Ongoing Challenges on Managerial Innovation at the Korean High-Tech Firms (Part II): The Owner-Centered System and Convoluted Governance Structure

One of the main characteristics of chaebols is their owner-centered management system. The founding families have exerted their influence through their corporate governance structures. The chaebol’s inadequate governance system has come under sharp criticism. Their weak system has been considered the main culprit of many problems chaebols have faced including obscure accounting system, overlending practices among affiliates, and ill-conceived diversification. Apart from this, one of the most appalling aspects of this structure, which is often overlooked, is the fact that it cripples innovation.

Let’s take a look at the case of Samsung Electronics, Asia’s most valuable high-tech company, in the context of the chaebol system to understand chaebols’ managerial practices.

Samsung Electronics is a part of Samsung Group, and the Lee family’s power at Samsung Group flows around a circle. “The Lee family now owns 46% of Everland, which in turn owns 13.3% of Samsung Life, South Korea’s biggest life insurer. Samsung Life owns 7.2% of Samsung Electronics, the world’s biggest electronics company, which owns 35.3% of Samsung Card, the country’s biggest credit-card firm – which in turn owns 25.65 of Everland.”

It has been criticized that Samsung Everland, an unlisted amusement-park operator and real-estate developer has been served as the Lee family’s de factor holding company. Samsung Life, an unlisted insurance company, is the largest single shareholder in Samsung Electronics and has played a role as a shield to protect their entire Samsung system. The Lee family has been allowed to control the entire Samsung Group through enlisted group affiliates. However, there is a concern that this may all change when Samsung Life becomes listed since it would trigger a class-action lawsuit by Samsung Life shareholders. Financial companies are not allowed to control industrial companies neither in the States nor in Europe.

The biggest flaw of this structure lies in their financial intricacy, causing conflicts of interest: owning each other’s shares and holding debt in one another. A good example is failed auto venture where Samsung affiliates became vulnerable to the chairman’s overleveraged project.

While this owner-centered managerial system had worked to their advantages in making speedy strategic decision-making needed for scale-intensive products in the risky high tech industry, it triggered bad repercussions such as unfair internal business trade practices. Furthermore, it has often hampered their affiliates’ independent strategy.

In many cases, the founding families of Korean chaebols still oversee their big businesses. It is not surprising to find out that the second and third generation family members continue to run the company. Even in the case that they put professional managers in the top position, the critical strategic decisions are often made by their core controlling family members.

The effects of this structure on innovation activities seem to be profound. It causes not only overlending problem among affiliates but its baneful effect on product innovations. It dampens entrepreneurial spirit, risk taking behavior and independent thinking. The reason Korean high-tech chaebols can’t go beyond the fast-follower stage runs deeper than a lack of the capacity to develop proprietary technology.

The fact that there is an indisputable power behind all the major decisions can foster an unconstructive culture in which cronyism and conformity are rampant. In the case of Samsung, it is so ironic that the products they produce are based on the state of art technology, yet their internal management system is outmoded. Improving corporate governance along with proper organization structure and managerial practices seems to be far more critical than reshuffling its workforce whenever a crisis arises.

Their convoluted governance system has been geared to keep the founding family’s influence over the chaebol intact. However, their cross-shareholding structure seems to be hanging by a tread: if one link is severed, the entire system breaks.

Why does a majority of Korean chaebols hang on to the owner-centered management system through inadequate governance structure? There can be many reasons for that. One seems to be closely related to social capital. The issue of social capital has been a deeply rooted problem in Korea, which will be discussed in the next post.