Question 1

The Chaebol structure

Benefits of the chaebol structure:
The centralized management system provides strategic vision,
administrative support and muscle for affiliates, necessary in the
early stages of the industrialization
Low costs since there are fewer contractors and since we are talking
about economies of scale
Market dominance which allows those powerful groups to be
competitive enough to expand abroad -> source of national pride
Provides enough resources for R&D
Pillars of the economy and large employers for the country
(Samsung accounts for 20% of the countrys exports)

Disadvantages of the chaebol structure
Lack of transparency
Centralized planning office and strong hierarchic relationships between
top managers
Tangled cross-shareholdings of affiliates and complex internal
ownership structures obscuring accountability
Provoke tensions within South Korean society between capitalist
profit-making and social egalitarianism
Involved in political games and corruption schemes
Ex: In 2005, Lee Kun Hee left the country for five months for what Samsung
described as health reasons while he was under investigation for allegedly
making big illegal donations in 1997 to presidential candidates.
Some of those schemes lead excessive state lending and to dangerous
leverage of the chaebols
Tax evasion
Governance issues
Shareholders who own few shares monopolize power and finance
in the chaebols
Ex: the Lee family have a final say over chaebols Samsung Electronics
while having only 3% of the shares (through and a pyramidal structure
of ownership and a centralized management system the Strategic
Planning Office (SPO), whose employees are technically paid by
Samsungs affiliates ) (Businessweek, April 28, 2008)
The SPO cant be legally hold responsible even if it makes serious
blunders
Minority shareholders are neglected the protection of their rights
is limited and they are never consulted
Imperialistic (Byzantine) way of governing



"Samsung simply doesn't have a system where the controlling
shareholder's management can be checked and monitored "Such a
system can't be sustainable., says Korea University corporate
governance expert Park Kyung Suh.

-> therefore doubtful transactions occur, such as buying company
shares for much less than the market price, are easily concealed
Question 2
Capital structure analysis: Samsung Electronics

All figures in Billion won 1997 1998 1999
Debt(long term and short
term)
12979 10219 5745
Total debt to total asset 41% 42% 20%
Debt to equity 223% 147% 43%
Cash and cash equivalence 1367 1187 46
Interest expenses 1581 1116 721
EBITDA 3812 4778 7300
Interest covering ratio 2.41 4.28 10.12
Source: Samsung Electronics Annual Report
Year 1998 and 1999
Intel capital structure analysis

All figures in million dollar 1997 1998 1999
Debt(long term and short
term)
770 903 861
Total debt to total asset 3%
3%
2%
Debt to equity 4%
4%
3%
Cash and cash equivalence 4102 2038 3695
Interest expenses 27 34 36
EBITDA 9887 9171 11264
Interest covering ratio 366.19 269.74 312.89
Source: Intel Annual Report Year 1998 and
1999
Difference between Samsung and Intel
From the first table, we can see in the year 1997 and 1998,
Samsung Electronics was financed mainly by raising debt. The debt
to equity in these 2 years both outnumbered 1 and the interest
cover ratio is relatively low. The cash and equivalence just covered
the interest payments. But this high leveraged capital structure
seem to improve in 1999.

We chose Intel as the comparable company in year s 1997 to 1999.
From the second table , we can see that Intels capital structure is
healthier than Samsung Electronics through financing by equity
rather than debt. Its leverage is only 4% during those 3 years, while
Samsung Electronics has soared to 223% in 1997.

The difference in capital structure between Samsung Electronics
and Intel is enormous. Before the economy liberalization policy, the
Korean government enforced large lending decisions to support the
chaebols.
Therefore, the banks had little incentives to evaluate credits or
monitor loans,
As a result, the Korean chaebols took advantage of the allowed
leverage.
In situations in which banks were not willing to lend them more
money, the chaebols managed to create their own internal capital
markets through cross-shareholdings and cross-guaranteeing of
debts.
This comportment, as well as the 1997 Asian currency crisis,
aggravated the high-leverage problem.
Question 3: Samsung Motors controlled by the Lee
family?
According to exhibit 3a, we have the
following information:
Family Lee owns:
5.41% of Samsung Electronics
2.32% of Samsung Co.
15% of Samsung Life Insurance
0.85% of Samsung Securities
0.30% of Samsung Engineering
67.30% of Samsung Everland
41.8% of Joon-Ang Daily News
0.36% of Samsung Fire & Machine
Insurance


According to exhibit 3b, we learn
that:
Samsung Electronics owns 21.11%
of Samsung Motors
Samsung Display Devices owns
7.45% of Samsung Motors
Samsung Heavy Industries owns
2.48% of Samsung Motors
Samsung Electro-Mechanics owns
6.08% of Samsung Motors
Samsung Everland owns 1.24% of
Samsung Motors
Percentage owned directly by the Lee family
If we sum the two percentages, we obtain that Family Lee owns
1.97% of Samsung Motors.

Hence, if Samsung Motors makes an after tax profit of USD 100
million, the Lee family would receive:

1.97%*100,000,000= USD1.970 million

According to Exhibit 3a, the Lee family does not own any
percentage of Samsung Motors.
Question 4
Evaluation of the current Board of Directors of Samsung
Electronics:
Number:
No universal agreement on the optimum size of a board of
directors.
But large number represents a challenge in terms of effectivness
and having any kind of meaningful individual participation.
According to the Corporate Library's study most boards range from
3 to 31 members.


Samsung Electronics board counts 23 members instead of 43 which
seems to be a better size.


Evaluation of the current Board of Directors of Samsung Electronics:

Content:



Strenghts Weaknesses
- Adequate number of members

- Various branches of the Samsung
Group represented

- Convergent interests, easier to find
agreements

- Synergies and good group dynamic




- No regulation or external mechanisms:
frauds, self-dealing, accounting
manipulations, corruption

- Chairman is in a superiority position
No checks and balances

- Minority shareholders rights neglected

- Lack of independence from the Samsung
group

- Mixed interests: Samsung Group
interests are favoured over Samsung
Electronics ( size)



Directors classification: Non-executive/ independent
Non Executive: A member of acompany's board of directors who is
not part of the executive team. A non-executive director is not
involved in the day-to-day management of the organization, but is
engaged in policy making and planning exercises. Thus, we can
assess that directors outside Samsung Electronics are non-
executives.

Thus, 16 out of 23 directors can be classified as Non-Executive
directors

Independent: Director out of the Samsung group (explanations on
next slide)
Thus, only 3 out of 23 directors can be classified as Independent
directors

Assessing directors independence
An indepenent director is a person who:
has not been employed by the Company or its Related Parties in
the past five years
is not, and is not affiliated with a company that is an advisor or
consultant to the Company or its Related Parties;
is not affiliated with a significant customer or supplier of the
Company or its Related Parties;
has no personal service contracts with the Company, its Related
Parties, or its senior management;
is not affiliated with a non-profit organization that receives
significant funding from the Company or its Related Parties;
is not employed as an executive of another company where any of
the Company's executives serve on that company's board of
directors;


Assessing directors independence (second part)
is not a member of the immediate family of an individual who is, or
has been during the past five years, employed by the Company or
its Related Parties as an executive officer;
is not, nor in the past five years has been, affiliated with or
employed by a present or former auditor of the Company or of a
Related Party; or
is not a controlling person of the Company (or member of a group
of individuals and/or entities that collectively exercise effective
control over the Company) or such persons brother, sister, parent,
grandparent, child, cousin, aunt, uncle, nephew or niece or a
spouse, widow, in-law, heir, legatee and successor of any of the
foregoing (or any trust or similar arrangement of which any such
persons or a combination thereof are the sole beneficiaries) or the
executor, administrator or personal representative of any Person
described in this sub-paragraph who is deceased or legally
incompetent,

Assessing directors independence (third part)
Thus, an independent board of directors is normally made of
members who have no material interests in a company. This
means that none of the members on such boards should have
had any business dealings with customers of the firm or firms
with which the company has any business dealings, in the past
five years and not be involved in day-to-day management of the
firm.

In our case, we can consider that a director who doesnt belong
to the Samsung Chaebol is independent because he will not
share the Samsung Groups interests but will focus on the
Samsung Electronics best interest .
Recommended changes to be made on the Board

Include external Directors (from the Samsung Group) in
the Samsung Electronics Board to implement regulation
and checks and balances .

Increase the proportion of independent directors, that is
people who have no material interests in the chaebol
other than their directorship to improve Samsung
Electronics corporate governance.
Better representation of minority shareholders



Question 5
The convertible bond issue: a self-dealing transaction?
Several arguments lead to the fact that the convertible bond issue
was a self-dealing transaction:

The bonds were sold to insiders; this is not common and questions
may arise on the fact that the bonds might have been undervalued;
We also know that convertible bonds can be converted into
common shares. If it occurs, this conversion could modify the equity
structure of the company. We will see further why this can be
considered as an important proof of self-dealing transaction
(dilution, etc.)

We can prove that claim by calculating the dilution of shareholders
(dilution that benefits to the son of the CEO).

Unsecured convertible bonds worth 60 billion won were issued on
March 24, 1997. In the year 1997, these bonds were converted into
common shares at the price of 49,931 won (see:
http://www.samsung.com/tr/aboutsamsung/ir/financialinformatio
n/auditedfinancialstatements/downloads/parent/97_end_05_note
_eng.pdf)
This conversion modified the equity structure of the company.

Information provided by exhibit 5:
We see that in March 1997, the share price was approximately
53,000 won.
In the same Note to Financial Statements, we learn that at
December 31, 1997, 121,963,467 shares of common stocks
outstanding.
Therefore, the market capitalization of Samsung Electronics was:
5198 billion won.

Question 5
The convertible bond issue: a self-dealing transaction?
According to the exhibit 5 of the case study, closing price of
Samsung Electronics Shares was about 53,000 on March
1997.
Market cap estimation to 6,464 billion in 1997.
To raise 60 billion in capital for a 6,464 billion
company requires issuing shares worth 0.93% of the
company.
The project to raise capital to 60 billion doesnt really
have influence on capital structure since it represents less
than 1% of existing long terms loans (p6. of case study)
Following this raise of capital, shareholders will now own:
90.07% * 6,464 billion = 6,390 billion in the company.

Question 5
The convertible bond issue: a self-dealing transaction?
The main evidence we have on our claims are:
Dilution of the shareholders, they lose some of their equity.

The son of Samsungs chairman bought most of the
convertible bonds which were converted into common shares.
Therefore he increased his personal ownership (an insider
increases its ownership).
In addition, this action reduces the weight of minority
shareholders.


Question 5
The convertible bond issue: a self-dealing transaction?
Question 6
Pan-Pacific = simple direct investment or something
else?
Direct investment: An investment, which is sufficiently large to
affect a company's subsequent decisions. This is sometimes a
majority ownership, but sometimes it's just a significant minority
ownership.

At first glance, the Pan-Pacific (PP) agreement looked like a direct
investment into Samsung Motors by a foreign entity (PP). But there
was a clause that provided a return with a system of call/put
options.

PP bought shares of Samsung -> Samsung issued call/put options on
those underlying assets to provide a certain return to PP. There is a
counterpart to the investment of PP into Samsung, so it is no longer
a direct investment, and it is not in accordance with the Korean
law regarding other types of transactions.

Guarantee clause?

Guarantee = put/call clause. It was put in the contract to provide
more security to PP: to make sure PP would earn money and to
make the investment more attractive. Because of that, it is no
longer a direct investment according to Korean regulation.


Audit questions:

Why sign an agreement with such a clause? What is the hidden
reason?
Did PP really earn money on the options provided by the clause?

Question 6
Pan-Pacific = simple direct investment or something
else?