Anatomy of an Asian Conglomerate: The Rise and Fall of Daewoo and the Formation of Modern Corporate...

Anatomy of an Asian Conglomerate: Anatomy of an Asian Conglomerate: The Rise and Fall of Daewoo and the Formation of The Rise and Fall of Daewoo and the Formation of

Modern Corporate GovernanceModern Corporate Governance

Anatomy of an Asian Conglomerate: Anatomy of an Asian Conglomerate: The Rise and Fall of Daewoo and the Formation of The Rise and Fall of Daewoo and the Formation of

Modern Corporate GovernanceModern Corporate Governance

Joongi KimExecutive Director

Hills Governance Center at Yonsei December 7, 2005

Launching Ceremony of the

Hills Center on Governance at Tsinghua University Launching Ceremony of the

Hills Center on Governance at Tsinghua University

22

IntroductionIntroduction

Asian Conglomerates & Korean Asian Conglomerates & Korean ConglomeratesConglomerates

Concentrated Decision-Making and the Concentrated Decision-Making and the Failure of OversightFailure of Oversight

ConclusionConclusion

AGENDAAGENDA

33

Business and Government RelationsBusiness and Government Relations

Ownership StructureOwnership Structure

Related-Party TransactionsRelated-Party Transactions and Self-Dealingand Self-Dealing

Accounting Fraud and Loan FraudAccounting Fraud and Loan Fraud

Financial StructureFinancial Structure

Asian Conglomerates & Korean Conglomerates Asian Conglomerates & Korean Conglomerates

ConglomeratesConglomerates

44

Founded in 1967, became the largest Founded in 1967, became the largest transnational company among developing transnational company among developing countries in less than three decadescountries in less than three decades

Acquired distressed companies from the Acquired distressed companies from the government, restructured & turned them around government, restructured & turned them around

Benefited from personal ties between Chairman Benefited from personal ties between Chairman Kim Woo-Choong and President Park Chung-HeeKim Woo-Choong and President Park Chung-Hee

State-oriented corporate governance through State-oriented corporate governance through industrial policyindustrial policy

Policymakers guided business decisions Policymakers guided business decisions Regulatory landscapeRegulatory landscape

Business and Government Relations – The Rise of DaewooBusiness and Government Relations – The Rise of Daewoo


55

DaewooDaewoo

大宇大宇

66

Potential IncentivesPotential Incentives Preferential policy financing & creditPreferential policy financing & credit SubsidiesSubsidies Tax benefitsTax benefits Tariff Tariff protectionprotection Bailouts Bailouts

Negative IncentivesNegative Incentives Failure to obtain lucrative licenses and permitsFailure to obtain lucrative licenses and permits Administrative sanctions or finesAdministrative sanctions or fines Tax auditsTax audits Criminal investigations & prosecutionCriminal investigations & prosecution



77

Government ties created enormous windfalls Government ties created enormous windfalls and phenomenal compressed growth, but alsoand phenomenal compressed growth, but also clientelismclientelism cronyismcronyism corruptioncorruption

First crisis in 1988 due to severe liquidity First crisis in 1988 due to severe liquidity problemsproblems bailed out through government rescue planbailed out through government rescue plan failure to deal decisively fueled dependence failure to deal decisively fueled dependence created moral hazardcreated moral hazard

Paradigm change Paradigm change financial crisis & decline of state influencefinancial crisis & decline of state influence privatization of financial institutionsprivatization of financial institutions expansion of equity marketsexpansion of equity markets



88

Ownership structures in Asia generally based Ownership structures in Asia generally based on family-controlon family-control

Control secured through interlocking, cross- Control secured through interlocking, cross- shareownership between affiliatesshareownership between affiliates

Divergence of cash flow rights and control Divergence of cash flow rights and control rightsrights

Strong state influenceStrong state influence



99

For listing on the stock exchange, For listing on the stock exchange, legal and regulatory system protected legal and regulatory system protected

controlling interestscontrolling interests

Institutional investors had to shadow vote sharesInstitutional investors had to shadow vote shares Unfriendly mergers and acquisitions were curbedUnfriendly mergers and acquisitions were curbed Disclosure standards remained minimalDisclosure standards remained minimal Minority shareholder rights faced high ownership Minority shareholder rights faced high ownership

requirementsrequirements Accounting audits and internal controls were ineffectiveAccounting audits and internal controls were ineffective

Ownership dispersion policy led to Ownership dispersion policy led to misalignment between controlling and misalignment between controlling and minority shareholdersminority shareholders



1010

DaewooDaewoo

DW CorpDW Corp

DW ElectronicsDW Electronics

KimKimFamilyFamily

DW MotorDW Motor

DW Develop.DW Develop.

DW Elect. ComDW Elect. Com

DW HeavyDW Heavy

DW IndustriesDW Industries

DW Auto SalesDW Auto Sales

Keang Nam Ent.Keang Nam Ent.

DW SecuritiesDW Securities

DW FinanceDW Finance

Orion Elect.Orion Elect.

DW PrecisionDW Precision

DWDWShip-Ship-buil_buil_dingding

DW Telecom.DW Telecom.

DWDWCorpCorp

DWDWElec-Elec-trontron

DW DW MotorMotor

DW DW Deve-Deve-lop.lop.

DW DW Elect.Elect.ComCom

DWDWHeavyHeavy ESOPESOP

DWDWAutoAutoSalesSales

Treas.Treas.sharesshares

DWDWSecu-Secu-ritiesrities

TOTALTOTALOrionOrionElect.Elect.

DW DW Prec-Prec-isionision

DW DW Tele-Tele-com.com.

TOTALTOTAL

InvestorInvestor

InvesteeInvestee

0.40.4 1.81.8 0.40.4 4.34.3 1.11.1 88

3737 2323 8.58.5 6969

3.13.1 6.96.9 0.20.2 0.10.1 2.92.9 0.10.1 1.41.4 1515

22 0.40.4 1.71.7 0.50.5 4.64.6

5.75.7 2.12.1 7.87.8

0.40.4 2.82.8 0.50.5 11 4.84.8

4.74.7 4.74.7 2.32.3 2.32.3 1.61.6 1.71.7 3.63.6 1.11.1 1.21.2 2.72.7 2626

7.67.6 6.16.1 1111 2.52.5 5050

1919 0.80.8 2020

4.14.1 0.90.9 3.33.3 1.21.2 2020

3030 4545 2525 100100

3939 3939

8.58.5 1919 0.50.5 0.10.1 2828

-- -- -- -- -- -- -- -- -- -- -- -- 11 0.80.8 1.51.5 3131

2929 5.35.3 1.11.1 1.11.1 2.32.3 00 0.80.8 0.20.2 6.96.9 4.74.7

Source: Chaebol Information Center, Inha University

1111

Daewoo in 1997Daewoo in 1997

1.39

DWDWCorpCorp

DW DW ElectronicsElectronics

KimKimFamilyFamily

DW MotorDW Motor

DW DW Develop.Develop.

DWDWElect. ComElect. Com

DWDWHeavyHeavy

DW DW IndustriesIndustries

DW DW Auto SalesAuto Sales

Keang NamKeang NamEnt.Ent.

DWDWSecuritiesSecurities

DWDWFinanceFinance

OrionOrionElect.Elect.

DW DW PrecisionPrecision

DWDWShipbuildingShipbuilding

29.137

39

8.5

5.3

233.1

DWDWTelecom.Telecom.

4.7

8.5

11.1

4.1

24.7

19.1

45

25

3.6

6.87

1

11.75

7.6

6.9

30

6.1

2.319.2

1.7

1.55

1.8

0.41

Unit: % Unit: % ccompanies larger than 1 billion wonompanies larger than 1 billion won

1212

Chaebols trace their corporate history to Chaebols trace their corporate history to subsidization through related-party subsidization through related-party transactionstransactions

With scarce credit and financing, With scarce credit and financing, government promoted these transactions government promoted these transactions among affiliatesamong affiliates

Interlocking debt guaranteesInterlocking debt guarantees In Dec. 1997, Daewoo‘s cross-guarantees amounted In Dec. 1997, Daewoo‘s cross-guarantees amounted

to 8.5 trillion wonto 8.5 trillion won Weaker affiliate‘s default could start a chain reaction Weaker affiliate‘s default could start a chain reaction

of payment demands and a collapseof payment demands and a collapse Exacerbated Exacerbated “too-big-to-fail” mentality and moral “too-big-to-fail” mentality and moral

hazardhazard

Related-Party Transactions & Self-DealingRelated-Party Transactions & Self-Dealing


1313

Entered into risky automobile industry Entered into risky automobile industry Joint venture with GM; later bought GM stakeJoint venture with GM; later bought GM stake Acquired numerous other domestic and foreign Acquired numerous other domestic and foreign

automobile makers, e.g., Ssangyong Motorautomobile makers, e.g., Ssangyong Motor Employees were pressured to buy carsEmployees were pressured to buy cars Affiliates assumed most of the burdenAffiliates assumed most of the burden

Daewoo Motor, Ssangyong Motor, Daewoo Daewoo Motor, Ssangyong Motor, Daewoo Corp. and Daewoo Heavy Industries Corp. and Daewoo Heavy Industries accounted for close to 83% of the entire net accounted for close to 83% of the entire net debt of the conglomeratedebt of the conglomerate

DW Related-Party Transactions & Self-DealingDW Related-Party Transactions & Self-Dealing


1414

Moral hazardMoral hazard led to riskier ventures and led to riskier ventures and more improper actsmore improper acts Self-dealing for personal benefitsSelf-dealing for personal benefits Appointing unqualifiedAppointing unqualified relatives as executivesrelatives as executives Various forms of earnings managementVarious forms of earnings management

Kim and senior managers allegedly did not Kim and senior managers allegedly did not engage in direct self-dealingengage in direct self-dealing decisions were apparently carried out on behalf of decisions were apparently carried out on behalf of

the company, not for their own personal gainsthe company, not for their own personal gains unaccounted BFC fundsunaccounted BFC funds

Ultimately, accounting fraud and loan fraud Ultimately, accounting fraud and loan fraud represented another form of self-dealingrepresented another form of self-dealing

Related-Party Transactions & Self-DealingRelated-Party Transactions & Self-Dealing


1515

Unit: No. of, 100 million wonUnit: No. of, 100 million won

Source: FTCSource: FTC

GroupProvider

companiesSupportedcompanies

Amt oftransactions

Amount ofsupport

Subcharge

Daewoo 6 7 4,229 - 89

Average* 18.5 7 9,009 - 133.3

Daewoo 11 3 415 - 44.6

Average* 5.5 4.5 3,628 - 41.2

Daewoo 7 10 54,301 858 135

Average* 11.5 7 17,257 410.5 164.8

Jun-98

Jul-98

Jul-99

GroupProvider

companiesSupportedcompanies

Amt oftransactions

Amount ofsupport

Subcharge

Daewoo 6 7 4,229 - 89

Average* 18.5 7 9,009 - 133.3

Daewoo 11 3 415 - 44.6

Average* 5.5 4.5 3,628 - 41.2

Daewoo 7 10 54,301 858 135

Average* 11.5 7 17,257 410.5 164.8

Jun-98

Jul-98

Jul-99

Conglomerates: DaewooConglomerates: Daewoo

Improper Internal TradingImproper Internal Trading

1616

Internal and external corporate governance failed to Internal and external corporate governance failed to detect or prevent 22.9 trillion won in accounting detect or prevent 22.9 trillion won in accounting fraudfraud

Government tacitly condoned accounting opacityGovernment tacitly condoned accounting opacity

To attract foreign capital, inflation of financial To attract foreign capital, inflation of financial figures were deemed necessaryfigures were deemed necessary

State-controlled banks focused on the size of State-controlled banks focused on the size of revenues, sales volume and assets, rather than revenues, sales volume and assets, rather than profits and cash flowprofits and cash flow

Daewoo chose to overcome its financial difficulties Daewoo chose to overcome its financial difficulties through expansion, and with it, more deceitthrough expansion, and with it, more deceit With the financial crisis, the company could no longer With the financial crisis, the company could no longer

sustain accounting and loan fraudsustain accounting and loan fraud



1717

Source: Government Final Report, Sept. 15, 2000Source: Government Final Report, Sept. 15, 2000

Unit: trillion WonUnit: trillion Won

Company Figures Due Diligence

Daewoo Corp. 2.6 -17.4 20 14.6

Daewoo Motor 5.1 -6.1 11.2 3.2

Daewoo Heavy 3.1 1 2.1 2.1Daewoo

Electron. 0.7 -3 3.7 2Daewoo

Telecom 0.3 -0.9 1.2 0.6

Subtotal 11.8 -26.4 38.2 22.57 Other Daewoo

Affi liates 2.5 -2.2 4.7 0.4

Total 14.3 -28.6 42.9 22.9

CompaniesCapital (99.8)

I nitial FSC Report Final Gov’t Report

Company Figures Due Diligence

Daewoo Corp. 2.6 -17.4 20 14.6

Daewoo Motor 5.1 -6.1 11.2 3.2

Daewoo Heavy 3.1 1 2.1 2.1Daewoo

Electron. 0.7 -3 3.7 2Daewoo

Telecom 0.3 -0.9 1.2 0.6

Subtotal 11.8 -26.4 38.2 22.57 Other Daewoo

Affi liates 2.5 -2.2 4.7 0.4

Total 14.3 -28.6 42.9 22.9

CompaniesCapital (99.8)

I nitial FSC Report Final Gov’t Report

Accounting FraudAccounting Fraud


1818

Used affiliates and overseas BFC accounts to Used affiliates and overseas BFC accounts to reduce debts and manipulate export returnsreduce debts and manipulate export returns

BFC used for related paper companies to obtain BFC used for related paper companies to obtain fraudulent commercial invoices, bills of lading, fraudulent commercial invoices, bills of lading, and packing listsand packing lists

Asset swaps between sister companies at Asset swaps between sister companies at discounted or inflated valuesdiscounted or inflated values

15 trillion won in off-balance sheet liabilities15 trillion won in off-balance sheet liabilities 4 trillion won in non-performing loans4 trillion won in non-performing loans 3 trillion won in false inventories3 trillion won in false inventories 1 trillion won in false research and 1 trillion won in false research and

development expensesdevelopment expenses



1919

operated under state-supported debt operated under state-supported debt financing as part of the Industrial policyfinancing as part of the Industrial policy

top four chaebols debt-to-equity ratios top four chaebols debt-to-equity ratios exceeded 450% at the time of the exceeded 450% at the time of the financial crisis in December 1997financial crisis in December 1997

Daewoo‘s financial structure had several Daewoo‘s financial structure had several distinctive featuresdistinctive features Over-relied on debt gearingOver-relied on debt gearing Increased debt-to-equity ratio, not decreasedIncreased debt-to-equity ratio, not decreased Daewoo Corp. was not the main profit center Daewoo Corp. was not the main profit center

and could not provide financial support to and could not provide financial support to sustain weaker affiliatessustain weaker affiliates



2020

Debt/Equity Ratio of Top Four ChaebolsDebt/Equity Ratio of Top Four Chaebols

0

100

200

300

400

500

600

700

Dec 95

Dec 96

Dec 97

Dec 98

Jun 99

Dec 99

Hyundai

Daewoo

Samsung

LG


unit: %

2121

Due to the financial crisis, Daewoo Group Due to the financial crisis, Daewoo Group could no longer maintain financial could no longer maintain financial balancing actbalancing act Foreign debt jumped from Foreign debt jumped from

26.3 trillion won to 49 trillion won26.3 trillion won to 49 trillion won $5.1 billion in foreign currency loans; $5.1 billion in foreign currency loans;

$1.9 billion in foreign currency loans $1.9 billion in foreign currency loans to convertible bond ownersto convertible bond owners

Sudden increase in interest rates Sudden increase in interest rates led to financing costs jumping led to financing costs jumping from 3 trillion won from 3 trillion won to 6 trillion wonto 6 trillion won



2222

Daewoo Group’s Domestic BorrowingsDaewoo Group’s Domestic Borrowings

unit: billion won

Source: Korea Financial Supervisory CommisionSource: Korea Financial Supervisory Commision

0

5,000

10,000

15,000

20,000

25,000

Commercialbanks

Non-bankfinancial

institutions

Corporatenotes

Commercialpapers

Dec-97

Dec-98

J un-99


2323

Concentrated Decision MakingConcentrated Decision Making

Failure of OversightFailure of Oversight by by representative representative directors, boards of directors directors, boards of directors and statutory auditorsand statutory auditors

Shareholders & StakeholdersShareholders & Stakeholders

Concentrated Decision Making & Failure of OversightConcentrated Decision Making & Failure of Oversight

DaewooDaewoo

2424

Common attributes of large Asian Common attributes of large Asian conglomeratesconglomerates Management stylesManagement styles Business culturesBusiness cultures Business modelsBusiness models

Daewoo‘s success andDaewoo‘s success andfate is linked with fate is linked with its founder, its founder, Kim Woo-ChoongKim Woo-Choong

As chairman and controlling As chairman and controlling shareholder of the conglomerate, he shareholder of the conglomerate, he maintained total controlmaintained total control

Concentrated Decision-MakingConcentrated Decision-Making

2525

Dominated all major decision-Dominated all major decision-makingmaking International and domestic International and domestic

financingfinancing Appointment of all CEOs and board Appointment of all CEOs and board

members for all companiesmembers for all companies Business strategiesBusiness strategies Inter-company relationsInter-company relations Overseas operations controlOverseas operations control


2626

Decisive, vertical, efficient and speedy Decisive, vertical, efficient and speedy decision-makingdecision-making

Despite corporate governance breakdown, Despite corporate governance breakdown, Kim made examplary decisionsKim made examplary decisions Management succession Management succession no relatives no relatives Donated personal holdings in Daewoo Corp. to the Donated personal holdings in Daewoo Corp. to the

Daewoo FoundationDaewoo Foundation Sceptics claim that they served ulterior purposesSceptics claim that they served ulterior purposes

preempt political crackdown preempt political crackdown foundation acted as a shelter to minimise foundation acted as a shelter to minimise

personal inheritances taxespersonal inheritances taxes de facto holding company to help maintain de facto holding company to help maintain

controlcontrol


2727

Financial crisis exposed the Financial crisis exposed the weaknesses of concentrated weaknesses of concentrated governance structuregovernance structure

Structure played a critical role in Structure played a critical role in accounting and loan fraud and accounting and loan fraud and ultimately collapseultimately collapse


2828

insufficient check and balance and insufficient check and balance and ineffective internal control mechanismsineffective internal control mechanisms

failed as institutions to counterbalance failed as institutions to counterbalance controlling shareholders; instead controlling shareholders; instead succumbed to their dictates succumbed to their dictates

did not provide oversight and act as did not provide oversight and act as independent, front-line monitorsindependent, front-line monitors

disregarded their roles as fiduciaries disregarded their roles as fiduciaries directors and officers not legally directors and officers not legally

distinguished; internal & external auditorsdistinguished; internal & external auditors

Failure of OversightFailure of Oversight

Directors and Auditors Directors and Auditors

2929

no non-executive outside directors no non-executive outside directors until 1998; no audit committees until 1998; no audit committees 25% outside directors did not change 25% outside directors did not change

mattersmatters

colleagues of Kim‘s generation colleagues of Kim‘s generation Could advise and monitor decision-makingCould advise and monitor decision-making replaced by new executives who were replaced by new executives who were

unable to effectively counsel and confrontunable to effectively counsel and confront

failed to persuade chairman to pursue failed to persuade chairman to pursue a contraction-oriented policy and a contraction-oriented policy and prevent fraudprevent fraud



3030

only held accountable to controlling only held accountable to controlling

shareholder & conglomerateshareholder & conglomerate no labour market flexibility no labour market flexibility

remained captive to their conglomeratesremained captive to their conglomerates

insufficient outside scrutinyinsufficient outside scrutiny

for auditors only major clientfor auditors only major client

only after the collapse did they face civil only after the collapse did they face civil

and criminal liability; Chungun & Sandongand criminal liability; Chungun & Sandong



3131

YearTotal No.

of Policies

1996 1

1997 5

1998 105

1999 320

2000 101

2001 264

2002 386

2003 372

2004(est.) 500

YearTotal No.

of Policies

1996 1

1997 5

1998 105

1999 320

2000 101

2001 264

2002 386

2003 372

2004(est.) 500

Total No. of Policies

0

100

200

300

400

500

600

1996 1998 2000 2002 2004(est.)

Total No. of Policies

0

100

200

300

400

500

600

1996 1998 2000 2002 2004(est.)


Directors and Officer Liability Insurance Directors and Officer Liability Insurance

3232

passive in monitoring managementpassive in monitoring management did not question or challengedid not question or challenge did not seek information did not seek information did not attempt to get representation did not attempt to get representation

on the boardon the board did not attend AGM or votedid not attend AGM or vote failed to take any action, no matter failed to take any action, no matter

how dire the casehow dire the case


Shareholders and StakeholdersShareholders and Stakeholders

3333

weak shareholder rights; lack of weak shareholder rights; lack of awarenessawareness

investment on a short-term basisinvestment on a short-term basis difficult to obtain information due difficult to obtain information due

to weak disclosure standardsto weak disclosure standards absence of a class action vehicle absence of a class action vehicle

and obstacles to litigationand obstacles to litigation confined institutional investors to confined institutional investors to

shadow votingshadow voting ineffective proxy rulesineffective proxy rules



3434

Stakeholders such as creditors, Stakeholders such as creditors, employees, labor and consumers employees, labor and consumers failed to serve as checks and balancesfailed to serve as checks and balances

Employment stock ownership plans Employment stock ownership plans (ESOP) did not serve as monitoring (ESOP) did not serve as monitoring forces forces voting rights rarely exercisedvoting rights rarely exercised limited ownershiplimited ownership complicated proxy procedurescomplicated proxy procedures



3535

Strong sense of group loyalty & Strong sense of group loyalty & strong corporate culture against strong corporate culture against whistleblowers whistleblowers

Lack of access to information and Lack of access to information and little incentive to question the little incentive to question the decision-making of executivesdecision-making of executives

Rarely challenged questionable Rarely challenged questionable decision-making or contemplate decision-making or contemplate exposing wrongdoings exposing wrongdoings



3636

Business- Business- GovernmentGovernment RelationsRelations

OwnershipOwnership StructureStructure

Related-PartyRelated-Party TransactionsTransactions

FinancialFinancial StructureStructure

IneffectiveIneffectiveEnforcementEnforcement

Concentrated Concentrated DecisionDecisionMakingMaking

Lack of Lack of OversightOversight

ShareholdersShareholders& &

StakeholdersStakeholders

Daewoo’sDaewoo’s FallFall

ConclusionConclusion

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