Fast reading
- The dominance of ‘chaebols’ – large, family-owned business conglomerates – has contributed to limited protection for minority shareholders in South Korea and, as a result, lower equity valuations.
- In addition to complex shareholding and ownership structures, other concerns include: sizeable balances of shares sometimes held in treasury; directors having no legal fiduciary duty to company shareholders; lack of tag-along rights for minority investors around takeovers, resulting in minority shareholders being more vulnerable.
- The Corporate Value-Up Programme announced in February includes guidelines for voluntary corporate value disclosures, tax incentives, and benefits for companies that enhance their corporate value. A South Korean Value-Up Index is set to launch – showcasing companies that have proven profitability or potential for value enhancement – and the Stewardship Code is set to be revised.
The South Korean stock market has long been characterised by domestic companies trading at lower price-to-earnings multiples than their global peers (see Figure 1). As a mature economy, South Korea is less likely to grow at high rates seen elsewhere in emerging markets. It is one of the reasons behind the so-called ‘Korea discount’, along with the cyclical nature of many sectors in South Korea. However, another crucial factor behind the low valuations is the poor corporate governance in the country.
The dominance of ‘chaebols’ – large, family-owned business conglomerates – has contributed to limited protection for minority shareholders and, as a result, lower equity valuations. In addition to complex shareholding and ownership structures, other concerns include:
- Sizeable balances of shares sometimes held in treasury;
- Directors having no legal fiduciary duty to company shareholders;
- A lack of tag-along rights for minority investors around takeovers, resulting in minority shareholders being more vulnerable.
Figure 1: South Korean equities lag other markets
Addressing the issue
The Seoul government’s new ‘Corporate Value-Up Programme’, announced in February, aims to address this issue and reduce the ‘Korea discount’. Japan’s benchmark Nikkei 225 Index hit its highest ever level this year, partly due to the country’s corporate governance reforms, and South Korean politicians and regulators are keen to replicate Japan’s success.
The Corporate Value-Up Programme includes guidelines for voluntary corporate value disclosures, tax incentives, and benefits for companies that enhance their corporate value.
A South Korean Value-Up Index is set to launch this year, showcasing companies that have proven profitability or potential for value enhancement. The Stewardship Code, meanwhile, is set to be revised to ensure institutional investors consider value enhancement initiatives. Such changes are welcome and well-intended, but meaningful corporate governance reforms in the country still face strident opposition from powerful controlling shareholders.
The government under President Yoon Suk Yeol does not have a majority in the National Assembly and, in the face of robust opposition, may struggle to pass any significant laws.
Given that Japan’s reforms took over a decade to facilitate significant change, South Korea’s reforms should not be expected to happen overnight.
However, retail investors now make up one third of the market which should provide further bipartisan support for reforms that seek to boost shareholder value. Activist investors, meanwhile, are becoming more prevalent.
Further details on the Corporate Value-Up Programme are expected in the second half of the year, which we will be watching closely. Previous attempts to level the playing field between South Korea’s conglomerate owners and minority investors did not result in significant change so there rightly remains plenty of scepticism.
However, given that Japan’s reforms took over a decade to facilitate significant change, South Korea’s reforms should not be expected to happen overnight but should be considered an important starting point for long-term improvements.
Effective Engagement
Although this is a positive development and we have stocks that will benefit from the programme, our investment thesis is not reliant on it. We continue to focus on companies that have a solid underlying business as well as superior quality metrics in key parameters that should continue to increase their intrinsic value. Therefore, any upside from Value-Up will be an added optionality for the portfolio.
We also continue to engage with companies on corporate governance issues. Earlier this year, we wrote to all of our South Korean holdings to encourage them to establish (and disclose) more investor-friendly policies covering dividends, the use of share buy-backs and approach to mergers and acquisitions (M&A). We also used the opportunity to request that companies provide shareholders with the opportunity to vote on significant related-party transactions and, in some cases, to flag the need for more international corporate experience on boards, including at Samsung Electronics, LG Chem and Hansol Chemicals.
This latter issue is particularly relevant in South Korea where independent directors on boards often come from academic backgrounds rather than an international corporate pool – an issue exacerbated by the stringent over-boarding rules in South Korea which prohibit directors from sitting on more than three boards at one time.
Extract of letter to South Korean holding:
‘We note that your dividend payout ratio has been below 20% for the last five years. While we appreciate the need for investments in future growth, we believe that this is overly conservative, particularly in an upcycle, and out of step with best practice as evidenced by global peers. We encourage you to revisit this as soon as possible and set out your future approach to capital allocation in a ‘Shareholder Returns Policy’ covering dividends, buy-backs, treasury shares and M&A in particular.’
Some companies are already taking action as a result of Value-Up and engagement from minority shareholders.
For example, KB Financial has increased its shareholder returns, predominantly via buy-backs and treasury share cancellations, as well as allowing a potential increase in dividend payouts over the longer term.
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