SEOUL, January 21 (AJP) - Korea’s reputation as a developed country took a big hit with the ongoing crisis over President Yoon Suk Yeol’s martial law bid.
Not only did it raise questions internationally about political stability, but it has also led business people to worry whether the legal system works to the level expected of a developed country.
It is no surprise then that foreign investors have been withdrawing from the market and that the value of the won has dropped dramatically.
The timing of all this could not have been worse. In the wake of the presidential election in the United States, Korean markets were already reeling because Donald Trump’s “America First” policies caused concern for Korea’s export-led economy. Yoon’s failed martial law bid has made it a double-whammy.
It is unclear at this point how the impeachment saga will end, but at least Korea is not powerless in the face of Trump’s “America First” stance. It holds its own “trump card” because the U.S. needs short-term help in several areas, most notably shipbuilding and semiconductors, and Korean companies have also actively invested in U.S.-based production.
Ultimately, however, Korea’s solution lies in answer to the question, “is the country ready to truly move on to the next level in terms of both political and business culture?” If not, will it continue pushing mediocre reforms that look good superficially but do not really change underlying core issues?
With the necessary holistic approach, I would argue that Korea Inc. actually has considerable further growth potential. This relates both to corporate governance across companies of all sizes, as well as the untapped potential of small and medium-sized companies (SMEs) – particularly those tech-centered, globally scalable SMEs that are typically financed by venture capital.
Time to outgrow the miracle model
As we all know, Korea’s post-war expansion was so staggering that it is widely referred to as miraculous. Some might claim now that this growth potential has peaked. I beg to differ, for reasons that should be evident. For example, while chaebol dominate the corporate landscape, they stifle the productivity and innovation of SMEs, which account for 99% of the country’s enterprises and hire 83% of its workforce. This is a huge resource pool that currently performs below its full potential.
While large corporations have built a strong global position, the majority of SMEs are still local and suffer from poor productivity (estimated at about 60% of the OECD average).
Over the past decade, since my company started partnering with Korean firms to foster growth, I have seen how the model that used to drive Korea’s miraculous growth no longer does so. The family-run conglomerate model has become entwined with cross-ownership, which has handed corporate decision-making power to a small group of people even though they are not majority shareholders. This is part of what drives the “Korea discount”. So, while there is a lot of room for improvement among SMEs, the same applies to large Korean companies.
Under the guidance of a chairman, CEOs act more in the fashion of a western-style COO. They handle operations while boards are made up of hand-picked loyalists. This structure allows a family that owns a conglomerate, for example, to make moves such as restructuring the portfolio to their own benefit, even if it harms shareholder value.
The majority of shareholders get to wield very little influence while bearing the cost of the notorious “Korea discount” amid increased risks and fleeting foreign investment in undervalued listed companies.
In the past, when the Korean capital markets were not yet very developed, the chaebol model and close-knit decision making had its benefits. It allowed faster capital allocation than market mechanisms. However, with today’s more developed financial markets, the model shows clear weaknesses with a high risk on non-optimal capital allocation as well as having a negative effect on the rest of the business ecosystem.
The knock-on effects are substantial, as smaller businesses and supply chains are also caught in this web of chaebol domination, causing innovation and talent to be monopolized and under-utilized. In addition, there is an ever-growing income gap between the top and bottom households that destabilizes society at large.
As the majority of the nation’s workforce experiences the negative effects of income inequality, is it any surprise that we see chronic social threats like low birth rates?
It might seem daunting to move away from the nation’s reliance on family-run conglomerates. It is hard to move on from something that has worked so well. However, it is necessary for Korea to turn away from the current trickle towards sub-1% growth, which the government has recognized is inevitable by 2035.
The transition will not be without pain. This is why the government has been reluctant to take decisive measures. Yet history suggests they must inevitably do so, as the country moves from developing to developed status.
A change of this sort is not only relevant in the business sector. Just as in business where poor governance leads to suboptimal capital allocation, poor value creation and an unreliable overall ecosystem, poor politics lead to inefficient and corrupted decision-making that deprives the country of its full potential. By “poor politics,” I mean the “strong person rules” mindset and biased governance that we have seen emerging now.
What good corporate governance looks like
Good corporate governance involves a shift in decision-making power to an independent and diverse board, whose responsibility is to shareholders at large.
Not only do boards then hold CEOs to account, but they also tend to prioritize long-term sustainable growth. They will usually focus their attention on specific business sectors, rather than broad areas of interest, because it is usually seen as a more profitable and value creating way to operate.
This in turn allows SMEs to thrive in their sectors because larger corporations no longer seek to dominate multiple sectors and whole supply chains. Examples abound, from US, Japan and Germany to the Nordic countries, including Finland.
Furthermore, with good governance emphasizing shareholder returns, companies can expect to see a valuation increase of up to 30%. This will then attract more investment from home and abroad, open greater access to foreign markets, and encourage economic growth - which is further bolstered by the fostering of an entrepreneurial spirit among start-ups and SMEs.
It is no surprise, then, that on an overall market level, something like a 10-15% value increase can be expected.
I was very familiar with this type of progression before I arrived in Korea because I had witnessed the reform of corporate governance in my home country of Finland. I remember businesses had been very poorly governed up to around 2000. But then, a currency crisis drove many companies to a financial crash, and this forced changes in governance as well as how capital was controlled within the Finnish market.
Cross-ownership and the kind of cozy management ties that were forged in saunas and on hunting trips were replaced by independent board leadership. Out went the “yes men” and in came more women and foreigners. Out went cash hoarding and in came foreign investment.
Even the collapse of Nokia’s mobile handset business, seismic though it was at the time, opened the way for a vibrant tech start-up environment that continues to feed the Finnish economy today.
The transition was not painless, and as part of the process, weak companies were weeded out. But the result was a stronger corporate sector and more importantly a globally competitive SME and startup sector.
How Korea can embrace change
Admittedly, Korea has already recognized the need to improve corporate governance. The problem has been finding the “how” and achieving a consensus. While a crisis such as that experienced by Finland can act as a catalyst, Korea might be able to execute a gentler transition by voluntarily and proactively making the shift. If not, a crisis will drive change.
However, there was a lukewarm response to the government’s Corporate Value-up Program (CVP) unveiled last year to address the “Korea discount.” This was partly because of opposing interests between the chaebol, which has little incentive to embrace reform under their current leadership systems, and investors, where the CVP does not go far enough to force listed corporations to prioritize shareholders.
The recent political events suggest a weakness in Korea’s legal framework. The same applies in business. There has to be a change in Korea’s legal framework if corporations are going to be nudged along.
Korean law currently states that the duty of a board is to their company, often referring to a small number of leaders, over shareholders. Sounds a lot like the duty of the PSS is to the President (rather than the government and legal authorities), does it not? While management control loopholes should be closed, merger regulations tightened, and cross-ownership targeted by legislation to bring transparency to corporate leadership, shareholder rights must be more explicitly protected - to the extent that corporate board members be held personally liable for causing damage to shareholders.
This is the case in Finland. In the face of inevitable opposition to legislative change, I would point to global standards that protect shareholders’ rights and ensure their equitable treatment. Adhering to global standards is not only important for foreign investors focusing on large Korean corporations, it is even more important for venture capital and private equity. Thus, the effects relate to the entire business ecosystem and play a big role also in innovation and renewal.
Aside from such steps, this is the time for the government to allow businesses to flourish. Corporate governance does not benefit from the kind of industrial policies that supported Korea’s economy in the past. Rather than five-year plans, we need to allow good corporate governance and systematic fact-based strategy work to sustain itself inside the companies while fostering a better livelihood for all.
And of course, it would help if the political drama and confusion we are now seeing would not drag on for weeks and months.
---------------------------------------------
This article was contributed by Per Stenius, the founder and CEO of Reddal, a management consulting firm established in Finland in 2010, with over 20 years of experience at global firms like Accenture and McKinsey. He specializes in corporate governance, strategy, and startup management.
Copyright ⓒ Aju Press All rights reserved.