Why Samsung Electronics is courting its shareholders
Top chaebol family moves to preempt new president's legislative agenda
Peter S. Kim
Moves by Samsung Electronics to court minority shareholders ahead of expected legislative proposals by new liberal President Moon Jae-in could have a profound impact on South Korean corporate culture.
Rather than convert to a holding company structure as encouraged by existing legislation, Samsung has stepped up dividend payouts and share buybacks and canceled treasury shares, stock traditionally held in reserve by chaebol groups as a defensive tool against activist shareholders.
These measures should not only help the Lee family which controls Samsung to win favor from minority shareholders but also could serve as an example to other conglomerates on a way forward amid shifting political winds.
Moon's election was triggered by a corruption scandal involving predecessor Park Geun-hye, close associate Choi Soon-sil and chaebol including the Samsung group. Choi received a three-year sentence for abusing her influence to win a university place for her daughter on June 23 but trials continue on other much more serious charges. Trials for Park and Lee Jae-yong, the de facto head of the Samsung group, are also ongoing.
Among the incidents under scrutiny in the cases is the alleged intervention of Park's government in support of Lee's 2015 effort to merge two Samsung affiliates, Samsung C&T and Cheil Industries, to enhance his control. The merger received crucial support from the National Pension Service, a shareholder in both companies, even though critics said the plan went against the interests of minority stockholders.
The scandal has not been Samsung Electronics' only challenge. Last year's recall of the Galaxy Note 7 smartphone cost the company billions of dollars. Yet its stock is hovering near an all-time high, driven by buoyant semiconductor sales and positive market reception for the company's latest Galaxy mobile phone model.
There is also rising investor hope that the Samsung group might lead the nation in setting higher standards of corporate governance. Improved protection for minority shareholders in turn would significantly help usher in a new investment culture for the South Korean equities market, with characteristics commensurate with the developed market status the government desires.
For decades, chaebol have enjoyed policy support from the government on the premise that their success was essential for the entire nation's export competitiveness and economic growth. One of the measures that has allowed families to maintain control over their chaebol has been the issuance of treasury shares, which can dilute the voting power of other shareholders. Corporate governance flaws have been one of the key factors in the persistent valuation gap between local equities and their regional or industry peers, a phenomenon known as the "Korea discount."
Untangling the web
Ever since Samsung Chairman Lee Kun-hee fell critically ill in 2014, the market has been speculating that his group would unravel its labyrinth-like structure by breaking down a dozen crossholding links to create a holding company structure.
Share crossholdings have helped to lock in family control over many chaebol companies. In 2002, the predecessor party of Moon's Democratic Party of Korea introduced a bill to encourage chaebol to transform their collusive group structures into holding companies to provide transparency in accounting and corporate governance. Instead, the holding companies became a vehicle for families to concentrate their holdings into a mothership into which subsidiaries or operating companies fed their earnings via dividends.
The loose legislative framework led to many grey areas that benefitted majority shareholders over minority ones. But now with Moon in charge, the inherent protection afforded to chaebol families is under threat. One important proposal would restrict the conversion of treasury shares into voting shares for the benefit of holdings companies.
Among Moon's key appointments has been naming Kim Sang-jo to head the Fair Trade Commission. The agency is the main supervisory body monitoring the trade and business practices of large corporations. It also regulates intra-group transactions between chaebol affiliates, a frequent source of minority shareholder complaint.
Kim is a professor of economics and a civic activist who in 2004 was physically removed from Samsung Electronics' shareholder meeting for vocally challenging the company's governance. Even more significant is the newly created post of chief policy strategist that has been given to Jang Ha-sung. Jang, previously dean of the Korea University Business School, is well-known as the foremost critic of chaebol governance practices.
Leading by example?
As if to preempt the looming political storm, the Samsung group in May officially announced that it would not form a holding company after all. This is likely in part because trying to establish permanent control via a holding company would have drawn further political and public scrutiny.
The road ahead will instead require garnering the support of minority shareholders, especially the foreign investors who collectively own 54% of Samsung Electronics.
Already the share buyback program, higher dividend payouts and other measures over the past couple of years have set Samsung on this path. Samsung Electronics' new commitment to canceling treasury shares, a major factor dragging down its return on equity, will help too.
Local investors still view Samsung's actions with some degree of cynicism. To them, Samsung still places growth objectives over return on equity and shareholder gains. They also see Samsung Electronics' decision to cancel treasury shares as a means of seeking political reprieve, given its recent foibles.
On the positive side, the Samsung group is setting a strong positive example for other chaebol. Share buybacks and the cancellation of treasury shares could result in Samsung Electronics receiving a higher valuation in the global market, possibly encouraging other chaebol to follow its lead on corporate governance reform.
Samsung Electronics is embarking on a path rarely taken by chaebol at a time when its management control is no longer guaranteed by government support and legislative loopholes. In the coming months, new anti-chaebol legislation will determine the scale and pace of corporate governance reform in South Korea. Samsung's announcement is a preemptive move in preparation for the new set of rules chaebol are about to face.
Samsung's leading role, wholly voluntary or not, in setting a precedent for other chaebol may have a profound impact on the local equities culture. Establishing higher standards of corporate governance and transparency and embracing the concept of maximizing returns to shareholders should ultimately produce a valuation premium for the entire South Korean equities market rather than the current discount.
Peter S. Kim is a managing director and investment strategist at Mirae Asset Daewoo. The views expressed here are his own.
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