Formation and Growth of the Chaebol

(A)

Origin

The history of the Chaebol is relatively short. The origins of few Chaebol can be traced back beyond the beginning of this century, and many Chaebol have their foundations in the Japanese colonial period (1910 - 45). During this period, several enterprises were already shaped as Chaebols, such as the Samyang group (1938)4, Hwasin group (1931), and Doosan group (1898), which is perhaps the oldest Chaebol. M ost enterprises were, however, in the embryonic stage before independence. As of 1988, only 6 of the 30 largest Chaebols had been founded before liberation from Japan (Kang, 1996, p 22).

Before the liberation in 1945, the majority of Korea’s total economic assets were controlled by the Japanese. Although under the Japanese management control, many Koreans worked in their factories and plants but were rarely promoted to managerial positions. The economic activities of a few existing Korean businessmen were strictly restricted.

At the time of liberation, Koreans who had worked with Japanese-operated companies were allowed to acquire the rights to take over the firms (by 1948, more than 2,500 companies were taken over by them). However, the large number of assets, 166,301 assets including 3,551 operating plants and firms, land, infrastructure, and inventories (accounting for about 30 per cent of formerly Japanese owned national total wealth) were entrusted to the American Office of the Property Custodian (AOPC), and 513 items were later distributed to Koreans; the AOPC handed the remaining properties

over to the government in 1948, and they were distributed by the government up to 1957 (Kang, 1996, p. 26). The vested properties were sold at lower prices than their real value and were accompanied by favourable conditions such as cheap bank loans, import licenses for raw materials, and the granting of foreign exchange at the official rate. As of 1961, 14 of the 23 largest Chaebols, such as Ssangyoung group (1948) and Tongyang group (1956), directly or indirectly purchased the vested properties (Kong, 1995, p. 96). The acquisition of these vested properties was one of the most significant factors that provide a core for the larger Chaebols in later years.

Despite the fact that some Chaebols did not acquire these vested properties, they established business foundations in manufacturing with foreign aid (the majority was American aid) and local credit by the government’s promotion (for example, the Samsung group (1953) and Lucky-Goldstar group (LG) (1947) (Kong, 1995, pp. 95- 6)). Some Chaebols started through the acquisition of state-owned plants producing textiles, glass, cement, and fertilisers. The Hyundai group (1950) grew to a Chaebol based on the construction business during the reconstruction period after the Korean War.

There were a couple of interesting features of Chaebol growth during the 1950s. First, almost all the large Chaebol actively operated importing businesses during that period. After the liberation, importing was a highly profitable business due to high inflation and a supply shortage in the deficient domestic market. Although import licenses and the necessary foreign exchange (supplied by the inflow of aid from the United States at the official rate) were required, it was not difficult to obtain them (any applicant was issued a license as long as the items were eligible). Although the government in 1948 restricted imports to protect domestic industry, import trading was a profitable business throughout the 1950s due to the continued high inflation, excessive

demand for imported goods, and the overvaluation of the domestic currency. Nine out of the ten largest Chaebols were engaged in importing and here they acquired business training in trading and accumulated their wealth (Kang, 1996, p. 28).

Second, many Chaebols acquired majority shares in the state-owned commercial banks when they were privatised by the government in 1956. During that period, the post - Korean war inflation was high and the government adopted a low interest rate policy. This caused a continuous shortage of financial supply. To operate businesses, it was very important to increase the accessibility to bank loans. As a result, Samsung acquired half of all commercial bank shares, and Samho and several other Chaebols became major shareholders in the commercial banks (Kang, 1996, p. 30). This allowed the Chaebols preferential access to industrial credit, taking advantage of the negative real interest rate.

It is said that most of today’s Chaebols were formed, and a few Chaebol had become dominant players in the national economy, during the late 1940s and the 1950s. As of 1988, 16 of the 30 largest Chaebols had started primarily in importing, banking, and the so-called three white industries - the sugar and flour, textiles, and cement industries, during that period. The average number of member companies within a group was 5.1 (Kang, 1996, p. 34).

(B) Consolidation

With the drive for economic growth through a series of Five - Year Economic Development Plans, a number of Chaebols grew and consolidated significantly during the 1960s. The role of the government during this period was significant for the growth of the Chaebols. The government intervened in economic affairs, with direct or indirect

growth strategy policies, and facilitated companies which had demonstrated high achievements during the previous period, in order to achieve its goals for economic development within a short period of time.

The government concentrated its resources on a few large projects rather than many small ones, not only because a small number of entrepreneurs had survived successfully in a limited and underdeveloped market during the 1950s, but also because there was a great deal of need to maximise limited resources available with the least risks. It was those 1950s’ Chaebols that had opportunities to engage in a few large projects supported by the government.

There were two ways for smaller Chaebols to become larger during that period: (1) obtaining a major investment license from the government, particularly to win the major domestic construction projects supported by the government to develop basic industries and infrastructures (for example, a license to build a ten-million-dollar chemical plant, a cement plant, an oil refinery plant, bridges, or motorways), and (2) obtaining credit allocation by the government. In fact, these two factors were closely related. The company that had already acquired an investment license for a project specified in the Economic Development Plans had advantages to receive credit allocation by the government.

The allocation of credit was an essential factor enabling Chaebols to survive with the heavy dependence on borrowing rather than on internal savings or new equity for the rapid expansion of their businesses (the average debt - equity ratio of the manufacturing sector rose from 1.36 in 1961 to 3.94 in 1971) (Kang, 1996, p. 43). As reviewed in

Chapter 4, the government controlled and allocated financial resources to fund government-approved projects as a major shareholder in commercial banks (after the renationalisation of commercial banks in 1961). Although the government gave

Chaebols a benefit in credit allocation, it monitored closely the economic activities of Chaebols to ensure that opportunities favoured by the government would be used productively to contribute to the country’s economic development at the same time (Kang, 1996, p. 39).

Other sources of Chaebol growth were the acquisition of state-owned firms that had been monopolies and were privatised in the mid-1960s, although not all acquisitions of the state - owned companies were to be successful in their growth. There were many favourable incentives, such as long and cheap bank loans, converting outstanding bank loans into equity, and protection of monopoly, attached to the acquisition agreements. With the same reasons applied for investment licenses and credit allocation by the government, Chaebols were at a great advantage in acquiring such companies from the government.

The rapid growth of South Korea’s economy and trade was contributed to by the Chaebols’ export performance. Many Chaebols built their own transportation and warehousing companies, following the example of the Hanjin group, which purchased Korean Air Lines from the government and became a major Chaebol (Kang, 1996, p. 45).

(C) Expansion

During the 1970s, the Chaebols continued to expand and particularly concentrated on the diversification of their businesses. Chaebols covered almost all areas. As one of the sources of its diversification, the Chaebols took advantage of the government’s heavy and chemical industry (HCI) promotion policies and supportive measures for exports. The government planned large-scale projects and designated

participants in selected HCIs such as non-ferrous metals, petrochemicals, general-type machinery, shipbuilding, automobiles and electronics under the strict licensing system. These designated participants enjoyed policy loans, general bank loans, and full protection from domestic competition and imports from the government. The Chaebols, which were large enough to undertake such huge projects, were designated to engage in those industries, and about 70 per cent of all policy loans went to them (Kang, 1996, p. 48).

Another opportunity to diversify Chaebol organisations during this period was the acquisition of ill-managed companies at the government’s request. Under the government’s supervision, some 62 ill-managed companies were operated. Although a principal restructuring of these ill-managed firms had taken place during the early 1980s, 17 of them were sold to other firms, and among them, 13 companies were acquired by the top 10 Chaebols (Kang, 1996, p. 51).

The acquisition of insolvent companies also contributed to the Chaebols’ growth and diversification in other industries. When these ill-managed companies were acquired by other companies including the Chaebols, the government awarded incentives, such as turning the bank loans into equity and providing preferential taxation. For example, Daewoo acquired the Korea Machinery Company, Shinjin M otors, and Okpo Shipyard. This contributed to the establishment of its substantial expansion into heavy industry. Inchon Steel Company was acquired by Hyundai, and this gave the company an opportunity to engage in a so-called strategic industry. Samsung acquired the Korea Engineering Company, obtaining an entry into the overseas construction business.

With the booming construction market in the Middle East during the 1970s, many Chaebols grew rapidly by completing construction projects in the region. During the period, 13.3 per cent of the asset growth of the 10 largest Chaebols was in

construction (Kang, 1996, p. 49). Many Chaebols which did not have a construction company acquired one to engage in overseas contracts. The government also provided subsidies for overseas construction, as it did for exports, because those projects increased foreign exchange earnings and exports of construction and building materials.

The government adopted a system of licenses for the General Trading Company (GTC), aiming at a rapid increase in exports by creating GTC which would be internationally competitive by specialising in international trade. GTC licenses were issued to companies whose products and markets were highly-diversified. It is said that this was one of the sources of Chaebol growth. During the 1970s, twelve of the thirteen issued GTC licenses went to the Chaebols, and the 8 largest GTCs in 1979 were owned by 8 of the top 10 Chaebols. These GTCs increased their share of total national exports from 12.4 per cent in 1975 to 31.5 per cent in 1979 (Kang, 1996, p. 51).

In the financial sector, many Chaebols operated non-bank financial institutions, such as insurance and security companies. Between 1972 and 1978, the 10 largest Chaebols purchased or established 14 financial institutions and incorporated them into their group organisation (Kang, 1996, p. 52). These institutions played an important role in many ways. Firstly, the Chaebols could attract external resources into their business organisations. Secondly, for the interest of the Chaebols as a whole, the financial institutions could allocate the necessary funds to the Chaebols’ subsidiaries according to decisions made by the Chaebols. Thirdly, the Chaebols used these financial institutions as a control centre to manage their financial and ownership structure, and even to circumvent government regulations on stock trading and taxation.

(D) Global Enlargement

Compared with the previous two decades, during the 1980s the government changed a few important polices, including increased promotion of the small and medium-sized company sector and the restructuring of industry policy from the strategic industry-favoured policy to a project- or function-specific one, although it provided a consistent economic development policy with the previous one (Kang, 1996, p. 53).

The Chaebols demonstrated rather different growth patterns than those of the past two decades during this period. The diversification of their businesses was no longer significant during this period. As seen in Table 5.1, the number of member companies owned by the Chaebols did not change much, and some Chaebols had even reduced the number of subsidiaries since 1979. In addition to the changes in the government policy, increasing internationalisation may force the Chaebols to increase their specialisation (by reducing diversification).

Table 5.1 Number of Member Companies of the 9 Largest Chaebols, 1985

Number of mer (number of dii nber companies Terent sectors)

Chaebol

1972

1979

1985

Samsung

16 (15)

33 (26)

39 (26)

Hyundai

6(5)

31 (15)

43 (23)

Lucky

18 (14)

43 (24)

48 (24)

Daewoo

2(3)

34 (20)

29 (24)

Sunkyung

5(6)

14 (16)

14 (17)

Ssangyoung

6(7)

20 (13)

14 (15)

Korea Explosive

7(8)

18 (16)

21 (19)

Hanjin

8(10)

14 (16)

12 (16)

Hyosung

4(4)

24 (15)

13 (16)

Total

72 (8.0 a)

231 (17 9 a)

233 (20.0 a)

Note: a: indicates average for industries. Source: Kim, 1987; Kang, 1996, p. 61.

In the 1980s, rapid growth of Chaebols continued more through a dominant position in the domestic market and the expansion of exports than through diversification of business activities. During this period, the GTC showed impressive export performance and played an important role in the growth of the Chaebols. The export share of GTCs owned by the Chaebols ranged from 38.6 per cent to 49.7 per cent of South Korea’s total commodity exports during the 1980 to 1985 period (Kang,

1996, p. 56).

The Chaebols were already involved in non-bank financial institutions, but they could enlarge their financial businesses into the banking sector in the 1980s. After 1981, when the government began to sell its shares in the commercial banks, the largest Chaebols purchased bank shares through their financial institutions and their family members, and became major shareholders in the banks, despite the fact that the government prohibited the 26 largest Chaebols from the auction, and limited the maximum share of a single person or a corporation to 8 per cent: the 10 largest Chaebols held between 11.9 per cent and 51.6 per cent of total bank stocks as of October 1983 (Kang, 1996, p. 58).

In this period, many Chaebols also expanded by interlocking investment among member companies in order to use less capital to take over other companies and to increase more credit from the banks (the banks awarded credit that was proportional to the borrower’s equity at that time), without actual capital injection. As of the end of 1983, the 30 largest Chaebol invested 36.9 per cent of their net stockholders’ equity in their member companies, and total interlocking shareholding, including investment in non-group firms, amounted to 45.2 per cent of their net stockholders’ equity (Kang, 1996, p. 59). Despite the government restrictions on inter-company shareholding by

amending regulations (the Commercial Law in 1984 and the Fair Trade Acts in 1986), the Chaebols still continued to expand their business by interlocking investment.

With regard to economic concentration, the size of the Chaebols affected the national and local economy. The Chaebols grew faster than the national economy during this period, and the top 10 largest Chaebols accounted for 15.1 per cent of national production in 1974. They increased their share to 67.4 per cent in 1984 (see Table 5.2). The 50 largest Chaebols’ sales were equivalent to over 90 per cent of GNP in 1986, and among these 50 largest companies, 30 were owned by the top 10 largest Chaebols (Kang, 1996, p. 187).

Table. 5.2 Combined Sales of Top Ten Chaebol, 1974-84 (as % o f G N P ) #

Group _{1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984} 1 4.9 4.3 4.7 7.9 6.9 8.3 8.3 10.5 10.4 11.8 12.0 2 7.2 7.5 8.1 12.5 12.9 12.8 16.3 19.1 19.0 21.2 24.0 3 9.0 9.8 11.3 16.0 16.9 17.6 23.9 27.6 27.4 30.5 35.8 4 10.3 11.4 12.9 18.2 20.7 22.1 30.1 35.2 35.6 38.7 44.3 5 11.6 12.8 14.5 19.8 22.9 24.6 35.0 41.3 42.2 46.7 52.4 6 12.7 14.1 16.1 21.3 24.7 26.6 38.2 44.9 46.0 51.0 56.2 7 13.5 15.3 17.5 22.8 26.4 28.5 41.0 48.0 49.2 54.2 59.4 8 14.3 16.2 18.4 24.0 27.7 30.3 43.6 50.9 52.2 57.1 62.1 9 14.7 16.7 19.3 25.2 28.9 31.6 46.0 53.3 55.1 59.8 64.8 1 0 15.1 17.1 19.8 26.0 30.1 32.8 48.1 55.7 57.6 62.4 67.4

Note: # means aggregate net sales of the largest ten business group / GNP * 100 for each year.

Source: Kim, 1987; Amsden, 1989, p. 116.

From the 1980s, the Chaebols have shifted into capital- intensive and advanced technology industries as the core for their continued growth and have tried to increase exports of those products. They also began to enlarge those major businesses globally through mergers and acquisitions (M & A) and joint ventures as a means of direct investments along with setting up their branches. In the capital and technology business

areas, for example, as of 1994 the Samsung group set up 33 overseas companies, and the Daewoo group, Lucky-Goldstar group, and Hyundai group had 31 companies, 24 companies, and 12 companies abroad respectively, excluding overseas branches (Bank of Korea, 1994, pp. 672-704).

During the last three decades, each Chaebol seemed to choose its own strategy to consolidate, expand, and become MNEs, although there are some common features of the Chaebols’ strategy in their expansion. Some knowledge of the theory of the firm can be applied to explain how the Chaebols have grown. Throughout the growth of the Chaebols, a market imperfection in the form of government intervention, was clearly identified, although there are other imperfections such as a firm’s attempt to create new structural imperfections in order to gain larger profits and rapid changes in the external economic environment. These market imperfections opened up the possibilities for firms in making strategic choices.

Under these circumstances, the entrepreneurs and managers have positively played strategic roles which vary according to the nature and extent of the market imperfections. The Chaebols’ growth and expansion have shown different paces depending on their strategist’s judgement of the probability and time profile of the outcome of alternative courses of action, and their attitudes towards risk taking (refer Chapter 2).

In the course of the Chaebol’s growth and expansion, as mentioned above, the government engagement within the private sectors, with its control over resource allocation and incentives which distorted the market conditions, affected the Chaebols significantly. The entrepreneurs and managers of the Chaebols often had to make a decision against their will because of the strong government intervention, although they could partly achieve their goals by their own strategies. This was particularly observed in

the 1970s. The government pressurised some Chaebols to take over ill-managed companies, resulting in the diversification of the Chaebols in non-related businesses (these insolvent companies were the result of over-capacity within the HCI industries due to the implementation of the government’s HCI policies), although it is normal to observe that a firm is involved in non-related businesses when it become larger.

As Rumelt (1974) argues, the essence of diversification is taken to be any entry into new products by using the range of skills possessed corporately by a firm, requiring the development of new competences or the augmentation of existing ones. In the case of the Chaebols, they adopted diversification strategies even before developing or increasing the available managerial competence within the firm for a new entry into a new business area. In other words, in a diversification move, the Chaebols took advantages of the government intervention rather than matched an opportunity with their possessed skills and resources as well as strengths.

As discussed in the income-driven product cycle model, HCIs are scale-sensitive. The market demand should be large enough to have economies of scale. The South Korean domestic demand could not meet the minimum viable size of plants, in other words it was too early for firms to enter the HCIs, although the market was in a dynamic stage of the product cycle. The government adopted its HCI policy at an inadequate

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