Since Lee Jae-myung received South Korea’s presidential election on June 3, the Korean inventory market has been on a tear. On June 2, the Korea Composite Inventory Value Index (KOSPI)—the weighted index of all frequent shares traded within the Korea Trade—closed at 2,698.97. Round two months afterward Aug. 4, the index closed at 3,147.75—a outstanding 16.6 % enhance, outpacing Japan’s TOPIX index (which noticed a 3.7 % acquire) and even the US’ Dow Jones Industrial Common index (6.7 % acquire) in the identical interval.
A few of this acquire comes from a easy sigh of aid that South Korea’s interval of uncertainty after the self-coup try by impeached former President Yoon Suk-yeol is over. But the honeymoon rally for Lee could signify one thing extra sturdy. Throughout the presidential election marketing campaign, he ran on a pledge that he would usher within the “KOSPI 5000 period.” Though it’s nonetheless early in Lee’s presidency, he’s already following by means of with insurance policies.
Traditionally, the South Korean inventory market has delivered poorer outcomes than the basics of its companies recommend, in a phenomenon termed the “Korea low cost.” Usually, a calculation known as the price-to-book a number of—i.e., market worth per share divided by an organization’s guide worth per share—is used to find out if an organization is overvalued or undervalued. The a number of is often greater than 1, as a result of the value of a inventory incorporates each an organization’s present property (represented by guide worth) and the corporate’s anticipated future earnings.
However at the moment, the South Korean inventory market has a ahead price-to-book a number of of 0.98, whereas the identical quantity for the Japanese inventory market is 1.5 and the equal for the Taiwanese inventory market is 2.3. Acknowledged otherwise, a inventory for a publicly traded Korean firm trades at two-thirds of the value relative to a inventory for a Japanese firm with the identical stage of property and roughly 43 % of a Taiwanese firm with the identical stage of property.
It’s a unusual phenomenon for an financial system recognized for being on the bleeding fringe of future applied sciences resembling semiconductors, electrical automobile batteries, and photo voltaic panels—which ought to trigger traders to put a excessive worth on Korean firms’ future prospects.
The Korea low cost has endured due to South Korea’s regulation and insurance policies that favor the founding households of chaebol teams, the megaconglomerates that dominate the Korean financial system.
In the US, for instance, it’s taken as a provided that the chief process of an govt of a publicly traded firm is to ship worth to its shareholders by pushing up its inventory worth.
Not so in South Korea—as a result of Korean executives are both themselves members of the founding household or reply solely to the founding household, whose management of the corporate isn’t threatened, no matter its inventory efficiency. By way of advanced and opaque cross-holding buildings, the founding household of a chaebol group sometimes controls dozens of firms with out essentially holding a majority of the issued shares. This permits members of the chaebol founding household to take measures that inure solely to their profit whereas damaging abnormal shareholders.
As an legal professional, I used to be a part of the authorized staff that handled one of the crucial infamous examples of such an abuse. In 2015, the Samsung group—South Korea’s main chaebol, recognized globally for its smartphones and semiconductors—orchestrated a merger between two of its key associates, Samsung C&T and Cheil Industries. Like many chaebol teams, the Samsung Group is comprised of round 80 firms, together with 17 listed firms. Though every listed firm has its personal board of administrators as a proper matter, they’re all finally managed by the Lee household, which based the group in 1938.
In 2015, Lee Kun-hee, the patriarch of the household, was on his deathbed. Earlier than the elder Lee handed away, the Samsung Group devised a plan to move down the management of the group to the inheritor obvious, Lee Jae-yong, whereas minimizing the potential property tax that may in any other case run to the billions of {dollars}. The Samsung Group’s plan was to intentionally damage the share worth of Samsung C&T, the group’s de facto holding firm, and inflate the share worth of Cheil, which was managed by the youthful Lee. Then Cheil would merge with C&T, successfully buying C&T on a budget.
Samsung’s execution of the plan led to absurd actions within the share worth of Samsung C&T. At one level, Samsung C&T’s share worth implied that the corporate’s worth was decrease than the worth of its shareholdings in different Samsung associates—as if a coat with a $100 b
sick in its pocket was being valued at $85. Then Cheil acquired Samsung C&T based mostly on the nonsensically low share worth, completely destroying the possibility for Samsung C&T’s minority shareholders to see their holdings get better their worth.
Regardless that the merger clearly damage Samsung C&T’s minority shareholders, Samsung’s founding household was capable of railroad Samsung C&T into voting in favor of the merger, partly by bribing then-South Korean President Park Geun-hye to strain the Nationwide Pension Service, the second-largest shareholder of Samsung C&T, to approve the merger.
This scandal later grew into worldwide litigation, with U.S.-based hedge funds Elliott Associates and Mason Capital Administration, which have been minority traders in Samsung C&T, suing the Korean authorities for damages. I used to be one of many attorneys who represented Elliott Associates, which prevailed in opposition to the Republic of Korea in an arbitration facilitated by the United Nations Fee on Worldwide Commerce Legislation in Geneva, Switzerland, held in November 2021.
One other instance is the 2022 preliminary public providing (IPO) of LG Vitality Answer, a pacesetter in electrical automobile batteries that holds greater than 14 % of the worldwide EV battery market. Till 2021, LG Vitality Answer was a division of LG Chem, which additionally operated divisions for petrochemicals, superior supplies, and life sciences. However in December 2020, LG Chem spun off its worthwhile EV battery division into the separate firm known as LG Vitality Answer.
Then in January 2022, LG Vitality Answer went public. The IPO, the largest in South Korean historical past, raised $10.8 billion. However it was additionally a logo of the distortion that causes the Korea low cost.
Whilst LG Chem’s EV battery division was rising as a worldwide chief, the share worth for LG Chem by no means absolutely mirrored the forward-looking worth of its EV battery division, as a result of traders have been cautious of the potential predatory conduct by the LG group’s founding household.
After the IPO, LG Chem traders have been left with a husk of an organization with out its most useful division. The height share worth for LG Chem in February 2021 was greater than 1 million South Korean received per share; simply over a 12 months later in March 2022, it dropped to as little as 437,000 received. However the drop in share worth meant little to LG’s founding Koo household, which controls each LG Chem and LG Vitality Answer, whereas the LG Group as an entire grew to become $10.8 billion richer.
South Korea’s weak company governance legal guidelines allow such predatory conduct. In the US, for instance, Jeff Bezos can not merely spin off Amazon Internet Providers (AWS), the cloud computing service that’s Amazon’s most worthwhile division, make himself the most important shareholder of AWS, and take it public. Doing so would provoke an instantaneous and large shareholder litigation marketing campaign from Amazon’s shareholders that may cease such transactions lifeless and sure end in private legal responsibility for Bezos, as a result of participating in transactions that clearly harm minority shareholders constitutes a breach of fiduciary obligation on the a part of controlling shareholders.
This was not the case in South Korea till very lately. On July 3, the Lee Jae-myung administration handed an modification to Article 382-3 of the Business Act to develop the scope of obligation for boards of administrators from “firm” to “firm and shareholders.” The modification additionally mandated administrators to “defend the curiosity of all shareholders and deal with the curiosity of every shareholder pretty.”
In different phrases, the modification precludes the board of administrators from taking steps that arguably profit the corporate—or, successfully, the corporate’s controlling shareholders—on the expense of the corporate’s minority shareholders.
Within the Samsung C&T merger, for instance, the board of Samsung C&T defended its motion by claiming that the merger would stabilize the Samsung group’s possession construction and make it much less weak to takeover makes an attempt from overseas hedge funds resembling Elliott or Mason. Below the brand new regime, railroading a vote based mostly on this sort of argument would expose members of the board to non-public legal responsibility for breach of obligation—and doubtlessly felony legal responsibility for occupational breach of belief.
The July change to the Business Act contained different measures to guard minority shareholders. Bigger public firms are mandated to carry on-line shareholder conferences and on-line voting to permit simpler participation by shareholders. When electing auditors, the controlling shareholders and associated individuals can not train greater than 3 % of the votes. Shareholders of a mother or father firm can now convey a category motion lawsuit in opposition to a director of a subsidiary firm. The amendments additionally impose higher disclosure necessities as to board minutes and the corporate’s possession construction.
The Lee administration has mentioned that it’s going to move extra legal guidelines to advertise South Korea’s inventory market. The federal government pledged that it might push firms to problem extra dividends, partly by mandating firms to extinguish most of their treasury shares. Different new legal guidelines would place higher scrutiny on inventory market manipulation and improve felony penalties. With Lee’s Democratic Celebration holding a majority within the Nationwide Meeting, South Korea’s unicameral legislature, the proposed payments are more likely to be handed within the close to future.
If these reforms might usher in a basic shift in investor attitudes towards the South Korean inventory market, the consequence could also be revolutionary. For Korean small cap traders, the funding of alternative has lengthy been actual property, as a result of the inventory market has been seen as vulnerable to manipulation and predation from the highly effective chaebol households. An extended-term funding technique like those generally utilized in the US is all however unimaginable, provided that, say, an LG Chem investor who purchased shares based mostly on the corporate’s prospect on EV batteries might get up in the future with shares in an LG Chem that now not has an EV batteries division.
For worldwide traders, historically cautious of investing in a rustic that produced such weak returns, an assurance that they are going to be protected against chaebol households’ abuse could present the consolation they should wager on the prospects of South Korea’s main know-how firms.
With more cash getting into the market, an enormous, sustained run for South Korean inventory market just isn’t tough to think about. If the Korea low cost disappears and the nation’s inventory market achieves a price-to-book ratio that’s similar to its Asian industrial friends resembling Japan or Taiwan, that alone would push the KOSPI index previous 5,000 from the present stage of round 3,100.
The inventory market reform may additionally have a optimistic aspect impact: controlling South Korea’s actual property market. Actual property regulation has lengthy been the Achilles’ heel of South Korea’s liberals, who struggled to regulate the nation’s financial progress fueling actual property hypothesis. South Korea’s world-class response in opposition to the COVID-19 pandemic stored its financial system buzzing, however a lot of the surplus capital generated by the roaring financial system poured into actual property, inflicting a runaway enhance in the price of housing. Throughout President Moon Jae-in’s five-year time period from 2017 to 2022, common residence costs in Seoul rose by an eye-watering 83 %.
Though Moon remained widespread till the top of his presidency, the grievance over the rising value of housing and property tax allowed a knife’s-edge win within the 2022 presidential election for conservative Yoon Suk-yeol. If Lee’s inventory market reform can break the ability of chaebol households and divert capital away from actual property, then he has the possibility to solidify a generational shift in each South Korean financial system and politics.
