Sustainability in corporate Korea: reporting advances but governance is still muddied by Chaebols

The family link to the country’s corporate giants leaves investors with an accountability issue.

Korea was a comparable late starter in terms of adaption of sustainability management practices. However, what has characterised the success of Korean companies over the last decade also applies to sustainable management: review, analyse, adapt, and, maybe most importantly, implement quickly. The change of awareness and implementation of management systems related to sustainability has been significant since the Korean government’s 2009 announcement of the national “low carbon green growth strategy” in the aftermath of the financial crisis. An obvious sign is the flood of sustainability reports: nearly all major companies now communicate sustainability activities in one form or another, with leading companies leap-frogging directly to integrated reporting. Reporting can be a proxy for management awareness, but a sustainability report alone does not necessarily mean that a company implements sustainability throughout its operations. Our CSR review, based on an industry-specific ESG evaluation methodology, reveals that sustainability management systems and performance have increased throughout a large number of sustainability criteria. The average ‘economic sustainability’ level of companies has improved by 5.8% since 2012 on the back of improved risk management, early warning systems and ethical management. The introduction and upgrading of (often IT-based) environmental performance tracking systems (energy, water, GHG emissions) has lead to increased resource efficiency (measured against productivity), reflected in an increase of the average environmental sustainability performance by 27.5% since 2007. Social sustainability management has increased by 29.8% over the same time period due to better integrated HR management and development systems, alignment of social philanthropy, and slight improvements in integrating sustainability considerations into supply chain management.However, while the average sustainability integration has moved significantly, there is still plenty of room for further improvements. In some relevant criteria, no improvements have been observed. One of these is corporate governance. On the face of it, Korean corporations have a clean governance structure complying with what is generally referred to as governance best practice: a two-tier structure with an executive management and a Board of Directors with a majority of non-executive (outside) directors, CEO/Chairman role is normally split, a director selection committee, audit committees staffed with outside directors, bios of directors and meeting attendance disclosed. However, power is located outside the board room and decisions are made elsewhere. Korean corporations have a particular form of organisation known as “Chaebol”, a name retrieved from the words “chae” (wealth) and “pol” (family, clan). The control of these companies has been passed from the company founders to their male heirs (there has been no case of a female family successor to this date). The expansion of these groups to their current seize would not have been possible without external capital, leading to a situation where the actual ownership of the founding families in percentage of stocks of the company is negligible. Companies within a Chaebol are organised in an elaborate ownership-structure (circular ownership (e.g. Samsung), cross-ownership (e.g. Hyundai Motors Group), or pro-forma holding structures, e.g. LG), whose single purpose is to ensure that total control over all group companies remains within the family. In other words, Chaebols are little monarchies whose fate rests solemnly with the heirs of the founders, who themselves are not the owners of the company. The role of a board director in such a company is a role of honour after a long career in academics, government offices or the jurisprudence system. The director’s role is to approve
the heir’s family decisions instead of guaranteeing checks and balances in the interest of the shareholders. Family-owned businesses can be good investment value, as empirical studies suggest. However, in the case of the Chaebol, there is a high disparity between ownership and control. Absolute and unchallenged control tends to corrupt. The chairman (founding family heirs) of four of the largest Chaebol have been prosecuted and sentenced to prison for a variety of illegal business transactions such as channelling company assets into private accounts and creating secret slash funds with company assets to garner favours from politicians and prosecutors. If the law was applied to all Koreans equally, they would currently be in prison. However, due to their “importance to the nation”, they have all been pardoned, and are back in their controlling positions as if nothing happened. For investors, this structure implies a set of risks:
• a not foreseeable risk of incidents/scandals that might affect the company value and continuity
• risk of sudden restructuring, e.g. moving a division from one company to another without adequate compensation, or shady transaction between group companies negatively affecting the value of one of the companies
• risk of continued feuds between family members over control of the conglomerate, paralysing strategic decision-making
• risk of discontinuity: next-generation leaders are chosen based on birth, not based on merit. If they do not possess the foresight required to steer a company, the company is in risk of losing its edgeAnalysis of the financial performance of the leading Korean companies in terms of overall sustainability in Korea shows the merit of sustainable investment: the shares of companies that have higher sustainability management capabilities achieve higher returns than the market. However, some SRI benchmarks appear to underperform the market, underscoring a need for ESG methodologies that do not rely too much on voluntary disclosure (sustainability related policies and reports) or questionnaires.
SRI market developments: corporates from Venus, financials from Mars. The main (and only) driver for SRI/RI/ESG investment in Korea has been the Korean National Pension Service (NPS), that first tendered asset mandates against SRI in 2006, and has committed to increase related investments to more than U$10 billion in the next years. However, the policy and investment requirements for those funds are very vague, leaving the definition of “SRI” to asset managers. In practice that means that SRI investment in Korea is equal to mainstream investment with the only difference that the starting universe is screened against certain SRI criteria, i.e. the investment universe might be slightly different compared to a mainstream fund. After an initial but very short-lived surge of SRI investment in 2007, SRI investment on the retail side is close to non-existent. While some thematic funds do exist, their relevance in the financial industry remains insignificant. With a focus on short-term returns among both institutional and private investors, there is unfortunately no sign of change in sight despite the significant activities by corporations in terms of improving sustainability management and capitalising on green growth opportunities.

Andy Gebhardt is Founder, SolAbility Sustainability Services in Korea