South Korea's Corporate Governance Program Faces Challenges in Tackling 'Korea Discount'

The measure for improving corporate governance in South Korea through the "Corporate Value-up Program" might not be sufficient to address the undervalued stock markets and the so-called "Korea discount." On Monday, the country's Financial Services Commission announced the program aimed at enhancing shareholder returns with incentives, including tax benefits.

Comparison with Japan's Corporate Governance Push

South Korea, as Asia's fourth-largest economy, is striving to raise its stock market valuations, which are notably lower compared to its peers. Analysts have pointed to the existence of the "Korea discount" to describe this phenomenon. While the FSC's program shares similarities with Japan's, the effectiveness may differ. Japan's corporate governance measures, coupled with strong earnings, have propelled Tokyo markets to record highs after 34 years.

Unique Challenges with South Korean Markets

One of the distinguishing features of South Korean markets is the prevalence of "chaebols," which are sprawling family-owned conglomerates such as Samsung Electronics, LG, SK, and Hyundai. The influence of these large family-controlled corporations, particularly the limited say of minority stakeholders in critical decisions, has been cited as an essential factor contributing to the "Korea discount."

Insights from Financial Analysts

"The key issue is that 'Korea discount' exists because controlling shareholders take disproportional benefits," stated James Lim, a senior research analyst at Dalton Investments. He highlighted the challenge posed by the higher number of companies with strong controlling shareholders in Korea compared to Japan.

The resistance from controlling shareholders presents hurdles to enacting changes swiftly. However, aligning measures with the interests of both controlling and minority shareholders could facilitate faster implementation.

FSC's Initiatives and Future Plans

The Korean Financial Services Commission has urged listed companies on the Korean Stock Exchange to voluntarily establish and disclose plans for enhancing valuation. This effort aims to introduce greater transparency and bolster market returns. Detailed guidelines will be framed, and a dedicated web portal will be set up in June, enabling companies to disclose their plans in the second half of 2024.

Assessment from Portfolio Managers

"The behavior that leads to South Korea's low stock prices is motivated, and therefore seeking to coax South Korean controlling families into 'being nice' to minority stockholders is unlikely to be successful," remarked Jonathan Pines, lead portfolio manager of Asia ex-Japan at Federated Hermes. He emphasized the substantial financial benefits that family-controlled companies in South Korea currently derive from the regulatory status quo.

While recent measures indicate a step in the right direction, experts assert that more substantial actions need to be taken to address corporate practices favoring controlling stakeholders over smaller shareholders.

Need for Strong Reforms

Experts argue that targeted and robust reforms are essential for South Korean markets to achieve a similar rally as Japanese markets. They advocate for laws mandating company directors to be accountable for enhancing shareholder returns, rather than merely being "loyal" to the company.

Furthermore, it is suggested that South Korean companies should propose plans to elevate stock prices to at least their book value. The price-to-book ratio is identified as a crucial metric for evaluating whether a company's shares are undervalued. For instance, the price-to-book value of Samsung Electronics stands at 1.40, while that of Taiwan-listed Taiwan Semiconductor Manufacturing Company is 5.23, and that of U.S.-listed Apple Inc is 37.80.

South Korea’s efforts to improve corporate governance are a step in the right direction, but more comprehensive and targeted reforms are necessary to address the challenges related to the "Korea discount" and undervalued stock markets.