In this blog post, we will examine the necessity of banning circular shareholdings, focusing on the concept and problems of the circular shareholding system and its relationship to economic democratization.

Economic Democratization and the Circular Shareholding System

Economic democratization has long been discussed as a key policy issue in the South Korean economy. Among the most crucial measures cited in this context is the ban on circular shareholdings. The ban on circular shareholdings, as the term suggests, refers to a system that restricts or prohibits circular shareholdings within corporate groups. This method of circular shareholding has long been used as a key means of shaping the corporate governance structures of some large conglomerates in South Korea.
Circular shareholding refers to an investment structure in which, for example, Company A invests in Company B, Company B invests in Company C, and Company C, in turn, invests in Company A. In such a structure, the major shareholder of Company A can exercise effective control over Companies A, B, and C as a whole with relatively little capital. In this process, the capital base may appear larger than the amount actually invested due to the interlocking nature of the corporate structure.
A similar structure is the pyramid-type cross-shareholding. For example, this is a structure in which Company A invests in Company B, Company B then invests in Company C, and Company A exercises control over both Company B and Company C. The capital structure formed through this investment process is not inherently problematic in itself. However, unlike pyramid-type investments, circular investments have faced criticism for potentially undermining the transparency of corporate governance and market fairness, as they allow control to be expanded through the circulation of investment funds.

The Impact of Circular Investment on the Economy

Circular investment goes beyond a mere accounting structure and can affect corporate governance and the efficiency of capital markets. When circular investment is established, it can have the effect of significantly expanding a company’s control beyond its actual capital size, which has the potential to distort the market’s allocation of resources. Furthermore, it has been consistently pointed out that this structure allows the families of a small number of chaebol leaders to control massive corporate groups without holding sufficient equity stakes.
Some argue that cross-shareholdings were a practical management strategy that companies had no choice but to adopt given the institutional environment at the time. However, there are also corporate groups that have maintained stable corporate governance and financial soundness without adopting such structures. Therefore, it is difficult to conclude that cross-shareholdings were an absolutely necessary system for corporate management.
In South Korea, regulations have already evolved to restrict new circular shareholdings through fair trade-related systems. While existing circular shareholding structures have been largely dismantled on a conglomerate-by-conglomerate basis, some still remain, and discussions on continuous improvements to enhance the transparency of corporate governance are ongoing.
Circular shareholdings distort the economic structure because they have the potential to interfere with the efficient allocation of capital in the market. As explained earlier, when circular shareholdings are formed, they allow for the acquisition of greater control than would otherwise be possible, which can make it difficult for investors to accurately assess a company’s intrinsic value and corporate governance structure. Consequently, market functions may not operate fully, and this can also affect the efficient flow of capital.
For example, a corporate group that has established its governance structure through circular shareholdings can exert influence greater than its actual investment scale, and such a structure may serve as a factor in strengthening market dominance within a specific industry. For this reason, South Korea’s Fair Trade Act has long restricted cross-shareholdings and, in principle, prohibits new circular shareholdings as well.
Another issue with circular shareholdings is that they allow companies to maintain or expand management control without securing a sufficient stake in accordance with market principles. In such cases, a discrepancy may arise between a company’s actual ownership structure and its governance structure, potentially creating an imbalance between corporate performance and control. Such structures have also been a source of ongoing controversy regarding the transparency of corporate governance and the protection of minority shareholders’ rights and interests.

Is the circular ownership system truly necessary?

Some argue that circular ownership is an inevitable outcome of companies adapting to government regulations—such as restrictions on cross-shareholdings—following the International Monetary Fund (IMF) foreign exchange crisis, and that it was not formed solely based on the interests of the business community. However, there are also opposing viewpoints to this argument.
Even amid government regulations, there are quite a few corporate groups that have stably maintained management voting rights and secured financial soundness without resorting to circular ownership. In fact, several conglomerates—including LG, GS, CJ, Doosan, SK, Dongwon, SBS, Nongshim, Amorepacific Group, Hanwha, and Kolon—have largely eliminated cross-shareholdings by transitioning to a holding company structure or improving their corporate governance. Since then, South Korea’s major conglomerates have continued to reduce their cross-shareholding structures in line with institutional reforms by the Fair Trade Commission.
Even when looking at examples from abroad, circular shareholdings are not the only way to expand corporate control. Although systems vary by country, other forms of corporate governance are generally used more frequently than circular shareholdings. Representative examples include pyramid-type shareholdings and weighted voting rights systems.
As explained earlier, a pyramid-type investment structure involves a one-way chain of investments among affiliates, allowing the top-tier company to exercise control over multiple affiliates. While this structure is also difficult to view as an ideal governance model, it differs from a circular investment structure, in which the same capital circulates repeatedly to expand control.
Differential voting rights is a system in which different classes of stock with varying numbers of voting rights are issued to simultaneously pursue fundraising and the maintenance of management control. Since investors are aware of these conditions when investing, the scope of voting rights is clear, and this system is characterized by the fact that it does not create unnecessary circular structures. However, in South Korea, differential voting rights are not widely permitted for general listed companies; rather, they are being introduced within a limited scope, primarily among venture companies.

What Is More Important Than the Cost of Resolving Circular Shareholdings?

Among the arguments against resolving existing circular shareholding structures, the most frequently raised claim is that the resolution costs are too high, and it would be more efficient to allocate those funds elsewhere. However, this argument also needs to be examined from a different perspective.
The primary beneficiary of circular shareholdings is likely not the company itself, but rather the controlling shareholder, who was able to control the entire corporate group with a small stake. Therefore, interpreting the costs required to resolve circular shareholdings as a burden solely on the company as a whole can lead to the fallacy of viewing the company and the controlling shareholder as the same economic entity.
Of course, in reality, since the head of the corporate group exercises management control, there are cases where the company bears significant costs during the restructuring process. Nevertheless, if the structural problems inherent in circular shareholdings are clear, there is also the view that addressing them early—rather than maintaining them over the long term—could lead to greater overall economic efficiency.
Conversely, if the costs currently being invested to resolve cross-shareholdings had been used in the past to establish a more transparent corporate governance structure, these problems might not have arisen. Furthermore, it is entirely reasonable to expect that the longer the cross-shareholding structure is maintained, the greater the costs of resolving it will become.

Is the claim that cross-shareholding has contributed to economic growth valid?

Another argument posits that the cross-shareholding structure has contributed to South Korea’s economic growth and job creation by ensuring stable management control for conglomerate owners and defending against hostile mergers and acquisitions (M&A) by foreign capital, thereby generating the so-called “trickle-down effect.”
However, based on a comprehensive review of research findings to date, it is difficult to regard these claims as proven facts. In particular, the “trickle-down effect” has long been the subject of diverse debates within the domestic and international economics communities, and studies continue to be published indicating that there is insufficient clear evidence to prove that economic growth necessarily leads to improved income distribution.
Studies have also shown that, in the past, income growth did not spread evenly across all socioeconomic classes. Furthermore, concerns have persistently been raised regarding the potential for unfair competition arising from transactions between large corporations and their suppliers, market monopolies, and internal transactions among affiliates; for these reasons, fair trade regulations have also been continuously strengthened.

Is the inflow of foreign capital necessarily negative?

Contrary to what many people fear, the inflow of foreign capital cannot be viewed as unconditionally negative. While some worry that foreign capital drains South Korea’s wealth overseas, the principle is that foreign investors earn returns commensurate with their invested capital. Furthermore, if foreign investment enhances the competitiveness of domestic companies and boosts the productivity of the economy as a whole, it is difficult to distinguish the resulting economic effects solely based on the criteria of domestic versus foreign capital.
Nor does foreign capital securing voting rights in a company necessarily lead only to negative outcomes. If fair competition takes place between existing management and foreign investors, companies will be required to adopt more transparent management practices and make more efficient decisions. In the long term, this could serve as a positive factor in improving corporate governance.
Furthermore, there has been persistent criticism that some large conglomerates restrict competition in the domestic market by leveraging their strong market dominance and then use the profits secured through this to strengthen their competitiveness in overseas markets. In such cases, policies that promote the entry of new competitors into the market—to invigorate market competition and expand consumer choice—may also be necessary.
Of course, when aggressive mergers and acquisitions (M&A) by foreign companies are likely to have a significant impact on the national economy or industrial security, the government must review or restrict them in accordance with relevant laws. In fact, major countries, including South Korea, currently operate separate review systems for corporate acquisitions related to core national technologies or strategic industries. However, such regulations are intended to protect the national economy and the public interest, and are a separate issue from the rationale for maintaining the cross-shareholding system.

Is cross-shareholding an essential condition for corporate competitiveness?

Some describe cross-shareholding as an essential mechanism for maintaining the competitiveness of South Korean companies. However, it is difficult to conclude that there is a direct causal relationship between cross-shareholding and a company’s sustained growth. Nor does a stable ownership structure achieved through cross-shareholding automatically translate into excellent business performance.
A company’s long-term growth is built on a rational ownership structure, transparent management, and the trust of shareholders and stakeholders. Sustainable growth is possible only when management enhances corporate value and balances the interests of shareholders.
Conversely, if a controlling shareholder uses cross-shareholding to dominate an entire corporate group with a small stake, an imbalance may arise between control and economic responsibility. Such a structure has the potential to negatively impact a company’s financial soundness and management transparency, and the resulting social costs may ultimately be borne by the company, the market, and the economy as a whole.
Under the corporate system, it is natural for management to utilize various mechanisms to maintain stable control. It is not uncommon for foreign companies to employ various mechanisms to maintain control with a small stake as well. However, such efforts to strengthen control must be carried out within limits that do not undermine the fundamental principles of a market economy or the transparency of corporate governance.
Cross-shareholdings have long been established as one of the key elements shaping South Korea’s unique chaebol governance structure. While this structure developed alongside the country’s industrial growth, it has also left behind various challenges, including monopoly and oligopoly issues, lack of transparency in corporate governance, protection of minority shareholders, and fair competition. Accordingly, South Korea has improved its regulations to prohibit new circular shareholdings and continuously eliminate existing ones; as a result, the scale of circular shareholdings has now significantly decreased compared to the past.
Corporate growth and the development of the market economy can be sustained more effectively on the foundation of fair competition and transparent corporate governance. Therefore, the issue of circular shareholdings must also be continuously reviewed and improved from the perspective of the efficiency and fairness of the South Korean economy as a whole, rather than the interests of specific corporate groups.

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