Circular shareholding

Circular shareholding or circular investment (순환출자/循環出資) refers to cross shareholding by three or more companies. In other words, A Company invests in B Company, which invests in C Company, and then C Company invests in A Company making circle shaped investments.

Generally speaking, affiliates in a group of companies invest each other to increase the nominal capital base and solidify the ownership of the group without actual payment of cash.

Key words
circular shareholding/investment, cross shareholding, large-scale business group (Chaebeol), Economic democratization

Statutory ground
Under the Commercial Act and the Monopoly Regulation and Fair Trade Act, merely executed cross shareholding (교차출자/交叉出資) is prohibited. That is a Company invests in B Company under common control, while B Company invests in A Company.

As a matter of law, circular investment to avoid the prohibited cross shareholding by indirect method is not illegal. However, the circular shareholding of big businesses is regulated by means of aggregate investment regulation, etc.

The reasons why circular shareholding is criticized are:
 * It amounts to the acquisition of company's own shares by an indirect method.
 * It would solidify the management control distorting corporate governance.
 * It might undermine the solid capital base of the company.
 * If an affiliate company under common control goes insolvent, the other related company would be adversely affected.

In the course of 2012 presidential election campaign, the issue of "Economic Democratization" (경제민주화/經濟民主化) appeared on the surface of politics. At that time most of candidates and politicians were claiming the resolution of controvercial circular investment to regulate Chaebeol (재벌/財閥) and economic concentration.

Circular Investment of Big Businesses
At present, the number of circular investment-regulated business groups is 63, 43 groups of which are those with the leadership of a single natural person (총수가 있는 기업집단) and accordingly called as Chaebeol. 15 business groups, one third of such Chaebeol groups, proved to have a kind of circular investment structure.

They are Samsung, Hyundai-Kia Motors, Hyundai, Hyundai Heavy Industries, Hanjin including Korean Air, Dongbu, and so on. Even though the owner family have only 4 - 5 percent of total shares, the owner has secured 100 percent managemet control over the group through circular shareholding.

The Fair Trade Commission's big businesses' ownership map (대규모 기업집단 지분도) as of April 12, 2012 and other disclosure materials show the following phenomena of the ownership of 30 largest business groups.
 * Mutual investment prohibited by law was not found in the companies under common control.
 * Circular investment structure was found in most business groups, but amounted hardly to such parent-subsidiary relationship as to violate the relevant law.
 * Circular investment was found in companies which were originally under common control but separated afterwards, and, in some rare cases, non-affiliated-business-group companies But they are in no way violating the relevant provisions of the Commercial Act.

Latest Developments
In the course of 2012 presidential election campaign, circular investment was one of the hottest issues in relation to "Economic Demoratization".

In this connection, the opposition Democratic United Party proposed nine bills in July 2012 to prohibit the controversial circular investment by Chaebeol groups and to reintroduce the aggregate investment control system.

President Park Geun-Hye declared, after election, the prohibition of new circular investment and a new measure that the existing circula invested companies would not participated in the capital increase of affiliated company according to the National Agenda disclosed by the Transition Committee on February 22, 2013.

For example, it is restricted for the financial company belonging to a Chaebeol group to exercise the voting rights of shares of non-financial company under common control. In this case, the restriction is up to five percent of the total shares of the financial companies under common control. As a result, Samsung Life Insurance and Samsung Fire Insurance, which have 7.53 percent and 1.26 percent, respectively, of Samsung Electronics, are restricted to exercise their voting rights of 3.79 percent beyond the threshold ownership. At the moment, the enforcement date subject to the amendment to the relevant laws is yet to be decided in the near future.

At Issue
In 2004, Lawmaker Soo-Chan Chai submitted a bill of the Fair Trade Law for prohibition of circular equity investment to the National Assembly to make a improvement of corporate governance and ownership structure.

The Korea Fair Trade Commission made also a plan to revise the Fair Trade Act for prohibition of circular investment on October 23, 2006. The proposed revision of the law beared so many problems not only in formality but also in content. To make matters worse, it would be nconstitutional.

In this regard, the legal backgrounds of the amendment bills of the Fair rade Act to prohibit circular investment proposed respectively by the Fair Trade Commission and Lawmaker Soo-Chan Chai were scrutinized.

This kind of investment control could be attributed, in part, to the companies themselves which have accumulated wealth through unfair manners such as improper relationship with politics, unclear corporate governance, labor abuse, unfair transactions, and tax evasion. However, if the very fundamental objective of enterprises of making profits was ignored, companies had no reason d'etre to concentrate on its management.

It is high time to form environments where companies can work hard with no worries. Ultimately, the prohibition of circular investment and restriction of cross-affiliate holdings cannot help contracting investment from enterprises, and enterprises with no investment are nothing but dead ones. Therefore, the prohibition of circular investment is the major culprit of enhancing pains that people suffer from.