[Insight & Opinion] How Should the Retirement of Treasury Shares Be Mandated?

Need for Introducing Management Defense Mechanisms
Differences from Major Countries in Legal Mandates
Balanced Approach Required for Corporate Governance Reform

The stock market has been rising sharply under the new administration. There would be few who oppose the presidential campaign pledge to usher in the "KOSPI 5000 era." Even so, policy should focus on addressing the Korea Discount (the undervaluation of the Korean stock market) by improving unfair corporate governance, rather than causing economic side effects. Recently, several amendments to the Commercial Act mandating the retirement of treasury shares have been proposed.

The retirement of treasury shares reduces the number of shares in circulation, thereby increasing earnings per share (EPS). Furthermore, it lowers the price-to-earnings ratio (PER) and encourages an increase in return on equity (ROE). As a result, the authorities believe this could make a significant contribution to resolving the undervaluation of the stock market. The average proportion of treasury shares among KOSPI-listed companies is 3.2%. If all of these were retired, the price-to-book ratio (PBR) for the entire KOSPI would rise by approximately 3.3%. However, companies are not entirely pleased with this prospect. There are two major issues we need to consider from different perspectives.

First, there is the concern about the potential elimination of tools for business groups to defend management control. Business groups argue that, aside from treasury shares, they lack effective defense mechanisms; thus, if the retirement of treasury shares becomes mandatory, they could be left defenseless against attacks from foreign speculative capital. Business groups believe that at least some defensive measures, such as poison pills or dual-class shares, should be introduced first. Dual-class shares are a structure in which different classes of shares are granted different voting rights, despite equal capital contributions.

Generally, the principle of one share, one vote applies, but under a dual-class share system, certain shares are granted more voting rights. As a result, this helps founders or management maintain control. A poison pill is a defense mechanism against hostile mergers and acquisitions (M&A). When a hostile M&A attempt is made, new stock purchase rights are granted to existing shareholders, excluding the acquirer, at a lower price. Issuing a poison pill can severely dilute the acquirer's stake, making the takeover impossible or significantly more expensive.

Next is the question of how to mandate the retirement of treasury shares. In the United States, the retirement of treasury shares is not mandatory in most states (except California). However, if treasury shares are used in a way that harms all shareholders, directors may face various lawsuits for breaching their fiduciary duty to shareholders.

In Europe, companies are not allowed to hold more than 10% of their own shares. If they exceed 10%, they must retire or dispose of the excess within 12 months. Since mandatory retirement of treasury shares is not common in Korea, there are concerns about enforcing it. The acquisition of treasury shares itself could be severely restricted. Even the acquisition of treasury shares for reasonable purposes, such as employee compensation, may become less active. To move beyond the past, improvements in corporate governance must be made to match the changing environment. For the sake of stock price stability and enhancement of shareholder value, the Commercial Act should specify that purchases of treasury shares are premised on their retirement.

The financial effects and increases in shareholder value resulting from retirement must also be transparent. The basis for returning idle capital and business plans should be clearly disclosed. Major overseas markets such as the United Kingdom and Japan do not legally mandate the retirement of treasury shares; instead, a virtuous cycle is established where market principles naturally encourage retirement.

Recently, the market has seen the emergence of so-called "last train strategies," as companies try to utilize treasury shares before the bill passes. Indirect disposal methods, such as conversion of exchangeable bonds (EB) or third-party sales, are spreading. Companies are taking action to buy time before the legislation is enacted.

Ultimately, the issue of treasury share retirement comes down to finding a balance between enhancing shareholder value and protecting management control. Consideration should also be given to restricting the rights granted to treasury shares and introducing shareholder remedies for problems arising from unfair disposal of treasury shares.

Wonkyung Cho, Professor at UNIST and Director of the Global Industry-Academia Cooperation Center