Q1: What are the benefits and disadvantages of the Korean chaebol structure?
The advantages and disadvantages of the Chaebols are those of every conglomerate.
Advantages: Chaebols raised considerable investment tools.
• A chance for developing countries to organize the whole economy and build the very first foundation of the exchanges structure • An extraordinary way to avoid loss of energy that would have caused an unnecessary competition
• The opportunity to “educate” the firms until they are strong and competitive enough to successfully undergo the adversity of a free market
• Gives to the State a unique partner with which it will organize the development of the country around a consistent policy
Disadvantages: the main problem of the Chaebols model is that it kept its strategy consisting in growing in size at any cost
• The lack of risk due to the mutual assistance (through the agreements between the firms) and the support of the State led the Chaebols top managers to take unconsidered investment decisions
• Too much involvement into unprofitable businesses
• Their leverage ratio rose dangerously and their debt, mainly held by foreign investors, made them vulnerable to a sudden change in interests rates
Q1: What governance issues can arise due to this structure?
• The governance issue of the Chaebol was born among the inextricable links of the companies that
resulted from cross-holding investments
• The establishment at the head of the firms tended to promote transactions that were not profitable to
their company but to their peers or members of family
• High difficulty to prove the illegality of leader’s decisions that were suspected to be taken
accordingly to their own interests only
How can one prove that a board decision is destined to make richer a third?
What tells the difference between wrong decisions and corruption?
Q2: Analyze the capital structure of Samsung Electronics. Compare it with the capital structure of a
company in the similar line of business from another developed country and comment on the
differences
Q2: Analyze the capital structure of Samsung Electronics. Compare it with the capital structure of a company in the
similar line of business from another developed country and comment on the differences
In order to analyze the capital structure of Samsung Electronics, we extracted some figures from 1997’s consolidated balance sheet, and compared them with Texas Instrument, American leader in the chip manufacturing business.
(In K US $) Samsung
Electronics Texas Instrument
Total Assets 26,541,367 10,849,000
Total Liabilities 22,785,043 4,935,000
Shareholders’ equity 3,756,324 5,914,000
D/E Ratio 607% 83%
Debt Ratio 86% 45%
Samsung Electronics is very highly leveraged: extremely high D/E Ratio.
This is not specific to the industry, considering that its foreign competitors like Texas Instrument (or Intel) have rather low D/E ratios. This high debt-to-equity ratio is common to all Cheabols. They have worked this way since over 30 years for historical reasons, and still allows them to retain more control and expand their business more easily.
Risks
• Interest rate fluctuations exposure (most of loans are dependent on LIBOR) • Low flexibility (difficulty in additional debt issuing)
Q3.If Samsung Motors makes an after tax profit of $100 million, what share of that profit would go to
the Lee family? What percentage of the firm do they directly own?
Samsung Motors $100 million earnings $40 million dividends* Samsung Electronics $8.44 million earnings $3.38 million dividends* Samsung Display Devices $2.98 million earnings $1.19 million dividends* Samsung Heavy Inustries $0.99 million earnings 0.4 million dividends* Samsung Electro Mechanics $2.43 million earnings $0.97 million dividends* Samsung Everland $0.5 million earnings $0.2 million dividends*
*In the early 90’s, payout ratio was around 40% (S&P 500)
21.11% 7.45% 2.48% 6.08% 1.24%
Lee family
$183,000 Lee family $135,000
5.41% 67.30%
But it does not end there, because the Lee family
also partially controls affiliates of the above firms
Q3.If Samsung Motors makes an after tax profit of $100 million, what share of that profit would go to the Lee family?
What percentage of the firm do they directly own?
Firms / affiliates owners (% of Lee family control) Samsung Electronics (5.41%) Samsung Co (2.32%) Samsun Life Ins. (15%) The Joong-‐ Ang Daily news (41.80%)
Samsung Electronics
4.45%
8.16%
Samsung Display Devices
10.87%
5.39%
Samsung Heavy industries
18.92%
4.92%
Samsung Electro-‐mechanics
21.92%
5.59%
Samsung Everland
1.89%
17.10%
*Only the participations > 1% are taken into account here
To determine in what extent the Lee family controls the affiliates owners of Samsung Motors, we have to use the decomposition of their capital in terms of affiliates directly controlled by the Lee family. (In facts, thanks to cross-ownership, the control level should be higher than what we will find, but the high level of dilution makes the additional control very limited).
So, the Lee family indirectly controls :
• 4.45% x 2.32% + 8.16% x 15% = 1.33% of Samsung Electronics • 10.87% x 5.41% + 5.39% x 15% = 1.37% of Samsung Display
• 18.92 % x 5.41% + 4.92% x 15% = 1.76% of Samsung Heavy Industries • 21.92% x 5.41% + 5.59% x 15% = 2.02% of Samsung Electro-Mechanic • 1.89% x 2.32% + 17.10% x 41.80% =7.19%
Q3.If Samsung Motors makes an after tax profit of $100 million, what share of that profit would go to the Lee family?
What percentage of the firm do they directly own?
As a result, we find that the Lee family will perceive $420,000 of dividends*.
Finally, the Lee family has claim on 1.05% of the dividends*, whereas they have no direct control on the firm.
*
This estimation strongly depends on Samsung motor’s and of its affiliates’ payout ratio.Samsung Electronics $8.44 million earnings $3.38 million dividends* Samsung Display Devices $2.98 million earnings $1.19 million dividends* Samsung Heavy Inustries $0.99 million earnings 0.4 million dividends* Samsung Electro Mechanics $2.43 million earnings $0.97 million dividends* Samsung Everland $0.5 million earnings $0.2 million dividends* Lee family $45,000 Lee family $14,000 1.33% Lee family $16,400 1.38% Lee family $7,000 1.76% Lee family $19,600 2.02% 7.19%
Q3.If Samsung Motors makes an after tax profit of $100 million, what share of that profit would go to the Lee family?
What percentage of the firm do they directly own?
Composition of the board
• 7 Samsung Electronics executives
• 12 Samsung Cheabol executives (including the wife of Samsung Electronics’ Chairman)
• 1 family member (son of Samsung Electronics’ Chairman) and large shareholder of a Samsung Cheabol company
• 3 independent directors: one advisor from the Boston Consulting Group, one president of a law office and one CEO of a company that doesn’t belong to the Samsung Cheabol
Comments
This composition reveals that most of the members are either members of the Samsung Cheabol executives or members of the family.
Only 3 members of the board can be considered as independent as they are neither stakeholders nor employees nor members of the Samsung Cheabol.
The representation of the family, executives and affiliate firms (87% of the board) seems disproportionate when compared with their ownership of the company (21% in total).
Strengths
• Stability and guarantees in the firm’s strategy: given the board composition, we can be sure that any vote coming from Samsung Electronics executives will result in an approval (given the cross-ownership structure of the Chaebol, Samsung Electronics
executives are also present in affiliates board, so no affiliate executive will venture himself in voting against Samsung Electronics executives because they need them to approve their own board decisions).
• No risk of takeover : this composition makes sure that Samsung Electronics belongs and obeys to Samsung’s Chaebol (especially trough affiliates).
Weaknesses
• No way to ensure that the value of the independent shareholder is maximized : the board could take decisions at the benefit of the Chaebol as the whole (transfer pricing concern) and not at the one of the proper firm.
• Given the importance of M. Lee or of his subordinates in this board, the concern for self-dealing is legitimate.
In order to pursue what should be Samsung Electronics’ goal (shareholder wealth maximization), a solution would be to increase the number of outside directors, and to decrease the number of Samsung Cheabol’s executives.
The Price of the Bonds issued
• The previous bonds issue happened in September 1996: Issued on the London Stock Exchange and their price : KRW72,784 per bond
• The second bonds issue was in December 1997: their price dropped to KRW49,931 per bond.
• The price of a convertible bond is determined partly by the price of the share. The convertible bond consists of an underlying asset (the stock) plus a premium. In theory, the price of the convertible bond should be much higher the price of the stock. • During the month of the second issue, the price of the stock was quite low (around 35). But the linear price is slightly declining
but still above 50.
• Hence, the board could expect the share price to rise again. The natural conclusion would be that the deal was favourable to the buyers.
The explanations provided by Samsung
• The other evidence, harder to find, concern the difficulties Samsung had to find sources of funding.
• We could compare Samsung to similar firms: could a firm similar to Samsung managed to successfully issue bonds on the international market ?
• We should also try to demonstrate that Samsung was able to rise money from the domestic financial institutions, again using a comparison with similar companies
