[Yes and No] Money Also Dislikes Discrimination

[Asia Economy Reporter Jeon Pil-su] “You need to invest long-term. But not in domestic stocks, rather in US stocks.”

This was said by the head of a major asset management company I recently met. It sounded natural for a fund manager, whose business is investing, to talk about long-term investment like a teacher telling students to study. However, the statement that domestic stocks are not suitable for long-term investment was unexpected. The reason why the CEO of an asset management company does not recommend domestic stocks is simple. Shareholders owning 1% should gain 1%, and those owning 10% should gain 10%, but in a situation where a major shareholder holding 20-30% of shares can appropriate the benefits of 70-80% of other shareholders without it being illegal, long-term investment becomes difficult.

Suppose there are two companies within a group: Company A with a price-to-book ratio (PBR) of 1 and Company B with a PBR of 0.1. The major shareholder controlling both companies holds many shares of the more expensive Company A. What happens if the two companies merge? In Korea, mergers between listed companies use the market price merger system, so the merger ratio between Company A and Company B shares would be 10 to 1. The major shareholder holding many shares of Company A would be delighted, but shareholders of Company B would inevitably suffer losses. Exploiting this loophole, major shareholders can increase the value of the company they own while deliberately lowering the value of the other company to facilitate the merger, and this is not illegal. It was not only the major domestic conglomerates that once caused a stir by engaging in such practices. It is an open secret in the securities industry that small and medium-sized companies, which do not care about public opinion, frequently engage in such activities.

Excessive control premiums also hinder long-term investment. Control premiums for management rights in KOSPI or KOSDAQ listed companies often exceed 100%. If a major shareholder sells shares nominally worth 10,000 won at 20,000 won due to management rights and exits, the remaining shareholders have no choice but to sell their shares in the market on their own. If the new major shareholder uses the market price merger system to merge with other affiliates, the remaining shareholders may end up in the same situation as Company B’s shareholders mentioned earlier.

The corporate spin-off system, which drew complaints from minority shareholders last year, is similar. Under current law, shareholders opposing personnel spin-offs or mergers and acquisitions (M&A) have the right to request stock buybacks, but this right does not apply to physical spin-offs. Moreover, unlike personnel spin-offs where new corporation shares are distributed, physical spin-offs only create subsidiaries. This is why physical spin-offs have been used as a way to circumvent listing valuable business units. The physical spin-off listing of LG Energy Solution, which both ruling and opposition parties agreed to legislate against, is a representative case.

All these factors have contributed to what is called the “Korea discount,” but there are solutions. Instead of the market price merger system, which allows major shareholders to adjust merger ratios in their favor, a fair value merger system can be implemented. This would prevent the country from being troubled by individual company mergers. In the US, mergers are conducted at fair value by commissioning two accounting firms. The excessive premium problem can be addressed by requiring that minority shareholders’ shares be purchased at the same price as the major shareholders’ during M&A. Europe has legislated a “mandatory tender offer system,” which obliges the buyer to purchase minority shareholders’ shares at the same price paid with the control premium. Granting minority shareholders the right to request buybacks even in physical spin-offs would make it difficult to force spin-offs that reduce company value.

As a regime change approaches, the topic of making the country more business-friendly has resurfaced. For a country to be good for business, the investment environment must also improve. No matter how pro-business the policies are, if my money is discriminated against, I will hesitate to invest. Money dislikes discrimination too.

This content was produced with the assistance of AI translation services.