Companies concerned about commercial law revision

By Yoon Ja-young

The government and lawmakers are moving to revise the commercial act to better represent small shareholders, but it is triggering concern among businesses that it will enable speculative funds to hurt their managerial control.

The Ministry of Justice recently submitted a report about the commercial act revision plan to the legislation and judiciary committee of the National Assembly, which focuses on enhancing the rights of small shareholders while restricting the power of large shareholders.

It includes obligating companies listed on the bourse with over 2 trillion won of assets to adopt a cumulative voting system in elections of new board members. According to Chaebul.com, a business information provider, only 10 percent of the top 138 listed firms here have adopted the system. In cumulative voting, shareholders are given votes equal to the number of board members to be elected. If the company is to choose three board members, for instance, the shareholders will be given three votes for each share they have. The shareholders can freely exercise their votes, including casting all their votes to a single candidate. Previously, they could only vote "yes or no" on each candidate. As a result, large shareholders could fill the whole board with the persons of their choice. With the adoption of the cumulative voting system, however, small shareholders will be able to elect a board member they want by joining forces, reining in power abuses of large shareholders.

The revision would also allow multiple derivative actions. A shareholder with more than a 0.1 percent stake in the mother company can raise suit against executives of subsidiaries where the mother company holds over a 50 percent stake.

It also plans to increase the independence of company auditors from large shareholders. According to commercial law, listed companies with over 2 trillion won in assets should designate at least three of the board members as auditors. Following the revision, one of the auditors should be selected independently from the board members. Since the law will also restrict the voting rights of the largest shareholder to 3 percent when electing new auditors, at least one auditor will be selected according to the will of the small shareholders.

The revision is also likely to obligate companies to use electronic voting systems, so that small shareholders can have their say even if they do not attend the general shareholders meetings.

The move for the commercial law revision comes amid growing social anger toward the power abuse scandals of conglomerate owner families. The country's top 10 conglomerate families hold on average of only a 2.5 percent stake in their businesses, but they have been controlling the whole group by filling the board room with their people.

The alleged abuse of Korean Air employees by the family members of company chairman Cho Yang-ho added to these voices. The governing Democratic Party floor leader Woo Won-shik said that the scandal symbolically shows how the conglomerates despise law and order due to the lack of restrictions and supervision. "To prevent similar incidents, the commercial law revision is essential," he said.

Businesses, however, are concerned about the revision which would deprive them of being shielded from outside attackers. They can be exposed to hostile M&As when speculative funds take seats at the board.

"While the revision of the commercial law will lessen the power of the large shareholder, businesses will be threatened by speculative funds from overseas. It is dangerous to discuss the revision of commercial law without equipping businesses with measures to protect their managerial control," said Sohn Kyung-shik, chairman of the Korea Employers Federation.

The country's conglomerates have a history of being threatened by speculative funds. For instance, U.S. billionaire investor Carl Icahn purchased a 6.59 percent stake of the tobacco and ginseng company KT&G in 2006 in collaboration with other hedge funds. As the company had a cumulative voting system back then, he could name a board member he wanted. He made diverse demands that the company could not accept through this system. KT&G had to pour in 2.8 trillion won to protect its managerial control, and the investor walked away with a 148 billion won profit.

"Previously, hedge funds used to maximize short-term profit by selling off core assets after taking over half of the seats on the board through a hostile M&A. Recently, however, they purchase the minimum amount of a stake in a company with which they can name new board members, who will then demand the company sell its key assets or businesses to lead to a rise in stock prices. They then leave after cashing in on their gains," said Shin Seok-hoon, a senior researcher at the Korea Economic Research Institute.

According to the institute, hedge funds are expected to be allowed to name at least one new board member in at least four out of the top 10 conglomerates here, including Samsung Electronics, Hyundai Motor, Kia Motors and Hyundai Mobis, following the revision.

Some experts point out that the revision plan adversely discriminates against large shareholders. The three percent rule which restricts the voting rights of the largest shareholder to 3 percent when electing new auditors is cited as an example. Yoo Ju-seon, a professor at Kangnam University, pointed out that a hedge fund may divide its stake into small pieces to avoid such a restriction, freely exercising its right as a shareholder. Large shareholders, meanwhile, will have their rights infringed upon.

"Though these measures intend to protect the rights of small shareholders, they may lead to diverse side effects. The administration thus should be cautious in the introduction the new regulation," he said.

Other developed countries initiated cumulative voting in the 1950s, but they started scrapping it or leaving the decision to the businesses due to side effects such as conflict between shareholders, inefficiency, and intervention by speculative funds.

Those supporting revision, however, say the conglomerates' fear is groundless.

"The problems conglomerates that have faltered or suffered crisis had, stem from a poor decision-making system, coupled with the power abuse and incompetence of the owner family," said Rep. Chae Yi-bae of the centrist opposition Bareun Mirae Party.

"Small shareholders and institutional investors should have stronger rights. Even if one or two people recommended by small shareholders enter the board, they won't dominate the board."

The concern of conglomerates, however, is turning into a reality, as the U.S. activist hedge fund Elliott Management _ known to have around a $1 billion stake in Hyundai Motor Group _ recently demanded the group adopt a cumulative voting system and restrict the voting rights of large shareholders. Conglomerates have been demanding adoption of shields for them, such as poison pills and golden parachutes, but it remains to be seen whether they get approval at the National Assembly.