The South Korea discount will remain an issue despite the introduction of country’s Corporate Value-Up programme until the rights of minority shareholders are strengthened.
That is the view of Jonathan Pines (pictured), lead portfolio manager for Asia ex-Japan at Federated Hermes.
In February, Korea first proposed its Corporate Value-Up programme, which aimed to tackle the so-called Korea discount, the fact that many Korean companies trade at valuations which are on average among the lowest among their peers in other countries.
The programme was designed very much to follow in the footsteps of Japan, which has seen its stock market rally on the back of corporate governance reforms.
However, critics have argued that Korea’s Corporate Value-Up programme does not go far enough, even when compared with Japan.
The programme is voluntary, whereas in Japan, the system is based on a comply or explain basis.
However, Pines thinks that the problems run deeper than that due to the preponderance of controlling shareholders in Korea, which is not the case in Japan.
He notes that this is not something that the Corporate Value-Up programme seeks to address.
“You could say to be kind it (the Corporate Value-up Programme) starts to contribute to a change in culture. One company sees it and maybe there’ll be some kind of subtle pressure,” he said.
“But in our view, none of the subtle pressure is enough to overcome this massive vested interest that controlling shareholders have in the status quo.”
Pines sees two major reforms which are needed to overcome the issue with controlling shareholders, which he describes as a mixture of carrot and stick.
The carrot would be to reduce inheritance tax. Korea’s inheritance tax is currently as high as 50%, which is levied on inheritance in excess of W3bbn ($2.17m). This reduces the incentive of controlling shareholders to increase their share price.
In July, the government proposed reducing this to 40%, although it needs to get through the National Assembly, which is currently controlled by the opposition.
The stick is to introduce a fiduciary duty as Korea uniquely among most developed countries does not currently have a duty of care to shareholders, which allows controlling shareholders to benefit themselves at the expense of minority shareholders.
In Korea, directors are obligated to act in good faith for the benefit of the company as per articles 382-383 of the Korean Commercial Code, although this has been interpreted narrowly, drawing a distinction between the company’s interests and those of shareholders.
Pines is sceptical that without top-down reforms, any change will materialise.
“In Korea, there is a vested class of powerful people who don’t want change, because they don’t want to give up the significant benefits that they have from the current status quo.”
“In Korea, the controlling shareholders can force minority shareholders to sell shares to them at a low price, they can enter into related-party transactions with the companies they control without getting approval, so they are allowed to do all kinds of things that benefit themselves at the expense of minority shareholders.”
This naturally begs the question why Pines is currently overweight Korea.
“The reason is because Korea is extraordinarily cheap. Following China’s run, Korea is now the standout cheapest country in Asia ex-Japan. We don’t see much downside in any reasonable scenarios,” he said.
Indeed, the Kopsi currently trades at a price-to-book ratio of 0.91x compared with 1.14x for the H-share index and 1.37x for the Shanghai Composite index.
Regarding the two risks which are often cited in relation to Korea, the fact that Korean companies may struggle if the AI boom fizzles out and the market’s correlation to China, Pines is dismissive of both, pointing out that valuations in Korea are currently not factoring in the significant upside potential of AI, while the market’s correlation with China is overstated.
“If you take Samsung Electronics, it currently trades at 1x book value, which is an extraordinarily cheap valuation for a company that is still dominant in memory. So what you’re scared of has already happened. Samsung is not being rewarded in any way for AI,” he said.
“In the case of China, yes, there is some correlation between the two markets. The main source of correlation is they both derive benefits from exporting. But as we’ve seen lately, the Chinese market has ramped up and Korea hasn’t. If you’re saying there’s correlation between China and Korea, then why hasn’t Korea posted any solid gains?”
