Samsung, Lee Jae-yong’s Conviction, and How Business in South Korea Is Changing

(Samsung Headquarter, Seoul)

Samsung, Lee Jae-yong’s Conviction, and How Business in South Korea Is Changing

By Hansoo Choi, Harvard Business Review, Sept. 29, 2017

In late August, Lee Jae-yong, the heir apparent of Samsung, South Korea’s largest conglomerate, was sentenced to five years in prison. Last February Lee was charged on five counts: bribery, illegally transferring assets overseas, embezzlement, concealing criminal proceeds, and perjury, which are seemingly unrelated to one another but all point to one event: the succession of control over Samsung.

There once was public sentiment that what is good for Samsung is good for South Korea, given how important the company is to the country’s economy. This sentiment allowed Lee Kun-hee, the father of Lee Jae-yong, to be pardoned by the government twice, in 2008 for tax evasion and breach of trust, and in 1997 for bribing a former South Korean president.

Now, Lee Jae-yong’s conviction has surprised some observers in the “republic of Samsung.” Considering all the allegations against Lee, a plausible sentence in the South Korean legal system would be 10 to 15 years. But whatever the sentence, the verdict’s bigger signal seems more clear: no longer will anyone be “too big to jail.”

What changed the public sentiment?

Two factors contributed. One was the five-month protest that led to the impeachment of former president Park Guen-hey. The other is related to a more fundamental factor. Samsung — and, more generally speaking, the chaebol, South Korea’s family-run conglomerates — has been an engine of rapid economic growth for a long time. However, there is a growing skeptical view of the trickle-down effect that the conglomerate generates. For example, in 2017 the profits of the 30 largest South Korean conglomerates rose by 48%, compared with one year before, but the number of workers employed by those companies decreased by 0.4% in the first half of the year. Samsung’s operating profits rose by 128% (USD $6.12 billion), while the number of Samsung workers was stagnant. So more and more people are starting to believe that Samsung’s interests are not necessarily aligned with the country’s.

How does Lee Jae-yong’s case differ from his father’s?

First, Moon Jae-in, South Korea’s current president, vowed during his campaign that he would not pardon convicted tycoons. In addition, there has been a change in the judiciary. My colleagues and I investigated what constituted leniency toward chaebol-related defendants. Examining 252 convictions against high-profile white-collar offenders in South Korea, we found that leniency occurs because the judiciary worries that strict sentences against the defendants may cause systemic risk to the economy. But the court has little reason to be reluctant to punish Lee harshly, because Samsung Electronics has posted record profits even facing the absence of Lee, the de facto CEO. So the prospect that Lee’s conviction will be overturned looks unlikely.

How has the stock market responded to the guilty verdict?

It might surprise readers, especially those not from South Korea, to know that the criminal justice process involving Lee has been good for Samsung: Since Lee’s detention in mid-February, Samsung Electronics’ stock price has surged 30%, from USD $1,672 to USD $2,168. The company’s shares were down 1.5% following the verdict, but have since bounced back and risen 4.3%.

This stock surge may seem puzzling, because one could easily expect that the indictment or conviction of controlling shareholders would have a negative effect on the value of a firm, due to the vacuum of power. However, data tells a different story. My study of 18 chaebols from 2000 to 2014 investigates the impact of the criminal justice process on the stock value of the conglomerates. The study found that the process has mixed effects on affiliates within a conglomerate: It has a positive effect on the stock price of affiliates where a controlling shareholder holds a large proportion of shares; however, it has a negative impact on the stock prices of affiliates that are expected to grow at faster rates in the future. As a result, criminal cases targeting a controlling shareholder do not have any significant group-wide effect in terms of market value, suggesting that the conviction of Lee could be either a curse or a blessing for investors. This makes sense because the conviction of a controlling shareholder may increase uncertainty from a leadership vacuum, but may also prevent further wrongdoing by the shareholder.

But is Samsung as a whole still thriving?

To answer that, it’s important to understand that the Future Strategic Office, Samsung’s centralized headquarters, was totally disbanded and key staff members were laid off. This is unprecedented. It meant that the individual subsidiaries of Samsung, for example Samsung Electronics, have more autonomy when it comes to management. Having that central headquarters incentivized Samsung’s leadership to serve Lee’s interests at the expense of shareholders. The conviction offers more independence from Lee, which may be good for investors, although the influence of the overall Lee family on the company remains to be seen.

What about Samsung’s future?

Lee’s five-year absence appears to have done little damage to day-to-day management of the company. Inside Samsung Electronics, for instance, short-run decision making has already been delegated to unit heads. Ironically, if a problem were to happen in the future, it may be not because the unit heads are not capable but because they are so capable that they act in only their unit’s interests, resulting in a coordination failure from the company’s perspective. “After the headquarters’ breakup, no attempt to coordinate interactions among subsidiaries was made,” Kwak Jung-soo, reporter for the Hankyoreh newspaper, told me. “CEOs of each affiliate do not even eat lunch together. Why? The main concern of Samsung is how to save Mr. Lee. Other issues are secondary. Given these situations, keeping the status quo is a best strategy.”

A research analyst who wants to be anonymous raises a similar issue: “Competition in a tech industry is so intense that even a current dominant player would fall behind if it neglects innovation for a couple of years. Samsung Electronics was not good at a full-scale renovation because the company has already established a huge empire. Mr. Lee is the only person that can jump over a barrier to innovation. At Samsung’s new Silicon Valley offices, there are many tech prodigies who are not suited to a hierarchical culture of Samsung. My concern is that they will leave if the absence of Mr. Lee will last for a long time, which will be substantial damage to Samsung.”

Even after the verdict, considerable uncertainty remains. However, one obvious thing is that Samsung and Lee cannot return to the past. In fact, we are getting closer to saying good-bye to the “republic of Samsung.” As Kim San-jo, FTC chair and longtime critic of Samsung, says, this situation may have both blessings and hardships for Samsung. It is evident that Samsung must endure its intense suffering for the moment. This is also the case for South Korea. The Korean people should admit that what’s good for Samsung is not always good for the country, and prepare for change, even if that change may hurt the country’s economy in the short run. This is a challenging task, but an inevitable one.

- - - - - - - -

#Samsung #SouthKoreanCulture #KoreanBusinessCulture #businessinKorea