Control, Ownership, and Firm Performance: the Case of Korea

Abstract

Since the Asian economic crisis in 1997, some have argued that the poor corporate governance system was a contributing cause of the crisis. They claim that the weakness of minority shareholders' rights protection and the lack of market discipline for poor performing firms in the region made it easier for controlling shareholders to divert resources and to pursue their private interests rather than firm value maximization. Consequently, the corporate sector suffered from poor performance and weakened the financial system. Despite such claims, few studies have empirically examined the size of these conflicts of interests among shareholders and how they affect firm performance. Using the newly available ownership information and financial statements on 5858 Korean firms in non-financial sectors between 1993-1997, this paper examines how the conflicts among shareholders affect firm profitability. After documenting the ownership patterns, the paper investigates whether firm performance suffers when the disparity between control and ownership increases. When firm size, capital structure, and industry and firm characters are controlled for, the empirical tests show that firms with concentrated ownership by controlling shareholders exhibit a higher profitability than firms with less concentrated ownership. Publicly traded firms show lower performance than privately held firms. These tests also show that business groups of horizontally and vertically distributed firms (chaebols) have lower profitability than independent firms. Moreover, the study also identifies a mechanism through which firm resources are wasted. Firms that divert their assets through financial investment to their affiliated firms show weaker performance. Transfer of resources from publicly traded firms to group affiliated firms show even weaker performance. These results are consistent with the argument that controlling shareholders with small stakes in the firms pursued their private interests at the expenses of other shareholders.