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. Twentyfive 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. Does Korea look like a good market to invest? Why or why not?
2. What are the key mistakes Kim Woo-Choong made in formulating and
implementing Daewoos product-brand marketing 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? Suggest some
suitable product/brand strategies for GM.