Understanding Family business; the Korean “Chaebol” and Japanese “Keiretsu” case study

The Korean Chaebol system refers to a unique form of family-controlled conglomerates that dominate the economy in South Korea.

During our class on macroeconomics, startups and family businesses, we had a brief conversation about the Korean, Chaebol system, starting from as far back as the Joseon era, before making comparison with African family businesses and the Japanese Keiretsu business methodology, along the line we digressed a little bit to explain what some key words meant, and we also made use of real-time examples and use cases.

Introduction

The Korean Chaebol system refers to a unique form of family-controlled conglomerates that dominate the economy in South Korea. Chaebols are large, diversified business groups characterized by a complex network of cross-ownership, family ownership and control, and interlocking relationships between companies. The term "Chaebol" originated from the Korean word "jaebol," which means wealth or power.

Brief History & Background 

Gojoseon: According to Korean mythology, Gojoseon was the first kingdom in Korean history, founded in 2333 BCE by Dangun. While the historicity of Gojoseon is debated, it is considered the starting point of Korean history.

Three Kingdoms Period: The Three Kingdoms Period (1st century BCE – 7th century CE) saw the emergence of three powerful kingdoms on the Korean peninsula: Goguryeo, Baekje, and Silla. These kingdoms engaged in fierce warfare for control of the peninsula, with Silla ultimately emerging as the victor.

Unified Silla: In 668 CE, the Silla kingdom unified the Korean peninsula under its rule, ushering in a period of cultural and artistic flourishing known as the Golden Age of Silla.

Goryeo Dynasty: The Goryeo Dynasty (918-1392 CE) was founded by Wang Geon, who established a centralised government and a system of civil service examinations. The Goryeo Dynasty also saw the spread of Buddhism and the invention of the Korean alphabet, Hangul.

Joseon Dynasty: The Joseon Dynasty (1392-1910 CE) was founded by Yi Seong-gye, who overthrew the Goryeo Dynasty and established a new capital in Seoul. The Joseon Dynasty was characterised by a rigid social hierarchy, Confucianism, and isolationism.

King Sejong the Great: King Sejong the Great (r. 1418-1450) is known for his contributions to Korean culture and technology, including the creation of Hangul, the invention of a water clock, and the establishment of a system of standardised weights and measures.

Japanese Colonial Rule: Japan annexed Korea in 1910 and ruled the country until the end of World War II in 1945. During this period, the Japanese imposed a policy of cultural assimilation and forced labour, leading to widespread resentment and resistance.

Syngman Rhee: Syngman Rhee was a prominent Korean independence activist who became the first president of South Korea after its establishment in 1948. Rhee's presidency was marked by authoritarianism and corruption.

Korean War: The Korean War (1950-1953) began when North Korea invaded South Korea, sparking a conflict that would last for three years and result in the deaths of millions of Koreans and the division of the peninsula.

Park Chung-hee: Park Chung-hee was a general who seized power in a military coup in 1961 and served as the president of South Korea from 1963 until his assassination in 1979. Park's presidency was characterised by rapid industrialization, authoritarianism, and corruption.

Wealth & Power

Lee Byung-chul: Lee Byung-chul is often regarded as the founder of the modern chaebol system in Korea. He established Samsung as a small trading company in 1938, which later evolved into one of the world's largest conglomerates with diverse business interests in electronics, construction, finance, and more.

Chung Ju-yung: Chung Ju-yung is the founder of Hyundai, one of the most well-known chaebols in Korea. He started Hyundai as a small construction company in 1947 and expanded it into a global conglomerate with interests in automobiles, shipbuilding, electronics, and more.

Koo In-hwoi: Koo In-hwoi was the founder of LG, another prominent chaebol in Korea. He started LG as a small trading company in 1947, and it has since grown into a conglomerate with businesses in electronics, chemicals, telecommunications, and more.

Lee Kun-hee: Lee Kun-hee was the chairman of Samsung from 1987 to 2020 and played a significant role in transforming Samsung into a global powerhouse. Under his leadership, Samsung became a leader in various industries, including semiconductors, smartphones, and displays.

Chung Mong-koo: Chung Mong-koo is the chairman of Hyundai Motor Group, which includes Hyundai Motor Company and Kia Motors. He has played a crucial role in the global expansion and success of Hyundai Motor Group, making it one of the world's top automobile manufacturers.

Lee Myung-bak: Lee Myung-bak was a former president of South Korea (2008-2013) and was known for his pro-business policies that supported the chaebols. During his tenure, he advocated for the expansion of Korean conglomerates into global markets.

Park Chung-hee: Park Chung-hee was a former president of South Korea (1963-1979) who played a significant role in the industrialization of the country, including the growth of the chaebols. He implemented policies that supported the development of large conglomerates, including tax benefits and favorable regulations.

Roh Tae-woo: Roh Tae-woo was a former president of South Korea (1988-1993) who implemented economic reforms that helped chaebols expand internationally. He encouraged chaebols to focus on high-tech industries and helped them secure loans and investments for overseas expansion.

Lee Jae-yong: Lee Jae-yong, also known as Jay Y. Lee, is the vice chairman of Samsung Group and the son of Lee Kun-hee. He has been involved in the management and strategic decisions of Samsung, including its global business operations.

Chung Eui-sun: Chung Eui-sun is the chairman of Hyundai Motor Group, succeeding his father, Chung Mong-koo. He has been leading the group's efforts to expand into emerging industries, such as electric vehicles and autonomous driving, while also focusing on sustainable business practices.

The Chaebol system emerged in South Korea during the 1960s and played a crucial role in the country's rapid economic development. These conglomerates were initially supported by the government through favorable policies, subsidies, and loans, as part of the government's strategy to promote industrialization and export-oriented growth. Over time, Chaebols grew into massive conglomerates with significant influence in various sectors of the economy, including electronics, automotive, steel, construction, finance, and more.

Methodology:

The Chaebol system in South Korea is characterised by several key methodologies:

Diversification: Chaebols are known for their diversified business portfolios, with member companies involved in a wide range of industries and sectors. This diversification strategy allows Chaebols to spread risks and leverage synergies across different businesses.

Cross-Ownership: Chaebols often maintain complex networks of cross-ownership, where member companies own shares in each other, creating a web of interlocking relationships. This cross-ownership structure enables the founding family to retain control over the entire Chaebol group with a relatively small ownership stake.

Family Ownership and Control: Chaebols are predominantly family-controlled, with the founding family members holding significant ownership stakes and exercising control over key decision-making processes. This allows the founding family to maintain their influence and authority within the conglomerate, even across generations.

Long-term Planning: Chaebols are known for their long-term planning and strategic vision. They often invest heavily in research and development, and pursue aggressive expansion strategies to achieve market dominance and global competitiveness.

Examples of Chaebols in South Korea:

Samsung Group: One of the largest Chaebols in South Korea, Samsung Group is involved in various businesses, including electronics, finance, construction, heavy industry, and more. Samsung is known for its flagship companies, such as Samsung Electronics, Samsung Heavy Industries, and Samsung Life Insurance.

Hyundai Motor Group: Another major Chaebol in South Korea, Hyundai Motor Group is a leading global automotive conglomerate. It includes Hyundai Motor Company, Kia Motors, and other companies involved in automotive manufacturing, sales, and related industries.

LG Group: LG Group is a diversified conglomerate with businesses in electronics, chemicals, finance, and more. It includes companies such as LG Electronics, LG Display, and LG Chem.

SK Group: SK Group is a conglomerate with businesses in energy, telecommunications, chemicals, and more. It includes companies such as SK Innovation, SK Telecom, and SK Hynix.

Lotte Group: Lotte Group is a conglomerate with businesses in retail, hospitality, chemicals, and more. It includes companies such as Lotte Shopping, Lotte Chemical, and Lotte Hotels & Resorts.

Hanwha Group: Hanwha Group is a conglomerate with businesses in defense, finance, chemicals, and more. It includes companies such as Hanwha Aerospace, Hanwha Life Insurance, and Hanwha Chemical.

POSCO: POSCO is a major Chaebol in the steel industry, involved in steel manufacturing, engineering, and construction. It is one of the world's largest steel producers.

Chaebol business structure 

The Chaebol system in South Korea is known for its complex structure and various methods used by Chaebols to protect and consolidate their businesses. Here are 20 case studies that highlight different strategies employed by Chaebols to structure and safeguard their businesses in Korea:

Cross-Shareholding: Samsung Group, one of the largest Chaebols, uses cross-shareholding to maintain control. The founding Lee family holds only a small ownership stake in Samsung companies but controls them through a web of cross-shareholding among group affiliates.

What is Cross-shareholding

Cross-shareholding refers to a practice in which two or more companies hold ownership stakes in each other's shares. In other words, it is a mutual ownership of shares between companies, where they hold shares in each other's capital stock. This creates a complex web of shareholdings among companies, often resulting in a close relationship between them.

Cross-shareholding can be strategic and intentional, with companies entering into such arrangements for various reasons, including:

Mutual Support: Cross-shareholding can create a mutual support mechanism among companies, as they become each other's shareholders. This can facilitate cooperation and collaboration, such as joint ventures, technology sharing, and strategic alliances.

Protection against Takeovers: Cross-shareholding can be used as a defense mechanism against potential hostile takeovers, as it can make it difficult for an external party to acquire a significant stake in the company without acquiring shares from multiple entities.

Stability of Shareholding: Cross-shareholding can provide stability to the shareholding structure of companies, as it can deter short-term speculative trading and help maintain a long-term shareholder base.

Access to Capital: Cross-shareholding can provide companies with access to capital from other companies in the form of share swaps or capital injections, helping them raise funds for investment or expansion.

Cross-shareholding has been a common practice in some countries, particularly in Japan, where it has been a hallmark of the Keiretsu system, which is a network of cross-shareholdings among large Japanese corporations. However, cross-shareholding has also been criticized for its potential negative effects, such as reduced transparency, entrenchment of management, and lack of accountability to shareholders.

Circular Shareholding: Hyundai Motor Group utilizes circular shareholding, where member companies hold shares in each other, to consolidate control. This structure allows the founding Chung family to retain control over the conglomerate with a relatively small ownership stake.

What is Circular shareholding ?

Circular shareholding, also known as circular ownership or circular equity, refers to a situation where two or more companies are linked through a chain of shareholdings, creating a circular pattern of ownership. In other words, Company A owns shares in Company B, which in turn owns shares in Company C, and so on, with Company N eventually owning shares in Company A, completing the circle.

Circular shareholding can result in a complex web of interconnected ownership, where the ownership of one company is intertwined with that of another in a circular manner. This can create a complex and opaque ownership structure, making it difficult to determine the true ownership and control of the companies involved.

Circular shareholding can have various motivations and implications. It can be used as a means of consolidating control within a group of companies, as the circular ownership can create a closed loop where a small group of companies effectively control each other. It can also be used as a means of avoiding regulatory scrutiny or concealing ownership, as the complex ownership structure can make it challenging to trace the true ownership of the companies involved.

However, circular shareholding can also raise concerns about transparency, accountability, and potential conflicts of interest. It can create challenges in corporate governance, as it may blur the lines of responsibility and decision-making among the interconnected companies. Circular shareholding can also limit competition and hinder market transparency, as it can make it difficult for new entrants or outside investors to gain a foothold in the market.

Circular shareholding has been a topic of regulatory scrutiny in some jurisdictions, with efforts to increase transparency and regulate such ownership structures to prevent abuse or concentration of power. It is important for regulators, investors, and other stakeholders to closely examine the implications of circular shareholding and its impact on corporate governance, competition, and transparency in the business landscape.

Prime example 

One prominent example of circular shareholding is the case of Samsung Group, a South Korean chaebol conglomerate. Samsung Group has been known to have utilized circular shareholding as a part of its complex ownership structure.

In the case of Samsung Group, circular shareholding was used to maintain control within the Lee family, the founding family of Samsung. The Lee family used a complex web of cross-shareholdings among various Samsung companies to consolidate their control over the conglomerate. For example, Samsung Life Insurance, which is a Samsung Group affiliate, held shares in Samsung Electronics, the flagship company of Samsung Group. At the same time, Samsung Electronics also held shares in Samsung Life Insurance. This created a circular pattern of shareholdings between the two companies, effectively allowing the Lee family to maintain control over Samsung Group through the cross-shareholding structure.

Circular shareholding has been a topic of controversy in the case of Samsung Group, as it has been criticized for its lack of transparency and potential for concentration of power within the Lee family. In recent years, Samsung Group has taken steps to simplify its ownership structure and reduce circular shareholding, in response to regulatory pressure and calls for greater transparency and corporate governance reforms.

The example of Samsung Group highlights how circular shareholding can be used as a mechanism for maintaining control within a family-owned conglomerate, but also raises concerns about transparency, accountability, and potential conflicts of interest in such complex ownership structures. It underscores the importance of regulatory scrutiny and corporate governance reforms to ensure transparency, accountability, and fair competition in business environments where circular shareholding is prevalent.

Internal Trading: Lotte Group has been accused of engaging in unfair internal trading practices, where group affiliates trade among themselves at inflated prices to consolidate control and transfer wealth within the conglomerate.

Complex Subsidiary Structure: SK Group has a complex subsidiary structure with multiple layers of subsidiaries and affiliates, which enables the founding Chey family to maintain control over the conglomerate and protect its businesses from external influence.

Cross-Debt Guarantee: LG Group employs cross-debt guarantee, where member companies provide guarantees for each other's debts, to protect the group's businesses from financial risks and to maintain control over subsidiaries.

Definition 

A complex subsidiary structure refers to a hierarchical arrangement of subsidiary companies within a larger corporate group, characterized by multiple layers of ownership and control, often involving numerous intermediate holding companies. In other words, it is a structure where a parent company owns multiple layers of subsidiary companies, which in turn may own additional subsidiary companies, creating a complex web of ownership relationships.

Complex subsidiary structures are often employed by large corporations or conglomerates to organize their business operations, manage legal and tax considerations, and optimize corporate governance and ownership control.

Related-Party Transactions: Hanwha Group has been criticised for engaging in related-party transactions, where group affiliates conduct business with each other at preferential terms, leading to concerns of unfair practices and potential conflicts of interest.

Strategic Alliances: Chaebols often form strategic alliances with other conglomerates to expand their businesses and gain competitive advantage. For example, Samsung Group and Lotte Group formed a strategic alliance to jointly develop and market electric vehicle (EV) batteries.

Lobbying and Government Relations: Chaebols are known to have close ties with the government and engage in lobbying and government relations activities to influence policies and regulations in their favor, thereby protecting their businesses from potential threats.

Succession Planning: Chaebols carefully plan and manage succession to ensure that control remains within the founding family. For example, Samsung Group went through a succession process where the founding Lee family transferred leadership from father to son to maintain family control over the conglomerate.

Corporate Social Responsibility (CSR): Chaebols often engage in CSR activities, such as charitable donations, community development, and environmental initiatives, to enhance their public image and protect their businesses from reputational risks.

Innovation and Technological Advancement: Chaebols invest heavily in research and development to foster innovation and technological advancement, which helps them maintain competitiveness and protect their businesses from market disruptions.

Diversification into Non-Core Businesses: Chaebols diversify into non-core businesses to spread risks and safeguard their businesses from fluctuations in their core industries. For example, Samsung Group has investments in areas such as finance, construction, and heavy industry to reduce reliance on its electronics business.

Branding and Marketing Strategies: Chaebols invest significantly in branding and marketing to build strong brand identities and customer loyalty, which helps protect their businesses from competition and gain market share

Global Expansion: Chaebols expand their businesses globally to diversify revenue sources and protect their businesses from domestic market risks. For example, Hyundai Motor Group has established manufacturing plants and sales networks in various countries to reduce reliance on the domestic market.

Intellectual Property Protection: Chaebols invest in protecting their intellectual property, such as patents, trademarks, and copyrights, to safeguard their technological innovations and prevent infringement by competitors.

Financial Support and Subsidies from the Government: Chaebols receive financial support and subsidies from the government

Advantages of the Chaebol system 

Some of the advantages of the chaebol system include:

Economies of scale: The chaebols are large conglomerates with diversified businesses, which allows them to achieve economies of scale. By leveraging their size and scope, chaebols can benefit from cost savings in procurement, production, marketing, and distribution, which can lead to increased competitiveness and profitability.

Synergy and diversification: The chaebols typically have diverse business portfolios, spanning multiple industries, which allows them to achieve synergies and diversification. For example, a chaebol with businesses in electronics, construction, and finance can benefit from cross-business synergies in research and development, technology sharing, and financial support.

Access to resources and capital: Chaebols often have access to significant resources and capital, including financial capital, technological expertise, and human resources. This enables them to undertake large-scale projects, invest in research and development, and expand their operations domestically and internationally.

debt-to-equity ratio is a financial metric that measures the relative proportion of debt and equity used by a company to finance its operations and investments. It is calculated by dividing a company's total debt by its total equity.

The formula for calculating the debt-to-equity ratio is:

Debt-to-Equity Ratio = Total Debt / Total Equity

Where:

Total Debt: Represents the sum of all the debts owed by the company, including short-term and long-term debt obligations such as loans, bonds, and other borrowings.

Total Equity: Represents the residual interest in the assets of the company after deducting total liabilities. It includes shareholders' equity, which comprises of common equity, preferred equity, retained earnings, and other comprehensive income.

The debt-to-equity ratio is an important financial ratio that is used by investors, analysts, and creditors to assess a company's financial leverage and risk profile. A high debt-to-equity ratio indicates that a company has a higher proportion of debt in its capital structure, which may suggest higher financial risk and potential for default. On the other hand, a low debt-to-equity ratio indicates that a company has a lower proportion of debt and is relatively less reliant on debt financing.

The optimal debt-to-equity ratio varies by industry and depends on various factors such as the company's risk tolerance, growth prospects, and market conditions. It is important for companies to carefully manage their debt-to-equity ratio to ensure an appropriate balance between debt and equity financing, taking into consideration their financial goals, risk tolerance, and overall financial health.

D/E Ratio of Samsung

https://ycharts.com/companies/SSNGY/debt_equity_ratio

Strong brand recognition: Many chaebols are globally recognized brands, which can provide them with a competitive edge in the market. The strong brand recognition allows chaebols to command customer loyalty, gain market share, and enter new markets more easily.

Disadvantage of the Chaebol system

Concentration of Power: The chaebols in Korea have significant power and influence over the country's economy, with some critics arguing that this has led to a concentration of wealth and resources in the hands of a few individuals and companies. This has led to concerns about the potential for abuse of power and the impact on competition and innovation.

Lack of Transparency: Some critics argue that the chaebols have lacked transparency in their business practices, including accounting and financial reporting. This has led to concerns about corruption and the potential for fraud, as well as difficulties in assessing the true financial health of these companies.

Weak Governance: The chaebols in Korea have been criticized for having weak governance structures, with some arguing that they prioritize the interests of the controlling family over those of shareholders and other stakeholders. This has led to concerns about conflicts of interest and the potential for mismanagement.

Limited Competition: The chaebols in Korea have been accused of limiting competition in the country, with some arguing that they have used their dominant market positions to stifle competition and innovation. This has led to concerns about the impact on smaller businesses and potential negative effects on consumers.

Influence on Politics: Some critics argue that the chaebols in Korea have significant influence over politics and government policies, with some even alleging that they engage in bribery and other corrupt practices to influence government decision-making. This has led to concerns about the impact on democracy and the potential for a lack of accountability.

A trip to Africa

Family Control: Both chaebol and African family businesses are often controlled by a single family or a small group of families, with ownership and management tightly held within the family.

Long-term Orientation: Both chaebol and African family businesses tend to have a long-term orientation, with a focus on building and sustaining the business over multiple generations rather than maximizing short-term profits.

Relationship-based: Both chaebol and African family businesses place a strong emphasis on relationships and personal connections, with networks of family members and business associates playing a crucial role in the success of the business.

Flexibility: Both chaebol and African family businesses are often able to respond quickly to changing market conditions and adapt their strategies as needed, due to their relatively small and flexible organizational structures.

Lack of Transparency: Both chaebol and African family businesses can be criticized for a lack of transparency, particularly in their financial reporting and governance structures.

Challenges with Succession: Both chaebol and African family businesses often face challenges with succession planning, with the transition of leadership from one generation to the next sometimes leading to conflicts and instability