South Korean President Moon Jae-in won election last May with a pledge to break the collusive relationship between the government and the chaebol, the country's family-controlled conglomerates. The stage was set for his victory with the impeachment of his predecessor, Park Geun-hye, as a result of what the general public saw as cozy ties taken too far.
For decades, South Koreans accepted close links between the government and the chaebol as a necessary evil of the country's export model. Through policy lending and numerous subsidies, the government helped manufacturers bring export revenues into the domestic economy, creating jobs and spurring consumption.
In recent years, however, South Korean companies, like many others globally, have stopped hiring at home in search of cheaper labor overseas. As a result, the working class no longer benefits while chaebol are reaping the fruits of overseas investment.
Moon campaigned on a promise to strip privileges from the chaebol and level the playing field for smaller companies and the working class. Investors and South Koreans will be watching to see if chaebol reform will materialize in 2018.
Despite its agenda for change, the Moon government is hamstrung by the fact that it lacks a majority in parliament where its support rests on a coalition with two other left-wing parties, making sweeping reform difficult. Despite the scandals that have blighted the chaebol, the influence of business interest groups in parliament remains strong.
At a time when the economy is still fragile, there are fears that aggressive reform could derail job creation and corporate investment and lead to strategic mistakes that could jeopardize Korea Inc.'s competitiveness. This concern is exacerbated by the emergence of Chinese companies as challengers in South Korea's key industry sectors.
There are, however, two significant measures that the Moon government can implement soon to ensure reform momentum without seeking parliamentary approval.
The first relates to the process of unwinding cross-holdings between chaebol and their units. These links allow chaebol families to control group companies through minority ownership stakes. The result has been poor corporate governance and unfair treatment of independent shareholders. These factors have contributed in turn to the so-called "Korea discount," persistently lower valuations given to local equities relative to regional peers.
Holding the line
In 2002, the then left-wing ruling party, the predecessor of Moon's Minjoo Party of Korea, introduced legislation to encourage chaebol to transform their complex group structures into holding companies that would be more transparent in their accounting and corporate governance. As an incentive, the government offered to exempt from tax the capital gains that would be incurred from breaking the cross-holdings.
After 15 years and five deadline extensions, a handful of the largest and strongest of the chaebol, including the Samsung Group and Hyundai Motor, have yet to comply.
The Moon government could allow the sixth deadline, set for the end of 2018, to pass without extension or further concessions. The chaebol would then face tougher conversion laws afterward if they still have not restructured. For example, treasury shares held by chaebol families will no longer be allowed to be automatically converted into voting shares, diminishing their latent power.
The Moon government can also move to ensure the commitment of the National Pension Service to adopt a stewardship code in 2018 as the investment body recently promised. South Korea's stewardship code, a set of guidelines for companies and investors to facilitate and encourage engagement, was introduced with the backing of the government Financial Services Commission just over a year ago but has yet to be widely embraced.
The NPS is the biggest and most influential investor in South Korea. As the largest owner of local stocks, and with its assets under management projected to grow fivefold over the next 25 years, the NPS can be the champion of corporate governance to galvanize other investors.
Institutional investors seeking fund mandates from the NPS will be pressured to conform with the stewardship code. Minority shareholders who in the past had been reluctant to engage with the management of investee companies will now have a government-backed platform to voice their rights.
The Moon government can press for change among chaebol by simply enforcing existing frameworks. Sticking to the holding company conversion deadline and pushing the NPS into the stewardship code may not, by themselves, lead to a major change in the behavior of investors, who are traditionally passive in South Korea. But these steps would send an important message to chaebol families that permanent change is at hand for an economy that is fast approaching developed economy status but still lags far behind on corporate governance and transparency.
Late last year, Choi Soon-sil, friend and confidant of former president Park, was sentenced to 25 years in jail for her influence-peddling role in the scandal that led to Park's downfall. There is a risk that Choi's sentence could draw the line under the case and that chaebol reform could once again fade into the background. Rather than see the sentence as the end, the Moon government and minority shareholders can seize it as the beginning of chaebol reform and finally set South Korea on course to match its regional peers in corporate governance.
Peter S. Kim is a managing director and investment strategist at Mirae Asset Daewoo. The views expressed here are his own.