Can Korea Value Up?

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

From pop groups, television dramas and action flicks—not to mention cars, home appliances, electronics and smart phones—South Korean brands have taken the world by storm. 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.^[i] So taking a cue from Japan, South Korea is attempting to “level up” its markets. While the idea makes sense and is worth watching, like Japan, we think it is already well-known and largely priced. We see it as more structural background change—if it can overcome entrenched interests. This would be welcome if adopted, but don’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. President Yoon Suk Yeol has seized on this, making it a policy goal for South Korea to become officially recognized as a developed market. 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.

Most analysts see 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. But mostly the discount stems from perceptions of poor corporate governance. This is a long-running problem inherent in the largest South Korean companies’ structure, which entails cross-shareholding ownership structures that give founding families control over Korean conglomerates (chaebol) at outside and minority shareholders’ expense. 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.

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. In a highly anticipated announcement, the FSC unveiled its “Corporate Value-Up Program” on February 26. As expected, it seeks to reduce stocks’ discount through voluntary corporate efforts to prioritize shareholder return and encourages companies to disclose plans enhancing mid- to long-term corporate value. This would include the creation of a “Korea Value-Up index,” scheduled to launch in Q3, and an ETF to follow in Q4—mirroring Japan’s JPX Prime 150 Index. The FSC will hold a second seminar in May after a feedback period, and guidelines will be formalized in the second half of the year.

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

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

Lurking behind all this is the Yoon administration’s flagging popularity ahead of April 10 legislative elections. While the presidency isn’t up for a vote, whether Yoon’s conservative People Power Party (PPP) can take control of Korea’s National Assembly from the progressive Democratic Party could determine the Corporate Value-Up Program’s success or failure. Yoon sees it as the centerpiece of his policy priorities to win over Korea’s 14 million retail investors, a key voting bloc, amid his low poll numbers. 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. Current polling puts Yoon’s party neck and neck with the opposition. Either way, we see uncertainty falling after the election.

However it goes, we don’t see the program as make or break for Korean stocks. Although shareholder value and corporate governance reforms would be welcome, 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 priced, likely limiting the effects—if those plans even become a reality.

Hat Tip: Fisher Investments Research Analyst Austin Fraser