By Kim Young-soo
Despite being home to Asia’s fourth-largest economy, Korea’s stock market has long endured a valuation disparity that chronically hinders its trading potential. As coined by pundits, the “Korea discount” refers to a tendency for Korean securities to exhibit systematically lower valuations while suffering from overblown risk premiums. While traceable to myriad factors, experts point to Korea’s corporate governance as a major cause for concern.
According to Jiang Zhang — an Asian markets expert at First Plus Asset Management, the Korean economy suffers from an over-dependence on its family-owned chaebol companies, many of which have complex governance structures that at times can obfuscate decision-making processes and misalign corporate initiatives with shareholder interests. Given that these families maintain insurmountably dominant stakes in corporate affairs, shareholders may feel their stake in the company is all but trivial, driving investor preferences toward alternative exchanges where their input may be valued more.
These conditions are only exacerbated by Korea’s relatively unique dividend-payout structure. As noted by IHS Markit, ex-dividend dates in Korea come before dividend announcement dates, which starkly contrasts with most other advanced markets that announce the dates and payouts well before the ex-dividend dates have passed. To make matters worse, Zhang noted that Korean companies exhibited an average dividend payout ratio of only a fraction of what comparable companies paid in Chinese, Japanese, and Southeast Asian markets.
These two elements conspire to facilitate a shareholder dynamic that isn’t encouraging for new and returning investors alike. According to the Korea Exchange, the KOSPI benchmark index’s price-to-book ratio hovers below 1, indicating that Korean securities are consistently priced lower than their fair value.
While this may seem like an attractive proposition for those who believe the trading values will eventually approach fair values, prices often will continue to fall or remain stagnant, manifesting into a classic example of the so-called value trap. Even for investors who are willing to compromise on capital gains in exchange for dividend payouts, expectations are marred by the aforementioned dividend payout mechanism. Evidently, these conditions prove to be a calamitous environment for those looking to invest in the Korean market.
While admittedly an ambitious proposition considering Korea’s corporate landscape, the most advisable course of action to stoke these lukewarm investor sentiments would be a series of reforms aimed towards making Korea a better proposition for foreign direct investment.
Most importantly, chaebol corporations should work towards increased transparency and accountability in their corporate governance. According to CNBC, many chaebol executives were able to use their controlling stake to pursue initiatives that strayed away from core business operations or at times even incurred losses.
By welcoming external input, aligning corporate values, and increasing shareholder confidence, chaebol companies can lead the effort in Korea becoming a more desirable country to invest in. As a proof of concept, it should be noted that comparable companies like TSMC and Hitachi have been resoundingly successful in enhancing transparency, with approximately half of their boards composed of foreign nationals.
While far from eliminating the Korea discount outright, it must be said that Korea’s regulatory agencies have already achieved significant progress in revitalizing the Korean stock market. Through a commendable course of action in late 2023, Korea abolished its foreign investor registration system that previously required approval for trading even local penny stocks.
In addition to banning short-selling, Korea’s Financial Services Commission has improved dividend distribution policies, foreigners’ access to capital markets, and disclosures in the English language. By lowering these bureaucratic hurdles for foreign direct investments, Korea is laying a solid foundation for the further globalization of its stock exchanges.
Earlier this year, Korean markets also benefited following a high-profile visit from Meta CEO Mark Zuckerberg, further demonstrating how foreign involvement in Korea’s markets are indispensable to narrowing the Korea discount. This is precisely what industry experts at Thornburg Investments deem to be the start of a “virtuous cycle” for investments in Korea; narrowing the gap increases foreign confidence in Korea, spurring additional investments, leading to greater efficiencies and thus an even narrower gap.
While it may seem like countries around the globe are adopting increasingly autarkic economic policies as of late, Korea’s future is in globalization. According to many market analysts, foreign withdrawals from China serve as a unique opportunity for Korea to capture investments and further evolve into a regional economic powerhouse. Such an effort requires the dedication and commitment of both the public and private sectors, but these are the efforts that will indubitably transform Korea into an oasis for foreign direct investments.
Kim Young-soo is a student at the New York University, Leonard N. Stern School of Business, Finance and Business Economics.