The last month has been a busy one for investigations into Choi Soon-sil and President Park Geun-hye. The revelations of Samsung’s involvement in bribery have surprised few, especially given the close, historic ties between Korean conglomerates and government. Nevertheless, the indictment of Samsung’s acting head, Lee Jae-yong, is one that demands closer examination. Specifically, we must ask why the crown prince of Samsung, one of the top 20 largest corporations in the world, had to stoop to do business with someone like Choi.
To begin, one must consider Korea’s inheritance tax. This tax is one of the highest for OECD countries at 50 percent, behind only Japan’s 55 percent. This is compared to the 40 percent, 30 percent, and 0 percent rates in the United States, Germany, and Canada, respectively. The average rate for OECD countries is around 15 percent. In most countries, like the U.S., a high rate can be misleading for inheritors of small estates because there are many exemptions. In 2015, for example, the total value of these exemptions for U.S. taxpayers was around $5 million. For the inheritors of larger estates, however, exemptions become less meaningful.
The estate of Lee Kun-hee, Lee Jae-yong’s father, would be fall comfortably into the category of “enormous.” The senior Lee currently holds about a 3.5 percent stake in Samsung Electronics and a 20 percent stake in Samsung Life Insurance. The tax bill for inheriting this estate has been estimated to be around $6 billion, a prohibitive sum despite the fact the Korean government would likely allow installments be paid across a decade or more. Installments or not, a tax bill of this size could only be addressed by liquidating stock to generate cash, an activity that would relinquish large portions of Lee family ownership. It is in this reality that Lee Jae-yong’s need to bribe Choi Soon-sil was born.
Like most Korean corporations, the top shareholders of Samsung companies are members of the owning family. The top private stakeholders of Samsung Electronics, for example, are Lee Kun-hee, Hong Ra-Hee (Lee Kun-hee’s wife), and Lee Jae-yong. These three hold 3.49 percent, 0.76 percent, and 0.59 percent of all common stock, respectively. Common stock, as opposed to preferred stock, grants voting rights. It may surprise some to learn Lee’s family still maintains tight control over Samsung Electronics despite privately holding less than 5 percent of its common stock. This is because most of the control is exerted through other companies and corporations owned by the family. These other companies hold even greater shares, especially when combined.
Take, for example, the Everland Corporation, which was originally created to build and operate theme parks for children. Starting about two decades ago, Everland began to diversify its portfolio by purchasing stock in other companies, most notably Samsung Life Insurance. Samsung Life owns 7.75 percent of Samsung Electronics while about 46 percent of Everland is owned by the Lee family. This ownership structure is only part of a much larger network in which tens, perhaps hundreds, of companies owned or controlled by the Lee family are linked together to share commanding stakes in various Samsung subsidiaries.
This network of ownership has a number of positive effects for the Lee family. The first is protection from the inheritance tax. For the last three decades, Lee Kun-hee and older members of the family have made a concerted effort to offload as much personal stock as possible, replacing it with networked holdings through other companies that younger family members control. Not only have these holdings functioned as protection from tax, legal scandals, and fines (the latter two of which Lee Kun-hee was no stranger to), they have also improved the efficiency of family control. This is because owning 50 percent of a company which holds 7 percent of another company’s stock still gives full control of the latter 7 percent, requiring less money to maintain. This control becomes even more efficient when multiple companies hold stakes in each other, forming a tight web of dependencies.
This sprawling network of ownership has prompted many economists to refer to the Samsung structure as a tangled mess. The management of this network has, until recently, been undertaken by the secretive Corporate Strategy Office, which functioned as the “control tower” for the Lee family. This office consisted of about 200 employees from the various companies in the network, with the sole purpose of coordinating activities according to the desires of the Lee family, especially when voting in shareholder meetings. Through this office, the Lee family has been able to coordinate all of its holdings to exert commanding influence over the Samsung conglomerate.
So how does Choi Soon-sil fit in? In 2014, Lee Kun-hee suffered a serious heart attack, requiring hospitalization. This hospitalization was prolonged, prompting many to wonder if Lee was still alive or perhaps being kept alive artificially to buy time for a more orderly transition of power to his children. Despite the illness and lack of any meaningful appearances in public since, Lee Kun-hee’s Samsung holdings and position as chairman were maintained. This suggested one of two things: either 1) there was internal dispute over how to transfer power or 2) the process of transferring networked shares to other companies was not yet complete, requiring the elder Lee’s position as a personal stakeholder be preserved.
Although it remains unclear exactly how many dealings Choi Soon-sil had with the Lee family, one example clearly shows how Choi fit into their dynastic ambitions. That example is the 2015 merger between two Samsung affiliates: Cheil Industries and Samsung C&T. Both Cheil and C&T were critical holders of stock in the Lee family ownership network. However, Lee control over C&T had grown tenuous over the years with an increasing proportion of shares being held by outside investors, most notably the U.S. hedge fund Elliot, which had, on numerous occasions, openly declared its intentions to undermine and loosen Lee family control of Samsung ownership by competing for various companies in the ownership network.
The purpose of the 2015 merger, therefore, was to consolidate Lee power by combining C&T with Cheil, the latter a company with 42 percent of its stock owned by the Lee family. To make the deal happen, the Lee family needed two things. The first was a devaluation of C&T so C&T’s pre-merger ownership would not dilute the post-merger ownership too much, threatening Lee family control. This devaluation was handled by offering an unfavorable share exchange in which one C&T share was exchanged for 0.35 shares of Cheil, severely diminishing C&T ownership of the merged company. Elliot and a host of international NGOs criticized this rate as unfair but the Korean government approved it anyway. We now know key figures in the government were directly pressured by the Blue House through Choi connections to achieve this approval.
The second thing required for a successful merger was a two-thirds majority vote of shareholders. With Elliot and its 7 percent of shares vehemently against the merger, the Lee family needed to convince another key shareholder to get on board. This partner was the National Pension Service (NPS), a government organization that provided pensions for all retired Koreans who paid the pension tax. This entity, before merger, held an 11.6 percent stake in C&T. Although the merger was obviously disadvantageous for the NPS, the NPS voted in favor anyway, resulting in an estimated loss in value of about $1.5 billion. As was the case for the rate approval, we now know Choi’s network in the Blue House was instrumental in pressuring the head of the NPS, Moon Hyung-pyo, and others to vote in favor of the merger.
Despite the obviously illegal aspects of the merger, another important angle that comes into play in these collaborations between corporation and government is highlighted by Korea’s high export dependency. Samsung’s businesses and affiliates account for about 17 percent of Korea’s entire GDP. This makes Samsung a critical cog in the Korean economic wheel, one that the Korean government can ill afford to have fall from Korean hands. With over 100,000 domestic employees and even more domestic businesses supported by Samsung, the potential loss of control to foreign investors like Elliot would likely be devastating, resulting in the mass exodus of manufacturing and financial centers to other countries with lower labor costs and more lenient tax laws. It is, therefore, actually in the Korean government’s long-term interest to maintain Korean ownership of Samsung.
Now that Lee Jae-yong has been indicted, it remains unclear what will happen next. Lee’s indictment was followed by the swift closure of the Corporate Strategy Office, likely to protect it from becoming a target of further investigations. The upcoming trials will likely be long and drawn-out. Prison time for Lee is a real possibility but the length remains uncertain. It is conceivable a lengthy sentence could shake the foundations of Korean hegemony over Samsung, an opportunity foreign investors have long been licking their chops over. Although most Koreans will likely be cheering for more prison time, many should also be aware of the potential economic consequences.
Justin Fendos is a professor at Dongseo University in South Korea and the associate director of the Tan School at Fudan University in Shanghai.