While the Japanese stock market has recently enjoyed the successes of its corporate governance reforms, a similar campaign for change could be about to take shape across the Korea Strait.
Back in February, the South Korean regulator first proposed the Corporate Value-Up Programme, aimed at incentivising companies to address low valuations in order to tackle the so-called ‘Korea discount’.
Earlier this month, the Korean Financial Services Commission followed up its initial announcement with draft guidelines for the value up programme.
Under the proposals, participating companies select targets to improve their valuation based on key metrics, such as price-to-book and price-to-earnings ratios.
Indicators could also include non-financial metrics, such as improving corporate governance.
However, the guidelines place emphasis on autonomy and participation is voluntary, with no penalties for failing to meet set targets. Firms will also be able to adjust their targets at any point and issue correction notices.
“If the Korea discount narrows, it improves the wealth of the man on the street. That’s why I think there is more pressure on corporate governance,” says Nikko Asset Management portfolio manager Grace Yan.
“Some companies have been on the sidelines waiting to see what the government says before they do anything. But on the other hand, we do see other companies proactively taking a positive stance.
“Kepco, for example, which is a Korean utility provider, has said it would introduce shareholder value enhancement. It has also announced a dividend payout, given that its cash flow is now positive.”
Power imbalance
The ‘Korea discount’ is a term used to describe traditionally lower valuations when compared with its global peers.
While the discount can be partly attributed to the Korean market having volatile earnings tied to economic cycles, Federated Hermes’ lead portfolio manager for Asia ex-Japan Jonathan Pines believes the main cause comes from a unique power imbalance between controlling and minority shareholders.
“Over the last 10 years, Korea has performed almost as poorly as China. The key question is why? We believe the main reason for that is because of poor corporate governance. And when we talk about governance in the context of Korea, the laws are such that they enable controlling shareholders to mistreat minority shareholders and benefit at their expense.”
Pines says many controlling shareholders in the market prefer lower stock prices for two reasons – one is inheritance tax. With a sizeable number of companies family-owned in the market, there is an incentive to keep the share price low to reduce inheritance tax liabilities.
“It’s quite an interesting dynamic. When a founder passes away, the stock price often immediately goes up because investors understand that the incentive to keep stock prices low has partially gone away.”
“Korean laws allow controlling shareholders to force minorities out at the market price. So if the market price is low, they have continued opportunities to force minorities out cheaply. Stock prices are also low in response to pervasive mistreatment of minority shareholders.
“Related party transactions don’t need to be approved by minority shareholders, so you get these situations where a controlling shareholder can sell their own personal assets to the company that they control and no minority shareholder need approve that transaction, which leads to the perception of widespread abuse.”
There is a real desire to tackle corporate misbehaviour, Pines says, but this is combined with pride in the conglomerates and a belief among many politicians and citizens that leading executives need “support” for South Korea to do well.
“Controlling shareholders will, of course, support ‘voluntary’ measures. They will also likely support compulsory but inconsequential ones, such as tightening adviser regulations, easing foreign investor registration and enhancing individual savings account features. Why wouldn’t they?
“But none of these measures will meaningfully reduce the Korea discount.
“On the other hand, controlling shareholders are likely to resist the measures that will be effective in reducing the Korea discount, such as introducing a directors’ fiduciary duty to shareholders, or requiring minority approval for related party transactions. Indeed, we understand that some controlling shareholders consider these reforms to be ‘no go’s’.”
Semiconductor wave
While the Korean stockmarket is small in comparison with some of its global peers, dominated by companies such as Samsung and SK Hynix, managers are seeing opportunities in the country due to its technological expertise.
Templeton Emerging Markets Investment Trust (Temit) is overweight to the region in its portfolio. Portfolio manager Chetan Sehgal is particularly excited about the opportunities presented by supply chain diversification away from China.
“India and Korea don’t compete in many areas, but both of them compete with China,” he says. “India, in trying to get some manufacturing and engineering jobs, and Korea on the electronic and battery side. Particularly in electric batteries, Korea is a big supplier away from China.
“The other theme which is really propelling Korea right now is the semiconductor wave, which has come back. Last year, it was all about oversupply and memory prices were quite significantly down and that is now coming back because of interest in artificial intelligence and language models picking up.
“A lot of consumers are demanding these kind of applications and, apart from using the latest GPUs from Nvidia, there is also a requirement of high bandwidth memory. We have Samsung and Hynix, which are both in the memory industry and that is rebounding very well.”
This story first appeared on our sister publication, Portfolio Adviser.
