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July 1, 2024 | Global Equity
Korea’s Path to Better Corporate Governance

Global Research Analyst

Rita Spitz, CFA, partner, is a global equity research analyst focusing on ESG integration. She is on William Blair’s Global Inclusion Council and the ESG/Impact Investing Working Group. Previously, she was a research analyst covering U.S. and global consumer stocks across the range of market capitalizations. She served as director of research from 2001 to 2008. Rita joined William Blair in 1986 as a sell-side research analyst covering advertising and marketing firms, a role she held for 13 years. She is a member of the CFA Society Chicago, the CFA Institute, and The Economic Club of Chicago. She has also served on the advisory groups of the Financial Accounting Standards Board. She is a trustee of The Joffrey Ballet. Rita received a B.B.A. in finance and Spanish from the University of Wisconsin–Madison and an M.B.A. from the University of Chicago’s Booth School of Business.

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Korea has been grappling with corporate governance issues for several decades, driven by the concentration of power and opaque business practices. But significant efforts to reform these practices have gained momentum, with government initiatives paving the way for more transparent and accountable corporate standards.

For global investors, these reforms will be crucial, not only in mitigating risks associated with governance scandals, but also in aligning Korea’s corporate environment with international standards, which has the potential to unlock new investment opportunities and foster a more attractive market.

Historical Challenges

Historical challenges to effective corporate governance in Korea include insufficient regulation of complex ownership structures and related-party transactions; lack of accountability for poor capital-allocation decisions; and a culture that considers it disrespectful to question decisions made by people in authority.

But one of the primary challenges has been the large, family-controlled conglomerates, which are known as chaebols. Chaebols often wield substantial power, which can result in decision-making that prioritizes family interests over those of other stakeholders.

The Impact of Chaebols

In 2021, nearly 60% of South Korea’s gross domestic product (GDP) came from the 10 largest family-run chaebols. Members of these families have resisted changes to corporate governance that might decrease their personal wealth and power. 

As a result, chaebols often fall short of global standards for board independence. There is little ownership structure transparency (affiliates often hold shares in one another), accountability when there are conflicts of interest, and protection of minority shareholders’ rights. Weak governance has also contributed to low return on investment (ROI) and uncertainty about capital allocation.    

An additional problem stemming from the influence of chaebols is the lack of a dividend culture, as valuations aren’t supported by return of cash via dividends to shareholders. Korea’s dividend tax rate is 49.5% for high earners, such as those in chaebol families, which is a clear disincentive to increase dividends. 

In 2021, nearly 60% of South Korea’s gross domestic product (GDP) came from the 10 largest family-run chaebols.

We believe that successful corporate governance reform in Korea will require changes to the tax system, which is a key driver of corporate behavior. However, dividend tax policy is politically sensitive, as it would likely be unpopular to be seen as helping the rich.      

But if Korean companies raised dividend payouts to match those in other regions, it could potentially improve Korean valuations by 20% to 25%.

Comparison With Japan

Both Korea and Japan have dominant business groups—chaebols in Korea and keiretsu in Japan—where corporate governance primarily serves the interests of insiders (management, family members, buyers and suppliers, affiliated firms, and banks). 

But in the 1990s, both countries took steps to reform corporate governance, help improve national economic performance, and invigorate capital markets. More recently, Korea and Japan added reforms targeting the chronic valuation discounts in their respective stock markets.

However, more progress has been made in Japan due to the greater alignment of interests of key groups. 

For instance, Japan’s Ministry of Economy, Trade, and Industry (METI) and the Tokyo Stock Exchange (TSE) have pushed board independence and better capital-allocation decisions with mandatory reporting from lagging companies on how they will improve return on equity (ROE).

The METI and TSE are promoting more shareholder engagement and activism as part of their market structure reorganizations; the TSE has also promoted shareholder engagements by mandating English versions of financial and non-financial disclosures. Major government pension funds, which are large shareholders in most Japanese companies, are encouraging corporate reform as well.    

In addition, leading Japanese companies are becoming case studies of success after embracing governance changes and following through with higher dividend payouts, buybacks, and divestiture of underperforming assets. This is helping create peer pressure on lagging companies.

These improvements, plus macro factors such as inflation and a weak Japanese yen, have propelled Japan’s stock market to all-time highs.  

We believe that successful corporate governance reform in Korea will require changes to the tax system, which is a key driver of corporate behavior.

Government Initiatives and Reforms

In response to these governance challenges, the Korean government has introduced several initiatives aimed at improving corporate governance.

A primary reform is the Korea Corporate Value-Up Program, a comprehensive initiative brought forth by the Financial Services Commission (FSC) aimed at enhancing corporate governance standards to boost transparency, accountability, and shareholder rights, as well as market values of Korean companies.

Key components of the program include disclosure of plans to improve financial performance (for example, price-to-book valuation, ROE, etc.); improve dividend payments; improve transparency around material spin-offs, insider trading, tender offers, and mergers and acquisitions; and strengthen the protection of minority shareholders. 

Companies are expected to make disclosures in English and strengthen investor relations activities; investors, including foreign institutions and Korean government pension funds, are expected to engage with companies on their Value-Up plans.

In addition, the Korean government established the Corporate Code of Governance for companies and the Stewardship Code for investors in these companies. 

The Corporate Code of Governance is made up of guidelines for listed companies to enhance governance practices, including recommendations on board composition, independence, and the protection of shareholder rights. The Stewardship Code was adopted in 2018, encouraging institutional investors to actively engage in corporate governance by voting on important issues and holding companies accountable for their actions.

While these are steps in the right direction, implementation has been relatively weak since adherence to the Corporate Code of Governance guidelines is not mandatory. However, companies that choose not to comply and believe their governance practices are sufficient must disclose their non-compliance.

There is also a proposed exchange-traded fund (ETF) comprising companies that demonstrate progress toward Value-Up targets, in addition to a new benchmark called the Korea Value-Up Index that consists of listed companies demonstrating best practices.  

If Korean companies raised dividend payouts to match those in other regions, it could potentially improve Korean valuations by 20% to 25%.

The Role of the Korea National Pension Service

The Korea National Pension Service (KNPS) is a significant institutional investor and a public pension fund management organization in Korea. Established in 1988, it is responsible for the administration of the national pension program and the management of the National Pension Fund. Today, it owns about 7% of the top 100 companies in Korea and manages approximately $795 billion.[1]

The KNPS plays a proactive role in corporate governance by exercising its voting rights and engaging with companies to promote better governance practices, all in conjunction with its support of Korea’s Stewardship Code guidelines for institutional investors. 

In addition, the KNPS looks to fulfill its fiduciary duties by closely monitoring investee companies and engaging with them on strategies to achieve mid- and long-term goals. We believe this could enhance investment returns for KNPS’s beneficiaries, as well as support the general development of capital markets and the overall economy. 

Overall, the KNPS has been effective in helping raise awareness of the importance of governance reforms, but change will likely be slow and evolve over a long period.

Conclusion

Korea’s corporate governance landscape is undergoing significant reform, helping align the country’s governance practices with international standards.

But despite ongoing challenges, including resistance from entrenched interests and the need for continuous enforcement, we believe the progress made so far highlights Korea’s commitment to improving corporate governance and promotes a more transparent, equitable, and competitive market environment.

It also presents promising opportunities for global investors. By considering the positive shift in Korea’s approach to corporate governance, investors can better evaluate the potential for increased returns in the Korean market.

Rita Spitz, CFA, partner, is a global equity research analyst focusing on ESG integration.

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[1] Sources: NPS, Bloomberg, and William Blair, as of June 2024. The National Pension Service Investment Management was launched in 1999 as an investment arm of the National Pension Service (NPS), with the objectives of effectively coping with fast-changing economic and financial circumstances and managing the National Pension Fund (NPF), commissioned by the Minister of Health and Welfare, in a systematic and professional manner. Backed by the endeavors, the NPF has evolved into one of the world’s largest pension funds, with assets under management of KRW 1,101 trillion, with a cumulative return of KRW 639 trillion from its inception in 1988 to March 31, 2024.

Global Research Analyst

Rita Spitz, CFA, partner, is a global equity research analyst focusing on ESG integration. She is on William Blair’s Global Inclusion Council and the ESG/Impact Investing Working Group. Previously, she was a research analyst covering U.S. and global consumer stocks across the range of market capitalizations. She served as director of research from 2001 to 2008. Rita joined William Blair in 1986 as a sell-side research analyst covering advertising and marketing firms, a role she held for 13 years. She is a member of the CFA Society Chicago, the CFA Institute, and The Economic Club of Chicago. She has also served on the advisory groups of the Financial Accounting Standards Board. She is a trustee of The Joffrey Ballet. Rita received a B.B.A. in finance and Spanish from the University of Wisconsin–Madison and an M.B.A. from the University of Chicago’s Booth School of Business.

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