Kim Young-soo
Despite being Asia’s fourth-largest economy, South Korea’s stock market has long been plagued by a valuation gap that chronically hampers its trading potential. The “Korea discount,” as experts call it, refers to the tendency for Korean securities to display systematically low valuations while at the same time inflating risk premiums. While this is attributable to a variety of factors, experts point to corporate governance in South Korea as a major concern.
According to Jan Chang, an Asian markets expert at Firstplus Asset Management, the Korean economy suffers from an over-reliance on family-run conglomerates. Many of these companies have complex governance structures that can obscure decision-making processes and lead to misalignment of corporate efforts with shareholder interests. Given that these families maintain a dominant position in corporate affairs, shareholders feel that their stakes in the companies are largely insignificant, leading investors to prefer other exchanges where their opinions may be more valued.
This situation is further exacerbated by South Korea’s relatively unique dividend payout structure. As IHS Markit points out, South Korea’s ex-dividend date precedes the dividend announcement date, in stark contrast to most other developed markets, which announce the date and payout well before the ex-dividend date has passed. To make matters worse, Chang noted that the average dividend payout ratio of South Korean companies is only a fraction of the dividend payout ratios paid by their counterparts in China, Japan and Southeast Asian markets.
These two factors combine to foster unfavorable shareholder relationships for both new and repeat investors.According to the Korea Exchange, the price-to-book ratio of the KOSPI benchmark index is below 1, indicating that Korean securities are consistently priced below their fair value.
While this may seem like an attractive proposition to those who believe that trading prices will eventually approach fair value, prices often continue to fall or stagnate, making them a classic example of a so-called value trap. Even for investors willing to compromise capital gains in exchange for dividend payments, expectations are undermined by the aforementioned dividend payment mechanism. Clearly, these circumstances have proven to be a disastrous environment for those considering investing in the Korean market.
While certainly an ambitious proposal given South Korea’s business environment, the most desirable action to stoke these lukewarm investor sentiments would be a set of reforms aimed at making South Korea more attractive to foreign direct investment.
Most importantly, chaebols should strive to increase transparency and accountability in their corporate governance. According to CNBC, executives at many chaebol companies have been able to use their controlling stakes to pursue initiatives that are outside their core business or that sometimes result in losses.
By welcoming outside input, aligning corporate values, and increasing shareholder confidence, chaebols can lead the effort to make South Korea a more desirable investment destination. As proof of concept, it is noteworthy that similar companies such as TSMC and Hitachi have been very successful in increasing transparency, with roughly half of their boards of directors made up of foreigners.
While they are far from eradicating the Korean discount entirely, it must be said that Korean regulators have already made great strides in revitalizing the Korean stock market. In a commendable move in late 2023, South Korea abolished the foreign investor registration system that previously required approval even to trade domestic penny stocks.
In addition to banning short selling, the Financial Services Commission of Korea has improved dividend distribution policies, foreign access to capital markets, and English-language disclosure. By lowering these bureaucratic hurdles to foreign direct investment, Korea is laying a strong foundation for further globalization of its stock exchange.
The Korean market also benefited from a high-profile visit by Meta CEO Mark Zuckerberg earlier this year, further demonstrating that foreign engagement in the Korean market is essential to narrowing the Korea discount. This is exactly what industry experts at Thornburg Investments see as the start of a “virtuous cycle” of investment in Korea: narrowing the gap increases foreign confidence in Korea, encouraging additional investment, increasing efficiency and narrowing the gap further.
While countries around the world seem to be increasingly adopting self-sufficient economic policies these days, South Korea’s future lies in globalization. According to many market analysts, the foreign retreat from China presents a unique opportunity for South Korea to gain investment and further evolve into a regional economic powerhouse. Such efforts will require dedication and commitment from both the public and private sectors, but these efforts will undoubtedly transform South Korea into an oasis for foreign direct investment.
Young Soo Kim is a student in the Department of Finance, Business and Economics at the Leonard N. Stern School of Business at New York University.
