Since the financial crisis, Korea has achieved considerable progress in its corporate governance. Dramatic changes in its legal and regulatory infrastructure have led to much more transparent and accountable companies. Boards of directors, shareholders, stakeholders, auditors, creditors and others have begun to function effectively to establish many forms of internal and external corporate governance and market-oriented discipline that previously never existed. Korean companies are now poised to make a quantum leap on the evolutionary scale of corporate governance if they can muster enough effort to complete their modernizing process.
Korea's progress must be viewed from a relative perspective, particularly in light of the immediate past. At the time of the financial crisis, for instance, an appropriate translation of the term "corporate governance" did not even exist in Korea. Boards of directors did not formally hold board meetings and shareholder meetings usually lasted less than five minutes, with little participation, if any. Accounting audits often occurred perfunctorily. One barometer of the lack of director accountability is that director and officer liability insurance virtually did not exist. Companies assessed that they faced no legal risk because no matter what they did they would never be held accountable in terms of civil liability.
Overall, Korea has indeed come a long way since those elementary stages. Financial institutions in particular have undergone the most reform in corporate governance, largely spurred by foreign ownership. Gone are the days of generous government-driven policy loans, and the resultant lending discipline has led loan portfolios to shift from large conglomerates to small and medium-sized companies and the retail market. Due to financial necessity, therefore, companies must improve their corporate governance either to secure commercial loans or to tap capital markets. A more equity-oriented culture has emerged, much in line with global trends.
Boards of directors of Korean corporations are finally functioning. Listed companies must appoint outside directors, large listed companies must establish audit committees, internal controls and codes of conduct are becoming commonplace and disclosure standards have been substantially strengthened.
In 1997, the first shareholder derivative action occurred. Two major accounting firms collapsed due to their delinquent external audits. For the first time, corporate executives, bank executives, and accountants, have been facing accountability through civil and criminal liability and administrative sanctions. Shareholders have prevailed in several landmark derivative actions against such high-profile companies as Samsung Electronics that were brought against directors for breaches in fiduciary duty.
Prosecutors have been aggressive in light of recent accounting fraud at such major conglomerates as SK and Doosan. Moreover, the Supreme Court recently affirmed that companies cannot use company funds to bribe government officials even if they are given so solely for the benefit of the company.
Following the accounting scandal that rocked the SK Group, Korea even became one of the first countries in Asia to adopt class action litigation. The new law allows class actions for a limited number of securities-related matters such as accounting fraud, market manipulation and insider trading. A vast array of protections have been added to the law to prevent potential abusive or frivolous litigation. While hopeful, unfortunately, the actual implementation of the law has been delayed for two years to allegedly give companies time to clean up their books.
Hence, the rule of law in corporate governance is gradually being established. This potential discipline has forced companies to improve their corporate governance and gatekeepers such as accounting firms to be far more rigorous. One of the net effects has been that corporate valuations have recently reached all time highs.
Remarkable progress notwithstanding, Korean companies, particularly many blue-chip entities, still face doubts that they continue poor practices. The dreaded "Korean discount," that undervalues Korean companies because of market skepticism about their transparency, still prevails. In the most recent CLSA and Asian Corporate Governance Association annual corporate governance ranking of Asian countries, Korea not only trails Singapore and Hong Kong, but also India and Malaysia. Korea's corporate governance practice and standards continue to lag behind its economic development. Several major scandals involving such leading companies as Samsung, SK, Hyundai, Doosan, Daesang and several KOSDAQ companies over the past couple of years have once again shaken confidence in Korean companies.
Controlling shareholders of some of the largest conglomerates, i.e. chaebol, still wield inordinately large power, particularly relative to their ownership. In most countries of the world, family ownership does remain the norm. In Korea, however, unlike in other countries, controlling shareholders maintain only minimal ownership positions. Their family stakes often amount to less than 5 percent of an entire conglomerate.
Controlling shareholders and their families maintain their control through vast networks of cross-shareholding. The ability to utilize customer accounts in non-bank financial institutions, for instance, plays a pivotal role in their cross-shareholding structures and has emerged as one of the most pressing current issues. In other words, affiliated insurance companies, securities firms, investment trusts and merchant banks have acted as conduits through which controlling families sustain their control.
The effectiveness of outside directors of chaebol companies remains a critical concern. Close to 85 percent of outside directors, for example, are still chosen solely based upon personal relations with the controlling shareholder. The best way to select qualified and independent outside directors continues to be a never-ending project.
Chaebols still play an exceedingly powerful role in Korea with their market concentration reaching alarming heights in many sectors. They remain the benchmark by which all Korean companies are measured, particularly in the eyes of international investors, analysts and creditors. Hence, modernizing their corporate governance to global standards remains one of the most important tasks remaining in Korea. In this light, several conglomerates such as the LG Group have transformed themselves through reorganization according to a transparent holding company ownership structure.
More recently, brewing protectionist sentiment has served to dampen efforts to attract foreign investment. These concerns were sparked by several proactive institutional investors with the leading example being Sovereign Asset Management's bold attempts to modernize SK Corp's corporate governance. As witnessed in the case of CNOOC's recent failure to acquire Unocal in the U.S. and PepsiCo's attempts to acquire Danone or Wal-Mart's for Carrefour in France, however, protectionism prevails everywhere. It must be remembered that no matter how duplicitous these advanced countries might appear they have a long tradition of foreign investment.
At this critical juncture, Korea does not have this type of luxury and cannot afford to protect itself in an antiquated, mercantilist fashion. To shed its status as an emerging market, Korea must shed its image as a reclusive hermit kingdom. As it has done so successfully in the goods and services, where it openly competes in global markets, Korean companies must reach similar competitiveness in capital markets. Capital is a precious commodity that Korean companies require. Otherwise, Korea will lose its momentum in its rivalry with other regional challengers such as China, India, Malaysia and Thailand.
Around Asia, the best companies such as Infosys and HSBC make every effort to enhance their corporate governance. Recent scandals exposed that, despite recent reforms, Korean companies continue to have inherent vulnerabilities in their corporate governance. Korean companies therefore must continue to strive to enhance their reputational capital and integrity. Korean companies can thus receive internationally competitive valuations if they continue to embrace, not shy away from, higher corporate governance standards. Only then can Korea join the league of advanced capital markets, and only then can Korean corporations receive the proper premiums that they so rightfully deserve.
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