SAMSUNG case study finance corporate governance

samsung

1. Samsung Electronics A Profitable Investment Opportunity? ‹#› Laura Musset, Maciej Jablonski, Valeri Kulman, Jessica Qiu Capital Structure and Corporate Reorganisation

2. Table of Contents Korean Chaebols Samsung Electronics Capital Structure Board Composition Evolution Past Tunneling Issues Corporate Governance Changes Outcome for Minority Shareholders ‹#›

3. The Korean Chaebol (Question 1) A large, usually family owned conglomerate in SK Originated in the 1960s, promoted by government. Vertical growth and horizontal growth Critics : impact on the development of SMEs ; Are chaebols too big to fail? Examples: Samsung, Hyundai, LG, SK group… Sources : Wonhyuk (2012) Chaebol and industrial policy in Korea, Asian Economic Policy Review 7(2), 69 Almeida and others (2011) The structure and formation of business groups: evidence from Korean chaebols, Journal of Financial Economics, 99(2), 447

4. The Korean Chaebol BENEFITS Diversification → reduces overall risk exposure → fast-paced growth of chaebols ⇒ Allows for large investments in SK’s R&D sector ++ Net gain in technical efficiency by utilizing internal market transactions to mitigate liquidity constraints. → Reduction of costs, advantageous financing conditions by utilizing cross-shareholding and cross guarantee structures. Sources : Keunsoo (2013) Chaebols and their Effect on Economic Growth in South Korea, Korean Social Sciences Review (KSSR) 3(2)

5. The Korean Chaebol DISADVANTAGES Monitoring issues (additional agency costs) Governance issues → difficulties in ensuring transparency and accountability Chaebols’ contribution to the financial crisis by amplicating structural vulnerabilities . Sources : Campbell & Keys (2002) Corporate Governance in South Korea: the chaebol experience, Journal of Corporate Finance 8(4), 373-391.

6. Capital Structure (Question 2)

7. Capital Structure (Question 2) Samsung Electronics (bln wons) China Mobile (mln RMB) Sony Group Corporation (mln yen) 1997 2023 1997 2023 1997 2023 Assets 23,066 455,905,980 61,265 1,992,657 5,680,246 31,154,095 Liabilities 17,236 92,228,115 8,878 646,672 4,220,914 24,496,945 Equity 5,830 363,677,865 52,387 1,345,985,000 1,459,332 6,657,150 Debt-to-Equity 2.96 0.25 0.17 0.48 2.89 3.68

8. Capital Structure Samsung Electronics (bln wons) China Mobile (mln RMB) Sony Group Corporation (mln yen) 1997 2023 1997 2023 1997 2023 Assets 23,066 455,905,980 61,265 1,992,657 5,680,246 31,154,095 Liabilities 17,236 92,228,115 8,878 646,672 4,220,914 24,496,945 Equity 5,830 363,677,865 52,387 1,345,985,000 1,459,332 6,657,150 Debt-to-Equity 2.96 0.25 0.17 0.48 2.89 3.68 Sources : Samsung Electronics (Exhibit 4 – Case instructions), China Mobile (https://www.chinamobileltd.com/en/ir/reports/), Sony Group Corporation (https://www.sony.com/en/SonyInfo/IR/)

9. Capital Structure Samsung Electronics (bln wons) China Mobile (mln RMB) Sony Group Corporation (mln yen) 1997 2023 1997 2023 1997 2023 Assets 23,066 455,905,980 61,265 1,992,657 5,680,246 31,154,095 Liabilities 17,236 92,228,115 8,878 646,672 4,220,914 24,496,945 Equity 5,830 363,677,865 52,387 1,345,985,000 1,459,332 6,657,150 Debt-to-Equity 2.96 0.25 0.17 0.48 2.89 3.68 Sources : Samsung Electronics (Exhibit 4 – Case instructions), China Mobile (https://www.chinamobileltd.com/en/ir/reports/), Sony Group Corporation (https://www.sony.com/en/SonyInfo/IR/)

10. Capital Structure – Analysis 1990s : Samsung Electronics and Sony with highly leveraged positions ⇒ Chaebols ~ Keiretsu China Mobile with very low D/E ratio ⇒ equity financing 2010-2020s : Samsung Electronics deleveraged Benefits : lower financial risk, greater stability, higher profit retention, higher flexibility + lower debt overhang, risk shifting issues Risks : lower ROE, tax inefficiencies + FCF problem, weaker monitoring and discipline, lower commitment to shareholder value

11. Lee’s Stakes in Samsung Motors (question 3) Profit of 100 million USD in SM, what share going to owners? What percentage do owners own?

12. Lee’s Stakes in Samsung Motors (question 3) Profit of 100 million USD in SM, what share going to owners? What percentage do owners own?

13. After tax profit (question 3) Directors and managers own 30.6% of Samsung Motors (exhibit 3a) According to exhibit 3b, total of affiliate firms is equal to 21.11 + 7.45 + 2.48 + 6.08 + 1.24 = 38.36%. According to exhibit 1, the Lee family owns 8.50% of the Samsung group. Therefore, the share going to the owners will be equal to: ⇒ 0.085 * 38.6 million = 3.3 million

14. Old Board Composition (question 4a)

15. Old Board Composition (question 4a) Non-executive 16 - Assuming that only the first 7 people on the list are involved in the day-to-day running of Samsung Electronics. Independent 3 could be classified as independent. Criteria’s for assessing director independence No (past) affiliation with Samsung Electronics and related branches

16. Old Board Composition (question 4a) Strengths Weaknesses Having directors with long-standing ties to the company might contribute to a deep understanding of Samsung’s operations and the chaebol culture ½ did not attend meetings regularly, thus the board’s ability to oversee management and challenge decisions was compromised → only 11 out of 23 directors attended more than 75% meetings ​​ Having large board could be beneficial as it would be composed of industry experts ( diversification ) Board members appointed by insiders (controlling family) - → close ties to the controlling family. Board members were insiders themselves - part of the controlling family. To write about possible more democratic and more informed decision- making The mix of family members, insiders, and affiliated directors could lead to groupthink and self-dealing, reducing accountability. With 23 members on the board, transparency & accountability may be diluted, making it challenging to assign responsibility effectively.

17. Fast-forward: New Samsung Board (question 4b) Improvements: Smaller, more efficient board (43→23 →9 directors) Higher proportion of independent directors (⅔) Increased attendance (11/23 in the past) Reduction in cross-shareholding : i.) Regulatory tightening → rules restricting circular shareholding structures and new managerial duties ii.) Mergers → Samsung Heavy Industries & Samsung Engineering iii.) IPOs → Samsung SDS & Cheil ⇒ Thus, less complexity → more transparency and accountability

18. Source : https://www.samsung.com/global/ir/governance-csr/board-of-directors/ http://www.rns-pdf.londonstockexchange.com/rns/8731P_1-2023-2-14.pdf Chief Investment Officer for Samsung Asset Management (2011-2013) Attended 3 meetings over 3 years of tenure (out of 28) Attended 3 meetings over 3 years of tenure (out of 28) Director at Hyundai Engeneering & Construction → Samsung & Hyundai collaborations Former Chairman of the Financial Services Commission of South Korea

19. Fast-forward: New Samsung Board (question 4b) Challenges : Family control remains strong (8.5% group ownership) Lee Jae-yong is de facto leader of Samsung chaebol → Succession & inheritance tax (50%) Risks of: fire sales, stock fluctuations or more complex web of ownership Cross-shareholding continues to resemble the ‘Byzantine’ corporate structure (Conglomerate) One merger and Two IPOs → sufficient change? Agency problems : Self-Dealing i.) Convertible Bonds ii.) Shady Deals

20. Self-Dealing (questions 5-6) Corporate Bonds Controversy Hidden Transactions in Samsung Electronics

21. A. Convertible Bonds Controversy (question 5) Backg ro und On March 24, 1997, Samsung Electronics privately placed unsecured convertible bonds worth 60 billion won (approximately US $46.1 million) Insiders were the sole purchasers —with the Chairman’s son acquiring 45 billion won of bonds and another Samsung affiliate buying the remaining 15 billion won. Was it a self-dealing? How to prove it? Compare the conversion price of the bonds with the market price of Samsung Electronics shares at the time. Look at bond issues from comparable companies during the same period to identify significant differences . Review the internal approval process of the bond issuance, specifically: Were independent directors involved? Was there a relevant committee appointed to oversee the transaction? Was the vote of minority shareholders considered? Analyse of capital structure pre and post bond issuance - in case of conversion would minority shareholders be diluted? Possible evidence: Correspondence and Internal Memos Board Meeting Minutes Shareholder Voting Records Approval from Relevant Committees Bond Issuance Documents

22. B. Hidden Transactions – Background (Question 6) Samsung Motors and Pan Pacific Industrial Investments (PP) enter into a joint-venture Samsung Motors → on the brink of insolvency Pan Pacific → Ireland-based paper company Samsung Electronics → “allegedly” a third party Deal resembled a Foreign Direct Investment (FDI) , but with caveat → Return on Equity guarantees NB! Guarantees : Risk-free investment for PP due to put & call options warranting returns Success Scenario: Call option → buy more stocks for a fixed low price Failure Scenario: Put option → sell existing shares for a fixed high price In case of Samsung Motor’s failure – Samsung Electronics bears all the risks

23. Controversy (Question 6) Samsung Motors ownership: 30.6% Directors/Managers; 38.36% Affiliate Firms Prior direct and indirect investments into Samsung Motors: Direct investment → e.g., direct acquisition of a 21.1% stake Indirect investment → e.g., joint-venture at hand This Deal: Samsung Electronics assumed all risks of the deal Pan Pacific was guaranteed a riskless return (via put and call option in the contract) PP’s benefit was at the expense of minority shareholders (per Dr. Hasung Jang) Alarming considerations: Transparency/ Fairness/ Disclosure Regulatory compliance Conflict of interests

24. Corporate Governance (CG) (Question 6) What CG measures could have been in place? → Audit Committee (AC) Why AC? → more scrutiny as to: i.) The real rationale behind guarantees for PP and their importance for the deal at all ii.) The extent of the risk exposure of Samsung Electronics, particularly minority shareholders iii.) The deal’s overall transparency – e.g., its disclosure to minority shareholders iv.) The deal’s compliance with the regulatory framework for FDIs Impact of robust CG?: Elimination/ reduction of self-dealing transactions More transparency and shareholder protection Prevention of disproportionate risk-taking

25. Main Corporate Changes (Question 7)

26. Main Corporate Changes (Question 7) 1 . Reduced Cross-Shareholding Structure 2. Increased Independent Board Representation 3. Greater Transparency and Financial Disclosure 4. Legal and Ethical Reforms After Scandals 5. Succession Planning and Leadership Restructuring Source : Hwang I & Seo JH (2000). Corporate Governance and Chaebol Reform in Korea, Seoul Journal of Economics 13, 3.

27. 1. Reduced Cross-Shareholding Structure Prohibition of direct cross-shareholding [Commercial Code, Securities Exchange Law, Monopoly Regulation and Fair Trade Act] ⇒ increased transparency and preventing conflicts of interests that Lee family previously benefited at the expense of minority investors Han-Jo Kim [Chairman & Independent] - Eun-Nyeong Heo [Independent] Jong-Hee Han [Vice-Chairman & CEO] - Myung-Hee Yoo [Independent] Tae-Moon Roh [President & Head of Mobile eXperience] Jung-Bae Lee [President & Head of Memory] - Je-Yoon Shin [Independent] Jun-Sung Kim [Independent Director] - Hye-Kyung Cho [Independent] 2 . Increased Board Independence Representation

28. Source : https://www.samsung.com/global/ir/governance-csr/board-of-directors/ http://www.rns-pdf.londonstockexchange.com/rns/8731P_1-2023-2-14.pdf Chief Investment Officer for Samsung Asset Management (2011-2013) Attended 3 meetings over 3 years of tenure (out of 28) Attended 3 meetings over 3 years of tenure (out of 28) Director at Hyundai Engeneering & Construction → Samsung & Hyundai collaborations Former Chairman of the Financial Services Commission of South Korea

29. 3 . Greater Transparency and Financial Disclosure Improved financial reporting and regulatory compliance ⇒ less opaque transactions, more management transparency ⇒ domestic auditing practices to comply with international standards combined financial statements requirement large internal transactions need board approval and public disclosure Director’s duty of loyalty [Arts 382-3 South Korean Commercial Code] “Directors shall perform their duties faithfully for the good of the company in accordance with the relevant acts, subordinate statutes and the articles of incorporation” ⇒ proposed revision to include shareholders’ interests 4 . Legal and Ethical Reforms

30. 5 . Succession Planning and Leadership Restructuring Transfer to son Lee Jae-yong ⇒ IPOs and mergers streamlining Samsung Electronics’ business operations ⇒ reduction of uncertainty in the future of the business’ corporate governance COMMITMENT TO END HEIR SUCCESSION (2020)

31. Restructuring and Public Listing: Implications for Minority Shareholders (Question 8)

32. Restructuring and Public Listing: Implications for Minority Shareholders (Question 8) Benefits Transparency and clearer governance standards: increased disclosure requirements Enhanced liquidity and valuation : better access to capital markets Can lead to potential gains for minority shareholders. Challenges Cross-shareholding: control could remain in the family’s hands Potential favoritism in share allocation?

33. Restructuring and Public Listing: Implications for Minority Shareholders (Question 8) Benefits Transparency and clearer governance standards: increased disclosure requirements Enhanced liquidity and valuation: better access to capital markets Can lead to potential gains for minority shareholders. Challenges Cross-shareholding: control could remain in the family’s hands Potential favoritism in share allocation? Benefits: Access to a privately controlled business Access to governance and profit distribution Challenges: Uncertainty about the use of IPO proceeds: payment of inheritance taxes?

34. Questions?

35. Appendix Additional Sources Mentioned Almeida and others (2011) The structure and formation of business groups: evidence from Korean chaebols, Journal of Financial Economics, 99(2), 447 Campbell & Keys (2002) Corporate Governance in South Korea: the chaebol experience, Journal of Corporate Finance 8(4), 373-391. Hwang I & Seo JH (2000). Corporate Governance and Chaebol Reform in Korea, Seoul Journal of Economics 13, 3. Keunsoo (2013) Chaebols and their Effect on Economic Growth in South Korea, Korean Social Sciences Review (KSSR) 3(2) Wonhyuk (2012) Chaebol and industrial policy in Korea, Asian Economic Policy Review 7(2), 69 .