#Key Business Issue l 2018-08-06
The National Pension Service has decided to adopt a stewardship code. The national pension fund manages 635 trillion won or about 570 billion US dollars worth of investments as the nest egg of many retired people in Korea. On July 30, the National Pension Fund Management Committee decided to actively exercise its rights as a shareholder of the companies it invests in, paving the way for its participation in the management of listed companies. The decision is expected to cause tremendous ripple effects. Here is Professor Kim Yeon-hak from the Graduate School of Management of Technology at Sogang University to discuss the new era of stewardship code.
Stewardship means an act of overseeing and managing the funds under its control, just as a steward’s role is to protect the interests of his owner. A stewardship code is an international guideline that allows institutional investors to actively get involved in management decisions of the companies they invest in to promote the interests of beneficiaries. In the wake of the 2008 global financial crisis, many financial institutions felt the need to intervene in the management of the firms they put money into and to encourage them to make decisions in a way to improve shareholders’ interests, rather than simply investing in the companies. The stewardship code was first introduced in Britain in 2010, and more nations followed suit gradually. Currently, most advanced countries have adopted the code, with South Korea also joining the drive. It is a soft law that has no legal binding force, only allowing institutional investors to implement it in a voluntary and flexible way.
The stewardship code is a guideline concerning the shareholders’ rights in the management of the firms where they have stakes in. About 20 countries including Britain, the Netherlands, Canada, Italy and Japan have adopted their own version of a stewardship code. On a similar note, the National Pension Service or NPS in Korea has decided to expand shareholders’ rights step by step and participate in corporate management in a limited fashion when it is considered necessary. Professor Kim explains why the state pension fund operator has decided to introduce this rather unfamiliar guideline.
Basically, the purpose is to safeguard the NPS’ interests as a shareholder by monitoring corporate management. In fact, the NPS has examined ways to introduce a stewardship code for a few years. But relevant laws are inadequate in Korea, and it is necessary to revise the Commercial Act and the Capital Market Act. Earlier this year, President Moon Jae-in instructed the NPS to consider adopting a stewardship code to facilitate conglomerate governance structure reform. After the eruption of the power abuse scandal involving the Korean Air owner family, the NPS, which has a 12 percent stake in Korean Air, came under criticism for not meddling in such improper management of the company.
The NPS is the world’s third-largest pension fund. It holds a stake of more than 5 percent in as many as nearly 300 listed firms. It has been criticized for being rather passive about exercising its stockholder’s rights, despite the fact that it is a major shareholder in numerous companies. Even when the brand value of Korean Air fell sharply over a series of allegations involving the owner family, the NPS didn’t really use its shareholder’s rights, although it is the second-largest investor in the company. With the introduction of the stewardship code, however, the situation will be different. The NPS will focus on shareholder activity related to dividend payments in the second half of this year. But starting next year, it will expand the scope of its shareholder’s rights and touch on matters about hurting corporate values. From 2020, the NPS will take action against problematic companies. As the NPS will have a greater say in the management of companies it invests in, dividend payouts by local listed firms is expected to improve.
The dividend payout ratio refers to the amount of dividends paid to stockholders relative to the net income of a company. South Korean listed firms’ dividend payouts fell from 24 percent in 2016 to 20 percent last year. That’s less than half of the world’s average of 43 percent. Last year, the dividend payout ratio of Japanese companies was 32 percent and that of U.S. and German firms was 39 percent and 41 percent, respectively. Britain and France had dividend yield ratios of 65 percent, meaning that companies in those countries returned two-thirds of their earnings back to shareholders. The ratios of some underdeveloped countries are still higher than Korea’s: 57 percent in Taiwan, 42 percent in Indonesia, 38 percent in Brazil and 32 percent in China. Korea’s ratio is shamefully low. Of course, a higher ratio is not necessarily a good thing, since it means that companies distribute its earnings to its stockholders, not investing in the future. It is not necessarily desired that dividend payout ratios are extremely high. Still, the ratio of 20 percent is too low and it is necessary to raise it.
The low dividend payout ratio is considered one of the factors behind undervalued Korean stocks, but the NPS’ decision to adopt the stewardship code will likely improve the situation. Japan, for example, had a dividend yield ratio of 26.1 percent in 2014 when it introduced the stewardship code, but the figure rose to 30.3 percent in 2016. If the NPS exercises its voting rights more actively as an institutional investor, corporate management could be more transparent. However, some analysts point out that it is difficult for the new policy to produce the intended effect in the current environment.
Japan manages 1.3 trillion US dollars of the public pension fund, two-and-half times more than that of Korea. The Japanese national pension fund has only set basic principles and direction, and delegates 100 percent of its fund and voting rights to private management companies. In the case of the NPS in Korea, half of its assets invested in the domestic stock market are managed by the NPS itself and the other half, by private companies. So, it is structured to fall under government control. Many are pointing out the problem of a lack of independence in operating the NPS, and there are concerns that the pension fund might be used to fulfill the government’s policy goals, rather than to maximize its own profits. So, the situation in Korea is different from that of Japan. In the current system, I think it will be difficult for Korea to produce an effect similar to that of Japan.
In regards to the introduction of the stewardship code, the pending task of the NPS is to secure independence. The NPS accounts for 7 percent of the domestic market capitalization and has stakes of 10 percent in large companies. Given its huge influence, the government may exploit the national pension fund to interfere with corporate management, if the NPS fails to secure its independence when exercising its shareholder’s rights. The NPS is, in effect, a government agency, as it is under the Ministry of Health and Welfare. Apparently having these concerns in mind, the ministry says that the NPS will allow entrusted asset management firms to exercise its voting rights so it is prevented from wielding excessive influence. That is, the ministry will establish a system where the pension fund can keep any political influence at bay. Analysts are saying that it is necessary to take a step further to overhaul the NPS’ management structure and system.
First of all, there’s a need for an institutional framework to guarantee the independence of the fund management headquarters of the NPS. Some people say that it is necessary to separate the headquarters from the NPS and make it a new public corporation. But that’s not enough. Even if a new public corporation is created, its head should be allowed to operate the organization independently, free of any intervention by the government or other institutions. Some suggest that the National Assembly, not the government, name the leader of the corporation. If the head is appointed under a bipartisan agreement, the person will remain politically neutral and focus on the fund’s own profitability. Second, it is necessary for the NPS to entrust all its assets invested in the local stock market to private management companies, just like Japan’s national public fund. The private firms will certainly use the assets to maximize profits and dividends because they don’t have to care about public policy goals. Also, the NPS may only set the principles of the stewardship code and allow the private asset management firms to implement it.
For the NPS to exercise its rights properly as a major shareholder in the Korean stock market, it seems necessary to arrange an institutional strategy to enhance independence and transparency in fund management.