As global investors scrutinize South Korea’s plan to boost corporate valuations, they note a key hurdle — the prevalence of family-controlled businesses, or chaebols, which are often blamed for keeping stocks undervalued.

From Samsung Electronics to Hyundai Motor, Korean conglomerates are run by members of the founding families who can wield outsized power through complex cross-shareholdings. The controversial structure and a tendency to sideline minority shareholders are among reasons why Korean firms have traded at a much lower valuation than overseas peers for years, resulting in a phenomenon that investors call the “Korea Discount.”

Officials in Seoul are taking a cue from Japan, where a push for corporate reforms has been one of the key drivers for a world-beating equity rally. Yet the lukewarm market response to Korea’s “Corporate Value-up Program” this week showed that the efforts are falling short of firmly addressing poor governance.

Also, after driving Korean stocks higher for weeks in anticipation of the measures, investors seem to be coming around to the view that any reform and a re-rating of equities will take years to bear fruit, as was the case in Japan.

“Regulators must understand that there are no effective ways to reduce the Korea Discount other than by reducing the power of controlling shareholders,” said Jonathan Pines, lead portfolio manager of Asia ex-Japan equity at Federated Hermes. “Some controlling shareholders prefer lower stock prices to reduce inheritance tax and provide continuing opportunities to force minority shareholders out at the cheap market price.”

Cheap Korea

The benchmark Kospi Index trades at a little over 10 times its earnings estimates, compared with ratios near 16 and 17 respectively for Japan’s Topix Index and Taiwan’s Taiex gauge.

The Kospi has fallen 1 percent this week following the release of the government’s plan, halting a five-week winning streak. It has gained about 9 percent over the past 12 months. In the same period, Japan’s gauge has rallied more than 35 percent and Taiwan’s 21 percent.

Seoul’s valuation drive relies on voluntary efforts and lacks punitive measures, with companies encouraged to self-evaluate their improvement in areas including corporate governance and shareholder returns for tax incentives.

Some skeptics even downplay the plan as a political move ahead of the April parliament election to win retail votes, saying it may lose momentum once that’s over. Mom and pop investors, which account for more than a quarter of the country’s 52 million population, have become a key political bloc.

Faced with pushback that the value-up plan lacks teeth, authorities emphasized that they are seeking a longer-term upgrade of the market. Their determination on delivering a change in corporate behavior will be put to test in June, when the details of tax incentives and other guidelines are released.

“Whether it’s incentives or penalties, they both seem insufficient at the moment,” said James Lim, senior research analyst at Dalton Investments Inc. “Controlling shareholders control the board and the management. Are these incentives big enough to change their behavior meaningfully? It’s not compulsory so it remains weak.”

Chaebol Problem

Chaebols’ business structure has been under debate in Korea for decades. While their concentrated leadership allows speedy decision making and has proved crucial in transforming the country into industrial powerhouse, it has also been criticized for a lack of transparency and decisions that neglect shareholder interest.

In a landmark case that involved the country’s largest conglomerate, governance watchers have expressed concern that Samsung Electronics Executive Chairman Lee Jae-yong has been acquitted from charges of stock manipulation related to the merger of two Samsung affiliates.

While some Japanese companies have founding families participating in management, the practice isn’t as widespread as in Seoul, with their influence non-existent in long-standing conglomerates like Mitsubishi group and Sumitomo group.

Reforms in Japan have been years in the making, starting almost a decade ago when the Shinzo Abe government urged companies to tackle low profitability and introduced measures to hold the management accountable for boosting corporate value.

It was a slow process that finally started to pay off last year as the Tokyo Stock Exchange deployed a name-and-shame tactic. Many companies initially only did the bare minimum to comply with government requests, such as installing more outside directors on the board.

The Nikkei and Topix benchmarks have powered ahead to multi-decade highs with the historic rally also driven by a weaker yen as the Bank of Japan kept its policy loose, and a revival of price pressures in Japan’s deflation-plagued economy. A growing presence of activist investors has also instilled fear into corporate leaders.

Activism is also on the rise in Korea, which could spur a push for more reforms to protect the interest of minority shareholders, according to Bloomberg Intelligence. Retail investors becoming more vocal can also add tailwind to reform efforts.

“I have been always thinking that the biggest reason behind the Korea Discount is governance problems,” said Kenji Hashizume, chief investment officer at Sumitomo Mitsui DS Private Fund Management (Shanghai). “If governance reforms accelerate, there will be huge room for rerating in South Korean stocks.” (Bloomberg)