"Korean Stocks Are Not to Be Bought"…Bitter 'Korea Discount' [Song Seungseop's Financial Light]

Decades-Long 'Korea Discount'
Economy Has Grown, but Korea's Undervaluation Remains
Due to Insufficient Shareholder Returns and Weak Governance
Yoon Aims to Solve with Financial Investment Tax and Inheritance Tax Reforms
Will Changing Tax Systems Really Affect Corporate Value?

"Becoming a director is not something to do."

If you have ever invested in stocks in Korea, you might have heard this advice. "Director" is an abbreviation for the Korean stock market, meaning "Don't buy domestic stocks." Many individual investors complain that it is difficult to make profits in the domestic stock market. The value of Korean companies is undervalued, and there is no sign of it rising. This phenomenon is called 'Korea discount.' Why does the Korea discount occur? How can it be eliminated?

The term Korea discount began to be used in academia and the financial industry after the 1997 Asian financial crisis. Foreigners started to evaluate Korean stock prices lower than their actual value. Of course, there is some debate about whether the Korea discount truly exists. However, considerable research has shown that since 2000, the Korean stock market has been undervalued in various aspects.

In 2006, the Korea Securities Association published a study titled "Diagnosis and Cause Analysis of the Korea Discount." They first selected the top 50 Korean companies and compared them with 50 similar foreign companies. The results were shocking. From 1998 to 2004, the price-to-cash-flow ratio (PCR) of Korean companies was up to three times lower than that of foreign companies. It was even lower than that of the Philippines. This indicated that the investment value of Korean companies was low.

A table comparing the price-to-book ratio and price-to-earnings ratio of Korean and foreign companies. The Korean indicators, marked with a dark blue line, notably remain at the bottom. Korea's price-to-book ratio ranked 43rd out of 45 countries from 2005 to 2011 and 41st out of 45 countries from 2012 to 2021. For the price-to-earnings ratio, Korea ranked 20th out of 40 countries from 2005 to 2011 and 29th out of 38 countries from 2012 to 2021, placing it in the lower-middle tier. Photo and data description = Korea Capital Market Institute.

Has the situation changed after more than 20 years? The Korea Capital Market Institute released a study in May last year titled "Analysis of the Causes of the Korea Discount." Using data from 32,428 listed companies in 45 countries from 2005 to 2021, they examined the price-to-book ratio (PBR) and price-to-earnings ratio (PER). Korea's average PBR from 2012 to 2021 was 1.2, lower than that of developed countries (2.2), emerging markets (2.0), Asia-Pacific (1.7), and the global average (2.2). The PER was 17.0, 17-23% lower than foreign countries. The economy has grown, but the Korea discount remains unchanged.

Why is that? The first reason cited is the insufficient 'shareholder returns.' Shareholder returns refer to the act of a company returning profits to its shareholders. It is easy to think that the owner of a corporation is the "boss," but in fact, everyone who owns shares is an owner. According to the Korea Capital Market Institute, Korea's shareholder return rate ranked below 40th among 45 major countries from 2010 to 2018, placing it in the lowest tier. Investors who become owners by buying company shares but do not share in the profits naturally consider these companies to have low value.

Poor shareholder returns are likely due to 'corporate governance.' According to the Asian Corporate Governance Association, Korea ranked 9th out of 12 Asian countries in corporate governance evaluation in 2020, placing it in the lower tier. In Korea, actions that harm the entire shareholders or the company are sometimes taken for the benefit of a small number of controlling shareholders. Bloomberg even criticized the Korean stock market, stating that "Korean companies tend to be undervalued due to weak corporate governance and unfriendly attitudes toward minority shareholders."

President Yoon Suk-yeol is listening to the remarks of participants at the "Public Livelihood Forum - Fourth Session, Coexistent Finance, Expanding the Ladder of Opportunity" held at the Korea Exchange in Yeouido, Seoul on the 17th.
[Image source=Yonhap News]

Domestic stock investors can only feel frustrated. The Korea discount, which has been called out as a problem for decades, has not been resolved until now. Although past administrations have addressed the Korea discount, investors have not been satisfied. Former President Moon Jae-in mainly said that the Korea discount would disappear when peace comes to inter-Korean relations. Former President Lee Myung-bak even claimed that the Korea discount had been resolved and replaced by a Korea premium.

President Yoon Suk-yeol announced on the 2nd that he would push for the abolition of the financial investment income tax (금투세), saying, "During my term, I will boldly reform capital market regulations that do not meet global standards to eliminate the Korea discount to the level of global stock markets." On the 17th, he mentioned excessive inheritance tax, emphasizing, "By reforming such excessive tax systems, we can fundamentally solve the Korea discount." He pointed to "abolishing taxes imposed on investors" and "lowering high inheritance tax rates" as ways to resolve the Korea discount.

There is ongoing debate about whether improving the tax system will increase corporate value. Civil society organizations are currently demanding the withdrawal of the plan to abolish the financial investment income tax. The Citizens' Coalition for Economic Justice (CCEJ) issued a statement saying, "The Korea discount stems from backward corporate governance centered on a few chaebol families and an unfair and opaque capital market," and "It is by no means a problem caused by the financial investment income tax, which has not even been implemented yet."