Bloomberg News

Koreans Fret World-Beating Chaebol Destroy Small Business

November 13, 2012

South Koreans Fret World-Beating Chaebol Destroy Small Business

The Samsung Electronics Co. Seocho office building, right, stand in Seoul, South Korea. Photographer: SeongJoon Cho/Bloomberg

Lee Bok Sun is ready to shut her 28-year-old fruit store in Seoul, after her customers switched to a new hypermarket owned by one of South Korea’s chaebol, the family-controlled business groups that dominate the economy.

“My baby brother gave me the money to start this shop to thank me for the years I worked as a seamstress to pay for his college fees,” said Lee, 63, as she counted the day’s earnings from a battered Nike shoe box. “He wouldn’t have gotten his job at a chaebol without that degree, and now I’m being put out of business by the same system I worked so hard to get him into.”

Since Lee moved to Seoul to sew clothes at the age of 15, the business empires that include Samsung Electronics Co. (005930) and Hyundai Motor Co. have lifted South Korea’s economy 22 places, to 15th, in the World Bank’s ranking, making their brands household names around the globe. As Koreans prepare to vote for a new president, the spotlight is turning to the cost of success: a widening income gap, struggling small businesses and the highest suicide rate in the developed world.

“To outsiders, it may seem like the economy is doing relatively well, but there are people stuck in the cracks of society where chaebol wealth was supposed to trickle down to,” said Kim Woo Chan, a finance professor at Korea University Business School in Seoul. “People realize that the chaebol’s success alone does not create jobs or enliven domestic activity like the government said it would.”

New Path

South Korea is facing a watershed that Japan reached in the 1980s and China is rapidly approaching -- a point where a country that has tapped an investment-and-exports model to pull the population out of poverty has to find a new path that caters to an increasingly demanding domestic population. That may mean accepting slower growth, said Jaewoo Lee, chief Korea economist for Bank of America Merrill Lynch.

“The era of high single-digit growth based on manufacturing exports has passed,” said Lee. “South Korea is at a crossroads, where a discussion is in order to identify the next stage or framework of economic growth, with more emphasis on services and domestic activity.”

South Korea’s presidential hopefuls, led by software mogul Ahn Cheol Soo, who has campaigned to break up the crossholdings to weaken the grip of the controlling families, have tried to win over voters by pledging to rein in big business.

Ahn has teamed up with opposition-party nominee Moon Jae In after the two fell behind in the polls to ruling party candidate Park Geun Hye, whose late father Park Chung Hee was responsible for building up the chaebol in the 1960s and 1970s during his time as the country’s longest-serving military dictator.

Park Leading

Park’s approval rating was 41.5 percent, with Ahn second at 26.6 percent and Moon a close third at 25.3 percent, according to Seoul-based Realmeter’s Nov. 5-11 poll. The survey of 5,250 respondents had a margin of error of 1.4 percentage points.

Even Park has tried to distance herself from the chaebol, which are closely tied to her New Frontier Party.

“Big businesses aren’t the only ones in the economic ecosystem,” said Park at an Oct. 30 rally for small business owners and independent shopkeepers. “Small and medium-sized enterprises, independent shop owners, the self-employed must all support the ecosystem and nurture it to growth. Nobody should fall behind because of an unfair structure.”

Popular support for change has been fueled by the perceived failure of policies of outgoing President Lee Myung Bak, whose single term ends in February. Lee pledged to put the nation of 50 million people on a path that would yield annual growth of 7 percent and per capita income of $40,000 by 2017.

Exports Curbed

Instead, the U.S. mortgage meltdown that began infecting global markets in 2007, along with debt woes in Europe the past three years, have crimped exports that account for nearly half of the nation’s gross domestic product. Overseas sales have fallen for three of the past four months and the Bank of Korea estimates growth this year will be 2.4 percent.

“People are more likely to focus on issues surrounding the distribution of wealth when economic growth slows, especially if businesses’ share is growing,” said Lee at Bank of America.

The biggest of the industrial groups touch almost every aspect of South Koreans’ lives, an influence that is magnified for chaebol workers by corporate loyalty and staff discounts.

Samsung Electronics sales employee Ellen Jeon, 33, takes the elevator down in the morning from her home in Tower Palace, a 3,070-apartment complex in Seoul’s Gangnam district built 10 years ago by Samsung C&T Corp. (000830), the original trading company of the Samsung group, founded in 1938.

Caramel Macchiato

She crosses the lobby to Starbucks, a franchise owned by a unit of retailer Shinsegae Group (004170) that’s run by Samsung Chairman Lee Kun Hee’s nephew, Chung Yong Jin. Wearing her favorite Tory Burch flats, bought at a Shinsegae department store, she carries her caramel macchiato down to the car park to drive her Renault Samsung Motors Co. SM5 sedan to work.

Near her home is the Samsung Medical Center, where she gave birth to her first son eight weeks ago, a year after her wedding at Seoul’s five-star Shilla Hotel (008770), run by Lee’s eldest daughter, Lee Boo Jin. On her way to Samsung Digital City in the southern suburb of Suwon, she passes close to Shinsegae’s Jookjeon outlet, where her husband bought his first suit -- a pinstripe from the Galaxy label of Cheil Industries Inc. (001300), of which Lee’s second daughter, Lee Seo Hyeon, is vice president.

Naturally, Jeon and her husband both carry Samsung phones.

Getting Bigger

The country’s 10 biggest conglomerates make up more than half the total value of the 1,779 companies on the Korea Stock Exchange. And they continue to grow. In the past four years, the number of companies linked to the top 35 business groups has almost doubled, to nearly 600, according to a February report by the Fair Trade Commission.

Exports by the 30 largest chaebol accounted for 84 percent of South Korea’s overseas shipments in 2010, according to the Federation of Korean Industries.

At the same time, those 30 employed just 6 percent of the nation’s workforce, while corporate tax paid by groups with more than 100 billion won ($92 million) in sales amounted to 12 percent of the total tax collected in 2010, according to the National Tax Service.

Still, the economic importance of global brands like Samsung, Hyundai and LG Electronics Inc. (066570) means that, electioneering aside, any progress in dismantling the chaebol structure is likely to be slow, according to a September report from CLSA Asia-Pacific Markets Ltd. and the Hong Kong-based Asian Corporate Governance Association.

Toned Down

“The most aggressive policies will be toned down due to practical constraints and the importance of the chaebol to the economy,” Shaun Cochran, head of Korea research for CLSA, wrote in this year’s annual report of corporate governance. “However, investors should make no mistake; there is a clear push to reduce the ability of families to exploit control of companies.”

Park Chung Hee provided chaebol with subsidies such as unlimited cheap credit, protection from foreign competition and tax breaks. In the seven years before his assassination in 1979, he introduced policies to encourage them to take over smaller companies, to “rid” the economy of “unsound” businesses.

Park had near-total control of financial resources and credit in the country, a legacy of the state’s acquisition of the colonial-Japanese banking system after World War II.

Money was channeled into industrialization and building an education system that fed the need for engineers and technical graduates in industries such as shipbuilding, electronics and automaking. Last year, South Korea’s 30 biggest business groups hired more than 80 percent of the 320,000 new college graduates.

Circular Holdings

As the groups grew and moved into more businesses, complex, circular shareholding structures developed, with relatives of the chairman installed in major affiliates, ensuring the families kept control, even with minority shareholdings.

Chung Mong Koo is chairman of Hyundai Motor Co. (005380) He’s a son of the late Chung Ju Yung, who is a symbol of South Korea’s industrial transformation -- rising from a poor farming family in what is now North Korea to build a group that spawned the world’s largest shipbuilder and fifth-largest carmaker.

Hyundai Motor, which split from the Hyundai Group in 2000, is 20.8 percent owned by its parts supplier Hyundai Mobis (012330), which in turn is 16.9 percent owned by Kia Motors Corp. (000270), which has 33.9 percent of its equity held by Hyundai Motor, according to data compiled by Bloomberg from the latest figures published in April by the nation’s Fair Trade Commission.

Steel Suppliers

Including other family stakes and affiliate crossholdings - - a similar circular structure exists with Hyundai Motor, Kia and their steel suppliers Hyundai Hysco Co. and Hyundai Steel Co. (004020) -- Chung is able to retain control of the entire auto group with a 5.2 percent stake in Hyundai Motor and 7 percent of Mobis.

To dismantle this structure and rearrange Hyundai Motor Group into a vertical structure of parent and subsidiaries would cost 10.8 trillion won, according to Chaebul.com, which tracks the wealth of the nation’s richest families.

Failing to do so may reinforce concerns about the nation’s corporate governance that contribute to the so-called Korea Discount in the stock market. The benchmark Kospi (KOSPI) stock index trades at 8.3 times next year’s earnings, according to data compiled by Bloomberg. That’s the lowest of Asia’s 10 biggest equity markets.

It’s not the first time the government has been under pressure to rein in the chaebol. The 1997-1998 Asian financial crisis, which led the country to accept a bailout from the International Monetary Fund, raised criticism amid the collapse of the Daewoo and Hanbo groups.

Presidential Pardon

In 2008, Hyundai’s Chung Mong Koo was convicted on charges of embezzlement and breach of duty, including the sale of stock in a unit to his son at below-market prices. He received a suspended jail term after promising nearly 1 trillion won to charity and was later pardoned by President Lee.

This year, Hanwha Group Chairman Kim Seung Youn, 60, was sentenced to four years in jail and fined 5.1 billion won after a court found that he used funds from the nation’s 10th-largest industrial group to pay debts of private firms owned under false names. Kim, who was granted a presidential pardon in 2008 after striking a man with a steel pipe and threatening others with an electric shock device, has appealed the Aug. 16 ruling.

The economic slowdown, scandals, and social criticism have made the chaebol and their ruling families into political pinatas in the presidential election race.

Investment Path

Front-runner Park said she will increase fines for conglomerates that violate fair-trade laws to as much as 10 times the incurred damage and wants to ban new cross-shareholdings. Moon is calling for a three-year grace period to resolve the question of the cross-holdings as well as the practice of channeling investment funds between affiliates.

Ahn, who founded anti-virus software company Ahnlab Inc. (053800), would incrementally break up the web of affiliates altogether, to sever the family ties and release more capital for smaller businesses. He would also halve holding companies’ current debt ratio of 200 percent and limit their investment in affiliates.

South Korea’s gross domestic product may fall by more than 2 percent if tougher regulations restrict chaebol from investing and creating more jobs, said Oh Jung Gun, an economics professor at Korea University, at an Oct. 30 seminar hosted by the Korea Chamber of Commerce and Industry, one of the nation’s largest business lobby groups.

Many South Koreans are proud of the success of companies like Samsung and Hyundai, which have given the nation global standing and lifted per capita income from $67 in 1953 to $22,489 last year, according to the Bank of Korea.

Taste Test

“As much as we hate to admit it, the chaebol just run businesses better,” said Hongik University student Kim Seung Kyu, 20, coming out of an 8Seconds fashion store, another Cheil label, clutching a Starbucks iced caramel macchiato. “I like individuality as much as anyone, but let’s be honest, Starbucks tastes better.”

Even Lee Bok Sun the fruit-seller said she’s still proud that she managed to get a member of the family into a chaebol. That love-hate relationship may mean that the restructuring of the groups will come slowly, said Charles Lee, North Asia research director for the Asian Corporate Governance Association, in the September report.

“Korea’s renewed momentum on corporate governance may lack conviction and could fade once this year’s election passes,” Lee said. “We sense a widely shared fatalism among most Koreans that the reform process can only go so far, because certain features of the current system -- such as the chaebol structure -- are simply accepted as the Korean way of doing business.”

Economic Backbone

The chaebol are “the backbone of the South Korean economy” and limiting or banning cross-shareholdings would make them vulnerable to hostile foreign takeovers, the Federation of Korean Industries, which represents the nation’s biggest companies, said in an Aug. 6 statement. Samsung Group declined to comment in an e-mailed response.

“I don’t think anyone can deny that South Korea’s economy wouldn’t be where it is today without the chaebol,” said Kim Kyung Won, 26, who works in marketing in Seoul and owns an LG phone, Samsung TV and Kia sedan. “But I’m not so sure how positive the current structure will be for the economy in future. I mean, it can’t be healthy to have just a few companies own almost everything, right?”

To contact the reporter on this story: Sangwon Yoon in Seoul at syoon32@bloomberg.net

To contact the editor responsible for this story: Peter Hirschberg at phirschberg@bloomberg.net


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