Korean and Japanese companies share many structural similarities. Conglomerates within the two neighbouring North Asian economies typically have a large, dominant shareholder (often a family) with cross-shareholdings, inefficient balance sheets comprising large cash reserves or investments weighing on returns on equity (ROE), and low payout ratios.
In Korea, the Chaebols (family-run conglomerates) dominate the business landscape, and convoluted cross-shareholdings characterise these business operations.
Having started a decade ago, corporate reform in Japan intensified in 2023. The Tokyo Stock Exchange (TSE) targeted companies with an ROE under 8% and a valuation of less than 1x book and this represented around half the country’s listed stocks.
A year ago, the TSE asked these companies to explain their plans to become more capital efficient, improve returns and shareholder value via distributions – and lift price-to-book above 1x.
TSE’s threat to “name and shame”, rather than legally enforce the directive, appears to be working. Companies are increasingly communicating shareholder return targets, introducing return on capital and excess return KPIs, and increasing their board diversity.
As a result, the earnings growth of Japanese companies has been building for some time (even outperforming US equities) and dividends and buybacks are back on an upward trajectory.
Japanese equities’ record-breaking run
Japanese stocks have surged since the TSE announced its carrot-and-stick policy—up 33% in local currency at the time of writing. The Nikkei Index has finally breached its previous all-time high, set 35 years ago. Even accounting for the benefit of a weak Yen, the Nikkei’s performance is only marginally behind the S&P 500’s in USD terms, without the benefit of Nvidia.
Korean regulators step forward
Korean stocks have underperformed the Nikkei over the last decade despite experiencing a higher economic growth rate. Korean regulators recently unveiled the Value Up programme, which may signal plans to follow Japan’s lead in improving corporate governance and stock-market performance – over two thirds (70%) of the Korea Composite Stock Price Index (KOSPI) constituents are currently priced at less than 1x book.
The Korean regulator aims to incentivise the better use of capital, reduce cross-shareholdings and improve shareholder returns. Korea’s Finance Minister has hinted at government plans in 2024 to implement tax incentives for corporates that increase dividends and/or cancel treasury shares. The government may potentially cut income tax on dividends for investors – another powerful incentive for the formidable family-run Chaebols to increase distributions.
Inheritance tax reduction, a key impediment to unwinding complex family cross-shareholdings within the Chaebols, is also under discussion. Any progress here, along with evidence that the National Pension Service (NPS) is putting its weight behind the scheme, would be a significant positive catalyst – the NPS owns 10% of the Korean equity market.
As in Japan, Korean regulators have also hinted at publishing a list of friendly and unfriendly companies, and non-compliance may ultimately risk delisting. However, only time will tell how this policy unfolds, and how it will be enforced.
Corporate governance reforms have experienced false starts before, and while it’s dangerous to expect things to be any different this time, the regulator appears to be acting more forcefully. The performance of the Nikkei over the last 12 months could encourage Korea’s regulators to take similar action.
To find out more about our views on Korean equities, see this Good Value Briefing.