Law still matters – ESG in a corporate landscape controlled by chaebols

Will the current global and national wave of ESG succeed to transform Korean firms into more responsible parties for the environment and society?

The recent pandemic has shined a spotlight on ESG in Korea. Companies, from SMEs to the largest conglomerates, have been announcing their “ESG management” strategies. Many large public companies renamed their board CSR committees to “ESG committees.” The Korean National Pension Service (NPS), the world’s third largest pension fund, implemented various ESG investment strategies to conform with the government’s pro-ESG policies or not to lag behind the market trend. The Korean government stimulated this “ESG boom” by providing ESG related policy funds, announcing “K-ESG Guidelines” setting forth key ESG factors and standards, and releasing a “K-Taxonomy” drawing boundaries between green and brown activities. President Moon Jae-in even proclaimed that the year 2021 would be the starting year of “ESG management” and emphasized the government’s role in supporting ESG activities.

Will the current global and national wave of ESG succeed to transform Korean firms into more responsible parties for the environment and society? Unfortunately, the outlook is not too bright. Most Korean conglomerates are controlled by family shareholders, i.e. chaebols. Unlike the United States, where voting rights are concentrated in the hands of large index fund managers [1], Korean conglomerates are controlled by families that have secured their power over several generations through implementing various control-enhancing mechanisms, namely pyramid ownership. Although NPS boasts a shareholding of more than 5% in around 300 listed Korean companies, it is usually the second or third largest shareholder – far behind the controlling families. The existence of such controlling shareholders poses a high obstacle to ESG activism, making it much more difficult to replicate success stories such as that of Engine No 1 securing board seats in ExxonMobil. [2]

Unless the controlling families are thoroughly convinced that ESG management will ultimately benefit their wealth and sustainability, ESG may become at best a marketing instrument to promote the firm’s image.

Given such a shareholder ownership environment and limited influence of active institutional investors, many of the promises of ESG management announced by Korean firms may likely be illusory. Unless the controlling families are thoroughly convinced that ESG management will ultimately benefit their wealth and sustainability, ESG may become at best a marketing instrument to promote the firm’s image, or at worst a disguise for managerial failure or private benefit extraction by controlling shareholders.

With the capital market having its hands tied, the product market may be able to play a larger role in pursuing ESG goals in Korea. Consumer boycotts can be effective against asocial controllers, such as in the recent case of Namyang Dairy. Its chairman, who succeeded his father as the controller of the dairy manufacturer, stepped down from his position and decided to sell his controlling block after a wide boycott by its consumers. The boycott movement was triggered by a series of corporate scandals, and ultimately intensified when the firm misleadingly claimed that its products were effective in preventing COVID-19 infections. Labor markets can also pressure firms to be responsible as it “may make it easier to attract desirable employees” as Milton Friedman acknowledged in his famous 1970 NY Times essay. However such market mechanisms are also limited in effect due to the dominance of Korean markets by a small number of chaebols - consumers and potential employees are left with little choice in most sectors.

Criminal and administrative sanctions are still the most influential means to steer corporate directors into compliance, and to lead them to internalize externalities.

If the markets are unreliable, legislation and regulation may step in and play the key role of handling environmental and social problems. The recent enactment of the Serious Accident Punishment Act which imposes criminal liabilities on CEOs responsible for serious industrial accidents, well portrays Korea’s approach to safety concerns. Due to the limited influence of institutional investors, scarce shareholder suits against directors and controllers, and the lack of punitive civil damages in Korea, criminal and administrative sanctions are still the most influential means to steer corporate directors into compliance, and to lead them to internalize externalities.

Amidst Korea’s struggle to embrace ESG movements, the agency problem between the controlling shareholder and minority shareholders remains its most important corporate governance issue since the Asian Financial Crises in 1997. Shareholder primacy is rarely blamed as a cause of climate change or inequality in Korea. Empowerment of (minority) shareholders is still a key part of the corporate governance reform agenda, and board isolation from shareholder influence is not a topic of hot debate in Korea. All these can be contributed to one key factor – the existence of controlling families, the chaebols.

However, reform may also be triggered in unexpected ways. Again coinciding with the pandemic, the activities of retail investors in the Korean stock market has dramatically increased since 2020. The number of retail investors increased from 6.14 million in 2019 to 13.74 million in 2021, according to KSD, a central securities depository. Such an influx of retail investors into the stock market is effectively raising public attention to corporate governance concerns. LG Chem’s hive-down and subsequent listing of its battery business stirred up a huge backlash from the public, as it allegedly harmed minority shareholders of LG Chem by selling its crown jewel to its newly established subsidiary despite their dissent. The mass disposal of shares in Kakao Pay, a fintech payment solution provider, by its executives soon after its IPO also brought on fierce criticism by retail investors.

Minority shareholder protection mechanisms surfaced as one of the key topics dealt with by major candidates during the recent presidential elections.

The increase in retail investment is also capturing the attention of politicians. Minority shareholder protection mechanisms surfaced as one of the key topics dealt with by major candidates during the recent presidential elections. The policy pledge by the president-elect, Yoon Seok-yeol, whose term will start in May, included stronger restrictions on insider trading, regulations on hive-down and subsequent listing, and the potential adoption of a mandatory takeover bid rule. While on the lookout for the new wave of ESG, Korea will also be tending to its unfinished business of protecting its most important stakeholder – the (minority) shareholder.

======

Joon Hyug Chung is an assistant professor at Seoul National University School of Law.