ADB Book Zhuang, J. D. Edward & V.A. Capulong. 2000.

Corporate Governance
and Finance in East Asia

A Study of Indonesia, Republic of Korea,
Malaysia,Philippines,andThailand
VOLUME TWO
Country Studies
Edited by:
Juzhong Zhuang
SeniorEconomist
RegionalEconomicMonitoringUnit
AsianDevelopmentBank
David Edwards
AssistantChiefEconomist
ProjectEconomicEvaluationDivision
Ma. Virginita A. Capulong

SeniorSectorAnalyst
AgricultureandSocialSectorsDepartment(West)
© Asian Development Bank 2001
Allrightsreserved.
ThispublicationwaspreparedundertheAsianDevelopmentBanksregionalTech-
nical Assistance 5802: A Study on Corporate Governance and Financing in Se-
lected DMCs. The views expressed in this book are those of the authors and do
notnecessarilyreflecttheviewsandpoliciesoftheAsianDevelopmentBank,or
itsBoardofDirectorsorthegovernmentstheyrepresent.
The Asian Development Bank does not guarantee the accuracy of the data in-
cludedinthispublicationandacceptsnoresponsibilityforanyconsequencesfor
theiruse.
Use of the term country does not imply any judgment by the authors or the
AsianDevelopmentBankastothelegalorotherstatusofanyterritorialentity.
ISBN 971-561-323-3
Publication Stock No. 100800
Published and printed by theAsian Development Bank

P.O. Box 789, 0980 Manila, Philippines
iii
Contents
List of Tables vi
List of Figures ix
Foreword x
Preface xi
Abbreviations xii
1 Indonesia 1
1.1 Introduction 1
1.2 OverviewoftheCorporateSector 3
1.2.1 HistoricalDevelopment 3
1.2.2 TheCapitalMarket 4
1.2.3 The Banking Sector 5
1.2.4 ForeignCapital 7
1.2.5 GrowthandFinancialPerformance 8
1.2.6 LegalandRegulatoryFramework 15
1.3 CorporateOwnershipandControl 17
1.3.1 CorporateOwnershipStructure 17
1.3.2 ManagementandInternalControl 25
1.3.3 ExternalControl 30
1.4 CorporateFinancing 32
1.4.1 FinancialMarketInstruments 32
1.4.2 PatternsofCorporateFinancing 34
1.4.3 CorporateFinancingandOwnershipConcentration 35
1.5 TheCorporateSectorintheFinancialCrisis 36
1.5.1 CausesoftheFinancialCrisis 36
1.5.2 ImpactoftheFinancialCrisisontheCorporateand
BankingSectors 39
1.5.3 Responses to the Crisis 42
1.6 Summary, Conclusions, and Recommendations 45
1.6.1 SummaryandConclusions 45
1.6.2 Policy Recommendations 48
References 51
2 Republic of Korea 53
2.1 Introduction 53
2.2.2 Rise of the Large Business Groups (Chaebols) 60
2.2.3 RoleoftheCapitalMarketandForeignCapital 62
iv
2.3.1 PatternsofCorporateOwnership 74
2.3.2 InternalManagementandControl 94
2.3.3 ShareholderRights 103
2.3.4 ControlbyCreditors 105
2.3.5 TheMarketforCorporateControl 108
2.3.6 ControlbytheGovernment 110
2.3.7 EmployeeParticipationinCorporateGovernance 111
2.4.1 Overview of the Financial System 113
2.4.3 FinancialStructure,Diversification,andCorporate
Performance 128
2.5.1 WeaknessesinCorporateGovernance 132
2.5.2 TheRoleofGovernmentIntervention 134
2.5.3 ManifestationsofWeakCorporateGovernanceand
GovernmentIntervention 134
2.5.4 ShortcomingsinMacroeconomicPolicy 137
2.6 Responses to the Crisis and Policy Recommendations 139
2.6.1 CorporateRestructuringActivities 139
2.6.2 PolicyMeasuresforCorporateReform 143
References 153
3 The Philippines 155

3.1 Introduction 155
3.3.2 CorporateManagementandShareholderControl 186
3.3.3 TheRoleofCreditorsinCorporateControl 198
3.4.1 TheFinancialMarketandInstruments 199
3.4.3 OwnershipConcentration,FinancialLeverage,and
Performance 209
3.5.1 TheFinancialCrisis:CausesandManifestations 210
3.5.2 ImpactoftheCrisisontheCorporateSector 212
v

References 226
4 Thailand 229
4.1 Introduction 229
4.2.2 DevelopmentofCapitalMarkets 233
4.3.2 CorporateManagementandControl 244
4.3.3 ExternalControl 248
4.4.1 OverviewoftheFinancialSector 252
4.5 TheCorporateSectorduringtheFinancialCrisis 261
4.5.1 ImpactoftheFinancialCrisisontheCorporateSector 261
References 277
vi
List of Tables
1. Indonesia
Table 1.1 Growth of the Banking Sector, 1993-1999 6
Table 1.2 Foreign Capital Flows, 1990-1998 7
Table 1.3 GrowthandFinancialPerformanceofPubliclyListed
Companies, 1992-1997 9
Table 1.4 Growth Performance of Publicly Listed Companies by
Sector, 1992-1997 11
Table 1.5 Financial Performance of Publicly Listed Companies by
Sector, 1992-1997 12
Table 1.6 GrowthandFinancialPerformanceofState-Owned
Companies, 1992-1995 14
Table 1.7 Growth Performance of the Top 300 Conglomerates,
1990-1997 14
Table 1.8 OwnershipConcentrationofPubliclyListedCompanies,
1993-1997 18
Table 1.9 OwnershipConcentrationofPubliclyListedCompanies
by Sector, 1997 19
Table 1.10 Anatomy of the Top 300 Indonesian Conglomerates,
1988-1996 21
Table 1.11 CharacteristicsoftheBoardofCommissioners 26
Table 1.12 CharacteristicsoftheBoardofDirectors 27
Table 1.13 Presence of Board Committees in Listed Companies 28
Table 1.14 Banking Sector Outstanding Loans, 1992-1999 32
Table 1.15 Value of Stocks Issued and Stock Market Capitalization,
1992-1999 33
Table 1.16 FinancingPatternsofPubliclyListedNonfinancial
Companies, 1986-1996 34
Table 1.17 DER of Listed Companies by Degree of Ownership
Concentration 36
Table 1.18 GDP Growth by Sector, 1996-1999 39
Table 1.19 DER and ROE of Publicly Listed Companies by Sector,
1996-1998 40
Table 1.20 ROE of the Banking Sector, 1992-1997 41
Table 1.21 Nonperforming Loans by Type of Bank, 1996-1998 41
2. Republic of Korea
Table 2.1 Listed Firms with Positive Economic ValueAdded,
1992-1998 54
Table 2.2 KeyMacroeconomicIndicators 56
Table 2.3 Subsidiaries of the 30 Largest Chaebols 61
Table 2.4 Development of the Stock Market, 1985-1998 63
vii
Table 2.5 Private Capital Flows to Korea, 1985-1998 64

Table 2.6 GrowthandFinancialPerformanceoftheNonfinancial
Corporate Sector, 1990-1997 66
Table 2.7 InternationalComparisonofRatiosofOrdinaryIncome
toSalesinManufacturing 66
Table 2.8 GrowthandFinancialPerformanceofSelectedIndustries 68
Table 2.9 GrowthandFinancialPerformanceofListedCompanies,
1985-1997 70
Table 2.10 GrowthandFinancialPerformanceofListedCompanies
by Size, 1988-1997 71
Table 2.11 Features of the 30 Largest Chaebols 72
Table 2.12 GrowthandFinancialPerformanceofthe30Largest
Chaebols, 1993-1997 73
Table 2.13 The Top 30 Chaebols Debt-to-Equity Ratio, 1995-1997 75
Table 2.14 Ownership Composition of Listed Companies, 1988-1997 78
Table 2.15 Ownership Composition of Listed Nonfinancial Firms
by Industry, 1990 and 1997 80
by Size, 1997 82
by Control Type, 1997 82
Table 2.18 Ownership Composition of Listed Firms in Selected
Countries, 1997 83
Table 2.19 Ownership Concentration ofAll Listed Firms, 1992-1997 84
Table 2.20 OwnershipConcentrationofListedNonfinancialFirms,
1988-1997 85
Table 2.21 OwnershipConcentrationofListedNonfinancialFirms
by Industry, 1997 86
Table 2.22 OwnershipConcentrationofListedNonfinancialFirms
by Firm Size, 1988-1997 87
Table 2.23 Ownership Concentration of the Survey Sample of 81
Listed Firms, 1999 90
Table 2.24 InternalShareholdingsofthe30Largest Chaebols,
1987-1997 91
Table 2.25 FlowofFundsoftheNonfinancialCorporateSector,
1988-1997 120
Table 2.26 FinancingPatternsoftheNonfinancialCorporateSector,
1988-1997 121
Table 2.27 FinancingPatternsoftheNonfinancialCorporateSectorby
Industry 122
Table 2.28 Financing Patterns of Listed Companies, 1994-1998 126
Table 2.29 Financing Patterns of the Top 30 Chaebols, 1994-1997 126
Table 2.30 Cross-Payment Guarantees of the Top 30Chaebols,
1993-1997 127
viii
Table 2.31 Net Profit Margins of Chaebols, 1985-1997 131

Table 2.32 Number of Firms with Dishonored Checks, 1986-1998 137
Table 2.33 Nonperforming Loans of General Banks, 1990-1998 138
3. The Philippines
Table 3.1 GDP Growth of SoutheastAsian Countries, 1990-1999 158
Table 3.2 Growth and Financial Performance of the Top 1,000
Companies, 1988-1997 159
Table 3.3 TheCorporateSectorandGrossDomesticProduct,
1988-1997 160
Table 3.4 GrowthandFinancialPerformanceoftheCorporateSector
by Ownership Type, 1988-1997 161
by Control Structure, 1988-1997 163
by Firm Size, 1988-1997 164
by Industry, 1988-1997 166
Table 3.8 Ownership Composition of Philippine Publicly Listed
Companies by Sector, 1997 173
Table 3.9 OwnershipConcentrationatCriticalLevelsofControl
Over Publicly Listed Companies, 1997 175
Table 3.10 Composition of Top Five Shareholders of Philippine
Publicly Listed Companies by Sector, 1997 176
Table 3.11 TotalandPerCompanySales,SectorOrientation,
Flagship Company, andAffiliated Banks of Selected
Business Groups, 1997 180
Table 3.12 Control Structure of the Top 50 Corporate Entities, 1997 184
Table 3.13 ADB Survey Results on Shareholder Rights 191
Table 3.14 Philippine Stock Market Performance, 1983-1997 201
Table 3.15 Financing Patterns of the Corporate Sector, 1989-1997 203
Table 3.16 CorporateFinancing PatternsbyOwnershipType,1989-1997 204
Table 3.17 Composition ofAssets and Financing of the Publicly
Listed Sector, 1992-1996 205
Table 3.18 Financing Patterns by Control Structure, 1989-1997 206
Table 3.19 Financing Patterns by Firm Size, 1989-1997 207
Table 3.20 Financing Patterns by Industry, 1989-1997 208
Table 3.21 OwnershipConcentration,Profitability,andFinancial
Leverage 209
Table 3.22 Foreign Investment Flows, 1995-1998 212
4. Thailand
Table 4.1 Public Companies Registered, 1978-2000 235
Table 4.2 Public Offerings of Securities, 1992-1999 236
ix
Table 4.3 StatisticalHighlightsoftheStockExchangeofThailand,

1993-1999 237
Table 4.4 Key Financial Ratios of Publicly Listed Companies,
1985-1996 238
Table 4.5 Average Key Financial Ratios by Company Size, 1985-1996 239
Table 4.6 Top-Five Ownership Concentration of Publicly Listed
Companies in Thailand, 1990-1998 241
Table 4.7 StatisticalRelationshipsbetweenCorporateProfitability,
Leverage, Ownership Concentration, and Company Size 242
Table 4.8 Top-Five Shareholder Composition of Publicly Listed
Companies in Thailand, 1990-1998 243
Table 4.9 Merger and Acquisition Activities, 1993-1999 251
Table 4.10 Size and Composition of the Thai Financial Sector,
1992-1999 252
Table 4.11 Offerings of Debt Securities, 1992-1999 256
Table 4.12 Common-Size Statements for Companies Listed in SET,
1990-1996 258
Table 4.13 Common-Size Statements of Public Companies by
Ownership Concentration, 1990-1996 259
Table 4.14 Financial Ratios of All Listed Firms, 1990-1996 260
Table 4.15 Financial Ratios of Listed Companies by Ownership
Concentration, 1990-1996 261
Table 4.16 External Debt, 1986-1999 262
Table 4.17 NumberofNewlyRegisteredandBankrupted/Closed
Companies, 1985-1999 264
List of Figures
Figure 1.1 TheSuhartoGroup 24
Figure 1.2 TypicalInternalOrganizationalStructureofaPublicly
Listed Company in Indonesia 25
Figure 3.1 CorporateControlStructure:TheCaseofAyalaCorporation 195
Figure 3.2 CorporateControlStructure:theCaseofLopezGroup 197
x
Foreword
Corporate governance has become a major policy concern in the wake of the
Asian financial crisis. Weak governance structure, poor investment, and risky
financingpracticesofthecorporatesectorintheaffectedcountriescontributedto
their sharp economic recession in 1997-1998. The weaknesses in corporate gov-
ernanceandfinanceunderminedthecapacityofthesecountriestowithstandthe
combined shocks of depreciated currencies, massive capital outflows, increased
interestrates,andlargecontractionindomesticdemand.
Tohelpunderstandcorporategovernanceissuesandtheirimpact,aswell
astoidentifyneedsforinterventionsinaddressingpolicyandinstitutionalweak-
nesses, the Economics and Development Resource Center of theAsian Develop-
ment Bank (ADB) undertook a regional study on corporate governance and fi-
nance in selected developing member countries. The countries covered are Indo-
nesia, Republic of Korea, Malaysia, Philippines, and Thailand. This book presents
the major findings of the study. The policy recommendations will supportADBs
financialsectorworkinitsdevelopingmembercountries.
Arvind Panagariya
ChiefEconomist
xi
Preface
Corporate Governance and Finance in EastAsia presents the findings of a re-

gionalstudyofcorporategovernanceandfinanceinselecteddevelopingmember
countries of theAsian Development Bank (ADB). The study attempts to identify
theweaknessesincorporategovernanceandfinanceincountriesmostaffected
by the 1997Asian financial crisis, and recommends policy and reform measures
to address the weaknesses. The study covers Indonesia, Republic of Korea, Ma-
laysia, Philippines, and Thailand.
The findings of the study are presented in two volumes. Volume One,A
ConsolidatedReport,presentsaframeworkforanalyzingcorporategovernance
and finance, summarizes the major findings of the five country studies, and pro-
videskeypolicyrecommendationsforstrengtheningcorporategovernanceand
improving the efficiency of corporate finance inADB member countries. Volume
Two,CountryStudies,collectsfourcountryreports.Wewouldliketothankcountry
experts Saud Husnan of Gadsab Mada University, Indonesia; Kwang S. Chung
andYen Kyun Wang of Chung-Ang University, Republic of Korea; FazilahAbdul
Samad of University of Malaya, Malaysia; Cesar G. Saldaña of PSR Consulting,
Inc., the Philippines; and Piman Limpaphayom of Asian University of Science
and Technology, Thailand, for their efforts and cooperation in conducting the
countrystudies.CesarG.Saldañaalsoprovidedusefulinputstothepreparation
oftheconsolidatedreport.
The volumes benefited extensively from constructive comments from
ADBstaffandofficialsoftheministriesoffinance,centralbanks,securitiesand
exchangecommissions,stockexchanges,andcorporaterestructuringagenciesof
theeightADBmembercountriesthatparticipatedinthestudysfinalizationwork-
shop in Manila, on 18-19 November 1999.
Our deep appreciation goes to Jungsoo Lee, former Chief Economist,
and S. Ghon Rhee, former Resident Scholar, for their strong support at various
stages of the study; Manabu Fujimura, for his efforts in organizing the finaliza-
tionworkshop;MarceliaGarcia,MarinieBaguisa,Ma.ReginaSibal,andRosanna
Benavidez, for their administrative support and assistance; and JosefYap, Leah
Sumulong, Graham James Dwyer, Judith Banning,andLynetteMallery, for their
editorialassistanceandadvice.
xii
Abbreviations
ADB Asian Development Bank

AGM annualgeneralmeeting
AGSM annualgeneralshareholdersmeeting
AMU assetmanagementunit
APEC Asia-Pacific Economic Cooperation
B baht
BDC Bond Dealers Club
BIBF BangkokInternationalBankingFacility
BIS BankforInternationalSettlements
BOC board of commissioners
BOD boardofdirectors
BSDC BangkokStockDealingCenter
BSP BangkoSentralngPilipinas(CentralBank)
BUN Bank Umum Nasional
CB convertiblebond
CDRAC CorporateDebtRestructuringAdvisoryCommittee
CEO chiefexecutiveofficer
CP commercialpaper
CRA CorporateRestructuringAgreement
DER debt-to-equityratio
ESOP employee stock ownership plan
EVA economicvalueadded
FDI foreigndirectinvestment
FSC Financial Supervisory Commission
GAAP generallyacceptedaccountingprinciples
GATT GeneralAgreementonTariffsandTrade
GDP grossdomesticproduct
GNP grossnationalproduct
HCI heavyandchemicalindustries
IBRA IndonesianBankRestructuringAgency
IDFR incrementaldebtfinancingratio
IEFR incrementalequityfinancingratio
IFS InternationalFinancialStatistics
IMF InternationalMonetaryFund
IPO initialpublicoffering
IPP investmentprioritiesplan
JSX JakartaStockExchange
NBFI nonbankfinancialinstitution
NEFR newequityfinancingratio
NPL nonperformingloan
OECD OrganisationforEconomicCo-operationandDevelopment
OTC over-the-counter
xiii
P peso
PCO planningandcoordinationoffice
PD PresidentialDecree
PICPA PhilippineInstituteofCertifiedPublicAccountants
PLDT Philippine Long Distance Telephone Co.
PSE Philippine Stock Exchange
PTB principaltransactionsbank
ROA returnonassets
ROE returnonequity
Rp rupiah
RSA Revised SecuritiesAct
SBL singleborrowerlimit
SCS shareofacontrollingshareholder
SEA Securities and ExchangeAct
SEC Securities and Exchange Commission
SET StockExchangeofThailand
SFR self-financingratio
SMC SanMiguelCorporation
SSS Social Security System
SOC State-ownedcompany
TIE timesinterestearned
TQ Tobins Q
W won
US UnitedStates
Note: In this volume, $ refers to US dollars, unless otherwise stated.

1
Indonesia
Saud Husnan1
1.1 Introduction
The currency crisis that began in mid-1997 in Thailand spread quickly to

Indonesia and the rest of Southeast Asia. Initially, Indonesia’s monetary
authority tried to defend the domestic currency, the rupiah, by widening the
intervention band, while maintaining its managed floating system. From
5 to 8 percent in June 1997, when the currency crisis hit Thailand, the band
was widened to 12 percent on 11 July 1997 when the crisis started spilling
over to Indonesia. After resisting pressure for a short period, the rupiah fell
by 6 percent against the dollar on 21 July 1997, the biggest one-day fall in
five years. Finally, the Indonesian monetary authority realized that the sys-
tem could not cope with the continuing pressure on the currency, as the risk
of losing all foreign exchange reserves to prop up the rupiah was too high.
On 14 August 1997, the monetary authority decided to adopt a free floating
exchange rate system.
The currency fell further because of strong demand for dollars. As
the rupiah weakened, nervous lenders refused to refinance maturing loans,
investors cut down and then reversed the flow of funds, borrowers tried to
obtain dollars before the rupiah fell further, and individuals joined the chase
for dollars. At that time, several banks ran out of dollar notes. From Rp4,950
to the dollar at the end of December 1997, the exchange rate fell to more
than Rp15,000 at the height of the crisis in June 1998, although it later
stabilized at about Rp9,000. At that exchange rate, it is estimated that half
of Indonesian corporations became technically insolvent. The crisis also
exacerbated an already deepening political turmoil.
The financial crisis devastated the Indonesian economy. In 1998,
gross domestic product (GDP) contracted by 13 percent and the inflation
1
Associate Professor, Faculty of Economics, Gadsab Mada University, Yogyakarta,
Indonesia. The author wishes to thank Juzhong Zhuang, David Edwards, both of
ADB, and David Webb of the London School of Economics for their guidance and
supervision in conducting the study, the Jarkata Stock Exchange for its help and
support in conducting company surveys, and Lea Sumulong and Graham Dwyer for
their editorial assistance.
2 Corporate Governance and Finance in East Asia, Vol. II
rate reached 58.5 percent. All sectors, except utilities, posted negative growth.
The construction sector was the worst hit, contracting by 36.5 percent, fol-
lowed by finance (-26.6 percent) and trade (-18 percent).
The scale of the financial crisis exposed weaknesses of the coun-
try’s corporate sector. The highly concentrated and family-based ownership
structure of corporate groups and companies resulted in a governance struc-
ture where corporate decisions lie in the hands of controlling families. In
many instances, these controlling families had political connections that
allowed their companies to enjoy special privileges. Foreign creditors, no
doubt, placed a high premium on these political connections in assessing
the chances of being repaid. To facilitate even easier access to credit, the
controlling families of corporate groups often established banks to provide
funds to affiliated nonfinancial companies. These banks were allowed to
operate even if they violated minimum capital adequacy requirements. In
this setup, short-term loans were used to finance long-term investments.
Lending activities of affiliate banks that were not sufficiently backed by
owners’ equity and the reliance by foreign lenders on the strength of politi-
cal connections paved the way for risky investments. These were already
contributing to high levels of nonperforming loans (NPLs) in the Indone-
sian banking sector several years before the 1997 crisis erupted.
On the other hand, prior to the financial crisis, the Indonesian
economy seemed to be in generally good shape. Economic growth reached
more than 7 percent per year and the inflation rate was kept at single digit
levels. However, the currency composition and term structure of corporate
foreign indebtedness were causes for concern. Foreign debt reached more
than $100 billion. Although as a percent of GDP the stock of outstanding
foreign debt owed directly by the private sector was smaller than that of
the Republic of Korea, Malaysia, or Thailand, this left the Indonesian
economy extremely vulnerable. When the crisis hit the country, highly
leveraged companies, particularly those with large foreign loans, were
the ones most affected.
This study reviews the Indonesian corporate sector’s historical de-
velopment, regulatory framework, patterns of ownership and control, pat-
terns of financing, and responses to the financial crisis. It analyzes the weak-
nesses of corporate governance in Indonesia, how it has affected corporate
financial performance and financing, and how it contributed to the crisis.
The study also identifies family-based companies and corporate groups,
and analyzes their importance to the corporate sector in Indonesia.
Section 1.2 presents an overview of the Indonesian corporate sec-
tor. Section 1.3 looks at patterns of corporate ownership and control, and
Chapter 1: Indonesia 3
profiles the corporate sector’s governance characteristics. This section

reports the results of an Asian Development Bank (ADB) survey on cor-
porate management and control practices in Indonesian publicly listed
companies.2 Section 1.4 analyzes corporate financing patterns. It also ex-
amines the statistical relationship between corporate performance and cor-
porate governance characteristics. Section 1.5 examines the corporate sector
during the financial crisis in terms of its role, how it was affected by the
crisis, and its response. Section 1.6 summarizes the major findings of the
study and suggests recommendations to improve governance in the Indo-
nesian corporate sector.
1.2 Overview of the Corporate Sector
1.2.1 Historical Development
The marked permeability between the State and business in Indonesia goes
back to the country’s struggle for independence. The Government became
directly involved in industry as a result of the nationalization of Dutch-
owned shipping firms and oil companies, in the course of the fight for na-
tionhood from 1942 to 1950. Up until the mid-1960s, while Chinese and
indigenous entrepreneurs ran some large businesses in trading, textiles, and
tobacco industries, medium- and large-scale companies were dominated by
state-run industrial concerns.
With the relatively liberal laws governing foreign and domestic
private investments introduced by the New Order Government in 1967 and
1968, a gradual shift in public investment away from manufacturing took
place. Subsequently, substantial volumes of private investment entered the
scene.
In the early 1970s, the windfall from oil and gas revenues was an
important factor that allowed the Government to promote industrial devel-
opment via import substitution. The industries that emerged were highly
import-dependent and reliant on tariff protection. Despite the oil revenues,
2
Survey questionnaires were sent to 280 companies listed in the Jakarta Stock Exchange.
However, only 40 companies replied—39 are private companies and one state-owned
company (Bank BNI). Not all items in the questionnaires were answered by the re-
spondents.
the currency needed to be devalued periodically under a managed floating

exchange rate system to avoid large current account deficits. During this
period, a distinct industrial elite started to emerge. These were families
with strong links to the political elite of the New Order.
In the 1980s, the Government shifted its industrial policy toward
the promotion of labor-intensive exports. Export credits with low interest
rates were granted to industries that were intensive in the use of local labor
and raw materials. By 1987, exports of nonoil products (particularly tex-
tiles and footwear, wood, and related products) had shares in total exports
that were rapidly increasing. In 1992, the value of manufactured exports
overtook the value of oil and gas exports for the first time.
Partly as a result of various government policies, the Indonesian
industrial sector was quite diverse. While most of the companies were small,
produced consumer goods, and employed the bulk of the industrial labor
force, there were also many rapidly growing large-scale companies and
business groups or conglomerates, which dominated their respective sectoral
outputs and markets.
1.2.2 The Capital Market
The Government reactivated the stock exchange in 1977. A number of un-

derwriters emerged, mostly nonbank financial institutions and stockbro-
kers. But until the end of 1988, the number of firms quoted in the stock
market was only 24. The equity market remained largely unappealing due
to a number of factors. First, many founding owners of companies were
reluctant to go public and dilute their corporate ownership. Generally speak-
ing, the dilution of corporate ownership, even when new shareholders do
not threaten the control exercised by the original owners, potentially sub-
jects companies to greater regulatory scrutiny. Second, the stock exchange
was also unattractive to companies trying to raise capital as they could
borrow from state banks at very low interest rates. Third, investors were
reluctant to supply funds to the stock market because they did not know
whom to trust and the mechanisms that could protect small investors and
shareholders against expropriation by controlling shareholders were under-
developed. Regulations in the banking sector led to equities having higher
risk but lower returns than bank deposits. Last, the Capital Market Execu-
tive Agency and National Investment Trust tried to attract small investors to
the stock market by setting prices and preferring small orders in initial
public offerings (IPOs). But these proved counterproductive because they
limited the potential for capital gains to prospective investors.
At the end of 1988, the liberalization of the banking industry al-

lowed banks to determine lending rates for nonpriority loans. Thus, compa-
nies could no longer enjoy low-interest credit from state banks. The Gov-
ernment also abolished the practice of setting prices for IPOs and removed
restrictions on price movements in the secondary market, which were pre-
viously constrained to 4 percent per day. The Government also allowed
foreign investors to buy up to 49 percent of listed shares. Consequently, the
number of listed companies in the stock exchange increased substantially,
from 24 in 1988 to more than 300 in 1997. During this period, the capital
market played an increasing role in raising long-term funds needed by the
corporate sector. Conglomerates carried out 210 out of 257 IPOs, with a
total value of Rp16.5 trillion. The development of the Indonesian stock
market also provided a vehicle for the privatization of state-owned compa-
nies (SOCs). Since 1977, six SOCs had issued equities in the market, with
a total value of more than Rp8 trillion. However, to date, the controlling
shareholder of these SOCs is still the State.
1.2.3 The Banking Sector
Despite the development of the stock market, the banking sector has been
and still is the major source of credit for the corporate sector. Through the
years, the banking sector has undergone many reforms. However, the legal
infrastructure that was supposed to guide the evolution of the banking sec-
tor was not backed by effective enforcement.
The initial banking sector reform was introduced in 1983. Interest
rate regulations on state banks and credit ceilings in general were removed.
The banking sector, which up to then was channeling oil revenues to prior-
ity sectors, began to face competition. The dominance of state banks started
to erode. However, priority credits still enjoyed subsidized interest rates
and funding from the Central Bank. In 1988, more significant reforms were
introduced. These included the opening of the banking industry to new
entrants, reduced restrictions on foreign exchange transactions, and increased
access of domestic banks to international financial markets. Further reforms
along the same direction and affecting state-controlled banks came in the
1990s.
Partly as a result of these reforms, the number of private domes-
tic banks increased. Table 1.1 shows that from 1994 to 1998, private
domestic banks dominated the sector in terms of number and total as-
sets. But in terms of assets per bank, state-owned banks were still among
the biggest.
Table 1.1
Growth of the Banking Sector, 1993-1999
Type of Bank 1993 1994 1995 1996 1997 1998 1999
State-Owned Banks
Assets (Rp trillion) 100.6 104.5 122.6 141.3 201.9 304.8 391.5
Number of Banks 7 7 7 7 7 7 5
Foreign Banks
Number of Banks 10 10 10 10 10 10 10
Joint Venture Banks
Number of Banks 29 30 31 31 34 34 39
Regional Government Banks
Number of Banks 27 27 27 27 27 27 27
Private National Banks
Number of Banks 161 166 165 164 144 130 92
Total
Number of Banks 234 240 240 239 222 208 173
Source: Bank Indonesia.
Assets and liabilities were concentrated in the top 10 banks. In

terms of assets, private domestic banks among the top 10 in 1997 included
Bank Central Asia (BCA) (ranked first and linked to the Salim group),
Bank Danamon (ranked 7th), and Bank International Indonesia (ranked 9th).
The other banks among the top 10 were state banks. Among private domes-
tic banks, the 10 largest were all affiliated with major business groups. Of
these, BCA, Bank Danamon, and Bank Umum Nasional (BUN) have failed
and the first two are now under management of the Indonesian Bank Re-
structuring Agency (IBRA), while BUN has been closed down by the Gov-
ernment. Both BCA and BUN have shareholders linked to the former Presi-
dent Suharto.
The deregulation of the banking industry and the liberalization of
the capital account created a variety of new sources of financing for the
corporate sector. But the banking system proved incapable of performing
its intermediation function. Because regulation was weak, banks could earn
profits even when they did not gather and process information about risk.
Foreign and domestic banks defaulted on their responsibility of deciding

where capital should go and ensuring that it was used in the most effective
way. In effect, there was an explosion of credit for which the probability of
repayment was based on little but blind faith in the sustainability of rapid
growth and on the presumption that political connections were as good as
government guarantees against bankruptcy of borrowers.
1.2.4 Foreign Capital
The years of rapid industrial growth attracted a large amount of foreign

direct investments (FDIs), initially from Japan and the Republic of Korea.
But FDIs were only one form of foreign capital inflows to Indonesia. In the
1990s, there was a phenomenal growth in direct borrowings by Indonesian
corporations. Until the onset of the crisis, foreign creditors were eager to
provide financing to Indonesia, especially through bank loans. Between
1990 and 1996, Indonesia received capital inflows averaging about 4 per-
cent of GDP. Although these inflows were not nearly as large as those re-
ceived by Thailand (10 percent of GDP) and Malaysia (9 percent of GDP),
they still amounted to a large sum for the economy to absorb.
From the mid-1980s until July 1997, when the financial crisis hit
Indonesia, FDI flows were strong. Most FDIs came in through joint ven-
tures with business groups having strong political connections. Net FDI
flows increased to $5.59 billion in 1996, as shown in Table 1.2. Successive
policy deregulation facilitated FDIs in various light manufacturing indus-
tries, such as metal goods, textiles, and footwear. Increasingly, foreign in-
vestment also had a strong presence in the services and infrastructure sec-
tors. In 1994, the Government allowed foreign investors to own 100 percent
of an Indonesian company, except in certain strategic sectors.
Table 1.2
Foreign Capital Flows, 1990-1998
($ billion)
Type of Flows 1990 1991 1992 1993 1994 1995 1996 1997 1998
Net FDI 1.09 1.48 1.78 2.00 2.11 3.74 5.59 4.50 (0.40)
Net Portfolio Investment (0.09) (0.01) (0.09) 1.81 3.88 4.10 5.01 (2.63) (1.88)
Foreign Bank Loans — — — — — — 8.87 7.33 (13.15)
— = not available.
Source: IFS CD-ROM, IMF, September 2000; Joint BIS-IMF-OECD-World Bank Statistics on Exter-
nal Debt, November 2000.
Up until the late 1980s, participation in the Indonesian stock mar-

ket was exclusive to domestic investors. The Government relaxed this re-
striction in 1988, allowing foreign investors to buy up to 49 percent of
stocks of a publicly listed company. Consequently, foreign investors began
to dominate daily trading, increasing the total trading value from Rp8 tril-
lion in 1992 to Rp120.4 trillion in 1997. In September 1997, with the onset
of the Asian crisis, the limit on foreign portfolio investment was removed
and foreign investors were allowed to buy up to 100 percent of shares of a
listed Indonesian company. Between 1989 and 1992, the average foreign
ownership of listed companies was 21 percent. This increased to 30 percent
by the end of 1993, but declined to an average of 25 percent during 1995-
1997.
In the 1990s, foreign banks became a significant source of financ-
ing for the corporate sector. By the end of 1997, more than 50 percent of
total Indonesian private debt and 60 percent of total foreign exchange debt
were owed to 175 foreign banks and other foreign financial institutions.
Capital account liberalization permitted the inflow of foreign capital that
fueled the credit boom in the country. Private borrowers preferred foreign
loans since these were relatively cheaper, especially the short-term ones.
From 1987 to 1996, the average borrowing rate for dollar loans was 9 per-
cent, plus 4 percent for the depreciation of the rupiah. This is lower than the
average borrowing rate of 18 percent for loans in domestic currency. The
private sector left foreign loans unhedged because the depreciation of the
rupiah had never reached more than 4 percent annually since the 1986 de-
valuation under the managed floating system. In November 1998, total cor-
porate debt reached nearly $118 billion. Domestic corporate debt was about
$50 billion equivalent, of which two thirds were rupiah-denominated. The
external corporate debt owed to foreign commercial banks was $67 billion.
The excessive dollar borrowings made the corporate sector vulnerable to
sudden currency fluctuations.
1.2.5 Growth and Financial Performance
While it was obvious that the term structure and currency composition of
debt suggested problems in the run-up to the crisis, an interesting question
is whether standard measures of corporate profitability and performance
also indicated the same. The following section looks at the growth and
financial performance of the corporate sector. Due to data constraints, the
analysis focuses only on publicly listed companies, state-owned companies
(SOCs), and conglomerates.
Publicly Listed Companies
Table 1.3 shows the growth and financial performance of Indonesian pub-
licly listed companies. During 1992-1997, total sales of listed companies
grew at an annual average rate of 31 percent, while total assets grew at
43 percent. Despite such rapid growth, publicly listed companies as a group
contributed less than 10 percent to GDP, although the contribution increased
over time. Net profits grew at an annual rate of more than 20 percent from
1992 to 1996, but turned negative in 1997. The growth of listed companies
was sustained by continuing investments.
Table 1.3
Growth and Financial Performance of Publicly Listed Companies,
1992-1997
(percent)
Item 1992 1993 1994 1995 1996 1997
Growth Indicators
Sales Growth — 45.1 50.3 37.8 18.2 7.0
Share of Value Added in GDPa 3.7 4.6 6.0 6.9 7.0 6.4
Asset Growth — 48.5 64.8 37.1 33.8 31.9
Financial Indicators
Debt-to-Equity Ratio 250.0 240.0 220.0 220.0 230.0 310.0
Return on Equity 12.6 12.5 12.0 11.3 10.7 1.1
Return on Assets 3.4 3.5 3.5 3.5 3.2 0.6
Asset Turnoverb 38.4 37.6 34.2 34.4 30.4 24.7
Note: The number of firms is not identical for each year. In 1997, there were 204 firms; 1996, 248
firms; 1995, 246 firms; 1994, 250 firms; 1993, 226 firms, and 1992, 174 firms.
a
Value added was assumed to be 30 percent of total sales.
b
Asset turnover is defined as sales over assets.
Source: JSX Monthly (several publications).
Average return on equity (ROE) of listed firms was 11.8 percent

between 1992 and 1996, but dropped to 1.1 percent in 1997 when the crisis
began to buffet Indonesia. Return on assets (ROA) was also relatively sta-
ble during 1992-1996, averaging 3.4 percent, but declined to 0.6 percent in
1997. Asset turnover was above 30 percent until 1996, but fell to 24.7 per-
cent in 1997. The debt-to-equity ratio (DER) was high compared to those
of listed companies in Malaysia and the Philippines, ranging from 220 to
250 percent between 1992 and 1996. When the crisis battered Indonesia in
1997, the average DER increased to 310 percent from 230 percent the
previous year. This indicates that a substantial part of corporate debt was
denominated in dollars and unhedged. Overall, it appeared that the per-
formance of listed companies was quite satisfactory prior to the crisis, al-
though asset turnover was slow. The ROE levels suggest that high leverage
enabled listed companies to achieve high returns on equity.
The Jakarta Stock Exchange (JSX) classified listed companies into
nine sectors: agriculture; mining; basic industry and chemicals; miscella-
neous industry; consumer goods; property, real estate, and building con-
struction; infrastructure; finance; and trade, investment, and services. In
terms of sales and asset levels in 1997, the dominant sector was the finance
sector. However, in terms of growth of sales and assets, the mining sector
ranked first, followed by agriculture (Table 1.4). In terms of share of value
added to GDP, only two sectors (mining and finance) showed a consistently
increasing trend from 1992. The finance sector’s contribution to GDP, mean-
while, increased from 0.73 percent in 1992 to 1.64 percent in 1997.
Table 1.5 presents the financial performance of listed companies
by sector. From 1995, the mining sector had the lowest DER, indicating its
reliance on equity to support growth. The finance; trade, investment, and
services; and property, real estate, and building construction sectors had the
highest DERs because companies in these sectors found it easy to obtain
credit from banks. For instance, when the property sector was booming
during 1993-1997, the banks eagerly provided credit to property develop-
ment companies. The same applied to the trade sector.
Before the crisis, the mining sector had the highest ROE, averaging
21.3 percent between 1992 and 1996. But the sector’s ROE fluctuated a lot,
due mainly to the domination of the International Nickel Company of
Canada, which operated in nickel and copper mining in 1992 and 1993.
During those years, the fluctuation in nickel and copper prices contributed
to the oscillation of ROE. The consumer goods sector ranked second in
terms of ROE, averaging 17.7 percent during 1992-1996. This sector was
less affected by the crisis, still posting a positive but lower ROE, helped in
part by the relatively strong demand for consumer goods. Also, the compa-
nies in the sector did not operate with a high leverage. Meanwhile, the
property sector was severely affected by the crisis, with ROE falling to
-11.2 in 1997. When interest rates increased, ROE fell drastically because
the sector had one of the highest DERs. Most companies in the sector that
had unhedged dollar-denominated loans suffered exchange rate losses when
the rupiah weakened.
ROA of all sectors dropped in 1997. Four sectors (basic industry
and chemicals, miscellaneous industry, property, and trade) even posted
Table 1.4
Growth Performance of Publicly Listed Companies
by Sector, 1992-1997
(percent)
Indicator/Sector 1992 1993 1994 1995 1996 1997

Sales Growth
Agriculture — 155.0 (75.3) 51.4 58.5 45.2
Mining — 64.1 53.1 38.8 5.9 54.9
Basic Industry and Chemicals — 32.6 42.0 29.4 14.1 (11.4)
Misc. Industry — 26.3 43.4 30.1 8.2 13.0
Consumer Goods Industry — 31.7 64.8 23.8 31.5 (8.4)
Prop., Real Estate, and Bldg. Constn. — — (76.7) 24.7 6.0 (20.5)
Infrastructure — — 26.5 24.7 6.5 9.9
Finance — 11.5 61.7 62.9 31.8 28.4
Trade, Investment, and Services — 95.4 40.8 54.4 21.6 (0.6)
Asset Growth
Agriculture — 103.5 66.1 44.9 119.7 112.8
Mining — 23.7 16.4 36.2 27.6 135.7
Basic Industry and Chemicals — 21.5 31.1 41.3 17.5 53.7
Misc. Industry — 13.0 67.2 17.2 28.9 59.0
Consumer Goods Industry — 68.8 59.5 35.8 22.1 0.9
Prop., Real Estate, and Bldg. Constn. — 62.1 92.1 32.3 25.9 8.0
Infrastructure — — 35.6 31.2 18.2 14.7
Finance — 39.6 83.8 41.9 43.6 24.4
Trade, Investment, and Services — 85.8 51.6 53.1 30.5 28.7
Net Profit Growth
Agriculture — 50.0 133.3 71.4 133.3 92.9
Mining — (28.6) 340.0 77.3 (7.7) (27.8)
Basic Industry and Chemicals — 25.2 16.9 51.7 (12.7) (113.5)
Misc. Industry — 11.6 64.9 34.6 13.4 (149.5)
Consumer Goods Industry — 51.6 123.4 28.6 49.6 (41.6)
Prop., Real Estate, and Bldg. Constn. — 22.7 170.4 15.1 19.0 (192.0)
Infrastructure — — 43.5 28.7 46.5 (11.3)
Finance — 36.7 68.7 54.0 39.1 (41.7)
Trade, Investment, and Services — 90.0 (82.8) 24.6 17.3 (203.2)
Share of Value Added in GDP
Agriculture 0.1 0.3 0.1 0.1 0.1 0.1
Mining 0.0 0.1 0.1 0.1 0.1 0.1
Basic Industry and Chemicals 0.8 0.9 1.0 1.1 1.1 0.8
Misc. Industry 1.1 1.2 1.5 1.6 1.5 1.5
Consumer Goods Industry 0.6 0.6 0.9 0.9 1.0 0.8
Prop., Real Estate, and Bldg. Constn. 0.1 1.3 0.3 0.3 0.3 0.2
Infrastructure 0.0 0.4 0.4 0.5 0.4 0.4
Finance 0.7 0.7 1.0 1.3 1.5 1.6
Trade, Investment, and Services 0.4 0.6 0.7 1.0 1.0 0.9
Table 1.5
Financial Performance of Publicly Listed Companies
by Sector, 1992-1997
(percent)
Indicator/Sector 1992 1993 1994 1995 1996 1997

Debt-to-Equity
Agriculture 20.0 130.0 80.0 80.0 100.0 230.0
Mining 50.0 80.0 80.0 70.0 70.0 110.0
Misc. Industry 120.0 130.0 120.0 150.0 160.0 220.0
Infrastructure 90.0 180.0 70.0 80.0 110.0 100.0
Finance 560.0 650.0 680.0 650.0 630.0 700.0
Return on Equity
Agriculture 8.8 19.2 15.5 17.6 14.2 23.9
Mining 44.7 7.7 17.7 19.1 17.1 (5.8)
Basic Industry and Chemicals 12.4 12.7 10.8 10.0 8.2 (4.0)
Misc. Industry 13.2 10.6 9.3 8.4 7.1 (3.6)
Prop., Real Estate, and Bldg. Constn. 13.3 8.8 10.6 10.2 8.6 (11.2)
Infrastructure 17.1 20.5 13.2 13.4 15.0 12.1
Finance 11.0 11.8 11.9 13.1 13.4 5.4
Return on Assets
Agriculture 6.9 5.1 7.1 8.5 9.0 8.1
Mining 4.7 2.7 10.3 13.5 9.7 3.0
Basic Industry and Chemicals 5.5 5.7 5.1 5.5 4.1 (0.4)
Misc. Industry 4.2 4.1 4.1 4.7 4.1 (1.3)
Prop., Real Estate, and Bldg. Constn. 4.2 3.2 4.5 3.9 3.7 (3.2)
Infrastructure 8.7 7.3 7.7 7.6 9.4 7.3
Finance 1.3 1.2 1.1 1.2 1.2 0.6
Trade, Investment, and Services 38.2 39.1 4.4 3.6 3.2 (2.6)
Asset Turnover
Agriculture 382.8 479.7 71.4 74.7 53.9 36.8
Mining 26.4 35.0 46.0 46.9 38.9 25.6
Misc. Industry 63.7 71.2 61.1 67.8 56.9 40.4
Infrastructure 73.9 38.3 35.7 33.9 30.6 29.3
Finance 17.5 14.0 12.3 14.1 13.0 13.4

negative ROA. Trade had the highest ROA of 39.1 percent in 1993, but
dropped dramatically to 4.4 percent the following year. The finance and
miscellaneous industry, and basic industry and chemicals sectors had rela-
tively stable ROA before the crisis. Only the agriculture sector showed an
increase in ROA in the couple of years before 1997.
State-Owned Companies
At the end of 1995, there were 165 state-owned companies (SOCs)3 in

Indonesia. SOCs actively operated in various sectors4 under the supervi-
sion of “technical” departments. For instance, the Department of Finance
supervised 30 SOCs, which collectively had the largest assets. The Depart-
ment of Mining and Energy ranked first in terms of sales of SOCs under its
control. This was due to large sales by the National Oil Company
(Pertamina).
Just like private companies, SOCs diversified into many businesses.
By 1995, there were 58 SOCs with subsidiaries and affiliates. Taken to-
gether, the subsidiaries and affiliates number 459 with total assets of Rp343.3
trillion. SOCs’ sales growth fluctuated during 1990-1996, registering an
average annual rate of 10 percent. Similarly, growth of net profits and as-
sets was erratic, averaging 24 and 31 percent, respectively, between 1993
and 1995. These growth rates were low compared to those for listed compa-
nies during the same period.
Assuming a fixed ratio of value added to sales, the SOCs’ value
added as a percentage of GDP ranged from 6 to 8.7 percent. This was rela-
tively high compared to the 3.7 to 7 percent for publicly listed companies.
However, the ratio decreased from 8.7 percent in 1990 to 6 percent in 1996,
indicating SOCs’ declining contribution to GDP.
SOCs’ ROE ranged from 6.6 to 8.8 percent between 1992 and 1995
(Table 1.6), much lower than that of companies listed in the stock exchange.
The DER was slightly higher than for listed companies, but it continuously
declined from 370 percent in 1992 to 250 percent in 1995. ROA had been at
high levels from 1992 to 1995, increasing from 21.1 percent in 1992 to
28.3 percent in 1995. Asset turnover rates were lower relative to those of
publicly listed companies. While asset turnover rates of publicly listed
3
SOCs are those in which the State has at least a 51 percent equity interest. Six SOCs
were listed in the Jakarta Stock Exchange.
4
The sectoral distribution of 165 SOCs is as follows: nonfinancial (143 companies); banks
(seven companies); insurance (11 companies); and finance company (four companies).
companies consistently declined over time, SOCs’ asset turnover rates

showed a downward trend from 32.4 percent in 1992 to 28.6 percent in
1994, but climbed to 30.5 percent in 1995.
Table 1.6
Growth and Financial Performance of State-Owned Companies,
1992-1995
(percent)
Indicator 1992 1993 1994 1995
Growth Indicators
Sales Growth — 16.4 (9.1) 25.1
Share of Value Added in GDPa 7.2 7.2 5.7 6.0
Assets Growth — 23.1 (2.6) 17.3
Financial Indicators
Debt-to-Equity Ratio 370.0 310.0 260.0 250.0
Return on Equity 8.8 7.0 6.6 8.6
Return on Assets 21.1 24.1 28.0 28.3
Asset Turnoverb 32.4 30.7 28.6 30.5
a
b
Asset turnover is defined as sales over assets.
Source: Indonesian Data Business Center.
Conglomerates
This study used available data on the top 300 conglomerates in Indonesia.
In 1997, these conglomerates owned 9,766 business units, mostly private
companies. Their total sales increased from Rp90.1 trillion in 1990 to
Rp234 trillion in 1997. Assuming a constant ratio of value added to sales, the
contribution of conglomerates to GDP increased from 12.8 percent in 1990
to 13.4 percent in 1994, but dropped to 11.2 percent in 1997 (Table 1.7).
Table 1.7
Growth Performance of the Top 300 Conglomerates, 1990-1997
(percent)
Item 1990 1991 1992 1993 1994 1995 1996 1997

Sales Growth — 17.1 19.4 16.7 16.2 18.1 12.5 3.0
Share of Value Added in GDPa 12.8 12.7 13.4 13.4 13.4 13.3 12.8 11.2
a
Source: Indonesian Data Business Center.
1.2.6 Legal and Regulatory Framework
During the 1990s, the Government promulgated a number of laws and regu-
lations to protect investors. By international standards, however, the legal
and regulatory framework of the corporate sector was far from adequate.
The Corporate Law
The Corporate Law of 1995 governs the establishment and operation of

limited liability companies in Indonesia. The law replaced an earlier statute
that was based on the Dutch system. The 1995 law requires limited liability
companies to set up two boards: the board of commissioners (BOC), tasked
with supervising the firm; and the board of directors (BOD), tasked to pro-
vide direction to the company. A chairman heads the BOC while a chief
executive officer (CEO) heads the BOD. The BOD undertakes operating
decisions while the BOC participates in strategic decisions and operations
review. The actual responsibilities of BOCs vary by company and are stipu-
lated in the company’s charter. For instance, the decision to use certain
company assets as collateral for bank credit might need BOC approval.
The law mandates the BOC and BOD to work for the best interests
of the company and not just of the shareholders. This guards against shady
intercompany dealings within a group of companies. For instance, a mem-
ber company might sign a disadvantageous contract with another company
where the same controlling shareholder has a higher stake. The law also
holds the directors and commissioners jointly responsible for decisions made
by the company. The BOC, as representative of shareholders, is the only
shareholder mechanism for monitoring and controlling the BOD. If the
BOC does not perform well, shareholders lose control.
The law also specifies that the highest “institution” in the limited
company is the shareholders’ meeting. The meeting decides on important
issues, such as the appointment (or replacement) of directors, commission-
ers, and the accountant. The law explicitly requires approval during the
meeting of decisions on strategic issues such as amendment of the com-
pany charter (articles of incorporation); acquisitions, mergers, and consoli-
dations; and declaration of bankruptcy. The company charter details the
issues that need shareholder meeting approval. In general, an approval needs
the majority (50 percent plus one) vote, except in strategic issues stated in
the law. For example, the decision to amend the company charter should be
approved by two thirds of shareholders present in the meeting, and the
attendance should at least be two thirds of total shareholders. For mergers,
acquisitions, consolidations, and bankruptcy, the decision should be ap-

proved by three fourths of the shareholders present, and the attendance should
at least be three fourths of total shareholders. Because of such require-
ments, some listed companies sell no more than a small proportion of shares
to the public in order to retain the freedom of the founders to make strategic
decisions.
The law provides the following rights to or protection of share-
holders: (i) access to regular and reliable information free of charge; (ii)
proxy voting; (iii) proxy voting by mail; (iv) cumulative voting for direc-
tors; (v) preemptive rights on new share issues; (vi) one share one vote;
(vii) the right to call an emergency shareholders’ meeting; (viii) the right to
make proposals at the shareholders’ meeting; (ix) mandatory shareholders’
approval of interested transactions; (x) mandatory shareholders’ approval
of major transactions; (xi) mandatory disclosure of transactions by signifi-
cant shareholders; (xii) mandatory disclosure of connected interests; (xiii)
mandatory disclosure of nonfinancial information; (xiv) mandatory disclo-
sure of intercompany affiliation such as affiliated lending or guarantees;
(xv) mechanisms to resolve disputes between the company and sharehold-
ers; (xvi) independence of auditing; (xvii) mandatory independent board
committee; and (xviii) severe penalties for insider trading.
The Capital Market Law
The Capital Market Law (1995) regulates companies listed in the stock ex-
change, delineating the tasks and responsibilities of the Capital Market Su-
pervisory Agency. It regulates the requirements of investment companies,
securities companies, underwriters, brokers, investment managers, investment
advisors, and other supporting agencies, such as custodian banks and the
securities registration bureau. It also regulates reporting and auditing proce-
dures, transparency requirements, insider trading (including market rigging
and manipulation) investigation, and administrative and legal punishment.
The law is supplemented by Government regulations, decrees of
the finance minister, and guidelines promulgated by the head of capital
market supervision. Examples in the area of corporate governance are guide-
lines for situations that can potentially lead to conflicts of interest and for
acquisitions of substantial shares of listed companies. An important rule is
the requirement for independent shareholders’ approval for arrangements
that might lead to conflicts of interest. Controlling shareholders have no
vote on the matter. A tender offer is also required for acquisitions of up to
20 percent of listed shares.
Bankruptcy Law
Despite loan covenants, creditors of unsecured loans are unprotected when

borrowers fail to meet their obligations. The old bankruptcy law based on
the Dutch system was biased in favor of debtors and made it almost impos-
sible for creditors to seek court resolution when debtors defaulted.
A new bankruptcy law was passed in August 1998. It aimed to
protect creditors by providing easier and faster access to legal redress. Un-
secured creditors could proceed against a debtor in default based on loan
covenants and through the legal process of collection against the latter’s
assets. A Commercial Court was also set up to deal with bankruptcy cases.
The court can declare the debtor bankrupt upon the request of at least two
creditors and default on one loan.
Banking Laws Affecting the Corporate Sector
Some elements of the banking law also affect the corporate sector. For
instance, the Banking Law (1992), amended in October 1998, states that a
bank is not allowed to provide credit without collateral. However, the col-
lateral could take the form of nonphysical assets (e.g., the viability of a
project). Banking regulations also set lending limits, net open positions,
capital adequacy, etc.
1.3 Corporate Ownership and Control
This section looks at the ownership structure of the corporate sector and
reports the results of an ADB survey on corporate management and control
of publicly listed companies. Discussions on corporate ownership cover
listed companies and conglomerates.
1.3.1 Corporate Ownership Structure
Quality of corporate governance is closely related to corporate ownership

structure (see discussions in the Consolidated Report of this study). The
two most important elements of ownership structure are concentration and
composition. Ownership concentration is usually measured by the propor-
tion of shares owned by the top one, five, or 20 shareholders. It reveals
characteristics of controlling shareholders, for instance, whether they are
individuals, families, holding companies, or financial institutions.
Publicly Listed Companies
Table 1.8 shows average proportions of shares owned by the five largest
shareholders of publicly listed companies during 1993-1997. On average,
the five largest shareholders owned 68.9 percent of total outstanding shares.
The percentage owned by each of the five largest shareholders was 48.6,
13.6, 3.9, 2, and 0.8, respectively. The pattern of ownership concentration
changed little over this period. This is partly due to the prevailing practice
of raising equity through rights issues in Indonesia. This preserves the pro
rata share of existing shareholders. When a company makes a rights issue,
the controlling shareholders usually act as standby buyers.
Table 1.8
Ownership Concentration of Publicly Listed Companies, 1993-1997
(percent)
Shareholder Rank 1993 1994 1995 1996 1997 Average
First Largest 50.5 48.1 47.9 48.5 48.2 48.6

Second Largest 16.6 13.7 14.1 12.0 11.6 13.6
Third Largest 3.0 3.9 4.0 4.2 4.4 3.9
Fourth Largest 2.1 2.0 1.9 1.8 2.1 2.0
Fifth Largest 0.5 0.6 0.8 1.0 1.2 0.8
Total 72.7 68.3 68.7 67.5 67.5 68.9
Source: The Indonesian Capital Market Directory.
Table 1.9 shows that ownership by the largest shareholder in 1997

was more concentrated in the agriculture, mining, consumer goods, and
basic industry and chemicals sectors than in others. Meanwhile, ownership
widely held by the general public is highest in the infrastructure and trans-
portation sector (not shown in the table). This is because a few companies
in the transportation sector issued high proportions of shares to the public.
Zebra Nusantara (taxi services), for instance, issued 93.4 percent, Rig Ten-
ders Indonesia (shipping services) issued 51.6 percent, and Berlian Laju
Tankers (liquid bulk maritime transportation services) issued 48.5 percent.
Data from the Indonesian Capital Market Directory (various pub-
lications) show that between 1993 and 1997, about two thirds of publicly
listed companies’ outstanding shares were owned by corporations that were
directly or indirectly controlled by families. When a company goes public,
the founder usually continues to own the majority of shares through a
fully-owned limited liability company (Perseroan Terbatas). Thus the founder

keeps the proportion of shares necessary to retain control over management
of the listed firm. Most of the five largest owners of Indonesian publicly
listed companies are limited liability companies rather than individuals.
Table 1.9
Ownership Concentration of Publicly Listed Companies
by Sector, 1997
(percent)
First Second Third Fourth Fifth
Sector Biggest Biggest Biggest Biggest Biggest
Agriculture 54.5 15.6 2.5 1.3 1.1

Mining 58.9 9.4 1.4 0.7 0.6
Basic Industry and Chemicals 50.9 11.3 4.0 1.9 1.3
Misc. Industry 44.4 14.1 5.1 3.6 2.9
Consumer Goods Industry 54.9 13.2 1.5 0.1 0.1
Prop., Real Estate, and Bldg. Constn. 44.4 10.6 4.3 2.2 2.1
Infrastructure, Util., and Transportation 44.2 8.7 0.7 0.1 0.1
Finance 46.3 9.7 6.8 2.4 1.1
Trade, Investment, and Services 36.3 13.1 14.7 6.2 1.9
Average 48.2 11.6 4.4 2.1 1.2
Source: The Indonesian Capital Market Directory.
This is confirmed in Claessens et al. (1999), which shows that in

1996, two thirds (67.1 percent) of Indonesian publicly listed companies
were in family hands, and only 0.6 percent were widely held. In fact, Indo-
nesia has the largest number of companies controlled by a single family. In
terms of capitalization, the top family controls 16.6 percent of total market
capitalization while the top 15 families control 61.7 percent of the market.
These figures suggest that ultimate control of the corporate sector rests in
the hands of a small number of families.
Claessens et al. (1999) also found, in a cross-country study, that
the correlation between the share of the largest 15 families in total market
capitalization, on the one hand, and the efficiency of the judicial system,
the rule of law, and corruption, on the other, is strong. The findings suggest
that the concentration of corporate control in the hands of few families is a
major determinant of the evolution of an inefficient legal and judicial sys-
tem, as well as the existence of corruption. Legal and regulatory develop-
ments may have been impeded by the concentration of corporate wealth in
the small number of families and the tight links between companies and the
Government. If the role of a limited number of families in the corporate
sector is so large and the Government is heavily involved in and influenced
by business, the legal system is less likely to evolve in a manner that pro-
tects minority shareholders.
The corruption and regulatory problems generated by high own-
ership concentration by families in Indonesia are likely to overwhelm its
benefits. Family control is said to have positive effects in that it allows
group members in conglomerates to make strategic decisions quicker. Co-
ordination is easier because informal communication channels exist. But
these benefits are few and often dubious compared to the high costs of
concentration.
When the Government allowed foreign investors to buy up to
49 percent of listed shares in 1988, foreign ownership increased to 21 per-
cent. In 1993, it rose to 30 percent, but later declined and steadied at around
25 percent. In September 1997, the Government allowed foreign investors
to buy up to 100 percent of listed shares. However, the onset of the crisis
negated this development, resulting instead in a decline in the proportion of
foreign investor ownership.5
Conglomerates
Table 1.10 shows the anatomy of the top 300 conglomerates in terms of
year of establishment, ethnicity, political affiliation, and family origin.
Among the top 300 conglomerates, most were established during
the New Order Government, numbering 162 in 1988 and 170 in 1996. This
may indicate that the New Order Government, with all its regulations, was
able to create a favorable environment for business development. However,
conglomerates established before 1969 dominated in terms of sales, ac-
counting for 64 percent of total conglomerate sales in 1988-1996.
In Indonesia, there is a dichotomy between corporations owned by
indigenous and nonindigenous businesspeople. Indigenous businesspeople
include the Javanese, Sundanese, Batak, and Padang. The nonindigenous
businesspeople are usually Chinese, Indian, or other ethnic groups. During
1988-1996, nonindigenous groups owned a larger proportion of the top 300
Indonesian conglomerates. From 193 in 1988, their number increased to
5
In 1997, the proportion of foreign ownership declined from 27.55 percent in August to
25.42 percent in December.
Table 1.10
Anatomy of the Top 300 Indonesian Conglomerates, 1988-1996
Item 1988 1989 1990 1991 1992 1993 1994 1995 1996
Number of Groups
Year of Establishment
Before 1946 13 13 13 13 13 12 12 11 10
1946-1968 125 125 123 120 118 122 122 120 120
1969 Forward 162 162 164 167 169 166 166 169 170
Ethnicity
Mixed 86 83 80 76 76 71 69 71 68
Nonindigenous 193 196 196 199 198 201 205 204 204
Indigenous 21 21 24 25 26 28 26 25 28
Political Affiliation
Nonofficial 260 259 260 260 262 263 262 260 259
Official-Related 40 41 41 40 38 37 38 40 41
Origin
Family 176 175 171 174 172 171 172 177 175
Nonfamily 124 125 129 126 128 129 128 123 125
Sales (Rp trillion)
Year of Establishment
Before 1946 9.4 12.3 13.3 15.8 20.4 21.9 25.2 30.1 33.4
1946-1968 31.2 36.8 43.2 49.7 59.1 73.1 86.1 103.0 116.4
1969 Forward 23.2 28.4 33.6 40.0 46.5 52.1 59.8 68.9 77.4
Ethnicity
Mixed 12.8 15.1 17.6 18.7 21.2 22.8 25.2 29.0 31.1
Nonindigenous 38.6 46.4 54.4 64.5 76.7 87.3 101.5 120.9 137.4
Indigenous 12.4 16.0 18.0 22.3 28.1 37.0 44.4 52.1 58.7
Political Affiliation
Nonofficial 48.9 58.4 58.4 80.7 95.6 114.3 134.2 159.1 179.8
Official-Related 14.9 19.1 31.7 24.8 30.4 32.8 36.9 42.9 47.4
Origin
Family 35.0 42.6 49.1 57.2 68.4 77.4 89.5 106.3 120.4
Nonfamily 28.8 34.9 41.0 48.3 57.6 69.7 81.6 95.7 106.8
Source: Indonesian Business Data Centre, Conglomeration Indonesia 1997.
204 in 1996. Their total sales also increased from Rp38.6 trillion in 1988 to
Rp137.4 trillion in 1996, due to their “go public” activities. For instance,
sales of the Bakrie group before it went public in 1990 were only
Rp369.9 billion. In 1996, its sales reached Rp1.9 trillion, more than five
times its 1988 level. Meanwhile, the number of mixed groups declined
from 86 in 1988 to 68 in 1996. While they supplied 20.1 percent of total
sales in 1988, their contribution declined to 13.7 percent in 1996. The con-
traction in the number and economic contribution of mixed groups may be
an indication of increasing social polarization along ethnic lines.
Conglomerates were also classified into nonofficial- and official-
related groups. Official-related groups have owners (or founders) who are
or are allied with former or current government officials (or their
families). Most of the top 300 conglomerates were established by ordi-
nary citizens. Only about 13 percent were formed by official or ex-official
families, or have resulted from alliances between entrepreneurs and offi-
cials. The well-known official-business alliances are those between
Sudwikatmono (former President Suharto’s cousin) and Soedono Salim,
Djuhar Soetanto, and Ibrahim Risyad of the Salim group. More recent
alliances were between Bambang Trihatmodjo (former President Suharto’s
son) and Johannes Kotjo, Bambang Rijadi Soegomo, and Wisnu
Suhardhono of Apac-Bhakti Karya. Average sales of official-related con-
glomerates were substantially greater than nonoffficial-related ones dur-
ing 1988-1996. In 1996, average sales of official-related conglomerates
reached Rp1.2 trillion, compared with the less than Rp700 billion of a
nonofficial-related conglomerate.
Political alliances between entrepreneurs and officials have often
led to the violation of regulations meant to promote prudent business prac-
tices in the banking industry. Banks owned by groups or conglomerates
typically act as a “cashier” that provides credit to companies within the
group. Prudential credit analysis tends to be ignored. The high NPLs accu-
mulated by banks within official-related groups could be partly attributed
to this practice. In November 1997, most of the 16 liquidated banks had
violated the legal lending limit set by the central bank, Bank Indonesia. In
1997 and 1998, banks that had to be closed down included Bank Surya
(owned by Sudwikatmono) and Bank Andromeda (owned by Bambang
Trihatmodjo).
In 1996, there were 175 groups that originated from a family busi-
ness. Some of them later became public companies by listing in the stock
market. But listed companies within conglomerates were few. The Salim
group, for instance, which is the largest conglomerate in Indonesia, owns
four groups with many subsidiaries and affiliate companies. Out of 174
companies, 117 are jointly owned by the family and 57 are owned by indi-
vidual family members. But only a handful of these companies are listed in
the market, including Indofood Sukses Makmur (food industry), Indocement
Tunggal Prakarsa (cement industry), and Fast Food (restaurants). The Suharto
family is the largest stockholder in Indonesia, collectively controlling
assets worth $24 billion (Claessens et al., 1999). The family controls 417
listed and unlisted companies through a number of business groups led by
the Suharto children, as well as other relatives and business partners, many
of whom, besides Suharto himself, served in some government function
(see Figure 1.1). The Salim Group is also in part controlled by the Suharto
family.
The families retain control of the companies through ownership,
management, or both. Although some groups employ professional man-
agers, families mostly manage the groups and make strategic decisions
themselves. The BOC chairperson often represents the controlling party
of the company. He or she could either be the biggest shareholder, or
someone very close to and trusted by the controlling shareholders. If the
family members cannot actively manage the companies as directors, they
maintain their position as commissioners. Although they are not actively
involved in the daily operations of the companies, they still control the
work of the directors.
Some of the groups related to officials have a unique share owner-
ship structure. The officials (or their family members) often own a small
portion of shares given to them freely by controlling shareholders. In so
doing, the controlling shareholders are able to maintain their special rela-
tionship with officials, and hence, continue receiving some kind of protec-
tion and special treatment.
Cross-Shareholdings
Cross-shareholding is one way to enhance corporate control and occurs

when a company down the chain of control has some shares in another
company within the same chain. Indonesian law allows cross-shareholdings,
with no restrictions. But it is difficult to obtain data on cross-shareholding
among firms. It is generally believed that there are cross-holdings between
financial and nonfinancial companies and among nonfinancial firms. In 1996,
for instance, Indofood Sukses Makmur (food industry) was owned by
Indocement Tunggal Prakarsa (cement industry). Both are listed companies
and members of the Salim group.
Cross-holdings between financial and nonfinancial firms poten-
tially create more serious problems. This is because cross-owned banks
had to consider not only their own interests, but those of the entire group.
Cases in point are the Bank Papan Sejahtera and Bank Niaga, which were
liquidated or recapitalized after being acquired by the Tirtamas group that
owns a listed cement company, Semen Cibinong. While the source of the
Figure 1.1
The Suharto Group
Tirtamas
262 firms with Salim Group Usaha Mulia Group
control over 20% (friend Soedono) (cousin Hasim) Cemen 21 firms with
Cibinong control over 20%
Sempati Air
Hanurata
Humpuss Group
Bank Utamar Suharto Family
Group
Trias 18 firms
17 firms with Citra Lamoro Group with control
Sentosa
control over 20% (daughter Mbak Tutut) over 20%
Bank
Bimantara Group Bank Citra Persda Central
TPI Yama Marga Tollroad
(son Bambang)
Bob Hasan Group Indomobil
Andromed Tripolita (Mohamad Hasan)
Mercu Buana Group
8 firms with Kabelindro Kiani 22 firms with (step brother Probo)
Gatari
control over 20% Murmi Sakti control over 20% 11 firms
with control
over 20%
Source: Stijn Claessens, Simeon Djankov, and Kedaung Indah Kedaung Group
Larry H. P. Lang, (Feb. 1999). Who Controls East (Agus Nursalim)
Asian Corporations? Financial Economics Unit, 14 firms
Financial Sector Practice Department, World Bank. with control
over 20%
problem is inconclusive, one possibility is that legal lending limits had

been violated.
1.3.2 Management and Internal Control
A company’s internal organizational structure determines how sharehold-

ers control management. The typical structure of a publicly listed company
in Indonesia is shown in Figure 1.2. Shareholders are at the top of the
organization, both controlling and minority. The BOD leads the company
and makes strategic and operational decisions. The managers execute the
BOD’s decisions and lead employees in their departments. As the owners’
representatives, the BOC supervises the work of directors. Therefore, the
BOC has the right to obtain any information concerning the firm, seek an
audience with directors, and, if necessary, request a shareholders’ meeting.
This is based on the Dutch system.
Figure 1.2
Typical Internal Organizational Structure of a Publicly Listed
Company in Indonesia
Shareholders
Board of Board of
Directors Commissioners
M a n a g e r s
Employees
The succeeding discussions examine some aspects of the internal

management and control system in practice in Indonesian listed compa-
nies, including the boards, the directors, management and managerial com-
pensation, role and protection of minority shareholders, and accounting
and auditing procedures. The discussions are based on the ADB survey of
40 companies listed in the Jakarta Stock Exchange.
Board of Commissioners and Board of Directors
Table 1.11 presents a summary of some characteristics of the BOC. The

table reveals that 29 out of 40 companies surveyed did not have independ-
ent commissioners. Although 23 companies reported that commissioners
were elected based on professional expertise, nine companies reported that
selection was based on relationships with controlling shareholders, and
another nine reported that commissioners were the company’s founders.
Table 1.11
Characteristics of the Board of Commissioners
Number
of Firms
Questions Responded
Presence of Independent Commissioners
a. Yes 11
b. No 29
Basis for Electing the Board of Commissioners
a. Professional expertise 23
b. Relationship with controlling shareholders 9
c. As founders of the company 9
Procedure in Electing the Board of Commissioners
a. Nominated by the management and confirmed by the AGM 10
b. Nominated by significant shareholders and confirmed by the AGM 22
c. Nominated and elected by shareholders during the AGM 7
Basis for Electing the Chairman of BOC
b. Shareholdings 7
d. Relationship with controlling shareholders 8
Relationship between the Chairman and CEO
a. Not related by blood or marriage 30
b. Related by blood or marriage 6
c. No answer 4
Note: Since companies could answer more than one alternative, the total does not necessarily add up to
40 for each question.
Source: ADB Survey.
In most companies (22 out of 40), members of the BOC were nomi-
nated by significant shareholders and confirmed at the annual general meet-
ings (AGMs). A nominee that was not supported by significant shareholders
was unlikely to be chosen as a commissioner. Most companies (27 out of

40) elected their BOC chairman based on professional expertise. The ma-
jority of firms (30 out of 40) also reported no relationship between the
chairman and CEO either by blood or marriage. A similar picture is ob-
tained for the BOD (Table 1.12). Most companies (30 out of 40) reported
not having independent directors. Professional expertise was an important
basis in electing directors for 29 companies. Relationships with controlling
shareholders and founders of the company were the basis for selecting di-
rectors in 11 companies.
Table 1.12
Characteristics of the Board of Directors
Number
of Firms
Questions Responded
Presence of Independent Directors
a. Yes 10
b. No 30
Basis in Electing Board of Directors
b. Relationship with controlling shareholders 7
c. As founders 4
Procedure in Electing Board of Directors
a. Nominated by the management and confirmed by the AGM 13
b. Nominated by significant shareholders and confirmed by the AGM 22
c. Nominated and elected by shareholders during the AGM 6
Basis in Electing the Chief Executive Officer
b. Shareholdings 3
d. Relationship with controlling shareholders 8
Note: Since companies could answer more than one alternative, the total does not necessarily add up to
40 for each question.
Source: ADB Survey.
Twenty-two out of the 40 respondents elected their directors through

nomination by significant shareholders and confirmation by the AGM. Most
companies (29 out of 40) selected the CEO based on professional expertise,
although some companies based it on relationships with controlling share-
holders.
Management and Managerial Compensation
The Corporate Law mandates the BOD to lead the company and make
strategic and operational decisions, and the BOC to supervise the work of
the directors. The BOC also reviews the results of operations and partici-
pates in strategic decision making. This indicates some overlapping func-
tions for the BOC and the BOD, which is confirmed in the ADB survey.
This overlapping of responsibilities, particularly in making strategic de-
cisions, may result in conflicts. However, since the BOC appoints mem-
bers of the BOD and determines their remuneration, the BOC is in a strong
position to dominate the BOD. Twenty-five out of 40 firms indicated that
the CEO makes important decisions after consulting the chairman of the
BOC.
In carrying out their tasks, the majority of firms reported not hav-
ing committees to assist the BOD and BOC, as shown in Table 1.13. Only
a few companies have nomination, remuneration, and auditing committees,
most of which were set up between 1995 and 1997. In 1995, Bank Indone-
sia required commercial banks to have an auditing committee.
Table 1.13
Presence of Board Committees in Listed Companies
Type of Committee BOD BOC
Nomination Committee 5 1
Remuneration Committee 5 1
Auditing Committee 5 3
None 23 35
Total 38 40
Source: ADB Survey.
Most firms reported terms of appointment of three to five years for

the BOD and BOC. In some companies, the term differs for commissioners
and directors. Although the term is for three to five years, in 13 out of 40
companies, the directors and commissioners have been in service for more
than five years.
Results of the ADB survey show that in 18 companies, the CEO is
given fixed compensation plus a profit-related bonus. In 14 companies,
only fixed compensation is given. For the BOC chairman, 10 companies
provide fixed compensation plus profit related bonus, while 14 companies

provide fixed compensation only.
Role and Protection of Minority Shareholders
Indonesian law requires publicly listed companies to have at least 300 share-
holders to help ensure share liquidity and dispersed ownership. The highest
number of shareholders is found in Bank BNI (a state-owned bank), report-
edly having 27,568 shareholders. Small companies simply comply with the
minimum shareholder number requirement. Most companies reported that
their shareholders enjoy all mandated rights and protection, except those on
proxy voting by mail, cumulative voting for directors, and the independent
board committee.
A company charter (articles of incorporation) stipulates the quo-
rum requirement during annual meetings, which is usually two thirds of
total shareholders. The ADB survey showed that more than 67 percent of
shareholders attended the last annual meeting in most companies. While
proxy voting is allowed, proxy votes accounted for less than 10 percent of
shareholders on average. Brokerage companies and management were the
usual proxies.
A change in the company charter requires a two-thirds majority
vote by shareholders. The ADB survey revealed that in the last three years,
only one management proposal (i.e., director’s fee) was rejected during the
AGM. This is not surprising because management usually seeks prior ap-
proval of proposals from controlling shareholders.
Accounting and Auditing Procedures
Thirty-five out of 40 respondents in the ADB survey claimed to have sub-

stantially followed international accounting standards even prior to the fi-
nancial crisis. Accounting authorities, however, can easily change accept-
able accounting methods. After the crisis, for instance, the Indonesian Ac-
countants Association recommended that potential foreign exchange losses
be reported as losses at the end of the accounting year. Later, the associa-
tion allowed companies to choose between declaring it in the profit and loss
statement at the end of the accounting year or in the balance sheet.
All companies in the survey reported the presence of an independ-
ent auditor, which is usually an international audit company. Most compa-
nies have been associated with their independent auditors for more than
five years. Shareholders appoint the external auditor during the AGM.
1.3.3 External Control
Control by Creditors
The control of creditors over a debtor company rests on assets used as col-
lateral for loans. Unsecured creditors resort to the legal process when prob-
lems arise. Based on the ADB survey, each company was associated with
an average of five creditors, the majority of which were banks. Some com-
panies were associated with an excessively large number of creditors, reach-
ing up to 30. Most of the companies have been dealing with their institu-
tional creditors for less than three years.
Although the banking law requires collateral for bank loans, some
creditors did not enforce the requirement. Only 10 companies reported that
they were required to provide collateral by all creditors. Twelve companies
claimed having creditors that did not ask for collateral.
Twenty-five out of 32 companies reported having renegotiated loans
with creditors in the last five years, mostly after the Asian crisis. This indi-
cates that many companies experienced serious difficulties in repaying debts
as a result of the crisis. But most of these companies stated they would
possibly borrow from the same creditors, indicating their relatively strong
bargaining position. The majority of firms (22 out of 29) also said that
creditors had no influence in management decision making.
In 1998, the Bankruptcy Law was passed to protect creditors and
the Commercial Court was set up to deal with bankruptcies. This paved the
way for unsecured creditors to proceed against a debtor in default based on
loan covenants and through the legal process of collection against the debt-
or’s assets. However, enforcement of the law was a disappointment to those
who hoped that it would put corporate restructuring and the settlement of
corporate debts on a running start. Only 17 cases had been filed with the
court by late November 1998. Just two companies had been declared bank-
rupt, and three suits were dismissed by the Commercial Court. The Gov-
ernment’s political will and support are still very much needed in order to
set up a well functioning Commercial Court. Long and hard work is re-
quired to restore creditors’ confidence in Indonesia’s legal system.
The Market for Corporate Control
Between 1992 and 1997, there were 40 cases of acquisition and takeover of
Indonesian companies. Most of these, however, were internal acquisitions
(i.e., acquisition of a company in the same group). Only five cases were
external acquisitions. A study by Connie Tjandra (1993) shows that inter-

nal acquisitions were often initiated for tax shelter purposes.
One famous takeover was Bank Papan Sejahtera, which was
acquired by Yopie Wijaya in 1995. Wijaya and his friends bought shares
of the bank on several occasions until they gained control. They then re-
placed the BOD and later sold the bank, at a large profit, to Hashim
Djojohadikusumo, the owner of Tirtamas group.6 In this case, the acquir-
ing interest was apparently seeking economic profits. Another case was the
takeover of Bank Niaga in 1997 by Djojohadikusumo, who was acquiring
his second commercial bank. However, the takeover brought significant
losses to Djojohadikusumo when share prices plunged7 during the crisis. A
more recent case was the acquisition by Nutricia (the fourth largest baby
food firm in the world) of PT Sari Husada (another baby food firm) in
1998. The BOD and BOC of PT Sari Husada were allowed to complete
their terms before they were replaced. In these two latter cases, the acquir-
ing parties were trying to obtain operating synergies because they had com-
panies in the same industry.
Control by the Government
Government control could be in the form of state ownership, appointment of

management, restrictions on market entry, or direct subsidies. Most Indone-
sian state companies are 100 percent owned by the Government, except for
publicly listed SOCs. State ownership for listed SOCs ranges from 25 to
35 percent. The Government appoints the BOD and BOC of these firms.
Before the financial crisis, it was common for the Government to
invest in certain private companies. For instance, with the minister’s ap-
proval, a state-owned insurance company may invest its funds in a private
firm. The Government is thus able to appoint some officials to be members
of the private firm’s BOD or BOC. This used to be a common practice in
companies associated with the Suharto regime.
In the massive restructuring of the banking sector that commenced
after the crisis, the Government took over NPLs and put them under IBRA
management. Since the NPLs reached up to Rp300 trillion, IBRA found
itself tasked with managing large amounts of assets in the private sector.
6
Later in March 1999, the bank was liquidated. The bank was reported to have high NPLs
and had broken the legal lending limit.
7
In April 1999, Bank Niaga was under a recapitalization program.
1.4 Corporate Financing
1.4.1 Financial Market Instruments
Prior to 1977, bank loans were the only instruments available to the corpo-
rate sector for short term (working capital) or long term (investment) fi-
nancing. Since then, new instruments have been introduced to the corporate
sector, including bonds, stocks, and others offered by nonbank financial
institutions or finance companies. Bank loans, however, remain the major
financing instrument for the corporate sector.
Bank Credit
As shown in Table 1.14, bank credit surged from Rp122.9 trillion in 1992
to Rp487.4 trillion in 1998. Private national banks and state-owned banks
were the biggest domestic creditors, jointly providing almost 90 percent of
loans until 1997. Data from Bank Indonesia show that from 1994 to 1997,
private national banks overtook state banks as the dominant credit source.
From 34.4 percent in 1992, the share of private national banks in outstand-
ing total loans increased to 44.6 percent in 1997.
Table 1.14
Banking Sector Outstanding Loans, 1992-1999
(Rp trillion)
Type of Bank 1992 1993 1994 1995 1996 1997 1998 1999
State-Owned Banks 68.2 71.5 80.0 93.5 108.9 153.3 220.7 112.3
Foreign Banks 9.3 14.7 18.4 24.2 27.6 48.6 66.7 50.0
Regional Govt Banks 3.0 3.6 4.2 5.2 6.5 7.5 6.6 6.8
Private National Banks 42.3 60.4 86.3 111.6 150.0 168.7 193.4 56.0
Total 122.9 150.3 188.9 234.6 292.9 378.1 487.4 225.1
Equities
In 1977, when the Government reactivated the stock exchange, equities

became available to the corporate sector. However, because of the restric-
tions discussed below, this market was not well developed. When the Gov-
ernment liberalized the banking industry at the end of 1988 (which allowed
for higher interest rates), companies considered alternatives to bank loans.
Some companies went public, thus increasing the role of the capital market
in raising long-term funds.
In 1988, when foreign investors were not yet allowed to purchase
listed shares, funds raised in the stock market were less than 5 percent of
the credit disbursed by the banking sector. The ratio reached 8.3 percent in
1990 when the stock market was liberalized and foreign investors were
allowed to purchase up to 49 percent of listed firms’ shares, but dropped to
8 percent in 1991 when the Government tried to stabilize an overheating
economy. It gradually increased again starting in 1991, shooting up to
18.7 percent in 1997. Overall, the stock market has gained a bigger role in
corporate sector financing (Table 1.15).
Table 1.15
Value of Stocks Issued and Stock Market Capitalization, 1992-1999
(Rp trillion)
Item 1992 1993 1994 1995 1996 1997 1998 1999
Stocks Issued Outstanding 11.2 16.1 26.5 35.4 50.0 70.9 76.0 206.7
(As % of Outstanding
Bank Credit) 9.1 10.7 14.0 15.1 17.1 18.7 15.6 91.8
Market Capitalization 48.6 123.4 207.6 310.9 406.6 301.5 333.6 859.5
Financing by Finance Companies
Finance companies first emerged at the end of 1980, offering services such
as leasing, factoring, credit cards, and consumer credit. They were not,
however, allowed to accept deposit accounts from the public. Prior to 1995,
the activities of finance companies were not covered by regulations on pru-
dential practices in the banking sector (e.g., legal lending limit, capital ad-
equacy ratio, and net open position). Most banks therefore set up subsidi-
ary finance companies to circumvent banking regulations. During the 1990s,
finance companies were increasingly used as channels for the inflow of
foreign loans.
In 1995, the Government issued regulations to supervise and pro-
mote prudential practices in finance companies, i.e., limiting loans to a maxi-
mum of 15 times equity and foreign loans to five times the equity. The ratio
of funds raised by finance companies to credit disbursed by the banking sec-
tor has been increasing from about 5 percent in 1992 to 13 percent in 1996.
Commercial Papers
Commercial papers, which are unsecured negotiable promissory notes with

a maximum maturity of 270 days, have been popular in Indonesia since
1990. While banks had some exposure to these instruments, they were not
rated by a rating agency. Thus in November 1995, Bank Indonesia prohib-
ited banks from underwriting issues of commercial papers but allowed them
to act as paying agents. Banks could invest only in commercial papers that
were rated by the Indonesian Rating Agency (which was set up only in
1995 to rate debt instruments), otherwise it would be classified as a loss in
the banks’ books.
1.4.2 Patterns of Corporate Financing
Table 1.16 shows financing sources of Indonesian publicly listed nonfinancial

companies estimated by using flow-of-funds analysis. In the second half of
the 1980s, publicly listed nonfinancial companies had high proportions of
equity and internal finance (retained earnings), averaging 26.5 percent and
36.8 percent, respectively. This is in contrast to the lower share of borrow-
ings during the same period. In terms of composition, short-term borrow-
ings were greater than long-term debts, at 81 percent of total borrowings.
Table 1.16
Financing Patterns of Publicly Listed Nonfinancial Companies,
1986-1996
(percent)
Financing Source 1986-1990 1991-1996 1986-1996
Internal 36.8 16.0 17.3

Borrowings 17.3 39.3 37.9
Short-Term 14.0 16.7 16.5
Long-Term 3.2 22.6 21.4
Debentures/Equity 26.5 23.3 23.5
Debentures — (0.1) (0.1)
Equity 26.5 23.4 23.6
Trade Credit 11.8 8.4 8.6
Others 7.6 13.0 12.6
Total 100.0 100.0 100.0
Source: Author’s estimates based on the Pacific-Basin Capital Markets (PACAP) Databases, PACAP
Research Center, 1996.
In the 1990s, the pattern changed. Corporate debts grew over time,
rising from Rp54.4 trillion in 1993 to Rp112.9 trillion in 1996. This amount
doubled in 1997, reaching Rp229.2 trillion. Of the various financing sources,
corporate debts accounted for 39.3 percent during 1991-1996, with long-
term debts increasing rapidly. These liabilities grew significantly because
corporate expansion was largely financed by debt.
Many companies suffered big losses in 1997 due to their high ex-
posure to dollar loans. For instance, Indofood registered losses of almost
Rp1.2 trillion (mostly foreign exchange losses), while Semen Cibinong’s
losses reached Rp2.9 trillion. Two telecommunications companies, Indosat
and Telekom, also suffered from foreign exchange losses but managed to
post profits of Rp0.6 trillion and Rp1.1 trillion, respectively. All companies
in the cement industry suffered from foreign exchange losses, except Se-
men Gresik (an SOC), which managed to post significant profits due to low
exposure to dollar-denominated loans.
Hence, the corporate sector’s high leverage, as evidenced by an
average DER of 230 percent during 1992-1996 that rose to 310 percent in
1997, was due largely to a rapid rise in long-term debts, which was masked
by the rapid growth in investments. The corporate sector invested heavily
from 1991 to 1993 and slowed down its investment spending a few years
before the 1997 crisis.
Note that the corporate sector’s high leverage existed side by side
with sizable equity capital raised from the capital market. The high share of
equity financing was due to the surge in capital market activity following
the 1988 reforms. Bank loans also surged when the banking sector was
liberalized in 1988.
1.4.3 Corporate Financing and Ownership Concentration
It has been suggested, in the context of Indonesia and some other countries,
that ownership concentration may be associated with heightened risk-taking
by companies. Large shareholders are inclined to undertake risky projects in-
tended to generate high returns using borrowed funds. They also do not want
to dilute corporate control and are more likely to finance growth with debt.
Table 1.17 compares the DER of listed firms by degree of owner-
ship concentration. The results indicate that firms with higher ownership
concentration tend to have a higher DER. The analysis of ownership pat-
terns in Section 3 indicated that founders (the controlling party) or the five
biggest owners held at least 50 percent of total shares. Most corporate char-
ters require commissioners to approve debt issues or sign debt agreements.
However, since commissioners represent the controlling party, decisions on

debt are made with the implicit endorsement of owners. Controlling parties
rely on external financing to maintain their equity share and, ultimately, to
maintain control of the company.
Table 1.17
DER of Listed Companies by Degree of Ownership Concentration
(percent)
DER of Firms with High DER of Firms with Low

Item Ownership Concentration Ownership Concentration
Mean 699.0 351.0

Standard Deviation 1,358.0 386.0
Notes: Firms with high ownership concentration have more than 50 percent of shares owned by the top
five shareholders. The test of the difference between the two means found the t-value of 1.56 signifi-
cant at the 10 percent level.
Source: Author’s estimates.
1.5 The Corporate Sector in the Financial Crisis
1.5.1 Causes of the Financial Crisis
Many intertwined factors led to the crisis. This section highlights those that
were seen to have contributed significantly to the crisis in Indonesia: inad-
equacy of the regulatory framework under the financial liberalization, heavy
reliance of companies on bank credits to finance investments, and high
ownership concentration among families with political affiliation.
Inadequate Financial Regulatory Framework
Liberalization of financial markets increased the corporate sector’s access

to domestic and foreign private capital. The availability of bank credit brought
by the rapid rise in the number of banks and the free capital flow system led
to a credit boom.
Between 1987 and 1996, the private sector borrowed heavily in
unhedged dollars. The low cost of foreign loans and the relatively stable
exchange rate created a false sense of security for corporations. In addition,
the free capital flow system allowed private companies to borrow dollars
offshore without any restriction. As a result, the borrowings swelled, aided
by the lack of an existing mechanism to supervise and monitor foreign

transactions.
The removal of entry barriers in the banking sector caused the number
of private national banks to soar from only 65 in 1988 to 144 in 1997. The
supervising agency was caught unprepared. A director at Bank Indonesia
revealed that in 1995, the level of corporations’ foreign debt could not even
be ascertained. It was doubly difficult to exercise supervision when groups
with political clout owned the banks. Conglomerates that had difficulty in
getting loans (i.e., those with high DERs) established their own banks. The
banks served as a “cashier” that provided easy credit to nonfinancial compa-
nies within the group. This often led to the violation of prudential credit
management practices. It also meant that the cashier bank had neither the
independence nor the incentive to exercise ex ante and ad interim monitoring
of borrowers. They were, after all, only created to serve the companies to
which they lent. As a result, large amounts of credit were directed to the
companies within the group, and the negative net open position (short posi-
tion in dollars) continuously rose to precarious levels. The Government later
specified the legal lending limit and the net open position that banks had to
follow. However, to circumvent these banking regulations, conglomerates set
up finance companies and used these as channels for the unfettered inflow of
foreign loans in lieu of banks. It was only in 1995 that some regulations on
the activities of finance companies were contemplated. It is not known if
these regulations had an effect on nonbank intermediaries.
Heavy Reliance on Bank Credits to Finance Investments
Companies relied heavily on bank loans to finance rapid corporate expan-

sion because internal financing was insufficient and the capital market was
not developed. There was also a smaller demand for equity compared to
external debt financing since controlling shareholders preferred the latter to
maintain their control of the companies. In the process, many firms became
highly leveraged. This left them vulnerable to interest rate surges as well as
sudden currency fluctuations in the case of dollar loans.
The large supply of foreign funds, averaging about 4 percent of
GDP, did finance many viable ventures. However, substantial amounts were
also funneled into projects that guaranteed repayment mainly on the strength
of borrowers’ close political connections. A lot of short-term foreign funds
were used to finance long-term investment projects. Decisions to borrow in
dollars made sense to many borrowers because dollar loans were cheaper
than rupiah loans.
By mid-1997, $35 billion of Indonesia’s foreign debt owed to pri-

vate foreign banks was about to mature in less than one year. In early 1998,
total private sector foreign debt stood at $72.5 billion, of which $64.5 bil-
lion was owed directly by corporations. Aside from the fact that many of
these loans were channeled through banks and corporations of politically
connected families, there was also almost universal confidence that the eco-
nomic growth would continue indefinitely. Corporations were certain that
they could roll over short-term loans when these fell due, as they had done
so in the years before the crisis.
High Ownership Concentration
High concentration of corporate ownership (particularly by families) led to

poor financing and investment practices. The ultimate control of the corpo-
rate sector rests in the hands of a small number of families who own groups
of companies. Families retain control by keeping the majority percentage
of outstanding shares. They ensure that commissioners represent their in-
terests and maintain close relationships with the chairperson. Controlling
shareholders also prefer to use debts to finance expansion so as not to dilute
their ownership, and in the process maintain control of the company. They
enhance their control over companies through cross-shareholdings, by set-
ting up their own banks, and investing shares among nonfinancial compa-
nies within the group and in other groups’ companies.
Collusion between big businesses and the political elite was wide-
spread in Indonesia. This was often the case in the banking industry, where
private banks are usually in the hands of big businesses, politicians, or
both. In many cases, banks did not lend on the basis of the soundness of the
project, but on the basis of who the borrower was. There were cases where
banks and borrowing companies were controlled by the same groups or
families with strong political connections. This fact was usually not dis-
closed in financial statements, partly because they used nominee accounts
to register ownership rather than set up a holding company. Family-con-
trolled corporations were generally structured as a complicated web of af-
filiates and associated companies.
Projects involving massive capital investments and long-term op-
erating deals (in telecommunications, toll roads, and power generation) re-
quire huge capital. Since the Government could not afford to undertake
these projects, contracts were granted to the private sector, most often to
people who were close to the ruling regime.
1.5.2 Impact of the Financial Crisis on the Corporate and Banking

Sectors
Impact on the Corporate Sector
Table 1.18 shows that growth in most sectors significantly fell in 1997.
This continued in 1998, when all sectors, except utilities, posted negative
growth rates. The construction sector was the worst hit, followed by the
finance and trade sectors.
Table 1.18
GDP Growth by Sector, 1996-1999
(percent)
Sector 1996 1997 1998 1999
Agriculture, Livestock, Forestry, and Fisheries 3.1 1.0 (0.7) 2.1
Mining and Quarrying 6.3 2.1 (2.8) (1.7)
Manufacturing 11.6 5.3 (11.4) 2.6
Electricity, Gas, and Water Supply 13.6 12.4 2.6 8.2
Construction 12.8 7.4 (36.5) (1.6)
Trade, Hotels, and Restaurants 8.2 5.8 (18.0) (0.4)
Transport and Communications 8.7 7.0 (15.1) (0.7)
Financial, Real Estate, and Business Services 6.0 5.9 (26.6) (8.1)
Other Services 3.4 3.6 (3.8) 1.8
GDP 7.8 4.7 (13.0) 0.3
Source: Central Bureau of Statistics (Biro Pusat Statistik, BPS).
The JSX Monthly reported that total losses of 214 listed companies
amounted to Rp39.24 trillion for the first six months of 1998; 53 compa-
nies reported negative equity of Rp6.58 trillion (meaning their losses were
greater than the paid-up capital); and 128 companies reported a total loss of
Rp46.52 trillion. Only 86 companies reported profits.
Using the financial statements as of 30 June 1998 of 161 publicly
listed companies, DER and ROE were calculated per sector, as shown in
Table 1.19. The average DER was found to be 1,370 percent, much higher
than the 307 percent registered in December 1997. Sectors with lower ROE
generally had higher DER. The consumer goods industry reported the low-
est ROE, followed by property, real estate, and building construction. Most
sectors showed significant increases in leverage, indicating a rapid rise in
Table 1.19
DER and ROE of Publicly Listed Companies by Sector, 1996-1998
(percent)
DER ROE
a
Sector 1996 1997 1998 1996 1997 1998a
Agriculture 104.0 234.0 186.0 14.2 23.9 12.8
Mining 65.0 108.0 72.0 17.1 (5.8) 36.5
Basic Industry 111.0 193.0 635.0 8.2 (4.0) (78.1)
Miscellaneous Industry 158.0 219.0 1,097.0 7.1 (3.6) (115.4)
Consumer Goods Industry 108.0 177.0 2,271.0 18.3 7.8 (373.4)
Property 177.0 191.0 864.0 8.6 (11.2) (264.6)
Infrastructure 105.0 97.0 92.0 15.0 12.1 30.2
Finance 631.0 697.0 1,395.0 13.4 5.4 (6.7)
Trade/Services 163.0 205.0 2,625.0 6.1 1.1 (92.0)
Average 229.0 307.0 1,370.0 10.7 1.1 (124.1)
Note: DERs were calculated for only 161 companies (out of 214) that had positive equity.
a
Actual data for 1st semester only, but annualized to approximate full year values.
Source: JSX Monthly, several publications.
rupiah values of dollar-denominated debts due to the weakening of the lo-

cal currency and the rapid decline in equity because of losses.
The huge losses suffered by most companies were caused by three
factors. First, losses in operation were due to declines in sales and increases
in the cost of imported inputs. Second, interest expenses rose as credit rates
increased from 20 percent in early 1998 to 40 percent in mid-1999. Third,
foreign exchange losses came about with the use of unhedged foreign debt.
Impact on the Banking Sector
Table 1.20 reveals that the banking sector’s ROE decreased significantly in
1997. Mostly suffering from a liquidity squeeze, private banks posted nega-
tive ROEs in the same year. The table also reveals that although private
national banks dominated the banking sector in terms of assets and credits,
small foreign banks enjoyed the highest profits.
As the rupiah weakened and interest rates increased, the NPL ratio
rose to 25.5 percent in April 1998, from only 8.8 percent in 1996. This
figure further increased to 47.7 percent in July 1998, as shown in Table
1.21. Financial and banking analysts estimate that by September 1998, the
NPL ratio had reached more than 60 percent, and would have kept on in-
creasing if interest rates had not declined.
Table 1.20
ROE of the Banking Sector, 1992-1997
(percent)
Type of Bank 1992 1993 1994 1995 1996 1997

State-Owned Banks 7.06 15.84 14.73 7.25 8.28 5.89
Foreign Banks 20.34 27.72 30.69 22.2 27.15 20.86
Joint Venture Banks 16.91 16.47 14.37 8.81 11.30 5.39
Regional Development Banks 21.45 20.07 19.44 13.67 13.09 11.43
Private National Banks 21.45 13.12 15.24 8.50 10.09 (11.38)
Total — 15.07 15.70 9.68 11.24 (4.20)
Source: The National Banking Association.
Table 1.21
Nonperforming Loans by Type of Bank, 1996-1998
(Rp trillion)
Private Regional Foreign and
State-Owned National Development Joint Venture
Item Banks Banks Banks Banks Total
Total Loans
Dec 1996 — — — — 331.3
July 1997 140.1 179.8 9.2 32.2 361.3
Dec 1997 198.1 187.5 10.8 48.7 445.0
July 1998 274.2 222.2 14.6 106.7 622.7
NPLs
Dec 1996 — — — — 29.1
July 1997 19.3 8.6 1.1 1.5 30.5
Dec 1997 22.0 6.5 1.2 2.2 31.9
July 1998 129.6 128.6 1.9 37.0 297.2
NPL Ratio (%)
Dec 1996 — — — — 8.8
July 1997 13.8 4.8 11.9 4.7 8.4
Dec 1997 11.1 3.5 11.1 4.5 7.2
July 1998 47.3 57.9 13.0 34.7 47.7
Source: Infobank, July No. 227/1998 and October No. 230/1998.
State-owned banks initially had the highest NPL ratio. In July 1998,
however, private national banks overtook State-owned banks when their
NPL ratio jumped to 57.9 percent. The high and increasing NPLs, coupled
with negative spreads (deposit rate was higher than the credit rate), put
pressure on the banking sector.
1.5.3 Responses to the Crisis
Corporate Restructuring Measures
At the end of 1997, the Government and private sector formed a committee
to help corporates deal with the crisis, particularly in terms of debt resolu-
tion. The committee was tasked to ascertain the level of private corporate
sector debts and arrange negotiations between debtors and creditors.
Corporate debt accounted for 46.7 percent ($64.6 billion) of Indone-
sia’s total external debt in March 1998. In addition, the corporate sector had
more than Rp600 trillion ($75 billion at Rp8,000/$1) in debt from domestic
commercial banks. Total amortization payments due on foreign debt in 1998
were placed at $32 billion (before restructuring), about 80 percent of which
was private. More than two thirds of private debt was short-term and the
average maturity of all private debt was estimated to be only 18 months.
In June 1998, IBRA was formed to offer Mexican-style resolution
for private sector foreign debt. The scheme offered a hedging facility against
rupiah devaluations for restructuring agreements. However, by mid-Sep-
tember 1998, none of the 2,000 eligible firms had signed up for the scheme.
Aside from being described as overly complicated, few companies were in
a position to resume interest payments. Thus, the scheme failed.
On 9 September 1998, the committee launched the Jakarta Initia-
tive, a more comprehensive scheme to tackle domestic and foreign corpo-
rate debt. The scheme encourages negotiation between creditors and debt-
ors, assembling the legal and policy framework to facilitate corporate re-
structuring. One premise of the initiative was that creditors should agree to
a standstill for a certain period (creditors would desist from exercising their
claims on a distressed company’s assets) to allow debtors to operate nor-
mally after obtaining fresh financing.
Since September 1998, a number of prominent companies, such as
Garuda (a national flag carrier), Astra International (automotive), and Ciputra
(property business), have been subject to restructuring deals under the ini-
tiative. In November, Semen Cibinong (cement industry) became the first
Indonesian company to resume paying part (25 percent) of the interest on
its $1.2 billion debt. By end-November, the Jakarta Initiative Task Force
had conducted negotiations for 52 companies with Rp2.4 trillion of domes-
tic debt and $6.7 billion of foreign exchange debt. While the process of
restructuring was in progress, companies were not servicing their debts.
Another option that companies could take under the Jakarta Initia-
tive was debt restructuring via debt-to-equity swaps. Unfortunately, only a
few companies reached agreement with their creditors on this. Astra Inter-
national (automotive industry) and Bakrie Brothers (a holding company in
several sectors) explored this option. In the banking industry, Bank Bali
agreed on a debt-to-equity swap with its creditor, Standard Chartered, un-
der which the latter would become one of the bank’s shareholders. Bank
Niaga also negotiated with some of its creditors, i.e., Rabobank and Citibank,
for equity infusion.
Meanwhile, some companies attempted to restructure their busi-
nesses on their own. When credit from the banking sector became unavail-
able and interest rates increased significantly, the companies’ financial per-
formance deteriorated, forcing them to cut costs, lay off workers, consoli-
date business units, and sell noncore businesses or nonoperating assets. For
instance, Astra International, a publicly listed company operating in the
automotive industry, focused on its core business of car and motorcycle
manufacturing and sold off its subsidiaries in semiconductors, plantations,
mining, and mining equipment. Some listed companies with relatively “rich”
shareholders decided to replace their loans with additional equity through
rights issues and privileged subscription (limited offering).
Bankruptcy Reform
The Bankruptcy Law was passed in August 1998, aiming to modernize the
bankruptcy system and promote the fair and expeditious resolution of com-
mercial disputes. Qualified professionals from the private sector will act as
receivers and administrators in the management of estates of companies in
bankruptcy or reorganization. Procedural rules are also being introduced to
ensure certainty and transparency in the proceedings, especially in prevent-
ing unjustifiable delays in the adjudication of bankruptcy. Protection against
insider and fraudulent transactions taken by a debtor prior to the adjudica-
tion of bankruptcy will be enhanced. Moreover, limitations will be im-
posed on the ability of secured creditors to foreclose on their collateral
during bankruptcy proceedings (as is provided for in the bankruptcy laws
of most other countries), with the requirement that adequate compensation
and protection will be provided to such creditors during that period.
A Commercial Court was set up to handle corporate restructuring
and debt settlements, as well as general commercial disputes. Debtors, who
fail to reach agreements with creditors in out-of-court workouts under the
Jakarta Initiative or fail to gain the requisite creditor support for the workout
plan can resort to the Commercial Court. The Commercial Court can be asked
to hold off creditors and impose strict guidelines on the negotiating process
to achieve liquidation of the company. In the longer term, it is envisaged that

the Commercial Court will play a central role in modernizing the commercial
legal system. The significance of a sound bankruptcy system cannot be un-
derstated as it provides a backdrop for negotiations in the workout and re-
structuring process against which parties often gauge their legal rights.
However, the Court’s early record has been a disappointment, with
only 17 cases filed as of November 1998. The Court has also declared only
two companies bankrupt. The bias in favor of debtors has retarded the pace of
corporate restructuring. Some companies simply decided not to pay their
loans knowing that it would be difficult for creditors to take the case to court.
To push bankruptcy reforms, legislation against corruption, collu-
sion, and nepotism (anti-KNN) was signed in 1999. There will be changes
in the implementation of the bankruptcy law, including procedures for han-
dling operational issues and processing bankruptcy cases. The Government,
in consultation with IMF and the World Bank, is also reviewing the Bank-
ruptcy Law.
Capital Market Reform
In the capital market, the Capital Market Supervisory Agency allows compa-
nies to offer additional shares directly to the public. Previously, companies
were allowed to sell shares only by issuing stock rights. The Agency also
allowed companies to buy back up to 10 percent of outstanding shares to
improve the condition of the stock market. However, since the market reflects
the condition of the economy, the measure had only a minimal impact.
The Government has also been concerned with the issue of capital
controls. Realizing that they undermine investors’ confidence, the Govern-
ment did not impose restrictions nor did it attempt to regulate capital flows.
Rather, the monitoring system for foreign exchange transactions will be
strengthened to improve transparency and better assess the credit exposure
of the corporate and banking sectors.
Banking Sector Reforms
The Government’s banking sector reform strategy is focused on (i) govern-

ment-assisted recapitalization programs for potentially viable private banks;
(ii) the resolution of nonviable private banks; (iii) the merger, reform, and
recapitalization of state banks; (iv) measures to recover liquidity support
previously extended to troubled banks by Bank Indonesia; and (v) a strength-
ened banking supervision system.
In 1997, the Government established IBRA to supervise problem

banks. The agency set up an Asset Management Unit (AMU) to directly
manage problem loans of banks under its supervision. To obtain a clearer
picture of the banking sector, the Government required banks to be audited
by international external auditors.
In October 1998, Parliament approved amendments to the banking
law that were geared toward strengthening the legal powers of IBRA and its
AMU. A new central banking law, providing Bank Indonesia with substan-
tially enhanced autonomy, was enacted in 1999.
The Bank Indonesia 21st package includes recapitalization, improve-
ment of rules and prudential regulations, and follow-up action on bank re-
structuring. Bank Indonesia has announced a recapitalization program for
potentially viable private banks. Banks deemed ineligible for recapitalization
will be closed, merged, or sold (after transferring NPLs to the AMU). How-
ever, depositors will be fully protected by the Government. Liquidity sup-
port given to troubled banks should be repaid in four years. The four state
banks (BDN, BEII, BBD, and Bapindo) will be merged into one bank named
Bank Mandiri. The merger process will be finished within two years.
Other Regulatory Reforms
To push corporate restructuring further, the Government has drafted a regu-

lation providing tax neutrality for mergers and removing other tax disin-
centives for restructuring. It has also drafted regulations to remove obsta-
cles for converting debt to equity. The importance of this legislation may
need to be emphasized. The Company Law at present can be interpreted as
severely limiting the scope for debt-equity swaps. In particular, it is doubt-
ful whether pure holding companies are able to enter into swaps. To over-
come these problems, regulations will need to be issued to permit debt-to-
equity swaps in the context of corporate restructuring plans.
1.6 Summary, Conclusions, and Recommendations
1.6.1 Summary and Conclusions
Corporate Ownership and Structure
Most of Indonesia’s top conglomerates were established as family busi-

nesses. Some 175 groups that originated from family businesses controlled
53 percent of total assets of the top 300 Indonesian conglomerates. How-

ever, not all of the conglomerate-affiliated companies are publicly listed.
Among those listed in the Jakarta Stock Exchange, the majority remains
family-controlled. On average, families control 67.1 percent of publicly
listed companies in Indonesia, while a single family controlled 16.6 per-
cent of the total stock market capitalization in 1996 and the top 15 families
controlled 61.7 percent. These figures show the extent of power wielded
over the corporate sector by a small number of families.
The restructuring and resolution of financial distress may, how-
ever, put a significant amount of corporate assets of conglomerates in the
hands of creditors or the Government. The financial crisis created opportu-
nities for addressing the inefficiencies in the legal and judicial system that
supported corruption.
Financing Patterns
Controlling shareholders opted to use debts to finance expansion, allowing

them to maintain their equity shares and, thus, retain ownership control of
companies. As a result, corporate debts grew over time. Rapid growth in
investments masked the corporate sector’s increasing leverage.
Companies preferred to borrow in dollars because interest rates of
foreign loans were lower than for domestic loans and the exchange rate was
relatively stable. But because foreign creditors were reluctant to lend long
term, Indonesian companies borrowed short term. Foreign creditors, mean-
while, lacked the information necessary to allow them to assess projects’
risks and chances for success.
Companies relied heavily on bank credit. However, banks were
unwilling to provide credit to highly leveraged companies. Therefore, when
barriers to entry in the banking sector were lifted, conglomerates set up
their own banks to serve as “cashiers” providing credit to companies within
groups. These banks also obtained cheap offshore funds. The free capital
flow system permitted the inflow of foreign capital to fuel the credit boom
in the economy. When the Government regulated the legal lending limit
and the net open position of banks, conglomerates set up finance compa-
nies to bring in cheap foreign loans as these companies were not adequately
regulated.
This study reveals that Indonesian listed companies with higher
ownership concentration had higher levels of leverage. On the one hand,
this financing pattern supports the claim that family-based controlling share-
holders relied on excessive borrowing to finance corporate expansion
without diluting their control. On the other hand, it also reflects the failure
of the financial sector to channel funds to the corporate sector efficiently
due to weak prudential regulation and supervision.
Impact of the Financial Crisis
Prior to the crisis, the corporate sector was in quite good shape in terms of
growth and profitability. The problem was in the maturity structure of its
dollar-denominated debt and high debt-to-equity ratios in some sectors.
Sales of conglomerates as well as those of publicly listed companies were
increasing, although at a declining rate. Net profits of publicly listed com-
panies had consistently been growing at an average rate of 20 percent each
year.
When the crisis hit Indonesia, the highly leveraged companies, par-
ticularly those with large short-term foreign loans, were the most adversely
affected. Total profits of publicly listed companies dropped to Rp3.1 tril-
lion in 1997 from Rp13.21 trillion in 1996, and registered a net loss of
Rp39.24 trillion in the first half of 1998. DER increased to 307 percent in
1997 and further surged to 1,370 percent in 1998. ROE dropped from
1.1 percent in 1997 to -124.1 percent in 1998; the consumer goods industry
was the worst hit, followed by the property sector. The significant increases
in leverage indicate a rapid rise in the rupiah value of debts due to the
revaluation of dollar-denominated debts, the high domestic interest rates
that prevailed from 1998, and the rapid decline in equity due to losses.
The financial crisis led to the closure of several dozen banks. As
the rupiah weakened and interest rates increased, NPLs rose and capital
adequacy ratios fell. At the height of the crisis, Bank Indonesia extended
emergency loans to many banks, financed by issuing nearly $80 billion
worth of bank restructuring bonds.
Responses to the Crisis
The impact of the financial crisis on the corporate sector was serious. The
Government and the private sector responded with measures to mitigate the
negative effects. The Government introduced reforms to improve bankruptcy
procedures, facilitate debt restructuring, and strengthen prudential regula-
tions and supervision of the financial sector.
To restructure the corporate sector, the Government initiated cor-
porate debt restructuring measures (Mexican-style foreign debt resolution
and the Jakarta Initiative). Meanwhile, corporate-initiated debt restructuring
measures included internal business restructuring (e.g., cost cutting and

business consolidation) and acquisitions by creditors or foreign investors
through debt-to-equity swaps and equity infusions.
1.6.2 Policy Recommendations
The Government should introduce measures to address the weaknesses in

corporate governance identified in this study. Specific recommendations
include protecting the rights of minority shareholders, improving the legal
and regulatory framework for bank supervision, and protecting creditors’
rights.
Protecting Minority Shareholders’ Rights
The Corporate Law provides sufficient rights and protection for all share-
holders, but inadequate protection to minority shareholders from the domi-
nance of large shareholders. In particular, minority shareholders have not
been able to oppose controlling shareholders’ decisions to invest in unprof-
itable projects financed by unhedged foreign currency debts. If the role of a
limited number of families in the corporate sector is so large and the Gov-
ernment is either heavily involved in or influenced by business, the legal
system is less likely to evolve in a manner that will allow it to protect
minority shareholders.
The Corporate Law should be reviewed and amended in the con-
text of pervasive control by large shareholders. Amendments should in-
clude (i) empowering minority shareholders by raising the majority per-
centage of votes required on critical corporate decisions and mandating
minimum representation of minority shareholders on the board; (ii) delin-
eating the functions of the board of directors and commissioners; and (iii)
strengthening transparency and disclosure requirements. Most companies
claim to have adopted international standards of accounting and auditing
procedures, but it is not clear whether in practice these standards are in
place. The Government should ensure that all laws and regulations are ef-
fectively enforced.
Improving the Legal and Regulatory Framework for Bank

Supervision
After the liberalization of the financial sector, the regulatory environment

was not prepared to supervise the increasing number of banks and nonbank
financial institutions. In the first place, the banking regulatory framework

was inadequate in regulating banks’ dealings with affiliated nonfinancial
companies. The ownership of banks (including finance companies) by share-
holders of nonfinancial companies undermined the capability of these banks
to conduct prudential credit management. Consequently, most of banks’
NPLs resulted from credit to companies within the same group. The regula-
tory framework was also weak in supervising and monitoring foreign trans-
actions. When finance companies were used to channel offshore loans in
lieu of commercial banks, the Government lost monitoring and control pow-
ers over foreign fund flows.
The Central Bank needs to monitor and control dealings by banks
within business groups and improve enforcement methods to prevent cir-
cumvention of prudential regulations. One way is to set limits on lending
activities by banks to affiliated nonfinancial companies, with necessary le-
gal sanctions for violations.
The Government should also continue strengthening the monitor-
ing system for foreign exchange transactions. Banks should be required to
provide data on such transactions and charged penalties for noncompli-
ance. The tendency of foreign creditors to lend short term is a problem that
must be confronted once private capital flows to Indonesia recover. Be-
cause foreign creditors are faced with more information asymmetries than
domestic creditors, it is likely that future private financial flows for the
corporate sector will continue to conform to a short-term structure.
Protecting Creditors’ Rights
To protect creditors’ rights, a new bankruptcy law was passed in the after-
math of the crisis and a Commercial Court was set up to deal with bank-
ruptcy cases. However, the Court has been slow and ineffective in process-
ing bankruptcy suits. Further, in contrast to the Republic of Korea and Thai-
land, the Indonesian corporate sector directly owes an inordinate amount
and a greater portion of its loans to foreign banks. Because these banks are
neither easily convinced nor compelled to submit their claims to the juris-
diction of Indonesian commercial and bankruptcy courts, it has been diffi-
cult to implement standstills, orderly restructuring, recapitalization, and
liquidation of corporate assets.
With credit being coursed through the domestic banking system
rather than directly to numerous local corporations, the Republic of Korea
and Thailand were more successful in getting foreign creditors to collec-
tively solve their problems during the crisis. This is a significant factor in
explaining the greater depth of the crisis in Indonesia, despite the smaller
level of capital inflows (as a percentage of GDP).
The Bankruptcy Law should thus be reinforced and creative means
should be introduced to avoid a prolonged and costly paralysis of corporate
activity and financing. Only when creditors have the confidence that their
rights are protected will they resume financing companies.
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ing Market. Working Paper #58, Center for International Business Education and
Research, University of Maryland, Maryland.
Indonesian Business Data Centre. 1997. Conglomeration Indonesia: Regenera-

tion and Transformation into World Class Corporate Entities.
Indonesian Business Data Centre. 1998. The Private Debt Anatomy.
Indonesian Central Bureau of Statistics. 1996. Large and Medium Manufacturing

Statistics.
Institute for Economic and Financial Research. Indonesian Capital Market Di-
rectory 1992-1998.
Jakarta Stock Exchange. JSX Monthly Statistics, various publications.
Keasey, K., and M. Wright. 1997. Corporate Governance: Responsibilities, Risks,

and Remuneration. John Wiley and Sons.
Embassy of Indonesia. 1995. Economy of Indonesia. Embassy of Indonesia

Homepage.
Letter of Intent of the Government of Indonesia to the IMF, 14 May 1999.
The Economist Intelligence Unit. Indonesia Country Profile, various publica-

tions.
The Economist Intelligence Unit. Indonesia Country Report, various publica-

tions.
2
Republic of Korea
Kwang S. Chung and Yen Kyun Wang1
2.1 Introduction
The economic crisis that began in Thailand and swept through Asia starting
in the summer of 1997 hit the Republic of Korea (henceforth, Korea) in
November of that year. As the Korean currency, markets, and corporates
were sent reeling, the Government and business sector had good reason to
reflect on the causes of the crisis. Poor corporate governance and political
and government intervention in the business and financial sectors are widely
viewed as contributory factors. It had been the norm in Korea to conduct
business based on political and administrative favoritism rather than on
competitive merits. A national consensus is emerging that a democratic
system based on free market principles should be firmly established to pro-
mote more intense competition in every sector of the economy. The coun-
try’s winners would then emerge based only on economic efficiency, timely
exit of poor performers from the market, and curtailing of morally hazard-
ous behavior that has been prevalent among economic decision makers.
Inefficient investment coupled with excessive financial leverage was
found to be at the root of the economic crisis at the corporate level. The
extent of inefficient investment can be seen from the fact that more than
70 percent of listed firms had negative economic value added (EVA) before
the crisis while those with positive EVA declined (Table 2.1). Business
managers and controlling shareholders were maximizing firm size at the
expense of profits, a practice that was not checked by creditors, internal
control mechanisms, or capital market discipline. This has been the crux of
the corporate governance problem in Korea. Further, banks as major credi-
tors had governance problems of their own and failed to monitor or exercise
the control rights generally afforded to lenders via loan agreements.
1
Professors, Department of Economics, Chung-Ang University, Seoul, the Republic of
Korea. The authors wish to thank Juzhong Zhuang, David Edwards, both of ADB, and
David Webb of the London School of Economics for their guidance and supervision in
conducting the study, the Korea Stock Exchange for its help and support in conducting
company surveys, and Graham Dwyer for his editorial assistance.
Table 2.1
Listed Firms with Positive Economic Value Added, 1992-1998
Item 1992 1993 1994 1995 1996 1997 1998
Total Number of Firms 508 513 531 560 561 518 490
Firms with Positive EVA 180 174 165 163 163 104 164
Percentage of Firms with
Positive EVA 35.4 33.9 31.1 29.1 29.1 20.1 33.5
Note: The EVAs are calculated as: EVA = NOPAT – WACC, where NOPAT is the net operating profit
after taxes and WACC is the weighted average cost of capital multiplied by invested capital. The EVAs
are the same as the economic profit as explained in T. Copeland, T. Koller, and J Murrin (1995).
Source: Korea Stock Exchange, June 1999.
Weaknesses in the overall corporate governance system in Korea

had many ramifications. Inefficient investment undermined the competi-
tiveness of Korean firms in the global marketplace. Dividend payments
were at less than 2 percent annually as opposed to the double-digit interest
rates in the past decades. Self-dealings by controlling shareholders—cross-
subsidization and cross-guarantees among member firms within a chaebol
(a conglomerate/large business group)—and the lack of transparency hin-
dered the development of an efficient capital market capable of mobilizing
low-cost equity funds.
This broad perspective can help clarify the ongoing reform efforts
of businesses and the Government. Government reform goals for the corpo-
rate sector include enhancement of corporate transparency, accountability
of controlling shareholders and boards of directors, capital market disci-
pline, and improvement of bankruptcy procedures. Restructuring efforts
have focused on reduction in the degree of business diversification and in
the financial leverage of large-sized firms, especially chaebols.
This study collects and analyzes data on the Korean economy, the
corporate sector, and individual companies, aiming to identify the areas in
need of further reform and to provide policy recommendations for improved
corporate governance. A survey was conducted for the nonfinancial listed
companies using a questionnaire developed by the Asian Development Bank
(ADB)2 to supplement official data. This study also reviews the legal and
2
The survey was conducted mainly through the Korea Stock Exchange, which distributed
and collected the questionnaire. The total number of respondents was 81 out of about
550 nonfinancial firms listed on the Exchange. Many firms left some questions unan-
swered.
Chapter 2: Korea 55
regulatory framework for the corporate sector and reform measures taken
after the crisis.
This chapter is composed of six sections. Section 2.2 presents an
overview of the corporate sector. It traces the country’s economic develop-
ment, reviewing government policies responsible for the development of the
modern corporate sector. Section 2.3 identifies characteristics of corporate
governance by analyzing the ownership structures and control patterns of listed
companies and the largest chaebols, which account for a substantial portion
of the Korean economy. It reviews such elements as shareholders’ rights, the
board of directors system, corporate control by the Government, creditors,
and employees and their role in shaping corporate governance practices. Sec-
tion 2.4 contains analyses of corporate financing and its relationship to per-
formance. Section 2.5 describes the state of the corporate sector in the financial
crisis and draws on the results of the foregoing sections to outline the causes of
the crisis. Section 2.6 discusses responses of the Government and the business
sector and explains in detail their reform and restructuring efforts. It then presents
recommendations for further reform in corporate governance and financing.
2.2.1 Historical Development3
The development of the Korean corporate sector is closely related to the

progress of the economy. The evolution of the modern Korean economy
can be divided into four periods. Major economic indicators for some of
these periods are shown in Table 2.2.
Import Substitution: 1948-1961
The Korean War (1950-1953) devastated Korea’s industrial capacity. From

1948 to 1961, the Government relied heavily on aid from the United States
(US) and United Nations to alleviate poverty and high inflation. The Gov-
ernment tried to produce food, clothing, and other necessities domestically,
and naturally adopted an import substitution policy. In the period 1948-
1961, the import liberalization rate was below 7 percent and the average
tariff rate was in the range of 25 to 30 percent.
3
The review of historical development of the Korean economy draws substantially from
the book by Sohn, Yang, and Yim (1998).
Table 2.2
Key Macroeconomic Indicators
Annual Average (percent, unless otherwise indicated)
Indicator 1962-1971 1972-1979 1980-1989 1990-1997
GNP Growth Rate 8.7 9.1 8.3 7.2

Inflation Rate 14.9 15.4 8.4 6.1
Savings Rate — 24.4 29.2 35.7
Investment Rate — 29.0 30.7 37.1
Manufacturing/GDP 21.1a 27.9b 30.7c 29.1d
Interest Rate on Time Depositse 21.5 15.2 11.2 9.9
Exchange Rate (won/$) 250.5 452.0 757.8 794.4
Export Growth Rate 38.8 41.2 15.8 10.6
Import Growth Rate 24.8 32.4 12.2 11.8
Trade Balance (million $) (724.0) (1,949.5) 314.2 (8,332.9)
Current Account (million $) (297.0) (1,265.9) 1,855.2 (7,102.5)
Capital Account (million $) 492.1 1,447.2 31.4 8,753.1
a
Refers to 1971.
b
Refers to 1979.
c
Refers to 1989.
d
Refers to 1997.
e
For maturities of one year or more.
Source: Bank of Korea, Economic Statistics Yearbook; IMF, International Financial Statistics.
However, the Government was not successful in solving the prob-

lems of slow growth, high unemployment and inflation, and large current
account deficits, largely because of political instability, lack of strong drive,
and inconsistent economic policies. Large amounts of aid in the form of
agricultural goods from the US kept prices of local goods low and discour-
aged efforts to increase agricultural production.
Export Drive: 1962-1971
Between 1962 and 1971, the Government redirected the policy focus away
from import substitution to an export-led manufacturing-based economy.
In 1961 it devalued the won from W65 to W130/dollar and announced its
first Five-Year Economic Development Plan (1962-1966). In the Plan, the
Government called for an unprecedented average annual economic growth
rate of 7.1 percent with moderate rates of inflation and introduced a series
of reform packages aimed at developing key industries, modernizing the
industrial structure, and implementing new budget and tax measures. This
goal required very high savings and investment rates. The Government tried
Chapter 2: Korea 57
to meet its targets by borrowing large amounts of foreign capital on the one
hand, and maximizing mobilization of domestic savings on the other. In
1963-1964, Korea normalized political and economic relations with Japan
to encourage inflows of Japanese capital that could finance big develop-
ment projects.
During the first five-year plan period, the Government undertook
important economic reforms in two areas: the foreign exchange rate and the
interest rate. In 1964, the Government changed the multiple and fixed ex-
change rate system to a unitary floating exchange rate system, and almost
doubled the foreign exchange rate from W130/dollar to W256/dollar to en-
hance the international competitiveness of exports. The exchange rate sys-
tem was a kind of crawling peg until 1974. The Government abolished
temporary direct subsidy measures and introduced a new comprehensive
export promotion system.
Exports increased sharply from $41 million in 1961 to $2.2 billion
in 1972. The average growth rate of the economy from 1960 to 1964 was
5.5 percent, a modest improvement over the 4.3 percent average between
1954 and 1959; but the average growth rate for 1965-1969 shot up to 10
percent. The well-educated, abundant, and cheap labor force was well uti-
lized by the export-led growth strategy, which laid a solid foundation for a
steady growth path.
During this period, the Government tried to provide exporting firms
with a free trade environment. However, due to continuous current account
deficits, imports of consumer goods and luxury items were highly restricted.
These were considerably liberalized in 1967 when Korea joined the Gen-
eral Agreement on Tariffs and Trade (GATT), but tariff rates were raised to
40 percent in the 1960s, up from 30 percent in the late 1950s. The positive
list system for imports was replaced with a negative list that indicated only
those items that could not be imported. This change raised the import liber-
alization rate from 9.3 percent to 60.4 percent. But the liberalization trend
turned out to be short lived as current account deficits continued. In 1971,
the import liberalization rate was 55 percent, while the average tariff rate
was 39 percent.
In 1965 the interest rate on one-year deposits doubled from 15 to
30 percent, resulting in high real interest rates. Bank deposits increased
rapidly, channeling funds from curb markets into the banking sector. The
interest rate reform enabled banks to allocate large funds to the industrial
sector and reduced the high inflationary pressure that had built up in the
economy. Also, the growth of gross domestic product (GDP) raised domes-
tic savings, boosting internal investment resources.
Heavy and Chemical Industry Promotion: 1972-1979
In the Third Five-Year Economic Development Plan (1972-1976), the Gov-

ernment changed its industrial policy emphasis from light industries to heavy
and chemical industries (HCIs). By promoting HCIs, it tried to substitute
imports and export high value-added HCI products. There were three rea-
sons for the switch: first, the Government felt the need to strengthen the
defense industry. Second, the emergence of competition of other low-wage,
less developed countries forced Korea to adjust its industrial structure. Third,
the Government felt that continuous trade deficits arising from increasing
intermediate and capital goods imports could be prevented by developing
import substitution industries. This strategy formally took off with the an-
nouncement of the HCI Promotion Plan in June 1973. The Government
targeted six industries—steel, nonferrous metal, machinery (including au-
tomobiles), shipbuilding, electronics, and chemicals—as future core indus-
tries, investing a total of $9.6 billion between 1973 and 1981 into these
sectors.
In 1972, in the face of a world economic slump, the domestic
economy was stagnant and many businesses, overburdened with debts and
high interest rates, faced the danger of bankruptcy. The Government took
emergency measures, announcing rescue packages for businesses and banks.
These included rescheduling business debts, reducing or exempting debts
of farmers and fishermen, and giving low interest rate loans to banks from
the central bank. The Government has since used similar emergency rescue
measures for large businesses and banks almost once every 10 years. These
practices contained an implicit government guarantee that large businesses
and banks could never fail, becoming a seed of the economic crisis in 1997.
The HCI promotion policy was much more comprehensive than
past economic development plans. It included a detailed construction and
investment schedule over a 10-year time frame and mandated coercive im-
plementation. The Government encouraged a variety of business projects,
and assigned them to specific chaebols. It promoted HCIs by supplying
massive capital for construction and development, and allocating virtually
unlimited amounts of credit at below-market rates while controlling the
financial system.
One industrial policy adopted during the heavy and chemical in-
dustrialization drive was administered credit rationing. Unlike the previous
system, where preferential export credit was given to almost every exporter,
this new strategy had the Government explicitly allocating credit only to
those firms deemed vital to HCIs in the form of below-market interest rates
Chapter 2: Korea 59
through state-controlled banks. Firms that followed the Government ex-

panded greatly, with many turning into the now well-known chaebols. New
start-up firms, however, met increased difficulty. Such an approach gave
the Government increased control over the economy, as it had to control
only a few large chaebols.
The industrial and trade policy resulted in high inflation in the 1970s
and serious excess capacity problems by 1979. The severe world recession
caused by the second oil shock, coupled with political uncertainty due to
the assassination of President Park in 1979, exacerbated the overcapacity
problem. This required industrial restructuring by the Government, includ-
ing forced liquidations and mergers and acquisitions (M&As).
Evaluations of HCI promotion policies are mixed. The plan of the
1970s was thought to be successful in the long run, since during the second
half of the1980s many of the promoted firms became world-class competi-
tors and exporters, and their utilization ratios were very high. Gross na-
tional product (GNP) growth rates on average were higher in the
1972-1979 compared to 1962-1971 (Table 2.2). However, the policy wasted
substantial amounts of resources in the short and medium terms, such as
widespread underutilization of capacities of HCIs and related plants, espe-
cially between 1979 and 1985. Meanwhile, light manufacturing and service
industries were weakened by disadvantages such as a lack of credit. Cheap
credit and distorted prices resulted in overexpansion in the HCIs. Macr-
oeconomic policies became hostages of the industrial strategy.
Economic Liberalization and Globalization: 1980-1997
In 1979, faced with high inflation, a heavy foreign debt burden, and the
large excess capacity of HCIs, the Government adopted comprehensive
measures to promote economic stabilization. The growth rate of the money
supply was reduced drastically, fiscal expenditure maintained zero growth,
imports were further liberalized while tariff rates were lowered, price con-
trols were abolished, and the won depreciated by 20 percent with the adop-
tion of a Basket-Currency Gliding System in 1980. Meanwhile, the Gov-
ernment restructured some large businesses through forced liquidation and
M&As. The incentives available became more market-based. In order to
improve economic efficiency, various measures to increase competition were
taken. The two important ones were import liberalization and deregulation
of the financial sector, including denationalization of banks.
In 1986-1989, Korea recorded current account surpluses and rapid
economic growth due to the “three lows”: low value of the US dollar, low
world interest rates, and low oil prices. The low value of the dollar led to a
low won and high yen, while continuous and large current account sur-
pluses saved Korea from the foreign debt problem. In 1988, Korea became
a signatory country to the International Monetary Fund (IMF) Article VIII,
giving up its foreign exchange controls related to the current account, and
declaring that it would follow Article XI of GATT, further increasing its
pace of import liberalization. In 1993, the import liberalization ratio reached
98.1 percent and average tariff rates 8.9 percent. In 1990, Korea adopted a
market average exchange rate system, in which the official rate for the day
would be based on the interbank transaction volume-weighted average of
rates of the previous business day. The official rate fluctuated within a band,
which gradually widened.
Korea began participating in many multilateral trade negotiations
during the Uruguay Round, joined the Asia Pacific Economic Cooperation
(APEC) Group in 1993, and acceded to the World Trade Organization (WTO)
in 1994. The Government tried to adjust economic policies and regulations to
meet global standards. Industrial and trade policies were modified to be con-
sistent with WTO. Korea abolished remaining direct subsidy systems for ex-
port activities as well as some traditionally managed trade systems. By join-
ing the Organisation for Economic Co-operation and Development (OECD)
in December 1996, the Government committed itself to further liberalization
of the goods and capital markets, but it chose to liberalize gradually.
Meanwhile, the importance of chaebols was increasing, with the
30 largest in the total economy in 1997 standing as follows: value-added,
13.1 percent; total assets, 46.3 percent; total debts, 47.9 percent; total sales,
45.9 percent; and total workforce, 4.2 percent.
2.2.2 Rise of the Large Business Groups (Chaebols)4
The Korean Fair Trade Act defines a business group as “a group of compa-
nies, whose business activities are controlled by an identical person.” A
large-scale business group is called a chaebol. The most important element
characterizing chaebols is the concentration of ownership, where particular
individuals and their family have de facto control of the management of all
subsidiary companies of groups.
The birth of chaebols can be traced to the selling of Japanese colo-
nial properties that were reverted to the Korean Government after World
4
The historical review of chaebols draws substantially from the paper of Lee and Lee
(1996).
Chapter 2: Korea 61
War II. Large-scale companies owned by the Japanese were sold to indi-
viduals under preferential terms and later enjoyed a relatively favorable
position for accumulating capital. Since the 1960s, the Korean Government
has set the national goals of economic development and offered all kinds of
support and incentives to achieve them. The Government provided subsi-
dies, financial assistance, and tax breaks to key industries to promote ex-
ports and industrial upgrading. This policy contributed greatly to the ex-
pansion of chaebols.
In the mid-1970s,when the Government put a great deal of empha-
sis on development of the HCIs, large-scale businesses and chaebols were
thought to be appropriate actors because they could meet the huge invest-
ment requirements of these industries. The Government provided financial
and fiscal incentives to chaebols and trading companies with relatively abun-
dant financial resources. From the standpoint of the Government, it was
more effective to deal with a small number of companies to secure tangible
outcomes. This galvanized the fast growth of chaebols. Since the Govern-
ment controlled most business activities, chaebols that maintained a close
relationship with the political authorities were able to grow fast.
Chaebols have a history of substantial concentration of ownership.
One reason for this controlling power is inter-company shareholding among
subsidiaries. Table 2.3 shows that the number of subsidiaries of the 30 larg-
est chaebols increased considerably since 1993, reaching 669 in 1996. How-
ever, after the financial crisis, the number of subsidiaries declined drasti-
cally due to corporate restructuring. Important managerial decisions are
made primarily by owners. In this sense, the ownership and management of
a chaebol’s subsidiaries are not separate. Chaebols are also excessively
diversified. Subsidiary companies of chaebols are subject to “fleet-type
management” in that they are controlled by the overall managerial system
of chaebols, and they are aided and supported by one another.
Table 2.3
Subsidiaries of the 30 Largest Chaebols, 1993-1996
Year No. of Subsidiaries Average No. of Subsidiaries per Chaebol

1993 604 20.1
1994 616 20.5
1995 623 20.8
1996 669 22.3
Source: The Fair Trade Commission.
Theoretically, chaebols can benefit from synergies, including the

“economies of organizational size” inherent in multi-product and multi-
plant firms, in addition to the usual economies of scale. Since chaebols are
engaged in many different businesses, they can reduce uncertainties and
dilute risks through sharing of information and diversification. This could
ensure their stable growth and enhance their investment abilities.
On the other hand, there are many negative assessments of or-
ganizational structures and practices of chaebols. For example, internali-
zation of the market that could enhance the internal efficiency of a chaebol
may close the market to other firms, which may ultimately lead to the
decline of social efficiency. Diversification may raise chaebol profitabil-
ity but could also work to eliminate more efficient competitors because
bigger chaebols have a higher capability to enforce unfair methods of
competition. Meanwhile, diversification can make chaebols stable through
the portfolio effect. However, if a chaebol has an unsound financial struc-
ture but strong financial links through mutual payment guarantees among
their subsidiaries, the bankruptcy of one or a few marginal subsidiaries
could lead to a chain of bankruptcies for the entire chaebol. Related to
this is the tendency of chaebols to assist unprofitable firms at the expense
of profitable ones.
2.2.3 Role of the Capital Market and Foreign Capital
In the 1960s, the Government’s efforts to develop the stock market culmi-
nated in the Capital Market Development Act of 1968. In the early years
after the enactment of the law, listed companies enjoyed corporate tax rates
that were 10 to 20 percentage points lower than those imposed on privately
held firms, and were allowed extra depreciation charges for tax purposes.
The law also allowed employees of listed firms to get 20 percent of the
subscription rights in offerings of new shares.
Another law that contributed to the development of the stock mar-
ket was the Act to Expedite the Going Public of Corporations of 1972.
Under this law, the Government reviewed the financial performance of com-
panies and recommended (or ordered) selected ones to go public. They had
to meet certain requirements in terms of firm size, years since establish-
ment, profitability, etc. The law also contained provisions to afford tax and
other benefits to firms that went public and to impose tax-related penalties
on those that refused to comply with government recommendations. This
law was in effect until 1987 when it was partly absorbed into the Capital
Market Development Act.
Chapter 2: Korea 63
During the 1980s and 1990s, several important policy measures

were implemented to promote the development of the stock market. First,
the Government announced the gradual opening of the capital market to
foreign investors in January 1981. In this regard, a country fund, The Korea
Fund, Inc., was established to invest in domestic shares beginning in Sep-
tember 1985. Second, the Government announced measures to increase the
demand for shares by providing tax and financial incentives to individual
investors. Also that year, Korean firms were allowed for the first time to
issue in international financial markets equity-related securities such as
convertible bonds (CBs) and depository receipts. Third, in 1986 the Gov-
ernment imposed limits to bond issues on firms that were recommended to
go public but refused.
The policy to expand the size of the stock market, mainly by in-
creasing the supply of shares by initial public offerings (IPOs) and sea-
soned issues, continued until 1989. Beginning 1990, however, the Govern-
ment attempted to stabilize the stock market by limiting IPOs and share
issues by listed companies, especially those paying small or no dividends.
This reversal in policy reflected declining stock prices and was generally
maintained until the outbreak of the economic crisis in 1997.
Because of government policies and the booming economy, the
stock market grew rapidly during the 1980s. As shown in Table 2.4, the
number of firms listed on the Korea Stock Exchange almost doubled in the
five-year period from 1985 (342 firms) to 1990 (669 firms). The aggregate
Table 2.4
Development of the Stock Market, 1985-1998
No. of Stock Market

Listed Price Capitalization Market Capitalization
Year Firms Index (W billion) as a Ratio to GDP (%)
1985 342 138.9 6,570 8.0
1989 626 918.6 95,476 79.2
1990 669 747.0 79,020 44.0
1994 699 965.7 151,217 49.4
1995 721 934.9 141,151 40.1
1996 760 833.4 117,370 30.1
1997 776 654.5 70,989 16.9
1998 748 406.1 137,798 34.6
Source: Monthly Review (Securities Supervisory Board) and the Financial Supervisory Service.
market value of all listed firms represented only 8 percent of GDP in 1985,
but increased sharply to 79.2 percent by 1989. The relative size of the stock
market diminished to 44 percent in 1990, due to declining stock prices, and
stayed at the 30-40 percent level up to 1996. The growth in the number of
listed firms also slowed in the 1990s. The number shrank for the first time
in 1998 to 748 firms from 776 the previous year. The reasons for the decline
include increases in bankruptcies and mergers involving listed companies
since the outbreak of the economic crisis. The aggregate market value of
listed shares bottomed at 16.86 percent of GDP in 1997, but rose again to
34.59 percent in 1998 and to more than 50 percent in the early months of
1999.
Korean companies borrowed substantial amounts of foreign capital
due to the excess of investments over savings and chronic current account
deficits—except in the period 1986-1989, and 1993. However, foreign di-
rect investment (FDI) has been very small relative to GDP and compared to
other East Asian countries. Table 2.5 shows net FDI—inward investments
by foreigners less outward investments by Koreans—in the period 1985-1998.
Table 2.5
Private Capital Flows to Korea, 1985-1998
($ million)
Portfolio Other Of Which

Year Net FDIa Investments Investmentsb Loans Trade Credits
1985 313 1,737 1,453 1,650 (518)

1986 (9) (333) (2,339) (1,433) (418)
1987 696 (297) (9,852) (9,658) 63
1988 809 (607) (2,542) (3,870) 1,352
1989 147 (2) (1,414) (1,910) 471
1990 (808) 218 5,500 2,150 3,440
1991 (115) 2,338 7,001 5,085 1,255
1992 (311) 4,953 4,924 2,583 2,126
1993 (832) 10,553 (1,455) 25 (1,694)
1994 (2,264) 8,149 13,642 10,817 2,858
1995 (3,008) 13,875 21,450 16,239 4,141
1996 (3,017) 21,183 24,571 19,347 4,546
1997 1,123 12,287 2,800 3,785 (2,296)
1998 3,742 (340) (7,413) (1,942) (6,944)
Total (3,534) 73,714 56,326 42,868 8,382
a
Permit basis.
b
Other investments include loans, trade credits, currency and deposits, and other liabilities.
Source: Balance of Payments, Bank of Korea.
Chapter 2: Korea 65
Complicated government regulations, weak incentives for attracting FDI,

and high production costs were the main reasons for low FDI in Korea.
Large amounts of outward investment by Koreans in the mid-1990s arose
out of increased liberalization of foreign exchange regulations.
In addition to FDI, other net private capital inflows amounted to
$130 billion during 1985-1998. Of this, portfolio investments amounted
to $73.7 billion and loans $42.9 billion. Between 1986 and 1989, Korea
had substantial current account surpluses and experienced net private capital
outflow. Net private capital inflow, excluding FDI, increased substantially
in 1994-1996 due to accelerated liberalization of capital movements
(Table 2.5).
This section looks at the performance of (i) the aggregate corporate sector;
(ii) listed firms; and (iii) chaebols. This would lay the foundation for evalu-
ating the effect of corporate governance on performance. The same catego-
ries will be analyzed in later sections.
The Aggregate Corporate Sector
The aggregate corporate sector in this study excludes the financial sector.
The contribution of the corporate sector to GDP was 73.2 percent in 1987,
increasing to 76 percent in 1997. The growth rates of total assets, equity,
and sales of the aggregate sector during this period were very high (Table
2.6). However, the growth rates of equity and sales dropped sharply in 1996
and 1997.
Corporate sector net proft margins increased from 1993 to 1995,
but dropped in 1996 and were negative by 1997. Return on equity (ROE)
and return on assets (ROA) showed similar patterns. The debt-to-equity
ratio (DER) averaged 311 percent for the period 1990-1996 and peaked
at 424.6 percent in 1997, following the sharp depreciation of the won.
This indicates that a substantial proportion of debt was denominated in
dollars.
Profit rates of Korean firms were relatively low compared to those
of Taipei,China and the US. Table 2.7 compares the ratio of ordinary in-
come to sales of Korea’s manufacturing sector with those of Japan;
Taipei,China; and US. The ratio is generally in the same range for Japan
and Korea, but between 1988 and 1993, Japan’s was consistently higher.
The dismal performance of the Korean corporate sector compared to the
Table 2.6
Growth and Financial Performance of the
Nonfinancial Corporate Sector, 1990-1997
(percent)
Growth Performance Financial Performance
Year Total Assets Equity Sales Net Profit Margin DER ROE ROA
1990 23.8 14.9 19.3 1.4 297.1 6.2 1.6
1991 22.2 16.0 21.0 1.5 318.0 6.7 1.7
1992 13.3 10.7 13.4 1.2 325.1 5.5 1.3
1993 11.9 15.9 10.3 1.2 312.9 5.4 1.3
1994 18.2 16.2 17.3 1.9 308.1 8.1 2.0
1995 19.7 18.2 21.2 2.0 305.6 9.1 2.3
1996 15.8 9.8 13.9 0.5 335.6 2.5 0.6
1997 21.3 1.4 13.4 (0.8) 424.6 (4.2) (0.9)
DER = debt-to-equity ratio, Net profit margin = ratio of net income to sales, ROA = return on assets
(ratio of net income to total assets), ROE = return on equity (ratio of net income to stockholders’ equity).
Source: Bank of Korea, Financial Statement Analysis Yearbook.
Table 2.7
International Comparison of Ratios of Ordinary Income
to Sales in Manufacturing
(percent)
Year Korea US Japan Taipei,China

1985 2.5 5.9 3.9 6.0
1986 3.6 5.8 2.8 8.0
1987 3.6 2.8 3.7 13.6
1988 4.1 8.3 4.5 13.9
1989 2.5 6.9 4.7 18.4
1990 2.3 3.7 4.3 4.5
1991 1.8 3.7 3.4 4.0
1992 1.5 4.0 2.6 3.4
1993 1.7 4.0 1.9 2.9
1994 2.7 7.5 2.4 4.9
1995 3.6 7.9 2.9 5.1
1996 1.0 8.3 3.4 —
1997 (0.3) — — —
Note: Ratio of ordinary income to sales = (ordinary income/sales). Ordinary income = operating in-
come + nonoperating income (from financial activities) – nonoperating expenses (from financial activi-
ties).
Source: Bank of Korea, Financial Statement Analysis Yearbook.
Chapter 2: Korea 67
other three economies can be attributed to the emphasis on growth in sales

and market shares rather than on profits. This preference of Korean firms
has its roots in the structure of corporate governance.
Performance followed similar patterns across different industries
(Table 2.8). Growth rates of total assets are generally high, with the whole-
sale and retail trade sector and the construction sector having the highest
figures. Profit rates of most industries are also quite low, the exception
being the electricity, gas, and steam supply industry. This may be related to
its having the lowest DER. The other financial ratios follow the general
pattern of the aggregate corporate sector.
All sectors experienced a sharp decline in equity and sales growth
in 1997, with equity in wholesale and retail trade even contracting. Profit
rates of different industries also mirrored the downward trend of the aggre-
gate corporate sector prior to the crisis. The manufacturing, construction,
trade, and transport sectors recorded negative profit rates in 1997. It is no-
table that the construction sector’s profit rate began its decline in 1995, a
year ahead of the other industries.
Listed Companies
The number of listed firms increased from 334 in 1985 to 775 in 1997
(Table 2.9). In most years, the sales growth of listed firms was higher than
that of the aggregate sector (see Table 2.6). In 1997, sales of listed firms
grew 18.5 percent while the aggregate sector recorded only 13.4 percent.
The superior performance of listed firms in terms of sales growth may be
due to large firms’ easy access to credit and the inclusion of financial firms
in the listed firms category.
The profit margin of listed firms was generally higher than that of
the aggregate corporate sector. However, both ROA and ROE were lower
for the listed firms compared to the latter.
A comparison of performance by firm size reveals some interesting
results. The growth performance of large firms for the 1988-1997 period
was better than that of medium- and small-scale firms (Table 2.10). Again,
this may be an indication of the bias toward large firms in terms of access to
credit. However, the average ROE was lowest for large firms, while their
average net profit margin was lower than that of medium firms, but higher
than that of small firms. Net profit margins, ROEs, and ROAs of all listed
firms declined substantially in 1996 and turned negative in 1997. Small
listed firms were hardest hit by the financial crisis, followed by medium-
sized firms and large ones.
Table 2.8
Growth and Financial Performance of Selected Industries
(percent)

a b
Year Assets Equity Sales NPM DER ROE ROA
Manufacturing
1985 13.0 10.3 9.8 1.1 348.4 5.8 1.3
1986 15.2 15.0 16.8 2.0 350.9 10.9 2.4
1987 20.4 24.9 22.6 1.9 340.1 10.7 2.4
1988 15.8 31.0 15.8 2.0 296.0 10.2 2.5
1989 24.0 37.8 7.0 1.6 254.3 6.4 1.7
1990 23.8 16.8 18.8 1.4 285.5 5.6 1.5
1991 22.6 16.3 17.4 1.4 306.6 5.6 1.4
1992 12.3 8.6 10.3 1.0 318.7 3.7 0.9
1993 11.2 17.6 10.0 1.1 294.8 4.2 1.0
1994 16.9 14.1 18.2 2.0 302.5 7.6 1.9
1995 19.3 21.4 20.4 2.8 286.7 11.0 2.8
1996 15.0 5.8 10.3 0.5 317.1 2.0 0.5
1997 22.4 1.1 11.0 (1.0) 396.2 (4.2) (0.9)
Average 17.8 17.0 15.0 1.4 315.2 6.1 1.5
Construction
1985 18.4 8.0 1.5 0.9 520.5 5.2 0.9
1986 4.0 (0.1) (5.7) (0.3) 569.4 (1.6) (0.2)
1987 5.3 (3.2) 2.9 (1.1) 740.9 (6.6) (0.8)
1988 8.2 22.8 16.2 0.5 538.4 3.2 0.5
1989 24.8 35.5 18.9 1.0 458.5 5.5 1.0
1990 34.5 28.5 29.2 1.1 473.4 6.4 1.1
1991 30.9 23.1 36.2 1.5 474.8 10.3 1.8
1992 16.7 20.0 16.0 1.4 461.5 8.8 1.6
1993 17.0 22.7 5.5 2.0 432.6 12.3 2.3
1994 24.8 30.6 13.7 2.1 375.2 10.4 2.1
1995 24.9 12.4 16.1 0.6 423.8 3.2 0.6
1996 14.5 9.2 16.5 0.1 562.6 0.7 0.1
1997 14.3 5.9 16.3 (0.5) 655.7 (3.0) (0.4)
Average 18.3 16.6 14.1 0.7 514.4 4.2 0.8
Real Estate, Renting, and Business Activities
1985 11.4 7.7 16.0 7.5 241.5 14.5 4.3
1986 12.2 (0.2) 16.0 3.9 270.3 6.8 1.9
1987 15.3 15.3 21.2 5.6 288.7 14.5 3.7
1988 13.6 25.1 25.8 6.7 228.0 19.0 5.5
1989 24.7 22.6 32.5 7.0 245.5 19.2 5.6
1990 22.8 14.9 27.7 3.4 338.5 12.9 3.0
1991 14.0 10.8 21.3 2.4 483.8 13.4 2.3
1992 12.1 23.2 15.7 2.2 526.8 10.8 1.7
1993 10.9 2.2 9.1 0.5 616.5 2.8 0.4
1994 25.6 6.6 27.3 1.1 239.4 2.8 0.9
1995 17.3 7.8 31.1 1.0 291.1 3.4 0.9
1996 15.3 13.5 28.6 (0.0) 290.9 (0.1) (0.0)
1997 14.6 5.8 14.0 0.8 428.8 3.9 0.8
Average 16.1 12.0 22.0 3.2 345.4 9.5 2.4
Table 2.8 (Cont’d)
Year Assets Equitya Sales NPMb DER ROE ROA
Wholesale/Retail Trade
1985 — — — — — — —
1986 — — — — — — —
1987 — — — — — — —
1988 — — — — — — —
1989 — — — — — — —
1990 31.3 14.4 17.6 0.8 448.5 10.4 2.0
1991 23.6 21.0 21.9 0.5 462.9 6.9 1.3
1992 14.1 14.4 18.5 0.7 456.5 9.6 1.7
1993 11.1 13.8 13.3 0.4 539.3 6.1 0.9
1994 21.7 14.1 17.5 0.4 524.3 6.8 1.1
1995 20.5 16.1 26.6 0.4 543.7 6.6 1.0
1996 16.9 17.3 18.1 0.4 510.5 6.1 1.0
1997 18.3 (2.2) 15.2 (0.7) 612.6 (11.1) (1.1)
Average 19.7 13.6 18.6 0.4 512.3 5.2 1.0
Transport, Storage, and Communication
1985 15.9 (10.7) (0.3) (2.4) 698.3 (15.9) (2.3)
1986 17.4 (4.8) 11.7 (1.1) 740.4 (8.0) (1.1)
1987 11.4 (12.5) 11.4 (0.0) 1,062.0 (0.3) (0.0)
1988 6.9 22.5 12.9 1.6 921.4 15.2 1.4
1989 10.5 47.6 8.2 1.5 633.4 10.8 1.3
1990 14.8 (2.2) 14.6 2.4 341.5 6.9 1.7
1991 12.8 9.5 20.4 3.3 344.9 10.6 2.4
1992 12.4 14.6 14.4 3.0 332.9 9.7 2.2
1993 10.4 12.0 15.5 2.3 321.1 7.8 1.8
1994 16.1 21.0 15.6 4.2 323.5 14.5 3.4
1995 15.7 14.9 19.2 3.3 307.4 11.4 2.8
1996 15.3 4.6 14.7 0.5 367.5 1.9 0.4
1997 34.5 1.8 19.0 (2.8) 482.8 (11.3) (2.2)
Average 14.9 9.1 13.6 1.2 529.0 4.1 0.9
Electricity, Gas, and Steam Supply
1985 12.7 8.4 7.6 7.3 187.4 6.2 2.2
1986 2.6 9.5 6.6 8.7 169.2 7.3 2.6
1987 0.3 12.2 9.7 11.6 143.0 9.6 3.7
1988 0.6 18.9 11.3 19.6 106.0 15.5 7.0
1989 4.0 12.6 4.3 16.2 89.2 11.6 5.9
1990 7.7 9.1 12.5 10.8 90.0 8.3 4.3
1991 16.2 11.2 14.3 11.2 98.3 8.9 4.6
1992 18.9 11.4 18.7 10.0 112.2 8.5 4.1
1993 12.7 7.5 14.3 5.1 122.7 4.6 2.1
1994 12.1 15.1 18.8 8.8 116.5 8.4 3.8
1995 15.5 14.6 15.9 8.1 117.8 7.8 3.6
1996 30.4 34.3 17.2 4.9 111.6 4.4 2.0
1997 30.6 2.4 15.1 3.9 172.3 3.5 1.4
Average 12.6 12.9 12.8 9.7 125.9 8.0 3.7
a
New equity does not include capital surplus.
b
NPM denotes net profit margin.
Source: Calculated using data from Bank of Korea, Financial Statement Analysis Yearbooks.
Table 2.9
Growth and Financial Performance of Listed Companies, 1985-1997
(percent, unless otherwise indicated)
Financial Performance
Year No. of Firms Sales Growth Net Profit Margin ROE ROA
1985 334 10.9 0.6 3.5 0.3
1986 351 11.3 0.8 5.0 0.5
1987 386 20.9 0.6 3.2 0.4
1988 503 26.4 2.3 9.2 1.4
1989 626 22.5 2.9 6.8 1.6
1990 669 19.6 2.9 6.8 1.4
1991 680 23.3 2.1 5.3 1.0
1992 681 15.2 1.7 4.6 0.9
1993 687 9.6 1.4 3.9 0.7
1994 698 22.8 2.2 6.1 1.1
1995 715 24.9 2.4 6.9 1.2
1996 754 21.0 0.6 1.7 0.3
1997 775 18.5 (1.4) (5.1) (0.7)
Average 19.7 1.5 4.5 0.9
Source: Constructed using data from Korea Investors Service, Kis-Fas, 1998.
Performance of Chaebols
This section uses available data on the top 30 chaebols. The criteria for
selection of largest chaebols have changed a few times, but the number of
designated groups has been fixed at 30 since 1993. In 1995, the largest
chaebol, Hyundai Group, had 46 member companies, of which 16 were
publicly listed (Table 2.11). The number of Hyundai member companies
rose to 57 in 1997. The smallest group had 16 members in 1995, of which
four were listed. Generally, it is the chaebols’ large firms that are listed.
Chaebols have been the most important actors and engines of growth
in the Korean economy. In 1997, the 30 largest chaebols accounted for
13.1 percent of the economy’s total value added (excluding the financial
sector), and close to half of total assets (46.3 percent), debts (47.9 percent),
sales (45.9 percent), and net profits (46.7 percent) of the corporate sector.
Between 1993 and 1997, the growth of sales of the top 30 chaebols
exceeded that of the aggregate corporate sector (compare Tables 2.6 and
2.12). The top five chaebols registered the highest growth rates, followed
by the top 6-10 (Table 2.12). It should also be noted that when the financial
crisis struck in 1997, the top 11-30 chaebols experienced a decline of
Table 2.10
Growth and Financial Performance of Listed Companies by Size, 1988-1997
(percent)
Net Profit Margin ROE ROA Growth Performance

Year Large Medium Small Large Medium Small Large Medium Small Large Medium Small
1988 2.5 3.7 3.4 9.8 15.1 16.0 1.6 3.9 4.2 17.2 14.3 13.5
1989 3.1 2.6 3.1 6.9 8.6 10.8 1.4 2.4 3.2 13.0 11.3 5.2
1990 2.9 2.4 2.1 6.6 3.9 6.9 1.2 2.0 2.0 19.5 15.0 10.0
1991 2.2 1.9 1.6 5.5 6.3 5.6 0.9 1.6 1.5 25.4 17.2 1.4
1992 1.9 1.8 0.9 5.0 6.0 3.2 0.8 1.5 0.8 16.3 12.2 5.6
1993 1.7 1.9 0.7 4.4 6.2 2.7 0.7 1.6 0.6 9.7 13.9 6.6
1994 2.5 2.3 (0.3) 6.6 7.1 (1.0) 1.0 2.8 (0.2) 18.9 14.9 8.4
1995 2.6 3.8 0.3 7.3 11.6 0.9 1.1 0.9 0.2 25.0 22.8 11.8
1996 0.6 0.7 (0.2) 1.8 2.0 (0.9) 0.3 0.5 (0.2) 16.5 10.6 7.4
1997 (1.4) (1.5) (1.8) (5.1) (4.8) (6.3) (0.6) (1.0) (1.5) 17.8 13.3 3.6
Average 1.7 1.9 1.2 5.0 6.8 5.6 0.8 1.7 1.4 17.3 15.2 9.5
Note: Large firms have a capital base greater than W15 billion and small firms smaller than W5 billion. Others are medium firms.
Source: Korea Investors Service, Kis-Fas, 1998.
Table 2.11
Features of the 30 Largest Chaebols
Total Assets No. of No. of

(W billion) Member Companies Listed Companies
Name 1995 1997 1995 1997 1995
Hyundai 43,743 53,597 46 57 16
Samsung 40,761 351,651 55 80 14
LG 31,395 38,376 49 49 11
Daewoo 31,313 35,455 25 30 9
Sunkyung 14,501 22,927 32 46 5
Ssangyong 13,929 16,457 23 25 11
Hanjin 12,246 14,309 24 24 9
Kia 11,427 14,287 16 28 5
Hanwha 9,158 10,967 31 31 8
Lotte 7,090 7,774 28 30 4
Kumho 6,423 7,486 27 26 4
Doosan 5,756 6,370 26 25 9
Daelim 5,364 6,177 18 21 5
Hanbo 5,147 — 21 — 2
Dong-A 5,117 6,458 16 19 4
Halla 4,766 6,640 17 18 3
Hyosung 3,574 4,131 16 18 2
Dongkuk 3,433 3,956 16 17 7
Jinro 3,303 3,951 14 24 4
Kolon 3,129 3,910 19 24 4
Tongyang 2,995 3,445 22 24 4
Hansol 2,990 4,346 19 6 6
Dongbu 2,935 3,677 24 8 8
Kohap 2,924 3,690 11 2 2
Haitai 2,873 3,398 14 15 5
Sammi 2,475 — 8 — 2
Hanil 2,180 2,599 8 7 2
Keukdong 2,158 — 11 — 2
New Core 1,996 2,798 18 18 0
Byucksan 1,853 — 16 — 4
Source: Fair Trade Commission.
Table 2.12
Growth and Financial Performance of the 30 Largest Chaebols,
1993-1997
(percent)
Growth Rates Financial Performance

Year Sales Assets Net Profit Margin ROE ROA
Top 1-5
1993 12.9 12.5 1.5 5.3 1.9
1994 20.0 19.3 2.7 9.9 3.5
1995 31.9 27.0 4.0 18.0 5.6
1996 17.2 19.4 0.8 2.3 1.0
1997 20.3 38.2 0.3 0.4 0.3
Top 6-10
1993 11.8 11.7 1.0 0.9 0.9
1994 18.5 15.6 1.3 3.3 1.2
1995 27.5 19.8 1.2 3.1 1.2
1996 32.4 27.5 0.2 (1.4) 0.2
1997 12.7 20.3 (2.5) (14.1) (2.2)
Top 11-30
1993 10.6 15.3 (0.5) (1.5) (0.4)
1994 18.1 16.6 (0.1) (0.2) (0.1)
1995 27.1 25.7 (0.1) (2.3) (0.1)
1996 10.4 15.6 0.1 0.2 0.1
1997 (2.0) 4.7 (3.2) (16.0) (2.4)
Top 30
1993 12.3 13.0 1.0 3.0 1.1
1994 19.4 17.9 2.0 6.7 2.2
1995 30.1 24.9 2.7 10.7 3.2
1996 19.3 20.4 0.5 1.2 0.6
1997 14.8 26.6 (0.7) (5.0) (0.7)
Source: Bank of Korea.

2 percent in their sales and a very low 4.7 percent growth in total assets.
Only the top five chaebols registered a positive net profit margin in 1997.
The financial performance of the top 11-30 chaebols deteriorated during
1993-1997. Their worst year was 1997 when ROE hit -15.95 percent. The
better showing of the top five chaebols was a direct result of their domi-
nance in human resources, technology, and access to credit.
The ROE of the top 30 chaebols was consistently higher than that
of the aggregate corporate sector. However, except for 1995, the net profit
margin of the aggregate sector exceeded that of the top 30 chaebols.
There has been a wide range in DER among chaebols, from 190 to
3,765 percent (Table 2.13). By the end of 1997, the average DER of the 30
largest chaebols reached 519 percent. In general, chaebols had a higher aver-
age DER than the corporate sector as a whole. The absence of a well-devel-
oped equity market and the provision of subsidized credit, coupled with weak
corporate governance, resulted in the chaebols’ excessive leverage.
This section looks at the key aspects of corporate governance in Korea.

Ownership patterns, internal and external control mechanisms, and govern-
ment intervention interacted through a set of laws and regulations to bring
about the existing structure. The Commercial Code stipulates the basic gov-
ernance framework and applies to all corporations. However, loopholes and
inconsistent policies spawned strategic behavior and agency problems, and
led to a high concentration of ownership, weak corporate control, and vul-
nerable balance sheets. Attempts to rectify the corporate structure were half-
hearted and it was only after the onset of the crisis that many of the most
serious reforms were instituted.
2.3.1 Patterns of Corporate Ownership
The ownership of most Korean listed firms is highly concentrated.5 Found-

ing families are mostly still the largest shareholders and, more important, a
pyramidal structure of corporate ownership is prevalent.
5
While “ownership concentration” can be defined and measured differently in different
contexts, in this instance, it refers to the degree of concentration and shareholdings in
the hands of an “identical person.” This “identical person,” in Korea’s legal and regula-
tory framework, includes the largest shareholder, his/her relatives, and the companies
that are under the control of the largest shareholder.
Table 2.13
The Top 30 Chaebols’ Debt-to-Equity Ratio, 1995-1997
(percent)
Chaebols Debt-to-Equity Ratio

1995
1. Hyundai 376.4
2. Samsung 205.8
3. LG 312.8
4. Daewoo 336.5
5. Sunkyung 343.3
6. Ssangyong 297.7
7. Hanjin 621.7
8. Kia 416.7
9. Hanwha 620.4
10. Lotte 175.5
11. Kumho 464.4
12. Doosan 622.1
13. Daelim 385.1
14. Hanbo 674.9
15. Dongah Construction 321.5
16. Halla 2,855.3
17. Hyosung 315.1
18. Dongkuk Steel 190.2
19. Jinro 2,441.2
20. Kolon 328.1
21. Tongyang 278.8
22. Hansol 313.3
23. Dongbu 328.3
24. Kohap 572.0
25. Haitai 506.1
26. Sammi 3,244.6
27. Hanil 936.2
28. Kukdong Construction 471.2
29. Newcore 924.0
30. Byucksan 486.0
1996
1. Hyundai 436.7
2. Samsung 267.2
3. LG 346.5
4. Daewoo 337.5
5. Sunkyung 383.6
6. Ssangyong 409.4
7. Hanjin 556.6
8. Kia 516.9
9. Hanwha 751.4
10. Lotte 192.1
11. Kumho 477.6
12. Halla 2,065.7
13. Dongah 354.7
14. Doosan 688.2
15. Daelim 423.2
16. Hansol 292.0
17. Hyosung 370.0
19. Jinro 3,764.6
Chaebols Debt-to-Equity Ratio
20. Kolon 317.8
21. Kohab 590.5
22. Dongbu 261.8
23. Tongyang 307.8
24. Haitai 658.5
25. Newcore 1,225.6
26. Anam 478.5
27. Hanil 576.8
28. Keopyong 347.6
29. Miwon 416.9
30. Shinho 490.9
1997
1. Hyundai 578.7
2. Samsung 370.9
3. Daewoo 472.0
4. LG 505.8
5. SK 468.0
6. Hanjin 907.8
7. Ssangyong 399.7
8. Hanwha 1,214.7
9. Kumho 944.1
10. Dongah 359.9
11. Lotte 216.5
12. Halla (1,600.4)
13. Daelim 513.6
14. Doosan 590.3
15. Hansol 399.9
16. Hyosung 465.1
17. Kohab 472.1
18. Kolon 433.5
20. Dongbu 338.4
21. Anam 1,498.5
22. Jinro (893.5)
23. Tongyang 404.3
24. Haitai 1,501.3
25. Shinho 676.8
26. Daesang 647.9
27. Newcore 1,784.1
28. Keopyong 438.1
29. Kamgwon Industrial 375.0
30. Saehan 419.3
Average of All Chaebolsa

1995 347.5
1996 386.5
1997 519.0
Average of All Industries Excluding Financial Sectorb
1995 305.6
1996 335.6
1997 424.6
Sources: aFair Trade Commission. bBank of Korea, Financial Statement Analysis Yearbook.
Chapter 2: Korea 77
When controlling shareholders hold a very small percentage of the

shares, an increase in their ownership may bring their ownership incentives
to converge with those of the minority shareholders, that is, the ownership
structure can bring about an incentive effect. However, large ownership can
also bring about the entrenchment effect, i.e., an entrenched manager is
insulated from market pressure and can pursue personal goals without the
fear of being replaced. Theoretically, with a given range of managerial share-
holdings (for instance, 10 to 30 percent), the entrenchment effect outweighs
the incentive effect. Beyond that range, the incentive effect once again domi-
nates. When managerial holdings are reinforced by artificial control mecha-
nisms such as pyramiding, managerial entrenchment becomes more likely.
Most non-chaebol listed firms in Korea are believed to have owner-
ship concentrations within the 10-30 percent range. The controlling share-
holders of chaebols hold comparatively smaller percentages of shares, re-
sorting to extensive use of pyramiding to maintain control. Thus, the en-
trenchment effect and problems of agency may be more pronounced in
chaebols than in independent firms.
Composition of Ownership
Among listed companies, including banks and other financial firms, the
individual owners—the portfolio investors as well as the controlling share-
holders and their family members—formed the largest shareholder group
(Table 2.14). The next important group was “other corporations,” followed
by banks. The pattern of distribution changed little through 1992-1997.
Financial institutions owned as much as 28 percent of the total corporate
shareholdings in 1992, but their shares declined to 21.7 percent by 1997.
Securities companies reduced their holdings over this period of falling stock
prices as the size of investment trust companies’ stock portfolios declined.
The percentage of shares owned by “other corporations,” foreigners, and
insurance companies increased during the period, while those owned by
banks, the Government, and state-owned companies and securities compa-
nies declined.
Among listed nonfinancial companies, individuals were also the
largest shareholder group. However, the extent of ownership by these indi-
viduals declined gradually after 1988, the year the stock market was in a
frenzy due to buying sprees. From 69.1 percent, the percentage of holdings
by individuals slipped to 60.6 percent by 1997. The holdings of financial
institutions, including investment trust companies, fluctuated widely dur-
ing the period, and then steadily declined after 1993. The reduction can be
Table 2.14
Ownership Composition of Listed Companies, 1988-1997
(percent)
Financial Institutions
No. of The Banks, Securities Insurance Other
Year Firms Statea etc.b Firms Firms Total Corporations Foreigners Individuals
A. All Listed Companiesc
1992 681 9.2 16.9 5.2 5.9 28.0 18.8 4.1 39.9
1993 687 8.6 17.5 4.7 5.8 28.0 17.2 8.7 37.6
1994 698 8.7 18.3 3.6 5.4 27.3 18.1 9.1 36.9
1995 715 8.0 18.3 2.9 5.7 26.9 18.6 10.1 36.4
1996 754 7.4 17.4 2.2 6.5 26.1 20.6 11.6 34.3
1997 775 6.6 13.2 2.1 6.4 21.7 22.8 9.1 39.8
B. Listed Nonfinancial Companiesd
1988 406 0.5 4.1 4.3 1.3 9.7 17.4 3.3 69.1
1989 498 0.7 8.0 5.5 1.2 14.7 14.3 1.9 68.5
1990 531 0.6 9.2 7.5 1.5 18.2 17.4 1.8 62.0
1991 505 0.5 9.2 7.2 1.5 17.9 18.6 2.2 60.8
1992 508 2.2 9.6 7.7 1.8 19.1 16.5 3.2 59.0
1993 511 2.3 12.2 7.0 2.1 21.3 12.4 5.0 59.1
1994 521 1.8 8.6 8.0 1.9 18.5 13.6 5.3 60.8
1995 548 2.3 9.3 5.5 2.1 16.9 16.1 5.2 59.7
1996 570 2.4 8.5 4.9 2.3 15.6 17.6 5.0 59.5
1997 551 1.7 6.5 4.9 2.4 13.8 19.1 4.8 60.6
Note: Ownership is based on number of shares.
a
The State covers the Government and state-owned companies.
b
“Banks, etc.” includes commercial banks, merchant banks, investment trust companies, mutual savings, and finance companies.
c
Data from Korea Stock Exchange.
d
Constructed from data files of the Korea Listed Companies Association.
Chapter 2: Korea 79
ascribed to prudence in staying away from the stock market—as part of

their risk management strategy—as the stock market was in doldrums
throughout the 1990s. The holdings of other corporations are mainly equity
investments in affiliate companies. Corporate holdings averaged 16 percent
throughout 1988-1997. Foreigners gradually increased their equity shares
in 1992 when direct purchases by them were first permitted. Before such
liberalization, foreign holdings were derived from purchases through coun-
try funds and direct capital investments.
Compared with its holdings in all listed companies, government
ownership in nonfinancial companies was remarkably smaller and more
concentrated. In most instances, the Government was the sole owner. This
trend can be explained by government ownership, whether partial or abso-
lute, of some banks. In 1998, the Government acquired an even bigger
share in several banks as part of its program to bail out these distressed
institutions.
Individuals held the majority of the shares in all industries except
in telecommunications, electricity, and service of motor vehicles (Table
2.15). In general, financial institutions had more shares in the manufactur-
ing sector than in primary industries. Over the years, other corporations’
holdings shifted toward service industries, indicating their increased in-
vestments particularly in the service industries with high growth rates. The
Government’s and state-owned institutions’ (including some banks) owner-
ship was generally small except in the power sector, with the Government
continuing to hold a sizable share in the Korea Electric Power Corporation.
The ownership distribution in listed nonfinancial firms, categorized
into large, medium, and small companies, did not vary significantly (Table
2.16). One minor difference is that the percentage of shareholdings by cor-
porations is slightly higher in large-sized firms, indicating their heavier
reliance on inter-firm financing investments.
When independent companies are distinguished from firms affili-
ated with the 30 largest chaebols, there appears to be no significant differ-
ence in the overall shareholding patterns between the two groups (Table
2.17). However, a more detailed breakdown of the data on majority
shareholdings in the next section shows significant differences in the two
groups’ composition and level of majority shareholdings.
Institutional investors, as distinguished from individual and for-
eign investors, held 26.8 percent of listed shares in 1997. This is low com-
pared with those in Japan, UK, and US (Table 2.18). However, the holdings
of institutional investors were expected to increase significantly with the
Government’s introduction of US-type investment companies in 1998 and
Table 2.15
Ownership Composition of Listed Nonfinancial Firms by Industry, 1990 and 1997
(percent)
Financial Institutions
The Banks, Securities Insurance Other
Industry Statea Etc.b Firms Firms Corporations Foreigners Individuals
1990
Fishing and Fish Farms — 3.8 9.3 — 3.7 — 83.1
Mining — 6.1 2.4 — 2.9 — 88.7
Food Products and Beverages 0.2 8.9 8.6 0.6 16.7 0.3 64.8
Wearing Apparel and Fur Articles 0.2 4.4 5.3 1.2 14.7 1.0 73.4
Wood, Paper, and Printing — 7.1 9.3 0.5 20.9 — 62.2
Pulp, Paper, and Printing — 8.2 6.4 0.9 19.6 0.0 64.9
Chemicals, Rubber, and Plastics 0.4 9.3 8.1 1.9 18.7 2.4 59.2
Basic Metal 1.3 10.5 7.2 1.2 22.6 2.3 54.9
Fabricated Metal and Machinery 0.5 12.0 9.0 1.4 24.1 0.2 52.9
Office and Computing Machinery — 10.9 9.5 0.3 10.7 2.1 66.7
Electronics, Elecl Mach., and App. 1.0 10.6 7.8 1.7 14.7 4.8 59.4
Motor Vehicles — 11.2 7.7 2.1 20.8 1.5 56.7
Electricity, Gas, and Steam Supply 39.5 22.5 2.5 0.2 5.8 0.1 29.5
Precision and Optical Instruments — 4.3 6.0 0.5 3.0 0.4 85.9
Other Manufacturing 0.0 11.0 7.3 0.2 20.7 5.2 55.7
Construction 0.2 9.1 7.8 1.8 17.4 0.3 63.3
Service of Motor Vehicles — 27.9 8.0 7.0 14.9 4.1 38.1
Wholesale and Retail Trade 0.1 8.8 8.0 1.8 15.5 0.7 65.3
Transport 0.4 7.2 9.8 3.4 19.7 1.6 57.9
Telecommunications — 17.8 7.6 8.9 22.9 — 42.9
Other Business Activities 0.3 7.3 8.7 0.3 23.1 — 60.4
Nonmetallic Mineral Products 0.5 13.0 6.2 2.4 19.5 2.1 56.3
Average 0.6 9.2 7.5 1.5 17.4 1.8 62.0
1997
Fishing and Fish Farms 1.0 2.8 3.6 1.0 9.9 — 81.9
Mining 1.8 6.8 1.7 3.3 6.9 0.9 78.6
Food Products and Beverages 0.9 5.0 4.4 1.8 20.3 6.7 60.9
Wearing Apparel and Fur Articles 1.2 4.4 3.9 2.2 15.8 2.9 69.6
Wood, Paper, and Printing 1.3 0.9 7.9 0.9 12.6 1.2 75.3
Pulp, Paper, and Printing 0.9 5.3 7.6 0.9 14.9 4.7 65.8
Chemicals, Rubber, and Plastics 2.1 7.0 5.8 2.4 18.6 6.3 57.9
Basic Metal 1.8 7.9 5.0 2.4 18.8 6.2 57.8
Fabricated Metal and Machinery 0.8 5.4 5.7 1.1 27.2 5.5 54.4
Office and Computing Machinery 2.5 6.6 2.2 2.6 13.7 4.6 68.0
Electronics, Elecl Mach. and App. 1.3 7.3 5.0 2.4 17.6 6.1 60.4
Motor Vehicles 1.2 8.4 6.1 2.5 20.3 3.0 58.4
Electricity, Gas, and Steam Supply 7.6 4.0 4.5 0.9 31.1 6.4 45.6
Precision and Optical Instruments 0.2 8.6 3.2 2.7 9.5 16.4 59.4
Other Manufacturing 0.8 3.5 3.5 1.2 12.9 1.9 76.4
Construction 3.2 7.8 3.7 4.2 20.7 2.2 58.2
Service of Motor Vehicles 1.4 11.2 2.4 8.1 23.1 4.3 49.5
Wholesale and Retail Trade 1.6 6.6 4.7 2.4 18.4 2.8 63.5
Transport 2.1 6.1 5.1 2.6 20.0 4.6 59.4
Telecommunications — 1.5 9.1 2.5 43.2 0.5 43.3
Other Business Activities 1.4 6.8 3.1 3.5 23.0 5.1 57.1
Nonmetallic Mineral Products — 2.3 25.5 — 11.7 6.2 54.3
Average 1.7 6.5 4.9 2.4 19.1 4.78 60.6
Note: Ownership is based on number of shares.
a
The State covers the government and state-owned companies.
b
Source: Constructed from data files of the Korea Listed Companies Association.
Table 2.16
Ownership Composition of Listed Nonfinancial Firms by Size, 1997
(percent)

Firm Sizea Firms Stateb etc.c Firms Firms Corporations Foreigners Individuals
Large 211 1.2 6.8 4.8 2.4 21.5 4.9 58.4
Medium 208 1.4 6.4 4.9 2.5 18.6 4.4 61.5
Small 80 2.4 5.1 5.8 2.1 16.5 5.4 62.6
Total 499 1.7 6.5 4.9 2.4 19.3 4.8 60.4
a
Large firms have a capital base greater than W15 billion and small firms smaller than W5 billion. Others are medium firms.
b
The State covers the government and state-owned companies.
c
Table 2.17
Ownership Composition of Listed Nonfinancial Firms by Control Type, 1997
(percent)

Control Type Firms State etc. Firms Firms Corporations Foreigners Individuals
Independent Firms 316 1.7 8.7 6.0 2.0 16.4 4.8 60.4
Affiliates of 30 Largest Chaebols 117 0.7 8.1 6.3 1.8 17.5 3.7 61.8
Total 433 1.5 8.5 6.1 2.0 16.7 4.5 60.7
Chapter 2: Korea 83
Table 2.18
Ownership Composition of Listed Firms in Selected Countries, 1997
(percent)
Country Institutional Investors Individuals Foreigners
Japan 42.4 23.6 9.8

Korea 26.8 39.8 9.1
Taipei,China 10.3 56.5 8.7
United Kingdom 54.5 20.3 16.3
United States 45.6 47.6 6.1
Source: Stock Exchange of Korea.
financial institutions’ establishment of corporate pension fund accounts. At

the moment, only closed-end investment companies and traditional invest-
ment trust companies are allowed. The more popular open-end investment
companies (mutual funds) were expected to come into existence by the end
of 1999 with the Government’s deregulation of the capital market. Foreign
holdings of Korean shares were 9.1 percent and appear to be similar to the
proportion of foreign holdings in the four other countries.
Concentration of Ownership
The analysis of ownership concentration in this section focuses on

shareholdings of the majority shareholder, including those of the largest
shareholder, his/her family members, and the companies under the control
of the largest shareholder; minority shareholders, defined as those holding
less than 1 percent of shares; and other shareholders who do not belong to
either the minority shareholders or the majority shareholder group. Gener-
ally, the majority shareholder group in all listed companies consists of the
corporate, rather than the individual, investors (Table 2.19). In 1997, for
example, corporations held 70 percent of the controlling blocks of shares,
while family members accounted for only 30 percent. This has had pro-
found implications for corporate governance and the market for corporate
control in Korea.
Among nonfinancial listed firms, the majority shareholder group
on average held 23-30 percent of outstanding shares in the period 1988-
1997 (Table 2.20).
The majority shareholder group’s shareholdings in listed
nonfinancial firms steadily declined from 1990 to 1996. But these may
Table 2.19
Ownership Concentration of All Listed Firms, 1992-1997
(percent)
Minority Shareholders Majority Shareholders Other Shareholders

Year Corporation Individual Subtotal Corporation Individual Subtotal Corporation Individual Subtotal
1992 41.5 30.0 71.6 15.1 7.9 23.0 3.4 2.0 5.4
1993 43.1 29.9 73.0 14.3 7.7 22.0 3.9 1.2 5.0
1994 37.7 32.1 69.8 18.7 6.9 25.6 2.6 2.0 4.6
1995 44.6 28.2 72.8 16.1 6.1 22.1 2.9 2.2 5.1
1996 46.9 26.1 73.0 15.7 5.8 21.6 3.1 2.3 5.4
1997 33.3 32.7 66.0 18.7 8.1 26.8 4.9 2.3 7.2
Note: The majority shareholder includes the largest shareholder, his/her family members, and the companies under the control of the largest shareholder. Minority shareholders are
those holding less than 1 percent of shares. Other shareholders are those who do not belong to either the minority shareholders or the majority shareholder group.
Source: Stock Exchange of Korea.
Chapter 2: Korea 85
Table 2.20
Ownership Concentration of Listed Nonfinancial Firms, 1988-1997
(percent)
Minority Majority Other
Year Shareholders Shareholders Shareholders
1988 53.8 27.8 18.5
1989 57.6 28.9 13.5
1990 57.6 29.4 12.9
1991 58.5 28.9 12.6
1992 60.3 27.9 11.8
1993 62.0 25.8 12.2
1994 58.8 25.4 15.7
1995 54.1 23.5 18.0
1996 50.9 23.3 22.0
1997 48.8 25.9 20.4
have been underestimated because it was widely believed that the largest
shareholder often had hidden shares registered in the names of relatives and
subordinates of the company. The practice of hidden shares seems to have
been less prevalent in recent years. Besides, hiding shares offers no addi-
tional tax or other benefits. Meanwhile, minority shareholders, which held
less than 1 percent of a company’s outstanding shares as of 1997, collec-
tively owned less than 50 percent of an average firm. The shareholders that
held more than 1 percent but did not belong to the majority group held
about 20 percent on average.
Across industry, utility companies have a relatively higher degree
of ownership concentration with the majority shareholder owning nearly
45 percent of an average company (partly because these companies were
owned solely by the Government before their privatization [Table 2.21]). In
such cases, the Government has retained a large number of shares. Majority
ownership is also high in the chemicals, rubber and plastics, and mining
categories. In most industries, the majority owner held more than 20 per-
cent of an average firm. In telecommunications, ownership was relatively
diffused due to government regulation.
Ownership concentration tended to be lower in large compared to
medium and small listed firms. It was highest in medium-sized firms be-
fore 1993 and, thereafter, in the small firms. The percentage of shares held
by minority owners (with less than 1 percent of outstanding shares) was
highest for large firms at more than 55 percent (Table 2.22).
Table 2.21
Ownership Concentration of Listed Nonfinancial Firms by Industry, 1997
(percent)
Number Minority Majority Other

Industry of Firms Shareholders Shareholders Shareholders
Fishing and Fish Farms 3 36.8 25.6 12.4

Mining 2 51.1 38.0 11.0
Food Products and Beverages 43 43.5 30.7 21.5
Wearing Apparel and Fur Articles 49 44.8 27.8 16.3
Wood, Paper, and Printing 12 31.5 29.2 39.3
Pulp, Paper, and Printing 16 52.9 26.2 19.1
Chemicals, Rubber, and Plastics 90 44.5 37.9 17.4
Basic Metal 39 47.6 26.6 16.3
Fabricated Metal and Machinery 31 50.4 19.8 26.2
Electronics, Elecl Mach., and App. 71 53.6 21.7 22.2
Motor Vehicles 34 53.7 26.8 19.5
Electricity, Gas, and Steam Supply 8 36.0 44.8 19.2
Other Manufacturing 9 51.8 24.5 23.7
Construction 49 55.1 23.5 17.7
Wholesale and Retail Trade 40 49.0 21.1 21.5
Transport 15 39.0 19.9 41.2
Telecommunications 1 54.6 10.7 34.8
Other Business Activities 10 34.2 24.7 41.2
Nonmetallic Mineral Products 29 46.2 29.6 20.5
Total 551 48.8 25.9 20.4
Source: Constructed from data files of Korea Listed Companies Association.

Table 2.22
Ownership Concentration of Listed Nonfinancial Firms
by Firm Size, 1988-1997
(percent)
No. of Minority Majority Other

Year Firms Shareholders Shareholders Shareholders
Small
1988 66 53.8 26.4 19.8
1989 81 52.0 30.1 17.9
1990 72 55.3 27.6 17.1
1991 76 55.6 27.7 16.7
1992 80 55.9 28.5 15.6
1993 67 56.8 27.9 15.3
1994 78 52.4 28.3 19.3
1995 102 51.2 27.2 21.7
1996 134 50.4 26.7 22.9
1997 115 47.1 31.4 21.5
Medium
1988 148 48.5 30.5 21.1
1989 197 51.2 33.2 15.7
1990 219 52.9 32.6 14.5
1991 212 55.7 31.4 12.9
1992 210 57.0 30.8 12.2
1993 217 59.2 27.9 12.9
1994 216 56.9 26.5 16.5
1995 216 53.8 26.3 19.9
1996 215 50.5 26.4 23.1
1997 215 49.7 29.6 20.7
Large
1988 165 57.1 24.8 17.5
1989 213 58.9 28.5 12.6
1990 220 60.8 28.0 11.2
1991 217 62.6 26.0 11.5
1992 218 65.0 24.2 10.8
1993 217 66.6 21.2 11.7
1994 227 62.6 21.2 16.2
1995 230 59.8 21.4 18.9
1996 231 56.2 21.3 22.5
1997 221 55.2 25.5 19.2
Source: Korea Listed Companies Association.

Ownership Concentration and Financial Performance
J. H. Kim (1992) and Kim, Hong, and Kim (1995) studied the empirical
relationship between the degree of ownership concentration and financial
performance in Korea. Both studies used Tobin’s Q (TQ) for the value of a
firm as an index of financial performance, and the shareholding of a con-
trolling shareholder (SCS) as the degree of ownership concentration. TQ
was calculated by dividing the market value of a firm by the substitution
price of its assets. If TQ is higher than 1, it means the firm creates value; if
TQ is lower than 1, the firm destroys value.
J. H. Kim (1992) found the relation between TQ and SCS to be
nonlinear. If SCS is below 10 percent, TQ increases as the SCS increases. If
SCS reaches 10 percent, TQ has a maximum value. Then TQ declines until
SCS reaches 45 percent and increases until it reaches 50 percent. If SCS is
below the range of 20-25 percent, TQ is above 1, thus a firm creates value.
If SCS is above 20-25 percent, TQ is below 1, thus a firm destroys value.
The study by Kim, Hong, and Kim (1995) reached a similar con-
clusion. They analyzed firms in which controlling shareholders participate
as managers. The relationship between TQ and SCS shows a similar pat-
tern. The pattern of the relationship between SCS and TQ is similar be-
tween Korean and US firms (Mork, Shleifer, and Vishny, 1988), although
turning points in the value of firms are different.
Inter-Firm Investments and Pyramiding in Chaebols
The Commercial Code imposes limits on direct cross-shareholding. This

refers to the situation wherein Company A holds shares of Company B and
simultaneously Company B holds shares of Company A. The Code prohib-
its a subsidiary company from owning shares of its parent company, which
is the company holding more than 40 percent of outstanding shares of its
subsidiary. Where direct cross-shareholding is not allowed, one company
can still place equity investments in another, which can then pass the equity
capital to a third. This type of inter-firm investment, called “pyramiding”—
commonly (though incorrectly) known as “indirect cross-shareholding”—
is prevalent in Korea. One of the merits of pyramiding, from the standpoint
of the controlling shareholder, is effective control of a certain group of
companies even with a smaller investment.
In Korea, affiliated companies have been able to conduct inter-firm
transactions, often at terms unfair to one of the transacting parties. For
example, one company from a chaebol group could obtain debt payment
Chapter 2: Korea 89
guarantees from other members of the group at no cost. Thus, firms linked
through partial equity investments could enjoy the advantage of consolida-
tion without an actual formal consolidation or merger of operations taking
place. This also partly explains why chaebols frequently opted to expand
by establishing new firms rather than placing investments internally. Until
recently, neither the investors nor the relevant government authorities were
active in monitoring such unfair dealings between firms.
The extent of pyramiding can be seen in some of the previous ta-
bles. In Table 2.14, for example, corporations hold about 20 percent of the
outstanding shares of all listed nonfinancial firms. In many instances, fi-
nancial institutions that are subsidiaries of a chaebol also hold shares in its
member firms. These shares should be added to the control block although
the financial institutions belonging to the 30 largest chaebols are prohibited
from exercising their voting rights in the member firms of the chaebol.
The fact that corporations, not individuals, dominated the majority
shareholder group in chaebol-affiliated companies is consistent with the
results of the ADB survey conducted for this study. For the whole sample,
the top five shareholders consisted of 2.5 corporations and two individuals,
together owning an average of 38.5 percent of shares. Among chaebol af-
filiated firms, 62 percent (16 out of 26) had a corporation as the largest
shareholder. The top five shareholders of the chaebol-affiliated firms con-
sisted of one individual and 3.4 corporations, together owning an average
of 37.9 percent of shares. Of the 81 respondents, 59 were parent firms with
one or more subsidiaries, together having a total of 292 domestic subsidiar-
ies, or about four firms each, and 319 foreign subsidiaries, or about five
subsidiaries each. Twenty-two of the 81 respondents were independent,
standalone setups. Partial results are shown in Table 2.23.
Among the 81 listed firms in the ADB survey, 59 parent companies
collectively had investments in 759 firms, or an average of 13 firms per
company. Among the subsidiaries or firms receiving investments, 53 per-
cent were domestic nonfinancial firms, 34 percent were foreign companies,
and about 11 percent were domestic financial institutions. Only six firms
(or 13 percent) indicated that their subsidiaries also owned shares in them-
selves. Thus, there are instances of direct cross-shareholding in Korean firms,
although they are likely to be insignificant.
In the case of the 30 largest chaebols, the average shareholding of the
controlling owners and their families was 8.5 percent as of 1997. But the
controlling power of the owners also stems from inter-company shareholdings
of the subsidiaries. For the same year, the top 30 chaebols’ shareholding by
subsidiaries was 34.5 percent. If we define the internal shareholdings of a
Table 2.23
Ownership Concentration in the Survey Sample of 81 Listed Firms, 1999
Five Largest Shareholders

Largest
No. of Shareholder’s Compositiona Shareholdings (%)
Classification Firms Holdings (%) Individuals Firms Individuals Firms Total
Total Sample 81 20.4 2.0 2.5 21.2 17.3 38.5
Non-Chaebol Affiliated 55 21.5 2.5 2.1 25.8 12.9 38.7
Largest Shareholder is CEO 31 24.0 2.6 1.5 31.5 5.7 37.2
Largest Shareholder is an Individual 10 21.7 3.0 1.6 31.8 5.6 37.4
Largest Shareholder is a Firm 14 19.4 1.4 3.6 8.4 34.3 42.8
Chaebol Affiliatedb 26 18.0 1.1 3.4 11.4 26.5 37.9
Largest Shareholder is CEO 3 13.5 3.0 2.0 25.1 4.6 29.7
Largest Shareholder is an Individual 7 18.8 1.7 3.0 22.5 16.9 39.4
Largest Shareholder is a Firm 16 18.5 0.5 3.9 4.0 34.8 38.8
Note: The survey was conducted during the period January through May 1999 and included nonfinancial listed firms only.
a
Number of shareholders. A few companies reported less than five largest shareholders.
b
The chaebol affiliated firms are those belonging to one of the 30 largest groups.
Chapter 2: Korea 91
chaebol as the shareholdings of the controlling family and the member com-
panies of the group, the average internal shareholding ratio of the top 30
chaebols was at least 43 percent. Internal shareholdings in some chaebols
also include shares owned by nonprofit organizations operated by the con-
trolling family. Family holdings include shares owned by the family mem-
bers and by parties considered to be under the influence of the family.
Table 2.24 shows the average internal shareholdings in the 30 larg-
est chaebols. The family and member companies’ shareholdings have been
declining over time. As of 1997, the controlling families owned 8.5 percent
and member companies, 34.5 percent. The relatively high internal holdings
of the 30 largest chaebols were due partly to the fact that many of the
chaebols’ firms are still privately held.
Table 2.24
Internal Shareholdings of the 30 Largest Chaebols, 1987-1997
Type of Shareholding 1987 1990 1992 1993 1994 1997

Internal Shareholdings 56.2 45.4 46.2 43.4 42.7 43.0
Family 15.8 13.7 12.8 10.2 9.6 8.5
Member Companies 40.4 31.7 33.4 33.2 33.1 34.5
Source: Korea Fair Trade Commission.
Judging from the historical record, it appears that the chaebol fami-
lies have had a strong desire to expand their business bases. Thus it can be
inferred that their strategy in designing the ownership structure of their
business groups was to minimize the financial resources required to main-
tain their grip on the management of the member firms while maximizing
their control.
Many attempts have been made by researchers to identify the typi-
cal patterns of ownership structures in chaebols. Hattori (1989) identified
three patterns based on data in the early 1980s.6 Later studies by Lee (1997)
and Lim (1998)7 find similar patterns. Based on these studies, the owner-
ship patterns can be described as follows.
6
Hattori, Tamio. 1989. “Japanese Zaibatsu and Korean Chaebols.” In Korean Manage-
rial Dynamics, edited by K. H. Chung and H. C. Lee, pp. 79-95. New York: Praeger.
7
Lee, Jae Woo. 1997. “Is the Fair Trade Policy Fair?” Korea Economic Research Insti-
tute. Ungki Lim. 1998. “The Ownership Structure and Family Control in Korean Con-
glomerates: With Cases of the 30 Largest Chaebols.” Paper presented at the Annual
Conference of Financial Management Association, Chicago, 15 October 1998.
The first (Type A) is called “direct family ownership.” A family

owns a substantial portion of shares of member firms and becomes the
controlling shareholder of each. The Hanjin Group, consisting of eight listed
and 16 privately held firms as of 1997, is an example of this type.
The second (Type B), called the “indirect control via base com-
pany,” shows a simple pyramidal structure. Here the family is the control-
ling shareholder of one or more strategic base companies that have enough
equity participation in the subsidiaries. Investments between the lower level
subsidiaries are rare. The Hanwha Group can be classified as such a com-
pany. It consists of seven listed and 24 privately held firms. Its controlling
family holds shares in three base companies through which they exercise
control over the other member firms.
The third (Type C) is “indirect control via complex shareholding.”
Here the family directly controls a base company and a nonprofit founda-
tion, which then make investments in the subsidiaries. The family itself
holds shares in some subsidiaries, which in turn hold shares in some of the
other subsidiaries. The Hyundai Group exemplifies this. As of 1997, it had
18 listed and 39 private companies. The controlling family has sizable in-
vestments in two base companies and smaller investments in many others.
A nonprofit foundation under the family’s control is the largest shareholder
of one of the base companies. The two base companies have investments in
three other base companies. Also, subsidiaries have extensive investments
in other subsidiaries. Thus, the family controls the group’s member compa-
nies by its own shareholdings, investments made by the base companies,
holdings of the nonprofit foundation, and subsidiaries’ equity participation.
The fourth type (Type D) is “management control.” Under this type
of ownership pattern, there is no controlling shareholder. The Kia Group
was about the only management-controlled group but was out of existence
by 1999, completely dissolved under financial distress. Most of its member
firms were acquired by, or merged into, other firms. For example, Hyundai
Motors acquired Kia Motors via an international auction. Kia Motors was
the base company and had such strategic shareholders as Ford Motors of
the US and Mazda of Japan. But the former chief executive officer (CEO),
Sun Hong Kim, and his management team exercised full control over the
group without much interference from major investors.
Chaebol Reforms
Various measures have been taken to improve the transparency of chaebols

with regard to accounting, financial, and business activities. One of the
Chapter 2: Korea 93
pronounced purposes of government intervention in the corporate sector

has been to prevent concentration of economic power in the hands of a few
large chaebols. The first serious attempt to deal with this issue was the
introduction of the Monopoly Regulation and Fair Trade Act of 1980 (here-
inafter, the Fair Trade Act). Initially, the act did not have any important
provisions except the standard clauses prohibiting monopolization of an
industry through business combinations. However, direct control of the
management of chaebols was attempted through amendments of the act in
1986 and 1990. These amendments prohibited holding companies and di-
rect cross-shareholding, and limited the amount of total investments made
by a member firm of a chaebol in other firms to less than 40 percent of its
net assets. This limit was also applicable to banks and insurance compa-
nies. The limit on investments was reduced to 25 percent in 1994 and com-
pletely eliminated by 1997. The prohibition of holding companies was also
abolished in 1999.
Until the end of 1998, only operating holding companies were al-
lowed to be established. An operating holding company is defined by the
Fair Trade Act as one whose investment in others does not exceed 50 per-
cent of its total assets. This was the reason why chaebols chose to employ
pyramidal structures. The Fair Trade Act was amended in 1998 to allow
pure holding companies to be established under restrictive conditions. One
condition requires that the DER of the holding company should not exceed
100 percent. Another is that the holding company should own more than 50
percent of the shares of a nonlisted subsidiary company and more than 30
percent of a listed company. A third disallows multiple layering of holding
companies. The Government is also considering whether to allow consoli-
dated taxation for pure holding companies. These conditions are aimed at
restricting excessive pyramiding and expansion of chaebols. At this early
stage, following the amendment of the law, there are reports that some top
chaebols are studying the feasibility of transforming their organizational
structure. It remains to be seen whether they will adopt the holding com-
pany structure in the future.
The Fair Trade Act was also revised in February 1998 to prohibit
cross-guarantees of debt among members of a chaebol. Existing guarantees
had to be resolved by March 2000. Also, the Credit Management Regula-
tion rules were amended to prohibit financial institutions from requiring
guarantees from affiliated firms when extending new loans. Cross-guaran-
tees are believed to constitute a form of wealth transfer from financially
strong members to weak ones, thus hurting the shareholders of stronger
firms. They hindered early exits (liquidation, bankruptcy reorganization,
etc.) of nonviable member firms and helped afford a disproportionate ad-

vantage to chaebols in obtaining favorable bank loans because (it was gen-
erally believed) the Government would not let large chaebols go bankrupt.
The Fair Trade Commission has been deeply involved in promot-
ing managerial transparency by exercising its power to investigate and levy
penalties on “unfair internal transactions” among member firms of chaebols.
Since the economic crisis, the Commission has strengthened its investiga-
tive activities to eradicate cross-subsidization and wealth transfer activities
among group members. The 30 largest chaebols are now required to pub-
lish “combined” financial statements, which put together the accounts of
all members of a chaebol, unlike the regular consolidated statements that
only cover those firms that are related through direct equity participation.
In 1998, chaebols dismantled their “planning and coordination of-
fices” or “chairman’s offices” under pressure from the Government. These
offices were legally informal and functioned as the headquarters of chaebols.
The staff of these organizations were employees of member firms. Their
operating costs were borne by the member companies rather than by the
controlling shareholder, who is universally called the “group chairman.”
The group chairman operated through these offices and treated the indi-
vidual member firms as if they were the divisions of a single legal entity,
even though they were legally independent with their own board of direc-
tors and the outside shareholder groups were not identical.
The chairman’s office had its own chief executive officer, usually
in the rank of a company president. The office established strategies for the
group as a whole, planned for capital raising and allocation on a group-
wide basis, and transferred funds generated by one firm to another. It also
acted as the secretariat for the unofficial “presidential meeting” of the member
firm presidents. Some chaebols operated “group management boards” at-
tended by top executives (presidents or chairpersons) of larger member firms.
Despite chaebols’ decision to dismantle the chairman’s offices, there
have been no significant changes. Some chaebols have disintegrated or
shrunk in size, but the larger and stronger ones still operate their newly
named “restructuring headquarters” under the control of the group chair-
person. Chaebols maintain that the restructuring headquarters will exist
only for a limited period, until urgent restructuring is complete.
2.3.2 Internal Management and Control
Monitoring of corporate management by shareholders, boards of directors,

and the capital market was almost nonexistent until the recent reform
Chapter 2: Korea 95
efforts. There are many reasons for this. The Government’s policy and se-
curities law provisions to protect control rights of the incumbent manage-
ment had been in place until the early 1990s. This policy managed to
hamper any monitoring initiatives from the capital market. Legal provi-
sions to protect investors were limited, the concept of fiduciary duty of
managers was not well established, and takeover codes were not accom-
modative to active monitoring. Professionalism in management was not
well developed and managers were content with receiving orders from
controlling shareholders.
Meanwhile, creditors were not active in monitoring debtor firms
and relied mainly on guarantees and collateral. Loan agreements and debt
indentures did not include strict covenants. Even when the covenants were
violated, the creditors did not declare defaults. Banks, as the major credi-
tors, had their own governance problems.
Under such circumstances, only the Government could play an ef-
fective role in monitoring corporations. However, this was complicated by
the prevailing attitude that large companies, especially chaebols, were too
big to fail.
Board of Directors
General Characteristics of the Boards
Under the Commercial Code, corporations should have a board of directors

consisting of at least three members. Directors are elected at the general
shareholders meeting for a term not exceeding three years. The board elects
one or more representative directors from among the board members.
Most companies have one representative director, but some large
ones have two or more. In most listed companies, except for banks, the
controlling shareholder is officially the representative director and the CEO,
or at least acts as the de facto CEO. As of 1997, the controlling shareholder
(or a member of the controlling group) was the legally registered repre-
sentative director in 354 out of 551 nonfinancial listed firms. With few
exceptions, the representative director was also the chairperson of the board.
Even where the largest shareholder is not the representative director, he or
she generally approves major decisions made by the management. Thus, in
most Korean firms, control is not separate from ownership. This implies
that the typical agency problems in Korean corporations stem from con-
flicts of interest between inside (the largest) and outside (minority) share-
holders.
When the Commercial Code first introduced the corporate board

system in the 1960s, members of the board, other than the representative
director(s), were supposed to be outside directors. However, it has been
common practice that candidates for directorship are handpicked by the
controlling shareholder/CEO from among the senior managers and are au-
tomatically approved at the general shareholders meeting. Most of the out-
side directors in those days were the controlling shareholders of chaebols
or executives of affiliated companies.
With the boards consisting only of insiders, they were virtually
under the full control of the CEOs and in practice functioned only as
management councils without any decision-making power—at least until
1998. A few large companies had more than 50 directors, all of whom
were managers.
Recent Reform Efforts on the Board System
In 1997, the listing rules of the Korea Stock Exchange were revised to
require that listed companies have one or more “independent outside direc-
tors” by the 1998 annual shareholders meeting. The rules further require
that the number of outside directors be not less than a quarter of the size of
the board by the annual shareholders meeting in 1999. Moreover, the list-
ing rules restrict the eligibility of independent outside directors to those
who have no family ties with the managers and no significant business
transactions with the company.
Despite the qualification requirements, there is concern that newly
elected outside directors still lack independence from the management or
the controlling shareholder. In order to address this concern, the stock ex-
change recently amended the listing rules to require that companies dis-
close a detailed profile of the candidate and the person who made the nomi-
nation. Further, companies have to disclose in their annual reports the fre-
quency of board meetings, the attendance rate of outside directors, and their
positions (accept or reject) on matters voted on in board meetings. The
exchange is also expected to recommend company charters to have provi-
sions that allow for information demanded by outside directors to be promptly
supplied to them.
The Commercial Code was also revised in 1998 to introduce cu-
mulative voting for the election of directors. However, cumulative voting is
not mandatory and a company can exclude itself from its application by
amending its charter. In the 1999 annual shareholders meetings, almost all
companies succeeded in adopting cumulative voting.
Chapter 2: Korea 97
The committee structure of the board as found in the US has not

yet been adopted by listed companies, although some banks recently have
established board committees. This is because most banks, having no con-
trolling shareholders, are required to have a majority of outside directors.
The controlling shareholder of some banks is the Government, which had
extended financial support in their recent recapitalization efforts.
In March 1999, a blue-ribbon committee, the Corporate Gov-
ernance Reform Committee, was established under the auspices of the
Ministry of Finance and Economy and the Korea Stock Exchange. In
September of the same year, this committee adopted the Code of Best
Practice in Corporate Governance. Meanwhile, the OECD principles of
corporate governance were the minimum standard for the Korean Code
of Best Practice. Among others, the Korean Code recommends that large
listed firms should have at least three independent directors, who would
comprise at least 50 percent of the boards, an audit committee, and a
nominating committee. The Commercial Code is being amended to al-
low a choice between the audit committee system and the current inter-
nal auditor system. The Securities and Exchange Act will require large
listed firms with W2 trillion or more in total assets to adopt the audit
committee system.
ADB Survey Results on Boards
The ADB survey results confirm the above assessments and provide early
indications on the effects of the reforms.
The average board had 8.4 directors. Almost all (92 percent) of the
respondents had one or more outside directors and 70 percent were elected
after the Asian financial crisis. Among the firms with no outside directors,
88 percent had plans to hold elections in the near future. These results are in
accordance with the new listing rules introduced in 1998.
On average, inside directors owned 16.1 percent and outside direc-
tors 1.1 percent of outstanding shares of a listed company. In 78 percent of
the responding firms, the chairperson of the board was also the CEO and on
average held 10.5 percent of the shares. Where the chairperson was not the
CEO, he or she held 6.2 percent and the CEO 14.9 percent on average.
Where the two were separate, they had a parent/child relationship in 20
percent of the cases.
Directors were most frequently elected because of their professional
expertise (74 percent of the respondents marked this answer). Directors
were also chosen on the basis of their relationship with the controlling
shareholder (30 percent). Less frequently, election of directors was based

on shareholdings (7 percent) and status as founder (7 percent). Most fre-
quently, the management nominated director candidates (64 percent of the
directors). Some directors were nominated by significant shareholders (18
percent) or introduced (and elected) at the shareholders meeting.
Chairpersons of the board were elected on the basis of professional
expertise (33 percent of the firms), relationship with controlling sharehold-
ers (21 percent), and shareholding (10 percent). In some instances, found-
ers of the company acted as the chairperson (22 percent).
In 91 percent of the sample firms, the board had no committees. In
a very small number of firms, the board had a nomination and an audit
committee. These were established only recently. As discussed earlier, most
firms just began to elect a small number of outside directors to meet a new
requirement in the listing rules and thus have no experience in the Anglo-
American type of board processes.
In most firms, the term of appointment of directors and board chair-
persons is three years. The current chairperson has been in office for 6.2
years on average. This rather long tenure must be due to their status as
controlling shareholders in most firms. About five directors per firm have
been in office for more than one term.
Remuneration for chairpersons include only fixed fees in 76 per-
cent of the sample firms; and fixed fees plus performance-related pay, in-
cluding stock options, in 23 percent. According to the Commercial Code,
compensation for directors must be approved by the annual shareholders
meeting for each fiscal year. The general practice is that shareholders ap-
prove the upper limit on the total amount to be paid to all directors. The
board or the management then determines compensation packages for indi-
vidual directors. The survey results indicate that boards determine remu-
neration packages for chairpersons in 42 percent of the firms. In 13 percent,
the management determines the remuneration. However, in some firms, the
package for the chairperson is directly proposed at the annual shareholders
meeting either by the board (31 percent of the firms) or by the management
(9 percent).
In 1997, among the 81 sample firms, a total of 562 directors were
sitting on two or more corporate boards. In one case, one person was sitting
on nine boards and this person was the CEO of a chaebol firm. The reason
for this high frequency of interlocking directorship is that many listed firms
belong to chaebols. Members of controlling shareholder families or their
trusted company personnel often act as directors for multiple chaebol firm
boards.
Chapter 2: Korea 99
Management
CEO
In the survey sample, 86 percent of the firms answered positively when asked
whether the largest shareholder was CEO. According to the survey, CEO is
also the founder in 52 percent of the firms. In 21 percent of cases, CEO was
given shares by the family; and in another 21 percent CEO bought shares in
the market. In the 25 firms where CEO was not the chairperson of the board,
he or she was selected on the basis of professional expertise in 15 firms,
shareholding in three firms, and was appointed by the Government in five firms.
When CEO is not the chairperson, compensation is by fixed salary
in 74 percent of the firms; fixed salary plus net profit-related bonus in
9 percent; and fixed salary plus performance-related pay including stock
options in 13 percent. These results show that the incentive compensation
scheme for professional CEOs is not well developed in Korean firms. The
remuneration package was proposed by the board (and approved by the
annual general meeting) in 56 percent of the firms. In 20 percent, it was
proposed by CEO and approved by the board.
In a handful of sample firms, in which there is no controlling share-
holder, CEO generally has the ultimate power to decide on corporate af-
fairs. In cases where CEO is not the largest shareholder and chairperson, he
or she does not enjoy much power. However, the survey tells a slightly
different story than is generally believed in Korea. It indicates that CEO,
who is not the chairperson, decides on important matters on his/her own in
13 out of the 44 firms. CEO decides on important matters after consulting
the chairperson in the majority (55 percent) of the firms. In 4 percent of the
cases, CEO simply follows the orders of the chairperson.
CEOs generally maintain their positions for a long time because
they are frequently the founders or largest shareholders of their firms. In the
survey, CEOs have been in their positions for an average of 9.2 years. In
less than 20 percent of the firms, CEO is entitled to a large sum in cases his/
her contract is terminated before its expiration. In such cases, the payment
is about five times the CEO’s annual salary.
The firms in the survey consider steady growth of a company and
maximization of the shareholder value as the most important responsibili-
ties of CEO. A smaller number of firms consider maximization of a compa-
ny’s market share and looking after the interests of such stakeholders as
creditors and employees as very important. Ensuring that a company serves
the public interest is considered a less important responsibility of CEO.
Senior Executives
In the past, it was common for all senior executives to be elected as direc-
tors at the shareholders meeting. Senior managers were even often called
directors although they were not official members of the board. The term of
appointment of executives did not have any real meaning because they had
to leave the company if and when the controlling shareholder demanded.
Usually CEO suggests the maximum amount of all the directors’
compensation at the shareholders meeting to get approval and then sets the
base salary and bonus for individual executives. The bonus is supposed to
be linked to company performance, but in practice is fixed and understood
as part of a fixed salary.
Korean firms have rarely used shares for executive compensation.
However, executives sometimes have the opportunity to buy company shares
at favorable prices because the board of directors (CEO, in practice) allo-
cates the unsubscribed portion of new shares issued in rights offerings to
executives.
Incentive stock options have become a popular compensation method
since the Securities and Exchange Act was amended in 1996 to allow the
issuance of stock options to managers and other employees. About 40 percent
of the listed companies had amended their charters to introduce incentive
stock options by the 1999 shareholders meetings, but as of March 1999 only
27 firms actually had given stock options to their executives or employees.
Transparency and Disclosure
Accounting Standards
The Financial Supervisory Commission (FSC) was established in April

1998 to take charge of supervising the financial markets and institutions.
The commission has played an active role in introducing new rules on cor-
porate governance, disclosure, and accounting standards. One area has been
to enhance the reliability of financial statements of corporations in line
with internationally accepted standards. This action was in response to calls
by international investors and, in particular, from IMF and the World Bank.
Penalties for fraudulent financial reports were increased.
Reforms in accounting standards since May 1998 have proceeded
in several areas: (i) revision of financial accounting standards that are pri-
mary sources of the Korean Generally Accepted Accounting Principles;
(ii) establishment of accounting standards for financial institutions; and
Chapter 2: Korea 101
(iii) establishment of accounting standards for “combined” financial state-

ments of chaebols.
The External Audit Act and its Decree require financial statements
of corporations with total assets of W7 billion or more to be prepared and
audited according to the financial accounting standards and working rules
set by FSC. The revised accounting standards apply to the firms subject to
external auditing for the fiscal year starting on or after January 1999. The
primary sources of reference in the revision were International Accounting
Standards and US Accounting Standards.
The new accounting standards for financial institutions adopt the
mark-to-market basis to account for securities. Thus, financial institutions
must report their securities holdings at market value and recognize
100 percent of unrealized holding gains or losses in the current year’s in-
come statement. The new rules also require financial institutions to recog-
nize realized losses and allowances for potential losses arising from guar-
antees in the current year’s financial statements. Korean listed companies
with subsidiaries are required to compile consolidated balance sheets. Con-
solidated reporting was introduced before the outbreak of the crisis.
In the ADB survey, 41 percent of the companies believed that they
have followed some international accounting standards, but 49 percent con-
fessed that they have not followed international standards at all. Only
10 percent of the respondents have followed all international accounting
standards. Most of the companies following all or some of the international
standards in the past adopted such standards before the crisis started. Those
that never adopted international standards show their willingness to do so
once the Government introduces international standards.
Internal and External Auditing
The Commercial Code requires a corporation to have at least one internal

auditor elected at the general shareholders meeting. The internal auditors
are supposed to play the role of the audit committee found in the board of
directors in US corporations without being members of the board. Under
the Commercial Code, they also have the power and duty to monitor the
activities of executive directors. In practice, however, they cannot be ex-
pected to discharge this responsibility because the representative director
selects the internal auditor and can force him or her to resign. Notwith-
standing a regulation limiting the votes of the largest shareholder to a
maximum of 3 percent of the outstanding voting rights in selecting an inter-
nal auditor, the internal auditor is considered to be a subordinate of the
controlling shareholder/CEO. In order to increase independence, the rel-

evant laws and regulations were changed after the Asian crisis to require at
least one of the internal auditors to be full time and to recommend that
listed firms have outside (independent) auditors.
Listed and registered corporations must publish financial statements
audited by external accounting firms. Previously, the board of directors had
the power to appoint an external auditing firm, but since 1998 a committee
consisting of internal auditors, outside directors, and creditors selects it.
Responsibilities of the External Auditors Committee include recommend-
ing a selection to the annual shareholders meeting and ensuring that exter-
nal auditors conform to new transparency standards. External auditors are
selected for a term of three years. If the company changes its external audi-
tor for reasons that are not listed in the relevant regulation, then the Securi-
ties and Futures Commission can appoint a new one.
In the ADB survey, almost all firms affirmed that the external auditor
is independent from the company. Big Korean accounting firms are affiliated
with US accounting firms. The current external auditors have been associated
with the surveyed companies for an average of 4.6 years. In the past, how-
ever, there were many cases where external auditors failed to detect omis-
sions and false numbers in financial statements of listed firms. The problem
of misconduct on the part of the external auditor was caused partly by weak
penalties on wrongdoing, underdeveloped market discipline for accounting
firms, and lack of strong professional ethics in the accounting profession.
The internal auditor in the Korean corporate system can be argued
to be inferior to the Anglo-American audit committee and the German su-
pervisory board. This is because the auditor, as a monitor of management in
the Korean (and also the Japanese) system, does not have the power to hire
and fire the managers. If the status of internal auditors is elevated to that of
independent board members, this problem will largely disappear. The gen-
eral organizational/social culture in Korea abhors conflict and may also
have hindered effective functioning of internal auditors. But this problem
can be mitigated if auditors function under the umbrella of the board.
Accepting these arguments, the Korean Code of Best Practice also
recommends that large firms adopt the audit committee structure with two
thirds of its members consisting of independent directors. The Commercial
Code will be revised to allow corporations to choose from the two options:
the internal auditor or the board audit committee system. The Securities
and Exchange Act will also be revised to require an audit committee for
large listed companies with total assets equal to or exceeding W2 trillion.
About 100 listed firms will be subject to this requirement.
2.3.3 Shareholder Rights
Voting Rights and Practices
Under the Commercial Code, corporations cannot issue common shares

without voting rights. One common share should have one vote. Preferred
shares can be nonvoting and issued up to one quarter of the total number of
shares. About one fifth of the listed firms issued nonvoting preferred shares.
The Korea Securities Depository can exercise the voting rights of
shares left thereto by the investors (beneficial owners) if the owner of the
share does not indicate his or her intention to vote personally. However, the
Depository is subject to “shadow voting,” meaning that it should divide its
votes in accordance with the accept/reject ratio of votes cast by other share-
holders attending the shareholders meeting. Thus, the only purpose of allow-
ing the Depository to vote was to help listed companies to meet the quorum
requirement for the general shareholders meeting. However, voting by the
Depository can influence the outcome of votes because an “ordinary resolu-
tion” of the general shareholders meeting requires a majority of the votes
attending and one quarter of total votes outstanding. A “special resolution”
requires two thirds of the votes attending and one third of total votes out-
standing. Approval of mergers and major divestitures, charter amendments,
and dismissal of directors and internal auditors require a “special resolution.”
The survey shows that the Korea Securities Depository holds
69.21 percent of total shares issued. A total of 326 shareholders per firm, or
10.79 percent of the shareholders, attended the last annual general meeting,
representing 62.77 percent of the shares. The Depository represented
20 percent of the shares attending the meetings. The above results indicate
that, in general, small shareholders do not attend the annual meeting and that,
for some firms, the Depository is instrumental in getting resolutions passed.
About 100 shareholders per firm voted by proxy at the last annual
general meetings (of the 40 firms answering the relevant questions). These
voters represented only 5.93 percent of the shareholders but 26.53 percent
of the total shareholdings. This shows that a relatively larger number of
shareholders send in their proxies. The management is the most important
proxy. The securities companies and banks are the second and third, respec-
tively. Citizens’ coalitions sometimes solicit proxies in order to file law-
suits against a management. No companies have so far introduced voting
by mail, Internet, or telephone.
Under the Commercial Code, amendments of the articles of incor-
poration require a “special resolution.” Companies can increase the number
of votes required for a resolution to amend the articles. Changes in the

authorized capital require an amendment of the articles of incorporation.
However, the board of directors decides on issues of shares within the limit
of the authorized capital. Shareholders have preemptive rights, but these
can be waived by an amendment of the articles of incorporation.
Proposals put forward by management are rarely rejected at the
general meetings. Only two out of 62 respondents to this question have had
cases in which proposals were rejected. Those that are most likely to be
rejected relate to election of directors, dividend proposals, mergers and ac-
quisition plans, and major investment projects (only five firms answered
this question). In four out of 62 respondents, the annual general meeting
passed a resolution that was not proposed by the management nor the board
of directors but rather by shareholders.
Shareholder Protection
Before the economic crisis, laws and regulations were generally very loose
in protecting the rights of minority shareholders. Various measures have
since been taken to improve investor protection. In February 1998 and again
in March, the Securities and Exchange Act was revised to lower the repre-
sentation requirement for shareholder derivative suits from 1 to 0.01 per-
cent. For recommendations for dismissal of directors and internal auditors,
the requirement was lowered from 1 to 0.5 percent, and for access to un-
published accounting books and records, from 3 to 1.0 percent.
Due to the changes in rules for investor protection, an activist citi-
zens’ coalition has brought shareholder derivative suits against several large
listed firms. The charges included self-dealing by a controlling shareholder
and unfair subsidization of affiliated companies by a chaebol firm. This
citizens’ coalition actively contacted the management of selected compa-
nies and negotiated measures to protect shareholders. It also attended the
shareholders meeting of several companies to present the views of outside
shareholders, demand changes in business policy, or block charter amend-
ments considered harmful to minority shareholders. This coalition also at-
tempted to cooperate with domestic and foreign institutional investors to
find their way into general shareholders meetings.
As an example, the Tiger Fund, an institutional investor based in
the US, was able to force a change in the charter of SK Telecom. The amend-
ment included a provision requiring the company management to get prior
approval of shareholders to undertake major investments and raise capital
in international markets. The company also agreed to the right of the fund
to recommend two directors to the corporate board. This was one of the
most significant developments with respect to shareholder activism in the
Korean capital market.
After the economic crisis, controlling shareholders have become
more susceptible to liability claims by other (minority) shareholders. This
has strengthened the accountability of controlling shareholders as de facto
CEOs. The Commercial Code has a new clause that regards the controlling
shareholder as a de facto director if he or she uses personal influence to
affect business decisions of the management. The Code has also been
amended to state more clearly the fiduciary duty (of care and loyalty) of the
management. Before the amendment, managers were considered to be sub-
ject to the duty of care, but it was not entirely clear whether they had the
duty of loyalty as well.
For further protection of investors, the Government had for some
time pushed for the enactment of class action suits on false statements
and omissions in disclosure materials. However, it now appears that it has
backed away from its earlier efforts to introduce legislation on class ac-
tion suits.
The laws and regulations of the country protect shareholders from
interested transactions, affiliated lending or guarantees, loans to directors,
mergers and acquisitions, and transactions with major shareholders. These
have to be disclosed under the Securities and Exchange Act or approved by
shareholders under the Commercial Code and other laws.
2.3.4 Control by Creditors
Role of Creditors in Corporate Monitoring
Traditionally, creditors did not interfere with the management of a debtor. The
covenants in loan agreements and bond indentures were very loose, simple,
and not strictly enforced. Banks themselves were poorly governed and bank
managements had little incentive to monitor borrowers. As for bond issues,
underwriting securities firms acted also as trustees. Thus, there was the usual
conflict of interest problem and the trustee did not have the incentive to strictly
enforce the covenants. In fact, bond indentures are only a few pages long com-
pared to a few dozen pages found in advanced bond markets.
Banks have played some limited role in monitoring the investment
activities of chaebols. In 1974, the Government introduced the Credit Man-
agement Regulation system whereby chaebols were required to seek
the approval of their main banks prior to undertaking large investments,
acquisitions, and purchases of real estate. In 1994 the approval requirement

was abolished.
In 1996, the main bank system was introduced and has been ap-
plied to the 51 largest business groups to which banks extended more than
W250 billion in loans and payment guarantees. The objective of the system
is to improve the financial condition of the largest business groups and
promote the soundness of bank management. However, there have been
concerns that the Government might use the system to intervene in the
management of the business groups.
Under the system, a main bank is charged with collecting and
analyzing financial information of the firm and delivering its opinion on
various applications and matters requiring consultation among lenders to
the firm. The main bank should also monitor and restrict extension of loans
to the controlling shareholder and other firms in the group. The firms sub-
ject to the system are required to get the approval of the main bank prior to
purchasing real estate. Purchase of real estate should be financed by equity
capital and not by borrowed funds.
The 10 largest business groups are required to select no more than
three core companies in consultation with their respective main banks. In
turn, the main banks should review the feasibility and financing plans of
projects undertaken by the core companies and monitor their financial con-
ditions and prospects.
Emphasis on the monitoring role of banks has been growing since
the beginning of the Asian crisis. Besides the setting up of an “External
Auditors Committee” by firms, as discussed earlier, creditors now have a
bigger say in court proceedings for receivership and composition.
Some proponents argue that creditors should have the right to send
their representatives to boards of directors of borrowers. However, this pro-
posal has only a slim chance of being accepted by the Government or legis-
lature. The view that is more popular among theorists is that creditors would
pursue goals that are not in harmony with value maximization and the deci-
sion-making role should be bestowed on the shareholders as residual claim-
ants. On the other hand, recently banks have been increasingly interested
and successful in electing former bank officers as outside directors of firms
that underwent workout processes.
ADB Survey Results on Borrowing and Lending Practices
The ADB survey shows that a typical nonfinancial company is associated

with various types of creditors, including, on average, 11 banks, 10 nonbank
financial institutions (NBFIs), and 17 nonfinancial corporations. Most of

the financial institutions are not affiliates of the borrowing company, whereas
seven of the 17 nonfinancial corporations are. The borrower’s relationship
with most banks has lasted for more than five years. The typical company
has also maintained its relationship with five of the 10 NBFIs for more than
five years.
Among the creditors, banks are most likely to require collateral.
NBFIs infrequently ask for collateral. With respect to the types of loans,
collateral is more likely to be required of loans for working capital than for
fixed investments. Most firms feel that requirements for collateral have been
tightened since the crisis started.
About 60 percent of the firms have experienced renegotiation of
loan repayment with creditors during the last five years. For more than half
of such firms, renegotiation took place after the crisis. When loans could
not be repaid on time, payments were usually rescheduled through negotia-
tion without any penalty. For a small number of firms, penalty was in-
volved in rescheduling, collateral was taken away, or creditors filed for
receivership. Most of the 43 firms with renegotiation experience were able
to borrow from the same creditors afterwards.
More than half of the firms think that creditors have no influence
on their management and decision making, while a third think that credi-
tors have weak influence. Only a few feel that creditors have very strong
influence. Creditors usually exercise their influence through covenants re-
lating to the use of loans. A few creditors exercise influence through cov-
enants relating to major decisions by the company, or through their
shareholdings.
One tenth of the firms received assistance from the Government in
loan applications, most frequently in the form of loan guarantees and less
frequently by arrangement of guarantees by a third party. About half of the
respondents received assistance from other sources in the form of loan guar-
antees and/or provision of collateral. The assistance came from, in order of
importance: affiliated companies, holding companies, subsidiaries, control-
ling shareholders, and other financial institutions. Relationships with affili-
ated companies providing guarantees or collateral include ownership of each
other’s shares, holding shares of another company by both the borrower
and the guarantor, mutual guarantee agreements, and purchase or supply of
raw materials.
Breakdown of loan guarantors is as follows: about 40 percent of
loans are without any guarantees, 35 percent are guaranteed by the com-
pany itself (by collateral and purchase of guarantee insurance), 16 percent
by other affiliated companies, 4 percent by subsidiaries, 2 percent by hold-

ing companies, and 1 percent by the Government.
Role of Creditors in the Corporate Restructuring Process
In the current process of business restructuring and workouts of an unprec-

edented number of firms under financial distress, banks and other institu-
tional lenders are playing more important roles than ever before. Behind
these new strengthened roles of creditors is the newly set-up FSC. The new
ways through which creditors, especially banks, will get involved in the
restructuring and workout processes, and in continued monitoring of debt-
ors, are summarized below.
First, major creditors, including commercial and merchant banks,
have been the driving forces for restructuring activities of the largest 64
chaebols. In this connection, the lead creditor banks formally signed Capital
Structure Improvement Plans with chaebols. The leading creditor banks
will continuously monitor the progress in implementing the signed Plans.
Second, the main vehicle for implementing the workout concept
(or the London Approach) is the Corporate Restructuring Agreement (CRA)
signed by 210 financial institutions in July 1998. This agreement will pro-
vide guiding principles in coordinating diverse interests among creditor
institutions and promoting cooperation. In cases where the creditors are
unable to reach an agreement on a workout plan, the Corporate Restructur-
ing Coordination Committee (CRCC) will provide arbitration. This com-
mittee was set up in accordance with the provisions of the CRA. Separate
from but emulating the CRA, a Lead Creditor Council Agreement was signed
for restructuring the top five chaebols.
Third, the creditor banks will send a delegation composed of bank
officers to the workout firm to oversee its management. Under a contract
signed between the creditors and the debtor, the delegation has the right to
approve wide-ranging financial activities of the firm.
2.3.5 The Market for Corporate Control
Government Policy Toward Hostile Takeovers
Until 1994, the Korean Government maintained a policy of protecting the

incumbent management of listed companies. Representative of the policy
was the stipulation under the Securities and Exchange Act that no one can
accumulate more than 10 percent of the voting shares of a listed company
unless he or she obtains prior approval of the Securities and Exchange Com-
mission. The shareholders already owning more than 10 percent at the time
the company went public were exceptions to the rule. Stock purchases by
tender offer were also exempted. It was generally believed that the securi-
ties authority would use its power to review and order revisions of the ten-
der offer statement to halt any hostile takeover attempt.
In the early 1990s the Government shifted its policy toward freer
activities in the market for corporate control. The policy to protect the in-
cumbent owners/managers was formally dropped when the Securities and
Exchange Act was amended in 1994 to abolish the 10 percent limit.
As far as institutional arrangements are concerned, it can be safely
stated that Korea now has one of the most accommodating capital markets
with respect to hostile takeovers in the region. Poison pills cannot be used
mainly because companies cannot distribute stock options as dividends to
shareholders. A company cannot issue new shares to a third party without
first amending the corporate charter. Privately placed CBs cannot be con-
verted into shares in one year. Publicly issued CBs require three months
before their owners can convert them to shares. Unlike the UK, Korea does
not have the mandatory takeover rules applying to those who amass more
than 30 percent of the shares outstanding (until 1998, an acquirer of shares
wishing to own more than 25 percent of the issued shares was required to
make a tender offer to buy at least 50 percent). Unlike Germany, corpora-
tions cannot limit the voting rights of large shareholders to a given maxi-
mum. Limits on acquisitions of shares of a Korean firm by a single investor
were gradually increased over a six-year period beginning in 1992, but were
completely eliminated in 1998.
Takeover Activity
As soon as the Act was amended, hostile takeovers by tender offers began to
appear in the capital market. Between 1994 and 1997, a total of 13 hostile
takeover attempts occurred. However, more than half of these attempts failed.
The reasons for failure are diverse. The incumbent controlling shareholders
used various tactics such as issuing privately placed CBs, turning to white
knights, and announcing competitive tender offers by the controlling share-
holder. In one case, the outside shareholders did not want to sell shares be-
cause the share price went above the offer price due to a share repurchase by
the target and anticipation of a competitive bid from a third party.
For takeover defense, listed firms rely mainly on shareholdings by
the largest shareholder. Companies have also utilized share repurchases.
The Securities and Exchange Act was revised in 1998 to abolish the
10 percent limit on share repurchases and the Government simultaneously
eliminated the limit on foreign ownership of shares of listed firms. Charter
amendments have also been employed by some firms to limit the maxi-
mum number of directors. In their charters, some firms have included a
supermajority provision for the dismissal of directors and provided for a
staggered board. Golden parachutes are almost unknown in Korea because
the total amount of director compensation has to be voted on at the general
shareholders meeting each year.
Hostile takeovers in Korea will be rare in the future. One reason is
that the percentage of inside shareholdings (by the controlling shareholder
group and the firms under its control) for an average listed firm is very high
(26.7 percent on average as of the end of 1997 for nonfinancial listed firms).
Many of the takeover targets in the past did not have a controlling share-
holder (group). Some had two or more large shareholders who had joint
control of the firm but could not cooperate. It is harder now to find such
firms. Another reason is that many listed firms belong to chaebols. Firms
affiliated with a large group are generally regarded as difficult targets as the
other members of the group will come to the rescue or act as white knights.
As of February 1999, 172 firms (or 22 percent of listed firms) belong to the
30 largest chaebols.
2.3.6 Control by the Government
State-Owned Enterprises
Government ownership of listed companies is very limited. As of the end of

1997, a steel company, an electric power company, and a bank had govern-
ment ownership. In 1998, the Government became the largest shareholder
of several commercial banks through equity participation purporting to
recapitalize them out of financial distress. In 1999, Korea Telecom, in which
the Government still holds the largest ownership, was newly listed.
The Government-owned listed companies, except for the banks,
are designated as public companies, which are allowed by the Securities
and Exchange Act to set the limit on the ownership of shares by one single
shareholder. Currently the limit is 3 percent. For the steel company, the
limit will be eliminated when it is fully privatized in two years. For the
others, it is not certain whether the Government will ever fully privatize
them and whether it will hold a golden share in the case of a complete sale
of Government-held shares.
The Government used to appoint a few public officials to the boards

of state-owned corporations. But this rule, as applied to four large corpora-
tions, was amended in 1997 to introduce a board structure consisting of a
majority of nonexecutive directors. The Government’s right to send public
officials to the boards was eliminated. Beginning in 1999, more state-owned
corporations became subject to this new board structure. The nonexecutive
directors are now recommended by a committee, nominated by the minister
in charge of the company in question, and approved by the Chairperson of
the Planning and Budget Commission.
Control Over Private Companies
One of the pronounced purposes of government intervention in the corpo-

rate sector has been to prevent concentration of economic power in the
hands of a few large chaebols (see 2.3.1). Meanwhile, the main bank sys-
tem, which was introduced in 1996, is being applied to the 51 largest busi-
ness groups to which the banks extended more than W250 billion in loans
and payment guarantees. The objective of the system was to improve the
financial condition of the chaebols and to promote the soundness of bank
management.
The Government has frequently imposed restrictions on the use of
capital markets by large companies, especially those belonging to chaebols.
For example, the Government, administering through a self-regulatory com-
mittee of the securities industry, controlled the total amount of corporate
bonds issued per month and allocated amounts to individual corporations.
This was aimed at limiting the supply of bonds thereby stabilizing interest
rates. It was abolished before the economic crisis but another regulation,
which limits the total amount of bonds issued by the five largest chaebols,
went into effect in 1998 to prevent them from absorbing too much of the
funds available in the market. In addition, only qualified firms could issue
new shares. There were also limits on the amount raised and the number of
issues per year. Further, each of the 10 largest chaebols was allowed to raise
funds no more than 4 percent of the total market capitalization of the mem-
ber firms.
2.3.7 Employee Participation in Corporate Governance
Employee participation in corporate governance is very limited. Labor is

not represented in corporate boards. There is no active debate or discussion
going on about this potentially difficult issue. Even where employees hold
shares of their companies through employee stock ownership plans, they

delegate their voting rights to plans’ representatives. This practice may be
due to the fact that employees are typically submissive to their employers
and that their total shareholdings are minimal. The relevant regulation was
amended recently in order to facilitate voting by individual employees.
Employees of companies have had the opportunity to buy shares of
their employing businesses at favorable prices. Under the Capital Market
Development Act of 1968, employees of listed firms issuing shares through
rights offerings are entitled to 10 percent of the rights. Under another law
enacted in 1972 to induce private companies to go public, these firms have to
offer 20 percent of the shares being issued to their employees at the public
offer prices, which were generally much lower than estimated values.
Employee stock ownership plans became popular in 1974 when
the Government allowed tax and financial benefits for stock purchases by
employees. In 1987, the subscription rights given to employees when a
company goes public and when a listed company issues shares were in-
creased to 20 percent of the new shares. The percentage of shares held by
the employee stock ownership plans in listed companies was 1.9 in 1980,
2.5 in 1990, and 2.1 in 1997.
Under the Labor Management Council Law, employers are required
to meet with representatives of labor unions at least once every three months.
This law is not intended for wage negotiations but for employers to seek
cooperation and productivity increases from workers. In actuality, the council
meetings have been superficial.
Trade unions are organized on an enterprise basis. Local unions in
the same industry have established industrial labor federations. At the na-
tional level, there are two federations of labor unions. The typical collective
bargaining agreement has a one-year duration. Collective bargaining is, in
principle, carried out at the enterprise level.
The respondents of the ADB survey had 2,654 employees per firm
on average, of which 2 percent were senior managers, 32 percent techni-
cians and professional staff, and 66 percent manual workers. Two thirds of
the respondents had an organized union. In these firms, union members
account for 54 percent of the employees. In 70 percent of the firms with
organized unions, the management usually consults the union on major
issues relating to the management, operation, and development of the com-
pany. About half of these firms considered the influence of the union on the
management of the company to be weak, but 27 percent of them felt that it
was strong. The union had no influence on the management in 17 percent of
the firms.
2.4 Corporate Financing7
2.4.1 Overview of the Financial System
The foundation of the modern financial system in Korea was laid during the
early 1950s. Specialized banks were established during the 1960s to facili-
tate capital mobilization and strengthen financial support for underdevel-
oped or strategically important sectors. Most NBFIs were introduced dur-
ing the 1970s to diversify financing sources, promote the development of
the money market, and attract funds into the organized market. From the
early 1980s, several commercial banks and NBFIs were added as part of a
series of broad measures to spur financial liberalization and internationali-
zation. These measures coincided with a shift from a government-oriented
economic policy toward a market-oriented stance.
Recently, the Korean financial system has been undergoing sub-
stantial changes through a comprehensive financial reform program. This
program was agreed upon by the Korean Government and IMF upon the
signing of a financial aid package. At present, financial institutions in Ko-
rea may be divided into three categories by function: the central bank (the
Bank of Korea); banking institutions, including commercial and special-
ized banks; and NBFIs, including development, savings, investment, insur-
ance, and other institutions. Corporations raise funds through direct loans
from the banks and NBFIs, and by transactions with the public through the
money market, stock market, and bond market.
Banks
To a certain extent commercial banks have engaged in long-term financing

in addition to their short-term banking operations. They still tend to depend
heavily on borrowings from the Bank of Korea to cover persistent shortages
in their own loanable funds, although the ratio of these borrowings to their
total sources of funds has decreased. Commercial banks in Korea may, as in
most countries, engage in a wide range of business. In addition to their core
activities, they also handle such businesses as guarantees and acceptances,
own-account securities investment, and receipt and disbursement of Treas-
ury funds as agencies of the Bank of Korea. Specific authorization is re-
quired for each area of nonbank business they engage in: such as trust ac-
7
The authors gratefully acknowledge the help of Prof. Bong-Han Yoon who contributed
several sections of this part.
counts, credit card business, and some aspects of securities business. Special-
ized banks, which function as deposit money banks alongside commercial
banks, conduct a similar range of business in addition to their own areas.
From the early 1980s, banking institutions moved into a number of
new business areas and developed a variety of innovative products to raise
their competitiveness against NBFIs, and to meet the growing and diversi-
fied demand for financial products. Examples are credit cards, sale of com-
mercial bills discounted by themselves, factoring business, trust business,
certificates of deposit (CDs) business, and sale of cover bills. They also
entered such security businesses as sales of government, public, and corpo-
rate bonds under repurchase agreements; the acceptance, discount, and sale
of trade bills; and lead underwriting and over-the-counter sales of govern-
ment and public bonds. In the early 1980s, the trust business, which had
been limited to Bank of Seoul and Trust Company, was opened to all banks.
Nonbank Financial Institutions
NBFIs can be broadly classified into the following categories: (i) develop-
ment institutions comprising the Korea Development Bank and the Export-
Import Bank of Korea; (ii) savings institutions including the trust accounts
of banking institutions, mutual savings and finance companies, credit un-
ions, mutual credit facilities, and postal savings; (iii) investment companies
comprising investment trust companies and merchant banking institutions;
and (iv) contractual institutions such as insurance companies and pension
funds. In addition, there are various nonbank institutions that handle spe-
cialized lending such as leasing, factoring, credit cards, consumer loans,
housing loans, and venture financing without receiving deposits.
NBFIs have increased their share of total funds supplied since the
1980s as they have been permitted greater freedom in management and
operations. The market share of banking institutions in terms of Korean
won deposits dropped sharply from about 71 percent in 1980 to 30 percent
in 1997; while that of NBFIs increased from 29 percent to 70 percent dur-
ing the corresponding period.
Differences in regulatory treatment accounted for the greater free-
dom in management for the NBFIs. They were allowed relatively greater
flexibility in their management of assets and liabilities and, most impor-
tant, were permitted to apply higher interest rates on their deposits and
loans. Evenness in regulatory treatment concerning such interest rates has,
however, largely been achieved following the completion of a four-stage
plan for deregulation of interest rates from 1991 to 1997.
Money Market
The money market is composed of the call market and a wide range of other
short-term financial markets including those for Treasury Bills, Monetary
Stabilization Bonds (MSBs), negotiable CDs, repurchase agreements (RPs),
commercial papers (CPs), trade bills, and cover bills. The beginning of the
organized money market in Korea dates from when MSBs and Treasury
bills were first issued in 1961 and 1967, respectively. However, the money
market remained underdeveloped until the early 1970s when the Govern-
ment took a series of measures designed to channel curb market funds into
financial institutions and to systematically organize the short-term finan-
cial market.
In 1972, with the passage of the Short-Term Financing Business
Act and the establishment of investment and finance companies, the sale of
papers issued by nonfinancial business firms and investment and finance
companies was initiated. This was a first step toward the formation of an
advanced money market. In 1974, negotiable CDs (large-value time depos-
its at banks) were introduced. In addition, call transactions, which had pre-
viously taken place between individual banks, were put on a systematic
basis. In 1977, the Korea Securities Finance Corporation initiated repur-
chase agreements with securities companies involving bonds on a short-
term basis.
Various new financial instruments, including CPs, were introduced
in the early 1980s. Since 1985, there has been a sharp increase in the out-
standing balance of money market instruments. This is chiefly due to prod-
uct innovation and expansion in the number of financial institutions
handling such instruments. The volume of money market transactions
expanded from W7,995 billion in 1985 to W44,201 billion in 1990, and
W98,100 billion in 1995 (as of the end of June).
Stock Market
Activity in the primary (new issues) stock market was extremely brisk dur-
ing the period 1986 through 1989. The value of shares sold in IPOs and in
rights offerings by listed companies grew 48 times from W294 billion in
1985 to W14,176 billion in 1989. But the stock market sagged in 1990,
resulting in a decline in IPOs and seasoned issues. The composite stock
price index declined substantially during 1990-1992 due to continued labor-
management disputes and a slowdown in economic growth. Though the
market recovered temporarily from 1993 to 1995, it again went into a slump
after 1996 until the index hit 350 in December 1997 with the onset of the
financial crisis.
A new stock market was organized in April 1987 to provide a new
means of trading stocks for small- and medium-sized companies and ven-
ture businesses not eligible for listing on the Korea Stock Exchange. A
corporation satisfying less stringent criteria can register with the Korean
Securities Dealers Association under the sponsorship of at least two securi-
ties companies. This market, named KOSDAQ, is not exactly an over-the-
counter (OTC) market in that, unlike the National Association of Securities
Dealers Automated Quotations (NASDAQ) in the US, there are no active
dealers for registered shares. Still, investors are assured of a certain degree
of liquidity of the shares registered at the KOSDAQ. Though the KOSDAQ
is still in its infancy, it has been showing a great potential for growth by
providing liquidity to shares of small and large firms before they are even-
tually listed on the Korea Stock Exchange.
Despite the considerable growth and good performance of the Ko-
rean stock market, many problems were exposed with the onset of the fi-
nancial crisis in 1997. The major problems may be identified in the follow-
ing areas: (i) corporate disclosure system; (ii) reliability of accounting in-
formation; (iii) protection of small shareholders; and (iv) inactive takeover
markets.
Bond Market
Public and corporate bonds are issued in the Korean bond market. Public
bonds include government and other bonds that are issued by provincial
and municipal governments, government-owned enterprises, and govern-
ment-owned financial institutions. All public bonds are implicitly or ex-
plicitly guaranteed by the central Government. Corporate bonds are those
issued by private companies under the Commercial Code. The value of
listed public bonds became larger than listed corporate bonds in 1986 and
remains to be so.
The secondary bond market consists of the exchange and the OTC
market. However, as in most other countries, the OTC market has domi-
nated trading in bonds. Almost all of the bond transactions still take place
on the OTC market despite government efforts to develop a separate ex-
change market for bonds.
Most corporate bonds were issued as guaranteed bonds where the
payment of principal and interest is guaranteed by financial institutions.
Nonguaranteed bonds or debentures accounted for only 15 percent of the
total issued in 1997, although their proportion reached 30 percent in 1995.

This implies that most bonds were issued according to similar conditions
regardless of the financial standing of the issuing company and that the
bond rating system has not been well developed in Korea. However, all of
this is changing. Bond rating agencies are now applying tighter criteria.
Banks have strengthened their credit reviews in extending debt payment
guarantees because of tighter regulatory and market pressures on their own
financial conditions. Most securities companies have all but stopped ex-
tending guarantees.
One of the dramatic changes in the bond market after the IMF bail-
out is that most corporate bonds are now issued on a nonguaranteed basis.
The proportion of nonguaranteed bonds accounted for 69 percent of the
total offerings of corporate bonds in 1998. This is in contrast with the pre-
bailout period, when the proportion of guaranteed bonds was more than
80 percent of the total offerings. One problem for the corporate bond mar-
ket is that most bonds are issued with maturities of less than four years. The
maturity of corporate bonds should be lengthened to generate stable long-
term funds for corporations.
Financial Deregulation
Discriminatory government regulations in the financial sector were preva-

lent during the 1970s. Entry into financial industries such as commercial
banking, investment banking, securities brokerage, merchant banking, and
insurance was strictly controlled. Ownership of commercial banks and their
internal governance structures were controlled for many decades. These
factors resulted in a serious structural imbalance in the financial industry. It
diminished the role and profitability of banks while encouraging growth of
NBFIs. In addition, the capital structure of business firms worsened and the
unorganized money market rapidly expanded.
In order to reduce government intervention and to restore the bal-
anced development of the financial market, interest rate deregulation was
initiated in June 1981. A significant advance occurred in December 1988,
when most of the lending rates of banks and NBFIs were liberalized. Only
interest rates on long-term deposits were regulated to avoid excessive com-
petition among financial institutions. Interest rates on remaining deposits
were gradually deregulated. However, in 1989, when interest rates rose rap-
idly and macroeconomic conditions deteriorated, the Government again
placed extensive control over interest rate movements, including window
guidance. In August 1991, the Government announced the Four-Stage
Interest Rate Deregulation Plan, implementing the first stage in November

1991. The Government adopted a cautious approach, opting to bring in the
plan step-by-step to avoid market dislocation from a sudden shift in the
system.
The Government handed over its controlling stakes in four com-
mercial banks to private hands in 1981-1983. In addition, entry barriers to
banks and NBFIs were lowered in an attempt to promote competition, which
resulted in the establishment of a number of new banks, short-term finance
companies, mutual savings, finance companies, etc. With the privatization
of nationwide commercial banks, the Government simplified various direc-
tives and instructions regulating personnel management, budget, and organi-
zation of commercial banks. Also, the required reserve ratio was substan-
tially lowered from an average of 23 percent in 1979 to 3.5 percent in No-
vember 1981. Some policy loans were also abolished. Moreover, the busi-
ness scope of financial institutions was greatly widened from the early 1980s.
The Government began to considerably deregulate foreign exchange
in 1987 due to the shift of the current account into surplus in 1986 (see
2.2.1). Meanwhile, as a first step toward liberalization of capital account
transactions, the Government announced a plan in 1981 that substantially
improved foreign investors’ access to the domestic capital market. Since
1985, Korean firms have been allowed to issue CBs in international finan-
cial markets. In June 1993, the Korean Government announced its Finan-
cial Liberalization and Market Opening Plan. The plan was launched par-
tially to accommodate US demands for comprehensive structural deregula-
tion and market opening of the financial sector. It included such important
issues as interest rate deregulation, revision of the credit control system,
development of the money market, and liberalization of foreign and capital
transactions. The capital market, especially the domestic bond market, was
liberalized drastically in 1998 after the financial crisis.
Corporate Financing Practices
In this section, flow of funds analysis was used to examine patterns of

financing of the aggregate corporate sector, listed companies, and the 30
largest chaebols. On the basis of flows of funds, the following measures
can be constructed:
Self-financing ratio (SFR) is the ratio of change in internal funds to
change in total assets. Internal funds include retained earnings, depreciation,
and net capital transfers from the Government, but do not include capital
surplus (asset revaluation allowance and the excess of current value over
issue value of stock).
New equity financing ratio (NEFR) is the ratio of change in equity
(stocks issued + equity other than stocks) to change in total assets. Equity
capital represents the shareholders’ commitment to the business. Additional
equity capital used to finance growth reduces the financial cost and the
financial risk of investment.
Incremental debt financing ratio (IDFR) is the ratio of change in
total borrowings to change in total assets. It measures the degree of financ-
ing growth in total assets by additional debts. The use of additional debt to
finance growth increases financial risks as the company may not be able to
pay interest during periods of recession or high interest rates.
Incremental equity financing ratio (IEFR) is the ratio of change in
stockholders’ equity to change in total assets or 1-IDFR. It measures the
degree of financing growth in total assets by additional equity, comprising
internally generated capital (retained earnings, capital surplus, deprecia-
tion, and allowances) and new equity capital.
Financing Patterns of the Aggregate Corporate Sector
Table 2.25 shows the flow of funds of the nonfinancial corporate sector in
Korea during 1988-1997. The share of external financing, including all
sources other than retained earnings, depreciation, and government trans-
fers, on average, was 71 percent during the period. This high proportion
deprived Korean businesses of flexibility during recession periods due to
high financial costs. Before 1988, the corporate sector’s most important
source of external finance was bank borrowings, particularly in the short
term. In 1988 when the stock market boomed, the proportion of borrowings
from NBFIs fell to its lowest value at 4 percent. Securities finance became
a more important source from 1988 onwards, except in 1991, 1994, and
1997. In securities finance, financing by corporate bonds and CPs was more
significant than by new equity, except for the stock market boom of 1987-
1988. Meanwhile, the proportion of foreign borrowings in total finance
rose steadily, particularly in the 1990s in response to the liberalization of
the capital market; but it remained less than 10 percent of total financing.
Table 2.26 shows the four measures of corporate financing calcu-
lated from Table 2.25. The SFR averaged 28.4 percent in the precrisis pe-
riod 1988-1997. This means that internal funds after dividend payment were
insufficient to finance growth in total assets. The corporate sector used
Table 2.25
Flow of Funds of the Nonfinancial Corporate Sector, 1988-1997
(percent)
Sources of Funds 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997
Internal Financinga 43.8 28.4 27.1 26.7 28.7 30.0 27.3 27.9 22.6 26.9
External Financing 56.2 71.6 72.9 73.3 71.3 70.0 72.7 72.1 77.4 73.1
Bank Borrowings 13.6 25.4 28.0 30.7 25.9 22.0 32.4 23.0 21.7 27.7
Banks 9.6 10.6 11.5 14.5 10.8 9.1 15.1 10.7 10.9 10.0
Nonbanks 4.0 14.8 16.5 16.1 15.1 12.8 17.3 12.2 10.8 17.7
Merchant Banks 1.5 4.9 2.7 1.7 (0.3) 1.7 3.2 0.4 (0.3) 1.3
Insurance and Others 2.5 9.9 13.8 14.4 15.3 11.2 14.2 11.9 11.1 16.4
Securities 29.5 38.6 30.9 27.8 27.7 34.4 26.5 34.7 36.6 27.1
Natl. and Public Bonds 2.6 2.0 2.1 1.8 2.3 2.4 0.3 (0.7) 0.2 0.4
Commercial Paper 3.0 9.5 2.7 -2.8 5.4 9.7 3.6 11.6 13.5 3.0
Corporate Bonds 3.7 9.2 15.7 17.7 8.6 10.2 10.3 11.1 13.8 16.6
Stock Issuesb 7.1 15.4 8.6 8.4 9.3 10.3 10.8 10.4 8.5 5.3
Equity Other than Stock 3.0 2.4 1.7 2.6 2.0 1.8 1.6 2.2 0.6 1.7
Foreign Loans 3.2 0.3 4.7 3.0 5.1 1.1 4.8 6.1 8.1 4.5
Foreign Current Bonds — — — — — 2.6 1.2 1.2 1.7 2.4
Trade Credit — — — — — 0.0 1.5 2.1 2.7 1.3
Direct Investment — — — — — 0.4 0.4 0.7 1.0 1.2
Others — — — — — (2.0) 1.6 2.1 2.6 (0.4)
Others 9.9 8.0 9.4 8.6 12.6 12.6 9.0 8.4 11.1 13.8
Government Loans 0.1 (0.1) (0.1) 0.2 0.7 (0.1) 0.2 0.1 (1.6) 0.9
Business Credit 3.2 4.1 4.8 6.4 6.3 6.3 5.0 3.6 5.3 6.3
Other Financial Debts — — — — — 6.4 3.8 4.7 6.0 6.6
a
Includes retained earnings, depreciation, and net capital transfers from the Government.
b
Includes capital surplus, which is the excess of current value over issue value of stock.
Source: Understanding Flow of Fund Accounts, Bank of Korea, 1994; and Flow of Funds, Bank of Korea.
Table 2.26
Financing Patterns of the Nonfinancial Corporate Sector, 1988-1997
(percent)
Year SFRa NEFRa IDFR IEFR
1988 43.8 20.1 36.1 63.9

1989 28.4 17.8 53.8 46.2
1990 27.1 10.3 62.6 37.4
1991 26.7 11.0 62.3 37.7
1992 28.7 11.4 60.0 40.0
1993 30.0 12.1 57.9 42.1
1994 27.3 12.3 60.3 39.7
1995 27.9 12.7 59.5 40.5
1996 22.6 9.0 68.3 31.7
1997 26.9 5.5 73.3 26.7
Average 28.4 12.2 59.4 40.6
a
Excludes capital surplus.
Source: Calculations from Understanding Flow of Fund Accounts, Bank of Korea, 1994; and Flow of
Funds, Bank of Korea.
additional equity to finance 12.2 percent of the growth in total assets. The
balance, an average of 59.4 percent, was financed by additional debts. In-
cremental financing from equity was 40.6 percent over the 10-year period.
There were significant time trends. In periods of high economic
growth such as in 1988, SFR peaked at 44 percent. It dropped to 28 percent
the following year, declining to 26.9 percent by 1997 when net profit mar-
gins were negative. NEFR registered 20.1 percent in 1988 during the stock
market boom, but plunged to 5.5 percent in 1997. IEFR ranged from
32 percent to 64 percent of asset growth during the boom years, but also
continuously fell, dropping to 26.7 percent in 1997. While SFRs, NEFRs,
and IEFRs were declining, the corporate sector relied heavily on external
financing for its expansion. IDFR reached 73.3 percent in 1997, indicating
a high financial risk position.
Across industry, in the manufacturing sector, average SFR was
37.5 percent, higher than the aggregate 28.4 percent (Table 2.27). On aver-
age, 45.2 percent of incremental asset growth was financed by equity, higher
than the aggregate 40.6 percent. Manufacturing financed 54.8 percent of its
total asset growth through debts, and the total debt ratio was much higher in
1996 and 1997 at 62.5 and 76.4 percent, respectively. Lower income dimin-
ished the industry’s equity position toward crisis year 1997. Its IEFR and
NEFR dropped to 23.6 percent and 1.6 percent, respectively.
The construction industry showed the most cyclical pattern in an-

nual asset growth. It had the highest average SFR in 1988 at 31.9 percent,
which decreased to 8.8 percent in 1990, then increased to 20.2 percent in
1993, and fell to about 10 percent in 1997. Equity financed an average
25.1 percent of total asset growth for the period; from 17.7 percent in 1996,
this dropped further to 15.8 percent in crisis year 1997. Total debt financed
an average 74.9 percent of asset growth, with the total debt ratio much
higher in 1995-1997 at 82 to 84 percent. Since 1992, the proportion of
short-term borrowings in total financing has been high, explaining partly
the collapses of several construction companies in 1995, one year ahead of
the other industries.
Financing patterns of the wholesale, retail, and hotels sector and
realty/renting/business activities sector were similar. These sectors had rela-
tively low equity financing ratios and high total debt ratios in financing
asset growth between 1988 and 1997. On the other hand, the utilities (elec-
tricity, gas, and steam) and the transportation, storage, and communication
sector had relatively high incremental equity ratios, and low total debt and
short-term borrowing ratios. In 1997, the two sectors also had low equity
financing ratios and high debt financing ratios.
Categorized according to company size, large firms showed more
cyclical patterns in these financing ratios than small- and medium-sized
firms. Since large firms were more profitable, their average SFR was higher.
Table 2.27
Financing Patterns of the Nonfinancial Corporate Sector by Industry
(percent)
Manufacturing
1988 50.0 9.5 34.4 65.6
1989 42.3 7.2 46.4 53.6
1990 28.1 5.4 63.2 36.7
1991 29.6 3.8 62.6 37.4
1992 37.7 4.9 53.0 47.0
1993 47.6 6.0 42.6 57.4
1994 37.8 3.6 54.3 45.7
1995 50.0 3.2 52.6 47.4
1996 30.2 3.5 62.5 37.5
1997 21.7 1.6 76.4 23.6
Average 37.5 4.9 54.8 45.2
Wholesale/Retail Trade, Household Goods, Hotels

1988 33.6 9.7 53.4 46.6
1989 26.6 8.0 62.8 37.2
1990 12.8 4.1 81.7 18.3
1991 14.3 4.0 78.6 21.4
1992 24.4 2.5 71.1 28.9
1993 22.3 7.8 66.7 33.5
1994 15.3 4.2 78.5 21.5
1995 16.2 4.3 76.8 23.2
1996 16.9 2.7 76.5 23.5
1997 8.9 1.9 87.6 12.4
Average 19.1 4.9 73.4 26.7
Construction
1988 31.9 15.7 52.8 47.2
1989 20.3 6.6 70.7 29.3
1990 8.8 9.6 80.9 19.1
1991 9.6 7.9 80.8 19.2
1992 14.5 9.2 74.1 25.9
1993 20.2 8.6 69.5 30.5
1994 20.0 8.0 70.1 29.9
1995 10.3 4.2 84.0 16.0
1996 10.2 5.2 82.3 17.7
1997 10.9 3.7 84.2 15.8
Average 15.7 7.9 74.9 25.1
Trasport, Storage, and Communication

1988 64.9 3.6 25.9 74.1
1989 63.0 4.3 29.8 70.2
1990 50.8 (9.4) 54.0 46.0
1991 51.9 2.8 40.0 60.0
1992 56.9 2.9 34.8 65.2
1993 63.7 1.0 29.6 70.5
1994 53.4 1.9 37.7 62.3
1995 53.5 1.6 42.3 57.7
1996 42.6 2.0 47.0 53.0
1997 29.2 0.5 68.7 31.1
Average 53.0 1.1 41.0 59.0
Real Estate, Renting, and Business

1988 51.1 6.0 31.0 69.0
1989 34.8 (0.4) 56.7 43.3
1990 19.6 3.0 70.5 29.5
1991 18.2 1.5 77.1 22.9
1992 18.8 8.3 54.7 45.3
1993 11.7 7.4 69.0 31.0
1994 8.6 7.6 79.0 21.0
1995 17.7 7.8 67.0 33.0
1996 18.6 17.3 53.9 46.1
1997 23.8 3.4 65.3 34.7
Average 22.3 5.9 62.4 37.6
Electricity, Gas, and Steam Supply

1988 118.6 1.0 (107.8) 207.8
1989 118.6 0.4 (35.8) 135.3
1990 82.1 0 7.1 92.9
1991 56.0 0 35.1 64.9
1992 51.1 0 42.8 57.2
1993 55.4 0 36.7 63.3
1994 72.4 1.4 18.9 81.1
1995 62.4 1.0 28.4 71.6
1996 45.0 0.4 47.1 52.9
1997 24.9 0.1 70.7 29.3
Average 75.6 0.4 14.3 85.6
IDFR = incremental debt financing ratio, IEFR = incremental equity financing ratio, NEFR = new
equity financing ratio, SFR = self-financing ratio.
a
Source: Calculated using data from Bank of Korea, Financial Statement Analysis Yearbooks.
Their average IEFR was also higher and IDFR smaller. The trend was re-
versed in 1996-1997, however, when large firms had much lower equity
financing ratios and higher debt financing ratios than small- and medium-
scale firms. Higher growth in total assets and sales and easier access to
debts by large firms could be reasons for this. The large firms had a higher
proportion of external financing in 1996-1997. Long- and short-term bor-
rowings of these firms shot up in that period.
Financing Patterns of the Publicly Listed Firms
The average SFR of listed companies in 1994-1997 was much lower than
that of the corporate sector as a whole (Table 2.28). The average IEFR and
IDFR were 10.3 and 89.7 percent, respectively, for listed companies, com-
pared with the entire corporate sector’s 35 percent and 65.4 percent. The
debt financing ratio of listed companies was high since they relied more on
external financing. They had easier access to bank loans and the markets for
corporate bonds and CPs than nonlisted companies, and were large borrow-
ers. The proportion of their short-term financing averaged 72.5 percent and
their total external financing, 91.6 percent. In 1997, the IDFR of listed
companies increased to 93.8 percent.
Financing Patterns of Chaebols
For chaebols, the average SFR was 28.2 percent, about the same as that of
the corporate sector as a whole, and higher than that of listed companies
(Table 2.29). The average IEFR of the top 30 chaebols of 29.5 percent is
lower than that of the corporate sector in general, but higher than that of
listed companies. Group-member firms borrowed less, at an average
70.6 percent of total asset growth, compared with 89.7 percent for all listed
companies.
The chaebols’ drive to expand their empires resulted in heavy bor-
rowings. They were able to borrow easily from banks by issuing corporate
bonds and CP, and using cross-payment guarantees among affiliated com-
panies. All of the top 30 chaebols relied heavily on short-term borrowings.
In 1996-1997, the NEFR of the top 30 chaebols plunged while the debt
ratio increased substantially.
The largest borrowers were the top 11-30 chaebols. Their short-
term borrowings accounted for 86.8 percent of their total finance in 1997.
External financing reached 94.7 percent.
Another key feature of corporate finance in Korea is the widespread
use of loan guarantees among the top 30 chaebols. Cross-payment guaran-
tees have been declining since 1993 and reached 91.3 percent of their eq-
uity capital in 1997 (Table 2.30). In 1997, the top 11-30 chaebols had the
highest guarantees commitments at 207.1 percent of their equity capital;
the top 6-10 chaebols, 153.9 percent; and the top five chaebols, the lowest
ratio of 58.9 percent. Many firms affiliated with the top 30 chaebols saw
loan guarantees turn into their own debts because of defaults in debt pay-
ments.
Table 2.28
Financing Patterns of Listed Companies, 1994-1998
(percent)

1994 12.1 2.5 85.4 14.6
1995 8.9 2.6 88.5 11.5
1996 7.3 1.6 91.1 8.9
1997 5.5 0.7 93.8 6.2
Average 8.5 1.9 89.7 10.3
a
Source: Calculated from data obtained from data files of the Korea Listed Companies Association.
Table 2.29
Financing Patterns of the Top 30 Chaebols, 1994-1997
(percent)

1994 41.2 1.2 57.6 42.4
1995 36.8 1.4 61.8 38.2
1996 22.4 1.3 76.3 23.7
1997 12.3 1.1 86.6 13.4
Average 28.2 1.3 70.6 29.5
a
Source: Calculated using data of Seung No Choi, Largest Business Groups in Korea, Korea Federation of Industries.
Table 2.30
Cross-Payment Guarantees of the Top 30 Chaebols, 1993-1997
(as percentage of equity capital)
Rank 1993 1994 1995 1996 1997
Top 30 Chaebols 469.9 258.1 161.9 105.3 91.3

Top 5 Chaebols — — — 64.7 58.9
Top 6-10 Chaebols — — — 150.3 153.0
Top 11-30 Chaebols — — — 200.0 207.1
Source: Fair Trade Commission and the Federation of Korean Industries.
Factors Influencing Corporate Financing Choices
Until recently, Korean firms preferred debt financing (bank and nonbank
borrowings). There were several reasons for this. First, more than half of
bank loans were priority loans with low interest rates, so that the firms
engaged in lobbying to gain access to them. Further, the Korean economy
was plagued with high inflation, especially in the 1970s when real interest
rates of bank loans were negative. Second, poor financial and corporate
governance resulted in overlending by banks, inefficient investment and
excessive diversification of corporations, and underdevelopment of the stock
market. Third, the Government provided implicit guarantees on bank lend-
ing and large businesses. Fourth, chaebols could easily borrow funds from
banks and NBFIs by using cross-payment guarantees. Financial institu-
tions did not strictly screen their loan projects and monitor their debtors,
and extended loans based on cross-payment guarantees. And fifth, the Gov-
ernment applied high tax rates on net profits of corporations. Interest pay-
ments on debts were considered a loss when calculating taxes.
According to the ADB survey, company preferences in financing
investment projects before the crisis were, in order of ranking, loans from
banks, bond issues, rights issues, and reserves and retained earnings. Few
firms ranked loans from NBFIs as their first preference. Controlling share-
holders usually tried to avoid dilution in their shareholdings for fear of
losing control. This attitude appears to have changed after the crisis be-
cause reserves and retained earnings and rights issues became the preferred
financing choices. These are followed by loans from banks, bond issues,
and loans from NBFIs. Firms now prefer internal funds and new equity
capital. This change implies that firms now give more attention to financial
risks.
In seeking external financing, the majority (60 percent) of the firms

responding to the ADB survey look first for nonaffiliated financial institu-
tions. This preference has changed little after the crisis. According to the
survey, in selecting financing sources, firms give their first consideration to
minimization of transaction and interest costs. Other factors include, in
order of importance, ensuring the liquidity of the company, maintenance of
the existing ownership structure, and reduction in tax burden.
About half of the respondents of the ADB survey borrowed for-
eign currency denominated loans from foreign banks. For these firms, the
percentage of foreign currency denominated debt in the portfolio was
14.5 percent at the end of 1997. The most important reasons why they
chose to borrow foreign currency denominated loans were that terms of
foreign loans were more favorable and/or these loans were considered
cheaper. Only a few firms sought foreign loans because domestic loans
were not available.
Among the responding companies that had foreign currency de-
nominated loans, more than half (53 percent) hedged against exchange rate
fluctuations. The percentage of foreign currency denominated loans hedged
against exchange rate risks was 21.36 percent on average for these compa-
nies. Among those that never hedged against exchange rate risks, many
firms (or 42 percent) never considered hedging; some (36 percent) thought
that a hedging facility was not available or not working properly; and oth-
ers (29 percent) expected the local currency to appreciate in value. Few
companies felt that hedging was too costly or was unnecessary as the ex-
change rate was considered fixed.
These survey results indicate that many companies were not very
attentive to exchange rate risks (and possibly to financial risks in general).
Korea now provides a better environment for financial risk management. A
futures exchange launched in 1999 trades foreign exchange options, and
futures and other financial derivatives.
2.4.3 Financial Structure, Diversification, and Corporate

Performance
Corporate Performance and Financial Structure
Many chaebols were vulnerable to unfavorable cyclical shocks such as the

business downturn at the end of 1995 and the terms of trade shock in 1996.
Nonetheless, even with a heavy debt burden, they survived for two to three
years before collapsing at the time of the 1997 financial crisis (2.2.3, Table
2.13). The extremely high leverage and the ability of chaebols to survive
for several years with huge debts are evidence of poor internal governance
of both the corporate and financial institutions, as well as lax financial su-
pervision (Nam et al., 1999).
In order to determine the relationship between financing pat-
terns and corporate performance, Nam et al. (1999) compared the finan-
cial positions of 504 chaebol affiliates and non-chaebol independent
firms during the period 1986-1998. Among the main findings were the
following.
(i) In terms of total borrowings to total assets, the top five
chaebols and the top 6-70 chaebols had similar ratios, but
the ratios of independent firms were much lower.
(ii) In terms of net income to total assets, the ratios of inde-
pendent firms were higher than those of the top five and
top 6-70 chaebols during the entire period, except in 1993-
1995 when semiconductor prices were extraordinarily high.
The ratios of the top 6-70 chaebols were lower than those
of the top five chaebols, except in 1991.
(iii) Interest payment coverage ratios are calculated as operat-
ing earnings over interest expenses. Operating earnings are
earnings before interest payments and taxes plus deprecia-
tion and amortization (EBITDA). Those firms whose in-
terest payment coverage ratios are below 1 are likely to go
bankrupt. Interest coverage ratios of non-chaebols were
higher than those of the top 6-70 chaebols during the en-
tire period. They were also higher than those of the top five
chaebols until 1992. However, the trend was reversed in
1993 when the interest coverage ratios of the top five
chaebols exceeded those of the independent firms. The ra-
tios of the top five chaebols were similar to those of the top
6-70 chaebols until 1991 when the top five chaebols’ ra-
tios shot up.
(iv) In terms of EBITDA to total assets, the ratios of non-
chaebols were remarkably higher than those of the top 6-
70 chaebols during the entire period. They were also higher
than those of the top five chaebols until 1991. But since
1992, the top five chaebols’ ratios were much higher.
These findings indicate that independent firms have had a lower
leverage and performed better financially.
Corporate Performance and Diversification
As a chaebol further diversified into nonrelated areas, its profit rate de-
clined. During 1985-1997, the degree of diversification was highest in the
top five chaebols, second highest in the top 6-30, and lowest in the top 31-
72 chaebols. The differences in the degrees of diversification among the
three groups are substantial. The diversification of the top five chaebols
remained at about the same level within the period; the top 6-30 and 31-72
chaebols gradually increased their diversification beginning 1990.
The degree of diversification of chaebols that fell into default, court
receivership, and composition was lower than that of the top 6-30 but higher
than that of the top 31-72 chaebols on average. The diversification of chaebols
under workout was much lower than that of the top 6-30. Chaebols have
been subsidizing new or low-profit industries by transferring resources from
high-profit industries through inside dealings, debt guarantees for free, or
outright transfer of resources due to poor corporate governance practices.
In terms of the net profit margin (the ratio of net profits to sales
revenue), the top five chaebols outperformed the top 6-30 chaebols for most
of 1985-1997. But the net profit margins of the top 31-72 chaebols were
higher than those of the top five in 1985-1992, then declined to levels lower
than those of the top five in the years of economic downturn 1993-1997.
Meanwhile, net profit margins of the top 31-72 chaebols were always higher
than those of the top 6-30, except in the recession years of 1996-1997. This
indicates that excessive diversification and inefficient investment of the top
30 chaebols resulted in relatively low net profit margins (Table 2.31). Their
subsidiaries, however, had easier access to credit than the top 31-72 chaebols.
The more diversified top five chaebols performed better than the less diver-
sified top 6-30 because they were better established in most business areas
and have superior personnel and technology, larger research and develop-
ment expenditure, and easier access to cheap credit.
This section looks at the various causes of the crisis in 1997. Factors related
to weak corporate governance were closely intertwined with shortcomings
in macroeconomic policy and vulnerabilities in the financial sector. Gov-
ernment intervention, too, had a significant role. Indicators such as increas-
ing debt-to-equity ratios, rising nonperforming loans (NPLs) and falling
Table 2.31
Net Profit Margins of Chaebols, 1985-1997
Item 1985 1987 1989 1990 1992 1994 1995 1996 1997
Top 5 1.1 1.4 1.6 0.9 1.1 2.3 3.4 0.8 0.1
Hyundai 0.3 1.3 1.7 0.7 1.3 1.2 2.6 0.3 (0.0)
Samsung 1.0 1.6 3.2 1.6 1.1 4.8 7.0 0.2 0.4
LG 1.3 1.8 1.2 0.6 1.2 3.3 4.5 1.0 (0.8)
Daewoo 0.5 (0.1) (0.1) 0.6 1.1 0.9 1.1 1.1 0.3
SK 2.1 2.6 2.2 1.1 0.8 1.2 1.9 1.3 0.7
Top 6-30 0.3 1.2 1.3 0.7 (0.2) (0.1) (0.3) (0.7) (4.2)
Top 31-72 1.0 1.6 1.8 1.0 1.1 1.2 0.4 (0.8) (4.6)
Default, Court
Receivership, and
Reconciliation 0.1 0.2 0.7 0.4 (0.6) (0.8) (1.0) (3.2) (13.7)
Kia (1.2) 1.3 1.5 1.9 0.4 (0.4) (0.5) (0.9) (8.1)
Jinro 1.5 (0.4) (0.3) (1.4) (4.8) (3.4) (5.5) (2.6) (12.8)
Hanbo (1.4) (6.7) (1.8) (0.2) (0.2) 1.4 (0.8) (1.5) (2.8)
Sammi 0.4 1.9 0.8 0.0 (7.5) (7.8) (4.9) (9.8) (37.3)
Newcore 0.6 1.3 1.7 2.5 1.1 0.8 0.7 0.7 —
Haitai (0.1) 0.9 1.3 0.8 1.8 0.1 (0.1) 1.1 (4.5)
Chungku 1.5 1.1 1.0 1.1 4.7 2.6 0.3 (0.2) (13.3)
Kukdong 0.5 (4.0) (0.3) 0.7 0.6 0.8 0.1 (1.8) (20.8)
Daenong 0.9 8.4 1.1 0.7 (1.0) 0.3 0.2 (17.6) (20.6)
Halla (1.9) (1.6) 1.7 (0.8) (1.1) (2.0) 0.1 0.3 (3.1)
Workout Target 0.9 0.3 (0.5) (0.3) 0.3 0.1 0.2 (0.2) (4.2)
Kuhpyong 3.5 4.6 (1.4) (3.3) 12.6 (0.9) 2.5 (0.2) (3.2)
Kangwon-sanup 0.6 0.7 (1.1) 0.7 0.4 0.9 0.5 (0.2) (0.7)
Pyuksan 0.6 (10.9) (1.9) 1.3 1.4 0.5 0.7 0.7 (0.4)
Sinho 2.2 (0.1) 2.1 0.5 1.1 (4.1) (2.3) (0.3) (12.2)
Tongil (1.7) (1.8) (9.3) (6.6) (12.3) (0.6) (4.0) (4.8) (11.2)
Kohap 0.2 1.6 0.6 (0.0) (0.3) 0.8 2.0 0.8 (0.3)
Sinwon 3.0 6.4 5.6 3.4 (2.9) 2.2 1.3 1.0 (2.8)
Anam 1.1 1.4 0.5 0.4 1.1 0.8 0.4 0.5 (6.3)
Donga (1.6) 0.6 1.0 0.9 1.3 1.4 0.7 0.6 (0.1)
Source: Whan Whang, 1998, Background and Task of Structural Adjustment, Beyond the Limit, Manage-
ment Research Institute, Chung Ang University, p.11.
corporate profitability were signs that the Korean economy had reached the
edge of a slippery slope. A remote trigger in the Thai crisis was all that took
to push the economy over the edge.
2.5.1 Weaknesses in Corporate Governance
Concentration of Ownership and Entrenched Management
Concentration of ownership has been the root cause of many problems re-
lated to corporate governance. Along with government policies to protect
the status quo, this has led to entrenched management. The most serious
problem among most Korean listed firms has been that a controlling share-
holder acting as CEO could never be replaced. The hold was tightened by
the practice wherein candidates for directors were handpicked from among
the managers by the controlling shareholder. They were then almost auto-
matically elected at the general shareholders meeting.
Internal and External Control
Concentration of ownership has been and will be the major obstacle to the
independence of the board of directors from management, and to the devel-
opment of the market for corporate control. Until 1997, the boards of all listed
companies were composed of insiders only. But in 1998, after the crisis, the
Korea Stock Exchange introduced listing rules requiring that listed firms elect
“independent outside directors” to comprise not less than a quarter of the board
members. Moreover, the recently adopted Code of Best Practice in Corporate
Governance recommends the strengthening of the board system.
Ownership concentration also had ramifications on corporate trans-
parency. Until 1997, a firm’s board of directors had the power to appoint
an external auditor. Thus, the independence and objectivity of the exter-
nal auditor were often questioned. Now, a committee composed of inter-
nal auditors, outside directors, and creditors should select (recommend)
the external auditor. Meanwhile, the controlling shareholder or CEO gen-
erally selects the internal auditor despite a legal provision limiting the
votes of the largest shareholder to a maximum of 3 percent. Thus, internal
auditors cannot be expected to perform their function independently of
management. The Code of Best Practice recommends board audit com-
mittees for large listed firms and the Commercial Code is being amended
to introduce the audit committee system as an alternative to the internal
auditor system.
There had been some devices to protect management so that com-

panies could indulge in business activities without fear of takeover. These
included restrictions of shareholdings of institutional investors, restrictions
of voting rights of shares of institutional investors, a large issuance of pre-
ferred stocks with no voting rights, regulatory and practical difficulty in
implementing proxy voting, and restrictions on hostile takeovers.
Traditionally, the Government maintained a policy of protecting
the incumbent management of a listed company. The purpose was to in-
crease the size of the stock market by having financially sound private firms
go public with an assurance that they would not be taken over. Representa-
tive of the policy was the stipulation under the Securities and Exchange Act
that no one other than founders could accumulate more than 10 percent of
the voting shares of a listed company unless he or she obtained prior ap-
proval of the Securities and Exchange Commission.
Meanwhile, corporate accounting information was not reliable due
to the lack of independence of external auditors, prevalent window dressing
practices, and some differences in Korea’s generally accepted accounting
principles from international standards. In this situation, individuals, as
well as institutions, participated in the stock market as short-term traders
rather than long-term investors. Banks did not function as monitors of cor-
porate management although they were shareholders as well as the most
influential creditors.
Many changes were introduced to promote M&A in the 1990s.
However, hostile takeovers in Korea will likely be rare in the future. One
reason is that the percentage of inside shareholdings for an average listed
firm is very high. Many of the takeover targets in the past did not have a
controlling shareholder. Another reason is that firms affiliated with a chaebol
are generally regarded as difficult targets as the other members of the group
will come to the rescue or act as a white knight.
Dominance of Chaebols
A chaebol is tightly controlled by the largest shareholder, usually a mem-

ber of the founding family. There were no effective monitoring mecha-
nisms for its management.
Under the direction of the controlling shareholder, profitable firms
within a chaebol tended to subsidize unprofitable firms. These internal deal-
ings made strong firms weak and helped marginal firms survive. Diversifi-
cation can reduce chaebols’ risks through the portfolio effect; however, when
a large diversified chaebol, as a whole, has an unsound capital structure and
strong financial links among its member firms through investments and
cross-guarantees, the financial distress of one or a few marginal firms can
lead to a chain of bankruptcies across the entire chaebol. Such problems
may eventually cause ripples through the entire economy. This effectively
becomes an exit barrier for chaebols and would justify the intervention and
support of the Government.
As mentioned earlier, the typical chaebol firm had an extremely high
DER, while (non-chaebol) independent firms had much lower borrowing ra-
tios. Profitability of the top 6-70 chaebol firms has been lower than that of the
top five chaebol firms, as the latter are well established in most business
areas. Net profit margins of the top 31-72 chaebols were higher than those of
the top five or of the top 6-30. This indicates that too much diversification and
overinvestment in the top 30 chaebols resulted in relatively low net profit
margins, although their subsidiaries had better quality workforce and easier
access to cheap credit than the top 31-72 chaebol affiliates.
2.5.2 The Role of Government Intervention
Strong government intervention in the early stages of economic develop-

ment was useful for overcoming inefficiencies in financial and capital mar-
kets and for managing high investment risks. However, the intervention
later resulted in the accumulation of adverse side effects: underdeveloped
product, capital, and other individual markets; prevalence of rent-seeking
and morally hazardous behavior by economic decision makers; and a high
degree of inefficiency in the economy.
The Government’s supervision and regulation of financial institu-
tions were poor. The Government and the Bank of Korea did not have accu-
rate information on the extent of transactions that corporations and finan-
cial institutions had abroad. Further, the authorities did not properly check
on banks’ lending practices—banks did not screen the lending projects and
evaluate the creditworthiness of corporations properly.
2.5.3 Manifestations of Weak Corporate Governance and

Government Intervention
Preference of Debt Over Equity Financing in the Precrisis Period
Before the crisis, financing choices of listed firms in order of preference were
bank loans, bond issues, share issues, and internal funds. Financing prefer-
ences changed drastically after the crisis. The new preference ordering is as
follows: internal funds, share issues, bank loans, and bond issues. This change
implies that firms are now more attentive to financial risk and inefficient
investment financed by external funds is less likely to recur in the future.
The foremost reason why listed companies preferred debt financ-
ing over issues of new shares lies in the largest shareholders’ desire to keep
control of the management by preventing dilution of their ownership. Other
factors also contributed to this preference. Bank loans, which were the most
important financing source until 1987, consisted of high proportions of
policy loans. Nonpolicy loans were also considered to be cheap because of
interest rate regulations. The poor state of corporate governance in the bank-
ing and financial sectors was responsible for overlending by banks and
NBFIs through perfunctory screening of loan applications. Implicit guar-
antees by the Government on bank loans to large businesses, as evidenced
by occasional, large-scale bailouts of financially distressed firms, obviously
contributed to overlending and aggravated the situation. The lending prac-
tices of banks, which generally required guarantees or collateral, were ad-
vantageous to chaebols because they were in an “ideal” position to meet the
loan requirement through cross-guarantees among their member firms. As
of the end of 1997, the top 30 chaebols showed a DER of 519 percent,
which is far higher than the average ratio of around 400 percent for
nonfinancial listed firms.
The financing choice of listed firms was also influenced by the under-
development of the stock market. Although the ratio of stock market capitaliza-
tion to GDP in Korea was not very different from those in the Philippines and
Thailand, the size of the stock market was not adequate to digest all the poten-
tial supply of new shares to finance the rapid growth of corporations.
The preference for debt finance also led to a relatively large foreign
debt. At the end of 1996, total foreign debt amounted to $157.5 billion,
63 percent of which was short-term. The ratio of external debts to GDP
reached 48 percent at the end of 1998. The high proportion of foreign debt
led to a mismatch problem where borrowers were unhedged against foreign
exchange risk.
After the financial crisis erupted in Indonesia and Thailand, over-
seas borrowing became difficult and higher interest rates were charged on
foreign borrowing. In the international financial market, won/dollar
nondeliverable forward rates increased rapidly, signaling a bearish specula-
tive move on the won. However, the Government and the Bank of Korea
defended the currency, reducing foreign exchange reserves to a dangerous
level. In November 1997, the exchange rate (won/dollar) increased sharply
and the financial crisis erupted in Korea.
Inefficient Corporate Investment and Low Profitability
Ownership concentration among Korean firms, regardless of whether it is

caused by large personal holdings of the controlling shareholder or by
pyramiding, has given rise to various types of self-dealings by the control-
ling shareholder, and the pursuit of growth through excessive diversifica-
tion and inefficient investment. Moreover, legal and other barriers prevented
the exit of financially nonviable firms.
Overlending and inefficient investment were also a result of moral
hazard due to implicit government guarantees and “too big to fail” legacies
to large businesses. The banks and merchant banks lent to large businesses,
especially chaebols, without strictly evaluating the creditworthiness of busi-
nesses and the profitability of projects. They utilized mutual payment guar-
antees among their affiliates and believed that they would never fail.
The inevitable result of inefficient investment was a fall in corpo-
rate profits. The number of insolvent companies increased rapidly in 1991
and doubled to more than 11,000 per year starting 1992. It jumped to 17,200
in 1997, then 20,000 during January-September of 1998. The monthly
number reached more than 3,000 from December 1997 to February 1998,
decelerated from March 1998, and returned to about 1,000 in September
1998 (Table 2.32). Meanwhile, the ratios of net profits to sales, total assets,
and shareholders’ equity of all industries, excluding the financial sector,
were low in 1996 and 1997. In 1997 they became negative. Before the
crisis, a large number of construction companies failed due to the recession
in the real estate market and decline in real estate prices. Further, nine out
of the 30 top chaebols failed. The Government could hardly help them
because of the number and magnitude of business failures.
Financial Sector Vulnerability
Because of financial losses in the corporate sector, the NPL ratio8 of banks
and other financial institutions began to increase. The bank supervisory
8
NPLs of banks comprise fixed (substandard) and doubtful loans, and estimated losses.
Fixed loans are those for which interest is not received for six months or longer, and
there is collateral. Doubtful loans are those for which interest is not received for six months
or longer, and there is no collateral. These were the definitions until 30 June 1998. How-
ever, starting 1 July 1998, they are defined as loans for which interest payments are
overdue by three months or more. According to the “six months” definition, the NPL
ratio of commercial banks increased rapidly from 4.1 percent in 1996, reaching highs of
6 percent in 1997 and 8.6 percent in June 1998. Following the “three months” defini-
tion, the NPL ratio reached 7.7 percent in 1997.
Table 2.32
Number of Firms with Dishonored Checks, 1986-1998
Year Total Manufacturing Construction Services Others

1986 4,890 1,114 380 3,244 152
1987 4,754 811 354 3,457 132
1988 3,573 706 242 2,517 108
1989 3,238 696 195 2,250 97
1990 4,107 866 294 2,859 88
1991 6,159 1,657 585 3,759 161
1992 10,769 3,259 1,131 6,053 326
1993 9,502 2,850 1,135 5,265 252
1994 11,255 3,133 1,210 6,647 274
1995 13,992 3,553 1,751 8,386 302
1996 11,589 3,855 1,544 5,637 553
1997 171,69 6,856 2,472 6,979 861
1998 20,027 7,673 2,985 8,417 952
Note: 1998 figures cover only January-September.
authorities were not too concerned about the high NPL ratios at Korean
banks in 1997 simply because the high and rising ratios had precedents.
Policymakers thought that economic growth would resolve the NPL prob-
lem without the need for corrective action. In 1990-1993, the ratio reached
7-8 percent, and declined to 4-6 percent in 1994-1996 (Table 2.33). The
difference between the Korean and Western definitions of NPLs left foreign
investors with suspicions that the size of NPLs in Korea might be much
larger than the government-announced magnitude. This speculation was
said to be one of the causes of the financial crisis in Korea.
Meanwhile, ROEs and ROAs of Korean and Japanese banks were
low compared with those of the US, European countries, and Taipei,China.
Compared to ROAs and ROEs of domestic branches of foreign banks, those
of domestic banks were lower in the 1990s. This was mainly due to the high
ratios of NPLs, low efficiency, and large government-directed loans.
2.5.4 Shortcomings in Macroeconomic Policy
The macroeconomic framework also contributed to the crisis in 1997. Ex-

change rates were virtually pegged to the US dollar in all troubled Asian
countries. As a result they had largely overvalued currencies, and continu-
ous and large current account deficits. The current account deficits in terms
Table 2.33
Nonperforming Loans of General Banks, 1990-1998
(W billion)
Total Fixed Doubtful Estimated Loss NPL NPL
Year Loans (A)a (B)b (C) (A+B+C) Ratio (%)
1990 90,556 5,310 952 958 7,221 8.0
1991 118,475 6,176 1,170 920 8,266 7.0
1992 143,705 7,736 1,584 840 10,160 7.1
1993 160,520 8,997 2,116 816 11,929 7.4
1994 194,739 9,537 1,639 213 11,390 5.8
1995 241,827 10,190 1,910 385 12,484 5.2
1996 289,649 9,430 1,954 490 11,874 4.1
1997 375,832 12,562 9,600 490 22,652 6.0
1998 337,584 18,192 10,237 648 29,077 8.6
a
Fixed loans are those requiring collateral and for which interest is not received for six months or
longer.
b
Doubtful loans are collateral-free loans for which interest is not received for six months or longer.
of percentage of GDP were as follows: Malaysia -8.6 percent (1995); Thai-

land -8.1 percent (1995); Korea -4.8 percent (1996); and Indonesia
-3.6 percent (1995). It was estimated that the Korean won was overvalued
by 20 to 30 percent from 1989 to 1997, and 30 percent in 1996, judging
from the real effective exchange rate indexes using unit labor cost indexes
as a deflator and 1985 as a base year. In addition to the overvaluation of the
won, the terms of trade deteriorated 12 percent in 1996 and 11 percent in
1997, which led to large corporate losses.
The pegged currency also encouraged foreign borrowing as inves-
tors believed that the exchange rate would remain stable. Related to this,
the ratio of short-term debt to foreign reserves was very high.
Meanwhile large businesses could not legally lay off workers, even
in times of economic slowdown, because of the rigid labor market. Busi-
nesses served as a social safety net. Mass layoffs became legally possible
only after the economic crisis.
The main result of the rigid labor market was a “high-cost and low-
efficiency” economy. In 1997, the hourly wage rate in the Korean manufac-
turing sector was higher than in Singapore or Taipei,China, although per
capita income in Korea was much lower. Real interest rates in Korea had
been two to three times higher than those of Japan or Taipei,China. Land
prices and real estate rents were also high compared to trading partners.
2.6 Responses to the Crisis and Policy Recommendations
2.6.1 Corporate Restructuring Activities
Restructuring activities in the corporate and financial sectors of the Korean

economy were aimed at enhancing their long-term viability and competi-
tiveness. However, the immediate objective centered on restoring the inter-
national investment community’s confidence in the Korean economy. To
achieve this, the excessive amount of debt of Korean corporations had to be
reduced to a sustainable level. Ailing banks needed to be recapitalized after
the huge amount of NPLs was disposed. Nonviable firms and financial
institutions, including banks, had been forced into bankruptcy proceedings
or merged into healthier entities. Other firms experiencing financial dis-
tress were subjected to workout procedures through negotiations between
debtors and creditor institutions.
The FSC—later called the Financial Supervisory Service (FSS)—
which is in charge of prudential regulation of financial institutions, has
been actively utilizing its influence to motivate institutions to coordinate
debtor firms’ restructuring activities. Corporations, which were laden with
huge amounts of debt and were on the verge of bankruptcy, embarked on
their own restructuring programs and/or implemented restructuring demands
of the creditor banks.
‘Voluntary’ Restructuring
Chaebols have been under pressure from the Government to abolish their
informal group headquarters to increase the managerial independence of
member firms. They have been pressured to stop such practices as provid-
ing loan guarantees, and subsidizing money-losing units. They have also
been urged to divest themselves of strategically ill-fitting businesses and
sell equity holdings of attractive business units to foreign firms to reduce
debts. A guideline informally promulgated by FSC required the 30 largest
chaebols to lower their DER of 412.6 percent as of the end of June 1998 to
no more than 200 percent by the end of 1999.
Measures have been taken by several chaebols to streamline opera-
tions and improve incentives of managers and employees. Downsizing by
curtailing employment has been prevalent, although efforts to lay off thou-
sands of blue-collar employees at Hyundai Motors encountered fierce op-
position from labor and ended up in mediation after intervention by politi-
cians from the ruling coalition.
Divestitures to raise cash for debt reduction and to focus on core

businesses have not proved to be easy. The reasons are manifold. Locally,
sellers could not find buyers as almost all domestic firms struggled to raise
cash for debt reduction and for working capital needs while there was a
severe credit crunch following the outbreak of the crisis. Internationally,
potential foreign buyers waited for the price of acquisition targets to come
down further. It was frequently observed that the negotiating parties could
not agree on a price due to large discrepancies in valuation. In many cases,
banks and other creditors were reluctant to absorb losses realized by debt
compositions, or to agree on debt-equity swaps demanded by potential pur-
chasers as a precondition for the deal. The process of voluntary debt
recontracting by creditors was prolonged because Korean lending organiza-
tions lacked experience and expertise when it involved a multitude of credi-
tors. More important, they were reluctant to allow recontracting for fear of
further deterioration in the capital adequacy ratio.
Korean firms have been slowly stepping up their restructuring since
the latter half of 1998 as the economy began to show signs of recovery.
Data collected by the Korean Chamber of Commerce and Industry show
that the number of potential domestic and foreign buyers in the M&A mar-
ket increased by about 50 percent over the six-month period from April to
October 1998. This number was at 779 firms in April and grew to 1,138 by
the end of October. More than 59 percent of potential buyers were foreign
firms. On the other hand, the number of potential sellers decreased some-
what from 2,281 in April to 2,045 in October. The data also show that about
24 percent of acquisition negotiations ended up in actual deals, while only
14 percent of the negotiations were completed from the beginning of the
crisis up to April 1998.
Involuntary Exits
The Government has been involved in the restructuring process mainly

through its supervisory capacity over banks. Banks did not have the incen-
tive to force financially nonviable firms to liquidate, because liquidation of
debtor firms would exacerbate the banks’ already weak balance sheets.
Noticing this disincentive, FSC directed banks to appraise the long-term
viability of client firms showing symptoms of failure. A debtor whose liq-
uidation value was estimated to be greater than its going concern value was
subject to “exit”—meaning the creditors would altogether stop lending and
not allow renewal of the existing debt. In their first review, the creditor
banks selected 55 firms as targets for exit. These included 20 firms from the
top five chaebols and 32 from the top 6-30 chaebols.
Although the intention of the Government and the banks was to
effect immediate liquidation of these selected firms, the results thus far
have not entirely been as desired. Among the 55 firms selected, 24 were
liquidated, 11 were merged into other group members, three filed for court-
supervised bankruptcy reorganization, and 12 were sold off to other firms.
Among the sell-offs, two were acquired by newly organized employee stock
ownership plans.
A second round of review to select more firms for exit was con-
ducted by the Major Creditors’ Council organized for each of the top five
chaebols. These chaebols submitted plans for restructuring to improve their
respective capital structures. Based on these plans, the creditor banks drafted
their own restructuring plans with assistance from outside advisory groups
led by foreign investment banks. Negotiations were then held between the
chaebols and the creditors’ councils to finalize the financial structure im-
provement plans. The plans were put into action immediately following
finalization. The creditor banks and the advisory groups also drafted such
plans for the top 6-64 chaebols.
Corporate Workouts
Workouts in the forms of debt rescheduling, interest reductions, write-offs,

and/or conversion of debt into equity have been applied to those firms that
are considered to be viable in the long run and have voluntarily entered into
negotiations with creditor banks. The workout plans were completed for
most firms by early 1999. FSC has been monitoring the processes from a
prudential regulation standpoint.
A portion of the Technical Assistance Loan of $33 million, pro-
vided by the World Bank, was allocated to the six largest banks for them to
employ outside experts as advisors, not only for the design of corporate
workout programs but also their implementation.
More than 200 financial institutions signed the Corporate Restruc-
turing Agreement to carry out corporate workouts with the top 6-64 chaebols.
Also, workouts are being applied to non-chaebol firms identified as finan-
cially weak, but viable, by their creditors. By the end of 1998, creditor
banks completed evaluation of the financial status of 35 subsidiaries be-
longing to 13 chaebols, and 16 non-chaebol corporations that had been
selected as possible workout candidates. Upon completion of the evaluation,
creditor banks and the corporations will devise detailed workout programs
based on the rehabilitation plans submitted by the corporations.
Big Deals
Ever since the outbreak of the economic crisis, the Government has been
urging the largest chaebols to strike “big deals” or business swaps among
themselves to consolidate overlapping manufacturing facilities. These deals
could eliminate excess capacity in such industries as semiconductors, auto-
mobiles, railroad cars, power plant facilities, vessel engines, aircraft, oil
refineries, and petrochemicals. Big deals would, it is hoped, enable chaebols
to streamline their overly diversified operations and focus on several core
business areas. Big deals have been elevated to the status of the most im-
portant means of effective corporate restructuring.
On 3 September 1998, chaebols did announce their agreements on
big deals in seven industries excluding the automobile industry. As of April
1999, most of the big deals have entered their final stages of negotiation. In
the case of automobiles, Hyundai Motor Corporation won the international
auction of Kia Motors in its third bidding and Daewoo Motors agreed to
acquire Samsung Motors.
Foreign Acquisitions
Confidence in the Korean economy depends critically on the lowering of

the level of corporate debt. In the early days after the outbreak of the crisis,
inducement of foreign direct investments was considered to be the most
effective means of achieving that end. Thus, Korea adopted and implemented
policies to open its capital market completely. Restrictions on foreign own-
ership of land were also abolished.
Foreign investment—in the form of acquisition of controlling in-
terests, purchase of divested assets, and equity participation—reached about
$8.5 billion on agreement basis during the 10-month period after Decem-
ber 1997. This figure contrasts sharply with the total of $700 million for all
of 1997. However, some of the acquisition agreements have been discarded
for various reasons. In one case, the foreign buyer demanded specific pro-
tections against adverse developments in the business environment. In an-
other, labor union demands of the seller were not acceptable to the transact-
ing parties.
The less than satisfactory state of foreign capital infusion in the
early days stems from a number of factors. First, uncertainty over the future
course of the Korean economy remains high. Second, many of the potential
buyers believed that prices asked by sellers were still too high and there
would be opportunities to buy assets on fire sales in the future. With this in
mind, some of the potential acquirers demanded terms that were unreason-
able or unacceptable from the sellers’ point of view. Third, foreign buyers
usually employed discounted cash flow methods of valuation while local
sellers often put greater emphasis on replacement costs of assets. Fourth,
local creditor banks were reluctant to absorb losses arising from debt com-
positions and debt-equity swaps that were necessary in deals involving in-
solvent sellers. Fifth, foreign buyers were concerned with the inflexibility
of the labor market. Sixth, many of the businesses that Korean firms put on
sale did not prove to be attractive to foreign firms. Seventh, the widespread
practice of cross-guarantees of loans and the lack of corporate transparency
could potentially give rise to contingent liabilities to the buyer and this has
posed a bottleneck problem to the speedy consummation of deals.
2.6.2 Policy Measures for Corporate Reform
Goals and Policy Measures for Reform in the Corporate Sector
Based on their assessments of what caused the economic crisis in Korea

and what needs to be done to overcome it, the Government and chaebols
reached an agreement on the goals of restructuring and reform efforts. As
set forth in the agreement, these goals were: (i) to enhance managerial trans-
parency; (ii) to remove cross-guarantees of loans among group members;
(iii) to reduce financial leverage; (iv) to focus on a small number of core
businesses; and (v) to improve the accountability of controlling sharehold-
ers and the board.
Overhaul of Bankruptcy Procedures
In February 1998, legal procedures pertaining to corporate rehabilitation

and bankruptcy filings were simplified to expedite rulings on the exit of
nonviable firms and to ensure better representation of creditor banks in the
resolution process for court receivership or court-supervised composition.
In effect, the improved procedures stipulated in the Bankruptcy Reorgani-
zation Act and the Composition Act reduced what had previously been le-
galistic exit barriers. Not only does this represent progress in terms of an
improved institutional framework for market competition, but it also has
important implications with respect to corporate workouts. The presence of
an expeditious exit scheme is expected to better induce negotiation for

workouts between creditor banks and corporations. Also, the changes in the
institutional setting for corporate reorganization will enable creditors and
debtors to promptly respond to the development of financial problems.
The changes in the reorganization procedures can be summarized
as follows. First, if a final reorganization plan is not worked out within
one year from the date of the court order placing a firm in receivership,
the court may annul its previous decision and force the firm into immedi-
ate liquidation. The purpose of this rule is to shorten the reorganization
planning period. In the past this stage usually extended for as long as two
to three years. Also, the maximum grace period on loans to the firm being
reorganized was shortened to 10 from 20 years. Second, the new rules
made it clear that a court receivership order is available only when the
going concern value of the firm under consideration is greater than its
liquidation value. Third, a “Management Committee,” comprised of ex-
perts in the legal, accounting, and economics professions should be or-
ganized to provide for expeditious proceedings in court. Fourth, the right
to revoke court receivership is allowed to the creditors. The creditors can
form a “Creditors Committee” among themselves to allow them to par-
ticipate in the decision processes in court. Fifth, the Composition Act was
amended to narrow the eligibility of applying for court-supervised com-
position, thereby preventing abuses by controlling shareholders/manag-
ers of financially distressed firms. The court can refuse to accept the ap-
plication for composition if it finds it inappropriate considering the size
of corporate assets, number of creditors, etc.
Improving Transparency and Corporate Governance9
Transparency and accountability in corporate governance will be promoted

by the following measures: (i) consolidated financial statements are required
beginning 1999; (ii) legal changes have been made so that domestic ac-
counting practices conform to international standards; (iii) the representa-
tion requirement for shareholder derivative suits was drastically relaxed
from 1 percent to 0.01 percent in May 1998; (iv) restrictions on institu-
tional investors’ voting rights were eliminated in June 1998; (v) all listed
companies are required to appoint outside directors beginning 1998
9
This and the following two subsections draw on the Ministry of Finance and Economy,
Korea’s Economic Progress Report, October 1998.
(as of the end of May 1998, 514 listed companies had appointed 677 out-
side directors); (vi) bankruptcy laws were revised in February 1998 to fa-
cilitate the exit of insolvent firms; (vii) by the end of March 1998, cross-
debt guarantees totaling about W10 trillion—about 30 percent of the total
guarantees among the 30 largest chaebols—were dissolved; and (viii) as of
1 April 1998, financial institutions could no longer require cross-debt guar-
antees. Existing cross-debt guarantees should be completely eliminated by
the end of March 2000. These new standards are and will continue to be
strictly enforced. A recent case in point is the penalty imposed by the Fair
Trade Commission on chaebol subsidiaries found to be involved in unfair
transactions among group members, including financial subsidization. Meas-
ures for improving standards in corporate governance are already effecting
a generally more open corporate culture and greater transparency in busi-
ness practices.
Capital Market Liberalization
Since 1998, Korea has rapidly liberalized the capital market by adopting
the following measures: (i) the ceiling on foreign equity ownership was
completely eliminated in May 1998. Foreigners are now able to invest in
local bonds and short-term money market instruments without any restric-
tions; (ii) full liberalization of foreign exchange transactions was legislated
and will be put into effect in two stages, beginning on 1 April 1999; (iii)
hostile mergers and acquisitions by foreigners were fully liberalized in May
1998; (iv) during April and May 1998, 21 industries were further liberal-
ized or newly opened to FDI (now, only 31 out of 1,148 industries remain
closed, either partially or fully, to FDI); (v) by the end of May 1999, an
additional nine industries will be opened or further liberalized; and (vi) all
current laws related to FDI have been streamlined and incorporated into a
single legal framework represented by the Foreign Investment Promotion
Act, which was passed in August 1998.
Foreign Investment Promotion Act
The Foreign Investment Promotion Act was put into effect in November
1998. According to the law, administrative procedures for FDI will be dra-
matically simplified and made transparent. As for promotion, the Korea
Trade and Investment Agency (KOTRA) will provide a one-stop service
with respect to FDI. In addition, various supporting measures, including
tax exemptions and reductions, have been instituted for FDI:
(i) Tax exemption and reduction: Corporate and income taxes

will be exempted or reduced for FDI in target industries,
such as the high-tech industry, for 10 years (full exemption
for the first seven years and 50 percent tax reduction for
the remaining three years). Various local taxes will also be
exempted or reduced for eight to 15 years at the discretion
of local governments.
(ii) Low cost rental facility: National and public real proper-
ties will be rented to foreign-invested firms for up to 50
years. The law allows rental cost exemptions and reduc-
tions for FDI.
(iii) Free Investment Zone (FIZ): A free investment zone will be
developed to accommodate large-scale FDI. The location of
the FIZ will be determined at the request of foreign inves-
tors. Various support measures, including infrastructure and
tax support, will be provided to foreign firms in the FIZ.
Liberalization of Foreign Exchange Transactions
In September 1998 the Foreign Exchange Management Act was replaced

by the Foreign Exchange Transaction Act. The primary aims of the law are
the liberalization of the capital account and the development of the foreign
exchange market.
These liberalization measures, however, are not risk-free. To mini-
mize potential risks, the Korean Government is strengthening prudent regu-
lations and market monitoring, as well as building an early warning sys-
tem. Also, the Government intends to supplement these measures with a
sound macroeconomic policy in order to secure more effective protection
against systemic risks.
Capital Market Augmentation
Bond Market
The Government recently introduced a policy plan to deepen Korea’s bond

market. It aims to establish a benchmark by consolidating various govern-
ment bonds. Three-year government bonds will be used to establish a bench-
mark.
The majority of government bonds to be issued in the next two to
three years will carry a maturity of three years. These bonds will be issued
monthly. If interest rates stabilize at a low level, and the demand for longer-
term bonds increases in the future, the Government will correspondingly
expand the issuance of government bonds that have a maturity of five years
or more.
In order to promote a greater market demand for government bonds,
a primary dealers system will be introduced for healthy financial institu-
tions. Prior to the introduction of this system, commercial banks were al-
lowed to carry out dealing operations for government bonds starting in
October 1998. The Government established specific qualification criteria
and selected the primary dealers in 1999. It also opened the credit rating
service market to foreign competition, and is promoting joint ventures be-
tween foreign and domestic agencies. In August 1998, Moody’s signed a
joint venture contract with Korea Investors Service.
Investment Companies
Korea has developed an institutional framework for closed-end investment

companies so that they function as a key instrument for long-term financ-
ing. Related legislation was put into effect in September 1998.
It is now easy for private investors, both domestic and foreign, to
establish closed-end investment companies. No qualification requirements
are being imposed on investors who are sponsoring new mutual funds, with
only minor standard exceptions. Mutual funds (or open-end investment com-
panies) will be allowed starting 2001.
As a pilot program, a debt restructuring fund and three balanced
funds (funds that invest in both equity and debt) were established in Sep-
tember 1998. Twenty-five domestic financial institutions, including the Korea
Development Bank, invested a total of W1.6 trillion in these funds:
W0.6 trillion for the debt restructuring fund, and W1 trillion divided equally
between the three balanced funds. These are expected to operate for the
next three years, but may be extended as required. To ensure transparency
and efficiency of the fund operations, they will be managed by foreign
investment management companies.
Asset-Backed Securities
A new law providing for asset-backed securities (ABS) was passed in Sep-
tember 1998. This law will not only provide an effective institutional envi-
ronment for the disposal of NPLs, but it will also help improve financial
institutions’ risk management. According to the law, financial institutions
and qualified public corporations, such as the Korea Asset Management Cor-
poration (KAMCO), can utilize ABS. More important, foreign business cor-
porations with good credit standing are now also permitted to issue ABS.
Poorly performing markets and the resulting lack of market discipline jus-
tified the government intervention in recent corporate and financial restruc-
turing activities. However, this can only be a temporary measure. As mar-
kets become more efficient, the government intervention will have to be
refocused so that it only sets the rules of the game in the marketplace. Self-
dealings, cross-subsidization, and other unfair internal transactions among
affiliated companies should be stopped primarily by improving rules on
corporate governance rather than by boosting the Government’s policing
role.
A good governance system is essential for the healthy growth of
corporations and financial institutions. Policies aiming to improve the cor-
porate governance system should take into account the high ownership con-
centration often created by pyramiding. The corporate governance structure
cannot be expected to function efficiently if this issue is not addressed.
There must be stronger rules to control agency problems. For instance, the
role of the board of directors as the internal control mechanism must loom
large in corporate governance.
Direct controls of interfirm investments and/or pyramidal owner-
ship structures will not be persuasive. It would be more desirable for the
market-oriented measures to be put into place and strictly enforced. The
Government has restored a previously abolished regulation that imposes a
ceiling on the total amount that a chaebol company can invest in other
firms. However, unless the limit is tight and binding, this regulation may
not be effective in curtailing pyramidal structures. On the other hand, when
the limit is binding, which is the case for many chaebols, then the regula-
tion will inhibit efficient investment of firms. In principle, greater efforts to
improve corporate governance are preferable to regulation of interfirm invest-
ment. However, there is another view that placing a maximum limit on interfirm
investments, as stipulated by the government measure, is inevitable, consid-
ering that there is no other effective way to limit circular investments among
chaebol affiliates (e.g., A investing in B, B investing in C, and C investing in
D, etc.) and the level of interfirm investments is very high.
One way of strengthening independence of the boards is to require
that listed companies accept nominations for directors by institutional
investors or their trade associations. Companies could also invite nomina-

tions from such organizations as the Korea Listed Companies Association
or citizens’ coalitions that have been active in monitoring corporate man-
agement through proxy solicitations. The annual shareholders meetings could
also elect reputable “monitoring companies” to recommend director candi-
dates (Latham, 1997).10 Other means to improve independence of the boards
include mandating that independent outside directors form the majority;
using audit, governance, and other committees; and requiring that all direc-
tors hold shares of their companies. The Government has already announced
that it intends to amend the Commercial Code to introduce Anglo-Ameri-
can type audit committees as an alternative to the current internal auditor
system. The Securities and Exchange Act will then require large listed com-
panies to switch to a board audit committee system from an internal auditor
system. Listing rules may recommend that all or large listed companies
adopt an audit committee. Each listed firm should be required to disclose
the extent of its compliance with the Code in its annual report. Further, the
Korea Stock Exchange could incorporate provisions of the Code of Best
Practice in Corporate Governance in its listing rules.
More effective measures to protect investors will enhance corpo-
rate transparency and also the accountability of directors to shareholders,
thereby helping to strengthen board independence and enlisting boards’ more
active involvement in monitoring corporate management. Since the eco-
nomic crisis, various measures have been implemented to promote inves-
tors’ rights. One action that has yet to be taken is the introduction of an act
to facilitate class action suits against corporate directors and internal and
external auditors for their wrongdoings. If and when the law is introduced,
it will have to include making self-dealings by directors and officers, and
also negligence of external (independent) auditors actionable. Class action
suits are an efficient means for corporate monitoring.
Institutional investors will play an increasingly important role in
corporate governance. There has recently been a general shift in individual
investor preference from direct personal stock trading to investing in tradi-
tional investment trust companies and the newly introduced (closed-end)
investment funds. The Government can prompt institutional investors to
contribute more to good corporate governance by paying greater attention
to corporate affairs. One way of motivating institutions to do this is to
10
M. Latham, 1997. Proposed: A Governance Monitor, The Corporate Board, September/
October 1997, pp. 23-26.
provide comprehensive guidelines for their actions in matters related to

corporate governance. The institutions’ respective trade associations, such
as the Korea Investment Trust Association, could prepare such guidelines.
These guidelines would recommend shareholder activism and faithful dis-
charge of fiduciary duties by actively participating in shareholder voting,
reviewing independence and expertise of candidates for outside directors,
objecting to certain defensive measures proposed by the management,
strengthening incentive compensation schemes for executives, etc.
Shareholdings concentrated in investment companies and other in-
stitutional investors pose a serious dilemma. Many of the larger investment
trust companies, insurance companies, securities companies, and other
NBFIs are subsidiaries of chaebols— especially the five largest ones. Also,
important pension funds including public employee funds and teacher funds
seem to have their own governance problems because their top manage-
ment and portfolio management policies are controlled by the Government,
and thus cannot be expected to be actively involved in monitoring portfolio
firms.
In the coming years, the Government will have to come up with
appropriate policy measures to solve these problems. Measures that are
being implemented or introduced will require that the management of insti-
tutional investors be closely monitored by a board consisting of a majority
of independent outside directors, an audit committee, and compliance of-
ficers. Rights of minority shareholders should also be strengthened for these
institutions. Another measure, more drastic in nature, is to restrict owner-
ship of investment trust companies and NBFIs by the five largest chaebols
and, possibly, by all nonfinancial companies (or “industrial capital”). An
efficient means to control problems arising from ownership of financial
institutions by industrial capital is to strengthen the accountability and fi-
duciary duty of the very management of these institutions. The Govern-
ment can also lower the limits on investments in affiliated companies,
strengthen its supervisory activities, and impose stronger penalties on vio-
lations of the rules on portfolio investments.
Application of more stringent bankruptcy-related rules to firms in
financial distress will effect greater discipline over corporate management.
The Government recently proposed the revision of bankruptcy-related laws.
One issue that is being debated is the necessity of the court ordering a firm
into bankruptcy once it is found to be nonviable during deliberation on
composition or receivership. Another concerns whether the court-appointed
receiver should be given the power to convene board and shareholder meet-
ings and also to replace directors and officers with court approval.
There still exist widespread concerns that the Government will con-
tinue to exercise a great deal of discretionary power over banks. In turn, the
banks have great leverage over the management of debtor firms. This means
that the Government can control the banks and, through them, private firms.
In order to minimize government intervention in bank and corporate man-
agement, bank managers should be made accountable to shareholders but
not to the Government. For this, the limit on ownership of bank shares will
have to be eased so that strategic investors (shareholders) can act as true
effective monitors of bank management. The Government needs to sell off
at the earliest feasible dates the bank shares that it acquired in the course of
recapitalizing banks. Banks should adopt strong incentive compensation
schemes for management. Bank boards also need to be made more inde-
pendent from management. Banks need to play a bigger role than they do at
present in monitoring corporate investment and management. The Govern-
ment should substantially reduce the proportion of policy loans from bank
loans.
Many concepts regarding good corporate governance are still new
to a lot of market players in Korea, and thus full-scale education programs
should be developed. The public and corporations should be taught or fully
informed of the best practices in corporate governance.
Chaebols are overly indebted, excessively diversified into nonrelated
business areas, and consistently show low profit rates. An effective policy
package is needed for chaebols to dispose of marginal firms with low prof-
itability at the earliest date, to concentrate instead on a small number of
core businesses, and stop unfair internal transactions. Such measures in-
clude providing an effective corporate governance system; reduction of pro-
tection of domestic markets and entry barriers; the elimination of implicit
guarantees for financial support to chaebols, large firms, and financial in-
stitutions; lessening the degree of double taxation of dividends (or further
reducing personal income taxes on dividends), and introducing disincen-
tive schemes for excessive borrowings, such as application of higher inter-
est rates by banks to chaebols with higher DERs.
Many corporations are burdened with excessive debt and, therefore
are vulnerable to economic shocks. The Government should put more ef-
forts into developing the capital market, which could provide alternative
sources of long-term corporate finance. To facilitate the development of the
Korean stock market, the important issues to be addressed are: (i) improve-
ment of the corporate disclosure system; (ii) provision of reliable account-
ing information; and (iii) a good corporate governance system to protect
investors. The current obligatory system of disclosure that emphasizes “hard”
information on past performance needs to be transformed into a system in

which corporations voluntarily announce “soft” information on future pros-
pects. Currently, penalties on violations of disclosure rules are not effective
enough to have a significant impact. More effective punitive means need to
be devised to penalize both corporations in violation of disclosure rules and
the officers in charge.
One of the significant changes in the bond market after the eco-
nomic crisis is that most corporate bonds are now issued nonguaranteed
and on the basis of credit quality of the issuer. Policies are needed to help
develop more reliable services by bond rating agencies. Another problem
with the corporate bond market is that most bonds are issued with maturities
of less than four years. These should be lengthened to make them a source
of stable long-term funds. The development of the OTC bond market re-
quires a well-developed dealer system. The function of securities compa-
nies as dealers of bonds should be improved. At the same time, the infor-
mation system of the bond market should be better organized to transmit,
on a real time basis, data on quotations and trading volumes. The network
should cover not only the exchange market but also OTC transactions of
investors and dealers.
Overvaluation of exchange rates should be avoided in order for
export and import-substitution industries to stay internationally competi-
tive. Maintaining current account surpluses for a considerable period is
needed to pay back foreign debts. In determining optimal exchange rates,
profitability of export industries and real effective exchange rates that ac-
count for changes in nominal exchange rates, wage rates, and labor produc-
tivity should be considered.
Prevalent corruption, especially among business people, politicians,
and bureaucrats, is considered to be one of the major causes of the eco-
nomic crisis. Without successfully addressing this problem, no economic
reforms will be effective. The establishment of a Corruption Prevention
Institute will be helpful in this regard. Future research could include causes
of corruption, reasons for different degrees of corruption in various coun-
tries, and measures to reduce corruption.
References
Bank of Korea. Economic Statistics Yearbook, various issues.
Bank of Korea. Financial Statement Analysis Yearbook, various issues.
Bank of Korea. 1993. Korea’s Financial System.
Bank of Korea. 1994. Understanding Flow of Fund Accounts.
Cho, D. S. 1997. Korea’s Chaebol. Maeil Daily Economic Newspapers, Septem-

ber 1997.
Choi, S. N. 1998. Korea’s Large Conglomerates, 1995, 1996, 1997, and 1998
issues. Center for Free Enterprise, September 1998.
Chon, I. W. 1996. Determinants of Diversification of Korean Business Groups.

Korea Economic Research Institute, KERI.
Chon, I. W. 1996. Market Concentration and Diversification of Business Groups.

Korea Economic Research Institute, KERI.
Chung, K. H., and H. C. Lee (eds.). 1989. Korean Managerial Dynamics, pp. 79-
95. New York: Praeger.
Hattori, Tomio. 1989. Japanese Zaibatsu and Korean Chaebols, in Korean Mana-
gerial Dynamics, edited by K. H. Chung and H. C. Lee, pp. 79-95. New York:
Praeger.
International Monetary Fund, International Financial Statistics, various issues.
Jua, S. H. 1999. Evolutionary Chaebol. Bibong Publishing Co.
Kang, H. S., S. K. Kwon, W. H. Lee, and J. Y. Cho. 1998. Corporate Restructur-

ing. Hong Moon Sa, September 1998.
Kim, Ju Hyun. 1992. A Study on the Relationship between Ownership Structure

of a Firm and Value of a Firm. Financial Studies.
Kim, W. T., C. D. Hong, and K. S. Kim. 1995. An Empirical Evidence on Value of

a Firm and Ownership Structure. Financial Studies.
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tember/October 1997, pp. 23-26.
Lee, Jae Woo. 1997. Is the Fair Trade Policy Fair? Korea Economic Research
Institute, KERI.
Lee, K. U., and J. H. Lee. 1996. Business Groups in Korea: Characteristics and
Government Policy. KIET Occasional Paper No. 23, Korea Institute for Industrial
Economics and Trade, November 1996.
Lee, Y. S. 1996. A New Trade and Industrial Policy in the Globalization of Korea.
Korea Institute for International Economics and Trade.
Lim, Ungki. 1998. The Ownership Structure and Family Control in Korean Con-
glomerates: With Cases of the 30 Largest Chaebols. Annual Conference of Finan-
cial Management Association, Chicago, October 1998.
Lim, Ungki. 1999. The Pattern of Ownership Structure and their Characteristics
in Korean Conglomerates: With Cases of the 30 Largest Chaebols, 2nd Sangnam
Forum, Yonsei University, Seoul, March 1999.
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October 1998.
Nam, I. C., J. K. Kim, Y. J. Kang, S. W. Joh, and J. I. Kim. 1999. Corporate

Governance in Korea. Conference on Corporate Governance in Asia: A Compara-
tive Perspective. Korea Development Institute and World Bank.
Sohn, C. H., J. S. Yang, and H. S. Yim. 1998. Korea’s Trade and Industrial Poli-
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Economic Policy, September 1998.
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ures. Korea Finance Institute, January 1995.
Whang, Whan. 1998. Background and Task of Structural Adjustment, Beyond the
Limit. Management Research Institute, Chung Ang University.
3
The Philippines
Cesar G. Saldaña1
3.1 Introduction
In recent years, the Philippine corporate sector has played a leading role in
the government’s efforts to get the country on track toward sustainable eco-
nomic development. This has come about following a political and eco-
nomic upheaval from 1983 to 1987, about a decade before the recent Asian
crisis. Issues such as State ownership of businesses, state-sanctioned mo-
nopolies, and government subsidies were tackled during that period, aim-
ing at eventually limiting the Government’s role to economic policy setting
and allowing the private sector to conduct most economic activity. The
Government pursued the privatization of various state-owned corporations
as part of its financial rehabilitation programs sponsored by the World Bank
and the International Monetary Fund (IMF).
The lifting of the debt moratorium in 1991, after the completion of
debt negotiations with the IMF and Paris Club, allowed the Government
and the corporate sector to gradually access foreign debt markets after a
long absence. Companies of other Asian countries were already using these
markets to finance investment and growth. When the Asian crisis erupted in
1997, the Philippine economy and corporate sector were in a relatively
sound financial position. From 1993 to 1996, healthy profits from the pre-
vious five years and new equity raised through successful initial public
offerings (IPOs) in a robust stock market allowed the corporate sector to
accelerate investments and borrowings. The Asian financial crisis revealed
that, overall, the Philippine nonfinancial corporate sector had managed its
borrowing risks relatively well by largely avoiding imprudent use of debts
and risky investments.
1
Principal, PSR Consulting, Inc., the Philippines. The author wishes to thank Juzhong
Zhuang, David Edwards, both of ADB, and David Webb of the London School of Eco-
nomics for their guidance and supervision in conducting the study, the PSR Consult-
ing, Inc. staff, in particular Francisco C. Roble, Denise B. Pineda, and Liza V. Serrana,
for their research assistance, the Philippine Stock Exchange for its help and support in
conducting company surveys, and Lea Sumulong and Graham Dwyer for their editorial
assistance.
Still, the corporate sector showed structural weaknesses similar to

those in neighboring Asian countries. The highly concentrated and
family-based ownership of corporate groups has resulted in governance struc-
tures that depend largely on internal control systems. Investments of large
corporate groups tend to focus on obtaining market shares and industry
dominance. Corporate financing relies excessively on bank loans. Compa-
nies finance long-term investments with short-term debt, usually with the
acquiescence of bank creditors. Banks have significant presence as mem-
bers of affiliated business groups, which leads to their easing of due dili-
gence and monitoring standards when lending to group members.
This study reviews the Philippine corporate sector in terms of its
historical development, regulatory framework, patterns of ownership, con-
trol by internal and external governance agents, patterns of financing, and
responses to the financial crisis. It analyzes the impact of corporate govern-
ance on company financial performance and financing, on family-based
and controlled conglomerates, and on the financial crisis.
During the 1950s and 1960s, nationalist sentiments led to policies that
favored import substitution and heavy government intervention in business.
To implement these policies, the Government overvalued the local currency
and imposed high import tariffs. Companies were profitable because of
protection from foreign competition. But protectionist policies made labor
relatively more expensive and, therefore, companies were necessarily large
and capital-intensive. While new manufacturing industries were success-
fully established, their growth could not be sustained. An industrial elite,
composed mostly of families previously in trading businesses, emerged to
influence industrial policies. These early industrialists naturally opposed
any initiative to reduce tariffs, yet they did not risk new capital required for
modernizing and expanding manufacturing capacity. Sugar refining and
textile mills are examples of industries that floundered in the 1980s be-
cause of government import substitution policies.
Government interventions under the notion of “master planning”
for economic and social development characterized the 1970s and early
1980s. The policy was crafted by the martial law regime at that time. The
Board of Investments (BOI) was created to draw up an investment priorities
Chapter 3: Philippines 157
plan (IPP) to encourage private sector investments by offering tax and other
incentives. The Government signaled through the IPP its intent to shape the
future industrial landscape, organizing industries into sectors and picking
“winners.” No strategic industry could take off without the Government’s
participation in its management and operations. Foreign ownership was
allowed only in industries with high technological and market barriers, i.e.,
the “pioneer” industries identified in the IPP. Quantitative restrictions and
tariff protection of preferred industries remained firmly in place. Exports
were not competitive because of the high costs of imported materials. Fol-
lowing government initiatives in the control of the infrastructure and utili-
ties sectors, the State took over the generation and distribution of electric-
ity, assumed ownership of the largest petroleum refining company, and ini-
tiated the development of alternative energy sources in response to the oil
crises.
The 1980s were marked by a peaceful transition of political power.
Reforms in policies, including the reduction of tariffs, quantitative restric-
tions, and import licensing requirements, clearly shifted economic man-
agement toward reliance on markets rather than on decisions by bureau-
crats in the Government. Better access to cheaper imported raw materials
improved the competitiveness of local manufacturers. Starting in 1981, the
Government continuously revised the enabling law of BOI so that incen-
tives were reduced in number, made less associated with capital invest-
ments, and oriented toward exports. Nevertheless, BOI incentives retained
a strong bias in favor of capital-intensive enterprises and domestic-oriented
industries.
In the early 1990s, the Government narrowed the range of tariff
rates by commodity categories and reduced the average tariff rate from
28 to 20 percent. In 1991, the legislative body passed the Foreign Invest-
ment Act (FIA). The FIA allowed foreign equity investment in many areas
and at the same time provided a transparent, advance notice of areas where
the country disallowed or restricted foreign investment. It limited the bu-
reaucratic cost and discretion that accompanied the necessary approvals of
foreign investments.
Probably the most significant effects of tariff protection and biases
for capital intensity were the corporate sector’s high degree of concentra-
tion, dominance by large companies, and orientation toward domestic mar-
kets. In many industries, the top three companies accounted for a dispro-
portionately large share of total sales and assets. The high industrial con-
centration led to practices of price leadership and output restrictions and
the rise of industry lobby groups—common features of an oligopolistic
market. With economic reforms introduced in the 1980s and 1990s, how-
ever, competition from liberalized imports had somewhat reduced
oligopolistic tendencies and concentration in many industries.
A comparison of the Philippines’ economic performance in terms
of real gross domestic product (GDP) growth with selected countries in
Southeast Asia places the succeeding review of the corporate sector’s per-
formance in context. The Philippines substantially lagged behind other coun-
tries from 1990 to 1995 (Table 3.1). Its growth rate began to catch up with
others in 1996, only to be unsettled by the crisis of 1997.
Table 3.1
GDP Growth of Southeast Asian Countries, 1990-1999
(percent)
Year Indonesia Korea, Rep. of Malaysia Philippines Thailand
1990 9.0 9.5 9.7 3.0 11.2

1991 8.9 9.1 8.6 (0.6) 8.5
1992 7.2 5.1 7.8 0.3 8.1
1993 7.3 5.8 8.3 2.1 8.3
1994 7.5 8.3 9.2 4.4 9.0
1995 8.2 8.9 9.8 4.7 8.9
1996 7.8 6.8 10.0 5.8 5.9
1997 4.7 5.0 7.5 5.2 (1.7)
1998 (13.2) (6.7) (7.5) (0.5) (10.2)
1999 0.2 10.7 5.4 3.2 4.2
Source: ADB, Key Indicators of Developing Asian and Pacific Countries 2000.
Performance of All Companies
The analysis of corporate performance in this section used financial data

from the Securities and Exchange Commission (SEC)-BusinessWorld An-
nual Survey of Top 1,000 corporations, which was taken as a representation
of the Philippine corporate sector.2 During 1988-1997, net sales of the top
1,000 Philippine companies grew 17.5 percent per year (Table 3.2). This
rate of growth was sustained by a comparable 18.8 percent growth in fixed
2
The SEC-BusinessWorld Annual Survey of the Top 1,000 Corporations covers financial
and nonfinancial companies. In this section, only nonfinancial companies were used.
Table 3.2
Growth and Financial Performance of the Top 1,000 Companies, 1988-1997
Compound
Indicators 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 Growth (%)
Growth Indicators (P billion)
Net Sales 464.7 519.1 629.6 741.3 862.3 954.1 1,177.6 1,394.0 1,697.5 1,978.9 17.5
Net Income 28.4 33.6 35.2 46.5 64.8 72.9 144.4 148.3 193.5 96.5 14.6
Fixed Assets 260.8 290.2 378.4 411.9 480.9 617.2 776.9 941.2 1,191.4 1,225.9 18.8
Total Assets 618.6 707.1 861.4 952.6 1,123.5 1,317.1 1,781.2 2,341.1 3,160.1 3,893.9 22.7
Total Liabilities 426.5 468.7 555.3 570.1 615.3 714.4 900.1 1,209.7 1,647.5 2,332.4 20.8
Stockholders’ Equity 192.1 238.4 306.1 382.5 508.2 602.7 881.2 1,131.4 1,512.7 1,561.5 26.2
Retained Earnings 51.4 63.1 95.8 136.4 188.6 218.0 338.0 411.7 443.6 446.9 27.2
Financial Ratios (%) Average
Leverage 222 197 181 149 121 119 102 107 109 149 146
ROE 14.8 14.1 11.5 12.2 12.8 12.1 16.4 13.1 12.8 6.2 12.6
ROA 4.6 4.7 4.1 4.9 5.8 5.5 8.1 6.3 6.1 2.5 5.3
Turnover 75 73 73 78 77 72 66 60 54 51 68
Net Profit Margin 6.1 6.5 5.6 6.3 7.5 7.6 12.3 10.6 11.4 4.9 7.9
Other Indicators
No. of Companies 899 887 896 903 902 900 898 900 898 896 898
Sales per Company (P billion) 0.5 0.6 0.7 0.8 1.0 1.1 1.3 1.6 1.9 2.2 1.2
Leverage = total liabilities/stockholders’ equity, net profit margin = net income/net sales, return on assets (ROA) = net income/total assets, return on equity (ROE) = net income/
stockholders’ equity, turnover = net sales/total assets.
Source: SEC-BusinessWorld Annual Survey of Top 1,000 Corporations in the Philippines.
assets. Net income consistently increased from 1988 to 1996 and declined
only in the crisis year 1997. Total assets grew at an average annual rate of
22.7 percent. Asset growth was funded by debt that grew at an average of
20.8 percent per year, and by equity that grew at a higher average annual
rate of 26.2 percent. The data suggest no evidence of excessive borrowing
in the run-up to the crisis in 1997.
Return on equity (ROE) and return on assets (ROA) averaged
12.6 percent and 5.3 percent, respectively, for the 10-year period. These
rates of return are high compared with other Asian countries. The debt-to-
equity ratio ranged from 222 percent in 1988 to 102 percent in 1994. This
is high compared with developed countries but compares favorably with
other Asian countries. Further, leverage increased from 109 percent in
1996 to 149 percent in 1997, but the extent of the increase was not as
dramatic as in other Asian countries, indicating that the corporate sector’s
exposure to foreign currency-denominated loans was not as significant as
in other countries. Net profit margins for the top 1,000 companies aver-
aged 7.9 percent for the period.
The growth rates of corporate sales for the period 1988-1997 ex-
ceeded those of the country’s GDP for the same period (Table 3.3). Assuming
Table 3.3
The Corporate Sector and Gross Domestic Product, 1988-1997
Top 1,000 Companies

GDP Net Sales Ratio of Estimated Value
Year (P billion) (P billion) Addeda to GDP (%)
1988 799 465 17.5
1989 925 519 16.8
1990 1,077 630 17.5
1991 1,248 741 17.8
1992 1,352 862 19.1
1993 1,474 954 19.4
1994 1,693 1,178 20.9
1995 1,906 1,394 21.9
1996 2,172 1,697 23.4
1997 2,427 1,979 24.5
Average Growth (%) 13.1 17.5
a
Value-added is assumed to be 30 percent of net sales.
Sources: ADB, Key Indicators of Developing Asian and Pacific Countries 1999; and the SEC-BusinessWorld
Annual Survey of Top 1,000 Corporations in the Philippines, various years.
a constant ratio of value added to sales, these figures suggest a significant

and increasing contribution of the corporate sector to GDP.
A study of company performance by ownership type, size, corporate
control structure, and industry reveals further structural characteristics of the
growth and financial performance of the corporate sector. The premise is that
these variables have a direct bearing on corporate performance and growth.
Performance by Ownership Type
The Philippine corporate sector can be categorized into four groups based
on ownership: (i) publicly listed, (ii) foreign-owned, (iii) Government-owned,
and (iv) privately owned. Averaging 42.8 percent of the corporate sector’s
total sales between 1988 and 1997, privately owned companies constituted
the largest group (Table 3.4). The foreign-owned companies were the
Table 3.4
Growth and Financial Performance of the Corporate Sector
by Ownership Type, 1988-1997
Publicly Privately Foreign- Government-

Indicators Listed Owned Owned Owned
Growth Indicators (Compound Annual Growth Rate, %)

Net Sales 20.0 17.3 21.8 4.0
Net Income 19.4 22.0 3.9 4.3
Fixed Assets 19.6 28.4 26.3 9.8
Total Assets 29.4 28.5 22.8 14.1
Total Liabilities 26.4 27.0 22.9 12.9
Stockholders’ Equity 32.5 31.8 22.7 17.0
Retained Earnings 30.1 2.9 22.0 5.4
Financial Ratios (%)
Leverage 89 158 142 190
ROE 15.1 13.0 22.2 5.7
ROA 8.0 5.2 9.3 2.1
Turnover 53 103 146 22
Net Profit Margin 15.5 5.3 6.3 10.3
Other Indicators
Share of Sales (%) 17.8 42.8 27.9 11.5
No. of Companies 73 606 196 23
Sales per Company (P billion) 2.5 0.8 1.5 4.8
Source: SEC-BusinessWorld Annual Survey of the Top 1,000 Corporations in the Philippines, various
years.
second largest at about 27.9 percent, followed by publicly listed ones. Pub-
licly listed companies had a minor though steadily increasing share in total
sales. Only 84 of the 221 public companies listed on the Philippine Stock
Exchange (PSE), or 38 percent, were among the top 1,000 companies in
1997, meaning that the remaining 62 percent were relatively small in sales
and assets. However, while there were few of them, these companies were
comparatively large, selling an average of P4.1 billion per company in 1997,
compared with P2.75 billion per company for foreign-owned companies.
The privately-owned companies were only about one third of the average
size of per company sales of the publicly listed companies. Government-
owned companies in the top 1,000 list, although small in number, regis-
tered the largest per company sales at about P9 billion in 1997. These were
mostly large public utilities.
The compound annual sales growth rate was 21.8 percent for for-
eign-owned companies and 20 percent for publicly listed companies dur-
ing 1988-1997, exceeding the 17.5 percent average growth rate of the
entire corporate sector. Privately-owned and Government-owned compa-
nies grew at slower rates. With an average leverage ratio of 142 percent, a
level high by Western standards but at par with those of other Asian coun-
tries, foreign-owned companies borrowed more than publicly listed ones.
But by being most efficient in employing assets, they generated the high-
est return on investments, with an average ROE of 22.2 percent and ROA
of 9.3 percent. Publicly listed companies had the lowest leverage at
89 percent, the highest net profit margin of 15.5 percent, reflecting the
significant presence of holding companies as the gross revenues of hold-
ing companies flow through to operating income, the second best ROE
and ROA, and the second lowest asset turnover. The government-owned
companies had the highest leverage at 190 percent but lowest ROA and
ROE because these are primarily public utilities and companies in the
energy sector where turnover is low, the asset base is large, and low return
on investment is the norm. It should also be added that the profit margin
of Government-owned companies is distorted by the presence of holding
companies such as the Philippine National Oil Company, Bases Conver-
sion Development Authority, and government-subsidized agencies such
as the National Food Authority and Local Water Utilities Administration.
The privately-owned companies had a high average leverage ratio of
158 percent. Their ROA and ROE were both more than twice as high as
those of government-owned companies, but lower than those of foreign-
owned and publicly listed companies.
Performance by Control Structure
By control structure, a company can be a member of a conglomerate or

independent. The independent companies contributed about 56 percent of
corporate sales on average during the period 1988-1997, compared with
32.3 percent for the conglomerates. But the conglomerates were larger
measured in sales per company, grew faster, had a lower leverage ratio, and
achieved higher returns on invested assets than independent companies
(Table 3.5).
Table 3.5
by Control Structure, 1988-1997
Indicators Group Member Independent

Net Sales 20.2 18.7
Net Income 21.2 2.0
Fixed Assets 25.7 25.2
Total Assets 32.3 23.0
Total Liabilities 30.7 22.4
Stockholders’ Equity 34.1 24.6
Retained Earnings 32.3 26.0
Leverage 98 166
ROE 15.8 15.8
ROA 8.0 6.1
Turnover 67 124
Net Profit Margin 12.3 5.0
Other Indicators
Share in Sales (%) 32.3 55.6
No. of Company 159 715
Sales per Company (P billion) 2.1 0.8
Source: SEC-BusinessWorld Annual Survey of Top 1,000 Corporations in the Philippines, various years.
Performance by Firm Size
By firm size, the corporate sector is divided into large, medium, and small
companies, depending on assets and sales. Sales and resources of the
Philippine corporate sector are highly concentrated among the large com-
panies, which, for this study, are defined as the largest 100 companies in
the top 1,000 list. Sales per company in this group averaged P13.4 billion
in 1997. Medium-sized companies, defined in this study as the next 200
largest companies in the top 1,000 list, averaged a far less P3 billion in per
company sales, while small companies, referring to the remaining compa-
nies in the list, averaged only P920 million in per company sales during the
same year.
Large companies accounted for 56.1 percent of the total sales of
the corporate sector, although they comprised only 8.8 percent of the total
number of companies in the list (Table 3.6). However, sales of medium-
sized companies grew faster than large companies. Medium-sized com-
panies also performed better in terms of ROE, averaging 16 percent, indi-
cating that they deployed resources more efficiently than large and small
companies.
Table 3.6
by Firm Size, 1988-1997
Indicators Large Medium Small

Net Sales 15.7 19.6 19.9
Net Income 1.3 47.2 26.2
Fixed Assets 15.5 29.9 25.4
Total Assets 18.4 32.5 28.1
Total Liabilities 18.2 25.6 25.0
Stockholders’ Equity 18.9 49.6 32.7
Retained Earnings 13.9 36.0 44.5
Leverage 158 156 128
ROE 13.1 16.0 10.1
ROA 5.3 7.1 4.5
Turnover 65 81 73
Net Profit Margin 8.2 9.5 6.6
Other Indicators
Share in Sales (%) 56.1 12.9 31.0
No. of Companies 79 89 730
Sales per Company (P billion) 7.3 1.6 0.5
Small companies, although the largest in number, showed the low-

est ROE, averaging 10.1 percent. Poor returns appear to have been caused
by the low profit margin at 6.6 percent, compared with 9.5 percent for
medium-sized companies and 8.2 percent for large ones. Medium-sized
companies apparently enjoyed efficiencies associated with economies of
scale and made more productive use of their assets.
The Asian financial crisis affected large companies most severely,
with their ROE dropping to 3.8 percent in 1997, from 14.8 the previous
year. ROE dropped from 10.7 percent in 1996 to 8.7 percent in 1997 for
medium-sized companies. For small companies, ROE dropped to 7.4 per-
cent in 1997 from 11.7 percent a year earlier. Leverage was the highest for
large companies, at 158 percent on average during 1988-1997. Medium-
sized companies’ leverage level was slightly lower, at 156 percent. But small
companies’ leverage was significantly lower, at 128 percent for the period.
Large- and medium-sized companies did not substantially increase their
leverage in years running up to the crisis in 1997, unlike their counterparts
in other Asian countries.
Performance by Industry
This study also looked at corporate performance by industry, specifically

those industries least and most affected by the financial crisis. The growth
and financial performance of selected industries, i.e., manufacturing, utili-
ties, real estate, and construction, are shown in Table 3.7. Manufacturing
companies represented more than half of the corporate sector in number in
the period 1988-1997 and accounted for about 82 percent of total sales. The
sector showed consistent growth in sales, profits, assets, and equity up to
1996, but suffered its largest decline in net profits in 1997, as indicated by
the negative annual growth, at -12.8 percent, of net income. Net income
declined from P54.1 billion in 1996 to P4.2 billion in 1997 for this sector.
The leverage ratio of the manufacturing sector was higher than that of the
real estate and property sector, but lower than that of construction, and
utilities and services sectors.
Growth of sales, net income, and assets was much higher for the
real estate and property, and the construction sectors than for the manufac-
turing, and utilities and services sectors, reflecting to some extent a “bub-
ble” phenomena in the former two sectors, especially during the period
1994-1996. The real estate and property sector also suffered significantly in
sales, net income, and profitability in 1997 when the crisis started. Sales
revenue and net income declined from P76.7 billion and P35.8 billion in
Table 3.7
by Industry, 1988-1997
Utilities Real Estate

and and
Indicators Manufacturing Services Property Construction

Net Sales 16.9 17.7 39.2 27.3
Net Income (12.8) 17.3 37.8 55.9
Fixed Assets 20.5 12.4 48.2 23.0
Total Assets 19.4 19.6 45.7 23.0
Total Liabilities 18.3 20.8 52.8 25.7
Stockholders’ Equity 21.4 16.3 41.7 19.0
Retained Earnings 17.1 10.6 28.6 21.7
Leverage 142 181 69 192
ROE 13.9 5.7 16.7 9.1
ROA 5.9 2.0 10.1 2.7
Turnover 112 24 24 83
Net Profit Margin 5.2 8.5 42.4 2.9
Other Indicators
Share in Sales (%) 82.2 12.6 3.0 2.2
No. of Company 454 17 31 28
Sales per Company
(P billion) 1.3 5.4 0.7 0.6
1996 to P56.9 billion and P24.7 billion in 1997, respectively. As a result,

the sector’s ROE dropped from 15.7 percent to 10.4 percent. But the im-
pact of the Asian crisis on the real estate and property sector was much
smaller than that on the manufacturing sector, and was also much more
limited compared with the property sectors in other Asian countries. Its
knock-on effect on the economy was small as it accounted for less than
3 percent of the top 1,000 companies’ total sales on average during 1988-
1997. With a modest increase in total liabilities and leverage level of less
than 100 percent in 1997, it does not appear to have been excessively ex-
posed to foreign currency-denominated loans. The sector’s buildup in eq-
uity during the stock market boom of 1994-1996 may have cushioned the
impact of the crisis.
The utilities sector had the second highest leverage during 1988-
1997 at 181 percent on average, reaching up to 313 percent in 1997. The
currency devaluation bloated the foreign currency-denominated loans of
these companies. Overall, the leverage of all four industries was low, un-
like in neighboring countries hit by the Asian crisis.
The Corporation Code of 1980 is the main law governing the corporate
sector. Two other pertinent laws are Presidential Decree (PD) 902-A, which
is also the organic law governing the operations of SEC, and the Insol-
vency Law. For publicly listed companies, the Revised Securities Act (RSA)
and PSE’s public listing requirements also apply. The General Banking
Law, which regulates banks and nonbank financial institutions except in-
surance companies, contains some provisions affecting corporations’ deal-
ings with banks.
Corporation Code of 1980
Supplanting the old Corporation Law of 1906, which was based on Ameri-
can corporate law, the Corporation Code of 1980 is a compilation of impor-
tant juridical rulings, administrative regulations, and recognized rules on
corporate practices. It provides the basic constitutional structure for the
organization, operation, and dissolution of corporations. It specifies the
minimum information to be indicated in the articles of incorporation,3 which
serve as the company’s declaration that the minimum percentage of author-
ized capital required by law has been subscribed and paid-up. Under the
Code, the ownership of Filipino citizens in the corporation is not less than
the legally required percentage of capital stock.
Amendments to the articles of incorporation require approval by a
majority of the board of directors and a two-thirds vote of outstanding
capital stock. One month after registration, the Code requires a corporation
3
A company’s articles of incorporation should include: (i) corporate name; (ii) purpose
of the corporation; (iii) principal office; (iv) term of existence; (v) number of directors
(not less than five nor more than 15); (vi) names, nationalities, and residences of incor-
porators and directors; (vii) number, par value, and amount of authorized capital stock;
and (viii) names, nationalities, and residences of original subscribers, and amount sub-
scribed and paid by each. The articles of incorporation may also include other matters
such as waiver of preemptive right and classes of shares such as founders’ or redeem-
able shares describing their rights, privileges, and restrictions.
to adopt a code of bylaws or rules for its internal governance. To be valid,

the bylaws must be consistent with the law, the corporation’s articles of
incorporation, and public policy; must be general, uniform, and reasonable;
and should not impair vested rights.4
Philippine corporate law distinguishes between management deci-
sions that require only a majority vote of the board and major decisions that
require a two-thirds majority vote of shareholders. A majority of the out-
standing shares of shareholders must vote to authorize amendments to the
bylaws. However, shareholders may delegate this power to the board of
directors by a two-thirds vote of outstanding capital stock.
Securities and Exchange Commission: PD 902-A
SEC is the government agency responsible for implementation of the Cor-

poration Code. Its mandate is to supervise corporations in order to encour-
age investments and protect investors. It implements rules and regulations
that protect minority shareholders from possible fraud and misbehavior by
controlling shareholders, directors, or officers.
In 1976, PD 902-A expanded SEC’s mandate to include absolute
jurisdiction, supervision (regulatory), and control (adjudicative) of all cor-
porations. In addition, PD 902-A also granted SEC the exclusive jurisdic-
tion to hear and decide cases involving: (i) complaints about devices or
schemes employed by the board of directors and officers amounting to fraud
and misrepresentation that may be detrimental to the interest of the public
or shareholders; (ii) controversies arising out of intra-corporate relations,
among shareholders, between the shareholders and the corporation, and
between the corporation and the State concerning its franchise or right to
exist; (iii) controversies in the election or appointments of directors and
officers of corporations; and (iv) petition of corporations to be declared in a
state of suspension of payments in cases when their assets cover all debts
but they cannot pay these debts when they fall due.
4
Some of the items that a corporation may provide in its bylaws are the following: (i)
time, place, and manner of calling and conducting regular or special meetings of the
directors and shareholders; (ii) required quorum in shareholders’ meetings, manner of
voting, and forms of proxies and manner of voting them; (iii) qualifications, duties, and
compensation of directors, officers, and employees; (iv) time for holding annual elec-
tion of directors and manner of giving the election notice; (v) manner of election or
appointment and term of office of all officers other than directors; (vi) penalties for
violation of the bylaws; and (vii) manner of issuing certificates in the case of stock
corporations.
The last item of PD 902-A is the special jurisdiction granted to

SEC over applications by corporations for “suspension of payments” to
creditors, a role of the regular courts that was originally part of the Insol-
vency Law. Under this authority to approve applications for suspension of
payments, SEC has the power to appoint rehabilitation receivers or man-
agement committees for petitioning corporations.
A presidential writ issued in 1981 placed SEC under the supervi-
sion of the Ministry of Finance, but in 1998, control of the agency was
returned to the Office of the President.
Insolvency Law
The Insolvency Law is designed to effect an equitable distribution of insol-

vent debtors’ properties among their creditors. It permits debtors to be dis-
charged from their liabilities to enable them to start afresh with property set
apart for them from assets to be used as payment to creditors. The regular
courts have jurisdiction for insolvency proceedings including suspension
of payments for individual debtors. A debtor can petition the court to sus-
pend payment of debts or to be discharged from liabilities and debts by
voluntary or involuntary insolvency proceedings.
Revised Securities Act: Law on Securities Dealing
Like its predecessor, the 45-year-old Securities Act, the RSA was patterned
after several US securities acts. The RSA is primarily designed to prevent
the exploitation of investors through the sale of unsound or fraudulent secu-
rities. For this purpose, the law requires full and accurate disclosure of all
material facts concerning the issuer and the securities it proposes to sell,
and prohibits misrepresentations, manipulations, and other fraudulent prac-
tices in the sale of securities. To enforce these regulations, the law requires
the registration of securities. The registration requirement covers full and
accurate disclosure of the character of the securities to be sold to the public,
including detailed information regarding past dealings between the issuer
and its directors, officers, and principal shareholders.
Public Listing Rules of the Philippine Stock Exchange
PSE is the country’s facility for secondary trading of shares of publicly

listed companies. In 1998, SEC, which originally supervised PSE, granted
the exchange the status of a “self-regulated” organization. Thus, PSE now
has the authority, within general guidelines set by SEC, to set rules and
regulations for PSE members and listed companies.
The general requirements for maintenance of listed status include
submission of financial reports that conform with generally accepted ac-
counting principles (GAAP) and regulations established by PSE, and com-
pliance with laws relating to securities and exchange regulations, board
resolutions, and agreements executed with the agency. Violations of PSE
requirements are subject to sanctions, including delisting.
PSE is responsible for ensuring that listed companies follow the
exchange’s rules of disclosure and fair treatment of investors. It has the
power to impose sanctions on any company that fails or erroneously dis-
closes material information that affects the rights and benefits of investors
and misrepresents information in its application, prospectus, financial state-
ments, or reports. In the area of corporate governance, PSE requires corpo-
rations to resolve, and, where possible, eliminate arrangements within groups
of companies and own-company dealings that can lead to conflicts of inter-
est. Upon complaints by minority investors, PSE can review the deals in
question, using such criteria as benefits to the company, adequate disclo-
sure to shareholders, and internal control procedures to ensure fair and rea-
sonable terms.
Banking Laws Affecting Corporations
Some aspects of banking laws affect the governance of corporations. The

important ones concern: (i) the capacity of officers of corporations to
assume positions as members of the board of directors of banks, (ii) lim-
its on ownership of banks by nonfinancial corporations, (iii) limits of
lending by banks to corporations, and (iv) rules on lending to directors
and other insiders.
The General Banking Law governs the regulation of the establish-
ment, management, and operations of banks. As the highest policymaking
body of the banking system, the Monetary Board prescribes the qualifica-
tions of bank directors and reviews the qualifications of those appointed as
bank directors and officers. It could disqualify anyone found, for whatever
reason, unfit for the position. There are no other restrictions on corporate
officers to be appointed as members of the board of directors of banks.
A corporation, including its wholly or majority-owned subsidiar-
ies, can own common shares of banks up to a maximum of 30 percent of
banks’ voting stock. In the event that the corporation is majority-owned by
one person or by relatives, the limit is 20 percent of banks’ voting shares.
Regulations on the single borrower limit (SBL) put a ceiling on the

maximum amount that a bank can lend to a debtor. SBL rules limit the total
liabilities of any borrower of a commercial bank to 15 percent of the bank’s
unimpaired capital and surplus, and an additional 15 percent for “adequately
secured loans,” to a maximum 30 percent (“unimpaired capital and sur-
plus” refers to the total paid-in capital, surplus, and undivided profits, net
of valuation reserves of a bank). SBL limits exclude risk-free loans such as
Government-guaranteed loans and loans secured by cash deposits. Total
corporate liabilities include all liabilities of the debtors and their majority-
owned subsidiaries. The Monetary Board may prescribe the consolidation
of the liabilities of subsidiaries with the parent corporation under certain
conditions.
Central Bank (Bangko Sentral ng Pilipinas [BSP]) regulations do
not prohibit loans by the bank to its directors, officers, shareholders, and
other related interests, known as DOSRI. However, they are subject to cer-
tain prudential requirements under banking laws, as follows: (i) a director
or officer of a bank can only borrow or become a guarantor, endorser, or
surety for loans from the bank with the written approval of all other direc-
tors of the bank (i.e., excluding the director concerned); (ii) the amount of
outstanding credit accommodations that a bank extends to its shareholders
shall be limited to an amount equal to the sum of their unencumbered de-
posits and book value of their paid-in capital contributions; and (iii) loans
and advances given to officers in the form of fringe benefits shall not form
part of liabilities under DOSRI.
The historical development of Philippine corporate ownership is rooted in

the country’s colonial past, the industrial policies of the Government, and
the recent emergence of industrialists and an entrepreneurial class. During
the Spanish and American period up to World War II, a small number of
families acquired land and owned large businesses. These families built and
preserved their businesses over several generations. Many of them became
controlling shareholders of family-based corporations and business groups
that are major players in the present-day Philippine corporate sector.
Ownership is a key element in corporate control and governance.
Public listing rules of PSE require that a minimum of 10 to 20 percent of
outstanding shares, depending on the size of the company, be available for

trading in the stock exchange. As companies usually only issue the mini-
mum required number of shares, large blocs of controlling shareholders
often dominate corporate decision making in publicly listed companies.
Public investors and minority shareholders are not in a position to influence
management. Moreover, the presence of large controlling shareholders makes
takeovers by other companies difficult. For these reasons, the resolution of
conflicts between the interests of controlling shareholders, minority share-
holders, public investors, and creditors in Philippine companies depends
very much on the effectiveness of internal control systems.
Ownership Concentration of Listed Companies
This study measures ownership concentration in terms of shareholdings by

the top one, five, and 20 shareholders.5 Table 3.8 shows that the top share-
holder owned 40.8 percent of the market value of an average nonfinancial
company. The shareholding of the top shareholder varied across sectors. It
was highest for the property sector at 54.8 percent, followed by holding
companies (as a sector) at 53 percent. One shareholder held majority con-
trol of an average company in these two sectors. The average shareholding
of the largest shareholder was less than 25 percent only in sectors with large
market capitalization, such as power and energy, and transportation, and in
sectors with high risks, such as oil exploration and mining. These figures
suggest that for publicly listed companies, a single shareholder often has
substantial or even dominant control.
Combined, the holding of the top five shareholders in an average
company was about 65.3 percent for the nonfinancial sector and 59.2 per-
cent for the financial sector. The five largest shareholders held majority
control over an average Philippine publicly listed company, except in three
sectors—transportation; food, beverage, and tobacco; and oil exploration.
Ownership by the five largest shareholders was on average most concen-
trated among holding companies (78.4 percent), and in construction
(74 percent), property (69.8 percent), manufacturing and trading (68.4 per-
cent), and communications (67.3 percent).
5
The study derived ownership data for 194 (169 nonfinancial) companies out of 221 (190
nonfinancial) listed on the Philippine Stock Exchange as of 1997. Shareholdings by the
top one, five, and 20 shareholders were estimated for each company and averaged by
using the market capitalization of each company as a weight.
Table 3.8
Ownership Concentration of Philippine Publicly Listed Companies
by Sector, 1997
Sector Top 1 Top 5 Top 20a
Financial Institution
Banks 26.9 59.2 76.4
Financial Services 41.3 63.2 65.8
Average Shareholdingb 27.2 59.2 76.2
Nonfinancial Company
Communication 35.4 67.3 76.9
Power and Energy 21.5 55.4 72.1
Transportation Services 23.8 48.4 69.2
Construction and Other Related Products 47.7 74.0 86.2
Food, Beverage, and Tobacco 22.7 44.1 69.7
Holding Companies 53.0 78.4 86.0
Manufacturing, Distribution, and Trading 37.4 68.4 42.6
Hotel, Recreation, and Other Services 28.9 55.3 68.0
Property 54.8 69.8 74.5
Mining 23.4 56.0 51.9
Oil 19.9 45.1 64.3
Average Shareholdingb 40.8 65.3 75.9
a
Information on the top 20 shareholders is not available for five holding companies, 10 manufacturing
companies, and two property companies.
b
Weighted by market capitalization.
Source: PSE databank.
The shareholding of the 20 largest shareholders in an average com-

pany was 75.9 percent for the nonfinancial sector and 76.2 percent for the
financial sector. In 12 out of 13 sectors, the top 20 shareholders owned
more than 50 percent of the voting shares of an average company. In 10 out
of 13 sectors, the top 20 shareholders held more than a two-thirds majority
control of an average company.
Ownership Concentration at Critical Levels of Control
PSE listing rules require that a minimum of 10 to 20 percent of outstanding

shares of a company be issued to the public, depending on its size. An
interesting question is whether in reality Philippine publicly listed compa-
nies issue enough shares to be truly widely held or whether they barely
meet this minimum requirement. The answer to this can be gleaned from an
analysis of the number of companies in which the top one, five, or 20 share-
holders owned more than 50 percent (signifying operating control), 66 per-
cent (signifying strategic control), or 80 percent (only nominally publicly
listed) of outstanding shares.
Table 3.9 shows that in 44 companies, or about 30 percent of the
total, a single shareholder held operating control of a company. In 21 com-
panies, or 14 percent of the total, a single shareholder held two-thirds ma-
jority control. In four companies, or 3 percent of the total, a single owner
owned more than 80 percent of outstanding shares. In 111 companies, or
almost 75 percent of the total, the top five shareholders owned more than
50 percent of the voting shares. In 76 companies, or 51 percent of the total,
the top five shareholders held more than two-thirds majority control of a
company. In 116 companies, or 78 percent of the total, the top 20 share-
holders collectively owned a majority of a company’s shares.
With such high levels of ownership concentration, minority share-
holders are unlikely to be able to influence the strategic and operating deci-
sions of a company without the support of one or more large shareholders.
The limited volume of shares issued to the public is one of the causes of the
underdevelopment of the Philippine stock market. The shares of publicly
listed companies are thinly traded and illiquid, and share prices are sensi-
tive to movements of foreign funds.
Composition of Ownership of Publicly Listed Companies
Another important issue concerning corporate ownership is the composi-

tion of the controlling shareholders. Who are the top one, five, and 20 share-
holders? In Table 3.10, the top five controlling shareholders were classified
into eight groups. The largest group is nonfinancial corporations, including
pure holding companies, controlling an average of 52.1 percent of publicly
listed companies in the Philippines in 1997. In four of 11 nonfinancial sec-
tors, nonfinancial corporations held majority control. Individuals did not
constitute a significant shareholder group among the top five shareholders,
holding only an average of 2.2 percent of outstanding shares of publicly
listed companies.
Nonfinancial corporations with controlling shareholdings are likely
to be holding companies, which are mostly privately owned and controlled
by family-based shareholder blocs. Parent companies usually spin off oper-
ating units into new companies that they continue to control as affiliates.
There are advantages to establishing pure holding companies. Through these,
large and family-based shareholders pool the family’s ownership over many
Table 3.9
Ownership Concentration at Critical Levels of Control Over Publicly Listed Companies, 1997
% of Firms with Top % of Firms with Top % of Firms with Top

Shareholders Controlling Shareholders Controlling Shareholders Controlling
more than 50% of Shares more than 66% of Shares more than 80% of Shares
Sector Top 1 Top 5 Top 20a Top 1 Top 5 Top 20a Top 1 Top 5 Top 20a
Communication 30 90 100 20 70 90 — 40 60
Construction 40 80 87 13 60 80 13 33 67
Food, Beverage, and Tobacco 50 86 93 43 57 86 7 50 64
Manufacturing, Distribution, and Trading 20 72 36 8 48 36 — 28 20
Holding 31 73 82 14 49 76 2 27 47
Power — 50 100 — 50 100 — 50 50
Transportation 14 57 100 — 14 71 — — 43
Property 24 72 80 8 52 76 — 28 36
Total 30 74 78 14 51 72 3 30 45
a
Data for top 20 shareholders were not available for five holding companies, 10 manufacturing companies, and two companies in the property sector.
Table 3.10
Composition of Top Five Shareholders of Philippine Publicly Listed Companies by Sector, 1997
(percent)
Nonfinancial Investment Nominee Commercial Securities Insurance

Sector Company Trust Fund Company Individual Bank Government Broker Company
Financial Company
Banks 33.9 1.3 3.0 9.1 5.4 2.3 2.6 1.7
Financial Services 6.6 0.0 10.2 7.6 19.3 1.0 18.6 0.0
Average Shareholdinga 33.5 1.2 3.1 9.0 5.6 2.3 2.8 1.6
Nonfinancial Company
Communication 53.5 8.5 3.9 0.0 0.0 0.2 0.6 0.6
Power and Energy 26.3 12.6 0.2 0.0 5.7 10.7 0.0 0.0
Transportation Services 37.2 0.0 3.2 5.1 0.0 0.0 2.6 0.2
Construction and Other Related Products 59.4 1.3 3.0 6.6 0.6 1.2 1.5 0.1
Food, Beverage, and Tobacco 29.8 12.3 1.5 0.4 0.0 0.0 0.0 0.0
Holding Companies 66.0 0.2 4.2 5.5 1.7 0.0 0.8 0.1
Manufacturing, Distribution, and Trading 45.9 0.8 5.6 4.3 0.3 0.3 11.0 0.2
Hotel, Recreation, and Other Services 36.7 0.0 5.7 5.3 0.0 0.0 7.6 0.0
Property 67.3 0.2 0.7 1.0 0.1 0.0 0.6 0.0
Mining 26.8 1.7 3.9 0.4 5.8 5.0 12.5 0.0
Oil 21.9 0.0 0.4 8.5 0.0 0.0 13.7 0.5
Average Shareholdinga 52.1 4.7 2.4 2.2 1.3 1.4 1.1 0.1
a
Weighted by market capitalization.
Source: PSE Databank.
companies and share in the risks and profits of the group. They can also
better manage their income taxes because income from affiliated compa-
nies passes through a holding company. Such advantages have contributed
to the popularity of holding companies among publicly listed companies.
Holding companies as a sector had the largest market capitaliza-
tion in PSE in 1997, accounting for P258.6 billion or 26.7 percent of mar-
ket capitalization of the nonfinancial publicly listed companies. Holding
companies were themselves 66 percent owned by other nonfinancial corpo-
rations. Privately-owned pure holding companies own a majority of shares
and exercise control of publicly listed holding and operating companies
through a multilayered pyramid structure. This complex layering of owner-
ship masks the identity of individuals or families that actually own and
control operating companies, while still allowing the public to own minor-
ity shares.
As a group, financial institutions did not have a significant owner-
ship in nonfinancial corporations, with an average of only 7.2 percent in
1997. The financial institutions among the top five shareholders of
nonfinancial corporations are investment trust funds (with 4.7 percent of
shareholdings), commercial banks (1.3 percent), securities brokers
(1.1 percent), and insurance companies (0.1 percent). The 7.2 percent
shareholding by the financial institutions was even inflated to some extent
because securities brokers held trading portfolios for their clients rather
than long-term investments. Insurance companies were very minor inves-
tors in the stock market because prudential regulations prevent them from
investing significant amounts even in equities of large companies.
Investment trust funds were the most important institutional inves-
tors. These are mainly the Social Security System (SSS) and the Govern-
ment Service Insurance System (GSIS). Funds of SSS and GSIS consist
mainly of compulsory contributions from members of the country’s pri-
vate sector and government workforce, respectively. These institutions
keep a stock portfolio mostly in shares of a few companies with large
capitalization and high liquidity in select industries. These include Phil-
ippine Long Distance Telephone Company (PLDT) in telecommunica-
tions, Petron and MERALCO in power and energy, and San Miguel Cor-
poration (SMC) in food and beverages. The investment funds’ presence in
these sectors ranged from 8.5 to 12.6 percent of market capitalization in
1997. Because of limited ownership by institutional investors, there was no
real market for investment information. The Philippine capital market did
not have an active analyst community comparable to those in more devel-
oped capital markets.
Family-Based Ownership and Business Groups
The Asian Development Bank (ADB) survey of publicly listed companies

conducted for this study reveals that about one third of responding compa-
nies started out as family businesses. More than three fourths of the re-
spondents are either a parent or subsidiary (about 70 percent of these are
domestic nonfinancial companies), suggesting that most publicly listed
companies are parts of business groups. Most family businesses that went
public did so because they wanted to raise capital and to gain the prestige
associated with being a public company. However, many companies in fam-
ily-owned groups are not publicly listed.
To understand the ownership and governance characteristics of fam-
ily-owned business groups, the study put together a list of prominent busi-
ness groups, identified the companies belonging to each of these groups,
and tracked the financial performance of each company from 1992 to 1997,
using data on the Philippines’ top 1,000 companies.6
The total sales of these groups in 1997 were estimated at
P806 billion (Table 3.11). Family-based groups have larger companies since
their total sales were about 33.4 percent of the top 1,000 corporations’ sales,
but they comprised only 23.8 percent of total companies in number. All ma-
jor industries were represented, suggesting that business groups are common
in all major markets. Some 20 financial institutions were affiliated with these
groups, including 16 commercial banks. This is significant considering that
there were only 31 local commercial banks in the country in 1997.7
6
The study used publicly available shareholder information and published reports. The
process identified a total of 238 companies belonging to 39 business groups from the
SEC-BusinessWorld Annual Survey of the Top 1,000 Corporations in the Philippines.
7
A common feature of corporate ownership of a business group is the centrality of a com-
mercial bank. Large shareholders and their families own these banks directly or through
their controlled companies. Commercial banks hold the largest share, about three fourths,
of the financial resources in the country. Corporate financing depends on intermediation
by banks. For this reason, a nonfinancial company that owns a commercial bank has better
access to loans at favorable rates and terms. The Central Bank deregulated interest rates
and foreign exchange, liberalized the regulations on entry of foreign bank branches and
foreign ownership of local banks, and increased the capital requirements for all types of
banks. Prudential regulations, including SBL and DOSRI rules, remain in force to control
excessive lending of banks to insiders. Still, the Central Bank’s reforms are probably
changing the conduct but not necessarily the structure of the banking system. Foreign
banks have a growing presence but have not necessarily increased the supply of credit to
the corporate sector, so far limiting their involvement to selected products. Banks that are
members of business groups have an advantage in raising funds from the internal capital
market of the group. This could further increase the concentration of ownership and ex-
pand the scope of own-group lending by these larger banks.
Compared with other Asian countries, an average group in the Phil-

ippines has fewer member companies. Together, the top 10 family-based
business groups had only 119 companies in the top 1,000 companies, or an
average of about 12 per group. The main constraint may be the availability
of family members that could be drawn for top management positions.
In terms of number of companies, the largest family-based busi-
ness group was the Ayala Corporation Group, with 27 affiliated companies
in the top 1,000. In terms of sales, the largest was the Eduardo Cojuangco
group, the principal owner of SMC, the biggest private company in the
Philippines.
The significance of family-based business groups in the Philippine
corporate sector is immediately evident in the 50 largest corporate entities,
including business groups and independent companies, ranged according
to their sales (Table 3.12). These corporate entities accounted for 53.6 per-
cent of the total sales of the top 1,000 corporations in 1997. Significantly,
the three largest entities were family-based groups, namely, Cojuangco,
Lopez, and Ayala. Also, 25 out of the 50 top corporate entities were family-
based groups. Family-based business groups are most dominant in sectors
such as manufacturing, real estate, construction, and banking. Foreign-owned
companies mainly serve the export markets.
Interlocking Relationship between Financial and Nonfinancial Firms
Although financial institutions as a whole did not own directly significant

proportions of shares of nonfinancal corporations in the Philippines, as dis-
cussed in previous sections, the two were closely related through their af-
filiations to business groups. Commercial banks are often affiliated to a
particular business group. To show this, the study used the four largest
business groups—Ayala, Gokongwei, Lopez, and Henry Sy—as examples.
In 1997, nonfinancial companies contributed about 36 to 60 per-
cent of total profits for these groups. For the Ayala group, the nonfinancial
sector was real estate (60.4 percent of the group’s 1997 profits); for the
Gokongwei Group, it was manufacturing (36.2 percent); for the Lopez group,
broadcasting (49.8 percent); and for the Henry Sy group, retail merchandis-
ing (69.1 percent). In the meantime, for each of these groups, a substantial
proportion of group profits came from its financial subsidiaries. Commer-
cial banking contributed about 40 percent of group profits for the Ayala
group and Gokongwei group, and more than 20 percent for the Lopez group
and Henry Sy group. It is also noteworthy that, with the exception of Banco
de Oro, which was majority-owned by the Henry Sy group, in most
Table 3.11
Total and Per Company Sales, Sector Orientation, Flagship Company, and Affiliated Bank of Selected Business Groups, 1997
Estimated Average
No. of Total Sales
Affiliated Sales Per Company
Business Group Major Sector Orientation Companies (P billion) (P billion)
1. Eduardo Cojuangco Beverages, food, coconut oil, and packaging 19 123.7 6.5
2. Lopez Family Group Power distribution and mass communications 15 98.8 6.6
3. Ayala Corp. Group Real estate, food, and car manufacturing 27 84.5 3.1
4. George Ty Car manufacturing and real estate 12 49.4 4.1
5. John Gokongwei Food and telecommunications 12 48.5 4.0
6. Henry Sy Department store and real estate 9 47.5 5.3
7. Lucio Tan Airlines, beverages, agriculture, and tobacco 4 46.5 11.6
8. Ramon Cojuangco Family Group Telecommunications 6 44.0 7.3
9. Del Rosario/Phinma Group Cement and construction materials 11 26.5 2.4
10. Zuellig Group Pharmaceutical and distribution 4 26.0 6.5
11. First Pacific/
Metro Pacific Group Real estate, telecom, and personal care prods 8 17.5 2.2
12. Aboitiz Family Group Shipping, power, and food 9 17.2 1.9
13. Jose Concepcion/RFM Group Food, beverages, and dairy products 5 16.3 3.3
14. Alfonso Yuchengco Investments, construction, and mining 4 15.5 3.9
15. Andres Soriano Family Group Management, real estate, and tourism 5 13.0 2.6
16. George Go Credit card 6 13.0 2.2
17. Wilfred Uytengsu/
General Milling Group Food and dairy products 4 10.4 2.6
18. David M. Consunji Construction and mining 3 10.1 3.4
19. Jollibee Foods Fast food 4 8.5 2.1
20. Luis Lorenzo Family Group Beverages and agro-industrial products distribution 7 8.3 1.2
21. Alcantara Family Group Cement and wood products 5 7.9 1.6
22. Bienvenido Tantoco Retail merchandising 2 7.8 3.9
23. Elena Lim Electronic appliances 4 6.9 1.7
24. Andrew Gotianum Real estate 4 6.2 1.6
25. Brimo Family Group Mining 3 6.0 2.0
26. Andrew Tan Real estate 2 5.6 2.8
27. J. P. Enrile/JAKA Group Telecommunication, distribution, and real estate 5 5.4 1.1
28. Jaime Gow Retail merchandising 7 5.2 0.7
29. Guoco Group Ceramics and real estate 5 4.7 0.9
30. Jose Go Department store and real estate 5 4.4 0.9
31. Jardine Davies Cement and sugar central 2 3.7 1.9
32. Gerardo Lanuza Real estate and securities trading 3 3.4 1.1
33. Alfredo C. Ramos Bookstore, mining, and real estate 2 3.3 1.7
34. Gaisano Family Group Department store 3 2.5 0.8
35. Felipe Yap Mining 2 2.0 1.0
36. Felipe F. Cruz Construction 2 1.8 0.9
37. Jose Luis Santiago Telecommunication 2 1.4 0.7
38. Keppel Group Shipyard and power 2 1.1 0.6
39. Robert John Sobrepeña/
Fil-Estate Group Real estate 4 1.1 0.3
Total 238 805.6 2.8
Sources: PSE Databank, SEC-BusinessWorld Annual Survey of Top 1,000 Corporations (1997), and various company annual reports.
Table 3.11 (continuation)
Total and Per Company Sales, Sector Orientation, Flagship Company, and Affiliated Bank of Selected Business Groups, 1997
Business Group Size Classa Flagship Company Affiliate Bankb

1. Eduardo Cojuangco Large San Miguel Corporation UCPB
2. Lopez Family Group Large MERALCO PCIBank
3. Ayala Corp. Group Medium Ayala Corporation BPI
4. George Ty Medium Toyota Motors Metrobank/Global Bank
5. John Gokongwei Medium Robinson PCIBank
6. Henry Sy Large Shoe Mart Banco de Oro
7. Lucio Tan Large Philippine Airlines Allied Bank
8. Ramon Cojuangco Family Group Large Phil. Long Distance Telephone Bank of Commerce
9. Del Rosario/Phinma Group Medium Phinma Asian Bank
10. Zuellig Group Large Zuellig Pharmaceutical
11. First Pacific/Metro Pacific Group Medium Metro Pacific PDCP Bank
12. Aboitiz Family Group Medium William Gothong and Aboitiz Union Bank
13. Jose Concepcion/RFM Group Medium Swift Foods/RFM Consumer Bank (Savings Bank)
14. Alfonso Yuchengco Medium House of Investment RCBC
15. Andres Soriano Family Group Medium Anscor Asian Bank
16. George Go Medium Equitable Card Network Inc. Equitable Banking Corp.
17. W. Uytengsu/General Milling Group Medium Alaska Milk Corporation
18. David M. Consunji Medium DM Consunji, Inc.
19. Jollibee Foods Medium Jollibee Foods Corporation
20. Luis Lorenzo Family Group Small Pepsi Cola Products
21. Alcantara Family Group Small Alsons Cement
22. Bienvenido Tantoco Medium Rustans
23. Elena Lim Medium Solid Group
24. Andrew Gotianum Small Filinvest East-West Bank
25. Brimo Family Group Medium Philex Mining International Exchange Bank
26. Andrew Tan Medium Megaworld Properties
27. J. P. Enrile/JAKA Group Small Jaka Investment Corporation
28. Jaime Gow Small Uniwide Corporation Ecology Bank (Savings Bank)
29. Guoco Group Small Guoco Ceramics Dao Heng Bank
30. Jose Go Small Ever Gotesco Orient Bank
31. Jardine Davies Medium Republic Cement
32. Gerardo Lanuza Small PhilRealty International Exchange Bank
33. Alfredo C. Ramos Medium National Bookstore International Exchange Bank
34. Gaisano Family Group Small Gaisano Department Store Philbanking Corp.
35. Felipe Yap Small Lepanto Consolidated Mining
36. Felipe F. Cruz Small F. F. Cruz & Co., Inc.
37. Jose Luis Santiago Small PT&T Corp.
38. Keppel Group Small Kepphil Shipyard Inc. Keppel-Monte Bank
39. Robert John Sobrepeña/Fil-Estate Group Small Fil-Estate Development Inc.
a
Size class is measured in terms of sales: Large = greater than P4.48 billion; medium = P1.65 billion to P4.48 billion; small = less than P1.65 billion.
b
Refers to commercial banks, unless otherwise indicated.
Sources: PSE Databank, SEC-BusinessWorld Annual Survey of Top 1,000 Corporations (1997), and various company annual reports.
Table 3.12
Control Structure of the Top 50 Corporate Entities, 1997
Sales
Corporate Entity (P billion) Control Structure Major Industrial Orientation
1. Eduardo Cojuangco 123.7 Business Group Beverages, food, coconut oil, and packaging
2. Lopez Family Group 98.8 Business Group Power distribution, mass communications, and bank
3. Ayala Corporation Group 84.5 Business Group Real estate, bank, food, and car manufacturing
4. National Power Corp. 77.1 Government-Owned Power
5. Petron Corporation 60.8 Publicly Listed/Foreign-Owned Refined petroleum products
6. Pilipinas Shell Petroleum Corporation 53.2 Foreign-owned Refined petroleum products
7. George Ty 49.4 Business Group Banking, car manufacturing, and real estate
8. John Gokongwei 48.5 Business Group Banking, food, and telecommunications
9. Henry Sy 47.5 Business Group Department store and banking
10. Lucio Tan 46.5 Business Group Airlines, beverages, agriculture, and tobacco
11. Ramon Cojuangco Family Group 44.0 Business Group Telecommunications and banking
12. Caltex (Philippines) Inc. 38.0 Foreign-Owned Refined petroleum products
13. Texas Instruments (Phils.), Inc. 37.6 Foreign-Owned Radar equipment and radio remote control apparatus
14. Del Rosario/PHINMA 26.5 Business Group Cement and construction materials
15. Zuellig Group 26.0 Business Group Pharmaceutical and distribution
16. Toshiba Information Equipment (Phils.), Inc. 24.8 Foreign-Owned Electronic data processing equipment and accessories
17. Fujitsu Computer Products Corp. of the Phils. 22.4 Privately-Owned Electronic data processing equipment and accessories
18. Philippine National Bank 19.6 Publicly Listed/Foreign-Owned Bank
19. Mercury Drug Corp. 18.1 Privately-Owned Drugs and pharmaceuticals goods retailing
20. First Pacific/Metro Pacific Group 17.5 Business Group Real estate, telecommunication, and
personal care products
21. Aboitiz Family Group 17.2 Business Group Shipping, power, and food
22. Jose Concepcion/RFM Group 16.3 Business Group Food, beverages, and dairy products
23. Alfonso Yuchengco 15.5 Business Group Investments, banking, construction, and mining
24. Philippine Associated Smelting and Refining Corp. 15.2 Government- and Gold and other precious metal refining
Foreign Jointly Owned
25. La Suerte Cigar and Cigarette Factory 14.9 Privately-Owned Cigarettes
26. Land Bank of the Philippines 14.7 Government-Owned Bank
27. Procter and Gamble Philippines 13.3 Foreign-Owned Soap and detergents
28. Andres Soriano Family Group 13.0 Business Group Management, real estate, and tourism
29. George Go 13.0 Business Group Banking
30. Hitachi Computer Products (Asia) Corp. 12.6 Foreign-Owned Radar equipment and radio remote control apparatus
31. National Steel Corporation 12.0 Government-Owned Operation of rolling mills
32. National Food Authority 11.5 Government-Owned Palay, corn (unmilled), and other grains wholesaling
33. Phil. Amusement and Gaming Corporation 10.7 Government-Owned Other amusement and recreational activities
34. Mitsubishi Motors Phils. Corp. 10.7 Foreign-Owned Motor vehicles
35. W. Uytengsu/General Milling Group 10.4 Business Group Food and dairy products
36. David M. Consunji 10.1 Business Group Construction and mining
37. Uniden Philippines Laguna, Inc. 9.8 Foreign-Owned Television and radio transmitters, and apparatus for
line telephony and line telegraphy
38. EAC Distributors Inc. 9.8 Foreign-Owned Tobacco products wholesaling
39. Philip Morris Philippines, Inc. 9.6 Foreign-Owned Cigarettes
40. Philips Semiconductors Phils., Inc. 9.5 Foreign-Owned Radar equipment, radio and remote control apparatus
41. Jollibee Foods 8.5 Business Group Fast food
42. Citibank N.A. 8.4 Foreign-Owned Bank
43. Luis Lorenzo Family Group 8.3 Business Group Beverages and distribution of agro-industrial products
44. United Laboratories 8.2 Privately-Owned Drugs and medicines, including biological products
45. Development Bank of the Philippines 7.9 Government-Owned Bank
46. Alcantara Family Group 7.9 Business Group Cement and wood products
47. Bienvenido Tantoco 7.8 Business Group Retail merchandising
48. Elena Lim 6.9 Business Group Electronic appliances
49. Brimo Family Group 6.0 Business Group Mining
50. Andrew Tan 5.6 Business Group Real estate
Total 1,290
Share in Top 1,000 Companies Sales (%) 53.6
Sources: SEC-BusinessWorld Annual Survey of Top 1,000 Corporations (1997), PSE Databank, and various company annual reports.
publicly listed commercial banks affiliated to these groups, business groups

had only minority ownership. However, although public investors held a
majority of shares, these were dispersed shareholdings. Actual control of
the banks was still held by the groups.
3.3.2 Corporate Management and Shareholder Control
The main mechanisms by which shareholders control corporate manage-

ment are the board of directors, appointment and compensation of senior
executives, shareholder voting in general meetings and legal protection of
their rights, accounting and auditing, and financial disclosure. This section
reviews practices of corporate management and shareholder control in Phil-
ippine publicly listed companies. The review is based on an ADB survey of
listed companies in the Philippines conducted in 1999 for this study.8
The Board of Directors
As the representative of shareholders in a company, the board of directors

plays a crucial role in corporate governance. The Philippine Corporation
Code mandates the board of directors to exercise its control over a corpora-
tion. Shareholders limit the broad power of the board by ratifying their
decisions on critical corporate affairs, such as amendments of the articles of
incorporation, issuance of corporate bonds, sale or disposition of a substan-
tial portion of corporate assets, investments of corporate funds in other
companies or purposes, issuance of stocks, corporate mergers or consolida-
tions, voluntary dissolution, approval of management contracts, amend-
ments in the bylaws, determination of compensation to board members,
removal of directors, and declaration of cash dividends. The Corporation
Code holds members of the board of directors liable, jointly and individu-
ally, to the corporation and its shareholders for damages caused if they
agree to unlawful corporate acts. They are likewise liable if they pursue
financial interests that conflict with their duty as directors. Shareholders
have the right under the Code to file derivative suits against directors and
officers and other third parties to redress any wrongdoing committed against
the corporation for which the board refuses to sue or to remedy. Of course,
8
The ADB survey of corporate governance practices was conducted in the first semester
of 1999 using a questionnaire prepared by Juzhong Zhuang of the Asian Development
Bank. A total of 44 companies responded to the survey (out of about 221 financial and
nonfinancial listed companies).
actual practices of board functions and the role of shareholders may diverge
somewhat from the legal framework.
Respondents of the ADB survey ranked the following as the most
important responsibilities of the board: making strategic decisions; protect-
ing shareholder interests; appointing senior management; ensuring that a
company follows legal and regulatory requirements; and determining re-
muneration for board directors and senior management, in a descending
order. Making day-to-day management decisions was not regarded as an
important board responsibility.
The ADB survey shows that the number of board directors ranged
from six to nine among the responding companies. The majority of re-
spondents indicated that board directors and chairpersons were elected mainly
on the basis of either relationship with major shareholders (31.9 percent),
or percentages of shareholdings (28.7 percent). But professional expertise
is also an important criterion (28.7 percent). In a few cases, board directors
were the founder of a company, appointed by the Government, or repre-
sentatives of creditors. More than half of respondents indicated that board
directors were elected during the shareholder general meetings. But half of
respondents indicated that they also had board directors directly nominated
by controlling shareholders or management, or the Government without
approval by shareholder general meetings.
According to the ADB survey, a typical chairperson owned
3 to 5 percent of outstanding shares of a company on average, with a maxi-
mum of 36 percent. Board chairpersons in a substantial number of respond-
ing companies did not own significant amounts of shares in their personal
capacities. This can partly be explained by the fact that many family-based
large shareholders control companies through holding companies in which
they have majority ownership.
The average stipulated term of office of the chairperson and mem-
bers of the board for most responding companies was one year. Such a
short tenure may to some extent suggest that large shareholders want to
keep their board members under close control. In practice, the average
number of years of holding office was 6.6 for board chairpersons and
7.5 for board members. The longest was 27 years for board chairpersons
and 14 years for board directors.
Financial compensation is another means by which shareholders
can motivate boards and board members to manage companies in their in-
terests. The ADB survey results show that a chairperson is compensated
either by a fixed fee (52 percent of respondents), a fixed fee plus perform-
ance-related bonuses (30 percent), or a per diem for meetings (18 percent).
Compensation for the chairperson was determined either by the board

(54 percent of respondents), the parent company or company bylaws
(21 percent), or management (15 percent).
The Corporation Code prohibits the removal of any director with-
out cause if that act would deprive minority shareholders of representation
in the board. There was no case found in the ADB survey where a minority
shareholder invoked such a provision of the Corporation Code. Ninety-
three percent of the respondents had one or more outside directors. But the
independence of these outside directors is often doubtful. It is also not clear
whether the outside directors were elected before or after the financial cri-
sis. In some companies, owners brought prominent political or civic lead-
ers into their boards with the intention of improving the visibility of the
corporation rather than improving the quality of board decisions.
Companies may set up special board committees to strengthen due
diligence procedures.9 In practice, however, large shareholder-dominated
companies often view such committees as unnecessary formalities. In the
ADB survey, only 35 percent of responding companies have set up board
committees. About half of the active committees were audit committees
and the other half nomination committees. These committees were estab-
lished only recently.
Senior Executives
The Corporation Code does not specify the role and responsibilities of sen-
ior executives. The ADB survey shows that in 41 percent of the responding
companies, the chairperson of the board was also the chief executive officer
(CEO). A CEO that was not the chairperson of the board was selected on
the basis of professional expertise (42 percent of respondents), relationship
with controlling shareholders (35 percent), or amount of shareholding
(15 percent). This suggests that large shareholders control CEOs by means
other than shareholdings, namely, by tenure and compensation. Unlike in
Western corporate models, CEOs apparently cannot increase their
shareholdings because family-based owners restrict the number of shares
available to management. When the CEO was not the chairperson, the CEO
9
The three most common board subcommittees are the compensation, audit, and nomi-
nation committees. The compensation committee reviews and recommends remunera-
tion plans of key officers and employee stock option plans. The nomination committee
searches and reviews candidates for key management positions. The audit committee
selects external auditors, negotiates the audit fees and scope of audits, and reviews the
findings of external audits.
was not related to the chairperson by blood or marriage in all of the cases
except one.
About 60 percent of respondents of the ADB survey considered
maximizing shareholder values as the CEO’s most important responsibil-
ity. But about 27 percent viewed it to be ensuring steady growth of the
company. A substantial number of respondents also considered looking af-
ter interests of other stakeholders and the general public as among the im-
portant responsibilities of the CEO. An overwhelming 70 percent of re-
spondents said a CEO who was not the chairperson of the board could
make key decisions only after consulting the chairperson or the entire board.
The majority of responding companies compensated their CEOs
by using a fixed salary plus a performance-related bonus. The “golden para-
chute” was apparently not a common feature of CEOs’ compensation pack-
ages. Only one respondent indicated that its CEO was entitled to a substan-
tial amount of compensation, equal to three years’ pay, if the CEO’s con-
tract was preterminated. The average service length of CEOs was 5.2 years.
The longest service rendered was 27 years.
Shareholder Rights and Protection
Under the Corporation Code, shareholders enjoy a number of rights and

protection. Among others, first, to help ensure the representation of minor-
ity interests in the board, the Corporation Code allows cumulative voting
for directors, and prohibits the removal, without cause, of directors repre-
senting minority shareholders. Second, shareholders may exercise appraisal
rights, i.e., the rights to demand payment for shares of those who do not
agree with the board’s decisions when a company (i) amends the articles of
incorporation; (ii) disposes of or mortgages a substantial portion or all of
corporate properties and assets; (iii) invests in another company for a pur-
pose different from that of the corporation; or (iv) enters into a merger or
consolidation with another corporate entity. Third, shareholders have
preemptive rights to maintain their proportionate ownership of a company
under any financing plan that may be undertaken by the company. They can
vote through proxy, including electronic means. Companies are not allowed
to issue shares with different voting rights. Fourth, the Corporation Code
requires that the following types of transactions involving potential conflict
of interest between shareholders and management be reviewed and approved
by the board: (i) dealings of a company with directors or officers; (ii) con-
tracts with companies linked through interlocking directorship; and (iii)
involvement of directors in businesses that compete with the company. Fifth,
shareholders are allowed to inspect a company’s stock and transfer books.

Regardless of the amount of shares held, a shareholder could file a deriva-
tive suit against a director to redress a wrongdoing. Sixth, in cases of corpo-
rate takeovers, potential buyers are required to make a tender offer to mi-
nority shareholders at a price equal to the offer it is making to controlling
shareholders. Last, the Revised Securities Act has strict provisions designed
to deter insider trading.
In practice, because of poor compliance and enforcement as well as
some loopholes in corporate laws, minority shareholders were often vul-
nerable to the expropriation of their interests by controlling shareholders
and management. Few minority shareholders actually exercised their ap-
praisal rights. Those who did were usually offered below-market values for
their shares. Dissenting minority shareholders did not necessarily have re-
course to a third party for an objective appraisal of their shares. During
annual general meetings where minority shareholders could exercise their
rights, because of the dominance of large controlling shareholders, there
were often no real discussions of board proposals or actions. There was
little chance that a proposal from minority shareholders could ever get ap-
proved. In the case of preemptive rights, the Corporation Code allows a
company to waive this in the article of incorporation upon registration or in
a subsequent amendment.
Although transactions involving potential conflict of interest need
to be reviewed and approved by the board, there are no requirements for
disclosing such transactions to shareholders under the Corporation Code.
Consequently, it is doubtful whether this legal protection for shareholders
will achieve what it intends to in practice. Being appointees of controlling
shareholders, board members are likely to be under pressure to approve
transactions that benefit controlling shareholders to the detriment of minor-
ity shareholders. In cases of derivative suits against directors for wrongdo-
ings or actions against insider trading, SEC proceedings were costly and
time-consuming. In the past, no one has been successfully prosecuted for
insider trading. There was only one case, that of Interport Resources Cor-
poration, where SEC made substantial progress in investigation. But an
action by the regular court on a petition by the company’s owners/officers
prevented SEC from pursuing the investigation. The company was dissolved
before indictment.
An effective market for corporate control may provide some pro-
tection for minority shareholders against the expropriation of their interests
by the incumbent management. However, in the Philippines, hostile takeo-
vers are not common because in most companies ownership is concentrated
in a few controlling shareholders and families. Nevertheless, the successful

hostile takeover by First Pacific Group of PLDT, a company that is widely
held but has a large shareholder, demonstrates the feasibility of developing
a market for corporate control if publicly listed companies were widely
held.
The ADB survey provides further evidence on shareholder rights,
protection, and their activism in the corporate sector. The responding com-
panies had on average 43,522 shareholders each. Nominees held about
45 percent of the outstanding shares. An average of 327 shareholders per
company attended the last annual meeting and they represented about
63 percent of total shares. About 333 shareholders per company voted by
proxy, representing 3.4 percent of shareholders but 58 percent of out-
standing shares. The brokers or securities companies were the most im-
portant proxy voters, followed by management and banks. An average of
about 4,900 shareholders per company did not vote during the last annual
general meeting, representing about 24 percent of outstanding shares. Table
3.13 summarizes rights that the shareholders of the responding compa-
nies enjoyed.
Table 3.13
ADB Survey Results on Shareholder Rights
Percentage of Respondents
Shareholder Rights Yes No
One Share One Vote 100.0 0.0
Proxy Voting by Mail 51.4 48.6
Preemptive Rights on New Share Issues 70.0 30.0
Prohibition of Loans to Directors 36.8 63.2
Mechanisms to Resolve Disputes with Company 56.8 43.2
Independent Audit 92.7 7.3
Mandatory Independent Board Committees 43.2 56.8
Severe Penalty for Insider Dealings 69.4 30.6
Source: ADB Survey of Philippines Publicly Listed Companies, 1999.
Independence of Auditing
The ADB survey revealed that all the responding companies had an inde-
pendent auditor, appointed either by the board or shareholders during the
annual general meetings. About 93 percent of the respondents contracted
their annual audit to an international auditing firm. On average, the re-

sponding companies have been associated with their present auditors for
13 years, with the longest being 50 years. More than 20 percent of the
respondents have been dealing with their auditors for 20 years or more.
Because of such long relationships, independent auditors are likely
to be quite familiar with the operations and financial aspects of their cli-
ents. Nevertheless, independent audits do not guarantee the absence of ques-
tionable accounting practices. In two celebrated cases, a preferred inde-
pendent auditing firm either reported assets that did not exist (Victorias
Milling Corp., a bankruptcy case) or hid a large amount of liabilities and
losses (PLDT, a hostile takeover case).
Disclosure and Transparency
The disclosures required by the Corporation Code are achieved through

shareholders’ inspection of a company’s books and an “information state-
ment” that companies should regularly issue to shareholders. The Code
grants a shareholder the right to inspect business records and minutes of
board meetings. Meanwhile, the information statement transmitted to every
shareholder should contain the audited financial statements, a management
discussion of the business, and an analysis of financial statements.
SEC requires all registered companies to periodically submit re-
ports for the purpose of updating their respective registration statements
filed at the agency. From publicly listed companies, the agency also re-
quires reports on important details about their operations and management,
imposing penalties on violators.
In practice, financial reporting standards allow room for interpreta-
tion by independent auditors. An auditor can choose among three alterna-
tive sets of GAAP, namely, the local standard (i.e., as practiced in the Phil-
ippines), the international accounting standard, or the accounting standard
of a specific developed country (for example, the US GAAP). These differ-
ent versions of GAAP, although closely related, vary in their evaluation of
some major accounts such as securities and other liquid assets, long-term
leases, investments in subsidiaries, revaluation of fixed assets, foreign cur-
rency-denominated liabilities, intangible assets, intra-company receivables
and payables, and consolidation policy.
The accounting profession in the Philippines is considered fairly
developed and Manila is a known regional center for accounting expertise.
Most major international auditing firms operate in the Philippines. Never-
theless, there are many cases of poor financial reporting by large companies.
Many small- and medium-sized businesses did not have quality financial
statements. Publicly available financial information was often of low qual-
ity, arguably, because of the highly concentrated ownership of Philippine
corporations, as large shareholders had no need for financial statements to
monitor their companies and management that were under their own con-
trol. Even for widely held public companies, the authorities, namely SEC
and the Philippine Institute of Certified Public Accountants (PICPA), some-
times did not penalize independent auditors for poorly prepared audited
financial statements.
Corporate Control by Controlling Shareholders
As in many other Asian countries, controlling shareholders in the Philip-

pines usually exercise their corporate control through the setting up of
business groups, which are usually controlled by holding companies.
Holding companies enable controlling shareholders to collectively own
shares of other companies in a business group and to centralize the group’s
management. They allow risk pooling and can achieve economies of scale
in management, marketing, and financing. However, they also make it
easier for controlling shareholders to expropriate interests of minority
shareholders. Such expropriation is due to gaps between control rights
and cash flow rights that pyramiding structures of business groups centered
on holding companies create. When control rights exceed cash flow rights,
large shareholders can use their control to transfer wealth from a com-
pany in a business group where they have low cash flow rights to another
where they have high cash flow rights, e.g., from a minority-controlled to
a majority-owned subsidiary. The popularity of holding companies in the
Philippine corporate sector is evident: with a market capitalization of
P258.6 billion, they formed the largest group of corporate entities in the
Philippine stock market in 1997, accounting for 27 percent of the total
stock market capitalization that year.
Laws of many Southeast Asian countries allow the establishment
of pure holding companies (with the exception of Korea up to 1999). Fam-
ily-based controlling shareholders use them as vehicles for controlling busi-
ness groups. Pure holding companies can be privately owned, which are
closely held by large shareholders and family members, and publicly listed,
which are controlled by large shareholders with public investors in a minor-
ity position. “Selective public listing” is a strategy of many business groups
for channeling funds from public investors to member companies. Control-
ling shareholders usually select member companies that require large
equity investment for public listing. Selective public listing combined with
use of pure holding companies to own and control member companies lead
to various organizational structures of business groups.
Some holding companies are not pure holding companies. They
are operating companies but at the same time have majority or minority
share ownership in other operating companies. In cases of minority owner-
ship, controlling shareholders of a parent company hold these shares as
“strategic investments” that they could increase or reduce depending on
business opportunities. These investments can be classified according to
the role of the controlling shareholders in the management of the invested
company, namely, active minority or passive minority holdings. In an ac-
tive minority-owned operating company, the parent company plays an ac-
tive role in management. Depending on the performance of the company,
controlling shareholders of the parent company may eventually increase
their shares to a majority position. In a passive minority-owned operating
company, controlling shareholders of the parent company do not partici-
pate in management. They may have a representative in the board. Control-
ling shareholders gain additional leverage in management control over mi-
nority-owed companies. This is most evident when a minority-owned com-
pany transacts with other members of the group where the controlling share-
holders hold majority control. Minority-owned companies may also need
access to resources of the group, especially its management, financing, and
customers.
The stylized features of control structure of business groups in the
Philippines can be illustrated by using a leading Philippine family-based
conglomerate, Ayala Corporation, as an example (Figure 3.1). Ayala Cor-
poration is a publicly listed pure holding company. It is majority-owned by
Mermac, Inc., a family-owned pure holding company, with 59 percent of
shares. Public investors collectively hold a minority of 41 percent. Ayala
Corporation then holds a sufficient number of shares to achieve various
degrees of control in two types of holding companies and two types of
operating companies. It has a majority control at 71.1 percent of Ayala
Land, minority control at 42.4 percent of Bank of the Philippine Islands, an
active minority share at 44.6 percent of Globe Telecom, and a passive mi-
nority investment at 15 percent in Honda Cars (Philippines). The first three
companies are publicly listed while the fourth, Honda Cars (Philippines), is
privately owned. Ayala Corporation’s majority- and minority-controlled
operating companies are also holding companies. Ayala Land fully owns
Makati Development Corporation and holds a minority stake, at 47.2 per-
cent, of Cebu Holdings (a publicly listed government-owned company).
Figure 3.1
Corporate Control Structure: The Case of Ayala Corporation
Family Public
Members Investors
100%
Mermac,
Privately-Held Pure
Inc.
Holding Company
(58.96%) (41.04%)
>50% <50%
Publicly Listed Pure Ayala

Holding Company Corporation
>50% <50% >15% &<50% <15%

Majority- Minority- Active Passive
Controlled Controlled Minority- Minority-
Operating Operating Owned Owned
and and Pure Pure
Holding Holding Operating Operating
Company Company Company Company
Ayala Bank of the Globe Honda Cars

Land Philippine Islands Telecoms Phils., Inc.
(71.06%) (42.44%) (44.6%) (15%)
>50% <50% >50% <50%

Majority- Minority- Majority- Minority-
Controlled Controlled Controlled Controlled
Pure Pure Pure Pure
Operating Operating Operating Operating
Company Company Company Company
Makati Cebu BPI Family
Development Holdings, Savings
Corporation Inc. Bank
(100%) (47.2%) (100%)
Note: Data as of 31 December 1998.

Bank of the Philippine Islands owns 100 percent of the BPI-Family Sav-
ings Bank, a privately owned company.
The control of companies through indirect corporate shareholdings,
defined as control by large shareholders of an operating company through
minority ownership by several companies, is illustrated in the Lopez Group
(Figure 3.2). Being in the public utilities sector, companies in the Lopez
Group are large and minority-controlled. MERALCO, Rockwell Land, and
First Philippine Industrial Corporation are indirectly held by a majority-
controlled holding company, Benpres Holdings, and a minority-controlled
holding company, First Philippine Holdings Corporation. The Lopez Fam-
ily owns a significant portion of shares of these companies if these indirect
shareholdings are summed up and attributed to the beneficial owners. Gen-
erally, however, indirect shareholdings do not appear to be a prevalent prac-
tice in the Philippine corporate sector.10
The Ayala family’s control rights over BPI was 1.7 times its cash
flow rights by virtue of the double layer pyramid structure of the Ayala
group.11 The Lopez family’s control rights over MERALCO was 5.7 times
its cash flow rights by virtue of its cross-holdings via Benpres and First
Holdings.12 These examples show that even when large shareholder groups
are minority shareholders, they exercise far greater control (two to five times
more) than they are entitled to by virtue of their ownership rights. The
situation offers large shareholders tremendous incentive to move resources
10
For details, see the World Bank research papers by Stijn Claessens, Simeon Djankov,
and Larry H. P. Lang: 1999a, The Separation of Ownership and Control in East Asian
Corporations; 1999b, Expropriation of Minority Shareholders: Evidence from East Asia;
and 1999c, Diversification and Efficiency of Investment by East Asian Corporations.
See also Stijn Claessens, Simeon Djankov, Joseph P. H. Fan, and Larry H. P. Lang,
1998, Who Owns and Controls East Asian Corporations?
11
Ibid.
[control right] [control rights via Ayala Corporation]
=
[cash flow right] [cash flow rights via Ayala Corporation]
= [42.44%] / [58.98% x 42.44%]
= [42.44%] / [25%]
= 1.7 times
12
Ibid.
[control right] [sum of control rights via Benpres and First Holdings]
=
[cash flow right] [sum of cash flow rights via Benpres and First Holdings]
= [1.64% +37.5%] / [(88.3% x 1.64%) + (37.5% x 14.76%)]
= [39.14%] / [1.3% x 5.5%]
= [39.14%] / [6.8%]
= 5.7 times
Figure 3.2
Corporate Control Structure: The Case of Lopez Group
Family Public
Members Investors
Lopez, Privately-Held Pure 11.7%

Inc. Holding Company
88.3% 62.5%
Benpres Majority-Controlled Minority-Controlled First Philippine
Holding Publicly Listed Pure Publicly Listed Pure Holdings
Corporation Holding Company Holding Company Corporation
Manila Minority-
1.64% Controlled 14.76%
Electric
Company Operating
Company
Rockwell Minority-
24.5% Controlled 24.5%
Land
Corporation Operating
Company
First Majority-
Philippine 50% Controlled 50%
Industrial Operating
Corporation Company
Note: Data as of 31 December 1998.

from their subsidiaries to their majority-owned publicly listed holding com-

pany or elsewhere up the pyramid. The controlling shareholders could also
use the resources of minority-owned subsidiaries to engage in overexpansion
and empire building investments.
3.3.3 The Role of Creditors in Corporate Control
This study examines the role of creditors in corporate control by looking at

(i) how corporate borrowers perceive the control power of their creditors,
and (ii) how the legal framework protects creditor interests and rights.
According to the ADB survey, a publicly listed company dealt with an av-
erage of eight banks and six nonbank financial institutions. Most respond-
ing companies had dealt with their commercial bank creditors for more
than five years and nonbank creditors for only about two years. The average
company, the data suggest, accessed nonbank creditors for specific pur-
poses but dealt with commercial banks on a long-term basis.
Sixty-one percent of respondents indicated that creditors usually
asked for collateral for all types of loans, whether for working capital or
capital expenditure. However, it was not common for creditors to take legal
action against debtors or foreclose on those assets held as collateral in cases
of default. Only a minority of respondents (18 percent) indicated that they
had faced adverse creditor actions such as a collection lawsuit or foreclos-
ure of collateral. Most respondents (81 percent) indicated that they had
renegotiated with their creditors on loan repayment when they faced liquid-
ity problems.
The survey results also revealed that creditors did not intervene in
the management of borrowing companies and wanted to maintain business
relationships with corporate borrowers even when they were in trouble.
Some 85 percent of respondents believed that creditors had no influence or
only weak influence on corporate management, while 80 percent reported
that creditors with which they had renegotiated loans were still willing to
lend to them.
Suspension of Payments of Debts
Under PD 902-A, SEC could suspend the rights of a creditor to demand

payment from a borrower in accordance with the terms of the loan
agreement. PD 902-A granted SEC blanket powers to intervene and adjudi-

cate claims. This explains why creditors invariably oppose any move by
borrowers to file for suspension of payments at SEC.
There are two modes of suspension of payments under PD 902-
A. The first mode is for simple suspension of payments, under which, a
company’s assets are of sufficient value to cover all of its debts; the bor-
rower requests to defer payments for a certain period to enable it to gen-
erate the necessary liquidity. The second mode is for suspension of pay-
ments with the appointment of a management committee (Mancom) or
rehabilitation receiver. Under this mode, it is not clear whether the corpo-
rate borrower’s assets are of sufficient value to cover its liabilities. An
impending conflict between the two parties could result in dissipation of
assets of the company due to creditors’ action to liquidate the company’s
assets they hold as collateral. Under such circumstances, SEC could in-
tervene to avoid asset dissipation. The borrower will propose a rehabilita-
tion plan to SEC, which determines the viability of the rehabilitation plan
and appoints a Mancom or a rehabilitation receiver to implement the pro-
posal if approved.
There are no legal or practical limits to the time period of suspen-
sion of payments. The law on suspension of payments envisions resetting
the corporation’s business for a temporary period to prevent its irreversible
collapse. In practice, the litigation process, including the rehabilitation of
the corporation, could take an indefinite period. For example, SEC and the
court required that the creditors of BF Homes, Inc., a real estate-based
business group, wait for 14 years from the time the company petitioned for
suspension of payments in 1984. The corporation continued to be under
rehabilitation receivership as of June 1999.
3.4.1 The Financial Market and Instruments
The Philippine financial market has remained underdeveloped compared

with other countries in the region. Commercial banks hold about three
fourths of the resources of the financial system. Consequently, bank credit
is the main source of corporate financing. Markets for equity and debt
instruments are small and there are serious structural problems that dis-
courage large, profitable companies from going public. Publicly listed
companies do not represent a cross section of the Philippine corporate
sector. Of the 221 companies listed in the Philippine Stock Exchange in

1997, only 84 had sales large enough to be placed in the top 1,000 compa-
nies. Most publicly listed companies issue only up to 20 percent of total
shares to the public, the minimum required to qualify as a public corpora-
tion. As a result, most listed companies are controlled by their five largest
shareholders.
The Philippine stock market is not a liquid market. Table 3.14 shows
that the average volume of daily trading in 1997 stood at P2.4 billion (or
$59 million using the average exchange rate). Foreign funds were wary of
the Philippine stock market because of its limited liquidity. They invested
in only a few large companies whose shares were relatively liquid. The
market capitalization of the Philippine stock market in August 1997, about
the size of Thailand’s, was one of the smallest in the region at $47.7 billion,
compared with Malaysia ($186 billion), the Republic of Korea (henceforth,
Korea) ($143 billion), and Indonesia ($61.5 billion). The ratio of market
capitalization to GDP over the last 15 years put the development of the
Philippine stock market at par with other developing markets in the region
(e.g., Korea and Thailand). Malaysia, however, is far ahead of the flock.
Interest rates, inflation, and fiscal management were among inter-
related factors explaining the underdeveloped state of the Philippine finan-
cial market. From the 1970s up to the early 1990s, the country experienced
double-digit inflation. The Government financed its chronic fiscal deficits
by issuing short-term Treasury bills, while interest rates were at high levels
and volatile. The stock market was depressed up to the early 1990s.
Rising stock prices during the Ramos administration reflected to
some extent the business optimism. The period 1993-1997 was one of lower
inflation and declining lending rates. Equity financing through IPOs was
active. However, the collapse of the stock market during the Asian financial
crisis suggested that the earlier stock price surge in part reflected the “bub-
bles” common to other stock markets in the region.
The crisis affected the Philippine corporate sector, but not to the
same extent as it did in other Asian economies. In part, this is because,
compared with other economies, Philippine companies were less leveraged,
less exposed to foreign debt, especially short-term debt, and less engaged
in risky investments. Most companies invested only in projects that met
hurdle rates as high as 20 to 30 percent and had short payback periods.
Foreign portfolio investments also remained small. Even in the real estate
sector, companies expanded only at a moderate pace.
Equity instruments include common stocks, preferred stocks, and
convertible securities. The corporate sector raised a substantial amount of
Table 3.14
Philippine Stock Market Performance, 1983-1997
Daily Trading Volume
Market Capitalization Gross Domestic Product Ratio of Market
Year (year end, P billion) (current prices, P billion) Capitalization to GDP (P million) ($ million)
1983 19.5 369.1 0.1 — —
1984 16.5 524.5 0.0 — —
1985 12.7 571.9 0.0 — —
1986 41.2 608.9 0.1 — —
1987 61.1 682.8 0.1 129.5 6.2
1988 88.6 799.2 0.1 72.7 3.4
1989 261.0 925.4 0.3 207.9 9.3
1990 161.2 1,077.2 0.2 114.3 4.1
1991 297.7 1,248.0 0.2 158.3 5.9
1992 391.2 1,351.6 0.3 314.4 12.5
1993 1,088.8 1,474.5 0.7 728.7 26.3
1994 1,386.5 1,692.9 0.8 1,445.6 59.2
1995 1,545.7 1,906.3 0.8 1,515.9 57.8
1996 2,121.8 2,171.9 1.0 2,686.0 102.2
1997 1,251.3 2,421.3 0.5 2,373.2 59.4
Note: Combined transactions of Makati and Manila Stock Exchanges are not available for the years 1983 to 1986.
equity capital through IPOs during the stock market boom from 1993 to the
first half of 1997. From 1988 to 1997, about 127 companies went public
with a total value of offerings of about P134.6 billion, of which 85 percent
was raised from 1993 to the first half of 1997. Because existing sharehold-
ers wanted to retain their proportionate control over their companies, the
rights issue was a popular way of raising equity capital. Few companies
offer preferred stocks because the Philippine tax system does not allow tax
deductibility of dividends on preferred stocks.
Debt instruments include negotiated credits and debt securities.
Negotiated credits, which were the principal source of corporate financing
in the Philippines, include bank credits, asset-backed credits, leases, dis-
counting of receivables, and inventory financing.
Debt securities include commercial papers and corporate bonds.
Only a few large companies floated commercial papers because of the lim-
ited market, tight regulations, and high transaction costs. Under SEC regu-
lations, issuing companies had to undergo a process of review and credit
rating by the Credit Information Bureau Inc., which ultimately influences
the pricing of commercial paper issues. The underwriter, which in most
cases is an affiliate of the issuing company, sells these commercial papers
through brokers. The largest buyers have been commercial banks, which
buy commercial papers either for their own account or for their clients.
Corporate bonds are another type of debt securities. However, cor-
porate bond issuing was even more limited. This is because only companies
with strong capitalization and predictable cash flows such as public utility
companies can issue bonds. The corporate bond market was stunted, moreo-
ver, by volatile interest rates and the absence of a secondary market.
The picture of the financial system that emerges is thus one of lim-
ited capital markets, lack of competition among financial institutions, and
the dominance of large commercial banks. Capital markets cannot provide
the market discipline that corporate investors need. Only the commercial
banks, by virtue of their large stakes in the financial system, are in a posi-
tion to provide such discipline. However, because business groups often
own large commercial banks, a strong regulatory system for bank supervi-
sion is imperative.
The study looked at retained earnings, new equity, and debt as sources of
corporate financing by using flow of funds analysis. The measures used in
the analysis are:
(i) Self-financing ratio of fixed assets (SFRF): ratio of changes

in retained earnings to changes in fixed assets. It measures
a company’s capacity to finance growth in fixed assets by
internally generated funds;
(ii) Self-financing ratio of total assets (SFRT): ratio of changes
in retained earnings to changes in total assets. It measures
a company’s capacity to finance asset growth by internally
generated funds;
(iii) New equity financing ratio (NEFR): ratio of changes in
stockholders’ equity (excluding retained earnings) to
changes in total assets;
(iv) Incremental debt financing ratio (IDFR): ratio of changes
in total liabilities to changes in total assets. It measures a
company’s reliance on borrowings in financing asset
growth;
(v) Incremental equity financing ratio (IEFR): ratio of changes
in shareholders’ equity inclusive of retained earnings to
changes in total assets. It measures a company’s capacity
to finance asset growth by equity capital. By definition, it
is one minus IDFR.
All Companies
Financial flows data were derived from the SEC-BusinessWorld Annual Sur-
vey of Top 1,000 Corporations in the Philippines from 1988 to 1997. As
shown in Table 3.15, during this period, the average SFRF was high at
109 percent. Retained earnings were sufficient to finance the entire growth of
fixed assets in the corporate sector. On the other hand, the SFRT was low at
Table 3.15
Financing Patterns of the Corporate Sector, 1989-1997
Financing
Indicators 1989 1990 1991 1992 1993 1994 1995 1996 1997 Average
SFRF 1.1 0.4 1.4 0.9 0.5 0.9 0.9 0.8 2.8 1.1
SFRT 0.1 0.2 0.5 0.3 0.2 0.3 0.1 0.0 0.0 0.2
NEFR 0.4 0.2 0.4 0.4 0.3 0.3 0.3 0.4 0.1 0.3
IDFR 0.5 0.6 0.2 0.3 0.5 0.4 0.6 0.5 0.9 0.5
IEFR 0.5 0.4 0.8 0.7 0.5 0.6 0.5 0.5 0.1 0.5
Source: SEC-BusinessWorld Annual Survey of Top 1,000 Corporations in the Philippines, 1988-1997.
only 19 percent, implying that internal funds were far from sufficient to fi-
nance growth in total assets. The corporate sector used new equity to finance
32 percent and new debts to finance 49 percent of growth in total assets.
There were significant year-to-year variations. In periods of an eco-
nomic crunch such as in 1989, 1991, and 1997, the SFRF was higher. Com-
panies financed fixed assets from internal sources in hard times. In all the
years, internal funds were not a significant source of financing growth in
total assets, except in 1991, when it financed 45 percent of it. The corporate
sector consistently relied on debt and new equity to finance asset growth
throughout the period. In 1997, retained earnings declined and few new
equity investments flowed into the corporate sector. Total assets grew by
23 percent that year, with debt providing 93 percent of the financing re-
quirements. As a result, the level of corporate leverage increased. It can also
be observed that the relative importance of stockholders’ equity (including
retained earnings and new equity investment) was declining and that of debts
increasing in financing the growth of the corporate sector from 1991 to 1997.
This was mainly caused by the declining contribution from retained earnings,
suggesting that there was a deterioration of financial performance in the Phil-
ippine corporate sector in the years running up to the crisis.
Corporate Financing by Ownership Type
As shown in Table 3.16, for all three types of companies—publicly listed,

privately- and foreign-owned, debts were the most important source of fi-
nancing. Retained earnings were the least important, except for foreign-
owned companies that had a negative new equity financing ratio, reflecting
the capital flight caused by political instability in the early 1990s. On
Table 3.16
Corporate Financing Patterns by Ownership Type, 1989-1997
Financing Indicators Publicly Listed Privately-Owned Foreign-Owned
a
SFRF 1.3 0.8 1.7
SFRTa 0.3 0.2 0.2
NEFR 0.3 0.3 (0.0)
IDFRa 0.5 0.6 0.9
IEFRa 0.5 0.5 0.1
a
Excludes negative balances.
average, publicly listed companies relied more on new equity financing

than privately- and foreign-owned companies. Foreign-owned companies
relied more heavily on debt financing, contributing 90 percent of growth in
total assets, compared with 47 percent for publicly listed companies and 55
percent for privately-held firms. This financing pattern supports the earlier
finding that foreign-owned companies had the highest leverage among the
three types of companies.
A breakdown of the financial structure of publicly listed companies
measured in balance sheet items is shown in Table 3.17. It presents a compo-
sition analysis of assets and financing sources for the period 1992-1996.
The sector built up its short-term debts, especially bank loans, significantly
Table 3.17
Composition of Assets and Financing of the Publicly Listed Sector,
1992-1996
(percent)
1992 1993 1994 1995 1996
Assets
Cash and Temporary Investment 14.7 14.0 19.3 13.7 13.3
Accounts Receivable 13.5 13.3 12.0 12.1 13.0
Inventory 12.7 11.7 9.4 10.5 9.8
Other Current Assets 2.4 2.4 2.6 3.4 2.8
Total Current Assets 43.3 41.3 43.4 39.8 38.9
Investment 10.2 12.5 12.9 16.9 16.0
Fixed Assets 42.3 41.8 38.9 38.6 37.7
Other Assets 4.2 4.4 4.8 4.7 7.4
Total Assets 100.0 100.0 100.0 100.0 100.0
Liabilities and Equity
Accounts Payable 12.2 10.9 9.4 9.3 9.3
Short-Term Loans 12.2 12.2 10.4 10.9 13.8
Other Current Liabilities 3.5 3.6 3.7 3.9 3.8
Total Current Liabilities 27.9 26.8 23.5 24.1 26.8
Long-Term Debt 16.8 17.6 16.5 15.8 16.9
Other Long-Term Debt 0.0 0.1 0.0 0.1 0.1
Other Long-Term Liabilities 6.8 7.2 8.3 9.1 10.0
Total Liabilities 51.6 51.6 48.3 49.1 53.8
Stockholders’ Equity 48.4 48.4 51.7 50.9 46.2
Total Liabilities and
Stockholders’ Equity 100.0 100.0 100.0 100.0 100.0
in 1996 and became more vulnerable to the financial crisis in 1997. The
traditional measure of liquidity, the current ratio,13 was at 1.45 in 1996,
indicating that many publicly listed companies were likely to be in a tight
liquidity position.
Corporate Financing by Control Structure
Conglomerates have certain advantages in financing because of the oppor-

tunities offered by the internal capital markets, their inherent ability to pool
risks, the easier access to external credit, and economies of scale in fund
raising. As shown in Table 3.18, the average SFRF of business groups was
higher compared with that of independent companies. On average, retained
earnings financed 113 percent of growth in fixed assets and 23 percent of
growth in total assets from 1989 to 1997 for business groups, as opposed to
94 and 30 percent, respectively, for independent companies. The SFRF for
independent companies would have been even lower if the highly profitable
foreign-owned companies were excluded.
Table 3.18
Financing Patterns by Control Structure, 1989-1997
Financing Indicators Group Member Independent Company
SFRFa 1.1 0.9

SFRTa 0.2 0.3
NEFR 0.3 0.3
IDFRa 0.5 0.5
IEFRa 0.6 0.5
a
Excludes negative balances
Group companies financed an average of 45 percent of growth in

total assets by debt, compared with an average of 54 percent for independ-
ent companies. Group companies were generally more profitable than inde-
pendent companies. Further, group companies usually financed their in-
vestment in member companies by equity rather than debt. For these two
reasons, group companies were less reliant on debt financing than
13
Defined as total current assets divided by total current liabilities. The normal standard
liquid position is a current ratio of 2 or higher.
independent companies. These results support the earlier finding that the
leverage of business groups was lower than that of the independent compa-
nies from 1988 to 1997.
Corporate Financing by Firm Size
SFRF was highest for medium-sized companies, with an average of 3.06.

The corresponding ratio was 0.76 for small companies and 0.88 for large
companies (Table 3.19). The lower SFRF for large companies may be caused
by their larger outlays for growth in fixed assets. With assets growing at a
fast pace during this period, medium-sized companies used more debts,
averaging 61 percent of growth in total assets, compared with 55 percent
for large companies and 47 percent for small ones.
Table 3.19
Financing Patterns by Firm Size, 1989-1997
Financing Indicators Large Medium Small
SFRFa 0.9 3.1 0.8

SFRTa 0.2 0.3 0.2
NEFR 0.3 0.2 0.3
IDFRa 0.6 0.6 0.5
IEFRa 0.5 0.4 0.5
a
The medium-sized companies’ high debt financing ratio was due

mainly to three years of complete reliance on debt to finance growth. These
years were 1991 with 110 percent, 1993 with 96 percent, and 1997 with
131 percent. Large companies’ IDFR of 0.55 was substantially higher than
the small companies’ 0.47. Large firms consistently increased their reliance
on debts from 1994 to 1997.
Corporate Financing by Industry
The manufacturing sector had an average SFRF of 1.08 and SFRT of 0.50
(Table 3.20). On average, equity financed 42 percent of incremental asset
growth. There was also increased reliance on debt financing. Excluding
1991, when debts declined, the manufacturing industry financed 57 percent

of its total asset growth by debt. While this level is considered prudent, the
total debt ratio was much higher in 1996 at 0.79 and in 1997 at 0.91. Low
incomes diminished the equity financing position of the manufacturing in-
dustry toward the crisis year.
Table 3.20
Financing Patterns by Industry, 1989-1997
Utilities and Real Estate
Financing Indicators Manufacturing Construction Services and Property
SFRFa 1.1 0.5 0.3 3.6

SFRTa 0.5 (0.2) 0.3 0.3
NEFR 0.4 0.7 0.3 0.4
IDFRa 0.6 0.5 0.6 0.4
IEFRa 0.4 0.5 0.4 0.6
a
The real estate industry financed its growth by substantial equity

funds. Up to 1997, the industry generated internal funds, achieving an aver-
age SFRF of 3.58 and SFRT of 0.27. Equity financed an average of
62 percent of total asset growth. During the crisis year, debt financed about
78 percent of asset growth in real estate. In the eight years preceding the
crisis, the incremental equity ratios of the industry were high, ranging from
41 to 118 percent. Equity financed the rapid expansion in the industry’s
assets in the period 1994 to 1997. Since the real estate boom coincided with
that of the stock market, many of the leading real estate companies success-
fully went public during that time.
The construction sector was a heavy user of debt financing. Its SFRF
and SFRT were volatile because of chronic losses and reduction in fixed
and total assets. The utilities sector showed weaknesses in internal fund
generation in 1989-1994, with an SFRF as low as 0.04. The situation im-
proved beginning 1994, increasing to 0.47 two years later. Excluding 1997
when fixed assets declined, SFRF for the sector averaged 0.32, while SFRT
averaged only 0.29. The effects of the crisis of 1997 were adverse. Total
liabilities increased partly as a result of the local currency devaluation and
financed all of asset growth for the year. Incremental equity financing
amounted to an average of 44 percent of total asset growth. The sector had
the highest leverage among all industries that year.
3.4.3 Ownership Concentration, Financial Leverage, and

Performance
Previous studies on corporate governance have often associated owner-

ship concentration with heightened risk-taking by companies.14 Large
shareholders may borrow excessively to undertake risky projects, know-
ing that if an investment turns out to be successful they could capture
most of the gain; while if it fails, creditors bear the consequences. Large
shareholders may also overuse financial leverage to avoid diluting owner-
ship and control.
Using the PSE database, the degree of ownership concentration,
measured by the percentage of shareholdings of the largest five sharehold-
ers, was regressed against measures of profitability and of financial lever-
age. Three regressions were run with the shareholding of the largest five
shareholders as an independent variable and ROA, ROE, and leverage, al-
ternatively, as the dependent variable. As shown in Table 3.21, the coeffi-
cient of the ownership concentration measure in all the three regressions is
positive and statistically significant. ROE, ROA, and financial leverage are
all positively and significantly related to the degree of ownership concen-
tration. These results suggest that companies with higher ownership con-
centration tend to be more highly leveraged and, at the same time, more
profitable.
Table 3.21
Ownership Concentration, Profitability, and Financial Leverage
Dependent Variable
Item ROE ROA Leverage
Coefficient of Ownership Concentration 0.00056 0.00036 0.00125

T-statistics 1.769 2.287 2.421
Adjusted R-squared 0.004 0.008 0.009
F-statistics 3.130 5.230 5.860
Leverage = the ratio of total assets to total equity, ownership concentration = the total shareholdings of
the top five shareholders, ROA = return on assets, ROE = return on equity.
Source: Author’s estimates based on the PSE databank, 1992-1996.
14
See for example Michael Jensen (1993), The Modern Industrial Revolution, Exit, and
the Failure of Internal Control Systems, Journal of Finance 48: 831-880.
3.5.1 The Financial Crisis: Causes and Manifestations
A devaluation of the local currency signaled the arrival of the financial

crisis in 1997. The Government explained that the country had “sound eco-
nomic fundamentals” but that the problems were caused by “contagion.”
The Government’s judgment that economic fundamentals were strong was
based on stable growth rates, which averaged 4.5 percent per year from
1992 to 1997. Although much lower than those of other Asian countries,
the country’s GDP growth pace indicated that it did not have a “bubble
economy,” that is, an overexpansion of capacities. The costs of an eco-
nomic correction brought about by the regional financial crisis were thought
probably to be low due to the sound structure of the real economy and the
strong position of the financial sector.
The structure of the economy may be understood by looking at its
sectoral composition and export competitiveness. The largest contributors
to GDP were services at 43 percent, industry at 34 percent, and agriculture
at 21 percent. Exports were growing at about 20 percent per year in the
three years preceding the crisis. Manufactures accounted for about 85 per-
cent of exports, with commodities accounting for the balance. The export
sector had a very narrow breadth. In 1997, more than half (52 percent) of
exports were semiconductors. Garments was the second largest export sec-
tor at about 9 percent, but its share had been declining by 4 percent per year
since 1995. Commercial and industrial activities in the country were largely
oriented to domestic markets. About 80 percent of imports were capital
goods (particularly power generating and telecommunications equipment),
raw materials, and intermediate goods. Net trades in goods and services
averaged a deficit of 4.8 percent of GDP from 1995 to 1997. The country
experienced balance of payments surpluses but these were due to transfers,
notably remittances of overseas workers. In sum, the economy still showed
vestiges of its import-dependent and substituting character, with a narrow
exporting industry base.
Compared to other East Asian crisis-affected countries, the country
was less dependent on foreign private capital. Net investment inflows were
$3.5 billion in 1996 and grew at an average of 48 percent per annum from
1992 to 1996. Historically, foreign investments in the country have been
low, their growth gathering momentum only beginning in 1992. Because of
limited local capital, the growth in foreign investments fueled that of the
manufacturing and services sectors in the years preceding the crisis. After a
long period of debt moratorium and restructuring that started in 1983 and
ended in 1991, the Government sought stability and achieved this in 1992-
1997. Prudent fiscal management and controls on foreign borrowings were
part of the adjustments required by IMF and foreign creditors. Eventually,
the Government restructured its debts into longer tenors with a maximum
of 25 years. During this time, the country and the corporate sector had no
access to foreign currency debts from the international financial market,
unlike their counterparts in the region.
The lessons from debt restructuring became the basis for the Gov-
ernment’s economic policies. Economic performance during 1992-1997 was
characterized by an average growth rate of real gross national product (GNP)
at 3.5 percent, an average inflation rate of 7.8 percent, an average Treasury
bill rate of 13.1 percent, a government fiscal surplus from 1994 to 1997, a
positive balance of payments from 1992 to 1996, and a relatively healthy
banking system. Since the regional financial crisis was triggered by the loss
of confidence in some East Asian economies by foreign creditors and in-
vestors, adjustments were focused on the quantity and quality of the bank-
ing system’s corporate loans, which, in turn, depended on the quality of the
corporate sector’s investments. Financial institutions called on their short-
term loans and shortened the maturity of existing loans.
Five years of stable growth before the crisis enabled the country to
build its net international reserves to $10.6 billion as of March 1997. The
adverse impact of the crisis in most Asian countries was proportional to the
amount of short-term foreign debts relative to net international reserves. In
the Philippines, the discipline of the loan moratorium and the restructuring
of the country’s loans to long-term maturity kept this ratio below 100 per-
cent up to September 1997. After hovering in the range of 100 to 127 per-
cent, the ratio of short-term debts to international reserves dipped below
100 percent beginning June 1998. The Central Bank conserved interna-
tional reserves by allowing the local currency to float within a wider trad-
ing margin, resulting in stability in the short-term debt to reserves ratio.
The corporate sector was in a relatively stable financial condition
around the time of the crisis. Profitable operations since 1992 had allowed
it to build equity, fueled also by successful IPOs during the stock market
boom of 1993-1996. Total debts were only 52 percent of assets or
108 percent of equity. From 1988 to 1996, average ROE was 13.3 percent.
Closer analysis, however, shows that investments of the corporate sector
were growing at a faster rate than sales revenues in the years immediately
preceding the crisis. From 1993 to 1997, assets grew at a compound annual
rate of about 31 percent, while sales grew by only 20 percent per year.
The corporate sector indeed overexpanded after 1993 like its coun-
terparts in the region, but to a lesser degree. Debts financed a large part of
this expansion, growing by about 34 percent per year from 1994 to 1997.
The debt level of the Philippine corporate sector in 1997 was low by Asian
standards but still high by developed country standards. Most of this lever-
age happened during the boom years in the region. These patterns in invest-
ment and financing are similar to those of other countries in the region. In
sum, the country’s economic and corporate sector growth in 1994 to 1997
appeared to have been part of a positive “contagion” effect of optimism by
investors and creditors about the region. It is understandable then that the
effect of the Asian financial crisis on the Philippines was correspondingly
that of a negative “contagion.”
3.5.2 Impact of the Crisis on the Corporate Sector
Aside from the foreign exchange adjustment, the other immediate impact
of the crisis was that on foreign investment flows. Net foreign investments
more than doubled from 1995 to 1996 but declined by 78 percent in 1997
(Table 3.22). Foreign investments in the Philippines have not been as high
as the inflows to other Asian countries—and this, precisely, mitigated the
effects of the pullout and liquidation of investments in the aftermath.
Net foreign portfolio investment amounted to $1.5 billion in 1995,
or 114 percent of net foreign direct investment (FDI). It rose to $2.101 billion
or 196 percent of net FDI in 1996. In 1997, net FDI remained stable at more
than $1 billion. It financed 26 percent of corporate capital growth. But portfo-
lio investment amounting to $406 million flew out of the Philippines.
Table 3.22
Foreign Investment Flows, 1995-1998
Item 1995 1996 1997 1998
Net Foreign Investments ($ million) 1,609 3,517 762 739

Foreign Direct Investment (FDI) 1,300 1,074 1,073 555
Foreign Portfolio Investment 1,485 2,101 (406) 328
Net Capital Increase by Corporations
(P million) 145,303 92,718 121,749 69,650
Net FDI as a Percentage of Corporate
Net Capital Increase (%) 23.0 30.4 26.0 32.7
Note: Peso-dollar exchange rates used are: 1995 = 25.71; 1996 = 26.22; 1997 = 29.47; 1998 = 41.06.
Data for 1998 cover only January-August.
Sources: Bangko Sentral ng Pilipinas and SEC.
Corporate financial performances and conditions deteriorated dur-

ing 1997. Net profit margins were at a 10-year low at 4.9 percent, ROE at
6.2 percent was barely above inflation rate, and leverage increased to
149 percent compared with 109 percent in 1996. Companies deferred in-
vestments in new fixed assets. Because of weak internal fund generation, new
borrowings financed asset growth. With the increase in borrowings and re-
duced liquidity, the corporate sector became vulnerable to loan calls and high
interest rates. Loan calls, in turn, depended on the liquidity and capital posi-
tion of commercial banks, which held about 75 percent of the assets of the
financial system in 1997. The resources of the financial system that year
totaled P3,369 billion, with commercial banks holding P2,513 billion.
The banking system was able to absorb the impact of the crisis
primarily because of its strong capital position. By March 1988, the com-
mercial banking sector’s capital remained strong at 17.3 percent of assets.
A number of small banks closed but they represented less than 1 percent of
the financial system’s total resources.
The real problem of the corporate sector during the crisis was the
rise in interest rates. Because commercial banks were strongly capitalized,
they were willing to restructure and renegotiate existing loans by corporate
borrowers, albeit at current market interest rates. Bank loan pricing was
based on the bellwether 91-day Treasury bill rates rather than inflation. The
interest rates on Treasury bills, meanwhile, ranged from 11 to 13 percent
from 1993 to July 1997, then rose to a high of 22.7 percent in January 1998,
sparking a rise in interest rates on corporate loans. Average bank lending
rates climbed to their peak of 25.2 to 28.2 percent in November 1997. Lend-
ing rates were well above the 20 percent level from July 1997 to March
1998. Although corporate borrowers were not highly leveraged, they could
not initiate a large reduction of their loans because these in part financed
long-term growth in assets.
When the Treasury bill rates eased in March 1998, lending rates
also came down, suggesting that commercial banks required a higher pre-
mium at about the height of the crisis but not beyond. Bank spreads over
Treasury bill rates increased in 1997 but were within the range experienced
in the past.
The combined effects of shrinking demand and high interest rates
reduced the corporate sector’s demand for loans. Loans outstanding of com-
mercial banks declined by the first quarter of 1998, in varying degrees for
each sector. By October 1998, the sectors with the highest outstanding loans
had reduced their credit exposures. Manufacturing reduced its loans out-
standing by 11 percent from October 1997 levels; and the wholesale and
retail trade sector, by 12 percent. However, loans outstanding of the real

estate sector increased by 11 percent from June 1997 to June 1998. These
figures show that adjustment problems were industry-specific and that the
real estate industry, as with its counterparts in other Asian countries, was a
problem sector. In March 1997, real estate loans averaged 11.9 percent of
bank loan portfolios. These peaked at 14.3 percent in December 1997, and
subsequently went down to 13.6 percent in June 1998. The pattern indi-
cates that real estate loans were of substandard quality but banks had con-
tained the problem by mid-1998.
As for nonperforming loans (NPLs), the ratio increased to a high of
11.5 percent by September 1998. But the Philippine banking system had
gone through worse crises in the past, and its experience of low, single-digit
NPL ratios began only since 1989. Still, the aggregate effect of the crisis on
NPLs was of a magnitude comparable only to the country’s last major bank-
ing crisis in 1984-1986.
Government Responses
The Government’s policy and regulatory responses to the crisis focused on

monetary and credit issues, the fiscal position, and the financial system.
The Central Bank introduced regulations on foreign exchange trading to
control speculation and nondeliverable forward contracts, set limits on
overbought/oversold foreign exchange positions of banks, and set up a hedg-
ing facility for borrowers with foreign currency-denominated loans. The
latter measure was especially beneficial to companies with unhedged for-
eign currency loans from commercial banks.
The Central Bank also moved to control inflation and bring down
domestic interest rates by reducing the statutory reserve requirement by
3 percentage points and raising the liquidity reserve ratio by the same amount.
The move retained the liquidity position of banks but lowered their cost of
reserves, thereby reducing overall intermediation costs. This allowed the
Central Bank to convince the banks, through the Bankers’ Association of
the Philippines, to reduce their lending spreads over the 91-day Treasury
bill rates from 3-8 percent to 1.5-6 percent. This “voluntary agreement”
partly explains why the loan spreads of banks were within the range of
recent experience.
The Central Bank adopted other measures to strengthen the financial
system, including (i) a regulatory limit of 20 percent on banks’ loans to the
real estate sector; (ii) shortening the period for classifying unpaid loans as
past due from three months to one month; (iii) fixing loan loss provisions of
2 percent of the gross amount of loan portfolio on top of individually rated
bad loan accounts; (iv) increasing banks’ capital requirement by 20 percent
for universal banks (banks with expanded licenses) and 40 percent for ordi-
nary commercial banks; (v) improving disclosure requirements on the finan-
cial position of banks; and (vi) issuing guidelines on duties and responsibili-
ties of banks’ boards of directors for improved quality of bank management.
The policy directions and actions taken by the Government appear
to have ushered in recovery. The economy avoided a recession in 1998 and
achieved 3.6 percent growth in 1999. With prudent monetary management,
the Government kept inflation below 10 percent. Average Treasury bill rates
have cooled since mid-1998. In response to calls for lower bank interme-
diation costs, bank loan rates have also come down. The real estate portfo-
lio of commercial banks also declined and was well below the Central Bank’s
regulatory ceiling by March 1998.
Responses of the Corporate Sector
The corporate sector’s financial position, its accessibility to foreign capital,

and the legal framework for reorganization and liquidation conditioned its
response to the crisis. With its weakened financial position, the corporate
sector dealt with the crisis as any company facing a recession and drying up
of credit would—companies cut costs by reducing staff, changing tech-
nologies, subcontracting and outsourcing, consolidating business units, and
giving up noncore businesses. Financially strong companies were able to
survive the crisis by effecting such internal restructuring. Large companies
with heavy loan exposures such as Philippine Airlines Inc. (PAL), the coun-
try’s flag carrier, took more action. PAL, which was privatized with the
Lucio Tan group gaining control and the Government retaining minority
ownership, came up with a rehabilitation plan by May 1999 that was found
acceptable to all parties.
Publicly listed Philippine companies could also be restructured
through takeovers by local and foreign investors. Takeovers in the past in-
volved cooperative negotiations between purchasers of a target company
and family-based large shareholders. In the case of PLDT, the largest tel-
ecommunications setup in the Philippines, the Asian crisis opened a unique
opportunity for foreign investors. A 40 percent devaluation of the Philip-
pine peso lowered the purchase price of PLDT to foreign investors. The
acquiring company, First Pacific Corporation, was known to have a policy
of investing to control companies that are dominant players in their indus-

tries. First Pacific could have acquired sufficient shares to take control of
PLDT in three ways. One mode was the outright purchase of shares in the
open market. Consequently, the stock price of PLDT was buoyant during
the takeover period. A second method was to purchase the shares of other
large minority shareholders. PLDT’s large minority shareholders such as
the SSS and First Philippine Fund publicly announced their willingness to
offer their entire holdings in a block sale at a premium. A third method was
to make a formal tender offer to PLDT’s controlling minority shareholders,
the Cojuangcos, at a premium over the market price to reflect the value of
management control. First Pacific, using some or all of these means, even-
tually took over PLDT and announced a restructuring plan for the entire
group of companies.
SMC is another widely-held company managed by a minority share-
holder, the Soriano family. In a legal process that ended in his takeover of
management, Eduardo Cojuangco was able to assert his ownership of shares
taken over by the Government during the transition of power in 1986. Al-
though considered the prime industrial company in the Philippines, SMC
had lagged behind other groups of companies such as Ayala Corporation in
financial performance for some years. Its stock price and returns to share-
holders had stagnated. When Cojuangco took over, he restructured the com-
pany toward its core brewery business and sold off local and foreign sub-
sidiaries.
The Philippine corporate sector has been shaped by the country’s economic
and industrial development policies. Ownership is highly concentrated and
a few dominant players control major industries. Corporate governance is
conditioned by the high ownership concentration of these large companies.
When companies are highly profitable, controlling shareholders can cap-
ture these profits by excluding public investors from ownership. By itself,
concentrated ownership of companies is not equivalent to weakness in cor-
porate governance. It may even solve agency problems that a separation of
control and ownership could precipitate because large shareholders have an
incentive to closely oversee management. The question, however, is whether
there are sufficient safeguards to prevent controlling shareholders from
expropriating the wealth of minority shareholders through aggressive and

risky investment. With large shareholders in control, minority shareholders
need to be protected by external control mechanisms. This study points out
weaknesses in external control mechanisms such as weak legal protection
for minority shareholders, oligopolistic market structures, an underdevel-
oped capital market, ownership of banks by business groups, an ineffective
insolvency system, passive independent auditing, and the lack of market
for corporate control. The result is that corporate governance depends only
on internal controls.
This study analyzed trends in corporate performance and financing
in relation to corporate governance from 1988 to 1997. The Philippine cor-
porate sector was relatively efficient in investing and financing compared
with other countries affected by the Asian crisis. Returns to capital ex-
ceeded inflation rates. Leverage was within Asian norms but above devel-
oped country standards. By ownership structure, foreign companies were
the most profitable but highly leveraged. Privately-owned companies, the
most numerous in the corporate sector, were the least profitable. Publicly
listed companies had the highest profit margins and lowest leverage among
the local companies.
By control structure, companies that are members of family-based
conglomerates had higher returns and lower leverage than independent com-
panies. By size, medium companies showed higher profitability than large
and small ones. Performance was, to some extent, influenced by industry
characteristics, with the real estate and public utilities industries standing
out for their pronounced cyclical patterns.
Corporate governance should be viewed in the context of an in-
creasing presence and growth of large shareholders-centered conglomerate
business organizations. Ownership of publicly listed companies is highly
concentrated. The five largest shareholders have majority control of an av-
erage publicly listed company, while the largest 20 shareholders control
more than 75 percent of shares. Financial institutions are not significant
shareholders. Forming business groups appears to be a viable means of
competing because this allows for more efficient organization and utiliza-
tion of resources of large controlling shareholders. Business groups occu-
pied seven of the top 10 and 25 of the top 50 largest corporate entities in the
Philippines in 1997.
The financing pattern of the corporate sector was influenced by the
tight financial conditions prevailing in the country up to 1992. The corpo-
rate sector consistently relied on internally generated funds and equity be-
fore resorting to borrowings. Analysis of corporate financing by ownership
type gave similar results, with the foreign-owned companies found to rely
more on borrowed funds.
After controlling for industry effects, statistical analysis of com-
pany-level data revealed significant relationships between corporate per-
formance and corporate governance. ROA, ROE, and leverage were all posi-
tively related to the degree of ownership concentration. The positive rela-
tionship between financial leverage and ownership concentration is con-
sistent with the hypothesis that controlling shareholders prefer to use debt
financing in order to avoid ownership dilution.
Internal financial markets operated by business groups allowed them
to optimize their financial resources at lower external debt levels. Publicly
listed companies were responsive to investors’ requirements for prudent
use of debts. Ownership concentration was positively related to both re-
turns and leverage. Companies whose large shareholders have higher de-
gree of control tend to borrow more but generate better returns.
Family-based business groups have focused their investments in
industries where their superior financing capacities and political/social in-
fluence give them unique advantages. Large companies owned or control-
led by business groups tend to dominate their industries. A business group
is an effective business organizational model for achieving leadership in
industries, superior profitability, and sustained growth. A commercial bank
is an important part of most business groups. Even in cases where the group
owned only a minority share of a commercial bank, the bank usually ac-
counted for a large share of each group’s net profits. Large, family-based
shareholders gain control by such means as the setting up of holding com-
panies, selective public listing of companies in the group, and centralized
management and financing. The pyramid model is useful for centrally man-
aging smaller companies, as typified by the Ayala Group.
Business groups with pyramiding structures heighten the issue of
corporate governance. Such structures result in control by large sharehold-
ers through disproportionately smaller investments in equity ownership.
The difference between management control and ownership rights is usu-
ally substantial. Larger disparities in control over cash flow rights imply
higher incentives for large shareholders to (i) expropriate wealth of share-
holders not belonging to the controlling group and (ii) invest in empire-
building and high-risk projects. The extent of governance problems de-
pends on internal control policies of the controlling shareholders, the amount
of pressure from stock market investors and PSE (for publicly listed com-
panies in the group), and the extent of supervision of outside institutions
such as independent auditors and SEC.
The financial crisis came when the Philippine economy was in a

relatively strong financial position, with recently restructured public debt, a
strong international reserves position, low inflation, the government budget
in surplus, and a market-oriented policy environment. The corporate sector
was also in good financial condition with rich internal cash flows accumu-
lated from a number of profitable years, strong capital position built on IPOs
in a buoyant stock market, and sound overall creditworthiness. The corporate
sector accessed the foreign debt market only in the mid-1990s because of the
country’s long-drawn debt moratorium. Still, there was a sharp rise in bor-
rowings and decreasing productivity of investments a few years before the
crisis in a pattern similar to that of Asian crisis countries. The crisis caused a
tightening of credit to the corporate sector and a spike in interest rates, ad-
versely affecting companies’ operations and financial position.
The Central Bank responded by improving the liquidity of the sys-
tem and by establishing conditions for bringing down interest rates on bank
loans. As the crisis wore on in 1998, there were sharp rises in the number of
bankruptcies and petitions for debt relief, mostly by highly leveraged com-
panies and speculative investors in real estate. The Central Bank imposed
strict limits on real estate lending, resulting in the banks’ accelerated re-
structuring of troubled debts in this sector. A number of large debtors peti-
tioned SEC for rehabilitation under procedures set by PD 902-A. This law
is flawed in concept because it supplants a market-based credit agreement
with a political process. That is, SEC officials, rather than the banks that
lent millions of pesos, decide on the financial future of a troubled debtor.
Under the new Securities Regulation Code enacted in 2000, SEC’s quasi-
judicial functions, including suspension of payments, are to be removed
and transferred to courts.
The Government should address weaknesses in corporate governance iden-

tified in this study by introducing reforms in the policy and regulatory frame-
work and promoting the development of markets. Specific actions recom-
mended are described below.
Promoting a Broader Ownership of the Corporate Sector
The highly concentrated ownership of the publicly listed corporate sector

should be a concern of SEC and PSE. There are systemic risks involved in
highly concentrated ownership. For example, decisions by large sharehold-
ers often cause wide volatility in stock prices and invite reaction from credi-
tors. The following recommendations involve amendments to the Corpora-
tion Code that will improve transparency of ownership and address the
current high level of ownership concentration in Philippine business:
(i) require disclosures of underlying ownership of shares held
by nominees and holding companies;
(ii) require disclosure of material changes in ownership; and
(iii) increase the minimum required percentage of outstanding
shares for public listing in the stock exchange from the
present 10-20 percent, depending on the size of the com-
pany, to 25 percent. The adjustment should be made over a
fixed period of time.
Increasing the Statutory Accountability of Directors and

Strengthening the Board System
The Government should clarify statutory fiduciary responsibilities of the

board of directors. This will enable SEC to enforce prudential requirements
on management of companies and enable minority shareholders to pursue
grievances against their boards. Clear legal accountability is a precondition
for successful shareholder activism.
Another measure would be to impose a statutory limit on the number
of directorships that one can accept. This may limit current practices of
appointing prominent individuals and family members as directors.
To strengthen the board, the PSE Listing Rules require the appoint-
ment of a minimum number of independent directors in the board of pub-
licly listed companies. Because independent directors tend to adopt the
perspective of minority shareholders in board decisions, they serve to curb
the powers of controlling shareholders. To help ensure this, PSE Listing
Rules should specify criteria and a selection process that will help ensure
that the nominees for the position are truly independent and qualified.
Strengthening Minority Shareholder Rights
An issue that concerns minority shareholders is whether they have instru-

ments—legal or ethical—that can prevent controlling shareholders from
expropriating their wealth through risky investment and financing, inad-
equate disclosures, insider information, and self-dealing. SEC should
strengthen disclosure requirements by issuing specific guidelines on
minimum disclosures required for related party transactions. It has suffi-
cient case history that can be used as a basis for tightening its disclosure
requirements.
Minority shareholders have failed to use traditional venues such as
the annual general shareholders’ meetings to discipline controlling share-
holders that expropriate their wealth. They need legal empowerment such
as higher majority voting requirements, e.g., raising the current two-thirds
majority to a three-fourths majority. For example, current rules allow boards
of directors to approve own-dealings or related party transactions by simple
majority. Because ownership is generally concentrated in five shareholders,
the board can easily muster the needed majority to approve the deal. By
requiring sufficient disclosure and a 75 percent majority vote on such deci-
sions, the board will be compelled to initiate a thorough discussion of the
merits of the proposed related-party deals that will require the participation
of minority shareholders. Finally, the Corporation Code should be amended
to impose sufficiently stiff penalties for self-dealings that patently expro-
priate the wealth of other shareholders.
Improving Financial Regulation and Strengthening Implementation
The Asian crisis demonstrated the need to strengthen banking regulation.

The Government should improve its prudential supervision system to en-
sure that banks perform their role as external control agents of their corpo-
rate debtors. The following recommendations aim to further improve bank-
ing regulations and supervision in the Philippines:
(i) limit shareholdings of nonfinancial companies in banks,
and of banks in nonfinancial companies in order to avoid
connected lending;
(ii) set strict limits on lending by banks to affiliated compa-
nies, officers, directors, and related interests. Impose se-
vere penalties for any attempt by banks to circumvent this
regulation;
(iii) adopt international standards of capital adequacy and en-
sure that banks comply with these standards;
(iv) require banks to follow international financial accounting,
reporting, and disclosure standards; and
(v) closely monitor, limit, or prohibit cross-guarantees by com-
panies belonging to affiliated groups.
It is encouraging that the newly enacted 2000 Banking Laws have
introduced changes along these lines, in particular, in areas of supervisory
functions of the central bank, prudential measures and regulations, fit and
proper rule, foreign ownership of banks, transparency, and lending to

DOSRI.
Reforming the Legal and Regulatory Framework for Investment

Funds and Venture Capital
Owners of Philippine publicly listed companies consist of controlling share-

holders and investors that hold trading portfolios. This investor profile has
a “missing middle”—long-term investors who intend to participate in long-
term growth of a company and who also trade shares depending on com-
pany performance. Investment and venture capital funds meet this de-
scription. In developed capital markets, institutional investors lead public
investors in providing market signals to companies. This way, institu-
tional investors can be a driving force in providing market discipline to
management.
The absence of institutional investors indicates that the legal and
regulatory basis is inadequate. Presently, SEC appears to be taking a prima-
rily regulatory posture in the operation of investment funds. Its priority is to
protect prospective fund investors from unscrupulous fund managers. By
supporting the establishment and operation of institutional investors, SEC
and PSE can help ensure that these external control agents provide market
discipline even in companies controlled by large investors. Institutional in-
vestors impose market discipline by voting on strategic corporate decisions.
If institutional investors are present, an active financial analyst community
can begin to form. Other investors benefit from the information that ana-
lysts produce for these institutional investors as information technology
makes their output a public good. Managements find that their investment
and financing decisions affect stock prices and become aware of their re-
sponsibility to create shareholder value.
Promoting Shareholder Activism
Promoting shareholder activism to encourage small shareholders to actively

monitor management is an approach that has not been tried out in the Phil-
ippines. Two measures should be adopted to promote shareholder activism.
One is improved transparency and disclosure on specific items that poten-
tially involve expropriation of wealth of minority shareholders. The other is
the addition of provisions in the Corporation Code to facilitate class action
suits against corporate directors, management, and external auditors. The
current law should expand class action suits to include management and
auditors. Placing the means for prosecuting in the hands of minority share-
holders may instill more discipline in controlling shareholders, their direc-
tors and management, and the external auditors.
Legal provisions for class action suits should cover self-dealing by
directors, compensation contracts, information disclosures, and dividend
decisions. SEC should allow minority shareholders to be represented by
activist groups. These groups have an incentive to gather technical exper-
tise, leadership, and broad-based political and popular support to pursue
possible cases involving expropriation of minority shareholders’ wealth.
The present provision on class action suits is inadequate because share-
holders view the process as ineffective and expensive. SEC should take
steps to simplify the process of class action suits and provide an avenue for
out-of-court settlements similar to practices in the US, where the threat of
class action suits alone is sufficient to encourage quality decisions and
behavior from management.
Expanding Debt Securities Financing
The Philippine corporate sector relies on bank loans because controlling

shareholders do not want to dilute their control by issuing equities. The
Government should enhance the securities markets as an alternative source
of corporate financing and pursue aggressive development of the local debt
securities markets. It should develop a medium-term yield curve for the
corporate debt market by strengthening the Government bond market. And
by issuing Government Treasury securities in longer tenors, the Govern-
ment could develop the market for future issues of corporate bonds. Philip-
pine Government Treasury bonds should provide bellwether rates for cor-
porate bonds in the way that they have for short-term bank debts. Promot-
ing the corporate bond market requires that the Government develop trad-
ing systems and services of credit risk rating of corporate issuers. There are
existing institutions such as Dun and Bradsreet, and Credit Information
Bureau that can be the starting point of this effort. Securities market devel-
opment efforts should coincide with strict regulation of the commercial
banking sector. Companies are likely to remain dependent on bank financ-
ing if the authorities do not strictly enforce prudential lending regulations.
Promoting Competition in Product Markets
The Government should pursue industrial development policies that pro-

mote competition through the elimination of subsidies, guarantees, entry
and exit barriers, and various other forms of protection. The Government’s
competition policies should aim to facilitate the free entry and exit of do-
mestic and foreign companies and regulation of anticompetitive practices.
The Government should also continue to improve infrastructure, so that
small- and medium-scale companies can become more competitive relative
to large companies. Efforts to reduce graft and corruption, improve en-
forcement of the rule of law, and provide quality basic services should also
be heightened.
Increasing the Supply of Quality Equities in the Stock Market
To promote the capital market as an external control agent in corporate

governance, there is a need to increase the supply of quality securities from
top-tier local companies in the Philippine stock market. Many large compa-
nies remain privately owned, and publicly listed companies trade barely the
minimum number of shares required for public listing. Lack of liquidity
deters institutional investors. The resulting absence of a strong investor
base makes share prices vulnerable to manipulation or insider trading by
large shareholders.
PSE and SEC need to build a liquid and efficient market. PSE should
campaign for top-tier companies to go public and work with SEC in en-
couraging publicly listed companies to expand their share offerings to the
public. SEC should require that a larger percentage of publicly listed com-
panies’ shares be sold to the public. The increase in percentage of public
holdings may be gradually implemented to enable the companies to adjust.
Improving External Audit Standards and Information Disclosure
Effective external control in corporate governance requires accurate and

timely information about companies. Audited financial statements contain
basic information about a company’s financial position and performance.
Many of the problems associated with auditing and disclosure stem from
the tendency of SEC and PICPA to be satisfied with replicating what their
counterparts in the US require by way of audit standards and disclosures.
Little attention is given to the conditions that make those regulations effec-
tive in the US corporate sector but not present in the Philippines. Another
problem is the orientation of external auditors to the interest of large share-
holders rather than public investors.
Current disclosure requirements of SEC are not rigorous enough
for public investors. Penalties for poor conduct of auditing by independent
auditors and the mechanism for imposing them are weak. In spite of the
many well-known cases of poorly audited financial statements that resulted
in losses for investors, SEC and PICPA have not publicly penalized any
auditor company that violated disclosure requirements or failed to submit
audited financial statements. Instead, violators were made to pay only nomi-
nal penalties. SEC and PICPA need to formulate more specific disclosure
standards, review the system of penalties on professionals involved in a
company’s violation of disclosure rules, and implement those standards
and penalties rigorously.
Improving the Legal Framework for Suspension of Payments,

Reorganization, and Liquidation.
Reforming the legal framework for suspension of payments, reorganiza-

tion, and liquidation of troubled companies should be made a priority of the
Government. PD 902-A has not accomplished any successful rehabilitation
of a petitioning company since its implementation. The law is obviously
not in line with the Government’s policy of allowing market mechanisms to
work and not intervening in private sector business. The law on suspension
of payments replaces a market-oriented solution with a political process.
For that matter, it creates a moral hazard problem. Although the new Secu-
rities Regulation Code enacted in 2000 has removed some of SEC’s quasi-
judicial functions, including the resolution of intracorporate disputes, sus-
pension of payments and private damage actions, and transferred these to
courts, the new law needs to be effectively implemented and enforced.
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4
Thailand
Piman Limpaphayom1
4.1 Introduction
In May to July 1997, the Thai baht came under pressure from speculative
attacks, heralding not only a financial crisis in the country, but also the
stalling of East Asia’s “economic miracle.” After mounting an aggressive
defense of the currency, the Thai Government conceded and adopted a float-
ing exchange rate regime. Thailand’s crisis exposed similar vulnerabilities
in other East Asian economies, with the currencies of Indonesia, Republic
of Korea (henceforth, Korea), Malaysia, and Philippines all depreciating
significantly.
The crisis in Thailand stemmed directly from unsound macroeco-
nomic policies and imbalances. But it also laid bare weaknesses in both the
financial and corporate sectors. The banking system, poorly regulated and
sheltered from competition, had been plagued with prudential problems for
a long time. It was inefficient in financial intermediation. Instead of serving
as a buffer between the large inflow of foreign capital and the corporate
sector, the banking system merely validated the financial risks.
The corporate sector also contributed significantly to the crisis, with
Thai corporations overutilizing short-term foreign currency-denominated
loans. For the period 1994-1996, annual short-term capital inflows to Thai-
land were equivalent to 7-10 percent of gross domestic product (GDP). In
the prelude to the 1997 crisis, short-term private debt obligations grew to
about 60 percent of total private sector debts. The majority of these debts
were not properly hedged. As a result, Thai corporations were collectively
overexposed to exchange rate risks. The fixed exchange rate policy, cou-
pled with financial liberalization and deregulation in the absence of an ef-
fective regulatory and supervisory system, magnified the impact of these
problems on the economy when the crisis hit.
1
Associate Professor, Faculty of Business, Asian University of Science and Technology,
Chonburi, Thailand. The author wishes to thank Juzhong Zhuang, David Edwards, both
of ADB, and David Webb of the London School of Economics for their guidance and
supervision in conducting the study, the Stock Exchange of Thailand for its help and
support in conducting company surveys, and Lea Sumulong and Graham Dwyer for
their editorial assistance.
There is now a consensus that weak governance was partly respon-

sible for the corporate sector’s poor financing and investment practices.
Key factors that led to weak corporate governance include the ineffective-
ness of the regulatory framework, lack of transparency and adequate disclo-
sure, and a family-based corporate ownership structure. This study exam-
ines these and other factors that might have weakened corporate sector gov-
ernance in Thailand, focusing mainly on the companies listed in the Stock
Exchange of Thailand (SET).
Section 4.2 discusses the development of the Thai corporate sector
under the National Economic and Social Development Plans, its growth
and financial performance, as well as its legal and regulatory framework.
Section 4.3 looks at corporate ownership patterns that resulted in inadequate
protection for minority shareholders and weak corporate governance in
Thailand. Section 4.4 provides an overview of Thailand’s financial mar-
kets and examines patterns of corporate financing and investment in the
years prior to the 1997 crisis. Section 4.5 discusses how the corporate
sector contributed to the financial crisis and looks at its impacts. The
study then considers policy recommendations with emphasis on corpo-
rate governance improvement.
The corporate sector has long been considered the engine of Thailand’s
economic growth, with government policy providing support but avoiding
direct interference. The country initiated national economic development
planning in 1961 when the economy was growing rapidly. The National
Economic and Social Development Board was created to plan the country’s
economic and social development.
The First and Second Plans (1961-1971)
Under the first two plans, the Government implemented major infrastruc-
ture projects and modified its tax policy to encourage capital investment
and savings. Import tariffs on machinery and heavy equipment were re-
moved. To protect domestic industries, the Government increased tariffs on
products that could be produced locally, while new industries were encour-
aged to reduce the need for imports.
Chapter 4: Thailand 231
During this period, gross national product grew by about 7 per-

cent per year, with the agricultural sector the major contributor. Industrial
sector growth was also rapid and many industries (tires, textiles, chemi-
cals, canned foods, processed steel, and automobile assembly) emerged.
But the sustained importation of heavy machinery and equipment resulted
in large trade deficits. However, capital inflows, especially foreign aid
from the United States, helped offset these deficits. Inflation levels were
low, averaging 1.6 percent per year. Consequently, the value of the baht
remained stable.
The Third, Fourth, and Fifth Plans (1972-1986)
An economic downturn at the end of the Second Plan led to an adjustment

in policies. External factors, including a weakening of the dollar, and in-
creases in world food and oil prices, resulted in increases in the current
account deficit, leaving the Government no choice but to resort to overseas
borrowings. Budget deficits also increased throughout the Fourth Plan. Thus,
the government’s debt burden escalated. Inflation reached 15.5 percent in
1973 and 24.3 percent in 1974, remaining high until 1981.
The Government had to shift emphasis to restoration of economic
stability, using tax policy to control prices of consumer goods and imple-
menting several price control measures to curb inflation. At the same time,
it proceeded with its development plan for the industrial sector. As a result,
the industrial sector grew at a faster rate than the agricultural sector. Unem-
ployment, however, became a major problem as domestic investment de-
clined.
The Government decided to embark on restructuring measures in
the Fifth Plan (1982-1986) to rehabilitate the ailing economy. The focus
shifted to export promotion, with the devaluation of the baht in 1984 a
major step in this direction. The results were increased exports, an im-
proved trade balance, and reduced current account deficits. The decline in
imports was steady. In the wake of lower world oil prices and the rapid
growth in income from the tourism and travel industry, the current account
registered a surplus in 1986.
Budget deficits remained a major problem during the Fifth Plan,
however. The average budget deficit reached an all-time high of $2.15 bil-
lion per year or 4.4 percent of GDP. To close the fiscal gap, the Government
borrowed $6.4 billion from overseas and increased taxes on numerous items,
including luxury goods. Average growth for the period was 4 percent per
year, lower than anticipated due to a worldwide economic recession.
The Sixth Plan (1987-1991)
Industrial sector productivity improved gradually during the Sixth Plan

period, while exports expanded considerably. From 1989, the Government
successfully balanced the budget and even settled its foreign debt of
$4 billion before this was due. Growth rates during 1987-1991 ranged from
9.5 to 13.2 percent per year, averaging 10.5 percent. The manufacturing
sector became a dominant force in the economy, increasing its share in total
export value from 42 to 76 percent. The country also attracted a large amount
of foreign direct investments (FDIs), reaching an annual inflow of $2 billion
in 1991. Most of the FDIs—originating mainly from Japan; United States;
Singapore; Europe; and Hong Kong, China—went to export-oriented manu-
facturing industries. The exchange rate was steady at around B25 to the
dollar.
The Seventh Plan (1992-1996)
The economy’s performance from 1992 to 1996 generally met the targets
of the Seventh Plan. Average annual growth in real GDP was 8 percent,
compared with the 8.2 percent target. Private sector investment grew at an
average annual rate of 7 percent, lower than the target of 8.8 percent. Growth
of exports and imports averaged 14.2 and 13.6 percent, respectively, com-
pared with the 14.7 and 11.4 percent targets. Inflation was 4.8 percent,
better than the 5.6 percent target of the Seventh Plan.
Thailand’s rapid growth up to the mid-1990s made the country
one of the world’s fastest-growing economies. Key to this growth per-
formance was the government’s adoption in 1993 of an aggressive pro-
gram for attracting foreign capital to finance domestic investments. The
country’s high ratings in the international capital market, combined with
its liberal financial policies, invited a deluge of capital seeking profit-
able investments. Thailand became a debtor’s market, with private for-
eign debt reaching $92 billion by the end of 1996, from only $31 billion
in 1992.
On top of its predominantly “borrowed” nature, the bulk of domes-
tic investments went to speculative ventures such as real estate, property
development, and the stock market, rather than to productive activities. By
1995, an oversupply of housing emerged. With loans increasingly becom-
ing expensive and hard to come by due to a lending squeeze by the central
bank and high interest rates, compounded by a slump in property sales, the
property sector began to collapse in 1996.
Toward the end of the Plan period, the signs of an economy about
to falter were there. Exports went into a tailspin, with growth shrinking
from 23.8 percent in 1995 to 1.3 percent in 1996, on account of an overval-
ued baht that weakened export competitiveness. The country had a current
account deficit of about 8 percent of GDP in 1995 and 1996. A series of
increases in customs and excise taxes on luxury imports did little to stem
rampant consumer spending. The deficits caused the Government to rely on
even more external borrowing, which raised the debt service ratio.
4.2.2 Development of Capital Markets
Although the corporate sector has long been the government’s main tool for
economic development, the capital markets didn’t play a significant role
until 1975. Included in the Second Plan (1967-1971) was a proposal to
establish the country’s first authorized and regulated securities market. Its
most crucial role was to help mobilize funds to support Thailand’s industri-
alization and economic development. In 1969, a former Chief Economist
from the US Securities and Exchange Commission, Sidney M. Robbins,
prepared a comprehensive report entitled “A Capital Market in Thailand,”
which later became the master plan for the development of the Thai capital
market. In his report, Robbins recommended an overhaul of the existing
informal stock market established earlier by a group of local brokers in
favor of a centrally regulated institution.
In 1972, the Government amended the “Announcement of the Ex-
ecutive Council No. 58 on the Control of Commercial Undertakings Af-
fecting Public Safety and Welfare,” extending its control and regulatory
powers to the finance and securities companies operating freely at the time.
In May 1974, the establishment of the Securities Exchange of Thailand
(SET) was legislated and trading began on 30 April 1975. SET officially
became “the Stock Exchange of Thailand” in 1991.
In 1978, the Government passed the Public Limited Company Act,
placing all publicly listed companies under regulation. However, many com-
panies considered the Act too restrictive and a hindrance to growth.
Before the capital market emerged, the corporate sector’s main
source of funding was the banks. And because the Government considered
the banking system vital to the development of the economy, its policy had
always been to protect domestic banks. Foreign banks were barred from
competing directly with domestic banks, a policy that held throughout the
first six economic development plans. Under the 1962 Commercial Bank-
ing Act, which was amended in 1979 and 1985, the Bank of Thailand and
the Ministry of Finance had full authority to supervise all commercial banks.
At the end of the Sixth Plan, there were 29 commercial banks (15 domestic
and 14 foreign banks) in Thailand.
With the liberalization of financial markets, Thai banks gained ac-
cess to a variety of funding sources from around the world. The resulting
availability of funds propelled the corporate sector’s growth through the
early part of the 1990s.
However, the financial and banking laws were generally ineffec-
tive. The regulatory measures were inadequately designed and poorly en-
forced. The banks and finance companies operated at insufficient levels of
reserve capital and were overexposed in high-risk businesses such as real
estate. While the Bank of Thailand had the regulatory power to influence
business practices, it usually relied on “moral suasion.” The Government
also granted financial institutions overly generous bailouts, creating a moral
hazard problem—the perverse expectation that imprudent bank behavior
would be rewarded with forbearance and bailout.
In the 1990s, Thailand’s capital market entered a new era with im-
proved legislation and regulation, increased financial market activities, and
new financial instruments. Laws were enacted to stimulate growth of the
corporate sector. The Public Company Act of 1992 relaxed some of the
rules and restrictions contained in the original laws, while the Securities
and Exchange Act (SEA) the same year sought to improve capital market
supervision.
The introduction of these two laws came just after the Govern-
ment’s signing of Article VIII of an Agreement with the International Mon-
etary Fund (IMF) in May 1990 to deregulate and liberalize financial mar-
kets. Thailand discarded controls on foreign exchange transactions and capital
flows—a turning point for the Thai corporate sector.
A number of internal and external factors contributed to the Thai
Government’s acceptance of the IMF’s Article VIII agreement. Economic
growth had been rapid and domestic savings could not keep up with the
pace to support investments. Financial deregulation and liberalization al-
lowed the country to attract foreign savings and investments that helped
finance the growth of the economy.
Externally, the Government was under international pressure to
deregulate the financial sector. Earlier, the World Bank had recommended
such a move, and the General Agreement on Tariffs and Trade (GATT)
meeting in Uruguay had the liberalization of financial services on its agenda.
The pressure dovetailed with the Government’s intention to make Bangkok
one of the financial centers of the region, to cater specifically to its
fast-growing neighbors. Financial deregulation and liberalization were key

to realizing that vision. The Bangkok International Banking Facility (BIBF)
was thus established to facilitate international borrowings and encourage
capital flows as a means of financing the current account deficit.
The stock market boom from 1991 until the financial crash of 1997
reflected international investors’ response to Government policies. The re-
sult was a corresponding growth and development in Thailand’s capital
markets. Worldwide, the country became recognized as an economic devel-
opment model for other emerging economies.
Since the 1978 enactment of the Public Limited Company Act, about 661
companies with total registered capital of B2.1 trillion and paid-up capital
of B1.3 trillion have been registered with the authority (Table 4.1). The
majority of the companies are in manufacturing, finance, and wholesale/
retail trade and restaurant/hotel sectors, in that order. In terms of capital,
however, the financial sector is the largest, with B1.4 trillion in registered
capital and B791 billion in paid-up capital. The manufacturing sector is a
far second with registered capital of B350 billion and paid-up capital of
Table 4.1
Public Companies Registered, 1978-2000
Number Registered Paid-up

of Capital Capital
Type of Business Companies (B billion) (B billion)
Agriculture, Hunting, Forestry, and Fishing 5 1.9 1.2

Mining and Quarrying 6 16.6 11.9
Manufacturing 245 350.1 261.0
Electricity, Gas, and Water 5 30.9 19.6
Construction 13 34.5 23.3
Wholesale and Retail Trade, and
Restaurants and Hotel 129 111.0 83.1
Transport, Storage, and Communication 22 110.9 78.5
Financing, Insurance, Real Estate, and
Business Service 194 1,394.5 791.0
Community, Social and Personal Service 42 50.6 21.6
Total 661 2,101.0 1,291.2
Note: The data for 2000 is as of October 2000.
Source: Department of Commercial Registration, Ministry of Commerce, Thailand.
B261 billion. The preeminence of the financial sector is a direct result of

financial deregulation and liberalization.
The development of the corporate sector closely followed the de-
velopment of capital markets. After the passage of the SEA of 1992, the
value of public offerings rose steadily, reaching a precrisis peak in 1996
(Table 4.2). Debt market activities also increased significantly with the es-
tablishment of the Bond Dealers’ Club (BDC) in 1994. Domestic and off-
shore debt issues reached B54.7 billion and B27.8 billion, respectively,
from only B20.5 billion and B1 billion the previous year.
Table 4.2
Public Offerings of Securities, 1992-1999
(B billion)
Type of Securities 1992 1993 1994 1995 1996 1997 1998 1999
Equity 1.2 34.0 82.1 64.6 65.2 15.7 136.4 277.2

Debt Instrument
Domestic Offering 5.1 20.5 54.7 39.3 40.4 12.2 31.1 286.8
Offshore Offering — 1.0 27.8 31.3 51.9 25.9 — 26.5
Hybrid Instrument
Domestic Offering — 1.6 7.5 8.7 5.7 0.3 6.7 9.1
Offshore Offering — 39.3 22.4 7.9 37.8 2.5 — —
Total Funds Raised 6.4 96.3 194.6 151.8 201.0 56.6 174.1 599.6
Source: Key Capital Market Statistics, Securities and Exchange Commission of Thailand.
The 1997 crisis battered the primary market for securities, reduc-
ing the value of offerings to a little more than a quarter of the previous
year’s level. While a rebound was apparent beginning in 1998, this was due
to the recapitalization of commercial banks in compliance with the new
loan provisioning requirement.
With the enactment of the SEA of 1992 that brought suppliers of
finance services and their clients together, the capital market became in-
strumental in the rapid growth and development of the corporate sector.
The signing of Article VIII with the IMF, moreover, allowed Thai financial
institutions and corporations to obtain funds overseas. These peaked at
B89.7 billion in 1996, the year before the crisis struck.
The stock market also became an invaluable source of funds for
corporations. The number of listed companies and securities steadily in-
creased until 1996 (Table 4.3). Market capitalization, meanwhile, reached
Table 4.3
Statistical Highlights of the Stock Exchange of Thailand, 1993-1999
Item 1993 1994 1995 1996 1997 1998 1999

a
Number of Listed Companies 347 389 416 454 431 418 392
Number of Listed Securities 408 494 538 579 529 494 450
Market Capitalization
(B billion) 3,325 3,301 3,565 2,560 1,133 1,268 2,193
Turnover Value (B billion) 2,201 2,114 1,535 1,303 930 855 1,610
SET Index 1,683 1,360 1,281 832 373 356 482
a
Due to listing requirements and other reasons, not all public companies are listed on the SET.
Source: Securities and Exchange Commission of Thailand.
its high point in 1995 at B3.6 trillion. Foreigners accounted for an increas-
ing proportion of SET’s turnover value, their share rising from 17 percent
in 1993 to 43 percent in 1997.
Side by side with this surge of financing for corporate growth,
however, was the ominous deterioration in the key financial ratios of pub-
licly listed companies. Throughout the 1990s, corporate profitability had
been declining. But instead of shifting to a low gear, the highly liquid
financial system continued offering cheap funds to sustain corporate sec-
tor investments.
The key financial ratios of all companies listed on SET bear this
out (Table 4.4). Corporate profitability, as measured by return on assets
(ROA), return on equity (ROE), and gross profit margin, had been on the
rise throughout the 1980s. The upward trends for ROE and ROA continued
through 1989, then stalled in 1990. Meanwhile, gross profit margin rose
until 1991 before falling in 1992. By the early 1990s, the averages for all
three profitability ratios took a downswing all the way until 1996. ROA
dipped from 10.3 percent in 1989 to 3.4 percent in 1996. ROE similarly fell
from 21.4 percent to 5.8 percent. While the decline in gross profit margin
was not as sharp, in the end, the companies could not generate enough net
returns from their assets and equity, resulting in their inability to fulfill debt
obligations. From 10.5 at its peak in 1987, the average times interest earned
(TIE) was down to 5.1 by 1996.
The financial leverage of all companies declined until 1994, pulled
down by active public offering activities. The trend reversed in 1995, how-
ever, when long-term debt grew as Thai corporations began to borrow heav-
ily to finance growth. The plunge in profitability and asset turnover—from
117 percent in 1985 to 65 percent in 1996 for the latter—cast doubts on the
Table 4.4
Key Financial Ratios of Publicly Listed Companies, 1985-1996
Long- Long-
Total Term Total Term
Return Return Gross Debt Debt Debt Debt
on on Profit Times to to to to Asset
Assets Equity Margin Interest Equity Equity Assets Assets Turnover
Year (%) (%) (%) Earned (%) (%) (%) (%) (%)
1985 3.7 7.6 25.4 3.4 242.2 59.4 63.1 14.4 117.4
1986 4.9 12.7 24.9 4.2 215.6 47.9 60.8 12.7 119.0
1987 8.1 15.7 27.2 10.5 168.2 39.6 54.7 12.3 125.1
1988 9.3 20.7 27.4 9.4 161.0 36.7 54.5 12.7 120.1
1989 10.3 21.4 28.0 9.8 139.9 35.4 51.5 12.8 114.3
1990 8.9 18.5 29.5 8.4 144.8 34.6 50.8 11.7 91.8
1991 7.2 15.8 30.2 5.9 151.6 41.7 51.4 12.7 88.7
1992 6.7 14.2 27.7 7.6 138.4 34.2 51.9 12.4 80.9
1993 5.8 10.2 27.6 7.4 139.6 35.5 51.2 12.9 77.9
1994 5.3 10.0 27.7 7.7 125.9 38.1 49.5 14.1 66.5
1995 4.4 7.7 27.4 5.8 140.0 44.4 52.1 16.1 63.2
1996 3.4 5.8 26.0 5.1 145.7 44.0 52.7 16.0 64.6
Source: Pacific-Basin Capital Markets Database compiled by the University of Rhode Island, US.
practice of heavy borrowing. Despite the availability of the equity market,

these companies opted for debt. A major reason for this was the rapid rise in
asset prices, resulting in higher collateral values for borrowers. It has also
been argued that family-based controlling shareholders borrowed exces-
sively to avoid diluting their control over their corporations.
The downtrend in corporate profitability, which was particularly sig-
nificant in the two years preceding the crisis, was felt across industries, but
was most severe in building and furnishing material industries as a result of
the downturn in the real estate market. Severely affected by global competi-
tion throughout the decade, the textiles, clothing, and footwear industries
also experienced losses. Hotels and travel showed the highest ROE of
15 percent while textiles, clothing, and footwear had the lowest at 11 percent.
Among the crisis-hit countries, Korea and Thailand had the highest
debt-to-equity ratios. Thailand’s ROE, which fell from 16 percent in 1991
to just under 6 percent in 1996, was also distinct in the region.
Overall, large companies (where size is reckoned in terms of assets
or sales) were more profitable than small companies in terms of ROE (Ta-
ble 4.5). They were generally more efficient in managing their assets and
Table 4.5
Average Key Financial Ratios by Company Size, 1985-1996
Company Size by Assets Company Size by Sales

Item Small Medium Large Small Medium Large
Return on Assets (%) 6.5 6.2 5.9 5.1 6.8 6.7

Return on Equity (%) 12.6 12.8 13.3 10.1 13.6 14.9
Gross Profit Margin (%) 26.3 23.8 25.7 30.1 25.1 20.6
Times Interest Earned 6.5 7.2 6.3 5.4 8.2 6.3
Total Debt-to-Equity (%) 121.3 135.0 176.8 134.8 142.6 164.3
Long-Term Debt-to-Equity (%) 20.1 29.3 62.3 30.6 31.8 49.4
Total Debt-to-Assets (%) 43.3 49.6 52.2 47.0 48.6 52.3
Long-Term Debt-to-Assets (%) 7.7 10.5 18.0 10.2 10.6 15.4
Asset Turnover (%) 94.3 88.6 83.1 61.5 87.8 116.7
capital despite the higher gross margins of small companies. They also
tended to use more financial leverage than small companies as their total
DERs show.
During the 1990s, the overall activities of listed companies, meas-
ured by total asset turnover, also deteriorated. Although stable in the 1980s,
total asset turnover declined after 1989. In sum, although the performance
of listed companies in the late 1980s was strong, by the 1990s, weaknesses
became evident. Increasingly heavy borrowings rendered the sector even
more vulnerable to lower profitability and sales.
Before 1992, the Public Limited Company Act of 1978 and its amendments
regulated Thai publicly listed companies. However, some rules and regula-
tions of this particular law were believed to be too restrictive and were
discouraging companies from going public. For instance, the law disal-
lowed cumulative voting. The argument was that having a Board of Direc-
tors whose members represented different groups of investors would create
conflicts and hamper management effectiveness. Cumulative voting, it was
thought, could lead to a high turnover in the board, which would be disrup-
tive to company management. There were also concerns that the provisions
governing the criminal prosecution and penalties of directors and manage-
ment were harsh and inappropriate.
Another issue was the proportion of shareholding by top share-

holders. The law prohibited the largest shareholders, as a group, from hold-
ing more than 50 percent of total outstanding shares and other shareholders
from holding more than 10 percent of outstanding shares individually. The
provision discouraged original family owners from registering their com-
panies.
The Public Company Act of 1992, adopted to promote the develop-
ment of publicly listed companies, relaxed the contentious provisions of
the 1978 Public Limited Company Act. Cumulative voting was made op-
tional, the limit on shareholdings by the largest shareholders was increased
from 50 to 70 percent of total outstanding shares, and the punishment for
management misconduct was also lightened considerably. The original com-
pany owners welcomed the changes and the number of publicly listed com-
panies subsequently rose to more than 600.
However, the new legislation removed a number of incentives that
would have kept public companies prudent and diligent in their operations.
As the succeeding sections point out, the exit of these provisions appears to
have contributed to the 1997 financial crisis. The legal and regulatory frame-
work for the corporate sector also includes provisions related to insolvency.
This will be discussed in Section 4.5.
Ownership and control of corporations in Thailand are highly concentrated,

a feature that is believed to have impaired the effectiveness of existing regu-
latory mechanisms in the corporate sector. The protection of minority share-
holders was inadequate under the Public Company Act of 1992, and exter-
nal monitoring and control of corporations were also weak. An Asian De-
velopment Bank (ADB) survey conducted for this study shows, for instance,
that creditors had generally little influence on the management of corpora-
tions.2 The market for corporate control was not active and did not give
managers strong incentives to perform efficiently. As it turned out, concen-
trated ownership, coupled with weak corporate governance, played an im-
portant role in bringing about the financial crisis.
2
ADB survey questionnaires were sent to all Thai listed companies in early 1999. Forty-
six companies responded, but not all questions were answered.
A World Bank study covering nine Asian countries finds that firms in Japan
and Taipei,China have the least concentrated ownership, with the largest
shareholder on average controlling 10.3 percent and 18.9 percent of shares
of a company. In contrast, Thai; Indonesian; and Hong Kong, China firms
have the highest single shareholder ownership concentration at 35.3 per-
cent, 33.7 percent, and 28.1 percent of control rights, respectively.
Most large Thai corporations listed on SET started out as family
businesses. The Public Company Act of 1992 allowed ownership and con-
trol of these companies to remain with the founding families even as they
became increasingly dependent on nonfamily resources. In the past, these
companies obtained funding solely from banks or from their own retained
earnings. But with their increased reliance on new varieties of equity and
debt instruments, one would expect the public, creditors, and minority share-
holders to stake their claim in the control and regulation of these compa-
nies. Unfortunately, this was not the case.
Ownership Concentration
Between 1990 and 1998, the top five shareholders of each of publicly listed
Thai companies held, on average, 56.4 percent of outstanding shares, with
the top three shareholders accounting for almost 50 percent (Table 4.6).
This implies that the top five shareholders enjoyed full control over the
outcomes of shareholder meetings. Across industries, there were only slight
variations in the pattern. Ownership was most concentrated in the packaging,
Table 4.6
Top-Five Ownership Concentration of Publicly Listed Companies in
Thailand, 1990-1998
Averagea 1990 1991 1992 1993 1994 1995 1996 1997 1998
1st Largest 28.1 26.2 26.3 26.8 32.3 26.4 27.7 28.1 28.5 28.9
2nd Largest 12.0 11.4 11.4 11.0 16.5 10.7 11.3 11.7 11.7 12.1
3rd Largest 7.4 6.6 6.8 7.1 9.9 6.9 7.0 7.1 7.3 7.3
4th Largest 5.2 4.9 5.0 5.2 6.4 4.9 5.0 5.1 5.1 5.2
5th Largest 4.0 3.9 3.9 4.0 4.6 3.9 3.9 3.9 4.1 4.2
Top Five 56.4 52.4 52.4 53.8 68.9 52.6 54.3 55.6 56.6 57.5
a
Average for 1990-1998 period.
Source: Comprehensive Listed Company Information Database, Stock Exchange of Thailand.
agribusiness, and building and furnishing industries, with a top-five owner-

ship concentration of at least 60 percent. Other industries had their top five
shareholders controlling at least 55 percent of outstanding shares.
Based on a regression analysis, there is no statistically significant
relationship between ownership concentration (measured by percentage of
shares owned by the top five shareholders) and profitability of Thai pub-
licly listed companies (Table 4.7). On the other hand, results show a signifi-
cant positive relationship between ownership concentration and financial
leverage, as measured by debt-to-equity and debt-to-asset ratios. These are
consistent with the hypothesis that companies with more concentrated own-
ership tend to engage in higher debt financing because their controlling
owners do not want to dilute their control by bringing in new equity hold-
ers. Company size is significantly related to ROE and leverage.
Table 4.7
Statistical Relationships between Corporate Profitability, Leverage,
Ownership Concentration, and Company Size
Item ROA ROE Debt-to-Equity Debt-to-Assets
Intercept 0.058* (0.116) (1.533)*** (0.072)

Top Five
Ownership
Concentration (0.001) 0.001 0.005** 0.001***
Company Size 0.003 0.022*** 0.169*** 0.034***
Adjusted
R-Squared 0.029 0.031 0.080 0.115
F-Statistic 3.037 3.090 6.800 9.647
Note: The regression included dummy variables for industry, year, and ownership types.
*
Denotes significance at the 10 percent level; ** at the 5 percent level; *** at the 1 percent level.
Source: Author’s estimation based on the Pacific-Basin Capital Markets Database compiled by the
University of Rhode Island, US.
Composition of Controlling Shareholders
Affiliated corporations comprise the largest group among the top five share-
holders of publicly listed companies, owning 26.7 percent of outstanding
shares on average (Table 4.8). It is the practice of Thai corporate founding
families to set up holding companies to own shares in affiliated companies
or subsidiaries. Through these holding companies, founding families main-
tain effective control of entire groups, including those that are publicly listed
Table 4.8
Top-Five Shareholder Composition of Publicly Listed Companies in
Thailand, 1990-1998
Year Company Bank NBFIsa Individuals Government Other
1990 28.3 2.1 6.9 13.9 0.7 1.1

1991 27.6 1.8 7.2 15.2 0.5 0.9
1992 25.4 1.6 7.5 18.0 0.8 0.7
1993 22.8 1.6 2.9 17.9 0.7 —
1994 23.3 1.4 6.5 18.9 1.3 1.3
1995 27.3 1.2 5.1 19.4 1.3 0.5
1996 27.8 1.5 4.7 20.0 1.2 0.5
1997 28.6 1.3 5.6 19.3 1.5 0.4
1998 28.5 1.6 5.2 20.0 1.4 1.0
Average 26.7 1.5 5.5 18.5 1.1 3.3
a
NBFIs denotes nonbank financial institutions, including finance and investment companies.
Source: Comprehensive Listed Company Information Database, Stock Exchange of Thailand.
in SET. Although holding companies set up affiliate firms, the affiliate firms
rarely hold shares of their parent companies, unlike in Japan where cross-
shareholding is common. The ADB survey indicated that listed companies
held shares in an average of 11 companies.
Individual family members also hold a significant amount of out-
standing shares, averaging about 18.5 percent. These individuals usually
hold important management positions in concerned companies. Typically,
founding families and their relatives maintain control of many companies
by jointly holding on to the most significant chunk of shares.
This practice is illustrated by Central Pattana, a company listed in
the real estate sector of SET. Established in 1980 with a registered capital
of B300 million, the company, a joint venture among three families, oper-
ates five of the most successful shopping malls in Thailand. In 1994, the
company increased its registered capital and became a public company listed
in SET. The roster of its major shareholders as of December 1997 illus-
trates the typical ownership concentration of a publicly listed company in
Thailand. The largest shareholder is Central Holdings Company, owned by
the Chirathivat family, one of the founding members, with 29.3 percent of
outstanding shares. In addition, individual members of the Chirathivat fam-
ily aggregately hold 25.6 percent of outstanding shares. The top 10 share-
holders include a holding company owned by the Tejapaibul family,
another of the company’s founding members. In effect, the top 10 share-

holders consist predominantly of members of founding families and their
holding companies. By owning 62 percent of voting shares, these share-
holders are able to control the company.
Across industries, the predominance of individual family members
and holding companies in the top shareholder list remains valid. Except in
the hotel and travel service sector, holdings by individual family members
and holding companies account for at least 50 percent of outstanding shares
of an average listed company.
Although the list of top shareholders of publicly listed companies
includes financial institutions, they exercise limited influence in operations
because of the restricted size of their shareholdings. On average, commer-
cial banks account for only 1.5 percent of total outstanding shares of listed
companies. Moreover, only one tenth of listed companies have commercial
banks on their top-five shareholder list. Nonbank financial institutions hold
an aggregate 5.5 percent of total outstanding shares. About half of listed
companies have nonbank financial institutions such as finance and invest-
ment companies in their top-five shareholder list.
The Government holds, on average, 1.1 percent of total outstanding
shares of listed companies. Only a handful of companies have the Govern-
ment among their large shareholders. In such cases, the Government owns
the majority of the shares. For example, Thai Airways International Plc. has
the Ministry of Finance as its only large shareholder with 92.9 percent of out-
standing shares. Another example is Bangchak Petroleum Plc., where the top
three shareholders are the Ministry of Finance, the Petroleum Authority of
Thailand, and a state bank. Together, they account for 80 percent of total out-
standing shares. There was a trend of rising government shareholdings through-
out the period 1990 to 1998. However, with the envisioned privatization master
plan, the Government’s role in public companies is expected to decline.
4.3.2 Corporate Management and Control3
Board of Directors
The Public Company Act of 1992 stipulates the appointment process, quali-
fication, roles, duties, and responsibilities of directors of public companies.
3
Discussions in this section are based on results of company surveys by SET and ADB,
both conducted in 1999.
Directors are required to meet minimum qualifications specified under the

SEA of 1992 and the Listing Rules issued by SET. Unless stipulated in
public companies’ articles of association, directors shall be elected at the
annual general shareholders’ meetings (AGSMs).
In their business conduct, directors are required to act with care
and honesty for the company’s best interest, and to comply with the laws
and articles of association. If found in violation of these provisions, direc-
tors may be imprisoned or fined. In addition, directors could be compelled
to compensate the company for damages arising from their misconduct.
Many companies have a formal policy on corporate governance and busi-
ness ethics.
A survey by SET found that the majority (58 percent) of the 202
responding companies held their board meetings every quarter, while
30 percent of respondent companies held board meetings monthly. Almost
all companies (98 percent) exceeded the minimum required five members
in their Board of Directors. Most companies (83 percent) satisfied SET’s
requirement of having two independent board members, while 15 percent
of respondents went beyond the requirement. Meanwhile, the ADB survey
found that 31 companies (out of 46 responding) required outside directors
to be present at all board meetings.
Chair of the Board and Chief Executive Officer
The SET survey showed that about 73 percent of listed companies had a
separate executive (management) board. Generally, an executive board con-
sists of senior management and some main board members. Some compa-
nies (36 percent) had five to six main board members holding seats in their
executive boards.
The ADB survey indicated, meanwhile, that only in two of the 46
responding companies were the chair of the boards elected based on the
extent of their shareholdings. Nineteen companies stated that selection was
based on professional qualifications. In five other companies, selection was
based on relationships with controlling shareholders. The appointment of
the chief executive officer (CEO) needed approval during the AGSM in 11
of the responding companies, but not in 22 others. Three companies indi-
cated that the CEO and the chair were close relatives. Although 28 percent
of the chairpersons came from the ranks of independent outside directors,
the majority (71 percent) had board chairs who were also members of top
management teams.
Compensation of Directors, Chair, and CEO
The majority of company respondents to the SET survey provided similar

compensation packages to internal and external directors. Where differ-
ent, these were attributed to variations in the extent of duties and respon-
sibilities assumed by those directors. Half of the companies in the SET
survey had a separate remuneration committee. However, the work of this
committee was often considered part of the executive board’s responsi-
bilities, not an independent assignment. Also, the majority of the compa-
nies (77 percent) did not have outside directors as members of their remu-
neration committees. These committees were mainly responsible for de-
termining compensation for senior and regular staff. The directors’ com-
pensation was determined largely by the Board of Directors except in
19 percent of the companies surveyed where a remuneration committee
was in charge.
The ADB survey indicated that 18 of the 46 responding companies
compensated their chairpersons using a fixed-fee schedule. Fourteen other
companies had profit-related incentive schemes in addition to fixed fees. In
25 companies, the remuneration packages had to be approved during AGSMs.
Three companies allowed their management to determine the chair’s com-
pensation package.
Audit Committees and Accounting Standards
Since January 1999, all listed companies have been instructed to establish
audit committees to be responsible for examining the quality and reliability
of company financial statements. Directors with managerial responsibility
or those related to major shareholders cannot be members of such audit
committees. The SET survey found that the majority of listed companies
(81 percent) still have no separate audit committee. Companies already
with audit committees did not have independent outside directors as audit
committee members.
SET’s attempts to bring accounting practices to international stand-
ards have included requiring listed companies to consolidate all liabilities—
including those on off-balance sheets—in their financial statements begin-
ning June 1998. Twenty-five of the 46 respondents to the ADB survey de-
clared adherence to all relevant international standards, while 19 compa-
nies observed only some of them. All respondents confirmed the use of
external auditors, with 41 firms admitting the use of services of interna-
tional auditing firms. In one company, however, the auditor is not
independent from the company. The majority of the companies (85 per-
cent) require the appointment of external auditors during annual general
meetings. Relationships between firms and external auditors are generally
long-term, averaging about 14 years. However, the corporate sector lacks a
strong self-regulatory body to compel compliance with these standards,
although recently, the Securities and Exchange Commission (SEC) and SET
were actively prosecuting violating firms.
Minority Shareholders and their Rights
Many different rights and entitlements of shareholders are laid out in the
Public Company Act of 1992. SET’s rules and regulations closely follow
this Act. For instance, shareholders can claim compensation in cases of
negligence or dishonesty by management. The Act also holds directors li-
able for any damage to shareholders, including false statements to conceal
information about the financial condition and operations of the company
during the sale of shares, debentures, or other financial instruments. The
Act, likewise, stipulates the proper conduct of shareholder meetings, as
well as the registration and holding of shares.
While safeguards are in place, there are also significant gaps in the
system of shareholder protection. (i) No standards are enforced in the con-
tent and timing of notices for shareholder meetings. Proxy solicitation tends
to be abused to the extent that shareholders are inadequately informed about
matters to be taken up in shareholder assemblies. (ii) The prudential role of
outside directors is limited by the noncompulsory character of their partici-
pation in key decision-making bodies such as the audit, remuneration, and
executive committees. (iii) Because the chair is frequently also part of the
top management team, there is the danger that top management may be
capable of unduly influencing the board’s decisions. (iv) The roles and re-
sponsibilities of the major government agencies regulating shareholder
rights—the Ministry of Commerce, SEC, SET, and the Bank of Thailand—
are not clearly defined. As a result, the institutional machinery is not fully
responsive to complaints about violation of shareholder rights.
According to the ADB survey, most responding companies have
rules and regulations intended to protect shareholders. In the majority of
these companies (38 out of 46 respondents), shareholders have access to
reliable information at no cost. Forty-four companies indicated that they
had proxy voting in place, with 13 companies allowing proxy voting through
mail. Shareholders are also entitled to call emergency meetings and present
proposals at AGSMs. At least 28 responding companies had the following
mechanisms in place: mandatory shareholder approval of major transac-

tions and interested or related party transactions; and mandatory disclosure
of related interests and significant shareholders’ transactions.
The SEA of 1992 and the listing rules also contain provisions for
the protection of shareholders against transfer pricing, takeover of the com-
pany, and insider trading. On paper, minority shareholders are assured ad-
equate legal protection. In practice, however, such protection has been in-
sufficient.
Written law and its enforcement diverge partly because of a provi-
sion that shareholders who take action against erring directors must have at
least 5 percent of the total number of shares. But with the ownership con-
centration of Thai companies, it would be difficult for minority sharehold-
ers to gather the shares needed to take action. In theory, minority sharehold-
ers may also appoint an outside inspector to examine the company’s opera-
tions and financial condition, and call an extraordinary session. But the
exercise of these rights requires even higher shareholding levels. In effect,
the only group of shareholders that can exercise rights is the top five share-
holders.
The difficulty minority shareholders have in exercising their rights
can be seen from the ADB survey results. Only a small number of share-
holders attended the latest AGSMs. Although the attendees held, on aver-
age, 66 percent of total outstanding shares, they comprised only 8 percent
of total shareholders. Almost 82 percent of shareholders, representing only
about 28 percent of shareholdings, did not vote in previous AGSMs. The
ADB survey results reveal that the proposals presented by management
were rarely rejected during the general meetings.
These problems appear to be partly a result of the relaxation of the
rules and regulations in the original Public Limited Company Act of 1978.
While stimulating the growth of the sector, the new Public Company Act of
1992 inadvertently weakened the governance of public companies by di-
minishing minority shareholder rights.
4.3.3 External Control
The fact that insider control in Thai companies is very strong should com-
pel a search for alternative external control and monitoring mechanisms.
Banks would be obvious candidates to implement these mechanisms, given
their importance in providing finance and their stake in companies.
Historically, Thailand has relied on commercial banks and finance

companies to channel funds to private enterprises. However, creditors do
not always require project feasibility studies or business plans in granting
loans. Only 28 of the responding companies in the ADB survey indicated
that their creditors required such feasibility studies. Apparently, a compa-
ny’s reputation and its long-term relationship with creditors sufficed in many
instances, as the ADB survey confirmed.
Seven of the companies responding to the ADB survey indicated
that all their creditors required collateral, 17 indicated that only some of
their creditors had such a requirement, while 18 said none of their creditors
required collateral. Most companies reported that banks were more likely
to require collateral, while loans for fixed investment were also more likely
to be supported by collateral. The presence of collateral usually diminishes
banks’ incentives for screening project feasibility and monitoring project
implementation.
The impact of the financial crisis on credit eligibility and supervi-
sion requirements has been significant. Among 16 companies in the ADB
survey whose loan applications in the last three years were rejected, 11
experienced rejection after the crisis started. For 20 of the 46 responding
companies, creditors’ collateral requirements were tightened after the cri-
sis. Fifteen of the 20 companies that had to renegotiate loan repayment
with creditors in the last five years did so after the crisis. In the end, how-
ever, the majority believed that creditors had little influence on company
management and decision making. Only three companies thought other-
wise. Eleven companies stated that creditors usually exercised whatever
influence they had on management through covenants regarding the use of
loans.
Normally, when insiders want to expand their company’s opera-
tions without losing control, they resort to borrowing. Leverage allows the
assets and operations of the company to grow without diluting corporate
control. One tempering mechanism that could inhibit the excessive use of
borrowing is the threat of losing control in the event of bankruptcy. Under
a weak bankruptcy system, such as that seen in Thailand before the crisis,
borrowers seldom lose control to creditors even when they default and be-
come insolvent. The old bankruptcy law in Thailand also made it difficult
for creditors to obtain payment against bankrupt borrowers. There were
many options, other than losing control, to solve debt repayment problems.
Debtors had many handles to stall the bankruptcy process, including proce-
dural disputes, which could cause a delay by at least a year. Actual bank-
ruptcy proceedings took more than five years on average.
The financial crisis has presented a unique opportunity for reinventing

the framework for corporate bankruptcy and for creating regulatory and judi-
cial precedents. Such efforts would serve to strengthen external discipline on
controlling owners. It will take years, however, before the extent to which the
bankruptcy framework has been strengthened becomes clear.
The Market for Corporate Control
The SEA of 1992 was the first legislation that stipulated rules and regula-
tions regarding the market for corporate control. SEC was later made re-
sponsible for regulating corporate takeovers.
According to the SEA of 1992, there are two categories of merger
and acquisition activities with associated regulatory measures. The first cat-
egory is the acquisition of shares in the open market. In this case, a person
who acquires more than 5 percent of issued shares must file a report with
SEC one day after the date of acquisition, if the purchase of shares implies
a change in the directors or business activities.
The second category is the tender offer, which is a general offer made
to shareholders of a company to acquire at least 25 percent of outstanding
shares. There are detailed requirements regarding such notification, whether
directly or indirectly, of shareholders: (i) all shareholders must receive tender
offers; (ii) an advertisement regarding the tender offer must be placed in ma-
jor newspapers for at least three consecutive days; and (iii) tender offers will
be effective 30 days after the report has been filed with the SEC.
The company has 21 days to evaluate the tender offer and submit a
report to SEC and all shareholders. SEC has no authority to either approve
or reject tender offers; its main role is to ensure transparency and fairness.
Recently, the minimum tender offer was reduced to 10 percent and some
procedural modifications have also been introduced.
The market for corporate control has not been active in Thailand,
and failed to provide managers with strong incentives to perform efficiently.
Since the introduction of the Public Limited Company Act of 1978, only a
limited number of successful mergers of public companies have taken place.
In 1994 and 1995, there were 41 cases of tender offers, with a total tender
offer value of B42.3 billion (Table 4.9). In 1996, there were only six tender
offers, with a significantly lower total tender offer value of B8.3 billion.
The situation remained sluggish in 1997 at nine tender offers and a further
decline in total offered value. The dearth of tender offers before the crisis
suggests that the Thai capital market did not offer a venue for imposing
market discipline on corporate management. Although merger and acquisi-
Table 4.9
Merger and Acquisition Activities, 1993-1999
Tender Offer Valuea Purchase Value Number of

Year (B billion) B billion % of Tender Offer Value Companies
1993 5.4 4.6 84.1 8
1994 23.1 17.3 75.1 27
1995 19.2 11.2 58.1 14
1996 8.3 6.9 84.0 6
1997 6.2 3.5 55.8 9
1998 7.7 6.2 81.3 13
1999 11.0 6.7 60.8 23
a
Tender offer value refers to the minimum offer value.
Source: Securities and Exchange Commission of Thailand.
tion activities increased after 1997, most of these were forced mergers or
related to rescue packages.
The number of domestic institutional investors rose after the mu-
tual fund industry was established in 1991. But instead of opting for an
active role in the market for corporate control, they have mostly been con-
cerned with short-term gains. While the Thai mutual fund industry com-
pares well to those in other developing countries in the region, it remains
small. Since 1994, trading by mutual funds in SET represented less than
10 percent of total trading. Pension funds are perhaps even weaker in Thai-
land. Provident funds for government workers and workers in public enter-
prises have been established only recently.
Employee Participation in Corporate Governance
There has been little, if any, employee participation in corporate govern-

ance in Thailand. Few companies offer employee stock option plans
(ESOPs). Even when companies offer ESOPs, employees regard the plans
as monetary incentives, not with a view to becoming involved in actual
management. Because of the current crisis, employees are even less willing
to accept common shares as a form of compensation or benefit. Eleven of
the 46 responding companies in the ADB survey offer ESOPs, but employ-
ees have never been represented in the board of directors since their
shareholdings are minimal. Twenty-nine firms indicated that employees held
shares of their companies, but the average shareholding is smaller than
1 percent of total outstanding shares.
4.4.1 Overview of the Financial Sector
A breakdown of the Thai financial sector for the period 1992-1999 (Table
4.10) shows that Thailand is a highly bank-dependent economy. The total
values of loans from financial institutions and commercial banks were con-
sistently larger than the market capitalization of SET. The bond market
played only a marginal role in corporate financing, although its role in-
creased in the wake of the crisis.
Table 4.10
Size and Composition of the Thai Financial Sector, 1992-1999
(B billion)
Outstanding Outstanding Domestic

Loans from Loans from SET Debt
All Financial Commercial Market Securities
Year Institutions Banks Capitalization Outstanding
1992 2,906.1 2,161.9 1,485.0 215.2

1993 3,663.4 2,669.1 3,325.4 262.0
1994 4,775.1 3,430.5 3,300.8 339.0
1995 5,979.6 4,230.5 3,564.6 424.4
1996 6,912.0 4,825.1 2,559.6 519.3
1997 8,171.1 6,037.5 1,133.3 546.8
1998 7,360.5 5,372.3 1,268.2 941.4
1999 6,477.5 5,119.0 2,193.1 1,390.4
Source: Stock Exchange of Thailand, Thai Bond Dealing Centre, and Bank of Thailand.
The Banking System
Until recently, the banking sector was highly concentrated; there were 29
commercial banks, 15 of which were domestic banks. Competition from
foreign banks was limited as they were not allowed to engage in full branch
operations. In 1996, total assets of commercial banks amounted to
B5.5 trillion. The share of domestic banks in the banking system’s total
assets was 80 percent. The country’s largest bank, Bangkok Bank Ltd.,
accounted for 28 percent of the banking sector’s total assets; the next four
largest banks accounted for 63 percent. Many large commercial banks had
affiliates among the 93 finance companies that served the high-risk market.
The Government was also a major figure in the banking system, owning
70 percent of the country’s second largest bank.
Banking activity peaked in the mid-1990s. The Government re-
moved controls on capital and dividend repatriation in 1991, and almost all
capital account transactions were deregulated. In 1993, the Government
established the BIBF to expand the banking sector and reduce the borrow-
ing costs of Thai companies. Licenses were granted to 15 Thai banks, 12
existing foreign banks, and 20 new foreign banks. Banks under the BIBF
scheme were allowed to mobilize funds from abroad and lend to Thai com-
panies in foreign currency. Because borrowers carried the exchange rate
risk, the liberalization of interest rates and capital account transactions stimu-
lated a credit expansion through short-term borrowings in foreign currency.
BIBF banks also enjoyed tax incentives on their operations and profits. In
contrast, hardly any progress was made in lowering the cost of domestic
financial intermediation or in developing new financial instruments for cor-
porations.
The Equity Market
During the first few years of its operations, SET was not very active. Many
company founders did not want to release even a small portion of corporate
ownership and refused to go public. Easy access to commercial bank loans
by family business groups, due to their close ties, also made it unattractive
to raise capital from the equity market. The lack of supply of quality shares
was a big problem for SET at that time. SET is organized into 32 major
industries. Through the years, banking, finance, and property have accounted
for the bulk of trading volumes.
Benefiting from rapid economic and industrial growth, the stock
market entered its first boom period in 1986. Despite the worldwide market
crash in 1987, SET immediately recovered due to the strength of the Thai
economy. Stock prices tripled in the next three years until the market expe-
rienced its first crash as a result of the Gulf Crisis in 1990. After that, the
market rose steadily and reached a record high in the fourth quarter of 1993.
Turnover value reached B2.2 trillion. The number of listed companies also
quadrupled between 1981 and 1993. Some 347 companies were listed in
the same year with a total market capitalization of B3.3 trillion. In the
following years, the SET index declined, reaching 355.8 in 1998.
In 1995, an over-the-counter market, the Bangkok Stock Dealing
Center (BSDC), was set up by 74 members with an initial capital of B500
million. BSDC is a nonprofit, self-regulatory organization under the
jurisdiction of SEC. Its main role is to serve as a secondary market for

unlisted companies trying to raise capital. Only one security was listed in
BSDC in 1995 and two more in 1996. Turnover value was B1.8 billion in
1996, but dropped the following year to B122 million. In 1998, turnover
value was negligible and the BSDC Index remained flat throughout 1996-
1998. Consequently, the BSDC was dissolved in 1999.
The SEA of 1992 installed the legal and regulatory framework for
Thai capital markets. It separated the primary and secondary markets to
promote more flexible and effective supervision of both. The primary mar-
ket is supervised by SEC, which has a legal mandate to examine a compa-
ny’s financial status and operations before allowing it to issue securities to
the public. After initial public offerings, securities can be traded in the sec-
ondary markets, which consist of SET and BSDC.
According to the SEA of 1992, SET’s primary functions are to
serve as a center for the trading of listed securities and to provide the essen-
tial systems needed to facilitate securities trading. SET, however, also acts
as a clearinghouse, securities deposit center, and securities registrar, among
other functions approved by SEC.
Before 1993, there were two kinds of companies in SET—“listed”
and “authorized” companies, with each facing different listing requirements.
Listed companies were those that had (i) paid-up capital of at least
B20 million, and (ii) a minimum of 300 shareholders, each holding no
more than 0.5 percent and collectively owning at least 30 percent of paid-
up capital. Authorized companies were those with a minimum of 200 share-
holders owning collectively at least 25 percent of paid-up capital.
In 1996, the two classifications were merged, so now only listed
companies are traded in SET. Proposed changes in capital must be submit-
ted for approval to SET accompanied by a detailed memorandum outlining
the use of proceeds, financial projections, and pro forma balance sheet and
income statements.
In July 1990, SET established new requirements for initial public
offerings. A company wishing to qualify for listing in SET must file an
information booklet (prospectus) with SEC and SET. Company applicants
must have an established history of operating under substantially the same
management. The company should then appoint a financial adviser, ap-
proved by SET, to assist in the public offering process. The listing applica-
tion should be submitted concurrently to SEC and SET. If approved by
SEC and the SET Board of Governors, stock trading can commence within
five days. The allocation procedure is nondiscretionary. If the issue is over-
subscribed, lottery drawing must be used to ensure fairness.
The Bond Market
The Thai bond market has played a marginal role in corporate financing
until recently. In 1996, it accounted for a small share of the entire financial
sector, at about 11 percent of the total value of outstanding loans extended
by commercial banks and 20 percent of total equity market capitalization.
To gain some perspective of the size of the bond market in Thailand, in
1994, it represented only 9 percent of GDP, compared to 110 percent in the
US and 74 percent in Japan in the same year. The Thai bond market was
also smaller than that of Malaysia (56 percent of GDP) and the Philippines
(39 percent of GDP) in that year.
The bond market in Thailand started in 1933, the year the Ministry
of Finance first issued government bonds to finance infrastructure projects
and economic development. Upon its founding in 1942, the Bank of Thai-
land assumed responsibility for regulating the bond market. Beginning 1961,
the Government issued more bonds to finance industrial development projects
and perennial deficits. The budget surpluses of the 1990s eliminated the
need for new bond issuance, and the Government did not issue new bonds
during 1990-1997. The recent financial crisis, however, led to the renewed
issuance of Government bonds to finance the resurgent budget deficit and
support cash-strapped financial institutions.
State-owned enterprises became active issuers of bonds since 1993
because the Government constrained their borrowings (Table 4.11). How-
ever, the market for these bonds has been slow owing to the change in the
Government’s original policy of requiring the use of state-guaranteed bonds
as legal reserves.
The corporate sector played a limited role in the bond market in the
early years because of the complicated rules and regulations in effect at that
time. Companies generally issued short-term debt instruments like promis-
sory notes or bills of exchange. Investors had limited knowledge of debt
instruments. A turning point of the corporate debt market was the enact-
ment of the SEA of 1992, which encouraged limited companies and public
companies to issue debt instruments. Four years after the passage of the
SEA, the size of the corporate debt market rose to B132.9 billion. The Thai
Rating Information Services, the first bond rating agency in Thailand, was
also instrumental to the growth of the corporate debt market.
A breakdown of domestic offerings of corporate debt securities from
1992 to 1996 shows that unsecured debts accounted for about 60 percent,
while secured debt instruments accounted for just above 10 percent. The
proportion of domestic convertible debt instruments increased until 1995,
Table 4.11
Offerings of Debt Securities, 1992-1999
(B billion)
Item 1992 1993 1994 1995 1996 1997 1998 1999
Government Bonds — — — — — — 400.0 333.7

Treasury Bills — — — — — — — 77.0
State Enterprise Bonds 27.0 60.4 57.1 55.2 57.4 49.3 46.7 95.2
Guaranteed — — 50.8 55.2 43.1 41.3 46.7 90.1
Nonguaranteed — — 6.3 — 14.3 8.0 — 5.1
Other Government Bonds — — — 29.5 138.8 191.5 55.0 —
Corporate Bonds 5.1 61.4 110.0 86.7 132.9 40.9 37.1 315.9
Domestic 5.1 21.1 59.8 47.5 43.1 12.5 37.1 289.3
Secured — — 3.5 5.5 10.7 0.0 0.0 33.7
Unsecured 5.1 10.8 31.9 30.3 29.7 7.3 13.1 107.4
With Warrant — 9.6 19.3 3.5 — 0.0 17.3 140.6
Convertible — 0.7 5.1 8.2 2.7 0.3 6.0 7.7
Short-Term — — — — — 4.9 0.7 —
Offshore — 40.3 50.2 39.2 89.7 28.4 — 26.5
Secured — — — 3.1 6.0 5.4 — —
Unsecured — 1.0 26.2 28.2 45.9 20.5 — —
With Warrant — — 1.6 — — 0.0 — 26.5
Convertible — 39.3 22.4 7.9 37.8 2.5 — —
Total 32.1 121.8 167.1 141.9 329.0 281.7 538.7 821.8
Source: Securities and Exchange Commission of Thailand and the Thai Bond Dealing Centre.
then declined substantially in 1996 and 1997. The domestic debt market
declined after 1994 because corporations could borrow offshore at lower
costs. A sharp rise in unsecured offshore debt offerings can be noted all the
way through 1996. The decline in total domestic debt offerings in 1996 can
be ascribed to the increase in offshore convertible debts. Total offshore debt
offerings peaked in the run-up to the financial crisis. However, by the end
of 1997, the year the crisis unraveled and the baht was floated, total off-
shore debt offerings had plunged by 68 percent to a mere B28.4 billion.
BDC was established in November 1994 by 50 securities compa-
nies based on the provisions of the SEA of 1992. The club was considered
the first organized secondary bond market in Thailand to serve as the whole-
sale market for debt securities. By 1995, turnover value had reached
B51.5 billion. The following year, this had climbed to B200.6 billion, a
surge attributed to capital inflows encouraged by high returns on Thai bonds,
compared with investment in equities. In 1997, turnover value plummeted

to B106.2 billion as a result of the default of debentures due to the Asian
crisis. The closure of 58 finance companies affected the BDC significantly
since half of its members were suspended as a result. Turnover fell further
to B72.1 billion in 1998. In the same year, BDC was renamed “the Thai
Bond Dealing Centre” following its status upgrade to a bond exchange.
An examination of financing patterns among Thai companies listed in SET

shows that on the asset side, listed companies experienced liquidity prob-
lems with declining reserves of cash and marketable securities during the
period 1990 to 1996 (Table 4.12). The proportion of accounts receivable
also declined steadily. The ratio of net working capital to total assets de-
creased from a peak of 31 percent in 1993 to 28 percent in 1996. The over-
all trend is consistent with the decline in profitability observed in the analy-
sis of corporate sector performance earlier. In any case, overall asset quality
and liquidity of listed Thai companies deteriorated throughout the period.
Thailand’s publicly listed companies rely mainly on loans from
commercial banks and financial institutions to finance their growth. At lower
than 5 percent of total liabilities, the use of debentures remains minimal
even though the trend was generally upward until the 1997 crisis. From
1990 to 1996, short-term loans accounted for more than 40 percent of total
liabilities, a trend most apparent in the leap between 1991 and 1992. Long-
term loans accounted for about 20 percent of total liabilities, steadily eas-
ing up between 1990 and 1996.
Equity financing remains an important part of listed companies’
long-term financing, with equity levels remaining high despite an increase
in debt. Retained earnings accounted for about 30 percent of total equity
financing. There was also little change in the trend in retained earnings
within the seven-year period.
Across industries, significant variations can be noted. Construc-
tion and property development industries tended to have high proportions
of long-term loans and debentures. For the construction industry, these ac-
counted for 33 percent of total liabilities, while for the property develop-
ment industry, these comprised 31 percent. The average for all industries
was only 22 percent. Companies in construction and property development
seemed unable to generate internal funds, judging by their relatively low
levels of retained earnings, cash balances, and marketable securities hold-
ings. In addition, they also had a relatively small proportion of equity and
Table 4.12
Common-Size Statements for Companies Listed in SET, 1990-1996
(percent)
Item All Years 1990 1991 1992 1993 1994 1995 1996
Assets
Cash 2.3 2.2 3.2 2.9 2.4 2.2 1.7 1.9
Marketable Securities 0.8 3.3 1.6 0.5 0.7 0.6 0.6 0.3
Accounts Receivable 12.9 16.2 15.0 13.6 13.1 13.0 10.9 12.0
Inventories 15.2 17.9 14.6 15.9 14.9 14.7 14.9 15.0
Other Current Assets 12.4 6.8 9.0 10.2 12.0 14.6 14.8 14.2
Total Current Assets 43.8 46.4 43.5 43.2 43.2 45.2 42.9 43.6
Net Fixed Assets 36.1 36.5 37.8 37.6 38.8 34.2 34.3 34.8
Other Assets 20.2 17.1 18.8 19.3 17.9 20.6 22.6 21.6
Total Assets 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0
Accounts Payable 6.9 10.8 9.8 6.9 6.1 5.9 6.3 6.2
Short-Term Loans 22.2 17.6 18.8 25.3 25.4 21.8 21.3 21.8
Other Current Liabilities 7.8 10.5 9.4 8.0 7.4 7.6 6.7 7.7
Total Current Liabilities 36.9 38.8 37.9 40.3 38.8 35.3 34.2 35.6
Long-Term Loans 10.1 7.8 8.5 9.6 8.7 9.6 11.6 12.0
Debentures 2.2 2.2 1.6 0.2 2.1 2.9 3.2 2.5
Other Liabilities 1.5 1.3 1.6 2.0 1.8 1.2 1.5 1.3
Total Liabilities 50.7 50.1 49.7 52.0 51.4 49.1 50.6 51.4
Capital Stock 17.3 18.3 18.2 17.9 17.1 17.7 16.2 16.8
Paid-In Capital 17.7 16.7 17.7 18.2 16.9 18.4 17.9 17.4
Retained Earnings 14.3 14.9 14.5 11.9 14.5 14.7 15.3 14.4
Total Equity 49.3 49.9 50.3 48.0 48.6 50.9 49.4 48.6
Total Liabilities and Equity 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0
were highly leveraged. The agribusiness industry relied more heavily on

short-term loans at 56 percent of the industry’s total liabilities, compared
with the 44 percent general average. Printing and publishing companies
had lower financial leverage than companies in other industries.
Analysis of common-size statements by ownership concentration
(based on the levels of top-five ownership concentration classified as high,
medium, and low) also underscores that companies with high ownership
concentration had high levels of long-term loans (Table 4.13). The level of
total liabilities for the group characterized by high ownership concentration
Table 4.13
Common-Size Statements of Public Companies by Ownership
Concentration, 1990-1996
Degree of Ownership Concentration

Item High Medium Low
Assets
Cash 2.6 2.3 1.9
Marketable Securities 0.6 1.2 0.7
Accounts Receivable 14.6 11.9 12.4
Inventories 15.5 16.5 13.8
Other Current Assets 11.1 13.2 13.0
Total Current Assets 44.4 45.1 41.9
Net Fixed Assets 35.7 36.0 36.5
Other Assets 19.9 19.0 21.6
Total Assets 100.0 100.0 100.0
Accounts Payable 7.2 6.6 6.9
Short-Term Loans 22.2 22.9 21.4
Other Current Liabilities 8.4 7.8 7.3
Total Current Liabilities 37.8 37.3 35.6
Long-Term Loans 12.2 8.6 9.4
Debentures 0.9 2.4 3.3
Other Liabilities 2.1 1.4 1.1
Total Liabilities 53.0 49.7 49.5
Capital Stock 16.3 17.1 18.4
Paid-In Capital 16.0 18.2 18.8
Retained Earnings 14.6 14.9 13.4
Total Equity 47.0 50.3 50.5
Total Liabilities and Equity 100.0 100.0 100.0
was 53 percent of total assets compared with 49.7 percent for medium own-
ership concentration companies and 49.5 percent for low ownership con-
centration companies. For the high ownership concentration group, com-
mon equity accounted for a smaller proportion of total assets (47 percent)
than companies with lower ownership concentration. This is consistent with
the observation that majority shareholders try to maintain their control by
utilizing debt as a major source of funds. Companies with medium owner-
ship concentration tended to have a higher proportion of short-term loans.
Results from the ADB survey reveal that Thai companies preferred
to use reserves and retained earnings as their first choice of financing, fol-
lowed by bank loans, bond issues, and rights issues. After the crisis, how-
ever, bond issues overtook loans from commercial banks as the second
preference. Generally, the choice of financing is determined by the compa-
ny’s liquidity considerations, minimization of transaction and interest costs,
and maintenance of the existing ownership structure.
An overall picture of SET-listed companies’ financing and invest-
ment patterns in the 1990s shows a steady rise in the use of financial lever-
age (Table 4.14). The ratio of total debt to total assets increased from
50.8 percent in 1990 to 52.7 percent in 1996. Short-term debt accounted for
most of the increase, especially from 1994 to 1996. Public companies re-
lied more on short-term debt financing in the period before the financial
crisis. More important, however, was the headlong deterioration of firms’
ability to meet their interest payment obligations. The TIE ratio declined
from its peak of 7.7 in 1994 to 5.1 in 1996. Such deterioration of financial
positions during the period was a common feature of listed companies.
Table 4.14
Financial Ratios of All Listed Firms, 1990-1996
Ratio 1990 1991 1992 1993 1994 1995 1996
Times Interest Earned 8.4 5.9 7.6 7.4 7.7 5.8 5.1
Total Debt to Equity (%) 144.8 151.6 138.4 139.6 125.9 140.0 145.7
Long-Term Debt to Equity (%) 34.6 41.7 34.2 35.5 38.1 44.4 44.0
Total Debt-to-Assets (%) 50.8 51.4 51.9 51.2 49.5 52.1 52.7
Long-Term Debt-to-Assets (%) 11.7 12.7 12.4 12.9 14.1 16.1 16.0
Net Working Capital-to-Assets (%) 25.1 23.7 28.1 31.3 31.1 31.0 28.9
Operating Capital-to-Assets (%) 63.3 61.7 66.2 68.8 65.8 65.1 64.3
Source: Estimated from the Pacific-Basin Capital Markets Database compiled by the University of
Rhode Island, US.
The direct relationship between the degree of leverage and the de-
gree of ownership concentration is apparent in Table 4.15. The financing
patterns indicate that companies with high ownership concentration were
more highly leveraged than companies with medium and low concentra-
tion. While further detailed investigations are necessary, it would seem that
firms with concentrated ownership and associated links to the banking sys-
tem have easier access to debt financing. As a result, these firms more eas-
ily increased their leverage, thus rendering them more vulnerable.
Table 4.15
Financial Ratios of Listed Companies by Ownership Concentration,
1990-1996
Degree of Ownership Concentration

Ratio Low Medium High
Times Interest Earned 6.5 7.2 6.5

Total Debt to Equity (%) 126.5 124.6 148.3
Long-Term Debt to Equity (%) 34.2 30.8 42.4
Total Debt-to-Assets (%) 49.4 49.6 52.8
Long-Term Debt-to-Assets (%) 13.4 11.8 14.8
Net Working Capital-to-Assets (%) 27.4 29.8 28.0
Operating Capital-to-Assets (%) 63.8 66.1 64.3
Source: Estimated from the Pacific-Basin Capital Markets Database compiled by the University of
Rhode Island, US.
4.5 The Corporate Sector during the Financial Crisis
4.5.1 Impact of the Financial Crisis on the Corporate Sector
The financial crisis came after a period of rapid growth in the Thai economy.
The corporate sector contributed significantly to the crisis because of its
rising levels of leverage, unhedged foreign exchange liabilities, and a pre-
ponderance of short-term debt liabilities. The proportion of nondebt-creat-
ing capital flows, such as direct equity and portfolio investment, continued
to slide from 1985 to 1997. Their average annual growth rate declined from
28.5 percent between 1985 and 1990 to 8.7 percent from 1991 to 1996.
This decline was accompanied, on the other hand, by a remarkable growth
in the proportion of debt-creating capital inflows in the wake of the devel-
opment of the debt market and the establishment of the BIBF. From
45 percent of total net capital movements in 1985, debt-creating capital
inflows rose to 65 percent in 1990, peaking in 1994 at 84 percent.
The proportion of external debt as a percentage of GDP consequently
increased from 42.2 percent in 1986 to 251.9 percent in 1997. The composi-
tion and term-structure of this debt, however, is even more telling. From only
34 percent in 1986, private debt accounted for 84.5 percent of external debt in
1996 (Table 4.16). Nonbank private debt increased from 27.4 percent to
46 percent during the same period. Additionally, the proportion of short-term
debt increased from 15.8 percent in 1986 to 52 percent in 1995.
Table 4.16
External Debt, 1986-1999
($ billion)
Government Private Nonbank BIBF Commercial Bank

Year Long-Term Short-Term Long-Term Short-Term Long-Term Short-Term Long-Term Short-Term Total
1986 12.0 0.1 3.1 1.9 — — 0.3 0.9 18.3
1987 13.9 0.1 2.8 1.7 — — 0.3 1.2 20.0
1988 13.0 0.3 3.0 2.3 — — 0.3 2.2 21.1
1989 11.9 0.2 4.6 2.9 — — 0.3 2.8 22.9
1990 11.3 0.3 7.3 6.2 — — 0.3 3.9 29.3
1991 12.1 0.7 10.0 10.5 — — 0.3 4.1 37.9
1992 12.5 0.6 11.5 12.8 — — 0.7 5.5 43.6
1993 14.2 — 12.7 12.3 1.4 6.4 1.3 4.0 52.1
1994 15.5 0.2 13.7 7.4 3.0 15.1 3.5 6.4 64.9
1995 16.3 0.1 23.9 18.6 3.8 23.7 4.4 10.0 100.8
1996 16.7 0.1 31.2 18.8 10.7 20.5 2.3 8.4 108.7
1997 24.1 0.0 32.1 13.9 10.9 19.2 3.9 5.2 109.3
1998 30.9 0.2 34.8 10.9 6.9 14.9 3.9 2.5 105.1
1999 35.9 0.1 31.6 10.4 5.3 7.8 3.0 1.6 95.6
Source: Bank of Thailand.

This shows that although banking and finance companies suffered

most because of their short-term exposure, nonfinancial companies also
experienced severe liquidity problems as a result of the baht’s devaluation.
With easy access to foreign funds, large Thai companies had actively bor-
rowed at low interest rates from foreign financial institutions. The ADB
survey conducted for this study confirms this: 35 of the 46 respondents
indicated that they took out foreign-denominated loans mostly from for-
eign banks. On average, foreign currency-denominated debts constituted
55 percent of their total debt portfolio. Most of these foreign debts were not
properly hedged, exposing the companies to disaster when the baht started
tumbling on 2 July 1997.
The severity of the impact of the crisis on the corporate sector was
apparent from (i) the decline in the volume of public offerings; (ii) the rise
in the nonperforming loan (NPL) ratio and consequent tightening of credit
even for viable firms; and (iii) bankruptcies, closures, and drastic decline in
the number and capital of newly registered companies.
The value of public offerings sank in 1997 to B56.6 billion from
the 1996 level of B201 billion. The proportion of NPLs as a percentage of
outstanding loans demonstrates the liquidity problem experienced by the
corporate sector. NPLs spiraled from 12 percent in the second quarter of
1997 to almost 40 percent in the third quarter of 1998, reaching 45 percent
of total outstanding credit in December, based on the three-month past due
definition. Aside from the problem of NPLs, according to the Bank of Thai-
land, outstanding credit also declined throughout the second half of 1998.
If lending rates remained high, banks would be recording more of such
NPLs. Similarly, the liquidity problems faced by the corporate sector are
likely to continue for some time.
Due in part to liquidity problems on the one hand, and poor business
confidence on the other, the numbers of bankruptcies and company closures
reached all-time highs in 1998 (Table 4.17). Meanwhile, from its peak in
1995, the number of newly registered companies dropped to a 10-year low in
1998. The effects of the crisis were felt across all industry sectors.
SET’s dismal performance is indicative of the extent of the setback
suffered by the Thai capital market. Foreign investors retreated from the
market, leaving domestic investors with large capital losses. Even before
the crisis, trading activity at SET had been on the downturn. At the end of
1994, the SET Index stood at 1,360. After that, the index declined to 1,281
in December 1995 and to 831.6 in December 1996. It hit a 10-year low in
the second quarter of 1998. Trading volume has since been thin, suggesting
that serious investors have not returned to the market.
Table 4.17
Number of Newly Registered and Bankrupted/Closed Companies,
1985-1999
Year Newly Registered Bankrupted/Closed

1985 10,777 2,797
1986 11,095 4,410
1987 14,066 5,105
1988 19,096 4,307
1989 22,312 4,902
1990 25,933 3,218
1991 25,052 3,224
1992 36,134 4,334
1993 31,288 4,112
1994 35,915 9,695
1995 37,410 3,792
1996 37,407 7,080
1997 28,904 9,925
1998 20,201 12,409
1999 24,677 6,977
Source: Department of Commercial Registration, Ministry of Commerce, Thailand.
The price-to-earnings (P/E) ratio deteriorated from 19.5 at the end

of 1994 to 12 in 1996 and further to 6.6 in 1997. The increase of the P/E
ratio in 1998 was mostly a result of a decrease in earnings for most listed
companies. A steady price decline over the past few years has dragged down
the ratio of market price to book value. It also explains the higher dividend
yield ratio.
Initially, the Thai Government was lukewarm to the idea of obtaining IMF
assistance because of the requirements and conditions attached to the finan-
cial package. But when assistance from other sources did not materialize,
the Government was left with no choice. The IMF financial package was a
credit facility of $17.2 billion for balance of payments support and buildup
of the country’s reserves. As part of the assistance package, IMF required
Thailand to meet a set of performance criteria and implement various re-
structuring measures. The first Letter of Intent was cosigned by the Minis-
ter of Finance and the Governor of the Bank of Thailand on 14 August 1997.
The terms of the agreement required the Government to maintain tight

monetary and fiscal policies. In early 1998, IMF relaxed these key condi-
tions.
The core of the IMF conditionalities was the restructuring of the
banking and financial sector to regain investor confidence, increase profit-
ability, and restore solvency. The Financial Sector Restructuring Authority
was established in October 1997 to address the problems of 58 finance
companies that were suspended in 1997. As it turned out, only two compa-
nies emerged intact from the suspension. The assets of the other companies
were liquidated by auctions.
The Bank of Thailand also improved banking standards. Strict loan
classifications, loan provisioning, and income recognition were implemented.
The Government required all remaining financial institutions to recapitalize
and instituted closer monitoring measures to ensure full compliance with
this requirement.
Regulatory Response by the Government
The IMF program, drawn up with World Bank and ADB assistance, also
aimed at institutionalizing legal and regulatory reforms. Several changes in
the banking and financial policy environment have been effected in line
with the restructuring program. These include repeal of the Commercial
Bank Act, the Civil and Commercial Code, and the Act Regulating the
Finance, Securities, and Credit Foncier Businesses. The Government also
passed the Bankruptcy Act and Foreclosure Act Amendments, and worked
on revisions to the Secured Transaction Law.
Under the old bankruptcy laws, creditors seldom succeeded in ob-
taining payment against bankrupt borrowers. There were many options for
solving debt repayment problems. Creditors could negotiate to reschedule
debt repayments, and if necessary, follow through with a civil or bank-
ruptcy suit. They could seek civil action through the courts and could also
use criminal sanctions to enforce debt repayments. The old law allowed
only creditors to file bankruptcy suits, and did not recognize debtor-initi-
ated bankruptcy declarations. While no definition for “insolvency” could
be found in the bankruptcy law, it was widely interpreted as “having debts
more than assets.” Creditors thus bore the burden of proving a debtor’s
insolvency before the courts. By invoking procedural loopholes, however,
debtors could drag out the process for many years.
Many believed that the process was inefficient. For example, se-
cured creditors had to obtain the court’s approval before starting proceedings
for the recovery of debt through the realization of any collateral. Foreign
secured creditors had to go through the motions of establishing that their
country of domicile granted Thai creditors similar rights. To make matters
worse for creditors, any new loan to a company extended after the creditor
discovered the insolvency would not be eligible for repayment.
In 1999, the National Assembly passed an amended Bankruptcy
Act and approved the establishment of special bankruptcy courts. The amend-
ment added reorganization provisions to the Bankruptcy Act of 1940, thereby
allowing court-supervised corporate restructuring. The original Bankruptcy
Act dealt only with liquidation and composition. The amended legislation
also includes voluntary bankruptcy as a new feature.
Under the old Bankruptcy Act, creditors always had to contend
with the threat of disruptions in a delinquent borrower’s business. The new
law is designed to prevent bankruptcy due to temporary liquidity problems
by allowing an insolvent debtor to file a reorganization plan with the court.
The amended law also introduced the concept of automatic stay, which
means that a debtor could continue in business while the reorganization
program was being implemented. In effect, a remedy beneficial to bor-
rowers and creditors is made possible through a business reorganization
that should improve the borrower’s debt position and ensure its continued
operations.
The reorganization process is successful if (i) the debts shall have
been discharged; (ii) management of the company reverts to the borrower;
(iii) shareholders regain their legal rights; and (iv) the debts shall have been
settled within a five-year period. If the process fails to revive the business,
the company shall be declared bankrupt and liquidation of assets shall fol-
low.
The model for Thailand’s amended bankruptcy law was the US
Chapter 11, the main purpose of which is to assist in the rehabilitation
process so that a company can repay its debt and still retain its assets while
remaining in business. Chapter 11 is the main tool in restructuring bank-
rupted companies in the US, but it is a complicated, time consuming, and
expensive process. Chapter 11 cases account for only 5 percent of bank-
ruptcy suits in the US but consume 90 percent of the courts’ time. In Thai-
land, the judges and court officers have yet to learn and master the new
bankruptcy procedure. Enforcement of the new law is bound to be ponder-
ous and lengthy.
There are other potential problems. For one, the amended law lim-
its the rights of secured creditors. But more important, it covers only the
court-supervised reorganization of distressed companies. Companies need
to solve the problems (e.g., corporate governance) that caused the bank-
ruptcy in the first place. Without the necessary corporate restructuring, the
Bankruptcy Amendment will just prolong the problems of nonviable bor-
rowers. Under the new law, the test for insolvency still uses the balance
sheet criterion, namely “liabilities exceed assets,” as opposed to the more
appropriate criterion of “ability to pay when the debt falls due.”
The Foreclosure Act Amendment was likewise passed in 2000. The
amendment seeks to revise old rules and procedures that tended to delay
foreclosure proceedings. Procedural delays give borrowers an advantage
because they can refuse to pay back their loans even though they can meet
their obligations. The new foreclosure law cuts short the procedures re-
quired under the Civil and Commercial Code for petty or simple cases deal-
ing with mortgage defaults: (i) submission by the drafting committee of a
default judgment bill within a week, and (ii) processing of default cases
within four to six months of filing of a court claim. The amendment also
remedies the slow process of executing or disposing of assets in a public
auction.
Still pending Parliament approval is the amendment to the Secured
Transaction Law, which aims to increase liquidity in the domestic economy
by allowing businesses to use both tangible and intangible assets in securing
credit. In the past, only tangible assets were the norm. The proposed new law
seeks to expand the type of assets that a borrower can use as collateral.
SEC also examined the possibility of an amendment to the Public
Company Act of 1992. Replacing the Public Limited Company Act of 1978,
the 1992 Act relaxed some of the original restrictive rules and regulations
to encourage public company registration. The result, however, has not been
satisfactory. Most important, minority shareholders’ rights are not adequately
protected. The minimum shareholding requirement is too high for any indi-
viduals or groups of minority shareholders to take action against control-
ling shareholders. Minority shareholders also have to absorb the costs re-
lated to their actions because the 1992 Act does not allow them to be reim-
bursed by the company. Consequently, questions have been raised regard-
ing the appropriateness of the 1992 Act.
There have been proposals to lower the minimum shareholdings
required for a minority group to request the board of directors to call an
extraordinary general meeting at any time. In case the board of directors
does not comply, the court, after determining the legitimacy of the request,
shall have the power to call the extraordinary general meeting. The pro-
posed amendment also includes a provision for the company to reimburse
minority shareholders for expenses related to calling such a meeting.
Another issue is the assumption in the 1992 Act that there is a

separation of ownership and control functions. This may be true in coun-
tries where publicly traded companies are widely held. But as demonstrated,
this is not so in publicly traded companies in Thailand. Because of high
ownership concentration, the controlling shareholders have the exclusive
domain to appoint or exercise management, and determine voting results
on virtually any matter. The textbook separation between owners who sit in
the company’s board and professional managers who run the company does
not apply in Thailand. But because this is the assumption embedded in the
regulation, the main problem is overlooked, i.e., the dominance of control-
ling shareholders, who are also the managers, vis-a-vis the minority share-
holders. Consequently, there are few provisions in the Act that deal with
related or connected transactions that potentially reduce shareholders’ value.
The 1992 Act also allows directors to engage in business activities
that may directly or indirectly affect the company, subject only to approval
by the board of directors. In addition, it permits directors, with the approval
of the board, to borrow from the company without consideration to the
fairness of the transaction or transparency of the approval process. Direc-
tors enjoy unusual protection under the 1992 Act in that they can be par-
doned by shareholders in the annual general shareholders’ meeting for any
violation of fiduciary duties. The only reason Thai investors placed their
money in stock issues despite these legal cracks was the rapid increase in
stock prices in the 1990s.
In the absence of such a stock market boom now, minority share-
holders are likely to be wary of increasing their equity without correspond-
ing control mechanisms at their disposal. Where equity will come forward,
it will probably be expensive because of the higher risk that comes with
weak accountability mechanisms. The radically changed circumstances af-
ter 1997 offer the possibility that firms and their controlling shareholders
will be under greater pressure to concede to the exercise of minority rights.
Otherwise, they face the prospect of being unable to compete for the scarce
funds available in the equities market. The regulators are drafting a pro-
posal to amend the provisions on related transactions. The proposal clearly
delineates duties of care and loyalty for directors of public companies.
The 1992 Act only prescribes—not requires—the use of the cumu-
lative voting procedure. Most companies decide against cumulative voting,
claiming that it creates fragmentation in the board of directors, which, in
turn, disrupts the company’s management and decision making. However,
without cumulative voting, minority shareholders have no chance of being
represented in the board. The proposal for the amendment of the Public
Company Act of 1992 includes a recommendation to require all public com-

panies to use cumulative voting to ensure that the board of directors con-
sists of representatives from all groups of shareholders.
Corporate Debt Restructuring and Bankruptcy
The 1997 crisis led to a severe liquidity problem in the economy, contribut-
ing to the unprecedented rise in the corporate sector’s bad debt. In response,
the Government introduced debt restructuring-related measures to help re-
solve bad debts.
The Bank of Thailand issued guidelines in 1998 encouraging fi-
nancial institutions to specify their own policies, methods, and procedures
for debt restructuring. Considerable progress has been achieved on this front.
By October 2000, 322,764 debt restructuring cases involving B1.8 trillion
had been completed. Commercial banks initiated 74 percent of these cases,
accounting for B1.1 trillion of outstanding credit. Another 77,068 cases
involving B475 billion are undergoing restructuring.
In addition, a Corporate Debt Restructuring Advisory Committee
(CDRAC) was established in 1998 to map out debt restructuring measures
in support of efficient negotiations between the private sector and financial
institutions. As of November 2000, CDRAC’s target debtors comprised
10,767 cases involving outstanding credit of B2.6 trillion. However, only
7,147 cases (B1.6 trillion) have agreed to cooperate with CDRAC’s re-
structuring process. Some 82 percent of these cases have been successfully
restructured, accounting for B1.1 trillion in outstanding credit, with the
majority of the debtors coming from the commerce, personal consumption,
and manufacturing sectors. Another 5 percent of cases (B70 billion) are
undergoing restructuring negotiations. Cases for which negotiations were
unsuccessful, as well as those that did not cooperate with CDRAC’s re-
structuring process, will be settled by the courts.
The first bankruptcy court in Thailand opened on 18 June 1999.
Within three months, the court had more than 80 cases for disposition,
although since then, the number of cases has abated. The reason is that
bankruptcy law amendments appear to facilitate settlements outside the court.
Reforms in bankruptcy procedures should be seen not only in the
context of crisis resolution. Equally important is the contribution of effective
and reliable bankruptcy procedures for improved corporate governance. In
particular, where bankruptcy procedures are swift and effective, the mere threat
of external control alters the incentives faced by managers and controlling
shareholders significantly. This point is crucial because compared with
Malaysia, Philippines, and even Indonesia, Thailand is coming from a situa-

tion where excessively high leverage became the norm because firms could
obtain finance without having to concede a measure of control to outsiders.
Weak bankruptcy procedures were part and parcel of the perverse set of in-
centives that led firms to build up unsustainable levels of debt.
Reforms through SET and Improved Disclosure
The financial crisis prompted SET to introduce a range of improvements to

its operation and regulation. It required listed companies to establish their
own audit committees by the end of 1999. Financial information from listed
companies will also soon be required to conform to International Account-
ing Standards. The exchange has already required that listed companies’
quarterly reports be directly comparable with annual statements.
Such improvements in disclosure standards are part of the efforts
of SET and SEC, despite the weakness of their disciplinary powers, to push
companies to harmonize their accounting with international standards.
This study has provided an overview of the corporate sector and governance
in Thailand. Emphasis was on the structure of corporate governance and pat-
terns of corporate ownership and financing of publicly listed companies. The
study covers the period 1985 to 1996, a time span that includes the onset of
financial liberalization—the turning point of Thai economic development in
the last decade—and represents the decade preceding the Asian financial cri-
sis of 1997. Examination of corporate ownership, behavior, and performance
during this period helps understand the causes of the crisis.
The economic development of Thailand took off with the imple-
mentation of a series of National Economic and Social Development Plans
beginning with the first medium-term plan for 1961 to 1966. In the next
three decades, the Thai Government managed its economy with the corpo-
rate sector as the main engine of growth and development. For this reason,
the Government protected certain corporate sectors through tariffs and regu-
lation, and promoted key industries through incentives. The banking indus-
try played a key role in the early stages of economic development because
it represented the only avenue for funding Thai corporations. The
importance of bank financing continued throughout the 1990s, even after

the development of capital markets. In 1992, the corporate sector entered a
new era with the enactment of two major pieces of legislation, the Public
Company Act of 1992 and the SEA of 1992. Subsequently, there was a
marked increase in the number of public corporations.
The SEA of 1992 also marked the beginning of an active bond
market in Thailand. After 1992, the number and value of public offerings of
securities accelerated. The financial performance of the corporate sector
remained satisfactory up to the years before the outbreak of the financial
crisis. Profitability increased throughout the 1980s but began to decline in
the first half of the 1990s. In 1995 and 1996, the profitability of publicly
listed companies abruptly declined and their financial leverage increased.
Financial liberalization apparently encouraged companies to borrow over-
seas to finance investments that were not productively employed.
At the onset of the 1997 financial crisis, the overall corporate sec-
tor was seriously affected. The number of newly registered companies in
1997 dropped by almost 10,000 from the previous year’s level. At the same
time, the numbers of bankruptcy cases and company closures reached all-
time highs. Meanwhile, the number of listed companies in SET fell from
454 in 1996 to 392 in 1999. The impact of the crisis was felt across all
industries.
One of the principal causes of the crisis was the excessive use of
foreign debt by the corporate sector. During 1992-1997, foreign debt in the
Thai corporate sector increased continuously, reaching its peak in 1996.
Nonbank private corporations accounted for most of the increase. Although
there was a decline in short-term foreign debt, the increase in long-term
debt more than compensated for the drop. Because most of these debts
were not hedged, Thai companies were vulnerable to exchange rate risks.
Consequently, the devaluation of the baht that began on 2 July 1997 af-
fected the financial condition of Thai corporations, at a time when most of
them were already experiencing declining profits and high leverage.
The study examined the impact of ownership structure on corpo-
rate governance and financing patterns. One of the major findings is the
high ownership concentration among Thai companies listed on SET. On
average, the top five largest shareholders hold about 56 percent of total
outstanding shares. Although there are some variations across industries,
the overall pattern of ownership concentration seems to have been stable
for the past 10 years. This implies that the control of an average Thai com-
pany is typically in the hands of a few persons (founders or their associates)
who own a majority of total outstanding shares. Minority shareholders,
although larger in number, hold only a small portion of total outstanding

shares. Consequently, they have little influence over management decision
making and control.
Among the five largest shareholders of Thai companies listed on
SET, holding companies and affiliated corporations hold the largest propor-
tion at 27 percent of total outstanding shares. Individuals and insiders hold
the second largest proportion at about 19 percent. Financial institutions hold
a very small proportion; commercial banks hold only about 2 percent of total
outstanding shares while nonbank financial institutions hold about 6 percent.
The Government holds about 1 percent of total outstanding shares but these
holdings represent majority shares of a few companies. The investing public
holds the rest of the outstanding shares, averaging 46 percent.
An analysis of the corporate ownership structure in Thailand sug-
gests that founders and management continue to own and control publicly
listed Thai companies, through the use of holding and affiliated compa-
nies. The implications of ownership structures that are concentrated to
such a high degree are serious. The absence of external market controls
on the management of publicly listed corporations is dangerous. With
financial institutions playing limited roles in the capital market, there is a
clear lack of outside monitors for these publicly listed but family-control-
led companies.
Institutional investors in Thailand, foreign and domestic, are not
active. In the past, the government pension fund was the only major institu-
tional investor. Recently, the mutual fund industry has entered the picture
but with limited roles and activities. Most foreign institutional investors
invest only on a short-term basis and aim for short-term trading profits. All
these, along with a highly concentrated ownership structure, contribute to
the lack of external controls on the corporate sector through the capital
markets. Thus, publicly listed and unlisted companies in Thailand are equally
subject to the consequences of the risk-taking behavior of controlling own-
ers. It remains to be seen how reforms in bankruptcy procedures—includ-
ing the increased threat of creditor control—could shift the incentives of
controlling shareholders toward greater acceptance of equity finance and its
consequent accession of control to new shareholders.
The highly concentrated ownership structure weakens the protec-
tion of minority shareholder rights. Nominally, the existing legal and regu-
latory framework suggests otherwise. The key laws, the Public Company
Act of 1992 and the SEA of 1992, protect the interests of all shareholders of
public companies. These laws stipulate rules and regulations concerning
the activities of all public companies. The rules in both Acts governing
minority shareholders’ participation in decision making and in initiatives

against management conform to international standards. However, the high
ownership concentration of many listed Thai companies inhibits the effec-
tiveness of these provisions, because there is no separation between owner-
ship and management.
In view of this, the main challenge is not how the board can control
management to maximize shareholder value. Rather, because there are shared
interests between the controlling shareholders and key management per-
sonnel, the main challenge is in protecting minority shareholders from the
possibility of expropriation by the majority. For instance, before the crisis,
laws did not provide minority shareholders sufficient safeguards in cases of
transactions involving companies where the controlling shareholders had
related interests.
Certain provisions, moreover, posed formidable barriers in the mi-
nority shareholders’ exercise of their rights. For example, the Public Com-
pany Act of 1992 allows shareholders to act only when they hold a mini-
mum proportion of shareholdings, a requirement impossible to meet due to
the concentrated shareholdings of founding family members and manage-
ment. The Government has been moving to amend the Public Company
Act of 1992 to increase minority shareholders’ protection in this regard.
The ownership structure of Thai listed companies also significantly
affects company behavior. Ownership concentration appears to have little
impact on corporate profit performance, but is significantly related to fi-
nancing patterns. Specifically, the degree of ownership concentration has a
statistically significant positive relationship to the degree of financial lever-
age. It appears that founding family members use debt extensively to fi-
nance investments because they want to preserve control of their firms.
Consequently, these companies tend to become overleveraged, making them
vulnerable to economic shocks.
There are three major policy issues and recommendations that could im-
prove corporate governance in Thailand. The first issue involves the devel-
opment of a comprehensive supervisory framework and the strengthening
of the capacity of supervisory agencies. The second issue involves the pro-
tection of shareholder rights, an aim that can be achieved mostly through
legal reforms. The third issue involves creating external market controls through
better regulation and development of the capital markets. In this third area,
key reforms that will strengthen the regulation of financial institutions,
encourage market competition, activate the market for corporate control, and
increase the participation of institutional investors are imperative.
Development of a Comprehensive Supervisory Framework
There is a need for the Government to establish a comprehensive supervi-

sory framework for the corporate sector. Under the current system, three
major government organizations (the Ministry of Commerce, SET, and SEC)
are involved in corporate supervision. This is due to the historical develop-
ment of the Thai corporate sector: before 1975, the Ministry of Commerce
had the sole supervisory responsibility; in 1975, SET was mandated to
supervise listed companies; and after the enactment of the SEA in 1992,
SEC was established as another supervisory agency. Consequently, the su-
pervisory system is fragmented and not as effective as it should be. It is
important that the roles and responsibilities of each agency are clearly de-
fined to the public. The Government must develop an overall framework
for corporate sector supervision and redefine the regulatory jurisdiction of
each agency along functional lines. Only then will these agencies be able to
act promptly and effectively. The best approach may entail establishing a
single, unified supervisory agency or a permanent regulatory division con-
sisting of supervisory units from the three agencies. Once the roles and
responsibilities are clearly defined, the supervisory agencies also need to be
empowered to enforce the laws.
Protection of Shareholder Rights
The common assumption is that publicly traded corporations are widely

dispersed in terms of ownership. There is also supposed to be separation of
ownership and control, with control delegated to professional managers.
The owners of a firm rely on a board of directors to supervise the managers,
voting only on major decisions. If this were the situation, the key issue in
corporate governance would then be to ensure that managers act in the best
interests of the shareholders. The board therefore plays a pivotal role.
In reality, in most of Thailand’s publicly traded firms, the principal
shareholder typically plays a key role in management and often serves as
the chief executive officer. If the principal shareholder is in fact chair of the
board, he/she often has the decisive vote. In this setting, the key issue in
corporate governance is how to prevent insiders from expropriating assets
of minority shareholders. As in other crisis economies in the region, this is
a problem in Thailand.
There is a need to recognize the unique ownership structure in Thai-

land and its effects on corporate investment and financing behavior. Cur-
rent laws allow a high degree of ownership concentration and provide inad-
equate safeguards against possible conflict-of-interest transactions and their
impact on minority shareholders. The current ownership structure leads to
ineffective corporate governance and inadequate protection of minority share-
holders. The situation prompts two specific recommendations.
The first recommendation involves the repeal of current legisla-
tion to allow minority shareholders to have greater influence over man-
agement decision making. This includes prescribing ways to empower
minority shareholders without disrupting the company’s operations. SEC
is exploring the possibility of amending the law toward this direction.
Some of the legal reforms under consideration concern settling conflict-
of-interest situations with significant effects on minority shareholders,
increasing penalties for directors engaged in misconduct, requiring cu-
mulative voting for the election of directors, and a prohibition of con-
nected transactions by directors or management. The Ministry of Com-
merce is conducting a study on proposed amendments to the Public Com-
pany Act of 1992.
The second recommendation is to dilute ownership concentration
through the use of regulatory power. Through an amendment in the Public
Company Act, the Government can change the shareholding limit for con-
trolling shareholders. This move is expected to be unpopular among found-
ing family members and original owners. There is also a need for legisla-
tion dealing with nominee or holding companies because they are the insti-
tutional means that founding family members use to maintain control. The
Government does not have an effective way of monitoring the financial
activities of these companies even as it is widely believed that a large amount
of funds is being channeled through them. Because these holding compa-
nies control a number of large public companies in Thailand, they should
be monitored and regulated.
To ensure a level playing field, regulators must increase transpar-
ency and step up enforcement. Since the Asian financial crisis, there has
been much progress in this area. Both SET and SEC are taking an active
stance in improving the transparency and efficiency of Thai capital mar-
kets. But weaknesses in accounting and auditing practices have been inhib-
iting the development of capital markets. The slow improvement in the
legal framework has likewise obstructed progress in this area.
SEC has been trying to lay the foundations of good corporate
governance by espousing fairness, transparency, accountability, and
responsibility among companies. However, the SEC’s disposition toward a

largely voluntary approach for adoption of these characteristics has resulted
in uneven compliance among public companies. Accounting standards have
also been under review.
Capital Market Development and Regulation
Another important issue concerns the development of capital markets. With-

out a strong and efficient capital market, it will be difficult to improve
corporate governance in Thailand. In the stock market, for instance, there is
a need to increase market disciplinary power through market competition.
In an environment of highly concentrated ownership, the power of the capi-
tal market to discipline inefficient management is almost nonexistent. One
way the Government can improve the current situation is to require pub-
licly listed companies to trade a higher proportion of outstanding shares in
the secondary market. The promotion of active roles for domestic institu-
tional investors should also improve corporate governance in Thailand.
There will be no incentive for companies to raise capital in the
equities market if they can obtain funds at a lower cost elsewhere. The
Bank of Thailand’s enforcement of prudent lending practices among Thai
financial institutions, aimed at ensuring that banks finance only creditwor-
thy projects, will incidentally close off easy sources of finance for compa-
nies that have been practicing regulatory arbitrage. The same goes for im-
provements in the bankruptcy system.
Because the financing of Thailand’s corporate sector is predomi-
nantly bank-based and will remain so for a long while yet, it is important to
explore reforms that can lead to the enhanced role of banks in monitoring
enterprises. This may not be possible without reforms in the banking sector
itself, especially in the area of connected lending.
Thailand should develop a strong public debt market to supple-
ment the banking system in financing corporate investments. The first step
is to establish an active secondary Government bond market, which, in
turn, will lead to the emergence of a reference yield curve. The variety of
debt instruments available to the corporate sector and investors should be
increased and longer-term sources of bond finance actively promoted. A
well-developed domestic debt market will provide corporations with an
alternative to bank financing, while a strong domestic debt market will also
offer protection from foreign exchange risk. Further, a well-developed sec-
ondary market will pave the way for market disciplinary forces to act against
poorly managed companies.
References
Annual Report. 1997. The Securities and Exchange Commission of Thailand.
Bank of Thailand Monthly Bulletin. 1995-1999. Bank of Thailand.
Bank of Thailand Quarterly Bulletin. 1995-1999. Bank of Thailand.
Bond Market Development in Thailand. 1998. The Thai Bond Dealing Centre.
Department of Commercial Registration Database, Ministry of Commerce, Thai-

land.
Fact Book. 1995-1999. The Stock Exchange of Thailand.
Key Capital Market Statistics. 1997-1999. The Securities and Exchange Com-
mission of Thailand.
PACAP-Thailand Database, Pacific-Basin Capital Markets Research Center, The

University of Rhode Island, Kingston, US.
Thai Accounting Standards. 1995. The Stock Exchange of Thailand.
The Stock Market in Thailand. 1997. The Stock Exchange of Thailand.

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Corporate Governance

and Finance in East Asia

Ma. Virginita A. Capulong

Published and printed by theAsian Development Bank

3 The Philippines 155

3.6 Summary, Conclusions, and Recommendations 216

Table 2.5 Private Capital Flows to Korea, 1985-1998 64

Table 2.31 Net Profit Margins of Chaebols, 1985-1997 131

Table 4.3 StatisticalHighlightsoftheStockExchangeofThailand,

Corporate Governance and Finance in EastAsia presents the findings of a re-

ADB Asian Development Bank

Note: In this volume, $ refers to US dollars, unless otherwise stated.

The currency crisis that began in mid-1997 in Thailand spread quickly to

profiles the corporate sector’s governance characteristics. This section

1.2 Overview of the Corporate Sector

1.2.1 Historical Development

the currency needed to be devalued periodically under a managed floating

1.2.2 The Capital Market

The Government reactivated the stock exchange in 1977. A number of un-

At the end of 1988, the liberalization of the banking industry al-

1.2.3 The Banking Sector

Type of Bank 1993 1994 1995 1996 1997 1998 1999

Source: Bank Indonesia.

Assets and liabilities were concentrated in the top 10 banks. In

Foreign and domestic banks defaulted on their responsibility of deciding

1.2.4 Foreign Capital

The years of rapid industrial growth attracted a large amount of foreign

Up until the late 1980s, participation in the Indonesian stock mar-

1.2.5 Growth and Financial Performance

Publicly Listed Companies

Item 1992 1993 1994 1995 1996 1997

Average return on equity (ROE) of listed firms was 11.8 percent

Indicator/Sector 1992 1993 1994 1995 1996 1997

Indicator/Sector 1992 1993 1994 1995 1996 1997

Source: JSX Monthly (several publications).

At the end of 1995, there were 165 state-owned companies (SOCs)3 in

companies consistently declined over time, SOCs’ asset turnover rates

Item 1990 1991 1992 1993 1994 1995 1996 1997

1.2.6 Legal and Regulatory Framework

The Corporate Law

The Corporate Law of 1995 governs the establishment and operation of

acquisitions, consolidations, and bankruptcy, the decision should be ap-

The Capital Market Law

Despite loan covenants, creditors of unsecured loans are unprotected when

Banking Laws Affecting the Corporate Sector

1.3 Corporate Ownership and Control

1.3.1 Corporate Ownership Structure

Quality of corporate governance is closely related to corporate ownership

Publicly Listed Companies

Shareholder Rank 1993 1994 1995 1996 1997 Average

First Largest 50.5 48.1 47.9 48.5 48.2 48.6

Table 1.9 shows that ownership by the largest shareholder in 1997

fully-owned limited liability company (Perseroan Terbatas). Thus the founder

Agriculture 54.5 15.6 2.5 1.3 1.1

This is confirmed in Claessens et al. (1999), which shows that in

Cross-shareholding is one way to enhance corporate control and occurs

problem is inconclusive, one possibility is that legal lending limits had

1.3.2 Management and Internal Control

Note: In this volume, $ refers to US dollars, unless otherwise stated.