'Response to Shareholder Activism and Issues in Institutional Investors' Voting Rights Exercise'
[Asia Economy Reporter Dongwoo Lee] As the revised Enforcement Decree of the Capital Markets Act, including the relaxation of the 5% rule, came into effect this month, concerns are rising that hedge funds could attack companies through short-term performance-focused shareholder activism. Accordingly, there are calls for institutional improvements such as strengthening the large shareholder reporting system.
The 5% rule refers to the large shareholder reporting system, which requires disclosure within five days when holding 5% or more of a listed company's shares or when there is a change of 1% or more in shareholding thereafter.
On the 11th, the Korea Economic Research Institute (KERI) under the Federation of Korean Industries commissioned Professor Emeritus Choi Junsun of Sungkyunkwan University School of Law to conduct a research report titled "Responses to Shareholder Activism and Issues in Institutional Investors' Exercise of Voting Rights." The report argued that the large shareholder reporting threshold should be lowered to 3%, and the disclosure obligation for institutional investors should be strengthened to require reporting within one day.
KERI pointed out that while hedge fund activism can reduce agency costs between shareholders and management and potentially enhance shareholder value, it can also harm corporate sustainability and the interests of ordinary shareholders due to short-term performance focus.
KERI explained that hedge funds are targeting not unethical or legally problematic companies but rather high-quality companies with good profitability but relatively low dividend payout ratios and high cash holdings compared to the industry.
KERI ultimately judged that hedge funds' short-term performance focus damages companies' future sustainability and leads to reduced investment and employment. A representative example is DuPont, which, after hedge fund attacks, sharply cut research and development (R&D) investments and closed technology research centers to boost short-term stock prices through cost reductions, resulting in the loss of thousands of jobs.
There are also cases of artificial corporate restructuring. The activist fund Jana Partners pressured the management of Whole Foods in the U.S. to raise stock prices and subsequently sold the company to Amazon. Management replacements due to hedge fund demands have also occurred at GE, Ford Motor Company, US Steel, AIG, and Yahoo.
The report highlighted that the main stage of hedge fund activities is shifting to Asian markets, including Korea. According to JP Morgan, cases of management interventions in Asian companies increased more than tenfold from 2011 to 2018, exceeding twice the global average.
Professor Choi explained, "In Korea, among the 55 listed companies of the four major groups including Samsung Electronics, Hyundai Motor, and SK Hynix, 19 (35%) have higher foreign ownership than major shareholders, making them vulnerable to hedge funds. Since there are no defensive measures like dual-class shares or poison pills, companies defend management rights through treasury stock purchases."
A poison pill is a corporate defense mechanism that grants existing shareholders the right to purchase shares at a price much lower than market value in the event of hostile takeovers or management control infringement attempts.
Professor Choi claimed that including indirect treasury stock purchases through treasury stock trusts, companies spent 8.1 trillion KRW in 2017 and 3.6 trillion KRW in the first half of 2018 to buy back their own shares.
Professor Choi also noted that the recent increase in corporate dividends is not unrelated to the heightened external threats to management rights. He said, "Increasing dividend levels may be desirable in promoting stable long-term stock investments," but expressed concern that "in a situation where sluggish domestic demand and stagnant corporate facility investments are cited as main causes of delayed domestic economic recovery, treasury stock purchases and dividend expansions could undermine companies' long-term growth potential."
As a way to balance hedge funds' freedom of activity and the resulting side effects, Professor Choi advocated for "prohibiting coordinated voting" and "strengthening disclosure obligations."
Recently, hedge funds' attack tactics are called "wolf pack tactics" or "wolf pack activism." This refers to multiple hedge funds holding shares below the reporting threshold (10% in the U.S., 5% in Korea) to evade disclosure obligations and then suddenly attacking the target company together.
The report revealed that due to such wolf pack strategies, 343 U.S.-listed companies were attacked in 2015 alone, and 113 companies in the first half of 2016. Attacks in the Asian region increased tenfold in just seven years.
To prevent this, the report proposed prohibiting coordinated voting, changing the large shareholder reporting system to a 3% rule with reporting within one day, and strengthening disclosure obligations by stripping voting rights in case of violations. It also urged the introduction of corporate defense mechanisms such as dual-class shares and poison pills.
Professor Choi said, "The recent revisions to the Enforcement Decree of the Capital Markets Act and the Enforcement Decree of the National Pension Act were intended to facilitate shareholder rights exercises by the National Pension Service," but added, "The revised decrees have issues of violating higher laws, so legislative improvements are urgently needed."
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