum required five members in their Board of Directors. directors may be imprisoned or fined. Some companies (36 percent) had five to six main board members holding seats in their executive boards. Generally. meanwhile. the ADB survey found that 31 companies (out of 46 responding) required outside directors to be present at all board meetings. In addition. an executive board consists of senior management and some main board members. and to comply with the laws and articles of association. while 30 percent of respondent companies held board meetings monthly. directors could be compelled to compensate the company for damages arising from their misconduct.
Directors with managerial responsibility or those related to major shareholders cannot be members of such audit committees. II Compensation of Directors. not an independent assignment. while 19 companies observed only some of them. these were attributed to variations in the extent of duties and responsibilities assumed by those directors. Twenty-five of the 46 respondents to the ADB survey declared adherence to all relevant international standards. the majority of the companies (77 percent) did not have outside directors as members of their remuneration committees. and CEO The majority of company respondents to the SET survey provided similar compensation packages to internal and external directors. These committees were mainly responsible for determining compensation for senior and regular staff. Fourteen other companies had profit-related incentive schemes in addition to fixed fees. The SET survey found that the majority of listed companies (81 percent) still have no separate audit committee. Chair. In 25 companies. the remuneration packages had to be approved during AGSMs. All respondents confirmed the use of external auditors. all listed companies have been instructed to establish audit committees to be responsible for examining the quality and reliability of company financial statements. 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.246 Corporate Governance and Finance in East Asia. In one company. Also. Half of the companies in the SET survey had a separate remuneration committee. Vol. Companies already with audit committees did not have independent outside directors as audit committee members. the work of this committee was often considered part of the executive board’s responsibilities. The ADB survey indicated that 18 of the 46 responding companies compensated their chairpersons using a fixed-fee schedule. however. with 41 firms admitting the use of services of international auditing firms. 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. Three companies allowed their management to determine the chair’s compensation package. However. the auditor is not . Audit Committees and Accounting Standards Since January 1999.
According to the ADB survey. (i) No standards are enforced in the content and timing of notices for shareholder meetings. likewise. stipulates the proper conduct of shareholder meetings. with 13 companies allowing proxy voting through mail. (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.Chapter 4: Thailand 247 independent from the company. there are also significant gaps in the system of shareholder protection. (iv) The roles and responsibilities of the major government agencies regulating shareholder rights—the Ministry of Commerce. the Securities and Exchange Commission (SEC) and SET were actively prosecuting violating firms. For instance. and the Bank of Thailand— are not clearly defined. most responding companies have rules and regulations intended to protect shareholders. debentures. and executive committees. At least 28 responding companies had the following . Shareholders are also entitled to call emergency meetings and present proposals at AGSMs. 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. In the majority of these companies (38 out of 46 respondents). SET’s rules and regulations closely follow this Act. averaging about 14 years. The Act. As a result. remuneration. there is the danger that top management may be capable of unduly influencing the board’s decisions. SET. However. Minority Shareholders and their Rights Many different rights and entitlements of shareholders are laid out in the Public Company Act of 1992. Proxy solicitation tends to be abused to the extent that shareholders are inadequately informed about matters to be taken up in shareholder assemblies. or other financial instruments. The majority of the companies (85 percent) require the appointment of external auditors during annual general meetings. shareholders have access to reliable information at no cost. Relationships between firms and external auditors are generally long-term. the corporate sector lacks a strong self-regulatory body to compel compliance with these standards. While safeguards are in place. the institutional machinery is not fully responsive to complaints about violation of shareholder rights. (iii) Because the chair is frequently also part of the top management team. as well as the registration and holding of shares. although recently. SEC. Forty-four companies indicated that they had proxy voting in place. The Act also holds directors liable for any damage to shareholders.
Banks would be obvious candidates to implement these mechanisms. Almost 82 percent of shareholders. . the only group of shareholders that can exercise rights is the top five shareholders. 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. and call an extraordinary session. such protection has been insufficient. 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. on average.248 Corporate Governance and Finance in East Asia. given their importance in providing finance and their stake in companies. In theory. But the exercise of these rights requires even higher shareholding levels. the new Public Company Act of 1992 inadvertently weakened the governance of public companies by diminishing minority shareholder rights.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. minority shareholders are assured adequate legal protection. The difficulty minority shareholders have in exercising their rights can be seen from the ADB survey results. 66 percent of total outstanding shares. it would be difficult for minority shareholders to gather the shares needed to take action. and insider trading. representing only about 28 percent of shareholdings. they comprised only 8 percent of total shareholders. and mandatory disclosure of related interests and significant shareholders’ transactions. did not vote in previous AGSMs. Only a small number of shareholders attended the latest AGSMs. Vol. On paper. In practice. In effect. Although the attendees held. But with the ownership concentration of Thai companies. takeover of the company.3. The ADB survey results reveal that the proposals presented by management were rarely rejected during the general meetings. The SEA of 1992 and the listing rules also contain provisions for the protection of shareholders against transfer pricing. 4. While stimulating the growth of the sector. minority shareholders may also appoint an outside inspector to examine the company’s operations and financial condition. however. II mechanisms in place: mandatory shareholder approval of major transactions and interested or related party transactions.
One tempering mechanism that could inhibit the excessive use of borrowing is the threat of losing control in the event of bankruptcy. Fifteen of the 20 companies that had to renegotiate loan repayment with creditors in the last five years did so after the crisis. There were many options. while loans for fixed investment were also more likely to be supported by collateral.Chapter 4: Thailand 249 Historically. however. Thailand has relied on commercial banks and finance companies to channel funds to private enterprises. a company’s reputation and its long-term relationship with creditors sufficed in many instances. Most companies reported that banks were more likely to require collateral. Debtors had many handles to stall the bankruptcy process. For 20 of the 46 responding companies. 17 indicated that only some of their creditors had such a requirement. Only 28 of the responding companies in the ADB survey indicated that their creditors required such feasibility studies. Normally. Actual bankruptcy proceedings took more than five years on average. while 18 said none of their creditors required collateral. such as that seen in Thailand before the crisis. Under a weak bankruptcy system. the majority believed that creditors had little influence on company management and decision making. Among 16 companies in the ADB survey whose loan applications in the last three years were rejected. The presence of collateral usually diminishes banks’ incentives for screening project feasibility and monitoring project implementation. Leverage allows the assets and operations of the company to grow without diluting corporate control. . including procedural disputes. However. In the end. Only three companies thought otherwise. 11 experienced rejection after the crisis started. The old bankruptcy law in Thailand also made it difficult for creditors to obtain payment against bankrupt borrowers. to solve debt repayment problems. Eleven companies stated that creditors usually exercised whatever influence they had on management through covenants regarding the use of loans. when insiders want to expand their company’s operations without losing control. which could cause a delay by at least a year. The impact of the financial crisis on credit eligibility and supervision requirements has been significant. creditors do not always require project feasibility studies or business plans in granting loans. creditors’ collateral requirements were tightened after the crisis. Apparently. 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. they resort to borrowing. as the ADB survey confirmed. other than losing control.
before the extent to which the bankruptcy framework has been strengthened becomes clear. if the purchase of shares implies a change in the directors or business activities. which is a general offer made to shareholders of a company to acquire at least 25 percent of outstanding shares. there were 41 cases of tender offers. a person who acquires more than 5 percent of issued shares must file a report with SEC one day after the date of acquisition. The first category is the acquisition of shares in the open market. (ii) an advertisement regarding the tender offer must be placed in major newspapers for at least three consecutive days. SEC was later made responsible for regulating corporate takeovers. its main role is to ensure transparency and fairness. 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. with a total tender offer value of B42. and failed to provide managers with strong incentives to perform efficiently. In this case.250 Corporate Governance and Finance in East Asia. Although merger and acquisi- . The situation remained sluggish in 1997 at nine tender offers and a further decline in total offered value. The second category is the tender offer. Recently. and (iii) tender offers will be effective 30 days after the report has been filed with the SEC. Such efforts would serve to strengthen external discipline on controlling owners. According to the SEA of 1992.3 billion (Table 4. there are two categories of merger and acquisition activities with associated regulatory measures. There are detailed requirements regarding such notification. whether directly or indirectly. The market for corporate control has not been active in Thailand. Vol. the minimum tender offer was reduced to 10 percent and some procedural modifications have also been introduced. In 1996. only a limited number of successful mergers of public companies have taken place. II The financial crisis has presented a unique opportunity for reinventing the framework for corporate bankruptcy and for creating regulatory and judicial precedents. however. there were only six tender offers.9). SEC has no authority to either approve or reject tender offers.3 billion. Since the introduction of the Public Limited Company Act of 1978. with a significantly lower total tender offer value of B8. of shareholders: (i) all shareholders must receive tender offers. The company has 21 days to evaluate the tender offer and submit a report to SEC and all shareholders. In 1994 and 1995. It will take years.
.1 58. it remains small. but the average shareholding is smaller than 1 percent of total outstanding shares. Provident funds for government workers and workers in public enterprises have been established only recently. The number of domestic institutional investors rose after the mutual fund industry was established in 1991.2 6. Eleven of the 46 responding companies in the ADB survey offer ESOPs. Few companies offer employee stock option plans (ESOPs). but employees have never been represented in the board of directors since their shareholdings are minimal.4 23. employees regard the plans as monetary incentives.1 75.9 3. trading by mutual funds in SET represented less than 10 percent of total trading.5 6.6 17. they have mostly been concerned with short-term gains. employee participation in corporate governance in Thailand.8 81.0 B billion 4. But instead of opting for an active role in the market for corporate control.2 6.2 7. Twenty-nine firms indicated that employees held shares of their companies.7 Purchase Value Number of % of Tender Offer Value Companies 84. tion activities increased after 1997.3 6. Because of the current crisis. While the Thai mutual fund industry compares well to those in other developing countries in the region.7 11. 1993-1999 Year 1993 1994 1995 1996 1997 1998 1999 a Tender Offer Valuea (B billion) 5. not with a view to becoming involved in actual management.2 8.Chapter 4: Thailand 251 Table 4.3 11.1 84.3 60. if any.1 19. Even when companies offer ESOPs. most of these were forced mergers or related to rescue packages.0 55.9 Merger and Acquisition Activities. Employee Participation in Corporate Governance There has been little. employees are even less willing to accept common shares as a form of compensation or benefit.8 8 27 14 6 9 13 23 Tender offer value refers to the minimum offer value. Pension funds are perhaps even weaker in Thailand. Since 1994. Source: Securities and Exchange Commission of Thailand.
906.5 5. the next four largest banks accounted for 63 percent.372.5 4.0 3. 1992-1999 (B billion) Outstanding Loans from All Financial Institutions 2. .3 5.8 3. Many large commercial banks had affiliates among the 93 finance companies that served the high-risk market. Competition from foreign banks was limited as they were not allowed to engage in full branch operations.4 4.4 1.5 6. accounted for 28 percent of the banking sector’s total assets.230.0 424. although its role increased in the wake of the crisis.390.5 Outstanding Loans from Commercial Banks 2.825.775. Thai Bond Dealing Centre.477.979.6 2.1 5.300. 15 of which were domestic banks.5 trillion.. The share of domestic banks in the banking system’s total assets was 80 percent. total assets of commercial banks amounted to B5.430.4.360.0 8.268.0 339.2 262.3 546.1 Corporate Financing Overview of the Financial Sector A breakdown of the Thai financial sector for the period 1992-1999 (Table 4.4 3. The Banking System Until recently.1 6. The total values of loans from financial institutions and commercial banks were consistently larger than the market capitalization of SET. and Bank of Thailand.1 3.669. Table 4.252 Corporate Governance and Finance in East Asia.1 3.171.4 519.119.564.193.4 4.133. II 4.8 941. Vol.325.10 Size and Composition of the Thai Financial Sector.3 1. The bond market played only a marginal role in corporate financing.559.1 7.0 SET Market Capitalization 1.10) shows that Thailand is a highly bank-dependent economy.663.037.6 6.485. there were 29 commercial banks.1 Domestic Debt Securities Outstanding 215.4 Year 1992 1993 1994 1995 1996 1997 1998 1999 Source: Stock Exchange of Thailand.9 2.2 2. the banking sector was highly concentrated.912. In 1996.5 4. Bangkok Bank Ltd.161. The country’s largest bank.6 1.
and property have accounted for the bulk of trading volumes. 12 existing foreign banks.Chapter 4: Thailand 253 The Government was also a major figure in the banking system. the SET index declined. and almost all capital account transactions were deregulated. the liberalization of interest rates and capital account transactions stimulated a credit expansion through short-term borrowings in foreign currency. and 20 new foreign banks. In 1993. BIBF banks also enjoyed tax incentives on their operations and profits. SET is organized into 32 major industries. In contrast.8 in 1998. the stock market entered its first boom period in 1986. Despite the worldwide market crash in 1987. Benefiting from rapid economic and industrial growth. was set up by 74 members with an initial capital of B500 million. The lack of supply of quality shares was a big problem for SET at that time. reaching 355. finance. banking. Licenses were granted to 15 Thai banks. Banks under the BIBF scheme were allowed to mobilize funds from abroad and lend to Thai companies in foreign currency. an over-the-counter market. The Government removed controls on capital and dividend repatriation in 1991. Turnover value reached B2. Some 347 companies were listed in the same year with a total market capitalization of B3. owning 70 percent of the country’s second largest bank. also made it unattractive to raise capital from the equity market. The Equity Market During the first few years of its operations. the market rose steadily and reached a record high in the fourth quarter of 1993. the Bangkok Stock Dealing Center (BSDC).2 trillion. due to their close ties. BSDC is a nonprofit. SET immediately recovered due to the strength of the Thai economy. In 1995. 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 .3 trillion. SET was not very active. Through the years. Banking activity peaked in the mid-1990s. The number of listed companies also quadrupled between 1981 and 1993. In the following years. Stock prices tripled in the next three years until the market experienced its first crash as a result of the Gulf Crisis in 1990. Easy access to commercial bank loans by family business groups. Many company founders did not want to release even a small portion of corporate ownership and refused to go public. Because borrowers carried the exchange rate risk. the Government established the BIBF to expand the banking sector and reduce the borrowing costs of Thai companies. After that.
The primary market is supervised by SEC. and (ii) a minimum of 300 shareholders. however. Before 1993. the BSDC was dissolved in 1999. which consist of SET and BSDC. In 1996. 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. there were two kinds of companies in SET—“listed” and “authorized” companies. SET established new requirements for initial public offerings. A company wishing to qualify for listing in SET must file an information booklet (prospectus) with SEC and SET. which has a legal mandate to examine a company’s financial status and operations before allowing it to issue securities to the public. In 1998. II jurisdiction of SEC. Company applicants must have an established history of operating under substantially the same management. to assist in the public offering process. stock trading can commence within five days. If approved by SEC and the SET Board of Governors. lottery drawing must be used to ensure fairness. the two classifications were merged. securities deposit center. Consequently. It separated the primary and secondary markets to promote more flexible and effective supervision of both. also acts as a clearinghouse.5 percent and collectively owning at least 30 percent of paidup capital. . Authorized companies were those with a minimum of 200 shareholders owning collectively at least 25 percent of paid-up capital. The allocation procedure is nondiscretionary. with each facing different listing requirements. approved by SET. so now only listed companies are traded in SET. turnover value was negligible and the BSDC Index remained flat throughout 19961998. SET. The company should then appoint a financial adviser. In July 1990. If the issue is oversubscribed. According to the SEA of 1992. but dropped the following year to B122 million. and pro forma balance sheet and income statements. financial projections. The listing application should be submitted concurrently to SEC and SET. and securities registrar. Turnover value was B1. Vol.8 billion in 1996. each holding no more than 0. After initial public offerings. Only one security was listed in BSDC in 1995 and two more in 1996. The SEA of 1992 installed the legal and regulatory framework for Thai capital markets. securities can be traded in the secondary markets. among other functions approved by SEC.254 Corporate Governance and Finance in East Asia. 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.
However.9 billion. State-owned enterprises became active issuers of bonds since 1993 because the Government constrained their borrowings (Table 4. The budget surpluses of the 1990s eliminated the need for new bond issuance. The corporate sector played a limited role in the bond market in the early years because of the complicated rules and regulations in effect at that time. The Thai Rating Information Services. A breakdown of domestic offerings of corporate debt securities from 1992 to 1996 shows that unsecured debts accounted for about 60 percent. which encouraged limited companies and public companies to issue debt instruments. however. To gain some perspective of the size of the bond market in Thailand. the first bond rating agency in Thailand. the size of the corporate debt market rose to B132. and the Government did not issue new bonds during 1990-1997. In 1996. led to the renewed issuance of Government bonds to finance the resurgent budget deficit and support cash-strapped financial institutions. in 1994. The bond market in Thailand started in 1933. it represented only 9 percent of GDP. the year the Ministry of Finance first issued government bonds to finance infrastructure projects and economic development. Companies generally issued short-term debt instruments like promissory notes or bills of exchange. The proportion of domestic convertible debt instruments increased until 1995. 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. Upon its founding in 1942. A turning point of the corporate debt market was the enactment of the SEA of 1992. while secured debt instruments accounted for just above 10 percent. was also instrumental to the growth of the corporate debt market. the Government issued more bonds to finance industrial development projects and perennial deficits. Beginning 1961. at about 11 percent of the total value of outstanding loans extended by commercial banks and 20 percent of total equity market capitalization.Chapter 4: Thailand 255 The Bond Market The Thai bond market has played a marginal role in corporate financing until recently. Four years after the passage of the SEA. The recent financial crisis. . it accounted for a small share of the entire financial sector. compared to 110 percent in the US and 74 percent in Japan in the same year.11). the Bank of Thailand assumed responsibility for regulating the bond market. 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. Investors had limited knowledge of debt instruments.
7 7.7 538.7 28.6 billion.7 5.7 — — 40.8 47.1 107.4 billion.2 28.1 10.9 30.1 315.9 5.4 — — — 1. The club was considered the first organized secondary bond market in Thailand to serve as the wholesale market for debt securities.2 89.0 17. BDC was established in November 1994 by 50 securities companies based on the provisions of the SEA of 1992. turnover value had reached B51.6 19.2 45.0 7.2 57. the year the crisis unraveled and the baht was floated. a surge attributed to capital inflows encouraged by high returns on Thai bonds.3 29.5 — — — — 1.5 43. this had climbed to B200.0 33.1 — — 6. Vol.4 — 9. then declined substantially in 1996 and 1997.3 140. by the end of 1997.7 0.5 — 39.5 138.1 59. Total offshore debt offerings peaked in the run-up to the financial crisis.7 821.0 0.7 — — — — — — — 77.6 — — 0.1 141.8 55.3 6.9 0.8 2.7 95.256 Corporate Governance and Finance in East Asia.9 20.0 — 5.4 110.11 Offerings of Debt Securities.1 12.8 191.7 5. .0 5.5 37.0 27.4 — 26. A sharp rise in unsecured offshore debt offerings can be noted all the way through 1996. The decline in total domestic debt offerings in 1996 can be ascribed to the increase in offshore convertible debts.4 57. II Table 4.3 — — 3.1 41.1 55.1 289.3 46.1 — — — 29.5 — — 32.1 121.3 46.7 0.4 49.9 37.8 Source: Securities and Exchange Commission of Thailand and the Thai Bond Dealing Centre.0 26.0 333.7 132.3 3.7 — — — — — 4.5 10.5 5.3 22.0 — 5. total offshore debt offerings had plunged by 68 percent to a mere B28.5 55.6 — 0. The domestic debt market declined after 1994 because corporations could borrow offshore at lower costs.3 13.7 90.2 43.0 86.5 — — — 3.1 21.2 — — 50.5 billion. However. 1992-1999 (B billion) Item Government Bonds Treasury Bills State Enterprise Bonds Guaranteed Nonguaranteed Other Government Bonds Corporate Bonds Domestic Secured Unsecured With Warrant Convertible Short-Term Offshore Secured Unsecured With Warrant Convertible Total 1992 1993 1994 1995 1996 1997 1998 1999 — — — — — — 400.1 6.2 39.5 — 0.0 60.9 40. The following year.9 37.1 61.4 7.1 8.3 50.3 8.9 329.8 167.0 — 26. By 1995.2 2.8 31.3 — 14.0 281.
overall asset quality and liquidity of listed Thai companies deteriorated throughout the period. significant variations can be noted. In any case. There was also little change in the trend in retained earnings within the seven-year period. The proportion of accounts receivable also declined steadily. The overall trend is consistent with the decline in profitability observed in the analysis of corporate sector performance earlier. 4.12). The ratio of net working capital to total assets decreased from a peak of 31 percent in 1993 to 28 percent in 1996. In the same year.2 Patterns of Corporate Financing An examination of financing patterns among Thai companies listed in SET shows that on the asset side. these comprised 31 percent.1 billion in 1998.2 billion as a result of the default of debentures due to the Asian crisis. Longterm loans accounted for about 20 percent of total liabilities. and marketable securities holdings. Retained earnings accounted for about 30 percent of total equity financing. In 1997. Equity financing remains an important part of listed companies’ long-term financing. The closure of 58 finance companies affected the BDC significantly since half of its members were suspended as a result. cash balances. Across industries. a trend most apparent in the leap between 1991 and 1992. the use of debentures remains minimal even though the trend was generally upward until the 1997 crisis. From 1990 to 1996. For the construction industry. listed companies experienced liquidity problems with declining reserves of cash and marketable securities during the period 1990 to 1996 (Table 4. The average for all industries was only 22 percent. Companies in construction and property development seemed unable to generate internal funds.4. turnover value plummeted to B106. these accounted for 33 percent of total liabilities. In addition. short-term loans accounted for more than 40 percent of total liabilities. steadily easing up between 1990 and 1996. At lower than 5 percent of total liabilities. while for the property development industry. BDC was renamed “the Thai Bond Dealing Centre” following its status upgrade to a bond exchange. Construction and property development industries tended to have high proportions of long-term loans and debentures.Chapter 4: Thailand 257 compared with investment in equities. with equity levels remaining high despite an increase in debt. Turnover fell further to B72. Thailand’s publicly listed companies rely mainly on loans from commercial banks and financial institutions to finance their growth. judging by their relatively low levels of retained earnings. they also had a relatively small proportion of equity and .
0 100.3 38.8 17.4 7.7 0.2 17.7 15.6 11.2 45.6 36.6 0.9 16.0 2.8 46.4 17.0 100.3 18.8 19.1 18.4 17.5 1.1 50.8 20.0 14.2 22.1 17.0 12.5 0.3 48.3 17.4 6.8 37.8 21.0 51.9 18. medium. and low) also underscores that companies with high ownership concentration had high levels of long-term loans (Table 4.4 8. Analysis of common-size statements by ownership concentration (based on the levels of top-five ownership concentration classified as high.0 15.9 2.2 43.0 100.8 6.3 6.2 12.7 36.2 2.7 16.7 7.6 12.3 50.6 18. The agribusiness industry relied more heavily on short-term loans at 56 percent of the industry’s total liabilities.9 6.3 1. Vol.4 14.2 34.6 15.0 7.0 100.7 50.2 16.9 0.7 14.8 25.0 10.1 5.9 17.2 17.0 100.0 100.0 13.7 18.6 50.9 14.6 0.8 7. US. II Table 4.8 34.2 1.5 9.5 1.6 100.9 12.3 34.4 21. 1990-1996 (percent) Item All Years 1990 1991 1992 1993 1994 1995 1996 2.8 37.4 49.0 100.3 14.8 8.2 17.0 48.6 6.13).2 17.8 35.12 Common-Size Statements for Companies Listed in SET.6 8.9 14.8 9.9 14.6 38.1 2.8 9.0 100. Printing and publishing companies had lower financial leverage than companies in other industries.9 49.4 2.0 100.5 43.9 38.0 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.258 Corporate Governance and Finance in East Asia.2 42.0 100. The level of total liabilities for the group characterized by high ownership concentration .2 43.9 15.9 20.7 1.0 1.6 100.1 49.2 15.6 13.6 14.9 14.8 3.6 10.6 51.3 1.0 100.1 7.0 100.6 0.2 35.3 21.8 1.7 9.9 43.3 49.1 36. compared with the 44 percent general average.2 1.1 13.3 2.3 12.6 0.3 14.2 2.9 50.9 40.4 48.4 43.5 37.4 49.9 17.0 100.6 22.7 16.6 21.6 2.9 6.2 1.2 3.8 14.9 3.0 100.2 2.5 14.9 14.2 2.9 10.5 11.3 25.5 9.7 17.0 10.7 52.2 16.5 1.8 10.3 18.3 34.0 6. were highly leveraged.
9 0.5 100.5 11.4 1. common equity accounted for a smaller proportion of total assets (47 percent) than companies with lower ownership concentration.0 Source: Pacific-Basin Capital Markets Database compiled by the University of Rhode Island.4 7.1 18.2 11. was 53 percent of total assets compared with 49.Chapter 4: Thailand 259 Table 4.0 Low 1.0 100.9 50.6 15.6 22.4 37.6 47.6 0.9 7.2 0.4 3.0 6.9 36.1 44.3 16.9 21.3 8.9 100.0 41.0 7.5 13.2 8.8 13.7 17. Companies with medium ownership concentration tended to have a higher proportion of short-term loans.8 12.7 19.3 35.2 14.0 100.2 22.3 100.7 12. .4 18.0 16.4 13.4 50.8 13.13 Common-Size Statements of Public Companies by Ownership Concentration.4 35.8 37.7 percent for medium ownership concentration companies and 49.5 percent for low ownership concentration companies.0 14.9 16. 1990-1996 Degree of Ownership Concentration Item Assets Cash Marketable Securities Accounts Receivable Inventories Other Current Assets Total Current Assets Net Fixed Assets Other Assets Total Assets Liabilities and Equity Accounts Payable Short-Term Loans Other Current Liabilities Total Current Liabilities Long-Term Loans Debentures Other Liabilities Total Liabilities Capital Stock Paid-In Capital Retained Earnings Total Equity Total Liabilities and Equity High 2.3 1.0 6.3 1. This is consistent with the observation that majority shareholders try to maintain their control by utilizing debt as a major source of funds.5 21.0 Medium 2.1 49.0 19.1 53.6 2.1 36.5 18.4 49.2 45. For the high ownership concentration group.6 14. US.6 9.9 2.6 100.
As a result. thus rendering them more vulnerable.1 52.8 151. the choice of financing is determined by the company’s liquidity considerations.6 125.7 34. While further detailed investigations are necessary.7 28.4 44. 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 4.9 140.15.9 14.1 31. especially from 1994 to 1996.5 52.1 16. Public companies relied more on short-term debt financing in the period before the financial crisis. followed by bank loans. these firms more easily increased their leverage.1 44. 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 8.14).4 12.2 49.8 65.4 51. bond issues overtook loans from commercial banks as the second preference.6 7.0 25.1 64. After the crisis. Table 4.7 in 1994 to 5. it would seem that firms with concentrated ownership and associated links to the banking system have easier access to debt financing.7 percent in 1996.9 63.6 41. however.9 51. bond issues.9 7.7 66.4 139. The direct relationship between the degree of leverage and the degree of ownership concentration is apparent in Table 4.4 5.6 138.14 Financial Ratios of All Listed Firms. The TIE ratio declined from its peak of 7.3 Source: Estimated from the Pacific-Basin Capital Markets Database compiled by the University of Rhode Island.8 percent in 1990 to 52.8 65.3 61. The financing patterns indicate that companies with high ownership concentration were more highly leveraged than companies with medium and low concentration.260 Corporate Governance and Finance in East Asia. and rights issues. Vol. More important.8 5.0 145.4 7. II Results from the ADB survey reveal that Thai companies preferred to use reserves and retained earnings as their first choice of financing.7 12.1 144. . The ratio of total debt to total assets increased from 50.1 31. was the headlong deterioration of firms’ ability to meet their interest payment obligations. Such deterioration of financial positions during the period was a common feature of listed companies.7 12. minimization of transaction and interest costs. US.1 16. Generally.1 23.8 51.7 5.7 34.2 35.3 31. and maintenance of the existing ownership structure.2 68.0 50.1 in 1996.0 28. however.7 11.5 38. Short-term debt accounted for most of the increase.
From 45 percent of total net capital movements in 1985. 4.1 High 6. The proportion of external debt as a percentage of GDP consequently increased from 42.4 27.2 124. the proportion of short-term debt increased from 15.2 49. The composition and term-structure of this debt.8 29. and a preponderance of short-term debt liabilities.5 percent of external debt in 1996 (Table 4.5 126.9 percent in 1997.2 percent in 1986 to 251. debt-creating capital inflows rose to 65 percent in 1990.6 30.7 percent from 1991 to 1996. US.8 14. is even more telling.6 11.Chapter 4: Thailand 261 Table 4. .3 Source: Estimated from the Pacific-Basin Capital Markets Database compiled by the University of Rhode Island.4 63. on the other hand.4 13. continued to slide from 1985 to 1997. This decline was accompanied. such as direct equity and portfolio investment. however.4 52.16).8 28.5 percent between 1985 and 1990 to 8.5 148.3 42.8 66.8 49. The proportion of nondebt-creating capital flows. 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. Nonbank private debt increased from 27. Additionally.8 percent in 1986 to 52 percent in 1995. 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 6.1 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.4 percent to 46 percent during the same period. unhedged foreign exchange liabilities.8 Medium 7. Their average annual growth rate declined from 28.5 34. From only 34 percent in 1986.15 Financial Ratios of Listed Companies by Ownership Concentration. The corporate sector contributed significantly to the crisis because of its rising levels of leverage.5 4.5. peaking in 1994 at 84 percent. private debt accounted for 84.0 64.
5 16.9 43.7 13.9 100.7 24.0 13.8 13.2 2.3 0.9 10.9 1.5 14.16 External Debt.4 2.3 10.8 0.3 3.8 31.9 7.5 1.2 15.3 0.2 0.2 0.7 1.4 18.9 3.1 Source: Bank of Thailand.7 109.3 0.0 6.3 20.0 11.1 12.3 16.4 10.1 22.0 0.9 0.3 12.6 7.2 0.9 13.8 3.6 Total 18.3 0.3 2.8 10.3 37.4 15.6 18.1 0.3 0.2 2.6 52.7 2.0 11.9 11.3 0.1 0.0 Long-Term Short-Term BIBF Commercial Bank Long-Term Short-Term 0.6 — 0.2 32.1 95.9 5.7 0.9 6.3 3.8 3.9 1.4 — — — — — — — 1.4 3.2 2.9 35.3 7.5 4.3 105.1 30.2 14.Table 4.5 19.5 4.6 1.9 4.9 31.1 34.0 4.1 23.1 5.4 5.8 12. .3 0.3 0.2 10.1 0.5 12.1 2.0 8.7 23.6 Government Year Long-Term Short-Term 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 12.9 6.7 20.5 12.8 108.9 29.3 — — — — — — — 6.1 64.9 3.0 3.9 10.1 0.0 21.7 10. 1986-1999 ($ billion) Private Nonbank Long-Term Short-Term 3.
nonfinancial companies also experienced severe liquidity problems as a result of the baht’s devaluation. suggesting that serious investors have not returned to the market. Aside from the problem of NPLs. The effects of the crisis were felt across all industry sectors. foreign currency-denominated debts constituted 55 percent of their total debt portfolio. and (iii) bankruptcies. closures. exposing the companies to disaster when the baht started tumbling on 2 July 1997. After that. the index declined to 1.6 billion from the 1996 level of B201 billion. Most of these foreign debts were not properly hedged. Trading volume has since been thin. outstanding credit also declined throughout the second half of 1998. The severity of the impact of the crisis on the corporate sector was apparent from (i) the decline in the volume of public offerings. and poor business confidence on the other. With easy access to foreign funds.6 in December 1996.281 in December 1995 and to 831.17). the number of newly registered companies dropped to a 10-year low in 1998.Chapter 4: Thailand 263 This shows that although banking and finance companies suffered most because of their short-term exposure. . SET’s dismal performance is indicative of the extent of the setback suffered by the Thai capital market. On average. trading activity at SET had been on the downturn. Even before the crisis. reaching 45 percent of total outstanding credit in December. 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. from its peak in 1995. If lending rates remained high. Foreign investors retreated from the market. according to the Bank of Thailand. The proportion of NPLs as a percentage of outstanding loans demonstrates the liquidity problem experienced by the corporate sector. the SET Index stood at 1. NPLs spiraled from 12 percent in the second quarter of 1997 to almost 40 percent in the third quarter of 1998. Similarly. leaving domestic investors with large capital losses. banks would be recording more of such NPLs. (ii) the rise in the nonperforming loan (NPL) ratio and consequent tightening of credit even for viable firms. the liquidity problems faced by the corporate sector are likely to continue for some time. large Thai companies had actively borrowed at low interest rates from foreign financial institutions.360. It hit a 10-year low in the second quarter of 1998. and drastic decline in the number and capital of newly registered companies. Due in part to liquidity problems on the one hand. the numbers of bankruptcies and company closures reached all-time highs in 1998 (Table 4. based on the three-month past due definition. At the end of 1994. Meanwhile. The value of public offerings sank in 1997 to B56.
080 9.095 14. It also explains the higher dividend yield ratio.792 7.977 Source: Department of Commercial Registration.312 25. Vol. The first Letter of Intent was cosigned by the Minister of Finance and the Governor of the Bank of Thailand on 14 August 1997.307 4.224 4.288 35.17 Number of Newly Registered and Bankrupted/Closed Companies.334 4.5 at the end of 1994 to 12 in 1996 and further to 6.777 11.066 19. .2 Responses to the Crisis Initially.052 36. IMF required Thailand to meet a set of performance criteria and implement various restructuring measures. Thailand.112 9.797 4. A steady price decline over the past few years has dragged down the ratio of market price to book value.218 3.410 5. The IMF financial package was a credit facility of $17. the Government was left with no choice.105 4.409 6. As part of the assistance package.933 25.096 22.201 24.2 billion for balance of payments support and buildup of the country’s reserves.264 Corporate Governance and Finance in East Asia. Ministry of Commerce. the Thai Government was lukewarm to the idea of obtaining IMF assistance because of the requirements and conditions attached to the financial package.915 37. 1985-1999 Year 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 Newly Registered 10.6 in 1997. II Table 4.134 31.407 28. But when assistance from other sources did not materialize.695 3. 4.925 12.904 20.410 37.5. The price-to-earnings (P/E) ratio deteriorated from 19. The increase of the P/E ratio in 1998 was mostly a result of a decrease in earnings for most listed companies.677 Bankrupted/Closed 2.902 3.
There were many options for solving debt repayment problems. and the Act Regulating the Finance. While no definition for “insolvency” could be found in the bankruptcy law. For example. and did not recognize debtor-initiated bankruptcy declarations. and if necessary. debtors could drag out the process for many years. and income recognition were implemented. secured creditors had to obtain the court’s approval before starting proceedings . They could seek civil action through the courts and could also use criminal sanctions to enforce debt repayments. and restore solvency. The assets of the other companies were liquidated by auctions. also aimed at institutionalizing legal and regulatory reforms. Securities. creditors seldom succeeded in obtaining payment against bankrupt borrowers. The Financial Sector Restructuring Authority was established in October 1997 to address the problems of 58 finance companies that were suspended in 1997. The Government required all remaining financial institutions to recapitalize and instituted closer monitoring measures to ensure full compliance with this requirement. By invoking procedural loopholes. only two companies emerged intact from the suspension. Regulatory Response by the Government The IMF program. The Bank of Thailand also improved banking standards. Under the old bankruptcy laws. The Government also passed the Bankruptcy Act and Foreclosure Act Amendments. IMF relaxed these key conditions. loan provisioning. follow through with a civil or bankruptcy suit. As it turned out. The old law allowed only creditors to file bankruptcy suits. and worked on revisions to the Secured Transaction Law. Creditors could negotiate to reschedule debt repayments. In early 1998.Chapter 4: Thailand 265 The terms of the agreement required the Government to maintain tight monetary and fiscal policies. increase profitability. Several changes in the banking and financial policy environment have been effected in line with the restructuring program. and Credit Foncier Businesses. the Civil and Commercial Code. Strict loan classifications. The core of the IMF conditionalities was the restructuring of the banking and financial sector to regain investor confidence. it was widely interpreted as “having debts more than assets.” Creditors thus bore the burden of proving a debtor’s insolvency before the courts. Many believed that the process was inefficient. drawn up with World Bank and ADB assistance. These include repeal of the Commercial Bank Act. however.
any new loan to a company extended after the creditor discovered the insolvency would not be eligible for repayment. which means that a debtor could continue in business while the reorganization program was being implemented. The model for Thailand’s amended bankruptcy law was the US Chapter 11. But more important. the main purpose of which is to assist in the rehabilitation process so that a company can repay its debt and still retain its assets while remaining in business. The reorganization process is successful if (i) the debts shall have been discharged. II for the recovery of debt through the realization of any collateral. In Thailand. In effect. Under the old Bankruptcy Act. the company shall be declared bankrupt and liquidation of assets shall follow. (iii) shareholders regain their legal rights. Chapter 11 cases account for only 5 percent of bankruptcy suits in the US but consume 90 percent of the courts’ time. the National Assembly passed an amended Bankruptcy Act and approved the establishment of special bankruptcy courts. Vol. There are other potential problems. To make matters worse for creditors. Foreign secured creditors had to go through the motions of establishing that their country of domicile granted Thai creditors similar rights. For one. 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. but it is a complicated. and expensive process. the judges and court officers have yet to learn and master the new bankruptcy procedure. The original Bankruptcy Act dealt only with liquidation and composition. The amendment added reorganization provisions to the Bankruptcy Act of 1940. 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 1999. time consuming. The amended legislation also includes voluntary bankruptcy as a new feature. the amended law limits the rights of secured creditors. it covers only the court-supervised reorganization of distressed companies. If the process fails to revive the business. and (iv) the debts shall have been settled within a five-year period. The amended law also introduced the concept of automatic stay. Companies need . thereby allowing court-supervised corporate restructuring. Enforcement of the new law is bound to be ponderous and lengthy. Chapter 11 is the main tool in restructuring bankrupted companies in the US. creditors always had to contend with the threat of disruptions in a delinquent borrower’s business. (ii) management of the company reverts to the borrower.266 Corporate Governance and Finance in East Asia.
only tangible assets were the norm. Most important.. the court. shall have the power to call the extraordinary general meeting.” The Foreclosure Act Amendment was likewise passed in 2000. the Bankruptcy Amendment will just prolong the problems of nonviable borrowers. Still pending Parliament approval is the amendment to the Secured Transaction Law. has not been satisfactory. In case the board of directors does not comply. Procedural delays give borrowers an advantage because they can refuse to pay back their loans even though they can meet their obligations. namely “liabilities exceed assets. however. the test for insolvency still uses the balance sheet criterion. The proposed new law seeks to expand the type of assets that a borrower can use as collateral. which aims to increase liquidity in the domestic economy by allowing businesses to use both tangible and intangible assets in securing credit. and (ii) processing of default cases within four to six months of filing of a court claim. In the past. The proposed amendment also includes a provision for the company to reimburse minority shareholders for expenses related to calling such a meeting. questions have been raised regarding the appropriateness of the 1992 Act. minority shareholders’ rights are not adequately protected. Consequently. 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 amendment also remedies the slow process of executing or disposing of assets in a public auction.g. corporate governance) that caused the bankruptcy in the first place. Without the necessary corporate restructuring. . SEC also examined the possibility of an amendment to the Public Company Act of 1992. 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. after determining the legitimacy of the request. Under the new law.Chapter 4: Thailand 267 to solve the problems (e. The amendment seeks to revise old rules and procedures that tended to delay foreclosure proceedings. the 1992 Act relaxed some of the original restrictive rules and regulations to encourage public company registration. Replacing the Public Limited Company Act of 1978. The result.” as opposed to the more appropriate criterion of “ability to pay when the debt falls due. 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.
who are also the managers. The 1992 Act also allows directors to engage in business activities that may directly or indirectly affect the company. minority shareholders are likely to be wary of increasing their equity without corresponding control mechanisms at their disposal. Where equity will come forward. 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.. it permits directors. But as demonstrated. in turn. The textbook separation between owners who sit in the company’s board and professional managers who run the company does not apply in Thailand. The 1992 Act only prescribes—not requires—the use of the cumulative voting procedure. II Another issue is the assumption in the 1992 Act that there is a separation of ownership and control functions. with the approval of the board. Most companies decide against cumulative voting. claiming that it creates fragmentation in the board of directors. But because this is the assumption embedded in the regulation. they face the prospect of being unable to compete for the scarce funds available in the equities market. The regulators are drafting a proposal to amend the provisions on related transactions. disrupts the company’s management and decision making. Otherwise. this is not so in publicly traded companies in Thailand. However. Vol. 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. i. The proposal for the amendment of the Public . This may be true in countries where publicly traded companies are widely held.268 Corporate Governance and Finance in East Asia. to borrow from the company without consideration to the fairness of the transaction or transparency of the approval process. which. vis-a-vis the minority shareholders. and determine voting results on virtually any matter.e. 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. there are few provisions in the Act that deal with related or connected transactions that potentially reduce shareholders’ value. Consequently. Because of high ownership concentration. The proposal clearly delineates duties of care and loyalty for directors of public companies. it will probably be expensive because of the higher risk that comes with weak accountability mechanisms. In addition. without cumulative voting. minority shareholders have no chance of being represented in the board. subject only to approval by the board of directors. the dominance of controlling shareholders. the main problem is overlooked. In the absence of such a stock market boom now. the controlling shareholders have the exclusive domain to appoint or exercise management.
Another 77. Considerable progress has been achieved on this front.1 trillion in outstanding credit. However.147 cases (B1. Within three months. and manufacturing sectors. as well as those that did not cooperate with CDRAC’s restructuring process. with the majority of the debtors coming from the commerce. As of November 2000. Equally important is the contribution of effective and reliable bankruptcy procedures for improved corporate governance.767 cases involving outstanding credit of B2. Reforms in bankruptcy procedures should be seen not only in the context of crisis resolution. although since then.6 trillion) have agreed to cooperate with CDRAC’s restructuring process. 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. This point is crucial because compared with . The reason is that bankruptcy law amendments appear to facilitate settlements outside the court.068 cases involving B475 billion are undergoing restructuring. accounting for B1. 322. The first bankruptcy court in Thailand opened on 18 June 1999. Some 82 percent of these cases have been successfully restructured. Corporate Debt Restructuring and Bankruptcy The 1997 crisis led to a severe liquidity problem in the economy. Cases for which negotiations were unsuccessful. In response.8 trillion had been completed. the mere threat of external control alters the incentives faced by managers and controlling shareholders significantly. By October 2000. The Bank of Thailand issued guidelines in 1998 encouraging financial institutions to specify their own policies. the court had more than 80 cases for disposition.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.6 trillion. contributing to the unprecedented rise in the corporate sector’s bad debt. In addition. will be settled by the courts. the number of cases has abated. Another 5 percent of cases (B70 billion) are undergoing restructuring negotiations. where bankruptcy procedures are swift and effective. only 7. CDRAC’s target debtors comprised 10. methods. the Government introduced debt restructuring-related measures to help resolve bad debts. Commercial banks initiated 74 percent of these cases. In particular. and procedures for debt restructuring. personal consumption.764 debt restructuring cases involving B1.1 trillion of outstanding credit. accounting for B1.
Examination of corporate ownership.6 4. The economic development of Thailand took off with the implementation of a series of National Economic and Social Development Plans beginning with the first medium-term plan for 1961 to 1966. Financial information from listed companies will also soon be required to conform to International Accounting Standards. Philippines. II Malaysia. It required listed companies to establish their own audit committees by the end of 1999. The banking industry played a key role in the early stages of economic development because it represented the only avenue for funding Thai corporations. 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. In the next three decades.6. For this reason. the Thai Government managed its economy with the corporate sector as the main engine of growth and development. and promoted key industries through incentives.1 Summary. and performance during this period helps understand the causes of the crisis. The study covers the period 1985 to 1996. 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. Reforms through SET and Improved Disclosure The financial crisis prompted SET to introduce a range of improvements to its operation and regulation. despite the weakness of their disciplinary powers. the Government protected certain corporate sectors through tariffs and regulation. and Recommendations Summary and Conclusions This study has provided an overview of the corporate sector and governance in Thailand. behavior. and even Indonesia. Conclusions. 4. Such improvements in disclosure standards are part of the efforts of SET and SEC. Emphasis was on the structure of corporate governance and patterns of corporate ownership and financing of publicly listed companies. Weak bankruptcy procedures were part and parcel of the perverse set of incentives that led firms to build up unsustainable levels of debt.270 Corporate Governance and Finance in East Asia. to push companies to harmonize their accounting with international standards. The . The exchange has already required that listed companies’ quarterly reports be directly comparable with annual statements. Vol.
One of the principal causes of the crisis was the excessive use of foreign debt by the corporate sector. the profitability of publicly listed companies abruptly declined and their financial leverage increased. In 1995 and 1996. One of the major findings is the high ownership concentration among Thai companies listed on SET. On average. the numbers of bankruptcy cases and company closures reached alltime highs. In 1992. the increase in long-term debt more than compensated for the drop. The impact of the crisis was felt across all industries.Chapter 4: Thailand 271 importance of bank financing continued throughout the 1990s. The study examined the impact of ownership structure on corporate governance and financing patterns. foreign debt in the Thai corporate sector increased continuously. At the same time. Although there are some variations across industries. the overall corporate sector was seriously affected. Thai companies were vulnerable to exchange rate risks. During 1992-1997. 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. even after the development of capital markets. the corporate sector entered a new era with the enactment of two major pieces of legislation. Subsequently. the number of listed companies in SET fell from 454 in 1996 to 392 in 1999. the number and value of public offerings of securities accelerated. The financial performance of the corporate sector remained satisfactory up to the years before the outbreak of the financial crisis. the devaluation of the baht that began on 2 July 1997 affected the financial condition of Thai corporations. Nonbank private corporations accounted for most of the increase. The SEA of 1992 also marked the beginning of an active bond market in Thailand. Because most of these debts were not hedged. Consequently. After 1992. The number of newly registered companies in 1997 dropped by almost 10. At the onset of the 1997 financial crisis. the Public Company Act of 1992 and the SEA of 1992. Although there was a decline in short-term foreign debt. at a time when most of them were already experiencing declining profits and high leverage. the overall pattern of ownership concentration seems to have been stable for the past 10 years. . Meanwhile. Minority shareholders. Profitability increased throughout the 1980s but began to decline in the first half of the 1990s. Financial liberalization apparently encouraged companies to borrow overseas to finance investments that were not productively employed. the top five largest shareholders hold about 56 percent of total outstanding shares. reaching its peak in 1996.000 from the previous year’s level. there was a marked increase in the number of public corporations.
there is a clear lack of outside monitors for these publicly listed but family-controlled companies. 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. Recently. the government pension fund was the only major institutional investor. Nominally. The highly concentrated ownership structure weakens the protection of minority shareholder rights. Financial institutions hold a very small proportion. Thus. The rules in both Acts governing . All these. contribute to the lack of external controls on the corporate sector through the capital markets. The implications of ownership structures that are concentrated to such a high degree are serious. publicly listed and unlisted companies in Thailand are equally subject to the consequences of the risk-taking behavior of controlling owners. These laws stipulate rules and regulations concerning the activities of all public companies. In the past. hold only a small portion of total outstanding shares. commercial banks hold only about 2 percent of total outstanding shares while nonbank financial institutions hold about 6 percent. averaging 46 percent. Among the five largest shareholders of Thai companies listed on SET. II although larger in number. holding companies and affiliated corporations hold the largest proportion at 27 percent of total outstanding shares. The Government holds about 1 percent of total outstanding shares but these holdings represent majority shares of a few companies. Consequently. the existing legal and regulatory framework suggests otherwise. foreign and domestic. Individuals and insiders hold the second largest proportion at about 19 percent. are not active. they have little influence over management decision making and control. protect the interests of all shareholders of public companies. Vol. An analysis of the corporate ownership structure in Thailand suggests that founders and management continue to own and control publicly listed Thai companies. With financial institutions playing limited roles in the capital market. the mutual fund industry has entered the picture but with limited roles and activities. 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. The key laws. through the use of holding and affiliated companies.272 Corporate Governance and Finance in East Asia. Institutional investors in Thailand. along with a highly concentrated ownership structure. The absence of external market controls on the management of publicly listed corporations is dangerous. the Public Company Act of 1992 and the SEA of 1992.
Certain provisions. a requirement impossible to meet due to the concentrated shareholdings of founding family members and management. but is significantly related to financing patterns.6. In view of this. The third issue involves creating external market controls through better regulation and development of the capital markets. moreover. 4. posed formidable barriers in the minority shareholders’ exercise of their rights. making them vulnerable to economic shocks. the main challenge is in protecting minority shareholders from the possibility of expropriation by the majority. The Government has been moving to amend the Public Company Act of 1992 to increase minority shareholders’ protection in this regard. The second issue involves the protection of shareholder rights. laws did not provide minority shareholders sufficient safeguards in cases of transactions involving companies where the controlling shareholders had related interests. key reforms that will strengthen the regulation of financial institutions. because there is no separation between ownership and management.2 Policy Recommendations There are three major policy issues and recommendations that could improve corporate governance in Thailand. However. For example. before the crisis. In this third area. these companies tend to become overleveraged. 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. Consequently. The ownership structure of Thai listed companies also significantly affects company behavior. because there are shared interests between the controlling shareholders and key management personnel. the Public Company Act of 1992 allows shareholders to act only when they hold a minimum proportion of shareholdings. For instance. 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. Rather. the main challenge is not how the board can control management to maximize shareholder value.Chapter 4: Thailand 273 minority shareholders’ participation in decision making and in initiatives against management conform to international standards. . The first issue involves the development of a comprehensive supervisory framework and the strengthening of the capacity of supervisory agencies. It appears that founding family members use debt extensively to finance investments because they want to preserve control of their firms. Specifically.
SET was mandated to supervise listed companies. Protection of Shareholder Rights The common assumption is that publicly traded corporations are widely dispersed in terms of ownership. and after the enactment of the SEA in 1992. the Ministry of Commerce had the sole supervisory responsibility. SEC was established as another supervisory agency. he/she often has the decisive vote. with control delegated to professional managers. The best approach may entail establishing a single. the supervisory agencies also need to be empowered to enforce the laws. the key issue in corporate governance would then be to ensure that managers act in the best interests of the shareholders. In this setting. The owners of a firm rely on a board of directors to supervise the managers. three major government organizations (the Ministry of Commerce. Only then will these agencies be able to act promptly and effectively. If this were the situation. There is also supposed to be separation of ownership and control. The board therefore plays a pivotal role. in 1975. in most of Thailand’s publicly traded firms. the supervisory system is fragmented and not as effective as it should be. and increase the participation of institutional investors are imperative. The Government must develop an overall framework for corporate sector supervision and redefine the regulatory jurisdiction of each agency along functional lines. Vol. SET. Consequently. It is important that the roles and responsibilities of each agency are clearly defined to the public. and SEC) are involved in corporate supervision.274 Corporate Governance and Finance in East Asia. voting only on major decisions. As in other crisis economies in the region. the key issue in corporate governance is how to prevent insiders from expropriating assets of minority shareholders. Once the roles and responsibilities are clearly defined. . If the principal shareholder is in fact chair of the board. II encourage market competition. this is a problem in Thailand. activate the market for corporate control. Under the current system. This is due to the historical development of the Thai corporate sector: before 1975. In reality. Development of a Comprehensive Supervisory Framework There is a need for the Government to establish a comprehensive supervisory framework for the corporate sector. unified supervisory agency or a permanent regulatory division consisting of supervisory units from the three agencies. the principal shareholder typically plays a key role in management and often serves as the chief executive officer.
Since the Asian financial crisis. and . and a prohibition of connected transactions by directors or management. transparency. The Ministry of Commerce is conducting a study on proposed amendments to the Public Company Act of 1992. the Government can change the shareholding limit for controlling shareholders. The current ownership structure leads to ineffective corporate governance and inadequate protection of minority shareholders. regulators must increase transparency and step up enforcement.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. requiring cumulative voting for the election of directors. The second recommendation is to dilute ownership concentration through the use of regulatory power. Some of the legal reforms under consideration concern settling conflictof-interest situations with significant effects on minority shareholders. The slow improvement in the legal framework has likewise obstructed progress in this area. Through an amendment in the Public Company Act. SEC is exploring the possibility of amending the law toward this direction. Because these holding companies control a number of large public companies in Thailand. This move is expected to be unpopular among founding family members and original owners. Current laws allow a high degree of ownership concentration and provide inadequate safeguards against possible conflict-of-interest transactions and their impact on minority shareholders. SEC has been trying to lay the foundations of good corporate governance by espousing fairness. This includes prescribing ways to empower minority shareholders without disrupting the company’s operations. 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. there has been much progress in this area. 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. But weaknesses in accounting and auditing practices have been inhibiting the development of capital markets. The situation prompts two specific recommendations. The first recommendation involves the repeal of current legislation to allow minority shareholders to have greater influence over management decision making. To ensure a level playing field. Both SET and SEC are taking an active stance in improving the transparency and efficiency of Thai capital markets. they should be monitored and regulated. increasing penalties for directors engaged in misconduct. accountability.
Thailand should develop a strong public debt market to supplement the banking system in financing corporate investments.276 Corporate Governance and Finance in East Asia. II responsibility among companies. aimed at ensuring that banks finance only creditworthy projects. In an environment of highly concentrated ownership. there is a need to increase market disciplinary power through market competition. . it is important to explore reforms that can lead to the enhanced role of banks in monitoring enterprises. This may not be possible without reforms in the banking sector itself. in turn. will incidentally close off easy sources of finance for companies that have been practicing regulatory arbitrage. especially in the area of connected lending. The same goes for improvements in the bankruptcy system. There will be no incentive for companies to raise capital in the equities market if they can obtain funds at a lower cost elsewhere. which. Vol. Accounting standards have also been under review. A well-developed domestic debt market will provide corporations with an alternative to bank financing. The Bank of Thailand’s enforcement of prudent lending practices among Thai financial institutions. The variety of debt instruments available to the corporate sector and investors should be increased and longer-term sources of bond finance actively promoted. while a strong domestic debt market will also offer protection from foreign exchange risk. it will be difficult to improve corporate governance in Thailand. the SEC’s disposition toward a largely voluntary approach for adoption of these characteristics has resulted in uneven compliance among public companies. for instance. Further. a well-developed secondary market will pave the way for market disciplinary forces to act against poorly managed companies. Without a strong and efficient capital market. However. Because the financing of Thailand’s corporate sector is predominantly bank-based and will remain so for a long while yet. In the stock market. will lead to the emergence of a reference yield curve. The promotion of active roles for domestic institutional investors should also improve corporate governance in Thailand. Capital Market Development and Regulation Another important issue concerns the development of capital markets. The first step is to establish an active secondary Government bond market. 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. the power of the capital market to discipline inefficient management is almost nonexistent.
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