Chaebol

Know this topic well? Help others and get FREE products!

A chaebol is a type of Korean conglomerate, similar to the prewar zaibatsu of Japan, which has multiplied in the Republic of Korea (South Korea) since the 1960s. A chaebol may be defined as "a diversified business group which is exclusively owned and controlled by a person and that person's family" (Kang 1997: 31). Its two major characteristics are that it is a business group that is owned and governed by the dominant shareholder and his family (a divergence from the legal definition of a chaebol—according to the Fair Trade Law of Korea—as a large-scale business group), and that it is a diversified business group with coverage extending from manufacturing to services, and from small retailers to multinational corporations.

The fact that it is family-owned, however, constitutes a major difference between the Korean chaebol and the prewar Japanese zaibatsu. The Japanese zaibatsu "family" was not always made up of blood relatives. An excellent manager could belong to the "family" in Japan, but not in Korea. The ownership of currently existing corporate groups in Japan has been diversified to their affiliates, main banks, and the public. To make another comparison, in the United States in the 1960s, conglomerates were diversified in business and assets, but not necessarily owned by dominant families.

Thirty chaebol are famous: their names are announced officially as the thirty largest business groups on the first of April every year. In 1998 they accounted for 46 percent of total sales in the manufacturing sector, 24.1 percent of value added (comprised of wages, cost of borrowing, rent, depreciation, and net profit before corporate tax), and 12.9 percent of employment in the same manufacturing sector.

Chaebol have been the leading force in Korean economic development. At the same time, however, they are the target of strong and widespread criticism. That is, the chaebol are successful but are not necessarily fair competitors.

Historically, the chaebol have grown under a government-led development strategy. The South Korean government selected as "national champions" certain companies in the major industries during the first Five Year Economic Development Plan in the early 1960s, and subsidized them through financial aid, tax exemptions, suppression of the labor movement, and so forth. The firms singled out by the government received enormous economic benefits and were able to rise to a level of international competitiveness.

With their information-gathering and lobbying power, the chaebol leadership could influence government officials to approve policy loans, which were obtained by forcing the banks to follow government policy. The chaebol thus were able to borrow continuously under favorable conditions, based not on the soundness of their operations but on their lobbying power. In addition, the chaebol got special tax exemptions.

This unhealthy development policy eventually drove the Korean economy to the financial crisis of 1997. In November 1997, bad loans held by Korean banks comprised about 15 percent (32.2 trillion won) of their total loans, while the corresponding figure for advanced countries is generally less than 1 percent. Most of these nonperforming loans had been granted to the thirty largest chaebol.

The Korean chaebol have diversified through various related and unrelated fields of business including electronics, the automotive sector, heavy industry, textiles and garments, petrochemicals, banking, information, and telecommunications. Often depicted as an octopus, the typical chaebol has grown many different business legs in order to diversify its operations and thereby minimize its risks so as to secure financing at low interest rates.

Two strategies were used by the chaebol to facilitate their rapid expansion: mutual loan guarantees between related companies within the same chaebol, and cross investments between the affiliated companies of one chaebol. These strategies allowed the chaebol to increase their leverage while maintaining the unity of their corporate governance.

While the chaebol have helped Korea attain rapid economic growth and are the manufacturers of world-renowned brand names, they have also become an obstacle to further economic development. First, the chaebol have hindered and distorted efficient market development through their wielding of both market and nonmarket power. This has allowed them to block the normal development of small and medium-sized industries, due to unfair distribution of resources and entry barriers. Second, they hinder smooth industrial development in this time of transition from traditional to information- and communication-based industries. The problem is that the chaebol still operate via traditional mass-production systems for standardized products, using unskilled or semi-skilled laborers. Third, the development of the financial industry itself has been stunted because capital from the financial institutions is concentrated in chaebol loans—as shown by the large number of nonperforming loans. Fourth, the chaebol have distorted the distribution of income and assets.

In response to the 1997 financial crisis, the Korean government has carried out reforms of banks and corporations. The chaebol reforms include enhancing transparent business management through the early introduction of consolidated financial statements, banning the system of cross guarantees between individual subsidiaries of a business group, defining core sectors and cooperation with small and medium-sized firms, making majority shareholders and management more accountable for their actions, banning chaebol dominance of nonbanking financial institutions, prohibiting mutual investments between subsidiaries, and banning illegal hereditary transfer of chaebol ownership.

Some of the reforms have shown good results, but others have yet to bear fruit. By the end of 1999, the chaebol had eliminated almost all mutual loan guarantees between affiliates—loans which for the top thirty business groups amounted to four times their own capital in 1997. The average debt/equity ratio of the top five groups, excluding Daewoo, fell from 386 percent in 1998 to less than 200 percent by the end of 1999. By June 1999, the top thirty chaebol had spun off 484 firms; this has helped them focus on their core competencies and has enhanced their competitiveness.

Reform of the corporate governance structure is still incomplete. Until transparent corporate governance systems are set up, chaebol reform cannot be termed a success. Until recently, the corporate governance structure of a chaebol was centered in the owner and the chaebol subsidiaries, whose average combined shareholdings reached 50.5 percent in 1999 but declined to 44 percent in 2000. The chaebol head dominated decision making, a practice that is criticized because of the consequent lack of surveillance, supervision, and accountability.

Since the foreign exchange crisis of 1997, the Korean chaebol have begun to change their corporate structures (e.g., by establishing protections for minor shareholders and by allowing directors from outside the firm) including their governance, though management is still dominated by the owner-manager head.

In the twenty-first century, the new model for corporate governance ought to ensure proper surveillance from both inside and outside the firm. The decisionmaking power should be shifted from the dominant family to a board of directors that represents the greater number of shareholders. A 1999 law required that companies whose assets are more than two trillion Korean won must nominate directors from outside the firm for more than half the total board members. In addition, the group-suit system will be legalized in 2002. Along with these reforms bank management should be allowed to be independent from government manipulation. One important reform will be to shift the chaebol's traditional group management system to an independent management system, as the group system is contrary to fair market competition.

Korea will probably choose to replace its rent-seeking model with the market-based corporate governance model that is popular in Western countries such as the United States and the United Kingdom, where household and institutional investors are the main shareholders: they empower the board of directors, which in turn supervises management and hires and fires the CEO. This is the desirable and expected direction of chaebol reform in the twenty-first century.

Kang, Chul-Kyu. (1997) "Diversification Process and the Ownership Structure of Samsung Chaebol." In Beyond The Firm, edited by Takao Shiba and Masahiro Shimotani. New York: Oxford University Press.

——. (1999) Chaebol gaehyuk ui kyongjehak (The Economics of Chaebol Reform). Seoul: Dasan.

Kang, Chul-Kyu, Chi-Sang Chang, and Jong-Pyo Choi. (1991) Chaebol: seongjang ui juyeok in ga tamyok ui hwasin inga? (Chaebol: The Leading Actors of Growth or the Incarnation of Avarice?). Seoul: Bibong.

Kim, Dae-Hwan, and Kyun Kim, eds. (1999) Hanhuk chaebol gaehyuk ron (Studies of Korean Chaebol Reform). Seoul: Nanam.

Kim, Seok Ki. (1987) "Business Concentration and Government Policy: A Study of the Phenomenon of Business Groups in Korea, 1945–85." D.B.A. diss. Harvard University.

This is the complete article, containing 1,418 words (approx. 5 pages at 300 words per page).