Close ties between big business groups and political elites are ubiquitous in Asia.
In a recent book that we published, these links are termed the ‘connections world’. In this world, business group structures facilitate opaque corporate governance, weak minority shareholder rights and a raft of undesirably close relationships with politicians. They also leverage their connections to build substantial market power.
Although Asia’s high levels of concentration and business entrenchment have not been a barrier to growth, they have resulted in constraints on competition and, in particular, a brake on innovation, threatening Asia’s prospects. Yet neither businesses nor politicians have incentives to deviate from their mutually rewarding relationships.
Unravelling the ‘connections world’
To start loosening this chokehold of the ‘connections world’ to induce greater competition along with more entry and exit of companies, something should be done to lower the appeal of the business group format.
The most radical approaches to do this were taken in the United States in the 1930s and in Japan post-1945, where Roosevelt and then Macarthur respectively pushed through policies to effectively eliminate the business group format. Limits were placed on the number of levels or tiers, higher taxes were imposed on inter-group dividends, consolidated group tax filing was eliminated, and constraints imposed on financial institutions acting as controlling shareholders as well as on business groups controlling public utilities.
However, such drastic policies were undertaken at a time of economic depression or defeat in war and a backlash against incumbent companies. It is unlikely anything so sweeping would now be feasible in Asia. Rather, incremental policies that address corporate governance, taxation and market structure have far more chance of success.
Asian business groups, with few exceptions, have highly opaque corporate governance. This facilitates the dominant (mostly family) owners exerting control, usually at the expense of the minority shareholders.
Improving protection of minority shareholders by giving them legal rights to call shareholder meetings and to limit the dilution of shareholdings by the majority shareholders can begin to address this imbalance. Reducing non-transparent inter-group financial transfers can also be aided by requiring the publication of plans for related party transactions and ensuring minority shareholders have a say in such transactions. This could be done through voting at shareholder meetings and mandatory veto rights over the sale of additional shares.
Policy initiatives are needed to govern how businesses configure themselves. A variety of policies have been experimented with to reduce the number of levels permitted in pyramid structures along with the number of subsidiaries. Policies to restrict crossholdings and the use of holding companies have also been adopted.
Yet these measures have largely failed. An alternative approach taken in Israel, for example, has been to give business groups a specified and limited time in which to reduce to no more than two layers, while also banning large companies from controlling both financial and non-financial entities. This approach has proven relatively effective.
Using tax policy to influence how a business is organised is another option. Although, in principle, higher taxation of dividends could restrict inter-group transfers, most Asian business groups do not rely on dividends for these purposes, using loans and transfer-pricing instead.
Imposing additional tax liabilities, over and above normal corporate tax rates, on closely held family businesses (but excluding young entrepreneurial family firms) is more promising. By targeting the business entity, the value of any control premium is effectively attributed and taxed to all the relevant members of the family. This has the additional advantage of targeting the format of the business group.
A further tax intervention could be the adoption of inheritance taxes. South Korea – following in the footsteps of Japan – has recently introduced a 50 per cent inheritance tax rate. The effective tax rate in 2020 on the value of the deceased chairman of the Samsung Group shares amounted to over 58 per cent. This has led the current chairman to announce he does not intend to hand over management to his children. Over time, inheritance taxation may prove to be an effective way of curtailing family business groups and also help address the high levels of wealth inequality in Asia.
In most Asian economies, competition laws are in place, as are bankruptcy laws. All – except Malaysia – have merger control laws. Yet, their implementation has been erratic and the competition authorities have often been captured by the same entities whose behaviour they seek to check.
To deal with the anti-competitive impact of business groups, authorities need to move beyond evaluating marginal changes to market structure via mergers and acquisitions. Following Israel’s experience in the 2010s, policy measures could explicitly target the overall levels of market concentration, as well as sectoral market concentration.
One way to do this is to set limits on the maximum market share a firm or business group can hold – say, 30 percent – and then require that existing firms be broken up to ensure the thresholds are not exceeded, sector by sector. The thresholds might be lowered when firms are affiliates of the business groups to counter their ability to leverage resources and market power through their position in other markets.
Although this sort of approach would be more stringent than in most advanced economies, it could be the starting point in much of Asia where there is far more market power vested in a limited number of business groups.
Of equal importance is to apply pressure on politicians and political parties to limit their leveraging of connections with business.
This requires greater involvement of civil society by increasing transparency and creating a workable enforcement system. Yet these are all hard to achieve, even in democracies.
Plenty could be done. Rules regarding political contributions can be tightened. Except for South Korea, no other country has banned or limited political contributions by businesses.
Compulsory asset and interest declarations also have a role to play. Although many Asian countries do notionally mandate such declarations, much depends on how such reporting is designed, let alone implemented. Registers of interests – individual and family– can be used for parliamentarians and ministers. Pushing for greater automatic disclosure along with easy and wide access, along with measures aimed at limiting corruption in public spending decisions, are necessary.
Such measures include frequent external audits. Some countries have achieved traction by setting up dedicated and autonomous anti-corruption agencies – for instance, Indonesia’s KPK – that have sufficient political support to take on sensitive cases.
Asia’s sustained growth has been built on the concentration of resources, assets and market power. These features will be less benign in the future. Dismantling the hold of business groups and limiting the ability of politicians to leverage connections to business are some of the most urgent policy challenges now on the table.
Simon Commander is managing partner of Altura Partners, which provides policy advice to governments and companies in emerging economies. He is also visiting professor of economics at IE Business School in Madrid.
Saul Estrin was the founding head of the department of management at the London School of Economics, and formerly a professor of economics and associate dean at London Business School.
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