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Vicious South Korean family feud exposes chaebol peril

Shin Dong-Bin speaks with the media in Seoul on August 3, 2015
Chung Sung-Jun - Getty Images

It's a saga that could belong on daytime television: a wealthy family fighting for control of a huge corporation, complete with betrayal, disinheritances and allegations of impaired judgment.

Unfortunately for the Lotte Group, this is no tele-drama. The company—South Korea's largest retailer—is embroiled in an intricate succession battle that exemplifies the pitfalls of the country's family-run conglomerates, known as chaebols.

Lotte was founded by 93-year-old Shin Kyuk-ho and its businesses span retail, hotels and chemicals in South Korea and Japan. Now, Kyuk-ho's sons are engaged in a high-profile spat over control of Lotte Holdings, the holding company behind Lotte Group and key to the corporate empire.

A brief re-cap

The fight began on July 27 when the younger son, 60-year old Shin Dong-bin, chairman of Lotte Group and chief executive of Lotte Holdings, was reportedly dismissed by his father. Dong-bin held an emergency meeting the next day at which he sacked his father as general chairman of Lotte Holdings in a boardroom coup and kept both his executive titles.

That angered Dong-bin's elder brother, who called the actions "illegitimate." On July 29, 61-year old Shin Dong-joo produced a document signed by their father that confirmed Dong-bin's firing and proclaimed Dong-joo as head of Lotte Holdings.

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Dong-joo himself was fired from the holding firm back in January.

Dong-bin quickly denounced the document, saying it wasn't legally binding. However, Dong-joo's claims are supported by his father, who said over the weekend that he never appointed Dong-bin as heir. The 93-year old founder also apologized profusely for Lotte's current "pitiable situation."

The public apology ties in with the high-profile nature of the dispute, which has seen the warring family publicly slam each other in the media.

Dong-bin questioned Kyuk-ho's mental capacity, saying the aged founder has "difficulties making judgments," while Dong-joo accused his brother of feeding their father "distorted information."

This week, Dong-bin told Reuters that Lotte Holdings was debating when to hold a shareholder meeting that could finally decide who will reign over the business empire. According to a Lotte Group spokesman, the conglomerate could never be split between the two brothers, Reuters added.

Reputation aside, the controversy has also weighed on Lotte share prices. Over the past seven days, Lotte Shopping has sank over 8 percent while Lotte Chemical and Lotte HiMart are down 4 and 2.7 percent, respectively.

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The group has not yet responded to CNBC's request for comment.

The bigger issues

The nasty succession battle exemplifies the opaque nature of chaebols, experts say.

"At times like this, it's of paramount importance to have transparent rules and procedures and rational norms of succession. In that sense, the perceptions and actions of the chaebol families are astonishingly out of touch," noted a recent editorial in daily newspaper The Hankyoreh.

Families running chaebols control a vast network of companies through a circular holding structure and their control rights typically exceed cash-flow rights, giving them the final say on corporate decisions. Negative consequences of the system include mandatory support of distressed subsidiary firms, excessive concentration of power within a small group and inheritance of the controlling shareholder position by heirs that may not be qualified to effectively shape a company's future.

Other well-known chaebols include Hyundai, Daewoo and LG.

Asia's fourth-largest economy is no stranger to controversial family dynasties. In July, Samsung C&T and Cheil Industries agreed on a deal that would consolidate the Lee family's power over Samsung Electronics, sparking the ire of activist shareholder Paul Singer, CEO of U.S. hedge fund Elliott Associates, who said the deal undervalued Samsung C&T while overvaluing Cheil.

Read More Investors approve fraught Samsung C&T-Cheil deal

The chaebol structure also has a broader economic impact.

The tight control exercised by family owners is a hindrance to the liberalization of South Korea's services sector, which should be the economy's next leg of growth, Barclays economist Wai Ho Leung told CNBC, adding that the entire sector remains insular and domestic-oriented.

An editorial in The Korea Times on Tuesday said the Lotte scandal offered South Korean President Park Geun-hye the perfect chance to toughen corporate laws, including replacing owners' arbitrary decisions with legal institutions and setting stricter limits on cross-shareholding.

"At stake is not the image and performance of a single group, but the reputation of entire Korea Inc. That is why the ongoing succession scandal can be a blessing in disguise―depending on how Seoul deals with it."

However, no major changes are expected.

"There has been talk that the Samsung C&T and Cheil Industries deal would push people to think that chaebols shouldn't have such a big hold, but I don't see it easing unless the government needs to break them up for various reasons, which may happen in future," Port Shelter Investment chief executive Richard Harris told CNBC in July.

"Investors know that and will continue to consider it when investing in South Korea."