The End of an Act and an Era? South Korea’s Corporate Restructuring Act

(Original version of Asia-Pacific Circle article)

Industrial planning by super ministries during periods of rapid industrialization and economic growth is a common feature in the South Korean, and before that, the Japanese economies. In addition to christening a development model that captivated the world, it planted deeply rooted ties between the government and businesses.

On 2018 June 30, the Corporate Restructuring Promotion Act (heretofore, the “Act”), one of the key pieces of legislation holding up the bond between the Republic of Korea (ROK) and its conglomerates (chaebol), expired. In its martyrdom, it mired ROK finance officials and opposition party members in the National Assembly in a contentious debate regarding the future of the government’s role in business. The Act served as the legal basis for the government and business to enter into a workout agreement, even if the latter already defaulted. This allowed firms to renegotiate terms of their corporate liabilities to avoid bankruptcy, liquidation and/or foreclosure.

Keeping up the Act

Finance ministers and officials in the majority party, as well as considerable representation from the private sector, pushed a motion through the National Assembly calling for the reinstitution of the Act. Their argument has been that the current state of the Korean economy requires workout options to prevent exacerbating already record low levels of youth employment; only 42% of the people between 15-29 years-old are employed.[1]

In addition to dwindling youth employment, another motivation behind the reinstitution of the Act includes prolonged recession in the shipbuilding and marine industry. That the government would take an involved role in this industry with the motive of bolstering socioeconomic development was clear from the start of the Moon Jae-in Administration when he acted upon the legal basis provided by the Act to shore up two large shipbuilders: Sungdong Shipbuilding & Marine Engineering Co. and STX Offshore & Shipbuildng Co., Ltd. Yet President Moon represents a shift in direction from past presidencies, which would maintain a more traditional stance of publicly financing shipbuilding firms despite their being zombie companies. The legitimacy of these actions were that they are historically strategic sectors and that allowing these firms to fall into bankruptcy would result in considerable financial fallout for shareholders – the majority holder being the Korean Exim Bank.

More recently, in 2018 May, the government released a more ambitious plan. It identified five regions in Korea to benefit from public support programs including tax exemptions and reductions, financial support, and infrastructure development. Many of the workers in these areas fell victim to cyclical or structural unemployment following dismal economic performance in manufacturing sectors.

Figure 1. Five special industrial crisis response zones, source: author’s illustration

Notable about this most recent use of corporate restructuring is that it also included General Motors and its Korea GM manufacturing plants. The Korea Development Bank, a policy bank, doubled its investment in Korea GM as part of a negotiated debt-restructuring plan. While investigations into Korea GM found that many of its financial woes originated from mismanagement, accounting and transparency issues, the government decided to move ahead with reshoring Korea GM given its anticipated spillover impacts in already economically distressed provinces of the country.

Prologue to the Act

The Act was introduced in 2001 September, empowering the government to insulate domestic firms against the impacts of the 1997 Asian Financial Crisis. During that period, a tremendous wave of insolvencies haemorrhaged throughout the economy as foreign currency loans became nonperforming with the introduction of a floating currency. The powers provisioned by the Act were extended five times and served as a vehicle to push forward strategic sectors with public finance.

Figure 2. GDP growth v Corporate debt, 1999-2017, source: World Bank and OECD

As illustrated in Figure 2, slowing performance in the economy was largely been aligned with periods of falling corporate debt as per cent of GDP. These periods incentivized the government was to implement restructuring measures on the basis of the Act on three occasions: (1) 2001-2005, (2) 2007-2010 and (3) 2011-2013. Two additional implementation periods took place in 2014-2015 and 2016-2018 aimed at industry-specific measures in shipbuilding and steel production.

The Epilogue?

If the government withdraws the legal basis upon which businesses are able to restructure their debt under government management, then it means that it will be left up to these entities themselves to refinance or go insolvent. That being said, however, even if the government were to withdraw its role in saving these sectors, they will look to modes of finance that can further destabilize the Korean financial system. The Bank of Korea (BOK) showed in its Financial Stability Report (2018 March) that 3,216 highly indebted companies in Korea reached a 100% interest coverage ratio and that 365 of those companies have not been profitable for seven years. These firms have been looking to extend their credit with commercial banks and when that option is unavailable resort to nonfinancial intermediaries, such as “savings banks”, for high interest loans. This has been a critical financial challenge for Korea as nonperforming loans and distress in debt service ratios (DSR) have been showing historic rises, which are further aggravated by increasing policy interest rates in the United States.

The combination of risk-taking firm-level behaviour, public interest objectives and structural features of the Korean economy illustrates that corporate restructuring is deeply ingrained. While coming at costs and arguably self-perpetuating, corporate restructuring has been a determining factor behind Korea’s dynamic growth and continues to forecast long-run gains.[2]

 Opposition party members argue that the Act serves as a springboard for government intervention in business, ultimately blocking the structural adjustment necessary to remain competitive. Whether this ongoing political row results in a curtain call for the Act is uncertain, but it brings up a slightly metaphysical question for Korean economic policy: what should be its role?

[1] “2018 March Employment Trends” (in Korean), Statistics Korea, 2018 April 11. Available at: http://kostat.go.kr/portal/korea/kor_nw/2/1/index.board?bmode=read&bSeq=&aSeq=367078&pageNo=1&rowNum=10&navCount=10&currPg=&sTarget=title&sTxt=.

[2] See, for instance, Chung, Jae and Ratnovski, Lev. “Benefits and Costs of Corporate Debt Restructuring: An Estimation for Korea.” IMF Working Paper 16/204 (2016).