Foreign South Korea has one of the wealthiest and most advanced economies in the world. The impressive growth the country has seen over the last half century is thanks in large part to its massive family-run conglomerates such as Samsung and Hyundai which have become leaders in semiconductors, electronics, and heavy industry. One of the biggest of these business conglomerates was a company called Daewoo Group which had subsidiaries and industries ranging from automobiles to shipbuilding and consumer electronics. In the 1990s, Deru had 80 billion dollars of annual revenues and over 300 000 employees, making it the second largest corporation in the country, second only to Hyundai.

It's not an exaggeration to say that Daewoo was a strategically important company and in large part responsible for making South Korea into the economic Powerhouse it is today. However, its growth was built on pillars of debt-fueled excesses and accounting fraud. In 1999, the House of Cards finally came crumbling down. The company collapsed under the burden of over 50 billion dollars of debt, and the founder Kim Liu Chung was eventually convicted of masterminding what at the time was the single largest corporate fraud in history.

The economic Fallout of the collapse was devastating, with tens of thousands of direct and indirect employees losing their jobs. It also caused many to question the outside's role in undue political influence wielded by family-run conglomerates. Fast forward 20 years to 2021, and the country is still grappling with these same issues following Samsung's 8 billion dollar bribery scandal. But before we dive deep into the story of Daewoo and the challenges South Korea faces I'd like to take a moment to thank our sponsor for today's video.

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In fact, on a per capita basis, they were poorer than their neighbors to the north within. North Korea Having a greater endowment of natural resources and generous economic existence from the Soviet Union in China South Korea's economy was primarily focused on agriculture. The industrial base was not well developed and primarily consisted of labor-intensive textile manufacturing, which took advantage of the country's vast number of unskilled and poorly paid workers. At this point, most economists weren't terribly optimistic about the country's future prospects.

In fact, the economic situation was so bad and the government was so weak that an ambitious army colonel named Park Chung hee was able to orchestrate a coup and establish himself as military dictator in 1963.. Park's main goal was to turn Korea from A Primitive economy focus on agriculture and textile production into an advanced economy revolving around technology and heavy industry. The liberal free market economic model the country had employed since the end of the Korean War was clearly not achieving these goals. In his view, the free market was played by counterproductive competition between private businesses and lacked the vision to invest in strategic industries that can drive industrialization.

In response to these challenges, Park introduced a series of five-year economic plans. The concept of five-year plans is often linked to Stalin's efforts to industrialize the Soviet Union during the 1930s. While Park's objectives mirrored those of Stalin, his methods were markedly distinct. rather than centralizing power directly.

Park implemented a fascist economic model in which the state established development targets and employed a carrot and stick approach to encourage private Enterprises to meet these goals. It was under the guidance of these five-year plans that Daewoo transformed from a modest textile exporter into an industrial. Powerhouse The Crux of Park's five-year plans was to subsidize the development of heavy industry and establish Korea as an export-focused economy. Park Believed a completely free market system was inadequate for the task.

Industrialization often suffers from the chicken and egg problem. Say you want to develop the automobile industry. To do this, you need raw materials such as steel and other components, but there's no incentive to develop the steel industry because there aren't any customers to buy the steel yet. Investing tens of millions of dollars into a steel plant in the hopes that an automobile industry will eventually form to buy your steel is a risk that most entrepreneurs aren't willing to take.

Park's idea was to build all the necessary Industries for a competitive, export-focused economy all at once. So he went to the heads of the largest family-run companies in the country and made them an offer. Each one of them would be assigned a specific industry, which Park viewed as strategically important for Korea's development. In return, the government would provide them with subsidized loans, tax breaks, and Implement High tariffs to protect them from foreign competition.

This was a great deal for the companies. If they agree to enter the industries they were assigned to, they'd be able to achieve de facto Monopoly status. Their government subsidies would allow them to underprice any potential competitor going forward, so they are all but guaranteed to establish a dominant Market position. As part of the second Five-Year Plan, the government arranged for Deru to acquire a train car manufacturer and diesel engine manufacturer called Hankook Machinery Hankook Had been losing money for years and was on the brink of bankruptcy.

but day we was able to turn the company into profitability with the help of subsidized loans and lucrative government contracts. With the successful acquisition of Hankook, they created Daewoo Heavy Industries which grew rapidly through further Acquisitions Most of their Acquisitions were supported either directly or indirectly by the government. By the 1970s, they had transformed from a textile exporter to an industrial Powerhouse creating train cars, machine tools and Industrial Equipment Daewoo quickly gained a reputation of being able to acquire failing companies and turned them around to profitability. Because of this reputation, the government convinced them to acquire a cargo shipbuilding company which was on the brink of bankruptcy.

Shipbuilding is one of the toughest businesses to run. Building a 50 000 ton ship is technically complex and is prone to delays in cost over cargo ships are generally commissioned by cargo companies and if prices agreed before construction begins. However, if cargo rates decline, your customer may go bankrupt by the time you finish the ship. This puts the shipbuilder in the unviable position of scrambling to find a new buyer at the worst possible time.

Despite the risks involved, building on Armada of cargo ships was crucial for Park's plan to turn South Korea into an export-driven economy. so he pressured Daewoo to make the acquisition perhaps the single most consequential decision Deru made was to acquire the automobile manufacturer Seihan Motor in 1978. like many of Deru's other Acquisitions, Seihan was mismanaged and struggling financially. They replaced the management team, rebranded it as Daewoo Motors and it became a huge success, reaching 700 000 units sold per year by the mid-1990s By this point, David was the second largest company in South Korea with 80 billion dollars of annual revenue and over 300 000 employees around the world.

They had hundreds of subsidiaries manufacturing heavy machine, scenery, cargo ships, electronic devices, and even started an investment bank called Daewoo Securities. But the Crown Jewel and main focus was their automobile business. They built their cars in massive quantities and sold them for cheap prices. This made them popular in many developing countries in Asia Eastern Europe and Latin America Daewoo Founder and chairman Kim Woo Chung became a legendary businessman not only within Korea but around the world.

He was featured in Fortune magazine in the U.S He even wrote an autobiography called every street is Paved with Gold which became an international bestseller with over 2 million copies sold. Graduates from Korea's top universities all wanted to get jobs at Daewoo Group and it looked like the company was Unstoppable foreign. But despite the outward appearance of strength, Daewoo's business Empire was a house of Cards propped up by a highly sophisticated and deliberate system of accounting fraud. Greed is a part of human nature and corporate fraud happens in every country, But there were a few features unique to the Korean economic system that made Daewoo's fraud in subsequent collapse particularly catastrophic.

Firstly, Daewoo was massive, with their revenue equaling 10 of South Korea's entire gross domestic product. A lot of this Revenue was generated internationally, and revenue is not directly comparable to GDP. Nevertheless, the conglomerate was systematically important to the South Korean economy, employing over a hundred thousand people within the country directly and hundreds of thousands more indirectly through their contractors and suppliers. Remember that day? We was formed by a massive binge of acquisitions by the 1990s.

They had over 500 subsidiaries all over the world, operating in Industries ranging from shipbuilding to electronics manufacturing. The massive web of subsidiaries lent money to each other, borrowed money from each other, and bought and sold assets from each other. The corporate structure was so complex and opaque that it was all but impossible for outside observers to understand the financial position of the conglomerate as a whole. During the 1970s and 80s, the government actively encouraged conglomerates like Daewoo to borrow as much money as possible to expand as quickly as possible.

They facilitated this by pressuring Banks to give them subsidized loans in addition to getting favorable loans from domestic. Banks Korean Conglomerates were also able to borrow large amounts of money from foreign financial institutions. Because of their systematically important nature, there is a perception that these conglomerates were too big to fail in the case of Daewoo. This theory was validated when the global shipping industry took a downturn in the 1980s and their shipbuilding business started to lose money.

The government effectively bailed them out with a 600 million dollar subsidized loan with cheap and abundant financing from both domestic and foreign. Banks All of Korea's industrial conglomerates were highly leveraged, with most having debt to equity ratios in excess of 500 percent. But a mere 500 leverage ratio wasn't enough to satisfy Kim Woo Chung's Ambitions He wanted to borrow even more money, expand even more quickly, and surpass all of his peers, so he turned to accounting fraud. When a bank or bondholder decides whether or not to approve a new loan for you, one of the most important metrics they look at is your debt to equity ratio.

This is the total amount of debt divided by the shareholders Equity shareholders. Equity is total assets minus total liabilities. To improve this ratio, you either need to decrease your amount of debt or increase the value of your assets. Daewoo Used accounting fraud to do both.

One way that they decrease their reported amounts of debt was to issue debt without calling it debt. They would do this by issuing Equity shares to foreign investors at inflated prices. They would agree to buy back the shares at a higher price at some point in the future. So, while they called them Equity shares, they were economically identical to debt, with the contractual repurchase price effectively acting as an interest payment.

On the asset side of the equation, they would have their subsidiaries by assets from other subsidiaries at inflated prices. As a hypothetical example, let's say their shipbuilding subsidiary buys an office building for 10 million dollars. Their automobile subsidiary could buy the building for an inflated price of 20 million dollars. Now, the shipbuilding subsidiary has 20 million dollars of cash, which is an asset.

The automobile subsidiary now owns an office building which they value at cost which is 20 million dollars. With this transaction, they inflate the value of the office building from 10 million dollars to 20 million dollars at the group level. This increases the total value of their assets by 10 million dollars out of thin air. Also, this allows them to cross subsidize by having their strongest subsidiaries inject cash into their weaker subsidiaries.

Kim Woo Chun became a legendary businessman by having the seemingly magical ability to acquire failing companies and turn them around to profitability. However, Kim wasn't as much of a business genius as he appeared to be. A lot of the companies that they acquired continued to lose money. They were just made to look profitable with these fake asset sales.

As Warren Buffett says, only when the tide goes out do you learn who was swimming naked and Korea the tide went out in 1997. In the 1990s, many Asian economies were growing rapidly thanks to globalization and trade liberalization. Foreign investors want to get a piece of this growth, so they poured money into the region, hand over fists to buy shares of Asian companies. South Korea was a major beneficiary of this, with valuations of stocks on the Korean Stock Exchange inflating substantially.

This created a massive Financial bubble that popped in 1997 and what would come to be called the Asian Financial crisis and had the first signs of stress. Foreign investors started pulling out of the region and the bubble popped far faster than inflated. The South Korean Cosby Stock Market index declined by 70 from its peak in 1995 to its trough in 1997.. As foreign investors sold their shares, they also converted their Korean Won into their home currencies.

This caused the one to lose half of its value depreciating from 901 per US dollar to more than 90 800 won per US dollar in the matter of months. By this point, the Central Bank had all but run out of foreign currency reserves and the government was on the brink of sovereign default. They had no choice but to accept a bailout from the air National Monetary fund as a condition for the loan. The IMF forced the Korean Central Bank to raise interest rates to 30 percent in an attempt to boost the crumbling value of their currency.

The 30 interest rate was economically catastrophic, causing the country to fall into a deep recession with the economy in recession, most companies cut costs, laid off workers, and started selling off their assets to reduce leverage. However, Kim did the opposite. He saw the market crash as a once in a lifetime buying opportunity and did even more. Acquisitions For example, at the peak of the crisis, they borrowed more than two billion dollars to buy a competing Korean automobile company called Sangyong Motor.

In fact, from 1997 to 1999, they acquired 14 new companies in an attempted combat falling sales. They increased their advertising and marketing budget digits, but with consumers tightening their belts, these advertising campaigns ended up being a complete waste of money. A lot of Daewoo's debt was denominated in foreign currencies. The value of these debts effectively doubled due to the depreciation of the one.

Also, with one interest rates having increased due to the IMF bailout, they had to refinance much of their domestic debt at rates as high as 20 percent. But no matter how bad the situation became, they refused to perform meaningful cost reductions or divest any of their companies. Daewoo Was like a gambler who was losing money but continues to double down in an attempt to make back their prior losses, they were trying to borrow as much money as they could to buy a time and wait for the economy to recover, but the Clock Was quickly running out in November of 1999, it was finally game over. With interest expenses mounting, they were completely out of cash.

by this point, they had 50 billion dollars of total debt and only 2.5 billion dollars of shareholders. Equity giving them a leverage ratio of two thousand percent. Kim Desperately tried to secure a government bailout, but the government itself was in a desperate Financial condition and was under strict scrutiny by the IMF. A bailout was simply not possible.

Kim's once proud business Empire collapsed with tens of thousands of Daewoo's employees becoming unemployed overnight After the collapse, All the accounting fraud was also exposed. Kim fled to Vietnam to avoid prosecution, but after a few years, he came back to South Korea and pled guilty to committing the largest accounting fraud in the country's history. He was sentenced to eight years in prison, foreign went bankrupt. Most of its subsidiaries were shut down, but a few of them were either sold or taken over by the creditors.

For example, Daewoo Engineering and Construction still operates to this day, and in 2010, they built the 1.4 kilometer long Yoga Bridge which was the first large-scale bridge in South Korea to incorporate and express bus lane. This allows buses to travel at higher speeds and bypass traffic congestion, making it a faster and more efficient mode of transportation for commuters. Daewoo Electronics is also still operating today, although they stopped producing consumer electronics and now only produce electrical components for automobiles. The government arranged for the Hyundai group to buy a majority stake in Daewoo's shipbuilding business in 2017.

It was re-listened on the Korean Stock Exchange. While it has suffered from inconsistent profitability, it remains one of the largest shipbuilders in the world. The automobile manufacturing business, which was the Crown Jewel of the Daewoo group was sold to General Motors. However, they eventually phased out the brand and the old Daewoo factories now make sure Relay branded cars.

So, while some remnants of the Daewoo Group remain today, it's only a tiny shadow of its former self. The collapse of the Daewoo Group exposed some key weaknesses in South Korea's economic development model, which relies heavily on family-run Industrial conglomerates. The Daewoo group was controlled by Kim Woo Choo, and all the board members were long-time Associates of his, many of them were even his high school friends. Nobody was willing to challenge the boss, so they went along with all the accounting fraud schemes he masterminded.

Also, because Daewoo was a conglomerate, they were able to cross-subsidize money losing businesses which were economically inefficient and probably should have been shut down long ago. Finally, because of the perception that Dewey was too big to fail Banks and other investors were willing to continue to bankroll the company despite the opacity of its Financial condition. This allowed them to grow far bigger and more bloated than they otherwise could have during the 16 years that President Park Chung-hee was. President South Korea's GDP more than tripled in what was nothing short of an economic Miracle.

He couldn't have done this without the help of the country's industrial conglomerates, including Daewoo which became even more powerful as a country grew. You can think of Park's five-year plans as the economic equivalent to performance-enhancing drugs. They allow you to develop very rapidly, but if you use them for long enough, they'll eventually cause catastrophic side effects. Daewoo was the metaphorical side effect of President Park's five-year plans.

Yes, Chairman Kim Woo Chun did commit a massive fraud, and had he been more prudent about managing leverage, the company probably could have survived. But had it not been Daewoo it would have been a different conglomerate. At some point when family-run businesses become so powerful and receive so many government subsidies, Inefficiencies and fraud are unavoidable. Following the collapse of Daewoo, the South Korean government implemented several reforms aimed at strengthening corporate governance, such as mandating that large corporations have independent board members in developing stricter auditing standards for financial statements.

However, despite these efforts, the South Korean economy remains dominated by family-run industrial conglomerates, which often have complex ownership and financial structures that are not fully transparent. In 2021, the country faced another setback when the heir to the Samsung family was convicted in an 8 billion bribery. Scandal. This case highlights the ongoing challenges of corporate governance in South Korea And you can learn more about the Samsung scandal in this video that we published previously.

All right guys, that wraps it up for this video. what do you think about the collapse of Daewoo Let us know in the comments section below. As always, thank you so much for watching and we'll see in the next one. Wall Street Millennial Signing out.