Case Study: The Daewoo Group and the

Asian Financial Crisis

In 1999, Daewoo Group Koreas second largest chaebol, or family-owned conglomerate,
collapse under $57 billion in debt and was forced to split into independent companies. The Asian
financial crisis and its aftermath finally took its toll on the expansion-minded Daewoo and forced
both Daewoo and the Korean government to decide how to dissolve the chaebol. Kim Woo-
Choong started Daewoo in 1967 as a small textile company with only five employees and
$10,000 in capital. In just 30 years, Mr. Kim had grown Daewoo into a diversified company with
250,000 employees worldwide as well as over 30 domestic companies and 300 overseas
subsidiaries that generated sales of more than $100 billion annually. However, some estimated
that Daewoo and its subcontractors employed 2.5 million people in Korea. Although Daewoo
started in textiles, it quickly moved into other fields, first heavy and chemical industries in the
1970s, and then technology intensive industries in the 1980s. By the end of 1999, Daewoo was
organized into six major divisions:
Trading Division
Heavy Industry and Shipbuilding
Construction and Hotels
Motor Vehicle Division
Electronics and Telecommunications
Finance and Service
However, Daewoo was struggling. Its $50 billion debt was 40 percent greater than in 1998,
equaling 13 percent of Koreas entire GDP. A good share of that total, about $10 billion, was
owed to overseas creditors. Its debt-to-equity ratio (total debt divided by shareholders equity) in
1998 was 5 to 1, which was higher than the 4 to 1 average of other large chaebol, but it was
significantly higher than the U.S. average, which usually is around 1 to 1 but which rarely climbs
above 2 to 1. Of course, there is no way of knowing the true picture of Daewoos financial
information because of the climate of secrecy in Korean companies. In addition, it is possible
that Daewoos estimated debt might be greatly underestimated because no one knows whether or
not the $50 billion figure7.3 included debt of foreign subsidiaries. How did Daewoo get into
such a terrible position, and how much did the nature of the Korean economy and the Asian
financial crisis affect Daewoo?

Korean Economy
The impact of the Asian financial crisis on Korea was partly a result of the economic system of
state intervention adopted by Korea in the mid-1950s. Modeled after the Japanese economic
system, the Korean authoritarian government targeted export growth as the key for the countrys
future. Initially, the government adopted a strategy of import substitution, and that later gave
way to a strategy of expo,, or die. Significant incentives were given to exporters, such as
access to low-cost money (often borrowed abroad in dollars and loaned to companies at
belowmarket interest rates in Korean won), lower corporate income taxes, tariff exemptions, tax
holidays for domestic suppliers of export firms, reduced rates on public utilities, and monopoly
rights for new export markets. Clearly, the government wanted Korean companies to export. The
chaebol, of which the four largest were Hyundai, Daewoo, Samsung, and the LG Group, became
the dominant business institutions during the rise in the Korean economy. They were among W
largest companies in the world and were very diversified, as can b:: seen by Daewoos
investment and business choices. They were held together by ownership, management, and
family ties. In particular family ties played a key role in controlling the chaebol. Until the 1980s,
the banks in Korea provided most of the funding to the chaebol, and they were owned and
controlled by the government. Because of the importance of exporting, the chaebol were all tied
to general trading companies. The chaebol received lots of support from the government, and
they were also very loyal to the government, giving rise to charges of corruption. Most chaebol
were initially involved in light industry, such as textile production, but the government realized
that companies needed to shift first to heavy industry and then to technology industries. Daewoo
transitioned to heavy industry in 1976 when the Korean government asked President Kim to
acquire an ailing industrial firm rather than let the firm go out of business and create
unemployment.
Asian Financial Crisis and Its Impact On Korea
The country continued to liberalize, and democracy finally came into being in 1988 with the
introduction of a new constitution and the election of Kim Young-Sam, the first democratic
president in Koreas, history. The economy also continued to grow at 5 to 8 percent annually
during the early to mid- 1990s, led primarily by exports, and the World Bank predicted that
Korea would have the seventh largest economy in the world by 2020. However, the Asian
financial crisis brought that growth to a halt. After the Thai baht was devalued on July 2, 1997,
the Korean won soon followed, and the Korean stock market crashed as well. By the end of
1997, the South Korean won as 46.2 percent lower than its predevaluation rate. At the time the
Crisis hit. Koreas external debt was estimated to be $110 billion to S 50 billion, 60 percent of it
maturing in less than one year. In additional, Korea had another $368 billion of domestic debt.
Koreas banks had been a tool of state industrial policy, with the government ordering banks to
make loans to certain companies even if they were not healthy. Banks borrowed money in dollars
and lent them to firms in won, shifting the burden of the foreign exchange from the firms to the
banks. Hanbo Steel and Kia Motors went bankrupt, leaving some banks with huge losses. The
Korean won fell in the fall of 1997, causing the government to raise interest rates to support the
won and resulting in more problem loans. Bad loans at the nine largest financial institutions in
Korea ranged from 94 percent to 376 percent of the banks capital, making the banks technically
insolvent. The chaebol were also very overextended. The top five chaebol were in an average of
140 different businesses, ranging from semiconductor manufacture to shipbuilding to auto
manufacturing. This was happening during a time when most other companies in the industrial
world were selling off unrelated businesses and focusing on their core competencies. Twenty-
five of the top 30 chaebol had debt-to-equity ratios of 3 to 1, and 10 had ratios of over 5 to 1, as
noted earlier. Compare this to Toyota Motor of Japan, which had a debt-to-equity ratio in 1998
of 0.7 to 1. During this crisis, Korea began to negotiate with the IMF for help. The IMF agreed to
help, but only if Korea raised interest rates to support its currency, reduced its budget deficits,
reformed its banks, restructured the chaebol, improved financial disclosure, devalued the
currency (to stimulate exports even more), promoted exports, and restricted imports. In return for
a pledge to introduce the reforms, the IMF released funds to Korea to help it payoff its foreign
debt and to keep its banks from going bankrupt. This in turn brought in more money from
foreign banks that were encouraged by Koreas pledge to reform itself. One of the IMFs key
areas was banking reform. The IMF encouraged Korea to open up its banking sector to foreign
investment, hoping that an infusion of foreign banking expertise might help the Korean banks
make better loans. Of course, foreign banks had made a sizable number of bad loans in Asia as
well. In addition, the IMF encouraged the Korean government to pass good bankruptcy laws to
allow bad companies, including banks, to fail. However, the IMF hoped that Korean banking
institutions would merge, forming fewer but stronger banks. In addition, the IMF encouraged
banking reform in order to cut the links between bankers and politics, tighten supervision and
regulation of the banking industry, and improve accounting and disclosure.
Impact of the Crisis on Daewoo
While the financial crisis was going on, Daewoos President Kim ignored the warning signs and
continued to expand. In 1998, a year when the Daewoo Group lost money, it added 14 new firms
to its existing 275 subsidiaries. While Samsung and LG were cutting back, Daewoo added 40
percent more debt. Finally, Korean President Kim Dae Jung had had enough. He ordered the
banks to stop lending to the chaebol until they came up with and began to execute a plan to sell
off businesses and to focus on their core competencies. But that didnt stop Daewoo. To get
access to more money to feed its growth. Daewoo issued corporate bonds, which were purchased
by Investment Trust Companies (lTCs), finance companies associated with the chaebol. The
ITCs purchased nearly $20 billion in corporate bonds.
In early 1999, Daewoo announced a plan to sell off some of its businesses to comply with
government restructuring requirements before the government took more drastic action, such as
nationalization. However, the plans limped along until July 1999. At that point with Korea still in
a deep recession, Daewoo announced that it would go bankrupt unless its Korean creditors
backed off. It basically could not even service its interest payments of $500 million a month. let
alone its principal. The government immediately stepped in and froze Daewoos loans until
November 1999. This shock rippled
through Korea, because nobody thought a chaebol would ever be allowed to collapse. That had
never happened before, and the close ties between government and business were such that it
was never expected to happen. The shock of Daewoos announcement negatively affected the
corporate bond market and the ITCs came under pressure because of their huge exposure to
Daewoo. Negotiations in Korea involved 60 banks, some owned by the government, others in the
private sector.
On September 16, 1999, Daewoo asked its foreign creditors for a moratorium on interest
payments until March 2000, so the instability spread to the international markets.
Daewoos Future
By the end of 1999, Daewoos President Kim was left with few options to solve Daewoos
problems. One possibility was to dismantle Daewoo and let it have only auto-related businesses.
All of the other businesses would be sold off to domestic or foreign investors, and the name
would be changed to something other than Daewoo. Another option for President Kim was to
sell some of Daewoos auto assets. Ford, Daimler Chrysler, and General Motors showed interest,
but selling Daewoo Motor, the second largest automaker in Korea, would be a big blow to the
country. As the Korean economy began to recover in 1999, some felt that the chaebol should
weather the storm and not allow themselves to be broken up. However, President Kim Dae Jung
had mandated that the chaebol get their debt-to-equity ratios from 5 to 1 to 2 to 1 by the end of
1999, and that goal seemed impossible unless there was a huge infusion of equity capital or
either a write-off of debt through debt restructuring with the banks or a selling off of debt-laden
businesses to others. Under immense pressures caused by the debt and by accusations of fraud
and embezzlement, President Kim Woo-Choong abandoned his company and fled the country.
The government separated the Daewoo subsidiaries and worked with creditors to convert the
debt to equity, to set up subsidiaries on debt workout programs, and to look for buyers. After a
year of negotiations, General Motors purchased a portion of the $1.2 billion Daewoo Motor in
April 2002 for $400 million agreed to keep only three manufacturing plantstwo in Korea and one
in Vietnam-leaving creditors scrambling to sell its other plants in Eastern Europe, Asia, and the
Middle East. By mid-2002, the Korean economy was showing promising signs of recovery and
reform. In 2001, the economy grew by 3 percent and was expected to grow by 5 to 6 percent in
2002. The government has done away with debt-based management of the large chaebol and is
working to dissolve the large conglomerates to better compete internationally. Of the top-30
chaebol that existed prior to the economic crisis, only 14 remain. The improving economy helped
General Motors make its decision to purchase Daewoo Motor, but GM is faced with a new
decision: how to market Daewoo cars and reduce the $830 million of Daewoo debt Should GM
continue selling Daewoo cars in the United States and Europe and compete with its own brands?
Without increasing its debt, will it be able to restore Daewoos 37 percent share of the market in
Korea?
Questions
1. How would you describe Koreas economic system? What are the key elements in that
system? How would you describe the interaction between politics and economics in Korea?
2. Does Korea look like a good place to invest? Why or why not?
3. What are the key mistakes Kim Woo-Choong made in formulating and implementing
Daewoos strategy, and how did the economic crisis in Korea and in the rest of Asia affect that
strategy?
4. What risks does GM face in taking over Daewoo Motors?