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
1996-1998 2.18 GDP Growth by Sector. 1993-1999 Table 1. 1992-1997 Table 1.5 Financial Performance of Publicly Listed Companies by Sector. 1996-1999 Table 1.4 Development of the Stock Market.1 Growth of the Banking Sector.21 Nonperforming Loans by Type of Bank.11 CharacteristicsoftheBoardofCommissioners Table 1.8 OwnershipConcentrationofPubliclyListedCompanies. 1990-1997 Table 1.2 KeyMacroeconomicIndicators Table 2.15 V alue of Stocks Issued and Stock Market Capitalization. 1988-1996 Table 1. 1993-1997 Table 1.9 OwnershipConcentrationofPubliclyListedCompanies by Sector. 1992-1995 Table 1.3 Subsidiaries of the 30 Largest Chaebols Table 2.3 GrowthandFinancialPerformanceofPubliclyListed Companies.1 Listed Firms with Positive Economic V alueAdded. 1996-1998 Table 1. 1986-1996 Table 1.20 ROE of the Banking Sector.17 DER of Listed Companies by Degree of Ownership Concentration Table 1.6 GrowthandFinancialPerformanceofState-Owned Companies. 1997 Table 1.12 CharacteristicsoftheBoardofDirectors Table 1. Indonesia Table 1.19 DER and ROE of Publicly Listed Companies by Sector. 1992-1997 Table 1. 1992-1998 Table 2.vi List of Tables 1. 1992-1999 Table 1.2 Foreign Capital Flows. 1990-1998 Table 1.4 Growth Performance of Publicly Listed Companies by Sector. 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 . 1992-1999 Table 1.13 Presence of Board Committees in Listed Companies Table 1. Republic of Korea Table 2.16 FinancingPatternsofPubliclyListedNonfinancial Companies. 1992-1997 Table 1.7 Growth Performance of the Top 300 Conglomerates.10 Anatomy of the Top 300 Indonesian Conglomerates. 1992-1997 Table 1.14 Banking Sector Outstanding Loans.
19 Table 2. 1985-1997 GrowthandFinancialPerformanceofListedCompanies by Size.8 Table 2.24 Table 2.11 Table 2. 1995-1997 Ownership Composition of Listed Companies.14 Table 2.30 Private Capital Flows to Korea. 1988-1997 FinancingPatternsoftheNonfinancialCorporateSector.27 Table 2.10 Table 2. 1988-1997 Ownership Composition of Listed Nonfinancial Firms by Industry. 1990-1997 InternationalComparisonofRatiosofOrdinaryIncome toSalesinManufacturing GrowthandFinancialPerformanceofSelectedIndustries GrowthandFinancialPerformanceofListedCompanies.29 Table 2. 1997 OwnershipConcentrationofListedNonfinancialFirms by Firm Size.vii Table 2.15 Table 2.25 Table 2. 1997 Ownership Composition of Listed Nonfinancial Firms by Control Type. 1997 Ownership Composition of Listed Firms in Selected Countries.7 Table 2.9 Table 2.20 Table 2.28 Table 2. 1988-1997 Ownership Concentration of the Survey Sample of 81 Listed Firms. 1988-1997 Features of the 30 Largest Chaebols GrowthandFinancialPerformanceofthe30Largest Chaebols. 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 . 1993-1997 The Top 30 Chaebols Debt-to-Equity Ratio. 1994-1998 Financing Patterns of the Top 30 Chaebols.6 Table 2. 1999 InternalShareholdingsofthe30Largest Chaebols.12 Table 2. 1994-1997 Cross-Payment Guarantees of the Top 30Chaebols. 1992-1997 OwnershipConcentrationofListedNonfinancialFirms.26 Table 2.18 Table 2. 1988-1997 OwnershipConcentrationofListedNonfinancialFirms by Industry. 1990 and 1997 Ownership Composition of Listed Nonfinancial Firms by Size. 1988-1997 FinancingPatternsoftheNonfinancialCorporateSectorby Industry Financing Patterns of Listed Companies. 1987-1997 FlowofFundsoftheNonfinancialCorporateSector.21 Table 2. 1997 Ownership Concentration ofAll Listed Firms.16 Table 2.13 Table 2.17 Table 2.5 Table 2.22 Table 2. 1985-1998 GrowthandFinancialPerformanceoftheNonfinancial Corporate Sector.23 Table 2.
13 ADB Survey Results on Shareholder Rights Table 3.20 Financing Patterns by Industry.19 Financing Patterns by Firm Size. 1986-1998 Nonperforming Loans of General Banks. andAffiliated Banks of Selected Business Groups. 1992-1996 Table 3. 1997 Table 3. 1988-1997 Table 3. 1989-1997 Table 3.6 GrowthandFinancialPerformanceoftheCorporateSector by Firm Size.viii Table 2.12 Control Structure of the Top 50 Corporate Entities.16 CorporateFinancing PatternsbyOwnershipType. 1983-1997 Table 3.32 Table 2.7 GrowthandFinancialPerformanceoftheCorporateSector by Industry. 1988-1997 Table 3. 1989-1997 Table 3. Flagship Company. 1988-1997 Table 3.31 Table 2. 1992-1999 .9 OwnershipConcentrationatCriticalLevelsofControl Over Publicly Listed Companies. The Philippines Table 3.4 GrowthandFinancialPerformanceoftheCorporateSector by Ownership Type. 1988-1997 Table 3.SectorOrientation. 1990-1998 131 137 138 158 159 160 161 163 164 166 173 175 176 180 184 191 201 203 204 205 206 207 208 209 212 235 236 3. 1995-1998 4.5 GrowthandFinancialPerformanceoftheCorporateSector by Control Structure. Leverage Table 3. 1989-1997 Table 3.1 GDP Growth of SoutheastAsian Countries. 1989-1997 Table 3.1 Public Companies Registered.10 Composition of Top Five Shareholders of Philippine Publicly Listed Companies by Sector.17 Composition ofAssets and Financing of the Publicly Listed Sector.33 Net Profit Margins of Chaebols. Thailand Table 4. 1997 Table 3. 1997 Table 3. 1988-1997 Table 3.1989-1997 Table 3.3 TheCorporateSectorandGrossDomesticProduct.22 Foreign Investment Flows.15 Financing Patterns of the Corporate Sector. 1978-2000 Table 4.8 Ownership Composition of Philippine Publicly Listed Companies by Sector.2 Growth and Financial Performance of the Top 1.11 TotalandPerCompanySales. 1990-1999 Table 3.Profitability andFinancial .000 Companies.18 Financing Patterns by Control Structure.21 OwnershipConcentration. 1997 Table 3. 1985-1997 Number of Firms with Dishonored Checks. 1997 Table 3.14 Philippine Stock Market Performance. 1988-1997 Table 3.2 Public Offerings of Securities.
1993-1999 Key Financial Ratios of Publicly Listed Companies.1 Figure 1.10 Table 4.3 Table 4. 1986-1999 NumberofNewlyRegisteredandBankrupted/Closed Companies. 1993-1999 Size and Composition of the Thai Financial Sector.9 Table 4. 1985-1996 Top-Five Ownership Concentration of Publicly Listed Companies in Thailand. 1990-1996 External Debt. 1992-1999 Offerings of Debt Securities. Ownership Concentration.15 Table 4.2 TheSuhartoGroup TypicalInternalOrganizationalStructureofaPublicly Listed Company in Indonesia CorporateControlStructure:TheCaseofAyalaCorporation CorporateControlStructure:theCaseofLopezGroup 24 25 195 197 . Leverage.7 Table 4.12 Table 4. 1990-1996 Financial Ratios of All Listed Firms. 1985-1996 Average Key Financial Ratios by Company Size.16 Table 4.14 Table 4.5 Table 4.1 Figure 3.2 Figure 3. and Company Size Top-Five Shareholder Composition of Publicly Listed Companies in Thailand.11 Table 4. 1990-1998 Merger and Acquisition Activities.ix Table 4. 1990-1998 StatisticalRelationshipsbetweenCorporateProfitability.13 Table 4.4 Table 4. 1990-1996 Common-Size Statements of Public Companies by Ownership Concentration.6 Table 4. 1990-1996 Financial Ratios of Listed Companies by Ownership Concentration. 1992-1999 Common-Size Statements for Companies Listed in SET.17 StatisticalHighlightsoftheStockExchangeofThailand. 1985-1999 237 238 239 241 242 243 251 252 256 258 259 260 261 262 264 List of Figures Figure 1.8 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.
placed a high premium on these political connections in assessing the chances of being repaid. This study reviews the Indonesian corporate sector’s historical development. how it has affected corporate financial performance and financing. Malaysia. 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. Foreign creditors. the currency composition and term structure of corporate foreign indebtedness were causes for concern. patterns of ownership and control. contracting by 36. These were already contributing to high levels of nonperforming loans (NPLs) in the Indonesian banking sector several years before the 1997 crisis erupted. and analyzes their importance to the corporate sector in Indonesia. These banks were allowed to operate even if they violated minimum capital adequacy requirements. Economic growth reached more than 7 percent per year and the inflation rate was kept at single digit levels. In this setup. All sectors. these controlling families had political connections that allowed their companies to enjoy special privileges.2 presents an overview of the Indonesian corporate sector. this left the Indonesian economy extremely vulnerable. To facilitate even easier access to credit. II rate reached 58. were the ones most affected. prior to the financial crisis. or Thailand.6 percent) and trade (-18 percent). and responses to the financial crisis. followed by finance (-26. and . short-term loans were used to finance long-term investments.5 percent. regulatory framework. the Indonesian economy seemed to be in generally good shape. In many instances. It analyzes the weaknesses of corporate governance in Indonesia. Section 1. patterns of financing. Foreign debt reached more than $100 billion. The scale of the financial crisis exposed weaknesses of the country’s corporate sector. Section 1. particularly those with large foreign loans. On the other hand.5 percent.2 Corporate Governance and Finance in East Asia. The construction sector was the worst hit.3 looks at patterns of corporate ownership and control. and how it contributed to the crisis. 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. However. 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. posted negative growth. no doubt. the controlling families of corporate groups often established banks to provide funds to affiliated nonfinancial companies. except utilities. highly leveraged companies. Vol. The study also identifies family-based companies and corporate groups. When the crisis hit the country.
Section 1.2 1. The Government became directly involved in industry as a result of the nationalization of Dutchowned shipping firms and oil companies. This section reports the results of an Asian Development Bank (ADB) survey on corporate management and control practices in Indonesian publicly listed companies. In the early 1970s.and large-scale companies were dominated by state-run industrial concerns. in the course of the fight for nationhood from 1942 to 1950. Subsequently.2 Section 1. a gradual shift in public investment away from manufacturing took place. and its response. Up until the mid-1960s. medium. only 40 companies replied—39 are private companies and one state-owned company (Bank BNI). the windfall from oil and gas revenues was an important factor that allowed the Government to promote industrial development via import substitution. 2 Survey questionnaires were sent to 280 companies listed in the Jakarta Stock Exchange. and tobacco industries.2. Despite the oil revenues.4 analyzes corporate financing patterns. how it was affected by the crisis. However. textiles.6 summarizes the major findings of the study and suggests recommendations to improve governance in the Indonesian corporate sector. The industries that emerged were highly import-dependent and reliant on tariff protection.5 examines the corporate sector during the financial crisis in terms of its role.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. It also examines the statistical relationship between corporate performance and corporate governance characteristics. while Chinese and indigenous entrepreneurs ran some large businesses in trading.Chapter 1: Indonesia 3 profiles the corporate sector’s governance characteristics. . substantial volumes of private investment entered the scene. Not all items in the questionnaires were answered by the respondents. 1. With the relatively liberal laws governing foreign and domestic private investments introduced by the New Order Government in 1967 and 1968. Section 1.
a distinct industrial elite started to emerge. Vol. Export credits with low interest rates were granted to industries that were intensive in the use of local labor and raw materials. II the currency needed to be devalued periodically under a managed floating exchange rate system to avoid large current account deficits.2. the stock exchange was also unattractive to companies trying to raise capital as they could borrow from state banks at very low interest rates. But until the end of 1988. the value of manufactured exports overtook the value of oil and gas exports for the first time. A number of underwriters emerged. 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). By 1987. there were also many rapidly growing large-scale companies and business groups or conglomerates. wood. which dominated their respective sectoral outputs and markets. The equity market remained largely unappealing due to a number of factors. During this period. exports of nonoil products (particularly textiles and footwear.2 The Capital Market The Government reactivated the stock exchange in 1977. Last. Regulations in the banking sector led to equities having higher risk but lower returns than bank deposits. the Indonesian industrial sector was quite diverse. Third. investors were reluctant to supply funds to the stock market because they did not know whom to trust and the mechanisms that could protect small investors and shareholders against expropriation by controlling shareholders were underdeveloped. Second. Partly as a result of various government policies. and related products) had shares in total exports that were rapidly increasing. First.4 Corporate Governance and Finance in East Asia. the number of firms quoted in the stock market was only 24. 1. mostly nonbank financial institutions and stockbrokers. In the 1980s. many founding owners of companies were reluctant to go public and dilute their corporate ownership. even when new shareholders do not threaten the control exercised by the original owners. These were families with strong links to the political elite of the New Order. . In 1992. the Government shifted its industrial policy toward the promotion of labor-intensive exports. But these proved counterproductive because they limited the potential for capital gains to prospective investors. produced consumer goods. the dilution of corporate ownership. potentially subjects companies to greater regulatory scrutiny. While most of the companies were small. Generally speaking. and employed the bulk of the industrial labor force.
The dominance of state banks started to erode. Further reforms along the same direction and affecting state-controlled banks came in the 1990s.3 The Banking Sector Despite the development of the stock market. Interest rate regulations on state banks and credit ceilings in general were removed. The banking sector. which were previously constrained to 4 percent per day. The Government also abolished the practice of setting prices for IPOs and removed restrictions on price movements in the secondary market. and increased access of domestic banks to international financial markets. In 1988. Consequently. Since 1977. the liberalization of the banking industry allowed banks to determine lending rates for nonpriority loans. state-owned banks were still among the biggest. The Government also allowed foreign investors to buy up to 49 percent of listed shares. private domestic banks dominated the sector in terms of number and total assets. more significant reforms were introduced. the banking sector has undergone many reforms. However. the number of listed companies in the stock exchange increased substantially. the controlling shareholder of these SOCs is still the State. Partly as a result of these reforms. with a total value of more than Rp8 trillion.2. began to face competition. with a total value of Rp16. the banking sector has been and still is the major source of credit for the corporate sector. the capital market played an increasing role in raising long-term funds needed by the corporate sector. These included the opening of the banking industry to new entrants. from 24 in 1988 to more than 300 in 1997. The development of the Indonesian stock market also provided a vehicle for the privatization of state-owned companies (SOCs). six SOCs had issued equities in the market. But in terms of assets per bank.5 trillion. the legal infrastructure that was supposed to guide the evolution of the banking sector was not backed by effective enforcement. .Chapter 1: Indonesia 5 At the end of 1988. reduced restrictions on foreign exchange transactions. However. Thus. The initial banking sector reform was introduced in 1983. the number of private domestic banks increased. priority credits still enjoyed subsidized interest rates and funding from the Central Bank. Conglomerates carried out 210 out of 257 IPOs. which up to then was channeling oil revenues to priority sectors. to date. Through the years. 1. companies could no longer enjoy low-interest credit from state banks. Table 1. During this period.1 shows that from 1994 to 1998. However.
BCA.8 391. The other banks among the top 10 were state banks.5 7 7 7 5 15.8 10 37. the 10 largest were all affiliated with major business groups.9 248.3 30 7.5 528. Because regulation was weak. while BUN has been closed down by the Government. But the banking system proved incapable of performing its intermediation function.6 240 1996 1997 1998 1999 141.6 7 12.4 789.8 10 19. II Table 1.5 27 66.1 240 1995 122. and Bank Umum Nasional (BUN) have failed and the first two are now under management of the Indonesian Bank Restructuring Agency (IBRA).4 34 12. banks could earn profits even when they did not gather and process information about risk.6 34 14.8 29 6.4 10 35.9 31 9.5 27 88.1 10 47.3 201.3 27 51.5 165 308. Among private domestic banks. Vol.9 762. and Bank International Indonesia (ranked 9th). 1993-1999 Type of Bank State-Owned Banks Assets (Rp trillion) Number of Banks Foreign Banks Assets (Rp trillion) Number of Banks Joint Venture Banks Assets (Rp trillion) Number of Banks Regional Government Banks Assets (Rp trillion) Number of Banks Private National Banks Assets (Rp trillion) Number of Banks Total Assets (Rp trillion) Number of Banks Source: Bank Indonesia.8 27 147.9 291.6 7 7. Of these.8 31 10. Both BCA and BUN have shareholders linked to the former President Suharto.4 239 222 208 173 Assets and liabilities were concentrated in the top 10 banks.8 27 200. Bank Danamon (ranked 7th).6 164 144 130 92 387.3 10 17. Bank Danamon. . private domestic banks among the top 10 in 1997 included Bank Central Asia (BCA) (ranked first and linked to the Salim group).6 Corporate Governance and Finance in East Asia. In terms of assets.9 10 11.9 304.7 351.9 27 113.7 27 37.0 234 1994 104. The deregulation of the banking industry and the liberalization of the capital account created a variety of new sources of financing for the corporate sector.8 166 248.2 161 214.1 Growth of the Banking Sector.5 7 9. 1993 100.2 10 14.9 39 18.
IMF. Although these inflows were not nearly as large as those received by Thailand (10 percent of GDP) and Malaysia (9 percent of GDP).11 3. September 2000.33 (13. 1990-1998 ($ billion) Type of Flows Net FDI Net Portfolio Investment Foreign Bank Loans 1990 1991 1992 1993 1994 1995 1996 1997 1998 1. FDI flows were strong.59 billion in 1996.01) (0.2.15) — = not available.87 7.2 Foreign Capital Flows.50 (0. In 1994.88 4. as shown in Table 1. Joint BIS-IMF-OECD-World Bank Statistics on External Debt. and footwear. foreign creditors were eager to provide financing to Indonesia. initially from Japan and the Republic of Korea.00 2. November 2000. In the 1990s. Table 1. 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.63) (1. when the financial crisis hit Indonesia.88) — — — — — — 8. But FDIs were only one form of foreign capital inflows to Indonesia.4 Foreign Capital The years of rapid industrial growth attracted a large amount of foreign direct investments (FDIs). From the mid-1980s until July 1997. Successive policy deregulation facilitated FDIs in various light manufacturing industries.81 3. Increasingly. foreign investment also had a strong presence in the services and infrastructure sectors. .48 1.40) (0.09 1. they still amounted to a large sum for the economy to absorb. there was a phenomenal growth in direct borrowings by Indonesian corporations.09) 1. In effect. such as metal goods. textiles. Source: IFS CD-ROM. especially through bank loans.59 4.10 5. Net FDI flows increased to $5. Between 1990 and 1996.2. the Government allowed foreign investors to own 100 percent of an Indonesian company.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.78 2. Until the onset of the crisis. Most FDIs came in through joint ventures with business groups having strong political connections. 1. except in certain strategic sectors.09) (0.01 (2.74 5. Indonesia received capital inflows averaging about 4 percent of GDP.
By the end of 1997. In November 1998. Vol. The Government relaxed this restriction in 1988. Capital account liberalization permitted the inflow of foreign capital that fueled the credit boom in the country. Between 1989 and 1992.2. The private sector left foreign loans unhedged because the depreciation of the rupiah had never reached more than 4 percent annually since the 1986 devaluation under the managed floating system. the 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. From 1987 to 1996. the analysis focuses only on publicly listed companies. foreign banks became a significant source of financing for the corporate sector. plus 4 percent for the depreciation of the rupiah. total corporate debt reached nearly $118 billion. an interesting question is whether standard measures of corporate profitability and performance also indicated the same. II Up until the late 1980s. the average foreign ownership of listed companies was 21 percent. In September 1997.5 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. increasing the total trading value from Rp8 trillion in 1992 to Rp120. allowing foreign investors to buy up to 49 percent of stocks of a publicly listed company. with the onset of the Asian crisis. Consequently. but declined to an average of 25 percent during 19951997. . This is lower than the average borrowing rate of 18 percent for loans in domestic currency. participation in the Indonesian stock market was exclusive to domestic investors. more than 50 percent of total Indonesian private debt and 60 percent of total foreign exchange debt were owed to 175 foreign banks and other foreign financial institutions. of which two thirds were rupiah-denominated. Due to data constraints. 1. The external corporate debt owed to foreign commercial banks was $67 billion.4 trillion in 1997. the average borrowing rate for dollar loans was 9 percent. especially the short-term ones.8 Corporate Governance and Finance in East Asia. This increased to 30 percent by the end of 1993. In the 1990s. Private borrowers preferred foreign loans since these were relatively cheaper. Domestic corporate debt was about $50 billion equivalent. The excessive dollar borrowings made the corporate sector vulnerable to sudden currency fluctuations. and conglomerates. state-owned companies (SOCs). foreign investors began to dominate daily trading. The following section looks at the growth and financial performance of the corporate sector.
1 0. 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. total sales of listed companies grew at an annual average rate of 31 percent.0 1. publicly listed companies as a group contributed less than 10 percent to GDP.1 4.2 30.1 220. averaging 3.6 48. although the contribution increased over time.2 7. the average DER increased to 310 percent from 230 percent the . Source: JSX Monthly (several publications).0 12.5 37.2 1995 37.0 64.0 11.7 3.0 12. 1994.5 240. 1993.7 — = not available. Note: The number of firms is not identical for each year. 1995. there were 204 firms.9 37.5 3. Average return on equity (ROE) of listed firms was 11. b Asset turnover is defined as sales over assets. ranging from 220 to 250 percent between 1992 and 1996.0 6.8 230.3 6. 1996.6 percent in 1997. In 1997. a Value added was assumed to be 30 percent of total sales.4 38.3 3.8 220. and 1992. Net profits grew at an annual rate of more than 20 percent from 1992 to 1996.8 6.0 3.4 31.1 percent in 1997 when the crisis began to buffet Indonesia.5 34. 246 firms.0 33.4 1996 18. 248 firms.8 percent between 1992 and 1996. 226 firms. Asset turnover was above 30 percent until 1996.6 3. Table 1. Return on assets (ROA) was also relatively stable during 1992-1996.Chapter 1: Indonesia 9 Publicly Listed Companies Table 1.6 1994 50.7 — 250. but dropped to 1. When the crisis battered Indonesia in 1997. 174 firms.0 10. but fell to 24.4 1997 7.7 percent in 1997.6 24.4 percent.5 34. 250 firms.9 310. During 1992-1997. while total assets grew at 43 percent. The growth of listed companies was sustained by continuing investments.4 1993 45. but declined to 0.3 Growth and Financial Performance of Publicly Listed Companies. but turned negative in 1997.0 12. Despite such rapid growth. The debt-to-equity ratio (DER) was high compared to those of listed companies in Malaysia and the Philippines.3 shows the growth and financial performance of Indonesian publicly listed companies.
In terms of sales and asset levels in 1997. When interest rates increased.64 percent in 1997. trade. ROE fell drastically because the sector had one of the highest DERs. From 1995.7 percent during 1992-1996. it appeared that the performance of listed companies was quite satisfactory prior to the crisis. miscellaneous industry. The Jakarta Stock Exchange (JSX) classified listed companies into nine sectors: agriculture. miscellaneous industry.73 percent in 1992 to 1. real estate. increased from 0. the mining sector had the lowest DER. when the property sector was booming during 1993-1997. and services. The finance sector’s contribution to GDP. This indicates that a substantial part of corporate debt was denominated in dollars and unhedged. II previous year. property. Also. basic industry and chemicals. and property. The same applied to the trade sector. Before the crisis. Most companies in the sector that had unhedged dollar-denominated loans suffered exchange rate losses when the rupiah weakened. But the sector’s ROE fluctuated a lot. Vol. averaging 21.5 presents the financial performance of listed companies by sector. In terms of share of value added to GDP.4). the property sector was severely affected by the crisis.3 percent between 1992 and 1996.10 Corporate Governance and Finance in East Asia. mining. finance. Four sectors (basic industry and chemicals. the dominant sector was the finance sector.2 in 1997. in terms of growth of sales and assets. The finance. still posting a positive but lower ROE. and trade) even posted . the mining sector had the highest ROE. real estate. Table 1. indicating its reliance on equity to support growth. property. which operated in nickel and copper mining in 1992 and 1993. consumer goods. investment. and building construction sectors had the highest DERs because companies in these sectors found it easy to obtain credit from banks. ROA of all sectors dropped in 1997. and building construction. The consumer goods sector ranked second in terms of ROE. However. although asset turnover was slow. the companies in the sector did not operate with a high leverage. with ROE falling to -11. Meanwhile. For instance. the banks eagerly provided credit to property development companies. averaging 17. The ROE levels suggest that high leverage enabled listed companies to achieve high returns on equity. helped in part by the relatively strong demand for consumer goods. the mining sector ranked first. investment. the fluctuation in nickel and copper prices contributed to the oscillation of ROE. Overall. only two sectors (mining and finance) showed a consistently increasing trend from 1992. followed by agriculture (Table 1. This sector was less affected by the crisis. infrastructure. meanwhile. and services. due mainly to the domination of the International Nickel Company of Canada. During those years. and trade.
0 0.5) 6.4 1.4 43.9 0.5 23.4 Growth Performance of Publicly Listed Companies by Sector.7 0.4 44.4 21.3 0. Real Estate..6 (41.9 31. Constn.5 92.2 35.3 0.9 25. 1992 — — — — — — — — — — — — — — — — — — — — — — — — — — — 0.0 0.7 28..0 0.5) 49.9 1.5 0.1 1.5 1.1 23.7 1995 51.8) 0.8 1.6 (0.7 0.0 16. Real Estate.4 38.7) 17.1 0. Real Estate.1 0.8 29.5 1.4) 8.6) 19.5 68. and Bldg.4 77.6 0.0 0.7 (82. Real Estate.4 0. Constn.5 45.6 28.3 (203.2 0.1 0.7 — — 11.6 0.7) (113.8 24.3) 39.5 0. and Bldg.3 0. and Bldg.4 170.1 42.1 1.0 1996 1997 58. Investment.8 62.8 27.9 .1 — 39.3 17.4 1993 155.6 133.0 24.3) 53.4 103. Industry Consumer Goods Industry Prop.4 (149.7 34.2 13.4 30..6 15.9 53.9 0.9 14.3 31.2) 0.3 31.5 28.0 0.5 1. and Services Net Profit Growth Agriculture Mining Basic Industry and Chemicals Misc.8 66.6 1.4 30. Investment.3 0.7 90.1 1.1 32.2 41.0 1. and Services Asset Growth Agriculture Mining Basic Industry and Chemicals Misc.3 92.6 22.9 (7. Source: JSX Monthly (several publications).7 43. Constn.7 — 36.1 (11.0) 46.6 135.6 0.7 54.6 83.1 28.1 0.9 59. and Services Share of Value Added in GDP Agriculture Mining Basic Industry and Chemicals Misc.7 112.3 340.1 1.1 0.9 8. Investment.0 31.8 (76.2 41.0 43.7) (27.2 59.2 14.1 16.6 0. Infrastructure Finance Trade.1 0.0 (28.5 9.1 0.1 1.4 31.9 123.7 62.6 24.1 71.Table 1.2 0.3 1.8 51. Infrastructure Finance Trade. Industry Consumer Goods Industry Prop. and Services — = not available.4) 6.5 53. Investment. Constn. Infrastructure Finance Trade.8) (12.6) 119.4 1.0 22.8 1.8 28.1 0.5 95.2 11.0 0.1 (41.7 133.0 64.5 13.3 0.1 0.8 50.7 24.1 35.3 51.0 (20.6 51.9 36.6) 25.6 85. Infrastructure Finance Trade.5 (11. 1992-1997 (percent) Indicator/Sector Sales Growth Agriculture Mining Basic Industry and Chemicals Misc.. and Bldg.7 21.0 (192.5 (8.5 61. Industry Consumer Goods Industry Prop.4 64.7) 26.6 26.6 1994 (75.7 17.9 54.0 68.1 0.0 18.1 67.9 64.9 54.4 1.8 0.7 40.2 5.8 32. Industry Consumer Goods Industry Prop.5) 13.
5 56.6 14.5 1995 80.1 6.0 50.1 4. and Services Return on Equity Agriculture Mining Basic Industry and Chemicals Misc.0 630. Infrastructure Finance Trade.8 20.0 86.8 382.0 80.1 11.4 13.1 4.4 35.8 3.8 5.0 150.2 6.0 180.0 46.0 3.0 8.0 100.0 120.0 150.6 74.3 17.9 7.0 100.9 4.7 12.1 63.2 7.9 29.5 14.4 5.9 41.5 43. and Bldg.7 1. Real Estate.3 0.1 4.0 680.0 110.6 13.0 17.4 6.3 1. and Bldg.8 9.4 71.0 110.0 1997 230. Investment.7 (3.2 8.2 (4.7 4.0 160.5 13.7 71.1 (3.0 190.0 110.0 150.0) 7.4 35. Infrastructure Finance Trade.0 190.4 .9 42.1 10.7 1.2 53.7 10.3 5.8 44.8 25.0 80. Investment.4 46.1 1996 100.6 8.0 190.8 11.0 8.2 3.1 1994 80.6 8.6 19.1 2.0 650.7 26.0 3.4 13. Real Estate.8 8.5 7.. Investment.0 180.3 64.2) 15.1 10.6 (11.3 73.9 17.1 9.0 120.0 (0.7 10.5 11.6 18.2) 7.7 12.9 40.0 110.4 46. Constn.8 11.9 38.2 1993 130.7 61.3 7. and Bldg. Industry Consumer Goods Industry Prop..8 479.7 8. and Services Source: JSX Monthly (several publications).6) 18.0 160. Real Estate.7 46.0 120.5 4. Investment.Table 1. Infrastructure Finance Trade.1 1.2 111.1 7.2 11.7 9.0 110.0 69.7 5.0 70.4 4. 1992 20. and Bldg.3 38.0 70.0 15.4 17.0 120.2 23.0 70.0 700.3 18.5 17. Constn.0 110.0 220. Industry Consumer Goods Industry Prop. Industry Consumer Goods Industry Prop. and Services Return on Assets Agriculture Mining Basic Industry and Chemicals Misc.1 8.3 33.2 3.0 110.0 80.3) 5.7 5.0 210. Constn.0 170.2 7.1 65.0 39.0 130.0 180.0 11. 1992-1997 (percent) Indicator/Sector Debt-to-Equity Agriculture Mining Basic Industry and Chemicals Misc.1 89.8 16.9 87. Industry Consumer Goods Industry Prop.6 23.4 79. Constn.5 Financial Performance of Publicly Listed Companies by Sector.0 100.7 10.7 12.9 38.0 19.4 20. and Services Asset Turnover Agriculture Mining Basic Industry and Chemicals Misc.0 380.1 3.3 13.3 7..5 4.3 17. Real Estate.6 (2.0 90.0 100.7 13.5 19.5 5.4 6..0 14.8 67.2 39.1 9.7 8.2 30.0 140.0 140.0 60.9 10.1 13.2 15.7 4.0 9.8 81.6 1.8) 8.9 14. Infrastructure Finance Trade.0 650.0 12.8 168.0 160.7 4.4) (1.1 (5.4 1.0 560.0 66.6) 36.1 10.2 13.6 13.
but it continuously declined from 370 percent in 1992 to 250 percent in 1995. averaging 24 and 31 percent. banks (seven companies). SOCs’ sales growth fluctuated during 1990-1996. registering an average annual rate of 10 percent.4 percent the following year.7 percent in 1990 to 6 percent in 1996. growth of net profits and assets was erratic. which collectively had the largest assets. Assuming a fixed ratio of value added to sales. This was relatively high compared to the 3.1 percent in 1992 to 28. there were 165 state-owned companies (SOCs)3 in Indonesia.6). Trade had the highest ROA of 39. . These growth rates were low compared to those for listed companies during the same period. SOCs actively operated in various sectors4 under the supervision of “technical” departments. much lower than that of companies listed in the stock exchange. This was due to large sales by the National Oil Company (Pertamina). the SOCs’ value added as a percentage of GDP ranged from 6 to 8. For instance.6 to 8. SOCs’ ROE ranged from 6.8 percent between 1992 and 1995 (Table 1. indicating SOCs’ declining contribution to GDP. ROA had been at high levels from 1992 to 1995. and finance company (four companies). SOCs diversified into many businesses. the subsidiaries and affiliates number 459 with total assets of Rp343. Similarly. State-Owned Companies At the end of 1995.3 percent in 1995. but dropped dramatically to 4. insurance (11 companies).7 percent. Asset turnover rates were lower relative to those of publicly listed companies. Taken together. The DER was slightly higher than for listed companies. and basic industry and chemicals sectors had relatively stable ROA before the crisis.Chapter 1: Indonesia 13 negative ROA. While asset turnover rates of publicly listed 3 4 SOCs are those in which the State has at least a 51 percent equity interest. However. Just like private companies. The finance and miscellaneous industry. the ratio decreased from 8. The Department of Mining and Energy ranked first in terms of sales of SOCs under its control. The sectoral distribution of 165 SOCs is as follows: nonfinancial (143 companies). Six SOCs were listed in the Jakarta Stock Exchange.3 trillion. Only the agriculture sector showed an increase in ROA in the couple of years before 1997. increasing from 21. between 1993 and 1995. respectively. the Department of Finance supervised 30 SOCs. there were 58 SOCs with subsidiaries and affiliates.1 percent in 1993.7 to 7 percent for publicly listed companies. By 1995.
1 30. Table 1.3 30.4 13.2 — 370.7 13.2 23.7 16.1 310.0 28.3 250.2 — = not available.0 8.5 Conglomerates This study used available data on the top 300 conglomerates in Indonesia.4 16.3 12. II companies consistently declined over time.2 percent in 1997 (Table 1. Assuming a constant ratio of value added to sales.0 17. a Value added was assumed to be 30 percent of total sales.8 12. 1992-1995 (percent) Indicator Growth Indicators Sales Growth Share of Value Added in GDPa Assets Growth Financial Indicators Debt-to-Equity Ratio Return on Equity Return on Assets Asset Turnoverb — = not available.1 19. but dropped to 11.6 28.2 18. but climbed to 30.6) 260. Source: Indonesian Data Business Center.8 percent in 1990 to 13.14 Corporate Governance and Finance in East Asia. Their total sales increased from Rp90. Source: Indonesian Data Business Center.6 28. 1992 — 7. Vol.766 business units.5 percent in 1995.0 24.4 1993 16. b Asset turnover is defined as sales over assets.1 trillion in 1990 to Rp234 trillion in 1997.7 Growth Performance of the Top 300 Conglomerates.4 13.8 11. the contribution of conglomerates to GDP increased from 12.1 12. . mostly private companies.7 (2.1 6.0 7.4 percent in 1992 to 28. In 1997. a Value added was assumed to be 30 percent of total sales.0 6.1 32.7 1994 (9.6 1995 25. 1990-1997 (percent) Item Sales Growth Share of Value Added in GDPa 1990 1991 1992 1993 1994 1995 1996 1997 — 17. Table 1.4 7.5 3.7).4 13.6 percent in 1994.8 21.1) 5. SOCs’ asset turnover rates showed a downward trend from 32. these conglomerates owned 9.6 Growth and Financial Performance of State-Owned Companies.0 8.4 percent in 1994.0 12.
and consolidations. tasked to provide direction to the company. and declaration of bankruptcy. the decision to use certain company assets as collateral for bank credit might need BOC approval. the Government promulgated a number of laws and regulations to protect investors. The law also specifies that the highest “institution” in the limited company is the shareholders’ meeting. The meeting decides on important issues. acquisitions. The BOD undertakes operating decisions while the BOC participates in strategic decisions and operations review. shareholders lose control. a member company might sign a disadvantageous contract with another company where the same controlling shareholder has a higher stake. If the BOC does not perform well. . and the attendance should at least be two thirds of total shareholders. the decision to amend the company charter should be approved by two thirds of shareholders present in the meeting. The actual responsibilities of BOCs vary by company and are stipulated in the company’s charter.Chapter 1: Indonesia 15 1. an approval needs the majority (50 percent plus one) vote. For instance. For instance. By international standards. This guards against shady intercompany dealings within a group of companies. In general. The law also holds the directors and commissioners jointly responsible for decisions made by the company. commissioners. as representative of shareholders. The 1995 law requires limited liability companies to set up two boards: the board of commissioners (BOC). the legal and regulatory framework of the corporate sector was far from adequate. The company charter details the issues that need shareholder meeting approval. The Corporate Law The Corporate Law of 1995 governs the establishment and operation of limited liability companies in Indonesia. and the accountant. A chairman heads the BOC while a chief executive officer (CEO) heads the BOD.2. The law mandates the BOC and BOD to work for the best interests of the company and not just of the shareholders. For example. except in strategic issues stated in the law. For mergers. is the only shareholder mechanism for monitoring and controlling the BOD. The law replaced an earlier statute that was based on the Dutch system. such as the appointment (or replacement) of directors. tasked with supervising the firm. and the board of directors (BOD). The law explicitly requires approval during the meeting of decisions on strategic issues such as amendment of the company charter (articles of incorporation).6 Legal and Regulatory Framework During the 1990s. The BOC. mergers. however.
Vol. (ii) proxy voting. securities companies. II acquisitions. . (x) mandatory shareholders’ approval of major transactions. 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. An important rule is the requirement for independent shareholders’ approval for arrangements that might lead to conflicts of interest. It also regulates reporting and auditing procedures. Controlling shareholders have no vote on the matter. It regulates the requirements of investment companies. and bankruptcy. and the attendance should at least be three fourths of total shareholders.16 Corporate Governance and Finance in East Asia. (xvi) independence of auditing. (xiv) mandatory disclosure of intercompany affiliation such as affiliated lending or guarantees. (vii) the right to call an emergency shareholders’ meeting. (xvii) mandatory independent board committee. The law provides the following rights to or protection of shareholders: (i) access to regular and reliable information free of charge. (iv) cumulative voting for directors. (xiii) mandatory disclosure of nonfinancial information. consolidations. investment managers. underwriters. The law is supplemented by Government regulations. A tender offer is also required for acquisitions of up to 20 percent of listed shares. delineating the tasks and responsibilities of the Capital Market Supervisory Agency. such as custodian banks and the securities registration bureau. and administrative and legal punishment. The Capital Market Law The Capital Market Law (1995) regulates companies listed in the stock exchange. (xii) mandatory disclosure of connected interests. decrees of the finance minister. transparency requirements. (viii) the right to make proposals at the shareholders’ meeting. (v) preemptive rights on new share issues. (xv) mechanisms to resolve disputes between the company and shareholders. insider trading (including market rigging and manipulation) investigation. Because of such requirements. (ix) mandatory shareholders’ approval of interested transactions. the decision should be approved by three fourths of the shareholders present. and guidelines promulgated by the head of capital market supervision. investment advisors. (iii) proxy voting by mail. Examples in the area of corporate governance are guidelines for situations that can potentially lead to conflicts of interest and for acquisitions of substantial shares of listed companies. brokers. (vi) one share one vote. (xi) mandatory disclosure of transactions by significant shareholders. and (xviii) severe penalties for insider trading. and other supporting agencies.
Banking regulations also set lending limits. Discussions on corporate ownership cover listed companies and conglomerates. net open positions. .g. The two most important elements of ownership structure are concentration and composition. amended in October 1998. capital adequacy. states that a bank is not allowed to provide credit without collateral. creditors of unsecured loans are unprotected when borrowers fail to meet their obligations.1 Corporate Ownership Structure Quality of corporate governance is closely related to corporate ownership structure (see discussions in the Consolidated Report of this study). or 20 shareholders. families. 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. five. It aimed to protect creditors by providing easier and faster access to legal redress. However. for instance. the viability of a project). A new bankruptcy law was passed in August 1998. The court can declare the debtor bankrupt upon the request of at least two creditors and default on one loan.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. whether they are individuals. For instance. A Commercial Court was also set up to deal with bankruptcy cases. 1. Banking Laws Affecting the Corporate Sector Some elements of the banking law also affect the corporate sector. etc. holding companies. the collateral could take the form of nonphysical assets (e. It reveals characteristics of controlling shareholders.3.Chapter 1: Indonesia 17 Bankruptcy Law Despite loan covenants. Ownership concentration is usually measured by the proportion of shares owned by the top one. the Banking Law (1992).. or financial institutions. 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. 1.
3. and 0.9 14. Table 1. This preserves the pro rata share of existing shareholders. the founder usually continues to own the majority of shares through a .5 Average 48.7 1996 48.7 3.8 1. This is because a few companies in the transportation sector issued high proportions of shares to the public. When a company makes a rights issue. Table 1.5 16. about two thirds of publicly listed companies’ outstanding shares were owned by corporations that were directly or indirectly controlled by families.8 68.2 1.9.8 68. the controlling shareholders usually act as standby buyers.3 1995 47. mining.9 percent of total outstanding shares.5 72. consumer goods.9 2.8. and basic industry and chemicals sectors than in others. II Publicly Listed Companies Table 1. the five largest shareholders owned 68.9 2.7 1994 48.4 2. respectively. issued 93.1 1.0 0.8 shows average proportions of shares owned by the five largest shareholders of publicly listed companies during 1993-1997.1 0. 13. 2.1 4. and Berlian Laju Tankers (liquid bulk maritime transportation services) issued 48.4 percent.6 percent.8 Ownership Concentration of Publicly Listed Companies.5 1997 48. Meanwhile.6 13.5 percent.0 67. Vol.2 67. On average. for instance. The percentage owned by each of the five largest shareholders was 48. When a company goes public.6 68.1 13. Data from the Indonesian Capital Market Directory (various publications) show that between 1993 and 1997. This is partly due to the prevailing practice of raising equity through rights issues in Indonesia.0 2.0 4.6 3.9 Source: The Indonesian Capital Market Directory. Rig Tenders Indonesia (shipping services) issued 51. Zebra Nusantara (taxi services).5 12. 1993-1997 (percent) Shareholder Rank First Largest Second Largest Third Largest Fourth Largest Fifth Largest Total 1993 50.2 11.6 3.18 Corporate Governance and Finance in East Asia.6. ownership widely held by the general public is highest in the infrastructure and transportation sector (not shown in the table).9 0. The pattern of ownership concentration changed little over this period.6 4.9 shows that ownership by the largest shareholder in 1997 was more concentrated in the agriculture.0 0.6.0 1.
1 1. (1999).4 44.1 2.3 14.3 48.4 6.5 1.6 2.. and corruption.1 2.9 0.1 1. (1999) also found.6 0.0 5. In fact. on the one hand.2 10. on the other. These figures suggest that ultimate control of the corporate sector rests in the hands of a small number of families. the rule of law.2 46.6 percent were widely held.1 percent) of Indonesian publicly listed companies were in family hands.1 1. that the correlation between the share of the largest 15 families in total market capitalization. and Services Average Source: The Indonesian Capital Market Directory. and Transportation Finance Trade. Util.Chapter 1: Indonesia 19 fully-owned limited liability company (Perseroan Terbatas).7 6.2 0. In terms of capitalization.. Indonesia has the largest number of companies controlled by a single family.3 36.1 13. in a cross-country study. Constn.9 3. 1997 (percent) Sector Agriculture Mining Basic Industry and Chemicals Misc. Industry Consumer Goods Industry Prop.8 14.9 44.1 1.9 Ownership Concentration of Publicly Listed Companies by Sector. is strong.9 1.1 0. and the efficiency of the judicial system. as well as the existence of corruption. The findings suggest that the concentration of corporate control in the hands of few families is a major determinant of the evolution of an inefficient legal and judicial system.7 4. Most of the five largest owners of Indonesian publicly listed companies are limited liability companies rather than individuals. two thirds (67.1 2. the top family controls 16. Legal and regulatory developments may have been impeded by the concentration of corporate wealth in .1 0.7 percent of the market.5 58.2 15.7 13. Table 1.9 44. Infrastructure. First Second Third Fourth Fifth Biggest Biggest Biggest Biggest Biggest 54.7 9.3 0.2 This is confirmed in Claessens et al. Investment.1 11.6 8.3 0.6 percent of total market capitalization while the top 15 families control 61.2 2.9 50.6 1.5 4. and only 0.4 54. Claessens et al.7 1.4 4.6 9. Real Estate. which shows that in 1996.4 1.3 2. and Bldg. Thus the founder keeps the proportion of shares necessary to retain control over management of the listed firm.4 11.
Vol. The corruption and regulatory problems generated by high ownership concentration by families in Indonesia are likely to overwhelm its benefits. it rose to 30 percent. numbering 162 in 1988 and 170 in 1996. was able to create a favorable environment for business development. In Indonesia. This may indicate that the New Order Government. Indian. nonindigenous groups owned a larger proportion of the top 300 Indonesian conglomerates. In 1993. Sundanese. II the small number of families and the tight links between companies and the Government. . with all its regulations. From 193 in 1988. and family origin. Indigenous businesspeople include the Javanese. the legal system is less likely to evolve in a manner that protects minority shareholders.5 Conglomerates Table 1. ethnicity. and Padang. 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. most were established during the New Order Government. foreign ownership increased to 21 percent. but later declined and steadied at around 25 percent. But these benefits are few and often dubious compared to the high costs of concentration. In September 1997. Coordination is easier because informal communication channels exist. their number increased to 5 In 1997. political affiliation. accounting for 64 percent of total conglomerate sales in 1988-1996. Batak. Among the top 300 conglomerates. During 1988-1996. resulting instead in a decline in the proportion of foreign investor ownership. or other ethnic groups. the onset of the crisis negated this development. there is a dichotomy between corporations owned by indigenous and nonindigenous businesspeople. Family control is said to have positive effects in that it allows group members in conglomerates to make strategic decisions quicker. the Government allowed foreign investors to buy up to 100 percent of listed shares.20 Corporate Governance and Finance in East Asia. conglomerates established before 1969 dominated in terms of sales. However.10 shows the anatomy of the top 300 conglomerates in terms of year of establishment.42 percent in December. When the Government allowed foreign investors to buy up to 49 percent of listed shares in 1988.55 percent in August to 25. The nonindigenous businesspeople are usually Chinese. However. the proportion of foreign ownership declined from 27.
3 120.4 32.1 25.7 28.5 106.4 15.6 114.9 42.7 49.3 101.9 35.2 159.7 64.3 43.8 38.2 12.3 80.2 76.6 77.4 68.0 31.2 29.6 12.8 30.1 87.1 58.8 49.8 25.9 73.4 81.6 34.4 59.1 103.2 48.1 33.8 28. more than five times its 1988 level.3 36.1 46.9 77.8 Source: Indonesian Business Data Centre.7 89.4 59.5 120.1 41. In 1996.1 46.9 137.0 58.2 33. Meanwhile.4 22.4 37.8 57.4 57.3 134.1 21.4 69.8 36.1 42.0 44.8 12. 1988-1996 Item Number of Groups Year of Establishment Before 1946 1946-1968 1969 Forward Ethnicity Mixed Nonindigenous Indigenous Political Affiliation Nonofficial Official-Related Origin Family Nonfamily Sales (Rp trillion) Year of Establishment Before 1946 1946-1968 1969 Forward Ethnicity Mixed Nonindigenous Indigenous Political Affiliation Nonofficial Official-Related Origin Family Nonfamily 1988 1989 1990 1991 1992 1993 1994 1995 1996 13 125 162 86 193 21 260 40 176 124 13 125 162 83 196 21 259 41 175 125 13 123 164 80 196 24 260 41 171 129 13 120 167 76 199 25 260 40 174 126 13 118 169 76 198 26 262 38 172 128 12 122 166 71 201 28 263 37 171 129 12 122 166 69 205 26 262 38 172 128 11 120 169 71 204 25 260 40 177 123 10 120 170 68 204 28 259 41 175 125 9.0 58.4 trillion in 1996.1 52.4 31.4 31.0 116.1 percent of total . its sales reached Rp1.9 13.7 24.6 54.0 18.4 86.Chapter 1: Indonesia 21 Table 1.5 22.5 21.4 16.7 95.9 47. While they supplied 20.8 68.4 48.4 52.7 40.7 106.2 30.6 95.6 17. Their total sales also increased from Rp38.9 trillion.3 20.1 179.4 19.0 28. the number of mixed groups declined from 86 in 1988 to 68 in 1996.9 14. Conglomeration Indonesia 1997.0 15. due to their “go public” activities.4 18.6 trillion in 1988 to Rp137. sales of the Bakrie group before it went public in 1990 were only Rp369.10 Anatomy of the Top 300 Indonesian Conglomerates.9 billion.2 23. 204 in 1996. For instance.
Bank Indonesia. their contribution declined to 13. for instance. Banks owned by groups or conglomerates typically act as a “cashier” that provides credit to companies within the group. But listed companies within conglomerates were few. and Wisnu Suhardhono of Apac-Bhakti Karya. The contraction in the number and economic contribution of mixed groups may be an indication of increasing social polarization along ethnic lines. or have resulted from alliances between entrepreneurs and officials. Bambang Rijadi Soegomo. and Fast Food (restaurants). Only about 13 percent were formed by official or ex-official families. Djuhar Soetanto.and officialrelated groups. The Salim group. The high NPLs accumulated by banks within official-related groups could be partly attributed to this practice. collectively controlling . compared with the less than Rp700 billion of a nonofficial-related conglomerate. Prudential credit analysis tends to be ignored. Official-related groups have owners (or founders) who are or are allied with former or current government officials (or their families). average sales of official-related conglomerates reached Rp1. The Suharto family is the largest stockholder in Indonesia. owns four groups with many subsidiaries and affiliate companies. which is the largest conglomerate in Indonesia. In 1997 and 1998. banks that had to be closed down included Bank Surya (owned by Sudwikatmono) and Bank Andromeda (owned by Bambang Trihatmodjo). 117 are jointly owned by the family and 57 are owned by individual family members. Out of 174 companies. The well-known official-business alliances are those between Sudwikatmono (former President Suharto’s cousin) and Soedono Salim. In November 1997.2 trillion. Indocement Tunggal Prakarsa (cement industry). II sales in 1988.22 Corporate Governance and Finance in East Asia. Political alliances between entrepreneurs and officials have often led to the violation of regulations meant to promote prudent business practices in the banking industry. In 1996. and Ibrahim Risyad of the Salim group. most of the 16 liquidated banks had violated the legal lending limit set by the central bank.7 percent in 1996. Some of them later became public companies by listing in the stock market. More recent alliances were between Bambang Trihatmodjo (former President Suharto’s son) and Johannes Kotjo. Average sales of official-related conglomerates were substantially greater than nonoffficial-related ones during 1988-1996. Conglomerates were also classified into nonofficial. In 1996. Vol. But only a handful of these companies are listed in the market. there were 175 groups that originated from a family business. including Indofood Sukses Makmur (food industry). Most of the top 300 conglomerates were established by ordinary citizens.
Both are listed companies and members of the Salim group. In 1996. continue receiving some kind of protection and special treatment.1). While the source of the . The officials (or their family members) often own a small portion of shares given to them freely by controlling shareholders. as well as other relatives and business partners. In so doing. He or she could either be the biggest shareholder. It is generally believed that there are cross-holdings between financial and nonfinancial companies and among nonfinancial firms. Some of the groups related to officials have a unique share ownership structure.. The BOC chairperson often represents the controlling party of the company. management. 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. Cross-holdings between financial and nonfinancial firms potentially create more serious problems. or someone very close to and trusted by the controlling shareholders. for instance. families mostly manage the groups and make strategic decisions themselves. with no restrictions. besides Suharto himself. which were liquidated or recapitalized after being acquired by the Tirtamas group that owns a listed cement company. served in some government function (see Figure 1.Chapter 1: Indonesia 23 assets worth $24 billion (Claessens et al. Although they are not actively involved in the daily operations of the companies. Cases in point are the Bank Papan Sejahtera and Bank Niaga. The family controls 417 listed and unlisted companies through a number of business groups led by the Suharto children. 1999). Indofood Sukses Makmur (food industry) was owned by Indocement Tunggal Prakarsa (cement industry). and hence. or both. Indonesian law allows cross-shareholdings. If the family members cannot actively manage the companies as directors. But it is difficult to obtain data on cross-shareholding among firms. the controlling shareholders are able to maintain their special relationship with officials. many of whom. but those of the entire group. This is because cross-owned banks had to consider not only their own interests. they still control the work of the directors. Although some groups employ professional managers. Semen Cibinong. The Salim Group is also in part controlled by the Suharto family. they maintain their position as commissioners. The families retain control of the companies through ownership.
World Bank. Financial Sector Practice Department. and Larry H. .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). (Feb. Simeon Djankov. P.Figure 1. Lang. Who Controls East Asian Corporations? Financial Economics Unit.
This is based on the Dutch system. both controlling and minority.2. The discussions are based on the ADB survey of 40 companies listed in the Jakarta Stock Exchange. Shareholders are at the top of the organization. Therefore. including the boards.2 Management and Internal Control A company’s internal organizational structure determines how shareholders control management. the BOC supervises the work of directors. the BOC has the right to obtain any information concerning the firm. The BOD leads the company and makes strategic and operational decisions.3. As the owners’ representatives. and. The managers execute the BOD’s decisions and lead employees in their departments. request a shareholders’ meeting. seek an audience with directors. The typical structure of a publicly listed company in Indonesia is shown in Figure 1. if necessary. 1. one possibility is that legal lending limits had been violated.Chapter 1: Indonesia 25 problem is inconclusive. role and protection of minority shareholders.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. and accounting and auditing procedures. . the directors. Figure 1. management and managerial compensation.
Corporate Governance and Finance in East Asia, Vol. II
Board of Commissioners and Board of Directors Table 1.11 presents a summary of some characteristics of the BOC. The table reveals that 29 out of 40 companies surveyed did not have independent commissioners. Although 23 companies reported that commissioners were elected based on professional expertise, nine companies reported that selection was based on relationships with controlling shareholders, and another nine reported that commissioners were the company’s founders. Table 1.11 Characteristics of the Board of Commissioners
Number of Firms Responded 11 29 23 9 9 10 22 7 27 7 8 8 30 6 4
Questions Presence of Independent Commissioners a. Yes b. No Basis for Electing the Board of Commissioners a. Professional expertise b. Relationship with controlling shareholders c. As founders of the company Procedure in Electing the Board of Commissioners a. Nominated by the management and confirmed by the AGM b. Nominated by significant shareholders and confirmed by the AGM c. Nominated and elected by shareholders during the AGM Basis for Electing the Chairman of BOC a. Professional expertise b. Shareholdings c. As founders of the company d. Relationship with controlling shareholders Relationship between the Chairman and CEO a. Not related by blood or marriage b. Related by blood or marriage c. No answer
Note: Since companies could answer more than one alternative, the total does not necessarily add up to 40 for each question. Source: ADB Survey.
In most companies (22 out of 40), members of the BOC were nominated by significant shareholders and confirmed at the annual general meetings (AGMs). A nominee that was not supported by significant shareholders
Chapter 1: Indonesia
was unlikely to be chosen as a commissioner. Most companies (27 out of 40) elected their BOC chairman based on professional expertise. The majority of firms (30 out of 40) also reported no relationship between the chairman and CEO either by blood or marriage. A similar picture is obtained for the BOD (Table 1.12). Most companies (30 out of 40) reported not having independent directors. Professional expertise was an important basis in electing directors for 29 companies. Relationships with controlling shareholders and founders of the company were the basis for selecting directors in 11 companies. Table 1.12 Characteristics of the Board of Directors
Number of Firms Responded 10 30 29 7 4 13 22 6 29 3 7 8
Questions Presence of Independent Directors a. Yes b. No Basis in Electing Board of Directors a. Professional expertise b. Relationship with controlling shareholders c. As founders Procedure in Electing Board of Directors a. Nominated by the management and confirmed by the AGM b. Nominated by significant shareholders and confirmed by the AGM c. Nominated and elected by shareholders during the AGM Basis in Electing the Chief Executive Officer a. Professional expertise b. Shareholdings c. As founders of the company d. Relationship with controlling shareholders
Note: Since companies could answer more than one alternative, the total does not necessarily add up to 40 for each question. Source: ADB Survey.
Twenty-two out of the 40 respondents elected their directors through nomination by significant shareholders and confirmation by the AGM. Most companies (29 out of 40) selected the CEO based on professional expertise, although some companies based it on relationships with controlling shareholders.
Corporate Governance and Finance in East Asia, Vol. II
Management and Managerial Compensation The Corporate Law mandates the BOD to lead the company and make strategic and operational decisions, and the BOC to supervise the work of the directors. The BOC also reviews the results of operations and participates in strategic decision making. This indicates some overlapping functions for the BOC and the BOD, which is confirmed in the ADB survey. This overlapping of responsibilities, particularly in making strategic decisions, may result in conflicts. However, since the BOC appoints members of the BOD and determines their remuneration, the BOC is in a strong position to dominate the BOD. Twenty-five out of 40 firms indicated that the CEO makes important decisions after consulting the chairman of the BOC. In carrying out their tasks, the majority of firms reported not having committees to assist the BOD and BOC, as shown in Table 1.13. Only a few companies have nomination, remuneration, and auditing committees, most of which were set up between 1995 and 1997. In 1995, Bank Indonesia required commercial banks to have an auditing committee. Table 1.13 Presence of Board Committees in Listed Companies
Type of Committee Nomination Committee Remuneration Committee Auditing Committee None Total
Source: ADB Survey.
BOD 5 5 5 23 38
BOC 1 1 3 35 40
Most firms reported terms of appointment of three to five years for the BOD and BOC. In some companies, the term differs for commissioners and directors. Although the term is for three to five years, in 13 out of 40 companies, the directors and commissioners have been in service for more than five years. Results of the ADB survey show that in 18 companies, the CEO is given fixed compensation plus a profit-related bonus. In 14 companies, only fixed compensation is given. For the BOC chairman, 10 companies
Chapter 1: Indonesia
provide fixed compensation plus profit related bonus, while 14 companies provide fixed compensation only. Role and Protection of Minority Shareholders Indonesian law requires publicly listed companies to have at least 300 shareholders to help ensure share liquidity and dispersed ownership. The highest number of shareholders is found in Bank BNI (a state-owned bank), reportedly having 27,568 shareholders. Small companies simply comply with the minimum shareholder number requirement. Most companies reported that their shareholders enjoy all mandated rights and protection, except those on proxy voting by mail, cumulative voting for directors, and the independent board committee. A company charter (articles of incorporation) stipulates the quorum requirement during annual meetings, which is usually two thirds of total shareholders. The ADB survey showed that more than 67 percent of shareholders attended the last annual meeting in most companies. While proxy voting is allowed, proxy votes accounted for less than 10 percent of shareholders on average. Brokerage companies and management were the usual proxies. A change in the company charter requires a two-thirds majority vote by shareholders. The ADB survey revealed that in the last three years, only one management proposal (i.e., director’s fee) was rejected during the AGM. This is not surprising because management usually seeks prior approval of proposals from controlling shareholders. Accounting and Auditing Procedures Thirty-five out of 40 respondents in the ADB survey claimed to have substantially followed international accounting standards even prior to the financial crisis. Accounting authorities, however, can easily change acceptable accounting methods. After the crisis, for instance, the Indonesian Accountants Association recommended that potential foreign exchange losses be reported as losses at the end of the accounting year. Later, the association allowed companies to choose between declaring it in the profit and loss statement at the end of the accounting year or in the balance sheet. All companies in the survey reported the presence of an independent auditor, which is usually an international audit company. Most companies have been associated with their independent auditors for more than five years. Shareholders appoint the external auditor during the AGM.
Corporate Governance and Finance in East Asia, Vol. II
Control by Creditors The control of creditors over a debtor company rests on assets used as collateral for loans. Unsecured creditors resort to the legal process when problems arise. Based on the ADB survey, each company was associated with an average of five creditors, the majority of which were banks. Some companies were associated with an excessively large number of creditors, reaching up to 30. Most of the companies have been dealing with their institutional creditors for less than three years. Although the banking law requires collateral for bank loans, some creditors did not enforce the requirement. Only 10 companies reported that they were required to provide collateral by all creditors. Twelve companies claimed having creditors that did not ask for collateral. Twenty-five out of 32 companies reported having renegotiated loans with creditors in the last five years, mostly after the Asian crisis. This indicates that many companies experienced serious difficulties in repaying debts as a result of the crisis. But most of these companies stated they would possibly borrow from the same creditors, indicating their relatively strong bargaining position. The majority of firms (22 out of 29) also said that creditors had no influence in management decision making. In 1998, the Bankruptcy Law was passed to protect creditors and the Commercial Court was set up to deal with bankruptcies. This paved the way for unsecured creditors to proceed against a debtor in default based on loan covenants and through the legal process of collection against the debtor’s assets. However, enforcement of the law was a disappointment to those who hoped that it would put corporate restructuring and the settlement of corporate debts on a running start. Only 17 cases had been filed with the court by late November 1998. Just two companies had been declared bankrupt, and three suits were dismissed by the Commercial Court. The Government’s political will and support are still very much needed in order to set up a well functioning Commercial Court. Long and hard work is required to restore creditors’ confidence in Indonesia’s legal system. The Market for Corporate Control Between 1992 and 1997, there were 40 cases of acquisition and takeover of Indonesian companies. Most of these, however, were internal acquisitions (i.e., acquisition of a company in the same group). Only five cases were
the bank was liquidated. except for publicly listed SOCs. In April 1999. Bank Niaga was under a recapitalization program. it was common for the Government to invest in certain private companies. In the massive restructuring of the banking sector that commenced after the crisis. The BOD and BOC of PT Sari Husada were allowed to complete their terms before they were replaced. They then replaced the BOD and later sold the bank. the Government took over NPLs and put them under IBRA management. at a large profit. or direct subsidies. the acquiring parties were trying to obtain operating synergies because they had companies in the same industry.6 In this case. This used to be a common practice in companies associated with the Suharto regime. who was acquiring his second commercial bank. the takeover brought significant losses to Djojohadikusumo when share prices plunged7 during the crisis. Wijaya and his friends bought shares of the bank on several occasions until they gained control. the owner of Tirtamas group. However. State ownership for listed SOCs ranges from 25 to 35 percent. to Hashim Djojohadikusumo. Control by the Government Government control could be in the form of state ownership. Another case was the takeover of Bank Niaga in 1997 by Djojohadikusumo. IBRA found itself tasked with managing large amounts of assets in the private sector. 6 7 Later in March 1999. with the minister’s approval. In these two latter cases. One famous takeover was Bank Papan Sejahtera. A study by Connie Tjandra (1993) shows that internal acquisitions were often initiated for tax shelter purposes. Since the NPLs reached up to Rp300 trillion.Chapter 1: Indonesia 31 external acquisitions. restrictions on market entry. . a state-owned insurance company may invest its funds in a private firm. The bank was reported to have high NPLs and had broken the legal lending limit. Most Indonesian state companies are 100 percent owned by the Government. The Government is thus able to appoint some officials to be members of the private firm’s BOD or BOC. Before the financial crisis. The Government appoints the BOD and BOC of these firms. the acquiring interest was apparently seeking economic profits. For instance. 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. appointment of management. which was acquired by Yopie Wijaya in 1995.
6 3. bank credit surged from Rp122. the share of private national banks in outstanding total loans increased to 44.1 Corporate Financing Financial Market Instruments Prior to 1977.2 6. Data from Bank Indonesia show that from 1994 to 1997.1 Equities In 1977. Vol.6 48. this market was not well developed.5 108. Table 1. including bonds. new instruments have been introduced to the corporate sector. Bank Credit As shown in Table 1. however.3 60.3 111.3 9. companies considered alternatives to bank loans. When the Government liberalized the banking industry at the end of 1988 (which allowed for higher interest rates). jointly providing almost 90 percent of loans until 1997. and others offered by nonbank financial institutions or finance companies.9 150. stocks.2 5.1 220.14 Banking Sector Outstanding Loans.7 50.3 14. equities became available to the corporate sector.4 86.4 1.6 150.9 trillion in 1992 to Rp487.0 6. 1992-1999 (Rp trillion) Type of Bank State-Owned Banks Foreign Banks Regional Govt Banks Private National Banks Total Source: Bank Indonesia.6 4.6 percent in 1997. From 34. II 1. Bank loans. because of the restrictions discussed below.0 487.0 3.0 168. remain the major financing instrument for the corporate sector. Private national banks and state-owned banks were the biggest domestic creditors.32 Corporate Governance and Finance in East Asia.8 193.4 percent in 1992.7 122.5 7.4 56. when the Government reactivated the stock exchange. .6 292.9 378. 1992 1993 1994 1995 1996 1997 1998 1999 68.7 112.9 234.0 93. bank loans were the only instruments available to the corporate sector for short term (working capital) or long term (investment) financing.14.2 71.4 trillion in 1998.7 18. However.4.9 153.3 188.4 225. Since then.4 24.5 42.3 66.6 6. private national banks overtook state banks as the dominant credit source.5 80.2 27.
It gradually increased again starting in 1991. The ratio reached 8. Prior to 1995.e. the activities of finance companies were not covered by regulations on prudential practices in the banking sector (e.4 1996 1997 1998 50. capital adequacy ratio.6 310.1 1994 26.7 percent in 1997.6 123. when foreign investors were not yet allowed to purchase listed shares.5 Financing by Finance Companies Finance companies first emerged at the end of 1980.5 333.7 15.7 14.7 9. In 1995. 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 1996.0 206.. They were not. shooting up to 18.8 48. however. factoring.9 1999 76. limiting loans to a maximum of 15 times equity and foreign loans to five times the equity.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.1 18. but dropped to 8 percent in 1991 when the Government tried to stabilize an overheating economy.Chapter 1: Indonesia 33 Some companies went public. i.. the Government issued regulations to supervise and promote prudential practices in finance companies.g. credit cards.15 Value of Stocks Issued and Stock Market Capitalization. funds raised in the stock market were less than 5 percent of the credit disbursed by the banking sector. and net open position).6 91. legal lending limit.6 859.0 15. offering services such as leasing.9 406.5 1995 35.15). and consumer credit.4 207. In 1988. . finance companies were increasingly used as channels for the inflow of foreign loans. During the 1990s. Most banks therefore set up subsidiary finance companies to circumvent banking regulations. allowed to accept deposit accounts from the public. Overall.6 301.1 10. 1992-1999 (Rp trillion) Item Stocks Issued Outstanding (As % of Outstanding Bank Credit) Market Capitalization Source: Bank Indonesia. 1992 1993 11.1 17.2 16. Table 1.0 70. the stock market has gained a bigger role in corporate sector financing (Table 1. thus increasing the role of the capital market in raising long-term funds.
While banks had some exposure to these instruments.8 7.6 100. at 81 percent of total borrowings.4.4 8.34 Corporate Governance and Finance in East Asia. publicly listed nonfinancial companies had high proportions of equity and internal finance (retained earnings).0 39.5 — 26. Source: Author’s estimates based on the Pacific-Basin Capital Markets (PACAP) Databases.0 — = not available. have been popular in Indonesia since 1990.3 37.1) 23.8 17.9 16. PACAP Research Center. . otherwise it would be classified as a loss in the banks’ books.4 13.6 23. II Commercial Papers Commercial papers. they were not rated by a rating agency. respectively. In the second half of the 1980s.5 11. Thus in November 1995.5 percent and 36.6 8.3 14.16 shows financing sources of Indonesian publicly listed nonfinancial companies estimated by using flow-of-funds analysis.3 16. 1996.0 1986-1996 17.6 12.4 23.16 Financing Patterns of Publicly Listed Nonfinancial Companies.5 (0. In terms of composition.2 Patterns of Corporate Financing Table 1. This is in contrast to the lower share of borrowings during the same period. averaging 26. 1. Table 1.2 26.6 100. Bank Indonesia prohibited banks from underwriting issues of commercial papers but allowed them to act as paying agents.5 21. short-term borrowings were greater than long-term debts. which are unsecured negotiable promissory notes with a maximum maturity of 270 days.3 (0.8 percent. Vol.0 100. 1986-1996 (percent) Financing Source Internal Borrowings Short-Term Long-Term Debentures/Equity Debentures Equity Trade Credit Others Total 1986-1990 36.7 22.0 3. 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).1) 23.0 1991-1996 16.
the corporate sector’s high leverage. that ownership concentration may be associated with heightened risk-taking by companies.2 trillion (mostly foreign exchange losses). corporate debts accounted for 39. rising from Rp54.3 percent during 1991-1996.2 trillion.9 trillion in 1996.4 trillion in 1993 to Rp112. Indofood registered losses of almost Rp1. Bank loans also surged when the banking sector was liberalized in 1988. For instance. Hence.9 trillion. Indosat and Telekom.4. Two telecommunications companies. also suffered from foreign exchange losses but managed to post profits of Rp0. 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. was due largely to a rapid rise in long-term debts. Table 1. The high share of equity financing was due to the surge in capital market activity following the 1988 reforms.Chapter 1: Indonesia 35 In the 1990s. The corporate sector invested heavily from 1991 to 1993 and slowed down its investment spending a few years before the 1997 crisis. The results indicate that firms with higher ownership concentration tend to have a higher DER. Of the various financing sources. respectively. in the context of Indonesia and some other countries. .1 trillion. which was masked by the rapid growth in investments. Many companies suffered big losses in 1997 due to their high exposure to dollar loans. All companies in the cement industry suffered from foreign exchange losses. Large shareholders are inclined to undertake risky projects intended to generate high returns using borrowed funds.17 compares the DER of listed firms by degree of ownership concentration. with longterm debts increasing rapidly. the pattern changed. as evidenced by an average DER of 230 percent during 1992-1996 that rose to 310 percent in 1997. which managed to post significant profits due to low exposure to dollar-denominated loans. Most corporate charters require commissioners to approve debt issues or sign debt agreements. while Semen Cibinong’s losses reached Rp2. This amount doubled in 1997.3 Corporate Financing and Ownership Concentration It has been suggested. except Semen Gresik (an SOC). These liabilities grew significantly because corporate expansion was largely financed by debt. They also do not want to dilute corporate control and are more likely to finance growth with debt.6 trillion and Rp1. 1. reaching Rp229. Note that the corporate sector’s high leverage existed side by side with sizable equity capital raised from the capital market. Corporate debts grew over time.
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. Inadequate Financial Regulatory Framework Liberalization of financial markets increased the corporate sector’s access to domestic and foreign private capital. the free capital flow system allowed private companies to borrow dollars offshore without any restriction.5. 1. II However.358.1 The Corporate Sector in the Financial Crisis Causes of the Financial Crisis Many intertwined factors led to the crisis. and high ownership concentration among families with political affiliation. Source: Author’s estimates.0 351.0 386. Controlling parties rely on external financing to maintain their equity share and. In addition. since commissioners represent the controlling party. The low cost of foreign loans and the relatively stable exchange rate created a false sense of security for corporations. aided . heavy reliance of companies on bank credits to finance investments. the borrowings swelled.0 1. Between 1987 and 1996. 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. As a result. ultimately. the private sector borrowed heavily in unhedged dollars. to maintain control of the company. Table 1.56 significant at the 10 percent level. The test of the difference between the two means found the t-value of 1. Vol.5 1.0 Notes: Firms with high ownership concentration have more than 50 percent of shares owned by the top five shareholders.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 699.36 Corporate Governance and Finance in East Asia. decisions on debt are made with the implicit endorsement of owners.
e. The banks served as a “cashier” that provided easy credit to nonfinancial companies within the group. averaging about 4 percent of GDP. They were. Heavy Reliance on Bank Credits to Finance Investments Companies relied heavily on bank loans to finance rapid corporate expansion because internal financing was insufficient and the capital market was not developed. the level of corporations’ foreign debt could not even be ascertained. large amounts of credit were directed to the companies within the group. Decisions to borrow in dollars made sense to many borrowers because dollar loans were cheaper than rupiah loans. after all. It was only in 1995 that some regulations on the activities of finance companies were contemplated. The large supply of foreign funds. substantial amounts were also funneled into projects that guaranteed repayment mainly on the strength of borrowers’ close political connections. This left them vulnerable to interest rate surges as well as sudden currency fluctuations in the case of dollar loans. did finance many viable ventures. A lot of short-term foreign funds were used to finance long-term investment projects. The Government later specified the legal lending limit and the net open position that banks had to follow. many firms became highly leveraged. to circumvent these banking regulations. However. only created to serve the companies to which they lent. This often led to the violation of prudential credit management practices. 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. It was doubly difficult to exercise supervision when groups with political clout owned the banks. As a result. and the negative net open position (short position in dollars) continuously rose to precarious levels. . The supervising agency was caught unprepared. 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. Conglomerates that had difficulty in getting loans (i. those with high DERs) established their own banks. A director at Bank Indonesia revealed that in 1995.. conglomerates set up finance companies and used these as channels for the unfettered inflow of foreign loans in lieu of banks. It also meant that the cashier bank had neither the independence nor the incentive to exercise ex ante and ad interim monitoring of borrowers. In the process.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. However.
total private sector foreign debt stood at $72. The ultimate control of the corporate sector rests in the hands of a small number of families who own groups of companies. most often to people who were close to the ruling regime. Families retain control by keeping the majority percentage of outstanding shares. $35 billion of Indonesia’s foreign debt owed to private foreign banks was about to mature in less than one year. partly because they used nominee accounts to register ownership rather than set up a holding company. but on the basis of who the borrower was. and in the process maintain control of the company. Controlling shareholders also prefer to use debts to finance expansion so as not to dilute their ownership. and investing shares among nonfinancial companies within the group and in other groups’ companies. This fact was usually not disclosed in financial statements.5 billion. and power generation) require huge capital. In early 1998. This was often the case in the banking industry. II By mid-1997. there was also almost universal confidence that the economic growth would continue indefinitely. contracts were granted to the private sector. banks did not lend on the basis of the soundness of the project. There were cases where banks and borrowing companies were controlled by the same groups or families with strong political connections. toll roads. by setting up their own banks. They ensure that commissioners represent their interests and maintain close relationships with the chairperson. Corporations were certain that they could roll over short-term loans when these fell due. Collusion between big businesses and the political elite was widespread in Indonesia. Family-controlled corporations were generally structured as a complicated web of affiliates and associated companies. Projects involving massive capital investments and long-term operating deals (in telecommunications. of which $64. as they had done so in the years before the crisis. Aside from the fact that many of these loans were channeled through banks and corporations of politically connected families.5 billion was owed directly by corporations. Since the Government could not afford to undertake these projects. They enhance their control over companies through cross-shareholdings. In many cases. where private banks are usually in the hands of big businesses. High Ownership Concentration High concentration of corporate ownership (particularly by families) led to poor financing and investment practices. Vol.38 Corporate Governance and Finance in East Asia. politicians. . or both.
6) (0.1) 1.0 2.4 5. Using the financial statements as of 30 June 1998 of 161 publicly listed companies.24 trillion for the first six months of 1998.6 8. followed by the finance and trade sectors.5.7 6.1 5.9 3. posted negative growth rates. 53 companies reported negative equity of Rp6. except utilities.8 7. Livestock.2 Impact of the Financial Crisis on the Corporate and Banking Sectors Impact on the Corporate Sector Table 1.5) (18. The JSX Monthly reported that total losses of 214 listed companies amounted to Rp39.7) (2.3 12.52 trillion.6) (3.2 8. The construction sector was the worst hit. and Water Supply Construction Trade.6 4.370 percent.6 12.8) (11. Sectors with lower ROE generally had higher DER.1 6.2 (1. BPS).Chapter 1: Indonesia 39 1.19.4) (0.8 0. and Business Services Other Services GDP 1996 3.7) 2. This continued in 1998. Gas.7 1998 (0. and Restaurants Transport and Communications Financial. Only 86 companies reported profits.0 3. followed by property. The average DER was found to be 1. when all sectors. and 128 companies reported a total loss of Rp46.3 11. Forestry. DER and ROE were calculated per sector. Most sectors showed significant increases in leverage. much higher than the 307 percent registered in December 1997.8) (13. indicating a rapid rise in . Real Estate.18 shows that growth in most sectors significantly fell in 1997. as shown in Table 1. Table 1.8 8.1) (26.4) 2.7) (8.4 7.8 1997 1. The consumer goods industry reported the lowest ROE.3 Source: Central Bureau of Statistics (Biro Pusat Statistik.6 (36.18 GDP Growth by Sector.6 13.58 trillion (meaning their losses were greater than the paid-up capital). 1996-1999 (percent) Sector Agriculture. real estate.1 (1.4 7.0) 1999 2. Hotels. and building construction. and Fisheries Mining and Quarrying Manufacturing Electricity.0) (15.0 5.
0 229. the NPL ratio had reached more than 60 percent.0 635.0 163.1 30. the NPL ratio rose to 25. losses in operation were due to declines in sales and increases in the cost of imported inputs.0 2.0 108.0 1. private banks posted negative ROEs in the same year.6 (11.8 percent in 1996.8 (373. a Actual data for 1st semester only.5 8.1 (3.1 1. Source: JSX Monthly.7 percent in July 1998. This figure further increased to 47.19 DER and ROE of Publicly Listed Companies by Sector.2 (4.0 307.0 72.1) 7. The huge losses suffered by most companies were caused by three factors.0 2.2 23.0 177.0 111.0 1998 186.20 reveals that the banking sector’s ROE decreased significantly in 1997.0 697.6) 15.625. small foreign banks enjoyed the highest profits.271. Mostly suffering from a liquidity squeeze.1 (124.40 Corporate Governance and Finance in East Asia.2) (264. interest expenses rose as credit rates increased from 20 percent in early 1998 to 40 percent in mid-1999.0 191.0 97. As the rupiah weakened and interest rates increased.0 65.0 219. Vol.0 108.097.0 205. but annualized to approximate full year values.0) (78.8 17.0 a ROE 1996 1997 1998a 14.0 1. from only 8.2 13.0 1997 234. .5 percent in April 1998. foreign exchange losses came about with the use of unhedged foreign debt.4) 18.7 1.0) 10.0 193. First.0 158.1 (5.4 5.4 (6.8) 36.0 105.395.6) (115. The table also reveals that although private national banks dominated the banking sector in terms of assets and credits.0 12.4) 8.9 12.0 864.0 631.21. several publications. 1996-1998 (percent) DER Sector Agriculture Mining Basic Industry Miscellaneous Industry Consumer Goods Industry Property Infrastructure Finance Trade/Services Average 1996 104. Impact on the Banking Sector Table 1.7) 6.1 (92.1) Note: DERs were calculated for only 161 companies (out of 214) that had positive equity. Second. as shown in Table 1. Third.0 177.0 92.370. rupiah values of dollar-denominated debts due to the weakening of the local currency and the rapid decline in equity because of losses. and would have kept on increasing if interest rates had not declined.3 7. II Table 1.0 1. Financial and banking analysts estimate that by September 1998.
1 274. 1996-1998 (Rp trillion) State-Owned Banks — 140.7 4.45 21.07 1994 14.67 8.8 14.9 11.8 8.7 29.1 198. 230/1998. State-owned banks initially had the highest NPL ratio.8 11.45 — 1993 15.68 1996 1997 8.9 percent. July No.3 445. put pressure on the banking sector.0 622.2 10. coupled with negative spreads (deposit rate was higher than the credit rate).2 — 8.1 13.5 34.09 (11.2 — 19.21 Nonperforming Loans by Type of Bank.2 1.73 30.2 8.0 — 32. 227/1998 and October No.20) Table 1.1 1.8 3.09 11.06 20.24 (4.6 — 4.8 187. The high and increasing NPLs.20 ROE of the Banking Sector.6 — 13.81 13.72 16.6 — 1.38) 11.15 20.2 47. Source: Infobank.24 15.7 — 1.84 27. 1992 7.5 222.37 19. 1992-1997 (percent) Type of Bank State-Owned Banks Foreign Banks Joint Venture Banks Regional Development Banks Private National Banks Total — = not available.91 21.6 6.5 57.50 9.86 11.5 128.12 15.Chapter 1: Indonesia 41 Table 1.1 30.25 22.2 48.28 5.2 37.43 10.2 8.3 Private National Banks — 179. Source: The National Banking Association.39 13. . In July 1998.34 16.70 1995 7.7 106.30 5. however. private national banks overtook State-owned banks when their NPL ratio jumped to 57.1 47.9 Regional Foreign and Development Joint Venture Banks Banks — 9.47 20.3 361.0 129.5 2.7 — = not available.5 31.89 27.69 14.07 13.7 Item Total Loans Dec 1996 July 1997 Dec 1997 July 1998 NPLs Dec 1996 July 1997 Dec 1997 July 1998 NPL Ratio (%) Dec 1996 July 1997 Dec 1997 July 1998 Total 331.0 — 4.9 297.4 7.3 22.44 15.9 — 11.
only a . Vol.5. The scheme encourages negotiation between creditors and debtors. a more comprehensive scheme to tackle domestic and foreign corporate debt.000/$1) in debt from domestic commercial banks. While the process of restructuring was in progress. the Jakarta Initiative Task Force had conducted negotiations for 52 companies with Rp2. 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.42 Corporate Governance and Finance in East Asia.7 percent ($64. the scheme failed. The committee was tasked to ascertain the level of private corporate sector debts and arrange negotiations between debtors and creditors. In June 1998. particularly in terms of debt resolution.2 billion debt. II 1. have been subject to restructuring deals under the initiative. The scheme offered a hedging facility against rupiah devaluations for restructuring agreements. about 80 percent of which was private. However.3 Responses to the Crisis Corporate Restructuring Measures At the end of 1997. by mid-September 1998.000 eligible firms had signed up for the scheme. the corporate sector had more than Rp600 trillion ($75 billion at Rp8. In addition. companies were not servicing their debts. 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. Corporate debt accounted for 46. few companies were in a position to resume interest payments. Thus. Semen Cibinong (cement industry) became the first Indonesian company to resume paying part (25 percent) of the interest on its $1. IBRA was formed to offer Mexican-style resolution for private sector foreign debt. assembling the legal and policy framework to facilitate corporate restructuring. a number of prominent companies. Aside from being described as overly complicated. Total amortization payments due on foreign debt in 1998 were placed at $32 billion (before restructuring). and Ciputra (property business).6 billion) of Indonesia’s total external debt in March 1998. none of the 2.7 billion of foreign exchange debt. In November. Since September 1998. Another option that companies could take under the Jakarta Initiative was debt restructuring via debt-to-equity swaps. such as Garuda (a national flag carrier). By end-November. Unfortunately. Astra International (automotive).4 trillion of domestic debt and $6. On 9 September 1998. the Government and private sector formed a committee to help corporates deal with the crisis. the committee launched the Jakarta Initiative.
. Astra International (automotive industry) and Bakrie Brothers (a holding company in several sectors) explored this option. Some listed companies with relatively “rich” shareholders decided to replace their loans with additional equity through rights issues and privileged subscription (limited offering). Moreover. plantations. mining. Rabobank and Citibank.e. focused on its core business of car and motorcycle manufacturing and sold off its subsidiaries in semiconductors. and mining equipment. and sell noncore businesses or nonoperating assets. consolidate business units. 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). a publicly listed company operating in the automotive industry. Qualified professionals from the private sector will act as receivers and administrators in the management of estates of companies in bankruptcy or reorganization. Standard Chartered. lay off workers. the companies’ financial performance deteriorated. 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. Bank Bali agreed on a debt-to-equity swap with its creditor. Procedural rules are also being introduced to ensure certainty and transparency in the proceedings.Chapter 1: Indonesia 43 few companies reached agreement with their creditors on this. with the requirement that adequate compensation and protection will be provided to such creditors during that period. Protection against insider and fraudulent transactions taken by a debtor prior to the adjudication of bankruptcy will be enhanced. Meanwhile. Astra International. for equity infusion. some companies attempted to restructure their businesses on their own. When credit from the banking sector became unavailable and interest rates increased significantly. Debtors. Bank Niaga also negotiated with some of its creditors. Bankruptcy Reform The Bankruptcy Law was passed in August 1998. aiming to modernize the bankruptcy system and promote the fair and expeditious resolution of commercial disputes. as well as general commercial disputes. under which the latter would become one of the bank’s shareholders. A Commercial Court was set up to handle corporate restructuring and debt settlements. For instance. In the banking industry. 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. forcing them to cut costs. i.
companies were allowed to sell shares only by issuing stock rights. 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. the Court’s early record has been a disappointment. In the longer term. in consultation with IMF and the World Bank. However. Rather. (iv) measures to recover liquidity support previously extended to troubled banks by Bank Indonesia. (iii) the merger. 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 has also declared only two companies bankrupt. The significance of a sound bankruptcy system cannot be understated as it provides a backdrop for negotiations in the workout and restructuring process against which parties often gauge their legal rights. with only 17 cases filed as of November 1998. the measure had only a minimal impact. The bias in favor of debtors has retarded the pace of corporate restructuring. Some companies simply decided not to pay their loans knowing that it would be difficult for creditors to take the case to court. since the market reflects the condition of the economy. However. including procedures for handling operational issues and processing bankruptcy cases. 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. The Government has also been concerned with the issue of capital controls. collusion. Capital Market Reform In the capital market. and (v) a strengthened banking supervision system. reform. Vol. is also reviewing the Bankruptcy Law. legislation against corruption. Realizing that they undermine investors’ confidence.44 Corporate Governance and Finance in East Asia. the Government did not impose restrictions nor did it attempt to regulate capital flows. To push bankruptcy reforms. . and recapitalization of state banks. Previously. The Agency also allowed companies to buy back up to 10 percent of outstanding shares to improve the condition of the stock market. the Capital Market Supervisory Agency allows companies to offer additional shares directly to the public. There will be changes in the implementation of the bankruptcy law. The Government. and nepotism (anti-KNN) was signed in 1999. (ii) the resolution of nonviable private banks.
Conclusions. The Bank Indonesia 21st package includes recapitalization. improvement of rules and prudential regulations. and Recommendations Summary and Conclusions Corporate Ownership and Structure Most of Indonesia’s top conglomerates were established as family businesses. The four state banks (BDN. Banks deemed ineligible for recapitalization will be closed. The Company Law at present can be interpreted as severely limiting the scope for debt-equity swaps.Chapter 1: Indonesia 45 In 1997. Parliament approved amendments to the banking law that were geared toward strengthening the legal powers of IBRA and its AMU. To overcome these problems. merged. the Government has drafted a regulation providing tax neutrality for mergers and removing other tax disincentives for restructuring. 1. the Government required banks to be audited by international external auditors. the Government established IBRA to supervise problem banks. The agency set up an Asset Management Unit (AMU) to directly manage problem loans of banks under its supervision.6. To obtain a clearer picture of the banking sector. providing Bank Indonesia with substantially enhanced autonomy. BEII. it is doubtful whether pure holding companies are able to enter into swaps. regulations will need to be issued to permit debt-toequity swaps in the context of corporate restructuring plans. depositors will be fully protected by the Government. Some 175 groups that originated from family businesses controlled .6 1. and follow-up action on bank restructuring. In October 1998. In particular. However. Liquidity support given to troubled banks should be repaid in four years. The merger process will be finished within two years. and Bapindo) will be merged into one bank named Bank Mandiri. BBD. was enacted in 1999. A new central banking law. It has also drafted regulations to remove obstacles for converting debt to equity. The importance of this legislation may need to be emphasized. Other Regulatory Reforms To push corporate restructuring further.1 Summary. Bank Indonesia has announced a recapitalization program for potentially viable private banks. or sold (after transferring NPLs to the AMU).
Rapid growth in investments masked the corporate sector’s increasing leverage. These figures show the extent of power wielded over the corporate sector by a small number of families. Foreign creditors. Therefore. put a significant amount of corporate assets of conglomerates in the hands of creditors or the Government. Vol. II 53 percent of total assets of the top 300 Indonesian conglomerates.7 percent.1 percent of publicly listed companies in Indonesia. the majority remains family-controlled. The restructuring and resolution of financial distress may. when barriers to entry in the banking sector were lifted. banks were unwilling to provide credit to highly leveraged companies. These banks also obtained cheap offshore funds. families control 67. however. lacked the information necessary to allow them to assess projects’ risks and chances for success. Among those listed in the Jakarta Stock Exchange. However. Companies relied heavily on bank credit. retain ownership control of companies. On the one hand. conglomerates set up finance companies to bring in cheap foreign loans as these companies were not adequately regulated. As a result. 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. thus. conglomerates set up their own banks to serve as “cashiers” providing credit to companies within groups. The free capital flow system permitted the inflow of foreign capital to fuel the credit boom in the economy. corporate debts grew over time.6 percent of the total stock market capitalization in 1996 and the top 15 families controlled 61. However. Financing Patterns Controlling shareholders opted to use debts to finance expansion. This study reveals that Indonesian listed companies with higher ownership concentration had higher levels of leverage. not all of the conglomerate-affiliated companies are publicly listed. On average. The financial crisis created opportunities for addressing the inefficiencies in the legal and judicial system that supported corruption. Indonesian companies borrowed short term. while a single family controlled 16. But because foreign creditors were reluctant to lend long term. allowing them to maintain their equity shares and.46 Corporate Governance and Finance in East Asia. this financing pattern supports the claim that family-based controlling shareholders relied on excessive borrowing to finance corporate expansion . meanwhile. When the Government regulated the legal lending limit and the net open position of banks.
Bank Indonesia extended emergency loans to many banks. the corporate sector was in quite good shape in terms of growth and profitability. followed by the property sector. although at a declining rate.1 percent in 1997 to -124. the high domestic interest rates that prevailed from 1998.1 percent in 1998. the Government initiated corporate debt restructuring measures (Mexican-style foreign debt resolution and the Jakarta Initiative). facilitate debt restructuring. ROE dropped from 1. Meanwhile. NPLs rose and capital adequacy ratios fell. particularly those with large short-term foreign loans.Chapter 1: Indonesia 47 without diluting their control. and registered a net loss of Rp39. DER increased to 307 percent in 1997 and further surged to 1. Impact of the Financial Crisis Prior to the crisis. The Government and the private sector responded with measures to mitigate the negative effects. The financial crisis led to the closure of several dozen banks. Responses to the Crisis The impact of the financial crisis on the corporate sector was serious. The Government introduced reforms to improve bankruptcy procedures. corporate-initiated debt restructuring .21 trillion in 1996. The problem was in the maturity structure of its dollar-denominated debt and high debt-to-equity ratios in some sectors.24 trillion in the first half of 1998. At the height of the crisis. the consumer goods industry was the worst hit. On the other hand. the highly leveraged companies. and strengthen prudential regulations and supervision of the financial sector. and the rapid decline in equity due to losses.370 percent in 1998. Sales of conglomerates as well as those of publicly listed companies were increasing. The significant increases in leverage indicate a rapid rise in the rupiah value of debts due to the revaluation of dollar-denominated debts. financed by issuing nearly $80 billion worth of bank restructuring bonds. As the rupiah weakened and interest rates increased. To restructure the corporate sector. Total profits of publicly listed companies dropped to Rp3. Net profits of publicly listed companies had consistently been growing at an average rate of 20 percent each year. When the crisis hit Indonesia. were the most adversely affected.1 trillion in 1997 from Rp13. it also reflects the failure of the financial sector to channel funds to the corporate sector efficiently due to weak prudential regulation and supervision.
but inadequate protection to minority shareholders from the dominance of large shareholders. the regulatory environment was not prepared to supervise the increasing number of banks and nonbank . In particular. minority shareholders have not been able to oppose controlling shareholders’ decisions to invest in unprofitable projects financed by unhedged foreign currency debts. Protecting Minority Shareholders’ Rights The Corporate Law provides sufficient rights and protection for all 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. Improving the Legal and Regulatory Framework for Bank Supervision After the liberalization of the financial sector. Vol.. and protecting creditors’ rights. the legal system is less likely to evolve in a manner that will allow it to protect minority shareholders.6. improving the legal and regulatory framework for bank supervision.g. The Government should ensure that all laws and regulations are effectively enforced. Most companies claim to have adopted international standards of accounting and auditing procedures.2 Policy Recommendations The Government should introduce measures to address the weaknesses in corporate governance identified in this study. Specific recommendations include protecting the rights of minority shareholders.48 Corporate Governance and Finance in East Asia. 1. cost cutting and business consolidation) and acquisitions by creditors or foreign investors through debt-to-equity swaps and equity infusions. II measures included internal business restructuring (e. If the role of a limited number of families in the corporate sector is so large and the Government is either heavily involved in or influenced by business. and (iii) strengthening transparency and disclosure requirements. but it is not clear whether in practice these standards are in place. The Corporate Law should be reviewed and amended in the context of pervasive control by large shareholders. (ii) delineating the functions of the board of directors and commissioners.
and liquidation of corporate assets. the Indonesian corporate sector directly owes an inordinate amount and a greater portion of its loans to foreign banks. it is likely that future private financial flows for the corporate sector will continue to conform to a short-term structure. Consequently. The regulatory framework was also weak in supervising and monitoring foreign transactions. recapitalization. most of banks’ NPLs resulted from credit to companies within the same group. The ownership of banks (including finance companies) by shareholders of nonfinancial companies undermined the capability of these banks to conduct prudential credit management. Because foreign creditors are faced with more information asymmetries than domestic creditors. Further.Chapter 1: Indonesia 49 financial institutions. Because these banks are neither easily convinced nor compelled to submit their claims to the jurisdiction of Indonesian commercial and bankruptcy courts. the banking regulatory framework was inadequate in regulating banks’ dealings with affiliated nonfinancial companies. One way is to set limits on lending activities by banks to 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. Protecting Creditors’ Rights To protect creditors’ rights. In the first place. in contrast to the Republic of Korea and Thailand. with necessary legal sanctions for violations. the Republic of Korea and Thailand were more successful in getting foreign creditors to collectively solve their problems during the crisis. This is a significant factor in . The Central Bank needs to monitor and control dealings by banks within business groups and improve enforcement methods to prevent circumvention of prudential regulations. When finance companies were used to channel offshore loans in lieu of commercial banks. the Court has been slow and ineffective in processing bankruptcy suits. the Government lost monitoring and control powers over foreign fund flows. Banks should be required to provide data on such transactions and charged penalties for noncompliance. The Government should also continue strengthening the monitoring system for foreign exchange transactions. 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. orderly restructuring. it has been difficult to implement standstills. However.
Vol.50 Corporate Governance and Finance in East Asia. Only when creditors have the confidence that their rights are protected will they resume financing companies. II explaining the greater depth of the crisis in Indonesia. . 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.
Jonathan. Corporate Governance: Responsibilities. Manuscript. Indonesia: An Emerging Market. Indonesian Business Data Centre. Asia in Crisis: The Implosion of the Banking and Finance System. Economy of Indonesia. Large and Medium Manufacturing Statistics. Working Paper #58. John Wiley and Sons. K. Letter of Intent of the Government of Indonesia to the IMF. Bank Indonesia. 1997. various publications. Forest. The Economist Intelligence Unit. Embassy of Indonesia Homepage. World Bank. 14 May 1999. Embassy of Indonesia. . 1998. 1996. Risks. Center for International Business Education and Research. Indonesian Capital Market Directory 1992-1998. P. Who Controls East Asian Corporations? Financial Economics Unit. 1995. and Richard Turtil. various publications. Yogyakarta.. various publications. University of Maryland. Jakarta Stock Exchange. Indonesia Country Profile. Conglomeration Indonesia: Regeneration and Transformation into World Class Corporate Entities. 1999. F. 1999. 1995. The Impact of Acquisition to Shareholders Wealth: Comparison Between Internal and External Acquisition. Indonesian Business Data Centre. P. Unpublished thesis MMUGM. JSX Monthly Statistics. Lang. Economic and Financial Statistics. various publications. and M. Indonesia: Sustaining Manufactured Export Growth.Chapter 1: Indonesia 51 References ADB Programs Department (East). 1997. Indonesia Country Report. 1996. 1998. Michael Krill. Keasey. The Economist Intelligence Unit. Wright. Delhaise. Maryland. Simeon Djankov. Conny Tjandra Rahardja. Institute for Economic and Financial Research. The Private Debt Anatomy. John Wiley and Sons. Indonesian Central Bureau of Statistics. Financial Sector Practice Department. Stijn. and Larry H. Claessens. and Remuneration.
and Graham Dwyer for his editorial assistance. . Further. It had been the norm in Korea to conduct business based on political and administrative favoritism rather than on competitive merits. and curtailing of morally hazardous behavior that has been prevalent among economic decision makers. Department of Economics. the Korea Stock Exchange for its help and support in conducting company surveys. both of ADB. Inefficient investment coupled with excessive financial leverage was found to be at the root of the economic crisis at the corporate level. timely exit of poor performers from the market.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. markets. The country’s winners would then emerge based only on economic efficiency. and corporates were sent reeling.2 Republic of Korea Kwang S. As the Korean currency. Chung and Yen Kyun Wang1 2. Chung-Ang University.1). This has been the crux of the corporate governance problem in Korea. David Edwards. a practice that was not checked by creditors. the Republic of Korea. Korea) in November of that year. The authors wish to thank Juzhong Zhuang. 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. or capital market discipline. Poor corporate governance and political and government intervention in the business and financial sectors are widely viewed as contributory factors. Business managers and controlling shareholders were maximizing firm size at the expense of profits. 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. Seoul. and David Webb of the London School of Economics for their guidance and supervision in conducting the study. 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. the Government and business sector had good reason to reflect on the causes of the crisis. internal control mechanisms. 1 Professors.
accountability of controlling shareholders and boards of directors. Inefficient investment undermined the competitiveness of Korean firms in the global marketplace.1 Listed Firms with Positive Economic Value Added. especially chaebols. Source: Korea Stock Exchange. 1992-1998 Item Total Number of Firms Firms with Positive EVA Percentage of Firms with Positive EVA 1992 508 180 35. T.5 Note: The EVAs are calculated as: EVA = NOPAT – WACC. where NOPAT is the net operating profit after taxes and WACC is the weighted average cost of capital multiplied by invested capital. Restructuring efforts have focused on reduction in the degree of business diversification and in the financial leverage of large-sized firms. 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. Koller. Vol. Government reform goals for the corporate sector include enhancement of corporate transparency.1 1995 560 163 29. aiming to identify the areas in need of further reform and to provide policy recommendations for improved corporate governance. Copeland.54 Corporate Governance and Finance in East Asia.9 1994 531 165 31. This study collects and analyzes data on the Korean economy.1 1997 518 104 20. and individual companies. II Table 2. The EVAs are the same as the economic profit as explained in T. . capital market discipline. and J Murrin (1995). Weaknesses in the overall corporate governance system in Korea had many ramifications.1 1996 561 163 29.1 1998 490 164 33. This study also reviews the legal and 2 The survey was conducted mainly through the Korea Stock Exchange. and improvement of bankruptcy procedures. June 1999. The total number of respondents was 81 out of about 550 nonfinancial firms listed on the Exchange. A survey was conducted for the nonfinancial listed companies using a questionnaire developed by the Asian Development Bank (ADB)2 to supplement official data.4 1993 513 174 33. Many firms left some questions unanswered. the corporate sector. This broad perspective can help clarify the ongoing reform efforts of businesses and the Government. Dividend payments were at less than 2 percent annually as opposed to the double-digit interest rates in the past decades.
and Yim (1998). Section 2. Yang.5 describes the state of the corporate sector in the financial crisis and draws on the results of the foregoing sections to outline the causes of the crisis. corporate control by the Government. the board of directors system. It then presents recommendations for further reform in corporate governance and financing. Section 2. 2. .3 identifies characteristics of corporate governance by analyzing the ownership structures and control patterns of listed companies and the largest chaebols. 3 The review of historical development of the Korean economy draws substantially from the book by Sohn.2.Chapter 2: Korea 55 regulatory framework for the corporate sector and reform measures taken after the crisis. Section 2.2 presents an overview of the corporate sector.1 Overview of the Corporate Sector Historical Development3 The development of the Korean corporate sector is closely related to the progress of the economy. and other necessities domestically.4 contains analyses of corporate financing and its relationship to performance. and employees and their role in shaping corporate governance practices. In the period 19481961. creditors.2. and naturally adopted an import substitution policy. It reviews such elements as shareholders’ rights. This chapter is composed of six sections. Major economic indicators for some of these periods are shown in Table 2. Section 2.6 discusses responses of the Government and the business sector and explains in detail their reform and restructuring efforts. clothing. The evolution of the modern Korean economy can be divided into four periods. which account for a substantial portion of the Korean economy. the Government relied heavily on aid from the United States (US) and United Nations to alleviate poverty and high inflation. The Government tried to produce food. the import liberalization rate was below 7 percent and the average tariff rate was in the range of 25 to 30 percent. reviewing government policies responsible for the development of the modern corporate sector. From 1948 to 1961. Import Substitution: 1948-1961 The Korean War (1950-1953) devastated Korea’s industrial capacity. It traces the country’s economic development.2 2. Section 2.
2 452. This goal required very high savings and investment rates.8 24.265. b Refers to 1979. 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. II Table 2.1 9. International Financial Statistics.1 29.1 35.1 15.56 Corporate Governance and Finance in East Asia.2 32.0 41. and inconsistent economic policies.1a 21. the Government called for an unprecedented average annual economic growth rate of 7.102.2 1980-1989 8.5) (1.2 6.4 29.753. Economic Statistics Yearbook. the Government was not successful in solving the problems of slow growth.1 — = not available.2 757.855.2 314. e For maturities of one year or more.1d 9.8 12. IMF.447. d Refers to 1997.8 (724.7c 11.7 14.8 (8. the Government redirected the policy focus away from import substitution to an export-led manufacturing-based economy.4 10. c Refers to 1989.7 37.8 15.5 250.9b 15. 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. However.5) 8.2 1. In 1961 it devalued the won from W65 to W130/dollar and announced its first Five-Year Economic Development Plan (1962-1966).9) 1. Export Drive: 1962-1971 Between 1962 and 1971.0 27.2 31. modernizing the industrial structure.0) 492. lack of strong drive. and large current account deficits.4 29.0) (297.2 Key Macroeconomic Indicators Annual Average (percent. Source: Bank of Korea.332. and implementing new budget and tax measures.9 794.4 (1. In the Plan. The Government tried .4 1990-1997 7.9 — — 21.9) (7. Vol.949.1 percent with moderate rates of inflation and introduced a series of reform packages aimed at developing key industries.4 24. high unemployment and inflation. a Refers to 1971.6 11.3 8.7 30. largely because of political instability.5 38.2 30.
due to continuous current account deficits. During the first five-year plan period. abundant. the Government changed the multiple and fixed exchange rate system to a unitary floating exchange rate system. This change raised the import liberalization rate from 9. But the liberalization trend turned out to be short lived as current account deficits continued. The well-educated. .2 billion in 1972.5 percent.3 percent to 60. resulting in high real interest rates. and cheap labor force was well utilized by the export-led growth strategy. the import liberalization rate was 55 percent. The average growth rate of the economy from 1960 to 1964 was 5. the Government undertook important economic reforms in two areas: the foreign exchange rate and the interest rate.Chapter 2: Korea 57 to meet its targets by borrowing large amounts of foreign capital on the one hand.4 percent. a modest improvement over the 4. In 1971. During this period. Exports increased sharply from $41 million in 1961 to $2. but tariff rates were raised to 40 percent in the 1960s. Bank deposits increased rapidly. 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. but the average growth rate for 1965-1969 shot up to 10 percent. and almost doubled the foreign exchange rate from W130/dollar to W256/dollar to enhance the international competitiveness of exports. However. the Government tried to provide exporting firms with a free trade environment.3 percent average between 1954 and 1959. These were considerably liberalized in 1967 when Korea joined the General Agreement on Tariffs and Trade (GATT). The positive list system for imports was replaced with a negative list that indicated only those items that could not be imported. imports of consumer goods and luxury items were highly restricted. Korea normalized political and economic relations with Japan to encourage inflows of Japanese capital that could finance big development projects. In 1963-1964. the growth of gross domestic product (GDP) raised domestic savings. The Government abolished temporary direct subsidy measures and introduced a new comprehensive export promotion system. Also. which laid a solid foundation for a steady growth path. The exchange rate system was a kind of crawling peg until 1974. while the average tariff rate was 39 percent. channeling funds from curb markets into the banking sector. up from 30 percent in the late 1950s. and maximizing mobilization of domestic savings on the other. In 1965 the interest rate on one-year deposits doubled from 15 to 30 percent. boosting internal investment resources. In 1964.
and giving low interest rate loans to banks from the central bank.58 Corporate Governance and Finance in East Asia. The Government targeted six industries—steel. The Government has since used similar emergency rescue measures for large businesses and banks almost once every 10 years. faced the danger of bankruptcy. The HCI promotion policy was much more comprehensive than past economic development plans. It promoted HCIs by supplying massive capital for construction and development. the Government felt the need to strengthen the defense industry. II Heavy and Chemical Industry Promotion: 1972-1979 In the Third Five-Year Economic Development Plan (1972-1976). and chemicals—as future core industries. Third. and allocating virtually unlimited amounts of credit at below-market rates while controlling the financial system. Second. In 1972. nonferrous metal. where preferential export credit was given to almost every exporter. Unlike the previous system. overburdened with debts and high interest rates. becoming a seed of the economic crisis in 1997. investing a total of $9. 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 . less developed countries forced Korea to adjust its industrial structure. it tried to substitute imports and export high value-added HCI products. These practices contained an implicit government guarantee that large businesses and banks could never fail. The Government took emergency measures. the emergence of competition of other low-wage. shipbuilding. the Government felt that continuous trade deficits arising from increasing intermediate and capital goods imports could be prevented by developing import substitution industries. The Government encouraged a variety of business projects. and assigned them to specific chaebols. It included a detailed construction and investment schedule over a 10-year time frame and mandated coercive implementation. This strategy formally took off with the announcement of the HCI Promotion Plan in June 1973. There were three reasons for the switch: first. in the face of a world economic slump. reducing or exempting debts of farmers and fishermen.6 billion between 1973 and 1981 into these sectors. Vol. the Government changed its industrial policy emphasis from light industries to heavy and chemical industries (HCIs). the domestic economy was stagnant and many businesses. electronics. announcing rescue packages for businesses and banks. machinery (including automobiles). By promoting HCIs. These included rescheduling business debts. One industrial policy adopted during the heavy and chemical industrialization drive was administered credit rationing.
the Government adopted comprehensive measures to promote economic stabilization. Korea recorded current account surpluses and rapid economic growth due to the “three lows”: low value of the US dollar. and the won depreciated by 20 percent with the adoption of a Basket-Currency Gliding System in 1980. The industrial and trade policy resulted in high inflation in the 1970s and serious excess capacity problems by 1979. coupled with political uncertainty due to the assassination of President Park in 1979.Chapter 2: Korea 59 through state-controlled banks. especially between 1979 and 1985. Firms that followed the Government expanded greatly. Evaluations of HCI promotion policies are mixed. including forced liquidations and mergers and acquisitions (M&As). light manufacturing and service industries were weakened by disadvantages such as a lack of credit. as it had to control only a few large chaebols. met increased difficulty. with many turning into the now well-known chaebols. The two important ones were import liberalization and deregulation of the financial sector. Meanwhile. such as widespread underutilization of capacities of HCIs and related plants. various measures to increase competition were taken. This required industrial restructuring by the Government. the policy wasted substantial amounts of resources in the short and medium terms. Cheap credit and distorted prices resulted in overexpansion in the HCIs. Meanwhile.2). Economic Liberalization and Globalization: 1980-1997 In 1979. The severe world recession caused by the second oil shock. a heavy foreign debt burden. In order to improve economic efficiency. Gross national product (GNP) growth rates on average were higher in the 1972-1979 compared to 1962-1971 (Table 2. the Government restructured some large businesses through forced liquidation and M&As. and the large excess capacity of HCIs. The growth rate of the money supply was reduced drastically. The incentives available became more market-based. and their utilization ratios were very high. New start-up firms. In 1986-1989. fiscal expenditure maintained zero growth. price controls were abolished. However. exacerbated the overcapacity problem. Macroeconomic policies became hostages of the industrial strategy. however. including denationalization of banks. The plan of the 1970s was thought to be successful in the long run. Such an approach gave the Government increased control over the economy. imports were further liberalized while tariff rates were lowered. low . since during the second half of the1980s many of the promoted firms became world-class competitors and exporters. faced with high inflation.
Vol. 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). 13.3 percent.2. The official rate fluctuated within a band. the Government committed itself to further liberalization of the goods and capital markets. . whose business activities are controlled by an identical person. the importance of chaebols was increasing. and low oil prices. The most important element characterizing chaebols is the concentration of ownership. and acceded to the World Trade Organization (WTO) in 1994. Korea abolished remaining direct subsidy systems for export activities as well as some traditionally managed trade systems.9 percent.2 Rise of the Large Business Groups (Chaebols)4 The Korean Fair Trade Act defines a business group as “a group of companies. The Government tried to adjust economic policies and regulations to meet global standards. joined the Asia Pacific Economic Cooperation (APEC) Group in 1993. Korea became a signatory country to the International Monetary Fund (IMF) Article VIII. 4. Korea began participating in many multilateral trade negotiations during the Uruguay Round. The low value of the dollar led to a low won and high yen. which gradually widened. total sales.2 percent. In 1988. Meanwhile. 2.60 Corporate Governance and Finance in East Asia.9 percent. II world interest rates. In 1993. while continuous and large current account surpluses saved Korea from the foreign debt problem. further increasing its pace of import liberalization. 45. with the 30 largest in the total economy in 1997 standing as follows: value-added. but it chose to liberalize gradually. and declaring that it would follow Article XI of GATT. where particular individuals and their family have de facto control of the management of all subsidiary companies of groups. giving up its foreign exchange controls related to the current account. 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. 46. 47. the import liberalization ratio reached 98. In 1990. Korea adopted a market average exchange rate system.1 percent. By joining the Organisation for Economic Co-operation and Development (OECD) in December 1996. total debts. total assets. Industrial and trade policies were modified to be consistent with WTO. and total workforce.9 percent.1 percent and average tariff rates 8.” A large-scale business group is called a chaebol.
and they are aided and supported by one another. The Government provided financial and fiscal incentives to chaebols and trading companies with relatively abundant financial resources. Subsidiary companies of chaebols are subject to “fleet-type management” in that they are controlled by the overall managerial system of chaebols. However. In the mid-1970s. 1993-1996 Year 1993 1994 1995 1996 No. financial assistance.3 Subsidiaries of the 30 Largest Chaebols.3 shows that the number of subsidiaries of the 30 largest chaebols increased considerably since 1993. Large-scale companies owned by the Japanese were sold to individuals under preferential terms and later enjoyed a relatively favorable position for accumulating capital. Chaebols have a history of substantial concentration of ownership.5 20. Table 2. reaching 669 in 1996. the ownership and management of a chaebol’s subsidiaries are not separate. The Government provided subsidies. Important managerial decisions are made primarily by owners. . Chaebols are also excessively diversified. Table 2. From the standpoint of the Government. of Subsidiaries per Chaebol 20.1 20. This galvanized the fast growth of chaebols. Since the Government controlled most business activities. after the financial crisis.when the Government put a great deal of emphasis on development of the HCIs.Chapter 2: Korea 61 War II. the number of subsidiaries declined drastically due to corporate restructuring. 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. Since the 1960s. and tax breaks to key industries to promote exports and industrial upgrading. large-scale businesses and chaebols were thought to be appropriate actors because they could meet the huge investment requirements of these industries.8 22. it was more effective to deal with a small number of companies to secure tangible outcomes. This policy contributed greatly to the expansion of chaebols. chaebols that maintained a close relationship with the political authorities were able to grow fast.3 Source: The Fair Trade Commission. One reason for this controlling power is inter-company shareholding among subsidiaries. In this sense.
the bankruptcy of one or a few marginal subsidiaries could lead to a chain of bankruptcies for the entire chaebol. and were allowed extra depreciation charges for tax purposes. they can reduce uncertainties and dilute risks through sharing of information and diversification. listed companies enjoyed corporate tax rates that were 10 to 20 percentage points lower than those imposed on privately held firms. diversification can make chaebols stable through the portfolio effect. 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. chaebols can benefit from synergies. including the “economies of organizational size” inherent in multi-product and multiplant firms. This could ensure their stable growth and enhance their investment abilities. in addition to the usual economies of scale. Meanwhile. The law also allowed employees of listed firms to get 20 percent of the subscription rights in offerings of new shares. This law was in effect until 1987 when it was partly absorbed into the Capital Market Development Act. Vol. Another law that contributed to the development of the stock market was the Act to Expedite the Going Public of Corporations of 1972. profitability. if a chaebol has an unsound financial structure but strong financial links through mutual payment guarantees among their subsidiaries. etc.62 Corporate Governance and Finance in East Asia. which may ultimately lead to the decline of social efficiency.2. Related to this is the tendency of chaebols to assist unprofitable firms at the expense of profitable ones. the Government reviewed the financial performance of companies and recommended (or ordered) selected ones to go public. 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. For example. Since chaebols are engaged in many different businesses.3 Role of the Capital Market and Foreign Capital In the 1960s. there are many negative assessments of organizational structures and practices of chaebols. In the early years after the enactment of the law. 2. However. . On the other hand. II Theoretically. internalization of the market that could enhance the internal efficiency of a chaebol may close the market to other firms. years since establishment. Under this law. They had to meet certain requirements in terms of firm size.
Also that year. Korean firms were allowed for the first time to issue in international financial markets equity-related securities such as convertible bonds (CBs) and depository receipts. As shown in Table 2.476 79. The aggregate Table 2. however. In this regard.1 16. mainly by increasing the supply of shares by initial public offerings (IPOs) and seasoned issues.020 151.151 117.5 406.0 965. Second. the Government attempted to stabilize the stock market by limiting IPOs and share issues by listed companies.0 49.9 918. the Government announced measures to increase the demand for shares by providing tax and financial incentives to individual investors.9 34. the stock market grew rapidly during the 1980s.370 70. especially those paying small or no dividends. This reversal in policy reflected declining stock prices and was generally maintained until the outbreak of the economic crisis in 1997.6 Year 1985 1989 1990 1994 1995 1996 1997 1998 Source: Monthly Review (Securities Supervisory Board) and the Financial Supervisory Service.4 Development of the Stock Market.2 44.989 137. Because of government policies and the booming economy. continued until 1989. in 1986 the Government imposed limits to bond issues on firms that were recommended to go public but refused. The policy to expand the size of the stock market. a country fund.0 79.4 654.570 95.1 Market Capitalization (W billion) 6. Third. was established to invest in domestic shares beginning in September 1985. of Listed Firms 342 626 669 699 721 760 776 748 Stock Price Index 138. First.4 40.. Inc. 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). Beginning 1990.9 833.6 747. several important policy measures were implemented to promote the development of the stock market.7 934.798 Market Capitalization as a Ratio to GDP (%) 8. .1 30. the Government announced the gradual opening of the capital market to foreign investors in January 1981. 1985-1998 No. The Korea Fund.Chapter 2: Korea 63 During the 1980s and 1990s.217 141.4.
858 4.183 12. The aggregate market value of listed shares bottomed at 16.742 (3.553 8. Table 2.942) 42.817 16. but rose again to 34.126 (1.64 Corporate Governance and Finance in East Asia.296) (6. foreign direct investment (FDI) has been very small relative to GDP and compared to other East Asian countries.085 2. Source: Balance of Payments.150 5.546 (2.255 2. due to declining stock prices.453 (2.414) 5.785 (1.86 percent of GDP in 1997.542) (1. but increased sharply to 79.382 Permit basis.944) 8.650 (1.642 21. trade credits.141 4.714 1.868 (518) (418) 63 1.264) (3.413) 56.450 24. and stayed at the 30-40 percent level up to 1996.338 4. The growth in the number of listed firms also slowed in the 1990s. Other investments include loans. 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. and 1993.339) (9. currency and deposits.924 (1.571 2. . The reasons for the decline include increases in bankruptcies and mergers involving listed companies since the outbreak of the economic crisis.287 (340) 73.440 1. and other liabilities.583 25 10.953 10.852) (2.352 471 3.008) (3.737 (333) (297) (607) (2) 218 2.910) 2.001 4. II market value of all listed firms represented only 8 percent of GDP in 1985.694) 2.500 7.017) 1.347 3.2 percent by 1989.800 (7. Vol.5 shows net FDI—inward investments by foreigners less outward investments by Koreans—in the period 1985-1998.455) 13. Table 2.658) (3.149 13.239 19.870) (1. 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) (2.123 3. The number shrank for the first time in 1998 to 748 firms from 776 the previous year.534) 1. However.433) (9.5 Private Capital Flows to Korea. The relative size of the stock market diminished to 44 percent in 1990. Bank of Korea.875 21.59 percent in 1998 and to more than 50 percent in the early months of 1999.326 1.
Of this.China and the US. equity.6). and sales of the aggregate sector during this period were very high (Table 2. Japan’s was consistently higher.2. The contribution of the corporate sector to GDP was 73.China. but between 1988 and 1993. The same categories will be analyzed in later sections. the growth rates of equity and sales dropped sharply in 1996 and 1997. The debt-to-equity ratio (DER) averaged 311 percent for the period 1990-1996 and peaked at 424. portfolio investments amounted to $73.6 percent in 1997.Chapter 2: Korea 65 Complicated government regulations. increased substantially in 1994-1996 due to accelerated liberalization of capital movements (Table 2. (ii) listed firms.5). Large amounts of outward investment by Koreans in the mid-1990s arose out of increased liberalization of foreign exchange regulations. Profit rates of Korean firms were relatively low compared to those of Taipei. This indicates that a substantial proportion of debt was denominated in dollars. weak incentives for attracting FDI. The ratio is generally in the same range for Japan and Korea. The growth rates of total assets. However. Corporate sector net proft margins increased from 1993 to 1995. The dismal performance of the Korean corporate sector compared to the . increasing to 76 percent in 1997.4 Growth and Financial Performance This section looks at the performance of (i) the aggregate corporate sector. Return on equity (ROE) and return on assets (ROA) showed similar patterns.7 compares the ratio of ordinary income to sales of Korea’s manufacturing sector with those of Japan. other net private capital inflows amounted to $130 billion during 1985-1998. Net private capital inflow.7 billion and loans $42. Table 2.9 billion.2 percent in 1987. 2. following the sharp depreciation of the won. and high production costs were the main reasons for low FDI in Korea. Korea had substantial current account surpluses and experienced net private capital outflow. This would lay the foundation for evaluating the effect of corporate governance on performance. excluding FDI. Taipei. but dropped in 1996 and were negative by 1997. and US. Between 1986 and 1989. In addition to FDI. and (iii) chaebols. The Aggregate Corporate Sector The aggregate corporate sector in this study excludes the financial sector.
6 4.0 0.7 2.7 3.9 8.6 9.4 2.4 1. Net profit margin = ratio of net income to sales.1 2. Financial Statement Analysis Yearbook.0 13.7 4.3 — 3.6 318.9 13.3 335.8 3.6 13.9 2.1 — — — = not available.0 3.3 21.1 8.5 4.4 2. 1990-1997 (percent) Growth Performance Year Total Assets Equity Sales Financial Performance Net Profit Margin DER ROE ROA 1990 1991 1992 1993 1994 1995 1996 1997 23.2 1.9 5.9 18.5 7.9 3.9 2.3 312. Source: Bank of Korea.3 14.7 15.Table 2.6 1.2 9.3 11.7 International Comparison of Ratios of Ordinary Income to Sales in Manufacturing (percent) Year Korea US Japan Taipei.2 18.4 — 6.9 16.5 (0.5 4.4 10. Ordinary income = operating income + nonoperating income (from financial activities) – nonoperating expenses (from financial activities).6 3.5 1.9 2.6 1.8 1. Note: Ratio of ordinary income to sales = (ordinary income/sales).7 3.5 2.5 1.8 8.4 1.China 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 2.2) (0.3 6. Financial Statement Analysis Yearbook. Table 2.9 5.5 0.4 19.0 8.8 21.9 4.9 18.2 1.2 1.9 3.7 15.3 17. .4 1.0 4. ROE = return on equity (ratio of net income to stockholders’ equity).6 (4.3 1.8) 297.3 308. ROA = return on assets (ratio of net income to total assets).9 16.4 2.2 19.6 Growth and Financial Performance of the Nonfinancial Corporate Sector.6 2.8 22.1 2.7 325.7 4.8 2.4 4.8 1.0 13.1 2.3 21.0 305.0 10.6 424.9 5.9) DER = debt-to-equity ratio.7 1.2 13.1 6. Source: Bank of Korea.3) 5.1 5.0 6.2 13.5 3.0 (0.0 7.7 4.5 1.3 3.
this may be an indication of the bias toward large firms in terms of access to credit. a year ahead of the other industries. Growth rates of total assets are generally high. This preference of Korean firms has its roots in the structure of corporate governance. The manufacturing.6). The growth performance of large firms for the 1988-1997 period was better than that of medium. and transport sectors recorded negative profit rates in 1997. followed by mediumsized firms and large ones. and steam supply industry.8). . ROEs. In 1997. 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. Again.Chapter 2: Korea 67 other three economies can be attributed to the emphasis on growth in sales and market shares rather than on profits. Small listed firms were hardest hit by the financial crisis.and small-scale firms (Table 2. the exception being the electricity. It is notable that the construction sector’s profit rate began its decline in 1995. the average ROE was lowest for large firms.5 percent while the aggregate sector recorded only 13. trade. Performance followed similar patterns across different industries (Table 2. The profit margin of listed firms was generally higher than that of the aggregate corporate sector. This may be related to its having the lowest DER. Profit rates of different industries also mirrored the downward trend of the aggregate corporate sector prior to the crisis.4 percent. The other financial ratios follow the general pattern of the aggregate corporate sector. while their average net profit margin was lower than that of medium firms. both ROA and ROE were lower for the listed firms compared to the latter. gas. construction. with the wholesale and retail trade sector and the construction sector having the highest figures. but higher than that of small firms. and ROAs of all listed firms declined substantially in 1996 and turned negative in 1997. sales of listed firms grew 18. However. with equity in wholesale and retail trade even contracting. In most years. Listed Companies The number of listed firms increased from 334 in 1985 to 775 in 1997 (Table 2. Profit rates of most industries are also quite low. All sectors experienced a sharp decline in equity and sales growth in 1997. Net profit margins.9). However. the sales growth of listed firms was higher than that of the aggregate sector (see Table 2. A comparison of performance by firm size reveals some interesting results.10).
0 15.3 14.9 (0.3) (1.1 0.0 15.4 14.4 10.8 Real Estate.2 (1.4 9.2) 15.5 19.6) (6.8 23.2 15.7 16.7 514.5 1.4 2.8 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 13.0) 1.8 14.1 22. and Business Activities 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 Average 11.4 5.0 24.0 19.9 (0.3 2.5 23.2 12.8 12.0 7.7 228.0 (0.3 15.2) 6.0 23.8 32.6 11.5 338.8) 0.3 10.4 17.3 13.7 (3.3 15.1 2.0 1.0 245.7 294.9 16.4 (0.0 5.6 17.1 28.5 1.2 5.9 428.3 1.2 5.6 12.1 1.2 20.0 (0.5 16.5 27.5 270.8 3.3 8.4 4.2 6.7 30.2 18.7 10.6 6.0 16.3 14.2 315.1) 3.9 29.9 5.6 0.9 31.3 15.4 3.8 2.1 20.9 538.8 35.5 306.4 474.5 Construction 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 Average 18.4 2.0 1.3 11.8 13.4 458.9 0.0 1.0) 0.8 1.1 21.1 (0.6 14.7 17.9 340.8 14.6 2.4 2.9 1.0 5.8 10.0 21.7 9.8 24.4 348.5 483.4) 0.2 16.1 1.4 350.0 254.6 375.5 6.2 2.2) (0.4 0.9 25.1 1.4 .6) 3.1 2.9 16.5 30.6 655.3 285.6 16.4 740.7 (0.0 1.6 1.0 9.9 (0.8 2.4 5.3 31.8 526.8 0.1) (3.4 12.7 22.6 24.8 2.8 302.9 3.6 3.3 8.5 1.8 16.5 286.1) 0.0 22.5 1.6 3.1 (0.4 2.6 14.2 16.0 2.0 1.7 0.8 24.8 3.2 0.4 0.4 2.9 10.8 12.8 22.8 10.7 317.8 17.3 8.2 0.0 (4.0 18.0 24.2 24.7 4.0 2.6 12.8 34.5 (0.9 13.8 461.5 5.4 1.0 18.9 2.4 291.3 11.1 396.9) 1.5 239.7 21.9 16.0 22.0 1.8 7.3 25.4 10.8 16.1 16.2 7.6 17.6 15.2 5.5 432.2 241.9 14. Renting.2 36.1 290.4 1.9 9.8 1.0 2.1 27.2 423.4 10.1 296.5 1.5 28.5 6.3 8.0 37.8 22.0 16.1 7.9 10.3 288.8 16.5 473.8 562.6 318.2 0.1 0.7 1.1 1.7 7.2 20.4 15.5 13.5) 0.3 18.5 5.5 (5.3 15.7) 2.8 0.5 4.1 0.8 616.6 0.2) 22.4 10.0) 4.6 7.1 10.5 (1.7 520.4 5.5 3.0) 0.Table 2.7 5.2 25.3 1.0 2.3 2.6 1.5 569.1 17.3 10.9 19.0 3.5 1.5 14.0 1.0 22.0 12.6 5.9 2.6 14.2 6.8 345.
5 462.2 10.0 1.7 15.7) 0.5 16.3 543.3 1.8) 1.5 11.6 16.8 14.4 3.0 1.1) 5.9 (10.5 47.9 17.1 (0.9 8.0 2.4 9.0 1.6 2.3 17.6 8.5 307.6 4.7 16.0 106.4 15.2) 0.1) (0.8 12.8 6.8 11.4 10.7 116.6 3.3) 11.2) 9.5 14.4 3.6 4.7 — = not available.2 90.4 0.6 6.8 0.9 18.7 11.1 2.2 10.3 4.2 1.1 6.3 0.3) (1.9 9.0) 1.2 11. Gas.5 14.5 14.9 9.8 14.3 — — — — — 10.3 9.3) 15.6 (2.4 0.3 740.6 9.6 18.9) (8.6 1.5 12.4 1.5 117.3 12.4 7.9 456.8 7.2) 13.2 3.7 20.7 7.4 13.9 18.6 8.5 2.9 10.2 14.6 0. Source: Calculated using data from Bank of Korea.1 21.7 0.6 6.7) (4.0 2.4 633.9 6.1 15.1 8.4 6.3 (2.2 18.7 2.3 8.4 12.9 12.2 18.1) (0.0) (0.3 112.4 (0.4 341.6 12. and Communication 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 Average 15.1 323.9 12.3) 4.4 1. Storage.0 89.1) 1.4 12.0 (1.4 3.0 14.5 15.5 539.6 14.6 9.8 (Cont’d) Growth Performance Year Assets Equitya Sales NPMb Financial Performance DER ROE ROA Wholesale/Retail Trade 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 Average — — — — — 31.1 11.5 482.5 344.2 14.4 (2.4 16.8 6.3 4.5 14.8 4.3 3. .9 4.1 16.9 Electricity.9 7.8 15.0 5.4 7.4) (1.7 19.2 15.3 18.4 — — — — — 448.7 0.6 (2.7 — — — — — 14.8 8.6 172.4 169.2 143.5 15.6 1.3 23.9 17.3 2.8 3.7 11.0 921.7 187.8 12.5 26. a New equity does not include capital surplus.1 15.1 4.6 20.6 19.1 15.3 125.0 5.8 111.2 122.4 6.5 11.4 14.2 18.0 98.0 7.9 (11.4 2.1 14.3 19.4 367.9 1.5 (2.5 0.6 9.1 (2.7 510.2 2.3 34.1 3. b NPM denotes net profit margin.5 4. Financial Statement Analysis Yearbooks.1 (11.5 13.4 2.6 15.3 8.7 14.9 4.3 4.5 30.8 3.6 6.6 34.7 11.0 14.6 8.4 30.9 10.7 7.9 8.3 0.8 0.2 — — — — — 2.7 12.9 321.1 17.4 21.1 12.0 13.6 12.8 9.0 (15.2 698.6 — — — — — 0.3 1.5 612.1 11.062.9 332. and Steam Supply 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 Average 12.0 Transport.9 3.4 0.0 21.6 — — — — — 17.8 529.6 21.6 512.4 11.4 1.3 18.6 19.3 524.1 1.0) 1.5) 22.2 10.8) (12.7 2.2 7.5 8.Table 2.
It should also be noted that when the financial crisis struck in 1997.9 21.6 0.2 9.9 percent).3 (0. In 1995. In 1997.4) 1.5 ROE 3. but the number of designated groups has been fixed at 30 since 1993.5 19.1) 4.7 percent) of the corporate sector.7 Net Profit Margin 0.3 15.12).9 0. the 30 largest chaebols accounted for 13. Generally.8 6. of which 16 were publicly listed (Table 2. 1998.7 (5.3 percent). had 46 member companies. Between 1993 and 1997. the top 11-30 chaebols experienced a decline of .2 6.3 2.9 percent).1 6.4 1. of Firms 334 351 386 503 626 669 680 681 687 698 715 754 775 Sales Growth 10. it is the chaebols’ large firms that are listed.8 5.9 26.9 11.70 Corporate Governance and Finance in East Asia.4 1. Hyundai Group.7 1. Vol.5 19. The number of Hyundai member companies rose to 57 in 1997. Chaebols have been the most important actors and engines of growth in the Korean economy. The criteria for selection of largest chaebols have changed a few times.7) 0.0 18.8 24.7 1.5 0.4 0. The top five chaebols registered the highest growth rates.6 2. The smallest group had 16 members in 1995.1 1.2 0. Performance of Chaebols This section uses available data on the top 30 chaebols. sales (45. of which four were listed.4 1.5 ROA 0.4 2.6 23. 1985-1997 (percent. and close to half of total assets (46.12). II Table 2.9 6.8 0.6 and 2. followed by the top 6-10 (Table 2. the largest chaebol. debts (47.9 2. the growth of sales of the top 30 chaebols exceeded that of the aggregate corporate sector (compare Tables 2.6 22.5 5.11).0 0.1 percent of the economy’s total value added (excluding the financial sector).9 1.6 3.3 4.2 9. unless otherwise indicated) Financial Performance Year 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 Average No.1 1.9 Growth and Financial Performance of Listed Companies.0 3.3 20.4 22. and net profits (46.6 (1. Kis-Fas.9 Source: Constructed using data from Korea Investors Service.9 2.6 1.2 2.3 0.
4 3.3 9.1) 5.7 (0.5 5.10 Growth and Financial Performance of Listed Companies by Size.2) (1.8 17.5 0.Table 2.9 3.5 1.5) 1.2) 0.9 (0.3 (0.7 (1. .7 18.7 2.3) 0.6 3.8 0.7 2.3 3.9 2.8 10.8 6.2 13.6 6.1 0.8 3.2 10.9 1.0 1.2 0.6) 0.6 1.7 3.6 5. Others are medium firms.2 (0.6 2.6 7.3 6.0 17.6 1.6 3.8 1.8 16.0 1.2 12.5 5.8) 6.2 Note: Large firms have a capital base greater than W15 billion and small firms smaller than W5 billion.8) 1.6 (1.5 Net Profit Margin Year Large Medium Small 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 Average 2.6 0.6 13.4 5.8 0.2 3.6 (0.6 8.2 Small 13.9 5.6 2.4 1.7 (1.2 2.0 6.1 11.4 Medium Small Large Medium Small ROA Growth Performance Large 17. Source: Korea Investors Service.0 4.6 2.8 0. 1988-1997 (percent) ROE Large 9.8 6.9 2.0 10.6 9. 1998.2 2.1 2.2 1.9 6.9 14.9 2.4 6.3 (0.7 1.9 25.4 2.8 7.2) (1.6 0.2 7.1 8.5 25.3 Medium 14.9 6.4) 1.1 1.0 19.0 15.6 1.9 0.8 0.3 15.4 16.5 2.0 1.5 17.1 2.0) 1.5) 1.5 3.0 16.9 0.0 1.3 11.5 (1.8 (5.4 3.7 4.9 22.9 0.9 1.4 11.9) (6.4 1.3) 5.3 15.2 13. Kis-Fas.3 1.0) 0.0 (4.
910 3.158 1.457 14.501 13.287 10.303 3.951 3.967 7. Source: Fair Trade Commission.651 38.743 40.486 6.995 2.766 3.090 6.873 2.309 14.597 351.761 31.246 11.798 — No.147 5. .574 3.423 5.346 3.774 7.690 3.927 16.180 2.924 2.458 6.364 5.131 3.640 4.11 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. 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.475 2.177 — 6.398 — 2.996 1.376 35. 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.853 1997 53.427 9.956 3.370 6.599 — 2.935 2.990 2.929 12.677 3.756 5.117 4.445 4.433 3.158 7.Table 2.129 2.313 14.455 22.395 31.
5 (0.1 (2.7) Source: Bank of Korea.3 16.3) 0.0 2.3 19.4 26.8 27.0) 12.1) (1.4 (2.5) (0.0 6.2 1.5) (0.Table 2.4 0.5) (0.9 3.4 30.2 (2.3 14.9 20.3 1.9 24.2) 1.2) (2.0) 3.8 18.3 9.7 15.4 38.1 2.9 20.12 Growth and Financial Performance of the 30 Largest Chaebols.0 0.0) ROA 1.0 1.2 0.0 2.5 2.7 1.9 3.3 3.2) (0. .1 27.3 15.7 10.3 0.7 13.1 19.2 11. 1993-1997 (percent) Growth Rates Year Top 1-5 1993 1994 1995 1996 1997 Top 6-10 1993 1994 1995 1996 1997 Top 11-30 1993 1994 1995 1996 1997 Top 30 1993 1994 1995 1996 1997 Sales 12.1) (0.4 12.1 (1.6 4.0 31.2 0.5 27.0 19.1) 0.1) 0.6 18.0 17.3 11.8 0.9 1.7 15.6 (0.5 5.2 0.9 18.4) 1.3 1.6 25.1) (0.2 20.7 10.2 (16.5 19.3 0.3 27.2 (2.7) ROE 5.2 (5.9 17.0 2.2 3.7 0.1 (3.8 Assets 12.1 10.4) (0.0 0.6 19.6 Financial Performance Net Profit Margin 1.5 32.7 4.5 20.4) (14.6 1.
his/her relatives.” This “identical person. the average DER of the 30 largest chaebols reached 519 percent. The ROE of the top 30 chaebols was consistently higher than that of the aggregate corporate sector. The better showing of the top five chaebols was a direct result of their dominance in human resources. chaebols had a higher average DER than the corporate sector as a whole. includes the largest shareholder. the net profit margin of the aggregate sector exceeded that of the top 30 chaebols. The absence of a well-developed equity market and the provision of subsidized credit. II 2 percent in their sales and a very low 4. technology. . in this instance.3. Vol. a pyramidal structure of corporate ownership is prevalent. and access to credit. Ownership patterns. internal and external control mechanisms.” in Korea’s legal and regulatory framework.1 Patterns of Corporate Ownership The ownership of most Korean listed firms is highly concentrated.765 percent (Table 2. 2. and the companies that are under the control of the largest shareholder. coupled with weak corporate governance. weak corporate control. loopholes and inconsistent policies spawned strategic behavior and agency problems. and led to a high concentration of ownership. In general. Their worst year was 1997 when ROE hit -15. from 190 to 3. Only the top five chaebols registered a positive net profit margin in 1997. 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. There has been a wide range in DER among chaebols. except for 1995.3 Corporate Ownership and Control This section looks at the key aspects of corporate governance in Korea.13).5 Founding families are mostly still the largest shareholders and. 2. it refers to the degree of concentration and shareholdings in the hands of an “identical person. resulted in the chaebols’ excessive leverage. However.95 percent. The Commercial Code stipulates the basic governance framework and applies to all corporations. By the end of 1997. and government intervention interacted through a set of laws and regulations to bring about the existing structure.74 Corporate Governance and Finance in East Asia. The financial performance of the top 11-30 chaebols deteriorated during 1993-1997.7 percent growth in total assets. and vulnerable balance sheets. However. more important. 5 While “ownership concentration” can be defined and measured differently in different contexts.
4 205.5 464.5 3.13 The Top 30 Chaebols’ Debt-to-Equity Ratio. Samsung 3. Byucksan 1996 1.7 621.0 218. Sunkyung 6.3 297. Haitai 26. Lotte 11. Ssangyong 7. Dongah 14. Hyundai 2.1 477. Dongbu 24. Kukdong Construction 29.4 175.Table 2.2 328.3 328.2 292.7 267. Sammi 27.1 190. Hanwha 10.6 409.0 436. Dongkuk Steel 19.7 688. Halla 13.9 321. Hanil 28. Sunkyung 6.1 385.6 2. Halla 17.8 336. Ssangyong 7. LG 4.244. Hanjin 8.4 192.4 556.5 2.2 471.2 346.764.7 620. Dongah Construction 16.9 751. Daelim 14. Kolon 21. Hansol 23. Doosan 13.855. Kia 9. Newcore 30.441. Kia 9. Hanbo 15.2 2.8 312. Tongyang 22. Kohap 25. Dongkuk Steel 19.5 337. Jinro Debt-to-Equity Ratio 376. 1995-1997 (percent) Chaebols 1995 1.2 924.0 506.0 486.1 278.6 516. Samsung 3. Jinro 20. Daewoo 5. Hanwha 10. Daelim 16.1 674.2 423. Kumho 12.3 315.7 416. Hyosung 18.6 . Daewoo 5. Hyosung 18.065.5 343. Hyundai 2. Doosan 15. Lotte 11.8 313. LG 4.5 383.4 622.3 572.0 370.1 3. Hanjin 8.7 354. Hansol 17.6 936. Kumho 12.
Hanjin 7.7 1.5 323.8 347.4) 513.9 1. Kumho 10. Tongyang 24. Haitai 25. .5 576. Anam 27.3 347.8 658.784.6 424. Dongbu 23. Dongbu 21.5 519. Hansol 16. LG 5.5 1.4 1. Hanil 28. Newcore 28.225. Newcore 26.9 490.3 1. Kolon 19.1 438.0 305. Keopyong 29. Ssangyong 8. Saehan Average of All Chaebolsa 1995 1996 1997 Average of All Industries Excluding Financial Sectorb 1995 1996 1997 Debt-to-Equity Ratio 317.Table 2. bBank of Korea. Kohab 22.214.8 468.8 590. SK 6.6 416.6 Sources: aFair Trade Commission.5) 404. Hyundai 2. Shinho 1997 1. Dongkuk Steel 20.9 472.9 216.7 944.5 261.7 370. Kohab 18. Halla 13.1 375.9 465.1 359.1 472.5 386. Jinro 23. Anam 22.0 505.8 399. Doosan 15.6 478. Financial Statement Analysis Yearbook.5 (893. Samsung 3.6 590. Hanwha 9. Miwon 30.13 (Cont’d) Chaebols 20. Daewoo 4. Daelim 14. Hyosung 17.9 578. Shinho 26.3 676.501.8 338.5 (1. Tongyang 24.8 307.3 399.0 907.600.6 335. Kamgwon Industrial 30. Dongah 11.0 419. Keopyong 29. Haitai 25.1 433.8 647.498. Lotte 12. Kolon 21. Daesang 27.
” followed by banks.” foreigners. From 69. i. an entrenched manager is insulated from market pressure and can pursue personal goals without the fear of being replaced. The pattern of distribution changed little through 1992-1997. large ownership can also bring about the entrenchment effect. Securities companies reduced their holdings over this period of falling stock prices as the size of investment trust companies’ stock portfolios declined. the entrenchment effect outweighs the incentive effect.6 percent by 1997. Beyond that range. Among listed nonfinancial companies. the Government.7 percent by 1997. resorting to extensive use of pyramiding to maintain control. but their shares declined to 21. with a given range of managerial shareholdings (for instance. However. and insurance companies increased during the period.. the incentive effect once again dominates.14). including banks and other financial firms. Thus. fluctuated widely during the period. the extent of ownership by these individuals declined gradually after 1988. However. the individual owners—the portfolio investors as well as the controlling shareholders and their family members—formed the largest shareholder group (Table 2. including investment trust companies. the percentage of holdings by individuals slipped to 60. The holdings of financial institutions. When managerial holdings are reinforced by artificial control mechanisms such as pyramiding. while those owned by banks.1 percent. and then steadily declined after 1993. individuals were also the largest shareholder group. The next important group was “other corporations. 10 to 30 percent). The controlling shareholders of chaebols hold comparatively smaller percentages of shares. the year the stock market was in a frenzy due to buying sprees. Most non-chaebol listed firms in Korea are believed to have ownership concentrations within the 10-30 percent range.Chapter 2: Korea 77 When controlling shareholders hold a very small percentage of the shares. that is. and state-owned companies and securities companies declined. an increase in their ownership may bring their ownership incentives to converge with those of the minority shareholders. Theoretically. managerial entrenchment becomes more likely. the entrenchment effect and problems of agency may be more pronounced in chaebols than in independent firms. The percentage of shares owned by “other corporations. The reduction can be . Financial institutions owned as much as 28 percent of the total corporate shareholdings in 1992. Composition of Ownership Among listed companies.e. the ownership structure can bring about an incentive effect.
1 21.5 62. mutual savings.3 1994 521 1.6 1991 505 0.8 59. b “Banks.8 2.5 7.1 10.8 17.1 21.1 3.1 4. etc.4 5.3 1996 570 2.7 18.6 22.6 13.6 2.6 36.7 7.2 8.3 18.7 9.8 69.4 34.1 18.6 16.2 4.9 37.4 6.6 Year No.8 1995 548 2.0 7.1 8.3 1.7 3.9 36.1 2.2 B.0 5.6 12.5 7.5 12. etc.4 18.9 19.6 9.3 17.4 13. investment trust companies.0 60.5 16.3 8. All Listed Companiesc 1992 681 1993 687 1994 698 1995 715 1996 754 1997 775 9.5 1.0 28.0 27.b A.1 60.9 1.7 1990 531 0.3 1.3 26.Table 2.0 8.2 9.0 4.5 1.1 17.5 18.2 1993 511 2.3 17.1 11.2 18.8 17.5 6.5 4.3 39.1 1. of Firms The Statea Banks.8 2.3 18. Listed Nonfinancial Companiesd 1988 406 0.4 14.9 2.5 6. and finance companies.0 59.1 68.6 19.8 4.2 1. d Constructed from data files of the Korea Listed Companies Association.4 Insurance Firms Other Corporations Foreigners Individuals 39.” includes commercial banks.7 8.9 17.2 5.7 6.1 18.7 14.4 5.8 59.8 5.2 5.9 26.2 17.2 2. .8 5.5 Note: Ownership is based on number of shares.9 4.2 7.7 9.2 9.7 59.0 5. c Data from Korea Stock Exchange.9 2.2 8.9 15.6 9.5 60.5 1992 508 2.7 4.3 5.6 16.3 5. a The State covers the Government and state-owned companies.1 8.6 16.4 13.3 2.6 8.4 1997 551 1.2 3.5 1989 498 0. merchant banks.14 Ownership Composition of Listed Companies.6 20.9 1.0 9. 1988-1997 (percent) Financial Institutions Securities Firms Total 28.9 5.
the Government was the sole owner. The Government’s and state-owned institutions’ (including some banks) ownership was generally small except in the power sector. The holdings of other corporations are mainly equity investments in affiliate companies. there appears to be no significant difference in the overall shareholding patterns between the two groups (Table 2. and US (Table 2. Institutional investors. In 1998.16).8 percent of listed shares in 1997. government ownership in nonfinancial companies was remarkably smaller and more concentrated. When independent companies are distinguished from firms affiliated with the 30 largest chaebols. This trend can be explained by government ownership. Over the years. This is low compared with those in Japan. categorized into large. indicating their increased investments particularly in the service industries with high growth rates. Before such liberalization. In most instances. and small companies. with the Government continuing to hold a sizable share in the Korea Electric Power Corporation. Individuals held the majority of the shares in all industries except in telecommunications. One minor difference is that the percentage of shareholdings by corporations is slightly higher in large-sized firms. However. other corporations’ holdings shifted toward service industries. the holdings of institutional investors were expected to increase significantly with the Government’s introduction of US-type investment companies in 1998 and . indicating their heavier reliance on inter-firm financing investments. financial institutions had more shares in the manufacturing sector than in primary industries. Corporate holdings averaged 16 percent throughout 1988-1997. did not vary significantly (Table 2. Foreigners gradually increased their equity shares in 1992 when direct purchases by them were first permitted. 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.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.15). the Government acquired an even bigger share in several banks as part of its program to bail out these distressed institutions. However.18). foreign holdings were derived from purchases through country funds and direct capital investments. In general. of some banks. medium. held 26. whether partial or absolute. as distinguished from individual and foreign investors. Compared with its holdings in all listed companies. and service of motor vehicles (Table 2.17). electricity. UK. The ownership distribution in listed nonfinancial firms.
2 22.7 29.4 — 0. 1990 and 1997 (percent) Financial Institutions The Statea — — 0.8 1. Rubber.3 2.2 9.7 22.9 15. Paper.8 Individuals 83.2 0.3 4.5 12.2 1.3 38.5 3. and App.8 6.0 9.6 8.8 3.0 9.7 22.0 10.1 0.1 1.9 0.8 5. and Steam Supply Precision and Optical Instruments Other Manufacturing Construction Service of Motor Vehicles Wholesale and Retail Trade Transport Telecommunications Other Business Activities Nonmetallic Mineral Products Average .1 7. Gas.7 1.7 59.4 Banks.4 62. and Printing Chemicals.9 10.9 59.2 0.9 1.4 8.7 20.1 0.0 0. and Printing Pulp.9 1.9 60.4 0.2 1.2 0.2 9.3 57.6 3.b Securities Firms Insurance Firms Other Corporations Foreigners — — 0.1 4.2 7.7 17.Table 2.4 2.7 64.5 0.4 8.7 20.5 — 0.9 42.1 0.5 17.2 54.3 62.3 7.5 6.3 1.4 56.0 7.0 — 39.5 0.8 7.8 7.6 18.7 14.4 1.5 19.4 7.7 2.1 0.8 3.4 8.3 1.5 0.1 8.5 0.1 88.3 2.5 7.8 7.8 8.9 8.4 5.7 63.2 64.1 27.3 9.9 66.8 7.9 55.7 14.6 — — 2.3 6.0 Industry 1990 Fishing and Fish Farms Mining Food Products and Beverages Wearing Apparel and Fur Articles Wood.5 — 1.9 16.1 65.9 52.0 9.7 2.3 13.4 1..1 8.6 11.6 5.3 0.2 2.4 14. Elecl Mach. and Plastics Basic Metal Fabricated Metal and Machinery Office and Computing Machinery Electronics. Paper.0 8.0 1. Motor Vehicles Electricity. Etc.3 11.5 — — 0.0 9.7 6.15 Ownership Composition of Listed Nonfinancial Firms by Industry.7 2.2 0.0 — 0.5 85.5 4.0 20.4 56.1 10.6 1.9 23.3 0.3 10.2 — 0.3 0.8 7.9 4.9 19.0 2.6 24.1 19.8 73.2 — — 0.2 17.2 9.
2 23.6 18.3 0.6 6.4 — 1.1 9.9 6.0 5.1 9.4 1.5 4.4 6.4 58.2 1.5 63.4 4.5 0.9 20.9 1.2 1.5 12.0 43.8 54. Gas.2 3.6 14.3 31.2 49.3 57.8 2.5 3. Note: Ownership is based on number of shares.8 3.3 65. Paper.9 7.8 27. Paper.2 0.2 13.5 3.5 7.6 6.7 19.7 2.7 2.8 2.4 16.0 11.7 6.2 4.7 2.3 7.1 — 0.7 1.8 6.8 11.2 4.9 0.1 2.0 1.9 1.9 2.9 69.3 15.5 — 2. Rubber.1997 Fishing and Fish Farms Mining Food Products and Beverages Wearing Apparel and Fur Articles Wood. etc.0 8.0 60.0 4.8 5.6 0.3 60.6 2.1 3. a The State covers the government and state-owned companies. .6 1.8 2.6 2.6 60.9 1.9 57.9 2.6 0. merchant banks.1 18. Source: Constructed from data files of the Korea Listed Companies Association.2 5.7 17.9 2.6 5.1 4.3 1.8 5.3 2.2 8.4 1.7 23.3 1.3 8.7 5. investment trust companies.5 6.1 1.4 20.5 59.4 2.0 6.” includes commercial banks.8 57.4 43.1 2.6 75.5 3. and Printing Chemicals.8 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 1.2 4.9 5.2 4.9 6.9 2. and App.6 3.1 — 1.1 3.4 45.5 1.5 4.5 3.3 6.4 2.7 2.1 1.4 1. and Plastics Basic Metal Fabricated Metal and Machinery Office and Computing Machinery Electronics.6 — = not available. b “Banks.4 76.8 4.6 20.9 5.4 3.2 6.78 81.1 54.4 2.1 6.0 7.0 3. Elecl Mach.4 68.2 0.6 59. and finance companies.8 12.9 20.5 5.9 18. mutual savings.1 25. Motor Vehicles Electricity. and Printing Pulp.4 58.6 2.4 4.2 7.8 0.7 4.6 7.9 7.0 6.3 6.2 5.4 0.4 9.9 78.
of Firms Independent Firms Affiliates of 30 Largest Chaebols Total 316 117 433 Source: Constructed from data files of the Korea Listed Companies Association.1 8.0 Other Corporations 16.9 4.9 2.1 6.7 Foreigners 4.9 5. etc. 1997 (percent) The Stateb Foreigners 4.4 5.5 62.8 2.8 1. Others are medium firms.4 Firm Sizea No.4 1. etc.6 16.c Securities Firms Insurance Firms Other Corporations Individuals 58.16 Ownership Composition of Listed Nonfinancial Firms by Size.1 Banks.5 Individuals 60.5 18.3 6.8 3.4 2.5 6. 1997 (percent) The State 1.8 4.7 8. .5 19.8 6.7 Control Type No.4 17. investment trust companies.1 2.4 61. The State covers the government and state-owned companies.5 4.4 21.7 6. Securities Firms Insurance Firms 2.4 2. mutual savings.6 60.8 60. merchant banks.5 2. and finance companies.8 4. Source: Constructed from data files of the Korea Listed Companies Association. b Table 2.7 0.4 4.2 1.7 1.Table 2. etc.0 6.17 Ownership Composition of Listed Nonfinancial Firms by Control Type.5 8.” includes commercial banks.4 61.7 4.5 16. c “Banks.4 5.0 1.3 Banks. 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.
Among nonfinancial listed firms. Foreign holdings of Korean shares were 9. investors (Table 2.5 20. the majority shareholder group on average held 23-30 percent of outstanding shares in the period 19881997 (Table 2. and other shareholders who do not belong to either the minority shareholders or the majority shareholder group. while family members accounted for only 30 percent.7 16.Chapter 2: Korea 83 Table 2.20).18 Ownership Composition of Listed Firms in Selected Countries. This has had profound implications for corporate governance and the market for corporate control in Korea. corporations held 70 percent of the controlling blocks of shares.8 10. for example. At the moment. Concentration of Ownership The analysis of ownership concentration in this section focuses on shareholdings of the majority shareholder.3 54.China United Kingdom United States Source: Stock Exchange of Korea. defined as those holding less than 1 percent of shares. 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. minority shareholders. 1997 (percent) Country Japan Korea Taipei.6 39.8 56.8 9. The majority shareholder group’s shareholdings in listed nonfinancial firms steadily declined from 1990 to 1996. including those of the largest shareholder. Generally.1 percent and appear to be similar to the proportion of foreign holdings in the four other countries. only closed-end investment companies and traditional investment trust companies are allowed. In 1997.6 Individuals 23.4 26.1 financial institutions’ establishment of corporate pension fund accounts.1 8. But these may .19). and the companies under the control of the largest shareholder.3 47.5 45.6 Foreigners 9. his/her family members.3 6. Institutional Investors 42. rather than the individual. the majority shareholder group in all listed companies consists of the corporate.
1 15. 1992-1997 (percent) Majority Shareholders Corporation 15.2 2.7 6.2 Minority Shareholders Subtotal 71.5 43.1 4.1 37.0 4.3 30.6 46.8 73.3 Subtotal 5.0 29. his/her family members.3 2.9 33.9 32.6 22.0 66.8 72.0 2.6 26.1 21.2 2. Minority shareholders are those holding less than 1 percent of shares.2 26.7 16.9 Individual 2.9 3.0 69. and the companies under the control of the largest shareholder.0 25.19 Ownership Concentration of All Listed Firms.1 14.7 18.4 5. .9 7.4 7. Source: Stock Exchange of Korea.1 5.1 5.0 Year Corporation Individual 1992 1993 1994 1995 1996 1997 41.7 7.6 73.0 1.1 32.7 44.9 6.9 2.0 22. Other shareholders are those who do not belong to either the minority shareholders or the majority shareholder group.1 23.Table 2.8 Individual Subtotal Other Shareholders Corporation 3.6 5.3 18.4 3.7 Note: The majority shareholder includes the largest shareholder.6 2.8 8.1 28.
which held less than 1 percent of a company’s outstanding shares as of 1997.22). 1988-1997 (percent) Year 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 Minority Shareholders 53.9 12. thereafter.2 15.5 23.7 18. Across industry.4 28. 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 2.0 20. Besides.9 48.8 12.8 Majority Shareholders 27. Meanwhile. The practice of hidden shares seems to have been less prevalent in recent years.3 62.6 11. 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 2.3 25.6 57. Majority ownership is also high in the chemicals.0 58.5 60. Ownership concentration tended to be lower in large compared to medium and small listed firms.8 57.5 12. .8 54.4 Source: Constructed from data files of the Korea Listed Companies Association. in the small firms.5 13.21]). collectively owned less than 50 percent of an average firm. The shareholders that held more than 1 percent but did not belong to the majority group held about 20 percent on average. the majority owner held more than 20 percent of an average firm.8 28.6 58.9 27.20 Ownership Concentration of Listed Nonfinancial Firms. In telecommunications.8 25. the Government has retained a large number of shares. ownership was relatively diffused due to government regulation.Chapter 2: Korea 85 Table 2.9 29.9 Other Shareholders 18. It was highest in medium-sized firms before 1993 and. rubber and plastics. minority shareholders.0 22.4 23.1 50. In most industries.9 25. and mining categories. In such cases. hiding shares offers no additional tax or other benefits. 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.
7 26.3 39.9 26.2 19. and Printing Chemicals.8 41.0 54.5 19.6 34. 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 36.9 Minority Shareholders Majority Shareholders Other Shareholders 12.1 17.4 11.8 25. .2 22.Table 2.5 16.7 29.7 36.5 44.7 27.2 37.4 Industry Fishing and Fish Farms Mining Food Products and Beverages Wearing Apparel and Fur Articles Wood.0 39.6 25.8 51. Elecl Mach.8 55.2 23.5 47.4 53.2 26. Motor Vehicles Electricity.5 20..6 50.8 44.1 49.5 23. Rubber.21 Ownership Concentration of Listed Nonfinancial Firms by Industry. Gas.0 21. Paper.2 34. and Steam Supply Other Manufacturing Construction Wholesale and Retail Trade Transport Telecommunications Other Business Activities Nonmetallic Mineral Products Total Source: Constructed from data files of Korea Listed Companies Association. and Printing Pulp.1 19.3 26. Paper.8 31. and App.8 29.3 19.8 21.8 24.7 17.5 52.9 44.7 21.5 21.2 20.6 53.0 51.1 43.6 38.5 41.4 16.7 24.2 48. and Plastics Basic Metal Fabricated Metal and Machinery Electronics.2 46.9 10.0 30.6 19.
6 11.3 55.9 16. 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 53.9 28.2 26.3 19.2 56.8 52.2 32.0 24.5 49.7 22.7 15.9 26.9 23.9 17.4 30.8 50.0 66.6 31.2 55.9 22.7 57.6 59.4 30.0 55.1 48.6 55.2 21.5 26.8 27.7 57.2 18.9 21.4 29.3 21.2 21.1 20.5 28.5 19.0 26.6 65.6 15.5 27.9 55.7 17.5 12.2 Majority Shareholders 26.3 25. .1 15.5 Other Shareholders 19.4 51.7 31.4 30.5 12.5 21.1 16.5 19.2 50.4 47.3 26.7 14.4 21.9 56.9 53.5 33.5 51.22 Ownership Concentration of Listed Nonfinancial Firms by Firm Size.6 24.8 62.2 11.6 27.2 12.9 60.9 12.7 16.8 52.8 11. 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.1 58.Table 2.5 10.8 56.2 Source: Korea Listed Companies Association.6 62.2 52.2 21.7 28.1 27.8 17.0 59.8 28.3 27.
Hong. TQ increases as the SCS increases. Shleifer. This type of inter-firm investment. J. and Kim (1995) reached a similar conclusion. from the standpoint of the controlling shareholder. H. 1988). If TQ is higher than 1.88 Corporate Governance and Finance in East Asia. one company can still place equity investments in another. The Code prohibits a subsidiary company from owning shares of its parent company. 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. Where direct cross-shareholding is not allowed. affiliated companies have been able to conduct inter-firm transactions. One of the merits of pyramiding. thus a firm destroys value. Inter-Firm Investments and Pyramiding in Chaebols The Commercial Code imposes limits on direct cross-shareholding. H. which is the company holding more than 40 percent of outstanding shares of its subsidiary. In Korea. II Ownership Concentration and Financial Performance J. If SCS is below 10 percent. and Kim (1995) studied the empirical relationship between the degree of ownership concentration and financial performance in Korea. The relationship between TQ and SCS shows a similar pattern. which can then pass the equity capital to a third. TQ is above 1. thus a firm creates value. one company from a chaebol group could obtain debt payment . If SCS is below the range of 20-25 percent. TQ has a maximum value. Hong. Kim (1992) found the relation between TQ and SCS to be nonlinear. The pattern of the relationship between SCS and TQ is similar between Korean and US firms (Mork. if TQ is lower than 1. it means the firm creates value. although turning points in the value of firms are different. is effective control of a certain group of companies even with a smaller investment. called “pyramiding”— commonly (though incorrectly) known as “indirect cross-shareholding”— is prevalent in Korea. They analyzed firms in which controlling shareholders participate as managers. and Vishny. If SCS reaches 10 percent. TQ was calculated by dividing the market value of a firm by the substitution price of its assets. the firm destroys value. often at terms unfair to one of the transacting parties. Then TQ declines until SCS reaches 45 percent and increases until it reaches 50 percent. Kim (1992) and Kim. TQ is below 1. If SCS is above 20-25 percent. The study by Kim. Vol. For example. Both studies used Tobin’s Q (TQ) for the value of a firm as an index of financial performance.
neither the investors nor the relevant government authorities were active in monitoring such unfair dealings between firms. not individuals. Among the 81 listed firms in the ADB survey.14. 53 percent were domestic nonfinancial firms. 59 were parent firms with one or more subsidiaries. Of the 81 respondents. For the whole sample.5 corporations and two individuals. Among chaebol affiliated firms. or an average of 13 firms per company. or about five subsidiaries each. The top five shareholders of the chaebol-affiliated firms consisted of one individual and 3. In the case of the 30 largest chaebols. there are instances of direct cross-shareholding in Korean firms. for example. standalone setups. the top 30 chaebols’ shareholding by subsidiaries was 34. financial institutions that are subsidiaries of a chaebol also hold shares in its member firms. Partial results are shown in Table 2. In Table 2. Thus. Thus. 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. For the same year. and 319 foreign subsidiaries. the top five shareholders consisted of 2.5 percent as of 1997. Until recently. and about 11 percent were domestic financial institutions. Twenty-two of the 81 respondents were independent. or about four firms each. together owning an average of 38. the average shareholding of the controlling owners and their families was 8. firms linked through partial equity investments could enjoy the advantage of consolidation without an actual formal consolidation or merger of operations taking place. together owning an average of 37. This also partly explains why chaebols frequently opted to expand by establishing new firms rather than placing investments internally. The fact that corporations.Chapter 2: Korea 89 guarantees from other members of the group at no cost. dominated the majority shareholder group in chaebol-affiliated companies is consistent with the results of the ADB survey conducted for this study. 59 parent companies collectively had investments in 759 firms. corporations hold about 20 percent of the outstanding shares of all listed nonfinancial firms.5 percent of shares. 62 percent (16 out of 26) had a corporation as the largest shareholder. In many instances. together having a total of 292 domestic subsidiaries.4 corporations. although they are likely to be insignificant. If we define the internal shareholdings of a .5 percent. 34 percent were foreign companies.23. Among the subsidiaries or firms receiving investments.9 percent of shares. The extent of pyramiding can be seen in some of the previous tables. But the controlling power of the owners also stems from inter-company shareholdings of the subsidiaries. Only six firms (or 13 percent) indicated that their subsidiaries also owned shares in themselves.
8 31.1 22.0 3.2 25.0 3. 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 20.0 2.8 37.4 11. a Number of shareholders.9 21.0 17.1 1.4 2.6 16.8 Note: The survey was conducted during the period January through May 1999 and included nonfinancial listed firms only.5 4.0 13.7 39.7 37.4 1.1 3.6 3.8 18.0 1.Table 2.5 2.23 Ownership Concentration in the Survey Sample of 81 Listed Firms.8 38.4 42.6 34.7 5.7 19.3 12.5 31.8 8.5 38.6 3. .5 2.9 5.0 21.5 2.3 26.5 1.5 18.9 34.4 38.7 0.6 3. b The chaebol affiliated firms are those belonging to one of the 30 largest groups.5 2.5 24. 1999 Five Largest Shareholders No.4 18.0 1.4 25.9 29.2 37.4 21. A few companies reported less than five largest shareholders.5 4.
2 15.4 10. 1997. edited by K.6 33.5 percent. 6 7 Hattori.2 12. Jae Woo.5 34. Thus it can be inferred that their strategy in designing the ownership structure of their business groups was to minimize the financial resources required to maintain their grip on the management of the member firms while maximizing their control. the average internal shareholding ratio of the top 30 chaebols was at least 43 percent.24 shows the average internal shareholdings in the 30 largest chaebols. 15 October 1998. As of 1997. Hattori (1989) identified three patterns based on data in the early 1980s.5 percent and member companies. Table 2. “Japanese Zaibatsu and Korean Chaebols. Family holdings include shares owned by the family members and by parties considered to be under the influence of the family. Chicago.6 Later studies by Lee (1997) and Lim (1998)7 find similar patterns.0 8. Lee.4 1993 43. 1989.2 33. C. 79-95.7 1992 46. pp.5 Judging from the historical record.2 1994 42. Ungki Lim. 1987 56. 34. Table 2. Internal shareholdings in some chaebols also include shares owned by nonprofit organizations operated by the controlling family.” Paper presented at the Annual Conference of Financial Management Association. Chung and H. the ownership patterns can be described as follows. the controlling families owned 8. 1998. The family and member companies’ shareholdings have been declining over time.24 Internal Shareholdings of the 30 Largest Chaebols. 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. Many attempts have been made by researchers to identify the typical patterns of ownership structures in chaebols.4 13.8 33. 1987-1997 Type of Shareholding Internal Shareholdings Family Member Companies Source: Korea Fair Trade Commission.7 31.” In Korean Managerial Dynamics.1 1997 43. “Is the Fair Trade Policy Fair?” Korea Economic Research Institute. New York: Praeger.8 40. .7 9.4 1990 45. Tamio. H. Lee. it appears that the chaebol families have had a strong desire to expand their business bases. Based on these studies.Chapter 2: Korea 91 chaebol as the shareholdings of the controlling family and the member companies of the group. “The Ownership Structure and Family Control in Korean Conglomerates: With Cases of the 30 Largest Chaebols.
it had 18 listed and 39 private companies. A nonprofit foundation under the family’s control is the largest shareholder of one of the base companies. Most of its member firms were acquired by. consisting of eight listed and 16 privately held firms as of 1997. The family itself holds shares in some subsidiaries. Kia Motors was the base company and had such strategic shareholders as Ford Motors of the US and Mazda of Japan. Also. The fourth type (Type D) is “management control. But the former chief executive officer (CEO). Investments between the lower level subsidiaries are rare. II The first (Type A) is called “direct family ownership. The second (Type B). other firms.” Under this type of ownership pattern. which then make investments in the subsidiaries. Chaebol Reforms Various measures have been taken to improve the transparency of chaebols with regard to accounting. completely dissolved under financial distress. and his management team exercised full control over the group without much interference from major investors. and subsidiaries’ equity participation. Vol. Thus. The two base companies have investments in three other base companies. financial. The Kia Group was about the only management-controlled group but was out of existence by 1999. As of 1997. The Hanwha Group can be classified as such a company. or merged into. The controlling family has sizable investments in two base companies and smaller investments in many others. It consists of seven listed and 24 privately held firms. The Hyundai Group exemplifies this. Sun Hong Kim. holdings of the nonprofit foundation. The third (Type C) is “indirect control via complex shareholding. One of the .” shows a simple pyramidal structure.” 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. Hyundai Motors acquired Kia Motors via an international auction.92 Corporate Governance and Finance in East Asia. For example. subsidiaries have extensive investments in other subsidiaries. investments made by the base companies.” Here the family directly controls a base company and a nonprofit foundation. which in turn hold shares in some of the 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 Hanjin Group. there is no controlling shareholder. the family controls the group’s member companies by its own shareholdings. called the “indirect control via base company. and business activities. is an example of this type.
They hindered early exits (liquidation. However. These amendments prohibited holding companies and direct cross-shareholding. This limit was also applicable to banks and insurance companies. Cross-guarantees are believed to constitute a form of wealth transfer from financially strong members to weak ones. the Credit Management Regulation rules were amended to prohibit financial institutions from requiring guarantees from affiliated firms when extending new loans. following the amendment of the law. direct control of the management of chaebols was attempted through amendments of the act in 1986 and 1990. 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.Chapter 2: Korea 93 pronounced purposes of government intervention in the corporate sector has been to prevent concentration of economic power in the hands of a few large chaebols. The prohibition of holding companies was also abolished in 1999. A third disallows multiple layering of holding companies. This was the reason why chaebols chose to employ pyramidal structures. These conditions are aimed at restricting excessive pyramiding and expansion of chaebols. At this early stage. Also. 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. Initially. thus hurting the shareholders of stronger firms. It remains to be seen whether they will adopt the holding company structure in the future. there are reports that some top chaebols are studying the feasibility of transforming their organizational structure. The Government is also considering whether to allow consolidated taxation for pure holding companies. The limit on investments was reduced to 25 percent in 1994 and completely eliminated by 1997. only operating holding companies were allowed to be established. The Fair Trade Act was also revised in February 1998 to prohibit cross-guarantees of debt among members of a chaebol. The Fair Trade Act was amended in 1998 to allow pure holding companies to be established under restrictive conditions. bankruptcy reorganization. the Fair Trade Act). 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. Existing guarantees had to be resolved by March 2000. Until the end of 1998. . the act did not have any important provisions except the standard clauses prohibiting monopolization of an industry through business combinations. The first serious attempt to deal with this issue was the introduction of the Monopoly Regulation and Fair Trade Act of 1980 (hereinafter. One condition requires that the DER of the holding company should not exceed 100 percent.
II etc. The 30 largest chaebols are now required to publish “combined” financial statements. there have been no significant changes. The office established strategies for the group as a whole. 2. the Commission has strengthened its investigative activities to eradicate cross-subsidization and wealth transfer activities among group members.94 Corporate Governance and Finance in East Asia.) 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. who is universally called the “group chairman. which put together the accounts of all members of a chaebol. 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. chaebols dismantled their “planning and coordination offices” or “chairman’s offices” under pressure from the Government. but the larger and stronger ones still operate their newly named “restructuring headquarters” under the control of the group chairperson. Chaebols maintain that the restructuring headquarters will exist only for a limited period. Some chaebols have disintegrated or shrunk in size. These offices were legally informal and functioned as the headquarters of chaebols. Despite chaebols’ decision to dismantle the chairman’s offices. and transferred funds generated by one firm to another. Vol. The chairman’s office had its own chief executive officer. The staff of these organizations were employees of member firms. Some chaebols operated “group management boards” attended by top executives (presidents or chairpersons) of larger member firms. planned for capital raising and allocation on a groupwide basis. even though they were legally independent with their own board of directors and the outside shareholder groups were not identical. In 1998. Their operating costs were borne by the member companies rather than by the controlling shareholder. unlike the regular consolidated statements that only cover those firms that are related through direct equity participation. usually in the rank of a company president. and the capital market was almost nonexistent until the recent reform . 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. Since the economic crisis.3. It also acted as the secretariat for the unofficial “presidential meeting” of the member firm presidents. boards of directors.2 Internal Management and Control Monitoring of corporate management by shareholders.
Board of Directors General Characteristics of the Boards Under the Commercial Code. and takeover codes were not accommodative to active monitoring. In most listed companies. were too big to fail. Even where the largest shareholder is not the representative director. only the Government could play an effective role in monitoring corporations. Professionalism in management was not well developed and managers were content with receiving orders from controlling shareholders. Meanwhile. Under such circumstances. the controlling shareholder (or a member of the controlling group) was the legally registered representative director in 354 out of 551 nonfinancial listed firms. Legal provisions to protect investors were limited. . Banks. This policy managed to hamper any monitoring initiatives from the capital market. he or she generally approves major decisions made by the management. especially chaebols. but some large ones have two or more. creditors were not active in monitoring debtor firms and relied mainly on guarantees and collateral. the concept of fiduciary duty of managers was not well established. There are many reasons for this. Loan agreements and debt indentures did not include strict covenants. except for banks. or at least acts as the de facto CEO. had their own governance problems. as the major creditors. Directors are elected at the general shareholders meeting for a term not exceeding three years. the controlling shareholder is officially the representative director and the CEO.Chapter 2: Korea 95 efforts. the representative director was also the chairperson of the board. With few exceptions. The board elects one or more representative directors from among the board members. the creditors did not declare defaults. As of 1997. in most Korean firms. However. corporations should have a board of directors consisting of at least three members. Most companies have one representative director. this was complicated by the prevailing attitude that large companies. control is not separate from ownership. Thus. This implies that the typical agency problems in Korean corporations stem from conflicts of interest between inside (the largest) and outside (minority) shareholders. The Government’s policy and securities law provisions to protect control rights of the incumbent management had been in place until the early 1990s. Even when the covenants were violated.
cumulative voting is not mandatory and a company can exclude itself from its application by amending its charter. other than the representative director(s). 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. were supposed to be outside directors. they were virtually under the full control of the CEOs and in practice functioned only as management councils without any decision-making power—at least until 1998. The Commercial Code was also revised in 1998 to introduce cumulative voting for the election of directors. II When the Commercial Code first introduced the corporate board system in the 1960s. 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. the attendance rate of outside directors. Despite the qualification requirements. In order to address this concern. almost all companies succeeded in adopting cumulative voting. and their positions (accept or reject) on matters voted on in board meetings. Further. all of whom were managers. In the 1999 annual shareholders meetings. there is concern that newly elected outside directors still lack independence from the management or the controlling shareholder. However. Most of the outside directors in those days were the controlling shareholders of chaebols or executives of affiliated companies. 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. However. A few large companies had more than 50 directors. Moreover. With the boards consisting only of insiders. 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.96 Corporate Governance and Finance in East Asia. Recent Reform Efforts on the Board System In 1997. members of the board. companies have to disclose in their annual reports the frequency of board meetings. Vol. . The rules further require that the number of outside directors be not less than a quarter of the size of the board by the annual shareholders meeting in 1999. 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.
the Corporate Governance Reform Committee.9 percent on average. this committee adopted the Code of Best Practice in Corporate Governance. Where the two were separate. who would comprise at least 50 percent of the boards. The Securities and Exchange Act will require large listed firms with W2 trillion or more in total assets to adopt the audit committee system. Directors were most frequently elected because of their professional expertise (74 percent of the respondents marked this answer).2 percent and the CEO 14.1 percent and outside directors 1. Where the chairperson was not the CEO. In September of the same year. are required to have a majority of outside directors. These results are in accordance with the new listing rules introduced in 1998. Among others. On average. a blue-ribbon committee. Meanwhile. the chairperson of the board was also the CEO and on average held 10.1 percent of outstanding shares of a listed company. and a nominating committee. an audit committee. The controlling shareholder of some banks is the Government. he or she held 6. This is because most banks. they had a parent/child relationship in 20 percent of the cases. having no controlling shareholders. the OECD principles of corporate governance were the minimum standard for the Korean Code of Best Practice.4 directors. the Korean Code recommends that large listed firms should have at least three independent directors. ADB Survey Results on Boards The ADB survey results confirm the above assessments and provide early indications on the effects of the reforms. inside directors owned 16. was established under the auspices of the Ministry of Finance and Economy and the Korea Stock Exchange. The average board had 8. although some banks recently have established board committees. Directors were also chosen on the basis of their relationship with the controlling .Chapter 2: Korea 97 The committee structure of the board as found in the US has not yet been adopted by listed companies. In 78 percent of the responding firms. The Commercial Code is being amended to allow a choice between the audit committee system and the current internal auditor system. Almost all (92 percent) of the respondents had one or more outside directors and 70 percent were elected after the Asian financial crisis.5 percent of the shares. which had extended financial support in their recent recapitalization efforts. In March 1999. Among the firms with no outside directors. 88 percent had plans to hold elections in the near future.
The general practice is that shareholders approve the upper limit on the total amount to be paid to all directors. a total of 562 directors were sitting on two or more corporate boards. II shareholder (30 percent). including stock options. These were established only recently. In one case. Most frequently. the term of appointment of directors and board chairpersons is three years. the board had a nomination and an audit committee. the management determines the remuneration. Less frequently. Some directors were nominated by significant shareholders (18 percent) or introduced (and elected) at the shareholders meeting. the board had no committees. In 1997. founders of the company acted as the chairperson (22 percent). . in 23 percent. The current chairperson has been in office for 6. In 91 percent of the sample firms. In some instances. and fixed fees plus performance-related pay. This rather long tenure must be due to their status as controlling shareholders in most firms. Members of controlling shareholder families or their trusted company personnel often act as directors for multiple chaebol firm boards. the management nominated director candidates (64 percent of the directors). compensation for directors must be approved by the annual shareholders meeting for each fiscal year. About five directors per firm have been in office for more than one term. one person was sitting on nine boards and this person was the CEO of a chaebol firm. In most 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. The reason for this high frequency of interlocking directorship is that many listed firms belong to chaebols. As discussed earlier. In a very small number of firms. election of directors was based on shareholdings (7 percent) and status as founder (7 percent). in some firms. and shareholding (10 percent). among the 81 sample firms. Remuneration for chairpersons include only fixed fees in 76 percent of the sample firms. Chairpersons of the board were elected on the basis of professional expertise (33 percent of the firms).98 Corporate Governance and Finance in East Asia. However. Vol. The survey results indicate that boards determine remuneration packages for chairpersons in 42 percent of the firms. the package for the chairperson is directly proposed at the annual shareholders meeting either by the board (31 percent of the firms) or by the management (9 percent). According to the Commercial Code. relationship with controlling shareholders (21 percent). In 13 percent. The board or the management then determines compensation packages for individual directors.2 years on average.
he or she does not enjoy much power. and in another 21 percent CEO bought shares in the market. shareholding in three firms. and fixed salary plus performance-related pay including stock options in 13 percent. fixed salary plus net profit-related bonus in 9 percent.Chapter 2: Korea 99 Management CEO In the survey sample. These results show that the incentive compensation scheme for professional CEOs is not well developed in Korean firms. A smaller number of firms consider maximization of a company’s market share and looking after the interests of such stakeholders as creditors and employees as very important. In cases where CEO is not the largest shareholder and chairperson. Ensuring that a company serves the public interest is considered a less important responsibility of CEO. CEO decides on important matters after consulting the chairperson in the majority (55 percent) of the firms. 86 percent of the firms answered positively when asked whether the largest shareholder was CEO. CEOs have been in their positions for an average of 9. decides on important matters on his/her own in 13 out of the 44 firms. the survey tells a slightly different story than is generally believed in Korea. who is not the chairperson. CEO simply follows the orders of the chairperson.2 years. it was proposed by CEO and approved by the board. CEOs generally maintain their positions for a long time because they are frequently the founders or largest shareholders of their firms. CEO is also the founder in 52 percent of the firms. In 4 percent of the cases. When CEO is not the chairperson. compensation is by fixed salary in 74 percent of the firms. and was appointed by the Government in five firms. The remuneration package was proposed by the board (and approved by the annual general meeting) in 56 percent of the firms. It indicates that CEO. the payment is about five times the CEO’s annual salary. However. in which there is no controlling shareholder. CEO generally has the ultimate power to decide on corporate affairs. he or she was selected on the basis of professional expertise in 15 firms. In 21 percent of cases. In less than 20 percent of the 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. CEO was given shares by the family. According to the survey. In the survey. In 20 percent. . CEO is entitled to a large sum in cases his/ her contract is terminated before its expiration. In the 25 firms where CEO was not the chairperson of the board. In such cases. In a handful of sample firms.
executives sometimes have the opportunity to buy company shares at favorable prices because the board of directors (CEO. However. 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. The commission has played an active role in introducing new rules on corporate governance. disclosure. Penalties for fraudulent financial reports were increased. but in practice is fixed and understood as part of a fixed salary. 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. it was common for all senior executives to be elected as directors at the shareholders meeting. About 40 percent of the listed companies had amended their charters to introduce incentive stock options by the 1999 shareholders meetings. 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. from IMF and the World Bank. 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. and accounting standards. II Senior Executives In the past. The bonus is supposed to be linked to company performance. in particular. Senior managers were even often called directors although they were not official members of the board. (ii) establishment of accounting standards for financial institutions. 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. in practice) allocates the unsubscribed portion of new shares issued in rights offerings to executives. and . Vol. This action was in response to calls by international investors and. Korean firms have rarely used shares for executive compensation. One area has been to enhance the reliability of financial statements of corporations in line with internationally accepted standards.100 Corporate Governance and Finance in East Asia.
Korean listed companies with subsidiaries are required to compile consolidated balance sheets. 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. Consolidated reporting was introduced before the outbreak of the crisis. 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. Those that never adopted international standards show their willingness to do so once the Government introduces international standards. Under the Commercial Code. Internal and External Auditing The Commercial Code requires a corporation to have at least one internal auditor elected at the general shareholders meeting. 41 percent of the companies believed that they have followed some international accounting standards. In the ADB survey. 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. but 49 percent confessed that they have not followed international standards at all. however. In practice. Most of the companies following all or some of the international standards in the past adopted such standards before the crisis started. The revised accounting standards apply to the firms subject to external auditing for the fiscal year starting on or after January 1999. the internal auditor is considered to be a subordinate of the . The new accounting standards for financial institutions adopt the mark-to-market basis to account for securities. Only 10 percent of the respondents have followed all international accounting standards. The primary sources of reference in the revision were International Accounting Standards and US Accounting Standards.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. 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. they cannot be expected to discharge this responsibility because the representative director selects the internal auditor and can force him or her to resign. 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.
About 100 listed firms will be subject to this requirement. In the ADB survey. does not have the power to hire and fire the managers. Listed and registered corporations must publish financial statements audited by external accounting firms. and creditors selects it. But this problem can be mitigated if auditors function under the umbrella of the board. the board of directors had the power to appoint an external auditing firm. but since 1998 a committee consisting of internal auditors. however. 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. Previously. 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. The Commercial Code will be revised to allow corporations to choose from the two options: the internal auditor or the board audit committee system. outside directors. This is because the auditor. underdeveloped market discipline for accounting firms. there were many cases where external auditors failed to detect omissions and false numbers in financial statements of listed firms. and lack of strong professional ethics in the accounting profession. Big Korean accounting firms are affiliated with US accounting firms. II controlling shareholder/CEO. External auditors are selected for a term of three years. The general organizational/social culture in Korea abhors conflict and may also have hindered effective functioning of internal auditors. this problem will largely disappear. The problem of misconduct on the part of the external auditor was caused partly by weak penalties on wrongdoing. 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. Accepting these arguments. In the past. then the Securities and Futures Commission can appoint a new one. Responsibilities of the External Auditors Committee include recommending a selection to the annual shareholders meeting and ensuring that external auditors conform to new transparency standards. . Vol. 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. If the status of internal auditors is elevated to that of independent board members. In order to increase independence. almost all firms affirmed that the external auditor is independent from the company. The current external auditors have been associated with the surveyed companies for an average of 4. as a monitor of management in the Korean (and also the Japanese) system. If the company changes its external auditor for reasons that are not listed in the relevant regulation.102 Corporate Governance and Finance in East Asia.6 years.
The Depository represented 20 percent of the shares attending the meetings. or telephone. charter amendments. the Depository is subject to “shadow voting. Preferred shares can be nonvoting and issued up to one quarter of the total number of shares. About one fifth of the listed firms issued nonvoting preferred shares. The management is the most important proxy. Under the Commercial Code. attended the last annual general meeting. This shows that a relatively larger number of shareholders send in their proxies.” The survey shows that the Korea Securities Depository holds 69.77 percent of the shares. These voters represented only 5.53 percent of the total shareholdings. 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.21 percent of total shares issued. 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.” Companies can increase the number .” meaning that it should divide its votes in accordance with the accept/reject ratio of votes cast by other shareholders attending the shareholders meeting. About 100 shareholders per firm voted by proxy at the last annual general meetings (of the 40 firms answering the relevant questions). However. in general. amendments of the articles of incorporation require a “special resolution.93 percent of the shareholders but 26. Internet. the Depository is instrumental in getting resolutions passed. corporations cannot issue common shares without voting rights. representing 62. and dismissal of directors and internal auditors require a “special resolution.3 Shareholder Rights Voting Rights and Practices Under the Commercial Code. for some firms. or 10. However. Thus.79 percent of the shareholders. small shareholders do not attend the annual meeting and that. 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. The securities companies and banks are the second and third.3. A total of 326 shareholders per firm. respectively. One common share should have one vote. the only purpose of allowing the Depository to vote was to help listed companies to meet the quorum requirement for the general shareholders meeting.Chapter 2: Korea 103 2. Approval of mergers and major divestitures. The above results indicate that. Citizens’ coalitions sometimes solicit proxies in order to file lawsuits against a management.
an institutional investor based in the US. This coalition also attempted to cooperate with domestic and foreign institutional investors to find their way into general shareholders meetings. and for access to unpublished accounting books and records. Proposals put forward by management are rarely rejected at the general meetings. an activist citizens’ coalition has brought shareholder derivative suits against several large listed firms. the Tiger Fund. II of votes required for a resolution to amend the articles. Those that are most likely to be rejected relate to election of directors. the board of directors decides on issues of shares within the limit of the authorized capital. the annual general meeting passed a resolution that was not proposed by the management nor the board of directors but rather by shareholders. The amendment included a provision requiring the company management to get prior approval of shareholders to undertake major investments and raise capital in international markets. The charges included self-dealing by a controlling shareholder and unfair subsidization of affiliated companies by a chaebol firm. Only two out of 62 respondents to this question have had cases in which proposals were rejected. For recommendations for dismissal of directors and internal auditors. Various measures have since been taken to improve investor protection. Shareholders have preemptive rights.5 percent. from 3 to 1. Vol. Changes in the authorized capital require an amendment of the articles of incorporation. mergers and acquisition plans. However. As an example. In February 1998 and again in March. the Securities and Exchange Act was revised to lower the representation requirement for shareholder derivative suits from 1 to 0.01 percent.0 percent. This citizens’ coalition actively contacted the management of selected companies and negotiated measures to protect shareholders. or block charter amendments considered harmful to minority shareholders. demand changes in business policy. The company also agreed to the right of the fund . and major investment projects (only five firms answered this question). Shareholder Protection Before the economic crisis.104 Corporate Governance and Finance in East Asia. In four out of 62 respondents. laws and regulations were generally very loose in protecting the rights of minority shareholders. was able to force a change in the charter of SK Telecom. dividend proposals. but these can be waived by an amendment of the articles of incorporation. the requirement was lowered from 1 to 0. Due to the changes in rules for investor protection. It also attended the shareholders meeting of several companies to present the views of outside shareholders.
As for bond issues. there was the usual conflict of interest problem and the trustee did not have the incentive to strictly enforce the covenants. and not strictly enforced. underwriting securities firms acted also as trustees. Thus. However. it now appears that it has backed away from its earlier efforts to introduce legislation on class action suits.4 Control by Creditors Role of Creditors in Corporate Monitoring Traditionally. This was one of the most significant developments with respect to shareholder activism in the Korean capital market. managers were considered to be subject to the duty of care. controlling shareholders have become more susceptible to liability claims by other (minority) shareholders. bond indentures are only a few pages long compared to a few dozen pages found in advanced bond markets. the Government introduced the Credit Management Regulation system whereby chaebols were required to seek the approval of their main banks prior to undertaking large investments. mergers and acquisitions. After the economic crisis.3. affiliated lending or guarantees. In 1974. The Code has also been amended to state more clearly the fiduciary duty (of care and loyalty) of the management. In fact. This has strengthened the accountability of controlling shareholders as de facto CEOs. creditors did not interfere with the management of a debtor. 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. For further protection of investors. but it was not entirely clear whether they had the duty of loyalty as well. simple. Banks themselves were poorly governed and bank managements had little incentive to monitor borrowers. Banks have played some limited role in monitoring the investment activities of chaebols. and transactions with major shareholders. the Government had for some time pushed for the enactment of class action suits on false statements and omissions in disclosure materials. . The laws and regulations of the country protect shareholders from interested transactions. Before the amendment. These have to be disclosed under the Securities and Exchange Act or approved by shareholders under the Commercial Code and other laws. loans to directors.Chapter 2: Korea 105 to recommend two directors to the corporate board. The covenants in loan agreements and bond indentures were very loose. 2.
Some proponents argue that creditors should have the right to send their representatives to boards of directors of borrowers. as discussed earlier. and purchases of real estate. Besides the setting up of an “External Auditors Committee” by firms. Under the system. the main banks should review the feasibility and financing plans of projects undertaken by the core companies and monitor their financial conditions and prospects. The 10 largest business groups are required to select no more than three core companies in consultation with their respective main banks. However. The objective of the system is to improve the financial condition of the largest business groups and promote the soundness of bank management. 10 nonbank . Emphasis on the monitoring role of banks has been growing since the beginning of the Asian crisis. Purchase of real estate should be financed by equity capital and not by borrowed funds. II acquisitions. 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. In turn. 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. this proposal has only a slim chance of being accepted by the Government or legislature. 11 banks. The main bank should also monitor and restrict extension of loans to the controlling shareholder and other firms in the group. Vol. recently banks have been increasingly interested and successful in electing former bank officers as outside directors of firms that underwent workout processes. However. there have been concerns that the Government might use the system to intervene in the management of the business groups. In 1996. 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. on average. In 1994 the approval requirement was abolished. including. creditors now have a bigger say in court proceedings for receivership and composition. The firms subject to the system are required to get the approval of the main bank prior to purchasing real estate. On the other hand. ADB Survey Results on Borrowing and Lending Practices The ADB survey shows that a typical nonfinancial company is associated with various types of creditors.106 Corporate Governance and Finance in East Asia.
renegotiation took place after the crisis. For more than half of such firms. Among the creditors.Chapter 2: Korea 107 financial institutions (NBFIs). One tenth of the firms received assistance from the Government in loan applications. and other financial institutions. subsidiaries. About 60 percent of the firms have experienced renegotiation of loan repayment with creditors during the last five years. payments were usually rescheduled through negotiation without any penalty. holding shares of another company by both the borrower and the guarantor. penalty was involved in rescheduling. Creditors usually exercise their influence through covenants relating to the use of loans. while a third think that creditors have weak influence. Most of the 43 firms with renegotiation experience were able to borrow from the same creditors afterwards. most frequently in the form of loan guarantees and less frequently by arrangement of guarantees by a third party. collateral is more likely to be required of loans for working capital than for fixed investments. The assistance came from. Most firms feel that requirements for collateral have been tightened since the crisis started. NBFIs infrequently ask for collateral. For a small number of firms. holding companies. Breakdown of loan guarantors is as follows: about 40 percent of loans are without any guarantees. or creditors filed for receivership. banks are most likely to require collateral. The typical company has also maintained its relationship with five of the 10 NBFIs for more than five years. whereas seven of the 17 nonfinancial corporations are. With respect to the types of loans. Only a few feel that creditors have very strong influence. Relationships with affiliated companies providing guarantees or collateral include ownership of each other’s shares. or through their shareholdings. collateral was taken away. The borrower’s relationship with most banks has lasted for more than five years. and 17 nonfinancial corporations. When loans could not be repaid on time. 16 percent . More than half of the firms think that creditors have no influence on their management and decision making. A few creditors exercise influence through covenants relating to major decisions by the company. Most of the financial institutions are not affiliates of the borrowing company. About half of the respondents received assistance from other sources in the form of loan guarantees and/or provision of collateral. in order of importance: affiliated companies. 35 percent are guaranteed by the company itself (by collateral and purchase of guarantee insurance). mutual guarantee agreements. controlling shareholders. and purchase or supply of raw materials.
banks and other institutional lenders are playing more important roles than ever before. Behind these new strengthened roles of creditors is the newly set-up FSC. Third. 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. including commercial and merchant banks. The leading creditor banks will continuously monitor the progress in implementing the signed Plans. Under a contract signed between the creditors and the debtor. 4 percent by subsidiaries. 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.108 Corporate Governance and Finance in East Asia. Vol. This committee was set up in accordance with the provisions of the CRA. This agreement will provide guiding principles in coordinating diverse interests among creditor institutions and promoting cooperation. a Lead Creditor Council Agreement was signed for restructuring the top five chaebols. Representative of the policy was the stipulation under the Securities and Exchange Act that no one can accumulate more than 10 percent of the voting shares of a listed company . and in continued monitoring of debtors. In cases where the creditors are unable to reach an agreement on a workout plan.5 The Market for Corporate Control Government Policy Toward Hostile Takeovers Until 1994. 2. are summarized below. the Corporate Restructuring Coordination Committee (CRCC) will provide arbitration. especially banks. will get involved in the restructuring and workout processes. the creditor banks will send a delegation composed of bank officers to the workout firm to oversee its management. Separate from but emulating the CRA. Second. The new ways through which creditors. II by other affiliated companies. the delegation has the right to approve wide-ranging financial activities of the firm. the Korean Government maintained a policy of protecting the incumbent management of listed companies. 2 percent by holding companies.3. major creditors. have been the driving forces for restructuring activities of the largest 64 chaebols. and 1 percent by the Government. First. the lead creditor banks formally signed Capital Structure Improvement Plans with chaebols.
corporations cannot limit the voting rights of large shareholders to a given maximum. hostile takeovers by tender offers began to appear in the capital market. . Limits on acquisitions of shares of a Korean firm by a single investor were gradually increased over a six-year period beginning in 1992. Unlike Germany. listed firms rely mainly on shareholdings by the largest shareholder. As far as institutional arrangements are concerned. Takeover Activity As soon as the Act was amended. It was generally believed that the securities authority would use its power to review and order revisions of the tender offer statement to halt any hostile takeover attempt. The policy to protect the incumbent owners/managers was formally dropped when the Securities and Exchange Act was amended in 1994 to abolish the 10 percent limit. Companies have also utilized share repurchases. In the early 1990s the Government shifted its policy toward freer activities in the market for corporate control. Poison pills cannot be used mainly because companies cannot distribute stock options as dividends to shareholders. a total of 13 hostile takeover attempts occurred. 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. The reasons for failure are diverse. it can be safely stated that Korea now has one of the most accommodating capital markets with respect to hostile takeovers in the region. but were completely eliminated in 1998. 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).Chapter 2: Korea 109 unless he or she obtains prior approval of the Securities and Exchange Commission. more than half of these attempts failed. Unlike the UK. The incumbent controlling shareholders used various tactics such as issuing privately placed CBs. A company cannot issue new shares to a third party without first amending the corporate charter. Stock purchases by tender offer were also exempted. Privately placed CBs cannot be converted into shares in one year. and announcing competitive tender offers by the controlling shareholder. Between 1994 and 1997. Publicly issued CBs require three months before their owners can convert them to shares. In one case. However. For takeover defense. turning to white knights. The shareholders already owning more than 10 percent at the time the company went public were exceptions to the rule. Korea does not have the mandatory takeover rules applying to those who amass more than 30 percent of the shares outstanding (until 1998.
172 firms (or 22 percent of listed firms) belong to the 30 largest chaebols. 2. As of the end of 1997. which are allowed by the Securities and Exchange Act to set the limit on the ownership of shares by one single shareholder. 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. 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. Charter amendments have also been employed by some firms to limit the maximum number of directors.7 percent on average as of the end of 1997 for nonfinancial listed firms). in which the Government still holds the largest ownership. It is harder now to find such firms. . II The Securities and Exchange Act was revised in 1998 to abolish the 10 percent limit on share repurchases and the Government simultaneously eliminated the limit on foreign ownership of shares of listed firms. the limit will be eliminated when it is fully privatized in two years. the Government became the largest shareholder of several commercial banks through equity participation purporting to recapitalize them out of financial distress.3. some firms have included a supermajority provision for the dismissal of directors and provided for a staggered board. a steel company. For the steel company. The Government-owned listed companies. Korea Telecom. Another reason is that many listed firms belong to chaebols. 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. In 1999. 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. Some had two or more large shareholders who had joint control of the firm but could not cooperate.6 Control by the Government State-Owned Enterprises Government ownership of listed companies is very limited. was newly listed. and a bank had government ownership. are designated as public companies. except for the banks. As of February 1999. For the others. Vol. In 1998. Currently the limit is 3 percent.110 Corporate Governance and Finance in East Asia. Hostile takeovers in Korea will be rare in the future. In their charters. Many of the takeover targets in the past did not have a controlling shareholder (group).
each of the 10 largest chaebols was allowed to raise funds no more than 4 percent of the total market capitalization of the member firms. administering through a self-regulatory committee of the securities industry. The Government’s right to send public officials to the boards was eliminated. Labor is not represented in corporate boards.3. For example.7 Employee Participation in Corporate Governance Employee participation in corporate governance is very limited. There were also limits on the amount raised and the number of issues per year. The Government has frequently imposed restrictions on the use of capital markets by large companies.3. In addition. as applied to four large corporations. Beginning in 1999. the main bank system. 2. the Government. The objective of the system was to improve the financial condition of the chaebols and to promote the soundness of bank management. There is no active debate or discussion going on about this potentially difficult issue. Meanwhile. more state-owned corporations became subject to this new board structure. which limits the total amount of bonds issued by the five largest chaebols. It was abolished before the economic crisis but another regulation. was amended in 1997 to introduce a board structure consisting of a majority of nonexecutive directors. 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. Further. The nonexecutive directors are now recommended by a committee. nominated by the minister in charge of the company in question. Even where employees hold .Chapter 2: Korea 111 The Government used to appoint a few public officials to the boards of state-owned corporations. controlled the total amount of corporate bonds issued per month and allocated amounts to individual corporations. is being applied to the 51 largest business groups to which the banks extended more than W250 billion in loans and payment guarantees. and approved by the Chairperson of the Planning and Budget Commission. which was introduced in 1996. 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 2.1). This was aimed at limiting the supply of bonds thereby stabilizing interest rates. only qualified firms could issue new shares.
In these firms. carried out at the enterprise level. Trade unions are organized on an enterprise basis. In 70 percent of the firms with organized unions. This practice may be due to the fact that employees are typically submissive to their employers and that their total shareholdings are minimal.1 in 1997.5 in 1990. The union had no influence on the management in 17 percent of the firms. union members account for 54 percent of the employees. 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. The respondents of the ADB survey had 2. in principle. 32 percent technicians and professional staff. This law is not intended for wage negotiations but for employers to seek cooperation and productivity increases from workers. At the national level. Under the Capital Market Development Act of 1968. and 66 percent manual workers. . there are two federations of labor unions. but 27 percent of them felt that it was strong. In actuality.9 in 1980. the management usually consults the union on major issues relating to the management.654 employees per firm on average. which were generally much lower than estimated values. these firms have to offer 20 percent of the shares being issued to their employees at the public offer prices. Vol. Under the Labor Management Council Law. The relevant regulation was amended recently in order to facilitate voting by individual employees. II shares of their companies through employee stock ownership plans. the council meetings have been superficial. Employee stock ownership plans became popular in 1974 when the Government allowed tax and financial benefits for stock purchases by employees. The typical collective bargaining agreement has a one-year duration. Two thirds of the respondents had an organized union. they delegate their voting rights to plans’ representatives.112 Corporate Governance and Finance in East Asia. of which 2 percent were senior managers. employees of listed firms issuing shares through rights offerings are entitled to 10 percent of the rights. and development of the company. In 1987. operation. Employees of companies have had the opportunity to buy shares of their employing businesses at favorable prices. Local unions in the same industry have established industrial labor federations. Collective bargaining is. About half of these firms considered the influence of the union on the management of the company to be weak. The percentage of shares held by the employee stock ownership plans in listed companies was 1. Under another law enacted in 1972 to induce private companies to go public. and 2. 2. employers are required to meet with representatives of labor unions at least once every three months.
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
2 Patterns of Corporate Financing Corporate Financing Practices In this section. In June 1993. The Government began to considerably deregulate foreign exchange in 1987 due to the shift of the current account into surplus in 1986 (see 2. was liberalized drastically in 1998 after the financial crisis.2. Since 1985.1). which resulted in the establishment of a number of new banks. short-term finance companies.5 percent in November 1981. budget. the required reserve ratio was substantially lowered from an average of 23 percent in 1979 to 3. flow of funds analysis was used to examine patterns of financing of the aggregate corporate sector. revision of the credit control system. the Government announced a plan in 1981 that substantially improved foreign investors’ access to the domestic capital market. In addition. The plan was launched partially to accommodate US demands for comprehensive structural deregulation and market opening of the financial sector. The Government handed over its controlling stakes in four commercial banks to private hands in 1981-1983. Korean firms have been allowed to issue CBs in international financial markets. Vol. entry barriers to banks and NBFIs were lowered in an attempt to promote competition. The Government adopted a cautious approach. and liberalization of foreign and capital transactions.4. and the 30 largest chaebols. 2. etc. Internal funds include retained earnings. Moreover. the business scope of financial institutions was greatly widened from the early 1980s. finance companies. listed companies. opting to bring in the plan step-by-step to avoid market dislocation from a sudden shift in the system. implementing the first stage in November 1991. as a first step toward liberalization of capital account transactions. It included such important issues as interest rate deregulation. Some policy loans were also abolished. the Korean Government announced its Financial Liberalization and Market Opening Plan.118 Corporate Governance and Finance in East Asia. On the basis of flows of funds. development of the money market. mutual savings. Also. With the privatization of nationwide commercial banks. especially the domestic bond market. . The capital market. the following measures can be constructed: Self-financing ratio (SFR) is the ratio of change in internal funds to change in total assets. depreciation. Meanwhile. and organization of commercial banks. II Interest Rate Deregulation Plan. the Government simplified various directives and instructions regulating personnel management.
Incremental debt financing ratio (IDFR) is the ratio of change in total borrowings to change in total assets. but it remained less than 10 percent of total financing. In securities finance. Securities finance became a more important source from 1988 onwards.Chapter 2: Korea 119 and net capital transfers from the Government. This means that internal funds after dividend payment were insufficient to finance growth in total assets. capital surplus. was 71 percent during the period. particularly in the short term.25. and government transfers. Additional equity capital used to finance growth reduces the financial cost and the financial risk of investment. and 1997. depreciation. depreciation. 1994. the proportion of foreign borrowings in total finance rose steadily. New equity financing ratio (NEFR) is the ratio of change in equity (stocks issued + equity other than stocks) to change in total assets. Incremental equity financing ratio (IEFR) is the ratio of change in stockholders’ equity to change in total assets or 1-IDFR. Equity capital represents the shareholders’ commitment to the business. the corporate sector’s most important source of external finance was bank borrowings.26 shows the four measures of corporate financing calculated from Table 2. Before 1988. It measures the degree of financing growth in total assets by additional debts.4 percent in the precrisis period 1988-1997. Meanwhile. financing by corporate bonds and CPs was more significant than by new equity. Financing Patterns of the Aggregate Corporate Sector Table 2. The SFR averaged 28. but do not include capital surplus (asset revaluation allowance and the excess of current value over issue value of stock). the proportion of borrowings from NBFIs fell to its lowest value at 4 percent. except for the stock market boom of 19871988. The share of external financing. comprising internally generated capital (retained earnings. including all sources other than retained earnings. except in 1991. Table 2. In 1988 when the stock market boomed. on average. This high proportion deprived Korean businesses of flexibility during recession periods due to high financial costs. The corporate sector used .25 shows the flow of funds of the nonfinancial corporate sector in Korea during 1988-1997. and allowances) and new equity capital. particularly in the 1990s in response to the liberalization of the capital market. 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. It measures the degree of financing growth in total assets by additional equity.
9 34.8 17.8 1.1 0.7 13.6 9.1 10.6 14.8 0.1 — 27.0 3.4 21. Source: Understanding Flow of Fund Accounts.7 4.6 8.4 27.1) 6.8 15.6 1.4 27. depreciation.4) 13.5 2.7 11.7 71.2 5.1 — — — — 12.3 2.2 15.0 70.0 9.8 27.4 1.1 3.6 11.7 73.4 2.2 (0.2 2.6 Sources of Funds Internal Financinga External Financing Bank Borrowings Banks Nonbanks Merchant Banks Insurance and Others Securities Natl.8 — 26.0 1997 26.1 1.9 10.7 7.4 3.2 26.5 2.3 6.9 28.6 25.3 27.1 1.2 — 28.9 73.0 16.8 (0.7 2. and Flow of Funds.4 11.3 5.0 9.1 (1.9 2.6 3.6 0. which is the excess of current value over issue value of stock.9 6.6 4.6 77.8 4.3 6.0 3.5 2.5 16.5 0.0 0.0 17.1 72.7 14.0 2.2 — — — — 9.2 14.1 17.2 10.4 0.6 9.7 1.6 0.8 1.3 30.2 1.7 12.1 (0.8 1.7 — — — — 9.8 -2.9 0.0 — — — — 8.1 23.3 1.5 2. 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.1 1.7 10.6 4.4 (2.3 72.1 36.8 8.3 16.4 27.1 2.4 2.6 0.3) 11.6 11.Table 2.3) 15.6 (0.9 72.4 2.7 2.6 9.5 0.2 6.1) 4.7 6.2 0.4 10.7 8.5 16.25 Flow of Funds of the Nonfinancial Corporate Sector.1 0. and net capital transfers from the Government.1 12. 1988-1997 (percent) 1988 43.0 0.1 27.5 0.9 9.3 25.1 3.7 8.1 8.2 13.1 3.3 — — — — 8.4 8.7 10.4 9.6 2.0) 12.7) 11.4 15.4 (0.3 3.2 13.3 6.7 32.7 15.9 38. b Includes capital surplus.4 1.8 1.4 — 28.0 11.7 14.7 4.7 2.6 0.1) 4.3 10.3 1. Bank of Korea. 1994.6 10.6 3. a Includes retained earnings.7 1.4 71.0 1.0 5.0 3.6 4.3 3. Bank of Korea.6 5.8 56.8 1.1 2.3 1.3 — 30.0 (0.4 0.7 (0.7 1989 1990 1991 1992 1993 1994 1995 1996 22.2 6.0 10. .4 2.5 29.8 30.5 9.0 22.5 13.9 10.6) 5.7 10.2 34.
1994.3 60. in the manufacturing sector. but plunged to 5.4 percent.6 percent over the 10-year period.6 percent.3 11.9 22. but also continuously fell.3 percent in 1997.7 percent in 1997.7 40.4 NEFRa 20.3 59.2 IDFR 36.2 37.Chapter 2: Korea 121 Table 2.7 40. average SFR was 37.7 40. Its IEFR and NEFR dropped to 23. IDFR reached 73.8 10. higher than the aggregate 28. respectively. and the total debt ratio was much higher in 1996 and 1997 at 62.4 IEFR 63.8 62.9 percent by 1997 when net profit margins were negative. was financed by additional debts.6 62.8 28. the corporate sector relied heavily on external financing for its expansion.4 percent.1 12.6 percent. dropping to 26. Across industry. While SFRs. On average.1 26.2 percent of incremental asset growth was financed by equity.4 27.3 12.0 5.6 26. Lower income diminished the industry’s equity position toward crisis year 1997. respectively. Bank of Korea.27).7 28.3 27.5 31. and IEFRs were declining.6 Excludes capital surplus.4 12.5 percent. There were significant time trends. In periods of high economic growth such as in 1988.8 percent of its total asset growth through debts. The balance.0 11. Source: Calculations from Understanding Flow of Fund Accounts. and Flow of Funds. Manufacturing financed 54. declining to 26. additional equity to finance 12. NEFRs. 1988-1997 (percent) Year 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 Average a SFRa 43.26 Financing Patterns of the Nonfinancial Corporate Sector.0 42.9 46.1 39.9 28.5 68.5 12. .4 37.5 percent in 1997.5 and 76.4 percent (Table 2. higher than the aggregate 40.6 percent and 1.7 9. It dropped to 28 percent the following year. Bank of Korea. IEFR ranged from 32 percent to 64 percent of asset growth during the boom years. an average of 59.1 53.0 57.0 27.3 59. 45.3 73. NEFR registered 20.1 17.2 percent of the growth in total assets.9 60. Incremental financing from equity was 40. indicating a high financial risk position.7 26.7 30.1 percent in 1988 during the stock market boom. SFR peaked at 44 percent.
4 54.0 57.9 percent of asset growth. Equity financed an average 25. retail.8 IEFR 65. In 1997. gas.4 37.3 52. Since large firms were more profitable.2 percent in 1993.2 . and hotels sector and realty/renting/business activities sector were similar. this dropped further to 15.4 45.6 53.8 percent in crisis year 1997.5 23.7 47. Total debt financed an average 74.7 37.3 28.7 percent in 1996. which decreased to 8. and low total debt and short-term borrowing ratios. large firms showed more cyclical patterns in these financing ratios than small. the utilities (electricity. explaining partly the collapses of several construction companies in 1995.6 37.0 42.4 46.27 Financing Patterns of the Nonfinancial Corporate Sector by Industry (percent) Year Manufacturing 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 Average SFRa 50.2 5.0 3. and steam) and the transportation.9 percent.5 76.and medium-sized firms. and communication sector had relatively high incremental equity ratios. These sectors had relatively low equity financing ratios and high total debt ratios in financing asset growth between 1988 and 1997.2 3.5 1.5 NEFRa 9. then increased to 20.1 29.6 53.8 percent in 1990. Since 1992. Table 2. and fell to about 10 percent in 1997. It had the highest average SFR in 1988 at 31.0 30. from 17. with the total debt ratio much higher in 1995-1997 at 82 to 84 percent.7 47.8 50. Vol.6 4. II The construction industry showed the most cyclical pattern in annual asset growth.4 3.7 37.6 3.6 37.8 4.6 62.4 47.6 45. Financing patterns of the wholesale. the two sectors also had low equity financing ratios and high debt financing ratios.6 36. storage.122 Corporate Governance and Finance in East Asia. On the other hand.2 21. Categorized according to company size.2 62.5 7. the proportion of short-term borrowings in total financing has been high.1 percent of total asset growth for the period. one year ahead of the other industries.9 6. their average SFR was higher.4 63.6 54.0 42.9 IDFR 34.
9 1989 63.3 47.8 2.9 52.2 74.6 71.0 1.6 2.5 70.9 47.1 Trasport.2 Average 53.6 9.7 53.7 78.5 76.1 19.2 46.3 21.7 41.7 15.6 1997 29.1 69.5 29.0 0.6 8.9 15.8 4.4) 2.2 1995 16.5 1996 42.9 20.0 .3 4.9 1.0 65.6 73.3 (9.9 29.4 IEFR 46.5 21.3 4.6 7.Table 2.9 9.27 (Cont’d) Year SFRa NEFRa IDFR 53.0 82.4 2.8 9.8 76.0 1990 12.5 20.3 84.7 78. Storage.2 8.6 37.1 59.0 17. and Communication 1988 64.6 4.5 62.8 29.3 10.4 28.9 1993 63.9 1.4 1995 53.0 74.3 7.8 54.0 1992 24.1 1991 14.2 18.2 70.8 74.5 1.0 10.9 2.2 25.0 34.7 1989 26.8 1991 51.3 19.2 5.0 1990 50.6 37.1 70.5 23.9 1992 56.7 80.1 66.5 87.1 25.4 62.9 1.0 31.0 40.2 20.2 4.7 15.0 68.3 57.2 23.9 Average 19.8 1994 15.4 26.3 8.7 42.6 14.6 8.2 10.5 1993 22.8 70.7 6.9 30.2 29.2 3.5 12.9 Construction 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 Average 31.9 80. Hotels 1988 33.3 1996 16.7 1997 8.0 4.8 81.9 33.0 60.7 Wholesale/Retail Trade.7 1994 53.6 9.9 16. Household Goods.0 3.1 84.1 4.7 7.8 25.
SFR = self-financing ratio.1 70.9 65.0 21.7 18.0 1997 24. The trend was reversed in 1996-1997. a Excludes capital surplus.6 1991 18.8 17.0 67.3 85.0 0.0 33.3 62.27 (Cont’d) Year SFRa NEFRa 6.0 1992 51.4 0.0 56.7 1996 18.8 1990 19.4 7.4 1994 72.3 3.3 Electricity.5 22. Renting.8 Average 22. II Table 2.6 IDFR = incremental debt financing ratio.4 IEFR 69.1 1991 56.3 207.3 81. Source: Calculated using data from Bank of Korea.9 64.1 1993 55.6 52.9 57.1 34. and Steam Supply 1988 118.1 0.4 0 0 0 0 1.4 1.3 29.4 1996 45. IEFR = incremental equity financing ratio. . Gas.2 1992 18. NEFR = new equity financing ratio.0 79. Vol.0 0.8) (35. however.7 14.6 1990 82.9 Average 75.and short-term borrowings of these firms shot up in that period.0 1.1 54.3 31.1 35. when large firms had much lower equity financing ratios and higher debt financing ratios than small.6 1. The large firms had a higher proportion of external financing in 1996-1997.4 5.8) 7.4 (107.6 Real Estate.7 69.1 1989 34.8 135.4 1995 62.6 7.7 37. Long.7 1994 8.1 42.0 (0.124 Corporate Governance and Finance in East Asia. Their average IEFR was also higher and IDFR smaller. Higher growth in total assets and sales and easier access to debts by large firms could be reasons for this.9 29.6 1995 17.8 36.1 71. and Business 1988 51.4) 3.6 1997 23.0 46.8 1993 11.6 1989 118.and mediumscale firms.9 28.5 8.9 IDFR 31.3 7.0 53.7 70.0 43.4 47. Financial Statement Analysis Yearbooks.3 92.2 63.5 77.9 45.
for listed companies.4 percent. In 1997.5 percent and their total external financing.1 percent of their equity capital. the top 11-30 chaebols had the highest guarantees commitments at 207.3 percent of their equity capital in 1997 (Table 2. about the same as that of the corporate sector as a whole. compared with the entire corporate sector’s 35 percent and 65. . They were able to borrow easily from banks by issuing corporate bonds and CP. Financing Patterns of Chaebols For chaebols.7 percent.7 percent. 153. The proportion of their short-term financing averaged 72.5 percent is lower than that of the corporate sector in general. Cross-payment guarantees have been declining since 1993 and reached 91. The average IEFR and IDFR were 10.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 2.6 percent of total asset growth.6 percent. the average SFR was 28. the lowest ratio of 58. In 1997.2 percent. at an average 70. External financing reached 94. and the top five chaebols. All of the top 30 chaebols relied heavily on short-term borrowings. the IDFR of listed companies increased to 93. Many firms affiliated with the top 30 chaebols saw loan guarantees turn into their own debts because of defaults in debt payments. the NEFR of the top 30 chaebols plunged while the debt ratio increased substantially.30). 91. The average IEFR of the top 30 chaebols of 29. and higher than that of listed companies (Table 2.9 percent.8 percent of their total finance in 1997. The chaebols’ drive to expand their empires resulted in heavy borrowings.3 and 89. Their shortterm borrowings accounted for 86. and using cross-payment guarantees among affiliated companies. The largest borrowers were the top 11-30 chaebols. Another key feature of corporate finance in Korea is the widespread use of loan guarantees among the top 30 chaebols. The debt financing ratio of listed companies was high since they relied more on external financing. Group-member firms borrowed less.28). the top 6-10 chaebols. and were large borrowers. They had easier access to bank loans and the markets for corporate bonds and CPs than nonlisted companies.8 percent. In 1996-1997. respectively. compared with 89.7 percent for all listed companies. but higher than that of listed companies.29).9 percent.
1 93.1 8.9 NEFRa IEFR 14.4 88.3 Year 1994 1995 1996 1997 Average a Excludes capital surplus.3 5. .5 2.4 29. Korea Federation of Industries.4 38.5 8.8 76.6 70. Source: Calculated from data obtained from data files of the Korea Listed Companies Association. 1994-1997 (percent) SFRa 41.6 IEFR 42.7 13.28 Financing Patterns of Listed Companies.8 22.7 12.9 6. 1994-1998 (percent) SFRa IDFR 85.6 0.2 10.3 86.29 Financing Patterns of the Top 30 Chaebols.5 8.2 23.6 11.7 1. Largest Business Groups in Korea.4 12. Source: Calculated using data of Seung No Choi.5 Year 1994 1995 1996 1997 Average a Excludes capital surplus. Table 2.2 NEFRa 1.6 1.1 1.4 1.8 89.2 1.6 61.3 IDFR 57.Table 2.3 1.5 91.3 28.2 36.9 7.5 2.
Few firms ranked loans from NBFIs as their first preference. Factors Influencing Corporate Financing Choices Until recently. And fifth. rights issues. This change implies that firms now give more attention to financial risks. Further. According to the ADB survey. Controlling shareholders usually tried to avoid dilution in their shareholdings for fear of losing control.9 — — — 1996 105.3 58. There were several reasons for this. bond issues.1 — = not available. the Korean economy was plagued with high inflation. in order of ranking.9 — — — 1994 258. company preferences in financing investment projects before the crisis were. and reserves and retained earnings. Financial institutions did not strictly screen their loan projects and monitor their debtors. and extended loans based on cross-payment guarantees. 1993-1997 (as percentage of equity capital) Rank Top Top Top Top 30 Chaebols 5 Chaebols 6-10 Chaebols 11-30 Chaebols 1993 469. so that the firms engaged in lobbying to gain access to them. especially in the 1970s when real interest rates of bank loans were negative. the Government provided implicit guarantees on bank lending and large businesses. Interest payments on debts were considered a loss when calculating taxes. First. Third. Firms now prefer internal funds and new equity capital.Chapter 2: Korea 127 Table 2. inefficient investment and excessive diversification of corporations. poor financial and corporate governance resulted in overlending by banks. Fourth. chaebols could easily borrow funds from banks and NBFIs by using cross-payment guarantees. These are followed by loans from banks.3 200. .1 — — — 1995 161.0 207.30 Cross-Payment Guarantees of the Top 30 Chaebols.7 150. Second.9 153. This attitude appears to have changed after the crisis because reserves and retained earnings and rights issues became the preferred financing choices. more than half of bank loans were priority loans with low interest rates.3 64. Korean firms preferred debt financing (bank and nonbank borrowings). and loans from NBFIs.0 1997 91. Source: Fair Trade Commission and the Federation of Korean Industries. loans from banks. the Government applied high tax rates on net profits of corporations. and underdevelopment of the stock market. bond issues.
even with a heavy debt burden. About half of the respondents of the ADB survey borrowed foreign currency denominated loans from foreign banks. they survived for two to three . 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. Korea now provides a better environment for financial risk management. in selecting financing sources. 2. A futures exchange launched in 1999 trades foreign exchange options.36 percent on average for these companies. the percentage of foreign currency denominated debt in the portfolio was 14. and reduction in tax burden. For these firms.128 Corporate Governance and Finance in East Asia. Other factors include.5 percent at the end of 1997. The percentage of foreign currency denominated loans hedged against exchange rate risks was 21. ensuring the liquidity of the company.3 Financial Structure.4. Vol. These survey results indicate that many companies were not very attentive to exchange rate risks (and possibly to financial risks in general). Among the responding companies that had foreign currency denominated loans. maintenance of the existing ownership structure. Among those that never hedged against exchange rate risks. Nonetheless. Few companies felt that hedging was too costly or was unnecessary as the exchange rate was considered fixed. firms give their first consideration to minimization of transaction and interest costs. in order of importance. more than half (53 percent) hedged against exchange rate fluctuations. some (36 percent) thought that a hedging facility was not available or not working properly. and futures and other financial derivatives. This preference has changed little after the crisis. and others (29 percent) expected the local currency to appreciate in value. According to the survey. the majority (60 percent) of the firms responding to the ADB survey look first for nonaffiliated financial institutions. 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. many firms (or 42 percent) never considered hedging. Only a few firms sought foreign loans because domestic loans were not available. Diversification. II In seeking external financing.
However. 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. The ratios of the top five chaebols were similar to those of the top 6-70 chaebols until 1991 when the top five chaebols’ ratios shot up. Those firms whose interest payment coverage ratios are below 1 are likely to go bankrupt. Nam et al. The ratios of the top 6-70 chaebols were lower than those of the top five chaebols.13). as well as lax financial supervision (Nam et al. the top five chaebols and the top 6-70 chaebols had similar ratios. They were also higher than those of the top five chaebols until 1991. the trend was reversed in 1993 when the interest coverage ratios of the top five chaebols exceeded those of the independent firms. But since 1992. the top five chaebols’ ratios were much higher. but the ratios of independent firms were much lower. Operating earnings are earnings before interest payments and taxes plus depreciation and amortization (EBITDA). They were also higher than those of the top five chaebols until 1992.Chapter 2: Korea 129 years before collapsing at the time of the 1997 financial crisis (2. except in 1991.. except in 19931995 when semiconductor prices were extraordinarily high.3. (iv) In terms of EBITDA to total assets. (iii) Interest payment coverage ratios are calculated as operating earnings over interest expenses. (1999) compared the financial positions of 504 chaebol affiliates and non-chaebol independent firms during the period 1986-1998. 1999). the ratios of nonchaebols were remarkably higher than those of the top 670 chaebols during the entire period. (ii) In terms of net income to total assets. Interest coverage ratios of non-chaebols were higher than those of the top 6-70 chaebols during the entire period.2. These findings indicate that independent firms have had a lower leverage and performed better financially. In order to determine the relationship between financing patterns and corporate performance. Table 2. . (i) In terms of total borrowings to total assets. 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.
But the net profit margins of the top 31-72 chaebols were higher than those of the top five in 1985-1992. debt guarantees for free. court receivership. The diversification of chaebols under workout was much lower than that of the top 6-30. however. and easier access to cheap credit. rising nonperforming loans (NPLs) and falling . second highest in the top 6-30. Government intervention. had easier access to credit than the top 31-72 chaebols.5 The Corporate Sector in the Financial Crisis This section looks at the various causes of the crisis in 1997. II Corporate Performance and Diversification As a chaebol further diversified into nonrelated areas. 2. too. During 1985-1997. larger research and development expenditure.31). In terms of the net profit margin (the ratio of net profits to sales revenue). Their subsidiaries. had a significant role. except in the recession years of 1996-1997. then declined to levels lower than those of the top five in the years of economic downturn 1993-1997. net profit margins of the top 31-72 chaebols were always higher than those of the top 6-30. Indicators such as increasing debt-to-equity ratios. This indicates that excessive diversification and inefficient investment of the top 30 chaebols resulted in relatively low net profit margins (Table 2. the degree of diversification was highest in the top five chaebols.130 Corporate Governance and Finance in East Asia. or outright transfer of resources due to poor corporate governance practices. Chaebols have been subsidizing new or low-profit industries by transferring resources from high-profit industries through inside dealings. The degree of diversification of chaebols that fell into default. its profit rate declined. and lowest in the top 3172 chaebols. 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 top 6-30 and 31-72 chaebols gradually increased their diversification beginning 1990. Factors related to weak corporate governance were closely intertwined with shortcomings in macroeconomic policy and vulnerabilities in the financial sector. the top five chaebols outperformed the top 6-30 chaebols for most of 1985-1997. and composition was lower than that of the top 6-30 but higher than that of the top 31-72 chaebols on average. The differences in the degrees of diversification among the three groups are substantial. Meanwhile. Vol. The diversification of the top five chaebols remained at about the same level within the period.
6 (0.4 (1.9 0.1) 0.7 0.7 1.2 0.4 (1.4 (1.9 0.4 0.9) (1.2 (0.2 (17.6 1.2) (13.2 (0.1 0.3 0.5) (1.4 0.31 Net Profit Margins of Chaebols.5 (0.5 1.6 1.9) 0.6 0.6 (10.1 0.3 (0.3 (3.2 4.3) (0.4 2.3) 0.1 0.8) (11.6 1.0 1.7 3.8 0. Management Research Institute.6 1989 1.6 0.0 (2.7 0.8) 1.5) (0.1 0.8 (0.3 1.1 4.5 1.4 (0.8) 0.6 5.7) (1.7 1.6 0.7) 0.1 1.7) (0.9 8.0 6.9) 2.5 0.3) 0.7) (0.2) 1.1) 1.7 0.0 1992 1994 1.0) 0.3 1.9) (9.8) (37.1 1.2) (0.2) 1.2 1.3 1.6 0.7 (0.3 (0.5 4.3 (0.4) (2.3) (1.8) (0.8 3.6 0.1 1.2 1.7 0.7 0.8) 2.3) (12.7 1.1 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 3.7 1.8 0.0) 0.5 1.3) 12.9 1.4 1.4) (0.7 0.1 0.3 1.4 1996 0.1) (1.0) (0.8) (1.3) 0.4) (1.1) 2.2 1995 3.1 0. Court Receivership.3 (0.8) 1997 0.4 0.0) (4.6) (12.1 0.3 1.2 1.2 1.4 1.6) 0.0 (7.9 1.1 0.2 1.5 (0. Beyond the Limit.0 1.3) 0.2) (3.2 (0.8 1.1 2.8) 0.3) (0.3 0.7) 0.8) (4.6 0.1 (9.1 (4.11.6) (0.3 1.9 1.2 (0. 1998.6 1.2) (4.4) (1.0) (3.Table 2.9 0.1) 1.3 1.1 (3.1) (1.6 (0.9) 2.5 (0.8 1.7 (1.6) (12.0 1987 1.4 1.3 0.0 (0.0) (0.3 0.5 1.8 0.1) — = not available.2) 2.4 (0.4) (4.1 1.6) (0.8) (3.4 (0.5) (7.4) (6.3 1.5 (0.8 0.8 (0.1 1.8 0.1) (2.8 3.5 1.2 1.9 0.3) 0.5) 0.1 1.6 1.1 (0.0 0.7 (0.0) 0.5) (2. 1985-1997 Item Top 5 Hyundai Samsung LG Daewoo SK Top 6-30 Top 31-72 Default.6 7.1) (5.8) (1.9 (0.5) (2.2) (0.3) 0.9 1.4 0.6 3.8) 0.7 2.6) 0.4 1.3) 1.5 (6.5 2.1 (4.1 0.9) (8. Chung Ang University. p.2) (4.2) 2.2) (13.3 1.2) 0.6) 0.4) (1.8 (0.1) 0. Background and Task of Structural Adjustment.8) (20.8) 0.3 1.1) (6.1 (1.2 (1. .3 1.7 (4.9) 2.2) (4.8 1990 0.3 0.6) 0.5 (4.3) 0.6 0.0 4.2) 1. Source: Whan Whang.6) (20.4 (2.1) 2.7 — (0.8) 0.6 0.3) 1.0 0.
Until 1997. this has led to entrenched management. the recently adopted Code of Best Practice in Corporate Governance recommends the strengthening of the board system. A remote trigger in the Thai crisis was all that took to push the economy over the edge. a firm’s board of directors had the power to appoint an external auditor. and to the development of the market for corporate control. . Moreover. after the crisis. Thus. the boards of all listed companies were composed of insiders only. Ownership concentration also had ramifications on corporate transparency. outside directors. Along with government policies to protect the status quo.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. Thus. 2. 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 most serious problem among most Korean listed firms has been that a controlling shareholder acting as CEO could never be replaced. II corporate profitability were signs that the Korean economy had reached the edge of a slippery slope. Internal and External Control Concentration of ownership has been and will be the major obstacle to the independence of the board of directors from management. Now. But in 1998. the independence and objectivity of the external auditor were often questioned. Meanwhile.132 Corporate Governance and Finance in East Asia. Until 1997. a committee composed of internal auditors. The Code of Best Practice recommends board audit committees for large listed firms and the Commercial Code is being amended to introduce the audit committee system as an alternative to the internal auditor system. the Korea Stock Exchange introduced listing rules requiring that listed firms elect “independent outside directors” to comprise not less than a quarter of the board members. They were then almost automatically elected at the general shareholders meeting. and creditors should select (recommend) the external auditor.5. internal auditors cannot be expected to perform their function independently of management. The hold was tightened by the practice wherein candidates for directors were handpicked from among the managers by the controlling shareholder. Vol.
as a whole. profitable firms within a chaebol tended to subsidize unprofitable firms. restrictions of voting rights of shares of institutional investors. Many changes were introduced to promote M&A in the 1990s. Diversification can reduce chaebols’ risks through the portfolio effect. 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. prevalent window dressing practices. Dominance of Chaebols A chaebol is tightly controlled by the largest shareholder. Traditionally. usually a member of the founding family. These included restrictions of shareholdings of institutional investors. 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. however. individuals. In this situation. Meanwhile. These internal dealings made strong firms weak and helped marginal firms survive. There were no effective monitoring mechanisms for its management. Under the direction of the controlling shareholder.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. Many of the takeover targets in the past did not have a controlling shareholder. when a large diversified chaebol. the Government maintained a policy of protecting the incumbent management of a listed company. 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. participated in the stock market as short-term traders rather than long-term investors. and some differences in Korea’s generally accepted accounting principles from international standards. regulatory and practical difficulty in implementing proxy voting. and restrictions on hostile takeovers. Banks did not function as monitors of corporate management although they were shareholders as well as the most influential creditors. One reason is that the percentage of inside shareholdings for an average listed firm is very high. has an unsound capital structure and . as well as institutions. 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.
and a high degree of inefficiency in the economy. and other individual markets. prevalence of rent-seeking and morally hazardous behavior by economic decision makers. 2. Vol. although their subsidiaries had better quality workforce and easier access to cheap credit than the top 31-72 chaebol affiliates. II strong financial links among its member firms through investments and cross-guarantees. financing choices of listed firms in order of preference were bank loans. 2. This indicates that too much diversification and overinvestment in the top 30 chaebols resulted in relatively low net profit margins.134 Corporate Governance and Finance in East Asia. as the latter are well established in most business areas. the financial distress of one or a few marginal firms can lead to a chain of bankruptcies across the entire chaebol.5. Financing preferences changed drastically after the crisis. However. As mentioned earlier. bond issues. and internal funds.2 The Role of Government Intervention Strong government intervention in the early stages of economic development was useful for overcoming inefficiencies in financial and capital markets and for managing high investment risks. The Government and the Bank of Korea did not have accurate information on the extent of transactions that corporations and financial institutions had abroad.3 Manifestations of Weak Corporate Governance and Government Intervention Preference of Debt Over Equity Financing in the Precrisis Period Before the crisis.5. the authorities did not properly check on banks’ lending practices—banks did not screen the lending projects and evaluate the creditworthiness of corporations properly. the typical chaebol firm had an extremely high DER. Net profit margins of the top 31-72 chaebols were higher than those of the top five or of the top 6-30. capital. This effectively becomes an exit barrier for chaebols and would justify the intervention and support of the Government. Such problems may eventually cause ripples through the entire economy. share issues. the intervention later resulted in the accumulation of adverse side effects: underdeveloped product. Profitability of the top 6-70 chaebol firms has been lower than that of the top five chaebol firms. The Government’s supervision and regulation of financial institutions were poor. The new preference ordering is as . Further. while (non-chaebol) independent firms had much lower borrowing ratios.
which were the most important financing source until 1987. as evidenced by occasional. However. and bond issues. total foreign debt amounted to $157. In November 1997. 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. Bank loans. The ratio of external debts to GDP reached 48 percent at the end of 1998. The financing choice of listed firms was also influenced by the underdevelopment of the stock market. overseas borrowing became difficult and higher interest rates were charged on foreign borrowing. large-scale bailouts of financially distressed firms. The preference for debt finance also led to a relatively large foreign debt. The lending practices of banks. share issues. obviously contributed to overlending and aggravated the situation. the exchange rate (won/dollar) increased sharply and the financial crisis erupted in Korea. . 63 percent of which was short-term. bank loans. In the international financial market. the top 30 chaebols showed a DER of 519 percent. were advantageous to chaebols because they were in an “ideal” position to meet the loan requirement through cross-guarantees among their member firms.Chapter 2: Korea 135 follows: internal funds. At the end of 1996. the Government and the Bank of Korea defended the currency. which is far higher than the average ratio of around 400 percent for nonfinancial listed firms. which generally required guarantees or collateral.5 billion. Implicit guarantees by the Government on bank loans to large businesses. Other factors also contributed to this preference. 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. consisted of high proportions of policy loans. Although the ratio of stock market capitalization to GDP in Korea was not very different from those in the Philippines and Thailand. As of the end of 1997. 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. Nonpolicy loans were also considered to be cheap because of interest rate regulations. 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. signaling a bearish speculative move on the won. The high proportion of foreign debt led to a mismatch problem where borrowers were unhedged against foreign exchange risk. After the financial crisis erupted in Indonesia and Thailand. won/dollar nondeliverable forward rates increased rapidly. reducing foreign exchange reserves to a dangerous level.
Following the “three months” definition. and there is collateral. They utilized mutual payment guarantees among their affiliates and believed that they would never fail.000 in September 1998 (Table 2. The inevitable result of inefficient investment was a fall in corporate profits. and there is no collateral. without strictly evaluating the creditworthiness of businesses and the profitability of projects. II Inefficient Corporate Investment and Low Profitability Ownership concentration among Korean firms. However. a large number of construction companies failed due to the recession in the real estate market and decline in real estate prices. decelerated from March 1998.000 during January-September of 1998. The monthly number reached more than 3. and shareholders’ equity of all industries. The banks and merchant banks lent to large businesses.000 per year starting 1992. Vol. the NPL ratio of commercial banks increased rapidly from 4. Moreover.32). nine out of the 30 top chaebols failed. starting 1 July 1998. Overlending and inefficient investment were also a result of moral hazard due to implicit government guarantees and “too big to fail” legacies to large businesses. Before the crisis.000 from December 1997 to February 1998. Financial Sector Vulnerability Because of financial losses in the corporate sector. Fixed loans are those for which interest is not received for six months or longer. reaching highs of 6 percent in 1997 and 8.7 percent in 1997. then 20. Doubtful loans are those for which interest is not received for six months or longer. were low in 1996 and 1997. Further. excluding the financial sector. the NPL ratio8 of banks and other financial institutions began to increase.200 in 1997. The Government could hardly help them because of the number and magnitude of business failures. and returned to about 1. the ratios of net profits to sales. total assets. they are defined as loans for which interest payments are overdue by three months or more.6 percent in June 1998. and the pursuit of growth through excessive diversification and inefficient investment. According to the “six months” definition. legal and other barriers prevented the exit of financially nonviable firms. Meanwhile. the NPL ratio reached 7. . and estimated losses. regardless of whether it is caused by large personal holdings of the controlling shareholder or by pyramiding.136 Corporate Governance and Finance in East Asia. has given rise to various types of self-dealings by the controlling shareholder.1 percent in 1996. In 1997 they became negative. especially chaebols. These were the definitions until 30 June 1998. It jumped to 17. The number of insolvent companies increased rapidly in 1991 and doubled to more than 11. The bank supervisory 8 NPLs of banks comprise fixed (substandard) and doubtful loans.
673 Construction 380 354 242 195 294 585 1.890 4.992 11.133 3.472 2. Policymakers thought that economic growth would resolve the NPL problem without the need for corrective action. those of domestic banks were lower in the 1990s. 1986-1998 Year 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 Total 4. The current account deficits in terms .Chapter 2: Korea 137 Table 2.859 3. and continuous and large current account deficits. Compared to ROAs and ROEs of domestic branches of foreign banks.769 9.053 5.855 6.259 2.69 20.210 1.517 2.850 3. Exchange rates were virtually pegged to the US dollar in all troubled Asian countries.985 Services 3. Meanwhile.457 2.553 3.751 1. 2.589 171.250 2.114 811 706 696 866 1.4 Shortcomings in Macroeconomic Policy The macroeconomic framework also contributed to the crisis in 1997.255 13.657 3.759 6.159 10.979 8. and Taipei. and declined to 4-6 percent in 1994-1996 (Table 2.573 3. 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. the ratio reached 7-8 percent.754 3. European countries. This was mainly due to the high ratios of NPLs.417 Others 152 132 108 97 88 161 326 252 274 302 553 861 952 Note: 1998 figures cover only January-September.386 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.544 2. and large government-directed loans.244 3.856 7. As a result they had largely overvalued currencies. Source: Bank of Korea.265 6.32 Number of Firms with Dishonored Checks.238 4.131 1.647 8.502 11.637 6.33).China. In 1990-1993.135 1. ROEs and ROAs of Korean and Japanese banks were low compared with those of the US. low efficiency. This speculation was said to be one of the causes of the financial crisis in Korea.027 Manufacturing 1.5.107 6.
33 Nonperforming Loans of General Banks. . II Table 2. Korea -4.237 Estimated Loss (C) 958 920 840 816 213 385 490 490 648 NPL (A+B+C) 7.0 8. Real interest rates in Korea had been two to three times higher than those of Japan or Taipei. Source: Bank of Korea.176 7. of percentage of GDP were as follows: Malaysia -8.6 percent (1995).8 5.649 375.1 percent (1995).077 NPL Ratio (%) 8.390 12.910 1. although per capita income in Korea was much lower.520 194.116 1.192 Doubtful (B)b 952 1. and Indonesia -3.929 11. 1990-1998 (W billion) Year 1990 1991 1992 1993 1994 1995 1996 1997 1998 a Total Loans 90.954 9.6 percent (1995). Meanwhile large businesses could not legally lay off workers.639 1.160 11.484 11.China.584 Fixed (A)a 5.190 9.874 22.138 Corporate Governance and Finance in East Asia. Businesses served as a social safety net. In addition to the overvaluation of the won.475 143.0 7.736 8.832 337. the hourly wage rate in the Korean manufacturing sector was higher than in Singapore or Taipei.537 10. because of the rigid labor market. The main result of the rigid labor market was a “high-cost and lowefficiency” economy. Related to this.8 percent (1996).600 10. It was estimated that the Korean won was overvalued by 20 to 30 percent from 1989 to 1997.221 8. even in times of economic slowdown. b Doubtful loans are collateral-free loans for which interest is not received for six months or longer.6 Fixed loans are those requiring collateral and for which interest is not received for six months or longer. which led to large corporate losses.2 4.1 7. the terms of trade deteriorated 12 percent in 1996 and 11 percent in 1997.705 160.562 18. Mass layoffs became legally possible only after the economic crisis. The pegged currency also encouraged foreign borrowing as investors believed that the exchange rate would remain stable.4 5.584 2.266 10.652 29. In 1997. Thailand -8.997 9. judging from the real effective exchange rate indexes using unit labor cost indexes as a deflator and 1985 as a base year.310 6. Vol. the ratio of short-term debt to foreign reserves was very high. and 30 percent in 1996.1 6.China.556 118.0 7.739 241.827 289. Land prices and real estate rents were also high compared to trading partners.430 12.170 1.
. 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. To achieve this. Measures have been taken by several chaebols to streamline operations and improve incentives of managers and employees. and subsidizing money-losing units. They have been pressured to stop such practices as providing loan guarantees. The FSC—later called the Financial Supervisory Service (FSS)— which is in charge of prudential regulation of financial institutions. the excessive amount of debt of Korean corporations had to be reduced to a sustainable level. including banks. However. embarked on their own restructuring programs and/or implemented restructuring demands of the creditor banks. A guideline informally promulgated by FSC required the 30 largest chaebols to lower their DER of 412. Nonviable firms and financial institutions.6. Corporations.Chapter 2: Korea 139 2. Ailing banks needed to be recapitalized after the huge amount of NPLs was disposed. 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. Downsizing by curtailing employment has been prevalent.6 2. 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 percent as of the end of June 1998 to no more than 200 percent by the end of 1999. Other firms experiencing financial distress were subjected to workout procedures through negotiations between debtors and creditor institutions. has been actively utilizing its influence to motivate institutions to coordinate debtor firms’ restructuring activities. which were laden with huge amounts of debt and were on the verge of bankruptcy. ‘Voluntary’ Restructuring Chaebols have been under pressure from the Government to abolish their informal group headquarters to increase the managerial independence of member firms. the immediate objective centered on restoring the international investment community’s confidence in the Korean economy.
On the other hand.138 by the end of October. More important. the number of potential sellers decreased somewhat from 2. they were reluctant to allow recontracting for fear of further deterioration in the capital adequacy ratio. while only 14 percent of the negotiations were completed from the beginning of the crisis up to April 1998. because liquidation of debtor firms would exacerbate the banks’ already weak balance sheets. In many cases. Internationally. II Divestitures to raise cash for debt reduction and to focus on core businesses have not proved to be easy. or to agree on debt-equity swaps demanded by potential purchasers as a precondition for the deal.140 Corporate Governance and Finance in East Asia. It was frequently observed that the negotiating parties could not agree on a price due to large discrepancies in valuation. The reasons are manifold. More than 59 percent of potential buyers were foreign firms. 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. Noticing this disincentive. 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. Banks did not have the incentive to force financially nonviable firms to liquidate. Involuntary Exits The Government has been involved in the restructuring process mainly through its supervisory capacity over banks. banks and other creditors were reluctant to absorb losses realized by debt compositions. FSC directed banks to appraise the long-term viability of client firms showing symptoms of failure. 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. potential foreign buyers waited for the price of acquisition targets to come down further. The data also show that about 24 percent of acquisition negotiations ended up in actual deals.281 in April to 2. Locally. Vol.045 in October. Korean firms have been slowly stepping up their restructuring since the latter half of 1998 as the economy began to show signs of recovery. The process of voluntary debt recontracting by creditors was prolonged because Korean lending organizations lacked experience and expertise when it involved a multitude of creditors. In their first review. This number was at 779 firms in April and grew to 1. the creditor .
was allocated to the six largest banks for them to employ outside experts as advisors. and 16 non-chaebol corporations that had been selected as possible workout candidates. These chaebols submitted plans for restructuring to improve their respective capital structures. workouts are being applied to non-chaebol firms identified as financially weak. A portion of the Technical Assistance Loan of $33 million. the results thus far have not entirely been as desired. Upon completion of the evaluation. two were acquired by newly organized employee stock ownership plans. by their creditors. interest reductions. Corporate Workouts Workouts in the forms of debt rescheduling.Chapter 2: Korea 141 banks selected 55 firms as targets for exit. Among the sell-offs. the creditor banks drafted their own restructuring plans with assistance from outside advisory groups led by foreign investment banks. Based on these plans. but viable. not only for the design of corporate workout programs but also their implementation. write-offs. Negotiations were then held between the chaebols and the creditors’ councils to finalize the financial structure improvement plans. three filed for courtsupervised bankruptcy reorganization. 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. Although the intention of the Government and the banks was to effect immediate liquidation of these selected firms. These included 20 firms from the top five chaebols and 32 from the top 6-30 chaebols. 11 were merged into other group members. and 12 were sold off to other firms. The creditor banks and the advisory groups also drafted such plans for the top 6-64 chaebols. The workout plans were completed for most firms by early 1999. More than 200 financial institutions signed the Corporate Restructuring Agreement to carry out corporate workouts with the top 6-64 chaebols. Also. Among the 55 firms selected. creditor banks completed evaluation of the financial status of 35 subsidiaries belonging to 13 chaebols. FSC has been monitoring the processes from a prudential regulation standpoint. The plans were put into action immediately following finalization. By the end of 1998. provided by the World Bank. . 24 were liquidated. 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.
enable chaebols to streamline their overly diversified operations and focus on several core business areas. Big Deals Ever since the outbreak of the economic crisis. On 3 September 1998. However. Big deals have been elevated to the status of the most important means of effective corporate restructuring. railroad cars. automobiles. Foreign Acquisitions Confidence in the Korean economy depends critically on the lowering of the level of corporate debt. oil refineries. Hyundai Motor Corporation won the international auction of Kia Motors in its third bidding and Daewoo Motors agreed to acquire Samsung Motors. Korea adopted and implemented policies to open its capital market completely. As of April 1999. it is hoped. In another. Vol. purchase of divested assets. labor union demands of the seller were not acceptable to the transacting parties.142 Corporate Governance and Finance in East Asia. The less than satisfactory state of foreign capital infusion in the early days stems from a number of factors. and petrochemicals. Thus. power plant facilities. most of the big deals have entered their final stages of negotiation. In one case. In the early days after the outbreak of the crisis. Restrictions on foreign ownership of land were also abolished. This figure contrasts sharply with the total of $700 million for all of 1997. inducement of foreign direct investments was considered to be the most effective means of achieving that end. some of the acquisition agreements have been discarded for various reasons. chaebols did announce their agreements on big deals in seven industries excluding the automobile industry. vessel engines. the Government has been urging the largest chaebols to strike “big deals” or business swaps among themselves to consolidate overlapping manufacturing facilities. and equity participation—reached about $8. Foreign investment—in the form of acquisition of controlling interests. In the case of automobiles. the foreign buyer demanded specific protections against adverse developments in the business environment. Big deals would. uncertainty over the future . II creditor banks and the corporations will devise detailed workout programs based on the rehabilitation plans submitted by the corporations. aircraft.5 billion on agreement basis during the 10-month period after December 1997. These deals could eliminate excess capacity in such industries as semiconductors. First.
Second. 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. The presence of . As set forth in the agreement. Fourth. 2. Overhaul of Bankruptcy Procedures In February 1998. With this in mind. these goals were: (i) to enhance managerial transparency. local creditor banks were reluctant to absorb losses arising from debt compositions and debt-equity swaps that were necessary in deals involving insolvent sellers. and (v) to improve the accountability of controlling shareholders and the board. Not only does this represent progress in terms of an improved institutional framework for market competition. (ii) to remove cross-guarantees of loans among group members. Seventh.6. foreign buyers usually employed discounted cash flow methods of valuation while local sellers often put greater emphasis on replacement costs of assets.Chapter 2: Korea 143 course of the Korean economy remains high. (iv) to focus on a small number of core businesses. but it also has important implications with respect to corporate workouts. many of the businesses that Korean firms put on sale did not prove to be attractive to foreign firms. the improved procedures stipulated in the Bankruptcy Reorganization Act and the Composition Act reduced what had previously been legalistic exit barriers. Fifth.2 Policy Measures for Corporate Reform Goals and Policy Measures for Reform in the Corporate Sector Based on their assessments of what caused the economic crisis in Korea and what needs to be done to overcome it. Sixth. some of the potential acquirers demanded terms that were unreasonable or unacceptable from the sellers’ point of view. Third. In effect. (iii) to reduce financial leverage. 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. the Government and chaebols reached an agreement on the goals of restructuring and reform efforts. foreign buyers were concerned with the inflexibility of the labor market. 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.
144 Corporate Governance and Finance in East Asia. The creditors can form a “Creditors Committee” among themselves to allow them to participate in the decision processes in court.” comprised of experts in the legal. The court can refuse to accept the application for composition if it finds it inappropriate considering the size of corporate assets. Fifth. the Composition Act was amended to narrow the eligibility of applying for court-supervised composition. The purpose of this rule is to shorten the reorganization planning period. accounting. if a final reorganization plan is not worked out within one year from the date of the court order placing a firm in receivership. Third. 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. (iii) the representation requirement for shareholder derivative suits was drastically relaxed from 1 percent to 0. the maximum grace period on loans to the firm being reorganized was shortened to 10 from 20 years. etc. (iv) restrictions on institutional investors’ voting rights were eliminated in June 1998.01 percent in May 1998. The changes in the reorganization procedures can be summarized as follows. October 1998. Also. Also. Vol. a “Management Committee. Fourth. (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. number of creditors. In the past this stage usually extended for as long as two to three years. . Korea’s Economic Progress Report. First. (ii) legal changes have been made so that domestic accounting practices conform to international standards. 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. Second. the court may annul its previous decision and force the firm into immediate liquidation. and economics professions should be organized to provide for expeditious proceedings in court. thereby preventing abuses by controlling shareholders/managers of financially distressed firms. the right to revoke court receivership is allowed to the creditors. II an expeditious exit scheme is expected to better induce negotiation for workouts between creditor banks and corporations. the changes in the institutional setting for corporate reorganization will enable creditors and debtors to promptly respond to the development of financial problems.
As for promotion. crossdebt guarantees totaling about W10 trillion—about 30 percent of the total guarantees among the 30 largest chaebols—were dissolved. (vii) by the end of March 1998. Measures for improving standards in corporate governance are already effecting a generally more open corporate culture and greater transparency in business practices. 514 listed companies had appointed 677 outside directors). which was passed in August 1998.148 industries remain closed. including tax exemptions and reductions. various supporting measures. (iv) during April and May 1998. to FDI). 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. 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. financial institutions could no longer require cross-debt guarantees. (ii) full liberalization of foreign exchange transactions was legislated and will be put into effect in two stages. (vi) bankruptcy laws were revised in February 1998 to facilitate the exit of insolvent firms. These new standards are and will continue to be strictly enforced. (iii) hostile mergers and acquisitions by foreigners were fully liberalized in May 1998. including financial subsidization. either partially or fully. administrative procedures for FDI will be dramatically simplified and made transparent. Foreigners are now able to invest in local bonds and short-term money market instruments without any restrictions. Capital Market Liberalization Since 1998. According to the law. only 31 out of 1. In addition. an additional nine industries will be opened or further liberalized. beginning on 1 April 1999. the Korea Trade and Investment Agency (KOTRA) will provide a one-stop service with respect to FDI. (v) by the end of May 1999. and (viii) as of 1 April 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.Chapter 2: Korea 145 (as of the end of May 1998. 21 industries were further liberalized or newly opened to FDI (now. Existing cross-debt guarantees should be completely eliminated by the end of March 2000. Foreign Investment Promotion Act The Foreign Investment Promotion Act was put into effect in November 1998. have been instituted for FDI: .
Various local taxes will also be exempted or reduced for eight to 15 years at the discretion of local governments. such as the high-tech industry. Also. the Korean Government is strengthening prudent regulations and market monitoring. II (i) (ii) (iii) Tax exemption and reduction: Corporate and income taxes will be exempted or reduced for FDI in target industries. The primary aims of the law are the liberalization of the capital account and the development of the foreign exchange market. It aims to establish a benchmark by consolidating various government bonds. as well as building an early warning system. The majority of government bonds to be issued in the next two to three years will carry a maturity of three years. for 10 years (full exemption for the first seven years and 50 percent tax reduction for the remaining three years). To minimize potential risks. Liberalization of Foreign Exchange Transactions In September 1998 the Foreign Exchange Management Act was replaced by the Foreign Exchange Transaction Act. The location of the FIZ will be determined at the request of foreign investors. Vol. are not risk-free. The law allows rental cost exemptions and reductions for FDI. Low cost rental facility: National and public real properties will be rented to foreign-invested firms for up to 50 years. These bonds will be issued . the Government intends to supplement these measures with a sound macroeconomic policy in order to secure more effective protection against systemic risks. Capital Market Augmentation Bond Market The Government recently introduced a policy plan to deepen Korea’s bond market. including infrastructure and tax support. These liberalization measures. Three-year government bonds will be used to establish a benchmark. Free Investment Zone (FIZ): A free investment zone will be developed to accommodate large-scale FDI. will be provided to foreign firms in the FIZ.146 Corporate Governance and Finance in East Asia. Various support measures. however.
According to the law. and is promoting joint ventures between foreign and domestic agencies. they will be managed by foreign investment management companies. with only minor standard exceptions. but it will also help improve financial institutions’ risk management. To ensure transparency and efficiency of the fund operations. As a pilot program. If interest rates stabilize at a low level. It also opened the credit rating service market to foreign competition. and W1 trillion divided equally between the three balanced funds. These are expected to operate for the next three years. Asset-Backed Securities A new law providing for asset-backed securities (ABS) was passed in September 1998.6 trillion for the debt restructuring fund. In order to promote a greater market demand for government bonds. In August 1998. but may be extended as required. and the demand for longerterm bonds increases in the future. Related legislation was put into effect in September 1998.6 trillion in these funds: W0. invested a total of W1. both domestic and foreign. No qualification requirements are being imposed on investors who are sponsoring new mutual funds. a primary dealers system will be introduced for healthy financial institutions. It is now easy for private investors. commercial banks were allowed to carry out dealing operations for government bonds starting in October 1998. The Government established specific qualification criteria and selected the primary dealers in 1999. a debt restructuring fund and three balanced funds (funds that invest in both equity and debt) were established in September 1998. including the Korea Development Bank. the Government will correspondingly expand the issuance of government bonds that have a maturity of five years or more. to establish closed-end investment companies. Twenty-five domestic financial institutions.Chapter 2: Korea 147 monthly. Mutual funds (or open-end investment companies) will be allowed starting 2001. Prior to the introduction of this system. This law will not only provide an effective institutional environment for the disposal of NPLs. 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. Moody’s signed a joint venture contract with Korea Investors Service. financial institutions .
then the regulation will inhibit efficient investment of firms. is inevitable. However. cross-subsidization. such as the Korea Asset Management Corporation (KAMCO). 2. One way of strengthening independence of the boards is to require that listed companies accept nominations for directors by institutional . the role of the board of directors as the internal control mechanism must loom large in corporate governance. this can only be a temporary measure. There must be stronger rules to control agency problems. which is the case for many chaebols.g. B investing in C. there is another view that placing a maximum limit on interfirm investments. can utilize ABS. 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. It would be more desirable for the market-oriented measures to be put into place and strictly enforced. as stipulated by the government measure. 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.) and the level of interfirm investments is very high.. the government intervention will have to be refocused so that it only sets the rules of the game in the marketplace. etc. Selfdealings. and C investing in D. On the other hand. Policies aiming to improve the corporate governance system should take into account the high ownership concentration often created by pyramiding. However. However. A investing in B. foreign business corporations with good credit standing are now also permitted to issue ABS. In principle. Vol. II and qualified public corporations.3 Policy Recommendations Poorly performing markets and the resulting lack of market discipline justified the government intervention in recent corporate and financial restructuring activities. For instance. As markets become more efficient. when the limit is binding. and other unfair internal transactions among affiliated companies should be stopped primarily by improving rules on corporate governance rather than by boosting the Government’s policing role. A good governance system is essential for the healthy growth of corporations and financial institutions. unless the limit is tight and binding. Direct controls of interfirm investments and/or pyramidal ownership structures will not be persuasive. The corporate governance structure cannot be expected to function efficiently if this issue is not addressed. More important.148 Corporate Governance and Finance in East Asia.6. this regulation may not be effective in curtailing pyramidal structures.
The Government can prompt institutional investors to contribute more to good corporate governance by paying greater attention to corporate affairs. the Korea Stock Exchange could incorporate provisions of the Code of Best Practice in Corporate Governance in its listing rules. it will have to include making self-dealings by directors and officers. If and when the law is introduced. One way of motivating institutions to do this is to 10 M. and also negligence of external (independent) auditors actionable. various measures have been implemented to promote investors’ rights. The Corporate Board. Proposed: A Governance Monitor. 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. More effective measures to protect investors will enhance corporate transparency and also the accountability of directors to shareholders. 23-26.10 Other means to improve independence of the boards include mandating that independent outside directors form the majority. Further. 1997). Listing rules may recommend that all or large listed companies adopt an audit committee. Latham. 1997. The Securities and Exchange Act will then require large listed companies to switch to a board audit committee system from an internal auditor system. Class action suits are an efficient means for corporate monitoring. 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. governance. Since the economic crisis. September/ October 1997. and requiring that all directors hold shares of their companies. . Each listed firm should be required to disclose the extent of its compliance with the Code in its annual report. thereby helping to strengthen board independence and enlisting boards’ more active involvement in monitoring corporate management. There has recently been a general shift in individual investor preference from direct personal stock trading to investing in traditional investment trust companies and the newly introduced (closed-end) investment funds. Institutional investors will play an increasingly important role in corporate governance.Chapter 2: Korea 149 investors or their trade associations. using audit. and other committees. One action that has yet to be taken is the introduction of an act to facilitate class action suits against corporate directors and internal and external auditors for their wrongdoings. The annual shareholders meetings could also elect reputable “monitoring companies” to recommend director candidates (Latham. pp.
etc. the Government will have to come up with appropriate policy measures to solve these problems. such as the Korea Investment Trust Association. Shareholdings concentrated in investment companies and other institutional investors pose a serious dilemma. . securities 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. could prepare such guidelines. an audit committee. Rights of minority shareholders should also be strengthened for these institutions. II provide comprehensive guidelines for their actions in matters related to corporate governance. In the coming years.150 Corporate Governance and Finance in East Asia. Also. 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. and impose stronger penalties on violations of the rules on portfolio investments. Another measure. Many of the larger investment trust companies. Vol. The institutions’ respective trade associations. by all nonfinancial companies (or “industrial capital”). strengthen its supervisory activities. and thus cannot be expected to be actively involved in monitoring portfolio firms. more drastic in nature. These guidelines would recommend shareholder activism and faithful discharge of fiduciary duties by actively participating in shareholder voting. and other NBFIs are subsidiaries of chaebols— especially the five largest ones. The Government can also lower the limits on investments in affiliated companies. possibly. is to restrict ownership of investment trust companies and NBFIs by the five largest chaebols and. The Government recently proposed the revision of bankruptcy-related laws. strengthening incentive compensation schemes for executives. objecting to certain defensive measures proposed by the management. 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. insurance companies. Application of more stringent bankruptcy-related rules to firms in financial distress will effect greater discipline over corporate management. 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. reviewing independence and expertise of candidates for outside directors. and compliance officers. 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.
To facilitate the development of the Korean stock market. the elimination of implicit guarantees for financial support to chaebols. and consistently show low profit rates. and thus full-scale education programs should be developed. therefore are vulnerable to economic shocks.Chapter 2: Korea 151 There still exist widespread concerns that the Government will continue to exercise a great deal of discretionary power over banks. lessening the degree of double taxation of dividends (or further reducing personal income taxes on dividends). The Government needs to sell off at the earliest feasible dates the bank shares that it acquired in the course of recapitalizing banks. the important issues to be addressed are: (i) improvement of the corporate disclosure system. In order to minimize government intervention in bank and corporate management. Chaebols are overly indebted. (ii) provision of reliable accounting information. and financial institutions. 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. For this. to concentrate instead on a small number of core businesses. The Government should put more efforts into developing the capital market. This means that the Government can control the banks and. the banks have great leverage over the management of debtor firms. Banks need to play a bigger role than they do at present in monitoring corporate investment and management. Such measures include providing an effective corporate governance system. such as application of higher interest rates by banks to chaebols with higher DERs. which could provide alternative sources of long-term corporate finance. and (iii) a good corporate governance system to protect investors. The public and corporations should be taught or fully informed of the best practices in corporate governance. Many concepts regarding good corporate governance are still new to a lot of market players in Korea. In turn. Banks should adopt strong incentive compensation schemes for management. and introducing disincentive schemes for excessive borrowings. and stop unfair internal transactions. An effective policy package is needed for chaebols to dispose of marginal firms with low profitability at the earliest date. Many corporations are burdened with excessive debt and. through them. The Government should substantially reduce the proportion of policy loans from bank loans. Bank boards also need to be made more independent from management. large firms. The current obligatory system of disclosure that emphasizes “hard” . bank managers should be made accountable to shareholders but not to the Government. reduction of protection of domestic markets and entry barriers. private firms. excessively diversified into nonrelated business areas.
. wage rates. Future research could include causes of corruption. no economic reforms will be effective. is considered to be one of the major causes of the economic crisis. Another problem with the corporate bond market is that most bonds are issued with maturities of less than four years. penalties on violations of disclosure rules are not effective enough to have a significant impact. More effective punitive means need to be devised to penalize both corporations in violation of disclosure rules and the officers in charge. II information on past performance needs to be transformed into a system in which corporations voluntarily announce “soft” information on future prospects. and measures to reduce corruption. Policies are needed to help develop more reliable services by bond rating agencies. In determining optimal exchange rates. Currently. These should be lengthened to make them a source of stable long-term funds. The network should cover not only the exchange market but also OTC transactions of investors and dealers. and labor productivity should be considered. reasons for different degrees of corruption in various countries. especially among business people. and bureaucrats. The development of the OTC bond market requires a well-developed dealer system. on a real time basis. Overvaluation of exchange rates should be avoided in order for export and import-substitution industries to stay internationally competitive. Maintaining current account surpluses for a considerable period is needed to pay back foreign debts. profitability of export industries and real effective exchange rates that account for changes in nominal exchange rates. data on quotations and trading volumes. At the same time. The function of securities companies as dealers of bonds should be improved. 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. Without successfully addressing this problem. Vol. the information system of the bond market should be better organized to transmit. Prevalent corruption. The establishment of a Corruption Prevention Institute will be helpful in this regard.152 Corporate Governance and Finance in East Asia.
Chung. 1995. 1998. September 1997. I. Korean Managerial Dynamics. S. Kim. Lee. various issues. S. Lee (eds. Choi. Kang. 1997. September 1998. 1998. Kwon. H. S. Korea Economic Research Institute.). Bank of Korea. pp.. New York: Praeger. September 1998. Japanese Zaibatsu and Korean Chaebols. KERI. Korea’s Large Conglomerates. K. Bank of Korea. Bank of Korea. T. and H. H. 1989. W. Understanding Flow of Fund Accounts. Maeil Daily Economic Newspapers. Is the Fair Trade Policy Fair? Korea Economic Research Institute. Kim. 1999. Tomio. pp. M. Lee. 1995. Jae Woo. Hong. International Monetary Fund. S. H. Financial Statement Analysis Yearbook. 1993. pp. 1997. Lee. Jua. C. Korea Development Bank. Chon. 1992. Chung and H. 1996. 1997. 1994. KERI. I. International Financial Statistics. various issues. Hong Moon Sa. Survey of Facility Investment Plan. Korea Economic Research Institute. Ju Hyun. and K. K. Center for Free Enterprise. The Corporate Board. D. and J. Latham.. Hattori. Cho. 1996. New York: Praeger. Proposed: A Governance Monitor. 1997. Financial Studies. and 1998 issues. 23-26.Chapter 2: Korea 153 References Bank of Korea. Korea’s Financial System. September/October 1997. Financial Studies. D. various issues. Determinants of Diversification of Korean Business Groups. C. H. Market Concentration and Diversification of Business Groups. Corporate Restructuring. Kim. edited by K. S. A Study on the Relationship between Ownership Structure of a Firm and Value of a Firm. . C. Y. W. H. N. 1989. Cho. in Korean Managerial Dynamics.. Evolutionary Chaebol. S. various issues. Economic Statistics Yearbook. 7995. An Empirical Evidence on Value of a Firm and Ownership Structure. Bibong Publishing Co. 1996. KERI. W. W. 79-95. Korea’s Chaebol. Chon.
Ungki. October 1998. and J. Beyond the Limit. H. Management Research Institute. Yim. The Ownership Structure and Family Control in Korean Conglomerates: With Cases of the 30 Largest Chaebols. Korea Institute for International Economic Policy. Real Exchange Rate and Policy Measures. 1999. The Pattern of Ownership Structure and their Characteristics in Korean Conglomerates: With Cases of the 30 Largest Chaebols. J. Vol. Sohn. C. November 1996. Joh. 1998. A New Trade and Industrial Policy in the Globalization of Korea. Background and Task of Structural Adjustment. J. K. I. 1998. U.154 Corporate Governance and Finance in East Asia. Whang. Corporate Governance in Korea... Seoul. 1996. 1998. Lee. October 1998. S. C. Ministry of Finance and Economy. Kang. S. Nam. Business Groups in Korea: Characteristics and Government Policy. and J. Korea Development Institute and World Bank. and H. Yang. Korea’s Economic Progress Report. Y. H. Lim. KIEP Working Paper 98-05. I. Y. K. Wang. Chicago. II Lee. 1995. January 1995. Korea Institute for Industrial Economics and Trade. Kim. Chung Ang University. Lim. Korea Finance Institute. Conference on Corporate Governance in Asia: A Comparative Perspective. Capital Liberalization. Yonsei University. Lee. Y. W. Ungki. March 1999. Korea’s Trade and Industrial Policies: 1948-1998. S. . KIET Occasional Paper No. S. 23. 2nd Sangnam Forum. 1999. K.. Annual Conference of Financial Management Association. Whan. 1998. September 1998. J. 1996. Korea Institute for International Economics and Trade. Kim.
both of ADB. Denise B. This has come about following a political and economic upheaval from 1983 to 1987. Companies of other Asian countries were already using these markets to finance investment and growth. and Liza V. healthy profits from the previous five years and new equity raised through successful initial public offerings (IPOs) in a robust stock market allowed the corporate sector to accelerate investments and borrowings.. in particular Francisco C. Inc. about a decade before the recent Asian crisis. From 1993 to 1996. Inc. Roble. state-sanctioned monopolies. Saldaña1 3. . Serrana. Issues such as State ownership of businesses.1 Introduction In recent years. 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). staff. The lifting of the debt moratorium in 1991. and government subsidies were tackled during that period. the Philippine economy and corporate sector were in a relatively sound financial position. after the completion of debt negotiations with the IMF and Paris Club. Pineda. 1 Principal. the Philippines. aiming at eventually limiting the Government’s role to economic policy setting and allowing the private sector to conduct most economic activity. PSR Consulting. the PSR Consulting. the Philippine nonfinancial corporate sector had managed its borrowing risks relatively well by largely avoiding imprudent use of debts and risky investments. the Philippine Stock Exchange for its help and support in conducting company surveys. overall. When the Asian crisis erupted in 1997. for their research assistance. The Asian financial crisis revealed that. and Lea Sumulong and Graham Dwyer for their editorial assistance. the Philippine corporate sector has played a leading role in the government’s efforts to get the country on track toward sustainable economic development. The author wishes to thank Juzhong Zhuang. allowed the Government and the corporate sector to gradually access foreign debt markets after a long absence.3 The Philippines Cesar G. David Edwards. and David Webb of the London School of Economics for their guidance and supervision in conducting the study.
II Still. The Board of Investments (BOI) was created to draw up an investment priorities . their growth could not be sustained. These early industrialists naturally opposed any initiative to reduce tariffs. usually with the acquiescence of bank creditors. nationalist sentiments led to policies that favored import substitution and heavy government intervention in business. But protectionist policies made labor relatively more expensive and. Vol. control by internal and external governance agents. patterns of financing. regulatory framework.2 3. The policy was crafted by the martial law regime at that time. Government interventions under the notion of “master planning” for economic and social development characterized the 1970s and early 1980s. yet they did not risk new capital required for modernizing and expanding manufacturing capacity.1 Overview of the Corporate Sector Historical Development During the 1950s and 1960s.2. and on the financial crisis. which leads to their easing of due diligence and monitoring standards when lending to group members. This study reviews the Philippine corporate sector in terms of its historical development. 3. Investments of large corporate groups tend to focus on obtaining market shares and industry dominance. composed mostly of families previously in trading businesses. The highly concentrated and family-based ownership of corporate groups has resulted in governance structures that depend largely on internal control systems. companies were necessarily large and capital-intensive. the corporate sector showed structural weaknesses similar to those in neighboring Asian countries. While new manufacturing industries were successfully established. the Government overvalued the local currency and imposed high import tariffs. on family-based and controlled conglomerates. Sugar refining and textile mills are examples of industries that floundered in the 1980s because of government import substitution policies. Companies finance long-term investments with short-term debt.156 Corporate Governance and Finance in East Asia. Banks have significant presence as members of affiliated business groups. and responses to the financial crisis. Corporate financing relies excessively on bank loans. To implement these policies. It analyzes the impact of corporate governance on company financial performance and financing. An industrial elite. emerged to influence industrial policies. Companies were profitable because of protection from foreign competition. therefore. patterns of ownership.
Better access to cheaper imported raw materials improved the competitiveness of local manufacturers. organizing industries into sectors and picking “winners. The high industrial concentration led to practices of price leadership and output restrictions and the rise of industry lobby groups—common features of an oligopolistic . including the reduction of tariffs. Starting in 1981. In the early 1990s. Reforms in policies. advance notice of areas where the country disallowed or restricted foreign investment. clearly shifted economic management toward reliance on markets rather than on decisions by bureaucrats in the Government. The 1980s were marked by a peaceful transition of political power. In many industries. dominance by large companies. Quantitative restrictions and tariff protection of preferred industries remained firmly in place. the “pioneer” industries identified in the IPP. and orientation toward domestic markets. i. Following government initiatives in the control of the infrastructure and utilities sectors. assumed ownership of the largest petroleum refining company.e. Foreign ownership was allowed only in industries with high technological and market barriers. made less associated with capital investments. the State took over the generation and distribution of electricity. Exports were not competitive because of the high costs of imported materials. the Government continuously revised the enabling law of BOI so that incentives were reduced in number. Nevertheless. and import licensing requirements. BOI incentives retained a strong bias in favor of capital-intensive enterprises and domestic-oriented industries. the Government narrowed the range of tariff rates by commodity categories and reduced the average tariff rate from 28 to 20 percent.. and oriented toward exports. In 1991. Probably the most significant effects of tariff protection and biases for capital intensity were the corporate sector’s high degree of concentration. It limited the bureaucratic cost and discretion that accompanied the necessary approvals of foreign investments. The FIA allowed foreign equity investment in many areas and at the same time provided a transparent. and initiated the development of alternative energy sources in response to the oil crises.” No strategic industry could take off without the Government’s participation in its management and operations. The Government signaled through the IPP its intent to shape the future industrial landscape.Chapter 3: Philippines 157 plan (IPP) to encourage private sector investments by offering tax and other incentives. quantitative restrictions. the top three companies accounted for a disproportionately large share of total sales and assets. the legislative body passed the Foreign Investment Act (FIA).
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.0 (6.9 6. only to be unsettled by the crisis of 1997. .0 7.000 Corporations covers financial and nonfinancial companies. Rep.3 8.1 GDP Growth of Southeast Asian Countries.2 (0.3 7.2).2 Source: ADB.8 8.7 8. Vol.8 10.7 (13.1).2 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 1.158 Corporate Governance and Finance in East Asia. which was taken as a representation of the Philippine corporate sector.5 9.0 8. Key Indicators of Developing Asian and Pacific Countries 2000. Its growth rate began to catch up with others in 1996.5 (7.3 9.0 8.6 7.1 5.3 9.8 percent growth in fixed 2 The SEC-BusinessWorld Annual Survey of the Top 1. 3.7 Malaysia 9. 1990-1999 (percent) Year 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 Indonesia 9.8 5.2 7.1 8.1 4.8 5.5 8.5 8.4 4.2.2 During 1988-1997.5) 3.7) 10.9 5.8 4.2 Korea.6) 0. This rate of growth was sustained by a comparable 18. of 9.3 2.000 Philippine companies grew 17.9 (1.000 corporations.2 7. II market.2 8. With economic reforms introduced in the 1980s and 1990s.4 Philippines 3.5) 5.1 5. The Philippines substantially lagged behind other countries from 1990 to 1995 (Table 3.8 8. net sales of the top 1. In this section.2) 4.2 Thailand 11.9 7. competition from liberalized imports had somewhat reduced oligopolistic tendencies and concentration in many industries.2) 0.5 percent per year (Table 3. only nonfinancial companies were used. Table 3.0 (0.7 5. however.7) (10.
1 468.5 119 12.Table 3.6 896 0.5 51 4.1 4.6 149 12.0 900 1.191.6 1.2 4.1 Other Indicators No.3 382.4 602.332. return on assets (ROA) = net income/total assets.1 615.4 555.0 148.6 144.6 102 16.5 446. . 1988-1997 1989 519.2 27.9 480. of Companies Sales per Company (P billion) 899 0.5 887 0.647. return on equity (ROE) = net income/ stockholders’ equity.7 218.3 60 10.5 192.7 903 0.4 63.9 952.3 107 13.9 96.9 896 2.6 18.6 1990 1991 1992 1993 1994 1995 1996 1997 1.000 Companies.5 570.5 72 7.1 197 14.1 72.7 238.3 68 7.160.3 121 12.8 5.3 898 1.4 Financial Ratios (%) Leverage ROE ROA Turnover Net Profit Margin 222 14.6 426.5 1.1 33.6 5.2 900.5 Leverage = total liabilities/stockholders’ equity.4 260.1 51.4 1.1 5.1 73 5.8 77 7.6 290.7 443.7 20.1 714.561.6 954.2 2.781.5 14.1 54 11.9 617.5 1.1 181 11.5 1.4 861.177.9 149 6.2 338.317.225.3 862.8 6.1 1. Source: SEC-BusinessWorld Annual Survey of Top 1.6 900 1.2 378.978.5 193.7 1.5 508.8 411.0 1.6 35.6 109 12.7 28.4 188.8 26.2 Compound Growth (%) 17.000 Corporations in the Philippines.8 902 1.8 4.1 881.3 306.893.512.2 Growth and Financial Performance of the Top 1.4 898 1.8 22.9 898 1.2 707.1 6.7 73 6.6 75 6.2 2.9 629.1 95.2 136.2 Indicators 1988 Growth Indicators (P billion) Net Sales Net Income Fixed Assets Total Assets Total Liabilities Stockholders’ Equity Retained Earnings 464.8 618.9 2.4 776.697.1 1.131. net profit margin = net income/net sales.394.9 1.5 4.4 422.214.171.124 741.9 3.7 1.9 78 6.3 941.2 1.2 Average 146 12.1 66 12.0 1.4 3.4 8.5 64. turnover = net sales/total assets.3 46.341.
Assuming Table 3. respectively.1 Net Sales (P billion) 465 519 630 741 862 954 1.427 13.9 21.5 16.3).2 percent. indicating that the corporate sector’s exposure to foreign currency-denominated loans was not as significant as in other countries. The data suggest no evidence of excessive borrowing in the run-up to the crisis in 1997. Net profit margins for the top 1.5 17.4 24.4 20. various years.979 17.5 Ratio of Estimated Value Addeda to GDP (%) 17. Asset growth was funded by debt that grew at an average of 20. but the extent of the increase was not as dramatic as in other Asian countries.7 percent.474 1.000 companies averaged 7. II assets.172 2. for the 10-year period. leverage increased from 109 percent in 1996 to 149 percent in 1997.693 1. Return on equity (ROE) and return on assets (ROA) averaged 12. This is high compared with developed countries but compares favorably with other Asian countries. Total assets grew at an average annual rate of 22.6 percent and 5.1 19.9 23.352 1.178 1. The debt-toequity ratio ranged from 222 percent in 1988 to 102 percent in 1994.9 percent for the period. Key Indicators of Developing Asian and Pacific Countries 1999. Net income consistently increased from 1988 to 1996 and declined only in the crisis year 1997. and by equity that grew at a higher average annual rate of 26.248 1.000 Corporations in the Philippines.3 percent.906 2. and the SEC-BusinessWorld Annual Survey of Top 1. The growth rates of corporate sales for the period 1988-1997 exceeded those of the country’s GDP for the same period (Table 3. . These rates of return are high compared with other Asian countries.160 Corporate Governance and Finance in East Asia.8 17. Vol. Further.077 1.3 The Corporate Sector and Gross Domestic Product. Sources: ADB.697 1.8 percent per year.8 19.5 Value-added is assumed to be 30 percent of net sales. 1988-1997 Top 1.394 1.000 Companies Year 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 Average Growth (%) a GDP (P billion) 799 925 1.
7 22. The foreign-owned companies were the Table 3.2 9.9 22.8 606 0.0 5.4 Total Liabilities 26. various years.3 9. %) 17.3 22. (iii) Government-owned. corporate control structure. Averaging 42.7 2.4 Fixed Assets 19.8 3. . and industry reveals further structural characteristics of the growth and financial performance of the corporate sector. size.8 Growth Indicators (Compound Annual Growth Net Sales 20.3 22. Performance by Ownership Type The Philippine corporate sector can be categorized into four groups based on ownership: (i) publicly listed.1 22 10.0 28.5 Retained Earnings 30.4 28.5 23 4.9 26.5 Other Indicators Share of Sales (%) 17.4).3 146 6.1 ROA 8.3 11. The premise is that these variables have a direct bearing on corporate performance and growth. and (iv) privately owned.3 27.4 Stockholders’ Equity 32.4 Growth and Financial Performance of the Corporate Sector by Ownership Type.4 190 5.8 percent of the corporate sector’s total sales between 1988 and 1997.9 158 13.3 42. 1988-1997 Indicators Publicly Listed Privately Owned Rate.0 5. these figures suggest a significant and increasing contribution of the corporate sector to GDP. (ii) foreign-owned.5 27.5 Source: SEC-BusinessWorld Annual Survey of the Top 1.6 Total Assets 29.1 Financial Ratios (%) Leverage 89 ROE 15. A study of company performance by ownership type.8 2.2 103 5.0 31.0 142 22.8 22.000 Corporations in the Philippines.0 Net Income 19.8 No.Chapter 3: Philippines 161 a constant ratio of value added to sales.0 Turnover 53 Net Profit Margin 15.0 4.9 196 1.5 GovernmentOwned 4. privately owned companies constituted the largest group (Table 3. of Companies 73 Sales per Company (P billion) 2.8 ForeignOwned 21.1 12.9 17.8 14.
These were mostly large public utilities. selling an average of P4. The privately-owned companies were only about one third of the average size of per company sales of the publicly listed companies. and government-subsidized agencies such as the National Food Authority and Local Water Utilities Administration.9 percent. .2 percent and ROA of 9. But by being most efficient in employing assets. and low return on investment is the norm. they generated the highest return on investments. 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. while there were few of them.162 Corporate Governance and Finance in East Asia. reflecting the significant presence of holding companies as the gross revenues of holding companies flow through to operating income. were among the top 1. the asset base is large. a level high by Western standards but at par with those of other Asian countries. registered the largest per company sales at about P9 billion in 1997. compared with P2. 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. the highest net profit margin of 15.75 billion per company for foreign-owned companies. Governmentowned companies in the top 1.000 companies in 1997. exceeding the 17.5 percent average growth rate of the entire corporate sector. the second best ROE and ROA. followed by publicly listed ones. II second largest at about 27. However. The privately-owned companies had a high average leverage ratio of 158 percent. Privately-owned and Government-owned companies grew at slower rates. or 38 percent. Publicly listed companies had the lowest leverage at 89 percent. foreign-owned companies borrowed more than publicly listed ones.3 percent. Bases Conversion Development Authority. although small in number.1 billion per company in 1997. but lower than those of foreignowned and publicly listed companies. Publicly listed companies had a minor though steadily increasing share in total sales. meaning that the remaining 62 percent were relatively small in sales and assets.5 percent. The compound annual sales growth rate was 21.8 percent for foreign-owned companies and 20 percent for publicly listed companies during 1988-1997. With an average leverage ratio of 142 percent. Vol. with an average ROE of 22.000 list. Their ROA and ROE were both more than twice as high as those of government-owned companies. and the second lowest asset turnover. Only 84 of the 221 public companies listed on the Philippine Stock Exchange (PSE).
4 24. %) Net Sales 20.7 Total Assets 32.2 Fixed Assets 25. 1988-1997 Indicators Group Member Independent 18. compared with 32.0 Turnover 67 Net Profit Margin 12. Performance by Firm Size By firm size.2 Net Income 21.8 ROA 8.Chapter 3: Philippines 163 Performance by Control Structure By control structure. the corporate sector is divided into large. of Company 159 Sales per Company (P billion) 2.3 No. various years.3 Total Liabilities 30.5).1 124 5. grew faster.1 Source: SEC-BusinessWorld Annual Survey of Top 1. medium.6 26. and achieved higher returns on invested assets than independent companies (Table 3. depending on assets and sales.5 Growth and Financial Performance of the Corporate Sector by Control Structure.0 166 15. a company can be a member of a conglomerate or independent.0 22.1 Retained Earnings 32.8 6.8 Growth Indicators (Compound Annual Growth Rate. Sales and resources of the .3 Financial Ratios (%) Leverage 98 ROE 15.000 Corporations in the Philippines.3 percent for the conglomerates. had a lower leverage ratio.0 25.0 55.3 Other Indicators Share in Sales (%) 32.6 715 0.7 Stockholders’ Equity 34.7 2. But the conglomerates were larger measured in sales per company. The independent companies contributed about 56 percent of corporate sales on average during the period 1988-1997. Table 3. and small companies.2 23.
6 49. although they comprised only 8.0 7. Table 3.9 26.3 Fixed Assets 15. However. averaging 16 percent.5 25.000 list. Sales per company in this group averaged P13.9 32.3 Source: SEC-BusinessWorld Annual Survey of Top 1.0 156 16. are defined as the largest 100 companies in the top 1.2 29.2 Stockholders’ Equity 18. Large companies accounted for 56. for this study.5 73 6. Medium-sized companies also performed better in terms of ROE.7 44. various years.1 No.1 percent of the total sales of the corporate sector.0 730 0. referring to the remaining companies in the list. averaged a far less P3 billion in per company sales. defined in this study as the next 200 largest companies in the top 1.6 Small 19. %) Net Sales 15.4 Total Liabilities 18.6 47.8 percent of the total number of companies in the list (Table 3.6).164 Corporate Governance and Finance in East Asia.1 4. Vol.7 Net Income 1.6 31.6 36.0 32.000 list. sales of mediumsized companies grew faster than large companies.1 25.4 28.1 81 9.9 Retained Earnings 13. 1988-1997 Indicators Large Medium 19. of Companies 79 Sales per Company (P billion) 7.4 billion in 1997.000 Corporations in the Philippines.2 Other Indicators Share in Sales (%) 56.5 Growth Indicators (Compound Annual Growth Rate.5 Total Assets 18. indicating that they deployed resources more efficiently than large and small companies. which.5 128 10.6 Growth and Financial Performance of the Corporate Sector by Firm Size. while small companies. Medium-sized companies. averaged only P920 million in per company sales during the same year. II Philippine corporate sector are highly concentrated among the large companies.5 12. .2 25.9 Financial Ratios (%) Leverage 158 ROE 13.3 Turnover 65 Net Profit Margin 8.1 ROA 5.9 89 1.
Net income declined from P54. ROE dropped from 10.4 percent in 1997 from 11. Large. Poor returns appear to have been caused by the low profit margin at 6. net income. with their ROE dropping to 3. ROE dropped to 7. specifically those industries least and most affected by the financial crisis. averaging 10. i. Growth of sales. net income. as indicated by the negative annual growth. Mediumsized companies’ leverage level was slightly lower.7 billion and P35. at -12.1 billion in 1996 to P4. and construction.Chapter 3: Philippines 165 Small companies. The Asian financial crisis affected large companies most severely. at 158 percent on average during 1988-1997. The real estate and property sector also suffered significantly in sales. Medium-sized companies apparently enjoyed efficiencies associated with economies of scale and made more productive use of their assets.8 percent in 1997.8 the previous year.7 percent in 1997 for medium-sized companies.2 percent for large ones.8 billion in . unlike their counterparts in other Asian countries. For small companies. from 14. and utilities and services sectors. and utilities and services sectors. assets.5 percent for medium-sized companies and 8. Sales revenue and net income declined from P76. at 128 percent for the period. Manufacturing companies represented more than half of the corporate sector in number in the period 1988-1997 and accounted for about 82 percent of total sales.2 billion in 1997 for this sector.1 percent. at 156 percent. The growth and financial performance of selected industries.7 percent a year earlier.7 percent in 1996 to 8. profits. and equity up to 1996. and the construction sectors than for the manufacturing. and assets was much higher for the real estate and property. utilities. but lower than that of construction. Performance by Industry This study also looked at corporate performance by industry.and medium-sized companies did not substantially increase their leverage in years running up to the crisis in 1997. manufacturing. especially during the period 1994-1996..7.8 percent. showed the lowest ROE. But small companies’ leverage was significantly lower. but suffered its largest decline in net profits in 1997. and profitability in 1997 when the crisis started. Leverage was the highest for large companies. The sector showed consistent growth in sales. of net income. are shown in Table 3. reflecting to some extent a “bubble” phenomena in the former two sectors.e. real estate. although the largest in number. compared with 9. The leverage ratio of the manufacturing sector was higher than that of the real estate and property sector.6 percent.
%) Net Sales 16.7 28.6 Total Liabilities 18.4 percent. 1996 to P56.0 Turnover 112 24 Net Profit Margin 5. various years. The sector’s buildup in equity during the stock market boom of 1994-1996 may have cushioned the impact of the crisis.0 31 0.9 5. it does not appear to have been excessively exposed to foreign currency-denominated loans.3 5.8 Stockholders’ Equity 21.1 2.000 companies’ total sales on average during 19881997. But the impact of the Asian crisis on the real estate and property sector was much smaller than that on the manufacturing sector.6 69 16.3 Retained Earnings 17.6 Financial Ratios (%) Leverage 142 181 ROE 13.7 10.2 45.166 Corporate Governance and Finance in East Asia.0 25. .7 Growth and Financial Performance of the Corporate Sector by Industry. respectively.7 192 9. With a modest increase in total liabilities and leverage level of less than 100 percent in 1997.9 2.0 23.4 16.9 billion and P24.1 10.3 55.6 No.1 24 42.4 3. the sector’s ROE dropped from 15. 1988-1997 Utilities Real Estate and and Services Property 39. Its knock-on effect on the economy was small as it accounted for less than 3 percent of the top 1. Vol.5 Other Indicators Share in Sales (%) 82.4 Total Assets 19.2 12. As a result.7 percent to 10.9 17.7 83 2.2 8.000 Corporations in the Philippines.8 41.4 19.7 52.8) 17. of Company 454 17 Sales per Company (P billion) 1.8 48.0 21.3 Fixed Assets 20.2 28 0.9 2.6 Growth Indicators (Compound Annual Growth Rate. and was also much more limited compared with the property sectors in other Asian countries.5 12. II Table 3.2 37.9 23.4 Source: SEC-BusinessWorld Annual Survey of Top 1.7 Net Income (12.3 20.7 Indicators Manufacturing Construction 27.7 ROA 5.7 billion in 1997.7 19.
3. The General Banking Law. reaching up to 313 percent in 1997. and restrictions. The currency devaluation bloated the foreign currency-denominated loans of these companies.Chapter 3: Philippines 167 The utilities sector had the second highest leverage during 19881997 at 181 percent on average. privileges. the Corporation Code of 1980 is a compilation of important juridical rulings. For publicly listed companies. the ownership of Filipino citizens in the corporation is not less than the legally required percentage of capital stock. Two other pertinent laws are Presidential Decree (PD) 902-A. nationalities. which regulates banks and nonbank financial institutions except insurance companies. (ii) purpose of the corporation. Under the Code. unlike in neighboring countries hit by the Asian crisis. and the Insolvency Law. the Code requires a corporation 3 A company’s articles of incorporation should include: (i) corporate name. the Revised Securities Act (RSA) and PSE’s public listing requirements also apply. administrative regulations.3 which serve as the company’s declaration that the minimum percentage of authorized capital required by law has been subscribed and paid-up. and residences of incorporators and directors. operation. and dissolution of corporations. . 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. 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. the leverage of all four industries was low.2. One month after registration.3 Legal and Regulatory Framework The Corporation Code of 1980 is the main law governing the corporate sector. which is also the organic law governing the operations of SEC. It provides the basic constitutional structure for the organization. and (viii) names. Overall. and amount of authorized capital stock. and residences of original subscribers. Corporation Code of 1980 Supplanting the old Corporation Law of 1906. and amount subscribed and paid by each. contains some provisions affecting corporations’ dealings with banks. (vi) names. par value. nationalities. which was based on American corporate law. It specifies the minimum information to be indicated in the articles of incorporation. and recognized rules on corporate practices. (iv) term of existence. (v) number of directors (not less than five nor more than 15). (iii) principal office.
(iii) qualifications. shareholders may delegate this power to the board of directors by a two-thirds vote of outstanding capital stock.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. It implements rules and regulations that protect minority shareholders from possible fraud and misbehavior by controlling shareholders. Securities and Exchange Commission: PD 902-A SEC is the government agency responsible for implementation of the Corporation Code. the bylaws must be consistent with the law. Vol. and public policy. PD 902-A expanded SEC’s mandate to include absolute jurisdiction. (iii) controversies in the election or appointments of directors and officers of corporations. between the shareholders and the corporation. and compensation of directors. To be valid. or officers. manner of voting. (ii) required quorum in shareholders’ meetings. and reasonable. (ii) controversies arising out of intra-corporate relations. directors. and should not impair vested rights. and forms of proxies and manner of voting them. In addition. and manner of calling and conducting regular or special meetings of the directors and shareholders. (v) manner of election or appointment and term of office of all officers other than directors. A majority of the outstanding shares of shareholders must vote to authorize amendments to the bylaws. 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 (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. the corporation’s articles of incorporation. (iv) time for holding annual election of directors and manner of giving the election notice. and (vii) manner of issuing certificates in the case of stock corporations. 4 Some of the items that a corporation may provide in its bylaws are the following: (i) time. uniform. . and employees. must be general. (vi) penalties for violation of the bylaws. In 1976. However. and control (adjudicative) of all corporations. II to adopt a code of bylaws or rules for its internal governance. place. Its mandate is to supervise corporations in order to encourage investments and protect investors. and between the corporation and the State concerning its franchise or right to exist. duties. among shareholders. officers.168 Corporate Governance and Finance in East Asia. supervision (regulatory).
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
five. a single shareholder held two-thirds majority control. holding only an average of 2.174 Corporate Governance and Finance in East Asia. large and family-based shareholders pool the family’s ownership over many .1 percent of publicly listed companies in the Philippines in 1997. or 20 shareholders owned more than 50 percent (signifying operating control). There are advantages to establishing pure holding companies. including pure holding companies. and share prices are sensitive to movements of foreign funds.9 shows that in 44 companies. the top 20 shareholders collectively owned a majority of a company’s shares. Who are the top one. or 51 percent of the total. the top five shareholders held more than two-thirds majority control of a company. or 3 percent of the total. a single owner owned more than 80 percent of outstanding shares. In four of 11 nonfinancial sectors.2 percent of outstanding shares of publicly listed companies. minority shareholders are unlikely to be able to influence the strategic and operating decisions of a company without the support of one or more large shareholders. In 76 companies. II analysis of the number of companies in which the top one. Table 3. or 80 percent (only nominally publicly listed) of outstanding shares. the top five shareholders owned more than 50 percent of the voting shares. nonfinancial corporations held majority control. Nonfinancial corporations with controlling shareholdings are likely to be holding companies. Parent companies usually spin off operating units into new companies that they continue to control as affiliates. 66 percent (signifying strategic control). In 116 companies. The shares of publicly listed companies are thinly traded and illiquid.10. and 20 shareholders? In Table 3. the top five controlling shareholders were classified into eight groups. or almost 75 percent of the total. 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. In 21 companies. or 78 percent of the total. controlling an average of 52. In 111 companies. Through these. Composition of Ownership of Publicly Listed Companies Another important issue concerning corporate ownership is the composition of the controlling shareholders. Individuals did not constitute a significant shareholder group among the top five shareholders. With such high levels of ownership concentration. a single shareholder held operating control of a company. or 14 percent of the total. Vol. which are mostly privately owned and controlled by family-based shareholder blocs. In four companies. The largest group is nonfinancial corporations. five.
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. Source: PSE databank. . a Data for top 20 shareholders were not available for five holding companies. and Tobacco Manufacturing. and two companies in the property sector. and Trading Holding Power Transportation Property Total — = not available.Table 3. Beverage. Distribution. 10 manufacturing companies.9 Ownership Concentration at Critical Levels of Control Over Publicly Listed Companies.
Table 3.8 11.5 2.1 5.0 1.2 3.2 59.3 12.2 0.5 26.6 0.9 0.0 1.0 0.7 3. Recreation.7 0.4 1.6 0.8 0.7 1.7 0. and Tobacco Holding Companies Manufacturing.6 1.0 5.2 0.0 7.2 3.0 0.1 9.6 0.0 0.0 0.3 26. .1 6. and Other Services Property Mining Oil Average Shareholdinga 33.7 0.0 0.0 1.3 0.0 1.5 0.1 0.5 0.8 66.6 12.1 1.0 0.0 0.7 3.2 5.1 a Weighted by market capitalization.6 0.6 2.1 8.0 0.2 0.5 53.4 0.8 21.1 0.7 0.0 0.4 5. and Trading Hotel.6 0.1 7. Source: PSE Databank.6 9. Distribution.3 2.5 13.3 5.3 37.3 0.7 0.4 8.5 12.6 33.0 2.3 0.0 1.0 5.0 0.0 0.0 10.2 10.6 5.0 1.0 1. 1997 (percent) Nonfinancial Investment Nominee Commercial Company Trust Fund Company Individual Bank Government Securities Broker Insurance Company Sector Financial Company Banks Financial Services Average Shareholdinga Nonfinancial Company Communication Power and Energy Transportation Services Construction and Other Related Products Food.3 5.0 5.0 0.9 6.4 19.2 3.2 0.4 29.6 18.8 0.2 3.5 4.5 4.3 0.8 0.0 0.3 1.0 0.7 67. Beverage.0 1.0 2.3 1.9 36.9 52.6 0.0 4.6 0.10 Composition of Top Five Shareholders of Philippine Publicly Listed Companies by Sector.2 1.0 5.4 2.6 2.2 0.3 0.7 0.0 0.0 45.9 0.
commercial banks (1. Such advantages have contributed to the popularity of holding companies among publicly listed companies. The investment funds’ presence in these sectors ranged from 8. 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. These are mainly the Social Security System (SSS) and the Government Service Insurance System (GSIS). securities brokers (1.1 percent).5 to 12. The 7. financial institutions did not have a significant ownership in nonfinancial corporations. Funds of SSS and GSIS consist mainly of compulsory contributions from members of the country’s private sector and government workforce. The Philippine capital market did not have an active analyst community comparable to those in more developed capital markets.2 percent in 1997. As a group. while still allowing the public to own minority shares. This complex layering of ownership masks the identity of individuals or families that actually own and control operating companies. Holding companies as a sector had the largest market capitalization in PSE in 1997. Because of limited ownership by institutional investors.2 percent shareholding by the financial institutions was even inflated to some extent because securities brokers held trading portfolios for their clients rather than long-term investments. accounting for P258. Petron and MERALCO in power and energy. They can also better manage their income taxes because income from affiliated companies passes through a holding company.7 percent of market capitalization of the nonfinancial publicly listed companies. there was no real market for investment information.1 percent).3 percent). and insurance companies (0. The financial institutions among the top five shareholders of nonfinancial corporations are investment trust funds (with 4.6 percent of market capitalization in 1997.7 percent of shareholdings). respectively. These include Philippine Long Distance Telephone Company (PLDT) in telecommunications. Investment trust funds were the most important institutional investors.6 billion or 26. Holding companies were themselves 66 percent owned by other nonfinancial corporations. .Chapter 3: Philippines 177 companies and share in the risks and profits of the group. with an average of only 7. 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. These institutions keep a stock portfolio mostly in shares of a few companies with large capitalization and high liquidity in select industries.
Banks that are members of business groups have an advantage in raising funds from the internal capital market of the group. This is significant considering that there were only 31 local commercial banks in the country in 1997. For this reason. 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.000 corporations’ sales.000 Corporations in the Philippines. Family-based groups have larger companies since their total sales were about 33. the Central Bank’s reforms are probably changing the conduct but not necessarily the structure of the banking system. but they comprised only 23.000 companies. Vol. All major industries were represented. suggesting that most publicly listed companies are parts of business groups. Prudential regulations. 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. including SBL and DOSRI rules. Corporate financing depends on intermediation by banks. identified the companies belonging to each of these groups. This could further increase the concentration of ownership and expand the scope of own-group lending by these larger banks. including 16 commercial banks. suggesting that business groups are common in all major markets. the study put together a list of prominent business groups. However. about three fourths. To understand the ownership and governance characteristics of family-owned business groups.178 Corporate Governance and Finance in East Asia. and increased the capital requirements for all types of banks. so far limiting their involvement to selected products. The Central Bank deregulated interest rates and foreign exchange. Foreign banks have a growing presence but have not necessarily increased the supply of credit to the corporate sector. using data on the Philippines’ top 1.4 percent of the top 1. many companies in family-owned groups are not publicly listed.11).8 percent of total companies in number. The process identified a total of 238 companies belonging to 39 business groups from the SEC-BusinessWorld Annual Survey of the Top 1.7 6 7 The study used publicly available shareholder information and published reports. Some 20 financial institutions were affiliated with these groups. Still. of the financial resources in the country. Large shareholders and their families own these banks directly or through their controlled companies. 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). and tracked the financial performance of each company from 1992 to 1997. a nonfinancial company that owns a commercial bank has better access to loans at favorable rates and terms. liberalized the regulations on entry of foreign bank branches and foreign ownership of local banks. A common feature of corporate ownership of a business group is the centrality of a commercial bank.6 The total sales of these groups in 1997 were estimated at P806 billion (Table 3. . Commercial banks hold the largest share.
the three largest entities were family-based groups. for the Gokongwei Group. as discussed in previous sections. In terms of sales. The significance of family-based business groups in the Philippine corporate sector is immediately evident in the 50 largest corporate entities. In 1997. Foreign-owned companies mainly serve the export markets. or an average of about 12 per group. real estate. with the exception of Banco de Oro.4 percent of the group’s 1997 profits). namely.2 percent). Also. It is also noteworthy that. the biggest private company in the Philippines. Cojuangco. the nonfinancial sector was real estate (60.6 percent of the total sales of the top 1. the largest was the Eduardo Cojuangco group. with 27 affiliated companies in the top 1.12). 25 out of the 50 top corporate entities were familybased groups. for the Lopez group.000 corporations in 1997. the study used the four largest business groups—Ayala. Lopez. Significantly. and banking. broadcasting (49. construction.Chapter 3: Philippines 179 Compared with other Asian countries. in most . The main constraint may be the availability of family members that could be drawn for top management positions. ranged according to their sales (Table 3.1 percent). the two were closely related through their affiliations to business groups. the largest family-based business group was the Ayala Corporation Group. For the Ayala group.000 companies. nonfinancial companies contributed about 36 to 60 percent of total profits for these groups. and more than 20 percent for the Lopez group and Henry Sy group. and Henry Sy—as examples. In terms of number of companies. To show this. for each of these groups. Commercial banks are often affiliated to a particular business group. a substantial proportion of group profits came from its financial subsidiaries. Family-based business groups are most dominant in sectors such as manufacturing. it was manufacturing (36. Gokongwei. Together. These corporate entities accounted for 53. an average group in the Philippines has fewer member companies. and for the Henry Sy group. Lopez. which was majority-owned by the Henry Sy group. including business groups and independent companies. and Ayala. the top 10 family-based business groups had only 119 companies in the top 1. 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.000. In the meantime. retail merchandising (69. the principal owner of SMC. Commercial banking contributed about 40 percent of group profits for the Ayala group and Gokongwei group.8 percent).
Sector Orientation. construction.5 47. food.6 7. 4. and Affiliated Bank of Selected Business Groups.6 3. coconut oil.2 1.7 98.11 Total and Per Company Sales. Consunji 4 3 Food and dairy products Construction and mining 10. 5.5 46.5 26. 6.1 2.6 3.3 2. 14. 3. 7.1 4.5 6.4 . 1997 Business Group 19 15 27 12 12 9 4 6 11 4 8 9 5 4 5 6 Major Sector Orientation Estimated No.9 2.8 84. Eduardo Cojuangco Lopez Family Group Ayala Corp. of Affiliated Companies Total Sales (P billion) 123. 2. and personal care prods Shipping. Beverages.4 48.2 1.5 13. 8. 13.Table 3. and tobacco Telecommunications Cement and construction materials Pharmaceutical and distribution 12. power. and food Food.5 44. 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 Wilfred Uytengsu/ General Milling Group David M.4 6. and car manufacturing Car manufacturing and real estate Food and telecommunications Department store and real estate Airlines. telecom. 11. and packaging Power distribution and mass communications Real estate.3 15. and tourism Credit card 18.0 5. and mining Management.0 13. 17.6 2.5 17. Real estate.1 4. Flagship Company.4 10.3 3. 16.0 26. and dairy products Investments.0 Average Sales Per Company (P billion) 6. 9.5 2. beverages. beverages.0 17. food. real estate.2 16.3 11.9 3.5 49. 15. agriculture.
25.1 805.7 0. 33.2 1. 36.7 3. 28.0 0. mining. 29.8 6. Ramos Gaisano Family Group Felipe Yap Felipe F. 20. 21.3 2. Enrile/JAKA Group Jaime Gow Guoco Group Jose Go Jardine Davies Gerardo Lanuza Alfredo C.1 1. 32. 39. 38.6 2.9 6.4 5. 23.4 3.8 1.7 1. SEC-BusinessWorld Annual Survey of Top 1. 27.6 3.9 1.0 5.3 2.0 2. and real estate Department store Mining Construction Telecommunication Shipyard and power 4 7 5 2 4 4 3 2 5 7 5 5 2 3 2 3 2 2 2 2 8.9 1.6 5. 24.8 1. distribution. 35. 37. 4 238 1. 26. 30. .9 1.1 1.9 0.7 0.9 7.000 Corporations (1997).19.7 0.9 0.2 6. 34.7 4.8 Jollibee Foods Luis Lorenzo Family Group Alcantara Family Group Bienvenido Tantoco Elena Lim Andrew Gotianum Brimo Family Group Andrew Tan J. P.1 2.5 8. and various company annual reports.1 0.0 1. Cruz Jose Luis Santiago Keppel Group Robert John Sobrepeña/ Fil-Estate Group Total Real estate Sources: PSE Databank.4 3. 31.2 4.4 1. 22.8 1.3 7.6 Fast food Beverages and agro-industrial products distribution Cement and wood products Retail merchandising Electronic appliances Real estate Mining Real estate Telecommunication. and real estate Retail merchandising Ceramics and real estate Department store and real estate Cement and sugar central Real estate and securities trading Bookstore.5 2.6 0.
16. 11. 5. 10. 4. Jollibee Foods Corporation Pepsi Cola Products Alsons Cement . 7. 19. Uytengsu/General Milling Group David M. 18. 8. 6.Table 3. 12. Sector Orientation.11 (continuation) Total and Per Company Sales. Flagship Company. Alaska Milk Corporation DM Consunji. 3. 1. 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. 9. 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. 17. 14. 13. Inc. 21. 20. 2. and Affiliated Bank of Selected Business Groups. Long Distance Telephone Phinma Zuellig Pharmaceutical Metro Pacific William Gothong and Aboitiz Swift Foods/RFM House of Investment Anscor Equitable Card Network Inc. 15. Eduardo Cojuangco Lopez Family Group Ayala Corp. 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.
65 billion. 30. PT&T Corp. 35.48 billion. 39. 33. . 29. small = less than P1. 28. Kepphil Shipyard Inc. 26. Enrile/JAKA Group Jaime Gow Guoco Group Jose Go Jardine Davies Gerardo Lanuza Alfredo C.65 billion to P4. F. Inc. and various company annual reports.East-West Bank International Exchange Bank Ecology Bank (Savings Bank) Dao Heng Bank Orient Bank International Exchange Bank International Exchange Bank Philbanking Corp. unless otherwise indicated. 32. 25.000 Corporations (1997). Fil-Estate Development Inc. 24. 22. Sources: PSE Databank. 36. Ramos Gaisano Family Group Felipe Yap Felipe F. Cruz & Co. 37. SEC-BusinessWorld Annual Survey of Top 1. Refers to commercial banks. Keppel-Monte Bank Bienvenido Tantoco Elena Lim Andrew Gotianum Brimo Family Group Andrew Tan J.48 billion. P. 34. 23. a b Size class is measured in terms of sales: Large = greater than P4. 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. 31. medium = P1. 38. 27..
Texas Instruments (Phils. 7.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. 18. agriculture. 19.1 17. Petron Corporation Pilipinas Shell Petroleum Corporation George Ty John Gokongwei Henry Sy Lucio Tan Ramon Cojuangco Family Group Caltex (Philippines) Inc.8 22. and food Food. mass communications.8 53. bank. and bank Real estate.7 98.3 15. 16. 15. Eduardo Cojuangco Lopez Family Group Ayala Corporation Group National Power Corp. Fujitsu Computer Products Corp. Inc.). 9. 10. food.). and car manufacturing Power Refined petroleum products Refined petroleum products Banking. car manufacturing. 5. 2. 13.2 Business Group Business Group Business Group Government. beverages. First Pacific/Metro Pacific Group 21.2 49.5 15. food.0 38. beverages. 23.5 26.0 24.5 17. 24. Philippine National Bank Mercury Drug Corp. 1997 Sales (P billion) Control Structure Major Industrial Orientation 123. Del Rosario/PHINMA Zuellig Group Toshiba Information Equipment (Phils.12 Control Structure of the Top 50 Corporate Entities. 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. banking. coconut oil. and personal care products Shipping. 3. 6.0 37. of the Phils. and packaging Power distribution. and real estate Banking.6 26. and mining Gold and other precious metal refining . construction. 14.4 48. telecommunication.8 84. Beverages. 8. Inc. 20.Table 3. Aboitiz Family Group Jose Concepcion/RFM Group Alfonso Yuchengco Philippine Associated Smelting and Refining Corp.5 44.6 18.1 60. 22. 11. 12.5 46. 4.4 19. and dairy products Investments.5 77. and telecommunications Department store and banking Airlines. 17. power.2 16.5 47. food.
real estate.0 11. Amusement and Gaming Corporation Mitsubishi Motors Phils. 42.9 7.0 12.000 Corporations (1997). and various company annual reports. Inc.7 10. 30. 46. 28. W. 44.000 Companies Sales (%) Cigarettes Bank Soap and detergents Management. 9. Philip Morris Philippines. 29.3 13. Inc.25.8 9. 39.6 9. Corp. 32. 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 1.0 13.6 12. 47. Uytengsu/General Milling Group David M. and apparatus for line telephony and line telegraphy Tobacco products wholesaling Cigarettes Radar equipment.5 10. 50. 34.2 7.9 7.8 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. Philips Semiconductors Phils. 26. 33. 45. 36.6 1. 43. PSE Databank. Jollibee Foods Citibank N.290 53. radio and remote control apparatus Fast food Bank Beverages and distribution of agro-industrial products Drugs and medicines.0 5. 37. 49. . 35. 40.5 8. National Steel Corporation National Food Authority Phil. 27. EAC Distributors Inc.9 14. 41.. and tourism Banking Radar equipment and radio remote control apparatus Operation of rolling mills Palay.1 9.7 13.4 10. 31. Consunji Uniden Philippines Laguna. 48.7 10. 14.4 8.8 6.A. including biological products Bank Cement and wood products Retail merchandising Electronic appliances Mining Real estate Sources: SEC-BusinessWorld Annual Survey of Top 1. Inc.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. corn (unmilled).9 6. and other grains wholesaling Other amusement and recreational activities Motor vehicles Food and dairy products Construction and mining Television and radio transmitters.5 8.3 8.
jointly and individually. 3. to the corporation and its shareholders for damages caused if they agree to unlawful corporate acts. appointment and compensation of senior executives. amendments in the bylaws. these were dispersed shareholdings. Of course. A total of 44 companies responded to the survey (out of about 221 financial and nonfinancial listed companies). Shareholders limit the broad power of the board by ratifying their decisions on critical corporate affairs. the board of directors plays a crucial role in corporate governance.8 The Board of Directors As the representative of shareholders in a company. The Corporation Code holds members of the board of directors liable. corporate mergers or consolidations. accounting and auditing.186 Corporate Governance and Finance in East Asia. shareholder voting in general meetings and legal protection of their rights.2 Corporate Management and Shareholder Control The main mechanisms by which shareholders control corporate management are the board of directors. although public investors held a majority of shares. sale or disposition of a substantial portion of corporate assets. approval of management contracts. such as amendments of the articles of incorporation. and declaration of cash dividends. issuance of stocks. This section reviews practices of corporate management and shareholder control in Philippine publicly listed companies. Vol. II publicly listed commercial banks affiliated to these groups. The review is based on an ADB survey of listed companies in the Philippines conducted in 1999 for this study. 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.3. removal of directors. and financial disclosure. investments of corporate funds in other companies or purposes. The Philippine Corporation Code mandates the board of directors to exercise its control over a corporation. They are likewise liable if they pursue financial interests that conflict with their duty as directors. determination of compensation to board members. issuance of corporate bonds. 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. business groups had only minority ownership. However. Actual control of the banks was still held by the groups. voluntary dissolution. .
Chapter 3: Philippines 187 actual practices of board functions and the role of shareholders may diverge somewhat from the legal framework. or a per diem for meetings (18 percent). protecting shareholder interests.7 percent). Financial compensation is another means by which shareholders can motivate boards and board members to manage companies in their interests. or representatives of creditors. Such a short tenure may to some extent suggest that large shareholders want to keep their board members under close control. with a maximum of 36 percent.6 for board chairpersons and 7. 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.9 percent). In a few cases. The longest was 27 years for board chairpersons and 14 years for board directors. The ADB survey results show that a chairperson is compensated either by a fixed fee (52 percent of respondents). or percentages of shareholdings (28. the average number of years of holding office was 6. . a fixed fee plus performance-related bonuses (30 percent). According to the ADB survey. or the Government without approval by shareholder general meetings. But half of respondents indicated that they also had board directors directly nominated by controlling shareholders or management. appointed by the Government. board directors were the founder of a company. Board chairpersons in a substantial number of responding companies did not own significant amounts of shares in their personal capacities. and determining remuneration for board directors and senior management.5 for board members. ensuring that a company follows legal and regulatory requirements. More than half of respondents indicated that board directors were elected during the shareholder general meetings. 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. appointing senior management. in a descending order. The majority of respondents indicated that board directors and chairpersons were elected mainly on the basis of either relationship with major shareholders (31. Respondents of the ADB survey ranked the following as the most important responsibilities of the board: making strategic decisions. In practice. a typical chairperson owned 3 to 5 percent of outstanding shares of a company on average. The average stipulated term of office of the chairperson and members of the board for most responding companies was one year.7 percent). Making day-to-day management decisions was not regarded as an important board responsibility.
II Compensation for the chairperson was determined either by the board (54 percent of respondents). the parent company or company bylaws (21 percent). These committees were established only recently. and reviews the findings of external audits. The ADB survey shows that in 41 percent of the responding companies. or management (15 percent). only 35 percent of responding companies have set up board committees. There was no case found in the ADB survey where a minority shareholder invoked such a provision of the Corporation Code. audit. 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. by tenure and compensation. large shareholder-dominated companies often view such committees as unnecessary formalities. Senior Executives The Corporation Code does not specify the role and responsibilities of senior executives. namely. the chairperson of the board was also the chief executive officer (CEO). Ninetythree percent of the respondents had one or more outside directors. Companies may set up special board committees to strengthen due diligence procedures. The nomination committee searches and reviews candidates for key management positions. Unlike in Western corporate models. But the independence of these outside directors is often doubtful. negotiates the audit fees and scope of audits. 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. the CEO 9 The three most common board subcommittees are the compensation. This suggests that large shareholders control CEOs by means other than shareholdings. however. and nomination committees. or amount of shareholding (15 percent). In some companies. In the ADB survey. About half of the active committees were audit committees and the other half nomination committees.188 Corporate Governance and Finance in East Asia. It is also not clear whether the outside directors were elected before or after the financial crisis. A CEO that was not the chairperson of the board was selected on the basis of professional expertise (42 percent of respondents). Vol. The compensation committee reviews and recommends remuneration plans of key officers and employee stock option plans.9 In practice. The audit committee selects external auditors. . relationship with controlling shareholders (35 percent). When the CEO was not the chairperson.
including electronic means. The “golden parachute” was apparently not a common feature of CEOs’ compensation packages. . Fifth.. shareholders have preemptive rights to maintain their proportionate ownership of a company under any financing plan that may be undertaken by the company. About 60 percent of respondents of the ADB survey considered maximizing shareholder values as the CEO’s most important responsibility. i. But about 27 percent viewed it to be ensuring steady growth of the company. They can vote through proxy. of directors representing minority shareholders. Fourth. Shareholder Rights and Protection Under the Corporation Code.e. Second. shareholders may exercise appraisal rights. and prohibits the removal. equal to three years’ pay. if the CEO’s contract was preterminated. Third. (iii) invests in another company for a purpose different from that of the corporation. shareholders enjoy a number of rights and protection.2 years. Only one respondent indicated that its CEO was entitled to a substantial amount of compensation. The average service length of CEOs was 5.Chapter 3: Philippines 189 was not related to the chairperson by blood or marriage in all of the cases except one. first. or (iv) enters into a merger or consolidation with another corporate entity. (ii) disposes of or mortgages a substantial portion or all of corporate properties and assets. 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. the Corporation Code requires that the following types of transactions involving potential conflict of interest between shareholders and management be reviewed and approved by the board: (i) dealings of a company with directors or officers. the Corporation Code allows cumulative voting for directors. The longest service rendered was 27 years. (ii) contracts with companies linked through interlocking directorship. Among others. The majority of responding companies compensated their CEOs by using a fixed salary plus a performance-related bonus. without cause. to help ensure the representation of minority interests in the board. Companies are not allowed to issue shares with different voting rights. the rights to demand payment for shares of those who do not agree with the board’s decisions when a company (i) amends the articles of incorporation. and (iii) involvement of directors in businesses that compete with the company. 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.
Dissenting minority shareholders did not necessarily have recourse to a third party for an objective appraisal of their shares. SEC proceedings were costly and time-consuming. a shareholder could file a derivative suit against a director to redress a wrongdoing. An effective market for corporate control may provide some protection for minority shareholders against the expropriation of their interests by the incumbent management. Regardless of the amount of shares held. Although transactions involving potential conflict of interest need to be reviewed and approved by the board. 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. During annual general meetings where minority shareholders could exercise their rights. the Corporation Code allows a company to waive this in the article of incorporation upon registration or in a subsequent amendment. II shareholders are allowed to inspect a company’s stock and transfer books. minority shareholders were often vulnerable to the expropriation of their interests by controlling shareholders and management. it is doubtful whether this legal protection for shareholders will achieve what it intends to in practice. there are no requirements for disclosing such transactions to shareholders under the Corporation Code. Consequently. But an action by the regular court on a petition by the company’s owners/officers prevented SEC from pursuing the investigation. Few minority shareholders actually exercised their appraisal rights. because of poor compliance and enforcement as well as some loopholes in corporate laws. no one has been successfully prosecuted for insider trading.190 Corporate Governance and Finance in East Asia. The company was dissolved before indictment. However. There was little chance that a proposal from minority shareholders could ever get approved. board members are likely to be under pressure to approve transactions that benefit controlling shareholders to the detriment of minority shareholders. Last. because of the dominance of large controlling shareholders. Being appointees of controlling shareholders. In the past. Sixth. in cases of corporate takeovers. Those who did were usually offered below-market values for their shares. There was only one case. that of Interport Resources Corporation. in the Philippines. In practice. there were often no real discussions of board proposals or actions. In cases of derivative suits against directors for wrongdoings or actions against insider trading. hostile takeovers are not common because in most companies ownership is concentrated . In the case of preemptive rights. Vol. where SEC made substantial progress in investigation. the Revised Securities Act has strict provisions designed to deter insider trading.
0 63.4 No 0.6 30. About 333 shareholders per company voted by proxy.2 69.0 48. An average of about 4. representing about 24 percent of outstanding shares.900 shareholders per company did not vote during the last annual general meeting.13 ADB Survey Results on Shareholder Rights Percentage of Respondents Shareholder Rights One Share One Vote Proxy Voting by Mail Preemptive Rights on New Share Issues Prohibition of Loans to Directors Mechanisms to Resolve Disputes with Company Independent Audit Mandatory Independent Board Committees Severe Penalty for Insider Dealings Source: ADB Survey of Philippines Publicly Listed Companies. The ADB survey provides further evidence on shareholder rights.4 percent of shareholders but 58 percent of outstanding shares. The brokers or securities companies were the most important proxy voters. demonstrates the feasibility of developing a market for corporate control if publicly listed companies were widely held. Table 3. Yes 100.8 30. The responding companies had on average 43.2 7.522 shareholders each. followed by management and banks.3 56. Nominees held about 45 percent of the outstanding shares.13 summarizes rights that the shareholders of the responding companies enjoyed.Chapter 3: Philippines 191 in a few controlling shareholders and families. An average of 327 shareholders per company attended the last annual meeting and they represented about 63 percent of total shares. and their activism in the corporate sector.8 56.6 Independence of Auditing The ADB survey revealed that all the responding companies had an independent auditor. Table 3. the successful hostile takeover by First Pacific Group of PLDT. Nevertheless. protection.0 51.8 92.0 36.7 43. About 93 percent of the respondents contracted . appointed either by the board or shareholders during the annual general meetings. representing 3.4 70.2 43. a company that is widely held but has a large shareholder. 1999.
or the accounting standard of a specific developed country (for example. II their annual audit to an international auditing firm. More than 20 percent of the respondents have been dealing with their auditors for 20 years or more. Nevertheless. independent audits do not guarantee the absence of questionable accounting practices. although closely related. a preferred independent auditing firm either reported assets that did not exist (Victorias Milling Corp. long-term leases. and consolidation policy. a bankruptcy case) or hid a large amount of liabilities and losses (PLDT. In two celebrated cases.192 Corporate Governance and Finance in East Asia. Meanwhile. as practiced in the Philippines). From publicly listed companies. there are many cases of poor financial reporting by large companies. 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. imposing penalties on violators. On average. the information statement transmitted to every shareholder should contain the audited financial statements. In practice. These different versions of GAAP. Because of such long relationships.e. SEC requires all registered companies to periodically submit reports for the purpose of updating their respective registration statements filed at the agency. financial reporting standards allow room for interpretation by independent auditors. the local standard (i. with the longest being 50 years.. investments in subsidiaries. vary in their evaluation of some major accounts such as securities and other liquid assets.. the responding companies have been associated with their present auditors for 13 years. Most major international auditing firms operate in the Philippines. a management discussion of the business. The accounting profession in the Philippines is considered fairly developed and Manila is a known regional center for accounting expertise. a hostile takeover case). intra-company receivables and payables. namely. The Code grants a shareholder the right to inspect business records and minutes of board meetings. Vol. and an analysis of financial statements. the US GAAP). intangible assets. revaluation of fixed assets. Nevertheless. the international accounting standard. foreign currency-denominated liabilities. independent auditors are likely to be quite familiar with the operations and financial aspects of their clients. the agency also requires reports on important details about their operations and management. . An auditor can choose among three alternative sets of GAAP.
which are closely held by large shareholders and family members. from a minority-controlled to a majority-owned subsidiary.g. “Selective public listing” is a strategy of many business groups for channeling funds from public investors to member companies. because of the highly concentrated ownership of Philippine corporations. Even for widely held public companies. Holding companies enable controlling shareholders to collectively own shares of other companies in a business group and to centralize the group’s management. Family-based controlling shareholders use them as vehicles for controlling business groups.and medium-sized businesses did not have quality financial statements. 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. However. e. Such expropriation is due to gaps between control rights and cash flow rights that pyramiding structures of business groups centered on holding companies create. Controlling shareholders usually select member companies that require large . Laws of many Southeast Asian countries allow the establishment of pure holding companies (with the exception of Korea up to 1999).. They allow risk pooling and can achieve economies of scale in management. namely SEC and the Philippine Institute of Certified Public Accountants (PICPA). the authorities. which are controlled by large shareholders with public investors in a minority position. as large shareholders had no need for financial statements to monitor their companies and management that were under their own control.Chapter 3: Philippines 193 Many small. sometimes did not penalize independent auditors for poorly prepared audited financial statements.6 billion. arguably. marketing. The popularity of holding companies in the Philippine corporate sector is evident: with a market capitalization of P258. they also make it easier for controlling shareholders to expropriate interests of minority shareholders. they formed the largest group of corporate entities in the Philippine stock market in 1997. which are usually controlled by holding companies. Publicly available financial information was often of low quality. Pure holding companies can be privately owned. accounting for 27 percent of the total stock market capitalization that year. and financing. Corporate Control by Controlling Shareholders As in many other Asian countries. and publicly listed. When control rights exceed cash flow rights. controlling shareholders in the Philippines usually exercise their corporate control through the setting up of business groups.
Some holding companies are not pure holding companies. II equity investment for public listing. is privately owned. In an active minority-owned operating company.4 percent of Bank of the Philippine Islands. They are operating companies but at the same time have majority or minority share ownership in other operating companies. and a passive minority investment at 15 percent in Honda Cars (Philippines)..6 percent of Globe Telecom. Ayala Corporation’s majority. Selective public listing combined with use of pure holding companies to own and control member companies lead to various organizational structures of business groups. Inc.1). controlling shareholders of the parent company do not participate in management. They may have a representative in the board. Public investors collectively hold a minority of 41 percent. It is majority-owned by Mermac.and minority-controlled operating companies are also holding companies. It has a majority control at 71. controlling shareholders of a parent company hold these shares as “strategic investments” that they could increase or reduce depending on business opportunities.2 percent. These investments can be classified according to the role of the controlling shareholders in the management of the invested company. In a passive minority-owned operating company. Controlling shareholders gain additional leverage in management control over minority-owed companies.194 Corporate Governance and Finance in East Asia. financing. Honda Cars (Philippines). The first three companies are publicly listed while the fourth. of Cebu Holdings (a publicly listed government-owned company). minority control at 42. This is most evident when a minority-owned company transacts with other members of the group where the controlling shareholders hold majority control. the parent company plays an active role in management. Depending on the performance of the company. an active minority share at 44. a family-owned pure holding company.1 percent of Ayala Land. 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. Ayala Corporation is a publicly listed pure holding company. Minority-owned companies may also need access to resources of the group. The stylized features of control structure of business groups in the Philippines can be illustrated by using a leading Philippine family-based conglomerate. active minority or passive minority holdings. namely. controlling shareholders of the parent company may eventually increase their shares to a majority position. . as an example (Figure 3. Ayala Land fully owns Makati Development Corporation and holds a minority stake. with 59 percent of shares. especially its management. Ayala Corporation. In cases of minority ownership. Vol. at 47. and customers.
1 Corporate Control Structure: The Case of Ayala Corporation Family Members 100% Mermac. (15%) MinorityControlled Operating and Holding Company Bank of the Philippine Islands (42. .04%) <50% Ayala Corporation >50% Publicly Listed Pure Holding Company >50% MajorityControlled Operating and Holding Company Ayala Land (71.06%) <50% >15% &<50% Active MinorityOwned Pure Operating Company Globe Telecoms (44.Figure 3.2%) >50% MajorityControlled Pure Operating Company BPI Family Savings Bank (100%) <50% MinorityControlled Pure Operating Company Note: Data as of 31 December 1998.96%) Privately-Held Pure Holding Company Public Investors (41. (47. Inc..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. (58. Inc.
Who Owns and Controls East Asian Corporations? 11 Ibid. The Separation of Ownership and Control in East Asian Corporations. [control right] [control rights via Ayala Corporation] = [cash flow right] [cash flow rights via Ayala Corporation] = [42.7 times its cash flow rights by virtue of the double layer pyramid structure of the Ayala group.11 The Lopez family’s control rights over MERALCO was 5. they exercise far greater control (two to five times more) than they are entitled to by virtue of their ownership rights.76%)] [39. First Philippine Holdings Corporation. Generally.44%] = [42. Being in the public utilities sector.12 These examples show that even when large shareholder groups are minority shareholders.2).5% x 14. Simeon Djankov. Vol. See also Stijn Claessens. [control right] [cash flow right] = = = = = [sum of control rights via Benpres and First Holdings] [sum of cash flow rights via Benpres and First Holdings] [1.64% +37. II Bank of the Philippine Islands owns 100 percent of the BPI-Family Savings Bank. Rockwell Land. Lang. and Larry H. Fan. 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.7 times its cash flow rights by virtue of its cross-holdings via Benpres and First Holdings. and a minority-controlled holding company.196 Corporate Governance and Finance in East Asia.14%] / [6. 1998.98% x 42.44%] / [58. and Larry H. a privately owned company. Benpres Holdings. The situation offers large shareholders tremendous incentive to move resources 10 For details. The control of companies through indirect corporate shareholdings. Joseph P.3% x 5.5%] / [(88. companies in the Lopez Group are large and minority-controlled. and 1999c. however. and First Philippine Industrial Corporation are indirectly held by a majoritycontrolled holding company.5%] [39.44%] / [25%] = 1. Lang: 1999a. indirect shareholdings do not appear to be a prevalent practice in the Philippine corporate sector. defined as control by large shareholders of an operating company through minority ownership by several companies. Diversification and Efficiency of Investment by East Asian Corporations.10 The Ayala family’s control rights over BPI was 1. MERALCO.14%] / [1. is illustrated in the Lopez Group (Figure 3. 1999b. P. Simeon Djankov.8%] 5.3% x 1.64%) + (37. Expropriation of Minority Shareholders: Evidence from East Asia. P.7 times Ibid. see the World Bank research papers by Stijn Claessens.7 times 12 . H.
Figure 3.76% Operating Company MinorityControlled 24.5% First Philippine Industrial Corporation 50% 50% Note: Data as of 31 December 1998.2 Corporate Control Structure: The Case of Lopez Group Public Investors Family Members Lopez.7% 62. Privately-Held Pure Holding Company 88. Inc.3% 11.5% 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% Operating Company MajorityControlled Operating Company Rockwell Land Corporation 24.64% MinorityControlled 14. .
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. Most respondents (81 percent) indicated that they had renegotiated with their creditors on loan repayment when they faced liquidity problems. and (ii) how the legal framework protects creditor interests and rights. 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. However. accessed nonbank creditors for specific purposes but dealt with commercial banks on a long-term basis. the data suggest. SEC could suspend the rights of a creditor to demand payment from a borrower in accordance with the terms of the loan . it was not common for creditors to take legal action against debtors or foreclose on those assets held as collateral in cases of default.3. a publicly listed company dealt with an average of eight banks and six nonbank financial institutions. Sixty-one percent of respondents indicated that creditors usually asked for collateral for all types of loans. The controlling shareholders could also use the resources of minority-owned subsidiaries to engage in overexpansion and empire building investments. II from their subsidiaries to their majority-owned publicly listed holding company or elsewhere up the pyramid. Control by Creditors According to the ADB survey. Most responding companies had dealt with their commercial bank creditors for more than five years and nonbank creditors for only about two years. Suspension of Payments of Debts Under PD 902-A. Some 85 percent of respondents believed that creditors had no influence or only weak influence on corporate management.198 Corporate Governance and Finance in East Asia. whether for working capital or capital expenditure. 3. Vol. while 80 percent reported that creditors with which they had renegotiated loans were still willing to lend to them. Only a minority of respondents (18 percent) indicated that they had faced adverse creditor actions such as a collection lawsuit or foreclosure of collateral. The average company.
Under this mode. The first mode is for simple suspension of payments.4 3. Commercial banks hold about three fourths of the resources of the financial system. There are two modes of suspension of payments under PD 902A. The second mode is for suspension of payments with the appointment of a management committee (Mancom) or rehabilitation receiver. Inc. SEC could intervene to avoid asset dissipation. The borrower will propose a rehabilitation plan to SEC. a company’s assets are of sufficient value to cover all of its debts. wait for 14 years from the time the company petitioned for suspension of payments in 1984. The corporation continued to be under rehabilitation receivership as of June 1999. SEC and the court required that the creditors of BF Homes. This explains why creditors invariably oppose any move by borrowers to file for suspension of payments at SEC.4.1 Corporate Financing The Financial Market and Instruments The Philippine financial market has remained underdeveloped compared with other countries in the region. profitable companies from going public. In practice. including the rehabilitation of the corporation. Consequently. which determines the viability of the rehabilitation plan and appoints a Mancom or a rehabilitation receiver to implement the proposal if approved. Publicly listed companies do not represent a cross section of the Philippine corporate . Markets for equity and debt instruments are small and there are serious structural problems that discourage large. under which. it is not clear whether the corporate borrower’s assets are of sufficient value to cover its liabilities. the litigation process.. There are no legal or practical limits to the time period of suspension of payments. The law on suspension of payments envisions resetting the corporation’s business for a temporary period to prevent its irreversible collapse. 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. For example. bank credit is the main source of corporate financing. a real estate-based business group. Under such circumstances. the borrower requests to defer payments for a certain period to enable it to generate the necessary liquidity. PD 902-A granted SEC blanket powers to intervene and adjudicate claims.Chapter 3: Philippines 199 agreement. could take an indefinite period. 3.
The market capitalization of the Philippine stock market in August 1997. From the 1970s up to the early 1990s.7 billion. Rising stock prices during the Ramos administration reflected to some extent the business optimism. and less engaged in risky investments. Even in the real estate sector. 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. companies expanded only at a moderate pace. however. Interest rates. They invested in only a few large companies whose shares were relatively liquid. about the size of Thailand’s. Philippine companies were less leveraged. The Government financed its chronic fiscal deficits by issuing short-term Treasury bills. The corporate sector raised a substantial amount of . the minimum required to qualify as a public corporation. this is because. Korea) ($143 billion).14 shows that the average volume of daily trading in 1997 stood at P2. Most companies invested only in projects that met hurdle rates as high as 20 to 30 percent and had short payback periods. Most publicly listed companies issue only up to 20 percent of total shares to the public. Malaysia. while interest rates were at high levels and volatile. and fiscal management were among interrelated factors explaining the underdeveloped state of the Philippine financial market. Foreign portfolio investments also remained small. Of the 221 companies listed in the Philippine Stock Exchange in 1997. and Indonesia ($61. but not to the same extent as it did in other Asian economies. less exposed to foreign debt.000 companies. the country experienced double-digit inflation. inflation. In part. As a result. The crisis affected the Philippine corporate sector. The period 1993-1997 was one of lower inflation and declining lending rates. especially short-term debt. compared with other economies. Korea and Thailand).. preferred stocks. The Philippine stock market is not a liquid market.5 billion). and convertible securities.g. is far ahead of the flock. Table 3. Equity financing through IPOs was active. 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. However. the Republic of Korea (henceforth. compared with Malaysia ($186 billion). Equity instruments include common stocks. most listed companies are controlled by their five largest shareholders. Foreign funds were wary of the Philippine stock market because of its limited liquidity. Vol. only 84 had sales large enough to be placed in the top 1.4 billion (or $59 million using the average exchange rate). II sector. The stock market was depressed up to the early 1990s.200 Corporate Governance and Finance in East Asia. was one of the smallest in the region at $47.
8 102.7 391.4 728.3 0.5 1.1 0.2 3.0 2.9 12.0 0.9 2.5 72.8 0.686.9 114.5 12.3 59.3 314.7 41.421.3 4.7 0.6 261.9 608.2 57.8 799.7 2.Table 3.445.077.1 0.2 925.2 61.373.351. Source: PSE databank.8 1.2 0.3 Market Capitalization (year end.171.8 1.9 1.121.0 161.0 0.545.474.5 571.386.8 1.692.2 1.4 9.6 1.5 16.5 Year 369.2 1.7 1.4 Ratio of Market Capitalization to GDP 0.1 0.515. 1983-1997 Daily Trading Volume (P million) — — — — 129.1 88.7 207.2 ($ million) — — — — 6.3 2.0 1. Note: Combined transactions of Makati and Manila Stock Exchanges are not available for the years 1983 to 1986.1 0.1 5.3 — = not available.6 1.248.3 158.14 Philippine Stock Market Performance.9 2.5 1. P billion) 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 19.2 0.3 0.5 26. P billion) Gross Domestic Product (current prices.2 59.906.4 1.251.088.9 682. .0 0.1 524.2 297.
leases. However. Because existing shareholders wanted to retain their proportionate control over their companies. Vol.. The picture of the financial system that emerges is thus one of limited capital markets. Under SEC regulations.202 Corporate Governance and Finance in East Asia. moreover. The largest buyers have been commercial banks. The corporate bond market was stunted. and debt as sources of corporate financing by using flow of funds analysis. sells these commercial papers through brokers. are in a position to provide such discipline. This is because only companies with strong capitalization and predictable cash flows such as public utility companies can issue bonds. by volatile interest rates and the absence of a secondary market. From 1988 to 1997. which were the principal source of corporate financing in the Philippines. issuing companies had to undergo a process of review and credit rating by the Credit Information Bureau Inc. and the dominance of large commercial banks. 3. Debt instruments include negotiated credits and debt securities. corporate bond issuing was even more limited.6 billion. Capital markets cannot provide the market discipline that corporate investors need. because business groups often own large commercial banks. Corporate bonds are another type of debt securities. a strong regulatory system for bank supervision is imperative. which ultimately influences the pricing of commercial paper issues. II equity capital through IPOs during the stock market boom from 1993 to the first half of 1997. However. lack of competition among financial institutions. and inventory financing. asset-backed credits.4. of which 85 percent was raised from 1993 to the first half of 1997. Few companies offer preferred stocks because the Philippine tax system does not allow tax deductibility of dividends on preferred stocks. and high transaction costs. tight regulations. Negotiated credits. discounting of receivables.2 Patterns of Corporate Financing The study looked at retained earnings. the rights issue was a popular way of raising equity capital. which buy commercial papers either for their own account or for their clients. Debt securities include commercial papers and corporate bonds. by virtue of their large stakes in the financial system. about 127 companies went public with a total value of offerings of about P134. Only the commercial banks. which in most cases is an affiliate of the issuing company. new equity. The underwriter. The measures used in the analysis are: . Only a few large companies floated commercial papers because of the limited market. include bank credits.
1 0. As shown in Table 3. the SFRT was low at Table 3.8 0.4 0.3 0.0 0.000 Corporations in the Philippines from 1988 to 1997.3 0.4 0. it is one minus IDFR.2 0.1 Average 1.4 0. On the other hand. It measures a company’s capacity to finance growth in fixed assets by internally generated funds.5 0. New equity financing ratio (NEFR): ratio of changes in stockholders’ equity (excluding retained earnings) to changes in total assets.5 0.5 0.4 0.6 0. Retained earnings were sufficient to finance the entire growth of fixed assets in the corporate sector. It measures a company’s reliance on borrowings in financing asset growth.4 1. .8 0. Incremental debt financing ratio (IDFR): ratio of changes in total liabilities to changes in total assets.3 0.5 0. Self-financing ratio of total assets (SFRT): ratio of changes in retained earnings to changes in total assets. during this period.1 0.9 0. Incremental equity financing ratio (IEFR): ratio of changes in shareholders’ equity inclusive of retained earnings to changes in total assets.15.2 0.0 0.5 0.3 0.3 0. 1989-1997 Financing Indicators SFRF SFRT NEFR IDFR IEFR 1989 1990 1991 1992 1993 1994 1995 1996 1997 1.Chapter 3: Philippines 203 (i) (ii) (iii) (iv) (v) Self-financing ratio of fixed assets (SFRF): ratio of changes in retained earnings to changes in fixed assets.5 0. It measures a company’s capacity to finance asset growth by equity capital. the average SFRF was high at 109 percent.2 0.2 0.9 0.1 0.4 0.5 0.5 Source: SEC-BusinessWorld Annual Survey of Top 1.4 0.000 Corporations in the Philippines.7 0.9 0.5 0.2 0.6 0.3 0. 1988-1997.5 0. All Companies Financial flows data were derived from the SEC-BusinessWorld Annual Survey of Top 1.9 0.1 0.6 0.1 0.3 0. It measures a company’s capacity to finance asset growth by internally generated funds.4 0.5 2.15 Financing Patterns of the Corporate Sector.8 0. By definition.
and 1997. The corporate sector consistently relied on debt and new equity to finance asset growth throughout the period.000 Corporations in the Philippines. debts were the most important source of financing. On Table 3. As a result.3 0. except for foreignowned companies that had a negative new equity financing ratio. 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 1997.2 (0. privately.0) 0. the SFRF was higher.7 0.6 0.16. Corporate Financing by Ownership Type As shown in Table 3. There were significant year-to-year variations. the level of corporate leverage increased. Vol. with debt providing 93 percent of the financing requirements. In 1997. internal funds were not a significant source of financing growth in total assets.5 0. In all the years.5 Foreign-Owned 1. 1991. 1988-1997.1 a Excludes negative balances.2 0.8 0. In periods of an economic crunch such as in 1989. suggesting that there was a deterioration of financial performance in the Philippine corporate sector in the years running up to the crisis.3 0.3 0. Source: SEC-BusinessWorld Annual Survey of Top 1. except in 1991.204 Corporate Governance and Finance in East Asia. II only 19 percent. when it financed 45 percent of it. The corporate sector used new equity to finance 32 percent and new debts to finance 49 percent of growth in total assets. Total assets grew by 23 percent that year. Companies financed fixed assets from internal sources in hard times. retained earnings declined and few new equity investments flowed into the corporate sector. for all three types of companies—publicly listed. reflecting the capital flight caused by political instability in the early 1990s.and foreign-owned.3 0. This was mainly caused by the declining contribution from retained earnings.16 Corporate Financing Patterns by Ownership Type. implying that internal funds were far from sufficient to finance growth in total assets. Retained earnings were the least important. .5 Privately-Owned 0.9 0. 1989-1997 Financing Indicators SFRF SFRTa NEFR IDFRa IEFRa a Publicly Listed 1.
0 Source: SEC-BusinessWorld Annual Survey of Top 1.0 8.4 3.0 9.3 48.0 1993 14.3 51.4 12.5 27.0 53.9 16. It presents a composition analysis of assets and financing sources for the period 1992-1996.9 12.0 9.5 16.6 37.0 13.7 100.9 16.0 12.5 9. A breakdown of the financial structure of publicly listed companies measured in balance sheet items is shown in Table 3.0 1995 1996 13.0 38.3 12. .8 51.3 12. This financing pattern supports the earlier finding that foreign-owned companies had the highest leverage among the three types of companies.0 10.4 2.5 41.2 100.0 9.0 6. 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 14.1 7.8 39.1 10.9 100.6 48.8 46.8 26.1 49.8 17.3 10.8 100.9 38.0 100.3 10.9 16.6 0.2 12. significantly Table 3.9 3.1 50.7 13.4 100.1 15.4 41.3 11.7 2.7 13.9 24.2 51.3 12. compared with 47 percent for publicly listed companies and 55 percent for privately-held firms.8 4.1 9.8 16.2 3.5 12.0 9.8 3. 1988-1997.2 42.6 43.0 1994 19.3 13.4 2.7 23.4 10.17.0 10.9 4.4 100.17 Composition of Assets and Financing of the Publicly Listed Sector. especially bank loans.000 Corporations in the Philippines.9 0.8 0.7 4.3 4.6 48. The sector built up its short-term debts.8 0.Chapter 3: Philippines 205 average.2 100. contributing 90 percent of growth in total assets.4 100.6 26.4 100.4 43.5 0. publicly listed companies relied more on new equity financing than privately.2 3. Foreign-owned companies relied more heavily on debt financing.1 13.7 7.8 3.and foreign-owned companies.7 2.8 38.
Group companies financed an average of 45 percent of growth in total assets by debt. Corporate Financing by Control Structure Conglomerates have certain advantages in financing because of the opportunities offered by the internal capital markets.000 Corporations in the Philippines. compared with an average of 54 percent for independent companies. As shown in Table 3. Group companies were generally more profitable than independent companies. 1988-1997. 1989-1997 Financing Indicators SFRFa SFRTa NEFR IDFRa IEFRa a Group Member 1.2 0. The traditional measure of liquidity. 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. the easier access to external credit. indicating that many publicly listed companies were likely to be in a tight liquidity position. On average.9 0.5 Excludes negative balances Source: SEC-BusinessWorld Annual Survey of Top 1.45 in 1996.3 0.5 0. The SFRF for independent companies would have been even lower if the highly profitable foreign-owned companies were excluded.13 was at 1.6 Independent Company 0. and economies of scale in fund raising.18. group companies were less reliant on debt financing than 13 Defined as total current assets divided by total current liabilities. the current ratio.3 0. II in 1996 and became more vulnerable to the financial crisis in 1997. as opposed to 94 and 30 percent. group companies usually financed their investment in member companies by equity rather than debt. Vol.18 Financing Patterns by Control Structure.5 0. Table 3. Further. respectively. their inherent ability to pool risks. . for independent companies.206 Corporate Governance and Finance in East Asia.1 0. For these two reasons. The normal standard liquid position is a current ratio of 2 or higher. the average SFRF of business groups was higher compared with that of independent companies.
19 Financing Patterns by Firm Size.47. These results support the earlier finding that the leverage of business groups was lower than that of the independent companies from 1988 to 1997. compared with 55 percent for large companies and 47 percent for small ones.1 0.4 Small 0. Excluding .000 Corporations in the Philippines. These years were 1991 with 110 percent. On average. medium-sized companies used more debts. Corporate Financing by Firm Size SFRF was highest for medium-sized companies.5 0. and 1997 with 131 percent. 1988-1997.9 0. Large companies’ IDFR of 0.55 was substantially higher than the small companies’ 0. 1989-1997 Financing Indicators SFRFa SFRTa NEFR IDFRa IEFRa a Large 0.08 and SFRT of 0. Corporate Financing by Industry The manufacturing sector had an average SFRF of 1.8 0. With assets growing at a fast pace during this period. equity financed 42 percent of incremental asset growth. The medium-sized companies’ high debt financing ratio was due mainly to three years of complete reliance on debt to finance growth.3 0.88 for large companies (Table 3.2 0.3 0.2 0.76 for small companies and 0.06.2 0. Large firms consistently increased their reliance on debts from 1994 to 1997. There was also increased reliance on debt financing. The lower SFRF for large companies may be caused by their larger outlays for growth in fixed assets.5 Medium 3.3 0. averaging 61 percent of growth in total assets. Source: SEC-BusinessWorld Annual Survey of Top 1. The corresponding ratio was 0.5 Excludes negative balances.50 (Table 3. with an average of 3.Chapter 3: Philippines 207 independent companies.6 0. Table 3.6 0.20). 1993 with 96 percent.19).
58 and SFRT of 0. Total liabilities increased partly as a result of the local currency devaluation and financed all of asset growth for the year. debt financed about 78 percent of asset growth in real estate. Since the real estate boom coincided with that of the stock market. In the eight years preceding the crisis.04. the industry generated internal funds. The utilities sector showed weaknesses in internal fund generation in 1989-1994. Its SFRF and SFRT were volatile because of chronic losses and reduction in fixed and total assets.6 0.3 0.4 0.5 (0.27. increasing to 0.2) 0. The real estate industry financed its growth by substantial equity funds. During the crisis year. Vol. when debts declined. the incremental equity ratios of the industry were high. the total debt ratio was much higher in 1996 at 0.4 0.47 two years later. with an SFRF as low as 0. Table 3. Source: SEC-BusinessWorld Annual Survey of Top 1.29.91. Excluding 1997 when fixed assets declined.5 Utilities and Real Estate Services and Property 0. while SFRT averaged only 0. the manufacturing industry financed 57 percent of its total asset growth by debt. many of the leading real estate companies successfully went public during that time. While this level is considered prudent. Equity financed the rapid expansion in the industry’s assets in the period 1994 to 1997. The effects of the crisis of 1997 were adverse.32. The sector had the highest leverage among all industries that year. achieving an average SFRF of 3.3 0.000 Corporations in the Philippines.3 0. The construction sector was a heavy user of debt financing. .6 0.79 and in 1997 at 0. Equity financed an average of 62 percent of total asset growth.4 3.3 0. Low incomes diminished the equity financing position of the manufacturing industry toward the crisis year. 1988-1997. SFRF for the sector averaged 0.5 0. II 1991.4 Construction 0.208 Corporate Governance and Finance in East Asia.6 0.7 0.20 Financing Patterns by Industry. The situation improved beginning 1994. Incremental equity financing amounted to an average of 44 percent of total asset growth.1 0. Up to 1997.6 a Excludes negative balances.4 0. ranging from 41 to 118 percent. 1989-1997 Financing Indicators Manufacturing SFRFa SFRTa NEFR IDFRa IEFRa 1.5 0.
ROA = return on assets. These results suggest that companies with higher ownership concentration tend to be more highly leveraged and. and the Failure of Internal Control Systems. Exit.004 3. Profitability. Table 3.14 Large shareholders may borrow excessively to undertake risky projects. the degree of ownership concentration. Using the PSE database.769 0. Journal of Finance 48: 831-880. ROE.Chapter 3: Philippines 209 3. As shown in Table 3.009 5. and leverage. . 1992-1996.860 Leverage = the ratio of total assets to total equity. Source: Author’s estimates based on the PSE databank. measured by the percentage of shareholdings of the largest five shareholders. and Financial Leverage Dependent Variable Item Coefficient of Ownership Concentration T-statistics Adjusted R-squared F-statistics ROE 0.21 Ownership Concentration. ownership concentration = the total shareholdings of the top five shareholders. creditors bear the consequences.130 ROA 0. was regressed against measures of profitability and of financial leverage.287 0. knowing that if an investment turns out to be successful they could capture most of the gain.421 0. ROE = return on equity.3 Ownership Concentration.00036 2. The Modern Industrial Revolution. Financial Leverage. Large shareholders may also overuse financial leverage to avoid diluting ownership and control. Three regressions were run with the shareholding of the largest five shareholders as an independent variable and ROA.4.00056 1. 14 See for example Michael Jensen (1993). more profitable.21.008 5.230 Leverage 0. as the dependent variable. alternatively. at the same time. while if it fails. and financial leverage are all positively and significantly related to the degree of ownership concentration. the coefficient of the ownership concentration measure in all the three regressions is positive and statistically significant. ROA. and Performance Previous studies on corporate governance have often associated ownership concentration with heightened risk-taking by companies.00125 2. ROE.
the country’s GDP growth pace indicated that it did not have a “bubble economy. Because of limited local capital.” that is. Compared to other East Asian crisis-affected countries. Exports were growing at about 20 percent per year in the three years preceding the crisis. 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. The Government explained that the country had “sound economic fundamentals” but that the problems were caused by “contagion.5 3. raw materials. Manufactures accounted for about 85 percent of exports. In 1997. II 3. The structure of the economy may be understood by looking at its sectoral composition and export competitiveness.8 percent of GDP from 1995 to 1997. their growth gathering momentum only beginning in 1992. Garments was the second largest export sector at about 9 percent.” The Government’s judgment that economic fundamentals were strong was based on stable growth rates.210 Corporate Governance and Finance in East Asia. Although much lower than those of other Asian countries. industry at 34 percent. About 80 percent of imports were capital goods (particularly power generating and telecommunications equipment).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 1997.5 percent per year from 1992 to 1997.5 billion in 1996 and grew at an average of 48 percent per annum from 1992 to 1996. which averaged 4. The export sector had a very narrow breadth. but its share had been declining by 4 percent per year since 1995. more than half (52 percent) of exports were semiconductors. In sum. The largest contributors to GDP were services at 43 percent. Net investment inflows were $3.5. Net trades in goods and services averaged a deficit of 4. foreign investments in the country have been low. and intermediate goods. and agriculture at 21 percent. an overexpansion of capacities. Historically. Commercial and industrial activities in the country were largely oriented to domestic markets. the economy still showed vestiges of its import-dependent and substituting character. After a . Vol. The country experienced balance of payments surpluses but these were due to transfers. with commodities accounting for the balance. the country was less dependent on foreign private capital. with a narrow exporting industry base. the growth in foreign investments fueled that of the manufacturing and services sectors in the years preceding the crisis. notably remittances of overseas workers.
the ratio of short-term debts to international reserves dipped below 100 percent beginning June 1998. From 1988 to 1996. while sales grew by only 20 percent per year.8 percent. In the Philippines. Financial institutions called on their shortterm loans and shortened the maturity of existing loans. and a relatively healthy banking system. After hovering in the range of 100 to 127 percent. From 1993 to 1997. 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. a positive balance of payments from 1992 to 1996. Prudent fiscal management and controls on foreign borrowings were part of the adjustments required by IMF and foreign creditors. The corporate sector was in a relatively stable financial condition around the time of the crisis.5 percent. Closer analysis. in turn. During this time. the Government sought stability and achieved this in 19921997. . a government fiscal surplus from 1994 to 1997. The Central Bank conserved international reserves by allowing the local currency to float within a wider trading margin. shows that investments of the corporate sector were growing at a faster rate than sales revenues in the years immediately preceding the crisis.Chapter 3: Philippines 211 long period of debt moratorium and restructuring that started in 1983 and ended in 1991. assets grew at a compound annual rate of about 31 percent. Profitable operations since 1992 had allowed it to build equity. an average inflation rate of 7. 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 1997.3 percent. depended on the quality of the corporate sector’s investments. The lessons from debt restructuring became the basis for the Government’s economic policies.1 percent. fueled also by successful IPOs during the stock market boom of 1993-1996. the country and the corporate sector had no access to foreign currency debts from the international financial market. Since the regional financial crisis was triggered by the loss of confidence in some East Asian economies by foreign creditors and investors. an average Treasury bill rate of 13. resulting in stability in the short-term debt to reserves ratio.6 billion as of March 1997. Five years of stable growth before the crisis enabled the country to build its net international reserves to $10. Eventually. unlike their counterparts in the region. adjustments were focused on the quantity and quality of the banking system’s corporate loans. however. the Government restructured its debts into longer tenors with a maximum of 25 years. average ROE was 13. Total debts were only 52 percent of assets or 108 percent of equity. Economic performance during 1992-1997 was characterized by an average growth rate of real gross national product (GNP) at 3. which.
101 92.5 billion in 1995.517 1.749 26.212 Corporate Governance and Finance in East Asia.650 32. Foreign investments in the Philippines have not been as high as the inflows to other Asian countries—and this.” 3. the other immediate impact of the crisis was that on foreign investment flows. or 114 percent of net foreign direct investment (FDI). . These patterns in investment and financing are similar to those of other countries in the region. II The corporate sector indeed overexpanded after 1993 like its counterparts in the region. In 1997. Debts financed a large part of this expansion. net FDI remained stable at more than $1 billion.22 Foreign Investment Flows. precisely.074 2. 1997 = 29.5.2 Impact of the Crisis on the Corporate Sector Aside from the foreign exchange adjustment. It is understandable then that the effect of the Asian financial crisis on the Philippines was correspondingly that of a negative “contagion. Vol. Table 3. In sum.303 23.0 1996 3.7 Note: Peso-dollar exchange rates used are: 1995 = 25. 1996 = 26. It financed 26 percent of corporate capital growth. Net foreign investments more than doubled from 1995 to 1996 but declined by 78 percent in 1997 (Table 3.300 1.06. Data for 1998 cover only January-August. 1995-1998 Item Net Foreign Investments ($ 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 1.485 145. 1998 = 41.22). The debt level of the Philippine corporate sector in 1997 was low by Asian standards but still high by developed country standards. Most of this leverage happened during the boom years in the region.101 billion or 196 percent of net FDI in 1996.22.71.073 (406) 121.4 1997 762 1. mitigated the effects of the pullout and liquidation of investments in the aftermath.0 1998 739 555 328 69. growing by about 34 percent per year from 1994 to 1997.609 1. Sources: Bangko Sentral ng Pilipinas and SEC. But portfolio investment amounting to $406 million flew out of the Philippines. but to a lesser degree. 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. It rose to $2.718 30. Net foreign portfolio investment amounted to $1.47.
Manufacturing reduced its loans outstanding by 11 percent from October 1997 levels. they were willing to restructure and renegotiate existing loans by corporate borrowers. the sectors with the highest outstanding loans had reduced their credit exposures. Because of weak internal fund generation. The real problem of the corporate sector during the crisis was the rise in interest rates.513 billion. albeit at current market interest rates. Companies deferred investments in new fixed assets. suggesting that commercial banks required a higher premium at about the height of the crisis but not beyond. 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. which held about 75 percent of the assets of the financial system in 1997. the commercial banking sector’s capital remained strong at 17. When the Treasury bill rates eased in March 1998.2 to 28. ROE at 6. Net profit margins were at a 10-year low at 4. By October 1998.9 percent. and the wholesale and . ranged from 11 to 13 percent from 1993 to July 1997. Loan calls. meanwhile. Although corporate borrowers were not highly leveraged.3 percent of assets. Loans outstanding of commercial banks declined by the first quarter of 1998. lending rates also came down. Lending rates were well above the 20 percent level from July 1997 to March 1998. Bank loan pricing was based on the bellwether 91-day Treasury bill rates rather than inflation. The banking system was able to absorb the impact of the crisis primarily because of its strong capital position. 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. Because commercial banks were strongly capitalized. The resources of the financial system that year totaled P3.7 percent in January 1998. in turn. Bank spreads over Treasury bill rates increased in 1997 but were within the range experienced in the past. new borrowings financed asset growth.369 billion. The interest rates on Treasury bills. the corporate sector became vulnerable to loan calls and high interest rates. depended on the liquidity and capital position of commercial banks.2 percent was barely above inflation rate.Chapter 3: Philippines 213 Corporate financial performances and conditions deteriorated during 1997. By March 1988.2 percent in November 1997. Average bank lending rates climbed to their peak of 25. With the increase in borrowings and reduced liquidity. in varying degrees for each sector. The combined effects of shrinking demand and high interest rates reduced the corporate sector’s demand for loans. and leverage increased to 149 percent compared with 109 percent in 1996. then rose to a high of 22.
6 percent in June 1998. real estate loans averaged 11. single-digit NPL ratios began only since 1989. to reduce their lending spreads over the 91-day Treasury bill rates from 3-8 percent to 1. The Central Bank also moved to control inflation and bring down domestic interest rates by reducing the statutory reserve requirement by 3 percentage points and raising the liquidity reserve ratio by the same amount. and subsequently went down to 13. loans outstanding of the real estate sector increased by 11 percent from June 1997 to June 1998. 3.3 Responses to the Crisis Government Responses The Government’s policy and regulatory responses to the crisis focused on monetary and credit issues. thereby reducing overall intermediation costs. including (i) a regulatory limit of 20 percent on banks’ loans to the . This “voluntary agreement” partly explains why the loan spreads of banks were within the range of recent experience. through the Bankers’ Association of the Philippines. This allowed the Central Bank to convince the banks.5.5-6 percent. Vol.9 percent of bank loan portfolios. The pattern indicates that real estate loans were of substandard quality but banks had contained the problem by mid-1998. and the financial system. The latter measure was especially beneficial to companies with unhedged foreign currency loans from commercial banks. the fiscal position. was a problem sector. However. As for nonperforming loans (NPLs). set limits on overbought/oversold foreign exchange positions of banks. by 12 percent.5 percent by September 1998.214 Corporate Governance and Finance in East Asia. and set up a hedging facility for borrowers with foreign currency-denominated loans. Still. the ratio increased to a high of 11. the aggregate effect of the crisis on NPLs was of a magnitude comparable only to the country’s last major banking crisis in 1984-1986. These peaked at 14. These figures show that adjustment problems were industry-specific and that the real estate industry. II retail trade sector. The move retained the liquidity position of banks but lowered their cost of reserves. In March 1997. The Central Bank introduced regulations on foreign exchange trading to control speculation and nondeliverable forward contracts. But the Philippine banking system had gone through worse crises in the past. and its experience of low. as with its counterparts in other Asian countries.3 percent in December 1997. The Central Bank adopted other measures to strengthen the financial system.
6 percent growth in 1999.Chapter 3: Philippines 215 real estate sector. and giving up noncore businesses. In response to calls for lower bank intermediation costs. (ii) shortening the period for classifying unpaid loans as past due from three months to one month. was known to have a policy . consolidating business units. changing technologies. the Asian crisis opened a unique opportunity for foreign investors. A 40 percent devaluation of the Philippine peso lowered the purchase price of PLDT to foreign investors. the largest telecommunications setup in the Philippines. Large companies with heavy loan exposures such as Philippine Airlines Inc. The acquiring company. With prudent monetary management. (v) improving disclosure requirements on the financial position of banks. the country’s flag carrier. Average Treasury bill rates have cooled since mid-1998. The policy directions and actions taken by the Government appear to have ushered in recovery. With its weakened financial position. bank loan rates have also come down. and the legal framework for reorganization and liquidation conditioned its response to the crisis. its accessibility to foreign capital. which was privatized with the Lucio Tan group gaining control and the Government retaining minority ownership. the Government kept inflation below 10 percent. came up with a rehabilitation plan by May 1999 that was found acceptable to all parties. and (vi) issuing guidelines on duties and responsibilities of banks’ boards of directors for improved quality of bank management. subcontracting and outsourcing. First Pacific Corporation. (iv) increasing banks’ capital requirement by 20 percent for universal banks (banks with expanded licenses) and 40 percent for ordinary commercial banks. The real estate portfolio of commercial banks also declined and was well below the Central Bank’s regulatory ceiling by March 1998. Responses of the Corporate Sector The corporate sector’s financial position. took more action. Publicly listed Philippine companies could also be restructured through takeovers by local and foreign investors. Takeovers in the past involved cooperative negotiations between purchasers of a target company and family-based large shareholders. Financially strong companies were able to survive the crisis by effecting such internal restructuring. The economy avoided a recession in 1998 and achieved 3. 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. (PAL). (iii) fixing loan loss provisions of 2 percent of the gross amount of loan portfolio on top of individually rated bad loan accounts. In the case of PLDT. PAL.
Ownership is highly concentrated and a few dominant players control major industries. the stock price of PLDT was buoyant during the takeover period. By itself. The question. When companies are highly profitable. One mode was the outright purchase of shares in the open market. the Cojuangcos. First Pacific could have acquired sufficient shares to take control of PLDT in three ways. 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. eventually took over PLDT and announced a restructuring plan for the entire group of companies. and Recommendations Summary and Conclusions The Philippine corporate sector has been shaped by the country’s economic and industrial development policies. concentrated ownership of companies is not equivalent to weakness in corporate governance. Although considered the prime industrial company in the Philippines. at a premium over the market price to reflect the value of management control.1 Summary. he restructured the company toward its core brewery business and sold off local and foreign subsidiaries. Conclusions.6 3. using some or all of these means. In a legal process that ended in his takeover of management. however. II of investing to control companies that are dominant players in their industries. Eduardo Cojuangco was able to assert his ownership of shares taken over by the Government during the transition of power in 1986. Corporate governance is conditioned by the high ownership concentration of these large companies. First Pacific. When Cojuangco took over. A second method was to purchase the shares of other large minority shareholders. 3.216 Corporate Governance and Finance in East Asia.6. Its stock price and returns to shareholders had stagnated. 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. Vol. the Soriano family. Consequently. A third method was to make a formal tender offer to PLDT’s controlling minority shareholders. SMC is another widely-held company managed by a minority shareholder. is whether there are sufficient safeguards to prevent controlling shareholders from . controlling shareholders can capture these profits by excluding public investors from ownership. SMC had lagged behind other groups of companies such as Ayala Corporation in financial performance for some years.
influenced by industry characteristics. By size. 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 financing pattern of the corporate sector was influenced by the tight financial conditions prevailing in the country up to 1992. The Philippine corporate sector was relatively efficient in investing and financing compared with other countries affected by the Asian crisis. ownership of banks by business groups. with the real estate and public utilities industries standing out for their pronounced cyclical patterns. Corporate governance should be viewed in the context of an increasing presence and growth of large shareholders-centered conglomerate business organizations. Leverage was within Asian norms but above developed country standards. Returns to capital exceeded inflation rates. The corporate sector consistently relied on internally generated funds and equity before resorting to borrowings. were the least profitable. companies that are members of family-based conglomerates had higher returns and lower leverage than independent companies. Ownership of publicly listed companies is highly concentrated. the most numerous in the corporate sector. Analysis of corporate financing by ownership . Privately-owned companies. Performance was. The five largest shareholders have majority control of an average publicly listed company.Chapter 3: Philippines 217 expropriating the wealth of minority shareholders through aggressive and risky investment. medium companies showed higher profitability than large and small ones. This study points out weaknesses in external control mechanisms such as weak legal protection for minority shareholders. an underdeveloped capital market. Business groups occupied seven of the top 10 and 25 of the top 50 largest corporate entities in the Philippines in 1997. Publicly listed companies had the highest profit margins and lowest leverage among the local companies. By control structure. foreign companies were the most profitable but highly leveraged. an ineffective insolvency system. With large shareholders in control. and the lack of market for corporate control. oligopolistic market structures. minority shareholders need to be protected by external control mechanisms. By ownership structure. Financial institutions are not significant shareholders. The result is that corporate governance depends only on internal controls. passive independent auditing. to some extent. while the largest 20 shareholders control more than 75 percent of shares. This study analyzed trends in corporate performance and financing in relation to corporate governance from 1988 to 1997.
and the extent of supervision of outside institutions such as independent auditors and SEC. statistical analysis of company-level data revealed significant relationships between corporate performance and corporate governance. superior profitability. the bank usually accounted for a large share of each group’s net profits. After controlling for industry effects. Such structures result in control by large shareholders through disproportionately smaller investments in equity ownership. The extent of governance problems depends on internal control policies of the controlling shareholders. Companies whose large shareholders have higher degree of control tend to borrow more but generate better returns. The difference between management control and ownership rights is usually substantial. Publicly listed companies were responsive to investors’ requirements for prudent use of debts. family-based shareholders gain control by such means as the setting up of holding companies. and centralized management and financing. Vol. The pyramid model is useful for centrally managing smaller companies. Ownership concentration was positively related to both returns and leverage. II type gave similar results. the amount of pressure from stock market investors and PSE (for publicly listed companies in the group). ROE. A commercial bank is an important part of most business groups. Internal financial markets operated by business groups allowed them to optimize their financial resources at lower external debt levels. Even in cases where the group owned only a minority share of a commercial bank.218 Corporate Governance and Finance in East Asia. selective public listing of companies in the group. and leverage were all positively related to the degree of ownership concentration. Large. and sustained growth. 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. Large companies owned or controlled by business groups tend to dominate their industries. as typified by the Ayala Group. 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. ROA. Family-based business groups have focused their investments in industries where their superior financing capacities and political/social influence give them unique advantages. with the foreign-owned companies found to rely more on borrowed funds. . Business groups with pyramiding structures heighten the issue of corporate governance. A business group is an effective business organizational model for achieving leadership in industries.
the government budget in surplus. a strong international reserves position. adversely affecting companies’ operations and financial position. strong capital position built on IPOs in a buoyant stock market. Still. Specific actions recommended are described below. The corporate sector was also in good financial condition with rich internal cash flows accumulated from a number of profitable years.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. As the crisis wore on in 1998. The corporate sector accessed the foreign debt market only in the mid-1990s because of the country’s long-drawn debt moratorium. 3. A number of large debtors petitioned SEC for rehabilitation under procedures set by PD 902-A. For example. decide on the financial future of a troubled debtor. including suspension of payments. 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. 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. with recently restructured public debt. SEC officials.Chapter 3: Philippines 219 The financial crisis came when the Philippine economy was in a relatively strong financial position. resulting in the banks’ accelerated restructuring of troubled debts in this sector. SEC’s quasijudicial functions. rather than the banks that lent millions of pesos. and sound overall creditworthiness.6. are to be removed and transferred to courts. The Central Bank responded by improving the liquidity of the system and by establishing conditions for bringing down interest rates on bank loans. there were sharp rises in the number of bankruptcies and petitions for debt relief. That is. This law is flawed in concept because it supplants a market-based credit agreement with a political process. low inflation. The crisis caused a tightening of credit to the corporate sector and a spike in interest rates. Under the new Securities Regulation Code enacted in 2000. There are systemic risks involved in highly concentrated ownership. mostly by highly leveraged companies and speculative investors in real estate. decisions by large sharehold- . and a market-oriented policy environment. The Central Bank imposed strict limits on real estate lending.
To help ensure this. The adjustment should be made over a fixed period of time. Because independent directors tend to adopt the perspective of minority shareholders in board decisions. inadequate disclosures. Another measure would be to impose a statutory limit on the number of directorships that one can accept. and (iii) increase the minimum required percentage of outstanding shares for public listing in the stock exchange from the present 10-20 percent. they serve to curb the powers of controlling shareholders. This may limit current practices of appointing prominent individuals and family members as directors. Increasing the Statutory Accountability of Directors and Strengthening the Board System The Government should clarify statutory fiduciary responsibilities of the board of directors. Vol. SEC should strengthen disclosure requirements by issuing specific guidelines on minimum disclosures required for related party transactions. to 25 percent. This will enable SEC to enforce prudential requirements on management of companies and enable minority shareholders to pursue grievances against their boards. II ers often cause wide volatility in stock prices and invite reaction from creditors. It has suffi- .220 Corporate Governance and Finance in East Asia. depending on the size of the company. (ii) require disclosure of material changes in ownership. Clear legal accountability is a precondition for successful shareholder activism. insider information. the PSE Listing Rules require the appointment of a minimum number of independent directors in the board of publicly listed companies. PSE Listing Rules should specify criteria and a selection process that will help ensure that the nominees for the position are truly independent and qualified. The following recommendations involve amendments to the Corporation Code that will improve transparency of ownership and address the current high level of ownership concentration in Philippine business: (i) require disclosures of underlying ownership of shares held by nominees and holding companies. To strengthen the board. 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 self-dealing.
Impose severe penalties for any attempt by banks to circumvent this regulation. prudential measures and regulations. officers. in particular.. It is encouraging that the newly enacted 2000 Banking Laws have introduced changes along these lines. and (v) closely monitor. and related interests. or prohibit cross-guarantees by companies belonging to affiliated groups. They need legal empowerment such as higher majority voting requirements. the Corporation Code should be amended to impose sufficiently stiff penalties for self-dealings that patently expropriate the wealth of other shareholders. For example. reporting. (iii) adopt international standards of capital adequacy and ensure that banks comply with these standards. raising the current two-thirds majority to a three-fourths majority. limit. current rules allow boards of directors to approve own-dealings or related party transactions by simple majority. The following recommendations aim to further improve banking regulations and supervision in the Philippines: (i) limit shareholdings of nonfinancial companies in banks. The Government should improve its prudential supervision system to ensure that banks perform their role as external control agents of their corporate debtors. (iv) require banks to follow international financial accounting. Finally. and disclosure standards. the board can easily muster the needed majority to approve the deal. fit and . in areas of supervisory functions of the central bank. 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. and of banks in nonfinancial companies in order to avoid connected lending. (ii) set strict limits on lending by banks to affiliated companies. By requiring sufficient disclosure and a 75 percent majority vote on such decisions.g. Minority shareholders have failed to use traditional venues such as the annual general shareholders’ meetings to discipline controlling shareholders that expropriate their wealth. Improving Financial Regulation and Strengthening Implementation The Asian crisis demonstrated the need to strengthen banking regulation. Because ownership is generally concentrated in five shareholders. e.Chapter 3: Philippines 221 cient case history that can be used as a basis for tightening its disclosure requirements. directors.
By supporting the establishment and operation of institutional investors. management. 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. Other investors benefit from the information that analysts produce for these institutional investors as information technology makes their output a public good. Presently. an active financial analyst community can begin to form. In developed capital markets. institutional investors can be a driving force in providing market discipline to management. SEC and PSE can help ensure that these external control agents provide market discipline even in companies controlled by large investors. and external auditors. The current law should expand class action suits to include management and . This way. Institutional investors impose market discipline by voting on strategic corporate decisions. 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. Two measures should be adopted to promote shareholder activism. Investment and venture capital funds meet this description.222 Corporate Governance and Finance in East Asia. Managements find that their investment and financing decisions affect stock prices and become aware of their responsibility to create shareholder value. Its priority is to protect prospective fund investors from unscrupulous fund managers. One is improved transparency and disclosure on specific items that potentially involve expropriation of wealth of minority shareholders. The other is the addition of provisions in the Corporation Code to facilitate class action suits against corporate directors. II proper rule. The absence of institutional investors indicates that the legal and regulatory basis is inadequate. If institutional investors are present. foreign ownership of banks. and lending to DOSRI. SEC appears to be taking a primarily regulatory posture in the operation of investment funds. 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. transparency. institutional investors lead public investors in providing market signals to companies. Vol.
and broad-based political and popular support to pursue possible cases involving expropriation of minority shareholders’ wealth. Legal provisions for class action suits should cover self-dealing by directors. There are existing institutions such as Dun and Bradsreet. their directors and 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. And by issuing Government Treasury securities in longer tenors. information disclosures. Companies are likely to remain dependent on bank financing if the authorities do not strictly enforce prudential lending regulations. These groups have an incentive to gather technical expertise. SEC should allow minority shareholders to be represented by activist groups. Securities market development efforts should coincide with strict regulation of the commercial banking sector. leadership. It should develop a medium-term yield curve for the corporate debt market by strengthening the Government bond market. Promoting Competition in Product Markets The Government should pursue industrial development policies that promote competition through the elimination of subsidies. compensation contracts. The Government should enhance the securities markets as an alternative source of corporate financing and pursue aggressive development of the local debt securities markets. Philippine Government Treasury bonds should provide bellwether rates for corporate bonds in the way that they have for short-term bank debts. where the threat of class action suits alone is sufficient to encourage quality decisions and behavior from management. the Government could develop the market for future issues of corporate bonds. and the external auditors. and Credit Information Bureau that can be the starting point of this effort. and dividend decisions. Promoting the corporate bond market requires that the Government develop trading systems and services of credit risk rating of corporate issuers.Chapter 3: Philippines 223 auditors. 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. entry . The present provision on class action suits is inadequate because shareholders view the process as ineffective and expensive. Placing the means for prosecuting in the hands of minority shareholders may instill more discipline in controlling shareholders. guarantees.
Increasing the Supply of Quality Equities in the Stock Market To promote the capital market as an external control agent in corporate governance.and medium-scale companies can become more competitive relative to large companies. Vol. there is a need to increase the supply of quality securities from top-tier local companies in the Philippine stock market. II and exit barriers. Many large companies remain privately owned. Audited financial statements contain basic information about a company’s financial position and performance. Little attention is given to the conditions that make those regulations effective in the US corporate sector but not present in the Philippines. and various other forms of protection. 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. so that small. The Government’s competition policies should aim to facilitate the free entry and exit of domestic and foreign companies and regulation of anticompetitive practices. Lack of liquidity deters institutional investors. improve enforcement of the rule of law. The increase in percentage of public holdings may be gradually implemented to enable the companies to adjust. Current disclosure requirements of SEC are not rigorous enough for public investors. and publicly listed companies trade barely the minimum number of shares required for public listing. PSE and SEC need to build a liquid and efficient market. Improving External Audit Standards and Information Disclosure Effective external control in corporate governance requires accurate and timely information about companies. Another problem is the orientation of external auditors to the interest of large shareholders rather than public investors. The resulting absence of a strong investor base makes share prices vulnerable to manipulation or insider trading by large shareholders. Efforts to reduce graft and corruption. The Government should also continue to improve infrastructure. 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.224 Corporate Governance and Finance in East Asia. SEC should require that a larger percentage of publicly listed companies’ shares be sold to the public. and provide quality basic services should also be heightened. Penalties for poor conduct of auditing by independent .
Reforming the legal framework for suspension of payments. reorganization. and implement those standards and penalties rigorously. and transferred these to courts. SEC and PICPA need to formulate more specific disclosure standards. suspension of payments and private damage actions. For that matter. PD 902-A has not accomplished any successful rehabilitation of a petitioning company since its implementation. review the system of penalties on professionals involved in a company’s violation of disclosure rules. In spite of the many well-known cases of poorly audited financial statements that resulted in losses for investors. Although the new Securities Regulation Code enacted in 2000 has removed some of SEC’s quasijudicial functions. including the resolution of intracorporate disputes. it creates a moral hazard problem. Instead. violators were made to pay only nominal penalties. 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. Improving the Legal Framework for Suspension of Payments. SEC and PICPA have not publicly penalized any auditor company that violated disclosure requirements or failed to submit audited financial statements. The law on suspension of payments replaces a market-oriented solution with a political process. Reorganization.Chapter 3: Philippines 225 auditors and the mechanism for imposing them are weak. the new law needs to be effectively implemented and enforced. . and Liquidation. and liquidation of troubled companies should be made a priority of the Government.
Journal of Political Economy 93 (6). XXIX. P. . Lang. 1998c. 1999. Demsetz. Joseph P. Joseph Fan. 1999. edited by Toida Mitusuru and Daisuke Hiratsuka. Diane K. Lang. Stijn. Stijn. Dennis Gromb. Vol. 693-728. Manila: Asian Development Bank. David J. 1998a. Thailand’s Corporate Financing and Governance Structures: Impact on Firms’ Competitiveness. Denis. and Larry H. 1994. Large Shareholders. Equity Ownership. and Larry H. Joseph P. Fan. Asian Industrializing Region in 2005. Emilio. Barclay. Lang. Pedro. World Bank. Joseph P.226 Corporate Governance and Finance in East Asia. Diversification and Efficiency of Investment by East Asian Corporations. and Larry H. World Bank. Claessens. Stijn. Working Paper. Antonio. Simeon Djankov.. and Atulya Sarin. Tokyo: Institute of Developing Economies. H. Harold. Jr. World Bank. Michael. George. Stijn. May. P. The Structure of Corporate Ownership: Causes and Consequences. and Simeon Djankov. 1998b. 1997. 1985. II References Abonyi. Monitoring and the Value of the Firm. Private Benefits from Control of Public Corporations. and Fausto Panunzi. Simeon Djankov. Bangko Sentral ng Pilipinas. 1998. Key Indicators of Developing Asian and Pacific Countries 1998. Fan. Simeon Djankov. M. and Corporate Diversification. P. Thailand: From Financial Crisis to Economic Renewal. P. World Bank. and Clifford Holderness. P. Expropriation of Minority Shareholders in East Asia. Burkart. Claessens. Vol. Claessens. Journal of Financial Economics 25: 371-395. Ownership Structure and Corporate Performance in East Asia. Dennis.. March. Fan. Stijn. and Larry H. 1999. Conference on Thailand’s Dynamic Economic Recovery and Competitiveness. October. Who Owns and Controls East Asian Corporations? Discussion Paper 2054. 1988. Alba. World Bank. 1997. Asian Development Bank. Journal of Finance 2 (1). 1989. The Philippines: Onward to Recovery. July. Claessens. Claessens. Working Paper. Institute of Southeast Asian Studies. Lang. Discussion Paper. Simeon Djankov. Agency Problems. and Larry H. Working Paper 2088. Philippine Macroeconomic Prospects: The Next Ten Years. H. Lang. Quarterly Journal of Economics. and Kenneth Lehn. 1998. The Separation of Ownership and Control in East Asian Corporations. Stijn Claessens. H. Simeon Djankov.
and David Scharfstein. Jensen. Stein.). Michael. and Merton Miller. Hart. Joseph C. Journal of Financial Economics 11: 5-50. Agency Costs of Free Cash Flow. The Modern Industrial Revolution. Euromoney Books. David S. Jensen. Capital Structure and the Information Role of Debt. 1994. November. Corporate Finance and Takeovers. Theory of the Firm: Managerial Behavior. 1986. 1995. Internal versus External Capital Markets. Institutional Investment Patterns and Corporate Financial Behavior in the United States and Japan. Harris. 1958. and the Theory of Investment. Prowse. Michael. Journal of Finance 48: 831-80. American Economic Review 76: 323-29. and John Moore. Corporate Structure. American Economic Review 48 (3): 261297.. Stephen. Philippine Stock Exchange Fact Book 1997. Michael. Gestner. and the Failure of Internal Control Systems. Anil Kashyap. Corporation Finance. 1991. Financial Intermediation and Delegated Monitoring. Agency Costs and Ownership Structure. Journal of Finance 45: 321-350. 1990. 1976. World Bank. Michael. 1983. and David Gallagher (eds. Jensen. 1990. Stuart. . Jensen.. Review of Economic Studies 51: 393-414. 1993. Journal of Financial Economics 27: 4366. Debt and Seniority: An Analysis of the Role of Hard Claims in Constraining Management. The Market for Corporate Control: A Scientific Evidence. American Economic Review 85: 567-85. and Richard Ruback. Franco. 1995. and William Meckling. Prowse. Exit. International Corporate Governance. F. and Artur Raviv. Stephen. Takeo. Journal of Financial Economics 3: 305-360. The Quarterly Journal of Economics. Lufkin. Milton. Modigliani. Determinants of Corporate Borrowing. Quarterly Journal of Economics 106: 33-60. Oliver. Journal of Financial Economics 5: 147-175. 1977.Chapter 3: Philippines 227 Diamond. and Jeremy C. Douglas. Robert H. Scharfstein. The Cost of Capital. 1998. Corporate Governance: Emerging Issues and Lessons from East Asia. 1990. 1994 and Investment Guide 1997. 1984. Myers. Liquidity and Investment: Evidence from Japanese Industrial Groups. Hoshi.
DC. IFC/WB. Shleifer. Large Shareholders and Corporate Control. 2. David. November. Stiglitz. Ajit. 1. Technical paper No. and Robert W. Mimeograph. Journal of Money. DC. 1.228 Corporate Governance and Finance in East Asia. 1998. 1997. Some Conceptual Issues in Corporate Governance and Finance. March. Internal Capital Markets and the Competition for Corporate Resources. Journal of Political Economy 94: 461-88. 1992. Journal of Finance 91: 1121-1139. Webb. Andrei. A Survey of Corporate Governance. and Banking Lecture 17. The Structure of Ownership in Japan. Credit. World Bank. No. Andrei. 1996. 1997. . Jeremy C. Journal of Finance LII. How Do Large Corporations in Developing Countries Finance their Growth? Corporate Financial Structures in Developing Countries. Singh. Vishny. II Prowse. May. 1998. Stein. Asian Development Bank. No. 1991. Journal of Finance L11: 737-783. Credit Markets and the Control of Capital. East Asia: The Road to Recovery. Joseph E. Stephen. Vishny. Washington. and Robert W. Shleifer. Vol. Washington. 1985.
short-term private debt obligations grew to about 60 percent of total private sector debts. and David Webb of the London School of Economics for their guidance and supervision in conducting the study. the Thai baht came under pressure from speculative attacks. both of ADB. annual short-term capital inflows to Thailand were equivalent to 7-10 percent of gross domestic product (GDP). 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. The fixed exchange rate policy.1 Introduction In May to July 1997. Chonburi. But it also laid bare weaknesses in both the financial and corporate sectors. the Stock Exchange of Thailand for its help and support in conducting company surveys. Asian University of Science and Technology. but also the stalling of East Asia’s “economic miracle. The majority of these debts were not properly hedged. magnified the impact of these problems on the economy when the crisis hit. the banking system merely validated the financial risks. Malaysia.4 Thailand Piman Limpaphayom1 4. For the period 1994-1996. coupled with financial liberalization and deregulation in the absence of an effective regulatory and supervisory system. the Thai Government conceded and adopted a floating exchange rate regime. had been plagued with prudential problems for a long time. Thai corporations were collectively overexposed to exchange rate risks. with Thai corporations overutilizing short-term foreign currency-denominated loans. The author wishes to thank Juzhong Zhuang. . Republic of Korea (henceforth. poorly regulated and sheltered from competition. The corporate sector also contributed significantly to the crisis. The banking system. and Philippines all depreciating significantly. As a result. and Lea Sumulong and Graham Dwyer for their editorial assistance. David Edwards. It was inefficient in financial intermediation. Thailand.” After mounting an aggressive defense of the currency. Korea). heralding not only a financial crisis in the country. In the prelude to the 1997 crisis. with the currencies of Indonesia. Thailand’s crisis exposed similar vulnerabilities in other East Asian economies. 1 Associate Professor. Faculty of Business.
To protect domestic industries. its growth and financial performance. The First and Second Plans (1961-1971) Under the first two plans. with government policy providing support but avoiding direct interference.2. Section 4.230 Corporate Governance and Finance in East Asia. . The National Economic and Social Development Board was created to plan the country’s economic and social development. Section 4. The study then considers policy recommendations with emphasis on corporate governance improvement. 4. the Government implemented major infrastructure projects and modified its tax policy to encourage capital investment and savings. the Government increased tariffs on products that could be produced locally.1 Overview of the Corporate Sector Historical Development The corporate sector has long been considered the engine of Thailand’s economic growth. Section 4. II There is now a consensus that weak governance was partly responsible for the corporate sector’s poor financing and investment practices. Key factors that led to weak corporate governance include the ineffectiveness of the regulatory framework.3 looks at corporate ownership patterns that resulted in inadequate protection for minority shareholders and weak corporate governance in Thailand. while new industries were encouraged to reduce the need for imports.2 4. focusing mainly on the companies listed in the Stock Exchange of Thailand (SET). as well as its legal and regulatory framework.2 discusses the development of the Thai corporate sector under the National Economic and Social Development Plans.5 discusses how the corporate sector contributed to the financial crisis and looks at its impacts. and a family-based corporate ownership structure. Vol. lack of transparency and adequate disclosure. Section 4. The country initiated national economic development planning in 1961 when the economy was growing rapidly.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. Import tariffs on machinery and heavy equipment were removed. This study examines these and other factors that might have weakened corporate sector governance in Thailand.
Consequently. gross national product grew by about 7 percent per year.5 percent in 1973 and 24. Unemployment. the industrial sector grew at a faster rate than the agricultural sector. resulted in increases in the current account deficit.6 percent per year. Budget deficits remained a major problem during the Fifth Plan. At the same time.4 percent of GDP. the government’s debt burden escalated. textiles. with the agricultural sector the major contributor. with the devaluation of the baht in 1984 a major step in this direction. and increases in world food and oil prices. however.15 billion per year or 4. capital inflows. and reduced current account deficits. Fourth. including a weakening of the dollar. Thus. using tax policy to control prices of consumer goods and implementing several price control measures to curb inflation. canned foods. the value of the baht remained stable. it proceeded with its development plan for the industrial sector. Budget deficits also increased throughout the Fourth Plan. The results were increased exports. The average budget deficit reached an all-time high of $2. the current account registered a surplus in 1986. leaving the Government no choice but to resort to overseas borrowings. including luxury goods.4 billion from overseas and increased taxes on numerous items. chemicals. the Government borrowed $6. The Third. To close the fiscal gap. However. The Government decided to embark on restructuring measures in the Fifth Plan (1982-1986) to rehabilitate the ailing economy. remaining high until 1981.3 percent in 1974. lower than anticipated due to a worldwide economic recession. and Fifth Plans (1972-1986) An economic downturn at the end of the Second Plan led to an adjustment in policies. however. As a result. . and automobile assembly) emerged. External factors. But the sustained importation of heavy machinery and equipment resulted in large trade deficits. Inflation reached 15. Average growth for the period was 4 percent per year. processed steel. Industrial sector growth was also rapid and many industries (tires. especially foreign aid from the United States. an improved trade balance. In the wake of lower world oil prices and the rapid growth in income from the tourism and travel industry. The Government had to shift emphasis to restoration of economic stability. The decline in imports was steady. Inflation levels were low. helped offset these deficits.Chapter 4: Thailand 231 During this period. The focus shifted to export promotion. averaging 1. became a major problem as domestic investment declined.
while exports expanded considerably. respectively.7 and 11. Average annual growth in real GDP was 8 percent. Growth of exports and imports averaged 14. Singapore. United States. Thailand’s rapid growth up to the mid-1990s made the country one of the world’s fastest-growing economies. reaching an annual inflow of $2 billion in 1991.2 and 13. Thailand became a debtor’s market. increasing its share in total export value from 42 to 76 percent. property development. compared with the 8. combined with its liberal financial policies. From 1989.6 percent target of the Seventh Plan. Inflation was 4. with private foreign debt reaching $92 billion by the end of 1996. The Seventh Plan (1992-1996) The economy’s performance from 1992 to 1996 generally met the targets of the Seventh Plan. . compounded by a slump in property sales. The manufacturing sector became a dominant force in the economy. an oversupply of housing emerged.5 percent. By 1995. the Government successfully balanced the budget and even settled its foreign debt of $4 billion before this was due. better than the 5.5 to 13. rather than to productive activities.2 percent per year.4 percent targets. Private sector investment grew at an average annual rate of 7 percent. China—went to export-oriented manufacturing industries. The country’s high ratings in the international capital market. II The Sixth Plan (1987-1991) Industrial sector productivity improved gradually during the Sixth Plan period.8 percent. Growth rates during 1987-1991 ranged from 9.232 Corporate Governance and Finance in East Asia. from only $31 billion in 1992. the bulk of domestic investments went to speculative ventures such as real estate. and Hong Kong. Most of the FDIs—originating mainly from Japan. and the stock market. Europe. compared with the 14.6 percent. Vol.2 percent target. On top of its predominantly “borrowed” nature. lower than the target of 8. The exchange rate was steady at around B25 to the dollar. invited a deluge of capital seeking profitable investments.8 percent. With loans increasingly becoming expensive and hard to come by due to a lending squeeze by the central bank and high interest rates. averaging 10. the property sector began to collapse in 1996. Key to this growth performance was the government’s adoption in 1993 of an aggressive program for attracting foreign capital to finance domestic investments. The country also attracted a large amount of foreign direct investments (FDIs).
prepared a comprehensive report entitled “A Capital Market in Thailand. The country had a current account deficit of about 8 percent of GDP in 1995 and 1996. Exports went into a tailspin. Foreign banks were barred from competing directly with domestic banks.” which later became the master plan for the development of the Thai capital market. Robbins. The deficits caused the Government to rely on even more external borrowing. 58 on the Control of Commercial Undertakings Affecting Public Safety and Welfare. In 1972. In May 1974. the corporate sector’s main source of funding was the banks. the signs of an economy about to falter were there. In 1978. A series of increases in customs and excise taxes on luxury imports did little to stem rampant consumer spending. its policy had always been to protect domestic banks. Before the capital market emerged. the Government amended the “Announcement of the Executive Council No. Sidney M. 4.2. a former Chief Economist from the US Securities and Exchange Commission. which raised the debt service ratio.8 percent in 1995 to 1. the capital markets didn’t play a significant role until 1975. Robbins recommended an overhaul of the existing informal stock market established earlier by a group of local brokers in favor of a centrally regulated institution.3 percent in 1996. the establishment of the Securities Exchange of Thailand (SET) was legislated and trading began on 30 April 1975. In his report. on account of an overvalued baht that weakened export competitiveness. many companies considered the Act too restrictive and a hindrance to growth. the Government passed the Public Limited Company Act. with growth shrinking from 23. SET officially became “the Stock Exchange of Thailand” in 1991. Included in the Second Plan (1967-1971) was a proposal to establish the country’s first authorized and regulated securities market.Chapter 4: Thailand 233 Toward the end of the Plan period. which was amended in 1979 and 1985. Its most crucial role was to help mobilize funds to support Thailand’s industrialization and economic development.2 Development of Capital Markets Although the corporate sector has long been the government’s main tool for economic development. placing all publicly listed companies under regulation. a policy that held throughout the first six economic development plans. And because the Government considered the banking system vital to the development of the economy. In 1969. Under the 1962 Commercial Banking Act. However. the Bank of Thailand and .” extending its control and regulatory powers to the finance and securities companies operating freely at the time.
The pressure dovetailed with the Government’s intention to make Bangkok one of the financial centers of the region.” The Government also granted financial institutions overly generous bailouts. While the Bank of Thailand had the regulatory power to influence business practices. Earlier.234 Corporate Governance and Finance in East Asia. increased financial market activities. Financial deregulation and liberalization allowed the country to attract foreign savings and investments that helped finance the growth of the economy. Vol. Thailand discarded controls on foreign exchange transactions and capital flows—a turning point for the Thai corporate sector. the financial and banking laws were generally ineffective. However. the World Bank had recommended such a move. In the 1990s. II the Ministry of Finance had full authority to supervise all commercial banks. to cater specifically to its . while the Securities and Exchange Act (SEA) the same year sought to improve capital market supervision. Economic growth had been rapid and domestic savings could not keep up with the pace to support investments. The regulatory measures were inadequately designed and poorly enforced. it usually relied on “moral suasion. A number of internal and external factors contributed to the Thai Government’s acceptance of the IMF’s Article VIII agreement. and new financial instruments. and the General Agreement on Tariffs and Trade (GATT) meeting in Uruguay had the liberalization of financial services on its agenda. Externally. creating a moral hazard problem—the perverse expectation that imprudent bank behavior would be rewarded with forbearance and bailout. 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. there were 29 commercial banks (15 domestic and 14 foreign banks) in Thailand. Thailand’s capital market entered a new era with improved legislation and regulation. The introduction of these two laws came just after the Government’s signing of Article VIII of an Agreement with the International Monetary Fund (IMF) in May 1990 to deregulate and liberalize financial markets. The resulting availability of funds propelled the corporate sector’s growth through the early part of the 1990s. At the end of the Sixth Plan. With the liberalization of financial markets. The banks and finance companies operated at insufficient levels of reserve capital and were overexposed in high-risk businesses such as real estate. Laws were enacted to stimulate growth of the corporate sector. The Public Company Act of 1992 relaxed some of the rules and restrictions contained in the original laws.
1 trillion and paid-up capital of B1.1 30. Forestry.9 34. Insurance. and Water Construction Wholesale and Retail Trade.5 50.4 trillion in registered capital and B791 billion in paid-up capital.291. Hunting. the financial sector is the largest. Ministry of Commerce. The manufacturing sector is a far second with registered capital of B350 billion and paid-up capital of Table 4.2.6 350. Social and Personal Service Total Note: The data for 2000 is as of October 2000.0 21.2 Type of Business Agriculture.5 111. and Restaurants and Hotel Transport. with B1. and Business Service Community.Chapter 4: Thailand 235 fast-growing neighbors. 1978-2000 Number Registered of Capital Companies (B billion) 5 6 245 5 13 129 22 194 42 661 1. finance. In terms of capital.6 2.5 791. 4.1 78. in that order. 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. Storage. the country became recognized as an economic development model for other emerging economies.0 19. The majority of the companies are in manufacturing.9 261.101.3 Growth and Financial Performance Since the 1978 enactment of the Public Limited Company Act. Thailand.2 11. The stock market boom from 1991 until the financial crash of 1997 reflected international investors’ response to Government policies.0 Paid-up Capital (B billion) 1. Real Estate. about 661 companies with total registered capital of B2. .9 16.3 trillion have been registered with the authority (Table 4.3 83.9 1. Gas.1 Public Companies Registered.394.1). and Fishing Mining and Quarrying Manufacturing Electricity. Source: Department of Commercial Registration. however. and Communication Financing. Financial deregulation and liberalization were key to realizing that vision. and wholesale/ retail trade and restaurant/hotel sectors.6 23. Worldwide.0 110. The result was a corresponding growth and development in Thailand’s capital markets.6 1.
2 40. The 1997 crisis battered the primary market for securities.7 billion and B27. Market capitalization. this was due to the recapitalization of commercial banks in compliance with the new loan provisioning requirement.7 7.2 Public Offerings of Securities.7 5.3 22.1 54.1 2.1 599. meanwhile.5 — — 56.2 5. II B261 billion.3 194.3).1 286.5 1. the value of public offerings rose steadily. respectively. The preeminence of the financial sector is a direct result of financial deregulation and liberalization.9 37.9 1998 1999 15.5 billion and B1 billion the previous year.8 billion. 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 1.0 1994 82.7 9. the year before the crisis struck. Securities and Exchange Commission of Thailand.7 27.3 1996 1997 65. Source: Key Capital Market Statistics.3 31.6 8. The development of the corporate sector closely followed the development of capital markets.2).8 — 26. reaching a precrisis peak in 1996 (Table 4. After the passage of the SEA of 1992. With the enactment of the SEA of 1992 that brought suppliers of finance services and their clients together. Table 4.8 151.5 1.4 34. Debt market activities also increased significantly with the establishment of the Bond Dealers’ Club (BDC) in 1994. The signing of Article VIII with the IMF.7 136.6 39.4 96.1 — — — 6.8 201. the capital market became instrumental in the rapid growth and development of the corporate sector.6 7. The number of listed companies and securities steadily increased until 1996 (Table 4.0 20. reached .8 1995 64.5 39. The stock market also became an invaluable source of funds for corporations.0 0. moreover.236 Corporate Governance and Finance in East Asia. Vol. reducing the value of offerings to a little more than a quarter of the previous year’s level.6 174. allowed Thai financial institutions and corporations to obtain funds overseas.4 277. Domestic and offshore debt issues reached B54.2 12.9 31.2 25.6 — = not available.4 51. While a rebound was apparent beginning in 1998. from only B20.3 6. These peaked at B89.7 billion in 1996.
Chapter 4: Thailand 237 Table 4. The trend reversed in 1995. as measured by return on assets (ROA). Meanwhile. The key financial ratios of all companies listed on SET bear this out (Table 4. the averages for all three profitability ratios took a downswing all the way until 1996. the average times interest earned (TIE) was down to 5.3 Statistical Highlights of the Stock Exchange of Thailand.360 1. But instead of shifting to a low gear.535 1. and gross profit margin.281 832 373 356 482 Due to listing requirements and other reasons. By the early 1990s. gross profit margin rose until 1991 before falling in 1992. when long-term debt grew as Thai corporations began to borrow heavily to finance growth. resulting in their inability to fulfill debt obligations. had been on the rise throughout the 1980s. was the ominous deterioration in the key financial ratios of publicly listed companies.201 2. While the decline in gross profit margin was not as sharp.4 percent in 1996. From 10. Corporate profitability.565 2. Foreigners accounted for an increasing proportion of SET’s turnover value.560 1.610 1. Side by side with this surge of financing for corporate growth. return on equity (ROE).3 percent in 1989 to 3.4 percent to 5.8 percent. their share rising from 17 percent in 1993 to 43 percent in 1997. The upward trends for ROE and ROA continued through 1989.5 at its peak in 1987.683 1. pulled down by active public offering activities.133 1.114 1. The financial leverage of all companies declined until 1994. its high point in 1995 at B3. 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. the highly liquid financial system continued offering cheap funds to sustain corporate sector investments. however.4). not all public companies are listed on the SET. The plunge in profitability and asset turnover—from 117 percent in 1985 to 65 percent in 1996 for the latter—cast doubts on the .325 3.268 2. ROA dipped from 10. however. ROE similarly fell from 21. Source: Securities and Exchange Commission of Thailand.1 by 1996.193 2.303 930 855 1.301 3. in the end.6 trillion. the companies could not generate enough net returns from their assets and equity. then stalled in 1990. Throughout the 1990s. corporate profitability had been declining.
8 14.7 35.9 140.7 12.7 15. these companies opted for debt.238 Corporate Governance and Finance in East Asia.5 9.3 10. which fell from 16 percent in 1991 to just under 6 percent in 1996.7 12.1 120.2 10.8 54.5 50.8 5.9 8.5 15. They were generally more efficient in managing their assets and .4 51.5 51. clothing.8 8.4 12.9 14. clothing.1 114.8 51. US.9 7. resulting in higher collateral values for borrowers. practice of heavy borrowing.2 35.7 5.2 215.9 39.9 51.4 7.1 9.1 44.4 47.4 9.4 44.2 27. but was most severe in building and furnishing material industries as a result of the downturn in the real estate market.0 145.4 5. 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 4. II Table 4.7 12.9 66.3 12.2 49.6 168.4 24.1 60. Thailand’s ROE.7 20.9 7. which was particularly significant in the two years preceding the crisis.4 28. 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 (%) (%) (%) 3.5 38.7 80.7 12.3 91.7 LongTerm Debt to Asset Assets Turnover (%) (%) 14.4 18. Despite the availability of the equity market.2 10.6 138.7 27.4 26. Hotels and travel showed the highest ROE of 15 percent while textiles.0 117.7 34.5).8 151.7 59.1 16.7 21. Vol. The downtrend in corporate profitability.3 8.0 3.2 6.4 7. was felt across industries.9 144.4 119.2 161.1 242.5 63.0 63.7 27. and footwear had the lowest at 11 percent.9 77. the textiles. A major reason for this was the rapid rise in asset prices.6 12. It has also been argued that family-based controlling shareholders borrowed excessively to avoid diluting their control over their corporations.7 54.0 125.6 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. Overall. Among the crisis-hit countries.8 5.2 27.7 5.6 7.8 25.0 139.0 7. Severely affected by global competition throughout the decade.9 27.1 52. was also distinct in the region.6 125. and footwear industries also experienced losses.4 34.4 3.5 52.1 16. Korea and Thailand had the highest debt-to-equity ratios.7 5.3 4.6 27.0 29.8 11.4 Key Financial Ratios of Publicly Listed Companies.6 41.4 12.4 139.6 36.2 64.5 30.4 4.8 88.2 10.
There were also concerns that the provisions governing the criminal prosecution and penalties of directors and management were harsh and inappropriate.2 18.8 47. although the performance of listed companies in the late 1980s was strong. which would be disruptive to company management. Cumulative voting.1 Small Medium Large 5.3 43. .0 48.1 13. 4.5 87.3 15.3 164.1 29. The argument was that having a Board of Directors whose members represented different groups of investors would create conflicts and hamper management effectiveness. In sum. They also tended to use more financial leverage than small companies as their total DERs show.3 23.3 135.5 6.7 6.8 6.6 6. also deteriorated.3 52. the law disallowed cumulative voting.7 10.3 49. However.1 6.8 142. Increasingly heavy borrowings rendered the sector even more vulnerable to lower profitability and sales.9 20.4 Legal and Regulatory Framework Before 1992.1 25.6 10. the Public Limited Company Act of 1978 and its amendments regulated Thai publicly listed companies.6 12.3 49.2 10. US.4 8.6 30.4 116. weaknesses became evident. some rules and regulations of this particular law were believed to be too restrictive and were discouraging companies from going public. the overall activities of listed companies.6 31.4 52.9 13. it was thought.1 5.6 7.7 14.3 88.0 83. measured by total asset turnover.2 12.Chapter 4: Thailand 239 Table 4.8 10. During the 1990s.6 5. For instance.3 25. Although stable in the 1980s.8 6.2. by the 1990s. 1985-1996 Company Size by Assets Company Size by Sales Item Return on Assets (%) Return on Equity (%) Gross Profit Margin (%) Times Interest Earned Total Debt-to-Equity (%) Long-Term Debt-to-Equity (%) Total Debt-to-Assets (%) Long-Term Debt-to-Assets (%) Asset Turnover (%) Small Medium Large 6.5 Average Key Financial Ratios by Company Size.5 94.5 7.8 62.0 20.7 Source: Pacific-Basin Capital Markets Database compiled by the University of Rhode Island.8 26. capital despite the higher gross margins of small companies.6 30.2 121.2 134.3 176. could lead to a high turnover in the board. total asset turnover declined after 1989.6 61.
This will be discussed in Section 4. the limit on shareholdings by the largest shareholders was increased from 50 to 70 percent of total outstanding shares. a feature that is believed to have impaired the effectiveness of existing regulatory mechanisms in the corporate sector.240 Corporate Governance and Finance in East Asia. the exit of these provisions appears to have contributed to the 1997 financial crisis. Vol. but not all questions were answered. The provision discouraged original family owners from registering their companies. and external monitoring and control of corporations were also weak.5. Fortysix companies responded. played an important role in bringing about the financial crisis. As it turned out. adopted to promote the development of publicly listed companies. from holding more than 50 percent of total outstanding shares and other shareholders from holding more than 10 percent of outstanding shares individually. However. The Public Company Act of 1992. as a group. concentrated ownership. Cumulative voting was made optional. that creditors had generally little influence on the management of corporations. The original company owners welcomed the changes and the number of publicly listed companies subsequently rose to more than 600.3 Corporate Ownership and Control Ownership and control of corporations in Thailand are highly concentrated. The protection of minority shareholders was inadequate under the Public Company Act of 1992.2 The market for corporate control was not active and did not give managers strong incentives to perform efficiently. As the succeeding sections point out. II Another issue was the proportion of shareholding by top shareholders. An Asian Development Bank (ADB) survey conducted for this study shows. and the punishment for management misconduct was also lightened considerably. 4. coupled with weak corporate governance. 2 ADB survey questionnaires were sent to all Thai listed companies in early 1999. relaxed the contentious provisions of the 1978 Public Limited Company Act. for instance. the new legislation removed a number of incentives that would have kept public companies prudent and diligent in their operations. The law prohibited the largest shareholders. The legal and regulatory framework for the corporate sector also includes provisions related to insolvency. .
But with their increased reliance on new varieties of equity and debt instruments.3 28.China have the least concentrated ownership. . Thai.8 5.9 52.1 5.7 percent.4 26.7 11. Unfortunately.1 5.1 3. on average.7 7.3 5.0 53.3 11.6).0 56.0 5.9 55.6 28.2 56. Most large Thai corporations listed on SET started out as family businesses.4 26. Across industries. with the largest shareholder on average controlling 10.4 26.5 Average for 1990-1998 period.9 11.1 7. and minority shareholders to stake their claim in the control and regulation of these companies. 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.1 percent of control rights.8 32. Table 4.6 Top-Five Ownership Concentration of Publicly Listed Companies in Thailand.4 6.9 3.3.1 11. respectively.9 percent of shares of a company. This implies that the top five shareholders enjoyed full control over the outcomes of shareholder meetings.4 10. 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 9.0 7.3 percent and 18.9 52.8 11. Source: Comprehensive Listed Company Information Database.3 7.0 3. these companies obtained funding solely from banks or from their own retained earnings.Chapter 4: Thailand 241 4.1 5.1 12.6 27.0 7. 56. Stock Exchange of Thailand. In contrast.1 Patterns of Corporate Ownership A World Bank study covering nine Asian countries finds that firms in Japan and Taipei. In the past.4 5. China firms have the highest single shareholder ownership concentration at 35. one would expect the public.7 6. the top five shareholders of each of publicly listed Thai companies held.9 4.9 54. creditors.4 6.6 4.3 16. and Hong Kong.2 4.2 4.9 52.2 4.9 3.4 percent of outstanding shares.1 4. 33. there were only slight variations in the pattern. Indonesian. Ownership was most concentrated in the packaging.9 26. Ownership Concentration Between 1990 and 1998.4 4.5 28.2 11.6 57. with the top three shareholders accounting for almost 50 percent (Table 4.0 3.3 percent. and 28.9 6.3 7.7 12.6 68. this was not the case.
* Denotes significance at the 10 percent level. ** at the 5 percent level.7).005** 0.072) (0. Leverage.090 0. Table 4.001) 0. founding families maintain effective control of entire groups. and ownership types.116) Debt-to-Equity (1. On the other hand.037 0. Other industries had their top five shareholders controlling at least 55 percent of outstanding shares. and building and furnishing industries.115 9.003 0.647 Note: The regression included dummy variables for industry. It is the practice of Thai corporate founding families to set up holding companies to own shares in affiliated companies or subsidiaries.800 0.080 6. and Company Size Item Intercept Top Five Ownership Concentration Company Size Adjusted R-Squared F-Statistic ROA 0.7 percent of outstanding shares on average (Table 4. Company size is significantly related to ROE and leverage. as measured by debt-to-equity and debt-to-asset ratios.001 0.169*** 0. US.242 Corporate Governance and Finance in East Asia.058* ROE (0. including those that are publicly listed . 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. year. results show a significant positive relationship between ownership concentration and financial leverage. Composition of Controlling Shareholders Affiliated corporations comprise the largest group among the top five shareholders of publicly listed companies.022*** 0.7 Statistical Relationships between Corporate Profitability.8). Source: Author’s estimation based on the Pacific-Basin Capital Markets Database compiled by the University of Rhode Island.034*** 0. Vol. Through these holding companies.001*** 0. with a top-five ownership concentration of at least 60 percent.029 3. Based on a regression analysis.533)*** Debt-to-Assets (0. owning 26. Ownership Concentration. *** at the 1 percent level. II agribusiness. 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 4.031 3.
. a joint venture among three families. Typically.3 percent of outstanding shares.3 27.3 0. one of the founding members.6 5.2 18.3 1. the company. Stock Exchange of Thailand.4 20.6 percent of outstanding shares.5 0.8 0.5 NBFIsa 6. In 1994.7 Bank 2.1 1.9 18.5 2. Source: Comprehensive Listed Company Information Database. founding families and their relatives maintain control of many companies by jointly holding on to the most significant chunk of shares. individual members of the Chirathivat family aggregately hold 25.4 1.2 1.5 percent.7 0.8 1.6 1.5 5.9 6.5 1.5 0. the affiliate firms rarely hold shares of their parent companies. Established in 1980 with a registered capital of B300 million. The ADB survey indicated that listed companies held shares in an average of 11 companies.0 3.5 Individuals 13.1 4.9 0.1 1. the company increased its registered capital and became a public company listed in SET. These individuals usually hold important management positions in concerned companies.6 25. including finance and investment companies.9 19. The top 10 shareholders include a holding company owned by the Tejapaibul family. owned by the Chirathivat family. averaging about 18. unlike in Japan where crossshareholding is common.4 1.4 22.3 27. with 29. In addition.7 5. Although holding companies set up affiliate firms.6 1.8 28.5 1.8 23.3 1. The roster of its major shareholders as of December 1997 illustrates the typical ownership concentration of a publicly listed company in Thailand. Individual family members also hold a significant amount of outstanding shares.2 5.3 1.2 1.0 17. The largest shareholder is Central Holdings Company. in SET. a NBFIs denotes nonbank financial institutions. This practice is illustrated by Central Pattana.0 19.9 7.3 — = not available.5 Government Other 0.6 28.5 26.1 0.6 1.9 15.7 1.8 Top-Five Shareholder Composition of Publicly Listed Companies in Thailand.2 7. operates five of the most successful shopping malls in Thailand.3 27.5 0. a company listed in the real estate sector of SET. 1990-1998 Year 1990 1991 1992 1993 1994 1995 1996 1997 1998 Average Company 28.0 18.4 1.3 20.Chapter 4: Thailand 243 Table 4.7 — 1.
By owning 62 percent of voting shares. the predominance of individual family members and holding companies in the top shareholder list remains valid. However.2 Corporate Management and Control3 Board of Directors The Public Company Act of 1992 stipulates the appointment process. On average. . The Government holds. they account for 80 percent of total outstanding shares. both conducted in 1999. these shareholders are able to control the company. II another of the company’s founding members.1 percent of total outstanding shares of listed companies. Together. only one tenth of listed companies have commercial banks on their top-five shareholder list. Across industries. the top 10 shareholders consist predominantly of members of founding families and their holding companies. Except in the hotel and travel service sector. duties. Vol. Although the list of top shareholders of publicly listed companies includes financial institutions. Only a handful of companies have the Government among their large shareholders. 3 Discussions in this section are based on results of company surveys by SET and ADB. Thai Airways International Plc.5 percent of total outstanding shares of listed companies. qualification. For example. There was a trend of rising government shareholdings throughout the period 1990 to 1998. the Petroleum Authority of Thailand. and a state bank. where the top three shareholders are the Ministry of Finance. on average. and responsibilities of directors of public companies.5 percent of total outstanding shares. In such cases.9 percent of outstanding shares. Another example is Bangchak Petroleum Plc. the Government’s role in public companies is expected to decline. 1. has the Ministry of Finance as its only large shareholder with 92. with the envisioned privatization master plan. holdings by individual family members and holding companies account for at least 50 percent of outstanding shares of an average listed company. About half of listed companies have nonbank financial institutions such as finance and investment companies in their top-five shareholder list. they exercise limited influence in operations because of the restricted size of their shareholdings. 4.244 Corporate Governance and Finance in East Asia. Moreover. roles. the Government owns the majority of the shares.3. In effect. Nonbank financial institutions hold an aggregate 5. commercial banks account for only 1..
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. In five other companies. the ADB survey found that 31 companies (out of 46 responding) required outside directors to be present at all board meetings. directors could be compelled to compensate the company for damages arising from their misconduct. but not in 22 others. The appointment of the chief executive officer (CEO) needed approval during the AGSM in 11 of the responding companies. selection was based on relationships with controlling shareholders. A survey by SET found that the majority (58 percent) of the 202 responding companies held their board meetings every quarter. The ADB survey indicated. Many companies have a formal policy on corporate governance and business ethics. Although 28 percent of the chairpersons came from the ranks of independent outside directors. Meanwhile. Generally. Three companies indicated that the CEO and the chair were close relatives.Chapter 4: Thailand 245 Directors are required to meet minimum qualifications specified under the SEA of 1992 and the Listing Rules issued by SET. In their business conduct. and to comply with the laws and articles of association. that only in two of the 46 responding companies were the chair of the boards elected based on the extent of their shareholdings. directors are required to act with care and honesty for the company’s best interest. Most companies (83 percent) satisfied SET’s requirement of having two independent board members. while 30 percent of respondent companies held board meetings monthly. directors shall be elected at the annual general shareholders’ meetings (AGSMs). directors may be imprisoned or fined. Nineteen companies stated that selection was based on professional qualifications. Almost all companies (98 percent) exceeded the minimum required five members in their Board of Directors. In addition. Unless stipulated in public companies’ articles of association. the majority (71 percent) had board chairs who were also members of top management teams. while 15 percent of respondents went beyond the requirement. meanwhile. an executive board consists of senior management and some main board members. . If found in violation of these provisions. Some companies (36 percent) had five to six main board members holding seats in their executive boards.
Audit Committees and Accounting Standards Since January 1999. The ADB survey indicated that 18 of the 46 responding companies compensated their chairpersons using a fixed-fee schedule. Fourteen other companies had profit-related incentive schemes in addition to fixed fees. All respondents confirmed the use of external auditors. Companies already with audit committees did not have independent outside directors as audit committee members. In one company. not an independent assignment. however. and CEO The majority of company respondents to the SET survey provided similar compensation packages to internal and external directors. Chair. these were attributed to variations in the extent of duties and responsibilities assumed by those directors. Twenty-five of the 46 respondents to the ADB survey declared adherence to all relevant international standards. Also. Where different. Vol. 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. with 41 firms admitting the use of services of international auditing firms. Three companies allowed their management to determine the chair’s compensation package. all listed companies have been instructed to establish audit committees to be responsible for examining the quality and reliability of company financial statements. Directors with managerial responsibility or those related to major shareholders cannot be members of such audit committees. the work of this committee was often considered part of the executive board’s responsibilities. II Compensation of Directors. while 19 companies observed only some of them. Half of the companies in the SET survey had a separate remuneration committee.246 Corporate Governance and Finance in East Asia. the remuneration packages had to be approved during AGSMs. the majority of the companies (77 percent) did not have outside directors as members of their remuneration committees. In 25 companies. These committees were mainly responsible for determining compensation for senior and regular staff. the auditor is not . However. The SET survey found that the majority of listed companies (81 percent) still have no separate audit committee. 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.
and the Bank of Thailand— are not clearly defined. with 13 companies allowing proxy voting through mail. the Securities and Exchange Commission (SEC) and SET were actively prosecuting violating firms. According to the ADB survey. there are also significant gaps in the system of shareholder protection. most responding companies have rules and regulations intended to protect shareholders. SET’s rules and regulations closely follow this Act. (ii) The prudential role of outside directors is limited by the noncompulsory character of their participation in key decision-making bodies such as the audit. (iv) The roles and responsibilities of the major government agencies regulating shareholder rights—the Ministry of Commerce. there is the danger that top management may be capable of unduly influencing the board’s decisions. In the majority of these companies (38 out of 46 respondents). While safeguards are in place. shareholders have access to reliable information at no cost. as well as the registration and holding of shares. At least 28 responding companies had the following . although recently. the institutional machinery is not fully responsive to complaints about violation of shareholder rights. The Act. debentures. the corporate sector lacks a strong self-regulatory body to compel compliance with these standards. SET. or other financial instruments. remuneration. Relationships between firms and external auditors are generally long-term. Proxy solicitation tends to be abused to the extent that shareholders are inadequately informed about matters to be taken up in shareholder assemblies. averaging about 14 years. The Act also holds directors liable for any damage to shareholders. (iii) Because the chair is frequently also part of the top management team. shareholders can claim compensation in cases of negligence or dishonesty by management. The majority of the companies (85 percent) require the appointment of external auditors during annual general meetings. stipulates the proper conduct of shareholder meetings. SEC. (i) No standards are enforced in the content and timing of notices for shareholder meetings. and executive committees. including false statements to conceal information about the financial condition and operations of the company during the sale of shares.Chapter 4: Thailand 247 independent from the company. likewise. Minority Shareholders and their Rights Many different rights and entitlements of shareholders are laid out in the Public Company Act of 1992. Forty-four companies indicated that they had proxy voting in place. Shareholders are also entitled to call emergency meetings and present proposals at AGSMs. For instance. However. As a result.
however. In effect. 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. minority shareholders may also appoint an outside inspector to examine the company’s operations and financial condition. In theory. the only group of shareholders that can exercise rights is the top five shareholders. such protection has been insufficient. and mandatory disclosure of related interests and significant shareholders’ transactions. The ADB survey results reveal that the proposals presented by management were rarely rejected during the general meetings. Banks would be obvious candidates to implement these mechanisms. 4. . Almost 82 percent of shareholders. On paper. But with the ownership concentration of Thai companies.3. and insider trading. minority shareholders are assured adequate legal protection. Although the attendees held. representing only about 28 percent of shareholdings. given their importance in providing finance and their stake in companies. In practice. II mechanisms in place: mandatory shareholder approval of major transactions and interested or related party transactions.248 Corporate Governance and Finance in East Asia. did not vote in previous AGSMs.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. 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. While stimulating the growth of the sector. it would be difficult for minority shareholders to gather the shares needed to take action. Vol. the new Public Company Act of 1992 inadvertently weakened the governance of public companies by diminishing minority shareholder rights. on average. takeover of the company. But the exercise of these rights requires even higher shareholding levels. Written law and its enforcement diverge partly because of a provision that shareholders who take action against erring directors must have at least 5 percent of the total number of shares. and call an extraordinary session. 66 percent of total outstanding shares. The difficulty minority shareholders have in exercising their rights can be seen from the ADB survey results. Only a small number of shareholders attended the latest AGSMs.
Only 28 of the responding companies in the ADB survey indicated that their creditors required such feasibility studies. Only three companies thought otherwise. they resort to borrowing. as the ADB survey confirmed. Eleven companies stated that creditors usually exercised whatever influence they had on management through covenants regarding the use of loans. The old bankruptcy law in Thailand also made it difficult for creditors to obtain payment against bankrupt borrowers. while loans for fixed investment were also more likely to be supported by collateral. however. borrowers seldom lose control to creditors even when they default and become insolvent. other than losing control. Leverage allows the assets and operations of the company to grow without diluting corporate control. Fifteen of the 20 companies that had to renegotiate loan repayment with creditors in the last five years did so after the crisis. Seven of the companies responding to the ADB survey indicated that all their creditors required collateral. 11 experienced rejection after the crisis started. to solve debt repayment problems. including procedural disputes. the majority believed that creditors had little influence on company management and decision making. Under a weak bankruptcy system. creditors do not always require project feasibility studies or business plans in granting loans. such as that seen in Thailand before the crisis. The impact of the financial crisis on credit eligibility and supervision requirements has been significant.Chapter 4: Thailand 249 Historically. . Normally. However. Apparently. Debtors had many handles to stall the bankruptcy process. a company’s reputation and its long-term relationship with creditors sufficed in many instances. 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. which could cause a delay by at least a year. The presence of collateral usually diminishes banks’ incentives for screening project feasibility and monitoring project implementation. In the end. 17 indicated that only some of their creditors had such a requirement. For 20 of the 46 responding companies. Actual bankruptcy proceedings took more than five years on average. Thailand has relied on commercial banks and finance companies to channel funds to private enterprises. while 18 said none of their creditors required collateral. Most companies reported that banks were more likely to require collateral. There were many options. 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.
before the extent to which the bankruptcy framework has been strengthened becomes clear. SEC has no authority to either approve or reject tender offers. however. The first category is the acquisition of shares in the open market. According to the SEA of 1992. (ii) an advertisement regarding the tender offer must be placed in major newspapers for at least three consecutive days.3 billion. which is a general offer made to shareholders of a company to acquire at least 25 percent of outstanding shares. Since the introduction of the Public Limited Company Act of 1978. whether directly or indirectly. and (iii) tender offers will be effective 30 days after the report has been filed with the SEC. Vol.9). there are two categories of merger and acquisition activities with associated regulatory measures. The Market for Corporate Control The SEA of 1992 was the first legislation that stipulated rules and regulations regarding the market for corporate control. II The financial crisis has presented a unique opportunity for reinventing the framework for corporate bankruptcy and for creating regulatory and judicial precedents. only a limited number of successful mergers of public companies have taken place. In this case. Although merger and acquisi- . SEC was later made responsible for regulating corporate takeovers. with a total tender offer value of B42. of shareholders: (i) all shareholders must receive tender offers. with a significantly lower total tender offer value of B8. its main role is to ensure transparency and fairness.3 billion (Table 4. there were 41 cases of tender offers. In 1994 and 1995. The market for corporate control has not been active in Thailand. It will take years. In 1996. and failed to provide managers with strong incentives to perform efficiently. the minimum tender offer was reduced to 10 percent and some procedural modifications have also been introduced. The company has 21 days to evaluate the tender offer and submit a report to SEC and all shareholders. Recently. there were only six tender offers. Such efforts would serve to strengthen external discipline on controlling owners. a person who acquires more than 5 percent of issued shares must file a report with SEC one day after the date of acquisition.250 Corporate Governance and Finance in East Asia. 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. There are detailed requirements regarding such notification. The situation remained sluggish in 1997 at nine tender offers and a further decline in total offered value. if the purchase of shares implies a change in the directors or business activities. The second category is the tender offer.
3 6.2 6. employees regard the plans as monetary incentives. Even when companies offer ESOPs. employees are even less willing to accept common shares as a form of compensation or benefit.7 Purchase Value Number of % of Tender Offer Value Companies 84.2 7. tion activities increased after 1997.0 B billion 4. Provident funds for government workers and workers in public enterprises have been established only recently.6 17.Chapter 4: Thailand 251 Table 4. most of these were forced mergers or related to rescue packages.0 55.8 8 27 14 6 9 13 23 Tender offer value refers to the minimum offer value. Because of the current crisis. but the average shareholding is smaller than 1 percent of total outstanding shares. Source: Securities and Exchange Commission of Thailand. Twenty-nine firms indicated that employees held shares of their companies. Eleven of the 46 responding companies in the ADB survey offer ESOPs.1 58. While the Thai mutual fund industry compares well to those in other developing countries in the region. Since 1994.7 11.5 6. Pension funds are perhaps even weaker in Thailand.3 60. But instead of opting for an active role in the market for corporate control. employee participation in corporate governance in Thailand.2 8. it remains small. trading by mutual funds in SET represented less than 10 percent of total trading. 1993-1999 Year 1993 1994 1995 1996 1997 1998 1999 a Tender Offer Valuea (B billion) 5.1 84. but employees have never been represented in the board of directors since their shareholdings are minimal.1 75. . Few companies offer employee stock option plans (ESOPs).2 6. they have mostly been concerned with short-term gains. Employee Participation in Corporate Governance There has been little.8 81.9 Merger and Acquisition Activities. The number of domestic institutional investors rose after the mutual fund industry was established in 1991. if any. not with a view to becoming involved in actual management.3 11.4 23.1 19.9 3.
In 1996.9126.96.36.199 3.6 2. Competition from foreign banks was limited as they were not allowed to engage in full branch operations. total assets of commercial banks amounted to B5.564. accounted for 28 percent of the banking sector’s total assets.230.5 5.912.300.372.252 Corporate Governance and Finance in East Asia.133.6 6.0 424.559. II 4. 1992-1999 (B billion) Outstanding Loans from All Financial Institutions 2.0 3.2 2.4 3. Thai Bond Dealing Centre.4 Year 1992 1993 1994 1995 1996 1997 1998 1999 Source: Stock Exchange of Thailand.825. there were 29 commercial banks.1 7. The bond market played only a marginal role in corporate financing.775.6 1.906.4 519. Many large commercial banks had affiliates among the 93 finance companies that served the high-risk market.669. Table 4.0 339.4 1.4 4.2 262.10) shows that Thailand is a highly bank-dependent economy.390.1 3.5 4.4.10 Size and Composition of the Thai Financial Sector. the next four largest banks accounted for 63 percent.663. The country’s largest bank.5 Outstanding Loans from Commercial Banks 2.9 2.325.5 trillion. 15 of which were domestic banks.3 1.1 6.0 8.4 4.5 4.037. The Banking System Until recently.485. Vol.1 Corporate Financing Overview of the Financial Sector A breakdown of the Thai financial sector for the period 1992-1999 (Table 4. .193.477. The share of domestic banks in the banking system’s total assets was 80 percent.1 Domestic Debt Securities Outstanding 215.5 6..360. Bangkok Bank Ltd.3 5.0 SET Market Capitalization 1.3 546. The total values of loans from financial institutions and commercial banks were consistently larger than the market capitalization of SET.1 5. although its role increased in the wake of the crisis. and Bank of Thailand. the banking sector was highly concentrated.119.268.430.8 941.8 3.
SET immediately recovered due to the strength of the Thai economy.8 in 1998. The Equity Market During the first few years of its operations. also made it unattractive to raise capital from the equity market. the liberalization of interest rates and capital account transactions stimulated a credit expansion through short-term borrowings in foreign currency. the stock market entered its first boom period in 1986. Benefiting from rapid economic and industrial growth. reaching 355.3 trillion. banking. the SET index declined. Some 347 companies were listed in the same year with a total market capitalization of B3. owning 70 percent of the country’s second largest bank. In the following years. due to their close ties. The lack of supply of quality shares was a big problem for SET at that time. and property have accounted for the bulk of trading volumes. and 20 new foreign banks. the market rose steadily and reached a record high in the fourth quarter of 1993. was set up by 74 members with an initial capital of B500 million. self-regulatory organization under the . SET is organized into 32 major industries. Licenses were granted to 15 Thai banks. Because borrowers carried the exchange rate risk. Through the years. the Government established the BIBF to expand the banking sector and reduce the borrowing costs of Thai companies. Banks under the BIBF scheme were allowed to mobilize funds from abroad and lend to Thai companies in foreign currency. Easy access to commercial bank loans by family business groups. hardly any progress was made in lowering the cost of domestic financial intermediation or in developing new financial instruments for corporations. 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 Bangkok Stock Dealing Center (BSDC). 12 existing foreign banks. an over-the-counter market. Turnover value reached B2. finance. BIBF banks also enjoyed tax incentives on their operations and profits. In 1993. In contrast. The number of listed companies also quadrupled between 1981 and 1993.Chapter 4: Thailand 253 The Government was also a major figure in the banking system. Many company founders did not want to release even a small portion of corporate ownership and refused to go public. BSDC is a nonprofit. In 1995. After that. The Government removed controls on capital and dividend repatriation in 1991. and almost all capital account transactions were deregulated. Banking activity peaked in the mid-1990s. Despite the worldwide market crash in 1987.2 trillion. SET was not very active.
II jurisdiction of SEC.8 billion in 1996. Only one security was listed in BSDC in 1995 and two more in 1996. each holding no more than 0. financial projections. Proposed changes in capital must be submitted for approval to SET accompanied by a detailed memorandum outlining the use of proceeds. SET established new requirements for initial public offerings. turnover value was negligible and the BSDC Index remained flat throughout 19961998. Vol. with each facing different listing requirements. however. and pro forma balance sheet and income statements. According to the SEA of 1992. securities can be traded in the secondary markets. approved by SET. After initial public offerings. Company applicants must have an established history of operating under substantially the same management. Consequently. the BSDC was dissolved in 1999. among other functions approved by SEC. If approved by SEC and the SET Board of Governors. also acts as a clearinghouse. Its main role is to serve as a secondary market for unlisted companies trying to raise capital. and securities registrar. The allocation procedure is nondiscretionary. In July 1990. stock trading can commence within five days. The primary market is supervised by SEC. the two classifications were merged.254 Corporate Governance and Finance in East Asia. SET. which consist of SET and BSDC. In 1998. If the issue is oversubscribed. A company wishing to qualify for listing in SET must file an information booklet (prospectus) with SEC and SET. there were two kinds of companies in SET—“listed” and “authorized” companies. Listed companies were those that had (i) paid-up capital of at least B20 million. The listing application should be submitted concurrently to SEC and SET. securities deposit center. to assist in the public offering process. Before 1993. and (ii) a minimum of 300 shareholders. . It separated the primary and secondary markets to promote more flexible and effective supervision of both. Turnover value was B1. but dropped the following year to B122 million. so now only listed companies are traded in SET. which has a legal mandate to examine a company’s financial status and operations before allowing it to issue securities to the public. The SEA of 1992 installed the legal and regulatory framework for Thai capital markets. 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. Authorized companies were those with a minimum of 200 shareholders owning collectively at least 25 percent of paid-up capital. In 1996. The company should then appoint a financial adviser. lottery drawing must be used to ensure fairness.5 percent and collectively owning at least 30 percent of paidup capital.
Upon its founding in 1942. it represented only 9 percent of GDP.9 billion. the first bond rating agency in Thailand. the Bank of Thailand assumed responsibility for regulating the bond market. The budget surpluses of the 1990s eliminated the need for new bond issuance. To gain some perspective of the size of the bond market in Thailand.11). however. In 1996. in 1994. The recent financial crisis. 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. A breakdown of domestic offerings of corporate debt securities from 1992 to 1996 shows that unsecured debts accounted for about 60 percent. A turning point of the corporate debt market was the enactment of the SEA of 1992. State-owned enterprises became active issuers of bonds since 1993 because the Government constrained their borrowings (Table 4.Chapter 4: Thailand 255 The Bond Market The Thai bond market has played a marginal role in corporate financing until recently. The proportion of domestic convertible debt instruments increased until 1995. The Thai Rating Information Services. The bond market in Thailand started in 1933. compared to 110 percent in the US and 74 percent in Japan in the same year. led to the renewed issuance of Government bonds to finance the resurgent budget deficit and support cash-strapped financial institutions. 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. at about 11 percent of the total value of outstanding loans extended by commercial banks and 20 percent of total equity market capitalization. and the Government did not issue new bonds during 1990-1997. was also instrumental to the growth of the corporate debt market. while secured debt instruments accounted for just above 10 percent. the year the Ministry of Finance first issued government bonds to finance infrastructure projects and economic development. Investors had limited knowledge of debt instruments. the Government issued more bonds to finance industrial development projects and perennial deficits. Beginning 1961. which encouraged limited companies and public companies to issue debt instruments. Companies generally issued short-term debt instruments like promissory notes or bills of exchange. it accounted for a small share of the entire financial sector. the size of the corporate debt market rose to B132. However. Four years after the passage of the SEA. 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. .
6 — — 0.7 — — 40.6 billion. by the end of 1997. The club was considered the first organized secondary bond market in Thailand to serve as the wholesale market for debt securities. turnover value had reached B51. However.1 121.2 89.2 43.3 46.1 61.3 50.5 43.0 — 5.4 — 26.5 — — 32.3 22.6 19.3 — — 3. the year the crisis unraveled and the baht was floated.7 0.9 20.7 5.7 538.5 billion.0 333. then declined substantially in 1996 and 1997.2 28.0 7.1 59.2 — — 50.5 — 0.3 140. 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 — — — — — — 400.7 132. Total offshore debt offerings peaked in the run-up to the financial crisis.1 12.5 — — — — 1.0 0.256 Corporate Governance and Finance in East Asia. .0 — 26.1 107.0 17.6 — 0.11 Offerings of Debt Securities.1 21.7 5.3 13.2 2.1 41. By 1995.7 — — — — — 4.0 — 5.2 39.1 8.8 47.3 — 14.7 28.0 60.3 8.3 6.0 26.8 55.5 5.4 — — — 1.2 57.0 281.5 10.3 46. total offshore debt offerings had plunged by 68 percent to a mere B28.8 191.2 45. The domestic debt market declined after 1994 because corporations could borrow offshore at lower costs.5 37.9 329.0 27.7 — — — — — — — 77.7 7.1 55.4 7.1 289.4 49. A sharp rise in unsecured offshore debt offerings can be noted all the way through 1996.5 138.5 — 39.8 Source: Securities and Exchange Commission of Thailand and the Thai Bond Dealing Centre. The following year. Vol.3 3.4 110.1 — — 6.1 315.8 31.1 10. this had climbed to B200.9 37.1 141.0 86.7 95. BDC was established in November 1994 by 50 securities companies based on the provisions of the SEA of 1992.1 6.8 2.7 0.4 57. The decline in total domestic debt offerings in 1996 can be ascribed to the increase in offshore convertible debts.9 0.7 90. a surge attributed to capital inflows encouraged by high returns on Thai bonds.4 — 9.7 821.9 37.8 167.0 5.5 55.9 30.4 billion.9 5.3 29. II Table 4.0 33.1 — — — 29.5 — — — 3.9 40.
and marketable securities holdings. In any case. Turnover fell further to B72. a trend most apparent in the leap between 1991 and 1992. these comprised 31 percent. Longterm loans accounted for about 20 percent of total liabilities. overall asset quality and liquidity of listed Thai companies deteriorated throughout the period. Companies in construction and property development seemed unable to generate internal funds. judging by their relatively low levels of retained earnings.4. these accounted for 33 percent of total liabilities. The ratio of net working capital to total assets decreased from a peak of 31 percent in 1993 to 28 percent in 1996. 4. while for the property development industry. turnover value plummeted to B106. In addition. From 1990 to 1996. The closure of 58 finance companies affected the BDC significantly since half of its members were suspended as a result. listed companies experienced liquidity problems with declining reserves of cash and marketable securities during the period 1990 to 1996 (Table 4.Chapter 4: Thailand 257 compared with investment in equities. they also had a relatively small proportion of equity and . BDC was renamed “the Thai Bond Dealing Centre” following its status upgrade to a bond exchange. Across industries. with equity levels remaining high despite an increase in debt. The proportion of accounts receivable also declined steadily.2 billion as a result of the default of debentures due to the Asian crisis. steadily easing up between 1990 and 1996. cash balances. the use of debentures remains minimal even though the trend was generally upward until the 1997 crisis. For the construction industry. Construction and property development industries tended to have high proportions of long-term loans and debentures.12). The average for all industries was only 22 percent.2 Patterns of Corporate Financing An examination of financing patterns among Thai companies listed in SET shows that on the asset side. At lower than 5 percent of total liabilities.1 billion in 1998. There was also little change in the trend in retained earnings within the seven-year period. Equity financing remains an important part of listed companies’ long-term financing. short-term loans accounted for more than 40 percent of total liabilities. significant variations can be noted. 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. In the same year. In 1997. The overall trend is consistent with the decline in profitability observed in the analysis of corporate sector performance earlier.
US.3 18.6 13.1 13.8 17.2 43. compared with the 44 percent general average.6 21.2 17.9 17.9 0.7 36. Analysis of common-size statements by ownership concentration (based on the levels of top-five ownership concentration classified as high.8 3.0 100.2 2.0 100.1 18.3 14. 1990-1996 (percent) Item All Years 1990 1991 1992 1993 1994 1995 1996 2.3 2.12 Common-Size Statements for Companies Listed in SET.8 21.1 50.8 34.6 22.2 17.4 8.2 12.9 6.5 9.258 Corporate Governance and Finance in East Asia.9 10.2 2. Vol.3 50.7 9.8 10.0 48.2 42.9 20.7 1.6 36.2 17.4 7.2 16.6 15.3 34.8 9.0 100.6 8.5 9.3 49.3 17.8 14.9 14.1 17.8 25.2 15.9 12.1 49.4 49.1 7.8 35.6 0.6 50.9 49.2 1.7 15.2 2.1 5.3 48.5 0.1 36. medium.9 14.7 17.9 2.9 50.2 3.6 51.8 9.9 40.0 51.2 17.0 100.9 38.8 6.6 100.2 2.2 34.3 1.0 7.6 14.9 6.3 1.13).2 35.0 14.9 18.1 2.0 10.9 14.9 17.4 2. and low) also underscores that companies with high ownership concentration had high levels of long-term loans (Table 4.2 45.7 52.5 11.4 49.7 14.6 10.0 6.2 1.4 21.0 100. The agribusiness industry relied more heavily on short-term loans at 56 percent of the industry’s total liabilities.2 1.0 12.6 100.7 16. The level of total liabilities for the group characterized by high ownership concentration .3 14.3 34.9 16.6 0.9 43.2 16.0 13.5 37.2 43.0 100.8 8.7 7.5 1.6 11.6 0.8 7.0 100.8 20.0 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.2 22.8 37.9 3. II Table 4.0 15.6 0.5 1.3 38.0 2.9 14.8 46.0 100. Printing and publishing companies had lower financial leverage than companies in other industries.5 1.7 0.8 1.6 38.4 48.0 100.4 17.4 17.3 12.5 14.0 100.8 19.0 100.8 37.3 6.6 18.0 100.5 43.7 18.0 100.6 2.6 12.3 25.9 14.6 6.0 1.7 50.3 18.4 14. were highly leveraged.9 15.3 21.4 6.0 10.4 43.0 100.7 16.
9 36.7 17.5 13.4 7.13 Common-Size Statements of Public Companies by Ownership Concentration. was 53 percent of total assets compared with 49.6 9.6 14. common equity accounted for a smaller proportion of total assets (47 percent) than companies with lower ownership concentration.1 36.6 47.2 22.4 50. .9 50.5 100.7 percent for medium ownership concentration companies and 49.6 100. This is consistent with the observation that majority shareholders try to maintain their control by utilizing debt as a major source of funds. 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 35.2 11.5 18.0 Low 1.5 21.1 49.6 22.4 18.5 percent for low ownership concentration companies.9 7.3 35.8 13.0 7.6 0.0 19.4 3.9 16.7 12.4 1.0 Medium 2.Chapter 4: Thailand 259 Table 4.1 53.1 44.0 6.3 1.0 Source: Pacific-Basin Capital Markets Database compiled by the University of Rhode Island.4 49.2 0.8 37.3 100.6 2.2 45.8 13.0 41.5 11.9 100. Companies with medium ownership concentration tended to have a higher proportion of short-term loans.0 100.0 14.8 12.0 16.7 19.4 13.9 2.1 18.9 0.3 1.4 37.2 14.0 6.0 100. US.3 16.3 8. For the high ownership concentration group.2 8.9 21.6 15.
minimization of transaction and interest costs. Public companies relied more on short-term debt financing in the period before the financial crisis.0 50.8 5. however.6 125.1 44.2 49.8 51.7 11.4 7.1 52.9 51.4 12. Such deterioration of financial positions during the period was a common feature of listed companies.4 5.2 35. As a result. II Results from the ADB survey reveal that Thai companies preferred to use reserves and retained earnings as their first choice of financing.9 63.7 percent in 1996.1 31. While further detailed investigations are necessary. followed by bank loans.9 7. and rights issues. Vol.4 51.14 Financial Ratios of All Listed Firms. however.4 44. An overall picture of SET-listed companies’ financing and investment patterns in the 1990s shows a steady rise in the use of financial leverage (Table 4. The TIE ratio declined from its peak of 7. thus rendering them more vulnerable.15. The financing patterns indicate that companies with high ownership concentration were more highly leveraged than companies with medium and low concentration. .0 28. Table 4.7 5.1 16.7 34. After the crisis.4 139. bond issues.260 Corporate Governance and Finance in East Asia. More important.1 31. US. 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 8.9 14.6 7.1 16.7 12. Short-term debt accounted for most of the increase.7 34.5 52.6 138.1 64.3 Source: Estimated from the Pacific-Basin Capital Markets Database compiled by the University of Rhode Island.9 140.1 144.2 68.8 65.8 percent in 1990 to 52.0 145.7 66. was the headlong deterioration of firms’ ability to meet their interest payment obligations.0 25.7 in 1994 to 5. it would seem that firms with concentrated ownership and associated links to the banking system have easier access to debt financing. The ratio of total debt to total assets increased from 50.1 in 1996.8 65.6 41. these firms more easily increased their leverage.14).7 12.8 151.1 23. especially from 1994 to 1996. the choice of financing is determined by the company’s liquidity considerations.5 38. and maintenance of the existing ownership structure.3 31.7 28. bond issues overtook loans from commercial banks as the second preference.3 61. Generally. The direct relationship between the degree of leverage and the degree of ownership concentration is apparent in Table 4.
Nonbank private debt increased from 27. and a preponderance of short-term debt liabilities.5 percent between 1985 and 1990 to 8. This decline was accompanied. 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.5.8 49.5 148. on the other hand.Chapter 4: Thailand 261 Table 4.7 percent from 1991 to 1996.2 percent in 1986 to 251. The composition and term-structure of this debt.5 percent of external debt in 1996 (Table 4.6 11.4 13.8 Medium 7.4 52. . From 45 percent of total net capital movements in 1985. private debt accounted for 84.2 49.6 30.5 34.3 42. The corporate sector contributed significantly to the crisis because of its rising levels of leverage.8 14. 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. From only 34 percent in 1986.5 4.8 29.9 percent in 1997.8 percent in 1986 to 52 percent in 1995. unhedged foreign exchange liabilities. is even more telling. continued to slide from 1985 to 1997. US.4 percent to 46 percent during the same period.8 66. Their average annual growth rate declined from 28.1 High 6. The proportion of external debt as a percentage of GDP consequently increased from 42.3 Source: Estimated from the Pacific-Basin Capital Markets Database compiled by the University of Rhode Island.2 124. peaking in 1994 at 84 percent.5 126. 4.1 The Corporate Sector during the Financial Crisis Impact of the Financial Crisis on the Corporate Sector The financial crisis came after a period of rapid growth in the Thai economy. debt-creating capital inflows rose to 65 percent in 1990. Additionally. The proportion of nondebt-creating capital flows.8 28.4 27. however.0 64.4 63.15 Financial Ratios of Listed Companies by Ownership Concentration. such as direct equity and portfolio investment. the proportion of short-term debt increased from 15.16).
3 — — — — — — — 6.0 Long-Term Short-Term BIBF Commercial Bank Long-Term Short-Term 0.0 13.2 2.9 1.3 3.7 13.0 4.7 0.2 2.16 External Debt.2 0.6 Government Year Long-Term Short-Term 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 12.7 20.0 11.0 0.4 15.1 Source: Bank of Thailand.7 109.7 1.3 0.3 0. .3 7.1 64.3 20.8 13.4 10.3 10.8 12.9 5.4 3.1 22.5 19.1 0.4 18.4 — — — — — — — 1.9 7.3 12.3 37.3 0.6 Total 18.9 6.9 43.9 0.5 14. 1986-1999 ($ billion) Private Nonbank Long-Term Short-Term 3.2 0.1 0.8 108.0 6.9 29.7 10.5 12.9 3.0 21.3 3.2 10.9 6.9 31.9 10.8 10.2 15.Table 4.1 5.1 95.7 2.7 23.0 11.5 4.4 5.9 35.2 32.3 0.9 11.8 3.6 7.9 10.5 4.6 1.1 2.1 23.1 12.8 3.3 105.1 34.3 0.7 24.1 0.6 — 0.3 0.5 12.3 2.3 0.9 4.0 3.8 31.8 0.2 14.6 18.2 0.2 2.3 16.1 0.3 0.5 16.9 1.9 100.9 13.5 1.6 52.4 2.0 8.1 30.9 3.
(ii) the rise in the nonperforming loan (NPL) ratio and consequent tightening of credit even for viable firms.360. outstanding credit also declined throughout the second half of 1998. Meanwhile. based on the three-month past due definition. exposing the companies to disaster when the baht started tumbling on 2 July 1997.17). according to the Bank of Thailand. The effects of the crisis were felt across all industry sectors. foreign currency-denominated debts constituted 55 percent of their total debt portfolio.6 in December 1996. SET’s dismal performance is indicative of the extent of the setback suffered by the Thai capital market. the numbers of bankruptcies and company closures reached all-time highs in 1998 (Table 4.Chapter 4: Thailand 263 This shows that although banking and finance companies suffered most because of their short-term exposure. trading activity at SET had been on the downturn. It hit a 10-year low in the second quarter of 1998. and poor business confidence on the other. The value of public offerings sank in 1997 to B56.6 billion from the 1996 level of B201 billion. suggesting that serious investors have not returned to the market. closures. banks would be recording more of such NPLs. On average.281 in December 1995 and to 831. from its peak in 1995. Similarly. . the number of newly registered companies dropped to a 10-year low in 1998. large Thai companies had actively borrowed at low interest rates from foreign financial institutions. the SET Index stood at 1. and (iii) bankruptcies. NPLs spiraled from 12 percent in the second quarter of 1997 to almost 40 percent in the third quarter of 1998. reaching 45 percent of total outstanding credit in December. Trading volume has since been thin. nonfinancial companies also experienced severe liquidity problems as a result of the baht’s devaluation. With easy access to foreign funds. At the end of 1994. If lending rates remained high. Even before the crisis. Most of these foreign debts were not properly hedged. Foreign investors retreated from the market. and drastic decline in the number and capital of newly registered companies. 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. After that. the liquidity problems faced by the corporate sector are likely to continue for some time. Aside from the problem of NPLs. The proportion of NPLs as a percentage of outstanding loans demonstrates the liquidity problem experienced by the corporate sector. Due in part to liquidity problems on the one hand. 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. the index declined to 1.
The first Letter of Intent was cosigned by the Minister of Finance and the Governor of the Bank of Thailand on 14 August 1997.096 22.134 31.288 35.112 9.105 4.2 billion for balance of payments support and buildup of the country’s reserves.5. The increase of the P/E ratio in 1998 was mostly a result of a decrease in earnings for most listed companies.933 25.218 3. the Government was left with no choice. It also explains the higher dividend yield ratio.902 3. . But when assistance from other sources did not materialize.264 Corporate Governance and Finance in East Asia.925 12. 1985-1999 Year 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 Newly Registered 10.066 19.695 3.6 in 1997.095 14.410 37. the Thai Government was lukewarm to the idea of obtaining IMF assistance because of the requirements and conditions attached to the financial package. The price-to-earnings (P/E) ratio deteriorated from 19.409 6.777 11.410 5. The IMF financial package was a credit facility of $17.977 Source: Department of Commercial Registration.915 37. IMF required Thailand to meet a set of performance criteria and implement various restructuring measures.312 25.407 28.052 36.17 Number of Newly Registered and Bankrupted/Closed Companies.224 4. Thailand.797 4.792 7.904 20. As part of the assistance package.334 4. II Table 4.5 at the end of 1994 to 12 in 1996 and further to 6.080 9.677 Bankrupted/Closed 2. 4.2 Responses to the Crisis Initially. Vol.201 24. Ministry of Commerce. A steady price decline over the past few years has dragged down the ratio of market price to book value.307 4.
follow through with a civil or bankruptcy suit. The Financial Sector Restructuring Authority was established in October 1997 to address the problems of 58 finance companies that were suspended in 1997. drawn up with World Bank and ADB assistance. only two companies emerged intact from the suspension. IMF relaxed these key conditions. also aimed at institutionalizing legal and regulatory reforms. Many believed that the process was inefficient.Chapter 4: Thailand 265 The terms of the agreement required the Government to maintain tight monetary and fiscal policies. it was widely interpreted as “having debts more than assets. These include repeal of the Commercial Bank Act. By invoking procedural loopholes. and Credit Foncier Businesses. The Government also passed the Bankruptcy Act and Foreclosure Act Amendments. however. The old law allowed only creditors to file bankruptcy suits. Regulatory Response by the Government The IMF program. and restore solvency. The core of the IMF conditionalities was the restructuring of the banking and financial sector to regain investor confidence. loan provisioning. As it turned out. and if necessary. and the Act Regulating the Finance. There were many options for solving debt repayment problems. For example. the Civil and Commercial Code. increase profitability. Several changes in the banking and financial policy environment have been effected in line with the restructuring program. In early 1998. Creditors could negotiate to reschedule debt repayments. While no definition for “insolvency” could be found in the bankruptcy law. and worked on revisions to the Secured Transaction Law. They could seek civil action through the courts and could also use criminal sanctions to enforce debt repayments. and income recognition were implemented. secured creditors had to obtain the court’s approval before starting proceedings . debtors could drag out the process for many years. Securities. The assets of the other companies were liquidated by auctions.” Creditors thus bore the burden of proving a debtor’s insolvency before the courts. and did not recognize debtor-initiated bankruptcy declarations. Under the old bankruptcy laws. The Bank of Thailand also improved banking standards. The Government required all remaining financial institutions to recapitalize and instituted closer monitoring measures to ensure full compliance with this requirement. Strict loan classifications. creditors seldom succeeded in obtaining payment against bankrupt borrowers.
To make matters worse for creditors. time consuming.266 Corporate Governance and Finance in East Asia. Companies need . the company shall be declared bankrupt and liquidation of assets shall follow. There are other potential problems. 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. and (iv) the debts shall have been settled within a five-year period. In Thailand. The amended legislation also includes voluntary bankruptcy as a new feature. Vol. but it is a complicated. The model for Thailand’s amended bankruptcy law was the US Chapter 11. which means that a debtor could continue in business while the reorganization program was being implemented. The amended law also introduced the concept of automatic stay. 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. For one. it covers only the court-supervised reorganization of distressed companies. Enforcement of the new law is bound to be ponderous and lengthy. In 1999. But more important. The reorganization process is successful if (i) the debts shall have been discharged. The original Bankruptcy Act dealt only with liquidation and composition. Under the old Bankruptcy Act. In effect. the National Assembly passed an amended Bankruptcy Act and approved the establishment of special bankruptcy courts. II for the recovery of debt through the realization of any collateral. Chapter 11 is the main tool in restructuring bankrupted companies in the US. any new loan to a company extended after the creditor discovered the insolvency would not be eligible for repayment. the judges and court officers have yet to learn and master the new bankruptcy procedure. (ii) management of the company reverts to the borrower. The amendment added reorganization provisions to the Bankruptcy Act of 1940. 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. (iii) shareholders regain their legal rights. creditors always had to contend with the threat of disruptions in a delinquent borrower’s business. If the process fails to revive the business. Foreign secured creditors had to go through the motions of establishing that their country of domicile granted Thai creditors similar rights. Chapter 11 cases account for only 5 percent of bankruptcy suits in the US but consume 90 percent of the courts’ time. and expensive process. the amended law limits the rights of secured creditors. thereby allowing court-supervised corporate restructuring.
In the past. Without the necessary corporate restructuring.” The Foreclosure Act Amendment was likewise passed in 2000. Procedural delays give borrowers an advantage because they can refuse to pay back their loans even though they can meet their obligations. however. namely “liabilities exceed assets. The proposed new law seeks to expand the type of assets that a borrower can use as collateral.” as opposed to the more appropriate criterion of “ability to pay when the debt falls due. the court. the Bankruptcy Amendment will just prolong the problems of nonviable borrowers. The proposed amendment also includes a provision for the company to reimburse minority shareholders for expenses related to calling such a meeting. 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.Chapter 4: Thailand 267 to solve the problems (e. and (ii) processing of default cases within four to six months of filing of a court claim. minority shareholders’ rights are not adequately protected. questions have been raised regarding the appropriateness of the 1992 Act. only tangible assets were the norm. Consequently. Minority shareholders also have to absorb the costs related to their actions because the 1992 Act does not allow them to be reimbursed by the company. The result. Under the new law. Still pending Parliament approval is the amendment to the Secured Transaction Law. the test for insolvency still uses the balance sheet criterion. The new foreclosure law cuts short the procedures required under the Civil and Commercial Code for petty or simple cases dealing with mortgage defaults: (i) submission by the drafting committee of a default judgment bill within a week. The amendment also remedies the slow process of executing or disposing of assets in a public auction. corporate governance) that caused the bankruptcy in the first place. Replacing the Public Limited Company Act of 1978. after determining the legitimacy of the request. has not been satisfactory. In case the board of directors does not comply.g. which aims to increase liquidity in the domestic economy by allowing businesses to use both tangible and intangible assets in securing credit. . The minimum shareholding requirement is too high for any individuals or groups of minority shareholders to take action against controlling shareholders.. the 1992 Act relaxed some of the original restrictive rules and regulations to encourage public company registration. Most important. There have been proposals to lower the minimum shareholdings required for a minority group to request the board of directors to call an extraordinary general meeting at any time. The amendment seeks to revise old rules and procedures that tended to delay foreclosure proceedings.
. disrupts the company’s management and decision making.e. subject only to approval by the board of directors. But because this is the assumption embedded in the regulation. it will probably be expensive because of the higher risk that comes with weak accountability mechanisms. to borrow from the company without consideration to the fairness of the transaction or transparency of the approval process. In addition. The proposal for the amendment of the Public . the controlling shareholders have the exclusive domain to appoint or exercise management. 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. II Another issue is the assumption in the 1992 Act that there is a separation of ownership and control functions. However. Because of high ownership concentration. The 1992 Act only prescribes—not requires—the use of the cumulative voting procedure. with the approval of the board. In the absence of such a stock market boom now. in turn. which. minority shareholders have no chance of being represented in the board. The regulators are drafting a proposal to amend the provisions on related transactions. Where equity will come forward.268 Corporate Governance and Finance in East Asia. minority shareholders are likely to be wary of increasing their equity without corresponding control mechanisms at their disposal. Otherwise. and determine voting results on virtually any matter. The proposal clearly delineates duties of care and loyalty for directors of public companies. who are also the managers. there are few provisions in the Act that deal with related or connected transactions that potentially reduce shareholders’ value. This may be true in countries where publicly traded companies are widely held. The textbook separation between owners who sit in the company’s board and professional managers who run the company does not apply in Thailand. it permits directors. 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. without cumulative voting. 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. the main problem is overlooked. Vol. they face the prospect of being unable to compete for the scarce funds available in the equities market. The 1992 Act also allows directors to engage in business activities that may directly or indirectly affect the company. claiming that it creates fragmentation in the board of directors. Consequently. this is not so in publicly traded companies in Thailand. But as demonstrated. vis-a-vis the minority shareholders. Most companies decide against cumulative voting. the dominance of controlling shareholders. i.
Reforms in bankruptcy procedures should be seen not only in the context of crisis resolution. In particular. Commercial banks initiated 74 percent of these cases.767 cases involving outstanding credit of B2. The reason is that bankruptcy law amendments appear to facilitate settlements outside the court. This point is crucial because compared with .1 trillion of outstanding credit. although since then.764 debt restructuring cases involving B1. methods.6 trillion) have agreed to cooperate with CDRAC’s restructuring process. As of November 2000. Within three months. and manufacturing sectors. accounting for B1. In response.068 cases involving B475 billion are undergoing restructuring. 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. with the majority of the debtors coming from the commerce. the Government introduced debt restructuring-related measures to help resolve bad debts. personal consumption. Equally important is the contribution of effective and reliable bankruptcy procedures for improved corporate governance. only 7. Another 77. Cases for which negotiations were unsuccessful. the number of cases has abated.147 cases (B1. and procedures for debt restructuring. will be settled by the courts. The first bankruptcy court in Thailand opened on 18 June 1999. Some 82 percent of these cases have been successfully restructured. the court had more than 80 cases for disposition. CDRAC’s target debtors comprised 10.6 trillion. the mere threat of external control alters the incentives faced by managers and controlling shareholders significantly. contributing to the unprecedented rise in the corporate sector’s bad debt.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. However. By October 2000.1 trillion in outstanding credit. 322. The Bank of Thailand issued guidelines in 1998 encouraging financial institutions to specify their own policies. where bankruptcy procedures are swift and effective. as well as those that did not cooperate with CDRAC’s restructuring process. Corporate Debt Restructuring and Bankruptcy The 1997 crisis led to a severe liquidity problem in the economy. In addition. Another 5 percent of cases (B70 billion) are undergoing restructuring negotiations.8 trillion had been completed. accounting for B1. Considerable progress has been achieved on this front.
Philippines. and performance during this period helps understand the causes of the crisis. and even Indonesia. It required listed companies to establish their own audit committees by the end of 1999. 4. and Recommendations Summary and Conclusions This study has provided an overview of the corporate sector and governance in Thailand.6 4. behavior. Examination of corporate ownership. Vol. a time span that includes the onset of financial liberalization—the turning point of Thai economic development in the last decade—and represents the decade preceding the Asian financial crisis of 1997.270 Corporate Governance and Finance in East Asia. 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. In the next three decades. and promoted key industries through incentives. The study covers the period 1985 to 1996. The . Conclusions. Financial information from listed companies will also soon be required to conform to International Accounting Standards.6. For this reason. the Government protected certain corporate sectors through tariffs and regulation. II Malaysia. 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. the Thai Government managed its economy with the corporate sector as the main engine of growth and development. Such improvements in disclosure standards are part of the efforts of SET and SEC. Emphasis was on the structure of corporate governance and patterns of corporate ownership and financing of publicly listed companies. The exchange has already required that listed companies’ quarterly reports be directly comparable with annual statements. 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. to push companies to harmonize their accounting with international standards. Weak bankruptcy procedures were part and parcel of the perverse set of incentives that led firms to build up unsustainable levels of debt. Reforms through SET and Improved Disclosure The financial crisis prompted SET to introduce a range of improvements to its operation and regulation. despite the weakness of their disciplinary powers.
reaching its peak in 1996. the number and value of public offerings of securities accelerated.000 from the previous year’s level. the top five largest shareholders hold about 56 percent of total outstanding shares. . During 1992-1997. the numbers of bankruptcy cases and company closures reached alltime highs. One of the principal causes of the crisis was the excessive use of foreign debt by the corporate sector. Profitability increased throughout the 1980s but began to decline in the first half of the 1990s. One of the major findings is the high ownership concentration among Thai companies listed on SET. there was a marked increase in the number of public corporations. Minority shareholders. Subsequently. the devaluation of the baht that began on 2 July 1997 affected the financial condition of Thai corporations. After 1992. even after the development of capital markets. At the onset of the 1997 financial crisis. The study examined the impact of ownership structure on corporate governance and financing patterns. Nonbank private corporations accounted for most of the increase. Although there are some variations across industries.Chapter 4: Thailand 271 importance of bank financing continued throughout the 1990s. the Public Company Act of 1992 and the SEA of 1992. foreign debt in the Thai corporate sector increased continuously. 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. Meanwhile. Because most of these debts were not hedged. The number of newly registered companies in 1997 dropped by almost 10. Thai companies were vulnerable to exchange rate risks. at a time when most of them were already experiencing declining profits and high leverage. the corporate sector entered a new era with the enactment of two major pieces of legislation. the profitability of publicly listed companies abruptly declined and their financial leverage increased. The financial performance of the corporate sector remained satisfactory up to the years before the outbreak of the financial crisis. Although there was a decline in short-term foreign debt. Consequently. In 1992. the increase in long-term debt more than compensated for the drop. the number of listed companies in SET fell from 454 in 1996 to 392 in 1999. the overall pattern of ownership concentration seems to have been stable for the past 10 years. The SEA of 1992 also marked the beginning of an active bond market in Thailand. The impact of the crisis was felt across all industries. In 1995 and 1996. On average. Financial liberalization apparently encouraged companies to borrow overseas to finance investments that were not productively employed. the overall corporate sector was seriously affected. At the same time.
Among the five largest shareholders of Thai companies listed on SET. foreign and domestic. averaging 46 percent. All these. hold only a small portion of total outstanding shares. The key laws. along with a highly concentrated ownership structure. The highly concentrated ownership structure weakens the protection of minority shareholder rights. Thus. The absence of external market controls on the management of publicly listed corporations is dangerous. the existing legal and regulatory framework suggests otherwise. holding companies and affiliated corporations hold the largest proportion at 27 percent of total outstanding shares. Recently. through the use of holding and affiliated companies. Vol. Consequently. In the past. protect the interests of all shareholders of public companies. II although larger in number. With financial institutions playing limited roles in the capital market. Individuals and insiders hold the second largest proportion at about 19 percent.272 Corporate Governance and Finance in East Asia. The implications of ownership structures that are concentrated to such a high degree are serious. An analysis of the corporate ownership structure in Thailand suggests that founders and management continue to own and control publicly listed Thai companies. Nominally. the government pension fund was the only major institutional investor. publicly listed and unlisted companies in Thailand are equally subject to the consequences of the risk-taking behavior of controlling owners. the mutual fund industry has entered the picture but with limited roles and activities. they have little influence over management decision making and control. The Government holds about 1 percent of total outstanding shares but these holdings represent majority shares of a few companies. are not active. there is a clear lack of outside monitors for these publicly listed but family-controlled companies. Financial institutions hold a very small proportion. The rules in both Acts governing . These laws stipulate rules and regulations concerning the activities of all public companies. commercial banks hold only about 2 percent of total outstanding shares while nonbank financial institutions hold about 6 percent. Most foreign institutional investors invest only on a short-term basis and aim for short-term trading profits. the Public Company Act of 1992 and the SEA of 1992. Institutional investors in Thailand. contribute to the lack of external controls on the corporate sector through the capital markets. It remains to be seen how reforms in bankruptcy procedures—including the increased threat of creditor control—could shift the incentives of controlling shareholders toward greater acceptance of equity finance and its consequent accession of control to new shareholders. The investing public holds the rest of the outstanding shares.
the Public Company Act of 1992 allows shareholders to act only when they hold a minimum proportion of shareholdings.2 Policy Recommendations There are three major policy issues and recommendations that could improve corporate governance in Thailand. making them vulnerable to economic shocks. For example. the main challenge is not how the board can control management to maximize shareholder value. However. posed formidable barriers in the minority shareholders’ exercise of their rights. because there is no separation between ownership and management. The first issue involves the development of a comprehensive supervisory framework and the strengthening of the capacity of supervisory agencies. The third issue involves creating external market controls through better regulation and development of the capital markets. Ownership concentration appears to have little impact on corporate profit performance. key reforms that will strengthen the regulation of financial institutions. 4. In this third area. The ownership structure of Thai listed companies also significantly affects company behavior. these companies tend to become overleveraged. The Government has been moving to amend the Public Company Act of 1992 to increase minority shareholders’ protection in this regard. moreover. Specifically. before the crisis. Consequently. For instance. . laws did not provide minority shareholders sufficient safeguards in cases of transactions involving companies where the controlling shareholders had related interests. It appears that founding family members use debt extensively to finance investments because they want to preserve control of their firms. the high ownership concentration of many listed Thai companies inhibits the effectiveness of these provisions.6. because there are shared interests between the controlling shareholders and key management personnel.Chapter 4: Thailand 273 minority shareholders’ participation in decision making and in initiatives against management conform to international standards. In view of this. an aim that can be achieved mostly through legal reforms. a requirement impossible to meet due to the concentrated shareholdings of founding family members and management. Rather. the main challenge is in protecting minority shareholders from the possibility of expropriation by the majority. Certain provisions. The second issue involves the protection of shareholder rights. but is significantly related to financing patterns. the degree of ownership concentration has a statistically significant positive relationship to the degree of financial leverage.
Once the roles and responsibilities are clearly defined. Consequently. If the principal shareholder is in fact chair of the board. As in other crisis economies in the region. and after the enactment of the SEA in 1992. It is important that the roles and responsibilities of each agency are clearly defined to the public. the principal shareholder typically plays a key role in management and often serves as the chief executive officer. the Ministry of Commerce had the sole supervisory responsibility. he/she often has the decisive vote. The board therefore plays a pivotal role. the supervisory agencies also need to be empowered to enforce the laws. Only then will these agencies be able to act promptly and effectively. In this setting. SET was mandated to supervise listed companies. This is due to the historical development of the Thai corporate sector: before 1975. Development of a Comprehensive Supervisory Framework There is a need for the Government to establish a comprehensive supervisory framework for the corporate sector. the key issue in corporate governance would then be to ensure that managers act in the best interests of the shareholders. three major government organizations (the Ministry of Commerce. The owners of a firm rely on a board of directors to supervise the managers. in most of Thailand’s publicly traded firms. Vol. Under the current system. II encourage market competition. Protection of Shareholder Rights The common assumption is that publicly traded corporations are widely dispersed in terms of ownership. this is a problem in Thailand. There is also supposed to be separation of ownership and control. voting only on major decisions. unified supervisory agency or a permanent regulatory division consisting of supervisory units from the three agencies.274 Corporate Governance and Finance in East Asia. activate the market for corporate control. . with control delegated to professional managers. and SEC) are involved in corporate supervision. the key issue in corporate governance is how to prevent insiders from expropriating assets of minority shareholders. in 1975. SEC was established as another supervisory agency. If this were the situation. In reality. The best approach may entail establishing a single. SET. the supervisory system is fragmented and not as effective as it should be. The Government must develop an overall framework for corporate sector supervision and redefine the regulatory jurisdiction of each agency along functional lines. and increase the participation of institutional investors are imperative.
But weaknesses in accounting and auditing practices have been inhibiting the development of capital markets. The Government does not have an effective way of monitoring the financial activities of these companies even as it is widely believed that a large amount of funds is being channeled through them. There 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. and a prohibition of connected transactions by directors or management. regulators must increase transparency and step up enforcement. Some of the legal reforms under consideration concern settling conflictof-interest situations with significant effects on minority shareholders. Both SET and SEC are taking an active stance in improving the transparency and efficiency of Thai capital markets. This includes prescribing ways to empower minority shareholders without disrupting the company’s operations. increasing penalties for directors engaged in misconduct. This move is expected to be unpopular among founding family members and original owners. there has been much progress in this area. and . requiring cumulative voting for the election of directors. 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. The second recommendation is to dilute ownership concentration through the use of regulatory power. The Ministry of Commerce is conducting a study on proposed amendments to the Public Company Act of 1992. To ensure a level playing field. transparency. Through an amendment in the Public Company Act. SEC is exploring the possibility of amending the law toward this direction. The first recommendation involves the repeal of current legislation to allow minority shareholders to have greater influence over management decision making.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. 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. The current ownership structure leads to ineffective corporate governance and inadequate protection of minority shareholders. they should be monitored and regulated. The situation prompts two specific recommendations. The slow improvement in the legal framework has likewise obstructed progress in this area. Since the Asian financial crisis. accountability. the Government can change the shareholding limit for controlling shareholders.
In an environment of highly concentrated ownership. 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. II responsibility among companies. in turn. The promotion of active roles for domestic institutional investors should also improve corporate governance in Thailand. The same goes for improvements in the bankruptcy system. there is a need to increase market disciplinary power through market competition. . Vol. it is important to explore reforms that can lead to the enhanced role of banks in monitoring enterprises. In the stock market. 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.276 Corporate Governance and Finance in East Asia. The Bank of Thailand’s enforcement of prudent lending practices among Thai financial institutions. Thailand should develop a strong public debt market to supplement the banking system in financing corporate investments. Because the financing of Thailand’s corporate sector is predominantly bank-based and will remain so for a long while yet. The variety of debt instruments available to the corporate sector and investors should be increased and longer-term sources of bond finance actively promoted. will lead to the emergence of a reference yield curve. However. it will be difficult to improve corporate governance in Thailand. especially in the area of connected lending. which. for instance. while a strong domestic debt market will also offer protection from foreign exchange risk. the SEC’s disposition toward a largely voluntary approach for adoption of these characteristics has resulted in uneven compliance among public companies. Without a strong and efficient capital market. Capital Market Development and Regulation Another important issue concerns the development of capital markets. A well-developed domestic debt market will provide corporations with an alternative to bank financing. Accounting standards have also been under review. This may not be possible without reforms in the banking sector itself. a well-developed secondary market will pave the way for market disciplinary forces to act against poorly managed companies. The first step is to establish an active secondary Government bond market. Further. There will be no incentive for companies to raise capital in the equities market if they can obtain funds at a lower cost elsewhere.
Department of Commercial Registration Database. Kingston. The University of Rhode Island. PACAP-Thailand Database.Chapter 4: Thailand 277 References Annual Report. Thai Accounting Standards. 1995-1999. Bank of Thailand. 1995-1999. The Stock Market in Thailand. 1995. The Stock Exchange of Thailand. Fact Book. 1995-1999. . Bank of Thailand Quarterly Bulletin. The Securities and Exchange Commission of Thailand. Bank of Thailand. Thailand. Key Capital Market Statistics. Pacific-Basin Capital Markets Research Center. 1998. Bank of Thailand Monthly Bulletin. 1997-1999. 1997. Bond Market Development in Thailand. The Securities and Exchange Commission of Thailand. The Stock Exchange of Thailand. Ministry of Commerce. US. The Thai Bond Dealing Centre. The Stock Exchange of Thailand. 1997.
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.