Profile of Director: The Case of Korea

1
Profile of DirectorThe 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 [phone] Fax[phone] Email
  jangya_at_chollian.net

2
New Regulation on Board Composition

• Outside Director
• All public companys 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 Directors Liability
• Controlling Shareholders 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 persons
  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 Chairmans Secretary 0
  0 8
• IJ Kim Chairmans 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

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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
Hyundai Co.
H. Precision
H Elevator
H. Motors
H. Heavy Ind
H Shipping
H Financing
Mipo Shipyard
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 Foudation
Samsung Heavy Ind.
Samsung SDI
Samsung Mech. Elec
Samsung Security
Hotel Shilla
Samsung Everland
Samsung Card
Samsung FM 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 Lees
  Personal Liability
• Case 2 Samsung SDI
• Board Approved Purchase of Shares of a Private
  Company Owned by Chairmans 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

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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

• Directors 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