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Conditions for Successful Holding Companies
Special Contribution
By Dr. Eugen Loeffler
General Electric
A realistic assessment of the merits of holding companies is an important business issue in Korea, mainly for two reasons. Firstly, chaebols are encouraged to set up holding company structures to improve the transparency of their ownership structure. And secondly, financial holding companies allow comprehensive financial services spanning banking, securities business, asset management, and insurance under one roof with a full exchange of customer information.

Traditionally, economic theory focused on the functioning of the market mechanism rather than on institutional features like holding companies. Oliver E. Williamson, a prominent American neo-institutionalist, is one of the few economists who seriously wrote about holding companies. He sees the main function of holding companies in the allocation of capital among a business group's subsidiaries. Usually, the allocation of capital is considered as the main role of capital markets.

Oliver Williamson
Therefore, Williamson looks at holding companies as internal capital markets. But, why should holding companies do what capital markets already can do? Williamson makes the claim that holding companies have crucial advantages compared to public capital markets. The holding company management has access to internal information and full authority over subsidiaries. Therefore, it can better ensure than the stock market that capital is used efficiently, in the extreme case by sacking the subsidiaries' management.

Stock markets are faced with the problem of dispersed ownership. Small shareholders have no incentive to control managers as they have to bear all the costs for waging proxy fights but receive only a small part of the benefits. Therefore, individual rationality asks for being passive and hoping that other shareholders will do the job. If all shareholders think like that, no one will take action.

As a result of this well-known free rider problem, stock markets are often quite inefficient in controlling managers. To me, Williamson logic is persuasive, however, it is missing the crucial point. Yes, holding companies can control subsidiaries better than public markets, but what ensures that they will exercise their control power to the benefit of all shareholders of the holding company and not to the holding company mangers own benefit or the benefit of a particular influential shareholder?

Williamson theory doesn't even try to address this crucial question. Still, holding companies can be considered as an improvement compared to the traditional chaebol structure as they increase the transparency of ownership and provide some protection mechanisms for shareholders of subsidiaries. However, they are definitely no panacea and the major problems stemming from conglomerate diversification remain in place. There are examples for successful conglomerate diversification in Korea as well as abroad, but the likes of Samsung or General Electric clearly appear as exceptions rather than the general rule.

Samsung
Now, what about financial holding companies? They focus on financial services and as such seem not subject to the problem of conglomerate diversification into unrelated business fields. Still, the question is open whether retail, commercial and investment banking, brokerage, life and non life insurance and asset management, even though all financial services are by nature very similar or rather quite different businesses? So far, the industry leading companies are mostly deeply rooted in their respective industry.

The world's biggest insurance companies like AIG, Allianz, Axa are still insurance companies rather than banks owning insurance companies. In asset management the picture is a bit different: the majority of the largest global wealth managers belong to financial groups centered around banks or insurance companies. Investment banking shows a mixed picture as well. Still, leading global players investment banks like Goldman Sachs, Morgan Stanley or Merrill Lynch are strongly focused on investment banking and brokerage.

This does in no way mean that the concept of comprehensive financial services companies is flawed. It rather means that it is not a guaranteed or even the single path to success, at least not in every market: each institution has to carefully assess the particularities of its own market including the preferences of clients and find out what is core capability is: is it the distribution of financial services to clients or the manufacturing of such services or both?

Comprehensive financial services companies are often dubbed "financial supermarkets." Yet, traditional retailers like department stores don't necessarily produce the goods they sell. An obvious solution for banks, which are the centerpiece of many financial holdings companies, is to form joint ventures with companies specialized on the production of non-banking financial services like insurance or asset management.




Dr. Eugen Loeffler currently serves as president of HanaAllianz Investment Trust Management. Dr. Loeffler contributes his articles to various newspapers including The Seoul Times and Hankyung.

 

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