“Is the company's price-to-book ratio (PBR) 0.3 times? That corporation should be subjected to a hostile merger and acquisition (M&A).”
On Dec. 19 of last year, a discussion on the revision of the commercial law was held at the National Assembly by the Democratic Party. At the head of the discussion, Democratic Party leader Lee Jae-myung asked the chief financial officer (CFO) of a listed company about its PBR and said this. He also noted, “Isn't that (hostile M&A) what triggers competition and normalizes stock prices?”
Lee’s comments are a somewhat radical assertion that the management rights of corporations that do not receive proper recognition of their value should be replaced, but the market responded positively. Voices have emerged stating that “management rights are not the absolute power of controlling shareholders” and “hostile M&A is neither illegal nor impossible.”
◇ Hostile M&A increases… changing perceptions hastening commercial law revisions
The perception of hostile M&A is changing. In the past, it was recognized as a kind of corporate raiding led by private equity fund (PEF) operators, but now the view is spreading that it is a natural occurrence in the capital market. As the number of stock investors increases, individual investors’ perception of hostile M&A has also changed compared to the past.
In particular, there are forecasts that hostile M&A will increase significantly when the Democratic Party's proposed commercial law revisions pass. The crux of the bill is to expand the target of directors' fiduciary duties from the existing corporation to include both the corporation and its shareholders.
Most notably, the Democratic Party's commercial law revision includes numerous mechanisms that allow the opinions of minority shareholders to be directly reflected in management. The introduction of cumulative voting and the expansion of the audit committee are representative examples. These mechanisms can hinder decisions centered on controlling shareholders and, if utilized to consolidate the power of minority shareholders, can lead to immediate management changes.
Park Se-ik, representative of Chesley Investment Advisors, said, “In the past, even if asset value was 10 trillion won while market capitalization was only 3 trillion won, investors would just accept it, but now the view has shifted to seeing it as a management issue.” He further stated, “The revision of the commercial law will encourage a shift in perception from ‘if they do it improperly, management will change’ to ‘management rights could be taken away.’”
◇ “Management should be for shareholders” Directors' fiduciary duties move beyond the corporation
The revision of the commercial law was ignited when President Yoon Suk-yeol visited the Korea Exchange last January and said, “We will pursue the revision of the commercial law so that minority shareholders can voice their opinions,” leading to discussions. However, in response to pushback from the business community, the government and ruling party shifted to revising the Capital Markets Act. But the Democratic Party accepted this and made it their party's stance to revise the commercial law.
With the impeachment proposal against President Yoon passing through the National Assembly due to the 12·3 emergency state, and the looming possibility of an early presidential election along with the Democratic Party’s control of the government, the push for the revision of the commercial law is expected to accelerate even further. The Democratic Party has made the ‘partial revision of the commercial law’ proposed by 18 lawmakers, including Lee Jung-moon, its party stance. The bill is currently under review by the Legislative and Judiciary Committee.
Under the current commercial law, directors, as management, are only required to carry out their duties ‘for the company’, and there are no fiduciary duties toward shareholders. This has led to criticism that corporations make decisions centered on controlling shareholders while ignoring the interests of minority shareholders.
The revision of the commercial law is also being viewed as a spark to reverse the stagnation in the domestic stock market, known as the Korean stock market. This stems from the judgment that the decision-making structure unique to Korea, where major corporate decisions are dominated by a small number of controlling shareholders, has been a decisive factor leading investors to avoid Korea, referred to as the Korea discount.
◇ The details of the revised commercial law are expected to play a key role in increasing hostile M&A
Specifically, in the revision, the part on directors' fiduciary duties has been explicitly changed from ‘for the company’ to ‘for the corporation and its shareholders.’ At the same time, specifics have been included to prevent management from ignoring the interests of minority shareholders. Key points include the mandatory adoption of cumulative voting and the expansion of the number of separately elected audit committee members. The term ‘independent director’ has been introduced for outside directors.
The immediate increase in both cumulative voting and the number of separately elected audit committee members is expected to be a key driver for the rise in hostile M&A. First, cumulative voting is a system that grants voting rights equal to the number of directors one wishes to elect per share when selecting directors to manage the corporation.
For instance, when a corporation seeks to elect 10 directors, under the cumulative voting system, each share grants 10 voting rights. These voting rights can be concentrated on a single director candidate, meaning that even a controlling shareholder with a majority equity may not be able to dominate the board.
Lee Byung-tae, a professor at KAIST's Department of Industrial and Management Engineering, stated, “Cumulative voting could limit the voting rights of major shareholders in director elections” and added, “If the number of audit committee members to whom the ‘3% rule’ applies increases to two, the likelihood of pressure on management rights through hostile M&A will inevitably rise.”
◇ “Controlling the board becomes easier” The rise of hostile M&A has already begun
The 3% rule for the selection of audit committee members limits the voting rights of shareholders holding more than 3% of equity to 3%. While the current commercial law already limits the voting rights to a maximum of 3% for the election of audit committee members, the revised proposal increases the number of audit committee members from one to two.
Kim Chun, head of Policy Division 1 at the Corporate Association, said, “Even if the existing major shareholders hold a lot of equity, they can only exercise voting rights up to 3%, allowing aggressors to fill the audit committee with candidates of their choosing” and added, “If two audit committee members are filled and some directors are secured using cumulative voting, it becomes possible to control the board.”
Investment bank (IB) industry experts report that the increase in hostile M&A has already begun. This is because among listed companies on the KOSDAQ market, those with relatively low ownership of controlling shareholders and those whose PBR does not reach 1 time have emerged with a strategy to replace management through hostile M&A.
In 2021, Cheongdam Investment, designated as a new technology finance company, recently introduced hostile M&A as a new operating strategy. Cheongdam Investment has been identified as pursuing the purchase of convertible bonds (CB) of KOSDAQ-listed companies, aiming to leverage cumulative voting to control the board following the commercial law revision.
Representative Park Se-ik said, “In the past, no matter how much one bought stocks or sent letters to shareholders, it felt like talking to a wall, but after the revision of the commercial law, the situation may change.” He noted, “If the ownership ratio of controlling shareholders is relatively low at below 40%, and the corporation has high business attractiveness, it may become a target for hostile M&A.”
◇ “Hostile M&A is not inherently bad”
Foreign shareholders may appear transformed into activist funds. If the asset value is 10 trillion won but the market capitalization is only 5 trillion won or even less than 3 trillion won, it may open the way for them to use cumulative voting to elect directors to the board and demand and ensure an increase in shareholder value.
Corporations are beginning to respond ahead of the increase in hostile M&A. Above all, share buybacks are on the rise. The potential for utilizing friendly shares through share buybacks is significant. From January to November 2024, a total of 665 companies disclosed share buybacks, marking a 58% increase compared to 421 companies in the same period last year.
Experts suggest that regardless of the validity of the commercial law revision, the operation of hostile M&A will become a catalyst to enhance the investment appeal of corporations and activate the capital market because minority shareholders also desire to enhance corporate value through improved governance without wanting to see a loss of corporate competitiveness.
Yoo Hyung-sang, president of the Unicorn Management and Economic Research Institute, stated, “Hostile M&A is not inherently bad,” and added, “The reasons for hostile M&A stem from major shareholders mismanaging the company or underperforming stock prices, and efforts through hostile M&A could lead to improved management or encourage better communication with shareholders.”