From Tokyo, Japan and Changsha, China – this is Down to Business English. With your hosts Skip Montreux and Dez Morgan. Summer has definitely arrived here in Changsha, Skip. 31º yesterday and it’s here to stay. Oh. Tokyo has been warming up too. Not in the 30s yet, but the mid to high 20s. I’m trying to enjoy it before rainy season kicks in later this month. I’m trying to make the most of the weather too and I’ve been getting out and about in the city of Changsha more. Oh, nice.
I also want to travel a bit, so I am heading to Shanghai the weekend after next. Shanghai? Will that be your first time in Shanghai? No, it won't actually. I spent some time there, er, must be 20 years ago. So I am sure that lots has changed. I’m kind of excited to see what it looks like today. Absolutely. Cities in Asia change very quickly with new buildings and infrastructure projects constantly sprouting up. There is no doubt about that.
As a matter of fact, our report today is about one country in Asia that has changed a lot over the past several decades, but at the same time remains rather traditional. Japan and Thailand are two countries that certainly fit that bill. Yes, they do. But it’s neither of those. Maybe I should clarify. When I say traditional I am referring more to the traditional way businesses are run in the country. I'm tempted to say India but I don’t think that’s the answer.
Well, here is a tidbit that might help you out. In this country, the five largest companies are all family-owned and their products are known around the world. And their economy is sometimes referred to as The Miracle on the Han River Oh, you gave it away there. Is it South Korea? Very good Dez. Today, we are going to report on South Korea's chaebols and a stock market phenomenon known as the Korea Discount. Great!
We haven’t reported on South Korea on Down to Business English in quite some time. So let’s do it. Let’s get D2B … Down to Business with the South Korean Chaebols and the Korea Discount. Chaebol. Are we pronouncing that right? Yes, I think that is the correct pronunciation. 'Ch' as in ‘chair’. 'Ay' as in ‘say’. And 'bl' as in, I don’t know … ‘bull’. Chaebol. Okay. So Skip, what exactly is a chaebol?
A chaebol is a South Korean business structure that came into existence shortly after the Korean Armistice Agreement ended the fighting between North and South Korea. And that must be what, whoo ... sixty, seventy years ago? Seventy one next month to be exact. In Korean, the word chaebol means ‘rich business family’ and in essence it is a very large company or monopoly. So, a type of conglomerate? Yes, a conglomerate would be another definition.
Chaebols can be either one large company, or can consist of several smaller companies that operate over a wide range of business areas, but belong to the same business group. Isn’t there something similar in Japan? I seem to remember Zaibatsu it was called. Well, Zaibatsus in Japan were somewhat similar. Whereas the word ‘chaebol’ in Korean means rich business family, the Japanese word ‘zaibatsu’ translates to money clan, or money group. Similar concepts.
I don’t mean to digress, but you said were somewhat similar — past tense. So you’re saying they don’t exist anymore? Well, Zaibatsus originated about a century before Chaebols did. But after World War 2, they were reorganized into what is known today as Keiretsus. Of course. Mitsubishi and Sumitomo are well known Japanese keiretsus now that I come to think of it. They are. Now, even though both Keiretsus and Chaebols are conglomerates, there is a major difference between them.
And what would that be? Chaebols are owned and operated by a single family, keiretsus are not. And that is a big difference. Another notable difference is the sheer scale of the chaebols in the South Korean economy. ‘kay, what do you mean? Roughly half of the value of the South Korean stock market is made up of shares of chaebol-related companies. 50% of the KOSPI is chaebol companies?! Wow, that is huge. It is.
And similarly, around 50% of South Korea’s exports are from chaebol operated companies. Then without a doubt, chaebols are a very dominant part of the South Korean economy. And they have a very close relationship with the South Korean government. I’m sure they do after operating for over 70 years, the entire history of South Korea. They are often granted tax incentives, receive subsidies, and are given special loans.
Well that’s all fine and good for them, but it hardly seems fair to smaller businesses that are not part of a chaebol. That is one of the prime complaints critics of the system have. Because chaebols receive preferential treatment from the government, it is difficult for smaller businesses to compete. And I imagine a significant result of that would be entrepreneurship and innovation being suppressed. That does happen.
Chaebols swallow up small and mid-sized companies before they have a chance to grow organically and energize the economy. Kind of like how big tech companies in Silicon valley buy up small, innovative startups before they can become a competitive threat. Along those lines, yes. Another common criticism of chaebols is that even though they dominate the economy, they don’t actually employ much of the South Korean workforce. No? That’s a bit err, counterintuitive. It is.
But the reality is 90% of South Koreans work for small and medium-sized businesses. Only 10% of the workforce is employed at chaebol owned companies?! Like you said, it is a bit counterintuitive — but that is the case. And yet another major concern of the chaebol system is how ownership and senior positions are all kept amongst the members of a single family. Nepotism is generally not seen as the best method of choosing successful candidates for important positions. No it isn’t.
The complaint is this nepotistic practice leads to a lack of transparency, which leads to corporate governance issues … and in some cases, corruption. The more opaque a company is, the greater chance for corruption to take hold. So who are the families in control? In all there are 82 chaebols. But the top five are the Lee family of Samsung, the Koos of LG, the Cheys of SK, the Shins of Lotte, and the Chungs of Hyundai. Samsung and LG are electronics manufacturers. Lotte is a food producer.
Hyundai, obviously automotives and heavy industry. But I’m not familiar with SK. Oh, SK is a massive conglomerate with interests in telecom, pharmaceuticals, oil and gas, and semiconductors. Wow, very diverse. And they employ more than 118,000 people in 473 offices worldwide. Amazing that I’ve never heard of it. I suppose SK is not as much of a household name as Samsung, Hyundai, or Lotte, but it is well known.
So the bottom line is that chaebols are massive, family run conglomerates who have a cozy relationship with the government. That is a good synopsis, yes. Well, most large corporations tend to be well-connected with governments, so I suppose that isn’t too surprising. True. But the South Korean government, at times, has shielded chaebols from corporate and even criminal scrutiny in a movement often dubbed as too big to jail. ‘Too big to jail’.
A play on the ‘too big to fail’ moniker that was applied to US banks in the financial crisis of 2008. Well in Korea, the expression refers to the fact that members of the chaebol’s founding families have a tendency to escape being convicted of crime. In fact, Korea’s legal system is notorious for its lenient rulings for chaebol family members. Judges take it easy on them if they are having legal trouble? There have been many cases of the so-called ‘three-five rule’ being applied.
What’s the three-five rule? It’s when a person is found guilty of a crime and receives a three-year prison sentence. But the sentence is then immediately suspended for five years. So, they don’t go to prison until five years later? It gets worse than that. If they stay out of legal trouble over those five years, they will be exempted from serving the original three-year prison sentence. Potentially then, they never see the inside of a prison cell.
Precisely. Tell me Skip. Why does Korean society put up with this? It seems these chaebols and the families who run them live by a different set of rules, like they’re above the law. In recent years there has been a lot of public outcry over the 3-5 rule and towards these families in general. I would hope so. But you need to keep in mind that it is these very conglomerates who are largely responsible for South Korea being in the relatively strong economic condition it is today.
If it wasn’t for chaebols, and the support they received from the government, it is highly unlikely South Korea would have been able to rebuild in the way they did after the Korean War. The Miracle on the Han River would never have happened. You're saying that the chaebol system has a lot to do with South Korea going from an absolutely devastated society in 1953 to the world’s 13th largest economy today.
Yes. Now, having said that, the system has some obvious issues, and over the years there have been attempts to modernize the chaebol system and address some of the criticisms. And what kind of changes have been made? There have been steps toward corporate governance reforms, pressure to increase transparency and accountability, and anti-competitive regulations have even been enacted. Those are certainly steps in the right direction.
And another important reform has been the requirement that chaebols start putting independent, non-family members onto the board of directors of their companies. That is so crucial. I don’t know how any shareholder or potential investor could comfortably invest with a Board of Directors completely made up of members of the same family. And it is exactly that sentiment Dez, which is directly related to a phenomenon known as The Korea Discount. The Korea Discount.
This refers to how world-class Korean companies, like Samsung, Hyundai, Lotte, and other chaebols, are valued much lower than their peers in the United States, Japan, and Europe. Hyundai and Toyota may be on par with each other in terms of their size, but Toyota has a much higher valuation. My understanding is that The Korea Discount has become much more apparent over the past 10 years. But I’m not really clear on how it is measured.
There are two ways the discount is calculated and actually Dez, I was hoping you could help me out with this. One is based on Price to Book ratios. The other is related to the Price to Earnings ratio. Two concepts I am not very familiar with. Ah yes. P/B and P/E ratios are commonly used in the banking and financial services industry to place a value on a company. Great. So, could you explain them to our listeners … and to me?
Sure. The P/B, or price to book ratio, is calculated by dividing a company’s market capitalization by the value of its outstanding shares. So you basically divide the total amount of capital the company's stock is valued at by how many shares the company has issued. Exactly. The P/E, or price to earnings ratio, is calculated by dividing the company’s share price by its earnings per share. I see.
So, the P/E ratio focuses on a company's earnings or profitability, while the P/B ratio looks at the value of a company relative to its stock price. Er, on a basic level, yes that’s true. Well looking just at P/B ratios, Korean companies trade at only 58% of the value of the average company on other stock indexes. And I’m assuming those are from indices in advanced countries. That’s right. When you look at indexes from emerging markets the discount is 34%. How about in terms of the P/E ratio?
Are you familiar with MSCI indexes? Sure. Those would be the Morgan Stanley Capital Indices. Although not run by Morgan Stanley anymore, they are maintained by MSCI Inc. and are widely used as benchmarks for global equity markets. Many investors rely on them heavily. Well, according to a report from Bloomberg, between 2014 and 2023, the MSCI Korea Index’s average P/E ratio was 12.2. Ooh, that is very low indeed.
And it represents a 19% discount in comparison to MSCI Taiwan and a 28% discount to MSCI Japan over the same period. So in the big picture, all these numbers and ratios illustrate that Korean companies are looked at by international investors as being less valuable than their non-Korean counterparts. Which is not good for the Korean economy. How does that play out? First, the discount encourages foreign investors to only make short term investments in the market.
Buy low, sell high, make a quick profit. That’s right. They are not investing for the longer-term and without a large pool of long-term investors Korean stock prices tend to be volatile. That volatility not only scares away other foreign investment, but is also one reason many South Koreans avoid investing in domestic stocks. They prefer to put their money into real estate or US stocks. Both of which are safer than a volatile market.
And it is the chaebols who are mainly responsible for those low valuations? That is one theory. The chaebol structure holds back growth and development. However this theory doesn’t account for the fact that the discount is less among chaebol companies than the stock market as a whole. I suppose though that because chaebols are getting a leg up from the government, their valuations would be higher than companies that don’t get as much support. Perhaps.
Another theory is the national security risk North Korea poses to South Korea. Right. That situation does add a certain amount of the instability to the market. Yes, but Taiwan faces a significant security threat as well, and Taiwanese valuations are not being affected. Yeah, that’s true. A more likely explanation for The Korea Discount is the low shareholder return policies most publicly traded Korean companies have.
You mean their policies around stock buybacks and paying dividends to investors? Yes. Investors in Korean stocks don’t seem to be treated very well. Dez, can you explain how dividend payout ratios are calculated? Yeah, this is an easy one. It’s simply the percentage of net earnings a company pays out in dividends to its shareholders. Well, South Korea’s dividend payout ratio in 2021 was 19%. That was the lowest ratio among its regional counterparts.
By comparison, Taiwan had a much higher rate of 55%. And how about China? China too surpassed South Korea. Its dividend payout ratio was 35%. Very interesting. It looks to me that South Korea, as advanced as its economy may be, is in need of further corporate reform. Perhaps it's time for the chaebols to fade into the history books. I am sure that is easier said than done. And on that note, I think it’s time for us to get D2V … Down to Vocabulary.
I will get things started today with the expression to fit the bill. When something fits the bill it’s exactly what is needed in a particular situation, or fits all the necessary requirements. This expression has a very interesting origin. Oh? What’s that? The ‘bill’ in ‘fit the bill’ refers to a poster or leaflet advertising of a theatrical production, or play in the 19th century. The bill listed all of the acts who would be performing.
If there were too few acts, the producers would look for more artists to ‘fit the bill’. Er, interesting. I knew the expression had something to do with theaters, but I hadn’t heard that explanation before. Anyway, in the introduction to today’s story I commented that Japan and Thailand fit the bill as traditional countries that are also changing rapidly. Dez was saying that Japan and Thailand fit all the requirements of a country that is traditional but also changing quickly.
Can you give us an example using ‘fit the bill’ in a business context, Skip? Logistics companies may find that electric vans or trucks fit the bill for local deliveries within city limits because they are greener and cheaper to operate and maintain. I have noticed most Chinese logistics companies are doing just that. Oh, that is very good. But I don’t think electric trucks fit the bill for long distance deliveries and shipments. Not yet at least. Next I have the noun nepotism.
Nepotism is the practice of appointing family members to senior positions in a company. Not because they have the skill set necessary to do the job, but simply because they’re a relative. Exactly. In today’s report, Dez commented that nepotism is not a very good strategy for attracting the best candidates. In other words, he was saying appointing your brother, uncle, or cousin as CFO of your company is not a very good practice. A similar practice is called cronyism. And what is cronyism?
Instead of appointing family members, you appoint your friends. Again, if the criteria for the appointment is merely that the person is a friend, it's less likely the candidate will perform very well. True enough. Our next and final item today is the expression to give someone a leg up, which means to give someone or something help or assistance.
The original meaning was to help someone to climb over a wall or help them mount a horse by pushing their leg upwards, hence the expression to give someone a leg up. However, the expression is most often used metaphorically. In the story I commented that chaebols were getting a leg up from the government. In other words, I was saying that the government was giving chaebols help. The relatively weak value of the British Pound over the last few years has been giving British exporters a leg up.
It certainly has. The cost for overseas buyers to buy British goods has dropped, in some cases quite significantly. This has helped exports sell in greater volume. Which is a great help given the state of the rest of the economy. Thank you Skip, for that report on the South Korean Chaebols and The Korea Discount. It appears that South Korea is slowly but surely changing. It does indeed. We will have to revisit this topic in the future to see what developments there are. Yes, let’s do that.
We should report on more business stories coming out of Korea. I completely concur. D2B Members, the Bonus vocabulary for today’s episode is in the pipeline and will be released soon on your Members-only RSS feed. The words and phrases we will focus on in that Bonus D2V episode will be: to kick in, to be sheer, transparency, to take it easy on someone, and a peer.
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