It is not uncommon to find conglomerate businesses in Korea and Japan with a large dominant shareholder, cross shareholdings, inefficient balance sheets with loads of cash or investments weighing on returns on equity, and low payout ratios.
In Korea, a handful of family-run conglomerates – the Chaebols – dominate the business landscape, and cross shareholdings among the family’s business interests can resemble a Jackson Pollock.
Japan has been on a pathway of reform for the past decade, but the pressure to lift corporate governance intensified in 2023 when the Tokyo Stock Exchange set its sights on companies with an ROE of less than 8 per cent and valuation of less than 1x book – almost half the stocks listed in Japan.
These companies have been told to provide a plan of how they will, among other things, increase capital efficiency, returns and shareholder value via distributions – and lift price to book above 1x.
There is no legal enforcement but Japanese companies are responding to the TSE’s threat to name and shame.
Today, more companies are communicating shareholder return targets, introducing return on capital and excess return KPIs, and are increasing diversity on their boards.
The earnings growth of Japanese companies has been building for some time, even outperforming US equities, and now dividends and buybacks are also increasing.
But Japan has had a phenomenal run in the 12 months since the TSE announced its carrot and stick policy – up 45 per cent in local currency at writing.
Nikkei has finally breached its previous all-time high set 35 years ago, and even removing the benefit of the weak yen, the Nikkei’s performance is only a whisker behind the S&P 500’s in USD terms, without the benefit of Nvidia.
However, Korea (the KOSPI) is being left behind its neighbour and it is not just the past 12 months.
The KOSPI has underperformed the Nikkei over the past decade despite a higher economic growth rate.
With 70 per cent of KOSPI constituents priced at less than 1x book, Korean regulators look like they may be following the path carved by Japan with the recent announcement of their "corporate value up" programme.
In a similar vein, the rationale is to incentivise better use of capital, reduce cross shareholdings and improve shareholder returns.
Korea’s finance minister has indicated tax incentives for corporates that increase dividends and/or cancel treasury shares will be implemented in 2024, as well as potentially cutting income tax on dividends for investors – another powerful incentive for the formidable Chaebols to increase distributions.
Also in discussion is a reduction in inheritance tax, which is known to be a key impediment to unwinding complex family crossholdings within the Chaebols.
Any progress here, along with evidence that the National Pension Service is putting its weight behind the scheme, would be significant positive catalysts – the National Pension Service owns 10 per cent of the Korean equity market.
