Profile of Director The Case of Korea 3

Profile of Director: The Case of Korea 3 rd Asian Roundtable on Corporate Governance OECD The Role of Boards and Stakeholders in Corporate Governance 4 -6 April, 2001 Singapore Hasung Jang Korea University / PSPD Phone: 82 -2 -3290 -1929 Fax: 82 -2 -929 -3405 Email: jangya@chollian. net 1

New Regulation on Board Composition • Outside Director – All public company’s board should be comprised at least 25% outside directors – Financial Institutions & public companies with assets over 2 tr won, at least 50% outside director • Outside Director Nomination Committee – Mandatory for public companies with assets over 2 tr won and security brokerage companies. 2

New Regulation on Board Composition • Audit Committee – Public company with asset larger than 2 tr won ($1. 7 bil) – 2/3 of the committee should be outside directors – 3% voting right limit for election of committee member (2001) • Cumulative Voting System – Opt-out system 3

New Regulation on Director • Fiduciary Duty of Directors – Explicitly Stated in Commercial Code • Shadow Director’s Liability – Controlling Shareholder’s Liability Acknowledged • Minority Shareholder Rights Strengthened Filing Derivative Suit Requesting Termination of Directors and Auditors 1997 1% 1% 1998 0. 01% 0. 5% 2001 0. 005% 0. 25% 4

Qualification of Outside Director • Security Exchange Code Defines Negative List • List is to Preclude Individuals Who have Direct Conflict of Interest. – Person who has a “special” relationship with the largest shareholder – Major shareholder of the company or that person’s spouse or lineal ascendant or descendant 5

Qualification of Outside Director – Person who is an executive or full-time employee of the company or any of its affiliated companies or who was one for any of these companies within the preceding two years – Spouse or lineal ascendant or descendant of an officer or director of the company – Officer, director or full-time employee of a company that has an “important business relationship, ” or who was one for any of these companies within the preceding two years 6

Qualification of Outside Director – Officer, director or full-time employee of a company in which an officer, director or employee of the concerned company is a non-standing director • More challenging question is whether similar qualification should also be established for inside directors who has more of interest conflicts than outside directors 7

Composition of Board Number of Company Executive Directors Outside Directors Auditors Outside Auditors 1998 1999 2000 (736) (701) (693) 5, 857 (88. 6%) 669 (11. 4%) 4, 850 (75. 2%) 1, 204 (24. 8%) 4, 601 (69. 2%) 1, 418 (30. 8%) 1, 059 (89. 7%) 109 (10. 3%) 1, 016 (87. 9%) 123 (12. 1%) 795 (90. 3%) 77 (9. 7%) 8

Composition of Board 9

Persistent Problems with the Board • Self Dealing of Directors – Fiduciary duty not enforced – More interest conflict than outside directors • Entrenchment of Management through Affiliates’ Ownership – Controlling shareholder own less than 4% – Equity investment into affiliates increased substantially 10

Persistent Problems with the Board • Cumulative Voting Opted Out – Top 30 Chaebols : 92% excluded – Non Chaebols: 76% excluded • Independence of Outside Director in Question – Majority are chosen by controlling shareholder & Mgt. – Rubber Stamping – Poor Attendance 11

Persistent Problems with the Board • Attendance Rate of Outside Directors 1 st Half 1999 43. 9% 2 nd Half 1999 47. 7% 1 st Half 2000 53. 5% • Who Selected Outside Director? Controlling Shareholder Management Creditor Banks Others 1999 41. 8% 46. 4% 5. 1% 6. 7% 2000 39. 9% 4. 5% 15. 7% 12

Attendance of Board Meetings Samsung Electronics Co. KH Lee HS Lee IJ Kim JY Yoon DS Choi SH Lee KT Lee Number of Meetings 1998 11 Chairman’s Secretary CEO CFO Director 0 0 9 11 - 0 0 2 12 13 - 0 8 10 11 11 5 6 5 7 - 10 9 - 9 7 6 SR Lim Outside Director F Hirlinger Outside Director Iwasaki Outside Director 1999 13 2000 11 13

Obstacle on Independent Board • Concentrated Ownership Structure – Circular Equity Ownership – Pyramidal Equity Ownership • Passive Local Institutional Shareholder – Investment Institutions are owned by chaebols – “Corporate Account” in Investment Institutions • Complex and Costly Proxy Procedure – Election of outside director is practically impossible 14

Case: Election of Outside Director • Case 1: Samsung Electronics Co. – Minority shareholders propose outside director candidate, but failed in proxy contest – 16% of supports mostly from foreign institutions – Could have been successful if cumulative voting • Case 2: SK Telecom, Hyundai Heavy Ind. – Elected 2 outside director at SKT, 1 at HHI – Cooperation from management and major foreign shareholders 15

Management Entrenchment through Ownership by Affiliates Top 10 Chaebols: Listed Companies 16

Circular Equity Ownership: Hyundai Group Kia Motors H Securities H. Precision Hyundai Co. H Elevator H. Motors H. Heavy Ind H Shipping Mipo Shipyard H Financing Ulsan Merchant Bank H Construction H. Steel Pipe Inchon Steel H Electronics 17

Pyramidal Equity Ownership: Samsung Group Samsung Elec Samsung Life Samsung Corp Cheil Comm. Samsung Heavy Ind. Samsung Everland Samsung Techwin Samsung Mech. Elec Samsung SDI Samsung Security Hotel Shilla Samsung Prec. Chem Samsung Foudation Samsung Card Samsung Engineering Cheil Textile Samsung F&M Ins Samsung Capital 18

Case: Election of Outside Director • Case 1: Samsung Electronics Co. – Minority shareholders propose outside director candidate, but failed in proxy contest – 16% of supports mostly from foreign institutions – Could have been successful if cumulative voting • Case 2: SK Telecom Hyundai Heavy Ind. – Elected 2 outside directors at SKT, 1 at HHI – Cooperation from management and major foreign 19 shareholders

Independence of Outside Director in Question • Case 1: Samsung Electronics Co. – Board Approved Debt Guarantee of Chairman Lee’s Personal Liability • Case 2: Samsung SDI – Board Approved Purchase of Shares of a Private Company Owned by Chairman’s Son • Case 3: Hyundai Heavy Industry – Board Filed Law Suit against Affiliated Companied to Recover Loss 20

Case 1: Board Approve Debt Guarantee of Chairman's Liability Samsung Motor Samsung Electronics Samsung SDI Samsung Mech. Elec. Samsung etc. Default Loan $2. 5 BIl Creditor Banks Debt Guarantee Loss $1. 7 bil at $200/Sh Penalty Interest $487/year Collateral Samsung Life Ins. 4 mil Shares at $635/Sh Chairman KH Lee 21

Case 2: Board Approve Purchase of Shares Owned by Chairman's Son • Samsung SDI – – Board Approved Unanimously Purchase Amount: 3. 6 bil won ($2. 8 m) 3 Days Share Value Loss: 444. 1 bil won ($341. 6 m) Market adjusted price change: -14. 7% • Cheil Communication Co. – Purchase Amount: 20. 8 bil won – 3 Days Share Value Loss: 76. 2 bil won – Market adjusted price change: -16. 3% ($16. 1 m) ($58. 6 m) 22

Case 2: Negative Effect on Share Price 23

Case 3: Board Acting Independently from the Group Affiliation Hyundai Electronics $200 Mil CIBC Debt Guarantee Law Suit! Hynudai Securities $200 Mil Debt Guarantee Hyundai Heavy Ind. Debt Guarantee 24

Case 3: Positive Effect on Share Price Board Acting Independently • Hyundai Heavy Industry Board Acting Independently • Hyundai Motors Co. Separated from the Group KOSPI Jan 4: Mar 14: Family Feud Started May 31: HMC Revolt July 28: HHI Law Suit Aug 31: HMC Separated Oct 31: Jan 31: Mar 16: 100. 0 79. 9 69. 1 65. 4 65. 0 48. 6 58. 4 50. 9 HMC HHI 100. 0 83. 2 62. 6 48. 5 58. 5 46. 7 67. 4 50. 6 81. 2 45. 6 62. 8 60. 7 74. 2 61. 6 81. 4 HCE 100. 0 76. 5 68. 4 43. 7 78. 8 27. 2 22. 7 12. 2 HEI 100. 0 65. 5 54. 9 65. 4 47. 8 22. 0 42. 2 25. 5 25

Case 3: Positive Effect on Share Price Family Feud Started HMC Separation HHI Law Suit 26

Possible Solutions • Cumulative Voting – It should be mandatory for countries where ownership is concentrated – Only way to elect independent director of minority shareholders’ choice • Ownership Diversification – Stricter Listing Requirements on Ownership Diversification 27

Possible Solutions • Increasing Liability of Directors – Derivative suit should be allowed for any shareholder – Security class action suit should be allowed • Independence of Executive Director – Independence qualification of executive director should be defined similar to one of outside director – Independence from controlling shareholders 28

Possible Solutions • Director’s Term Should be Shortened – One/Two year term: Re-election every year – All Directors’ term should expire at the same time • Incentive Compensation – Stock option to directors – Compensation committee solely by outside directors 29

Possible Solutions • Pro-Active Role of Institutional Shareholder – Independence of local institutions – Corporate finance section should be separated by “Chinese Wall” from equity investment section – Active involvement of public pension fund – Pro-active voice from foreign shareholders – Rule of “Sell it if you do not like management” does not work in emerging markets 30

Possible Solutions • Market for Outside Directors – Education for Directors – Assignment system from the “certified pool” • Separation of Ownership of “Financial Institution” from Ownership of “Industrial Company” 31