The corporate sector reform had two objectives. The first was to restructure insolvent firms that could not repay their debts, and the second was to strengthen market discipline to prevent future crises.
First, the restructuring effort relied on two strategies. One was the swapping of business lines (so-called“big deals”) between the chaebol that was arranged and enforced by the government. The other was out-of-court debt settlements, known as“workout” programs, whereby afirm and its creditors negotiated rescheduling or restructuring with more flexibility than in formal proceedings. These were emergency measures to speed up the restructuring. They differed from the industrial rationalization of the 1980s in that the size of bad loans was far larger. The restructuring process was also made as open and transparent as possible by inviting foreign as well as domestic investors to buy insolvent firms.
Second, the structural reform of the corporate sector was based on“the five plus three principles.” In January 1998, president-elect Kim Dae-jung and the owners of the four largest chaebol agreed on (1) enhancing the transparency of corporate management, (2) eliminating cross-debt guarantees, (3) improving the capital structure considerably, (4) focusing on core lines of business and strengthening cooperation with SMEs, and (5) increasing the accountability of controlling shareholders and managers. In accordance with these five principles, consolidated financial statements became mandatory for the chaebol ,international accounting standards were introduced, listed companies were required to appoint outside directors, auniform debt-equity ratio ceiling of 200 percent was set for all firms (to be met by the end of 1999), and the Commerce Act was revised to recognize as de facto directors those who carried out adirector’s role without such title (e.g., controlling shareholders). In August 1999, three more principles were added; (1) improving the governance structure of the NBFIs, (2) restraining intra-group circular shareholdings within the chaebol and blocking unfair inside trading, and (3) prohibiting unlawful inheritance and gifts. The main objective was to stop the chaebol from exploiting NBFIs under their control to escape restructuring, and to discourage chaebol owners from handing over their controlling interest illegally to their descendants and relatives.
Among the five plus three principles, two－namely, enhancing corporate transparency and increasing the accountability of controlling shareholders and managers－were essential in strengthening market discipline. Others－eliminating cross debt guarantees, improving the capital structure, etc.－were temporary measures employed during the period when the market principle was not working properly. The lack of market discipline was manifested when Daewoo issued an enormous amount of corporate bonds (17 trillion won) between the end of 1997 and September 1998 on the assumption that the government would not let the five largest chaebol falter.
On top of“the five plus three” principles, additional efforts were made to dispel moral hazard, improve corporate governance, and intensify competitive pressures. To dispel moral hazard, apartial deposit insurance system and forward-looking criteria for non-performing loans were introduced, and insolvent firms were allowed to go bankrupt (as in the case of Daewoo in 1999), inflicting losses on shareholders, financial institutions and other concerned parties. To improve corporate governance, conditions on the exercise of shareholders’rights were relaxed, the role of institutional investors was expanded, and M&As were deregulated, leading to the stronger position of shareholders vis-a-vis the management. Lastly, to intensify competitive pressure, regulations on FDI were eliminated almost completely, the import diversification system was discontinued, and the bankruptcy law was revised.
Source : SaKong, Il and Koh, Youngsun, 2010. The Korean Economy Six Decades of Growth and Development. Seoul: Korea Development Institute.
