[The Treasury Stock Trap]③ ‘Stock Price Support vs Management Control Threat’ Controversy Over Cancellation Effects

Individual Investors "Actively Welcome, Expect Undervaluation Resolution"
Business Community "Management Rights Defense Measures Should Be Introduced and Then Organized"

Editor's NoteThe Financial Services Commission is reviewing a reform plan for the treasury stock system. Key points include 'mandatory cancellation after treasury stock repurchase' and 'prohibition of new share allotment to treasury stock during spin-offs.' The financial investment industry and individual investors welcome these changes, expecting improvements in shareholder rights. Conversely, the business community opposes the plan, fearing the loss of one of the means to defend management rights. This article analyzes the current status and effects of treasury stock repurchase and cancellation among listed companies in Korea to explore possible reforms to the treasury stock system.

[Asia Economy Reporter Lee Seon-ae] The Financial Services Commission, which introduced multiple policies last year to protect minority shareholders, is now reviewing reforms to the treasury stock system, sparking intense debate over issues such as 'mandatory cancellation after treasury stock repurchase.' While the financial investment industry and individual investors welcome the move as a way to enhance shareholder value, the business community is concerned that one of the tools for defending management rights may disappear. Although the authorities have stated that "nothing has been finalized," the controversy is expected to continue as the possibility of reform arises.

On the 25th, the Financial Services Commission stated, "We are reviewing improvements to the treasury stock system to protect the rights and interests of general investors," but added, "No specific measures have been decided yet." Earlier, Kim So-young, Deputy Chairperson of the Financial Services Commission, also mentioned at the '2023 Securities and Derivatives Market Opening Ceremony' that she would consider improving the system in response to criticisms that the process of acquiring and disposing of treasury stock undermines market trust.

The market is particularly focused on whether the reform plan will include ▶mandatory cancellation after treasury stock repurchase ▶prohibition of new share allotment to treasury stock during spin-offs. The authorities view the domestic capital market practice, where treasury stock repurchases do not lead to cancellation, as one factor contributing to the Korea discount (the undervaluation of the Korean stock market) and believe improvements are necessary.

In advanced countries, cancellation after treasury stock repurchase has become a common practice. The United States is a prime example. Kim Su-hyun, Head of Research at DS Investment & Securities, explained, "In the U.S., if a company resells treasury stock to the market, it must go through a process as difficult as an initial public offering (IPO), and treasury stock that is not canceled is excluded from market capitalization calculations." In the U.S., companies that repurchase treasury stock and then resell it must re-register with the Securities and Exchange Commission (SEC) and meet strict requirements similar to those for issuing new shares.

The Financial Services Commission is also concerned about the so-called 'treasury stock magic,' where controlling shareholders strengthen their control without significant cost by converting to a holding company through spin-offs. Many large corporations have used this 'treasury stock magic' when transitioning to a holding company structure. In a spin-off, the newly established company’s shares are distributed to existing shareholders according to their shareholding ratios, so the surviving company automatically secures shares in the new company corresponding to its treasury stock ratio. Since the spin-off creates a new legal entity, voting rights are restored. To block this treasury stock magic, the Financial Services Commission sees the need for measures such as restricting voting rights of new company shares allotted to treasury stock, prohibiting allotment of new company shares to treasury stock, and mandatory cancellation.

The business community has expressed concerns. They argue that strengthening treasury stock regulations under current circumstances could eliminate one of the tools for defending management rights. A business official said, "Since Korea does not adopt dual-class shares, there are limited means to defend management rights," adding, "The business community’s position is that other defense mechanisms should be introduced before reforming the treasury stock system." Another official warned, "Treasury stock regulations could discourage spin-offs and transitions to holding company structures, which would worsen corporate governance transparency."

Professor Kwon Jae-yeol of Kyung Hee University Law School said, "If a law mandating companies to cancel treasury stock is enacted, it should be considered that the defense tools against hostile M&A attempts would be reduced," and added, "Since stock cancellation is an important system under the Commercial Act, discussions with the Ministry of Justice are necessary."

Individual investors have a different perspective. Jeong Eui-jeong, representative of the Korea Stock Investors Union, which has 50,000 members, emphasized, "The KOSPI price-to-book ratio (PBR) was 0.83 around the 2007 financial crisis and remained at 0.84 at the end of last year, showing no progress for 15 years," and stressed, "Companies’ passive attitude toward enhancing shareholder value is largely to blame." He added, "We need to break the treasury stock magic and open an era of coexistence through proactive shareholder-friendly policies." Kim Jun-seok, Senior Research Fellow at the Korea Capital Market Institute, also stated, "Using treasury stock to strengthen control, rather than bearing costs by controlling shareholders, cannot avoid legitimacy controversies," and called for "regulations that consider treasury stock acquisition as equivalent to stock cancellation."

The Financial Services Commission plans to review specific reform directions after gathering opinions from various sectors. Attention is growing on which side?the business community or individual investors?will have more influence on the reform plan.

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