Complex Mega-Companies Dominate South Korea's Stock Market
South Korea’s economy and its stock market are dominated by dozens of financially complex, family-run multinational conglomerates that have been central to the nation's rise on the global stage.
These enormous companies have incubated global brands such as Samsung Electronics, Hyundai Motor, and LG Electronics.
But some view “chaebols,” as they are known in Korea, as squelching competition, currying government favor and engaging in secretive “interior” transactions that tend to benefit family members over shareholders.
The Korean government has gone back and forth between tightening and loosening regulations on chaebols over the years, and the trend now is toward tightening. The conglomerates are increasingly being reined in with new laws and taxes that seek to hold family members accountable, and to increase the transparency of these behemoth corporations.
How far these laws will go — with a presidential election coming in December — remains to be seen, says Shaun Cochran, head of research for Korea at CLSA Asia Pacific Markets.
“Things will probably get better, but the chaebol will fight tooth and nail to maintain their position,” Cochran says. “It pays to be skeptical.”
What Is a “Chaebol”?
Chaebols grew to power beginning in the 1960s, as the government encouraged companies to boost exports to lift the Korean economy. Government support came in the form of loans, guarantees and tax breaks that allowed many of these companies to grow and enter more and more export markets, in a formula that brought Korea out of poverty.
But overexpansion and a heavy reliance on debt caused many chaebols to weaken and in many cases go bankrupt in the Asian Financial Crisis of 1997.
“When the music stopped in ‘97 and ‘98, a lot of these chaebols were left looking exposed,” says Edmund Harriss, manager of Guinness Atkinson Asia Focus. “They massively expanded their range of businesses, and expanded capacity, and then (they) hit the buses.”
The ones left standing thinned their debt burdens and focused on improving the quality of their products, and today, dozens of chaebols still exist.
These conglomerates are complex businesses that often have circular ownership structures, in which a family member owns a stake in a company within the group, and that company in turn owns a stake in another company within the group, and so on in links that return to the original company.
One problem is chaebols dominate their industries, leaving little room for competition. They are often supported with components made by small- and medium-sized enterprises. But these smaller companies fly under the radar, are often unlisted, and rarely gain a foothold beyond their small market because of the power and influence of the chaebols — despite the fact they employ a sizable amount of the Korean workforce, analysts say.
Another concern for investors, who can have a difficult time figuring out the financials behind some of the listed companies in the chaebols (see story on investing in South Korea’s market.) But many investors have also found the major chaebols to be attractive investments.
“Some of the groups have proven themselves to be well managed, and a number of the underlying listed companies have generated fantastic returns in recent years – especially with the Samsung and Hyundai groups,” says Nick Beecroft, Asia portfolio specialist at T. Rowe Price.
Tightening Laws and Regulations
Despite the chaebols' dominance and influence, they are increasingly coming under pressure from new laws and regulations designed to increase financial transparency and accountability of family members.
For instance, the government recently enacted a “deemed inheritance tax,” so that family members can’t get around South Korea’s inheritance tax laws, and has revised commercial laws to tighten requirements for reporting internal transactions, according to analysts.
These changes are already increasing transparency. Michael Oh, portfolio manager of Matthews Korea Investors, notes that more chaebols have appointed boards of directors, and the government has made it easier for them to restructure into holding companies. Also, Korea was one of the first Asian countries to adopt the International Financial Reporting Standard, creating more transparency for investors.
“In the past, Korean chaebols did not really care too much about minority shareholder rights, but I think now, at least a few progressive chaebols are taking several steps toward reducing cross ownership of different companies and improving transparency of capital allocation within the group,” says Ashish Swarup, manager of Fidelity Investment’s Emerging Markets Discover Fund.
Also, Beecroft at T. Rowe Price notes that generational changes within a number of these groups “may well result in changes to group structure or new companies to invest in over time.”