Is Corporate Governance to Blame?

“There is no such thing as a ‘Korea discount.’”

Since the financial crisis, the term “Korea discount” has been widely used to express that stock prices of Korean companies were undervalued compared to those of their foreign counterparts. The vulnerable corporate governance of Korean firms was pointed out as the reason.

The Samsung Economic Research Institute (SERI) released a report on March 20 that strongly refuted this argument.

A controversy is expected, as the report criticizes the views of some government authorities, civic groups, and foreign press outlets that argue: “Korean stocks are undervalued due to poor corporate governance.”

SERI: “Corporate governance is irrelevant to stock prices.”-

In its report titled: “The Korea Discount and Corporate Governance,” SERI repudiated each element of the claim that says, “Fragile corporate governance of Korean companies drives out domestic and foreign investors, and the resulting underestimation of stocks undermines the interests of shareholders.”

Based on price-earnings ratio (P/E ratio: a company’s current share price divided by per-share earnings), the publicized document pointed out that the case for the underrated Korean stock market was poorly founded.

Compared with the P/E ratios of major countries from 1999 to 2003, Korea’s ratio (16.9) has been similar or higher than those of some other newly emerging markets and the European region such as Britain, Germany, and France, ranking fourth following that of Japan (48.7), the U.S. (32.2), and Taiwan (20.8). This shows that the claim of a “Korea discount” is not substantiated.

The argument that attributes low stock prices to bad corporate governance is not well founded, the report said.

According to a comparison of financial indicators between 36 companies, with good corporate governance, which are included in the corporate governance index of Korea Exchange, and the top 36 companies in market value excluded from the list, the return on equity (ROE) of businesses not included in the index stood at 14.8 percent, higher than the 13.4 percent of companies with good corporate governance.

There are cases where stock prices are undervalued in a company whose controlling shareholder has strong control over the firm. But even so, the cause lies not with the low profitability of the business, but with the investment patterns of foreign investors such as private equity funds that aim for short-term arbitrage trading, analyzed the report.

“Rather than corporate governance, threats to security, political instability, and destructive labor-management relations are contributing to the so-called “newly-emerging market discount” in Korea as well,” said SERI, which urged, “The government must focus on stabilizing labor-management relations and looking for growth engines for corporations.”

Korea Fair Trade Commission (KFTC) says report is “unacceptable”-

The KFTC, in charge of regulation policies on large conglomerates, expressed its position that the report was unconvincing

Some civic groups that had been denouncing the problems of corporate governance also showed negative reactions to the contents of the report.

“The financial crisis broke mainly because conglomerates dominated the management control of their affiliates with small shareholding, while over-diversifying their business structures,” a KFTC official said. “Some analyses point to the fact that companies that had good corporate governance records achieved good management performance, and that the findings may vary with the period selected for the study.”

Young-Hae Choi yhchoi65@donga.com