GLOBAL investors have been pouring money into South Korea’s stock market in the hope that a government drive to make company boards more accountable to shareholders will boost depressed valuations.
President Yoon Suk Yeol has made fixing the “Korea Discount” a priority as he seeks to win favour with the country’s growing base of retail investors. He is not the first leader to try, and he will need to overcome powerful business interests that have benefited from the status quo.
1. What is the Korea Discount?
South Korea is home to world-class companies such as Samsung Electronics, Asia’s largest electronics company, and Hyundai Motor Group, the world’s third-largest automaker. But investors often price them below their book value and lower than oversees rivals, such as Taiwan Semiconductor Manufacturing Co (TSMC) or Toyota Motor, even when they achieve a comparable level of profitability. One explanation often given is the risk discount placed on South Korean assets because of the country’s stand-off with nuclear-armed North Korea. More credible reasons can be found in the corporate structures that were pillars of the nation’s “miracle economy” but may now be holding it back.
2. How did we get here?
Korea’s decades-long transformation from economic minnow to industrial giant owes much to its sprawling, family-run conglomerates known as chaebols. These include LG Electronics, Hyundai, SK, Lotte and, largest of them all, Samsung. Now run by the second or third-generation descendants of their founders, the chaebols – meaning “wealth clique” in Korean – enjoy oversized influence and have often had cozy relationships with governments that were highlighted by a series of influence-peddling scandals. There are now 64 conglomerates that fit the traditional definition of a chaebol, according to Korea’s Fair Trade Commission. The combined turnover of the five biggest chaebols is equal to about 45 per cent of South Korea’s gross domestic product as of 2022, according to estimates from the Citizens’ Coalition for Economic Justice.
Chaebols exert control over hundreds of listed companies, thanks to a complicated web of cross-shareholding. Their founding families often control the boards and the management of those listed companies and are accused of ignoring the interests of other shareholders. Critics say they keep their share prices artificially low in order to avoid Korean inheritance tax, which is among the highest in the world. Challenging this arrangement is seen as crucial for the government’s overhaul to have teeth.
3. Why is the Korea Discount a problem?
The Korea Discount dampens economic growth by making it harder for companies to raise affordable capital close to home. Foreign investors are discouraged from holding Korean equities for the longer-term, preferring to flip in and out of stocks for quick gains, in part for fear of being penalised by corporate decisions that go against the interests of minority shareholders.
The relative absence of a large pool of long-term investors is often blamed for making Korean stock prices volatile. The Korea Discount is also one reason why many South Koreans have avoided investing in stocks in the past, preferring to put their money in real estate or US stocks, depriving the country’s capital markets of much of the wealth generated by rising disposable incomes.
4. How big is the Korea Discount?
Take Samsung Electronics, South Korea’s most valuable company. The world’s largest maker of memory chips trades at slightly above its book value, whereas Taiwanese arch-rival TSMC is worth more than five times the value of its balance sheet assets. If Samsung Electronics matched the price-to-book ratio of US rival Micron Technology, its valuation would double.
Overall, companies on the benchmark Korean Kospi share index trade roughly on a par with their book value, while Taiwanese stocks change hands for twice their book value. Korea Capital Market Institute researchers who studied the price-to-book ratio of listed companies in 45 countries found South Korea sat in 41st place. They blamed weak shareholder returns, low profitability and poor growth prospects.
5. What is the government doing about it?
It has been taking steps to improve access to capital markets for investors and revising systems and rules to better protect the rights of minority shareholders. One of the most keenly awaited steps was a “Corporate Value-up Program” announced in late February aimed at pushing listed companies to voluntarily improve shareholder returns and reform corporate governance in return for tax benefits. The program takes a cue from Japanese corporate reforms that helped to push stocks to multi-decade highs.
South Korea’s financial regulator says the idea is to propel South Korean stocks higher over the coming decades, rather than provide a short-term boost. President Yoon has zeroed in on the high inheritance taxes that give an incentive to controlling shareholders to keep a lid on stock prices.
6. How did Japan do it?
The chaebols are widely believed to have been influenced by Japan’s zaibatsu – both share the same Chinese characters and meaning. Like the chaebols, zaibatsu were family-controlled conglomerates that dominated Japan’s economy until they were disbanded by the US after World War II. While some Japanese companies have founding families in management, the practice is not as widespread as it is in Seoul, with their influence non-existent in long-standing conglomerates such as Mitsubishi UFJ Financial Group and Sumitomo Mitsui Financial Group.
Japan’s corporate reforms began almost a decade ago, when the government of Shinzo Abe introduced measures to prod managers to boost the valuations of their companies. At first, many did just the bare minimum to comply with the requirements, which included installing more outside directors on boards. The efforts eventually gained traction, and a tipping point arrived in 2023 when the Tokyo Stock Exchange asked companies to come up with capital efficiency plans, forcing many to turn lip service into concrete action. The growing presence of activist investors in Japan has made CEOs more aware that they can lose their jobs if they keep ignoring the demands of investors.
7. What are the next steps?
The government plans to issue detailed guidelines by the end of June that will serve as a template for listed companies to disclose voluntary measures to improve shareholder returns and corporate governance. Depending on the results of National Assembly elections on Apr 10, the government may seek to drum up support for a revision of laws that require parliamentary approval, such as a lowering of inheritance tax rates.
Other milestones that could add momentum to the government’s reform push include MSCI’s annual country classification review, with the government hoping for an upgrade to “developed market” status from “emerging market”. FTSE Russell will also decide whether to include South Korea in its World Government Bond Index. BLOOMBERG
