[Economy Pulse]Suggestions for an Orderly Exit of Insolvent Companies

The stock index is climbing at a frightening pace. The heat in the KOSPI is now being felt in the KOSDAQ as well. Seizing the moment, the financial authorities are rowing hard while the tide is in their favor. They are rolling out a series of measures to revitalize the sluggish KOSDAQ market. Following the "Measures to Enhance Trust and Innovation in the KOSDAQ Market," they have now announced "Delisting Measures for the Exit of Insolvent Companies." They have effectively made it a foregone conclusion that up to around 200 companies will be forced out this year. The intention is to maximize upward momentum by normalizing the market.

The direction is absolutely right. The content is also substantive. These are measures that should have been implemented long ago. However, the pace is an issue. The measures also lack some sophistication in terms of detail. Above all, there is no discussion of investor protection.

For now, the approach feels overly rushed. A speed battle is indeed necessary if the authorities want to see immediate results. But if policy consistency and predictability decline, trust will be lost. Last July, they tightened the market capitalization standard for delisting and then moved up the implementation timeline. Until last year, the KOSDAQ delisting threshold for market capitalization was 4 billion won. From next year, this threshold was to become 20 billion won, and with this latest announcement it has been raised further to 30 billion won. In just a year and a half, the delisting standard has become seven times stricter. While this will allow insolvent companies to be weeded out quickly, it may also sweep away potential growth companies. Most new-industry and innovative companies are initially loss-making and have small market capitalizations. There is a need to distinguish these companies from others.

The basis for defining penny stocks is also ambiguous. From July, stocks trading below 1,000 won will be delisted. To prevent companies from gaming the system through reverse stock splits, stocks trading "below par value after a reverse split" are also included. However, the stock price itself is not directly related to corporate value. It only has meaning when considered together with the number of shares outstanding. Moreover, Korea has a par-value system. If a stock with a par value of 500 won trades at 900 won and another stock with a par value of 5,000 won trades at 1,100 won, the former will be delisted while the latter is exempt. This is not a reasonable logic. Two companies with the same intrinsic value may or may not be forced out of the market depending solely on par value. This is a point at which the principle of regulatory neutrality can be undermined. A more sophisticated approach is required for the delisting of penny stocks.

The strengthening of delisting rules for disclosure violations is wholeheartedly welcome. Over the past year, the threshold for cumulative disclosure penalty points was lowered from 15 points to 10 points, and it could be lowered even further. Companies that violate disclosure rules should face ruinous consequences. Disclosure is the only channel through which investors can assess a company's situation in a timely manner. False or misleading disclosure is an act of deceiving investors. Our disclosure regime is somewhat weak compared with global standards. It is overly focused on form, and ex post sanctions are weak. Companies only need to meet the deadline and filing format. The information is technically made public, but the market still remains in the dark. The expected cost of violating disclosure rules is also low. Administrative fines are small, and minority shareholders rarely make use of class actions. Civil and criminal liability for disclosure violations should be strengthened, and class actions should be actively enabled in cases of false or omitted disclosures.

If a large number of insolvent companies are actually delisted, market turmoil will be inevitable. This will be even more true for small investors. When delisting proceeds swiftly, minority shareholders lack both the time and information to respond. If the settlement trading period is short or relief procedures are inadequate, controversy over the infringement of property rights may arise. In particular, penny stocks and companies that fall short of the market capitalization threshold have a high proportion of individual investors, which means the fallout will inevitably return as a policy burden.

This is why an orderly exit program for insolvent companies is needed. The largely nominal K-OTC market needs to be restructured in a more constructive way. In addition to serving as a pre-IPO market, it should be reborn as a market for delisted companies. The financial authorities have already drawn up plans to utilize the K-OTC for delisted firms. However, this is not enough. There are structural limitations under the current system. It is worth exploring, through a shift in thinking, the option of having a separate institution, rather than the Korea Financial Investment Association, operate this market.

Above all, an approach from the perspective of investor protection is necessary. First, information disclosure must be strengthened. Disclosure should be made mandatory and standardized not only for financial statements, but also for business status, key risks, largest shareholders and governance structure, reasons for delisting, the status of issuances of convertible bonds (CBs) and bonds with warrants (BWs), and future plans (rehabilitation, relisting, or liquidation). To this end, an independent disclosure platform is worth considering. It is also worth pursuing the revitalization of trading through the introduction of liquidity providers or market makers. Another option is to grant minority shareholders a "creditorization" option in the event of delisting (minority shareholder convertible bonds), allowing their shares to be converted into rehabilitation claims so that they can be compensated if the restructuring succeeds.

The cleanup of insolvent listed companies is something that should have been done from the outset. I hope that the orderly exit of zombie companies will improve soundness and restore investor confidence. I also hope that greater market dynamism will allow promising innovative companies to fill the void. I look forward to seeing a quantum leap in the KOSDAQ market.

Professor Lee Junseo, Department of Business Administration, Dongguk University