Ethic matters - 윤리는 중요하다

Ethic Matters: Window Dressing or Salad Dressing?

-Brief analysis of ethical issues of Daewoo Shipbuilding & Marine Engineering-

<Naver Stock Information>

         Daewoo Shipbuilding & Marine Engineering, one of the biggest shipbuilding companies on the world, is now facing a forced procedure of massive layoff and a huge amount of government fund to survive. Daewoo Shipbuilding & Marine Engineering (DSME from here) has been incorporated as Daewoo Shipbuilding Co., Ltd. in 1978 and has come to have the current name in 2002. DSME was once the world’s biggest order-received company and has been on the essential role of Korean economy especially for Geoje-si, Gyeongsangnam-do Province even there’s saying that DSME accounts for a quarter of the whole population’s livelihood in the region. It is just too big to fail.

         It is argued that the accounting of DSME has been window-dressing. Critics say that a gigantic amount of loss hasn’t been realized properly on the corp’s accounting on purpose due to mostly cheating investors and hiding business-wide failures with a manager’s incompetence. The others say that it is simply a normal practice in the industry. When you order a salad, you expect the salad to come with salad dressing on top obviously. A delayed realization of loss is merely a common practice, which is always accompanied by shipbuilding/planting business booking. 

         Some base knowledge is required to properly comprehend what is going on. In shipbuilding industry, it usually takes around 3 years, from the day of a purchase order received, to build and finally hand over a ship. Therefore, when to reflect the loss on financial statement caused by low-price order, sporadically incurred additional expenses, unscheduled delay of due date and etc. is purely in the hands of a manager. Nothing, moreover, goes as scheduled because what the mechanism industry like plant or shipbuilding is dealing with is far too complicated to clarify how much it would cost or how long it will take to complete the job with a lot of interested parties intertwined and big uncertainties with many processes related to making a ship or plant. However, there’s been an old practice in Korean construction industry that a company gets a contract from a customer no matter what it takes by bidding the lowest price at an auction, lying about company’s capability or promising an infeasible due date. Once the contract is won, they ask customers for more money-double, triple even to quadruple-with an appropriate threat such as delaying the due date purposefully, charging for unnecessary materials bought or complaining that they can not finish the construction due to lack of fund. It didn’t work well on the international markets though. DSME had to bear a big portion of the extra expenses unexpectedly.

         The previous CEO, Go Jaeho(고재호), announced, through an electronic disclosure of financial statement, that the operating profits for 2013 and 2014 were $440m and $470m for each. No one ever questioned it and even the Deloitte Anjin accounting firm, which was responsible for the audit of DSME, kept silent. In early 2015, when Go JaeHo’s ambition had failed to keep his job as CEO in the second term, he suddenly shifted his ground making an outrageous statement that the company was not in profit but in a massive loss which the amount to $2.5 billion. It is a very reasonable assumption that he kept any knowledge about the losses in the dark to run for a consecutive term. Every investor got devastated in an immense shock from the fact that a company with a decent record of performance just yesterday suddenly became the company on the verge of bankruptcy today recording a 3-year-consecutive loss. The shock has peaked when a public disclosure of a new CEO, Jeong Seongrip(정성립), was released stating that there’s additional loss of $3 billion unreflected so that the loss is now in total $5.5 billion. The market immediately reacted with a long blue minus stick.

         It turns out that the company has never made any profit for the past 3 years as shown in the following chart. The investors had no choice left but to helplessly believe the financial statements the company forged and fabricated. It was that moment that the credibility of the entire Korean companies collapsed.  

         A company that was once dressed with its overflowing pride became a naked beggar asking for relief loan in a moment. The accounting audit company Anjin, now indicted by a group of shareholders, claimed ignorance at first saying that they didn’t know the detail due to industrial issues that a normal accounting firm can’t understand; but soon admitted that there have been errors in the accounting. Furthermore, DSME’s major shareholder, Korea Development Bank(산업은행), holding 49.7% as of now also has neglected all of the unethical issues that happened inside the company. The major holder implanted only one deputy in the company as CFO who, later revealed, was nowhere powerful enough to intervene in and influence the managerial decisions and, on the contrary, was rather isolated as an outsider by the incumbents inside the company. It seems undeniable that Korea Development Bank(산업은행) hasn’t played a given roll of monitoring and affecting DSME in a right direction.

         As a result, DSME is drawing a long descending slope on the stock price graph which is now only a tenth of what it used to be 3 years ago(38,000 to 4,000 won). It is true that the world economy is in a deep recession and the number of purchase orders is decreasing even some existing orders are being canceled. Nevertheless, the company in the time of crisis needs more conscientious and competitive managers.

         DSME situation is about, simply speaking, an ethic issue with a several unethical parties - 1) an incapable leader with unethical behaviors only seeking one’s own short-sighted pleasure, 2) a major shareholder that’s uncaring and indifferent to what is happening in its own company while playing with national tax, 3) a lazy and unethical audit firm that’s not carrying the very tasks the firm is hired for in the first place, 4) unethical industrial practices that forced or tempted managers to solely focus on getting contracts which end up with a huge loss and pain for small investors, and 5) wrongly designed and placed incentives for CEOs, major shareholders and audit firms.

         If necessary, Too-big-to-fail shall fail. It is meaningless to merely manage to balance on ice with wounded and festering legs. The legs need to be medically treated first so as to walk out of the ice area. An extreme and painful countermeasure must be taken. Simply firing or punishing people in charge is never a fundamental solution. A total restruction of incentives for each party in the economy is essential for Korean companies to enhance the competitiveness and to secure the sound financial frame to survive economic crises. A thorough review of cost accounting ought to be carried especially for shipbuilding and planting companies.

         Instead of forcing someone to be ethical, it is recommendable to design the system itself and the incentives in the way that leads people to act on ethics. It will be ideal that the biggest incentive matches the best interest of each party in an ethical way.