Majority stakeholders’ right to defend control amid PEFs’ looming interference

Majority stakeholders’ right to defend control amid PEFs’ looming interference. September. 29, 2018 07:36. .
Choi Jong-koo, head of the Financial Services Commission of South Korea, said Friday that the institution will revise regulations to allow Korean private equity funds to participate in management of companies, and submit the bill to the National Assembly by year’s end. While Korean private equity funds have failed to take their root due to all different regulations, private equity funds are raised from a small number of investors, and operated in private. Among private equity funds (PEFs for participating in management) and hedge funds (for professional investment), a PEF is allowed to only use 10 percent of its assets to buy stock, whereas a hedge fund is allowed to use more than 10 percent to buy stock but is prohibited from exercising the voting right for stock exceeding the 10 percent cap, or so called "10-percent rule" that has been a major hurdle.

Once there will be no difference in the scope between hedge funds and PEFs, any form of private equity funds will be allowed to participate in management of companies even when holding a minority stake of 10 percent or less. If the 10 percent rule is lifted, domestic private equity funds will be able to proactively take part in mergers and acquisitions, which in turn will allow for efficient corporate restructuring through the market. With the new measure in place, investors will no longer have to turn a blind eye to Korean companies being sold to foreign buyers at dirt-cheap prices due to lack of domestic buyers. The measure will also help spur investment in the startup market.

However, domestic private equity funds are no different from foreign PEFs such as Elliott Capital Advisors and Lone Star in that they all can use whatever measures at their disposal in order to maximize investment return. They can instantly transform into hostile takeover bidders, and even collude with foreign funds to threaten managerial control of domestic companies. Furthermore, since stewardship code has already been introduced to Korea to allow institutional investors to actively exercise their shareholder right to intervene in management, Korean companies may find it more difficult to defend their managerial control. Even companies that have been focusing on their original business could face interference by shareholders that demand short-term return, and have to be always on alert to protect their managerial control.

Since multiple measures that could threaten managerial control will be introduced concurrently, the Korean government should provide measures to prevent domestic companies from becoming an easy target of hostile takeover bids. The government should consider, more than anything, introduction of "Poison Pill" that grants existing shareholders the option to purchase stake at a price lower than the market price in the event that a hostile takeover bid is made. Poison Pill is already used as a common measure for existing shareholders to defend their managerial control in advanced countries including the U.S. and Japan. If ordinary shareholders are opposed to dual class share that grants more than one voting right to shares held by majority stakeholders, the government can introduce the system for a limited period of time and test it.