Introducing Transparency in Corporate Groups : Korean Context

1. OECD/KDI Conference Corporate Governance in Asia Introducing Transparency in Corporate Groups : Korean Context Panel Discussion by Il-Sup Kim

2. Background Thirty largest business groups (called “Chaebol” or “Group”) occupy 13% of GNP in 1997 - Combined Revenue : :401 trillion (U.S.$321 billion) - Combined Assets : 421 “ ( “ 337 “ ) - Combined Net Loss : 3 “ ( “ 3 “ ) - Combined Value Added : 54 “ ( “ 43 “ ) Chairman of the Group traditionally dominated management, board of directors and shareholders’ meeting Growing criticism over excessive concentration of economic and management power by the Group chairman Corporate governance issue first raised in 1995 by Committee on Globalization Policy, followed by policy measures on governance practice of the Group in 1996 2

3. Background , Continued Commitments by Korean government with IMF and World Bank to improve corporate governance - Reduction of guarantees of payment between member companies of the Groups - Upgrading financial accounting standards and disclosure requirements to be consistent with international accounting standards - Release of combined financial statements of the Groups - Outside directors mandatory for public companies - External auditor selection committee mandatory for public and the Group companies - Only internationally recognized accounting firms may audit large financial institutions - Mark-to-market accounting for all financial institutions D. J. Kim’s government reform agenda of the large Groups - Accelerated implementation of combined financial statements - Prohibition of cross guarantees of payment - Accelerated business restructuring - Improvement of corporate governance and transparency in management 3

4. Criticism Over Governance Practice of the Groups Expropriations by controlling shareholders Lack of creditors’ and minority shareholders’ influence over corporate governance Misappropriation of funds Lack of legal liability by Group chairman and his/her staff Lack of transparency in management and external monitoring function Lack of external discipline over mismanagement Succession of management rights 4

5. Transparency Issues in Korea No genuine demand for transparency under Korean social and business environment, and current ownership and management structure External auditors are frequently under influence of controlling shareholder Financial accounting standards lack rigorous interpretation Supervisory authorities often revised accounting rules for benefit of financial service industry Korean accounting standards deviated from internationally accepted accounting standards Lack of reliance on financial statements by financial institutions who based lending decisions more on collateral and guarantee of payment than analysis of financial information Lack of interest in internal control structure and risk management 5

6. Recent Development Minority shareholders with more than 0.01% ownership are allowed to file derivative suit Minority shareholders are entitled to propose items on the agenda at the general shareholders’ meetings Beginning in 1999, public companies are requested to fill at least one quarter of the board of directors with outside directors Public companies with assets of 100 billion Won or more are required to appoint at least one full time statutory auditor Korea’s financial accounting standards have been amended to be substantially consistent with international accounting standards, effective January 1, 1999 Thirty largest business Groups are to file the audited combined financial statements from the fiscal year ending December 31, 1999 6

7. Recent Development , Continued Financial accounting standards for financial service industry have been fully upgraded to be consistent with international best practices, effective January 1, 1999 Poor performance of audit is to be subject to increased review and heavier sanctions MOFE/World Bank funded studies are underway - Improvement of auditing profession - Strengthening regulation and discipline over audit market - Enhancing the role of the Korean Institute of CPAs - Introduction of audit committee - Establishment of independent standards-setting organization (KASB) 7

8. Combined Financial Statements Required of 30 largest Groups Pro forma financial statements Based on management control as defined under the Monopoly Regulation and Fair Trade Act Eliminate inter-company transactions and substantially identical to consolidated financial statements, except that minority interest is not identified Disclosure of inter-company transactions, financial information of individual companies and segment information Will lose ground when guarantees between member companies are eliminated 8

9. Suggestions Anti-corruption legislation should be strengthened Transactions with related parties should be strictly regulated, monitored and disclosed Internal control structure, internal monitoring system and risk management system should be strengthened for public companies and Group companies Independence and professionalism of statutory auditors should be secured. Institutional investors should be more active at the shareholders’ meeting 9

10. Suggestions , Continued Role and independence of external auditors should be improved - Auditor change should be closely monitored and disclosed - Review of the audit quality should be reinforced - Heavier sanction on audit failure - Higher audit fee should be allowed - Ethical standards and enforcement thereof should be strengthened - Reform of self-regulating organization - Introduction of audit committee should be considered Private independent standards-setting organization, e.g. Korean Accounting Standards Board, should be established 10

11. Challenges Ahead Role and power of outside directors Attitude of government and political circle Social culture respecting relationship Enforcement of ethical rules Discipline of capital and financial market Protection of whistle blowers Self-regulating ability of auditing profession 11