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Profile of Director: The Case of Korea

Profile of Director: The Case of Korea. 3 rd Asian Roundtable on Corporate Governance OECD The Role of Boards and Stakeholders in Corporate Governance 4-6 April, 2001 Singapore Hasung Jang Korea University / PSPD Phone: 82-2-3290-1929 Fax:82-2-929-3405 Email: jangya@chollian.net.

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Profile of Director: The Case of Korea

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  1. Profile of Director:The Case of Korea 3rd Asian Roundtable on Corporate Governance OECD The Role of Boards and Stakeholders in Corporate Governance 4-6 April, 2001 Singapore Hasung Jang Korea University / PSPD Phone: 82-2-3290-1929 Fax:82-2-929-3405 Email: jangya@chollian.net

  2. New Regulation on Board Composition • Outside Director • All public company’s board should be comprised at least 25% outside directors • Financial Institutions & public companies with assets over 2 tr won, at least 50% outside director • Outside Director Nomination Committee • Mandatory for public companies with assets over 2 tr won and security brokerage companies.

  3. New Regulation on Board Composition • Audit Committee • Public company with asset larger than 2 tr won ($1.7bil) • 2/3 of the committee should be outside directors • 3% voting right limit for election of committee member (2001) • Cumulative Voting System • Opt-out system

  4. New Regulation on Director • Fiduciary Duty of Directors • Explicitly Stated in Commercial Code • Shadow Director’s Liability • Controlling Shareholder’s Liability Acknowledged • Minority Shareholder Rights Strengthened 1997 1998 2001 Filing Derivative Suit 1 % 0.01% 0.005% Requesting Termination 1% 0.5% 0.25% of Directors and Auditors

  5. Qualification of Outside Director • Security Exchange Code Defines Negative List • List is to Preclude Individuals Who have Direct Conflict of Interest. • Person who has a “special” relationship with the largest shareholder • Major shareholder of the company or that person’s spouse or lineal ascendant or descendant

  6. Qualification of Outside Director • Person who is an executive or full-time employee of the company or any of its affiliated companies or who was one for any of these companies within the preceding two years • Spouse or lineal ascendant or descendant of an officer or director of the company • Officer, director or full-time employee of a company that has an “important business relationship,” or who was one for any of these companies within the preceding two years

  7. Qualification of Outside Director • Officer, director or full-time employee of a company in which an officer, director or employee of the concerned company is a non-standing director • More challenging question is whether similar qualification should also be established for inside directors who has more of interest conflicts than outside directors

  8. Composition of Board 1998 1999 2000 Number of Company (736) (701) (693) Executive Directors 5,857 4,850 4,601 (88.6%) (75.2%) (69.2%) Outside Directors 669 1,204 1,418 (11.4%) (24.8%) (30.8%) Auditors 1,059 1,016 795 (89.7%) (87.9%) (90.3%) Outside Auditors 109 123 77 (10.3%) (12.1%) (9.7%)

  9. Composition of Board

  10. Persistent Problems with the Board • Self Dealing of Directors • Fiduciary duty not enforced • More interest conflict than outside directors • Entrenchment of Management through Affiliates’ Ownership • Controlling shareholder own less than 4% • Equity investment into affiliates increased substantially

  11. Persistent Problems with the Board • Cumulative Voting Opted Out • Top 30 Chaebols : 92% excluded • Non Chaebols: 76% excluded • Independence of Outside Director in Question • Majority are chosen by controlling shareholder & Mgt. • Rubber Stamping • Poor Attendance

  12. Persistent Problems with the Board • Attendance Rate of Outside Directors 1st Half 1999 2nd Half 1999 1st Half 2000 43.9% 47.7% 53.5% • Who Selected Outside Director? 1999 2000 Controlling Shareholder 41.8% 39.9% Management 46.4% 39.9% Creditor Banks 5.1% 4.5% Others 6.7% 15.7%

  13. Attendance of Board MeetingsSamsung Electronics Co. 1998 1999 2000 Number of Meetings 11 13 11 KH Lee Chairman 0 0 0 HS Lee Chairman’s Secretary 0 0 8 IJ Kim Chairman’s Secretary - 2 10 JY Yoon CEO 9 12 11 DS Choi CFO 11 13 11 SH Lee Director - - 5 KT Lee Director - - 6 SR Lim Outside Director 5 10 9 F Hirlinger Outside Director 7 9 7 Iwasaki Outside Director - - 6

  14. Obstacle on Independent Board • Concentrated Ownership Structure • Circular Equity Ownership • Pyramidal Equity Ownership • Passive Local Institutional Shareholder • Investment Institutions are owned by chaebols • “Corporate Account” in Investment Institutions • Complex and Costly Proxy Procedure • Election of outside director is practically impossible

  15. Case: Election of Outside Director • Case 1: Samsung Electronics Co. • Minority shareholders propose outside director candidate, but failed in proxy contest • 16% of supports mostly from foreign institutions • Could have been successful if cumulative voting • Case 2: SK Telecom, Hyundai Heavy Ind. • Elected 2 outside director at SKT, 1 at HHI • Cooperation from management and major foreign shareholders

  16. Management Entrenchment through Ownership by Affiliates Top 10 Chaebols: Listed Companies

  17. Circular Equity Ownership: Hyundai Group Kia Motors H Securities H. Precision Hyundai Co. H Elevator H. Motors H. Heavy Ind H Shipping Mipo Shipyard H Financing Ulsan Merchant Bank H Construction H. Steel Pipe Inchon Steel H Electronics

  18. Pyramidal Equity Ownership: Samsung Group Samsung Elec Samsung Corp Samsung Life Cheil Comm. Samsung Heavy Ind. Samsung Foudation Samsung Mech. Elec Samsung SDI Samsung Security Samsung Everland Hotel Shilla Samsung Card Samsung F&M Ins Samsung Engineering Samsung Techwin Samsung Prec.Chem Samsung Capital Cheil Textile

  19. Case: Election of Outside Director • Case 1: Samsung Electronics Co. • Minority shareholders propose outside director candidate, but failed in proxy contest • 16% of supports mostly from foreign institutions • Could have been successful if cumulative voting • Case 2: SK Telecom Hyundai Heavy Ind. • Elected 2 outside directors at SKT, 1 at HHI • Cooperation from management and major foreign shareholders

  20. Independence of Outside Director in Question • Case 1: Samsung Electronics Co. • Board Approved Debt Guarantee of Chairman Lee’s Personal Liability • Case 2: Samsung SDI • Board Approved Purchase of Shares of a Private Company Owned by Chairman’s Son • Case 3: Hyundai Heavy Industry • Board Filed Law Suit against Affiliated Companied to Recover Loss

  21. Case 1: Board Approve Debt Guarantee of Chairman's Liability Creditor Banks Default Loan $2.5 BIl Samsung Motor Samsung Electronics Collateral Samsung Life Ins. Debt Guarantee Loss $1.7 bil at $200/Sh Samsung SDI 4 mil Shares at $635/Sh Samsung Mech. Elec. Penalty Interest $487/year Chairman KH Lee Samsung etc.

  22. Case 2: Board Approve Purchase of Shares Owned by Chairman's Son • Samsung SDI • Board Approved Unanimously • Purchase Amount: 3.6 bil won ($2.8 m) • 3 Days Share Value Loss: 444.1 bil won ($341.6m) • Market adjusted price change: -14.7% • Cheil Communication Co. • Purchase Amount: 20.8 bil won ($16.1m) • 3 Days Share Value Loss: 76.2 bil won ($58.6m) • Market adjusted price change: -16.3%

  23. Case 2: Negative Effect on Share Price

  24. Case 3: Board Acting Independently from the Group Affiliation Hyundai Electronics $200Mil Hynudai Securities Debt Guarantee CIBC Law Suit! $200Mil Debt Guarantee Debt Guarantee Hyundai Heavy Ind.

  25. Case 3: Positive Effect on Share PriceBoard Acting Independently • Hyundai Heavy Industry Board Acting Independently • Hyundai Motors Co. Separated from the Group KOSPI HMC HHI HCE HEI Jan 4: 100.0 100.0 100.0 100.0 100.0 Mar 14: Family Feud Started 79.9 83.2 62.6 76.5 65.5 May 31: HMC Revolt 69.1 48.5 58.5 68.4 54.9 July 28: HHI Law Suit 65.4 46.7 67.4 43.7 65.4 Aug 31: HMC Separated 65.0 50.6 81.2 78.8 47.8 Oct 31: 48.6 45.6 62.8 27.2 22.0 Jan 31: 58.4 60.7 74.2 22.7 42.2 Mar 16: 50.9 61.6 81.4 12.2 25.5

  26. Case 3: Positive Effect on Share Price Family Feud Started HMC Separation HHI Law Suit

  27. Possible Solutions • Cumulative Voting • It should be mandatory for countries where ownership is concentrated • Only way to elect independent director of minority shareholders’ choice • Ownership Diversification • Stricter Listing Requirements on Ownership Diversification

  28. Possible Solutions • Increasing Liability of Directors • Derivative suit should be allowed for any shareholder • Security class action suit should be allowed • Independence of Executive Director • Independence qualification of executive director should be defined similar to one of outside director • Independence from controlling shareholders

  29. Possible Solutions • Director’s Term Should be Shortened • One/Two year term: Re-election every year • All Directors’ term should expire at the same time • Incentive Compensation • Stock option to directors • Compensation committee solely by outside directors

  30. Possible Solutions • Pro-Active Role of Institutional Shareholder • Independence of local institutions • Corporate finance section should be separated by “Chinese Wall” from equity investment section • Active involvement of public pension fund • Pro-active voice from foreign shareholders • Rule of “Sell it if you do not like management” does not work in emerging markets

  31. Possible Solutions • Market for Outside Directors • Education for Directors • Assignment system from the “certified pool” • Separation of Ownership of “Financial Institution” from Ownership of “Industrial Company”

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