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Some remarks on corporate governance in Korea before and after the 1997-1998 crisis
Dante Mendes Aldrighi*
The Republic of Korea (hereafter Korea) has had an outstanding economic performance since
the beginnings of the 1960s. As any other case of economic success, the reasons lying behind
the remarkable Korean experience of economic development are still under dispute, the kernel
of which seeming to reside in the relative importance of markets and government policies in
promoting the “economic miracle.” No wonder that the same debate is replicated as regards
the driving forces responsible for the outbreak of the devastating financial crisis in that
country in 1997. Most analysts focusing on that subject have elected as the main culprit the
poor governance of chaebols. Some, however, have blamed the financial liberalisation as well
as the government’s relinquishment of the co-ordination of private investments for the wave
of bankruptcies of banks and enterprises. Thus, much of the controversy swirls, once again,
around the virtues and vices of markets and governmental interventions.
It is noteworthy that as regards the motives of the Korean economic crisis, on both interpretative fronts the gist of the arguments dwells in corporate governance issues.1 Consensus seems to prevail on the leading role played by chaebols' unsound governance in leading to over-investment that triggered the crisis. Contentions emerge, however, around the roots of this lack of governance. Would it stem from financial deregulation and government’s abandonment of industrial policy, in particular of its role as investment co-ordinator? Or, conversely, from the hurdles hindering the market discipline, more specifically the corrupt relationship between government and chaebols, whereby the latter provided money to politicians in exchange for some economic privileges (rents) – the so-called crony capitalism? This paper attempts to address such thorny debate on the governance of chaebols before and after the 1997 crisis. Arguments presented by each of the opposing views are reviewed and some unsettled issues are pinpointed. The paper is organised in seven sections, on top of this introduction. Section I presents a brief discussion of the concept and main mechanisms of corporate governance. The three subsequent sections deal with the workings of these mechanisms in the Korean corporate landscape. Section V analyses two views attempting to explain the leading forces behind the economic crisis in Korea. Section VI discusses the reforms adopted to face the crisis, and the last section concludes. I.- Corporate Governance: Definition and Mechanisms
Corporate governance may be broadly defined as the way control rights (or power, or
authority) are effectively distributed among corporate stakeholders, such as shareholders,
managers, directors, employees, creditors, and suppliers. A more restricted view of corporate
governance places emphasis on the agency problem between outside shareholders, on the one
hand, and controlling shareholders and managers, on the other hand.2 Ample residual rights of
control left to managers because contracts are incomplete vest them with great discretionary
power, which may be used to their own private benefits at the expense of shareholders.
The main mechanisms for tackling managerial slackness as well as opportunism and expropriation by controlling shareholders are: a) Monitoring provided by large shareholders or creditors: it is frequently claimed that concentrated shareholdings in, or debt claims on, companies grant their holders incentives and power to monitor managers and to participate actively and independently in the company’s strategic decisions. Owing to greater dividend rights, large shareholders would be spurred to use their control rights to bring pressure to bear on managers to be efficient. The collective action problem would therefore be alleviated, as monitoring costs (such as those related to information search) are dwarfed by potential benefits from control (Jensen and Meckling, 1976). “Voice” would be exerted either through creditors’ threats to refuse renewing the loans or, regarding large shareholders, via board of directors or shareholders’ general meetings. Nonetheless, large-block shareholders may also act counter to the best interests of the firm. They can use their power over the board of directors to expropriate or consume firm’s wealth setting excessive compensation for themselves, consuming perquisites, contracting relatives, or diverting resources to firms they, their relatives or friends control through biased transfer pricing. b) The legal and regulatory environment, involving securities exchange laws, corporate laws, commercial codes, and bankruptcy procedures. c) The board of directors, the efficiency with which its members carry out their mandatory duty rests critically on its composition, since it defines the actual degree of autonomy directors have vis-à-vis management. d) Market-based instruments, embracing competitive markets for product, capital and corporate control. One could hold that competition in the product market ensures, in the end, corporate efficiency, inasmuch as firms whose managers are incompetent or pursue private goals would inevitably be swept away. By the same token, should these under-performing firms have to raise funds in the capital markets, they would have to pay a substantial premium, also making their permanence in the product market unsustainable. Hence, however relevant other governance mechanisms may turn out to be in the short run, competitive capital and product markets alone would pressure companies into efficiency in the long run. Tender offers together with proxy fights, mergers and negotiated purchases make up the market for corporate control, or takeover market (Manne, 1965). The ultimate rationale lying behind hostile tender offers as a disciplinary mechanism is that mismanaged publicly held companies leave space for arbitrage. If capital market efficiency prevails, mismanagement would be reflected on lower share prices, prompting whoever perceives this opportunity for profits to make a tender offer to buy the shares of the putative bungled firm. The “predator” (be it another firm or an individual) offers a price higher than the current market price of the share but lower than the price she reckons the share is worth were the “target” well run. If the unsolicited tender offer turns out to be successful, the raider may reap a large reward by replacing the incumbent managers with others deemed able to raise the value of the firm. By that account, the mere threat of hostile takeovers would be enough to discipline managers, functioning itself as an incentive-based mechanism of governance. e) Performance-related compensation packages, involving share options, pay in shares, or bonus plans. To make compensation contracts very sensitive to the market value of the company or its profits is claimed to provide high-powered incentives for executives to be efficient. Nevertheless, there are compelling reasons for doubting about the efficacy of this sot of pay as an incentive to align the firm’s decision-making with the interests of its shareholders. Measuring managerial performance carries insurmountable difficulties of both verifiability and enforcement, since it cannot be directly observed, let alone verified. To take observable outcomes such as firms’ profits or share prices as proxies for their performance can give rise to serious distortions, inasmuch as these outcomes do not depend exclusively on managers’ efforts and competence. f) Debt commitments: according to Milgrom and Roberts (1992, p. 492 and 494), free cash flows, “Managers and their boards may be severely tempted to use these resources
within the firm, however, carrying out new investments that (by definition) are not profitable
and not in the shareholders’ interests. They may also be more inclined to indulge themselves
in excessive perks and to share the wealth with the employees
”. In fact, managers of mature,
cash-cow firms, with low growth opportunities, are liable to overinvestment. In particular,
managers in declining industries with excess capacity, where agency costs of free cash flow
are high, are likely to eschew the necessary restructuring, let alone exit. Accordingly, Jensen
(1986, p. 324) claims that debt can serve as an invaluable disciplinary tool, inasmuch as it
reduces the agency costs of free cash flow by reducing the cash flow available for spending
at the discretion of managers
”. Thus debt operates as “an effective substitute for dividends”,
forcing “managers to effectively bond their promise to pay out future cash flows”. A crucial
assumption underlying this claim is that the cost of capital raised by debt exceeds the
perceived cost of equity capital, because the latter source of financing confers on managers
some clout with the dividend policy. Fears of losing job and reputation that default and
bankruptcy could imply render managers committed to running the firm efficiently in order to
ensure a return on capital at least enough to meet the fixed interest obligations. Therefore,
managers can be compelled to contract more debt than they would like.
In the next three sections, it is described how some of these governance mechanisms worked
in the Korean corporate context.

II. Chaebols
' Ownership, Control and Governance Structures
Chaebol is Korean large firms's predominant ownership structure. It is a business group
embracing legally independent firms operating in a wide range of industries,3 each of which
effectively controlled by a single family who, despite holding a relatively small stake in its
capital, manages to control it, and hence the whole chaebol.4 Most analysts have pointed out
that the foremost hindrance to corporate governance improvements in Korea lies in the vast
latitude the dominant shareholder of chaebol-affiliated companies has to control them with a
relatively tiny shareholding. How exactly have chaebols’ controlling shareholders managed to
attain control rights far exceeding their cash-flow rights? One way whereby these dominant
shareholders have managed to ensure control is by making their affiliates to borrow from
financial institutions and channelling the funds to finance investments in other, already
existing or new, affiliates. These borrowings were taken with guarantees provided by the
affiliates (intra-group cross-debt guarantees) and allowed finance the building of a complex
web of cross-shareholdings and pyramidal schemes connecting them. This asymmetry
between chaebols’ control and ownership structures is by and large viewed as an outcome of
prior governments’ mistakes in industrial policy and financial regulation and supervision,
which induced moral hazard behaviour on the part of non-financial corporations and financial
institutions (Nam, 2003, p. 45).
Owing to the ban imposed by several pieces of legislation – such as the Commercial Code, the Securities and Exchange Law and the Monopoly Regulation and Fair Trade Act – on direct cross-shareholding between two subsidiaries belonging to one chaebol, this device of leveraging control rights does not seem to typify the chaebol ownership structure (Hwang and Seo, 2004, pp. 65-67). The pyramidal ownership structure, in turn, appears to be a widespread mechanism to ensure external finance to investments in new subsidiaries, allowing the controlling families to retain their control with a small shareholding. It entails controlling shareholders’ moral hazard behaviour because expansion and diversification of the group provide ample latitude for them to take private benefits while the downside risks can largely be transferred to outside investors. Table I
Top 30 Chaebols
’s Structural Characteristics
a. Cross-debt guarantee is the ratio of the total amount of cross guarantee over equity capital b. The numbers on parenthesis are for the top 5 chaebols
Table II
Debt-Equity Ratio in the Corporate Sector: Korea, USA, Japan and Taiwan (%)

While it can be argued that in developing countries pyramid schemes may contribute to overcoming certain structural and institutional deficiencies, their agency costs cannot be undervalued. Controlling shareholders has power (decision-making concerning corporate strategies as well as operating issues are all under their control) and incentives to expropriate minority shareholders are strong. Chaebols controlling shareholders recur still to the affiliated non-bank financial institutions as an avenue to guarantee funds to finance the group’s expansion while preserving their control. These institutions are predominantly chaebols’s subsidiaries. It is frequently contended that chaebols’ ownership structure was at the root of the Korean crisis. Having easy access to borrowed funds and strong incentives to expand and, in
addition, facing no material monitoring from creditors, shareholders and financial regulators,
chaebols tended to overinvesting (and to overborrowing), neglecting the projects’ expected
rate of return adjusted to risk.

III. Banks and Institutional Investors

As Lee (1999) points out, the corporate governance role of Korean banks seems to have been
so far trifling. Being mostly state-owned until the beginnings of the 1980s, Korean banks
served as a financial tool for the government to implement its strategy of economic
development, especially of its industrial policy. A great fraction of the banks’ asset portfolio consisted of policy loans, that is, loans at below-market interest rates directed to activities, industries and sectors designated by the government. Government interference in banks’ decisions (allocation of credit, interest rate structures, appointment of top executives etc.) weakened the incentives for banks to undertake their due functions of evaluating credit risk and monitoring. Therefore, they did not exercise their potential governance role. As borrowings contracted by chaebols’ subsidiaries usually involved other subsidiaries’ guarantees, credit allocation tended to be concentrated on them. This was reinforced by the general perception that the chaebol would bail out any affiliate facing financial distress, implying a lower risk of default and biasing banks’ lending decision towards large groups. Even after privatisation of the commercial banks, the government continued to exert control over the allocation of privatised banks’ loans, although how exactly it managed to control privatised banks’ loan portfolio is still an unclear question. The governance of banks’ management as well as the governance by banks of non-financial firms’ management remained at low levels until the financial crisis. Formal evidence on the Korean banks' poor disciplinary action is provided by Joh (2004), who shows that financial institutions lent much more funds to firms in financial distress than to sound ones. Corporate governance provided by institutional investors was also paltry before the crisis. A number of factors contributed to this passive behaviour. First of all, their
shareholdings in listed companies were, and still are, very small compared to their own
portfolio and to other OECD countries.5 This made it easier the “exit” option, since the
underlying price effects were low, at the same that made it costlier the “voice” (monitoring)
option, due to the free-rider problem. The proportion of equity investment in their portfolio is
even far below the regulation-imposed ceiling. Second, most of non-bank financial
institutions in Korea belong to chaebols, reason for which they are primarily concerned with
controlling families’ interests rather than the interests of investors whose money they manage.
These financial institutions are often used by the chaebol’s controlling shareholder as its
“private treasury” to ensure the control of the group, especially through insurance companies.6
Thus, it can be said that non-bank financial institutions have their own problems of
governance. Third, chaebols’ affiliated institutional investors strategically abdicate their rights
of monitoring the management of other chaebols’ subsidiary, because either they are colluded
or for fear of triggering retaliation on the part of non-bank financial institutions affiliated with
other chaebols. Forth, given chaebols’ overwhelming economic power in the Korean
economy, institutional investors not affiliated with them face a more rewarding payoff if they
choose to remain inactive than that of monitoring effectively chaebols’ affiliates. Fifth, public
pension funds have played no relevant role in corporate governance issues for several reason:
their shareholdings are small,7 allocation of funds are sometimes guided by policy and
political decisions, managers lack the profit incentive to monitor the listed firms wherein they
invest, and their own governance is poor. Sixth, regulations limited both the volume and the
purpose of stock investments by institutional investors. Apart from situations involving
financial distress, workout or merger of the firm where they had an equity stake, institutional
investors were prohibited from influencing on its decisions. By the mandatory rule of shadow
voting, investment trust companies and trust accounts of commercial banks were deprived of
exercising autonomously their rights of voting, inasmuch as they were obligated to distribute
their votes in the same proportion of the votes cast by the other shareholders. Thus, they were
unable to affect the shareholder meeting’s resolutions. Mandatory rules were also imposed on
the amounts of investment in shares institutional investors can made.8
IV. Other Mechanisms of Corporate Governance: Board of Directors and Markets
Some commentators have argued that before the 1997 crisis neither the product market nor
the capital market operated as a sharp disciplinary device, as a consequence of the prevalence
of activist industrial policies, which provided implicit guarantees and availability of cheap
credit to the targeted industries, regulated entry and exit of firms, distorted prices etc.
Contrariwise, Amsden (1989) and Chang (1994) claim that governance was provided by the
government, which attached allocation of subsidies and rights of rents to performance,
therefore disciplining chaebols.
As for the market for corporate control, the regulatory framework coupled with the chaebols’ ownership structure prevented its operation. Legislation and policies inhibited mergers and acquisitions with a view to preventing economic power concentration.9 Hostile takeovers were also deterred by chaebols’ pyramidal schemes of ownership and cross-shareholdings among their subsidiaries. The virtual absence of a market for corporate control made it easier the incumbent management’s entrenchment.10 Concerning the board of directors, the ownership and control structures that typify the chaebols render it largely ineffective. In fact, as the chaebol’s controlling shareholder owns only a small fraction of the affiliates’ capital but has enough voting rights to elect most of the directors, the board is submissive and does not monitor the management. Frequently the chief executive officer is a member of the controlling family. The absence of a market for corporate
control, in turn, led the management and the directors to neglect minority shareholders’
V. Causes of the 1997 Financial Crisis in Korea: Two Opposing Views
The mainstream interpretation for the Korean economic collapse assigns it to poor corporate
governance, particularly to the close relationship between chaebols and government. As
already mentioned, past governmental economic policies are supposed to have shaped
chaebols’ current structures of ownership and control. Easy availability of loans at preferential
interest rates induced the chaebols to overborrow in order to finance their expansion and
diversification, contributing to reduce the return on investments. The confidence in
governmental bail-outs should the investment projects fail motivated moral hazard behaviour
on the part of both chaebols and banks, leading to excessive investments.
The large gap between voting rights and cash-flow rights for the chaebols’ controlling investor coupled with the blind belief in the too-big-to-fail principle reinforced the moral hazard problem, inducing them to a empire-building strategy and to the neglect of risk-return criteria. In the mid-1990s, financial dire straits of some chaebols that had invested excessively began to be revealed. The cases of Hanbo and Kia are emblematic: both had high debt and low profitability. The corporate crisis spilt over to the financial sector through the wave of non-performing loans. Being domestic banks overburdened with short-term foreign debt, they began to default on them, leading foreign creditors to liquidate their positions in Korean assets and sparking off the currency crisis. Thus, poor corporate governance and the corrupt relationship between chaebols and government (“crony capitalism”) would explain why the excessive investments, the high gearing ratio and the low profitability of the chaebols were not curbed by market discipline and how they combined themselves to end up in the 1997 economic downfall. Chang and Park (2004) reject this mainstream view on the causes underlying the Korean economic crisis in 1997-1998. For them, it is equivocal to identify the high financial leverage as the leading factor of the financial crisis. They argued that the average debt-equity ratio in Korean corporations was close to their French and Japanese counterparts and significantly lower than those for Finland and Sweden. In their view, Korean corporations’ high leverage did not hinder investments for two basic reasons: government’s tacit guarantee over private investments and the controls over financial flows to ensure that they were “recycled back to the corporate sector.” For them, “it was the breakdown of this recycling mechanism, rather than high leverage itself, that was behind the 1997 financial crisis” (p. 34). Chang and Park identify the main problems of the chaebols as being their propensity to over-investment and the abuse of their ever-growing economic and political power. As regards the over-investment problem, they contend that, as chaebols operate in oligopolistic market structures, competition is harsh and favours excess capacity, facilitated by their easy access to finance. Until the mid-1980s, over-investment was refrained by the state, whose policy-makers co-ordinated entry, exit and capacity expansion in several industries. The subsequent abandonment of the industrial policies, replaced by the hands-off approach with respect to investment decisions and financial liberalisation, resulted in excessive investment in some key industries, such as semiconductors, steel, and automobiles. Deregulation and liberalisation rather than lack of market discipline were therefore the culprit of the economic and financial crises that later on would outburst. In the same vein, they refute the moral hazard and too-big-to-fail arguments holding that chaebols’ under-performing management probably never remained unscathed. The state not only allowed the bankruptcy of some large chaebols in the 1960s and 1970s, but also co-ordinated the takeovers of “their carcasses” by other chaebols (p. 48). The 1990s were not different: over the period 1990-1996 three of the top 30 chaebols went bankrupt, and at the beginning of the crisis in 1997 others six would follow suit (among which Kia and Hanbo). As a rule, financially distressed firms were helped by the government “conditional, with very few exceptions, on the change of ownership and of top management, and were always accompanied by tough terms of financial restructuring” (p. 48). In the light of these arguments, Chang and Park emphasise that, before the 1990s, there actually existed in Korea an effective corporate governance framework, wherein the state played a leading role. Notwithstanding chaebols’ peculiar ownership structure that empowered controlling shareholders and management to ignore outside investors’ interests, the government was in condition to cope with the problems of overinvestment and inefficiency. Combining ex ante investment co-ordination with ex post industrial and corporate restructuring, it managed to control excessive investment (p. 50). It was successful in forcing chaebols to be efficient by making subsidies and access to other types of rents (cheap rationed finance and scarce foreign exchange) dependent on their previous performance, evaluated mainly in terms of productivity growth and levels of exports. VI. How the Korean Economic Crisis Was Addressed: The Restructuring of the
Corporate Sector
The financial crisis ushered in a sea change in the institutional framework regulating the
governance of Korean corporations, including financial institutions. The most prominent
measures comprising the reform agenda carried out by the government with a view to
improving the corporate governance are discussed below.
Regarding the reform of the board of directors, the Securities and Exchange Act was amended in 2001 to render mandatory for listed firms a board composition of at least 25% of outside directors. For large companies, the board must be composed of at least 50% of outside directors and they are also obliged to set up an auditing committee in which outside directors represent 2/3 of its members. Nevertheless, in chaebol-affiliated firms, controlling shareholder has voting power to appoint outside directors. The Code of Commerce was also amended in 1998 to make legally responsible everyone assuming a controlling position in the corporation, regardless if he/she is not formally a director. This measure targets non-director controlling shareholders who effectively manage the corporation. A further amendment of that code in 2001 made it mandatory for corporations to have the board’s approval of disposal of certain assets and transactions involving significant increases in their liabilities. Strengthening outside shareholders’ rights and power was another intent envisaged by the government. The threshold shareholding needed to exercise some rights was significantly relaxed. For filing derivative suits, it fell drastically to 0.01% in March 2001; for inspecting accounting books, it was reduced from 3% to 0.1%; for requesting the dismissal of a director or an auditor and for filing shareholders proposal, from 1% to 0.5%. Tougher requirements of disclosure were imposed on corporations in order that outside investors could have access to relevant financial information and adoption of international standards of accounting was made mandatory. Financial markets have been increasingly liberalised: restrictions on equity investment and hostile takeovers by foreigners were removed and the mandatory purchase of stocks in a takeover was repealed. With respect to chaebols reform, the administration of President D. J. Kim set out five objectives when he began his turn in January 1998: enhanced transparency, strengthening of accountability, resolution of cross-debt guarantees, improvement of financial structure and streamlining of business activities. Three principles would be added in August 1998: the prohibition of circular equity investment among affiliates, unfair trading among affiliates, and unlawful bequests. As regards chaebols’ high leverage, the government urged them via their main lending banks to reduce debt-equity ratio from over 400% to 200% by the end of 1999 as well as to get rid of the debt cross-guarantees by 2000. As shown in Table III, the five largest chaebols, were able to comply with this schedule, selling assets and new shares. Table III
Debt-Equity Ratios of Five Biggest Groups (%)

1997.I 1998.I 1999.I 1999.I
Debt Guarantees and Capital of the 30 Largest Chaebols*
Source: Lee (2004, p. 163) * Trillion won at the end of April Concerning the requirement for the 30 largest chaebols to eliminate all debt-payment guarantees by the end of March 2000, provision included into the IMF agreement, table IV testifies the enormous progress they have. This has been achieved by means of debt redemption, provision of further collateral, and risk-adjusted interest rate increases (Lee, 2004, p. 162). Debt guarantees are no longer allowed. Finally, another watershed is represented by the way privatisation of three large state- owned enterprises (POSCO, Korea Telecom, and Korea Tobacco and Ginseng) was undertaken during the D. J. Kim administration. They were sold to dispersed shareholders, becoming the first Korean large enterprises owned and controlled neither by a chaebol nor by the government (Nam, 1994). Concluding Remarks

Two opposing analyses on the causes of the Korean financial crises were reviewed in this
paper. Both place great emphasis on corporate governance failures. The mainstream view
identifies the discrepancy between controlling shareholder’s control rights and cash flow
rights as the central weakness in the governance of large corporations in Korea. This gap
stemmed mainly from borrowings contracted by affiliates as well as from pyramidal schemes.
Consequently, advocates of this view contend that the Korean corporate governance system
must be reformed in accordance with the Anglo-American model, eliminating the basis on
which the chaebols rely and paving the way for the free working of the capital market and the
market for corporate control. They are sceptical about the ability of recent reforms to
effectively reduce the power of large companies' controlling shareholder. In fact, they seem to
continue to appoint the directors and the CEO. In addition, there still remains significant
scope for self-dealing, diversion of resources among intra-group affiliates, and “creative”
Contrariwise, Chang and Park claim that the hands-off approach followed by the Korean government combined with financial liberalisation and deregulation in the 1990s suppressed the co-ordination framework that inhibited excessive competition and overinvestment. Their policy implication is that industrial policy and financial regulation should be revived. Thus, their recommendation is for the government to resume its pivotal role in corporate governance issues. These two instigating accounts raise a number of questions. With respect to Chang and Park’s unorthodox analysis, one could ask about the feasibility of industrial policies in a context where Korea has to comply with commitments accorded with the World Trade Organisation and the OECD. Furthermore, would these authors not be underestimating the costs and difficulties underlying government interference, such as rent-seeking, corruption, and policy-makers’ informational problems and lack of high-powered incentives? Are not they neglecting the expropriation of minority shareholders by chaebols’ controlling shareholders? What should be done for convincing savers to accept controls on financial flows, that is, financial repression, in order to ensure the patient capital needed to finance longer-term investment? Regarding the mainstream version, one could argue that Korean economy has ceaselessly exhibited an outstanding performance since the 1960s and ask if this has happened thanks to or despite the prevailing mechanisms of corporate governance. Moreover, should the Korean arrangements of corporate governance follow the path converging towards the Anglo-Saxon model, would there not be the risk of "short-termism", leading to the neglect of potential value-enhancing investments, such as those in R&D? A similar question could be raised as regards the effects of foreign institutional investors' increasing shareholdings in chaebols' companies: would they be prone to neglect Korean national interests? Could one take for granted that institutional investors’ interests are aligned with those of minority shareholders? Finally, bearing in mind a more comprehensive definition of corporate governance, how would labour react to a market-based governance system? As put at the beginning of this paper, this debate reflects a more general controversy on the relative role of markets and government in the process of economic growth. Reviewing these alternative interpretations on the Korean financial crisis, elaborated by scholars who comply with the academic requirements of persuasive empirical arguments as well as well-founded theoretical reasoning, leads to the suspicion that the roots of the controversy spill over the theoretical and empirical domains.11 * Department of Economics, University of São Paulo. I gratefully acknowledge the Korea Foundation’s financial support for undertaking on-site research in Seoul. 1 This concept, almost absent in academic discussions until the mid-1980s, has thereafter become widely spread within and outside academia. It did not appear, for example, on the Palgrave Dictionary's 1987 edition. 2 The standard argument for justifying the shareholder model is that employees and creditors, unlike outside investors, are already well positioned and protected to receive the right reward for their contribution to enhancing firm’s value. Contrariwise, some authors claim that corporate governance schemes neglecting non-owner stakeholders’ interests may lead to sub-optimal level of firm-specific investments. Hence, corporate governance should encompass arrangements affecting stakeholders’ incentives to make irrevocable firm-specific investments. See Blair (1995) and Milgrom and Roberts (1992). On the difficulties surrounding the “stakeholder society”, see Tirole (2001). 3 As shown in Table I with respect to the top 30 chaebols, the average number of subsidiaries was 27.2 in 1997 (as against 16.4 in 1987 and 20.8 in 1995) and the average number of industries wherein they were engaged was 19.8 (30.0 for the 5 top chaebols). 4 For the top 30 chaebols, the controlling family owned on average only 8.5% of the group’s overall capital in 1997, while his/her control rights achieved 43% (See Table I). The discrepancy between voting rights and cash-flow rights for the controlling shareholder has tended to widen along the time. 5 For example, in 2002, insurance companies held only 3.6% of their total assets in stocks, securities companies 3.9%, public pension funds 3.2%, and investment trust companies 9.4%. In OECD countries, pension funds’ investments in corporate equity capital range from 26.7% to 64.5% of the value of their assets. 6 According to Nam (2004, p. 20), there prevails the suspicion that “chaebols have used their affiliated financial institutions as a vehicle for conducting improper intra-group transactions and subsidising under-performing companies in their groups.” Chung et al (2004, p. 46) pointed out that “chaebol-affiliated financial institutions were involved in 87% of the “unfair intra-group transactions” and directly subsidised sister companies in 51% of such cases.” Controlling shareholder has typically recurred to life insurance companies to leverage control rights out of a low cash flow right basis. The Samsung Life Insurance is a clear illustration of this procedure. In 2003 it owned a 80,0% share of the Samsung Features’ capital, 11.4% of the Samsung Securities, 3.9% of the Samsung Heavy Industries, 4.8% of the Samsung Corporation, and, most important, 7.1% of Samsung Electronics, tantamount to US$ 2.46 billion. 7 Only the largest four of them owned shares of listed companies in 1995, representing 5.3% of the total amount of shares in the Korea Stock Exchange. In 1999, shareholdings by the largest three funds accounted for only 1.2 % of the total value of shares of listed companies. 8 Banks could not invest in stocks and bonds more than 60% of their own equity and up to 15% of the total shares of any company. The ceiling on stock investment by insurance companies as a fraction of total assets was 30%, while on investment in the same large business conglomerate was 5%. For mutual funds and investment trusts, investments in securities issued by an affiliate of the same chaebol are limited to 5% of a fund’s total assets. Public pension funds are allowed to invest in equity only with the prior approval from higher authorities. 9 Until the 1997 revision, the Securities and Exchange Law imposed a ceiling of 10% on the firm’s capital an individual could hold. Moreover, should anyone buy more than 25% of the firm’s capital, he would have to make a tender offer for more than a 50% share. Takeovers undertaken directly by institutional investors other than private funds were prohibited. Foreign investors’ acquisitions were subject to strict regulations as regards the volume of shareholding and the firm size (Hwang and Seo, 2004, p. 75-76). 10 According to Hwang and Seo (2004), 13 hostile bids were launched over the period 1994-1997, most of which unsuccessful thanks to defensive actions by the target firm, such as resort to white knights and green mail. Some claim that there prevails co-operation and a sort of coalition among chaebols when foreign raiders threaten any of them. REFERENCES
AKAMA, Hiroshi, Kunihisa NORO and Hiroko TADA. “Financial and Corporate Restructuring in South Korea.” Bank of Japan. June 20, 2003. BLAIR, Margaret. 1995. Ownership and Control: Rethinking Corporate Governance for the Twenty-First Century. Washington, D. C.: Brookings Institution. CHANG, Ha-Joon and Hong-Jae PARK. “An Alternative Perspective on Government Policy Towards the Chaebol in Korea: Industrial Policy, Financial Regulations and Political Democracy. In Sung-Hee Jwa and In Kwon Lee (eds.) Competition and Corporate Governance in Korea: Reforming and Restructuring the Chaebol. Cheltenham: Edward Elgar, 2004. CHUNG, Kwang, Kwangwoo PARK and Bonghan YOON. The Role of Institutional Investors in Corporate Governance: The Case of Korea. February 2004. HANG, Inhak and Jung-Hwan SEO. “Corporate Governance and Chaebol Reform in Korea. In Sung-Hee Jwa and In Kwon Lee (eds.) Competition and Corporate Governance in Korea: Reforming and Restructuring the Chaebol. Cheltenham: Edward JENSEN, Michael and W. MECKLING. 1976. “Theory of the Firm: Managerial Behavior, Agency Costs and Ownership Structure.” Journal of Financial Economics 3: 305-60 (October). JENSEN, Michael. 1986. “Agency Costs of Free Cash Flow, Corporate Finance, and Takeovers.” American Economic Review, vol. 76, No. 2. JOH, Sung Wook. “The Monitoring Role of Financial Institutions in the Korean Corporate Sector.” In Sung-Hee Jwa and In Kwon Lee (eds.) Competition and Corporate Governance in Korea: Reforming and Restructuring the Chaebol. LEE, Jae-Woo. “Chaebol Restructuring Revisited: A Coasian Perspective.” In Sung-Hee Jwa and In Kwon Lee (eds.) Competition and Corporate Governance in Korea: Reforming and Restructuring the Chaebol. Cheltenham: Edward Elgar, 2004. LEE, Keun. “Corporate Governance and Growth in the Korean Chaebols: A Microeconomic Foundation for the 1997 Crisis.” Seoul National University. May 1999. MANNE, Henry. 1965. “Mergers and the Market for Corporate Control.” Journal of Political Economy 73 (April). MILGROM, Paul and John ROBERTS. 1992. Economics, Organization and Management. New Jersey: Prentice-Hall. NAM, Il Chong. corporate governance in the Republic of Korea and its Implication for Firm Performance. Asian Development Bank Institute Discussion Paper TIROLE, Jean. 2001. “Corporate Governance.” Econometrica 69(1): 1-35.


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