Too Big to Jail? Company Status and Judicial Bias in an Emerging Market

• Author: Hyung‐Goo Kang,Jongsik Park,Woojin Kim,Hansoo Choi,Changmin Lee
• DOI: http://doi.org/10.1111/corg.12142
• Published date: 01 March 2016
• Date: 01 March 2016

Too Big to Jail? Company Status and Judicial Bias

in an Emerging Market

Hansoo Choi, Hyung-Goo Kang, Woojin Kim*, Changmin Lee and

Jongsik Park

ABSTRACT

Manuscript Type: Empirical

Research Question/Issue: This paper examines prosecutorial and judicial decisions to incarcerate the suspect upon indictment

or convictionof embezzlement or breach of fiduciaryduty in Korean firms. Our aim is toevaluate whether the judicialsystem is

biased in favor of large business groups or chaebols in criminal cases.

Research Findings/Insights: Using a sample of 84 indictments and 78 convictions for embezzlement or breach of duty against

managers of publicly traded firms in Korea between 2004 and 2008, we find that the probability of incarceration is much smaller

if the indicted are associated with large business groups or largefirms . In non-large business group firms, initial disclosure of such

accusation results in an average loss of a quarter of market value, and three quarters of convicted individ uals are eventually re-

moved from managerial positions. However, we observe neithersuchalossnorturnoverinlargebusinessgroupmemberfirms.

Theoretical/Academic Implications: We identifya new determinant of judicial bias, namely the statusof the company,inaddi-

tion to individual-level social status or class that has been examined in the previous literature. Such bias may reflect potential

future careerconcerns of the prosecutors andjudges who later become lawyers.The results also suggest that anadditional mo-

tivation behind empire building or size-maximizing behaviorof top management is to effectively implement a legal strategy, a

form of non-market strategy.

Practitioner/Policy Implications: Corporate managersmay apply our findings to manage legal risksand to formulate nonmar-

ket strategies. However, biases in individualsentences may create system risk and economy-wide inefficiencies. In order to re-

form the legal system, policymakers should take into account the externalities in individual sentencing decisions.

Keywords: Corporate Governance, Sentencing Bias, White Collar Crime, Chaebol, Korea

INTRODUCTION

The dialectic relationship between economic and legal

states has been a very important subject not only in eco-

nomics but also in other disciplines in social science (e.g.,

Giddens, 1984). In the law and fin ance literature p ioneered

by La Porta, López-de-Silanes, Shleifer, and Vishny (LLSV,

1997, 1998, 2000a, 2000b, 2002),a key determinant of the over-

all development of financial markets is the legal protection of

investor rights.The degree of protection that investors receive

in variousjurisdictions depends not onlyon the characteristics

of the legal rules themselves, but also on the quality of legal

enforcement (LLSV, 1998).

Although the quality of enforcementmay vary across coun-

tries withdifferent institutionalregimes, various formsof judi-

cial biases with respect to specific legal outcomes have been

documented even in developed economies. A stream of re-

search along these lines examines whether sentencing biases

exist in white-collar crimes where defendants with relatively

higher social status may receive more lenient punishment. A

common characteristic of these studies is that they focus on

the status of individuals within a company. For example, they

typically categorize defendants into owner-managers, man-

agers withoutownership, and workers, and test whetherindi-

viduals in a certain class receive preferential judicial

treatment.

In this study, we suggest and empirically test whether

business-group level or firm-level status which varies across

companies is a potential source of judicial bias in Korea. An

important characteristic of the Korean market is that family-

controlled large business groups, commonly referred to as

chaebols, account for a substantial fraction of the overall econ-

omy. For example, the top 10 chaebols’gross total sales

amounted to more than three quarters of the total gross do-

mestic product (GDP), according to chaebol.com, a local data

provider (http://www.chaebol.com, August 27, 2012). Such

dominance of chaebols has provided them with unique social

*Addressfor correspondence: Woojin Kim,Seoul National University BusinessSchool, 1

Gwanak-ro, Gwanak-gu, Seoul,151-916, Korea. Tel: +822-880-5831; Fax: +822-880-5831;

E-mail:woojinkim@snu.ac.kr

© 2015 JohnWiley & Sons Ltd

doi:10.1111/corg.12142

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Corporate Governance: An International Review, 2016, 24(2): 85–104

status beyond their economic influence. Korea also exhibits

relatively poor quality of legal enforcement, despite its rapid

economic development during the past few decades, accord-

ing to LLSV (1998). Such poor legal quality is reflected in its

high level of private benefits, particularly tunneling or the ex-

propriation of minority shareholders (Bae, Kang, & Kim,

2002; Baek, Kang, & Lee, 2006; Nenova, 2003).

These two factors jointly suggest that judicial bias may exist

in favor of large business groups. In fact, Korean judicial author-

ities are often criticized by the local media for being too lenient

on criminal charges against the management of chaebols. For ex-

ample, on August 14, 2009, the Seoul High Court released the

former executives and the controlling shareholder of Samsung

–the largest chaebol in Korea –by suspending the sentence even

though they were found guilty of a breach of fiduciary duty

1

in

ahighprofile case in which bonds with warrants of an unlisted

member firm were issued to the controlling shareholder’sonly

son at prices far below market value.

We examine two sets of judiciary decisions in criminal cases

involving embezzlement or breach of fiduciary duty by the

management of publicly traded firms in Korea: (1) prosecu-

tors’decisions to arrest and detain suspectsin jail, conditional

on indictment,and (2) judicial decisions to imprisonconvicted

persons without probation, conditional on conviction.

According to the traditional perspective on while-collar

crimes, such judicial leniency is driven by the defendant’s rel-

ative position within the company. That is, those who hold

high-level executive positions, such as chairman or CEO,

may be favored overrank-and-file employees. To the contrary,

we argue that firm-level status across companies, which has

not been explored in the previous literature, is also an impor-

tant determinant of sentencing bias.

We focus on embezzlement and breach of fiduciary duty,

which are the most typically observed white-collar crimes in

Korea. Our key measureof severity of punishment is whether

defendants are physically detained in jail upon indictment or

imprisoned without probation upon conviction.

2

Arrest and

subsequent detention in jail during the indictment process

are often viewed by the general public as a form of criminal

punishment, although this decision is largely discretionary.

3

The court also has discretion over whether to actually im-

prison the suspect upon conviction, or to release them by

suspending the sentence or through probation.

4

In any jurisdiction, though, the first order criterionfor these

decisions is of course the factual evidence for the charge. In

common law countries, juries are responsible for factualjudg-

ments, while in civil law countries prosecutors and judges

make factual as well as legal judgments. If factual evidence

is weak (strong) prosecutors are less (more) likely to indict

the accused to maintain their track record of winning (Hagan

& Parker, 1985; Wheeler and Rothman, 1982). As such, inves-

tigated but non-indicted cases may largely reflectthatthere

was not enough factualevidence rather than intentionto favor

any specificparty.

If there is indeed selection bias at the indictment stage, it is

more likely to be in favor of suspects from large business

groups so thatthey may avoid being indicted in thefirst place.

If so, then for large business group suspects, only those cases

with relatively “stronger evidence”would actually end up

being indicted, which would bias us against finding any

leniency toward large business groups within the indicted

sample. In addition, Hagan and Parker (1985) also note that

potential selection at conviction stage does not influence the

determinants of punishment in white-collar crimes. For these

reasons, we examine neither the decision by prosecutors

whether to indict or the decision by courts whether to find

the defendant guilty.

Using a sample of 84 indictments and 78 convictionsof em-

bezzlement or breach of duty against managers of publicly

traded firms in Korea between 2004 and 2008, we investigate

whether the decision to release or detain the indicted or

convicted management is influenced by the status of their

companies, proxied by size or membership in a largebusiness

group. From the manager ’s perspec tive, preferential t reat-

ment for large firms or members of large business groups in

criminal cases wouldprovide an additional incentive to make

empire building decisions in the standard agency framework

(Jensen, 1988). From the prosecutors’and judges’perspective,

building a reputation for be ing “business friendly”may pro-

vide better job opportunities after they resign from office.

Such career concerns largely reflect differences in career paths

between US and Korean legal professionals. For example, in

the US, elected lead prosecutors and judges typically start

out as lawyers (in some cases as assistant prosecutors) after

passing the bar exam, and become public officials later on af-

ter accumulatinglegal experience. In Korea, a subsetof candi-

dates who just passed the Korean bar exam initially start out

their career as prosecutors or judges who later resign to be-

come lawyers.

Our first findingis that the probability of being arrestedand

put in jail beforethe trial declines dramatically(by 68 percent-

age points) if the indictedmanager is employed by a member

firm in a large businessgroup, after controllingfor the individ-

ual’s status asCEO or a controlling shareholder, the age of the

indicted, the magnitude of the damage from the crime, poten-

tial socialconnections through boardmembers, and other firm

characteristics. This finding strongly suggests that member-

ship of the defendant in a large business group has an influ-

ence on prosecutors when they make detention decisions

upon indictment.

Next, we investigate whether the probation decision by the

court is influenced by firm size or large busine ss group mem-

bership. Strikingly, no manager or controlling shareholder in

our conviction sample has ever been actually imprisoned if

the company belongs to a large business group. This prohibited

us from employing large business group membership as the

main explanatory variable in regressions as the coefficient on

this dummy cannot be estimated due to perfect prediction.

As an alternative, we resort to firm-level size variables such

as sales, total assets, or market capitalization as potential

proxy variablesfor a firm’s status. When we partitionthe sam-

ple based on firm-levelsize, we again find that the probability

of being physically imprisoned is significantly smaller for

large firms, after controlling for the individual’sstatusas

CEO or a controlling shareholder, the level of the sentencing

court, board characteristics including potentialsocial network

of the board members, and other firm characteristics. These

results indicate that both the prosecutors’and the judges’

decisions to physically confine the indicted or convicted are

heavily influencedby the status of the employing firms,which

varies across companies, rather than the defendants’relative

position within the firm or their individual social status.

86 CORPORATE GOVERNANCE

© 2015 JohnWiley & Sons LtdVolume 24 Number 2 March 2016