According to the Fair Trade Commission (FTC), the number of holding companies in Korea is 127 as of the end of September, and that of the conglomerates converted to holding companies is 16, 25.8% of the total of 62 conglomerates.
Conversion into a holding company brings advantages such as a more transparent ownership structure. This is evidenced by the fact that the average debt ratio of the converted business groups is 32.4%, much lower than the total average of 108.6%. Also, they make investments through an average of 3.07 steps while the number increases to 5.29 for others.
Nevertheless, it has been found that about 30% of the subsidiaries of the converted business groups are run without being incorporated into the groups. The situation is tarnishing the purpose of the system, that is, a more transparent corporate governance structure.
For example, electrical communication company GS Neotek, a subsidiary of the GS Group, is a non-listed firm fully owned by Heo Jeong-soo, who is the younger brother of GS Group chairman Heo Chang-soo. GS Neotek’s transactions with the other affiliates amounted to 392.2 billion won (US$368 million), or 65% of the annual sales, for last year. Thanks to internal transactions, the sole owner received subsidies of no less than 49 billion won (US$46 million) from the firm for the last five years. GS Neotek has recently been designated as a company subject to the regulations against internal trading. GS Neotek has not been incorporated into GS Holding yet.
The FTC’s data shows that 196 out of the 652 subsidiaries of the 16 converted conglomerates have yet to be incorporated into the holding companies. The average number per group is 12.3. The number is the largest for the GS Group (45 out of 76), followed by the Daesung Group (31), CJ (28), LS (22), and SK (20). The percentage of incorporations rose to 73.3% in 2010 and has declined to 70.8% and 69.4% in 2011 and 2012, respectively.
The main reason for non-incorporation is to avoid the various regulations imposed on the holding companies. One of the examples is the minimum shareholding ratio of 20% for listed companies and 40% for non-listed firms.
“In the holding company system, no owner can be in possession of 100% of the subsidiary shares, and not a few business group heads are trying to circumvent the restriction,” said the FTC. In addition, there are many cases in which the owner’s family members or relatives run non-incorporated affiliates. They are unwilling to be put themselves into the holding company structure because they have to give up on their shares otherwise.
Inter-company Transactions Prevail in Non-incorporated Affiliates Run by Owners’ Families
The problem is that the subsidiaries out of the system are used as a sort of wealth transfer channel between direct and extended family members. They earn sales by means of inter-company transactions, and then the owners’ family members take a large sum of dividends.
In the SK Group, the internal transaction ratio of SK C&C and ANTS, 48% and 100% of whose shares are owned by the family, amounts to 60%, and the two firms’ inter-company transactions exceed one trillion won (US$940 million). The CJ Group’s C&I Leisure Industry is fully owned by the owner’s family and the ratio is 98%, meaning the firm is completely isolated.
“The higher the shareholding ratio of the family members, the larger the volume of internal transactions for those subsidiaries out of the holding company structure,” FTC Competition Policy Bureau director Shin Yeong-seon explained. Specifically, the non-incorporated affiliates in which the family members’ shareholding ratio is less than 20% have an average inter-company transaction ratio of just 9.5%, whereas the percentage goes up to 40.5% when the shareholding ratio is between 50% and 99%, and to 51.3% when the shareholding ratio is 100%. The director continued, “We will more closely monitor the profit-seeking activities of the system from February next year, when the revised Fair Trade Act is put into effect.”
The FTC is planning to continue its efforts for a legal amendment so that financial subsidiaries can be owned by intermediate financial holding companies, too. The idea is based on the assumption that the current regulation forbidding the incorporation of financial subsidiaries into general holding companies according to the separation of banking and commerce is hindering a smooth transition.
“Since the holding company system was first introduced, the government has applied rather strict restrictions to prevent a concentration of economic power,” said Hansung University professor Kim Sang-jo. He pointed out, “However, the regulations need to be somewhat eased now, so that a larger number of subsidiaries can be incorporated into the system.”