A Survey of Research on the

Corporate Governance of
Korean Firms
Finance Working Paper N° 804/2021 Woochan Kim
December 2021 Korea University Business School, AICG and ECGI

Woojin Kim
Seoul National University and ECGI

Kyung Suh Park

Korea University Business School

© Woochan Kim, Woojin Kim and Kyung Suh Park

2021. All rights reserved. Short sections of text, not
to exceed two paragraphs, may be quoted without
explicit permission provided that full credit, includ-
ing © notice, is given to the source.

This paper can be downloaded without charge from:

http://ssrn.com/abstract_id=3982236

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 ECGI Working Paper Series in Finance

A Survey of Research on the

Corporate Governance of Korean Firms

Working Paper N° 804/2021

December 2021

Woochan Kim
Woojin Kim
Kyung Suh Park

We thank Dohan Kim, Wook Sohn, and other participants of the 2021 Korea Finance Association (KFA) Fall
Conference for their valuable comments. Also note that this article constitutes a part of the 2020 Knowledge
Database Project initiated by the Korea Finance Association (KFA), and financially supported by KFA and NH
Investment & Securities Co. Ltd.

© Woochan Kim, Woojin Kim and Kyung Suh Park 2021. All rights reserved. Short sections of text,
not to exceed two paragraphs, may be quoted without explicit permission provided that full credit,
including © notice, is given to the source.
 Abstract
This article reviews research conducted from 2011-2020 on the corporate gover-
nance of Korean firms. The purpose is to promote academic interest in Korean
corporate governance research especially among non-Korean scholars and to
provide guidance to young Korean scholars who are working in this area. We
begin with the institutional features that are unique to Korea. We explain how
they allowed researchers to develop interesting hypotheses that cannot be stud-
ied elsewhere, to establish causality that is not possible in other country settings,
or to obtain data that are not available elsewhere. Then, we review the studies
that examine the control (ownership) and governance structures of Korean firms.
We pay attention to their determinants and their consequences. Lastly, we raise
methodological concerns in existing studies and also discuss research topics for
future research.

Keywords: corporate governance, Korea, control structure, ownership structure, business

groups, family firms, related-party transactions

JEL Classifications: G30, G32, G34, G35

Woochan Kim*
Professor of Finance
Korea University Business School, Department of Finance
Anam, Seongbuk
Seoul 136-701, Korea
phone: +822 3290 2816
e-mail: wckim@korea.ac.kr

Woojin Kim
Professor of Finance
Seoul National University, Business School
1 Gwanak-ro, Gwanak-gu
Seoul, 08826, Republic of Korea
phone: +822-880-5831
e-mail: woojinkim@snu.ac.kr

Kyung Suh Park

Professor of Finance
Korea University Business School
Anam-Dong, Sungbuk-Ku
Seoul 136-701, Korea
phone: +822-3290-1950
e-mail: kspark@korea.ac.kr

*Corresponding Author
 A Survey of Research on the Corporate Governance of Korean Firms *

Woochan Kim (Korea University Business School) †

Woojin Kim (Seoul National University Business School) ‡

Kyung Suh Park (Korea University Business School) §

December 2021

Abstract

This article reviews research conducted from 2011-2020 on the corporate governance of Korean firms.
The purpose is to promote academic interest in Korean corporate governance research especially
among non-Korean scholars and to provide guidance to young Korean scholars who are working in
this area. We begin with the institutional features that are unique to Korea. We explain how they
allowed researchers to develop interesting hypotheses that cannot be studied elsewhere, to establish
causality that is not possible in other country settings, or to obtain data that are not available
elsewhere. Then, we review the studies that examine the control (ownership) and governance
structures of Korean firms. We pay attention to their determinants and their consequences. Lastly, we
raise methodological concerns in existing studies and also discuss research topics for future research.

Keywords: corporate governance, Korea, control structure, ownership structure, business groups,
family firms, related-party transactions

JEL classification: G30, G32, G34, G35

*
We thank Dohan Kim, Wook Sohn, and other participants of the 2021 Korea Finance Association (KFA) Fall
Conference for their valuable comments. Also note that this article constitutes a part of the 2020 Knowledge
Database Project initiated by the Korea Finance Association (KFA), and financially supported by KFA and NH
Investment & Securities Co. Ltd.
†
Corresponding author. Professor of Finance, Korea University Business School; e-mail: wckim@korea.ac.kr;
tel.: +822-3290-2816.
‡
Professor of Finance, Seoul National University Business School; e-mail: woojinkim@snu.ac.kr; tel.: +822-
880-5831.
§
Professor of Finance, Korea University Business School; e-mail: kspark@korea.ac.kr; tel.: +822-3290-1950.
I. Introduction

The definition of corporate governance in Shleifer and Vishny (1997) focuses on the interest

of (outside) investors and how they might align themselves with the interests of insiders

(managers). Since U.S. public firms are primarily owned by dispersed shareholders, academic

discussion on corporate governance evolved around how to motivate professional managers,

who do not have much of an ownership stake in the firms they manage, to care about

shareholder value.

As described in La Porta, Lopez-de-Silanes, and Shleifer (1999), corporate structures

outside the U.S. are quite different from those found in the U.S. Specifically, non-U.S. firms

are typically characterized by: 1) family control and (2) business groups. Korea is no

exception. The main mechanism through which families retain control over a large amount of

assets is through inter-corporate shareholdings of public member firms that create a

pyramidal business group. This structure creates a deviation between cash flow and the

control rights of the controlling shareholder, which is not observed often in the U.S. (i.e.,

except for a small subset of firms with dual class shares.) While this structure may aggravate

the agency problem between minority shareholders and controlling shareholders (Morck,

Wolfenzon, and Yeung, 2005), legal enforcement is generally not in place to effectively curb

the pursuit of various private benefits of control. Extreme forms of private benefits, such as

wealth transfer or tunneling from the minority shareholders to the heirs of the controlling

families, are observed quite often and are deemed legal in many cases.

The purpose of this review is to survey the academic literature that covers corporate

control and governance issues of Korean firms. While our primary objective is to promote

academic interest in Korean corporate governance research, especially among non-Korean

scholars, we would also like to provide guidance to young Korean scholars who are working

-1-
in this area. We also explain corporate governance institutions unique to Korea so that non-

Korean scholars can better understand the research setting.

This survey paper constitutes a part of the 2020 Knowledge Database Project initiated

by the Korea Finance Association, and is an extension of an earlier study on the same subject

that covers publications from 1999-2010 (Yang, 2011). In this survey, we review academic

research published from 2011-2020 on corporate governance of Korean firms. Our search

resulted in 108 articles, 74 from 14 international journals and 34 from Korean journals.

following journals. １

In the process, we not only cover the traditional governance mechanisms widely

studied in the U.S. including managerial compensation, board of directors, institutional

activism, and the market for corporate control, but also the implications of family control,

business groups, and the deviation between cash flow and control rights. We also highlight

the empirical challenge inevitable in corporate governance research since both (family’s)

control structure and (investors’) governance mechanism are sometimes treated as the

dependent variables and sometimes as independent variables. In fact, some studies use the

governance variable as both a dependent and independent variable at the same time.

The remainder of the paper is organized as follows. In Section II, we describe, in detail,

the institutional features that shape the ownership and control structures of Korean firms and

how they are different from U.S. firms. In Section III, we review the studies that consider

control and governance structure as dependent variables, namely studies that examine the

１
14 international journals include Journal of Finance, Journal of Financial Economics, Journal of Corporate
Finance, Journal of Banking and Finance, Financial Management, Pacific-Basin Finance Journal, Corporate
Governance: An International Review, Emerging Markets Review, Emerging Markets Finance and Trade, Asia-
Pacific Journal of Financial Studies, Journal of Business Finance and Accounting, Journal of International
Economics, and the Journal of International Money and Finance. We also cover studies published in the
following local journals (in Korean): Asian Review of Financial Research (재무연구), Korean Journal of Financial
Studies (한국증권학회지), Journal of Money and Finance (금융연구), and the Korean Journal of Financial
Management (재무관리연구).

-2-
determinants of control and the governance mechanism. Sections IV and V cover studies that

treat control and the governance mechanism as explanatory variables, respectively. That is,

Section IV reviews studies that examine the consequences of control structures, including

business groups, while Section V reviews those that examine the consequences of various

governance mechanisms similar to those in the U.S. Section VI provides a brief conclusion

including some directions for future research.

II. Unique Corporate Governance Institutions in Korea

Many corporate governance studies in Korea owe greatly to the institutions that are unique to

Korea. They allow researchers to develop interesting hypotheses that cannot be studied

elsewhere, to establish causality that is not possible in other country settings, or to obtain data

that are not available in other countries. In this chapter, we discuss the regulatory settings

(firm and group levels) and the data sources that enabled these studies.

1. Regulatory Settings: Firm-level Regulation

1.1 Board Structure Reform

Researchers are fond of utilizing exogenous rule changes. It helps them overcome selection

bias and obtain unbiased treatment effects. This is also the case for corporate governance

studies, where corporate governance reform measures are used as exogenous shocks. Here,

we outline board structure reform that took place in Korea and discuss the studies that made

use of it to establish causality in their studies.

Before the financial crisis of 1997, few Korean firms had outside directors. These

included a few banks and state-owned enterprises (SOEs). However, things changed after the

financial crisis. In 1998, the Korea Stock Exchange (KSE) amended its listing rule to require

all listed firms to have at least a 25% outside director ratio. Starting in July 1999, discussions
-3-
ensued to legally mandate large publicly traded firms to have at least a 50% outside director

ratio Initially, it was recommended that listed firms with a total asset size above one trillion

Korean won (approximately, one billion U.S. dollars) be subject to the rule requirement. ２

However, when the recommendation was actually drafted in November for the

purpose of amending the Securities Transaction Act, the asset size threshold requiring a 50%

outside director ratio was raised from one trillion Korean won totwo2 trillion Korean won.

The amendment, which took place in December 1999, introduced additional reform measures.

For listed firms above the two trillion won threshold, the law required a minimum of three

outside directors, an audit committee, and an outside director nomination committee. The

audit committee had to be chaired by an outside director and maintain a minimum outside

director ratio of two-thirds. The outside director nomination committee had to maintain a

minimum outside director ratio of one-half. ３

After the 1999 reform, there were four additional board-related reform measures,

none of which are fully exploited yet in governance research. In 2003, the National Assembly

amended the Securities Transaction Act to mandate listed firms above the two trillion won

threshold to elect more than half of the board members as outside directors. In addition, in the

same amendment, the National Assembly required at least one audit committee member to be

an expert in finance or accounting. Moreover, in January 2020, the government amended the

Enforcement Decree of the Commercial Act to impose a six-year limit on the length of years

an outside director can serve in one company. For outside directors serving in multiple firms

２
Black and Kim (2012) and Black, Kim, Jang, and Park (2015) made use of this announcement to assess the
effect of board independence on firm value. They conducted a series of event studies where June-August of
1999 is used as the event period for firms with a total asset size above one trillion Korean won (see Section
V.2.1 for their research findings).
３
Black and Kim (2012) made use of this amendment to assess the effect of board independence on firm value.
They employed difference-in-differences (DiD) estimation, where listed firms above the two trillion won
threshold are classified as treated firms. They supplemented this by an instrumental variable (IV) approach and
regression discontinuity analyses (see Section V.2.1 for their research findings).
-4-
within the same business group, the combined length of service cannot exceed nine years. ４

In December 2020, the National Assembly amended the Commercial Act to require

firms above the 2 trillion won threshold to elect at least one audit committee member

separately from the other directors. This is a significant rule change that made the 3% voting

rights restriction imposed on large shareholders effective for at least one audit committee

member. Prior to this amendment, audit committee members were elected sequentially. They

had to be first elected as directors and then as audit committee members. Since the 3% voting

rights restriction applied to the second stage, but not the first stage, the candidates put to a

vote in the second stage were all under the influence of the controlling shareholder,

undermining the purpose of the voting rights restriction. However, with the 2020 amendment,

at least one audit committee member had to be set aside from the others to go through a

single election where membership to the board and audit committee is determined

simultaneously and the 3% voting rights restriction is applied. ５

1.2 Disclosure of Executive Compensation

To conduct empirical research on executive compensation, it is desirable to have access to

compensation data at the individual executive level. Prior to 2013, this data was available

only for share-based compensation in Korea. For cash-based compensation, companies

disclosed figures aggregated at the group level. Specifically, the three groups included: 1) all

inside directors not serving on the audit committee, 2) all outside directors not serving on the

audit committee, and 3) all audit committee members (i.e., the statutory auditor in case the

４
Very few countries have tenure-related regulations (CFA Institute, 2020). Among this handful of countries,
Korea has the strictest regulations.
５
Doo and Yoon (2020) study the setting that existed prior to the 2020 amendment. They investigate firms
below the two trillion won threshold that were given the option to choose between the internal auditor system
and the audit committee system (see Section III.2.1 for their research findings).
-5-
company does not have an audit committee). ６

The disclosure rule went through a major change in April 2013 when the National

Assembly amended the Financial Investment Services and Capital Markets Act to require any

director (or statutory auditor) whose total pay exceeds 500 million Korean won in a given

fiscal year to disclose their total pay, its components, and the criteria/methods used to set the

pay in the company’s business reports. According to the detailed disclosure guidelines set by

the financial authorities, total pay is composed of labor income (i.e., salary, bonus, and

incentives), retirement income, and other income including realized gains from stock option

exercises. ７

However, this new regime received criticism for its vulnerability to disclosure evasion.

Two avoidance strategies were pointed out. One is director deregistration. That is, registered

board members stepping down from the board, but retaining a non-registered executive

position. Another is pay cut involving a registered board member deliberately setting their

pay below the disclosure threshold of 500 million Korean won. In response to these criticisms

concerning the vulnerability to disclosure evasion and many actual incidents of director

deregistration by family executives, the National Assembly amended the Financial

Investment Services and Capital Markets Act in 2016 to expand the scope of executives

subject to mandatory disclosure. In addition to registered board members receiving more than

500 million Korean won a year, it required non-registered executives to disclose their pay as

long as they are among the top five highest paid executives in the company and receive more

than 500 million Korean won a year. This new rule came into effect in 2018. To date, no

study has explored the effect of this rule change.

６
Studies using group-level compensation data include Garner and Kim (2013) and Kim and Kim (2020),
among others (see Section V.2.3 and III.2.2.1 respectively for their findings).
７
A number of studies took advantage of this new disclosure rule. These include Kim, Lee, and Shin (2017),
Kim and Han (2018), and Cheong and Kim (2019) (see Section III.2.2.1 for their findings).
-6-
1.3 Disclosure of Block Ownership and Pre-meeting Vote Disclosures

Disclosure of significant interests in listed companies' voting securities is a regulation that is

indispensable for researchers of shareholder activism. For example, many U.S. studies assess

the effect of shareholder activism via the extent of abnormal returns that take place around

the Schedule 13D filing date.

This empirical strategy became possible for Korean firms beginning in 2005. The

National Assembly amended the Securities Transaction Act mandating block holders to

disclose the purpose of their holdings. According to the new rule, block holders with the

purpose of influencing control must file a detailed long form within five days after the

acquisition and check at least one of the ten potential areas of engagement. ８

Another rule change regarding the 5% rule took place in February 2020. The

Enforcement Decree of the Financial Investment Services and Capital Markets Act was

revised to specify certain engagement activities not be classified as those influencing

corporate control. These activities include: 1) exercising the right to injunction or requesting

the court to remove directors if they are in violation of any statute or the articles of

incorporation, 2) dividend payouts related engagement activities, and 3) public pension funds

who propose amending the articles of incorporation following their pre-disclosed principles

and guidelines for the sole purpose of improving corporate governance.

This amendment was made with the intention of removing the hurdles the National

Pension Service (NPS) had to face when carrying out its stewardship responsibilities.

According to the Financial Investment Services and Capital Markets Act and its Enforcement

Decree, any public pension fund owning a block of shares greater than 10% with the intention

８
A number of studies took advantage of this new rule. These include Kim, Kim, and Kwon (2009) and Kim,
Sung, and Wei (2017), among others (See Section V.2.3 for their findings). Also note that 5% block holding data
is readily available from KRX (https://find.krx.co.kr).
-7-
of influencing corporate control is subject to the short-swing profit rule. That is, returning

profits to investee companies if profits are made from purchases and sales occurring within a

six-month period. ９ As one of the largest asset owners in the world, NPS owns such blocks

in most of the major companies listed on KRX. However, thanks to the new 5% rule, NPS

can now participate in certain engagement activities without triggering short-swing profits.

To date, we have not found any study exploring the revised 5% rule.

In close-call votes, large institutional investors can have a significant influence over

the voting outcomes of shareholder meeting resolution items. More so if they disclose their

voting decisions prior to the meeting and other shareholders follow their pre-disclosed votes.

In July 2018, NPS decided to do exactly this and delegated the implementation details to the

Special Committee on Responsible Investment & Governance. In February 2019, the

Committee decided that firms whose share ownership by NPS is greater than 10% or whose

weight in the NPS domestic equity portfolio is greater than 1% should be subject to pre-

meeting disclosure. The first pre-meeting disclosure took place in the 2019 proxy season. １０

1.4 Shareholders’ Meeting Dates

Korean public firms tend to hold annual general meetings (AGM) of shareholders on the last

Friday of March. This significantly limits the shareholders who own shares of multiple firms

from physically attending all of the meetings, which is especially troublesome if firms do not

allow electronic voting. １１

Regulation is partly responsible for these clustered AGM dates. Prior to 2021, Korean

９
NPS maintains an external management system where private asset managers trade under the name of NPS,
but make independent trading decisions. Under this system, there is no guarantee that the shares registered under
the name of NPS will be held for more than six months.
１０
Ko and Kim (2020) study the stock price reaction to NPS dissenting votes disclosed before the shareholders’
meeting (See Section V.2.3 on their findings).
１１
According to the Korea Securities Depository (KSD), from 2016-2020, 85.5% of public firms in Korea held
their AGMs during the last ten days of March.
-8-
public firms had to set dividend record dates at fiscal year-end and hold the AGM not more

than 90 days after the record date. Given that most Korean public firms use a calendar year

from January 1 to December 21 as their fiscal year, this regulation, in effect, required firms to

hold AGMs by the end of March. In addition, Korean public firms had to submit audit reports

at least one week before the AGM. Since it is extremely challenging to prepare the audit

report by February, most Korean public firms inevitably held their AGMs in March. However,

this may not be the only story. Gam, Gupta, Im, and Shin (2021) explore whether Korean

firms deliberately schedule their AGMs on highly clustered dates to prevent shareholders

from attending AGMs.

The regulation responsible for the AGM clustering was lifted with the amendment of

the Commercial Act in 2020. Korea public firms no longer need to set their dividend record

dates at fiscal year-end. In the case of firms using a calendar year as their fiscal year, they can

set their record dates after December 31 and hold AGMs not only in March, but also in April

or May. With the goal of inducing firms to hold their AGMs in April or May, the government

amended the Enforcement Decree of the Commercial Act and obligated public firms to

submit their annual business reports at least a week prior to the AGM. Note that Korean

public firms must submit their annual business reports not more than 90 days after the fiscal

year-end and have typically submitted them on the last day of March. One interesting topic

for future research is investigating the types of firms that opt to move the dividend record

date to hold AGMs in April or May and the types firms that opt not to do so, but continue to

hold AGMs on the clustered dates.

2. Regulatory Settings: Group-level Regulation

2.1 Control-enhancing Mechanisms

Control-enhancing mechanisms or anti-takeover devices are popular corporate governance

-9-
research topics in many countries. However, this is not the case in Korea where we find only

a handful of research in this area. This is partly due to the fact that Korean firms are banned

from issuing multiple voting shares or poison pills that take up a large part of the research in

this area.

In the absence of multiple voting shares and poison pills, Korean firms make use of

alternative devices that are not commonly found in other countries. One good example is the

use of treasury stocks. Unlike firms in other countries, Korean firms seldom retire the shares

they repurchase. They keep them in the form of treasury stocks for an extended period of time.

One motivation behind this is to sell them to white knights in times of proxy fights. １２

Another example is the use of death spirals (i.e., floating-priced warrants or

convertibles) as a control-enhancing mechanism. Unlike the death spirals in the U.S. that

allow exercise prices (i.e., conversion prices in the case of convertible bonds) to adjust in

both directions, Korean death spirals allow exercise prices to adjust only downward. This is a

very attractive feature to whoever wishes to exercise control over the firm as any downward

movement in the share price triggers a downward spiral of share prices by lowering the

exercise price and increasing the number of shares that a warrant holder can purchase. １３

Among smaller Korean firms, various types of charter-based anti-takeover provisions

(ATP) are popular. These include: 1) supermajority requirements for dismissing directors, 2)

an upper limit on the maximum number of directors that can be dismissed per year, 3) golden

parachutes, 4) supermajority requirements for mergers, 5) supermajority requirements for

１２
Kim and Lim (2017) investigate this motivation of holding and reselling treasury stocks (see Section V.1.1
for their findings).
１３
Over time, the Korean government introduced a series of regulations regarding the private issuance of
bonds with detachable warrants. For example, in 2002, immediately after the Doosan Corporation incident, it
banned issuing firms from redeeming the bonds with more than two-thirds of the maturity remaining. In 2013, it
completely banned the private issuance of bonds with detachable warrants in listed firms. Kim, Kim, and Kim
(2013) study the control enhancing or the control transferring motive behind the issuance of death spirals (see
Section V.2.2 for their findings).

- 10 -
amending any of these control-related charter provisions, and 6) delaying the effective date of

any control-related charter amendments. １４

As previously mentioned, Korean firms cannot issue multiple voting shares. This does

not mean, however, that Korean firms are completely deprived of forming a dual class share

(DCS) structure. With the amendment of the Commercial Act in 2012, they can issue no-vote

common shares that can serve a similar purpose. This is the same type of shares issued by

Alphabet Inc. (i.e., its Class C share with a ticker GOOG) and Snap Inc. (i.e., its Class A

share with a ticker SNAP). At the time of this writing, no Korean firm has yet issued no-vote

common shares. The 2012 amendment also allowed Korea firms to issue convertible

preferred stocks where conversion is at the discretion of management. This is a close cousin

of the poison pill. Upon hostile takeover attempts, management can convert preferred stock

held by friendly investors into common stock thereby increasing its control over the firm. １５

Finally, the tax system in Korea can work as a barrier to hostile tender offers. This is

because for shareholders owning stocks worth less than one billion Korean won, capital gains

from over-the-counter trades (e.g., selling shares to a tender offer bid) are taxed, while gains

from on-exchange trades are not. Under this unique tax regime, raiders must offer a higher

bidding price to induce shareholders to tender their shares. To date, we have not seen any

study utilizing this unique feature in the Korean tax system.

2.2 Related-party Transactions

Tunneling, which is defined as the transfer of assets and profits out of firms for the benefit of

their controlling shareholders, is an important theme in corporate governance research. In

１４
Hwang and Kim (2012) study the motivation behind the adoption of ATPs and the consequences of
adopting them (see Section V.2.4 for their findings).
１５
Kim, Hwang, and Kim (2020) explore the motivation behind the issuance of these convertible preferred
stocks and the consequences of adopting them (see Section V.2.4 for their findings).
- 11 -
business group settings, this expropriation is often realized by related-party transactions

(RPTs) that take place between member firms under common family control. To discourage

unfair RPTs, a number of approaches are taken around the world. These include independent

or disinterested director approval, majority of the minority (MoM) approval, ex post fairness

review by courts, and the involvement of government agencies.

In Korea, KFTC plays an important role in regulating unfair RPTs among large

business group firms. Authorized by the Monopoly Regulation and the Fair Trade Act (FTA),

it requires large scale RPTs to be approved by the board and be disclosed immediately upon

approval. It also prohibits assistance to related parties if it harms competition and its terms

are substantially preferential. From 2013, it also bans large business group firms from

providing undue benefits to controlling families. This regulation is not only applicable to

provisions that benefit controlling families directly, but also to provisions that benefit them

indirectly through member firms where controlling families have substantial equity

stakes. １６ A virtuous feature of this new regulation lies in the fact that it can be applicable

even when the provision does not harm competition. The types of undue benefit provisions

include: 1) RPTs that are carried out in substantially beneficial terms, 2) RPTs that funnel a

substantial amount of business even if they are carried out in market terms, and 3) business

opportunities that provide substantial benefits. To date, we have not found any study that

investigates the effect of these regulations.

In addition to the FTA, the National Tax Service (NTS) also plays a role in regulating

RPTs in Korea. Since the amendment of the Inheritance Tax and Gift Tax Act in 2012, NTS

collects gift taxes from controlling shareholders of firms with significant sales to related-

１６
Prior to the 2020 FTA amendment, the minimum ownership by controlling families in beneficiary firms was
30% for publicly traded firms and 20% for privately held firms. In December 2020, the FTA was amended to
expand the scope of beneficiary firms. The minimum ownership was unified to be 20% for all firms regardless
of their listing status. Also, firms in which these aforementioned beneficiary firms own more than 50% of shares
are classified as beneficiary firms.

- 12 -
party firms. The rationale behind this is that when a firm benefits from excessive related-

party sales, the resulting profits are deemed to have been donated to the controlling

shareholders of the firm. １７

3. Data Sources

3.1 Business Group Data

Korea is not the only country with family-controlled business groups. However, Korea is one

of the most heavily studied countries when it comes to family-controlled business groups.

This is attributable to the government-compiled business group data that is readily available

to the public (https://egroup.go.kr).

For regulatory purposes, the Korea Fair Trade Commission (KFTC) has been

designating large business groups (or more popularly known as chaebols in Korea) every

year since 1987. To be designated as a large business group, the sum of the member firms'

assets (i.e., net assets in the case of financial firms) must be within the top 30 prior to 2002,

above 2 trillion Korean won from 2002-2008, or above 5 trillion Korean won since 2009.

Together with the list of large business groups, the KFTC announces the names of

those who control each of the groups and the list of firms under these . A person in control

could be a natural person or a legal person. When identifying member firms, KFTC considers

not only the shares directly owned by the controlling persons, but also the shares they

indirectly own through their related parties including their relatives, non-for-profit entities

under their control, and other member firms they control. It also considers channels of

influence that do not rely on share ownership. In other words, KFTC uses the concept of de

facto control.

１７
Chung, Choi, and Jung (2019) examine whether this new gift tax succeeded in deterring excessive related-
party sales (see Section V.2.4 for their findings).
- 13 -
 What makes the Korean business group data distinctive is the detailed ownership data

of non-listed member firms. This feature allows researchers to compute a controlling person’s

cash flow rights more precisely by considering the control chains that go through non-listed

firms in addition to listed firms. From 2022, KFTC mandates large business groups to

disclose detailed control chains that go through overseas subsidiaries as well. This will allow

researchers to compute cash flow rights even more precisely. Many studies have used KFTC

data in their business group research. We summarize these studies in Section IV.2.

3.2 Corporate Governance Ratings Data

Corporate governance indices or ratings are heavily used in corporate governance research.

This is no exception for studies of Korean companies thanks to the ratings data compiled by

the Korea Corporate Governance Service (KCGS). KCGS is a non-profit organization set up

in 2002 by the Korea Stock Exchange (KSE), the predecessor of the Korea Exchange (KRX),

for the purpose of promoting corporate governance in Korea.

Since 2003, KCGS has been conducting annual ratings of all the KOSPI-listed

companies. Over the past few years, it expanded its ratings coverage to include KOSDAQ

150 stocks, the remaining KOSDAQ-listed firms that are members of large business groups,

and all financial companies subject to the Act on Corporate Governance of Financial

Companies regardless of their listing status. Since 2011, it added ratings on environmental

and social practices. When rating governance, it focuses on four distinct areas (i.e.,

shareholder rights protection, board of directors, auditing body, and disclosure) that have

their own separate ratings. Procedurally, it goes through five steps: 1) the preparation stage

where raw data is collected from publicly available sources, 2) the initial evaluation stage, 3)

the feedback stage where revision requests are taken from rated companies, 4) the interview

stage, if necessary, and 5) the final rating stage. Note that the overall governance rating has

- 14 -
seven grades (S, A+, A, B+, B, C, and D) and is available to the public from its homepage

(http://www.cgs.or.kr). Detailed ratings data, including the four sub-ratings, however, are

available only through data vendors. We discuss the paper utilizing KCGS governance ratings

rata in Section V.1.

3.3 Related-party Transactions Data

Related-party transaction data is available from two sources in Korea. One source is from

financial statements. All public firms and privately-held firms subject to external audit must

disclose in the footnotes of their financial statements the amounts of purchases (sales) of

goods and services from (to) related-parties, the amounts of payables (receivables) owed to

(by) related-parties, and the amounts of debt (credit) owed to (by) related-parties. The data is

available from the Data Analysis, Retrieval and Transfer System (DART) database

(http://newdart.fss.or.kr) managed by the Financial Supervisory Service (FSS), the financial

regulatory agency in Korea, and from the Korea Investor's Network for Disclosure System

(KIND) database (https://kind.krx.co.kr) managed by the Korean Exchange. １８

Another source of related-party transaction data is from KFTC. Although the data it

provides is confined to the member firms of KFTC-designated large business groups, it

provides the data in greater detail. One example is the transaction of trademark royalties. For

each business group, it provides the names of licensing firms, the names of licensee firms, the

amount of royalties received or paid, and the formula used to calculate the royalties. For the

convenience of users, this KFTC related-party transaction data is available through DART. To

date, we know of only one working paper making use of this data. We expect to see more

studies utilizing this data in the years to come.

１８
Black, Kim, Jang, and Park (2015), Hwang and Kim (2016), and Kim and Kim (2020) made use of this data
in their research on related-party transactions (see Sections V.1.2, IV.1.1, and III.2.2.1 on their findings).
- 15 -
3.4 Financial Statements Data of Unlisted Firms

In most countries, financial statement data is available only for publicly traded firms. This is

especially problematic given that a large fraction of business group firms are privately held.

However, this is not the case in Korea. Thanks to the Act on External Audit of Stock

Companies, any stock company above a certain size threshold must receive external audits

and disclose their financial statements to the public. １９

This rule dates back in 1981 when the act was first introduced. The size threshold was

initially set to three billion Korean won in total assets. Over time, the threshold was gradually

raised. At the time of this writing, any stock company that has total assets above 50 billion

Korean won or total sales above 50 billion Korean won must receive an external audit. In

addition, any stock company that has total assets above 12 billion Korean won, total debt

above seven billion Korean won, total sales above ten billion Korean won, and a total number

of employees above 100 must receive an external audit. ２０

III. Determinants of Control Structure and Governance Mechanism

In this section, we review studies that examine the determinants of corporate ownership and

control structures, as well as governance mechanisms.

1. What Determines Ownership and Control Structure?

１９
Separate from the Act on External Audit of Stock Companies, the FTA also obligates unlisted firms to
disclose their financial information. However, this is limited to the member firms of large business groups
(group total assets greater than five trillion Korean won) and the financial information disclosed is highly
constrained. Balance sheet data includes current assets (cash and cash equivalents as a separate item), fixed
assets, total assets, current liabilities, long-term liabilities, and book equity (paid-in capital as a separate item).
Income statement data includes total sales, operating income, other income, other costs (interest expense as a
separate item), and net income.
２０
A number of studies we cover in this review make use of this data of unlisted firms. Kim, Kim, and Yang
(2015) use it to investigate how business groups establish new member firms. Hwang and Kim (2016) use it to
investigate how member firms privately owned by heirs benefit from related-party sales (see Sections III.1 and
V.1.1 for their findings).
- 16 -
The law and finance literature broadly suggests that concentrated corporate ownership found

in non-U.S. countries is generally attributable to poor investor protection. In these economies,

controlling shareholders do not sell their shares or issue new equity that would reduce their

proportional ownership for fear of losing various forms of private benefits of control that they

currently enjoy. According to Roe (2006), the existence of strong labor unions in Europe may

explain the prevalence of family firms. Although this perspective is useful in understanding

cross-country variations, it has limited implications as to how the control structure may vary

within an economy dominated by concentrated ownership, such as Korea.

Studies that examine the control structures of Korean firms primarily focus on the

nature of business groups or pyramidal structures. Almeida, Park, Subrahmanyam, and

Wolfenzon (2011) study the evolution of Korean chaebols (i.e., business groups) and find that

chaebols grow vertically (as pyramids) when the controlling family uses well-established

group firms (i.e., “central firms”) to acquire firms with low pledgeable income and high

acquisition premiums. In contrast, chaebols grow horizontally (i.e., through direct ownership)

when the family acquires firms with high pledgeable income and low acquisition premiums.

In this setting, central firms trade at a relative discount due to shareholders’ anticipation of

value-destroying acquisitions. This study is important since a widely accepted explanation for

setting up pyramids was to tunnel from firms located in the bottom. In contrast, they argue

that the underperformance of pyramidal firms is not due to tunneling, but rather through

selection. Highly profitable firms that require little capital are directly owned by the family,

while less profitable firms are largely owned by affiliated firms.

Kim, Kim, and Yang (2015) confirm this finding by comparing the size and

profitability of private firms newly established by individuals against those set up by another

member firm. Korean accounting regulations require even private firms that exceed a certain

size threshold to be externally audited and file their financial statements rendering this type of
- 17 -
study feasible. They find that firms set up by individuals are smaller and more profitable

compared to firms set up by other firms, consistent with the selection hypothesis. However,

they also suggest that profitability may not be exogenously determined based on the inherent

characteristics of the business as suggested by Almeida et al. (2011), but rather determined

endogenously based on related party transactions with other member firms in the business

group.

Some studies point out incentives to avoid inheritance taxes in the process of

transferring control to the next generation may induce certain organizational changes. Yang

(2016) examines how inheritance tax structure may affect the creation of pyramids. The

Korean inheritance tax code, adopting a weighted average of the net asset value of the most

recent year (40%) and three‐year average net income (60%) as firm value for inheritance

taxation, implicitly leads controlling shareholders to vertically split or insert an intermediary

to control subsidiaries, both of which yield a pyramidal control structure within family

business groups. Inheriting unlisted firms via intermediaries reduces inheritance taxes and its

tax savings effect is maximized when intermediary firms are much smaller than the

subsidiaries.

Similarly, Shin (2020) argues that avoidance of inheritance taxes may facilitate

intragroup mergers. In 1999, Korea initiated a tax reform that bumped up personal inheritance

taxes by 25 percentage points. In the post-tax‐reform period, he finds that family firms

increase stock‐for‐stock intragroup mergers involving targets owned by heirs. Specifically, in

business groups where heirs face heavy inheritance taxes, intra-group mergers occur between

public member firms and private member firms largely owned by heirs.

Kim, Kim, Kim, and Byun (2010) examine what may determine foreign ownership in

Korean firms. They find that foreign investors allocate a disproportionately higher share of

their funds to firms with foreign outside directors. They interpret this finding as evidence that
- 18 -
improvements in corporate governance attract more foreign investments.

Kim, Hwang, and Kim (2020) take advantage of a regulatory change in Korea that

allowed firms to adopt two new classes of shares: preferred stocks convertible to voting

stocks at the discretion of management and preferred stocks redeemable at the discretion of

investors. They find that firms adopt the former for managerial entrenchment purposes, while

the latter is adopted in times of financial constraint. They also determine that adoption of both

classes results in lower firm value suggesting that changes in control or ownership structure

are less likely to be motivated by value maximization.

2. What Determines Governance Mechanism?

In this subsection, we review studies that examine various governance mechanisms in Korean

firms. By governance mechanisms, we are referring to all mechanisms designed to reduce

agency problems between managers and shareholders. We follow the standard classification

of a governance mechanism. An internal mechanism including board of directors and

managerial incentives and external mechanisms including institutional activism and market

for corporate control.

Alternatively, the term “corporate governance” or “governance mechanism” often

implies a completely different concept in Korea. Specifically, the media typically uses the

term to refer to the inter-corporate control structure of a business group from the perspective

of the controlling families. This leads to substantial confusion of the key concepts and issues

as the Korean perspective does not clearly reveal the inherent agency problem between the

controlling shareholders, with low cash flow rights, and the vast majority of the minority

shareholders. This misperception is reinforced through the media who often refer to the

controlling families as “owners” implying that they are principals rather than agents. In this

paper, we refer to inter-corporate shareholdings from the family’s perspective as the “control

- 19 -
structure” to distinguish it from the standard governance mechanism.

2.1 Board of Directors

While the board of directors, composed of at least some outside independent directors, is a

key governance mechanism, it is relatively new in Korea. As is the case for most other

governance mechanisms, it was instituted only after the 1997 Asian Financial Crisis. Even

today, outside director candidates are largely approved by the controlling family before

formally being voted on at the shareholders meeting. This practice makes it difficult to find

research on what determines the structure of the board members precisely as they are largely

dependent on the will of the controlling family.

Doo and Yoon (2020) investigate whether and how a regulatory change in the

appointment procedure of audit committees affects firms’ choice of an auditor or a voluntary

audit committee. In Korea, mid-sized public firms may choose between an internal auditor or

a comptroller, similar to that of German corporate law, or an audit committee under the board,

similar to the U.S. system. Korean regulations traditionally put a strict limit on the maximum

number of votes shareholders can exercise when they elect auditing bodies. Specifically,

controlling shareholders are allowed to exercise up to 3%. The new law at the time, however,

allowed the board members to be elected first, after which audit committee members are

elected with the binding 3% constraint. The authors find that mid-sized companies voluntarily

switched from a traditional German style comptroller system, where they are subject to the

binding 3% constraint, to the American style audit committee system effectively postponing

the 3% constraint to the second stage. They also find that audit committees do not necessarily

improve financial reporting suggesting that these changes in the auditing mechanism largely

reflect agency motives rather than monitoring incentives.

- 20 -
2.2 Managerial Incentives

2.2.1 Compensation

Disclosure of executive compensation was not mandatory until 2014 in Korea. It is only after

that point that we are able to find studies based on individual compensation data. Kim and

Han (2018) examine executive compensation in Korea with a focus on family business

groups, and find that family CEOs of Korean business groups are paid 60% more than

professional CEOs. Moreover, this discrepancy is not based on performance-contingent

payments, but rather generated by differences in fixed payments. They also note that the

operation of internal capital markets, CEO talent, CEO stock ownership, and family board

membership do not explain the excessive compensation of family CEOs indicating that rent

extraction through executive compensation is prevalent in Korean family business groups.

Cheong and Kim (2019) empirically test the prediction that family pay discounts

documented in the U.S. do not hold in a business group setting and this is attributable to the

lack of monitoring by other family members. They find that family executives receive higher

compensation than non-family executives (i.e., the family pay premium) in business group

firms in Korea (chaebols). They also determine that the pay offered to family executives

tends to be high when the proportion of shares held by other family members is low, which is

typically the case in business group firms.

Kim and Kim (2020) examine how executive compensation may be influenced by

other member firms within the same business group. They find that a member firm's

executive cash compensation is positively linked not only to its own stock performance, but

also to other member firms. This positive link suggests that managers may be rewarded for

their decision to benefit the controlling family at the expense of the firm they manage.

Specifically, the sensitivity of executive pay to other member firms’ performance exists only

- 21 -
in respect to firms where the cash flow rights of the controlling family exceed those of the

subject firm.

2.2.2 Managerial Turnover

Most controlling shareholders in Korea are often the CEOs themselves. As such, it is not

trivial to fire the CEO even if their performance is poor as they are effectively entrenched

through concentrated ownership. This is probably one of the reasons why the literature on

what determines CEO turnover is relatively scant. A substantial number of CEOs still retain

their position even if they are formally convicted of a criminal offense.

Johnson and Yi (2014) investigate the consequences of fraud for CEOs and how they

depend on CEO power. They find that CEO power can reduce the likelihood of director

turnover, as well as CEO turnover, even after fraud is detected. They also find that CEO

power is negatively related to long‐term stock performance after fraud detection and this

negative relationship is particularly strong for powerful CEOs when the board has low overall

turnover. These results imply that powerful CEOs may entrench themselves and survive by

potentially working with board members who are favorable to them.

2.3 Institutional Activism / Market for Corporate Control

Both institutional activism and the market for corporate control were also introduced only

after the 1997 Asian Financial Crisis. Previously, institutional investors were subject to a

“shadow voting” system where you are allowed to exercise your voting rights only in direct

proportion to the outcome of the remaining votes. The market for corporate control also did

not exist as no one other than the controlling shareholder at the time of the IPO can hold more

than 10% of the voting rights in any publicly traded firm. An important milestone in

institutional activism was the adoption of the stewardship code by the National Pension Fund

- 22 -
of Korea (NPF) in 2018, the largest institutional investor in Korea.

Kim, Park, and Jung (2020) analyze the characteristics of institutional investors who

adopted the Korea stewardship code that was introduced in 2016. They find that institutional

investors tend to participate more actively in the stewardship code if they invest a larger

amount of money in stocks, pay more dividends in cash, and showed a higher level of

negative votes before code participation. They also conform that institutional investors with

foreign origin or those belonging to financial groups are more likely to adopt the stewardship

code. They also note that institutional investors who have introduced the code tend to vote

negatively, especially when the invested firms have more severe agency problems. These

results suggest that the introduction of the stewardship code may lead to more active

monitoring by domestic institutional investors.

Kim and Kim (2020) examine how credit ratings may affect M&A activity in Korea.

They find that credit ratings are negatively correlated with the probability of being a target

indicating that target firms in Korea may be in distress. They also determine that acquiring

firms with high credit ratings exhibit low cumulative abnormal returns consistent with agency

problem arising from free cash flow.

2.4 Overall Governance / Index

The Korea Corporate Governance Service (KCGS), a non-profit organization sponsored by

the Korea Exchange (KRX), has been compiling firm-level corporate governance indices

since 2003. Many Korean researchers have relied on this index as the dependent variable and

other times as an explanatory variable in their empirical studies.

Lee and Chung (2015) find that a firm’s corporate governance index increases with

the duration of institutional stock ownership emphasizing that investors’ investment horizons

may be an important determinant of corporate governance. Bereskin, Kim, and Oh (2015)

- 23 -
confirm that firms near rating upgrades or downgrades are associated with improved

corporate governance implying that managers’ concerns over their firms’ credit ratings may

affect corporate governance.

3. What Determines Governance Mechanisms and How Does It Affect Corporate

Outcomes (Firm Value)?

Park and Ryu (2020) take into account the possible joint determination of corporate

governance and firm value and present a theoretical model focusing on the effect of private

equity trading platforms. Electronic platforms where unlisted stocks are traded have become

popular among retail investors in Korea recently and provided the motivation behind this

study. The authors argue that these platforms may increase the liquidity in the unlisted stock

market by easing regulations on the trading of these stocks further enhancing firm values and

the corporate governance of the corresponding firms. Specifically, in an unlisted firm, a

potential dual agency problem exists where the manager, who is also a blockholder, invests

less than the external shareholders’ profit-maximizing levels. Managers have the incentives to

increase a firm’s investment when the liquidity in the unlisted stock market improves with the

growth of the private equity trading platform implying that these platforms potentially

enhance the corporate governance of unlisted companies and promote their growth

simultaneously.

Byun, Lee, and Park (2012) empirically test whether member firms in a business

group (chaebol) behave differently from stand‐alone firms in their decisions regarding

internal corporate governance given product market competition. They find chaebol member

firms maintain better internal corporate governance in a non‐competitive environment, while

stand‐alone firms do so in a competitive environment. They next use corporate governance as

an explanatory variable and determine that the positive effects of internal corporate

- 24 -
governance on firm value are stronger in a non‐competitive environment for stand‐alone

firms, but not for member firms. They ascribe the detected differences in corporate behavior

and performance to differences in the level of competitive pressure to which firms are

exposed.

Goh, Lee, and Cho (2016) examine how the controlling shareholders’ control-

ownership wedge may be determined by firm characteristics and how it affects firms’

investment decisions. They find a non‐monotonic relation between the controlling

shareholders’ control-ownership wedge and a firm's overinvestment in their piecewise linear

regressions. Specifically, the relation between the controlling shareholders’ wedge and

overinvestment is significant for certain wedge levels.

Hwang, Kim, Park, and Park (2013) take advantage of unique survey data and

examine how business group membership may affect corporate governance that may, in turn,

affect payout policies. They find that business group (chaebol) firms have overall stronger

governance practices, but weaker shareholder rights and lower dividend payout ratios than

independent firms. They also note that the adverse effect of chaebol firms' weak shareholder

rights on dividend payout ratios appears to intensify with the onset of the global financial

crisis in 2008. The positive correlation between corporate governance practices and dividend

payout ratios is weaker among chaebol firms. Their interpretation is that the entrenched

control by chaebol families places less weight on protecting minority shareholders resulting

in smaller distributions of dividend payments.

IV. Consequences of Corporate Control Structure

Corporate control by insiders and corporate governance for outside investors are not only

determined by various firm, industry, market characteristics, but they also may affect various

corporate outcomes including firm value. In this section, we review the literature on the effect
- 25 -
of corporate control on corporate outcomes. In Section V, we continue with those studies

exploring how governance mechanisms may affect firm decisions.

1. The Effect of Family Ownership

1.1 Percentage Cash Flow Rights or Dollar Amount Wealth Invested

Traditional literature on managerial ownership or family firms begin by examining how the

family’s proportional claim on a firm’s cash flows, or cash flow rights, may affect corporate

outcomes. Hwang and Kim (2016) focus on the ownership of the second and third generation

heirs of the founding families and investigate how related-party sales may be used to

financially support those firms owned largely by these heirs. They implement a series of

difference-in-differences tests and find that these firms experience greater related-party sales,

benefit in terms of earnings, and gain importance in controlling other firms in the group.

These findings suggest that families’, especially heirs’, ownership may determine the

direction and magnitude of related-party transactions within a business group.

Kang, Anderson, Eom, and Kang (2017) propose a new measure of controlling

family’s relative dollar value interest in a given member firm. It is defined as the value of the

controlling shareholders' stake in an affiliate divided by their stake in all affiliates. This

measure, which they refer to as the controlling shareholders' value, is designed to capture

differences in the magnitude of the family’s interest in different member firms that is not

captured in conventional cash flow rights defined at the firm level. Using data on Korean

family-controlled business groups, they find that this new measure has greater explanatory

power for firm performance than traditional cash flow rights. Chae, Kang, Lee, and Lee

(2020) use the same measure to explore family business groups’ risk taking behavior in each

affiliate. They determine that the affiliates in which the controlling family has greater (less)

investment take less (greater) risk. Their results indicate that the controlling family decides
- 26 -
the riskiness of each affiliate based on the family’s interests at both the firm level and the

business‐group level.

Kim and Wee (2019) examine how managerial ownership may affect corporate giving.

They find that low managerial ownership is associated with greater corporate giving,

especially when the controlling shareholder is the CEO, and conclude that this corporate

giving may be motivated by the controlling shareholders’ pursuit of personal gain.

Kim, Jung, and Kim (2018) examine how the complexity of group ownership

structure may affect capital structure decisions. They find that controlling shareholders of

cross-shareholding business groups are more likely use debt for tunneling purposes than those

of pyramidal business groups.

Park and Jung (2015) empirically investigate the relationship between controlling

shareholders’ ownership and the risk-taking behavior of savings banks in Korea. They find

that the risk of savings banks increases with higher ownership of the controlling shareholders.

These findings suggest that regulatory scrutiny may be required to curb potential excessive

risk taking in savings banks with more concentrated ownership.

1.2 Importance in Business Group Control: Centrality

Almeida et al. (2011) propose a new measure of corporate control that they refer to as

“centrality.” Although this measure is defined at the firm level, it measures how important

this firm is in terms of maintaining control over other firms within the business group. Some

studies utilize this measure and examine how centrality may affect corporate outcomes.

Choi, Gam, and Shin (2020) explore a potential causal relationship between firms'

ownership structure and the likelihood of corporate fraud related to illegal related-party

transactions (RPTs) regulated by the KFTC. They determine that central firms that control

other member firms are subject to more corporate frauds than are non-central firms. They

- 27 -
argue that central firms commit fraud by expropriating non-central firms, where controlling

shareholder’s cash flow rights is low by providing financial assistance to non-central firms

that are suffering from financial distress. Exploiting the 2001 regulatory reform that imposed

the ceiling on the amount of equity investment a member firm can make in domestic affiliates,

they also find that the frequency of corporate fraud drop more significantly in central firms

than in non-central firms as central firms’ ability to provide financial assistance to non-central

firms drop and the controlling owner's cash-flow rights in non-central firms increase.

1.3 The Effect of Control-Ownership Disparity or “Wedge”

In a typical stand-alone style U.S. firm, we do not observe a wedge between cash flow rights

and control rights unless there are dual class shares. Alternatively, in non-U.S. economies,

where corporate pyramids and cross-shareholdings prevail, cash flow rights held by the

controlling shareholding may be much smaller than the control rights they may exercise,

separating cash flow rights from control rights. This divergence is commonly referred to as

the control-ownership disparity or “wedge” and has been used as a measure of the degree of

the agency problem in non-U.S. firms. Theoretically, the disparity between control and

ownership rights gives rise to the risk of tunneling by the controlling shareholder, and is

prevalent in many emerging market economies and present in some developed countries.

However, in Korean business groups, where all member firms are tightly controlled by the

controlling shareholders, the degree of de facto control does not vary much among member

firms. Under this circumstance, the differences in cash flow rights, rather than disparity, may

better explain wealth transfer among member firms.

Kim, Sung, and Wei (2011) study whether the difference in the degrees of control-

ownership disparity in investors' home countries affects their portfolio choice in an emerging

market. Their key finding is that investors from low disparity countries do not favor high

- 28 -
disparity stocks in Korea, but investors from high disparity countries are indifferent.

Moreover, investors from low disparity countries became averse to the disparity only after the

Asian financial crisis. These results suggest that the nature of corporate governance in

international investors' home countries affects their portfolio choices abroad.

Choi, Cho, and Sul (2014) investigate how the disparity or wedge may influence

foreign investors' shareholdings in Korean firms. They find that foreign shareholders invest

less in companies with high ownership-control disparity suggesting that aggravated agency

problems created by the wedge negatively affects foreign investors' shareholdings.

Kang, Lee, Lee, and Park (2014) examine whether related-party transactions (RPT)

are used as a mechanism for tunneling among firms belonging to large business groups

(chaebols). First, they test whether the control-ownership wedge affects RPTs and then

explore whether RPTs affect firm value. They find the control–ownership wedge to be

positively associated with the magnitude of RPTs. RPTs increase as voting rights increase,

while RPTs decrease as cash flow rights increase. They also note that RPTs of Korean

chaebol firms, on average, reduce firm value, but this value destruction is observed only

when the control-ownership wedge is high and is more pronounced in the top five chaebol

firms. Overall, their results imply that RPTs occur when the agency problem is severe and are

used as a means of tunneling thereby destroying firm value.

2. Business Group Membership or Affiliation

One important defining characteristic of the Korean corporate sector is that many public

firms belong to a business group that consists of multiple public firms. This is not typically

found in the U.S. Many studies have taken advantage of this characteristic and have

compared business group member firms with non-member firms or stand-alone firms in

various dimensions.

- 29 -
 Most of these studies resort to the business group classification provided by the Korea

Fair Trade Commission (KFTC). A key issue with this approach is that the KFTC only

designates “large” business groups that exceed a certain size threshold. As a consequence,

member firms in many smaller business groups that are not designated by the KFTC are

incorrectly identified as stand-alone firms. Since the KFTC designated groups are large

business groups, it is difficult to disentangle a pure business group effect from a potential size

effect based on this classification.

Another confounding issue is that while many of these large business groups are

controlled by families, some are not. Two prominent examples, POSCO and KT, the largest

steel producer and telecom provider, respectively, are widely held public firms after being

privatized a while ago. However, both firms are members of a larger entity, the POSCO group

and the KT group, each of which consists of multiple public firms. Although these are also

designated by KFTC as large business groups, they are not referred to as chaebols since there

are no controlling families. With these caveats in mind, we review the literature on Korean

business groups.

2.1 The Bright Side of Business Groups

Proponents of business groups emphasize that they may substitute for weak market

mechanisms in emerging economies, especially underdeveloped capital and labor markets. In

these economies, business group member firms may pool resources at the group-level

optimizing group-level outcomes. During a crisis, member firms that are better off may

provide a financial buffer for less fortunate member firms allowing the latter to survive

difficult times.

Kim (2011b) investigates the impact of business group structure on investment

activities by group affiliated companies and finds that during a global economic crisis,

- 30 -
chaebol‐affiliated firms increased investments, while a set of matched control firms

significantly decreased their investments. The investments of chaebol member firms were not

financed through internal capital markets, but through external capital markets. However, the

relatively greater decreases in Tobin’s Q for chaebol firms suggest that investment efficiency

of group‐affiliated firms is worse than that of the control firms. However, as previously

mentioned, this result may be driven by the size effect rather than the business group effect.

Kim (2012) next investigates the long‐term value implication of business group

affiliations. He finds that the long‐term performance of chaebol‐affiliated firms is superior to

that of the matched control firms although the two groups are very similar at the beginning of

the sample period. The differential performance between the two groups has been caused by

changes in firm characteristics over time. Difference‐in‐difference estimators on important

firm characteristics indicate that over time, chaebol‐affiliated firms become larger and more

profitable, grow faster with more investments, have higher debt, and have more foreign

ownership leading to a larger overall firm size.

Almeida, Kim, and Kim (2015) document similar results to that of Kim (2012) based

on a rigorous empirical approach. They examine capital reallocation among firms in Korean

business groups in the aftermath of the 1997 Asian financial crisis and the consequences of

this capital reallocation for the investment and performance of chaebol firms. They show that

chaebols transferred cash from low growth to high growth member firms using cross‐firm

equity investments. This capital reallocation allowed chaebol firms with greater investment

opportunities to invest more than the control firms after the crisis. These firms also showed

greater profitability and lower declines in valuation than the control firms following the crisis.

Their results suggest that chaebol internal capital markets helped them mitigate the negative

effects of the Asian crisis on investment and performance.

Jung, Lee, Rhee, and Shin (2019) examine how business group affiliation affects a
- 31 -
firm's labor investment decisions. They find that chaebol‐affiliated firms make more efficient

labor investments than nonaffiliated firms. The positive relation between chaebol‐affiliated

firms and labor investment efficiency is attributed to the mitigation of underinvestment in

labor. Chaebol affiliates have higher labor productivity than stand‐alone firms. They further

determine that labor sharing among affiliated firms and easy access to external financing lead

to more efficient labor investments for chaebol firms when compared to stand‐alone firms.

Kim, Park, and Kim (2012) also emphasize a potentially positive role of the internal

labor market in business groups focusing on CEO turnover. They find that CEOs are more

likely to be replaced, without a new appointment within the business group, when firm

performance is poor. CEOs in chaebol member firms often relocate to other member firms

within the business group, but this relocation is not driven by firm performance. The authors

interpret this finding as being consistent with the existence of an internal labor market within

a business group.

Byun, Choi, Hwang, and Kim (2013) examine the relation between business group

affiliations and the cost of debt capital. Business group membership may affect the cost of

debt in two different ways. The co-insurance effect associated with business groups can

reduce the cost of debt, while expropriation by controlling shareholders can raise the cost of

debt. They find that firms affiliated with chaebols enjoy a substantially lower cost of public

debt than independent firms, consistent with the co-insurance argument.

Bae, Kwon, and Lee (2011) investigate the valuation effects of diversification

activities by chaebols. They find that unrelated diversification by Korean firms erodes firm

value, but related diversification does not decrease firm value, which is more pronounced for

large business group firms. Their findings suggest that stronger internal factor markets in

large business group firms enables them to take advantage of the synergic benefits associated

with related diversification.

- 32 -
2.2 The Dark Side of Business Groups

Alternatively, business groups may provide the controlling families the incentive and the

ability to expropriate minority shareholders of public member firms. In addition, an external

shock may have a greater impact on business group member firms that are tightly linked

through inter-corporate shareholdings and debt guarantees.

Park, Jung, and Kim (2018) analyze the stock price behavior of firms engaging in

intra-group mergers, which have been a key channel of tunneling in business groups. Due to

the severity of conflicts of interest in these transactions, U.S. law requires a very strict “entire

fairness” doctrine in non-arms’ length mergers. However, Korean regulations mechanically

apply a formula based on the historical prices of the acquirer and the target in setting merger

ratios, even if they are from the same business group. As such, the controlling families have

incentives to inflate the market value of the firms in which they have larger cash flow rights

prior to an intra-group merger regardless as to whether the firm is the acquirer or the target.

The authors find that firms where the controlling families have larger cash flows exhibit

greater price increases leading up to a merger announcement.

Joh and Kim (2013) examine the effect of firm characteristics of member firms

engaging in intra-group equity investment and the subsequent stock market's response. They

find that member firms with more financial slack and less ownership by the controlling

family tend to invest more in the equities of other member firms. The stock market responds

negatively when the investing firm is diversifying and has considerable cash. Their findings

suggest that idle cash of a firm largely owned by minority shareholders is the source of funds

in the internal capital market and these funds are directed to poorly performing affiliated

firms that are under the influence of the same controlling shareholder.

Kim, Lim, and Yoon (2017) examine how controlling shareholders of business groups

may pass on the costs of IPO underpricing to minority shareholders. Based on a sample of
- 33 -
IPOs taken place in the Korea Exchange, they find that sale of secondary shares in Korea, in

general, does not reduce underpricing as it does in the U.S. However, they do find less

underpricing or even overpricing when the offered shares are directly sold by the controlling

shareholders. Alternatively, the sale of secondary shares held by affiliated firms leads to a

negative market reaction for the selling firms implying a direct wealth transfer from

shareholders of the affiliated firms to the IPO subscribers. Their findings suggest that

minority shareholders in certain affiliated firms, or scapegoats, may bear the cost of

underpricing, while controlling shareholders of the business group remain effectively

protected.

Park and Jung (2011) study how the withdrawal of an existing member firm from a

business group affects the remaining member firms. They find that the remaining firms

realize a positive announcement return, while the departing firm realizes negative

announcement returns, especially when the controlling shareholder’s ownership in the

leaving firm is high. This result suggests that the leaving firm has been supported by other

member firms as a member, consistent with the tunneling hypothesis.

The influence of large business groups sometimes extends well beyond the private

sector and may affect decisions made in the public sector including the judiciary. Choi, Kang,

Kim, Lee, and Park (2016) examine whether executives from chaebol member firms are

treated favorably in criminal cases. They find that the probability of actually incarcerating a

suspect is much smaller if the indicted are associated with large business groups. This finding

is consistent with the public’s perception of a general legal leniency toward the wealthy, a

tendency referred to as “with money no crime, without money yes crime” in Korea.

Choi, Kang, and Lee (2018) extend the work of Choi et al. (2016) and explore what

may drive this judicial bias. They present two possible explanations. The first is that the

larger the chaebol, the greater the judicial bias implying that the chaebol bias is stronger for
- 34 -
the top business groups than for other chaebols. An alternative explanation is that intra‐group

transactions account for much of the bias. This suggests that the judiciary widely accepts the

defense of chaebol offenders that intra‐group transactions are in the interest of the entire

business group and not in the interests of the offenders or the controlling family.

Kwon and Han (2020) examine how payout policies may be affected in business

groups. They compare family firms against non-family firms and find that family firms have

a lower payout ratio than non-family firms, which is more pronounced in family business

groups or chaebols. Kim, Kim, and Kim (2013) study the motives for issuing floating-priced

convertibles or warrants, known as death spirals, in Korean business groups. They find that

unlike in the U.S. where these securities are generally issued as last resort financing, Korean

firms seem to issue them directly or indirectly to the next generation family members to

facilitate control transfers.

Kwon, Han, and Lee (2016) examine the negative spillover from one group-affiliated

firm to another in the same business group using credit rating downgrade announcement data

in Korea. They hypothesize that the existence of controlling shareholders and internal capital

markets is a major cause of the negative spillover. Consistent with their conjecture, they find

the financial constraints of a group-affiliated firm negatively affect the value of other group

affiliates. Similarly, Kwon, Jung, Sunwoo, and Yim (2019) study the spillover of the stock

price crash within business groups. They find that the crash risk of a firm is positively

associated with the crash risk of other member firms in the same business group, and this is

more pronounced in firms with more RPTs.

2.3 Business Groups and Asset Pricing

Some studies extend the implications of business group membership beyond corporate

finance and explore how these memberships may affect asset prices and information transfers.

- 35 -
Kim, Kim, and Lee (2015) examine stock return comovement within business groups in

Korea and find that stocks of companies belonging to the same business group commove with

each other more than stocks in the same industry. The within-group correlation in excess of

the within-industry correlation has become more pronounced over time, especially following

the 1997-1998 Asian crisis. The increase in correlation appears to be driven more by non-

fundamental factors, such as correlated trading, rather than fundamental factors, such as

related-party transactions.

Kim and Wang (2019) examine how arbitrage may contribute to rather than remove

temporary price deviations between two related securities. Based on a unique sample of

stock-for-stock tender offers by a member firm for another member firm within Korean

family business groups, they find that arbitrage opportunities exist in more than three quarters

of the sample, consistent with Lamont and Thaler (2003). Prices of the two securities tend to

diverge away from each other leading up to the tender offer, which may be impacted by the

controlling families who benefit from a larger deviation. This deviation is more likely to be

sustained when there is more short-selling during the arbitrage possible period. Their results

suggest that, under certain circumstances, arbitrage may support temporary deviations in the

relative prices of two related securities.

Kim, Kim, and Park (2012) examine the effects of a series of regulatory changes that

facilitated business groups in Korea to switch from a complex circular shareholding or “loop”

structure to a more simplified and transparent pure holding company structure. They find that

firms that transform into holding companies exhibit a significant decrease in beta subsequent

to structural change that is reflected in positive market reactions at the initial announcement.

However, for other subsidiary member firms, they do not observe these patterns. The results

suggest that these structural changes alleviate business and financial interdependence among

member firms and that the benefits, if any, mostly accrue to (the shareholders of) the apex
- 36 -
holding companies.

Ducret and Isakov (2020) examine how chaebols may affect the “Korea Discount,” a

phenomenon that refers to a claim that stocks of Korean firms are undervalued and trade at a

discount relative to comparable foreign firms. They find that Korean stocks exhibit

significantly lower price-earnings ratios than their global peers, but chaebols are not

specifically driving this discount.

Bae and Goyal (2010) test whether business group membership can explain the extent

to which firms benefit when countries liberalize their equity markets. They use chaebol

membership as a proxy for poor corporate governance since the deviation between cash flow

and control is more severe in business groups. They find that non-chaebol firms experience

higher abnormal returns than chaebol firms suggesting that better governed firms experience

significantly greater stock price increases upon equity market liberalization.

2.4 Financial Companies in Business Groups

Some Korean business groups, or chaebols, have a large stake in securities firms that issue

analysts’ reports on their member companies. Song, Mantecon, and Altintig (2012)

investigate the informational content of earnings forecasts, stock recommendations, and

target prices made by the chaebol-affiliated analysts. They find that chaebol analysts tend to

make more optimistic earnings forecasts for member companies. The chaebol analysts also

assign more favorable recommendations by almost one level out of five and set target prices

higher for member companies after controlling for company and analyst characteristics.

These results are consistent with the hypothesis that chaebol analysts’ reports are biased by

conflicts of interest.

Park and Kim (2012) examine the performance of chaebol-affiliated asset

management companies when they invest in other member firms. They find that chaebol-

- 37 -
affiliated asset managers outperform other asset managers when investing in their group

member firm stocks implying information transfers between member firms within a business

group.

3. Political Connections

Firm-level corporate governance is inherently influenced by the institutional environment

under which the firm operates. One of the institutional factors is the effect of potential

political connections. Since Korea’s economic growth was largely driven by the government,

the magnitude of this effect may not be trivial.

Schoenherr (2019) finds that politicians can increase the amount of government

resources allocated through their social networks to benefit private firms connected to these

networks. After winning the election, the new president appoints members of his networks as

CEOs of state‐owned firms that act as intermediaries in allocating government contracts to

private firms. In turn, these state firms allocate significantly more procurement contracts to

private firms with a CEO from the same network. Contracts allocated to connected private

firms are executed poorly and exhibit more frequent cost increases through contract

renegotiations.

Similarly, Yu and Lee (2016) find that SOEs with a politically connected CEO

perform well even during a financial crisis as the SOEs are able to obtain more favorable

treatment. However, the results also indicate that politically connected CEOs perform poorly

when government subsidies are excluded as they may lack the skills for successful

management. These results suggest that political connections may directly benefit the firms

being favored, but not the overall economy.

Alternatively, Cho and Song (2017) argue that political connections may be beneficial

not only to the firm being favored, but also to the economy as a whole. Specifically, they find

- 38 -
that firms with a politically connected audit committee exhibit higher earnings quality than

those without these connections. They also note that the former have better access to equity

financing, but only when their earnings quality is higher.

4. CEO Characteristics

Since many CEOs in Korean public firms are either founders themselves or descendants of

the founders, studies on CEO characteristics, which would be more relevant for professional

CEOs, are also relatively scant. Mun, Han, and Seo (2020) examine the effect of CEOs'

educational background on the cash holdings policy and value of excess cash. They show that

while firms with CEOs who majored in business have less cash holdings, the value of excess

the cash holdings is higher than other CEOs. Similarly, Lim and Lee (2019) investigate the

relationship between excess cash holdings of firms and CEO characteristics, such as

ownership type, presence of stock options, inclusion in a chaebol, and CEO tenure, and find

that professional CEOs have higher excess cash holdings than family managers.

Choi, Jung, and Kim (2020) investigate the relationship between the traumatic war

experiences of chief executive officers (CEOs) and their corporate decisions. Using the

Korean war as an event, they find that CEOs exposed to the war earlier in their lives are more

conservative in their corporate policies. Among war-experienced CEOs, they also determine

that those who have witnessed large scale massacres exhibit more conservative behavior.

Moreover, war-experienced CEOs make more conservative decisions during a period of

financial crisis or when they have ownership. Their results indicate that early life exposure to

traumatic experiences significantly induces CEOs to be risk averse.

V. Consequences of Corporate Governance Mechanisms

In this section, we explore studies that investigate the consequences of various corporate

- 39 -
governance mechanisms. We split these studies into two groups. The first group studies the

overall level of governance, while the second group limits their attention to a single

governance mechanism. The studies in the first group typically use KCGS governance ratings

data to measure the strength of governance.

1. Corporate Governance in General

Corporate governance, in general, can influence a variety of outcomes. Some outcomes take

place inside the company, such as corporate financial policies or the opportunistic behavior of

corporate insiders (internal outcomes). Others outcomes take place outside the company, such

as the reactions of stock market participants or credit rating agencies (external outcomes).

1.1. Internal Outcomes

We review those studies that focus on corporate financial policies, such as investments,

leverage, managerial compensation, dividend payouts, stock repurchases, retirement of

treasury stocks, and corporate pension plan funds. We also cover studies that investigate

earnings management and insider trading.

Kook and Kang (2011) find evidence that stronger investor projection mitigates over-

or under-investment problems. They confirm that stronger investor protection, measured by

KCGS ratings, leads to lower earnings volatility in firms that are likely to overinvest (i.e.,

firms with high cash flow, but low growth opportunities). In contrast, they determine that

stronger investor protection leads to higher earnings volatility in firms that are likely to

underinvest (i.e., firms with high growth opportunities, but low cash flow). Kim, Jeon, and

Kim (2014) present evidence that better governed firms make better dividend payout

decisions. They note that the negative relationship between growth opportunities and

dividend payouts strengthens with better corporate governance as measured by the KCGS

- 40 -
ratings. Kim and Oh (2015) show that increases in outside director ratios and institutional

ownership are related to increases in the amounts of stock repurchases and dividend payouts.

However, they also note that the increase in stock repurchases and dividend payouts are

related to reduced expenditures on research and development (R&D).

Kim (2015) finds that firms with poor KCGS governance ratings tend to have higher

debt ratios and shorter debt maturity than firms with high governance ratings. The study

attributes this to the monitoring role of debt that can substitute for traditional governance

arrangements. However, the study does not provide any direct evidence of debt holders

playing a monitoring role. Song and Jung (2014) find evidence that KCGS governance

ratings and executive compensation have a complementary relationship. They confirm that

well governed firms are more likely to pay performance-based incentives to their executives

than poorly governed ones.

Kim and Lim (2017) find evidence that poorly governed firms use treasury stocks to

protect incumbent management. They show that Korean firms tend to resell most of the

treasury shares that have been repurchased rather than retiring them. They also find this

tendency to be stronger for firms with poor KCGS governance ratings. Kim and Wee (2020)

investigate how corporate governance is associated with the funding decisions of defined

benefit corporate pension plans. They show that funding ratios are higher in firms with higher

KCGS governance ratings, higher managerial ownership, higher foreign investor ownership,

or higher outside director ratios.

Kim and Kang (2011) investigate whether corporate governance can curb earnings

management. They find that firms with better KCGS governance ratings engage less in real

activity-based earnings management. Yoon (2013) investigates the relationship between

corporate governance and insider trading. The study shows that insiders of well governed

firms earn significantly smaller abnormal returns than insiders of poorly governed firms and
- 41 -
this tendency is stronger after the Financial Investment Services and Capital Markets Act

(FISCMA) was introduced in 2009.

1.2. External Outcomes

One of the key research topics in the corporate governance literature is studying the

relationship between corporate governance and firm value. This research evolved in two

directions. In one direction, researchers tried to address the endogenous nature of corporate

governance to obtain its unbiased treatment effect. In another direction, researchers tried to

identify the channels through which governance can affect firm value.

We focus on two studies regarding this second endeavor. Byun, Hwang, and Lee

(2011) test whether corporate governance practices influence firm value by enhancing the

value relevance of corporate financial decisions. Using KCGS governance ratings, they find

that the value relevance of financing, investment, dividend, and cash-holding decisions

increases with governance ratings. Black, Kim,, Jang, and Park (2015) explore whether the

reduced incentive of tunneling serves as a channel through which governance can improve

firm value. Their panel regression results are estimated from 1998-2004 and demonstrate that

better governance moderates the negative effect of related-party transactions on firm value.

Note that Black et al. (2015) use their own index to measure governance. This index, the

Korea Corporate Governance Index (KCGI), utilizes the same raw data KCGS uses for its

governance ratings, but is limited to elements that are time consistent and more meaningful.

Another popular research topic is studying the relationship between corporate

governance and stock returns. Here, we have two lines of research. One investigates whether

corporate governance can mitigate the degree stock prices will fall in a time of crisis. The

second explores the return predictability of corporate governance. Cho, Shin, and Park (2016)

examine the first issue. By investigating stock price reactions to the 2008 global financial

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crisis, they find that firms with independent boards and higher dividend payout ratios perform

better than others. They deduce that these firms are better equipped to mitigate agency

problems that can be greater in times of crisis. Sohn and Choi (2016) examine whether

investment strategies based on corporate governance can generate alpha. In general, they find

that corporate governance, measured by KCGS ratings, does not predict future stock returns.

One exception is inside ownership. They determine that firms with low inside ownership

exhibit higher stock returns. They suggest that investors are asking for higher return

premiums from firms with dispersed ownership for fear that they will suffer more from

agency problems. Jung and Park (2020) investigate whether better governed firms exhibit

greater efficiency in stock pricing. They confirm that firms with higher KCGS governance

ratings have higher variance ratios and shorter delays in stock pricing. They also show that

better governed firms have lower idiosyncratic volatility and lower skewness of stock returns.

Credit rating agencies may also react to corporate governance. If stronger corporate

governance lowers default risk, rating agencies should give higher ratings to well governed

firms. Shin, Suh, and Park (2012) find that firms with stronger corporate governance,

measured by the KCGS ratings, are more likely receive higher credit ratings. They also note

that higher scores in disclosure and audit strengthen the positive association between earnings

and credit ratings. Kang, Yoon, and Kim (2016) find similar results. They confirm that firms

with stronger corporate governance are more likely to have higher bond ratings and have

better chances of obtaining investment-grade ratings. They also find that this relationship is

stronger for smaller firms that typically suffer more from information asymmetry problems.

2. Specific Corporate Governance Mechanisms

In this subsection, we review the studies on individual corporate governance mechanisms and

their outcomes. Our discussion begins with internal mechanisms, such as corporate boards,

- 43 -
executive compensation, and disclosure. Then, we move to external mechanisms including

institutional investors, anti-takeover devices, product market compensation, and many others.

2.1. Corporate Boards

Inside corporations, corporate boards are the key to monitoring management. However, for it

to be effective in carrying out its role as monitor, it is crucial that members of the board be

independent from management and have the relevant skills and experience. Naturally, the

studies on Korean corporate boards also focus on these two qualifications.

Most of the studies on board independence examine firm value as an outcome. For

example, Black and Kim (2012) identify the causal relationship between board independence

and firm value by making use of the 1999 board structure reform that required large firms to

have a 50% outside director ratio and introduced audit committees with independent chairs

(section II provides a detailed account of this reform). To identify the causal effect of this

shock, they use multiple identification strategies including event studies, difference-in-

differences (DiD) analyses, instrumental variable methods, and regression discontinuity

design (RDD). They find that legal shock causes the share price of large firms to increase

relative to mid-sized firms that were not subject to the reform. Black, Kim, Jang, and Park

(2015) also make use of the 1999 board structure reform. To investigate whether reduced

incentives for tunneling serves as a channel through which governance can improve firm

value, they conduct a series of event studies around the event dates in June-August 1999 and

show that large firms (total assets > one trillion Korean won) whose controllers have the

incentive to tunnel (measured by the Expropriation Risk Index) earn stronger positive returns

relative to mid-sized firms.

Joh and Jung (2012) and Byun, Lee, and Park (2013) also find a positive association

between board independence and firm value. However, they suggest that this association can

- 44 -
be moderated by other factors. They indicate that information transaction costs and the

disparity between controlling shareholders’ control rights and cash flow rights can weaken

the positive link. Note that Joh and Jung (2012) measure board independence using the

fraction of independent outside directors, while Byun, Lee, and Park (2013) use the average

proportion of outside directors in each monitoring committee and whether the chairperson of

the monitoring committee is an outside director. Kim and Shin (2016) investigate the effect of

board independence in a different way. They examine the social ties of outside directors and

show how they are associated with firm value. They confirm that strong social ties to

executives result in significantly lower firm value, whiles their social ties with controlling

shareholders do not.

We also review studies that investigate other outcomes. Kang Kook, and Yoon (2015)

show that firms with a higher fraction of independent outside directors hold less cash and

make more efficient use of it. In particular, they find that the tendency for low growth

opportunity firms to increase dividend payouts strengthens with higher fractions of

independent outside directors. They also note that the market value of cash is higher in these

firms. Black, Kim, and Nasev (2021) determine that board independence leads to greater

transparency. Using annual DiD within the framework of RDD, they find robust evidence that

the 1999 board structure reform improved the disclosure practices of Korean firms.

Regarding the skills and experiences directors, we review studies on bureaucrat

directors and academic directors. Lee and Chung (2017) examine the performance of former

bureaucrats as outside directors. They find that firms where bureaucrat directors serve do not

necessarily perform worse than firms without them in terms of ROA, ROE, and Tobin’s Q.

Cho and Chung (2019) examine the performance of professors as outside directors. They

confirm that firms where academic directors with high research productivity serve perform

better than other firms without them in terms of ROA, ROE, and Tobin’s Q.
- 45 -
2.2. Other Internal Mechanisms

In addition to corporate boards, we cover studies focusing on executive compensation and

disclosure. Executive compensation, if well designed, can help align the economic interests

of managers and shareholders. However, if it is designed in the interest of managers, it can

harm shareholder value. We focus on two studies that document the dark side of stock option

grants using Korean data.

Lee, Lee, and Choi (2011) examine the effect of stock option grants on earnings

management. Specifically, they show that firms with higher values of exercised options and

higher option delta engage more in earnings management than other firms. They also confirm

that this relationship intensifies with information asymmetry and in samples where executives

sell stocks acquired from stock option exercises. Kim, Kim, and Sul (2011) study the

announcement effect of stock option grants using a sample of Korean banks. They find that

stock option grants generate significant and negative abnormal returns, but this effect is

mitigated by the presence of foreign block holders and the ratio of outside directors that

exceeds the legal minimum. They also note that the negative announcement effect is smaller

when granting performance-based options rather than plain vanilla options.

Disclosure also plays an important role in corporate governance. It allows outside

shareholders to obtain the information necessary to monitor management. Also, by reducing

information asymmetry, disclosure mitigates the adverse selection problem. Han, Kim, Lee,

and Lee (2014) investigate firms that are not faithful in their disclosures. They find that firms,

designated as unfaithful disclosure firms by the Korea Exchange, exhibit significantly

negative stock price returns upon designation. However, they note that this negative price

reaction is mitigated in firms with high managerial ownership. Disclosure can also have

unintended consequences. Kim, Lee, and Shin (2017) investigate the effect of the new

executive compensation disclosure rule adopted in 2013. The new rule requires listed firms to
- 46 -
disclose pay information for registered directors who earn more than 500 million Korean won

per year (section II provides a detailed account of this rule). They find that executives receive

higher pay after the new rule, and this is pronounced for executives who received suboptimal

pay in prior years. They argue that this would not have taken place if it were not for the

availability of the executive pay information of other executives. They also suggest that pay-

performance sensitivity increased only in those firms with strong corporate governance.

2.3. Institutional Investors

The monitoring role of institutional investors is the most heavily studied external governance

mechanism for Korean firms. The research questions are also diverse. We begin with those

studies that ask whether voting decisions by institutional investors affect the share price of

target firms. Kim and Yon (2014) find that dissenting votes cast by institutional investors

result in positive stock price reactions. They also confirm that this is more pronounced for

resolution items that are eventually disapproved. Kim, Sung, and Wei (2017) provide

evidence for foreign institutional investors. They show that share prices react positively to 5%

block holding announcements if foreign institutional investors declare themselves as activists

and that the effect is greater if the activists come from countries with strong traditions of

investor activism. However, the results for the National Pension Service (NPS) are mixed.

Kim, Byun, and Lee (2014) find that target firm share prices do not react to dissenting votes

cast by NPS in the short run. However, they suggest that these firms eventually exhibit higher

firm value on the condition that they improve their internal governance ex post. Ko and Kim

(2020) study the effect of NPS votes disclosed prior to the shareholders’ meeting. They make

use of the 2019 rule change that mandates the NPS to make pre-meeting disclosure of votes

for firms in which the NPS owns at least 10% of the voting shares or firms whose weight is at

least 1% of the NPS domestic equity portfolio (section II provides a detailed account of this

- 47 -
rule). They find that the share prices of target firms react negatively to NPS dissenting vote

announcements. They attribute this to the possibility that NPS dissenting vote disclosure, in

effect, reveals negative private information to the public.

Another central research question is the role of institutional block holders on

corporate investment decisions. These studies are usually motivated by the concern that

foreign block holders are myopic and this can discourage firms from taking risky investments.

Contrary to this expectation, Kim (2011a) finds that firms with higher foreign ownership

exhibit greater cash flow volatility, a proxy capturing the riskiness of investments, and

eventually grow faster. Similarly, Park and Yoon (2017) determine that business group firms

with higher foreign ownership make more corporate investments and suffer less from external

financial constraints. However, they do not find evidence that higher foreign ownership leads

to greater risk taking. Studies focusing on research and development (R&D) provide mixed

results. Kang, Chung, and Kim (2019) show that firms with higher foreign short-term block

holdings spend significantly less on R&D expenditures than others. Alternatively, Joe, Chung,

and Morscheck (2020) find that institutional block holders positively influence firm

innovation and this positive effect is largely driven by foreign institutional block holders

engaging in passive monitoring.

Another set of studies find that foreign ownership improves the workings of internal

governance mechanisms and increases dividend payouts to shareholders. Garner and Kim

(2013) determine that firms with higher foreign ownership tend to have higher pay-

performance sensitivity, while their lower foreign ownership counterparts do not. Kim and

Jang (2012) find a significant positive relationship between the changes in the ownership of

long-term foreign investors and the changes in dividend payouts. Kim, Sung, and Wei (2017)

show that target firms of foreign activist block holders peg dividend payouts, stock

repurchases, and CEO turnover more closely to the changes in earnings, but only if they
- 48 -
come from countries with strong traditions of activism.

Finally, a group of studies documents the role of institutional investors in curbing

managerial rent diversion and earnings management. Lim (2011) is the first to show that tax

avoidance lowers the cost of debt. The study attributes this to the possibility that tax

avoidance is a substitute for the use of debt, but unlike debt not subject to default risk. The

study then indicates that this negative relationship strengthens when the level of institutional

ownership is high and this becomes even stronger after 1998 when the level of investor

protection is significantly improved. The study attributes this to the role of institutional

investors that lower the cost of debt even further by lowering the risk of managerial rent

diversions. Liu, Chung, Sul, and Wang (2018) find evidence that institutional block holders

deter opportunistic financial reporting, but that the effect comes solely from domestic

institutional block holders.

2.4. Other External Mechanisms

In addition to institutional investors, there are many other external mechanisms that can shape

the way firms are governed. In this review, we cover takeovers, anti-takeover devices,

product market competition, shareholders’ meetings, shareholder litigation, taxes, and dual

listings.

In Korea, firms tend to takeover other firms by acquiring controlling minority blocks.

The problem with this is that the remaining non-controlling shareholders of the target firm are

vulnerable to expropriation by the controlling minority shareholders. This is what Byun, Kim,

Lee, and Park (2019) find in their research. They confirm that the probability of

embezzlement or breach of fiduciary duty is significantly higher in these targets than in

targets with majority block acquisitions or in matched non-targets.

Korea does not allow poison pills. Nor does it allow the issuance of shares with

- 49 -
multiple voting rights. However, this does not mean that Korean firms are completely

stripped of anti-takeover devices. According to Hwang and Kim (2012), charter-based anti-

takeover devices are popular among firms with low foreign ownership (see Section II.1.2.1

for details regarding these devices). They also find that these firms experience a fall in share

prices upon adopting these provisions and during the post-adoption years, experience a rise in

capital expenditures, a fall in profitability and dividend payouts, and a greater chance of

delisting. Kim, Hwang, and Kim (2020) study the motivation and the effect of adopting

convertible preferred stocks whose conversion rights are in the hands of the board. They find

that firms adopt these types of stocks for managerial entrenchment purposes and destroy firm

value upon adopting them.

It is well known in the literature that product market competition can be a substitute

for internal or external governance mechanisms. We find similar results in the Korean

literature as well. Park, Byun, and Lee (2011) show that the positive effect of internal

corporate governance on dividend payouts and stock repurchases and the negative effect of

internal corporate governance on investments are observed only in less competitive product

markets, but not in the more competitive product markets. Similarly, Lee and Byun (2016)

find that the negative effect of ownership disparity of the controlling shareholders on firm

value is observed in less competitive product markets, but not in the more competitive

product markets. Lee and Byun (2016) find that the negative effect of corporate governance

on corporate risk-taking behavior exists only in less competitive product markets, but not in

more competitive product markets. Finally, Byun, Lee, and Park (2018) investigate whether

product market competition works as a disciplinary mechanism that reduces the incentives of

controlling shareholders to pursue private benefits of control. Specifically, they find that

member firms in more competitive markets have less disparity between the control and cash

flow rights of controlling shareholders.

- 50 -
 Tax enforcement can benefit shareholders by uncovering hidden earnings. In Korea,

tax rules can benefit minority shareholders by discouraging unfair related-party transactions.

Chung, Choi, and Jung (2019) examine the effect of the 2012 Inheritance Tax and Gift Tax

Act amendment that required the National Tax Service (NTS) to collect gift taxes from

controlling shareholders of firms with significant sales to related-party firms. By employing a

difference-in-differences approach, they find that treatment group firms (i.e., firms whose

controlling shareholders are likely to be subject to the gift tax) exhibit a significant drop in

related-party sales during the post-amendment period, while there is no significant change in

related-party sales for the control group firms (i.e., firms whose controlling shareholders are

not likely to be subject to the gift tax).

The threat of shareholder litigation can prevent corporate directors from engaging in

illegal activities. However, the threat can also increase liability insurance coverage for

directors and officers. Park (2018) finds support for this conjecture. The study shows that

firms increase liability insurance coverage after the introduction of shareholder class action

lawsuits in 2004, and that this effect is more pronounced for firms operating in high litigation

risk industries and firms with greater agency conflicts. Cross-listing can strengthen investor

protection by bonding to the rules and regulations of another country. Choi and Choi (2015)

provide supporting evidence on this for Korean firms. They find that cross-listed firms are

worth more than other KRX-listed firms that are not cross-listed. They also note that cross-

listed firms improve their governance after cross-listing.

Shareholders discipline management by exercising their rights at the shareholders’

meetings. However, this is a challenge for shareholders in Korea, where AGM dates are

highly clustered (see Section II.1.4 for details). Are firms deliberately scheduling their AGMs

on highly clustered dates? Gam, Gupta, Im, and Shin (2021) confirm this. They find that

firms that never held AGMs on clustered dates in previous years, but then held an AGM on
- 51 -
one of the clustered dates are more likely to face a corporate fraud investigation in that same

year.

VI. Conclusion

In this survey, we have reviewed academic studies that examine the determinants and

consequences of Korean corporate control structures and governance mechanisms. In

addition to the studies covering traditional mechanisms, such as boards of directors or

managerial compensation, we also cover studies that focus on the implications of non-U.S.

style corporate control structures, such as family control and business groups.

At this point, the results of the empirical research suggests both bright and dark sides

to the Korean corporate control structure. While family-controlled business groups or

chaebols may mitigate labor and capital market frictions through internal labor and capital

markets, they have also caused inefficiencies, as well as wealth transfers.

Regarding empirical methodology, we find that various efforts have been made to

tease out causality by taking advantage of certain regulatory changes as exogenous shocks.

These methodologies include event studies, matched sample analyses, instrumental variable

(IV) regressions, difference-in-differences (DiD) regressions, and regression discontinuity

analyses. However, we also find studies that lack a clear identification strategy. Some even

use corporate governance mechanisms as both the right hand side and the left hand side

variables. These studies generally focus on certain characteristics that may affect corporate

governance, which, in turn, may ultimately affect firm value. Although this approach may

document correlations between certain firm characteristics and corporate governance or

between corporate governance and firm value, it is difficult to tease out causality in such a

framework.

There are some other methodological concerns in the Korean studies. One has to do
- 52 -
with the measurement of concentrated ownership. In a business group structure, not all

member firms are directly owned by the controlling family. Some are controlled indirectly

through other member firms without any direct family ownership. For the latter type of firms,

one should compute the controlling family’s cash flow rights to correctly measure how

greatly they are economically exposed to each member firm. However, we find some studies

that do not make such an effort. We dropped these studies in this survey.

Another concern has to do with the definition of chaebol firms. Some studies do not

clearly state whether they only include family-controlled business groups, or also widely-held

ones in their definition of chaebol firms. POSCO, the largest steel manufacturer in Korea, has

many subsidiary firms. As such, it is clear that POSCO and its member firms constitute a

business group. However, POSCO itself is widely held with no family standing behind it.

Thus, if the chaebol affiliation dummy is not clearly defined, it is not clear whether it is

picking up the business group effect or the family effect.

Related to this, it should also be noted that the business groups designated by the

Korea Fair Trade Commission are not any business group, but only “large” business groups

that exceed a certain size threshold. Accordingly, firms outside of these large business groups

not only include stand-alone firms, but also smaller business groups. Thus, using a chaebol

affiliation dummy that takes a value of one for all KFTC-designated business groups and zero

otherwise would fail to pick up the business group effect, but would pick up the business

group “size” effect. Unfortunately, we find some Korean studies doing exactly this even when

their intension was to identify the business group effect.

It has been only a quarter of a century since Korean firms have been subject to any

form of corporate governance. Prior to the 1997 Asian Financial Crisis, there were virtually

no constraints on controlling families’ power to expropriate corporate resources or to make

empire building decisions. Since 1998, there have been many regulatory changes, both at the
- 53 -
group level and also at the firm level to constrain the power of controlling families. However,

these regulatory changes did not fully deliver the intended effects. Controlling shareholders,

who still consider themselves as principals rather than agents, are primarily responsible for

this. More recently, the National Pension Fund adopted its own Stewardship Code that

provided the groundwork for active monitoring or engagement by institutional investors in

Korea. We are hoping that such empowerment would change the way controlling

shareholders perceive themselves in the future.

On the direction of future research, we would like to highlight the importance of

utilizing various governance-related reform measures. These policy experiments help

researchers to establish causality more rigorously. In Section II, we have mentioned four

board related reforms and other regulatory changes on the disclosure of executive

compensation, 5% blockholdings, and related-party transactions. ２１ We hope to see more

research that takes advantage of the unique Korean setting, especially the regulatory changes.

２１
(i) 2003 Securities Exchange Act (SEA) reform on outside director ratio, (ii) 2003 Securities Exchange Act
(SEA) reform on audit committee’s financial/accounting expertise, (iii) 2020 Commercial Code Enforcement
Decree reform on outside directors’ length of tenure, (iv) 2020 Commercial Code reform on audit committee
member election, (v) 2016 Capital Markets Act (CMA) reform on executive compensation disclosure, (vi) 2019
Capital Markets Act (CMA) Enforcement Decree reform on 5% rule, (vii) 2019 NPS reform on pre-meeting
vote disclosures, (viii) 2020 Commercial Code and its Enforcement Decree reforms on shareholders’ meeting
dates, (ix) 2013 and 2020 Fair Trade Act (FTA) reform on related-party transactions.
- 54 -
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 about ECGI

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Editor Mike Burkart, Professor of Finance, London School

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