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A Study of Indonesia, Republic of Korea, Malaysia,Philippines,andThailand
Edited by: Juzhong Zhuang SeniorEconomist RegionalEconomicMonitoringUnit AsianDevelopmentBank David Edwards AssistantChiefEconomist ProjectEconomicEvaluationDivision AsianDevelopmentBank Ma. Virginita A. Capulong SeniorSectorAnalyst AgricultureandSocialSectorsDepartment(West) AsianDevelopmentBank
© Asian Development Bank 2001 Allrightsreserved. ThispublicationwaspreparedundertheAsianDevelopmentBanksregionalTechnical Assistance 5802: A Study on Corporate Governance and Financing in Selected DMCs. The views expressed in this book are those of the authors and do notnecessarilyreflecttheviewsandpoliciesoftheAsianDevelopmentBank,or itsBoardofDirectorsorthegovernmentstheyrepresent. The Asian Development Bank does not guarantee the accuracy of the data includedinthispublicationandacceptsnoresponsibilityforanyconsequencesfor theiruse. Use of the term country does not imply any judgment by the authors or the AsianDevelopmentBankastothelegalorotherstatusofanyterritorialentity . ISBN 971-561-323-3 Publication Stock No. 100800 Published and printed by theAsian Development Bank P.O. Box 789, 0980 Manila, Philippines
List of Tables List of Figures Foreword Preface Abbreviations 1 Indonesia 1.1 Introduction 1.2 OverviewoftheCorporateSector 1.2.1 HistoricalDevelopment 1.2.2 TheCapitalMarket 1.2.3 The Banking Sector 1.2.4 ForeignCapital 1.2.5 GrowthandFinancialPerformance 1.2.6 LegalandRegulatoryFramework 1.3 CorporateOwnershipandControl 1.3.1 CorporateOwnershipStructure 1.3.2 ManagementandInternalControl 1.3.3 ExternalControl 1.4 CorporateFinancing 1.4.1 FinancialMarketInstruments 1.4.2 PatternsofCorporateFinancing 1.4.3 CorporateFinancingandOwnershipConcentration 1.5 TheCorporateSectorintheFinancialCrisis 1.5.1 CausesoftheFinancialCrisis 1.5.2 ImpactoftheFinancialCrisisontheCorporateand BankingSectors 1.5.3 Responses to the Crisis 1.6 Summary, Conclusions, and Recommendations 1.6.1 SummaryandConclusions 1.6.2 Policy Recommendations References vi ix x xi xii 1 1 3 3 4 5 7 8 15 17 17 25 30 32 32 34 35 36 36 39 42 45 45 48 51
2 Republic of Korea 2.1 Introduction 2.2 OverviewoftheCorporateSector 2.2.1 HistoricalDevelopment 2.2.2 Rise of the Large Business Groups (Chaebols) 2.2.3 RoleoftheCapitalMarketandForeignCapital 2.2.4 GrowthandFinancialPerformance
53 53 55 55 60 62 65
iv 2.3 CorporateOwnershipandControl 2.3.1 PatternsofCorporateOwnership 2.3.2 InternalManagementandControl 2.3.3 ShareholderRights 2.3.4 ControlbyCreditors 2.3.5 TheMarketforCorporateControl 2.3.6 ControlbytheGovernment 2.3.7 EmployeeParticipationinCorporateGovernance 2.4 CorporateFinancing 2.4.1 Overview of the Financial System 2.4.2 PatternsofCorporateFinancing 2.4.3 FinancialStructure,Diversification,andCorporate Performance 2.5 TheCorporateSectorintheFinancialCrisis 2.5.1 WeaknessesinCorporateGovernance 2.5.2 TheRoleofGovernmentIntervention 2.5.3 ManifestationsofWeakCorporateGovernanceand GovernmentIntervention 2.5.4 ShortcomingsinMacroeconomicPolicy 2.6 Responses to the Crisis and Policy Recommendations 2.6.1 CorporateRestructuringActivities 2.6.2 PolicyMeasuresforCorporateReform 2.6.3 Policy Recommendations References 3 The Philippines 3.1 Introduction 3.2 OverviewoftheCorporateSector 3.2.1 HistoricalDevelopment 3.2.2 GrowthandFinancialPerformance 3.2.3 LegalandRegulatoryFramework 3.3 CorporateOwnershipandControl 3.3.1 PatternsofCorporateOwnership 3.3.2 CorporateManagementandShareholderControl 3.3.3 TheRoleofCreditorsinCorporateControl 3.4 CorporateFinancing 3.4.1 TheFinancialMarketandInstruments 3.4.2 PatternsofCorporateFinancing 3.4.3 OwnershipConcentration,FinancialLeverage,and Performance 3.5 TheCorporateSectorintheFinancialCrisis 3.5.1 TheFinancialCrisis:CausesandManifestations 3.5.2 ImpactoftheCrisisontheCorporateSector 3.5.3 Responses to the Crisis 74 74 94 103 105 108 110 111 113 113 118 128 130 132 134 134 137 139 139 143 148 153 155 155 156 156 158 167 171 171 186 198 199 199 202 209 210 210 212 214
v 3.6 Summary, Conclusions, and Recommendations 3.6.1 SummaryandConclusions 3.6.2 Policy Recommendations References 216 216 219 226
4 Thailand 4.1 Introduction 4.2 OverviewoftheCorporateSector 4.2.1 HistoricalDevelopment 4.2.2 DevelopmentofCapitalMarkets 4.2.3 GrowthandFinancialPerformance 4.2.4 LegalandRegulatoryFramework 4.3 CorporateOwnershipandControl 4.3.1 PatternsofCorporateOwnership 4.3.2 CorporateManagementandControl 4.3.3 ExternalControl 4.4 CorporateFinancing 4.4.1 OverviewoftheFinancialSector 4.4.2 PatternsofCorporateFinancing 4.5 TheCorporateSectorduringtheFinancialCrisis 4.5.1 ImpactoftheFinancialCrisisontheCorporateSector 4.5.2 Responses to the Crisis 4.6 Summary, Conclusions, and Recommendations 4.6.1 SummaryandConclusions 4.6.2 Policy Recommendations References
229 229 230 230 233 235 239 240 241 244 248 252 252 257 261 261 264 270 270 273 277
9 OwnershipConcentrationofPubliclyListedCompanies by Sector. 1992-1997 Table 1.12 CharacteristicsoftheBoardofDirectors Table 1.17 DER of Listed Companies by Degree of Ownership Concentration Table 1.6 GrowthandFinancialPerformanceofState-Owned Companies. Indonesia Table 1.16 FinancingPatternsofPubliclyListedNonfinancial Companies. 1992-1999 Table 1.14 Banking Sector Outstanding Loans. 1992-1995 Table 1.21 Nonperforming Loans by Type of Bank.20 ROE of the Banking Sector. 1990-1998 Table 1. 1992-1998 Table 2.3 GrowthandFinancialPerformanceofPubliclyListed Companies. 1992-1997 Table 1.1 Listed Firms with Positive Economic V alueAdded.15 V alue of Stocks Issued and Stock Market Capitalization.10 Anatomy of the Top 300 Indonesian Conglomerates. 1993-1999 Table 1. 1986-1996 Table 1. 1997 Table 1. 1988-1996 Table 1. 1992-1997 Table 1.19 DER and ROE of Publicly Listed Companies by Sector. Republic of Korea Table 2. 1992-1999 Table 1. 1993-1997 Table 1.4 Development of the Stock Market. 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 .2 Foreign Capital Flows.11 CharacteristicsoftheBoardofCommissioners Table 1. 1996-1998 Table 1. 1992-1997 Table 1. 1996-1998 2.5 Financial Performance of Publicly Listed Companies by Sector.1 Growth of the Banking Sector. 1996-1999 Table 1.13 Presence of Board Committees in Listed Companies Table 1. 1990-1997 Table 1.vi List of Tables 1.3 Subsidiaries of the 30 Largest Chaebols Table 2.4 Growth Performance of Publicly Listed Companies by Sector.7 Growth Performance of the Top 300 Conglomerates.8 OwnershipConcentrationofPubliclyListedCompanies.18 GDP Growth by Sector.2 KeyMacroeconomicIndicators Table 2.
1994-1998 Financing Patterns of the Top 30 Chaebols.vii Table 2.25 Table 2.12 Table 2. 1987-1997 FlowofFundsoftheNonfinancialCorporateSector. 1992-1997 OwnershipConcentrationofListedNonfinancialFirms. 1997 Ownership Concentration ofAll Listed Firms. 1988-1997 Features of the 30 Largest Chaebols GrowthandFinancialPerformanceofthe30Largest Chaebols.11 Table 2.9 Table 2. 1990-1997 InternationalComparisonofRatiosofOrdinaryIncome toSalesinManufacturing GrowthandFinancialPerformanceofSelectedIndustries GrowthandFinancialPerformanceofListedCompanies. 1988-1997 FinancingPatternsoftheNonfinancialCorporateSectorby Industry Financing Patterns of Listed Companies. 1997 OwnershipConcentrationofListedNonfinancialFirms by Firm Size. 1995-1997 Ownership Composition of Listed Companies. 1997 Ownership Composition of Listed Firms in Selected Countries.22 Table 2. 1988-1997 OwnershipConcentrationofListedNonfinancialFirms by Industry.28 Table 2.19 Table 2. 1997 Ownership Composition of Listed Nonfinancial Firms by Control Type.14 Table 2.6 Table 2.21 Table 2. 1993-1997 The Top 30 Chaebols Debt-to-Equity Ratio.15 Table 2.20 Table 2.30 Private Capital Flows to Korea.29 Table 2. 1985-1998 GrowthandFinancialPerformanceoftheNonfinancial Corporate Sector.27 Table 2.24 Table 2. 1994-1997 Cross-Payment Guarantees of the Top 30Chaebols. 1988-1997 Ownership Composition of Listed Nonfinancial Firms by Industry.7 Table 2.16 Table 2. 1988-1997 Ownership Concentration of the Survey Sample of 81 Listed Firms. 1988-1997 FinancingPatternsoftheNonfinancialCorporateSector.10 Table 2.8 Table 2. 1990 and 1997 Ownership Composition of Listed Nonfinancial Firms by Size.18 Table 2.13 Table 2. 1999 InternalShareholdingsofthe30Largest Chaebols.17 Table 2. 1993-1997 64 66 66 68 70 71 72 73 75 78 80 82 82 83 84 85 86 87 90 91 120 121 122 126 126 127 . 1985-1997 GrowthandFinancialPerformanceofListedCompanies by Size.23 Table 2.5 Table 2.26 Table 2.
17 Composition ofAssets and Financing of the Publicly Listed Sector. 1988-1997 Table 3. Thailand Table 4. 1997 Table 3.12 Control Structure of the Top 50 Corporate Entities.6 GrowthandFinancialPerformanceoftheCorporateSector by Firm Size.10 Composition of Top Five Shareholders of Philippine Publicly Listed Companies by Sector.31 Table 2.8 Ownership Composition of Philippine Publicly Listed Companies by Sector.2 Public Offerings of Securities. 1990-1999 Table 3. 1978-2000 Table 4. 1988-1997 Table 3. 1983-1997 Table 3. 1989-1997 Table 3.20 Financing Patterns by Industry. 1986-1998 Nonperforming Loans of General Banks. Flagship Company.5 GrowthandFinancialPerformanceoftheCorporateSector by Control Structure.14 Philippine Stock Market Performance.19 Financing Patterns by Firm Size. 1989-1997 Table 3. 1992-1999 .33 Net Profit Margins of Chaebols.32 Table 2.21 OwnershipConcentration.22 Foreign Investment Flows.2 Growth and Financial Performance of the Top 1. 1988-1997 Table 3.Profitability andFinancial . 1997 Table 3.13 ADB Survey Results on Shareholder Rights Table 3.SectorOrientation.1 GDP Growth of SoutheastAsian Countries. 1989-1997 Table 3. 1997 Table 3. Leverage Table 3. 1988-1997 Table 3.16 CorporateFinancing PatternsbyOwnershipType.1 Public Companies Registered. 1989-1997 Table 3. 1988-1997 Table 3.9 OwnershipConcentrationatCriticalLevelsofControl Over Publicly Listed Companies.18 Financing Patterns by Control Structure. 1988-1997 Table 3.000 Companies. 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 3.4 GrowthandFinancialPerformanceoftheCorporateSector by Ownership Type.viii Table 2.1989-1997 Table 3. The Philippines Table 3.3 TheCorporateSectorandGrossDomesticProduct.7 GrowthandFinancialPerformanceoftheCorporateSector by Industry. 1995-1998 4. 1997 Table 3. 1992-1996 Table 3.11 TotalandPerCompanySales. andAffiliated Banks of Selected Business Groups. 1997 Table 3.15 Financing Patterns of the Corporate Sector. 1985-1997 Number of Firms with Dishonored Checks.
Ownership Concentration. 1985-1999 237 238 239 241 242 243 251 252 256 258 259 260 261 262 264 List of Figures Figure 1.1 Figure 3. Leverage.1 Figure 1. 1990-1996 External Debt. 1992-1999 Offerings of Debt Securities.3 Table 4.16 Table 4.7 Table 4. and Company Size Top-Five Shareholder Composition of Publicly Listed Companies in Thailand.ix Table 4. 1990-1998 StatisticalRelationshipsbetweenCorporateProfitability. 1986-1999 NumberofNewlyRegisteredandBankrupted/Closed Companies. 1992-1999 Common-Size Statements for Companies Listed in SET. 1993-1999 Key Financial Ratios of Publicly Listed Companies.12 Table 4.11 Table 4. 1985-1996 Average Key Financial Ratios by Company Size. 1990-1996 Financial Ratios of Listed Companies by Ownership Concentration.5 Table 4.2 TheSuhartoGroup TypicalInternalOrganizationalStructureofaPublicly Listed Company in Indonesia CorporateControlStructure:TheCaseofAyalaCorporation CorporateControlStructure:theCaseofLopezGroup 24 25 195 197 .15 Table 4. 1990-1996 Financial Ratios of All Listed Firms.8 Table 4. 1985-1996 Top-Five Ownership Concentration of Publicly Listed Companies in Thailand.14 Table 4. 1990-1998 Merger and Acquisition Activities.10 Table 4.9 Table 4.4 Table 4.17 StatisticalHighlightsoftheStockExchangeofThailand. 1993-1999 Size and Composition of the Thai Financial Sector.13 Table 4.2 Figure 3. 1990-1996 Common-Size Statements of Public Companies by Ownership Concentration.6 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.
5 percent. patterns of ownership and control. II rate reached 58. The scale of the financial crisis exposed weaknesses of the country’s corporate sector. or Thailand. Economic growth reached more than 7 percent per year and the inflation rate was kept at single digit levels. and responses to the financial crisis. placed a high premium on these political connections in assessing the chances of being repaid.2 Corporate Governance and Finance in East Asia. On the other hand. the controlling families of corporate groups often established banks to provide funds to affiliated nonfinancial companies. except utilities. Section 1. short-term loans were used to finance long-term investments. In this setup. particularly those with large foreign loans. Vol. contracting by 36. When the crisis hit the country.5 percent. prior to the financial crisis. how it has affected corporate financial performance and financing. these controlling families had political connections that allowed their companies to enjoy special privileges. The study also identifies family-based companies and corporate groups. 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. were the ones most affected. Section 1. posted negative growth. All sectors. the Indonesian economy seemed to be in generally good shape.3 looks at patterns of corporate ownership and control. Although as a percent of GDP the stock of outstanding foreign debt owed directly by the private sector was smaller than that of the Republic of Korea. The construction sector was the worst hit. and how it contributed to the crisis. To facilitate even easier access to credit. In many instances. These banks were allowed to operate even if they violated minimum capital adequacy requirements. However. highly leveraged companies.2 presents an overview of the Indonesian corporate sector. Foreign debt reached more than $100 billion. and . patterns of financing. This study reviews the Indonesian corporate sector’s historical development. It analyzes the weaknesses of corporate governance in Indonesia. 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. Malaysia. no doubt. this left the Indonesian economy extremely vulnerable. Foreign creditors.6 percent) and trade (-18 percent). the currency composition and term structure of corporate foreign indebtedness were causes for concern. regulatory framework. and analyzes their importance to the corporate sector in Indonesia. These were already contributing to high levels of nonperforming loans (NPLs) in the Indonesian banking sector several years before the 1997 crisis erupted. followed by finance (-26.
a gradual shift in public investment away from manufacturing took place. Section 1. 2 Survey questionnaires were sent to 280 companies listed in the Jakarta Stock Exchange. Despite the oil revenues. However. Not all items in the questionnaires were answered by the respondents. In the early 1970s. how it was affected by the crisis.4 analyzes corporate financing patterns. The industries that emerged were highly import-dependent and reliant on tariff protection. while Chinese and indigenous entrepreneurs ran some large businesses in trading. Subsequently. and tobacco industries. and its response. The Government became directly involved in industry as a result of the nationalization of Dutchowned shipping firms and oil companies. medium. only 40 companies replied—39 are private companies and one state-owned company (Bank BNI). . textiles. the windfall from oil and gas revenues was an important factor that allowed the Government to promote industrial development via import substitution.5 examines the corporate sector during the financial crisis in terms of its role.Chapter 1: Indonesia 3 profiles the corporate sector’s governance characteristics. It also examines the statistical relationship between corporate performance and corporate governance characteristics. This section reports the results of an Asian Development Bank (ADB) survey on corporate management and control practices in Indonesian publicly listed companies.2 1. With the relatively liberal laws governing foreign and domestic private investments introduced by the New Order Government in 1967 and 1968. substantial volumes of private investment entered the scene. 1.1 Overview of the Corporate Sector Historical Development The marked permeability between the State and business in Indonesia goes back to the country’s struggle for independence.2. Section 1. in the course of the fight for nationhood from 1942 to 1950.6 summarizes the major findings of the study and suggests recommendations to improve governance in the Indonesian corporate sector.2 Section 1.and large-scale companies were dominated by state-run industrial concerns. Up until the mid-1960s.
the Indonesian industrial sector was quite diverse. These were families with strong links to the political elite of the New Order. 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. In 1992. Partly as a result of various government policies.2 The Capital Market The Government reactivated the stock exchange in 1977. Export credits with low interest rates were granted to industries that were intensive in the use of local labor and raw materials. By 1987. Third. II the currency needed to be devalued periodically under a managed floating exchange rate system to avoid large current account deficits. many founding owners of companies were reluctant to go public and dilute their corporate ownership. Regulations in the banking sector led to equities having higher risk but lower returns than bank deposits. the dilution of corporate ownership. even when new shareholders do not threaten the control exercised by the original owners. and employed the bulk of the industrial labor force. wood. the Government shifted its industrial policy toward the promotion of labor-intensive exports. In the 1980s. 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). exports of nonoil products (particularly textiles and footwear. The equity market remained largely unappealing due to a number of factors. potentially subjects companies to greater regulatory scrutiny. which dominated their respective sectoral outputs and markets. there were also many rapidly growing large-scale companies and business groups or conglomerates. A number of underwriters emerged. mostly nonbank financial institutions and stockbrokers. 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 these proved counterproductive because they limited the potential for capital gains to prospective investors. produced consumer goods. During this period. First.4 Corporate Governance and Finance in East Asia. . Vol.2. Second. Generally speaking. the value of manufactured exports overtook the value of oil and gas exports for the first time. But until the end of 1988. Last. and related products) had shares in total exports that were rapidly increasing. the number of firms quoted in the stock market was only 24. 1. a distinct industrial elite started to emerge. While most of the companies were small.
companies could no longer enjoy low-interest credit from state banks.5 trillion. However. reduced restrictions on foreign exchange transactions. Thus. However. The Government also allowed foreign investors to buy up to 49 percent of listed shares. Consequently. the banking sector has been and still is the major source of credit for the corporate sector. Further reforms along the same direction and affecting state-controlled banks came in the 1990s. private domestic banks dominated the sector in terms of number and total assets. The development of the Indonesian stock market also provided a vehicle for the privatization of state-owned companies (SOCs). Conglomerates carried out 210 out of 257 IPOs. with a total value of more than Rp8 trillion. But in terms of assets per bank. These included the opening of the banking industry to new entrants. the legal infrastructure that was supposed to guide the evolution of the banking sector was not backed by effective enforcement. the banking sector has undergone many reforms.1 shows that from 1994 to 1998. However. the capital market played an increasing role in raising long-term funds needed by the corporate sector. 1. the controlling shareholder of these SOCs is still the State. Through the years. to date. Table 1. The banking sector. state-owned banks were still among the biggest. began to face competition. During this period. Since 1977. the number of listed companies in the stock exchange increased substantially. The dominance of state banks started to erode. the liberalization of the banking industry allowed banks to determine lending rates for nonpriority loans.Chapter 1: Indonesia 5 At the end of 1988. which were previously constrained to 4 percent per day. Partly as a result of these reforms. In 1988.3 The Banking Sector Despite the development of the stock market. The initial banking sector reform was introduced in 1983. and increased access of domestic banks to international financial markets. the number of private domestic banks increased. The Government also abolished the practice of setting prices for IPOs and removed restrictions on price movements in the secondary market. from 24 in 1988 to more than 300 in 1997. six SOCs had issued equities in the market. Interest rate regulations on state banks and credit ceilings in general were removed.2. priority credits still enjoyed subsidized interest rates and funding from the Central Bank. . which up to then was channeling oil revenues to priority sectors. with a total value of Rp16. more significant reforms were introduced.
5 7 7 7 5 15.4 34 12. Among private domestic banks.8 31 10.9 39 18. But the banking system proved incapable of performing its intermediation function. and Bank Umum Nasional (BUN) have failed and the first two are now under management of the Indonesian Bank Restructuring Agency (IBRA). 1993 100.6 34 14.6 Corporate Governance and Finance in East Asia.5 165 308.0 234 1994 104. Both BCA and BUN have shareholders linked to the former President Suharto.9 304.3 201.5 7 9.7 27 37. 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. Of these. .8 166 248.9 27 113.7 351.6 7 12.5 27 88. private domestic banks among the top 10 in 1997 included Bank Central Asia (BCA) (ranked first and linked to the Salim group).9 248.2 161 214.3 10 17.6 240 1996 1997 1998 1999 141. Because regulation was weak.8 10 19. 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.6 164 144 130 92 387.8 391.4 239 222 208 173 Assets and liabilities were concentrated in the top 10 banks. II Table 1.8 27 147. banks could earn profits even when they did not gather and process information about risk. and Bank International Indonesia (ranked 9th).8 10 37.1 10 47.1 Growth of the Banking Sector.5 528. while BUN has been closed down by the Government. In terms of assets.4 789. BCA. Vol.4 10 35.8 27 200.5 27 66.9 291.3 30 7. Bank Danamon. the 10 largest were all affiliated with major business groups. Bank Danamon (ranked 7th).9 762.6 7 7.3 27 51.8 29 6.2 10 14.9 31 9. The other banks among the top 10 were state banks.9 10 11.1 240 1995 122.
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. Most FDIs came in through joint ventures with business groups having strong political connections. In 1994.48 1.88) — — — — — — 8. Successive policy deregulation facilitated FDIs in various light manufacturing industries.59 4. Joint BIS-IMF-OECD-World Bank Statistics on External Debt. especially through bank loans. textiles. 1990-1998 ($ billion) Type of Flows Net FDI Net Portfolio Investment Foreign Bank Loans 1990 1991 1992 1993 1994 1995 1996 1997 1998 1. they still amounted to a large sum for the economy to absorb. FDI flows were strong.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. the Government allowed foreign investors to own 100 percent of an Indonesian company.40) (0. In the 1990s. Between 1990 and 1996.11 3. Until the onset of the crisis. when the financial crisis hit Indonesia.50 (0. 1. From the mid-1980s until July 1997. Table 1.2 Foreign Capital Flows. foreign investment also had a strong presence in the services and infrastructure sectors.59 billion in 1996. IMF.78 2. there was a phenomenal growth in direct borrowings by Indonesian corporations. Source: IFS CD-ROM.01 (2.4 Foreign Capital The years of rapid industrial growth attracted a large amount of foreign direct investments (FDIs). November 2000. initially from Japan and the Republic of Korea.2.09) 1. such as metal goods. . foreign creditors were eager to provide financing to Indonesia. Although these inflows were not nearly as large as those received by Thailand (10 percent of GDP) and Malaysia (9 percent of GDP).81 3. except in certain strategic sectors.63) (1.01) (0.09) (0. Indonesia received capital inflows averaging about 4 percent of GDP. In effect.2.88 4.00 2.33 (13. as shown in Table 1.15) — = not available. Net FDI flows increased to $5.87 7. But FDIs were only one form of foreign capital inflows to Indonesia.09 1. September 2000.10 5. Increasingly. and footwear.74 5.
In November 1998. This increased to 30 percent by the end of 1993. By the end of 1997. In the 1990s. allowing foreign investors to buy up to 49 percent of stocks of a publicly listed company. plus 4 percent for the depreciation of the rupiah. and conglomerates. foreign banks became a significant source of financing for the corporate sector. Consequently. The external corporate debt owed to foreign commercial banks was $67 billion. foreign investors began to dominate daily trading. but declined to an average of 25 percent during 19951997.4 trillion in 1997. Due to data constraints. state-owned companies (SOCs).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. total corporate debt reached nearly $118 billion. Domestic corporate debt was about $50 billion equivalent. In September 1997. Vol. Private borrowers preferred foreign loans since these were relatively cheaper. Between 1989 and 1992. 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. especially the short-term ones. an interesting question is whether standard measures of corporate profitability and performance also indicated the same. The following section looks at the growth and financial performance of the corporate sector. the analysis focuses only on publicly listed companies. The private sector left foreign loans unhedged because the depreciation of the rupiah had never reached more than 4 percent annually since the 1986 devaluation under the managed floating system. II Up until the late 1980s. with the onset of the Asian crisis. Capital account liberalization permitted the inflow of foreign capital that fueled the credit boom in the country.2. the average borrowing rate for dollar loans was 9 percent. 1. . From 1987 to 1996. The Government relaxed this restriction in 1988. 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.8 Corporate Governance and Finance in East Asia. of which two thirds were rupiah-denominated. The excessive dollar borrowings made the corporate sector vulnerable to sudden currency fluctuations. the average foreign ownership of listed companies was 21 percent. 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. increasing the total trading value from Rp8 trillion in 1992 to Rp120.
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 — 3.7 — = not available. Asset turnover was above 30 percent until 1996. During 1992-1997.1 percent in 1997 when the crisis began to buffet Indonesia. but fell to 24. 246 firms. averaging 3.6 24. b Asset turnover is defined as sales over assets. a Value added was assumed to be 30 percent of total sales. 1995. there were 204 firms.0 1.6 percent in 1997.8 6. 174 firms.2 1995 37.0 12. 248 firms.8 percent between 1992 and 1996. 1994.3 3. Average return on equity (ROE) of listed firms was 11. total sales of listed companies grew at an annual average rate of 31 percent. Despite such rapid growth.8 220.2 30.6 3.0 33. but declined to 0. and 1992.6 1994 50. the average DER increased to 310 percent from 230 percent the .0 6.3 Growth and Financial Performance of Publicly Listed Companies.7 — 250.6 48.0 12.4 1993 45.8 230.0 11. Net profits grew at an annual rate of more than 20 percent from 1992 to 1996. 1996.4 31.3 6.4 38.5 37.4 1997 7. Return on assets (ROA) was also relatively stable during 1992-1996.5 34. The growth of listed companies was sustained by continuing investments.7 percent in 1997. 1993.2 7.0 3. The debt-to-equity ratio (DER) was high compared to those of listed companies in Malaysia and the Philippines. Note: The number of firms is not identical for each year. while total assets grew at 43 percent.5 3.1 4.5 34. When the crisis battered Indonesia in 1997. 226 firms. Table 1.3 shows the growth and financial performance of Indonesian publicly listed companies.7 3.9 310. In 1997. but dropped to 1.1 0. ranging from 220 to 250 percent between 1992 and 1996.9 37.0 12. Source: JSX Monthly (several publications).Chapter 1: Indonesia 9 Publicly Listed Companies Table 1.1 220.5 240. publicly listed companies as a group contributed less than 10 percent to GDP. but turned negative in 1997.4 percent. although the contribution increased over time.4 1996 18.0 10. 250 firms.0 64.
due mainly to the domination of the International Nickel Company of Canada. the banks eagerly provided credit to property development companies. with ROE falling to -11. The ROE levels suggest that high leverage enabled listed companies to achieve high returns on equity. Before the crisis. When interest rates increased. finance. helped in part by the relatively strong demand for consumer goods.7 percent during 1992-1996. meanwhile. consumer goods. property. only two sectors (mining and finance) showed a consistently increasing trend from 1992.4). During those years. the mining sector had the highest ROE. investment. and building construction. it appeared that the performance of listed companies was quite satisfactory prior to the crisis. ROE fell drastically because the sector had one of the highest DERs. mining. real estate. The finance sector’s contribution to GDP. averaging 17. when the property sector was booming during 1993-1997. and trade) even posted . The same applied to the trade sector. indicating its reliance on equity to support growth. the companies in the sector did not operate with a high leverage. However. II previous year.10 Corporate Governance and Finance in East Asia. which operated in nickel and copper mining in 1992 and 1993. The Jakarta Stock Exchange (JSX) classified listed companies into nine sectors: agriculture. the mining sector ranked first. But the sector’s ROE fluctuated a lot. In terms of sales and asset levels in 1997. in terms of growth of sales and assets. basic industry and chemicals. Most companies in the sector that had unhedged dollar-denominated loans suffered exchange rate losses when the rupiah weakened. Meanwhile.73 percent in 1992 to 1. and trade. This sector was less affected by the crisis. and building construction sectors had the highest DERs because companies in these sectors found it easy to obtain credit from banks. the mining sector had the lowest DER. ROA of all sectors dropped in 1997. property. Overall. the fluctuation in nickel and copper prices contributed to the oscillation of ROE. For instance. followed by agriculture (Table 1.5 presents the financial performance of listed companies by sector. Also. investment. This indicates that a substantial part of corporate debt was denominated in dollars and unhedged. averaging 21. and services. and services.64 percent in 1997. miscellaneous industry. miscellaneous industry. the dominant sector was the finance sector.2 in 1997. From 1995. still posting a positive but lower ROE. although asset turnover was slow. infrastructure. and property.3 percent between 1992 and 1996. increased from 0. the property sector was severely affected by the crisis. The finance. The consumer goods sector ranked second in terms of ROE. trade. Vol. Table 1. Four sectors (basic industry and chemicals. real estate. In terms of share of value added to GDP.
1 23. Industry Consumer Goods Industry Prop. and Bldg.2 13.5 28.Table 1.7 24.9 0.0 0.2 0.6 0.4 30.0 1.3) 53.0 1996 1997 58.1 1..0 0. and Services — = not available. 1992-1997 (percent) Indicator/Sector Sales Growth Agriculture Mining Basic Industry and Chemicals Misc. Infrastructure Finance Trade.7 40.1 0.6 1994 (75.8 (76. Real Estate.3 31.4 0.1 71.8) 0.6 0.6 135.4 31.5) 13..4 43.1 — 39.0 (20.8) (12. Investment.1 35.6 0.3 17.4 21.9 (7.5 1. and Services Net Profit Growth Agriculture Mining Basic Industry and Chemicals Misc.1 0.6 26. and Bldg.1 0.7 62.9 54.3) 39.5 1.5 95. Constn.4 Growth Performance of Publicly Listed Companies by Sector..7 1995 51.3 0.5 68.2 59.1 0.3 340.1 0.2) 0.7 — — 11.0 0.7 0.8 62..5 13.1 1.5) 6. Industry Consumer Goods Industry Prop.4 103.8 66.0 68.0 18.6 15.0) 46.4) 6.8 24.8 0.6 1. Infrastructure Finance Trade.9 8.7 (82. and Bldg.5) 49.5 0.4 38.4 1993 155.6) 25.1 0.5 (11.5 (8. Real Estate.9 .9 54.2 14. Industry Consumer Goods Industry Prop.3 92.7 — 36.1 42. Infrastructure Finance Trade.7 43.5 53.7 54. Investment.0 0.1 28.4 170.7) (27.6) 19.1 16.2 0.4 77.5 1.0 0.2 35.5 92.6 22.7) (113.3 0.9 59.2 41.8 50. Constn.6 85.2 5. Constn.1 (11.1 (41.7 133.0 (28.8 1.4 44.8 1.9 31.4 1.9 36.2 41.5 61.6 51. Infrastructure Finance Trade.7 112.0 (192.6 0.4 30.9 64.4 64.0 64.3 0.3 0. 1992 — — — — — — — — — — — — — — — — — — — — — — — — — — — 0.3 0.7 34.7) 17.1 32.1 67. Real Estate.3 51.4) 8.1 0.5 0.0 31.8 32.9 1. and Services Share of Value Added in GDP Agriculture Mining Basic Industry and Chemicals Misc.0 43.7 28.5 23.8 27.8 28.8 29.6 28.6 133.6 (41. and Services Asset Growth Agriculture Mining Basic Industry and Chemicals Misc. Real Estate.9 123. Constn.1 0. Industry Consumer Goods Industry Prop.1 1. Investment.6 (0.8 51.6) 119.7 21.4 1.3 (203.6 24.3 1.9 25. Source: JSX Monthly (several publications).3 31.0 24. and Bldg.7 0.7 17.0 16.4 (149.1 0.9 53.1 0.1 1.0 0.1 1.6 83.5 45.7) 26.7 90.4 1.9 14. Investment.9 0.2 11.5 9.0 22.
0 3.3 38.0 110.0 110.1 10.4 17.6 (2.5 4. Real Estate.3 7.0 160.0 17..0 39.0 140.0 86.0 69.2 111.0 19.1 2.3 18.2) 15.4 4.7 5. 1992 20.0 700.0 180.4) (1.8 3.7 12. Real Estate.0 100.0 160. and Services Return on Equity Agriculture Mining Basic Industry and Chemicals Misc.3 17.5 7.1 (5. Infrastructure Finance Trade.1 1994 80.2 11.0 100..3 7.5 Financial Performance of Publicly Listed Companies by Sector. Investment. Infrastructure Finance Trade.9 38.1 6.0 650.6 74.2 15.0 110.6 8.8 168. Investment.3 73.8 44.1 4.0 8.0 70.5 1995 80.5 4.4 20.3) 5.7 5.5 56.0 210. Investment.3 64.8 9.2 23.2 3.4 35.7 4.0 680.0 9.0 3.2 7.0 66.8 81.0 150.0 190.0 50.9 38.3 1.4 35.1 (3.6 8. Constn. Industry Consumer Goods Industry Prop.8 479..0 120.5 43.0 90.1 4.0 100.2 (4.8 20. and Bldg. 1992-1997 (percent) Indicator/Sector Debt-to-Equity Agriculture Mining Basic Industry and Chemicals Misc.7 12.0 120.8 16.1 8.0 15.0 650.0 46.9 4.7 26.4 46. and Services Asset Turnover Agriculture Mining Basic Industry and Chemicals Misc.6 19.9 40.7 4.0 560.0 630. Industry Consumer Goods Industry Prop.0 120.7 46.0 70.1 7.1 4.7 4.0 120.5 13.9 14.1 10.7 10.3 13.2) 7.4 46.2 3.Table 1.1 89.0 180.8 382.9 17.3 33. and Services Source: JSX Monthly (several publications).4 6.6) 18.0 190.0) 7.8 8.0 140. Constn.2 1993 130.0 80.0 60.5 5.0 190. Investment.2 8.0 (0.6) 36.9 41.2 6. and Services Return on Assets Agriculture Mining Basic Industry and Chemicals Misc.9 42.4 .1 9. and Bldg. and Bldg.0 8.9 29.4 1.0 80.9 10.6 13.2 53.7 61.6 14.0 380.6 13.9 87. Real Estate.0 170.4 6.7 10.1 9.6 18.0 160.0 150.0 110.0 11.3 0.8 67.5 19.1 13.4 71.0 80.2 13.7 10.8 11.8 11.0 70.0 12.7 1.5 17.5 11.4 79.1 11.4 13.1 1996 100. Industry Consumer Goods Industry Prop.6 1.6 23.6 (11.7 (3.0 1997 230.7 12. Infrastructure Finance Trade.7 9.1 10.3 5.0 180.5 14.2 30. and Bldg..7 71.0 110.7 13.0 150.0 110.0 220.4 13. Infrastructure Finance Trade.0 14.9 7.0 130.1 3.0 110.3 17.7 1.2 39. Real Estate. Constn.1 1. Constn.7 8.8 5.4 5.2 7.0 100.8) 8. Industry Consumer Goods Industry Prop.8 25.1 63.7 8.1 65.
Taken together. For instance. Only the agriculture sector showed an increase in ROA in the couple of years before 1997.7 to 7 percent for publicly listed companies. Assuming a fixed ratio of value added to sales. Trade had the highest ROA of 39. and finance company (four companies). growth of net profits and assets was erratic. However. Just like private companies.4 percent the following year. the ratio decreased from 8. respectively. the Department of Finance supervised 30 SOCs. SOCs’ ROE ranged from 6. but it continuously declined from 370 percent in 1992 to 250 percent in 1995. Asset turnover rates were lower relative to those of publicly listed companies. but dropped dramatically to 4. which collectively had the largest assets.7 percent. While asset turnover rates of publicly listed 3 4 SOCs are those in which the State has at least a 51 percent equity interest.1 percent in 1993.3 percent in 1995. banks (seven companies). averaging 24 and 31 percent. Similarly. This was due to large sales by the National Oil Company (Pertamina). SOCs actively operated in various sectors4 under the supervision of “technical” departments. registering an average annual rate of 10 percent. there were 58 SOCs with subsidiaries and affiliates. insurance (11 companies).3 trillion. the SOCs’ value added as a percentage of GDP ranged from 6 to 8.6). SOCs’ sales growth fluctuated during 1990-1996. This was relatively high compared to the 3.Chapter 1: Indonesia 13 negative ROA. and basic industry and chemicals sectors had relatively stable ROA before the crisis. State-Owned Companies At the end of 1995. The Department of Mining and Energy ranked first in terms of sales of SOCs under its control. These growth rates were low compared to those for listed companies during the same period.1 percent in 1992 to 28. .7 percent in 1990 to 6 percent in 1996. SOCs diversified into many businesses.6 to 8. between 1993 and 1995. Six SOCs were listed in the Jakarta Stock Exchange. indicating SOCs’ declining contribution to GDP. By 1995. The DER was slightly higher than for listed companies. much lower than that of companies listed in the stock exchange. The sectoral distribution of 165 SOCs is as follows: nonfinancial (143 companies). ROA had been at high levels from 1992 to 1995. increasing from 21. The finance and miscellaneous industry. there were 165 state-owned companies (SOCs)3 in Indonesia. the subsidiaries and affiliates number 459 with total assets of Rp343.8 percent between 1992 and 1995 (Table 1.
the contribution of conglomerates to GDP increased from 12.0 17.1 trillion in 1990 to Rp234 trillion in 1997. Table 1.0 12.5 Conglomerates This study used available data on the top 300 conglomerates in Indonesia.7 1994 (9. In 1997.5 3.2 — 370. these conglomerates owned 9.6 1995 25. but dropped to 11.6) 260. .6 Growth and Financial Performance of State-Owned Companies.6 28.7 16.8 12.0 7.2 percent in 1997 (Table 1. Table 1. 1990-1997 (percent) Item Sales Growth Share of Value Added in GDPa 1990 1991 1992 1993 1994 1995 1996 1997 — 17.7 (2.1 32.1 30.6 28. SOCs’ asset turnover rates showed a downward trend from 32.2 — = not available.4 13.0 8.7 13.1 19.0 8. II companies consistently declined over time. 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.4 7.1 310.766 business units.8 percent in 1990 to 13.8 21. Source: Indonesian Data Business Center.5 percent in 1995.1 12. Source: Indonesian Data Business Center.1) 5.3 250. Their total sales increased from Rp90.3 30.4 1993 16. a Value added was assumed to be 30 percent of total sales. b Asset turnover is defined as sales over assets.2 18.7).0 24.4 13. but climbed to 30.8 11.14 Corporate Governance and Finance in East Asia. 1992 — 7.2 23. mostly private companies.0 6. Assuming a constant ratio of value added to sales.6 percent in 1994.3 12.4 percent in 1994.4 16.4 percent in 1992 to 28.1 6.7 Growth Performance of the Top 300 Conglomerates.4 13.0 28. Vol. a Value added was assumed to be 30 percent of total sales.
For instance. the legal and regulatory framework of the corporate sector was far from adequate. such as the appointment (or replacement) of directors. The law explicitly requires approval during the meeting of decisions on strategic issues such as amendment of the company charter (articles of incorporation). The company charter details the issues that need shareholder meeting approval. and declaration of bankruptcy. except in strategic issues stated in the law. as representative of shareholders.2. and consolidations. For example. is the only shareholder mechanism for monitoring and controlling the BOD. A chairman heads the BOC while a chief executive officer (CEO) heads the BOD. The meeting decides on important issues. an approval needs the majority (50 percent plus one) vote. If the BOC does not perform well. The law also holds the directors and commissioners jointly responsible for decisions made by the company. The BOC.Chapter 1: Indonesia 15 1. The 1995 law requires limited liability companies to set up two boards: the board of commissioners (BOC). the decision to amend the company charter should be approved by two thirds of shareholders present in the meeting. tasked with supervising the firm. shareholders lose control. . In general. For mergers. mergers. The BOD undertakes operating decisions while the BOC participates in strategic decisions and operations review. This guards against shady intercompany dealings within a group of companies. a member company might sign a disadvantageous contract with another company where the same controlling shareholder has a higher stake. however. The law mandates the BOC and BOD to work for the best interests of the company and not just of the shareholders. The actual responsibilities of BOCs vary by company and are stipulated in the company’s charter. and the attendance should at least be two thirds of total shareholders. The law replaced an earlier statute that was based on the Dutch system. and the board of directors (BOD).6 Legal and Regulatory Framework During the 1990s. the Government promulgated a number of laws and regulations to protect investors. commissioners. The Corporate Law The Corporate Law of 1995 governs the establishment and operation of limited liability companies in Indonesia. tasked to provide direction to the company. For instance. and the accountant. The law also specifies that the highest “institution” in the limited company is the shareholders’ meeting. acquisitions. By international standards. the decision to use certain company assets as collateral for bank credit might need BOC approval.
such as custodian banks and the securities registration bureau. (iii) proxy voting by mail. An important rule is the requirement for independent shareholders’ approval for arrangements that might lead to conflicts of interest. (xi) mandatory disclosure of transactions by significant shareholders. (vii) the right to call an emergency shareholders’ meeting. consolidations. and bankruptcy. (viii) the right to make proposals at the shareholders’ meeting. Controlling shareholders have no vote on the matter. II acquisitions. and the attendance should at least be three fourths of total shareholders. (xii) mandatory disclosure of connected interests. and guidelines promulgated by the head of capital market supervision. Examples in the area of corporate governance are guidelines for situations that can potentially lead to conflicts of interest and for acquisitions of substantial shares of listed companies. . decrees of the finance minister. (xiv) mandatory disclosure of intercompany affiliation such as affiliated lending or guarantees. It also regulates reporting and auditing procedures.16 Corporate Governance and Finance in East Asia. (v) preemptive rights on new share issues. The Capital Market Law The Capital Market Law (1995) regulates companies listed in the stock exchange. underwriters. Because of such requirements. The law is supplemented by Government regulations. 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. A tender offer is also required for acquisitions of up to 20 percent of listed shares. It regulates the requirements of investment companies. Vol. insider trading (including market rigging and manipulation) investigation. (xvi) independence of auditing. (ii) proxy voting. (ix) mandatory shareholders’ approval of interested transactions. The law provides the following rights to or protection of shareholders: (i) access to regular and reliable information free of charge. securities companies. transparency requirements. and other supporting agencies. the decision should be approved by three fourths of the shareholders present. (vi) one share one vote. delineating the tasks and responsibilities of the Capital Market Supervisory Agency. (xiii) mandatory disclosure of nonfinancial information. (xvii) mandatory independent board committee. investment advisors. investment managers. and administrative and legal punishment. brokers. (xv) mechanisms to resolve disputes between the company and shareholders. and (xviii) severe penalties for insider trading. (x) mandatory shareholders’ approval of major transactions. (iv) cumulative voting for directors.
However. or financial institutions. net open positions. 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. 1. whether they are individuals. 1. It aimed to protect creditors by providing easier and faster access to legal redress. creditors of unsecured loans are unprotected when borrowers fail to meet their obligations. states that a bank is not allowed to provide credit without collateral. The two most important elements of ownership structure are concentration and composition. the viability of a project). A Commercial Court was also set up to deal with bankruptcy cases.3 Corporate Ownership and Control This section looks at the ownership structure of the corporate sector and reports the results of an ADB survey on corporate management and control of publicly listed companies. for instance. holding companies. capital adequacy.. It reveals characteristics of controlling shareholders.g. or 20 shareholders. etc. families.3. Discussions on corporate ownership cover listed companies and conglomerates. Ownership concentration is usually measured by the proportion of shares owned by the top one. five.1 Corporate Ownership Structure Quality of corporate governance is closely related to corporate ownership structure (see discussions in the Consolidated Report of this study). For instance. Banking Laws Affecting the Corporate Sector Some elements of the banking law also affect the corporate sector. 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.Chapter 1: Indonesia 17 Bankruptcy Law Despite loan covenants. Banking regulations also set lending limits. 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. . amended in October 1998. the collateral could take the form of nonphysical assets (e. the Banking Law (1992).
4 2. issued 93. for instance.7 1994 48.0 4.0 0.2 1. This preserves the pro rata share of existing shareholders.9.0 2.9 0.6 3.6 3.3 1995 47.9 Source: The Indonesian Capital Market Directory.6 68.6. This is because a few companies in the transportation sector issued high proportions of shares to the public. On average.5 Average 48. Table 1. respectively. mining.7 3. The percentage owned by each of the five largest shareholders was 48.8 shows average proportions of shares owned by the five largest shareholders of publicly listed companies during 1993-1997. and 0.8 68.1 1.6. Meanwhile.9 14.9 2. ownership widely held by the general public is highest in the infrastructure and transportation sector (not shown in the table). When a company makes a rights issue.8.9 2.8 1. 13.1 13. and basic industry and chemicals sectors than in others.2 67. consumer goods.8 Ownership Concentration of Publicly Listed Companies.9 shows that ownership by the largest shareholder in 1997 was more concentrated in the agriculture. 3.1 4.5 16.18 Corporate Governance and Finance in East Asia.8 68. II Publicly Listed Companies Table 1.6 percent. the controlling shareholders usually act as standby buyers. Rig Tenders Indonesia (shipping services) issued 51. 2.5 percent.2 11.9 percent of total outstanding shares. and Berlian Laju Tankers (liquid bulk maritime transportation services) issued 48. 1993-1997 (percent) Shareholder Rank First Largest Second Largest Third Largest Fourth Largest Fifth Largest Total 1993 50.4 percent. This is partly due to the prevailing practice of raising equity through rights issues in Indonesia.5 12. When a company goes public.5 72. about two thirds of publicly listed companies’ outstanding shares were owned by corporations that were directly or indirectly controlled by families. Zebra Nusantara (taxi services). Vol. Table 1. the five largest shareholders owned 68. The pattern of ownership concentration changed little over this period.0 67. Data from the Indonesian Capital Market Directory (various publications) show that between 1993 and 1997.6 13.5 1997 48.1 0.0 1.0 0. the founder usually continues to own the majority of shares through a .6 4.7 1996 48.
3 48. the rule of law. is strong. and Bldg. and Services Average Source: The Indonesian Capital Market Directory.1 1.9 Ownership Concentration of Publicly Listed Companies by Sector.6 8. on the one hand.9 3.3 14. and only 0. Thus the founder keeps the proportion of shares necessary to retain control over management of the listed firm. First Second Third Fourth Fifth Biggest Biggest Biggest Biggest Biggest 54.9 0.3 36..6 1.7 1.1 0.6 percent of total market capitalization while the top 15 families control 61.1 1.2 0. These figures suggest that ultimate control of the corporate sector rests in the hands of a small number of families. In fact.1 11.5 1. Infrastructure. and the efficiency of the judicial system. (1999) also found.4 6.9 1. and Transportation Finance Trade. as well as the existence of corruption.7 13. Investment.3 0.4 54. Indonesia has the largest number of companies controlled by a single family.6 9.Chapter 1: Indonesia 19 fully-owned limited liability company (Perseroan Terbatas). Most of the five largest owners of Indonesian publicly listed companies are limited liability companies rather than individuals. that the correlation between the share of the largest 15 families in total market capitalization.4 44.7 6.4 1.4 4.1 1. Claessens et al. Industry Consumer Goods Industry Prop.5 58.7 4.2 46.6 percent were widely held.1 1. and corruption.1 2.2 10.3 2.6 0. the top family controls 16. 1997 (percent) Sector Agriculture Mining Basic Industry and Chemicals Misc. two thirds (67.6 2.0 5.5 4.2 15. Real Estate. Util. In terms of capitalization. Legal and regulatory developments may have been impeded by the concentration of corporate wealth in .9 44. Constn. in a cross-country study.3 0.2 2.1 2.2 This is confirmed in Claessens et al.4 11.. (1999).7 9.1 percent) of Indonesian publicly listed companies were in family hands.8 14. Table 1.9 50.1 0.9 44.1 13.7 percent of the market. on the other.1 2. The findings suggest that the concentration of corporate control in the hands of few families is a major determinant of the evolution of an inefficient legal and judicial system. which shows that in 1996.
foreign ownership increased to 21 percent.10 shows the anatomy of the top 300 conglomerates in terms of year of establishment.5 Conglomerates Table 1. Coordination is easier because informal communication channels exist. but later declined and steadied at around 25 percent. When the Government allowed foreign investors to buy up to 49 percent of listed shares in 1988. However. conglomerates established before 1969 dominated in terms of sales. the proportion of foreign ownership declined from 27. II the small number of families and the tight links between companies and the Government. political affiliation. and Padang. most were established during the New Order Government. Indigenous businesspeople include the Javanese. But these benefits are few and often dubious compared to the high costs of concentration. accounting for 64 percent of total conglomerate sales in 1988-1996. the Government allowed foreign investors to buy up to 100 percent of listed shares. Among the top 300 conglomerates. numbering 162 in 1988 and 170 in 1996. or other ethnic groups. with all its regulations. Sundanese. If the role of a limited number of families in the corporate sector is so large and the Government is heavily involved in and influenced by business. the onset of the crisis negated this development. In 1993. Family control is said to have positive effects in that it allows group members in conglomerates to make strategic decisions quicker. their number increased to 5 In 1997.42 percent in December. This may indicate that the New Order Government. Indian. In Indonesia. The nonindigenous businesspeople are usually Chinese. Batak. From 193 in 1988.20 Corporate Governance and Finance in East Asia. However. was able to create a favorable environment for business development. ethnicity. Vol. resulting instead in a decline in the proportion of foreign investor ownership. there is a dichotomy between corporations owned by indigenous and nonindigenous businesspeople. The corruption and regulatory problems generated by high ownership concentration by families in Indonesia are likely to overwhelm its benefits. In September 1997. it rose to 30 percent. the legal system is less likely to evolve in a manner that protects minority shareholders. During 1988-1996. nonindigenous groups owned a larger proportion of the top 300 Indonesian conglomerates. and family origin.55 percent in August to 25. .
1 58.4 59.0 18.1 percent of total .8 28.4 81.0 28.6 trillion in 1988 to Rp137.4 31.9 13. Their total sales also increased from Rp38.7 49.7 28.8 30.6 34.4 52. For instance.4 86.3 80.Chapter 1: Indonesia 21 Table 1.2 48.2 76. sales of the Bakrie group before it went public in 1990 were only Rp369. the number of mixed groups declined from 86 in 1988 to 68 in 1996.0 58.1 33.4 16.0 15.3 20. Meanwhile.8 49.9 137.8 38.0 31.3 36.10 Anatomy of the Top 300 Indonesian Conglomerates.0 116.7 40.9 47.9 42. In 1996.6 114.4 31.1 52.4 37.1 87.4 57.2 29.1 103. While they supplied 20.1 46.2 33.9 trillion.9 billion.1 179.5 120.2 159.9 35.8 68.4 18.4 22.9 73.4 68.4 19.3 134.6 12.2 23.7 24.2 12.4 59.4 69. its sales reached Rp1.3 120.8 25.1 42.1 21.0 44.3 43.0 58. 1988-1996 Item Number of Groups Year of Establishment Before 1946 1946-1968 1969 Forward Ethnicity Mixed Nonindigenous Indigenous Political Affiliation Nonofficial Official-Related Origin Family Nonfamily Sales (Rp trillion) Year of Establishment Before 1946 1946-1968 1969 Forward Ethnicity Mixed Nonindigenous Indigenous Political Affiliation Nonofficial Official-Related Origin Family Nonfamily 1988 1989 1990 1991 1992 1993 1994 1995 1996 13 125 162 86 193 21 260 40 176 124 13 125 162 83 196 21 259 41 175 125 13 123 164 80 196 24 260 41 171 129 13 120 167 76 199 25 260 40 174 126 13 118 169 76 198 26 262 38 172 128 12 122 166 71 201 28 263 37 171 129 12 122 166 69 205 26 262 38 172 128 11 120 169 71 204 25 260 40 177 123 10 120 170 68 204 28 259 41 175 125 9.6 54.3 101.7 64. due to their “go public” activities.4 48.4 32.6 77.5 21.8 36.8 12.6 17.7 95.8 57.5 106.4 trillion in 1996.6 95.1 25.5 22. more than five times its 1988 level.1 46.8 Source: Indonesian Business Data Centre.7 89.1 41.4 15. Conglomeration Indonesia 1997. 204 in 1996.7 106.9 14.2 30.9 77.
or have resulted from alliances between entrepreneurs and officials. II sales in 1988. The contraction in the number and economic contribution of mixed groups may be an indication of increasing social polarization along ethnic lines. Average sales of official-related conglomerates were substantially greater than nonoffficial-related ones during 1988-1996. for instance. Banks owned by groups or conglomerates typically act as a “cashier” that provides credit to companies within the group. which is the largest conglomerate in Indonesia. Indocement Tunggal Prakarsa (cement industry). The well-known official-business alliances are those between Sudwikatmono (former President Suharto’s cousin) and Soedono Salim. Conglomerates were also classified into nonofficial. Djuhar Soetanto. Political alliances between entrepreneurs and officials have often led to the violation of regulations meant to promote prudent business practices in the banking industry. compared with the less than Rp700 billion of a nonofficial-related conglomerate. and Fast Food (restaurants).2 trillion. there were 175 groups that originated from a family business. In 1997 and 1998. owns four groups with many subsidiaries and affiliate companies. average sales of official-related conglomerates reached Rp1. collectively controlling .7 percent in 1996. Most of the top 300 conglomerates were established by ordinary citizens. But only a handful of these companies are listed in the market. In November 1997. In 1996. But listed companies within conglomerates were few. The Salim group. Prudential credit analysis tends to be ignored. Out of 174 companies.and officialrelated groups. including Indofood Sukses Makmur (food industry). Only about 13 percent were formed by official or ex-official families. In 1996. 117 are jointly owned by the family and 57 are owned by individual family members. Bambang Rijadi Soegomo. Some of them later became public companies by listing in the stock market.22 Corporate Governance and Finance in East Asia. More recent alliances were between Bambang Trihatmodjo (former President Suharto’s son) and Johannes Kotjo. Vol. Official-related groups have owners (or founders) who are or are allied with former or current government officials (or their families). The Suharto family is the largest stockholder in Indonesia. their contribution declined to 13. and Ibrahim Risyad of the Salim group. banks that had to be closed down included Bank Surya (owned by Sudwikatmono) and Bank Andromeda (owned by Bambang Trihatmodjo). Bank Indonesia. most of the 16 liquidated banks had violated the legal lending limit set by the central bank. and Wisnu Suhardhono of Apac-Bhakti Karya. The high NPLs accumulated by banks within official-related groups could be partly attributed to this practice.
families mostly manage the groups and make strategic decisions themselves. many of whom. Both are listed companies and members of the Salim group.Chapter 1: Indonesia 23 assets worth $24 billion (Claessens et al. 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. and hence. 1999). with no restrictions. The BOC chairperson often represents the controlling party of the company. the controlling shareholders are able to maintain their special relationship with officials. besides Suharto himself. But it is difficult to obtain data on cross-shareholding among firms. Cases in point are the Bank Papan Sejahtera and Bank Niaga. Although some groups employ professional managers. The families retain control of the companies through ownership. The Salim Group is also in part controlled by the Suharto family. It is generally believed that there are cross-holdings between financial and nonfinancial companies and among nonfinancial firms. Semen Cibinong. Cross-holdings between financial and nonfinancial firms potentially create more serious problems. Although they are not actively involved in the daily operations of the companies. or someone very close to and trusted by the controlling shareholders. which were liquidated or recapitalized after being acquired by the Tirtamas group that owns a listed cement company.1). In 1996. In so doing. for instance. they maintain their position as commissioners. If the family members cannot actively manage the companies as directors. While the source of the . as well as other relatives and business partners. but those of the entire group. He or she could either be the biggest shareholder. This is because cross-owned banks had to consider not only their own interests. or both.. The officials (or their family members) often own a small portion of shares given to them freely by controlling shareholders. Indonesian law allows cross-shareholdings. management. they still control the work of the directors. Indofood Sukses Makmur (food industry) was owned by Indocement Tunggal Prakarsa (cement industry). The family controls 417 listed and unlisted companies through a number of business groups led by the Suharto children. continue receiving some kind of protection and special treatment. Some of the groups related to officials have a unique share ownership structure. served in some government function (see Figure 1.
Lang. Simeon Djankov. Who Controls East Asian Corporations? Financial Economics Unit. 1999).Figure 1. Financial Sector Practice Department. and Larry H. (Feb.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. World Bank. . P.
The discussions are based on the ADB survey of 40 companies listed in the Jakarta Stock Exchange. The BOD leads the company and makes strategic and operational decisions. if necessary. seek an audience with directors. the BOC has the right to obtain any information concerning the firm.2 Management and Internal Control A company’s internal organizational structure determines how shareholders control management. Figure 1. .Chapter 1: Indonesia 25 problem is inconclusive. 1. role and protection of minority shareholders. The typical structure of a publicly listed company in Indonesia is shown in Figure 1. the BOC supervises the work of directors. This is based on the Dutch system. both controlling and minority.2. management and managerial compensation. The managers execute the BOD’s decisions and lead employees in their departments. request a shareholders’ meeting. Therefore. Shareholders are at the top of the organization. As the owners’ representatives. and accounting and auditing procedures.3. and. including the boards.2 Typical Internal Organizational Structure of a Publicly Listed Company in Indonesia Shareholders Board of Directors Board of Commissioners M a n a g e r s Employees The succeeding discussions examine some aspects of the internal management and control system in practice in Indonesian listed companies. one possibility is that legal lending limits had been violated. the directors.
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 BOD and BOC of PT Sari Husada were allowed to complete their terms before they were replaced. The Government appoints the BOD and BOC of these firms. except for publicly listed SOCs. appointment of management. Since the NPLs reached up to Rp300 trillion. A more recent case was the acquisition by Nutricia (the fourth largest baby food firm in the world) of PT Sari Husada (another baby food firm) in 1998. the takeover brought significant losses to Djojohadikusumo when share prices plunged7 during the crisis. They then replaced the BOD and later sold the bank. it was common for the Government to invest in certain private companies. 6 7 Later in March 1999.Chapter 1: Indonesia 31 external acquisitions. One famous takeover was Bank Papan Sejahtera. who was acquiring his second commercial bank. at a large profit. IBRA found itself tasked with managing large amounts of assets in the private sector. For instance. Before the financial crisis. restrictions on market entry. However. the owner of Tirtamas group. which was acquired by Yopie Wijaya in 1995. In April 1999. with the minister’s approval. . the acquiring parties were trying to obtain operating synergies because they had companies in the same industry. the Government took over NPLs and put them under IBRA management. In these two latter cases. A study by Connie Tjandra (1993) shows that internal acquisitions were often initiated for tax shelter purposes. 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. Bank Niaga was under a recapitalization program. In the massive restructuring of the banking sector that commenced after the crisis. Control by the Government Government control could be in the form of state ownership. This used to be a common practice in companies associated with the Suharto regime. the acquiring interest was apparently seeking economic profits.6 In this case. the bank was liquidated. or direct subsidies. Another case was the takeover of Bank Niaga in 1997 by Djojohadikusumo. to Hashim Djojohadikusumo. The bank was reported to have high NPLs and had broken the legal lending limit. a state-owned insurance company may invest its funds in a private firm. State ownership for listed SOCs ranges from 25 to 35 percent. Wijaya and his friends bought shares of the bank on several occasions until they gained control.
4 1.7 50.4 86.2 27. including bonds.9 378. because of the restrictions discussed below.8 193.3 9. Since then.2 6.3 188. Table 1.4 percent in 1992. 1992 1993 1994 1995 1996 1997 1998 1999 68.3 111. From 34. however.9 trillion in 1992 to Rp487.0 6.5 80. the share of private national banks in outstanding total loans increased to 44.9 153. when the Government reactivated the stock exchange.7 122.6 4.1 220.0 487.4 225.32 Corporate Governance and Finance in East Asia.9 234. Vol.1 Corporate Financing Financial Market Instruments Prior to 1977. remain the major financing instrument for the corporate sector.3 60.6 percent in 1997. new instruments have been introduced to the corporate sector.14 Banking Sector Outstanding Loans. .0 93.7 18.6 150. Private national banks and state-owned banks were the biggest domestic creditors. However.6 292. II 1.0 168. Data from Bank Indonesia show that from 1994 to 1997.7 112.4.5 42. Bank Credit As shown in Table 1. this market was not well developed. private national banks overtook state banks as the dominant credit source.5 108.4 56.0 3.4 24. and others offered by nonbank financial institutions or finance companies.1 Equities In 1977.4 trillion in 1998.3 14.14. bank credit surged from Rp122. bank loans were the only instruments available to the corporate sector for short term (working capital) or long term (investment) financing. stocks. companies considered alternatives to bank loans. Bank loans. 1992-1999 (Rp trillion) Type of Bank State-Owned Banks Foreign Banks Regional Govt Banks Private National Banks Total Source: Bank Indonesia.5 7.6 3.6 6.9 150. When the Government liberalized the banking industry at the end of 1988 (which allowed for higher interest rates).2 5. equities became available to the corporate sector.3 66. jointly providing almost 90 percent of loans until 1997.6 48.2 71.
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.e..7 15. Overall. but dropped to 8 percent in 1991 when the Government tried to stabilize an overheating economy. limiting loans to a maximum of 15 times equity and foreign loans to five times the equity. funds raised in the stock market were less than 5 percent of the credit disbursed by the banking sector.Chapter 1: Indonesia 33 Some companies went public. credit cards. i. finance companies were increasingly used as channels for the inflow of foreign loans.0 15. It gradually increased again starting in 1991.2 16.1 10.8 48.6 301. The ratio reached 8.1 18.15 Value of Stocks Issued and Stock Market Capitalization. allowed to accept deposit accounts from the public. In 1995. offering services such as leasing.0 70. 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.g. the Government issued regulations to supervise and promote prudential practices in finance companies.5 333. 1992 1993 11.4 1996 1997 1998 50.6 123.0 206.7 percent in 1997. Prior to 1995. During the 1990s.5 1995 35. shooting up to 18.. . factoring. Most banks therefore set up subsidiary finance companies to circumvent banking regulations.6 91.15). legal lending limit. and net open position). when foreign investors were not yet allowed to purchase listed shares. Table 1.9 406. the activities of finance companies were not covered by regulations on prudential practices in the banking sector (e. capital adequacy ratio. They were not. 1992-1999 (Rp trillion) Item Stocks Issued Outstanding (As % of Outstanding Bank Credit) Market Capitalization Source: Bank Indonesia.1 17.9 1999 76. and consumer credit.6 859.6 310.1 1994 26.4 207. the stock market has gained a bigger role in corporate sector financing (Table 1.7 14. In 1988. however.7 9.5 Financing by Finance Companies Finance companies first emerged at the end of 1980. thus increasing the role of the capital market in raising long-term funds.
6 8.5 — 26. Bank Indonesia prohibited banks from underwriting issues of commercial papers but allowed them to act as paying agents.5 21.4 8.6 100.0 1986-1996 17.3 14. 1. short-term borrowings were greater than long-term debts.5 11.0 39.0 3. at 81 percent of total borrowings.8 7.0 — = not available.8 percent.1) 23. otherwise it would be classified as a loss in the banks’ books. Table 1.6 23. Thus in November 1995.6 12. publicly listed nonfinancial companies had high proportions of equity and internal finance (retained earnings). 1996. 1986-1996 (percent) Financing Source Internal Borrowings Short-Term Long-Term Debentures/Equity Debentures Equity Trade Credit Others Total 1986-1990 36.0 100. In the second half of the 1980s.7 22. respectively. Vol.3 (0.8 17. averaging 26.5 percent and 36.5 (0.3 16.16 shows financing sources of Indonesian publicly listed nonfinancial companies estimated by using flow-of-funds analysis. which are unsecured negotiable promissory notes with a maximum maturity of 270 days. Source: Author’s estimates based on the Pacific-Basin Capital Markets (PACAP) Databases.6 100. 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). .9 16. II Commercial Papers Commercial papers. they were not rated by a rating agency. PACAP Research Center.1) 23.0 1991-1996 16.2 Patterns of Corporate Financing Table 1.4 13. have been popular in Indonesia since 1990.16 Financing Patterns of Publicly Listed Nonfinancial Companies.4 23.34 Corporate Governance and Finance in East Asia. In terms of composition.3 37. This is in contrast to the lower share of borrowings during the same period.2 26.4. While banks had some exposure to these instruments.
that ownership concentration may be associated with heightened risk-taking by companies. was due largely to a rapid rise in long-term debts. except Semen Gresik (an SOC). The results indicate that firms with higher ownership concentration tend to have a higher DER. These liabilities grew significantly because corporate expansion was largely financed by debt. respectively. Many companies suffered big losses in 1997 due to their high exposure to dollar loans. Large shareholders are inclined to undertake risky projects intended to generate high returns using borrowed funds. For instance. Corporate debts grew over time. Two telecommunications companies. 1.4 trillion in 1993 to Rp112. as evidenced by an average DER of 230 percent during 1992-1996 that rose to 310 percent in 1997.6 trillion and Rp1. which managed to post significant profits due to low exposure to dollar-denominated loans. Bank loans also surged when the banking sector was liberalized in 1988. . reaching Rp229. Most corporate charters require commissioners to approve debt issues or sign debt agreements.3 percent during 1991-1996. corporate debts accounted for 39. This amount doubled in 1997. rising from Rp54. All companies in the cement industry suffered from foreign exchange losses.17 compares the DER of listed firms by degree of ownership concentration.9 trillion.Chapter 1: Indonesia 35 In the 1990s. Hence. Indosat and Telekom. Of the various financing sources. with longterm debts increasing rapidly. The high share of equity financing was due to the surge in capital market activity following the 1988 reforms.4.2 trillion (mostly foreign exchange losses). in the context of Indonesia and some other countries. The corporate sector invested heavily from 1991 to 1993 and slowed down its investment spending a few years before the 1997 crisis. Indofood registered losses of almost Rp1. while Semen Cibinong’s losses reached Rp2. 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.3 Corporate Financing and Ownership Concentration It has been suggested. Table 1. Note that the corporate sector’s high leverage existed side by side with sizable equity capital raised from the capital market. also suffered from foreign exchange losses but managed to post profits of Rp0. the corporate sector’s high leverage.2 trillion. They also do not want to dilute corporate control and are more likely to finance growth with debt.9 trillion in 1996.1 trillion. the pattern changed. which was masked by the rapid growth in investments.
ultimately. decisions on debt are made with the implicit endorsement of owners.358. Controlling parties rely on external financing to maintain their equity share and.56 significant at the 10 percent level. 1. As a result. Source: Author’s estimates.0 1. the free capital flow system allowed private companies to borrow dollars offshore without any restriction.17 DER of Listed Companies by Degree of Ownership Concentration (percent) Item Mean Standard Deviation DER of Firms with High DER of Firms with Low Ownership Concentration Ownership Concentration 699.0 Notes: Firms with high ownership concentration have more than 50 percent of shares owned by the top five shareholders. 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.5 1. The test of the difference between the two means found the t-value of 1. and high ownership concentration among families with political affiliation. Table 1. the borrowings swelled. Vol. 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. to maintain control of the company.0 351. the private sector borrowed heavily in unhedged dollars. In addition. aided .1 The Corporate Sector in the Financial Crisis Causes of the Financial Crisis Many intertwined factors led to the crisis.0 386. II However. since commissioners represent the controlling party.36 Corporate Governance and Finance in East Asia. The low cost of foreign loans and the relatively stable exchange rate created a false sense of security for corporations.5. Between 1987 and 1996. heavy reliance of companies on bank credits to finance investments.
the level of corporations’ foreign debt could not even be ascertained. They were. 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. did finance many viable ventures.. substantial amounts were also funneled into projects that guaranteed repayment mainly on the strength of borrowers’ close political connections. A lot of short-term foreign funds were used to finance long-term investment projects. 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.Chapter 1: Indonesia 37 by the lack of an existing mechanism to supervise and monitor foreign transactions. This left them vulnerable to interest rate surges as well as sudden currency fluctuations in the case of dollar loans. Decisions to borrow in dollars made sense to many borrowers because dollar loans were cheaper than rupiah loans. many firms became highly leveraged. However. The large supply of foreign funds. to circumvent these banking regulations. only created to serve the companies to which they lent. averaging about 4 percent of GDP. Heavy Reliance on Bank Credits to Finance Investments Companies relied heavily on bank loans to finance rapid corporate expansion because internal financing was insufficient and the capital market was not developed. The Government later specified the legal lending limit and the net open position that banks had to follow. large amounts of credit were directed to the companies within the group. It was only in 1995 that some regulations on the activities of finance companies were contemplated. and the negative net open position (short position in dollars) continuously rose to precarious levels. As a result. It also meant that the cashier bank had neither the independence nor the incentive to exercise ex ante and ad interim monitoring of borrowers. It was doubly difficult to exercise supervision when groups with political clout owned the banks. those with high DERs) established their own banks. conglomerates set up finance companies and used these as channels for the unfettered inflow of foreign loans in lieu of banks. It is not known if these regulations had an effect on nonbank intermediaries. This often led to the violation of prudential credit management practices. after all. The supervising agency was caught unprepared. The banks served as a “cashier” that provided easy credit to nonfinancial companies within the group. . However. A director at Bank Indonesia revealed that in 1995. Conglomerates that had difficulty in getting loans (i. In the process.e.
total private sector foreign debt stood at $72. II By mid-1997. contracts were granted to the private sector. Collusion between big businesses and the political elite was widespread in Indonesia. $35 billion of Indonesia’s foreign debt owed to private foreign banks was about to mature in less than one year. as they had done so in the years before the crisis. Since the Government could not afford to undertake these projects. Vol. banks did not lend on the basis of the soundness of the project. They ensure that commissioners represent their interests and maintain close relationships with the chairperson. The ultimate control of the corporate sector rests in the hands of a small number of families who own groups of companies.38 Corporate Governance and Finance in East Asia. most often to people who were close to the ruling regime. High Ownership Concentration High concentration of corporate ownership (particularly by families) led to poor financing and investment practices. Corporations were certain that they could roll over short-term loans when these fell due. In early 1998. there was also almost universal confidence that the economic growth would continue indefinitely. but on the basis of who the borrower was. . This was often the case in the banking industry. There were cases where banks and borrowing companies were controlled by the same groups or families with strong political connections. toll roads.5 billion. Controlling shareholders also prefer to use debts to finance expansion so as not to dilute their ownership. and in the process maintain control of the company. where private banks are usually in the hands of big businesses. partly because they used nominee accounts to register ownership rather than set up a holding company. This fact was usually not disclosed in financial statements. Family-controlled corporations were generally structured as a complicated web of affiliates and associated companies.5 billion was owed directly by corporations. They enhance their control over companies through cross-shareholdings. In many cases. and power generation) require huge capital. by setting up their own banks. or both. and investing shares among nonfinancial companies within the group and in other groups’ companies. Projects involving massive capital investments and long-term operating deals (in telecommunications. Aside from the fact that many of these loans were channeled through banks and corporations of politically connected families. Families retain control by keeping the majority percentage of outstanding shares. politicians. of which $64.
and Water Supply Construction Trade.6 4.7) (8.6) (3.6 8.2 8. The average DER was found to be 1. Only 86 companies reported profits.1 6.8) (13. 53 companies reported negative equity of Rp6.9 3. The construction sector was the worst hit. and Fisheries Mining and Quarrying Manufacturing Electricity.4 7. Using the financial statements as of 30 June 1998 of 161 publicly listed companies.4) (0. Hotels.7) (2.2 (1. followed by the finance and trade sectors.4) 2.8) (11.0 3.19.2 Impact of the Financial Crisis on the Corporate and Banking Sectors Impact on the Corporate Sector Table 1.0 5.4 7. and Restaurants Transport and Communications Financial.8 1997 1. and Business Services Other Services GDP 1996 3. and 128 companies reported a total loss of Rp46. Real Estate.6 13.6 12. posted negative growth rates.1 (1. Sectors with lower ROE generally had higher DER. The JSX Monthly reported that total losses of 214 listed companies amounted to Rp39.5) (18.7) 2.4 5. except utilities.8 0. Gas.1) 1.5.8 8.0) 1999 2.0 2.1) (26. followed by property.3 11. The consumer goods industry reported the lowest ROE. 1996-1999 (percent) Sector Agriculture.370 percent. Table 1.Chapter 1: Indonesia 39 1. This continued in 1998.0) (15.58 trillion (meaning their losses were greater than the paid-up capital).1 5.18 shows that growth in most sectors significantly fell in 1997. much higher than the 307 percent registered in December 1997. when all sectors.8 7.24 trillion for the first six months of 1998. Most sectors showed significant increases in leverage.7 6. Livestock.52 trillion. real estate. Forestry.18 GDP Growth by Sector.3 Source: Central Bureau of Statistics (Biro Pusat Statistik. and building construction. as shown in Table 1. indicating a rapid rise in .6) (0.6 (36.7 1998 (0. BPS). DER and ROE were calculated per sector.3 12.
0 97.0 1.1 (3.19 DER and ROE of Publicly Listed Companies by Sector.6) 15. foreign exchange losses came about with the use of unhedged foreign debt.4) 8. several publications.5 8.1 30.2 (4. The huge losses suffered by most companies were caused by three factors.0 108. 1996-1998 (percent) DER Sector Agriculture Mining Basic Industry Miscellaneous Industry Consumer Goods Industry Property Infrastructure Finance Trade/Services Average 1996 104.0 631.370.0 2.0 105. the NPL ratio had reached more than 60 percent.5 percent in April 1998.0 635.40 Corporate Governance and Finance in East Asia.625. and would have kept on increasing if interest rates had not declined.0 191.395.0 1.0 229.0 65.1 1.0 307.0 697.0 177.21.271.1) 7.0 2.0 864.0 92.6) (115. Mostly suffering from a liquidity squeeze.0 1997 234. but annualized to approximate full year values.0 177.1 (5.9 12.0 1.0 12. interest expenses rose as credit rates increased from 20 percent in early 1998 to 40 percent in mid-1999. Third. Impact on the Banking Sector Table 1.7 1.0 72. The table also reveals that although private national banks dominated the banking sector in terms of assets and credits.2 23.0 193. Source: JSX Monthly.0 a ROE 1996 1997 1998a 14.8 17.0) 10.0 219. First.0 158.1 (124.8 percent in 1996. small foreign banks enjoyed the highest profits. As the rupiah weakened and interest rates increased.4 5. II Table 1.6 (11.8 (373. This figure further increased to 47.097.0 1998 186.8) 36.3 7.1 (92. Vol. losses in operation were due to declines in sales and increases in the cost of imported inputs. as shown in Table 1. from only 8.0 163.1) Note: DERs were calculated for only 161 companies (out of 214) that had positive equity. rupiah values of dollar-denominated debts due to the weakening of the local currency and the rapid decline in equity because of losses. Second.7 percent in July 1998.0 205.0) (78. private banks posted negative ROEs in the same year.2 13. .7) 6.20 reveals that the banking sector’s ROE decreased significantly in 1997.2) (264.4) 18.4 (6. the NPL ratio rose to 25.0 108. Financial and banking analysts estimate that by September 1998. a Actual data for 1st semester only.0 111.
09 (11.0 — 32.24 (4.91 21.50 9.7 106.7 — 1.9 Regional Foreign and Development Joint Venture Banks Banks — 9. Source: Infobank.68 1996 1997 8. however.47 20. 1996-1998 (Rp trillion) State-Owned Banks — 140.7 — = not available.5 222.9 11.1 198.5 2.3 445.3 22.07 1994 14. coupled with negative spreads (deposit rate was higher than the credit rate).8 187.84 27.1 13.2 48.24 15.7 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. .6 — 4.7 29.2 47.37 19.9 297. State-owned banks initially had the highest NPL ratio. 1992 7.1 1.39 13. The high and increasing NPLs.2 8. private national banks overtook State-owned banks when their NPL ratio jumped to 57.2 8.3 Private National Banks — 179.4 7.25 22.45 — 1993 15.67 8.7 4. 227/1998 and October No.07 13.9 — 11.81 13.69 14.70 1995 7.2 10.20) Table 1.38) 11.0 — 4.5 128.09 11.0 622.2 1.2 — 19. Source: The National Banking Association.8 14.20 ROE of the Banking Sector. 230/1998.44 15. July No.0 129.28 5.5 34.34 16.2 37.5 31.5 57.30 5.06 20.1 274.2 — 8.9 percent.73 30.1 47. In July 1998.86 11.12 15.15 20.8 11. 1992-1997 (percent) Type of Bank State-Owned Banks Foreign Banks Joint Venture Banks Regional Development Banks Private National Banks Total — = not available.89 27.8 3.72 16.6 — 13.6 6.1 30.43 10.8 8. put pressure on the banking sector.Chapter 1: Indonesia 41 Table 1.21 Nonperforming Loans by Type of Bank.3 361.45 21.6 — 1.
Semen Cibinong (cement industry) became the first Indonesian company to resume paying part (25 percent) of the interest on its $1. On 9 September 1998. and Ciputra (property business). have been subject to restructuring deals under the initiative. the corporate sector had more than Rp600 trillion ($75 billion at Rp8. The scheme offered a hedging facility against rupiah devaluations for restructuring agreements. a number of prominent companies.3 Responses to the Crisis Corporate Restructuring Measures At the end of 1997. Total amortization payments due on foreign debt in 1998 were placed at $32 billion (before restructuring).000/$1) in debt from domestic commercial banks. The committee was tasked to ascertain the level of private corporate sector debts and arrange negotiations between debtors and creditors. 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. While the process of restructuring was in progress.5. In November. by mid-September 1998.7 billion of foreign exchange debt. the Government and private sector formed a committee to help corporates deal with the crisis. none of the 2. IBRA was formed to offer Mexican-style resolution for private sector foreign debt. companies were not servicing their debts. Since September 1998. Vol.7 percent ($64. The scheme encourages negotiation between creditors and debtors. Aside from being described as overly complicated. In addition. assembling the legal and policy framework to facilitate corporate restructuring. Unfortunately. In June 1998. only a . particularly in terms of debt resolution.42 Corporate Governance and Finance in East Asia. few companies were in a position to resume interest payments. However. 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. about 80 percent of which was private. II 1. Thus. By end-November. Corporate debt accounted for 46.4 trillion of domestic debt and $6. the scheme failed. the committee launched the Jakarta Initiative. a more comprehensive scheme to tackle domestic and foreign corporate debt.6 billion) of Indonesia’s total external debt in March 1998. the Jakarta Initiative Task Force had conducted negotiations for 52 companies with Rp2.000 eligible firms had signed up for the scheme. Another option that companies could take under the Jakarta Initiative was debt restructuring via debt-to-equity swaps.2 billion debt. such as Garuda (a national flag carrier). Astra International (automotive).
The Commercial Court can be asked to hold off creditors and impose strict guidelines on the negotiating process . mining. focused on its core business of car and motorcycle manufacturing and sold off its subsidiaries in semiconductors. i. Protection against insider and fraudulent transactions taken by a debtor prior to the adjudication of bankruptcy will be enhanced. and mining equipment. and sell noncore businesses or nonoperating assets. Astra International (automotive industry) and Bakrie Brothers (a holding company in several sectors) explored this option. A Commercial Court was set up to handle corporate restructuring and debt settlements.e. 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). with the requirement that adequate compensation and protection will be provided to such creditors during that period. especially in preventing unjustifiable delays in the adjudication of bankruptcy. the companies’ financial performance deteriorated. Rabobank and Citibank. For instance. aiming to modernize the bankruptcy system and promote the fair and expeditious resolution of commercial disputes. In the banking industry.. plantations. 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. some companies attempted to restructure their businesses on their own. Qualified professionals from the private sector will act as receivers and administrators in the management of estates of companies in bankruptcy or reorganization. under which the latter would become one of the bank’s shareholders. for equity infusion. Procedural rules are also being introduced to ensure certainty and transparency in the proceedings. Bank Bali agreed on a debt-to-equity swap with its creditor.Chapter 1: Indonesia 43 few companies reached agreement with their creditors on this. Some listed companies with relatively “rich” shareholders decided to replace their loans with additional equity through rights issues and privileged subscription (limited offering). a publicly listed company operating in the automotive industry. as well as general commercial disputes. Astra International. Bankruptcy Reform The Bankruptcy Law was passed in August 1998. Standard Chartered. Bank Niaga also negotiated with some of its creditors. forcing them to cut costs. Moreover. lay off workers. consolidate business units. Meanwhile. When credit from the banking sector became unavailable and interest rates increased significantly. Debtors.
. is also reviewing the Bankruptcy Law. II to achieve liquidation of the company. In the longer term. the Capital Market Supervisory Agency allows companies to offer additional shares directly to the public. (ii) the resolution of nonviable private banks. Previously. reform. legislation against corruption. The Government. Banking Sector Reforms The Government’s banking sector reform strategy is focused on (i) government-assisted recapitalization programs for potentially viable private banks. it is envisaged that the Commercial Court will play a central role in modernizing the commercial legal system. with only 17 cases filed as of November 1998. 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 Agency also allowed companies to buy back up to 10 percent of outstanding shares to improve the condition of the stock market. The Court has also declared only two companies bankrupt. (iii) the merger. The bias in favor of debtors has retarded the pace of corporate restructuring. The significance of a sound bankruptcy system cannot be understated as it provides a backdrop for negotiations in the workout and restructuring process against which parties often gauge their legal rights. the Government did not impose restrictions nor did it attempt to regulate capital flows. Capital Market Reform In the capital market. Rather. and nepotism (anti-KNN) was signed in 1999. There will be changes in the implementation of the bankruptcy law. in consultation with IMF and the World Bank. However. Realizing that they undermine investors’ confidence. To push bankruptcy reforms. including procedures for handling operational issues and processing bankruptcy cases. However. collusion. the Court’s early record has been a disappointment. the measure had only a minimal impact. Some companies simply decided not to pay their loans knowing that it would be difficult for creditors to take the case to court. The Government has also been concerned with the issue of capital controls. (iv) measures to recover liquidity support previously extended to troubled banks by Bank Indonesia. and (v) a strengthened banking supervision system. since the market reflects the condition of the economy.44 Corporate Governance and Finance in East Asia. companies were allowed to sell shares only by issuing stock rights. Vol. and recapitalization of state banks.
Liquidity support given to troubled banks should be repaid in four years. 1. the Government established IBRA to supervise problem banks. To overcome these problems. However. merged. It has also drafted regulations to remove obstacles for converting debt to equity. regulations will need to be issued to permit debt-toequity swaps in the context of corporate restructuring plans. Other Regulatory Reforms To push corporate restructuring further.Chapter 1: Indonesia 45 In 1997. or sold (after transferring NPLs to the AMU). In October 1998. and follow-up action on bank restructuring. it is doubtful whether pure holding companies are able to enter into swaps. was enacted in 1999. Conclusions. Some 175 groups that originated from family businesses controlled .6 1. BEII. and Recommendations Summary and Conclusions Corporate Ownership and Structure Most of Indonesia’s top conglomerates were established as family businesses. A new central banking law. and Bapindo) will be merged into one bank named Bank Mandiri. The merger process will be finished within two years. Banks deemed ineligible for recapitalization will be closed. Bank Indonesia has announced a recapitalization program for potentially viable private banks. In particular.6. The four state banks (BDN. the Government required banks to be audited by international external auditors. The Bank Indonesia 21st package includes recapitalization. Parliament approved amendments to the banking law that were geared toward strengthening the legal powers of IBRA and its AMU. improvement of rules and prudential regulations. providing Bank Indonesia with substantially enhanced autonomy. The agency set up an Asset Management Unit (AMU) to directly manage problem loans of banks under its supervision. The Company Law at present can be interpreted as severely limiting the scope for debt-equity swaps. depositors will be fully protected by the Government. To obtain a clearer picture of the banking sector.1 Summary. the Government has drafted a regulation providing tax neutrality for mergers and removing other tax disincentives for restructuring. BBD. The importance of this legislation may need to be emphasized.
However. The restructuring and resolution of financial distress may. 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. meanwhile. When the Government regulated the legal lending limit and the net open position of banks.7 percent. On average. banks were unwilling to provide credit to highly leveraged companies. when barriers to entry in the banking sector were lifted. the majority remains family-controlled. Rapid growth in investments masked the corporate sector’s increasing leverage. families control 67.6 percent of the total stock market capitalization in 1996 and the top 15 families controlled 61. These figures show the extent of power wielded over the corporate sector by a small number of families. Companies relied heavily on bank credit. however. This study reveals that Indonesian listed companies with higher ownership concentration had higher levels of leverage. Therefore. retain ownership control of companies. conglomerates set up finance companies to bring in cheap foreign loans as these companies were not adequately regulated. this financing pattern supports the claim that family-based controlling shareholders relied on excessive borrowing to finance corporate expansion . Vol.46 Corporate Governance and Finance in East Asia. lacked the information necessary to allow them to assess projects’ risks and chances for success. These banks also obtained cheap offshore funds. As a result. put a significant amount of corporate assets of conglomerates in the hands of creditors or the Government.1 percent of publicly listed companies in Indonesia. Financing Patterns Controlling shareholders opted to use debts to finance expansion. not all of the conglomerate-affiliated companies are publicly listed. allowing them to maintain their equity shares and. The financial crisis created opportunities for addressing the inefficiencies in the legal and judicial system that supported corruption. Indonesian companies borrowed short term. The free capital flow system permitted the inflow of foreign capital to fuel the credit boom in the economy. conglomerates set up their own banks to serve as “cashiers” providing credit to companies within groups. corporate debts grew over time. thus. II 53 percent of total assets of the top 300 Indonesian conglomerates. Among those listed in the Jakarta Stock Exchange. Foreign creditors. while a single family controlled 16. But because foreign creditors were reluctant to lend long term. On the one hand. However.
The Government and the private sector responded with measures to mitigate the negative effects. and registered a net loss of Rp39. Meanwhile. DER increased to 307 percent in 1997 and further surged to 1. followed by the property sector.21 trillion in 1996. ROE dropped from 1.24 trillion in the first half of 1998. the consumer goods industry was the worst hit. corporate-initiated debt restructuring . and strengthen prudential regulations and supervision of the financial sector.1 trillion in 1997 from Rp13.Chapter 1: Indonesia 47 without diluting their control. NPLs rose and capital adequacy ratios fell. were the most adversely affected.1 percent in 1997 to -124. the corporate sector was in quite good shape in terms of growth and profitability. the high domestic interest rates that prevailed from 1998. Bank Indonesia extended emergency loans to many banks. At the height of the crisis. The Government introduced reforms to improve bankruptcy procedures. Total profits of publicly listed companies dropped to Rp3. The significant increases in leverage indicate a rapid rise in the rupiah value of debts due to the revaluation of dollar-denominated debts. particularly those with large short-term foreign loans. On the other hand. although at a declining rate. As the rupiah weakened and interest rates increased. Net profits of publicly listed companies had consistently been growing at an average rate of 20 percent each year. the highly leveraged companies. financed by issuing nearly $80 billion worth of bank restructuring bonds. To restructure the corporate sector.1 percent in 1998. When the crisis hit Indonesia.370 percent in 1998. Responses to the Crisis The impact of the financial crisis on the corporate sector was serious. and the rapid decline in equity due to losses. The problem was in the maturity structure of its dollar-denominated debt and high debt-to-equity ratios in some sectors. Sales of conglomerates as well as those of publicly listed companies were increasing. The financial crisis led to the closure of several dozen banks. Impact of the Financial Crisis Prior to the crisis. facilitate debt restructuring. the Government initiated corporate debt restructuring measures (Mexican-style foreign debt resolution and the Jakarta Initiative). it also reflects the failure of the financial sector to channel funds to the corporate sector efficiently due to weak prudential regulation and supervision.
If the role of a limited number of families in the corporate sector is so large and the Government is either heavily involved in or influenced by business. Amendments should include (i) empowering minority shareholders by raising the majority percentage of votes required on critical corporate decisions and mandating minimum representation of minority shareholders on the board. The Government should ensure that all laws and regulations are effectively enforced. cost cutting and business consolidation) and acquisitions by creditors or foreign investors through debt-to-equity swaps and equity infusions.. Specific recommendations include protecting the rights of minority shareholders. improving the legal and regulatory framework for bank supervision. but it is not clear whether in practice these standards are in place. and (iii) strengthening transparency and disclosure requirements.2 Policy Recommendations The Government should introduce measures to address the weaknesses in corporate governance identified in this study. minority shareholders have not been able to oppose controlling shareholders’ decisions to invest in unprofitable projects financed by unhedged foreign currency debts. II measures included internal business restructuring (e.g.48 Corporate Governance and Finance in East Asia.6. Improving the Legal and Regulatory Framework for Bank Supervision After the liberalization of the financial sector. the legal system is less likely to evolve in a manner that will allow it to protect minority shareholders. Most companies claim to have adopted international standards of accounting and auditing procedures. but inadequate protection to minority shareholders from the dominance of large shareholders. Vol. and protecting creditors’ rights. 1. Protecting Minority Shareholders’ Rights The Corporate Law provides sufficient rights and protection for all shareholders. the regulatory environment was not prepared to supervise the increasing number of banks and nonbank . The Corporate Law should be reviewed and amended in the context of pervasive control by large shareholders. In particular. (ii) delineating the functions of the board of directors and commissioners.
The ownership of banks (including finance companies) by shareholders of nonfinancial companies undermined the capability of these banks to conduct prudential credit management. The tendency of foreign creditors to lend short term is a problem that must be confronted once private capital flows to Indonesia recover. Consequently. The regulatory framework was also weak in supervising and monitoring foreign transactions. it has been difficult to implement standstills. with necessary legal sanctions for violations. In the first place. With credit being coursed through the domestic banking system rather than directly to numerous local corporations. in contrast to the Republic of Korea and Thailand. most of banks’ NPLs resulted from credit to companies within the same group. Protecting Creditors’ Rights To protect creditors’ rights. Because these banks are neither easily convinced nor compelled to submit their claims to the jurisdiction of Indonesian commercial and bankruptcy courts. When finance companies were used to channel offshore loans in lieu of commercial banks. the Indonesian corporate sector directly owes an inordinate amount and a greater portion of its loans to foreign banks. The Central Bank needs to monitor and control dealings by banks within business groups and improve enforcement methods to prevent circumvention of prudential regulations. the Court has been slow and ineffective in processing bankruptcy suits. The Government should also continue strengthening the monitoring system for foreign exchange transactions. recapitalization.Chapter 1: Indonesia 49 financial institutions. Further. the Government lost monitoring and control powers over foreign fund flows. it is likely that future private financial flows for the corporate sector will continue to conform to a short-term structure. Banks should be required to provide data on such transactions and charged penalties for noncompliance. the Republic of Korea and Thailand were more successful in getting foreign creditors to collectively solve their problems during the crisis. However. This is a significant factor in . and liquidation of corporate assets. the banking regulatory framework was inadequate in regulating banks’ dealings with affiliated nonfinancial companies. orderly restructuring. Because foreign creditors are faced with more information asymmetries than domestic creditors. a new bankruptcy law was passed in the aftermath of the crisis and a Commercial Court was set up to deal with bankruptcy cases. One way is to set limits on lending activities by banks to affiliated nonfinancial companies.
. II explaining the greater depth of the crisis in Indonesia. despite the smaller level of capital inflows (as a percentage of GDP). Only when creditors have the confidence that their rights are protected will they resume financing companies.50 Corporate Governance and Finance in East Asia. 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. Vol.
Indonesian Business Data Centre. various publications. various publications. 1997. John Wiley and Sons. JSX Monthly Statistics. Letter of Intent of the Government of Indonesia to the IMF. Manuscript. Economic and Financial Statistics. Center for International Business Education and Research. Large and Medium Manufacturing Statistics. Indonesia Country Profile. Risks. Lang. World Bank. The Private Debt Anatomy. and Larry H. Indonesia: An Emerging Market. Who Controls East Asian Corporations? Financial Economics Unit. 1997. Maryland. 1999. various publications. John Wiley and Sons. 1996. Indonesian Central Bureau of Statistics. The Economist Intelligence Unit. Unpublished thesis MMUGM. 1995. Indonesian Capital Market Directory 1992-1998. Jonathan. Financial Sector Practice Department. Delhaise. F. Keasey. K. and Richard Turtil. various publications. and Remuneration. The Impact of Acquisition to Shareholders Wealth: Comparison Between Internal and External Acquisition. Conglomeration Indonesia: Regeneration and Transformation into World Class Corporate Entities. University of Maryland. Simeon Djankov. Claessens. and M. Embassy of Indonesia Homepage. 1999. Forest. 14 May 1999. Wright. Michael Krill. 1996..Chapter 1: Indonesia 51 References ADB Programs Department (East). Economy of Indonesia. Conny Tjandra Rahardja. P. Jakarta Stock Exchange. Corporate Governance: Responsibilities. Working Paper #58. Institute for Economic and Financial Research. . Stijn. P. Indonesia Country Report. Asia in Crisis: The Implosion of the Banking and Finance System. 1998. Indonesian Business Data Centre. 1998. Yogyakarta. Embassy of Indonesia. 1995. Bank Indonesia. The Economist Intelligence Unit. Indonesia: Sustaining Manufactured Export Growth.
and Graham Dwyer for his editorial assistance. The country’s winners would then emerge based only on economic efficiency. A national consensus is emerging that a democratic system based on free market principles should be firmly established to promote more intense competition in every sector of the economy. The authors wish to thank Juzhong Zhuang. Business managers and controlling shareholders were maximizing firm size at the expense of profits. David Edwards.1). Seoul. The extent of inefficient investment can be seen from the fact that more than 70 percent of listed firms had negative economic value added (EVA) before the crisis while those with positive EVA declined (Table 2. the Government and business sector had good reason to reflect on the causes of the crisis. 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. timely exit of poor performers from the market. Department of Economics. Korea) in November of that year. . Poor corporate governance and political and government intervention in the business and financial sectors are widely viewed as contributory factors. both of ADB. As the Korean currency. This has been the crux of the corporate governance problem in Korea. Further. Inefficient investment coupled with excessive financial leverage was found to be at the root of the economic crisis at the corporate level. and David Webb of the London School of Economics for their guidance and supervision in conducting the study. the Korea Stock Exchange for its help and support in conducting company surveys. and corporates were sent reeling. a practice that was not checked by creditors. the Republic of Korea.2 Republic of Korea Kwang S. 1 Professors. and curtailing of morally hazardous behavior that has been prevalent among economic decision makers.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. It had been the norm in Korea to conduct business based on political and administrative favoritism rather than on competitive merits. or capital market discipline. markets. internal control mechanisms. Chung and Yen Kyun Wang1 2. Chung-Ang University.
aiming to identify the areas in need of further reform and to provide policy recommendations for improved corporate governance. 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. The EVAs are the same as the economic profit as explained in T. and individual companies. Copeland. capital market discipline. Weaknesses in the overall corporate governance system in Korea had many ramifications. especially chaebols. A survey was conducted for the nonfinancial listed companies using a questionnaire developed by the Asian Development Bank (ADB)2 to supplement official data.4 1993 513 174 33.54 Corporate Governance and Finance in East Asia.1 1998 490 164 33. Government reform goals for the corporate sector include enhancement of corporate transparency. Koller. Dividend payments were at less than 2 percent annually as opposed to the double-digit interest rates in the past decades. .1 1996 561 163 29. the corporate sector. Vol.1 1997 518 104 20. This broad perspective can help clarify the ongoing reform efforts of businesses and the Government. II Table 2. 1992-1998 Item Total Number of Firms Firms with Positive EVA Percentage of Firms with Positive EVA 1992 508 180 35. Many firms left some questions unanswered.1 Listed Firms with Positive Economic Value Added. where NOPAT is the net operating profit after taxes and WACC is the weighted average cost of capital multiplied by invested capital. June 1999.5 Note: The EVAs are calculated as: EVA = NOPAT – WACC. and J Murrin (1995). Restructuring efforts have focused on reduction in the degree of business diversification and in the financial leverage of large-sized firms. This study collects and analyzes data on the Korean economy. accountability of controlling shareholders and boards of directors. This study also reviews the legal and 2 The survey was conducted mainly through the Korea Stock Exchange. Inefficient investment undermined the competitiveness of Korean firms in the global marketplace.1 1995 560 163 29. The total number of respondents was 81 out of about 550 nonfinancial firms listed on the Exchange.9 1994 531 165 31. Source: Korea Stock Exchange. T. and improvement of bankruptcy procedures. which distributed and collected the questionnaire.
corporate control by the Government. The evolution of the modern Korean economy can be divided into four periods. Major economic indicators for some of these periods are shown in Table 2. Section 2. From 1948 to 1961. Section 2. and other necessities domestically. and Yim (1998). It traces the country’s economic development. . Section 2. This chapter is composed of six sections. Section 2.3 identifies characteristics of corporate governance by analyzing the ownership structures and control patterns of listed companies and the largest chaebols. the board of directors system. creditors. which account for a substantial portion of the Korean economy. and naturally adopted an import substitution policy. 2. In the period 19481961.2 presents an overview of the corporate sector. Section 2.5 describes the state of the corporate sector in the financial crisis and draws on the results of the foregoing sections to outline the causes of the crisis. the Government relied heavily on aid from the United States (US) and United Nations to alleviate poverty and high inflation.2 2. 3 The review of historical development of the Korean economy draws substantially from the book by Sohn. and employees and their role in shaping corporate governance practices.Chapter 2: Korea 55 regulatory framework for the corporate sector and reform measures taken after the crisis.4 contains analyses of corporate financing and its relationship to performance. Import Substitution: 1948-1961 The Korean War (1950-1953) devastated Korea’s industrial capacity.2. clothing.6 discusses responses of the Government and the business sector and explains in detail their reform and restructuring efforts. It then presents recommendations for further reform in corporate governance and financing. Yang. It reviews such elements as shareholders’ rights. 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.2. reviewing government policies responsible for the development of the modern 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.
8 12. However. and inconsistent economic policies. In the Plan. This goal required very high savings and investment rates. International Financial Statistics.2 757.2 30.2 314. the Government called for an unprecedented average annual economic growth rate of 7.5 250.7 30.6 11. d Refers to 1997.2 6.2 452.56 Corporate Governance and Finance in East Asia.1 9.8 24. and implementing new budget and tax measures.0 27. b Refers to 1979. modernizing the industrial structure.1a 21.2 1980-1989 8.855. the Government was not successful in solving the problems of slow growth.5) 8.265. Export Drive: 1962-1971 Between 1962 and 1971.9) 1.8 (724.102.2 1.9) (7. lack of strong drive. The Government tried .7c 11.2 Key Macroeconomic Indicators Annual Average (percent.0) 492. and large current account deficits.9 — — 21. In 1961 it devalued the won from W65 to W130/dollar and announced its first Five-Year Economic Development Plan (1962-1966).949. a Refers to 1971.0 41.447.4 10.1 15. largely because of political instability. II Table 2.4 24.753.7 14.9b 15.5 38. 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. 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.7 37.4 1990-1997 7.1 35.5) (1.4 (1.0) (297.2 32.1d 9. Economic Statistics Yearbook. the Government redirected the policy focus away from import substitution to an export-led manufacturing-based economy.8 (8.1 — = not available.2 31. e For maturities of one year or more.1 29.8 15. Source: Bank of Korea.332.9 794.1 percent with moderate rates of inflation and introduced a series of reform packages aimed at developing key industries. Vol. high unemployment and inflation.3 8.4 29. c Refers to 1989. IMF.4 29.
These were considerably liberalized in 1967 when Korea joined the General Agreement on Tariffs and Trade (GATT). During the first five-year plan period. resulting in high real interest rates. Exports increased sharply from $41 million in 1961 to $2. . boosting internal investment resources. due to continuous current account deficits.2 billion in 1972. In 1965 the interest rate on one-year deposits doubled from 15 to 30 percent. and maximizing mobilization of domestic savings on the other. and almost doubled the foreign exchange rate from W130/dollar to W256/dollar to enhance the international competitiveness of exports. but tariff rates were raised to 40 percent in the 1960s. up from 30 percent in the late 1950s. Bank deposits increased rapidly. During this period. but the average growth rate for 1965-1969 shot up to 10 percent.3 percent average between 1954 and 1959. the import liberalization rate was 55 percent. the growth of gross domestic product (GDP) raised domestic savings. the Government undertook important economic reforms in two areas: the foreign exchange rate and the interest rate.4 percent. This change raised the import liberalization rate from 9. The exchange rate system was a kind of crawling peg until 1974. The Government abolished temporary direct subsidy measures and introduced a new comprehensive export promotion system. abundant. In 1964. The average growth rate of the economy from 1960 to 1964 was 5.3 percent to 60. while the average tariff rate was 39 percent. In 1971. The well-educated. channeling funds from curb markets into the banking sector. In 1963-1964. Korea normalized political and economic relations with Japan to encourage inflows of Japanese capital that could finance big development projects. However. the Government changed the multiple and fixed exchange rate system to a unitary floating exchange rate system. imports of consumer goods and luxury items were highly restricted. and cheap labor force was well utilized by the export-led growth strategy. Also. But the liberalization trend turned out to be short lived as current account deficits continued. which laid a solid foundation for a steady growth path. a modest improvement over the 4. the Government tried to provide exporting firms with a free trade environment. 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.Chapter 2: Korea 57 to meet its targets by borrowing large amounts of foreign capital on the one hand. The positive list system for imports was replaced with a negative list that indicated only those items that could not be imported.5 percent.
The Government encouraged a variety of business projects.6 billion between 1973 and 1981 into these sectors. There were three reasons for the switch: first. By promoting HCIs. the domestic economy was stagnant and many businesses. 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 . nonferrous metal. Second. less developed countries forced Korea to adjust its industrial structure. One industrial policy adopted during the heavy and chemical industrialization drive was administered credit rationing. and assigned them to specific chaebols. reducing or exempting debts of farmers and fishermen. the Government felt that continuous trade deficits arising from increasing intermediate and capital goods imports could be prevented by developing import substitution industries.58 Corporate Governance and Finance in East Asia. It promoted HCIs by supplying massive capital for construction and development. This strategy formally took off with the announcement of the HCI Promotion Plan in June 1973. and giving low interest rate loans to banks from the central bank. Unlike the previous system. Third. the Government felt the need to strengthen the defense industry. electronics. and chemicals—as future core industries. overburdened with debts and high interest rates. machinery (including automobiles). becoming a seed of the economic crisis in 1997. In 1972. It included a detailed construction and investment schedule over a 10-year time frame and mandated coercive implementation. These included rescheduling business debts. faced the danger of bankruptcy. The Government targeted six industries—steel. shipbuilding. II Heavy and Chemical Industry Promotion: 1972-1979 In the Third Five-Year Economic Development Plan (1972-1976). the emergence of competition of other low-wage. the Government changed its industrial policy emphasis from light industries to heavy and chemical industries (HCIs). The HCI promotion policy was much more comprehensive than past economic development plans. announcing rescue packages for businesses and banks. The Government has since used similar emergency rescue measures for large businesses and banks almost once every 10 years. investing a total of $9. and allocating virtually unlimited amounts of credit at below-market rates while controlling the financial system. 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. Vol. The Government took emergency measures. in the face of a world economic slump. where preferential export credit was given to almost every exporter.
The growth rate of the money supply was reduced drastically. In 1986-1989. such as widespread underutilization of capacities of HCIs and related plants. as it had to control only a few large chaebols. and their utilization ratios were very high.Chapter 2: Korea 59 through state-controlled banks. The two important ones were import liberalization and deregulation of the financial sector. Evaluations of HCI promotion policies are mixed. the Government restructured some large businesses through forced liquidation and M&As. Gross national product (GNP) growth rates on average were higher in the 1972-1979 compared to 1962-1971 (Table 2. light manufacturing and service industries were weakened by disadvantages such as a lack of credit. low . Korea recorded current account surpluses and rapid economic growth due to the “three lows”: low value of the US dollar. The plan of the 1970s was thought to be successful in the long run. the policy wasted substantial amounts of resources in the short and medium terms. various measures to increase competition were taken. including forced liquidations and mergers and acquisitions (M&As). However. a heavy foreign debt burden. Firms that followed the Government expanded greatly. including denationalization of banks. The severe world recession caused by the second oil shock. fiscal expenditure maintained zero growth. Meanwhile. faced with high inflation. however. met increased difficulty. Meanwhile. This required industrial restructuring by the Government. The incentives available became more market-based. and the large excess capacity of HCIs. New start-up firms. the Government adopted comprehensive measures to promote economic stabilization. The industrial and trade policy resulted in high inflation in the 1970s and serious excess capacity problems by 1979.2). Economic Liberalization and Globalization: 1980-1997 In 1979. since during the second half of the1980s many of the promoted firms became world-class competitors and exporters. Such an approach gave the Government increased control over the economy. and the won depreciated by 20 percent with the adoption of a Basket-Currency Gliding System in 1980. Cheap credit and distorted prices resulted in overexpansion in the HCIs. coupled with political uncertainty due to the assassination of President Park in 1979. imports were further liberalized while tariff rates were lowered. price controls were abolished. In order to improve economic efficiency. Macroeconomic policies became hostages of the industrial strategy. especially between 1979 and 1985. exacerbated the overcapacity problem. with many turning into the now well-known chaebols.
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. 45. with the 30 largest in the total economy in 1997 standing as follows: value-added. In 1990.2 percent. Korea abolished remaining direct subsidy systems for export activities as well as some traditionally managed trade systems. the import liberalization ratio reached 98. while continuous and large current account surpluses saved Korea from the foreign debt problem. 47. The Government tried to adjust economic policies and regulations to meet global standards.1 percent. The most important element characterizing chaebols is the concentration of ownership. 46. the Government committed itself to further liberalization of the goods and capital markets. total debts. 4. The official rate fluctuated within a band. II world interest rates. the importance of chaebols was increasing. giving up its foreign exchange controls related to the current account.9 percent.9 percent. The birth of chaebols can be traced to the selling of Japanese colonial properties that were reverted to the Korean Government after World 4 The historical review of chaebols draws substantially from the paper of Lee and Lee (1996). Korea began participating in many multilateral trade negotiations during the Uruguay Round. whose business activities are controlled by an identical person.2. further increasing its pace of import liberalization. where particular individuals and their family have de facto control of the management of all subsidiary companies of groups.60 Corporate Governance and Finance in East Asia. Meanwhile.2 Rise of the Large Business Groups (Chaebols)4 The Korean Fair Trade Act defines a business group as “a group of companies. joined the Asia Pacific Economic Cooperation (APEC) Group in 1993. Vol. Korea became a signatory country to the International Monetary Fund (IMF) Article VIII. and declaring that it would follow Article XI of GATT. total sales. The low value of the dollar led to a low won and high yen. Industrial and trade policies were modified to be consistent with WTO. and acceded to the World Trade Organization (WTO) in 1994. By joining the Organisation for Economic Co-operation and Development (OECD) in December 1996.3 percent. and total workforce. total assets. which gradually widened. but it chose to liberalize gradually. and low oil prices.1 percent and average tariff rates 8.9 percent.” A large-scale business group is called a chaebol. Korea adopted a market average exchange rate system. . In 1988. In 1993. 13. 2.
3 Subsidiaries of the 30 Largest Chaebols. The Government provided financial and fiscal incentives to chaebols and trading companies with relatively abundant financial resources. However. 1993-1996 Year 1993 1994 1995 1996 No. This galvanized the fast growth of chaebols. after the financial crisis. Chaebols are also excessively diversified. Since the 1960s. financial assistance. the Korean Government has set the national goals of economic development and offered all kinds of support and incentives to achieve them.when the Government put a great deal of emphasis on development of the HCIs. large-scale businesses and chaebols were thought to be appropriate actors because they could meet the huge investment requirements of these industries. Since the Government controlled most business activities. . The Government provided subsidies. reaching 669 in 1996. and tax breaks to key industries to promote exports and industrial upgrading. In this sense. the ownership and management of a chaebol’s subsidiaries are not separate. One reason for this controlling power is inter-company shareholding among subsidiaries.1 20. of Subsidiaries per Chaebol 20. In the mid-1970s. Table 2. the number of subsidiaries declined drastically due to corporate restructuring. Important managerial decisions are made primarily by owners. Subsidiary companies of chaebols are subject to “fleet-type management” in that they are controlled by the overall managerial system of chaebols. From the standpoint of the Government. and they are aided and supported by one another.Chapter 2: Korea 61 War II. Chaebols have a history of substantial concentration of ownership. 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.5 20. of Subsidiaries 604 616 623 669 Average No. Large-scale companies owned by the Japanese were sold to individuals under preferential terms and later enjoyed a relatively favorable position for accumulating capital.3 shows that the number of subsidiaries of the 30 largest chaebols increased considerably since 1993.8 22. Table 2. chaebols that maintained a close relationship with the political authorities were able to grow fast.3 Source: The Fair Trade Commission.
in addition to the usual economies of scale. 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. 2. years since establishment.3 Role of the Capital Market and Foreign Capital In the 1960s. On the other hand. However. In the early years after the enactment of the law.62 Corporate Governance and Finance in East Asia. The law also allowed employees of listed firms to get 20 percent of the subscription rights in offerings of new shares. there are many negative assessments of organizational structures and practices of chaebols. 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 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. Meanwhile. Another law that contributed to the development of the stock market was the Act to Expedite the Going Public of Corporations of 1972.2. 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. etc. Vol. . They had to meet certain requirements in terms of firm size. internalization of the market that could enhance the internal efficiency of a chaebol may close the market to other firms. including the “economies of organizational size” inherent in multi-product and multiplant firms. This could ensure their stable growth and enhance their investment abilities. if a chaebol has an unsound financial structure but strong financial links through mutual payment guarantees among their subsidiaries. diversification can make chaebols stable through the portfolio effect. they can reduce uncertainties and dilute risks through sharing of information and diversification. For example. the Government’s efforts to develop the stock market culminated in the Capital Market Development Act of 1968. profitability. chaebols can benefit from synergies. Since chaebols are engaged in many different businesses. This law was in effect until 1987 when it was partly absorbed into the Capital Market Development Act. listed companies enjoyed corporate tax rates that were 10 to 20 percentage points lower than those imposed on privately held firms. which may ultimately lead to the decline of social efficiency. Under this law. II Theoretically.
370 70. First. The policy to expand the size of the stock market.4 654.6 747. The aggregate Table 2. the stock market grew rapidly during the 1980s.7 934.476 79. however. As shown in Table 2. especially those paying small or no dividends.6 Year 1985 1989 1990 1994 1995 1996 1997 1998 Source: Monthly Review (Securities Supervisory Board) and the Financial Supervisory Service. the Government announced measures to increase the demand for shares by providing tax and financial incentives to individual investors.1 30.798 Market Capitalization as a Ratio to GDP (%) 8.2 44. in 1986 the Government imposed limits to bond issues on firms that were recommended to go public but refused.151 117. 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.5 406. the Government announced the gradual opening of the capital market to foreign investors in January 1981. The Korea Fund. . Because of government policies and the booming economy. a country fund. 1985-1998 No. mainly by increasing the supply of shares by initial public offerings (IPOs) and seasoned issues.9 918.1 Market Capitalization (W billion) 6.020 151. continued until 1989.4 Development of the Stock Market. the Government attempted to stabilize the stock market by limiting IPOs and share issues by listed companies.Chapter 2: Korea 63 During the 1980s and 1990s.570 95.217 141.. Third. This reversal in policy reflected declining stock prices and was generally maintained until the outbreak of the economic crisis in 1997.0 79. several important policy measures were implemented to promote the development of the stock market.989 137.9 34. Second.0 49.4.9 833.0 965.1 16. In this regard.4 40. Inc. Beginning 1990. was established to invest in domestic shares beginning in September 1985. 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). of Listed Firms 342 626 669 699 721 760 776 748 Stock Price Index 138.
571 2. Source: Balance of Payments.694) 2.339) (9. but increased sharply to 79. trade credits.817 16.910) 2.239 19.5 Private Capital Flows to Korea. Table 2.352 471 3.296) (6.714 1.455) 13.433) (9.126 (1. due to declining stock prices. .085 2.658) (3. Bank of Korea.141 4.347 3.287 (340) 73. However.650 (1. and other liabilities.546 (2.264) (3. 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) (2.59 percent in 1998 and to more than 50 percent in the early months of 1999.944) 8.453 (2.942) 42.583 25 10.150 5.86 percent of GDP in 1997.149 13.001 4. Vol.255 2. and stayed at the 30-40 percent level up to 1996.382 Permit basis. and 1993. The growth in the number of listed firms also slowed in the 1990s.413) 56.450 24.500 7.017) 1.742 (3.875 21. II market value of all listed firms represented only 8 percent of GDP in 1985.008) (3. foreign direct investment (FDI) has been very small relative to GDP and compared to other East Asian countries.542) (1. The reasons for the decline include increases in bankruptcies and mergers involving listed companies since the outbreak of the economic crisis.64 Corporate Governance and Finance in East Asia.440 1. currency and deposits.5 shows net FDI—inward investments by foreigners less outward investments by Koreans—in the period 1985-1998.924 (1. The aggregate market value of listed shares bottomed at 16.785 (1.534) 1. The relative size of the stock market diminished to 44 percent in 1990. 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 1986-1989.183 12.858 4.326 1.414) 5. Table 2. Other investments include loans.852) (2.870) (1.2 percent by 1989.737 (333) (297) (607) (2) 218 2.868 (518) (418) 63 1.800 (7.123 3.553 8.953 10.642 21. but rose again to 34. The number shrank for the first time in 1998 to 748 firms from 776 the previous year.338 4.
excluding FDI. In addition to FDI. This indicates that a substantial proportion of debt was denominated in dollars.5). Large amounts of outward investment by Koreans in the mid-1990s arose out of increased liberalization of foreign exchange regulations. Taipei. Between 1986 and 1989. This would lay the foundation for evaluating the effect of corporate governance on performance. and high production costs were the main reasons for low FDI in Korea. and sales of the aggregate sector during this period were very high (Table 2. Korea had substantial current account surpluses and experienced net private capital outflow. increased substantially in 1994-1996 due to accelerated liberalization of capital movements (Table 2. Table 2.7 billion and loans $42. and (iii) chaebols.6 percent in 1997. The ratio is generally in the same range for Japan and Korea.China and the US. portfolio investments amounted to $73.7 compares the ratio of ordinary income to sales of Korea’s manufacturing sector with those of Japan. Profit rates of Korean firms were relatively low compared to those of Taipei. The dismal performance of the Korean corporate sector compared to the . following the sharp depreciation of the won.9 billion. The Aggregate Corporate Sector The aggregate corporate sector in this study excludes the financial sector. (ii) listed firms.Chapter 2: Korea 65 Complicated government regulations.China.4 Growth and Financial Performance This section looks at the performance of (i) the aggregate corporate sector. and US. The debt-to-equity ratio (DER) averaged 311 percent for the period 1990-1996 and peaked at 424. the growth rates of equity and sales dropped sharply in 1996 and 1997. Japan’s was consistently higher. However. equity. weak incentives for attracting FDI.2.6). Corporate sector net proft margins increased from 1993 to 1995. other net private capital inflows amounted to $130 billion during 1985-1998. Return on equity (ROE) and return on assets (ROA) showed similar patterns. but between 1988 and 1993. Net private capital inflow. Of this. The contribution of the corporate sector to GDP was 73. but dropped in 1996 and were negative by 1997.2 percent in 1987. 2. The same categories will be analyzed in later sections. The growth rates of total assets. increasing to 76 percent in 1997.
4 1.8 21.0 0.7 2. ROE = return on equity (ratio of net income to stockholders’ equity).2 18.5 3.5 4. Table 2.6 1.9 3.0 13.0 6.6 3.7 4.9 18.9 2.7 325.9 5. ROA = return on assets (ratio of net income to total assets).9 5.4 1.2) (0.2 13.7 15.6 (4.0 7.0 3.4 1.2 1.China 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 2.4 19.5 2.6 13.6 Growth and Financial Performance of the Nonfinancial Corporate Sector.1 5.8 22.3 312.3 — 3.3 308. Source: Bank of Korea.4 2.8 3.5 0.9) DER = debt-to-equity ratio.2 9. 1990-1997 (percent) Growth Performance Year Total Assets Equity Sales Financial Performance Net Profit Margin DER ROE ROA 1990 1991 1992 1993 1994 1995 1996 1997 23.8 1.1 — — — = not available.7 15.8 8.0 10.8 2.6 4.9 2. Ordinary income = operating income + nonoperating income (from financial activities) – nonoperating expenses (from financial activities).3 1.9 13.6 2.9 2. Financial Statement Analysis Yearbook.8 1.0 13.3 11.4 4.9 3.4 10.8) 297.3) 5.3 335.2 19.6 9. .0 8.5 1.1 8.1 2.9 16.5 (0.9 5.7 3.3 21.9 16.7 1. Net profit margin = ratio of net income to sales.9 4.7 4.4 — 6.5 1.6 424. Financial Statement Analysis Yearbook.9 8.1 6.Table 2.5 4.7 International Comparison of Ratios of Ordinary Income to Sales in Manufacturing (percent) Year Korea US Japan Taipei.1 2.4 2.3 6.3 3.2 1.2 1.5 1.9 18.4 2.0 305.7 4.3 21.1 2.2 13.6 318. Note: Ratio of ordinary income to sales = (ordinary income/sales).5 7.6 1. Source: Bank of Korea.3 17.7 3.0 4.3 14.0 (0.
Net profit margins. Profit rates of most industries are also quite low. Listed Companies The number of listed firms increased from 334 in 1985 to 775 in 1997 (Table 2. This preference of Korean firms has its roots in the structure of corporate governance. In 1997. sales of listed firms grew 18. However.Chapter 2: Korea 67 other three economies can be attributed to the emphasis on growth in sales and market shares rather than on profits.and small-scale firms (Table 2.4 percent. Again. A comparison of performance by firm size reveals some interesting results. both ROA and ROE were lower for the listed firms compared to the latter.9). and steam supply industry. However. the average ROE was lowest for large firms. construction. All sectors experienced a sharp decline in equity and sales growth in 1997.5 percent while the aggregate sector recorded only 13. The profit margin of listed firms was generally higher than that of the aggregate corporate sector. The other financial ratios follow the general pattern of the aggregate corporate sector. trade. . 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. Performance followed similar patterns across different industries (Table 2. and transport sectors recorded negative profit rates in 1997. The growth performance of large firms for the 1988-1997 period was better than that of medium. with the wholesale and retail trade sector and the construction sector having the highest figures. Profit rates of different industries also mirrored the downward trend of the aggregate corporate sector prior to the crisis. Growth rates of total assets are generally high. Small listed firms were hardest hit by the financial crisis. This may be related to its having the lowest DER. the exception being the electricity. while their average net profit margin was lower than that of medium firms. gas. followed by mediumsized firms and large ones. The manufacturing. and ROAs of all listed firms declined substantially in 1996 and turned negative in 1997. this may be an indication of the bias toward large firms in terms of access to credit.8). ROEs. It is notable that the construction sector’s profit rate began its decline in 1995. In most years. a year ahead of the other industries. the sales growth of listed firms was higher than that of the aggregate sector (see Table 2.6). but higher than that of small firms.10). with equity in wholesale and retail trade even contracting.
8 22.5 1.0 15.9 10.1 21.7 520.9 16.1 16.6 375.8 7.4 .1 17.4 10.1 1.3 1.8 12.5 13.5 19.4 10.4 458.8 23.0 16.5 27.9 29.9 0.8 1.4 2.8 10.7 317.5 23.6 0.2) 22.2 12. and Business Activities 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 Average 11.6 1.3) (1.8 14.3 288.5 1.2 315.7 514.9 2.6 1.4 2.2 6.1 290.3 1.7 22.7 5.2 5.8 12.0 2.0 18.7 1.7 17.8 Real Estate.6 16.8 616.1 22.2 16.9 25.2 (1.5 569.9 3.7 4.0 37.0 15.2 5.1 (0.7 21.4 5.9 16.8 16.6 17.3 18.5 (1.7 7.0 (0.6 3.4 0.9 428.4 2.6 14.3 8.3 10.9 5.9) 1.9 (0.6 318.1 20.7) 2.1 (0.7 228.3 25.4 474.6 0.6 6.4) 0.8 526.0) 0.4 5.8 14.8 461.0) 0.6 14.3 8.4 12.7 (0.4 15.3 15.0 9.5 270.2 241.1 10.1 2.6 2.0 1.2 7.4 (0.0 1.9 10.4 10.1) 0.7 0.8 302.0) 4.6 12.2) 15.8) 0.8 16.3 15.0 254.9 (0.2 36.4 9. Renting.0 1.0 (0.9 1.5 (5.8 16.3 8.0 18.6 14.4 17.5 306.6 7.1) 3.1 1.0 22.2 18.6 15.0 16.0 22.2) (0.8 562.2 0.5 483.5) 0.0 19.3 31.6 17.0 245.5 6.2 20.4 14.4 348.8 0.0 1.4 350.6 12.1 396.2) 6.5 5.1 1.9 9.3 2.8 35.0 1.8 1.4 0.4 2.5 14.0 1.4 3.0 2.5 16.9 19.8 10.8 3.2 2.7 (3.4 2.6 24.5 Construction 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 Average 18.1 7.8 2.0 5.5 286.0 2.7 10.8 24.1 0.0 24.2 15.1 1.8 2.4 4.4 291.9 16.0 (4.6) (6.8 34.0 21.4 10.5 (0.1 27.2 0.5 6.3 8.0 12.3 14.8 32.3 2.8 17.8 22.3 14.5 1.1) (3.7 9.4 1.9 13.5 473.Table 2.1 2.3 11.1 296.2 16.3 13.0 3.4 740.8 3.3 15.5 5.2 6.5 28.2 423.5 3.7 16.9 538.5 4.0 22.0 2.2 5.6 3.0) 1.0 23.9 2.8 0.9 340.3 285.0 7.0 1.7 294.0 5.6 11.5 338.2 25.5 432.3 15.8 13.1 0.8 24.9 (0.2 20.0 24.6 5.8 345.5 30.3 10.8 Growth and Financial Performance of Selected Industries (percent) Growth Performance Year Assets Equity a Financial Performance NPM b Sales DER ROE ROA Manufacturing 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 Average 13.9 14.5 239.5 1.8 2.5 1.9 31.4 5.1 0.6) 3.2 24.2 0.6 655.1 28.4 1.3 11.5 1.7 30.
5 13.0) 1.4 0.6 4.3 1.2 10.3 17.1 15.0 1.3 18.0 921.7 — — — — — 14.0 7.062.7 116.4 3.4 2.2 14.6 6.7 15.0 5.2 1.4 1.8 (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 — — — — — 31.8 0.8 14.5 307.0 106.9 321.3) 15.5 539.2 10.6 6.0 (1.0 98.3 19. .9 12.3 8.3 34.5 47.6 — — — — — 0.0 14.0) 1.8 6.3 524.1 11.8 0.5 15.1 15.4 6.9 10.7 0.9 Electricity.6 8.6 19.3 (2.7) (4.6 0.0 14.0 (15.1 6.1 323.7 7.7 0.8 14.5 2.4) (1.8 11.7 2.8 8.1 15. and Communication 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 Average 15.3 543.0 2.2 698.0 2.6 6.2 90.0 21.6 14.4 0.3 2.4 1.8 9.3) 4.9 (11.5) 22.4 3.9 18.7 11.5 11.5 462.7 20.6 9.4 15.6 9.8 12.9 1.7 16.2 10.9 9.2 15.6 512.2) 9.3 3.9 4.9 8.6 19.5 0.1) (0.1) 1.2 14.6 21.7 187.5 26.3 4.8) (12.5 (2.4 7.2) 13.1 (0.9 17.9 3.4 21.5 14.9 456.3 12.9 6.6 (2.6 — — — — — 17.0 5.4 10.6 16.7 510.9 8.6 1.8 12.5 612.1 (11.4 341.4 — — — — — 448.7) 0.9 12.5 8.6 20.0 Transport.3 9.5 12.4 14. Financial Statement Analysis Yearbooks.5 4.5 11. a New equity does not include capital surplus.6 18.6 15.2) 0.6 9.Table 2.8 7.3 18.5 117.5 482.5 14.3 0.1 3.7 11.7 2.8 4.2 2.1) 5.3 8.8 3.9 10.6 (2.3 740.5 30.2 122.2 18.4 30.3 1.5 344.3) 11.3 4.3 125.7 11.6 34.6 2.1 17.7 14.2 18.8 3. Gas.5 14.9 9.9) (8.0 1.0 1.2 11.0 89.4 11.2 18.6 4.9 332.7 12.6 172.1 1.4 0.6 12.8 111.4 3.3 112.9 4.3 — — — — — 10.9 17.1 14.3 23.4 12.6 3.4 633.4 169.7 — = not available.8 15.6 1.5 16. Source: Calculated using data from Bank of Korea.2 — — — — — 2.4 (2.1 11.1 8.5 15.1 (2.4 1.2 7. and Steam Supply 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 Average 12.4 16.5 14.4 9.2 3.3 0.1 4.9 7.9 (10.4 6.1) (0.1 21.1 16.3) (1.4 12.8 6.4 7.0 13.7 7.4 13.6 12.4 (0. Storage.4 2.8) 1.8 529.1 2.6 8.7 19.6 8.0) (0.1 12. b NPM denotes net profit margin.4 367.3 4.9 18.2 143.
3 2. the largest chaebol.2 9. debts (47. followed by the top 6-10 (Table 2.5 19.4 1. Vol.0 0.1 6.4) 1.5 5.5 ROE 3. In 1995.9 2.9 percent).6 3.1 1.2 0.9 Source: Constructed using data from Korea Investors Service.9 Growth and Financial Performance of Listed Companies. the top 11-30 chaebols experienced a decline of .12).7 (5.9 percent).0 3. Kis-Fas.8 6.8 5.4 2.3 20. had 46 member companies. The criteria for selection of largest chaebols have changed a few times.6 23. In 1997.6 22.4 1.6 2.4 22.6 and 2.3 0. it is the chaebols’ large firms that are listed.1 1. Generally.7 1.70 Corporate Governance and Finance in East Asia.4 0. Chaebols have been the most important actors and engines of growth in the Korean economy. Between 1993 and 1997.2 9. The number of Hyundai member companies rose to 57 in 1997. but the number of designated groups has been fixed at 30 since 1993. Hyundai Group.8 0.6 0.3 percent). of Firms 334 351 386 503 626 669 680 681 687 698 715 754 775 Sales Growth 10.9 2. the growth of sales of the top 30 chaebols exceeded that of the aggregate corporate sector (compare Tables 2. 1998.9 11.3 4.12). The smallest group had 16 members in 1995. unless otherwise indicated) Financial Performance Year 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 Average No.5 19. The top five chaebols registered the highest growth rates.7 Net Profit Margin 0.6 (1.3 (0.7) 0.5 ROA 0.5 0.2 6.9 26. II Table 2.3 15. of which 16 were publicly listed (Table 2.0 18.6 1.4 1.7 percent) of the corporate sector.11).1 percent of the economy’s total value added (excluding the financial sector).9 0. and net profits (46.1) 4. of which four were listed. and close to half of total assets (46.8 24.2 2.9 6. It should also be noted that when the financial crisis struck in 1997. sales (45.7 1.9 21. 1985-1997 (percent.9 1. the 30 largest chaebols accounted for 13. Performance of Chaebols This section uses available data on the top 30 chaebols.
8 0.0) 0.0 19.8 16.6 3.0) 1.1 11.9) (6.4 3.2 (0.6 9.7 (0.3 (0.7 4. Kis-Fas.1 0.4 1.8 1.2 10.5 17.4 3. 1988-1997 (percent) ROE Large 9.6 (1.0 6.7 (1.9 (0.5 0.1 2.0 17.1 1.8) 1.9 14. 1998. Source: Korea Investors Service.9 2.4 16.6 2.7 2.9 5.0 1.8) 6.5) 1.4 6.6 (0.3 (0.2 Note: Large firms have a capital base greater than W15 billion and small firms smaller than W5 billion.6) 0.8 10.2 2.3 9.9 2.9 3.6 1.8 7.7 (1.4) 1.3 11.9 1.0 1.5 1.Table 2.8 3.0 4.6 3.7 3.6 8.6 0.6 13.0 1.5 (1.4 Medium Small Large Medium Small ROA Growth Performance Large 17.6 1.3 1.1 2.1 8.9 6.7 18.2 1.9 1.5 25.2) 0.8 17.5 2.9 22.8 (5.0 1.2 13.6 7.2) (1.3 Medium 14.0 15.6 1.6 0.5 5.6 2.9 0.7 1.8 0.9 6.2 0.5 5.9 25.8 0.9 0.2 13.2) (1.0 (4.4 2.9 2.6 5.3) 5.2 7.8 6.2 2.4 11.3 15.6 2.3 6. .2 3.2 Small 13.1) 5.8 6.3 15.10 Growth and Financial Performance of Listed Companies by Size.5) 1.5 3.4 1.9 0. Others are medium firms.6 6.5 Net Profit Margin Year Large Medium Small 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 Average 2.4 5.0 16.8 0.2 12.3) 0.7 2.0 10.3 3.
445 4.996 1.395 31.313 14.927 16.853 1997 53.743 40.924 2.798 — No.287 10.457 14.873 2. Source: Fair Trade Commission.427 9.376 35.995 2.774 7.180 2.131 3.574 3. .433 3. 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.090 6.Table 2.761 31.177 — 6. 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.766 3.423 5.11 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 43.690 3.455 22.677 3.935 2.640 4.364 5.346 3.309 14.129 2.458 6.597 351.158 1.486 6.967 7.599 — 2.398 — 2.756 5.990 2.929 12.117 4.147 5.651 38.303 3.475 2.158 7.956 3.370 6.951 3.910 3.501 13.246 11.
7 4.3 15.3) 0.0 2.0 2.1 (2.2 (2.2 0.1) 0.1) 0.7) Source: Bank of Korea.5 19.6 18.7 0.9 3.9 18.8 Assets 12.3 9.7 10.5 27.2 (16.0 19.9 20.0 17.7 13.1 10.5 (0.3 3.2 3.0) 12.1 2.1) (1.2 11.1 (1.1 27.3 1.9 24.5) (0.7) ROE 5.1) (0.6 25.12 Growth and Financial Performance of the 30 Largest Chaebols. .8 27.4 (2.6 4.7 15.6 19.4 0.4) 1.4) (0.3 1.0 1.2 (5.5) (0.4 30.3 19.2 0.1) (0.0 2.3 27.3 14.0) ROA 1.0 0.4) (14.5) (0.3 0.2 20.2) (2.0 0.7 1.0) 3.4 12.9 17.5 32.8 0.9 20.6 Financial Performance Net Profit Margin 1.1 (3.Table 2.5 5.9 3.0 6.3 16.5 20.3 0.1 19.4 38.2) (0.9 1.6 1.4 26.8 18.2) 1. 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 12.7 15.0 31.5 2.2 (2.2 0.7 10.6 (0.3 11.2 1.
2. and led to a high concentration of ownership. 5 While “ownership concentration” can be defined and measured differently in different contexts. The absence of a well-developed equity market and the provision of subsidized credit.7 percent growth in total assets. from 190 to 3. and vulnerable balance sheets. II 2 percent in their sales and a very low 4. chaebols had a higher average DER than the corporate sector as a whole. includes the largest shareholder. and access to credit. a pyramidal structure of corporate ownership is prevalent. In general. The better showing of the top five chaebols was a direct result of their dominance in human resources.3 Corporate Ownership and Control This section looks at the key aspects of corporate governance in Korea. By the end of 1997. However. the net profit margin of the aggregate sector exceeded that of the top 30 chaebols.3. the average DER of the 30 largest chaebols reached 519 percent. in this instance. The ROE of the top 30 chaebols was consistently higher than that of the aggregate corporate sector. Only the top five chaebols registered a positive net profit margin in 1997. except for 1995. Vol.1 Patterns of Corporate Ownership The ownership of most Korean listed firms is highly concentrated.74 Corporate Governance and Finance in East Asia.” in Korea’s legal and regulatory framework. coupled with weak corporate governance.” This “identical person.13). technology. internal and external control mechanisms. 2. and the companies that are under the control of the largest shareholder.95 percent.5 Founding families are mostly still the largest shareholders and. his/her relatives. and government intervention interacted through a set of laws and regulations to bring about the existing structure. The financial performance of the top 11-30 chaebols deteriorated during 1993-1997. Ownership patterns. resulted in the chaebols’ excessive leverage. it refers to the degree of concentration and shareholdings in the hands of an “identical person. The Commercial Code stipulates the basic governance framework and applies to all corporations.765 percent (Table 2. loopholes and inconsistent policies spawned strategic behavior and agency problems. There has been a wide range in DER among chaebols. weak corporate control. more important. . However. Their worst year was 1997 when ROE hit -15. 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.
6 2.1 385. LG 4.4 556. Hanwha 10.7 620.6 936.2 471. Haitai 26.8 313.9 321.2 292.0 370.2 423. Dongbu 24.5 383.7 354. Hanbo 15.5 337.1 278.065. Hanwha 10. Hansol 23. Ssangyong 7. Hyundai 2. Dongah 14. Doosan 15. Hanjin 8.7 688. Daelim 14.1 190. Kumho 12.0 486.5 343. Hyundai 2. Hansol 17. Samsung 3. Hanil 28. Dongkuk Steel 19. Byucksan 1996 1.6 . Samsung 3. Tongyang 22.244.7 416. Halla 17.441. Dongah Construction 16.0 436. Sammi 27. Kohap 25. LG 4.9 751.2 924. Kolon 21.5 464.0 218.6 409.0 506.Table 2. Lotte 11. Kumho 12. Daewoo 5.855. Hyosung 18. Lotte 11.4 205.7 267. Newcore 30.5 2. Halla 13.3 328.13 The Top 30 Chaebols’ Debt-to-Equity Ratio.7 621.2 346. Jinro 20. Daelim 16.5 3.3 297.1 674.4 175. Ssangyong 7.2 328.4 192. Dongkuk Steel 19. Hyosung 18. Kukdong Construction 29. 1995-1997 (percent) Chaebols 1995 1.764.4 622.8 336. Hanjin 8. Doosan 13. Jinro Debt-to-Equity Ratio 376. Sunkyung 6.8 312. Kia 9.2 2.6 516. Daewoo 5. Sunkyung 6. Kia 9.3 572.1 3.1 477.3 315.
Daesang 27.7 944. Financial Statement Analysis Yearbook. Daewoo 4. Kamgwon Industrial 30.8 468.7 370. Tongyang 24. Shinho 26.8 399.5 (893. Doosan 15.6 478. Hanwha 9.6 Sources: aFair Trade Commission.3 399.6 424. Hyosung 17. Lotte 12.784.9 1.0 907.7 1.225.5 323.1 359.600. Hyundai 2.5 (1.8 658. LG 5.9 472.1 472. Dongbu 23. Kumho 10.Table 2. Kohab 18.5 576. Kolon 21.214. Keopyong 29. Kohab 22. SK 6. Haitai 25. Tongyang 24. Kolon 19.5 519.8 347.3 1.4 1. Hanjin 7. Dongah 11.9 490.5 1. .1 433.0 505. Newcore 28. Hanil 28.0 419. Anam 22. Saehan Average of All Chaebolsa 1995 1996 1997 Average of All Industries Excluding Financial Sectorb 1995 1996 1997 Debt-to-Equity Ratio 317.3 347.9 578.501.5) 404. Dongkuk Steel 20. bBank of Korea.1 375.8 338. Daelim 14.4) 513.5 386.13 (Cont’d) Chaebols 20. Newcore 26.8 590. Haitai 25.6 335.8 647.9 216. Halla 13.8 307.6 416.3 676.6 590.5 261. Shinho 1997 1. Keopyong 29. Dongbu 21. Anam 27. Jinro 23.9 465.0 305.1 438. Samsung 3.498. Hansol 16. Miwon 30. Ssangyong 8.
1 percent. Financial institutions owned as much as 28 percent of the total corporate shareholdings in 1992. including investment trust companies. but their shares declined to 21. The reduction can be . 10 to 30 percent). the individual owners—the portfolio investors as well as the controlling shareholders and their family members—formed the largest shareholder group (Table 2. an increase in their ownership may bring their ownership incentives to converge with those of the minority shareholders. fluctuated widely during the period. From 69. the entrenchment effect outweighs the incentive effect. large ownership can also bring about the entrenchment effect. i. When managerial holdings are reinforced by artificial control mechanisms such as pyramiding. Beyond that range. Theoretically. However. that is.e. The controlling shareholders of chaebols hold comparatively smaller percentages of shares. while those owned by banks. the entrenchment effect and problems of agency may be more pronounced in chaebols than in independent firms. including banks and other financial firms.. and then steadily declined after 1993. with a given range of managerial shareholdings (for instance.” foreigners. and state-owned companies and securities companies declined. The holdings of financial institutions. Securities companies reduced their holdings over this period of falling stock prices as the size of investment trust companies’ stock portfolios declined. the ownership structure can bring about an incentive effect.” followed by banks. the Government.6 percent by 1997. resorting to extensive use of pyramiding to maintain control. and insurance companies increased during the period. Most non-chaebol listed firms in Korea are believed to have ownership concentrations within the 10-30 percent range. However.14). an entrenched manager is insulated from market pressure and can pursue personal goals without the fear of being replaced. The next important group was “other corporations. The pattern of distribution changed little through 1992-1997.7 percent by 1997. the incentive effect once again dominates. the percentage of holdings by individuals slipped to 60. the extent of ownership by these individuals declined gradually after 1988. managerial entrenchment becomes more likely. Thus. the year the stock market was in a frenzy due to buying sprees.Chapter 2: Korea 77 When controlling shareholders hold a very small percentage of the shares. Among listed nonfinancial companies. Composition of Ownership Among listed companies. individuals were also the largest shareholder group. The percentage of shares owned by “other corporations.
8 4.5 1.2 8. merchant banks.2 1.6 22.3 5.3 17.4 5.0 60.2 9.1 17. investment trust companies.9 19.1 68.1 21.9 2.3 18. of Firms The Statea Banks.6 9.7 9.0 7. b “Banks.4 1997 551 1.7 18.7 14.6 19.5 62.14 Ownership Composition of Listed Companies. etc.3 8.7 6.8 59.9 1. .2 5.7 59.6 12.7 4.9 1.1 2.5 7.6 20. 1988-1997 (percent) Financial Institutions Securities Firms Total 28.0 5.1 8.1 8.3 1996 570 2.0 9.2 2.5 6. All Listed Companiesc 1992 681 1993 687 1994 698 1995 715 1996 754 1997 775 9.3 39.6 16.4 18.1 18.6 9.9 37.4 34. c Data from Korea Stock Exchange.0 59.8 2.2 9.8 17. and finance companies.8 1995 548 2.5 12.4 14.2 18.0 4.5 4.” includes commercial banks. d Constructed from data files of the Korea Listed Companies Association.2 8.9 26.2 3.1 21.Table 2.6 Year No. mutual savings.9 5.4 6.1 3.3 5.8 17.2 4.0 8.3 18.1 4.9 15.5 6.8 2.5 1.8 5.6 16.9 36.8 59.3 1.5 Note: Ownership is based on number of shares.3 1994 521 1.8 5.4 13.b A.4 Insurance Firms Other Corporations Foreigners Individuals 39.0 28.4 5.1 11.1 60.6 8.1 1.7 8.3 26.5 1992 508 2.6 2. a The State covers the Government and state-owned companies.2 B.1 10.5 16.9 17.6 13.9 4.6 36. Listed Nonfinancial Companiesd 1988 406 0.0 5.2 17. etc.5 18.3 17.5 1989 498 0.7 9.2 5.6 1991 505 0.3 2.0 27.3 1.7 7.2 1993 511 2.6 16.9 2.2 7.5 7.1 18.7 3.4 13.5 60.8 69.7 1990 531 0.
UK. When independent companies are distinguished from firms affiliated with the 30 largest chaebols. the Government acquired an even bigger share in several banks as part of its program to bail out these distressed institutions. However. The holdings of other corporations are mainly equity investments in affiliate companies.8 percent of listed shares in 1997. whether partial or absolute. and US (Table 2. This is low compared with those in Japan. 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. medium. Individuals held the majority of the shares in all industries except in telecommunications. Before such liberalization. This trend can be explained by government ownership. indicating their increased investments particularly in the service industries with high growth rates. One minor difference is that the percentage of shareholdings by corporations is slightly higher in large-sized firms. The ownership distribution in listed nonfinancial firms. Over the years. Compared with its holdings in all listed companies. the holdings of institutional investors were expected to increase significantly with the Government’s introduction of US-type investment companies in 1998 and .18). there appears to be no significant difference in the overall shareholding patterns between the two groups (Table 2. financial institutions had more shares in the manufacturing sector than in primary industries. with the Government continuing to hold a sizable share in the Korea Electric Power Corporation. Foreigners gradually increased their equity shares in 1992 when direct purchases by them were first permitted. In 1998. In general.17). and service of motor vehicles (Table 2. The Government’s and state-owned institutions’ (including some banks) ownership was generally small except in the power sector.15). Corporate holdings averaged 16 percent throughout 1988-1997. the Government was the sole owner. did not vary significantly (Table 2. held 26. and small companies. Institutional investors. as distinguished from individual and foreign investors. electricity. government ownership in nonfinancial companies was remarkably smaller and more concentrated. However. indicating their heavier reliance on inter-firm financing investments. other corporations’ holdings shifted toward service industries.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.16). In most instances. foreign holdings were derived from purchases through country funds and direct capital investments. of some banks. categorized into large.
7 14.2 0.9 23. 1990 and 1997 (percent) Financial Institutions The Statea — — 0.0 9.4 56.7 22.3 9.1 88.5 12.6 — — 2. Etc. and App.0 8.5 0. Paper.2 0.4 2. 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 .9 1.1 65.6 18.2 54.5 7.0 Industry 1990 Fishing and Fish Farms Mining Food Products and Beverages Wearing Apparel and Fur Articles Wood.8 5.0 1.3 4.15 Ownership Composition of Listed Nonfinancial Firms by Industry.4 1.3 6.9 10. Gas. Motor Vehicles Electricity.8 7.2 — 0.0 0.2 — — 0.3 1.9 0.b Securities Firms Insurance Firms Other Corporations Foreigners — — 0.5 85.1 1.5 — 1.8 3.8 Individuals 83.3 1.4 Banks.4 7.7 1.0 7.7 20.1 27.9 16.7 2.9 42.6 1. and Printing Pulp.5 3.1 10.4 1.2 2.7 2.3 13.8 73.4 8.1 0.0 10.3 10.8 8.2 0. Rubber. Elecl Mach.7 14.1 7.3 38.8 6.2 64.2 0.2 9.7 59.9 60. and Printing Chemicals.7 2.1 0.6 24.4 56.1 0.5 17.5 0.1 19.7 29.9 8.9 15..8 7.3 2.9 66.9 59.7 64.1 8.3 62. Paper.5 0.0 — 0.3 11.0 9.3 2. and Plastics Basic Metal Fabricated Metal and Machinery Office and Computing Machinery Electronics.0 9.4 0.3 0.2 7.4 62.9 19.1 0.7 22.0 20.3 0.0 2.8 7.6 8.4 5.2 9.Table 2.7 20.4 8.4 14.7 63.2 1.8 1.7 6.9 55.5 19.5 — 0.9 1.9 4.1 4.5 4.4 8.7 17.5 — — 0.4 — 0.8 3.0 9.1 8.2 1.6 5.3 7.8 7.0 — 39.5 0.3 57.2 17.2 9.9 52.5 6.3 0.6 11.8 7.2 22.6 3.
3 15.7 5.8 5.8 4.4 1.0 43.3 6.5 0.1 6.2 7.7 2.0 8.9 78.0 60.6 0.2 23.2 4.5 3.1 1.5 4.1997 Fishing and Fish Farms Mining Food Products and Beverages Wearing Apparel and Fur Articles Wood.3 1.3 57.0 6.4 9. merchant banks.4 16.7 23.9 7.3 6.7 17.2 8.0 1.9 57.8 5.6 6.8 3.6 2.5 6.1 9.2 1.6 18.4 76.9 0.4 1.6 60. etc.4 2.3 60.5 63.5 3.1 — 1.1 1. Gas.6 7.2 4.2 6.2 0.6 — = not available.7 4.6 59.1 54.9 5.2 5.8 11.9 6.9 69.1 4.7 2.4 6.9 7.1 3.6 2.6 1.2 49.4 68. Motor Vehicles Electricity.6 6.0 3.4 58.1 25. and App.6 2. b “Banks.3 31.9 2.0 11.2 13.0 7.0 6.1 18.7 2. a The State covers the government and state-owned companies.4 2. and finance companies.9 1. and Printing Pulp. .8 0.4 0. Paper.6 5.78 81.7 19.7 2.9 18.8 12.4 1.4 — 1.9 5.2 0. mutual savings. and Printing Chemicals.2 4.5 59.6 20.8 2. 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. Note: Ownership is based on number of shares.3 1.4 2.5 — 2. Source: Constructed from data files of the Korea Listed Companies Association.8 57.6 14.7 1.6 3.8 27.3 7.5 5.9 1.1 2.8 2.3 0.1 2. investment trust companies.3 65.5 12. Paper.9 1.0 5.2 3.9 2.1 3.4 4.5 3.2 4.4 58.7 6.6 75.6 0.2 5.9 20.3 8.4 20.5 3.1 9.5 1.1 — 0.2 1.4 4.9 2.” includes commercial banks.8 6.8 2.4 45.0 4.5 4.3 2.9 6.4 3.9 20.9 2. Elecl Mach.8 0.8 54. Rubber. and Plastics Basic Metal Fabricated Metal and Machinery Office and Computing Machinery Electronics.5 7.4 43.
4 2.9 5. 1997 (percent) The State 1.4 61.0 Other Corporations 16.7 Foreigners 4. b Table 2.6 16.c Securities Firms Insurance Firms Other Corporations Individuals 58.16 Ownership Composition of Listed Nonfinancial Firms by Size. Source: Constructed from data files of the Korea Listed Companies Association.2 1.4 4. The State covers the government and state-owned companies. merchant banks.5 8.9 4.Table 2.8 1.5 16.4 5.5 Individuals 60.7 Control Type No. 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.” includes commercial banks. Others are medium firms. etc.6 60.1 6.8 6.8 4.7 1.8 4.5 4.7 4.4 17.4 21.5 19.17 Ownership Composition of Listed Nonfinancial Firms by Control Type.0 1.5 62.1 8.4 Firm Sizea No. c “Banks.7 8. 1997 (percent) The Stateb Foreigners 4. of Firms Independent Firms Affiliates of 30 Largest Chaebols Total 316 117 433 Source: Constructed from data files of the Korea Listed Companies Association. etc. investment trust companies.4 61. mutual savings.3 6.8 3.1 2.7 0.0 6.5 6.5 2.4 1.1 Banks. Securities Firms Insurance Firms 2.8 2. etc.3 Banks.4 5.5 18.8 60.4 2.7 6. and finance companies. .9 2.
and the companies under the control of the largest shareholder.8 56.4 26.3 6. In 1997. At the moment.1 percent and appear to be similar to the proportion of foreign holdings in the four other countries. Concentration of Ownership The analysis of ownership concentration in this section focuses on shareholdings of the majority shareholder. only closed-end investment companies and traditional investment trust companies are allowed. minority shareholders. for example.19). the majority shareholder group in all listed companies consists of the corporate. 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. rather than the individual.8 10. 1997 (percent) Country Japan Korea Taipei.5 45. the majority shareholder group on average held 23-30 percent of outstanding shares in the period 19881997 (Table 2. The majority shareholder group’s shareholdings in listed nonfinancial firms steadily declined from 1990 to 1996. Institutional Investors 42.6 Individuals 23. But these may . Foreign holdings of Korean shares were 9. including those of the largest shareholder. while family members accounted for only 30 percent.5 20. and other shareholders who do not belong to either the minority shareholders or the majority shareholder group.Chapter 2: Korea 83 Table 2.7 16. Generally.China United Kingdom United States Source: Stock Exchange of Korea. his/her family members.1 8. defined as those holding less than 1 percent of shares.1 financial institutions’ establishment of corporate pension fund accounts. corporations held 70 percent of the controlling blocks of shares. This has had profound implications for corporate governance and the market for corporate control in Korea.8 9.6 39.18 Ownership Composition of Listed Firms in Selected Countries.3 54.3 47.20).6 Foreigners 9. investors (Table 2. Among nonfinancial listed firms.
6 73.2 Minority Shareholders Subtotal 71.6 2.7 6.9 3.6 22.8 8.7 44.0 25.19 Ownership Concentration of All Listed Firms.8 Individual Subtotal Other Shareholders Corporation 3.1 28.1 5.1 4.3 2. Source: Stock Exchange of Korea.7 16.7 18.7 Note: The majority shareholder includes the largest shareholder.8 73.4 7.1 15.2 2.0 1.3 18.0 4.0 2.8 72.2 26. and the companies under the control of the largest shareholder.1 37. Minority shareholders are those holding less than 1 percent of shares. 1992-1997 (percent) Majority Shareholders Corporation 15.0 29.9 33.7 7.2 2.6 46.1 21.0 66.1 23.9 Individual 2. .5 43.3 30.9 32.0 22.1 14. his/her family members.9 6.1 32.0 69.0 Year Corporation Individual 1992 1993 1994 1995 1996 1997 41.4 5.1 5. Other shareholders are those who do not belong to either the minority shareholders or the majority shareholder group.6 5.3 Subtotal 5.9 7.Table 2.6 26.9 2.4 3.
8 Majority Shareholders 27. collectively owned less than 50 percent of an average firm. and mining categories.4 Source: Constructed from data files of the Korea Listed Companies Association. The practice of hidden shares seems to have been less prevalent in recent years.6 57.5 13.Chapter 2: Korea 85 Table 2.3 62.9 25. thereafter. In most industries. .20 Ownership Concentration of Listed Nonfinancial Firms. have been underestimated because it was widely believed that the largest shareholder often had hidden shares registered in the names of relatives and subordinates of the company.6 58. In such cases.9 48.9 29. in the small firms. The shareholders that held more than 1 percent but did not belong to the majority group held about 20 percent on average. hiding shares offers no additional tax or other benefits.9 12.5 12.9 Other Shareholders 18.0 22.5 60. the majority owner held more than 20 percent of an average firm.8 57. ownership was relatively diffused due to government regulation. Across industry.8 25. In telecommunications.8 28.21]).7 18.4 28. Meanwhile. Besides.4 23. 1988-1997 (percent) Year 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 Minority Shareholders 53. Ownership concentration tended to be lower in large compared to medium and small listed firms.8 12.5 23.3 25. minority shareholders. 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 2.8 54.2 15. the Government has retained a large number of shares. 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 2.6 11.9 27. Majority ownership is also high in the chemicals.22). rubber and plastics.0 58. which held less than 1 percent of a company’s outstanding shares as of 1997. It was highest in medium-sized firms before 1993 and.0 20.1 50.
2 23.6 25.6 38.5 47.5 23.2 26.5 21.5 19. and Plastics Basic Metal Fabricated Metal and Machinery Electronics.3 19. Paper.8 31.5 41. Elecl Mach. Gas.9 Minority Shareholders Majority Shareholders Other Shareholders 12. and App.1 49.7 27.4 Industry Fishing and Fish Farms Mining Food Products and Beverages Wearing Apparel and Fur Articles Wood.9 10.2 37.7 17.2 34.0 30.4 16.9 26.2 46.8 29.0 54. and Printing Pulp. Rubber. 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.3 39.3 26.7 21.7 26.2 20.8 21. Paper.8 25.5 16.8 24. 1997 (percent) Number of Firms 3 2 43 49 12 16 90 39 31 71 34 8 9 49 40 15 1 10 29 551 36.8 44.0 21.8 55.1 19.2 48.Table 2.2 19.9 44.6 50.4 11.7 29.0 39. .5 20.0 51.21 Ownership Concentration of Listed Nonfinancial Firms by Industry.5 52.7 24.8 41.5 44.6 34.8 51. and Printing Chemicals.1 17.2 22.6 53. Motor Vehicles Electricity.4 53.7 36.1 43..6 19.
3 25.9 56.9 53.7 14.3 55.2 32.3 27.4 30.5 10.0 66.9 26.6 27.6 59.Table 2.9 21.7 28.0 55.7 57.3 26.0 26.5 51.4 51.5 Other Shareholders 19.6 24.9 12.2 56.8 28.6 55.5 49.6 62.2 11.3 21.5 33.1 15.2 21.2 26.1 58.5 19.2 52.8 62.2 12.2 21.4 29.5 26.7 17.7 57.9 60.6 11. .5 12.6 15.2 21.9 17.6 65. 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.8 52.9 23.2 18.5 19.2 Source: Korea Listed Companies Association.5 28.5 27.1 20. 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 53.4 30.4 30.9 16.5 12.8 56.7 15.1 16.22 Ownership Concentration of Listed Nonfinancial Firms by Firm Size.7 31.6 31.8 17.7 22.2 50.4 47.8 52.9 55.8 50.3 19.4 21.2 55.1 48.7 16.9 22.0 24.5 21.0 59.8 11.8 27.9 28.2 Majority Shareholders 26.1 27.
the firm destroys value. Kim (1992) found the relation between TQ and SCS to be nonlinear. often at terms unfair to one of the transacting parties. Shleifer. if TQ is lower than 1. Hong. 1988). and Kim (1995) studied the empirical relationship between the degree of ownership concentration and financial performance in Korea. For example. TQ is above 1. TQ was calculated by dividing the market value of a firm by the substitution price of its assets. it means the firm creates value. one company can still place equity investments in another. and Vishny. TQ is below 1. Inter-Firm Investments and Pyramiding in Chaebols The Commercial Code imposes limits on direct cross-shareholding. If SCS is above 20-25 percent. The relationship between TQ and SCS shows a similar pattern. one company from a chaebol group could obtain debt payment . If SCS is below the range of 20-25 percent. H. TQ has a maximum value. II Ownership Concentration and Financial Performance J. which is the company holding more than 40 percent of outstanding shares of its subsidiary. TQ increases as the SCS increases. Kim (1992) and Kim. which can then pass the equity capital to a third. The study by Kim. affiliated companies have been able to conduct inter-firm transactions. In Korea. This type of inter-firm investment. The Code prohibits a subsidiary company from owning shares of its parent company. Then TQ declines until SCS reaches 45 percent and increases until it reaches 50 percent. Both studies used Tobin’s Q (TQ) for the value of a firm as an index of financial performance. called “pyramiding”— commonly (though incorrectly) known as “indirect cross-shareholding”— is prevalent in Korea. although turning points in the value of firms are different. If TQ is higher than 1. Hong.88 Corporate Governance and Finance in East Asia. thus a firm creates value. If SCS is below 10 percent. and the shareholding of a controlling shareholder (SCS) as the degree of ownership concentration. H. J. 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. and Kim (1995) reached a similar conclusion. is effective control of a certain group of companies even with a smaller investment. They analyzed firms in which controlling shareholders participate as managers. Vol. from the standpoint of the controlling shareholder. One of the merits of pyramiding. The pattern of the relationship between SCS and TQ is similar between Korean and US firms (Mork. If SCS reaches 10 percent. thus a firm destroys value.
Thus.4 corporations. Of the 81 respondents. Only six firms (or 13 percent) indicated that their subsidiaries also owned shares in themselves. firms linked through partial equity investments could enjoy the advantage of consolidation without an actual formal consolidation or merger of operations taking place. In Table 2. or about five subsidiaries each. In many instances. If we define the internal shareholdings of a . But the controlling power of the owners also stems from inter-company shareholdings of the subsidiaries. together owning an average of 37. 62 percent (16 out of 26) had a corporation as the largest shareholder. Among the 81 listed firms in the ADB survey. The fact that corporations. standalone setups. Partial results are shown in Table 2. there are instances of direct cross-shareholding in Korean firms. Until recently. financial institutions that are subsidiaries of a chaebol also hold shares in its member firms.9 percent of shares. and about 11 percent were domestic financial institutions. dominated the majority shareholder group in chaebol-affiliated companies is consistent with the results of the ADB survey conducted for this study. For the same year. Twenty-two of the 81 respondents were independent. the top 30 chaebols’ shareholding by subsidiaries was 34. the average shareholding of the controlling owners and their families was 8. or an average of 13 firms per company. not individuals. neither the investors nor the relevant government authorities were active in monitoring such unfair dealings between firms. The extent of pyramiding can be seen in some of the previous tables.14. corporations hold about 20 percent of the outstanding shares of all listed nonfinancial firms. 53 percent were domestic nonfinancial firms.5 percent of shares. for example. Among the subsidiaries or firms receiving investments. 59 were parent firms with one or more subsidiaries. Among chaebol affiliated firms. This also partly explains why chaebols frequently opted to expand by establishing new firms rather than placing investments internally.Chapter 2: Korea 89 guarantees from other members of the group at no cost. and 319 foreign subsidiaries. Thus. 59 parent companies collectively had investments in 759 firms. the top five shareholders consisted of 2.23. 34 percent were foreign companies. together owning an average of 38. or about four firms each.5 corporations and two individuals.5 percent. 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. together having a total of 292 domestic subsidiaries. The top five shareholders of the chaebol-affiliated firms consisted of one individual and 3. For the whole sample. In the case of the 30 largest chaebols.5 percent as of 1997. although they are likely to be insignificant.
5 2. .2 37.6 34.5 24.8 37.2 25.0 1.5 1.5 31.9 29.4 42.7 5.8 18.4 25.4 1. A few companies reported less than five largest shareholders.5 4.23 Ownership Concentration in the Survey Sample of 81 Listed Firms.5 2.1 3.4 2.3 12.9 5.8 38.8 31. b The chaebol affiliated firms are those belonging to one of the 30 largest groups.7 0.1 1.0 3.4 21.6 3.6 16.5 4. a Number of shareholders. of Firms Largest Shareholder’s Holdings (%) Compositiona Individuals Firms Shareholdings (%) Individuals Firms Total Classification Total Sample Non-Chaebol Affiliated Largest Shareholder is Largest Shareholder is Largest Shareholder is Chaebol Affiliatedb Largest Shareholder is Largest Shareholder is Largest Shareholder is CEO an Individual a Firm CEO an Individual a Firm 81 55 31 10 14 26 3 7 16 20.0 13.9 34.8 8.3 26.0 3.5 38.0 2.6 3.0 17.6 3.4 38.0 21. 1999 Five Largest Shareholders No.5 18.0 1.7 39.4 11.5 2.1 22.Table 2.4 18.5 2.8 Note: The survey was conducted during the period January through May 1999 and included nonfinancial listed firms only.9 21.7 37.7 19.
Chicago. Family holdings include shares owned by the family members and by parties considered to be under the influence of the family. As of 1997. Lee. “The Ownership Structure and Family Control in Korean Conglomerates: With Cases of the 30 Largest Chaebols.7 9. 1987-1997 Type of Shareholding Internal Shareholdings Family Member Companies Source: Korea Fair Trade Commission. Many attempts have been made by researchers to identify the typical patterns of ownership structures in chaebols.6 Later studies by Lee (1997) and Lim (1998)7 find similar patterns. 34.7 1992 46. edited by K.24 shows the average internal shareholdings in the 30 largest chaebols.5 34.4 13.7 31.8 33. New York: Praeger. Ungki Lim. Jae Woo.Chapter 2: Korea 91 chaebol as the shareholdings of the controlling family and the member companies of the group. Chung and H. 1989.24 Internal Shareholdings of the 30 Largest Chaebols. Table 2.2 33.4 1990 45. 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. 1998. it appears that the chaebol families have had a strong desire to expand their business bases. “Is the Fair Trade Policy Fair?” Korea Economic Research Institute.2 12. Hattori (1989) identified three patterns based on data in the early 1980s. . pp. Tamio.0 8. 6 7 Hattori. Table 2.8 40.4 1993 43.2 1994 42.” In Korean Managerial Dynamics.” Paper presented at the Annual Conference of Financial Management Association. 1987 56. “Japanese Zaibatsu and Korean Chaebols. C. H.5 percent and member companies. 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.6 33.2 15.1 1997 43. the ownership patterns can be described as follows. 15 October 1998. Lee. The family and member companies’ shareholdings have been declining over time.5 Judging from the historical record. Based on these studies. Internal shareholdings in some chaebols also include shares owned by nonprofit organizations operated by the controlling family.5 percent. 79-95. the average internal shareholding ratio of the top 30 chaebols was at least 43 percent. the controlling families owned 8.4 10. 1997.
” Under this type of ownership pattern.” A family owns a substantial portion of shares of member firms and becomes the controlling shareholder of each. As of 1997. completely dissolved under financial distress. or merged into. is an example of this type. and his management team exercised full control over the group without much interference from major investors. other firms. The family itself holds shares in some subsidiaries. which then make investments in the subsidiaries. II The first (Type A) is called “direct family ownership. holdings of the nonprofit foundation. financial. it had 18 listed and 39 private companies. Vol. The third (Type C) is “indirect control via complex shareholding. called the “indirect control via base company. the family controls the group’s member companies by its own shareholdings. It consists of seven listed and 24 privately held firms. and subsidiaries’ equity participation. Sun Hong Kim. Chaebol Reforms Various measures have been taken to improve the transparency of chaebols with regard to accounting. Also. The Hanjin Group. The Hyundai Group exemplifies this. Its controlling family holds shares in three base companies through which they exercise control over the other member firms. The two base companies have investments in three other base companies. Hyundai Motors acquired Kia Motors via an international auction. Most of its member firms were acquired by. One of the . subsidiaries have extensive investments in other subsidiaries. The Kia Group was about the only management-controlled group but was out of existence by 1999. The controlling family has sizable investments in two base companies and smaller investments in many others. investments made by the base companies. and business activities.” shows a simple pyramidal structure. The fourth type (Type D) is “management control. Thus. Here the family is the controlling shareholder of one or more strategic base companies that have enough equity participation in the subsidiaries. consisting of eight listed and 16 privately held firms as of 1997. For example. A nonprofit foundation under the family’s control is the largest shareholder of one of the base companies.” Here the family directly controls a base company and a nonprofit foundation.92 Corporate Governance and Finance in East Asia. The second (Type B). which in turn hold shares in some of the other subsidiaries. Kia Motors was the base company and had such strategic shareholders as Ford Motors of the US and Mazda of Japan. there is no controlling shareholder. Investments between the lower level subsidiaries are rare. The Hanwha Group can be classified as such a company. But the former chief executive officer (CEO).
It remains to be seen whether they will adopt the holding company structure in the future. Initially. This limit was also applicable to banks and insurance companies. following the amendment of the law. Until the end of 1998. They hindered early exits (liquidation. These conditions are aimed at restricting excessive pyramiding and expansion of chaebols. direct control of the management of chaebols was attempted through amendments of the act in 1986 and 1990. the act did not have any important provisions except the standard clauses prohibiting monopolization of an industry through business combinations. Existing guarantees had to be resolved by March 2000.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. there are reports that some top chaebols are studying the feasibility of transforming their organizational structure. The Fair Trade Act was also revised in February 1998 to prohibit cross-guarantees of debt among members of a chaebol. . A third disallows multiple layering of holding companies. The limit on investments was reduced to 25 percent in 1994 and completely eliminated by 1997. the Credit Management Regulation rules were amended to prohibit financial institutions from requiring guarantees from affiliated firms when extending new loans. thus hurting the shareholders of stronger firms. bankruptcy reorganization. One condition requires that the DER of the holding company should not exceed 100 percent. the Fair Trade Act). Another is that the holding company should own more than 50 percent of the shares of a nonlisted subsidiary company and more than 30 percent of a listed company. The prohibition of holding companies was also abolished in 1999. At this early stage. An operating holding company is defined by the Fair Trade Act as one whose investment in others does not exceed 50 percent of its total assets. The first serious attempt to deal with this issue was the introduction of the Monopoly Regulation and Fair Trade Act of 1980 (hereinafter. This was the reason why chaebols chose to employ pyramidal structures. The Government is also considering whether to allow consolidated taxation for pure holding companies. 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. These amendments prohibited holding companies and direct cross-shareholding. However. The Fair Trade Act was amended in 1998 to allow pure holding companies to be established under restrictive conditions. Cross-guarantees are believed to constitute a form of wealth transfer from financially strong members to weak ones. only operating holding companies were allowed to be established.
In 1998.3. even though they were legally independent with their own board of directors and the outside shareholder groups were not identical.) 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. Some chaebols have disintegrated or shrunk in size. which put together the accounts of all members of a chaebol. Chaebols maintain that the restructuring headquarters will exist only for a limited period. boards of directors. Since the economic crisis. the Commission has strengthened its investigative activities to eradicate cross-subsidization and wealth transfer activities among group members. and transferred funds generated by one firm to another. chaebols dismantled their “planning and coordination offices” or “chairman’s offices” under pressure from the Government.94 Corporate Governance and Finance in East Asia. The chairman’s office had its own chief executive officer. Some chaebols operated “group management boards” attended by top executives (presidents or chairpersons) of larger member firms. It also acted as the secretariat for the unofficial “presidential meeting” of the member firm presidents. unlike the regular consolidated statements that only cover those firms that are related through direct equity participation. until urgent restructuring is complete. The staff of these organizations were employees of member firms. and the capital market was almost nonexistent until the recent reform . Vol.2 Internal Management and Control Monitoring of corporate management by shareholders. 2.” The group chairman operated through these offices and treated the individual member firms as if they were the divisions of a single legal entity. The 30 largest chaebols are now required to publish “combined” financial statements. usually in the rank of a company president. there have been no significant changes. The office established strategies for the group as a whole. Despite chaebols’ decision to dismantle the chairman’s offices. planned for capital raising and allocation on a groupwide basis. Their operating costs were borne by the member companies rather than by the controlling shareholder. but the larger and stronger ones still operate their newly named “restructuring headquarters” under the control of the group chairperson. II etc. who is universally called the “group chairman. These offices were legally informal and functioned as the headquarters of chaebols. 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.
The Government’s policy and securities law provisions to protect control rights of the incumbent management had been in place until the early 1990s. only the Government could play an effective role in monitoring corporations. 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. With few exceptions. As of 1997. This implies that the typical agency problems in Korean corporations stem from conflicts of interest between inside (the largest) and outside (minority) shareholders. The board elects one or more representative directors from among the board members. but some large ones have two or more. in most Korean firms. corporations should have a board of directors consisting of at least three members. Even where the largest shareholder is not the representative director. as the major creditors. Thus. This policy managed to hamper any monitoring initiatives from the capital market. especially chaebols. Banks. Most companies have one representative director. creditors were not active in monitoring debtor firms and relied mainly on guarantees and collateral. Under such circumstances. Professionalism in management was not well developed and managers were content with receiving orders from controlling shareholders. this was complicated by the prevailing attitude that large companies. had their own governance problems. were too big to fail. except for banks. and takeover codes were not accommodative to active monitoring. the concept of fiduciary duty of managers was not well established. Board of Directors General Characteristics of the Boards Under the Commercial Code. or at least acts as the de facto CEO. There are many reasons for this. However.Chapter 2: Korea 95 efforts. Loan agreements and debt indentures did not include strict covenants. the representative director was also the chairperson of the board. the controlling shareholder is officially the representative director and the CEO. control is not separate from ownership. In most listed companies. the creditors did not declare defaults. Meanwhile. Directors are elected at the general shareholders meeting for a term not exceeding three years. he or she generally approves major decisions made by the management. . Even when the covenants were violated.
the listing rules restrict the eligibility of independent outside directors to those who have no family ties with the managers and no significant business transactions with the company. . the attendance rate of outside directors. Further. 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. cumulative voting is not mandatory and a company can exclude itself from its application by amending its charter. almost all companies succeeded in adopting cumulative voting. Despite the qualification requirements. other than the representative director(s). it has been common practice that candidates for directorship are handpicked by the controlling shareholder/CEO from among the senior managers and are automatically approved at the general shareholders meeting. However. Recent Reform Efforts on the Board System In 1997. In order to address this concern. 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. A few large companies had more than 50 directors. all of whom were managers. members of the board. Most of the outside directors in those days were the controlling shareholders of chaebols or executives of affiliated companies. 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. there is concern that newly elected outside directors still lack independence from the management or the controlling shareholder.96 Corporate Governance and Finance in East Asia. With the boards consisting only of insiders. In the 1999 annual shareholders meetings. 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. Moreover. Vol. companies have to disclose in their annual reports the frequency of board meetings. The rules further require that the number of outside directors be not less than a quarter of the size of the board by the annual shareholders meeting in 1999. The Commercial Code was also revised in 1998 to introduce cumulative voting for the election of directors. and their positions (accept or reject) on matters voted on in board meetings. were supposed to be outside directors. However.
the chairperson of the board was also the CEO and on average held 10.2 percent and the CEO 14. they had a parent/child relationship in 20 percent of the cases.Chapter 2: Korea 97 The committee structure of the board as found in the US has not yet been adopted by listed companies.1 percent and outside directors 1. The Securities and Exchange Act will require large listed firms with W2 trillion or more in total assets to adopt the audit committee system. 88 percent had plans to hold elections in the near future. ADB Survey Results on Boards The ADB survey results confirm the above assessments and provide early indications on the effects of the reforms. Among others. The Commercial Code is being amended to allow a choice between the audit committee system and the current internal auditor system. In March 1999.5 percent of the shares. Where the chairperson was not the CEO.4 directors. This is because most banks. the Corporate Governance Reform Committee. who would comprise at least 50 percent of the boards. this committee adopted the Code of Best Practice in Corporate Governance.9 percent on average. which had extended financial support in their recent recapitalization efforts. Almost all (92 percent) of the respondents had one or more outside directors and 70 percent were elected after the Asian financial crisis. the Korean Code recommends that large listed firms should have at least three independent directors. although some banks recently have established board committees. Where the two were separate. Directors were also chosen on the basis of their relationship with the controlling . was established under the auspices of the Ministry of Finance and Economy and the Korea Stock Exchange. and a nominating committee. The controlling shareholder of some banks is the Government. In September of the same year. inside directors owned 16. In 78 percent of the responding firms. The average board had 8.1 percent of outstanding shares of a listed company. Among the firms with no outside directors. an audit committee. On average. having no controlling shareholders. These results are in accordance with the new listing rules introduced in 1998. are required to have a majority of outside directors. Directors were most frequently elected because of their professional expertise (74 percent of the respondents marked this answer). he or she held 6. the OECD principles of corporate governance were the minimum standard for the Korean Code of Best Practice. a blue-ribbon committee. Meanwhile.
the package for the chairperson is directly proposed at the annual shareholders meeting either by the board (31 percent of the firms) or by the management (9 percent). the board had a nomination and an audit committee. As discussed earlier. Most frequently. The current chairperson has been in office for 6. a total of 562 directors were sitting on two or more corporate boards. In one case. relationship with controlling shareholders (21 percent). The board or the management then determines compensation packages for individual directors. election of directors was based on shareholdings (7 percent) and status as founder (7 percent). the board had no committees. These were established only recently. the management nominated director candidates (64 percent of the directors). Chairpersons of the board were elected on the basis of professional expertise (33 percent of the firms). The survey results indicate that boards determine remuneration packages for chairpersons in 42 percent of the firms. in some firms. and shareholding (10 percent). the management determines the remuneration. In 91 percent of the sample firms. and fixed fees plus performance-related pay. The reason for this high frequency of interlocking directorship is that many listed firms belong to chaebols. In 13 percent. Less frequently. According to the Commercial Code. the term of appointment of directors and board chairpersons is three years. Some directors were nominated by significant shareholders (18 percent) or introduced (and elected) at the shareholders meeting.2 years on average. The general practice is that shareholders approve the upper limit on the total amount to be paid to all directors. II shareholder (30 percent). one person was sitting on nine boards and this person was the CEO of a chaebol firm. About five directors per firm have been in office for more than one term. . This rather long tenure must be due to their status as controlling shareholders in most firms. In 1997.98 Corporate Governance and Finance in East Asia. Vol. Remuneration for chairpersons include only fixed fees in 76 percent of the sample firms. In a very small number of firms. In some instances. compensation for directors must be approved by the annual shareholders meeting for each fiscal year. Members of controlling shareholder families or their trusted company personnel often act as directors for multiple chaebol firm boards. among the 81 sample firms. However. In most firms. including stock options. 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. in 23 percent. founders of the company acted as the chairperson (22 percent).
and fixed salary plus performance-related pay including stock options in 13 percent. In 20 percent. and in another 21 percent CEO bought shares in the market. In the survey. According to the survey. In 4 percent of the cases. CEO simply follows the orders of the chairperson. In cases where CEO is not the largest shareholder and chairperson. . who is not the chairperson. However. CEO is entitled to a large sum in cases his/ her contract is terminated before its expiration. These results show that the incentive compensation scheme for professional CEOs is not well developed in Korean firms. fixed salary plus net profit-related bonus in 9 percent. compensation is by fixed salary in 74 percent of the firms. In a handful of sample firms. In 21 percent of cases. CEOs have been in their positions for an average of 9. CEO was given shares by the family. In such cases. shareholding in three firms. he or she was selected on the basis of professional expertise in 15 firms.Chapter 2: Korea 99 Management CEO In the survey sample. in which there is no controlling shareholder. and was appointed by the Government in five firms. When CEO is not the chairperson. the survey tells a slightly different story than is generally believed in Korea. It indicates that CEO. it was proposed by CEO and approved by the board. the payment is about five times the CEO’s annual salary. decides on important matters on his/her own in 13 out of the 44 firms. Ensuring that a company serves the public interest is considered a less important responsibility of CEO. CEO is also the founder in 52 percent of the firms. CEO decides on important matters after consulting the chairperson in the majority (55 percent) of the firms. CEO generally has the ultimate power to decide on corporate affairs. In less than 20 percent of the firms. he or she does not enjoy much power.2 years. The remuneration package was proposed by the board (and approved by the annual general meeting) in 56 percent of the firms. 86 percent of the firms answered positively when asked whether the largest shareholder was CEO. A smaller number of firms consider maximization of a company’s market share and looking after the interests of such stakeholders as creditors and employees as very important. In the 25 firms where CEO was not the chairperson of the board. CEOs generally maintain their positions for a long time because they are frequently the founders or largest shareholders of their 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.
from IMF and the World Bank. Senior managers were even often called directors although they were not official members of the board. 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. but in practice is fixed and understood as part of a fixed salary. 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. Korean firms have rarely used shares for executive compensation. This action was in response to calls by international investors and. Vol. and . and accounting standards. executives sometimes have the opportunity to buy company shares at favorable prices because the board of directors (CEO. The commission has played an active role in introducing new rules on corporate governance. 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. The bonus is supposed to be linked to company performance. in particular. II Senior Executives In the past. (ii) establishment of accounting standards for financial institutions. in practice) allocates the unsubscribed portion of new shares issued in rights offerings to executives. About 40 percent of the listed companies had amended their charters to introduce incentive stock options by the 1999 shareholders meetings. disclosure. but as of March 1999 only 27 firms actually had given stock options to their executives or employees.100 Corporate Governance and Finance in East Asia. it was common for all senior executives to be elected as directors at the shareholders meeting. One area has been to enhance the reliability of financial statements of corporations in line with internationally accepted standards. 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. 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. Penalties for fraudulent financial reports were increased. However.
the internal auditor is considered to be a subordinate of the . The new rules also require financial institutions to recognize realized losses and allowances for potential losses arising from guarantees in the current year’s financial statements. The new accounting standards for financial institutions adopt the mark-to-market basis to account for securities. they also have the power and duty to monitor the activities of executive directors. 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. In the ADB survey. Notwithstanding a regulation limiting the votes of the largest shareholder to a maximum of 3 percent of the outstanding voting rights in selecting an internal auditor. Korean listed companies with subsidiaries are required to compile consolidated balance sheets. In practice. but 49 percent confessed that they have not followed international standards at all. The External Audit Act and its Decree require financial statements of corporations with total assets of W7 billion or more to be prepared and audited according to the financial accounting standards and working rules set by FSC. however. Only 10 percent of the respondents have followed all international accounting standards. The revised accounting standards apply to the firms subject to external auditing for the fiscal year starting on or after January 1999. 41 percent of the companies believed that they have followed some international accounting standards. Consolidated reporting was introduced before the outbreak of the crisis. they cannot be expected to discharge this responsibility because the representative director selects the internal auditor and can force him or her to resign. Those that never adopted international standards show their willingness to do so once the Government introduces international standards. 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. Internal and External Auditing The Commercial Code requires a corporation to have at least one internal auditor elected at the general shareholders meeting. Under the Commercial Code. Thus. Most of the companies following all or some of the international standards in the past adopted such standards before the crisis started. 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.
About 100 listed firms will be subject to this requirement.6 years. as a monitor of management in the Korean (and also the Japanese) system. The general organizational/social culture in Korea abhors conflict and may also have hindered effective functioning of internal auditors. Previously. External auditors are selected for a term of three years. outside directors. . then the Securities and Futures Commission can appoint a new one. The problem of misconduct on the part of the external auditor was caused partly by weak penalties on wrongdoing. If the status of internal auditors is elevated to that of independent board members. the board of directors had the power to appoint an external auditing firm. Accepting these arguments. The internal auditor in the Korean corporate system can be argued to be inferior to the Anglo-American audit committee and the German supervisory board. this problem will largely disappear. Vol. underdeveloped market discipline for accounting firms. If the company changes its external auditor for reasons that are not listed in the relevant regulation. there were many cases where external auditors failed to detect omissions and false numbers in financial statements of listed firms. But this problem can be mitigated if auditors function under the umbrella of the board. In order to increase independence. and lack of strong professional ethics in the accounting profession. but since 1998 a committee consisting of internal auditors. II controlling shareholder/CEO. The Securities and Exchange Act will also be revised to require an audit committee for large listed companies with total assets equal to or exceeding W2 trillion.102 Corporate Governance and Finance in East Asia. Listed and registered corporations must publish financial statements audited by external accounting firms. the 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. 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. however. In the past. Big Korean accounting firms are affiliated with US accounting firms. and creditors selects it. The Commercial Code will be revised to allow corporations to choose from the two options: the internal auditor or the board audit committee system. This is because the auditor. In the ADB survey. does not have the power to hire and fire the managers. The current external auditors have been associated with the surveyed companies for an average of 4. 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. almost all firms affirmed that the external auditor is independent from the company.
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. The management is the most important proxy.” Companies can increase the number .3.3 Shareholder Rights Voting Rights and Practices Under the Commercial Code. Citizens’ coalitions sometimes solicit proxies in order to file lawsuits against a management. for some firms.” meaning that it should divide its votes in accordance with the accept/reject ratio of votes cast by other shareholders attending the shareholders meeting. These voters represented only 5. or telephone. About 100 shareholders per firm voted by proxy at the last annual general meetings (of the 40 firms answering the relevant questions). the Depository is subject to “shadow voting.Chapter 2: Korea 103 2.79 percent of the shareholders. The Depository represented 20 percent of the shares attending the meetings. small shareholders do not attend the annual meeting and that. or 10. The above results indicate that. in general. 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. A “special resolution” requires two thirds of the votes attending and one third of total votes outstanding. voting by the Depository can influence the outcome of votes because an “ordinary resolution” of the general shareholders meeting requires a majority of the votes attending and one quarter of total votes outstanding. About one fifth of the listed firms issued nonvoting preferred shares.21 percent of total shares issued. However. Internet. Approval of mergers and major divestitures.93 percent of the shareholders but 26. charter amendments. the Depository is instrumental in getting resolutions passed. corporations cannot issue common shares without voting rights. representing 62.53 percent of the total shareholdings. attended the last annual general meeting.77 percent of the shares. and dismissal of directors and internal auditors require a “special resolution. respectively. However. The securities companies and banks are the second and third. A total of 326 shareholders per firm. This shows that a relatively larger number of shareholders send in their proxies. Under the Commercial Code. Preferred shares can be nonvoting and issued up to one quarter of the total number of shares. Thus.” The survey shows that the Korea Securities Depository holds 69. No companies have so far introduced voting by mail. amendments of the articles of incorporation require a “special resolution.
was able to force a change in the charter of SK Telecom. The company also agreed to the right of the fund . dividend proposals. However. or block charter amendments considered harmful to minority shareholders. and major investment projects (only five firms answered this question). the board of directors decides on issues of shares within the limit of the authorized capital.01 percent. Shareholder Protection Before the economic crisis. from 3 to 1. Only two out of 62 respondents to this question have had cases in which proposals were rejected.5 percent. This coalition also attempted to cooperate with domestic and foreign institutional investors to find their way into general shareholders meetings.104 Corporate Governance and Finance in East Asia. The charges included self-dealing by a controlling shareholder and unfair subsidization of affiliated companies by a chaebol firm. the requirement was lowered from 1 to 0. laws and regulations were generally very loose in protecting the rights of minority shareholders. In February 1998 and again in March. For recommendations for dismissal of directors and internal auditors. Various measures have since been taken to improve investor protection. Shareholders have preemptive rights. an activist citizens’ coalition has brought shareholder derivative suits against several large listed firms. Those that are most likely to be rejected relate to election of directors. II of votes required for a resolution to amend the articles. 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. an institutional investor based in the US. As an example. the annual general meeting passed a resolution that was not proposed by the management nor the board of directors but rather by shareholders.0 percent. the Tiger Fund. Vol. It also attended the shareholders meeting of several companies to present the views of outside shareholders. Proposals put forward by management are rarely rejected at the general meetings. the Securities and Exchange Act was revised to lower the representation requirement for shareholder derivative suits from 1 to 0. In four out of 62 respondents. This citizens’ coalition actively contacted the management of selected companies and negotiated measures to protect shareholders. but these can be waived by an amendment of the articles of incorporation. Due to the changes in rules for investor protection. mergers and acquisition plans. Changes in the authorized capital require an amendment of the articles of incorporation. and for access to unpublished accounting books and records. demand changes in business policy.
and not strictly enforced. controlling shareholders have become more susceptible to liability claims by other (minority) shareholders. . After the economic crisis. As for bond issues.3. there was the usual conflict of interest problem and the trustee did not have the incentive to strictly enforce the covenants. affiliated lending or guarantees. the Government had for some time pushed for the enactment of class action suits on false statements and omissions in disclosure materials. Banks have played some limited role in monitoring the investment activities of chaebols. Thus. The Code has also been amended to state more clearly the fiduciary duty (of care and loyalty) of the management. 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. Before the amendment.4 Control by Creditors Role of Creditors in Corporate Monitoring Traditionally. The laws and regulations of the country protect shareholders from interested transactions. In 1974. managers were considered to be subject to the duty of care. creditors did not interfere with the management of a debtor. but it was not entirely clear whether they had the duty of loyalty as well. and transactions with major shareholders. For further protection of investors. This has strengthened the accountability of controlling shareholders as de facto CEOs. it now appears that it has backed away from its earlier efforts to introduce legislation on class action suits. 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. The covenants in loan agreements and bond indentures were very loose. This was one of the most significant developments with respect to shareholder activism in the Korean capital market. loans to directors. bond indentures are only a few pages long compared to a few dozen pages found in advanced bond markets. 2. mergers and acquisitions. However. In fact. Banks themselves were poorly governed and bank managements had little incentive to monitor borrowers.Chapter 2: Korea 105 to recommend two directors to the corporate board. simple. underwriting securities firms acted also as trustees. These have to be disclosed under the Securities and Exchange Act or approved by shareholders under the Commercial Code and other laws.
this proposal has only a slim chance of being accepted by the Government or legislature. The objective of the system is to improve the financial condition of the largest business groups and promote the soundness of bank management. Emphasis on the monitoring role of banks has been growing since the beginning of the Asian crisis. However. 10 nonbank . 11 banks. the main banks should review the feasibility and financing plans of projects undertaken by the core companies and monitor their financial conditions and prospects. The main bank should also monitor and restrict extension of loans to the controlling shareholder and other firms in the group. there have been concerns that the Government might use the system to intervene in the management of the business groups. However. including. 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. creditors now have a bigger say in court proceedings for receivership and composition.106 Corporate Governance and Finance in East Asia. as discussed earlier. Under the system. In 1994 the approval requirement was abolished. In turn. In 1996. on average. Besides the setting up of an “External Auditors Committee” by firms. 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. The view that is more popular among theorists is that creditors would pursue goals that are not in harmony with value maximization and the decision-making role should be bestowed on the shareholders as residual claimants. The firms subject to the system are required to get the approval of the main bank prior to purchasing real estate. Some proponents argue that creditors should have the right to send their representatives to boards of directors of borrowers. The 10 largest business groups are required to select no more than three core companies in consultation with their respective main banks. Purchase of real estate should be financed by equity capital and not by borrowed funds. ADB Survey Results on Borrowing and Lending Practices The ADB survey shows that a typical nonfinancial company is associated with various types of creditors. and purchases of real estate. II acquisitions. recently banks have been increasingly interested and successful in electing former bank officers as outside directors of firms that underwent workout processes. Vol. On the other hand.
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. mutual guarantee agreements. while a third think that creditors have weak influence. renegotiation took place after the crisis. 16 percent . When loans could not be repaid on time. whereas seven of the 17 nonfinancial corporations are. One tenth of the firms received assistance from the Government in loan applications. About half of the respondents received assistance from other sources in the form of loan guarantees and/or provision of collateral. penalty was involved in rescheduling.Chapter 2: Korea 107 financial institutions (NBFIs). and purchase or supply of raw materials. 35 percent are guaranteed by the company itself (by collateral and purchase of guarantee insurance). The assistance came from. or creditors filed for receivership. collateral was taken away. Among the creditors. With respect to the types of loans. Only a few feel that creditors have very strong influence. in order of importance: affiliated companies. Breakdown of loan guarantors is as follows: about 40 percent of loans are without any guarantees. subsidiaries. For more than half of such firms. For a small number of firms. Relationships with affiliated companies providing guarantees or collateral include ownership of each other’s shares. Most of the financial institutions are not affiliates of the borrowing company. Creditors usually exercise their influence through covenants relating to the use of loans. The borrower’s relationship with most banks has lasted for more than five years. holding companies. A few creditors exercise influence through covenants relating to major decisions by the company. NBFIs infrequently ask for collateral. More than half of the firms think that creditors have no influence on their management and decision making. or through their shareholdings. and 17 nonfinancial corporations. About 60 percent of the firms have experienced renegotiation of loan repayment with creditors during the last five years. controlling shareholders. and other financial institutions. collateral is more likely to be required of loans for working capital than for fixed investments. Most firms feel that requirements for collateral have been tightened since the crisis started. The typical company has also maintained its relationship with five of the 10 NBFIs for more than five years. banks are most likely to require collateral. holding shares of another company by both the borrower and the guarantor. payments were usually rescheduled through negotiation without any penalty.
the Korean Government maintained a policy of protecting the incumbent management of listed companies. In this connection. a Lead Creditor Council Agreement was signed for restructuring the top five chaebols. II by other affiliated companies. have been the driving forces for restructuring activities of the largest 64 chaebols. Vol. the creditor banks will send a delegation composed of bank officers to the workout firm to oversee its management. 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 1998.5 The Market for Corporate Control Government Policy Toward Hostile Takeovers Until 1994. In cases where the creditors are unable to reach an agreement on a workout plan. the delegation has the right to approve wide-ranging financial activities of the firm. The leading creditor banks will continuously monitor the progress in implementing the signed Plans. Under a contract signed between the creditors and the debtor. including commercial and merchant banks. especially banks. the Corporate Restructuring Coordination Committee (CRCC) will provide arbitration. 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. 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 . 2 percent by holding companies. This committee was set up in accordance with the provisions of the CRA. and 1 percent by the Government. First. This agreement will provide guiding principles in coordinating diverse interests among creditor institutions and promoting cooperation. 2. are summarized below.108 Corporate Governance and Finance in East Asia. Second. the lead creditor banks formally signed Capital Structure Improvement Plans with chaebols.3. Behind these new strengthened roles of creditors is the newly set-up FSC. Separate from but emulating the CRA. banks and other institutional lenders are playing more important roles than ever before. major creditors. will get involved in the restructuring and workout processes. 4 percent by subsidiaries. The new ways through which creditors. Third. and in continued monitoring of debtors.
The shareholders already owning more than 10 percent at the time the company went public were exceptions to the rule. In one case. more than half of these attempts failed. Stock purchases by tender offer were also exempted. 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. a total of 13 hostile takeover attempts occurred. For takeover defense. Korea does not have the mandatory takeover rules applying to those who amass more than 30 percent of the shares outstanding (until 1998. and announcing competitive tender offers by the controlling shareholder. The incumbent controlling shareholders used various tactics such as issuing privately placed CBs. Publicly issued CBs require three months before their owners can convert them to shares. In the early 1990s the Government shifted its policy toward freer activities in the market for corporate control. 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. Companies have also utilized share repurchases. Unlike Germany. turning to white knights. A company cannot issue new shares to a third party without first amending the corporate charter. 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). However. hostile takeovers by tender offers began to appear in the capital market. Unlike the UK. Poison pills cannot be used mainly because companies cannot distribute stock options as dividends to shareholders. but were completely eliminated in 1998. The reasons for failure are diverse. As far as institutional arrangements are concerned. listed firms rely mainly on shareholdings by the largest shareholder. . Limits on acquisitions of shares of a Korean firm by a single investor were gradually increased over a six-year period beginning in 1992. Between 1994 and 1997. it can be safely stated that Korea now has one of the most accommodating capital markets with respect to hostile takeovers in the region. corporations cannot limit the voting rights of large shareholders to a given maximum. Takeover Activity As soon as the Act was amended.Chapter 2: Korea 109 unless he or she obtains prior approval of the Securities and Exchange Commission. Privately placed CBs cannot be converted into shares in one year. 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.
Hostile takeovers in Korea will be rare in the future. in which the Government still holds the largest ownership. The Government-owned listed companies. Firms affiliated with a large group are generally regarded as difficult targets as the other members of the group will come to the rescue or act as white knights. For the others. and a bank had government ownership. Currently the limit is 3 percent. 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. except for the banks.6 Control by the Government State-Owned Enterprises Government ownership of listed companies is very limited. In 1999. an electric power company. For the steel company. Some had two or more large shareholders who had joint control of the firm but could not cooperate. As of February 1999.3. Korea Telecom. In 1998. 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. 172 firms (or 22 percent of listed firms) belong to the 30 largest chaebols. was newly listed. which are allowed by the Securities and Exchange Act to set the limit on the ownership of shares by one single shareholder. 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. a steel company. . Charter amendments have also been employed by some firms to limit the maximum number of directors. the limit will be eliminated when it is fully privatized in two years. In their charters. Another reason is that many listed firms belong to chaebols.7 percent on average as of the end of 1997 for nonfinancial listed firms). some firms have included a supermajority provision for the dismissal of directors and provided for a staggered board. 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. Vol. 2. are designated as public companies. It is harder now to find such firms. the Government became the largest shareholder of several commercial banks through equity participation purporting to recapitalize them out of financial distress. As of the end of 1997. Many of the takeover targets in the past did not have a controlling shareholder (group).110 Corporate Governance and Finance in East Asia.
which limits the total amount of bonds issued by the five largest chaebols. Meanwhile. was amended in 1997 to introduce a board structure consisting of a majority of nonexecutive directors.7 Employee Participation in Corporate Governance Employee participation in corporate governance is very limited. as applied to four large corporations.3. There is no active debate or discussion going on about this potentially difficult issue. went into effect in 1998 to prevent them from absorbing too much of the funds available in the market. only qualified firms could issue new shares. more state-owned corporations became subject to this new board structure. 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. The Government has frequently imposed restrictions on the use of capital markets by large companies. 2. nominated by the minister in charge of the company in question. For example. especially those belonging to chaebols. The objective of the system was to improve the financial condition of the chaebols and to promote the soundness of bank management. 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. and approved by the Chairperson of the Planning and Budget Commission.1). Labor is not represented in corporate boards. It was abolished before the economic crisis but another regulation. Further. Even where employees hold . controlled the total amount of corporate bonds issued per month and allocated amounts to individual corporations. Beginning in 1999.Chapter 2: Korea 111 The Government used to appoint a few public officials to the boards of state-owned corporations. The Government’s right to send public officials to the boards was eliminated. In addition. But this rule. The nonexecutive directors are now recommended by a committee. which was introduced in 1996. the main bank system. administering through a self-regulatory committee of the securities industry. There were also limits on the amount raised and the number of issues per year.3. the Government. is being applied to the 51 largest business groups to which the banks extended more than W250 billion in loans and payment guarantees. This was aimed at limiting the supply of bonds thereby stabilizing interest rates.
and 66 percent manual workers. About half of these firms considered the influence of the union on the management of the company to be weak. Under the Capital Market Development Act of 1968. This practice may be due to the fact that employees are typically submissive to their employers and that their total shareholdings are minimal. but 27 percent of them felt that it was strong. and 2. they delegate their voting rights to plans’ representatives. employees of listed firms issuing shares through rights offerings are entitled to 10 percent of the rights. 32 percent technicians and professional staff. In these firms. Vol. there are two federations of labor unions. the management usually consults the union on major issues relating to the management. . of which 2 percent were senior managers. employers are required to meet with representatives of labor unions at least once every three months.5 in 1990. these firms have to offer 20 percent of the shares being issued to their employees at the public offer prices. Collective bargaining is. The percentage of shares held by the employee stock ownership plans in listed companies was 1. carried out at the enterprise level. Under the Labor Management Council Law. II shares of their companies through employee stock ownership plans. 2. The union had no influence on the management in 17 percent of the firms. Two thirds of the respondents had an organized union.1 in 1997. At the national level. The relevant regulation was amended recently in order to facilitate voting by individual employees. In 70 percent of the firms with organized unions.654 employees per firm on average. In actuality. This law is not intended for wage negotiations but for employers to seek cooperation and productivity increases from workers. Trade unions are organized on an enterprise basis. in principle.112 Corporate Governance and Finance in East Asia. Under another law enacted in 1972 to induce private companies to go public.9 in 1980. Employees of companies have had the opportunity to buy shares of their employing businesses at favorable prices. The typical collective bargaining agreement has a one-year duration. In 1987. Local unions in the same industry have established industrial labor federations. Employee stock ownership plans became popular in 1974 when the Government allowed tax and financial benefits for stock purchases by employees. which were generally much lower than estimated values. The respondents of the ADB survey had 2. 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. union members account for 54 percent of the employees. and development of the company. the council meetings have been superficial. operation.
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
budget. In June 1993. . flow of funds analysis was used to examine patterns of financing of the aggregate corporate sector. Moreover. depreciation.4. Some policy loans were also abolished. The capital market. With the privatization of nationwide commercial banks. Also. The Government handed over its controlling stakes in four commercial banks to private hands in 1981-1983. Internal funds include retained earnings. listed companies. On the basis of flows of funds. the Government announced a plan in 1981 that substantially improved foreign investors’ access to the domestic capital market. In addition. It included such important issues as interest rate deregulation. revision of the credit control system.1). Vol. and organization of commercial banks. finance companies. The Government began to considerably deregulate foreign exchange in 1987 due to the shift of the current account into surplus in 1986 (see 2. opting to bring in the plan step-by-step to avoid market dislocation from a sudden shift in the system. as a first step toward liberalization of capital account transactions. 2. short-term finance companies. was liberalized drastically in 1998 after the financial crisis. development of the money market. the Government simplified various directives and instructions regulating personnel management. the business scope of financial institutions was greatly widened from the early 1980s. Since 1985. Meanwhile. etc. and the 30 largest chaebols. the following measures can be constructed: Self-financing ratio (SFR) is the ratio of change in internal funds to change in total assets.2 Patterns of Corporate Financing Corporate Financing Practices In this section.118 Corporate Governance and Finance in East Asia.5 percent in November 1981. mutual savings. II Interest Rate Deregulation Plan. the required reserve ratio was substantially lowered from an average of 23 percent in 1979 to 3. which resulted in the establishment of a number of new banks. implementing the first stage in November 1991. entry barriers to banks and NBFIs were lowered in an attempt to promote competition. The Government adopted a cautious approach.2. The plan was launched partially to accommodate US demands for comprehensive structural deregulation and market opening of the financial sector. Korean firms have been allowed to issue CBs in international financial markets. and liberalization of foreign and capital transactions. especially the domestic bond market. the Korean Government announced its Financial Liberalization and Market Opening Plan.
and allowances) and new equity capital. Before 1988. but do not include capital surplus (asset revaluation allowance and the excess of current value over issue value of stock). was 71 percent during the period. particularly in the short term. Incremental debt financing ratio (IDFR) is the ratio of change in total borrowings to change in total assets. including all sources other than retained earnings. but it remained less than 10 percent of total financing. Incremental equity financing ratio (IEFR) is the ratio of change in stockholders’ equity to change in total assets or 1-IDFR. Meanwhile. This means that internal funds after dividend payment were insufficient to finance growth in total assets. Additional equity capital used to finance growth reduces the financial cost and the financial risk of investment. depreciation. Financing Patterns of the Aggregate Corporate Sector Table 2. Equity capital represents the shareholders’ commitment to the business. except in 1991. The share of external financing. except for the stock market boom of 19871988. and government transfers. and 1997. the proportion of borrowings from NBFIs fell to its lowest value at 4 percent.25 shows the flow of funds of the nonfinancial corporate sector in Korea during 1988-1997. In 1988 when the stock market boomed. depreciation. The corporate sector used . New equity financing ratio (NEFR) is the ratio of change in equity (stocks issued + equity other than stocks) to change in total assets. 1994. 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. particularly in the 1990s in response to the liberalization of the capital market.4 percent in the precrisis period 1988-1997. It measures the degree of financing growth in total assets by additional equity. on average. Table 2.26 shows the four measures of corporate financing calculated from Table 2. In securities finance. the proportion of foreign borrowings in total finance rose steadily. capital surplus.25. It measures the degree of financing growth in total assets by additional debts. the corporate sector’s most important source of external finance was bank borrowings. The SFR averaged 28. financing by corporate bonds and CPs was more significant than by new equity. comprising internally generated capital (retained earnings. Securities finance became a more important source from 1988 onwards.Chapter 2: Korea 119 and net capital transfers from the Government. This high proportion deprived Korean businesses of flexibility during recession periods due to high financial costs.
5 0.0 0.6 11.5 9.7 6.9 34.2 0.4 1.4 27.3 3.7 10.4 (2.0 0.3 5.3 16.4 — 28.0 (0.7 2.0 2.7 10.1 1.0) 12.7 4.7 14.3 1.0 1.5 13.0 70.4 2.4) 13.6 9.0 3.3 10.1 2. and net capital transfers from the Government.1 — 27.3 — 30.0 11.5 16.0 16. b Includes capital surplus.6 4.6 Sources of Funds Internal Financinga External Financing Bank Borrowings Banks Nonbanks Merchant Banks Insurance and Others Securities Natl.1) 4.7 1.7 1.7 7.2 1.4 10.1 12. depreciation. a Includes retained earnings.1 0.3 25.3 6.6 3.4 27.4 8.8 8.8 27.6) 5.3 1.4 15.9 9.4 3.0 17.6 (0.8 1.1 1.2 — — — — 9.9 10.4 27.1 2.7 14.6 25. 1988-1997 (percent) 1988 43.2 5.7 4.6 4.8 0.6 77.6 9.6 0.7 13. Bank of Korea.5 16.1 27.3 30.0 1997 26.4 1.2 15.9 38.6 2.3) 15. and Flow of Funds.5 2.6 1.7) 11.3) 11.5 0.0 22.7 10.7 12.0 10.5 0.1 — — — — 12.2 13.4 2.0 9. .7 11.1 17.7 8.8 1.4 2.6 5.8 15.8 1.2 14.4 71. which is the excess of current value over issue value of stock.1) 6.3 3.8 4.6 0.0 — — — — 8.4 21.5 29.1 36.1 3.1 0.2 26.7 71. Bank of Korea.1 3.2 — 28.5 2.1 1. Source: Understanding Flow of Fund Accounts.6 0.3 27.6 3.2 13.2 34.8 56.7 (0.8 1.6 4.7 8.9 28.6 11.4 11.4 (0.0 9. 1994.5 2.7 — — — — 9.1 3.4 9.9 73.3 1.9 6.3 72.8 17.8 1.9 2.5 2.1 10.7 1989 1990 1991 1992 1993 1994 1995 1996 22.2 2.4 0.8 (0.0 3.6 14.9 10.8 30.4 0.2 6.0 3.25 Flow of Funds of the Nonfinancial Corporate Sector.6 10.7 15.2 10.9 72.3 6.8 — 26.1 (1.6 8.1 23.3 — — — — 8.8 -2.2 6.1) 4.7 32.Table 2.4 2.6 9.7 73.3 6.3 2.0 5.1 8.6 0. and Public Bonds Commercial Paper Corporate Bonds Stock Issuesb Equity Other than Stock Foreign Loans Foreign Current Bonds Trade Credit Direct Investment Others Others Government Loans Business Credit Other Financial Debts — = not available.7 2.7 2.1 (0.9 0.2 (0.1 72.
higher than the aggregate 40.5 68.8 28. In periods of high economic growth such as in 1988. Bank of Korea.4 12.2 percent of the growth in total assets.0 5.9 60. Bank of Korea.4 percent. and the total debt ratio was much higher in 1996 and 1997 at 62.6 26.7 40.6 percent. SFR peaked at 44 percent.9 percent by 1997 when net profit margins were negative.3 11.6 Excludes capital surplus. Source: Calculations from Understanding Flow of Fund Accounts. the corporate sector relied heavily on external financing for its expansion.6 percent. Its IEFR and NEFR dropped to 23. declining to 26. 45.5 31.1 39. and IEFRs were declining. 1994.1 53. NEFR registered 20.5 percent in 1997.3 12.2 37.8 percent of its total asset growth through debts.2 IDFR 36.3 percent in 1997.7 9.9 22. respectively.3 59.0 42.9 46.4 NEFRa 20.4 27.Chapter 2: Korea 121 Table 2. Lower income diminished the industry’s equity position toward crisis year 1997.1 12. 1988-1997 (percent) Year 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 Average a SFRa 43.4 percent (Table 2.6 percent and 1.1 percent in 1988 during the stock market boom.7 percent in 1997. NEFRs. .7 30.0 11.5 percent. While SFRs. an average of 59.1 26. Manufacturing financed 54.5 and 76.5 12.8 62. and Flow of Funds. higher than the aggregate 28. but also continuously fell. IDFR reached 73.0 27. It dropped to 28 percent the following year.1 17.26 Financing Patterns of the Nonfinancial Corporate Sector. Across industry. indicating a high financial risk position. The balance. respectively. was financed by additional debts. Incremental financing from equity was 40.7 28. but plunged to 5.6 percent over the 10-year period.8 10.7 40. in the manufacturing sector. additional equity to finance 12.4 37.4 percent.3 27.3 59.9 28.6 62.7 40. On average. There were significant time trends.4 IEFR 63.0 57.3 60.2 percent of incremental asset growth was financed by equity. average SFR was 37.3 73. IEFR ranged from 32 percent to 64 percent of asset growth during the boom years.7 26. dropping to 26.27).
the two sectors also had low equity financing ratios and high debt financing ratios.6 62.4 3. Categorized according to company size. and communication sector had relatively high incremental equity ratios. It had the highest average SFR in 1988 at 31. gas.6 53. and steam) and the transportation. then increased to 20. In 1997. II The construction industry showed the most cyclical pattern in annual asset growth. Financing patterns of the wholesale. and fell to about 10 percent in 1997.27 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. Since 1992.6 53.4 47.5 1. the utilities (electricity.0 57.8 4.1 29. from 17.0 42.0 30. Table 2.2 5. On the other hand. explaining partly the collapses of several construction companies in 1995.2 3.7 47.2 .8 percent in crisis year 1997.and medium-sized firms.0 42.8 50.4 46. retail. Since large firms were more profitable.3 28.5 NEFRa 9. and hotels sector and realty/renting/business activities sector were similar.0 3.7 47. These sectors had relatively low equity financing ratios and high total debt ratios in financing asset growth between 1988 and 1997. large firms showed more cyclical patterns in these financing ratios than small.7 percent in 1996.122 Corporate Governance and Finance in East Asia. Equity financed an average 25.4 54.8 percent in 1990.6 37.4 37. this dropped further to 15.1 percent of total asset growth for the period.5 7.2 percent in 1993. one year ahead of the other industries.4 45.9 6. the proportion of short-term borrowings in total financing has been high. their average SFR was higher.6 54.9 IDFR 34. with the total debt ratio much higher in 1995-1997 at 82 to 84 percent.6 4.6 37.2 62.5 23. and low total debt and short-term borrowing ratios. Vol.5 76.6 36.3 52.7 37. which decreased to 8.7 37.8 IEFR 65. storage.6 45.9 percent.2 21.9 percent of asset growth.6 3. Total debt financed an average 74.4 63.
0 74.0 1.6 14.9 1.2 4.9 15.27 (Cont’d) Year SFRa NEFRa IDFR 53.7 1989 26.9 1.8 76.5 1996 42.1 19.8 74.0 10.5 76.6 1997 29.3 57.7 15.8 4.0 0.3 10.0 68.2 70.0 3.5 20.2 25.9 Construction 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 Average 31.7 78.5 87.7 1997 8. Storage.1 84.3 8.9 1993 63.1 70.3 84.Table 2.9 33.0 1990 12.7 6.7 Wholesale/Retail Trade.3 1996 16.0 17.0 82.6 7.7 1994 53.6 73.1 59.5 21.1 Trasport.7 80.8 29.9 16.2 10.0 34.6 8.9 1.3 (9.9 9.8 1994 15.6 9.6 37.9 47.9 1992 56.5 70.5 12.5 1.4 62.8 54.4 26.7 7.2 1995 16.4 IEFR 46.6 4.8 25.6 2.3 7.4) 2.6 9.8 1991 51.2 29.3 4.0 60.9 Average 19.7 42.8 81.6 8.5 1993 22.0 1992 24.9 30.2 23.0 1990 50.5 29.6 71.4 2.9 1989 63.1 4.9 20.1 66.2 3.3 19.2 74.1 25.9 80.7 15.1 1991 14.9 2.8 70.2 46.1 69. and Communication 1988 64.4 28.3 21.0 31.3 4.0 65.5 23.0 4. Hotels 1988 33.8 9.2 18.6 37.8 2.7 41.9 29. Household Goods.5 62.0 .7 53.2 8.3 47.0 40.2 20.4 1995 53.9 52.7 78.2 5.2 Average 53.
6 IDFR = incremental debt financing ratio. Long.8 Average 22.3 29.7 18.3 81. . SFR = self-financing ratio.7 1994 8.3 207.7 1996 18.3 7.1 1993 55. Financial Statement Analysis Yearbooks.0 67.1 0. a Excludes capital surplus.0 0.0 53. II Table 2.4 1995 62.9 45.0 33.5 8.6 Real Estate.5 77.4 0.6 52.6 1991 18.1 34.4 (107.6 1989 118.9 IDFR 31.1 35.6 1997 23.9 57.4 1.0 79. and Steam Supply 1988 118.0 46.2 1992 18.4 1994 72.8 1990 19.3 31.27 (Cont’d) Year SFRa NEFRa 6.7 14.3 92.5 22. Renting.and short-term borrowings of these firms shot up in that period.0 1. Higher growth in total assets and sales and easier access to debts by large firms could be reasons for this.6 1.4 7.4 0 0 0 0 1.7 69.4 5.9 Average 75.1 71.0 56.0 43. IEFR = incremental equity financing ratio.1 1989 34.4 IEFR 69.8 17.0 (0.0 21.0 1992 51. Gas. NEFR = new equity financing ratio. The large firms had a higher proportion of external financing in 1996-1997.9 29.1 42.3 Electricity.8 135.6 1990 82.1 54.1 1991 56.8) (35.0 1997 24.4 47.9 65. Source: Calculated using data from Bank of Korea.6 7.6 1995 17.4) 3.7 70.3 85. however.8 36.7 37.124 Corporate Governance and Finance in East Asia.0 0.8) 7.4 1996 45.3 3. The trend was reversed in 1996-1997. Their average IEFR was also higher and IDFR smaller. Vol. and Business 1988 51.2 63.1 70.and mediumscale firms.9 64.9 28.8 1993 11.3 62. when large firms had much lower equity financing ratios and higher debt financing ratios than small.
and were large borrowers.5 percent is lower than that of the corporate sector in general.7 percent for all listed companies.1 percent of their equity capital. compared with 89. All of the top 30 chaebols relied heavily on short-term borrowings. Financing Patterns of Chaebols For chaebols.28).9 percent. and the top five chaebols. 153. The largest borrowers were the top 11-30 chaebols.7 percent. They were able to borrow easily from banks by issuing corporate bonds and CP.3 percent of their equity capital in 1997 (Table 2. The chaebols’ drive to expand their empires resulted in heavy borrowings. the lowest ratio of 58. In 1996-1997.6 percent of total asset growth.30).8 percent of their total finance in 1997. In 1997. the average SFR was 28.9 percent. and using cross-payment guarantees among affiliated companies. External financing reached 94.5 percent and their total external financing. the NEFR of the top 30 chaebols plunged while the debt ratio increased substantially. They had easier access to bank loans and the markets for corporate bonds and CPs than nonlisted companies. The debt financing ratio of listed companies was high since they relied more on external financing.6 percent. the top 6-10 chaebols.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. and higher than that of listed companies (Table 2. Many firms affiliated with the top 30 chaebols saw loan guarantees turn into their own debts because of defaults in debt payments. about the same as that of the corporate sector as a whole. for listed companies. at an average 70.3 and 89. 91. the top 11-30 chaebols had the highest guarantees commitments at 207. Cross-payment guarantees have been declining since 1993 and reached 91.8 percent. The proportion of their short-term financing averaged 72.4 percent.2 percent. compared with the entire corporate sector’s 35 percent and 65. Their shortterm borrowings accounted for 86. In 1997.7 percent. The average IEFR and IDFR were 10. respectively. but higher than that of listed companies. the IDFR of listed companies increased to 93. Another key feature of corporate finance in Korea is the widespread use of loan guarantees among the top 30 chaebols. The average IEFR of the top 30 chaebols of 29. .29). Group-member firms borrowed less.
7 12.4 29.3 Year 1994 1995 1996 1997 Average a Excludes capital surplus.4 1.3 28. Source: Calculated from data obtained from data files of the Korea Listed Companies Association. . Table 2. 1994-1998 (percent) SFRa IDFR 85.8 89.2 36.5 8.5 8. Source: Calculated using data of Seung No Choi.4 12.5 2.7 1.6 70.28 Financing Patterns of Listed Companies.4 88.8 22.7 13.6 61.6 IEFR 42.5 2. Largest Business Groups in Korea.5 91.4 38.1 8.6 11.3 5.9 6.9 NEFRa IEFR 14.2 1.1 93. 1994-1997 (percent) SFRa 41.3 86.6 1.6 0. Korea Federation of Industries.2 10.3 IDFR 57.29 Financing Patterns of the Top 30 Chaebols.1 1.8 76.2 NEFRa 1.9 7.3 1.Table 2.2 23.5 Year 1994 1995 1996 1997 Average a Excludes capital surplus.
30 Cross-Payment Guarantees of the Top 30 Chaebols. Source: Fair Trade Commission and the Federation of Korean Industries. and extended loans based on cross-payment guarantees. Financial institutions did not strictly screen their loan projects and monitor their debtors.9 — — — 1996 105. According to the ADB survey. poor financial and corporate governance resulted in overlending by banks. Firms now prefer internal funds and new equity capital. Fourth. Second. more than half of bank loans were priority loans with low interest rates. the Korean economy was plagued with high inflation. bond issues.3 64. Further.7 150. Interest payments on debts were considered a loss when calculating taxes. Korean firms preferred debt financing (bank and nonbank borrowings). And fifth. bond issues. inefficient investment and excessive diversification of corporations. There were several reasons for this. and reserves and retained earnings. These are followed by loans from banks.1 — = not available.0 1997 91. in order of ranking. Third. . the Government applied high tax rates on net profits of corporations.Chapter 2: Korea 127 Table 2.3 58. This change implies that firms now give more attention to financial risks.9 — — — 1994 258. loans from banks. Few firms ranked loans from NBFIs as their first preference. Controlling shareholders usually tried to avoid dilution in their shareholdings for fear of losing control.9 153.1 — — — 1995 161. the Government provided implicit guarantees on bank lending and large businesses. company preferences in financing investment projects before the crisis were. Factors Influencing Corporate Financing Choices Until recently. so that the firms engaged in lobbying to gain access to them. 1993-1997 (as percentage of equity capital) Rank Top Top Top Top 30 Chaebols 5 Chaebols 6-10 Chaebols 11-30 Chaebols 1993 469.0 207. and loans from NBFIs. especially in the 1970s when real interest rates of bank loans were negative. chaebols could easily borrow funds from banks and NBFIs by using cross-payment guarantees. and underdevelopment of the stock market. This attitude appears to have changed after the crisis because reserves and retained earnings and rights issues became the preferred financing choices. rights issues. First.3 200.
Among the responding companies that had foreign currency denominated loans. ensuring the liquidity of the company. II In seeking external financing. The percentage of foreign currency denominated loans hedged against exchange rate risks was 21. 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. This preference has changed little after the crisis. and futures and other financial derivatives. many firms (or 42 percent) never considered hedging. in order of importance. and reduction in tax burden. some (36 percent) thought that a hedging facility was not available or not working properly. more than half (53 percent) hedged against exchange rate fluctuations. For these firms. Nonetheless. According to the survey. Other factors include.4. Among those that never hedged against exchange rate risks. maintenance of the existing ownership structure. 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. Korea now provides a better environment for financial risk management. 2. Vol. in selecting financing sources. the majority (60 percent) of the firms responding to the ADB survey look first for nonaffiliated financial institutions. firms give their first consideration to minimization of transaction and interest costs. the percentage of foreign currency denominated debt in the portfolio was 14.5 percent at the end of 1997. A futures exchange launched in 1999 trades foreign exchange options. Few companies felt that hedging was too costly or was unnecessary as the exchange rate was considered fixed.36 percent on average for these companies. These survey results indicate that many companies were not very attentive to exchange rate risks (and possibly to financial risks in general).3 Financial Structure. and others (29 percent) expected the local currency to appreciate in value. they survived for two to three . About half of the respondents of the ADB survey borrowed foreign currency denominated loans from foreign banks. Only a few firms sought foreign loans because domestic loans were not available.128 Corporate Governance and Finance in East Asia. Diversification. even with a heavy debt burden.
These findings indicate that independent firms have had a lower leverage and performed better financially. (ii) In terms of net income to total assets.2. (iii) Interest payment coverage ratios are calculated as operating earnings over interest expenses. However. 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. the top five chaebols and the top 6-70 chaebols had similar ratios. 1999).3. The ratios of the top 6-70 chaebols were lower than those of the top five chaebols. except in 1991. Among the main findings were the following. except in 19931995 when semiconductor prices were extraordinarily high. (i) In terms of total borrowings to total assets. Those firms whose interest payment coverage ratios are below 1 are likely to go bankrupt.Chapter 2: Korea 129 years before collapsing at the time of the 1997 financial crisis (2. the top five chaebols’ ratios were much higher. .13). (1999) compared the financial positions of 504 chaebol affiliates and non-chaebol independent firms during the period 1986-1998. the ratios of independent firms were higher than those of the top five and top 6-70 chaebols during the entire period. In order to determine the relationship between financing patterns and corporate performance. the ratios of nonchaebols were remarkably higher than those of the top 670 chaebols during the entire period. 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. (iv) In terms of EBITDA to total assets. Table 2. Interest coverage ratios of non-chaebols were higher than those of the top 6-70 chaebols during the entire period.. as well as lax financial supervision (Nam et al. They were also higher than those of the top five chaebols until 1992. But since 1992. 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. Nam et al. Operating earnings are earnings before interest payments and taxes plus depreciation and amortization (EBITDA). but the ratios of independent firms were much lower.
the top five chaebols outperformed the top 6-30 chaebols for most of 1985-1997. had a significant role. This indicates that excessive diversification and inefficient investment of the top 30 chaebols resulted in relatively low net profit margins (Table 2.130 Corporate Governance and Finance in East Asia. and composition was lower than that of the top 6-30 but higher than that of the top 31-72 chaebols on average. The degree of diversification of chaebols that fell into default. In terms of the net profit margin (the ratio of net profits to sales revenue). During 1985-1997. too. or outright transfer of resources due to poor corporate governance practices. 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. 2. Chaebols have been subsidizing new or low-profit industries by transferring resources from high-profit industries through inside dealings. The diversification of the top five chaebols remained at about the same level within the period. second highest in the top 6-30. Government intervention. larger research and development expenditure. Vol. debt guarantees for free. the degree of diversification was highest in the top five chaebols. and easier access to cheap credit. The differences in the degrees of diversification among the three groups are substantial. the top 6-30 and 31-72 chaebols gradually increased their diversification beginning 1990. had easier access to credit than the top 31-72 chaebols.31). Factors related to weak corporate governance were closely intertwined with shortcomings in macroeconomic policy and vulnerabilities in the financial sector. its profit rate declined. 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. The diversification of chaebols under workout was much lower than that of the top 6-30. But the net profit margins of the top 31-72 chaebols were higher than those of the top five in 1985-1992. Meanwhile. court receivership. rising nonperforming loans (NPLs) and falling . Indicators such as increasing debt-to-equity ratios. net profit margins of the top 31-72 chaebols were always higher than those of the top 6-30. II Corporate Performance and Diversification As a chaebol further diversified into nonrelated areas. however.5 The Corporate Sector in the Financial Crisis This section looks at the various causes of the crisis in 1997. Their subsidiaries. and lowest in the top 3172 chaebols.
5 (6.9) 2.4 (0.8 0.3 (0.8) (37.5 0.6 0.1) (6.2 (0.2) 1.1) (1.8) 1997 0.3) 0.1 2.6 0.8 1990 0.9) (8.5) 0.0 4.2) (4.7 1.0 1.9) 2.8) (1.5 1.4) (1.8 0.4 2.4 1996 0.6 3.2 0.9) 0. p.2 (17.6 0.0 1992 1994 1.4) (2.2 4.1 0.3 (0.3) 1.4 0.4) (4.1 4.3) 12.7 0.3 1.3 1.6 (10.11. 1998.1) — = not available.5 (0.7 1.0) (0.2) (3.9 8.2 1.5) (7.6 (0. Beyond the Limit.6 1.7 0.7 0.8) (20.Table 2.9 1.1) (1.1 1.9) (9.2) (4.5 1.5) (1.5) (0.8) 0.0 1.1 (4.6) (20. Court Receivership.5) (2.8 (0.7) (1.8 0.1 1.6 1.6 0.2 1.7 2.5 (0.2) (13.3) 0.5 4.5) (2.6) 0.8 (0.3) (0.2 1.0) 0.9 (0. Background and Task of Structural Adjustment.4 (0.6 1989 1.8) (4.4 (1.3) 0.5 2.2 (1.4 0.0) 0.4 (1.2 1995 3.7 (0.8) (3.5 (0.8) 1.2) (4.3 0.7 0. .8 0.1) 1. Chung Ang University.3) 0.1 0.3 1.2) 2.6 0.3 0.1 0.6) 0.3 1.9 0.6) (0.6 (0.4 (0.4) (6.2) (0. Management Research Institute.9 1.1 1.3 0.1) 0.0) 0.3) (1.1 0.4 0.6 0.1) (2.1 0.1) 2.1 1.2 1.0) (0.6) 0.9 0.6 1.3 1.2 (0.1 0.0 (0.1 1.9 0.6 5.7 0.3) 1.0 1987 1.3 1.4) (1.4 1.3 (0.6 0.7 — (0.3 1.8 3.8 3.9 1.7 1.8) 0.2 1.3) 0.0 (2.3 0.1) 1. 1985-1997 Item Top 5 Hyundai Samsung LG Daewoo SK Top 6-30 Top 31-72 Default.9 0.6 1.0) (3.8) 0.1 (4.4 1.7 (1.9) (1.2 (0.4) (0.4 (1.0) (4.1 (1.7 0.7) (0.3 1.5 1.7 (4.2 (0.8 (0.1 1.0 6.7) 0.2) 0.2) 1.4) (1.9) 2.6 0.4 1.8) 2.8 0.31 Net Profit Margins of Chaebols.1 0.1 0.6) (12.1 (9.8 1.8 1.2 1.7) 0.5 1.3) (12.6) (12.0 (7.5 (4.7 (0.6) (0.2) 1.4 1.3 1.8) 0.0 0.8) (1.4 0.6) 0.8) (0.5 (0.1 (3.3 (0.3) 0.5 1.3 1.2) (13.4 (2.1 0.6 7.8) 0.1 (0.3) (0.6 1.9 1.3) 0.7 3. and Reconciliation Kia Jinro Hanbo Sammi Newcore Haitai Chungku Kukdong Daenong Halla Workout Target Kuhpyong Kangwon-sanup Pyuksan Sinho Tongil Kohap Sinwon Anam Donga 1985 1.8) (11.1) (5.7) (0. Source: Whan Whang.0 0.2) 2.3 3.2) (0.1) 0.1) 2.1 1.3 (3.7 1.3 1.3 0.
132 Corporate Governance and Finance in East Asia. The most serious problem among most Korean listed firms has been that a controlling shareholder acting as CEO could never be replaced. Until 1997. internal auditors cannot be expected to perform their function independently of management. Now. But in 1998. Thus. the independence and objectivity of the external auditor were often questioned. 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. II corporate profitability were signs that the Korean economy had reached the edge of a slippery slope. a firm’s board of directors had the power to appoint an external auditor. this has led to entrenched management. the controlling shareholder or CEO generally selects the internal auditor despite a legal provision limiting the votes of the largest shareholder to a maximum of 3 percent. the recently adopted Code of Best Practice in Corporate Governance recommends the strengthening of the board 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. and to the development of the market for corporate control. Moreover. Until 1997. Along with government policies to protect the status quo. outside directors. 2.5. 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. A remote trigger in the Thai crisis was all that took to push the economy over the edge. .1 Weaknesses in Corporate Governance Concentration of Ownership and Entrenched Management Concentration of ownership has been the root cause of many problems related to corporate governance. Meanwhile. the boards of all listed companies were composed of insiders only. Thus. Vol. and creditors should select (recommend) the external auditor. The hold was tightened by the practice wherein candidates for directors were handpicked from among the managers by the controlling shareholder. They were then almost automatically elected at the general shareholders meeting. a committee composed of internal auditors. Ownership concentration also had ramifications on corporate transparency. after the crisis.
restrictions of voting rights of shares of institutional investors. There were no effective monitoring mechanisms for its management. and some differences in Korea’s generally accepted accounting principles from international standards. Diversification can reduce chaebols’ risks through the portfolio effect. the Government maintained a policy of protecting the incumbent management of a listed company. as well as institutions. has an unsound capital structure and . regulatory and practical difficulty in implementing proxy voting. One reason is that the percentage of inside shareholdings for an average listed firm is very high. Dominance of Chaebols A chaebol is tightly controlled by the largest shareholder. individuals. prevalent window dressing practices. however. a large issuance of preferred stocks with no voting rights. when a large diversified chaebol. Meanwhile. Traditionally. corporate accounting information was not reliable due to the lack of independence of external auditors. usually a member of the founding family. However. Banks did not function as monitors of corporate management although they were shareholders as well as the most influential creditors. Many of the takeover targets in the past did not have a controlling shareholder. hostile takeovers in Korea will likely be rare in the future. Another reason is that firms affiliated with a chaebol are generally regarded as difficult targets as the other members of the group will come to the rescue or act as a white knight. profitable firms within a chaebol tended to subsidize unprofitable firms.Chapter 2: Korea 133 There had been some devices to protect management so that companies could indulge in business activities without fear of takeover. The purpose was to increase the size of the stock market by having financially sound private firms go public with an assurance that they would not be taken over. participated in the stock market as short-term traders rather than long-term investors. Many changes were introduced to promote M&A in the 1990s. In this situation. as a whole. Under the direction of the controlling shareholder. These included restrictions of shareholdings of institutional investors. These internal dealings made strong firms weak and helped marginal firms survive. Representative of the policy was the stipulation under the Securities and Exchange Act that no one other than founders could accumulate more than 10 percent of the voting shares of a listed company unless he or she obtained prior approval of the Securities and Exchange Commission. and restrictions on hostile takeovers.
The Government and the Bank of Korea did not have accurate information on the extent of transactions that corporations and financial institutions had abroad. Vol. while (non-chaebol) independent firms had much lower borrowing ratios. although their subsidiaries had better quality workforce and easier access to cheap credit than the top 31-72 chaebol affiliates. 2. the typical chaebol firm had an extremely high DER.5. financing choices of listed firms in order of preference were bank loans. and internal funds. However. capital.134 Corporate Governance and Finance in East Asia.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 financial distress of one or a few marginal firms can lead to a chain of bankruptcies across the entire chaebol. and other individual markets.3 Manifestations of Weak Corporate Governance and Government Intervention Preference of Debt Over Equity Financing in the Precrisis Period Before the crisis. bond issues. II strong financial links among its member firms through investments and cross-guarantees. the authorities did not properly check on banks’ lending practices—banks did not screen the lending projects and evaluate the creditworthiness of corporations properly. Such problems may eventually cause ripples through the entire economy. Net profit margins of the top 31-72 chaebols were higher than those of the top five or of the top 6-30. as the latter are well established in most business areas. This indicates that too much diversification and overinvestment in the top 30 chaebols resulted in relatively low net profit margins. prevalence of rent-seeking and morally hazardous behavior by economic decision makers. the intervention later resulted in the accumulation of adverse side effects: underdeveloped product.5. Profitability of the top 6-70 chaebol firms has been lower than that of the top five chaebol firms. This effectively becomes an exit barrier for chaebols and would justify the intervention and support of the Government. Financing preferences changed drastically after the crisis. As mentioned earlier. Further. The Government’s supervision and regulation of financial institutions were poor. and a high degree of inefficiency in the economy. The new preference ordering is as . 2. share issues.
After the financial crisis erupted in Indonesia and Thailand. the top 30 chaebols showed a DER of 519 percent. In the international financial market. The high proportion of foreign debt led to a mismatch problem where borrowers were unhedged against foreign exchange risk. The poor state of corporate governance in the banking and financial sectors was responsible for overlending by banks and NBFIs through perfunctory screening of loan applications. The ratio of external debts to GDP reached 48 percent at the end of 1998. 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. large-scale bailouts of financially distressed firms. The financing choice of listed firms was also influenced by the underdevelopment of the stock market. share issues. reducing foreign exchange reserves to a dangerous level. The preference for debt finance also led to a relatively large foreign debt.Chapter 2: Korea 135 follows: internal funds.5 billion. the Government and the Bank of Korea defended the currency. 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. The lending practices of banks. However. were advantageous to chaebols because they were in an “ideal” position to meet the loan requirement through cross-guarantees among their member firms. which is far higher than the average ratio of around 400 percent for nonfinancial listed firms. Nonpolicy loans were also considered to be cheap because of interest rate regulations. At the end of 1996. bank loans. as evidenced by occasional. total foreign debt amounted to $157. won/dollar nondeliverable forward rates increased rapidly. the exchange rate (won/dollar) increased sharply and the financial crisis erupted in Korea. which were the most important financing source until 1987. overseas borrowing became difficult and higher interest rates were charged on foreign borrowing. Other factors also contributed to this preference. As of the end of 1997. consisted of high proportions of policy loans. . 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. obviously contributed to overlending and aggravated the situation. signaling a bearish speculative move on the won. and bond issues. Bank loans. Although the ratio of stock market capitalization to GDP in Korea was not very different from those in the Philippines and Thailand. which generally required guarantees or collateral. 63 percent of which was short-term. Implicit guarantees by the Government on bank loans to large businesses.
the NPL ratio of commercial banks increased rapidly from 4. especially chaebols. Before the crisis. and shareholders’ equity of all industries. In 1997 they became negative. Further. The inevitable result of inefficient investment was a fall in corporate profits. Moreover. they are defined as loans for which interest payments are overdue by three months or more. and the pursuit of growth through excessive diversification and inefficient investment. decelerated from March 1998.7 percent in 1997.000 during January-September of 1998. a large number of construction companies failed due to the recession in the real estate market and decline in real estate prices. The monthly number reached more than 3. without strictly evaluating the creditworthiness of businesses and the profitability of projects. . Vol. II Inefficient Corporate Investment and Low Profitability Ownership concentration among Korean firms. and there is no collateral. They utilized mutual payment guarantees among their affiliates and believed that they would never fail. The Government could hardly help them because of the number and magnitude of business failures.6 percent in June 1998. total assets. were low in 1996 and 1997. Meanwhile.000 from December 1997 to February 1998. and returned to about 1. Following the “three months” definition. and there is collateral. then 20. the ratios of net profits to sales. Doubtful loans are those for which interest is not received for six months or longer. starting 1 July 1998. Financial Sector Vulnerability Because of financial losses in the corporate sector.136 Corporate Governance and Finance in East Asia. The bank supervisory 8 NPLs of banks comprise fixed (substandard) and doubtful loans. The number of insolvent companies increased rapidly in 1991 and doubled to more than 11. excluding the financial sector. According to the “six months” definition. has given rise to various types of self-dealings by the controlling shareholder. Fixed loans are those for which interest is not received for six months or longer. regardless of whether it is caused by large personal holdings of the controlling shareholder or by pyramiding. and estimated losses. nine out of the 30 top chaebols failed. 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.000 in September 1998 (Table 2.000 per year starting 1992. However. It jumped to 17.32).200 in 1997. These were the definitions until 30 June 1998. The banks and merchant banks lent to large businesses. legal and other barriers prevented the exit of financially nonviable firms.1 percent in 1996. the NPL ratio8 of banks and other financial institutions began to increase. the NPL ratio reached 7. reaching highs of 6 percent in 1997 and 8.
and declined to 4-6 percent in 1994-1996 (Table 2.472 2. Meanwhile.657 3.255 13. The difference between the Korean and Western definitions of NPLs left foreign investors with suspicions that the size of NPLs in Korea might be much larger than the government-announced magnitude. those of domestic banks were lower in the 1990s. Policymakers thought that economic growth would resolve the NPL problem without the need for corrective action.386 5.4 Shortcomings in Macroeconomic Policy The macroeconomic framework also contributed to the crisis in 1997.457 2.637 6.759 6.265 6.114 811 706 696 866 1.544 2.589 171.979 8.210 1.573 3.985 Services 3. 2.890 4.135 1. authorities were not too concerned about the high NPL ratios at Korean banks in 1997 simply because the high and rising ratios had precedents.859 3.053 5.751 1.502 11. low efficiency.769 9.553 3. This speculation was said to be one of the causes of the financial crisis in Korea. Exchange rates were virtually pegged to the US dollar in all troubled Asian countries.107 6. The current account deficits in terms .517 2.992 11.131 1. 1986-1998 Year 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 Total 4.159 10.754 3. the ratio reached 7-8 percent.417 Others 152 132 108 97 88 161 326 252 274 302 553 861 952 Note: 1998 figures cover only January-September.238 4. and continuous and large current account deficits. and large government-directed loans.647 8. European countries.856 7. In 1990-1993.133 3.Chapter 2: Korea 137 Table 2.673 Construction 380 354 242 195 294 585 1. Source: Bank of Korea. ROEs and ROAs of Korean and Japanese banks were low compared with those of the US.027 Manufacturing 1. As a result they had largely overvalued currencies. Compared to ROAs and ROEs of domestic branches of foreign banks.250 2.33).69 20.32 Number of Firms with Dishonored Checks. This was mainly due to the high ratios of NPLs.855 6.850 3.259 2.5. and Taipei.244 3.China.
1990-1998 (W billion) Year 1990 1991 1992 1993 1994 1995 1996 1997 1998 a Total Loans 90.832 337. which led to large corporate losses.649 375.310 6.1 6.160 11.1 7.997 9.6 Fixed loans are those requiring collateral and for which interest is not received for six months or longer.116 1.China. II Table 2.China.0 7.077 NPL Ratio (%) 8.600 10.910 1.827 289.430 12.584 2.2 4. the ratio of short-term debt to foreign reserves was very high.1 percent (1995). of percentage of GDP were as follows: Malaysia -8. Businesses served as a social safety net.705 160.33 Nonperforming Loans of General Banks.874 22.0 8. Vol. b Doubtful loans are collateral-free loans for which interest is not received for six months or longer.556 118. Thailand -8.562 18. although per capita income in Korea was much lower.221 8. Source: Bank of Korea. even in times of economic slowdown.6 percent (1995).138 Corporate Governance and Finance in East Asia.266 10.537 10. because of the rigid labor market. . The main result of the rigid labor market was a “high-cost and lowefficiency” economy. the hourly wage rate in the Korean manufacturing sector was higher than in Singapore or Taipei.652 29. and Indonesia -3.584 Fixed (A)a 5.190 9. judging from the real effective exchange rate indexes using unit labor cost indexes as a deflator and 1985 as a base year.390 12.520 194.8 5.192 Doubtful (B)b 952 1. Korea -4. Related to this.639 1. The pegged currency also encouraged foreign borrowing as investors believed that the exchange rate would remain stable.475 143. It was estimated that the Korean won was overvalued by 20 to 30 percent from 1989 to 1997.736 8.739 241.237 Estimated Loss (C) 958 920 840 816 213 385 490 490 648 NPL (A+B+C) 7. the terms of trade deteriorated 12 percent in 1996 and 11 percent in 1997.954 9.4 5.176 7. Real interest rates in Korea had been two to three times higher than those of Japan or Taipei.929 11. In 1997. Land prices and real estate rents were also high compared to trading partners.6 percent (1995). Meanwhile large businesses could not legally lay off workers. Mass layoffs became legally possible only after the economic crisis.484 11. In addition to the overvaluation of the won. and 30 percent in 1996.0 7.170 1.8 percent (1996).
To achieve this. 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. Corporations.6 2. However. the excessive amount of debt of Korean corporations had to be reduced to a sustainable level. Downsizing by curtailing employment has been prevalent. 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. has been actively utilizing its influence to motivate institutions to coordinate debtor firms’ restructuring activities. Other firms experiencing financial distress were subjected to workout procedures through negotiations between debtors and creditor institutions.Chapter 2: Korea 139 2. the immediate objective centered on restoring the international investment community’s confidence in the Korean economy. which were laden with huge amounts of debt and were on the verge of bankruptcy. Measures have been taken by several chaebols to streamline operations and improve incentives of managers and employees. including banks. embarked on their own restructuring programs and/or implemented restructuring demands of the creditor banks.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. ‘Voluntary’ Restructuring Chaebols have been under pressure from the Government to abolish their informal group headquarters to increase the managerial independence of member firms.6. They have been pressured to stop such practices as providing loan guarantees. Nonviable firms and financial institutions. Ailing banks needed to be recapitalized after the huge amount of NPLs was disposed.6 percent as of the end of June 1998 to no more than 200 percent by the end of 1999. The FSC—later called the Financial Supervisory Service (FSS)— which is in charge of prudential regulation of financial institutions. A guideline informally promulgated by FSC required the 30 largest chaebols to lower their DER of 412. and subsidizing money-losing units. . had been forced into bankruptcy proceedings or merged into healthier entities.
More important. 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. This number was at 779 firms in April and grew to 1. they were reluctant to allow recontracting for fear of further deterioration in the capital adequacy ratio. On the other hand.138 by the end of October. while only 14 percent of the negotiations were completed from the beginning of the crisis up to April 1998. The reasons are manifold. the number of potential sellers decreased somewhat from 2. Locally. or to agree on debt-equity swaps demanded by potential purchasers as a precondition for the deal. In many cases. More than 59 percent of potential buyers were foreign firms. because liquidation of debtor firms would exacerbate the banks’ already weak balance sheets. Involuntary Exits The Government has been involved in the restructuring process mainly through its supervisory capacity over banks. the creditor . 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. banks and other creditors were reluctant to absorb losses realized by debt compositions. 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. Internationally. FSC directed banks to appraise the long-term viability of client firms showing symptoms of failure. 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. Noticing this disincentive. The data also show that about 24 percent of acquisition negotiations ended up in actual deals. potential foreign buyers waited for the price of acquisition targets to come down further. It was frequently observed that the negotiating parties could not agree on a price due to large discrepancies in valuation. Banks did not have the incentive to force financially nonviable firms to liquidate.140 Corporate Governance and Finance in East Asia.281 in April to 2. Vol. Korean firms have been slowly stepping up their restructuring since the latter half of 1998 as the economy began to show signs of recovery. II Divestitures to raise cash for debt reduction and to focus on core businesses have not proved to be easy.045 in October. In their first review.
creditor banks completed evaluation of the financial status of 35 subsidiaries belonging to 13 chaebols. and 16 non-chaebol corporations that had been selected as possible workout candidates. 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. provided by the World Bank. Although the intention of the Government and the banks was to effect immediate liquidation of these selected firms. 11 were merged into other group members. three filed for courtsupervised bankruptcy reorganization. A portion of the Technical Assistance Loan of $33 million. Upon completion of the evaluation. not only for the design of corporate workout programs but also their implementation. 24 were liquidated. FSC has been monitoring the processes from a prudential regulation standpoint. but viable. the creditor banks drafted their own restructuring plans with assistance from outside advisory groups led by foreign investment banks. The creditor banks and the advisory groups also drafted such plans for the top 6-64 chaebols. was allocated to the six largest banks for them to employ outside experts as advisors. Among the sell-offs. and/or conversion of debt into equity have been applied to those firms that are considered to be viable in the long run and have voluntarily entered into negotiations with creditor banks. Also. Corporate Workouts Workouts in the forms of debt rescheduling. by their creditors. These included 20 firms from the top five chaebols and 32 from the top 6-30 chaebols. workouts are being applied to non-chaebol firms identified as financially weak. . Among the 55 firms selected. The workout plans were completed for most firms by early 1999. write-offs. By the end of 1998. two were acquired by newly organized employee stock ownership plans. The plans were put into action immediately following finalization. More than 200 financial institutions signed the Corporate Restructuring Agreement to carry out corporate workouts with the top 6-64 chaebols.Chapter 2: Korea 141 banks selected 55 firms as targets for exit. interest reductions. Negotiations were then held between the chaebols and the creditors’ councils to finalize the financial structure improvement plans. These chaebols submitted plans for restructuring to improve their respective capital structures. the results thus far have not entirely been as desired. and 12 were sold off to other firms. Based on these plans.
labor union demands of the seller were not acceptable to the transacting parties. most of the big deals have entered their final stages of negotiation. uncertainty over the future . some of the acquisition agreements have been discarded for various reasons. railroad cars. Big Deals Ever since the outbreak of the economic crisis. inducement of foreign direct investments was considered to be the most effective means of achieving that end. Big deals have been elevated to the status of the most important means of effective corporate restructuring. These deals could eliminate excess capacity in such industries as semiconductors. This figure contrasts sharply with the total of $700 million for all of 1997. In the case of automobiles. Big deals would. and equity participation—reached about $8. vessel engines. the foreign buyer demanded specific protections against adverse developments in the business environment. In one case. Vol. Korea adopted and implemented policies to open its capital market completely. However. Thus. On 3 September 1998. oil refineries. First. Foreign Acquisitions Confidence in the Korean economy depends critically on the lowering of the level of corporate debt. aircraft. it is hoped. The less than satisfactory state of foreign capital infusion in the early days stems from a number of factors.142 Corporate Governance and Finance in East Asia.5 billion on agreement basis during the 10-month period after December 1997. Hyundai Motor Corporation won the international auction of Kia Motors in its third bidding and Daewoo Motors agreed to acquire Samsung Motors. Foreign investment—in the form of acquisition of controlling interests. purchase of divested assets. II creditor banks and the corporations will devise detailed workout programs based on the rehabilitation plans submitted by the corporations. chaebols did announce their agreements on big deals in seven industries excluding the automobile industry. In another. In the early days after the outbreak of the crisis. Restrictions on foreign ownership of land were also abolished. the Government has been urging the largest chaebols to strike “big deals” or business swaps among themselves to consolidate overlapping manufacturing facilities. power plant facilities. As of April 1999. and petrochemicals. automobiles. enable chaebols to streamline their overly diversified operations and focus on several core business areas.
Fourth. 2. (ii) to remove cross-guarantees of loans among group members. foreign buyers usually employed discounted cash flow methods of valuation while local sellers often put greater emphasis on replacement costs of assets. but it also has important implications with respect to corporate workouts. Third. The presence of . foreign buyers were concerned with the inflexibility of the labor market. Second. some of the potential acquirers demanded terms that were unreasonable or unacceptable from the sellers’ point of view. Sixth. Fifth. the improved procedures stipulated in the Bankruptcy Reorganization Act and the Composition Act reduced what had previously been legalistic exit barriers. these goals were: (i) to enhance managerial transparency. the Government and chaebols reached an agreement on the goals of restructuring and reform efforts.6. In effect.Chapter 2: Korea 143 course of the Korean economy remains high. Not only does this represent progress in terms of an improved institutional framework for market competition. 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. 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. 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. With this in mind. and (v) to improve the accountability of controlling shareholders and the board. As set forth in the agreement. (iii) to reduce financial leverage.2 Policy Measures for Corporate Reform Goals and Policy Measures for Reform in the Corporate Sector Based on their assessments of what caused the economic crisis in Korea and what needs to be done to overcome it. Overhaul of Bankruptcy Procedures In February 1998. local creditor banks were reluctant to absorb losses arising from debt compositions and debt-equity swaps that were necessary in deals involving insolvent sellers. (iv) to focus on a small number of core businesses. Seventh. many of the businesses that Korean firms put on sale did not prove to be attractive to foreign firms.
. October 1998. the Composition Act was amended to narrow the eligibility of applying for court-supervised composition. if a final reorganization plan is not worked out within one year from the date of the court order placing a firm in receivership. The court can refuse to accept the application for composition if it finds it inappropriate considering the size of corporate assets. Also. and economics professions should be organized to provide for expeditious proceedings in court. a “Management Committee. the maximum grace period on loans to the firm being reorganized was shortened to 10 from 20 years. Second. thereby preventing abuses by controlling shareholders/managers of financially distressed firms. number of creditors.144 Corporate Governance and Finance in East Asia. The changes in the reorganization procedures can be summarized as follows.” comprised of experts in the legal. Fifth. the changes in the institutional setting for corporate reorganization will enable creditors and debtors to promptly respond to the development of financial problems. accounting. (iv) restrictions on institutional investors’ voting rights were eliminated in June 1998. (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. etc. Vol. Also. (iii) the representation requirement for shareholder derivative suits was drastically relaxed from 1 percent to 0. The purpose of this rule is to shorten the reorganization planning period. 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. Fourth. Third. the court may annul its previous decision and force the firm into immediate liquidation. the right to revoke court receivership is allowed to the creditors. First. (ii) legal changes have been made so that domestic accounting practices conform to international standards.01 percent in May 1998. The creditors can form a “Creditors Committee” among themselves to allow them to participate in the decision processes in court. Korea’s Economic Progress Report. Improving Transparency and Corporate Governance9 Transparency and accountability in corporate governance will be promoted by the following measures: (i) consolidated financial statements are required beginning 1999. II an expeditious exit scheme is expected to better induce negotiation for workouts between creditor banks and corporations. In the past this stage usually extended for as long as two to three years.
(iv) during April and May 1998. (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. (iii) hostile mergers and acquisitions by foreigners were fully liberalized in May 1998. Capital Market Liberalization Since 1998. 21 industries were further liberalized or newly opened to FDI (now. administrative procedures for FDI will be dramatically simplified and made transparent. As for promotion. According to the law. In addition. Foreigners are now able to invest in local bonds and short-term money market instruments without any restrictions. including tax exemptions and reductions. only 31 out of 1. crossdebt guarantees totaling about W10 trillion—about 30 percent of the total guarantees among the 30 largest chaebols—were dissolved. various supporting measures. an additional nine industries will be opened or further liberalized. (vi) bankruptcy laws were revised in February 1998 to facilitate the exit of insolvent firms. A recent case in point is the penalty imposed by the Fair Trade Commission on chaebol subsidiaries found to be involved in unfair transactions among group members. either partially or fully.Chapter 2: Korea 145 (as of the end of May 1998. including financial subsidization. to FDI). (v) by the end of May 1999. 514 listed companies had appointed 677 outside directors). financial institutions could no longer require cross-debt guarantees. Foreign Investment Promotion Act The Foreign Investment Promotion Act was put into effect in November 1998. have been instituted for FDI: . Existing cross-debt guarantees should be completely eliminated by the end of March 2000.148 industries remain closed. Korea has rapidly liberalized the capital market by adopting the following measures: (i) the ceiling on foreign equity ownership was completely eliminated in May 1998. and (viii) as of 1 April 1998. (ii) full liberalization of foreign exchange transactions was legislated and will be put into effect in two stages. beginning on 1 April 1999. the Korea Trade and Investment Agency (KOTRA) will provide a one-stop service with respect to FDI. These new standards are and will continue to be strictly enforced. which was passed in August 1998. and (vi) all current laws related to FDI have been streamlined and incorporated into a single legal framework represented by the Foreign Investment Promotion Act.
Free Investment Zone (FIZ): A free investment zone will be developed to accommodate large-scale FDI. The majority of government bonds to be issued in the next two to three years will carry a maturity of three years. including infrastructure and tax support. The primary aims of the law are the liberalization of the capital account and the development of the foreign exchange market. The law allows rental cost exemptions and reductions for FDI. the Korean Government is strengthening prudent regulations and market monitoring. for 10 years (full exemption for the first seven years and 50 percent tax reduction for the remaining three years). will be provided to foreign firms in the FIZ. The location of the FIZ will be determined at the request of foreign investors. Also.146 Corporate Governance and Finance in East Asia. Various local taxes will also be exempted or reduced for eight to 15 years at the discretion of local governments. These bonds will be issued . II (i) (ii) (iii) Tax exemption and reduction: Corporate and income taxes will be exempted or reduced for FDI in target industries. It aims to establish a benchmark by consolidating various government bonds. however. are not risk-free. Various support measures. Capital Market Augmentation Bond Market The Government recently introduced a policy plan to deepen Korea’s bond market. Liberalization of Foreign Exchange Transactions In September 1998 the Foreign Exchange Management Act was replaced by the Foreign Exchange Transaction Act. such as the high-tech industry. To minimize potential risks. Three-year government bonds will be used to establish a benchmark. Vol. These liberalization measures. the Government intends to supplement these measures with a sound macroeconomic policy in order to secure more effective protection against systemic risks. as well as building an early warning system. Low cost rental facility: National and public real properties will be rented to foreign-invested firms for up to 50 years.
In order to promote a greater market demand for government bonds. According to the law. with only minor standard exceptions. 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. This law will not only provide an effective institutional environment for the disposal of NPLs.6 trillion for the debt restructuring fund. financial institutions . a primary dealers system will be introduced for healthy financial institutions. invested a total of W1. Mutual funds (or open-end investment companies) will be allowed starting 2001. they will be managed by foreign investment management companies. and is promoting joint ventures between foreign and domestic agencies. Prior to the introduction of this system. Moody’s signed a joint venture contract with Korea Investors Service. Related legislation was put into effect in September 1998. It also opened the credit rating service market to foreign competition. including the Korea Development Bank. the Government will correspondingly expand the issuance of government bonds that have a maturity of five years or more. These are expected to operate for the next three years. but may be extended as required. The Government established specific qualification criteria and selected the primary dealers in 1999. commercial banks were allowed to carry out dealing operations for government bonds starting in October 1998. to establish closed-end investment companies. a debt restructuring fund and three balanced funds (funds that invest in both equity and debt) were established in September 1998. It is now easy for private investors. As a pilot program. and the demand for longerterm bonds increases in the future. and W1 trillion divided equally between the three balanced funds.Chapter 2: Korea 147 monthly. but it will also help improve financial institutions’ risk management. In August 1998. Twenty-five domestic financial institutions. To ensure transparency and efficiency of the fund operations. If interest rates stabilize at a low level. both domestic and foreign.6 trillion in these funds: W0. Asset-Backed Securities A new law providing for asset-backed securities (ABS) was passed in September 1998. No qualification requirements are being imposed on investors who are sponsoring new mutual funds.
there is another view that placing a maximum limit on interfirm investments.3 Policy Recommendations Poorly performing markets and the resulting lack of market discipline justified the government intervention in recent corporate and financial restructuring activities. However. this regulation may not be effective in curtailing pyramidal structures.. unless the limit is tight and binding. However.6. For instance. the government intervention will have to be refocused so that it only sets the rules of the game in the marketplace. The corporate governance structure cannot be expected to function efficiently if this issue is not addressed.148 Corporate Governance and Finance in East Asia.) and the level of interfirm investments is very high. as stipulated by the government measure. On the other hand. Direct controls of interfirm investments and/or pyramidal ownership structures will not be persuasive. foreign business corporations with good credit standing are now also permitted to issue ABS. can utilize ABS. is inevitable. One way of strengthening independence of the boards is to require that listed companies accept nominations for directors by institutional . then the regulation will inhibit efficient investment of firms. the role of the board of directors as the internal control mechanism must loom large in corporate governance. A investing in B.g. B investing in C. considering that there is no other effective way to limit circular investments among chaebol affiliates (e. when the limit is binding. As markets become more efficient. this can only be a temporary measure. 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. A good governance system is essential for the healthy growth of corporations and financial institutions. Policies aiming to improve the corporate governance system should take into account the high ownership concentration often created by pyramiding. In principle. cross-subsidization. such as the Korea Asset Management Corporation (KAMCO). There must be stronger rules to control agency problems. which is the case for many chaebols. However. More important. II and qualified public corporations. Vol. greater efforts to improve corporate governance are preferable to regulation of interfirm investment. and C investing in D. 2. etc. Selfdealings. 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.
The Government can prompt institutional investors to contribute more to good corporate governance by paying greater attention to corporate affairs. . 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. governance. Further. various measures have been implemented to promote investors’ rights. Each listed firm should be required to disclose the extent of its compliance with the Code in its annual report. One way of motivating institutions to do this is to 10 M. 23-26. Since the economic crisis. and requiring that all directors hold shares of their companies. Proposed: A Governance Monitor. The Corporate Board. 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. pp. the Korea Stock Exchange could incorporate provisions of the Code of Best Practice in Corporate Governance in its listing rules. thereby helping to strengthen board independence and enlisting boards’ more active involvement in monitoring corporate management. Latham. Listing rules may recommend that all or large listed companies adopt an audit committee.Chapter 2: Korea 149 investors or their trade associations. and also negligence of external (independent) auditors actionable. using audit. September/ October 1997. Companies could also invite nominations from such organizations as the Korea Listed Companies Association or citizens’ coalitions that have been active in monitoring corporate management through proxy solicitations. and other committees. The annual shareholders meetings could also elect reputable “monitoring companies” to recommend director candidates (Latham.10 Other means to improve independence of the boards include mandating that independent outside directors form the majority. Class action suits are an efficient means for corporate monitoring. Institutional investors will play an increasingly important role in corporate governance. There has recently been a general shift in individual investor preference from direct personal stock trading to investing in traditional investment trust companies and the newly introduced (closed-end) investment funds. The Securities and Exchange Act will then require large listed companies to switch to a board audit committee system from an internal auditor system. If and when the law is introduced. 1997. it will have to include making self-dealings by directors and officers. More effective measures to protect investors will enhance corporate transparency and also the accountability of directors to shareholders. 1997).
and thus cannot be expected to be actively involved in monitoring portfolio firms. Another concerns whether the court-appointed receiver should be given the power to convene board and shareholder meetings and also to replace directors and officers with court approval. insurance companies. Rights of minority shareholders should also be strengthened for these institutions. These guidelines would recommend shareholder activism and faithful discharge of fiduciary duties by actively participating in shareholder voting. securities companies. strengthen its supervisory activities. The Government recently proposed the revision of bankruptcy-related laws. and compliance officers. Many of the larger investment trust companies. Vol. the Government will have to come up with appropriate policy measures to solve these problems. An efficient means to control problems arising from ownership of financial institutions by industrial capital is to strengthen the accountability and fiduciary duty of the very management of these institutions. . by all nonfinancial companies (or “industrial capital”). etc. Also. The Government can also lower the limits on investments in affiliated 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. such as the Korea Investment Trust Association. possibly. strengthening incentive compensation schemes for executives. 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. more drastic in nature. The institutions’ respective trade associations. objecting to certain defensive measures proposed by the management. is to restrict ownership of investment trust companies and NBFIs by the five largest chaebols and.150 Corporate Governance and Finance in East Asia. Shareholdings concentrated in investment companies and other institutional investors pose a serious dilemma. and impose stronger penalties on violations of the rules on portfolio investments. Another measure. could prepare such guidelines. an audit committee. and other NBFIs are subsidiaries of chaebols— especially the five largest ones. In the coming years. reviewing independence and expertise of candidates for outside directors. II provide comprehensive guidelines for their actions in matters related to corporate governance. Application of more stringent bankruptcy-related rules to firms in financial distress will effect greater discipline over corporate 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.
private firms. the elimination of implicit guarantees for financial support to chaebols. The Government should put more efforts into developing the capital market. the important issues to be addressed are: (i) improvement of the corporate disclosure system. and introducing disincentive schemes for excessive borrowings. Many corporations are burdened with excessive debt and. lessening the degree of double taxation of dividends (or further reducing personal income taxes on dividends). and financial institutions. In turn. (ii) provision of reliable accounting information. excessively diversified into nonrelated business areas. To facilitate the development of the Korean stock market. Banks should adopt strong incentive compensation schemes for management. and stop unfair internal transactions. Banks need to play a bigger role than they do at present in monitoring corporate investment and management. and (iii) a good corporate governance system to protect investors. Such measures include providing an effective corporate governance system. For this. The Government should substantially reduce the proportion of policy loans from bank loans. In order to minimize government intervention in bank and corporate management.Chapter 2: Korea 151 There still exist widespread concerns that the Government will continue to exercise a great deal of discretionary power over banks. Many concepts regarding good corporate governance are still new to a lot of market players in Korea. Chaebols are overly indebted. Bank boards also need to be made more independent from management. An effective policy package is needed for chaebols to dispose of marginal firms with low profitability at the earliest date. This means that the Government can control the banks and. reduction of protection of domestic markets and entry barriers. bank managers should be made accountable to shareholders but not to the Government. 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. therefore are vulnerable to economic shocks. The public and corporations should be taught or fully informed of the best practices in corporate governance. and consistently show low profit rates. through them. which could provide alternative sources of long-term corporate finance. The current obligatory system of disclosure that emphasizes “hard” . to concentrate instead on a small number of core businesses. such as application of higher interest rates by banks to chaebols with higher DERs. The Government needs to sell off at the earliest feasible dates the bank shares that it acquired in the course of recapitalizing banks. and thus full-scale education programs should be developed. the banks have great leverage over the management of debtor firms. large firms.
on a real time basis.152 Corporate Governance and Finance in East Asia. and labor productivity should be considered. Prevalent corruption. The development of the OTC bond market requires a well-developed dealer system. and bureaucrats. In determining optimal exchange rates. Currently. These should be lengthened to make them a source of stable long-term funds. Another problem with the corporate bond market is that most bonds are issued with maturities of less than four years. II information on past performance needs to be transformed into a system in which corporations voluntarily announce “soft” information on future prospects. wage rates. Without successfully addressing this problem. especially among business people. The establishment of a Corruption Prevention Institute will be helpful in this regard. is considered to be one of the major causes of the economic crisis. Overvaluation of exchange rates should be avoided in order for export and import-substitution industries to stay internationally competitive. More effective punitive means need to be devised to penalize both corporations in violation of disclosure rules and the officers in charge. and measures to reduce corruption. the information system of the bond market should be better organized to transmit. Policies are needed to help develop more reliable services by bond rating agencies. penalties on violations of disclosure rules are not effective enough to have a significant impact. Future research could include causes of corruption. 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. data on quotations and trading volumes. Vol. reasons for different degrees of corruption in various countries. profitability of export industries and real effective exchange rates that account for changes in nominal exchange rates. Maintaining current account surpluses for a considerable period is needed to pay back foreign debts. The function of securities companies as dealers of bonds should be improved. At the same time. no economic reforms will be effective. . The network should cover not only the exchange market but also OTC transactions of investors and dealers. politicians.
The Corporate Board.. . W. various issues. 1997. and H. C. Bank of Korea. 1997. Choi. Market Concentration and Diversification of Business Groups. Bibong Publishing Co. edited by K. W. Is the Fair Trade Policy Fair? Korea Economic Research Institute. Japanese Zaibatsu and Korean Chaebols. Hong. KERI. and 1998 issues. New York: Praeger. Maeil Daily Economic Newspapers. various issues. H. Korea’s Large Conglomerates. Latham. Bank of Korea. 23-26. Chung. 7995. W..). T. various issues. I. Evolutionary Chaebol. Kim. M.Chapter 2: Korea 153 References Bank of Korea. An Empirical Evidence on Value of a Firm and Ownership Structure. 1994. September 1998. H. S. Ju Hyun. Y. KERI. S. 79-95. Determinants of Diversification of Korean Business Groups. S. in Korean Managerial Dynamics. Tomio. Lee. A Study on the Relationship between Ownership Structure of a Firm and Value of a Firm. September/October 1997. W. Chon. September 1997. N. and J. 1999. Cho. 1998. Jua. K. D. Kang. pp. New York: Praeger. Korea Development Bank. Kim. 1998. 1992. Proposed: A Governance Monitor. September 1998. 1989. Korea Economic Research Institute. Jae Woo. Bank of Korea. 1995. S. C. Financial Statement Analysis Yearbook. S. International Monetary Fund. Financial Studies. Lee (eds. pp. Chon. Economic Statistics Yearbook. 1993. Center for Free Enterprise. Korea Economic Research Institute. Hattori. Kwon. K. KERI. Korea’s Financial System. Korean Managerial Dynamics. H. H. 1997. various issues. Chung and H. and K. International Financial Statistics. Survey of Facility Investment Plan. 1997. Financial Studies.. 1996. 1995. Kim. I. 1996. Understanding Flow of Fund Accounts. Corporate Restructuring. 1989. S. C. H. Cho. D. Lee. Lee. Korea’s Chaebol. 1996. pp. Hong Moon Sa.
January 1995. and J. C. 1999. Lim. Korea Institute for Industrial Economics and Trade. Lee. 2nd Sangnam Forum. Corporate Governance in Korea. The Pattern of Ownership Structure and their Characteristics in Korean Conglomerates: With Cases of the 30 Largest Chaebols. 1996. Whan. 1998. K. S. S. H. October 1998. I. Korea’s Economic Progress Report. K. Ministry of Finance and Economy. 23. Yim. Annual Conference of Financial Management Association. S. and H. Chicago. Management Research Institute. Conference on Corporate Governance in Asia: A Comparative Perspective. Lee. Capital Liberalization. 1998.. Nam. Seoul. Whang. J. October 1998. Beyond the Limit. 1998. J. Kang. Wang. Chung Ang University. Business Groups in Korea: Characteristics and Government Policy. I. Korea Institute for International Economic Policy. Korea’s Trade and Industrial Policies: 1948-1998. H. U. Y.154 Corporate Governance and Finance in East Asia. September 1998.. Korea Development Institute and World Bank. 1998. Ungki. Yonsei University. Korea Institute for International Economics and Trade. J. Lim. K. Kim. Background and Task of Structural Adjustment. Kim. KIEP Working Paper 98-05. . A New Trade and Industrial Policy in the Globalization of Korea. 1995. Ungki. March 1999. Korea Finance Institute. C. Sohn. W. Yang. 1999. and J. 1996. November 1996. Vol. Joh. II Lee. Real Exchange Rate and Policy Measures.. Y. The Ownership Structure and Family Control in Korean Conglomerates: With Cases of the 30 Largest Chaebols. S. Y. KIET Occasional Paper No.
Saldaña1 3. The lifting of the debt moratorium in 1991. From 1993 to 1996.3 The Philippines Cesar G. the Philippines. allowed the Government and the corporate sector to gradually access foreign debt markets after a long absence. David Edwards. and Lea Sumulong and Graham Dwyer for their editorial assistance. 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). Inc. PSR Consulting. Serrana.. and government subsidies were tackled during that period. the Philippine Stock Exchange for its help and support in conducting company surveys. the PSR Consulting. for their research assistance. and David Webb of the London School of Economics for their guidance and supervision in conducting the study.1 Introduction In recent years. about a decade before the recent Asian crisis. the Philippine nonfinancial corporate sector had managed its borrowing risks relatively well by largely avoiding imprudent use of debts and risky investments. . Pineda. The Asian financial crisis revealed that. overall. 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. Issues such as State ownership of businesses. The author wishes to thank Juzhong Zhuang. the Philippine corporate sector has played a leading role in the government’s efforts to get the country on track toward sustainable economic development. When the Asian crisis erupted in 1997. Companies of other Asian countries were already using these markets to finance investment and growth. 1 Principal. Inc. and Liza V. staff. This has come about following a political and economic upheaval from 1983 to 1987. the Philippine economy and corporate sector were in a relatively sound financial position. Denise B. Roble. in particular Francisco C. both of ADB. after the completion of debt negotiations with the IMF and Paris Club. aiming at eventually limiting the Government’s role to economic policy setting and allowing the private sector to conduct most economic activity. state-sanctioned monopolies.
The highly concentrated and family-based ownership of corporate groups has resulted in governance structures that depend largely on internal control systems. This study reviews the Philippine corporate sector in terms of its historical development. Investments of large corporate groups tend to focus on obtaining market shares and industry dominance. and responses to the financial crisis. The policy was crafted by the martial law regime at that time. patterns of ownership.1 Overview of the Corporate Sector Historical Development During the 1950s and 1960s. Sugar refining and textile mills are examples of industries that floundered in the 1980s because of government import substitution policies. and on the financial crisis. Government interventions under the notion of “master planning” for economic and social development characterized the 1970s and early 1980s. control by internal and external governance agents. To implement these policies. II Still. Corporate financing relies excessively on bank loans. companies were necessarily large and capital-intensive. Vol. yet they did not risk new capital required for modernizing and expanding manufacturing capacity. Companies were profitable because of protection from foreign competition. These early industrialists naturally opposed any initiative to reduce tariffs. their growth could not be sustained.2. which leads to their easing of due diligence and monitoring standards when lending to group members.2 3. regulatory framework. 3. But protectionist policies made labor relatively more expensive and. Banks have significant presence as members of affiliated business groups. composed mostly of families previously in trading businesses. the corporate sector showed structural weaknesses similar to those in neighboring Asian countries. the Government overvalued the local currency and imposed high import tariffs. on family-based and controlled conglomerates. It analyzes the impact of corporate governance on company financial performance and financing. nationalist sentiments led to policies that favored import substitution and heavy government intervention in business. patterns of financing. An industrial elite. Companies finance long-term investments with short-term debt. usually with the acquiescence of bank creditors. The Board of Investments (BOI) was created to draw up an investment priorities .156 Corporate Governance and Finance in East Asia. While new manufacturing industries were successfully established. therefore. emerged to influence industrial policies.
and initiated the development of alternative energy sources in response to the oil crises. the legislative body passed the Foreign Investment Act (FIA).. The FIA allowed foreign equity investment in many areas and at the same time provided a transparent. In 1991.e. The high industrial concentration led to practices of price leadership and output restrictions and the rise of industry lobby groups—common features of an oligopolistic . and import licensing requirements. BOI incentives retained a strong bias in favor of capital-intensive enterprises and domestic-oriented industries. and orientation toward domestic markets. advance notice of areas where the country disallowed or restricted foreign investment.Chapter 3: Philippines 157 plan (IPP) to encourage private sector investments by offering tax and other incentives. dominance by large companies. Nevertheless. It limited the bureaucratic cost and discretion that accompanied the necessary approvals of foreign investments. Following government initiatives in the control of the infrastructure and utilities sectors. the Government narrowed the range of tariff rates by commodity categories and reduced the average tariff rate from 28 to 20 percent. Foreign ownership was allowed only in industries with high technological and market barriers. Quantitative restrictions and tariff protection of preferred industries remained firmly in place. Exports were not competitive because of the high costs of imported materials. In the early 1990s. made less associated with capital investments. The Government signaled through the IPP its intent to shape the future industrial landscape.” No strategic industry could take off without the Government’s participation in its management and operations. The 1980s were marked by a peaceful transition of political power. assumed ownership of the largest petroleum refining company. including the reduction of tariffs. the “pioneer” industries identified in the IPP. quantitative restrictions. Reforms in policies. the top three companies accounted for a disproportionately large share of total sales and assets. and oriented toward exports. i. Probably the most significant effects of tariff protection and biases for capital intensity were the corporate sector’s high degree of concentration. the Government continuously revised the enabling law of BOI so that incentives were reduced in number. the State took over the generation and distribution of electricity. clearly shifted economic management toward reliance on markets rather than on decisions by bureaucrats in the Government. Starting in 1981. Better access to cheaper imported raw materials improved the competitiveness of local manufacturers. organizing industries into sectors and picking “winners. In many industries.
1 5.0 (6. II market.2) 0.2. Key Indicators of Developing Asian and Pacific Countries 2000.8 10.2 (0.3 7.7 5.5 8.9 7. Its growth rate began to catch up with others in 1996.7 Malaysia 9. A comparison of the Philippines’ economic performance in terms of real gross domestic product (GDP) growth with selected countries in Southeast Asia places the succeeding review of the corporate sector’s performance in context.7) 10. Table 3.7 (13.2 Thailand 11.9 5.8 4.3 8.0 7.4 4. net sales of the top 1. competition from liberalized imports had somewhat reduced oligopolistic tendencies and concentration in many industries. only to be unsettled by the crisis of 1997.3 2.8 percent growth in fixed 2 The SEC-BusinessWorld Annual Survey of the Top 1.4 Philippines 3.6) 0.5 (7.2 8. which was taken as a representation of the Philippine corporate sector.000 Philippine companies grew 17.8 5.0 8.2) 4.2 During 1988-1997.7 8.6 7.8 5.7) (10.2 Source: ADB. .5) 5. Rep.8 8. only nonfinancial companies were used.3 9.5 8.2 7.2 Korea.0 8.000 Corporations covers financial and nonfinancial companies. The Philippines substantially lagged behind other countries from 1990 to 1995 (Table 3.2 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. however.1).9 6.158 Corporate Governance and Finance in East Asia.1 4.2 7.1 GDP Growth of Southeast Asian Countries.1 5.000 corporations. Vol.5 percent per year (Table 3.2). With economic reforms introduced in the 1980s and 1990s. 3.1 8. In this section.3 9. 1990-1999 (percent) Year 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 Indonesia 9.9 (1.0 (0.5 9. This rate of growth was sustained by a comparable 18.2 9. of 9.8 8.5) 3.
8 902 1.5 446.4 260.5 1.000 Companies.8 26.5 64. 1988-1997 1989 519.6 149 12.2 4.9 2.209.1 468.2 136.7 443.8 22.4 555.2 Compound Growth (%) 17.6 896 0.332.3 941.9 952.4 3.5 887 0.1 714.7 20.8 741.317. net profit margin = net income/net sales.9 629.3 46.1 54 11.2 2.5 72 7.5 14.1 72.2 Indicators 1988 Growth Indicators (P billion) Net Sales Net Income Fixed Assets Total Assets Total Liabilities Stockholders’ Equity Retained Earnings 464.4 602.0 900 1.5 1.6 900 1.6 954.4 898 1.5 570.512.5 51 4.7 73 6.1 881.4 63.8 5.6 1.225.0 1.6 426. return on assets (ROA) = net income/total assets.6 5.3 121 12.1 66 12.131.8 77 7.8 618.3 862.6 1990 1991 1992 1993 1994 1995 1996 1997 1.8 6.6 18.978.9 896 2.6 102 16.893.4 Financial Ratios (%) Leverage ROE ROA Turnover Net Profit Margin 222 14. return on equity (ROE) = net income/ stockholders’ equity.1 33.5 192. of Companies Sales per Company (P billion) 899 0.4 8.9 898 1.7 218.2 2.6 35.191. .2 1.7 903 0.2 707. Source: SEC-BusinessWorld Annual Survey of Top 1.1 4.2 27.1 615.9 78 6.1 5.000 Corporations in the Philippines.9 480.1 1.3 60 10.5 193.4 776.3 382.4 861.177.6 75 6.647.6 144.8 4.3 107 13.2 900.1 181 11.7 1.9 3.0 1.160. turnover = net sales/total assets.1 73 5.3 898 1.341.2 Average 146 12.1 Other Indicators No.4 188.394.2 378.4 1.6 109 12.1 1.7 28.9 96.9 617.1 51.5 Leverage = total liabilities/stockholders’ equity.8 411.3 68 7.7 238.2 Growth and Financial Performance of the Top 1.5 508.6 290.Table 3.9 149 6.9 1.0 148.781.561.5 1.7 1.3 306.5 119 12.123.4 411.2 338.1 95.1 197 14.5 4.697.1 6.
4 20. These rates of return are high compared with other Asian countries. Vol.8 19. 1988-1997 Top 1. various years.178 1. This is high compared with developed countries but compares favorably with other Asian countries. The data suggest no evidence of excessive borrowing in the run-up to the crisis in 1997.077 1.693 1.4 24. respectively.3 The Corporate Sector and Gross Domestic Product. indicating that the corporate sector’s exposure to foreign currency-denominated loans was not as significant as in other countries.8 percent per year.2 percent.1 Net Sales (P billion) 465 519 630 741 862 954 1. Return on equity (ROE) and return on assets (ROA) averaged 12. and by equity that grew at a higher average annual rate of 26.5 17. The debt-toequity ratio ranged from 222 percent in 1988 to 102 percent in 1994.394 1.474 1. Assuming Table 3.7 percent. Sources: ADB.3 percent.5 Ratio of Estimated Value Addeda to GDP (%) 17. Asset growth was funded by debt that grew at an average of 20.248 1.160 Corporate Governance and Finance in East Asia.8 17. II assets.000 Companies Year 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 Average Growth (%) a GDP (P billion) 799 925 1. Net profit margins for the top 1.9 21.1 19.979 17.6 percent and 5.352 1. for the 10-year period.3).427 13. Key Indicators of Developing Asian and Pacific Countries 1999.172 2.5 16. Total assets grew at an average annual rate of 22. leverage increased from 109 percent in 1996 to 149 percent in 1997. The growth rates of corporate sales for the period 1988-1997 exceeded those of the country’s GDP for the same period (Table 3. and the SEC-BusinessWorld Annual Survey of Top 1.9 percent for the period. Further.000 companies averaged 7.5 Value-added is assumed to be 30 percent of net sales. but the extent of the increase was not as dramatic as in other Asian countries.906 2. .000 Corporations in the Philippines.9 23. Net income consistently increased from 1988 to 1996 and declined only in the crisis year 1997.697 1.
4 28.000 Corporations in the Philippines.9 196 1.9 26.0 5.8 3.4).0 4.5 GovernmentOwned 4.0 Turnover 53 Net Profit Margin 15.0 31. %) 17. Averaging 42.0 142 22.9 17.5 27. (ii) foreign-owned. A study of company performance by ownership type.8 No. The foreign-owned companies were the Table 3.8 percent of the corporate sector’s total sales between 1988 and 1997.7 22. privately owned companies constituted the largest group (Table 3.8 ForeignOwned 21. corporate control structure.9 22.5 Retained Earnings 30.4 190 5.5 23 4.7 2.0 Net Income 19. (iii) Government-owned.3 9.1 22 10.6 Total Assets 29. Performance by Ownership Type The Philippine corporate sector can be categorized into four groups based on ownership: (i) publicly listed.1 ROA 8.8 Growth Indicators (Compound Annual Growth Net Sales 20.8 14.1 12.2 103 5.5 Other Indicators Share of Sales (%) 17.4 Total Liabilities 26.8 22.3 22.5 Source: SEC-BusinessWorld Annual Survey of the Top 1. 1988-1997 Indicators Publicly Listed Privately Owned Rate.8 2. of Companies 73 Sales per Company (P billion) 2. various years.3 11.9 158 13.4 Fixed Assets 19. and industry reveals further structural characteristics of the growth and financial performance of the corporate sector.Chapter 3: Philippines 161 a constant ratio of value added to sales. and (iv) privately owned.3 146 6. The premise is that these variables have a direct bearing on corporate performance and growth.3 27.3 22. .4 Stockholders’ Equity 32.3 42.4 Growth and Financial Performance of the Corporate Sector by Ownership Type.1 Financial Ratios (%) Leverage 89 ROE 15.2 9. these figures suggest a significant and increasing contribution of the corporate sector to GDP. size.0 5.8 606 0.0 28.
000 companies in 1997. a level high by Western standards but at par with those of other Asian countries. were among the top 1. The compound annual sales growth rate was 21. reflecting the significant presence of holding companies as the gross revenues of holding companies flow through to operating income.2 percent and ROA of 9. Privately-owned and Government-owned companies grew at slower rates. with an average ROE of 22.000 list. However. 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. meaning that the remaining 62 percent were relatively small in sales and assets. and low return on investment is the norm.1 billion per company in 1997.5 percent average growth rate of the entire corporate sector. compared with P2. Publicly listed companies had the lowest leverage at 89 percent. followed by publicly listed ones. the highest net profit margin of 15. Their ROA and ROE were both more than twice as high as those of government-owned companies. The privately-owned companies were only about one third of the average size of per company sales of the publicly listed companies. Only 84 of the 221 public companies listed on the Philippine Stock Exchange (PSE). 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. Vol. they generated the highest return on investments. registered the largest per company sales at about P9 billion in 1997. With an average leverage ratio of 142 percent. . These were mostly large public utilities. although small in number.3 percent. Governmentowned companies in the top 1. exceeding the 17. while there were few of them.75 billion per company for foreign-owned companies. the second best ROE and ROA. Bases Conversion Development Authority.5 percent. these companies were comparatively large. Publicly listed companies had a minor though steadily increasing share in total sales. and government-subsidized agencies such as the National Food Authority and Local Water Utilities Administration.8 percent for foreign-owned companies and 20 percent for publicly listed companies during 1988-1997. or 38 percent.162 Corporate Governance and Finance in East Asia. but lower than those of foreignowned and publicly listed companies. foreign-owned companies borrowed more than publicly listed ones. the asset base is large. II second largest at about 27. The privately-owned companies had a high average leverage ratio of 158 percent. selling an average of P4. But by being most efficient in employing assets. and the second lowest asset turnover.9 percent.
The independent companies contributed about 56 percent of corporate sales on average during the period 1988-1997.3 percent for the conglomerates.7 Stockholders’ Equity 34.1 124 5.5 Growth and Financial Performance of the Corporate Sector by Control Structure.0 55. 1988-1997 Indicators Group Member Independent 18.2 23.0 Turnover 67 Net Profit Margin 12. various years. %) Net Sales 20.3 Total Liabilities 30.0 25. and small companies. medium.000 Corporations in the Philippines. the corporate sector is divided into large. Performance by Firm Size By firm size.2 Fixed Assets 25. grew faster.8 ROA 8.4 24.1 Source: SEC-BusinessWorld Annual Survey of Top 1.3 Financial Ratios (%) Leverage 98 ROE 15. But the conglomerates were larger measured in sales per company.7 2.6 26.6 715 0.8 Growth Indicators (Compound Annual Growth Rate.3 No.0 22. of Company 159 Sales per Company (P billion) 2.7 Total Assets 32.0 166 15. compared with 32. depending on assets and sales. Sales and resources of the .1 Retained Earnings 32.8 6.3 Other Indicators Share in Sales (%) 32.Chapter 3: Philippines 163 Performance by Control Structure By control structure. a company can be a member of a conglomerate or independent.5). and achieved higher returns on invested assets than independent companies (Table 3. Table 3. had a lower leverage ratio.2 Net Income 21.
1 ROA 5. for this study.4 28.8 percent of the total number of companies in the list (Table 3.1 No.000 list. although they comprised only 8. %) Net Sales 15.0 32.2 Other Indicators Share in Sales (%) 56.1 percent of the total sales of the corporate sector.7 Net Income 1.0 7. referring to the remaining companies in the list.5 12. However. Table 3.9 Retained Earnings 13.1 25.2 29.3 Turnover 65 Net Profit Margin 8.9 89 1. 1988-1997 Indicators Large Medium 19.6 Small 19.0 156 16.5 73 6.2 25.6 Growth and Financial Performance of the Corporate Sector by Firm Size.5 25.1 4. defined in this study as the next 200 largest companies in the top 1.4 Total Liabilities 18.164 Corporate Governance and Finance in East Asia. averaged a far less P3 billion in per company sales.5 128 10. averaging 16 percent.9 Financial Ratios (%) Leverage 158 ROE 13. Large companies accounted for 56.000 Corporations in the Philippines.000 list. which. Vol.6 49. indicating that they deployed resources more efficiently than large and small companies.2 Stockholders’ Equity 18. Medium-sized companies also performed better in terms of ROE.9 26.1 81 9.6). Medium-sized companies. are defined as the largest 100 companies in the top 1.3 Source: SEC-BusinessWorld Annual Survey of Top 1.9 32.5 Total Assets 18. .6 31.3 Fixed Assets 15. while small companies. averaged only P920 million in per company sales during the same year. various years. sales of mediumsized companies grew faster than large companies.7 44. II Philippine corporate sector are highly concentrated among the large companies. of Companies 79 Sales per Company (P billion) 7. Sales per company in this group averaged P13.5 Growth Indicators (Compound Annual Growth Rate.0 730 0.6 47.6 36.4 billion in 1997.
at -12. assets. For small companies. ROE dropped from 10. Net income declined from P54. The leverage ratio of the manufacturing sector was higher than that of the real estate and property sector. are shown in Table 3.2 billion in 1997 for this sector.7 percent a year earlier. Large. The real estate and property sector also suffered significantly in sales. profits. Mediumsized companies’ leverage level was slightly lower. at 128 percent for the period.Chapter 3: Philippines 165 Small companies. as indicated by the negative annual growth.7 percent in 1997 for medium-sized companies. with their ROE dropping to 3. although the largest in number.e. compared with 9.1 percent. net income. reflecting to some extent a “bubble” phenomena in the former two sectors. unlike their counterparts in other Asian countries.6 percent. showed the lowest ROE. and construction. Performance by Industry This study also looked at corporate performance by industry. and equity up to 1996.8 billion in . The growth and financial performance of selected industries.2 percent for large ones.8 the previous year.5 percent for medium-sized companies and 8. but suffered its largest decline in net profits in 1997.4 percent in 1997 from 11.1 billion in 1996 to P4.7. real estate.7 billion and P35. at 156 percent.8 percent. The Asian financial crisis affected large companies most severely. 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.8 percent in 1997. But small companies’ leverage was significantly lower. Poor returns appear to have been caused by the low profit margin at 6.and medium-sized companies did not substantially increase their leverage in years running up to the crisis in 1997. and utilities and services sectors. from 14. Leverage was the highest for large companies. and utilities and services sectors. especially during the period 1994-1996. and profitability in 1997 when the crisis started. Sales revenue and net income declined from P76. averaging 10. i. and assets was much higher for the real estate and property. Growth of sales. Medium-sized companies apparently enjoyed efficiencies associated with economies of scale and made more productive use of their assets.. utilities. at 158 percent on average during 1988-1997. manufacturing. net income. ROE dropped to 7. specifically those industries least and most affected by the financial crisis. of net income.7 percent in 1996 to 8. and the construction sectors than for the manufacturing. The sector showed consistent growth in sales. but lower than that of construction.
2 8.8) 17.6 Financial Ratios (%) Leverage 142 181 ROE 13. .8 Stockholders’ Equity 21. various years. of Company 454 17 Sales per Company (P billion) 1.7 19.2 45.000 companies’ total sales on average during 19881997.9 17.7 52.7 Net Income (12. With a modest increase in total liabilities and leverage level of less than 100 percent in 1997.0 25.9 2.7 ROA 5.4 16. Vol.5 12.7 10.4 Total Assets 19. respectively.9 billion and P24. The sector’s buildup in equity during the stock market boom of 1994-1996 may have cushioned the impact of the crisis.3 Retained Earnings 17. 1988-1997 Utilities Real Estate and and Services Property 39. 1996 to P56.1 10.6 69 16. But the impact of the Asian crisis on the real estate and property sector was much smaller than that on the manufacturing sector. and was also much more limited compared with the property sectors in other Asian countries.4 3.166 Corporate Governance and Finance in East Asia.7 83 2.4 percent.7 percent to 10. it does not appear to have been excessively exposed to foreign currency-denominated loans.4 Source: SEC-BusinessWorld Annual Survey of Top 1.6 No.0 31 0. the sector’s ROE dropped from 15.7 192 9.8 48.7 28.3 20.3 5.8 41.4 19. As a result.1 2.000 Corporations in the Philippines.2 37.7 billion in 1997.0 23.1 24 42.0 Turnover 112 24 Net Profit Margin 5.3 Fixed Assets 20.6 Total Liabilities 18.2 12.9 23.7 Indicators Manufacturing Construction 27.6 Growth Indicators (Compound Annual Growth Rate. II Table 3.3 55.9 5.9 2. Its knock-on effect on the economy was small as it accounted for less than 3 percent of the top 1.2 28 0. %) Net Sales 16.0 21.7 Growth and Financial Performance of the Corporate Sector by Industry.5 Other Indicators Share in Sales (%) 82.
The articles of incorporation may also include other matters such as waiver of preemptive right and classes of shares such as founders’ or redeemable shares describing their rights. and residences of incorporators and directors.Chapter 3: Philippines 167 The utilities sector had the second highest leverage during 19881997 at 181 percent on average. 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. Corporation Code of 1980 Supplanting the old Corporation Law of 1906. reaching up to 313 percent in 1997.3 Legal and Regulatory Framework The Corporation Code of 1980 is the main law governing the corporate sector. and amount of authorized capital stock. . operation. the leverage of all four industries was low. and amount subscribed and paid by each. It provides the basic constitutional structure for the organization. unlike in neighboring countries hit by the Asian crisis. nationalities.2. which is also the organic law governing the operations of SEC. Under the Code. (v) number of directors (not less than five nor more than 15). which was based on American corporate law. the Corporation Code of 1980 is a compilation of important juridical rulings. par value. and the Insolvency Law. and restrictions. (ii) purpose of the corporation. which regulates banks and nonbank financial institutions except insurance companies. and recognized rules on corporate practices. the Revised Securities Act (RSA) and PSE’s public listing requirements also apply.3 which serve as the company’s declaration that the minimum percentage of authorized capital required by law has been subscribed and paid-up. One month after registration. and (viii) names. The currency devaluation bloated the foreign currency-denominated loans of these companies. and dissolution of corporations. and residences of original subscribers. The General Banking Law. Two other pertinent laws are Presidential Decree (PD) 902-A. (iii) principal office. (iv) term of existence. Overall. 3. For publicly listed companies. the Code requires a corporation 3 A company’s articles of incorporation should include: (i) corporate name. privileges. administrative regulations. (vii) number. It specifies the minimum information to be indicated in the articles of incorporation. nationalities. (vi) names. contains some provisions affecting corporations’ dealings with banks. the ownership of Filipino citizens in the corporation is not less than the legally required percentage of capital stock.
manner of voting. (ii) controversies arising out of intra-corporate relations.168 Corporate Governance and Finance in East Asia. must be general. and control (adjudicative) of all corporations. officers. 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. (ii) required quorum in shareholders’ meetings. uniform. or officers. and (vii) manner of issuing certificates in the case of stock corporations. (vi) penalties for violation of the bylaws. However. Vol. It implements rules and regulations that protect minority shareholders from possible fraud and misbehavior by controlling shareholders. and forms of proxies and manner of voting them. place. . In addition. duties. A majority of the outstanding shares of shareholders must vote to authorize amendments to the bylaws. shareholders may delegate this power to the board of directors by a two-thirds vote of outstanding capital stock. between the shareholders and the corporation. and between the corporation and the State concerning its franchise or right to exist. 4 Some of the items that a corporation may provide in its bylaws are the following: (i) time. and reasonable. (iii) qualifications. II to adopt a code of bylaws or rules for its internal governance. and compensation of directors. PD 902-A expanded SEC’s mandate to include absolute jurisdiction. (v) manner of election or appointment and term of office of all officers other than directors. and manner of calling and conducting regular or special meetings of the directors and shareholders. and should not impair vested rights. supervision (regulatory). and public policy. the corporation’s articles of incorporation. 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. directors. Its mandate is to supervise corporations in order to encourage investments and protect investors. (iv) time for holding annual election of directors and manner of giving the election notice. (iii) controversies in the election or appointments of directors and officers of corporations.4 Philippine corporate law distinguishes between management decisions that require only a majority vote of the board and major decisions that require a two-thirds majority vote of shareholders. and employees. To be valid. 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. In 1976. among shareholders.
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The last item of PD 902-A is the special jurisdiction granted to SEC over applications by corporations for “suspension of payments” to creditors, a role of the regular courts that was originally part of the Insolvency Law. Under this authority to approve applications for suspension of payments, SEC has the power to appoint rehabilitation receivers or management committees for petitioning corporations. A presidential writ issued in 1981 placed SEC under the supervision of the Ministry of Finance, but in 1998, control of the agency was returned to the Office of the President. Insolvency Law The Insolvency Law is designed to effect an equitable distribution of insolvent debtors’ properties among their creditors. It permits debtors to be discharged from their liabilities to enable them to start afresh with property set apart for them from assets to be used as payment to creditors. The regular courts have jurisdiction for insolvency proceedings including suspension of payments for individual debtors. A debtor can petition the court to suspend payment of debts or to be discharged from liabilities and debts by voluntary or involuntary insolvency proceedings. Revised Securities Act: Law on Securities Dealing Like its predecessor, the 45-year-old Securities Act, the RSA was patterned after several US securities acts. The RSA is primarily designed to prevent the exploitation of investors through the sale of unsound or fraudulent securities. For this purpose, the law requires full and accurate disclosure of all material facts concerning the issuer and the securities it proposes to sell, and prohibits misrepresentations, manipulations, and other fraudulent practices in the sale of securities. To enforce these regulations, the law requires the registration of securities. The registration requirement covers full and accurate disclosure of the character of the securities to be sold to the public, including detailed information regarding past dealings between the issuer and its directors, officers, and principal shareholders. Public Listing Rules of the Philippine Stock Exchange PSE is the country’s facility for secondary trading of shares of publicly listed companies. In 1998, SEC, which originally supervised PSE, granted the exchange the status of a “self-regulated” organization. Thus, PSE now
170 Corporate Governance and Finance in East Asia, Vol. II
has the authority, within general guidelines set by SEC, to set rules and regulations for PSE members and listed companies. The general requirements for maintenance of listed status include submission of financial reports that conform with generally accepted accounting principles (GAAP) and regulations established by PSE, and compliance with laws relating to securities and exchange regulations, board resolutions, and agreements executed with the agency. Violations of PSE requirements are subject to sanctions, including delisting. PSE is responsible for ensuring that listed companies follow the exchange’s rules of disclosure and fair treatment of investors. It has the power to impose sanctions on any company that fails or erroneously discloses material information that affects the rights and benefits of investors and misrepresents information in its application, prospectus, financial statements, or reports. In the area of corporate governance, PSE requires corporations to resolve, and, where possible, eliminate arrangements within groups of companies and own-company dealings that can lead to conflicts of interest. Upon complaints by minority investors, PSE can review the deals in question, using such criteria as benefits to the company, adequate disclosure to shareholders, and internal control procedures to ensure fair and reasonable terms. Banking Laws Affecting Corporations Some aspects of banking laws affect the governance of corporations. The important ones concern: (i) the capacity of officers of corporations to assume positions as members of the board of directors of banks, (ii) limits on ownership of banks by nonfinancial corporations, (iii) limits of lending by banks to corporations, and (iv) rules on lending to directors and other insiders. The General Banking Law governs the regulation of the establishment, management, and operations of banks. As the highest policymaking body of the banking system, the Monetary Board prescribes the qualifications of bank directors and reviews the qualifications of those appointed as bank directors and officers. It could disqualify anyone found, for whatever reason, unfit for the position. There are no other restrictions on corporate officers to be appointed as members of the board of directors of banks. A corporation, including its wholly or majority-owned subsidiaries, can own common shares of banks up to a maximum of 30 percent of banks’ voting stock. In the event that the corporation is majority-owned by one person or by relatives, the limit is 20 percent of banks’ voting shares.
Chapter 3: Philippines 171
Regulations on the single borrower limit (SBL) put a ceiling on the maximum amount that a bank can lend to a debtor. SBL rules limit the total liabilities of any borrower of a commercial bank to 15 percent of the bank’s unimpaired capital and surplus, and an additional 15 percent for “adequately secured loans,” to a maximum 30 percent (“unimpaired capital and surplus” refers to the total paid-in capital, surplus, and undivided profits, net of valuation reserves of a bank). SBL limits exclude risk-free loans such as Government-guaranteed loans and loans secured by cash deposits. Total corporate liabilities include all liabilities of the debtors and their majorityowned subsidiaries. The Monetary Board may prescribe the consolidation of the liabilities of subsidiaries with the parent corporation under certain conditions. Central Bank (Bangko Sentral ng Pilipinas [BSP]) regulations do not prohibit loans by the bank to its directors, officers, shareholders, and other related interests, known as DOSRI. However, they are subject to certain prudential requirements under banking laws, as follows: (i) a director or officer of a bank can only borrow or become a guarantor, endorser, or surety for loans from the bank with the written approval of all other directors of the bank (i.e., excluding the director concerned); (ii) the amount of outstanding credit accommodations that a bank extends to its shareholders shall be limited to an amount equal to the sum of their unencumbered deposits and book value of their paid-in capital contributions; and (iii) loans and advances given to officers in the form of fringe benefits shall not form part of liabilities under DOSRI.
Corporate Ownership and Control Patterns of Corporate Ownership
The historical development of Philippine corporate ownership is rooted in the country’s colonial past, the industrial policies of the Government, and the recent emergence of industrialists and an entrepreneurial class. During the Spanish and American period up to World War II, a small number of families acquired land and owned large businesses. These families built and preserved their businesses over several generations. Many of them became controlling shareholders of family-based corporations and business groups that are major players in the present-day Philippine corporate sector. Ownership is a key element in corporate control and governance. Public listing rules of PSE require that a minimum of 10 to 20 percent of
172 Corporate Governance and Finance in East Asia, Vol. II
outstanding shares, depending on the size of the company, be available for trading in the stock exchange. As companies usually only issue the minimum required number of shares, large blocs of controlling shareholders often dominate corporate decision making in publicly listed companies. Public investors and minority shareholders are not in a position to influence management. Moreover, the presence of large controlling shareholders makes takeovers by other companies difficult. For these reasons, the resolution of conflicts between the interests of controlling shareholders, minority shareholders, public investors, and creditors in Philippine companies depends very much on the effectiveness of internal control systems. Ownership Concentration of Listed Companies This study measures ownership concentration in terms of shareholdings by the top one, five, and 20 shareholders.5 Table 3.8 shows that the top shareholder owned 40.8 percent of the market value of an average nonfinancial company. The shareholding of the top shareholder varied across sectors. It was highest for the property sector at 54.8 percent, followed by holding companies (as a sector) at 53 percent. One shareholder held majority control of an average company in these two sectors. The average shareholding of the largest shareholder was less than 25 percent only in sectors with large market capitalization, such as power and energy, and transportation, and in sectors with high risks, such as oil exploration and mining. These figures suggest that for publicly listed companies, a single shareholder often has substantial or even dominant control. Combined, the holding of the top five shareholders in an average company was about 65.3 percent for the nonfinancial sector and 59.2 percent for the financial sector. The five largest shareholders held majority control over an average Philippine publicly listed company, except in three sectors—transportation; food, beverage, and tobacco; and oil exploration. Ownership by the five largest shareholders was on average most concentrated among holding companies (78.4 percent), and in construction (74 percent), property (69.8 percent), manufacturing and trading (68.4 percent), and communications (67.3 percent).
The study derived ownership data for 194 (169 nonfinancial) companies out of 221 (190 nonfinancial) listed on the Philippine Stock Exchange as of 1997. Shareholdings by the top one, five, and 20 shareholders were estimated for each company and averaged by using the market capitalization of each company as a weight.
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Table 3.8 Ownership Concentration of Philippine Publicly Listed Companies by Sector, 1997
Sector Financial Institution Banks Financial Services Average Shareholdingb Nonfinancial Company Communication Power and Energy Transportation Services Construction and Other Related Products Food, Beverage, and Tobacco Holding Companies Manufacturing, Distribution, and Trading Hotel, Recreation, and Other Services Property Mining Oil Average Shareholdingb
Top 1 26.9 41.3 27.2 35.4 21.5 23.8 47.7 22.7 53.0 37.4 28.9 54.8 23.4 19.9 40.8
Top 5 59.2 63.2 59.2 67.3 55.4 48.4 74.0 44.1 78.4 68.4 55.3 69.8 56.0 45.1 65.3
Top 20a 76.4 65.8 76.2 76.9 72.1 69.2 86.2 69.7 86.0 42.6 68.0 74.5 51.9 64.3 75.9
Information on the top 20 shareholders is not available for five holding companies, 10 manufacturing companies, and two property companies. b Weighted by market capitalization. Source: PSE databank.
The shareholding of the 20 largest shareholders in an average company was 75.9 percent for the nonfinancial sector and 76.2 percent for the financial sector. In 12 out of 13 sectors, the top 20 shareholders owned more than 50 percent of the voting shares of an average company. In 10 out of 13 sectors, the top 20 shareholders held more than a two-thirds majority control of an average company. Ownership Concentration at Critical Levels of Control PSE listing rules require that a minimum of 10 to 20 percent of outstanding shares of a company be issued to the public, depending on its size. An interesting question is whether in reality Philippine publicly listed companies issue enough shares to be truly widely held or whether they barely meet this minimum requirement. The answer to this can be gleaned from an
There are advantages to establishing pure holding companies. which are mostly privately owned and controlled by family-based shareholder blocs. or almost 75 percent of the total. large and family-based shareholders pool the family’s ownership over many . The limited volume of shares issued to the public is one of the causes of the underdevelopment of the Philippine stock market. Composition of Ownership of Publicly Listed Companies Another important issue concerning corporate ownership is the composition of the controlling shareholders. or 51 percent of the total. or 78 percent of the total. five. In four of 11 nonfinancial sectors. In 21 companies. Who are the top one.1 percent of publicly listed companies in the Philippines in 1997. nonfinancial corporations held majority control.174 Corporate Governance and Finance in East Asia.10. In four companies. or 3 percent of the total. 66 percent (signifying strategic control). Table 3. In 116 companies. Vol. a single owner owned more than 80 percent of outstanding shares. the top five controlling shareholders were classified into eight groups. the top five shareholders held more than two-thirds majority control of a company.9 shows that in 44 companies. In 111 companies. including pure holding companies. Through these. and 20 shareholders? In Table 3. Nonfinancial corporations with controlling shareholdings are likely to be holding companies. In 76 companies. or 14 percent of the total. The largest group is nonfinancial corporations. and share prices are sensitive to movements of foreign funds. controlling an average of 52. or 20 shareholders owned more than 50 percent (signifying operating control).2 percent of outstanding shares of publicly listed companies. II analysis of the number of companies in which the top one. holding only an average of 2. Individuals did not constitute a significant shareholder group among the top five shareholders. With such high levels of ownership concentration. five. a single shareholder held two-thirds majority control. a single shareholder held operating control of a company. or about 30 percent of the total. Parent companies usually spin off operating units into new companies that they continue to control as affiliates. the top five shareholders owned more than 50 percent of the voting shares. or 80 percent (only nominally publicly listed) of outstanding shares. 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. The shares of publicly listed companies are thinly traded and illiquid. the top 20 shareholders collectively owned a majority of a company’s shares.
and Tobacco Manufacturing.9 Ownership Concentration at Critical Levels of Control Over Publicly Listed Companies. Distribution. 10 manufacturing companies. 1997 % of Firms with Top Shareholders Controlling more than 50% of Shares Top 1 30 40 50 20 31 — 14 24 30 90 80 86 72 73 50 57 72 74 100 87 93 36 82 100 100 80 78 20 13 43 8 14 — — 8 14 70 60 57 48 49 50 14 52 51 Top 5 Top 20a Top 1 Top 5 Top 20a 90 80 86 36 76 100 71 76 72 % of Firms with Top Shareholders Controlling more than 66% of Shares % of Firms with Top Shareholders Controlling more than 80% of Shares Top 1 — 13 7 — 2 — — — 3 Top 5 40 33 50 28 27 50 — 28 30 Top 20a 60 67 64 20 47 50 43 36 45 Sector Communication Construction Food. Beverage. a Data for top 20 shareholders were not available for five holding companies. and Trading Holding Power Transportation Property Total — = not available. Source: PSE databank. and two companies in the property sector. .Table 3.
6 0. Source: PSE Databank.3 26.0 0.9 52. Distribution.2 3.1 5.6 18.0 1.5 13.0 10.2 3.3 0.2 1.3 0.0 0.0 0.7 0.0 0.6 33.9 0.3 5.0 0.6 0.0 1.6 0.1 1.Table 3.1 7.1 a Weighted by market capitalization.3 37.2 3.0 1.1 8.8 0.7 0.0 0.2 0.0 0.4 8.0 0.8 11.2 59.3 0.10 Composition of Top Five Shareholders of Philippine Publicly Listed Companies by Sector.0 5. 1997 (percent) Nonfinancial Investment Nominee Commercial Company Trust Fund Company Individual Bank Government Securities Broker Insurance Company Sector Financial Company Banks Financial Services Average Shareholdinga Nonfinancial Company Communication Power and Energy Transportation Services Construction and Other Related Products Food.2 0.9 6.6 2.6 0. Beverage. Recreation.0 0.0 0.9 36.5 2.2 0.0 5.1 6.0 1.6 5.4 1.6 0.2 0.5 0.4 0.6 9.5 4.7 0.4 5.0 2.5 0.7 3.0 1.2 5.0 1.0 0.4 2.6 1.0 5.7 0.0 7.0 1.0 4.2 10.8 0.0 45.0 2.8 66.0 0.5 12.3 1.1 0.5 4.1 9.6 0.3 2.8 0.5 26.0 0.7 1. and Other Services Property Mining Oil Average Shareholdinga 33.7 0.7 3.0 5.3 1.0 0.7 0.0 1.2 3.7 67.8 21.6 2. and Trading Hotel.5 53.6 0.1 0.0 0.3 5. .3 12.4 29.4 19.2 0.6 12. and Tobacco Holding Companies Manufacturing.3 0.9 0.3 0.
and San Miguel Corporation (SMC) in food and beverages. The 7.5 to 12. Investment trust funds were the most important institutional investors. securities brokers (1. accounting for P258.6 billion or 26.Chapter 3: Philippines 177 companies and share in the risks and profits of the group.6 percent of market capitalization in 1997. . These are mainly the Social Security System (SSS) and the Government Service Insurance System (GSIS). The financial institutions among the top five shareholders of nonfinancial corporations are investment trust funds (with 4.1 percent). respectively. These include Philippine Long Distance Telephone Company (PLDT) in telecommunications. As a group.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. with an average of only 7. They can also better manage their income taxes because income from affiliated companies passes through a holding company.3 percent). This complex layering of ownership masks the identity of individuals or families that actually own and control operating companies. while still allowing the public to own minority shares. commercial banks (1. Holding companies were themselves 66 percent owned by other nonfinancial corporations. These institutions keep a stock portfolio mostly in shares of a few companies with large capitalization and high liquidity in select industries.7 percent of market capitalization of the nonfinancial publicly listed companies. and insurance companies (0. Petron and MERALCO in power and energy. 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. Such advantages have contributed to the popularity of holding companies among publicly listed companies. there was no real market for investment information. 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. Because of limited ownership by institutional investors. The investment funds’ presence in these sectors ranged from 8.2 percent in 1997. Holding companies as a sector had the largest market capitalization in PSE in 1997.1 percent). The Philippine capital market did not have an active analyst community comparable to those in more developed capital markets. financial institutions did not have a significant ownership in nonfinancial corporations. Funds of SSS and GSIS consist mainly of compulsory contributions from members of the country’s private sector and government workforce.7 percent of shareholdings).
Prudential regulations. and increased the capital requirements for all types of banks.11). Large shareholders and their families own these banks directly or through their controlled companies. This could further increase the concentration of ownership and expand the scope of own-group lending by these larger banks. including 16 commercial banks. All major industries were represented.178 Corporate Governance and Finance in East Asia. identified the companies belonging to each of these groups. and tracked the financial performance of each company from 1992 to 1997. so far limiting their involvement to selected products. the Central Bank’s reforms are probably changing the conduct but not necessarily the structure of the banking system.8 percent of total companies in number. Still. For this reason.000 Corporations in the Philippines. Most family businesses that went public did so because they wanted to raise capital and to gain the prestige associated with being a public company. . many companies in family-owned groups are not publicly listed.4 percent of the top 1. However. Corporate financing depends on intermediation by banks. Family-based groups have larger companies since their total sales were about 33. suggesting that business groups are common in all major markets. The Central Bank deregulated interest rates and foreign exchange. 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. including SBL and DOSRI rules. about three fourths. Commercial banks hold the largest share. The process identified a total of 238 companies belonging to 39 business groups from the SEC-BusinessWorld Annual Survey of the Top 1. To understand the ownership and governance characteristics of family-owned business groups. using data on the Philippines’ top 1. A common feature of corporate ownership of a business group is the centrality of a commercial bank.000 corporations’ sales. remain in force to control excessive lending of banks to insiders. liberalized the regulations on entry of foreign bank branches and foreign ownership of local banks. Some 20 financial institutions were affiliated with these groups. suggesting that most publicly listed companies are parts of business groups. Foreign banks have a growing presence but have not necessarily increased the supply of credit to the corporate sector. but they comprised only 23. of the financial resources in the country. Vol. a nonfinancial company that owns a commercial bank has better access to loans at favorable rates and terms. This is significant considering that there were only 31 local commercial banks in the country in 1997.000 companies.6 The total sales of these groups in 1997 were estimated at P806 billion (Table 3.7 6 7 The study used publicly available shareholder information and published reports. More than three fourths of the respondents are either a parent or subsidiary (about 70 percent of these are domestic nonfinancial companies). Banks that are members of business groups have an advantage in raising funds from the internal capital market of the group. the study put together a list of prominent business groups.
for the Lopez group. It is also noteworthy that. as discussed in previous sections. the biggest private company in the Philippines. ranged according to their sales (Table 3. Together. 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.6 percent of the total sales of the top 1. Significantly. In terms of number of companies. Family-based business groups are most dominant in sectors such as manufacturing. with 27 affiliated companies in the top 1. the top 10 family-based business groups had only 119 companies in the top 1. namely. The significance of family-based business groups in the Philippine corporate sector is immediately evident in the 50 largest corporate entities. and more than 20 percent for the Lopez group and Henry Sy group.8 percent).4 percent of the group’s 1997 profits). and for the Henry Sy group. Commercial banking contributed about 40 percent of group profits for the Ayala group and Gokongwei group. Commercial banks are often affiliated to a particular business group. including business groups and independent companies. the two were closely related through their affiliations to business groups. an average group in the Philippines has fewer member companies. Foreign-owned companies mainly serve the export markets.2 percent). In the meantime. In 1997. the three largest entities were family-based groups. a substantial proportion of group profits came from its financial subsidiaries. the principal owner of SMC. Gokongwei. with the exception of Banco de Oro. it was manufacturing (36. for each of these groups.12). the largest family-based business group was the Ayala Corporation Group.Chapter 3: Philippines 179 Compared with other Asian countries.000 companies. real estate. in most . construction. Lopez. In terms of sales. Lopez. To show this. the largest was the Eduardo Cojuangco group. The main constraint may be the availability of family members that could be drawn for top management positions. These corporate entities accounted for 53. broadcasting (49. or an average of about 12 per group. Also. and Henry Sy—as examples.000 corporations in 1997. Cojuangco. and banking. For the Ayala group.1 percent). the nonfinancial sector was real estate (60. for the Gokongwei Group. retail merchandising (69.000. which was majority-owned by the Henry Sy group. 25 out of the 50 top corporate entities were familybased groups. nonfinancial companies contributed about 36 to 60 percent of total profits for these groups. and Ayala. the study used the four largest business groups—Ayala.
4 6. 7. 16. Sector Orientation.1 2. Consunji 4 3 Food and dairy products Construction and mining 10. 5. beverages. 2. Beverages. power.7 98. 4. agriculture.2 16.8 84. coconut oil.Table 3.1 4. 17.2 1.3 15. food. and personal care prods Shipping.9 2.9 3. and tobacco Telecommunications Cement and construction materials Pharmaceutical and distribution 12.0 17. 8.0 Average Sales Per Company (P billion) 6. and car manufacturing Car manufacturing and real estate Food and telecommunications Department store and real estate Airlines.6 7.5 47.3 11.3 2.4 10. food. real estate. of Affiliated Companies Total Sales (P billion) 123.4 48.2 1. construction. 10.5 46.1 4.0 5. and Affiliated Bank of Selected Business Groups.4 . Eduardo Cojuangco Lopez Family Group Ayala Corp. 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. and dairy products Investments.5 26. Flagship Company. telecom. 14.5 2.6 2.11 Total and Per Company Sales.0 26. beverages.3 3.5 13. 13.5 44. 1997 Business Group 19 15 27 12 12 9 4 6 11 4 8 9 5 4 5 6 Major Sector Orientation Estimated No.6 3.0 13. and tourism Credit card 18.5 49. and mining Management.6 3. and food Food. Real estate. 6. and packaging Power distribution and mass communications Real estate. 15. 11. 9. 3.5 6.5 17.
32. 21. 25.2 1.7 4.9 0.3 7. 33.19. Enrile/JAKA Group Jaime Gow Guoco Group Jose Go Jardine Davies Gerardo Lanuza Alfredo C.4 1.3 2. 26.0 1.1 1. 37.9 1. 35.4 5.000 Corporations (1997).3 2.8 1. 20.6 3. 28.2 6.4 3.6 5. and real estate Retail merchandising Ceramics and real estate Department store and real estate Cement and sugar central Real estate and securities trading Bookstore.9 1.1 2.2 4. and various company annual reports. mining. 23. . distribution.1 1.4 3.9 6. 38. P.6 0. 27. 34. Ramos Gaisano Family Group Felipe Yap Felipe F.0 0. 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 8.7 0.5 8.7 3.9 7. Cruz Jose Luis Santiago Keppel Group Robert John Sobrepeña/ Fil-Estate Group Total Real estate Sources: PSE Databank.1 0. 36.0 5.7 0. 22.8 Jollibee Foods Luis Lorenzo Family Group Alcantara Family Group Bienvenido Tantoco Elena Lim Andrew Gotianum Brimo Family Group Andrew Tan J.6 2.8 1.1 805.6 Fast food Beverages and agro-industrial products distribution Cement and wood products Retail merchandising Electronic appliances Real estate Mining Real estate Telecommunication. 4 238 1. 30. 29.7 1. 24.5 2. 31. SEC-BusinessWorld Annual Survey of Top 1.9 1.8 1. 39.8 6.0 2.9 0.7 0.
2. Uytengsu/General Milling Group David M. 11. 17. 1.Table 3. 5. Long Distance Telephone Phinma Zuellig Pharmaceutical Metro Pacific William Gothong and Aboitiz Swift Foods/RFM House of Investment Anscor Equitable Card Network Inc. 6. 4. 8. Alaska Milk Corporation DM Consunji. 7. and Affiliated Bank of Selected Business Groups. 19. 3. Sector Orientation. 14.11 (continuation) Total and Per Company Sales. 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. 15. 12. 21. 18. 10. 20. 9. Eduardo Cojuangco Lopez Family Group Ayala Corp. Flagship Company. Inc. 16. 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. 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. 13. Jollibee Foods Corporation Pepsi Cola Products Alsons Cement .
37. 22. Kepphil Shipyard Inc. Inc. 34. 35. Cruz & Co.65 billion.. 39. PT&T Corp. P. 26.48 billion. 25.East-West Bank International Exchange Bank Ecology Bank (Savings Bank) Dao Heng Bank Orient Bank International Exchange Bank International Exchange Bank Philbanking Corp. 36. and various company annual reports. 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. 33. 23. a b Size class is measured in terms of sales: Large = greater than P4. . 28. small = less than P1. Fil-Estate Development Inc. 24. Keppel-Monte Bank Bienvenido Tantoco Elena Lim Andrew Gotianum Brimo Family Group Andrew Tan J. 29.48 billion. 38. Enrile/JAKA Group Jaime Gow Guoco Group Jose Go Jardine Davies Gerardo Lanuza Alfredo C. 32.000 Corporations (1997). medium = P1. F. Refers to commercial banks. 31. 27. SEC-BusinessWorld Annual Survey of Top 1. Ramos Gaisano Family Group Felipe Yap Felipe F. Sources: PSE Databank. 30. unless otherwise indicated.65 billion to P4.
and mining Gold and other precious metal refining . 8. 19. and bank Real estate.).0 38. 15.1 60. 3. of the Phils. mass communications. and car manufacturing Power Refined petroleum products Refined petroleum products Banking. car manufacturing. 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. Inc. food. 10. 9.8 84.3 15.2 16. banking.5 15.). Fujitsu Computer Products Corp.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 1.4 19. and telecommunications Department store and banking Airlines. 18. 24. Aboitiz Family Group Jose Concepcion/RFM Group Alfonso Yuchengco Philippine Associated Smelting and Refining Corp. beverages. telecommunication. food. food. 16. and food Food.5 26.5 47. power. Del Rosario/PHINMA Zuellig Group Toshiba Information Equipment (Phils. 4. Eduardo Cojuangco Lopez Family Group Ayala Corporation Group National Power Corp. and real estate Banking.7 98. 14.2 49.2 Business Group Business Group Business Group Government. Petron Corporation Pilipinas Shell Petroleum Corporation George Ty John Gokongwei Henry Sy Lucio Tan Ramon Cojuangco Family Group Caltex (Philippines) Inc. beverages.12 Control Structure of the Top 50 Corporate Entities.5 77.6 18. Texas Instruments (Phils.5 46. Beverages.5 44. agriculture. coconut oil. construction. 5.0 37. 22. 13. Philippine National Bank Mercury Drug Corp.1 17. 1997 Sales (P billion) Control Structure Major Industrial Orientation 123. and packaging Power distribution. bank. 20. 6. 23. 11. 2. 12. First Pacific/Metro Pacific Group 21. 17. 7.8 53. and dairy products Investments. and personal care products Shipping.0 24. Inc.Table 3.4 48.5 17.6 26.8 22.
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. 39.5 8.8 6. and other grains wholesaling Other amusement and recreational activities Motor vehicles Food and dairy products Construction and mining Television and radio transmitters. 34. Consunji Uniden Philippines Laguna. W.3 8.290 53.4 10.6 9. 26.4 8.1 9.5 8. 41. 46. 40. 42.7 13. 29.3 13. 33.9 7.000 Companies Sales (%) Cigarettes Bank Soap and detergents Management. 35. . real estate.7 10. Uytengsu/General Milling Group David M. 45.7 10.2 7. and various company annual reports. 44. 43.A. EAC Distributors Inc.9 14. Corp.25. Amusement and Gaming Corporation Mitsubishi Motors Phils.6 12. 48. 28. Philips Semiconductors Phils.6 1. Inc..5 10.0 11. Inc. 27. and tourism Banking Radar equipment and radio remote control apparatus Operation of rolling mills Palay. 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 13.8 9.9 7. 37. 9.6 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. National Steel Corporation National Food Authority Phil. Jollibee Foods Citibank N. 14. and apparatus for line telephony and line telegraphy Tobacco products wholesaling Cigarettes Radar equipment. 30.9 6. 49. including biological products Bank Cement and wood products Retail merchandising Electronic appliances Mining Real estate Sources: SEC-BusinessWorld Annual Survey of Top 1. PSE Databank. 36. Inc.0 12.000 Corporations (1997). 32. 50. radio and remote control apparatus Fast food Bank Beverages and distribution of agro-industrial products Drugs and medicines. 31. Philip Morris Philippines. 47.0 5. corn (unmilled).
such as amendments of the articles of incorporation. and declaration of cash dividends. the board of directors plays a crucial role in corporate governance. business groups had only minority ownership. these were dispersed shareholdings. shareholder voting in general meetings and legal protection of their rights. They are likewise liable if they pursue financial interests that conflict with their duty as directors. . removal of directors. to the corporation and its shareholders for damages caused if they agree to unlawful corporate acts. although public investors held a majority of shares. issuance of corporate bonds. corporate mergers or consolidations. 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. determination of compensation to board members. This section reviews practices of corporate management and shareholder control in Philippine publicly listed companies. The review is based on an ADB survey of listed companies in the Philippines conducted in 1999 for this study. accounting and auditing. appointment and compensation of senior executives. The Corporation Code holds members of the board of directors liable. Shareholders limit the broad power of the board by ratifying their decisions on critical corporate affairs. 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. 3. Vol. Of course. investments of corporate funds in other companies or purposes. and financial disclosure.186 Corporate Governance and Finance in East Asia. approval of management contracts. amendments in the bylaws. II publicly listed commercial banks affiliated to these groups. sale or disposition of a substantial portion of corporate assets. However. issuance of stocks.2 Corporate Management and Shareholder Control The main mechanisms by which shareholders control corporate management are the board of directors. jointly and individually. A total of 44 companies responded to the survey (out of about 221 financial and nonfinancial listed companies). The Philippine Corporation Code mandates the board of directors to exercise its control over a corporation. voluntary dissolution. Actual control of the banks was still held by the groups.8 The Board of Directors As the representative of shareholders in a company.3.
Respondents of the ADB survey ranked the following as the most important responsibilities of the board: making strategic decisions. The average stipulated term of office of the chairperson and members of the board for most responding companies was one year.6 for board chairpersons and 7. The ADB survey results show that a chairperson is compensated either by a fixed fee (52 percent of respondents). board directors were the founder of a company. and determining remuneration for board directors and senior management.7 percent). or percentages of shareholdings (28. with a maximum of 36 percent. This can partly be explained by the fact that many family-based large shareholders control companies through holding companies in which they have majority ownership. The ADB survey shows that the number of board directors ranged from six to nine among the responding companies. appointing senior management.Chapter 3: Philippines 187 actual practices of board functions and the role of shareholders may diverge somewhat from the legal framework. In a few cases. More than half of respondents indicated that board directors were elected during the shareholder general meetings. or the Government without approval by shareholder general meetings. But professional expertise is also an important criterion (28.7 percent).5 for board members. Financial compensation is another means by which shareholders can motivate boards and board members to manage companies in their interests.9 percent). or representatives of creditors. a fixed fee plus performance-related bonuses (30 percent). a typical chairperson owned 3 to 5 percent of outstanding shares of a company on average. or a per diem for meetings (18 percent). ensuring that a company follows legal and regulatory requirements. The longest was 27 years for board chairpersons and 14 years for board directors. The majority of respondents indicated that board directors and chairpersons were elected mainly on the basis of either relationship with major shareholders (31. Making day-to-day management decisions was not regarded as an important board responsibility. In practice. the average number of years of holding office was 6. Board chairpersons in a substantial number of responding companies did not own significant amounts of shares in their personal capacities. in a descending order. protecting shareholder interests. But half of respondents indicated that they also had board directors directly nominated by controlling shareholders or management. appointed by the Government. According to the ADB survey. . Such a short tenure may to some extent suggest that large shareholders want to keep their board members under close control.
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. the chairperson of the board was also the chief executive officer (CEO). owners brought prominent political or civic leaders into their boards with the intention of improving the visibility of the corporation rather than improving the quality of board decisions.9 In practice. Ninetythree percent of the respondents had one or more outside directors. When the CEO was not the chairperson. the parent company or company bylaws (21 percent). The audit committee selects external auditors. About half of the active committees were audit committees and the other half nomination committees. Senior Executives The Corporation Code does not specify the role and responsibilities of senior executives. The ADB survey shows that in 41 percent of the responding companies. Companies may set up special board committees to strengthen due diligence procedures. The compensation committee reviews and recommends remuneration plans of key officers and employee stock option plans. large shareholder-dominated companies often view such committees as unnecessary formalities. Vol. and reviews the findings of external audits. or amount of shareholding (15 percent). or management (15 percent). These committees were established only recently. namely. This suggests that large shareholders control CEOs by means other than shareholdings. But the independence of these outside directors is often doubtful. There was no case found in the ADB survey where a minority shareholder invoked such a provision of the Corporation Code. In the ADB survey. the CEO 9 The three most common board subcommittees are the compensation. The Corporation Code prohibits the removal of any director without cause if that act would deprive minority shareholders of representation in the board. In some companies. . however. and nomination committees. CEOs apparently cannot increase their shareholdings because family-based owners restrict the number of shares available to management. relationship with controlling shareholders (35 percent). negotiates the audit fees and scope of audits. A CEO that was not the chairperson of the board was selected on the basis of professional expertise (42 percent of respondents). The nomination committee searches and reviews candidates for key management positions. II Compensation for the chairperson was determined either by the board (54 percent of respondents). audit. by tenure and compensation. only 35 percent of responding companies have set up board committees. Unlike in Western corporate models.
. But about 27 percent viewed it to be ensuring steady growth of the company. the Corporation Code allows cumulative voting for directors. Only one respondent indicated that its CEO was entitled to a substantial amount of compensation. Shareholder Rights and Protection Under the Corporation Code. first. shareholders have preemptive rights to maintain their proportionate ownership of a company under any financing plan that may be undertaken by the company. The longest service rendered was 27 years. An overwhelming 70 percent of respondents said a CEO who was not the chairperson of the board could make key decisions only after consulting the chairperson or the entire board. the 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. and (iii) involvement of directors in businesses that compete with the company. of directors representing minority shareholders.. Among others.2 years. They can vote through proxy. 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. or (iv) enters into a merger or consolidation with another corporate entity. and prohibits the removal. without cause. (iii) invests in another company for a purpose different from that of the corporation. shareholders enjoy a number of rights and protection. i. The average service length of CEOs was 5. if the CEO’s contract was preterminated. Fourth.e.Chapter 3: Philippines 189 was not related to the chairperson by blood or marriage in all of the cases except one. 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. The majority of responding companies compensated their CEOs by using a fixed salary plus a performance-related bonus. Companies are not allowed to issue shares with different voting rights. Second. Third. (ii) disposes of or mortgages a substantial portion or all of corporate properties and assets. The “golden parachute” was apparently not a common feature of CEOs’ compensation packages. (ii) contracts with companies linked through interlocking directorship. shareholders may exercise appraisal rights. Fifth. including electronic means. to help ensure the representation of minority interests in the board. equal to three years’ pay. About 60 percent of respondents of the ADB survey considered maximizing shareholder values as the CEO’s most important responsibility.
There was little chance that a proposal from minority shareholders could ever get approved. potential buyers are required to make a tender offer to minority shareholders at a price equal to the offer it is making to controlling shareholders. SEC proceedings were costly and time-consuming. Being appointees of controlling shareholders. In cases of derivative suits against directors for wrongdoings or actions against insider trading. Sixth. But an action by the regular court on a petition by the company’s owners/officers prevented SEC from pursuing the investigation. Although transactions involving potential conflict of interest need to be reviewed and approved by the board. there were often no real discussions of board proposals or actions. Consequently. Dissenting minority shareholders did not necessarily have recourse to a third party for an objective appraisal of their shares. the Revised Securities Act has strict provisions designed to deter insider trading. During annual general meetings where minority shareholders could exercise their rights. board members are likely to be under pressure to approve transactions that benefit controlling shareholders to the detriment of minority shareholders. hostile takeovers are not common because in most companies ownership is concentrated . in the Philippines. no one has been successfully prosecuted for insider trading. a shareholder could file a derivative suit against a director to redress a wrongdoing. Few minority shareholders actually exercised their appraisal rights. However. Last. because of poor compliance and enforcement as well as some loopholes in corporate laws. Vol. II shareholders are allowed to inspect a company’s stock and transfer books. There was only one case. minority shareholders were often vulnerable to the expropriation of their interests by controlling shareholders and management. because of the dominance of large controlling shareholders. In the case of preemptive rights.190 Corporate Governance and Finance in East Asia. the Corporation Code allows a company to waive this in the article of incorporation upon registration or in a subsequent amendment. it is doubtful whether this legal protection for shareholders will achieve what it intends to in practice. Those who did were usually offered below-market values for their shares. The company was dissolved before indictment. there are no requirements for disclosing such transactions to shareholders under the Corporation Code. In the past. In practice. where SEC made substantial progress in investigation. An effective market for corporate control may provide some protection for minority shareholders against the expropriation of their interests by the incumbent management. in cases of corporate takeovers. that of Interport Resources Corporation. Regardless of the amount of shares held.
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. appointed either by the board or shareholders during the annual general meetings. a company that is widely held but has a large shareholder. An average of about 4.0 36.0 63. An average of 327 shareholders per company attended the last annual meeting and they represented about 63 percent of total shares.2 43.2 7.0 48.2 69.6 30.522 shareholders each. About 333 shareholders per company voted by proxy. followed by management and banks. 1999.8 30. representing 3. demonstrates the feasibility of developing a market for corporate control if publicly listed companies were widely held. Yes 100. 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. The responding companies had on average 43. Table 3.8 92. the successful hostile takeover by First Pacific Group of PLDT.4 No 0. Nevertheless.4 percent of shareholders but 58 percent of outstanding shares.13 summarizes rights that the shareholders of the responding companies enjoyed. The ADB survey provides further evidence on shareholder rights.4 70. Nominees held about 45 percent of the outstanding shares. Table 3. The brokers or securities companies were the most important proxy voters. representing about 24 percent of outstanding shares. protection.Chapter 3: Philippines 191 in a few controlling shareholders and families. About 93 percent of the respondents contracted .7 43.3 56.0 51.900 shareholders per company did not vote during the last annual general meeting.
In two celebrated cases. imposing penalties on violators. independent auditors are likely to be quite familiar with the operations and financial aspects of their clients. financial reporting standards allow room for interpretation by independent auditors. a management discussion of the business. Vol. These different versions of GAAP. Disclosure and Transparency The disclosures required by the Corporation Code are achieved through shareholders’ inspection of a company’s books and an “information statement” that companies should regularly issue to shareholders. the international accounting standard. the US GAAP). investments in subsidiaries. Meanwhile. II their annual audit to an international auditing firm. and an analysis of financial statements. An auditor can choose among three alternative sets of GAAP. intangible assets. The Code grants a shareholder the right to inspect business records and minutes of board meetings. The accounting profession in the Philippines is considered fairly developed and Manila is a known regional center for accounting expertise.. the agency also requires reports on important details about their operations and management. On average. vary in their evaluation of some major accounts such as securities and other liquid assets.e. the local standard (i. revaluation of fixed assets. foreign currency-denominated liabilities. as practiced in the Philippines).192 Corporate Governance and Finance in East Asia. SEC requires all registered companies to periodically submit reports for the purpose of updating their respective registration statements filed at the agency. a hostile takeover case). Most major international auditing firms operate in the Philippines. or the accounting standard of a specific developed country (for example. intra-company receivables and payables. there are many cases of poor financial reporting by large companies. long-term leases.. a preferred independent auditing firm either reported assets that did not exist (Victorias Milling Corp. In practice. the information statement transmitted to every shareholder should contain the audited financial statements. Nevertheless. a bankruptcy case) or hid a large amount of liabilities and losses (PLDT. although closely related. From publicly listed companies. Nevertheless. . independent audits do not guarantee the absence of questionable accounting practices. namely. Because of such long relationships. the responding companies have been associated with their present auditors for 13 years. with the longest being 50 years. More than 20 percent of the respondents have been dealing with their auditors for 20 years or more. and consolidation policy.
. When control rights exceed cash flow rights. namely SEC and the Philippine Institute of Certified Public Accountants (PICPA). they formed the largest group of corporate entities in the Philippine stock market in 1997. as large shareholders had no need for financial statements to monitor their companies and management that were under their own control. Family-based controlling shareholders use them as vehicles for controlling business groups. because of the highly concentrated ownership of Philippine corporations.g. e. which are controlled by large shareholders with public investors in a minority position. Controlling shareholders usually select member companies that require large . from a minority-controlled to a majority-owned subsidiary. Publicly available financial information was often of low quality. Pure holding companies can be privately owned. Such expropriation is due to gaps between control rights and cash flow rights that pyramiding structures of business groups centered on holding companies create. However. which are closely held by large shareholders and family members. the authorities. they also make it easier for controlling shareholders to expropriate interests of minority shareholders. arguably.Chapter 3: Philippines 193 Many small. sometimes did not penalize independent auditors for poorly prepared audited financial statements. marketing. The popularity of holding companies in the Philippine corporate sector is evident: with a market capitalization of P258. 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. Even for widely held public companies. and financing. and publicly listed. accounting for 27 percent of the total stock market capitalization that year. Holding companies enable controlling shareholders to collectively own shares of other companies in a business group and to centralize the group’s management. 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. controlling shareholders in the Philippines usually exercise their corporate control through the setting up of business groups.and medium-sized businesses did not have quality financial statements. which are usually controlled by holding companies. Corporate Control by Controlling Shareholders As in many other Asian countries.6 billion. “Selective public listing” is a strategy of many business groups for channeling funds from public investors to member companies.
It is majority-owned by Mermac. Inc. In an active minority-owned operating company. Ayala Corporation then holds a sufficient number of shares to achieve various degrees of control in two types of holding companies and two types of operating companies. They may have a representative in the board.1 percent of Ayala Land. controlling shareholders of the parent company do not participate in management. Ayala Corporation is a publicly listed pure holding company. The stylized features of control structure of business groups in the Philippines can be illustrated by using a leading Philippine family-based conglomerate.194 Corporate Governance and Finance in East Asia. namely.4 percent of Bank of the Philippine Islands.. Public investors collectively hold a minority of 41 percent. and a passive minority investment at 15 percent in Honda Cars (Philippines).2 percent. the parent company plays an active role in management. Controlling shareholders gain additional leverage in management control over minority-owed companies. In a passive minority-owned operating company. This is most evident when a minority-owned company transacts with other members of the group where the controlling shareholders hold majority control. with 59 percent of shares. Honda Cars (Philippines). Ayala Corporation’s majority. Ayala Corporation. controlling shareholders of the parent company may eventually increase their shares to a majority position. minority control at 42.and minority-controlled operating companies are also holding companies. These investments can be classified according to the role of the controlling shareholders in the management of the invested company. financing. Depending on the performance of the company. is privately owned. Some holding companies are not pure holding companies. a family-owned pure holding company. an active minority share at 44. of Cebu Holdings (a publicly listed government-owned company). . as an example (Figure 3. The first three companies are publicly listed while the fourth. especially its management. 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. They are operating companies but at the same time have majority or minority share ownership in other operating companies. In cases of minority ownership. II equity investment for public listing. Ayala Land fully owns Makati Development Corporation and holds a minority stake.1). Vol. and customers.6 percent of Globe Telecom. active minority or passive minority holdings. at 47. Minority-owned companies may also need access to resources of the group. Selective public listing combined with use of pure holding companies to own and control member companies lead to various organizational structures of business groups.
(58.44%) >50% MajorityControlled Pure Operating Company Makati Development Corporation (100%) <50% MinorityControlled Pure Operating Company Cebu Holdings.Figure 3.2%) >50% MajorityControlled Pure Operating Company BPI Family Savings Bank (100%) <50% MinorityControlled Pure Operating Company Note: Data as of 31 December 1998.04%) <50% Ayala Corporation >50% Publicly Listed Pure Holding Company >50% MajorityControlled Operating and Holding Company Ayala Land (71.6%) <15% Passive MinorityOwned Pure Operating Company Honda Cars Phils.06%) <50% >15% &<50% Active MinorityOwned Pure Operating Company Globe Telecoms (44. . Inc.96%) Privately-Held Pure Holding Company Public Investors (41.. (15%) MinorityControlled Operating and Holding Company Bank of the Philippine Islands (42. (47. Inc.1 Corporate Control Structure: The Case of Ayala Corporation Family Members 100% Mermac. Inc.
The Separation of Ownership and Control in East Asian Corporations. Rockwell Land. P.10 The Ayala family’s control rights over BPI was 1.14%] / [6. P. 1998. The situation offers large shareholders tremendous incentive to move resources 10 For details. Vol.3% x 5.64%) + (37. defined as control by large shareholders of an operating company through minority ownership by several companies. Simeon Djankov.76%)] [39.5%] [39. The control of companies through indirect corporate shareholdings. 1999b. II Bank of the Philippine Islands owns 100 percent of the BPI-Family Savings Bank.5%] / [(88.7 times its cash flow rights by virtue of the double layer pyramid structure of the Ayala group. Who Owns and Controls East Asian Corporations? 11 Ibid.12 These examples show that even when large shareholder groups are minority shareholders.64% +37.5% x 14. MERALCO.8%] 5. see the World Bank research papers by Stijn Claessens. a privately owned company. Being in the public utilities sector. and a minority-controlled holding company. Expropriation of Minority Shareholders: Evidence from East Asia. Diversification and Efficiency of Investment by East Asian Corporations. Lang: 1999a.2).196 Corporate Governance and Finance in East Asia. they exercise far greater control (two to five times more) than they are entitled to by virtue of their ownership rights. indirect shareholdings do not appear to be a prevalent practice in the Philippine corporate sector. is illustrated in the Lopez Group (Figure 3. and Larry H. Generally. Lang.44%] / [25%] = 1. Fan. and Larry H.44%] / [58.11 The Lopez family’s control rights over MERALCO was 5. [control right] [cash flow right] = = = = = [sum of control rights via Benpres and First Holdings] [sum of cash flow rights via Benpres and First Holdings] [1.98% x 42. Joseph P. [control right] [control rights via Ayala Corporation] = [cash flow right] [cash flow rights via Ayala Corporation] = [42. H. 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.44%] = [42.7 times 12 . however. and 1999c.14%] / [1. and First Philippine Industrial Corporation are indirectly held by a majoritycontrolled holding company.7 times Ibid. See also Stijn Claessens.3% x 1. Simeon Djankov. Benpres Holdings. First Philippine Holdings Corporation. companies in the Lopez Group are large and minority-controlled.
2 Corporate Control Structure: The Case of Lopez Group Public Investors Family Members Lopez.5% First Philippine Industrial Corporation 50% 50% Note: Data as of 31 December 1998.3% 11.5% Operating Company MajorityControlled Operating Company Rockwell Land Corporation 24. Inc.Figure 3.64% MinorityControlled 14.7% 62.76% Operating Company MinorityControlled 24. Privately-Held Pure Holding Company 88. .5% Minority-Controlled Publicly Listed Pure Holding Company First Philippine Holdings Corporation Benpres Holding Corporation Majority-Controlled Publicly Listed Pure Holding Company Manila Electric Company 1.
whether for working capital or capital expenditure. 3.3. Vol. Sixty-one percent of respondents indicated that creditors usually asked for collateral for all types of loans. The survey results also revealed that creditors did not intervene in the management of borrowing companies and wanted to maintain business relationships with corporate borrowers even when they were in trouble.198 Corporate Governance and Finance in East Asia. while 80 percent reported that creditors with which they had renegotiated loans were still willing to lend to them. it was not common for creditors to take legal action against debtors or foreclose on those assets held as collateral in cases of default. Only a minority of respondents (18 percent) indicated that they had faced adverse creditor actions such as a collection lawsuit or foreclosure of collateral. a publicly listed company dealt with an average of eight banks and six nonbank financial institutions. Suspension of Payments of Debts Under PD 902-A. Most responding companies had dealt with their commercial bank creditors for more than five years and nonbank creditors for only about two years.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. accessed nonbank creditors for specific purposes but dealt with commercial banks on a long-term basis. Some 85 percent of respondents believed that creditors had no influence or only weak influence on corporate management. Most respondents (81 percent) indicated that they had renegotiated with their creditors on loan repayment when they faced liquidity problems. The average company. II from their subsidiaries to their majority-owned publicly listed holding company or elsewhere up the pyramid. However. Control by Creditors According to the ADB survey. The controlling shareholders could also use the resources of minority-owned subsidiaries to engage in overexpansion and empire building investments. and (ii) how the legal framework protects creditor interests and rights. SEC could suspend the rights of a creditor to demand payment from a borrower in accordance with the terms of the loan . the data suggest.
4 3. wait for 14 years from the time the company petitioned for suspension of payments in 1984. The law on suspension of payments envisions resetting the corporation’s business for a temporary period to prevent its irreversible collapse. There are no legal or practical limits to the time period of suspension of payments. Publicly listed companies do not represent a cross section of the Philippine corporate . the litigation process. The first mode is for simple suspension of payments. bank credit is the main source of corporate financing. it is not clear whether the corporate borrower’s assets are of sufficient value to cover its liabilities. SEC and the court required that the creditors of BF Homes. 3. which determines the viability of the rehabilitation plan and appoints a Mancom or a rehabilitation receiver to implement the proposal if approved. the borrower requests to defer payments for a certain period to enable it to generate the necessary liquidity. a real estate-based business group. Under such circumstances.4. including the rehabilitation of the corporation. The corporation continued to be under rehabilitation receivership as of June 1999. PD 902-A granted SEC blanket powers to intervene and adjudicate claims. a company’s assets are of sufficient value to cover all of its debts. For example. Inc.1 Corporate Financing The Financial Market and Instruments The Philippine financial market has remained underdeveloped compared with other countries in the region.Chapter 3: Philippines 199 agreement. Markets for equity and debt instruments are small and there are serious structural problems that discourage large. There are two modes of suspension of payments under PD 902A. SEC could intervene to avoid asset dissipation.. Commercial banks hold about three fourths of the resources of the financial system. In practice. Under this mode. Consequently. The second mode is for suspension of payments with the appointment of a management committee (Mancom) or rehabilitation receiver. profitable companies from going public. This explains why creditors invariably oppose any move by borrowers to file for suspension of payments at SEC. The borrower will propose a rehabilitation plan to SEC. could take an indefinite period. under which. 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.
however. and Indonesia ($61. The market capitalization of the Philippine stock market in August 1997. Most publicly listed companies issue only up to 20 percent of total shares to the public. The crisis affected the Philippine corporate sector. The stock market was depressed up to the early 1990s. compared with Malaysia ($186 billion). The period 1993-1997 was one of lower inflation and declining lending rates. preferred stocks. Equity instruments include common stocks. less exposed to foreign debt. companies expanded only at a moderate pace. only 84 had sales large enough to be placed in the top 1. II sector.200 Corporate Governance and Finance in East Asia. 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. most listed companies are controlled by their five largest shareholders. As a result. the Republic of Korea (henceforth. Of the 221 companies listed in the Philippine Stock Exchange in 1997. From the 1970s up to the early 1990s. and fiscal management were among interrelated factors explaining the underdeveloped state of the Philippine financial market. the collapse of the stock market during the Asian financial crisis suggested that the earlier stock price surge in part reflected the “bubbles” common to other stock markets in the region. The corporate sector raised a substantial amount of . The Philippine stock market is not a liquid market.g. but not to the same extent as it did in other Asian economies. inflation. However. about the size of Thailand’s.5 billion).14 shows that the average volume of daily trading in 1997 stood at P2. They invested in only a few large companies whose shares were relatively liquid. and convertible securities. In part. was one of the smallest in the region at $47. while interest rates were at high levels and volatile. Malaysia. Vol.. Korea) ($143 billion). Even in the real estate sector. Rising stock prices during the Ramos administration reflected to some extent the business optimism. is far ahead of the flock. especially short-term debt. The Government financed its chronic fiscal deficits by issuing short-term Treasury bills. Interest rates. Foreign portfolio investments also remained small. Equity financing through IPOs was active. Foreign funds were wary of the Philippine stock market because of its limited liquidity.4 billion (or $59 million using the average exchange rate). the country experienced double-digit inflation. Philippine companies were less leveraged. Table 3. Korea and Thailand). this is because.000 companies. and less engaged in risky investments.7 billion. compared with other economies. the minimum required to qualify as a public corporation. Most companies invested only in projects that met hurdle rates as high as 20 to 30 percent and had short payback periods.
0 1.5 1.545.2 0.2 297.2 61.1 524.8 1.0 2.4 1.1 88.0 0.7 391.8 0.3 59.515.8 799.3 158.2 1.9 608.7 207.5 26.9 1.1 0.8 102.088.2 57.2 0.1 5.4 9.906.3 0.4 Ratio of Market Capitalization to GDP 0. P billion) Gross Domestic Product (current prices.5 Year 369. P billion) 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 19.8 1.0 0.14 Philippine Stock Market Performance. 1983-1997 Daily Trading Volume (P million) — — — — 129.6 1.692.5 16.6 1.1 0.248.Table 3. .8 1.9 114.373.5 1.9 2.3 Market Capitalization (year end.2 1.421.2 ($ million) — — — — 6.2 59. Source: PSE databank.9 12.077. Note: Combined transactions of Makati and Manila Stock Exchanges are not available for the years 1983 to 1986.121.3 — = not available.251.6 261.9 682.445.351.1 0.2 925.7 2.171.9 2.3 2.474.3 4.5 571.5 72.7 1.0 161.5 12.1 0.3 314.2 3.686.0 0.386.7 41.4 728.7 0.3 0.
and high transaction costs. From 1988 to 1997. II equity capital through IPOs during the stock market boom from 1993 to the first half of 1997. The measures used in the analysis are: . Because existing shareholders wanted to retain their proportionate control over their companies. sells these commercial papers through brokers. and inventory financing. which ultimately influences the pricing of commercial paper issues. Negotiated credits. The largest buyers have been commercial banks. However. 3. are in a position to provide such discipline. Capital markets cannot provide the market discipline that corporate investors need. because business groups often own large commercial banks. of which 85 percent was raised from 1993 to the first half of 1997. The corporate bond market was stunted.2 Patterns of Corporate Financing The study looked at retained earnings. tight regulations. issuing companies had to undergo a process of review and credit rating by the Credit Information Bureau Inc. a strong regulatory system for bank supervision is imperative. The picture of the financial system that emerges is thus one of limited capital markets. new equity. Debt securities include commercial papers and corporate bonds. Only a few large companies floated commercial papers because of the limited market. Few companies offer preferred stocks because the Philippine tax system does not allow tax deductibility of dividends on preferred stocks. asset-backed credits.202 Corporate Governance and Finance in East Asia. This is because only companies with strong capitalization and predictable cash flows such as public utility companies can issue bonds. Debt instruments include negotiated credits and debt securities. moreover. which were the principal source of corporate financing in the Philippines. The underwriter. which in most cases is an affiliate of the issuing company. Only the commercial banks. by virtue of their large stakes in the financial system. leases. the rights issue was a popular way of raising equity capital. discounting of receivables.4. which buy commercial papers either for their own account or for their clients. and debt as sources of corporate financing by using flow of funds analysis. by volatile interest rates and the absence of a secondary market.. and the dominance of large commercial banks. However. about 127 companies went public with a total value of offerings of about P134. Corporate bonds are another type of debt securities. lack of competition among financial institutions. Under SEC regulations. Vol. include bank credits. corporate bond issuing was even more limited.6 billion.
000 Corporations in the Philippines.6 0.000 Corporations in the Philippines from 1988 to 1997.4 0.1 0.7 0. On the other hand.6 0. Incremental debt financing ratio (IDFR): ratio of changes in total liabilities to changes in total assets.4 0.3 0. 1989-1997 Financing Indicators SFRF SFRT NEFR IDFR IEFR 1989 1990 1991 1992 1993 1994 1995 1996 1997 1. It measures a company’s capacity to finance asset growth by equity capital. By definition.5 2.4 0.9 0. Incremental equity financing ratio (IEFR): ratio of changes in shareholders’ equity inclusive of retained earnings to changes in total assets.5 0.Chapter 3: Philippines 203 (i) (ii) (iii) (iv) (v) Self-financing ratio of fixed assets (SFRF): ratio of changes in retained earnings to changes in fixed assets.1 0.5 0.5 0.4 0. during this period.3 0. the average SFRF was high at 109 percent.4 0.3 0.2 0.3 0.5 0.5 Source: SEC-BusinessWorld Annual Survey of Top 1. the SFRT was low at Table 3. . Self-financing ratio of total assets (SFRT): ratio of changes in retained earnings to changes in total assets.9 0. As shown in Table 3.15 Financing Patterns of the Corporate Sector. New equity financing ratio (NEFR): ratio of changes in stockholders’ equity (excluding retained earnings) to changes in total assets. It measures a company’s capacity to finance asset growth by internally generated funds.2 0.6 0.3 0. 1988-1997. It measures a company’s reliance on borrowings in financing asset growth.2 0.0 0.1 Average 1.2 0.5 0.5 0.5 0.3 0.3 0.1 0.0 0.4 1.8 0.4 0.4 0.2 0.1 0.15.8 0. It measures a company’s capacity to finance growth in fixed assets by internally generated funds.9 0.9 0. All Companies Financial flows data were derived from the SEC-BusinessWorld Annual Survey of Top 1.5 0.5 0. Retained earnings were sufficient to finance the entire growth of fixed assets in the corporate sector. it is one minus IDFR.1 0.8 0.
1991. The corporate sector consistently relied on debt and new equity to finance asset growth throughout the period. reflecting the capital flight caused by political instability in the early 1990s.16 Corporate Financing Patterns by Ownership Type.5 0.8 0.2 0. for all three types of companies—publicly listed.3 0. Total assets grew by 23 percent that year. 1989-1997 Financing Indicators SFRF SFRTa NEFR IDFRa IEFRa a Publicly Listed 1. debts were the most important source of financing.5 Foreign-Owned 1. retained earnings declined and few new equity investments flowed into the corporate sector. the level of corporate leverage increased.9 0. the SFRF was higher. with debt providing 93 percent of the financing requirements. and 1997. There were significant year-to-year variations.0) 0. Retained earnings were the least important. Vol. 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. This was mainly caused by the declining contribution from retained earnings.2 (0.5 Privately-Owned 0.and foreign-owned.16. Companies financed fixed assets from internal sources in hard times. Corporate Financing by Ownership Type As shown in Table 3. As a result. internal funds were not a significant source of financing growth in total assets. In periods of an economic crunch such as in 1989. 1988-1997. . privately. In 1997. On Table 3. implying that internal funds were far from sufficient to finance growth in total assets. except for foreignowned companies that had a negative new equity financing ratio. Source: SEC-BusinessWorld Annual Survey of Top 1.3 0.7 0.3 0. II only 19 percent.3 0. The corporate sector used new equity to finance 32 percent and new debts to finance 49 percent of growth in total assets. In all the years.204 Corporate Governance and Finance in East Asia. suggesting that there was a deterioration of financial performance in the Philippine corporate sector in the years running up to the crisis.000 Corporations in the Philippines. when it financed 45 percent of it.1 a Excludes negative balances. except in 1991.6 0.
0 Source: SEC-BusinessWorld Annual Survey of Top 1.2 3.0 9.9 100.8 0.0 9.3 10.1 15.2 100.1 9.6 26.8 100.9 16.7 2. Foreign-owned companies relied more heavily on debt financing.4 41.0 9.7 4. . significantly Table 3.5 41.3 10.0 8.4 100.3 11. A breakdown of the financial structure of publicly listed companies measured in balance sheet items is shown in Table 3.3 12.17.8 3.3 12.7 2.3 48. 1988-1997.6 0.1 10.9 24.7 7. publicly listed companies relied more on new equity financing than privately.3 12.Chapter 3: Philippines 205 average.0 100.6 37.1 50.8 26.8 16.3 4.5 27.8 39.5 0.1 49. especially bank loans.4 12.0 6.2 42.5 12.4 100.3 13.5 9.0 9.8 46.5 16.7 100.7 23.8 0.9 3.1 13.1 7.6 43.2 12.17 Composition of Assets and Financing of the Publicly Listed Sector.7 13.2 100. 1992-1996 (percent) 1992 Assets Cash and Temporary Investment Accounts Receivable Inventory Other Current Assets Total Current Assets Investment Fixed Assets Other Assets Total Assets Liabilities and Equity Accounts Payable Short-Term Loans Other Current Liabilities Total Current Liabilities Long-Term Debt Other Long-Term Debt Other Long-Term Liabilities Total Liabilities Stockholders’ Equity Total Liabilities and Stockholders’ Equity 14. This financing pattern supports the earlier finding that foreign-owned companies had the highest leverage among the three types of companies.4 3.2 3.9 4.9 38.2 51.4 2.3 51.4 2. It presents a composition analysis of assets and financing sources for the period 1992-1996.0 1995 1996 13.0 13.0 10.7 13.0 38.8 17.0 12.0 53. compared with 47 percent for publicly listed companies and 55 percent for privately-held firms.6 48.0 1994 19.8 4. The sector built up its short-term debts.9 12.4 100.0 10.9 0.6 48.and foreign-owned companies.4 100.0 1993 14.4 10.9 16.8 3.4 43.9 16. contributing 90 percent of growth in total assets.8 51.8 38.000 Corporations in the Philippines.
their inherent ability to pool risks. group companies were less reliant on debt financing than 13 Defined as total current assets divided by total current liabilities. 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. 1989-1997 Financing Indicators SFRFa SFRTa NEFR IDFRa IEFRa a Group Member 1.18. the average SFRF of business groups was higher compared with that of independent companies. 1988-1997. Corporate Financing by Control Structure Conglomerates have certain advantages in financing because of the opportunities offered by the internal capital markets. and economies of scale in fund raising. the current ratio. The normal standard liquid position is a current ratio of 2 or higher. Vol. Table 3.000 Corporations in the Philippines. Group companies financed an average of 45 percent of growth in total assets by debt.1 0.45 in 1996. indicating that many publicly listed companies were likely to be in a tight liquidity position. respectively. The SFRF for independent companies would have been even lower if the highly profitable foreign-owned companies were excluded. . the easier access to external credit.5 0.2 0. II in 1996 and became more vulnerable to the financial crisis in 1997. compared with an average of 54 percent for independent companies. as opposed to 94 and 30 percent.18 Financing Patterns by Control Structure.206 Corporate Governance and Finance in East Asia.13 was at 1. for independent companies.3 0.3 0. The traditional measure of liquidity. On average. group companies usually financed their investment in member companies by equity rather than debt.6 Independent Company 0. Further. As shown in Table 3.5 0.5 Excludes negative balances Source: SEC-BusinessWorld Annual Survey of Top 1. Group companies were generally more profitable than independent companies. For these two reasons.9 0.
2 0.1 0. compared with 55 percent for large companies and 47 percent for small ones.8 0.47. Table 3.20). These years were 1991 with 110 percent.000 Corporations in the Philippines.5 Excludes negative balances. equity financed 42 percent of incremental asset growth. There was also increased reliance on debt financing. These results support the earlier finding that the leverage of business groups was lower than that of the independent companies from 1988 to 1997.6 0. With assets growing at a fast pace during this period. Corporate Financing by Firm Size SFRF was highest for medium-sized companies.19).2 0.9 0.3 0. The lower SFRF for large companies may be caused by their larger outlays for growth in fixed assets.06.08 and SFRT of 0.50 (Table 3. Corporate Financing by Industry The manufacturing sector had an average SFRF of 1. 1988-1997. Source: SEC-BusinessWorld Annual Survey of Top 1.19 Financing Patterns by Firm Size.76 for small companies and 0. medium-sized companies used more debts.5 0.3 0. with an average of 3.2 0. Large companies’ IDFR of 0.3 0.4 Small 0. The medium-sized companies’ high debt financing ratio was due mainly to three years of complete reliance on debt to finance growth. 1993 with 96 percent. Large firms consistently increased their reliance on debts from 1994 to 1997. averaging 61 percent of growth in total assets.88 for large companies (Table 3.Chapter 3: Philippines 207 independent companies. The corresponding ratio was 0. Excluding .6 0.55 was substantially higher than the small companies’ 0. 1989-1997 Financing Indicators SFRFa SFRTa NEFR IDFRa IEFRa a Large 0. and 1997 with 131 percent.5 Medium 3. On average.
many of the leading real estate companies successfully went public during that time. .4 Construction 0.6 a Excludes negative balances. Its SFRF and SFRT were volatile because of chronic losses and reduction in fixed and total assets.5 Utilities and Real Estate Services and Property 0. Source: SEC-BusinessWorld Annual Survey of Top 1. In the eight years preceding the crisis.6 0.32.58 and SFRT of 0. Up to 1997. debt financed about 78 percent of asset growth in real estate. II 1991.5 0. SFRF for the sector averaged 0. 1988-1997. The effects of the crisis of 1997 were adverse. The sector had the highest leverage among all industries that year.1 0. Total liabilities increased partly as a result of the local currency devaluation and financed all of asset growth for the year.3 0.04.6 0. The construction sector was a heavy user of debt financing. While this level is considered prudent.000 Corporations in the Philippines. the manufacturing industry financed 57 percent of its total asset growth by debt. increasing to 0. while SFRT averaged only 0. the incremental equity ratios of the industry were high.5 0. Low incomes diminished the equity financing position of the manufacturing industry toward the crisis year.6 0. ranging from 41 to 118 percent.2) 0. achieving an average SFRF of 3. Table 3.47 two years later.4 3. Incremental equity financing amounted to an average of 44 percent of total asset growth. Vol.3 0.29.5 (0. The situation improved beginning 1994. the total debt ratio was much higher in 1996 at 0. the industry generated internal funds. 1989-1997 Financing Indicators Manufacturing SFRFa SFRTa NEFR IDFRa IEFRa 1. when debts declined. Excluding 1997 when fixed assets declined. Since the real estate boom coincided with that of the stock market.3 0.4 0. Equity financed the rapid expansion in the industry’s assets in the period 1994 to 1997.20 Financing Patterns by Industry.208 Corporate Governance and Finance in East Asia.4 0. Equity financed an average of 62 percent of total asset growth.91. During the crisis year.27. The real estate industry financed its growth by substantial equity funds. with an SFRF as low as 0.7 0.4 0.3 0.79 and in 1997 at 0. The utilities sector showed weaknesses in internal fund generation in 1989-1994.
ownership concentration = the total shareholdings of the top five shareholders. and financial leverage are all positively and significantly related to the degree of ownership concentration. more profitable. The Modern Industrial Revolution.3 Ownership Concentration.421 0. Using the PSE database. As shown in Table 3. knowing that if an investment turns out to be successful they could capture most of the gain. 14 See for example Michael Jensen (1993). and leverage. Financial Leverage. Journal of Finance 48: 831-880. Profitability.009 5.860 Leverage = the ratio of total assets to total equity. and Financial Leverage Dependent Variable Item Coefficient of Ownership Concentration T-statistics Adjusted R-squared F-statistics ROE 0.00036 2. 1992-1996.008 5. alternatively.21 Ownership Concentration. Three regressions were run with the shareholding of the largest five shareholders as an independent variable and ROA. ROA = return on assets. the degree of ownership concentration.14 Large shareholders may borrow excessively to undertake risky projects. ROE = return on equity. ROA.287 0.Chapter 3: Philippines 209 3. Large shareholders may also overuse financial leverage to avoid diluting ownership and control. Source: Author’s estimates based on the PSE databank. the coefficient of the ownership concentration measure in all the three regressions is positive and statistically significant. . ROE. as the dependent variable. measured by the percentage of shareholdings of the largest five shareholders.130 ROA 0. ROE.230 Leverage 0.004 3.00125 2. was regressed against measures of profitability and of financial leverage. and Performance Previous studies on corporate governance have often associated ownership concentration with heightened risk-taking by companies. creditors bear the consequences. while if it fails. Exit. and the Failure of Internal Control Systems. These results suggest that companies with higher ownership concentration tend to be more highly leveraged and. Table 3.21.769 0.00056 1. at the same time.4.
The largest contributors to GDP were services at 43 percent. foreign investments in the country have been low. with a narrow exporting industry base.8 percent of GDP from 1995 to 1997. their growth gathering momentum only beginning in 1992.” The Government’s judgment that economic fundamentals were strong was based on stable growth rates. Because of limited local capital. Garments was the second largest export sector at about 9 percent. with commodities accounting for the balance. and intermediate goods. Manufactures accounted for about 85 percent of exports. About 80 percent of imports were capital goods (particularly power generating and telecommunications equipment). The export sector had a very narrow breadth. the growth in foreign investments fueled that of the manufacturing and services sectors in the years preceding the crisis.5. II 3. the country’s GDP growth pace indicated that it did not have a “bubble economy.5 percent per year from 1992 to 1997. raw materials.5 3.” that is. Compared to other East Asian crisis-affected countries.210 Corporate Governance and Finance in East Asia. In sum. the economy still showed vestiges of its import-dependent and substituting character.1 The Corporate Sector in the Financial Crisis The Financial Crisis: Causes and Manifestations A devaluation of the local currency signaled the arrival of the financial crisis in 1997. The structure of the economy may be understood by looking at its sectoral composition and export competitiveness. In 1997. The costs of an economic correction brought about by the regional financial crisis were thought probably to be low due to the sound structure of the real economy and the strong position of the financial sector. Although much lower than those of other Asian countries. more than half (52 percent) of exports were semiconductors. The Government explained that the country had “sound economic fundamentals” but that the problems were caused by “contagion. Net trades in goods and services averaged a deficit of 4.5 billion in 1996 and grew at an average of 48 percent per annum from 1992 to 1996. notably remittances of overseas workers. industry at 34 percent. but its share had been declining by 4 percent per year since 1995. Historically. Commercial and industrial activities in the country were largely oriented to domestic markets. which averaged 4. and agriculture at 21 percent. The country experienced balance of payments surpluses but these were due to transfers. Net investment inflows were $3. After a . the country was less dependent on foreign private capital. an overexpansion of capacities. Exports were growing at about 20 percent per year in the three years preceding the crisis. Vol.
6 billion as of March 1997. The lessons from debt restructuring became the basis for the Government’s economic policies.Chapter 3: Philippines 211 long period of debt moratorium and restructuring that started in 1983 and ended in 1991. From 1993 to 1997. and a relatively healthy banking system. . Since the regional financial crisis was triggered by the loss of confidence in some East Asian economies by foreign creditors and investors. the Government sought stability and achieved this in 19921997. the country and the corporate sector had no access to foreign currency debts from the international financial market. an average Treasury bill rate of 13. 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. Economic performance during 1992-1997 was characterized by an average growth rate of real gross national product (GNP) at 3. The Central Bank conserved international reserves by allowing the local currency to float within a wider trading margin. the ratio of short-term debts to international reserves dipped below 100 percent beginning June 1998. depended on the quality of the corporate sector’s investments. Financial institutions called on their shortterm loans and shortened the maturity of existing loans. From 1988 to 1996. shows that investments of the corporate sector were growing at a faster rate than sales revenues in the years immediately preceding the crisis. average ROE was 13. Profitable operations since 1992 had allowed it to build equity. Total debts were only 52 percent of assets or 108 percent of equity. During this time. while sales grew by only 20 percent per year. Prudent fiscal management and controls on foreign borrowings were part of the adjustments required by IMF and foreign creditors.5 percent. Eventually. The corporate sector was in a relatively stable financial condition around the time of the crisis. Five years of stable growth before the crisis enabled the country to build its net international reserves to $10. In the Philippines. the discipline of the loan moratorium and the restructuring of the country’s loans to long-term maturity kept this ratio below 100 percent up to September 1997. fueled also by successful IPOs during the stock market boom of 1993-1996.8 percent. a government fiscal surplus from 1994 to 1997. the Government restructured its debts into longer tenors with a maximum of 25 years. Closer analysis. in turn.3 percent. however. an average inflation rate of 7. adjustments were focused on the quantity and quality of the banking system’s corporate loans. which. assets grew at a compound annual rate of about 31 percent. unlike their counterparts in the region. After hovering in the range of 100 to 127 percent.1 percent. resulting in stability in the short-term debt to reserves ratio. a positive balance of payments from 1992 to 1996.
Foreign investments in the Philippines have not been as high as the inflows to other Asian countries—and this. 1996 = 26. It is understandable then that the effect of the Asian financial crisis on the Philippines was correspondingly that of a negative “contagion. The debt level of the Philippine corporate sector in 1997 was low by Asian standards but still high by developed country standards. mitigated the effects of the pullout and liquidation of investments in the aftermath.485 145.074 2. Sources: Bangko Sentral ng Pilipinas and SEC. Debts financed a large part of this expansion.47. 1997 = 29.71. 1998 = 41.2 Impact of the Crisis on the Corporate Sector Aside from the foreign exchange adjustment. precisely. Table 3.212 Corporate Governance and Finance in East Asia.300 1.4 1997 762 1.101 92.749 26. Most of this leverage happened during the boom years in the region. but to a lesser degree. Net foreign investments more than doubled from 1995 to 1996 but declined by 78 percent in 1997 (Table 3.517 1. Data for 1998 cover only January-August.650 32. 1995-1998 Item Net Foreign Investments ($ 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 1.303 23.0 1998 739 555 328 69. or 114 percent of net foreign direct investment (FDI). growing by about 34 percent per year from 1994 to 1997. These patterns in investment and financing are similar to those of other countries in the region.7 Note: Peso-dollar exchange rates used are: 1995 = 25.22).22. It financed 26 percent of corporate capital growth. But portfolio investment amounting to $406 million flew out of the Philippines.609 1. net FDI remained stable at more than $1 billion. the other immediate impact of the crisis was that on foreign investment flows.5 billion in 1995.073 (406) 121. It rose to $2. In 1997. the country’s economic and corporate sector growth in 1994 to 1997 appeared to have been part of a positive “contagion” effect of optimism by investors and creditors about the region. . Net foreign portfolio investment amounted to $1.718 30.5.0 1996 3. In sum. II The corporate sector indeed overexpanded after 1993 like its counterparts in the region.101 billion or 196 percent of net FDI in 1996.06. Vol.” 3.22 Foreign Investment Flows.
they were willing to restructure and renegotiate existing loans by corporate borrowers. By March 1988. When the Treasury bill rates eased in March 1998. sparking a rise in interest rates on corporate loans. and the wholesale and . and leverage increased to 149 percent compared with 109 percent in 1996. in varying degrees for each sector. ranged from 11 to 13 percent from 1993 to July 1997. the commercial banking sector’s capital remained strong at 17. Manufacturing reduced its loans outstanding by 11 percent from October 1997 levels. Because of weak internal fund generation. By October 1998. The combined effects of shrinking demand and high interest rates reduced the corporate sector’s demand for loans. ROE at 6. albeit at current market interest rates.513 billion. new borrowings financed asset growth. The banking system was able to absorb the impact of the crisis primarily because of its strong capital position. Loans outstanding of commercial banks declined by the first quarter of 1998.9 percent. 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. With the increase in borrowings and reduced liquidity. with commercial banks holding P2.7 percent in January 1998. Average bank lending rates climbed to their peak of 25.2 percent in November 1997.2 to 28. meanwhile. The resources of the financial system that year totaled P3. they could not initiate a large reduction of their loans because these in part financed long-term growth in assets. Although corporate borrowers were not highly leveraged. the sectors with the highest outstanding loans had reduced their credit exposures. Bank loan pricing was based on the bellwether 91-day Treasury bill rates rather than inflation.369 billion. Bank spreads over Treasury bill rates increased in 1997 but were within the range experienced in the past. The interest rates on Treasury bills. Net profit margins were at a 10-year low at 4. in turn. depended on the liquidity and capital position of commercial banks. A number of small banks closed but they represented less than 1 percent of the financial system’s total resources. which held about 75 percent of the assets of the financial system in 1997. Lending rates were well above the 20 percent level from July 1997 to March 1998. Because commercial banks were strongly capitalized. then rose to a high of 22. Loan calls. lending rates also came down.3 percent of assets.2 percent was barely above inflation rate. the corporate sector became vulnerable to loan calls and high interest rates.Chapter 3: Philippines 213 Corporate financial performances and conditions deteriorated during 1997. The real problem of the corporate sector during the crisis was the rise in interest rates.
Vol. including (i) a regulatory limit of 20 percent on banks’ loans to the . 3. and subsequently went down to 13. the aggregate effect of the crisis on NPLs was of a magnitude comparable only to the country’s last major banking crisis in 1984-1986. The Central Bank adopted other measures to strengthen the financial system. thereby reducing overall intermediation costs. and its experience of low. to reduce their lending spreads over the 91-day Treasury bill rates from 3-8 percent to 1. Still. the ratio increased to a high of 11.6 percent in June 1998.5 percent by September 1998. and set up a hedging facility for borrowers with foreign currency-denominated loans. But the Philippine banking system had gone through worse crises in the past. These peaked at 14. 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. as with its counterparts in other Asian countries. single-digit NPL ratios began only since 1989.3 percent in December 1997. through the Bankers’ Association of the Philippines. However. The pattern indicates that real estate loans were of substandard quality but banks had contained the problem by mid-1998. These figures show that adjustment problems were industry-specific and that the real estate industry. As for nonperforming loans (NPLs). real estate loans averaged 11. and the financial system. was a problem sector. loans outstanding of the real estate sector increased by 11 percent from June 1997 to June 1998. II retail trade sector. by 12 percent. The Central Bank introduced regulations on foreign exchange trading to control speculation and nondeliverable forward contracts.5-6 percent.3 Responses to the Crisis Government Responses The Government’s policy and regulatory responses to the crisis focused on monetary and credit issues. The latter measure was especially beneficial to companies with unhedged foreign currency loans from commercial banks.9 percent of bank loan portfolios. In March 1997. The move retained the liquidity position of banks but lowered their cost of reserves. the fiscal position.214 Corporate Governance and Finance in East Asia.5. set limits on overbought/oversold foreign exchange positions of banks. This allowed the Central Bank to convince the banks. This “voluntary agreement” partly explains why the loan spreads of banks were within the range of recent experience.
changing technologies. First Pacific Corporation. was known to have a policy . which was privatized with the Lucio Tan group gaining control and the Government retaining minority ownership. Responses of the Corporate Sector The corporate sector’s financial position. Average Treasury bill rates have cooled since mid-1998. and (vi) issuing guidelines on duties and responsibilities of banks’ boards of directors for improved quality of bank management.6 percent growth in 1999. With its weakened financial position. The economy avoided a recession in 1998 and achieved 3. the Asian crisis opened a unique opportunity for foreign investors. (v) improving disclosure requirements on the financial position of banks. the country’s flag carrier. took more action. In response to calls for lower bank intermediation costs. Publicly listed Philippine companies could also be restructured through takeovers by local and foreign investors. the Government kept inflation below 10 percent. A 40 percent devaluation of the Philippine peso lowered the purchase price of PLDT to foreign investors. subcontracting and outsourcing. In the case of PLDT. (PAL). (iii) fixing loan loss provisions of 2 percent of the gross amount of loan portfolio on top of individually rated bad loan accounts. (ii) shortening the period for classifying unpaid loans as past due from three months to one month. PAL.Chapter 3: Philippines 215 real estate sector. The acquiring company. consolidating business units. and the legal framework for reorganization and liquidation conditioned its response to the crisis. the largest telecommunications setup in the Philippines. Financially strong companies were able to survive the crisis by effecting such internal restructuring. Large companies with heavy loan exposures such as Philippine Airlines Inc. 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. and giving up noncore businesses. The policy directions and actions taken by the Government appear to have ushered in recovery. its accessibility to foreign capital. With prudent monetary management. came up with a rehabilitation plan by May 1999 that was found acceptable to all parties. The real estate portfolio of commercial banks also declined and was well below the Central Bank’s regulatory ceiling by March 1998. (iv) increasing banks’ capital requirement by 20 percent for universal banks (banks with expanded licenses) and 40 percent for ordinary commercial banks. bank loan rates have also come down. Takeovers in the past involved cooperative negotiations between purchasers of a target company and family-based large shareholders.
Ownership is highly concentrated and a few dominant players control major industries. When Cojuangco took over. Its stock price and returns to shareholders had stagnated. however. First Pacific could have acquired sufficient shares to take control of PLDT in three ways. Eduardo Cojuangco was able to assert his ownership of shares taken over by the Government during the transition of power in 1986. First Pacific. By itself. A second method was to purchase the shares of other large minority shareholders. at a premium over the market price to reflect the value of management control. The question. Vol. Consequently. the stock price of PLDT was buoyant during the takeover period. Conclusions. SMC is another widely-held company managed by a minority shareholder. the Soriano family. Corporate governance is conditioned by the high ownership concentration of these large companies. II of investing to control companies that are dominant players in their industries. A third method was to make a formal tender offer to PLDT’s controlling minority shareholders. eventually took over PLDT and announced a restructuring plan for the entire group of companies. concentrated ownership of companies is not equivalent to weakness in corporate governance. 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. When companies are highly profitable. It may even solve agency problems that a separation of control and ownership could precipitate because large shareholders have an incentive to closely oversee management. 3.6 3. the Cojuangcos. and Recommendations Summary and Conclusions The Philippine corporate sector has been shaped by the country’s economic and industrial development policies. One mode was the outright purchase of shares in the open market. SMC had lagged behind other groups of companies such as Ayala Corporation in financial performance for some years.216 Corporate Governance and Finance in East Asia.6.1 Summary. he restructured the company toward its core brewery business and sold off local and foreign subsidiaries. controlling shareholders can capture these profits by excluding public investors from ownership. Although considered the prime industrial company in the Philippines. is whether there are sufficient safeguards to prevent controlling shareholders from . using some or all of these means. In a legal process that ended in his takeover of management.
minority shareholders need to be protected by external control mechanisms. medium companies showed higher profitability than large and small ones. Leverage was within Asian norms but above developed country standards. were the least profitable. By size. Corporate governance should be viewed in the context of an increasing presence and growth of large shareholders-centered conglomerate business organizations. Forming business groups appears to be a viable means of competing because this allows for more efficient organization and utilization of resources of large controlling shareholders. foreign companies were the most profitable but highly leveraged. Business groups occupied seven of the top 10 and 25 of the top 50 largest corporate entities in the Philippines in 1997. Performance was. This study points out weaknesses in external control mechanisms such as weak legal protection for minority shareholders. The financing pattern of the corporate sector was influenced by the tight financial conditions prevailing in the country up to 1992. By ownership structure. passive independent auditing. Publicly listed companies had the highest profit margins and lowest leverage among the local companies. the most numerous in the corporate sector. By control structure. Ownership of publicly listed companies is highly concentrated. an underdeveloped capital market. Returns to capital exceeded inflation rates. The result is that corporate governance depends only on internal controls.Chapter 3: Philippines 217 expropriating the wealth of minority shareholders through aggressive and risky investment. Privately-owned companies. influenced by industry characteristics. oligopolistic market structures. The Philippine corporate sector was relatively efficient in investing and financing compared with other countries affected by the Asian crisis. Financial institutions are not significant shareholders. while the largest 20 shareholders control more than 75 percent of shares. with the real estate and public utilities industries standing out for their pronounced cyclical patterns. ownership of banks by business groups. The five largest shareholders have majority control of an average publicly listed company. to some extent. Analysis of corporate financing by ownership . With large shareholders in control. an ineffective insolvency system. and the lack of market for corporate control. The corporate sector consistently relied on internally generated funds and equity before resorting to borrowings. companies that are members of family-based conglomerates had higher returns and lower leverage than independent companies. This study analyzed trends in corporate performance and financing in relation to corporate governance from 1988 to 1997.
and the extent of supervision of outside institutions such as independent auditors and SEC. family-based shareholders gain control by such means as the setting up of holding companies. 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. After controlling for industry effects. Larger disparities in control over cash flow rights imply higher incentives for large shareholders to (i) expropriate wealth of shareholders not belonging to the controlling group and (ii) invest in empirebuilding and high-risk projects. The difference between management control and ownership rights is usually substantial. Ownership concentration was positively related to both returns and leverage. and leverage were all positively related to the degree of ownership concentration. A business group is an effective business organizational model for achieving leadership in industries. Vol. Publicly listed companies were responsive to investors’ requirements for prudent use of debts. ROA. Such structures result in control by large shareholders through disproportionately smaller investments in equity ownership. as typified by the Ayala Group. ROE. The pyramid model is useful for centrally managing smaller companies. the bank usually accounted for a large share of each group’s net profits. and centralized management and financing. selective public listing of companies in the group. the amount of pressure from stock market investors and PSE (for publicly listed companies in the group). statistical analysis of company-level data revealed significant relationships between corporate performance and corporate governance. II type gave similar results. and sustained growth. Business groups with pyramiding structures heighten the issue of corporate governance. Companies whose large shareholders have higher degree of control tend to borrow more but generate better returns. Large companies owned or controlled by business groups tend to dominate their industries. Large. A commercial bank is an important part of most business groups. . The extent of governance problems depends on internal control policies of the controlling shareholders.218 Corporate Governance and Finance in East Asia. 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. superior profitability. 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.
there were sharp rises in the number of bankruptcies and petitions for debt relief. rather than the banks that lent millions of pesos. Under the new Securities Regulation Code enacted in 2000. This law is flawed in concept because it supplants a market-based credit agreement with a political process. and a market-oriented policy environment. strong capital position built on IPOs in a buoyant stock market. decisions by large sharehold- . SEC officials. The Central Bank imposed strict limits on real estate lending. Specific actions recommended are described below. Still.2 Policy Recommendations The Government should address weaknesses in corporate governance identified in this study by introducing reforms in the policy and regulatory framework and promoting the development of markets. are to be removed and transferred to courts. and sound overall creditworthiness. The crisis caused a tightening of credit to the corporate sector and a spike in interest rates. The corporate sector accessed the foreign debt market only in the mid-1990s because of the country’s long-drawn debt moratorium.6.Chapter 3: Philippines 219 The financial crisis came when the Philippine economy was in a relatively strong financial position. As the crisis wore on in 1998. The Central Bank responded by improving the liquidity of the system and by establishing conditions for bringing down interest rates on bank loans. a strong international reserves position. the government budget in surplus. including suspension of payments. mostly by highly leveraged companies and speculative investors in real estate. There are systemic risks involved in highly concentrated ownership. SEC’s quasijudicial functions. with recently restructured public debt. 3. adversely affecting companies’ operations and financial position. 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. A number of large debtors petitioned SEC for rehabilitation under procedures set by PD 902-A. The corporate sector was also in good financial condition with rich internal cash flows accumulated from a number of profitable years. For example. 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. That is. decide on the financial future of a troubled debtor. resulting in the banks’ accelerated restructuring of troubled debts in this sector. low inflation.
PSE Listing Rules should specify criteria and a selection process that will help ensure that the nominees for the position are truly independent and qualified. Strengthening Minority Shareholder Rights An issue that concerns minority shareholders is whether they have instruments—legal or ethical—that can prevent controlling shareholders from expropriating their wealth through risky investment and financing. to 25 percent. II ers often cause wide volatility in stock prices and invite reaction from creditors.220 Corporate Governance and Finance in East Asia. The adjustment should be made over a fixed period of time. SEC should strengthen disclosure requirements by issuing specific guidelines on minimum disclosures required for related party transactions. the PSE Listing Rules require the appointment of a minimum number of independent directors in the board of publicly listed companies. Vol. (ii) require disclosure of material changes in ownership. insider information. inadequate disclosures. To help ensure this. Clear legal accountability is a precondition for successful shareholder activism. depending on the size of the company. Because independent directors tend to adopt the perspective of minority shareholders in board decisions. Another measure would be to impose a statutory limit on the number of directorships that one can accept. To strengthen the board. It has suffi- . and self-dealing. they serve to curb the powers of controlling shareholders. 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. Increasing the Statutory Accountability of Directors and Strengthening the Board System The Government should clarify statutory fiduciary responsibilities of the board of directors. This will enable SEC to enforce prudential requirements on management of companies and enable minority shareholders to pursue grievances against their boards. and (iii) increase the minimum required percentage of outstanding shares for public listing in the stock exchange from the present 10-20 percent. This may limit current practices of appointing prominent individuals and family members as directors.
The Government should improve its prudential supervision system to ensure that banks perform their role as external control agents of their corporate debtors. Minority shareholders have failed to use traditional venues such as the annual general shareholders’ meetings to discipline controlling shareholders that expropriate their wealth.Chapter 3: Philippines 221 cient case history that can be used as a basis for tightening its disclosure requirements. the board will be compelled to initiate a thorough discussion of the merits of the proposed related-party deals that will require the participation of minority shareholders. the Corporation Code should be amended to impose sufficiently stiff penalties for self-dealings that patently expropriate the wealth of other shareholders. and disclosure standards. They need legal empowerment such as higher majority voting requirements.. and related interests. in particular. (iv) require banks to follow international financial accounting. in areas of supervisory functions of the central bank. Because ownership is generally concentrated in five shareholders. directors. (ii) set strict limits on lending by banks to affiliated companies. It is encouraging that the newly enacted 2000 Banking Laws have introduced changes along these lines. fit and . prudential measures and regulations. Impose severe penalties for any attempt by banks to circumvent this regulation. or prohibit cross-guarantees by companies belonging to affiliated groups. the board can easily muster the needed majority to approve the deal. current rules allow boards of directors to approve own-dealings or related party transactions by simple majority. and (v) closely monitor. raising the current two-thirds majority to a three-fourths majority. limit. e. (iii) adopt international standards of capital adequacy and ensure that banks comply with these standards. By requiring sufficient disclosure and a 75 percent majority vote on such decisions. The following recommendations aim to further improve banking regulations and supervision in the Philippines: (i) limit shareholdings of nonfinancial companies in banks. officers. reporting.g. Finally. Improving Financial Regulation and Strengthening Implementation The Asian crisis demonstrated the need to strengthen banking regulation. For example. and of banks in nonfinancial companies in order to avoid connected lending.
In developed capital markets. Presently. transparency. This way. If institutional investors are present. SEC and PSE can help ensure that these external control agents provide market discipline even in companies controlled by large investors. Investment and venture capital funds meet this description. The current law should expand class action suits to include management and . and lending to DOSRI. Vol. One is improved transparency and disclosure on specific items that potentially involve expropriation of wealth of minority shareholders. 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. and external auditors. Managements find that their investment and financing decisions affect stock prices and become aware of their responsibility to create shareholder value.222 Corporate Governance and Finance in East Asia. Two measures should be adopted to promote shareholder activism. Institutional investors impose market discipline by voting on strategic corporate decisions. institutional investors can be a driving force in providing market discipline to management. an active financial analyst community can begin to form. SEC appears to be taking a primarily regulatory posture in the operation of investment funds. Its priority is to protect prospective fund investors from unscrupulous fund managers. institutional investors lead public investors in providing market signals to companies. By supporting the establishment and operation of institutional investors. management. The other is the addition of provisions in the Corporation Code to facilitate class action suits against corporate directors. Reforming the Legal and Regulatory Framework for Investment Funds and Venture Capital Owners of Philippine publicly listed companies consist of controlling shareholders and investors that hold trading portfolios. II proper rule. Promoting Shareholder Activism Promoting shareholder activism to encourage small shareholders to actively monitor management is an approach that has not been tried out in the Philippines. The absence of institutional investors indicates that the legal and regulatory basis is inadequate. foreign ownership of banks.
It should develop a medium-term yield curve for the corporate debt market by strengthening the Government bond market. Placing the means for prosecuting in the hands of minority shareholders may instill more discipline in controlling shareholders. The Government should enhance the securities markets as an alternative source of corporate financing and pursue aggressive development of the local debt securities markets. and dividend decisions. and Credit Information Bureau that can be the starting point of this effort. leadership. These groups have an incentive to gather technical expertise.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. their directors and management. Promoting the corporate bond market requires that the Government develop trading systems and services of credit risk rating of corporate issuers. the Government could develop the market for future issues of corporate bonds. and the external auditors. There are existing institutions such as Dun and Bradsreet. information disclosures. Companies are likely to remain dependent on bank financing if the authorities do not strictly enforce prudential lending regulations. 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. Promoting Competition in Product Markets The Government should pursue industrial development policies that promote competition through the elimination of subsidies. where the threat of class action suits alone is sufficient to encourage quality decisions and behavior from management. The present provision on class action suits is inadequate because shareholders view the process as ineffective and expensive. Securities market development efforts should coincide with strict regulation of the commercial banking sector. Legal provisions for class action suits should cover self-dealing by directors. guarantees. compensation contracts. and broad-based political and popular support to pursue possible cases involving expropriation of minority shareholders’ wealth. Philippine Government Treasury bonds should provide bellwether rates for corporate bonds in the way that they have for short-term bank debts. entry . And by issuing Government Treasury securities in longer tenors. SEC should allow minority shareholders to be represented by activist groups.
The Government’s competition policies should aim to facilitate the free entry and exit of domestic and foreign companies and regulation of anticompetitive practices. The resulting absence of a strong investor base makes share prices vulnerable to manipulation or insider trading by large shareholders. improve enforcement of the rule of law. The increase in percentage of public holdings may be gradually implemented to enable the companies to adjust. II and exit barriers. The Government should also continue to improve infrastructure.224 Corporate Governance and Finance in East Asia. Current disclosure requirements of SEC are not rigorous enough for public investors. 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. Penalties for poor conduct of auditing by independent . Audited financial statements contain basic information about a company’s financial position and performance. Another problem is the orientation of external auditors to the interest of large shareholders rather than public investors. 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. Improving External Audit Standards and Information Disclosure Effective external control in corporate governance requires accurate and timely information about companies. Little attention is given to the conditions that make those regulations effective in the US corporate sector but not present in the Philippines. SEC should require that a larger percentage of publicly listed companies’ shares be sold to the public. and various other forms of protection. Efforts to reduce graft and corruption. Lack of liquidity deters institutional investors. PSE should campaign for top-tier companies to go public and work with SEC in encouraging publicly listed companies to expand their share offerings to the public. Many large companies remain privately owned. so that small. PSE and SEC need to build a liquid and efficient market. there is a need to increase the supply of quality securities from top-tier local companies in the Philippine stock market. and provide quality basic services should also be heightened. and publicly listed companies trade barely the minimum number of shares required for public listing.
The law on suspension of payments replaces a market-oriented solution with a political process. Although the new Securities Regulation Code enacted in 2000 has removed some of SEC’s quasijudicial functions. reorganization. review the system of penalties on professionals involved in a company’s violation of disclosure rules. and transferred these to courts. SEC and PICPA have not publicly penalized any auditor company that violated disclosure requirements or failed to submit audited financial statements.Chapter 3: Philippines 225 auditors and the mechanism for imposing them are weak. including the resolution of intracorporate disputes. For that matter. SEC and PICPA need to formulate more specific disclosure standards. suspension of payments and private damage actions. it creates a moral hazard problem. Improving the Legal Framework for Suspension of Payments. 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. and liquidation of troubled companies should be made a priority of the Government. Reforming the legal framework for suspension of payments. In spite of the many well-known cases of poorly audited financial statements that resulted in losses for investors. . PD 902-A has not accomplished any successful rehabilitation of a petitioning company since its implementation. and implement those standards and penalties rigorously. Instead. and Liquidation. Reorganization. the new law needs to be effectively implemented and enforced.
Journal of Financial Economics 25: 371-395. II References Abonyi. Philippine Macroeconomic Prospects: The Next Ten Years. H. Monitoring and the Value of the Firm. World Bank. Emilio. July. Alba. 1998. Claessens. Denis. Fan. Institute of Southeast Asian Studies. Fan. Stijn. Lang. Demsetz. Equity Ownership. Lang.226 Corporate Governance and Finance in East Asia. David J. Simeon Djankov. 1999. 1999. Working Paper. and Corporate Diversification. and Kenneth Lehn. Ownership Structure and Corporate Performance in East Asia. Pedro. and Simeon Djankov. Vol. Joseph Fan. Joseph P. Claessens. Simeon Djankov. 1985. P. Joseph P. Diversification and Efficiency of Investment by East Asian Corporations. Thailand’s Corporate Financing and Governance Structures: Impact on Firms’ Competitiveness. 1994. Vol. Working Paper. H. Expropriation of Minority Shareholders in East Asia. Burkart. P. Stijn Claessens. Quarterly Journal of Economics. 1998c. Claessens. 1998. Simeon Djankov. 1998b. Jr. Who Owns and Controls East Asian Corporations? Discussion Paper 2054. Agency Problems. Journal of Political Economy 93 (6). and Clifford Holderness. May. Claessens. Lang. Dennis. World Bank. George. 1997. edited by Toida Mitusuru and Daisuke Hiratsuka. Conference on Thailand’s Dynamic Economic Recovery and Competitiveness. and Larry H. Tokyo: Institute of Developing Economies. World Bank. Asian Development Bank. October. Claessens. Bangko Sentral ng Pilipinas. . World Bank. March. Manila: Asian Development Bank. P. Stijn. Asian Industrializing Region in 2005. 1999. The Philippines: Onward to Recovery. XXIX. and Larry H. Working Paper 2088. World Bank. and Larry H. H. 1989. 693-728. Simeon Djankov. Harold. and Atulya Sarin. M. 1988. Lang. and Fausto Panunzi. and Larry H. Lang. Barclay. The Structure of Corporate Ownership: Causes and Consequences. Stijn. Stijn. P... Diane K. Michael. Thailand: From Financial Crisis to Economic Renewal. Key Indicators of Developing Asian and Pacific Countries 1998. Simeon Djankov. and Larry H. Dennis Gromb. Journal of Finance 2 (1). Stijn. 1998a. 1997. Discussion Paper. The Separation of Ownership and Control in East Asian Corporations. Large Shareholders. Joseph P. Antonio. P. Private Benefits from Control of Public Corporations. Fan.
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1998. Some Conceptual Issues in Corporate Governance and Finance. 1996.228 Corporate Governance and Finance in East Asia. Shleifer. Journal of Finance LII. II Prowse. . David. Washington. IFC/WB. Journal of Money. March. No. November. Journal of Finance L11: 737-783. Credit Markets and the Control of Capital. Internal Capital Markets and the Competition for Corporate Resources. Credit. DC. 1985. Journal of Finance 91: 1121-1139. Ajit. 1. Stiglitz. 1992. Vol. World Bank. and Robert W. 1998. Jeremy C. Large Shareholders and Corporate Control. 1. Andrei. Singh. DC. Stephen. Washington. and Robert W. Andrei. How Do Large Corporations in Developing Countries Finance their Growth? Corporate Financial Structures in Developing Countries. A Survey of Corporate Governance. Mimeograph. Technical paper No. 1997. Vishny. No. Joseph E. Stein. Shleifer. May. Journal of Political Economy 94: 461-88. 2. Asian Development Bank. The Structure of Ownership in Japan. East Asia: The Road to Recovery. and Banking Lecture 17. Webb. 1991. Vishny. 1997.
with Thai corporations overutilizing short-term foreign currency-denominated loans. 1 Associate Professor. Malaysia. The corporate sector also contributed significantly to the crisis. It was inefficient in financial intermediation. the banking system merely validated the financial risks. with the currencies of Indonesia.4 Thailand Piman Limpaphayom1 4. The author wishes to thank Juzhong Zhuang. heralding not only a financial crisis in the country. had been plagued with prudential problems for a long time. The crisis in Thailand stemmed directly from unsound macroeconomic policies and imbalances. Instead of serving as a buffer between the large inflow of foreign capital and the corporate sector. and David Webb of the London School of Economics for their guidance and supervision in conducting the study. . Faculty of Business. but also the stalling of East Asia’s “economic miracle. magnified the impact of these problems on the economy when the crisis hit. David Edwards. the Thai baht came under pressure from speculative attacks. In the prelude to the 1997 crisis. The majority of these debts were not properly hedged. both of ADB. the Stock Exchange of Thailand for its help and support in conducting company surveys. Chonburi. and Lea Sumulong and Graham Dwyer for their editorial assistance. and Philippines all depreciating significantly.” After mounting an aggressive defense of the currency. Asian University of Science and Technology. Thailand. annual short-term capital inflows to Thailand were equivalent to 7-10 percent of gross domestic product (GDP). The banking system. Thai corporations were collectively overexposed to exchange rate risks. The fixed exchange rate policy. Thailand’s crisis exposed similar vulnerabilities in other East Asian economies. short-term private debt obligations grew to about 60 percent of total private sector debts. For the period 1994-1996. As a result. coupled with financial liberalization and deregulation in the absence of an effective regulatory and supervisory system.1 Introduction In May to July 1997. But it also laid bare weaknesses in both the financial and corporate sectors. poorly regulated and sheltered from competition. Republic of Korea (henceforth. the Thai Government conceded and adopted a floating exchange rate regime. Korea).
To protect domestic industries. This study examines these and other factors that might have weakened corporate sector governance in Thailand. Key factors that led to weak corporate governance include the ineffectiveness of the regulatory framework.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. while new industries were encouraged to reduce the need for imports. focusing mainly on the companies listed in the Stock Exchange of Thailand (SET).2 4. Section 4. its growth and financial performance. The country initiated national economic development planning in 1961 when the economy was growing rapidly. The National Economic and Social Development Board was created to plan the country’s economic and social development. Import tariffs on machinery and heavy equipment were removed.2 discusses the development of the Thai corporate sector under the National Economic and Social Development Plans. II There is now a consensus that weak governance was partly responsible for the corporate sector’s poor financing and investment practices. Vol. The First and Second Plans (1961-1971) Under the first two plans.2. with government policy providing support but avoiding direct interference. lack of transparency and adequate disclosure. . 4.230 Corporate Governance and Finance in East Asia.1 Overview of the Corporate Sector Historical Development The corporate sector has long been considered the engine of Thailand’s economic growth.5 discusses how the corporate sector contributed to the financial crisis and looks at its impacts. as well as its legal and regulatory framework. and a family-based corporate ownership structure.3 looks at corporate ownership patterns that resulted in inadequate protection for minority shareholders and weak corporate governance in Thailand. Section 4. Section 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. The study then considers policy recommendations with emphasis on corporate governance improvement. Section 4.
4 billion from overseas and increased taxes on numerous items. At the same time. including a weakening of the dollar. Budget deficits remained a major problem during the Fifth Plan. . Fourth. the industrial sector grew at a faster rate than the agricultural sector. using tax policy to control prices of consumer goods and implementing several price control measures to curb inflation. became a major problem as domestic investment declined.15 billion per year or 4. the government’s debt burden escalated.4 percent of GDP. Inflation reached 15. But the sustained importation of heavy machinery and equipment resulted in large trade deficits. Budget deficits also increased throughout the Fourth Plan. Industrial sector growth was also rapid and many industries (tires. resulted in increases in the current account deficit. and automobile assembly) emerged. and reduced current account deficits. To close the fiscal gap. processed steel. Thus. gross national product grew by about 7 percent per year. textiles. the value of the baht remained stable. it proceeded with its development plan for the industrial sector. including luxury goods. with the devaluation of the baht in 1984 a major step in this direction. As a result. the current account registered a surplus in 1986. Average growth for the period was 4 percent per year. averaging 1. Inflation levels were low. In the wake of lower world oil prices and the rapid growth in income from the tourism and travel industry. The results were increased exports. with the agricultural sector the major contributor.5 percent in 1973 and 24. and Fifth Plans (1972-1986) An economic downturn at the end of the Second Plan led to an adjustment in policies. The decline in imports was steady. remaining high until 1981. especially foreign aid from the United States. however.3 percent in 1974. chemicals. leaving the Government no choice but to resort to overseas borrowings. canned foods. Consequently. The focus shifted to export promotion. External factors.6 percent per year. and increases in world food and oil prices. The Government decided to embark on restructuring measures in the Fifth Plan (1982-1986) to rehabilitate the ailing economy. Unemployment. an improved trade balance.Chapter 4: Thailand 231 During this period. The Third. However. the Government borrowed $6. The average budget deficit reached an all-time high of $2. The Government had to shift emphasis to restoration of economic stability. helped offset these deficits. however. capital inflows. lower than anticipated due to a worldwide economic recession.
United States. from only $31 billion in 1992. Average annual growth in real GDP was 8 percent. Private sector investment grew at an average annual rate of 7 percent. Inflation was 4. rather than to productive activities. The country also attracted a large amount of foreign direct investments (FDIs). With loans increasingly becoming expensive and hard to come by due to a lending squeeze by the central bank and high interest rates.8 percent. averaging 10. Key to this growth performance was the government’s adoption in 1993 of an aggressive program for attracting foreign capital to finance domestic investments. with private foreign debt reaching $92 billion by the end of 1996.8 percent. compared with the 14.4 percent targets. property development. Thailand became a debtor’s market. and the stock market. respectively. and Hong Kong. Europe. invited a deluge of capital seeking profitable investments. compared with the 8. while exports expanded considerably. By 1995.6 percent. The Seventh Plan (1992-1996) The economy’s performance from 1992 to 1996 generally met the targets of the Seventh Plan.6 percent target of the Seventh Plan. Most of the FDIs—originating mainly from Japan. The country’s high ratings in the international capital market.5 to 13. Thailand’s rapid growth up to the mid-1990s made the country one of the world’s fastest-growing economies. Vol. lower than the target of 8. Singapore. Growth of exports and imports averaged 14. increasing its share in total export value from 42 to 76 percent.2 percent target.232 Corporate Governance and Finance in East Asia.2 percent per year. II The Sixth Plan (1987-1991) Industrial sector productivity improved gradually during the Sixth Plan period. combined with its liberal financial policies. reaching an annual inflow of $2 billion in 1991. Growth rates during 1987-1991 ranged from 9. On top of its predominantly “borrowed” nature. the Government successfully balanced the budget and even settled its foreign debt of $4 billion before this was due. an oversupply of housing emerged. better than the 5. compounded by a slump in property sales.2 and 13. .5 percent. From 1989.7 and 11. the bulk of domestic investments went to speculative ventures such as real estate. The manufacturing sector became a dominant force in the economy. The exchange rate was steady at around B25 to the dollar. China—went to export-oriented manufacturing industries. the property sector began to collapse in 1996.
a former Chief Economist from the US Securities and Exchange Commission. Sidney M. the corporate sector’s main source of funding was the banks. the capital markets didn’t play a significant role until 1975. which raised the debt service ratio. In 1978.3 percent in 1996. Before the capital market emerged. the establishment of the Securities Exchange of Thailand (SET) was legislated and trading began on 30 April 1975.” which later became the master plan for the development of the Thai capital market. Exports went into a tailspin. the signs of an economy about to falter were there. many companies considered the Act too restrictive and a hindrance to growth. Included in the Second Plan (1967-1971) was a proposal to establish the country’s first authorized and regulated securities market. The country had a current account deficit of about 8 percent of GDP in 1995 and 1996. a policy that held throughout the first six economic development plans. The deficits caused the Government to rely on even more external borrowing. In May 1974. Its most crucial role was to help mobilize funds to support Thailand’s industrialization and economic development. SET officially became “the Stock Exchange of Thailand” in 1991.” extending its control and regulatory powers to the finance and securities companies operating freely at the time. its policy had always been to protect domestic banks. the Government amended the “Announcement of the Executive Council No. placing all publicly listed companies under regulation. A series of increases in customs and excise taxes on luxury imports did little to stem rampant consumer spending. which was amended in 1979 and 1985. the Bank of Thailand and .2 Development of Capital Markets Although the corporate sector has long been the government’s main tool for economic development. 4. In 1969. the Government passed the Public Limited Company Act. In 1972. Under the 1962 Commercial Banking Act. Foreign banks were barred from competing directly with domestic banks. Robbins. And because the Government considered the banking system vital to the development of the economy. on account of an overvalued baht that weakened export competitiveness. In his report. with growth shrinking from 23.Chapter 4: Thailand 233 Toward the end of the Plan period. 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.8 percent in 1995 to 1. However. 58 on the Control of Commercial Undertakings Affecting Public Safety and Welfare. prepared a comprehensive report entitled “A Capital Market in Thailand.2.
A number of internal and external factors contributed to the Thai Government’s acceptance of the IMF’s Article VIII agreement. In the 1990s.234 Corporate Governance and Finance in East Asia. and new financial instruments. Laws were enacted to stimulate growth of the corporate sector. The regulatory measures were inadequately designed and poorly enforced. Thai banks gained access to a variety of funding sources from around the world. However. creating a moral hazard problem—the perverse expectation that imprudent bank behavior would be rewarded with forbearance and bailout. the financial and banking laws were generally ineffective. Economic growth had been rapid and domestic savings could not keep up with the pace to support investments. it usually relied on “moral suasion. Thailand discarded controls on foreign exchange transactions and capital flows—a turning point for the Thai corporate sector. The introduction of these two laws came just after the Government’s signing of Article VIII of an Agreement with the International Monetary Fund (IMF) in May 1990 to deregulate and liberalize financial markets. Earlier. Externally. and the General Agreement on Tariffs and Trade (GATT) meeting in Uruguay had the liberalization of financial services on its agenda.” The Government also granted financial institutions overly generous bailouts. the World Bank had recommended such a move. At the end of the Sixth Plan. Thailand’s capital market entered a new era with improved legislation and regulation. The pressure dovetailed with the Government’s intention to make Bangkok one of the financial centers of the region. The resulting availability of funds propelled the corporate sector’s growth through the early part of the 1990s. increased financial market activities. the Government was under international pressure to deregulate the financial sector. Financial deregulation and liberalization allowed the country to attract foreign savings and investments that helped finance the growth of the economy. there were 29 commercial banks (15 domestic and 14 foreign banks) in Thailand. Vol. to cater specifically to its . The banks and finance companies operated at insufficient levels of reserve capital and were overexposed in high-risk businesses such as real estate. while the Securities and Exchange Act (SEA) the same year sought to improve capital market supervision. While the Bank of Thailand had the regulatory power to influence business practices. With the liberalization of financial markets. II the Ministry of Finance had full authority to supervise all commercial banks. The Public Company Act of 1992 relaxed some of the rules and restrictions contained in the original laws.
1978-2000 Number Registered of Capital Companies (B billion) 5 6 245 5 13 129 22 194 42 661 1. and Business Service Community. about 661 companies with total registered capital of B2.6 2.5 50.9 261. and Fishing Mining and Quarrying Manufacturing Electricity.5 111.0 Paid-up Capital (B billion) 1.6 350. Hunting.1 Public Companies Registered.0 21.1).394. The stock market boom from 1991 until the financial crash of 1997 reflected international investors’ response to Government policies.0 19. with B1.0 110. Worldwide.1 30. The result was a corresponding growth and development in Thailand’s capital markets.9 16. the country became recognized as an economic development model for other emerging economies. however.291. finance. The manufacturing sector is a far second with registered capital of B350 billion and paid-up capital of Table 4. .9 34. Insurance.9 1.2. Social and Personal Service Total Note: The data for 2000 is as of October 2000. Storage.3 trillion have been registered with the authority (Table 4.5 791.2 Type of Business Agriculture.3 83.101.6 23. Financial deregulation and liberalization were key to realizing that vision. Forestry. 4.Chapter 4: Thailand 235 fast-growing neighbors.3 Growth and Financial Performance Since the 1978 enactment of the Public Limited Company Act. The majority of the companies are in manufacturing. and Water Construction Wholesale and Retail Trade. the financial sector is the largest.1 trillion and paid-up capital of B1. and Restaurants and Hotel Transport. 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.4 trillion in registered capital and B791 billion in paid-up capital.2 11. In terms of capital. Source: Department of Commercial Registration. Real Estate. Ministry of Commerce. Gas. and wholesale/ retail trade and restaurant/hotel sectors. Thailand. and Communication Financing.1 78. in that order.6 1.
8 — 26.5 1. The stock market also became an invaluable source of funds for corporations.5 39.3 1996 1997 65.1 599.6 — = not available.4 34. the year before the crisis struck.2).236 Corporate Governance and Finance in East Asia.9 37. allowed Thai financial institutions and corporations to obtain funds overseas.7 billion in 1996.0 1994 82.3).5 — — 56. Securities and Exchange Commission of Thailand.2 25.8 billion. reaching a precrisis peak in 1996 (Table 4. this was due to the recapitalization of commercial banks in compliance with the new loan provisioning requirement. After the passage of the SEA of 1992. Source: Key Capital Market Statistics. Table 4.5 1.6 39.2 5. respectively.8 201.1 54.2 40.4 277. Domestic and offshore debt issues reached B54. reducing the value of offerings to a little more than a quarter of the previous year’s level.7 27. Market capitalization.0 0.9 1998 1999 15. moreover.3 194.8 151.0 20. the capital market became instrumental in the rapid growth and development of the corporate sector. With the enactment of the SEA of 1992 that brought suppliers of finance services and their clients together.1 2.1 286.8 1995 64.7 billion and B27. While a rebound was apparent beginning in 1998.9 31.7 9. II B261 billion. from only B20.2 Public Offerings of Securities.3 22. These peaked at B89.3 6.4 96. 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. Debt market activities also increased significantly with the establishment of the Bond Dealers’ Club (BDC) in 1994.5 billion and B1 billion the previous year. the value of public offerings rose steadily. The preeminence of the financial sector is a direct result of financial deregulation and liberalization. Vol. The number of listed companies and securities steadily increased until 1996 (Table 4.7 5.6 8. meanwhile.1 — — — 6.6 174.7 7.6 7.3 31.4 51. The development of the corporate sector closely followed the development of capital markets.2 12.7 136. The signing of Article VIII with the IMF. reached . The 1997 crisis battered the primary market for securities.
the companies could not generate enough net returns from their assets and equity. The financial leverage of all companies declined until 1994.360 1. corporate profitability had been declining.268 2.303 930 855 1. ROE similarly fell from 21.610 1. was the ominous deterioration in the key financial ratios of publicly listed companies.6 trillion.133 1. return on equity (ROE). not all public companies are listed on the SET. gross profit margin rose until 1991 before falling in 1992. Corporate profitability.114 1.535 1. their share rising from 17 percent in 1993 to 43 percent in 1997.4).4 percent to 5. the averages for all three profitability ratios took a downswing all the way until 1996.1 by 1996.560 1.565 2.193 2.5 at its peak in 1987.201 2. From 10. as measured by return on assets (ROA). Side by side with this surge of financing for corporate growth. then stalled in 1990. The plunge in profitability and asset turnover—from 117 percent in 1985 to 65 percent in 1996 for the latter—cast doubts on the . however. Foreigners accounted for an increasing proportion of SET’s turnover value. By the early 1990s.301 3. its high point in 1995 at B3.8 percent. While the decline in gross profit margin was not as sharp. when long-term debt grew as Thai corporations began to borrow heavily to finance growth. ROA dipped from 10.4 percent in 1996.3 Statistical Highlights of the Stock Exchange of Thailand.Chapter 4: Thailand 237 Table 4. and gross profit margin. Throughout the 1990s. The key financial ratios of all companies listed on SET bear this out (Table 4. in the end.281 832 373 356 482 Due to listing requirements and other reasons. Meanwhile. however. The trend reversed in 1995. But instead of shifting to a low gear. pulled down by active public offering activities.325 3. The upward trends for ROE and ROA continued through 1989. resulting in their inability to fulfill debt obligations.3 percent in 1989 to 3. the highly liquid financial system continued offering cheap funds to sustain corporate sector investments. the average times interest earned (TIE) was down to 5.683 1. had been on the rise throughout the 1980s. 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. Source: Securities and Exchange Commission of Thailand.
7 59.2 6.6 36.8 88. but was most severe in building and furnishing material industries as a result of the downturn in the real estate market.7 80.5 30.0 139.1 16.2 27.7 21.7 5.6 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. clothing.1 16.1 44.7 20.7 34.2 10. clothing.7 27.8 5.9 7.9 140. was felt across industries. and footwear industries also experienced losses.8 14.7 15. which was particularly significant in the two years preceding the crisis.9 77.9 144.6 41.5 50.8 8.6 125.7 12.2 10. which fell from 16 percent in 1991 to just under 6 percent in 1996.5 9.4 4.7 54. these companies opted for debt.4 18.5 38.0 29.9 39.3 4.9 51.9 66. practice of heavy borrowing.9 27.9 14.4 28.1 114.0 145. The downtrend in corporate profitability.7 12.4 119.4 34. A major reason for this was the rapid rise in asset prices.2 27.9 8.4 24.1 120.8 54. was also distinct in the region. Despite the availability of the equity market. Thailand’s ROE.1 242.4 139.7 LongTerm Debt to Asset Assets Turnover (%) (%) 14.1 52. They were generally more efficient in managing their assets and .4 12. II Table 4.4 51.0 3.7 4.0 63.4 7.6 138.8 11. Severely affected by global competition throughout the decade.3 91. It has also been argued that family-based controlling shareholders borrowed excessively to avoid diluting their control over their corporations. 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. large companies (where size is reckoned in terms of assets or sales) were more profitable than small companies in terms of ROE (Table 4.2 161. Overall.2 10.8 151.8 25.7 35.6 168.2 64. Vol.7 5. the textiles.5). Korea and Thailand had the highest debt-to-equity ratios.0 125.2 49.2 35.7 12.4 26.3 12.4 7.8 5.4 Key Financial Ratios of Publicly Listed Companies.5 51.2 215.4 5.7 12.0 7.4 9.8 51.1 60.3 10.4 3. and footwear had the lowest at 11 percent.7 27.5 63.5 52.1 9.4 12.4 44.6 12. Hotels and travel showed the highest ROE of 15 percent while textiles. US.0 117.238 Corporate Governance and Finance in East Asia. Among the crisis-hit countries.7 5.9 7. resulting in higher collateral values for borrowers.6 7.3 8.4 47.5 15.6 27.
1 6. 4. However.7 14. also deteriorated. Although stable in the 1980s. the law disallowed cumulative voting.4 52. although the performance of listed companies in the late 1980s was strong. total asset turnover declined after 1989. capital despite the higher gross margins of small companies.2 18.3 164.3 176.2 12.9 20.6 6.8 6. During the 1990s.4 8.8 26. US. . it was thought.1 13.5 7.3 23.8 62.6 31. which would be disruptive to company management.6 30.4 Legal and Regulatory Framework Before 1992.8 10.6 7.1 29. measured by total asset turnover.2. Increasingly heavy borrowings rendered the sector even more vulnerable to lower profitability and sales.2 10.3 49.3 43.8 6.4 116.5 94. For instance. 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 6.8 142.2 134.1 5.9 13.1 25.5 Average Key Financial Ratios by Company Size.3 135.7 10.2 121.1 Small Medium Large 5. Cumulative voting. by the 1990s. They also tended to use more financial leverage than small companies as their total DERs show.Chapter 4: Thailand 239 Table 4.3 15.6 12. weaknesses became evident. some rules and regulations of this particular law were believed to be too restrictive and were discouraging companies from going public.3 88. The argument was that having a Board of Directors whose members represented different groups of investors would create conflicts and hamper management effectiveness.6 10.0 48. could lead to a high turnover in the board.3 52.7 6.3 25.6 61. the Public Limited Company Act of 1978 and its amendments regulated Thai publicly listed companies.5 87.3 49.8 47.6 30.0 83.0 20. In sum.6 5.7 Source: Pacific-Basin Capital Markets Database compiled by the University of Rhode Island. There were also concerns that the provisions governing the criminal prosecution and penalties of directors and management were harsh and inappropriate. the overall activities of listed companies.5 6.
as a group. and external monitoring and control of corporations were also weak. This will be discussed in Section 4. The protection of minority shareholders was inadequate under the Public Company Act of 1992. played an important role in bringing about the financial crisis. The original company owners welcomed the changes and the number of publicly listed companies subsequently rose to more than 600. concentrated ownership. the limit on shareholdings by the largest shareholders was increased from 50 to 70 percent of total outstanding shares. adopted to promote the development of publicly listed companies. As it turned out. The provision discouraged original family owners from registering their companies.3 Corporate Ownership and Control Ownership and control of corporations in Thailand are highly concentrated. the exit of these provisions appears to have contributed to the 1997 financial crisis. 4. Vol. Fortysix companies responded.2 The market for corporate control was not active and did not give managers strong incentives to perform efficiently. The legal and regulatory framework for the corporate sector also includes provisions related to insolvency. relaxed the contentious provisions of the 1978 Public Limited Company Act. . coupled with weak corporate governance.240 Corporate Governance and Finance in East Asia. However. that creditors had generally little influence on the management of corporations. II Another issue was the proportion of shareholding by top shareholders. An Asian Development Bank (ADB) survey conducted for this study shows. but not all questions were answered. The Public Company Act of 1992. The law prohibited the largest shareholders. from holding more than 50 percent of total outstanding shares and other shareholders from holding more than 10 percent of outstanding shares individually. As the succeeding sections point out. 2 ADB survey questionnaires were sent to all Thai listed companies in early 1999. a feature that is believed to have impaired the effectiveness of existing regulatory mechanisms in the corporate sector. Cumulative voting was made optional.5. and the punishment for management misconduct was also lightened considerably. for instance. the new legislation removed a number of incentives that would have kept public companies prudent and diligent in their operations.
7 11. there were only slight variations in the pattern. In contrast.9 55.3 11. Source: Comprehensive Listed Company Information Database.4 6. the top five shareholders of each of publicly listed Thai companies held. Thai. 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. Indonesian. Most large Thai corporations listed on SET started out as family businesses. 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. with the top three shareholders accounting for almost 50 percent (Table 4.4 26.9 3. China firms have the highest single shareholder ownership concentration at 35. with the largest shareholder on average controlling 10. respectively.0 56.6 4.0 5.5 9.9 52. Across industries.1 4.2 56. this was not the case.3 7.0 3.7 6. In the past.2 4.4 5.5 28.0 3.2 4.1 percent of control rights.9 percent of shares of a company.6 68. Unfortunately.1 5.3 28. Ownership was most concentrated in the packaging.8 5.6 27. these companies obtained funding solely from banks or from their own retained earnings.1 11.6 Top-Five Ownership Concentration of Publicly Listed Companies in Thailand.6 57.3 percent.8 32.4 10.2 11.0 53.1 5.9 54.2 4.3 5. Table 4.1 Patterns of Corporate Ownership A World Bank study covering nine Asian countries finds that firms in Japan and Taipei.4 6.1 3. on average. 33. Stock Exchange of Thailand.9 6.6).1 7.9 11.7 percent.9 52. Ownership Concentration Between 1990 and 1998.4 26.8 11.9 26.7 7. and minority shareholders to stake their claim in the control and regulation of these companies.4 percent of outstanding shares.4 4.3 16.0 7.China have the least concentrated ownership.0 7. creditors.9 3. .9 52.9 4. This implies that the top five shareholders enjoyed full control over the outcomes of shareholder meetings.3 percent and 18.7 12. and 28. But with their increased reliance on new varieties of equity and debt instruments.5 Average for 1990-1998 period.6 28.3 7.4 26.1 5.3. 56. one would expect the public.1 12.Chapter 4: Thailand 241 4. and Hong Kong.
Company size is significantly related to ROE and leverage. ** at the 5 percent level.072) (0.8). founding families maintain effective control of entire groups.037 0. II agribusiness. Vol. On the other hand.7).533)*** Debt-to-Assets (0.022*** 0.115 9. results show a significant positive relationship between ownership concentration and financial leverage. * Denotes significance at the 10 percent level. Table 4.001*** 0. owning 26.800 0. and building and furnishing industries. Source: Author’s estimation based on the Pacific-Basin Capital Markets Database compiled by the University of Rhode Island. Through these holding companies. Based on a regression analysis.058* ROE (0. there is no statistically significant relationship between ownership concentration (measured by percentage of shares owned by the top five shareholders) and profitability of Thai publicly listed companies (Table 4.242 Corporate Governance and Finance in East Asia.001) 0. with a top-five ownership concentration of at least 60 percent. It is the practice of Thai corporate founding families to set up holding companies to own shares in affiliated companies or subsidiaries. US.7 Statistical Relationships between Corporate Profitability. as measured by debt-to-equity and debt-to-asset ratios.169*** 0. including those that are publicly listed .031 3.029 3.005** 0.034*** 0.090 0. These are consistent with the hypothesis that companies with more concentrated ownership tend to engage in higher debt financing because their controlling owners do not want to dilute their control by bringing in new equity holders. Leverage.001 0.647 Note: The regression included dummy variables for industry. and ownership types.7 percent of outstanding shares on average (Table 4. and Company Size Item Intercept Top Five Ownership Concentration Company Size Adjusted R-Squared F-Statistic ROA 0.116) Debt-to-Equity (1. *** at the 1 percent level.080 6. Other industries had their top five shareholders controlling at least 55 percent of outstanding shares.003 0. Composition of Controlling Shareholders Affiliated corporations comprise the largest group among the top five shareholders of publicly listed companies. Ownership Concentration. year.
2 1. These individuals usually hold important management positions in concerned companies.7 Bank 2.9 6.9 19.4 1.0 18.3 20. in SET. a joint venture among three families.6 1. 1990-1998 Year 1990 1991 1992 1993 1994 1995 1996 1997 1998 Average Company 28. including finance and investment companies.5 5. Source: Comprehensive Listed Company Information Database. the company.3 1. the affiliate firms rarely hold shares of their parent companies. owned by the Chirathivat family.1 4.3 27.5 0.4 1. averaging about 18. individual members of the Chirathivat family aggregately hold 25. In addition.8 0.5 0. with 29.1 1. the company increased its registered capital and became a public company listed in SET.6 28. one of the founding members.0 19.3 0.2 7. The top 10 shareholders include a holding company owned by the Tejapaibul family.5 0.5 Individuals 13.7 5.3 1.7 — 1. Individual family members also hold a significant amount of outstanding shares. This practice is illustrated by Central Pattana.5 1.6 1. unlike in Japan where crossshareholding is common.9 7. .2 18.5 26.4 22.8 1. Stock Exchange of Thailand.0 17.1 0.Chapter 4: Thailand 243 Table 4.2 1. Although holding companies set up affiliate firms.6 percent of outstanding shares.3 27.8 23. The ADB survey indicated that listed companies held shares in an average of 11 companies. The roster of its major shareholders as of December 1997 illustrates the typical ownership concentration of a publicly listed company in Thailand.5 percent.6 1.3 27.5 2.5 Government Other 0.1 1.7 1.8 Top-Five Shareholder Composition of Publicly Listed Companies in Thailand.4 20. operates five of the most successful shopping malls in Thailand.9 0. In 1994. a company listed in the real estate sector of SET.8 28.9 15.3 1.7 0.2 5.4 1. The largest shareholder is Central Holdings Company. founding families and their relatives maintain control of many companies by jointly holding on to the most significant chunk of shares.9 18.0 3.6 5.3 — = not available.3 percent of outstanding shares. a NBFIs denotes nonbank financial institutions.5 NBFIsa 6. Typically.5 1.6 25. Established in 1980 with a registered capital of B300 million.
and responsibilities of directors of public companies. holdings by individual family members and holding companies account for at least 50 percent of outstanding shares of an average listed company. For example. the predominance of individual family members and holding companies in the top shareholder list remains valid. Nonbank financial institutions hold an aggregate 5. qualification. the Government owns the majority of the shares. they exercise limited influence in operations because of the restricted size of their shareholdings. they account for 80 percent of total outstanding shares. Across industries. the Government’s role in public companies is expected to decline. In such cases. Thai Airways International Plc. The Government holds.1 percent of total outstanding shares of listed companies. where the top three shareholders are the Ministry of Finance. Except in the hotel and travel service sector.. the Petroleum Authority of Thailand. In effect. 3 Discussions in this section are based on results of company surveys by SET and ADB. both conducted in 1999. Although the list of top shareholders of publicly listed companies includes financial institutions.3. these shareholders are able to control the company. Moreover. Together. on average. Another example is Bangchak Petroleum Plc. II another of the company’s founding members.5 percent of total outstanding shares. There was a trend of rising government shareholdings throughout the period 1990 to 1998.2 Corporate Management and Control3 Board of Directors The Public Company Act of 1992 stipulates the appointment process. roles. duties. and a state bank.5 percent of total outstanding shares of listed companies. the top 10 shareholders consist predominantly of members of founding families and their holding companies. However. By owning 62 percent of voting shares. Only a handful of companies have the Government among their large shareholders. Vol. only one tenth of listed companies have commercial banks on their top-five shareholder list. 4. commercial banks account for only 1. has the Ministry of Finance as its only large shareholder with 92. On average. . 1.9 percent of outstanding shares. About half of listed companies have nonbank financial institutions such as finance and investment companies in their top-five shareholder list. with the envisioned privatization master plan.244 Corporate Governance and Finance in East Asia.
. Many companies have a formal policy on corporate governance and business ethics. In five other companies. The ADB survey indicated. the majority (71 percent) had board chairs who were also members of top management teams. directors are required to act with care and honesty for the company’s best interest. Almost all companies (98 percent) exceeded the minimum required five members in their Board of Directors. Unless stipulated in public companies’ articles of association. Chair of the Board and Chief Executive Officer The SET survey showed that about 73 percent of listed companies had a separate executive (management) board. directors could be compelled to compensate the company for damages arising from their misconduct. directors may be imprisoned or fined.Chapter 4: Thailand 245 Directors are required to meet minimum qualifications specified under the SEA of 1992 and the Listing Rules issued by SET. but not in 22 others. while 15 percent of respondents went beyond the requirement. that only in two of the 46 responding companies were the chair of the boards elected based on the extent of their shareholdings. Some companies (36 percent) had five to six main board members holding seats in their executive boards. meanwhile. In addition. directors shall be elected at the annual general shareholders’ meetings (AGSMs). Nineteen companies stated that selection was based on professional qualifications. the ADB survey found that 31 companies (out of 46 responding) required outside directors to be present at all board meetings. Although 28 percent of the chairpersons came from the ranks of independent outside directors. Most companies (83 percent) satisfied SET’s requirement of having two independent board members. A survey by SET found that the majority (58 percent) of the 202 responding companies held their board meetings every quarter. In their business conduct. Three companies indicated that the CEO and the chair were close relatives. Generally. and to comply with the laws and articles of association. an executive board consists of senior management and some main board members. while 30 percent of respondent companies held board meetings monthly. If found in violation of these provisions. 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. Meanwhile.
The directors’ compensation was determined largely by the Board of Directors except in 19 percent of the companies surveyed where a remuneration committee was in charge. the majority of the companies (77 percent) did not have outside directors as members of their remuneration committees. All respondents confirmed the use of external auditors. these were attributed to variations in the extent of duties and responsibilities assumed by those directors. all listed companies have been instructed to establish audit committees to be responsible for examining the quality and reliability of company financial statements. and CEO The majority of company respondents to the SET survey provided similar compensation packages to internal and external directors. In 25 companies. However. however. Twenty-five of the 46 respondents to the ADB survey declared adherence to all relevant international standards. Half of the companies in the SET survey had a separate remuneration 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. not an independent assignment. The SET survey found that the majority of listed companies (81 percent) still have no separate audit committee. The ADB survey indicated that 18 of the 46 responding companies compensated their chairpersons using a fixed-fee schedule. Where different. Three companies allowed their management to determine the chair’s compensation package. the work of this committee was often considered part of the executive board’s responsibilities.246 Corporate Governance and Finance in East Asia. Companies already with audit committees did not have independent outside directors as audit committee members. Audit Committees and Accounting Standards Since January 1999. II Compensation of Directors. Also. the auditor is not . Chair. Directors with managerial responsibility or those related to major shareholders cannot be members of such audit committees. with 41 firms admitting the use of services of international auditing firms. These committees were mainly responsible for determining compensation for senior and regular staff. the remuneration packages had to be approved during AGSMs. while 19 companies observed only some of them. In one company. Vol. Fourteen other companies had profit-related incentive schemes in addition to fixed fees.
For instance. there is the danger that top management may be capable of unduly influencing the board’s decisions. shareholders can claim compensation in cases of negligence or dishonesty by management. Forty-four companies indicated that they had proxy voting in place. remuneration. The majority of the companies (85 percent) require the appointment of external auditors during annual general meetings. Relationships between firms and external auditors are generally long-term. with 13 companies allowing proxy voting through mail. Proxy solicitation tends to be abused to the extent that shareholders are inadequately informed about matters to be taken up in shareholder assemblies. However. there are also significant gaps in the system of shareholder protection. most responding companies have rules and regulations intended to protect shareholders. as well as the registration and holding of shares. (i) No standards are enforced in the content and timing of notices for shareholder meetings. In the majority of these companies (38 out of 46 respondents). averaging about 14 years. The Act. shareholders have access to reliable information at no cost. (iii) Because the chair is frequently also part of the top management team. (ii) The prudential role of outside directors is limited by the noncompulsory character of their participation in key decision-making bodies such as the audit.Chapter 4: Thailand 247 independent from the company. the Securities and Exchange Commission (SEC) and SET were actively prosecuting violating firms. likewise. or other financial instruments. Shareholders are also entitled to call emergency meetings and present proposals at AGSMs. although recently. SET. and executive committees. including false statements to conceal information about the financial condition and operations of the company during the sale of shares. Minority Shareholders and their Rights Many different rights and entitlements of shareholders are laid out in the Public Company Act of 1992. According to the ADB survey. The Act also holds directors liable for any damage to shareholders. the institutional machinery is not fully responsive to complaints about violation of shareholder rights. debentures. SET’s rules and regulations closely follow this Act. While safeguards are in place. SEC. At least 28 responding companies had the following . the corporate sector lacks a strong self-regulatory body to compel compliance with these standards. As a result. (iv) The roles and responsibilities of the major government agencies regulating shareholder rights—the Ministry of Commerce. and the Bank of Thailand— are not clearly defined. stipulates the proper conduct of shareholder meetings.
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.248 Corporate Governance and Finance in East Asia. and insider trading. did not vote in previous AGSMs. minority shareholders are assured adequate legal protection.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. takeover of the company. and mandatory disclosure of related interests and significant shareholders’ transactions. representing only about 28 percent of shareholdings. The difficulty minority shareholders have in exercising their rights can be seen from the ADB survey results. 66 percent of total outstanding shares. Almost 82 percent of shareholders. minority shareholders may also appoint an outside inspector to examine the company’s operations and financial condition. however. In effect. 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. Banks would be obvious candidates to implement these mechanisms. Only a small number of shareholders attended the latest AGSMs. II mechanisms in place: mandatory shareholder approval of major transactions and interested or related party transactions. Vol.3. . the new Public Company Act of 1992 inadvertently weakened the governance of public companies by diminishing minority shareholder rights. and call an extraordinary session. on average. The ADB survey results reveal that the proposals presented by management were rarely rejected during the general meetings. 4. they comprised only 8 percent of total shareholders. In theory. such protection has been insufficient. the only group of shareholders that can exercise rights is the top five shareholders. The SEA of 1992 and the listing rules also contain provisions for the protection of shareholders against transfer pricing. While stimulating the growth of the sector. it would be difficult for minority shareholders to gather the shares needed to take action. Although the attendees held. In practice. On paper. But the exercise of these rights requires even higher shareholding levels. But with the ownership concentration of Thai companies. given their importance in providing finance and their stake in companies.
including procedural disputes. Only 28 of the responding companies in the ADB survey indicated that their creditors required such feasibility studies. however. In the end. Most companies reported that banks were more likely to require collateral. Eleven companies stated that creditors usually exercised whatever influence they had on management through covenants regarding the use of loans. Seven of the companies responding to the ADB survey indicated that all their creditors required collateral. Apparently. The presence of collateral usually diminishes banks’ incentives for screening project feasibility and monitoring project implementation. other than losing control. There were many options. a company’s reputation and its long-term relationship with creditors sufficed in many instances. . Among 16 companies in the ADB survey whose loan applications in the last three years were rejected. However.Chapter 4: Thailand 249 Historically. while loans for fixed investment were also more likely to be supported by collateral. Normally. 17 indicated that only some of their creditors had such a requirement. One tempering mechanism that could inhibit the excessive use of borrowing is the threat of losing control in the event of bankruptcy. when insiders want to expand their company’s operations without losing control. borrowers seldom lose control to creditors even when they default and become insolvent. For 20 of the 46 responding companies. Debtors had many handles to stall the bankruptcy process. Leverage allows the assets and operations of the company to grow without diluting corporate control. Only three companies thought otherwise. Under a weak bankruptcy system. creditors’ collateral requirements were tightened after the crisis. as the ADB survey confirmed. Thailand has relied on commercial banks and finance companies to channel funds to private enterprises. The old bankruptcy law in Thailand also made it difficult for creditors to obtain payment against bankrupt borrowers. Actual bankruptcy proceedings took more than five years on average. they resort to borrowing. creditors do not always require project feasibility studies or business plans in granting loans. which could cause a delay by at least a year. while 18 said none of their creditors required collateral. The impact of the financial crisis on credit eligibility and supervision requirements has been significant. to solve debt repayment problems. such as that seen in Thailand before the crisis. 11 experienced rejection after the crisis started. the majority believed that creditors had little influence on company management and decision making. Fifteen of the 20 companies that had to renegotiate loan repayment with creditors in the last five years did so after the crisis.
In 1994 and 1995. The second category is the tender offer. The company has 21 days to evaluate the tender offer and submit a report to SEC and all shareholders. the minimum tender offer was reduced to 10 percent and some procedural modifications have also been introduced. The Market for Corporate Control The SEA of 1992 was the first legislation that stipulated rules and regulations regarding the market for corporate control. The dearth of tender offers before the crisis suggests that the Thai capital market did not offer a venue for imposing market discipline on corporate management. if the purchase of shares implies a change in the directors or business activities. however. of shareholders: (i) all shareholders must receive tender offers. II The financial crisis has presented a unique opportunity for reinventing the framework for corporate bankruptcy and for creating regulatory and judicial precedents. According to the SEA of 1992. There are detailed requirements regarding such notification. In this case. only a limited number of successful mergers of public companies have taken place. The first category is the acquisition of shares in the open market. Vol. Recently. there were 41 cases of tender offers. before the extent to which the bankruptcy framework has been strengthened becomes clear. its main role is to ensure transparency and fairness.250 Corporate Governance and Finance in East Asia.3 billion. with a total tender offer value of B42. there are two categories of merger and acquisition activities with associated regulatory measures. which is a general offer made to shareholders of a company to acquire at least 25 percent of outstanding shares. It will take years. In 1996. Since the introduction of the Public Limited Company Act of 1978. Such efforts would serve to strengthen external discipline on controlling owners. whether directly or indirectly. The situation remained sluggish in 1997 at nine tender offers and a further decline in total offered value. The market for corporate control has not been active in Thailand. and (iii) tender offers will be effective 30 days after the report has been filed with the SEC. Although merger and acquisi- .3 billion (Table 4. SEC has no authority to either approve or reject tender offers. SEC was later made responsible for regulating corporate takeovers. and failed to provide managers with strong incentives to perform efficiently. (ii) an advertisement regarding the tender offer must be placed in major newspapers for at least three consecutive days. with a significantly lower total tender offer value of B8. there were only six tender offers. a person who acquires more than 5 percent of issued shares must file a report with SEC one day after the date of acquisition.9).
7 Purchase Value Number of % of Tender Offer Value Companies 84. it remains small. they have mostly been concerned with short-term gains. Twenty-nine firms indicated that employees held shares of their companies. 1993-1999 Year 1993 1994 1995 1996 1997 1998 1999 a Tender Offer Valuea (B billion) 5. if any. trading by mutual funds in SET represented less than 10 percent of total trading.0 55.2 8. employees are even less willing to accept common shares as a form of compensation or benefit. Even when companies offer ESOPs. . Since 1994. Eleven of the 46 responding companies in the ADB survey offer ESOPs. While the Thai mutual fund industry compares well to those in other developing countries in the region.0 B billion 4. But instead of opting for an active role in the market for corporate control.2 6.3 11.4 23.1 19. Few companies offer employee stock option plans (ESOPs).1 84. Employee Participation in Corporate Governance There has been little.1 75.8 8 27 14 6 9 13 23 Tender offer value refers to the minimum offer value.6 17.2 7. tion activities increased after 1997.2 6. Because of the current crisis. Source: Securities and Exchange Commission of Thailand. employees regard the plans as monetary incentives. but employees have never been represented in the board of directors since their shareholdings are minimal.7 11.Chapter 4: Thailand 251 Table 4. Provident funds for government workers and workers in public enterprises have been established only recently.1 58.3 6.9 Merger and Acquisition Activities. Pension funds are perhaps even weaker in Thailand.5 6.3 60. but the average shareholding is smaller than 1 percent of total outstanding shares.8 81. employee participation in corporate governance in Thailand. The number of domestic institutional investors rose after the mutual fund industry was established in 1991.9 3. not with a view to becoming involved in actual management. most of these were forced mergers or related to rescue packages.
372.171. 15 of which were domestic banks.5 5.390.6 6.161.3 5.477.4 4.485.. accounted for 28 percent of the banking sector’s total assets.1 3. The total values of loans from financial institutions and commercial banks were consistently larger than the market capitalization of SET.4 3.4 519. Vol. and Bank of Thailand.663.300.4.230.0 424.1 Domestic Debt Securities Outstanding 215.1 3. The bond market played only a marginal role in corporate financing.252 Corporate Governance and Finance in East Asia. although its role increased in the wake of the crisis.8 941.5 4.825.906. Thai Bond Dealing Centre.5 4. The country’s largest bank.119.0 339.10) shows that Thailand is a highly bank-dependent economy.9 2.979.037.5 trillion.268.6 2.3 1.912. 1992-1999 (B billion) Outstanding Loans from All Financial Institutions 2.1 5.2 262.10 Size and Composition of the Thai Financial Sector. total assets of commercial banks amounted to B5.325.3188.8.131.52 Corporate Financing Overview of the Financial Sector A breakdown of the Thai financial sector for the period 1992-1999 (Table 4.4 1.1 6.6 1. Many large commercial banks had affiliates among the 93 finance companies that served the high-risk market. there were 29 commercial banks.2 2. . the banking sector was highly concentrated. The share of domestic banks in the banking system’s total assets was 80 percent.669. Table 4.775.3 546. The Banking System Until recently. Competition from foreign banks was limited as they were not allowed to engage in full branch operations. the next four largest banks accounted for 63 percent.1 7.0 8.4 Year 1992 1993 1994 1995 1996 1997 1998 1999 Source: Stock Exchange of Thailand.4 4.0 SET Market Capitalization 1. In 1996. II 4.5 6. Bangkok Bank Ltd.559.564.5 Outstanding Loans from Commercial Banks 2.8 3.0 3.430.
2 trillion. due to their close ties. Banks under the BIBF scheme were allowed to mobilize funds from abroad and lend to Thai companies in foreign currency. Licenses were granted to 15 Thai banks. SET immediately recovered due to the strength of the Thai economy. SET is organized into 32 major industries. self-regulatory organization under the . the liberalization of interest rates and capital account transactions stimulated a credit expansion through short-term borrowings in foreign currency. The number of listed companies also quadrupled between 1981 and 1993. Because borrowers carried the exchange rate risk. 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 market rose steadily and reached a record high in the fourth quarter of 1993. After that. banking. Benefiting from rapid economic and industrial growth. also made it unattractive to raise capital from the equity market. the Bangkok Stock Dealing Center (BSDC). and almost all capital account transactions were deregulated. 12 existing foreign banks. an over-the-counter market. hardly any progress was made in lowering the cost of domestic financial intermediation or in developing new financial instruments for corporations. the Government established the BIBF to expand the banking sector and reduce the borrowing costs of Thai companies. The Equity Market During the first few years of its operations. owning 70 percent of the country’s second largest bank. In contrast.Chapter 4: Thailand 253 The Government was also a major figure in the banking system. finance. and 20 new foreign banks. and property have accounted for the bulk of trading volumes. Some 347 companies were listed in the same year with a total market capitalization of B3. Despite the worldwide market crash in 1987.8 in 1998. the stock market entered its first boom period in 1986. BSDC is a nonprofit. The lack of supply of quality shares was a big problem for SET at that time. was set up by 74 members with an initial capital of B500 million. Through the years. Many company founders did not want to release even a small portion of corporate ownership and refused to go public. reaching 355. SET was not very active. In the following years. Turnover value reached B2. Easy access to commercial bank loans by family business groups. Banking activity peaked in the mid-1990s. the SET index declined. BIBF banks also enjoyed tax incentives on their operations and profits. In 1995. The Government removed controls on capital and dividend repatriation in 1991. In 1993.3 trillion.
Consequently. the two classifications were merged. so now only listed companies are traded in SET. but dropped the following year to B122 million. After initial public offerings. The listing application should be submitted concurrently to SEC and SET. the BSDC was dissolved in 1999. . lottery drawing must be used to ensure fairness. and pro forma balance sheet and income statements. Listed companies were those that had (i) paid-up capital of at least B20 million.5 percent and collectively owning at least 30 percent of paidup capital. In 1996. If the issue is oversubscribed. It separated the primary and secondary markets to promote more flexible and effective supervision of both. SET established new requirements for initial public offerings. In July 1990. Company applicants must have an established history of operating under substantially the same management. and securities registrar. securities can be traded in the secondary markets. stock trading can commence within five days. II jurisdiction of SEC. approved by SET. also acts as a clearinghouse. According to the SEA of 1992. Proposed changes in capital must be submitted for approval to SET accompanied by a detailed memorandum outlining the use of proceeds.254 Corporate Governance and Finance in East Asia. The company should then appoint a financial adviser. there were two kinds of companies in SET—“listed” and “authorized” companies. financial projections. Turnover value was B1. The SEA of 1992 installed the legal and regulatory framework for Thai capital markets. SET. The allocation procedure is nondiscretionary.8 billion in 1996. to assist in the public offering process. turnover value was negligible and the BSDC Index remained flat throughout 19961998. and (ii) a minimum of 300 shareholders. Before 1993. securities deposit center. The primary market is supervised by SEC. Its main role is to serve as a secondary market for unlisted companies trying to raise capital. which has a legal mandate to examine a company’s financial status and operations before allowing it to issue securities to the public. each holding no more than 0. Authorized companies were those with a minimum of 200 shareholders owning collectively at least 25 percent of paid-up capital. 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. which consist of SET and BSDC. among other functions approved by SEC. Only one security was listed in BSDC in 1995 and two more in 1996. with each facing different listing requirements. however. Vol. A company wishing to qualify for listing in SET must file an information booklet (prospectus) with SEC and SET. In 1998. If approved by SEC and the SET Board of Governors.
compared to 110 percent in the US and 74 percent in Japan in the same year. State-owned enterprises became active issuers of bonds since 1993 because the Government constrained their borrowings (Table 4. A breakdown of domestic offerings of corporate debt securities from 1992 to 1996 shows that unsecured debts accounted for about 60 percent. The budget surpluses of the 1990s eliminated the need for new bond issuance. while secured debt instruments accounted for just above 10 percent. was also instrumental to the growth of the corporate debt market. . however. the Government issued more bonds to finance industrial development projects and perennial deficits. which encouraged limited companies and public companies to issue debt instruments. Beginning 1961. In 1996. the Bank of Thailand assumed responsibility for regulating the bond market. and the Government did not issue new bonds during 1990-1997. The recent financial crisis.11). at about 11 percent of the total value of outstanding loans extended by commercial banks and 20 percent of total equity market capitalization. Investors had limited knowledge of debt instruments. Upon its founding in 1942. The Thai Rating Information Services. Companies generally issued short-term debt instruments like promissory notes or bills of exchange. 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. 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. To gain some perspective of the size of the bond market in Thailand. it accounted for a small share of the entire financial sector. A turning point of the corporate debt market was the enactment of the SEA of 1992.9 billion. in 1994. The proportion of domestic convertible debt instruments increased until 1995. the first bond rating agency in Thailand. However. led to the renewed issuance of Government bonds to finance the resurgent budget deficit and support cash-strapped financial institutions. The bond market in Thailand started in 1933. the year the Ministry of Finance first issued government bonds to finance infrastructure projects and economic development. the size of the corporate debt market rose to B132. 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. Four years after the passage of the SEA. it represented only 9 percent of GDP.Chapter 4: Thailand 255 The Bond Market The Thai bond market has played a marginal role in corporate financing until recently.
The following year. However.5 — — — — 1.1 — — 6. II Table 4. total offshore debt offerings had plunged by 68 percent to a mere B28. The club was considered the first organized secondary bond market in Thailand to serve as the wholesale market for debt securities.3 — — 3.9 20.3 3.7 — — — — — 4.5 billion.3 29.9 30. then declined substantially in 1996 and 1997.1 315.0 — 5. this had climbed to B200. The domestic debt market declined after 1994 because corporations could borrow offshore at lower costs.2 2.4 7. a surge attributed to capital inflows encouraged by high returns on Thai bonds.6 19.0 60.2 28.9 329.1 10. A sharp rise in unsecured offshore debt offerings can be noted all the way through 1996.2 — — 50.5 — — 32.5 5.3 140.4 57.1 8.8 47.1 61.7 95.6 — — 0.0 — 26. by the end of 1997.4 110.5 — 0. 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 5.8 167.2 39.5 10.3 50. The decline in total domestic debt offerings in 1996 can be ascribed to the increase in offshore convertible debts.0 86.8 2.8 55.7 — — 40. Vol.7 0. BDC was established in November 1994 by 50 securities companies based on the provisions of the SEA of 1992.5 55.6 — 0.2 89.0 0.9 0.7 821.1 289.3 6.3 46.7 90. the year the crisis unraveled and the baht was floated.7 28.0 — 5.3 22.4 — 26. turnover value had reached B51.5 37.1 107.3 46.5 — 39.9 40.1 121.1 141.11 Offerings of Debt Securities.0 5.5 — — — 3.2 57.1 21.5 43.1 12.1 55. Total offshore debt offerings peaked in the run-up to the financial crisis.4 billion.3 — 14.9 5. .1 6.9 37.7 5.7 132.0 27.256 Corporate Governance and Finance in East Asia.4 — — — 1.7 0.0 7.1 41.3 13.2 45.8 Source: Securities and Exchange Commission of Thailand and the Thai Bond Dealing Centre.4 — 9.5 138.2 43.0 17.0 33.0 333.7 7.1 59.6 billion.7 538.9 37.3 8.0 26.1 — — — 29.7 — — — — — — — 77.8 191.8 31.4 49.0 281. By 1995.
the use of debentures remains minimal even though the trend was generally upward until the 1997 crisis. From 1990 to 1996. turnover value plummeted to B106. with equity levels remaining high despite an increase in debt.2 billion as a result of the default of debentures due to the Asian crisis. Longterm loans accounted for about 20 percent of total liabilities. The overall trend is consistent with the decline in profitability observed in the analysis of corporate sector performance earlier. Turnover fell further to B72. short-term loans accounted for more than 40 percent of total liabilities.Chapter 4: Thailand 257 compared with investment in equities. The closure of 58 finance companies affected the BDC significantly since half of its members were suspended as a result. cash balances. and marketable securities holdings. these accounted for 33 percent of total liabilities. 4. In 1997. judging by their relatively low levels of retained earnings. The ratio of net working capital to total assets decreased from a peak of 31 percent in 1993 to 28 percent in 1996. significant variations can be noted.4. Across industries. In the same year.2 Patterns of Corporate Financing An examination of financing patterns among Thai companies listed in SET shows that on the asset side. listed companies experienced liquidity problems with declining reserves of cash and marketable securities during the period 1990 to 1996 (Table 4. Thailand’s publicly listed companies rely mainly on loans from commercial banks and financial institutions to finance their growth. Construction and property development industries tended to have high proportions of long-term loans and debentures. In any case. these comprised 31 percent. There was also little change in the trend in retained earnings within the seven-year period. overall asset quality and liquidity of listed Thai companies deteriorated throughout the period. steadily easing up between 1990 and 1996. At lower than 5 percent of total liabilities.12). The proportion of accounts receivable also declined steadily. In addition. The average for all industries was only 22 percent. Companies in construction and property development seemed unable to generate internal funds. while for the property development industry. a trend most apparent in the leap between 1991 and 1992. For the construction industry.1 billion in 1998. BDC was renamed “the Thai Bond Dealing Centre” following its status upgrade to a bond exchange. Equity financing remains an important part of listed companies’ long-term financing. Retained earnings accounted for about 30 percent of total equity financing. they also had a relatively small proportion of equity and .
Printing and publishing companies had lower financial leverage than companies in other industries.0 100.3 1.3 18.4 14. US.1 13.0 100.9 12.0 100.0 48.2 17.3 12.0 51.258 Corporate Governance and Finance in East Asia.3 14.0 100.0 6.7 16.4 6.3 48.5 37.9 40.2 16.9 6.9 43.3 34.3 49.4 7.9 14.8 7.4 49.4 2.9 50.0 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. medium.0 14.0 12.4 21.8 9.9 20.4 17.3 14.0 100.3 1.5 9.0 7.6 36.6 38.2 16.9 17.9 18. The agribusiness industry relied more heavily on short-term loans at 56 percent of the industry’s total liabilities.3 18.8 46.7 0.4 17.0 15.3 17.7 18.0 100.1 7.8 6.3 2.5 14.8 34.7 7.2 42.4 8.8 14.1 49.2 2.9 16.8 9.2 34.8 19.5 9.6 21.8 17.5 1.2 15.7 1.3 6.6 22. and low) also underscores that companies with high ownership concentration had high levels of long-term loans (Table 4.2 2.8 35.2 17.8 3.6 100.9 49. The level of total liabilities for the group characterized by high ownership concentration .7 16.6 100.8 20.2 22.6 18.9 14.8 37.3 25.2 45.0 1.6 50. compared with the 44 percent general average.9 10.0 100.4 49.7 36.6 14.6 11. 1990-1996 (percent) Item All Years 1990 1991 1992 1993 1994 1995 1996 2.5 11.7 15.0 100.8 25.7 14.0 100.0 10.8 37.3 21.2 1.0 13.9 14.0 100.0 100.9 2.9 14.6 2.0 100.7 50.9 0.3 50.6 6.8 21.7 17.0 10.8 1.2 17.2 17.6 13.4 48.2 35.2 3.0 2.6 8.13).6 51.1 50.1 5.6 12. Vol.6 0.1 18.2 1.7 52.2 43.6 0.0 100.3 34.7 9.2 2.1 17.9 14.9 38.9 6.5 43.9 17.3 38.5 0.1 2.2 1.6 10.6 0. Analysis of common-size statements by ownership concentration (based on the levels of top-five ownership concentration classified as high.9 15.9 3.8 10.5 1.1 36. were highly leveraged.4 43.2 43.6 0.0 100. II Table 4.6 15.2 2.8 8.5 1.12 Common-Size Statements for Companies Listed in SET.2 12.
6 0.9 2.4 13.3 100.6 14.9 7.8 12.0 14.5 percent for low ownership concentration companies. US.4 35.5 18.0 19.1 36.2 45.7 12.4 37.0 7.3 1.9 16. common equity accounted for a smaller proportion of total assets (47 percent) than companies with lower ownership concentration.2 22.13 Common-Size Statements of Public Companies by Ownership Concentration.1 53.8 13.0 Medium 2.5 21.8 37. This is consistent with the observation that majority shareholders try to maintain their control by utilizing debt as a major source of funds.6 2.6 47.2 11.7 percent for medium ownership concentration companies and 49.0 6. Companies with medium ownership concentration tended to have a higher proportion of short-term loans.5 100.8 13.4 1.7 19.4 7.2 8.0 16.1 44.3 1.0 41.3 35.7 17.2 14.Chapter 4: Thailand 259 Table 4. 1990-1996 Degree of Ownership Concentration Item Assets Cash Marketable Securities Accounts Receivable Inventories Other Current Assets Total Current Assets Net Fixed Assets Other Assets Total Assets Liabilities and Equity Accounts Payable Short-Term Loans Other Current Liabilities Total Current Liabilities Long-Term Loans Debentures Other Liabilities Total Liabilities Capital Stock Paid-In Capital Retained Earnings Total Equity Total Liabilities and Equity High 2.0 100.6 100. For the high ownership concentration group.3 16.5 11.0 100.1 49.4 3.4 18.6 22.0 6. was 53 percent of total assets compared with 49.9 0.9 100.2 0.5 13.9 36.9 21.6 15.3 8.0 Low 1.4 50.9 50.1 18. .0 Source: Pacific-Basin Capital Markets Database compiled by the University of Rhode Island.6 9.4 49.
4 7.1 in 1996.0 145.1 31. minimization of transaction and interest costs.7 11. As a result. however.4 44. 1990-1996 Ratio Times Interest Earned Total Debt to Equity (%) Long-Term Debt to Equity (%) Total Debt-to-Assets (%) Long-Term Debt-to-Assets (%) Net Working Capital-to-Assets (%) Operating Capital-to-Assets (%) 1990 1991 1992 1993 1994 1995 1996 8.1 144.8 percent in 1990 to 52.4 5.9 63. . More important.9 51. bond issues.2 68.6 41. After the crisis. The ratio of total debt to total assets increased from 50.0 50. followed by bank loans.3 Source: Estimated from the Pacific-Basin Capital Markets Database compiled by the University of Rhode Island. II Results from the ADB survey reveal that Thai companies preferred to use reserves and retained earnings as their first choice of financing.6 7.8 65. especially from 1994 to 1996.4 51.4 139. 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 4.7 percent in 1996.8 5.8 51.0 28. was the headlong deterioration of firms’ ability to meet their interest payment obligations. Short-term debt accounted for most of the increase.1 44. The direct relationship between the degree of leverage and the degree of ownership concentration is apparent in Table 4.7 5. and rights issues. the choice of financing is determined by the company’s liquidity considerations.5 38. The TIE ratio declined from its peak of 7. While further detailed investigations are necessary.9 7.7 34. Table 4.8 151. Public companies relied more on short-term debt financing in the period before the financial crisis. bond issues overtook loans from commercial banks as the second preference. US.4 12.7 in 1994 to 5.14 Financial Ratios of All Listed Firms.1 16. these firms more easily increased their leverage.2 49.0 25.14). The financing patterns indicate that companies with high ownership concentration were more highly leveraged than companies with medium and low concentration.1 23.2 35.9 140. Such deterioration of financial positions during the period was a common feature of listed companies. it would seem that firms with concentrated ownership and associated links to the banking system have easier access to debt financing.7 28.7 34.6 138.3 31.7 66. Vol.7 12.1 16. Generally.1 52.6 125.260 Corporate Governance and Finance in East Asia. thus rendering them more vulnerable.1 31.7 12.9 14.5 52. and maintenance of the existing ownership structure.1 64.8 65. however.3 61.15.
This decline was accompanied.6 30. The proportion of nondebt-creating capital flows.5 percent of external debt in 1996 (Table 4.5 34.8 percent in 1986 to 52 percent in 1995. 1990-1996 Degree of Ownership Concentration Ratio Times Interest Earned Total Debt to Equity (%) Long-Term Debt to Equity (%) Total Debt-to-Assets (%) Long-Term Debt-to-Assets (%) Net Working Capital-to-Assets (%) Operating Capital-to-Assets (%) Low 6.1 The Corporate Sector during the Financial Crisis Impact of the Financial Crisis on the Corporate Sector The financial crisis came after a period of rapid growth in the Thai economy.4 13. such as direct equity and portfolio investment. the proportion of short-term debt increased from 15. is even more telling.8 49.4 52.4 percent to 46 percent during the same period.Chapter 4: Thailand 261 Table 4.8 Medium 7.4 27. 4. and a preponderance of short-term debt liabilities.5 126.4 63.5. Nonbank private debt increased from 27. peaking in 1994 at 84 percent.5 percent between 1985 and 1990 to 8.0 64.8 66.6 11. continued to slide from 1985 to 1997. Their average annual growth rate declined from 28. debt-creating capital inflows rose to 65 percent in 1990.15 Financial Ratios of Listed Companies by Ownership Concentration. 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. The composition and term-structure of this debt. private debt accounted for 84.3 42.2 49.8 28. on the other hand.5 4.1 High 6. Additionally. .8 14.16).3 Source: Estimated from the Pacific-Basin Capital Markets Database compiled by the University of Rhode Island.2 124. unhedged foreign exchange liabilities. The proportion of external debt as a percentage of GDP consequently increased from 42. however. US.9 percent in 1997.5 148. The corporate sector contributed significantly to the crisis because of its rising levels of leverage.7 percent from 1991 to 1996.2 percent in 1986 to 251. From 45 percent of total net capital movements in 1985.8 29. From only 34 percent in 1986.
0 Long-Term Short-Term BIBF Commercial Bank Long-Term Short-Term 0.9 6.1 0.8 108.2 10.6 Total 18.8 10.9 6.1 12.5 12.3 0.3 0.5 12.3 16.16 External Debt.8 12.8 31.3 37.2 2.3 0.3 2.8 0.9 5.0 11.0 13.7 1.9 10.1 30.0 21.9 4.5 4.4 18.Table 4.3 0.1 Source: Bank of Thailand.3 105.3 0.9 1.3 0.3 — — — — — — — 6.5 19.4 5.6 7.6 Government Year Long-Term Short-Term 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 12.9 10.5 1.2 14. .7 10.8 3.7 109.9 35.7 20.4 10.3 3.9 13.2 0.4 3.0 8.9 1.9 3.3 12.6 52.9 31. 1986-1999 ($ billion) Private Nonbank Long-Term Short-Term 3.3 3.3 7.1 22.9 11.1 95.7 24.3 10.8 3.5 16.7 2.1 0.1 64.2 32.0 6.6 — 0.5 14.0 0.3 0.1 0.9 100.4 15.1 34.3 0.6 1.0 11.1 2.1 23.2 0.1 5.9 0.1 0.0 3.7 23.3 20.6 18.5 4.8 13.0 4.9 43.4 2.7 13.2 2.2 2.2 0.2 15.9 3.7 0.4 — — — — — — — 1.9 7.9 29.
6 billion from the 1996 level of B201 billion. banks would be recording more of such NPLs. The proportion of NPLs as a percentage of outstanding loans demonstrates the liquidity problem experienced by the corporate sector. the numbers of bankruptcies and company closures reached all-time highs in 1998 (Table 4. The severity of the impact of the crisis on the corporate sector was apparent from (i) the decline in the volume of public offerings. closures. . Even before the crisis. At the end of 1994. and (iii) bankruptcies. The effects of the crisis were felt across all industry sectors. Trading volume has since been thin. NPLs spiraled from 12 percent in the second quarter of 1997 to almost 40 percent in the third quarter of 1998. and drastic decline in the number and capital of newly registered companies. outstanding credit also declined throughout the second half of 1998. With easy access to foreign funds. based on the three-month past due definition. leaving domestic investors with large capital losses. trading activity at SET had been on the downturn. On average. The value of public offerings sank in 1997 to B56.281 in December 1995 and to 831.360. the number of newly registered companies dropped to a 10-year low in 1998. nonfinancial companies also experienced severe liquidity problems as a result of the baht’s devaluation. 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 liquidity problems faced by the corporate sector are likely to continue for some time. from its peak in 1995. the index declined to 1. SET’s dismal performance is indicative of the extent of the setback suffered by the Thai capital market. It hit a 10-year low in the second quarter of 1998. If lending rates remained high. After that. Due in part to liquidity problems on the one hand. Similarly.6 in December 1996. reaching 45 percent of total outstanding credit in December. exposing the companies to disaster when the baht started tumbling on 2 July 1997. suggesting that serious investors have not returned to the market. foreign currency-denominated debts constituted 55 percent of their total debt portfolio. large Thai companies had actively borrowed at low interest rates from foreign financial institutions. according to the Bank of Thailand.Chapter 4: Thailand 263 This shows that although banking and finance companies suffered most because of their short-term exposure. and poor business confidence on the other. (ii) the rise in the nonperforming loan (NPL) ratio and consequent tightening of credit even for viable firms. Meanwhile. Aside from the problem of NPLs. the SET Index stood at 1. Most of these foreign debts were not properly hedged. Foreign investors retreated from the market.17).
904 20.409 6. 4.5. Thailand.695 3.797 4.915 37.307 4.096 22.224 4.410 5. The IMF financial package was a credit facility of $17.777 11.134 31.677 Bankrupted/Closed 2.902 3. II Table 4. Vol. . the Government was left with no choice.925 12. It also explains the higher dividend yield ratio.052 36.288 35. A steady price decline over the past few years has dragged down the ratio of market price to book value. Ministry of Commerce.977 Source: Department of Commercial Registration. The first Letter of Intent was cosigned by the Minister of Finance and the Governor of the Bank of Thailand on 14 August 1997.095 14. But when assistance from other sources did not materialize. The increase of the P/E ratio in 1998 was mostly a result of a decrease in earnings for most listed companies. IMF required Thailand to meet a set of performance criteria and implement various restructuring measures.080 9.218 3. The price-to-earnings (P/E) ratio deteriorated from 19. the Thai Government was lukewarm to the idea of obtaining IMF assistance because of the requirements and conditions attached to the financial package.2 billion for balance of payments support and buildup of the country’s reserves.410 37.5 at the end of 1994 to 12 in 1996 and further to 6. As part of the assistance package.201 24.334 4.066 19. 1985-1999 Year 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 Newly Registered 10.2 Responses to the Crisis Initially.112 9.792 7.933 25.312 25.105 4.407 28.264 Corporate Governance and Finance in East Asia.17 Number of Newly Registered and Bankrupted/Closed Companies.6 in 1997.
and did not recognize debtor-initiated bankruptcy declarations. They could seek civil action through the courts and could also use criminal sanctions to enforce debt repayments. As it turned out. and if necessary. For example. however. also aimed at institutionalizing legal and regulatory reforms. and the Act Regulating the Finance. 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. While no definition for “insolvency” could be found in the bankruptcy law. Many believed that the process was inefficient. In early 1998. Several changes in the banking and financial policy environment have been effected in line with the restructuring program. drawn up with World Bank and ADB assistance. only two companies emerged intact from the suspension. follow through with a civil or bankruptcy suit. secured creditors had to obtain the court’s approval before starting proceedings . IMF relaxed these key conditions. creditors seldom succeeded in obtaining payment against bankrupt borrowers. There were many options for solving debt repayment problems. increase profitability. and worked on revisions to the Secured Transaction Law. The old law allowed only creditors to file bankruptcy suits. Strict loan classifications. the Civil and Commercial Code. loan provisioning. The core of the IMF conditionalities was the restructuring of the banking and financial sector to regain investor confidence. and Credit Foncier Businesses. Under the old bankruptcy laws. The assets of the other companies were liquidated by auctions. The Financial Sector Restructuring Authority was established in October 1997 to address the problems of 58 finance companies that were suspended in 1997. debtors could drag out the process for many years.” Creditors thus bore the burden of proving a debtor’s insolvency before the courts. and income recognition were implemented. Securities. Regulatory Response by the Government The IMF program.Chapter 4: Thailand 265 The terms of the agreement required the Government to maintain tight monetary and fiscal policies. By invoking procedural loopholes. The Government also passed the Bankruptcy Act and Foreclosure Act Amendments. These include repeal of the Commercial Bank Act. Creditors could negotiate to reschedule debt repayments. it was widely interpreted as “having debts more than assets. and restore solvency.
Chapter 11 is the main tool in restructuring bankrupted companies in the US. Foreign secured creditors had to go through the motions of establishing that their country of domicile granted Thai creditors similar rights. but it is a complicated. time consuming. The model for Thailand’s amended bankruptcy law was the US Chapter 11. II for the recovery of debt through the realization of any collateral. If the process fails to revive the business. The amended law also introduced the concept of automatic stay. The amendment added reorganization provisions to the Bankruptcy Act of 1940. In Thailand.266 Corporate Governance and Finance in East Asia. the judges and court officers have yet to learn and master the new bankruptcy procedure. But more important. the company shall be declared bankrupt and liquidation of assets shall follow. The amended legislation also includes voluntary bankruptcy as a new feature. Under the old Bankruptcy Act. and (iv) the debts shall have been settled within a five-year period. The original Bankruptcy Act dealt only with liquidation and composition. it covers only the court-supervised reorganization of distressed companies. (ii) management of the company reverts to the borrower. Chapter 11 cases account for only 5 percent of bankruptcy suits in the US but consume 90 percent of the courts’ time. In 1999. There are other potential problems. thereby allowing court-supervised corporate restructuring. Enforcement of the new law is bound to be ponderous and lengthy. 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. For one. the amended law limits the rights of secured creditors. any new loan to a company extended after the creditor discovered the insolvency would not be eligible for repayment. Companies need . The reorganization process is successful if (i) the debts shall have been discharged. To make matters worse for creditors. In effect. the National Assembly passed an amended Bankruptcy Act and approved the establishment of special bankruptcy courts. 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. (iii) shareholders regain their legal rights. 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. and expensive process. which means that a debtor could continue in business while the reorganization program was being implemented. Vol. creditors always had to contend with the threat of disruptions in a delinquent borrower’s business.
Most important. and (ii) processing of default cases within four to six months of filing of a court claim. however. In case the board of directors does not comply.” as opposed to the more appropriate criterion of “ability to pay when the debt falls due. the Bankruptcy Amendment will just prolong the problems of nonviable borrowers. Under the new law. Consequently.g. the court. has not been satisfactory. Minority shareholders also have to absorb the costs related to their actions because the 1992 Act does not allow them to be reimbursed by the company.. The amendment seeks to revise old rules and procedures that tended to delay foreclosure proceedings. shall have the power to call the extraordinary general meeting. The minimum shareholding requirement is too high for any individuals or groups of minority shareholders to take action against controlling shareholders. after determining the legitimacy of the request. The result. namely “liabilities exceed assets. 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. 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. questions have been raised regarding the appropriateness of the 1992 Act. the test for insolvency still uses the balance sheet criterion. the 1992 Act relaxed some of the original restrictive rules and regulations to encourage public company registration. The proposed amendment also includes a provision for the company to reimburse minority shareholders for expenses related to calling such a meeting. which aims to increase liquidity in the domestic economy by allowing businesses to use both tangible and intangible assets in securing credit. Without the necessary corporate restructuring. . Procedural delays give borrowers an advantage because they can refuse to pay back their loans even though they can meet their obligations. In the past.Chapter 4: Thailand 267 to solve the problems (e. minority shareholders’ rights are not adequately protected. The amendment also remedies the slow process of executing or disposing of assets in a public auction. The proposed new law seeks to expand the type of assets that a borrower can use as collateral. Still pending Parliament approval is the amendment to the Secured Transaction Law. Replacing the Public Limited Company Act of 1978. corporate governance) that caused the bankruptcy in the first place. only tangible assets were the norm. SEC also examined the possibility of an amendment to the Public Company Act of 1992.” The Foreclosure Act Amendment was likewise passed in 2000.
i. disrupts the company’s management and decision making. Most companies decide against cumulative voting. The 1992 Act only prescribes—not requires—the use of the cumulative voting procedure. 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. Otherwise. and determine voting results on virtually any matter. This may be true in countries where publicly traded companies are widely held. 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. In the absence of such a stock market boom now. to borrow from the company without consideration to the fairness of the transaction or transparency of the approval process. But as demonstrated. The regulators are drafting a proposal to amend the provisions on related transactions. II Another issue is the assumption in the 1992 Act that there is a separation of ownership and control functions. But because this is the assumption embedded in the regulation. The proposal clearly delineates duties of care and loyalty for directors of public companies. which. they face the prospect of being unable to compete for the scarce funds available in the equities market. Consequently. Because of high ownership concentration. The 1992 Act also allows directors to engage in business activities that may directly or indirectly affect the company. without cumulative voting. The textbook separation between owners who sit in the company’s board and professional managers who run the company does not apply in Thailand. vis-a-vis the minority shareholders. the controlling shareholders have the exclusive domain to appoint or exercise management.. However. the main problem is overlooked. in turn. claiming that it creates fragmentation in the board of directors. with the approval of the board. subject only to approval by the board of directors. In addition. this is not so in publicly traded companies in Thailand. Where equity will come forward. there are few provisions in the Act that deal with related or connected transactions that potentially reduce shareholders’ value. 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 dominance of controlling shareholders.268 Corporate Governance and Finance in East Asia. minority shareholders have no chance of being represented in the board.e. Vol. The proposal for the amendment of the Public . minority shareholders are likely to be wary of increasing their equity without corresponding control mechanisms at their disposal. it permits directors. who are also the managers. it will probably be expensive because of the higher risk that comes with weak accountability mechanisms.
Considerable progress has been achieved on this front. This point is crucial because compared with . In response. The first bankruptcy court in Thailand opened on 18 June 1999. with the majority of the debtors coming from the commerce. although since then.764 debt restructuring cases involving B1.6 trillion) have agreed to cooperate with CDRAC’s restructuring process.1 trillion of outstanding credit. Within three months. personal consumption.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. methods.8 trillion had been completed.1 trillion in outstanding credit. the Government introduced debt restructuring-related measures to help resolve bad debts. Equally important is the contribution of effective and reliable bankruptcy procedures for improved corporate governance.068 cases involving B475 billion are undergoing restructuring. In addition. and manufacturing sectors.147 cases (B1. The reason is that bankruptcy law amendments appear to facilitate settlements outside the court. as well as those that did not cooperate with CDRAC’s restructuring process. the mere threat of external control alters the incentives faced by managers and controlling shareholders significantly. Another 77. Another 5 percent of cases (B70 billion) are undergoing restructuring negotiations. 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. where bankruptcy procedures are swift and effective. The Bank of Thailand issued guidelines in 1998 encouraging financial institutions to specify their own policies. CDRAC’s target debtors comprised 10. Some 82 percent of these cases have been successfully restructured. By October 2000.767 cases involving outstanding credit of B2. Corporate Debt Restructuring and Bankruptcy The 1997 crisis led to a severe liquidity problem in the economy. Reforms in bankruptcy procedures should be seen not only in the context of crisis resolution. accounting for B1. As of November 2000. accounting for B1.6 trillion. and procedures for debt restructuring. Commercial banks initiated 74 percent of these cases. However. the court had more than 80 cases for disposition. 322. the number of cases has abated. will be settled by the courts. Cases for which negotiations were unsuccessful. only 7. In particular. contributing to the unprecedented rise in the corporate sector’s bad debt.
to push companies to harmonize their accounting with international standards. and Recommendations Summary and Conclusions This study has provided an overview of the corporate sector and governance in Thailand. For this reason. 4. and promoted key industries through incentives. and even Indonesia. In the next three decades. the Government protected certain corporate sectors through tariffs and regulation. the Thai Government managed its economy with the corporate sector as the main engine of growth and development. Philippines. Examination of corporate ownership. Vol. II Malaysia. Financial information from listed companies will also soon be required to conform to International Accounting Standards. 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. Thailand is coming from a situation where excessively high leverage became the norm because firms could obtain finance without having to concede a measure of control to outsiders. The banking industry played a key role in the early stages of economic development because it represented the only avenue for funding Thai corporations. despite the weakness of their disciplinary powers. The study covers the period 1985 to 1996. Emphasis was on the structure of corporate governance and patterns of corporate ownership and financing of publicly listed companies. and performance during this period helps understand the causes of the crisis. The . a time span that includes the onset of financial liberalization—the turning point of Thai economic development in the last decade—and represents the decade preceding the Asian financial crisis of 1997. The exchange has already required that listed companies’ quarterly reports be directly comparable with annual statements. Weak bankruptcy procedures were part and parcel of the perverse set of incentives that led firms to build up unsustainable levels of debt.6. Such improvements in disclosure standards are part of the efforts of SET and SEC.6 4. Conclusions.1 Summary.270 Corporate Governance and Finance in East Asia. It required listed companies to establish their own audit committees by the end of 1999. Reforms through SET and Improved Disclosure The financial crisis prompted SET to introduce a range of improvements to its operation and regulation. behavior.
Although there was a decline in short-term foreign debt.Chapter 4: Thailand 271 importance of bank financing continued throughout the 1990s. The financial performance of the corporate sector remained satisfactory up to the years before the outbreak of the financial crisis. . In 1992. The study examined the impact of ownership structure on corporate governance and financing patterns. Financial liberalization apparently encouraged companies to borrow overseas to finance investments that were not productively employed. the number and value of public offerings of securities accelerated. Minority shareholders. At the same time. the overall corporate sector was seriously affected. The SEA of 1992 also marked the beginning of an active bond market in Thailand. the increase in long-term debt more than compensated for the drop. The impact of the crisis was felt across all industries. One of the principal causes of the crisis was the excessive use of foreign debt by the corporate sector. Nonbank private corporations accounted for most of the increase. 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 number of newly registered companies in 1997 dropped by almost 10. Although there are some variations across industries. the profitability of publicly listed companies abruptly declined and their financial leverage increased. even after the development of capital markets. the devaluation of the baht that began on 2 July 1997 affected the financial condition of Thai corporations. the numbers of bankruptcy cases and company closures reached alltime highs. the overall pattern of ownership concentration seems to have been stable for the past 10 years. After 1992. Subsequently. Meanwhile. the top five largest shareholders hold about 56 percent of total outstanding shares. the number of listed companies in SET fell from 454 in 1996 to 392 in 1999. Consequently. reaching its peak in 1996. foreign debt in the Thai corporate sector increased continuously. the Public Company Act of 1992 and the SEA of 1992. Profitability increased throughout the 1980s but began to decline in the first half of the 1990s. there was a marked increase in the number of public corporations. On average.000 from the previous year’s level. During 1992-1997. Thai companies were vulnerable to exchange rate risks. In 1995 and 1996. One of the major findings is the high ownership concentration among Thai companies listed on SET. Because most of these debts were not hedged. 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. At the onset of the 1997 financial crisis.
The Government holds about 1 percent of total outstanding shares but these holdings represent majority shares of a few companies. hold only a small portion of total outstanding shares. are not active. foreign and domestic. Institutional investors in Thailand. II although larger in number. The highly concentrated ownership structure weakens the protection of minority shareholder rights. the government pension fund was the only major institutional investor. there is a clear lack of outside monitors for these publicly listed but family-controlled companies. Individuals and insiders hold the second largest proportion at about 19 percent. the mutual fund industry has entered the picture but with limited roles and activities. These laws stipulate rules and regulations concerning the activities of all public companies. The key laws. protect the interests of all shareholders of public companies. Thus. The rules in both Acts governing . the existing legal and regulatory framework suggests otherwise. averaging 46 percent. Vol. 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. Financial institutions hold a very small proportion. With financial institutions playing limited roles in the capital market. Nominally. through the use of holding and affiliated companies. they have little influence over management decision making and control. In the past. Most foreign institutional investors invest only on a short-term basis and aim for short-term trading profits. holding companies and affiliated corporations hold the largest proportion at 27 percent of total outstanding shares. An analysis of the corporate ownership structure in Thailand suggests that founders and management continue to own and control publicly listed Thai companies. publicly listed and unlisted companies in Thailand are equally subject to the consequences of the risk-taking behavior of controlling owners. the Public Company Act of 1992 and the SEA of 1992. The investing public holds the rest of the outstanding shares.272 Corporate Governance and Finance in East Asia. Among the five largest shareholders of Thai companies listed on SET. All these. commercial banks hold only about 2 percent of total outstanding shares while nonbank financial institutions hold about 6 percent. Recently. The absence of external market controls on the management of publicly listed corporations is dangerous. Consequently. along with a highly concentrated ownership structure. contribute to the lack of external controls on the corporate sector through the capital markets. The implications of ownership structures that are concentrated to such a high degree are serious.
In this third area. For instance. key reforms that will strengthen the regulation of financial institutions. The first issue involves the development of a comprehensive supervisory framework and the strengthening of the capacity of supervisory agencies. the degree of ownership concentration has a statistically significant positive relationship to the degree of financial leverage. Rather. before the crisis. Certain provisions. 4. The ownership structure of Thai listed companies also significantly affects company behavior. the high ownership concentration of many listed Thai companies inhibits the effectiveness of these provisions. The Government has been moving to amend the Public Company Act of 1992 to increase minority shareholders’ protection in this regard. It appears that founding family members use debt extensively to finance investments because they want to preserve control of their firms. an aim that can be achieved mostly through legal reforms. Specifically. but is significantly related to financing patterns. moreover. a requirement impossible to meet due to the concentrated shareholdings of founding family members and management. . In view of this. the main challenge is in protecting minority shareholders from the possibility of expropriation by the majority. the Public Company Act of 1992 allows shareholders to act only when they hold a minimum proportion of shareholdings. these companies tend to become overleveraged. laws did not provide minority shareholders sufficient safeguards in cases of transactions involving companies where the controlling shareholders had related interests. However.2 Policy Recommendations There are three major policy issues and recommendations that could improve corporate governance in Thailand. the main challenge is not how the board can control management to maximize shareholder value. Ownership concentration appears to have little impact on corporate profit performance. because there are shared interests between the controlling shareholders and key management personnel. Consequently. The second issue involves the protection of shareholder rights. making them vulnerable to economic shocks.Chapter 4: Thailand 273 minority shareholders’ participation in decision making and in initiatives against management conform to international standards. For example. because there is no separation between ownership and management. The third issue involves creating external market controls through better regulation and development of the capital markets. posed formidable barriers in the minority shareholders’ exercise of their rights.6.
in 1975. It is important that the roles and responsibilities of each agency are clearly defined to the public. SEC was established as another supervisory agency. Only then will these agencies be able to act promptly and effectively. If this were the situation. Consequently. in most of Thailand’s publicly traded firms. The Government must develop an overall framework for corporate sector supervision and redefine the regulatory jurisdiction of each agency along functional lines. and after the enactment of the SEA in 1992. SET. The board therefore plays a pivotal role. Protection of Shareholder Rights The common assumption is that publicly traded corporations are widely dispersed in terms of ownership. activate the market for corporate control. In reality. Vol. II encourage market competition. voting only on major decisions. the supervisory agencies also need to be empowered to enforce the laws. The best approach may entail establishing a single. and increase the participation of institutional investors are imperative. with control delegated to professional managers.274 Corporate Governance and Finance in East Asia. This is due to the historical development of the Thai corporate sector: before 1975. this is a problem in Thailand. three major government organizations (the Ministry of Commerce. Once the roles and responsibilities are clearly defined. SET was mandated to supervise listed companies. the Ministry of Commerce had the sole supervisory responsibility. the supervisory system is fragmented and not as effective as it should be. . As in other crisis economies in the region. the key issue in corporate governance would then be to ensure that managers act in the best interests of the shareholders. Development of a Comprehensive Supervisory Framework There is a need for the Government to establish a comprehensive supervisory framework for the corporate sector. If the principal shareholder is in fact chair of the board. unified supervisory agency or a permanent regulatory division consisting of supervisory units from the three agencies. The owners of a firm rely on a board of directors to supervise the managers. In this setting. he/she often has the decisive vote. and SEC) are involved in corporate supervision. Under the current system. the principal shareholder typically plays a key role in management and often serves as the chief executive officer. There is also supposed to be separation of ownership and control. the key issue in corporate governance is how to prevent insiders from expropriating assets of minority shareholders.
SEC has been trying to lay the foundations of good corporate governance by espousing fairness. The first recommendation involves the repeal of current legislation to allow minority shareholders to have greater influence over management decision making. transparency. and . The second recommendation is to dilute ownership concentration through the use of regulatory power. The situation prompts two specific recommendations. and a prohibition of connected transactions by directors or management. This includes prescribing ways to empower minority shareholders without disrupting the company’s operations. The slow improvement in the legal framework has likewise obstructed progress in this area. Since the Asian financial crisis. But weaknesses in accounting and auditing practices have been inhibiting the development of capital markets. Some of the legal reforms under consideration concern settling conflictof-interest situations with significant effects on minority shareholders. To ensure a level playing field. requiring cumulative voting for the election of directors. Because these holding companies control a number of large public companies in Thailand. This move is expected to be unpopular among founding family members and original owners. there has been much progress in this area. regulators must increase transparency and step up enforcement. 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. accountability. Both SET and SEC are taking an active stance in improving the transparency and efficiency of Thai capital markets. Through an amendment in the Public Company Act. The current ownership structure leads to ineffective corporate governance and inadequate protection of minority shareholders. increasing penalties for directors engaged in misconduct. SEC is exploring the possibility of amending the law toward this direction. 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.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. they should be monitored and regulated. The Ministry of Commerce is conducting a study on proposed amendments to the Public Company Act of 1992. the Government can change the shareholding limit for controlling shareholders. 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.
will lead to the emergence of a reference yield curve. 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. the SEC’s disposition toward a largely voluntary approach for adoption of these characteristics has resulted in uneven compliance among public companies. II responsibility among companies. it will be difficult to improve corporate governance in Thailand. there is a need to increase market disciplinary power through market competition. Without a strong and efficient capital market. aimed at ensuring that banks finance only creditworthy projects. a well-developed secondary market will pave the way for market disciplinary forces to act against poorly managed companies. There will be no incentive for companies to raise capital in the equities market if they can obtain funds at a lower cost elsewhere. will incidentally close off easy sources of finance for companies that have been practicing regulatory arbitrage. The same goes for improvements in the bankruptcy system. In the stock market. especially in the area of connected lending. The variety of debt instruments available to the corporate sector and investors should be increased and longer-term sources of bond finance actively promoted. for instance. However. Further. Because the financing of Thailand’s corporate sector is predominantly bank-based and will remain so for a long while yet. This may not be possible without reforms in the banking sector itself. Accounting standards have also been under review. The promotion of active roles for domestic institutional investors should also improve corporate governance in Thailand. The first step is to establish an active secondary Government bond market. which. In an environment of highly concentrated ownership. while a strong domestic debt market will also offer protection from foreign exchange risk. in turn. 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. Capital Market Development and Regulation Another important issue concerns the development of capital markets. it is important to explore reforms that can lead to the enhanced role of banks in monitoring enterprises. . A well-developed domestic debt market will provide corporations with an alternative to bank financing. Vol.276 Corporate Governance and Finance in East Asia. the power of the capital market to discipline inefficient management is almost nonexistent.
Fact Book. 1997. 1997. The Stock Market in Thailand. The Stock Exchange of Thailand. US. 1995-1999. 1995. Thai Accounting Standards. Department of Commercial Registration Database. 1995-1999. Bank of Thailand Quarterly Bulletin. 1998. Pacific-Basin Capital Markets Research Center. 1995-1999. Thailand. Ministry of Commerce. PACAP-Thailand Database. Kingston. The Stock Exchange of Thailand. The Thai Bond Dealing Centre. The Stock Exchange of Thailand. The Securities and Exchange Commission of Thailand. The Securities and Exchange Commission of Thailand. Bank of Thailand. Bond Market Development in Thailand. Bank of Thailand. Key Capital Market Statistics. 1997-1999. .Chapter 4: Thailand 277 References Annual Report. The University of Rhode Island. Bank of Thailand Monthly Bulletin.
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