ΆΓ  Foreign capital advancement reshaping domestic markets

Korea Herald 2001. 2. 5

Since the currency crisis, foreign investment in the domestic market has been rapidly increasing. For the three years after the crisis, foreign direct investment (FDI) totaled $40.1 billion and foreign portfolio investment totaled $21.9 billion, adding up to a huge sum of $62 billion.

The reason for the increased advancement of foreign capital into the domestic market is, above all, the full-blown opening of the domestic market after the currency crisis. The second reason can be found in the government's policy to attract foreign capital to overcome the shortage of foreign currency liquidity and to secure funds needed for corporate and banking sector restructuring. The last reason can be found in the steep decline of the value of domestic stocks, companies and real estate, which made them attractive bargains to foreign investors.

The problem is that, with the active advancement of foreign capital into the domestic market, the influence of foreign capital on domestic financial markets, financial institutions and companies is increasing. Simultaneously, the influence of the government, large domestic companies and domestic financial institutions is decreasing.

As a result, many of the existing practices and order within the domestic economy have collapsed, and many of the so-called global standards have been extensively adopted. Domestic companies' strategies, governance structure and financial and human resources management have also been significantly affected. The volatility of the domestic economy and financial markets have increased, bringing about the increase of risks that domestic firms and financial institutions are faced with.

Financial markets

Foreign capital has been actively advancing into domestic financial markets. As of the end of 2000, the total market value of domestic stocks possessed by foreigners amounted to 56.6 trillion won, which is 30.1 percent of the total market capitalization. This is a huge jump from the 14.6 percent at the end of 1997.

However, as of the end of 2000, foreign investors hold only 692.1 billion won worth of bonds, which is 0.16 percent of the total value of outstanding bonds, despite the fact that the bond market was also completely opened at the end of 1997.

Foreigners' participation in the foreign exchange market has been rapidly increasing, too. In the third quarter of 2000, the weight of foreigners participating in forward transactions amounted to 66.9 percent, up 16.1 percentage points from 1997.

Financial industry

Foreign capital has also been actively advancing into the domestic financial industry. In the case of the commercial banking industry, the means of advancement has changed from the establishment of new branches to equity participation and acquisition of existing institutions. The number one majority shareholder of Korea First, KorAm, Korea Exchange, Hana and Kookmin Bank are foreigners.

Also, foreigners' collective shareholdings of other top-tier domestic banks through the purchase of shares on the stock market has increased briskly. For instance, foreigners' total shareholding of Korea Housing and Commercial, Kookmin, KorAm and Shinhan Bank exceeded 50 percent as of Jan. 29, 2001. Moreover, at the end of 1999, the market share of those banks in which foreigners are the number one majority shareholder in terms of deposits and loans amounted to 41.7 percent.

The same phenomenon is occurring in non-bank sectors, such as securities firms. As in the banking industry, foreign securities firms advancing into the domestic financial industry since the currency crisis have changed their means of advancement from the establishment of new branches and regional offices to the acquisition of and equity participation in existing financial institutions. As a result, the market share of Korean branches of foreign securities firms in terms of brokerage increased from 3.9 percent in 1997 to 10.7 percent at the end of November 2000. If securities firms with a foreign majority shareholder are included as foreign securities firms, the total market share would increase to 20.9 percent.

Industrial companies

Foreign industrial companies are also advancing into the domestic market, through the acquisition of domestic firms or the establishment of their own local subsidiaries. In the automobile industry, thirty domestic auto parts makers have been taken over by leading foreign firms. For example, Delphi of the U.S. took over Daewoo Precision Industries, thereby establishing Korea Delphi Automotive Systems Corp. Mando Machinery, which had been one of the largest auto parts makers, was split into four units, each unit being taken over by Gibbs of the U.S., Wapco of Germany, UBS Capital of Switzerland and Valeo of France, respectively.

In addition, foreign auto manufacturers have also been advancing into the domestic market. Renault, a French automaker, took over Samsung Motors, establishing Renault Samsung Motors, while DaimlerChrysler bought a 15 percent stake in Hyundai Motor Co. Daewoo Motors is also in a situation of being acquired by a foreign company.

The same phenomenon is occurring in the electronics and telecommunications industries. In June 1999, LG Electronics and Philips created a joint venture under a deal where Philips would invest a 50 percent stake in the newly established company, which was established as a result of the spin-off of the LCD (liquid crystal display) division from LG Electronics. The two have also agreed upon the establishment of another joint venture in regard to a picture tube unit in the second quarter of 2001.

Asahi Glass of Japan took over the Daewoo Group's Hankuk Electric Glass, dominating the domestic picture tube market with Samsung Corning. Furthermore, since the abolition of the import diversification regulation in June 1999, Japanese consumer electronics manufacturers have been steadily advancing into the domestic market. Sony and JVC have already established their local sales companies in the domestic market, and Matsushita Electric is currently preparing the establishment of their own.

In the case of heavy industries, Volvo, the Swedish auto giant, and Clark, an American company, took over Samsung Heavy Industries' excavator and forklift units in July 1998, respectively, emerging as the two second-largest companies in Korea. The market share of both companies now amount to over 40 percent, respectively.

Foreign oil refining companies have also been advancing into the domestic petrochemical market. As a result, three out of the four domestic petrochemical companies, excluding SK, have been acquired by foreigners or turned into joint ventures. For instance, International Petroleum Investment Co. of the United Arab Emirates took over Hyundai Oilbank from the Hyundai Group and Aramco of Saudi Arabia took over Ssangyong Oil Refining (later changed to S-Oil) from the Ssangyong Group. In the case of LG-Caltex Oil, Caltex of the U.S. currently holds a 50 percent stake in the company although the LG Group has managerial control of it.

Meanwhile, three out of the five domestic newsprint producers, excluding Sepoong and Daehan Paper, have been sold off to foreign newsprint companies. In the case of the seedling and liquor industries, foreign producers that acquired domestic companies have currently secured more than 50 percent of the market share.

Foreign capital advancement

The advancement of foreign capital has brought about many changes, some desirable, some not so desirable, in the management of domestic companies. First, the massive inflow of foreign capital into the domestic market has provided domestic firms and financial institutions with more funds and opportunities to promote financial and corporate restructuring.

However, there has also been increasing criticisms that domestic companies and assets have been sold too cheaply. Indeed, a considerable number of large companies have actually sold off their core and profitable businesses, maybe too hastily, under the pressures of the liquidity shortage, thereby weakening their long-term growth potential.

Second, the increasing influence of foreign capital in the domestic financial market has also caused domestic firms to plainly recognize the importance of management transparency. Due to the introduction of international accounting standards and efforts to strengthen the function of the domestic companies' boards, the average weight of outside directors in the board of directors increased from 11.4 foreign capital in 1998 to 30.9 foreign capital in 2000.

However, sudden requirements to adopt a U.S.-style corporate governance structure brought about the confusion of many domestic companies in setting their management goals, which had focused on long-term growth, not short-term profitability. The newly adopted systems have even worked as an impediment to the smooth operation of companies due to the lack of experience of the people who execute those systems.

Third, due to foreign investors's strong requirements to enhance the soundness of the capital structure of domestic companies, problems of much too high leverage of domestic companies have been somewhat resolved. In addition, the principle has increasingly been applied, as the cost of fund raising by companies is dependent on their credit ratings. However, many foreign investors and companies tend to concentrate too much on profitability, showing passiveness in building a base for future long-term growth.

Finally, domestic companies, greatly influenced by foreigners, are now adopting new human resources management systems based on the accomplishments of individual employees, such as a performance-based, not seniority-based, compensation and promotion system. The new system will definitely contribute to the enhancement of management efficiency. Moreover, with the vitalization of the labor market, flexible manpower management has become possible.

However, side effects are also emerging, such as massive layoffs and the decline of employee loyalty, which had been considered a great strength of domestic companies. There are even cases of the exodus of competent core employees with high technological skills into other companies, which completely deprived a company of its growth potential.

The writer is a researcher of Samsung Economic Research Institute. - Ed.