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Feb 11th 2012 | Seoul | from the print edition
IT IS sometimes asserted that low South Korean equity valuations stem from the
threat of instability in North Korea. That explanation looked a lot less
convincing after the death of Kim Jong Il in December, when the KOSPI 200 index
of leading shares and the won, the South Korean currency, both quickly shrugged
off the news.
So what is the source of the Korea discount , which means that the KOSPI has a
forward price-to-earnings ratio of under ten, below most other Asian
stockmarkets (see chart)? There are a few possibilities. The national economic
model is still built on exports, often in highly cyclical industries such as
shipbuilding. The capital structure of South Korean firms has historically been
debt-heavy.
But the prime cause of the discount is more likely to be poor corporate
governance at the family-run chaebol conglomerates that dominate the economy.
Nefarious schemes to pass on control to sons, avoid taxes and exploit company
assets for the benefit of family members are widely discussed in private. They
are also lambasted abroad: a 2010 survey by CLSA, a broker, placed the country
third-from-bottom in Asia on governance, ahead of only Indonesia and the
Philippines.
The issue is now also getting more of an airing at home. A recent report by
Tongyang Securities, a broker, drew an explicit link between Korea s low equity
valuations and the practices of tunnelling and propping , which benefit
insiders at the expense of smaller investors.
Tunnelling is the awarding of contracts to firms owned by family members.
Chaebol heads typically own only a small portion of their firms, but are able
to maintain control through complex cross-holdings; tunnelling offers a means
of exploiting that control to get richer, quicker. In 2007, for instance, the
Fair Trade Commission, an official watchdog, fined Hyundai Motor for, among
other things, giving 1.3 trillion won ($1.4 billion) of business to Glovis, a
firm owned by the son of Hyundai s chairman without any tendering.
Propping is similar to tunnelling, and means that unviable units get financial
support from sister companies. But it is no less damaging to small investors.
If company insiders are able to misuse shareholders funds at will, would-be
investors will reduce their expectations of future cash flows and thus attach
lower valuations to stocks.
Other allegations are even more serious. On February 3rd Hanwha Group announced
in a regulatory filing that its chairman, Kim Seung-yeon, was among several
officials being investigated for alleged embezzlement. Chey Tae-won, the
chairman of SK Group, was indicted in January over the disappearance of 99
billion won from company coffers, as part of a scheme allegedly planned by his
brother to cover futures-trading losses. Mr Chey denies the charges. The
Federation of Korean Industries, a chaebol pressure group, has urged
prosecutors to go easy on Mr Chey. They say that punishing him would harm
entrepreneurial spirit .
Mr Chey has had previous scrapes, having been convicted of a billion-dollar
accounting fraud in 2003. He eventually received a full pardon from the
president and was also chosen to represent the nation during the 2010 G20
summit, leading a meeting of international chief executives. Lee Kun-hee, the
chairman of Samsung, received a similar pardon in 2009, having been found
guilty of tax evasion, and was picked to front South Korea s bid for the 2018
Winter Olympics. Yujeon mujwai, mujeon yujwai an old expression meaning money
= innocence, no money = guilt is enjoying a resurgence in popularity.
The irony is that the largest chaebol are models of efficient production and
are enjoying a golden period. Their success, say proponents, vindicates the
family-run approach to business. Their ownership structure means they have no
need to appease short-termist investors or to meet quarterly earnings targets;
instead, they can invest for the long run. Smaller shareholders have reason to
feel less thrilled.
from the print edition | Finance and economics