[Chatham House] "Value Up, Quantitative Aspects Achieved... Tax Issues Must Be Resolved"

The Essence of the Korea Discount Is Low ROE
Need to Consider Separate Taxation on Dividend Income
Shareholder Returns Have Improved, but Governance Remains Lacking
Pension Funds Need an Active Stewardship Code

Editor's NoteSince last year, 'Value-up' has emerged as a key topic in our capital market. As a measure to resolve the so-called 'Korea Discount,' which refers to the relative undervaluation of the domestic stock market, the government announced a 'Value-up Program' in January last year aimed at enhancing the value of companies and the domestic stock market. Although there have been evaluations that the program has fallen short of expectations during the one year since its launch, it has also achieved some results. Concerns were raised that the momentum for Value-up might weaken following the emergency martial law incident on December 3 last year, but it is clear that the task of raising the value of domestic companies in the mid to long term must continue. Asia Economy held a 'Chatham House Roundtable' last month at its headquarters in Jung-gu, Seoul, to discuss the future direction of the Value-up Program. The roundtable was attended by Professor Kim Woo-jin of Seoul National University Business School, Professor Lee Joon-seo of Dongguk University Department of Business Administration (President of the Korean Securities Association), and Senior Research Fellow Lee Hyo-seop of the Korea Capital Market Institute (in alphabetical order). The roundtable followed the Chatham House rule, disclosing the list of participants but anonymizing each speaker's remarks.

On the 17th, Lee Hyoseop, Senior Research Fellow at the Korea Capital Market Institute, Kim Woojin, Professor at Seoul National University Business School, and Lee Junseo, President of the Securities Association (from left), are discussing at Chatham House in the Financial and Economic Department of Asia Economy. Photo by Heo Younghan

First, there is much debate about the definition of Value-up. What do you think Value-up means?

A: Value-up broadly has two concepts. In Korea, there is the so-called 'Korea Discount,' where the market value is formed lower compared to the intrinsic value of companies. The first concept of Value-up is to raise this market value to the level of intrinsic value. The other is to improve profitability and growth potential to increase the intrinsic value of the company itself.

B: Generally, we call a low Price-to-Book Ratio (PBR) the Korea Discount, and many mistakenly think that a company's book value is equivalent to its intrinsic value. But this is a misunderstanding. Simply put, PBR is the Return on Equity (ROE) divided by the required rate of return (cost of capital). The essence of the Korea Discount is that Korean companies' ROE is lower compared to the required rate of return. So why is ROE low? ROE is net income divided by book value (net assets or equity). If a company earns the same amount of money but does not return it to shareholders, the denominator (equity) grows heavier, lowering ROE. For example, if a company with 100 billion KRW in equity earns 20 billion KRW in net income, ROE is 20%, but if it does not return this to shareholders, the equity grows to 120 billion KRW, lowering ROE. Korean companies have an average ROE of about 5%. The market demands that companies continuously lighten the denominator through dividends and share buybacks and cancellations.

The term 'corporate Value-up' implies that Korean companies are undervalued. If you agree, what are the grounds and reasons for this?

B: Besides the low ROE compared to the required rate of return mentioned earlier, there is another issue: governance. There is a problem of insufficient investor protection. Even if a Korean company earns 20 billion KRW like a U.S. company, about 4 billion KRW may be siphoned off through high executive compensation, related-party transactions, and other means. This causes the market capitalization to be about 20% lower than a comparable U.S. company. This private benefit extraction by controlling shareholders leads to the undervaluation of Korean companies. Korea has a very high control premium, which is evidence of significant private benefit extraction by controlling shareholders.

C: We conducted statistical analysis on why PBR is low at the individual company level across 45 countries, and Korea came out particularly low. The biggest reason was relatively low shareholder returns, followed by profitability and governance issues. Governance can include various factors, but a representative one is the misalignment of interests between major shareholders and minority shareholders.

A: I don't think governance is the core reason for the undervaluation of Korean companies. I believe the biggest reason is that companies hardly invest capital and have fundamentally low shareholder return rates.

It is said that Japan was benchmarked. What is the core of Japan's Value-up?

C: In 2012, when former Prime Minister Shinzo Abe was in office, he proposed three arrows: accommodative monetary policy, fiscal spending expansion, and structural reform. As part of the third arrow, structural reform, the government launched a full-scale Value-up effort from 2014, focusing on improving corporate governance, fundamental deregulation, and innovation economy. The most recent benchmark for us was Japan's PBR reform in 2023, which encourages companies to disclose capital costs and stock price-conscious management. However, I think our current Value-up Program hardly considers the capital cost aspect.

B: Japan's concern started not just with corporate reform but with ensuring the livelihood of its citizens in old age. They thought that Japanese companies, which receive investments from pension funds and equity funds, must be Value-up. Many large Japanese companies are widely held, like Korea's POSCO, KT, and financial holding companies. CEOs do not oppose stock price increases. In Korea, there is an issue where chairpersons do not welcome stock price rises, making the situation more difficult than in Japan.

A: Another difference is that in Japan, Value-up is a means, not an end. Japan's Value-up was just one tool for bigger goals like stock exchange restructuring, but in Korea, Value-up is treated as the final destination, leading to haste and a thirst for visible results. Japan also reformed tax systems, increased tax-exempt accounts, and the financial authorities actively courted overseas asset managers, providing comprehensive government support. In contrast, in Korea, only tax reform discussions have been raised without progress. Although the financial authorities have presented active plans, the action plans for execution differ from Japan's.

B: The Japanese prime minister personally meets overseas hedge funds. Our perception of mergers and acquisitions (M&A) is also very different. Japan even abolished the term 'hostile M&A,' calling it 'unsolicited M&A.' In Korea, the view on M&A is negative. In the control battle between Korea Zinc and Young Poong/MBK, many people express antipathy toward MBK. The problem is that Korea Zinc's shareholders are overlooked in this conflict. Japan has detailed guidelines requiring the board to evaluate which offer is best for shareholders in control contests and decide accordingly. When discussing defense measures, Japan emphasizes maintaining appropriate stock prices to satisfy shareholders rather than tricks like allowing unrelated Australian companies to buy shares at the last minute. Japan's capital market awareness and level are at least 10 to 20 years ahead of ours.

What is your evaluation of the Value-up measures announced last year by the financial authorities and the stock exchange?

A: Personally, I feel most of what can be done has been done. It is a bit disappointing that problems the financial authorities cannot solve and those that must be resolved by the National Assembly remain unsolved, leading to harsh overall evaluations of the Value-up Program. The Value-up index was somewhat hastily created. Basically, Value-up should include companies with currently low value but promising future value, but the index was originally made mostly with companies that already had high value. Since it shows an 80-90% correlation with large-cap indices, criticism arises about what difference there is from existing indices. However, with subsequent rebalancing adding companies like KB Financial Group and over 100 companies disclosing Value-up, I think it is somewhat on track.

B: Two conflicting goals are embedded in one index. Including already expensive, good companies in the Value-up index means the index return cannot be high. However, the Value-up Program is meaningful in that it raised the issue that stock prices are directly related to corporate performance and should be reflected in management. Korean major shareholders only care about operating profit. But Value-up asks to look at operating profit relative to equity invested. That is ROE. Going further, recognizing shareholders' required rate of return, i.e., the company's cost of capital, is the core of Value-up. But almost no company goes that far.

C: Quantitatively, some progress has been made. About 100 companies, representing 40% of total market capitalization, have disclosed Value-up. However, participation among KOSDAQ-listed companies is very low, and Samsung Group's participation is somewhat disappointing. Also, qualitative aspects like paying attention to capital costs are still lacking.

A: The Value-up Program has the effect of making companies think more about shareholders. Looking at dividend payout ratios and total dividends, they have likely increased significantly. Also, the information asymmetry between insiders and general shareholders has somewhat eased. Whether a controlling shareholder exists is related to Value-up participation. Companies without controlling shareholders pay more attention to stock prices.

What measures are needed for Korean companies' Value-up? (Amendment of Commercial Act, separate taxation on dividends, tax exemption on dividends for long-term investors, etc.)

B: Amendment of the Commercial Act is essential to resolve the Korea Discount caused by private benefit extraction. However, the current amendment is being dismissed as a political issue, causing misunderstandings. The amendment is debated as if company interests and shareholder interests conflict, but the duty of loyalty means that when conflicts arise between general and controlling shareholders, the controlling shareholder should not infringe on the interests of other shareholders for their own benefit; it does not mean prioritizing shareholders' interests over the company's. I think it can also be done through amendments to the Capital Market Act, but it should be a general provision. If done narrowly, loopholes will be exploited. Ultimately, for Value-up to work properly, major shareholders must want the stock price to rise. But this is a problem the stock exchange cannot solve. There are also inheritance and gift tax issues, but dividends should be addressed first. Introducing separate taxation on dividend income would make major shareholders think dividends are more profitable than high compensation or related-party transactions. If possible, low tax rates on dividends are also needed. This would encourage major shareholders to receive dividends and increase dividends for general shareholders.

A: I agree with separate taxation on dividend income but see two issues. Both are financial income, but dividends are taxed at a low rate above 20 million KRW, while interest income is subject to comprehensive financial income taxation, which may cause fairness issues. Also, major shareholders receiving too much dividend income raises fairness concerns. Lowering tax rates on dividend income to increase dividends received by major shareholders but introducing differential dividends to ensure some redistribution is worth considering. Providing separate taxation on dividend income only for long-term stockholders could be another alternative. Capital gains tax is also reduced by up to 90% for long-term holdings. Reducing taxes proportionally to holding period would solve fairness issues with interest income and reduce resistance.

B: France gives more voting rights for long-term stock holdings.

C: The U.S., Europe, and Japan also provide incentives for long-term holdings.

Which Korean companies are exemplary in effectively implementing Value-up measures?

B: Meritz Financial Group can be cited. Despite having a controlling shareholder, Meritz is practically run by professional management among large business groups with a de facto owner. Meritz's motto is that the value of one share held by the controlling shareholder is equal to that of one share held by general shareholders. There are no dual listing issues, and the current vice chairman has stated he will not succeed. Even without owning a commercial bank, as of the 24th of this month, Meritz ranks second in market capitalization among financial holding companies after KB and Shinhan. They clearly recognize Total Shareholder Return (TSR) and cost of capital. Meritz is a model case showing that Value-up is possible even with a controlling shareholder. Korea's corporate dark history mostly stems from forced share transfers.

A: You can see which stock prices rose the most before and after Value-up. Financial holding companies generally rose a lot. Hana Financial Group had a shareholder return rate in the high 20% range. They announced plans to raise it by 7% annually to 50% by 2027, and it has now risen to 34%. Hana Financial actively conducts IR targeting major overseas institutions like JP Morgan and BlackRock. Overseas investors have become very interested in the increasing shareholder return rate. Woori Financial Group also saw its stock price rise 7-8% after promoting tax-exempt dividends by transferring capital surplus to retained earnings.

C: Financial companies are doing well, but it is somewhat disappointing that Value-up focuses heavily on shareholder returns. More attention should be paid to ROE as a way to increase intrinsic corporate value. I hoped Value-up would include plans on where to invest, how to restructure companies, and where to expand overseas. SK Group generally does well in these areas, but governance still has many shortcomings.

'Zombie companies' are also a problem. Most IPOs occur when profitability and growth peak. After listing, stock prices keep falling, so the index remains flat and market capitalization is almost the same as in 2007. Taiwan's market capitalization is much larger than ours, but it has twice as many listed companies. In the U.S., nearly 10% of listed companies are delisted annually, but in Korea, it's less than 1%. There are too many zombie companies. Like Japan, we could consider including provisions in the governance code requiring boards to make decisions aligning controlling and minority shareholders' interests, and only companies complying can maintain listing status.

B: I am skeptical whether the Japanese-style code system would work properly in Korea. For the board's duty of loyalty to be effective here, there must be pressure that legal lawsuits could arise. There is a famous precedent where outside directors of Kangwon Land who approved resort donation resolutions were held liable for damages to the company. Therefore, the process of nominating outside directors is very important from a governance perspective. In Korea, directors cannot be appointed without the controlling shareholder's approval, so directors lack awareness that they represent shareholders. Awareness that directors can be held liable if they harm the company and shareholders needs to spread more.

What role should pension funds play in Value-up?

A: Fundamentally, they must fulfill their fiduciary duty. They should properly exercise shareholder rights and actively engage with companies as shareholders. Above all, pension funds must make long-term investments. The National Pension Service must eventually return money in 30 or 40 years. To ensure the market survives until then, pension funds must invest in domestic stocks. Even fixing the domestic stock investment ratio at 14% would naturally increase the scale of domestic stock investments as the fund size grows.

B: We should not force pension funds to increase domestic investment ratios. Pensions will be depleted in the long term. Reducing Korean stock ratios now will lessen the shock when selling later.

C: The stewardship code for pension funds currently lacks enforceability. The National Pension Service entrusts huge amounts to sub-managers and evaluates their stewardship activities internally but does not disclose the results, which is a major difference from Japan's GPIF. If, like Japan, evaluation results graded A, B, or C were disclosed and managers receiving consecutive Cs were excluded from NPS mandates, asset managers might engage more actively in stewardship. Also, the NPS currently has 7-8 detailed strategies for domestic stocks; using the Value-up index as a benchmark for one of them could help drive the Value-up Program.