This action might not be possible to undo. Are you sure you want to continue?
A Study of Indonesia, Republic of Korea, Malaysia,Philippines,andThailand
Edited by: Juzhong Zhuang SeniorEconomist RegionalEconomicMonitoringUnit AsianDevelopmentBank David Edwards AssistantChiefEconomist ProjectEconomicEvaluationDivision AsianDevelopmentBank Ma. Virginita A. Capulong SeniorSectorAnalyst AgricultureandSocialSectorsDepartment(West) AsianDevelopmentBank
© Asian Development Bank 2001 Allrightsreserved. ThispublicationwaspreparedundertheAsianDevelopmentBanksregionalTechnical Assistance 5802: A Study on Corporate Governance and Financing in Selected DMCs. The views expressed in this book are those of the authors and do notnecessarilyreflecttheviewsandpoliciesoftheAsianDevelopmentBank,or itsBoardofDirectorsorthegovernmentstheyrepresent. The Asian Development Bank does not guarantee the accuracy of the data includedinthispublicationandacceptsnoresponsibilityforanyconsequencesfor theiruse. Use of the term country does not imply any judgment by the authors or the AsianDevelopmentBankastothelegalorotherstatusofanyterritorialentity . ISBN 971-561-323-3 Publication Stock No. 100800 Published and printed by theAsian Development Bank P.O. Box 789, 0980 Manila, Philippines
List of Tables List of Figures Foreword Preface Abbreviations 1 Indonesia 1.1 Introduction 1.2 OverviewoftheCorporateSector 1.2.1 HistoricalDevelopment 1.2.2 TheCapitalMarket 1.2.3 The Banking Sector 1.2.4 ForeignCapital 1.2.5 GrowthandFinancialPerformance 1.2.6 LegalandRegulatoryFramework 1.3 CorporateOwnershipandControl 1.3.1 CorporateOwnershipStructure 1.3.2 ManagementandInternalControl 1.3.3 ExternalControl 1.4 CorporateFinancing 1.4.1 FinancialMarketInstruments 1.4.2 PatternsofCorporateFinancing 1.4.3 CorporateFinancingandOwnershipConcentration 1.5 TheCorporateSectorintheFinancialCrisis 1.5.1 CausesoftheFinancialCrisis 1.5.2 ImpactoftheFinancialCrisisontheCorporateand BankingSectors 1.5.3 Responses to the Crisis 1.6 Summary, Conclusions, and Recommendations 1.6.1 SummaryandConclusions 1.6.2 Policy Recommendations References vi ix x xi xii 1 1 3 3 4 5 7 8 15 17 17 25 30 32 32 34 35 36 36 39 42 45 45 48 51
2 Republic of Korea 2.1 Introduction 2.2 OverviewoftheCorporateSector 2.2.1 HistoricalDevelopment 2.2.2 Rise of the Large Business Groups (Chaebols) 2.2.3 RoleoftheCapitalMarketandForeignCapital 2.2.4 GrowthandFinancialPerformance
53 53 55 55 60 62 65
iv 2.3 CorporateOwnershipandControl 2.3.1 PatternsofCorporateOwnership 2.3.2 InternalManagementandControl 2.3.3 ShareholderRights 2.3.4 ControlbyCreditors 2.3.5 TheMarketforCorporateControl 2.3.6 ControlbytheGovernment 2.3.7 EmployeeParticipationinCorporateGovernance 2.4 CorporateFinancing 2.4.1 Overview of the Financial System 2.4.2 PatternsofCorporateFinancing 2.4.3 FinancialStructure,Diversification,andCorporate Performance 2.5 TheCorporateSectorintheFinancialCrisis 2.5.1 WeaknessesinCorporateGovernance 2.5.2 TheRoleofGovernmentIntervention 2.5.3 ManifestationsofWeakCorporateGovernanceand GovernmentIntervention 2.5.4 ShortcomingsinMacroeconomicPolicy 2.6 Responses to the Crisis and Policy Recommendations 2.6.1 CorporateRestructuringActivities 2.6.2 PolicyMeasuresforCorporateReform 2.6.3 Policy Recommendations References 3 The Philippines 3.1 Introduction 3.2 OverviewoftheCorporateSector 3.2.1 HistoricalDevelopment 3.2.2 GrowthandFinancialPerformance 3.2.3 LegalandRegulatoryFramework 3.3 CorporateOwnershipandControl 3.3.1 PatternsofCorporateOwnership 3.3.2 CorporateManagementandShareholderControl 3.3.3 TheRoleofCreditorsinCorporateControl 3.4 CorporateFinancing 3.4.1 TheFinancialMarketandInstruments 3.4.2 PatternsofCorporateFinancing 3.4.3 OwnershipConcentration,FinancialLeverage,and Performance 3.5 TheCorporateSectorintheFinancialCrisis 3.5.1 TheFinancialCrisis:CausesandManifestations 3.5.2 ImpactoftheCrisisontheCorporateSector 3.5.3 Responses to the Crisis 74 74 94 103 105 108 110 111 113 113 118 128 130 132 134 134 137 139 139 143 148 153 155 155 156 156 158 167 171 171 186 198 199 199 202 209 210 210 212 214
v 3.6 Summary, Conclusions, and Recommendations 3.6.1 SummaryandConclusions 3.6.2 Policy Recommendations References 216 216 219 226
4 Thailand 4.1 Introduction 4.2 OverviewoftheCorporateSector 4.2.1 HistoricalDevelopment 4.2.2 DevelopmentofCapitalMarkets 4.2.3 GrowthandFinancialPerformance 4.2.4 LegalandRegulatoryFramework 4.3 CorporateOwnershipandControl 4.3.1 PatternsofCorporateOwnership 4.3.2 CorporateManagementandControl 4.3.3 ExternalControl 4.4 CorporateFinancing 4.4.1 OverviewoftheFinancialSector 4.4.2 PatternsofCorporateFinancing 4.5 TheCorporateSectorduringtheFinancialCrisis 4.5.1 ImpactoftheFinancialCrisisontheCorporateSector 4.5.2 Responses to the Crisis 4.6 Summary, Conclusions, and Recommendations 4.6.1 SummaryandConclusions 4.6.2 Policy Recommendations References
229 229 230 230 233 235 239 240 241 244 248 252 252 257 261 261 264 270 270 273 277
1992-1999 Table 1. 1997 Table 1.vi List of Tables 1.15 V alue of Stocks Issued and Stock Market Capitalization. 1990-1997 Table 1. 1992-1998 Table 2. Republic of Korea Table 2.3 GrowthandFinancialPerformanceofPubliclyListed Companies. 1996-1998 2.19 DER and ROE of Publicly Listed Companies by Sector. 1992-1997 Table 1.1 Listed Firms with Positive Economic V alueAdded.5 Financial Performance of Publicly Listed Companies by Sector.3 Subsidiaries of the 30 Largest Chaebols Table 2.6 GrowthandFinancialPerformanceofState-Owned Companies.14 Banking Sector Outstanding Loans. 1992-1997 Table 1.4 Growth Performance of Publicly Listed Companies by Sector.13 Presence of Board Committees in Listed Companies Table 1. 1988-1996 Table 1. 1992-1999 Table 1. 1990-1998 Table 1.12 CharacteristicsoftheBoardofDirectors Table 1.7 Growth Performance of the Top 300 Conglomerates. 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 .8 OwnershipConcentrationofPubliclyListedCompanies. 1993-1997 Table 1. 1992-1997 Table 1.9 OwnershipConcentrationofPubliclyListedCompanies by Sector.2 Foreign Capital Flows. 1993-1999 Table 1.4 Development of the Stock Market. Indonesia Table 1. 1992-1995 Table 1.18 GDP Growth by Sector.11 CharacteristicsoftheBoardofCommissioners Table 1.20 ROE of the Banking Sector.21 Nonperforming Loans by Type of Bank.17 DER of Listed Companies by Degree of Ownership Concentration Table 1. 1986-1996 Table 1.1 Growth of the Banking Sector. 1996-1998 Table 1. 1996-1999 Table 1.10 Anatomy of the Top 300 Indonesian Conglomerates.2 KeyMacroeconomicIndicators Table 2.16 FinancingPatternsofPubliclyListedNonfinancial Companies. 1992-1997 Table 1.
27 Table 2.24 Table 2.6 Table 2.26 Table 2. 1988-1997 Ownership Concentration of the Survey Sample of 81 Listed Firms.11 Table 2. 1988-1997 Ownership Composition of Listed Nonfinancial Firms by Industry.28 Table 2.17 Table 2. 1999 InternalShareholdingsofthe30Largest Chaebols.5 Table 2. 1988-1997 OwnershipConcentrationofListedNonfinancialFirms by Industry. 1985-1998 GrowthandFinancialPerformanceoftheNonfinancial Corporate Sector.12 Table 2. 1985-1997 GrowthandFinancialPerformanceofListedCompanies by Size. 1997 Ownership Concentration ofAll Listed Firms.18 Table 2.20 Table 2.8 Table 2.25 Table 2. 1990 and 1997 Ownership Composition of Listed Nonfinancial Firms by Size.19 Table 2. 1995-1997 Ownership Composition of Listed Companies. 1992-1997 OwnershipConcentrationofListedNonfinancialFirms.16 Table 2.15 Table 2.22 Table 2. 1997 Ownership Composition of Listed Firms in Selected Countries.13 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 . 1994-1998 Financing Patterns of the Top 30 Chaebols.10 Table 2.30 Private Capital Flows to Korea. 1987-1997 FlowofFundsoftheNonfinancialCorporateSector.23 Table 2. 1997 OwnershipConcentrationofListedNonfinancialFirms by Firm Size.9 Table 2. 1988-1997 FinancingPatternsoftheNonfinancialCorporateSector. 1988-1997 FinancingPatternsoftheNonfinancialCorporateSectorby Industry Financing Patterns of Listed Companies. 1997 Ownership Composition of Listed Nonfinancial Firms by Control Type.14 Table 2. 1988-1997 Features of the 30 Largest Chaebols GrowthandFinancialPerformanceofthe30Largest Chaebols. 1993-1997 The Top 30 Chaebols Debt-to-Equity Ratio.7 Table 2.29 Table 2.vii Table 2.21 Table 2. 1994-1997 Cross-Payment Guarantees of the Top 30Chaebols. 1990-1997 InternationalComparisonofRatiosofOrdinaryIncome toSalesinManufacturing GrowthandFinancialPerformanceofSelectedIndustries GrowthandFinancialPerformanceofListedCompanies.
10 Composition of Top Five Shareholders of Philippine Publicly Listed Companies by Sector. 1990-1999 Table 3. 1997 Table 3.20 Financing Patterns by Industry. 1997 Table 3.7 GrowthandFinancialPerformanceoftheCorporateSector by Industry. 1997 Table 3. 1989-1997 Table 3. 1989-1997 Table 3. 1985-1997 Number of Firms with Dishonored Checks. 1992-1999 .1 Public Companies Registered.19 Financing Patterns by Firm Size. 1997 Table 3. 1992-1996 Table 3. 1983-1997 Table 3.33 Net Profit Margins of Chaebols. Leverage Table 3. 1989-1997 Table 3. 1995-1998 4.1989-1997 Table 3. 1988-1997 Table 3.viii Table 2.21 OwnershipConcentration. 1988-1997 Table 3.Profitability andFinancial .2 Public Offerings of Securities.18 Financing Patterns by Control Structure.31 Table 2.14 Philippine Stock Market Performance.1 GDP Growth of SoutheastAsian Countries.12 Control Structure of the Top 50 Corporate Entities.3 TheCorporateSectorandGrossDomesticProduct. 1978-2000 Table 4.000 Companies. 1988-1997 Table 3.11 TotalandPerCompanySales. The Philippines Table 3.17 Composition ofAssets and Financing of the Publicly Listed Sector. 1989-1997 Table 3.15 Financing Patterns of the Corporate Sector.2 Growth and Financial Performance of the Top 1. 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 3.9 OwnershipConcentrationatCriticalLevelsofControl Over Publicly Listed Companies. 1988-1997 Table 3.32 Table 2.13 ADB Survey Results on Shareholder Rights Table 3. Flagship Company.4 GrowthandFinancialPerformanceoftheCorporateSector by Ownership Type.8 Ownership Composition of Philippine Publicly Listed Companies by Sector. andAffiliated Banks of Selected Business Groups.SectorOrientation.16 CorporateFinancing PatternsbyOwnershipType. 1988-1997 Table 3. 1986-1998 Nonperforming Loans of General Banks.5 GrowthandFinancialPerformanceoftheCorporateSector by Control Structure.6 GrowthandFinancialPerformanceoftheCorporateSector by Firm Size.22 Foreign Investment Flows. Thailand Table 4. 1988-1997 Table 3. 1997 Table 3.
17 StatisticalHighlightsoftheStockExchangeofThailand. 1990-1996 External Debt. 1993-1999 Size and Composition of the Thai Financial Sector. 1990-1998 StatisticalRelationshipsbetweenCorporateProfitability.2 TheSuhartoGroup TypicalInternalOrganizationalStructureofaPublicly Listed Company in Indonesia CorporateControlStructure:TheCaseofAyalaCorporation CorporateControlStructure:theCaseofLopezGroup 24 25 195 197 .2 Figure 3. 1985-1996 Top-Five Ownership Concentration of Publicly Listed Companies in Thailand.6 Table 4. 1990-1996 Common-Size Statements of Public Companies by Ownership Concentration. Leverage. and Company Size Top-Five Shareholder Composition of Publicly Listed Companies in Thailand.ix Table 4.7 Table 4.4 Table 4. 1985-1996 Average Key Financial Ratios by Company Size.16 Table 4.15 Table 4.10 Table 4.9 Table 4. 1985-1999 237 238 239 241 242 243 251 252 256 258 259 260 261 262 264 List of Figures Figure 1.3 Table 4.5 Table 4.13 Table 4.1 Figure 3. 1992-1999 Common-Size Statements for Companies Listed in SET. 1990-1996 Financial Ratios of Listed Companies by Ownership Concentration. 1992-1999 Offerings of Debt Securities. 1993-1999 Key Financial Ratios of Publicly Listed Companies. 1986-1999 NumberofNewlyRegisteredandBankrupted/Closed Companies. 1990-1998 Merger and Acquisition Activities. Ownership Concentration.11 Table 4.1 Figure 1.8 Table 4.14 Table 4. 1990-1996 Financial Ratios of All Listed Firms.12 Table 4.
Corporate governance has become a major policy concern in the wake of the Asian financial crisis. Weak governance structure, poor investment, and risky financingpracticesofthecorporatesectorintheaffectedcountriescontributedto their sharp economic recession in 1997-1998. The weaknesses in corporate governanceandfinanceunderminedthecapacityofthesecountriestowithstandthe combined shocks of depreciated currencies, massive capital outflows, increased interestrates,andlargecontractionindomesticdemand. Tohelpunderstandcorporategovernanceissuesandtheirimpact,aswell astoidentifyneedsforinterventionsinaddressingpolicyandinstitutionalweaknesses, the Economics and Development Resource Center of theAsian Development Bank (ADB) undertook a regional study on corporate governance and finance in selected developing member countries. The countries covered are Indonesia, Republic of Korea, Malaysia, Philippines, and Thailand. This book presents the major findings of the study. The policy recommendations will supportADBs financialsectorworkinitsdevelopingmembercountries.
Arvind Panagariya ChiefEconomist
Corporate Governance and Finance in EastAsia presents the findings of a regionalstudyofcorporategovernanceandfinanceinselecteddevelopingmember countries of theAsian Development Bank (ADB). The study attempts to identify theweaknessesincorporategovernanceandfinanceincountriesmostaffected by the 1997Asian financial crisis, and recommends policy and reform measures to address the weaknesses. The study covers Indonesia, Republic of Korea, Malaysia, Philippines, and Thailand. The findings of the study are presented in two volumes. Volume One,A ConsolidatedReport,presentsaframeworkforanalyzingcorporategovernance and finance, summarizes the major findings of the five country studies, and provideskeypolicyrecommendationsforstrengtheningcorporategovernanceand improving the efficiency of corporate finance inADB member countries. Volume Two,CountryStudies,collectsfourcountryreports.Wewouldliketothankcountry experts Saud Husnan of Gadsab Mada University, Indonesia; Kwang S. Chung andYen Kyun Wang of Chung-Ang University, Republic of Korea; FazilahAbdul Samad of University of Malaya, Malaysia; Cesar G. Saldaña of PSR Consulting, Inc., the Philippines; and Piman Limpaphayom of Asian University of Science and Technology, Thailand, for their efforts and cooperation in conducting the countrystudies.CesarG.Saldañaalsoprovidedusefulinputstothepreparation oftheconsolidatedreport. The volumes benefited extensively from constructive comments from ADBstaffandofficialsoftheministriesoffinance,centralbanks,securitiesand exchangecommissions,stockexchanges,andcorporaterestructuringagenciesof theeightADBmembercountriesthatparticipatedinthestudysfinalizationworkshop in Manila, on 18-19 November 1999. Our deep appreciation goes to Jungsoo Lee, former Chief Economist, and S. Ghon Rhee, former Resident Scholar, for their strong support at various stages of the study; Manabu Fujimura, for his efforts in organizing the finalizationworkshop;MarceliaGarcia,MarinieBaguisa,Ma.ReginaSibal,andRosanna Benavidez, for their administrative support and assistance; and JosefYap, Leah Sumulong, Graham James Dwyer, Judith Banning,andLynetteMallery, for their editorialassistanceandadvice.
ADB AGM AGSM AMU APEC B BDC BIBF BIS BOC BOD BSDC BSP BUN CB CDRAC CEO CP CRA DER ESOP EVA FDI FSC GAAP GATT GDP GNP HCI IBRA IDFR IEFR IFS IMF IPO IPP JSX NBFI NEFR NPL OECD OTC Asian Development Bank annualgeneralmeeting annualgeneralshareholdersmeeting assetmanagementunit Asia-Pacific Economic Cooperation baht Bond Dealers Club BangkokInternationalBankingFacility BankforInternationalSettlements board of commissioners boardofdirectors BangkokStockDealingCenter BangkoSentralngPilipinas(CentralBank) Bank Umum Nasional convertiblebond CorporateDebtRestructuringAdvisoryCommittee chiefexecutiveofficer commercialpaper CorporateRestructuringAgreement debt-to-equityratio employee stock ownership plan economicvalueadded foreigndirectinvestment Financial Supervisory Commission generallyacceptedaccountingprinciples GeneralAgreementonTariffsandTrade grossdomesticproduct grossnationalproduct heavyandchemicalindustries IndonesianBankRestructuringAgency incrementaldebtfinancingratio incrementalequityfinancingratio InternationalFinancialStatistics InternationalMonetaryFund initialpublicoffering investmentprioritiesplan JakartaStockExchange nonbankfinancialinstitution newequityfinancingratio nonperformingloan OrganisationforEconomicCo-operationandDevelopment over-the-counter
xiii P PCO PD PICPA PLDT PSE PTB ROA ROE Rp RSA SBL SCS SEA SEC SET SFR SMC SSS SOC TIE TQ W US peso planningandcoordinationoffice PresidentialDecree PhilippineInstituteofCertifiedPublicAccountants Philippine Long Distance Telephone Co. Philippine Stock Exchange principaltransactionsbank returnonassets returnonequity rupiah Revised SecuritiesAct singleborrowerlimit shareofacontrollingshareholder Securities and ExchangeAct Securities and Exchange Commission StockExchangeofThailand self-financingratio SanMiguelCorporation Social Security System State-ownedcompany timesinterestearned Tobins Q won UnitedStates
Note: In this volume, $ refers to US dollars, unless otherwise stated.
The currency crisis that began in mid-1997 in Thailand spread quickly to Indonesia and the rest of Southeast Asia. Initially, Indonesia’s monetary authority tried to defend the domestic currency, the rupiah, by widening the intervention band, while maintaining its managed floating system. From 5 to 8 percent in June 1997, when the currency crisis hit Thailand, the band was widened to 12 percent on 11 July 1997 when the crisis started spilling over to Indonesia. After resisting pressure for a short period, the rupiah fell by 6 percent against the dollar on 21 July 1997, the biggest one-day fall in five years. Finally, the Indonesian monetary authority realized that the system could not cope with the continuing pressure on the currency, as the risk of losing all foreign exchange reserves to prop up the rupiah was too high. On 14 August 1997, the monetary authority decided to adopt a free floating exchange rate system. The currency fell further because of strong demand for dollars. As the rupiah weakened, nervous lenders refused to refinance maturing loans, investors cut down and then reversed the flow of funds, borrowers tried to obtain dollars before the rupiah fell further, and individuals joined the chase for dollars. At that time, several banks ran out of dollar notes. From Rp4,950 to the dollar at the end of December 1997, the exchange rate fell to more than Rp15,000 at the height of the crisis in June 1998, although it later stabilized at about Rp9,000. At that exchange rate, it is estimated that half of Indonesian corporations became technically insolvent. The crisis also exacerbated an already deepening political turmoil. The financial crisis devastated the Indonesian economy. In 1998, gross domestic product (GDP) contracted by 13 percent and the inflation
Associate Professor, Faculty of Economics, Gadsab Mada University, Yogyakarta, Indonesia. The author wishes to thank Juzhong Zhuang, David Edwards, both of ADB, and David Webb of the London School of Economics for their guidance and supervision in conducting the study, the Jarkata Stock Exchange for its help and support in conducting company surveys, and Lea Sumulong and Graham Dwyer for their editorial assistance.
no doubt. Foreign creditors. and analyzes their importance to the corporate sector in Indonesia. Foreign debt reached more than $100 billion.2 Corporate Governance and Finance in East Asia. These banks were allowed to operate even if they violated minimum capital adequacy requirements. and . 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. short-term loans were used to finance long-term investments. particularly those with large foreign loans. the controlling families of corporate groups often established banks to provide funds to affiliated nonfinancial companies. or Thailand. and responses to the financial crisis.6 percent) and trade (-18 percent). regulatory framework. 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 financing. and how it contributed to the crisis. The construction sector was the worst hit. On the other hand. the Indonesian economy seemed to be in generally good shape. It analyzes the weaknesses of corporate governance in Indonesia. the currency composition and term structure of corporate foreign indebtedness were causes for concern. The scale of the financial crisis exposed weaknesses of the country’s corporate sector. placed a high premium on these political connections in assessing the chances of being repaid. contracting by 36. Section 1. followed by finance (-26. This study reviews the Indonesian corporate sector’s historical development. these controlling families had political connections that allowed their companies to enjoy special privileges. patterns of ownership and control. Economic growth reached more than 7 percent per year and the inflation rate was kept at single digit levels.3 looks at patterns of corporate ownership and control. II rate reached 58. Section 1. The study also identifies family-based companies and corporate groups. When the crisis hit the country. how it has affected corporate financial performance and financing.5 percent. highly leveraged companies. except utilities. Although as a percent of GDP the stock of outstanding foreign debt owed directly by the private sector was smaller than that of the Republic of Korea. were the ones most affected. Malaysia. posted negative growth.2 presents an overview of the Indonesian corporate sector. All sectors. Lending activities of affiliate banks that were not sufficiently backed by owners’ equity and the reliance by foreign lenders on the strength of political connections paved the way for risky investments. prior to the financial crisis.5 percent. To facilitate even easier access to credit. In many instances. this left the Indonesian economy extremely vulnerable. In this setup. Vol. However.
Not all items in the questionnaires were answered by the respondents.2.2 1.5 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.and large-scale companies were dominated by state-run industrial concerns.Chapter 1: Indonesia 3 profiles the corporate sector’s governance characteristics. . Up until the mid-1960s. Despite the oil revenues. In the early 1970s. Section 1. and its response. how it was affected by the crisis. and tobacco industries. a gradual shift in public investment away from manufacturing took place.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. medium. It also examines the statistical relationship between corporate performance and corporate governance characteristics. the windfall from oil and gas revenues was an important factor that allowed the Government to promote industrial development via import substitution. substantial volumes of private investment entered the scene. The Government became directly involved in industry as a result of the nationalization of Dutchowned shipping firms and oil companies. However. 2 Survey questionnaires were sent to 280 companies listed in the Jakarta Stock Exchange. Section 1. textiles. in the course of the fight for nationhood from 1942 to 1950.4 analyzes corporate financing patterns. 1. only 40 companies replied—39 are private companies and one state-owned company (Bank BNI). The industries that emerged were highly import-dependent and reliant on tariff protection. Subsequently.6 summarizes the major findings of the study and suggests recommendations to improve governance in the Indonesian corporate sector. With the relatively liberal laws governing foreign and domestic private investments introduced by the New Order Government in 1967 and 1968.2 Section 1.
which dominated their respective sectoral outputs and markets. Third. Last.2. many founding owners of companies were reluctant to go public and dilute their corporate ownership. During this period. The equity market remained largely unappealing due to a number of factors. These were families with strong links to the political elite of the New Order. even when new shareholders do not threaten the control exercised by the original owners. and related products) had shares in total exports that were rapidly increasing. produced consumer goods. the Indonesian industrial sector was quite diverse.2 The Capital Market The Government reactivated the stock exchange in 1977. Generally speaking. the stock exchange was also unattractive to companies trying to raise capital as they could borrow from state banks at very low interest rates. 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). Export credits with low interest rates were granted to industries that were intensive in the use of local labor and raw materials.4 Corporate Governance and Finance in East Asia. . the value of manufactured exports overtook the value of oil and gas exports for the first time. A number of underwriters emerged. the number of firms quoted in the stock market was only 24. Partly as a result of various government policies. mostly nonbank financial institutions and stockbrokers. a distinct industrial elite started to emerge. In 1992. 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. 1. Regulations in the banking sector led to equities having higher risk but lower returns than bank deposits. But these proved counterproductive because they limited the potential for capital gains to prospective investors. and employed the bulk of the industrial labor force. While most of the companies were small. In the 1980s. the Government shifted its industrial policy toward the promotion of labor-intensive exports. First. Second. By 1987. II the currency needed to be devalued periodically under a managed floating exchange rate system to avoid large current account deficits. exports of nonoil products (particularly textiles and footwear. potentially subjects companies to greater regulatory scrutiny. there were also many rapidly growing large-scale companies and business groups or conglomerates. But until the end of 1988. Vol. wood. the dilution of corporate ownership.
the legal infrastructure that was supposed to guide the evolution of the banking sector was not backed by effective enforcement. the banking sector has been and still is the major source of credit for the corporate sector. Partly as a result of these reforms. the controlling shareholder of these SOCs is still the State. The banking sector. Consequently. the number of listed companies in the stock exchange increased substantially. began to face competition. The Government also abolished the practice of setting prices for IPOs and removed restrictions on price movements in the secondary market. priority credits still enjoyed subsidized interest rates and funding from the Central Bank. the banking sector has undergone many reforms. Through the years. Since 1977. and increased access of domestic banks to international financial markets. However. Conglomerates carried out 210 out of 257 IPOs. private domestic banks dominated the sector in terms of number and total assets. Thus. with a total value of more than Rp8 trillion. from 24 in 1988 to more than 300 in 1997. Further reforms along the same direction and affecting state-controlled banks came in the 1990s. The development of the Indonesian stock market also provided a vehicle for the privatization of state-owned companies (SOCs). the capital market played an increasing role in raising long-term funds needed by the corporate sector. The initial banking sector reform was introduced in 1983. The dominance of state banks started to erode. These included the opening of the banking industry to new entrants. In 1988. with a total value of Rp16. six SOCs had issued equities in the market. state-owned banks were still among the biggest. But in terms of assets per bank. more significant reforms were introduced.5 trillion. the liberalization of the banking industry allowed banks to determine lending rates for nonpriority loans. companies could no longer enjoy low-interest credit from state banks.Chapter 1: Indonesia 5 At the end of 1988. which up to then was channeling oil revenues to priority sectors. to date. However. During this period. the number of private domestic banks increased. Table 1. . However.1 shows that from 1994 to 1998. reduced restrictions on foreign exchange transactions. Interest rate regulations on state banks and credit ceilings in general were removed.3 The Banking Sector Despite the development of the stock market. The Government also allowed foreign investors to buy up to 49 percent of listed shares. which were previously constrained to 4 percent per day.2. 1.
Bank Danamon.3 30 7. the 10 largest were all affiliated with major business groups.9 762.1 10 47.9 27 113.3 10 17. Vol. In terms of assets. Among private domestic banks. 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.4 10 35.8 29 6. while BUN has been closed down by the Government.4 239 222 208 173 Assets and liabilities were concentrated in the top 10 banks.6 7 7. Both BCA and BUN have shareholders linked to the former President Suharto. Because regulation was weak.6 Corporate Governance and Finance in East Asia.5 7 9. Bank Danamon (ranked 7th).3 201.8 31 10.6 164 144 130 92 387. and Bank Umum Nasional (BUN) have failed and the first two are now under management of the Indonesian Bank Restructuring Agency (IBRA).2 10 14. But the banking system proved incapable of performing its intermediation function. 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. and Bank International Indonesia (ranked 9th).1 240 1995 122. private domestic banks among the top 10 in 1997 included Bank Central Asia (BCA) (ranked first and linked to the Salim group). II Table 1.8 166 248.5 27 66.8 10 37.5 7 7 7 5 15.3 27 51.6 7 12. 1993 100.4 34 12.8 10 19. The other banks among the top 10 were state banks.0 234 1994 104.7 351.9 304.7 27 37.6 34 14. . banks could earn profits even when they did not gather and process information about risk.8 391.8 27 147.2 161 214.5 528.1 Growth of the Banking Sector.5 165 308.4 789.9 291. BCA.8 27 200.6 240 1996 1997 1998 1999 141.9 248.9 39 18. Of these.5 27 88.9 10 11.9 31 9.
59 4. initially from Japan and the Republic of Korea. From the mid-1980s until July 1997.33 (13.74 5.40) (0. In the 1990s. especially through bank loans.01 (2.50 (0. when the financial crisis hit Indonesia.15) — = not available. September 2000. they still amounted to a large sum for the economy to absorb. Between 1990 and 1996. Net FDI flows increased to $5. Until the onset of the crisis. there was a phenomenal growth in direct borrowings by Indonesian corporations.88 4. Source: IFS CD-ROM. 1990-1998 ($ billion) Type of Flows Net FDI Net Portfolio Investment Foreign Bank Loans 1990 1991 1992 1993 1994 1995 1996 1997 1998 1.00 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.2 Foreign Capital Flows. foreign creditors were eager to provide financing to Indonesia.81 3.10 5. But FDIs were only one form of foreign capital inflows to Indonesia.2. IMF. foreign investment also had a strong presence in the services and infrastructure sectors. In 1994. Although these inflows were not nearly as large as those received by Thailand (10 percent of GDP) and Malaysia (9 percent of GDP).09) 1.11 3. Successive policy deregulation facilitated FDIs in various light manufacturing industries. except in certain strategic sectors. Table 1.Chapter 1: Indonesia 7 Foreign and domestic banks defaulted on their responsibility of deciding where capital should go and ensuring that it was used in the most effective way. In effect. .78 2.09 1.87 7. FDI flows were strong.63) (1.4 Foreign Capital The years of rapid industrial growth attracted a large amount of foreign direct investments (FDIs). Most FDIs came in through joint ventures with business groups having strong political connections.2.88) — — — — — — 8. November 2000. and footwear.01) (0. Increasingly. as shown in Table 1.09) (0. the Government allowed foreign investors to own 100 percent of an Indonesian company. Indonesia received capital inflows averaging about 4 percent of GDP.59 billion in 1996. such as metal goods. textiles. 1.48 1. Joint BIS-IMF-OECD-World Bank Statistics on External Debt.
Due to data constraints. In September 1997.8 Corporate Governance and Finance in East Asia. foreign banks became a significant source of financing for the corporate sector. This increased to 30 percent by the end of 1993. The Government relaxed this restriction in 1988. 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. participation in the Indonesian stock market was exclusive to domestic investors. of which two thirds were rupiah-denominated. the average foreign ownership of listed companies was 21 percent. state-owned companies (SOCs).4 trillion in 1997. but declined to an average of 25 percent during 19951997. especially the short-term ones. plus 4 percent for the depreciation of the rupiah. and conglomerates. foreign investors began to dominate daily trading. 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. 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. Private borrowers preferred foreign loans since these were relatively cheaper. total corporate debt reached nearly $118 billion. In the 1990s.2. By the end of 1997. The following section looks at the growth and financial performance of the corporate sector. the analysis focuses only on publicly listed companies. . This is lower than the average borrowing rate of 18 percent for loans in domestic currency. The excessive dollar borrowings made the corporate sector vulnerable to sudden currency fluctuations. The external corporate debt owed to foreign commercial banks was $67 billion. II Up until the late 1980s. Capital account liberalization permitted the inflow of foreign capital that fueled the credit boom in the country. 1. Between 1989 and 1992. with the onset of the Asian crisis. In November 1998. an interesting question is whether standard measures of corporate profitability and performance also indicated the same.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. allowing foreign investors to buy up to 49 percent of stocks of a publicly listed company. Vol. Domestic corporate debt was about $50 billion equivalent. increasing the total trading value from Rp8 trillion in 1992 to Rp120. the average borrowing rate for dollar loans was 9 percent. Consequently. From 1987 to 1996.
Note: The number of firms is not identical for each year.1 0.3 shows the growth and financial performance of Indonesian publicly listed companies. 1994.0 6. Return on assets (ROA) was also relatively stable during 1992-1996.1 percent in 1997 when the crisis began to buffet Indonesia.7 — = not available. Table 1.8 6. During 1992-1997.3 Growth and Financial Performance of Publicly Listed Companies.0 1. Asset turnover was above 30 percent until 1996.0 12.3 3. but declined to 0.6 1994 50.2 30.7 percent in 1997. 250 firms.8 percent between 1992 and 1996.6 24.5 37.4 31. publicly listed companies as a group contributed less than 10 percent to GDP. a Value added was assumed to be 30 percent of total sales. The debt-to-equity ratio (DER) was high compared to those of listed companies in Malaysia and the Philippines.5 34.4 1993 45. 226 firms.0 12.8 220. 1992-1997 (percent) Item Growth Indicators Sales Growth Share of Value Added in GDPa Asset Growth Financial Indicators Debt-to-Equity Ratio Return on Equity Return on Assets Asset Turnoverb 1992 — 3.2 1995 37.0 33. but turned negative in 1997. When the crisis battered Indonesia in 1997.3 6.4 percent. 174 firms. the average DER increased to 310 percent from 230 percent the .6 3. 248 firms.8 230. Average return on equity (ROE) of listed firms was 11.4 1997 7. Source: JSX Monthly (several publications).1 4. ranging from 220 to 250 percent between 1992 and 1996. The growth of listed companies was sustained by continuing investments. while total assets grew at 43 percent. although the contribution increased over time. but fell to 24.0 12. but dropped to 1. Despite such rapid growth.Chapter 1: Indonesia 9 Publicly Listed Companies Table 1.5 3. 1995.4 38. 1993.9 310. total sales of listed companies grew at an annual average rate of 31 percent.2 7.1 220. In 1997. Net profits grew at an annual rate of more than 20 percent from 1992 to 1996.0 11.9 37. 246 firms. and 1992.5 34.0 10. there were 204 firms.7 3.0 3.4 1996 18.5 240.6 48. b Asset turnover is defined as sales over assets. 1996.0 64. averaging 3.6 percent in 1997.7 — 250.
the companies in the sector did not operate with a high leverage.3 percent between 1992 and 1996. although asset turnover was slow. still posting a positive but lower ROE. This indicates that a substantial part of corporate debt was denominated in dollars and unhedged. But the sector’s ROE fluctuated a lot. The same applied to the trade sector. property. The finance. the mining sector had the lowest DER. the fluctuation in nickel and copper prices contributed to the oscillation of ROE. the dominant sector was the finance sector. This sector was less affected by the crisis. miscellaneous industry. real estate. the mining sector ranked first. and property. consumer goods. indicating its reliance on equity to support growth.4). it appeared that the performance of listed companies was quite satisfactory prior to the crisis. The finance sector’s contribution to GDP. In terms of share of value added to GDP. and trade) even posted . and trade. Before the crisis. The consumer goods sector ranked second in terms of ROE. Vol. basic industry and chemicals. The ROE levels suggest that high leverage enabled listed companies to achieve high returns on equity. trade.10 Corporate Governance and Finance in East Asia. which operated in nickel and copper mining in 1992 and 1993. followed by agriculture (Table 1. real estate. averaging 21. and services. due mainly to the domination of the International Nickel Company of Canada. meanwhile. ROA of all sectors dropped in 1997. 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. Most companies in the sector that had unhedged dollar-denominated loans suffered exchange rate losses when the rupiah weakened.5 presents the financial performance of listed companies by sector. increased from 0. only two sectors (mining and finance) showed a consistently increasing trend from 1992. Overall.7 percent during 1992-1996. The Jakarta Stock Exchange (JSX) classified listed companies into nine sectors: agriculture. In terms of sales and asset levels in 1997.73 percent in 1992 to 1. Also.64 percent in 1997. helped in part by the relatively strong demand for consumer goods. miscellaneous industry. averaging 17. and building construction.2 in 1997. the banks eagerly provided credit to property development companies. property. infrastructure. Table 1. the mining sector had the highest ROE. When interest rates increased. with ROE falling to -11. ROE fell drastically because the sector had one of the highest DERs. in terms of growth of sales and assets. II previous year. For instance. During those years. finance. investment. However. Meanwhile. mining. the property sector was severely affected by the crisis. investment. Four sectors (basic industry and chemicals. and services. From 1995.
5 23.0 0. and Services Asset Growth Agriculture Mining Basic Industry and Chemicals Misc.9 0.4 1. Infrastructure Finance Trade.8 28.6 0.1 1.1 42.8 1.6 1.1 28.8 24.9 31.4 21. Source: JSX Monthly (several publications). Real Estate.6 135.5 (11.0 (28.0 0.2 59.0 (20.2 5.8 27.1 0. and Services — = not available.8) 0.3 0.1 32.0 24.7 — — 11.2 13.9 0.4 64.9 123.9 64.1 1.0 22.6 51. Infrastructure Finance Trade. Real Estate.1 0.2 11.7 54. Investment.3 0.6 (41.5 95.1 0.6 0.5) 13.9 14.0 1996 1997 58..6 22.0 16.5 (8.6) 119.1 1.0 0. and Bldg.9 1.9 59.8 (76.2 41. Real Estate.7 112.4 1.1 0.6 133.3 92.0 0. 1992-1997 (percent) Indicator/Sector Sales Growth Agriculture Mining Basic Industry and Chemicals Misc. 1992 — — — — — — — — — — — — — — — — — — — — — — — — — — — 0. Industry Consumer Goods Industry Prop. and Bldg.6 24.9 54.4 30.9 54.1 23.6 83.6) 19.Table 1.5 68.7 133.6 85.2) 0.5 92.6 (0.3 0.0 68.4 30. Investment.1 0. Industry Consumer Goods Industry Prop.0 0.7 24.0 31.3 340.0 0.6 26.4 1.3 1.7) 26.1 1.3 31.0 1.5 28.0 43.0 (192. Infrastructure Finance Trade. Industry Consumer Goods Industry Prop.4 38.9 8.8 62.2 41.8 0.7 — 36. Constn.8) (12.5 53. and Bldg.5 45.1 0.2 0.8 1.5 61. Investment.6 0.9 53.1 16.4 170.5 13.7 62.9 .2 35.6 15.3 31.5 0.7 (82.3) 53.9 25.0 64.4 1993 155.3 51. and Bldg.7 17.6) 25.1 35.3 0.4 (149.4) 6.7) (27.4 Growth Performance of Publicly Listed Companies by Sector. Industry Consumer Goods Industry Prop.7) 17.1 1.4 0. Constn.0) 46.6 0.1 67. and Services Net Profit Growth Agriculture Mining Basic Industry and Chemicals Misc.7 0.5) 49.8 32.7 40.3 17.7) (113.4 77.5 1.4 43. Constn.4 31.7 21.5 9.7 1995 51.1 0.1 0.7 90.1 71.6 28.7 0.8 50. Infrastructure Finance Trade.1 0.8 51...0 18.9 (7.5 0.4) 8.7 34.1 (41.8 29.2 14.5) 6.8 66.4 44.1 — 39.9 36.4 103.3 0.3) 39.2 0.7 43. Constn.1 (11. Investment.6 1994 (75.1 0. Real Estate.5 1.7 28. and Services Share of Value Added in GDP Agriculture Mining Basic Industry and Chemicals Misc.3 (203..5 1.
6 18.6 74.7 1.0 50.2) 7.0 80.0 66.1 3.3 64.9 7.0 150.2 6.2 53.0 86. and Bldg.0 12. Industry Consumer Goods Industry Prop.0 69.0) 7.0 110.2 30.6 14.5 4.8 5.2 13.0 110.0 120.4 1.1 1996 100.0 150.6 (2.7 10.2 (4.7 5.1 1.0 1997 230.3 73.0 100.3) 5.8) 8.9 38.6 8. Infrastructure Finance Trade.0 8.3 5.0 630..1 10.4 13.9 87.0 80.0 160.7 12.5 5.9 29.7 10.4 17.5 13.7 (3.0 9. 1992 20.0 110. Real Estate. Real Estate.9 42.0 39.3 33.0 110.5 11.7 12.1 65.0 70.7 4. and Bldg.8 20.1 4.7 9.4 35.2 7.5 19..2 11.3 7.0 120. and Services Asset Turnover Agriculture Mining Basic Industry and Chemicals Misc.4 46.7 26.9 4.3 7. Infrastructure Finance Trade.0 19.8 3.0 80.0 560.0 110.0 150.0 100.4 79.5 Financial Performance of Publicly Listed Companies by Sector.8 81.8 16.2 15.1 4.0 46.0 650.0 17.0 60. Investment.9 10.8 382. Investment.3 13.0 110.1 7.4 6.1 10.0 180.7 4.6 (11.2 7.8 11.8 168.2 111.2 1993 130.3 17.3 17. Constn.2) 15.7 1.4 13. Constn.6) 18.4 4. Infrastructure Finance Trade. and Bldg.7 5.4 35.1 11.0 (0.2 39.4) (1.9 17. 1992-1997 (percent) Indicator/Sector Debt-to-Equity Agriculture Mining Basic Industry and Chemicals Misc.1 6.0 15. Infrastructure Finance Trade.1 2. Industry Consumer Goods Industry Prop.5 17.6 23.0 160.0 160.0 700.0 380.9 14.0 140.1 13.7 12.4 .7 8. Industry Consumer Goods Industry Prop.6) 36.3 18.1 8. Real Estate.4 46.6 13.0 120.0 100.2 3. and Bldg.5 56.0 110.7 46.3 0.0 100.0 120.4 6.8 9.0 180.0 3.4 5. Investment.0 11. Investment.0 130.0 70.5 14.4 71.1 1994 80.7 13.7 10.8 25.1 4.0 8. Real Estate.8 67..5 7.7 71.8 11.2 8.0 190.4 20. and Services Return on Equity Agriculture Mining Basic Industry and Chemicals Misc..3 1.9 38.7 61.1 (5.9 41.0 180.0 650.0 70.6 19.1 63.8 44.7 4.6 1.5 4.1 9. Constn.3 38.5 43.6 13. Industry Consumer Goods Industry Prop.0 140.0 170.Table 1.9 40.0 220.0 14.0 680. Constn.2 3.1 10.0 3.8 479.1 89. and Services Return on Assets Agriculture Mining Basic Industry and Chemicals Misc.0 190. and Services Source: JSX Monthly (several publications).6 8.0 90.0 210.1 (3.8 8.0 190.7 8.5 1995 80.1 9.2 23.
indicating SOCs’ declining contribution to GDP.1 percent in 1992 to 28.3 percent in 1995.1 percent in 1993. the Department of Finance supervised 30 SOCs. This was due to large sales by the National Oil Company (Pertamina). While asset turnover rates of publicly listed 3 4 SOCs are those in which the State has at least a 51 percent equity interest. there were 165 state-owned companies (SOCs)3 in Indonesia. insurance (11 companies). These growth rates were low compared to those for listed companies during the same period. This was relatively high compared to the 3. registering an average annual rate of 10 percent. but dropped dramatically to 4. By 1995. increasing from 21. Similarly. SOCs diversified into many businesses. between 1993 and 1995.7 percent in 1990 to 6 percent in 1996. State-Owned Companies At the end of 1995.6 to 8. The sectoral distribution of 165 SOCs is as follows: nonfinancial (143 companies).3 trillion. growth of net profits and assets was erratic. and basic industry and chemicals sectors had relatively stable ROA before the crisis. Trade had the highest ROA of 39. The finance and miscellaneous industry. The DER was slightly higher than for listed companies. Taken together. Only the agriculture sector showed an increase in ROA in the couple of years before 1997. much lower than that of companies listed in the stock exchange. SOCs’ sales growth fluctuated during 1990-1996. However.8 percent between 1992 and 1995 (Table 1. The Department of Mining and Energy ranked first in terms of sales of SOCs under its control. . Just like private companies. ROA had been at high levels from 1992 to 1995. the ratio decreased from 8. which collectively had the largest assets.6). averaging 24 and 31 percent. SOCs actively operated in various sectors4 under the supervision of “technical” departments. the SOCs’ value added as a percentage of GDP ranged from 6 to 8. Assuming a fixed ratio of value added to sales. SOCs’ ROE ranged from 6.Chapter 1: Indonesia 13 negative ROA.4 percent the following year. the subsidiaries and affiliates number 459 with total assets of Rp343. banks (seven companies).7 percent. respectively. there were 58 SOCs with subsidiaries and affiliates.7 to 7 percent for publicly listed companies. For instance. but it continuously declined from 370 percent in 1992 to 250 percent in 1995. and finance company (four companies). Six SOCs were listed in the Jakarta Stock Exchange. Asset turnover rates were lower relative to those of publicly listed companies.
0 12. Table 1.1 32.6 percent in 1994.1 12. Vol. b Asset turnover is defined as sales over assets.4 13.1 trillion in 1990 to Rp234 trillion in 1997.2 — = not available.1 19. Source: Indonesian Data Business Center. these conglomerates owned 9.8 12.2 percent in 1997 (Table 1. Their total sales increased from Rp90.8 percent in 1990 to 13. a Value added was assumed to be 30 percent of total sales.8 21.6 28.4 7. the contribution of conglomerates to GDP increased from 12.14 Corporate Governance and Finance in East Asia.0 6.3 250. SOCs’ asset turnover rates showed a downward trend from 32. Table 1.7 Growth Performance of the Top 300 Conglomerates.4 1993 16.6 Growth and Financial Performance of State-Owned Companies.5 percent in 1995. 1990-1997 (percent) Item Sales Growth Share of Value Added in GDPa 1990 1991 1992 1993 1994 1995 1996 1997 — 17. a Value added was assumed to be 30 percent of total sales.3 12. but climbed to 30. Assuming a constant ratio of value added to sales.8 11. Source: Indonesian Data Business Center. 1992 — 7.6) 260.1 310.4 percent in 1994.0 17. 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. but dropped to 11.1 30.6 28.3 30.1) 5. mostly private companies.0 8.5 3. .1 6. In 1997.7 (2.7 13.5 Conglomerates This study used available data on the top 300 conglomerates in Indonesia.6 1995 25.7 16.0 28.4 16.4 percent in 1992 to 28.0 7. II companies consistently declined over time.0 8.2 18.4 13.2 23.7).4 13.2 — 370.7 1994 (9.0 24.766 business units.
For example. a member company might sign a disadvantageous contract with another company where the same controlling shareholder has a higher stake. The law also holds the directors and commissioners jointly responsible for decisions made by the company.2. an approval needs the majority (50 percent plus one) vote. The company charter details the issues that need shareholder meeting approval. In general. The meeting decides on important issues. except in strategic issues stated in the law. however. tasked to provide direction to the company. By international standards. For instance. the decision to amend the company charter should be approved by two thirds of shareholders present in the meeting. and consolidations. shareholders lose control. tasked with supervising the firm. For mergers. and the accountant. For instance. This guards against shady intercompany dealings within a group of companies. and the board of directors (BOD). and the attendance should at least be two thirds of total shareholders. is the only shareholder mechanism for monitoring and controlling the BOD. The BOD undertakes operating decisions while the BOC participates in strategic decisions and operations review. A chairman heads the BOC while a chief executive officer (CEO) heads the BOD. The law also specifies that the highest “institution” in the limited company is the shareholders’ meeting. such as the appointment (or replacement) of directors. The Corporate Law The Corporate Law of 1995 governs the establishment and operation of limited liability companies in Indonesia. . acquisitions.Chapter 1: Indonesia 15 1. the legal and regulatory framework of the corporate sector was far from adequate. If the BOC does not perform well. and declaration of bankruptcy. as representative of shareholders. commissioners. mergers. The law explicitly requires approval during the meeting of decisions on strategic issues such as amendment of the company charter (articles of incorporation). The actual responsibilities of BOCs vary by company and are stipulated in the company’s charter. The law replaced an earlier statute that was based on the Dutch system. the decision to use certain company assets as collateral for bank credit might need BOC approval. The law mandates the BOC and BOD to work for the best interests of the company and not just of the shareholders. The BOC. The 1995 law requires limited liability companies to set up two boards: the board of commissioners (BOC).6 Legal and Regulatory Framework During the 1990s. the Government promulgated a number of laws and regulations to protect investors.
(xiii) mandatory disclosure of nonfinancial information. II acquisitions. the decision should be approved by three fourths of the shareholders present. and bankruptcy. (x) mandatory shareholders’ approval of major transactions. such as custodian banks and the securities registration bureau. and the attendance should at least be three fourths of total shareholders. An important rule is the requirement for independent shareholders’ approval for arrangements that might lead to conflicts of interest. investment managers. 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. Vol. (vii) the right to call an emergency shareholders’ meeting. (viii) the right to make proposals at the shareholders’ meeting. (xi) mandatory disclosure of transactions by significant shareholders. and (xviii) severe penalties for insider trading. delineating the tasks and responsibilities of the Capital Market Supervisory Agency.16 Corporate Governance and Finance in East Asia. decrees of the finance minister. (xiv) mandatory disclosure of intercompany affiliation such as affiliated lending or guarantees. insider trading (including market rigging and manipulation) investigation. It also regulates reporting and auditing procedures. (xii) mandatory disclosure of connected interests. (xv) mechanisms to resolve disputes between the company and shareholders. brokers. securities companies. and other supporting agencies. and guidelines promulgated by the head of capital market supervision. 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. . consolidations. Because of such requirements. underwriters. Controlling shareholders have no vote on the matter. (iii) proxy voting by mail. transparency requirements. (ix) mandatory shareholders’ approval of interested transactions. (iv) cumulative voting for directors. (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. A tender offer is also required for acquisitions of up to 20 percent of listed shares. (xvi) independence of auditing. It regulates the requirements of investment companies. investment advisors. The Capital Market Law The Capital Market Law (1995) regulates companies listed in the stock exchange. The law is supplemented by Government regulations. and administrative and legal punishment. (v) preemptive rights on new share issues. (xvii) mandatory independent board committee. (ii) proxy voting.
for instance. the viability of a project). A new bankruptcy law was passed in August 1998. Ownership concentration is usually measured by the proportion of shares owned by the top one. five. However. 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 collateral could take the form of nonphysical assets (e. A Commercial Court was also set up to deal with bankruptcy cases. whether they are individuals. etc. the Banking Law (1992). It reveals characteristics of controlling shareholders. creditors of unsecured loans are unprotected when borrowers fail to meet their obligations.Chapter 1: Indonesia 17 Bankruptcy Law Despite loan covenants. Banking regulations also set lending limits. 1. or financial institutions.1 Corporate Ownership Structure Quality of corporate governance is closely related to corporate ownership structure (see discussions in the Consolidated Report of this study). amended in October 1998. It aimed to protect creditors by providing easier and faster access to legal redress. holding companies. families. capital adequacy. or 20 shareholders. 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.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. Banking Laws Affecting the Corporate Sector Some elements of the banking law also affect the corporate sector. . For instance.3. Discussions on corporate ownership cover listed companies and conglomerates. The court can declare the debtor bankrupt upon the request of at least two creditors and default on one loan.g. 1. states that a bank is not allowed to provide credit without collateral.. net open positions. The two most important elements of ownership structure are concentration and composition.
7 3.9 percent of total outstanding shares. The pattern of ownership concentration changed little over this period. issued 93. mining.8 68. Data from the Indonesian Capital Market Directory (various publications) show that between 1993 and 1997. On average.0 0. for instance.4 percent. ownership widely held by the general public is highest in the infrastructure and transportation sector (not shown in the table). Zebra Nusantara (taxi services).8 Ownership Concentration of Publicly Listed Companies.1 4. the five largest shareholders owned 68.6 4.5 72.5 1997 48.2 67. Meanwhile.0 1.8 1. Table 1. 13.3 1995 47. Vol.9 14. When a company makes a rights issue. The percentage owned by each of the five largest shareholders was 48.2 1.6.5 16.6 68. This is because a few companies in the transportation sector issued high proportions of shares to the public.8 shows average proportions of shares owned by the five largest shareholders of publicly listed companies during 1993-1997. and 0.9 2.6 3. This preserves the pro rata share of existing shareholders. about two thirds of publicly listed companies’ outstanding shares were owned by corporations that were directly or indirectly controlled by families.5 percent.5 Average 48.6 3. When a company goes public.4 2. and basic industry and chemicals sectors than in others. Rig Tenders Indonesia (shipping services) issued 51.6 percent.9 shows that ownership by the largest shareholder in 1997 was more concentrated in the agriculture. respectively. 2.7 1994 48.0 67.5 12. consumer goods. This is partly due to the prevailing practice of raising equity through rights issues in Indonesia.0 0.7 1996 48. Table 1.1 1. II Publicly Listed Companies Table 1. the founder usually continues to own the majority of shares through a . 3.8 68.1 0.0 2.9.9 Source: The Indonesian Capital Market Directory.6. 1993-1997 (percent) Shareholder Rank First Largest Second Largest Third Largest Fourth Largest Fifth Largest Total 1993 50.2 11.18 Corporate Governance and Finance in East Asia.9 2. and Berlian Laju Tankers (liquid bulk maritime transportation services) issued 48.1 13. the controlling shareholders usually act as standby buyers.0 4.9 0.6 13.8.
2 10.1 0.1 2.2 This is confirmed in Claessens et al.7 4. Constn. Investment..1 1.4 54.7 9. Legal and regulatory developments may have been impeded by the concentration of corporate wealth in .9 3.4 4. Util. and corruption. and Transportation Finance Trade. Claessens et al.1 1.6 percent of total market capitalization while the top 15 families control 61. Thus the founder keeps the proportion of shares necessary to retain control over management of the listed firm. on the one hand. which shows that in 1996.6 8.8 14.9 1.7 6.4 44.5 58.6 1.1 0. These figures suggest that ultimate control of the corporate sector rests in the hands of a small number of families. Industry Consumer Goods Industry Prop. In fact.0 5.9 44. Real Estate.5 4.1 2.7 1.6 2. as well as the existence of corruption. Most of the five largest owners of Indonesian publicly listed companies are limited liability companies rather than individuals. is strong.3 36. on the other.4 1. Indonesia has the largest number of companies controlled by a single family.4 11.4 6.1 2.1 percent) of Indonesian publicly listed companies were in family hands. in a cross-country study.3 14.1 11. and Bldg.6 0.3 0.1 1.. and the efficiency of the judicial system.Chapter 1: Indonesia 19 fully-owned limited liability company (Perseroan Terbatas). 1997 (percent) Sector Agriculture Mining Basic Industry and Chemicals Misc.9 Ownership Concentration of Publicly Listed Companies by Sector. two thirds (67.3 48.2 15. and only 0.9 50. the top family controls 16. In terms of capitalization.7 13.9 0.6 percent were widely held.3 0.5 1.7 percent of the market. (1999). Table 1. Infrastructure. (1999) also found.2 2.1 1. the rule of law. and Services Average Source: The Indonesian Capital Market Directory. First Second Third Fourth Fifth Biggest Biggest Biggest Biggest Biggest 54. that the correlation between the share of the largest 15 families in total market capitalization.3 2. 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.2 0.9 44.6 9.1 13.2 46.
accounting for 64 percent of total conglomerate sales in 1988-1996. From 193 in 1988. conglomerates established before 1969 dominated in terms of sales. there is a dichotomy between corporations owned by indigenous and nonindigenous businesspeople. or other ethnic groups. numbering 162 in 1988 and 170 in 1996. . nonindigenous groups owned a larger proportion of the top 300 Indonesian conglomerates. Indigenous businesspeople include the Javanese.55 percent in August to 25. However. Indian. the onset of the crisis negated this development. In 1993. The nonindigenous businesspeople are usually Chinese. resulting instead in a decline in the proportion of foreign investor ownership. Family control is said to have positive effects in that it allows group members in conglomerates to make strategic decisions quicker. ethnicity. The corruption and regulatory problems generated by high ownership concentration by families in Indonesia are likely to overwhelm its benefits. was able to create a favorable environment for business development. the proportion of foreign ownership declined from 27. most were established during the New Order Government. and Padang. political affiliation. In September 1997. it rose to 30 percent. their number increased to 5 In 1997. Batak. and family origin. but later declined and steadied at around 25 percent.20 Corporate Governance and Finance in East Asia. Among the top 300 conglomerates. with all its regulations. foreign ownership increased to 21 percent. Sundanese. Coordination is easier because informal communication channels exist. However. Vol. In Indonesia.5 Conglomerates Table 1. 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.42 percent in December. the Government allowed foreign investors to buy up to 100 percent of listed shares. But these benefits are few and often dubious compared to the high costs of concentration.10 shows the anatomy of the top 300 conglomerates in terms of year of establishment. When the Government allowed foreign investors to buy up to 49 percent of listed shares in 1988. the legal system is less likely to evolve in a manner that protects minority shareholders. II the small number of families and the tight links between companies and the Government. During 1988-1996. This may indicate that the New Order Government.
7 64.5 22.8 Source: Indonesian Business Data Centre. Meanwhile.4 15.6 95.8 30.8 49.7 49.2 30.2 12. Their total sales also increased from Rp38.8 68.9 47.9 137. For instance.1 33.9 73.6 114.2 33.1 25.1 103.0 15.1 percent of total .4 18.1 46.1 42.0 58.9 trillion.4 81.1 52.4 16.4 57. In 1996.3 80.2 159.3 101.7 106.3 36.1 41.4 59.1 58. 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 9.7 95.4 trillion in 1996.2 23.4 31.5 21.0 18.4 68.5 120.9 billion.2 48.4 31.8 12.8 36.8 25.4 52.4 19.8 38.8 28.0 31. While they supplied 20.7 28.6 trillion in 1988 to Rp137.9 35.9 42.0 58.0 28.6 34.0 44.4 32.5 106.9 13. sales of the Bakrie group before it went public in 1990 were only Rp369.2 29. its sales reached Rp1.9 77.3 43.1 21.3 120.8 57.6 17.10 Anatomy of the Top 300 Indonesian Conglomerates. due to their “go public” activities.1 179.4 22.3 20.6 54.9 14.4 69.0 116.7 24.4 37.2 76.7 40.1 46. 204 in 1996.4 86. Conglomeration Indonesia 1997.4 59.7 89.6 12.6 77.1 87.3 134.Chapter 1: Indonesia 21 Table 1. the number of mixed groups declined from 86 in 1988 to 68 in 1996.4 48. more than five times its 1988 level.
and officialrelated groups. their contribution declined to 13. But only a handful of these companies are listed in the market. average sales of official-related conglomerates reached Rp1. Out of 174 companies. 117 are jointly owned by the family and 57 are owned by individual family members. Vol. Conglomerates were also classified into nonofficial. Some of them later became public companies by listing in the stock market. owns four groups with many subsidiaries and affiliate companies. In 1996. and Wisnu Suhardhono of Apac-Bhakti Karya. which is the largest conglomerate in Indonesia. In 1997 and 1998. The Salim group.22 Corporate Governance and Finance in East Asia. Prudential credit analysis tends to be ignored. Banks owned by groups or conglomerates typically act as a “cashier” that provides credit to companies within the group. or have resulted from alliances between entrepreneurs and officials. Political alliances between entrepreneurs and officials have often led to the violation of regulations meant to promote prudent business practices in the banking industry. for instance. The well-known official-business alliances are those between Sudwikatmono (former President Suharto’s cousin) and Soedono Salim. Djuhar Soetanto. Bank Indonesia. collectively controlling . Official-related groups have owners (or founders) who are or are allied with former or current government officials (or their families).7 percent in 1996. Only about 13 percent were formed by official or ex-official families. The Suharto family is the largest stockholder in Indonesia. Bambang Rijadi Soegomo. But listed companies within conglomerates were few. In 1996. compared with the less than Rp700 billion of a nonofficial-related conglomerate.2 trillion. Indocement Tunggal Prakarsa (cement industry). In November 1997. Most of the top 300 conglomerates were established by ordinary citizens. II sales in 1988. including Indofood Sukses Makmur (food industry). there were 175 groups that originated from a family business. and Ibrahim Risyad of the Salim group. The contraction in the number and economic contribution of mixed groups may be an indication of increasing social polarization along ethnic lines. banks that had to be closed down included Bank Surya (owned by Sudwikatmono) and Bank Andromeda (owned by Bambang Trihatmodjo). 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. most of the 16 liquidated banks had violated the legal lending limit set by the central bank. and Fast Food (restaurants). More recent alliances were between Bambang Trihatmodjo (former President Suharto’s son) and Johannes Kotjo.
The officials (or their family members) often own a small portion of shares given to them freely by controlling shareholders. or someone very close to and trusted by the controlling shareholders. Cross-holdings between financial and nonfinancial firms potentially create more serious problems. Semen Cibinong. with no restrictions. The Salim Group is also in part controlled by the Suharto family. served in some government function (see Figure 1. While the source of the . they still control the work of the directors. The family controls 417 listed and unlisted companies through a number of business groups led by the Suharto children.Chapter 1: Indonesia 23 assets worth $24 billion (Claessens et al. Cases in point are the Bank Papan Sejahtera and Bank Niaga. and hence. It is generally believed that there are cross-holdings between financial and nonfinancial companies and among nonfinancial firms. 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. The families retain control of the companies through ownership. which were liquidated or recapitalized after being acquired by the Tirtamas group that owns a listed cement company. Indofood Sukses Makmur (food industry) was owned by Indocement Tunggal Prakarsa (cement industry). the controlling shareholders are able to maintain their special relationship with officials. Both are listed companies and members of the Salim group.1). besides Suharto himself. Indonesian law allows cross-shareholdings. they maintain their position as commissioners. Although they are not actively involved in the daily operations of the companies. continue receiving some kind of protection and special treatment. But it is difficult to obtain data on cross-shareholding among firms. Although some groups employ professional managers. The BOC chairperson often represents the controlling party of the company. families mostly manage the groups and make strategic decisions themselves. as well as other relatives and business partners. many of whom. In so doing. but those of the entire group. In 1996. management.. or both. for instance. This is because cross-owned banks had to consider not only their own interests. He or she could either be the biggest shareholder. 1999). Some of the groups related to officials have a unique share ownership structure. If the family members cannot actively manage the companies as directors.
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. 1999). P. Simeon Djankov.Figure 1. Lang. Financial Sector Practice Department. Who Controls East Asian Corporations? Financial Economics Unit. (Feb. World Bank. and Larry H. .
2.2 Management and Internal Control A company’s internal organizational structure determines how shareholders control management. management and managerial compensation.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 typical structure of a publicly listed company in Indonesia is shown in Figure 1. one possibility is that legal lending limits had been violated. The managers execute the BOD’s decisions and lead employees in their departments.Chapter 1: Indonesia 25 problem is inconclusive. and accounting and auditing procedures. The discussions are based on the ADB survey of 40 companies listed in the Jakarta Stock Exchange. role and protection of minority shareholders. both controlling and minority. This is based on the Dutch system. Therefore. and. Figure 1. 1. the BOC has the right to obtain any information concerning the firm. the BOC supervises the work of directors. seek an audience with directors. if necessary. including the boards. . request a shareholders’ meeting. Shareholders are at the top of the organization. As the owners’ representatives. the directors. The BOD leads the company and makes strategic and operational decisions.3.
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
One famous takeover was Bank Papan Sejahtera.Chapter 1: Indonesia 31 external acquisitions. a state-owned insurance company may invest its funds in a private firm. The Government is thus able to appoint some officials to be members of the private firm’s BOD or BOC. The BOD and BOC of PT Sari Husada were allowed to complete their terms before they were replaced. The bank was reported to have high NPLs and had broken the legal lending limit. This used to be a common practice in companies associated with the Suharto regime. except for publicly listed SOCs. They then replaced the BOD and later sold the bank. appointment of management. the acquiring parties were trying to obtain operating synergies because they had companies in the same industry. the takeover brought significant losses to Djojohadikusumo when share prices plunged7 during the crisis. A more recent case was the acquisition by Nutricia (the fourth largest baby food firm in the world) of PT Sari Husada (another baby food firm) in 1998. the bank was liquidated. In the massive restructuring of the banking sector that commenced after the crisis. .6 In this case. However. The Government appoints the BOD and BOC of these firms. Control by the Government Government control could be in the form of state ownership. the Government took over NPLs and put them under IBRA management. the acquiring interest was apparently seeking economic profits. which was acquired by Yopie Wijaya in 1995. Most Indonesian state companies are 100 percent owned by the Government. at a large profit. Wijaya and his friends bought shares of the bank on several occasions until they gained control. restrictions on market entry. to Hashim Djojohadikusumo. the owner of Tirtamas group. For instance. who was acquiring his second commercial bank. In April 1999. with the minister’s approval. In these two latter cases. or direct subsidies. 6 7 Later in March 1999. it was common for the Government to invest in certain private companies. State ownership for listed SOCs ranges from 25 to 35 percent. Before the financial crisis. A study by Connie Tjandra (1993) shows that internal acquisitions were often initiated for tax shelter purposes. IBRA found itself tasked with managing large amounts of assets in the private sector. Another case was the takeover of Bank Niaga in 1997 by Djojohadikusumo. Since the NPLs reached up to Rp300 trillion. Bank Niaga was under a recapitalization program.
0 168.9 trillion in 1992 to Rp487. this market was not well developed. private national banks overtook state banks as the dominant credit source.1 Equities In 1977.7 18. Bank loans.7 50.2 6.3 60.7 122.6 6.6 150. 1992 1993 1994 1995 1996 1997 1998 1999 68.2 27.0 487.9 150.4 1. Private national banks and state-owned banks were the biggest domestic creditors.4 trillion in 1998.4.7 112.4 percent in 1992. Bank Credit As shown in Table 1.9 234.1 220.3 9. jointly providing almost 90 percent of loans until 1997. .5 80. when the Government reactivated the stock exchange. remain the major financing instrument for the corporate sector.6 4.3 111.4 24. stocks.0 6. equities became available to the corporate sector. When the Government liberalized the banking industry at the end of 1988 (which allowed for higher interest rates).6 48.2 5.3 14. Table 1.6 3.14 Banking Sector Outstanding Loans.3 66.5 108. bank loans were the only instruments available to the corporate sector for short term (working capital) or long term (investment) financing. From 34. 1992-1999 (Rp trillion) Type of Bank State-Owned Banks Foreign Banks Regional Govt Banks Private National Banks Total Source: Bank Indonesia. including bonds.4 86. Since then. and others offered by nonbank financial institutions or finance companies.5 7. II 1. bank credit surged from Rp122. companies considered alternatives to bank loans.5 42. new instruments have been introduced to the corporate sector.1 Corporate Financing Financial Market Instruments Prior to 1977.3 188.2 71.0 93. However. because of the restrictions discussed below.6 292.32 Corporate Governance and Finance in East Asia.6 percent in 1997. Vol.9 153. the share of private national banks in outstanding total loans increased to 44. however.0 3.4 56.14.9 378. Data from Bank Indonesia show that from 1994 to 1997.4 225.8 193.
i.1 10. allowed to accept deposit accounts from the public. thus increasing the role of the capital market in raising long-term funds. . when foreign investors were not yet allowed to purchase listed shares.1 17.1 1994 26.8 48.7 15. Table 1. finance companies were increasingly used as channels for the inflow of foreign loans.15 Value of Stocks Issued and Stock Market Capitalization.7 9. The ratio reached 8. Most banks therefore set up subsidiary finance companies to circumvent banking regulations.7 14.3 percent in 1990 when the stock market was liberalized and foreign investors were allowed to purchase up to 49 percent of listed firms’ shares. In 1995. During the 1990s.0 15.6 859.9 1999 76. 1992 1993 11. but dropped to 8 percent in 1991 when the Government tried to stabilize an overheating economy.0 206.4 207.. capital adequacy ratio. and consumer credit.Chapter 1: Indonesia 33 Some companies went public. 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. offering services such as leasing.9 406.6 123. shooting up to 18.5 Financing by Finance Companies Finance companies first emerged at the end of 1980. factoring. Prior to 1995. 1992-1999 (Rp trillion) Item Stocks Issued Outstanding (As % of Outstanding Bank Credit) Market Capitalization Source: Bank Indonesia.1 18.4 1996 1997 1998 50. however.6 91. They were not. the activities of finance companies were not covered by regulations on prudential practices in the banking sector (e.15).6 310. the Government issued regulations to supervise and promote prudential practices in finance companies.2 16. limiting loans to a maximum of 15 times equity and foreign loans to five times the equity. funds raised in the stock market were less than 5 percent of the credit disbursed by the banking sector.5 1995 35.7 percent in 1997.0 70.. legal lending limit. credit cards.6 301.e. It gradually increased again starting in 1991.g.5 333. and net open position). the stock market has gained a bigger role in corporate sector financing (Table 1. In 1988. Overall.
0 — = not available.6 8.3 37. Vol.3 14. In terms of composition. averaging 26.0 3. 1996.16 shows financing sources of Indonesian publicly listed nonfinancial companies estimated by using flow-of-funds analysis. 1986-1996 (percent) Financing Source Internal Borrowings Short-Term Long-Term Debentures/Equity Debentures Equity Trade Credit Others Total 1986-1990 36. short-term borrowings were greater than long-term debts.5 percent and 36.6 100.8 percent.4 23. In the second half of the 1980s. II Commercial Papers Commercial papers.3 16. 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). Source: Author’s estimates based on the Pacific-Basin Capital Markets (PACAP) Databases. .1) 23.16 Financing Patterns of Publicly Listed Nonfinancial Companies.3 (0.2 26.0 39.4. 1. Bank Indonesia prohibited banks from underwriting issues of commercial papers but allowed them to act as paying agents. Thus in November 1995.0 1986-1996 17.5 (0.5 21.0 100.1) 23.9 16.6 12. PACAP Research Center.8 7. they were not rated by a rating agency. have been popular in Indonesia since 1990. at 81 percent of total borrowings.5 11. otherwise it would be classified as a loss in the banks’ books.0 1991-1996 16.6 23. respectively.4 8.5 — 26. publicly listed nonfinancial companies had high proportions of equity and internal finance (retained earnings). This is in contrast to the lower share of borrowings during the same period.4 13. which are unsecured negotiable promissory notes with a maximum maturity of 270 days.2 Patterns of Corporate Financing Table 1.6 100.7 22.8 17. Table 1. While banks had some exposure to these instruments.34 Corporate Governance and Finance in East Asia.
Most corporate charters require commissioners to approve debt issues or sign debt agreements. Of the various financing sources. rising from Rp54.2 trillion (mostly foreign exchange losses). The corporate sector invested heavily from 1991 to 1993 and slowed down its investment spending a few years before the 1997 crisis. Large shareholders are inclined to undertake risky projects intended to generate high returns using borrowed funds. Bank loans also surged when the banking sector was liberalized in 1988.6 trillion and Rp1. Table 1.3 Corporate Financing and Ownership Concentration It has been suggested. the corporate sector’s high leverage. 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. They also do not want to dilute corporate control and are more likely to finance growth with debt. in the context of Indonesia and some other countries. was due largely to a rapid rise in long-term debts. with longterm debts increasing rapidly.2 trillion. 1.4 trillion in 1993 to Rp112. For instance. Indosat and Telekom.4. All companies in the cement industry suffered from foreign exchange losses. that ownership concentration may be associated with heightened risk-taking by companies.9 trillion. Two telecommunications companies. Indofood registered losses of almost Rp1. the pattern changed. respectively. This amount doubled in 1997. which managed to post significant profits due to low exposure to dollar-denominated loans. while Semen Cibinong’s losses reached Rp2. Note that the corporate sector’s high leverage existed side by side with sizable equity capital raised from the capital market. also suffered from foreign exchange losses but managed to post profits of Rp0. The high share of equity financing was due to the surge in capital market activity following the 1988 reforms. Many companies suffered big losses in 1997 due to their high exposure to dollar loans. corporate debts accounted for 39.9 trillion in 1996.17 compares the DER of listed firms by degree of ownership concentration. These liabilities grew significantly because corporate expansion was largely financed by debt. .Chapter 1: Indonesia 35 In the 1990s.3 percent during 1991-1996. Corporate debts grew over time. as evidenced by an average DER of 230 percent during 1992-1996 that rose to 310 percent in 1997. The results indicate that firms with higher ownership concentration tend to have a higher DER. which was masked by the rapid growth in investments.1 trillion. Hence. reaching Rp229. except Semen Gresik (an SOC).
Vol.0 351. 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 low cost of foreign loans and the relatively stable exchange rate created a false sense of security for corporations. The test of the difference between the two means found the t-value of 1.17 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. 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. As a result. Source: Author’s estimates. aided . the free capital flow system allowed private companies to borrow dollars offshore without any restriction. II However.1 The Corporate Sector in the Financial Crisis Causes of the Financial Crisis Many intertwined factors led to the crisis.0 386. Table 1. 1.5.0 Notes: Firms with high ownership concentration have more than 50 percent of shares owned by the top five shareholders. Between 1987 and 1996. and high ownership concentration among families with political affiliation. In addition. since commissioners represent the controlling party. ultimately. Inadequate Financial Regulatory Framework Liberalization of financial markets increased the corporate sector’s access to domestic and foreign private capital. heavy reliance of companies on bank credits to finance investments.56 significant at the 10 percent level. to maintain control of the company. the borrowings swelled.0 1.36 Corporate Governance and Finance in East Asia.358. decisions on debt are made with the implicit endorsement of owners. the private sector borrowed heavily in unhedged dollars. Controlling parties rely on external financing to maintain their equity share and.5 1.
e. only created to serve the companies to which they lent. A lot of short-term foreign funds were used to finance long-term investment projects. The banks served as a “cashier” that provided easy credit to nonfinancial companies within the group. It also meant that the cashier bank had neither the independence nor the incentive to exercise ex ante and ad interim monitoring of borrowers. This left them vulnerable to interest rate surges as well as sudden currency fluctuations in the case of dollar loans. Conglomerates that had difficulty in getting loans (i. The Government later specified the legal lending limit and the net open position that banks had to follow. conglomerates set up finance companies and used these as channels for the unfettered inflow of foreign loans in lieu of banks. However. substantial amounts were also funneled into projects that guaranteed repayment mainly on the strength of borrowers’ close political connections. and the negative net open position (short position in dollars) continuously rose to precarious levels. to circumvent these banking regulations. The large supply of foreign funds. the level of corporations’ foreign debt could not even be ascertained. As a result. averaging about 4 percent of GDP. large amounts of credit were directed to the companies within the group..Chapter 1: Indonesia 37 by the lack of an existing mechanism to supervise and monitor foreign transactions. . It is not known if these regulations had an effect on nonbank intermediaries. It was doubly difficult to exercise supervision when groups with political clout owned the banks. It was only in 1995 that some regulations on the activities of finance companies were contemplated. after all. Decisions to borrow in dollars made sense to many borrowers because dollar loans were cheaper than rupiah loans. They were. In the process. 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. 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. those with high DERs) established their own banks. 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. many firms became highly leveraged. A director at Bank Indonesia revealed that in 1995. The supervising agency was caught unprepared. This often led to the violation of prudential credit management practices. did finance many viable ventures.
toll roads. and power generation) require huge capital. there was also almost universal confidence that the economic growth would continue indefinitely. and in the process maintain control of the company. Since the Government could not afford to undertake these projects. of which $64. Families retain control by keeping the majority percentage of outstanding shares. High Ownership Concentration High concentration of corporate ownership (particularly by families) led to poor financing and investment practices. They ensure that commissioners represent their interests and maintain close relationships with the chairperson. The ultimate control of the corporate sector rests in the hands of a small number of families who own groups of companies.38 Corporate Governance and Finance in East Asia. II By mid-1997. as they had done so in the years before the crisis. Collusion between big businesses and the political elite was widespread in Indonesia. where private banks are usually in the hands of big businesses.5 billion was owed directly by corporations. Corporations were certain that they could roll over short-term loans when these fell due. or both. politicians. banks did not lend on the basis of the soundness of the project. Controlling shareholders also prefer to use debts to finance expansion so as not to dilute their ownership. In many cases. Projects involving massive capital investments and long-term operating deals (in telecommunications. In early 1998. This was often the case in the banking industry. but on the basis of who the borrower was. and investing shares among nonfinancial companies within the group and in other groups’ companies.5 billion. Family-controlled corporations were generally structured as a complicated web of affiliates and associated companies. partly because they used nominee accounts to register ownership rather than set up a holding company. Aside from the fact that many of these loans were channeled through banks and corporations of politically connected families. $35 billion of Indonesia’s foreign debt owed to private foreign banks was about to mature in less than one year. . by setting up their own banks. contracts were granted to the private sector. There were cases where banks and borrowing companies were controlled by the same groups or families with strong political connections. Vol. They enhance their control over companies through cross-shareholdings. This fact was usually not disclosed in financial statements. total private sector foreign debt stood at $72. most often to people who were close to the ruling regime.
The construction sector was the worst hit.4) 2.18 shows that growth in most sectors significantly fell in 1997. Forestry. indicating a rapid rise in . and building construction.5) (18. when all sectors.6 4. followed by the finance and trade sectors.0) 1999 2. Sectors with lower ROE generally had higher DER.58 trillion (meaning their losses were greater than the paid-up capital). as shown in Table 1.6) (0. Gas. Hotels.2 8. and Fisheries Mining and Quarrying Manufacturing Electricity.7 1998 (0. and Water Supply Construction Trade.4 7. and Restaurants Transport and Communications Financial.1 (1. Table 1.7) 2.6 8.0) (15.52 trillion.8) (11. The average DER was found to be 1. Livestock.1) 1.1) (26. Only 86 companies reported profits.370 percent. except utilities.1 6.3 Source: Central Bureau of Statistics (Biro Pusat Statistik.2 Impact of the Financial Crisis on the Corporate and Banking Sectors Impact on the Corporate Sector Table 1.7 6.5. and 128 companies reported a total loss of Rp46.Chapter 1: Indonesia 39 1.0 2.2 (1.8 1997 1. 1996-1999 (percent) Sector Agriculture. BPS). much higher than the 307 percent registered in December 1997.0 5.3 11.19.4 7.8) (13. DER and ROE were calculated per sector.6 13.3 12.9 3.8 0. followed by property.8 8.7) (2. Using the financial statements as of 30 June 1998 of 161 publicly listed companies.8 7.4) (0. This continued in 1998.1 5. Real Estate.24 trillion for the first six months of 1998. Most sectors showed significant increases in leverage.7) (8.4 5.18 GDP Growth by Sector. The JSX Monthly reported that total losses of 214 listed companies amounted to Rp39. and Business Services Other Services GDP 1996 3. posted negative growth rates.6 12.6) (3. 53 companies reported negative equity of Rp6.0 3. real estate. The consumer goods industry reported the lowest ROE.6 (36.
7) 6.0 193.19 DER and ROE of Publicly Listed Companies by Sector. the NPL ratio had reached more than 60 percent.0 163. a Actual data for 1st semester only. Impact on the Banking Sector Table 1.3 7.0 111.0 1. small foreign banks enjoyed the highest profits.1 1.6 (11.0 65.0 1997 234. Financial and banking analysts estimate that by September 1998. as shown in Table 1.4) 18.6) (115. rupiah values of dollar-denominated debts due to the weakening of the local currency and the rapid decline in equity because of losses.0 2.8 17. from only 8.0 108. Vol. the NPL ratio rose to 25.8) 36.0 1. Mostly suffering from a liquidity squeeze.0 205.0 229. foreign exchange losses came about with the use of unhedged foreign debt. First.1) 7.1 30.5 percent in April 1998. but annualized to approximate full year values.0) 10.0 177.2 23. interest expenses rose as credit rates increased from 20 percent in early 1998 to 40 percent in mid-1999.0 697. and would have kept on increasing if interest rates had not declined. private banks posted negative ROEs in the same year.625.8 (373.271.2 (4.0) (78.6) 15.1) Note: DERs were calculated for only 161 companies (out of 214) that had positive equity.20 reveals that the banking sector’s ROE decreased significantly in 1997. The huge losses suffered by most companies were caused by three factors. .7 1.0 105.0 177.0 307.0 1.0 219.0 635.0 1998 186.0 a ROE 1996 1997 1998a 14. losses in operation were due to declines in sales and increases in the cost of imported inputs.4) 8. This figure further increased to 47.40 Corporate Governance and Finance in East Asia.21.2 13.5 8.0 191.0 864. Source: JSX Monthly.370.1 (5.9 12.0 92. II Table 1.4 (6.1 (3. Second.1 (92.0 72. 1996-1998 (percent) DER Sector Agriculture Mining Basic Industry Miscellaneous Industry Consumer Goods Industry Property Infrastructure Finance Trade/Services Average 1996 104.8 percent in 1996.395.4 5. Third.0 12.2) (264. The table also reveals that although private national banks dominated the banking sector in terms of assets and credits.0 108. As the rupiah weakened and interest rates increased.1 (124.0 2.0 158.0 631.7 percent in July 1998.097. several publications.0 97.
1 30. 230/1998.7 4.6 — 1.9 11.1 1.2 37.2 8. .6 — 4.28 5.91 21.24 15. 1992 7. July No. State-owned banks initially had the highest NPL ratio. Source: Infobank.8 14.Chapter 1: Indonesia 41 Table 1.73 30.68 1996 1997 8.24 (4.5 2.5 222.45 — 1993 15.47 20.9 — 11.3 Private National Banks — 179.15 20.9 percent.2 — 19.7 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. however.69 14.5 57.7 106.0 — 4.30 5.21 Nonperforming Loans by Type of Bank.43 10.2 10.3 445.2 1.12 15. 227/1998 and October No.0 — 32.20) Table 1.9 Regional Foreign and Development Joint Venture Banks Banks — 9. Source: The National Banking Association.8 11.06 20.44 15.20 ROE of the Banking Sector.07 1994 14.72 16.6 6.86 11. The high and increasing NPLs.50 9.2 48.0 622. 1992-1997 (percent) Type of Bank State-Owned Banks Foreign Banks Joint Venture Banks Regional Development Banks Private National Banks Total — = not available. private national banks overtook State-owned banks when their NPL ratio jumped to 57.38) 11.67 8.81 13.5 34.09 (11.25 22.2 47.7 29. put pressure on the banking sector.8 8.84 27.2 — 8.1 47.37 19.1 198.09 11.2 8.6 — 13.4 7.3 22.8 3.7 — 1.1 274. coupled with negative spreads (deposit rate was higher than the credit rate).5 128.3 361.07 13.8 187. 1996-1998 (Rp trillion) State-Owned Banks — 140.5 31.9 297.89 27. In July 1998.70 1995 7.34 16.39 13.7 — = not available.1 13.45 21.0 129.
the Government and private sector formed a committee to help corporates deal with the crisis.5. While the process of restructuring was in progress. Another option that companies could take under the Jakarta Initiative was debt restructuring via debt-to-equity swaps.7 billion of foreign exchange debt. Astra International (automotive). about 80 percent of which was private. few companies were in a position to resume interest payments. assembling the legal and policy framework to facilitate corporate restructuring. In addition. by mid-September 1998. a number of prominent companies. IBRA was formed to offer Mexican-style resolution for private sector foreign debt. The scheme offered a hedging facility against rupiah devaluations for restructuring agreements. Unfortunately.000 eligible firms had signed up for the scheme. Aside from being described as overly complicated. the Jakarta Initiative Task Force had conducted negotiations for 52 companies with Rp2. companies were not servicing their debts. The committee was tasked to ascertain the level of private corporate sector debts and arrange negotiations between debtors and creditors. Total amortization payments due on foreign debt in 1998 were placed at $32 billion (before restructuring).6 billion) of Indonesia’s total external debt in March 1998. Since September 1998. have been subject to restructuring deals under the initiative. the corporate sector had more than Rp600 trillion ($75 billion at Rp8. II 1. the committee launched the Jakarta Initiative. Corporate debt accounted for 46. a more comprehensive scheme to tackle domestic and foreign corporate debt. none of the 2. 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. Semen Cibinong (cement industry) became the first Indonesian company to resume paying part (25 percent) of the interest on its $1. The scheme encourages negotiation between creditors and debtors. Thus.3 Responses to the Crisis Corporate Restructuring Measures At the end of 1997. such as Garuda (a national flag carrier). In November.7 percent ($64. 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.000/$1) in debt from domestic commercial banks. only a . and Ciputra (property business). In June 1998.4 trillion of domestic debt and $6. particularly in terms of debt resolution. Vol.42 Corporate Governance and Finance in East Asia. On 9 September 1998. the scheme failed. By end-November. However.2 billion debt.
forcing them to cut costs. i. the companies’ financial performance deteriorated. Standard Chartered. Astra International. Moreover. for equity infusion. mining. Protection against insider and fraudulent transactions taken by a debtor prior to the adjudication of bankruptcy will be enhanced.e.. Bank Niaga also negotiated with some of its creditors. consolidate business units. under which the latter would become one of the bank’s shareholders. focused on its core business of car and motorcycle manufacturing and sold off its subsidiaries in semiconductors. with the requirement that adequate compensation and protection will be provided to such creditors during that period. Bankruptcy Reform The Bankruptcy Law was passed in August 1998. The Commercial Court can be asked to hold off creditors and impose strict guidelines on the negotiating process . especially in preventing unjustifiable delays in the adjudication of bankruptcy. aiming to modernize the bankruptcy system and promote the fair and expeditious resolution of commercial disputes. 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). For instance. a publicly listed company operating in the automotive industry. Astra International (automotive industry) and Bakrie Brothers (a holding company in several sectors) explored this option. and mining equipment. as well as general commercial disputes. A Commercial Court was set up to handle corporate restructuring and debt settlements. In the banking industry. Meanwhile. some companies attempted to restructure their businesses on their own. Qualified professionals from the private sector will act as receivers and administrators in the management of estates of companies in bankruptcy or reorganization.Chapter 1: Indonesia 43 few companies reached agreement with their creditors on this. Bank Bali agreed on a debt-to-equity swap with its creditor. Rabobank and Citibank. 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. Procedural rules are also being introduced to ensure certainty and transparency in the proceedings. Debtors. Some listed companies with relatively “rich” shareholders decided to replace their loans with additional equity through rights issues and privileged subscription (limited offering). lay off workers. When credit from the banking sector became unavailable and interest rates increased significantly. and sell noncore businesses or nonoperating assets. plantations.
the Government did not impose restrictions nor did it attempt to regulate capital flows. Banking Sector Reforms The Government’s banking sector reform strategy is focused on (i) government-assisted recapitalization programs for potentially viable private banks. the Court’s early record has been a disappointment. Previously. Realizing that they undermine investors’ confidence. with only 17 cases filed as of November 1998. To push bankruptcy reforms. There will be changes in the implementation of the bankruptcy law. However. the Capital Market Supervisory Agency allows companies to offer additional shares directly to the public. reform. and (v) a strengthened banking supervision system. and recapitalization of state banks. However. (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. in consultation with IMF and the World Bank. the measure had only a minimal impact. legislation against corruption.44 Corporate Governance and Finance in East Asia. collusion. The Government. The Agency also allowed companies to buy back up to 10 percent of outstanding shares to improve the condition of the stock market. 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. (iii) the merger. Capital Market Reform In the capital market. is also reviewing the Bankruptcy Law. The bias in favor of debtors has retarded the pace of corporate restructuring. including procedures for handling operational issues and processing bankruptcy cases. Rather. In the longer term. (ii) the resolution of nonviable private banks. since the market reflects the condition of the economy. The Government has also been concerned with the issue of capital controls. Some companies simply decided not to pay their loans knowing that it would be difficult for creditors to take the case to court. companies were allowed to sell shares only by issuing stock rights. The Court has also declared only two companies bankrupt. and nepotism (anti-KNN) was signed in 1999. . Vol. II to achieve liquidation of the company. it is envisaged that the Commercial Court will play a central role in modernizing the commercial legal system.
merged. depositors will be fully protected by the Government. Other Regulatory Reforms To push corporate restructuring further. BBD. The Bank Indonesia 21st package includes recapitalization. Bank Indonesia has announced a recapitalization program for potentially viable private banks. was enacted in 1999. Some 175 groups that originated from family businesses controlled . In particular. the Government has drafted a regulation providing tax neutrality for mergers and removing other tax disincentives for restructuring. The Company Law at present can be interpreted as severely limiting the scope for debt-equity swaps. In October 1998. The agency set up an Asset Management Unit (AMU) to directly manage problem loans of banks under its supervision. the Government established IBRA to supervise problem banks.1 Summary. BEII. regulations will need to be issued to permit debt-toequity swaps in the context of corporate restructuring plans.6. the Government required banks to be audited by international external auditors. Parliament approved amendments to the banking law that were geared toward strengthening the legal powers of IBRA and its AMU. Banks deemed ineligible for recapitalization will be closed. The four state banks (BDN. A new central banking law. and Recommendations Summary and Conclusions Corporate Ownership and Structure Most of Indonesia’s top conglomerates were established as family businesses.Chapter 1: Indonesia 45 In 1997.6 1. Conclusions. However. The importance of this legislation may need to be emphasized. and follow-up action on bank restructuring. Liquidity support given to troubled banks should be repaid in four years. and Bapindo) will be merged into one bank named Bank Mandiri. or sold (after transferring NPLs to the AMU). 1. The merger process will be finished within two years. providing Bank Indonesia with substantially enhanced autonomy. It has also drafted regulations to remove obstacles for converting debt to equity. To overcome these problems. it is doubtful whether pure holding companies are able to enter into swaps. To obtain a clearer picture of the banking sector. improvement of rules and prudential regulations.
thus. meanwhile. when barriers to entry in the banking sector were lifted. The financial crisis created opportunities for addressing the inefficiencies in the legal and judicial system that supported corruption. On the one hand.6 percent of the total stock market capitalization in 1996 and the top 15 families controlled 61. This study reveals that Indonesian listed companies with higher ownership concentration had higher levels of leverage. These banks also obtained cheap offshore funds.46 Corporate Governance and Finance in East Asia. lacked the information necessary to allow them to assess projects’ risks and chances for success.1 percent of publicly listed companies in Indonesia. allowing them to maintain their equity shares and. Vol. The free capital flow system permitted the inflow of foreign capital to fuel the credit boom in the economy. However. On average. As a result. But because foreign creditors were reluctant to lend long term. conglomerates set up their own banks to serve as “cashiers” providing credit to companies within groups. However. the majority remains family-controlled.7 percent. When the Government regulated the legal lending limit and the net open position of banks. not all of the conglomerate-affiliated companies are publicly listed. Financing Patterns Controlling shareholders opted to use debts to finance expansion. families control 67. put a significant amount of corporate assets of conglomerates in the hands of creditors or the Government. Among those listed in the Jakarta Stock Exchange. retain ownership control of companies. corporate debts grew over time. Rapid growth in investments masked the corporate sector’s increasing leverage. this financing pattern supports the claim that family-based controlling shareholders relied on excessive borrowing to finance corporate expansion . however. These figures show the extent of power wielded over the corporate sector by a small number of families. Indonesian companies borrowed short term. Foreign creditors. conglomerates set up finance companies to bring in cheap foreign loans as these companies were not adequately regulated. banks were unwilling to provide credit to highly leveraged companies. 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. Therefore. II 53 percent of total assets of the top 300 Indonesian conglomerates. The restructuring and resolution of financial distress may. Companies relied heavily on bank credit. while a single family controlled 16.
1 percent in 1998.21 trillion in 1996. The significant increases in leverage indicate a rapid rise in the rupiah value of debts due to the revaluation of dollar-denominated debts. Meanwhile. Impact of the Financial Crisis Prior to the crisis. ROE dropped from 1. Responses to the Crisis The impact of the financial crisis on the corporate sector was serious. corporate-initiated debt restructuring . particularly those with large short-term foreign loans. were the most adversely affected. and the rapid decline in equity due to losses. it also reflects the failure of the financial sector to channel funds to the corporate sector efficiently due to weak prudential regulation and supervision. As the rupiah weakened and interest rates increased. the Government initiated corporate debt restructuring measures (Mexican-style foreign debt resolution and the Jakarta Initiative). To restructure the corporate sector. the consumer goods industry was the worst hit. DER increased to 307 percent in 1997 and further surged to 1. The Government and the private sector responded with measures to mitigate the negative effects.Chapter 1: Indonesia 47 without diluting their control. The problem was in the maturity structure of its dollar-denominated debt and high debt-to-equity ratios in some sectors. NPLs rose and capital adequacy ratios fell.24 trillion in the first half of 1998. facilitate debt restructuring. financed by issuing nearly $80 billion worth of bank restructuring bonds. At the height of the crisis. the highly leveraged companies. although at a declining rate.1 trillion in 1997 from Rp13. When the crisis hit Indonesia. Net profits of publicly listed companies had consistently been growing at an average rate of 20 percent each year. and strengthen prudential regulations and supervision of the financial sector. the corporate sector was in quite good shape in terms of growth and profitability. the high domestic interest rates that prevailed from 1998. Sales of conglomerates as well as those of publicly listed companies were increasing. The Government introduced reforms to improve bankruptcy procedures. The financial crisis led to the closure of several dozen banks. Bank Indonesia extended emergency loans to many banks.1 percent in 1997 to -124. and registered a net loss of Rp39. followed by the property sector. On the other hand.370 percent in 1998. Total profits of publicly listed companies dropped to Rp3.
Vol.g. Specific recommendations include protecting the rights of minority shareholders. 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. but it is not clear whether in practice these standards are in place. The Government should ensure that all laws and regulations are effectively enforced. the regulatory environment was not prepared to supervise the increasing number of banks and nonbank . Improving the Legal and Regulatory Framework for Bank Supervision After the liberalization of the financial sector.2 Policy Recommendations The Government should introduce measures to address the weaknesses in corporate governance identified in this study. In particular. improving the legal and regulatory framework for bank supervision. the legal system is less likely to evolve in a manner that will allow it to protect minority shareholders. and (iii) strengthening transparency and disclosure requirements. cost cutting and business consolidation) and acquisitions by creditors or foreign investors through debt-to-equity swaps and equity infusions. but inadequate protection to minority shareholders from the dominance of large shareholders. 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. (ii) delineating the functions of the board of directors and commissioners.6.. 1. Most companies claim to have adopted international standards of accounting and auditing procedures. The Corporate Law should be reviewed and amended in the context of pervasive control by large shareholders. minority shareholders have not been able to oppose controlling shareholders’ decisions to invest in unprofitable projects financed by unhedged foreign currency debts.48 Corporate Governance and Finance in East Asia. II measures included internal business restructuring (e. and protecting creditors’ rights. Protecting Minority Shareholders’ Rights The Corporate Law provides sufficient rights and protection for all shareholders.
Further. and liquidation of corporate assets. Protecting Creditors’ Rights To protect creditors’ rights. it has been difficult to implement standstills. The Central Bank needs to monitor and control dealings by banks within business groups and improve enforcement methods to prevent circumvention of prudential regulations. Banks should be required to provide data on such transactions and charged penalties for noncompliance. the Republic of Korea and Thailand were more successful in getting foreign creditors to collectively solve their problems during the crisis. Because these banks are neither easily convinced nor compelled to submit their claims to the jurisdiction of Indonesian commercial and bankruptcy courts. the Court has been slow and ineffective in processing bankruptcy suits. The ownership of banks (including finance companies) by shareholders of nonfinancial companies undermined the capability of these banks to conduct prudential credit management. most of banks’ NPLs resulted from credit to companies within the same group. 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.Chapter 1: Indonesia 49 financial institutions. When finance companies were used to channel offshore loans in lieu of commercial banks. with necessary legal sanctions for violations. This is a significant factor in . However. The regulatory framework was also weak in supervising and monitoring foreign transactions. orderly restructuring. One way is to set limits on lending activities by banks to affiliated nonfinancial companies. Consequently. In the first place. The tendency of foreign creditors to lend short term is a problem that must be confronted once private capital flows to Indonesia recover. With credit being coursed through the domestic banking system rather than directly to numerous local corporations. Because foreign creditors are faced with more information asymmetries than domestic creditors. the banking regulatory framework was inadequate in regulating banks’ dealings with affiliated nonfinancial companies. a new bankruptcy law was passed in the aftermath of the crisis and a Commercial Court was set up to deal with bankruptcy cases. in contrast to the Republic of Korea and Thailand. recapitalization. it is likely that future private financial flows for the corporate sector will continue to conform to a short-term structure. The Government should also continue strengthening the monitoring system for foreign exchange transactions.
despite the smaller level of capital inflows (as a percentage of GDP). The Bankruptcy Law should thus be reinforced and creative means should be introduced to avoid a prolonged and costly paralysis of corporate activity and financing. II explaining the greater depth of the crisis in Indonesia. .50 Corporate Governance and Finance in East Asia. Only when creditors have the confidence that their rights are protected will they resume financing companies. Vol.
Letter of Intent of the Government of Indonesia to the IMF. Michael Krill. Indonesia: An Emerging Market. Jakarta Stock Exchange. Embassy of Indonesia Homepage. 1995. 1996. and Larry H. 14 May 1999. Unpublished thesis MMUGM. Forest. Conny Tjandra Rahardja. P. and Remuneration. Simeon Djankov. and Richard Turtil. JSX Monthly Statistics. . Claessens. F. Indonesian Business Data Centre. various publications. The Economist Intelligence Unit. Working Paper #58. 1998. 1995. Indonesia Country Report. Indonesian Capital Market Directory 1992-1998. World Bank. Economy of Indonesia. Wright. Indonesia: Sustaining Manufactured Export Growth. Economic and Financial Statistics. John Wiley and Sons. Delhaise. Indonesian Central Bureau of Statistics. Conglomeration Indonesia: Regeneration and Transformation into World Class Corporate Entities. Indonesia Country Profile. Corporate Governance: Responsibilities. 1998. 1999. various publications. Institute for Economic and Financial Research. 1997. Indonesian Business Data Centre. Stijn. Lang. Risks. Jonathan. 1999. John Wiley and Sons. Large and Medium Manufacturing Statistics. Keasey.. Yogyakarta. University of Maryland.Chapter 1: Indonesia 51 References ADB Programs Department (East). Bank Indonesia. Center for International Business Education and Research. and M. Who Controls East Asian Corporations? Financial Economics Unit. K. Financial Sector Practice Department. Embassy of Indonesia. The Private Debt Anatomy. various publications. The Economist Intelligence Unit. various publications. Manuscript. 1996. Asia in Crisis: The Implosion of the Banking and Finance System. The Impact of Acquisition to Shareholders Wealth: Comparison Between Internal and External Acquisition. 1997. Maryland. P.
Chung-Ang University. This has been the crux of the corporate governance problem in Korea. and corporates were sent reeling. Further. and Graham Dwyer for his editorial assistance. 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. 1 Professors. the Government and business sector had good reason to reflect on the causes of the crisis. timely exit of poor performers from the market. .2 Republic of Korea Kwang S. and David Webb of the London School of Economics for their guidance and supervision in conducting the study. or capital market discipline. Seoul. Poor corporate governance and political and government intervention in the business and financial sectors are widely viewed as contributory factors. 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. Chung and Yen Kyun Wang1 2. The country’s winners would then emerge based only on economic efficiency. The authors wish to thank Juzhong Zhuang. the Korea Stock Exchange for its help and support in conducting company surveys. and curtailing of morally hazardous behavior that has been prevalent among economic decision makers. Inefficient investment coupled with excessive financial leverage was found to be at the root of the economic crisis at the corporate level. Department of Economics.1). David Edwards.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. the Republic of Korea. both of ADB. 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. Business managers and controlling shareholders were maximizing firm size at the expense of profits. As the Korean currency. markets. internal control mechanisms. a practice that was not checked by creditors. It had been the norm in Korea to conduct business based on political and administrative favoritism rather than on competitive merits. Korea) in November of that year.
aiming to identify the areas in need of further reform and to provide policy recommendations for improved corporate governance. This broad perspective can help clarify the ongoing reform efforts of businesses and the Government. Inefficient investment undermined the competitiveness of Korean firms in the global marketplace. Dividend payments were at less than 2 percent annually as opposed to the double-digit interest rates in the past decades. accountability of controlling shareholders and boards of directors.1 1995 560 163 29. and J Murrin (1995). Many firms left some questions unanswered. the corporate sector. June 1999.9 1994 531 165 31. capital market discipline. 1992-1998 Item Total Number of Firms Firms with Positive EVA Percentage of Firms with Positive EVA 1992 508 180 35. Government reform goals for the corporate sector include enhancement of corporate transparency.4 1993 513 174 33. II Table 2. T. The EVAs are the same as the economic profit as explained in T. especially chaebols.5 Note: The EVAs are calculated as: EVA = NOPAT – WACC. Source: Korea Stock Exchange. .1 1998 490 164 33. This study also reviews the legal and 2 The survey was conducted mainly through the Korea Stock Exchange. Koller. Vol. This study collects and analyzes data on the Korean economy.1 1997 518 104 20. The total number of respondents was 81 out of about 550 nonfinancial firms listed on the Exchange. Copeland. Weaknesses in the overall corporate governance system in Korea had many ramifications. 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.1 1996 561 163 29. and individual companies.54 Corporate Governance and Finance in East Asia. where NOPAT is the net operating profit after taxes and WACC is the weighted average cost of capital multiplied by invested capital. and improvement of bankruptcy procedures. A survey was conducted for the nonfinancial listed companies using a questionnaire developed by the Asian Development Bank (ADB)2 to supplement official data.1 Listed Firms with Positive Economic Value Added. Restructuring efforts have focused on reduction in the degree of business diversification and in the financial leverage of large-sized firms.
In the period 19481961.6 discusses responses of the Government and the business sector and explains in detail their reform and restructuring efforts.2 presents an overview of the corporate sector. and naturally adopted an import substitution policy. It reviews such elements as shareholders’ rights.2. Yang. creditors. Section 2. Section 2. The evolution of the modern Korean economy can be divided into four periods. 2.2 2.1 Overview of the Corporate Sector Historical Development3 The development of the Korean corporate sector is closely related to the progress of the economy.Chapter 2: Korea 55 regulatory framework for the corporate sector and reform measures taken after the crisis. corporate control by the Government. From 1948 to 1961. 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 Government tried to produce food. and other necessities domestically. It traces the country’s economic development. which account for a substantial portion of the Korean economy. Import Substitution: 1948-1961 The Korean War (1950-1953) devastated Korea’s industrial capacity. Section 2. clothing. the import liberalization rate was below 7 percent and the average tariff rate was in the range of 25 to 30 percent.4 contains analyses of corporate financing and its relationship to performance. reviewing government policies responsible for the development of the modern corporate sector. Section 2. 3 The review of historical development of the Korean economy draws substantially from the book by Sohn. the Government relied heavily on aid from the United States (US) and United Nations to alleviate poverty and high inflation. and employees and their role in shaping corporate governance practices.3 identifies characteristics of corporate governance by analyzing the ownership structures and control patterns of listed companies and the largest chaebols. Section 2.2. It then presents recommendations for further reform in corporate governance and financing. and Yim (1998). . the board of directors system. Major economic indicators for some of these periods are shown in Table 2.
The Government tried .9) 1. modernizing the industrial structure.2 31.7c 11. and inconsistent economic policies.6 11. e For maturities of one year or more.0) (297.8 12. a Refers to 1971. Source: Bank of Korea.7 37.2 452.7 14. In 1961 it devalued the won from W65 to W130/dollar and announced its first Five-Year Economic Development Plan (1962-1966). and large current account deficits.1 29. and implementing new budget and tax measures.56 Corporate Governance and Finance in East Asia.0) 492.9 — — 21.4 24.3 8.5) 8.102.2 1980-1989 8. However.4 10.4 (1.9b 15.1 35. Economic Statistics Yearbook.8 (8.1 percent with moderate rates of inflation and introduced a series of reform packages aimed at developing key industries.8 24. the Government redirected the policy focus away from import substitution to an export-led manufacturing-based economy.0 41.7 30. Export Drive: 1962-1971 Between 1962 and 1971.0 27.9) (7. largely because of political instability.1a 21.753.332.1 — = not available.1 9.4 29.2 314.1 15.2 32.5 38.8 15.447.2 757. b Refers to 1979.949.265. c Refers to 1989. high unemployment and inflation. In the Plan. d Refers to 1997. This goal required very high savings and investment rates.8 (724. Vol. Large amounts of aid in the form of agricultural goods from the US kept prices of local goods low and discouraged efforts to increase agricultural production.4 1990-1997 7. II Table 2. lack of strong drive.9 794. the Government called for an unprecedented average annual economic growth rate of 7.2 1.5) (1.1d 9. IMF.2 Key Macroeconomic Indicators Annual Average (percent.855. 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 8.2 6.4 29. the Government was not successful in solving the problems of slow growth.2 30.5 250. International Financial Statistics.
imports of consumer goods and luxury items were highly restricted. the growth of gross domestic product (GDP) raised domestic savings. and maximizing mobilization of domestic savings on the other. due to continuous current account deficits.4 percent. This change raised the import liberalization rate from 9.5 percent. and cheap labor force was well utilized by the export-led growth strategy. the Government tried to provide exporting firms with a free trade environment.3 percent to 60. In 1964. The well-educated. Korea normalized political and economic relations with Japan to encourage inflows of Japanese capital that could finance big development projects. resulting in high real interest rates. but tariff rates were raised to 40 percent in the 1960s. channeling funds from curb markets into the banking sector. In 1963-1964. 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. the import liberalization rate was 55 percent. and almost doubled the foreign exchange rate from W130/dollar to W256/dollar to enhance the international competitiveness of exports.2 billion in 1972. abundant. The exchange rate system was a kind of crawling peg until 1974. In 1971. up from 30 percent in the late 1950s. boosting internal investment resources. But the liberalization trend turned out to be short lived as current account deficits continued. a modest improvement over the 4. The average growth rate of the economy from 1960 to 1964 was 5. During this period. The positive list system for imports was replaced with a negative list that indicated only those items that could not be imported. which laid a solid foundation for a steady growth path. The Government abolished temporary direct subsidy measures and introduced a new comprehensive export promotion system. Exports increased sharply from $41 million in 1961 to $2. During the first five-year plan period. the Government changed the multiple and fixed exchange rate system to a unitary floating exchange rate system. However. but the average growth rate for 1965-1969 shot up to 10 percent. the Government undertook important economic reforms in two areas: the foreign exchange rate and the interest rate. Also.Chapter 2: Korea 57 to meet its targets by borrowing large amounts of foreign capital on the one hand. In 1965 the interest rate on one-year deposits doubled from 15 to 30 percent. Bank deposits increased rapidly. .3 percent average between 1954 and 1959. These were considerably liberalized in 1967 when Korea joined the General Agreement on Tariffs and Trade (GATT). while the average tariff rate was 39 percent.
These included rescheduling business debts. becoming a seed of the economic crisis in 1997. These practices contained an implicit government guarantee that large businesses and banks could never fail. the Government changed its industrial policy emphasis from light industries to heavy and chemical industries (HCIs). Third. By promoting HCIs. It promoted HCIs by supplying massive capital for construction and development. and giving low interest rate loans to banks from the central bank. where preferential export credit was given to almost every exporter. The Government encouraged a variety of business projects. electronics. faced the danger of bankruptcy. announcing rescue packages for businesses and banks. shipbuilding. Second. and chemicals—as future core industries. machinery (including automobiles). One industrial policy adopted during the heavy and chemical industrialization drive was administered credit rationing. the Government felt that continuous trade deficits arising from increasing intermediate and capital goods imports could be prevented by developing import substitution industries. it tried to substitute imports and export high value-added HCI products. There were three reasons for the switch: first. nonferrous metal. Vol. in the face of a world economic slump. The Government targeted six industries—steel. and assigned them to specific chaebols. The Government took emergency measures. Unlike the previous system. The HCI promotion policy was much more comprehensive than past economic development plans. This strategy formally took off with the announcement of the HCI Promotion Plan in June 1973. investing a total of $9. and allocating virtually unlimited amounts of credit at below-market rates while controlling the financial system.6 billion between 1973 and 1981 into these sectors. II Heavy and Chemical Industry Promotion: 1972-1979 In the Third Five-Year Economic Development Plan (1972-1976). less developed countries forced Korea to adjust its industrial structure. the emergence of competition of other low-wage. the domestic economy was stagnant and many businesses. The Government has since used similar emergency rescue measures for large businesses and banks almost once every 10 years. reducing or exempting debts of farmers and fishermen. In 1972.58 Corporate Governance and Finance in East Asia. 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. this new strategy had the Government explicitly allocating credit only to those firms deemed vital to HCIs in the form of below-market interest rates . the Government felt the need to strengthen the defense industry.
Macroeconomic policies became hostages of the industrial strategy. such as widespread underutilization of capacities of HCIs and related plants. New start-up firms. however. the Government adopted comprehensive measures to promote economic stabilization. In order to improve economic efficiency. and the won depreciated by 20 percent with the adoption of a Basket-Currency Gliding System in 1980. coupled with political uncertainty due to the assassination of President Park in 1979. low . Meanwhile. fiscal expenditure maintained zero growth. Meanwhile. and the large excess capacity of HCIs. faced with high inflation. This required industrial restructuring by the Government. light manufacturing and service industries were weakened by disadvantages such as a lack of credit. The plan of the 1970s was thought to be successful in the long run. Cheap credit and distorted prices resulted in overexpansion in the HCIs. Economic Liberalization and Globalization: 1980-1997 In 1979. met increased difficulty. Such an approach gave the Government increased control over the economy. various measures to increase competition were taken. including denationalization of banks. price controls were abolished. Firms that followed the Government expanded greatly.Chapter 2: Korea 59 through state-controlled banks. a heavy foreign debt burden. However. The severe world recession caused by the second oil shock. especially between 1979 and 1985.2). In 1986-1989. imports were further liberalized while tariff rates were lowered. The growth rate of the money supply was reduced drastically. The incentives available became more market-based. with many turning into the now well-known chaebols. Gross national product (GNP) growth rates on average were higher in the 1972-1979 compared to 1962-1971 (Table 2. the policy wasted substantial amounts of resources in the short and medium terms. since during the second half of the1980s many of the promoted firms became world-class competitors and exporters. The industrial and trade policy resulted in high inflation in the 1970s and serious excess capacity problems by 1979. The two important ones were import liberalization and deregulation of the financial sector. the Government restructured some large businesses through forced liquidation and M&As. and their utilization ratios were very high. including forced liquidations and mergers and acquisitions (M&As). exacerbated the overcapacity problem. Evaluations of HCI promotion policies are mixed. Korea recorded current account surpluses and rapid economic growth due to the “three lows”: low value of the US dollar. as it had to control only a few large chaebols.
9 percent. . Korea adopted a market average exchange rate system. 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. where particular individuals and their family have de facto control of the management of all subsidiary companies of groups. whose business activities are controlled by an identical person. but it chose to liberalize gradually. 45. the Government committed itself to further liberalization of the goods and capital markets. The low value of the dollar led to a low won and high yen. The Government tried to adjust economic policies and regulations to meet global standards. 4. while continuous and large current account surpluses saved Korea from the foreign debt problem. The official rate fluctuated within a band. Korea abolished remaining direct subsidy systems for export activities as well as some traditionally managed trade systems. 2. II world interest rates.1 percent. which gradually widened. The most important element characterizing chaebols is the concentration of ownership.9 percent. further increasing its pace of import liberalization. By joining the Organisation for Economic Co-operation and Development (OECD) in December 1996. and low oil prices. the importance of chaebols was increasing. Korea began participating in many multilateral trade negotiations during the Uruguay Round. Industrial and trade policies were modified to be consistent with WTO.2. Meanwhile.2 Rise of the Large Business Groups (Chaebols)4 The Korean Fair Trade Act defines a business group as “a group of companies.3 percent. and acceded to the World Trade Organization (WTO) in 1994. Korea became a signatory country to the International Monetary Fund (IMF) Article VIII. total debts. giving up its foreign exchange controls related to the current account.” A large-scale business group is called a chaebol. and total workforce.60 Corporate Governance and Finance in East Asia. Vol.2 percent. 47. In 1990. 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). joined the Asia Pacific Economic Cooperation (APEC) Group in 1993. 46.1 percent and average tariff rates 8.9 percent. total assets. and declaring that it would follow Article XI of GATT. In 1993. In 1988. with the 30 largest in the total economy in 1997 standing as follows: value-added. total sales. 13. the import liberalization ratio reached 98.
when the Government put a great deal of emphasis on development of the HCIs.5 20. Subsidiary companies of chaebols are subject to “fleet-type management” in that they are controlled by the overall managerial system of chaebols.1 20. In the mid-1970s. However. of Subsidiaries 604 616 623 669 Average No. the Korean Government has set the national goals of economic development and offered all kinds of support and incentives to achieve them. In this sense. Chaebols have a history of substantial concentration of ownership. Table 2. Large-scale companies owned by the Japanese were sold to individuals under preferential terms and later enjoyed a relatively favorable position for accumulating capital.Chapter 2: Korea 61 War II.3 Source: The Fair Trade Commission. Since the 1960s. it was more effective to deal with a small number of companies to secure tangible outcomes.8 22. reaching 669 in 1996. Since the Government controlled most business activities. The Government provided financial and fiscal incentives to chaebols and trading companies with relatively abundant financial resources. From the standpoint of the Government. One reason for this controlling power is inter-company shareholding among subsidiaries. This policy contributed greatly to the expansion of chaebols. and tax breaks to key industries to promote exports and industrial upgrading.3 Subsidiaries of the 30 Largest Chaebols. Important managerial decisions are made primarily by owners. financial assistance. large-scale businesses and chaebols were thought to be appropriate actors because they could meet the huge investment requirements of these industries. chaebols that maintained a close relationship with the political authorities were able to grow fast. The Government provided subsidies. the ownership and management of a chaebol’s subsidiaries are not separate.3 shows that the number of subsidiaries of the 30 largest chaebols increased considerably since 1993. . of Subsidiaries per Chaebol 20. Chaebols are also excessively diversified. 1993-1996 Year 1993 1994 1995 1996 No. after the financial crisis. the number of subsidiaries declined drastically due to corporate restructuring. This galvanized the fast growth of chaebols. and they are aided and supported by one another. Table 2.
3 Role of the Capital Market and Foreign Capital In the 1960s.62 Corporate Governance and Finance in East Asia. the Government reviewed the financial performance of companies and recommended (or ordered) selected ones to go public. Since chaebols are engaged in many different businesses. listed companies enjoyed corporate tax rates that were 10 to 20 percentage points lower than those imposed on privately held firms. internalization of the market that could enhance the internal efficiency of a chaebol may close the market to other firms. The law also allowed employees of listed firms to get 20 percent of the subscription rights in offerings of new shares. including the “economies of organizational size” inherent in multi-product and multiplant firms. . there are many negative assessments of organizational structures and practices of chaebols. etc.2. which may ultimately lead to the decline of social efficiency. Related to this is the tendency of chaebols to assist unprofitable firms at the expense of profitable ones. 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. Meanwhile. On the other hand. 2. chaebols can benefit from synergies. II Theoretically. For example. profitability. in addition to the usual economies of scale. Under this law. This law was in effect until 1987 when it was partly absorbed into the Capital Market Development Act. Vol. the bankruptcy of one or a few marginal subsidiaries could lead to a chain of bankruptcies for the entire chaebol. However. 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 can reduce uncertainties and dilute risks through sharing of information and diversification. In the early years after the enactment of the law. They had to meet certain requirements in terms of firm size. 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. the Government’s efforts to develop the stock market culminated in the Capital Market Development Act of 1968. This could ensure their stable growth and enhance their investment abilities. years since establishment. if a chaebol has an unsound financial structure but strong financial links through mutual payment guarantees among their subsidiaries. and were allowed extra depreciation charges for tax purposes.
continued until 1989. The aggregate Table 2.1 Market Capitalization (W billion) 6.7 934.4 Development of the Stock Market. .4. Inc. Beginning 1990. 1985-1998 No.6 Year 1985 1989 1990 1994 1995 1996 1997 1998 Source: Monthly Review (Securities Supervisory Board) and the Financial Supervisory Service.9 34.1 16.0 49. however. the Government announced the gradual opening of the capital market to foreign investors in January 1981. Also that year. First.0 79.989 137.570 95. the stock market grew rapidly during the 1980s.370 70.6 747.9 833.0 965. Third.4 654. mainly by increasing the supply of shares by initial public offerings (IPOs) and seasoned issues. the Government attempted to stabilize the stock market by limiting IPOs and share issues by listed companies. In this regard. of Listed Firms 342 626 669 699 721 760 776 748 Stock Price Index 138.Chapter 2: Korea 63 During the 1980s and 1990s. a country fund. Second. the Government announced measures to increase the demand for shares by providing tax and financial incentives to individual investors.9 918. was established to invest in domestic shares beginning in September 1985..020 151. several important policy measures were implemented to promote the development of the stock market. especially those paying small or no dividends. The policy to expand the size of the stock market. As shown in Table 2.4 40. 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). This reversal in policy reflected declining stock prices and was generally maintained until the outbreak of the economic crisis in 1997.798 Market Capitalization as a Ratio to GDP (%) 8.476 79. Because of government policies and the booming economy.5 406. 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. in 1986 the Government imposed limits to bond issues on firms that were recommended to go public but refused.217 141.1 30.151 117. The Korea Fund.2 44.
455) 13.953 10.450 24.287 (340) 73. Korean companies borrowed substantial amounts of foreign capital due to the excess of investments over savings and chronic current account deficits—except in the period 1986-1989. currency and deposits.942) 42.296) (6. Vol.868 (518) (418) 63 1.5 Private Capital Flows to Korea. and stayed at the 30-40 percent level up to 1996. trade credits.008) (3.338 4.141 4. Other investments include loans.642 21. Source: Balance of Payments.86 percent of GDP in 1997.742 (3.910) 2.414) 5.737 (333) (297) (607) (2) 218 2. Bank of Korea.59 percent in 1998 and to more than 50 percent in the early months of 1999. .440 1.085 2.149 13.347 3. Table 2. Table 2.123 3.817 16.126 (1.001 4.658) (3.183 12. but rose again to 34.858 4. and other liabilities.382 Permit basis.944) 8. but increased sharply to 79. The relative size of the stock market diminished to 44 percent in 1990.264) (3.326 1.650 (1. and 1993. The reasons for the decline include increases in bankruptcies and mergers involving listed companies since the outbreak of the economic crisis.150 5.534) 1.583 25 10.239 19. foreign direct investment (FDI) has been very small relative to GDP and compared to other East Asian countries. However.875 21.339) (9.255 2. II market value of all listed firms represented only 8 percent of GDP in 1985. 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) (2.413) 56.571 2.2 percent by 1989.5 shows net FDI—inward investments by foreigners less outward investments by Koreans—in the period 1985-1998. due to declining stock prices.546 (2.352 471 3.694) 2.870) (1.64 Corporate Governance and Finance in East Asia.500 7.553 8.453 (2. The number shrank for the first time in 1998 to 748 firms from 776 the previous year.433) (9.714 1.852) (2. The growth in the number of listed firms also slowed in the 1990s.924 (1.800 (7.542) (1.017) 1.785 (1. The aggregate market value of listed shares bottomed at 16.
Korea had substantial current account surpluses and experienced net private capital outflow.China and the US. portfolio investments amounted to $73. 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. However. Taipei. excluding FDI. but dropped in 1996 and were negative by 1997. and high production costs were the main reasons for low FDI in Korea. the growth rates of equity and sales dropped sharply in 1996 and 1997. but between 1988 and 1993. Profit rates of Korean firms were relatively low compared to those of Taipei. The ratio is generally in the same range for Japan and Korea.2. other net private capital inflows amounted to $130 billion during 1985-1998.7 compares the ratio of ordinary income to sales of Korea’s manufacturing sector with those of Japan. and sales of the aggregate sector during this period were very high (Table 2. Japan’s was consistently higher. The growth rates of total assets.9 billion.Chapter 2: Korea 65 Complicated government regulations. The dismal performance of the Korean corporate sector compared to the .7 billion and loans $42. The contribution of the corporate sector to GDP was 73. In addition to FDI. and (iii) chaebols.2 percent in 1987. The same categories will be analyzed in later sections. weak incentives for attracting FDI.6 percent in 1997. increased substantially in 1994-1996 due to accelerated liberalization of capital movements (Table 2. This indicates that a substantial proportion of debt was denominated in dollars. Corporate sector net proft margins increased from 1993 to 1995.5).6). increasing to 76 percent in 1997. The debt-to-equity ratio (DER) averaged 311 percent for the period 1990-1996 and peaked at 424. Net private capital inflow. Table 2. 2.China. and US. (ii) listed firms. The Aggregate Corporate Sector The aggregate corporate sector in this study excludes the financial sector. This would lay the foundation for evaluating the effect of corporate governance on performance. Large amounts of outward investment by Koreans in the mid-1990s arose out of increased liberalization of foreign exchange regulations. Between 1986 and 1989. following the sharp depreciation of the won. Of this. equity.
2 9.1 8.8 21.6 1.5 1.3 1. ROE = return on equity (ratio of net income to stockholders’ equity).0 7.6 (4.0 4.2 19.2 1. Table 2.5 4.1 2.4 2.5 0.1 2.1 6.8 2. Financial Statement Analysis Yearbook.6 318.9 18.3) 5.4 4.4 2.8) 297.8 22.9 16.7 3.9 5.9) DER = debt-to-equity ratio.2) (0. Source: Bank of Korea.0 13. Note: Ratio of ordinary income to sales = (ordinary income/sales).6 3.0 13.8 1.0 6.7 3.3 14. Financial Statement Analysis Yearbook.9 2.1 — — — = not available.3 17.0 (0.7 4.3 312.3 — 3.5 3.6 2.7 15.2 18.8 1.9 5.5 (0.9 2.2 13.7 2.4 1.5 1.3 21.1 5. 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 23.6 424.2 1.7 15.0 8.6 1.6 Growth and Financial Performance of the Nonfinancial Corporate Sector.3 6.Table 2.1 2.3 308.5 1.7 1.7 International Comparison of Ratios of Ordinary Income to Sales in Manufacturing (percent) Year Korea US Japan Taipei.9 5.4 1.9 13.8 3.9 16.3 335.0 10.8 8.9 3.9 8.6 9. Source: Bank of Korea.2 1.7 4. ROA = return on assets (ratio of net income to total assets).7 325.0 3.5 2.2 13.4 19. Ordinary income = operating income + nonoperating income (from financial activities) – nonoperating expenses (from financial activities).4 — 6.3 3.4 2.4 10. Net profit margin = ratio of net income to sales.3 11.9 4.6 4.4 1.9 3.0 0. .3 21.9 18.5 4.5 7.0 305.9 2.6 13.7 4.China 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 2.
It is notable that the construction sector’s profit rate began its decline in 1995. while their average net profit margin was lower than that of medium firms. ROEs. The manufacturing. Net profit margins. Growth rates of total assets are generally high. this may be an indication of the bias toward large firms in terms of access to credit. with equity in wholesale and retail trade even contracting. This may be related to its having the lowest DER. the sales growth of listed firms was higher than that of the aggregate sector (see Table 2. However. Profit rates of most industries are also quite low. . both ROA and ROE were lower for the listed firms compared to the latter. This preference of Korean firms has its roots in the structure of corporate governance. construction.4 percent.5 percent while the aggregate sector recorded only 13. A comparison of performance by firm size reveals some interesting results. Small listed firms were hardest hit by the financial crisis. The other financial ratios follow the general pattern of the aggregate corporate sector.9). sales of listed firms grew 18. the average ROE was lowest for large firms. and transport sectors recorded negative profit rates in 1997. gas.6). The growth performance of large firms for the 1988-1997 period was better than that of medium. However.8). In most years. All sectors experienced a sharp decline in equity and sales growth in 1997. followed by mediumsized firms and large ones.10). Performance followed similar patterns across different industries (Table 2. Again. and ROAs of all listed firms declined substantially in 1996 and turned negative in 1997. Profit rates of different industries also mirrored the downward trend of the aggregate corporate sector prior to the crisis. The profit margin of listed firms was generally higher than that of the aggregate corporate sector. trade. but higher than that of small firms. a year ahead of the other industries. In 1997. with the wholesale and retail trade sector and the construction sector having the highest figures. the exception being the electricity. Listed Companies The number of listed firms increased from 334 in 1985 to 775 in 1997 (Table 2.and small-scale firms (Table 2. The superior performance of listed firms in terms of sales growth may be due to large firms’ easy access to credit and the inclusion of financial firms in the listed firms category. and steam supply industry.Chapter 2: Korea 67 other three economies can be attributed to the emphasis on growth in sales and market shares rather than on profits.
1 21.8 7.0 1.6 375.8 24.6) 3.3 2.8 24.6 5.6 3.6 0.5 270.1 1.1 16.9) 1.8 35.3 31.0 254.0 (0.0 12.2 18.5 239.7 30.0 245.2 15.5 286.5 4.8 526.9 3.3 11.0 23.0) 0.9 1.2 0.3 8.3 15.5 (5.5 28.8 2.1 17.5 3.6 3.9 16.7 514.0 1.8 22.3 11.4 458.8 34.5 (0.7 228.5 1.5 473.3 13.1) (3.5 6.7 21.5 1.2 (1.9 10.2 25.1 290.8 302.4 0.0 7.5 6.1 (0.1 0.1 27. Renting.8 17.8 0.1) 0.7 317.4 1.8 616.0 2. and Business Activities 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 Average 11.3 15.8 3.0 21.0 1.8 0.2 0.9 (0.0 22.4 (0.5 27.4 2.6 1.6 15.9 5.4 14.4 4.1 10.3 285.7 4.8 1.9 2.8 10.0 19.6 6.0) 1.9 14.5 5.6 11.0 9.3 18.5 1.3 14.9 16.1 2.7 22.4 350.4 3.7 520.7 (0.4 348.5) 0.4 2.2 24.2 16.5 23.5 Construction 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 Average 18.8 16.2 0.0 2.2 5.4 15.7 17.4 12.8 12.5 19.5 1.6 16.2 241.1 1.0 1.3 1.4 1.6 318.0 24.0 37.7 9.8) 0.0) 0.0 16.9 340.1 (0.3 10.4 17.2 20.6 14.Table 2.0 5.2 5.3 15.6 0.5 1.3) (1.0 22.7 0.0 15.4 5.9 25.6 17.3 15.6 12.8 345.1 28.8 2.3 1.0 (4.4 2.7 16.8 16.5 338.2 7.8 Real Estate.0 5.8 3.1 1.2 36.5 13.5 569.9 538.9 16.2 2.4 .4) 0.7) 2.2 20.1) 3.5 16.0 2.0 18.6 7.5 432.0 1.3 10.0 18.6 14.9 31.2 6.4 9.8 32.1 2.6 655.8 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 13.7 (3.0 1.8 14.6 17.8 23.0 24.9 13.0 (0.9 10.0) 4.7 7.8 562.1 296.4 5.6) (6.2) 15.0 3.7 294.4 10.9 29.0 16.5 483.1 396.4 2.4 10.6 2.5 (1.2) 22.4 740.0 1.3 8.9 (0.9 (0.6 1.8 13.4 10.8 10.1 20.7 10.1 0.0 2.8 16.9 2.7 5.0 22.8 12.6 12.2) (0.2 6.5 1.8 461.3 2.6 24.2 5.2 16.8 2.4 291.3 8.7 1.6 14.4 474.8 1.9 19.9 428.3 14.2 315.3 8.5 306.8 22.2 12.0 15.5 14.1 1.2 423.4 5.9 0.3 288.2) 6.3 25.4 0.4 10.9 9.4 2.1 0.8 14.5 5.5 30.1 7.1 22.
5 15.5 26.1 11.6 8.6 20.4 1.3 18.8 14.8 529.4) (1.8 12.7 11.5 16.6 4.4 12.0 1.6 18.4 633.6 (2.5 14.5 11.1 8.8 111.3 8.5 12.0 Transport.9 1.9 321.6 6.9 12.5 307.4 2.3 12. a New equity does not include capital surplus.4 13.4 15.0 2.2 7.2 18.9 10.6 2.0 7.1) 1.9 (10.5) 22.3 125.8 15.8 6.3 34.1 16.1 4.1 (11.9 3.9 12.2 122.5 344.6 — — — — — 0.2 1.6 512.3 4.3 543.7 11.5 14.5 11.4 21.7 7.0 (15.3 740.6 9.9 7.3 1.3 — — — — — 10.5 4.6 15.6 6.4 2.4 11.8 3. and Communication 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 Average 15.4 (2.5 0.2 698.0 89.0 5.3 (2.7 510.6 9.5 539.6 1.5 15.7 — = not available.5 612.5 2.1 3.7 7.8 12.2 14.2 18.4 3.3 9.8 8.4 9.4 14.6 1.9 6.7 11.3 3.8 3.5 47.0 2.4 10.6 21.7 0.8 6.4 16.4 (0.1 2.8 7.3 23. Gas.7 16.9 8.3) 15.8 0.6 (2.7 14.7 187.4 0.7 20.0 (1.8 9.4 6. .0 21.3 18.2) 9.2 10.4 367.9 17.1 15.6 12.2 143.6 4.9 9.3 0.6 3.9 456.8) (12.1 15.8 11.3 4.9 18.6 16.4 3.3) 11.2 10.1 (2.3 2.4 0.9 18.0 106.8 (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 — — — — — 31.7) (4.0 14.5 462.4 1.8) 1.3 4.5 30.1 1.2 11. Storage.Table 2.1 21.6 12.6 19.4 1.1) (0.6 14.8 14.0) 1.0) (0.9 Electricity. b NPM denotes net profit margin.7 0.1 (0.9 332.7 — — — — — 14.3 1.7 2.7 19.9 10.3 112.6 19.5 8. Source: Calculated using data from Bank of Korea.4 — — — — — 448.3 19.2 15.1 17.6 34.2 2.3) 4.4 12.0 14.4 7.5 14. Financial Statement Analysis Yearbooks.2) 0.1 15.3) (1.1 323.9 8.3 17.3 0.1 12.6 172.4 341.3 524.6 6.6 8.4 7.6 8.2) 13.0 13.1) 5.7 2.062.7 116.4 0.1) (0.2 3.2 — — — — — 2.0) 1.0 921.5 482.4 30.9 17.1 11.0 1.2 14.3 8.9 9.0 98.5 14.7 15.9) (8.7 12.9 4.4 3.6 0.4 169.9 (11.2 90.1 6.5 117.1 14.8 4.0 5.0 1.6 9.4 6.9 4.8 0.5 13. and Steam Supply 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 Average 12.6 — — — — — 17.5 (2.2 10.7) 0.2 18.
debts (47.4 22.5 ROE 3. the top 11-30 chaebols experienced a decline of .8 5. unless otherwise indicated) Financial Performance Year 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 Average No.2 9.12).4 1.5 0. Hyundai Group.8 6. of which 16 were publicly listed (Table 2.5 19. and net profits (46.1 percent of the economy’s total value added (excluding the financial sector). Kis-Fas.1 6. 1998. Vol.9 21.9 percent).12).0 3.9 Source: Constructed using data from Korea Investors Service.7 1.5 5.9 Growth and Financial Performance of Listed Companies.9 11.6 3.9 6.2 2.6 2.2 9. The number of Hyundai member companies rose to 57 in 1997. the growth of sales of the top 30 chaebols exceeded that of the aggregate corporate sector (compare Tables 2.3 0. The criteria for selection of largest chaebols have changed a few times.70 Corporate Governance and Finance in East Asia. The smallest group had 16 members in 1995.7 1. 1985-1997 (percent.1 1.9 0.4 1.9 percent). the largest chaebol.3 4. but the number of designated groups has been fixed at 30 since 1993.0 18.2 0.6 and 2.0 0.6 1.9 26.7 Net Profit Margin 0.5 19. Generally. Chaebols have been the most important actors and engines of growth in the Korean economy.3 (0.8 0.3 20.9 1. The top five chaebols registered the highest growth rates. followed by the top 6-10 (Table 2. the 30 largest chaebols accounted for 13.9 2. In 1995.6 (1. Between 1993 and 1997. and close to half of total assets (46.9 2. Performance of Chaebols This section uses available data on the top 30 chaebols.6 22. of which four were listed.1 1. had 46 member companies.4 2. it is the chaebols’ large firms that are listed.7) 0.2 6. II Table 2.3 2.1) 4.3 15.5 ROA 0.6 0.4 1.8 24.4) 1.6 23. of Firms 334 351 386 503 626 669 680 681 687 698 715 754 775 Sales Growth 10.11). In 1997.3 percent). sales (45. It should also be noted that when the financial crisis struck in 1997.7 (5.4 0.7 percent) of the corporate sector.
8 0. Source: Korea Investors Service.0 1.3 15.8 0.6 1.1 0.0 16.6 7.0 19.3 3.4 3.5 Net Profit Margin Year Large Medium Small 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 Average 2.2) (1.0 1.6 6.0 1.2 (0. Kis-Fas.9 2.9 25.5 2.3 9.8) 1.6 1.8 17.Table 2.2 2.8 10. 1998.9 0.9 6.1 2.5) 1.9 0.0 15.8 3.6 5.7 2.2 Note: Large firms have a capital base greater than W15 billion and small firms smaller than W5 billion.9 3.9 (0.6 9.6 2.1 1.5 5.4 Medium Small Large Medium Small ROA Growth Performance Large 17.4) 1.5 1.2) (1.6 2.7 2.6 3.8 (5.7 (0.0 (4.7 18. 1988-1997 (percent) ROE Large 9.2 0.6) 0.5 (1.2 10.8 1.7 3.3 11.8 6.0) 0. Others are medium firms.4 5.5) 1.3 1.5 3.0) 1.2 13.3 (0.8 0.7 4.2 12.0 1.8 7.5 0.6 (0.3 Medium 14.3 (0.7 (1.8 16.0 6.10 Growth and Financial Performance of Listed Companies by Size.5 17.6 0.6 0.4 1.2 1.3 6.5 25.1 8.4 6.9 22.6 8.4 11.8 6.6 (1.9) (6.9 1.9 1.6 2.9 14.2) 0.1) 5.4 2.4 16.4 3. .9 2.8 0.3) 0.3) 5.6 1.2 7.2 13.8) 6.4 1.2 3.9 2.2 2.6 13.0 10.6 3.0 4.7 (1.9 6.2 Small 13.1 11.1 2.9 0.9 5.0 17.5 5.3 15.7 1.
398 — 2.990 2.147 5.996 1.117 4.313 14.690 3.Table 2.433 3.180 2.158 7.457 14.935 2.11 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. .956 3.370 6.309 14.798 — No.455 22.951 3.427 9.995 2.303 3.597 351.486 6.395 31.873 2.651 38.599 — 2.423 5.677 3.177 — 6.376 35.761 31.475 2.131 3.346 3.853 1997 53.929 12. 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.774 7.574 3.246 11.090 6.287 10.766 3.927 16.458 6. of Member Companies 1995 46 55 49 25 32 23 24 16 31 28 27 26 18 21 16 17 16 16 14 19 22 19 24 11 14 8 8 11 18 16 1997 57 80 49 30 46 25 24 28 31 30 26 25 21 — 19 18 18 17 24 24 24 6 8 2 15 — 7 — 18 — No.743 40.364 5.158 1.129 2.924 2.445 4.910 3.967 7. Source: Fair Trade Commission.501 13.640 4.756 5.
2 1.1) 0.8 27.3 19.0 17.5) (0.2) (0.3 0.3 11.1 2.5 19.0) 3.9 20.0) ROA 1.Table 2.4 30.7 15.0 2.0 2.9 24.9 20.2 0.1 19.7 15.4 12.6 (0.8 18.1) (0.4 (2. .5 (0.6 1.2) 1.5 2.2 3.1) 0.7 10.4) 1.3 27.1 (2.6 25.4) (0.9 3.0 0.0 19.1) (0.1) (1.0 2.3 1.4 0.2 20.2 11.2 (2.3 9.2 0.1 10.2 (2.0 0.4 26.3 15.9 1.5 27.6 Financial Performance Net Profit Margin 1.7) Source: Bank of Korea.7 0.2 (16. 1993-1997 (percent) Growth Rates Year Top 1-5 1993 1994 1995 1996 1997 Top 6-10 1993 1994 1995 1996 1997 Top 11-30 1993 1994 1995 1996 1997 Top 30 1993 1994 1995 1996 1997 Sales 12.8 Assets 12.12 Growth and Financial Performance of the 30 Largest Chaebols.8 0.6 19.0) 12.5) (0.1 (3.0 6.2 (5.1 27.5) (0.7) ROE 5.7 10.7 13.5 32.6 18.3) 0.5 5.1 (1.4 38.0 1.9 3.9 17.7 4.6 4.3 14.3 3.9 18.5 20.0 31.3 0.4) (14.2 0.3 16.7 1.3 1.2) (2.
from 190 to 3.7 percent growth in total assets. 2. loopholes and inconsistent policies spawned strategic behavior and agency problems.” in Korea’s legal and regulatory framework. includes the largest shareholder. In general.3.95 percent. except for 1995.” This “identical person. and led to a high concentration of ownership. II 2 percent in their sales and a very low 4. 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. a pyramidal structure of corporate ownership is prevalent. and the companies that are under the control of the largest shareholder. his/her relatives. Vol.5 Founding families are mostly still the largest shareholders and. 5 While “ownership concentration” can be defined and measured differently in different contexts. it refers to the degree of concentration and shareholdings in the hands of an “identical person. . Their worst year was 1997 when ROE hit -15. the average DER of the 30 largest chaebols reached 519 percent. The financial performance of the top 11-30 chaebols deteriorated during 1993-1997. and government intervention interacted through a set of laws and regulations to bring about the existing structure. Only the top five chaebols registered a positive net profit margin in 1997. chaebols had a higher average DER than the corporate sector as a whole.1 Patterns of Corporate Ownership The ownership of most Korean listed firms is highly concentrated. in this instance.13). more important. 2. coupled with weak corporate governance. and vulnerable balance sheets. the net profit margin of the aggregate sector exceeded that of the top 30 chaebols. resulted in the chaebols’ excessive leverage. By the end of 1997. Ownership patterns. weak corporate control.74 Corporate Governance and Finance in East Asia. However. technology. There has been a wide range in DER among chaebols. The better showing of the top five chaebols was a direct result of their dominance in human resources. internal and external control mechanisms. The Commercial Code stipulates the basic governance framework and applies to all corporations. The ROE of the top 30 chaebols was consistently higher than that of the aggregate corporate sector.3 Corporate Ownership and Control This section looks at the key aspects of corporate governance in Korea. However. The absence of a well-developed equity market and the provision of subsidized credit. and access to credit.765 percent (Table 2.
7 620.6 409.6 516. LG 4.5 383. Hansol 17. Hyosung 18.1 477. Hyundai 2.3 315. Byucksan 1996 1.4 192.5 3.2 924. Daelim 14. Kia 9. Sunkyung 6. Hanjin 8. Jinro Debt-to-Equity Ratio 376. Dongah 14.2 292.13 The Top 30 Chaebols’ Debt-to-Equity Ratio. Samsung 3. Dongkuk Steel 19.3 572.7 354.7 688. Hanil 28.1 3. Kumho 12. Lotte 11.2 328.8 312. Halla 17.1 674.855.4 622. Haitai 26.3 328. Hanwha 10.7 267. Dongkuk Steel 19. Daewoo 5.2 346.7 416. Lotte 11.244.9 751.8 313. Newcore 30.0 436.0 506.2 423. Dongah Construction 16.065. Hanjin 8.6 .0 370. Doosan 13.9 321.1 278. Hyosung 18. Kukdong Construction 29.0 218. Tongyang 22.1 385.7 621. Samsung 3.4 175. Hanbo 15. Dongbu 24. Ssangyong 7. Kia 9.8 336. Jinro 20.4 205.2 471. Sunkyung 6.6 936. Kohap 25. Sammi 27. Daelim 16.4 556.3 297.441.764. Daewoo 5.5 343.5 2. Doosan 15.2 2. Hyundai 2.6 2.0 486. Hanwha 10.1 190.5 464. 1995-1997 (percent) Chaebols 1995 1. Hansol 23. Kumho 12.5 337. Ssangyong 7. LG 4. Halla 13. Kolon 21.Table 2.
Keopyong 29. Kamgwon Industrial 30.8 347. Dongbu 23.5 519. Doosan 15.3 1.6 424.4 1.9 1.1 433.9 465.6 Sources: aFair Trade Commission. Kohab 22. Daesang 27. Lotte 12.Table 2.6 416. Dongkuk Steel 20. Dongah 11.1 438.6 478.3 347. Keopyong 29.1 359. Miwon 30. Tongyang 24. Kolon 19. Kohab 18. Financial Statement Analysis Yearbook.8 468. SK 6.8 338. Halla 13. LG 5. Dongbu 21.5 386. bBank of Korea.600.13 (Cont’d) Chaebols 20.6 590.5 (1.8 590. Tongyang 24.0 419. Samsung 3. Haitai 25. Kolon 21. Newcore 26.784.5 (893. Saehan Average of All Chaebolsa 1995 1996 1997 Average of All Industries Excluding Financial Sectorb 1995 1996 1997 Debt-to-Equity Ratio 317.0 907. Anam 22.5) 404.7 1.8 399.5 323.0 505. Anam 27. Daelim 14. Hanwha 9.5 261. Jinro 23.8 307. Hyosung 17.498. Shinho 26. Newcore 28. Ssangyong 8.501. .6 335.9 472.1 472.7 944. Hanjin 7.9 490.5 1. Haitai 25.0 305.7 370.214.9 216.1 375.9 578. Hansol 16. Hyundai 2. Kumho 10.4) 513.8 658.3 676.3 399.8 647.5 576. Daewoo 4.225. Shinho 1997 1. Hanil 28.
the entrenchment effect and problems of agency may be more pronounced in chaebols than in independent firms. Among listed nonfinancial companies. The holdings of financial institutions. an increase in their ownership may bring their ownership incentives to converge with those of the minority shareholders.14). Thus.e.” followed by banks. and state-owned companies and securities companies declined. the Government.” foreigners. the extent of ownership by these individuals declined gradually after 1988. However.6 percent by 1997. the entrenchment effect outweighs the incentive effect. The percentage of shares owned by “other corporations. with a given range of managerial shareholdings (for instance. i. that is. Composition of Ownership Among listed companies.Chapter 2: Korea 77 When controlling shareholders hold a very small percentage of the shares. 10 to 30 percent). Securities companies reduced their holdings over this period of falling stock prices as the size of investment trust companies’ stock portfolios declined. Financial institutions owned as much as 28 percent of the total corporate shareholdings in 1992. fluctuated widely during the period. Beyond that range. the incentive effect once again dominates. the percentage of holdings by individuals slipped to 60.. but their shares declined to 21. Most non-chaebol listed firms in Korea are believed to have ownership concentrations within the 10-30 percent range. including banks and other financial firms. Theoretically.1 percent. including investment trust companies.7 percent by 1997. the year the stock market was in a frenzy due to buying sprees. and then steadily declined after 1993. When managerial holdings are reinforced by artificial control mechanisms such as pyramiding. resorting to extensive use of pyramiding to maintain control. and insurance companies increased during the period. However. while those owned by banks. The reduction can be . The controlling shareholders of chaebols hold comparatively smaller percentages of shares. the individual owners—the portfolio investors as well as the controlling shareholders and their family members—formed the largest shareholder group (Table 2. The next important group was “other corporations. The pattern of distribution changed little through 1992-1997. the ownership structure can bring about an incentive effect. individuals were also the largest shareholder group. an entrenched manager is insulated from market pressure and can pursue personal goals without the fear of being replaced. managerial entrenchment becomes more likely. From 69. large ownership can also bring about the entrenchment effect.
2 17.7 3.1 3.7 7.1 60. etc.3 17.1 1.6 19.5 7.2 3.6 9.5 1. merchant banks.8 5.5 6.3 26.9 1.9 5.3 8.8 69.5 60.8 59.6 2.5 1. investment trust companies.4 6.9 17.7 1990 531 0.9 15.7 9.6 12.0 5.1 8.2 9.2 5.0 4.8 2.5 6.1 11.7 8.7 14.8 1995 548 2.” includes commercial banks.5 7.6 20.3 1994 521 1.3 2.2 18.2 5.2 B.6 16.6 Year No.7 59.6 16. 1988-1997 (percent) Financial Institutions Securities Firms Total 28. All Listed Companiesc 1992 681 1993 687 1994 698 1995 715 1996 754 1997 775 9.3 18.8 5.4 5.9 37.5 16.1 2.9 1.0 59.2 4.6 22.3 1.7 9.0 60.4 18.1 17.2 1993 511 2.4 Insurance Firms Other Corporations Foreigners Individuals 39.0 28.4 14.14 Ownership Composition of Listed Companies. .0 8.2 9.6 8.5 12.9 26.0 27.2 8. etc.1 21.4 13.6 1991 505 0.2 1.9 36.3 39.1 10.b A.5 18.4 13. Listed Nonfinancial Companiesd 1988 406 0.5 62.3 5.1 18.5 4.8 4.1 4. a The State covers the Government and state-owned companies.Table 2.9 19.8 17. of Firms The Statea Banks.9 2.5 1992 508 2.1 21.0 7.6 13.3 1996 570 2. mutual savings.9 2.5 1989 498 0.6 9.7 6.1 18.5 Note: Ownership is based on number of shares.3 5.0 9.8 2.6 16.2 7.4 34.0 5.2 2.3 18.4 1997 551 1. d Constructed from data files of the Korea Listed Companies Association.1 8.7 4.9 4.3 1.1 68.6 36. b “Banks.2 8. and finance companies. c Data from Korea Stock Exchange.4 5.8 17.3 17.7 18.8 59.
This trend can be explained by government ownership.16). The holdings of other corporations are mainly equity investments in affiliate companies. In most instances. This is low compared with those in Japan. In 1998.18). and small companies.8 percent of listed shares in 1997. indicating their increased investments particularly in the service industries with high growth rates. Individuals held the majority of the shares in all industries except in telecommunications. with the Government continuing to hold a sizable share in the Korea Electric Power Corporation. Before such liberalization. other corporations’ holdings shifted toward service industries. The Government’s and state-owned institutions’ (including some banks) ownership was generally small except in the power sector. there appears to be no significant difference in the overall shareholding patterns between the two groups (Table 2. However. Corporate holdings averaged 16 percent throughout 1988-1997. electricity. UK. categorized into large. whether partial or absolute. The ownership distribution in listed nonfinancial firms. and US (Table 2. 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. the holdings of institutional investors were expected to increase significantly with the Government’s introduction of US-type investment companies in 1998 and . medium. One minor difference is that the percentage of shareholdings by corporations is slightly higher in large-sized firms.15). However. Compared with its holdings in all listed companies. financial institutions had more shares in the manufacturing sector than in primary industries.17). Over the years.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. the Government acquired an even bigger share in several banks as part of its program to bail out these distressed institutions. did not vary significantly (Table 2. When independent companies are distinguished from firms affiliated with the 30 largest chaebols. Foreigners gradually increased their equity shares in 1992 when direct purchases by them were first permitted. of some banks. as distinguished from individual and foreign investors. held 26. and service of motor vehicles (Table 2. Institutional investors. the Government was the sole owner. foreign holdings were derived from purchases through country funds and direct capital investments. government ownership in nonfinancial companies was remarkably smaller and more concentrated. In general. indicating their heavier reliance on inter-firm financing investments.
5 0.7 20.4 7.9 52.4 8.5 3.9 23.2 7.2 9.0 9.8 6.7 29.7 14.7 2.7 6.2 2.9 59.6 11.8 8.0 20.0 9.0 8.5 — 0.9 0.7 1.1 0.9 8.0 — 0.1 10.1 1.8 Individuals 83.8 7.4 2.9 15. and Printing Pulp.3 0.Table 2.1 7. 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 .0 10.9 16.1 0.6 1.6 — — 2. and App. and Plastics Basic Metal Fabricated Metal and Machinery Office and Computing Machinery Electronics.1 27.4 8.5 — 1.4 8. 1990 and 1997 (percent) Financial Institutions The Statea — — 0.6 5.3 2.3 11.3 10. Etc.2 — 0. Elecl Mach.5 4.4 1.2 1.9 55.7 17.3 0.4 56.5 0.8 3.3 0.8 7.3 38. Paper.3 57.0 9.1 0.2 1.1 88.3 6.1 4. Paper.6 18.6 24.7 64.5 17.3 1.2 9.5 0.3 1.1 8.0 Industry 1990 Fishing and Fish Farms Mining Food Products and Beverages Wearing Apparel and Fur Articles Wood.2 64.1 0.1 65.5 6.9 19.1 19.2 — — 0.2 22.7 22.3 4.4 14.9 1.9 4.1 8.15 Ownership Composition of Listed Nonfinancial Firms by Industry.b Securities Firms Insurance Firms Other Corporations Foreigners — — 0.5 85.7 2.9 66.4 — 0.0 2.4 62.2 0.8 5.7 20.0 9. Motor Vehicles Electricity.3 7.2 0.5 19.5 12. Rubber.5 7.4 1.3 13.9 10.8 7.5 0.5 — — 0.2 9.2 0.8 7.2 54.7 2. and Printing Chemicals.8 1.4 0.7 22.8 7.0 — 39.9 60..4 Banks.7 59. Gas.7 63.9 1.2 17.7 14.2 0.6 8.0 0.4 5.3 2.3 62.0 7.3 9.6 3.4 56.0 1.9 42.8 3.8 73.
and Printing Pulp.6 2.2 5.8 27.9 1.8 4.0 6.1 3.3 1.9 5.3 2.2 49. merchant banks.6 75. .4 1. Rubber.1997 Fishing and Fish Farms Mining Food Products and Beverages Wearing Apparel and Fur Articles Wood.9 6.6 — = not available. and App.9 0.8 0.1 1.4 2.0 8.0 3.6 6.6 3.5 4.2 6.9 1.7 2.4 3.9 6.4 45.5 3.8 6.1 3.9 20.2 5.5 0.6 18. and finance companies.6 1. and Plastics Basic Metal Fabricated Metal and Machinery Office and Computing Machinery Electronics.1 18.7 2.3 15.6 60. Gas.5 63.6 14.4 6.2 0.1 25.4 76.7 23.3 7.2 1.1 2.4 58.3 0.3 31.4 — 1. Elecl Mach.8 57.2 0. and Steam Supply Precision and Optical Instruments Other Manufacturing Construction Service of Motor Vehicles Wholesale and Retail Trade Transport Telecommunications Other Business Activities Nonmetallic Mineral Products Average 1.0 6.4 9.1 — 1.1 9. Note: Ownership is based on number of shares.0 4.6 5.8 54. b “Banks.6 59.8 12.3 6.9 18.5 6.0 60.9 7.” includes commercial banks.7 17.4 2.8 5.2 4. mutual savings.2 13.1 6.6 0.9 7.8 2.4 1.1 1. Paper.3 60.0 11.3 6.3 65.6 2.4 43.9 1.2 4.7 5.7 4.8 2.9 2.9 69.3 8.2 1.4 0.9 78.0 5.5 3.2 23.9 57. Paper.5 12.5 — 2.1 9.7 2.3 1.8 11.2 8.6 2.2 3.5 59.2 4. Motor Vehicles Electricity.9 2.8 2. etc.7 1.9 20.78 81.7 2.2 7.3 57.1 2. investment trust companies.4 68.6 0.6 6.1 54. Source: Constructed from data files of the Korea Listed Companies Association.4 2. a The State covers the government and state-owned companies.9 2.4 58.4 1.5 3.8 5.5 3.4 20.5 4.2 4.7 19.1 4.8 3.5 1.7 6.8 0.0 7.5 7. and Printing Chemicals.4 16.9 2.1 — 0.6 20.9 5.4 4.6 7.4 4.0 43.0 1.5 5.
3 6.0 6. 1997 (percent) The Stateb Foreigners 4.4 61.2 1.” includes commercial banks.3 Banks.4 2. etc.0 Other Corporations 16.8 4. of Firms Large Medium Small Total 211 208 80 499 a Large firms have a capital base greater than W15 billion and small firms smaller than W5 billion.1 8. etc.17 Ownership Composition of Listed Nonfinancial Firms by Control Type.4 5.5 2.5 62. and finance companies.0 1.7 4.7 Control Type No.4 2.4 61.8 1.5 6.7 1.1 2.9 4.5 Individuals 60.5 4.Table 2.8 4.5 8.4 17.7 0. merchant banks. Securities Firms Insurance Firms 2. mutual savings.8 60.7 8. Source: Constructed from data files of the Korea Listed Companies Association.8 3.5 18.5 16.7 6. investment trust companies. Others are medium firms. b Table 2.1 Banks.1 6.6 60.5 19.4 Firm Sizea No. c “Banks.c Securities Firms Insurance Firms Other Corporations Individuals 58.7 Foreigners 4.4 21. The State covers the government and state-owned companies.4 5.16 Ownership Composition of Listed Nonfinancial Firms by Size.8 6.8 2.6 16.4 4.9 5. of Firms Independent Firms Affiliates of 30 Largest Chaebols Total 316 117 433 Source: Constructed from data files of the Korea Listed Companies Association.9 2. etc. 1997 (percent) The State 1. .4 1.
At the moment.1 8. and other shareholders who do not belong to either the minority shareholders or the majority shareholder group. for example.1 percent and appear to be similar to the proportion of foreign holdings in the four other countries.6 Foreigners 9.Chapter 2: Korea 83 Table 2. defined as those holding less than 1 percent of shares. including those of the largest shareholder.1 financial institutions’ establishment of corporate pension fund accounts. 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. Concentration of Ownership The analysis of ownership concentration in this section focuses on shareholdings of the majority shareholder. corporations held 70 percent of the controlling blocks of shares.4 26. the majority shareholder group on average held 23-30 percent of outstanding shares in the period 19881997 (Table 2. the majority shareholder group in all listed companies consists of the corporate. In 1997. This has had profound implications for corporate governance and the market for corporate control in Korea.8 10.7 16. his/her family members. Among nonfinancial listed firms.6 39.5 45.3 6.5 20. rather than the individual. while family members accounted for only 30 percent.China United Kingdom United States Source: Stock Exchange of Korea.6 Individuals 23.8 56. only closed-end investment companies and traditional investment trust companies are allowed.8 9.20). Foreign holdings of Korean shares were 9. The majority shareholder group’s shareholdings in listed nonfinancial firms steadily declined from 1990 to 1996.3 47. Generally. But these may . 1997 (percent) Country Japan Korea Taipei.19). Institutional Investors 42. investors (Table 2. and the companies under the control of the largest shareholder.3 54. minority shareholders.18 Ownership Composition of Listed Firms in Selected Countries.
3 30.9 3.4 7.1 23.6 22.8 73. his/her family members.6 26.7 7.3 Subtotal 5.9 6.7 6.9 Individual 2.3 2.7 16.0 4.8 72. and the companies under the control of the largest shareholder.1 32.Table 2.0 29.1 15.6 5.9 32.0 22.1 5.1 37.0 66.1 4.7 44.0 2.0 1.2 2.9 7.8 Individual Subtotal Other Shareholders Corporation 3.7 Note: The majority shareholder includes the largest shareholder.0 25.1 14.4 3.5 43.1 28. 1992-1997 (percent) Majority Shareholders Corporation 15.2 26.1 5.7 18.1 21.3 18.9 2.0 69.6 46.0 Year Corporation Individual 1992 1993 1994 1995 1996 1997 41. Minority shareholders are those holding less than 1 percent of shares. Other shareholders are those who do not belong to either the minority shareholders or the majority shareholder group.2 2.6 73.8 8.9 33.4 5.6 2. Source: Stock Exchange of Korea.2 Minority Shareholders Subtotal 71. .19 Ownership Concentration of All Listed Firms.
and mining categories.9 29.8 28. The shareholders that held more than 1 percent but did not belong to the majority group held about 20 percent on average.8 57.4 23.20 Ownership Concentration of Listed Nonfinancial Firms. . 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. Besides.2 15.6 57. Meanwhile. collectively owned less than 50 percent of an average firm.0 58. minority shareholders.0 20. It was highest in medium-sized firms before 1993 and.4 Source: Constructed from data files of the Korea Listed Companies Association. ownership was relatively diffused due to government regulation. the Government has retained a large number of shares.5 23. 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 2.8 Majority Shareholders 27.8 54. 1988-1997 (percent) Year 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 Minority Shareholders 53. Ownership concentration tended to be lower in large compared to medium and small listed firms.7 18.4 28. rubber and plastics.21]).5 60.9 25. which held less than 1 percent of a company’s outstanding shares as of 1997. in the small firms.3 25. thereafter. In most industries.22).5 12.9 48.Chapter 2: Korea 85 Table 2.9 12.5 13. 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. In such cases. the majority owner held more than 20 percent of an average firm.6 58.3 62.1 50.9 27.0 22. In telecommunications.6 11. The practice of hidden shares seems to have been less prevalent in recent years.8 12.8 25.9 Other Shareholders 18. Across industry. hiding shares offers no additional tax or other benefits. Majority ownership is also high in the chemicals.
2 23.8 41.0 39.7 29.3 26.5 20. and App.7 17. and Printing Pulp.6 38.4 Industry Fishing and Fish Farms Mining Food Products and Beverages Wearing Apparel and Fur Articles Wood.4 53.7 36.8 31.2 37.6 25.3 19.5 41.. 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 36.0 51.0 30. Elecl Mach. Motor Vehicles Electricity.7 21.2 46.2 22.5 52.2 19.6 34.9 44.1 19. .9 10.2 34.8 51.Table 2.21 Ownership Concentration of Listed Nonfinancial Firms by Industry.6 53.0 21.6 50. Gas. Rubber.4 16. and Printing Chemicals.1 43.0 54.7 27. and Steam Supply Other Manufacturing Construction Wholesale and Retail Trade Transport Telecommunications Other Business Activities Nonmetallic Mineral Products Total Source: Constructed from data files of Korea Listed Companies Association.2 48.4 11.8 44.3 39.2 20.9 26.1 49.8 29.5 47.6 19.2 26.5 19.8 55.8 25.8 24.5 21. Paper. and Plastics Basic Metal Fabricated Metal and Machinery Electronics.5 16. Paper.7 26.1 17.9 Minority Shareholders Majority Shareholders Other Shareholders 12.5 23.8 21.5 44.7 24.
22 Ownership Concentration of Listed Nonfinancial Firms by Firm Size.4 30.9 21.5 19.6 27.0 55.7 14.3 19.5 27.7 57.7 15.9 28.5 12.5 21.6 62.2 26.1 58.6 31.9 26.9 60.4 51.8 50.6 15.7 17.8 62.5 28.2 21.0 26.6 55.9 22.4 47.3 26.1 48.4 30.9 23.Table 2.2 18.1 27.8 11.0 24.6 24.3 21.2 11.6 59.4 29.3 27. 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 53.2 21.5 51.2 32.5 26.3 55.2 Majority Shareholders 26.8 28.7 31.6 65.7 28.8 52.5 49.5 33.3 25.1 20.4 30.2 52.5 12.4 21.2 56.8 27.1 15.0 66.7 22. .2 Source: Korea Listed Companies Association.5 19.7 16.8 56.5 10.5 Other Shareholders 19.9 16.9 56.1 16.2 12.8 52.2 50. 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.7 57.9 12.0 59.6 11.9 55.8 17.2 55.2 21.9 17.9 53.
TQ increases as the SCS increases. which can then pass the equity capital to a third. They analyzed firms in which controlling shareholders participate as managers. Shleifer. often at terms unfair to one of the transacting parties. and Kim (1995) studied the empirical relationship between the degree of ownership concentration and financial performance in Korea. Both studies used Tobin’s Q (TQ) for the value of a firm as an index of financial performance. The Code prohibits a subsidiary company from owning shares of its parent company. If SCS is above 20-25 percent. from the standpoint of the controlling shareholder. The pattern of the relationship between SCS and TQ is similar between Korean and US firms (Mork. If SCS is below the range of 20-25 percent. it means the firm creates value. one company can still place equity investments in another. The relationship between TQ and SCS shows a similar pattern. TQ was calculated by dividing the market value of a firm by the substitution price of its assets. If TQ is higher than 1. the firm destroys value. one company from a chaebol group could obtain debt payment . although turning points in the value of firms are different. thus a firm creates value. and Vishny. Inter-Firm Investments and Pyramiding in Chaebols The Commercial Code imposes limits on direct cross-shareholding.88 Corporate Governance and Finance in East Asia. called “pyramiding”— commonly (though incorrectly) known as “indirect cross-shareholding”— is prevalent in Korea. affiliated companies have been able to conduct inter-firm transactions. H. H. and the shareholding of a controlling shareholder (SCS) as the degree of ownership concentration. This refers to the situation wherein Company A holds shares of Company B and simultaneously Company B holds shares of Company A. thus a firm destroys value. which is the company holding more than 40 percent of outstanding shares of its subsidiary. TQ is below 1. if TQ is lower than 1. For example. If SCS is below 10 percent. In Korea. 1988). If SCS reaches 10 percent. is effective control of a certain group of companies even with a smaller investment. Hong. This type of inter-firm investment. Kim (1992) and Kim. and Kim (1995) reached a similar conclusion. The study by Kim. Then TQ declines until SCS reaches 45 percent and increases until it reaches 50 percent. One of the merits of pyramiding. TQ is above 1. II Ownership Concentration and Financial Performance J. J. TQ has a maximum value. Hong. Vol. Where direct cross-shareholding is not allowed. Kim (1992) found the relation between TQ and SCS to be nonlinear.
Of the 81 respondents. corporations hold about 20 percent of the outstanding shares of all listed nonfinancial firms.9 percent of shares. 59 parent companies collectively had investments in 759 firms. although they are likely to be insignificant. or an average of 13 firms per company.5 percent. standalone setups. firms linked through partial equity investments could enjoy the advantage of consolidation without an actual formal consolidation or merger of operations taking place.4 corporations. Partial results are shown in Table 2.5 percent of shares. Only six firms (or 13 percent) indicated that their subsidiaries also owned shares in themselves. there are instances of direct cross-shareholding in Korean firms. the top 30 chaebols’ shareholding by subsidiaries was 34.5 corporations and two individuals. 59 were parent firms with one or more subsidiaries. For the same year. In the case of the 30 largest chaebols. the average shareholding of the controlling owners and their families was 8. Thus. 53 percent were domestic nonfinancial firms. not individuals. together having a total of 292 domestic subsidiaries.Chapter 2: Korea 89 guarantees from other members of the group at no cost. The extent of pyramiding can be seen in some of the previous tables. and about 11 percent were domestic financial institutions. Among the 81 listed firms in the ADB survey. and 319 foreign subsidiaries. Thus.14. Among the subsidiaries or firms receiving investments. But the controlling power of the owners also stems from inter-company shareholdings of the subsidiaries. or about four firms each. For the whole sample. In Table 2.23.5 percent as of 1997. financial institutions that are subsidiaries of a chaebol also hold shares in its member firms. neither the investors nor the relevant government authorities were active in monitoring such unfair dealings between firms. the top five shareholders consisted of 2. 34 percent were foreign companies. The top five shareholders of the chaebol-affiliated firms consisted of one individual and 3. Twenty-two of the 81 respondents were independent. This also partly explains why chaebols frequently opted to expand by establishing new firms rather than placing investments internally. These shares should be added to the control block although the financial institutions belonging to the 30 largest chaebols are prohibited from exercising their voting rights in the member firms of the chaebol. Until recently. together owning an average of 38. dominated the majority shareholder group in chaebol-affiliated companies is consistent with the results of the ADB survey conducted for this study. Among chaebol affiliated firms. In many instances. together owning an average of 37. 62 percent (16 out of 26) had a corporation as the largest shareholder. If we define the internal shareholdings of a . for example. or about five subsidiaries each. The fact that corporations.
8 38.5 4.0 1.0 17.8 Note: The survey was conducted during the period January through May 1999 and included nonfinancial listed firms only. .5 31.6 34.5 1.7 5.3 26.8 37.4 11.1 22.4 2.9 21.4 21.5 18. b The chaebol affiliated firms are those belonging to one of the 30 largest groups.2 37.2 25.8 31.1 3.4 1.0 3.8 8.Table 2.7 0.6 3.6 3.23 Ownership Concentration in the Survey Sample of 81 Listed Firms.6 16.9 29. A few companies reported less than five largest shareholders.5 24.7 37.5 2.0 21.0 13.9 34. 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 20.9 5.0 3.4 38.4 42.5 2.1 1. a Number of shareholders.6 3.0 2.7 39.4 18.5 2.4 25.7 19.5 38. 1999 Five Largest Shareholders No.3 12.8 18.5 4.0 1.5 2.
4 1993 43. 6 7 Hattori. 1997.2 33. 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.” In Korean Managerial Dynamics.2 1994 42. Hattori (1989) identified three patterns based on data in the early 1980s. Tamio. The family and member companies’ shareholdings have been declining over time. 1987-1997 Type of Shareholding Internal Shareholdings Family Member Companies Source: Korea Fair Trade Commission. the ownership patterns can be described as follows. Family holdings include shares owned by the family members and by parties considered to be under the influence of the family.7 9.7 1992 46.7 31. the average internal shareholding ratio of the top 30 chaebols was at least 43 percent.24 Internal Shareholdings of the 30 Largest Chaebols.4 10. Table 2. New York: Praeger. Table 2. H. 34. 1989.6 Later studies by Lee (1997) and Lim (1998)7 find similar patterns. C. “The Ownership Structure and Family Control in Korean Conglomerates: With Cases of the 30 Largest Chaebols. Many attempts have been made by researchers to identify the typical patterns of ownership structures in chaebols. Lee.5 34.8 33. 1987 56.Chapter 2: Korea 91 chaebol as the shareholdings of the controlling family and the member companies of the group.6 33.2 15. 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. Chicago. it appears that the chaebol families have had a strong desire to expand their business bases. the controlling families owned 8. Chung and H.4 13. Jae Woo.” Paper presented at the Annual Conference of Financial Management Association.5 Judging from the historical record.1 1997 43. “Japanese Zaibatsu and Korean Chaebols. 15 October 1998. Lee.8 40. Ungki Lim. 1998. Based on these studies. “Is the Fair Trade Policy Fair?” Korea Economic Research Institute. edited by K.5 percent.0 8. pp. Internal shareholdings in some chaebols also include shares owned by nonprofit organizations operated by the controlling family.4 1990 45. 79-95.2 12. .24 shows the average internal shareholdings in the 30 largest chaebols.5 percent and member companies. As of 1997.
The third (Type C) is “indirect control via complex shareholding.” Under this type of ownership pattern. it had 18 listed and 39 private companies. Most of its member firms were acquired by. completely dissolved under financial distress. The Hanjin Group. Kia Motors was the base company and had such strategic shareholders as Ford Motors of the US and Mazda of Japan. there is no controlling shareholder. holdings of the nonprofit foundation. is an example of this type. Sun Hong Kim. subsidiaries have extensive investments in other subsidiaries. Here the family is the controlling shareholder of one or more strategic base companies that have enough equity participation in the subsidiaries. The Hyundai Group exemplifies this. consisting of eight listed and 16 privately held firms as of 1997. other firms. which then make investments in the subsidiaries. But the former chief executive officer (CEO). the family controls the group’s member companies by its own shareholdings. The family itself holds shares in some subsidiaries. or merged into. Investments between the lower level subsidiaries are rare. The second (Type B).” Here the family directly controls a base company and a nonprofit foundation. The fourth type (Type D) is “management control. investments made by the base companies. Chaebol Reforms Various measures have been taken to improve the transparency of chaebols with regard to accounting.” shows a simple pyramidal structure. which in turn hold shares in some of the other subsidiaries. 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. The Hanwha Group can be classified as such a company. Thus. and business activities. financial. called the “indirect control via base company.” A family owns a substantial portion of shares of member firms and becomes the controlling shareholder of each. Its controlling family holds shares in three base companies through which they exercise control over the other member firms. Vol. One of the . It consists of seven listed and 24 privately held firms.92 Corporate Governance and Finance in East Asia. For example. As of 1997. and subsidiaries’ equity participation. The two base companies have investments in three other base companies. A nonprofit foundation under the family’s control is the largest shareholder of one of the base companies. Also. The Kia Group was about the only management-controlled group but was out of existence by 1999. The controlling family has sizable investments in two base companies and smaller investments in many others. Hyundai Motors acquired Kia Motors via an international auction.
direct control of the management of chaebols was attempted through amendments of the act in 1986 and 1990. 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. The limit on investments was reduced to 25 percent in 1994 and completely eliminated by 1997. there are reports that some top chaebols are studying the feasibility of transforming their organizational structure. the Fair Trade Act). These conditions are aimed at restricting excessive pyramiding and expansion of chaebols. They hindered early exits (liquidation. A third disallows multiple layering of holding companies. the Credit Management Regulation rules were amended to prohibit financial institutions from requiring guarantees from affiliated firms when extending new loans. thus hurting the shareholders of stronger firms. Initially. The Government is also considering whether to allow consolidated taxation for pure holding companies. Until the end of 1998. The Fair Trade Act was amended in 1998 to allow pure holding companies to be established under restrictive conditions. Also. bankruptcy reorganization. . This limit was also applicable to banks and insurance companies. At this early stage. However. only operating holding companies were allowed to be established. These amendments prohibited holding companies and direct cross-shareholding. The prohibition of holding companies was also abolished in 1999. The Fair Trade Act was also revised in February 1998 to prohibit cross-guarantees of debt among members of a chaebol. One condition requires that the DER of the holding company should not exceed 100 percent. The first serious attempt to deal with this issue was the introduction of the Monopoly Regulation and Fair Trade Act of 1980 (hereinafter. following the amendment of the law. Existing guarantees had to be resolved by March 2000. 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. Cross-guarantees are believed to constitute a form of wealth transfer from financially strong members to weak ones. 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. It remains to be seen whether they will adopt the holding company structure in the future. This was the reason why chaebols chose to employ pyramidal structures.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 act did not have any important provisions except the standard clauses prohibiting monopolization of an industry through business combinations.
which put together the accounts of all members of a chaebol. Despite chaebols’ decision to dismantle the chairman’s offices. Since the economic crisis.) 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. 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. but the larger and stronger ones still operate their newly named “restructuring headquarters” under the control of the group chairperson. Their operating costs were borne by the member companies rather than by the controlling shareholder. The 30 largest chaebols are now required to publish “combined” financial statements. until urgent restructuring is complete.” The group chairman operated through these offices and treated the individual member firms as if they were the divisions of a single legal entity. planned for capital raising and allocation on a groupwide basis.3. Some chaebols have disintegrated or shrunk in size. II etc. Chaebols maintain that the restructuring headquarters will exist only for a limited period.2 Internal Management and Control Monitoring of corporate management by shareholders. and the capital market was almost nonexistent until the recent reform .94 Corporate Governance and Finance in East Asia. who is universally called the “group chairman. there have been no significant changes. The office established strategies for the group as a whole. boards of directors. unlike the regular consolidated statements that only cover those firms that are related through direct equity participation. The Fair Trade Commission has been deeply involved in promoting managerial transparency by exercising its power to investigate and levy penalties on “unfair internal transactions” among member firms of chaebols. In 1998. usually in the rank of a company president. These offices were legally informal and functioned as the headquarters of chaebols. chaebols dismantled their “planning and coordination offices” or “chairman’s offices” under pressure from the Government. 2. The staff of these organizations were employees of member firms. even though they were legally independent with their own board of directors and the outside shareholder groups were not identical. 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. Some chaebols operated “group management boards” attended by top executives (presidents or chairpersons) of larger member firms. Vol.
. Banks. Most companies have one representative director. the concept of fiduciary duty of managers was not well established. but some large ones have two or more. Board of Directors General Characteristics of the Boards Under the Commercial Code. With few exceptions. except for banks. only the Government could play an effective role in monitoring corporations. As of 1997. In most listed companies. Legal provisions to protect investors were limited. However. in most Korean firms. the controlling shareholder is officially the representative director and the CEO. Thus. and takeover codes were not accommodative to active monitoring. the creditors did not declare defaults. corporations should have a board of directors consisting of at least three members. the controlling shareholder (or a member of the controlling group) was the legally registered representative director in 354 out of 551 nonfinancial listed firms.Chapter 2: Korea 95 efforts. Even where the largest shareholder is not the representative director. There are many reasons for this. especially chaebols. This implies that the typical agency problems in Korean corporations stem from conflicts of interest between inside (the largest) and outside (minority) shareholders. Under such circumstances. Even when the covenants were violated. Loan agreements and debt indentures did not include strict covenants. this was complicated by the prevailing attitude that large companies. Meanwhile. the representative director was also the chairperson of the board. This policy managed to hamper any monitoring initiatives from the capital market. control is not separate from ownership. Directors are elected at the general shareholders meeting for a term not exceeding three years. The Government’s policy and securities law provisions to protect control rights of the incumbent management had been in place until the early 1990s. The board elects one or more representative directors from among the board members. he or she generally approves major decisions made by the management. had their own governance problems. Professionalism in management was not well developed and managers were content with receiving orders from controlling shareholders. as the major creditors. or at least acts as the de facto CEO. were too big to fail. creditors were not active in monitoring debtor firms and relied mainly on guarantees and collateral.
other than the representative director(s). Moreover. 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. A few large companies had more than 50 directors. However. 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. Most of the outside directors in those days were the controlling shareholders of chaebols or executives of affiliated companies. almost all companies succeeded in adopting cumulative voting. companies have to disclose in their annual reports the frequency of board meetings. 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. Despite the qualification requirements. 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. members of the board. Vol. the attendance rate of outside directors. The Commercial Code was also revised in 1998 to introduce cumulative voting for the election of directors. all of whom were managers. 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. cumulative voting is not mandatory and a company can exclude itself from its application by amending its charter. However. and their positions (accept or reject) on matters voted on in board meetings.96 Corporate Governance and Finance in East Asia. . there is concern that newly elected outside directors still lack independence from the management or the controlling shareholder. 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. II When the Commercial Code first introduced the corporate board system in the 1960s. were supposed to be outside directors. Further. Recent Reform Efforts on the Board System In 1997. In order to address this concern. the listing rules of the Korea Stock Exchange were revised to require that listed companies have one or more “independent outside directors” by the 1998 annual shareholders meeting. With the boards consisting only of insiders. In the 1999 annual shareholders meetings.
88 percent had plans to hold elections in the near future. he or she held 6.1 percent and outside directors 1. Directors were also chosen on the basis of their relationship with the controlling . which had extended financial support in their recent recapitalization efforts. inside directors owned 16. and a nominating committee. The Securities and Exchange Act will require large listed firms with W2 trillion or more in total assets to adopt the audit committee system. having no controlling shareholders. The average board had 8. the chairperson of the board was also the CEO and on average held 10. an audit committee. the OECD principles of corporate governance were the minimum standard for the Korean Code of Best Practice. Meanwhile. the Corporate Governance Reform Committee. In March 1999. Among others. ADB Survey Results on Boards The ADB survey results confirm the above assessments and provide early indications on the effects of the reforms. they had a parent/child relationship in 20 percent of the cases. Directors were most frequently elected because of their professional expertise (74 percent of the respondents marked this answer).5 percent of the shares. Almost all (92 percent) of the respondents had one or more outside directors and 70 percent were elected after the Asian financial crisis. 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. this committee adopted the Code of Best Practice in Corporate Governance. Where the two were separate. Where the chairperson was not the CEO. who would comprise at least 50 percent of the boards. These results are in accordance with the new listing rules introduced in 1998.4 directors. This is because most banks.Chapter 2: Korea 97 The committee structure of the board as found in the US has not yet been adopted by listed companies. The controlling shareholder of some banks is the Government. On average. Among the firms with no outside directors.1 percent of outstanding shares of a listed company. In 78 percent of the responding firms. In September of the same year. was established under the auspices of the Ministry of Finance and Economy and the Korea Stock Exchange.9 percent on average. although some banks recently have established board committees.2 percent and the CEO 14. a blue-ribbon committee. the Korean Code recommends that large listed firms should have at least three independent directors.
In 13 percent. relationship with controlling shareholders (21 percent). Most frequently. Less frequently. a total of 562 directors were sitting on two or more corporate boards. compensation for directors must be approved by the annual shareholders meeting for each fiscal year. the term of appointment of directors and board chairpersons is three years. founders of the company acted as the chairperson (22 percent). the management nominated director candidates (64 percent of the directors). Remuneration for chairpersons include only fixed fees in 76 percent of the sample firms. in some firms. The current chairperson has been in office for 6. . Members of controlling shareholder families or their trusted company personnel often act as directors for multiple chaebol firm boards. As discussed earlier. 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). The survey results indicate that boards determine remuneration packages for chairpersons in 42 percent of the firms. and shareholding (10 percent). Vol. Chairpersons of the board were elected on the basis of professional expertise (33 percent of the firms). 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. According to the Commercial Code. The reason for this high frequency of interlocking directorship is that many listed firms belong to chaebols. About five directors per firm have been in office for more than one term. This rather long tenure must be due to their status as controlling shareholders in most firms. election of directors was based on shareholdings (7 percent) and status as founder (7 percent). In a very small number of firms. the board had a nomination and an audit committee.2 years on average.98 Corporate Governance and Finance in East Asia. However. In 1997. In 91 percent of the sample firms. Some directors were nominated by significant shareholders (18 percent) or introduced (and elected) at the shareholders meeting. These were established only recently. the management determines the remuneration. one person was sitting on nine boards and this person was the CEO of a chaebol firm. including stock options. the board had no committees. in 23 percent. In some instances. and fixed fees plus performance-related pay. In most firms. among the 81 sample firms. The general practice is that shareholders approve the upper limit on the total amount to be paid to all directors. II shareholder (30 percent). The board or the management then determines compensation packages for individual directors. In one case.
In less than 20 percent of the firms. fixed salary plus net profit-related bonus in 9 percent. CEOs generally maintain their positions for a long time because they are frequently the founders or largest shareholders of their firms. . In the 25 firms where CEO was not the chairperson of the board. CEO is also the founder in 52 percent of the firms. CEOs have been in their positions for an average of 9. compensation is by fixed salary in 74 percent of the firms. In 20 percent. and in another 21 percent CEO bought shares in the market. 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 fixed salary plus performance-related pay including stock options in 13 percent. In 4 percent of the cases. In 21 percent of cases. These results show that the incentive compensation scheme for professional CEOs is not well developed in Korean firms. decides on important matters on his/her own in 13 out of the 44 firms. CEO is entitled to a large sum in cases his/ her contract is terminated before its expiration. and was appointed by the Government in five firms. he or she was selected on the basis of professional expertise in 15 firms. he or she does not enjoy much power. It indicates that CEO. 86 percent of the firms answered positively when asked whether the largest shareholder was CEO. In the survey. CEO simply follows the orders of the chairperson. the payment is about five times the CEO’s annual salary. According to the survey. In a handful of sample firms. However.Chapter 2: Korea 99 Management CEO In the survey sample. in which there is no controlling shareholder.2 years. the survey tells a slightly different story than is generally believed in Korea. it was proposed by CEO and approved by the board. CEO was given shares by the family. In such cases. When CEO is not the chairperson. CEO decides on important matters after consulting the chairperson in the majority (55 percent) of the firms. Ensuring that a company serves the public interest is considered a less important responsibility of CEO. The remuneration package was proposed by the board (and approved by the annual general meeting) in 56 percent of the firms. CEO generally has the ultimate power to decide on corporate affairs. who is not the chairperson. In cases where CEO is not the largest shareholder and chairperson. shareholding in three firms. The firms in the survey consider steady growth of a company and maximization of the shareholder value as the most important responsibilities of CEO.
About 40 percent of the listed companies had amended their charters to introduce incentive stock options by the 1999 shareholders meetings. 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. Penalties for fraudulent financial reports were increased. in particular. from IMF and the World Bank. it was common for all senior executives to be elected as directors at the shareholders meeting. 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. The term of appointment of executives did not have any real meaning because they had to leave the company if and when the controlling shareholder demanded. and . II Senior Executives In the past.100 Corporate Governance and Finance in East Asia. This action was in response to calls by international investors and. However. Vol. 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. but as of March 1999 only 27 firms actually had given stock options to their executives or employees. executives sometimes have the opportunity to buy company shares at favorable prices because the board of directors (CEO. disclosure. Senior managers were even often called directors although they were not official members of the board. (ii) establishment of accounting standards for financial institutions. One area has been to enhance the reliability of financial statements of corporations in line with internationally accepted standards. and accounting standards. 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. The bonus is supposed to be linked to company performance. The commission has played an active role in introducing new rules on corporate governance. but in practice is fixed and understood as part of a fixed salary. Korean firms have rarely used shares for executive compensation. in practice) allocates the unsubscribed portion of new shares issued in rights offerings to executives.
Most of the companies following all or some of the international standards in the past adopted such standards before the crisis started. In practice.Chapter 2: Korea 101 (iii) establishment of accounting standards for “combined” financial statements of chaebols. 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 revised accounting standards apply to the firms subject to external auditing for the fiscal year starting on or after January 1999. 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. 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. 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. The new accounting standards for financial institutions adopt the mark-to-market basis to account for securities. 41 percent of the companies believed that they have followed some international accounting standards. however. The primary sources of reference in the revision were International Accounting Standards and US Accounting Standards. Under the Commercial Code. Only 10 percent of the respondents have followed all international accounting standards. the internal auditor is considered to be a subordinate of the . 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. Thus. 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. In the ADB survey. Korean listed companies with subsidiaries are required to compile consolidated balance sheets. Internal and External Auditing The Commercial Code requires a corporation to have at least one internal auditor elected at the general shareholders meeting. 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 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.
and lack of strong professional ethics in the accounting profession. If the status of internal auditors is elevated to that of independent board members. then the Securities and Futures Commission can appoint a new one. as a monitor of management in the Korean (and also the Japanese) system. outside directors. But this problem can be mitigated if auditors function under the umbrella of the board. and creditors selects it. does not have the power to hire and fire the managers. . almost all firms affirmed that the external auditor is independent from the company. External auditors are selected for a term of three years. 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. In the past. Listed and registered corporations must publish financial statements audited by external accounting firms. In the ADB survey. 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. Vol. The problem of misconduct on the part of the external auditor was caused partly by weak penalties on wrongdoing. About 100 listed firms will be subject to this requirement. 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. this problem will largely disappear.102 Corporate Governance and Finance in East Asia. underdeveloped market discipline for accounting firms.6 years. 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. II controlling shareholder/CEO. Big Korean accounting firms are affiliated with US accounting firms. 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. however. The general organizational/social culture in Korea abhors conflict and may also have hindered effective functioning of internal auditors. the board of directors had the power to appoint an external auditing firm. This is because the auditor. If the company changes its external auditor for reasons that are not listed in the relevant regulation. The current external auditors have been associated with the surveyed companies for an average of 4. Accepting these arguments. but since 1998 a committee consisting of internal auditors. Previously. In order to increase independence. 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.
79 percent of the shareholders. the Depository is subject to “shadow voting.” The survey shows that the Korea Securities Depository holds 69. for some firms.93 percent of the shareholders but 26. 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.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. in general. The Depository represented 20 percent of the shares attending the meetings. attended the last annual general meeting.77 percent of the shares.3. However. or 10. Under the Commercial Code. Preferred shares can be nonvoting and issued up to one quarter of the total number of shares.3 Shareholder Rights Voting Rights and Practices Under the Commercial Code. Citizens’ coalitions sometimes solicit proxies in order to file lawsuits against a management. A total of 326 shareholders per firm. amendments of the articles of incorporation require a “special resolution. 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. and dismissal of directors and internal auditors require a “special resolution. Approval of mergers and major divestitures. About one fifth of the listed firms issued nonvoting preferred shares.53 percent of the total shareholdings. These voters represented only 5. the Depository is instrumental in getting resolutions passed. the only purpose of allowing the Depository to vote was to help listed companies to meet the quorum requirement for the general shareholders meeting. small shareholders do not attend the annual meeting and that. Internet. Thus. charter amendments.” Companies can increase the number . The above results indicate that. corporations cannot issue common shares without voting rights. respectively. However. This shows that a relatively larger number of shareholders send in their proxies. or telephone. The management is the most important proxy.21 percent of total shares issued. The securities companies and banks are the second and third. representing 62. One common share should have one vote. A “special resolution” requires two thirds of the votes attending and one third of total votes outstanding. No companies have so far introduced voting by mail. About 100 shareholders per firm voted by proxy at the last annual general meetings (of the 40 firms answering the relevant questions).
In February 1998 and again in March. and major investment projects (only five firms answered this question). Vol. The company also agreed to the right of the fund . the requirement was lowered from 1 to 0. This coalition also attempted to cooperate with domestic and foreign institutional investors to find their way into general shareholders meetings. laws and regulations were generally very loose in protecting the rights of minority shareholders. This citizens’ coalition actively contacted the management of selected companies and negotiated measures to protect shareholders. Due to the changes in rules for investor protection. an activist citizens’ coalition has brought shareholder derivative suits against several large listed firms. and for access to unpublished accounting books and records. demand changes in business policy. Shareholder Protection Before the economic crisis. In four out of 62 respondents. Shareholders have preemptive rights. Changes in the authorized capital require an amendment of the articles of incorporation. Various measures have since been taken to improve investor protection. However. was able to force a change in the charter of SK Telecom. dividend proposals. the Tiger Fund.0 percent. 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.01 percent. but these can be waived by an amendment of the articles of incorporation. It also attended the shareholders meeting of several companies to present the views of outside shareholders. As an example. Only two out of 62 respondents to this question have had cases in which proposals were rejected. The charges included self-dealing by a controlling shareholder and unfair subsidization of affiliated companies by a chaebol firm.5 percent. the board of directors decides on issues of shares within the limit of the authorized capital. For recommendations for dismissal of directors and internal auditors. the annual general meeting passed a resolution that was not proposed by the management nor the board of directors but rather by shareholders. mergers and acquisition plans. Those that are most likely to be rejected relate to election of directors. II of votes required for a resolution to amend the articles. or block charter amendments considered harmful to minority shareholders. from 3 to 1. an institutional investor based in the US. Proposals put forward by management are rarely rejected at the general meetings.104 Corporate Governance and Finance in East Asia. the Securities and Exchange Act was revised to lower the representation requirement for shareholder derivative suits from 1 to 0.
However. This was one of the most significant developments with respect to shareholder activism in the Korean capital market. the Government had for some time pushed for the enactment of class action suits on false statements and omissions in disclosure materials. The Code has also been amended to state more clearly the fiduciary duty (of care and loyalty) of the management. creditors did not interfere with the management of a debtor. loans to directors. simple. In fact. 2. Banks have played some limited role in monitoring the investment activities of chaebols. managers were considered to be subject to the duty of care. In 1974. Thus. This has strengthened the accountability of controlling shareholders as de facto CEOs. controlling shareholders have become more susceptible to liability claims by other (minority) shareholders. 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. For further protection of investors. but it was not entirely clear whether they had the duty of loyalty as well. . After the economic crisis. Before the amendment. it now appears that it has backed away from its earlier efforts to introduce legislation on class action suits. and transactions with major shareholders. The laws and regulations of the country protect shareholders from interested transactions. These have to be disclosed under the Securities and Exchange Act or approved by shareholders under the Commercial Code and other laws.Chapter 2: Korea 105 to recommend two directors to the corporate board. underwriting securities firms acted also as trustees. As for bond issues. bond indentures are only a few pages long compared to a few dozen pages found in advanced bond markets. Banks themselves were poorly governed and bank managements had little incentive to monitor borrowers. and not strictly enforced. affiliated lending or guarantees.3.4 Control by Creditors Role of Creditors in Corporate Monitoring Traditionally. The covenants in loan agreements and bond indentures were very loose. there was the usual conflict of interest problem and the trustee did not have the incentive to strictly enforce the covenants. 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.
Some proponents argue that creditors should have the right to send their representatives to boards of directors of borrowers. In 1994 the approval requirement was abolished. The firms subject to the system are required to get the approval of the main bank prior to purchasing real estate.106 Corporate Governance and Finance in East Asia. on average. the main banks should review the feasibility and financing plans of projects undertaken by the core companies and monitor their financial conditions and prospects. and purchases of real estate. including. The 10 largest business groups are required to select no more than three core companies in consultation with their respective main banks. recently banks have been increasingly interested and successful in electing former bank officers as outside directors of firms that underwent workout processes. On the other hand. as discussed earlier. there have been concerns that the Government might use the system to intervene in the management of the business groups. creditors now have a bigger say in court proceedings for receivership and composition. a main bank is charged with collecting and analyzing financial information of the firm and delivering its opinion on various applications and matters requiring consultation among lenders to the firm. In 1996. ADB Survey Results on Borrowing and Lending Practices The ADB survey shows that a typical nonfinancial company is associated with various types of creditors. 11 banks. the main bank system was introduced and has been applied to the 51 largest business groups to which banks extended more than W250 billion in loans and payment guarantees. Under the system. this proposal has only a slim chance of being accepted by the Government or legislature. However. Vol. 10 nonbank . II acquisitions. Purchase of real estate should be financed by equity capital and not by borrowed funds. In turn. Emphasis on the monitoring role of banks has been growing since the beginning of the Asian crisis. Besides the setting up of an “External Auditors Committee” by firms. However. The main bank should also monitor and restrict extension of loans to the controlling shareholder and other firms in the group. The view that is more popular among theorists is that creditors would pursue goals that are not in harmony with value maximization and the decision-making role should be bestowed on the shareholders as residual claimants. The objective of the system is to improve the financial condition of the largest business groups and promote the soundness of bank management.
whereas seven of the 17 nonfinancial corporations are. Breakdown of loan guarantors is as follows: about 40 percent of loans are without any guarantees. collateral is more likely to be required of loans for working capital than for fixed investments. or creditors filed for receivership. payments were usually rescheduled through negotiation without any penalty. in order of importance: affiliated companies. A few creditors exercise influence through covenants relating to major decisions by the company. One tenth of the firms received assistance from the Government in loan applications. collateral was taken away. holding shares of another company by both the borrower and the guarantor. The typical company has also maintained its relationship with five of the 10 NBFIs for more than five years. penalty was involved in rescheduling. Among the creditors. NBFIs infrequently ask for collateral. For a small number of firms. The assistance came from. banks are most likely to require collateral. Most of the financial institutions are not affiliates of the borrowing company. 35 percent are guaranteed by the company itself (by collateral and purchase of guarantee insurance). and other financial institutions.Chapter 2: Korea 107 financial institutions (NBFIs). Creditors usually exercise their influence through covenants relating to the use of loans. 16 percent . Most of the 43 firms with renegotiation experience were able to borrow from the same creditors afterwards. More than half of the firms think that creditors have no influence on their management and decision making. subsidiaries. mutual guarantee agreements. Most firms feel that requirements for collateral have been tightened since the crisis started. About 60 percent of the firms have experienced renegotiation of loan repayment with creditors during the last five years. and purchase or supply of raw materials. and 17 nonfinancial corporations. Only a few feel that creditors have very strong influence. holding companies. For more than half of such firms. About half of the respondents received assistance from other sources in the form of loan guarantees and/or provision of collateral. When loans could not be repaid on time. or through their shareholdings. most frequently in the form of loan guarantees and less frequently by arrangement of guarantees by a third party. controlling shareholders. renegotiation took place after the crisis. Relationships with affiliated companies providing guarantees or collateral include ownership of each other’s shares. while a third think that creditors have weak influence. With respect to the types of loans. The borrower’s relationship with most banks has lasted for more than five years.
This agreement will provide guiding principles in coordinating diverse interests among creditor institutions and promoting cooperation. have been the driving forces for restructuring activities of the largest 64 chaebols. including commercial and merchant banks. will get involved in the restructuring and workout processes.3. the lead creditor banks formally signed Capital Structure Improvement Plans with chaebols.108 Corporate Governance and Finance in East Asia. Third. The new ways through which creditors. In cases where the creditors are unable to reach an agreement on a workout plan. 4 percent by subsidiaries. especially banks. II by other affiliated companies. Second. banks and other institutional lenders are playing more important roles than ever before. the delegation has the right to approve wide-ranging financial activities of the firm. 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. and 1 percent by the Government. Separate from but emulating the CRA. the Korean Government maintained a policy of protecting the incumbent management of listed companies. Behind these new strengthened roles of creditors is the newly set-up FSC. are summarized below. the Corporate Restructuring Coordination Committee (CRCC) will provide arbitration. Vol.5 The Market for Corporate Control Government Policy Toward Hostile Takeovers Until 1994. The leading creditor banks will continuously monitor the progress in implementing the signed Plans. the creditor banks will send a delegation composed of bank officers to the workout firm to oversee its management. 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. In this connection. 2 percent by holding companies. 2. a Lead Creditor Council Agreement was signed for restructuring the top five chaebols. Under a contract signed between the creditors and the debtor. This committee was set up in accordance with the provisions of the CRA. and in continued monitoring of debtors. 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 . First. major creditors.
listed firms rely mainly on shareholdings by the largest shareholder. . it can be safely stated that Korea now has one of the most accommodating capital markets with respect to hostile takeovers in the region. 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). Korea does not have the mandatory takeover rules applying to those who amass more than 30 percent of the shares outstanding (until 1998. The reasons for failure are diverse. Unlike the UK. hostile takeovers by tender offers began to appear in the capital market. For takeover defense. In one case. 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. Between 1994 and 1997. The shareholders already owning more than 10 percent at the time the company went public were exceptions to the rule. but were completely eliminated in 1998. the outside shareholders did not want to sell shares because the share price went above the offer price due to a share repurchase by the target and anticipation of a competitive bid from a third party. Stock purchases by tender offer were also exempted. Limits on acquisitions of shares of a Korean firm by a single investor were gradually increased over a six-year period beginning in 1992. However. turning to white knights. and announcing competitive tender offers by the controlling shareholder. corporations cannot limit the voting rights of large shareholders to a given maximum. In the early 1990s the Government shifted its policy toward freer activities in the market for corporate control. a total of 13 hostile takeover attempts occurred. more than half of these attempts failed. The incumbent controlling shareholders used various tactics such as issuing privately placed CBs. Takeover Activity As soon as the Act was amended. Companies have also utilized share repurchases. Publicly issued CBs require three months before their owners can convert them to shares.Chapter 2: Korea 109 unless he or she obtains prior approval of the Securities and Exchange Commission. Unlike Germany. As far as institutional arrangements are concerned. A company cannot issue new shares to a third party without first amending the corporate charter. Privately placed CBs cannot be converted into shares in one year. 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. Poison pills cannot be used mainly because companies cannot distribute stock options as dividends to shareholders.
Vol. and a bank had government ownership. In 1999. Korea Telecom. the Government became the largest shareholder of several commercial banks through equity participation purporting to recapitalize them out of financial distress. 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. are designated as public companies. Firms affiliated with a large group are generally regarded as difficult targets as the other members of the group will come to the rescue or act as white knights. For the steel company.7 percent on average as of the end of 1997 for nonfinancial listed firms). 172 firms (or 22 percent of listed firms) belong to the 30 largest chaebols. It is harder now to find such firms. which are allowed by the Securities and Exchange Act to set the limit on the ownership of shares by one single shareholder. In 1998. Many of the takeover targets in the past did not have a controlling shareholder (group). the limit will be eliminated when it is fully privatized in two years. Currently the limit is 3 percent. Charter amendments have also been employed by some firms to limit the maximum number of directors. 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. The Government-owned listed companies. As of February 1999. . Hostile takeovers in Korea will be rare in the future. 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 (26.3. a steel company. in which the Government still holds the largest ownership. except for the banks. In their charters. As of the end of 1997. an electric power company. 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. was newly listed.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. Another reason is that many listed firms belong to chaebols.110 Corporate Governance and Finance in East Asia. Some had two or more large shareholders who had joint control of the firm but could not cooperate. For the others. 2.
the main bank system. 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. 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 2.3. nominated by the minister in charge of the company in question. and approved by the Chairperson of the Planning and Budget Commission. In addition. 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. 2. The Government’s right to send public officials to the boards was eliminated.3.7 Employee Participation in Corporate Governance Employee participation in corporate governance is very limited.1). is being applied to the 51 largest business groups to which the banks extended more than W250 billion in loans and payment guarantees. was amended in 1997 to introduce a board structure consisting of a majority of nonexecutive directors. For example. Labor is not represented in corporate boards. Further. administering through a self-regulatory committee of the securities industry. There is no active debate or discussion going on about this potentially difficult issue. There were also limits on the amount raised and the number of issues per year. Even where employees hold . This was aimed at limiting the supply of bonds thereby stabilizing interest rates. It was abolished before the economic crisis but another regulation. Meanwhile. only qualified firms could issue new shares. The objective of the system was to improve the financial condition of the chaebols and to promote the soundness of bank management.Chapter 2: Korea 111 The Government used to appoint a few public officials to the boards of state-owned corporations. especially those belonging to chaebols. went into effect in 1998 to prevent them from absorbing too much of the funds available in the market. But this rule. the Government. The Government has frequently imposed restrictions on the use of capital markets by large companies. as applied to four large corporations. which was introduced in 1996. more state-owned corporations became subject to this new board structure. which limits the total amount of bonds issued by the five largest chaebols. Beginning in 1999.
employers are required to meet with representatives of labor unions at least once every three months. and 2. and 66 percent manual workers. In 70 percent of the firms with organized unions. This law is not intended for wage negotiations but for employers to seek cooperation and productivity increases from workers. Two thirds of the respondents had an organized union. employees of listed firms issuing shares through rights offerings are entitled to 10 percent of the rights. In actuality. About half of these firms considered the influence of the union on the management of the company to be weak. but 27 percent of them felt that it was strong. Employee stock ownership plans became popular in 1974 when the Government allowed tax and financial benefits for stock purchases by employees. Under another law enacted in 1972 to induce private companies to go public. 2. and development of the company.5 in 1990. In these firms. The typical collective bargaining agreement has a one-year duration. Under the Labor Management Council Law. Local unions in the same industry have established industrial labor federations. Vol. these firms have to offer 20 percent of the shares being issued to their employees at the public offer prices. . there are two federations of labor unions. This practice may be due to the fact that employees are typically submissive to their employers and that their total shareholdings are minimal. operation. 32 percent technicians and professional staff. The respondents of the ADB survey had 2. Under the Capital Market Development Act of 1968. Employees of companies have had the opportunity to buy shares of their employing businesses at favorable prices. The percentage of shares held by the employee stock ownership plans in listed companies was 1. the management usually consults the union on major issues relating to the management. The relevant regulation was amended recently in order to facilitate voting by individual employees.112 Corporate Governance and Finance in East Asia. The union had no influence on the management in 17 percent of the firms. which were generally much lower than estimated values.1 in 1997. they delegate their voting rights to plans’ representatives. in principle. of which 2 percent were senior managers. Collective bargaining is. In 1987. At the national level. union members account for 54 percent of the employees.9 in 1980. Trade unions are organized on an enterprise basis. carried out at the enterprise level.654 employees per firm on average. the council meetings have been superficial. 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. II shares of their companies through employee stock ownership plans.
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
The plan was launched partially to accommodate US demands for comprehensive structural deregulation and market opening of the financial sector.1). It included such important issues as interest rate deregulation. was liberalized drastically in 1998 after the financial crisis. which resulted in the establishment of a number of new banks. Moreover. the Korean Government announced its Financial Liberalization and Market Opening Plan. In June 1993. On the basis of flows of funds. The capital market. budget. With the privatization of nationwide commercial banks. II Interest Rate Deregulation Plan. Since 1985. In addition. implementing the first stage in November 1991.4.2 Patterns of Corporate Financing Corporate Financing Practices In this section. depreciation. The Government adopted a cautious approach. entry barriers to banks and NBFIs were lowered in an attempt to promote competition. flow of funds analysis was used to examine patterns of financing of the aggregate corporate sector. mutual savings. the business scope of financial institutions was greatly widened from the early 1980s. 2. Internal funds include retained earnings. etc. the required reserve ratio was substantially lowered from an average of 23 percent in 1979 to 3. as a first step toward liberalization of capital account transactions. and liberalization of foreign and capital transactions. opting to bring in the plan step-by-step to avoid market dislocation from a sudden shift in the system. and organization of commercial banks. Vol.118 Corporate Governance and Finance in East Asia. Korean firms have been allowed to issue CBs in international financial markets. Some policy loans were also abolished. The Government began to considerably deregulate foreign exchange in 1987 due to the shift of the current account into surplus in 1986 (see 2. . especially the domestic bond market. the Government announced a plan in 1981 that substantially improved foreign investors’ access to the domestic capital market. revision of the credit control system. finance companies. Also. Meanwhile. The Government handed over its controlling stakes in four commercial banks to private hands in 1981-1983. development of the money market.2. short-term finance companies. and the 30 largest chaebols.5 percent in November 1981. the Government simplified various directives and instructions regulating personnel management. listed companies. the following measures can be constructed: Self-financing ratio (SFR) is the ratio of change in internal funds to change in total assets.
25 shows the flow of funds of the nonfinancial corporate sector in Korea during 1988-1997.25. particularly in the 1990s in response to the liberalization of the capital market. comprising internally generated capital (retained earnings. It measures the degree of financing growth in total assets by additional equity.26 shows the four measures of corporate financing calculated from Table 2. on average. This means that internal funds after dividend payment were insufficient to finance growth in total assets. but do not include capital surplus (asset revaluation allowance and the excess of current value over issue value of stock). Incremental debt financing ratio (IDFR) is the ratio of change in total borrowings to change in total assets. 1994. The SFR averaged 28. The share of external financing. particularly in the short term. Equity capital represents the shareholders’ commitment to the business. capital surplus. In 1988 when the stock market boomed. Additional equity capital used to finance growth reduces the financial cost and the financial risk of investment. The corporate sector used . financing by corporate bonds and CPs was more significant than by new equity. depreciation.4 percent in the precrisis period 1988-1997.Chapter 2: Korea 119 and net capital transfers from the Government. the proportion of foreign borrowings in total finance rose steadily. Meanwhile. Table 2. New equity financing ratio (NEFR) is the ratio of change in equity (stocks issued + equity other than stocks) to change in total assets. including all sources other than retained earnings. Financing Patterns of the Aggregate Corporate Sector Table 2. and allowances) and new equity capital. Securities finance became a more important source from 1988 onwards. except in 1991. the proportion of borrowings from NBFIs fell to its lowest value at 4 percent. Incremental equity financing ratio (IEFR) is the ratio of change in stockholders’ equity to change in total assets or 1-IDFR. In securities finance. except for the stock market boom of 19871988. but it remained less than 10 percent of total financing. and government transfers. the corporate sector’s most important source of external finance was bank borrowings. and 1997. Before 1988. The use of additional debt to finance growth increases financial risks as the company may not be able to pay interest during periods of recession or high interest rates. This high proportion deprived Korean businesses of flexibility during recession periods due to high financial costs. was 71 percent during the period. depreciation. It measures the degree of financing growth in total assets by additional debts.
1 36.6) 5.7 10.1 — 27.4 8.6 25.5 0.1 — — — — 12.7 1. 1988-1997 (percent) 1988 43.0 22.6 0.4 27.6 10. depreciation.1 3.0 5.0 16.3 72.1 2.1 17.0 9.7 4.9 72.2 (0.7 14.8 15.7) 11.1 23.6 3.3 6.1 72. a Includes retained earnings.7 12.0 1.4 15.8 0.4 2.3 — 30.6 4.0) 12.3 6.4 0. .4) 13.9 34.2 1. b Includes capital surplus.9 10.0 — — — — 8.3 25.8 1.3 6.0 0.9 6.3) 11.2 5.2 0.5 2.9 0.2 6.7 7.7 10.25 Flow of Funds of the Nonfinancial Corporate Sector.0 17.7 2.2 14.6 3.2 15.6 9.0 1997 26.4 1.4 27.6 77.0 2.6 2.6 0.3 5.5 2.3 30.5 2. Source: Understanding Flow of Fund Accounts. Bank of Korea. which is the excess of current value over issue value of stock.0 70.1 2.7 2.8 1.1) 6.7 14.7 4.3 10.2 34.4 21.Table 2.8 56.4 10.7 71.7 1.7 — — — — 9.0 0.3 16.1 8.6 0.4 11.8 8.7 8.9 10.3 — — — — 8.2 13.8 -2.9 9.6 4.0 3.1 3.1 10.5 0.4 71.9 28.4 2.4 2.2 10.8 1.7 6.2 13.2 2.8 4.6 11.0 11.1 0.7 73.4 3.7 8.3 2.9 73.1 1.3) 15.7 15.5 29.6 5.0 (0.6 0.8 — 26.1 12.8 1.1 (1.4 (0.7 32.2 — — — — 9.7 2.5 9.6 (0. and net capital transfers from the Government.2 — 28.6 11. Bank of Korea.5 13.1 (0.6 9.1 0.7 11.4 (2.8 (0.7 (0.4 27.4 — 28.8 17. 1994.7 13.4 0.5 16.0 3.1 27. and Public Bonds Commercial Paper Corporate Bonds Stock Issuesb Equity Other than Stock Foreign Loans Foreign Current Bonds Trade Credit Direct Investment Others Others Government Loans Business Credit Other Financial Debts — = not available.0 9.2 26.3 1.3 1.4 2.1) 4.3 3.1 1.0 10. and Flow of Funds.9 2.5 16.6 1.8 30.6 14.1 3.9 38.8 27.1) 4.6 Sources of Funds Internal Financinga External Financing Bank Borrowings Banks Nonbanks Merchant Banks Insurance and Others Securities Natl.3 1.6 9.1 1.0 3.8 1.6 4.3 3.4 1.2 6.7 10.3 27.4 9.5 0.7 1989 1990 1991 1992 1993 1994 1995 1996 22.6 8.5 2.
26 Financing Patterns of the Nonfinancial Corporate Sector.8 10. .6 percent and 1.7 26. declining to 26. 1988-1997 (percent) Year 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 Average a SFRa 43. IEFR ranged from 32 percent to 64 percent of asset growth during the boom years. and Flow of Funds.1 percent in 1988 during the stock market boom. the corporate sector relied heavily on external financing for its expansion.3 73.3 60.4 NEFRa 20.8 percent of its total asset growth through debts. was financed by additional debts. On average.1 26. It dropped to 28 percent the following year.7 9.2 IDFR 36. Manufacturing financed 54.5 percent.8 62. dropping to 26. but plunged to 5.Chapter 2: Korea 121 Table 2.0 5.3 percent in 1997.4 percent. higher than the aggregate 28.3 27. indicating a high financial risk position.3 12. an average of 59. in the manufacturing sector.8 28. 45.4 percent.1 12. respectively. Bank of Korea. 1994. Lower income diminished the industry’s equity position toward crisis year 1997.0 57. Across industry.0 11. The balance. Bank of Korea.5 12.6 Excludes capital surplus.0 42. and IEFRs were declining. While SFRs.2 percent of incremental asset growth was financed by equity.2 37. Incremental financing from equity was 40.6 percent.1 53.9 28.7 30.7 40.9 percent by 1997 when net profit margins were negative.6 26. There were significant time trends.6 62.5 percent in 1997.3 11. but also continuously fell.5 68. average SFR was 37.4 IEFR 63.6 percent over the 10-year period. IDFR reached 73.4 percent (Table 2. NEFR registered 20.4 37. additional equity to finance 12.0 27.4 27.4 12.1 17.7 percent in 1997. Its IEFR and NEFR dropped to 23.7 40.3 59.5 31.3 59.2 percent of the growth in total assets.27).9 60. Source: Calculations from Understanding Flow of Fund Accounts.5 and 76. NEFRs. SFR peaked at 44 percent.1 39. higher than the aggregate 40.9 46.7 40.9 22.7 28. respectively. and the total debt ratio was much higher in 1996 and 1997 at 62.6 percent. In periods of high economic growth such as in 1988.
2 5. with the total debt ratio much higher in 1995-1997 at 82 to 84 percent.7 37.9 6.5 23.0 42.1 percent of total asset growth for the period.5 7. the proportion of short-term borrowings in total financing has been high. and communication sector had relatively high incremental equity ratios. Total debt financed an average 74.2 3. then increased to 20.2 21. retail. and low total debt and short-term borrowing ratios.7 47.8 IEFR 65.2 percent in 1993.6 53. On the other hand.8 4. Since 1992.6 54.9 IDFR 34.0 42. and steam) and the transportation. Table 2.6 62.9 percent.3 28.6 3. this dropped further to 15. These sectors had relatively low equity financing ratios and high total debt ratios in financing asset growth between 1988 and 1997. Vol. their average SFR was higher.2 62.4 45. Financing patterns of the wholesale. Since large firms were more profitable.6 45. In 1997.0 30. from 17. It had the highest average SFR in 1988 at 31.4 47. Categorized according to company size.1 29.6 36.6 53.27 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. which decreased to 8.6 37.8 50. and hotels sector and realty/renting/business activities sector were similar.4 37.6 37.7 37. Equity financed an average 25.5 1. the two sectors also had low equity financing ratios and high debt financing ratios.8 percent in 1990. gas.122 Corporate Governance and Finance in East Asia.6 4.4 3.7 percent in 1996. the utilities (electricity.2 .5 76.3 52.9 percent of asset growth.5 NEFRa 9. one year ahead of the other industries.and medium-sized firms. large firms showed more cyclical patterns in these financing ratios than small.4 46.4 63.8 percent in crisis year 1997. explaining partly the collapses of several construction companies in 1995.0 57. storage.4 54. II The construction industry showed the most cyclical pattern in annual asset growth.7 47. and fell to about 10 percent in 1997.0 3.
2 1995 16.9 29.1 4.5 62.5 87.8 1994 15.8 4.0 .9 80.4 28.0 60.8 29.9 1992 56.0 40.5 12.7 41.1 25.0 1990 50.3 84.9 1989 63.1 1991 14.6 4.0 4.9 15.5 76. Household Goods.7 1989 26.2 5.9 33.9 9.0 82.4 2.1 69.7 42.8 81.6 73.9 20.9 1.2 70.5 20.3 4.7 1997 8. Storage.1 66.8 74.2 25.5 29.5 23.7 6.8 1991 51.4 26.1 70.0 1990 12.6 8.0 10.1 59.9 1993 63. and Communication 1988 64.6 14.7 Wholesale/Retail Trade.2 3.6 71.9 1.0 34.7 78.5 1.7 7.2 4.9 Average 19.8 76.2 18.2 46.2 74.9 30.5 1996 42.0 65.6 7.Table 2.0 0.8 54.3 (9.7 15.6 9.5 70.7 53.3 47.4 IEFR 46.6 2.1 19.2 23.3 19.2 10.3 57.9 52.7 80.3 7.4 1995 53.1 Trasport.2 8.0 31.0 3.7 1994 53.8 25.27 (Cont’d) Year SFRa NEFRa IDFR 53.8 70.4 62.6 1997 29.3 4.0 68.5 1993 22.9 47.2 20.9 16.9 2.3 10.0 74.0 1.8 2.9 Construction 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 Average 31.3 1996 16.3 8.6 37.6 37.6 8.0 17.7 78.9 1.2 29.0 1992 24.4) 2.8 9.2 Average 53.3 21.6 9.7 15. Hotels 1988 33.5 21.1 84.
0 56.124 Corporate Governance and Finance in East Asia. The large firms had a higher proportion of external financing in 1996-1997.1 0.1 1989 34.4 1994 72. Gas. a Excludes capital surplus.4 7.4 47.0 53. The trend was reversed in 1996-1997.7 37.9 28.7 1996 18. and Steam Supply 1988 118.0 (0.3 85. Vol.9 65.0 43. IEFR = incremental equity financing ratio.5 22. II Table 2.0 67. Source: Calculated using data from Bank of Korea.3 7.4 1995 62.3 3.and mediumscale firms.3 31.0 0. Long.1 34.6 Real Estate.4) 3.9 Average 75.7 18.0 46.1 71.3 62.8 17.1 35.4 (107.0 79.6 1995 17.6 IDFR = incremental debt financing ratio.2 63.0 1. SFR = self-financing ratio.9 57.8 1993 11.7 14.7 70.8 Average 22.6 1989 118. Financial Statement Analysis Yearbooks.7 69.1 70.0 0.3 81.9 29.3 92.1 1993 55.1 1991 56.3 Electricity.0 21.6 52. NEFR = new equity financing ratio. .6 1.7 1994 8.1 42.8 1990 19.6 1997 23.3 207.4 IEFR 69.27 (Cont’d) Year SFRa NEFRa 6.1 54. Their average IEFR was also higher and IDFR smaller.4 1996 45.0 1997 24. however.8 135.5 77.4 0 0 0 0 1.4 0.6 1990 82. Higher growth in total assets and sales and easier access to debts by large firms could be reasons for this.0 33. Renting.4 1.9 45.8) (35.0 1992 51.9 64.8 36.2 1992 18.3 29.6 1991 18.4 5.5 8.8) 7. when large firms had much lower equity financing ratios and higher debt financing ratios than small. and Business 1988 51.and short-term borrowings of these firms shot up in that period.9 IDFR 31.6 7.
6 percent of total asset growth. Their shortterm borrowings accounted for 86. The proportion of their short-term financing averaged 72. They had easier access to bank loans and the markets for corporate bonds and CPs than nonlisted companies. External financing reached 94.3 and 89. the top 11-30 chaebols had the highest guarantees commitments at 207.5 percent and their total external financing. the average SFR was 28.29). the NEFR of the top 30 chaebols plunged while the debt ratio increased substantially. and the top five chaebols.7 percent. respectively.7 percent for all listed companies.30).8 percent of their total finance in 1997.28).4 percent.1 percent of their equity capital. but higher than that of listed companies. The chaebols’ drive to expand their empires resulted in heavy borrowings.8 percent.Chapter 2: Korea 125 Financing Patterns of the Publicly Listed Firms The average SFR of listed companies in 1994-1997 was much lower than that of the corporate sector as a whole (Table 2.3 percent of their equity capital in 1997 (Table 2. and using cross-payment guarantees among affiliated companies.6 percent. Another key feature of corporate finance in Korea is the widespread use of loan guarantees among the top 30 chaebols. the IDFR of listed companies increased to 93. In 1996-1997. In 1997. the lowest ratio of 58.7 percent. for listed companies. The debt financing ratio of listed companies was high since they relied more on external financing. All of the top 30 chaebols relied heavily on short-term borrowings. and were large borrowers. Cross-payment guarantees have been declining since 1993 and reached 91. compared with the entire corporate sector’s 35 percent and 65. 153. at an average 70. 91.9 percent. .2 percent. the top 6-10 chaebols. Group-member firms borrowed less. In 1997.5 percent is lower than that of the corporate sector in general. Many firms affiliated with the top 30 chaebols saw loan guarantees turn into their own debts because of defaults in debt payments. Financing Patterns of Chaebols For chaebols. The largest borrowers were the top 11-30 chaebols. and higher than that of listed companies (Table 2. The average IEFR of the top 30 chaebols of 29. The average IEFR and IDFR were 10. compared with 89. about the same as that of the corporate sector as a whole.9 percent. They were able to borrow easily from banks by issuing corporate bonds and CP.
28 Financing Patterns of Listed Companies.5 8.6 61.3 28.5 91.7 12.1 8.5 8. 1994-1998 (percent) SFRa IDFR 85.29 Financing Patterns of the Top 30 Chaebols.Table 2.6 1.4 38.4 29.4 12.9 7.6 0.8 89.3 86.8 76.6 11.1 93.3 Year 1994 1995 1996 1997 Average a Excludes capital surplus. Korea Federation of Industries. .5 Year 1994 1995 1996 1997 Average a Excludes capital surplus.4 1. Largest Business Groups in Korea.9 NEFRa IEFR 14. Source: Calculated using data of Seung No Choi.2 36.4 88.7 1.6 IEFR 42.7 13.3 5.3 IDFR 57.2 10.9 6.2 23.2 NEFRa 1.3 1. 1994-1997 (percent) SFRa 41.1 1.5 2.8 22. Table 2.6 70.5 2. Source: Calculated from data obtained from data files of the Korea Listed Companies Association.2 1.
Fourth.3 58.Chapter 2: Korea 127 Table 2.1 — = not available. This change implies that firms now give more attention to financial risks. and reserves and retained earnings. There were several reasons for this. the Government applied high tax rates on net profits of corporations. bond issues. First. especially in the 1970s when real interest rates of bank loans were negative. According to the ADB survey. inefficient investment and excessive diversification of corporations. This attitude appears to have changed after the crisis because reserves and retained earnings and rights issues became the preferred financing choices. loans from banks. the Korean economy was plagued with high inflation. the Government provided implicit guarantees on bank lending and large businesses. Source: Fair Trade Commission and the Federation of Korean Industries. so that the firms engaged in lobbying to gain access to them.1 — — — 1995 161. Third. These are followed by loans from banks. And fifth. Further. Controlling shareholders usually tried to avoid dilution in their shareholdings for fear of losing control. rights issues. Korean firms preferred debt financing (bank and nonbank borrowings).0 1997 91. and underdevelopment of the stock market. company preferences in financing investment projects before the crisis were. chaebols could easily borrow funds from banks and NBFIs by using cross-payment guarantees.7 150.9 — — — 1994 258. poor financial and corporate governance resulted in overlending by banks. more than half of bank loans were priority loans with low interest rates.30 Cross-Payment Guarantees of the Top 30 Chaebols. Few firms ranked loans from NBFIs as their first preference.3 64.0 207. Factors Influencing Corporate Financing Choices Until recently. Financial institutions did not strictly screen their loan projects and monitor their debtors. Firms now prefer internal funds and new equity capital. Interest payments on debts were considered a loss when calculating taxes. Second.9 — — — 1996 105. and extended loans based on cross-payment guarantees.9 153. 1993-1997 (as percentage of equity capital) Rank Top Top Top Top 30 Chaebols 5 Chaebols 6-10 Chaebols 11-30 Chaebols 1993 469. in order of ranking. bond issues. and loans from NBFIs.3 200. .
Nonetheless. The percentage of foreign currency denominated loans hedged against exchange rate risks was 21. and reduction in tax burden. A futures exchange launched in 1999 trades foreign exchange options.5 percent at the end of 1997.36 percent on average for these companies. the majority (60 percent) of the firms responding to the ADB survey look first for nonaffiliated financial institutions. This preference has changed little after the crisis. in selecting financing sources. II In seeking external financing. Other factors include. 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. These survey results indicate that many companies were not very attentive to exchange rate risks (and possibly to financial risks in general).4. Among those that never hedged against exchange rate risks.3 Financial Structure. maintenance of the existing ownership structure.128 Corporate Governance and Finance in East Asia. the percentage of foreign currency denominated debt in the portfolio was 14. About half of the respondents of the ADB survey borrowed foreign currency denominated loans from foreign banks. Korea now provides a better environment for financial risk management. For these firms. According to the survey. 2. in order of importance. and others (29 percent) expected the local currency to appreciate in value. firms give their first consideration to minimization of transaction and interest costs. Among the responding companies that had foreign currency denominated loans. Diversification. Vol. some (36 percent) thought that a hedging facility was not available or not working properly. Only a few firms sought foreign loans because domestic loans were not available. ensuring the liquidity of the company. 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. they survived for two to three . Few companies felt that hedging was too costly or was unnecessary as the exchange rate was considered fixed. more than half (53 percent) hedged against exchange rate fluctuations. and futures and other financial derivatives. even with a heavy debt burden. many firms (or 42 percent) never considered hedging.
the top five chaebols and the top 6-70 chaebols had similar ratios. These findings indicate that independent firms have had a lower leverage and performed better financially. Operating earnings are earnings before interest payments and taxes plus depreciation and amortization (EBITDA). (ii) In terms of net income to total assets.Chapter 2: Korea 129 years before collapsing at the time of the 1997 financial crisis (2.13). . but the ratios of independent firms were much lower. They were also higher than those of the top five chaebols until 1991. (i) In terms of total borrowings to total assets. Nam et al. the ratios of independent firms were higher than those of the top five and top 6-70 chaebols during the entire period. Among the main findings were the following. Table 2. except in 1991. (iii) Interest payment coverage ratios are calculated as operating earnings over interest expenses.3. (1999) compared the financial positions of 504 chaebol affiliates and non-chaebol independent firms during the period 1986-1998. Those firms whose interest payment coverage ratios are below 1 are likely to go bankrupt. the ratios of nonchaebols were remarkably higher than those of the top 670 chaebols during the entire period.. They were also higher than those of the top five chaebols until 1992. the top five chaebols’ ratios were much higher.2. except in 19931995 when semiconductor prices were extraordinarily high. (iv) In terms of EBITDA to total assets. Interest coverage ratios of non-chaebols were higher than those of the top 6-70 chaebols during the entire period. The ratios of the top 6-70 chaebols were lower than those of the top five chaebols. However. as well as lax financial supervision (Nam et al. 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. the trend was reversed in 1993 when the interest coverage ratios of the top five chaebols exceeded those of the independent firms. 1999). 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. In order to determine the relationship between financing patterns and corporate performance. But since 1992.
The differences in the degrees of diversification among the three groups are substantial. however. rising nonperforming loans (NPLs) and falling . larger research and development expenditure. and easier access to cheap credit. Indicators such as increasing debt-to-equity ratios. But the net profit margins of the top 31-72 chaebols were higher than those of the top five in 1985-1992. the degree of diversification was highest in the top five chaebols. except in the recession years of 1996-1997. Government intervention.5 The Corporate Sector in the Financial Crisis This section looks at the various causes of the crisis in 1997. or outright transfer of resources due to poor corporate governance practices. debt guarantees for free. and composition was lower than that of the top 6-30 but higher than that of the top 31-72 chaebols on average. Meanwhile. Chaebols have been subsidizing new or low-profit industries by transferring resources from high-profit industries through inside dealings. second highest in the top 6-30. the top 6-30 and 31-72 chaebols gradually increased their diversification beginning 1990. 2. net profit margins of the top 31-72 chaebols were always higher than those of the top 6-30. too. had easier access to credit than the top 31-72 chaebols. Their subsidiaries. II Corporate Performance and Diversification As a chaebol further diversified into nonrelated areas. During 1985-1997.130 Corporate Governance and Finance in East Asia. 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. the top five chaebols outperformed the top 6-30 chaebols for most of 1985-1997. 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. The diversification of chaebols under workout was much lower than that of the top 6-30. then declined to levels lower than those of the top five in the years of economic downturn 1993-1997. had a significant role. Vol. court receivership. 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 diversification of the top five chaebols remained at about the same level within the period. The degree of diversification of chaebols that fell into default.31). In terms of the net profit margin (the ratio of net profits to sales revenue).
3 0.0 (0.8 (0.1 1.4 1996 0.6 1.4 (1.3 0.1 1.1 (3.3) 12.2 1.1) (6.1 (0.2 1.9) 2.8 1.6 1.1 1.7) (0.1 (4.0 1.9 1.6) (0.8) 1.2 (0.6 1989 1.8) 0.1 0.8 1. Beyond the Limit.7) (0.7 1.8 0.6 1.7 0.7) 0.3 (0.0) 0.2) (4.1 0.9 1.3) 0.0 4.4 1.2 0.6 0. Management Research Institute.1 0.3 1.2 1995 3.1 0.4) (2.3) 1.6) 0.9 (0.3) 0.1 (1.4) (1.3) 0.1) (2.5) (2.4 (0.1) 0.0 1992 1994 1.2 (0.6 (0. Source: Whan Whang.2 (0.4 1.7 1.1 (9.3) 0.1 1.6 0.7 3.1) (1.8) 0.7 (0.8) (37.1 0.6) (12.9 0.7 1.7 (4.8 3.3 (0.0) (3.2 1.2 1.5 (0.9 8.8) (4. 1985-1997 Item Top 5 Hyundai Samsung LG Daewoo SK Top 6-30 Top 31-72 Default.8 0.1 1.0 1987 1.4 (0.2 4.5 1.3) (0.7 2.6 1.8 0.3 0.8 3.3) (1. p.7 0.3) (0.6) (20.2) 2.8) (20.4 1.5 1.4) (1.0) 0.7) 0.5) (0.4 (1.8) 0.4 (0.3 1.8 (0.0 (2.3 (3.8) (11.9 0.7 0.9) 0.2) (3.3 3.0) (0.1) 1.5 4.3 1. Chung Ang University.6) 0.9) 2.4 2.1 0.1) 0.8) (0.3 1.8 0.8 1990 0.6) (12.2) (13.3 1.5 2.3 1.5 (6.5) (2.3) 0.4 0.6 0.2) (13.5 (4.2) (0.8) (1.5 (0.1) 1.2) 1.2 (17.8 (0.3 (0.9 0.0 1.31 Net Profit Margins of Chaebols.0) (4. .0 (7.2) (4.5 (0.6 0.6 1. and Reconciliation Kia Jinro Hanbo Sammi Newcore Haitai Chungku Kukdong Daenong Halla Workout Target Kuhpyong Kangwon-sanup Pyuksan Sinho Tongil Kohap Sinwon Anam Donga 1985 1.3 1.11. Background and Task of Structural Adjustment.3) 1.7 (1.1 0.6 0.2) 0.1 2.4 1.3 1.6 7.3) (12.8) (3.2 1.9) (9.1) 2.0) 0.7 0.5 1.1 4.9 1.6 0.4) (1.9 0.2) 1.7) (1.5 1.1 (4.7 0.3) 0.2) (4.0 0.2) 2.9) 2.3) 0.4) (4.1 1.6 (0.0 0.1 0.1) — = not available.8) 1997 0.2 (0.0 6.2) (0.1) 2.1) (5.8) (1.0) (0.5 (0. 1998.5 1.6 3.5) (1.3 (0.1 1.8 0.2) 1.5 0.7 (0.3 1.3 0.7 — (0.4 0.6) 0.4) (0.4) (6.1) (1.6 (10.Table 2.9) (8. Court Receivership.6 0.9) (1.7 1.3 1.4 (2.6 0.8) 2.2 1.6 5.5) (7.4 0.3 1.6) (0.1 0.6) 0.4 0.8) 0.4 (1.5) 0.3 0.2 (1.9 1.8) 0.7 0.
Meanwhile. Vol.132 Corporate Governance and Finance in East Asia. Moreover. Ownership concentration also had ramifications on corporate transparency. after the crisis. and to the development of the market for corporate control. . and creditors should select (recommend) the external auditor. The most serious problem among most Korean listed firms has been that a controlling shareholder acting as CEO could never be replaced. the recently adopted Code of Best Practice in Corporate Governance recommends the strengthening of the board system.5. A remote trigger in the Thai crisis was all that took to push the economy over the edge. internal auditors cannot be expected to perform their function independently of management. II corporate profitability were signs that the Korean economy had reached the edge of a slippery slope. Now. a firm’s board of directors had the power to appoint an external auditor. 2. Thus. this has led to entrenched management. the controlling shareholder or CEO generally selects the internal auditor despite a legal provision limiting the votes of the largest shareholder to a maximum of 3 percent. 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. Thus. the boards of all listed companies were composed of insiders only. 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.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. 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. Until 1997. They were then almost automatically elected at the general shareholders meeting. Until 1997. a committee composed of internal auditors. The hold was tightened by the practice wherein candidates for directors were handpicked from among the managers by the controlling shareholder. But in 1998. the independence and objectivity of the external auditor were often questioned. Along with government policies to protect the status quo. outside directors.
as a whole. 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. a large issuance of preferred stocks with no voting rights. has an unsound capital structure and .Chapter 2: Korea 133 There had been some devices to protect management so that companies could indulge in business activities without fear of takeover. however. profitable firms within a chaebol tended to subsidize unprofitable firms. restrictions of voting rights of shares of institutional investors. Meanwhile. These included restrictions of shareholdings of institutional investors. corporate accounting information was not reliable due to the lack of independence of external auditors. hostile takeovers in Korea will likely be rare in the future. the Government maintained a policy of protecting the incumbent management of a listed company. Traditionally. These internal dealings made strong firms weak and helped marginal firms survive. and restrictions on hostile takeovers. Many of the takeover targets in the past did not have a controlling shareholder. prevalent window dressing practices. Dominance of Chaebols A chaebol is tightly controlled by the largest shareholder. 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. regulatory and practical difficulty in implementing proxy voting. There were no effective monitoring mechanisms for its management. Many changes were introduced to promote M&A in the 1990s. Diversification can reduce chaebols’ risks through the portfolio effect. Under the direction of the controlling shareholder. individuals. and some differences in Korea’s generally accepted accounting principles from international standards. In this situation. as well as institutions. usually a member of the founding family. Banks did not function as monitors of corporate management although they were shareholders as well as the most influential creditors. when a large diversified chaebol. However. The purpose was to increase the size of the stock market by having financially sound private firms go public with an assurance that they would not be taken over. participated in the stock market as short-term traders rather than long-term investors. One reason is that the percentage of inside shareholdings for an average listed firm is very high.
share issues. Net profit margins of the top 31-72 chaebols were higher than those of the top five or of the top 6-30. Profitability of the top 6-70 chaebol firms has been lower than that of the top five chaebol firms. bond issues. This effectively becomes an exit barrier for chaebols and would justify the intervention and support of the Government. prevalence of rent-seeking and morally hazardous behavior by economic decision makers. and other individual markets. II strong financial links among its member firms through investments and cross-guarantees. although their subsidiaries had better quality workforce and easier access to cheap credit than the top 31-72 chaebol affiliates. the financial distress of one or a few marginal firms can lead to a chain of bankruptcies across the entire chaebol. Financing preferences changed drastically after the crisis. and internal funds.134 Corporate Governance and Finance in East Asia. 2. financing choices of listed firms in order of preference were bank loans. The new preference ordering is as . the intervention later resulted in the accumulation of adverse side effects: underdeveloped product.5. Further.3 Manifestations of Weak Corporate Governance and Government Intervention Preference of Debt Over Equity Financing in the Precrisis Period Before the crisis. and a high degree of inefficiency in the economy. 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. 2. 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. The Government’s supervision and regulation of financial institutions were poor. However. the authorities did not properly check on banks’ lending practices—banks did not screen the lending projects and evaluate the creditworthiness of corporations properly. This indicates that too much diversification and overinvestment in the top 30 chaebols resulted in relatively low net profit margins. while (non-chaebol) independent firms had much lower borrowing ratios. As mentioned earlier. as the latter are well established in most business areas. Vol. the typical chaebol firm had an extremely high DER.5.
share issues. In November 1997. won/dollar nondeliverable forward rates increased rapidly. Although the ratio of stock market capitalization to GDP in Korea was not very different from those in the Philippines and Thailand. The high proportion of foreign debt led to a mismatch problem where borrowers were unhedged against foreign exchange risk. The financing choice of listed firms was also influenced by the underdevelopment of the stock market. the exchange rate (won/dollar) increased sharply and the financial crisis erupted in Korea. bank loans. 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 lending practices of banks. the size of the stock market was not adequate to digest all the potential supply of new shares to finance the rapid growth of corporations. signaling a bearish speculative move on the won. The ratio of external debts to GDP reached 48 percent at the end of 1998. At the end of 1996. 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. 63 percent of which was short-term. which were the most important financing source until 1987. consisted of high proportions of policy loans. which generally required guarantees or collateral. Implicit guarantees by the Government on bank loans to large businesses.Chapter 2: Korea 135 follows: internal funds.5 billion. the top 30 chaebols showed a DER of 519 percent. After the financial crisis erupted in Indonesia and Thailand. overseas borrowing became difficult and higher interest rates were charged on foreign borrowing. as evidenced by occasional. were advantageous to chaebols because they were in an “ideal” position to meet the loan requirement through cross-guarantees among their member firms. large-scale bailouts of financially distressed firms. Bank loans. However. Nonpolicy loans were also considered to be cheap because of interest rate regulations. the Government and the Bank of Korea defended the currency. . Other factors also contributed to this preference. and bond issues. As of the end of 1997. In the international financial market. 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. The preference for debt finance also led to a relatively large foreign debt. reducing foreign exchange reserves to a dangerous level. total foreign debt amounted to $157. which is far higher than the average ratio of around 400 percent for nonfinancial listed firms. obviously contributed to overlending and aggravated the situation.
They utilized mutual payment guarantees among their affiliates and believed that they would never fail. and returned to about 1. II Inefficient Corporate Investment and Low Profitability Ownership concentration among Korean firms. According to the “six months” definition. the NPL ratio reached 7. Doubtful loans are those for which interest is not received for six months or longer. and estimated losses.000 from December 1997 to February 1998.7 percent in 1997. Fixed loans are those for which interest is not received for six months or longer. Following the “three months” definition.6 percent in June 1998. a large number of construction companies failed due to the recession in the real estate market and decline in real estate prices. The bank supervisory 8 NPLs of banks comprise fixed (substandard) and doubtful loans. reaching highs of 6 percent in 1997 and 8.000 per year starting 1992. The number of insolvent companies increased rapidly in 1991 and doubled to more than 11. total assets. The Government could hardly help them because of the number and magnitude of business failures.000 in September 1998 (Table 2. . has given rise to various types of self-dealings by the controlling shareholder. Further. especially chaebols. excluding the financial sector.32).136 Corporate Governance and Finance in East Asia. they are defined as loans for which interest payments are overdue by three months or more. In 1997 they became negative. Before the crisis.000 during January-September of 1998. the ratios of net profits to sales. the NPL ratio8 of banks and other financial institutions began to increase. starting 1 July 1998. and shareholders’ equity of all industries. These were the definitions until 30 June 1998. were low in 1996 and 1997.200 in 1997. Meanwhile. It jumped to 17. nine out of the 30 top chaebols failed. The banks and merchant banks lent to large businesses. then 20. The monthly number reached more than 3. Vol. The inevitable result of inefficient investment was a fall in corporate profits. and there is collateral. However. legal and other barriers prevented the exit of financially nonviable firms. and the pursuit of growth through excessive diversification and inefficient investment.1 percent in 1996. without strictly evaluating the creditworthiness of businesses and the profitability of projects. the NPL ratio of commercial banks increased rapidly from 4. Moreover. regardless of whether it is caused by large personal holdings of the controlling shareholder or by pyramiding. and there is no collateral. decelerated from March 1998. Financial Sector Vulnerability Because of financial losses in the corporate sector. 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.
769 9.107 6.855 6.553 3. Source: Bank of Korea.027 Manufacturing 1. and Taipei. As a result they had largely overvalued currencies.250 2. the ratio reached 7-8 percent.33).457 2.4 Shortcomings in Macroeconomic Policy The macroeconomic framework also contributed to the crisis in 1997.544 2. This speculation was said to be one of the causes of the financial crisis in Korea.637 6.657 3. low efficiency.Chapter 2: Korea 137 Table 2.850 3.159 10. European countries.114 811 706 696 866 1.386 5. those of domestic banks were lower in the 1990s. In 1990-1993.210 1. and declined to 4-6 percent in 1994-1996 (Table 2.259 2.135 1.673 Construction 380 354 242 195 294 585 1.589 171. 2. Exchange rates were virtually pegged to the US dollar in all troubled Asian countries. ROEs and ROAs of Korean and Japanese banks were low compared with those of the US. and large government-directed loans.265 6. Compared to ROAs and ROEs of domestic branches of foreign banks.5. authorities were not too concerned about the high NPL ratios at Korean banks in 1997 simply because the high and rising ratios had precedents.992 11.754 3.69 20. Policymakers thought that economic growth would resolve the NPL problem without the need for corrective action. and continuous and large current account deficits.244 3.856 7.985 Services 3. This was mainly due to the high ratios of NPLs.502 11.647 8.890 4.472 2.China.238 4.255 13.32 Number of Firms with Dishonored Checks.759 6.751 1. The current account deficits in terms .573 3.859 3.133 3.053 5. Meanwhile.517 2. The difference between the Korean and Western definitions of NPLs left foreign investors with suspicions that the size of NPLs in Korea might be much larger than the government-announced magnitude. 1986-1998 Year 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 Total 4.979 8.417 Others 152 132 108 97 88 161 326 252 274 302 553 861 952 Note: 1998 figures cover only January-September.131 1.
6 Fixed loans are those requiring collateral and for which interest is not received for six months or longer. even in times of economic slowdown. Businesses served as a social safety net. Thailand -8. The main result of the rigid labor market was a “high-cost and lowefficiency” economy.310 6.736 8. which led to large corporate losses.739 241.390 12. It was estimated that the Korean won was overvalued by 20 to 30 percent from 1989 to 1997.584 Fixed (A)a 5.705 160.997 9. and Indonesia -3. the ratio of short-term debt to foreign reserves was very high. .8 5.832 337.1 7.649 375. Mass layoffs became legally possible only after the economic crisis. and 30 percent in 1996.1 percent (1995).8 percent (1996).0 7. Land prices and real estate rents were also high compared to trading partners. judging from the real effective exchange rate indexes using unit labor cost indexes as a deflator and 1985 as a base year.6 percent (1995).China.4 5. because of the rigid labor market.6 percent (1995).639 1.077 NPL Ratio (%) 8.2 4.600 10. In addition to the overvaluation of the won.170 1.484 11.1 6. although per capita income in Korea was much lower.475 143.954 9.266 10.520 194. Source: Bank of Korea.160 11.556 118. Related to this.537 10.0 8.827 289.910 1.929 11.138 Corporate Governance and Finance in East Asia.176 7.430 12.221 8. The pegged currency also encouraged foreign borrowing as investors believed that the exchange rate would remain stable. of percentage of GDP were as follows: Malaysia -8.0 7.192 Doubtful (B)b 952 1. Vol. Meanwhile large businesses could not legally lay off workers.874 22. Korea -4. In 1997. the terms of trade deteriorated 12 percent in 1996 and 11 percent in 1997. II Table 2. 1990-1998 (W billion) Year 1990 1991 1992 1993 1994 1995 1996 1997 1998 a Total Loans 90.33 Nonperforming Loans of General Banks.652 29.116 1.190 9.China.562 18. Real interest rates in Korea had been two to three times higher than those of Japan or Taipei. the hourly wage rate in the Korean manufacturing sector was higher than in Singapore or Taipei.584 2. b Doubtful loans are collateral-free loans for which interest is not received for six months or longer.237 Estimated Loss (C) 958 920 840 816 213 385 490 490 648 NPL (A+B+C) 7.
Measures have been taken by several chaebols to streamline operations and improve incentives of managers and employees. A guideline informally promulgated by FSC required the 30 largest chaebols to lower their DER of 412. ‘Voluntary’ Restructuring Chaebols have been under pressure from the Government to abolish their informal group headquarters to increase the managerial independence of member firms. 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.6. They have been pressured to stop such practices as providing loan guarantees. Other firms experiencing financial distress were subjected to workout procedures through negotiations between debtors and creditor institutions. had been forced into bankruptcy proceedings or merged into healthier entities.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.Chapter 2: Korea 139 2.6 2. including banks. embarked on their own restructuring programs and/or implemented restructuring demands of the creditor banks. which were laden with huge amounts of debt and were on the verge of bankruptcy. the immediate objective centered on restoring the international investment community’s confidence in the Korean economy. However. although efforts to lay off thousands of blue-collar employees at Hyundai Motors encountered fierce opposition from labor and ended up in mediation after intervention by politicians from the ruling coalition.6 percent as of the end of June 1998 to no more than 200 percent by the end of 1999. Downsizing by curtailing employment has been prevalent. To achieve this. . and subsidizing money-losing units. Ailing banks needed to be recapitalized after the huge amount of NPLs was disposed. The FSC—later called the Financial Supervisory Service (FSS)— which is in charge of prudential regulation of financial institutions. Corporations. Nonviable firms and financial institutions. the excessive amount of debt of Korean corporations had to be reduced to a sustainable level. has been actively utilizing its influence to motivate institutions to coordinate debtor firms’ restructuring activities.
Noticing this disincentive. Locally.138 by the end of October. The data also show that about 24 percent of acquisition negotiations ended up in actual deals. 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 and other creditors were reluctant to absorb losses realized by debt compositions. or to agree on debt-equity swaps demanded by potential purchasers as a precondition for the deal.045 in October. FSC directed banks to appraise the long-term viability of client firms showing symptoms of failure. Banks did not have the incentive to force financially nonviable firms to liquidate. In many cases. II Divestitures to raise cash for debt reduction and to focus on core businesses have not proved to be easy. 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 1998.140 Corporate Governance and Finance in East Asia. they were reluctant to allow recontracting for fear of further deterioration in the capital adequacy ratio. The reasons are manifold. Vol. In their first review. It was frequently observed that the negotiating parties could not agree on a price due to large discrepancies in valuation. More than 59 percent of potential buyers were foreign firms. Internationally. Korean firms have been slowly stepping up their restructuring since the latter half of 1998 as the economy began to show signs of recovery. This number was at 779 firms in April and grew to 1. while only 14 percent of the negotiations were completed from the beginning of the crisis up to April 1998. Involuntary Exits The Government has been involved in the restructuring process mainly through its supervisory capacity over banks. On the other hand.281 in April to 2. More important. because liquidation of debtor firms would exacerbate the banks’ already weak balance sheets. the number of potential sellers decreased somewhat from 2. potential foreign buyers waited for the price of acquisition targets to come down further. 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. 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 .
The creditor banks and the advisory groups also drafted such plans for the top 6-64 chaebols. the results thus far have not entirely been as desired. workouts are being applied to non-chaebol firms identified as financially weak. Also. By the end of 1998. 24 were liquidated. creditor banks completed evaluation of the financial status of 35 subsidiaries belonging to 13 chaebols. 11 were merged into other group members. Upon completion of the evaluation. More than 200 financial institutions signed the Corporate Restructuring Agreement to carry out corporate workouts with the top 6-64 chaebols. Among the sell-offs. A portion of the Technical Assistance Loan of $33 million. three filed for courtsupervised bankruptcy reorganization. Among the 55 firms selected. and 12 were sold off to other firms. provided by the World Bank. Based on these plans. two were acquired by newly organized employee stock ownership plans. but viable. Although the intention of the Government and the banks was to effect immediate liquidation of these selected firms. These chaebols submitted plans for restructuring to improve their respective capital structures. The plans were put into action immediately following finalization. The workout plans were completed for most firms by early 1999. by their creditors. was allocated to the six largest banks for them to employ outside experts as advisors. . 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. interest reductions. write-offs. FSC has been monitoring the processes from a prudential regulation standpoint. Corporate Workouts Workouts in the forms of debt rescheduling.Chapter 2: Korea 141 banks selected 55 firms as targets for exit. Negotiations were then held between the chaebols and the creditors’ councils to finalize the financial structure improvement plans. and 16 non-chaebol corporations that had been selected as possible workout candidates. not only for the design of corporate workout programs but also their implementation. These included 20 firms from the top five chaebols and 32 from the top 6-30 chaebols. the creditor banks drafted their own restructuring plans with assistance from outside advisory groups led by foreign investment banks. 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.
uncertainty over the future . inducement of foreign direct investments was considered to be the most effective means of achieving that end. Big deals have been elevated to the status of the most important means of effective corporate restructuring. This figure contrasts sharply with the total of $700 million for all of 1997. it is hoped. The less than satisfactory state of foreign capital infusion in the early days stems from a number of factors. aircraft. On 3 September 1998.5 billion on agreement basis during the 10-month period after December 1997. railroad cars. Restrictions on foreign ownership of land were also abolished. power plant facilities. First. chaebols did announce their agreements on big deals in seven industries excluding the automobile industry. vessel engines. the foreign buyer demanded specific protections against adverse developments in the business environment. the Government has been urging the largest chaebols to strike “big deals” or business swaps among themselves to consolidate overlapping manufacturing facilities. As of April 1999. and equity participation—reached about $8. These deals could eliminate excess capacity in such industries as semiconductors. II creditor banks and the corporations will devise detailed workout programs based on the rehabilitation plans submitted by the corporations. oil refineries. However. Big deals would. automobiles. Foreign Acquisitions Confidence in the Korean economy depends critically on the lowering of the level of corporate debt. In one case. labor union demands of the seller were not acceptable to the transacting parties. Thus. Big Deals Ever since the outbreak of the economic crisis. and petrochemicals. Korea adopted and implemented policies to open its capital market completely. Foreign investment—in the form of acquisition of controlling interests. Vol. enable chaebols to streamline their overly diversified operations and focus on several core business areas. purchase of divested assets. Hyundai Motor Corporation won the international auction of Kia Motors in its third bidding and Daewoo Motors agreed to acquire Samsung Motors. some of the acquisition agreements have been discarded for various reasons. most of the big deals have entered their final stages of negotiation. In the case of automobiles. In the early days after the outbreak of the crisis.142 Corporate Governance and Finance in East Asia. In another.
Fifth.6. Second. many of the businesses that Korean firms put on sale did not prove to be attractive to foreign firms. 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. foreign buyers usually employed discounted cash flow methods of valuation while local sellers often put greater emphasis on replacement costs of assets. Not only does this represent progress in terms of an improved institutional framework for market competition. With this in mind.Chapter 2: Korea 143 course of the Korean economy remains high. In effect. 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. local creditor banks were reluctant to absorb losses arising from debt compositions and debt-equity swaps that were necessary in deals involving insolvent sellers. Third.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. but it also has important implications with respect to corporate workouts. Overhaul of Bankruptcy Procedures In February 1998. the improved procedures stipulated in the Bankruptcy Reorganization Act and the Composition Act reduced what had previously been legalistic exit barriers. some of the potential acquirers demanded terms that were unreasonable or unacceptable from the sellers’ point of view. As set forth in the agreement. 2. (iii) to reduce financial leverage. The presence of . Fourth. foreign buyers were concerned with the inflexibility of the labor market. the Government and chaebols reached an agreement on the goals of restructuring and reform efforts. and (v) to improve the accountability of controlling shareholders and the board. 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. (ii) to remove cross-guarantees of loans among group members. Sixth. (iv) to focus on a small number of core businesses. these goals were: (i) to enhance managerial transparency.
number of creditors. the changes in the institutional setting for corporate reorganization will enable creditors and debtors to promptly respond to the development of financial problems. a “Management Committee.01 percent in May 1998. Korea’s Economic Progress Report. (v) all listed companies are required to appoint outside directors beginning 1998 9 This and the following two subsections draw on the Ministry of Finance and Economy. The changes in the reorganization procedures can be summarized as follows. etc. Vol. and economics professions should be organized to provide for expeditious proceedings in court. (iv) restrictions on institutional investors’ voting rights were eliminated in June 1998. First. Fourth. the new rules made it clear that a court receivership order is available only when the going concern value of the firm under consideration is greater than its liquidation value. The purpose of this rule is to shorten the reorganization planning period. the right to revoke court receivership is allowed to the creditors. In the past this stage usually extended for as long as two to three years. The creditors can form a “Creditors Committee” among themselves to allow them to participate in the decision processes in court. accounting. 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. II an expeditious exit scheme is expected to better induce negotiation for workouts between creditor banks and corporations. Also. (ii) legal changes have been made so that domestic accounting practices conform to international standards. 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 court can refuse to accept the application for composition if it finds it inappropriate considering the size of corporate assets.” comprised of experts in the legal. October 1998. Fifth. thereby preventing abuses by controlling shareholders/managers of financially distressed firms. . the maximum grace period on loans to the firm being reorganized was shortened to 10 from 20 years. the Composition Act was amended to narrow the eligibility of applying for court-supervised composition. Also. (iii) the representation requirement for shareholder derivative suits was drastically relaxed from 1 percent to 0. the court may annul its previous decision and force the firm into immediate liquidation. Second. Third.144 Corporate Governance and Finance in East Asia.
514 listed companies had appointed 677 outside directors). administrative procedures for FDI will be dramatically simplified and made transparent. which was passed in August 1998. Foreigners are now able to invest in local bonds and short-term money market instruments without any restrictions. an additional nine industries will be opened or further liberalized. (vi) bankruptcy laws were revised in February 1998 to facilitate the exit of insolvent firms.148 industries remain closed.Chapter 2: Korea 145 (as of the end of May 1998. have been instituted for FDI: . Measures for improving standards in corporate governance are already effecting a generally more open corporate culture and greater transparency in business practices. the Korea Trade and Investment Agency (KOTRA) will provide a one-stop service with respect to FDI. 21 industries were further liberalized or newly opened to FDI (now. In addition. either partially or fully. beginning on 1 April 1999. (v) by the end of May 1999. only 31 out of 1. According to the law. (iii) hostile mergers and acquisitions by foreigners were fully liberalized in May 1998. (iv) during April and May 1998. These new standards are and will continue to be strictly enforced. Capital Market Liberalization Since 1998. and (viii) as of 1 April 1998. (ii) full liberalization of foreign exchange transactions was legislated and will be put into effect in two stages. to FDI). (vii) by the end of March 1998. including tax exemptions and reductions. As for promotion. crossdebt guarantees totaling about W10 trillion—about 30 percent of the total guarantees among the 30 largest chaebols—were dissolved. financial institutions could no longer require cross-debt guarantees. 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. Existing cross-debt guarantees should be completely eliminated by the end of March 2000. various supporting measures. Foreign Investment Promotion Act The Foreign Investment Promotion Act was put into effect in November 1998. including financial subsidization. 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. 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.
Three-year government bonds will be used to establish a benchmark. Low cost rental facility: National and public real properties will be rented to foreign-invested firms for up to 50 years. Also. Various support measures. are not risk-free. Capital Market Augmentation Bond Market The Government recently introduced a policy plan to deepen Korea’s bond market. The primary aims of the law are the liberalization of the capital account and the development of the foreign exchange market. the Government intends to supplement these measures with a sound macroeconomic policy in order to secure more effective protection against systemic risks. These liberalization measures. will be provided to foreign firms in the FIZ. The law allows rental cost exemptions and reductions for FDI. the Korean Government is strengthening prudent regulations and market monitoring. 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. however. including infrastructure and tax support. Liberalization of Foreign Exchange Transactions In September 1998 the Foreign Exchange Management Act was replaced by the Foreign Exchange Transaction Act. II (i) (ii) (iii) Tax exemption and reduction: Corporate and income taxes will be exempted or reduced for FDI in target industries. It aims to establish a benchmark by consolidating various government bonds. Free Investment Zone (FIZ): A free investment zone will be developed to accommodate large-scale FDI.146 Corporate Governance and Finance in East Asia. for 10 years (full exemption for the first seven years and 50 percent tax reduction for the remaining three years). The location of the FIZ will be determined at the request of foreign investors. Vol. To minimize potential risks. These bonds will be issued . The majority of government bonds to be issued in the next two to three years will carry a maturity of three years. such as the high-tech industry.
a primary dealers system will be introduced for healthy financial institutions. Moody’s signed a joint venture contract with Korea Investors Service. The Government established specific qualification criteria and selected the primary dealers in 1999.6 trillion for the debt restructuring fund. Prior to the introduction of this system.6 trillion in these funds: W0. As a pilot program. invested a total of W1. Related legislation was put into effect in September 1998. both domestic and foreign. the Government will correspondingly expand the issuance of government bonds that have a maturity of five years or more. 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. To ensure transparency and efficiency of the fund operations. but may be extended as required. These are expected to operate for the next three years. No qualification requirements are being imposed on investors who are sponsoring new mutual funds. a debt restructuring fund and three balanced funds (funds that invest in both equity and debt) were established in September 1998. Mutual funds (or open-end investment companies) will be allowed starting 2001. including the Korea Development Bank. and W1 trillion divided equally between the three balanced funds. It also opened the credit rating service market to foreign competition. but it will also help improve financial institutions’ risk management. In August 1998. commercial banks were allowed to carry out dealing operations for government bonds starting in October 1998. Asset-Backed Securities A new law providing for asset-backed securities (ABS) was passed in September 1998. Twenty-five domestic financial institutions. and the demand for longerterm bonds increases in the future. In order to promote a greater market demand for government bonds. to establish closed-end investment companies. financial institutions . with only minor standard exceptions. and is promoting joint ventures between foreign and domestic agencies. It is now easy for private investors. they will be managed by foreign investment management companies.Chapter 2: Korea 147 monthly. According to the law. This law will not only provide an effective institutional environment for the disposal of NPLs. If interest rates stabilize at a low level.
Selfdealings. this regulation may not be effective in curtailing pyramidal structures.148 Corporate Governance and Finance in East Asia. then the regulation will inhibit efficient investment of firms. considering that there is no other effective way to limit circular investments among chaebol affiliates (e. greater efforts to improve corporate governance are preferable to regulation of interfirm investment. A good governance system is essential for the healthy growth of corporations and financial institutions. such as the Korea Asset Management Corporation (KAMCO). A investing in B. can utilize ABS. On the other hand. There must be stronger rules to control agency problems. It would be more desirable for the market-oriented measures to be put into place and strictly enforced. However. unless the limit is tight and binding.g. B investing in C. As markets become more efficient. 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. foreign business corporations with good credit standing are now also permitted to issue ABS. One way of strengthening independence of the boards is to require that listed companies accept nominations for directors by institutional . as stipulated by the government measure.) and the level of interfirm investments is very high. is inevitable. the government intervention will have to be refocused so that it only sets the rules of the game in the marketplace. when the limit is binding. In principle. More important. Direct controls of interfirm investments and/or pyramidal ownership structures will not be persuasive. which is the case for many chaebols. However. Vol. Policies aiming to improve the corporate governance system should take into account the high ownership concentration often created by pyramiding. this can only be a temporary measure. cross-subsidization. and C investing in D.. For instance.3 Policy Recommendations Poorly performing markets and the resulting lack of market discipline justified the government intervention in recent corporate and financial restructuring activities. 2. II and qualified public corporations. However. the role of the board of directors as the internal control mechanism must loom large in corporate governance. 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.6. The corporate governance structure cannot be expected to function efficiently if this issue is not addressed. etc. there is another view that placing a maximum limit on interfirm investments.
10 Other means to improve independence of the boards include mandating that independent outside directors form the majority. Listing rules may recommend that all or large listed companies adopt an audit committee. . 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. The Securities and Exchange Act will then require large listed companies to switch to a board audit committee system from an internal auditor system. 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. If and when the law is introduced. and other committees. Each listed firm should be required to disclose the extent of its compliance with the Code in its annual report. The Corporate Board. Class action suits are an efficient means for corporate monitoring. 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. governance. 1997). and requiring that all directors hold shares of their companies. Proposed: A Governance Monitor. The Government can prompt institutional investors to contribute more to good corporate governance by paying greater attention to corporate affairs. 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. and also negligence of external (independent) auditors actionable. 1997. various measures have been implemented to promote investors’ rights. Institutional investors will play an increasingly important role in corporate governance. 23-26. Since the economic crisis. it will have to include making self-dealings by directors and officers.Chapter 2: Korea 149 investors or their trade associations. using audit. the Korea Stock Exchange could incorporate provisions of the Code of Best Practice in Corporate Governance in its listing rules. thereby helping to strengthen board independence and enlisting boards’ more active involvement in monitoring corporate management. The annual shareholders meetings could also elect reputable “monitoring companies” to recommend director candidates (Latham. September/ October 1997. More effective measures to protect investors will enhance corporate transparency and also the accountability of directors to shareholders. Latham. pp. Further. One way of motivating institutions to do this is to 10 M.
These guidelines would recommend shareholder activism and faithful discharge of fiduciary duties by actively participating in shareholder voting. etc. In the coming years. by all nonfinancial companies (or “industrial capital”). Vol. such as the Korea Investment Trust Association. an audit committee.150 Corporate Governance and Finance in East Asia. possibly. and thus cannot be expected to be actively involved in monitoring portfolio firms. more drastic in nature. the Government will have to come up with appropriate policy measures to solve these problems. securities companies. II provide comprehensive guidelines for their actions in matters related to corporate governance. The Government can also lower the limits on investments in affiliated companies. Rights of minority shareholders should also be strengthened for these institutions. Shareholdings concentrated in investment companies and other institutional investors pose a serious dilemma. Application of more stringent bankruptcy-related rules to firms in financial distress will effect greater discipline over corporate management. is to restrict ownership of investment trust companies and NBFIs by the five largest chaebols and. could prepare such guidelines. and compliance officers. Also. The Government recently proposed the revision of bankruptcy-related laws. strengthening incentive compensation schemes for executives. 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. insurance companies. 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. objecting to certain defensive measures proposed by the management. and other NBFIs are subsidiaries of chaebols— especially the five largest ones. reviewing independence and expertise of candidates for outside directors. Another measure. The institutions’ respective trade associations. 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. Measures that are being implemented or introduced will require that the management of institutional investors be closely monitored by a board consisting of a majority of independent outside directors. . strengthen its supervisory activities. Many of the larger investment trust companies. 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. and impose stronger penalties on violations of the rules on portfolio investments.
therefore are vulnerable to economic shocks. The Government needs to sell off at the earliest feasible dates the bank shares that it acquired in the course of recapitalizing banks. excessively diversified into nonrelated business areas. and (iii) a good corporate governance system to protect investors. to concentrate instead on a small number of core businesses. and financial institutions. This means that the Government can control the banks and. through them. (ii) provision of reliable accounting information. large firms. In order to minimize government intervention in bank and corporate management.Chapter 2: Korea 151 There still exist widespread concerns that the Government will continue to exercise a great deal of discretionary power over banks. bank managers should be made accountable to shareholders but not to the Government. Bank boards also need to be made more independent from management. Chaebols are overly indebted. and introducing disincentive schemes for excessive borrowings. Such measures include providing an effective corporate governance system. and thus full-scale education programs should be developed. In turn. The public and corporations should be taught or fully informed of the best practices in corporate governance. reduction of protection of domestic markets and entry barriers. lessening the degree of double taxation of dividends (or further reducing personal income taxes on dividends). Many concepts regarding good corporate governance are still new to a lot of market players in Korea. Banks need to play a bigger role than they do at present in monitoring corporate investment and management. Banks should adopt strong incentive compensation schemes for management. and stop unfair internal transactions. the elimination of implicit guarantees for financial support to chaebols. The current obligatory system of disclosure that emphasizes “hard” . private firms. An effective policy package is needed for chaebols to dispose of marginal firms with low profitability at the earliest date. and consistently show low profit rates. The Government should put more efforts into developing the capital market. For this. 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. the banks have great leverage over the management of debtor firms. To facilitate the development of the Korean stock market. The Government should substantially reduce the proportion of policy loans from bank loans. the important issues to be addressed are: (i) improvement of the corporate disclosure system. Many corporations are burdened with excessive debt and. which could provide alternative sources of long-term corporate finance. such as application of higher interest rates by banks to chaebols with higher DERs.
no economic reforms will be effective. The development of the OTC bond market requires a well-developed dealer system. data on quotations and trading volumes. More effective punitive means need to be devised to penalize both corporations in violation of disclosure rules and the officers in charge. . and measures to reduce corruption. the information system of the bond market should be better organized to transmit. is considered to be one of the major causes of the economic crisis. The function of securities companies as dealers of bonds should be improved. Policies are needed to help develop more reliable services by bond rating agencies. Maintaining current account surpluses for a considerable period is needed to pay back foreign debts. and bureaucrats. Currently. The establishment of a Corruption Prevention Institute will be helpful in this regard. Vol. politicians. 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. Future research could include causes of corruption. reasons for different degrees of corruption in various countries. Without successfully addressing this problem. These should be lengthened to make them a source of stable long-term funds. especially among business people. Overvaluation of exchange rates should be avoided in order for export and import-substitution industries to stay internationally competitive. The network should cover not only the exchange market but also OTC transactions of investors and dealers. wage rates. Prevalent corruption. In determining optimal exchange rates. Another problem with the corporate bond market is that most bonds are issued with maturities of less than four years. profitability of export industries and real effective exchange rates that account for changes in nominal exchange rates. At the same time. and labor productivity should be considered. II information on past performance needs to be transformed into a system in which corporations voluntarily announce “soft” information on future prospects.152 Corporate Governance and Finance in East Asia. on a real time basis. penalties on violations of disclosure rules are not effective enough to have a significant impact.
7995. Bank of Korea. Lee. 1994. H. 1992. Evolutionary Chaebol. 1998. S. 1997. September 1998. Korea Economic Research Institute. Chon. W. C.. Chung. Financial Studies. Korea Economic Research Institute. Bank of Korea. Tomio. New York: Praeger. H. N. Financial Statement Analysis Yearbook. T. W. various issues. various issues. Korea’s Chaebol. Choi. pp. Bank of Korea. Cho. Kim. Understanding Flow of Fund Accounts. 79-95. Lee. Jae Woo. Hattori. September 1997. Korea’s Large Conglomerates.). . Hong Moon Sa. M. Bibong Publishing Co. pp. edited by K. Korean Managerial Dynamics.Chapter 2: Korea 153 References Bank of Korea. C. Jua. Survey of Facility Investment Plan. H. Ju Hyun. The Corporate Board. Economic Statistics Yearbook. Lee. H. 1989. W. 1997. K. September/October 1997. 1995. International Financial Statistics. Kim. various issues. Chon. KERI. Lee (eds. and 1998 issues. 1993. Corporate Restructuring. H. Latham. 1999. S. Kim. A Study on the Relationship between Ownership Structure of a Firm and Value of a Firm. Proposed: A Governance Monitor. Kwon. C. Financial Studies. Kang. in Korean Managerial Dynamics. KERI. 1996. International Monetary Fund. W. Y. and K. S. pp. D. K. and J. various issues. Korea’s Financial System. Center for Free Enterprise. 1995. Determinants of Diversification of Korean Business Groups. 1996. Market Concentration and Diversification of Business Groups. KERI. September 1998. New York: Praeger. Is the Fair Trade Policy Fair? Korea Economic Research Institute.. and H. S. I. An Empirical Evidence on Value of a Firm and Ownership Structure.. Japanese Zaibatsu and Korean Chaebols. I. Maeil Daily Economic Newspapers. S. Hong. Korea Development Bank. 1997. Chung and H. 1996. 1998. 1989. Cho. S. 23-26. D. 1997.
Conference on Corporate Governance in Asia: A Comparative Perspective. Beyond the Limit. Ungki. 1998.. Korea’s Economic Progress Report. U.154 Corporate Governance and Finance in East Asia. 1998. 1996. KIET Occasional Paper No. Management Research Institute. H. Ungki. Korea Institute for International Economic Policy. Business Groups in Korea: Characteristics and Government Policy.. 1995. Korea Institute for International Economics and Trade. Background and Task of Structural Adjustment. Kim. Korea Development Institute and World Bank. C. Seoul. Korea’s Trade and Industrial Policies: 1948-1998. I. S. Yonsei University. November 1996. Chung Ang University. . II Lee. Chicago. January 1995. Lim. 1999. Ministry of Finance and Economy. J. Sohn. The Ownership Structure and Family Control in Korean Conglomerates: With Cases of the 30 Largest Chaebols. J. Joh. October 1998. K. Yang. October 1998. Lee. and J. K. Corporate Governance in Korea. KIEP Working Paper 98-05. Lee. The Pattern of Ownership Structure and their Characteristics in Korean Conglomerates: With Cases of the 30 Largest Chaebols. J. 1999. March 1999. K. S. C.. S. 1998. Kim. 1998. H. and H. Nam. September 1998. I. Yim. Lim. 23. Y. Wang. Y. Whan. Y. Annual Conference of Financial Management Association. 2nd Sangnam Forum. Whang. W. and J. 1996. Kang. S. Capital Liberalization. Korea Institute for Industrial Economics and Trade. A New Trade and Industrial Policy in the Globalization of Korea. Korea Finance Institute. Vol. Real Exchange Rate and Policy Measures.
The Asian financial crisis revealed that. staff. The author wishes to thank Juzhong Zhuang. Pineda. When the Asian crisis erupted in 1997. Denise B. overall. and Lea Sumulong and Graham Dwyer for their editorial assistance. after the completion of debt negotiations with the IMF and Paris Club. Roble. and Liza V. The lifting of the debt moratorium in 1991. both of ADB. 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). and government subsidies were tackled during that period.3 The Philippines Cesar G. for their research assistance. 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. 1 Principal. . state-sanctioned monopolies. Serrana. PSR Consulting. From 1993 to 1996. the Philippine nonfinancial corporate sector had managed its borrowing risks relatively well by largely avoiding imprudent use of debts and risky investments. David Edwards. aiming at eventually limiting the Government’s role to economic policy setting and allowing the private sector to conduct most economic activity. about a decade before the recent Asian crisis. Companies of other Asian countries were already using these markets to finance investment and growth. Issues such as State ownership of businesses.. the Philippines. the Philippine economy and corporate sector were in a relatively sound financial position. in particular Francisco C. This has come about following a political and economic upheaval from 1983 to 1987.1 Introduction In recent years. and David Webb of the London School of Economics for their guidance and supervision in conducting the study. Inc. the Philippine Stock Exchange for its help and support in conducting company surveys. the PSR Consulting. Saldaña1 3. allowed the Government and the corporate sector to gradually access foreign debt markets after a long absence. the Philippine corporate sector has played a leading role in the government’s efforts to get the country on track toward sustainable economic development. Inc.
An industrial elite. yet they did not risk new capital required for modernizing and expanding manufacturing capacity. Companies finance long-term investments with short-term debt. Sugar refining and textile mills are examples of industries that floundered in the 1980s because of government import substitution policies. emerged to influence industrial policies. Companies were profitable because of protection from foreign competition. These early industrialists naturally opposed any initiative to reduce tariffs. Government interventions under the notion of “master planning” for economic and social development characterized the 1970s and early 1980s. The policy was crafted by the martial law regime at that time. usually with the acquiescence of bank creditors. which leads to their easing of due diligence and monitoring standards when lending to group members. companies were necessarily large and capital-intensive. therefore. and on the financial crisis. on family-based and controlled conglomerates. Vol.2 3. nationalist sentiments led to policies that favored import substitution and heavy government intervention in business. control by internal and external governance agents. and responses to the financial crisis.2. It analyzes the impact of corporate governance on company financial performance and financing. 3. Investments of large corporate groups tend to focus on obtaining market shares and industry dominance. 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. While new manufacturing industries were successfully established. composed mostly of families previously in trading businesses. patterns of ownership. But protectionist policies made labor relatively more expensive and. the corporate sector showed structural weaknesses similar to those in neighboring Asian countries. their growth could not be sustained. patterns of financing. This study reviews the Philippine corporate sector in terms of its historical development. Corporate financing relies excessively on bank loans. The Board of Investments (BOI) was created to draw up an investment priorities .156 Corporate Governance and Finance in East Asia. Banks have significant presence as members of affiliated business groups. II Still. To implement these policies. regulatory framework.
The FIA allowed foreign equity investment in many areas and at the same time provided a transparent. and oriented toward exports. the top three companies accounted for a disproportionately large share of total sales and assets. Reforms in policies. Quantitative restrictions and tariff protection of preferred industries remained firmly in place. dominance by large companies. In 1991. The 1980s were marked by a peaceful transition of political power. made less associated with capital investments. Nevertheless. quantitative restrictions.e. 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 .. In the early 1990s. Exports were not competitive because of the high costs of imported materials. Starting in 1981. It limited the bureaucratic cost and discretion that accompanied the necessary approvals of foreign investments.” No strategic industry could take off without the Government’s participation in its management and operations. including the reduction of tariffs. i. clearly shifted economic management toward reliance on markets rather than on decisions by bureaucrats in the Government. Following government initiatives in the control of the infrastructure and utilities sectors. the Government continuously revised the enabling law of BOI so that incentives were reduced in number. Foreign ownership was allowed only in industries with high technological and market barriers. organizing industries into sectors and picking “winners. the “pioneer” industries identified in the IPP. and import licensing requirements.Chapter 3: Philippines 157 plan (IPP) to encourage private sector investments by offering tax and other incentives. advance notice of areas where the country disallowed or restricted foreign investment. and orientation toward domestic markets. the Government narrowed the range of tariff rates by commodity categories and reduced the average tariff rate from 28 to 20 percent. the State took over the generation and distribution of electricity. the legislative body passed the Foreign Investment Act (FIA). Probably the most significant effects of tariff protection and biases for capital intensity were the corporate sector’s high degree of concentration. and initiated the development of alternative energy sources in response to the oil crises. In many industries. The Government signaled through the IPP its intent to shape the future industrial landscape. BOI incentives retained a strong bias in favor of capital-intensive enterprises and domestic-oriented industries. assumed ownership of the largest petroleum refining company. Better access to cheaper imported raw materials improved the competitiveness of local manufacturers.
6 7.7 8.3 9.2 Growth and Financial Performance Performance of All Companies The analysis of corporate performance in this section used financial data from the Securities and Exchange Commission (SEC)-BusinessWorld Annual Survey of Top 1.2 9.000 corporations.1 5.0 (6.2) 4.7) 10. Its growth rate began to catch up with others in 1996.2 Source: ADB. 1990-1999 (percent) Year 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 Indonesia 9. II market.2 8. The Philippines substantially lagged behind other countries from 1990 to 1995 (Table 3.4 4.158 Corporate Governance and Finance in East Asia.5 9.0 8.2 7. Key Indicators of Developing Asian and Pacific Countries 2000. Vol.1 8.2. Table 3.1 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.8 percent growth in fixed 2 The SEC-BusinessWorld Annual Survey of the Top 1.5 8.8 5.8 8.2 Thailand 11.2 7. This rate of growth was sustained by a comparable 18.9 (1.5) 5. .000 Philippine companies grew 17.8 8.2 (0.7 5.2 During 1988-1997.0 8. which was taken as a representation of the Philippine corporate sector.7 Malaysia 9. net sales of the top 1. only to be unsettled by the crisis of 1997. competition from liberalized imports had somewhat reduced oligopolistic tendencies and concentration in many industries.3 9.2) 0.0 7.8 10.3 2. 3.9 5. In this section.1 GDP Growth of Southeast Asian Countries.6) 0.5 8.000 Corporations covers financial and nonfinancial companies.1).7) (10.0 (0.5 (7. Rep. however.7 (13.4 Philippines 3.5) 3.2). of 9.3 7.3 8.5 percent per year (Table 3.1 4.9 6. only nonfinancial companies were used.9 7.2 Korea. With economic reforms introduced in the 1980s and 1990s.8 5.8 4.
2 900.2 Growth and Financial Performance of the Top 1.7 1.177.4 1.3 306.6 18. return on equity (ROE) = net income/ stockholders’ equity.5 14.8 6.4 3.1 4.1 5.3 107 13.6 426. return on assets (ROA) = net income/total assets.7 218.697.3 121 12.7 28.Table 3.1 72.2 1.7 903 0.131.7 20.781.4 776. Source: SEC-BusinessWorld Annual Survey of Top 1.000 Companies.6 290.5 64.2 136.8 77 7.512.978.3 382.3 941.6 896 0.1 1.8 4.9 2. .2 338.6 35.5 1.191.5 4.1 95.6 1990 1991 1992 1993 1994 1995 1996 1997 1.0 148.123.5 Leverage = total liabilities/stockholders’ equity.9 96.2 Average 146 12.6 149 12.1 73 5.3 898 1.9 149 6.2 2.3 46.2 2.000 Corporations in the Philippines.0 1.9 1.317.2 27.6 1.8 902 1.1 615.9 3.4 898 1.5 508.6 5.7 443.9 952.8 5.209.2 378.6 144.4 555.6 102 16.0 1.1 33.5 887 0.6 75 6.647.1 1.4 188.5 1.394.9 617.1 181 11.5 192.4 861. 1988-1997 1989 519.9 480.5 193.8 26. of Companies Sales per Company (P billion) 899 0.8 741.0 900 1.6 109 12.7 238.8 411.3 862.1 51. net profit margin = net income/net sales.9 78 6.6 954.2 Indicators 1988 Growth Indicators (P billion) Net Sales Net Income Fixed Assets Total Assets Total Liabilities Stockholders’ Equity Retained Earnings 464.4 8.9 898 1.332.1 468.1 197 14.4 602.2 4.160.4 260.8 22.561.5 1.6 900 1.4 Financial Ratios (%) Leverage ROE ROA Turnover Net Profit Margin 222 14.5 446.893.1 54 11.5 570.1 Other Indicators No.8 618.5 119 12.2 Compound Growth (%) 17.2 707.341.7 73 6.3 60 10.4 63.1 6.225.9 629.7 1.4 411.1 714.9 896 2.5 51 4.1 881.1 66 12. turnover = net sales/total assets.5 72 7.3 68 7.
Sources: ADB.000 Corporations in the Philippines. Key Indicators of Developing Asian and Pacific Countries 1999.693 1.248 1.4 24.2 percent.178 1.7 percent.8 17.000 Companies Year 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 Average Growth (%) a GDP (P billion) 799 925 1.3 percent.427 13.9 21.906 2.160 Corporate Governance and Finance in East Asia.474 1. These rates of return are high compared with other Asian countries. various years. Return on equity (ROE) and return on assets (ROA) averaged 12. Vol.000 companies averaged 7.4 20. Further.3 The Corporate Sector and Gross Domestic Product.1 Net Sales (P billion) 465 519 630 741 862 954 1. and by equity that grew at a higher average annual rate of 26.5 Value-added is assumed to be 30 percent of net sales.077 1. II assets.6 percent and 5. and the SEC-BusinessWorld Annual Survey of Top 1. .8 percent per year. respectively.8 19.1 19.5 17.5 Ratio of Estimated Value Addeda to GDP (%) 17. The debt-toequity ratio ranged from 222 percent in 1988 to 102 percent in 1994.5 16.172 2. Net profit margins for the top 1. Net income consistently increased from 1988 to 1996 and declined only in the crisis year 1997. Total assets grew at an average annual rate of 22. Asset growth was funded by debt that grew at an average of 20.394 1. The data suggest no evidence of excessive borrowing in the run-up to the crisis in 1997.352 1.979 17. This is high compared with developed countries but compares favorably with other Asian countries. indicating that the corporate sector’s exposure to foreign currency-denominated loans was not as significant as in other countries.9 percent for the period.697 1. 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. for the 10-year period.3). Assuming Table 3.9 23. The growth rates of corporate sales for the period 1988-1997 exceeded those of the country’s GDP for the same period (Table 3. 1988-1997 Top 1.
%) 17.9 22.4).3 146 6.9 158 13. of Companies 73 Sales per Company (P billion) 2.000 Corporations in the Philippines.7 2.8 ForeignOwned 21.3 27.0 4.5 23 4.4 190 5. and (iv) privately owned.1 12.9 26.6 Total Assets 29.3 22.1 Financial Ratios (%) Leverage 89 ROE 15. (ii) foreign-owned. privately owned companies constituted the largest group (Table 3.8 Growth Indicators (Compound Annual Growth Net Sales 20.9 196 1.8 2.0 Turnover 53 Net Profit Margin 15.1 22 10.0 28.4 Stockholders’ Equity 32.3 22.0 5. . various years.8 No.1 ROA 8.8 3.8 606 0. size.7 22.Chapter 3: Philippines 161 a constant ratio of value added to sales.2 9.4 Total Liabilities 26.5 27.8 percent of the corporate sector’s total sales between 1988 and 1997. corporate control structure.0 5. The premise is that these variables have a direct bearing on corporate performance and growth. and industry reveals further structural characteristics of the growth and financial performance of the corporate sector.5 Other Indicators Share of Sales (%) 17. Performance by Ownership Type The Philippine corporate sector can be categorized into four groups based on ownership: (i) publicly listed.8 14.4 Fixed Assets 19. The foreign-owned companies were the Table 3.4 28.3 42. 1988-1997 Indicators Publicly Listed Privately Owned Rate.0 Net Income 19.8 22. these figures suggest a significant and increasing contribution of the corporate sector to GDP.5 Retained Earnings 30.9 17. Averaging 42.3 9.3 11. (iii) Government-owned.0 142 22. A study of company performance by ownership type.0 31.2 103 5.5 Source: SEC-BusinessWorld Annual Survey of the Top 1.4 Growth and Financial Performance of the Corporate Sector by Ownership Type.5 GovernmentOwned 4.
Bases Conversion Development Authority.000 list. exceeding the 17. followed by publicly listed ones. Their ROA and ROE were both more than twice as high as those of government-owned companies. The compound annual sales growth rate was 21. and low return on investment is the norm. although small in number.9 percent. II second largest at about 27. reflecting the significant presence of holding companies as the gross revenues of holding companies flow through to operating income. The privately-owned companies had a high average leverage ratio of 158 percent. with an average ROE of 22. Only 84 of the 221 public companies listed on the Philippine Stock Exchange (PSE).5 percent. Publicly listed companies had the lowest leverage at 89 percent. These were mostly large public utilities. The privately-owned companies were only about one third of the average size of per company sales of the publicly listed companies. Privately-owned and Government-owned companies grew at slower rates. but lower than those of foreignowned and publicly listed companies. these companies were comparatively large. 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. meaning that the remaining 62 percent were relatively small in sales and assets. they generated the highest return on investments. while there were few of them.000 companies in 1997. were among the top 1. the highest net profit margin of 15. Publicly listed companies had a minor though steadily increasing share in total sales. and the second lowest asset turnover. 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.5 percent average growth rate of the entire corporate sector. registered the largest per company sales at about P9 billion in 1997.162 Corporate Governance and Finance in East Asia. and government-subsidized agencies such as the National Food Authority and Local Water Utilities Administration. Governmentowned companies in the top 1. selling an average of P4.75 billion per company for foreign-owned companies. the second best ROE and ROA. foreign-owned companies borrowed more than publicly listed ones.1 billion per company in 1997. a level high by Western standards but at par with those of other Asian countries. compared with P2. Vol.2 percent and ROA of 9.3 percent. or 38 percent. However. But by being most efficient in employing assets.8 percent for foreign-owned companies and 20 percent for publicly listed companies during 1988-1997. With an average leverage ratio of 142 percent. the asset base is large. .
3 Total Liabilities 30. medium.2 Net Income 21.0 55. and small companies.3 Financial Ratios (%) Leverage 98 ROE 15. 1988-1997 Indicators Group Member Independent 18.0 166 15. The independent companies contributed about 56 percent of corporate sales on average during the period 1988-1997. the corporate sector is divided into large. Performance by Firm Size By firm size.8 6.6 715 0.7 Stockholders’ Equity 34.3 Other Indicators Share in Sales (%) 32.8 ROA 8. a company can be a member of a conglomerate or independent.1 Retained Earnings 32. depending on assets and sales.3 percent for the conglomerates.0 22.2 23.7 2.1 Source: SEC-BusinessWorld Annual Survey of Top 1.0 Turnover 67 Net Profit Margin 12. Table 3. various years.2 Fixed Assets 25.000 Corporations in the Philippines.4 24.8 Growth Indicators (Compound Annual Growth Rate.5 Growth and Financial Performance of the Corporate Sector by Control Structure. of Company 159 Sales per Company (P billion) 2.0 25.3 No. compared with 32.5).7 Total Assets 32. and achieved higher returns on invested assets than independent companies (Table 3. had a lower leverage ratio. Sales and resources of the .Chapter 3: Philippines 163 Performance by Control Structure By control structure. But the conglomerates were larger measured in sales per company.1 124 5. grew faster. %) Net Sales 20.6 26.
6 47.6 36.000 Corporations in the Philippines.2 Other Indicators Share in Sales (%) 56.6 49. averaged a far less P3 billion in per company sales. sales of mediumsized companies grew faster than large companies.4 28. .9 89 1.6 Growth and Financial Performance of the Corporate Sector by Firm Size.5 Total Assets 18.7 44. Sales per company in this group averaged P13.0 730 0.5 73 6.1 percent of the total sales of the corporate sector. various years.1 81 9. Medium-sized companies. while small companies.2 25. %) Net Sales 15.000 list. defined in this study as the next 200 largest companies in the top 1.6 31. 1988-1997 Indicators Large Medium 19.000 list.2 29. indicating that they deployed resources more efficiently than large and small companies. of Companies 79 Sales per Company (P billion) 7.3 Turnover 65 Net Profit Margin 8. II Philippine corporate sector are highly concentrated among the large companies. averaging 16 percent.0 32. referring to the remaining companies in the list.4 Total Liabilities 18.9 32. although they comprised only 8.5 128 10.0 156 16.3 Source: SEC-BusinessWorld Annual Survey of Top 1.9 Retained Earnings 13.9 Financial Ratios (%) Leverage 158 ROE 13.8 percent of the total number of companies in the list (Table 3.3 Fixed Assets 15. are defined as the largest 100 companies in the top 1. Table 3. for this study.1 4.0 7.1 ROA 5. Large companies accounted for 56. averaged only P920 million in per company sales during the same year.1 No.5 12.1 25. which. However.5 Growth Indicators (Compound Annual Growth Rate. Medium-sized companies also performed better in terms of ROE.6).6 Small 19.4 billion in 1997.2 Stockholders’ Equity 18.164 Corporate Governance and Finance in East Asia.5 25.9 26.7 Net Income 1. Vol.
net income. especially during the period 1994-1996.5 percent for medium-sized companies and 8.8 the previous year. assets. compared with 9.1 billion in 1996 to P4. Leverage was the highest for large companies. Sales revenue and net income declined from P76. The sector showed consistent growth in sales. unlike their counterparts in other Asian countries. utilities. but lower than that of construction. and profitability in 1997 when the crisis started. The leverage ratio of the manufacturing sector was higher than that of the real estate and property sector. as indicated by the negative annual growth. Performance by Industry This study also looked at corporate performance by industry.8 percent. net income.and medium-sized companies did not substantially increase their leverage in years running up to the crisis in 1997.2 billion in 1997 for this sector.Chapter 3: Philippines 165 Small companies.e. Large.8 billion in . The growth and financial performance of selected industries. showed the lowest ROE. Growth of sales. at -12. at 158 percent on average during 1988-1997.7 percent a year earlier.4 percent in 1997 from 11. reflecting to some extent a “bubble” phenomena in the former two sectors. Net income declined from P54. from 14. The Asian financial crisis affected large companies most severely. Mediumsized companies’ leverage level was slightly lower. But small companies’ leverage was significantly lower.8 percent in 1997. of net income. ROE dropped to 7. specifically those industries least and most affected by the financial crisis. i. and utilities and services sectors. at 128 percent for the period. Poor returns appear to have been caused by the low profit margin at 6. are shown in Table 3.2 percent for large ones. although the largest in number.7 percent in 1996 to 8. ROE dropped from 10. and equity up to 1996. Medium-sized companies apparently enjoyed efficiencies associated with economies of scale and made more productive use of their assets.7 billion and P35. and the construction sectors than for the manufacturing..6 percent.7.7 percent in 1997 for medium-sized companies. with their ROE dropping to 3. real estate. For small companies.1 percent. The real estate and property sector also suffered significantly in sales. manufacturing. but suffered its largest decline in net profits in 1997. 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. and construction. profits. and assets was much higher for the real estate and property. at 156 percent. and utilities and services sectors. averaging 10.
Its knock-on effect on the economy was small as it accounted for less than 3 percent of the top 1.0 21.7 Indicators Manufacturing Construction 27.2 8.3 20.0 Turnover 112 24 Net Profit Margin 5. it does not appear to have been excessively exposed to foreign currency-denominated loans.7 192 9.0 25. %) Net Sales 16.2 37. the sector’s ROE dropped from 15. respectively.6 Growth Indicators (Compound Annual Growth Rate. various years.3 Fixed Assets 20.166 Corporate Governance and Finance in East Asia.9 2.6 Total Liabilities 18.3 55.6 69 16.2 12.7 10.7 19. As a result.3 5. of Company 454 17 Sales per Company (P billion) 1.8 Stockholders’ Equity 21.8 41.7 percent to 10.7 83 2. Vol.5 Other Indicators Share in Sales (%) 82.8) 17.4 3. .6 No.7 28.9 2.1 24 42.2 28 0.4 19.2 45.4 Source: SEC-BusinessWorld Annual Survey of Top 1.9 17.7 52.4 16.0 23.6 Financial Ratios (%) Leverage 142 181 ROE 13.7 Growth and Financial Performance of the Corporate Sector by Industry.9 5.7 billion in 1997.4 Total Assets 19. II Table 3.1 2.7 ROA 5.9 billion and P24.000 companies’ total sales on average during 19881997. and was also much more limited compared with the property sectors in other Asian countries.0 31 0.4 percent.8 48.9 23.000 Corporations in the Philippines.7 Net Income (12.3 Retained Earnings 17. 1988-1997 Utilities Real Estate and and Services Property 39.5 12. But the impact of the Asian crisis on the real estate and property sector was much smaller than that on the manufacturing sector. The sector’s buildup in equity during the stock market boom of 1994-1996 may have cushioned the impact of the crisis. 1996 to P56.1 10. With a modest increase in total liabilities and leverage level of less than 100 percent in 1997.
reaching up to 313 percent in 1997. (iii) principal office. (vi) names.Chapter 3: Philippines 167 The utilities sector had the second highest leverage during 19881997 at 181 percent on average. privileges. and restrictions. and recognized rules on corporate practices. (ii) purpose of the corporation. . (v) number of directors (not less than five nor more than 15). nationalities.2. the ownership of Filipino citizens in the corporation is not less than the legally required percentage of capital stock. contains some provisions affecting corporations’ dealings with banks. the Code requires a corporation 3 A company’s articles of incorporation should include: (i) corporate name. (iv) term of existence. The General Banking Law. Overall. which is also the organic law governing the operations of SEC. Corporation Code of 1980 Supplanting the old Corporation Law of 1906. and (viii) names.3 which serve as the company’s declaration that the minimum percentage of authorized capital required by law has been subscribed and paid-up. Under the Code. administrative regulations. 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. (vii) number. and residences of incorporators and directors. nationalities. and residences of original subscribers. The currency devaluation bloated the foreign currency-denominated loans of these companies. It specifies the minimum information to be indicated in the articles of incorporation. Two other pertinent laws are Presidential Decree (PD) 902-A. which was based on American corporate law.3 Legal and Regulatory Framework The Corporation Code of 1980 is the main law governing the corporate sector. 3. the leverage of all four industries was low. 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. and the Insolvency Law. which regulates banks and nonbank financial institutions except insurance companies. It provides the basic constitutional structure for the organization. and dissolution of corporations. For publicly listed companies. operation. unlike in neighboring countries hit by the Asian crisis. and amount subscribed and paid by each. the Revised Securities Act (RSA) and PSE’s public listing requirements also apply. the Corporation Code of 1980 is a compilation of important juridical rulings. and amount of authorized capital stock. par value. One month after registration.
shareholders may delegate this power to the board of directors by a two-thirds vote of outstanding capital stock. uniform. . II to adopt a code of bylaws or rules for its internal governance. To be valid. officers. and forms of proxies and manner of voting them. (ii) controversies arising out of intra-corporate relations. and employees. among shareholders. (iii) qualifications. 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. and (vii) manner of issuing certificates in the case of stock corporations. and public policy. and reasonable. the corporation’s articles of incorporation. (ii) required quorum in shareholders’ meetings. PD 902-A expanded SEC’s mandate to include absolute jurisdiction. between the shareholders and the corporation. and between the corporation and the State concerning its franchise or right to exist. 4 Some of the items that a corporation may provide in its bylaws are the following: (i) time. and should not impair vested rights. In 1976. and compensation of directors.4 Philippine corporate law distinguishes between management decisions that require only a majority vote of the board and major decisions that require a two-thirds majority vote of shareholders. and manner of calling and conducting regular or special meetings of the directors and shareholders. (iii) controversies in the election or appointments of directors and officers of corporations. (vi) penalties for violation of the bylaws. and control (adjudicative) of all corporations. directors. duties.168 Corporate Governance and Finance in East Asia. or officers. manner of voting. (iv) time for holding annual election of directors and manner of giving the election notice. the bylaws must be consistent with the law. Its mandate is to supervise corporations in order to encourage investments and protect investors. place. Securities and Exchange Commission: PD 902-A SEC is the government agency responsible for implementation of the Corporation Code. Vol. (v) manner of election or appointment and term of office of all officers other than directors. supervision (regulatory). A majority of the outstanding shares of shareholders must vote to authorize amendments to the bylaws. must be general. 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. It implements rules and regulations that protect minority shareholders from possible fraud and misbehavior by controlling shareholders. In addition. However.
Chapter 3: Philippines 169
The last item of PD 902-A is the special jurisdiction granted to SEC over applications by corporations for “suspension of payments” to creditors, a role of the regular courts that was originally part of the Insolvency Law. Under this authority to approve applications for suspension of payments, SEC has the power to appoint rehabilitation receivers or management committees for petitioning corporations. A presidential writ issued in 1981 placed SEC under the supervision of the Ministry of Finance, but in 1998, control of the agency was returned to the Office of the President. Insolvency Law The Insolvency Law is designed to effect an equitable distribution of insolvent debtors’ properties among their creditors. It permits debtors to be discharged from their liabilities to enable them to start afresh with property set apart for them from assets to be used as payment to creditors. The regular courts have jurisdiction for insolvency proceedings including suspension of payments for individual debtors. A debtor can petition the court to suspend payment of debts or to be discharged from liabilities and debts by voluntary or involuntary insolvency proceedings. Revised Securities Act: Law on Securities Dealing Like its predecessor, the 45-year-old Securities Act, the RSA was patterned after several US securities acts. The RSA is primarily designed to prevent the exploitation of investors through the sale of unsound or fraudulent securities. For this purpose, the law requires full and accurate disclosure of all material facts concerning the issuer and the securities it proposes to sell, and prohibits misrepresentations, manipulations, and other fraudulent practices in the sale of securities. To enforce these regulations, the law requires the registration of securities. The registration requirement covers full and accurate disclosure of the character of the securities to be sold to the public, including detailed information regarding past dealings between the issuer and its directors, officers, and principal shareholders. Public Listing Rules of the Philippine Stock Exchange PSE is the country’s facility for secondary trading of shares of publicly listed companies. In 1998, SEC, which originally supervised PSE, granted the exchange the status of a “self-regulated” organization. Thus, PSE now
170 Corporate Governance and Finance in East Asia, Vol. II
has the authority, within general guidelines set by SEC, to set rules and regulations for PSE members and listed companies. The general requirements for maintenance of listed status include submission of financial reports that conform with generally accepted accounting principles (GAAP) and regulations established by PSE, and compliance with laws relating to securities and exchange regulations, board resolutions, and agreements executed with the agency. Violations of PSE requirements are subject to sanctions, including delisting. PSE is responsible for ensuring that listed companies follow the exchange’s rules of disclosure and fair treatment of investors. It has the power to impose sanctions on any company that fails or erroneously discloses material information that affects the rights and benefits of investors and misrepresents information in its application, prospectus, financial statements, or reports. In the area of corporate governance, PSE requires corporations to resolve, and, where possible, eliminate arrangements within groups of companies and own-company dealings that can lead to conflicts of interest. Upon complaints by minority investors, PSE can review the deals in question, using such criteria as benefits to the company, adequate disclosure to shareholders, and internal control procedures to ensure fair and reasonable terms. Banking Laws Affecting Corporations Some aspects of banking laws affect the governance of corporations. The important ones concern: (i) the capacity of officers of corporations to assume positions as members of the board of directors of banks, (ii) limits on ownership of banks by nonfinancial corporations, (iii) limits of lending by banks to corporations, and (iv) rules on lending to directors and other insiders. The General Banking Law governs the regulation of the establishment, management, and operations of banks. As the highest policymaking body of the banking system, the Monetary Board prescribes the qualifications of bank directors and reviews the qualifications of those appointed as bank directors and officers. It could disqualify anyone found, for whatever reason, unfit for the position. There are no other restrictions on corporate officers to be appointed as members of the board of directors of banks. A corporation, including its wholly or majority-owned subsidiaries, can own common shares of banks up to a maximum of 30 percent of banks’ voting stock. In the event that the corporation is majority-owned by one person or by relatives, the limit is 20 percent of banks’ voting shares.
Chapter 3: Philippines 171
Regulations on the single borrower limit (SBL) put a ceiling on the maximum amount that a bank can lend to a debtor. SBL rules limit the total liabilities of any borrower of a commercial bank to 15 percent of the bank’s unimpaired capital and surplus, and an additional 15 percent for “adequately secured loans,” to a maximum 30 percent (“unimpaired capital and surplus” refers to the total paid-in capital, surplus, and undivided profits, net of valuation reserves of a bank). SBL limits exclude risk-free loans such as Government-guaranteed loans and loans secured by cash deposits. Total corporate liabilities include all liabilities of the debtors and their majorityowned subsidiaries. The Monetary Board may prescribe the consolidation of the liabilities of subsidiaries with the parent corporation under certain conditions. Central Bank (Bangko Sentral ng Pilipinas [BSP]) regulations do not prohibit loans by the bank to its directors, officers, shareholders, and other related interests, known as DOSRI. However, they are subject to certain prudential requirements under banking laws, as follows: (i) a director or officer of a bank can only borrow or become a guarantor, endorser, or surety for loans from the bank with the written approval of all other directors of the bank (i.e., excluding the director concerned); (ii) the amount of outstanding credit accommodations that a bank extends to its shareholders shall be limited to an amount equal to the sum of their unencumbered deposits and book value of their paid-in capital contributions; and (iii) loans and advances given to officers in the form of fringe benefits shall not form part of liabilities under DOSRI.
Corporate Ownership and Control Patterns of Corporate Ownership
The historical development of Philippine corporate ownership is rooted in the country’s colonial past, the industrial policies of the Government, and the recent emergence of industrialists and an entrepreneurial class. During the Spanish and American period up to World War II, a small number of families acquired land and owned large businesses. These families built and preserved their businesses over several generations. Many of them became controlling shareholders of family-based corporations and business groups that are major players in the present-day Philippine corporate sector. Ownership is a key element in corporate control and governance. Public listing rules of PSE require that a minimum of 10 to 20 percent of
172 Corporate Governance and Finance in East Asia, Vol. II
outstanding shares, depending on the size of the company, be available for trading in the stock exchange. As companies usually only issue the minimum required number of shares, large blocs of controlling shareholders often dominate corporate decision making in publicly listed companies. Public investors and minority shareholders are not in a position to influence management. Moreover, the presence of large controlling shareholders makes takeovers by other companies difficult. For these reasons, the resolution of conflicts between the interests of controlling shareholders, minority shareholders, public investors, and creditors in Philippine companies depends very much on the effectiveness of internal control systems. Ownership Concentration of Listed Companies This study measures ownership concentration in terms of shareholdings by the top one, five, and 20 shareholders.5 Table 3.8 shows that the top shareholder owned 40.8 percent of the market value of an average nonfinancial company. The shareholding of the top shareholder varied across sectors. It was highest for the property sector at 54.8 percent, followed by holding companies (as a sector) at 53 percent. One shareholder held majority control of an average company in these two sectors. The average shareholding of the largest shareholder was less than 25 percent only in sectors with large market capitalization, such as power and energy, and transportation, and in sectors with high risks, such as oil exploration and mining. These figures suggest that for publicly listed companies, a single shareholder often has substantial or even dominant control. Combined, the holding of the top five shareholders in an average company was about 65.3 percent for the nonfinancial sector and 59.2 percent for the financial sector. The five largest shareholders held majority control over an average Philippine publicly listed company, except in three sectors—transportation; food, beverage, and tobacco; and oil exploration. Ownership by the five largest shareholders was on average most concentrated among holding companies (78.4 percent), and in construction (74 percent), property (69.8 percent), manufacturing and trading (68.4 percent), and communications (67.3 percent).
The study derived ownership data for 194 (169 nonfinancial) companies out of 221 (190 nonfinancial) listed on the Philippine Stock Exchange as of 1997. Shareholdings by the top one, five, and 20 shareholders were estimated for each company and averaged by using the market capitalization of each company as a weight.
Chapter 3: Philippines 173
Table 3.8 Ownership Concentration of Philippine Publicly Listed Companies by Sector, 1997
Sector Financial Institution Banks Financial Services Average Shareholdingb Nonfinancial Company Communication Power and Energy Transportation Services Construction and Other Related Products Food, Beverage, and Tobacco Holding Companies Manufacturing, Distribution, and Trading Hotel, Recreation, and Other Services Property Mining Oil Average Shareholdingb
Top 1 26.9 41.3 27.2 35.4 21.5 23.8 47.7 22.7 53.0 37.4 28.9 54.8 23.4 19.9 40.8
Top 5 59.2 63.2 59.2 67.3 55.4 48.4 74.0 44.1 78.4 68.4 55.3 69.8 56.0 45.1 65.3
Top 20a 76.4 65.8 76.2 76.9 72.1 69.2 86.2 69.7 86.0 42.6 68.0 74.5 51.9 64.3 75.9
Information on the top 20 shareholders is not available for five holding companies, 10 manufacturing companies, and two property companies. b Weighted by market capitalization. Source: PSE databank.
The shareholding of the 20 largest shareholders in an average company was 75.9 percent for the nonfinancial sector and 76.2 percent for the financial sector. In 12 out of 13 sectors, the top 20 shareholders owned more than 50 percent of the voting shares of an average company. In 10 out of 13 sectors, the top 20 shareholders held more than a two-thirds majority control of an average company. Ownership Concentration at Critical Levels of Control PSE listing rules require that a minimum of 10 to 20 percent of outstanding shares of a company be issued to the public, depending on its size. An interesting question is whether in reality Philippine publicly listed companies issue enough shares to be truly widely held or whether they barely meet this minimum requirement. The answer to this can be gleaned from an
In 116 companies. or 51 percent of the total. and 20 shareholders? In Table 3. controlling an average of 52. five. or 78 percent of the total. or 20 shareholders owned more than 50 percent (signifying operating control). or about 30 percent of the total. The limited volume of shares issued to the public is one of the causes of the underdevelopment of the Philippine stock market. II analysis of the number of companies in which the top one. In 21 companies. large and family-based shareholders pool the family’s ownership over many . or 3 percent of the total.1 percent of publicly listed companies in the Philippines in 1997. holding only an average of 2. Vol. The largest group is nonfinancial corporations.174 Corporate Governance and Finance in East Asia. the top 20 shareholders collectively owned a majority of a company’s shares. Parent companies usually spin off operating units into new companies that they continue to control as affiliates. The shares of publicly listed companies are thinly traded and illiquid. With such high levels of ownership concentration. Individuals did not constitute a significant shareholder group among the top five shareholders. There are advantages to establishing pure holding companies. including pure holding companies. the top five shareholders owned more than 50 percent of the voting shares. or 80 percent (only nominally publicly listed) of outstanding shares. which are mostly privately owned and controlled by family-based shareholder blocs. Through these. 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. a single shareholder held two-thirds majority control. Nonfinancial corporations with controlling shareholdings are likely to be holding companies.9 shows that in 44 companies. Who are the top one. Composition of Ownership of Publicly Listed Companies Another important issue concerning corporate ownership is the composition of the controlling shareholders. or almost 75 percent of the total. nonfinancial corporations held majority control. 66 percent (signifying strategic control). or 14 percent of the total.10. the top five controlling shareholders were classified into eight groups. Table 3. a single owner owned more than 80 percent of outstanding shares. In four of 11 nonfinancial sectors. five. In four companies.2 percent of outstanding shares of publicly listed companies. In 76 companies. In 111 companies. a single shareholder held operating control of a company. the top five shareholders held more than two-thirds majority control of a company. and share prices are sensitive to movements of foreign funds.
a Data for top 20 shareholders were not available for five holding companies. . Source: PSE databank. 10 manufacturing companies. and Tobacco Manufacturing.9 Ownership Concentration at Critical Levels of Control Over Publicly Listed Companies. Beverage. Distribution. and two companies in the property sector. 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.Table 3. and Trading Holding Power Transportation Property Total — = not available.
8 0.4 2. 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.5 0.7 0.9 0.6 5.3 0.7 67.0 1. and Trading Hotel.9 36.4 0.0 1.8 0.0 5.7 0.6 12.0 0.0 1.2 3.8 21.1 8.6 2.7 3.4 8.1 6.2 0.6 0.0 1.5 0.0 5.6 18.9 0.0 0.0 0.6 33.3 26.6 1.3 0.6 2.5 4.7 0.0 10.9 6.3 1.0 0.1 0. and Other Services Property Mining Oil Average Shareholdinga 33.5 13.0 4.0 1.6 9.3 2. .2 5.1 9.0 0.0 0.2 10.0 0.0 0.6 0.4 29.1 a Weighted by market capitalization.2 0.0 5.1 0.2 59.1 5.6 0.5 4.5 2.0 2.7 3.0 1.0 1.0 1.0 0.2 0.6 0.7 1.3 37.4 1.8 11.3 12.0 5.2 0.0 45.0 0.3 5.3 0. Distribution.5 12.2 3.0 0.4 5.0 0. and Tobacco Holding Companies Manufacturing.0 2.2 1.7 0.3 1.3 5.7 0.6 0.2 3.1 7.8 66.0 0.6 0.5 53.5 26. Source: PSE Databank.0 0.Table 3.2 0.7 0.3 0.0 7.2 3.4 19.0 0.10 Composition of Top Five Shareholders of Philippine Publicly Listed Companies by Sector.8 0.9 52.1 1.6 0. Beverage.3 0. Recreation.
Holding companies were themselves 66 percent owned by other nonfinancial corporations.1 percent).2 percent in 1997. accounting for P258. securities brokers (1. Insurance companies were very minor investors in the stock market because prudential regulations prevent them from investing significant amounts even in equities of large companies. and San Miguel Corporation (SMC) in food and beverages.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.7 percent of market capitalization of the nonfinancial publicly listed companies. and insurance companies (0. while still allowing the public to own minority shares. Holding companies as a sector had the largest market capitalization in PSE in 1997. This complex layering of ownership masks the identity of individuals or families that actually own and control operating companies. They can also better manage their income taxes because income from affiliated companies passes through a holding company.1 percent). The 7. Such advantages have contributed to the popularity of holding companies among publicly listed companies. These include Philippine Long Distance Telephone Company (PLDT) in telecommunications. The Philippine capital market did not have an active analyst community comparable to those in more developed capital markets.5 to 12. The investment funds’ presence in these sectors ranged from 8. there was no real market for investment information.3 percent). Because of limited ownership by institutional investors.6 billion or 26. commercial banks (1. respectively. with an average of only 7. These institutions keep a stock portfolio mostly in shares of a few companies with large capitalization and high liquidity in select industries. 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. . Investment trust funds were the most important institutional investors. These are mainly the Social Security System (SSS) and the Government Service Insurance System (GSIS). financial institutions did not have a significant ownership in nonfinancial corporations.Chapter 3: Philippines 177 companies and share in the risks and profits of the group. Funds of SSS and GSIS consist mainly of compulsory contributions from members of the country’s private sector and government workforce.6 percent of market capitalization in 1997. The financial institutions among the top five shareholders of nonfinancial corporations are investment trust funds (with 4. As a group. Petron and MERALCO in power and energy.7 percent of shareholdings).
The process identified a total of 238 companies belonging to 39 business groups from the SEC-BusinessWorld Annual Survey of the Top 1. This could further increase the concentration of ownership and expand the scope of own-group lending by these larger banks.7 6 7 The study used publicly available shareholder information and published reports. identified the companies belonging to each of these groups.000 corporations’ sales. of the financial resources in the country. Commercial banks hold the largest share. Vol. liberalized the regulations on entry of foreign bank branches and foreign ownership of local banks. . Foreign banks have a growing presence but have not necessarily increased the supply of credit to the corporate sector. and increased the capital requirements for all types of banks. about three fourths.000 Corporations in the Philippines. 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. Family-based groups have larger companies since their total sales were about 33. so far limiting their involvement to selected products. many companies in family-owned groups are not publicly listed. Corporate financing depends on intermediation by banks. the study put together a list of prominent business groups.11).178 Corporate Governance and Finance in East Asia. 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. For this reason. Prudential regulations. Still.8 percent of total companies in number. To understand the ownership and governance characteristics of family-owned business groups. suggesting that business groups are common in all major markets. However. but they comprised only 23. using data on the Philippines’ top 1.000 companies. a nonfinancial company that owns a commercial bank has better access to loans at favorable rates and terms. Banks that are members of business groups have an advantage in raising funds from the internal capital market of the group. remain in force to control excessive lending of banks to insiders. More than three fourths of the respondents are either a parent or subsidiary (about 70 percent of these are domestic nonfinancial companies). the Central Bank’s reforms are probably changing the conduct but not necessarily the structure of the banking system. This is significant considering that there were only 31 local commercial banks in the country in 1997. Large shareholders and their families own these banks directly or through their controlled companies. Some 20 financial institutions were affiliated with these groups. The Central Bank deregulated interest rates and foreign exchange. A common feature of corporate ownership of a business group is the centrality of a commercial bank. and tracked the financial performance of each company from 1992 to 1997.6 The total sales of these groups in 1997 were estimated at P806 billion (Table 3. All major industries were represented. including SBL and DOSRI rules. suggesting that most publicly listed companies are parts of business groups. including 16 commercial banks.4 percent of the top 1.
real estate. Also. construction. as discussed in previous sections.Chapter 3: Philippines 179 Compared with other Asian countries. namely. a substantial proportion of group profits came from its financial subsidiaries. which was majority-owned by the Henry Sy group.12). the nonfinancial sector was real estate (60. Significantly. nonfinancial companies contributed about 36 to 60 percent of total profits for these groups. the three largest entities were family-based groups. Foreign-owned companies mainly serve the export markets. for the Lopez group.000 companies.4 percent of the group’s 1997 profits). Gokongwei. Together. In 1997.2 percent). Lopez. Family-based business groups are most dominant in sectors such as manufacturing. To show this. the biggest private company in the Philippines. It is also noteworthy that. the principal owner of SMC. and banking. the largest family-based business group was the Ayala Corporation Group. Interlocking Relationship between Financial and Nonfinancial Firms Although financial institutions as a whole did not own directly significant proportions of shares of nonfinancal corporations in the Philippines. In terms of sales. and for the Henry Sy group.6 percent of the total sales of the top 1. Commercial banks are often affiliated to a particular business group. broadcasting (49. the study used the four largest business groups—Ayala. The significance of family-based business groups in the Philippine corporate sector is immediately evident in the 50 largest corporate entities. The main constraint may be the availability of family members that could be drawn for top management positions. In the meantime. and more than 20 percent for the Lopez group and Henry Sy group. an average group in the Philippines has fewer member companies. for each of these groups. and Henry Sy—as examples.8 percent).000 corporations in 1997. the top 10 family-based business groups had only 119 companies in the top 1. with 27 affiliated companies in the top 1. with the exception of Banco de Oro. for the Gokongwei Group. the two were closely related through their affiliations to business groups. or an average of about 12 per group. 25 out of the 50 top corporate entities were familybased groups. Lopez. retail merchandising (69. In terms of number of companies. Commercial banking contributed about 40 percent of group profits for the Ayala group and Gokongwei group. ranged according to their sales (Table 3. Cojuangco. These corporate entities accounted for 53. including business groups and independent companies. the largest was the Eduardo Cojuangco group. it was manufacturing (36. and Ayala.000.1 percent). For the Ayala group. in most .
16.5 47. 8. power.2 1.5 13.5 6.6 3. 3.8 84. 9. 17.2 1.0 17. and personal care prods Shipping.6 3. 4. Flagship Company.5 49.5 44.4 10. 7.1 2.3 2.5 17. agriculture. of Affiliated Companies Total Sales (P billion) 123.7 98.0 Average Sales Per Company (P billion) 6. real estate. and mining Management. coconut oil. and dairy products Investments.0 26. 14.3 11. 13. Sector Orientation. and Affiliated Bank of Selected Business Groups.5 2. 1997 Business Group 19 15 27 12 12 9 4 6 11 4 8 9 5 4 5 6 Major Sector Orientation Estimated No.2 16.1 4.3 3. food.6 2.0 13. and packaging Power distribution and mass communications Real estate. beverages. 11.5 26. construction.Table 3. Beverages. 5.5 46. and tobacco Telecommunications Cement and construction materials Pharmaceutical and distribution 12. Eduardo Cojuangco Lopez Family Group Ayala Corp. Consunji 4 3 Food and dairy products Construction and mining 10.1 4. beverages. and car manufacturing Car manufacturing and real estate Food and telecommunications Department store and real estate Airlines.4 48.4 .6 7. telecom. food. 10.4 6.3 15. and food Food. 2. and tourism Credit card 18.9 2. 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. 15.9 3.11 Total and Per Company Sales. Real estate.0 5. 6.
25.7 3.9 1. 28. 33.5 8.8 1. 22.8 6.6 0.1 805.9 1.7 0. 30. 29.9 6.0 1.2 6.5 2.0 2.4 3. 24.1 1. P.6 2. 23. distribution. 31.4 3.1 1.1 2.2 4.7 4.0 5.7 0. 37. 4 238 1.9 7. Cruz Jose Luis Santiago Keppel Group Robert John Sobrepeña/ Fil-Estate Group Total Real estate Sources: PSE Databank. 20. 34. 27.19. . 38.6 3. and real estate Retail merchandising Ceramics and real estate Department store and real estate Cement and sugar central Real estate and securities trading Bookstore. Ramos Gaisano Family Group Felipe Yap Felipe F. 26. mining.3 2.9 1.3 2.4 5.9 0. Enrile/JAKA Group Jaime Gow Guoco Group Jose Go Jardine Davies Gerardo Lanuza Alfredo C. 39. 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 8.8 1.6 5.6 Fast food Beverages and agro-industrial products distribution Cement and wood products Retail merchandising Electronic appliances Real estate Mining Real estate Telecommunication.8 Jollibee Foods Luis Lorenzo Family Group Alcantara Family Group Bienvenido Tantoco Elena Lim Andrew Gotianum Brimo Family Group Andrew Tan J.000 Corporations (1997).2 1. 36.8 1.9 0. 32.7 0.1 0.3 7.4 1. 21. SEC-BusinessWorld Annual Survey of Top 1. and various company annual reports.7 1.0 0. 35.
Table 3. Inc. Flagship Company. 17. 7. 5. 16. 19. 11. Sector Orientation. 4. 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. 15. and Affiliated Bank of Selected Business Groups. Eduardo Cojuangco Lopez Family Group Ayala Corp. 6. 10. 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. 12. 9. 20. 2. 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. 14. 1. Jollibee Foods Corporation Pepsi Cola Products Alsons Cement . Uytengsu/General Milling Group David M.11 (continuation) Total and Per Company Sales. 21. Alaska Milk Corporation DM Consunji. 18. 13. Long Distance Telephone Phinma Zuellig Pharmaceutical Metro Pacific William Gothong and Aboitiz Swift Foods/RFM House of Investment Anscor Equitable Card Network Inc. 8. 3.
48 billion. Enrile/JAKA Group Jaime Gow Guoco Group Jose Go Jardine Davies Gerardo Lanuza Alfredo C. P. Inc. 26. 22. Ramos Gaisano Family Group Felipe Yap Felipe F. PT&T Corp. Cruz & Co. . 32. and various company annual reports.65 billion. 31. 37. unless otherwise indicated. 27. 29. small = less than P1. 33. 34. 25. 30.East-West Bank International Exchange Bank Ecology Bank (Savings Bank) Dao Heng Bank Orient Bank International Exchange Bank International Exchange Bank Philbanking Corp. Keppel-Monte Bank Bienvenido Tantoco Elena Lim Andrew Gotianum Brimo Family Group Andrew Tan J. SEC-BusinessWorld Annual Survey of Top 1. Refers to commercial banks. Kepphil Shipyard Inc. medium = P1. Fil-Estate Development Inc. F. 35.65 billion to P4.000 Corporations (1997). a b Size class is measured in terms of sales: Large = greater than P4. 38. 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. 28. Sources: PSE Databank. 39. 23.. 36.48 billion. 24.
car manufacturing. and personal care products Shipping.6 18.2 16. and food Food. 1997 Sales (P billion) Control Structure Major Industrial Orientation 123.0 37.1 17. 9. 2. 10. Aboitiz Family Group Jose Concepcion/RFM Group Alfonso Yuchengco Philippine Associated Smelting and Refining Corp.8 22. 4.). Fujitsu Computer Products Corp. beverages. of the Phils.5 17. Del Rosario/PHINMA Zuellig Group Toshiba Information Equipment (Phils. 17. and mining Gold and other precious metal refining . bank. and bank Real estate. 15.7 98. Inc. 20. 7.2 Business Group Business Group Business Group Government.1 60. Beverages.12 Control Structure of the Top 50 Corporate Entities. 23.4 19. Texas Instruments (Phils. 19. Inc. 3.8 84. coconut oil.6 26.Table 3.5 47. food. telecommunication.). banking. 24. mass communications. power. and real estate Banking. 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.5 77. Petron Corporation Pilipinas Shell Petroleum Corporation George Ty John Gokongwei Henry Sy Lucio Tan Ramon Cojuangco Family Group Caltex (Philippines) Inc. Eduardo Cojuangco Lopez Family Group Ayala Corporation Group National Power Corp.3 15.5 44.5 15. and telecommunications Department store and banking Airlines. First Pacific/Metro Pacific Group 21. food. agriculture. food. beverages.0 38.4 48. and dairy products Investments.5 26. Philippine National Bank Mercury Drug Corp. 16. 18. and packaging Power distribution.5 46. and car manufacturing Power Refined petroleum products Refined petroleum products Banking. 11. construction. 5. 6. 14.0 24. 12. 8.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. 22.8 53.2 49. 13.
PSE Databank. 9. 36. and various company annual reports.000 Corporations (1997). Philips Semiconductors Phils. 45.6 9. 33. 39. 42.9 14.0 11. 34. 29. 27. 31.8 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. 50. corn (unmilled).7 10.7 13. and other grains wholesaling Other amusement and recreational activities Motor vehicles Food and dairy products Construction and mining Television and radio transmitters. 49. EAC Distributors Inc. 44. 14. 32. 37. and tourism Banking Radar equipment and radio remote control apparatus Operation of rolling mills Palay.1 9..3 8. National Steel Corporation National Food Authority Phil. Inc.5 10.0 13. Philip Morris Philippines. Inc. 28. real estate.25. 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. 35. 40. 41.4 10. 43. 48. and apparatus for line telephony and line telegraphy Tobacco products wholesaling Cigarettes Radar equipment. 30.0 5.6 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. 46.5 8.8 6. Corp.290 53.2 7. W. Inc.4 8. Consunji Uniden Philippines Laguna.6 1.9 7. Jollibee Foods Citibank N. .6 12.3 13.0 12.7 10.A.9 7.000 Companies Sales (%) Cigarettes Bank Soap and detergents Management. including biological products Bank Cement and wood products Retail merchandising Electronic appliances Mining Real estate Sources: SEC-BusinessWorld Annual Survey of Top 1.8 9. 47. Uytengsu/General Milling Group David M.9 6.5 8. 26. Amusement and Gaming Corporation Mitsubishi Motors Phils. radio and remote control apparatus Fast food Bank Beverages and distribution of agro-industrial products Drugs and medicines.
to the corporation and its shareholders for damages caused if they agree to unlawful corporate acts. and declaration of cash dividends. issuance of stocks. appointment and compensation of senior executives. although public investors held a majority of shares. accounting and auditing. 3. . these were dispersed shareholdings. Shareholders limit the broad power of the board by ratifying their decisions on critical corporate affairs. The Philippine Corporation Code mandates the board of directors to exercise its control over a corporation. The review is based on an ADB survey of listed companies in the Philippines conducted in 1999 for this study. investments of corporate funds in other companies or purposes. II publicly listed commercial banks affiliated to these groups. business groups had only minority ownership. Of course. jointly and individually. Actual control of the banks was still held by the groups. This section reviews practices of corporate management and shareholder control in Philippine publicly listed companies.186 Corporate Governance and Finance in East Asia. approval of management contracts. and financial disclosure.8 The Board of Directors As the representative of shareholders in a company. voluntary dissolution.2 Corporate Management and Shareholder Control The main mechanisms by which shareholders control corporate management are the board of directors. Vol. amendments in the bylaws. The Corporation Code holds members of the board of directors liable. A total of 44 companies responded to the survey (out of about 221 financial and nonfinancial listed companies). sale or disposition of a substantial portion of corporate assets. such as amendments of the articles of incorporation. corporate mergers or consolidations. 8 The ADB survey of corporate governance practices was conducted in the first semester of 1999 using a questionnaire prepared by Juzhong Zhuang of the Asian Development Bank. However. Shareholders have the right under the Code to file derivative suits against directors and officers and other third parties to redress any wrongdoing committed against the corporation for which the board refuses to sue or to remedy. issuance of corporate bonds.3. They are likewise liable if they pursue financial interests that conflict with their duty as directors. the board of directors plays a crucial role in corporate governance. determination of compensation to board members. removal of directors. shareholder voting in general meetings and legal protection of their rights.
The majority of respondents indicated that board directors and chairpersons were elected mainly on the basis of either relationship with major shareholders (31. More than half of respondents indicated that board directors were elected during the shareholder general meetings. and determining remuneration for board directors and senior management. with a maximum of 36 percent. According to the ADB survey.7 percent).5 for board members. In practice. This can partly be explained by the fact that many family-based large shareholders control companies through holding companies in which they have majority ownership. Board chairpersons in a substantial number of responding companies did not own significant amounts of shares in their personal capacities.9 percent). in a descending order. Such a short tenure may to some extent suggest that large shareholders want to keep their board members under close control. appointing senior management. The average stipulated term of office of the chairperson and members of the board for most responding companies was one year. board directors were the founder of a company.6 for board chairpersons and 7. protecting shareholder interests. or percentages of shareholdings (28. The longest was 27 years for board chairpersons and 14 years for board directors. or the Government without approval by shareholder general meetings. Making day-to-day management decisions was not regarded as an important board responsibility. But professional expertise is also an important criterion (28. The ADB survey shows that the number of board directors ranged from six to nine among the responding companies. ensuring that a company follows legal and regulatory requirements. the average number of years of holding office was 6. a typical chairperson owned 3 to 5 percent of outstanding shares of a company on average. Respondents of the ADB survey ranked the following as the most important responsibilities of the board: making strategic decisions. a fixed fee plus performance-related bonuses (30 percent). . appointed by the Government.7 percent). The ADB survey results show that a chairperson is compensated either by a fixed fee (52 percent of respondents). But half of respondents indicated that they also had board directors directly nominated by controlling shareholders or management.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. or representatives of creditors. or a per diem for meetings (18 percent). Financial compensation is another means by which shareholders can motivate boards and board members to manage companies in their interests.
There was no case found in the ADB survey where a minority shareholder invoked such a provision of the Corporation Code. About half of the active committees were audit committees and the other half nomination committees. or amount of shareholding (15 percent). It is also not clear whether the outside directors were elected before or after the financial crisis. however. This suggests that large shareholders control CEOs by means other than shareholdings. Senior Executives The Corporation Code does not specify the role and responsibilities of senior executives. Vol. and reviews the findings of external audits. In the ADB survey. large shareholder-dominated companies often view such committees as unnecessary formalities. relationship with controlling shareholders (35 percent). Ninetythree percent of the respondents had one or more outside directors. The compensation committee reviews and recommends remuneration plans of key officers and employee stock option plans. These committees were established only recently. When the CEO was not the chairperson.9 In practice. The nomination committee searches and reviews candidates for key management positions. But the independence of these outside directors is often doubtful. The ADB survey shows that in 41 percent of the responding companies. the chairperson of the board was also the chief executive officer (CEO). The Corporation Code prohibits the removal of any director without cause if that act would deprive minority shareholders of representation in the board. CEOs apparently cannot increase their shareholdings because family-based owners restrict the number of shares available to management. Unlike in Western corporate models. negotiates the audit fees and scope of audits. only 35 percent of responding companies have set up board committees. A CEO that was not the chairperson of the board was selected on the basis of professional expertise (42 percent of respondents). Companies may set up special board committees to strengthen due diligence procedures. the CEO 9 The three most common board subcommittees are the compensation. II Compensation for the chairperson was determined either by the board (54 percent of respondents). the parent company or company bylaws (21 percent).188 Corporate Governance and Finance in East Asia. audit. 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. In some companies. The audit committee selects external auditors. by tenure and compensation. . namely. and nomination committees. or management (15 percent).
or (iv) enters into a merger or consolidation with another corporate entity.Chapter 3: Philippines 189 was not related to the chairperson by blood or marriage in all of the cases except one. shareholders have preemptive rights to maintain their proportionate ownership of a company under any financing plan that may be undertaken by the company. The longest service rendered was 27 years. including electronic means. i. of directors representing minority shareholders. first. The “golden parachute” was apparently not a common feature of CEOs’ compensation packages. and (iii) involvement of directors in businesses that compete with the company. and prohibits the removal. About 60 percent of respondents of the ADB survey considered maximizing shareholder values as the CEO’s most important responsibility. . 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. 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.. Fifth. But about 27 percent viewed it to be ensuring steady growth of the company. Only one respondent indicated that its CEO was entitled to a substantial amount of compensation. to help ensure the representation of minority interests in the board. equal to three years’ pay. They can vote through proxy. (iii) invests in another company for a purpose different from that of the corporation. Fourth. The average service length of CEOs was 5. 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) contracts with companies linked through interlocking directorship.e.2 years. Companies are not allowed to issue shares with different voting rights. Shareholder Rights and Protection Under the Corporation Code. The majority of responding companies compensated their CEOs by using a fixed salary plus a performance-related bonus. shareholders enjoy a number of rights and protection. shareholders may exercise appraisal rights. Among others. the Corporation Code allows cumulative voting for directors. without cause. 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. (ii) disposes of or mortgages a substantial portion or all of corporate properties and assets. Second. Third. if the CEO’s contract was preterminated.
a shareholder could file a derivative suit against a director to redress a wrongdoing. Although transactions involving potential conflict of interest need to be reviewed and approved by the board. During annual general meetings where minority shareholders could exercise their rights. it is doubtful whether this legal protection for shareholders will achieve what it intends to in practice. there were often no real discussions of board proposals or actions. But an action by the regular court on a petition by the company’s owners/officers prevented SEC from pursuing the investigation. SEC proceedings were costly and time-consuming. Few minority shareholders actually exercised their appraisal rights. Regardless of the amount of shares held. Vol. II shareholders are allowed to inspect a company’s stock and transfer books. In the past. minority shareholders were often vulnerable to the expropriation of their interests by controlling shareholders and management. there are no requirements for disclosing such transactions to shareholders under the Corporation Code. Those who did were usually offered below-market values for their shares. Last. the Revised Securities Act has strict provisions designed to deter insider trading. no one has been successfully prosecuted for insider trading. board members are likely to be under pressure to approve transactions that benefit controlling shareholders to the detriment of minority shareholders. However. Being appointees of controlling shareholders. in cases of corporate takeovers.190 Corporate Governance and Finance in East Asia. In the case of preemptive rights. because of poor compliance and enforcement as well as some loopholes in corporate laws. hostile takeovers are not common because in most companies ownership is concentrated . An effective market for corporate control may provide some protection for minority shareholders against the expropriation of their interests by the incumbent management. The company was dissolved before indictment. where SEC made substantial progress in investigation. the Corporation Code allows a company to waive this in the article of incorporation upon registration or in a subsequent amendment. that of Interport Resources Corporation. Consequently. in the Philippines. In practice. Sixth. 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. Dissenting minority shareholders did not necessarily have recourse to a third party for an objective appraisal of their shares. In cases of derivative suits against directors for wrongdoings or actions against insider trading. There was little chance that a proposal from minority shareholders could ever get approved. There was only one case.
About 93 percent of the respondents contracted .4 No 0.2 7. a company that is widely held but has a large shareholder. The ADB survey provides further evidence on shareholder rights.6 30.0 36.3 56. demonstrates the feasibility of developing a market for corporate control if publicly listed companies were widely held. 1999.Chapter 3: Philippines 191 in a few controlling shareholders and families. Nevertheless. followed by management and banks. Yes 100.13 summarizes rights that the shareholders of the responding companies enjoyed.6 Independence of Auditing The ADB survey revealed that all the responding companies had an independent auditor.2 43.4 percent of shareholders but 58 percent of outstanding shares. appointed either by the board or shareholders during the annual general meetings. Table 3. Table 3.8 92. About 333 shareholders per company voted by proxy. An average of 327 shareholders per company attended the last annual meeting and they represented about 63 percent of total shares.0 48.522 shareholders each. The responding companies had on average 43.13 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.7 43.8 30. Nominees held about 45 percent of the outstanding shares.900 shareholders per company did not vote during the last annual general meeting. representing 3. the successful hostile takeover by First Pacific Group of PLDT.0 51.0 63.8 56. and their activism in the corporate sector. protection. An average of about 4. The brokers or securities companies were the most important proxy voters.4 70.2 69. representing about 24 percent of outstanding shares.
the information statement transmitted to every shareholder should contain the audited financial statements. imposing penalties on violators.e. a preferred independent auditing firm either reported assets that did not exist (Victorias Milling Corp. More than 20 percent of the respondents have been dealing with their auditors for 20 years or more. The accounting profession in the Philippines is considered fairly developed and Manila is a known regional center for accounting expertise.. An auditor can choose among three alternative sets of GAAP. or the accounting standard of a specific developed country (for example. On average. Nevertheless. there are many cases of poor financial reporting by large companies. investments in subsidiaries. and an analysis of financial statements. the local standard (i. SEC requires all registered companies to periodically submit reports for the purpose of updating their respective registration statements filed at the agency. Vol. Meanwhile. long-term leases. a hostile takeover case). as practiced in the Philippines). foreign currency-denominated liabilities. intangible assets. II their annual audit to an international auditing firm. vary in their evaluation of some major accounts such as securities and other liquid assets. Nevertheless.192 Corporate Governance and Finance in East Asia. with the longest being 50 years. intra-company receivables and payables. independent auditors are likely to be quite familiar with the operations and financial aspects of their clients. the responding companies have been associated with their present auditors for 13 years. a management discussion of the business. In two celebrated cases. The Code grants a shareholder the right to inspect business records and minutes of board meetings. and consolidation policy. independent audits do not guarantee the absence of questionable accounting practices. 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.. financial reporting standards allow room for interpretation by independent auditors. the agency also requires reports on important details about their operations and management. namely. In practice. . From publicly listed companies. although closely related. Most major international auditing firms operate in the Philippines. Because of such long relationships. revaluation of fixed assets. These different versions of GAAP. the US GAAP). the international accounting standard. a bankruptcy case) or hid a large amount of liabilities and losses (PLDT.
from a minority-controlled to a majority-owned subsidiary. Laws of many Southeast Asian countries allow the establishment of pure holding companies (with the exception of Korea up to 1999). However. Pure holding companies can be privately owned. “Selective public listing” is a strategy of many business groups for channeling funds from public investors to member companies. controlling shareholders in the Philippines usually exercise their corporate control through the setting up of business groups. namely SEC and the Philippine Institute of Certified Public Accountants (PICPA). which are controlled by large shareholders with public investors in a minority position. Corporate Control by Controlling Shareholders As in many other Asian countries. Controlling shareholders usually select member companies that require large . Family-based controlling shareholders use them as vehicles for controlling business groups. The popularity of holding companies in the Philippine corporate sector is evident: with a market capitalization of P258. arguably. They allow risk pooling and can achieve economies of scale in management. they also make it easier for controlling shareholders to expropriate interests of minority shareholders. accounting for 27 percent of the total stock market capitalization that year. 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. they formed the largest group of corporate entities in the Philippine stock market in 1997. and financing. as large shareholders had no need for financial statements to monitor their companies and management that were under their own control.g. sometimes did not penalize independent auditors for poorly prepared audited financial statements.. When control rights exceed cash flow rights. which are closely held by large shareholders and family members. the authorities.and medium-sized businesses did not have quality financial statements.Chapter 3: Philippines 193 Many small. because of the highly concentrated ownership of Philippine corporations.6 billion. e. Holding companies enable controlling shareholders to collectively own shares of other companies in a business group and to centralize the group’s management. Even for widely held public companies. Such expropriation is due to gaps between control rights and cash flow rights that pyramiding structures of business groups centered on holding companies create. marketing. which are usually controlled by holding companies. and publicly listed. Publicly available financial information was often of low quality.
Selective public listing combined with use of pure holding companies to own and control member companies lead to various organizational structures of business groups. controlling shareholders of the parent company may eventually increase their shares to a majority position. Depending on the performance of the company. Honda Cars (Philippines). . Ayala Corporation is a publicly listed pure holding company. and a passive minority investment at 15 percent in Honda Cars (Philippines). These investments can be classified according to the role of the controlling shareholders in the management of the invested company.6 percent of Globe Telecom.and minority-controlled operating companies are also holding companies. They are operating companies but at the same time have majority or minority share ownership in other operating companies. Some holding companies are not pure holding companies. In cases of minority ownership. They may have a representative in the board. financing. is privately owned. controlling shareholders of a parent company hold these shares as “strategic investments” that they could increase or reduce depending on business opportunities. Ayala Corporation’s majority.. at 47. of Cebu Holdings (a publicly listed government-owned company).1). In a passive minority-owned operating company. minority control at 42. the parent company plays an active role in management. The first three companies are publicly listed while the fourth. Ayala Corporation. especially its management. controlling shareholders of the parent company do not participate in management. Ayala Land fully owns Makati Development Corporation and holds a minority stake. Inc. Vol. Controlling shareholders gain additional leverage in management control over minority-owed companies. namely. with 59 percent of shares. This is most evident when a minority-owned company transacts with other members of the group where the controlling shareholders hold majority control. II equity investment for public listing. It is majority-owned by Mermac.1 percent of Ayala Land. as an example (Figure 3.2 percent. and customers. Minority-owned companies may also need access to resources of the group. a family-owned pure holding company. In an active minority-owned operating company. active minority or passive minority holdings. It has a majority control at 71. an active minority share at 44. Public investors collectively hold a minority of 41 percent.194 Corporate Governance and Finance in East Asia. 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.4 percent of Bank of the Philippine Islands. The stylized features of control structure of business groups in the Philippines can be illustrated by using a leading Philippine family-based conglomerate.
44%) >50% MajorityControlled Pure Operating Company Makati Development Corporation (100%) <50% MinorityControlled Pure Operating Company Cebu Holdings.6%) <15% Passive MinorityOwned Pure Operating Company Honda Cars Phils. Inc. (47.1 Corporate Control Structure: The Case of Ayala Corporation Family Members 100% Mermac.Figure 3.04%) <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. (58.. .06%) <50% >15% &<50% Active MinorityOwned Pure Operating Company Globe Telecoms (44. Inc. Inc.2%) >50% MajorityControlled Pure Operating Company BPI Family Savings Bank (100%) <50% MinorityControlled Pure Operating Company Note: Data as of 31 December 1998. (15%) MinorityControlled Operating and Holding Company Bank of the Philippine Islands (42.
12 These examples show that even when large shareholder groups are minority shareholders. Simeon Djankov. Simeon Djankov. Rockwell Land. [control right] [control rights via Ayala Corporation] = [cash flow right] [cash flow rights via Ayala Corporation] = [42. a privately owned company.44%] / [58. The situation offers large shareholders tremendous incentive to move resources 10 For details.10 The Ayala family’s control rights over BPI was 1. [control right] [cash flow right] = = = = = [sum of control rights via Benpres and First Holdings] [sum of cash flow rights via Benpres and First Holdings] [1. and Larry H.64% +37.5%] [39. MERALCO.7 times its cash flow rights by virtue of its cross-holdings via Benpres and First Holdings.7 times Ibid. Lang: 1999a. indirect shareholdings do not appear to be a prevalent practice in the Philippine corporate sector. H.3% x 5. P.3% x 1. The control of companies through indirect corporate shareholdings.7 times its cash flow rights by virtue of the double layer pyramid structure of the Ayala group. and Larry H. see the World Bank research papers by Stijn Claessens. and First Philippine Industrial Corporation are indirectly held by a majoritycontrolled holding company. Vol. Being in the public utilities sector.5% x 14.98% x 42. and 1999c. and a minority-controlled holding company. 1999b.64%) + (37.14%] / [1. Diversification and Efficiency of Investment by East Asian Corporations. See also Stijn Claessens. 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. Expropriation of Minority Shareholders: Evidence from East Asia. Joseph P. companies in the Lopez Group are large and minority-controlled. P. Lang. Fan. they exercise far greater control (two to five times more) than they are entitled to by virtue of their ownership rights.8%] 5. however. First Philippine Holdings Corporation. The Separation of Ownership and Control in East Asian Corporations.44%] / [25%] = 1.5%] / [(88.2).7 times 12 . II Bank of the Philippine Islands owns 100 percent of the BPI-Family Savings Bank. defined as control by large shareholders of an operating company through minority ownership by several companies. 1998. is illustrated in the Lopez Group (Figure 3. Who Owns and Controls East Asian Corporations? 11 Ibid.44%] = [42. Generally.14%] / [6.11 The Lopez family’s control rights over MERALCO was 5.76%)] [39. Benpres Holdings.196 Corporate Governance and Finance in East Asia.
2 Corporate Control Structure: The Case of Lopez Group Public Investors Family Members Lopez.7% 62.5% Minority-Controlled Publicly Listed Pure Holding Company First Philippine Holdings Corporation Benpres Holding Corporation Majority-Controlled Publicly Listed Pure Holding Company Manila Electric Company 1.5% First Philippine Industrial Corporation 50% 50% Note: Data as of 31 December 1998.3% 11.64% MinorityControlled 14.5% Operating Company MajorityControlled Operating Company Rockwell Land Corporation 24.Figure 3. Inc. . Privately-Held Pure Holding Company 88.76% Operating Company MinorityControlled 24.
198 Corporate Governance and Finance in East Asia. Most responding companies had dealt with their commercial bank creditors for more than five years and nonbank creditors for only about two years. 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. accessed nonbank creditors for specific purposes but dealt with commercial banks on a long-term basis. Suspension of Payments of Debts Under PD 902-A. However. SEC could suspend the rights of a creditor to demand payment from a borrower in accordance with the terms of the loan . the data suggest. Only a minority of respondents (18 percent) indicated that they had faced adverse creditor actions such as a collection lawsuit or foreclosure of collateral. Control by Creditors According to the ADB survey. II from their subsidiaries to their majority-owned publicly listed holding company or elsewhere up the pyramid. 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. The average company. Sixty-one percent of respondents indicated that creditors usually asked for collateral for all types of loans. it was not common for creditors to take legal action against debtors or foreclose on those assets held as collateral in cases of default. Some 85 percent of respondents believed that creditors had no influence or only weak influence on corporate management.3.3 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. whether for working capital or capital expenditure. 3. and (ii) how the legal framework protects creditor interests and rights. Vol. a publicly listed company dealt with an average of eight banks and six nonbank financial institutions. while 80 percent reported that creditors with which they had renegotiated loans were still willing to lend to them.
under which. Publicly listed companies do not represent a cross section of the Philippine corporate . The second mode is for suspension of payments with the appointment of a management committee (Mancom) or rehabilitation receiver. The first mode is for simple suspension of payments. SEC could intervene to avoid asset dissipation. bank credit is the main source of corporate financing. There are no legal or practical limits to the time period of suspension of payments. it is not clear whether the corporate borrower’s assets are of sufficient value to cover its liabilities.4 3. could take an indefinite period. Markets for equity and debt instruments are small and there are serious structural problems that discourage large. a company’s assets are of sufficient value to cover all of its debts. PD 902-A granted SEC blanket powers to intervene and adjudicate claims. For example. The corporation continued to be under rehabilitation receivership as of June 1999. Under this mode. a real estate-based business group. The borrower will propose a rehabilitation plan to SEC.4. Inc. An impending conflict between the two parties could result in dissipation of assets of the company due to creditors’ action to liquidate the company’s assets they hold as collateral. Commercial banks hold about three fourths of the resources of the financial system. There are two modes of suspension of payments under PD 902A. Consequently. including the rehabilitation of the corporation. The law on suspension of payments envisions resetting the corporation’s business for a temporary period to prevent its irreversible collapse. profitable companies from going public. Under such circumstances..Chapter 3: Philippines 199 agreement. the borrower requests to defer payments for a certain period to enable it to generate the necessary liquidity. This explains why creditors invariably oppose any move by borrowers to file for suspension of payments at SEC. In practice. the litigation process. which determines the viability of the rehabilitation plan and appoints a Mancom or a rehabilitation receiver to implement the proposal if approved. wait for 14 years from the time the company petitioned for suspension of payments in 1984.1 Corporate Financing The Financial Market and Instruments The Philippine financial market has remained underdeveloped compared with other countries in the region. SEC and the court required that the creditors of BF Homes. 3.
From the 1970s up to the early 1990s. Korea) ($143 billion). companies expanded only at a moderate pace. Equity financing through IPOs was active.000 companies. Rising stock prices during the Ramos administration reflected to some extent the business optimism. and convertible securities. The stock market was depressed up to the early 1990s. Malaysia. however. less exposed to foreign debt. Philippine companies were less leveraged. preferred stocks. Korea and Thailand). The period 1993-1997 was one of lower inflation and declining lending rates. the minimum required to qualify as a public corporation. most listed companies are controlled by their five largest shareholders. However. In part. and fiscal management were among interrelated factors explaining the underdeveloped state of the Philippine financial market. is far ahead of the flock. Table 3.g. Most publicly listed companies issue only up to 20 percent of total shares to the public. and Indonesia ($61.7 billion. Foreign funds were wary of the Philippine stock market because of its limited liquidity.200 Corporate Governance and Finance in East Asia. As a result. Interest rates. compared with other economies. The Philippine stock market is not a liquid market. The Government financed its chronic fiscal deficits by issuing short-term Treasury bills. while interest rates were at high levels and volatile. II sector. compared with Malaysia ($186 billion). but not to the same extent as it did in other Asian economies. Vol. especially short-term debt. The corporate sector raised a substantial amount of .4 billion (or $59 million using the average exchange rate). Of the 221 companies listed in the Philippine Stock Exchange in 1997. was one of the smallest in the region at $47. Even in the real estate sector.. Most companies invested only in projects that met hurdle rates as high as 20 to 30 percent and had short payback periods. the country experienced double-digit inflation. and less engaged in risky investments. only 84 had sales large enough to be placed in the top 1. Equity instruments include common stocks. the Republic of Korea (henceforth. They invested in only a few large companies whose shares were relatively liquid. Foreign portfolio investments also remained small. The ratio of market capitalization to GDP over the last 15 years put the development of the Philippine stock market at par with other developing markets in the region (e. the collapse of the stock market during the Asian financial crisis suggested that the earlier stock price surge in part reflected the “bubbles” common to other stock markets in the region. The market capitalization of the Philippine stock market in August 1997. The crisis affected the Philippine corporate sector. about the size of Thailand’s. inflation.14 shows that the average volume of daily trading in 1997 stood at P2.5 billion). this is because.
5 16.515.7 41.0 0.4 1.7 391.2 59. 1983-1997 Daily Trading Volume (P million) — — — — 129.386.474.9 2.077.5 Year 369.3 2. Source: PSE databank.2 925.9 608.Table 3.0 2.8 799.2 1.171. P billion) 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 19.4 Ratio of Market Capitalization to GDP 0.1 0.7 1.1 5.9 12.2 61.3 0.373.421.6 261.545.5 72.2 3.5 1.0 0.7 2.2 ($ million) — — — — 6.9 682.1 0.6 1.0 161.2 57. P billion) Gross Domestic Product (current prices.121.2 1.1 0.3 Market Capitalization (year end.5 26.445.2 0.5 1.3 59.1 0.14 Philippine Stock Market Performance.2 297.248.7 0.7 207.686. .692.3 — = not available.8 1.8 102.351.2 0.251.4 9.1 88.9 114.5 12.4 728.3 0.0 0.6 1.9 1.1 524.5 571.0 1.088.3 158.8 1.9 2.3 4.3 314. Note: Combined transactions of Makati and Manila Stock Exchanges are not available for the years 1983 to 1986.906.8 0.8 1.
The picture of the financial system that emerges is thus one of limited capital markets. Only a few large companies floated commercial papers because of the limited market. by volatile interest rates and the absence of a secondary market. the rights issue was a popular way of raising equity capital. include bank credits. because business groups often own large commercial banks. The corporate bond market was stunted.6 billion. discounting of receivables. Under SEC regulations. However. 3.4. which were the principal source of corporate financing in the Philippines. Capital markets cannot provide the market discipline that corporate investors need. moreover. Negotiated credits. which buy commercial papers either for their own account or for their clients. asset-backed credits. sells these commercial papers through brokers. Corporate bonds are another type of debt securities.. new equity. and debt as sources of corporate financing by using flow of funds analysis. The measures used in the analysis are: . Vol. II equity capital through IPOs during the stock market boom from 1993 to the first half of 1997. Debt instruments include negotiated credits and debt securities. about 127 companies went public with a total value of offerings of about P134. However. and inventory financing. corporate bond issuing was even more limited. by virtue of their large stakes in the financial system. which ultimately influences the pricing of commercial paper issues. which in most cases is an affiliate of the issuing company. The underwriter. are in a position to provide such discipline. Only the commercial banks. From 1988 to 1997. and the dominance of large commercial banks. of which 85 percent was raised from 1993 to the first half of 1997. and high transaction costs. This is because only companies with strong capitalization and predictable cash flows such as public utility companies can issue bonds. Debt securities include commercial papers and corporate bonds. issuing companies had to undergo a process of review and credit rating by the Credit Information Bureau Inc. The largest buyers have been commercial banks. lack of competition among financial institutions. Because existing shareholders wanted to retain their proportionate control over their companies.2 Patterns of Corporate Financing The study looked at retained earnings. Few companies offer preferred stocks because the Philippine tax system does not allow tax deductibility of dividends on preferred stocks. leases. a strong regulatory system for bank supervision is imperative. tight regulations.202 Corporate Governance and Finance in East Asia.
Incremental equity financing ratio (IEFR): ratio of changes in shareholders’ equity inclusive of retained earnings to changes in total assets.1 0.1 0. it is one minus IDFR.6 0.000 Corporations in the Philippines.2 0.3 0. Retained earnings were sufficient to finance the entire growth of fixed assets in the corporate sector. It measures a company’s capacity to finance growth in fixed assets by internally generated funds.3 0.8 0.15.9 0.0 0.1 0.2 0.6 0. Self-financing ratio of total assets (SFRT): ratio of changes in retained earnings to changes in total assets.5 0. during this period.5 0.9 0.Chapter 3: Philippines 203 (i) (ii) (iii) (iv) (v) Self-financing ratio of fixed assets (SFRF): ratio of changes in retained earnings to changes in fixed assets. 1989-1997 Financing Indicators SFRF SFRT NEFR IDFR IEFR 1989 1990 1991 1992 1993 1994 1995 1996 1997 1.4 0.4 0.0 0.5 0. Incremental debt financing ratio (IDFR): ratio of changes in total liabilities to changes in total assets.5 0.5 0.8 0.5 0. It measures a company’s capacity to finance asset growth by internally generated funds.3 0.3 0.1 Average 1. New equity financing ratio (NEFR): ratio of changes in stockholders’ equity (excluding retained earnings) to changes in total assets.4 0.5 0. All Companies Financial flows data were derived from the SEC-BusinessWorld Annual Survey of Top 1.4 0.3 0. the average SFRF was high at 109 percent. It measures a company’s reliance on borrowings in financing asset growth.3 0.4 1. .5 0.7 0.1 0.6 0.2 0.000 Corporations in the Philippines from 1988 to 1997. On the other hand.3 0.4 0.8 0.2 0.9 0. the SFRT was low at Table 3.1 0.4 0.2 0.5 2. By definition.4 0.15 Financing Patterns of the Corporate Sector.5 Source: SEC-BusinessWorld Annual Survey of Top 1.5 0. 1988-1997.9 0. As shown in Table 3. It measures a company’s capacity to finance asset growth by equity capital.
1991.2 (0. There were significant year-to-year variations.8 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. Companies financed fixed assets from internal sources in hard times. internal funds were not a significant source of financing growth in total assets. Corporate Financing by Ownership Type As shown in Table 3. Vol. Retained earnings were the least important. 1988-1997.0) 0.3 0. In periods of an economic crunch such as in 1989.3 0. Source: SEC-BusinessWorld Annual Survey of Top 1.3 0. As a result. On Table 3. suggesting that there was a deterioration of financial performance in the Philippine corporate sector in the years running up to the crisis.5 0.and foreign-owned.16 Corporate Financing Patterns by Ownership Type.9 0.000 Corporations in the Philippines. In 1997. In all the years. This was mainly caused by the declining contribution from retained earnings. reflecting the capital flight caused by political instability in the early 1990s. II only 19 percent.204 Corporate Governance and Finance in East Asia.6 0. the SFRF was higher. the level of corporate leverage increased. except in 1991. . for all three types of companies—publicly listed. when it financed 45 percent of it. except for foreignowned companies that had a negative new equity financing ratio. 1989-1997 Financing Indicators SFRF SFRTa NEFR IDFRa IEFRa a Publicly Listed 1. debts were the most important source of financing. with debt providing 93 percent of the financing requirements.1 a Excludes negative balances. and 1997. The corporate sector consistently relied on debt and new equity to finance asset growth throughout the period.16. implying that internal funds were far from sufficient to finance growth in total assets.7 0.2 0.5 Foreign-Owned 1.5 Privately-Owned 0. retained earnings declined and few new equity investments flowed into the corporate sector. privately. The corporate sector used new equity to finance 32 percent and new debts to finance 49 percent of growth in total assets.3 0. Total assets grew by 23 percent that year.
5 41.7 100.6 0.0 53.3 48.0 Source: SEC-BusinessWorld Annual Survey of Top 1.Chapter 3: Philippines 205 average.4 100.6 37.8 3.4 2.9 3.9 12.2 3.17 Composition of Assets and Financing of the Publicly Listed Sector.2 12.3 10. 1988-1997.2 100.0 100.8 0.7 7.9 24.8 46.0 10.3 12.2 42.5 9.2 51. It presents a composition analysis of assets and financing sources for the period 1992-1996.3 12.9 16.0 38.6 26.6 48.3 10.5 27.7 2.8 17.0 8.2 100.1 7.17.1 15.0 1994 19.1 9.0 1995 1996 13.7 13.9 16.0 1993 14.1 50. .8 38.1 13.6 43.0 9.9 4. 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 14.5 12.000 Corporations in the Philippines.4 10.1 10.4 100.4 2.and foreign-owned companies.0 6.3 11.4 12.0 13.0 9.8 100. especially bank loans.8 39. The sector built up its short-term debts.8 26.9 0.9 38.9 16.7 23.8 0.3 4.8 16.6 48. This financing pattern supports the earlier finding that foreign-owned companies had the highest leverage among the three types of companies.3 12.7 4.5 0.2 3.8 4.8 3.4 41.4 100.3 51.0 9.9 100. compared with 47 percent for publicly listed companies and 55 percent for privately-held firms.0 10. significantly Table 3.3 13. Foreign-owned companies relied more heavily on debt financing.7 13.8 51.1 49.0 9.7 2. contributing 90 percent of growth in total assets.4 100.0 12.5 16. A breakdown of the financial structure of publicly listed companies measured in balance sheet items is shown in Table 3.4 3.4 43. publicly listed companies relied more on new equity financing than privately.
group companies were less reliant on debt financing than 13 Defined as total current assets divided by total current liabilities. as opposed to 94 and 30 percent. Further. As shown in Table 3.5 0. their inherent ability to pool risks. group companies usually financed their investment in member companies by equity rather than debt.6 Independent Company 0. 1988-1997.3 0. the easier access to external credit.3 0.5 0.45 in 1996. 1989-1997 Financing Indicators SFRFa SFRTa NEFR IDFRa IEFRa a Group Member 1. the average SFRF of business groups was higher compared with that of independent companies. and economies of scale in fund raising. Table 3.9 0.206 Corporate Governance and Finance in East Asia. . II in 1996 and became more vulnerable to the financial crisis in 1997.000 Corporations in the Philippines.18 Financing Patterns by Control Structure. Group companies financed an average of 45 percent of growth in total assets by debt.13 was at 1.18. On average. indicating that many publicly listed companies were likely to be in a tight liquidity position. The traditional measure of liquidity. Group companies were generally more profitable than independent companies. The SFRF for independent companies would have been even lower if the highly profitable foreign-owned companies were excluded. The normal standard liquid position is a current ratio of 2 or higher. 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.3 0.1 0. compared with an average of 54 percent for independent companies. Corporate Financing by Control Structure Conglomerates have certain advantages in financing because of the opportunities offered by the internal capital markets.2 0.5 Excludes negative balances Source: SEC-BusinessWorld Annual Survey of Top 1. the current ratio. for independent companies. For these two reasons. respectively. Vol.
Large companies’ IDFR of 0.19). 1988-1997.000 Corporations in the Philippines.3 0. These years were 1991 with 110 percent.8 0. 1993 with 96 percent. and 1997 with 131 percent.3 0.47. On average.20). With assets growing at a fast pace during this period.4 Small 0. Source: SEC-BusinessWorld Annual Survey of Top 1.08 and SFRT of 0.5 Medium 3.06.1 0. equity financed 42 percent of incremental asset growth.88 for large companies (Table 3.55 was substantially higher than the small companies’ 0. compared with 55 percent for large companies and 47 percent for small ones. medium-sized companies used more debts.2 0.76 for small companies and 0. The medium-sized companies’ high debt financing ratio was due mainly to three years of complete reliance on debt to finance growth.2 0.3 0.19 Financing Patterns by Firm Size. Table 3. Corporate Financing by Industry The manufacturing sector had an average SFRF of 1.5 Excludes negative balances. There was also increased reliance on debt financing. 1989-1997 Financing Indicators SFRFa SFRTa NEFR IDFRa IEFRa a Large 0. Corporate Financing by Firm Size SFRF was highest for medium-sized companies.6 0.5 0. The lower SFRF for large companies may be caused by their larger outlays for growth in fixed assets. with an average of 3.6 0.Chapter 3: Philippines 207 independent companies. averaging 61 percent of growth in total assets. Large firms consistently increased their reliance on debts from 1994 to 1997. These results support the earlier finding that the leverage of business groups was lower than that of the independent companies from 1988 to 1997.9 0. The corresponding ratio was 0.2 0. Excluding .50 (Table 3.
Since the real estate boom coincided with that of the stock market.3 0. While this level is considered prudent.3 0. The construction sector was a heavy user of debt financing.7 0.3 0. debt financed about 78 percent of asset growth in real estate.47 two years later. Total liabilities increased partly as a result of the local currency devaluation and financed all of asset growth for the year. with an SFRF as low as 0.208 Corporate Governance and Finance in East Asia. The sector had the highest leverage among all industries that year. 1989-1997 Financing Indicators Manufacturing SFRFa SFRTa NEFR IDFRa IEFRa 1. Excluding 1997 when fixed assets declined.91.4 0.6 0. the incremental equity ratios of the industry were high.79 and in 1997 at 0. the industry generated internal funds.1 0.3 0. Its SFRF and SFRT were volatile because of chronic losses and reduction in fixed and total assets.4 0. Equity financed the rapid expansion in the industry’s assets in the period 1994 to 1997. During the crisis year. Incremental equity financing amounted to an average of 44 percent of total asset growth. The effects of the crisis of 1997 were adverse. Table 3.6 a Excludes negative balances. when debts declined.4 0. Equity financed an average of 62 percent of total asset growth.000 Corporations in the Philippines.5 Utilities and Real Estate Services and Property 0.04. The real estate industry financed its growth by substantial equity funds.4 3.32.6 0. . many of the leading real estate companies successfully went public during that time. increasing to 0.2) 0. the total debt ratio was much higher in 1996 at 0.4 Construction 0. ranging from 41 to 118 percent. SFRF for the sector averaged 0. while SFRT averaged only 0. II 1991. The utilities sector showed weaknesses in internal fund generation in 1989-1994. achieving an average SFRF of 3.6 0. Low incomes diminished the equity financing position of the manufacturing industry toward the crisis year.20 Financing Patterns by Industry.5 0. Up to 1997.29.58 and SFRT of 0. Source: SEC-BusinessWorld Annual Survey of Top 1.27. Vol. In the eight years preceding the crisis. The situation improved beginning 1994.5 (0.5 0. 1988-1997. the manufacturing industry financed 57 percent of its total asset growth by debt.
These results suggest that companies with higher ownership concentration tend to be more highly leveraged and.004 3. ROE.008 5. . Source: Author’s estimates based on the PSE databank. The Modern Industrial Revolution. ROE = return on equity. and leverage. the coefficient of the ownership concentration measure in all the three regressions is positive and statistically significant. was regressed against measures of profitability and of financial leverage. Large shareholders may also overuse financial leverage to avoid diluting ownership and control. 14 See for example Michael Jensen (1993).Chapter 3: Philippines 209 3.860 Leverage = the ratio of total assets to total equity. Financial Leverage.00056 1. measured by the percentage of shareholdings of the largest five shareholders. alternatively.230 Leverage 0.00036 2. ROA = return on assets. ownership concentration = the total shareholdings of the top five shareholders. while if it fails. Journal of Finance 48: 831-880. as the dependent variable. Three regressions were run with the shareholding of the largest five shareholders as an independent variable and ROA. at the same time. ROA.00125 2. and the Failure of Internal Control Systems. creditors bear the consequences. and financial leverage are all positively and significantly related to the degree of ownership concentration.21 Ownership Concentration. Exit.421 0. As shown in Table 3.130 ROA 0. and Performance Previous studies on corporate governance have often associated ownership concentration with heightened risk-taking by companies.21. Table 3. Profitability.4. more profitable. 1992-1996. the degree of ownership concentration. and Financial Leverage Dependent Variable Item Coefficient of Ownership Concentration T-statistics Adjusted R-squared F-statistics ROE 0.287 0.14 Large shareholders may borrow excessively to undertake risky projects. ROE. Using the PSE database.769 0.3 Ownership Concentration. knowing that if an investment turns out to be successful they could capture most of the gain.009 5.
raw materials. the country’s GDP growth pace indicated that it did not have a “bubble economy. industry at 34 percent. and intermediate goods. Historically. foreign investments in the country have been low. the country was less dependent on foreign private capital. but its share had been declining by 4 percent per year since 1995. with a narrow exporting industry base.5 3. Because of limited local capital.5 billion in 1996 and grew at an average of 48 percent per annum from 1992 to 1996.” The Government’s judgment that economic fundamentals were strong was based on stable growth rates. the growth in foreign investments fueled that of the manufacturing and services sectors in the years preceding the crisis. Compared to other East Asian crisis-affected countries. with commodities accounting for the balance.8 percent of GDP from 1995 to 1997. The export sector had a very narrow breadth.210 Corporate Governance and Finance in East Asia. their growth gathering momentum only beginning in 1992.” that is. Although much lower than those of other Asian countries. Commercial and industrial activities in the country were largely oriented to domestic markets. an overexpansion of capacities. the economy still showed vestiges of its import-dependent and substituting character. which averaged 4. The Government explained that the country had “sound economic fundamentals” but that the problems were caused by “contagion. In 1997. II 3.5 percent per year from 1992 to 1997. The country experienced balance of payments surpluses but these were due to transfers. 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. In sum. notably remittances of overseas workers. The largest contributors to GDP were services at 43 percent. Vol.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. Manufactures accounted for about 85 percent of exports. Garments was the second largest export sector at about 9 percent. Net trades in goods and services averaged a deficit of 4. Exports were growing at about 20 percent per year in the three years preceding the crisis.5. and agriculture at 21 percent. Net investment inflows were $3. more than half (52 percent) of exports were semiconductors. About 80 percent of imports were capital goods (particularly power generating and telecommunications equipment). After a . The structure of the economy may be understood by looking at its sectoral composition and export competitiveness.
Profitable operations since 1992 had allowed it to build equity. assets grew at a compound annual rate of about 31 percent. Since the regional financial crisis was triggered by the loss of confidence in some East Asian economies by foreign creditors and investors. the Government sought stability and achieved this in 19921997. the country and the corporate sector had no access to foreign currency debts from the international financial market. The corporate sector was in a relatively stable financial condition around the time of the crisis. resulting in stability in the short-term debt to reserves ratio.3 percent. unlike their counterparts in the region. In the Philippines. an average inflation rate of 7. fueled also by successful IPOs during the stock market boom of 1993-1996. From 1988 to 1996. Five years of stable growth before the crisis enabled the country to build its net international reserves to $10.Chapter 3: Philippines 211 long period of debt moratorium and restructuring that started in 1983 and ended in 1991. The Central Bank conserved international reserves by allowing the local currency to float within a wider trading margin. which. average ROE was 13. an average Treasury bill rate of 13. Total debts were only 52 percent of assets or 108 percent of equity. adjustments were focused on the quantity and quality of the banking system’s corporate loans. a government fiscal surplus from 1994 to 1997.6 billion as of March 1997. Closer analysis. The lessons from debt restructuring became the basis for the Government’s economic policies. From 1993 to 1997. a positive balance of payments from 1992 to 1996. depended on the quality of the corporate sector’s investments. the Government restructured its debts into longer tenors with a maximum of 25 years. Eventually. however.8 percent. shows that investments of the corporate sector were growing at a faster rate than sales revenues in the years immediately preceding the crisis.1 percent. and a relatively healthy banking system. Prudent fiscal management and controls on foreign borrowings were part of the adjustments required by IMF and foreign creditors. Financial institutions called on their shortterm loans and shortened the maturity of existing loans. . the ratio of short-term debts to international reserves dipped below 100 percent beginning June 1998.5 percent. in turn. while sales grew by only 20 percent per year. After hovering in the range of 100 to 127 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. Economic performance during 1992-1997 was characterized by an average growth rate of real gross national product (GNP) at 3. During this time. 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.
In sum. Net foreign portfolio investment amounted to $1.0 1996 3. precisely. mitigated the effects of the pullout and liquidation of investments in the aftermath.” 3. Table 3. growing by about 34 percent per year from 1994 to 1997.517 1. Sources: Bangko Sentral ng Pilipinas and SEC.22.718 30.073 (406) 121. or 114 percent of net foreign direct investment (FDI).2 Impact of the Crisis on the Corporate Sector Aside from the foreign exchange adjustment.47.0 1998 739 555 328 69. . In 1997. 1996 = 26. the other immediate impact of the crisis was that on foreign investment flows. 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.101 92. It financed 26 percent of corporate capital growth.22 Foreign Investment Flows.650 32. Net foreign investments more than doubled from 1995 to 1996 but declined by 78 percent in 1997 (Table 3.300 1. These patterns in investment and financing are similar to those of other countries in the region. Data for 1998 cover only January-August. 1997 = 29.06.22).101 billion or 196 percent of net FDI in 1996.609 1.5. The debt level of the Philippine corporate sector in 1997 was low by Asian standards but still high by developed country standards.303 23. Debts financed a large part of this expansion.4 1997 762 1.71. 1998 = 41. Most of this leverage happened during the boom years in the region.074 2. net FDI remained stable at more than $1 billion. 1995-1998 Item Net Foreign Investments ($ 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. It is understandable then that the effect of the Asian financial crisis on the Philippines was correspondingly that of a negative “contagion.485 145.5 billion in 1995. Foreign investments in the Philippines have not been as high as the inflows to other Asian countries—and this.7 Note: Peso-dollar exchange rates used are: 1995 = 25.749 26. but to a lesser degree. But portfolio investment amounting to $406 million flew out of the Philippines. II The corporate sector indeed overexpanded after 1993 like its counterparts in the region. It rose to $2. Vol.212 Corporate Governance and Finance in East Asia.
then rose to a high of 22.3 percent of assets. they were willing to restructure and renegotiate existing loans by corporate borrowers. The combined effects of shrinking demand and high interest rates reduced the corporate sector’s demand for loans. The interest rates on Treasury bills.2 percent was barely above inflation rate. in varying degrees for each sector. Bank loan pricing was based on the bellwether 91-day Treasury bill rates rather than inflation. lending rates also came down. The resources of the financial system that year totaled P3. By March 1988. the corporate sector became vulnerable to loan calls and high interest rates. suggesting that commercial banks required a higher premium at about the height of the crisis but not beyond. Bank spreads over Treasury bill rates increased in 1997 but were within the range experienced in the past. Loan calls. Although corporate borrowers were not highly leveraged.2 to 28. and leverage increased to 149 percent compared with 109 percent in 1996. the sectors with the highest outstanding loans had reduced their credit exposures.7 percent in January 1998. By October 1998. new borrowings financed asset growth. Net profit margins were at a 10-year low at 4. Manufacturing reduced its loans outstanding by 11 percent from October 1997 levels. Because commercial banks were strongly capitalized.9 percent. albeit at current market interest rates. and the wholesale and . The banking system was able to absorb the impact of the crisis primarily because of its strong capital position. in turn.2 percent in November 1997. meanwhile. Loans outstanding of commercial banks declined by the first quarter of 1998. ROE at 6.369 billion. they could not initiate a large reduction of their loans because these in part financed long-term growth in assets. with commercial banks holding P2. A number of small banks closed but they represented less than 1 percent of the financial system’s total resources. sparking a rise in interest rates on corporate loans. Companies deferred investments in new fixed assets.Chapter 3: Philippines 213 Corporate financial performances and conditions deteriorated during 1997. depended on the liquidity and capital position of commercial banks. Average bank lending rates climbed to their peak of 25. When the Treasury bill rates eased in March 1998. With the increase in borrowings and reduced liquidity. ranged from 11 to 13 percent from 1993 to July 1997.513 billion. Because of weak internal fund generation. Lending rates were well above the 20 percent level from July 1997 to March 1998. which held about 75 percent of the assets of the financial system in 1997. the commercial banking sector’s capital remained strong at 17. The real problem of the corporate sector during the crisis was the rise in interest rates.
set limits on overbought/oversold foreign exchange positions of banks. and the financial system.3 Responses to the Crisis Government Responses The Government’s policy and regulatory responses to the crisis focused on monetary and credit issues. including (i) a regulatory limit of 20 percent on banks’ loans to the . the ratio increased to a high of 11. These peaked at 14. and set up a hedging facility for borrowers with foreign currency-denominated loans. through the Bankers’ Association of the Philippines. was a problem sector. However. This “voluntary agreement” partly explains why the loan spreads of banks were within the range of recent experience. Vol. Still. loans outstanding of the real estate sector increased by 11 percent from June 1997 to June 1998. single-digit NPL ratios began only since 1989.3 percent in December 1997. II retail trade sector. The Central Bank adopted other measures to strengthen the financial system. These figures show that adjustment problems were industry-specific and that the real estate industry.9 percent of bank loan portfolios. But the Philippine banking system had gone through worse crises in the past. 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. The pattern indicates that real estate loans were of substandard quality but banks had contained the problem by mid-1998. 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. In March 1997. as with its counterparts in other Asian countries. the fiscal position. thereby reducing overall intermediation costs. The move retained the liquidity position of banks but lowered their cost of reserves. 3. to reduce their lending spreads over the 91-day Treasury bill rates from 3-8 percent to 1. As for nonperforming loans (NPLs).214 Corporate Governance and Finance in East Asia. real estate loans averaged 11.5 percent by September 1998. This allowed the Central Bank to convince the banks. and its experience of low. and subsequently went down to 13. by 12 percent. The Central Bank introduced regulations on foreign exchange trading to control speculation and nondeliverable forward contracts.5. The latter measure was especially beneficial to companies with unhedged foreign currency loans from commercial banks.6 percent in June 1998.5-6 percent.
Financially strong companies were able to survive the crisis by effecting such internal restructuring. consolidating business units. subcontracting and outsourcing. The real estate portfolio of commercial banks also declined and was well below the Central Bank’s regulatory ceiling by March 1998. Takeovers in the past involved cooperative negotiations between purchasers of a target company and family-based large shareholders. the Asian crisis opened a unique opportunity for foreign investors. Large companies with heavy loan exposures such as Philippine Airlines Inc. which was privatized with the Lucio Tan group gaining control and the Government retaining minority ownership. bank loan rates have also come down. the Government kept inflation below 10 percent. Responses of the Corporate Sector The corporate sector’s financial position. The acquiring company. was known to have a policy . the country’s flag carrier. Average Treasury bill rates have cooled since mid-1998. With its weakened financial position. its accessibility to foreign capital. and the legal framework for reorganization and liquidation conditioned its response to the crisis. With prudent monetary management. Publicly listed Philippine companies could also be restructured through takeovers by local and foreign investors. (iv) increasing banks’ capital requirement by 20 percent for universal banks (banks with expanded licenses) and 40 percent for ordinary commercial banks. 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. In the case of PLDT. First Pacific Corporation.6 percent growth in 1999. PAL. came up with a rehabilitation plan by May 1999 that was found acceptable to all parties.Chapter 3: Philippines 215 real estate sector. and (vi) issuing guidelines on duties and responsibilities of banks’ boards of directors for improved quality of bank management. (iii) fixing loan loss provisions of 2 percent of the gross amount of loan portfolio on top of individually rated bad loan accounts. In response to calls for lower bank intermediation costs. took more action. (ii) shortening the period for classifying unpaid loans as past due from three months to one month. the largest telecommunications setup in the Philippines. 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. The policy directions and actions taken by the Government appear to have ushered in recovery. (v) improving disclosure requirements on the financial position of banks. (PAL). changing technologies. and giving up noncore businesses.
the stock price of PLDT was buoyant during the takeover period. When companies are highly profitable. Ownership is highly concentrated and a few dominant players control major industries. Vol. SMC is another widely-held company managed by a minority shareholder. First Pacific could have acquired sufficient shares to take control of PLDT in three ways. By itself. The question. however. SMC had lagged behind other groups of companies such as Ayala Corporation in financial performance for some years. concentrated ownership of companies is not equivalent to weakness in corporate governance. and Recommendations Summary and Conclusions The Philippine corporate sector has been shaped by the country’s economic and industrial development policies. 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. 3. using some or all of these means. Conclusions. When Cojuangco took over.6. Consequently. he restructured the company toward its core brewery business and sold off local and foreign subsidiaries. A third method was to make a formal tender offer to PLDT’s controlling minority shareholders. One mode was the outright purchase of shares in the open market. 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. at a premium over the market price to reflect the value of management control. the Cojuangcos.216 Corporate Governance and Finance in East Asia. First Pacific. In a legal process that ended in his takeover of management. Eduardo Cojuangco was able to assert his ownership of shares taken over by the Government during the transition of power in 1986. controlling shareholders can capture these profits by excluding public investors from ownership. Although considered the prime industrial company in the Philippines. Its stock price and returns to shareholders had stagnated. A second method was to purchase the shares of other large minority shareholders. II of investing to control companies that are dominant players in their industries. is whether there are sufficient safeguards to prevent controlling shareholders from . eventually took over PLDT and announced a restructuring plan for the entire group of companies. Corporate governance is conditioned by the high ownership concentration of these large companies. the Soriano family.1 Summary.6 3.
influenced by industry characteristics. This study analyzed trends in corporate performance and financing in relation to corporate governance from 1988 to 1997. an underdeveloped capital market. Corporate governance should be viewed in the context of an increasing presence and growth of large shareholders-centered conglomerate business organizations. The five largest shareholders have majority control of an average publicly listed company. oligopolistic market structures. Publicly listed companies had the highest profit margins and lowest leverage among the local companies.Chapter 3: Philippines 217 expropriating the wealth of minority shareholders through aggressive and risky investment. The result is that corporate governance depends only on internal controls. the most numerous in the corporate sector. an ineffective insolvency system. Privately-owned companies. medium companies showed higher profitability than large and small ones. The financing pattern of the corporate sector was influenced by the tight financial conditions prevailing in the country up to 1992. ownership of banks by business groups. The Philippine corporate sector was relatively efficient in investing and financing compared with other countries affected by the Asian crisis. 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. The corporate sector consistently relied on internally generated funds and equity before resorting to borrowings. minority shareholders need to be protected by external control mechanisms. Leverage was within Asian norms but above developed country standards. Ownership of publicly listed companies is highly concentrated. Performance was. Business groups occupied seven of the top 10 and 25 of the top 50 largest corporate entities in the Philippines in 1997. By ownership structure. By control structure. This study points out weaknesses in external control mechanisms such as weak legal protection for minority shareholders. With large shareholders in control. passive independent auditing. Analysis of corporate financing by ownership . with the real estate and public utilities industries standing out for their pronounced cyclical patterns. while the largest 20 shareholders control more than 75 percent of shares. companies that are members of family-based conglomerates had higher returns and lower leverage than independent companies. Financial institutions are not significant shareholders. to some extent. Returns to capital exceeded inflation rates. foreign companies were the most profitable but highly leveraged. and the lack of market for corporate control. were the least profitable. By size.
The extent of governance problems depends on internal control policies of the controlling shareholders. and leverage were all positively related to the degree of ownership concentration. Large. A commercial bank is an important part of most business groups. Publicly listed companies were responsive to investors’ requirements for prudent use of debts. Internal financial markets operated by business groups allowed them to optimize their financial resources at lower external debt levels. and centralized management and financing. Ownership concentration was positively related to both returns and leverage. statistical analysis of company-level data revealed significant relationships between corporate performance and corporate governance. family-based shareholders gain control by such means as the setting up of holding companies. . A business group is an effective business organizational model for achieving leadership in industries. Vol. Even in cases where the group owned only a minority share of a commercial bank. II type gave similar results. selective public listing of companies in the group. Such structures result in control by large shareholders through disproportionately smaller investments in equity ownership. ROA. The positive relationship between financial leverage and ownership concentration is consistent with the hypothesis that controlling shareholders prefer to use debt financing in order to avoid ownership dilution. Larger disparities in control over cash flow rights imply higher incentives for large shareholders to (i) expropriate wealth of shareholders not belonging to the controlling group and (ii) invest in empirebuilding and high-risk projects. The difference between management control and ownership rights is usually substantial. The pyramid model is useful for centrally managing smaller companies. Large companies owned or controlled by business groups tend to dominate their industries. the bank usually accounted for a large share of each group’s net profits.218 Corporate Governance and Finance in East Asia. Companies whose large shareholders have higher degree of control tend to borrow more but generate better returns. with the foreign-owned companies found to rely more on borrowed funds. as typified by the Ayala Group. Business groups with pyramiding structures heighten the issue of corporate governance. superior profitability. After controlling for industry effects. and sustained growth. Family-based business groups have focused their investments in industries where their superior financing capacities and political/social influence give them unique advantages. 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. ROE.
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. rather than the banks that lent millions of pesos. and sound overall creditworthiness. low inflation. The Central Bank imposed strict limits on real estate lending. SEC officials. are to be removed and transferred to courts. SEC’s quasijudicial functions.Chapter 3: Philippines 219 The financial crisis came when the Philippine economy was in a relatively strong financial position. The Central Bank responded by improving the liquidity of the system and by establishing conditions for bringing down interest rates on bank loans. decisions by large sharehold- . Specific actions recommended are described below. The corporate sector accessed the foreign debt market only in the mid-1990s because of the country’s long-drawn debt moratorium. including suspension of payments. 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. 3. For example. There are systemic risks involved in highly concentrated ownership. a strong international reserves position. adversely affecting companies’ operations and financial position. strong capital position built on IPOs in a buoyant stock market. A number of large debtors petitioned SEC for rehabilitation under procedures set by PD 902-A. resulting in the banks’ accelerated restructuring of troubled debts in this sector. This law is flawed in concept because it supplants a market-based credit agreement with a political process. 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. As the crisis wore on in 1998. and a market-oriented policy environment. with recently restructured public debt. there were sharp rises in the number of bankruptcies and petitions for debt relief. That is. The crisis caused a tightening of credit to the corporate sector and a spike in interest rates. mostly by highly leveraged companies and speculative investors in real estate.6. Still. decide on the financial future of a troubled debtor. the government budget in surplus. Under the new Securities Regulation Code enacted in 2000. The corporate sector was also in good financial condition with rich internal cash flows accumulated from a number of profitable years.
to 25 percent. 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. insider information. Because independent directors tend to adopt the perspective of minority shareholders in board decisions. To strengthen the board. 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. This will enable SEC to enforce prudential requirements on management of companies and enable minority shareholders to pursue grievances against their boards. they serve to curb the powers of controlling shareholders. The adjustment should be made over a fixed period of time. Another measure would be to impose a statutory limit on the number of directorships that one can accept. inadequate disclosures. It has suffi- . (ii) require disclosure of material changes in ownership.220 Corporate Governance and Finance in East Asia. II ers often cause wide volatility in stock prices and invite reaction from creditors. 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. Vol. and self-dealing. Increasing the Statutory Accountability of Directors and Strengthening the Board System The Government should clarify statutory fiduciary responsibilities of the board of directors. This may limit current practices of appointing prominent individuals and family members as directors. the PSE Listing Rules require the appointment of a minimum number of independent directors in the board of publicly listed companies. To help ensure this. depending on the size of the company. 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 related interests. The following recommendations aim to further improve banking regulations and supervision in the Philippines: (i) limit shareholdings of nonfinancial companies in banks. fit and . and disclosure standards. Finally. By requiring sufficient disclosure and a 75 percent majority vote on such decisions. reporting. 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. (ii) set strict limits on lending by banks to affiliated companies. (iv) require banks to follow international financial accounting. or prohibit cross-guarantees by companies belonging to affiliated groups. 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. It is encouraging that the newly enacted 2000 Banking Laws have introduced changes along these lines. Improving Financial Regulation and Strengthening Implementation The Asian crisis demonstrated the need to strengthen banking regulation. Impose severe penalties for any attempt by banks to circumvent this regulation. and (v) closely monitor. prudential measures and regulations. in particular. raising the current two-thirds majority to a three-fourths majority.. e. They need legal empowerment such as higher majority voting requirements. 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.g. the board can easily muster the needed majority to approve the deal. (iii) adopt international standards of capital adequacy and ensure that banks comply with these standards. limit. Because ownership is generally concentrated in five shareholders. The Government should improve its prudential supervision system to ensure that banks perform their role as external control agents of their corporate debtors. directors. the Corporation Code should be amended to impose sufficiently stiff penalties for self-dealings that patently expropriate the wealth of other shareholders. current rules allow boards of directors to approve own-dealings or related party transactions by simple majority. For example. officers.
institutional investors lead public investors in providing market signals to companies. institutional investors can be a driving force in providing market discipline to management. Managements find that their investment and financing decisions affect stock prices and become aware of their responsibility to create shareholder value. Other investors benefit from the information that analysts produce for these institutional investors as information technology makes their output a public good. Reforming the Legal and Regulatory Framework for Investment Funds and Venture Capital Owners of Philippine publicly listed companies consist of controlling shareholders and investors that hold trading portfolios. SEC and PSE can help ensure that these external control agents provide market discipline even in companies controlled by large investors. 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.222 Corporate Governance and Finance in East Asia. and external auditors. Investment and venture capital funds meet this description. By supporting the establishment and operation of institutional investors. The absence of institutional investors indicates that the legal and regulatory basis is inadequate. an active financial analyst community can begin to form. Two measures should be adopted to promote shareholder activism. SEC appears to be taking a primarily regulatory posture in the operation of investment funds. II proper rule. One is improved transparency and disclosure on specific items that potentially involve expropriation of wealth of minority shareholders. This way. The other is the addition of provisions in the Corporation Code to facilitate class action suits against corporate directors. Presently. The current law should expand class action suits to include management and . Its priority is to protect prospective fund investors from unscrupulous fund managers. Institutional investors impose market discipline by voting on strategic corporate decisions. management. Vol. If institutional investors are present. and lending to DOSRI. 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. In developed capital markets. transparency. foreign ownership of banks.
information disclosures. It should develop a medium-term yield curve for the corporate debt market by strengthening the Government bond market. compensation contracts. the Government could develop the market for future issues of corporate bonds. leadership. 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. Legal provisions for class action suits should cover self-dealing by directors. Securities market development efforts should coincide with strict regulation of the commercial banking sector. entry . Promoting the corporate bond market requires that the Government develop trading systems and services of credit risk rating of corporate issuers. and broad-based political and popular support to pursue possible cases involving expropriation of minority shareholders’ wealth. There are existing institutions such as Dun and Bradsreet. Companies are likely to remain dependent on bank financing if the authorities do not strictly enforce prudential lending regulations. and dividend decisions. 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. And by issuing Government Treasury securities in longer tenors. Promoting Competition in Product Markets The Government should pursue industrial development policies that promote competition through the elimination of subsidies. and Credit Information Bureau that can be the starting point of this effort.Chapter 3: Philippines 223 auditors. SEC should allow minority shareholders to be represented by activist groups. guarantees. These groups have an incentive to gather technical expertise. and the external auditors. The present provision on class action suits is inadequate because shareholders view the process as ineffective and expensive. where the threat of class action suits alone is sufficient to encourage quality decisions and behavior from management. 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. Philippine Government Treasury bonds should provide bellwether rates for corporate bonds in the way that they have for short-term bank debts. Placing the means for prosecuting in the hands of minority shareholders may instill more discipline in controlling shareholders.
Another problem is the orientation of external auditors to the interest of large shareholders rather than public investors. Little attention is given to the conditions that make those regulations effective in the US corporate sector but not present in the Philippines. SEC should require that a larger percentage of publicly listed companies’ shares be sold 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. PSE and SEC need to build a liquid and efficient market. Penalties for poor conduct of auditing by independent . The resulting absence of a strong investor base makes share prices vulnerable to manipulation or insider trading by large shareholders. The increase in percentage of public holdings may be gradually implemented to enable the companies to adjust. and various other forms of protection. so that small. Efforts to reduce graft and corruption. Lack of liquidity deters institutional investors. Many large companies remain privately owned. Audited financial statements contain basic information about a company’s financial position and performance. and publicly listed companies trade barely the minimum number of shares required for public listing. Improving External Audit Standards and Information Disclosure Effective external control in corporate governance requires accurate and timely information about companies. and provide quality basic services should also be heightened. The Government’s competition policies should aim to facilitate the free entry and exit of domestic and foreign companies and regulation of anticompetitive practices. there is a need to increase the supply of quality securities from top-tier local companies in the Philippine stock market.and medium-scale companies can become more competitive relative to large companies. Increasing the Supply of Quality Equities in the Stock Market To promote the capital market as an external control agent in corporate governance. The Government should also continue to improve infrastructure. improve enforcement of the rule of law.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. II and exit barriers. Vol. Current disclosure requirements of SEC are not rigorous enough for public investors.
reorganization.Chapter 3: Philippines 225 auditors and the mechanism for imposing them are weak. In spite of the many well-known cases of poorly audited financial statements that resulted in losses for investors. . it creates a moral hazard problem. The law on suspension of payments replaces a market-oriented solution with a political process. and implement those standards and penalties rigorously. the new law needs to be effectively implemented and enforced. review the system of penalties on professionals involved in a company’s violation of disclosure rules. Improving the Legal Framework for Suspension of Payments. PD 902-A has not accomplished any successful rehabilitation of a petitioning company since its implementation. including the resolution of intracorporate disputes. SEC and PICPA have not publicly penalized any auditor company that violated disclosure requirements or failed to submit audited financial statements. violators were made to pay only nominal penalties. Although the new Securities Regulation Code enacted in 2000 has removed some of SEC’s quasijudicial functions. Instead. Reforming the legal framework for suspension of payments. SEC and PICPA need to formulate more specific disclosure standards. and transferred these to courts. The law is obviously not in line with the Government’s policy of allowing market mechanisms to work and not intervening in private sector business. and Liquidation. For that matter. Reorganization. suspension of payments and private damage actions. and liquidation of troubled companies should be made a priority of the Government.
and Larry H. Demsetz. Stijn. The Philippines: Onward to Recovery. Harold. Equity Ownership. and Larry H. 1999. Joseph P. Simeon Djankov. 1997. P.. World Bank. P. Working Paper. World Bank. Private Benefits from Control of Public Corporations. P. H. Fan. Fan. H. Lang. Diane K. Lang. Tokyo: Institute of Developing Economies. Thailand’s Corporate Financing and Governance Structures: Impact on Firms’ Competitiveness. 1999. Large Shareholders. October. George. H. Journal of Political Economy 93 (6). Agency Problems. and Fausto Panunzi. Stijn. Manila: Asian Development Bank. Expropriation of Minority Shareholders in East Asia. Vol. Michael. Dennis Gromb. Quarterly Journal of Economics. Claessens. Denis. 693-728. Conference on Thailand’s Dynamic Economic Recovery and Competitiveness. Stijn. Simeon Djankov. 1994. Discussion Paper. 1998. World Bank. 1999. Thailand: From Financial Crisis to Economic Renewal. Simeon Djankov. May. Dennis. Stijn Claessens. and Larry H. M. The Separation of Ownership and Control in East Asian Corporations. Bangko Sentral ng Pilipinas. Claessens. Joseph Fan. Journal of Financial Economics 25: 371-395. and Clifford Holderness. Jr. 1998c. 1997. Working Paper. and Larry H. 1985. Lang. P. Claessens. and Simeon Djankov. Lang.226 Corporate Governance and Finance in East Asia. Vol. Pedro. Asian Development Bank. P. Barclay. II References Abonyi. and Kenneth Lehn. Claessens. Monitoring and the Value of the Firm. Joseph P. World Bank. and Corporate Diversification. Alba. 1998b. . 1988. Philippine Macroeconomic Prospects: The Next Ten Years. Working Paper 2088. Diversification and Efficiency of Investment by East Asian Corporations. Simeon Djankov. 1989. Joseph P. Burkart. Institute of Southeast Asian Studies. Stijn. 1998. Who Owns and Controls East Asian Corporations? Discussion Paper 2054. edited by Toida Mitusuru and Daisuke Hiratsuka. and Larry H. Fan.. Journal of Finance 2 (1). The Structure of Corporate Ownership: Causes and Consequences. World Bank. David J. July. XXIX. and Atulya Sarin. Antonio. Key Indicators of Developing Asian and Pacific Countries 1998. Asian Industrializing Region in 2005. 1998a. Ownership Structure and Corporate Performance in East Asia. Claessens. Lang. Emilio. March. Simeon Djankov. Stijn.
1977. Jensen. Stuart. American Economic Review 48 (3): 261297. Quarterly Journal of Economics 106: 33-60. 1984. Determinants of Corporate Borrowing. Oliver. Capital Structure and the Information Role of Debt. Jensen. 1990. Exit. Harris. Philippine Stock Exchange Fact Book 1997. Myers. Jensen. 1998. Stein. David S. The Quarterly Journal of Economics. 1986. International Corporate Governance. Hoshi. Agency Costs of Free Cash Flow. and Merton Miller. Prowse. Takeo. Milton.. Journal of Financial Economics 5: 147-175. Gestner. 1983. Joseph C. Corporate Structure. F. Liquidity and Investment: Evidence from Japanese Industrial Groups. and the Failure of Internal Control Systems. American Economic Review 76: 323-29. and William Meckling. Franco. Agency Costs and Ownership Structure. Lufkin.. Journal of Financial Economics 3: 305-360. Robert H. Michael. and Artur Raviv. and the Theory of Investment. 1990. Michael. Douglas. Hart. 1976. Prowse. November. and David Scharfstein. Journal of Finance 48: 831-80. and Jeremy C. 1991. Journal of Financial Economics 27: 4366. Review of Economic Studies 51: 393-414. Michael. Anil Kashyap. and Richard Ruback. Corporation Finance.). Stephen. Corporate Finance and Takeovers.Chapter 3: Philippines 227 Diamond. 1994. 1990. World Bank. 1993. Stephen. Financial Intermediation and Delegated Monitoring. The Market for Corporate Control: A Scientific Evidence. The Modern Industrial Revolution. 1995. Euromoney Books. . Scharfstein. 1958. Journal of Financial Economics 11: 5-50. Theory of the Firm: Managerial Behavior. The Cost of Capital. Internal versus External Capital Markets. Michael. American Economic Review 85: 567-85. Jensen. Debt and Seniority: An Analysis of the Role of Hard Claims in Constraining Management. and David Gallagher (eds. Institutional Investment Patterns and Corporate Financial Behavior in the United States and Japan. 1994 and Investment Guide 1997. 1995. Modigliani. and John Moore. Corporate Governance: Emerging Issues and Lessons from East Asia. Journal of Finance 45: 321-350.
and Banking Lecture 17. 1998. Journal of Finance L11: 737-783. Credit Markets and the Control of Capital. May. 1997. IFC/WB. Mimeograph. 1. II Prowse. 1992. Stein. Andrei. Journal of Money. and Robert W. Andrei. World Bank. Large Shareholders and Corporate Control. Webb. Washington. David. Shleifer. Stiglitz. Washington. November. Ajit. DC. March. How Do Large Corporations in Developing Countries Finance their Growth? Corporate Financial Structures in Developing Countries. Journal of Finance 91: 1121-1139. Vishny. Singh. DC. Asian Development Bank. No. Internal Capital Markets and the Competition for Corporate Resources. 1. Jeremy C. Technical paper No. Journal of Political Economy 94: 461-88. Vishny. A Survey of Corporate Governance.228 Corporate Governance and Finance in East Asia. 1996. 1985. Stephen. No. Joseph E. 1997. 2. Vol. Credit. . Journal of Finance LII. East Asia: The Road to Recovery. The Structure of Ownership in Japan. 1991. and Robert W. 1998. Shleifer. Some Conceptual Issues in Corporate Governance and Finance.
poorly regulated and sheltered from competition. David Edwards. As a result. The banking system. but also the stalling of East Asia’s “economic miracle. the Thai baht came under pressure from speculative attacks. Malaysia. Thailand. Korea). and Philippines all depreciating significantly. But it also laid bare weaknesses in both the financial and corporate sectors. The author wishes to thank Juzhong Zhuang. . and Lea Sumulong and Graham Dwyer for their editorial assistance. Instead of serving as a buffer between the large inflow of foreign capital and the corporate sector. The crisis in Thailand stemmed directly from unsound macroeconomic policies and imbalances. Chonburi.” After mounting an aggressive defense of the currency. Thailand’s crisis exposed similar vulnerabilities in other East Asian economies. the Stock Exchange of Thailand for its help and support in conducting company surveys. The corporate sector also contributed significantly to the crisis. heralding not only a financial crisis in the country.4 Thailand Piman Limpaphayom1 4. and David Webb of the London School of Economics for their guidance and supervision in conducting the study. with the currencies of Indonesia.1 Introduction In May to July 1997. the Thai Government conceded and adopted a floating exchange rate regime. For the period 1994-1996. the banking system merely validated the financial risks. In the prelude to the 1997 crisis. short-term private debt obligations grew to about 60 percent of total private sector debts. The majority of these debts were not properly hedged. with Thai corporations overutilizing short-term foreign currency-denominated loans. coupled with financial liberalization and deregulation in the absence of an effective regulatory and supervisory system. Republic of Korea (henceforth. annual short-term capital inflows to Thailand were equivalent to 7-10 percent of gross domestic product (GDP). had been plagued with prudential problems for a long time. Thai corporations were collectively overexposed to exchange rate risks. Faculty of Business. The fixed exchange rate policy. magnified the impact of these problems on the economy when the crisis hit. both of ADB. It was inefficient in financial intermediation. Asian University of Science and Technology. 1 Associate Professor.
II There is now a consensus that weak governance was partly responsible for the corporate sector’s poor financing and investment practices. Import tariffs on machinery and heavy equipment were removed. while new industries were encouraged to reduce the need for imports.230 Corporate Governance and Finance in East Asia. its growth and financial performance. focusing mainly on the companies listed in the Stock Exchange of Thailand (SET). and a family-based corporate ownership structure.2. To protect domestic industries. lack of transparency and adequate disclosure.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. the Government increased tariffs on products that could be produced locally. as well as its legal and regulatory framework. This study examines these and other factors that might have weakened corporate sector governance in Thailand. The study then considers policy recommendations with emphasis on corporate governance improvement. Key factors that led to weak corporate governance include the ineffectiveness of the regulatory framework.2 discusses the development of the Thai corporate sector under the National Economic and Social Development Plans. The First and Second Plans (1961-1971) Under the first two plans.5 discusses how the corporate sector contributed to the financial crisis and looks at its impacts.1 Overview of the Corporate Sector Historical Development The corporate sector has long been considered the engine of Thailand’s economic growth. Section 4. Section 4. with government policy providing support but avoiding direct interference. Section 4.3 looks at corporate ownership patterns that resulted in inadequate protection for minority shareholders and weak corporate governance in Thailand. . The country initiated national economic development planning in 1961 when the economy was growing rapidly. 4.2 4. Vol. Section 4. the Government implemented major infrastructure projects and modified its tax policy to encourage capital investment and savings. The National Economic and Social Development Board was created to plan the country’s economic and social development.
Fourth. the value of the baht remained stable. resulted in increases in the current account deficit. helped offset these deficits. with the agricultural sector the major contributor. using tax policy to control prices of consumer goods and implementing several price control measures to curb inflation. the government’s debt burden escalated. Unemployment. Thus. The Government decided to embark on restructuring measures in the Fifth Plan (1982-1986) to rehabilitate the ailing economy. Average growth for the period was 4 percent per year. the Government borrowed $6. The Third. Budget deficits remained a major problem during the Fifth Plan.3 percent in 1974. Inflation levels were low. processed steel.Chapter 4: Thailand 231 During this period. 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. an improved trade balance. and Fifth Plans (1972-1986) An economic downturn at the end of the Second Plan led to an adjustment in policies. External factors. averaging 1. The decline in imports was steady. gross national product grew by about 7 percent per year. the current account registered a surplus in 1986. However. capital inflows. The average budget deficit reached an all-time high of $2. As a result. Inflation reached 15.5 percent in 1973 and 24. The focus shifted to export promotion. Consequently. including a weakening of the dollar. Budget deficits also increased throughout the Fourth Plan. became a major problem as domestic investment declined. and reduced current account deficits. textiles. lower than anticipated due to a worldwide economic recession. Industrial sector growth was also rapid and many industries (tires.6 percent per year. leaving the Government no choice but to resort to overseas borrowings. At the same time. In the wake of lower world oil prices and the rapid growth in income from the tourism and travel industry. and automobile assembly) emerged.4 billion from overseas and increased taxes on numerous items. The results were increased exports. especially foreign aid from the United States. it proceeded with its development plan for the industrial sector. canned foods. however.4 percent of GDP. however. . The Government had to shift emphasis to restoration of economic stability. remaining high until 1981.15 billion per year or 4. and increases in world food and oil prices. chemicals. including luxury goods. To close the fiscal gap. with the devaluation of the baht in 1984 a major step in this direction.
with private foreign debt reaching $92 billion by the end of 1996. China—went to export-oriented manufacturing industries. rather than to productive activities. The country’s high ratings in the international capital market.8 percent. Europe. respectively. the property sector began to collapse in 1996. and Hong Kong. Thailand became a debtor’s market. The Seventh Plan (1992-1996) The economy’s performance from 1992 to 1996 generally met the targets of the Seventh Plan. On top of its predominantly “borrowed” nature. Inflation was 4. The exchange rate was steady at around B25 to the dollar. Thailand’s rapid growth up to the mid-1990s made the country one of the world’s fastest-growing economies. Singapore.2 and 13. combined with its liberal financial policies.5 percent. II The Sixth Plan (1987-1991) Industrial sector productivity improved gradually during the Sixth Plan period.4 percent targets.6 percent. the bulk of domestic investments went to speculative ventures such as real estate. Growth of exports and imports averaged 14. compared with the 8.5 to 13. the Government successfully balanced the budget and even settled its foreign debt of $4 billion before this was due. averaging 10. The country also attracted a large amount of foreign direct investments (FDIs).232 Corporate Governance and Finance in East Asia. Growth rates during 1987-1991 ranged from 9. Most of the FDIs—originating mainly from Japan.8 percent. from only $31 billion in 1992. lower than the target of 8. From 1989. property development. reaching an annual inflow of $2 billion in 1991. The manufacturing sector became a dominant force in the economy. By 1995. increasing its share in total export value from 42 to 76 percent. Key to this growth performance was the government’s adoption in 1993 of an aggressive program for attracting foreign capital to finance domestic investments.7 and 11. an oversupply of housing emerged. compared with the 14. and the stock market. compounded by a slump in property sales. United States. With loans increasingly becoming expensive and hard to come by due to a lending squeeze by the central bank and high interest rates. while exports expanded considerably. .2 percent target.2 percent per year. better than the 5. invited a deluge of capital seeking profitable investments. Vol.6 percent target of the Seventh Plan. Private sector investment grew at an average annual rate of 7 percent. Average annual growth in real GDP was 8 percent.
In 1978. Robbins. which raised the debt service ratio. the corporate sector’s main source of funding was the banks. the establishment of the Securities Exchange of Thailand (SET) was legislated and trading began on 30 April 1975. The country had a current account deficit of about 8 percent of GDP in 1995 and 1996. the Government passed the Public Limited Company Act. a former Chief Economist from the US Securities and Exchange Commission. prepared a comprehensive report entitled “A Capital Market in Thailand. In his report. the signs of an economy about to falter were there. on account of an overvalued baht that weakened export competitiveness. Included in the Second Plan (1967-1971) was a proposal to establish the country’s first authorized and regulated securities market. The deficits caused the Government to rely on even more external borrowing. SET officially became “the Stock Exchange of Thailand” in 1991. In 1969.2. Under the 1962 Commercial Banking Act. with growth shrinking from 23.8 percent in 1995 to 1. In 1972. 4.3 percent in 1996. its policy had always been to protect domestic banks. Exports went into a tailspin. However. 58 on the Control of Commercial Undertakings Affecting Public Safety and Welfare. A series of increases in customs and excise taxes on luxury imports did little to stem rampant consumer spending. the capital markets didn’t play a significant role until 1975. the Bank of Thailand and .Chapter 4: Thailand 233 Toward the end of the Plan period. the Government amended the “Announcement of the Executive Council No. which was amended in 1979 and 1985. placing all publicly listed companies under regulation.” which later became the master plan for the development of the Thai capital market. Sidney M. Foreign banks were barred from competing directly with domestic banks. many companies considered the Act too restrictive and a hindrance to growth.2 Development of Capital Markets Although the corporate sector has long been the government’s main tool for economic development. And because the Government considered the banking system vital to the development of the economy. a policy that held throughout the first six economic development plans. In May 1974. Its most crucial role was to help mobilize funds to support Thailand’s industrialization and economic development. Before the capital market emerged. 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.” extending its control and regulatory powers to the finance and securities companies operating freely at the time.
The resulting availability of funds propelled the corporate sector’s growth through the early part of the 1990s.234 Corporate Governance and Finance in East Asia. Thailand’s capital market entered a new era with improved legislation and regulation. the World Bank had recommended such a move. Externally. Vol. The banks and finance companies operated at insufficient levels of reserve capital and were overexposed in high-risk businesses such as real estate. The pressure dovetailed with the Government’s intention to make Bangkok one of the financial centers of the region. Earlier. while the Securities and Exchange Act (SEA) the same year sought to improve capital market supervision. it usually relied on “moral suasion. there were 29 commercial banks (15 domestic and 14 foreign banks) in Thailand. In the 1990s. Financial deregulation and liberalization allowed the country to attract foreign savings and investments that helped finance the growth of the economy. While the Bank of Thailand had the regulatory power to influence business practices. Economic growth had been rapid and domestic savings could not keep up with the pace to support investments. and new financial instruments.” The Government also granted financial institutions overly generous bailouts. At the end of the Sixth Plan. creating a moral hazard problem—the perverse expectation that imprudent bank behavior would be rewarded with forbearance and bailout. and the General Agreement on Tariffs and Trade (GATT) meeting in Uruguay had the liberalization of financial services on its agenda. increased financial market activities. II the Ministry of Finance had full authority to supervise all commercial banks. Thai banks gained access to a variety of funding sources from around the world. the Government was under international pressure to deregulate the financial sector. The regulatory measures were inadequately designed and poorly enforced. However. to cater specifically to its . the financial and banking laws were generally ineffective. A number of internal and external factors contributed to the Thai Government’s acceptance of the IMF’s Article VIII agreement. Thailand discarded controls on foreign exchange transactions and capital flows—a turning point for the Thai corporate sector. Laws were enacted to stimulate growth of the corporate sector. The introduction of these two laws came just after the Government’s signing of Article VIII of an Agreement with the International Monetary Fund (IMF) in May 1990 to deregulate and liberalize financial markets. With the liberalization of financial markets. The Public Company Act of 1992 relaxed some of the rules and restrictions contained in the original laws.
The stock market boom from 1991 until the financial crash of 1997 reflected international investors’ response to Government policies.6 350.9 16. finance.1 Public Companies Registered.Chapter 4: Thailand 235 fast-growing neighbors. Hunting. 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. with B1. Forestry.4 trillion in registered capital and B791 billion in paid-up capital.6 1.9 261.6 23.394.2 11. in that order. Real Estate. the financial sector is the largest.6 2.1). The result was a corresponding growth and development in Thailand’s capital markets.2.5 791. .9 1. Worldwide.9 34.1 30.101.0 21. The majority of the companies are in manufacturing. the country became recognized as an economic development model for other emerging economies. however. and wholesale/ retail trade and restaurant/hotel sectors. Insurance. about 661 companies with total registered capital of B2. 1978-2000 Number Registered of Capital Companies (B billion) 5 6 245 5 13 129 22 194 42 661 1. and Communication Financing.291. Ministry of Commerce.1 trillion and paid-up capital of B1. Source: Department of Commercial Registration.3 83.0 19. 4.0 110. Thailand. and Fishing Mining and Quarrying Manufacturing Electricity.2 Type of Business Agriculture.3 trillion have been registered with the authority (Table 4. and Business Service Community. and Restaurants and Hotel Transport. Social and Personal Service Total Note: The data for 2000 is as of October 2000.1 78.3 Growth and Financial Performance Since the 1978 enactment of the Public Limited Company Act. Gas. Storage.0 Paid-up Capital (B billion) 1. The manufacturing sector is a far second with registered capital of B350 billion and paid-up capital of Table 4.5 50. and Water Construction Wholesale and Retail Trade.5 111. In terms of capital. Financial deregulation and liberalization were key to realizing that vision.
this was due to the recapitalization of commercial banks in compliance with the new loan provisioning requirement.3 194. reducing the value of offerings to a little more than a quarter of the previous year’s level. The stock market also became an invaluable source of funds for corporations.1 54. Table 4.4 277.8 billion.9 37.2).6 39.6 7.2 40. Domestic and offshore debt issues reached B54.0 20. moreover.6 8.8 151. Securities and Exchange Commission of Thailand.3). Market capitalization.1 2.7 billion and B27.8 201.7 27.8 — 26.7 billion in 1996. The number of listed companies and securities steadily increased until 1996 (Table 4. respectively. reached .1 599.236 Corporate Governance and Finance in East Asia. The development of the corporate sector closely followed the development of capital markets. After the passage of the SEA of 1992.5 billion and B1 billion the previous year.7 7.5 1.7 136.7 5. These peaked at B89. Vol.3 31. The signing of Article VIII with the IMF. meanwhile. 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 1.4 51. The 1997 crisis battered the primary market for securities. While a rebound was apparent beginning in 1998.1 286. II B261 billion. allowed Thai financial institutions and corporations to obtain funds overseas.5 — — 56.4 34.2 5.4 96.6 174.9 1998 1999 15.7 9.5 1. With the enactment of the SEA of 1992 that brought suppliers of finance services and their clients together.2 12.2 25. the value of public offerings rose steadily. the year before the crisis struck.3 6. Source: Key Capital Market Statistics. The preeminence of the financial sector is a direct result of financial deregulation and liberalization.6 — = not available.9 31.3 22.1 — — — 6.8 1995 64. from only B20.5 39.0 0. the capital market became instrumental in the rapid growth and development of the corporate sector. reaching a precrisis peak in 1996 (Table 4.0 1994 82.2 Public Offerings of Securities. Debt market activities also increased significantly with the establishment of the Bond Dealers’ Club (BDC) in 1994.3 1996 1997 65.
pulled down by active public offering activities. The plunge in profitability and asset turnover—from 117 percent in 1985 to 65 percent in 1996 for the latter—cast doubts on the .683 1.565 2. resulting in their inability to fulfill debt obligations.133 1. the companies could not generate enough net returns from their assets and equity.4).360 1. But instead of shifting to a low gear. From 10. The key financial ratios of all companies listed on SET bear this out (Table 4.Chapter 4: Thailand 237 Table 4. then stalled in 1990.201 2. their share rising from 17 percent in 1993 to 43 percent in 1997. the averages for all three profitability ratios took a downswing all the way until 1996. By the early 1990s.3 Statistical Highlights of the Stock Exchange of Thailand. when long-term debt grew as Thai corporations began to borrow heavily to finance growth. was the ominous deterioration in the key financial ratios of publicly listed companies. ROE similarly fell from 21. its high point in 1995 at B3.3 percent in 1989 to 3. corporate profitability had been declining. gross profit margin rose until 1991 before falling in 1992. Meanwhile. The financial leverage of all companies declined until 1994.560 1.4 percent in 1996. The trend reversed in 1995. the highly liquid financial system continued offering cheap funds to sustain corporate sector investments.6 trillion. Throughout the 1990s. 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. not all public companies are listed on the SET. Side by side with this surge of financing for corporate growth. as measured by return on assets (ROA). ROA dipped from 10. return on equity (ROE).610 1. Foreigners accounted for an increasing proportion of SET’s turnover value.4 percent to 5. in the end.8 percent. had been on the rise throughout the 1980s.281 832 373 356 482 Due to listing requirements and other reasons.303 930 855 1.193 2. Source: Securities and Exchange Commission of Thailand. The upward trends for ROE and ROA continued through 1989. the average times interest earned (TIE) was down to 5.114 1. Corporate profitability.325 3. and gross profit margin.5 at its peak in 1987. however.1 by 1996.268 2. While the decline in gross profit margin was not as sharp.535 1.301 3. however.
0 3.2 10.8 25.2 64. Korea and Thailand had the highest debt-to-equity ratios.2 27.0 63. A major reason for this was the rapid rise in asset prices. and footwear had the lowest at 11 percent. Overall. Severely affected by global competition throughout the decade. II Table 4.7 21.8 11.1 44.8 88.4 24. these companies opted for debt.6 41.4 28.9 140.4 51.2 49.7 12.4 7.7 34. which was particularly significant in the two years preceding the crisis.238 Corporate Governance and Finance in East Asia. 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 (%) (%) (%) 3.6 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.5 15.5 50.1 16.4 18.7 35.6 12.7 54.4 Key Financial Ratios of Publicly Listed Companies.4 47.2 35. Thailand’s ROE.4 26.9 144.1 242.6 7.9 66.2 27.5 51. It has also been argued that family-based controlling shareholders borrowed excessively to avoid diluting their control over their corporations. Vol.7 LongTerm Debt to Asset Assets Turnover (%) (%) 14.7 12.6 36.2 10.5). They were generally more efficient in managing their assets and . US.4 119.0 139.6 138.0 29. Among the crisis-hit countries.6 125.4 34.7 12.8 151.1 120. was felt across industries.8 51.9 27.4 12.0 125. resulting in higher collateral values for borrowers.7 15.5 9.9 51.8 54.2 161.7 5.1 16.7 5.7 4. and footwear industries also experienced losses. practice of heavy borrowing.7 12.8 8.7 80. the textiles.7 59.4 3.7 27.1 52.4 5.3 10. clothing. clothing.9 77. Hotels and travel showed the highest ROE of 15 percent while textiles.1 9.4 4. which fell from 16 percent in 1991 to just under 6 percent in 1996.3 91. large companies (where size is reckoned in terms of assets or sales) were more profitable than small companies in terms of ROE (Table 4.7 27.4 44.2 6.6 168.4 139.8 5.5 30.3 12. but was most severe in building and furnishing material industries as a result of the downturn in the real estate market.8 14.1 114. Despite the availability of the equity market.4 12.9 8.0 7. The downtrend in corporate profitability.7 20.5 52.2 10.4 9.9 39.0 145.3 4.4 7.9 14.5 63.1 60.8 5.9 7. was also distinct in the region.0 117.2 215.6 27.5 38.7 5.3 8.9 7.
1 25.3 15. 4. Cumulative voting.7 10.6 7. The argument was that having a Board of Directors whose members represented different groups of investors would create conflicts and hamper management effectiveness. They also tended to use more financial leverage than small companies as their total DERs show.2 121. could lead to a high turnover in the board.7 Source: Pacific-Basin Capital Markets Database compiled by the University of Rhode Island.3 25.3 49.6 5.5 87.3 23. weaknesses became evident. measured by total asset turnover.8 10.3 88.3 43.8 6.6 10.0 48.7 14. which would be disruptive to company management.8 142. During the 1990s. In sum.3 176. However.8 6.5 6.8 26. For instance. the overall activities of listed companies.4 8.8 62. by the 1990s.3 164. although the performance of listed companies in the late 1980s was strong. Although stable in the 1980s.6 31. There were also concerns that the provisions governing the criminal prosecution and penalties of directors and management were harsh and inappropriate. capital despite the higher gross margins of small companies. also deteriorated.0 20.6 30.1 Small Medium Large 5. some rules and regulations of this particular law were believed to be too restrictive and were discouraging companies from going public. US. 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 6.6 61.3 49.0 83.4 Legal and Regulatory Framework Before 1992.2 10.5 94.Chapter 4: Thailand 239 Table 4. it was thought.2.1 29.2 134.1 6.1 5.6 6.9 20.8 47.6 12.2 18.9 13.7 6. .6 30. Increasingly heavy borrowings rendered the sector even more vulnerable to lower profitability and sales.4 116. the Public Limited Company Act of 1978 and its amendments regulated Thai publicly listed companies.3 135.1 13. total asset turnover declined after 1989.4 52.2 12.5 7. the law disallowed cumulative voting.5 Average Key Financial Ratios by Company Size.3 52.
but not all questions were answered. from holding more than 50 percent of total outstanding shares and other shareholders from holding more than 10 percent of outstanding shares individually. II Another issue was the proportion of shareholding by top shareholders. and the punishment for management misconduct was also lightened considerably. The original company owners welcomed the changes and the number of publicly listed companies subsequently rose to more than 600. The law prohibited the largest shareholders. Vol. for instance. the exit of these provisions appears to have contributed to the 1997 financial crisis. As it turned out.3 Corporate Ownership and Control Ownership and control of corporations in Thailand are highly concentrated. The legal and regulatory framework for the corporate sector also includes provisions related to insolvency. The provision discouraged original family owners from registering their companies.2 The market for corporate control was not active and did not give managers strong incentives to perform efficiently. An Asian Development Bank (ADB) survey conducted for this study shows. as a group. The protection of minority shareholders was inadequate under the Public Company Act of 1992. 2 ADB survey questionnaires were sent to all Thai listed companies in early 1999. 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. a feature that is believed to have impaired the effectiveness of existing regulatory mechanisms in the corporate sector. As the succeeding sections point out. coupled with weak corporate governance. played an important role in bringing about the financial crisis. concentrated ownership. 4. . the new legislation removed a number of incentives that would have kept public companies prudent and diligent in their operations. The Public Company Act of 1992. This will be discussed in Section 4. Fortysix companies responded. that creditors had generally little influence on the management of corporations.240 Corporate Governance and Finance in East Asia.5. Cumulative voting was made optional. However. and external monitoring and control of corporations were also weak. relaxed the contentious provisions of the 1978 Public Limited Company Act.
4 6.1 11.4 26.9 percent of shares of a company. 56. with the largest shareholder on average controlling 10.3 percent.9 52.7 11.0 53.3 7.0 7.7 percent. Unfortunately. But with their increased reliance on new varieties of equity and debt instruments.6 28. 33.6). this was not the case.8 11. with the top three shareholders accounting for almost 50 percent (Table 4.6 57. and minority shareholders to stake their claim in the control and regulation of these companies.1 12.3 7.6 68.1 5.7 7.4 4.8 32. creditors.4 26. Most large Thai corporations listed on SET started out as family businesses.4 26.4 6.1 5. respectively. and Hong Kong. Thai. In the past. Table 4. The Public Company Act of 1992 allowed ownership and control of these companies to remain with the founding families even as they became increasingly dependent on nonfamily resources.7 6.9 3.9 26.1 3.3. Ownership Concentration Between 1990 and 1998.2 4.0 56. on average. there were only slight variations in the pattern.3 28. these companies obtained funding solely from banks or from their own retained earnings. .6 Top-Five Ownership Concentration of Publicly Listed Companies in Thailand.2 4. Ownership was most concentrated in the packaging.5 Average for 1990-1998 period.0 5.0 7.9 55.4 percent of outstanding shares. This implies that the top five shareholders enjoyed full control over the outcomes of shareholder meetings.9 11.9 3. 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 28.5 9. and 28.1 4.0 3.4 10.3 5.1 Patterns of Corporate Ownership A World Bank study covering nine Asian countries finds that firms in Japan and Taipei.8 5. Indonesian. the top five shareholders of each of publicly listed Thai companies held.0 3.1 percent of control rights.9 6.2 56. Across industries.7 12. Source: Comprehensive Listed Company Information Database.9 52.1 7.5 28.3 percent and 18.6 4.China have the least concentrated ownership. In contrast.3 11. Stock Exchange of Thailand.2 11.4 5. China firms have the highest single shareholder ownership concentration at 35.2 4.9 4.9 52.6 27.Chapter 4: Thailand 241 4. one would expect the public.1 5.9 54.3 16.
800 0. Through these holding companies.7). Table 4. and ownership types. ** at the 5 percent level.533)*** Debt-to-Assets (0.058* ROE (0. * Denotes significance at the 10 percent level. US.115 9. founding families maintain effective control of entire groups. including those that are publicly listed . year.001 0.031 3. Composition of Controlling Shareholders Affiliated corporations comprise the largest group among the top five shareholders of publicly listed companies.034*** 0. Company size is significantly related to ROE and leverage. *** at the 1 percent level. with a top-five ownership concentration of at least 60 percent. owning 26. as measured by debt-to-equity and debt-to-asset ratios. results show a significant positive relationship between ownership concentration and financial leverage. and Company Size Item Intercept Top Five Ownership Concentration Company Size Adjusted R-Squared F-Statistic ROA 0.090 0. Source: Author’s estimation based on the Pacific-Basin Capital Markets Database compiled by the University of Rhode Island.072) (0.029 3.001) 0.169*** 0. 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 4.003 0.7 percent of outstanding shares on average (Table 4. On the other hand. Ownership Concentration. and building and furnishing industries.037 0. II agribusiness. Based on a regression analysis.001*** 0.7 Statistical Relationships between Corporate Profitability.005** 0. 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. Leverage.116) Debt-to-Equity (1.8). It is the practice of Thai corporate founding families to set up holding companies to own shares in affiliated companies or subsidiaries. Vol.242 Corporate Governance and Finance in East Asia. Other industries had their top five shareholders controlling at least 55 percent of outstanding shares.022*** 0.080 6.647 Note: The regression included dummy variables for industry.
7 Bank 2.1 0.2 7.4 20. Individual family members also hold a significant amount of outstanding shares.5 5.8 Top-Five Shareholder Composition of Publicly Listed Companies in Thailand.7 0.3 27. the company.6 25.3 27.5 0.2 5. The top 10 shareholders include a holding company owned by the Tejapaibul family.9 6.8 1.5 percent.9 15. one of the founding members.5 1.6 28. the company increased its registered capital and became a public company listed in SET. These individuals usually hold important management positions in concerned companies.3 1.1 1.5 26. This practice is illustrated by Central Pattana. a joint venture among three families.9 0.4 22. the affiliate firms rarely hold shares of their parent companies. individual members of the Chirathivat family aggregately hold 25.0 19.5 0.3 1.4 1. including finance and investment companies. In addition.9 18.8 23.Chapter 4: Thailand 243 Table 4.2 18. in SET. a NBFIs denotes nonbank financial institutions.3 0. . The roster of its major shareholders as of December 1997 illustrates the typical ownership concentration of a publicly listed company in Thailand.0 18.1 1.3 20. The ADB survey indicated that listed companies held shares in an average of 11 companies. owned by the Chirathivat family. 1990-1998 Year 1990 1991 1992 1993 1994 1995 1996 1997 1998 Average Company 28. founding families and their relatives maintain control of many companies by jointly holding on to the most significant chunk of shares.6 percent of outstanding shares. Stock Exchange of Thailand. unlike in Japan where crossshareholding is common. averaging about 18. The largest shareholder is Central Holdings Company.1 4.9 7.8 0.3 1.6 1.6 1.0 3.5 Government Other 0.7 5.4 1.7 1.3 percent of outstanding shares.5 NBFIsa 6. with 29. a company listed in the real estate sector of SET. Established in 1980 with a registered capital of B300 million.4 1. Source: Comprehensive Listed Company Information Database.5 Individuals 13. operates five of the most successful shopping malls in Thailand.6 5.3 27. Typically. Although holding companies set up affiliate firms.5 2.5 1.3 — = not available.2 1. In 1994.7 — 1.2 1.0 17.5 0.9 19.8 28.6 1.
3. Vol. and responsibilities of directors of public companies. 4. Although the list of top shareholders of publicly listed companies includes financial institutions. qualification. on average. the Government owns the majority of the shares. the predominance of individual family members and holding companies in the top shareholder list remains valid. they account for 80 percent of total outstanding shares. Moreover. where the top three shareholders are the Ministry of Finance. duties. On average. Together. roles. 1. About half of listed companies have nonbank financial institutions such as finance and investment companies in their top-five shareholder list. commercial banks account for only 1.9 percent of outstanding shares. Nonbank financial institutions hold an aggregate 5.1 percent of total outstanding shares of listed companies. 3 Discussions in this section are based on results of company surveys by SET and ADB. both conducted in 1999. In effect. only one tenth of listed companies have commercial banks on their top-five shareholder list.5 percent of total outstanding shares. Across industries.244 Corporate Governance and Finance in East Asia. the Government’s role in public companies is expected to decline. For example. .2 Corporate Management and Control3 Board of Directors The Public Company Act of 1992 stipulates the appointment process. holdings by individual family members and holding companies account for at least 50 percent of outstanding shares of an average listed company. By owning 62 percent of voting shares. the Petroleum Authority of Thailand. Another example is Bangchak Petroleum Plc. they exercise limited influence in operations because of the restricted size of their shareholdings. these shareholders are able to control the company. has the Ministry of Finance as its only large shareholder with 92. There was a trend of rising government shareholdings throughout the period 1990 to 1998. Except in the hotel and travel service sector. However. with the envisioned privatization master plan. The Government holds. In such cases. Only a handful of companies have the Government among their large shareholders.. Thai Airways International Plc. II another of the company’s founding members. the top 10 shareholders consist predominantly of members of founding families and their holding companies. and a state bank.5 percent of total outstanding shares of listed companies.
that only in two of the 46 responding companies were the chair of the boards elected based on the extent of their shareholdings. Most companies (83 percent) satisfied SET’s requirement of having two independent board members. Generally. Three companies indicated that the CEO and the chair were close relatives. In addition.Chapter 4: Thailand 245 Directors are required to meet minimum qualifications specified under the SEA of 1992 and the Listing Rules issued by SET. the majority (71 percent) had board chairs who were also members of top management teams. In five other companies. Many companies have a formal policy on corporate governance and business ethics. selection was based on relationships with controlling shareholders. directors shall be elected at the annual general shareholders’ meetings (AGSMs). directors could be compelled to compensate the company for damages arising from their misconduct. directors are required to act with care and honesty for the company’s best interest. Unless stipulated in public companies’ articles of association. while 30 percent of respondent companies held board meetings monthly. directors may be imprisoned or fined. but not in 22 others. Nineteen companies stated that selection was based on professional qualifications. Some companies (36 percent) had five to six main board members holding seats in their executive boards. . A survey by SET found that the majority (58 percent) of the 202 responding companies held their board meetings every quarter. while 15 percent of respondents went beyond the requirement. the ADB survey found that 31 companies (out of 46 responding) required outside directors to be present at all board meetings. In their business conduct. The ADB survey indicated. Almost all companies (98 percent) exceeded the minimum required five members in their Board of Directors. If found in violation of these provisions. Meanwhile. The appointment of the chief executive officer (CEO) needed approval during the AGSM in 11 of the responding companies. 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. Although 28 percent of the chairpersons came from the ranks of independent outside directors. an executive board consists of senior management and some main board members. and to comply with the laws and articles of association. meanwhile.
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. 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 1998.246 Corporate Governance and Finance in East Asia. Fourteen other companies had profit-related incentive schemes in addition to fixed fees. these were attributed to variations in the extent of duties and responsibilities assumed by those directors. Directors with managerial responsibility or those related to major shareholders cannot be members of such audit committees. the majority of the companies (77 percent) did not have outside directors as members of their remuneration committees. Twenty-five of the 46 respondents to the ADB survey declared adherence to all relevant international standards. All respondents confirmed the use of external auditors. In one company. the auditor is not . with 41 firms admitting the use of services of international auditing firms. Chair. II Compensation of Directors. not an independent assignment. These committees were mainly responsible for determining compensation for senior and regular staff. Where different. Three companies allowed their management to determine the chair’s compensation package. Also. however. and CEO The majority of company respondents to the SET survey provided similar compensation packages to internal and external directors. while 19 companies observed only some of them. Half of the companies in the SET survey had a separate remuneration committee. In 25 companies. the remuneration packages had to be approved during AGSMs. However. Companies already with audit committees did not have independent outside directors as audit committee members. The ADB survey indicated that 18 of the 46 responding companies compensated their chairpersons using a fixed-fee schedule. the work of this committee was often considered part of the executive board’s responsibilities. The SET survey found that the majority of listed companies (81 percent) still have no separate audit committee. all listed companies have been instructed to establish audit committees to be responsible for examining the quality and reliability of company financial statements. Vol. Audit Committees and Accounting Standards Since January 1999.
likewise. shareholders can claim compensation in cases of negligence or dishonesty by management. stipulates the proper conduct of shareholder meetings. According to the ADB survey. At least 28 responding companies had the following . and executive committees. there are also significant gaps in the system of shareholder protection. However. Forty-four companies indicated that they had proxy voting in place. (iii) Because the chair is frequently also part of the top management team. In the majority of these companies (38 out of 46 respondents). and the Bank of Thailand— are not clearly defined. SET’s rules and regulations closely follow this Act. the corporate sector lacks a strong self-regulatory body to compel compliance with these standards. Relationships between firms and external auditors are generally long-term. shareholders have access to reliable information at no cost. the Securities and Exchange Commission (SEC) and SET were actively prosecuting violating firms. there is the danger that top management may be capable of unduly influencing the board’s decisions. Shareholders are also entitled to call emergency meetings and present proposals at AGSMs. As a result.Chapter 4: Thailand 247 independent from the company. The Act also holds directors liable for any damage to shareholders. the institutional machinery is not fully responsive to complaints about violation of shareholder rights. SEC. averaging about 14 years. While safeguards are in place. The majority of the companies (85 percent) require the appointment of external auditors during annual general meetings. remuneration. (iv) The roles and responsibilities of the major government agencies regulating shareholder rights—the Ministry of Commerce. although recently. (i) No standards are enforced in the content and timing of notices for shareholder meetings. SET. or other financial instruments. including false statements to conceal information about the financial condition and operations of the company during the sale of shares. debentures. most responding companies have rules and regulations intended to protect shareholders. Minority Shareholders and their Rights Many different rights and entitlements of shareholders are laid out in the Public Company Act of 1992. The Act. Proxy solicitation tends to be abused to the extent that shareholders are inadequately informed about matters to be taken up in shareholder assemblies. with 13 companies allowing proxy voting through mail. For instance. as well as the registration and holding of shares. (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.
and insider trading. minority shareholders are assured adequate legal protection. did not vote in previous AGSMs. and call an extraordinary session. But with the ownership concentration of Thai companies. Only a small number of shareholders attended the latest AGSMs. such protection has been insufficient. . On paper. 4. The SEA of 1992 and the listing rules also contain provisions for the protection of shareholders against transfer pricing. they comprised only 8 percent of total shareholders. it would be difficult for minority shareholders to gather the shares needed to take action. In practice. Although the attendees held. the only group of shareholders that can exercise rights is the top five shareholders.248 Corporate Governance and Finance in East Asia. Almost 82 percent of shareholders. 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. 66 percent of total outstanding shares.3. takeover of the company.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. given their importance in providing finance and their stake in companies. The ADB survey results reveal that the proposals presented by management were rarely rejected during the general meetings. The difficulty minority shareholders have in exercising their rights can be seen from the ADB survey results. on average. representing only about 28 percent of shareholdings. and mandatory disclosure of related interests and significant shareholders’ transactions. however. In theory. While stimulating the growth of the sector. Vol. minority shareholders may also appoint an outside inspector to examine the company’s operations and financial condition. the new Public Company Act of 1992 inadvertently weakened the governance of public companies by diminishing minority shareholder rights. But the exercise of these rights requires even higher shareholding levels. Banks would be obvious candidates to implement these mechanisms. 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. In effect. II mechanisms in place: mandatory shareholder approval of major transactions and interested or related party transactions.
Actual bankruptcy proceedings took more than five years on average. Leverage allows the assets and operations of the company to grow without diluting corporate control. Only 28 of the responding companies in the ADB survey indicated that their creditors required such feasibility studies. Most companies reported that banks were more likely to require collateral. Debtors had many handles to stall the bankruptcy process. Apparently. other than losing control. The presence of collateral usually diminishes banks’ incentives for screening project feasibility and monitoring project implementation. however. Fifteen of the 20 companies that had to renegotiate loan repayment with creditors in the last five years did so after the crisis. Under a weak bankruptcy system. to solve debt repayment problems. Thailand has relied on commercial banks and finance companies to channel funds to private enterprises.Chapter 4: Thailand 249 Historically. The impact of the financial crisis on credit eligibility and supervision requirements has been significant. when insiders want to expand their company’s operations without losing control. Among 16 companies in the ADB survey whose loan applications in the last three years were rejected. as the ADB survey confirmed. One tempering mechanism that could inhibit the excessive use of borrowing is the threat of losing control in the event of bankruptcy. creditors’ collateral requirements were tightened after the crisis. while 18 said none of their creditors required collateral. which could cause a delay by at least a year. . Only three companies thought otherwise. such as that seen in Thailand before the crisis. The old bankruptcy law in Thailand also made it difficult for creditors to obtain payment against bankrupt borrowers. However. including procedural disputes. There were many options. 11 experienced rejection after the crisis started. creditors do not always require project feasibility studies or business plans in granting loans. borrowers seldom lose control to creditors even when they default and become insolvent. the majority believed that creditors had little influence on company management and decision making. 17 indicated that only some of their creditors had such a requirement. they resort to borrowing. In the end. For 20 of the 46 responding companies. Seven of the companies responding to the ADB survey indicated that all their creditors required collateral. Normally. while loans for fixed investment were also more likely to be supported by collateral. a company’s reputation and its long-term relationship with creditors sufficed in many instances. Eleven companies stated that creditors usually exercised whatever influence they had on management through covenants regarding the use of loans.
and (iii) tender offers will be effective 30 days after the report has been filed with the SEC. The situation remained sluggish in 1997 at nine tender offers and a further decline in total offered value. SEC has no authority to either approve or reject tender offers. Since the introduction of the Public Limited Company Act of 1978. before the extent to which the bankruptcy framework has been strengthened becomes clear. II The financial crisis has presented a unique opportunity for reinventing the framework for corporate bankruptcy and for creating regulatory and judicial precedents. if the purchase of shares implies a change in the directors or business activities. with a total tender offer value of B42. The second category is the tender offer. of shareholders: (i) all shareholders must receive tender offers. the minimum tender offer was reduced to 10 percent and some procedural modifications have also been introduced. There are detailed requirements regarding such notification. its main role is to ensure transparency and fairness. which is a general offer made to shareholders of a company to acquire at least 25 percent of outstanding shares. The first category is the acquisition of shares in the open market. only a limited number of successful mergers of public companies have taken place. It will take years. Such efforts would serve to strengthen external discipline on controlling owners. Recently. there were only six tender offers. (ii) an advertisement regarding the tender offer must be placed in major newspapers for at least three consecutive days.250 Corporate Governance and Finance in East Asia. The company has 21 days to evaluate the tender offer and submit a report to SEC and all shareholders. According to the SEA of 1992.3 billion (Table 4. In 1996. In this case. however. and failed to provide managers with strong incentives to perform efficiently. a person who acquires more than 5 percent of issued shares must file a report with SEC one day after the date of acquisition. there were 41 cases of tender offers.3 billion. Although merger and acquisi- . whether directly or indirectly. SEC was later made responsible for regulating corporate takeovers. there are two categories of merger and acquisition activities with associated regulatory measures.9). The Market for Corporate Control The SEA of 1992 was the first legislation that stipulated rules and regulations regarding the market for corporate control. with a significantly lower total tender offer value of B8. The market for corporate control has not been active in Thailand. Vol. 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. In 1994 and 1995.
2 8.2 7. Since 1994.1 75. Even when companies offer ESOPs.3 6.8 81. employee participation in corporate governance in Thailand.7 Purchase Value Number of % of Tender Offer Value Companies 84. Twenty-nine firms indicated that employees held shares of their companies. if any.1 19.4 23.1 84. most of these were forced mergers or related to rescue packages. they have mostly been concerned with short-term gains. 1993-1999 Year 1993 1994 1995 1996 1997 1998 1999 a Tender Offer Valuea (B billion) 5.9 Merger and Acquisition Activities. Provident funds for government workers and workers in public enterprises have been established only recently. but employees have never been represented in the board of directors since their shareholdings are minimal. The number of domestic institutional investors rose after the mutual fund industry was established in 1991. not with a view to becoming involved in actual management.8 8 27 14 6 9 13 23 Tender offer value refers to the minimum offer value.6 17. . but the average shareholding is smaller than 1 percent of total outstanding shares.9 3.Chapter 4: Thailand 251 Table 4.1 58.0 B billion 4.0 55.2 6.5 6. While the Thai mutual fund industry compares well to those in other developing countries in the region. Employee Participation in Corporate Governance There has been little. Because of the current crisis. it remains small. trading by mutual funds in SET represented less than 10 percent of total trading. employees are even less willing to accept common shares as a form of compensation or benefit.3 11. Few companies offer employee stock option plans (ESOPs). Pension funds are perhaps even weaker in Thailand. employees regard the plans as monetary incentives. Eleven of the 46 responding companies in the ADB survey offer ESOPs.7 11. But instead of opting for an active role in the market for corporate control. tion activities increased after 1997. Source: Securities and Exchange Commission of Thailand.3 60.2 6.
Thai Bond Dealing Centre.161.979.10 Size and Composition of the Thai Financial Sector.912. Many large commercial banks had affiliates among the 93 finance companies that served the high-risk market.4.775. The total values of loans from financial institutions and commercial banks were consistently larger than the market capitalization of SET. The country’s largest bank.559.300.1 Corporate Financing Overview of the Financial Sector A breakdown of the Thai financial sector for the period 1992-1999 (Table 4. The bond market played only a marginal role in corporate financing.4 1.360.5 trillion.0 SET Market Capitalization 1.133. Table 4. although its role increased in the wake of the crisis. Competition from foreign banks was limited as they were not allowed to engage in full branch operations.1 7.252 Corporate Governance and Finance in East Asia.430.1 Domestic Debt Securities Outstanding 215.119.5 4.4 4.1 6.669.6 2. the next four largest banks accounted for 63 percent.0 339.8 941. Bangkok Bank Ltd.4 Year 1992 1993 1994 1995 1996 1997 1998 1999 Source: Stock Exchange of Thailand. the banking sector was highly concentrated.325. The share of domestic banks in the banking system’s total assets was 80 percent. 15 of which were domestic banks. and Bank of Thailand. In 1996..8 3.4 3.037. accounted for 28 percent of the banking sector’s total assets.5 Outstanding Loans from Commercial Banks 2.2 2.564.9 2.0 8.10) shows that Thailand is a highly bank-dependent economy.171.477. total assets of commercial banks amounted to B5.6 6.0 3.485.1 3. .906. there were 29 commercial banks.1 5.3 546.1 3.5 6. The Banking System Until recently.3 1.3 5.4 4.663.5 4.2 262.825.4 519. 1992-1999 (B billion) Outstanding Loans from All Financial Institutions 2.390.230.268.5 5.6 1. II 4. Vol.0 424.193.372.
The Equity Market During the first few years of its operations. Licenses were granted to 15 Thai banks. In the following years. due to their close ties. the stock market entered its first boom period in 1986. The Government removed controls on capital and dividend repatriation in 1991. the Government established the BIBF to expand the banking sector and reduce the borrowing costs of Thai companies. and property have accounted for the bulk of trading volumes. hardly any progress was made in lowering the cost of domestic financial intermediation or in developing new financial instruments for corporations. The number of listed companies also quadrupled between 1981 and 1993. an over-the-counter market.8 in 1998. was set up by 74 members with an initial capital of B500 million. BSDC is a nonprofit.Chapter 4: Thailand 253 The Government was also a major figure in the banking system. In 1995. Banking activity peaked in the mid-1990s. SET was not very active. Stock prices tripled in the next three years until the market experienced its first crash as a result of the Gulf Crisis in 1990. the liberalization of interest rates and capital account transactions stimulated a credit expansion through short-term borrowings in foreign currency. reaching 355. In contrast. and almost all capital account transactions were deregulated. Despite the worldwide market crash in 1987. banking. the SET index declined. and 20 new foreign banks. Turnover value reached B2. owning 70 percent of the country’s second largest bank. The lack of supply of quality shares was a big problem for SET at that time. Many company founders did not want to release even a small portion of corporate ownership and refused to go public. 12 existing foreign banks. SET is organized into 32 major industries. Some 347 companies were listed in the same year with a total market capitalization of B3. also made it unattractive to raise capital from the equity market. self-regulatory organization under the . SET immediately recovered due to the strength of the Thai economy. Banks under the BIBF scheme were allowed to mobilize funds from abroad and lend to Thai companies in foreign currency. Through the years. the market rose steadily and reached a record high in the fourth quarter of 1993.2 trillion. Because borrowers carried the exchange rate risk. finance. the Bangkok Stock Dealing Center (BSDC).3 trillion. After that. Benefiting from rapid economic and industrial growth. In 1993. Easy access to commercial bank loans by family business groups. BIBF banks also enjoyed tax incentives on their operations and profits.
The SEA of 1992 installed the legal and regulatory framework for Thai capital markets. there were two kinds of companies in SET—“listed” and “authorized” companies. The listing application should be submitted concurrently to SEC and SET. In 1998. The allocation procedure is nondiscretionary. the two classifications were merged. It separated the primary and secondary markets to promote more flexible and effective supervision of both. Vol. Before 1993. Company applicants must have an established history of operating under substantially the same management. the BSDC was dissolved in 1999. Turnover value was B1. II jurisdiction of SEC. Consequently. however. The primary market is supervised by SEC. lottery drawing must be used to ensure fairness. but dropped the following year to B122 million.254 Corporate Governance and Finance in East Asia. financial projections. . so now only listed companies are traded in SET. Listed companies were those that had (i) paid-up capital of at least B20 million. If the issue is oversubscribed. In July 1990. SET established new requirements for initial public offerings. among other functions approved by SEC. to assist in the public offering process. securities can be traded in the secondary markets.5 percent and collectively owning at least 30 percent of paidup capital. A company wishing to qualify for listing in SET must file an information booklet (prospectus) with SEC and SET. SET. which consist of SET and BSDC. also acts as a clearinghouse. According to the SEA of 1992. which has a legal mandate to examine a company’s financial status and operations before allowing it to issue securities to the public. Only one security was listed in BSDC in 1995 and two more in 1996. Its main role is to serve as a secondary market for unlisted companies trying to raise capital.8 billion in 1996. and pro forma balance sheet and income statements. Proposed changes in capital must be submitted for approval to SET accompanied by a detailed memorandum outlining the use of proceeds. and securities registrar. approved by SET. stock trading can commence within five days. Authorized companies were those with a minimum of 200 shareholders owning collectively at least 25 percent of paid-up capital. In 1996. If approved by SEC and the SET Board of Governors. The company should then appoint a financial adviser. turnover value was negligible and the BSDC Index remained flat throughout 19961998. and (ii) a minimum of 300 shareholders. securities deposit center. with each facing different listing requirements. each holding no more than 0. After initial public offerings. 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.
The recent financial crisis. In 1996. it represented only 9 percent of GDP. A turning point of the corporate debt market was the enactment of the SEA of 1992. The budget surpluses of the 1990s eliminated the need for new bond issuance. 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. which encouraged limited companies and public companies to issue debt instruments. the year the Ministry of Finance first issued government bonds to finance infrastructure projects and economic development. the size of the corporate debt market rose to B132.Chapter 4: Thailand 255 The Bond Market The Thai bond market has played a marginal role in corporate financing until recently. A breakdown of domestic offerings of corporate debt securities from 1992 to 1996 shows that unsecured debts accounted for about 60 percent. led to the renewed issuance of Government bonds to finance the resurgent budget deficit and support cash-strapped financial institutions. The proportion of domestic convertible debt instruments increased until 1995. compared to 110 percent in the US and 74 percent in Japan in the same year. the market for these bonds has been slow owing to the change in the Government’s original policy of requiring the use of state-guaranteed bonds as legal reserves. the Bank of Thailand assumed responsibility for regulating the bond market. Investors had limited knowledge of debt instruments. The bond market in Thailand started in 1933. the first bond rating agency in Thailand.9 billion. Companies generally issued short-term debt instruments like promissory notes or bills of exchange. The Thai Rating Information Services. State-owned enterprises became active issuers of bonds since 1993 because the Government constrained their borrowings (Table 4. Four years after the passage of the SEA. and the Government did not issue new bonds during 1990-1997. 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. in 1994. Upon its founding in 1942. To gain some perspective of the size of the bond market in Thailand. However. the Government issued more bonds to finance industrial development projects and perennial deficits. it accounted for a small share of the entire financial sector. while secured debt instruments accounted for just above 10 percent.11). however. was also instrumental to the growth of the corporate debt market. . The corporate sector played a limited role in the bond market in the early years because of the complicated rules and regulations in effect at that time.
then declined substantially in 1996 and 1997.4 billion. By 1995.2 — — 50.5 10.5 — 39.8 167.6 — 0.7 7. II Table 4.1 41.7 538.3 46.0 333.1 6.2 57.2 45.4 7.7 132.4 49.6 billion.0 17.4 57.5 55.0 33.9 329. However.0 5.2 39.3 — — 3.1 289.0 0. the year the crisis unraveled and the baht was floated.5 — — — — 1. The domestic debt market declined after 1994 because corporations could borrow offshore at lower costs.3 — 14. this had climbed to B200.8 2. a surge attributed to capital inflows encouraged by high returns on Thai bonds.8 55.1 55.6 — — 0.4 — 26.9 5.3 8.3 22.2 2.7 95.5 43.3 6.8 Source: Securities and Exchange Commission of Thailand and the Thai Bond Dealing Centre.1 107.3 13.7 0. .3 29.7 5. The club was considered the first organized secondary bond market in Thailand to serve as the wholesale market for debt securities. by the end of 1997.9 37.3 3.5 — — — 3.2 43. The decline in total domestic debt offerings in 1996 can be ascribed to the increase in offshore convertible debts.7 — — 40.4 — — — 1.0 — 5.7 0.7 5.9 20.3 50.1 59.8 191.3 140. turnover value had reached B51.0 281.7 90.0 27.1 121.0 86.5 37.9 0. Vol.11 Offerings of Debt Securities. A sharp rise in unsecured offshore debt offerings can be noted all the way through 1996.6 19.8 47.0 — 26.1 315.2 28.7 — — — — — — — 77.1 12.1 21.4 — 9. total offshore debt offerings had plunged by 68 percent to a mere B28.0 7.4 110.1 — — 6.8 31.1 8.1 141.256 Corporate Governance and Finance in East Asia.0 — 5.5 — — 32.5 138. BDC was established in November 1994 by 50 securities companies based on the provisions of the SEA of 1992.5 — 0.7 28.3 46.2 89. Total offshore debt offerings peaked in the run-up to the financial crisis.0 60.9 37.7 — — — — — 4.5 5.0 26. The following year.9 30.5 billion.1 61.7 821. 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 10.9 40.1 — — — 29.
turnover value plummeted to B106. cash balances. 4. In any case.2 Patterns of Corporate Financing An examination of financing patterns among Thai companies listed in SET shows that on the asset side. Equity financing remains an important part of listed companies’ long-term financing. these comprised 31 percent.12). a trend most apparent in the leap between 1991 and 1992. In the same year. listed companies experienced liquidity problems with declining reserves of cash and marketable securities during the period 1990 to 1996 (Table 4. while for the property development industry. Thailand’s publicly listed companies rely mainly on loans from commercial banks and financial institutions to finance their growth. Retained earnings accounted for about 30 percent of total equity financing. with equity levels remaining high despite an increase in debt. they also had a relatively small proportion of equity and . From 1990 to 1996. the use of debentures remains minimal even though the trend was generally upward until the 1997 crisis. The overall trend is consistent with the decline in profitability observed in the analysis of corporate sector performance earlier. The average for all industries was only 22 percent. The ratio of net working capital to total assets decreased from a peak of 31 percent in 1993 to 28 percent in 1996. For the construction industry. judging by their relatively low levels of retained earnings. Turnover fell further to B72.4.1 billion in 1998. Across industries. In 1997. short-term loans accounted for more than 40 percent of total liabilities. steadily easing up between 1990 and 1996. and marketable securities holdings.Chapter 4: Thailand 257 compared with investment in equities.2 billion as a result of the default of debentures due to the Asian crisis. The proportion of accounts receivable also declined steadily. At lower than 5 percent of total liabilities. overall asset quality and liquidity of listed Thai companies deteriorated throughout the period. The closure of 58 finance companies affected the BDC significantly since half of its members were suspended as a result. Longterm loans accounted for about 20 percent of total liabilities. Construction and property development industries tended to have high proportions of long-term loans and debentures. Companies in construction and property development seemed unable to generate internal funds. There was also little change in the trend in retained earnings within the seven-year period. these accounted for 33 percent of total liabilities. In addition. BDC was renamed “the Thai Bond Dealing Centre” following its status upgrade to a bond exchange. significant variations can be noted.
7 36.0 100.1 49.8 25.9 20.9 6.2 16.4 49.7 52.9 50.2 35.2 43. The agribusiness industry relied more heavily on short-term loans at 56 percent of the industry’s total liabilities.8 14.2 17.2 1.5 1.2 2.2 3.2 1.2 1.6 100.9 18.9 17.4 49.8 35.6 0.3 18.7 17.4 8.0 100.0 1.2 15.3 12.6 22.6 38.0 100.1 36.0 100.13).4 17.9 40.2 2.7 15.1 18.3 14.0 100.2 42.6 0.8 17.0 6.6 14.6 100.8 20.7 18.5 1.9 12.0 48.5 14.0 2. II Table 4.0 12.9 17.5 9.0 14.3 1.8 34.3 38.5 43.2 22.6 12.9 38.9 14. compared with the 44 percent general average.3 49.8 6.2 17.8 3.4 43. medium.8 9.8 21.4 6.0 51.9 49.1 50.0 100.0 100.1 5.6 0. The level of total liabilities for the group characterized by high ownership concentration .1 2.12 Common-Size Statements for Companies Listed in SET.6 36.5 11.8 7. Printing and publishing companies had lower financial leverage than companies in other industries.9 3.2 16.6 11.1 7.3 1. US.5 1.5 37.9 0. Vol.7 7.0 100.4 48.5 9.4 21.0 13.6 18.8 37.9 2.3 17.6 50.6 13.0 10.3 25.258 Corporate Governance and Finance in East Asia.4 17.0 100.6 10.3 21.6 51.9 43.2 17.0 Assets Cash Marketable Securities Accounts Receivable Inventories Other Current Assets Total Current Assets Net Fixed Assets Other Assets Total Assets Liabilities and Equity Accounts Payable Short-Term Loans Other Current Liabilities Total Current Liabilities Long-Term Loans Debentures Other Liabilities Total Liabilities Capital Stock Paid-In Capital Retained Earnings Total Equity Total Liabilities and Equity Source: Pacific-Basin Capital Markets Database compiled by the University of Rhode Island.6 2.7 1.4 7.6 15.9 6.2 17.3 34.4 14.3 2.6 6.3 14.8 9.0 100.9 14.0 7.2 2.3 18.7 16.1 17.2 34. 1990-1996 (percent) Item All Years 1990 1991 1992 1993 1994 1995 1996 2.7 16. and low) also underscores that companies with high ownership concentration had high levels of long-term loans (Table 4.8 19.7 0.8 46.3 6.7 9.8 10.8 8.7 50. were highly leveraged.4 2.2 2.9 16.6 8.0 100.8 37.6 21.0 100.7 14.9 10.2 12.9 15. Analysis of common-size statements by ownership concentration (based on the levels of top-five ownership concentration classified as high.3 48.5 0.0 100.3 34.2 45.8 1.1 13.0 15.0 100.9 14.9 14.3 50.0 10.6 0.2 43.9 14.
Chapter 4: Thailand 259 Table 4. 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 2.4 49.9 2.8 13.0 Low 1.8 12.2 45.0 100. Companies with medium ownership concentration tended to have a higher proportion of short-term loans.1 18.3 35.9 50.0 Medium 2.0 100.5 11. US.4 3.5 percent for low ownership concentration companies.9 36.1 49. common equity accounted for a smaller proportion of total assets (47 percent) than companies with lower ownership concentration.8 37.9 21. This is consistent with the observation that majority shareholders try to maintain their control by utilizing debt as a major source of funds.0 6.9 7.1 36.7 12.4 50.3 1.0 6.4 1.6 15.5 18.0 7.2 11.6 2.6 47.2 14.9 16.3 1.0 41.3 8.9 0.7 percent for medium ownership concentration companies and 49.6 9.0 Source: Pacific-Basin Capital Markets Database compiled by the University of Rhode Island.6 14.2 8.5 21.1 44.0 16.4 35.6 22. .0 19.8 13.1 53.9 100.7 19.2 22.4 37.3 100.13 Common-Size Statements of Public Companies by Ownership Concentration.7 17.6 0.6 100.4 7.4 18.0 14. was 53 percent of total assets compared with 49.2 0.5 13. For the high ownership concentration group.5 100.3 16.4 13.
it would seem that firms with concentrated ownership and associated links to the banking system have easier access to debt financing. bond issues overtook loans from commercial banks as the second preference.7 34.1 23.7 percent in 1996. thus rendering them more vulnerable.15.4 5. and maintenance of the existing ownership structure. Table 4.8 65. bond issues.1 16.4 12. The direct relationship between the degree of leverage and the degree of ownership concentration is apparent in Table 4.14). Vol. 1990-1996 Ratio Times Interest Earned Total Debt to Equity (%) Long-Term Debt to Equity (%) Total Debt-to-Assets (%) Long-Term Debt-to-Assets (%) Net Working Capital-to-Assets (%) Operating Capital-to-Assets (%) 1990 1991 1992 1993 1994 1995 1996 8.7 in 1994 to 5.5 52.4 7. 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. and rights issues.8 5.8 65.1 144.4 44.2 49.1 64.7 66.4 51.14 Financial Ratios of All Listed Firms.0 50. however.1 52. minimization of transaction and interest costs.7 5.1 31.5 38.6 7. The TIE ratio declined from its peak of 7.8 percent in 1990 to 52.7 28. The ratio of total debt to total assets increased from 50.0 145.260 Corporate Governance and Finance in East Asia. these firms more easily increased their leverage.9 7. II Results from the ADB survey reveal that Thai companies preferred to use reserves and retained earnings as their first choice of financing.2 68.1 16.1 31.7 34.7 11. Generally.3 61. the choice of financing is determined by the company’s liquidity considerations.3 31.8 51.6 138. especially from 1994 to 1996. followed by bank loans.2 35. Public companies relied more on short-term debt financing in the period before the financial crisis.1 in 1996.9 63.0 28. .7 12. While further detailed investigations are necessary.3 Source: Estimated from the Pacific-Basin Capital Markets Database compiled by the University of Rhode Island. was the headlong deterioration of firms’ ability to meet their interest payment obligations. The financing patterns indicate that companies with high ownership concentration were more highly leveraged than companies with medium and low concentration.9 140.6 41.9 14.0 25.1 44.7 12. Short-term debt accounted for most of the increase. As a result.8 151. More important.6 125. US.4 139. however.9 51. After the crisis. Such deterioration of financial positions during the period was a common feature of listed companies.
From 45 percent of total net capital movements in 1985.4 27.Chapter 4: Thailand 261 Table 4.8 14. on the other hand.5 4.0 64.4 63.2 percent in 1986 to 251.5 126. continued to slide from 1985 to 1997. such as direct equity and portfolio investment. 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.3 42.1 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. Additionally. peaking in 1994 at 84 percent.8 Medium 7.3 Source: Estimated from the Pacific-Basin Capital Markets Database compiled by the University of Rhode Island. This decline was accompanied.5. The proportion of external debt as a percentage of GDP consequently increased from 42.1 High 6.8 49. private debt accounted for 84.15 Financial Ratios of Listed Companies by Ownership Concentration.5 34.9 percent in 1997. The composition and term-structure of this debt. unhedged foreign exchange liabilities. debt-creating capital inflows rose to 65 percent in 1990. The corporate sector contributed significantly to the crisis because of its rising levels of leverage. From only 34 percent in 1986.6 11.7 percent from 1991 to 1996. The proportion of nondebt-creating capital flows.16).5 percent between 1985 and 1990 to 8. US.8 percent in 1986 to 52 percent in 1995.8 28. and a preponderance of short-term debt liabilities. the proportion of short-term debt increased from 15. . 4.6 30.5 148.4 52. is even more telling.2 124.2 49. however. Their average annual growth rate declined from 28. 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. Nonbank private debt increased from 27.8 29.5 percent of external debt in 1996 (Table 4.4 percent to 46 percent during the same period.8 66.4 13.
16 External Debt.0 11.4 10.9 5.9 10.2 32.7 13.9 10.9 3.1 0.1 2.5 12.7 10.1 0.3 7.1 12.3 37.9 31.8 3.9 13.5 4.7 23.9 3.8 12.4 18.0 0.3 16.3 0.9 1.0 11.9 43.1 0.0 6.3 20.1 5.6 — 0.3 0.8 10.3 12.5 14.0 Long-Term Short-Term BIBF Commercial Bank Long-Term Short-Term 0.1 23.6 Total 18.1 22.9 29.6 7.Table 4.1 30.8 3.4 3.0 21.2 10.3 0.3 3.2 0.2 2.3 — — — — — — — 6.9 0.6 Government Year Long-Term Short-Term 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 12.0 8.4 15.4 — — — — — — — 1.3 0.9 7.1 0.2 2.8 13.9 4.9 6.6 1.3 105.6 52.1 34.3 0.9 11.9 35.5 19. .3 0.3 2.1 64.7 20.1 Source: Bank of Thailand.3 0.8 108.3 3.7 24.5 16.0 4.0 13.3 10.7 1.9 6.1 95. 1986-1999 ($ billion) Private Nonbank Long-Term Short-Term 3.6 18.3 0.2 15.9 1.8 0.2 0.5 4.2 2.4 5.5 12.4 2.0 3.7 109.7 2.2 0.9 100.8 31.2 14.7 0.5 1.
suggesting that serious investors have not returned to the market. the numbers of bankruptcies and company closures reached all-time highs in 1998 (Table 4. banks would be recording more of such NPLs. The proportion of NPLs as a percentage of outstanding loans demonstrates the liquidity problem experienced by the corporate sector. closures. At the end of 1994. Most of these foreign debts were not properly hedged. Foreign investors retreated from the market. the index declined to 1. and (iii) bankruptcies. With easy access to foreign funds. Due in part to liquidity problems on the one hand. If lending rates remained high. Trading volume has since been thin. The severity of the impact of the crisis on the corporate sector was apparent from (i) the decline in the volume of public offerings. leaving domestic investors with large capital losses. trading activity at SET had been on the downturn. and drastic decline in the number and capital of newly registered companies. Aside from the problem of NPLs. based on the three-month past due definition. reaching 45 percent of total outstanding credit in December. and poor business confidence on the other. SET’s dismal performance is indicative of the extent of the setback suffered by the Thai capital market.281 in December 1995 and to 831.6 billion from the 1996 level of B201 billion.17). Even before the crisis. from its peak in 1995. Meanwhile.6 in December 1996. foreign currency-denominated debts constituted 55 percent of their total debt portfolio. the SET Index stood at 1. 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. After that. It hit a 10-year low in the second quarter of 1998. (ii) the rise in the nonperforming loan (NPL) ratio and consequent tightening of credit even for viable firms. 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. exposing the companies to disaster when the baht started tumbling on 2 July 1997. . The value of public offerings sank in 1997 to B56. large Thai companies had actively borrowed at low interest rates from foreign financial institutions. according to the Bank of Thailand. outstanding credit also declined throughout the second half of 1998.360. the liquidity problems faced by the corporate sector are likely to continue for some time. The effects of the crisis were felt across all industry sectors. Similarly. On average. nonfinancial companies also experienced severe liquidity problems as a result of the baht’s devaluation. NPLs spiraled from 12 percent in the second quarter of 1997 to almost 40 percent in the third quarter of 1998.
224 4.312 25.2 Responses to the Crisis Initially.410 5.777 11.2 billion for balance of payments support and buildup of the country’s reserves.052 36. the Government was left with no choice. It also explains the higher dividend yield ratio. As part of the assistance package. 4.105 4.066 19.933 25. IMF required Thailand to meet a set of performance criteria and implement various restructuring measures. II Table 4.695 3.334 4.977 Source: Department of Commercial Registration.902 3.218 3.095 14.925 12.17 Number of Newly Registered and Bankrupted/Closed Companies.904 20. The increase of the P/E ratio in 1998 was mostly a result of a decrease in earnings for most listed companies. The IMF financial package was a credit facility of $17. the Thai Government was lukewarm to the idea of obtaining IMF assistance because of the requirements and conditions attached to the financial package.410 37.407 28.677 Bankrupted/Closed 2.915 37. But when assistance from other sources did not materialize.5.307 4.409 6. Thailand. The first Letter of Intent was cosigned by the Minister of Finance and the Governor of the Bank of Thailand on 14 August 1997.797 4.096 22.080 9.5 at the end of 1994 to 12 in 1996 and further to 6. Vol.201 24.112 9. A steady price decline over the past few years has dragged down the ratio of market price to book value.264 Corporate Governance and Finance in East Asia. . 1985-1999 Year 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 Newly Registered 10.6 in 1997.792 7.134 31.288 35. The price-to-earnings (P/E) ratio deteriorated from 19. Ministry of Commerce.
As it turned out. They could seek civil action through the courts and could also use criminal sanctions to enforce debt repayments. The Government also passed the Bankruptcy Act and Foreclosure Act Amendments. and the Act Regulating the Finance. IMF relaxed these key conditions. Several changes in the banking and financial policy environment have been effected in line with the restructuring program. While no definition for “insolvency” could be found in the bankruptcy law. Many believed that the process was inefficient. and worked on revisions to the Secured Transaction Law. and Credit Foncier Businesses.” Creditors thus bore the burden of proving a debtor’s insolvency before the courts. The assets of the other companies were liquidated by auctions. loan provisioning. The core of the IMF conditionalities was the restructuring of the banking and financial sector to regain investor confidence. follow through with a civil or bankruptcy suit. The Government required all remaining financial institutions to recapitalize and instituted closer monitoring measures to ensure full compliance with this requirement. The Bank of Thailand also improved banking standards. and restore solvency. creditors seldom succeeded in obtaining payment against bankrupt borrowers. Securities. The Financial Sector Restructuring Authority was established in October 1997 to address the problems of 58 finance companies that were suspended in 1997. and did not recognize debtor-initiated bankruptcy declarations. Regulatory Response by the Government The IMF program. debtors could drag out the process for many years. however. Strict loan classifications. There were many options for solving debt repayment problems. Under the old bankruptcy laws. These include repeal of the Commercial Bank Act. also aimed at institutionalizing legal and regulatory reforms. By invoking procedural loopholes. The old law allowed only creditors to file bankruptcy suits. and income recognition were implemented. it was widely interpreted as “having debts more than assets. and if necessary. Creditors could negotiate to reschedule debt repayments. For example. the Civil and Commercial Code. increase profitability. secured creditors had to obtain the court’s approval before starting proceedings . only two companies emerged intact from the suspension. In early 1998.Chapter 4: Thailand 265 The terms of the agreement required the Government to maintain tight monetary and fiscal policies. drawn up with World Bank and ADB assistance.
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 amended law limits the rights of secured creditors. The amended law also introduced the concept of automatic stay. (ii) management of the company reverts to the borrower. Vol. There are other potential problems. II for the recovery of debt through the realization of any collateral. and (iv) the debts shall have been settled within a five-year period. the National Assembly passed an amended Bankruptcy Act and approved the establishment of special bankruptcy courts. creditors always had to contend with the threat of disruptions in a delinquent borrower’s business. but it is a complicated. In Thailand. Enforcement of the new law is bound to be ponderous and lengthy. But more important. For one. the judges and court officers have yet to learn and master the new bankruptcy procedure. To make matters worse for creditors. In effect. 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. (iii) shareholders regain their legal rights. In 1999. it covers only the court-supervised reorganization of distressed companies. Under the old Bankruptcy Act. thereby allowing court-supervised corporate restructuring. time consuming. and expensive process. The original Bankruptcy Act dealt only with liquidation and composition. Chapter 11 cases account for only 5 percent of bankruptcy suits in the US but consume 90 percent of the courts’ time.266 Corporate Governance and Finance in East Asia. The amendment added reorganization provisions to the Bankruptcy Act of 1940. Foreign secured creditors had to go through the motions of establishing that their country of domicile granted Thai creditors similar rights. The model for Thailand’s amended bankruptcy law was the US Chapter 11. The amended legislation also includes voluntary bankruptcy as a new feature. Companies need . the company shall be declared bankrupt and liquidation of assets shall follow. The reorganization process is successful if (i) the debts shall have been discharged. which means that a debtor could continue in business while the reorganization program was being implemented. Chapter 11 is the main tool in restructuring bankrupted companies in the US. If the process fails to revive the business. any new loan to a company extended after the creditor discovered the insolvency would not be eligible for repayment. 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.
namely “liabilities exceed assets. In case the board of directors does not comply. Consequently. corporate governance) that caused the bankruptcy in the first place. the test for insolvency still uses the balance sheet criterion.Chapter 4: Thailand 267 to solve the problems (e. . only tangible assets were the norm. the 1992 Act relaxed some of the original restrictive rules and regulations to encourage public company registration. 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.” as opposed to the more appropriate criterion of “ability to pay when the debt falls due. after determining the legitimacy of the request. the Bankruptcy Amendment will just prolong the problems of nonviable borrowers.. Replacing the Public Limited Company Act of 1978. The amendment seeks to revise old rules and procedures that tended to delay foreclosure proceedings. Most important. Minority shareholders also have to absorb the costs related to their actions because the 1992 Act does not allow them to be reimbursed by the company.” The Foreclosure Act Amendment was likewise passed in 2000. Without the necessary corporate restructuring. shall have the power to call the extraordinary general meeting. SEC also examined the possibility of an amendment to the Public Company Act of 1992. Procedural delays give borrowers an advantage because they can refuse to pay back their loans even though they can meet their obligations. Still pending Parliament approval is the amendment to the Secured Transaction Law. the court. 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. In the past. questions have been raised regarding the appropriateness of the 1992 Act. however. The result. The proposed amendment also includes a provision for the company to reimburse minority shareholders for expenses related to calling such a meeting.g. The proposed new law seeks to expand the type of assets that a borrower can use as collateral. Under the new law. and (ii) processing of default cases within four to six months of filing of a court claim. The amendment also remedies the slow process of executing or disposing of assets in a public auction. minority shareholders’ rights are not adequately protected. The minimum shareholding requirement is too high for any individuals or groups of minority shareholders to take action against controlling shareholders. which aims to increase liquidity in the domestic economy by allowing businesses to use both tangible and intangible assets in securing credit. has not been satisfactory.
who are also the managers. the main problem is overlooked. Vol. However. and determine voting results on virtually any matter. subject only to approval by the board of directors. this is not so in publicly traded companies in Thailand. 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. vis-a-vis the minority shareholders. The 1992 Act only prescribes—not requires—the use of the cumulative voting procedure. to borrow from the company without consideration to the fairness of the transaction or transparency of the approval process. In the absence of such a stock market boom now. in turn. But because this is the assumption embedded in the regulation. disrupts the company’s management and decision making. Where equity will come forward. the dominance of controlling shareholders.. In addition. the controlling shareholders have the exclusive domain to appoint or exercise management. it permits directors. Because of high ownership concentration.268 Corporate Governance and Finance in East Asia. II Another issue is the assumption in the 1992 Act that there is a separation of ownership and control functions. The proposal clearly delineates duties of care and loyalty for directors of public companies. But as demonstrated. i. minority shareholders are likely to be wary of increasing their equity without corresponding control mechanisms at their disposal. The 1992 Act also allows directors to engage in business activities that may directly or indirectly affect the company. which. Consequently. claiming that it creates fragmentation in the board of directors. without cumulative voting. The proposal for the amendment of the Public . Most companies decide against cumulative voting.e. minority shareholders have no chance of being represented in the board. 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. they face the prospect of being unable to compete for the scarce funds available in the equities market. there are few provisions in the Act that deal with related or connected transactions that potentially reduce shareholders’ value. The regulators are drafting a proposal to amend the provisions on related transactions. The textbook separation between owners who sit in the company’s board and professional managers who run the company does not apply in Thailand. with the approval of the board. 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. This may be true in countries where publicly traded companies are widely held. Otherwise. it will probably be expensive because of the higher risk that comes with weak accountability mechanisms.
The first bankruptcy court in Thailand opened on 18 June 1999.068 cases involving B475 billion are undergoing restructuring. accounting for B1.764 debt restructuring cases involving B1. the Government introduced debt restructuring-related measures to help resolve bad debts. Considerable progress has been achieved on this front. Corporate Debt Restructuring and Bankruptcy The 1997 crisis led to a severe liquidity problem in the economy. Some 82 percent of these cases have been successfully restructured. although since then.767 cases involving outstanding credit of B2. 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. Within three months. This point is crucial because compared with . 322. In response. Another 77.147 cases (B1. personal consumption. In addition. By October 2000. CDRAC’s target debtors comprised 10. where bankruptcy procedures are swift and effective.1 trillion in outstanding credit. the court had more than 80 cases for disposition. However. The Bank of Thailand issued guidelines in 1998 encouraging financial institutions to specify their own policies. Commercial banks initiated 74 percent of these cases. methods.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. only 7. and procedures for debt restructuring. Another 5 percent of cases (B70 billion) are undergoing restructuring negotiations. Equally important is the contribution of effective and reliable bankruptcy procedures for improved corporate governance. accounting for B1.6 trillion. will be settled by the courts. Reforms in bankruptcy procedures should be seen not only in the context of crisis resolution. the mere threat of external control alters the incentives faced by managers and controlling shareholders significantly.1 trillion of outstanding credit.6 trillion) have agreed to cooperate with CDRAC’s restructuring process.8 trillion had been completed. In particular. with the majority of the debtors coming from the commerce. the number of cases has abated. As of November 2000. as well as those that did not cooperate with CDRAC’s restructuring process. contributing to the unprecedented rise in the corporate sector’s bad debt. and manufacturing sectors. Cases for which negotiations were unsuccessful. The reason is that bankruptcy law amendments appear to facilitate settlements outside the court.
and promoted key industries through incentives. Examination of corporate ownership. Such improvements in disclosure standards are part of the efforts of SET and SEC. to push companies to harmonize their accounting with international standards. and Recommendations Summary and Conclusions This study has provided an overview of the corporate sector and governance in Thailand. The banking industry played a key role in the early stages of economic development because it represented the only avenue for funding Thai corporations.1 Summary. Financial information from listed companies will also soon be required to conform to International Accounting Standards. the Thai Government managed its economy with the corporate sector as the main engine of growth and development. Reforms through SET and Improved Disclosure The financial crisis prompted SET to introduce a range of improvements to its operation and regulation.6 4. and even Indonesia. It required listed companies to establish their own audit committees by the end of 1999. 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. Philippines. 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. the Government protected certain corporate sectors through tariffs and regulation. The exchange has already required that listed companies’ quarterly reports be directly comparable with annual statements. behavior. 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. For this reason. and performance during this period helps understand the causes of the crisis. Weak bankruptcy procedures were part and parcel of the perverse set of incentives that led firms to build up unsustainable levels of debt. The study covers the period 1985 to 1996.6. 4. Emphasis was on the structure of corporate governance and patterns of corporate ownership and financing of publicly listed companies. Conclusions. despite the weakness of their disciplinary powers. In the next three decades. The .270 Corporate Governance and Finance in East Asia. II Malaysia. Vol.
One of the major findings is the high ownership concentration among Thai companies listed on SET. The impact of the crisis was felt across all industries. At the onset of the 1997 financial crisis. Because most of these debts were not hedged. At the same time. Minority shareholders. In 1995 and 1996. the numbers of bankruptcy cases and company closures reached alltime highs. the corporate sector entered a new era with the enactment of two major pieces of legislation. Consequently. the overall corporate sector was seriously affected. Profitability increased throughout the 1980s but began to decline in the first half of the 1990s. During 1992-1997. foreign debt in the Thai corporate sector increased continuously. the top five largest shareholders hold about 56 percent of total outstanding shares. Although there are some variations across industries. Thai companies were vulnerable to exchange rate risks. the overall pattern of ownership concentration seems to have been stable for the past 10 years.000 from the previous year’s level. . One of the principal causes of the crisis was the excessive use of foreign debt by the corporate sector. reaching its peak in 1996. there was a marked increase in the number of public corporations. The SEA of 1992 also marked the beginning of an active bond market in Thailand. the profitability of publicly listed companies abruptly declined and their financial leverage increased. Nonbank private corporations accounted for most of the increase. the increase in long-term debt more than compensated for the drop. Subsequently. On average. The financial performance of the corporate sector remained satisfactory up to the years before the outbreak of the financial crisis. at a time when most of them were already experiencing declining profits and high leverage. Although there was a decline in short-term foreign debt. even after the development of capital markets. This implies that the control of an average Thai company is typically in the hands of a few persons (founders or their associates) who own a majority of total outstanding shares. the number of listed companies in SET fell from 454 in 1996 to 392 in 1999. the Public Company Act of 1992 and the SEA of 1992.Chapter 4: Thailand 271 importance of bank financing continued throughout the 1990s. the devaluation of the baht that began on 2 July 1997 affected the financial condition of Thai corporations. In 1992. The number of newly registered companies in 1997 dropped by almost 10. Financial liberalization apparently encouraged companies to borrow overseas to finance investments that were not productively employed. Meanwhile. After 1992. The study examined the impact of ownership structure on corporate governance and financing patterns. the number and value of public offerings of securities accelerated.
Thus. The key laws. Nominally. An analysis of the corporate ownership structure in Thailand suggests that founders and management continue to own and control publicly listed Thai companies. the Public Company Act of 1992 and the SEA of 1992. These laws stipulate rules and regulations concerning the activities of all public companies. Among the five largest shareholders of Thai companies listed on SET. The Government holds about 1 percent of total outstanding shares but these holdings represent majority shares of a few companies. All these.272 Corporate Governance and Finance in East Asia. through the use of holding and affiliated companies. there is a clear lack of outside monitors for these publicly listed but family-controlled 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. Individuals and insiders hold the second largest proportion at about 19 percent. foreign and domestic. Vol. Institutional investors in Thailand. The implications of ownership structures that are concentrated to such a high degree are serious. Financial institutions hold a very small proportion. In the past. along with a highly concentrated ownership structure. contribute to the lack of external controls on the corporate sector through the capital markets. The absence of external market controls on the management of publicly listed corporations is dangerous. Consequently. the existing legal and regulatory framework suggests otherwise. The rules in both Acts governing . the government pension fund was the only major institutional investor. holding companies and affiliated corporations hold the largest proportion at 27 percent of total outstanding shares. Most foreign institutional investors invest only on a short-term basis and aim for short-term trading profits. they have little influence over management decision making and control. are not active. hold only a small portion of total outstanding shares. II although larger in number. commercial banks hold only about 2 percent of total outstanding shares while nonbank financial institutions hold about 6 percent. 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. publicly listed and unlisted companies in Thailand are equally subject to the consequences of the risk-taking behavior of controlling owners. The highly concentrated ownership structure weakens the protection of minority shareholder rights. averaging 46 percent. protect the interests of all shareholders of public companies.
key reforms that will strengthen the regulation of financial institutions. For example. an aim that can be achieved mostly through legal reforms. However.2 Policy Recommendations There are three major policy issues and recommendations that could improve corporate governance in Thailand. Consequently. In view of this. the high ownership concentration of many listed Thai companies inhibits the effectiveness of these provisions. laws did not provide minority shareholders sufficient safeguards in cases of transactions involving companies where the controlling shareholders had related interests. The Government has been moving to amend the Public Company Act of 1992 to increase minority shareholders’ protection in this regard. but is significantly related to financing patterns. Specifically. 4.6. Rather. these companies tend to become overleveraged.Chapter 4: Thailand 273 minority shareholders’ participation in decision making and in initiatives against management conform to international standards. the main challenge is not how the board can control management to maximize shareholder value. posed formidable barriers in the minority shareholders’ exercise of their rights. making them vulnerable to economic shocks. the Public Company Act of 1992 allows shareholders to act only when they hold a minimum proportion of shareholdings. Ownership concentration appears to have little impact on corporate profit performance. For instance. the main challenge is in protecting minority shareholders from the possibility of expropriation by the majority. a requirement impossible to meet due to the concentrated shareholdings of founding family members and management. because there is no separation between ownership and management. In this third area. 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. The third issue involves creating external market controls through better regulation and development of the capital markets. because there are shared interests between the controlling shareholders and key management personnel. The second issue involves the protection of shareholder rights. The ownership structure of Thai listed companies also significantly affects company behavior. . the degree of ownership concentration has a statistically significant positive relationship to the degree of financial leverage. before the crisis. moreover. Certain provisions.
274 Corporate Governance and Finance in East Asia. the supervisory agencies also need to be empowered to enforce the laws. This is due to the historical development of the Thai corporate sector: before 1975. activate the market for corporate control. The best approach may entail establishing a single. unified supervisory agency or a permanent regulatory division consisting of supervisory units from the three agencies. the key issue in corporate governance is how to prevent insiders from expropriating assets of minority shareholders. II encourage market competition. he/she often has the decisive vote. in 1975. this is a problem in Thailand. the Ministry of Commerce had the sole supervisory responsibility. the supervisory system is fragmented and not as effective as it should be. There is also supposed to be separation of ownership and control. Once the roles and responsibilities are clearly defined. three major government organizations (the Ministry of Commerce. If the principal shareholder is in fact chair of the board. the principal shareholder typically plays a key role in management and often serves as the chief executive officer. The board therefore plays a pivotal role. In reality. voting only on major decisions. The Government must develop an overall framework for corporate sector supervision and redefine the regulatory jurisdiction of each agency along functional lines. Vol. It is important that the roles and responsibilities of each agency are clearly defined to the public. . in most of Thailand’s publicly traded firms. with control delegated to professional managers. SET. Protection of Shareholder Rights The common assumption is that publicly traded corporations are widely dispersed in terms of ownership. SET was mandated to supervise listed companies. SEC was established as another supervisory agency. Development of a Comprehensive Supervisory Framework There is a need for the Government to establish a comprehensive supervisory framework for the corporate sector. Only then will these agencies be able to act promptly and effectively. and increase the participation of institutional investors are imperative. If this were the situation. Under the current system. The owners of a firm rely on a board of directors to supervise the managers. and after the enactment of the SEA in 1992. Consequently. the key issue in corporate governance would then be to ensure that managers act in the best interests of the shareholders. In this setting. As in other crisis economies in the region. and SEC) are involved in corporate supervision.
and a prohibition of connected transactions by directors or management. Since the Asian financial crisis. accountability. This includes prescribing ways to empower minority shareholders without disrupting the company’s operations. they should be monitored and regulated. Through an amendment in the Public Company Act. The current ownership structure leads to ineffective corporate governance and inadequate protection of minority shareholders. The slow improvement in the legal framework has likewise obstructed progress in this area. The first recommendation involves the repeal of current legislation to allow minority shareholders to have greater influence over management decision making. The Ministry of Commerce is conducting a study on proposed amendments to the Public Company Act of 1992. To ensure a level playing field. This move is expected to be unpopular among founding family members and original owners.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. Both SET and SEC are taking an active stance in improving the transparency and efficiency of Thai capital markets. But weaknesses in accounting and auditing practices have been inhibiting the development of capital markets. regulators must increase transparency and step up enforcement. the Government can change the shareholding limit for controlling shareholders. SEC is exploring the possibility of amending the law toward this direction. The situation prompts two specific recommendations. and . The second recommendation is to dilute ownership concentration through the use of regulatory power. there has been much progress in this area. SEC has been trying to lay the foundations of good corporate governance by espousing fairness. Because these holding companies control a number of large public companies in Thailand. increasing penalties for directors engaged in misconduct. 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. Some of the legal reforms under consideration concern settling conflictof-interest situations with significant effects on minority shareholders. transparency. 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. requiring cumulative voting for the election of directors. The Government does not have an effective way of monitoring the financial activities of these companies even as it is widely believed that a large amount of funds is being channeled through them.
The first step is to establish an active secondary Government bond market. The promotion of active roles for domestic institutional investors should also improve corporate governance in Thailand. Because the financing of Thailand’s corporate sector is predominantly bank-based and will remain so for a long while yet. in turn. Vol. Accounting standards have also been under review. will incidentally close off easy sources of finance for companies that have been practicing regulatory arbitrage. aimed at ensuring that banks finance only creditworthy projects. A well-developed domestic debt market will provide corporations with an alternative to bank financing. Further.276 Corporate Governance and Finance in East Asia. which. In an environment of highly concentrated ownership. Without a strong and efficient capital market. In the stock market. Capital Market Development and Regulation Another important issue concerns the development of capital markets. a well-developed secondary market will pave the way for market disciplinary forces to act against poorly managed companies. II responsibility among companies. it will be difficult to improve corporate governance in Thailand. there is a need to increase market disciplinary power through market competition. The Bank of Thailand’s enforcement of prudent lending practices among Thai financial institutions. it is important to explore reforms that can lead to the enhanced role of banks in monitoring enterprises. will lead to the emergence of a reference yield curve. The same goes for improvements in the bankruptcy system. 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. This may not be possible without reforms in the banking sector itself. especially in the area of connected lending. However. the SEC’s disposition toward a largely voluntary approach for adoption of these characteristics has resulted in uneven compliance among public companies. Thailand should develop a strong public debt market to supplement the banking system in financing corporate investments. the power of the capital market to discipline inefficient management is almost nonexistent. 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. . for instance. There will be no incentive for companies to raise capital in the equities market if they can obtain funds at a lower cost elsewhere.
The Securities and Exchange Commission of Thailand. Thai Accounting Standards. 1997-1999. Department of Commercial Registration Database. Pacific-Basin Capital Markets Research Center. The Stock Exchange of Thailand. .Chapter 4: Thailand 277 References Annual Report. The Thai Bond Dealing Centre. Bank of Thailand Monthly Bulletin. 1998. PACAP-Thailand Database. The Stock Exchange of Thailand. Bank of Thailand. 1995-1999. 1995-1999. US. Bank of Thailand Quarterly Bulletin. The Securities and Exchange Commission of Thailand. Fact Book. The Stock Exchange of Thailand. 1995-1999. 1995. Kingston. Thailand. 1997. Ministry of Commerce. The University of Rhode Island. Key Capital Market Statistics. Bond Market Development in Thailand. 1997. Bank of Thailand. The Stock Market in Thailand.
This action might not be possible to undo. Are you sure you want to continue?
We've moved you to where you read on your other device.
Get the full title to continue listening from where you left off, or restart the preview.