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enforceability of existing corporate governance rules and a lack of accountability. They call into question the true independence of the boards of Korean conglomerates and the ability of outside directors to effectively oversee management and protect all shareholders' interests.

Recent research on Korean-listed companies shows strong social ties between independent directors and management of Korean conglomerates. While 87% of boards are in theory independent, only 62% are when one considers social ties. The composition of Korean boards also poses concern as the percentage of directors with business or management backgrounds has decreased from 45.2% in 2004 to 28.4% in 2011. This, while the number of former public officials has sharply increased from 2.7% in 2004 to 8.9% in 2011. Interestingly, in Korea's boardrooms, the inclusion of professors and lawyers as independent directors has become common. The need for stronger independent oversight and monitoring of management is especially important for Korean chaebols as they concentrate the managerial power into the board's chairman, a member of the founding family. The chairman's control over all subsidiaries of the conglomerate through the management council and appointment of management of all affiliated firms has been a serious concern for minority shareholders seeking more accountability and managerial transparency.

"With the adoption of a Stewardship Code, our expectations are that shareholders in Korean equities, and especially in chaebols, will use their voice more actively to promote positive governance change and long-term shareholder value creation."

Protecting Shareholder Interests
At the core of Korea's governance challenges lies a structural problem at the chaebol: the complex system of cross-shareholdings. On average, the founding family of Korean conglomerates owns about 10% of the parent company's shares, while other listed subsidiaries own more than 30%. The founding family is a shareholder in the other chaebol subsidiaries, and the subsidiaries reciprocate by owning shares in the other companies. The circular ownership structure has been of investor concern as it provides a framework for related party transactions and potential conflict between family shareholders and external shareholders. For many, these concerns have been factored into what has been called for over a decade the "Korean discount."

With the promise of sweeping governance reform by the new President Moon Jae-In, foreign investors are looking today for better protection of minority shareholder rights and stronger constraints on chaebol businesses. On the politico-economic reform agenda are topics such as: 1) reforming the Korean Commercial Code by mandating separate elections for audit committee members, 2) allowing shareholders of parent companies to sue directors of subsidiary firms, 3) lowering eligibility thresholds for filing representative lawsuits, 4) regulating compensation for controlling shareholders and management, as well as 5) introducing mandatory electronic and cumulative voting.

One of the most ambitious goals includes proposed amendments to Korea's Monopoly Regulation and Fair Trade Act, introducing constraints on chaebol businesses and banning all existing circular ownership structures of chaebols within three years.

The calls for big governance reform in Korea were first publicly voiced by chaebols' shareholders themselves. In 2015, at Hyundai Motor's annual general meeting, shareholders openly confronted management about the controversial land deal and proposed a new governance committee to strengthen oversight and accountability. In an unprecedented fashion, their shareholder action prompted the company to set up a separate Corporate Governance and Communication Committee consisting of four independent directors, and to engage in shareholder outreach. In 2016, Hyundai Motor officially announced its new "Corporate Governance Charter" in an effort to enhance transparent business management and to promote shareholder rights. Similarly, in November 2016, Samsung announced a "Comprehensive Roadmap to Enhance Long-term Shareholder Value Creation," committing to improve governance by increasing its board's independence, as well as the diversity and breadth of experience of its directors.

Changing Korea's Business Culture
The expected governance reform in Korea is an opportunity not only to disentangle politics from business, but also to create better institutional protection for all shareholders. It also serves as an opportunity to change the culture of investing in the country.

In February, Korea's Financial Services Commission introduced the country's first Stewardship Code, encouraging big investors like pension plans and asset managers to actively engage with investee companies and to monitor their management decisions. This trend towards investor stewardship and active ownership echoes the progress already made in other Asian markets such as Japan, Hong Kong, Malaysia, the Philippines, Singapore, and Thailand. With the adoption of a Stewardship Code, our expectations are that shareholders in Korean equities, and especially in chaebols, will use their voice more actively to promote positive governance change and long-term shareholder value creation.

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