Samsung’s predicament puts South Korea at economic crossroad

Samsung’s predicament puts South Korea at economic crossroad

With his hospitalization, the family of Lee Kun-hee, Chairman of Samsung Electronics, risks losing management of the company. The South Korea’s National Assembly will soon face a crossroads on Chae-bols, South Korean family-owned business conglomerates, that will determine the structure of its economy.

The predicament

Samsung came under fire when the Q2 earnings report showed a 15% decline in operating profit from the previous quarter. The prospect does not look great, as Apple will soon launch its much-anticipated iPhone 6. Samsung has lost marketshare to Chinese manufacturers such as Xiaomi. However, the greater risk of underperformance might stem from the uncertainty that arises from who will manage the company, following the hospitalization of Samsung Chairman Lee Kun-hee May after suffering a heart attack.

The next heir of the company is his son, Lee Jae-yong, but he may lose the controlling threshold share of the company because of the inheritance tax of $5 billion and the possibility of “economic democratization” reform that limits the Chae-bol’s practice of cross-share holdings of companies that allows one family to control a conglomerate like Samsung Group through a web of 76 subsidiaries.

The new amendment

In September, the National Assembly and the Fair Trade Commission will debate whether to pass the amendment to the Insurance Business Act and the Separation of Banking and Commerce, known as the Samsung Life Insurance Act. There have been allegations that the complex web of cross shareholdings of Chae-bol leads to unclear and unfair practice of management, which also involves a moral hazard of one company controlling both banking and commerce industry leading to the ease of high risk investment at the cost of the financial system.

Currently, Chairman Lee Kun-hee holds only a 3.38% share of Samsung Electronics but he is able to gain control of the firm through a practice of cross-share holdings. Lee Kun-hee and Lee Jae-yong’s Samsung Everland are the two largest shareholders of Samsung Life Insurance, which accounts for a 7.56% share of Samsung Electronics. However, the new amendment will force Samsung Life Insurance to sell its share down to 3% of Samsung Electronics. This may weaken the Lee family’s position and potentially lead to their loss of the company.

Economic Democratization

When talking about the current state of South Korea’s stagnant economy, the consensus is that because about 90% of the jobs are employed by Small-and Medium Enterprises (SME), economic growth depends on the growth of SME.

In fact, this was the main political platform of President Park Geun-hye’s economic agenda during the presidential election campaign. President Park promised the “economic democratization” by ending the Chae-bol’s management of Korean conglomerates and promoting the “creative economy” by launching new government programs that will provide subsidies to startups to introduce new firms into the market that can develop disruptive products and create additional jobs.

The Park Administration has received widespread support. Public opinion agrees that the current generation of Chae-bol’s corporate governance is rather hindering the economic growth. These conglomerates compete in every sector of the economy and discourage competition in the domestic market. In the words of Bloomberg View writer William Pesek, With tentacles deep into any industry a young would-be innovator might want to crack, Chae-bol leaders can easily destroy any competitive threat.”

And the numbers speak volumes. The 10 largest Chae-bol conglomerates produce 84% of total GDP but only employ 5% of total labor market. Samsung Group alone owns 74 subsidiaries that make up 25% of total GDP. The large presence of conglomerates in itself is a gigantic barrier to entry into any lucrative market for any start-ups in South Korea.


Among a series of new economic policies by Park’s Administration, this contending amendment affects Samsung Electronics alone, which falls short of any structural improvement in the economy. Thus, the debate is essentially about the successful track record of Samsung Electronics in the international market and the stockpile of corporate retained earnings that are not being pumped back into the domestic economy.

Technology is a high-risk industry with fierce competition that can topple giants like Nokia, Sony, and Blackberry. The disappearance of Samsung means a potential loss of 25% of GDP. If the new law passes and Lee Kun-hee or his family lose a chunk of their shares to other investors, they may use the newly acquired voting power to sway the management to increase the dividend payment policy at the expense of research and development. This could lead Samsung Electronics to lose competitiveness in the market, harming the South Korean economy overall as a result.

Finland’s Nokia Experience

Finland is still struggling to recover from the Great Recession of 2008 and, in fact, the total output contracted in the fourth quarter of 2013 by 0.8% and contracted again by 0.9% in March and by 0.1% in May of 2014. The ongoing recession can be partially accredited to the fall of Nokia because of the introduction of smartphones by Apple’s iPhone. Before 2007, Nokia’s product accounted for one-fifth of the total export, hence dubbed “the Nokia Effect” in the Economist.

The sudden surge in the price of the stocks on the day of the news that Chairman Lee Kun-hee suffered from a heart attack suggests investors are now expecting to see an increase in dividend payment owing to the large stockpile of cash of about $28.5 billion that Samsung has.

However, the number noticeably falls short of the amount Apple owns in cash – $145 billion. The sheer difference raises a red flag on raising the dividend payment for the investors’ short-term profit and shows Samsung still needs time to grow. The shareholders and the government must let the lucrative firm continue its effort to aggressively invest in new product lines beyond the overcrowded mobile phone market for a win-win scenario to avoid a case like Finland and Nokia.

Categories: Asia Pacific, Economics

About Author

Yoon-Je Chung

Yoon-Je Chung is a specialist in East Asian affairs with experience at the Korea Chair of Center for Strategic and International Studies (CSIS). He is currently based in Seoul and is pursuing an MA at the Yonsei Graduate School of International Studies. He received his BA in Political Science and Economics from New York University.