The Reality of “Actions” by Activist Hedge Funds and Public Policies on Chaebols – Lessons from the Elliott-Samsung Dispute | E-Axes
 

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The Reality of “Actions” by Activist Hedge Funds and Public Policies on Chaebols – Lessons from the Elliott-Samsung Dispute

date Date: June 30, 2015
date Author(s): SHIN Jang-Sup
date Affiliation: National University of Singapore
Abstract

A titanic battle is ensuing between Elliott Associates, a pioneer of “vulture fund” or more commonly knownas an “activist hedge fund”, and Samsung Group, Korea’s biggest chaebol which owns the world’s largest electronics company, Samsung Electronics. On June 4, 2015, Elliott suddenly raised its stake of Samsung Construction & Trading Corp. (Samsung C&T) to 7.12% to emerge as the company’s third largest shareholder. Since then Elliott has been leading the opposition to a proposed merger between the company and Cheil Industries. Elliott is suing the Samsung C&T board to halt the merger on grounds of “unfairness” to minority shareholders and “unlawfulness” of the merger decision, and is attempting to persuade foreign and domestic investors to take its side. Samsung for its part is trying to gain support for the merger by emphasizing the transaction as desirable and lawful ahead of a vote in a shareholder meeting scheduled on July 17, 2015.

     The dispute between Elliott and Samsung has attracted global attention because the proposed merger is geared to completing the third-generation succession of management to Vice Chairman Lee Jae-Yong, by creating a ‘new Samsung C&T,’ which will become the de facto holding company of Samsung Group. The Elliott-Samsung dispute is also the first attempt by a foreign ‘activist fund’ to intervene in key management decisions at Korea’s largest chaebol (family-controlled business groups) to realize their own profits. The dispute thus raises the issue of how other Korean firms can prepare for such disputes in the future, and how the government and institutional investors should react to “actions” by such activist funds.

This paper begins by examining the controversy over the “fairness” of the stock swap ratio between the two companies. It argues that the controversy boils down to determining “who is manipulating the market”. If one assumes that the stock market functions efficiently, which is the basis of the Korean financial regulations governing mergers and acquisitions (M&As), it is difficult to say the share price of a company can be “undervalued” for an extended period of time. If one claims so, it is tantamount to alleging that somebody is manipulating the share price. In the same vein, if an activist fund argues that it can resolve the situation of “undervaluation” through its action, it is nothing more than saying that it can manipulate the share price through such action. The controversy can be better understood in view of an international study on hedge fund activism which concludes that campaigns by activist funds have, in most cases, failed to bring about a sustained appreciation in share prices (Section 2).

     The paper then investigates how Elliott and other activist funds actually “promote” shareholder interests. Considering its past investment activities around the globe, one can name Elliott a “holdout fund”. It has earned big money in Third World countries including Peru, Argentina and Congo by devising holdout schemes to stall international efforts at helping these countries such as the Brady Plan and international aids to West African countries. It is also estimated to have earned at least $1.2 billion by applying a similar holdout scheme even to the U.S government’s efforts at reviving General Motors during the Global Financial Crisis of 2008-9 (Sections 3). Elliott is certainly an extreme case of activist funds which stand on a broad spectrum of shareholder actions. But there is a common behavior of activist funds. They exploit populism for profits and ‘minority shareholders’ right’ is their mantra to gain public support. This paper analyzes how the populism-for-profit tactics were employed in the PSAM-Vivendi dispute and also in the Elliott-Samsung dispute (Section 4).

"     The paper then examines differing interests among parties involved in the dispute. In order to fathom the outcome of this dispute, we not only need to consider their own self-interests but also constraints from the national interest aspect. This is primarily because Korea’s National Pension Service, currently the fourth-largest pension fund in the world, is Samsung C&T’s second largest shareholder, owning about 10% of the company’s stock, and is going to make its decision on the vote by taking national interest into account. There is also room that domestic institutional investors will consider national interest to some extent, albeit in varying degrees. This would be more so if they believe that a healthy national economy will provide more opportunities for domestic institutional investors to increase their returns and that the interventions by activist funds are not desirable to the national economy. The paper also points out the fact that, as the decision on the merger would not only affect the share price of Samsung C&T but also those of other Samsung affiliates, both foreign and domestic investors who have stakes in multiple Samsung companies will carefully calculate the impact of the merger (or failure of the merger) on the value of their portfolios of Samsung companies, not simply on the value of Samsung C&T (Section 5).

     Chaebols become easy preys of activist hedge funds, contrary to the conventional perception that they are formidable business groups. This paper attributes the reason to strong chaebol policies in Korea. The government’s regulations over the chaebols have continued to strengthen, especially with corporate reforms after the Asian Financial Crisis of 1997-8. As a result, Korea currently maintains the world’s most stringent fair trading regulations, as well as a highly punitive system for the inheritance of management rights. Korea’s commercial law is also the most rigid in the world in enforcing the “one-share, one-vote” principle. In a sense, chaebols are currently victims of excessively strict anti-chaebol policies. The paper posits that the underlying causes of the restrictive regulatory regime lie in a combination of anti-chaebol sentiment, utopian views about corporations, and a misdirected application of ‘economic democracy’ to corporate governance (Section 6).

     The paper concludes that Korea should overhaul its chaebol policies based on a practical understanding of how a corporation functions in line with the global economic environment and the realities of the Korean economy. It then proposes practical measures to this end, including short-term measures like poison pills that protect corporations from speculative attacks, as well as long-term measures like allowing dual class shares by which longer-term investors have more say over shorter-term investors. It also suggests making it possible to inherit management rights through establishing public foundations as commonly done in most advanced countries.

 

 


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