case samsung

5/26/2018 Case Samsung

1/23

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)


2/23

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


3/23

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


4/23

"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


5/23

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


6/23

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


7/23

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 structureseem 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.


8/23

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.


9/23

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 owns7.45% 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


10/23

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 100million, the Lee family would receive:

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

According to Exhibit 3a, the Lee family does not own anypercentage of Samsung Motors.


11/23

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.


12/23

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)


13/23

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


14/23

Assessing directors independence

An indepenent director is a person who:

has not been employed by the Company or its Related Parties inthe 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 RelatedParties, 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 ofdirectors;


15/23

Assessing directors independence (second part)

is not a member of the immediate family of an individual who is, orhas been during the past five years, employed by the Company orits Related Parties as an executive officer;

is not, nor in the past five years has been, affiliated with oremployed 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 effectivecontrol over the Company) or such persons brother, sister, parent,grandparent, child, cousin, aunt, uncle, nephew or niece or aspouse, widow, in-law, heir, legatee and successor of any of the

foregoing (or any trust or similar arrangement of which any suchpersons or a combination thereof are the sole beneficiaries) or theexecutor, administrator or personal representative of any Persondescribed in this sub-paragraph who is deceased or legallyincompetent,


16/23

Assessing directors independence (third part)

Thus, an independent board of directors is normally made ofmembers 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 notshare the Samsung Groups interests but will focus on the

Samsung Electronics best interest .


17/23

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


18/23

Question 5

The convertible bond issue: a self-dealing transaction?

Several arguments lead to the fact that the convertible bond issuewas a self-dealing transaction:

The bonds were sold to insiders; this is not common and questionsmay arise on the fact that the bonds might have been undervalued;

We also know that convertible bonds can be converted intocommon shares. If it occurs, this conversion could modify the equitystructure of the company. We will see further why this can beconsidered 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).


19/23

Unsecured convertible bonds worth 60 billion won were issued onMarch 24, 1997. In the year 1997, these bonds were converted intocommon shares at the price of 49,931 won (see:http://www.samsung.com/tr/aboutsamsung/ir/financialinformation/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 approximately53,000 won.

In the same Note to Financial Statements, we learn that atDecember 31, 1997, 121,963,467 shares of common stocksoutstanding.

Therefore, the market capitalization of Samsung Electronics was:5198 billion won.

Question 5



20/23

According to the exhibit 5 of the case study, closing price ofSamsung Electronics Shares was about53,000 on March1997.

Market cap estimation to6,464 billion in 1997.

To raise 60 billion in capital for a 6,464 billioncompany requires issuing shares worth 0.93% of thecompany.

The project to raise capital to60 billion doesnt reallyhave 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



21/23

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 theconvertible 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



22/23

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 amajority ownership, but sometimes it's just a significant minorityownership.

At first glance, the Pan-Pacific (PP) agreement looked like a directinvestment into Samsung Motors by a foreign entity (PP). But therewas a clause that provided a return with a system of call/putoptions.

PP bought shares of Samsung -> Samsung issued call/put options onthose underlying assets to provide a certain return to PP. There is acounterpart to the investment of PP into Samsung, so it is no longera direct investment, and it is not in accordance with the Koreanlaw regarding other types of transactions.


23/23

Guarantee clause?

Guarantee = put/call clause. It was put in the contract to providemore security to PP: to make sure PP would earn money and tomake the investment more attractive. Because of that, it is nolonger a direct investment according to Korean regulation.

Audit questions:

Why sign an agreement with such a clause? What is the hiddenreason?

Did PP really earn money on the options provided by the clause?

Question 6

Pan-Pacific = simple direct investment or something

else?

case samsung

Documents

and19995262018 case

concealed5262018 case

samsung electronicsall

centralized management

total debt

total asset

chaebol structurebenefits

debtlong term