The South Korean government has recently laid out plans to greatly relax regulations on private equity funds (PEFs). Under the proposed regulations, any form of PEFs will be able to participate in the management of the companies they have invested in, even when their stakes are less than 10 percent. The new rules are intended to activate the capital market and promote innovations. To be sure, it is the right direction for Korea to go. However, companies are all tensed up due to concerns that predatory activist funds like Elliott Management of the United States can appear.
Korean businesses already have difficulty protecting their management rights as the National Pension Service (NPS) has introduced a stewardship code, which encourages institutional investors to exercise their voting rights more actively. Furthermore, the government is pushing to amend the Commercial Act to take power away from majority shareholders. The Korean business community claims that the government should come up with measures to protect management rights as well.
The Financial Services Commission (FSS) announced on Sept. 28 that it would reform regulations to clear the way for domestic PEFs to participate in the management of companies more easily. It plans to submit a bill to revise the relevant law to the National Assembly by the end of this year.
PEFs raise money from a small number of investors and privately operate the funds. Until now, local PEFs have been subject to various regulations that impeded their growth.
There will be no boundary that differentiates hedge funds from PEFs in the future. Any form of PEFs with less than a 10 percent stake in a company will be allpwed to participate in its management. Accordingly, activist funds can appear in South Korea. Local PEFs will be not be much different from foreign private funds such as Elliott Management and Lone Star Funds. They can turn into a corporate raider at any time or even collude with foreign funds to threaten the management rights of a domestic firm.
Companies are on the alert as they could face hostile takeover threats and lose their management rights. In particular, not only average businesses with less than a 10 percent stake owned by major shareholders but also mid-size enterprises that maintain the management rights through cross-shareholding links and conglomerates with a high reserve ratio are highly likely to become a target of management intervention and merger and acquisition (M&A) from private funds, according to market experts. A company official said, “Some activist funds have continuously made management intervention and threatened the management rights. Given the circumstances, companies’ business activities will be forced to shrink further if institutional investors have more rights.”
As the NPS has recently introduced a stewardship code, companies will have more difficulty in protecting their management rights. In addition, a considerable number of revision bills to the Commerical Act that woudl take away more rights from majority shareholders are currently pending at the National Assembly. A case in point is a multiple derivative suit, which enables shareholders of a parent company to file a compensation suit against executives of a subsidiary or a grandson company who commits an illegal act, and the measures that hold management in check, including the obligation of the concentrated vote system, which allows minority shareholders to appoint whoever they want when a company elect more than two board members.
In fact, according the Korea Economic Research Institute, there are 20 cases of the amendments in the Commercial Act related to corporate governance proposed from the opening of the 20th National Assembly to the end of March this year. Out of the 20, 18 cases are the revised laws to limit the management rights of a company, while only two cases focus on protective devices of the management rights.
Economic organizations, like Korea Listed Companies Association, said, “The measures that can protect the management rights of a company, including the disproportionate voting rights, should be adopted as well.” In other words, the government also need to provide companies with a shield to protect their management rights as it has decided to ease regulations on private funds.
A dual class stock is considered an effective defense mechanism, along with poison pills. It grants more voting rights to major shareholders or executives than other ordinary shares. For instance, the founders of Alphabet Inc., a holding company of Google, and Facebook have 10 votes per share.
However, the revisions of related laws have failed to pass the National Assembly for years with an anti-business sentiment of “special favors for founders’ family” and political opposition. Kim Jong-sun, head of the research policy division at the KOSDAQ Listed Companies Association, said, “The measures that threaten the management rights are to be introduced at the same time. So, it is fair for the government to establish a mechanism to protect the management rights so that business raiders cannot make a prey of sound companies.