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Research Monograph
Policy Agenda and Direction of Chaebol Reform

December 30, 2000

  • Author Kwangshik Shin
  • Series No. 2000-03
  • Language Korean
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From the perspective of the concentration and abuse of economic power, Korea’s chaebol structure and practices have been long criticized. Since the mid 1980s, control policies on chaebols and the concentration of their economic power have been actively carried out to regulate their ownership structure, management style, business scope, investment, finances and transaction activities. However, the series of bankruptcies and insolvencies of large companies initiated the economic crisis, which exposed problems
caused by chaebol governance and their practices, making the chaebol reform a key agenda in the economic recovery. These are the circumstances which reveal the accomplishments of existing chaebol policies and the limitations of its usefulness. Therefore, the efforts to reform chaebols should be exerted on the basis of critical reviews and assessments on the current situation.


The limitations of the existing chaebol policies largely are caused by flaws and restraints of the conceptual basis of economic power—and its concentration—and the fairness—and the unfairness—of competition and transactions. The concentration of economic power is a complex concept which embraces the chaebol-driven general concentration, market concentration, business diversification and ownership∙governance concentration, having served as a framework to recognize chaebol problems. However, since there was
no theological system for analyzing the problems but the conflicting relationships among its components, the policies made based on this framework emerged as a symptomatic therapy regulation whose intention is to ease the general phenomena of the concentration of economic power, triggering policy confusion in terms of goals and methods. The concept of the fairness or unfairness of competition and transactions focuses on the negative influences that corporate activities exert on the competition and transaction
proprietors, not on the impact that they make on market performance (price, quality, service and so on) and consumer welfare. As a result, policies that aim at establishing fair competition and transactions are implemented without clear objectives and analytic judgment standards, and are likely to result in anti-competitive and anti-consumer outcomes.


Diverse negative impacts caused by the concentration and abuse of economic power have been recognized as the problems of chaebol structure and their activities, but at the center of the impact lays the chaebol’s monopolistic market position and their monopoly of governance and management right. Given that companies which continuously expand their profits beyond competition are able to accumulate considerable wealth and broaden their business scopes and scales, the concentration of economic power is ultimately
the product of a long-term maintenance and execution of monopolistic power. The abuse of economic power is said to have resulted in isolating non-chaebol companies and deepening the concentration of economic power, but in order for almost all corporate activities—such as vertical restraints, internal transactions and pricing—to act as a tool for hampering competition and monopolizing markets, the monopolistic strength must be premised, and the actual possibility and magnitude of competition restraint depend on
the size of the monopolistic strength already held by companies. More importantly, chaebol’s market monopoly and the lack of competition over management rights bring out distortion and ineffectiveness in resource allocation and utilization, oppressive management activities and negligence by controlling shareholders, and poor management performance.  


Chaebol policies thus far have focused only on restraining the expansion of chaebol and alleviating the concentration of their economic power, and not many efforts were made to reduce and eliminate their monopolistic strength. With the recognition that excessive business diversification and ownership-management system are the main culprits, the monopolistic power itself has not been considered a problem, leaving their monopolistic market position and management neglected or even encouraged.


In the name of strengthening competitiveness, the market position and management rights of chaebols have been protected, and their monopolistic strength has been maintained and reinforced through the inducement and facilitation of horizontal expansion and vertical integration. The competition policy regulations on chaebol’s monopolistic position and practices were not strict enough, and most regulation reforms were about simplifying administrative procedures and regulations to push through an impasse of existing
companies.


The oppressive management practices and negligence by owner managers were pointed out as the defects of the ownership-management system. This has been neglected and as the company ownership decentralizes further, the problem of proxy became worse, overlooking the fact that the market power and legislative and institutional tools are increasingly important in preventing management incentive from being distorted. The rights of company stakeholders were significantly restricted, leaving legal measures for monitoring
and containing the management performance meaningless. Also, obviously illegal practices by company or managers were not strictly dealt with. The regulation on the capital market, the restrictions on business entry, scope, holding shares, and the intervention of industrial policy have limited the M&A and strictly regulated foreign investment. Chaebol’s monopolistic position in the market and the overprotection of their management rights resulted in the cost rise and lower management efficiency, but at the
same time allowed them strong incentives to pursue a high growth. For this reason, the problems of chaebol structure and practices have not been actually fixed despite the implementation of comprehensive chaebol policies so far.


The policy direction to resolve chaebol problems which emerged against the backdrop of the economic crisis was suggested as the ‘5+3’ principle or agenda for corporate structure reform. The reform of chaebols generally aims to reduce or cut the connection of capital, finance and transactions among their affiliates and then to establish an independent and responsible management system. The policy direction also contains new perspective and attitude of recognizing problems related to corporate governance and
management process. A number of multi-dimensional policy measures for chaebol reform and restructuring have been conducted, making legal and institutional improvements to strengthen the market functions such as improved management transparency, reinforced management responsibility, further M&A activation, liberalized foreign investment, shorter process for firm exit, and strengthened financial supervision. However, critical problems related to chaebol and the structural weakness of the Korean economy still
remain unresolved. Above all, a large part of legal and institutional improvements, which were pushed through for the reform of corporate structure, have not gained tangible effectiveness. Also, as a result of the hasty implementation of chaebol reform together with corporate restructuring as risk management, it was the government intervention and pressure, not the market power, that have induced the improvement of financial structure of companies, the reorganization of business structure, and the improvement
of governance structure and management process. This implies that the expansion of the government’s economic role and influential power has the risk of hindering the true growth of the market economy.


The experiences thus far with chaebol policy and the economic analysis imply that the existing approach of regulating activities is not enough to fundamentally solve the general problems of chaebol structure and their activities. In order to reform chaebols, it is critical to establish an economic framework where the market organization might work smoothly and to reinforce the market functions and competition. The general problems relating to chaebols and the concentration of economic power can be resolved
by the establishment of legislative system and the power of competitive market.


Above all, the establishment of the conceptual foundation and objectives of policy is a very significant agenda in the sense that for any policy, all of its principle, direction, agenda, contents and tools are determined by its basic concept and objective. The concepts of the concentration of economic power and the unfairness of competition and trade should be replaced with the monopolistic strength and competition restrictiveness, respectively, and the political and social objective of alleviating the concentration
of economic power. Furthermore, the fairness of competition and trade should be replaced with the objectives of economic efficiency or the advancement of consumer welfare. It is only through this that the possibility to establish and execute rational policies based on economic analysis will be grasped and obtaining the effectiveness and predictability of concerned policies are possible. This is because monopolistic strength is the root of the problem of chaebol and the concentration of economic power but, at
the same time, it is a concept that suggests the policy direction and criteria in accordance with the economic theory.


The chaebol policy should reform the structure of chaebol and their practices using the power of market competition by encouraging competition and reducing or eliminating monopoly. A number of direct regulations on chaebols could be effective under a feeble market regulation in limiting the excessive expansion of chaebols and alleviating the concentration of their economic power. However, since the chaebol regulation replaced the market function and regulations, it is highly likely that the outcomes could
threaten the development of legal and institutional bases and the roles of the market when it persists for long. After the crisis, a number of measures essential to revitalizing market functions have been implemented, and now is the time for the chaebol policy to move towards a direction of creating and complementing the market functions and power, not of replacing the market through regulation. Only when the economic environment of well functioning competition pressure and market power is created, it would be
possible to actually change the incentives of chaebols and their structure and practices, leading to higher economic outcomes. In this context, the existing regulative approach toward chaebols needs to be changed into a competition policy approach. In doing so, the core agenda would be to reduce or eliminate the competition restrictive regulations and strongly reinforce the roles and functions of the fair trade law as competition law.


Korea’s market structure of high concentration and chaebol’s monopolistic position come largely from the competition restrictiveness of economic regulations. It is necessary to expand the roles of the market in resource allocation through regulation reform from the perspective of redefining the economic role of the government for revitalizing competition. In particular, it is important to revitalize competition and improve the competitive nature of the market by eliminating the entry barrier like restrictions
on the business sector made by the government. Controlling the entry or restricting business scope in the name of holding back excessive diversification of chaebols and inducing them to a larger and professional scale would only end up in maintaining or deepening the concentration of economic power by protecting the monopolistic power of existing companies. The premise of regulative reform to strengthen the market function and competition is to discard the industry policy-driven ideas and intervention which are
based on the government’s information advantage and the distrust of market mechanism.


Fair trade law is a chaebol regulation law to refrain chaebols from expanding and pursuing the concentration of economic power as well as a competition law to sustain and reinforce the competition as the operating principle of the market economy. So far, the regulations on chaebol’s financing, debt guarantee and transactions have been strengthened, contrary to the loose application of the competition law on the monopolistic position and practices. Because the chaebol regulation has been used as a tool to
refrain their excessive expansion but this  does not directly change the market structure and competition conditions, there are limitations in changing the incentives of chaebol and their practices. Also, if regulating these activities are necessary to correct the abuses such as mutual investment, debt guarantee and internal transactions, it is important to stop chaebol’s monopolistic market position and the reinforcement of its affiliate structure—which serve as the base of the abuses. However, at present,
no legal fundamentals and instruments are prepared to make that happen. Even regulations on corporate integration have not been conducted strictly enough due to various policy considerations.


In order to overcome the limitations of existing policies, it is necessary to transform the chaebol regulation with its focus on curbing the concentration of economic power into different regulations to improve chaebol structure and their practices with its base on the concept of competition restrictiveness. It is more important to prevent or correct the chaebol’s dominance in the market and their monopolization than diversifying them through structural competition policy. The regulations on practices alone
would not solve the general problem caused by chaebols.  


By using the competition policy instruments—such as corporate-integration regulations and demonopolization, it is necessary to improve the affiliate structure, which serves as a base for chaebol’s inefficient and abusive practices as well as to prevent the formation, reinforcement and abuse of their monopolistic positions. It is also needed to consider the acquisition and incorporation of affiliate companies as corporate integration by the business group and then supervise and regulate them selectively from
the perspective of competition restrictiveness. Legal procedures are also needed that make it possible to separate company which abuses its monopolistic power and has faced no competition threats for a long time. In addition, as a way to improve the affiliate structure itself, it is necessary to adopt a system under which affiliates as a source of the abuse and reinforcement of monopolistic power of the business group should be separated in accordance with strict standards. Corporate integration that occurs in
the restructuring process has deepened the monopolistic structure in several areas, triggering concerns of possible degradation of consumer welfare and competitiveness power. In such condition, when domestic and overseas competitions are not vitalized in these areas, the method of company separation would be the only policy option that could prevent negative impacts through the adoption of competition. The measure of affiliate separation would be used as a restructuring improvement instrument to prevent illegal
monopolization and expansion that use the affiliate structure—for example, affiliate monopoly or financial company—of the business group. Also, it would be appropriate to induce the complex affiliate structure and opaque management system to be changed into a simple affiliate and governance structure through holding companies by revitalizing the holding company system.  


For creating competitive market environment, it is also very significant to prevent the creation, maintenance and strengthening of the monopolistic power by reinforcing a competition policy examination on company integration. The examination should be able to fulfill the criteria and objective of competition policy, setting aside the industrial policy idea of and intervention in M&A. The company integration in terms of competition restrictiveness must be prohibited in principle, and the acceptance of a
case with high efficiency effect and a company whose recovery is not possible must be treated exceptionally in accordance with strict criteria. In the case of approving conditional company integration which is a great concern for competition restrictiveness, it is necessary to impose conditions that could avoid continuous regulations on practices, such as market dominance rate and supply price, and in turn these could prevent the creation and strengthening of monopolistic power itself.


It is necessary to advance the practicality of the fair trade policy by improving the standards and procedures of law enforcement. This practicality could be enhanced only by way of selecting a case based on its importance—from the perspective of the impact on competition and consumer welfare—and distributing and using policy resources. Under this context, instead of cases on simple disputes on transactions or struggles between competitors, it is necessary to concentrate the policy resources on cases that
could raise the market performance by preserving and strengthening the competition process. Also, it is needed to supplement the limited law enforcement capacity of policy authority by vitalizing civil suit and also to improve the monitoring and deterrent effect on illegal practices. The measures to vitalize the enforcement of civil suits include: eliminating the Article, ‘restriction on the claim during the trial on damages,’ raising the incentive of trials by adopting the class action system, and allowing
the trial for prohibition of illegal actions that are likely to cause damages.


Given that several problems of chaebol structure and practices came from the economic management process led by the government, these problems could be solved only when the government’s discretion of resource allocation is reduced and the market’s function and regulations are strengthened. To clear the practices of political economy, the reform of its legal and institutional foundation is inevitable. A smooth operation of the market mechanism is premised on the followings: the limitation and restriction
on government’s discretional regulation and intervention; and the establishment of legal framework and institutions for the enforcement of contract, property right, and public’s rights against government.


Above all, it is significant to reduce or eliminate the economic administrative decrees that were intended for government regulations and intervention and to expand the scope of judicial regulations. Through identifying the areas where legislation-based regulations on economic activities might work more effectively, the public enforcement of administrative legislation needs to be replaced with private enforcement of rights legislation, letting the economic activities be regulated through economic subjects’
exercising rights and taking responsibility, not through government control and intervention. In the areas where the principle of private autonomy is supposed to reign, when the rights and responsibility of stakeholders are not specified and allocated reasonably and clearly enough, or the relation between rights and responsibility is distorted by the government’s intervention refraining the exercise of legal rights, the market regulation will not work smoothly and the efficient adjustment and integration of
economic activities through the market is unlikely to occur.   


The regulation on economic activities based on the public enforcement of laws needs to be focused on the cases where the incentives from exercising the private rights are not sufficient enough due to externalities. The penal defenses, including bribery, internal transactions, tax evasion, illegal collusion and fraud, should be punished more strictly. Any lukewarm attitudes on the punishment of violation and illegal activities made by companies and the management will amplify the negative recognition of chaebols
and will seriously undermine the prudence and safety of the market economy system. It is also an important agenda to secure the transparency, impartiality and accountability of the law legislation and enforcement. Also, it is necessary to set up legal procedures that could limit the discretional establishment and enforcement of laws and then also to expand the range of the judicial review on legal rights and administrative measures that the public might find problematic, therefore securing the transparency of
government’s activities and their legal responsibility.  


 

 
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