What Constitutes “Too Big to Jail?” Evidence from South Korea's Family Business Groups

• Published date: 01 December 2018
• Date: 01 December 2018
• Author: Changmin Lee,Hansoo Choi,Hyoung‐Goo Kang
• DOI: http://doi.org/10.1111/ajfs.12241

What Constitutes “Too Big to Jail?”

Evidence from South Korea’s Family

Business Groups*

Hansoo Choi

Korea Institute of Public Finance, Republic of Korea

Hyoung-Goo Kang

Business School, Hanyang University, Republic of Korea

Changmin Lee**

Business School, Hanyang University, Republic of Korea

Received 18 February 2018; Accepted 10 September 2018

Abstract

This paper investigates the judicial bias in favor of large economic organizations. The Korean

judiciary is biased towards chaebols (large family business groups). Convicted chaebol-related

defendants receive 9.9% more jail-sentence suspensions and 19 months shorter jail terms

than non-chaebol counterparts do. Observed leniency remains robust after controlling for the

quality of defense attorneys and other sentencing related factors. Then, we explore what

drives the bias. We present two possible explanations. The first explanation is that the larger

the chaebol, the larger the judicial bias, implying that the chaebol bias is stronger for top 10

business groups than for other chaebols. The second explanation is that in-group transactions

account for much of the bias. This suggests that the judiciary widely accepts a defense of

chaebol offenders to wrongdoings that illegal in-group transactions are for the interest of

entire business group, not for their private gain.

Keywords Business Group; White-Collar Crime; Tunneling; Civil Law; Self-Dealing

JEL Classification: G34, K14, K42

*This paper was supported by a research grant from Hanyang University 201300000001002.

We thank the editor, the associated editor, and two anonymous referees for their valuable

comments and suggestions.

**Corresponding author: Hanyang University Business School, 222 Wangsimni-ro, Seong-

dong-gu, Seoul, 04763, Korea. Tel: +82-2-2220-2883, Fax: +82-2-2220-0249, email: chang-

min74@hanyang.ac.kr.

Asia-Pacific Journal of Financial Studies (2018) 47, 881–919 doi:10.1111/ajfs. 12241

©2018 Korean Securities Association 881

1. Introduction

This paper examines a judicial bias in favor of large firms and its sources with

quantitative and qualitative studies on the sentencing of 252 high-profile convicted

corporate offenders in Korea. Korea offers an ideal environment for this study. Sev-

eral episodes in Korea suggest judicial leniency favoring corporate offenders, espe-

cially ones tied to large family business groups (chaebols).

An example is Lee Gun-Hee, the chairman of Samsung Group, the largest

chaebol in Korea. In April 2008, Mr. Lee resigned his post after being charged

with tax evasion and breach of fiduciary duty. The Korean judiciary, in August

2009, gave him a 3-year suspended jail sentence. By Christmas of that year,

President Lee Myung-Bak pardoned him, clearing the way for his return to his

former post in March 2010. Hence, a tycoon convicted of multiple felonies

returned to power in less than 2 years. As another example, consider Jeong

Mong-Goo, the chairman of Hyundai Motor Group (owner of Kia, the coun-

try’s second-largest carmaker). In 2006, he faced criminal charges of embezzle-

ment and illegal self-dealing. A lower court sentenced him to 3 years in prison,

but the appellate court, giving weight to his contribution to the national econ-

omy, suspended the sentence and instead demanded a donation of USD1 billion

to charity. In August 2008, he too was pardoned.

As seen in the above two episodes, the courts are reluctant to harshly punish

offenders whose companies are “too big to jail.” Moreover, according to our data,

the larger the firm or business group connected to a defendant, the greater the

leniency. As Christian (2010) put it, “[I]f Jeffrey Skilling, the former Enron chief

executive, was South Korean, you could imagine him back at his desk, making key

decisions.” Media often argue that this judicial bias contributes to the “Korea dis-

count,” the undervaluing of Korean stocks by foreign investors.

Corporate crime cases also illustrate how the civil law system addresses outlawed

self-dealing, especially in a business group, benefiting controlling shareholders.

Related-party transactions can expropriate minority shareholders for the benefit of

controlling shareholders especially in countries where business groups are prevale nt

(e.g. Khanna and Palepu, 2000; Morck, 2007). The regulation of self-dealing trans-

actions varies substantially across legal origins, but civil law is generally less protec-

tive of outside investors and minority shareholders (e.g. La Porta et al., 1999;

Johnson et al., 2000b; Djankov et al., 2008).

Existing studies focus on private enforcement, such as legal arrangements and

civil litigation, against self-dealing. However, there are few studies that investigate

public enforcement, especially the role of criminal courts in constraining self-deal-

ing. This is mainly due to the lack of credible data (Djankov et al., 2008). Such data

are available and rich in Korea, especially after the 1997 Korean financial crisis,

when prosecutors vigorously brought self-dealing cases to the courts, producing

more than 250 convictions. Filling the research gap, we analyze how Korean crimi-

nal courts, a civil law jurisdiction, perceive and discipline related-party transactions

H. Choi et al.

882 ©2018 Korean Securities Association

for controlling shareholders. To our knowledge, this paper is the first systematic

research on how civil law systems address self-dealing in its criminal courts.

Our dataset is unique. Using news articles, court decisions, and electronic legal

resources, we construct a dataset of sentencing outcomes for 252 convicted corpo-

rate offenders, most of whom committed outlawed self-dealing. The cases include

the large-scale corporate scandals of Samsung, Hyundai Motor Group, and SK

Group. All crimes occurred between 1993 and 2006 and were adjudicated from

2000 to 2007.

We find that the Korean judiciary exhibits a strong bias toward chaebols (hence-

forth, the “chaebol bias”). Chaebol-connected defendants are 9.9% less likely to be

imprisoned than other white-collar criminals. The former are 26.6% less likely to be

held in pretrial custody than the latter. In addition, the former serve 19-month

shorter prison terms even if they are held in jail. This preferential treatment for

chaebols remains robust after controlling for measures for the quality of legal repre-

sentation used. In addition, we also address selection bias issues, and this does not

alter our main findings.

Then, what drives the bias? We attempt to present two tentative explanations.

The first is that the larger the size of chaebols, the lighter the criminal sanctions to

them (too big to jail). Our evidence suggests that the chaebol bias is stronger for

the top 10 business groups than for other chaebols and higher for chaebols than for

non-chaebols. Jail sentences are more often suspended for convicted chaebol-related

defendants than for convicted non-chaebol defendants by 10.1%. However, for

defendants related to the top 10 chaebols, the gap widens to 11.2%. For those con-

nected to smaller chaebols, the difference narrows to 8.7%. In sum, the larger the

chaebol, the more leniency.

This can be explained as a direct extension of “too big to fail,” that systemati-

cally important financial institutions will receive a bailout (Mishkin et al., 2006).

Too-big-to-fail institutions are mostly large and interconnected. Their failure can

lead to an abrupt or disorderly breakdown of the financial and economic system.

Similarly, a judiciary can issue favorable rulings for top managers in economically

significant organizations in order to prevent disorderly failure and instability.

Second, after our extensive review of sentencing opinions, we find that the judi-

ciary widely accepts “no private gain” defenses, that a criminal acquires no direct

private gain from crimes in question, especially in chaebol cases. The judiciary often

accepts the claim that the crimes involving in-group transactions are designed to

facilitate the interests of a whole business group (e.g. propping troubled affiliates in

the group). Indeed, in-group transaction explains much chaebol bias.

The above findings suggest that the Korean justice system is generous when

assessing the degree of illegality of self-dealing. When crimes involve related-party

transactions, especially in order to prop up a troubled chaebol subsidiary, the courts

rule that the crimes deserve less condemnation. They claim that the transaction

increases the interest of a chaebol as a whole rather than the private benefit of crim-

inals and controlling shareholders. This attitude results in lighter sentences for

What Constitutes “Too Big to Jail?”

©2018 Korean Securities Association 883