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F

OR

many South Korean consumers, the

chaebol,

family-owned

conglomerates that are into everything fromelectronics to amusement

parks, are a source of pride. For investors, they can be a headache.

Shareholders were reminded of this in May when Samsung proposed to

merge two of its affiliates: Cheil Industries, the group’s de facto holding

company, and Samsung C&T, the country’s biggest construction firm (it

put up the world’s tallest building, the Burj Khalifa in Dubai).

When the deal was announced, Cheil’s share price was around its

highest since its IPO in December, and that of C&T was near a five-

year low. CLSA, a stockbroker, said the deal would give Cheil the core

operations of C&T “effectively for free”, after subtracting the value of its

stakes in other group companies. That would suit Lee Jae-yong, the only

son of Samsung’s chairman, Lee Kun-hee. The elder Mr Lee has been

in hospital for over a year since a heart attack; his son is preparing to

pay about $5 billion in inheritance tax while keeping family control of

the group, through small stakes in a hairball of cross-shareholdings. The

merger allows Mr Lee to consolidate that structure, and to gain more

than $12 billion in stakes in other Samsung companies, including a

further 4.1% stake in Samsung Electronics, its flagship firm.

In an effort to sort things out, Ohio’s state legislature now requires greater

precision when its members draw up new statutes. At the end of last

year John Kasich, the governor, signed a first-of-its-kind law that requires

new crimes to specify a threshold level of intent, or be declared void.

So, for example, if legislators want an action to be criminal regardless of

intent, they must state that in the law. Where the existing code is unclear,

the threshold for guilt becomes “reckless” behaviour. The bill passed

with unanimous support.

Not so fast, said Elliott Management. The American hedge fund (widely

known as a “vulture” fund for its investments in distressed debt)

boosted its C&T stake after the merger was announced, becoming its

third-largest investor, and filed a lawsuit to block the deal. Elliott argues

that the merger is unfair for C&T shareholders, who it says will lose $7

billion due to the huge disparity in the two firms’ valuations: when

the merger was announced, Cheil’s stock was trading at over 130 times

forecast earnings, whereas C&T’s ratio had slipped to around 20. (Firms

in South Korea’s KOSPI index on average have a forward price-earnings

ratio of about 11.)

A court in Seoul has rejected two injunctions filed by Elliott to try to halt

the deal; it ruled that the ratio by which shares in C&T will be swapped

for Cheil shares did not indicate any price manipulation. South Korean

law says that the ratio must be based on average stock prices over the

previous month, a formula that Samsung used. Samsung contends

that the deal will “ultimately increase shareholder value” by fusing the

global network of its construction arm with Cheil’s food and fashion

businesses, though it is vague on how bringing together outfits from

such different industries will save much money.

Business has often been the victim of Congress’s shoddy lawmaking.

The conflict will come to a head on July 17th, when C&T’s shareholders

vote on the deal. Two influential investor-advisory firms, ISS and

Glass Lewis, have urged them to reject it. Each side is lobbying other

shareholders, made up of foreign investors (who hold about a third of

C&T shares), domestic private investors (who have just over a third)

and South Korea’s National Pension Service (NPS), which has a stake

of almost 12% and could be the swing voter. In November an attempt

to merge two other group companies, Samsung Heavy Industries and

(loss-making) Samsung Engineering, was blocked by the NPS, which

threatened to exercise an option to sell its shares in both firms rather

than end up with a stake in the merged entity.

Shin Jang-sup, an economist at the National University of Singapore,

says Elliott has already benefited handsomely from its investment in

C&T, with gains he estimates at more than 100 billion won ($100m).

In Mr Shin’s view, South Korea has strict trading regulations and a

crippling tax on inherited management rights: it is because the

chaebol

are under such strict regulation, he says, that they have looked for

ways around them.

Sweeping reforms after the Asian financial crisis of 1997-98 boosted

shareholders’ rights and required large listed companies to bring in

more outside directors, for a time placing South Korea ahead of Japan

in the strength of its corporate-governance laws. But lobbying by the

chaebol has since undone much of the good work, says KimWoo-chan,

an economist at Korea University in Seoul. Only one big

chaebol

, LG,

has swapped its cross-shareholdings for a transparent holding-company

structure. South Korea now ranks at the bottom of Asian corporate-

governance league tables, with Indonesia and the Philippines.

The low valuation of South Korean firms relative to their developed-

country peers, known as the “Korea discount”, is blamed on corporate-

governance worries. Last year Hyundai Motors caused investor concern

when it bought land in Seoul for 10.6 trillion won, triple its assessed

value, for a glitzy new headquarters. The heads of four

chaebol

Samsung, Hanwha, Hyundai Motors and SK Telecoms—have been

convicted of crimes in the past decade.

The government has begun to push firms to redistribute their huge piles

of cash in increased wages or dividends. The president, Park Geun-

hye, initially championed “economic democratisation”—passing a law

to give the country’s Fair Trade Commission greater powers in levying

fines on illegal transactions benefiting

chaebol

family members, and

another preventing new cross-shareholdings. But she has since focused

on reviving a sluggish economy that is dependent on the

chaebol

: last

year two of her ministers suggested that convicted tycoons be pardoned

if they could contribute to boosting economic growth.

Bruce Lee, head of Zebra Investments, one of South Korea’s few funds

focused on corporate governance, says that even if Elliott’s bid fails, it

is only “the start of growing pains”: its challenge comes at a time when

succession issues loom at other

chaebol

—and as South Koreans become

increasingly frustrated with the families’ sense of entitlement. In a rare

show of solidarity, a group of small C&T shareholders have delegated

their voting rights to Elliott. Some have even bought their first shares in

C&T, simply to vote against the merger.

Business ı July 11th, 2015

Corporate governance in South Korea

ı

Reconstructing Samsung

A bid to merge two of the group’s companies raises wider questions

Eprinted and posted with permission to Elliott Associates, L.P. from The Economist

July © 2015 The Economist Newspaper Ltd.

Seoul

Keeping it in the family

Source:CLSA

*Ifmergerproceedson current terms

Shares held by the company itself

Shareholdings in Samsung group companies

2015, % of total

Samsung

Cheil

Samsung Merged

Electronics Industries C&T

Cheil/C&T* SDS

Samsung Life

Family members

4.7

42.2

1.4

30.0

19.1

20.8

Other Samsung cos.

na

10.2

na

7.3

na

na

Related groups

13.0

8.8

12.2

8.8

39.7

19.3

Treasury

11.1

14.1

6.1

12.7

na

5.5

Total

28.8

75.3

19.7

58.8

58.8 45.6