As emerging markets convulse in the wake of the US presidential result, a South Korean political scandal may mark a seminal moment in the battle to clean up the country’s corporate governance, says Ed Wiltshire.

Life isn’t getting any easier for Park Guen-hye. The leader of the world’s eleventh largest economy, South Korea, facing possible impeachment on corruption charges and an approval rating slumping to four per cent[1], has been obliged to place her future in the hands of parliament.

Much of President Park’s woes result from her association with so-called ‘shaman adviser’, Choi Soon-sil. Choi was indicted for abuse of power on 20 November over allegedly using her position to encourage South Korean household names such as Samsung and Lotte to donate millions of pounds to foundations under her control[2].

With her political future in doubt, Park finds herself in a weak position ahead of a summit with Japan and China in December that will no doubt now cover the potential implications of a Donald Trump US presidency on Asia. Furthermore, though the next presidential election is due in December 2017[3], it seems increasingly unlikely Korean legislators – or the public – will countenance her remaining in office until then.

As investigators attempted to track down the money flows between Ms Choi and big business, prosecutors raided Samsung Electronics’ headquarters, in the Gangnam district of Seoul, on 7 November. The company is alleged to have transferred €2.8 million (£2.5 million) to German-based Widec Sports, a company controlled by Ms Choi, to fund the development of national equestrian activity. Choi’s daughter is an aspiring equestrian hopeful for the next Olympic Games[4].

Raids were subsequently launched on Samsung Group, SK Group, Lotte Group and South Korea’s largest pension fund, the National Pension Service. Public prosecutors expanded the scope of investigations to include the NPS’s backing for Samsung Electronics subsidiary Cheil’s merger with Samsung C&T in July 2015, and the influence some of the country’s largest domestic conglomerates have over government policy[5].

Chaebols under fire

The latest South Korean political scandal underscores the close ties between domestic business and the government; vestiges of the large family-run conglomerates, or ‘chaebol’, that still account for over 60 per cent of the value of the stock market. Four chaebol – Samsung, Lotte, Hyundai Motor Group and LG Group – alone represent 42.3 per cent of the total[6].

Reflecting the tension that often exists between controlling families and minority shareholders, US activist investor Elliot Management launched its latest attempt to split up Samsung Electronics in October. Elliot has called for the business to be separated into a holding company and operating company, with the latter also listed in the US to increase the organisation’s appeal to foreign investors. Overseas investors own almost 60 per cent of Samsung. Additionally, Elliot seeks to improve the company’s governance by adding three independent directors to the board and has called for a $27 billion special dividend to shareholders.

The incumbent Lee family foiled the last attempt by Elliot and other minority shareholders to revamp corporate governance at the chaebol. On that occasion, minority shareholders’ concerns over a proposed corporate restructuring came to nothing when subsidiary Cheil’s merger with Samsung C&T was voted through in July 2015. The merger – which gave Cheil’s largest shareholder, Lee Jae-yong, effective control over Samsung C&T’s four per cent stake in Samsung Electronics – was seen as a significant step in the succession programme. He was appointed to the Samsung Electronics board at an extraordinary general meeting in October 2016.

The latest salvo from Elliot comes at a crucial time for South Korea’s largest business. Samsung was desperate to steal a march on smartphone rival Apple with the launch of the Galaxy Note 7 device in August. However, the company is now battling to protect its brand after the disastrous recall of an estimated 2.5 million Galaxy Note 7 smartphones, after many of the newly-launched phones’ batteries caught fire. Credit Suisse estimates this will trim $1.4 billion from Samsung’s earnings in the second half of 2016. Adding to the company’s woes, the business voluntarily withdrew some top-loader washing machine models in the US earlier this month over persisting safety concerns [7].

At the end of November, Samsung responded to the Elliott proposals by announcing it will undertake a review into the complexity of its corporate structure and consider reform upon its completion, expected in six months’ time. It also agreed to hire a new independent board member and to return more of the company’s cash to shareholders. Though this was only a small step towards implementing Elliott’s suggestions, it did at least represent welcome progress and the market responded by lifting Samsung’s share price to its highest level in 40 years.

Changing of the guard

Criticism of the chaebol structure from opposition politicians and overseas investors seems to be partly coming to a head given the age of many central kingpins at the conglomerates. For instance, the founder and chairman of Samsung Electronics, Lee Kun-hee, is 74 and has been hospitalised since a heart attack in 2014.

There are at least signs the new guard coming to power at the chaebol will be more receptive to calls for corporate structures that are in tune with international governance norms. For all the family feuding over replacing 94 year-old Lotte Group founder Shin Kyuk-ho and various ongoing corruption investigations into the company, chairman Shin Dong-bin – the founder’s youngest son – has pledged to accelerate his corporate governance reform programme.

However, despite attempts by local policymakers to adjust tax arrangements to encourage companies to pay higher dividends, progress has been slow. The gross annual dividend yield on South Korean stocks of around 1.6 per cent contrasts with 2.1 per cent in Japan and 4.0 per cent in Taiwan. That said, domestic dividends paid to shareholders by the largest 100 listed South Korean businesses in 2015 increased by a third on those paid in 2014, according to industry research company Chaebul.com. Furthermore, Samsung Electronics is one year into a three-year commitment to lift dividend payments, while steel producer Posco became the first South Korean company to pay quarterly dividends this year.

There is much work to do – the average dividend pay-out ratio for South Korean listed companies of 20.14 per cent compares with 38.53 per cent for listed companies in South-East Asia[8].

Emerging-market investors have long been frustrated by the painfully slow pace of South Korean corporate governance reforms. The hope now is that something positive will emerge from President Park’s travails, and the spotlight this has put on the murky links between politics and big business. The Korean market contains a number of attractive companies with globally recognised and admired brands. Any moves to reassure international investors that their interests were more closely aligned with the families who owned and managed these conglomerates would only add to their competitive advantage. It would be disappointing if this unique opportunity for such reforms goes begging.  That would be to the detriment of all parties with a long-term interest in these companies. 

 

1 Source: “South Korea political crisis hits Park rating, consumer confidence”, 24 November 2016

2 Source: “Power vacuum weighs on South Korea as Park fights for survival”, Reuters, 23 November 2016

3 Source: Park Geun-hye, a nation’s princess recast as puppet, the Financial Times, 5 November 2016

4 Source: “Prosecutors raid Samsung Electronics headquarters”, the Financial Times, 7 November 2016

5 Source: “South Korean investigators raid Lotte and SK offices amid political scandal”, Reuters, 23 November 2016

6 Source: FactSet, Bloomberg, Aviva Investors, 10 November 2016

7 Source: “Voluntary withdrawal of certain top-loader washers”, Samsung, 4 November 2016

8 Source: Bloomberg, 15 November 2016 based on the KOSPI dividend pay-out ratio in won and that for the MSCI AC Asia ex Japan Index (USD)

Important Information

Unless stated otherwise, any sources and opinions expressed are those of Aviva Investors Global Services Limited (Aviva Investors) as at 25 November 2016. This commentary is not an investment recommendation and should not be viewed as such. They should not be viewed as indicating any guarantee of return from an investment managed by Aviva Investors nor as advice of any nature. Past performance is not a guide to future returns. The value of an investment and any income from it may go down as well as up and the investor may not get back the original amount invested.

RA16/1037/28022017