The Tunneling Effect through M&A between Affiliated Firms: The Case of WooWon Development

This paper examines an example of the tunneling effect between affiliated firms at an M&A. Specifically, the controlling shareholder of WooWon Development, who also controls WooWon Infra, expropriates the wealth of WooWon Infra’s minority shareholders through an opportunistic choice of valuation models at the M&A. The controlling shareholder of both firms chooses to opportunistically use the standard stock price for Woowon Infra’s firm value, which is lower than the net asset value, while he uses a specific valuation model to overestimate the corporate value of Woowon Development. In addition, the appraisal rights of WooWon Infra’s minority shareholders, who have opposed the M&A, were valued much lower than the firm’s net asset value. As a result, the wealth of WooWon Infra’s minority shareholders, who owned about 83% of shares following the M&A, was transferred to the majority shareholder of WooWon Development upon the M&A. This paper demonstrates that the choice of WooWon Development’s valuation model, its model inputs, and the value of the appraisal rights can significantly affect the amount of wealth transferred. Moreover, this paper shows that tunneling is more likely to occur by adjusting income of the target firm before the M&A when the acquiring and target firms are owned by the same majority shareholder. This paper sheds light on the debate to improve the relevant laws to protect minority shareholders.