[The Trap of Treasury Stocks] ① Purchases Increase by 1 Trillion Won... Cancellation Only Around 4%

Minimal Burn Ratio in Preparation for Treasury Stock Acquisition and Disposal Disclosure
Reducing Circulating Shares Needed to Enhance Shareholder Value

Editor's NoteThe Financial Services Commission is reviewing a reform plan for the treasury stock system. Key points include 'mandatory cancellation after treasury stock repurchase' and 'prohibition of new share allotment to treasury stock during spin-offs.' The financial investment industry and individual investors welcome these changes, expecting improvements in shareholder rights. On the other hand, the business community opposes the plan, arguing that one of the means to defend management rights may disappear. This article analyzes the current status and effects of treasury stock repurchases and cancellations by domestic listed companies to explore reform measures for the treasury stock system.

[Asia Economy Reporter Lee Seon-ae] Last year, domestic listed companies increased their treasury stock repurchases, but the effect on stock price boosting was limited. This is because most repurchases did not lead to cancellations, so the number of circulating shares did not decrease. This is why individual investors should be cautious about interpreting corporate treasury stock repurchases as a positive signal such as 'undervaluation.'

On the 25th, Asia Economy analyzed data from the Financial Supervisory Service's electronic disclosure system and found that the number of disclosures regarding treasury stock acquisitions (decisions on treasury stock acquisition and trust contract decisions for treasury stock acquisition), excluding corrections and extensions, was 476 last year. This represents a 56.1% surge compared to 305 cases in 2021. The scale also increased. The total repurchase amount reported by companies was 5.2461 trillion KRW, about 30% higher than the previous year's 4.0565 trillion KRW. This was a result of domestic companies actively repurchasing treasury stock as the stock market entered its worst decline and bearish phase in 14 years since the 2008 financial crisis.

Decisions on treasury stock cancellations, which have a greater impact on stock prices than repurchases, also increased. Last year, there were 65 disclosures of stock cancellation decisions, double the 33 cases from the previous year. This is interpreted as an attempt to enhance shareholder value amid growing demands from investors for shareholder-friendly policies. However, the problem lies in the proportion of cancellations. Cases where repurchased treasury stock leads to cancellation remain few. The cancellation rate was only about 13.2% of repurchase cases.

According to data compiled by the Korea Exchange, the total number of disclosures related to treasury stock (including trusts) acquisitions and disposals last year was 1,427, a 17.7% increase from 1,212 the previous year. Based on this, the proportion of treasury stock cancellation disclosures was only 4.6%. Meritz Financial Group, Meritz Securities, and Meritz Fire & Marine Insurance each canceled shares three times, while Shinhan Financial Group, KB Financial Group, and SK Discovery (subsidiary SK Plasma) each made two cancellation disclosures. Excluding these duplicates, only 56 companies canceled treasury stock. Calculated on this basis, the cancellation rate shrinks to 3.9%. Due to the minimal cancellation rate, the stock price boosting effect was almost nonexistent. Last year, the KOSPI fell by 24.9%, marking the largest decline since 2008 (-40.7%).

The purposes of treasury stock repurchases by companies can be broadly divided into enhancing shareholder value and defending management rights. For domestic companies, the primary purpose is usually management rights defense. Kim Su-hyun, head of the DS Investment & Securities Research Center, pointed out, "Most domestic companies repurchase treasury stock to defend management rights. They aim for the so-called 'magic effect of treasury stock' by allotting new shares to treasury stock during spin-offs, or they exchange treasury stock with friendly parties after repurchase to increase or stabilize control."

The Korea Capital Market Institute pointed out that only 2.3% of listed companies that repurchased treasury stock used cancellations as a shareholder return method. Treasury stock cancellation involves a company acquiring its own shares and then canceling them to reduce the number of issued shares, thereby increasing the value per share. This benefits shareholders. Although the company's overall value does not change, the reduction in the number of shares increases the per-share value.

Cancellations can be categorized into 'capital reduction cancellation' under capital reduction regulations, 'profit cancellation' using profits distributable to shareholders according to articles of incorporation, 'voluntary cancellation' and 'compulsory cancellation' depending on whether shareholder consent is required, and 'paid cancellation' and 'free cancellation' depending on whether compensation is given. Choi Yoo-jun, a researcher at Shinhan Investment Corp., explained, "Profit cancellation involves repurchasing and canceling treasury stock using retained earnings, which does not reduce capital but reduces the actual number of circulating shares, thereby boosting stock prices. While treasury stock repurchases in the U.S. stock market tend to be based on cancellations, the proportion of profit cancellations in the domestic market is only around 3%."

Given this situation, it is problematic to interpret any company's treasury stock repurchase solely as a positive signal such as 'undervaluation.' Although most listed companies cite 'stock price stabilization and shareholder value enhancement' as their purpose for repurchasing treasury stock, repurchase alone is only half the story. To maximize shareholder value, repurchases must be followed by cancellations. If treasury stock is held without cancellation and later sold on the market, it is essentially a shell game from the shareholders' perspective. Kang So-hyun, a researcher at the Korea Capital Market Institute, emphasized, "If treasury stock is sold on the market without cancellation, the repurchase only produces a temporary effect. Shareholders can expect sustained shareholder value enhancement only if the number of issued shares permanently decreases through cancellation after acquisition."