[M&A Alssul Sinjab] Expansion of 'Director's Duty of Loyalty'... Attention on Corporate Governance Improvement

Corporate Governance Improvement vs. Excessive Infringement of Management Rights... Diverging Opinions on the Amendment
Actual Passage Uncertain... Demand for Governance Reform Expected to Intensify

"A director of a company must faithfully perform their duties for the 'company' in accordance with laws and the articles of incorporation."

The current Commercial Act defines the 'duty of loyalty of directors' in this way. However, on the 26th of last month, the National Assembly's Legislation and Judiciary Committee (LJ Committee) passed a bill to amend the Commercial Act to change the duty of loyalty of directors' target from 'company' to 'company and shareholders,' drawing close attention from the business community and investment banking (IB) industry. If the amendment passes the plenary session, it could bring significant changes to corporate governance in domestic companies.

On the 4th, M&A Alssul Sinjab will examine the ripple effects and justifications of partially changing the wording of the Commercial Act provisions.

Corporate Governance Improvement vs. Excessive Management Rights Infringement... Divergent Views on the Amendment

The core of the amendment passed by the LJ Committee is the revision of Article 382-3 (Duty of Loyalty of Directors). The amendment changes the duty of loyalty target from 'company' to 'company and shareholders.' It also newly adds a clause stating, "Directors must protect the interests of the majority shareholders while performing their duties and treat the interests of all shareholders fairly."

If the amendment passes the plenary session and the Commercial Act is revised, the board of directors, which has so far been responsible only to the 'company,' will enter an era where it must also consider 'shareholders' interests.' Yoonjung Kim, a researcher at LS Securities, noted, "The amendment to the Commercial Act is an area that contributes to improving corporate governance evaluation indicators that foreign investors have pointed out in the Korean capital market."

On the other hand, the business community worries about the possibility of excessive infringement on management rights by minority shareholders or activist funds. There is also a forecast that if directors are swept up by shareholders' excessive dividend demands, it could weaken companies' long-term investment and competitiveness. A law school professor who requested anonymity said, "It is difficult to regulate violations of the duty of loyalty between shareholders and directors because the shareholder composition is very diverse," adding, "If the amendment passes, it will cause significant disruption to the existing system."

What about overseas situations? This amendment was influenced by the Delaware General Corporation Law in the United States. The relevant provisions of Delaware law explicitly include "the pecuniary interests of the stockholders" as the duty target of directors. However, other major countries such as the UK, Japan, and Germany still specify only the 'company' as the target of directors' duty of loyalty. Delaware law also implies that directors should balance the interests of shareholders, related parties, and the public interest, so it does not prioritize shareholders' interests alone.

Actual Passage Uncertain... Demand for Governance Improvement Expected to Intensify

If the Commercial Act amendment passes, companies with low dividend payout ratios and abundant net cash are expected to receive more attention. We can get a hint from Japan's case, which has pursued corporate governance reform as part of 'Abenomics' since the mid-2010s. Japan implemented reforms focusing on expanding the proportion of outside directors and strengthening board responsibilities. As a result, the Japanese stock market has escaped long-term stagnation and recently reached record highs in 30 years, enjoying a boom.

Activist funds and others have pointed out that Korean companies' dividend payout ratios are excessively low, which has prevented the resolution of the Korea discount (undervaluation of the Korean stock market). In fact, the US, Japan, and Taiwan have corporate dividend payout ratios around 50%, but Korea shows a dividend payout ratio below 30%, even lower than China.

Researcher Kim said, "Japan experienced improvements in corporate governance indicators and the spread of shareholder activism, followed by increased foreign inflows and index rises," adding, "The amendment to the Korean Commercial Act is expected to contribute to the spread of domestic shareholder activism, and shareholder actions demanding improvements in Korea's low dividend payout ratio are likely to expand." According to LS Securities' analysis, companies such as Hyundai Mobis, Hankook Tire & Technology, Hyundai Construction, and Nongshim have dividend payout ratios of only 13-20%. These companies also have low price-to-book ratios (PBR) and abundant net cash. Generally, a PBR below 1 is interpreted as the stock being undervalued.

However, the ruling party, the People Power Party, has requested Choi Sang-mok, Acting Prime Minister and Minister of Economy and Finance, to exercise the right to request reconsideration (veto) if the amendment passes the plenary session. If the veto is exercised and reconsideration occurs, more than 200 votes in favor are required, meaning at least eight defections from the People Power Party would be necessary. On the 27th of last month, National Assembly Speaker Woo Won-shik said, "The impact on our society is very significant," and did not submit the amendment for plenary session consideration, urging prior consultation between the ruling and opposition parties.

However, regardless of whether the amendment passes, the broader trend of 'improving Korean governance' seems difficult to reverse. A recent report also showed that governance improvements positively affect corporate financial performance. Deloitte Korea compared the financial performance of companies with excellent governance and those with weak governance, selected by the Korea ESG Standards Institute from 2021 to 2023. Companies with excellent governance (grades S~B+) consistently recorded better financial indicators such as return on equity (ROE) and return on assets (ROA) than weak governance companies (grades B and below). The average market capitalization of companies with excellent governance was also higher than that of weak companies.

Soyeon Park, a researcher at Shin Young Securities, emphasized, "One of the key keywords that will run through the domestic stock market this year will be 'governance reform,' because not only individual shareholders but also major national institutions have consistently mentioned the need for improvement." She added, "The overall direction of expanding shareholder return movements by companies will be maintained. Regardless of the actual passage of the Commercial Act amendment, the ruling party has also prepared amendments to the Capital Markets Act, indicating that awareness of governance issues is forming."

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