Marketwatch

Bad dynasties
By the time Families In Business readers receive this issue of the magazine, second generation family owner of Korea's SK Global, Chey Tae Won, will be four months through a three-year jail term he received in June for serious accounting fraud. His actions prompted a new probe by Korea's Fair Trade Commission (FTC) into the country's top six "chaebol", family-owned dynasties, including LG Group and Samsung.

The charge highlighted a common practice within chaebol culture and its effects. Last March, Chey – nephew of SK Global's founder Jong-kun Chey and son-in-law of the former Korean president, Roh Tae-Woo – tried to increase his management weight at SK Global by swapping shares between SK affiliates. Computer software company SK C&C bought a stake in Seoul's Sheraton Walker Hill hotel from Chey, who in return bought a 5.1% interest in SK's oil refinery SK Corp from SK C&C. Chey became the refinery's biggest shareholder, and through the refinery's stake in the conglomerate's telecommunications arm SK Telecom, became its majority control stakeholder. He also tried to buy out JP Morgan Chase & Co's shares in SK's brokerage company, SK Securities, by channeling funds from other SK affiliates. Nine other SK Global executives received suspended sentences for their part.

In July, SK Global's US arm filed for bankruptcy protection, while its domestic creditors sought to have its trading business liquidated for the recovery of some Won1.8 trillion (€1.3 billion) in debt. In the same month, against strong criticism, SK Telecom announced that it had purchased SK Corporation's entire 2.7% holding in US steel manufacturer POSCO, for Won332.5 billion (€245.8 million).

SK's fall is the latest in a line of chaebol failures, highlighting the effects of deep-rooted bad practice within Korean dynasties.

As FIB went to press, it was reported that Chung Mong-Hu, chairman of Hyundai's investment arm Hyandai Asan and fifth son of founder Chung Ju-Young, died after falling from the 12th floor of the company's Seoul headquarters, in an apparent suicide. He was indicted in June on false accounting charges and faced a prison term. Koreans remember all too well the 'Hyundai crisis' in the same year, when the old family business chestnut –  succession – led to patriarch Chung Ju-Yung resigning and calling for his two eldest sons to follow suit. Hyundai survived after it was broken up and outside management were brought in.

The sale of collapsed Hanbo Steel in 1997 to POSCO heralded the trend, followed by Daewoo in 2000, having succumbed to some Won15 trillion (€1.1 billion) in debt.

Failure and reform
The first key to chaebol failure is bad governance, a product of protectionism. Most chaebol buoy up to 50 loss-making affiliate companies with small family shareholdings, purchased with money from healthier parts of the business – or in share swaps from those healthy parts – solely to maintain power over the whole dynasty.

Secondly, due to a lack of resources when the Korean financial market was established – less than 50 years ago – chaebol were built on credit, provided by Korean banks. They grew quickly from small family shops to pillars of world industry, but failed to repay their credit, leading to the bankruptcies of several lenders. Both the value and the reputation of the nascent Korean economy were seriously eroded because of this, and Korean stocks are now among the lowest valued in the world – known as the 'Korea Discount'.

"Because of the actions of these groups, the Korean economy is recognised by outside investors with more negativity than it deserves," one Seoul-based economist at a leading auditor, who declined to be named, told FIB. "However, most chaebol are collapsed, so in Korea we don't take them that seriously anymore."

Plans to reform chaebol culture have not been taken seriously either. In 1998, the Korean Financial Supervisory Commission unveiled a three-year plan to stop chaebol using intra-group transactions, and get them to focus on a maximum four core businesses, disposing of the remaining affiliates. Progress slowed with the 1999 economic recovery, and chaebol continued almost undisturbed.

Many explain the lack of true government will for reform on the retaliatory power of the chaebol, based in their political clout and contribution to the labour market.

"The key barrier to reform is economic nationalism," says Morgan Stanley's Chief Economist of Non-Japan Asia, Andy Xie. "Families of value-destroying chaebol hide behind nationalism to assert their control over businesses they can't run properly. The chaebol are run like ancient tribes to maximise political power for the leading families, rather than as normal businesses to maximise profits. But the government must be mindful of the economic impact if the chaebol take action to punish it."

Despite this, is the new FTC probe evidence that the Korean government has taken heed of the warning in SK Global's collapse? Morgan Stanley's Xie is doubtful. "Until the next crisis, the chaebol are pretty safe," he concedes. "Chances are, Chey is running his empire inside jail over a mobile phone."