[In-Depth Review] The Audit Committee Separate Appointment System Incompatible with Economic Democratization

Song Won-geun, Visiting Professor at Yonsei University, Former Vice President of Korea Economic Research Institute

Song Won-geun, Visiting Professor at Yonsei University, Former Vice President of the Korea Economic Research Institute

Activist fund Elliott Management demanded in January last year that Hyundai Motor Company pay a dividend of 21,967 KRW per share. The total dividend amount was 5.8 trillion KRW, which is 3.5 times the previous year's net profit. This proposal did not receive support from general shareholders or the proxy advisory firm ISS. The opposition reason was that distributing most of the company's liquidity as dividends would make research and development (R&D) and investment difficult, thereby damaging corporate value. Elliott recommended McQueen, chairman of Ballard Power Systems, a hydrogen fuel cell company, as an outside director candidate. Ballard Power Systems, a Canadian company, has Weichai Power, a Chinese company aggressively expanding its hydrogen-related business, as its largest shareholder. Elliott thus recommended a key figure from a company competing with Hyundai in the hydrogen economy sector, including hydrogen vehicles and hydrogen fuel cells, as a director of Hyundai.

According to the Ministry of Justice's amendment to the Commercial Act, one or more directors who become audit committee members must be separately elected from other directors, and at this time, the largest shareholder's voting rights, including those of special related parties, are limited to 3%. If this regulation were applied to the aforementioned case, it would be possible for a key figure from a competing company recommended by Elliott to be appointed as a director. While the largest shareholder's voting rights, typically around 30%, are limited to 3%, hedge funds like Elliott acquire shares below 3% through multiple funds, and with the support of global proxy advisory firms, the likelihood of appointing their recommended directors significantly increases. This means that key personnel from competing companies fiercely competing in the global market can enter the board of directors.

One might wonder why it is problematic for a person from a competing company to become a director. In the United States, it was not uncommon for corporate executives to serve on other companies' boards. However, even in the U.S., such practices have been disappearing since the enactment of the Sarbanes-Oxley Act, which mandated the establishment of audit committees in listed companies and strengthened management control by the board. In Korea, the public interest aspect of outside directors is emphasized, making it extremely rare for executives from other companies to become directors. Moreover, the hydrogen economy is a future core industrial ecosystem, with major countries fiercely competing to dominate it. Therefore, the entry of executives from a company whose largest shareholder is a Chinese competitor into Hyundai's board means that advanced hydrogen economy-related technologies and national strategies could be transferred intact to competitors and foreign countries. Thus, the separate election of audit committee members and the 3% voting rights limit for shareholders could cause serious problems not only at the corporate level but also at the national level.

The audit committee was introduced after the Asian financial crisis to strengthen the monitoring and supervision mechanisms of management. However, when this system was introduced, the existing regulation limiting the largest shareholder's voting rights during auditor appointments was maintained, and this obsession with limiting the largest shareholder's voting rights led to the separate election of audit committee members. However, limiting shareholders' voting rights during director appointments is a Galapagos regulation with no international legislative precedent. Even in the U.S. Sarbanes-Oxley Act, to strengthen the independence of the audit committee, all members are outside directors, but there is no limitation on shareholders' voting rights or separate election during director appointments. In Germany, where the board has a dual structure, shareholders' voting rights are not limited when appointing audit committee members, and in Japan, where separate election is optional, the same applies.

If the purpose is to strengthen the independence of the audit committee to protect minority shareholders, the requirements for directors who become audit committee members can be strengthened, or the audit committee can be composed entirely of outside directors as in the U.S. Since director appointments are decisions of a stock company based on the majority principle of shareholding, limiting voting rights contradicts the democratic decision-making principle of stock companies. Therefore, the Ministry of Justice's amendment proposal for the separate election of audit committee members does not coexist with economic democratization.