Can Korea Value Up?

Editors’ note: MarketMinder Europe is strictly nonpartisan, favouring no party nor any politician. Our election commentary serves only to assess political developments’ potential market effects.

From pop groups, television dramas and action films—not to mention cars, home appliances, electronics and smartphones—South Korean brands have taken the world by storm.^[i] Yet its stocks haven’t replicated the feat, underwhelming global investors by lagging the MSCI All-Country World Index for much of the last 15 years.^[ii] So taking a cue from Japan, South Korea is attempting to level up its markets.^[iii] Whilst we think the idea makes sense and is worth watching, like Japan, it is already well-known and largely priced, in our view. We see it as more structural background change—if it can overcome entrenched interests. Whilst this would likely be welcomed by many investors if adopted, we wouldn’t lose sight of South Korea’s main cyclical drivers.

Investors have long observed an apparent disconnect between South Korea’s advanced economy and Emerging Markets status.^[iv] President Yoon Suk Yeol has seized on this, making it a policy goal for South Korea to become officially recognised as a developed market.^[v] As the thinking goes, this would go a long way toward erasing the so-called “Korea discount” many of its stocks trade at—often below book value and global peers’ valuations relative to cash flow and earnings.^[vi]

Many analysts we read portray this discount as resulting partly from the ever-simmering tensions with North Korea. Those tensions don’t seem to be going away any time soon, in our view. But to us, the discount stems mostly from perceptions of poor corporate governance. This is a long-running issue inherent in the largest South Korean companies’ structure, which entails cross-shareholding ownership structures that give founding families control over Korean conglomerates (known as chaebol) at outside and minority shareholders’ expense.^[vii] For those familiar with Japan’s corporate history, the chaebol structure has much in common with the old zaibatsu structure there, which reigned before the keiretsu system retained cross-shareholdings but curbed family control.^[viii]

To take on the chaebols’ governance issues and improve competition, South Korea’s Financial Services Commission (FSC) borrowed a page from Japan’s corporate reform playbook introduced last year, which aimed to improve its corporations’ capital efficiency.^[ix] In a highly anticipated announcement, the FSC unveiled its “Corporate Value-Up Program” on 26 February.^[x] As commentators we follow anticipated, it seeks to reduce stocks’ discount through voluntary corporate efforts to prioritise shareholder return and encourages companies to disclose plans to enhance mid- to long-term corporate value. This would include the creation of a “Korea Value-Up index,” scheduled to launch in Q3, and an exchange-traded fund (ETF) to follow in Q4—mirroring Japan’s JPX Prime 150 Index.^[xi] The FSC will hold a second seminar in May after a feedback period, and guidelines will be formalised in the second half of the year.^[xii]

With details still vague—and subject to change—the high-level roadmap suggests the programme will be incentive-based (e.g., tax benefits for companies who participate) and focussed on strengthening governance, not on punitive measures (like delisting or penalties).^[xiii] An update by the FSC in March seemed to confirm this approach, but it went only as far as “actively considering tax support measures.”^[xiv]

Whilst these steps could prove positive, they aren’t a certainty. In our view, as the programme moves from idea to implementation, the road ahead becomes more challenging—and positive surprise more difficult to achieve. We think this is because—as is often the case with promising policies—the incentives (i.e., in taxes and commercial laws) need legislative approval, which opens them up to execution risks—and the potential for disappointment. Without even a draft law available yet, can it even pass? How generous will it be? And can that overcome (presumable) chaebol opposition?

Looming over this is the Yoon administration’s flagging popularity, which contributed to his conservative People Power Party’s (PPP) defeat in 10 April’s legislative elections.^[xv] Whilst the presidency wasn’t up for a vote, the PPP’s failure to take control of Korea’s National Assembly from the progressive Democratic Party could determine the Corporate Value-Up Program’s success or failure. The Democratic Party has also championed chaebol reform, but with different priorities, likely making it tough to find intraparty backing for the PPP’s reform agenda, based on our analysis.

However, whether South Korea’s corporate governance reforms proceed or stall, we don’t see the programme as make or break for Korean stocks. Although efforts boosting shareholder value would probably be welcome for investors, we think sector makeup, economic and political drivers—and how those relate to sentiment—are a larger influence. With all the attention paid to South Korea’s initial reform efforts, nascent plans are already known and probably priced, in our view, likely limiting the effects—if those plans even become a reality.