The past five years must have been good times for Korea’s chaebol groups. During this period, the nation’s 30 largest business groups saw their number of affiliates more than double. According to data compiled by the Financial Supervisory Service, the figure surged from 500 in January 2006 to 1,087 in April this year. This means the conglomerates added a new member to their fleet of subsidiaries every three days during that period.

These groups owe their rapid expansion partly to the deregulation drive of the Lee Myung-bak government. Lee eliminated or softened various regulations introduced to curb their excessive business diversification. For instance, he abolished the regulation restricting chaebol affiliates’ acquisition of equities in other companies. He also softened the rules on industrial corporations’ shareholdings in financial companies.

Lee took these steps to spur corporate investment in new growth sectors, such as renewable energy, biotechnology, health care, robotics and software. Without doubt these measures have boosted investment in these and other strategically important new technologies.

But an analysis of the 587 newly created affiliates suggests that the top business groups have been more engrossed in muscling into areas that are neither new growth sectors nor their present core business lines.

The tendency of chaebol groups to diversify into areas not related to their main business fields is nothing new. But their recent investment pattern appears excessive. This may be attributable partially to the ascendancy of third- and fourth-generation chaebol offspring to top posts. Many of the newly added subsidiaries were set up by these younger members of chaebol families.

Inexperienced chaebol siblings often start a company without doing their homework, captivated by the impulse to turn their hobbies or interests into a business. Companies established and run in this fashion cannot be expected to make money. Therefore it should not come as a surprise that about 45 percent of the newly established subsidiaries are in the red.

But these companies do not have to worry about their losses because they have sugar daddies ― parent companies that cover their losses. One problem with this practice is that it undermines the interests of the minority shareholders of the parent companies.

A more serious problem is that it distorts competition in the marketplace. Few small and medium-sized enterprises would be able to survive if their competitors are affiliates of big business groups that can rely on subsidization by their parent companies. In this regard it is a cause for concern that many of the newly created chaebol affiliates engage in business areas that have traditionally been the preserve of SMEs.

Another problem with companies run by chaebol offspring is that in many cases they are a channel through which chaebol families transfer their wealth and managerial control to their children without paying gift or inheritance taxes.
To give an example, many business groups have affiliates responsible for maintaining and repairing the computer systems of other subsidiaries. These firms can make money easily through intra-group deals. Since they are profitable, the chaebol children who operate them can make huge capital gains by making initial public offerings of their shares. They can use the proceeds from share offerings to boost their stakes in group holding companies, bolstering their managerial control.

The recent surge in the number of chaebol affiliates would have been seen in a positive light had they been the result of active investment in new technology fields that would power the nation’s economic growth for the next couple of decades. Unfortunately, this is not the case. If big business groups continue to focus on maximizing their private gains regardless of the negative consequences of their behavior, the government may have second thoughts about deregulation.