Institute for Corean-American Studies, Inc.
965 Clover Court, Blue Bell, PA 19422
Tel : (610) 277-9989; (610) 277-0149
Fax: (610) 277-3992
[Editor's note: We gratefully acknowledge this
contribution to ICAS of Tae-Hee Yoon.
This address was delivered on June 24, 2000 at the Prudential of America Board of
Advisor's meeting in Seoul. sjk]|
Corporate Reforms in Korea.
After 2.5 years following the crisis, Korea is currently enjoying relatively healthy macro economic indicators (high growth rate with stable price, - continued high savings rate, - recently worsening but reasonable trade balance, - declining external debt though with recently rising short term debt, and recovery of pre-crisis per capita GDP etc) . In addition, the country is under political euphoria with the historic North South Summit. However, the stock markets plunged and many firms are concerned about the possible defaulting in the face of prevailing liquidity problems. Some are fearing a possible second crisis while Government is confident/complacent, (except for a minority of officials who are expressing caution). External financial communities are urging the completion of the ongoing corporate reforms. Managers of business who depend on liquidity in the financial markets seem to be in a panic.
One question frequently asked is whether the financial sector reform, particularly the corporate reform, was a success or failure. It is not fair or responsible to give a simplistic answer of yes or no to this question. The expression of a "half full or half empty " glass of water might apply to this case. To be fair, it must be considered in the particular political circumstances in which reform was launched, given the fragile democracy under the coalition government's power-sharing arrangement. It seems reasonable to conclude that the policy objectives were in normative direction and that some measurable results were achieved. Furthermore, one might also admit that the reform measures undertaken following the 97/98 crisis were, in general, an acceleration of the on-going efforts which were so vast and time consuming that it would not have been possible for anyone to complete them in a short time. This paper is confined to the discussion of the most important and central issues in the corporate reform and their background which relates to the possible cause of recurrence of the financial crisis.
PRE-DAEWOO CRISIS REFORM AGENDA.
(Jan.98 Corporate Government - Creditor - Bank Agreement on Accelerating Restructuring of Big Five Chaebols).
This agreement contained the following elements:
DAEWOO CRISIS AND ENSUING ITC PANIC.
Korea witnessed a considerable panic created by Daewoo bankruptcy-triggered phobia on ITC (Investment Trust Companies) concurrent with the inclusion of Daewoo into the formal work-out program on August 26, 1999. The Daewoo crisis has started it's own history which is still unveiling, including the on-going saga of Daewoo motor sales. The ITC crisis, which was initially triggered by fear of a massive run on investment trust, attributed to the ITC's heavy exposures to Daewoo, temporarily disappeared in November, thanks to the Government's major preemptive efforts. But, it has revived, in a milder form, during the Hyundai liquidity debate in the recent past. The extraordinarily complex subject of Daewoo bankruptcy which involves more than 100 companies in 65 countries with almost 200 foreign lenders and 54 bn dollars debt is outside of the main focus of this paper, except for it's general relevance to the possible recurrence of the Korean financial crisis.
WORK-OUT OF 6-66 CHAEBOLS AND OTHERS:
The Work-Out Program under the Corporate Restructuring Agreement (CRA), signed by 210 banks and non-bank financial institutions in July 1998 eventually included a total of 104 companies (consisting of 12 Daewoo companies, 47 firms of 17 chaebols, 43 large and medium firms, and 2 leasing companies). It is extremely difficult to evaluate the effectiveness of the work-out program either in quantitative or qualitative terms. In general, as of the end of 1999, one fifth or one quarter of chaebol affiliates and more than one third of standalone companies are said to have met their targets. Such an under-performance is generally attributed to unrealistic business plans and/or failure to realize the planned cost reductions.
Major instruments employed for the execution of corporate restructuring programs include activities of Korea Asset Management Corporation (KAMCO), Corporate Restructuring Vehicles (CRV), as well as Court Supervised Insolvencies of Major Corporation, which are similar to practices in other countries. Government was mindful of the need for restructuring the nation's small and medium enterprises although this is a difficult subject other than to have their debt roll over. Since l997, about 100 companies from 21 chaebols have gone under court supervision. This group includes some of the prominent companies , such as Kia, OB, Hanbo Steel, etc.
IMPACT OF CORPORATE REFORM ON THE EXCESSIVE CORPORATE INDEBTEDNESS LEVEL.
The linkage between indebtedness of corporate sector and financial crisis of 97-98 can be established based on the high debt to equity ratios of non -financial corporations in the most seriously affected Asian countries, during the relevant periods. Korea stands out with the exceptionally high ratio of nearly 4 to 1. The high indebtedness led to serious corporate distress when the economic recession depressed corporate cash flows. Rising interest rates and increased costs of servicing the debt added to the distress. Given the close linkage between corporate and financial sectors in the Korean economic structure, whereby the excessive corporate indebtedness was the prime cause of the crisis, it would be meaningful to examine whether the corporate reform program has made a significant contribution towards the reduction of the debt servicing burden.
The severe 1998 corporate distress created by the rising borrowing costs attributable to the interest rate hikes and the squeezed cash flow led to losses of credit and insolvency by commercial banks and non-bank financial institutions. However, in l999, this situation was suddenly reversed, when the rapid economic recovery brought corporate cash flows and lower borrowing costs, substantially reducing their debt-servicing burden. It appeared as if Korea might work itself out of the financial crisis without further reduction to the indebtedness.
However, a review of the statistics by World Bank staff and others resulted in a seemingly counter-intuitive but revealing conclusion. The reduction of debt equity ratio from the l997 average of 4 to 2 times in two years apparently was not sufficient, in itself, to bring down the debt- servicing burden substantially, though this arbitrary level of reduction apparently had contributed towards bringing the aggregate corporate indebtedness down somewhat. In fact, the lower interest rate seems to have been an equally important contributing factor. During 1999, debt/equity ratio has been reduced by one third, largely through increased equities, not through debt reduction. The problem here was that much of l999 equity increase was not raised from the market, but it came from the revaluation of assets and unrealized capital gains on stockholdings, providing no additional cash flows support. With the year 2000 decline of the stock market (25%), most of the l999 equity gains have reversed back to l998 levels.
An aggregate analysis of data shows that, in 1998, the Korean manufacturing sector was not able to cover the payment of interest expenses from its operating cash-flow in that year. The financial sector was called upon to grant relief and/or extend additional debt funding toward meeting the debt-servicing requirement. In 1999, the situation had improved substantially. But it was only enough to service interest costs, insufficient to make a meaningful dent on the total debt levels. It was also revealed that about half of the Korean manufacturing firms were unable to service their debt level.
Implication of the above numbers is that there was no significant debt reduction in such form as debt work-out and write-downs. This is surprising in the light of the KAMCO's massive debt procurement of estimated 52 trillion won, during the past two years and the reported public fund injection of some 100 trillion won to financial and corporate sector restructuring. This may be attributable to the fact that much of KAMCO operation involved non-manufacturing, such as real estate and loans which were subjected to the court dictated restructuring.
One can ask as to what really should have been done to reduce the debt-servicing burden. The real answer is to achieve it through haircuts initiated by the leaders of the the work-outs i.e. banks. It is not difficult to conclude that the debt reduction through massive haircuts is not a realistic option in the current environment in Korea. It is because the concurrent pursuit of haircut and compliance with the government's financial sector requirement is a counter-survival practice in the short run. Substantial haircut which is really needed leads to incurring heavy losses which would erode their capital adequacy position, jeopardizing their capacity to comply with the regulatory requirements.
The total non-Daewoo debt forgiveness was a mere 1% of the total work-out program, while the corresponding figures for conversion into equity or convertible bonds amounts to about 24 %, and write-down about l.7%. At this rate, only one third of the firms in the work-out program is expected to progress, while the rest would be subject to a second round restructuring. In the case of Daewoo, conversion was initially expected to be 37% of the total Daewoo restructuring program. This was subsequently revised to only 14%. Only 2% of the lower figure is said to have been actually implemented. Under the circumstance, it can be argued that corporate work-out assets on the book of the banks are overvalued relative to the debt servicing capacity of the firms involved. It is also notable that the banks have grossly under-provisioned the work-out on their books, on average 15% rather than 50% which may be closer to the spirit of the forward-looking loan classification criteria. The Daewoo case may be somewhat similar situation. A recent estimate and survey by Goldman Sachs showed that only 9 out of the top 30 chaebols had an interest cover ratio above 2 times EBITDA. A debt reduction of 53 trillion won (40% of the total debt), was needed to bring all companies above 2 times debt service ratio. A lower cover ratio of 1.5 times EBITDA would still require a 26 trillion won write-down. According to an IFC survey, 26 of the top 64 chaebols (40%) had an interest cover ratio of 1 time EBIT.
The resulting vulnerability of the Korean financial system and the closely interrelated firms is manifested in the prevailing fear of defaults and the recent failure of a relatively "healthy" group like Saehan , despite the reasonable macro economic stability with single digit borrowing costs.
POLICY OPTIONS UNDER POLITICAL CONSTRAINTS.
During the formulation of the post-crisis financial restructuring in l998, both Korean authorities and the World Bank recognized that corporate restructuring would cause significant credit losses which would lead to a substantial erosion of the equity base of the financial system. As a result, it was proposed to link explicitly the re-capitalization of the bank to corporate debt restructuring, specifically the corporate leverage problem. However, the injection of public funds though KAMCO's NPL purchases and through KDIC's re-capitalization was linked merely to the approval of a bank's rehabilitation plan. At this point, the focus on speedy corporate restructuring was lost, despite the tireless and extraordinary dedication of Chairman Hogen Oh and his Corporate Restructuring Committee's staff who demonstrated examples of competence and transparent professionalism. . The World Bank pressed for a strong government role in the chaebol restructuring process, as it clearly saw no viable alternative. However it was rejected in favor of "lead bank" approach without any explicit linkage to the re-capitalization of the banks.
In any event, the government may need to return to the once rejected policy framework of combining capital injections with corporate restructuring, whereby the capital injections by KDIC and NPL purchase by KAMCO would be based on the actual losses incurred by the banks in corporate restructuring.
While the assessment of the corporate reform in Korea my be mixed, and may safely conclude that the main cause of the earlier crisis has not yet been removed , the overall benefit of the financial and corporate reform program may be seen differently, depending on individual perspective. At any rate, it is clear that Korea has gone through some fairly radical reforms in a short time and witnessed a new era of public awareness about sound cash-flow management, transparent corporate governance, as well as unprecedented change in the myth of chaebols. This experience will undoubtedly translate into a most profound impact on the formation of more normative business culture in this country.
This document contains information of a confidential nature. Neither the whole or any part of this document nor any reference thereto may be quoted without the prior permission of the author.
1. Dr. Tae Hee Yoon is Vice Chairman, PriceWaterhouseCoopers, Financial Advisory Services, Seoul, and CEO, Korea Economic Intelligence, New York He has been Adjunct Professor of Agricultural and Applied Economics, Clemson University for the past ten years. Dr. Yoon retired from the World Bank, Washington, D.C. after serving in a number of senior positions. In 1999 Dr. Yoon was called upon to serve as Senior Advisor to the World Bank to work on the Daewoo crisis and corporate and financial reforms in Korea.