President Moon's tricky task to clean up Korea Inc

SEOUL — The five nightclub workers cowered in the shadows as they were set upon by two dozen thugs. Abducted from their workplace in the heart of central Seoul, the South Korean capital, they had been taken to an abandoned warehouse, where they were beaten with steel pipes and stun batons.

Overseeing the brutal attack was Mr Kim Seung-youn, who later told police he intervened to deliver “several hooks”. Mr Kim was convicted in 2007 for his role in the attack, but received a suspended sentence. In 2012, he was convicted again, this time of embezzlement and sentenced to four years in prison, but was released shortly after on health grounds.

Mr Kim is head of one of South Korea’s largest and most prominent conglomerates, Hanwha, as he was at the time of both convictions. For critics, his case exemplifies the longstanding belief that South Korea’s corporate bosses are above the law and too close to the country’s political leaders.

But following a corruption scandal that has engulfed the country for much of the past 10 months and laid bare rampant cronyism in Asia’s fourth-largest economy, there is growing demand for change to the unchecked power of the family-run conglomerates, known as the chaebol. Few are seeking to break up the groups but reformers want greater oversight and enforcement of existing rules and regulations.

“I believe that this is the time for fundamental chaebol reform,” says Park Sang-in, a professor of economics at Seoul National University. “The Korean people’s understanding of the problems caused by the chaebol, as well as citizens’ desire for fundamental change to the political and economic structure, is higher than ever.”

Public anger that brought hundreds of thousands on to the streets in 2016 and again earlier this year has begun to feed through to government policy. Even as it grapples with the North Korea crisis the administration under President Moon Jae-in, who was elected in May, has taken tentative steps towards diluting the dominance of the handful of powerful conglomerates.

The issue is crucial not only for governance and corporate accountability, but also the long-term prospects for the country’s economy, vast swaths of which have been choked off by the hulking presence of the likes of Samsung, Hyundai and Lotte. The combined market capitalisation of the five biggest groups accounts for more than half of the Kospi, the main Korean stock index.

However, doubts remain over whether the flag-bearers of corporate and economic reform will be able to see the fight through and whether the alternative will satisfy the aspirations of South Korean citizens.

“It is a matter of balance,” says Mr Bruce Lee, chief executive of Zebra Investment Management, a Seoul-based hedge fund. “If chaebol reform causes the economy to deteriorate, then the government will end it. But if the economy can sustain growth, reform will be reinforced.”

Corporate reform in South Korea has often proven ephemeral. But last month the nation witnessed what many believe could be a watershed moment when a court sentenced Lee Jae-yong, the heir and de facto head of Samsung, to five years in prison for bribing the former president, Park Geun-hye.

A sprawling conglomerate composed of 62 affiliates covering everything from electronics to pharmaceuticals and heavy industry; Samsung is a bulwark of the South Korean economy. Its 16 listed entities alone account for almost 30 per cent of the Kospi, making Lee arguably the nation’s most powerful individual. Now, many experts hope his conviction — if not overturned on appeal — will prove an opening shot in the battle to pull apart the deep-set ties between big business, politics and the judiciary.

“This is a very significant moment for South Korea,” says Kim Woo-chan, a professor at Korea University and an expert on corporate governance. “It is an important signal to businesses not to go back to the old practices of colluding with corrupt politicians.”

In the past, top executives might have expected a suspended sentence or a presidential pardon. But the Moon administration has vowed to abolish such practices.

“If the sentence is upheld after appeal, it will be a good opportunity for the chaebol system to be upgraded but also an opportunity for Samsung to reform,” says Prof Kim.

The history of South Korea’s family-run conglomerates is closely entwined with that of the state. Following the devastation of the Korean war in the early 1950s, South Korea’s leader, Park Chung-hee, turned to the conglomerates to help rebuild the country in the 1960s and 1970s.

As the nation grew, so too did the relationship between politics and big business, with each side profiting from institutionalised influence-peddling and special treatment. The chaebol could be counted on to provide jobs and in return they received easy access to government contracts and an economy fenced off from foreign players.

As the conglomerates became richer, their influence expanded to the courts and media. Newspapers are financially underpinned by chaebol advertising, making editors hesitant to investigate or criticise corporate malfeasance. Meanwhile, the companies ingratiated themselves with the judiciary by dangling future employment opportunities in front of judges or fledgling lawyers.

In recent years, however, this business model — largely responsible for South Korea’s transformation from a poor backwater to one of the world’s most technologically advanced economies — has begun to fray. During the mass protests citizens poured scorn on the cronyism and backroom dealings of Lee, who was convicted of bribing Ms Park to secure support for a controversial merger that cemented his grip on Samsung.

This wave of unrest happened against a background of growing unemployment — with 9 per cent of young adults jobless — and stuttering economic growth, prompting questions of whether these immensely wealthy groups still warrant special treatment. Small and medium-sized enterprises have also complained bitterly that the chaebol’s control over supply chains and prices chokes their businesses.

“The fundamental problem of the chaebol, especially Samsung, is the concentration of economic power,” says Prof Park. “Since it controls so many economic resources, it can thus influence politics, media and the legal system for the private interests of the owner families. And it hinders the economy from moving into an innovation-based model.”

Much of the public anger stems from openly egregious practices, such as tax avoidance or the use of presidential pardons to free executives convicted of corruption. There are other aspects of chaebol reform that are more complex and focus on unravelling the web of cross-shareholdings that allow the founding families to exert control, and prosper, at the expense of minority shareholders.

Activists also complain about the lack of oversight, pointing to a dearth of independent directors and auditors. This lack of transparency is believed to be at least partly responsible for the “Korea discount phenomenon”, where local companies trade at lower price-to-earnings multiples than their global peers. The practice of intra-group trading — where contracts from publicly listed chaebol entities are handed to privately held affiliates without a bidding process — has also drawn the ire of activists.

For most experts, the success of chaebol reform depends on Mr Moon’s determination to reorganise the South Korean economy. The president, who has vowed to end the use of presidential pardons for corrupt executives will come under severe pressure to release Lee, the Samsung heir.
“It is going to be a very difficult job (reforming the chaebol). I don’t think this government can do it in a few years,” says one businessman at a large multinational company in Seoul. “It will take great leadership to convince the chaebol this is not about retribution but transparency.”

Mr Moon has appointed two corporate governance crusaders to take on the chaebol: Kim Sang-jo and Jang Ha-sung. As head of the Fair Trade Commission, the country’s top antitrust body, Mr Kim Sang-jo had already made his intentions clear, recently telling local media: “If the chaebol don’t show positive change or a willingness to reform by December, we (the FTC) will have no choice but to step in to impose structural prescriptions.”

Retailer Lotte has heeded the signs, announcing plans to simplify its group structure. Samsung will outline and explain its governance issues in a report later this month, but has already said it will not adopt a holding company structure that could, in theory, provide more transparency over affiliate ownership.
“It is now just a matter of enforcement,” says Chang Sea-jin, a professor at the National University of Singapore. “We already have all the rules and regulations.”

Under previous presidents, including Park, who won the 2012 election on a commitment to overhaul the chaebol, and her predecessor Lee Myung-bak, the excesses of the family businesses were subject to light-touch regulation amid fears that attempts at governance reform would damage the economy.
Mr Moon has publicly shifted from the notion that the chaebol’s success “trickles down” through society. He is instead focusing on support for SMEs and a policy of income-led growth, seeking to create higher wages, consumption, investment and employment.

South Korea is home to almost three million SMEs, which employ more than 85 per cent of the adult population. However, many are poorly run and average salaries are only about 70 per cent those of large conglomerates. In July, the Moon administration launched a ministry to support SMEs, which have languished in OECD rankings for their lack of entrepreneurial spirit. “The chaebol squeeze SMEs to a level where they can’t invest,” says Prof Chang.

Analysts believe that while the administration’s new approach may ease the pressure over unemployment, it is unclear whether the policies can translate into long-term growth.

It is also likely the chaebol will begin to push back if, and when, Mr Moon’s popularity dips. “The chaebol’s best weapon against reform is the propaganda of ‘fear’. They will argue that chaebol reform may endanger the Korean economy,” says Prof Park.

Others say the writing is already on the wall for Korea’s corporate titans. “They will try to do everything (to keep power),” says Prof Kim. “But in my view, the chaebol system will only last one generation more,” adding that it would be impossible for dynastic succession to continue past the current crop of leaders.

It is a notion that reverberates around the business community. Many believe the upheaval of the past year will force a gradual shift from family-oriented control to professional management.
“The chaebol have contributed greatly to South Korea, but society has changed and the chaebol should change too,” says Mr Mike Cho, president of the Korea Corporate Governance Service. “In the longer term, we will have a healthier economy as a result.”  THE FINANCIAL TIMES