Will proposed corporate governance reforms help to narrow the “Korea discount”?

The tendency for South Korean companies to trade at lower valuations than their global peers, in large part because of a poor record in corporate governance, has long been a feature of South Korea’s equity market. However, change may now be afoot with the government’s Corporate Value-up Program, announced in February. Could the proposed reforms help to narrow the so-called “Korea discount” and build on the momentum gathering pace elsewhere across Asia to improve corporate governance and shareholder returns?

The historical context

South Korea’s socioeconomic history has had a pronounced impact on the country’s approach to corporate governance. We believe that its poor track record in protecting minority shareholders’ interests, and its consequently lower equity valuations, can be largely explained by the dominance “chaebols” — opaque family-owned business conglomerates.

In the post-war reconstruction era, South Korean chaebols grew rapidly thanks to government sponsorship and strict limits on foreign ownership. This protectionist set-up indirectly contributed to opaque circular ownership by enabling controlling families to expand their businesses without ceding control to foreign capital. During the 1997 Asian financial crisis (AFC), many chaebols were forced to restructure by foreign creditors, further fuelling concerns about foreign control. A tendency to hoard cash also became prevalent.

Tax legislation has been another important factor in the evolution of corporate governance in South Korea. Dividend taxes approaching 50% act as a powerful brake on the payment of dividends. As a result, dividend yields in South Korea have consistently trailed emerging markets for over 20 years. And punitive inheritance taxes incentivise companies undergoing intergenerational wealth transfer to hoard cash and suppress valuations, to the detriment of minority shareholders.

What’s different this time?

Two previous attempts at corporate governance reform had limited success. Between 2014 and 2016, “Choinomics” — South Korea’s answer to Japan’s “Abenomics” — was short-lived given former President Park Geun-hye's impeachment. Her close ties to the chaebols also fed the public’s perception that the proposed tax measures would disproportionately benefit the wealthy. Reforms proposed between 2018 and 2020 by President Moon Jae-in, this time targeting chaebols, were equally ineffective given strong opposition from the chaebols and a change in priorities following the outbreak of the COVID pandemic. These failed attempts at corporate governance reform highlighted that, to be successful, reforms needed to be long-term oriented, especially given the deeply entrenched nature of the “Korea discount”, and have the widespread support of market participants.

In our view, the current push for reform differs from previous attempts for a number of reasons:

• Increased retail investing and political incentives — While South Koreans’ household net worth has historically centred around property, in recent years and especially since the COVID pandemic, South Korea’s equity market has become increasingly popular as a place to invest excess savings. Between 2016 and 2022, for example, the number of retail investors grew from 9.5% of the population to 27%. In the run up to April’s general elections, we have seen strong bipartisan support for the proposed reforms to boost shareholder value and bring South Korea’s capital market regulations in line with global standards. This consensus reflects the growing interest in retail investing but also the impact of a potentially extended downturn in the real estate sector.
• Lessons from Japan — Japan’s equity market hit all-time highs earlier this year, in part helped by a raft of corporate governance reform efforts. Looking to emulate Japan’s success, politicians and regulators have given their strong backing to South Korea’s latest efforts at reform. The government’s Corporate Value-up initiative includes guidelines to support companies’ voluntary disclosure of their corporate value plans, as well as tax incentives and benefits for companies taking measures aimed at increasing their corporate value. A Korea Value-up Index will also be created, for companies with “proven records of profitability or those anticipated to boost their corporate value”. And the Stewardship Code will be revised to “ensure institutional investors take into consideration listed companies’ value enhancement initiatives”. Unlike in Japan, however, South Korea faces challenges from the prevalence of strong controlling shareholders who have, in the past, been reluctant to accept reform.
• Growing investor activism — As in Japan, activist investors are increasing their presence in South Korea. Only 10 companies faced activist demands in 2020, but that number grew to 77 in 2023. Activism has typically tended to fail in South Korea given the strength of controlling shareholders, but progress on corporate governance reform could start to buck this trend. And as Figure 1 illustrates, while the number of shareholder proposals has increased much more significantly in Japan in the past decade, the numbers are also rising in South Korea, albeit from very low levels. 

Figure 1

The importance of engagement

It is vital to understand the impact of South Korea’s unique governance history and the proposed reforms at the individual company level to help us make more informed investment decisions and tailor our engagement strategies to create value for our clients. 

We view active engagement as key to identifying companies with a wide range of ESG opportunities or risks and, as illustrated in Figure 2, we undertake a broad range of regular long-term engagements, including with independent board members, with companies at different stages of their governance journeys. For example, in the case of an auto original equipment manufacturer (OEM), our long-term engagement programme helped us identify a meaningful shift in its attitude towards shareholder value creation after the company underwent management changes in 2020. The company refreshed its board, improved its payout ratio, changed the focus of management’s key performance indicators from volume growth towards profit growth and proactively worked with labour unions to avoid costly strikes, which had hurt the company in the past.

Figure 2

The path ahead

South Korea’s Corporate Value-up Program exemplifies the growing Asia-wide focus on improving corporate governance and shareholder returns. China, for example, is also considering corporate governance reform — its State-owned Assets Supervision and Administration Commission recently announced that it is studying the potential inclusion of more market-friendly key performance indicators for state-owned enterprises.

We think the drive for improved corporate governance has the potential to create a number of investment opportunities in South Korea, particularly in autos and holding companies and, to a lesser extent, the financials and telecom sectors. The Corporate Value-up Program is due to be implemented in the second half of the year after further feedback from stakeholders in May. We’ll be continuing to closely monitor developments in South Korea as well as Asia more broadly.