[Introduction]

Corporate Restructuring in a Transition Economy

The economic crisis of 1997 marked a watershed in the evolution of the South Korean economy, as it put into doubt the viability of the old system based on the public management of private risks. Although Korea's government-business risk partnership had contributed to rapid capital accumulation and impressive economic growth, the crisis made it clear that the old system, fraught with the risks of moral hazard and outright corruption, could not be sustained in a new economic environment characterized by liberalization and democratization. The crisis also revealed the inadequacy of the existing institutional infrastructure that had failed to impose discipline on the corporate sector and had, in effect, impeded the orderly exit of nonviable firms. No effective market-oriented alternative had emerged to replace the state-led approach to corporate restructuring, the dominant feature of the industrial rationalization programs during the authoritarian era (1961 to 1987).

As a result, in order to facilitate corporate restructuring in the post-crisis period, the institutional infrastructure formed around the government-business risk partnership had to be restructured as well. In fact, in post-crisis South Korea, the term "corporate restructuring" is often used interchangeably with "structural reform in the corporate sector," referring to wide-ranging institutional changes in corporate governance, corporate finance, market competition, and bankruptcy procedures. Although this semantic confusion is unfortunate, it highlights a crucial fact: South Korean firms have to take on the challenge of changing their business structure while the institutions governing corporate restructuring are themselves being changed. They do not have the luxury of a well-established institutional infrastructure that has been tested through time.

Moreover, this problem of transition is not just one of changing a few laws. The role of the government in the economy is also being changed in a fundamental yet potentially problematic way. As the crisis of 1997 is widely blamed on the old government-business risk partnership, the government no longer has the mandate to "lead" the economy. At the same time, with the de facto nationalization of many banks and other financial institutions in the wake of the crisis, the government ironically has more resources under its control than before. If the government delays the privatization of these financial institutions and yet refuses to impose discipline on financially distressed firms, little progress will likely be made in corporate restructuring. Worse, if the government bails out firms based on non-economic considerations, the reform program itself will lose its credibility.

As the controlling shareholder of the nationalized financial institutions, the government should ideally abide by economic principles and take proactive steps to sort out nonviable firms and quickly implement reforms designed to improve the operation of the market. Unless pushed by the government to sort out nonviable firms according to economic principles, the managers of the nationalized financial institutions have little incentive to get tough with large distressed firms. This combination of government activism and adherence to economic principles should be accompanied by a well-designed exit program for the government. The market-oriented reform package should include comprehensive measures designed to facilitate mergers and acquisitions (M&As) and to effect the privatization of financial institutions. Simultaneously, it should ensure the separation of banking and commerce. Of course, any appearance of government activism in the post-crisis period might invite charges of revived interventionism, but there seems to be no better alternative in the transition period as the Korean economy moves from a state-led system to a market-oriented one. This observation seems particularly relevant as Korea pushes ahead with the second round of structural reform amid charges of "excessive government intervention."