Foreign investors bet $5.2 billion on Kospi as 'Korea discount' plans near

The Korean government’s planned announcement of policies aimed to boost the stock market is attracting foreign investors into the country, pushing up the price of undervalued stocks.

[SHUTTERSTOCK]

The Korean government’s planned announcement of policies aimed to boost the stock market is attracting foreign investors into the country, pushing up the price of undervalued stocks.

Foreign investors net purchased more than 7 trillion won ($5.2 billion) worth of Kospi stocks over the past four weeks since the government in mid-January disclosed plans on the so-called “corporate value-up program.” The trading volume in the period was more than double the 3 trillion won they purchased in December.

The Financial Services Commission (FSC) plans to announce specific details of the program later this month. The goal is to resolve the so-called ‘Korea discount,’ or undervaluation of the country’s stocks to make the Korean market more attractive.

The FSC chief Kim Joo-hyun said the essence of the program will include making comparisons of listed companies by their price-to-book (PBR) ratio and the launch of exchange-traded funds (ETFs) that consist of companies with improved shareholder value.

PBR is calculated by dividing a company’s market capitalization by its book value of equity. A ratio below 1 indicates that a company is undervalued. Finance, insurance and retail are some of the sectors with low PBR.

The average PBR of companies listed on Kospi as of January was a ratio of 0.9, the second lowest of the member countries in the Organisation for Economic Cooperation and Development (OECD) after Columbia, according to the Korea Exchange data. The PBR of the S&P 500 is 4.6 and that of Nikkei 225 is 2.0.

The primary reasons behind the Korea discount include weak corporate governance and shareholder return.

“There’s a discordance between ownership and management rights in Korean companies,” said Lee Seung-hyup, associate fellow at the Korea Development Institute's Department of Macroeconomic and Financial Policies, noting Korea’s controversial corporate governance.

“Major shareholders can arbitrarily control the company beyond their controlling rights. That is explained by the deeply rooted management rights yielded by chaebol families in the past at the sacrifice of minor shareholders, which we haven’t yet been able to overcome.”

Such a way of management was efficient and was socially accepted in the past when the country was growing rapidly, as companies needed to attract large sums of funds from diverse investors, thereby diluting controlling rights, but had to make quick and bold decisions to grow. However, the corporate culture remains in place even after the market has advanced.

Financial Services Commission Chairman Kim Joo-hyun speaks at a conference held in Gangnam, southern Seoul, on Feb. 6. The FSC plans to announce details of the ″corporate value-up program,″ aimed to boost Korea's stock market. [YONHAP]

Insufficient shareholder returns is another risk, as Korea’s corporate governance structure raises the risk of controlling shareholders taking personal benefits from the free cash flow, said Kim Joon-seok, senior research fellow at the Korea Capital Market Institute in a report on the Korea discount last May.

For the corporate value-up program to succeed, it needs to incentivize companies to voluntarily participate in the program and needs to be a long-term project.

“The program mulled by the government is not desirable because its effect will not be sustainable by threatening companies to participate,” said Seok Byoung-hoon, an economics professor at Ewha Womans University. “The government needs to incentivize corporations to voluntarily take part.”

One possible measure is to start levying capital gains tax on retail investors for stock trading, which only makes sense when an income has been incurred, and offer tax incentives to those who invested in a stock for longer than a year, he said.

Retail investors in Korea do not pay capital gains tax when trading local securities.

Another method is to create an index that consists of companies with good shareholder value and create an ETF based on the index.

The upcoming program is known to have benchmarked Japan, which has pushed government-led stimulus measures since the early 2010s.

In 2014, Japan published the Stewardship Code that encouraged the country’s institutional investors to improve investment returns for their clients by enhancing companies’ corporate value and sustainable growth.

In 2022, the Tokyo Stock Exchange restructured its five market segments into three to encourage listed companies to enhance their mid to long-term corporate value. Last year the exchange adopted a tougher listing criteria aimed to improve companies’ capital efficiency.

The Nikkei 225 soared to a 34-year high this month.

“Japan’s recent stock boom was largely helped by record earnings of Japanese companies and because its major trading partner is the United States, which enjoyed a strong economy unlike China, Korea’s largest trading partner,” Seok said. “So good corporate earnings is a precondition that needs to be met for the program to be successful.”

BY JIN MIN-JI [jin.minji@joongang.co.kr]