The term economic power concentration got a legal status for the first time when the Monopoly Regulation and Fair Trade Act (MRFTA) was promulgated in December 1980. Article 1 of the MRFTA declared that its purpose should be served “by preventing … any excessive concentration of economic power.” Strange as it may sound, however, the MRFTA included no particular measures to curb the concentration of economic power. ##MORE_LAYER_BOX## Professor Kyu Uck Lee was a leading figure in drafting the MRFTA. He recollected in an interview how the Act got the phrase “excessive power concentration.” “I was convinced that transition to a free-market economy was hard to expect of Korea as long as the chaebols remained intact. Senior officials opined, however, that it would make the legislation impossible due to objections from chaebols if the proposed regulations on chaebols were put in the Act. I had to retreat. Yet I insisted on laying a ground on which the regulations could be put in the Act through an amendment at an opportune time. The Act thus proclaimed it as an aim ‘preventing any excessive concentration of economic power.’"##MORE_LAYER_BOX_END## It is through the first amendment in December 1986 that four such measures were included in Chapter 3, of which the title was changed to add the phrase “Suppression of Economic Power Concentration.” ##MORE_LAYER_BOX## It was not an obvious choice for the government to have the MRFTA include the anti-concentration measures. The government had reportedly considered having a special act deal with the task. “Special Act for Prevention of Economic Power Concentration” could have been the name. The final decision, however, was to introduce a few anti-concentration measures through amendments in the MRFTA, of which enforcement was the Fair Trade Commission’s responsibility. ##MORE_LAYER_BOX_END## This chapter was to include another anti-concentration measure in December 1992. The five measures were respectively named as Prohibition of Establishment of Holding Companies, Prohibition of Reciprocal Equity Investment, Ceiling on the Total Amount of Equity Investment, Restriction on Voting Rights of Financial or Insurance Companies, and Limitation on Debt Guarantees for Affiliated Companies.
Ceiling on the Total Amount of Equity Investment
Among the five anti-concentration measures put in the MRFTA, Ceiling on the Total Amount of Equity Investment could have been the most significant. It prohibited any company belonging to a Big Business Group from acquiring or owning stocks of other domestic companies in excess of its Ceiling Amount. A company’s Ceiling Amount depended on its Net Assets Amount, the former’s ratio to the latter being forty percent. The ratio was lowered to twenty-five percent as of April 1995 with a three-year grace period.
A chaebol group has only two ways of lowering its ratio of equity investment. It has either to lower its ratio of inside shareholding, or to reduce its amount of equity capital. ##MORE_LAYER_BOX## A set of equations may help to demonstrate the relations among the three ratios, that is, the ratio of equity investment (q) the ratio of inside shareholding (x), and the leverage ratio of equity capital. As for a chaebol group, let w and s represent the average ratios of stocks owned by the chaebol family and affiliated companies, respectively. Then x and u are defined as follows:
Note that u may be called the chaebol family’s ultimate ownership ratio, of which the inverse measures the leverage ratio of equity capital. Adding an obvious equation,
we can deduce the following:
That is, a chaebol group must lower either 1/u or x in order to lower q. The following graph illustrates the relation.
##MORE_LAYER_BOX_END## Either way, the chaebol owner’s economic power will shrink as a result. If the equity investment regulation had yielded a poor result, it would have been due to the long list of exceptions and exclusions. In fact, the list continued to grow after the regulation was recalled in December 1999.
Prohibition of Reciprocal Equity Investment
While the amount of inter-company shareholding was regulated by the Ceiling, the structure of inter-company shareholding was regulated by the Prohibition of Reciprocal Equity Investment. “Any company … shall not acquire or own stocks of an affiliated company which acquires or owns its stocks.” ##MORE_LAYER_BOX## Prior to the amendment of the MRFTA in December 1986, some reciprocal shareholding had been prohibited by the provisions of Article 342.2 of the Commercial Act. This article had been added in April 1984. Their ranges of application, however, were limited. Titled “Acquisition of a Parent Company’s Stocks by its Subsidiary Company,” Article 342.2 applied only to a pair of companies of which one owned forty per cent or more of the other’s stocks. A company might still own up to forty per cent of another company’s stocks if the latter owned less than forty per cent of the former’s stocks.
The amendment of the Commercial Act was a response of the government to criticisms on the high ratio of intra-group shareholding of chaebol groups, which was 40.0 per cent on average for the thirty largest chaebol groups in September 1983. “Reciprocal equity investment” and “equity investment in affiliated companies” were the two terms adopted to refer to intra-group shareholding, and most fierce criticisms were leveled at the former. To quote from a report of the Fair Trade Commission: “Companies could alienate real investors by exchanging and possessing control power upon fictional equity investment. Relying on this function of reciprocal equity investment, the chaebols have controlled companies so far without equity investment, thereby concentrating economic power in their hands.” Apparently, such criticisms were not abated by the amendment of the Commercial Act in April 1984. Stronger regulations were called for when the provisions of Article 342.2 turned out to be applicable to a tiny portion of the intra-group shareholding of chaebol groups. ##MORE_LAYER_BOX_END##
The prohibition, however, had a loophole. It was not extended to a nearly perfect substitute of reciprocal shareholding, namely, ##3D_LAYER##circular shareholding.##3D_TEXT:”Circular shareholding” refers to a case in which a sequence of inter-company shareholding constitutes a closed circle. If Company A owns stocks of Company B, Company B owns stocks of Company C, and Company C owns stocks of Company A, then the series of stock holdings is said to constitute a case of circular shareholding. Of course, more than three companies may be involved in a case of circular shareholding.##3D_LAYER_END## The difference between them exists only in the number of companies involved. Both of them help to make up the ##3D_LAYER##“fictional capital,”##3D_TEXT:Capital was called as “fictional” in the sense that it existed merely in the accounting books, with no corresponding funds brought into a group of companies. If funds were transferred through acquisition of new stocks between companies belonging to a same chaebol group, its total amount of equity capital would increase with no real funding from outside at all.##3D_LAYER_END## and to enhance the control power of chaebol owners. The amount of circular shareholding increased in a few chaebol groups by around 2000. ##MORE_LAYER_BOX## The figure below illustrates the circular shareholding of Hyundai Motor Group as of December 31, 2001. Although the structure of circular shareholding was built through a bit complicated process, the key elements were the acquisition of stocks of Hyundai Motors (A) by two affiliated companies (B1, B2) and the acquisition of the latter’s stocks by Kia Motors (C). Having been preceded by Hyundai Motors (A) acquiring stocks of Kia Motors (C), the series of stock acquisitions closed a circle of shareholding among the four member companies (C←A←B1&B2←C).
[Circular Shareholding of Hyundai Motors Group (December 31, 2001)]
Circular shareholding was not a unique choice of Hyundai Motors Group around 2000. The table below has been constructed to demonstrate it. The figures in this table have been obtained through a series of simulations with each of the thirty largest chaebol groups for each of the years 1997-2005.
[Circular Shareholding of Top Chaebol Groups, 1997-2005]
(Unit: billion won, %)
1) Included are the thirty largest business groups under control of a person or family as of April 2004, of which ‘top’ business groups are those with total assets of 5 trillion won or more. The number of business groups included varies because six of them were divided into sixteen business groups during the period.
2) Equity capital, equity investment, and circular shareholding are measured in terms of book value.
3) The amount of circular shareholding is the least amount of stocks that member companies have to dispose of in order to resolve circular shareholding.
Source: Annual reports and/or auditor’s reports of each member company
A brief explanation of some figures in the table might be needed. Let us start with the ‘number of cases.’ We can count the cases of circular shareholding while ignoring any shareholding of less than one or five per cent. In any case, the ‘number’ refers to the smallest number of those companies of which stocks must be disposed of for the concerned group of companies to completely get rid of circular shareholding. The ‘number,’ of course, will be smaller if we count the cases while ignoring any shareholding of less than five per cent instead of one per cent. The ‘number of cases’ so obtained and added for the thirty chaebol groups was doubled in December 2001, and almost tripled in December 2005.
We can also compute the least amount of stocks that the top thirty chaebol groups should have disposed of in order to completely get rid of circular shareholding. Comparing the least amount to the total amount of intra-group shareholding for each year, we shall see that the ratio rose from 1.9 per cent to 4.6 per cent during the four years after 1997. The ratio rose to 4.9 per cent in December 2005. The portion of circular shareholding in intra-group shareholding was more than tripled in those years. ##MORE_LAYER_BOX_END##
Restrictions on the Voting Rights of Financial or Insurance Companies
Financial or insurance companies raise a huge amount of funds in various forms. The raised funds themselves signify enhancement of the chaebol owner’s economic power. If the funds were turned to stocks and voting rights in other companies, the chaebol owner’s economic power would be further enhanced. Financial companies and insurance companies could be an ideal means for a chaebol owner to further enhance his/her economic power. ##MORE_LAYER_BOX## All the commercial banks of Korea had been nationalized in 1962 before they were privatized in the early 1980s. Two commercial banks having been founded in 1982 and 1983, there were seven nationwide commercial banks before the MRFTA was amended to enact the anti-concentration measures in December 1986. None of the seven commercial banks, however, were under full control of chaebol owners at the time. In fact, the government had strictly prohibited it by various measures. One such measure was the limitation on ownership. Added in the Banking Act in December 1982, Article 17.3 read: “no one shall own more than eight percent of outstanding stocks of a commercial bank or substantially control it.”
Yet the limitation on ownership did not apply to local banks or non-bank financial intermediaries, of which the latter included those called as insurance company, securities company, mutual savings and finance company, investment and finance company, and merchant banking company. Many of them were founded in the early 1980s, and most of them were under control of chaebol families in the mid-1980s. To be specific, twenty-four of the thirty-two investment and finance companies and all of the five merchant banks’ were reportedly owned by chaebol companies or family members. In addition, the chaebols had already taken control of all of the six life insurance companies and eleven of the twenty six securities companies. ##MORE_LAYER_BOX_END##
Nonetheless, financial companies and insurance companies were excluded from application of the Ceiling on the Total Amount of Equity Investment. The government opted for the Restriction on the Voting Rights instead. A financial or insurance company might still acquire and own stocks of affiliated companies, but it was prohibited from exercising its voting rights in those stocks. ##MORE_LAYER_BOX## To translate Article 7.5 of the MRFTA as amended in December 1986: “Neither financial nor insurance company belonging to a Big Business Group shall exercise its voting rights in stocks of domestic affiliated companies which it has acquired or owns.”
In its 2011 Annual Book, the Fair Trade Commission recapitulate the significance of this addition of Article 7.5 in December 1986.
As financial or insurance companies are supposed to manage the funds deposited by working class people, the funds should not be used as a means to strengthen or increase the power of large business groups. On the other hand, equity investment is one of the major asset management methods for financial or insurance companies, and, at the same time, the shares of affiliated companies cannot be excluded from asset management. As a result, the regulation of restricting financial or insurance companies from exercising their voting rights for the shares of other affiliates they acquired or owned was introduced in order to prevent the financial or insurance companies from being used to expand and strengthen the control of the business group. ##MORE_LAYER_BOX_END##
The restriction, however, was practically removed in 2002; a financial or insurance company might exercise up to 30 percent of the voting rights on any of the critical matters in the general meeting. The restriction then was partially restored; the upper limit of voting rights was lowered to fifteen percent as of April 2008.
Prohibition of Establishment of Holding Companies
The Prohibition of Establishment of Holding Companies was another anti-concentration measure enacted in December 1986: “No one shall establish a company (hereinafter referred to as ‘holding company’) whose main business is to control any domestic company’s business activities through the ownership of stocks, nor an established company shall be converted to a holding company in the country.” ##MORE_LAYER_BOX## The definition of a holding company included two terms to be specified; that is, “control” and “main.” Specified in the Fair Trade Commission’s Guidelines for Determination of the Scope of a Holding Company, the term “control” did not differ much from the same term specified in the Presidential Decree as for the Scope of a Business Group. That is, a company shall be considered to “control” another company’s business activities if the former is the latter’s largest shareholder with more than thirty percent of outstanding stocks. The other term “main” was specified by the Presidential Decree. It adopted as a criterion the amount of stocks that the concerned company owns to control any domestic company’s business activities. Specifically, the concerned company shall be considered as holding company if such stocks constitute more than a half of its total assets, both being measure in terms of book value. ##MORE_LAYER_BOX_END##
The prohibition, however, was lifted as of April 1999. It was replaced with some regulations on their shareholding and financing, but the regulations were relaxed further at a later time. The argument was that a holding company should facilitate “corporate restructuring.” Compared to the current ownership structure of chaebol groups, a simpler structure of inter-company shareholding was cited as another merit of the holding company system.
Limitation on Debt Guarantees for Affiliated Companies
The member companies of a chaebol group could borrow more with better terms from banks and non-bank financial institutions, by giving debt guarantees to each other. That is what happened in the 1970s and 1980s in Korea, and what the Limitation on Debt Guarantees was intended to change. Enacted in 1996 through the amendment of the MRFTA, the regulation has been reinforced twice thereafter. Before the last reinforcement in 1998, any company belonging to a Big Business Group was prohibited from giving debt guarantees to its affiliated companies in excess of a certain amount. Currently, the prohibition applies to any amount of debt guarantees, with a few exceptions. ##MORE_LAYER_BOX## When the Limitation on Debt Guarantees was enacted by adding Article 10.2 in the MARFTA, its first sentence read: “Any company belonging to a Big Business Group … shall not give debt guarantees to its domestic affiliated companies in excess of the amount derived by multiplying its amount of equity capital by 200/100.” The last phrase starting with ‘in excess’ was deleted in January 1998 after the ratio ‘200/100’ was lowered to ‘100/100’ in December 1996. That is, the upper limit on the total amount of debt guarantees had been lowered from 200 per cent to 100 per cent of equity capital before any debt guarantees were prohibited in principle. Having been through the two reinforcements, the provision of Article 10.2 completely banned new debt guarantees from April 1, 1998, and at the same time, existing debt guarantees must be removed before April 1, 2000. ##MORE_LAYER_BOX_END## This regulation was relatively better accepted by chaebol companies, and achieved visible results.
Designation of Big Business Groups
The Prohibition of Establishment of Holding Companies applied to any domestic company, whereas the other four anti-concentration measures exclusively applied to those companies belonging to a Big Business Group. Accordingly, the MRFTA needed to have the scope of Big Business Groups determined one way or another. ##MORE_LAYER_BOX## Logically speaking, the scope of Big Business Groups shall be determined as soon as the scope of Business Groups is determined and the criterion for their bigness is given. It also goes without saying that the scope of any group is determined by its constituents. It is, however, quite legally complex to specify what constitutes a Business Group. ##MORE_LAYER_BOX_END##
Deferring much of it to the Presidential Decree, Article 2 of the MRFTA got a new clause adopting de facto control as the yardstick for determination: “The term ‘business group’ herein refers to a group of companies the business activities of which a same person in fact controls … according to the criteria as specified in the Presidential Decree.” ##MORE_LAYER_BOX## Titled “Scope of Business Groups,” Article 2.2 of the Presidential Decree of April 1987 specified the criteria as to de facto control. Two criteria were set, one being much less concrete than the other. The former being applied, a person shall be considered to ‘control’ the concerned company if he or she “admittedly exercises influence on the concerned company’s business activities through appointment of directors or other ways.” This criterion has been further specified in the Presidential Decree of March 1997. The other criterion was set in terms of the ratio of shares that a person owns in the concerned company either solely or together with any of ‘Related Persons.’ If this ratio is thirty percent or higher and no one else owns more shares, then the person shall be considered to ‘control’ the concerned company. In this specification, ‘Related Persons’ did not only refer to the person’s immediate family, blood relatives, and in-laws; they also referred to companies and organizations under de facto control of the person. ##MORE_LAYER_BOX_END## The MRFTA then proceeded to set the criterion for bigness of Business Groups in terms of “total assets amount” while leaving further specifications to the Presidential Decree. ##MORE_LAYER_BOX## Titled “Scope of Big Business Groups,” Article 15 of the Presidential Decree of April 1987 defined the term Total Assets Amount differently between two sorts of companies before setting the criterion for bigness of Business Groups in terms of the sum of such amounts. That is, the sum should not include all assets, but rather equity capital in book value or par value, whichever is larger, as for a financial or insurance company. Given this article of the Presidential Decree, any company should abide by the provisions of Articles 7.3 through 7.5 of the MRFTA if it belonged to a Business Group with the so obtained sum exceeding 400 billion won. It is by this criterion that the Fair Trade Commission designated thirty-two Big Business Groups comprising five hundred eleven companies as of April 1, 1987. ##MORE_LAYER_BOX_END##
The criterion for bigness of Business Groups was not changed for years, and the number of Big Business Groups increased year after year. The number increased to seventy eight before the Presidential Decree was revised to fix it in February 1993 (see Table 5). Thirty was the fixed number of Big Business Groups then and after.
[Scope of Big Business Groups, 1987-1992]
(Unit: billion won)
|Number of groups||32||40||43||53||61||78|
|Number of affiliates||509||608||673||798||933||1056|
|Total assets amount (a)||57,471||70,907||88,340||110,002||145,395||187,156|
1) The total asset amount as defined by the Presidential Decree. It includes the amount of equity capital in book value or par value, whichever is larger, as for financial or insurance companies.
Source: Fair Trade Commission.