+a"nching Ceremony of the #ills Center on Governance at Tsingh"a ,niversity

Anatomy of an Asian Conglomerate:

The Rise and Fall of Daewoo and the Formation of Modern Corporate Governance Joongi Kim !ec"tive Director #ills Governance Center at $onsei Decem%er &' ())*

AG 2DA
-ntrod"ction Asian Conglomerates . Korean Conglomerates Concentrated Decision/Ma0ing and the Fail"re of 1versight Concl"sion

Conglomerates
Asian Conglomerates . Korean Conglomerates

3"siness and Government Relations 1wnership 4tr"ct"re Related/5arty Transactions and 4elf/Dealing Acco"nting Fra"d and +oan Fra"d Financial 4tr"ct"re

Conglomerates
3"siness and Government Relations ; The Rise of Daewoo

Fo"nded in 678&' %ecame the largest transnational company among developing co"ntries in less than three decades Ac9"ired distressed companies from the government' restr"ct"red . t"rned them aro"nd 3enefited from personal ties %etween Chairman Kim :oo/Choong and 5resident 5ar0 Ch"ng/#ee 4tate/oriented corporate governance thro"gh ind"strial policy
5olicyma0ers g"ided %"siness decisions Reg"latory landscape

Daewoo

Conglomerates
3"siness and Government Relations ; The Rise of Daewoo

5otential -ncentives

5referential policy financing . credit 4"%sidies Ta! %enefits Tariff protection 3ailo"ts

2egative -ncentives

Fail"re to o%tain l"crative licenses and permits Administrative sanctions or fines Ta! a"dits Criminal investigations . prosec"tion

Conglomerates
3"siness and Government Relations ; The Rise of Daewoo

Government ties created enormo"s windfalls and phenomenal compressed growth' %"t also clientelism cronyism corr"ption First crisis in 67<< d"e to severe li9"idity pro%lems %ailed o"t thro"gh government resc"e plan fail"re to deal decisively f"eled dependence created moral ha=ard 5aradigm change financial crisis . decline of state infl"ence privati=ation of financial instit"tions e!pansion of e9"ity mar0ets

Conglomerates
1wnership 4tr"ct"re

1wnership str"ct"res in Asia generally %ased on family/control Control sec"red thro"gh interloc0ing' cross/ shareownership %etween affiliates Divergence of cash flow rights and control rights 4trong state infl"ence

Conglomerates
1wnership 4tr"ct"re

For listing on the stoc0 e!change' legal and reg"latory system protected controlling interests
Institutional investors had to shadow vote shares Unfriendly mergers and acquisitions were curbed Disclosure standards remained minimal Minority shareholder rights faced high ownership requirements Accounting audits and internal controls were ineffective

1wnership dispersion policy led to misalignment %etween controlling and minority shareholders
9

Daewoo
-nvestor -nvestee D: #eavy D: Corp D: Motor D: 4ec"rities D: lectronics D: Telecom> 1rion lect> Keang 2am nt> D: -nd"stries D: A"to 4ales D: 5recision D: Finance D: Develop> D: lect> Com T1TA+ D: Corp D: D: D: D: D: D: D: 1rion D: 4hip/ lec/ Tele/ 5rec/ A"to Deve/ #eavy lect> Motor %"il? tron com> ision 4ales lop> ding D: D: Treas> lect> 4ec"/ shares Com rities 415 Kim T1TA+ Family

(7

*>A )>@

6>6

6>6 6><

(>A

) )>@

)>< @>A

)>( 6>6

8>7

@>& < 87

A&

(A A>6 8>7

<>* )>( ( )>6 )>@ (>7 6>& )>6 )>* (>6 )>@ (>< 6>& A>8 6>6 6>( )>* (>& 6 6>@

6* @>8 &>< @>< (8 *)

*>&

@>& &>8

@>&

(>A 8>6

(>A 66 (>* 67 @>6

6>8

)>< )>7 A>A 6>(

() () 6)) A7

A) A7 <>* / / 67 / / /

@*

(*

)>* / / / / / / / 6

)>6 )>< 6>*

(< A6

Source: Chaebol Information Center, Inha University

10

Daewoo in 677&
,nit: B companies larger than 6 %illion won

D: Corp

<>* A& (A A7
D: Motor

D: Telecom>

6>< @* (*

Kim Family D: Finance

(7>6 8><&
D: #eavy

A) 8>7 6>A7 6

(@>&
D: Develop>

8>6 *>A &>8

A>6

D: -nd"stries

D: 4ec"rities 1rion lect>

66>6

D: 6>& A"to 4ales 67>6 <>* 6>** D: lect> Com67>( (>A Keang 2am

@>6 A>8
D: 5recision

@>&

nt>

)>@6

D: lectronics

D: 4hip%"ilding

66>&*

11

Conglomerates
Related/5arty Transactions . 4elf/Dealing

Chae%ols trace their corporate history to s"%sidi=ation thro"gh related/party transactions :ith scarce credit and financing' government promoted these transactions among affiliates

-nterloc0ing de%t g"arantees

In Dec. 199 ! Daewoo"s cross#guarantees amounted to $.% trillion won &ea'er affiliate"s default could start a chain reaction of payment demands and a collapse ()acerbated *too#big#to#fail+ mentality and moral ha,ard

12

Conglomerates
D: Related/5arty Transactions . 4elf/Dealing ntered into ris0y a"tomo%ile ind"stry -oint venture with .M/ later bought .M sta'e Acquired numerous other domestic and foreign automobile ma'ers! e.g.! 0sangyong Motor (mployees were pressured to buy cars Affiliates assumed most of the burden

Daewoo Motor' 4sangyong Motor' Daewoo Corp> and Daewoo #eavy -nd"stries acco"nted for close to <AB of the entire net de%t of the conglomerate

13

Conglomerates
Related/5arty Transactions . 4elf/Dealing Moral ha=ard led to ris0ier vent"res and more improper acts

4elf/dealing for personal %enefits Appointing "n9"alified relatives as e!ec"tives Cario"s forms of earnings management

Kim and senior managers allegedly did not engage in direct self/dealing

decisions were apparently carried o"t on %ehalf of the company' not for their own personal gains "nacco"nted 3FC f"nds

,ltimately' acco"nting fra"d and loan fra"d represented another form of self/dealing

14

Conglomerates: Daewoo
-mproper -nternal Trading
,nit: 2o> of' 6)) million won

Gro"p

5rovider companies 8 6<>* 66 *>* & 66>*

4"pported companies & & A @>* 6) &

Amt of transactions @'((7 7'))7 @6* A'8(< *@'A)6 6&'(*&

Amo"nt of s"pport / / / / <*< @6)>*

4"%charge

Daewoo J"n/7< Average

D

<7 6AA>A @@>8 @6>( 6A* 68@><

Source: FTC

Daewoo J"l/7< Average

D

Daewoo J"l/77 Average

D

15

Conglomerates
Acco"nting Fra"d and +oan Fra"d
-nternal and e!ternal corporate governance failed to detect or prevent ((>7 trillion won in acco"nting fra"d Government tacitly condoned acco"nting opacity To attract foreign capital' inflation of financial fig"res were deemed necessary 4tate/controlled %an0s foc"sed on the si=e of reven"es' sales vol"me and assets' rather than profits and cash flow Daewoo chose to overcome its financial diffic"lties thro"gh e!pansion' and with it' more deceit

:ith the financial crisis' the company co"ld no longer s"stain acco"nting and loan fra"d

16

Conglomerates
Acco"nting Fra"d
Capit al E77><F Companies Company Fig"res Daewoo Corp> Daewoo Mot or Daewoo #eavy Daewoo lectron> Daewoo Telecom 4"%total & 1t her Daewoo A f f iliat es Total D"e Diligence -nitial F4C Report Final GovGt Report

,nit: trillion :on

(>8 *>6 A>6 )>& )>A 66>< (>* 6@>A

/6&>@ /8>6 6 /A /)>7 /(8>@ /(>( /(<>8

() 66>( (>6 A>& 6>( A<>( @>& @(>7

6@>8 A>( (>6 ( )>8 ((>* )>@ ((>7

Source: Government Final Report, Sept. 1 , !"""

17

Conglomerates
Acco"nting Fra"d and +oan Fra"d
,sed affiliates and overseas 3FC acco"nts to red"ce de%ts and manip"late e!port ret"rns 3FC "sed for related paper companies to o%tain fra"d"lent commercial invoices' %ills of lading' and pac0ing lists Asset swaps %etween sister companies at disco"nted or inflated val"es 6* trillion won in off/%alance sheet lia%ilities @ trillion won in non/performing loans A trillion won in false inventories 6 trillion won in false research and development e!penses

18

Conglomerates
Financial 4tr"ct"re

operated "nder state/s"pported de%t financing as part of the -nd"strial policy top fo"r chae%ols de%t/to/e9"ity ratios e!ceeded @*)B at the time of the financial crisis in Decem%er 677& DaewooHs financial str"ct"re had several distinctive feat"res
1ver/relied on de%t gearing -ncreased de%t/to/e9"ity ratio' not decreased Daewoo Corp> was not the main profit center and co"ld not provide financial s"pport to s"stain wea0er affiliates

19

Conglomerates
De%tI 9"ity Ratio of Top Fo"r Chae%ols
700 600 500 400 300 200 100 0 Dec 95 Dec 96 Dec 97 Dec 98 Jun 99 Dec 99 1yundai Daewoo 0amsung 2.
"nit: B

20

Conglomerates
Financial 4tr"ct"re

D"e to the financial crisis' Daewoo Gro"p co"ld no longer maintain financial %alancing act
Foreign de%t J"mped from (8>A trillion won to @7 trillion won K*>6 %illion in foreign c"rrency loansL K6>7 %illion in foreign c"rrency loans to converti%le %ond owners 4"dden increase in interest rates led to financing costs J"mping from A trillion won to 8 trillion won

21

Conglomerates
Daewoo Gro"pGs Domestic 3orrowings
"nit: %illion won

25,000 20,000 15,000 10,000 5,000 0

Commercial banks N on-bank financial institutions Corporate notes Commercial papers Dec/7& Dec/7< J"n/77

Source: #orea Financial Supervisory Commision

22

Daewoo
Concentrated Decision Ma0ing . Fail"re of 1versight

Concentrated Decision Ma0ing Fail"re of 1versight %y representative directors' %oards of directors and stat"tory a"ditors 4hareholders . 4ta0eholders

23

Concentrated Decision/Ma0ing

Common attri%"tes of large Asian conglomerates

Management styles 3"siness c"lt"res 3"siness models

DaewooHs s"ccess and fate is lin0ed with its fo"nder' Kim :oo/Choong As chairman and controlling shareholder of the conglomerate' he maintained total control

24

Concentrated Decision/Ma0ing

Dominated all maJor decision/ ma0ing

-nternational and domestic financing Appointment of all C 1s and %oard mem%ers for all companies 3"siness strategies -nter/company relations 1verseas operations control

25

Concentrated Decision/Ma0ing
Decisive' vertical' efficient and speedy decision/ma0ing Despite corporate governance %rea0down' Kim made e!amplary decisions

Management s"ccession no relatives Donated personal holdings in Daewoo Corp> to the Daewoo Fo"ndation 4ceptics claim that they served "lterior p"rposes preempt political crac0down fo"ndation acted as a shelter to minimise personal inheritances ta!es de facto holding company to help maintain control

26

Concentrated Decision/Ma0ing Financial crisis e!posed the wea0nesses of concentrated governance str"ct"re 4tr"ct"re played a critical role in acco"nting and loan fra"d and "ltimately collapse

27

Fail"re of 1versight
Directors and A"ditors

insufficient chec' and balance and ineffective internal control mechanisms failed as institutions to counterbalance controlling shareholders/ instead succumbed to their dictates did not provide oversight and act as independent! front#line monitors disregarded their roles as fiduciaries directors and officers not legally distinguished/ internal 3 e)ternal auditors

28

Fail"re of 1versight
Directors and A"ditors

no non/e!ec"tive o"tside directors "ntil 677<L no a"dit committees

(*B o"tside directors did not change matters

colleag"es of KimHs generation

Co"ld advise and monitor decision/ma0ing replaced %y new e!ec"tives who were "na%le to effectively co"nsel and confront

failed to pers"ade chairman to p"rs"e a contraction/oriented policy and prevent fra"d

29

Fail"re of 1versight
Directors and A"ditors

only held acco"nta%le to controlling shareholder . conglomerate

no la%o"r mar0et fle!i%ility remained captive to their conglomerates ins"fficient o"tside scr"tiny for a"ditors only maJor client only after the collapse did they face civil and criminal lia%ilityL Ch"ng"n . 4andong

30

Fail"re of 1versight
Directors and 1fficer +ia%ility -ns"rance
$ear 6778 677& 677< 6777 ())) ())6 ())( ())A ())@Eest>F Total 2o> of 5olicies 6 * 6)* A() 6)6 (8@ A<8 A&( *))

Total 2o> of 5olicies 600 500 400 300 200 100 0

1996 1998 2000 2002 2004(e s t.)

31

Fail"re of 1versight
4hareholders and 4ta0eholders

passive in monitoring management did not question or challenge did not see' information did not attempt to get representation on the board did not attend A.M or vote failed to ta'e any action! no matter how dire the case

32

Fail"re of 1versight
4hareholders and 4ta0eholders

wea0 shareholder rightsL lac0 of awareness investment on a short/term %asis diffic"lt to o%tain information d"e to wea0 disclos"re standards a%sence of a class action vehicle and o%stacles to litigation confined instit"tional investors to shadow voting ineffective pro!y r"les

33

Fail"re of 1versight
4hareholders and 4ta0eholders

4ta0eholders s"ch as creditors' employees' la%or and cons"mers failed to serve as chec0s and %alances mployment stoc0 ownership plans E 415F did not serve as monitoring forces
voting rights rarely e!ercised limited ownership complicated pro!y proced"res

34

Fail"re of 1versight
4hareholders and 4ta0eholders

4trong sense of gro"p loyalty . strong corporate c"lt"re against whistle%lowers +ac0 of access to information and little incentive to 9"estion the decision/ma0ing of e!ec"tives Rarely challenged 9"estiona%le decision/ma0ing or contemplate e!posing wrongdoings

35

Concl"sion
3"siness/ Government Relations

4hareholders . 4ta0eholders

1wnership 4tr"ct"re

+ac0 of 1versight

DaewooGs Fall

Related/5arty Transactions

Concentrated Decision Ma0ing

Financial 4tr"ct"re -neffective nforcement

36

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