Korean conglomerates: Governance gridlock

"Lone Star is no longer the most unpopular foreign investor in Korea, it's Elliott." The observation was made in jest at a recent AVCJ forum but it contains a kernel of truth. Lone Star was pilloried for its alleged transgressions over Korea Exchange Bank. Now hedge fund Elliot Management appears to have supplanted it as pantomime villain after mounting a challenge to restructuring within Samsung Group.

Samsung has engineered mergers between its businesses in what is seen as an effort to simplify its corporate structure ahead of a transition in control from the ailing Lee Kun-hee to his offspring.

When it was announced in May that Cheil Industries would acquire Samsung C&T - and thereby gain ownership of its holdings in various other group entities - Elliott took action. Increasing its minority stake in Samsung C&T, the hedge fund denounced the move as being counter to the interests of shareholders due to price manipulation, filed a lawsuit claiming breach of fiduciary duty, and called on investors to block the deal.

A local court dismissed the case and Samsung C&T's shareholders toed the line, although not by much and the stock has since slumped. The conflict stoked nationalistic sentiment and also cast Korean corporate governance in an unfavorable light. It has left investors asking questions about how - and for whom - the chaebol run their businesses, when they might become more transparent, and why the government isn't doing more to expedite the process.

"It is not the end of this type of behavior - Samsung was successful so it might encourage other chaebols," says Jasper Kim, founder of the Korea-based Asia-Pacific Global Research Group. "When you are dealing with a high-profile investor like Elliott it is in many ways viewed as a David versus Goliath scenario."

This debate is of indirect relevance to private equity. Divestments of non-core assets by the chaebol are seen as an attractive source of deal flow, but sales only tend to come when the parent is in severe financial distress. If these companies took decisions driven by return on equity rather than satisfying owners whose minority interests equate to control through a web of cross-shareholding, more assets might come onto the market.

No one is holding their breath. "There are always a lot of promises of chaebol rationalization, but it never happens for a number of reasons," says Jason Shin, managing partner at Vogo Investment. "First, it is not politically advantageous to be at odds with the chaebol. Second, you can't force a healthy chaebol to sell assets. The only way it happens is if they feel financial pain or come under pressure from creditors."

Policy vacuum

Korea fares poorly in the Asian Corporate Governance Association's (ACGA) 2014 market rankings. Of the 11 jurisdictions assessed, it beats only China, Philippines and Indonesia. A lack of government leadership on policy reform, a failure to progress with legislative amendments, a rotation of officials through regulatory agencies, and weak corporate governance culture among the chaebol are identified as the key problems.

Jamie Allen, secretary general of the ACGA, adds that he felt quite positive about the situation prior to the Samsung-Elliott stand-off because several large Korean companies seemed willing to engage on governance issues. There were efforts to publish audited accounts in a timely fashion, while Hyundai Motor and KB Financial both set up corporate governance committees. The latter, under pressure from shareholders, even allowed outside shareholders to submit nominations for independent directors.

However, he is particularly disappointed in President Park Geun-hye, whose administration has made little progress on issues like reducing cross-shareholding. "We are very disappointed about the pardons she recently announced, including Chey Tae-won, the chairman of SK Group, with the old excuse that he's needed for the national economy," Allen says.

They didn't ask the committee for a decision because they knew it would say no. Samsung is a lot stronger than SK politically - if Elliott targeted SK rather than Samsung it might have won - Bruce Lee

Such moves do little to convince minority investors that the government advocates promoting shareholder value for all investors rather than just the chosen few. "An important factor would be how the National Pension Service (NPS) and other domestic institutional investors properly balance their fiduciary duty to increase value for their Korean beneficiaries in the face of what are portrayed as nationalistic concerns," adds Joongi Kim, professor of law at Yonsei University.

There have been several examples of shareholders applying pressure to the chaebol in recent years - albeit usually not as aggressively as Elliott, and often over corporate Korea's notoriously low dividend payments - and NPS has wielded its voting power. Earlier this year the pension fund opposed a proposed merger between two SK Group units, citing minority shareholders' interests. However, it voted in favor of the Cheil-Samsung C&T deal, having declined to consult its external proxy advisory committee.

"They didn't ask the committee for a decision because they knew it would say no," says Bruce Lee, founder and CEO of Zebra Investment Management, a public markets fund that focuses on corporate governance. "Samsung is a lot stronger than SK politically - if Elliott targeted SK rather than Samsung it might have won."

Routes to reform

Some of the younger generations of chaebol founding families have poor public profiles, perhaps best exemplified by the Korean Air chairman's daughter, Heather Cho, ordering a plane to return to the gate because she was unhappy with the way a flight attendant served peanuts. However, this dissatisfaction at an individual level is thought unlikely to deliver change. Market watchers offer different assessments of what might.

Yonsei University's Kim points out that in the past external crisis and pressure - while not ideal - has contributed to change. In the wake of the Asian financial crisis, Korea saw its most substantial corporate reforms in modern history, with the introduction of independent directors, audit committees, stronger accounting standards, and the convening of formal board meetings. Activism and other oversight to enhance corporate transparency and managerial accountability is another key to the puzzle.

Others envisage a more gradual process. The five largest chaebol account for about two thirds of Korean GDP, which arguably puts them in a more dominant position than before the crisis, but they are operating in very different conditions. "Maybe what you need is a change of mindset; you need these chaebol leaders to realize that perhaps the way they have running these companies for the last 30 years needs to be different in a more competitive global economy," says the ACGA's Allen.

Another impetus for change is time. Korea's economy was built around the chaebol and they are operating on public markets that are only 60 years old. The investor community needs to mature and at the same time the chaebol themselves will evolve. If this does not mean cultural change, internal pressures will come to the fore, whether it is orderly succession planning or siblings fighting over assets.

With every generation most chaebol will be sub-divided among the various branches of family resulting in less concentrated ownership, Vogo's Shin adds. Until then, private equity firms will continue to buy assets wherever they can, picking up the low-hanging fruit often present in companies that are non-core and run for family rather than corporate interests.

"Sometimes these are regarded as third-tier assets within that group and they get third-tier management," Shin says, citing Vogo's acquisition of the Burger King Korea franchise from Doosan Group. "The managers were from heavy industry and had no food and beverage experience. With bad corporate governance, once you buy companies from these chaebol, there is a lot of room for improvement."

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• Topics
• Buyouts
• North Asia
• Regulation
• South Korea
• regulation
• buyout
• Vogo Investment