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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
1993-1997 Table 1.8 OwnershipConcentrationofPubliclyListedCompanies. 1985-1998 6 7 9 11 12 14 14 18 19 21 26 27 28 32 33 34 36 39 40 41 41 54 56 61 63 . 1992-1995 Table 1.4 Growth Performance of Publicly Listed Companies by Sector.2 KeyMacroeconomicIndicators Table 2. 1997 Table 1. 1986-1996 Table 1.5 Financial Performance of Publicly Listed Companies by Sector.19 DER and ROE of Publicly Listed Companies by Sector.20 ROE of the Banking Sector. 1992-1997 Table 1. 1992-1999 Table 1.6 GrowthandFinancialPerformanceofState-Owned Companies.15 V alue of Stocks Issued and Stock Market Capitalization.1 Growth of the Banking Sector.17 DER of Listed Companies by Degree of Ownership Concentration Table 1.vi List of Tables 1. 1992-1998 Table 2.9 OwnershipConcentrationofPubliclyListedCompanies by Sector.21 Nonperforming Loans by Type of Bank. 1990-1998 Table 1.3 Subsidiaries of the 30 Largest Chaebols Table 2. 1993-1999 Table 1.7 Growth Performance of the Top 300 Conglomerates. 1992-1997 Table 1. 1992-1997 Table 1.11 CharacteristicsoftheBoardofCommissioners Table 1.4 Development of the Stock Market. 1996-1999 Table 1.12 CharacteristicsoftheBoardofDirectors Table 1. 1992-1999 Table 1. Indonesia Table 1.13 Presence of Board Committees in Listed Companies Table 1. 1996-1998 2. 1992-1997 Table 1.14 Banking Sector Outstanding Loans.18 GDP Growth by Sector. 1988-1996 Table 1.16 FinancingPatternsofPubliclyListedNonfinancial Companies.3 GrowthandFinancialPerformanceofPubliclyListed Companies. Republic of Korea Table 2. 1996-1998 Table 1.10 Anatomy of the Top 300 Indonesian Conglomerates.2 Foreign Capital Flows. 1990-1997 Table 1.1 Listed Firms with Positive Economic V alueAdded.
1997 OwnershipConcentrationofListedNonfinancialFirms by Firm Size.12 Table 2.21 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 . 1987-1997 FlowofFundsoftheNonfinancialCorporateSector. 1988-1997 OwnershipConcentrationofListedNonfinancialFirms by Industry. 1988-1997 FinancingPatternsoftheNonfinancialCorporateSectorby Industry Financing Patterns of Listed Companies.vii Table 2. 1990 and 1997 Ownership Composition of Listed Nonfinancial Firms by Size. 1988-1997 Ownership Concentration of the Survey Sample of 81 Listed Firms.13 Table 2.10 Table 2. 1988-1997 Ownership Composition of Listed Nonfinancial Firms by Industry.8 Table 2.9 Table 2. 1990-1997 InternationalComparisonofRatiosofOrdinaryIncome toSalesinManufacturing GrowthandFinancialPerformanceofSelectedIndustries GrowthandFinancialPerformanceofListedCompanies.29 Table 2.14 Table 2.11 Table 2.17 Table 2. 1997 Ownership Composition of Listed Nonfinancial Firms by Control Type. 1997 Ownership Concentration ofAll Listed Firms. 1994-1998 Financing Patterns of the Top 30 Chaebols.22 Table 2. 1995-1997 Ownership Composition of Listed Companies.24 Table 2.28 Table 2. 1993-1997 The Top 30 Chaebols Debt-to-Equity Ratio. 1999 InternalShareholdingsofthe30Largest Chaebols.27 Table 2.7 Table 2. 1988-1997 Features of the 30 Largest Chaebols GrowthandFinancialPerformanceofthe30Largest Chaebols.16 Table 2. 1988-1997 FinancingPatternsoftheNonfinancialCorporateSector. 1997 Ownership Composition of Listed Firms in Selected Countries.18 Table 2. 1985-1998 GrowthandFinancialPerformanceoftheNonfinancial Corporate Sector.30 Private Capital Flows to Korea.25 Table 2.6 Table 2. 1992-1997 OwnershipConcentrationofListedNonfinancialFirms.20 Table 2.26 Table 2. 1994-1997 Cross-Payment Guarantees of the Top 30Chaebols.19 Table 2.5 Table 2.15 Table 2. 1985-1997 GrowthandFinancialPerformanceofListedCompanies by Size.23 Table 2.
SectorOrientation. 1989-1997 Table 3. 1988-1997 Table 3. 1989-1997 Table 3.3 TheCorporateSectorandGrossDomesticProduct.6 GrowthandFinancialPerformanceoftheCorporateSector by Firm Size.11 TotalandPerCompanySales. 1997 Table 3.32 Table 2. 1988-1997 Table 3.1 Public Companies Registered. 1992-1999 .10 Composition of Top Five Shareholders of Philippine Publicly Listed Companies by Sector. 1986-1998 Nonperforming Loans of General Banks. The Philippines Table 3. 1988-1997 Table 3. 1978-2000 Table 4. Thailand Table 4.16 CorporateFinancing PatternsbyOwnershipType. 1983-1997 Table 3. 1989-1997 Table 3. 1997 Table 3. 1992-1996 Table 3. 1995-1998 4.15 Financing Patterns of the Corporate Sector.1989-1997 Table 3.1 GDP Growth of SoutheastAsian Countries.8 Ownership Composition of Philippine Publicly Listed Companies by Sector.000 Companies.20 Financing Patterns by Industry.31 Table 2.22 Foreign Investment Flows.12 Control Structure of the Top 50 Corporate Entities.2 Growth and Financial Performance of the Top 1. 1990-1998 131 137 138 158 159 160 161 163 164 166 173 175 176 180 184 191 201 203 204 205 206 207 208 209 212 235 236 3.7 GrowthandFinancialPerformanceoftheCorporateSector by Industry. 1985-1997 Number of Firms with Dishonored Checks. 1988-1997 Table 3.Profitability andFinancial .13 ADB Survey Results on Shareholder Rights Table 3. 1990-1999 Table 3.21 OwnershipConcentration. 1997 Table 3. 1997 Table 3.9 OwnershipConcentrationatCriticalLevelsofControl Over Publicly Listed Companies. andAffiliated Banks of Selected Business Groups. 1997 Table 3.5 GrowthandFinancialPerformanceoftheCorporateSector by Control Structure.4 GrowthandFinancialPerformanceoftheCorporateSector by Ownership Type.17 Composition ofAssets and Financing of the Publicly Listed Sector.33 Net Profit Margins of Chaebols.19 Financing Patterns by Firm Size. 1988-1997 Table 3. 1989-1997 Table 3. 1988-1997 Table 3.18 Financing Patterns by Control Structure.2 Public Offerings of Securities. Leverage Table 3.viii Table 2. Flagship Company.14 Philippine Stock Market Performance.
1990-1996 Financial Ratios of All Listed Firms.ix Table 4.12 Table 4.4 Table 4.15 Table 4. 1985-1996 Top-Five Ownership Concentration of Publicly Listed Companies in Thailand. 1992-1999 Common-Size Statements for Companies Listed in SET.2 TheSuhartoGroup TypicalInternalOrganizationalStructureofaPublicly Listed Company in Indonesia CorporateControlStructure:TheCaseofAyalaCorporation CorporateControlStructure:theCaseofLopezGroup 24 25 195 197 . 1990-1996 Common-Size Statements of Public Companies by Ownership Concentration. Leverage.7 Table 4. 1993-1999 Key Financial Ratios of Publicly Listed Companies.10 Table 4.11 Table 4.5 Table 4. and Company Size Top-Five Shareholder Composition of Publicly Listed Companies in Thailand. 1990-1996 Financial Ratios of Listed Companies by Ownership Concentration. 1990-1998 StatisticalRelationshipsbetweenCorporateProfitability.6 Table 4.2 Figure 3. 1993-1999 Size and Composition of the Thai Financial Sector.14 Table 4. 1985-1996 Average Key Financial Ratios by Company Size.1 Figure 1. 1990-1998 Merger and Acquisition Activities.13 Table 4. 1985-1999 237 238 239 241 242 243 251 252 256 258 259 260 261 262 264 List of Figures Figure 1. 1992-1999 Offerings of Debt Securities. 1990-1996 External Debt. Ownership Concentration.17 StatisticalHighlightsoftheStockExchangeofThailand.8 Table 4.9 Table 4.1 Figure 3. 1986-1999 NumberofNewlyRegisteredandBankrupted/Closed Companies.3 Table 4.16 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.
regulatory framework. Economic growth reached more than 7 percent per year and the inflation rate was kept at single digit levels. The study also identifies family-based companies and corporate groups. The construction sector was the worst hit. Section 1. followed by finance (-26. This study reviews the Indonesian corporate sector’s historical development. These banks were allowed to operate even if they violated minimum capital adequacy requirements. When the crisis hit the country. and . the currency composition and term structure of corporate foreign indebtedness were causes for concern. and how it contributed to the crisis. Although as a percent of GDP the stock of outstanding foreign debt owed directly by the private sector was smaller than that of the Republic of Korea. Vol. 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.5 percent. no doubt. particularly those with large foreign loans. the controlling families of corporate groups often established banks to provide funds to affiliated nonfinancial companies.5 percent. posted negative growth. how it has affected corporate financial performance and financing. or Thailand. To facilitate even easier access to credit. prior to the financial crisis. Section 1. placed a high premium on these political connections in assessing the chances of being repaid. In many instances.2 presents an overview of the Indonesian corporate sector. except utilities.3 looks at patterns of corporate ownership and control. Foreign creditors. All sectors. and responses to the financial crisis. highly leveraged companies. These were already contributing to high levels of nonperforming loans (NPLs) in the Indonesian banking sector several years before the 1997 crisis erupted. these controlling families had political connections that allowed their companies to enjoy special privileges.6 percent) and trade (-18 percent). The scale of the financial crisis exposed weaknesses of the country’s corporate sector. this left the Indonesian economy extremely vulnerable. In this setup. patterns of ownership and control. Foreign debt reached more than $100 billion. short-term loans were used to finance long-term investments. However. 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. and analyzes their importance to the corporate sector in Indonesia.2 Corporate Governance and Finance in East Asia. the Indonesian economy seemed to be in generally good shape. were the ones most affected. On the other hand. It analyzes the weaknesses of corporate governance in Indonesia. II rate reached 58. patterns of financing. contracting by 36. Malaysia.
Chapter 1: Indonesia 3 profiles the corporate sector’s governance characteristics. Up until the mid-1960s. how it was affected by the crisis. while Chinese and indigenous entrepreneurs ran some large businesses in trading. medium. This section reports the results of an Asian Development Bank (ADB) survey on corporate management and control practices in Indonesian publicly listed companies. Despite the oil revenues.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. However. and tobacco industries. .2 1. The industries that emerged were highly import-dependent and reliant on tariff protection. substantial volumes of private investment entered the scene. The Government became directly involved in industry as a result of the nationalization of Dutchowned shipping firms and oil companies. It also examines the statistical relationship between corporate performance and corporate governance characteristics. 2 Survey questionnaires were sent to 280 companies listed in the Jakarta Stock Exchange. in the course of the fight for nationhood from 1942 to 1950.5 examines the corporate sector during the financial crisis in terms of its role.6 summarizes the major findings of the study and suggests recommendations to improve governance in the Indonesian corporate sector. In the early 1970s. Not all items in the questionnaires were answered by the respondents. Section 1. With the relatively liberal laws governing foreign and domestic private investments introduced by the New Order Government in 1967 and 1968. Subsequently.and large-scale companies were dominated by state-run industrial concerns. 1. a gradual shift in public investment away from manufacturing took place. textiles. the windfall from oil and gas revenues was an important factor that allowed the Government to promote industrial development via import substitution. and its response. only 40 companies replied—39 are private companies and one state-owned company (Bank BNI).4 analyzes corporate financing patterns.2 Section 1.2. Section 1.
Third. the dilution of corporate ownership. a distinct industrial elite started to emerge. even when new shareholders do not threaten the control exercised by the original owners. 1. the value of manufactured exports overtook the value of oil and gas exports for the first time. and related products) had shares in total exports that were rapidly increasing.2. and employed the bulk of the industrial labor force. 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. A number of underwriters emerged. But until the end of 1988. produced consumer goods. First. In 1992. The equity market remained largely unappealing due to a number of factors. 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). Regulations in the banking sector led to equities having higher risk but lower returns than bank deposits. Vol. During this period. many founding owners of companies were reluctant to go public and dilute their corporate ownership. the Indonesian industrial sector was quite diverse. Partly as a result of various government policies. the number of firms quoted in the stock market was only 24. wood. Export credits with low interest rates were granted to industries that were intensive in the use of local labor and raw materials.2 The Capital Market The Government reactivated the stock exchange in 1977. Second. These were families with strong links to the political elite of the New Order. In the 1980s. the stock exchange was also unattractive to companies trying to raise capital as they could borrow from state banks at very low interest rates. exports of nonoil products (particularly textiles and footwear. potentially subjects companies to greater regulatory scrutiny. Last. Generally speaking. By 1987. II the currency needed to be devalued periodically under a managed floating exchange rate system to avoid large current account deficits. . But these proved counterproductive because they limited the potential for capital gains to prospective investors. which dominated their respective sectoral outputs and markets. While most of the companies were small. mostly nonbank financial institutions and stockbrokers. the Government shifted its industrial policy toward the promotion of labor-intensive exports. there were also many rapidly growing large-scale companies and business groups or conglomerates.4 Corporate Governance and Finance in East Asia.
In 1988. During this period.Chapter 1: Indonesia 5 At the end of 1988. began to face competition. The banking sector. Since 1977. Table 1. However. the number of listed companies in the stock exchange increased substantially. and increased access of domestic banks to international financial markets. But in terms of assets per bank. The Government also allowed foreign investors to buy up to 49 percent of listed shares. The initial banking sector reform was introduced in 1983. companies could no longer enjoy low-interest credit from state banks. These included the opening of the banking industry to new entrants. Partly as a result of these reforms. the liberalization of the banking industry allowed banks to determine lending rates for nonpriority loans. Further reforms along the same direction and affecting state-controlled banks came in the 1990s. Through the years. which up to then was channeling oil revenues to priority sectors. the legal infrastructure that was supposed to guide the evolution of the banking sector was not backed by effective enforcement. The dominance of state banks started to erode. However. priority credits still enjoyed subsidized interest rates and funding from the Central Bank. Conglomerates carried out 210 out of 257 IPOs. from 24 in 1988 to more than 300 in 1997. the capital market played an increasing role in raising long-term funds needed by the corporate sector. private domestic banks dominated the sector in terms of number and total assets. the banking sector has undergone many reforms. However. Consequently. . The development of the Indonesian stock market also provided a vehicle for the privatization of state-owned companies (SOCs). more significant reforms were introduced. The Government also abolished the practice of setting prices for IPOs and removed restrictions on price movements in the secondary market. to date. with a total value of more than Rp8 trillion. the controlling shareholder of these SOCs is still the State. the number of private domestic banks increased. the banking sector has been and still is the major source of credit for the corporate sector. which were previously constrained to 4 percent per day.1 shows that from 1994 to 1998. 1.2. state-owned banks were still among the biggest. six SOCs had issued equities in the market. Interest rate regulations on state banks and credit ceilings in general were removed. with a total value of Rp16.3 The Banking Sector Despite the development of the stock market.5 trillion. Thus. reduced restrictions on foreign exchange transactions.
5 165 308.9 27 113.6 7 12. 1993-1999 Type of Bank State-Owned Banks Assets (Rp trillion) Number of Banks Foreign Banks Assets (Rp trillion) Number of Banks Joint Venture Banks Assets (Rp trillion) Number of Banks Regional Government Banks Assets (Rp trillion) Number of Banks Private National Banks Assets (Rp trillion) Number of Banks Total Assets (Rp trillion) Number of Banks Source: Bank Indonesia.4 34 12.4 10 35. and Bank International Indonesia (ranked 9th). Among private domestic banks.0 234 1994 104.1 Growth of the Banking Sector.8 31 10.9 304.9 10 11.5 27 88.5 7 7 7 5 15.3 201. banks could earn profits even when they did not gather and process information about risk.8 29 6.2 10 14. and Bank Umum Nasional (BUN) have failed and the first two are now under management of the Indonesian Bank Restructuring Agency (IBRA). Of these. Vol. II Table 1.7 351.5 7 9.8 391. while BUN has been closed down by the Government.3 10 17.6 34 14. In terms of assets.2 161 214.1 240 1995 122. 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.3 30 7.8 166 248.9 291. Both BCA and BUN have shareholders linked to the former President Suharto.4 239 222 208 173 Assets and liabilities were concentrated in the top 10 banks.8 27 147.7 27 37.8 10 37.3 27 51.5 27 66.9 762.9 39 18.4 789. The other banks among the top 10 were state banks.6 240 1996 1997 1998 1999 141. Because regulation was weak.9 248.8 27 200. But the banking system proved incapable of performing its intermediation function.9 31 9.1 10 47.5 528.6 Corporate Governance and Finance in East Asia.6 7 7. Bank Danamon. private domestic banks among the top 10 in 1997 included Bank Central Asia (BCA) (ranked first and linked to the Salim group). BCA. the 10 largest were all affiliated with major business groups. Bank Danamon (ranked 7th). .6 164 144 130 92 387. 1993 100.8 10 19.
textiles. except in certain strategic sectors. as shown in Table 1.01) (0.15) — = not available. Table 1.09 1.4 Foreign Capital The years of rapid industrial growth attracted a large amount of foreign direct investments (FDIs).2.09) 1. 1990-1998 ($ billion) Type of Flows Net FDI Net Portfolio Investment Foreign Bank Loans 1990 1991 1992 1993 1994 1995 1996 1997 1998 1.78 2.59 billion in 1996. November 2000.2. there was a phenomenal growth in direct borrowings by Indonesian corporations. Until the onset of the crisis. they still amounted to a large sum for the economy to absorb.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. especially through bank loans. 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. In the 1990s. In 1994. the Government allowed foreign investors to own 100 percent of an Indonesian company. Between 1990 and 1996. .81 3. Most FDIs came in through joint ventures with business groups having strong political connections. Indonesia received capital inflows averaging about 4 percent of GDP.74 5. Net FDI flows increased to $5. Increasingly. FDI flows were strong.88 4. Joint BIS-IMF-OECD-World Bank Statistics on External Debt. In effect. September 2000.00 2.10 5. and footwear.40) (0. such as metal goods. foreign creditors were eager to provide financing to Indonesia.50 (0.63) (1. IMF.88) — — — — — — 8. when the financial crisis hit Indonesia. initially from Japan and the Republic of Korea.59 4.33 (13.87 7.11 3.09) (0.01 (2. 1. Source: IFS CD-ROM.2 Foreign Capital Flows. foreign investment also had a strong presence in the services and infrastructure sectors. Although these inflows were not nearly as large as those received by Thailand (10 percent of GDP) and Malaysia (9 percent of GDP).48 1. From the mid-1980s until July 1997. Successive policy deregulation facilitated FDIs in various light manufacturing industries. But FDIs were only one form of foreign capital inflows to Indonesia.
plus 4 percent for the depreciation of the rupiah. From 1987 to 1996. foreign investors began to dominate daily trading. II Up until the late 1980s. Private borrowers preferred foreign loans since these were relatively cheaper. and conglomerates. Capital account liberalization permitted the inflow of foreign capital that fueled the credit boom in the country. By the end of 1997. allowing foreign investors to buy up to 49 percent of stocks of a publicly listed company. the average foreign ownership of listed companies was 21 percent. In September 1997. total corporate debt reached nearly $118 billion. The excessive dollar borrowings made the corporate sector vulnerable to sudden currency fluctuations. but declined to an average of 25 percent during 19951997. The following section looks at the growth and financial performance of the corporate sector. 1. state-owned companies (SOCs). participation in the Indonesian stock market was exclusive to domestic investors. more than 50 percent of total Indonesian private debt and 60 percent of total foreign exchange debt were owed to 175 foreign banks and other foreign financial institutions. . Due to data constraints. 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. This increased to 30 percent by the end of 1993.2. especially the short-term ones. increasing the total trading value from Rp8 trillion in 1992 to Rp120. 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. In the 1990s. the average borrowing rate for dollar loans was 9 percent. foreign banks became a significant source of financing for the corporate sector.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.8 Corporate Governance and Finance in East Asia. In November 1998. the analysis focuses only on publicly listed companies. Consequently. of which two thirds were rupiah-denominated. This is lower than the average borrowing rate of 18 percent for loans in domestic currency. with the onset of the Asian crisis. Domestic corporate debt was about $50 billion equivalent. Vol. The Government relaxed this restriction in 1988. an interesting question is whether standard measures of corporate profitability and performance also indicated the same. The external corporate debt owed to foreign commercial banks was $67 billion. Between 1989 and 1992.4 trillion in 1997.
Return on assets (ROA) was also relatively stable during 1992-1996. 1994.6 1994 50.6 3. 226 firms.2 1995 37.0 33. Note: The number of firms is not identical for each year. publicly listed companies as a group contributed less than 10 percent to GDP.8 percent between 1992 and 1996.3 6.8 6. Average return on equity (ROE) of listed firms was 11.6 percent in 1997. 248 firms. there were 204 firms.2 30.5 34. 1996.0 1.7 — = not available.8 230.5 34.0 64.7 percent in 1997.1 percent in 1997 when the crisis began to buffet Indonesia.0 10.3 3.1 4.1 0.4 1996 18. and 1992.6 24.7 — 250.0 11.0 3. while total assets grew at 43 percent.9 37.1 220.5 240. When the crisis battered Indonesia in 1997. 246 firms. averaging 3.4 percent.4 1993 45. the average DER increased to 310 percent from 230 percent the .5 3. although the contribution increased over time.9 310. but dropped to 1. During 1992-1997. The debt-to-equity ratio (DER) was high compared to those of listed companies in Malaysia and the Philippines. a Value added was assumed to be 30 percent of total sales. Table 1. 1995. 174 firms.0 12. but turned negative in 1997.7 3. Source: JSX Monthly (several publications). but declined to 0.5 37.6 48.0 6.2 7. b Asset turnover is defined as sales over assets. Despite such rapid growth. but fell to 24.0 12. 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. The growth of listed companies was sustained by continuing investments.4 38. Asset turnover was above 30 percent until 1996.4 31. ranging from 220 to 250 percent between 1992 and 1996.3 Growth and Financial Performance of Publicly Listed Companies.0 12. 250 firms.8 220. 1993. total sales of listed companies grew at an annual average rate of 31 percent.4 1997 7.3 shows the growth and financial performance of Indonesian publicly listed companies. Net profits grew at an annual rate of more than 20 percent from 1992 to 1996. In 1997.Chapter 1: Indonesia 9 Publicly Listed Companies Table 1.
property. due mainly to the domination of the International Nickel Company of Canada. the property sector was severely affected by the crisis. ROA of all sectors dropped in 1997. Table 1. in terms of growth of sales and assets. the mining sector had the lowest DER.7 percent during 1992-1996.3 percent between 1992 and 1996. with ROE falling to -11.10 Corporate Governance and Finance in East Asia. the dominant sector was the finance sector. investment.64 percent in 1997. Four sectors (basic industry and chemicals. For instance. miscellaneous industry. the mining sector had the highest ROE. and building construction. although asset turnover was slow. averaging 17. mining.4). Most companies in the sector that had unhedged dollar-denominated loans suffered exchange rate losses when the rupiah weakened. and building construction sectors had the highest DERs because companies in these sectors found it easy to obtain credit from banks. followed by agriculture (Table 1. From 1995. and services. Before the crisis. finance. the banks eagerly provided credit to property development companies. which operated in nickel and copper mining in 1992 and 1993. indicating its reliance on equity to support growth. When interest rates increased. consumer goods. the mining sector ranked first. The finance sector’s contribution to GDP. The finance. In terms of share of value added to GDP. In terms of sales and asset levels in 1997. Overall. ROE fell drastically because the sector had one of the highest DERs.73 percent in 1992 to 1. basic industry and chemicals. This sector was less affected by the crisis. the fluctuation in nickel and copper prices contributed to the oscillation of ROE. Also. only two sectors (mining and finance) showed a consistently increasing trend from 1992. The Jakarta Stock Exchange (JSX) classified listed companies into nine sectors: agriculture. meanwhile. and services. This indicates that a substantial part of corporate debt was denominated in dollars and unhedged. Meanwhile. it appeared that the performance of listed companies was quite satisfactory prior to the crisis. miscellaneous industry. infrastructure. increased from 0. trade. still posting a positive but lower ROE. helped in part by the relatively strong demand for consumer goods. and trade. real estate. II previous year. The ROE levels suggest that high leverage enabled listed companies to achieve high returns on equity. Vol. averaging 21. The same applied to the trade sector. During those years. property. The consumer goods sector ranked second in terms of ROE.5 presents the financial performance of listed companies by sector. and trade) even posted . the companies in the sector did not operate with a high leverage.2 in 1997. and property. real estate. But the sector’s ROE fluctuated a lot. when the property sector was booming during 1993-1997. investment. However.
5 95.2 0.1 0.5 53.2) 0.8 66.9 53.6 28.5 61. and Services — = not available.1 0.9 123.8) (12.9 14.4 1.6 26.1 32.9 0.5) 6. Constn. Industry Consumer Goods Industry Prop.5 28.7 112.0 0.2 14.1 1.9 54.6 24.9 1.7) (27. and Bldg.6 1.8 28.5) 13.8 1.2 13.4 43. Real Estate. and Bldg.4 64.0 (28.0 68.3) 39. Investment.7 62.6 1994 (75.1 0.7 — — 11.3 340.1 23.8 50.3 1.4) 6.4 21.4 38.1 (41.1 1.7 40.8 27.1 0.0 0.9 59.3 0.2 5.7 0.. and Services Net Profit Growth Agriculture Mining Basic Industry and Chemicals Misc.1 0.5 13. and Bldg. Industry Consumer Goods Industry Prop.3 17.8 24.5 45.7 (82.0 0.6 (41. Constn.0 (20.Table 1.0 18.1 1.1 1.3 31.8 0..4 (149.4 1993 155. 1992-1997 (percent) Indicator/Sector Sales Growth Agriculture Mining Basic Industry and Chemicals Misc.8 62.3 31.8 (76.5 23.5 68.9 31.3 92.0 1.0 1996 1997 58.1 0.7) 26.9 . Source: JSX Monthly (several publications).7 28.9 (7.3 0.4 30. Infrastructure Finance Trade.0 16. and Services Share of Value Added in GDP Agriculture Mining Basic Industry and Chemicals Misc. Constn. 1992 — — — — — — — — — — — — — — — — — — — — — — — — — — — 0.8 32.2 41.4 170.4) 8.7 0.7 43.0 24.8) 0.0 (192.1 0.1 16.2 41.0 0.1 35.7) (113. Industry Consumer Goods Industry Prop.7 54. Real Estate.5 1.8 1..6 135.5 (8.7 133.1 0.8 29.. and Services Asset Growth Agriculture Mining Basic Industry and Chemicals Misc.1 0.1 42.4 44. Infrastructure Finance Trade. Real Estate.9 64.6) 19.4 0.6 51. Investment.3 (203.4 77.0) 46.0 43.2 11.4 103.6 0.4 1.2 59.1 — 39.6 83.1 0.7 21.7) 17.0 0.6 22.5 0.0 22.5 1.6 0.3 0.0 0.3 0. Industry Consumer Goods Industry Prop.1 (11. Infrastructure Finance Trade.4 31.7 17.7 34.7 24.9 54.7 1995 51.6 (0.6 0. Infrastructure Finance Trade.9 0.3 51.1 1.5 (11.5) 49.0 64.1 67. Constn.8 51.9 25.2 35.7 90.6 0.6 133.4 30.9 8.6) 25.4 1.5 9.9 36.7 — 36. Investment.6 85.1 71.0 31.6 15.5 1.3 0.5 0.5 92. Real Estate.4 Growth Performance of Publicly Listed Companies by Sector. Investment.3) 53.6) 119. and Bldg.2 0.1 28.
4 13.5 17.0 (0.1 1.6 18. Investment.6 14. Industry Consumer Goods Industry Prop.1 10.2 23.4 79.1 11.0 17. Real Estate.6) 36.1 10.1 63.0) 7.5 11. and Bldg.0 69.2 53.2) 7.4 6.0 11. Industry Consumer Goods Industry Prop.0 190.5 7.8 11.0 120.9 42.8 5.1 (5.8 9.0 160.3 38.4 46.0 3.6 74.3 7.4 17.0 150. Infrastructure Finance Trade.6 19.8 16.9 10.4 20. Investment.6 1.0 180. 1992 20. and Services Asset Turnover Agriculture Mining Basic Industry and Chemicals Misc.1 2.2 13. Constn.9 41.7 4.2 3.0 100.7 4.1 89.1 (3.9 14.0 180.7 13.0 100.8 20.0 700.0 86.0 1997 230.2 3.5 4.6) 18.1 4.7 (3.9 40.6 13.5 1995 80.6 8. and Services Return on Assets Agriculture Mining Basic Industry and Chemicals Misc.0 100.8 168.0 46.1 1996 100.7 10.0 160.7 8.2 8.7 5. Investment.0 630. Investment.3 7.1 9. Infrastructure Finance Trade.2 39.. Industry Consumer Goods Industry Prop.0 120.0 380.6 23.9 7.0 80. Infrastructure Finance Trade.0 220.0 70. Real Estate.0 160. and Services Source: JSX Monthly (several publications). Constn.8 8.0 70.7 1.0 3.9 29.6 8. Industry Consumer Goods Industry Prop.8 25.3 73.0 650.0 60.0 15.2 6.2 1993 130.1 4.8) 8.3 33.2 7.7 12.2) 15.3 0.4 71.0 8.1 6.7 71.4 35. Constn. Real Estate.8 67.1 3.6 13.0 190.0 9.3 13.7 4.0 110.9 38.3) 5.7 1. and Services Return on Equity Agriculture Mining Basic Industry and Chemicals Misc.0 8.0 66.4 35. and Bldg.9 87.5 19.0 650.0 560. Constn.4) (1.5 4.4 5..1 4.3 64.5 13.1 8.8 44.4 46.3 17.7 12. and Bldg.0 14.9 17.3 1.0 150.0 680.0 110.2 30.0 80..5 14. and Bldg.8 3.4 6..1 65.3 17.1 9.0 90.4 1.7 8.8 81.0 19. Infrastructure Finance Trade.4 13.9 4.0 120.6 (11.0 110.0 180.7 10.1 7.0 120.2 111.3 18.0 100.0 39.5 Financial Performance of Publicly Listed Companies by Sector.6 (2.0 140.5 56.0 110.8 11.7 10. 1992-1997 (percent) Indicator/Sector Debt-to-Equity Agriculture Mining Basic Industry and Chemicals Misc.8 479.0 210.0 110.0 50.4 4.8 382.0 150.7 26.0 12.0 110.5 5.5 43.Table 1.2 15.7 9.0 130.7 12.0 170.2 11.3 5.7 46.0 190.0 140.4 .7 5.1 10. Real Estate.0 80.2 (4.1 13.1 1994 80.2 7.0 70.0 110.7 61.9 38.
4 percent the following year. which collectively had the largest assets. the Department of Finance supervised 30 SOCs. Taken together. Six SOCs were listed in the Jakarta Stock Exchange. The DER was slightly higher than for listed companies. .6). averaging 24 and 31 percent. The sectoral distribution of 165 SOCs is as follows: nonfinancial (143 companies). banks (seven companies). The finance and miscellaneous industry.3 trillion.1 percent in 1992 to 28. SOCs diversified into many businesses. the SOCs’ value added as a percentage of GDP ranged from 6 to 8.7 percent. The Department of Mining and Energy ranked first in terms of sales of SOCs under its control. and basic industry and chemicals sectors had relatively stable ROA before the crisis. State-Owned Companies At the end of 1995. indicating SOCs’ declining contribution to GDP. much lower than that of companies listed in the stock exchange. Asset turnover rates were lower relative to those of publicly listed companies. Only the agriculture sector showed an increase in ROA in the couple of years before 1997. there were 58 SOCs with subsidiaries and affiliates. However. SOCs’ sales growth fluctuated during 1990-1996.7 percent in 1990 to 6 percent in 1996. This was relatively high compared to the 3.Chapter 1: Indonesia 13 negative ROA.6 to 8. registering an average annual rate of 10 percent. increasing from 21.1 percent in 1993. Assuming a fixed ratio of value added to sales.8 percent between 1992 and 1995 (Table 1.3 percent in 1995. between 1993 and 1995. Trade had the highest ROA of 39. For instance. Just like private companies. there were 165 state-owned companies (SOCs)3 in Indonesia. This was due to large sales by the National Oil Company (Pertamina).7 to 7 percent for publicly listed companies. but it continuously declined from 370 percent in 1992 to 250 percent in 1995. the subsidiaries and affiliates number 459 with total assets of Rp343. and finance company (four companies). These growth rates were low compared to those for listed companies during the same period. the ratio decreased from 8. ROA had been at high levels from 1992 to 1995. respectively. growth of net profits and assets was erratic. insurance (11 companies). SOCs’ ROE ranged from 6. By 1995. but dropped dramatically to 4. Similarly. SOCs actively operated in various sectors4 under the supervision of “technical” departments. While asset turnover rates of publicly listed 3 4 SOCs are those in which the State has at least a 51 percent equity interest.
mostly private companies.1) 5.0 8.1 19.7).0 28.8 12.1 12. In 1997.0 6. b Asset turnover is defined as sales over assets.8 21. 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. Source: Indonesian Data Business Center. Table 1.1 6. II companies consistently declined over time. 1992 — 7.5 Conglomerates This study used available data on the top 300 conglomerates in Indonesia. Their total sales increased from Rp90. the contribution of conglomerates to GDP increased from 12.3 12.0 8. Assuming a constant ratio of value added to sales.8 percent in 1990 to 13.5 percent in 1995.4 1993 16.8 11.2 23. Table 1.0 17.4 percent in 1992 to 28.2 percent in 1997 (Table 1.1 32.2 — = not available.7 (2. a Value added was assumed to be 30 percent of total sales.0 24. these conglomerates owned 9.7 Growth Performance of the Top 300 Conglomerates.7 1994 (9.1 30.6 28.2 — 370. .6 1995 25.14 Corporate Governance and Finance in East Asia.4 13. a Value added was assumed to be 30 percent of total sales.6 28.3 30.7 13.4 13.5 3.4 16.7 16. 1990-1997 (percent) Item Sales Growth Share of Value Added in GDPa 1990 1991 1992 1993 1994 1995 1996 1997 — 17.1 310.6 percent in 1994.766 business units.0 12. Source: Indonesian Data Business Center.2 18.3 250.6) 260.4 7.4 percent in 1994. SOCs’ asset turnover rates showed a downward trend from 32.0 7.6 Growth and Financial Performance of State-Owned Companies. Vol.4 13. but dropped to 11. but climbed to 30.1 trillion in 1990 to Rp234 trillion in 1997.
an approval needs the majority (50 percent plus one) vote. By international standards. and consolidations. the decision to use certain company assets as collateral for bank credit might need BOC approval. tasked to provide direction to the company. This guards against shady intercompany dealings within a group of companies. The company charter details the issues that need shareholder meeting approval. and the accountant. and declaration of bankruptcy.Chapter 1: Indonesia 15 1. The Corporate Law The Corporate Law of 1995 governs the establishment and operation of limited liability companies in Indonesia. . except in strategic issues stated in the law. For instance. however. and the attendance should at least be two thirds of total shareholders. In general. The BOD undertakes operating decisions while the BOC participates in strategic decisions and operations review. mergers. The law replaced an earlier statute that was based on the Dutch system. For mergers. A chairman heads the BOC while a chief executive officer (CEO) heads the BOD. If the BOC does not perform well. the Government promulgated a number of laws and regulations to protect investors. and the board of directors (BOD). the decision to amend the company charter should be approved by two thirds of shareholders present in the meeting. 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 BOC. is the only shareholder mechanism for monitoring and controlling the BOD. The 1995 law requires limited liability companies to set up two boards: the board of commissioners (BOC). The meeting decides on important issues. For example.2. the legal and regulatory framework of the corporate sector was far from adequate. as representative of shareholders. a member company might sign a disadvantageous contract with another company where the same controlling shareholder has a higher stake. shareholders lose control. The law also holds the directors and commissioners jointly responsible for decisions made by the company. 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. commissioners. The law also specifies that the highest “institution” in the limited company is the shareholders’ meeting. For instance. acquisitions. tasked with supervising the firm.6 Legal and Regulatory Framework During the 1990s.
Examples in the area of corporate governance are guidelines for situations that can potentially lead to conflicts of interest and for acquisitions of substantial shares of listed companies. The law provides the following rights to or protection of shareholders: (i) access to regular and reliable information free of charge. (ii) proxy voting. (vii) the right to call an emergency shareholders’ meeting. and administrative and legal punishment. (viii) the right to make proposals at the shareholders’ meeting. underwriters. The law is supplemented by Government regulations. and (xviii) severe penalties for insider trading. (xvi) independence of auditing. the decision should be approved by three fourths of the shareholders present. The Capital Market Law The Capital Market Law (1995) regulates companies listed in the stock exchange. (iv) cumulative voting for directors. (xvii) mandatory independent board committee. It also regulates reporting and auditing procedures. such as custodian banks and the securities registration bureau. (iii) proxy voting by mail. It regulates the requirements of investment companies. (ix) mandatory shareholders’ approval of interested transactions. and guidelines promulgated by the head of capital market supervision. (xi) mandatory disclosure of transactions by significant shareholders. (xiv) mandatory disclosure of intercompany affiliation such as affiliated lending or guarantees. and bankruptcy. An important rule is the requirement for independent shareholders’ approval for arrangements that might lead to conflicts of interest. delineating the tasks and responsibilities of the Capital Market Supervisory Agency. and the attendance should at least be three fourths of total shareholders. decrees of the finance minister. transparency requirements. 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. (xiii) mandatory disclosure of nonfinancial information. Controlling shareholders have no vote on the matter. investment advisors. Because of such requirements. securities companies. insider trading (including market rigging and manipulation) investigation. (xv) mechanisms to resolve disputes between the company and shareholders. II acquisitions. and other supporting agencies. Vol. (vi) one share one vote. investment managers. consolidations. (xii) mandatory disclosure of connected interests. brokers. (x) mandatory shareholders’ approval of major transactions.16 Corporate Governance and Finance in East Asia. (v) preemptive rights on new share issues. .
A new bankruptcy law was passed in August 1998. etc. 1. states that a bank is not allowed to provide credit without collateral. five. 1.1 Corporate Ownership Structure Quality of corporate governance is closely related to corporate ownership structure (see discussions in the Consolidated Report of this study). A Commercial Court was also set up to deal with bankruptcy cases. net open positions.Chapter 1: Indonesia 17 Bankruptcy Law Despite loan covenants. . 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. Banking Laws Affecting the Corporate Sector Some elements of the banking law also affect the corporate sector. It aimed to protect creditors by providing easier and faster access to legal redress. or financial institutions. the collateral could take the form of nonphysical assets (e. for instance. Ownership concentration is usually measured by the proportion of shares owned by the top one. capital adequacy. families. holding companies. Discussions on corporate ownership cover listed companies and conglomerates.. amended in October 1998. the Banking Law (1992).g. the viability of a project). The court can declare the debtor bankrupt upon the request of at least two creditors and default on one loan. whether they are individuals.3. The two most important elements of ownership structure are concentration and composition. Banking regulations also set lending limits. For instance. or 20 shareholders. creditors of unsecured loans are unprotected when borrowers fail to meet their obligations. It reveals characteristics of controlling shareholders. Unsecured creditors could proceed against a debtor in default based on loan covenants and through the legal process of collection against the latter’s assets.3 Corporate Ownership and Control This section looks at the ownership structure of the corporate sector and reports the results of an ADB survey on corporate management and control of publicly listed companies. However.
the five largest shareholders owned 68. The pattern of ownership concentration changed little over this period.6 3. Data from the Indonesian Capital Market Directory (various publications) show that between 1993 and 1918.104.22.168.0 0. and 0. mining.8 1.0 0.7 1994 48.0 1. Table 1. When a company makes a rights issue. and Berlian Laju Tankers (liquid bulk maritime transportation services) issued 48.0 4.4 percent.1 13.9 shows that ownership by the largest shareholder in 1997 was more concentrated in the agriculture.2 1.8 68.6 3.8 68.7 1996 48. Rig Tenders Indonesia (shipping services) issued 51.5 percent.18 Corporate Governance and Finance in East Asia. Meanwhile.0 2.9 percent of total outstanding shares.9 2.2 67. the controlling shareholders usually act as standby buyers. 3.9 2.5 72.9 0.7 3.6 4. 13.1 1. This preserves the pro rata share of existing shareholders. issued 93. On average.6 13.8 Ownership Concentration of Publicly Listed Companies. ownership widely held by the general public is highest in the infrastructure and transportation sector (not shown in the table).5 16. Vol. the founder usually continues to own the majority of shares through a . II Publicly Listed Companies Table 1. This is because a few companies in the transportation sector issued high proportions of shares to the public. 1993-1997 (percent) Shareholder Rank First Largest Second Largest Third Largest Fourth Largest Fifth Largest Total 1993 50.9 14.2 11.6 percent.6.5 12. 2.4 2. about two thirds of publicly listed companies’ outstanding shares were owned by corporations that were directly or indirectly controlled by families. When a company goes public.3 1995 47. Zebra Nusantara (taxi services). and basic industry and chemicals sectors than in others.9 Source: The Indonesian Capital Market Directory. This is partly due to the prevailing practice of raising equity through rights issues in Indonesia. consumer goods.5 1997 48. respectively. 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. for instance.5 Average 48.1 4. Table 1.6 68.0 67.1 0.
and Services Average Source: The Indonesian Capital Market Directory. and Bldg.4 11. Legal and regulatory developments may have been impeded by the concentration of corporate wealth in .. (1999).3 48.6 2. two thirds (67. Infrastructure. Real Estate.4 6.9 3. the top family controls 16.5 1.8 14.1 0.2 This is confirmed in Claessens et al. and the efficiency of the judicial system.7 6.0 5.9 1.5 4. is strong.9 44.6 percent of total market capitalization while the top 15 families control 61.2 15.2 0.1 percent) of Indonesian publicly listed companies were in family hands.3 14.1 2. and corruption.7 4.6 0.1 1.1 1.1 1. Constn.9 44.9 0. on the one hand.3 36. and Transportation Finance Trade.3 0. Industry Consumer Goods Industry Prop. Table 1.9 50.1 2. the rule of law.6 percent were widely held.6 1. Most of the five largest owners of Indonesian publicly listed companies are limited liability companies rather than individuals.2 2. 1997 (percent) Sector Agriculture Mining Basic Industry and Chemicals Misc.9 Ownership Concentration of Publicly Listed Companies by Sector.1 11.2 46.3 2. which shows that in 1996. Thus the founder keeps the proportion of shares necessary to retain control over management of the listed firm.6 8. 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. in a cross-country study.4 1.Chapter 1: Indonesia 19 fully-owned limited liability company (Perseroan Terbatas). First Second Third Fourth Fifth Biggest Biggest Biggest Biggest Biggest 54.1 2.5 58.1 1.3 0.7 percent of the market.7 1. Indonesia has the largest number of companies controlled by a single family.7 13.6 9. In fact.2 10.4 54. In terms of capitalization. These figures suggest that ultimate control of the corporate sector rests in the hands of a small number of families. on the other. and only 0..4 4. Util. Claessens et al. Investment. that the correlation between the share of the largest 15 families in total market capitalization.1 13.1 0. (1999) also found.4 44. as well as the existence of corruption.7 9.
The nonindigenous businesspeople are usually Chinese. or other ethnic groups. Coordination is easier because informal communication channels exist. . and family origin.20 Corporate Governance and Finance in East Asia. was able to create a favorable environment for business development. their number increased to 5 In 1997. with all its regulations. 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. However. ethnicity.10 shows the anatomy of the top 300 conglomerates in terms of year of establishment. II the small number of families and the tight links between companies and the Government. Indian. and Padang. Indigenous businesspeople include the Javanese.5 Conglomerates Table 1. The corruption and regulatory problems generated by high ownership concentration by families in Indonesia are likely to overwhelm its benefits. From 193 in 1988.55 percent in August to 25. numbering 162 in 1988 and 170 in 1996. nonindigenous groups owned a larger proportion of the top 300 Indonesian conglomerates. but later declined and steadied at around 25 percent. resulting instead in a decline in the proportion of foreign investor ownership. the Government allowed foreign investors to buy up to 100 percent of listed shares. Family control is said to have positive effects in that it allows group members in conglomerates to make strategic decisions quicker. Sundanese. accounting for 64 percent of total conglomerate sales in 1988-1996. political affiliation. there is a dichotomy between corporations owned by indigenous and nonindigenous businesspeople. Vol. it rose to 30 percent. But these benefits are few and often dubious compared to the high costs of concentration. However.42 percent in December. Among the top 300 conglomerates. the proportion of foreign ownership declined from 27. In 1993. This may indicate that the New Order Government. the legal system is less likely to evolve in a manner that protects minority shareholders. most were established during the New Order Government. the onset of the crisis negated this development. conglomerates established before 1969 dominated in terms of sales. During 1988-1996. When the Government allowed foreign investors to buy up to 49 percent of listed shares in 1988. In Indonesia. In September 1997. foreign ownership increased to 21 percent. Batak.
5 120. For instance.2 159.1 58.1 42.3 20.6 54.2 30.8 30.4 18.4 86.Chapter 1: Indonesia 21 Table 1.1 87.0 31.4 31.8 68.1 46.2 23. Conglomeration Indonesia 1997.7 24.7 40.4 57.1 percent of total .0 116.5 21.7 49.1 25.8 25.6 114.9 trillion. 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 9.9 35.9 42.10 Anatomy of the Top 300 Indonesian Conglomerates.3 80.7 95. In 1996.2 48.9 137.7 106.3 134.4 15.4 trillion in 1996.1 41. its sales reached Rp1.1 46.3 43. sales of the Bakrie group before it went public in 1990 were only Rp369. Their total sales also increased from Rp38.7 89.8 36.2 29.4 37.4 48.4 22.8 57.4 81.4 31. While they supplied 20.8 12.3 120.7 64.0 28.4 32.0 18.6 17.3 36.6 trillion in 1988 to Rp137.8 49.9 13.6 77.0 58.0 15.9 73.8 38.2 12.6 34.4 16.0 58.8 Source: Indonesian Business Data Centre.1 103.1 179. 204 in 1996.6 12.8 28.5 106. more than five times its 1988 level.2 76.4 69.1 21.9 47.9 77.9 14.6 95.4 59.5 22.4 59.4 52. Meanwhile.3 101. due to their “go public” activities.9 billion.2 33.0 44.7 28. the number of mixed groups declined from 86 in 1988 to 68 in 1996.1 52.4 68.4 19.1 33.
Indocement Tunggal Prakarsa (cement industry). Bambang Rijadi Soegomo. Average sales of official-related conglomerates were substantially greater than nonoffficial-related ones during 1988-1996. More recent alliances were between Bambang Trihatmodjo (former President Suharto’s son) and Johannes Kotjo. In 1996. In 1996. Some of them later became public companies by listing in the stock market. their contribution declined to 13. and Wisnu Suhardhono of Apac-Bhakti Karya. 117 are jointly owned by the family and 57 are owned by individual family members. II sales in 1988. Bank Indonesia. Conglomerates were also classified into nonofficial. which is the largest conglomerate in Indonesia. Banks owned by groups or conglomerates typically act as a “cashier” that provides credit to companies within the group. Only about 13 percent were formed by official or ex-official families. Most of the top 300 conglomerates were established by ordinary citizens. compared with the less than Rp700 billion of a nonofficial-related conglomerate. and Ibrahim Risyad of the Salim group.and officialrelated groups. for instance. But listed companies within conglomerates were few. most of the 16 liquidated banks had violated the legal lending limit set by the central bank. there were 175 groups that originated from a family business. owns four groups with many subsidiaries and affiliate companies. Prudential credit analysis tends to be ignored. and Fast Food (restaurants).22 Corporate Governance and Finance in East Asia. In November 1997. The Suharto family is the largest stockholder in Indonesia. The Salim group. including Indofood Sukses Makmur (food industry).2 trillion. Political alliances between entrepreneurs and officials have often led to the violation of regulations meant to promote prudent business practices in the banking industry. or have resulted from alliances between entrepreneurs and officials.7 percent in 1996. Official-related groups have owners (or founders) who are or are allied with former or current government officials (or their families). Djuhar Soetanto. The well-known official-business alliances are those between Sudwikatmono (former President Suharto’s cousin) and Soedono Salim. But only a handful of these companies are listed in the market. banks that had to be closed down included Bank Surya (owned by Sudwikatmono) and Bank Andromeda (owned by Bambang Trihatmodjo). Out of 174 companies. average sales of official-related conglomerates reached Rp1. The high NPLs accumulated by banks within official-related groups could be partly attributed to this practice. The contraction in the number and economic contribution of mixed groups may be an indication of increasing social polarization along ethnic lines. Vol. In 1997 and 1998. collectively controlling .
The Salim Group is also in part controlled by the Suharto family. Cross-holdings between financial and nonfinancial firms potentially create more serious problems. they still control the work of the directors. In so doing. management. Semen Cibinong. If the family members cannot actively manage the companies as directors. continue receiving some kind of protection and special treatment. The officials (or their family members) often own a small portion of shares given to them freely by controlling shareholders. Although they are not actively involved in the daily operations of the companies. In 1996. The BOC chairperson often represents the controlling party of the company. besides Suharto himself. for instance. Cases in point are the Bank Papan Sejahtera and Bank Niaga.. 1999).Chapter 1: Indonesia 23 assets worth $24 billion (Claessens et al. But it is difficult to obtain data on cross-shareholding among firms. or someone very close to and trusted by the controlling shareholders. 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. but those of the entire group. or both. Both are listed companies and members of the Salim group. The families retain control of the companies through ownership. which were liquidated or recapitalized after being acquired by the Tirtamas group that owns a listed cement company. The family controls 417 listed and unlisted companies through a number of business groups led by the Suharto children. It is generally believed that there are cross-holdings between financial and nonfinancial companies and among nonfinancial firms. families mostly manage the groups and make strategic decisions themselves. Some of the groups related to officials have a unique share ownership structure. Indofood Sukses Makmur (food industry) was owned by Indocement Tunggal Prakarsa (cement industry). served in some government function (see Figure 1. This is because cross-owned banks had to consider not only their own interests. the controlling shareholders are able to maintain their special relationship with officials. and hence. While the source of the . many of whom. Although some groups employ professional managers. He or she could either be the biggest shareholder. they maintain their position as commissioners.1). as well as other relatives and business partners. with no restrictions. Indonesian law allows cross-shareholdings.
(Feb. and Larry H.1 The Suharto Group Usaha Mulia Group (cousin Hasim) Cemen Cibinong Hanurata Group Suharto Family Citra Lamoro Group (daughter Mbak Tutut) Bank Yama Bob Hasan Group (Mohamad Hasan) Gatari 22 firms with control over 20% Citra Marga Persda Tollroad Trias Sentosa Bank Central Indomobil Mercu Buana Group (step brother Probo) 11 firms with control over 20% Kedaung Indah 14 firms with control over 20% Kedaung Group (Agus Nursalim) 18 firms with control over 20% Tirtamas 21 firms with control over 20% 262 firms with control over 20% Salim Group (friend Soedono) Sempati Air Humpuss Group Bank Utamar 17 firms with control over 20% Bimantara Group (son Bambang) TPI Andromed Tripolita 8 firms with control over 20% Kabelindro Kiani Murmi Sakti Source: Stijn Claessens. Financial Sector Practice Department. Simeon Djankov. . P. Lang. World Bank. 1999). Who Controls East Asian Corporations? Financial Economics Unit.Figure 1.
Figure 1. The typical structure of a publicly listed company in Indonesia is shown in Figure 1. As the owners’ representatives. 1.2 Management and Internal Control A company’s internal organizational structure determines how shareholders control management. request a shareholders’ meeting. This is based on the Dutch system. The managers execute the BOD’s decisions and lead employees in their departments. 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. management and managerial compensation. if necessary. The BOD leads the company and makes strategic and operational decisions. and accounting and auditing procedures. role and protection of minority shareholders.2. one possibility is that legal lending limits had been violated. the BOC has the right to obtain any information concerning the firm.3. Shareholders are at the top of the organization. the directors. both controlling and minority.Chapter 1: Indonesia 25 problem is inconclusive. Therefore. and. the BOC supervises the work of directors. seek an audience with directors. The discussions are based on the ADB survey of 40 companies listed in the Jakarta Stock Exchange.
Corporate Governance and Finance in East Asia, Vol. II
Board of Commissioners and Board of Directors Table 1.11 presents a summary of some characteristics of the BOC. The table reveals that 29 out of 40 companies surveyed did not have independent commissioners. Although 23 companies reported that commissioners were elected based on professional expertise, nine companies reported that selection was based on relationships with controlling shareholders, and another nine reported that commissioners were the company’s founders. Table 1.11 Characteristics of the Board of Commissioners
Number of Firms Responded 11 29 23 9 9 10 22 7 27 7 8 8 30 6 4
Questions Presence of Independent Commissioners a. Yes b. No Basis for Electing the Board of Commissioners a. Professional expertise b. Relationship with controlling shareholders c. As founders of the company Procedure in Electing the Board of Commissioners a. Nominated by the management and confirmed by the AGM b. Nominated by significant shareholders and confirmed by the AGM c. Nominated and elected by shareholders during the AGM Basis for Electing the Chairman of BOC a. Professional expertise b. Shareholdings c. As founders of the company d. Relationship with controlling shareholders Relationship between the Chairman and CEO a. Not related by blood or marriage b. Related by blood or marriage c. No answer
Note: Since companies could answer more than one alternative, the total does not necessarily add up to 40 for each question. Source: ADB Survey.
In most companies (22 out of 40), members of the BOC were nominated by significant shareholders and confirmed at the annual general meetings (AGMs). A nominee that was not supported by significant shareholders
Chapter 1: Indonesia
was unlikely to be chosen as a commissioner. Most companies (27 out of 40) elected their BOC chairman based on professional expertise. The majority of firms (30 out of 40) also reported no relationship between the chairman and CEO either by blood or marriage. A similar picture is obtained for the BOD (Table 1.12). Most companies (30 out of 40) reported not having independent directors. Professional expertise was an important basis in electing directors for 29 companies. Relationships with controlling shareholders and founders of the company were the basis for selecting directors in 11 companies. Table 1.12 Characteristics of the Board of Directors
Number of Firms Responded 10 30 29 7 4 13 22 6 29 3 7 8
Questions Presence of Independent Directors a. Yes b. No Basis in Electing Board of Directors a. Professional expertise b. Relationship with controlling shareholders c. As founders Procedure in Electing Board of Directors a. Nominated by the management and confirmed by the AGM b. Nominated by significant shareholders and confirmed by the AGM c. Nominated and elected by shareholders during the AGM Basis in Electing the Chief Executive Officer a. Professional expertise b. Shareholdings c. As founders of the company d. Relationship with controlling shareholders
Note: Since companies could answer more than one alternative, the total does not necessarily add up to 40 for each question. Source: ADB Survey.
Twenty-two out of the 40 respondents elected their directors through nomination by significant shareholders and confirmation by the AGM. Most companies (29 out of 40) selected the CEO based on professional expertise, although some companies based it on relationships with controlling shareholders.
Corporate Governance and Finance in East Asia, Vol. II
Management and Managerial Compensation The Corporate Law mandates the BOD to lead the company and make strategic and operational decisions, and the BOC to supervise the work of the directors. The BOC also reviews the results of operations and participates in strategic decision making. This indicates some overlapping functions for the BOC and the BOD, which is confirmed in the ADB survey. This overlapping of responsibilities, particularly in making strategic decisions, may result in conflicts. However, since the BOC appoints members of the BOD and determines their remuneration, the BOC is in a strong position to dominate the BOD. Twenty-five out of 40 firms indicated that the CEO makes important decisions after consulting the chairman of the BOC. In carrying out their tasks, the majority of firms reported not having committees to assist the BOD and BOC, as shown in Table 1.13. Only a few companies have nomination, remuneration, and auditing committees, most of which were set up between 1995 and 1997. In 1995, Bank Indonesia required commercial banks to have an auditing committee. Table 1.13 Presence of Board Committees in Listed Companies
Type of Committee Nomination Committee Remuneration Committee Auditing Committee None Total
Source: ADB Survey.
BOD 5 5 5 23 38
BOC 1 1 3 35 40
Most firms reported terms of appointment of three to five years for the BOD and BOC. In some companies, the term differs for commissioners and directors. Although the term is for three to five years, in 13 out of 40 companies, the directors and commissioners have been in service for more than five years. Results of the ADB survey show that in 18 companies, the CEO is given fixed compensation plus a profit-related bonus. In 14 companies, only fixed compensation is given. For the BOC chairman, 10 companies
Chapter 1: Indonesia
provide fixed compensation plus profit related bonus, while 14 companies provide fixed compensation only. Role and Protection of Minority Shareholders Indonesian law requires publicly listed companies to have at least 300 shareholders to help ensure share liquidity and dispersed ownership. The highest number of shareholders is found in Bank BNI (a state-owned bank), reportedly having 27,568 shareholders. Small companies simply comply with the minimum shareholder number requirement. Most companies reported that their shareholders enjoy all mandated rights and protection, except those on proxy voting by mail, cumulative voting for directors, and the independent board committee. A company charter (articles of incorporation) stipulates the quorum requirement during annual meetings, which is usually two thirds of total shareholders. The ADB survey showed that more than 67 percent of shareholders attended the last annual meeting in most companies. While proxy voting is allowed, proxy votes accounted for less than 10 percent of shareholders on average. Brokerage companies and management were the usual proxies. A change in the company charter requires a two-thirds majority vote by shareholders. The ADB survey revealed that in the last three years, only one management proposal (i.e., director’s fee) was rejected during the AGM. This is not surprising because management usually seeks prior approval of proposals from controlling shareholders. Accounting and Auditing Procedures Thirty-five out of 40 respondents in the ADB survey claimed to have substantially followed international accounting standards even prior to the financial crisis. Accounting authorities, however, can easily change acceptable accounting methods. After the crisis, for instance, the Indonesian Accountants Association recommended that potential foreign exchange losses be reported as losses at the end of the accounting year. Later, the association allowed companies to choose between declaring it in the profit and loss statement at the end of the accounting year or in the balance sheet. All companies in the survey reported the presence of an independent auditor, which is usually an international audit company. Most companies have been associated with their independent auditors for more than five years. Shareholders appoint the external auditor during the AGM.
Corporate Governance and Finance in East Asia, Vol. II
Control by Creditors The control of creditors over a debtor company rests on assets used as collateral for loans. Unsecured creditors resort to the legal process when problems arise. Based on the ADB survey, each company was associated with an average of five creditors, the majority of which were banks. Some companies were associated with an excessively large number of creditors, reaching up to 30. Most of the companies have been dealing with their institutional creditors for less than three years. Although the banking law requires collateral for bank loans, some creditors did not enforce the requirement. Only 10 companies reported that they were required to provide collateral by all creditors. Twelve companies claimed having creditors that did not ask for collateral. Twenty-five out of 32 companies reported having renegotiated loans with creditors in the last five years, mostly after the Asian crisis. This indicates that many companies experienced serious difficulties in repaying debts as a result of the crisis. But most of these companies stated they would possibly borrow from the same creditors, indicating their relatively strong bargaining position. The majority of firms (22 out of 29) also said that creditors had no influence in management decision making. In 1998, the Bankruptcy Law was passed to protect creditors and the Commercial Court was set up to deal with bankruptcies. This paved the way for unsecured creditors to proceed against a debtor in default based on loan covenants and through the legal process of collection against the debtor’s assets. However, enforcement of the law was a disappointment to those who hoped that it would put corporate restructuring and the settlement of corporate debts on a running start. Only 17 cases had been filed with the court by late November 1998. Just two companies had been declared bankrupt, and three suits were dismissed by the Commercial Court. The Government’s political will and support are still very much needed in order to set up a well functioning Commercial Court. Long and hard work is required to restore creditors’ confidence in Indonesia’s legal system. The Market for Corporate Control Between 1992 and 1997, there were 40 cases of acquisition and takeover of Indonesian companies. Most of these, however, were internal acquisitions (i.e., acquisition of a company in the same group). Only five cases were
who was acquiring his second commercial bank. to Hashim Djojohadikusumo. which was acquired by Yopie Wijaya in 1995. For instance. They then replaced the BOD and later sold the bank. the takeover brought significant losses to Djojohadikusumo when share prices plunged7 during the crisis. . the owner of Tirtamas group.Chapter 1: Indonesia 31 external acquisitions. with the minister’s approval. The bank was reported to have high NPLs and had broken the legal lending limit. at a large profit. the acquiring interest was apparently seeking economic profits. In these two latter cases. In the massive restructuring of the banking sector that commenced after the crisis. 6 7 Later in March 1999. State ownership for listed SOCs ranges from 25 to 35 percent. The Government is thus able to appoint some officials to be members of the private firm’s BOD or BOC. except for publicly listed SOCs. IBRA found itself tasked with managing large amounts of assets in the private sector. One famous takeover was Bank Papan Sejahtera. the bank was liquidated. 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. Most Indonesian state companies are 100 percent owned by the Government. appointment of management. the acquiring parties were trying to obtain operating synergies because they had companies in the same industry. restrictions on market entry. or direct subsidies.6 In this case. Since the NPLs reached up to Rp300 trillion. This used to be a common practice in companies associated with the Suharto regime. Another case was the takeover of Bank Niaga in 1997 by Djojohadikusumo. a state-owned insurance company may invest its funds in a private firm. A more recent case was the acquisition by Nutricia (the fourth largest baby food firm in the world) of PT Sari Husada (another baby food firm) in 1998. the Government took over NPLs and put them under IBRA management. Bank Niaga was under a recapitalization program. In April 1999. Wijaya and his friends bought shares of the bank on several occasions until they gained control. However. A study by Connie Tjandra (1993) shows that internal acquisitions were often initiated for tax shelter purposes. Before the financial crisis. it was common for the Government to invest in certain private companies. Control by the Government Government control could be in the form of state ownership.
When the Government liberalized the banking industry at the end of 1988 (which allowed for higher interest rates).6 6.5 80.4 225. jointly providing almost 90 percent of loans until 1997. bank credit surged from Rp122. Bank Credit As shown in Table 1. Table 1.0 168.4 56.6 292.7 112. because of the restrictions discussed below.1 220. remain the major financing instrument for the corporate sector.5 7. the share of private national banks in outstanding total loans increased to 44.3 14.2 6.9 150.3 9.32 Corporate Governance and Finance in East Asia. this market was not well developed. 1992-1999 (Rp trillion) Type of Bank State-Owned Banks Foreign Banks Regional Govt Banks Private National Banks Total Source: Bank Indonesia. Since then. Vol.6 percent in 1997.6 48.4. From 34.14. new instruments have been introduced to the corporate sector. private national banks overtook state banks as the dominant credit source.6 150.7 18.2 71.4 86. Data from Bank Indonesia show that from 1994 to 1997. However. however. Private national banks and state-owned banks were the biggest domestic creditors. stocks.4 24.5 42.9 153. 1992 1993 1994 1995 1996 1997 1998 1999 68. companies considered alternatives to bank loans.0 93.5 108. II 1.3 111.14 Banking Sector Outstanding Loans. .9 trillion in 1992 to Rp487.6 4.2 27.4 percent in 1992.0 6. when the Government reactivated the stock exchange.2 5. Bank loans.9 378.0 487.0 3.7 50.3 188.6 3.4 trillion in 1998. equities became available to the corporate sector.4 1. including bonds.9 234.3 66.3 60.1 Equities In 1977. and others offered by nonbank financial institutions or finance companies. bank loans were the only instruments available to the corporate sector for short term (working capital) or long term (investment) financing.8 193.7 122.1 Corporate Financing Financial Market Instruments Prior to 1977.
6 859. legal lending limit.e. They were not. and consumer credit.0 70.0 206.4 207.8 48.9 1999 76. shooting up to 18.6 310.. During the 1990s. finance companies were increasingly used as channels for the inflow of foreign loans.. funds raised in the stock market were less than 5 percent of the credit disbursed by the banking sector. factoring. It gradually increased again starting in 1991. when foreign investors were not yet allowed to purchase listed shares.15 Value of Stocks Issued and Stock Market Capitalization. Most banks therefore set up subsidiary finance companies to circumvent banking regulations.9 406. . In 1995.1 18.7 9.6 301. offering services such as leasing.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. 1992-1999 (Rp trillion) Item Stocks Issued Outstanding (As % of Outstanding Bank Credit) Market Capitalization Source: Bank Indonesia.6 91.4 1996 1997 1998 50. but dropped to 8 percent in 1991 when the Government tried to stabilize an overheating economy.7 15. and net open position). the stock market has gained a bigger role in corporate sector financing (Table 1.5 1995 35. the Government issued regulations to supervise and promote prudential practices in finance companies.5 333.6 123.Chapter 1: Indonesia 33 Some companies went public. In 1988.0 15. credit cards. The ratio reached 8.1 10. limiting loans to a maximum of 15 times equity and foreign loans to five times the equity. Prior to 1995.15).1 17. however. 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. the activities of finance companies were not covered by regulations on prudential practices in the banking sector (e.g. Overall.7 percent in 1997.3 percent in 1990 when the stock market was liberalized and foreign investors were allowed to purchase up to 49 percent of listed firms’ shares.2 16. allowed to accept deposit accounts from the public. Table 1. i. capital adequacy ratio.1 1994 26.7 14. 1992 1993 11.
6 8.5 (0. II Commercial Papers Commercial papers.6 100.8 7.0 100. While banks had some exposure to these instruments.3 (0.8 17.3 14.3 16.0 1991-1996 16. PACAP Research Center.4 13.1) 23.9 16.8 percent. 1996.4.0 3.0 1986-1996 17. Table 1.6 12.7 22.1) 23. at 81 percent of total borrowings. publicly listed nonfinancial companies had high proportions of equity and internal finance (retained earnings).3 37. have been popular in Indonesia since 1990.2 Patterns of Corporate Financing Table 1. otherwise it would be classified as a loss in the banks’ books. In the second half of the 1980s.6 100.16 shows financing sources of Indonesian publicly listed nonfinancial companies estimated by using flow-of-funds analysis. 1. which are unsecured negotiable promissory notes with a maximum maturity of 270 days.0 — = not available.5 — 26. short-term borrowings were greater than long-term debts. Vol. This is in contrast to the lower share of borrowings during the same period. averaging 26.5 percent and 36. 1986-1996 (percent) Financing Source Internal Borrowings Short-Term Long-Term Debentures/Equity Debentures Equity Trade Credit Others Total 1986-1990 36. . Bank Indonesia prohibited banks from underwriting issues of commercial papers but allowed them to act as paying agents.34 Corporate Governance and Finance in East Asia.5 21. Source: Author’s estimates based on the Pacific-Basin Capital Markets (PACAP) Databases.4 23.6 23.16 Financing Patterns of Publicly Listed Nonfinancial Companies. 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).0 39. respectively.2 26. Thus in November 1995.5 11. In terms of composition. they were not rated by a rating agency.4 8.
3 percent during 1991-1996.9 trillion.2 trillion. Bank loans also surged when the banking sector was liberalized in 1988. . which managed to post significant profits due to low exposure to dollar-denominated loans.4. Table 1. Of the various financing sources.1 trillion. Indosat and Telekom. reaching Rp229. except Semen Gresik (an SOC). Many companies suffered big losses in 1997 due to their high exposure to dollar loans. This amount doubled in 1997. which was masked by the rapid growth in investments. as evidenced by an average DER of 230 percent during 1992-1996 that rose to 310 percent in 1997. the corporate sector’s high leverage. Corporate debts grew over time. The results indicate that firms with higher ownership concentration tend to have a higher DER. 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.17 compares the DER of listed firms by degree of ownership concentration.2 trillion (mostly foreign exchange losses). while Semen Cibinong’s losses reached Rp2. also suffered from foreign exchange losses but managed to post profits of Rp0. with longterm debts increasing rapidly.4 trillion in 1993 to Rp112. was due largely to a rapid rise in long-term debts.3 Corporate Financing and Ownership Concentration It has been suggested. Hence. the pattern changed. For instance. 1. The corporate sector invested heavily from 1991 to 1993 and slowed down its investment spending a few years before the 1997 crisis. respectively. The high share of equity financing was due to the surge in capital market activity following the 1988 reforms.6 trillion and Rp1. They also do not want to dilute corporate control and are more likely to finance growth with debt. Large shareholders are inclined to undertake risky projects intended to generate high returns using borrowed funds. Note that the corporate sector’s high leverage existed side by side with sizable equity capital raised from the capital market. Most corporate charters require commissioners to approve debt issues or sign debt agreements. corporate debts accounted for 39. Indofood registered losses of almost Rp1. These liabilities grew significantly because corporate expansion was largely financed by debt. that ownership concentration may be associated with heightened risk-taking by companies. in the context of Indonesia and some other countries. rising from Rp54.9 trillion in 1996.Chapter 1: Indonesia 35 In the 1990s. All companies in the cement industry suffered from foreign exchange losses. Two telecommunications companies.
0 351.1 The Corporate Sector in the Financial Crisis Causes of the Financial Crisis Many intertwined factors led to the crisis.358.5. and high ownership concentration among families with political affiliation.0 1. Between 1987 and 1996. heavy reliance of companies on bank credits to finance investments. to maintain control of the company. Controlling parties rely on external financing to maintain their equity share and.17 DER of Listed Companies by Degree of Ownership Concentration (percent) Item Mean Standard Deviation DER of Firms with High DER of Firms with Low Ownership Concentration Ownership Concentration 699. The test of the difference between the two means found the t-value of 1. the borrowings swelled.5 1. In addition. since commissioners represent the controlling party. Inadequate Financial Regulatory Framework Liberalization of financial markets increased the corporate sector’s access to domestic and foreign private capital. decisions on debt are made with the implicit endorsement of owners. Table 1. ultimately.36 Corporate Governance and Finance in East Asia.0 386. the free capital flow system allowed private companies to borrow dollars offshore without any restriction. 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.0 Notes: Firms with high ownership concentration have more than 50 percent of shares owned by the top five shareholders. As a result. 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. Vol. the private sector borrowed heavily in unhedged dollars.56 significant at the 10 percent level. Source: Author’s estimates. II However. 1. aided . The low cost of foreign loans and the relatively stable exchange rate created a false sense of security for corporations.
In the process. Heavy Reliance on Bank Credits to Finance Investments Companies relied heavily on bank loans to finance rapid corporate expansion because internal financing was insufficient and the capital market was not developed. Decisions to borrow in dollars made sense to many borrowers because dollar loans were cheaper than rupiah loans. The large supply of foreign funds. This often led to the violation of prudential credit management practices. They were. to circumvent these banking regulations. The Government later specified the legal lending limit and the net open position that banks had to follow. after all. It was doubly difficult to exercise supervision when groups with political clout owned the banks. . averaging about 4 percent of GDP. A lot of short-term foreign funds were used to finance long-term investment projects. Conglomerates that had difficulty in getting loans (i. the level of corporations’ foreign debt could not even be ascertained. A director at Bank Indonesia revealed that in 1995. It is not known if these regulations had an effect on nonbank intermediaries. The supervising agency was caught unprepared. conglomerates set up finance companies and used these as channels for the unfettered inflow of foreign loans in lieu of banks. only created to serve the companies to which they lent. substantial amounts were also funneled into projects that guaranteed repayment mainly on the strength of borrowers’ close political connections. The banks served as a “cashier” that provided easy credit to nonfinancial companies within the group. It also meant that the cashier bank had neither the independence nor the incentive to exercise ex ante and ad interim monitoring of borrowers. and the negative net open position (short position in dollars) continuously rose to precarious levels. However. However.. It was only in 1995 that some regulations on the activities of finance companies were contemplated. 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.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. 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. large amounts of credit were directed to the companies within the group. those with high DERs) established their own banks.e. many firms became highly leveraged. As a result.
Aside from the fact that many of these loans were channeled through banks and corporations of politically connected families. by setting up their own banks. or both. This fact was usually not disclosed in financial statements. toll roads. They ensure that commissioners represent their interests and maintain close relationships with the chairperson. banks did not lend on the basis of the soundness of the project. Since the Government could not afford to undertake these projects. most often to people who were close to the ruling regime.5 billion was owed directly by corporations. Collusion between big businesses and the political elite was widespread in Indonesia. contracts were granted to the private sector. where private banks are usually in the hands of big businesses. This was often the case in the banking industry. Controlling shareholders also prefer to use debts to finance expansion so as not to dilute their ownership. and power generation) require huge capital. politicians. II By mid-1997. There were cases where banks and borrowing companies were controlled by the same groups or families with strong political connections. They enhance their control over companies through cross-shareholdings. of which $64. Family-controlled corporations were generally structured as a complicated web of affiliates and associated companies. partly because they used nominee accounts to register ownership rather than set up a holding company. High Ownership Concentration High concentration of corporate ownership (particularly by families) led to poor financing and investment practices. The ultimate control of the corporate sector rests in the hands of a small number of families who own groups of companies. . Families retain control by keeping the majority percentage of outstanding shares. as they had done so in the years before the crisis. In many cases. and in the process maintain control of the company. Projects involving massive capital investments and long-term operating deals (in telecommunications. there was also almost universal confidence that the economic growth would continue indefinitely. and investing shares among nonfinancial companies within the group and in other groups’ companies. Corporations were certain that they could roll over short-term loans when these fell due.5 billion. Vol. total private sector foreign debt stood at $72. In early 1998. but on the basis of who the borrower was.38 Corporate Governance and Finance in East Asia. $35 billion of Indonesia’s foreign debt owed to private foreign banks was about to mature in less than one year.
6) (3. DER and ROE were calculated per sector. Real Estate.4) (0.58 trillion (meaning their losses were greater than the paid-up capital).8 8. Gas.8) (11.8 1997 1.1 5.2 (1. followed by property. 1996-1999 (percent) Sector Agriculture. except utilities.1) 1.18 GDP Growth by Sector. The consumer goods industry reported the lowest ROE. posted negative growth rates.9 3. and Fisheries Mining and Quarrying Manufacturing Electricity.6 12. Most sectors showed significant increases in leverage. 53 companies reported negative equity of Rp6.0) (15. The construction sector was the worst hit.6 4. Only 86 companies reported profits.370 percent. and Restaurants Transport and Communications Financial.6) (0.1 6. The JSX Monthly reported that total losses of 214 listed companies amounted to Rp39.19.8 7. as shown in Table 1. The average DER was found to be 1.0 5.0 3. Table 1.3 Source: Central Bureau of Statistics (Biro Pusat Statistik.4 5.5.6 (36.4) 2.6 13. followed by the finance and trade sectors. Forestry.2 8.6 8.8) (13. and Business Services Other Services GDP 1996 3.2 Impact of the Financial Crisis on the Corporate and Banking Sectors Impact on the Corporate Sector Table 1.3 12.7 1998 (0.7) (8.1 (1. Sectors with lower ROE generally had higher DER. and Water Supply Construction Trade. much higher than the 307 percent registered in December 1997.Chapter 1: Indonesia 39 1.0 2. when all sectors.4 7. BPS). This continued in 1998. and 128 companies reported a total loss of Rp46.52 trillion.3 11.24 trillion for the first six months of 1998.7) (2.7) 2.7 6. Hotels.8 0.5) (18. indicating a rapid rise in . real estate. Using the financial statements as of 30 June 1998 of 161 publicly listed companies. Livestock. and building construction.18 shows that growth in most sectors significantly fell in 1997.4 7.0) 1999 2.1) (26.
Third. several publications. This figure further increased to 47. as shown in Table 1.1 (92.2) (264. a Actual data for 1st semester only.0 631.0 1.0 1997 234.9 12.7 percent in July 1998.0 108.2 13.625.1 1.0 1.7 1.0 12. small foreign banks enjoyed the highest profits. but annualized to approximate full year values.4) 18.0 108. Source: JSX Monthly. rupiah values of dollar-denominated debts due to the weakening of the local currency and the rapid decline in equity because of losses.0 177.0 2.0 635. losses in operation were due to declines in sales and increases in the cost of imported inputs.271.1 (124. The table also reveals that although private national banks dominated the banking sector in terms of assets and credits. Mostly suffering from a liquidity squeeze. Financial and banking analysts estimate that by September 1998.097. the NPL ratio rose to 25. and would have kept on increasing if interest rates had not declined. Second.20 reveals that the banking sector’s ROE decreased significantly in 1997.0 697. .1 (5.0 229.1) Note: DERs were calculated for only 161 companies (out of 214) that had positive equity.21.0 92.0 65.4 (6. The huge losses suffered by most companies were caused by three factors.5 percent in April 1998. First.0 2.8 (373. Impact on the Banking Sector Table 1.0 a ROE 1996 1997 1998a 14.19 DER and ROE of Publicly Listed Companies by Sector.40 Corporate Governance and Finance in East Asia. private banks posted negative ROEs in the same year.1 (3.8 percent in 1996.0 219.0 1998 186. Vol.0 158. the NPL ratio had reached more than 60 percent.0 205.1) 7. interest expenses rose as credit rates increased from 20 percent in early 1998 to 40 percent in mid-1999.1 30. from only 8. foreign exchange losses came about with the use of unhedged foreign debt.0 193. 1996-1998 (percent) DER Sector Agriculture Mining Basic Industry Miscellaneous Industry Consumer Goods Industry Property Infrastructure Finance Trade/Services Average 1996 104.0 163.6 (11. As the rupiah weakened and interest rates increased.0 105.0) (78.4) 8.370.3 7.0 191.0 1.0) 10.8 17.0 864.2 23.5 8.0 111.395.4 5.0 177.0 97.2 (4.7) 6. II Table 1.0 307.6) (115.6) 15.8) 36.0 72.
86 11.1 47.2 37. The high and increasing NPLs.6 — 13.15 20.8 8.2 1. however.7 29.1 274. .9 percent.09 11.1 13.2 — 19.Chapter 1: Indonesia 41 Table 1. put pressure on the banking sector.3 361. private national banks overtook State-owned banks when their NPL ratio jumped to 57.07 13.24 (4.0 — 32.45 21. State-owned banks initially had the highest NPL ratio.4 7.5 128.89 27.20 ROE of the Banking Sector.6 — 4.21 Nonperforming Loans by Type of Bank.2 10.5 34.84 27. 227/1998 and October No.47 20.2 — 8. July No.9 — 11.20) Table 1.68 1996 1997 8.9 297.67 8.7 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 331.24 15.44 15.9 Regional Foreign and Development Joint Venture Banks Banks — 9.7 — 1. Source: Infobank.1 198.30 5.70 1995 7.3 445.1 30.2 47. 230/1998.5 2.7 4.8 11.06 20.39 13.2 48.50 9. Source: The National Banking Association. 1996-1998 (Rp trillion) State-Owned Banks — 140.09 (11.45 — 1993 15.2 8.6 6.5 222. coupled with negative spreads (deposit rate was higher than the credit rate).7 106.1 1.8 187.12 15.28 5.0 622.81 13.3 Private National Banks — 179.38) 11.5 57.6 — 1.8 3. 1992 7.25 22.7 — = not available.73 30.37 19.9 11.43 10.07 1994 14.2 8.34 16.91 21.8 14. 1992-1997 (percent) Type of Bank State-Owned Banks Foreign Banks Joint Venture Banks Regional Development Banks Private National Banks Total — = not available.5 31.72 16.3 22.69 14.0 — 4.0 129. In July 1998.
By end-November. IBRA was formed to offer Mexican-style resolution for private sector foreign debt. The scheme offered a hedging facility against rupiah devaluations for restructuring agreements. and Ciputra (property business). assembling the legal and policy framework to facilitate corporate restructuring. In addition. about 80 percent of which was private. have been subject to restructuring deals under the initiative. the corporate sector had more than Rp600 trillion ($75 billion at Rp8. the Jakarta Initiative Task Force had conducted negotiations for 52 companies with Rp2.7 billion of foreign exchange debt. 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.6 billion) of Indonesia’s total external debt in March 1998. Thus.3 Responses to the Crisis Corporate Restructuring Measures At the end of 1997. While the process of restructuring was in progress. the scheme failed. Semen Cibinong (cement industry) became the first Indonesian company to resume paying part (25 percent) of the interest on its $1. In November. II 1. particularly in terms of debt resolution. Aside from being described as overly complicated.000/$1) in debt from domestic commercial banks. On 9 September 1998. few companies were in a position to resume interest payments. Since September 1998. The committee was tasked to ascertain the level of private corporate sector debts and arrange negotiations between debtors and creditors. Vol. the Government and private sector formed a committee to help corporates deal with the crisis. a number of prominent companies. Unfortunately. Astra International (automotive). only a . none of the 2. One premise of the initiative was that creditors should agree to a standstill for a certain period (creditors would desist from exercising their claims on a distressed company’s assets) to allow debtors to operate normally after obtaining fresh financing.000 eligible firms had signed up for the scheme.2 billion debt. Corporate debt accounted for 46. Total amortization payments due on foreign debt in 1998 were placed at $32 billion (before restructuring). such as Garuda (a national flag carrier). by mid-September 1998.4 trillion of domestic debt and $6.5. Another option that companies could take under the Jakarta Initiative was debt restructuring via debt-to-equity swaps. companies were not servicing their debts. In June 1998. However. The scheme encourages negotiation between creditors and debtors.42 Corporate Governance and Finance in East Asia.7 percent ($64. the committee launched the Jakarta Initiative. a more comprehensive scheme to tackle domestic and foreign corporate debt.
aiming to modernize the bankruptcy system and promote the fair and expeditious resolution of commercial disputes. forcing them to cut costs. and mining equipment. some companies attempted to restructure their businesses on their own. Protection against insider and fraudulent transactions taken by a debtor prior to the adjudication of bankruptcy will be enhanced. Some listed companies with relatively “rich” shareholders decided to replace their loans with additional equity through rights issues and privileged subscription (limited offering). 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. mining.. For instance. especially in preventing unjustifiable delays in the adjudication of bankruptcy. When credit from the banking sector became unavailable and interest rates increased significantly. Rabobank and Citibank. the companies’ financial performance deteriorated. a publicly listed company operating in the automotive industry. consolidate business units. under which the latter would become one of the bank’s shareholders. Bank Bali agreed on a debt-to-equity swap with its creditor. and sell noncore businesses or nonoperating assets. In the banking industry.Chapter 1: Indonesia 43 few companies reached agreement with their creditors on this. Standard Chartered. Procedural rules are also being introduced to ensure certainty and transparency in the proceedings. Bank Niaga also negotiated with some of its creditors. Moreover. lay off workers. i. Qualified professionals from the private sector will act as receivers and administrators in the management of estates of companies in bankruptcy or reorganization. The Commercial Court can be asked to hold off creditors and impose strict guidelines on the negotiating process . Astra International (automotive industry) and Bakrie Brothers (a holding company in several sectors) explored this option. plantations. with the requirement that adequate compensation and protection will be provided to such creditors during that period. Astra International. Debtors. Bankruptcy Reform The Bankruptcy Law was passed in August 1998. for equity infusion. focused on its core business of car and motorcycle manufacturing and sold off its subsidiaries in semiconductors. as well as general commercial disputes. A Commercial Court was set up to handle corporate restructuring and debt settlements.e. Meanwhile. limitations will be imposed on the ability of secured creditors to foreclose on their collateral during bankruptcy proceedings (as is provided for in the bankruptcy laws of most other countries).
The Government has also been concerned with the issue of capital controls. However. reform. including procedures for handling operational issues and processing bankruptcy cases. In the longer term. To push bankruptcy reforms. companies were allowed to sell shares only by issuing stock rights. Previously. II to achieve liquidation of the company. the Government did not impose restrictions nor did it attempt to regulate capital flows. (iii) the merger. Some companies simply decided not to pay their loans knowing that it would be difficult for creditors to take the case to court. 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. in consultation with IMF and the World Bank. There will be changes in the implementation of the bankruptcy law. collusion. The bias in favor of debtors has retarded the pace of corporate restructuring. 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. and nepotism (anti-KNN) was signed in 1999. . and recapitalization of state banks. Banking Sector Reforms The Government’s banking sector reform strategy is focused on (i) government-assisted recapitalization programs for potentially viable private banks. the measure had only a minimal impact.44 Corporate Governance and Finance in East Asia. The Court has also declared only two companies bankrupt. and (v) a strengthened banking supervision system. it is envisaged that the Commercial Court will play a central role in modernizing the commercial legal system. The Agency also allowed companies to buy back up to 10 percent of outstanding shares to improve the condition of the stock market. The Government. the Court’s early record has been a disappointment. with only 17 cases filed as of November 1998. is also reviewing the Bankruptcy Law. (iv) measures to recover liquidity support previously extended to troubled banks by Bank Indonesia. legislation against corruption. However. the Capital Market Supervisory Agency allows companies to offer additional shares directly to the public. (ii) the resolution of nonviable private banks. Realizing that they undermine investors’ confidence. Capital Market Reform In the capital market. since the market reflects the condition of the economy. Vol. Rather.
Bank Indonesia has announced a recapitalization program for potentially viable private banks. It has also drafted regulations to remove obstacles for converting debt to equity. Other Regulatory Reforms To push corporate restructuring further. In October 1998. The agency set up an Asset Management Unit (AMU) to directly manage problem loans of banks under its supervision. and Bapindo) will be merged into one bank named Bank Mandiri. or sold (after transferring NPLs to the AMU). BEII. A new central banking law. Some 175 groups that originated from family businesses controlled . 1. providing Bank Indonesia with substantially enhanced autonomy. Conclusions. depositors will be fully protected by the Government. merged. it is doubtful whether pure holding companies are able to enter into swaps. and Recommendations Summary and Conclusions Corporate Ownership and Structure Most of Indonesia’s top conglomerates were established as family businesses. Banks deemed ineligible for recapitalization will be closed. The Company Law at present can be interpreted as severely limiting the scope for debt-equity swaps.Chapter 1: Indonesia 45 In 1997. The four state banks (BDN. regulations will need to be issued to permit debt-toequity swaps in the context of corporate restructuring plans.6 1. improvement of rules and prudential regulations. and follow-up action on bank restructuring. was enacted in 1999. However. The merger process will be finished within two years. The Bank Indonesia 21st package includes recapitalization. Liquidity support given to troubled banks should be repaid in four years. To overcome these problems.6. Parliament approved amendments to the banking law that were geared toward strengthening the legal powers of IBRA and its AMU. The importance of this legislation may need to be emphasized. the Government established IBRA to supervise problem banks. the Government required banks to be audited by international external auditors. To obtain a clearer picture of the banking sector. BBD. the Government has drafted a regulation providing tax neutrality for mergers and removing other tax disincentives for restructuring.1 Summary. In particular.
46 Corporate Governance and Finance in East Asia. retain ownership control of companies. put a significant amount of corporate assets of conglomerates in the hands of creditors or the Government. Among those listed in the Jakarta Stock Exchange. The restructuring and resolution of financial distress may. These figures show the extent of power wielded over the corporate sector by a small number of families. allowing them to maintain their equity shares and. families control 67. Indonesian companies borrowed short term. this financing pattern supports the claim that family-based controlling shareholders relied on excessive borrowing to finance corporate expansion . Rapid growth in investments masked the corporate sector’s increasing leverage. corporate debts grew over time. Companies relied heavily on bank credit. 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. while a single family controlled 16.7 percent. Vol. As a result. lacked the information necessary to allow them to assess projects’ risks and chances for success. The free capital flow system permitted the inflow of foreign capital to fuel the credit boom in the economy. However. Foreign creditors. not all of the conglomerate-affiliated companies are publicly listed. conglomerates set up finance companies to bring in cheap foreign loans as these companies were not adequately regulated. the majority remains family-controlled.6 percent of the total stock market capitalization in 1996 and the top 15 families controlled 61. These banks also obtained cheap offshore funds. meanwhile. This study reveals that Indonesian listed companies with higher ownership concentration had higher levels of leverage. Therefore. On average. The financial crisis created opportunities for addressing the inefficiencies in the legal and judicial system that supported corruption. On the one hand. However. thus. when barriers to entry in the banking sector were lifted. conglomerates set up their own banks to serve as “cashiers” providing credit to companies within groups. II 53 percent of total assets of the top 300 Indonesian conglomerates. But because foreign creditors were reluctant to lend long term. banks were unwilling to provide credit to highly leveraged companies. however.1 percent of publicly listed companies in Indonesia. When the Government regulated the legal lending limit and the net open position of banks. Financing Patterns Controlling shareholders opted to use debts to finance expansion.
1 percent in 1997 to -124. and the rapid decline in equity due to losses.21 trillion in 1996. ROE dropped from 1. the highly leveraged companies. To restructure the corporate sector. were the most adversely affected. it also reflects the failure of the financial sector to channel funds to the corporate sector efficiently due to weak prudential regulation and supervision. The Government introduced reforms to improve bankruptcy procedures. NPLs rose and capital adequacy ratios fell. Sales of conglomerates as well as those of publicly listed companies were increasing. When the crisis hit Indonesia. and registered a net loss of Rp39.1 percent in 1998. the Government initiated corporate debt restructuring measures (Mexican-style foreign debt resolution and the Jakarta Initiative). although at a declining rate. the high domestic interest rates that prevailed from 1998. financed by issuing nearly $80 billion worth of bank restructuring bonds. the consumer goods industry was the worst hit. Meanwhile. followed by the property sector. The Government and the private sector responded with measures to mitigate the negative effects. Total profits of publicly listed companies dropped to Rp3. Impact of the Financial Crisis Prior to the crisis.370 percent in 1998. The problem was in the maturity structure of its dollar-denominated debt and high debt-to-equity ratios in some sectors. As the rupiah weakened and interest rates increased. Net profits of publicly listed companies had consistently been growing at an average rate of 20 percent each year.1 trillion in 1997 from Rp13. particularly those with large short-term foreign loans.Chapter 1: Indonesia 47 without diluting their control. corporate-initiated debt restructuring . DER increased to 307 percent in 1997 and further surged to 1. Responses to the Crisis The impact of the financial crisis on the corporate sector was serious. On the other hand. The significant increases in leverage indicate a rapid rise in the rupiah value of debts due to the revaluation of dollar-denominated debts. At the height of the crisis. the corporate sector was in quite good shape in terms of growth and profitability. facilitate debt restructuring. and strengthen prudential regulations and supervision of the financial sector.24 trillion in the first half of 1998. The financial crisis led to the closure of several dozen banks. Bank Indonesia extended emergency loans to many banks.
1. 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. II measures included internal business restructuring (e. The Corporate Law should be reviewed and amended in the context of pervasive control by large shareholders. minority shareholders have not been able to oppose controlling shareholders’ decisions to invest in unprofitable projects financed by unhedged foreign currency debts.g.6.48 Corporate Governance and Finance in East Asia. but it is not clear whether in practice these standards are in place. Vol. but inadequate protection to minority shareholders from the dominance of large shareholders. the regulatory environment was not prepared to supervise the increasing number of banks and nonbank . 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. 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. Improving the Legal and Regulatory Framework for Bank Supervision After the liberalization of the financial sector. improving the legal and regulatory framework for bank supervision. In particular. 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.. Protecting Minority Shareholders’ Rights The Corporate Law provides sufficient rights and protection for all shareholders. and (iii) strengthening transparency and disclosure requirements. (ii) delineating the functions of the board of directors and commissioners.2 Policy Recommendations The Government should introduce measures to address the weaknesses in corporate governance identified in this study. and protecting creditors’ rights.
Chapter 1: Indonesia 49 financial institutions. One way is to set limits on lending activities by banks to affiliated nonfinancial companies. it is likely that future private financial flows for the corporate sector will continue to conform to a short-term structure. The Government should also continue strengthening the monitoring system for foreign exchange transactions. The ownership of banks (including finance companies) by shareholders of nonfinancial companies undermined the capability of these banks to conduct prudential credit management. the Indonesian corporate sector directly owes an inordinate amount and a greater portion of its loans to foreign banks. Consequently. The tendency of foreign creditors to lend short term is a problem that must be confronted once private capital flows to Indonesia recover. recapitalization. it has been difficult to implement standstills. most of banks’ NPLs resulted from credit to companies within the same group. the banking regulatory framework was inadequate in regulating banks’ dealings with affiliated nonfinancial companies. the Government lost monitoring and control powers over foreign fund flows. In the first place. This is a significant factor in . However. Banks should be required to provide data on such transactions and charged penalties for noncompliance. a new bankruptcy law was passed in the aftermath of the crisis and a Commercial Court was set up to deal with bankruptcy cases. and liquidation of corporate assets. The regulatory framework was also weak in supervising and monitoring foreign transactions. Because these banks are neither easily convinced nor compelled to submit their claims to the jurisdiction of Indonesian commercial and bankruptcy courts. orderly restructuring. When finance companies were used to channel offshore loans in lieu of commercial banks. in contrast to the Republic of Korea and Thailand. the Republic of Korea and Thailand were more successful in getting foreign creditors to collectively solve their problems during the crisis. with necessary legal sanctions for violations. the Court has been slow and ineffective in processing bankruptcy suits. Further. Because foreign creditors are faced with more information asymmetries than domestic creditors. With credit being coursed through the domestic banking system rather than directly to numerous local corporations. Protecting Creditors’ Rights To protect creditors’ rights. The Central Bank needs to monitor and control dealings by banks within business groups and improve enforcement methods to prevent circumvention of prudential regulations.
Only when creditors have the confidence that their rights are protected will they resume financing companies. Vol. despite the smaller level of capital inflows (as a percentage of GDP).50 Corporate Governance and Finance in East Asia. II explaining the greater depth of the crisis in Indonesia. The Bankruptcy Law should thus be reinforced and creative means should be introduced to avoid a prolonged and costly paralysis of corporate activity and financing. .
The Impact of Acquisition to Shareholders Wealth: Comparison Between Internal and External Acquisition. and Larry H. The Private Debt Anatomy. John Wiley and Sons. . Forest. Asia in Crisis: The Implosion of the Banking and Finance System. 1998. 1999. 1996. Simeon Djankov. F. Embassy of Indonesia Homepage. Conny Tjandra Rahardja. Who Controls East Asian Corporations? Financial Economics Unit. P. 1998.. Economy of Indonesia. John Wiley and Sons. Large and Medium Manufacturing Statistics. The Economist Intelligence Unit. Indonesia: Sustaining Manufactured Export Growth. The Economist Intelligence Unit. Economic and Financial Statistics. Delhaise. various publications.Chapter 1: Indonesia 51 References ADB Programs Department (East). Financial Sector Practice Department. and Remuneration. Indonesian Capital Market Directory 1992-1998. P. Keasey. Jonathan. JSX Monthly Statistics. Center for International Business Education and Research. World Bank. various publications. 1996. Letter of Intent of the Government of Indonesia to the IMF. Embassy of Indonesia. Working Paper #58. 1995. K. 1999. Lang. and M. 1997. Indonesia: An Emerging Market. University of Maryland. Conglomeration Indonesia: Regeneration and Transformation into World Class Corporate Entities. Indonesian Central Bureau of Statistics. Michael Krill. Manuscript. various publications. 1995. Indonesia Country Profile. Institute for Economic and Financial Research. Bank Indonesia. 14 May 1999. Unpublished thesis MMUGM. various publications. 1997. Risks. Jakarta Stock Exchange. Indonesian Business Data Centre. Claessens. and Richard Turtil. Wright. Stijn. Corporate Governance: Responsibilities. Yogyakarta. Indonesia Country Report. Maryland. Indonesian Business Data Centre.
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. a practice that was not checked by creditors. internal control mechanisms. As the Korean currency. David Edwards. Korea) in November of that year. Further. and David Webb of the London School of Economics for their guidance and supervision in conducting the study. Seoul. and corporates were sent reeling. the Korea Stock Exchange for its help and support in conducting company surveys. Department of Economics. 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. 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. both of ADB. This has been the crux of the corporate governance problem in Korea. It had been the norm in Korea to conduct business based on political and administrative favoritism rather than on competitive merits. markets. timely exit of poor performers from the market. or capital market discipline. The country’s winners would then emerge based only on economic efficiency. The authors wish to thank Juzhong Zhuang. Chung and Yen Kyun Wang1 2. the Republic of Korea. 1 Professors. Inefficient investment coupled with excessive financial leverage was found to be at the root of the economic crisis at the corporate level. Business managers and controlling shareholders were maximizing firm size at the expense of profits. Chung-Ang University.1).2 Republic of Korea Kwang S. the Government and business sector had good reason to reflect on the causes of the crisis. Poor corporate governance and political and government intervention in the business and financial sectors are widely viewed as contributory factors. . and curtailing of morally hazardous behavior that has been prevalent among economic decision makers. 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. and Graham Dwyer for his editorial assistance.
4 1993 513 174 33. A survey was conducted for the nonfinancial listed companies using a questionnaire developed by the Asian Development Bank (ADB)2 to supplement official data. Inefficient investment undermined the competitiveness of Korean firms in the global marketplace. Vol. Many firms left some questions unanswered. 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.54 Corporate Governance and Finance in East Asia. capital market discipline. This study also reviews the legal and 2 The survey was conducted mainly through the Korea Stock Exchange. The total number of respondents was 81 out of about 550 nonfinancial firms listed on the Exchange. This broad perspective can help clarify the ongoing reform efforts of businesses and the Government. Dividend payments were at less than 2 percent annually as opposed to the double-digit interest rates in the past decades. Weaknesses in the overall corporate governance system in Korea had many ramifications. 1992-1998 Item Total Number of Firms Firms with Positive EVA Percentage of Firms with Positive EVA 1992 508 180 35. Source: Korea Stock Exchange.1 1995 560 163 29.5 Note: The EVAs are calculated as: EVA = NOPAT – WACC. Copeland. June 1999. This study collects and analyzes data on the Korean economy.9 1994 531 165 31. . II Table 2. where NOPAT is the net operating profit after taxes and WACC is the weighted average cost of capital multiplied by invested capital. The EVAs are the same as the economic profit as explained in T.1 1996 561 163 29. T. Government reform goals for the corporate sector include enhancement of corporate transparency. and improvement of bankruptcy procedures. and J Murrin (1995). the corporate sector. which distributed and collected the questionnaire. Koller.1 1998 490 164 33. aiming to identify the areas in need of further reform and to provide policy recommendations for improved corporate governance. Restructuring efforts have focused on reduction in the degree of business diversification and in the financial leverage of large-sized firms.1 Listed Firms with Positive Economic Value Added.1 1997 518 104 20. especially chaebols. and individual companies. accountability of controlling shareholders and boards of directors.
Major economic indicators for some of these periods are shown in Table 2. clothing. and employees and their role in shaping corporate governance practices. Yang. Section 2. The evolution of the modern Korean economy can be divided into four periods. Section 2.2. which account for a substantial portion of the Korean economy.2 2. From 1948 to 1961. and Yim (1998). 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.2 presents an overview of the corporate sector. and naturally adopted an import substitution policy.1 Overview of the Corporate Sector Historical Development3 The development of the Korean corporate sector is closely related to the progress of the economy.Chapter 2: Korea 55 regulatory framework for the corporate sector and reform measures taken after the crisis. and other necessities domestically. the Government relied heavily on aid from the United States (US) and United Nations to alleviate poverty and high inflation.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. Section 2. In the period 19481961. 3 The review of historical development of the Korean economy draws substantially from the book by Sohn. It traces the country’s economic development.4 contains analyses of corporate financing and its relationship to performance. Section 2. Import Substitution: 1948-1961 The Korean War (1950-1953) devastated Korea’s industrial capacity. creditors. 2. It then presents recommendations for further reform in corporate governance and financing.2. . the import liberalization rate was below 7 percent and the average tariff rate was in the range of 25 to 30 percent. corporate control by the Government. It reviews such elements as shareholders’ rights. The Government tried to produce food. the board of directors system.6 discusses responses of the Government and the business sector and explains in detail their reform and restructuring efforts. reviewing government policies responsible for the development of the modern corporate sector.
1a 21.9 — — 21. In the Plan.7c 11.2 314. a Refers to 1971.7 37.1 — = not available. and large current account deficits.8 12. 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.2 31.8 (724.4 10.7 30.8 24. unless otherwise indicated) Indicator GNP Growth Rate Inflation Rate Savings Rate Investment Rate Manufacturing/GDP Interest Rate on Time Depositse Exchange Rate (won/$) Export Growth Rate Import Growth Rate Trade Balance (million $) Current Account (million $) Capital Account (million $) 1962-1971 1972-1979 8.2 32.855. c Refers to 1989.1 15.4 24.2 452.4 (1. IMF.5) (1.5 250.1d 9. the Government was not successful in solving the problems of slow growth.2 Key Macroeconomic Indicators Annual Average (percent.5 38.9) (7.7 14. This goal required very high savings and investment rates.949.2 30.9 794. II Table 2. In 1961 it devalued the won from W65 to W130/dollar and announced its first Five-Year Economic Development Plan (1962-1966). However.0 27.4 29.1 percent with moderate rates of inflation and introduced a series of reform packages aimed at developing key industries.2 1980-1989 8.6 11. the Government called for an unprecedented average annual economic growth rate of 7. International Financial Statistics. and inconsistent economic policies.0) (297. lack of strong drive.332. Source: Bank of Korea. Vol.265. largely because of political instability.4 1990-1997 7.5) 8. Economic Statistics Yearbook. e For maturities of one year or more. high unemployment and inflation.56 Corporate Governance and Finance in East Asia. modernizing the industrial structure. b Refers to 1979.1 35. d Refers to 1997.0) 492.2 1.0 41. Export Drive: 1962-1971 Between 1962 and 1971.102.8 (8.9) 1.753.2 6.4 29.3 8.9b 15. The Government tried . and implementing new budget and tax measures.1 29.8 15. the Government redirected the policy focus away from import substitution to an export-led manufacturing-based economy.447.2 757.1 9.
the Government tried to provide exporting firms with a free trade environment. due to continuous current account deficits. while the average tariff rate was 39 percent. The positive list system for imports was replaced with a negative list that indicated only those items that could not be imported. and cheap labor force was well utilized by the export-led growth strategy. resulting in high real interest rates.3 percent average between 1954 and 1959. up from 30 percent in the late 1950s. This change raised the import liberalization rate from 9. the import liberalization rate was 55 percent. But the liberalization trend turned out to be short lived as current account deficits continued. Also. In 1964. In 1965 the interest rate on one-year deposits doubled from 15 to 30 percent. . the Government undertook important economic reforms in two areas: the foreign exchange rate and the interest rate. imports of consumer goods and luxury items were highly restricted. but the average growth rate for 1965-1969 shot up to 10 percent. the Government changed the multiple and fixed exchange rate system to a unitary floating exchange rate system. abundant. The Government abolished temporary direct subsidy measures and introduced a new comprehensive export promotion system. and almost doubled the foreign exchange rate from W130/dollar to W256/dollar to enhance the international competitiveness of exports. However. During the first five-year plan period. These were considerably liberalized in 1967 when Korea joined the General Agreement on Tariffs and Trade (GATT).Chapter 2: Korea 57 to meet its targets by borrowing large amounts of foreign capital on the one hand. The exchange rate system was a kind of crawling peg until 1974. The well-educated. but tariff rates were raised to 40 percent in the 1960s. Korea normalized political and economic relations with Japan to encourage inflows of Japanese capital that could finance big development projects.3 percent to 60. The average growth rate of the economy from 1960 to 1964 was 5. Bank deposits increased rapidly. which laid a solid foundation for a steady growth path.4 percent. the growth of gross domestic product (GDP) raised domestic savings. In 1971. boosting internal investment resources. In 1963-1964. Exports increased sharply from $41 million in 1961 to $2. 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. During this period. channeling funds from curb markets into the banking sector.2 billion in 1972. a modest improvement over the 4.5 percent. and maximizing mobilization of domestic savings on the other.
It included a detailed construction and investment schedule over a 10-year time frame and mandated coercive implementation. There were three reasons for the switch: first. The Government encouraged a variety of business projects. It promoted HCIs by supplying massive capital for construction and development. Third. reducing or exempting debts of farmers and fishermen. and assigned them to specific chaebols. The HCI promotion policy was much more comprehensive than past economic development plans. the Government changed its industrial policy emphasis from light industries to heavy and chemical industries (HCIs). electronics. The Government has since used similar emergency rescue measures for large businesses and banks almost once every 10 years. the emergence of competition of other low-wage. and giving low interest rate loans to banks from the central bank. This strategy formally took off with the announcement of the HCI Promotion Plan in June 1973. The Government took emergency measures. it tried to substitute imports and export high value-added HCI products. shipbuilding. II Heavy and Chemical Industry Promotion: 1972-1979 In the Third Five-Year Economic Development Plan (1972-1976). One industrial policy adopted during the heavy and chemical industrialization drive was administered credit rationing. and chemicals—as future core industries. In 1972. the domestic economy was stagnant and many businesses.58 Corporate Governance and Finance in East Asia. the Government felt the need to strengthen the defense industry. becoming a seed of the economic crisis in 1997.6 billion between 1973 and 1981 into these sectors. faced the danger of bankruptcy. less developed countries forced Korea to adjust its industrial structure. investing a total of $9. These included rescheduling business debts. overburdened with debts and high interest rates. and allocating virtually unlimited amounts of credit at below-market rates while controlling the financial system. where preferential export credit was given to almost every exporter. announcing rescue packages for businesses and banks. Vol. this new strategy had the Government explicitly allocating credit only to those firms deemed vital to HCIs in the form of below-market interest rates . Second. By promoting HCIs. nonferrous metal. machinery (including automobiles). in the face of a world economic slump. These practices contained an implicit government guarantee that large businesses and banks could never fail. the Government felt that continuous trade deficits arising from increasing intermediate and capital goods imports could be prevented by developing import substitution industries. Unlike the previous system. The Government targeted six industries—steel.
the Government restructured some large businesses through forced liquidation and M&As. and the large excess capacity of HCIs. and their utilization ratios were very high. Cheap credit and distorted prices resulted in overexpansion in the HCIs. exacerbated the overcapacity problem. Meanwhile. However. The severe world recession caused by the second oil shock. price controls were abolished. Macroeconomic policies became hostages of the industrial strategy. as it had to control only a few large chaebols. low . The two important ones were import liberalization and deregulation of the financial sector. Gross national product (GNP) growth rates on average were higher in the 1972-1979 compared to 1962-1971 (Table 2. a heavy foreign debt burden. Korea recorded current account surpluses and rapid economic growth due to the “three lows”: low value of the US dollar. coupled with political uncertainty due to the assassination of President Park in 1979. especially between 1979 and 1985. Economic Liberalization and Globalization: 1980-1997 In 1979. The plan of the 1970s was thought to be successful in the long run. Firms that followed the Government expanded greatly. including denationalization of banks. The growth rate of the money supply was reduced drastically. The incentives available became more market-based. various measures to increase competition were taken. New start-up firms. and the won depreciated by 20 percent with the adoption of a Basket-Currency Gliding System in 1980. such as widespread underutilization of capacities of HCIs and related plants. Such an approach gave the Government increased control over the economy. met increased difficulty.2). with many turning into the now well-known chaebols. imports were further liberalized while tariff rates were lowered. since during the second half of the1980s many of the promoted firms became world-class competitors and exporters. Meanwhile. In order to improve economic efficiency. faced with high inflation. The industrial and trade policy resulted in high inflation in the 1970s and serious excess capacity problems by 1979. light manufacturing and service industries were weakened by disadvantages such as a lack of credit. the Government adopted comprehensive measures to promote economic stabilization. This required industrial restructuring by the Government. the policy wasted substantial amounts of resources in the short and medium terms. In 1986-1989. including forced liquidations and mergers and acquisitions (M&As). however. Evaluations of HCI promotion policies are mixed. fiscal expenditure maintained zero growth.Chapter 2: Korea 59 through state-controlled banks.
9 percent. further increasing its pace of import liberalization. the import liberalization ratio reached 98. and declaring that it would follow Article XI of GATT. . Vol. In 1988. By joining the Organisation for Economic Co-operation and Development (OECD) in December 1996.9 percent. total sales. Korea adopted a market average exchange rate system. 45.3 percent. In 1990. joined the Asia Pacific Economic Cooperation (APEC) Group in 1993. 47. which gradually widened. 4. The official rate fluctuated within a band. II world interest rates.1 percent.2. 13. and acceded to the World Trade Organization (WTO) in 1994. Korea abolished remaining direct subsidy systems for export activities as well as some traditionally managed trade systems. giving up its foreign exchange controls related to the current account. where particular individuals and their family have de facto control of the management of all subsidiary companies of groups.” A large-scale business group is called a chaebol. with the 30 largest in the total economy in 1997 standing as follows: value-added. Meanwhile. whose business activities are controlled by an identical person. 2. 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). Industrial and trade policies were modified to be consistent with WTO. and low oil prices. total assets.2 Rise of the Large Business Groups (Chaebols)4 The Korean Fair Trade Act defines a business group as “a group of companies. the importance of chaebols was increasing. The Government tried to adjust economic policies and regulations to meet global standards. total debts. but it chose to liberalize gradually. in which the official rate for the day would be based on the interbank transaction volume-weighted average of rates of the previous business day. The low value of the dollar led to a low won and high yen. and total workforce. In 1993.60 Corporate Governance and Finance in East Asia. Korea became a signatory country to the International Monetary Fund (IMF) Article VIII.2 percent. 46.9 percent.1 percent and average tariff rates 8. Korea began participating in many multilateral trade negotiations during the Uruguay Round. The most important element characterizing chaebols is the concentration of ownership. while continuous and large current account surpluses saved Korea from the foreign debt problem. the Government committed itself to further liberalization of the goods and capital markets.
Chaebols have a history of substantial concentration of ownership. However.1 20.Chapter 2: Korea 61 War II. . The Government provided financial and fiscal incentives to chaebols and trading companies with relatively abundant financial resources. financial assistance.3 Subsidiaries of the 30 Largest Chaebols. This galvanized the fast growth of chaebols. Table 2. In the mid-1970s.when the Government put a great deal of emphasis on development of the HCIs. chaebols that maintained a close relationship with the political authorities were able to grow fast. One reason for this controlling power is inter-company shareholding among subsidiaries. the number of subsidiaries declined drastically due to corporate restructuring. Since the Government controlled most business activities. and they are aided and supported by one another. reaching 669 in 1996. Subsidiary companies of chaebols are subject to “fleet-type management” in that they are controlled by the overall managerial system of chaebols. the Korean Government has set the national goals of economic development and offered all kinds of support and incentives to achieve them. Important managerial decisions are made primarily by owners.3 Source: The Fair Trade Commission.5 20. 1993-1996 Year 1993 1994 1995 1996 No. Since the 1960s. From the standpoint of the Government. Large-scale companies owned by the Japanese were sold to individuals under preferential terms and later enjoyed a relatively favorable position for accumulating capital. and tax breaks to key industries to promote exports and industrial upgrading. Chaebols are also excessively diversified. large-scale businesses and chaebols were thought to be appropriate actors because they could meet the huge investment requirements of these industries. In this sense. after the financial crisis. This policy contributed greatly to the expansion of chaebols. The Government provided subsidies. Table 2.3 shows that the number of subsidiaries of the 30 largest chaebols increased considerably since 1993.8 22. of Subsidiaries per Chaebol 20. it was more effective to deal with a small number of companies to secure tangible outcomes. the ownership and management of a chaebol’s subsidiaries are not separate. of Subsidiaries 604 616 623 669 Average No.
chaebols can benefit from synergies. diversification can make chaebols stable through the portfolio effect. listed companies enjoyed corporate tax rates that were 10 to 20 percentage points lower than those imposed on privately held firms. However. Related to this is the tendency of chaebols to assist unprofitable firms at the expense of profitable ones. For example. profitability. 2. The law also allowed employees of listed firms to get 20 percent of the subscription rights in offerings of new shares. internalization of the market that could enhance the internal efficiency of a chaebol may close the market to other firms. . the Government’s efforts to develop the stock market culminated in the Capital Market Development Act of 1968. the bankruptcy of one or a few marginal subsidiaries could lead to a chain of bankruptcies for the entire chaebol. 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. etc. in addition to the usual economies of scale. This could ensure their stable growth and enhance their investment abilities. II Theoretically. years since establishment. On the other hand. they can reduce uncertainties and dilute risks through sharing of information and diversification. This law was in effect until 1987 when it was partly absorbed into the Capital Market Development Act. In the early years after the enactment of the law. 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. Since chaebols are engaged in many different businesses. Another law that contributed to the development of the stock market was the Act to Expedite the Going Public of Corporations of 1972. and were allowed extra depreciation charges for tax purposes. if a chaebol has an unsound financial structure but strong financial links through mutual payment guarantees among their subsidiaries. there are many negative assessments of organizational structures and practices of chaebols. Under this law. Vol. They had to meet certain requirements in terms of firm size. the Government reviewed the financial performance of companies and recommended (or ordered) selected ones to go public. including the “economies of organizational size” inherent in multi-product and multiplant firms.3 Role of the Capital Market and Foreign Capital In the 1960s. Meanwhile.62 Corporate Governance and Finance in East Asia. which may ultimately lead to the decline of social efficiency.2.
Because of government policies and the booming economy. First. the Government attempted to stabilize the stock market by limiting IPOs and share issues by listed companies. the stock market grew rapidly during the 1980s.6 747.217 141. continued until 1989. As shown in Table 2. The policy to expand the size of the stock market. especially those paying small or no dividends. Also that year. however.9 833.0 79. the Government announced measures to increase the demand for shares by providing tax and financial incentives to individual investors.798 Market Capitalization as a Ratio to GDP (%) 8.1 16. mainly by increasing the supply of shares by initial public offerings (IPOs) and seasoned issues. 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). Inc.151 117. In this regard.0 49. 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. Second.4 Development of the Stock Market.9 34.1 30. several important policy measures were implemented to promote the development of the stock market.5 406. . the Government announced the gradual opening of the capital market to foreign investors in January 1981. a country fund.4.7 934. Beginning 1990.9 918. The Korea Fund..989 137. 1985-1998 No. This reversal in policy reflected declining stock prices and was generally maintained until the outbreak of the economic crisis in 1997. in 1986 the Government imposed limits to bond issues on firms that were recommended to go public but refused.6 Year 1985 1989 1990 1994 1995 1996 1997 1998 Source: Monthly Review (Securities Supervisory Board) and the Financial Supervisory Service.4 40. of Listed Firms 342 626 669 699 721 760 776 748 Stock Price Index 138. was established to invest in domestic shares beginning in September 1985.1 Market Capitalization (W billion) 6.020 151. The aggregate Table 2.370 70.Chapter 2: Korea 63 During the 1980s and 1990s. Third.2 44.0 965.4 654.476 79.570 95.
and stayed at the 30-40 percent level up to 1996.149 13. The reasons for the decline include increases in bankruptcies and mergers involving listed companies since the outbreak of the economic crisis. currency and deposits. Table 2.150 5.414) 5.924 (1.123 3.737 (333) (297) (607) (2) 218 2.714 1.2 percent by 1989. The relative size of the stock market diminished to 44 percent in 1990. Bank of Korea. but increased sharply to 79.347 3.413) 56.264) (3.296) (6.500 7. 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. The aggregate market value of listed shares bottomed at 16.453 (2.008) (3.352 471 3.001 4.642 21.858 4. .571 2.785 (1.742 (3.450 24. The number shrank for the first time in 1998 to 748 firms from 776 the previous year.239 19.5 shows net FDI—inward investments by foreigners less outward investments by Koreans—in the period 1985-1998.542) (1. The growth in the number of listed firms also slowed in the 1990s.86 percent of GDP in 1997. However.59 percent in 1998 and to more than 50 percent in the early months of 1999. Source: Balance of Payments.126 (1.085 2. II market value of all listed firms represented only 8 percent of GDP in 1985.875 21.183 12.650 (1. Table 2.800 (7.534) 1.339) (9. and 1993.868 (518) (418) 63 1.817 16.852) (2. and other liabilities.942) 42.64 Corporate Governance and Finance in East Asia.455) 13.870) (1.017) 1.287 (340) 73.694) 2.440 1. Other investments include loans.546 (2.141 4. but rose again to 34. Vol.433) (9.338 4.382 Permit basis.255 2.5 Private Capital Flows to Korea.658) (3. foreign direct investment (FDI) has been very small relative to GDP and compared to other East Asian countries. due to declining stock prices.910) 2.326 1. trade credits.953 10. 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 1986-1989.944) 8.553 8.583 25 10.
Table 2. Japan’s was consistently higher.6). the growth rates of equity and sales dropped sharply in 1996 and 1997.6 percent in 1997. Profit rates of Korean firms were relatively low compared to those of Taipei. but between 1988 and 1993. However. The contribution of the corporate sector to GDP was 73.Chapter 2: Korea 65 Complicated government regulations. The debt-to-equity ratio (DER) averaged 311 percent for the period 1990-1996 and peaked at 424. excluding FDI. Net private capital inflow. Of this.4 Growth and Financial Performance This section looks at the performance of (i) the aggregate corporate sector.China and the US. equity. Corporate sector net proft margins increased from 1993 to 1995. This would lay the foundation for evaluating the effect of corporate governance on performance. Between 1986 and 1989. portfolio investments amounted to $73.9 billion. weak incentives for attracting FDI. and sales of the aggregate sector during this period were very high (Table 2. The ratio is generally in the same range for Japan and Korea.5).2. following the sharp depreciation of the won. and US.2 percent in 1987. In addition to FDI. The Aggregate Corporate Sector The aggregate corporate sector in this study excludes the financial sector. The growth rates of total assets. and high production costs were the main reasons for low FDI in Korea. increased substantially in 1994-1996 due to accelerated liberalization of capital movements (Table 2. (ii) listed firms. This indicates that a substantial proportion of debt was denominated in dollars. Taipei. Large amounts of outward investment by Koreans in the mid-1990s arose out of increased liberalization of foreign exchange regulations.7 billion and loans $42. 2. Korea had substantial current account surpluses and experienced net private capital outflow. Return on equity (ROE) and return on assets (ROA) showed similar patterns. The dismal performance of the Korean corporate sector compared to the .China. The same categories will be analyzed in later sections. increasing to 76 percent in 1997.7 compares the ratio of ordinary income to sales of Korea’s manufacturing sector with those of Japan. but dropped in 1996 and were negative by 1997. other net private capital inflows amounted to $130 billion during 1985-1998. and (iii) chaebols.
3 6.2 1.4 2.7 3.8 21. Net profit margin = ratio of net income to sales.9 13. 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 22.1 2.9 5. .2 1.9 5.5 7.4 — 6.2 9.1 — — — = not available. Source: Bank of Korea.0 7.7 International Comparison of Ratios of Ordinary Income to Sales in Manufacturing (percent) Year Korea US Japan Taipei.6 424.9 8.6 9.3 1.1 8.0 3.0 8.3 14.5 3. ROA = return on assets (ratio of net income to total assets). Financial Statement Analysis Yearbook.6 1.8) 297.5 0.2 13.5 4.9) DER = debt-to-equity ratio.3) 5.4 10.8 1.0 13.6 4. Ordinary income = operating income + nonoperating income (from financial activities) – nonoperating expenses (from financial activities).6 13.0 13.9 3.5 2.9 3.3 308.9 2.0 0.7 4.3 3.2 13.4 1. Source: Bank of Korea.3 11.9 16. Table 2.9 16.7 1. Financial Statement Analysis Yearbook.4 19. Note: Ratio of ordinary income to sales = (ordinary income/sales).7 15.5 1.4 4.7 4.9 5.6 318.9 4.0 (0.Table 2.0 6.5 1.6 3.7 325.8 1. ROE = return on equity (ratio of net income to stockholders’ equity).3 17.0 4.China 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 2.1 2.8 3.4 1.9 2.8 2.2 1.6 (4.4 2.2 19.7 15.9 18.3 312.8 8.3 21.0 10.1 5.9 18.6 1.6 2.4 2.5 1.5 (0.3 335.0 305.3 — 3.4 1.9 2.7 3.2 18.2) (0.1 2.3 21.6 Growth and Financial Performance of the Nonfinancial Corporate Sector.7 2.5 4.1 6.7 4.
Again.and small-scale firms (Table 2. In 1997.6). but higher than that of small firms. and ROAs of all listed firms declined substantially in 1996 and turned negative in 1997. while their average net profit margin was lower than that of medium firms. This preference of Korean firms has its roots in the structure of corporate governance. Small listed firms were hardest hit by the financial crisis. trade. sales of listed firms grew 18. The manufacturing.Chapter 2: Korea 67 other three economies can be attributed to the emphasis on growth in sales and market shares rather than on profits. the average ROE was lowest for large firms. Growth rates of total assets are generally high. In most years. and steam supply industry. A comparison of performance by firm size reveals some interesting results. followed by mediumsized firms and large ones. Net profit margins. It is notable that the construction sector’s profit rate began its decline in 1995. Profit rates of most industries are also quite low.8). Performance followed similar patterns across different industries (Table 2.4 percent. ROEs. this may be an indication of the bias toward large firms in terms of access to credit.9). The other financial ratios follow the general pattern of the aggregate corporate sector. The growth performance of large firms for the 1988-1997 period was better than that of medium.10). a year ahead of the other industries. This may be related to its having the lowest DER. construction. The superior performance of listed firms in terms of sales growth may be due to large firms’ easy access to credit and the inclusion of financial firms in the listed firms category. the exception being the electricity. However. with the wholesale and retail trade sector and the construction sector having the highest figures. with equity in wholesale and retail trade even contracting. and transport sectors recorded negative profit rates 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. However. Profit rates of different industries also mirrored the downward trend of the aggregate corporate sector prior to the crisis. gas. the sales growth of listed firms was higher than that of the aggregate sector (see Table 2. both ROA and ROE were lower for the listed firms compared to the latter. . All sectors experienced a sharp decline in equity and sales growth in 1997. Listed Companies The number of listed firms increased from 334 in 1985 to 775 in 1997 (Table 2.
3 8.7 (3.3 2.1 (0.6 3.1 10.7 7.1 1.2 0.6 14.0 1.7 (0.0 24.9 16.2 5.1 28.4 1.6 12.0 16.0 245.8 1.5 5.7 228.9) 1.5 27.6 5.0 1.2 0.9 9.4 2.4 0.6 17.0 (0.2 5.5 6.2 16.3 11.4 (0.0 23.7 30.4 4.Table 2.3 18.6 16.0 7.5 1.0 37.8 616.5 270.5 14.0 21. and Business Activities 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 Average 11.7 294.1 1.2 241.1 0.3 10.6 12.3 15.6 6.8 24.2 7.1) 3.4 9.0 12.4 17.1 17.8 1.6 11.2 2.8 0.4 2.6 17.4 1.3 25.9 13.6 24.5) 0.2) 22.0 9.4 10.0 24.7 10.8 35.0 (0.6 14.4 15.4 2.5 4.0 1.0 15.0 16.9 2.0 1.8 22.7 17.0 22.6) 3.5 Construction 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 Average 18.2) 6.9 (0.0) 0.7 317.0) 1.5 (5.8 7.0 18.3 14.3 15.7 9.4 0.5 16.7 1.1 296.6 2.3 31.2 423.5 306. Renting.4 291.1 16.2 20.8 16.3 10.5 1.6 14.3 285.2) (0.0) 0.4 5.4 10.9 428.5 5.5 1.0 22.5 (0.7 22.3 288.8 345.9 16.0 2.7 0.1 1.9 14.5 286.8 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 (0.8 16.5 1.5 432.5 23.8 32.4 348.1 7.8 3.9 25.5 338.0 1.1) (3.4 2.6 0.4 14.7 21.5 28.9 10.4 12.1 0.3 15.9 1.8 10.8 2.8 562.5 (1.0 18.7 16.6 318.9 19.7 4.6 655.8 16.5 239.6) (6.5 1.5 1.8 0.2 5.8 12.8 12.9 3.3 11.1 2.6 0.3 1.3 8.8 461.5 13.2 24.3 15.8) 0.1 22.6 1.2 12.3 8.8 24.9 538.9 31.2 315.9 0.0 3.8 526.8 14.1 2.5 483.8 2.7 5.2 6.3 13.9 5.0 5.8 3.4 740.8 2.2 25.0 1.3 2.6 375.1 290.7 520.0 5.6 1.5 19.8 23.9 (0.0 2.8 22.1 27.1 0.7) 2.5 569.2 0.5 473.2 16.6 3.3 14.2 (1.0 19.0 22.2) 15.9 10.8 10.9 16.4) 0.4 2.8 302.5 30.7 514.4 5.6 7.1) 0.4 458.4 474.9 2.9 340.5 3.9 29.5 6.4 10.2 36.8 17.0 1.2 20.1 21.0) 4.8 13.3) (1.3 1.2 6.4 350.2 15.8 34.4 10.8 Real Estate.1 20.6 15.1 1.0 254.4 5.0 2.0 2.2 18.1 396.4 .0 15.1 (0.3 8.8 14.4 3.0 (4.
9 332.0 2.8 6.5 117.7 187.0 13.6 19.8 7.6 12.7 19.3) (1.8 15.6 6.1 14.5) 22.6 18. Storage.7 7.5 15.0 (1.8 8.0 7.5 482.6 21.1 (0.6 19.2 10.6 9. and Steam Supply 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 Average 12. and Communication 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 Average 15.3 1.1 16.6 6.9) (8.3) 4.9 Electricity.6 20.3 18.0 14.6 8.9 12.3 19.0 14.4 6.4 11.0 1.9 321.8 (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 — — — — — 31.5 539.2) 0.7) 0.2) 13.1 1.3 8. b NPM denotes net profit margin.5 12.9 8.7 11.1 323.9 8.1 15.2 — — — — — 2.6 9.3 18.1 21.4 3.9 1.1 11.4 15.6 15.0 98.6 9.5 11.Table 2.4 2.8 6.1 3.9 17.7 7.7 14.0 5.3 4.2 1.0 89.2 698.1 4.8 3.5 344.5 15.3 4.7 20.1 12.5 0.4 16.5 14.6 (2.2 143.9 (11.1 15.8 0. Gas.5 14.8 3.9 12.6 34.3 524.6 8.9 6.8 529.4 10.2 14.6 4.5 14. .1 2.7 0.6 6.2 2.4 (2.4 (0.0) 1.6 172.5 16.4 367.5 11.2 11.4 0.4 6.7 16.8 12.0) (0.6 16.4 3.3 3.7 2.4 9.9 456.2 18.6 1.3 2.9 9.8 0.2 18.6 2.9 18.3) 11.5 30.4 — — — — — 448.3 740.4 1. a New equity does not include capital surplus.7 15.6 — — — — — 17.4 14.2 18.0 Transport.3 0.9 17.0 1.4 21.5 47.2 90.9 18.5 14.1 8.6 1.7 11.5 462.9 10.0 2.7 0.3 12.6 3.1 (11.3 1.4 2.6 0.4) (1.4 1.8 14.9 3.0) 1.4 7.3 543.4 12.7 2.6 — — — — — 0.1 17.8 14.7 116.1) 5.8 12.1 15.2 3.0 1.0 (15.8) (12.5 8.2) 9.6 512.0 21.8) 1.3 — — — — — 10.2 122.4 0.1) 1.3 0.3 17.4 169.4 0.4 7.4 13.1 6.3 8.5 26.5 (2.062.7 — = not available. Financial Statement Analysis Yearbooks.2 10.0 5.7 11.3 23.4 341.1) (0.1 11.8 111.5 307.7 510.4 3.8 9.0 921.5 612.7) (4.8 4.7 12.4 30.3 34.9 10.1) (0.9 9.7 — — — — — 14.6 12.6 14.9 4.9 (10.5 4.9 7.3 9.3 112.2 7.3 (2.2 15.8 11.3) 15.2 14.4 633.5 13.0 106.4 1.6 (2.6 4.9 4.3 4.1 (2.5 2.2 10.6 8.3 125. Source: Calculated using data from Bank of Korea.4 12.
Vol. It should also be noted that when the financial crisis struck in 1997.4 1.5 0.9 26.5 19.7 1. 1985-1997 (percent.3 15.5 19.12).3 (0.9 21.9 Growth and Financial Performance of Listed Companies. The smallest group had 16 members in 1995.8 0.6 23. II Table 2.1 6.7 (5.9 2.0 18. Chaebols have been the most important actors and engines of growth in the Korean economy.8 24. Performance of Chaebols This section uses available data on the top 30 chaebols.4 2. the top 11-30 chaebols experienced a decline of .6 0. Kis-Fas. unless otherwise indicated) Financial Performance Year 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 Average No.7 1.0 3.3 4. In 1995.6 (1.2 0. of which four were listed. Between 1993 and 1997. sales (45. and net profits (46.6 22. 1998. but the number of designated groups has been fixed at 30 since 1993. The top five chaebols registered the highest growth rates.5 ROA 0.9 percent). it is the chaebols’ large firms that are listed.4 0.1 1.4) 1. had 46 member companies. Generally. The number of Hyundai member companies rose to 57 in 1997.9 percent).4 1.7) 0.6 3. In 1997.3 2.12).9 0.3 20.4 1.1 percent of the economy’s total value added (excluding the financial sector).7 percent) of the corporate sector.5 5.4 22.8 6.1 1. of which 16 were publicly listed (Table 2.2 9. of Firms 334 351 386 503 626 669 680 681 687 698 715 754 775 Sales Growth 10.3 percent).9 2. the growth of sales of the top 30 chaebols exceeded that of the aggregate corporate sector (compare Tables 2.2 9.5 ROE 3. the largest chaebol. Hyundai Group.7 Net Profit Margin 0. the 30 largest chaebols accounted for 13.6 1. debts (47.1) 4.2 2.70 Corporate Governance and Finance in East Asia. and close to half of total assets (46. followed by the top 6-10 (Table 2.6 and 2.9 6.6 2.3 0.0 0.9 1.2 6.9 11.9 Source: Constructed using data from Korea Investors Service.11). The criteria for selection of largest chaebols have changed a few times.8 5.
8 1.2 13.6 0.9 6.Table 2.5 3.9 14.5 (1.4 1.2) 0.8 0.0 16.8 17.1 2.1 11.6 6.8 0.2 13.4 11.9 3.9) (6.3 11.8 6.6 1.3 15.4 5.2 (0.6 2.4 6.6 (1.9 22.0 1.3 15. 1998.5 5.6 1.6 2.3 (0.0 6.0 17.0 10.6 0.1 1.7 3.2 7.0 1.5 17.8 (5.3) 5.5) 1.1 2.3 Medium 14.1 8.8) 6.7 18.2 12.8) 1.8 3.0 15.6 3.0) 0.9 0.9 1.6 8.8 0.5 0.5 Net Profit Margin Year Large Medium Small 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 Average 2.1) 5.6 9.2 1.5 2.3 6.4 16.9 0.3 3.3 (0.7 (0.9 0.6 2.8 16.9 6.7 (1.2 Small 13.2 Note: Large firms have a capital base greater than W15 billion and small firms smaller than W5 billion.4 Medium Small Large Medium Small ROA Growth Performance Large 17.9 2. Kis-Fas.2 2.7 1.9 1.1 0.6) 0.6 (0.2 0.8 6.0 19. Source: Korea Investors Service.8 7.3 1.2) (1.9 2.6 3.0 1.0 1.2) (1.9 2.6 5.6 13.0 4.0 (4.2 10.9 25.5 1.9 5.7 2.4 1.3) 0.4) 1.6 7.5 5.8 10.2 2.4 3. Others are medium firms. .4 2.2 3.0) 1.7 2.9 (0.5) 1.6 1.7 4.5 25.7 (1.10 Growth and Financial Performance of Listed Companies by Size.8 0.3 9. 1988-1997 (percent) ROE Large 9.4 3.
117 4.129 2.743 40.475 2.924 2.996 1.147 5.313 14.370 6.873 2.376 35.131 3.690 3.640 4.287 10.303 3.445 4.433 3.395 31.398 — 2.090 6.346 3.774 7.158 7.599 — 2.956 3.486 6.11 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 43.677 3.458 6.756 5.364 5. .158 1. 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.423 5.Table 2.651 38.761 31.501 13.910 3.927 16.951 3.246 11.935 2.597 351.967 7.457 14.309 14.929 12.798 — No.990 2.995 2.853 1997 53.177 — 6.180 2.574 3.766 3.455 22. 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.427 9. Source: Fair Trade Commission.
2 20.5 27.9 18.0 6.5) (0.4 0.2) (2.7 4.3) 0.4 26.0 2.7 10.2 11.8 18.5 32.5 (0.6 25. 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 12.4 12.0 19.1 27.0 1.7) Source: Bank of Korea.9 3.6 18.3 0.9 24.0 31.5) (0.2 3.4) (14.3 11.2 (2.9 3.6 4.3 0.5 19.2 (5.7 15.2 0.5 20. .1) (0.0 2.3 19.1 (1.2 1.2 0.9 1.7 0.0 0.3 3.2) 1.1 (3.1) (0.2 0.1 (2.4 (2.4) 1.12 Growth and Financial Performance of the 30 Largest Chaebols.6 Financial Performance Net Profit Margin 1.4 30.6 1.7) ROE 5.2 (2.6 19.0 0.3 1.4 38.8 0.Table 2.5) (0.1 10.1) 0.7 10.0 2.5 5.0) ROA 1.9 17.5 2.8 27.3 1.3 14.1) 0.3 15.9 20.2) (0.3 9.8 Assets 12.7 13.0 17.1) (1.7 1.0) 12.1 19.3 27.2 (16.0) 3.6 (0.7 15.1 2.9 20.3 16.4) (0.
in this instance. II 2 percent in their sales and a very low 4. and led to a high concentration of ownership. The absence of a well-developed equity market and the provision of subsidized credit. it refers to the degree of concentration and shareholdings in the hands of an “identical person. 2.95 percent. Their worst year was 1997 when ROE hit -15. The financial performance of the top 11-30 chaebols deteriorated during 1993-1997. except for 1995.765 percent (Table 2. There has been a wide range in DER among chaebols. resulted in the chaebols’ excessive leverage. internal and external control mechanisms.5 Founding families are mostly still the largest shareholders and. Vol. technology. In general. and vulnerable balance sheets.7 percent growth in total assets. coupled with weak corporate governance. The ROE of the top 30 chaebols was consistently higher than that of the aggregate corporate sector. his/her relatives. 2. Only the top five chaebols registered a positive net profit margin in 1997. the average DER of the 30 largest chaebols reached 519 percent. However. and government intervention interacted through a set of laws and regulations to bring about the existing structure. and the companies that are under the control of the largest shareholder. weak corporate control. includes the largest shareholder. a pyramidal structure of corporate ownership is prevalent. and access to credit.3. loopholes and inconsistent policies spawned strategic behavior and agency problems.” in Korea’s legal and regulatory framework. However. The Commercial Code stipulates the basic governance framework and applies to all corporations. By the end of 1997. from 190 to 3. chaebols had a higher average DER than the corporate sector as a whole. the net profit margin of the aggregate sector exceeded that of the top 30 chaebols. Ownership patterns. 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. more important.74 Corporate Governance and Finance in East Asia.1 Patterns of Corporate Ownership The ownership of most Korean listed firms is highly concentrated. 5 While “ownership concentration” can be defined and measured differently in different contexts. 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.” This “identical person.13).
4 205.6 936.6 516. Doosan 15.5 343.2 346.441. Dongah 14. Sunkyung 6. Jinro Debt-to-Equity Ratio 376.3 328.4 175.2 2.855.4 622.7 621.5 3. Haitai 26.1 674.0 486. Dongbu 24. Hansol 23. Kukdong Construction 29. Halla 17. Dongkuk Steel 19.0 218. Lotte 11.2 292.2 423. Doosan 13. Hansol 17.6 2. Halla 13.1 190. Kohap 25.3 315.4 192. Hyosung 18. Jinro 20. Tongyang 22.2 328.0 506.4 556.8 312.9 751.1 385.8 336. Daewoo 5. Dongah Construction 16. 1995-1997 (percent) Chaebols 1995 1. Daewoo 5.0 370. Kumho 12. Hyundai 2.2 924. Kia 9.6 409. Hyundai 2. Kia 9.1 3. Daelim 16.065. Daelim 14.764.Table 2. Samsung 3. Kumho 12. Hyosung 18.7 416. Hanwha 10.5 2. Sammi 27. Hanwha 10. Lotte 11. LG 4.5 383.1 278.7 267.3 572. Ssangyong 7. Hanjin 8.7 354.3 297.13 The Top 30 Chaebols’ Debt-to-Equity Ratio. Ssangyong 7. Dongkuk Steel 19. Sunkyung 6. Hanbo 15. LG 4.5 337. Hanil 28.9 321.7 620.2 471.244.5 464. Hanjin 8. Newcore 30.0 436. Samsung 3.6 . Byucksan 1996 1.8 313.1 477. Kolon 21.7 688.
Hyundai 2.0 505.501.5 386.5 261. Kamgwon Industrial 30. Dongah 11.8 338. Hansol 16. Hanwha 9.1 438. LG 5.8 347. Daewoo 4.6 424.9 465.0 419. Anam 27. . Jinro 23. Hyosung 17.7 370.6 590.3 676. Ssangyong 8.784. Saehan Average of All Chaebolsa 1995 1996 1997 Average of All Industries Excluding Financial Sectorb 1995 1996 1997 Debt-to-Equity Ratio 317.8 647. Keopyong 29.3 399. Kolon 21.3 1.8 468. Samsung 3.5) 404.9 472.6 478.214. Anam 22.4) 513.9 490.8 590.1 433. Shinho 1997 1.5 519. Miwon 30.9 216.9 578. Haitai 25.7 1. Haitai 25. Dongkuk Steel 20.1 375.498. Shinho 26. Financial Statement Analysis Yearbook.1 359. Daelim 14.5 1.Table 2. Doosan 15.600. Dongbu 23. Kohab 22.5 576. Keopyong 29.6 416.5 (1. Kolon 19.8 307.6 335. Kohab 18. Newcore 26. Tongyang 24. Hanil 28. Kumho 10. Lotte 12.5 (893. Newcore 28.6 Sources: aFair Trade Commission.3 347.9 1.0 907.5 323.7 944.4 1.0 305. bBank of Korea.8 658.1 472. SK 6. Dongbu 21. Tongyang 24. Daesang 27.13 (Cont’d) Chaebols 20.8 399.225. Halla 13. Hanjin 7.
” followed by banks. The next important group was “other corporations. the entrenchment effect and problems of agency may be more pronounced in chaebols than in independent firms. an increase in their ownership may bring their ownership incentives to converge with those of the minority shareholders. Among listed nonfinancial companies.1 percent.Chapter 2: Korea 77 When controlling shareholders hold a very small percentage of the shares. However.e. the extent of ownership by these individuals declined gradually after 1988. and state-owned companies and securities companies declined. and then steadily declined after 1993. However. Theoretically. When managerial holdings are reinforced by artificial control mechanisms such as pyramiding. but their shares declined to 21. an entrenched manager is insulated from market pressure and can pursue personal goals without the fear of being replaced. managerial entrenchment becomes more likely. Most non-chaebol listed firms in Korea are believed to have ownership concentrations within the 10-30 percent range.14). fluctuated widely during the period. 10 to 30 percent). large ownership can also bring about the entrenchment effect.7 percent by 1997. From 69. including investment trust companies. individuals were also the largest shareholder group.. The pattern of distribution changed little through 1992-1997. Financial institutions owned as much as 28 percent of the total corporate shareholdings in 1992. Securities companies reduced their holdings over this period of falling stock prices as the size of investment trust companies’ stock portfolios declined. the Government. the ownership structure can bring about an incentive effect. while those owned by banks.” foreigners.6 percent by 1997. Thus. the year the stock market was in a frenzy due to buying sprees. with a given range of managerial shareholdings (for instance. The controlling shareholders of chaebols hold comparatively smaller percentages of shares. The holdings of financial institutions. the percentage of holdings by individuals slipped to 60. resorting to extensive use of pyramiding to maintain control. the incentive effect once again dominates. that is. and insurance companies increased during the period. including banks and other financial firms. the individual owners—the portfolio investors as well as the controlling shareholders and their family members—formed the largest shareholder group (Table 2. i. Composition of Ownership Among listed companies. the entrenchment effect outweighs the incentive effect. Beyond that range. The percentage of shares owned by “other corporations. The reduction can be .
9 36. of Firms The Statea Banks.6 9.8 69.9 19. etc.3 2.6 16.1 3.1 8.14 Ownership Composition of Listed Companies.5 18.2 5.4 5.6 2.9 26.2 8.6 20. and finance companies.7 3.3 8.5 62.8 4. merchant banks.7 8.3 17.2 1.4 13.5 60.6 36.2 5.5 16. Listed Nonfinancial Companiesd 1988 406 0.5 6.6 8.4 18.9 37.8 5.0 27.8 59. investment trust companies.3 26.7 7.2 4.0 28. a The State covers the Government and state-owned companies.1 60.b A.6 22.0 59.9 4.8 17.7 4.9 17.8 2.1 21.8 17. mutual savings.4 5.4 34.4 1997 551 1.1 21.3 1.” includes commercial banks.1 18.0 9.3 1.0 4.9 15.7 1990 531 0.6 19.0 7. etc.2 18.6 16.5 6.2 9.6 12.1 11.0 5.2 2.1 8.3 17.8 2.Table 2.3 5.0 60.2 9.7 9.0 8.3 5.5 4.9 5.5 7. All Listed Companiesc 1992 681 1993 687 1994 698 1995 715 1996 754 1997 775 9.2 1993 511 2.7 18.4 Insurance Firms Other Corporations Foreigners Individuals 39.5 Note: Ownership is based on number of shares.1 17.8 5.5 1989 498 0.2 B.1 18.6 9.0 5. .1 4.3 39.4 13.4 14.7 59.5 1992 508 2.1 68. c Data from Korea Stock Exchange. b “Banks.3 1994 521 1.6 Year No.1 1.9 1.6 16.8 59.9 2. 1988-1997 (percent) Financial Institutions Securities Firms Total 28.1 10.6 13.8 1995 548 2.9 2.2 8.2 17.1 2.7 6.5 1.3 18.2 7.6 1991 505 0. d Constructed from data files of the Korea Listed Companies Association.5 1.3 1996 570 2.7 9.4 6.2 3.3 18.9 1.5 7.7 14.5 12.
Before such liberalization. foreign holdings were derived from purchases through country funds and direct capital investments. The ownership distribution in listed nonfinancial firms. 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. financial institutions had more shares in the manufacturing sector than in primary industries. electricity. Over the years. In general. This is low compared with those in Japan. held 26. Institutional investors. government ownership in nonfinancial companies was remarkably smaller and more concentrated.15). UK. Corporate holdings averaged 16 percent throughout 1988-1997. and US (Table 2. The holdings of other corporations are mainly equity investments in affiliate companies.18). and small companies. the Government acquired an even bigger share in several banks as part of its program to bail out these distressed institutions. there appears to be no significant difference in the overall shareholding patterns between the two groups (Table 2. In most instances. the holdings of institutional investors were expected to increase significantly with the Government’s introduction of US-type investment companies in 1998 and .17). indicating their increased investments particularly in the service industries with high growth rates. This trend can be explained by government ownership. However. of some banks.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. In 1998. Compared with its holdings in all listed companies. One minor difference is that the percentage of shareholdings by corporations is slightly higher in large-sized firms. as distinguished from individual and foreign investors. categorized into large. indicating their heavier reliance on inter-firm financing investments. The Government’s and state-owned institutions’ (including some banks) ownership was generally small except in the power sector. medium. When independent companies are distinguished from firms affiliated with the 30 largest chaebols. the Government was the sole owner.8 percent of listed shares in 1997. whether partial or absolute. and service of motor vehicles (Table 2. did not vary significantly (Table 2. a more detailed breakdown of the data on majority shareholdings in the next section shows significant differences in the two groups’ composition and level of majority shareholdings.16). other corporations’ holdings shifted toward service industries. However. Individuals held the majority of the shares in all industries except in telecommunications.
4 8.3 0.7 63.7 59.0 0.5 0.3 2.1 0.6 3.9 19.2 17.3 13.8 7. and Printing Chemicals.1 0.1 1.9 4.2 1.0 Industry 1990 Fishing and Fish Farms Mining Food Products and Beverages Wearing Apparel and Fur Articles Wood.2 2.7 6.8 1. Rubber.0 — 0.5 85.1 65.7 2.0 2.8 8.2 0.2 9. Paper.5 4.9 59.7 14.8 7.4 56.0 — 39.3 4.3 57.4 1.7 14.3 1.4 8.6 18.4 1. 1990 and 1997 (percent) Financial Institutions The Statea — — 0.1 8.4 8.4 — 0.7 20.4 7. and Plastics Basic Metal Fabricated Metal and Machinery Office and Computing Machinery Electronics.0 9.0 8.1 19.1 8. and Printing Pulp.1 4.1 27.8 5.0 20.9 15.3 10.9 42.5 17.4 62.5 6.8 7.2 64.7 2.Table 2.4 2.8 7.6 11.9 60.8 Individuals 83.9 0.2 — 0.0 1.3 2.9 10.4 56.7 22. Etc.3 62.5 — 0.3 7.1 0.3 38.1 0.9 55.6 24.b Securities Firms Insurance Firms Other Corporations Foreigners — — 0.5 — 1.5 0.5 3.8 73. and App.5 0.1 10.5 — — 0.3 1.3 0.7 20..3 0.3 11.4 0. Elecl Mach.6 1.4 5.2 54.7 2.0 9.2 22.7 64.3 9.2 7.5 0.7 29.1 88. Paper.0 9.6 — — 2.4 14.5 7.9 23.2 0.3 6.15 Ownership Composition of Listed Nonfinancial Firms by Industry.9 1.2 0.0 9.9 1.8 7.4 Banks.7 1.7 17.9 52.2 1.9 16.6 8.5 19.8 6.9 66.2 9.9 8.2 — — 0.1 7. Gas.5 12.2 0.2 9.0 7.8 3.6 5.7 22.0 10.8 3. 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 . Motor Vehicles Electricity.
1997 Fishing and Fish Farms Mining Food Products and Beverages Wearing Apparel and Fur Articles Wood.0 1.4 4.5 — 2.3 6.3 65.0 6.6 14.4 9.2 3.3 2. and Printing Chemicals.9 2.1 9.2 23.2 7.3 0.6 75.1 9.8 27.2 6.7 4. b “Banks.6 — = not available. and App.5 5.7 23.8 0.4 2.5 3.5 7.8 2. and finance companies.5 3.7 2. mutual savings.6 60.2 4. Rubber.9 78.1 3.4 16. Elecl Mach. and Plastics Basic Metal Fabricated Metal and Machinery Office and Computing Machinery Electronics.1 1.2 4.8 2.8 5.6 2.5 63.9 5.1 — 1.4 43.4 68.7 2. .2 4. and Steam Supply Precision and Optical Instruments Other Manufacturing Construction Service of Motor Vehicles Wholesale and Retail Trade Transport Telecommunications Other Business Activities Nonmetallic Mineral Products Average 1.2 13.9 57.6 0.0 5.6 2.4 0.9 18.3 7.2 0.5 1.3 31.2 1.4 6.0 4.4 1.2 8.7 2.8 5.3 8.3 6.9 2.9 7.0 3.9 2.8 6.1 2.9 0.1 6.78 81.9 69.0 7.7 5.4 — 1.4 58.6 1.8 11.6 3.8 12. and Printing Pulp. etc. Paper.9 1.1 3.6 6.0 11. investment trust companies.1 25.2 1.7 6.6 20.4 20.8 4.3 1.7 17.0 60.5 59. Source: Constructed from data files of the Korea Listed Companies Association. Motor Vehicles Electricity.9 5.6 0.5 4.9 6.1 2.8 57. merchant banks.7 19.9 7.8 3.4 2.2 5.4 2.9 6.9 2.6 6.5 6.3 15.2 0.6 5.9 1.1 — 0.5 3.8 2.6 18.5 4.0 43.4 4.1 1.” includes commercial banks.4 76.4 3.1 4. Note: Ownership is based on number of shares.2 5.3 1.7 1.0 6.1 54.3 60.2 49.0 8. a The State covers the government and state-owned companies. Paper.1 18.6 2.9 1.4 58.4 1.3 57.6 7.8 54.5 3.7 2.6 59.2 4.9 20.4 1.8 0.5 12.5 0. Gas.4 45.9 20.
Others are medium firms.” includes commercial banks.2 1.4 2.4 61.0 6.1 Banks.3 6.7 4.8 1. Source: Constructed from data files of the Korea Listed Companies Association.16 Ownership Composition of Listed Nonfinancial Firms by Size. 1997 (percent) The Stateb Foreigners 4.4 17.7 0.7 6. etc.4 4.5 2.0 Other Corporations 16. 1997 (percent) The State 1. b Table 2.6 60.17 Ownership Composition of Listed Nonfinancial Firms by Control Type.5 16. of Firms Large Medium Small Total 211 208 80 499 a Large firms have a capital base greater than W15 billion and small firms smaller than W5 billion.5 18.c Securities Firms Insurance Firms Other Corporations Individuals 58. of Firms Independent Firms Affiliates of 30 Largest Chaebols Total 316 117 433 Source: Constructed from data files of the Korea Listed Companies Association.5 19.5 4.4 Firm Sizea No.9 2.0 1.6 16.8 60.4 5.8 4.Table 2. mutual savings. etc.7 1.9 4. Securities Firms Insurance Firms 2. merchant banks. and finance companies.4 21.4 2. The State covers the government and state-owned companies.7 Control Type No.5 62. etc.5 Individuals 60.9 5.1 2.8 2.5 8. .7 8. c “Banks.4 61.4 1.8 3.3 Banks.1 6. investment trust companies.7 Foreigners 4.1 8.4 5.5 6.8 4.8 6.
1 8.18 Ownership Composition of Listed Firms in Selected Countries. his/her family members.China United Kingdom United States Source: Stock Exchange of Korea. This has had profound implications for corporate governance and the market for corporate control in Korea. In 1997.19).8 56. Among nonfinancial listed firms.3 54. Foreign holdings of Korean shares were 9. But these may . for example. defined as those holding less than 1 percent of shares.7 16. including those of the largest shareholder. 1997 (percent) Country Japan Korea Taipei.20).3 6. Generally. the majority shareholder group on average held 23-30 percent of outstanding shares in the period 19881997 (Table 2.1 financial institutions’ establishment of corporate pension fund accounts. The majority shareholder group’s shareholdings in listed nonfinancial firms steadily declined from 1990 to 1996. The more popular open-end investment companies (mutual funds) were expected to come into existence by the end of 1999 with the Government’s deregulation of the capital market. Concentration of Ownership The analysis of ownership concentration in this section focuses on shareholdings of the majority shareholder.5 45. minority shareholders.5 20.6 Foreigners 9. the majority shareholder group in all listed companies consists of the corporate. and the companies under the control of the largest shareholder. corporations held 70 percent of the controlling blocks of shares.1 percent and appear to be similar to the proportion of foreign holdings in the four other countries. while family members accounted for only 30 percent.4 26.8 9.Chapter 2: Korea 83 Table 2. and other shareholders who do not belong to either the minority shareholders or the majority shareholder group. investors (Table 2.3 47. At the moment. rather than the individual.6 Individuals 23. only closed-end investment companies and traditional investment trust companies are allowed.6 39. Institutional Investors 42.8 10.
9 2.Table 2.2 2. Source: Stock Exchange of Korea.1 5.8 8.0 29.1 14.8 Individual Subtotal Other Shareholders Corporation 3.1 32.3 2.7 Note: The majority shareholder includes the largest shareholder.7 6.1 28.7 7.7 18.8 72.2 26. his/her family members.0 66. .3 18.0 25.0 2. 1992-1997 (percent) Majority Shareholders Corporation 15.9 6.6 22.1 5.1 15.2 2.8 73.9 32.0 1.0 22.19 Ownership Concentration of All Listed Firms.7 44.0 4.5 43.4 7.2 Minority Shareholders Subtotal 71.1 21.1 23.9 33.0 69.4 5.7 16.6 46.6 5.3 30.4 3.9 3. Minority shareholders are those holding less than 1 percent of shares.6 73.3 Subtotal 5.0 Year Corporation Individual 1992 1993 1994 1995 1996 1997 41. and the companies under the control of the largest shareholder.9 Individual 2.6 26.1 37.9 7.1 4.6 2. Other shareholders are those who do not belong to either the minority shareholders or the majority shareholder group.
6 11. Besides.9 Other Shareholders 18. Across industry. 1988-1997 (percent) Year 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 Minority Shareholders 53.3 25. In most industries.8 28.8 54. Meanwhile. The practice of hidden shares seems to have been less prevalent in recent years.0 22.21]).3 62.8 12.6 58. thereafter.9 48.5 12.2 15. Ownership concentration tended to be lower in large compared to medium and small listed firms.1 50. 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.9 29.4 Source: Constructed from data files of the Korea Listed Companies Association.4 28.8 25.5 13. rubber and plastics.22).9 12. which held less than 1 percent of a company’s outstanding shares as of 1997. the majority owner held more than 20 percent of an average firm.9 25.0 58.20 Ownership Concentration of Listed Nonfinancial Firms. In telecommunications.Chapter 2: Korea 85 Table 2. 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 2.0 20. In such cases.5 23.4 23. hiding shares offers no additional tax or other benefits. Majority ownership is also high in the chemicals.9 27. ownership was relatively diffused due to government regulation.7 18. The shareholders that held more than 1 percent but did not belong to the majority group held about 20 percent on average.5 60. collectively owned less than 50 percent of an average firm. in the small firms. 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. the Government has retained a large number of shares. It was highest in medium-sized firms before 1993 and. minority shareholders.8 57. . and mining categories.6 57.8 Majority Shareholders 27.
2 23.5 20.4 11.0 54.6 19.2 48.9 44.1 43.7 36. Paper.7 29. Motor Vehicles Electricity.2 34.5 47.7 21.5 23. and Plastics Basic Metal Fabricated Metal and Machinery Electronics.8 29.0 30.6 50.8 24.8 25. 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 36.3 19.2 22.6 25.0 21..8 55. and Printing Pulp. and Printing Chemicals.7 26.0 39.4 53.5 44. 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. Gas.5 52.9 10.9 26.3 39.5 41.6 34.7 24.2 19.8 44.1 19.8 21.2 37.4 Industry Fishing and Fish Farms Mining Food Products and Beverages Wearing Apparel and Fur Articles Wood.21 Ownership Concentration of Listed Nonfinancial Firms by Industry.2 20. .2 46.5 19. Rubber.6 38.9 Minority Shareholders Majority Shareholders Other Shareholders 12.2 26.5 16. Elecl Mach.8 51.3 26.8 41. Paper.4 16.0 51.8 31.6 53.1 17.Table 2.1 49.5 21.7 27.7 17. and App.
1 20.2 26.2 Majority Shareholders 26.2 50.2 21.2 Source: Korea Listed Companies Association.Table 2.9 16.9 56.5 26.7 57. .3 19.2 21.9 55.9 53.4 30.7 31.7 28.1 15.4 30.9 21.2 55.2 32.5 27.1 16.9 17.1 58.2 11.9 12. 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 53.7 17.3 21.9 22.6 24.2 56.5 51.8 52.7 22.6 59.8 56.1 48.2 21.5 21.8 28.5 12.5 10.6 15.8 17.5 33.22 Ownership Concentration of Listed Nonfinancial Firms by Firm Size.3 25.0 59. 1988-1997 (percent) Year Small 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 Medium 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 Large 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 No.7 15.4 30.8 50.0 55.6 31.4 47.3 27.7 16.7 14.7 57.6 55.4 21.0 26.5 19.2 52.2 12.5 19.0 66.3 55.8 11.4 29.5 Other Shareholders 19.0 24.6 11.5 28.5 12.6 65.9 28.6 27.9 60.9 23.3 26.5 49.8 62.4 51.9 26.8 52.2 18.6 62.8 27.1 27.
The study by Kim. one company can still place equity investments in another. H. For example. This type of inter-firm investment. This refers to the situation wherein Company A holds shares of Company B and simultaneously Company B holds shares of Company A. Inter-Firm Investments and Pyramiding in Chaebols The Commercial Code imposes limits on direct cross-shareholding. If SCS is above 20-25 percent. Hong. II Ownership Concentration and Financial Performance J. One of the merits of pyramiding. it means the firm creates value.88 Corporate Governance and Finance in East Asia. TQ increases as the SCS increases. and Vishny. If TQ is higher than 1. Vol. The relationship between TQ and SCS shows a similar pattern. Kim (1992) and Kim. Kim (1992) found the relation between TQ and SCS to be nonlinear. TQ has a maximum value. which can then pass the equity capital to a third. Hong. is effective control of a certain group of companies even with a smaller investment. from the standpoint of the controlling shareholder. If SCS is below the range of 20-25 percent. 1988). and Kim (1995) reached a similar conclusion. If SCS reaches 10 percent. thus a firm destroys value. TQ is below 1. Shleifer. affiliated companies have been able to conduct inter-firm transactions. thus a firm creates value. J. H. They analyzed firms in which controlling shareholders participate as managers. the firm destroys value. Then TQ declines until SCS reaches 45 percent and increases until it reaches 50 percent. Where direct cross-shareholding is not allowed. The pattern of the relationship between SCS and TQ is similar between Korean and US firms (Mork. Both studies used Tobin’s Q (TQ) for the value of a firm as an index of financial performance. TQ is above 1. and Kim (1995) studied the empirical relationship between the degree of ownership concentration and financial performance in Korea. The Code prohibits a subsidiary company from owning shares of its parent company. one company from a chaebol group could obtain debt payment . which is the company holding more than 40 percent of outstanding shares of its subsidiary. if TQ is lower than 1. In Korea. If SCS is below 10 percent. and the shareholding of a controlling shareholder (SCS) as the degree of ownership concentration. TQ was calculated by dividing the market value of a firm by the substitution price of its assets. often at terms unfair to one of the transacting parties. although turning points in the value of firms are different. called “pyramiding”— commonly (though incorrectly) known as “indirect cross-shareholding”— is prevalent in Korea.
together having a total of 292 domestic subsidiaries. Twenty-two of the 81 respondents were independent. Of the 81 respondents. for example. together owning an average of 37. In many instances. For the whole sample. The extent of pyramiding can be seen in some of the previous tables. Partial results are shown in Table 2.5 percent. 34 percent were foreign companies. 59 were parent firms with one or more subsidiaries.14. standalone setups.4 corporations.5 corporations and two individuals. together owning an average of 38. Only six firms (or 13 percent) indicated that their subsidiaries also owned shares in themselves. corporations hold about 20 percent of the outstanding shares of all listed nonfinancial firms. Until recently. In the case of the 30 largest chaebols. and 319 foreign subsidiaries. Among the subsidiaries or firms receiving investments. Among the 81 listed firms in the ADB survey. dominated the majority shareholder group in chaebol-affiliated companies is consistent with the results of the ADB survey conducted for this study. In Table 2. not individuals. Among chaebol affiliated firms. neither the investors nor the relevant government authorities were active in monitoring such unfair dealings between firms. For the same year.5 percent as of 1997. there are instances of direct cross-shareholding in Korean firms. Thus. or about four firms each. 53 percent were domestic nonfinancial firms.5 percent of shares.9 percent of shares. the top five shareholders consisted of 2. although they are likely to be insignificant. 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.23. Thus. and about 11 percent were domestic financial institutions. The fact that corporations. This also partly explains why chaebols frequently opted to expand by establishing new firms rather than placing investments internally. 62 percent (16 out of 26) had a corporation as the largest shareholder. The top five shareholders of the chaebol-affiliated firms consisted of one individual and 3. the average shareholding of the controlling owners and their families was 8. financial institutions that are subsidiaries of a chaebol also hold shares in its member firms. But the controlling power of the owners also stems from inter-company shareholdings of the subsidiaries. or about five subsidiaries each. firms linked through partial equity investments could enjoy the advantage of consolidation without an actual formal consolidation or merger of operations taking place. the top 30 chaebols’ shareholding by subsidiaries was 34.Chapter 2: Korea 89 guarantees from other members of the group at no cost. If we define the internal shareholdings of a . 59 parent companies collectively had investments in 759 firms. or an average of 13 firms per company.
1 1.8 31.4 11.5 2.0 1.0 17.23 Ownership Concentration in the Survey Sample of 81 Listed Firms.0 1.6 3.4 21.7 0.1 3.2 25.9 34.9 5.8 Note: The survey was conducted during the period January through May 1999 and included nonfinancial listed firms only.7 5.6 34. A few companies reported less than five largest shareholders.4 25.8 37.6 3.0 3.Table 2.5 2. 1999 Five Largest Shareholders No.0 3.3 12.5 24.2 37.3 26.1 22.6 16.7 37.4 1.0 2.9 21.7 19.5 18. .5 38.5 31.5 2.4 2.9 29.5 1.8 18.4 38.4 42. a Number of shareholders.4 18.5 4. b The chaebol affiliated firms are those belonging to one of the 30 largest groups.6 3. of Firms Largest Shareholder’s Holdings (%) Compositiona Individuals Firms Shareholdings (%) Individuals Firms Total Classification Total Sample Non-Chaebol Affiliated Largest Shareholder is Largest Shareholder is Largest Shareholder is Chaebol Affiliatedb Largest Shareholder is Largest Shareholder is Largest Shareholder is CEO an Individual a Firm CEO an Individual a Firm 81 55 31 10 14 26 3 7 16 20.0 21.5 4.8 38.5 2.8 8.0 13.7 39.
79-95. 1997. Many attempts have been made by researchers to identify the typical patterns of ownership structures in chaebols.4 10. “Japanese Zaibatsu and Korean Chaebols. “The Ownership Structure and Family Control in Korean Conglomerates: With Cases of the 30 Largest Chaebols.2 12. As of 1997. it appears that the chaebol families have had a strong desire to expand their business bases. 1989. Internal shareholdings in some chaebols also include shares owned by nonprofit organizations operated by the controlling family.6 Later studies by Lee (1997) and Lim (1998)7 find similar patterns.2 33. the average internal shareholding ratio of the top 30 chaebols was at least 43 percent.4 1990 45.24 Internal Shareholdings of the 30 Largest Chaebols.5 percent and member companies. Chicago.Chapter 2: Korea 91 chaebol as the shareholdings of the controlling family and the member companies of the group.” Paper presented at the Annual Conference of Financial Management Association. H. 6 7 Hattori.24 shows the average internal shareholdings in the 30 largest chaebols.8 33.7 9. 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.8 40.1 1997 43. 15 October 1998.5 percent. Table 2. Lee. The family and member companies’ shareholdings have been declining over time. Ungki Lim. 1987 56.7 31.0 8.4 1993 43. the ownership patterns can be described as follows. the controlling families owned 8.4 13. 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. edited by K.5 34. Chung and H.2 1994 42.5 Judging from the historical record. 34.2 15. 1998.7 1992 46. “Is the Fair Trade Policy Fair?” Korea Economic Research Institute. Family holdings include shares owned by the family members and by parties considered to be under the influence of the family.6 33. Jae Woo. Based on these studies. 1987-1997 Type of Shareholding Internal Shareholdings Family Member Companies Source: Korea Fair Trade Commission. Table 2. Lee. . New York: Praeger. Tamio. pp. C. Hattori (1989) identified three patterns based on data in the early 1980s.” In Korean Managerial Dynamics.
Thus. Most of its member firms were acquired by. It consists of seven listed and 24 privately held firms. The two base companies have investments in three other base companies. it had 18 listed and 39 private companies. called the “indirect control via base company. Sun Hong Kim. Investments between the lower level subsidiaries are rare. the family controls the group’s member companies by its own shareholdings. which then make investments in the subsidiaries. is an example of this type. consisting of eight listed and 16 privately held firms as of 1997. Hyundai Motors acquired Kia Motors via an international auction. Kia Motors was the base company and had such strategic shareholders as Ford Motors of the US and Mazda of Japan. A nonprofit foundation under the family’s control is the largest shareholder of one of the base companies. The Hyundai Group exemplifies this.” A family owns a substantial portion of shares of member firms and becomes the controlling shareholder of each. The Hanwha Group can be classified as such a company.” Under this type of ownership pattern. The family itself holds shares in some subsidiaries. Chaebol Reforms Various measures have been taken to improve the transparency of chaebols with regard to accounting.92 Corporate Governance and Finance in East Asia. financial. As of 1997. The Hanjin Group. Vol. which in turn hold shares in some of the other subsidiaries. The second (Type B). or merged into. Its controlling family holds shares in three base companies through which they exercise control over the other member firms. The third (Type C) is “indirect control via complex shareholding. II The first (Type A) is called “direct family ownership.” Here the family directly controls a base company and a nonprofit foundation.” shows a simple pyramidal structure. Also. completely dissolved under financial distress. For example. investments made by the base companies. One of the . and his management team exercised full control over the group without much interference from major investors. But the former chief executive officer (CEO). subsidiaries have extensive investments in other subsidiaries. there is no controlling shareholder. The Kia Group was about the only management-controlled group but was out of existence by 1999. other firms. and business activities. holdings of the nonprofit foundation. The fourth type (Type D) is “management control. and subsidiaries’ equity participation. The controlling family has sizable investments in two base companies and smaller investments in many others. Here the family is the controlling shareholder of one or more strategic base companies that have enough equity participation in the subsidiaries.
the Fair Trade Act). The Government is also considering whether to allow consolidated taxation for pure holding companies. there are reports that some top chaebols are studying the feasibility of transforming their organizational structure. . However. Until the end of 1998. following the amendment of the law. bankruptcy reorganization. Existing guarantees had to be resolved by March 2000. These amendments prohibited holding companies and direct cross-shareholding. Initially.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. thus hurting the shareholders of stronger firms. the Credit Management Regulation rules were amended to prohibit financial institutions from requiring guarantees from affiliated firms when extending new loans. This limit was also applicable to banks and insurance companies. This was the reason why chaebols chose to employ pyramidal structures. the act did not have any important provisions except the standard clauses prohibiting monopolization of an industry through business combinations. A third disallows multiple layering of holding companies. 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. direct control of the management of chaebols was attempted through amendments of the act in 1986 and 1990. The Fair Trade Act was also revised in February 1998 to prohibit cross-guarantees of debt among members of a chaebol. One condition requires that the DER of the holding company should not exceed 100 percent. The limit on investments was reduced to 25 percent in 1994 and completely eliminated by 1997. At this early stage. Also. only operating holding companies were allowed to be established. 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. These conditions are aimed at restricting excessive pyramiding and expansion of chaebols. 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 first serious attempt to deal with this issue was the introduction of the Monopoly Regulation and Fair Trade Act of 1980 (hereinafter. 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. They hindered early exits (liquidation. The prohibition of holding companies was also abolished in 1999. It remains to be seen whether they will adopt the holding company structure in the future.
chaebols dismantled their “planning and coordination offices” or “chairman’s offices” under pressure from the Government. which put together the accounts of all members of a chaebol. Some chaebols have disintegrated or shrunk in size. and the capital market was almost nonexistent until the recent reform . In 1998. The chairman’s office had its own chief executive officer. the Commission has strengthened its investigative activities to eradicate cross-subsidization and wealth transfer activities among group members. The office established strategies for the group as a whole. there have been no significant changes. Chaebols maintain that the restructuring headquarters will exist only for a limited period. usually in the rank of a company president. 2. The staff of these organizations were employees of member firms. even though they were legally independent with their own board of directors and the outside shareholder groups were not identical. but the larger and stronger ones still operate their newly named “restructuring headquarters” under the control of the group chairperson. and transferred funds generated by one firm to another. Their operating costs were borne by the member companies rather than by the controlling shareholder. boards of directors. The Fair Trade Commission has been deeply involved in promoting managerial transparency by exercising its power to investigate and levy penalties on “unfair internal transactions” among member firms of chaebols. These offices were legally informal and functioned as the headquarters of chaebols.) 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. Since the economic crisis. until urgent restructuring is complete. Despite chaebols’ decision to dismantle the chairman’s offices. It also acted as the secretariat for the unofficial “presidential meeting” of the member firm presidents.2 Internal Management and Control Monitoring of corporate management by shareholders. planned for capital raising and allocation on a groupwide basis. II etc.94 Corporate Governance and Finance in East Asia. Some chaebols operated “group management boards” attended by top executives (presidents or chairpersons) of larger member firms.” The group chairman operated through these offices and treated the individual member firms as if they were the divisions of a single legal entity. who is universally called the “group chairman. unlike the regular consolidated statements that only cover those firms that are related through direct equity participation. Vol. The 30 largest chaebols are now required to publish “combined” financial statements.3.
had their own governance problems. creditors were not active in monitoring debtor firms and relied mainly on guarantees and collateral. This implies that the typical agency problems in Korean corporations stem from conflicts of interest between inside (the largest) and outside (minority) shareholders. as the major creditors. The board elects one or more representative directors from among the board members. Meanwhile. control is not separate from ownership. In most listed companies. Legal provisions to protect investors were limited. were too big to fail.Chapter 2: Korea 95 efforts. Banks. this was complicated by the prevailing attitude that large companies. except for banks. but some large ones have two or more. the concept of fiduciary duty of managers was not well established. in most Korean firms. Directors are elected at the general shareholders meeting for a term not exceeding three years. Thus. Most companies have one representative director. especially chaebols. the creditors did not declare defaults. With few exceptions. or at least acts as the de facto CEO. . only the Government could play an effective role in monitoring corporations. the controlling shareholder is officially the representative director and the CEO. Board of Directors General Characteristics of the Boards Under the Commercial Code. corporations should have a board of directors consisting of at least three members. Under such circumstances. Loan agreements and debt indentures did not include strict covenants. the representative director was also the chairperson of the board. However. he or she generally approves major decisions made by the management. Professionalism in management was not well developed and managers were content with receiving orders from controlling shareholders. As of 1997. Even when the covenants were violated. The Government’s policy and securities law provisions to protect control rights of the incumbent management had been in place until the early 1990s. and takeover codes were not accommodative to active monitoring. the controlling shareholder (or a member of the controlling group) was the legally registered representative director in 354 out of 551 nonfinancial listed firms. There are many reasons for this. This policy managed to hamper any monitoring initiatives from the capital market. Even where the largest shareholder is not the representative director.
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. Further. 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. However. The Commercial Code was also revised in 1998 to introduce cumulative voting for the election of directors. A few large companies had more than 50 directors. However. 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. members of the board. Vol. . cumulative voting is not mandatory and a company can exclude itself from its application by amending its charter. were supposed to be outside directors. and their positions (accept or reject) on matters voted on in board meetings. almost all companies succeeded in adopting cumulative voting. the attendance rate of outside directors. other than the representative director(s). With the boards consisting only of insiders. it has been common practice that candidates for directorship are handpicked by the controlling shareholder/CEO from among the senior managers and are automatically approved at the general shareholders meeting. there is concern that newly elected outside directors still lack independence from the management or the controlling shareholder. 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. all of whom were managers. companies have to disclose in their annual reports the frequency of board meetings. 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. Most of the outside directors in those days were the controlling shareholders of chaebols or executives of affiliated companies. In order to address this concern. II When the Commercial Code first introduced the corporate board system in the 1960s. Recent Reform Efforts on the Board System In 1997. In the 1999 annual shareholders meetings. Moreover. Despite the qualification requirements. 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 1999.96 Corporate Governance and Finance in East Asia.
Among the firms with no outside directors. the Korean Code recommends that large listed firms should have at least three independent directors. Where the chairperson was not the CEO. This is because most banks. Among others. and a nominating committee. Where the two were separate.5 percent of the shares.Chapter 2: Korea 97 The committee structure of the board as found in the US has not yet been adopted by listed companies.4 directors. Directors were also chosen on the basis of their relationship with the controlling .2 percent and the CEO 14. he or she held 6. In 78 percent of the responding firms. although some banks recently have established board committees. having no controlling shareholders. 88 percent had plans to hold elections in the near future.9 percent on average. ADB Survey Results on Boards The ADB survey results confirm the above assessments and provide early indications on the effects of the reforms. Directors were most frequently elected because of their professional expertise (74 percent of the respondents marked this answer). the OECD principles of corporate governance were the minimum standard for the Korean Code of Best Practice. Meanwhile. The controlling shareholder of some banks is the Government. The Commercial Code is being amended to allow a choice between the audit committee system and the current internal auditor system. a blue-ribbon committee. they had a parent/child relationship in 20 percent of the cases. an audit committee. which had extended financial support in their recent recapitalization efforts. In March 1999. The Securities and Exchange Act will require large listed firms with W2 trillion or more in total assets to adopt the audit committee system.1 percent and outside directors 1. the Corporate Governance Reform Committee. was established under the auspices of the Ministry of Finance and Economy and the Korea Stock Exchange. Almost all (92 percent) of the respondents had one or more outside directors and 70 percent were elected after the Asian financial crisis. inside directors owned 16. On average. this committee adopted the Code of Best Practice in Corporate Governance. These results are in accordance with the new listing rules introduced in 1998. are required to have a majority of outside directors. In September of the same year. who would comprise at least 50 percent of the boards. the chairperson of the board was also the CEO and on average held 10.1 percent of outstanding shares of a listed company. The average board had 8.
among the 81 sample firms. About five directors per firm have been in office for more than one term. compensation for directors must be approved by the annual shareholders meeting for each fiscal year. Remuneration for chairpersons include only fixed fees in 76 percent of the sample firms. The current chairperson has been in office for 6. Vol. In some instances. II shareholder (30 percent). The general practice is that shareholders approve the upper limit on the total amount to be paid to all directors. one person was sitting on nine boards and this person was the CEO of a chaebol firm. This rather long tenure must be due to their status as controlling shareholders in most firms. In most firms.2 years on average. Some directors were nominated by significant shareholders (18 percent) or introduced (and elected) at the shareholders meeting. In 13 percent. 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). a total of 562 directors were sitting on two or more corporate boards. most firms just began to elect a small number of outside directors to meet a new requirement in the listing rules and thus have no experience in the AngloAmerican type of board processes. the management nominated director candidates (64 percent of the directors). the term of appointment of directors and board chairpersons is three years. The reason for this high frequency of interlocking directorship is that many listed firms belong to chaebols. In a very small number of firms. In 91 percent of the sample firms. In one case. Chairpersons of the board were elected on the basis of professional expertise (33 percent of the firms). the board had a nomination and an audit committee. the management determines the remuneration. The survey results indicate that boards determine remuneration packages for chairpersons in 42 percent of the firms. and shareholding (10 percent). relationship with controlling shareholders (21 percent). including stock options. These were established only recently. in some firms.98 Corporate Governance and Finance in East Asia. the board had no committees. election of directors was based on shareholdings (7 percent) and status as founder (7 percent). Members of controlling shareholder families or their trusted company personnel often act as directors for multiple chaebol firm boards. and fixed fees plus performance-related pay. in 23 percent. In 1997. . However. Most frequently. Less frequently. The board or the management then determines compensation packages for individual directors. founders of the company acted as the chairperson (22 percent). As discussed earlier. According to the Commercial Code.
In a handful of sample firms.Chapter 2: Korea 99 Management CEO In the survey sample. compensation is by fixed salary in 74 percent of the firms. A smaller number of firms consider maximization of a company’s market share and looking after the interests of such stakeholders as creditors and employees as very important. In less than 20 percent of the firms. 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. However. who is not the chairperson. CEO is also the founder in 52 percent of the firms. In 4 percent of the cases. CEO was given shares by the family. In 20 percent. and in another 21 percent CEO bought shares in the market. . According to the survey. CEO generally has the ultimate power to decide on corporate affairs. and was appointed by the Government in five firms. In cases where CEO is not the largest shareholder and chairperson. CEO is entitled to a large sum in cases his/ her contract is terminated before its expiration. CEOs have been in their positions for an average of 9. and fixed salary plus performance-related pay including stock options in 13 percent. decides on important matters on his/her own in 13 out of the 44 firms. When CEO is not the chairperson. he or she was selected on the basis of professional expertise in 15 firms. in which there is no controlling shareholder. CEO simply follows the orders of the chairperson. In 21 percent of cases.2 years. In such cases. In the survey. he or she does not enjoy much power. 86 percent of the firms answered positively when asked whether the largest shareholder was CEO. It indicates that CEO. CEO decides on important matters after consulting the chairperson in the majority (55 percent) of the firms. the payment is about five times the CEO’s annual salary. In the 25 firms where CEO was not the chairperson of the board. The remuneration package was proposed by the board (and approved by the annual general meeting) in 56 percent of the firms. it was proposed by CEO and approved by the board. fixed salary plus net profit-related bonus in 9 percent. These results show that the incentive compensation scheme for professional CEOs is not well developed in Korean firms. Ensuring that a company serves the public interest is considered a less important responsibility of CEO. the survey tells a slightly different story than is generally believed in Korea. shareholding in three firms.
Reforms in accounting standards since May 1998 have proceeded in several areas: (i) revision of financial accounting standards that are primary sources of the Korean Generally Accepted Accounting Principles. The bonus is supposed to be linked to company performance. About 40 percent of the listed companies had amended their charters to introduce incentive stock options by the 1999 shareholders meetings. Penalties for fraudulent financial reports were increased. One area has been to enhance the reliability of financial statements of corporations in line with internationally accepted standards. it was common for all senior executives to be elected as directors at the shareholders meeting. and . II Senior Executives In the past. 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. in particular. (ii) establishment of accounting standards for financial institutions. The commission has played an active role in introducing new rules on corporate governance. executives sometimes have the opportunity to buy company shares at favorable prices because the board of directors (CEO. but in practice is fixed and understood as part of a fixed salary. Senior managers were even often called directors although they were not official members of the board. but as of March 1999 only 27 firms actually had given stock options to their executives or employees. in practice) allocates the unsubscribed portion of new shares issued in rights offerings to executives. 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. This action was in response to calls by international investors and. Korean firms have rarely used shares for executive compensation. 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.100 Corporate Governance and Finance in East Asia. from IMF and the World Bank. Vol. and accounting standards. However. disclosure. 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.
they also have the power and duty to monitor the activities of executive directors.Chapter 2: Korea 101 (iii) establishment of accounting standards for “combined” financial statements of chaebols. 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. the internal auditor is considered to be a subordinate of the . Under the Commercial Code. The primary sources of reference in the revision were International Accounting Standards and US Accounting Standards. but 49 percent confessed that they have not followed international standards at all. 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. 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. however. they cannot be expected to discharge this responsibility because the representative director selects the internal auditor and can force him or her to resign. Only 10 percent of the respondents have followed all international accounting standards. The External Audit Act and its Decree require financial statements of corporations with total assets of W7 billion or more to be prepared and audited according to the financial accounting standards and working rules set by FSC. In practice. Korean listed companies with subsidiaries are required to compile consolidated balance sheets. Consolidated reporting was introduced before the outbreak of the crisis. Most of the companies following all or some of the international standards in the past adopted such standards before the crisis started. In the ADB survey. Thus. 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. Those that never adopted international standards show their willingness to do so once the Government introduces international standards. Internal and External Auditing The Commercial Code requires a corporation to have at least one internal auditor elected at the general shareholders meeting. The new accounting standards for financial institutions adopt the mark-to-market basis to account for securities. 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.
If the company changes its external auditor for reasons that are not listed in the relevant regulation. 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. Big Korean accounting firms are affiliated with US accounting firms. 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. The Commercial Code will be revised to allow corporations to choose from the two options: the internal auditor or the board audit committee system. and creditors selects it. the relevant laws and regulations were changed after the Asian crisis to require at least one of the internal auditors to be full time and to recommend that listed firms have outside (independent) auditors. In the past. there were many cases where external auditors failed to detect omissions and false numbers in financial statements of listed firms. The current external auditors have been associated with the surveyed companies for an average of 4. . II controlling shareholder/CEO. but since 1998 a committee consisting of internal auditors. About 100 listed firms will be subject to this requirement. underdeveloped market discipline for accounting firms. then the Securities and Futures Commission can appoint a new one. In the ADB survey.6 years. and lack of strong professional ethics in the accounting profession. Listed and registered corporations must publish financial statements audited by external accounting firms. 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 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. External auditors are selected for a term of three years. This is because the auditor. Vol. however. does not have the power to hire and fire the managers. But this problem can be mitigated if auditors function under the umbrella of the board.102 Corporate Governance and Finance in East Asia. as a monitor of management in the Korean (and also the Japanese) system. 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. outside directors. Accepting these arguments. In order to increase independence. the board of directors had the power to appoint an external auditing firm. almost all firms affirmed that the external auditor is independent from the company. this problem will largely disappear. The general organizational/social culture in Korea abhors conflict and may also have hindered effective functioning of internal auditors. Previously.
Approval of mergers and major divestitures. corporations cannot issue common shares without voting rights. attended the last annual general meeting. Citizens’ coalitions sometimes solicit proxies in order to file lawsuits against a management. 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. the Depository is instrumental in getting resolutions passed.” Companies can increase the number . The securities companies and banks are the second and third.93 percent of the shareholders but 26. No companies have so far introduced voting by mail.53 percent of the total shareholdings. A total of 326 shareholders per firm. representing 62. or 10. in general. About one fifth of the listed firms issued nonvoting preferred shares. or telephone. Under the Commercial Code.3 Shareholder Rights Voting Rights and Practices Under the Commercial Code.3. small shareholders do not attend the annual meeting and that.” meaning that it should divide its votes in accordance with the accept/reject ratio of votes cast by other shareholders attending the shareholders meeting. The above results indicate that. About 100 shareholders per firm voted by proxy at the last annual general meetings (of the 40 firms answering the relevant questions). Preferred shares can be nonvoting and issued up to one quarter of the total number of shares. amendments of the articles of incorporation require a “special resolution. charter amendments. Internet. respectively.79 percent of the shareholders. 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. This shows that a relatively larger number of shareholders send in their proxies.” The survey shows that the Korea Securities Depository holds 69. These voters represented only 5.77 percent of the shares. the Depository is subject to “shadow voting. and dismissal of directors and internal auditors require a “special resolution. However. The Depository represented 20 percent of the shares attending the meetings.Chapter 2: Korea 103 2.21 percent of total shares issued. The management is the most important proxy. A “special resolution” requires two thirds of the votes attending and one third of total votes outstanding. 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. Thus. However. for some firms.
Changes in the authorized capital require an amendment of the articles of incorporation.01 percent. Due to the changes in rules for investor protection. an activist citizens’ coalition has brought shareholder derivative suits against several large listed firms. or block charter amendments considered harmful to minority shareholders. The company also agreed to the right of the fund .5 percent. This coalition also attempted to cooperate with domestic and foreign institutional investors to find their way into general shareholders meetings. It also attended the shareholders meeting of several companies to present the views of outside shareholders. Only two out of 62 respondents to this question have had cases in which proposals were rejected. the Securities and Exchange Act was revised to lower the representation requirement for shareholder derivative suits from 1 to 0. 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. However. Those that are most likely to be rejected relate to election of directors.0 percent. Shareholder Protection Before the economic crisis. laws and regulations were generally very loose in protecting the rights of minority shareholders.104 Corporate Governance and Finance in East Asia. In February 1998 and again in March. This citizens’ coalition actively contacted the management of selected companies and negotiated measures to protect shareholders. For recommendations for dismissal of directors and internal auditors. 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. Shareholders have preemptive rights. an institutional investor based in the US. but these can be waived by an amendment of the articles of incorporation. the Tiger Fund. the annual general meeting passed a resolution that was not proposed by the management nor the board of directors but rather by shareholders. the requirement was lowered from 1 to 0. from 3 to 1. demand changes in business policy. In four out of 62 respondents. As an example. mergers and acquisition plans. The charges included self-dealing by a controlling shareholder and unfair subsidization of affiliated companies by a chaebol firm. dividend proposals. Proposals put forward by management are rarely rejected at the general meetings. II of votes required for a resolution to amend the articles. was able to force a change in the charter of SK Telecom. Various measures have since been taken to improve investor protection. Vol. and for access to unpublished accounting books and records.
These have to be disclosed under the Securities and Exchange Act or approved by shareholders under the Commercial Code and other laws. it now appears that it has backed away from its earlier efforts to introduce legislation on class action suits.3. For further protection of investors.4 Control by Creditors Role of Creditors in Corporate Monitoring Traditionally. underwriting securities firms acted also as trustees. managers were considered to be subject to the duty of care. 2. The laws and regulations of the country protect shareholders from interested transactions. . and transactions with major shareholders. bond indentures are only a few pages long compared to a few dozen pages found in advanced bond markets. In fact. As for bond issues. mergers and acquisitions. controlling shareholders have become more susceptible to liability claims by other (minority) shareholders. This was one of the most significant developments with respect to shareholder activism in the Korean capital market. the Government had for some time pushed for the enactment of class action suits on false statements and omissions in disclosure materials. The Code has also been amended to state more clearly the fiduciary duty (of care and loyalty) of the management. there was the usual conflict of interest problem and the trustee did not have the incentive to strictly enforce the covenants. The Commercial Code has a new clause that regards the controlling shareholder as a de facto director if he or she uses personal influence to affect business decisions of the management. Banks themselves were poorly governed and bank managements had little incentive to monitor borrowers. After the economic crisis. simple. However. Banks have played some limited role in monitoring the investment activities of chaebols. In 1974. Thus. The covenants in loan agreements and bond indentures were very loose. affiliated lending or guarantees. and not strictly enforced.Chapter 2: Korea 105 to recommend two directors to the corporate board. but it was not entirely clear whether they had the duty of loyalty as well. This has strengthened the accountability of controlling shareholders as de facto CEOs. Before the amendment. 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. creditors did not interfere with the management of a debtor. loans to directors.
as discussed earlier.106 Corporate Governance and Finance in East Asia. and purchases of real estate. 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 objective of the system is to improve the financial condition of the largest business groups and promote the soundness of bank management. 11 banks. Some proponents argue that creditors should have the right to send their representatives to boards of directors of borrowers. Emphasis on the monitoring role of banks has been growing since the beginning of the Asian crisis. the main banks should review the feasibility and financing plans of projects undertaken by the core companies and monitor their financial conditions and prospects. 10 nonbank . Purchase of real estate should be financed by equity capital and not by borrowed funds. The 10 largest business groups are required to select no more than three core companies in consultation with their respective main banks. However. recently banks have been increasingly interested and successful in electing former bank officers as outside directors of firms that underwent workout processes. on average. 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. 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. there have been concerns that the Government might use the system to intervene in the management of the business groups. The main bank should also monitor and restrict extension of loans to the controlling shareholder and other firms in the group. ADB Survey Results on Borrowing and Lending Practices The ADB survey shows that a typical nonfinancial company is associated with various types of creditors. Besides the setting up of an “External Auditors Committee” by firms. In 1996. In 1994 the approval requirement was abolished. Under the system. In turn. The firms subject to the system are required to get the approval of the main bank prior to purchasing real estate. II acquisitions. this proposal has only a slim chance of being accepted by the Government or legislature. However. creditors now have a bigger say in court proceedings for receivership and composition. On the other hand. Vol. including.
About 60 percent of the firms have experienced renegotiation of loan repayment with creditors during the last five years. For a small number of firms. whereas seven of the 17 nonfinancial corporations are. More than half of the firms think that creditors have no influence on their management and decision making. and purchase or supply of raw materials. Most of the 43 firms with renegotiation experience were able to borrow from the same creditors afterwards. One tenth of the firms received assistance from the Government in loan applications. The typical company has also maintained its relationship with five of the 10 NBFIs for more than five years. Breakdown of loan guarantors is as follows: about 40 percent of loans are without any guarantees. For more than half of such firms. Creditors usually exercise their influence through covenants relating to the use of loans. The assistance came from. Most firms feel that requirements for collateral have been tightened since the crisis started.Chapter 2: Korea 107 financial institutions (NBFIs). most frequently in the form of loan guarantees and less frequently by arrangement of guarantees by a third party. Among the creditors. The borrower’s relationship with most banks has lasted for more than five years. 35 percent are guaranteed by the company itself (by collateral and purchase of guarantee insurance). or creditors filed for receivership. When loans could not be repaid on time. and 17 nonfinancial corporations. About half of the respondents received assistance from other sources in the form of loan guarantees and/or provision of collateral. while a third think that creditors have weak influence. With respect to the types of loans. holding shares of another company by both the borrower and the guarantor. banks are most likely to require collateral. collateral is more likely to be required of loans for working capital than for fixed investments. renegotiation took place after the crisis. subsidiaries. payments were usually rescheduled through negotiation without any penalty. Relationships with affiliated companies providing guarantees or collateral include ownership of each other’s shares. or through their shareholdings. and other financial institutions. penalty was involved in rescheduling. controlling shareholders. Most of the financial institutions are not affiliates of the borrowing company. NBFIs infrequently ask for collateral. collateral was taken away. A few creditors exercise influence through covenants relating to major decisions by the company. Only a few feel that creditors have very strong influence. 16 percent . in order of importance: affiliated companies. mutual guarantee agreements. holding companies.
Separate from but emulating the CRA. 2. Under a contract signed between the creditors and the debtor. and in continued monitoring of debtors. 4 percent by subsidiaries. especially banks. 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 . 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.108 Corporate Governance and Finance in East Asia. and 1 percent by the Government. The new ways through which creditors. Vol. The leading creditor banks will continuously monitor the progress in implementing the signed Plans.3.5 The Market for Corporate Control Government Policy Toward Hostile Takeovers Until 1994. the Korean Government maintained a policy of protecting the incumbent management of listed companies. including commercial and merchant banks. banks and other institutional lenders are playing more important roles than ever before. are summarized below. This committee was set up in accordance with the provisions of the CRA. a Lead Creditor Council Agreement was signed for restructuring the top five chaebols. will get involved in the restructuring and workout processes. This agreement will provide guiding principles in coordinating diverse interests among creditor institutions and promoting cooperation. the creditor banks will send a delegation composed of bank officers to the workout firm to oversee its management. Role of Creditors in the Corporate Restructuring Process In the current process of business restructuring and workouts of an unprecedented number of firms under financial distress. major creditors. In this connection. have been the driving forces for restructuring activities of the largest 64 chaebols. 2 percent by holding companies. II by other affiliated companies. Behind these new strengthened roles of creditors is the newly set-up FSC. Second. the lead creditor banks formally signed Capital Structure Improvement Plans with chaebols. the Corporate Restructuring Coordination Committee (CRCC) will provide arbitration. Third. the main vehicle for implementing the workout concept (or the London Approach) is the Corporate Restructuring Agreement (CRA) signed by 210 financial institutions in July 1998. First.
The reasons for failure are diverse. more than half of these attempts failed. 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). a total of 13 hostile takeover attempts occurred. Takeover Activity As soon as the Act was amended. Privately placed CBs cannot be converted into shares in one year. Poison pills cannot be used mainly because companies cannot distribute stock options as dividends to shareholders. corporations cannot limit the voting rights of large shareholders to a given maximum. Limits on acquisitions of shares of a Korean firm by a single investor were gradually increased over a six-year period beginning in 1992. but were completely eliminated in 1998. The shareholders already owning more than 10 percent at the time the company went public were exceptions to the rule. it can be safely stated that Korea now has one of the most accommodating capital markets with respect to hostile takeovers in the region. As far as institutional arrangements are concerned. For takeover defense. Companies have also utilized share repurchases. Publicly issued CBs require three months before their owners can convert them to shares.Chapter 2: Korea 109 unless he or she obtains prior approval of the Securities and Exchange Commission. Between 1994 and 1997. In one case. turning to white knights. Korea does not have the mandatory takeover rules applying to those who amass more than 30 percent of the shares outstanding (until 1998. . 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. Unlike the UK. the outside shareholders did not want to sell shares because the share price went above the offer price due to a share repurchase by the target and anticipation of a competitive bid from a third party. The incumbent controlling shareholders used various tactics such as issuing privately placed CBs. Unlike Germany. 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. However. In the early 1990s the Government shifted its policy toward freer activities in the market for corporate control. hostile takeovers by tender offers began to appear in the capital market. A company cannot issue new shares to a third party without first amending the corporate charter. Stock purchases by tender offer were also exempted. listed firms rely mainly on shareholdings by the largest shareholder. and announcing competitive tender offers by the controlling shareholder.
Hostile takeovers in Korea will be rare in the future. 2. Another reason is that many listed firms belong to chaebols. In 1998. For the steel company.110 Corporate Governance and Finance in East Asia. Currently the limit is 3 percent. Golden parachutes are almost unknown in Korea because the total amount of director compensation has to be voted on at the general shareholders meeting each year. the Government became the largest shareholder of several commercial banks through equity participation purporting to recapitalize them out of financial distress. Korea Telecom. a steel company.7 percent on average as of the end of 1997 for nonfinancial listed firms). are designated as public companies. 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. 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. and a bank had government ownership. For the others. In their charters.6 Control by the Government State-Owned Enterprises Government ownership of listed companies is very limited. As of the end of 1997.3. the limit will be eliminated when it is fully privatized in two years. some firms have included a supermajority provision for the dismissal of directors and provided for a staggered board. It is harder now to find such firms. The Government-owned listed companies. an electric power company. . One reason is that the percentage of inside shareholdings (by the controlling shareholder group and the firms under its control) for an average listed firm is very high (26. in which the Government still holds the largest ownership. 172 firms (or 22 percent of listed firms) belong to the 30 largest chaebols. Charter amendments have also been employed by some firms to limit the maximum number of directors. Many of the takeover targets in the past did not have a controlling shareholder (group). was newly listed. Some had two or more large shareholders who had joint control of the firm but could not cooperate. 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. As of February 1999. In 1999. except for the banks. which are allowed by the Securities and Exchange Act to set the limit on the ownership of shares by one single shareholder. Vol.
This was aimed at limiting the supply of bonds thereby stabilizing interest rates. 2. The objective of the system was to improve the financial condition of the chaebols and to promote the soundness of bank management. But this rule. It was abolished before the economic crisis but another regulation. nominated by the minister in charge of the company in question. which limits the total amount of bonds issued by the five largest chaebols. The Government’s right to send public officials to the boards was eliminated. The Government has frequently imposed restrictions on the use of capital markets by large companies. 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.3. especially those belonging to chaebols. 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. was amended in 1997 to introduce a board structure consisting of a majority of nonexecutive directors. controlled the total amount of corporate bonds issued per month and allocated amounts to individual corporations. went into effect in 1998 to prevent them from absorbing too much of the funds available in the market.Chapter 2: Korea 111 The Government used to appoint a few public officials to the boards of state-owned corporations.1). as applied to four large corporations. In addition. only qualified firms could issue new shares. is being applied to the 51 largest business groups to which the banks extended more than W250 billion in loans and payment guarantees. Labor is not represented in corporate boards. There were also limits on the amount raised and the number of issues per year.7 Employee Participation in Corporate Governance Employee participation in corporate governance is very limited. administering through a self-regulatory committee of the securities industry. Even where employees hold . Beginning in 1999. more state-owned corporations became subject to this new board structure. For example. the main bank system. which was introduced in 1996.3. the Government. The nonexecutive directors are now recommended by a committee. Meanwhile. There is no active debate or discussion going on about this potentially difficult issue. Further. and approved by the Chairperson of the Planning and Budget Commission.
and development of the company. II shares of their companies through employee stock ownership plans. in principle. union members account for 54 percent of the employees. and 66 percent manual workers. 32 percent technicians and professional staff. there are two federations of labor unions. The union had no influence on the management in 17 percent of the firms. Collective bargaining is.654 employees per firm on average. Under the Labor Management Council Law.9 in 1980. Local unions in the same industry have established industrial labor federations. Vol.5 in 1990. 2. The percentage of shares held by the employee stock ownership plans in listed companies was 1. Trade unions are organized on an enterprise basis. of which 2 percent were senior managers. At the national level. 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. Under another law enacted in 1972 to induce private companies to go public. Employees of companies have had the opportunity to buy shares of their employing businesses at favorable prices. operation. these firms have to offer 20 percent of the shares being issued to their employees at the public offer prices. they delegate their voting rights to plans’ representatives. Under the Capital Market Development Act of 1968. This law is not intended for wage negotiations but for employers to seek cooperation and productivity increases from workers. About half of these firms considered the influence of the union on the management of the company to be weak.1 in 1997. but 27 percent of them felt that it was strong. 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.112 Corporate Governance and Finance in East Asia. the management usually consults the union on major issues relating to the management. In actuality. In these firms. the council meetings have been superficial. In 1987. carried out at the enterprise level. Two thirds of the respondents had an organized union. employers are required to meet with representatives of labor unions at least once every three months. The typical collective bargaining agreement has a one-year duration. employees of listed firms issuing shares through rights offerings are entitled to 10 percent of the rights. The relevant regulation was amended recently in order to facilitate voting by individual employees. In 70 percent of the firms with organized unions. The respondents of the ADB survey had 2. This practice may be due to the fact that employees are typically submissive to their employers and that their total shareholdings are minimal. and 2.
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
was liberalized drastically in 1998 after the financial crisis. development of the money market. opting to bring in the plan step-by-step to avoid market dislocation from a sudden shift in the system. which resulted in the establishment of a number of new banks. the Korean Government announced its Financial Liberalization and Market Opening Plan. the business scope of financial institutions was greatly widened from the early 1980s. Also. Vol. revision of the credit control system. entry barriers to banks and NBFIs were lowered in an attempt to promote competition. II Interest Rate Deregulation Plan. Korean firms have been allowed to issue CBs in international financial markets. On the basis of flows of funds.118 Corporate Governance and Finance in East Asia. Moreover. It included such important issues as interest rate deregulation. the required reserve ratio was substantially lowered from an average of 23 percent in 1979 to 3. The plan was launched partially to accommodate US demands for comprehensive structural deregulation and market opening of the financial sector.2 Patterns of Corporate Financing Corporate Financing Practices In this section. and liberalization of foreign and capital transactions. flow of funds analysis was used to examine patterns of financing of the aggregate corporate sector. In June 1993. short-term finance companies. etc. as a first step toward liberalization of capital account transactions. . In addition. The Government handed over its controlling stakes in four commercial banks to private hands in 1981-1983. The Government adopted a cautious approach. and the 30 largest chaebols. finance companies. With the privatization of nationwide commercial banks. The Government began to considerably deregulate foreign exchange in 1987 due to the shift of the current account into surplus in 1986 (see 2. Internal funds include retained earnings. Some policy loans were also abolished. especially the domestic bond market. The capital market. the Government announced a plan in 1981 that substantially improved foreign investors’ access to the domestic capital market.5 percent in November 1981. listed companies. the Government simplified various directives and instructions regulating personnel management. Since 1985. budget. 2.4. depreciation. and organization of commercial banks. mutual savings. implementing the first stage in November 1991. Meanwhile.1).2. the following measures can be constructed: Self-financing ratio (SFR) is the ratio of change in internal funds to change in total assets.
but it remained less than 10 percent of total financing. Equity capital represents the shareholders’ commitment to the business.26 shows the four measures of corporate financing calculated from Table 2.Chapter 2: Korea 119 and net capital transfers from the Government. depreciation. capital surplus. Before 1988. and 1997. The corporate sector used . particularly in the short term. Meanwhile. In 1988 when the stock market boomed. This means that internal funds after dividend payment were insufficient to finance growth in total assets. but do not include capital surplus (asset revaluation allowance and the excess of current value over issue value of stock). the corporate sector’s most important source of external finance was bank borrowings. including all sources other than retained earnings. the proportion of foreign borrowings in total finance rose steadily. except for the stock market boom of 19871988. Incremental debt financing ratio (IDFR) is the ratio of change in total borrowings to change in total assets. The SFR averaged 28. The share of external financing. Table 2. In securities finance. Incremental equity financing ratio (IEFR) is the ratio of change in stockholders’ equity to change in total assets or 1-IDFR. and government transfers. particularly in the 1990s in response to the liberalization of the capital market. depreciation. 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. 1994. and allowances) and new equity capital. financing by corporate bonds and CPs was more significant than by new equity.25. It measures the degree of financing growth in total assets by additional debts. the proportion of borrowings from NBFIs fell to its lowest value at 4 percent. Securities finance became a more important source from 1988 onwards. Financing Patterns of the Aggregate Corporate Sector Table 2. on average.4 percent in the precrisis period 1988-1997. It measures the degree of financing growth in total assets by additional equity. was 71 percent during the period. Additional equity capital used to finance growth reduces the financial cost and the financial risk of investment. comprising internally generated capital (retained earnings. except in 1991. New equity financing ratio (NEFR) is the ratio of change in equity (stocks issued + equity other than stocks) to change in total assets.25 shows the flow of funds of the nonfinancial corporate sector in Korea during 1988-1997. This high proportion deprived Korean businesses of flexibility during recession periods due to high financial costs.
2 10.8 1.5 16.2 13.6 11.8 15.0 11.0 0.7 12.6 11. 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 73.1) 6.4 27. 1994.7 1.25 Flow of Funds of the Nonfinancial Corporate Sector.5 0.6 0.1 8. . Bank of Korea. b Includes capital surplus.7 4.8 56.7 15.8 0.1 1.7 8.1 17. a Includes retained earnings.1 (0.4 1.3 3.1 (1.7 6.9 34.7 10.1 0.2 — — — — 9.3 6.4 2.1 1. depreciation.1 3.6 4.3 6.5 0.7) 11.6) 5.6 4.6 9.4 10.0 9.3 10.0 70.8 1.8 17.0 1.7 14.6 14.4 (2.3 5.8 -2.2 6.4 9.3 1.6 2.8 4.7 — — — — 9.6 1.6 77.9 10.5 2.4 2.7 7.7 11.3 30.1 72.1 3.7 2.1 0.4 8.6 0.7 32.4 (0. Bank of Korea.4 21. Source: Understanding Flow of Fund Accounts.4 1.2 13.5 16.6 25.2 34.7 (0.4 71.7 1.4 0.8 8.3 1.5 2.7 4.6 Sources of Funds Internal Financinga External Financing Bank Borrowings Banks Nonbanks Merchant Banks Insurance and Others Securities Natl.8 30.4 27.3) 15.6 10.0 16.1 10.6 0.2 5.2 1.0 17.2 26.2 0.4 3.6 (0.3 6.5 0.4 27.1 1.7 8.1) 4.3 3.0 9.6 3.9 9.0 3.8 1.9 10.0 3.7 1989 1990 1991 1992 1993 1994 1995 1996 22.1 36.1 23.0 10. and Flow of Funds.1 — 27.3 16.0 — — — — 8.9 0.4 2.1 2.5 9.2 — 28.9 38.3 1.2 2.4 2.4) 13.6 0.Table 2.1 3.7 2.7 10.5 13.8 1.2 6.4 0.2 15.3 25.0 1997 26.9 73.9 28.5 2.6 4.0 3.1 — — — — 12.0 0.3) 11.7 71.0 2.3 — — — — 8.8 27.8 (0.5 2.0) 12.5 29.4 11.7 10.0 22. 1988-1997 (percent) 1988 43.3 72.3 2. and net capital transfers from the Government.2 (0.9 2.7 13.8 1.4 — 28.2 14.3 27.0 (0.1) 4.9 72. which is the excess of current value over issue value of stock.1 2.6 8.3 — 30.1 12.9 6.1 27.4 15.6 5.7 2.6 9.6 3.0 5.7 14.6 9.8 — 26.
9 22.8 10.3 12. Source: Calculations from Understanding Flow of Fund Accounts.1 percent in 1988 during the stock market boom. Its IEFR and NEFR dropped to 23.6 26. and IEFRs were declining.4 27.7 40.3 11.8 percent of its total asset growth through debts.7 40. 1988-1997 (percent) Year 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 Average a SFRa 43. but also continuously fell.6 percent over the 10-year period. While SFRs.5 percent in 1997.2 percent of the growth in total assets. In periods of high economic growth such as in 1988.27).3 percent in 1997.5 68. IEFR ranged from 32 percent to 64 percent of asset growth during the boom years.7 28.3 27.4 IEFR 63.9 28.6 Excludes capital surplus. but plunged to 5. respectively.5 percent.5 12.9 60.8 28.4 percent (Table 2. Incremental financing from equity was 40.6 62. and the total debt ratio was much higher in 1996 and 1997 at 62. higher than the aggregate 28. 45.1 12. an average of 59. It dropped to 28 percent the following year.6 percent. Manufacturing financed 54.9 percent by 1997 when net profit margins were negative. Across industry.9 46.0 11.2 IDFR 36.1 26.5 and 76.7 percent in 1997.5 31. The balance.4 NEFRa 20.7 26. the corporate sector relied heavily on external financing for its expansion.0 42.4 percent. was financed by additional debts. NEFR registered 20. Bank of Korea.4 37.0 57.3 60.4 12.3 59.26 Financing Patterns of the Nonfinancial Corporate Sector.7 9. There were significant time trends. indicating a high financial risk position. Bank of Korea. NEFRs.2 percent of incremental asset growth was financed by equity.3 73.6 percent. dropping to 26.8 62. and Flow of Funds. Lower income diminished the industry’s equity position toward crisis year 1997. higher than the aggregate 40.Chapter 2: Korea 121 Table 2. On average.0 5.6 percent and 1. respectively.2 37. 1994.1 39.1 53. IDFR reached 73. average SFR was 37. SFR peaked at 44 percent.0 27.7 30.3 59.1 17.4 percent. additional equity to finance 12. .7 40. declining to 26. in the manufacturing sector.
and hotels sector and realty/renting/business activities sector were similar.6 54.4 37.5 NEFRa 9.4 63.7 37. In 1997.2 21. then increased to 20. II The construction industry showed the most cyclical pattern in annual asset growth. the proportion of short-term borrowings in total financing has been high. which decreased to 8.3 52.8 50. their average SFR was higher. Categorized according to company size.4 47. Since 1992. this dropped further to 15.6 37.0 3. gas.0 57. one year ahead of the other industries. Equity financed an average 25.6 3. These sectors had relatively low equity financing ratios and high total debt ratios in financing asset growth between 1988 and 1997.5 7.6 37.6 45.4 45.2 62. It had the highest average SFR in 1988 at 31.7 47.5 23. large firms showed more cyclical patterns in these financing ratios than small.7 47.8 percent in crisis year 1997.9 6.9 IDFR 34.1 percent of total asset growth for the period. Total debt financed an average 74. Financing patterns of the wholesale.2 percent in 1993.8 4.2 5.4 46.7 37.0 30. retail.0 42. and low total debt and short-term borrowing ratios.6 4. explaining partly the collapses of several construction companies in 1995.5 1.1 29.6 62. the utilities (electricity. from 17.8 percent in 1990.7 percent in 1996.122 Corporate Governance and Finance in East Asia. and communication sector had relatively high incremental equity ratios.5 76. On the other hand.2 3. and fell to about 10 percent in 1997.2 . Since large firms were more profitable.6 36. with the total debt ratio much higher in 1995-1997 at 82 to 84 percent.8 IEFR 65.and medium-sized firms.9 percent of asset growth.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 50.6 53.3 28. and steam) and the transportation. Vol. the two sectors also had low equity financing ratios and high debt financing ratios.0 42. storage.6 53.9 percent.4 54. Table 2.4 3.
8 29. and Communication 1988 64.9 30.3 57.0 1.4 62.5 1993 22.2 10.9 20.9 9. Hotels 1988 33.9 52.4 2.5 1996 42.8 70.7 1989 26.2 29.27 (Cont’d) Year SFRa NEFRa IDFR 53.9 1.3 10.1 84.6 2.3 84.0 17.0 34. Storage.7 15.6 14.9 Average 19.1 66.7 1994 53.7 78.9 29. Household Goods.7 41.5 12.4 26.0 4.7 6.2 18.8 1991 51.0 3.3 47.9 2.8 25.2 46.3 7.2 74.9 15.9 1989 63.5 1.9 1.0 .9 1993 63.0 65.3 4.0 82.8 4.8 76.1 25.7 7.9 80.1 Trasport.6 71.5 23.9 16.6 9.6 37.8 81.2 4.2 Average 53.7 Wholesale/Retail Trade.6 8.4 1995 53.3 1996 16.0 1990 50.2 70.6 9.Table 2.0 1990 12.8 1994 15.0 74.1 69.9 33.9 1992 56.0 0.5 20.7 15.3 4.1 59.2 23.9 1.6 4.0 60.0 68.0 10.3 19.5 29.6 7.4 IEFR 46.8 2.6 8.6 73.7 1997 8.7 80.6 37.3 8.0 40.1 4.5 76.2 5.2 20.9 Construction 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 Average 31.8 9.1 70.2 25.4) 2.2 3.5 87.1 1991 14.3 (9.7 78.5 70.0 31.8 74.2 1995 16.9 47.2 8.7 53.6 1997 29.0 1992 24.7 42.5 62.4 28.8 54.5 21.1 19.3 21.
.3 207. IEFR = incremental equity financing ratio.9 57.9 29.and short-term borrowings of these firms shot up in that period.8) 7. and Business 1988 51.9 65.1 34.3 7. however.4) 3.1 0.6 7.8 1993 11.1 1989 34.5 22.2 1992 18.7 1994 8.3 81.7 37.5 8. when large firms had much lower equity financing ratios and higher debt financing ratios than small.9 Average 75. The trend was reversed in 1996-1997.1 42. Gas.0 1997 24.0 21.0 33.6 1995 17.6 1991 18.1 70.3 29. and Steam Supply 1988 118.9 45.1 35.4 1994 72.8) (35. Renting.0 56.4 0.0 0.0 46.7 18.8 17. NEFR = new equity financing ratio. a Excludes capital surplus.4 1.0 43.4 5.3 Electricity.6 52.6 1990 82.1 1993 55.6 1. Their average IEFR was also higher and IDFR smaller.4 0 0 0 0 1.3 62.7 70.7 1996 18. Source: Calculated using data from Bank of Korea.6 Real Estate. Long.and mediumscale firms.1 54.4 (107.0 53.9 64.8 135.0 79.4 IEFR 69.1 71.3 31. The large firms had a higher proportion of external financing in 1996-1997.27 (Cont’d) Year SFRa NEFRa 6.7 14.0 0.7 69.1 1991 56.3 85. Higher growth in total assets and sales and easier access to debts by large firms could be reasons for this.3 92.4 1995 62.2 63.6 1997 23.0 (0.9 28.0 67. II Table 2.8 1990 19. Financial Statement Analysis Yearbooks. Vol.0 1.9 IDFR 31.3 3.8 36. SFR = self-financing ratio.8 Average 22.4 7.4 1996 45.4 47.6 1989 118.6 IDFR = incremental debt financing ratio.124 Corporate Governance and Finance in East Asia.0 1992 51.5 77.
All of the top 30 chaebols relied heavily on short-term borrowings.5 percent and their total external financing.8 percent of their total finance in 1997.6 percent of total asset growth. the average SFR was 28. In 1997.7 percent. The average IEFR and IDFR were 10. Financing Patterns of Chaebols For chaebols. compared with the entire corporate sector’s 35 percent and 65. and using cross-payment guarantees among affiliated companies. The proportion of their short-term financing averaged 72.9 percent. In 1996-1997.7 percent for all listed companies. for listed companies. and higher than that of listed companies (Table 2. respectively. but higher than that of listed companies. They had easier access to bank loans and the markets for corporate bonds and CPs than nonlisted companies. about the same as that of the corporate sector as a whole. the top 6-10 chaebols. at an average 70.6 percent.7 percent. The debt financing ratio of listed companies was high since they relied more on external financing. the top 11-30 chaebols had the highest guarantees commitments at 207. They were able to borrow easily from banks by issuing corporate bonds and CP. 91.5 percent is lower than that of the corporate sector in general.30).3 and 89. Their shortterm borrowings accounted for 86. 153.4 percent. The average IEFR of the top 30 chaebols of 29. The chaebols’ drive to expand their empires resulted in heavy borrowings. External financing reached 94.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 2.28). compared with 89. the NEFR of the top 30 chaebols plunged while the debt ratio increased substantially.29). Many firms affiliated with the top 30 chaebols saw loan guarantees turn into their own debts because of defaults in debt payments.9 percent. Cross-payment guarantees have been declining since 1993 and reached 91. In 1997.1 percent of their equity capital. The largest borrowers were the top 11-30 chaebols. the lowest ratio of 58. and were large borrowers. .2 percent. the IDFR of listed companies increased to 93. and the top five chaebols. Another key feature of corporate finance in Korea is the widespread use of loan guarantees among the top 30 chaebols.8 percent. Group-member firms borrowed less.3 percent of their equity capital in 1997 (Table 2.
.6 61.7 12.3 Year 1994 1995 1996 1997 Average a Excludes capital surplus.9 6.2 1.9 NEFRa IEFR 14.4 1.1 93.5 2. Source: Calculated using data of Seung No Choi.5 Year 1994 1995 1996 1997 Average a Excludes capital surplus.2 36.7 1.5 2.6 1.8 76.3 5. Table 2. 1994-1997 (percent) SFRa 41.7 13. Korea Federation of Industries.3 IDFR 57.6 70.4 38.6 IEFR 42.3 1.6 0.9 7.5 8.Table 2.2 NEFRa 1. 1994-1998 (percent) SFRa IDFR 85.2 23.4 12.3 86.29 Financing Patterns of the Top 30 Chaebols.3 28.8 89.1 1. Source: Calculated from data obtained from data files of the Korea Listed Companies Association.4 29.2 10.5 8.5 91.8 22. Largest Business Groups in Korea.6 11.1 8.4 88.28 Financing Patterns of Listed Companies.
Factors Influencing Corporate Financing Choices Until recently. loans from banks. more than half of bank loans were priority loans with low interest rates. . in order of ranking. rights issues. company preferences in financing investment projects before the crisis were.9 — — — 1996 105.3 58. the Korean economy was plagued with high inflation. so that the firms engaged in lobbying to gain access to them.7 150. Fourth.1 — = not available. bond issues. chaebols could easily borrow funds from banks and NBFIs by using cross-payment guarantees. Source: Fair Trade Commission and the Federation of Korean Industries. Interest payments on debts were considered a loss when calculating taxes.9 — — — 1994 258. the Government provided implicit guarantees on bank lending and large businesses.9 153. and loans from NBFIs. There were several reasons for this. Third.0 207. bond issues. Korean firms preferred debt financing (bank and nonbank borrowings). According to the ADB survey.Chapter 2: Korea 127 Table 2. Few firms ranked loans from NBFIs as their first preference. poor financial and corporate governance resulted in overlending by banks. the Government applied high tax rates on net profits of corporations.1 — — — 1995 161. Further. This attitude appears to have changed after the crisis because reserves and retained earnings and rights issues became the preferred financing choices. and reserves and retained earnings. Second. And fifth. This change implies that firms now give more attention to financial risks.3 200. especially in the 1970s when real interest rates of bank loans were negative. These are followed by loans from banks.0 1997 91. First. 1993-1997 (as percentage of equity capital) Rank Top Top Top Top 30 Chaebols 5 Chaebols 6-10 Chaebols 11-30 Chaebols 1993 469.30 Cross-Payment Guarantees of the Top 30 Chaebols. and underdevelopment of the stock market. Financial institutions did not strictly screen their loan projects and monitor their debtors. inefficient investment and excessive diversification of corporations. Firms now prefer internal funds and new equity capital.3 64. and extended loans based on cross-payment guarantees. Controlling shareholders usually tried to avoid dilution in their shareholdings for fear of losing control.
This preference has changed little after the crisis. many firms (or 42 percent) never considered hedging. The most important reasons why they chose to borrow foreign currency denominated loans were that terms of foreign loans were more favorable and/or these loans were considered cheaper. The percentage of foreign currency denominated loans hedged against exchange rate risks was 21. and others (29 percent) expected the local currency to appreciate in value. About half of the respondents of the ADB survey borrowed foreign currency denominated loans from foreign banks.4.36 percent on average for these companies. even with a heavy debt burden. Nonetheless. Among those that never hedged against exchange rate risks. in selecting financing sources. 2. According to the survey. Only a few firms sought foreign loans because domestic loans were not available. they survived for two to three . some (36 percent) thought that a hedging facility was not available or not working properly. Korea now provides a better environment for financial risk management. Among the responding companies that had foreign currency denominated loans.5 percent at the end of 1997. Diversification. maintenance of the existing ownership structure. Few companies felt that hedging was too costly or was unnecessary as the exchange rate was considered fixed. more than half (53 percent) hedged against exchange rate fluctuations. For these firms.128 Corporate Governance and Finance in East Asia. and futures and other financial derivatives. the percentage of foreign currency denominated debt in the portfolio was 14. A futures exchange launched in 1999 trades foreign exchange options. the majority (60 percent) of the firms responding to the ADB survey look first for nonaffiliated financial institutions. in order of importance. ensuring the liquidity of the company. Other factors include.3 Financial Structure. II In seeking external financing. and reduction in tax burden. Vol. 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. firms give their first consideration to minimization of transaction and interest costs. These survey results indicate that many companies were not very attentive to exchange rate risks (and possibly to financial risks in general).
.13). but the ratios of independent firms were much lower.. The ratios of the top five chaebols were similar to those of the top 6-70 chaebols until 1991 when the top five chaebols’ ratios shot up. the top five chaebols and the top 6-70 chaebols had similar ratios. (1999) compared the financial positions of 504 chaebol affiliates and non-chaebol independent firms during the period 1986-1998. the ratios of nonchaebols were remarkably higher than those of the top 670 chaebols during the entire period. 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. Among the main findings were the following. Interest coverage ratios of non-chaebols were higher than those of the top 6-70 chaebols during the entire period. In order to determine the relationship between financing patterns and corporate performance. (iv) In terms of EBITDA to total assets. except in 1991. (iii) Interest payment coverage ratios are calculated as operating earnings over interest expenses. Nam et al. the trend was reversed in 1993 when the interest coverage ratios of the top five chaebols exceeded those of the independent firms. Table 2. However. But since 1992. The ratios of the top 6-70 chaebols were lower than those of the top five chaebols.3. These findings indicate that independent firms have had a lower leverage and performed better financially. 1999). as well as lax financial supervision (Nam et al.2. (i) In terms of total borrowings to total assets. the ratios of independent firms were higher than those of the top five and top 6-70 chaebols during the entire period. Operating earnings are earnings before interest payments and taxes plus depreciation and amortization (EBITDA). They were also higher than those of the top five chaebols until 1991.Chapter 2: Korea 129 years before collapsing at the time of the 1997 financial crisis (2. except in 19931995 when semiconductor prices were extraordinarily high. (ii) In terms of net income to total assets. Those firms whose interest payment coverage ratios are below 1 are likely to go bankrupt. the top five chaebols’ ratios were much higher. They were also higher than those of the top five chaebols until 1992.
The diversification of chaebols under workout was much lower than that of the top 6-30. debt guarantees for free.5 The Corporate Sector in the Financial Crisis This section looks at the various causes of the crisis in 1997. the top 6-30 and 31-72 chaebols gradually increased their diversification beginning 1990. its profit rate declined. the top five chaebols outperformed the top 6-30 chaebols for most of 1985-1997. Factors related to weak corporate governance were closely intertwined with shortcomings in macroeconomic policy and vulnerabilities in the financial sector. larger research and development expenditure. the degree of diversification was highest in the top five chaebols. and composition was lower than that of the top 6-30 but higher than that of the top 31-72 chaebols on average. and lowest in the top 3172 chaebols. court receivership. 2. except in the recession years of 1996-1997. Indicators such as increasing debt-to-equity ratios. The more diversified top five chaebols performed better than the less diversified top 6-30 because they were better established in most business areas and have superior personnel and technology. The differences in the degrees of diversification among the three groups are substantial. But the net profit margins of the top 31-72 chaebols were higher than those of the top five in 1985-1992. The degree of diversification of chaebols that fell into default. II Corporate Performance and Diversification As a chaebol further diversified into nonrelated areas. net profit margins of the top 31-72 chaebols were always higher than those of the top 6-30. or outright transfer of resources due to poor corporate governance practices. rising nonperforming loans (NPLs) and falling . Their subsidiaries. In terms of the net profit margin (the ratio of net profits to sales revenue). This indicates that excessive diversification and inefficient investment of the top 30 chaebols resulted in relatively low net profit margins (Table 2. During 1985-1997. and easier access to cheap credit.31). second highest in the top 6-30. however. then declined to levels lower than those of the top five in the years of economic downturn 1993-1997. Meanwhile. The diversification of the top five chaebols remained at about the same level within the period.130 Corporate Governance and Finance in East Asia. had a significant role. too. had easier access to credit than the top 31-72 chaebols. Government intervention. Vol. Chaebols have been subsidizing new or low-profit industries by transferring resources from high-profit industries through inside dealings.
1) 0.6) 0.6 0.7) (1.8 1. Source: Whan Whang.3 1.1) 2.3) 0.0 (0.0) (0.1 0.5 (0.2 1.4 (1.2) (13.0 4.0) 0.4 1.3 0.3) 0.9) (9.8) (3.6 0.3) 0.8) 0.0 1987 1.2) (13.1) 1.3 (0.5) (7.9 8.2) (4.1 1.6) (20.5 1.4 (2.5 1.7 0.0 1.2 (0.6 1.8) (11.3 0.3 1. Management Research Institute.3 1.1) 0.5) (1.8) 1.3 1.5) 0.7) 0.0 0.8 0.7 1.5 1.7 1.3) (1.8 0.3 (0.1 0.4 1.6 (0.9 0.4) (0.7 0. Court Receivership.2 (0.4) (1.6 1.6 0.2) (4.2) 1.2) (0.2 4.7) (0.1 (3.5 2.9) 0.4) (4.0) (3.3 0.4 0.0) (0.8) 0.4 0.7 (1.4 2.9) (1.4 0. Background and Task of Structural Adjustment.0 (2.3 1.Table 2.8 3.5 (4.2) (0.3) 0.3) 1.8) 0.6 (10.8) (4.8) 0.0 1992 1994 1.1) (1.4 1996 0.3 (0.3 0.9 (0.0 1.9 1.1 4.9) (8.8 1.1) (5.2 1.6) 0.1 0.6 0. Beyond the Limit.6 1989 1.3) 0.6) (0.5 0.2) 1.8) 0.8 1990 0.7 0.3 1.3) 12.6 1.7) (0.2 1.9 1.0) (4.4 1.6 0.4) (1.2 1.2) 0.8) (1.6 0.7 0.2 (0.3 1.9 1.7 (0.4 0.8 (0.6 1.1 0.1 0.3 1.2 1.6) 0.3) (0.4) (2.0) 0.8 (0.3) 1.1 0.5 1.5 (0.3 3.1 1.3) 0.9) 2.2 1995 3.0 6.6 0. 1985-1997 Item Top 5 Hyundai Samsung LG Daewoo SK Top 6-30 Top 31-72 Default.6 0.9) 2.1 (4.2) (4. Chung Ang University.1 (4.1 (1.4 (1.2) 1.2) 2.5 4.6 (0. 1998.9 1.6 5.1) 1. and Reconciliation Kia Jinro Hanbo Sammi Newcore Haitai Chungku Kukdong Daenong Halla Workout Target Kuhpyong Kangwon-sanup Pyuksan Sinho Tongil Kohap Sinwon Anam Donga 1985 1.1) (6.7) 0.6 7.5 1. p.5) (2.2) (3.8 0.8) (20.4) (6.4 (0.1 1.8) (0.2 (1.8 0.4 (1.9 0.3) 0.8) 1997 0.3 1.4 (0.6 1.4 1.6 3.6) (0.31 Net Profit Margins of Chaebols.3 (0.1) (1.6) 0.1) — = not available.5 (6.7 2.1) (2.1 1.1 2.2 1.1 1.8) (37.8) (1.7 3.9) 2.1) 2.1 0.5) (0.4) (1.0 (7.5 (0.7 1.0) 0.3) (0.8) 2.1 (9.3 1.2) 2.7 (0.7 — (0.9 0.7 0.2 (0.8 3.1 1.7 (4.11.3 0.1 (0.1 0.1 1.6) (12.5) (2. .4 (0.0 0.7 0.1 0.3) (12.2 0.3 1.8 0.9 0.6) (12.7 1.8 (0.5 (0.2 (17.3 (3.
132 Corporate Governance and Finance in East Asia. and to the development of the market for corporate control. A remote trigger in the Thai crisis was all that took to push the economy over the edge. the Korea Stock Exchange introduced listing rules requiring that listed firms elect “independent outside directors” to comprise not less than a quarter of the board members. They were then almost automatically elected at the general shareholders meeting. Until 1997. this has led to entrenched management. after the crisis. Thus. Now. Along with government policies to protect the status quo. the recently adopted Code of Best Practice in Corporate Governance recommends the strengthening of the board system. .1 Weaknesses in Corporate Governance Concentration of Ownership and Entrenched Management Concentration of ownership has been the root cause of many problems related to corporate governance. Internal and External Control Concentration of ownership has been and will be the major obstacle to the independence of the board of directors from management. internal auditors cannot be expected to perform their function independently of 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 independence and objectivity of the external auditor were often questioned. the boards of all listed companies were composed of insiders only. 2. a committee composed of internal auditors. The most serious problem among most Korean listed firms has been that a controlling shareholder acting as CEO could never be replaced. Thus. But in 1998. The hold was tightened by the practice wherein candidates for directors were handpicked from among the managers by the controlling shareholder. Moreover. outside directors. Vol.5. and creditors should select (recommend) the external auditor. Ownership concentration also had ramifications on corporate transparency. Until 1997. Meanwhile. a firm’s board of directors had the power to appoint an external auditor. II corporate profitability were signs that the Korean economy had reached the edge of a slippery slope. 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.
when a large diversified chaebol. participated in the stock market as short-term traders rather than long-term investors. The purpose was to increase the size of the stock market by having financially sound private firms go public with an assurance that they would not be taken over. Many changes were introduced to promote M&A in the 1990s. profitable firms within a chaebol tended to subsidize unprofitable firms. Meanwhile. One reason is that the percentage of inside shareholdings for an average listed firm is very high. Under the direction of the controlling shareholder. and some differences in Korea’s generally accepted accounting principles from international standards. 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. as a whole. Dominance of Chaebols A chaebol is tightly controlled by the largest shareholder. a large issuance of preferred stocks with no voting rights. Diversification can reduce chaebols’ risks through the portfolio effect. individuals. Representative of the policy was the stipulation under the Securities and Exchange Act that no one other than founders could accumulate more than 10 percent of the voting shares of a listed company unless he or she obtained prior approval of the Securities and Exchange Commission. however. as well as institutions. hostile takeovers in Korea will likely be rare in the future. Traditionally. corporate accounting information was not reliable due to the lack of independence of external auditors. and restrictions on hostile takeovers. has an unsound capital structure and . Banks did not function as monitors of corporate management although they were shareholders as well as the most influential creditors. In this situation. However. There were no effective monitoring mechanisms for its management. These internal dealings made strong firms weak and helped marginal firms survive. regulatory and practical difficulty in implementing proxy voting. These included restrictions of shareholdings of institutional investors. restrictions of voting rights of shares of institutional investors.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 Government maintained a policy of protecting the incumbent management of a listed company. usually a member of the founding family. Many of the takeover targets in the past did not have a controlling shareholder. prevalent window dressing practices.
Further. prevalence of rent-seeking and morally hazardous behavior by economic decision makers. the authorities did not properly check on banks’ lending practices—banks did not screen the lending projects and evaluate the creditworthiness of corporations properly. Profitability of the top 6-70 chaebol firms has been lower than that of the top five chaebol firms. Net profit margins of the top 31-72 chaebols were higher than those of the top five or of the top 6-30. share issues. The Government’s supervision and regulation of financial institutions were poor. As mentioned earlier. and other individual markets. as the latter are well established in most business areas.134 Corporate Governance and Finance in East Asia.5. 2. and a high degree of inefficiency in the economy. This indicates that too much diversification and overinvestment in the top 30 chaebols resulted in relatively low net profit margins. the financial distress of one or a few marginal firms can lead to a chain of bankruptcies across the entire chaebol.5. The new preference ordering is as . II strong financial links among its member firms through investments and cross-guarantees. 2. However. Such problems may eventually cause ripples through the entire economy. Vol. capital. This effectively becomes an exit barrier for chaebols and would justify the intervention and support of the Government.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. although their subsidiaries had better quality workforce and easier access to cheap credit than the top 31-72 chaebol affiliates. The Government and the Bank of Korea did not have accurate information on the extent of transactions that corporations and financial institutions had abroad. financing choices of listed firms in order of preference were bank loans. while (non-chaebol) independent firms had much lower borrowing ratios. the intervention later resulted in the accumulation of adverse side effects: underdeveloped product. and internal funds. bond issues.3 Manifestations of Weak Corporate Governance and Government Intervention Preference of Debt Over Equity Financing in the Precrisis Period Before the crisis. Financing preferences changed drastically after the crisis. the typical chaebol firm had an extremely high DER.
Chapter 2: Korea 135 follows: internal funds. Bank loans. Although the ratio of stock market capitalization to GDP in Korea was not very different from those in the Philippines and Thailand. . However. which were the most important financing source until 1987. consisted of high proportions of policy loans. large-scale bailouts of financially distressed firms. were advantageous to chaebols because they were in an “ideal” position to meet the loan requirement through cross-guarantees among their member firms. 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. Other factors also contributed to this preference. As of the end of 1997. share issues. The ratio of external debts to GDP reached 48 percent at the end of 1998. 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. as evidenced by occasional. The high proportion of foreign debt led to a mismatch problem where borrowers were unhedged against foreign exchange risk. the exchange rate (won/dollar) increased sharply and the financial crisis erupted in Korea. which generally required guarantees or collateral. overseas borrowing became difficult and higher interest rates were charged on foreign borrowing. In the international financial market. The financing choice of listed firms was also influenced by the underdevelopment of the stock market. total foreign debt amounted to $157. At the end of 1996. The foremost reason why listed companies preferred debt financing over issues of new shares lies in the largest shareholders’ desire to keep control of the management by preventing dilution of their ownership. 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 top 30 chaebols showed a DER of 519 percent.5 billion. 63 percent of which was short-term. and bond issues. bank loans. won/dollar nondeliverable forward rates increased rapidly. 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. obviously contributed to overlending and aggravated the situation. reducing foreign exchange reserves to a dangerous level. The lending practices of banks. signaling a bearish speculative move on the won. Implicit guarantees by the Government on bank loans to large businesses. In November 1997. The preference for debt finance also led to a relatively large foreign debt. the Government and the Bank of Korea defended the currency. After the financial crisis erupted in Indonesia and Thailand.
They utilized mutual payment guarantees among their affiliates and believed that they would never fail. Before the crisis. then 20. In 1997 they became negative. The inevitable result of inefficient investment was a fall in corporate profits. The monthly number reached more than 3. were low in 1996 and 1997. and there is collateral. a large number of construction companies failed due to the recession in the real estate market and decline in real estate prices. II Inefficient Corporate Investment and Low Profitability Ownership concentration among Korean firms.000 in September 1998 (Table 2. and shareholders’ equity of all industries.000 per year starting 1992. without strictly evaluating the creditworthiness of businesses and the profitability of projects. regardless of whether it is caused by large personal holdings of the controlling shareholder or by pyramiding. 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. Vol.6 percent in June 1998. Meanwhile. nine out of the 30 top chaebols failed. and the pursuit of growth through excessive diversification and inefficient investment. excluding the financial sector. reaching highs of 6 percent in 1997 and 8. starting 1 July 1998. and returned to about 1.136 Corporate Governance and Finance in East Asia. Further. total assets. The banks and merchant banks lent to large businesses. and there is no collateral. has given rise to various types of self-dealings by the controlling shareholder. Moreover. The number of insolvent companies increased rapidly in 1991 and doubled to more than 11. These were the definitions until 30 June 1998. The Government could hardly help them because of the number and magnitude of business failures.200 in 1997. and estimated losses. the ratios of net profits to sales. they are defined as loans for which interest payments are overdue by three months or more. According to the “six months” definition. the NPL ratio reached 7. especially chaebols.000 from December 1997 to February 1998. legal and other barriers prevented the exit of financially nonviable firms.7 percent in 1997. decelerated from March 1998. the NPL ratio8 of banks and other financial institutions began to increase. Following the “three months” definition. Financial Sector Vulnerability Because of financial losses in the corporate sector. However. The bank supervisory 8 NPLs of banks comprise fixed (substandard) and doubtful loans. . the NPL ratio of commercial banks increased rapidly from 4.000 during January-September of 1998.1 percent in 1996.32). Doubtful loans are those for which interest is not received for six months or longer. Fixed loans are those for which interest is not received for six months or longer. It jumped to 17.
33).250 2.053 5. As a result they had largely overvalued currencies.69 20.657 3.159 10.589 171.544 2.255 13. 1986-1998 Year 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 Total 4.890 4. authorities were not too concerned about the high NPL ratios at Korean banks in 1997 simply because the high and rising ratios had precedents. and continuous and large current account deficits. low efficiency.135 1.859 3.238 4.259 2. Exchange rates were virtually pegged to the US dollar in all troubled Asian countries. Compared to ROAs and ROEs of domestic branches of foreign banks.759 6. The current account deficits in terms .985 Services 3.979 8.027 Manufacturing 1.573 3.850 3.856 7. Meanwhile.637 6.472 2.673 Construction 380 354 242 195 294 585 1. 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.114 811 706 696 866 1.133 3.855 6.647 8.China.265 6.751 1.992 11.210 1. and large government-directed loans. This was mainly due to the high ratios of NPLs. ROEs and ROAs of Korean and Japanese banks were low compared with those of the US. and declined to 4-6 percent in 1994-1996 (Table 2.244 3.517 2. Source: Bank of Korea. 2.32 Number of Firms with Dishonored Checks.5. This speculation was said to be one of the causes of the financial crisis in Korea. and Taipei.Chapter 2: Korea 137 Table 2. In 1990-1993. those of domestic banks were lower in the 1990s.754 3.386 5. European countries.417 Others 152 132 108 97 88 161 326 252 274 302 553 861 952 Note: 1998 figures cover only January-September.502 11. Policymakers thought that economic growth would resolve the NPL problem without the need for corrective action.107 6.553 3.457 2.4 Shortcomings in Macroeconomic Policy The macroeconomic framework also contributed to the crisis in 1997. the ratio reached 7-8 percent.131 1.769 9.
Land prices and real estate rents were also high compared to trading partners. In 1997. the ratio of short-term debt to foreign reserves was very high.562 18.910 1. the terms of trade deteriorated 12 percent in 1996 and 11 percent in 1997. of percentage of GDP were as follows: Malaysia -8. Korea -4.077 NPL Ratio (%) 8. Businesses served as a social safety net.266 10.736 8. In addition to the overvaluation of the won.8 5.929 11.954 9.827 289.997 9.475 143. and Indonesia -3. Mass layoffs became legally possible only after the economic crisis.649 375.192 Doubtful (B)b 952 1.8 percent (1996). Real interest rates in Korea had been two to three times higher than those of Japan or Taipei.652 29.705 160. even in times of economic slowdown.537 10.310 6.1 6. 1990-1998 (W billion) Year 1990 1991 1992 1993 1994 1995 1996 1997 1998 a Total Loans 90.639 1.6 Fixed loans are those requiring collateral and for which interest is not received for six months or longer. because of the rigid labor market.China.221 8. The main result of the rigid labor market was a “high-cost and lowefficiency” economy.739 241.2 4.584 Fixed (A)a 5. judging from the real effective exchange rate indexes using unit labor cost indexes as a deflator and 1985 as a base year.430 12.170 1.237 Estimated Loss (C) 958 920 840 816 213 385 490 490 648 NPL (A+B+C) 7.832 337.0 7.390 12.33 Nonperforming Loans of General Banks. Vol.600 10.China.138 Corporate Governance and Finance in East Asia.160 11. Meanwhile large businesses could not legally lay off workers.0 8.874 22.190 9.1 7. . b Doubtful loans are collateral-free loans for which interest is not received for six months or longer.6 percent (1995).584 2.4 5. Related to this. II Table 2.556 118. the hourly wage rate in the Korean manufacturing sector was higher than in Singapore or Taipei. although per capita income in Korea was much lower.176 7.116 1. Source: Bank of Korea.6 percent (1995). Thailand -8.484 11.520 194. which led to large corporate losses. and 30 percent in 1996.0 7. The pegged currency also encouraged foreign borrowing as investors believed that the exchange rate would remain stable. It was estimated that the Korean won was overvalued by 20 to 30 percent from 1989 to 1997.1 percent (1995).
and subsidizing money-losing units. Other firms experiencing financial distress were subjected to workout procedures through negotiations between debtors and creditor institutions. Measures have been taken by several chaebols to streamline operations and improve incentives of managers and employees. had been forced into bankruptcy proceedings or merged into healthier entities. has been actively utilizing its influence to motivate institutions to coordinate debtor firms’ restructuring activities. the immediate objective centered on restoring the international investment community’s confidence in the Korean economy.6 percent as of the end of June 1998 to no more than 200 percent by the end of 1999. To achieve this. the excessive amount of debt of Korean corporations had to be reduced to a sustainable level.6 2.Chapter 2: Korea 139 2. They have been pressured to stop such practices as providing loan guarantees. 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. which were laden with huge amounts of debt and were on the verge of bankruptcy. However. Ailing banks needed to be recapitalized after the huge amount of NPLs was disposed. The FSC—later called the Financial Supervisory Service (FSS)— which is in charge of prudential regulation of financial institutions. .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. Downsizing by curtailing employment has been prevalent. 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. including banks.6. Nonviable firms and financial institutions. embarked on their own restructuring programs and/or implemented restructuring demands of the creditor banks. A guideline informally promulgated by FSC required the 30 largest chaebols to lower their DER of 412. Corporations. ‘Voluntary’ Restructuring Chaebols have been under pressure from the Government to abolish their informal group headquarters to increase the managerial independence of member firms.
The reasons are manifold. Noticing this disincentive. Internationally. while only 14 percent of the negotiations were completed from the beginning of the crisis up to April 1998. In their first review. It was frequently observed that the negotiating parties could not agree on a price due to large discrepancies in valuation. Locally.281 in April to 2. banks and other creditors were reluctant to absorb losses realized by debt compositions. This number was at 779 firms in April and grew to 1. FSC directed banks to appraise the long-term viability of client firms showing symptoms of failure. More important. sellers could not find buyers as almost all domestic firms struggled to raise cash for debt reduction and for working capital needs while there was a severe credit crunch following the outbreak of the crisis. the creditor . because liquidation of debtor firms would exacerbate the banks’ already weak balance sheets. Data collected by the Korean Chamber of Commerce and Industry show that the number of potential domestic and foreign buyers in the M&A market increased by about 50 percent over the six-month period from April to October 1998. the number of potential sellers decreased somewhat from 2. potential foreign buyers waited for the price of acquisition targets to come down further. More than 59 percent of potential buyers were foreign firms. Involuntary Exits The Government has been involved in the restructuring process mainly through its supervisory capacity over banks. or to agree on debt-equity swaps demanded by potential purchasers as a precondition for the deal. On the other hand. Korean firms have been slowly stepping up their restructuring since the latter half of 1998 as the economy began to show signs of recovery. Vol.045 in October. they were reluctant to allow recontracting for fear of further deterioration in the capital adequacy ratio. The data also show that about 24 percent of acquisition negotiations ended up in actual deals. II Divestitures to raise cash for debt reduction and to focus on core businesses have not proved to be easy. 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.138 by the end of October. 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.140 Corporate Governance and Finance in East Asia. Banks did not have the incentive to force financially nonviable firms to liquidate. In many cases.
the results thus far have not entirely been as desired. More than 200 financial institutions signed the Corporate Restructuring Agreement to carry out corporate workouts with the top 6-64 chaebols. provided by the World Bank. Negotiations were then held between the chaebols and the creditors’ councils to finalize the financial structure improvement plans. By the end of 1998. the creditor banks drafted their own restructuring plans with assistance from outside advisory groups led by foreign investment banks. workouts are being applied to non-chaebol firms identified as financially weak. creditor banks completed evaluation of the financial status of 35 subsidiaries belonging to 13 chaebols. 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. not only for the design of corporate workout programs but also their implementation. by their creditors. Among the sell-offs. and 12 were sold off to other firms. FSC has been monitoring the processes from a prudential regulation standpoint. Among the 55 firms selected. Based on these plans. The workout plans were completed for most firms by early 1999. 11 were merged into other group members. three filed for courtsupervised bankruptcy reorganization. 24 were liquidated. and/or conversion of debt into equity have been applied to those firms that are considered to be viable in the long run and have voluntarily entered into negotiations with creditor banks. The plans were put into action immediately following finalization. write-offs. The creditor banks and the advisory groups also drafted such plans for the top 6-64 chaebols. and 16 non-chaebol corporations that had been selected as possible workout candidates. A portion of the Technical Assistance Loan of $33 million. Although the intention of the Government and the banks was to effect immediate liquidation of these selected firms. Upon completion of the evaluation. These chaebols submitted plans for restructuring to improve their respective capital structures. but viable.Chapter 2: Korea 141 banks selected 55 firms as targets for exit. two were acquired by newly organized employee stock ownership plans. These included 20 firms from the top five chaebols and 32 from the top 6-30 chaebols. was allocated to the six largest banks for them to employ outside experts as advisors. Corporate Workouts Workouts in the forms of debt rescheduling. Also. interest reductions. .
automobiles. and equity participation—reached about $8. chaebols did announce their agreements on big deals in seven industries excluding the automobile industry. aircraft. it is hoped. This figure contrasts sharply with the total of $700 million for all of 1997.142 Corporate Governance and Finance in East Asia. First. In the case of automobiles. Foreign investment—in the form of acquisition of controlling interests. Vol. In another. Big Deals Ever since the outbreak of the economic crisis. enable chaebols to streamline their overly diversified operations and focus on several core business areas. In one case. II creditor banks and the corporations will devise detailed workout programs based on the rehabilitation plans submitted by the corporations. Korea adopted and implemented policies to open its capital market completely. On 3 September 1998. Big deals would. power plant facilities. and petrochemicals. labor union demands of the seller were not acceptable to the transacting parties. inducement of foreign direct investments was considered to be the most effective means of achieving that end. Thus. oil refineries. Big deals have been elevated to the status of the most important means of effective corporate restructuring. Foreign Acquisitions Confidence in the Korean economy depends critically on the lowering of the level of corporate debt. railroad cars.5 billion on agreement basis during the 10-month period after December 1997. The less than satisfactory state of foreign capital infusion in the early days stems from a number of factors. the foreign buyer demanded specific protections against adverse developments in the business environment. vessel engines. These deals could eliminate excess capacity in such industries as semiconductors. the Government has been urging the largest chaebols to strike “big deals” or business swaps among themselves to consolidate overlapping manufacturing facilities. However. purchase of divested assets. most of the big deals have entered their final stages of negotiation. Restrictions on foreign ownership of land were also abolished. Hyundai Motor Corporation won the international auction of Kia Motors in its third bidding and Daewoo Motors agreed to acquire Samsung Motors. some of the acquisition agreements have been discarded for various reasons. As of April 1999. uncertainty over the future . In the early days after the outbreak of the crisis.
the Government and chaebols reached an agreement on the goals of restructuring and reform efforts. As set forth in the agreement. Fourth. Overhaul of Bankruptcy Procedures In February 1998. (ii) to remove cross-guarantees of loans among group members. Second.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. many of the potential buyers believed that prices asked by sellers were still too high and there would be opportunities to buy assets on fire sales in the future. local creditor banks were reluctant to absorb losses arising from debt compositions and debt-equity swaps that were necessary in deals involving insolvent sellers.Chapter 2: Korea 143 course of the Korean economy remains high. Third. 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. some of the potential acquirers demanded terms that were unreasonable or unacceptable from the sellers’ point of view. and (v) to improve the accountability of controlling shareholders and the board. Not only does this represent progress in terms of an improved institutional framework for market competition. With this in mind. these goals were: (i) to enhance managerial transparency. but it also has important implications with respect to corporate workouts. many of the businesses that Korean firms put on sale did not prove to be attractive to foreign firms.6. 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. foreign buyers usually employed discounted cash flow methods of valuation while local sellers often put greater emphasis on replacement costs of assets. In effect. Seventh. (iv) to focus on a small number of core businesses. The presence of . the improved procedures stipulated in the Bankruptcy Reorganization Act and the Composition Act reduced what had previously been legalistic exit barriers. Sixth. 2. (iii) to reduce financial leverage. foreign buyers were concerned with the inflexibility of the labor market. Fifth.
The creditors can form a “Creditors Committee” among themselves to allow them to participate in the decision processes in court. First. if a final reorganization plan is not worked out within one year from the date of the court order placing a firm in receivership. Korea’s Economic Progress Report. (iii) the representation requirement for shareholder derivative suits was drastically relaxed from 1 percent to 0.” comprised of experts in the legal.144 Corporate Governance and Finance in East Asia. Fifth. thereby preventing abuses by controlling shareholders/managers of financially distressed firms. the Composition Act was amended to narrow the eligibility of applying for court-supervised composition. October 1998. the changes in the institutional setting for corporate reorganization will enable creditors and debtors to promptly respond to the development of financial problems. (ii) legal changes have been made so that domestic accounting practices conform to international standards. 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. The purpose of this rule is to shorten the reorganization planning period. the right to revoke court receivership is allowed to the creditors. . Also. and economics professions should be organized to provide for expeditious proceedings in court. a “Management Committee. (iv) restrictions on institutional investors’ voting rights were eliminated in June 1998. Vol. the maximum grace period on loans to the firm being reorganized was shortened to 10 from 20 years. etc. Second. The court can refuse to accept the application for composition if it finds it inappropriate considering the size of corporate assets. In the past this stage usually extended for as long as two to three years. (v) all listed companies are required to appoint outside directors beginning 1998 9 This and the following two subsections draw on the Ministry of Finance and Economy. the 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. accounting.01 percent in May 1998. Fourth. number of creditors. Third. The changes in the reorganization procedures can be summarized as follows. the court may annul its previous decision and force the firm into immediate liquidation. Also.
514 listed companies had appointed 677 outside directors). and (viii) as of 1 April 1998. 21 industries were further liberalized or newly opened to FDI (now. financial institutions could no longer require cross-debt guarantees. Korea has rapidly liberalized the capital market by adopting the following measures: (i) the ceiling on foreign equity ownership was completely eliminated in May 1998. either partially or fully. have been instituted for FDI: . Existing cross-debt guarantees should be completely eliminated by the end of March 2000. 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. Measures for improving standards in corporate governance are already effecting a generally more open corporate culture and greater transparency in business practices. an additional nine industries will be opened or further liberalized. In addition. Foreign Investment Promotion Act The Foreign Investment Promotion Act was put into effect in November 1998. which was passed in August 1998. various supporting measures. (v) by the end of May 1999. including financial subsidization. Capital Market Liberalization Since 1998. Foreigners are now able to invest in local bonds and short-term money market instruments without any restrictions. to FDI). beginning on 1 April 1999. These new standards are and will continue to be strictly enforced. (vi) bankruptcy laws were revised in February 1998 to facilitate the exit of insolvent firms. including tax exemptions and reductions. (ii) full liberalization of foreign exchange transactions was legislated and will be put into effect in two stages. As for promotion. (iii) hostile mergers and acquisitions by foreigners were fully liberalized in May 1998. (iv) during April and May 1998. the Korea Trade and Investment Agency (KOTRA) will provide a one-stop service with respect to FDI. According to the law. (vii) by the end of March 1998.148 industries remain closed.Chapter 2: Korea 145 (as of the end of May 1998. A recent case in point is the penalty imposed by the Fair Trade Commission on chaebol subsidiaries found to be involved in unfair transactions among group members. crossdebt guarantees totaling about W10 trillion—about 30 percent of the total guarantees among the 30 largest chaebols—were dissolved. administrative procedures for FDI will be dramatically simplified and made transparent. only 31 out of 1.
The law allows rental cost exemptions and reductions for FDI. These liberalization measures. The majority of government bonds to be issued in the next two to three years will carry a maturity of three years. It aims to establish a benchmark by consolidating various government bonds. 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). Capital Market Augmentation Bond Market The Government recently introduced a policy plan to deepen Korea’s bond market. however. The location of the FIZ will be determined at the request of foreign investors.146 Corporate Governance and Finance in East Asia. Low cost rental facility: National and public real properties will be rented to foreign-invested firms for up to 50 years. To minimize potential risks. II (i) (ii) (iii) Tax exemption and reduction: Corporate and income taxes will be exempted or reduced for FDI in target industries. Also. Various support measures. the Government intends to supplement these measures with a sound macroeconomic policy in order to secure more effective protection against systemic risks. Various local taxes will also be exempted or reduced for eight to 15 years at the discretion of local governments. are not risk-free. including infrastructure and tax support. Liberalization of Foreign Exchange Transactions In September 1998 the Foreign Exchange Management Act was replaced by the Foreign Exchange Transaction Act. Free Investment Zone (FIZ): A free investment zone will be developed to accommodate large-scale FDI. The primary aims of the law are the liberalization of the capital account and the development of the foreign exchange market. will be provided to foreign firms in the FIZ. as well as building an early warning system. Three-year government bonds will be used to establish a benchmark. These bonds will be issued . such as the high-tech industry. Vol.
Chapter 2: Korea 147 monthly. No qualification requirements are being imposed on investors who are sponsoring new mutual funds. the Government will correspondingly expand the issuance of government bonds that have a maturity of five years or more. It is now easy for private investors. According to the law.6 trillion for the debt restructuring fund. a primary dealers system will be introduced for healthy financial institutions. but it will also help improve financial institutions’ risk management. This law will not only provide an effective institutional environment for the disposal of NPLs. and W1 trillion divided equally between the three balanced funds. to establish closed-end investment companies. The Government established specific qualification criteria and selected the primary dealers in 1999. As a pilot program.6 trillion in these funds: W0. Related legislation was put into effect in September 1998. 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. If interest rates stabilize at a low level. Asset-Backed Securities A new law providing for asset-backed securities (ABS) was passed in September 1998. including the Korea Development Bank. and is promoting joint ventures between foreign and domestic agencies. and the demand for longerterm bonds increases in the future. In order to promote a greater market demand for government bonds. both domestic and foreign. Twenty-five domestic financial institutions. To ensure transparency and efficiency of the fund operations. financial institutions . In August 1998. Mutual funds (or open-end investment companies) will be allowed starting 2001. Moody’s signed a joint venture contract with Korea Investors Service. invested a total of W1. a debt restructuring fund and three balanced funds (funds that invest in both equity and debt) were established in September 1998. These are expected to operate for the next three years. but may be extended as required. they will be managed by foreign investment management companies. Prior to the introduction of this system. with only minor standard exceptions. commercial banks were allowed to carry out dealing operations for government bonds starting in October 1998. It also opened the credit rating service market to foreign competition.
the role of the board of directors as the internal control mechanism must loom large in corporate governance. A good governance system is essential for the healthy growth of corporations and financial institutions. when the limit is binding. Direct controls of interfirm investments and/or pyramidal ownership structures will not be persuasive. is inevitable.3 Policy Recommendations Poorly performing markets and the resulting lack of market discipline justified the government intervention in recent corporate and financial restructuring activities. can utilize ABS. the government intervention will have to be refocused so that it only sets the rules of the game in the marketplace. More important. foreign business corporations with good credit standing are now also permitted to issue ABS. as stipulated by the government measure. which is the case for many chaebols. II and qualified public corporations. there is another view that placing a maximum limit on interfirm investments. The corporate governance structure cannot be expected to function efficiently if this issue is not addressed. etc. cross-subsidization. In principle. However. On the other hand. For instance. greater efforts to improve corporate governance are preferable to regulation of interfirm investment. and C investing in D. However.148 Corporate Governance and Finance in East Asia. There must be stronger rules to control agency problems.. One way of strengthening independence of the boards is to require that listed companies accept nominations for directors by institutional . such as the Korea Asset Management Corporation (KAMCO). this can only be a temporary measure. then the regulation will inhibit efficient investment of firms.) and the level of interfirm investments is very high.g. It would be more desirable for the market-oriented measures to be put into place and strictly enforced.6. this regulation may not be effective in curtailing pyramidal structures. As markets become more efficient. Vol. unless the limit is tight and binding. 2. A investing in B. B investing in C. considering that there is no other effective way to limit circular investments among chaebol affiliates (e. 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. Policies aiming to improve the corporate governance system should take into account the high ownership concentration often created by pyramiding. However. 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. Selfdealings.
Class action suits are an efficient means for corporate monitoring. various measures have been implemented to promote investors’ rights. and also negligence of external (independent) auditors actionable. and other committees. it will have to include making self-dealings by directors and officers. . The Corporate Board. Latham. using audit. 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. governance. thereby helping to strengthen board independence and enlisting boards’ more active involvement in monitoring corporate management.10 Other means to improve independence of the boards include mandating that independent outside directors form the majority. the Korea Stock Exchange could incorporate provisions of the Code of Best Practice in Corporate Governance in its listing rules. 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. September/ October 1997. 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. Listing rules may recommend that all or large listed companies adopt an audit committee. The Securities and Exchange Act will then require large listed companies to switch to a board audit committee system from an internal auditor system. pp. If and when the law is introduced. More effective measures to protect investors will enhance corporate transparency and also the accountability of directors to shareholders. The annual shareholders meetings could also elect reputable “monitoring companies” to recommend director candidates (Latham. 23-26.Chapter 2: Korea 149 investors or their trade associations. Proposed: A Governance Monitor. Institutional investors will play an increasingly important role in corporate governance. 1997. One way of motivating institutions to do this is to 10 M. Each listed firm should be required to disclose the extent of its compliance with the Code in its annual report. Further. The Government can prompt institutional investors to contribute more to good corporate governance by paying greater attention to corporate affairs. The Government has already announced that it intends to amend the Commercial Code to introduce Anglo-American type audit committees as an alternative to the current internal auditor system. and requiring that all directors hold shares of their companies. Since the economic crisis.
150 Corporate Governance and Finance in East Asia. by all nonfinancial companies (or “industrial capital”). 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. Application of more stringent bankruptcy-related rules to firms in financial distress will effect greater discipline over corporate management. II provide comprehensive guidelines for their actions in matters related to corporate governance. Another measure. important pension funds including public employee funds and teacher funds seem to have their own governance problems because their top management and portfolio management policies are controlled by the Government. and thus cannot be expected to be actively involved in monitoring portfolio firms. strengthen its supervisory activities. insurance companies. and impose stronger penalties on violations of the rules on portfolio investments. possibly. is to restrict ownership of investment trust companies and NBFIs by the five largest chaebols and. 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. and compliance officers. such as the Korea Investment Trust Association. 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. objecting to certain defensive measures proposed by the management. reviewing independence and expertise of candidates for outside directors. In the coming years. The Government can also lower the limits on investments in affiliated companies. strengthening incentive compensation schemes for executives. could prepare such guidelines. Rights of minority shareholders should also be strengthened for these institutions. The institutions’ respective trade associations. securities companies. These guidelines would recommend shareholder activism and faithful discharge of fiduciary duties by actively participating in shareholder voting. an audit committee. the Government will have to come up with appropriate policy measures to solve these problems. Many of the larger investment trust companies. An efficient means to control problems arising from ownership of financial institutions by industrial capital is to strengthen the accountability and fiduciary duty of the very management of these institutions. Also. Shareholdings concentrated in investment companies and other institutional investors pose a serious dilemma. more drastic in nature. etc. and other NBFIs are subsidiaries of chaebols— especially the five largest ones. . The Government recently proposed the revision of bankruptcy-related laws. Vol.
lessening the degree of double taxation of dividends (or further reducing personal income taxes on dividends). the banks have great leverage over the management of debtor firms. Many corporations are burdened with excessive debt and. and stop unfair internal transactions. Such measures include providing an effective corporate governance system. which could provide alternative sources of long-term corporate finance. The public and corporations should be taught or fully informed of the best practices in corporate governance. the elimination of implicit guarantees for financial support to chaebols. The Government should substantially reduce the proportion of policy loans from bank loans. The current obligatory system of disclosure that emphasizes “hard” . the important issues to be addressed are: (i) improvement of the corporate disclosure system. therefore are vulnerable to economic shocks. bank managers should be made accountable to shareholders but not to the Government. For this. Many concepts regarding good corporate governance are still new to a lot of market players in Korea. To facilitate the development of the Korean stock market. private firms.Chapter 2: Korea 151 There still exist widespread concerns that the Government will continue to exercise a great deal of discretionary power over banks. Bank boards also need to be made more independent from management. through them. Banks should adopt strong incentive compensation schemes for management. and financial institutions. In turn. An effective policy package is needed for chaebols to dispose of marginal firms with low profitability at the earliest date. reduction of protection of domestic markets and entry barriers. This means that the Government can control the banks and. to concentrate instead on a small number of core businesses. the limit on ownership of bank shares will have to be eased so that strategic investors (shareholders) can act as true effective monitors of bank management. and introducing disincentive schemes for excessive borrowings. Chaebols are overly indebted. (ii) provision of reliable accounting information. The Government should put more efforts into developing the capital market. such as application of higher interest rates by banks to chaebols with higher DERs. and consistently show low profit rates. and (iii) a good corporate governance system to protect investors. excessively diversified into nonrelated business areas. In order to minimize government intervention in bank and corporate management. large firms. and thus full-scale education programs should be developed. Banks need to play a bigger role than they do at present in monitoring corporate investment and management. The Government needs to sell off at the earliest feasible dates the bank shares that it acquired in the course of recapitalizing banks.
In determining optimal exchange rates. the information system of the bond market should be better organized to transmit. is considered to be one of the major causes of the economic crisis.152 Corporate Governance and Finance in East Asia. Another problem with the corporate bond market is that most bonds are issued with maturities of less than four years. reasons for different degrees of corruption in various countries. The function of securities companies as dealers of bonds should be improved. and labor productivity should be considered. More effective punitive means need to be devised to penalize both corporations in violation of disclosure rules and the officers in charge. These should be lengthened to make them a source of stable long-term funds. The establishment of a Corruption Prevention Institute will be helpful in this regard. The development of the OTC bond market requires a well-developed dealer system. penalties on violations of disclosure rules are not effective enough to have a significant impact. Overvaluation of exchange rates should be avoided in order for export and import-substitution industries to stay internationally competitive. especially among business people. At the same time. II information on past performance needs to be transformed into a system in which corporations voluntarily announce “soft” information on future prospects. Prevalent corruption. . Vol. Future research could include causes of corruption. on a real time basis. no economic reforms will be effective. data on quotations and trading volumes. Without successfully addressing this problem. Maintaining current account surpluses for a considerable period is needed to pay back foreign debts. Currently. 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. politicians. Policies are needed to help develop more reliable services by bond rating agencies. wage rates. The network should cover not only the exchange market but also OTC transactions of investors and dealers. profitability of export industries and real effective exchange rates that account for changes in nominal exchange rates. and bureaucrats. and measures to reduce corruption.
Chon. Kang. Economic Statistics Yearbook. Hong Moon Sa. Chon. KERI. Korea Development Bank. edited by K. September/October 1997. Bank of Korea. 1995. 1998. various issues. New York: Praeger.. Evolutionary Chaebol. Korea Economic Research Institute. pp. W. Lee. S. Lee. Korea’s Chaebol. I. various issues. Financial Studies. Is the Fair Trade Policy Fair? Korea Economic Research Institute. Jua. H. D. Market Concentration and Diversification of Business Groups. Latham. S. S. D. 1997. S. Proposed: A Governance Monitor. and H. Cho. . Determinants of Diversification of Korean Business Groups. KERI. W. 23-26. KERI. Bank of Korea. The Corporate Board. 7995.. 1995. A Study on the Relationship between Ownership Structure of a Firm and Value of a Firm. pp. C. pp. S. Kim. Financial Statement Analysis Yearbook. C.. in Korean Managerial Dynamics.). International Monetary Fund. H. W. 1996. N. and K. Choi. W. H. Chung. Bank of Korea. International Financial Statistics. Bibong Publishing Co. 1998. H. K. Financial Studies. 1992. and 1998 issues. Chung and H. Survey of Facility Investment Plan. M. Korea’s Large Conglomerates. Y. K. 1993. Maeil Daily Economic Newspapers. September 1997. 1989. September 1998. Center for Free Enterprise. T. 1997. Japanese Zaibatsu and Korean Chaebols. 1994. Corporate Restructuring. 79-95. 1996. 1997. H. Hattori. New York: Praeger. September 1998. An Empirical Evidence on Value of a Firm and Ownership Structure. 1989. Understanding Flow of Fund Accounts. Lee (eds. 1997. I. 1999. Korean Managerial Dynamics.Chapter 2: Korea 153 References Bank of Korea. Hong. Lee. S. Kim. 1996. Kwon. Jae Woo. various issues. various issues. and J. Cho. Korea Economic Research Institute. Kim. Korea’s Financial System. Tomio. C. Ju Hyun.
S. Korea Development Institute and World Bank. The Pattern of Ownership Structure and their Characteristics in Korean Conglomerates: With Cases of the 30 Largest Chaebols. Y. Wang. Kim. October 1998. 1996. II Lee. Corporate Governance in Korea. J. I. 1995. Ungki. Capital Liberalization. and J. Lee. October 1998. KIET Occasional Paper No. Korea Finance Institute. Conference on Corporate Governance in Asia: A Comparative Perspective. March 1999. Korea Institute for International Economic Policy. Yang. Real Exchange Rate and Policy Measures. U. H. I.. Kim. Beyond the Limit. 23. and J. Nam. 2nd Sangnam Forum. K. Sohn. Whang. 1998. Seoul. 1998. Chung Ang University. S. J. Yim. KIEP Working Paper 98-05. Y. 1999. H. Y. Vol. S. Chicago. Annual Conference of Financial Management Association. Joh.. A New Trade and Industrial Policy in the Globalization of Korea. The Ownership Structure and Family Control in Korean Conglomerates: With Cases of the 30 Largest Chaebols. K. S. November 1996. January 1995. Korea Institute for Industrial Economics and Trade. Kang. Background and Task of Structural Adjustment. Lee. Lim. Ungki.. 1999. 1998. J. C. Ministry of Finance and Economy. 1998. Business Groups in Korea: Characteristics and Government Policy. Management Research Institute.154 Corporate Governance and Finance in East Asia. . W. Korea Institute for International Economics and Trade. Korea’s Trade and Industrial Policies: 1948-1998. Yonsei University. September 1998. K. Korea’s Economic Progress Report. C. 1996. Lim. and H. Whan.
after the completion of debt negotiations with the IMF and Paris Club. the PSR Consulting. the Philippines. This has come about following a political and economic upheaval from 1983 to 1987. Inc. The lifting of the debt moratorium in 1991. 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. both of ADB. staff. for their research assistance. and Liza V. PSR Consulting. When the Asian crisis erupted in 1997. Inc. overall. the Philippine economy and corporate sector were in a relatively sound financial position. Saldaña1 3.3 The Philippines Cesar G. and Lea Sumulong and Graham Dwyer for their editorial assistance. David Edwards. Roble. allowed the Government and the corporate sector to gradually access foreign debt markets after a long absence. and government subsidies were tackled during that period. From 1993 to 1996.. 1 Principal. and David Webb of the London School of Economics for their guidance and supervision in conducting the study. Pineda. Companies of other Asian countries were already using these markets to finance investment and growth. Denise B. The Asian financial crisis revealed that. the Philippine Stock Exchange for its help and support in conducting company surveys.1 Introduction In recent years. the Philippine nonfinancial corporate sector had managed its borrowing risks relatively well by largely avoiding imprudent use of debts and risky investments. in particular Francisco C. 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). the Philippine corporate sector has played a leading role in the government’s efforts to get the country on track toward sustainable economic development. Serrana. . aiming at eventually limiting the Government’s role to economic policy setting and allowing the private sector to conduct most economic activity. The author wishes to thank Juzhong Zhuang. state-sanctioned monopolies. about a decade before the recent Asian crisis.
But protectionist policies made labor relatively more expensive and. An industrial elite. the Government overvalued the local currency and imposed high import tariffs. on family-based and controlled conglomerates. yet they did not risk new capital required for modernizing and expanding manufacturing capacity. To implement these policies. their growth could not be sustained. 3. companies were necessarily large and capital-intensive. nationalist sentiments led to policies that favored import substitution and heavy government intervention in business. The highly concentrated and family-based ownership of corporate groups has resulted in governance structures that depend largely on internal control systems. Vol.2. and on the financial crisis. Investments of large corporate groups tend to focus on obtaining market shares and industry dominance. control by internal and external governance agents. Sugar refining and textile mills are examples of industries that floundered in the 1980s because of government import substitution policies. regulatory framework. It analyzes the impact of corporate governance on company financial performance and financing.1 Overview of the Corporate Sector Historical Development During the 1950s and 1960s. usually with the acquiescence of bank creditors. Corporate financing relies excessively on bank loans. Government interventions under the notion of “master planning” for economic and social development characterized the 1970s and early 1980s. Companies finance long-term investments with short-term debt. This study reviews the Philippine corporate sector in terms of its historical development. the corporate sector showed structural weaknesses similar to those in neighboring Asian countries.156 Corporate Governance and Finance in East Asia.2 3. The Board of Investments (BOI) was created to draw up an investment priorities . These early industrialists naturally opposed any initiative to reduce tariffs. patterns of ownership. patterns of financing. While new manufacturing industries were successfully established. emerged to influence industrial policies. II Still. therefore. The policy was crafted by the martial law regime at that time. Companies were profitable because of protection from foreign competition. which leads to their easing of due diligence and monitoring standards when lending to group members. Banks have significant presence as members of affiliated business groups. and responses to the financial crisis. composed mostly of families previously in trading businesses.
Exports were not competitive because of the high costs of imported materials. the legislative body passed the Foreign Investment Act (FIA). the Government continuously revised the enabling law of BOI so that incentives were reduced in number. Starting in 1981. 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. In 1991. Reforms in policies. quantitative restrictions. the “pioneer” industries identified in the IPP. The FIA allowed foreign equity investment in many areas and at the same time provided a transparent. advance notice of areas where the country disallowed or restricted foreign investment. and initiated the development of alternative energy sources in response to the oil crises. The Government signaled through the IPP its intent to shape the future industrial landscape. Better access to cheaper imported raw materials improved the competitiveness of local manufacturers. the Government narrowed the range of tariff rates by commodity categories and reduced the average tariff rate from 28 to 20 percent. and oriented toward exports. organizing industries into sectors and picking “winners. Probably the most significant effects of tariff protection and biases for capital intensity were the corporate sector’s high degree of concentration. and import licensing requirements. BOI incentives retained a strong bias in favor of capital-intensive enterprises and domestic-oriented industries. In the early 1990s. Nevertheless. dominance by large companies. Following government initiatives in the control of the infrastructure and utilities sectors. assumed ownership of the largest petroleum refining company. and orientation toward domestic markets..Chapter 3: Philippines 157 plan (IPP) to encourage private sector investments by offering tax and other incentives.” No strategic industry could take off without the Government’s participation in its management and operations. clearly shifted economic management toward reliance on markets rather than on decisions by bureaucrats in the Government. including the reduction of tariffs. The high industrial concentration led to practices of price leadership and output restrictions and the rise of industry lobby groups—common features of an oligopolistic . the top three companies accounted for a disproportionately large share of total sales and assets. It limited the bureaucratic cost and discretion that accompanied the necessary approvals of foreign investments. i.e. In many industries. The 1980s were marked by a peaceful transition of political power. made less associated with capital investments. the State took over the generation and distribution of electricity.
158 Corporate Governance and Finance in East Asia.000 Corporations covers financial and nonfinancial companies.8 4. The Philippines substantially lagged behind other countries from 1990 to 1995 (Table 3.4 4.5) 5.8 5.2) 0.2 9.8 percent growth in fixed 2 The SEC-BusinessWorld Annual Survey of the Top 1.7 (13.000 Philippine companies grew 17. 3. 1990-1999 (percent) Year 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 Indonesia 9.9 5. Table 3.5 8. competition from liberalized imports had somewhat reduced oligopolistic tendencies and concentration in many industries. of 9.1 GDP Growth of Southeast Asian Countries.2) 4.2 Source: ADB.0 7.7 Malaysia 9. With economic reforms introduced in the 1980s and 1990s. This rate of growth was sustained by a comparable 18.8 8. 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. however.0 (0.2 During 1988-1997.2 7.7) 10.2 8.3 7.5) 3.9 6. only to be unsettled by the crisis of 1997. Its growth rate began to catch up with others in 1996.0 8.3 9.8 5.7) (10.3 2.5 8.0 (6.1 5.5 9.3 8.1). II market.2 Korea.2.7 8. Vol.1 5.6 7.2).000 corporations.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 1.8 10.2 7.0 8. Key Indicators of Developing Asian and Pacific Countries 2000.7 5. net sales of the top 1.1 8.5 percent per year (Table 3. . Rep.2 (0.9 (1.9 7.6) 0.8 8.5 (7.3 9.1 4.2 Thailand 11. In this section. which was taken as a representation of the Philippine corporate sector.4 Philippines 3. only nonfinancial companies were used.
3 941.2 378.7 20.7 443. .5 1.6 109 12.6 896 0.5 1.6 1.322.214.171.124 149 12.6 954.2 2.0 1.0 900 1.1 51.5 14.1 54 11. Source: SEC-BusinessWorld Annual Survey of Top 1.1 181 11.4 8.3 60 10.7 1.5 51 4.5 887 0.1 72.3 46.8 6.9 898 1.6 900 1.978.6 290.225.8 4.1 33.7 238.5 192.1 714. of Companies Sales per Company (P billion) 899 0.5 508.1 Other Indicators No.647.1 1.9 629.8 77 7.7 1.3 121 12.394.332.7 28.3 306.1 6.1 66 12.893.4 63.9 78 6.1 197 14.6 35.9 952.7 73 6.1 881. turnover = net sales/total assets.5 570.2 338.9 896 2.1 95.4 602.2 1.1 468.6 18.5 Leverage = total liabilities/stockholders’ equity.0 148.5 193.8 411.4 411. 1988-1997 1989 519.7 903 0.3 107 13.2 Growth and Financial Performance of the Top 1.4 555.6 102 16. return on assets (ROA) = net income/total assets.9 3.5 72 7.9 2.2 4.8 26.191.4 861.1 4.0 1.6 75 6.9 480.2 2.8 5.9 96.1 1.6 5.4 260.6 1990 1991 1992 1993 1994 1995 1996 1997 1.000 Companies.6 144.1 615.2 900.4 188.5 119 12.9 1.3 68 7. net profit margin = net income/net sales.9 149 6.512.1 5.Table 3.5 446.9 617.1 73 5.2 Indicators 1988 Growth Indicators (P billion) Net Sales Net Income Fixed Assets Total Assets Total Liabilities Stockholders’ Equity Retained Earnings 464.8 618.5 4.123.781.000 Corporations in the Philippines.4 126.96.36.199 Financial Ratios (%) Leverage ROE ROA Turnover Net Profit Margin 222 14. return on equity (ROE) = net income/ stockholders’ equity.6 426.317.8 741.2 27.3 382.2 Average 146 12.3 898 1.2 136.3 862.7 218.5 64.4 3.697.8 902 1.5 1.8 22.561.2 Compound Growth (%) 17.4 898 1.2 707.4 776.
906 2. Assuming Table 3. Net profit margins for the top 1.2 percent.160 Corporate Governance and Finance in East Asia.8 percent per year. The debt-toequity ratio ranged from 222 percent in 1988 to 102 percent in 1994. leverage increased from 109 percent in 1996 to 149 percent in 1997. and by equity that grew at a higher average annual rate of 26. Net income consistently increased from 1988 to 1996 and declined only in the crisis year 1997. respectively.1 19.8 17.9 percent for the period.7 percent. for the 10-year period. Total assets grew at an average annual rate of 22.3 The Corporate Sector and Gross Domestic Product. These rates of return are high compared with other Asian countries.697 1.5 17. Further.000 companies averaged 7. various years.5 Ratio of Estimated Value Addeda to GDP (%) 17.4 24.9 21. Vol.3). indicating that the corporate sector’s exposure to foreign currency-denominated loans was not as significant as in other countries. but the extent of the increase was not as dramatic as in other Asian countries. This is high compared with developed countries but compares favorably with other Asian countries.000 Corporations in the Philippines.6 percent and 5.394 1. Key Indicators of Developing Asian and Pacific Countries 1999.5 Value-added is assumed to be 30 percent of net sales. Asset growth was funded by debt that grew at an average of 20. .5 16.178 1.172 2.9 23. and the SEC-BusinessWorld Annual Survey of Top 1.077 1.1 Net Sales (P billion) 465 519 630 741 862 954 1.474 1. Return on equity (ROE) and return on assets (ROA) averaged 12. 1988-1997 Top 1. II assets. The data suggest no evidence of excessive borrowing in the run-up to the crisis in 1997.352 1. Sources: ADB.000 Companies Year 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 Average Growth (%) a GDP (P billion) 799 925 1.427 13.248 1.979 17.4 20.693 1.3 percent.8 19. The growth rates of corporate sales for the period 1988-1997 exceeded those of the country’s GDP for the same period (Table 3.
0 5.3 22. various years.3 9.3 146 6.Chapter 3: Philippines 161 a constant ratio of value added to sales.0 142 22. (iii) Government-owned.0 Net Income 19.0 4.8 percent of the corporate sector’s total sales between 1988 and 1997.4 Growth and Financial Performance of the Corporate Sector by Ownership Type.8 606 0.4 28. these figures suggest a significant and increasing contribution of the corporate sector to GDP.3 11.4 Fixed Assets 19. size.9 26. 1988-1997 Indicators Publicly Listed Privately Owned Rate. of Companies 73 Sales per Company (P billion) 2.8 3.8 22.3 42.2 9.0 28.9 196 1. The premise is that these variables have a direct bearing on corporate performance and growth.0 Turnover 53 Net Profit Margin 15.4).5 Source: SEC-BusinessWorld Annual Survey of the Top 1.000 Corporations in the Philippines.8 14.4 Total Liabilities 26.6 Total Assets 29. and industry reveals further structural characteristics of the growth and financial performance of the corporate sector.1 ROA 8. Averaging 42. and (iv) privately owned.8 ForeignOwned 21. privately owned companies constituted the largest group (Table 3.7 2.3 27.9 22.4 190 5.5 23 4.8 2.8 No. A study of company performance by ownership type.5 GovernmentOwned 4.1 Financial Ratios (%) Leverage 89 ROE 15. Performance by Ownership Type The Philippine corporate sector can be categorized into four groups based on ownership: (i) publicly listed. (ii) foreign-owned.5 Other Indicators Share of Sales (%) 17.1 22 10.5 Retained Earnings 30.4 Stockholders’ Equity 32.3 22.7 22.9 158 13.0 5.5 27.1 12.9 17. .8 Growth Indicators (Compound Annual Growth Net Sales 20.2 103 5.0 31. %) 17. The foreign-owned companies were the Table 3. corporate control structure.
The privately-owned companies were only about one third of the average size of per company sales of the publicly listed companies. 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. the highest net profit margin of 15. while there were few of them. With an average leverage ratio of 142 percent.9 percent. were among the top 1.5 percent. a level high by Western standards but at par with those of other Asian countries. . II second largest at about 27. they generated the highest return on investments. The privately-owned companies had a high average leverage ratio of 158 percent.162 Corporate Governance and Finance in East Asia. compared with P2. exceeding the 17. the second best ROE and ROA. the asset base is large.000 list. 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. Publicly listed companies had the lowest leverage at 89 percent.5 percent average growth rate of the entire corporate sector.8 percent for foreign-owned companies and 20 percent for publicly listed companies during 1988-1997. Vol. selling an average of P4.000 companies in 1997. registered the largest per company sales at about P9 billion in 1997. foreign-owned companies borrowed more than publicly listed ones. reflecting the significant presence of holding companies as the gross revenues of holding companies flow through to operating income. The compound annual sales growth rate was 21. Governmentowned companies in the top 1. but lower than those of foreignowned and publicly listed companies.75 billion per company for foreign-owned companies.1 billion per company in 1997. Bases Conversion Development Authority. However. Only 84 of the 221 public companies listed on the Philippine Stock Exchange (PSE). These were mostly large public utilities. and government-subsidized agencies such as the National Food Authority and Local Water Utilities Administration. or 38 percent. meaning that the remaining 62 percent were relatively small in sales and assets.3 percent. these companies were comparatively large. and the second lowest asset turnover. with an average ROE of 22. But by being most efficient in employing assets. and low return on investment is the norm. followed by publicly listed ones. Their ROA and ROE were both more than twice as high as those of government-owned companies.2 percent and ROA of 9. although small in number. Publicly listed companies had a minor though steadily increasing share in total sales. Privately-owned and Government-owned companies grew at slower rates.
2 Net Income 21. had a lower leverage ratio.7 2.5). various years. Sales and resources of the .3 Total Liabilities 30.1 Retained Earnings 32.4 24.3 No.8 ROA 8.1 124 5. compared with 32.8 6. the corporate sector is divided into large.2 23.0 166 15. Performance by Firm Size By firm size. of Company 159 Sales per Company (P billion) 2. Table 3. depending on assets and sales. grew faster. a company can be a member of a conglomerate or independent.Chapter 3: Philippines 163 Performance by Control Structure By control structure.6 715 0.2 Fixed Assets 25.5 Growth and Financial Performance of the Corporate Sector by Control Structure.3 percent for the conglomerates.1 Source: SEC-BusinessWorld Annual Survey of Top 1. and small companies.0 55.3 Other Indicators Share in Sales (%) 32.3 Financial Ratios (%) Leverage 98 ROE 15.7 Stockholders’ Equity 34.0 22. and achieved higher returns on invested assets than independent companies (Table 3.8 Growth Indicators (Compound Annual Growth Rate.0 Turnover 67 Net Profit Margin 12. 1988-1997 Indicators Group Member Independent 18.6 26.7 Total Assets 32. The independent companies contributed about 56 percent of corporate sales on average during the period 1988-1997.000 Corporations in the Philippines.0 25. %) Net Sales 20. But the conglomerates were larger measured in sales per company. medium.
%) Net Sales 15. However. Large companies accounted for 56.1 25. of Companies 79 Sales per Company (P billion) 7.1 No.5 25. various years. are defined as the largest 100 companies in the top 1. averaging 16 percent. sales of mediumsized companies grew faster than large companies.4 28. referring to the remaining companies in the list.000 Corporations in the Philippines.9 89 1.2 Other Indicators Share in Sales (%) 56. for this study. averaged a far less P3 billion in per company sales.5 128 10.0 730 0.3 Turnover 65 Net Profit Margin 8. Medium-sized companies also performed better in terms of ROE. .1 81 9.8 percent of the total number of companies in the list (Table 3. 1988-1997 Indicators Large Medium 19. Medium-sized companies.9 26.6).6 Growth and Financial Performance of the Corporate Sector by Firm Size.000 list. Sales per company in this group averaged P13.9 Financial Ratios (%) Leverage 158 ROE 13.6 36.6 31.2 Stockholders’ Equity 18.2 25.000 list. II Philippine corporate sector are highly concentrated among the large companies.3 Fixed Assets 15.3 Source: SEC-BusinessWorld Annual Survey of Top 1.7 Net Income 1.4 billion in 1997.6 Small 19.5 73 6.164 Corporate Governance and Finance in East Asia. which.9 Retained Earnings 13.6 49. Vol.9 32. defined in this study as the next 200 largest companies in the top 1.1 percent of the total sales of the corporate sector.0 7. although they comprised only 8.4 Total Liabilities 18. while small companies. averaged only P920 million in per company sales during the same year.5 Total Assets 18.0 32.1 ROA 5.5 12.2 29. indicating that they deployed resources more efficiently than large and small companies.1 4.7 44.0 156 16. Table 3.5 Growth Indicators (Compound Annual Growth Rate.6 47.
and construction. 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. Poor returns appear to have been caused by the low profit margin at 6. Performance by Industry This study also looked at corporate performance by industry. showed the lowest ROE. The sector showed consistent growth in sales.8 the previous year. Sales revenue and net income declined from P76.1 percent. profits. assets.7 percent in 1997 for medium-sized companies. net income.2 billion in 1997 for this sector. but lower than that of construction. and the construction sectors than for the manufacturing.1 billion in 1996 to P4. especially during the period 1994-1996. ROE dropped from 10. The Asian financial crisis affected large companies most severely. utilities. Leverage was the highest for large companies. as indicated by the negative annual growth.8 percent in 1997.e. But small companies’ leverage was significantly lower.and medium-sized companies did not substantially increase their leverage in years running up to the crisis in 1997. Large. at 128 percent for the period.8 percent. The leverage ratio of the manufacturing sector was higher than that of the real estate and property sector.4 percent in 1997 from 11.Chapter 3: Philippines 165 Small companies.7 billion and P35. although the largest in number. i.5 percent for medium-sized companies and 8. reflecting to some extent a “bubble” phenomena in the former two sectors.7. real estate. The growth and financial performance of selected industries. For small companies. are shown in Table 3. manufacturing. of net income. and utilities and services sectors. with their ROE dropping to 3. from 14. Mediumsized companies’ leverage level was slightly lower.7 percent in 1996 to 8. specifically those industries least and most affected by the financial crisis. Growth of sales.8 billion in . The real estate and property sector also suffered significantly in sales. net income.6 percent.. averaging 10. and assets was much higher for the real estate and property. compared with 9.7 percent a year earlier. Medium-sized companies apparently enjoyed efficiencies associated with economies of scale and made more productive use of their assets. and equity up to 1996. unlike their counterparts in other Asian countries. at 158 percent on average during 1988-1997. Net income declined from P54. ROE dropped to 7. and profitability in 1997 when the crisis started. and utilities and services sectors. at -12. at 156 percent.2 percent for large ones. but suffered its largest decline in net profits in 1997.
%) Net Sales 16. . But the impact of the Asian crisis on the real estate and property sector was much smaller than that on the manufacturing sector.9 billion and P24.2 12.1 24 42.4 19. respectively.3 Retained Earnings 17.4 Source: SEC-BusinessWorld Annual Survey of Top 1. 1996 to P56.8 41.3 5. 1988-1997 Utilities Real Estate and and Services Property 39.4 16.0 21.9 17.0 23.1 2.6 Total Liabilities 18.2 8.3 55. The sector’s buildup in equity during the stock market boom of 1994-1996 may have cushioned the impact of the crisis. Its knock-on effect on the economy was small as it accounted for less than 3 percent of the top 1. Vol.7 83 2.7 10.6 Financial Ratios (%) Leverage 142 181 ROE 13.7 percent to 10.2 37.4 3.9 5.1 10. and was also much more limited compared with the property sectors in other Asian countries.8 Stockholders’ Equity 21.0 Turnover 112 24 Net Profit Margin 5. of Company 454 17 Sales per Company (P billion) 1.000 Corporations in the Philippines.9 2.9 2.7 Net Income (12.6 No.2 28 0.4 Total Assets 19.6 Growth Indicators (Compound Annual Growth Rate.7 192 9.7 28. various years.166 Corporate Governance and Finance in East Asia.6 69 16. With a modest increase in total liabilities and leverage level of less than 100 percent in 1997.4 percent.7 billion in 1997. As a result.2 45.7 19.7 52.7 Growth and Financial Performance of the Corporate Sector by Industry.5 12.9 23.7 ROA 5.8) 17.0 31 0. the sector’s ROE dropped from 15. it does not appear to have been excessively exposed to foreign currency-denominated loans. II Table 3.3 20.0 25.3 Fixed Assets 20.8 48.000 companies’ total sales on average during 19881997.7 Indicators Manufacturing Construction 27.5 Other Indicators Share in Sales (%) 82.
and dissolution of corporations. and (viii) names. the leverage of all four industries was low. and amount subscribed and paid by each. and the Insolvency Law. The General Banking Law. par value.Chapter 3: Philippines 167 The utilities sector had the second highest leverage during 19881997 at 181 percent on average. the ownership of Filipino citizens in the corporation is not less than the legally required percentage of capital stock. Corporation Code of 1980 Supplanting the old Corporation Law of 1906.3 which serve as the company’s declaration that the minimum percentage of authorized capital required by law has been subscribed and paid-up. contains some provisions affecting corporations’ dealings with banks. which is also the organic law governing the operations of SEC. and restrictions. The currency devaluation bloated the foreign currency-denominated loans of these companies. and recognized rules on corporate practices. operation. 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. Two other pertinent laws are Presidential Decree (PD) 902-A.2. the Corporation Code of 1980 is a compilation of important juridical rulings. privileges. (iii) principal office. and amount of authorized capital stock. Under the Code. and residences of incorporators and directors. (ii) purpose of the corporation. (v) number of directors (not less than five nor more than 15). and residences of original subscribers. It specifies the minimum information to be indicated in the articles of incorporation. which was based on American corporate law. the Code requires a corporation 3 A company’s articles of incorporation should include: (i) corporate name. (iv) term of existence. administrative regulations. It provides the basic constitutional structure for the organization. Overall. One month after registration.3 Legal and Regulatory Framework The Corporation Code of 1980 is the main law governing the corporate sector. (vi) names. 3. The articles of incorporation may also include other matters such as waiver of preemptive right and classes of shares such as founders’ or redeemable shares describing their rights. For publicly listed companies. the Revised Securities Act (RSA) and PSE’s public listing requirements also apply. reaching up to 313 percent in 1997. (vii) number. which regulates banks and nonbank financial institutions except insurance companies. . nationalities. unlike in neighboring countries hit by the Asian crisis. nationalities.
(iv) time for holding annual election of directors and manner of giving the election notice. directors. must be general. (v) manner of election or appointment and term of office of all officers other than directors. duties.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. the bylaws must be consistent with the law. However. (ii) controversies arising out of intra-corporate relations. and compensation of directors. and reasonable. 4 Some of the items that a corporation may provide in its bylaws are the following: (i) time. (iii) qualifications. and control (adjudicative) of all corporations. Its mandate is to supervise corporations in order to encourage investments and protect investors. A majority of the outstanding shares of shareholders must vote to authorize amendments to the bylaws. 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. shareholders may delegate this power to the board of directors by a two-thirds vote of outstanding capital stock. officers. PD 902-A expanded SEC’s mandate to include absolute jurisdiction. To be valid. or officers. (ii) required quorum in shareholders’ meetings. In addition. manner of voting. and between the corporation and the State concerning its franchise or right to exist. and should not impair vested rights. among shareholders. II to adopt a code of bylaws or rules for its internal governance. . and (vii) manner of issuing certificates in the case of stock corporations. In 1976. Vol. and public policy. supervision (regulatory). uniform. and manner of calling and conducting regular or special meetings of the directors and shareholders. 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. Securities and Exchange Commission: PD 902-A SEC is the government agency responsible for implementation of the Corporation Code. (iii) controversies in the election or appointments of directors and officers of corporations. between the shareholders and the corporation. the corporation’s articles of incorporation. (vi) penalties for violation of the bylaws. It implements rules and regulations that protect minority shareholders from possible fraud and misbehavior by controlling shareholders.168 Corporate Governance and Finance in East Asia. and forms of proxies and manner of voting them. place. and employees.
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The last item of PD 902-A is the special jurisdiction granted to SEC over applications by corporations for “suspension of payments” to creditors, a role of the regular courts that was originally part of the Insolvency Law. Under this authority to approve applications for suspension of payments, SEC has the power to appoint rehabilitation receivers or management committees for petitioning corporations. A presidential writ issued in 1981 placed SEC under the supervision of the Ministry of Finance, but in 1998, control of the agency was returned to the Office of the President. Insolvency Law The Insolvency Law is designed to effect an equitable distribution of insolvent debtors’ properties among their creditors. It permits debtors to be discharged from their liabilities to enable them to start afresh with property set apart for them from assets to be used as payment to creditors. The regular courts have jurisdiction for insolvency proceedings including suspension of payments for individual debtors. A debtor can petition the court to suspend payment of debts or to be discharged from liabilities and debts by voluntary or involuntary insolvency proceedings. Revised Securities Act: Law on Securities Dealing Like its predecessor, the 45-year-old Securities Act, the RSA was patterned after several US securities acts. The RSA is primarily designed to prevent the exploitation of investors through the sale of unsound or fraudulent securities. For this purpose, the law requires full and accurate disclosure of all material facts concerning the issuer and the securities it proposes to sell, and prohibits misrepresentations, manipulations, and other fraudulent practices in the sale of securities. To enforce these regulations, the law requires the registration of securities. The registration requirement covers full and accurate disclosure of the character of the securities to be sold to the public, including detailed information regarding past dealings between the issuer and its directors, officers, and principal shareholders. Public Listing Rules of the Philippine Stock Exchange PSE is the country’s facility for secondary trading of shares of publicly listed companies. In 1998, SEC, which originally supervised PSE, granted the exchange the status of a “self-regulated” organization. Thus, PSE now
170 Corporate Governance and Finance in East Asia, Vol. II
has the authority, within general guidelines set by SEC, to set rules and regulations for PSE members and listed companies. The general requirements for maintenance of listed status include submission of financial reports that conform with generally accepted accounting principles (GAAP) and regulations established by PSE, and compliance with laws relating to securities and exchange regulations, board resolutions, and agreements executed with the agency. Violations of PSE requirements are subject to sanctions, including delisting. PSE is responsible for ensuring that listed companies follow the exchange’s rules of disclosure and fair treatment of investors. It has the power to impose sanctions on any company that fails or erroneously discloses material information that affects the rights and benefits of investors and misrepresents information in its application, prospectus, financial statements, or reports. In the area of corporate governance, PSE requires corporations to resolve, and, where possible, eliminate arrangements within groups of companies and own-company dealings that can lead to conflicts of interest. Upon complaints by minority investors, PSE can review the deals in question, using such criteria as benefits to the company, adequate disclosure to shareholders, and internal control procedures to ensure fair and reasonable terms. Banking Laws Affecting Corporations Some aspects of banking laws affect the governance of corporations. The important ones concern: (i) the capacity of officers of corporations to assume positions as members of the board of directors of banks, (ii) limits on ownership of banks by nonfinancial corporations, (iii) limits of lending by banks to corporations, and (iv) rules on lending to directors and other insiders. The General Banking Law governs the regulation of the establishment, management, and operations of banks. As the highest policymaking body of the banking system, the Monetary Board prescribes the qualifications of bank directors and reviews the qualifications of those appointed as bank directors and officers. It could disqualify anyone found, for whatever reason, unfit for the position. There are no other restrictions on corporate officers to be appointed as members of the board of directors of banks. A corporation, including its wholly or majority-owned subsidiaries, can own common shares of banks up to a maximum of 30 percent of banks’ voting stock. In the event that the corporation is majority-owned by one person or by relatives, the limit is 20 percent of banks’ voting shares.
Chapter 3: Philippines 171
Regulations on the single borrower limit (SBL) put a ceiling on the maximum amount that a bank can lend to a debtor. SBL rules limit the total liabilities of any borrower of a commercial bank to 15 percent of the bank’s unimpaired capital and surplus, and an additional 15 percent for “adequately secured loans,” to a maximum 30 percent (“unimpaired capital and surplus” refers to the total paid-in capital, surplus, and undivided profits, net of valuation reserves of a bank). SBL limits exclude risk-free loans such as Government-guaranteed loans and loans secured by cash deposits. Total corporate liabilities include all liabilities of the debtors and their majorityowned subsidiaries. The Monetary Board may prescribe the consolidation of the liabilities of subsidiaries with the parent corporation under certain conditions. Central Bank (Bangko Sentral ng Pilipinas [BSP]) regulations do not prohibit loans by the bank to its directors, officers, shareholders, and other related interests, known as DOSRI. However, they are subject to certain prudential requirements under banking laws, as follows: (i) a director or officer of a bank can only borrow or become a guarantor, endorser, or surety for loans from the bank with the written approval of all other directors of the bank (i.e., excluding the director concerned); (ii) the amount of outstanding credit accommodations that a bank extends to its shareholders shall be limited to an amount equal to the sum of their unencumbered deposits and book value of their paid-in capital contributions; and (iii) loans and advances given to officers in the form of fringe benefits shall not form part of liabilities under DOSRI.
Corporate Ownership and Control Patterns of Corporate Ownership
The historical development of Philippine corporate ownership is rooted in the country’s colonial past, the industrial policies of the Government, and the recent emergence of industrialists and an entrepreneurial class. During the Spanish and American period up to World War II, a small number of families acquired land and owned large businesses. These families built and preserved their businesses over several generations. Many of them became controlling shareholders of family-based corporations and business groups that are major players in the present-day Philippine corporate sector. Ownership is a key element in corporate control and governance. Public listing rules of PSE require that a minimum of 10 to 20 percent of
172 Corporate Governance and Finance in East Asia, Vol. II
outstanding shares, depending on the size of the company, be available for trading in the stock exchange. As companies usually only issue the minimum required number of shares, large blocs of controlling shareholders often dominate corporate decision making in publicly listed companies. Public investors and minority shareholders are not in a position to influence management. Moreover, the presence of large controlling shareholders makes takeovers by other companies difficult. For these reasons, the resolution of conflicts between the interests of controlling shareholders, minority shareholders, public investors, and creditors in Philippine companies depends very much on the effectiveness of internal control systems. Ownership Concentration of Listed Companies This study measures ownership concentration in terms of shareholdings by the top one, five, and 20 shareholders.5 Table 3.8 shows that the top shareholder owned 40.8 percent of the market value of an average nonfinancial company. The shareholding of the top shareholder varied across sectors. It was highest for the property sector at 54.8 percent, followed by holding companies (as a sector) at 53 percent. One shareholder held majority control of an average company in these two sectors. The average shareholding of the largest shareholder was less than 25 percent only in sectors with large market capitalization, such as power and energy, and transportation, and in sectors with high risks, such as oil exploration and mining. These figures suggest that for publicly listed companies, a single shareholder often has substantial or even dominant control. Combined, the holding of the top five shareholders in an average company was about 65.3 percent for the nonfinancial sector and 59.2 percent for the financial sector. The five largest shareholders held majority control over an average Philippine publicly listed company, except in three sectors—transportation; food, beverage, and tobacco; and oil exploration. Ownership by the five largest shareholders was on average most concentrated among holding companies (78.4 percent), and in construction (74 percent), property (69.8 percent), manufacturing and trading (68.4 percent), and communications (67.3 percent).
The study derived ownership data for 194 (169 nonfinancial) companies out of 221 (190 nonfinancial) listed on the Philippine Stock Exchange as of 1997. Shareholdings by the top one, five, and 20 shareholders were estimated for each company and averaged by using the market capitalization of each company as a weight.
Chapter 3: Philippines 173
Table 3.8 Ownership Concentration of Philippine Publicly Listed Companies by Sector, 1997
Sector Financial Institution Banks Financial Services Average Shareholdingb Nonfinancial Company Communication Power and Energy Transportation Services Construction and Other Related Products Food, Beverage, and Tobacco Holding Companies Manufacturing, Distribution, and Trading Hotel, Recreation, and Other Services Property Mining Oil Average Shareholdingb
Top 1 26.9 41.3 27.2 35.4 21.5 23.8 47.7 22.7 53.0 37.4 28.9 54.8 23.4 19.9 40.8
Top 5 59.2 63.2 59.2 67.3 55.4 48.4 74.0 44.1 78.4 68.4 55.3 69.8 56.0 45.1 65.3
Top 20a 76.4 65.8 76.2 76.9 72.1 69.2 86.2 69.7 86.0 42.6 68.0 74.5 51.9 64.3 75.9
Information on the top 20 shareholders is not available for five holding companies, 10 manufacturing companies, and two property companies. b Weighted by market capitalization. Source: PSE databank.
The shareholding of the 20 largest shareholders in an average company was 75.9 percent for the nonfinancial sector and 76.2 percent for the financial sector. In 12 out of 13 sectors, the top 20 shareholders owned more than 50 percent of the voting shares of an average company. In 10 out of 13 sectors, the top 20 shareholders held more than a two-thirds majority control of an average company. Ownership Concentration at Critical Levels of Control PSE listing rules require that a minimum of 10 to 20 percent of outstanding shares of a company be issued to the public, depending on its size. An interesting question is whether in reality Philippine publicly listed companies issue enough shares to be truly widely held or whether they barely meet this minimum requirement. The answer to this can be gleaned from an
With such high levels of ownership concentration. Who are the top one. The shares of publicly listed companies are thinly traded and illiquid.10. controlling an average of 52. a single shareholder held two-thirds majority control. In four companies. Table 3. the top 20 shareholders collectively owned a majority of a company’s shares. In four of 11 nonfinancial sectors. nonfinancial corporations held majority control. 66 percent (signifying strategic control). or about 30 percent of the total. the top five shareholders owned more than 50 percent of the voting shares. Parent companies usually spin off operating units into new companies that they continue to control as affiliates.174 Corporate Governance and Finance in East Asia. In 111 companies. the top five controlling shareholders were classified into eight groups. In 21 companies. and 20 shareholders? In Table 3. a single shareholder held operating control of a company. a single owner owned more than 80 percent 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 top five shareholders held more than two-thirds majority control of a company. or 3 percent of the total.9 shows that in 44 companies. The limited volume of shares issued to the public is one of the causes of the underdevelopment of the Philippine stock market.2 percent of outstanding shares of publicly listed companies. Vol. and share prices are sensitive to movements of foreign funds. Nonfinancial corporations with controlling shareholdings are likely to be holding companies. II analysis of the number of companies in which the top one. including pure holding companies. or 78 percent of the total. or 20 shareholders owned more than 50 percent (signifying operating control). holding only an average of 2. large and family-based shareholders pool the family’s ownership over many . In 76 companies. Through these. five. or almost 75 percent of the total. or 80 percent (only nominally publicly listed) of outstanding shares. five. The largest group is nonfinancial corporations. or 14 percent of the total. Composition of Ownership of Publicly Listed Companies Another important issue concerning corporate ownership is the composition of the controlling shareholders. In 116 companies. Individuals did not constitute a significant shareholder group among the top five shareholders. or 51 percent of the total. There are advantages to establishing pure holding companies. which are mostly privately owned and controlled by family-based shareholder blocs.1 percent of publicly listed companies in the Philippines in 1997.
and Tobacco Manufacturing. . a Data for top 20 shareholders were not available for five holding companies.Table 3. 10 manufacturing companies. and Trading Holding Power Transportation Property Total — = not available. and two companies in the property sector.9 Ownership Concentration at Critical Levels of Control Over Publicly Listed Companies. Distribution. Beverage. Source: PSE databank. 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.
2 3.0 5.3 0.0 0.1 5.6 12.2 10.8 11.0 2.7 3.2 0.6 33.6 9.2 5.0 0. Distribution.0 1.8 66.0 0.0 5.8 21.1 1. and Trading Hotel.1 0.5 4.2 0.5 2.0 5. and Tobacco Holding Companies Manufacturing.6 5.2 3.3 1.6 2.0 0.2 59.1 6.5 4.1 0.4 1.0 0.5 0.2 0.6 0.0 1.6 0.0 5.0 0.1 7.0 0. Recreation.0 10.5 13.8 0.4 19.5 26.7 0.2 3.5 53.7 0.7 3.6 0.8 0.0 0.1 9.10 Composition of Top Five Shareholders of Philippine Publicly Listed Companies by Sector.7 67.0 2.0 1.2 3.9 0.Table 3.6 0.8 0.9 36.0 45. .3 0.9 6.3 12.0 0.2 0.0 1.3 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.0 7.0 1.7 0. Beverage.3 26.3 2.1 8.0 1.5 12.0 0.7 0.0 1.3 0.3 0.2 0.7 1.6 0.3 0.3 5.0 4.0 0.7 0.1 a Weighted by market capitalization.0 0.6 2.6 0.0 0.7 0.4 2.4 29.4 0.6 18.6 0.5 0.4 5.6 1.9 52. Source: PSE Databank.0 1.0 0.2 1.9 0.3 1.3 37.4 8. and Other Services Property Mining Oil Average Shareholdinga 33.0 0.
6 percent of market capitalization in 1997. and insurance companies (0.Chapter 3: Philippines 177 companies and share in the risks and profits of the group. These are mainly the Social Security System (SSS) and the Government Service Insurance System (GSIS). This complex layering of ownership masks the identity of individuals or families that actually own and control operating companies. .7 percent of market capitalization of the nonfinancial publicly listed companies. commercial banks (1. These include Philippine Long Distance Telephone Company (PLDT) in telecommunications.3 percent). Holding companies as a sector had the largest market capitalization in PSE in 1997. Funds of SSS and GSIS consist mainly of compulsory contributions from members of the country’s private sector and government workforce.6 billion or 26. financial institutions did not have a significant ownership in nonfinancial corporations.1 percent). respectively.2 percent in 1997. The 7.2 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. These institutions keep a stock portfolio mostly in shares of a few companies with large capitalization and high liquidity in select industries. accounting for P258. Investment trust funds were the most important institutional investors. and San Miguel Corporation (SMC) in food and beverages.5 to 12.7 percent of shareholdings). with an average of only 7. They can also better manage their income taxes because income from affiliated companies passes through a holding company. Holding companies were themselves 66 percent owned by other nonfinancial corporations. Because of limited ownership by institutional investors. Insurance companies were very minor investors in the stock market because prudential regulations prevent them from investing significant amounts even in equities of large companies. The financial institutions among the top five shareholders of nonfinancial corporations are investment trust funds (with 4. while still allowing the public to own minority shares. Such advantages have contributed to the popularity of holding companies among publicly listed companies. As a group. The investment funds’ presence in these sectors ranged from 8. there was no real market for investment information. The Philippine capital market did not have an active analyst community comparable to those in more developed capital markets. securities brokers (1. 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.1 percent).
More than three fourths of the respondents are either a parent or subsidiary (about 70 percent of these are domestic nonfinancial companies). However. Still. This is significant considering that there were only 31 local commercial banks in the country in 1997. Corporate financing depends on intermediation by banks. the Central Bank’s reforms are probably changing the conduct but not necessarily the structure of the banking system. The Central Bank deregulated interest rates and foreign exchange. This could further increase the concentration of ownership and expand the scope of own-group lending by these larger banks. but they comprised only 23. remain in force to control excessive lending of banks to insiders. Foreign banks have a growing presence but have not necessarily increased the supply of credit to the corporate sector.000 corporations’ sales. including 16 commercial banks. For this reason.178 Corporate Governance and Finance in East Asia.000 companies. and tracked the financial performance of each company from 1992 to 1997. Some 20 financial institutions were affiliated with these groups. All major industries were represented. 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. Prudential regulations.11).6 The total sales of these groups in 1997 were estimated at P806 billion (Table 3. To understand the ownership and governance characteristics of family-owned business groups. including SBL and DOSRI rules. The process identified a total of 238 companies belonging to 39 business groups from the SEC-BusinessWorld Annual Survey of the Top 1. . suggesting that most publicly listed companies are parts of business groups.7 6 7 The study used publicly available shareholder information and published reports.000 Corporations in the Philippines. so far limiting their involvement to selected products. Family-based groups have larger companies since their total sales were about 33. identified the companies belonging to each of these groups. Vol. a nonfinancial company that owns a commercial bank has better access to loans at favorable rates and terms. Large shareholders and their families own these banks directly or through their controlled companies. A common feature of corporate ownership of a business group is the centrality of a commercial bank. Most family businesses that went public did so because they wanted to raise capital and to gain the prestige associated with being a public company. suggesting that business groups are common in all major markets. the study put together a list of prominent business groups. of the financial resources in the country. Banks that are members of business groups have an advantage in raising funds from the internal capital market of the group. Commercial banks hold the largest share. liberalized the regulations on entry of foreign bank branches and foreign ownership of local banks. using data on the Philippines’ top 1.4 percent of the top 1. about three fourths.8 percent of total companies in number. and increased the capital requirements for all types of banks. many companies in family-owned groups are not publicly listed.
which was majority-owned by the Henry Sy group. for the Gokongwei Group. Commercial banking contributed about 40 percent of group profits for the Ayala group and Gokongwei group. the top 10 family-based business groups had only 119 companies in the top 1.12). or an average of about 12 per group. with the exception of Banco de Oro. the study used the four largest business groups—Ayala. Commercial banks are often affiliated to a particular business group. a substantial proportion of group profits came from its financial subsidiaries. To show this. the nonfinancial sector was real estate (60. the principal owner of SMC. Lopez. Family-based business groups are most dominant in sectors such as manufacturing. The main constraint may be the availability of family members that could be drawn for top management positions. ranged according to their sales (Table 3. 25 out of the 50 top corporate entities were familybased groups. Together. Gokongwei. in most . Cojuangco. the biggest private company in the Philippines.8 percent). with 27 affiliated companies in the top 1.000. Lopez. It is also noteworthy that. for the Lopez group. retail merchandising (69.2 percent). In terms of sales. For the Ayala group. the largest family-based business group was the Ayala Corporation Group. and banking. construction. an average group in the Philippines has fewer member companies. including business groups and independent companies. for each of these groups. In the meantime. Foreign-owned companies mainly serve the export markets. and for the Henry Sy group. In terms of number of companies. and Henry Sy—as examples. real estate. These corporate entities accounted for 53. In 1997.Chapter 3: Philippines 179 Compared with other Asian countries. Also. Interlocking Relationship between Financial and Nonfinancial Firms Although financial institutions as a whole did not own directly significant proportions of shares of nonfinancal corporations in the Philippines.000 corporations in 1997.4 percent of the group’s 1997 profits). as discussed in previous sections. the largest was the Eduardo Cojuangco group. nonfinancial companies contributed about 36 to 60 percent of total profits for these groups. the three largest entities were family-based groups. broadcasting (49. namely. and more than 20 percent for the Lopez group and Henry Sy group. the two were closely related through their affiliations to business groups. The significance of family-based business groups in the Philippine corporate sector is immediately evident in the 50 largest corporate entities. Significantly. and Ayala. it was manufacturing (36.6 percent of the total sales of the top 1.1 percent).000 companies.
15. 13.5 46.7 98. of Affiliated Companies Total Sales (P billion) 123.6 3.5 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. Beverages.6 7. and food Food. Sector Orientation.0 Average Sales Per Company (P billion) 6.1 2.5 13. 2.1 4. coconut oil.1 4. and Affiliated Bank of Selected Business Groups. 14. beverages. 11.5 26.4 6.3 3.9 3. Group George Ty John Gokongwei Henry Sy Lucio Tan Ramon Cojuangco Family Group Del Rosario/Phinma Group Zuellig Group First Pacific/ Metro Pacific Group Aboitiz Family Group Jose Concepcion/RFM Group Alfonso Yuchengco Andres Soriano Family Group George Go Wilfred Uytengsu/ General Milling Group David M. 6.5 49.9 2. and tobacco Telecommunications Cement and construction materials Pharmaceutical and distribution 12. and tourism Credit card 18. and personal care prods Shipping. food. 5. agriculture. and packaging Power distribution and mass communications Real estate.2 1. 3. power. 4. Real estate. construction.4 10. and dairy products Investments.0 5.11 Total and Per Company Sales.5 47. and car manufacturing Car manufacturing and real estate Food and telecommunications Department store and real estate Airlines. real estate.0 17. Consunji 4 3 Food and dairy products Construction and mining 10.Table 3.4 . 9.5 2.6 2.3 11.2 1. 10.8 84.3 15.6 3.0 26. telecom. food.2 16.3 2. Eduardo Cojuangco Lopez Family Group Ayala Corp.4 48.5 6. and mining Management. beverages.5 17. Flagship Company. 17. 7. 16.0 13. 8.
4 1.7 3. mining.5 8.0 1. 22.19.1 1.2 4. 31.1 1. 23.0 5. 38. 37.9 0. SEC-BusinessWorld Annual Survey of Top 1.7 1.2 6.4 3. Enrile/JAKA Group Jaime Gow Guoco Group Jose Go Jardine Davies Gerardo Lanuza Alfredo C. . 25. and real estate Retail merchandising Ceramics and real estate Department store and real estate Cement and sugar central Real estate and securities trading Bookstore. 27.3 2.9 1. 36.1 805.8 1.9 1.6 5. distribution.3 7.8 1.8 1.7 0. 39. and various company annual reports.6 2.3 2.1 0.0 2. P.9 0. 29.9 6. 26. 33.7 4.4 5.4 3. 35.8 Jollibee Foods Luis Lorenzo Family Group Alcantara Family Group Bienvenido Tantoco Elena Lim Andrew Gotianum Brimo Family Group Andrew Tan J. 28. 20. 24.2 1.5 2.8 6. 4 238 1. 32.9 7.6 0. 34.7 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. Cruz Jose Luis Santiago Keppel Group Robert John Sobrepeña/ Fil-Estate Group Total Real estate Sources: PSE Databank.6 Fast food Beverages and agro-industrial products distribution Cement and wood products Retail merchandising Electronic appliances Real estate Mining Real estate Telecommunication.000 Corporations (1997). 21.6 3. Ramos Gaisano Family Group Felipe Yap Felipe F. 30.7 0.1 2.0 0.9 1.
13. 11.Table 3. 14. Sector Orientation. 4. Long Distance Telephone Phinma Zuellig Pharmaceutical Metro Pacific William Gothong and Aboitiz Swift Foods/RFM House of Investment Anscor Equitable Card Network Inc. 18. Alaska Milk Corporation DM Consunji. Jollibee Foods Corporation Pepsi Cola Products Alsons Cement . 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. 19. 1. 20. 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. Flagship Company. 7. 6. 17. 8. 5. and Affiliated Bank of Selected Business Groups. 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. 3. 2. Uytengsu/General Milling Group David M. Inc.11 (continuation) Total and Per Company Sales. Eduardo Cojuangco Lopez Family Group Ayala Corp. 12. 10. 21. 9. 16. 15.
39..48 billion. medium = P1. Fil-Estate Development Inc. 25. F. 24. 33. unless otherwise indicated. 31.000 Corporations (1997). and various company annual reports. Cruz & Co. 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. 32. Refers to commercial banks.48 billion. a b Size class is measured in terms of sales: Large = greater than P4. SEC-BusinessWorld Annual Survey of Top 1. 23.65 billion to P4. 28. 29. Enrile/JAKA Group Jaime Gow Guoco Group Jose Go Jardine Davies Gerardo Lanuza Alfredo C. P.East-West Bank International Exchange Bank Ecology Bank (Savings Bank) Dao Heng Bank Orient Bank International Exchange Bank International Exchange Bank Philbanking Corp. 30. 37. 34. small = less than P1. 26. Kepphil Shipyard Inc. 38. Ramos Gaisano Family Group Felipe Yap Felipe F. . 35. Sources: PSE Databank. 27. PT&T Corp. Keppel-Monte Bank Bienvenido Tantoco Elena Lim Andrew Gotianum Brimo Family Group Andrew Tan J.65 billion. 36. 22. Inc.
0 24. 22.8 84. telecommunication.8 22. 18. Philippine National Bank Mercury Drug Corp.7 98.1 17.0 37.5 26. 19. of the Phils.). 15.6 26. agriculture.5 77.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. Inc. 5.5 44. food. 9.12 Control Structure of the Top 50 Corporate Entities. car manufacturing. 8. Eduardo Cojuangco Lopez Family Group Ayala Corporation Group National Power Corp. 13. and food Food. Del Rosario/PHINMA Zuellig Group Toshiba Information Equipment (Phils. 4.). Beverages. and dairy products Investments. 2.1 60.0 38.8 53. and mining Gold and other precious metal refining .Table 3. and telecommunications Department store and banking Airlines. 1997 Sales (P billion) Control Structure Major Industrial Orientation 123. mass communications. 10. Inc. 17. bank. First Pacific/Metro Pacific Group 21. banking.5 17. construction.2 Business Group Business Group Business Group Government. beverages. Aboitiz Family Group Jose Concepcion/RFM Group Alfonso Yuchengco Philippine Associated Smelting and Refining Corp. and bank Real estate. coconut oil. beverages.4 48.3 15.5 46. 7. food.6 18. 16.5 15. 3. and real estate Banking. 11. 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. 23.2 16. Fujitsu Computer Products Corp. 20. Texas Instruments (Phils. Petron Corporation Pilipinas Shell Petroleum Corporation George Ty John Gokongwei Henry Sy Lucio Tan Ramon Cojuangco Family Group Caltex (Philippines) Inc. 24. and personal care products Shipping. food. and packaging Power distribution. power. and car manufacturing Power Refined petroleum products Refined petroleum products Banking.4 19. 6. 14.5 47. 12.2 49.
39.5 8.9 14.0 11. and other grains wholesaling Other amusement and recreational activities Motor vehicles Food and dairy products Construction and mining Television and radio transmitters.5 8. radio and remote control apparatus Fast food Bank Beverages and distribution of agro-industrial products Drugs and medicines. 46. 41.0 13. 9. 47. EAC Distributors Inc.7 10. Uytengsu/General Milling Group David M. 28. 14. 36.9 7. Inc.7 10. 29.3 13.6 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.6 1. W.000 Corporations (1997). 49.6 9. . 42.7 13.2 7. 45.0 12. PSE Databank.4 8. real estate. corn (unmilled).8 9. 37.A.1 9. 50.3 8. Inc. and tourism Banking Radar equipment and radio remote control apparatus Operation of rolling mills Palay. 35. 27. 34. and various company annual reports. 40. 48. Inc. National Steel Corporation National Food Authority Phil.0 5.8 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 38.4 10.290 53.. 30.25.6 12. 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. and apparatus for line telephony and line telegraphy Tobacco products wholesaling Cigarettes Radar equipment.9 6. Philip Morris Philippines. 43.5 10. Consunji Uniden Philippines Laguna.8 6.9 7. 33. including biological products Bank Cement and wood products Retail merchandising Electronic appliances Mining Real estate Sources: SEC-BusinessWorld Annual Survey of Top 1. 31. Amusement and Gaming Corporation Mitsubishi Motors Phils. Jollibee Foods Citibank N. Corp. 44. Philips Semiconductors Phils. 32. 26.000 Companies Sales (%) Cigarettes Bank Soap and detergents Management.
The review is based on an ADB survey of listed companies in the Philippines conducted in 1999 for this study. issuance of stocks. . However. approval of management contracts. shareholder voting in general meetings and legal protection of their rights. sale or disposition of a substantial portion of corporate assets. Vol. amendments in the bylaws. these were dispersed shareholdings. issuance of corporate bonds. the board of directors plays a crucial role in corporate governance. to the corporation and its shareholders for damages caused if they agree to unlawful corporate acts. Shareholders limit the broad power of the board by ratifying their decisions on critical corporate affairs. Of course. voluntary dissolution. 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. Actual control of the banks was still held by the groups.3. and financial disclosure. This section reviews practices of corporate management and shareholder control in Philippine publicly listed companies. determination of compensation to board members. A total of 44 companies responded to the survey (out of about 221 financial and nonfinancial listed companies). although public investors held a majority of shares. 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.2 Corporate Management and Shareholder Control The main mechanisms by which shareholders control corporate management are the board of directors. investments of corporate funds in other companies or purposes. accounting and auditing. such as amendments of the articles of incorporation. business groups had only minority ownership. II publicly listed commercial banks affiliated to these groups. The Philippine Corporation Code mandates the board of directors to exercise its control over a corporation. and declaration of cash dividends. corporate mergers or consolidations.8 The Board of Directors As the representative of shareholders in a company. appointment and compensation of senior executives. removal of directors. jointly and individually. They are likewise liable if they pursue financial interests that conflict with their duty as directors. 3.186 Corporate Governance and Finance in East Asia. The Corporation Code holds members of the board of directors liable.
with a maximum of 36 percent. a typical chairperson owned 3 to 5 percent of outstanding shares of a company on average. The average stipulated term of office of the chairperson and members of the board for most responding companies was one year. More than half of respondents indicated that board directors were elected during the shareholder general meetings. board directors were the founder of a company. protecting shareholder interests.9 percent). or a per diem for meetings (18 percent). or representatives of creditors. Respondents of the ADB survey ranked the following as the most important responsibilities of the board: making strategic decisions. appointed by the Government.7 percent). In a few cases. The longest was 27 years for board chairpersons and 14 years for board directors. ensuring that a company follows legal and regulatory requirements. appointing senior management. a fixed fee plus performance-related bonuses (30 percent). . The majority of respondents indicated that board directors and chairpersons were elected mainly on the basis of either relationship with major shareholders (31. The ADB survey results show that a chairperson is compensated either by a fixed fee (52 percent of respondents).6 for board chairpersons and 7. The ADB survey shows that the number of board directors ranged from six to nine among the responding companies. Board chairpersons in a substantial number of responding companies did not own significant amounts of shares in their personal capacities. Making day-to-day management decisions was not regarded as an important board responsibility. and determining remuneration for board directors and senior management. According to the ADB survey. or the Government without approval by shareholder general meetings.5 for board members. or percentages of shareholdings (28.Chapter 3: Philippines 187 actual practices of board functions and the role of shareholders may diverge somewhat from the legal framework. Such a short tenure may to some extent suggest that large shareholders want to keep their board members under close control. But half of respondents indicated that they also had board directors directly nominated by controlling shareholders or management. in a descending order. the average number of years of holding office was 6. 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. Financial compensation is another means by which shareholders can motivate boards and board members to manage companies in their interests. But professional expertise is also an important criterion (28.7 percent). In practice.
A CEO that was not the chairperson of the board was selected on the basis of professional expertise (42 percent of respondents). Vol. only 35 percent of responding companies have set up board committees. and nomination committees. II Compensation for the chairperson was determined either by the board (54 percent of respondents). 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. namely. the parent company or company bylaws (21 percent). About half of the active committees were audit committees and the other half nomination committees. or management (15 percent). Unlike in Western corporate models. But the independence of these outside directors is often doubtful. When the CEO was not the chairperson. Ninetythree percent of the respondents had one or more outside directors. Senior Executives The Corporation Code does not specify the role and responsibilities of senior executives. The audit committee selects external auditors. There was no case found in the ADB survey where a minority shareholder invoked such a provision of the Corporation Code. negotiates the audit fees and scope of audits.188 Corporate Governance and Finance in East Asia. These committees were established only recently. however. large shareholder-dominated companies often view such committees as unnecessary formalities. The nomination committee searches and reviews candidates for key management positions. CEOs apparently cannot increase their shareholdings because family-based owners restrict the number of shares available to management. It is also not clear whether the outside directors were elected before or after the financial crisis. by tenure and compensation. The ADB survey shows that in 41 percent of the responding companies. This suggests that large shareholders control CEOs by means other than shareholdings. In the ADB survey. The Corporation Code prohibits the removal of any director without cause if that act would deprive minority shareholders of representation in the board. the chairperson of the board was also the chief executive officer (CEO). . the CEO 9 The three most common board subcommittees are the compensation. or amount of shareholding (15 percent). Companies may set up special board committees to strengthen due diligence procedures. In some companies. audit. and reviews the findings of external audits. relationship with controlling shareholders (35 percent). The compensation committee reviews and recommends remuneration plans of key officers and employee stock option plans.9 In practice.
shareholders may exercise appraisal rights. shareholders have preemptive rights to maintain their proportionate ownership of a company under any financing plan that may be undertaken by the company. Companies are not allowed to issue shares with different voting rights. . Fourth. But about 27 percent viewed it to be ensuring steady growth of the company. the Corporation Code requires that the following types of transactions involving potential conflict of interest between shareholders and management be reviewed and approved by the board: (i) dealings of a company with directors or officers. The longest service rendered was 27 years. The “golden parachute” was apparently not a common feature of CEOs’ compensation packages. (iii) invests in another company for a purpose different from that of the corporation. i.e.2 years. Shareholder Rights and Protection Under the Corporation Code. first. including electronic means. and prohibits the removal. (ii) disposes of or mortgages a substantial portion or all of corporate properties and assets. if the CEO’s contract was preterminated. Only one respondent indicated that its CEO was entitled to a substantial amount of compensation. They can vote through proxy. Second. or (iv) enters into a merger or consolidation with another corporate entity. (ii) contracts with companies linked through interlocking directorship. the Corporation Code allows cumulative voting for directors. The average service length of CEOs was 5. shareholders enjoy a number of rights and protection. equal to three years’ pay. without cause. Third.. 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. 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. 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. to help ensure the representation of minority interests in the board. Fifth.Chapter 3: Philippines 189 was not related to the chairperson by blood or marriage in all of the cases except one. of directors representing minority shareholders. and (iii) involvement of directors in businesses that compete with the company. The majority of responding companies compensated their CEOs by using a fixed salary plus a performance-related bonus. About 60 percent of respondents of the ADB survey considered maximizing shareholder values as the CEO’s most important responsibility. Among others.
Although transactions involving potential conflict of interest need to be reviewed and approved by the board. in the Philippines. However. board members are likely to be under pressure to approve transactions that benefit controlling shareholders to the detriment of minority shareholders. Consequently. it is doubtful whether this legal protection for shareholders will achieve what it intends to in practice. that of Interport Resources Corporation. the Corporation Code allows a company to waive this in the article of incorporation upon registration or in a subsequent amendment. In cases of derivative suits against directors for wrongdoings or actions against insider trading. II shareholders are allowed to inspect a company’s stock and transfer books. no one has been successfully prosecuted for insider trading. there are no requirements for disclosing such transactions to shareholders under the Corporation Code. a shareholder could file a derivative suit against a director to redress a wrongdoing. Last. the Revised Securities Act has strict provisions designed to deter insider trading. SEC proceedings were costly and time-consuming. In practice. Vol. But an action by the regular court on a petition by the company’s owners/officers prevented SEC from pursuing the investigation. Few minority shareholders actually exercised their appraisal rights. there were often no real discussions of board proposals or actions. There was little chance that a proposal from minority shareholders could ever get approved. There was only one case. Being appointees of controlling shareholders. because of the dominance of large controlling shareholders. The company was dissolved before indictment. 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. In the case of preemptive rights. During annual general meetings where minority shareholders could exercise their rights. Dissenting minority shareholders did not necessarily have recourse to a third party for an objective appraisal of their shares. hostile takeovers are not common because in most companies ownership is concentrated .190 Corporate Governance and Finance in East Asia. because of poor compliance and enforcement as well as some loopholes in corporate laws. minority shareholders were often vulnerable to the expropriation of their interests by controlling shareholders and management. Regardless of the amount of shares held. 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. Those who did were usually offered below-market values for their shares. where SEC made substantial progress in investigation. In the past. Sixth.
The ADB survey provides further evidence on shareholder rights. Table 3. demonstrates the feasibility of developing a market for corporate control if publicly listed companies were widely held. Nominees held about 45 percent of the outstanding shares.0 63. Table 3. Yes 100. The responding companies had on average 43.2 43. About 333 shareholders per company voted by proxy.0 36.8 92.2 7.8 56.13 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. representing about 24 percent of outstanding shares.2 69.Chapter 3: Philippines 191 in a few controlling shareholders and families.0 51.6 Independence of Auditing The ADB survey revealed that all the responding companies had an independent auditor.4 No 0.522 shareholders each. followed by management and banks. An average of 327 shareholders per company attended the last annual meeting and they represented about 63 percent of total shares. the successful hostile takeover by First Pacific Group of PLDT. 1999. a company that is widely held but has a large shareholder. and their activism in the corporate sector. The brokers or securities companies were the most important proxy voters.900 shareholders per company did not vote during the last annual general meeting. representing 3.6 30. Nevertheless.3 56.8 30.13 summarizes rights that the shareholders of the responding companies enjoyed. About 93 percent of the respondents contracted .7 43. protection.4 70.4 percent of shareholders but 58 percent of outstanding shares. An average of about 4. appointed either by the board or shareholders during the annual general meetings.0 48.
192 Corporate Governance and Finance in East Asia. independent audits do not guarantee the absence of questionable accounting practices. Nevertheless. the US GAAP). with the longest being 50 years. and consolidation policy. The accounting profession in the Philippines is considered fairly developed and Manila is a known regional center for accounting expertise. as practiced in the Philippines). the international accounting standard. and an analysis of financial statements. namely. or the accounting standard of a specific developed country (for example. intangible assets. SEC requires all registered companies to periodically submit reports for the purpose of updating their respective registration statements filed at the agency. foreign currency-denominated liabilities. independent auditors are likely to be quite familiar with the operations and financial aspects of their clients. there are many cases of poor financial reporting by large companies. Meanwhile. intra-company receivables and payables. In practice. Nevertheless. a preferred independent auditing firm either reported assets that did not exist (Victorias Milling Corp. a bankruptcy case) or hid a large amount of liabilities and losses (PLDT. On average. From publicly listed companies. An auditor can choose among three alternative sets of GAAP. . The Code grants a shareholder the right to inspect business records and minutes of board meetings. the local standard (i. the responding companies have been associated with their present auditors for 13 years. Most major international auditing firms operate in the Philippines. II their annual audit to an international auditing firm. imposing penalties on violators. long-term leases. although closely related. 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. revaluation of fixed assets.e. Because of such long relationships.. In two celebrated cases. a management discussion of the business.. vary in their evaluation of some major accounts such as securities and other liquid assets. These different versions of GAAP. investments in subsidiaries. Vol. financial reporting standards allow room for interpretation by independent auditors. a hostile takeover case). the agency also requires reports on important details about their operations and management. More than 20 percent of the respondents have been dealing with their auditors for 20 years or more. the information statement transmitted to every shareholder should contain the audited financial statements.
However. and publicly listed. which are usually controlled by holding companies. Corporate Control by Controlling Shareholders As in many other Asian countries. Laws of many Southeast Asian countries allow the establishment of pure holding companies (with the exception of Korea up to 1999). and financing. marketing.. arguably. the authorities. namely SEC and the Philippine Institute of Certified Public Accountants (PICPA). sometimes did not penalize independent auditors for poorly prepared audited financial statements. Pure holding companies can be privately owned. from a minority-controlled to a majority-owned subsidiary. Family-based controlling shareholders use them as vehicles for controlling business groups. accounting for 27 percent of the total stock market capitalization that year. Such expropriation is due to gaps between control rights and cash flow rights that pyramiding structures of business groups centered on holding companies create. they formed the largest group of corporate entities in the Philippine stock market in 1997.and medium-sized businesses did not have quality financial statements. Publicly available financial information was often of low quality. When control rights exceed cash flow rights. because of the highly concentrated ownership of Philippine corporations.g. The popularity of holding companies in the Philippine corporate sector is evident: with a market capitalization of P258. e. 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. as large shareholders had no need for financial statements to monitor their companies and management that were under their own control. they also make it easier for controlling shareholders to expropriate interests of minority shareholders. They allow risk pooling and can achieve economies of scale in management. “Selective public listing” is a strategy of many business groups for channeling funds from public investors to member companies. Even for widely held public companies. which are closely held by large shareholders and family members.6 billion. Holding companies enable controlling shareholders to collectively own shares of other companies in a business group and to centralize the group’s management. Controlling shareholders usually select member companies that require large .Chapter 3: Philippines 193 Many small. which are controlled by large shareholders with public investors in a minority position.
2 percent. Minority-owned companies may also need access to resources of the group.1). In a passive minority-owned operating company. The first three companies are publicly listed while the fourth. It is majority-owned by Mermac. In an active minority-owned operating company. The stylized features of control structure of business groups in the Philippines can be illustrated by using a leading Philippine family-based conglomerate. minority control at 42. Ayala Land fully owns Makati Development Corporation and holds a minority stake. 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. Selective public listing combined with use of pure holding companies to own and control member companies lead to various organizational structures of business groups. In cases of minority ownership.1 percent of Ayala Land. as an example (Figure 3. the parent company plays an active role in management. These investments can be classified according to the role of the controlling shareholders in the management of the invested company. active minority or passive minority holdings. an active minority share at 44. It has a majority control at 71. Inc. Controlling shareholders gain additional leverage in management control over minority-owed companies.and minority-controlled operating companies are also holding companies. Ayala Corporation.. namely. controlling shareholders of the parent company do not participate in management. especially its management. Ayala Corporation’s majority. . Honda Cars (Philippines). Some holding companies are not pure holding companies.4 percent of Bank of the Philippine Islands.6 percent of Globe Telecom. They are operating companies but at the same time have majority or minority share ownership in other operating companies. and customers. II equity investment for public listing.194 Corporate Governance and Finance in East Asia. a family-owned pure holding company. at 47. financing. Depending on the performance of the company. They may have a representative in the board. controlling shareholders of a parent company hold these shares as “strategic investments” that they could increase or reduce depending on business opportunities. of Cebu Holdings (a publicly listed government-owned company). This is most evident when a minority-owned company transacts with other members of the group where the controlling shareholders hold majority control. and a passive minority investment at 15 percent in Honda Cars (Philippines). is privately owned. controlling shareholders of the parent company may eventually increase their shares to a majority position. Ayala Corporation is a publicly listed pure holding company. with 59 percent of shares. Vol. Public investors collectively hold a minority of 41 percent.
. Inc.06%) <50% >15% &<50% Active MinorityOwned Pure Operating Company Globe Telecoms (44. (47.96%) Privately-Held Pure Holding Company Public Investors (41. Inc. Inc.04%) <50% Ayala Corporation >50% Publicly Listed Pure Holding Company >50% MajorityControlled Operating and Holding Company Ayala Land (71.1 Corporate Control Structure: The Case of Ayala Corporation Family Members 100% Mermac.2%) >50% MajorityControlled Pure Operating Company BPI Family Savings Bank (100%) <50% MinorityControlled Pure Operating Company Note: Data as of 31 December 1998.6%) <15% Passive MinorityOwned Pure Operating Company Honda Cars Phils.. (58. (15%) MinorityControlled Operating and Holding Company Bank of the Philippine Islands (42.Figure 3.44%) >50% MajorityControlled Pure Operating Company Makati Development Corporation (100%) <50% MinorityControlled Pure Operating Company Cebu Holdings.
1999b.10 The Ayala family’s control rights over BPI was 1. Generally. and Larry H. Who Owns and Controls East Asian Corporations? 11 Ibid. H.14%] / [6.7 times its cash flow rights by virtue of the double layer pyramid structure of the Ayala group. indirect shareholdings do not appear to be a prevalent practice in the Philippine corporate sector. Joseph P.7 times its cash flow rights by virtue of its cross-holdings via Benpres and First Holdings. See also Stijn Claessens. MERALCO. Rockwell Land. The control of companies through indirect corporate shareholdings.98% x 42. a privately owned company. P. 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.8%] 5.64%) + (37.196 Corporate Governance and Finance in East Asia. Diversification and Efficiency of Investment by East Asian Corporations. companies in the Lopez Group are large and minority-controlled. however. [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. they exercise far greater control (two to five times more) than they are entitled to by virtue of their ownership rights.5%] / [(88.11 The Lopez family’s control rights over MERALCO was 5. The Separation of Ownership and Control in East Asian Corporations.5%] [39. and 1999c. Fan. Vol. Simeon Djankov. and a minority-controlled holding company. Lang.5% x 14. defined as control by large shareholders of an operating company through minority ownership by several companies. The situation offers large shareholders tremendous incentive to move resources 10 For details. 1998.14%] / [1. P.44%] = [42. Expropriation of Minority Shareholders: Evidence from East Asia.44%] / [25%] = 1.3% x 1. and First Philippine Industrial Corporation are indirectly held by a majoritycontrolled holding company. Being in the public utilities sector. Lang: 1999a. First Philippine Holdings Corporation. II Bank of the Philippine Islands owns 100 percent of the BPI-Family Savings Bank.64% +37. and Larry H. see the World Bank research papers by Stijn Claessens.7 times 12 . is illustrated in the Lopez Group (Figure 3. Benpres Holdings.76%)] [39. Simeon Djankov. [control right] [control rights via Ayala Corporation] = [cash flow right] [cash flow rights via Ayala Corporation] = [42.7 times Ibid.2).44%] / [58.3% x 5.12 These examples show that even when large shareholder groups are minority shareholders.
Inc.5% First Philippine Industrial Corporation 50% 50% Note: Data as of 31 December 1998.Figure 3.3% 11. Privately-Held Pure Holding Company 88. .76% Operating Company MinorityControlled 24.5% Operating Company MajorityControlled Operating Company Rockwell Land Corporation 24.64% MinorityControlled 14.2 Corporate Control Structure: The Case of Lopez Group Public Investors Family Members Lopez.7% 62.5% Minority-Controlled Publicly Listed Pure Holding Company First Philippine Holdings Corporation Benpres Holding Corporation Majority-Controlled Publicly Listed Pure Holding Company Manila Electric Company 1.
198 Corporate Governance and Finance in East Asia. II from their subsidiaries to their majority-owned publicly listed holding company or elsewhere up the pyramid. Control by Creditors According to the ADB survey. Suspension of Payments of Debts Under PD 902-A. The average company. whether for working capital or capital expenditure. 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. Some 85 percent of respondents believed that creditors had no influence or only weak influence on corporate management. accessed nonbank creditors for specific purposes but dealt with commercial banks on a long-term basis. the data suggest. Most responding companies had dealt with their commercial bank creditors for more than five years and nonbank creditors for only about two years. Sixty-one percent of respondents indicated that creditors usually asked for collateral for all types of loans.3. it was not common for creditors to take legal action against debtors or foreclose on those assets held as collateral in cases of default. while 80 percent reported that creditors with which they had renegotiated loans were still willing to lend to them. Vol. a publicly listed company dealt with an average of eight banks and six nonbank financial institutions. Only a minority of respondents (18 percent) indicated that they had faced adverse creditor actions such as a collection lawsuit or foreclosure of collateral. 3. SEC could suspend the rights of a creditor to demand payment from a borrower in accordance with the terms of the loan . Most respondents (81 percent) indicated that they had renegotiated with their creditors on loan repayment when they faced liquidity problems.3 The Role of Creditors in Corporate Control This study examines the role of creditors in corporate control by looking at (i) how corporate borrowers perceive the control power of their creditors. The survey results also revealed that creditors did not intervene in the management of borrowing companies and wanted to maintain business relationships with corporate borrowers even when they were in trouble. However.
including the rehabilitation of the corporation. There are no legal or practical limits to the time period of suspension of payments. a real estate-based business group. the borrower requests to defer payments for a certain period to enable it to generate the necessary liquidity. In practice.4 3.Chapter 3: Philippines 199 agreement. Under this mode. This explains why creditors invariably oppose any move by borrowers to file for suspension of payments at SEC. Publicly listed companies do not represent a cross section of the Philippine corporate . it is not clear whether the corporate borrower’s assets are of sufficient value to cover its liabilities. Inc. PD 902-A granted SEC blanket powers to intervene and adjudicate claims. bank credit is the main source of corporate financing. a company’s assets are of sufficient value to cover all of its debts. which determines the viability of the rehabilitation plan and appoints a Mancom or a rehabilitation receiver to implement the proposal if approved. The borrower will propose a rehabilitation plan to SEC. 3. profitable companies from going public. 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. The second mode is for suspension of payments with the appointment of a management committee (Mancom) or rehabilitation receiver.4.. Commercial banks hold about three fourths of the resources of the financial system. wait for 14 years from the time the company petitioned for suspension of payments in 1984. under which. Markets for equity and debt instruments are small and there are serious structural problems that discourage large. could take an indefinite period. Consequently. the litigation process. SEC could intervene to avoid asset dissipation. The corporation continued to be under rehabilitation receivership as of June 1999. For example. SEC and the court required that the creditors of BF Homes. The first mode is for simple suspension of payments.1 Corporate Financing The Financial Market and Instruments The Philippine financial market has remained underdeveloped compared with other countries in the region. The law on suspension of payments envisions resetting the corporation’s business for a temporary period to prevent its irreversible collapse. There are two modes of suspension of payments under PD 902A. Under such circumstances.
the country experienced double-digit inflation. Foreign portfolio investments also remained small. Malaysia. this is because. while interest rates were at high levels and volatile. about the size of Thailand’s. Most companies invested only in projects that met hurdle rates as high as 20 to 30 percent and had short payback periods. the collapse of the stock market during the Asian financial crisis suggested that the earlier stock price surge in part reflected the “bubbles” common to other stock markets in the region. The market capitalization of the Philippine stock market in August 1997. The corporate sector raised a substantial amount of . They invested in only a few large companies whose shares were relatively liquid. companies expanded only at a moderate pace. the minimum required to qualify as a public corporation.14 shows that the average volume of daily trading in 1997 stood at P2. Philippine companies were less leveraged. Equity financing through IPOs was active. Korea and Thailand). inflation. preferred stocks. The Philippine stock market is not a liquid market. Rising stock prices during the Ramos administration reflected to some extent the business optimism. 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 publicly listed companies issue only up to 20 percent of total shares to the public. II sector.. and fiscal management were among interrelated factors explaining the underdeveloped state of the Philippine financial market.5 billion). The period 1993-1997 was one of lower inflation and declining lending rates. and Indonesia ($61. Even in the real estate sector. From the 1970s up to the early 1990s. Of the 221 companies listed in the Philippine Stock Exchange in 1997. less exposed to foreign debt. compared with other economies. is far ahead of the flock. The Government financed its chronic fiscal deficits by issuing short-term Treasury bills. The crisis affected the Philippine corporate sector. The stock market was depressed up to the early 1990s. and less engaged in risky investments. only 84 had sales large enough to be placed in the top 1. Foreign funds were wary of the Philippine stock market because of its limited liquidity. the Republic of Korea (henceforth.4 billion (or $59 million using the average exchange rate). However. Table 3. Equity instruments include common stocks. especially short-term debt. but not to the same extent as it did in other Asian economies.200 Corporate Governance and Finance in East Asia. Vol.000 companies. In part. most listed companies are controlled by their five largest shareholders. Korea) ($143 billion).7 billion. As a result. and convertible securities. was one of the smallest in the region at $47. compared with Malaysia ($186 billion).g. Interest rates. however.
4 1.0 1.3 — = not available.2 ($ million) — — — — 6.1 0.515.121.2 61.2 1.8 1.2 297.7 2.0 161.7 207.1 88.8 1.474.9 114.9 608.373.4 9.14 Philippine Stock Market Performance.7 391.1 5. Source: PSE databank.421.9 2.3 4.2 0.9 1.0 0.8 102.1 0.2 59.3 59.445.Table 3.3 Market Capitalization (year end.2 57.1 0.077.6 1.3 2.906. 1983-1997 Daily Trading Volume (P million) — — — — 129.3 158.351.3 0.248.9 12.5 1.4 Ratio of Market Capitalization to GDP 0.0 0.171.2 1.5 571.2 925.1 524.5 72.7 0.5 26. Note: Combined transactions of Makati and Manila Stock Exchanges are not available for the years 1983 to 1986.9 682.545.692.8 799.088.686.2 0.386.5 16.9 2.5 12.6 1.3 314.8 1.5 1.2 3.4 728.0 0.7 1.3 0.7 41.5 Year 369.8 0.0 2. .1 0.251. P billion) 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 19. P billion) Gross Domestic Product (current prices.6 261.
a strong regulatory system for bank supervision is imperative. The underwriter. However. and inventory financing. include bank credits.4. which were the principal source of corporate financing in the Philippines.2 Patterns of Corporate Financing The study looked at retained earnings. lack of competition among financial institutions.202 Corporate Governance and Finance in East Asia. The measures used in the analysis are: . Capital markets cannot provide the market discipline that corporate investors need. Under SEC regulations. about 127 companies went public with a total value of offerings of about P134. discounting of receivables.6 billion. which in most cases is an affiliate of the issuing company. Only a few large companies floated commercial papers because of the limited market. and high transaction costs. moreover. Vol.. Debt securities include commercial papers and corporate bonds. are in a position to provide such discipline. 3. Negotiated credits. new equity. This is because only companies with strong capitalization and predictable cash flows such as public utility companies can issue bonds. The largest buyers have been commercial banks. because business groups often own large commercial banks. and the dominance of large commercial banks. The picture of the financial system that emerges is thus one of limited capital markets. tight regulations. sells these commercial papers through brokers. Few companies offer preferred stocks because the Philippine tax system does not allow tax deductibility of dividends on preferred stocks. Corporate bonds are another type of debt securities. The corporate bond market was stunted. the rights issue was a popular way of raising equity capital. and debt as sources of corporate financing by using flow of funds analysis. by volatile interest rates and the absence of a secondary market. leases. of which 85 percent was raised from 1993 to the first half of 1997. However. corporate bond issuing was even more limited. Because existing shareholders wanted to retain their proportionate control over their companies. issuing companies had to undergo a process of review and credit rating by the Credit Information Bureau Inc. by virtue of their large stakes in the financial system. From 1988 to 1997. Only the commercial banks. which buy commercial papers either for their own account or for their clients. Debt instruments include negotiated credits and debt securities. asset-backed credits. II equity capital through IPOs during the stock market boom from 1993 to the first half of 1997. which ultimately influences the pricing of commercial paper issues.
9 0.3 0.3 0.5 0. the SFRT was low at Table 3.1 0.4 0.4 0.6 0.5 2. .1 0.2 0.0 0.4 0. New equity financing ratio (NEFR): ratio of changes in stockholders’ equity (excluding retained earnings) to changes in total assets. By definition. It measures a company’s capacity to finance asset growth by equity capital. 1989-1997 Financing Indicators SFRF SFRT NEFR IDFR IEFR 1989 1990 1991 1992 1993 1994 1995 1996 1997 1.2 0.0 0. All Companies Financial flows data were derived from the SEC-BusinessWorld Annual Survey of Top 1.8 0.000 Corporations in the Philippines.4 0.5 Source: SEC-BusinessWorld Annual Survey of Top 1.5 0.3 0.2 0.1 0.3 0.15 Financing Patterns of the Corporate Sector.9 0. It measures a company’s reliance on borrowings in financing asset growth.8 0.5 0. Self-financing ratio of total assets (SFRT): ratio of changes in retained earnings to changes in total assets.4 1.5 0.3 0.5 0. during this period.2 0.6 0.5 0.000 Corporations in the Philippines from 1988 to 1997.5 0. It measures a company’s capacity to finance asset growth by internally generated funds. 1988-1997.1 Average 1.8 0.3 0.5 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. Incremental debt financing ratio (IDFR): ratio of changes in total liabilities to changes in total assets.5 0. it is one minus IDFR.9 0.4 0.7 0. As shown in Table 3.1 0. On the other hand.15. Retained earnings were sufficient to finance the entire growth of fixed assets in the corporate sector. Incremental equity financing ratio (IEFR): ratio of changes in shareholders’ equity inclusive of retained earnings to changes in total assets. It measures a company’s capacity to finance growth in fixed assets by internally generated funds.2 0.3 0.6 0.4 0.9 0.4 0. the average SFRF was high at 109 percent.
16 Corporate Financing Patterns by Ownership Type.16.7 0. In 1997.5 Foreign-Owned 1. In periods of an economic crunch such as in 1989.3 0. retained earnings declined and few new equity investments flowed into the corporate sector. There were significant year-to-year variations.2 (0. debts were the most important source of financing. with debt providing 93 percent of the financing requirements. the level of corporate leverage increased. suggesting that there was a deterioration of financial performance in the Philippine corporate sector in the years running up to the crisis. reflecting the capital flight caused by political instability in the early 1990s.0) 0. for all three types of companies—publicly listed. implying that internal funds were far from sufficient to finance growth in total assets. 1988-1997.9 0. Corporate Financing by Ownership Type As shown in Table 3. Total assets grew by 23 percent that year.and foreign-owned. and 1997. The corporate sector consistently relied on debt and new equity to finance asset growth throughout the period.8 0.2 0.1 a Excludes negative balances. Source: SEC-BusinessWorld Annual Survey of Top 1. The corporate sector used new equity to finance 32 percent and new debts to finance 49 percent of growth in total assets.6 0. This was mainly caused by the declining contribution from retained earnings. 1989-1997 Financing Indicators SFRF SFRTa NEFR IDFRa IEFRa a Publicly Listed 1. 1991. Companies financed fixed assets from internal sources in hard times. 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. the SFRF was higher. As a result.3 0. Vol.000 Corporations in the Philippines. privately. II only 19 percent.3 0. On Table 3. Retained earnings were the least important. when it financed 45 percent of it. except in 1991. except for foreignowned companies that had a negative new equity financing ratio. .204 Corporate Governance and Finance in East Asia.5 0.3 0. internal funds were not a significant source of financing growth in total assets. In all the years.5 Privately-Owned 0.
8 39. 1988-1997.0 Source: SEC-BusinessWorld Annual Survey of Top 1. A breakdown of the financial structure of publicly listed companies measured in balance sheet items is shown in Table 3. 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 14.0 1993 14.1 7.6 0.0 38.9 100.0 100.6 48.1 49.8 3.7 13.3 10.5 41.4 100.6 26.5 12.0 53.5 9.1 15.3 13. significantly Table 3.0 9.1 50.1 13.2 3.5 0.9 0.4 43.8 0.4 2.9 38.4 12.6 48.2 100.4 100.2 51. contributing 90 percent of growth in total assets.7 7.0 10.4 100.0 9.2 3.0 10.0 6. publicly listed companies relied more on new equity financing than privately.0 12.000 Corporations in the Philippines.Chapter 3: Philippines 205 average.7 100.6 43. compared with 47 percent for publicly listed companies and 55 percent for privately-held firms. .9 4.3 11.9 16.9 12.9 16. especially bank loans.8 0.17.6 37.3 48.7 13.8 100.8 4.0 13.9 16.8 26.17 Composition of Assets and Financing of the Publicly Listed Sector.5 27.8 16.0 1994 19.7 2.3 51.3 12.2 12.1 10.1 9.7 4.8 3.0 1995 1996 13. The sector built up its short-term debts. This financing pattern supports the earlier finding that foreign-owned companies had the highest leverage among the three types of companies.3 10.0 9.4 41.4 2.9 3.8 38.4 3. Foreign-owned companies relied more heavily on debt financing.3 4.8 46.9 24.3 12.7 2.0 8.5 16.0 9.4 100.3 12.7 23.8 51.4 10.and foreign-owned companies.2 100.2 42.8 17. It presents a composition analysis of assets and financing sources for the period 1992-1996.
Further.000 Corporations in the Philippines.3 0.6 Independent Company 0. the average SFRF of business groups was higher compared with that of independent companies.1 0.5 0. II in 1996 and became more vulnerable to the financial crisis in 1997.45 in 1996. group companies usually financed their investment in member companies by equity rather than debt. 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.5 Excludes negative balances Source: SEC-BusinessWorld Annual Survey of Top 1. Vol. indicating that many publicly listed companies were likely to be in a tight liquidity position. 1989-1997 Financing Indicators SFRFa SFRTa NEFR IDFRa IEFRa a Group Member 1. as opposed to 94 and 30 percent. Group companies financed an average of 45 percent of growth in total assets by debt. 1988-1997.13 was at 1. The traditional measure of liquidity.18 Financing Patterns by Control Structure. Corporate Financing by Control Structure Conglomerates have certain advantages in financing because of the opportunities offered by the internal capital markets. The SFRF for independent companies would have been even lower if the highly profitable foreign-owned companies were excluded. respectively. On average. for independent companies.5 0.206 Corporate Governance and Finance in East Asia. the current ratio.9 0. For these two reasons.3 0. Table 3. and economies of scale in fund raising. Group companies were generally more profitable than independent companies. The normal standard liquid position is a current ratio of 2 or higher.18. compared with an average of 54 percent for independent companies. group companies were less reliant on debt financing than 13 Defined as total current assets divided by total current liabilities. As shown in Table 3. their inherent ability to pool risks. the easier access to external credit.2 0.3 0. .
1993 with 96 percent.Chapter 3: Philippines 207 independent companies. Large companies’ IDFR of 0. Corporate Financing by Industry The manufacturing sector had an average SFRF of 1.5 Medium 3. The lower SFRF for large companies may be caused by their larger outlays for growth in fixed assets. Corporate Financing by Firm Size SFRF was highest for medium-sized companies. 1988-1997.19).4 Small 0. These results support the earlier finding that the leverage of business groups was lower than that of the independent companies from 1988 to 1997.20).3 0. compared with 55 percent for large companies and 47 percent for small ones.19 Financing Patterns by Firm Size.8 0.6 0. Source: SEC-BusinessWorld Annual Survey of Top 1. Excluding .1 0. The medium-sized companies’ high debt financing ratio was due mainly to three years of complete reliance on debt to finance growth.55 was substantially higher than the small companies’ 0. 1989-1997 Financing Indicators SFRFa SFRTa NEFR IDFRa IEFRa a Large 0.47.06.3 0.2 0.2 0. Table 3.2 0.000 Corporations in the Philippines.50 (Table 3. There was also increased reliance on debt financing.5 0. equity financed 42 percent of incremental asset growth. and 1997 with 131 percent. medium-sized companies used more debts. These years were 1991 with 110 percent.6 0. On average. Large firms consistently increased their reliance on debts from 1994 to 1997.76 for small companies and 0. averaging 61 percent of growth in total assets.3 0.9 0.88 for large companies (Table 3. With assets growing at a fast pace during this period.5 Excludes negative balances. with an average of 3.08 and SFRT of 0. The corresponding ratio was 0.
04. 1988-1997. Table 3. SFRF for the sector averaged 0. the total debt ratio was much higher in 1996 at 0.5 (0.3 0.208 Corporate Governance and Finance in East Asia.000 Corporations in the Philippines.1 0.4 0. the incremental equity ratios of the industry were high. Incremental equity financing amounted to an average of 44 percent of total asset growth.91.32. the manufacturing industry financed 57 percent of its total asset growth by debt.4 Construction 0.4 3. In the eight years preceding the crisis.47 two years later. debt financed about 78 percent of asset growth in real estate. During the crisis year.5 0.3 0. Up to 1997. The situation improved beginning 1994. The effects of the crisis of 1997 were adverse. Equity financed an average of 62 percent of total asset growth.6 a Excludes negative balances. increasing to 0.6 0. Source: SEC-BusinessWorld Annual Survey of Top 1. with an SFRF as low as 0.29.6 0. The real estate industry financed its growth by substantial equity funds.3 0. . when debts declined. Its SFRF and SFRT were volatile because of chronic losses and reduction in fixed and total assets.3 0.20 Financing Patterns by Industry.6 0.2) 0. Low incomes diminished the equity financing position of the manufacturing industry toward the crisis year. 1989-1997 Financing Indicators Manufacturing SFRFa SFRTa NEFR IDFRa IEFRa 1. Total liabilities increased partly as a result of the local currency devaluation and financed all of asset growth for the year. ranging from 41 to 118 percent. the industry generated internal funds. Vol.5 0. Equity financed the rapid expansion in the industry’s assets in the period 1994 to 1997. While this level is considered prudent. Excluding 1997 when fixed assets declined. The utilities sector showed weaknesses in internal fund generation in 1989-1994. many of the leading real estate companies successfully went public during that time.4 0.27. II 1991. The sector had the highest leverage among all industries that year.5 Utilities and Real Estate Services and Property 0. achieving an average SFRF of 3.7 0.79 and in 1997 at 0. The construction sector was a heavy user of debt financing. Since the real estate boom coincided with that of the stock market.58 and SFRT of 0. while SFRT averaged only 0.4 0.
The Modern Industrial Revolution. Using the PSE database. As shown in Table 3.00056 1. ROE = return on equity.004 3.00125 2. 14 See for example Michael Jensen (1993).21. was regressed against measures of profitability and of financial leverage. and financial leverage are all positively and significantly related to the degree of ownership concentration. These results suggest that companies with higher ownership concentration tend to be more highly leveraged and.Chapter 3: Philippines 209 3. ROA.14 Large shareholders may borrow excessively to undertake risky projects. Large shareholders may also overuse financial leverage to avoid diluting ownership and control.4. alternatively.130 ROA 0.421 0. and leverage. ROA = return on assets. knowing that if an investment turns out to be successful they could capture most of the gain. while if it fails. the degree of ownership concentration.769 0.009 5. Source: Author’s estimates based on the PSE databank.21 Ownership Concentration. and the Failure of Internal Control Systems. ROE. .860 Leverage = the ratio of total assets to total equity. as the dependent variable. Journal of Finance 48: 831-880. Table 3. measured by the percentage of shareholdings of the largest five shareholders.008 5.3 Ownership Concentration.00036 2. Financial Leverage. Exit. Three regressions were run with the shareholding of the largest five shareholders as an independent variable and ROA. more profitable.230 Leverage 0. and Performance Previous studies on corporate governance have often associated ownership concentration with heightened risk-taking by companies. 1992-1996. ownership concentration = the total shareholdings of the top five shareholders. at the same time. creditors bear the consequences. Profitability. and Financial Leverage Dependent Variable Item Coefficient of Ownership Concentration T-statistics Adjusted R-squared F-statistics ROE 0. the coefficient of the ownership concentration measure in all the three regressions is positive and statistically significant.287 0. ROE.
Commercial and industrial activities in the country were largely oriented to domestic markets. The structure of the economy may be understood by looking at its sectoral composition and export competitiveness. and intermediate goods. Historically.1 The Corporate Sector in the Financial Crisis The Financial Crisis: Causes and Manifestations A devaluation of the local currency signaled the arrival of the financial crisis in 1997. Manufactures accounted for about 85 percent of exports.” that is. the growth in foreign investments fueled that of the manufacturing and services sectors in the years preceding the crisis. the country’s GDP growth pace indicated that it did not have a “bubble economy. II 3. In 1997. notably remittances of overseas workers. an overexpansion of capacities. and agriculture at 21 percent. Garments was the second largest export sector at about 9 percent. The Government explained that the country had “sound economic fundamentals” but that the problems were caused by “contagion.5 3. Net trades in goods and services averaged a deficit of 4. Compared to other East Asian crisis-affected countries. Vol. which averaged 4. In sum. Net investment inflows were $3. industry at 34 percent.” The Government’s judgment that economic fundamentals were strong was based on stable growth rates. more than half (52 percent) of exports were semiconductors. with a narrow exporting industry base. Exports were growing at about 20 percent per year in the three years preceding the crisis.210 Corporate Governance and Finance in East Asia.5 percent per year from 1992 to 1997. The export sector had a very narrow breadth. with commodities accounting for the balance. foreign investments in the country have been low. raw materials.5 billion in 1996 and grew at an average of 48 percent per annum from 1992 to 1996. The country experienced balance of payments surpluses but these were due to transfers. The largest contributors to GDP were services at 43 percent. Although much lower than those of other Asian countries. the economy still showed vestiges of its import-dependent and substituting character. 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.8 percent of GDP from 1995 to 1997. but its share had been declining by 4 percent per year since 1995. their growth gathering momentum only beginning in 1992. About 80 percent of imports were capital goods (particularly power generating and telecommunications equipment).5. the country was less dependent on foreign private capital. Because of limited local capital. After a .
Chapter 3: Philippines 211 long period of debt moratorium and restructuring that started in 1983 and ended in 1991. During this time. the country and the corporate sector had no access to foreign currency debts from the international financial market. The corporate sector was in a relatively stable financial condition around the time of the crisis. Economic performance during 1992-1997 was characterized by an average growth rate of real gross national product (GNP) at 3. From 1988 to 1996. Prudent fiscal management and controls on foreign borrowings were part of the adjustments required by IMF and foreign creditors. From 1993 to 1997. The adverse impact of the crisis in most Asian countries was proportional to the amount of short-term foreign debts relative to net international reserves. a positive balance of payments from 1992 to 1996. the Government sought stability and achieved this in 19921997. Profitable operations since 1992 had allowed it to build equity. the Government restructured its debts into longer tenors with a maximum of 25 years. The Central Bank conserved international reserves by allowing the local currency to float within a wider trading margin. depended on the quality of the corporate sector’s investments. however. in turn. average ROE was 13. Five years of stable growth before the crisis enabled the country to build its net international reserves to $10. 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 1997.6 billion as of March 1997. The lessons from debt restructuring became the basis for the Government’s economic policies. Eventually.5 percent. which. an average inflation rate of 7. shows that investments of the corporate sector were growing at a faster rate than sales revenues in the years immediately preceding the crisis. After hovering in the range of 100 to 127 percent. fueled also by successful IPOs during the stock market boom of 1993-1996. while sales grew by only 20 percent per year.8 percent. Financial institutions called on their shortterm loans and shortened the maturity of existing loans. Closer analysis. resulting in stability in the short-term debt to reserves ratio. Total debts were only 52 percent of assets or 108 percent of equity. adjustments were focused on the quantity and quality of the banking system’s corporate loans. unlike their counterparts in the region.3 percent. and a relatively healthy banking system. the ratio of short-term debts to international reserves dipped below 100 percent beginning June 1998. an average Treasury bill rate of 13. Since the regional financial crisis was triggered by the loss of confidence in some East Asian economies by foreign creditors and investors. . assets grew at a compound annual rate of about 31 percent.1 percent. a government fiscal surplus from 1994 to 1997. In the Philippines.
0 1998 739 555 328 69.650 32.22 Foreign Investment Flows. In sum. Data for 1998 cover only January-August.7 Note: Peso-dollar exchange rates used are: 1995 = 25.074 2. It is understandable then that the effect of the Asian financial crisis on the Philippines was correspondingly that of a negative “contagion. It rose to $2. but to a lesser degree.71.47.101 billion or 196 percent of net FDI in 1996. Net foreign investments more than doubled from 1995 to 1996 but declined by 78 percent in 1997 (Table 3. Foreign investments in the Philippines have not been as high as the inflows to other Asian countries—and this. These patterns in investment and financing are similar to those of other countries in the region.609 1. .4 1997 762 1.5 billion in 1995. or 114 percent of net foreign direct investment (FDI). Net foreign portfolio investment amounted to $1. The debt level of the Philippine corporate sector in 1997 was low by Asian standards but still high by developed country standards.22. 1997 = 29. Vol.” 3. It financed 26 percent of corporate capital growth.517 1.212 Corporate Governance and Finance in East Asia. growing by about 34 percent per year from 1994 to 1997.749 26.2 Impact of the Crisis on the Corporate Sector Aside from the foreign exchange adjustment.22).485 145. Most of this leverage happened during the boom years in the region. 1995-1998 Item Net Foreign Investments ($ million) Foreign Direct Investment (FDI) Foreign Portfolio Investment Net Capital Increase by Corporations (P million) Net FDI as a Percentage of Corporate Net Capital Increase (%) 1995 1. In 1997.06. 1998 = 41. 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. But portfolio investment amounting to $406 million flew out of the Philippines. II The corporate sector indeed overexpanded after 1993 like its counterparts in the region.303 23.0 1996 3. Table 3. mitigated the effects of the pullout and liquidation of investments in the aftermath.073 (406) 121.101 92. Sources: Bangko Sentral ng Pilipinas and SEC.300 1.718 30. precisely. 1996 = 26. Debts financed a large part of this expansion. the other immediate impact of the crisis was that on foreign investment flows.5. net FDI remained stable at more than $1 billion.
The banking system was able to absorb the impact of the crisis primarily because of its strong capital position. A number of small banks closed but they represented less than 1 percent of the financial system’s total resources. Loan calls. The real problem of the corporate sector during the crisis was the rise in interest rates. Bank spreads over Treasury bill rates increased in 1997 but were within the range experienced in the past. suggesting that commercial banks required a higher premium at about the height of the crisis but not beyond. Loans outstanding of commercial banks declined by the first quarter of 1998. Average bank lending rates climbed to their peak of 25. Because of weak internal fund generation. ROE at 6.9 percent.7 percent in January 1998. Although corporate borrowers were not highly leveraged.2 percent was barely above inflation rate. depended on the liquidity and capital position of commercial banks. they were willing to restructure and renegotiate existing loans by corporate borrowers. The resources of the financial system that year totaled P3.2 percent in November 1997. meanwhile. 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. and the wholesale and . The combined effects of shrinking demand and high interest rates reduced the corporate sector’s demand for loans. with commercial banks holding P2. new borrowings financed asset growth. Because commercial banks were strongly capitalized. albeit at current market interest rates. in varying degrees for each sector. the commercial banking sector’s capital remained strong at 17. they could not initiate a large reduction of their loans because these in part financed long-term growth in assets. Net profit margins were at a 10-year low at 4.369 billion. By October 1998. lending rates also came down. sparking a rise in interest rates on corporate loans. By March 1988. The interest rates on Treasury bills. With the increase in borrowings and reduced liquidity.Chapter 3: Philippines 213 Corporate financial performances and conditions deteriorated during 1997.513 billion. which held about 75 percent of the assets of the financial system in 1997.3 percent of assets. Companies deferred investments in new fixed assets. then rose to a high of 22. ranged from 11 to 13 percent from 1993 to July 1997. Manufacturing reduced its loans outstanding by 11 percent from October 1997 levels. and leverage increased to 149 percent compared with 109 percent in 1996. When the Treasury bill rates eased in March 1998. Lending rates were well above the 20 percent level from July 1997 to March 1998.2 to 28. the corporate sector became vulnerable to loan calls and high interest rates. in turn.
9 percent of bank loan portfolios. was a problem sector. The Central Bank introduced regulations on foreign exchange trading to control speculation and nondeliverable forward contracts. II retail trade sector. 3. set limits on overbought/oversold foreign exchange positions of banks. and its experience of low. by 12 percent. The move retained the liquidity position of banks but lowered their cost of reserves. 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.3 percent in December 1997. The pattern indicates that real estate loans were of substandard quality but banks had contained the problem by mid-1998. However. This allowed the Central Bank to convince the banks. and set up a hedging facility for borrowers with foreign currency-denominated loans.5-6 percent.214 Corporate Governance and Finance in East Asia. These figures show that adjustment problems were industry-specific and that the real estate industry. These peaked at 14. As for nonperforming loans (NPLs). through the Bankers’ Association of the Philippines.5. thereby reducing overall intermediation costs. This “voluntary agreement” partly explains why the loan spreads of banks were within the range of recent experience. single-digit NPL ratios began only since 1989. including (i) a regulatory limit of 20 percent on banks’ loans to the . The Central Bank adopted other measures to strengthen the financial system. the fiscal position. But the Philippine banking system had gone through worse crises in the past. Still. The latter measure was especially beneficial to companies with unhedged foreign currency loans from commercial banks.3 Responses to the Crisis Government Responses The Government’s policy and regulatory responses to the crisis focused on monetary and credit issues. and the financial system. real estate loans averaged 11. loans outstanding of the real estate sector increased by 11 percent from June 1997 to June 1998. Vol. 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. and subsequently went down to 13. the ratio increased to a high of 11. to reduce their lending spreads over the 91-day Treasury bill rates from 3-8 percent to 1.5 percent by September 1998. In March 1997.6 percent in June 1998.
the largest telecommunications setup in the Philippines. A 40 percent devaluation of the Philippine peso lowered the purchase price of PLDT to foreign investors. changing technologies. The policy directions and actions taken by the Government appear to have ushered in recovery. The acquiring company. consolidating business units. The economy avoided a recession in 1998 and achieved 3. 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. Publicly listed Philippine companies could also be restructured through takeovers by local and foreign investors. In response to calls for lower bank intermediation costs. its accessibility to foreign capital. (PAL). came up with a rehabilitation plan by May 1999 that was found acceptable to all parties. was known to have a policy . With prudent monetary management. and the legal framework for reorganization and liquidation conditioned its response to the crisis. (v) improving disclosure requirements on the financial position of banks. bank loan rates have also come down. The real estate portfolio of commercial banks also declined and was well below the Central Bank’s regulatory ceiling by March 1998. With its weakened financial position. and (vi) issuing guidelines on duties and responsibilities of banks’ boards of directors for improved quality of bank management. (iv) increasing banks’ capital requirement by 20 percent for universal banks (banks with expanded licenses) and 40 percent for ordinary commercial banks. PAL. Takeovers in the past involved cooperative negotiations between purchasers of a target company and family-based large shareholders. Average Treasury bill rates have cooled since mid-1998. and giving up noncore businesses. First Pacific Corporation. the Government kept inflation below 10 percent.6 percent growth in 1999. subcontracting and outsourcing. took more action.Chapter 3: Philippines 215 real estate sector. Responses of the Corporate Sector The corporate sector’s financial position. In the case of PLDT. the Asian crisis opened a unique opportunity for foreign investors. Financially strong companies were able to survive the crisis by effecting such internal restructuring. the country’s flag carrier. (ii) shortening the period for classifying unpaid loans as past due from three months to one month. which was privatized with the Lucio Tan group gaining control and the Government retaining minority ownership. (iii) fixing loan loss provisions of 2 percent of the gross amount of loan portfolio on top of individually rated bad loan accounts.
1 Summary. however. using some or all of these means. the stock price of PLDT was buoyant during the takeover period. and Recommendations Summary and Conclusions The Philippine corporate sector has been shaped by the country’s economic and industrial development policies. SMC is another widely-held company managed by a minority shareholder. II of investing to control companies that are dominant players in their industries. is whether there are sufficient safeguards to prevent controlling shareholders from . the Soriano family. Although considered the prime industrial company in the Philippines. at a premium over the market price to reflect the value of management control. he restructured the company toward its core brewery business and sold off local and foreign subsidiaries. A third method was to make a formal tender offer to PLDT’s controlling minority shareholders. eventually took over PLDT and announced a restructuring plan for the entire group of companies. It may even solve agency problems that a separation of control and ownership could precipitate because large shareholders have an incentive to closely oversee management. 3. First Pacific. Corporate governance is conditioned by the high ownership concentration of these large companies. One mode was the outright purchase of shares in the open market. When Cojuangco took over. Eduardo Cojuangco was able to assert his ownership of shares taken over by the Government during the transition of power in 1986. The question. Conclusions. By itself. First Pacific could have acquired sufficient shares to take control of PLDT in three ways. When companies are highly profitable. Ownership is highly concentrated and a few dominant players control major industries.216 Corporate Governance and Finance in East Asia.6 3. concentrated ownership of companies is not equivalent to weakness in corporate governance. Its stock price and returns to shareholders had stagnated.6. controlling shareholders can capture these profits by excluding public investors from ownership. Consequently. In a legal process that ended in his takeover of management. PLDT’s large minority shareholders such as the SSS and First Philippine Fund publicly announced their willingness to offer their entire holdings in a block sale at a premium. Vol. A second method was to purchase the shares of other large minority shareholders. SMC had lagged behind other groups of companies such as Ayala Corporation in financial performance for some years. the Cojuangcos.
with the real estate and public utilities industries standing out for their pronounced cyclical patterns. Privately-owned companies. Business groups occupied seven of the top 10 and 25 of the top 50 largest corporate entities in the Philippines in 1997.Chapter 3: Philippines 217 expropriating the wealth of minority shareholders through aggressive and risky investment. to some extent. By control structure. Publicly listed companies had the highest profit margins and lowest leverage among the local companies. minority shareholders need to be protected by external control mechanisms. By size. Forming business groups appears to be a viable means of competing because this allows for more efficient organization and utilization of resources of large controlling shareholders. passive independent auditing. foreign companies were the most profitable but highly leveraged. and the lack of market for corporate control. oligopolistic market structures. ownership of banks by business groups. Returns to capital exceeded inflation rates. Performance was. The Philippine corporate sector was relatively efficient in investing and financing compared with other countries affected by the Asian crisis. were the least profitable. The result is that corporate governance depends only on internal controls. This study points out weaknesses in external control mechanisms such as weak legal protection for minority shareholders. The corporate sector consistently relied on internally generated funds and equity before resorting to borrowings. This study analyzed trends in corporate performance and financing in relation to corporate governance from 1988 to 1997. By ownership structure. influenced by industry characteristics. an underdeveloped capital market. while the largest 20 shareholders control more than 75 percent of shares. With large shareholders in control. Leverage was within Asian norms but above developed country standards. Corporate governance should be viewed in the context of an increasing presence and growth of large shareholders-centered conglomerate business organizations. companies that are members of family-based conglomerates had higher returns and lower leverage than independent companies. The financing pattern of the corporate sector was influenced by the tight financial conditions prevailing in the country up to 1992. an ineffective insolvency system. Analysis of corporate financing by ownership . Ownership of publicly listed companies is highly concentrated. The five largest shareholders have majority control of an average publicly listed company. the most numerous in the corporate sector. medium companies showed higher profitability than large and small ones. Financial institutions are not significant shareholders.
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. Vol. Such structures result in control by large shareholders through disproportionately smaller investments in equity ownership. The extent of governance problems depends on internal control policies of the controlling shareholders. statistical analysis of company-level data revealed significant relationships between corporate performance and corporate governance. Business groups with pyramiding structures heighten the issue of corporate governance. The pyramid model is useful for centrally managing smaller companies. A business group is an effective business organizational model for achieving leadership in industries. and leverage were all positively related to the degree of ownership concentration. family-based shareholders gain control by such means as the setting up of holding companies. The positive relationship between financial leverage and ownership concentration is consistent with the hypothesis that controlling shareholders prefer to use debt financing in order to avoid ownership dilution. . and centralized management and financing. Publicly listed companies were responsive to investors’ requirements for prudent use of debts. 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. as typified by the Ayala Group. the bank usually accounted for a large share of each group’s net profits. the amount of pressure from stock market investors and PSE (for publicly listed companies in the group). A commercial bank is an important part of most business groups. Large. The difference between management control and ownership rights is usually substantial. After controlling for industry effects. II type gave similar results. ROA. and sustained growth. and the extent of supervision of outside institutions such as independent auditors and SEC. ROE. Large companies owned or controlled by business groups tend to dominate their industries. Ownership concentration was positively related to both returns and leverage. Companies whose large shareholders have higher degree of control tend to borrow more but generate better returns. superior profitability.218 Corporate Governance and Finance in East Asia. selective public listing of companies in the group. Even in cases where the group owned only a minority share of a commercial bank. Internal financial markets operated by business groups allowed them to optimize their financial resources at lower external debt levels.
there were sharp rises in the number of bankruptcies and petitions for debt relief. resulting in the banks’ accelerated restructuring of troubled debts in this sector. a strong international reserves position.Chapter 3: Philippines 219 The financial crisis came when the Philippine economy was in a relatively strong financial position. The crisis caused a tightening of credit to the corporate sector and a spike in interest rates. For example. rather than the banks that lent millions of pesos. That is. Under the new Securities Regulation Code enacted in 2000. 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. A number of large debtors petitioned SEC for rehabilitation under procedures set by PD 902-A. SEC officials. As the crisis wore on in 1998. Still. There are systemic risks involved in highly concentrated ownership. The corporate sector was also in good financial condition with rich internal cash flows accumulated from a number of profitable years.2 Policy Recommendations The Government should address weaknesses in corporate governance identified in this study by introducing reforms in the policy and regulatory framework and promoting the development of markets. including suspension of payments. and sound overall creditworthiness. are to be removed and transferred to courts. with recently restructured public debt. 3. decide on the financial future of a troubled debtor. mostly by highly leveraged companies and speculative investors in real estate. The Central Bank imposed strict limits on real estate lending. adversely affecting companies’ operations and financial position. The Central Bank responded by improving the liquidity of the system and by establishing conditions for bringing down interest rates on bank loans. Specific actions recommended are described below. low inflation. the government budget in surplus.6. SEC’s quasijudicial functions. The corporate sector accessed the foreign debt market only in the mid-1990s because of the country’s long-drawn debt moratorium. 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. strong capital position built on IPOs in a buoyant stock market. This law is flawed in concept because it supplants a market-based credit agreement with a political process. and a market-oriented policy environment. decisions by large sharehold- .
It has suffi- . To strengthen the board. to 25 percent. This may limit current practices of appointing prominent individuals and family members as directors. and (iii) increase the minimum required percentage of outstanding shares for public listing in the stock exchange from the present 10-20 percent. Increasing the Statutory Accountability of Directors and Strengthening the Board System The Government should clarify statutory fiduciary responsibilities of the board of directors. insider information. This will enable SEC to enforce prudential requirements on management of companies and enable minority shareholders to pursue grievances against their boards. (ii) require disclosure of material changes in ownership. Clear legal accountability is a precondition for successful shareholder activism. Another measure would be to impose a statutory limit on the number of directorships that one can accept. II ers often cause wide volatility in stock prices and invite reaction from creditors. PSE Listing Rules should specify criteria and a selection process that will help ensure that the nominees for the position are truly independent and qualified. The following recommendations involve amendments to the Corporation Code that will improve transparency of ownership and address the current high level of ownership concentration in Philippine business: (i) require disclosures of underlying ownership of shares held by nominees and holding companies. they serve to curb the powers of controlling shareholders. 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. The adjustment should be made over a fixed period of time. To help ensure this. inadequate disclosures.220 Corporate Governance and Finance in East Asia. depending on the size of the company. Because independent directors tend to adopt the perspective of minority shareholders in board decisions. the PSE Listing Rules require the appointment of a minimum number of independent directors in the board of publicly listed companies. Vol. and self-dealing. SEC should strengthen disclosure requirements by issuing specific guidelines on minimum disclosures required for related party transactions.
e. limit.. raising the current two-thirds majority to a three-fourths majority. Minority shareholders have failed to use traditional venues such as the annual general shareholders’ meetings to discipline controlling shareholders that expropriate their wealth. prudential measures and regulations. and of banks in nonfinancial companies in order to avoid connected lending. The following recommendations aim to further improve banking regulations and supervision in the Philippines: (i) limit shareholdings of nonfinancial companies in banks. Improving Financial Regulation and Strengthening Implementation The Asian crisis demonstrated the need to strengthen banking regulation.g. 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. They need legal empowerment such as higher majority voting requirements. directors. Impose severe penalties for any attempt by banks to circumvent this regulation. It is encouraging that the newly enacted 2000 Banking Laws have introduced changes along these lines. fit and . For example. and related interests. By requiring sufficient disclosure and a 75 percent majority vote on such decisions. in particular. or prohibit cross-guarantees by companies belonging to affiliated groups. (ii) set strict limits on lending by banks to affiliated companies.Chapter 3: Philippines 221 cient case history that can be used as a basis for tightening its disclosure requirements. current rules allow boards of directors to approve own-dealings or related party transactions by simple majority. reporting. officers. in areas of supervisory functions of the central bank. and (v) closely monitor. Finally. (iv) require banks to follow international financial accounting. Because ownership is generally concentrated in five shareholders. The Government should improve its prudential supervision system to ensure that banks perform their role as external control agents of their corporate debtors. (iii) adopt international standards of capital adequacy and ensure that banks comply with these standards. the board can easily muster the needed majority to approve the deal. 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.
In developed capital markets. 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. Investment and venture capital funds meet this description.222 Corporate Governance and Finance in East Asia. The current law should expand class action suits to include management and . foreign ownership of banks. transparency. institutional investors can be a driving force in providing market discipline to management. Vol. Its priority is to protect prospective fund investors from unscrupulous fund managers. 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. 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. Managements find that their investment and financing decisions affect stock prices and become aware of their responsibility to create shareholder value. Institutional investors impose market discipline by voting on strategic corporate decisions. SEC appears to be taking a primarily regulatory posture in the operation of investment funds. Two measures should be adopted to promote shareholder activism. and external auditors. Presently. institutional investors lead public investors in providing market signals to companies. and lending to DOSRI. The other is the addition of provisions in the Corporation Code to facilitate class action suits against corporate directors. an active financial analyst community can begin to form. 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. One is improved transparency and disclosure on specific items that potentially involve expropriation of wealth of minority shareholders. The absence of institutional investors indicates that the legal and regulatory basis is inadequate. By supporting the establishment and operation of institutional investors. II proper rule. This way. management.
Promoting the corporate bond market requires that the Government develop trading systems and services of credit risk rating of corporate issuers. information disclosures. Expanding Debt Securities Financing The Philippine corporate sector relies on bank loans because controlling shareholders do not want to dilute their control by issuing equities. and Credit Information Bureau that can be the starting point of this effort. There are existing institutions such as Dun and Bradsreet. Companies are likely to remain dependent on bank financing if the authorities do not strictly enforce prudential lending regulations. guarantees. their directors and management. and broad-based political and popular support to pursue possible cases involving expropriation of minority shareholders’ wealth. where the threat of class action suits alone is sufficient to encourage quality decisions and behavior from management. Legal provisions for class action suits should cover self-dealing by directors. SEC should allow minority shareholders to be represented by activist groups. These groups have an incentive to gather technical expertise. Securities market development efforts should coincide with strict regulation of the commercial banking sector. 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. compensation contracts.Chapter 3: Philippines 223 auditors. Philippine Government Treasury bonds should provide bellwether rates for corporate bonds in the way that they have for short-term bank debts. leadership. It should develop a medium-term yield curve for the corporate debt market by strengthening the Government bond market. and dividend decisions. And by issuing Government Treasury securities in longer tenors. the Government could develop the market for future issues of corporate bonds. The present provision on class action suits is inadequate because shareholders view the process as ineffective and expensive. Placing the means for prosecuting in the hands of minority shareholders may instill more discipline in controlling shareholders. Promoting Competition in Product Markets The Government should pursue industrial development policies that promote competition through the elimination of subsidies. 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 the external auditors. entry .
224 Corporate Governance and Finance in East Asia. II and exit barriers. Improving External Audit Standards and Information Disclosure Effective external control in corporate governance requires accurate and timely information about companies. Increasing the Supply of Quality Equities in the Stock Market To promote the capital market as an external control agent in corporate governance. Vol. and various other forms of protection. SEC should require that a larger percentage of publicly listed companies’ shares be sold to the public. and provide quality basic services should also be heightened.and medium-scale companies can become more competitive relative to large companies. Audited financial statements contain basic information about a company’s financial position and performance. there is a need to increase the supply of quality securities from top-tier local companies in the Philippine stock market. 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. so that small. Another problem is the orientation of external auditors to the interest of large shareholders rather than public investors. Little attention is given to the conditions that make those regulations effective in the US corporate sector but not present in the Philippines. The Government should also continue to improve infrastructure. improve enforcement of the rule of law. Current disclosure requirements of SEC are not rigorous enough for public investors. The increase in percentage of public holdings may be gradually implemented to enable the companies to adjust. The resulting absence of a strong investor base makes share prices vulnerable to manipulation or insider trading by large shareholders. and publicly listed companies trade barely the minimum number of shares required for public listing. Penalties for poor conduct of auditing by independent . 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. The Government’s competition policies should aim to facilitate the free entry and exit of domestic and foreign companies and regulation of anticompetitive practices. Lack of liquidity deters institutional investors. PSE and SEC need to build a liquid and efficient market. Many large companies remain privately owned. Efforts to reduce graft and corruption.
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. Reforming the legal framework for suspension of payments. and Liquidation. Reorganization. including the resolution of intracorporate disputes. violators were made to pay only nominal penalties. and liquidation of troubled companies should be made a priority of the Government. and transferred these to courts. Although the new Securities Regulation Code enacted in 2000 has removed some of SEC’s quasijudicial functions. Instead. review the system of penalties on professionals involved in a company’s violation of disclosure rules. reorganization. the new law needs to be effectively implemented and enforced. it creates a moral hazard problem. For that matter. . and implement those standards and penalties rigorously. suspension of payments and private damage actions. SEC and PICPA need to formulate more specific disclosure standards. The law on suspension of payments replaces a market-oriented solution with a political process. Improving the Legal Framework for Suspension of Payments. 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. PD 902-A has not accomplished any successful rehabilitation of a petitioning company since its implementation. In spite of the many well-known cases of poorly audited financial statements that resulted in losses for investors.
Working Paper 2088. Simeon Djankov. Discussion Paper. 1999. Claessens. Lang. Lang. 1998. Thailand’s Corporate Financing and Governance Structures: Impact on Firms’ Competitiveness. Diane K. Joseph P. Stijn. 1988. Vol. and Kenneth Lehn. The Separation of Ownership and Control in East Asian Corporations. Journal of Political Economy 93 (6). Simeon Djankov. Fan. Fan. Ownership Structure and Corporate Performance in East Asia. Lang. The Philippines: Onward to Recovery. P. Emilio. George. Expropriation of Minority Shareholders in East Asia. Key Indicators of Developing Asian and Pacific Countries 1998. and Larry H. Harold. 1999. Institute of Southeast Asian Studies. March.226 Corporate Governance and Finance in East Asia. Stijn. Lang. Quarterly Journal of Economics. and Larry H. P. Philippine Macroeconomic Prospects: The Next Ten Years. Stijn. Working Paper. David J. October. and Simeon Djankov. and Atulya Sarin. and Corporate Diversification. Who Owns and Controls East Asian Corporations? Discussion Paper 2054. 1998b. 1985. Monitoring and the Value of the Firm. Asian Industrializing Region in 2005. Claessens. Barclay. Thailand: From Financial Crisis to Economic Renewal.. P. Tokyo: Institute of Developing Economies. P. Dennis. and Larry H. H.. The Structure of Corporate Ownership: Causes and Consequences. Agency Problems. 1997. II References Abonyi. World Bank. 1998a. Joseph P. Stijn Claessens. Stijn. Claessens. World Bank. Private Benefits from Control of Public Corporations. Stijn. Large Shareholders. Journal of Financial Economics 25: 371-395. XXIX. Diversification and Efficiency of Investment by East Asian Corporations. Asian Development Bank. H. Journal of Finance 2 (1). and Larry H. Denis. Equity Ownership. Claessens. Demsetz. edited by Toida Mitusuru and Daisuke Hiratsuka. Conference on Thailand’s Dynamic Economic Recovery and Competitiveness. World Bank. Fan. P. Manila: Asian Development Bank. Vol. 1999. World Bank. Alba. Dennis Gromb. 1998. Burkart. Pedro. M. . Jr. 1994. and Fausto Panunzi. Lang. Claessens. and Larry H. Bangko Sentral ng Pilipinas. H. Simeon Djankov. May. July. Working Paper. 693-728. Joseph Fan. 1997. 1998c. World Bank. Simeon Djankov. 1989. and Clifford Holderness. Michael. Antonio. Simeon Djankov. Joseph P.
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The author wishes to thank Juzhong Zhuang. Thailand’s crisis exposed similar vulnerabilities in other East Asian economies.1 Introduction In May to July 1997. 1 Associate Professor. Chonburi. Korea). The corporate sector also contributed significantly to the crisis. coupled with financial liberalization and deregulation in the absence of an effective regulatory and supervisory system. with Thai corporations overutilizing short-term foreign currency-denominated loans. Asian University of Science and Technology. But it also laid bare weaknesses in both the financial and corporate sectors. Thailand. The fixed exchange rate policy. Thai corporations were collectively overexposed to exchange rate risks. poorly regulated and sheltered from competition. the Thai Government conceded and adopted a floating exchange rate regime. the Thai baht came under pressure from speculative attacks.4 Thailand Piman Limpaphayom1 4. but also the stalling of East Asia’s “economic miracle. short-term private debt obligations grew to about 60 percent of total private sector debts. magnified the impact of these problems on the economy when the crisis hit. In the prelude to the 1997 crisis. . As a result. and Lea Sumulong and Graham Dwyer for their editorial assistance. Instead of serving as a buffer between the large inflow of foreign capital and the corporate sector. The majority of these debts were not properly hedged. The banking system. and David Webb of the London School of Economics for their guidance and supervision in conducting the study. had been plagued with prudential problems for a long time. The crisis in Thailand stemmed directly from unsound macroeconomic policies and imbalances. both of ADB.” After mounting an aggressive defense of the currency. the Stock Exchange of Thailand for its help and support in conducting company surveys. It was inefficient in financial intermediation. For the period 1994-1996. annual short-term capital inflows to Thailand were equivalent to 7-10 percent of gross domestic product (GDP). the banking system merely validated the financial risks. Malaysia. David Edwards. Republic of Korea (henceforth. Faculty of Business. with the currencies of Indonesia. heralding not only a financial crisis in the country. and Philippines all depreciating significantly.
the Government increased tariffs on products that could be produced locally. II There is now a consensus that weak governance was partly responsible for the corporate sector’s poor financing and investment practices. focusing mainly on the companies listed in the Stock Exchange of Thailand (SET). Section 4. Section 4. The National Economic and Social Development Board was created to plan the country’s economic and social development.2 discusses the development of the Thai corporate sector under the National Economic and Social Development Plans. as well as its legal and regulatory framework.2. Section 4. with government policy providing support but avoiding direct interference. The First and Second Plans (1961-1971) Under the first two plans. the Government implemented major infrastructure projects and modified its tax policy to encourage capital investment and savings. 4. and a family-based corporate ownership structure. Vol. its growth and financial performance. .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. Import tariffs on machinery and heavy equipment were removed.5 discusses how the corporate sector contributed to the financial crisis and looks at its impacts. To protect domestic industries. Section 4.4 provides an overview of Thailand’s financial markets and examines patterns of corporate financing and investment in the years prior to the 1997 crisis. This study examines these and other factors that might have weakened corporate sector governance in Thailand. The country initiated national economic development planning in 1961 when the economy was growing rapidly. while new industries were encouraged to reduce the need for imports. The study then considers policy recommendations with emphasis on corporate governance improvement.3 looks at corporate ownership patterns that resulted in inadequate protection for minority shareholders and weak corporate governance in Thailand.2 4. lack of transparency and adequate disclosure. Key factors that led to weak corporate governance include the ineffectiveness of the regulatory framework.
However. The Government had to shift emphasis to restoration of economic stability.6 percent per year. with the agricultural sector the major contributor. In the wake of lower world oil prices and the rapid growth in income from the tourism and travel industry.4 billion from overseas and increased taxes on numerous items. Fourth. leaving the Government no choice but to resort to overseas borrowings. the government’s debt burden escalated. processed steel. lower than anticipated due to a worldwide economic recession. and automobile assembly) emerged.4 percent of GDP. The decline in imports was steady. Budget deficits remained a major problem during the Fifth Plan.3 percent in 1974. Thus. The results were increased exports. To close the fiscal gap. But the sustained importation of heavy machinery and equipment resulted in large trade deficits. . helped offset these deficits. The focus shifted to export promotion. including luxury goods. and increases in world food and oil prices.Chapter 4: Thailand 231 During this period. the value of the baht remained stable. using tax policy to control prices of consumer goods and implementing several price control measures to curb inflation. Budget deficits also increased throughout the Fourth Plan. however. As a result. especially foreign aid from the United States. remaining high until 1981. and Fifth Plans (1972-1986) An economic downturn at the end of the Second Plan led to an adjustment in policies. Inflation reached 15. chemicals. the Government borrowed $6. Consequently. The Government decided to embark on restructuring measures in the Fifth Plan (1982-1986) to rehabilitate the ailing economy. gross national product grew by about 7 percent per year. Unemployment. it proceeded with its development plan for the industrial sector.5 percent in 1973 and 24. and reduced current account deficits. resulted in increases in the current account deficit. Inflation levels were low. including a weakening of the dollar. textiles. became a major problem as domestic investment declined. capital inflows. an improved trade balance. Average growth for the period was 4 percent per year. The average budget deficit reached an all-time high of $2. At the same time. External factors. Industrial sector growth was also rapid and many industries (tires. the current account registered a surplus in 1986. with the devaluation of the baht in 1984 a major step in this direction. canned foods. the industrial sector grew at a faster rate than the agricultural sector.15 billion per year or 4. The Third. averaging 1. however.
the property sector began to collapse in 1996. Singapore.5 percent. while exports expanded considerably. Growth rates during 1987-1991 ranged from 9.2 percent target. invited a deluge of capital seeking profitable investments. With loans increasingly becoming expensive and hard to come by due to a lending squeeze by the central bank and high interest rates. The exchange rate was steady at around B25 to the dollar. The country also attracted a large amount of foreign direct investments (FDIs). from only $31 billion in 1992. Thailand became a debtor’s market. with private foreign debt reaching $92 billion by the end of 1996.2 percent per year. and Hong Kong.2 and 13. and the stock market. United States.8 percent.6 percent target of the Seventh Plan. II The Sixth Plan (1987-1991) Industrial sector productivity improved gradually during the Sixth Plan period.8 percent. lower than the target of 8. Growth of exports and imports averaged 14. By 1995.4 percent targets. Vol. Average annual growth in real GDP was 8 percent. compared with the 8. compared with the 14. The manufacturing sector became a dominant force in the economy. an oversupply of housing emerged. Inflation was 4.7 and 11. Thailand’s rapid growth up to the mid-1990s made the country one of the world’s fastest-growing economies. reaching an annual inflow of $2 billion in 1991. respectively. . The Seventh Plan (1992-1996) The economy’s performance from 1992 to 1996 generally met the targets of the Seventh Plan. combined with its liberal financial policies. better than the 5. Private sector investment grew at an average annual rate of 7 percent.232 Corporate Governance and Finance in East Asia. From 1989.6 percent.5 to 13. Europe. the Government successfully balanced the budget and even settled its foreign debt of $4 billion before this was due. rather than to productive activities. the bulk of domestic investments went to speculative ventures such as real estate. China—went to export-oriented manufacturing industries. increasing its share in total export value from 42 to 76 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. Most of the FDIs—originating mainly from Japan. The country’s high ratings in the international capital market. compounded by a slump in property sales. property development. On top of its predominantly “borrowed” nature.
its policy had always been to protect domestic banks. a former Chief Economist from the US Securities and Exchange Commission.2. the establishment of the Securities Exchange of Thailand (SET) was legislated and trading began on 30 April 1975. The deficits caused the Government to rely on even more external borrowing. Sidney M. The country had a current account deficit of about 8 percent of GDP in 1995 and 1996.2 Development of Capital Markets Although the corporate sector has long been the government’s main tool for economic development.” extending its control and regulatory powers to the finance and securities companies operating freely at the time. the Government passed the Public Limited Company Act. A series of increases in customs and excise taxes on luxury imports did little to stem rampant consumer spending. 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. a policy that held throughout the first six economic development plans. with growth shrinking from 23. Exports went into a tailspin. 58 on the Control of Commercial Undertakings Affecting Public Safety and Welfare. In May 1974. Foreign banks were barred from competing directly with domestic banks. 4. on account of an overvalued baht that weakened export competitiveness. However. the corporate sector’s main source of funding was the banks.3 percent in 1996. Included in the Second Plan (1967-1971) was a proposal to establish the country’s first authorized and regulated securities market. In 1972. In 1969. the Bank of Thailand and . which raised the debt service ratio.” which later became the master plan for the development of the Thai capital market. prepared a comprehensive report entitled “A Capital Market in Thailand. the Government amended the “Announcement of the Executive Council No. the capital markets didn’t play a significant role until 1975. Robbins. Its most crucial role was to help mobilize funds to support Thailand’s industrialization and economic development. In 1978. many companies considered the Act too restrictive and a hindrance to growth. which was amended in 1979 and 1985. SET officially became “the Stock Exchange of Thailand” in 1991.8 percent in 1995 to 1. Before the capital market emerged. And because the Government considered the banking system vital to the development of the economy. placing all publicly listed companies under regulation.Chapter 4: Thailand 233 Toward the end of the Plan period. Under the 1962 Commercial Banking Act. the signs of an economy about to falter were there. In his report.
The pressure dovetailed with the Government’s intention to make Bangkok one of the financial centers of the region. while the Securities and Exchange Act (SEA) the same year sought to improve capital market supervision. to cater specifically to its . At the end of the Sixth Plan. Thailand’s capital market entered a new era with improved legislation and regulation. The banks and finance companies operated at insufficient levels of reserve capital and were overexposed in high-risk businesses such as real estate. With the liberalization of financial markets. the financial and banking laws were generally ineffective.234 Corporate Governance and Finance in East Asia. Thai banks gained access to a variety of funding sources from around the world.” The Government also granted financial institutions overly generous bailouts. and the General Agreement on Tariffs and Trade (GATT) meeting in Uruguay had the liberalization of financial services on its agenda. II the Ministry of Finance had full authority to supervise all commercial banks. Laws were enacted to stimulate growth of the corporate sector. In the 1990s. The resulting availability of funds propelled the corporate sector’s growth through the early part of the 1990s. Earlier. A number of internal and external factors contributed to the Thai Government’s acceptance of the IMF’s Article VIII agreement. Financial deregulation and liberalization allowed the country to attract foreign savings and investments that helped finance the growth of the economy. it usually relied on “moral suasion. increased financial market activities. Vol. the Government was under international pressure to deregulate the financial sector. the World Bank had recommended such a move. 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. creating a moral hazard problem—the perverse expectation that imprudent bank behavior would be rewarded with forbearance and bailout. The Public Company Act of 1992 relaxed some of the rules and restrictions contained in the original laws. The regulatory measures were inadequately designed and poorly enforced. and new financial instruments. Externally. Thailand discarded controls on foreign exchange transactions and capital flows—a turning point for the Thai corporate sector. While the Bank of Thailand had the regulatory power to influence business practices. Economic growth had been rapid and domestic savings could not keep up with the pace to support investments. there were 29 commercial banks (15 domestic and 14 foreign banks) in Thailand. However.
In terms of capital. Hunting. . finance. however.1 trillion and paid-up capital of B1.6 2.6 23. Gas.1 Public Companies Registered. 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.6 350. The manufacturing sector is a far second with registered capital of B350 billion and paid-up capital of Table 4. in that order. The result was a corresponding growth and development in Thailand’s capital markets. Ministry of Commerce.1).3 Growth and Financial Performance Since the 1978 enactment of the Public Limited Company Act.1 30. the country became recognized as an economic development model for other emerging economies. Storage. and Restaurants and Hotel Transport.101.5 50. The majority of the companies are in manufacturing. 4.9 16. and Business Service Community.3 trillion have been registered with the authority (Table 4.9 1.2 11. Insurance. and Water Construction Wholesale and Retail Trade.4 trillion in registered capital and B791 billion in paid-up capital.0 21. and Fishing Mining and Quarrying Manufacturing Electricity. Financial deregulation and liberalization were key to realizing that vision.6 1. Thailand. with B1.9 34.3 83. Social and Personal Service Total Note: The data for 2000 is as of October 2000.1 78.5 111. Source: Department of Commercial Registration.5 791. and wholesale/ retail trade and restaurant/hotel sectors. 1978-2000 Number Registered of Capital Companies (B billion) 5 6 245 5 13 129 22 194 42 661 1. The stock market boom from 1991 until the financial crash of 1997 reflected international investors’ response to Government policies.2. about 661 companies with total registered capital of B2. the financial sector is the largest.0 110. and Communication Financing.394. Real Estate.0 Paid-up Capital (B billion) 1.291.0 19.2 Type of Business Agriculture. Worldwide. Forestry.9 261.Chapter 4: Thailand 235 fast-growing neighbors.
8 201. With the enactment of the SEA of 1992 that brought suppliers of finance services and their clients together. Vol. II B261 billion. from only B20.5 1.1 599. reached .1 2. Market capitalization. Debt market activities also increased significantly with the establishment of the Bond Dealers’ Club (BDC) in 1994.0 0.5 39.1 286.2).3 1996 1997 65.6 — = not available.236 Corporate Governance and Finance in East Asia. The number of listed companies and securities steadily increased until 1996 (Table 4. moreover.3 194.7 5.7 billion in 1996. reducing the value of offerings to a little more than a quarter of the previous year’s level.4 51.8 billion.2 5.3 31.0 20.9 37.6 8. the year before the crisis struck. this was due to the recapitalization of commercial banks in compliance with the new loan provisioning requirement. the capital market became instrumental in the rapid growth and development of the corporate sector.9 1998 1999 15.5 1. The signing of Article VIII with the IMF.9 31. After the passage of the SEA of 1992.2 Public Offerings of Securities.5 — — 56. These peaked at B89.1 — — — 6.0 1994 82.7 7.2 25.6 174. The 1997 crisis battered the primary market for securities.3 22. The preeminence of the financial sector is a direct result of financial deregulation and liberalization. The stock market also became an invaluable source of funds for corporations. While a rebound was apparent beginning in 1998. the value of public offerings rose steadily. Domestic and offshore debt issues reached B54. meanwhile.7 136. respectively.8 — 26.4 34. 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. reaching a precrisis peak in 1996 (Table 4. Source: Key Capital Market Statistics.2 12.1 54.7 27.4 277.8 151.3). Securities and Exchange Commission of Thailand. allowed Thai financial institutions and corporations to obtain funds overseas.8 1995 64.6 7. The development of the corporate sector closely followed the development of capital markets.4 96.5 billion and B1 billion the previous year.2 40.3 6.7 9.7 billion and B27.6 39. Table 4.
268 2. the averages for all three profitability ratios took a downswing all the way until 1996.610 1. Corporate profitability.3 percent in 1989 to 3. ROA dipped from 10. Foreigners accounted for an increasing proportion of SET’s turnover value.281 832 373 356 482 Due to listing requirements and other reasons. gross profit margin rose until 1991 before falling in 1992. The key financial ratios of all companies listed on SET bear this out (Table 4.193 2. By the early 1990s. as measured by return on assets (ROA).5 at its peak in 1987.360 1. pulled down by active public offering activities. the highly liquid financial system continued offering cheap funds to sustain corporate sector investments.3 Statistical Highlights of the Stock Exchange of Thailand. Side by side with this surge of financing for corporate growth. The plunge in profitability and asset turnover—from 117 percent in 1985 to 65 percent in 1996 for the latter—cast doubts on the . Throughout the 1990s.6 trillion. in the end. the companies could not generate enough net returns from their assets and equity. 1993-1999 Item Number of Listed Companies Number of Listed Securities Market Capitalization (B billion) Turnover Value (B billion) SET Index a 1993 1994 1995 1996 1997 1998 1999 a 347 408 389 494 416 538 454 579 431 529 418 494 392 450 3.301 3. The trend reversed in 1995.325 3.Chapter 4: Thailand 237 Table 4. was the ominous deterioration in the key financial ratios of publicly listed companies.4).683 1. The financial leverage of all companies declined until 1994. corporate profitability had been declining. however. The upward trends for ROE and ROA continued through 1989. when long-term debt grew as Thai corporations began to borrow heavily to finance growth. While the decline in gross profit margin was not as sharp.201 2.560 1.4 percent to 5. resulting in their inability to fulfill debt obligations. their share rising from 17 percent in 1993 to 43 percent in 1997. its high point in 1995 at B3.114 1.1 by 1996.565 2.4 percent in 1996.133 1.8 percent. return on equity (ROE). Meanwhile. ROE similarly fell from 21. however. Source: Securities and Exchange Commission of Thailand. and gross profit margin. had been on the rise throughout the 1980s. then stalled in 1990.535 1. But instead of shifting to a low gear.303 930 855 1. the average times interest earned (TIE) was down to 5. not all public companies are listed on the SET. From 10.
2 6.9 14.5 52.6 125.1 52.2 10.5 15.8 5. The downtrend in corporate profitability.4 44.7 5.4 5. and footwear industries also experienced losses.4 24.1 44.6 12. and footwear had the lowest at 11 percent. US.8 88. Vol. Severely affected by global competition throughout the decade.4 34.8 11.2 49.238 Corporate Governance and Finance in East Asia.6 168. Korea and Thailand had the highest debt-to-equity ratios.5 51.5 38.7 54.4 9.4 3.4 12.6 36. Overall.0 145.8 5.1 114.4 7.8 25.0 29.4 12.9 7.7 4.3 91.2 27.5).2 10. clothing.2 161.7 LongTerm Debt to Asset Assets Turnover (%) (%) 14.7 27. Thailand’s ROE. Among the crisis-hit countries. It has also been argued that family-based controlling shareholders borrowed excessively to avoid diluting their control over their corporations.0 63.9 66. these companies opted for debt. A major reason for this was the rapid rise in asset prices.8 51.4 Key Financial Ratios of Publicly Listed Companies. 1985-1996 LongTotal Term Total Return Return Gross Debt Debt Debt on on Profit Times to to to Assets Equity Margin Interest Equity Equity Assets (%) (%) (%) Earned (%) (%) (%) 3.2 215.2 10.7 59.9 140.3 4.9 8.8 151.7 80. the textiles.1 16.7 12. II Table 4.7 35.0 139.7 12.4 18.7 5.0 7.0 117.7 34.5 9.7 5.6 7.8 8.6 27. Hotels and travel showed the highest ROE of 15 percent while textiles.4 4.1 242.4 139.7 15.4 51.3 10.8 54. large companies (where size is reckoned in terms of assets or sales) were more profitable than small companies in terms of ROE (Table 4. but was most severe in building and furnishing material industries as a result of the downturn in the real estate market.9 39.2 64.3 12. which was particularly significant in the two years preceding the crisis. They were generally more efficient in managing their assets and .1 16. which fell from 16 percent in 1991 to just under 6 percent in 1996.5 50.9 7.2 27.6 138.9 144.9 51.4 7.1 60.7 20.7 27.5 30.4 28.3 8.1 9.8 14. was felt across industries.7 12.1 120.2 35.6 41.4 119.4 47.9 27. practice of heavy borrowing. was also distinct in the region. Despite the availability of the equity market.7 12. resulting in higher collateral values for borrowers.5 63.0 125.4 26.9 77.0 3.7 21.6 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.
3 49. although the performance of listed companies in the late 1980s was strong. the law disallowed cumulative voting.3 15.5 87.7 14.8 10. .8 62.5 6.8 6.2 10.5 94. 4. measured by total asset turnover.7 10.5 7.8 26. the Public Limited Company Act of 1978 and its amendments regulated Thai publicly listed companies.8 6.3 164.3 135.7 Source: Pacific-Basin Capital Markets Database compiled by the University of Rhode Island.2 134.6 5.4 52.1 13. For instance.3 25. by the 1990s.2 18.3 88. Although stable in the 1980s.4 8.1 Small Medium Large 5. could lead to a high turnover in the board. They also tended to use more financial leverage than small companies as their total DERs show.6 10.3 43.8 47.8 142. some rules and regulations of this particular law were believed to be too restrictive and were discouraging companies from going public. Increasingly heavy borrowings rendered the sector even more vulnerable to lower profitability and sales.7 6. US. which would be disruptive to company management.6 61.6 7.6 30.1 6. 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. There were also concerns that the provisions governing the criminal prosecution and penalties of directors and management were harsh and inappropriate.3 52. However.1 29.Chapter 4: Thailand 239 Table 4.2 121.0 48.4 Legal and Regulatory Framework Before 1992.4 116.2. The argument was that having a Board of Directors whose members represented different groups of investors would create conflicts and hamper management effectiveness.3 176.6 12.6 30.2 12.9 13.3 49. the overall activities of listed companies.3 23. During the 1990s.0 20. capital despite the higher gross margins of small companies.5 Average Key Financial Ratios by Company Size.0 83. weaknesses became evident. Cumulative voting.9 20.1 25. total asset turnover declined after 1989. it was thought. also deteriorated.1 5.6 31.6 6. In sum.
and the punishment for management misconduct was also lightened considerably. However. As it turned out. a feature that is believed to have impaired the effectiveness of existing regulatory mechanisms in the corporate sector. adopted to promote the development of publicly listed companies.3 Corporate Ownership and Control Ownership and control of corporations in Thailand are highly concentrated. . the new legislation removed a number of incentives that would have kept public companies prudent and diligent in their operations. The Public Company Act of 1992. Fortysix companies responded.240 Corporate Governance and Finance in East Asia. 2 ADB survey questionnaires were sent to all Thai listed companies in early 1999. the limit on shareholdings by the largest shareholders was increased from 50 to 70 percent of total outstanding shares. coupled with weak corporate governance. from holding more than 50 percent of total outstanding shares and other shareholders from holding more than 10 percent of outstanding shares individually. II Another issue was the proportion of shareholding by top shareholders. the exit of these provisions appears to have contributed to the 1997 financial crisis. The provision discouraged original family owners from registering their companies. but not all questions were answered. relaxed the contentious provisions of the 1978 Public Limited Company Act. played an important role in bringing about the financial crisis. This will be discussed in Section 4. and external monitoring and control of corporations were also weak. concentrated ownership. The legal and regulatory framework for the corporate sector also includes provisions related to insolvency. Cumulative voting was made optional. An Asian Development Bank (ADB) survey conducted for this study shows. 4. as a group. The protection of minority shareholders was inadequate under the Public Company Act of 1992. that creditors had generally little influence on the management of corporations. for instance. The law prohibited the largest shareholders.2 The market for corporate control was not active and did not give managers strong incentives to perform efficiently.5. The original company owners welcomed the changes and the number of publicly listed companies subsequently rose to more than 600. As the succeeding sections point out. Vol.
6 4.2 11.4 26.9 52.3 percent.0 3.7 11.9 11.0 5. Table 4.9 3. 33. and 28.1 12.4 6.6 27. there were only slight variations in the pattern.3 16.7 6.1 5.2 4.5 28.4 26.3 percent and 18.3 7.2 56.0 3. Stock Exchange of Thailand.7 12.8 11.3 28.9 52. and minority shareholders to stake their claim in the control and regulation of these companies.9 26.4 percent of outstanding shares. Thai.9 54.1 7. the top five shareholders of each of publicly listed Thai companies held. with the largest shareholder on average controlling 10. In the past. Indonesian.9 4.1 11. But with their increased reliance on new varieties of equity and debt instruments. this was not the case.Chapter 4: Thailand 241 4.1 Patterns of Corporate Ownership A World Bank study covering nine Asian countries finds that firms in Japan and Taipei.2 4.0 7. China firms have the highest single shareholder ownership concentration at 35.7 percent.3 11. with the top three shareholders accounting for almost 50 percent (Table 4.4 6. Ownership was most concentrated in the packaging.6 57.9 52. This implies that the top five shareholders enjoyed full control over the outcomes of shareholder meetings. these companies obtained funding solely from banks or from their own retained earnings.4 4.5 9. Source: Comprehensive Listed Company Information Database. Ownership Concentration Between 1990 and 1998.9 6.8 32.6).1 3.3.9 percent of shares of a company.7 7. one would expect the public.1 percent of control rights.9 55.1 5. and Hong Kong.0 56.1 5. 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.0 7.9 3.5 Average for 1990-1998 period. respectively. 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. Most large Thai corporations listed on SET started out as family businesses.4 10.3 7.4 26. In contrast. .6 28. on average. Unfortunately. Across industries.China have the least concentrated ownership.8 5.1 4. 56.6 Top-Five Ownership Concentration of Publicly Listed Companies in Thailand.2 4. creditors.4 5.6 68.3 5.0 53.
001) 0.072) (0.022*** 0.058* ROE (0.034*** 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.242 Corporate Governance and Finance in East Asia. * Denotes significance at the 10 percent level. as measured by debt-to-equity and debt-to-asset ratios. with a top-five ownership concentration of at least 60 percent.8). and building and furnishing industries. and Company Size Item Intercept Top Five Ownership Concentration Company Size Adjusted R-Squared F-Statistic ROA 0. II agribusiness. Ownership Concentration.7).533)*** Debt-to-Assets (0.7 Statistical Relationships between Corporate Profitability. Through these holding companies.001*** 0.080 6. 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 4.005** 0. US. Vol. year. It is the practice of Thai corporate founding families to set up holding companies to own shares in affiliated companies or subsidiaries. and ownership types.001 0. founding families maintain effective control of entire groups.647 Note: The regression included dummy variables for industry. owning 26. ** at the 5 percent level.090 0. Other industries had their top five shareholders controlling at least 55 percent of outstanding shares.003 0. results show a significant positive relationship between ownership concentration and financial leverage.169*** 0.800 0. Leverage.7 percent of outstanding shares on average (Table 4. Based on a regression analysis. Table 4. including those that are publicly listed .115 9.116) Debt-to-Equity (1. Source: Author’s estimation based on the Pacific-Basin Capital Markets Database compiled by the University of Rhode Island. Composition of Controlling Shareholders Affiliated corporations comprise the largest group among the top five shareholders of publicly listed companies.037 0. On the other hand. *** at the 1 percent level. Company size is significantly related to ROE and leverage.031 3.029 3.
5 26.1 0.8 23.9 15.3 27.7 — 1.2 1. Individual family members also hold a significant amount of outstanding shares. with 29.8 Top-Five Shareholder Composition of Publicly Listed Companies in Thailand. a company listed in the real estate sector of SET.7 Bank 2. operates five of the most successful shopping malls in Thailand.6 5. the company. In addition.7 1.3 — = not available.2 7.5 0.9 6.3 0. This practice is illustrated by Central Pattana.0 3.0 19.4 22.5 NBFIsa 6.6 28.8 28.9 7. . including finance and investment companies.4 1. founding families and their relatives maintain control of many companies by jointly holding on to the most significant chunk of shares. unlike in Japan where crossshareholding is common.7 5.4 1.2 1.6 1.3 27.5 0.9 19. Although holding companies set up affiliate firms. owned by the Chirathivat family.5 5. In 1994. Typically.3 1.5 Individuals 13.4 20.1 1.8 0. individual members of the Chirathivat family aggregately hold 25. a NBFIs denotes nonbank financial institutions. The roster of its major shareholders as of December 1997 illustrates the typical ownership concentration of a publicly listed company in Thailand.7 0.1 1. Source: Comprehensive Listed Company Information Database. 1990-1998 Year 1990 1991 1992 1993 1994 1995 1996 1997 1998 Average Company 28.6 25.3 20. Stock Exchange of Thailand. the company increased its registered capital and became a public company listed in SET.6 percent of outstanding shares.4 1.2 5.3 27.9 0.2 18.Chapter 4: Thailand 243 Table 4.8 1. The largest shareholder is Central Holdings Company.3 1.1 4. one of the founding members.0 17.5 0.3 1. the affiliate firms rarely hold shares of their parent companies.5 percent. in SET.5 1.5 1. averaging about 18.0 18. The top 10 shareholders include a holding company owned by the Tejapaibul family. Established in 1980 with a registered capital of B300 million.5 2.6 1. The ADB survey indicated that listed companies held shares in an average of 11 companies.6 1. These individuals usually hold important management positions in concerned companies.5 Government Other 0.9 18.3 percent of outstanding shares. a joint venture among three families.
Moreover. Together. Across industries. on average. and a state bank. and responsibilities of directors of public companies. roles. 1. The Government holds. the top 10 shareholders consist predominantly of members of founding families and their holding companies. 3 Discussions in this section are based on results of company surveys by SET and ADB. has the Ministry of Finance as its only large shareholder with 92. . Vol. holdings by individual family members and holding companies account for at least 50 percent of outstanding shares of an average listed company.5 percent of total outstanding shares of listed companies. For example. Another example is Bangchak Petroleum Plc. the Government’s role in public companies is expected to decline. commercial banks account for only 1. where the top three shareholders are the Ministry of Finance. 4. Only a handful of companies have the Government among their large shareholders. There was a trend of rising government shareholdings throughout the period 1990 to 1998. qualification. On average. they exercise limited influence in operations because of the restricted size of their shareholdings. However.244 Corporate Governance and Finance in East Asia. duties.5 percent of total outstanding shares. Thai Airways International Plc. II another of the company’s founding members. the Government owns the majority of the shares. only one tenth of listed companies have commercial banks on their top-five shareholder list. these shareholders are able to control the company. Although the list of top shareholders of publicly listed companies includes financial institutions. In such cases. both conducted in 1999.1 percent of total outstanding shares of listed companies.9 percent of outstanding shares. the predominance of individual family members and holding companies in the top shareholder list remains valid. Nonbank financial institutions hold an aggregate 5. In effect. Except in the hotel and travel service sector.2 Corporate Management and Control3 Board of Directors The Public Company Act of 1992 stipulates the appointment process. By owning 62 percent of voting shares. About half of listed companies have nonbank financial institutions such as finance and investment companies in their top-five shareholder list. they account for 80 percent of total outstanding shares.. with the envisioned privatization master plan.3. the Petroleum Authority of Thailand.
In addition. directors are required to act with care and honesty for the company’s best interest. 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. while 30 percent of respondent companies held board meetings monthly. Nineteen companies stated that selection was based on professional qualifications. In five other companies. selection was based on relationships with controlling shareholders. In their business conduct. directors may be imprisoned or fined. directors shall be elected at the annual general shareholders’ meetings (AGSMs). Meanwhile. The ADB survey indicated. The appointment of the chief executive officer (CEO) needed approval during the AGSM in 11 of the responding companies. meanwhile. while 15 percent of respondents went beyond the requirement. Generally. If found in violation of these provisions. Many companies have a formal policy on corporate governance and business ethics. Some companies (36 percent) had five to six main board members holding seats in their executive boards. Three companies indicated that the CEO and the chair were close relatives. directors could be compelled to compensate the company for damages arising from their misconduct. but not in 22 others. the ADB survey found that 31 companies (out of 46 responding) required outside directors to be present at all board meetings. that only in two of the 46 responding companies were the chair of the boards elected based on the extent of their shareholdings. Most companies (83 percent) satisfied SET’s requirement of having two independent board members. the majority (71 percent) had board chairs who were also members of top management teams. Although 28 percent of the chairpersons came from the ranks of independent outside directors. Almost all companies (98 percent) exceeded the minimum required five members in their Board of Directors. and to comply with the laws and articles of association. an executive board consists of senior management and some main board members. Unless stipulated in public companies’ articles of association. . A survey by SET found that the majority (58 percent) of the 202 responding companies held their board meetings every quarter.Chapter 4: Thailand 245 Directors are required to meet minimum qualifications specified under the SEA of 1992 and the Listing Rules issued by SET.
Chair. the auditor is not . The SET survey found that the majority of listed companies (81 percent) still have no separate audit committee. Three companies allowed their management to determine the chair’s compensation package. all listed companies have been instructed to establish audit committees to be responsible for examining the quality and reliability of company financial statements. Also. In one company. These committees were mainly responsible for determining compensation for senior and regular staff. The ADB survey indicated that 18 of the 46 responding companies compensated their chairpersons using a fixed-fee schedule. Half of the companies in the SET survey had a separate remuneration committee. Directors with managerial responsibility or those related to major shareholders cannot be members of such audit committees. All respondents confirmed the use of external auditors. II Compensation of Directors. Fourteen other companies had profit-related incentive schemes in addition to fixed fees. while 19 companies observed only some of them. However. the work of this committee was often considered part of the executive board’s responsibilities. The directors’ compensation was determined largely by the Board of Directors except in 19 percent of the companies surveyed where a remuneration committee was in charge. SET’s attempts to bring accounting practices to international standards have included requiring listed companies to consolidate all liabilities— including those on off-balance sheets—in their financial statements beginning June 1998. these were attributed to variations in the extent of duties and responsibilities assumed by those directors. however.246 Corporate Governance and Finance in East Asia. the remuneration packages had to be approved during AGSMs. In 25 companies. Companies already with audit committees did not have independent outside directors as audit committee members. Twenty-five of the 46 respondents to the ADB survey declared adherence to all relevant international standards. with 41 firms admitting the use of services of international auditing firms. Where different. the majority of the companies (77 percent) did not have outside directors as members of their remuneration committees. Audit Committees and Accounting Standards Since January 1999. and CEO The majority of company respondents to the SET survey provided similar compensation packages to internal and external directors. Vol. not an independent assignment.
SET’s rules and regulations closely follow this Act. At least 28 responding companies had the following . However. including false statements to conceal information about the financial condition and operations of the company during the sale of shares. The Act. Minority Shareholders and their Rights Many different rights and entitlements of shareholders are laid out in the Public Company Act of 1992. debentures. (iii) Because the chair is frequently also part of the top management team. shareholders have access to reliable information at no cost. (iv) The roles and responsibilities of the major government agencies regulating shareholder rights—the Ministry of Commerce. although recently. (i) No standards are enforced in the content and timing of notices for shareholder meetings. The majority of the companies (85 percent) require the appointment of external auditors during annual general meetings. or other financial instruments. In the majority of these companies (38 out of 46 respondents). most responding companies have rules and regulations intended to protect shareholders. the Securities and Exchange Commission (SEC) and SET were actively prosecuting violating firms. The Act also holds directors liable for any damage to shareholders. Proxy solicitation tends to be abused to the extent that shareholders are inadequately informed about matters to be taken up in shareholder assemblies. there is the danger that top management may be capable of unduly influencing the board’s decisions. Relationships between firms and external auditors are generally long-term. SEC. Shareholders are also entitled to call emergency meetings and present proposals at AGSMs. stipulates the proper conduct of shareholder meetings.Chapter 4: Thailand 247 independent from the company. As a result. Forty-four companies indicated that they had proxy voting in place. While safeguards are in place. averaging about 14 years. as well as the registration and holding of shares. According to the ADB survey. likewise. For instance. remuneration. SET. there are also significant gaps in the system of shareholder protection. the corporate sector lacks a strong self-regulatory body to compel compliance with these standards. shareholders can claim compensation in cases of negligence or dishonesty by management. the institutional machinery is not fully responsive to complaints about violation of shareholder rights. and executive committees. with 13 companies allowing proxy voting through mail. and the Bank of Thailand— are not clearly defined. (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.
they comprised only 8 percent of total shareholders. did not vote in previous AGSMs. But with the ownership concentration of Thai companies. Vol. Almost 82 percent of shareholders. Only a small number of shareholders attended the latest AGSMs. and call an extraordinary session. takeover of the company. minority shareholders are assured adequate legal protection. Although the attendees held. But the exercise of these rights requires even higher shareholding levels. .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. II mechanisms in place: mandatory shareholder approval of major transactions and interested or related party transactions. The SEA of 1992 and the listing rules also contain provisions for the protection of shareholders against transfer pricing. In theory. The ADB survey results reveal that the proposals presented by management were rarely rejected during the general meetings. minority shareholders may also appoint an outside inspector to examine the company’s operations and financial condition. the new Public Company Act of 1992 inadvertently weakened the governance of public companies by diminishing minority shareholder rights. In effect. 4. and insider trading. such protection has been insufficient. on average. On paper. and mandatory disclosure of related interests and significant shareholders’ transactions. it would be difficult for minority shareholders to gather the shares needed to take action. The difficulty minority shareholders have in exercising their rights can be seen from the ADB survey results. given their importance in providing finance and their stake in companies.248 Corporate Governance and Finance in East Asia.3. 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. 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. In practice. While stimulating the growth of the sector. 66 percent of total outstanding shares. representing only about 28 percent of shareholdings. the only group of shareholders that can exercise rights is the top five shareholders. Banks would be obvious candidates to implement these mechanisms. however.
a company’s reputation and its long-term relationship with creditors sufficed in many instances. 11 experienced rejection after the crisis started. . The old bankruptcy law in Thailand also made it difficult for creditors to obtain payment against bankrupt borrowers. The presence of collateral usually diminishes banks’ incentives for screening project feasibility and monitoring project implementation. while loans for fixed investment were also more likely to be supported by collateral. For 20 of the 46 responding companies. Among 16 companies in the ADB survey whose loan applications in the last three years were rejected. One tempering mechanism that could inhibit the excessive use of borrowing is the threat of losing control in the event of bankruptcy. such as that seen in Thailand before the crisis. Most companies reported that banks were more likely to require collateral. when insiders want to expand their company’s operations without losing control. Eleven companies stated that creditors usually exercised whatever influence they had on management through covenants regarding the use of loans. including procedural disputes. the majority believed that creditors had little influence on company management and decision making. they resort to borrowing. Debtors had many handles to stall the bankruptcy process. creditors’ collateral requirements were tightened after the crisis. There were many options.Chapter 4: Thailand 249 Historically. which could cause a delay by at least a year. other than losing control. Fifteen of the 20 companies that had to renegotiate loan repayment with creditors in the last five years did so after the crisis. Only 28 of the responding companies in the ADB survey indicated that their creditors required such feasibility studies. borrowers seldom lose control to creditors even when they default and become insolvent. Seven of the companies responding to the ADB survey indicated that all their creditors required collateral. In the end. however. as the ADB survey confirmed. Normally. Under a weak bankruptcy system. The impact of the financial crisis on credit eligibility and supervision requirements has been significant. Only three companies thought otherwise. while 18 said none of their creditors required collateral. to solve debt repayment problems. creditors do not always require project feasibility studies or business plans in granting loans. Actual bankruptcy proceedings took more than five years on average. However. Leverage allows the assets and operations of the company to grow without diluting corporate control. Apparently. Thailand has relied on commercial banks and finance companies to channel funds to private enterprises. 17 indicated that only some of their creditors had such a requirement.
3 billion (Table 4.250 Corporate Governance and Finance in East Asia. The company has 21 days to evaluate the tender offer and submit a report to SEC and all shareholders. if the purchase of shares implies a change in the directors or business activities. a person who acquires more than 5 percent of issued shares must file a report with SEC one day after the date of acquisition. and failed to provide managers with strong incentives to perform efficiently. there are two categories of merger and acquisition activities with associated regulatory measures. The Market for Corporate Control The SEA of 1992 was the first legislation that stipulated rules and regulations regarding the market for corporate control. Vol. SEC was later made responsible for regulating corporate takeovers. there were 41 cases of tender offers. whether directly or indirectly. which is a general offer made to shareholders of a company to acquire at least 25 percent of outstanding shares. The first category is the acquisition of shares in the open market.9). SEC has no authority to either approve or reject tender offers. however. II The financial crisis has presented a unique opportunity for reinventing the framework for corporate bankruptcy and for creating regulatory and judicial precedents. the minimum tender offer was reduced to 10 percent and some procedural modifications have also been introduced. In 1994 and 1995. with a total tender offer value of B42. (ii) an advertisement regarding the tender offer must be placed in major newspapers for at least three consecutive days. The second category is the tender offer. There are detailed requirements regarding such notification. It will take years. In 1996. with a significantly lower total tender offer value of B8. Although merger and acquisi- . The market for corporate control has not been active in Thailand. only a limited number of successful mergers of public companies have taken place. According to the SEA of 1992. Recently. The situation remained sluggish in 1997 at nine tender offers and a further decline in total offered value. there were only six tender offers. 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. before the extent to which the bankruptcy framework has been strengthened becomes clear. of shareholders: (i) all shareholders must receive tender offers.3 billion. its main role is to ensure transparency and fairness. Such efforts would serve to strengthen external discipline on controlling owners. and (iii) tender offers will be effective 30 days after the report has been filed with the SEC. In this case. Since the introduction of the Public Limited Company Act of 1978.
Provident funds for government workers and workers in public enterprises have been established only recently. employees regard the plans as monetary incentives. but the average shareholding is smaller than 1 percent of total outstanding shares.8 81.6 17. Even when companies offer ESOPs.9 3. Few companies offer employee stock option plans (ESOPs). Pension funds are perhaps even weaker in Thailand. if any.2 7. .2 8.7 Purchase Value Number of % of Tender Offer Value Companies 84. Since 1994. But instead of opting for an active role in the market for corporate control.9 Merger and Acquisition Activities.2 6.3 11.2 6. employee participation in corporate governance in Thailand.1 84. employees are even less willing to accept common shares as a form of compensation or benefit.3 60.8 8 27 14 6 9 13 23 Tender offer value refers to the minimum offer value. trading by mutual funds in SET represented less than 10 percent of total trading. tion activities increased after 1997. Eleven of the 46 responding companies in the ADB survey offer ESOPs.1 58. they have mostly been concerned with short-term gains. While the Thai mutual fund industry compares well to those in other developing countries in the region. Twenty-nine firms indicated that employees held shares of their companies.0 55. it remains small.3 6.7 11. but employees have never been represented in the board of directors since their shareholdings are minimal.5 6. Because of the current crisis. not with a view to becoming involved in actual management.1 75. The number of domestic institutional investors rose after the mutual fund industry was established in 1991.Chapter 4: Thailand 251 Table 4. Employee Participation in Corporate Governance There has been little.4 23. 1993-1999 Year 1993 1994 1995 1996 1997 1998 1999 a Tender Offer Valuea (B billion) 5.1 19. most of these were forced mergers or related to rescue packages. Source: Securities and Exchange Commission of Thailand.0 B billion 4.
Table 4.5 5.325.390. Thai Bond Dealing Centre. The country’s largest bank.4.1 6.2 262.10 Size and Composition of the Thai Financial Sector. The share of domestic banks in the banking system’s total assets was 80 percent.0 339.5 6.485. 1992-1999 (B billion) Outstanding Loans from All Financial Institutions 2.372.912.564.0 8.1 7.300.360.906. Vol.3 546.037.8 3. Bangkok Bank Ltd.161.268.4 519.1 3.1 Corporate Financing Overview of the Financial Sector A breakdown of the Thai financial sector for the period 1992-1999 (Table 4.1 3. and Bank of Thailand.669.4 4. In 1996.1 5.4 3. The total values of loans from financial institutions and commercial banks were consistently larger than the market capitalization of SET.193.4 Year 1992 1993 1994 1995 1996 1997 1998 1999 Source: Stock Exchange of Thailand.8 941. the next four largest banks accounted for 63 percent.2 2.133. total assets of commercial banks amounted to B5.3 5.119.230. The Banking System Until recently.5 Outstanding Loans from Commercial Banks 2.663.3 1.0 SET Market Capitalization 1..430. there were 29 commercial banks. . Many large commercial banks had affiliates among the 93 finance companies that served the high-risk market. Competition from foreign banks was limited as they were not allowed to engage in full branch operations.6 6. 15 of which were domestic banks.775.559. The bond market played only a marginal role in corporate financing. the banking sector was highly concentrated.5 trillion.171.6 1.979.4 1.1 Domestic Debt Securities Outstanding 215.5 4. although its role increased in the wake of the crisis. II 4.0 3.5 4.10) shows that Thailand is a highly bank-dependent economy.252 Corporate Governance and Finance in East Asia.825.477.6 2. accounted for 28 percent of the banking sector’s total assets.0 424.9 2.4 4.
The lack of supply of quality shares was a big problem for SET at that time. Turnover value reached B2. was set up by 74 members with an initial capital of B500 million. banking. The Government removed controls on capital and dividend repatriation in 1991. the market rose steadily and reached a record high in the fourth quarter of 1993. due to their close ties.8 in 1998. BIBF banks also enjoyed tax incentives on their operations and profits. BSDC is a nonprofit. Banks under the BIBF scheme were allowed to mobilize funds from abroad and lend to Thai companies in foreign currency. and property have accounted for the bulk of trading volumes. finance. SET immediately recovered due to the strength of the Thai economy. Through the years.2 trillion. the SET index declined. also made it unattractive to raise capital from the equity market. hardly any progress was made in lowering the cost of domestic financial intermediation or in developing new financial instruments for corporations. Despite the worldwide market crash in 1987. the liberalization of interest rates and capital account transactions stimulated a credit expansion through short-term borrowings in foreign currency. In the following years. After that. Benefiting from rapid economic and industrial growth. self-regulatory organization under the . the Bangkok Stock Dealing Center (BSDC). Because borrowers carried the exchange rate risk. reaching 355. Some 347 companies were listed in the same year with a total market capitalization of B3. and 20 new foreign banks. Stock prices tripled in the next three years until the market experienced its first crash as a result of the Gulf Crisis in 1990. Licenses were granted to 15 Thai banks. Many company founders did not want to release even a small portion of corporate ownership and refused to go public. an over-the-counter market. the Government established the BIBF to expand the banking sector and reduce the borrowing costs of Thai companies. SET is organized into 32 major industries. SET was not very active. Banking activity peaked in the mid-1990s.3 trillion. Easy access to commercial bank loans by family business groups. In contrast. In 1993. owning 70 percent of the country’s second largest bank. In 1995. the stock market entered its first boom period in 1986. The number of listed companies also quadrupled between 1981 and 1993. The Equity Market During the first few years of its operations.Chapter 4: Thailand 253 The Government was also a major figure in the banking system. and almost all capital account transactions were deregulated. 12 existing foreign banks.
A company wishing to qualify for listing in SET must file an information booklet (prospectus) with SEC and SET. securities can be traded in the secondary markets. After initial public offerings. Its main role is to serve as a secondary market for unlisted companies trying to raise capital. In 1996. II jurisdiction of SEC. If approved by SEC and the SET Board of Governors. Proposed changes in capital must be submitted for approval to SET accompanied by a detailed memorandum outlining the use of proceeds. the two classifications were merged. which consist of SET and BSDC. so now only listed companies are traded in SET. Consequently.8 billion in 1996. among other functions approved by SEC. According to the SEA of 1992. with each facing different listing requirements. there were two kinds of companies in SET—“listed” and “authorized” companies. The primary market is supervised by SEC. In July 1990. In 1998. approved by SET.5 percent and collectively owning at least 30 percent of paidup capital. lottery drawing must be used to ensure fairness. stock trading can commence within five days. Vol. Authorized companies were those with a minimum of 200 shareholders owning collectively at least 25 percent of paid-up capital. Before 1993. The company should then appoint a financial adviser. .254 Corporate Governance and Finance in East Asia. SET established new requirements for initial public offerings. which has a legal mandate to examine a company’s financial status and operations before allowing it to issue securities to the public. SET’s primary functions are to serve as a center for the trading of listed securities and to provide the essential systems needed to facilitate securities trading. The allocation procedure is nondiscretionary. and pro forma balance sheet and income statements. the BSDC was dissolved in 1999. turnover value was negligible and the BSDC Index remained flat throughout 19961998. The SEA of 1992 installed the legal and regulatory framework for Thai capital markets. If the issue is oversubscribed. to assist in the public offering process. also acts as a clearinghouse. financial projections. Only one security was listed in BSDC in 1995 and two more in 1996. and securities registrar. each holding no more than 0. and (ii) a minimum of 300 shareholders. It separated the primary and secondary markets to promote more flexible and effective supervision of both. Turnover value was B1. The listing application should be submitted concurrently to SEC and SET. SET. but dropped the following year to B122 million. securities deposit center. Company applicants must have an established history of operating under substantially the same management. however. Listed companies were those that had (i) paid-up capital of at least B20 million.
A turning point of the corporate debt market was the enactment of the SEA of 1992. 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. In 1996. Upon its founding in 1942.9 billion. The budget surpluses of the 1990s eliminated the need for new bond issuance. The proportion of domestic convertible debt instruments increased until 1995. at about 11 percent of the total value of outstanding loans extended by commercial banks and 20 percent of total equity market capitalization. it represented only 9 percent of GDP. however. The Thai Rating Information Services. was also instrumental to the growth of the corporate debt market. However.11). while secured debt instruments accounted for just above 10 percent. Companies generally issued short-term debt instruments like promissory notes or bills of exchange. Four years after the passage of the SEA. in 1994. the size of the corporate debt market rose to B132. A breakdown of domestic offerings of corporate debt securities from 1992 to 1996 shows that unsecured debts accounted for about 60 percent. the Bank of Thailand assumed responsibility for regulating the bond market. it accounted for a small share of the entire financial sector. Investors had limited knowledge of debt instruments. and the Government did not issue new bonds during 1990-1997. The Thai bond market was also smaller than that of Malaysia (56 percent of GDP) and the Philippines (39 percent of GDP) in that year. Beginning 1961. the first bond rating agency in Thailand. 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. which encouraged limited companies and public companies to issue debt instruments. State-owned enterprises became active issuers of bonds since 1993 because the Government constrained their borrowings (Table 4. The bond market in Thailand started in 1933.Chapter 4: Thailand 255 The Bond Market The Thai bond market has played a marginal role in corporate financing until recently. To gain some perspective of the size of the bond market in Thailand. led to the renewed issuance of Government bonds to finance the resurgent budget deficit and support cash-strapped financial institutions. The recent financial crisis. the Government issued more bonds to finance industrial development projects and perennial deficits. the year the Ministry of Finance first issued government bonds to finance infrastructure projects and economic development. compared to 110 percent in the US and 74 percent in Japan in the same year. .
1 — — — 29.0 26.7 90.9 329.6 — — 0.4 7.5 — — — — 1.3 3.0 5.9 0. by the end of 1997.7 538. 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. a surge attributed to capital inflows encouraged by high returns on Thai bonds. A sharp rise in unsecured offshore debt offerings can be noted all the way through 1996.0 — 5.4 — — — 1. However.256 Corporate Governance and Finance in East Asia.1 107.2 — — 50.1 12.2 89.3 46.3 29.5 43.2 2.8 31.0 — 5.0 86.2 43.3 — — 3.0 281.5 5.7 — — 40. Total offshore debt offerings peaked in the run-up to the financial crisis.1 289.1 121.5 billion.1 55. turnover value had reached B51.5 — 0. The decline in total domestic debt offerings in 1996 can be ascribed to the increase in offshore convertible debts. By 1995.7 5.1 21.7 95.0 333. The following year.6 billion. then declined substantially in 1996 and 1997.7 — — — — — — — 77.5 — — 32.4 — 9. this had climbed to B200.1 315.3 13.7 7. The club was considered the first organized secondary bond market in Thailand to serve as the wholesale market for debt securities.5 55.0 0.5 — 39.1 61.3 140.8 191.0 33.4 49.1 8.8 Source: Securities and Exchange Commission of Thailand and the Thai Bond Dealing Centre.9 5.7 — — — — — 4.7 132.1 141.9 40.1 59. .0 — 26. The domestic debt market declined after 1994 because corporations could borrow offshore at lower costs.7 821.7 28.8 47. II Table 4.9 20. total offshore debt offerings had plunged by 68 percent to a mere B28. the year the crisis unraveled and the baht was floated.5 10.4 billion.2 39.2 57.1 10.0 7.3 6.8 167.3 8.3 — 14.0 17.2 45.7 5.6 19.1 — — 6.6 — 0. BDC was established in November 1994 by 50 securities companies based on the provisions of the SEA of 1992. Vol.2 28.5 — — — 3.0 27.0 60.4 57.9 30.1 41.7 0.9 37.4 110.3 22.1 6.5 138.9 37.3 50.11 Offerings of Debt Securities.5 37.4 — 26.8 2.3 46.8 55.7 0.
and marketable securities holdings. In 1997. Companies in construction and property development seemed unable to generate internal funds. short-term loans accounted for more than 40 percent of total liabilities.4. There was also little change in the trend in retained earnings within the seven-year period. In any case. while for the property development industry.Chapter 4: Thailand 257 compared with investment in equities. The average for all industries was only 22 percent. these accounted for 33 percent of total liabilities. turnover value plummeted to B106. The proportion of accounts receivable also declined steadily. The overall trend is consistent with the decline in profitability observed in the analysis of corporate sector performance earlier. Equity financing remains an important part of listed companies’ long-term financing. BDC was renamed “the Thai Bond Dealing Centre” following its status upgrade to a bond exchange. these comprised 31 percent. 4. overall asset quality and liquidity of listed Thai companies deteriorated throughout the period. Across industries. the use of debentures remains minimal even though the trend was generally upward until the 1997 crisis. From 1990 to 1996.2 Patterns of Corporate Financing An examination of financing patterns among Thai companies listed in SET shows that on the asset side. a trend most apparent in the leap between 1991 and 1992. For the construction industry.1 billion in 1998. The closure of 58 finance companies affected the BDC significantly since half of its members were suspended as a result.12). At lower than 5 percent of total liabilities. In addition. significant variations can be noted. cash balances. In the same year. judging by their relatively low levels of retained earnings. steadily easing up between 1990 and 1996. 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. Turnover fell further to B72. they also had a relatively small proportion of equity and . Retained earnings accounted for about 30 percent of total equity financing. The ratio of net working capital to total assets decreased from a peak of 31 percent in 1993 to 28 percent in 1996. 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. listed companies experienced liquidity problems with declining reserves of cash and marketable securities during the period 1990 to 1996 (Table 4.
6 14.0 100.8 37.3 34.8 21.0 51.2 16.8 7.5 1.4 6.2 3.6 12.9 14.4 17.9 0.6 0.8 6.1 36.2 17.3 14.9 16.3 18.9 12.0 100.0 48.2 1.3 48.0 10.0 2.6 38.6 36.4 17.8 3.8 37.3 17.6 13.8 8.6 11.8 34.2 45.7 9.0 6.2 2.9 14.8 14.5 1. Vol. Printing and publishing companies had lower financial leverage than companies in other industries.2 17.2 42.6 0.7 17.4 2.0 100.6 2.6 15.2 16.8 9.9 17.0 1.6 6.1 18. Analysis of common-size statements by ownership concentration (based on the levels of top-five ownership concentration classified as high.9 6.6 100.4 7.4 43.3 49.0 100.3 50.3 6.3 21.2 17.7 7.3 1.4 48.1 5. The agribusiness industry relied more heavily on short-term loans at 56 percent of the industry’s total liabilities.2 17.7 15. II Table 4.6 0.9 43.8 10.3 14.12 Common-Size Statements for Companies Listed in SET.9 18.3 38.2 34.0 100.9 40.5 14.1 49.1 13.7 52. medium.1 17.0 100.7 50.3 12.0 14.7 16.0 7.5 0.4 14.9 10.2 35.4 8.8 46.5 11.4 49.0 13.8 17.2 43.2 1.2 2.5 1.5 37.2 43.0 100.9 20.1 7.8 20.0 100.8 35.6 22.1 50.9 14.1 2.0 10.6 100.7 0.5 43.6 8.0 100.4 49.3 2.3 18.6 21.6 10.2 12.0 100.6 0.0 100.9 50.9 38.7 1.9 14. compared with the 44 percent general average.3 34.0 15.9 14.0 100.13).9 3.6 18.8 19.9 17. were highly leveraged.9 15.8 25.9 49.3 25.5 9.6 51.6 50.2 22.0 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.0 100.7 16.2 2.4 21.2 15.258 Corporate Governance and Finance in East Asia. and low) also underscores that companies with high ownership concentration had high levels of long-term loans (Table 4.2 2.3 1.8 1.9 2.2 1.7 36.7 14.0 12.0 100. The level of total liabilities for the group characterized by high ownership concentration .8 9.5 9. 1990-1996 (percent) Item All Years 1990 1991 1992 1993 1994 1995 1996 2. US.9 6.7 18.
4 49.2 22. .13 Common-Size Statements of Public Companies by Ownership Concentration.4 50.Chapter 4: Thailand 259 Table 4. common equity accounted for a smaller proportion of total assets (47 percent) than companies with lower ownership concentration.2 11.5 18.9 21.4 3.7 percent for medium ownership concentration companies and 49.1 18.0 6.9 7.0 100.4 1.8 13.6 0.0 7.2 14.6 2.1 49.6 22.5 11.1 53.2 8. was 53 percent of total assets compared with 49.6 9. This is consistent with the observation that majority shareholders try to maintain their control by utilizing debt as a major source of funds.0 Medium 2.9 0.6 14. US. Companies with medium ownership concentration tended to have a higher proportion of short-term loans.2 45.8 12.0 16.0 Low 1.0 100.0 41.5 21.7 19.6 47.0 14.9 50.3 1.8 37.3 35.5 100.4 37.5 13.9 36.0 Source: Pacific-Basin Capital Markets Database compiled by the University of Rhode Island.9 100.7 12.9 16.1 44.4 35.4 18.3 1.1 36.8 13.6 100.5 percent for low ownership concentration companies.9 2. 1990-1996 Degree of Ownership Concentration Item Assets Cash Marketable Securities Accounts Receivable Inventories Other Current Assets Total Current Assets Net Fixed Assets Other Assets Total Assets Liabilities and Equity Accounts Payable Short-Term Loans Other Current Liabilities Total Current Liabilities Long-Term Loans Debentures Other Liabilities Total Liabilities Capital Stock Paid-In Capital Retained Earnings Total Equity Total Liabilities and Equity High 2.0 6.2 0.4 13. For the high ownership concentration group.3 16.3 8.3 100.0 19.6 15.7 17.4 7.
II Results from the ADB survey reveal that Thai companies preferred to use reserves and retained earnings as their first choice of financing. More important.7 12.1 52.8 5. however. it would seem that firms with concentrated ownership and associated links to the banking system have easier access to debt financing.6 41.15.7 percent in 1996.2 68. followed by bank loans.1 16.7 34.1 64.2 35.14 Financial Ratios of All Listed Firms.6 7. As a result. Table 4.7 28.1 in 1996.8 65.4 12. and rights issues.5 52.9 14.9 7.9 51. however. Public companies relied more on short-term debt financing in the period before the financial crisis.6 125.7 66. especially from 1994 to 1996.3 31. 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 4.1 144.8 51. While further detailed investigations are necessary. After the crisis.1 16. thus rendering them more vulnerable.8 percent in 1990 to 52.0 145.4 7. Short-term debt accounted for most of the increase. 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 8.4 139.0 50. .0 28.7 34.3 Source: Estimated from the Pacific-Basin Capital Markets Database compiled by the University of Rhode Island.4 51. bond issues overtook loans from commercial banks as the second preference. The direct relationship between the degree of leverage and the degree of ownership concentration is apparent in Table 4.1 44. Generally.9 140.0 25.9 63. US.7 in 1994 to 5.8 151. was the headlong deterioration of firms’ ability to meet their interest payment obligations. bond issues. Vol. Such deterioration of financial positions during the period was a common feature of listed companies.2 49.3 61.260 Corporate Governance and Finance in East Asia.1 23. these firms more easily increased their leverage. The ratio of total debt to total assets increased from 50.1 31.1 31.14).6 138.7 12. and maintenance of the existing ownership structure.4 44. The financing patterns indicate that companies with high ownership concentration were more highly leveraged than companies with medium and low concentration. minimization of transaction and interest costs.7 5. the choice of financing is determined by the company’s liquidity considerations.8 65.7 11.5 38.4 5. The TIE ratio declined from its peak of 7.
4 13. Nonbank private debt increased from 27.1 High 6. private debt accounted for 84. debt-creating capital inflows rose to 65 percent in 1990.5 148. unhedged foreign exchange liabilities. is even more telling. From only 34 percent in 1986. The proportion of nondebt-creating capital flows.8 percent in 1986 to 52 percent in 1995.2 49.Chapter 4: Thailand 261 Table 4.9 percent in 1997.8 14.4 percent to 46 percent during the same period.6 11.16). however. on the other hand. Their average annual growth rate declined from 28. The composition and term-structure of this debt.2 percent in 1986 to 251.5 4.8 66.8 Medium 7.5.0 64.4 52.15 Financial Ratios of Listed Companies by Ownership Concentration. such as direct equity and portfolio investment.8 49. peaking in 1994 at 84 percent. From 45 percent of total net capital movements in 1985. The proportion of external debt as a percentage of GDP consequently increased from 42.8 29.6 30.4 27.3 Source: Estimated from the Pacific-Basin Capital Markets Database compiled by the University of Rhode Island. US. 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. 1990-1996 Degree of Ownership Concentration Ratio Times Interest Earned Total Debt to Equity (%) Long-Term Debt to Equity (%) Total Debt-to-Assets (%) Long-Term Debt-to-Assets (%) Net Working Capital-to-Assets (%) Operating Capital-to-Assets (%) Low 6. Additionally. the proportion of short-term debt increased from 15.5 34.5 percent of external debt in 1996 (Table 4. and a preponderance of short-term debt liabilities.4 63.1 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.5 126.3 42. 4. continued to slide from 1985 to 1997.5 percent between 1985 and 1990 to 8.7 percent from 1991 to 1996.8 28.2 124. This decline was accompanied. . The corporate sector contributed significantly to the crisis because of its rising levels of leverage.
1 95.4 15.3 0.2 0.7 24.16 External Debt.4 — — — — — — — 1.8 12.2 2.5 12.3 3.8 108.7 2.5 4.3 10.9 6.6 7.2 14.3 0.1 23.4 2.9 0.9 3.9 5.5 14.3 0.3 0.0 6.2 2.2 0.6 Total 18.2 32.1 12.2 10.7 1.1 30.3 0.1 22.3 16.3 0.1 2.2 2.3 3.9 13.0 0.9 3.9 10.0 3.8 31.4 5.8 13.6 — 0.6 52.9 7.1 Source: Bank of Thailand.1 64.0 21.1 5.8 10.7 10.5 1.3 20.0 Long-Term Short-Term BIBF Commercial Bank Long-Term Short-Term 0.Table 4.5 12.3 — — — — — — — 6.3 105.0 8.9 31.3 37.1 0.7 109.3 7.5 19.8 3.3 12.9 35.6 18.7 13.2 15.0 4.5 16.0 13.7 0.0 11.4 18.9 100.1 0.6 1.7 20. .3 0. 1986-1999 ($ billion) Private Nonbank Long-Term Short-Term 3.9 11.9 6.9 1.9 29.2 0.8 3.1 34.9 43.9 1.0 11.3 0.9 4.8 0.5 4.4 3.6 Government Year Long-Term Short-Term 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 12.3 2.1 0.7 23.9 10.1 0.4 10.
large Thai companies had actively borrowed at low interest rates from foreign financial institutions. Foreign investors retreated from the market. based on the three-month past due definition.17). nonfinancial companies also experienced severe liquidity problems as a result of the baht’s devaluation. The proportion of NPLs as a percentage of outstanding loans demonstrates the liquidity problem experienced by the corporate sector. and (iii) bankruptcies.281 in December 1995 and to 831. trading activity at SET had been on the downturn. The effects of the crisis were felt across all industry sectors.6 billion from the 1996 level of B201 billion.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. 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. from its peak in 1995. (ii) the rise in the nonperforming loan (NPL) ratio and consequent tightening of credit even for viable firms.360. Most of these foreign debts were not properly hedged. outstanding credit also declined throughout the second half of 1998. . The value of public offerings sank in 1997 to B56. reaching 45 percent of total outstanding credit in December. and drastic decline in the number and capital of newly registered companies.6 in December 1996. the index declined to 1. Similarly. the number of newly registered companies dropped to a 10-year low in 1998. NPLs spiraled from 12 percent in the second quarter of 1997 to almost 40 percent in the third quarter of 1998. foreign currency-denominated debts constituted 55 percent of their total debt portfolio. Meanwhile. SET’s dismal performance is indicative of the extent of the setback suffered by the Thai capital market. At the end of 1994. Trading volume has since been thin. according to the Bank of Thailand. Aside from the problem of NPLs. leaving domestic investors with large capital losses. the numbers of bankruptcies and company closures reached all-time highs in 1998 (Table 4. After that. On average. the SET Index stood at 1. 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. Even before the crisis. exposing the companies to disaster when the baht started tumbling on 2 July 1997. banks would be recording more of such NPLs. suggesting that serious investors have not returned to the market. With easy access to foreign funds. It hit a 10-year low in the second quarter of 1998. Due in part to liquidity problems on the one hand. If lending rates remained high.
977 Source: Department of Commercial Registration.6 in 1997.096 22. .5 at the end of 1994 to 12 in 1996 and further to 6.288 35. It also explains the higher dividend yield ratio.134 31.334 4.925 12.915 37.080 9.933 25. the Thai Government was lukewarm to the idea of obtaining IMF assistance because of the requirements and conditions attached to the financial package.410 37.201 24.112 9. II Table 4. As part of the assistance package.902 3.677 Bankrupted/Closed 2. 4. A steady price decline over the past few years has dragged down the ratio of market price to book value. Thailand.410 5.409 6. The IMF financial package was a credit facility of $17.312 25. Vol.2 Responses to the Crisis Initially.695 3.904 20.407 28.052 36.218 3.17 Number of Newly Registered and Bankrupted/Closed Companies. The increase of the P/E ratio in 1998 was mostly a result of a decrease in earnings for most listed companies. But when assistance from other sources did not materialize. IMF required Thailand to meet a set of performance criteria and implement various restructuring measures.095 14. the Government was left with no choice. The price-to-earnings (P/E) ratio deteriorated from 19.792 7.264 Corporate Governance and Finance in East Asia. 1985-1999 Year 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 Newly Registered 10.2 billion for balance of payments support and buildup of the country’s reserves.307 4. Ministry of Commerce.066 19.777 11.224 4. The first Letter of Intent was cosigned by the Minister of Finance and the Governor of the Bank of Thailand on 14 August 1997.5.105 4.797 4.
and worked on revisions to the Secured Transaction Law. increase profitability. The old law allowed only creditors to file bankruptcy suits. These include repeal of the Commercial Bank Act. and did not recognize debtor-initiated bankruptcy declarations. and the Act Regulating the Finance. As it turned out. it was widely interpreted as “having debts more than assets. Many believed that the process was inefficient. follow through with a civil or bankruptcy suit.Chapter 4: Thailand 265 The terms of the agreement required the Government to maintain tight monetary and fiscal policies. IMF relaxed these key conditions. While no definition for “insolvency” could be found in the bankruptcy law. creditors seldom succeeded in obtaining payment against bankrupt borrowers. only two companies emerged intact from the suspension. also aimed at institutionalizing legal and regulatory reforms. the Civil and Commercial Code. Several changes in the banking and financial policy environment have been effected in line with the restructuring program. and Credit Foncier Businesses. and income recognition were implemented. The Bank of Thailand also improved banking standards. debtors could drag out the process for many years. The core of the IMF conditionalities was the restructuring of the banking and financial sector to regain investor confidence. and restore solvency. secured creditors had to obtain the court’s approval before starting proceedings . In early 1998. drawn up with World Bank and ADB assistance. There were many options for solving debt repayment problems. and if necessary. They could seek civil action through the courts and could also use criminal sanctions to enforce debt repayments. Regulatory Response by the Government The IMF program. Strict loan classifications. The Financial Sector Restructuring Authority was established in October 1997 to address the problems of 58 finance companies that were suspended in 1997. loan provisioning. however. By invoking procedural loopholes. The assets of the other companies were liquidated by auctions. Creditors could negotiate to reschedule debt repayments. Under the old bankruptcy laws. The Government required all remaining financial institutions to recapitalize and instituted closer monitoring measures to ensure full compliance with this requirement.” Creditors thus bore the burden of proving a debtor’s insolvency before the courts. Securities. For example. The Government also passed the Bankruptcy Act and Foreclosure Act Amendments.
In effect. But more important. (iii) shareholders regain their legal rights. The amended law also introduced the concept of automatic stay. and expensive process. the judges and court officers have yet to learn and master the new bankruptcy procedure. Under the old Bankruptcy Act. If the process fails to revive the business. a remedy beneficial to borrowers and creditors is made possible through a business reorganization that should improve the borrower’s debt position and ensure its continued operations. (ii) management of the company reverts to the borrower. In Thailand. In 1999. the amended law limits the rights of secured creditors. There are other potential problems. The original Bankruptcy Act dealt only with liquidation and composition. The reorganization process is successful if (i) the debts shall have been discharged. Enforcement of the new law is bound to be ponderous and lengthy. the National Assembly passed an amended Bankruptcy Act and approved the establishment of special bankruptcy courts. The amended legislation also includes voluntary bankruptcy as a new feature. which means that a debtor could continue in business while the reorganization program was being implemented. but it is a complicated. thereby allowing court-supervised corporate restructuring. it covers only the court-supervised reorganization of distressed companies. II for the recovery of debt through the realization of any collateral. 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. Companies need . and (iv) the debts shall have been settled within a five-year period. Chapter 11 is the main tool in restructuring bankrupted companies in the US. creditors always had to contend with the threat of disruptions in a delinquent borrower’s business. any new loan to a company extended after the creditor discovered the insolvency would not be eligible for repayment. time consuming. To make matters worse for creditors. The model for Thailand’s amended bankruptcy law was the US Chapter 11.266 Corporate Governance and Finance in East Asia. 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. The amendment added reorganization provisions to the Bankruptcy Act of 1940. For one. Chapter 11 cases account for only 5 percent of bankruptcy suits in the US but consume 90 percent of the courts’ time. the company shall be declared bankrupt and liquidation of assets shall follow. Foreign secured creditors had to go through the motions of establishing that their country of domicile granted Thai creditors similar rights. Vol.
Under the new law.g. The new foreclosure law cuts short the procedures required under the Civil and Commercial Code for petty or simple cases dealing with mortgage defaults: (i) submission by the drafting committee of a default judgment bill within a week. the 1992 Act relaxed some of the original restrictive rules and regulations to encourage public company registration. after determining the legitimacy of the request. only tangible assets were the norm.” The Foreclosure Act Amendment was likewise passed in 2000. and (ii) processing of default cases within four to six months of filing of a court claim. the test for insolvency still uses the balance sheet criterion. The proposed amendment also includes a provision for the company to reimburse minority shareholders for expenses related to calling such a meeting. shall have the power to call the extraordinary general meeting. Replacing the Public Limited Company Act of 1978. Without the necessary corporate restructuring. minority shareholders’ rights are not adequately protected. corporate governance) that caused the bankruptcy in the first place.. however. Most important. The result. There have been proposals to lower the minimum shareholdings required for a minority group to request the board of directors to call an extraordinary general meeting at any time. . the court. Still pending Parliament approval is the amendment to the Secured Transaction Law. SEC also examined the possibility of an amendment to the Public Company Act of 1992. The amendment also remedies the slow process of executing or disposing of assets in a public auction. Consequently. The proposed new law seeks to expand the type of assets that a borrower can use as collateral. has not been satisfactory. In case the board of directors does not comply. The minimum shareholding requirement is too high for any individuals or groups of minority shareholders to take action against controlling shareholders. which aims to increase liquidity in the domestic economy by allowing businesses to use both tangible and intangible assets in securing credit. 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. questions have been raised regarding the appropriateness of the 1992 Act. The amendment seeks to revise old rules and procedures that tended to delay foreclosure proceedings.Chapter 4: Thailand 267 to solve the problems (e. namely “liabilities exceed assets. the Bankruptcy Amendment will just prolong the problems of nonviable borrowers. 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.” as opposed to the more appropriate criterion of “ability to pay when the debt falls due.
Otherwise. Because of high ownership concentration. minority shareholders have no chance of being represented in the board. there are few provisions in the Act that deal with related or connected transactions that potentially reduce shareholders’ value. i. The 1992 Act also allows directors to engage in business activities that may directly or indirectly affect the company.. This may be true in countries where publicly traded companies are widely held. II Another issue is the assumption in the 1992 Act that there is a separation of ownership and control functions. The regulators are drafting a proposal to amend the provisions on related transactions. they face the prospect of being unable to compete for the scarce funds available in the equities market. in turn. who are also the managers. The proposal clearly delineates duties of care and loyalty for directors of public companies. In addition. Most companies decide against cumulative voting. it permits directors. Consequently. without cumulative voting. In the absence of such a stock market boom now. However. The textbook separation between owners who sit in the company’s board and professional managers who run the company does not apply in Thailand. this is not so in publicly traded companies in Thailand. But because this is the assumption embedded in the regulation. it will probably be expensive because of the higher risk that comes with weak accountability mechanisms. But as demonstrated. vis-a-vis the minority shareholders. with the approval of the board.e. Vol. The 1992 Act only prescribes—not requires—the use of the cumulative voting procedure. minority shareholders are likely to be wary of increasing their equity without corresponding control mechanisms at their disposal. the dominance of controlling shareholders. to borrow from the company without consideration to the fairness of the transaction or transparency of the approval process. the controlling shareholders have the exclusive domain to appoint or exercise management.268 Corporate Governance and Finance in East Asia. 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. subject only to approval by the board of directors. disrupts the company’s management and decision making. which. claiming that it creates fragmentation in the board of directors. The proposal for the amendment of the Public . and determine voting results on virtually any matter. 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. The only reason Thai investors placed their money in stock issues despite these legal cracks was the rapid increase in stock prices in the 1990s. the main problem is overlooked. Where equity will come forward.
and procedures for debt restructuring. with the majority of the debtors coming from the commerce. the mere threat of external control alters the incentives faced by managers and controlling shareholders significantly.6 trillion) have agreed to cooperate with CDRAC’s restructuring process. The Bank of Thailand issued guidelines in 1998 encouraging financial institutions to specify their own policies. Reforms in bankruptcy procedures should be seen not only in the context of crisis resolution.1 trillion of outstanding credit. and manufacturing sectors. However. the number of cases has abated. accounting for B1. Within three months. 322. although since then. Cases for which negotiations were unsuccessful. methods. This point is crucial because compared with .764 debt restructuring cases involving B1.1 trillion in outstanding credit. will be settled by the courts. Corporate Debt Restructuring and Bankruptcy The 1997 crisis led to a severe liquidity problem in the economy. As of November 2000. Another 5 percent of cases (B70 billion) are undergoing restructuring negotiations.147 cases (B1. as well as those that did not cooperate with CDRAC’s restructuring process.6 trillion. The first bankruptcy court in Thailand opened on 18 June 1999. By October 2000. CDRAC’s target debtors comprised 10. the court had more than 80 cases for disposition. contributing to the unprecedented rise in the corporate sector’s bad debt. In addition. Considerable progress has been achieved on this front. Some 82 percent of these cases have been successfully restructured. where bankruptcy procedures are swift and effective. Another 77.Chapter 4: Thailand 269 Company Act of 1992 includes a recommendation to require all public companies to use cumulative voting to ensure that the board of directors consists of representatives from all groups of shareholders. only 7.767 cases involving outstanding credit of B2.068 cases involving B475 billion are undergoing restructuring. personal consumption. Equally important is the contribution of effective and reliable bankruptcy procedures for improved corporate governance. In response. the Government introduced debt restructuring-related measures to help resolve bad debts.8 trillion had been completed. accounting for B1. In particular. Commercial banks initiated 74 percent of these cases. 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. The reason is that bankruptcy law amendments appear to facilitate settlements outside the court.
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. Examination of corporate ownership. and even Indonesia. For this reason. and performance during this period helps understand the causes of the crisis. Emphasis was on the structure of corporate governance and patterns of corporate ownership and financing of publicly listed companies. and promoted key industries through incentives. It required listed companies to establish their own audit committees by the end of 1999. II Malaysia. 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 Government protected certain corporate sectors through tariffs and regulation. and Recommendations Summary and Conclusions This study has provided an overview of the corporate sector and governance in Thailand. Such improvements in disclosure standards are part of the efforts of SET and SEC.6. Conclusions.270 Corporate Governance and Finance in East Asia. In the next three decades. The exchange has already required that listed companies’ quarterly reports be directly comparable with annual statements. 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. Reforms through SET and Improved Disclosure The financial crisis prompted SET to introduce a range of improvements to its operation and regulation. 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 Thai Government managed its economy with the corporate sector as the main engine of growth and development.1 Summary. Philippines. Financial information from listed companies will also soon be required to conform to International Accounting Standards. 4. Weak bankruptcy procedures were part and parcel of the perverse set of incentives that led firms to build up unsustainable levels of debt.6 4. to push companies to harmonize their accounting with international standards. The . behavior. The study covers the period 1985 to 1996. Vol.
reaching its peak in 1996. Consequently. the devaluation of the baht that began on 2 July 1997 affected the financial condition of Thai corporations. Subsequently. On average. the overall corporate sector was seriously affected. After 1992. even after the development of capital markets. Although there was a decline in short-term foreign debt. The impact of the crisis was felt across all industries. The study examined the impact of ownership structure on corporate governance and financing patterns. In 1992. the increase in long-term debt more than compensated for the drop. Although there are some variations across industries. at a time when most of them were already experiencing declining profits and high leverage. Financial liberalization apparently encouraged companies to borrow overseas to finance investments that were not productively employed. there was a marked increase in the number of public corporations. the Public Company Act of 1992 and the SEA of 1992. The number of newly registered companies in 1997 dropped by almost 10. At the same time.000 from the previous year’s level. the corporate sector entered a new era with the enactment of two major pieces of legislation. The SEA of 1992 also marked the beginning of an active bond market in Thailand.Chapter 4: Thailand 271 importance of bank financing continued throughout the 1990s. In 1995 and 1996. At the onset of the 1997 financial crisis. The financial performance of the corporate sector remained satisfactory up to the years before the outbreak of the financial crisis. Because most of these debts were not hedged. Thai companies were vulnerable to exchange rate risks. . One of the major findings is the high ownership concentration among Thai companies listed on SET. Meanwhile. the profitability of publicly listed companies abruptly declined and their financial leverage increased. the number of listed companies in SET fell from 454 in 1996 to 392 in 1999. Profitability increased throughout the 1980s but began to decline in the first half of the 1990s. Nonbank private corporations accounted for most of the increase. the number and value of public offerings of securities accelerated. During 1992-1997. One of the principal causes of the crisis was the excessive use of foreign debt by the corporate sector. Minority shareholders. the numbers of bankruptcy cases and company closures reached alltime highs. the top five largest shareholders hold about 56 percent of total outstanding shares. This implies that the control of an average Thai company is typically in the hands of a few persons (founders or their associates) who own a majority of total outstanding shares. the overall pattern of ownership concentration seems to have been stable for the past 10 years. foreign debt in the Thai corporate sector increased continuously.
there is a clear lack of outside monitors for these publicly listed but family-controlled companies.272 Corporate Governance and Finance in East Asia. foreign and domestic. Recently. the Public Company Act of 1992 and the SEA of 1992. The implications of ownership structures that are concentrated to such a high degree are serious. Most foreign institutional investors invest only on a short-term basis and aim for short-term trading profits. It remains to be seen how reforms in bankruptcy procedures—including the increased threat of creditor control—could shift the incentives of controlling shareholders toward greater acceptance of equity finance and its consequent accession of control to new shareholders. The key laws. All these. they have little influence over management decision making and control. commercial banks hold only about 2 percent of total outstanding shares while nonbank financial institutions hold about 6 percent. hold only a small portion of total outstanding shares. The investing public holds the rest of the outstanding shares. the mutual fund industry has entered the picture but with limited roles and activities. With financial institutions playing limited roles in the capital market. Individuals and insiders hold the second largest proportion at about 19 percent. Financial institutions hold a very small proportion. An analysis of the corporate ownership structure in Thailand suggests that founders and management continue to own and control publicly listed Thai companies. contribute to the lack of external controls on the corporate sector through the capital markets. Institutional investors in Thailand. Vol. holding companies and affiliated corporations hold the largest proportion at 27 percent of total outstanding shares. The Government holds about 1 percent of total outstanding shares but these holdings represent majority shares of a few companies. Among the five largest shareholders of Thai companies listed on SET. the government pension fund was the only major institutional investor. through the use of holding and affiliated companies. II although larger in number. publicly listed and unlisted companies in Thailand are equally subject to the consequences of the risk-taking behavior of controlling owners. Thus. the existing legal and regulatory framework suggests otherwise. The absence of external market controls on the management of publicly listed corporations is dangerous. The highly concentrated ownership structure weakens the protection of minority shareholder rights. protect the interests of all shareholders of public companies. along with a highly concentrated ownership structure. Nominally. Consequently. The rules in both Acts governing . These laws stipulate rules and regulations concerning the activities of all public companies. are not active. averaging 46 percent. In the past.
but is significantly related to financing patterns. the Public Company Act of 1992 allows shareholders to act only when they hold a minimum proportion of shareholdings. 4. the high ownership concentration of many listed Thai companies inhibits the effectiveness of these provisions. a requirement impossible to meet due to the concentrated shareholdings of founding family members and management. Rather. The Government has been moving to amend the Public Company Act of 1992 to increase minority shareholders’ protection in this regard. Specifically. Ownership concentration appears to have little impact on corporate profit performance.6. key reforms that will strengthen the regulation of financial institutions. Consequently. The ownership structure of Thai listed companies also significantly affects company behavior. because there is no separation between ownership and management. The second issue involves the protection of shareholder rights. before the crisis. moreover. It appears that founding family members use debt extensively to finance investments because they want to preserve control of their firms. For instance.Chapter 4: Thailand 273 minority shareholders’ participation in decision making and in initiatives against management conform to international standards. the main challenge is in protecting minority shareholders from the possibility of expropriation by the majority. In this third area. the degree of ownership concentration has a statistically significant positive relationship to the degree of financial leverage. .2 Policy Recommendations There are three major policy issues and recommendations that could improve corporate governance in Thailand. laws did not provide minority shareholders sufficient safeguards in cases of transactions involving companies where the controlling shareholders had related interests. posed formidable barriers in the minority shareholders’ exercise of their rights. However. For example. In view of this. The third issue involves creating external market controls through better regulation and development of the capital markets. these companies tend to become overleveraged. an aim that can be achieved mostly through legal reforms. the main challenge is not how the board can control management to maximize shareholder value. because there are shared interests between the controlling shareholders and key management personnel. making them vulnerable to economic shocks. Certain provisions. The first issue involves the development of a comprehensive supervisory framework and the strengthening of the capacity of supervisory agencies.
As in other crisis economies in the region. the supervisory agencies also need to be empowered to enforce the laws. the key issue in corporate governance is how to prevent insiders from expropriating assets of minority shareholders. Once the roles and responsibilities are clearly defined. voting only on major decisions. Development of a Comprehensive Supervisory Framework There is a need for the Government to establish a comprehensive supervisory framework for the corporate sector. with control delegated to professional managers.274 Corporate Governance and Finance in East Asia. The owners of a firm rely on a board of directors to supervise the managers. Protection of Shareholder Rights The common assumption is that publicly traded corporations are widely dispersed in terms of ownership. . the principal shareholder typically plays a key role in management and often serves as the chief executive officer. Vol. activate the market for corporate control. If the principal shareholder is in fact chair of the board. The best approach may entail establishing a single. SET. SET was mandated to supervise listed companies. In this setting. this is a problem in Thailand. The board therefore plays a pivotal role. II encourage market competition. he/she often has the decisive vote. in most of Thailand’s publicly traded firms. three major government organizations (the Ministry of Commerce. unified supervisory agency or a permanent regulatory division consisting of supervisory units from the three agencies. It is important that the roles and responsibilities of each agency are clearly defined to the public. SEC was established as another supervisory agency. The Government must develop an overall framework for corporate sector supervision and redefine the regulatory jurisdiction of each agency along functional lines. Only then will these agencies be able to act promptly and effectively. and SEC) are involved in corporate supervision. and increase the participation of institutional investors are imperative. the Ministry of Commerce had the sole supervisory responsibility. If this were the situation. Under the current system. the supervisory system is fragmented and not as effective as it should be. In reality. This is due to the historical development of the Thai corporate sector: before 1975. Consequently. in 1975. the key issue in corporate governance would then be to ensure that managers act in the best interests of the shareholders. There is also supposed to be separation of ownership and control. and after the enactment of the SEA in 1992.
regulators must increase transparency and step up enforcement. 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. This move is expected to be unpopular among founding family members and original owners. SEC is exploring the possibility of amending the law toward this direction. The situation prompts two specific recommendations. they should be monitored and regulated. 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. The second recommendation is to dilute ownership concentration through the use of regulatory power. 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. This includes prescribing ways to empower minority shareholders without disrupting the company’s operations.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. Since the Asian financial crisis. Both SET and SEC are taking an active stance in improving the transparency and efficiency of Thai capital markets. there has been much progress in this area. The first recommendation involves the repeal of current legislation to allow minority shareholders to have greater influence over management decision making. increasing penalties for directors engaged in misconduct. 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. The slow improvement in the legal framework has likewise obstructed progress in this area. and . requiring cumulative voting for the election of directors. accountability. The current ownership structure leads to ineffective corporate governance and inadequate protection of minority shareholders. To ensure a level playing field. SEC has been trying to lay the foundations of good corporate governance by espousing fairness. Because these holding companies control a number of large public companies in Thailand. The Ministry of Commerce is conducting a study on proposed amendments to the Public Company Act of 1992. Through an amendment in the Public Company Act. and a prohibition of connected transactions by directors or management. the Government can change the shareholding limit for controlling shareholders. transparency.
aimed at ensuring that banks finance only creditworthy projects. while a strong domestic debt market will also offer protection from foreign exchange risk. for instance. which. in turn. will incidentally close off easy sources of finance for companies that have been practicing regulatory arbitrage. especially in the area of connected lending. a well-developed secondary market will pave the way for market disciplinary forces to act against poorly managed companies. . This may not be possible without reforms in the banking sector itself. II responsibility among companies. The promotion of active roles for domestic institutional investors should also improve corporate governance in Thailand. The variety of debt instruments available to the corporate sector and investors should be increased and longer-term sources of bond finance actively promoted. Because the financing of Thailand’s corporate sector is predominantly bank-based and will remain so for a long while yet. will lead to the emergence of a reference yield curve. the SEC’s disposition toward a largely voluntary approach for adoption of these characteristics has resulted in uneven compliance among public companies. A well-developed domestic debt market will provide corporations with an alternative to bank financing. The Bank of Thailand’s enforcement of prudent lending practices among Thai financial institutions. However. it is important to explore reforms that can lead to the enhanced role of banks in monitoring enterprises. The same goes for improvements in the bankruptcy system. it will be difficult to improve corporate governance in Thailand. the power of the capital market to discipline inefficient management is almost nonexistent. Further. In an environment of highly concentrated ownership. Accounting standards have also been under review. There will be no incentive for companies to raise capital in the equities market if they can obtain funds at a lower cost elsewhere. Thailand should develop a strong public debt market to supplement the banking system in financing corporate investments. The first step is to establish an active secondary Government bond market. Capital Market Development and Regulation Another important issue concerns the development of capital markets.276 Corporate Governance and Finance in East Asia. Vol. In the stock market. Without a strong and efficient capital market. One way the Government can improve the current situation is to require publicly listed companies to trade a higher proportion of outstanding shares in the secondary market. there is a need to increase market disciplinary power through market competition.
Key Capital Market Statistics. 1995. Bond Market Development in Thailand. . Fact Book. Ministry of Commerce. 1997-1999. Bank of Thailand. PACAP-Thailand Database. Bank of Thailand Monthly Bulletin. The Securities and Exchange Commission of Thailand. US. 1997.Chapter 4: Thailand 277 References Annual Report. The Stock Market in Thailand. 1995-1999. Bank of Thailand. Department of Commercial Registration Database. 1995-1999. Thai Accounting Standards. The Stock Exchange of Thailand. The Stock Exchange of Thailand. Kingston. The Securities and Exchange Commission of Thailand. 1995-1999. Bank of Thailand Quarterly Bulletin. 1997. 1998. The Thai Bond Dealing Centre. The University of Rhode Island. Pacific-Basin Capital Markets Research Center. The Stock Exchange of Thailand. Thailand.
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