One Day, 816 Meetings: Where South Korean Reform Begins

(Bloomberg) -- Investors considering South Korean stocks in the past few weeks had plenty of geopolitical reasons to hesitate before buying. But once the diplomatic air clears, a far deeper challenge will remain: a shareholder climate that’s been at times downright unfriendly.

To get a sense of just how arcane and impenetrable South Korea’s corporate regime is, imagine being a local investor running around the country, trying to attend all of the annual general meetings scheduled on March 25 last year.

Yep, all 816 of them.

That’s about 40 percent of the more than 2,000 AGMs in South Korea all last year, all happening on the same day. In fact, if they were scheduled back-to-back in a 24-hour period, that would allot just under two minutes per meeting -- hardly enough time to hit the refreshments table.

By contrast, the busiest day for AGMs in the U.S. -- which hosted more than 4,600 of them last year -- was on May 19, with a whopping 158 gatherings, according to data compiled by Bloomberg.

“That’s really a peculiarity of the market,” said Michael Herskovich, head of corporate governance with the environmental, social and governance (ESG) research team at BNP Paribas Asset Management, on the phone from Paris. “When you have such a concentrated market it’s harder to do engagement for investors. That’s something that is a challenge in Korea -- to have a change in culture to do engagement throughout the year.”

Chaebol Reform

The Korean government has encouraged use of an electronic voting system since 2010 to at least make investors’ shares count. But needing a time machine to interact with and meet management face-to-face remains one of the more absurd examples of the litany of governance issues that have long plagued the nation.

At the root of South Korea’s problems is the chaebol -- family-owned dynastic conglomerates that emerged amid reforms from President Park Chung-hee beginning in the 1960s. They rose to prominence by propelling blinding economic growth in the following decades that established the country as a leading market in Asia.

The chaebols derive their power from complex cross-ownership share structures woven across many businesses, Herskovich said. This insular structure can foster a lack of accountability to external minority shareholders, low dividend yields and share buybacks, and cronyism with large asset managers who have gotten too cozy with their investments, according to analysts. The top five chaebols -- Samsung, Hyundai, SK, LG and Lotte Group --account for more than half of the weightings in the Kospi index of stocks, according to data compiled by Bloomberg, exerting huge force on markets, the economy and government.

The model has led to charges of rampant corruption, including the influence-peddling scandal that engulfed the elder Park’s daughter Park Geun-hye -- whose presidency ended in scandal and impeachment -- and with Samsung Group’s heir apparent Jay Y. Lee convicted Aug. 25 of bribery and sentenced to five years in prison. Lee’s lawyer said he will appeal the verdict “immediately.” Samsung declined to comment on the ruling.

While these problems are not new, the set of circumstances leading to the election of President Moon Jae-in in May has him uniquely poised to confront these issues and succeed where others have failed, voted in by a populace galvanized for change.

“All the pieces are in place. Now is probably the best chance you’re going to get,” said Gregory Elders, Bloomberg Intelligence ESG senior analyst in an interview from New York. “That’s really the question now, is how much can the president follow through? How much is he willing to follow through? If the reforms start happening, money will follow with activist investors.”

Moon’s made tackling the chaebol issue a priority from the start of his administration.

“I’ll take a lead in chaebol reform,” Moon said in his inaugural speech May 10, as translated by Bloomberg. “Under the Moon Jae-in government, the word of ‘politics-business collusion’ will completely disappear.”

5-Year Plan

As part of its five-year plan for growth unveiled in July, Moon’s government unveiled proposals Aug. 2 to raise taxes on the country’s largest corporations and high-earning individuals to help address inequality. Alongside the tax increases, Moon is targeting a gradual reduction in cross-shareholdings, stiffer punishment for stock manipulation and greater empowerment to the Fair Trade Commission to monitor unfair deals.

“We hope executives at companies do not consider shareholders’ exercising their rights as a barrier for management,” said Son Young-chae, head of the fair market division with South Korea’s Financial Services Commission, the country’s top financial regulator. “Cooperate with them as part of efforts to boost long-term value of companies, rather than focusing on earnings in the short-term only.”

While it’s unrealistic to expect Moon to completely dismantle the chaebol system, the path to unwinding the tentacle-like web of chaebol ownership and thus true reform starts with greater transparency, Elders said. That includes clarity in the voting process and clarity in ownership structure for both conglomerates and the institutional asset managers who need to do more to hold the companies accountable on behalf of regular investors, he said.

“SK has been doing our best by striving for responsible management and considering society and shareholders’ interests and also through changing into a holding company structure,” the company said in an email.

SK units SK Telecom and SK Hynix have introduced new rules that donations of more than 1 billion won need to be approved at a board of directors meeting, the company said.

Lotte Group meanwhile is working towards a holding company structure to help unravel the web of its cross-shareholdings and encourage more transparency, a spokeswoman said in an email.

“We will do our best to enhance the value of businesses at each affiliate under the group and the interests of shareholders,” she said.

Stewardship Code

When it comes to developing a game plan for these changes, Korea can learn a few lessons from its neighbor Japan. 

Prime Minister Shinzo Abe has made governance reform one of the three arrows of his Abenomics economics strategy, ushering in changes to the corporate culture of companies and investors.

The Government Pension Investment Fund of Japan, the world’s largest such fund, has been a supporter of the country’s voluntary stewardship code -- a series of principles introduced in 2014 designed to push for greater transparency and accountability from asset managers. South Korea introduced its own voluntary stewardship code in December, but as yet lacks the support of the country’s National Pension Service, the world’s third-largest pension fund, managing 589 trillion won ($522 billion) as of May 2017, which is still reviewing the guidelines.

Chi Young Hye, a spokeswoman with NPS, said the study may be completed by the end of this year.

Japan Example

“The adoption of the Japanese stewardship code resulted in a positive impact on the Japanese stock market,” Chan H. Lee, Seoul-based managing partner with Petra Capital Management, said in an email. “Similarly, the adoption of the Korean stewardship code by NPS will bring in positive results in improving the Korean corporate governance. NPS is the largest stock investor in Korea and many institutional investors are likely to follow their suit.”

External managers who oversee NPS assets will also be bound by the code if the pension fund adopts it, expanding its reach even further, Lee said. More than 40 asset management companies in South Korea have submitted plans to the Korea Corporate Governance Service to adopt the stewardship codes. KCGS, which wrote the code approved by the top regulator, is a private organization sponsored by the government and other financial institutions.

However, complicating matters is the pension fund’s alleged involvement in the trial of Samsung’s Lee, which has left it “slightly more in a weakened state” when it comes to exerting influence on investor stewardship, Elders said.

The NPS was the deciding vote in a 2015 merger of two Samsung units to give Lee greater control over the conglomerate. The former chairman of the pension fund, Moon Hyung-pyo, was convicted in June for pressuring the fund to vote for the merger and sentenced to 2 1/2 years in jail. Moon, who was the minister of health and welfare at the time and became NPS chairman after the merger, is appealing the case. Huh Hyun-chang, a spokesman at NPS, declined to comment on the Samsung case.

Lee’s case, the so-called “trial of the century” in South Korea, saw prosecutors accuse the billionaire of bribing a presidential confidante, Choi Soon-sil, to increase his control over Samsung. Choi denies all charges against her. A special prosecutor has focused on Samsung’s contributions, including a 1 billion won horse given to Choi’s daughter. In testimony, Lee confirmed Samsung gave millions to Choi’s foundations but denied the company sought favors in return.

Samsung’s shares closed 1.96 percent down to 2.305 million won on Monday.

Controversial Case

On the corporate side, Japan’s Tokyo Stock Exchange adopted a comply-or-explain corporate governance code in 2015 that includes principles guiding proper dialogue with and equal treatment of shareholders, appropriate information disclosures and transparency, responsibilities of the board, and appropriate cooperation with stakeholders other than shareholders. As of the end of 2016, virtually all of the more than 2,500 companies listed on the first two sections of the exchange have submitted reports on compliance with the code, with 85 percent at 90 percent or more compliance.

While South Korea requires firms report their greenhouse gas emissions and energy usage, there is no wider corporate governance code in the country, according to a 2016 report on global investment regulation from index provider MSCI Inc. and the Principles for Responsible Investment, an investor initiative supported by the United Nations.

Korea Discount

Investors are optimistic these changes will open up the Korean market and, in time, eliminate the so-called Korean discount.

The discount is a longstanding valuation gap between Korean equities and their global peers, seen across a wide range of financial metrics. The Kospi 200 Index, a gauge of leading Korean companies, currently boasts a valuation of 9 times its consensus estimate of 12-month forward earnings. The Nikkei 225’s forward P/E ratio meanwhile stands at 16.1 while the S&P 500 is at 17.4 as of Aug. 25, according to data compiled by Bloomberg.

“Korean equity markets have always been the cheapest in Asia purely because people put a corporate discount on it,” said June Chua, fund manager and head of Asian equities at Harvest Global Investments in Hong Kong. Her firm manages about $114 billion as of March 31. “If this can be removed, I think it’s good news for Korea.”

A more accountable and transparent Korean market would make it a much more attractive investment, Chua said. There are signs already that tides are starting to turn, with Samsung making the surprising decision in April to cancel treasury shares instead of hanging onto them, she said. The company-held stock, which only gains voting rights when sold, can be transferred to third parties that will back the companies up on contentious decisions.

The decision to cancel Samsung’s treasury shares “helps further enhance value for its shareholders,” Samsung spokesperson So-eui Rhee said.

First Dividend

Samsung also announced its first-ever quarterly dividend at the time. The move was an apparent concession to calls from U.S. activist investor Paul Elliott Singer’s Elliott Management Corp. for the technology giant to reorganize into a holding company.

Increasing dividend payouts and share buybacks are two of the main ways for investors to evaluate the progress of reform, said Tuan Huynh, chief investment officer for the Asia-Pacific region with Deutsche Bank Wealth Management, in a phone interview from Singapore.

“One of the best ways to express how confident you are in your own company is if you buy back your own shares,” Huynh said. “Or, if you’re paying a dividend you’re expressing to the market your operational business is improving so you can increase the dividend payout and reward your shareholders.”

Korean investors such as Choi Young-Gwon, chief executive at Seoul-based HI Asset Management, are jumping on the reform bandwagon. Choi, who took over the firm earlier this year, started a Socially Responsible Investment fund in May that primarily targets companies based on their corporate governance policies, including dividends.

“South Korean equities have been discounted for a long time due to governance issues of owners,” Choi said. “If that issue is resolved, Korean equities are no longer under evaluated.”

--With assistance from Sam Kim and Kanga Kong

To contact the reporters on this story: Eric Lam in Hong Kong at elam87@bloomberg.net, Abhishek Vishnoi in Singapore at avishnoi4@bloomberg.net, Heejin Kim in Seoul at hkim579@bloomberg.net.

To contact the editors responsible for this story: Christopher Anstey at canstey@bloomberg.net, Siobhan Wagner, Divya Balji