[Inside Chodong] Is Corporate Inheritance Tax the Cause of the 'Korea Discount'?

Im Cheol-yeong, Deputy Head of the Economic and Financial Department

"If we ease the corporate inheritance tax system, will the 'Korea discount' be fundamentally resolved?"

"That's a topic I haven't considered before." The economist, who has long analyzed macroeconomics, fiddled with his now-cold coffee cup and responded awkwardly after a moment of silence.

The president's unexpected response at the 2024 public forum sharing government plans with citizens (Public Discussion on Livelihood with the People) has been repeatedly discussed. In response to the suggestion that "government institutional efforts to protect minority shareholders are necessary to resolve the 'Korea discount,'" the president said, "Minority shareholders benefit when stock prices rise, but for major shareholders, if stock prices rise too much, they face enormous inheritance taxes. Excessive tax systems must be reformed to fundamentally solve the 'Korea discount.'"

The 'Korea discount' is a concept that refers to the phenomenon where the corporate value of Korean listed companies and the overall market valuation indicators are lower compared to foreign listed companies, which emerged in the early 2000s. The price-to-book ratio (PBR) of the Korea Composite Stock Price Index (KOSPI) is around 0.88 to 0.89, which is less than a quarter of the PBR of the U.S. benchmark index, the Standard & Poor's (S&P), and it is still frequently used when analyzing the limitations of the Korean stock market.

Academia and industry have long identified 'geopolitical factors,' such as being the world's only divided nation, and 'structural factors,' including backward governance structures, minimal shareholder return policies, opaque accounting, low disclosure reliability, and a high proportion of individual investors, as the core causes of the Korea discount. These factors have been established through numerous analytical reports, academic papers, and investment guidelines from global investment banks (IBs). For example, in terms of geopolitical factors, the Geopolitical Risk Index (GPR) and the Global Peace Index (GPI) are used; Korea ranks 10th among 43 major countries in GPR, placing it among high-risk countries, and its GPI is in the top 25%, indicating relatively high risk.

The president's remarks at the public forum challenged conventional concepts and assumptions. Even most macro experts have found it difficult to continue analysis based on the president's diagnosis that excessive inheritance tax is the fundamental cause of the undervaluation of the Korean stock market. A week after the president's remarks, reports focusing on inheritance tax to forecast and analyze its impact are hard to find. Among commentators, there are only criticisms that linking these two issues, which are difficult to establish causality between, is an overreach. The presidential office's policy chief later appeared to backtrack by saying, "This does not mean immediate action," but this only provided grounds for further criticism.

On one hand, there are concerns that statements implying "the Korea discount occurs because major shareholders of listed companies keep stock prices low due to excessive inheritance tax" could send distorted signals to the financial market. Artificial price management or manipulation is legally prohibited as market disruption. Even if there is no legal issue, since this is directly related to the backward governance problems of companies, which are cited as causes of the undervaluation of the Korean stock market, it could undermine trust.

Poor diagnoses tend to lead to fatal prescriptions. If the causal relationship between 'corporate inheritance tax and Korea discount' is not ultimately established, this diagnosis is likely to remain a 'forced and unfounded interpretation (견강부회).' With a poor diagnosis, there is no way to move even an inch away from the long-standing 'Korea discount.'