Samsung Bribery Scandal Threatens South Korea Success Story

South Korea’s political turmoil could usher in a new group of leaders less inclined to treat its business titans with kid gloves. The public is increasingly fed up with white-collar crime. Further, South Korea’s unique blend of business, politics and top-down hierarchical management is looking increasingly untenable in a modern age of innovation, public dissatisfaction with the old order and cutthroat competition from China and the rest of the world.

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Mr. Lee and key aides are accused of using bribes to cement the family’s control of the Samsung empire — an accusation that, if proven, would add to growing public perception that the country’s business elite are in it only for themselves. The ensuing scandal threatens to topple South Korea’s government and lead to tougher moves against big business here.

Prosecutors also indicted a group of executives tasked with cementing Mr. Lee’s grip over the sprawling empire — a group that critics say epitomizes where the country’s business culture went wrong.

South Koreans are now coming to grips with a tale of corporate power and family intrigue. It includes a mysteriously ill patriarch, a Rasputin-like confidante of the country’s president, a shadowy Samsung office that has disappeared and reappeared before, and an alleged bribe in the form of a horse.

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But it also includes the growing realization that, to compete, Samsung and South Korea as a whole will have to take a hard look at the way they do business.

“We should not miss this opportunity to cut the corrupt ties between politics and businesses,” said Moon Jae-in, a lawmaker and opposition leader who is the favorite to become South Korea’s next president. “Only when Samsung repents its collusion with politics and its anti-market activities, like seeking political favors, can it become stronger.”

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Rise of an Empire

Like its home country, Samsung is a giant in transition. The conglomerate is one of the world’s top sellers of televisions and smartphones, a key supplier for the innards of Apple’s iPhones, and the maker of products as varied as cargo ships and credit cards. Its many companies posted estimated combined sales of $262 billion. By itself, it accounts for one-fifth of its home country’s exports.

All of that is under pressure. The infamous failure of its fire-prone Galaxy Note 7 smartphone tarnished its name. Chinese rivals are making cheaper — and increasingly sophisticated — phones, televisions and appliances. Its shipbuilding business is shedding jobs. China’s government is investing lavishly to build out rival makers of microchips and memory. The scandal will delay long-term efforts to address these problems.

All in the Family

South Korea’s economy is dominated by family-controlled conglomerates called chaebol that often run business around the world. Late last year, some of the chiefs of these companies testified before lawmakers about donations to charities in the center of a political bribery scandal. These are four of the country’s biggest chaebol:

Samsung

Kim Hong-Ji/Reuters

Businesses: Smartphones,
televisions, semiconductors,
appliances, shipbuilding,
hotels, movie production

Controlling family: The
Lee family. Jay Y. Lee,
Samsung’s vice chairman,
became its de facto leader in
2014 after Lee Kun-hee, his
father and the company’s
chairman, fell ill.

Lee
Kun-hee was convicted of
corruption charges twice,
and pardoned. His son has
been indicted on bribery
charges.

LG

Jung Yeon-Je/Agence France-Presse — Getty Images

Businesses: Smartphones,
televisions, appliances,
chemicals

Controlling family: The
Koo family. Koo Bon-moo is
the chairman.

Asked by
lawmakers about the
donations to the charities in
the current scandal, Mr. Koo
denied seeking or receiving
special treatment for them
and told lawmakers, “It was
difficult to go against the
government’s wishes.”

Hyundai

Kim Hong-Ji/Reuters

Businesses: Car making,
shipbuilding, steel,
elevators, logistics,
construction

Controlling family: The
Chung family.

Its chairman, Chung Mong-koo, was found
guilty of fraud in 2007 and
pardoned.

SK

Jung Yeon-Je/Agence France-Presse — Getty Images

Businesses: Energy,
telecommunications,
semiconductors, chemicals,
construction

Controlling family: The
Chey family. Chey Tae-won
is the chairman.

Mr. Chey
was convicted of
embezzlement in 2013 and
pardoned two years later.

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Mr. Lee still may emerge unscathed. He argues that he didn’t commit bribery and that, instead, he is the victim of extortion. Samsung said in a statement that it neither paid bribes nor sought favors, and said the truth would come to light in court.

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But Mr. Lee’s troubles — he was arrested, unprecedented for the leader of South Korea’s largest company, before he was indicted — were a jolt to those who assumed Samsung could once again turn to its political ties for help.

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Samsung, which means “three stars” in Korean, has long prospered from politics. Founded by a grandfather of Mr. Lee as a small fish and produce trader in 1938, it branched out into new businesses after the Korean War, including textiles, sugar and alcohol — and later, in 1969, electronics.

The expansion was, in many respects, funded by the government. Its military dictator, Park Chung-hee, wanted to transform South Korea into a country that made what it needed and exported the rest. At the same time, Mr. Park and his successors faced pressure from the country’s struggling populace to get tough on businesses that were seen as profiting from the government’s efforts to kick-start the economy.

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The two sides struck a compromise. Mr. Park allowed Mr. Lee’s grandfather and other business leaders to keep their wealth. In return, he urged them to invest in the country’s economic development and to back his push to make South Korea an export powerhouse. To help, he plied them with cheap bank loans, beneficial “buy Korea” policies and other inducements.

This business-government partnership helped wealthy business leaders and their families squeeze out smaller businesses and international competitors. Those groups came to be known as chaebol, or “rich clan” in Korean, and they dominate South Korea’s economic life to this day. The nation’s top 10 chaebol generate combined annual revenue equivalent to 80 percent of South Korea’s total economic output, according to analyst estimates.

“To South Koreans, chaebol have two faces,” said Kim Sang-jo, an economist at Hansung University in Seoul and an authority on Samsung. “On one hand, chaebol symbolize corrupt ties between business and politics, so people call for reforming chaebol. On the other hand, the economy is so heavily dependent on chaebol that people fear that shaking them too much might make them collapse.”

“South Korean people,” he added, “have never had a chance to learn how a modern globalized company should be run.”

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Jay Y. Lee’s father, Lee Kun-hee, became Samsung’s chairman after his father, Lee Byung-chull, died in 1987. He faced an immediate challenge: South Korea’s economy had become one of the most successful in Asia, but abroad its products were seen as cheap and unreliable.

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In a move that is now part of Samsung’s internal lore, Lee Kun-hee told his (mostly male) executives to “change everything except your wife and kids” and worked to improve Samsung’s quality. He brought in foreign experts. When one batch of phones turned out to be defective, in 1995, he gathered thousands of them into a pile at one of Samsung’s factories and set them on fire. The effort worked. Today Samsung is one of a very few electronics makers to command premium prices for its high-end televisions, smartphones and kitchen appliances.

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But Samsung also found itself repeatedly entangled in some of South Korea’s biggest corruption scandals. Lee Kun-hee was twice convicted, first of bribery and then of tax evasion. Each time, he received a suspended prison term and was later pardoned by the president.

In 2014, Lee Kun-hee had a heart attack and disappeared from public view. Samsung has said he is incapacitated, but it hasn’t released details. Still, thanks to a powerful group of executives and advisers, the Lee family’s grip on Samsung remained unchallenged.

Photo

Jay Y. Lee, a vice chairman of Samsung and de facto chairman of the company, arriving for questioning last month at the office of a special prosecutor investigating a corruption scandal in Seoul.

Credit
Jung Yeon-Je/Agence France-Presse — Getty Images

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A New Generation

When Lee Kun-hee’s son, Jay Y. Lee, now 48, took effective reins of the family empire, he didn’t do it alone.

The Lee family’s ownership in the various Samsung companies isn’t clear because many are not publicly traded, but it is widely believed to hold only small minority stakes. Instead, it controls the companies through loyal executives, as well as through interlocking contracts and shareholdings between the companies and other shadowy links.

At Samsung, some of the most loyal executives staffed the corporate strategy office. The office linked Samsung’s chairman with a host of professional executives who run dozens of individual Samsung subsidiaries, which together now employ a half-million people globally. But the office had a less publicized role: It worked to enable the Lee family to pull off the dynastic transfer of control over Samsung’s management.

Mr. Lee, polite and casual where his father could be remote and distant, by title a Samsung vice chairman, had the appearance of a with-it executive who wanted to bring Samsung into the modern era. Though Samsung’s electronics arm made cutting-edge hardware, it was largely missing out on the boom in mobile apps and online services. He also believed that Samsung’s strict corporate culture was holding back innovation.

In a few ways, under Mr. Lee, Samsung began to loosen up. He began a campaign to discourage managers from using harsh language with underlings, a common occurrence in South Korean offices. He also pledged to cut meetings and office hours, encouraged workers to challenge their bosses, and barred employees from using hierarchical titles in addressing one another — a norm in the South Korean corporate world. The initiative, heavily touted by the company, was called Start-Up Samsung.

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But critics still saw a top-down approach. For example, the company announced Start-Up Samsung with a coordinated pledge from top executives.

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Some current and former employees, who spoke on condition of anonymity for fear of losing their jobs, said pressure from the top has only grown worse under Mr. Lee. Samsung’s phone business — which was losing market share in China and elsewhere to cheap and increasingly sophisticated Chinese products made by Huawei and OnePlus — had made gains against Apple at the top end of the smartphone market. Hoping to capitalize, Samsung executives rushed to get its most powerful phone yet, the Galaxy Note 7, on the market before Apple introduced its new iPhone 7.

The result was disaster. First, a few Note 7 phones caught fire. Then, after an embarrassing and costly recall, some new versions caught on fire too. In an unusual move in the gadget business, Samsung pulled the phone from the market and canceled it. Kim Sang-jo, the Hansung University economist, and other outside experts blamed Mr. Lee and the corporate strategy office for the Note 7 debacle, saying they pushed big goals without listening to lower-level managers.

At the same time, the corporate strategy office was coming under fire for another move, a deal that would strengthen the family’s hold on Samsung — but one that would also engulf it in scandal.

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Turmoil at the Top

Under that office, Samsung pushed a merger of two of its units, Cheil Industries and Samsung C&T. Many outside shareholders opposed the move, which would cement Mr. Lee’s control over the whole conglomerate.

The trick was getting government approval — and to win it, prosecutors say, Mr. Lee and the corporate strategy office broke the law.

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According to prosecutors, Mr. Lee met with South Korea’s president, Park Geun-hye, three times in an effort to cement the deal and smooth Mr. Lee’s rise to power. In return, they say, Ms. Park, who has been impeached, asked Mr. Lee to support two foundations controlled by her secret confidante, a woman named Choi Soon-sil. According to prosecutors, Mr. Lee and members of Samsung’s corporate strategy office gave foundations and businesses linked to Ms. Choi $38 million. Samsung’s contributions to Ms. Choi included an $900,000 horse for her equestrian daughter.

Photo

Lee Kun-hee, the former Samsung Group chairman and the father of Jay Y. Lee, the company’s de facto chairman, leaves after his trial for tax evasion at a Seoul court in 2008. He was handed a suspended three-year jail term.

Credit
Jo Yong-hak/Reuters

The country’s national pension fund, a major shareholder of the two Samsung companies, approved the deal. According to prosecutors, the completed merger increased the stock value of the Lee family by at least $758 million. The country’s national pension fund lost at least $123 million on the deal.

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In a statement, Samsung said shareholders of both companies approved the deal before any donations were made. But it also said it introduced measures to manage donations, including greater public disclosure and more reviews by executives and directors.

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Ms. Choi’s relationship with Ms. Park last year ignited a nationwide scandal. Ms. Choi, who has no formal government title, was reported to have been involved with writing Ms. Park’s speeches, choosing top government officials and even selecting her outfits. As the scandal spread, the alleged bribes came to the attention of prosecutors.

For many South Koreans, the scandal resonates. Ms. Park, who could soon be removed from office, is the daughter of the dictator who gave Mr. Lee’s family the support to broaden Samsung into the giant it is today. It also underscores the perception that today’s chaebol leaders are hurting more than they are helping the country.

Others have said that the company culture has grown more strict since Mr. Lee’s father was incapacitated and pressures on the company to perform well under Mr. Lee grew.

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“They forgot their fathers’ and grandfathers’ entrepreneurship,” said Mr. Moon, the opposition leader, referring to Mr. Lee and other third-generation chaebol leaders, “and chose to make easy money.”

Stung by the scandal, Samsung closed the corporate strategy office. Skeptics point out that Samsung has done that before. Mr. Lee’s father disbanded the office when he ran into legal trouble, only to re-establish it under its current name once those troubles blew over. Its functions may simply migrate to another part of the empire, they say.

“The mission right now is to save Jay Y. Lee,” said Chang Sea-jin, a professor at the National University of Singapore. “It’s like ‘Saving Private Ryan.’”

Samsung said in a statement that its companies would be managed independently by its chief executives and directors.

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But there is reason to believe this time could be different.

Already Mr. Lee has been punished more than his father, who never spent any time in jail. The case also implicates South Korea’s president, while approval ratings for her pro-business party have plummeted, meaning political protection from the top is less likely. And public anger about collusion between companies and the government has never been greater, with protests breaking out this year.

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It isn’t clear whether somebody else may emerge to lead Samsung. Lee Boo-jin, Mr. Lee’s sister and the country’s richest woman, runs the Samsung affiliate Hotel Shilla, which also operates duty-free shops. With her brother in jail, some analysts speculated that she might try to increase her profile within the vast corporate empire. But most analysts say Samsung’s complicated hierarchy is already dominated by executives loyal to Mr. Lee.

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While analysts warn it isn’t likely anything will immediately change, Samsung is undoubtedly facing a new level of pressure and scrutiny.

“The thing about Samsung is, it’s a giant wound-up ball of yarn of cross-holdings,” said Geoffrey Cain, the author of a coming book on Samsung. “The setup is so complicated that sometimes I wonder if a group of smart people could find a way to tug at the right connection and find a way to loosen it up, to unravel it a bit, just to see if they could pull it away from the company.”

He added, “That’s never happened in Korea before.”

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