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Doctoral dissertation called “Political Connections and Allocative Distortions” recently submitted to the London Business School by David Schoenherr

A recently submitted academic paper argues that former president Lee Myung-bak’s connection with Korea University and Hyundai Engineering and Construction influenced the area of public procurement during Lee’s presidency, resulting in between 0.21% to 0.32% of damage to the yearly gross domestic product (GDP).

In a doctoral dissertation called “Political Connections and Allocative Distortions” recently submitted to the London Business School, David Schoenherr concluded that companies connected with Lee, who had previously studied at Korea University’s business school and served as the president of Hyundai Engineering and Construction, were given special treatment in the area of public procurement during Lee’s time in office, which created a distortion in the allocation of resources.

In the dissertation, Schoenherr provides two definitions of companies that were connected with Lee. First, there were those whose president at the time that Lee became the head of the Grand National Party (today’s Saenuri Party) in Aug. 2007 was a graduate of the Korea University business school or a former employee at Hyundai Construction and was not replaced in the first half of 2008. Second, there were those whose CEO in the first half of 2008 was a graduate of the Korea University business school or a former employee of Hyundai Construction.

Next, Schoenherr analyzed the relationship in the public procurement market between those private firms and state-owned companies whose executives were appointed by President Lee.

As evidence that the presidential connection exerted an influence during Lee’s term in office, Schoenherr noted that the percentage of chief public prosecutors who were graduates of Korea University rose from five to 11, that the percentage of minister-level officials from that university increased from 11.7% to 13.3%, and that the percentage of high-ranking officials in the Blue House from the university increased from 14.7% to 22.9%. He also suggested that this kind of connection would have had a “trickle down” effect on lower positions in these organizations.

As a sample for analysis, Schoenherr took public procurement contracts carried out online through the Korea ON-line E-Procurement System by 630 publicly listed companies between the time that Lee was chosen as the presidential candidate by the Grand National Party until 2011, the year before the next presidential election. He then compared the public procurement contracts of companies connected with Lee with those unconnected with Lee for approximately three years after Lee took office (Q2 of 2008 to Q4 of 2011) and for the previous three years (Q3 of 2004 to Q1 of 2008).

As a result, Schoenherr found that the number of public procurement contracts won by companies that were connected with Lee increased by 3.03% percentage points over companies with no such connection.

But such contracts often did not end well. In the area of construction, contracts won by companies connected with Lee were 11.48% more likely to end badly - with a delay in construction, for example - than those won by unconnected companies.

In particular, the percentage of contracts that ended badly in which both the state-owned companies and the private firms were connected with Lee’s networks was 40.5% higher than when the public company awarding the contract was not connected with Lee.

In the end, Schoenherr concludes in his dissertation that companies that were connected with Lee won more contracts in public procurement after Lee became president and that this resulted in a distortion of resource allocation. Based on his tentative calculations, public procurement contracts were funneled to companies connected to Lee, adding 17 to 27 cents to each dollar of cost. The total cost to society, Lee said, was from 0.21% to 0.32% of the yearly GDP.

Given that South Korea’s GDP for 2010 was around 1.27 quadrillion won (US$1.04 trillion), this would mean a social cost ranging from 2.66 trillion (US$2.19 billion) to 4.5 trillion won (US$3.71 billion).

“What we know for sure is that the social loss resulting from such political connections occurs not only in South Korea but also in Germany and the UK,” said Schoenherr in an email interview with the Hankyoreh. “The reason that I chose the Lee Myung-bak administration for my analysis is that I was able to access data related to these connections.”

“There were already papers analyzing how political connections affect company value,” said Choi Han-soo, an analyst with the Korea Institute of Public Finance who read the paper. “I would say that the significance of this paper lies in the fact that it went beyond this to assess how political connections affect not only corporations but also society.”

Schoenherr’s dissertation can be found at the website of Social Science Research Network (ssrn.com), a database of academic papers.

By Lee Jeong-hun, staff reporter

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