Management changes: key to solving Korea’s chronic corporate undervaluation
This article is the second in a three-part contribution on the “Korea discount” and McKinsey Korea’s take on how to resolve it. — ED
Over the next 10 to 20 years, Korea is expected to go through one of the most profound changes in its corporate history — the transition of ownership in key businesses via intergenerational transfers.
Such transitions have been observed throughout past decades, but what should be noted in recent years is the consistent application of inheritance taxes, which may rise to as high as 60 percent in effective rates for large conglomerates.
This tax burden is making it increasingly difficult for owner families to retain control and pursue business stability. In a landmark press conference in 2020, Lee Jaeyong, Samsung Group’s third-generation chief who was then vice chairman of Samsung Electronics, announced that he would not pass the management rights of the conglomerate on to his own children.
Even the conglomerates with weaker family ownership affiliations, such as steelmaker POSCO, mobile carrier KT and tobacco provider KT&G, have faced backlashes over their CEO successions, especially from activist investors who called for corporate governance reforms to unlock shareholder value.
Despite the concerns that the removal of “chaebol owners” may hinder the drive for growth, leading global businesses have been inching toward a more dispersed power structure.
Among Fortune’s top 500 companies by revenue in the United States, only eight have family shareholders as of today — Walmart, Ford, Comcast, 21st Century Fox, Tyson Foods, Gap, Estée Lauder and Campbell Soup.
Japan saw its so-called “zaibatsu,” or conventional family-controlled conglomerates, nationalized during and after World War II.
It is now high time for Korea to figure out a compatible solution for business transition - not only for the benefit of conglomerate owner families but also for the sake of market stability and business growth.
The country’s tax system, along with the consequent disincentives for management change, is, in fact, one of the factors dampening foreign investments here.
Korea’s foreign direct investment (FDI) volume was ranked the world’s 23rd as of 2022 with $18 billion, an amount far lower than that of peer economies and neckand-neck with less developed ones such as Chile and Colombia.
Given that FDI inflows in Korea have created almost 300,000 jobs and an additional 75,000 work opportunities for young people during the past 10 years, this sluggish FDI volume should be seen as a major hurdle to growth.
Despite various setbacks, however, some companies have managed to carry out ownership changes.
An example is oil refiner and energy company S-Oil, which was acquired by Saudi Aramco in 1991, changing from Ssangyong Refinery to its current multinational subsidiary identity. Similarly, beer maker Oriental Brewery was acquired by the world’s largest brewer, Anheuser-Busch InBev, or AB InBev, in 2014.
Another category is businesses acquired by private equities, which are, in most cases, former conglomerate subsidiaries that were put on the market as a result of restructuring.
These examples of successful management transitions provide key lessons for Korean companies on how to grow out of conventional family-owned governance.
First, it is crucial that the governance of the company be fundamentally tied to shareholders’ interests.
Under the current system, many listed Korean companies see little reason to work on shareholder value, as higher stock prices would mostly increase the inheritance tax burden on the controlling shareholder. Once this tax disincentive is removed, business managers will face greater pressure for performance as they might be either dismissed or replaced.
Second, the board must remain independent from management and speak on behalf of shareholders.
Private equities often strongly empower the board with key decisions, including M&As or even the appointment and dismissal of the CEO. They also tend to hire industry veterans for top managerial posts instead of former high-profile government officials, as is often the case in listed Korean companies.
Finally, management incentives must be aligned with shareholders. They could take place in a more direct form such as stock options, or a relatively indirect one such as profits and revenues. Also, management’s tenure needs to be stabilized in order to fully realize the value creation potential.
It is true that Korea, despite its economic size and leading industries, still stands at a relatively early stage of capitalism. But in order for the country to leap into the next phase of the market, it is crucial that policymakers and businesses step out of the conventional frame and reorganize corporate governance.