China reaction

Jonathan Pines

Investors for a long time have not understood why China’s approach has been so “limp” and incremental response to its deep recession. The most likely reason for its incremental response is that it has bad memories of having stimulated too much during the global financial crisis, which caused excess capacity and a poor allocation of resources. But the incremental response over the last two years to revive sentiment among consumers has been largely ineffective – especially because it has been paired with a simultaneous anti-graft crackdown, which has scared many business leaders from making big investment decisions.

For at least a year, investors have been awaiting the “bazooka” that will revive confidence in both equities and property (two key assets held by Chinese households). This multifaceted, strong new approach at the very least underlines the government’s seriousness in tackling the problem. And may be what is required to finally result in asset values rising, which will help to revive consumer confidence.

Separately, a comment from him on Korea’s Value-Up programme (intended to boost depressed stock prices). Keen to continue pushing his Korea campaign, so if you can think of any journalists that would be interested in a discussion or follow-up please let me know.

We commend the seriousness with which Korean authorities are addressing this problem. A raft of measures have been announced that are under consideration.

However, the Value Up Index is in our view a red herring. 90%+ of companies in Korea are controlled by Families.  Most companies won’t care whether they are a part of the index because they don’t prioritize a higher stock price. Indeed, many prefer lower stock prices for inheritance tax reasons, or alternatively are indifferent to low stock prices because they value the benefit that controlling shareholders gain from poor governance more than they mind low stock prices.

So the presence of an index with seemingly arbitrary criteria for inclusion isn’t going to work because it  is not addressing the key cause of the Korea Discount, – the substantial benefit the controlling shareholders enjoy by controlling poorly governed companies, in particular their ability to benefit at the expense of minority shareholders. Many controlling shareholders  view the companies they control as belonging exclusively to them, with minorities being treated as a nuisance or resource to be used to benefit them.

Measures under consideration that would make a difference if implemented are (1) lowering inheritance tax to 40% or below (under consideration) – reducing the incentive for low stock prices (2) the introduction of a fiduciary duty (reducing the perception that the companies are the property of the controlling shareholders alone).

Other important measures that would make a difference would be to introduce tag along rights for minorities in the event of a takeover, end the practice of minorities being forced to sell their shares in terms of a restructuring, require minority approval for related party transactions, require annual board opinions on capital structure – particularly for companies with a low payout ratio.

By Jonathan Pines, Head of Asia ex Japan