A bill banning chaebol companies from making fresh circular equity investments in sister firms is likely to be passed in the National Assembly within this year. If enacted, the bill is expected to improve corporate governance.

The current law bans cross-shareholding between two units of a business group. To work around this ban, chaebol groups use circular shareholding structures. An ownership loop is created when Company A makes an equity investment in Company B, which buys a stake in Company C, which in turn secures a stake in Company A.

This chain of ownership relations enables chaebol owners to achieve control of their business empires with tiny personal shareholdings. The rapid expansion of chaebol groups owes a lot to this mechanism.

This governance structure is harmful not only because economic power becomes concentrated in the hands of chaebol chairmen but also because it hampers fair competition. Chaebol families also use this arrangement to siphon off corporate wealth or facilitate father-to-son transfers of corporate control.

Given these and other ill effects, circular shareholding needs to be eliminated. But an abrupt wholesale ban is not desirable as it would deal a hard blow to many business groups.

Among large business groups with assets exceeding 5 trillion won ($4.7 billion), 14 currently have circular shareholding structures, including Samsung, Lotte, Hanjin, Hyundai Motor and Hyundai Heavy Industries. The number of the affiliates involved in these arrangements totals 124.

An across-the-board ban would require these groups to spend trillions of won to change their governance structures. This would be bound to impose a significant drag on their ability to invest and create jobs.

For this reason, President Park Geun-hye promised on the campaign trail to recognize existing circular shareholding loops and only ban corporations from making additional ones.

In contrast, the main opposition Democratic Party has demanded that all existing arrangements, not just new ones, be banned to prevent chaebol families from expropriating minority shareholders’ wealth.

But the party backed down from its demands Monday, allowing lawmakers on the Assembly’s National Policy Committee to reach a compromise. The party’s decision was well-advised.

What motivated the DP to soften its position was the urgent need to prevent companies undergoing restructuring from using circular shareholding to secure capital in a facile way.

For instance, Kumho Industrial Co., a key subsidiary of Kumho-Asiana Group, is under a debt-workout program. The tire manufacturer faces delisting due to serious capital impairment. To avoid delisting, it needs an infusion of fresh equity capital. So it has been seeking to arrange for other group affiliates to make equity investments in it through circular shareholding.

Now, the company has little chance of raising capital from its sister firms. It will have to sell its own assets or hope its owner family injects fresh capital into it.

The ban on new circular equity investments is expected to push companies toward a holding company system. Many chaebol groups, including LG, SK, GS and Doosan, have already adopted this structure. Samsung, Hyundai Motor and other groups that still have old governance structures will face growing pressure for reform.