Does the Professional Manager Blow the Whistle on Founding Families? New Evidence on the Dark Side of Family-Controlled Firms

In our recent paper, “Does the Professional Manager Blow the Whistle on Founding Families? New Evidence on the Dark Side of Family-Controlled Firm”, we examine the observed patterns and outcomes of corporate crimes committed by professional top managers in Korea and present the following findings. First, the Korean judiciary is much tougher on controlling shareholders than on professional CEOs when both are charged with the same crime. The probability of imprisonment for the CEOs is lower than controlling shareholders by 35.7%, and the prison terms imposed on the professional CEOs are also shorter. Surprisingly, no top manager has ever actually gone to prison; an appellate court always suspends the sentence. Similar patterns arise during pretrial procedures. Professional CEOs are 39.2% less likely to be detained than controlling shareholders.

Second, qualitative studies identify which mitigating factors can explain such leniency toward top management. The qualitative analysis vividly portrays how the Korean judiciary de facto accommodates the outlawed practice of “tunneling,” self-dealing transactions within conglomerates. The Korean judiciary is well aware of a conglomerate’s dynastic management practices, epitomized by “a strong controlling shareholder versus a weak manager”. Judges thus hesitate to punish professional executives despite their misconduct.

Finally, in addition to the legal environment, labor market conditions incentivize professional top managers to take part in corporate crimes and to refrain from whistleblowing. Almost 55% of the professional top managers involved in corporate crimes eventually come back to their original position at the company, or a similar one in an affiliated firm, after sentencing decisions. Almost 84% (46 out of 55) of resurrected professional top managers in the market had worked for Chaebol-affiliated firms at the time of their corporate crimes. 60.5% (46 out of 76) of managers at Chaebol firms had resurrected compared to 37.5% (9 out of 24) at Non-Chaebol firms. More surprisingly, 87% of returned Chaebol managers took up another executive position at the same chaebol. This finding may be explained by an internal market (or lack thereof) for professional managers. Business groups are known to have an internal market for resources, including professional top managers. The problem is that this internal market is not subject to market discipline, and a CEO with a record of criminal convictions can easily return to his position. We should emphasize here the dominant power of controlling shareholders in an internal market. This makes hired CEOs less concerned about their reputation, and gives them an important incentive to assist in corporate crimes by controlling shareholders.

Changmin Lee is Assistant Professor in IB & Finance at the School of Business of Hanyang University, Seoul (South Korea) and a non-resident Research Fellow at the Edmond J. Safra Center for Ethics at Harvard University. Hansoo Choi is an Associate Fellow of the Korea Institute of Public Finance (KIPF).