Some of the criticism singles out the establishment of policy targets and the execution strategy, which again resulted in another round of serious market disruptions. Despite significant progress in restructuring efforts of attaining global standards, operational efficiency remains unresolved issue since the market mechanism may not work without government guidance and support. Passive and conservative attitudes in the corporate and financial sector may actually result in sagging performance over the medium term and system inefficiency may add to even more serious problems ahead. Market oriented restructuring efforts still need to be observed with gradual fostering of various market infrastructures.

Five years may be too short to expect fundamental changes in the corporate sector. Intricate conflicts of interest and strong opposition to changes still pose serious threats to continued restructuring efforts. The kind of rapid progress would not be possible without the unexpected occasion of the economic crisis, which helped most decision-makers change their mindset. In this sense, some argue that crisis was a blessing in disguise.

Looking back into the 1960s, large corporations in Korea played the key role of spearheading the economy toward rapid growth. However, the concentration of economic resources brought some unique features that need to be discarded if the firms are to remain globally competitive. Overborrowing and reckless expansion, close links with political interest groups and dominance of major shareholders, lack of transparency, outdated governance structures all added to the negative image of chaebol. Above all, the old growth engine outlived its usefulness when increased financial opening required more transparent management practices at larger corporations. Sagging profits began to take on important performance criterion as international investors' sentiment seriously affected cash flow for firms. Korea needed a system overhaul to better cope with changing circumstances, but vested interests prevented timely transition to an advanced market based system. The accumulated pressure from supporting unprofitable enterprises finally erupted in the form of financial crisis.

Major restructuring was geared toward fixing non-viable management practices and shedding excess capacities. Overly expanded lines of business were whittled down to core competencies and governance structures were improved. The first round of corporate sector restructuring was about cutting off various redundancies to enhance transparency, improving financial structure, establishing core competencies, and ensuring responsible management by dominant shareholders and managers. Streamlining their vastly expansive lines of business was initially emphasized as well as the improvement in the governance structure in the direction of preventing autocratic rule by a number of major shareholders. Some development in outside monitoring of corporate management can also be cited as one of the significant achievements. The so-called "big-deals" to exchange duplicate investments among chaebols on the basis of newly grouped lines of business was the hallmark of the first-round of restructuring that eliminated wasteful competition.

In terms of improving financial structure, the elimination of mutual debt guarantee was emphasized. Payment guarantees on new debts were prohibited and debt ratios were reduced. Major client banks were required to monitor the progress of their client's financial structure according to the agreement by which the responsible bank can decide on the liquidation of potentially troubled firms. Other changes to improve the management practices include hostile M&As.; Even though few cases were reported, some of the regulations on corporate consolidation and mutual investment were relaxed to activate the hostile M&A.; Corporations can buy their own stock to a greater extent to help protect their management rights and restrictions on capital increase with consideration were also lifted. These changes to promote management efficiency and activate restructuring came into conflict with fair trade policy to ease the concentration of economic power.

Other changes include the speedy exit procedure for troubled firms, the set of measures to enhance management responsibilities of non-viable firms, and improvement of corporate bankruptcy procedures. Tax incentives were also formulated to speed up the exit of non-viable firms by waiving taxes on asset liquidation. To speed up the lay-off procedures, management can now fire workers without waiting until it is ready to close down.

The corporate restructuring drive was pushed forward by the authority with the basic understanding that prevailing settings for the chaebol could not guarantee any viable business activities in the future. Core competency of at most three to four areas was emphasized for maintaining international competitiveness. Both governance structure and ownership structure as well as financial structure were subject to serious restructuring according to global standards and best practices. Interestingly, the goals were largely achieved by direct intervention of the authority or indirect monitoring and supervision of major creditor banks.

From 2000 and onwards, the focus has been shifting in the corporate sector restructuring drive from massive adjustment to fine-tuning, from shedding off extra facilities and correcting serious anomalies to a more system oriented improvement in profitability and business exit procedures. Most of the major initial efforts were judged to have been accomplished and new goals for restructuring were regarded as pertinent.


Disposal of Non-viable Firms

In order to shed excess capacity in major industries, the government arranged "big deals," which consisted of exchanging businesses with others to concentrate on core competencies and maximize synergy effects. However, it turned out to be a rather risky undertaking as exemplified by the lingering difficulties of Hynix, a successor to Hyundai Electronics which acquired LG Semiconductor.


Improved Financial Structure

The most notable achievement of the corporate sector can be found in the dramatic turnaround of financial soundness. The average debt ratio of manufacturing industries fell from 396.3 percent at the end of 1997 to 182.2 percent at the end of 2001, while equity ratio (equity/total asset) rose from 20.2 percent to 35.4 percent for the corresponding period, reaching the overall international benchmark. Some concerns remain because the size of debt has not been reduced significantly, suggesting that reduction in debt ratio was largely the result of increased paid-in capital and asset revaluation, debt equity swaps, and exclusion of debts of exit firms. The so-called target ratio of 200 percent contributed to the recapitalization efforts for most firms rather than prompting the reduction of the size of debt. Marginally contributing factors include various measures enacted in 1998 to encourage hostile takeovers by temporarily allowing the total cap on capitalization by member companies of chaebol. Other indicators also confirm that the interest burden remains sizable even with the reduction in debt ratio: interest coverage ratio (operating profit/financial costs) remains at 132.6 percent in 2001, still below the stable level of 200 percent by World Bank standards.

In fact, the overall reduction in debt ratio cannot be an indicator of the soundness of the corporate sector per se, and it may have contributed to unintended environment in which dynamism is sacrificed in favor of soundness.


Improvement in the Governance Structure

One of the most serious structural problems of the chaebol system is the autocratic decision making process in which ownership and management cannot be distinguished. The core effort in improving the governance structure consisted of various checks on the dominance of governing shareholders by securing minority shareholders' right and strengthening market discipline. (Table 2). Financial institutions with asset size over 2 trillion won (US$1.5 billion) must hire outside directors as members of the board. The candidate committee also checks for special relations with the major shareholders, and the audit committee run by outside directors remains the essential part of internal control. Now board of directors have become the supreme decision making body of the corporate world.

(Table 1)

Fluctuation of Major Financial Analysis Indicator in Manufacturing Industry

(unit: %)

97 98 99 00 01 America (01) Japan (00) Financial Structure Indicator Debt Ratio Borrowing Dependence Capital Ratio Current Ratio Fixed Ratio 396.3 54.2 20.2 91.8 261.1 303.0 50.8 24.8 89.8 242.5 214.7 42.8 31.8 92.0 202.3 210.6 41.2 32.2 83.2 198.5 182.2 39.8 35.4 97.9 181.6 159.4 27.4 38.6 122.1 177.9 159.7 29.7 38.5 132.3 128.9 Profitability Indicator Operating Profit to Sales Ratio Current Profit to Sales Ratio Interest Coverage Ratio Interest Expenses to Sales Borrowing Average Interest Rate 8.3 -0.3 129.7 6.4 10.6 6.1 -1.8 68.3 9.0 13.5 6.6 1.7 96.1 6.9 11.5 7.4 1.3 157.2 4.7 10.5 5.5 0.4 132.6 4.2 9.4 4.3 2.0 224.9 2.3 3.8 3.9 551.0 0.7

Definitions of Each Indicators: Debt Ratio=(debt/capital), Borrowing Dependence=(short-term,long-term borrowings +corporate bond)/total capital Capital Dependence=equity capital/total capital, Current Ratio=current assets/current debt, Fixed Ratio=fixed assets/equity capital Interest Coverage Ratio=operating profit/interest cost Interest Expenses to Sale=financing cost/sales amount Source: Bank of Korea, [Financial Statement Analysis], Various Issues

(Table 2)

Profitability Indicators of the Manufacturing Industry Change

(compared to sale price %)

Section 90~96 Average 97 98 99 00 01 America (01) Japan (00) Operating Income 7.1 8.3 6.1 6.6 7.4 5.5 4.3 3. Non-operating Income and Expenditure -5.0 -8.6 -8.0 -4.9 -6.1 -5.1 -2.3 0.1 (Net Financing Cost) -4.0 -4.9 -6.7 -5.4 -3.8 -3.3 - - -5.7 -6.4 -9.0 -6.9 -4.7 -4.2 -2.3 -0.7 (Net Profits of the Foreign Exchange) -0.1 -3.1 0.1 0.3 -0.7 -0.3 - - (Gain on Disposition of Tangible Assets-investment) - - - 1.0 0.2 0.0 - - (Gain on Valuation of Marketable Securities-Gain on Disposition of Marketable Securities) - - - 0.2 -0.2 0.1 - - Ordinary Income 2.1 -0.3 -1.9 1.7 1.3 0.4 2.0 3.9 Net Income 1.5 -1.0 -4.4 0.0 -2.0 0.0 0.9 1.2

Note: (+) is profit, (-) is loss Includes profit and loss on foreign exchange Source: Bank of Korea, [Financial Statement Analysis], various issues.

Also, the government relaxed various regulations on M&A;, abolishing investment limits for foreigners and obligatory open purchase was also phased out. In fact the focus of these measures was to bring market discipline for the management. Also, banks continue to exercise indirect scrutiny of management practices as part of the joint effort to improve financial structures.

Other changes include a streamlined accounting and announcement system to improve transparency. In fact, most of these changes are the outcome of the agreement with the IMF. Independent auditing, complete public announcement, and consolidated balance sheets are also important developments to improve the management transparency. Introduction of consolidated balance sheet contributed to improved accounting transparencies. Introduction of various systems need to be coordinated and fully adopted to expect a sizable synergy effect. And Korea is making steady progress in operating these new market devices.


Performance

The ultimate objective of corporate restructuring lies in improved management through enhanced competitiveness.

The operating profit of manufacturing industries still show less than dramatic performance. The relative low level of profit needs to be interpreted with caution because of the damaging effect of restructuring in the short run.

The rather lukewarm performance in terms of operating profit can be interpreted as a successful outcome of restructuring since a crisis would normally imply drastic cut in profitability. General improvement in profit following the financial crisis largely comes from improved labor productivity associated with drastic cuts in payrolls.

Various indicators suggest that corporate sector restructuring has not yet translated into improved profit, and some improvements in other indicators point out that payroll cuts largely contributed to improved statistics.

Since the financial crisis, Korea underwent the most notable restructuring efforts in its history in the corporate, financial, public, and labor market. In corporate sector restructuring, efforts have been made to fix the autocratic chaebol system, improve management transparency, and strengthen financial structure. Mutual capitalization and mutual debt guarantees were abolished and efforts to focus on core competencies were strongly encouraged. Despite strong criticism on active involvement of the government authority, the restructuring efforts resulted in significant improvement in securing a sound financial system, and more transparent management practices. Improved labor productivity and more resilient corporate system also resulted from rigorous restructuring efforts. At least, international comparison shows that Korea's restructuring was instrumental in fixing nagging problems of the chaebol system and unusual practices of debt-financed growth strategy. Even by international standards, restructuring seems to be the vital part of the V-shaped recovery that was observed after the crisis.

Despite these achievements, Korea has to face the challenge of even more difficult tasks of emphasizing operational efficiency. Despite significant changes in institutions and systems, actual practices are not entirely free from old customs and still require government intervention in many areas.