The election of Moon Jae-in as Korea’s new president is, we think, good news for shareholders in Korean companies, as we expect President Moon to drive further improvements in corporate governance standards leading to better returns for shareholders and ultimately higher share prices.
For many years investors have been wary of South Korean companies, primarily because of their poor governance standards. Korea’s economy is dominated by family-run conglomerates, known as chaebol, which have been criticised for ignoring the interests of minority shareholders at best, and corruption, at worst. The catalyst for the recent election was, in fact, the impeachment of the former president amid a corruption scandal that has also seen the leader of Samsung Group arrested for alleged involvement.
Concerns about poor governance practices, including a lack of consideration for shareholders, have contributed to South Korea’s historical discount to other Asian markets.
Recently, however, as a result of pressure from the government and investors, both overseas and domestic, there have been some encouraging developments at the chaebol. Foreign investors have been calling for change for some time, but more recently Korean investors too have expressed a desire for higher income and higher returns from their equity investments.
We have started to see corporate restructuring and more shareholder-friendly policies, such as increased dividend payouts, while in 2016 the dividend yield for companies in the Korean market (the KOSPI) exceeded the bank deposits rate for the first time. (We discussed these changes in a previous blog).
Earlier this month, investors’ hopes for further corporate governance reform received a boost when Moon Jae-in, a liberal human rights lawyer, was elected as President. As part of a policy called ‘economic democratisation’, Mr Moon has stated that he plans to tackle the dominance of the chaebol and make the country’s economy more efficient and innovative by supporting smaller firms.
As if to confirm his determination to curb the conglomerates, one of the President’s first appointments was Kim Sang-Jo as head of Korea’s Fair Trade Commission. Kim’s long-standing criticism of chaebol and support for reform has earned him the moniker ‘chaebol sniper’.
While Kim’s role could be deemed a threat for investors in the country’s many chaebol, the overriding impact should be positive given any reforms are likely to be beneficial to the Korean economy and minority shareholders at the same time due to reduced corruption, greater focus on governance and more cash flow returns.
In addition to this encouraging move, there are expectations that Moon’s government will introduce bills to improve the transparency of companies and increase the alignment between the board of directors and minority shareholders.
One of the proposals being discussed is restricting the use of pardons for chaebol leaders who have committed crimes. It seems hard to believe, but many convicted executives have received pardons from politicians, reinforcing the perception that they are above the law and that a cosy relationship exists between big business and politics.
While these bills seek to tackle how firms are run, another potential change focuses on the role of shareholders. The government is expected to push for the adoption of the Korean Stewardship Code, which outlines the responsibilities for shareholders. If the National Pension Service, the country’s largest pension fund, were to apply the code and hold firms to account, this could well lead to better governance.
The election of President Moon has given investors optimism that a notable change in corporate culture might be on the horizon. Over the past few years, Korean companies have undoubtedly taken steps to become more shareholder-friendly and shareholder returns have risen. Samsung Electronics, the technology giant, has been at the forefront of this trend. Since 2014, its shareholder return policy has returned around 50% of its cashflow to investors through dividends and share buy backs from a paltry 7% payout previously. Furthermore, Samsung was one of the first Korean corporates to cancel the shares it bought back rather than holding them as treasury shares. Just last month Samsung pleased investors further by cancelling existing treasury shares worth around $35 billion. Such moves would arguably not have occurred a few years ago.
Despite the arrest of the company’s chairman, there are clear positives to be seen in terms of how Samsung is now operating in relation to minority investors. As the dominant firm in Korea, where Samsung leads others tend to follow. With President Moon placing corporate governance reform at the heart of his agenda, we think investors in South Korean stocks could be on the verge of an exciting journey.
We are optimistic that shareholder returns will rise over time and if Korean companies start paying out dividends at levels that are more in line with their regional peers, we could see the country’s valuation discount close as well. After recent small steps, President Moon’s victory could be the springboard for a giant leap towards better governance.