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In the latest installment of the Salzburg Questions for Corporate Governance series, professor of strategy and corporate governance Myeong Cho reflects on an innovative proposal for new Korean legislation which its supporters argue would improve the oversight of boards
This article is part of the Salzburg Questions for Corporate Governance series, facilitated by the Salzburg Global Corporate Governance Forum
To strengthen the oversight role of a board, several board composition models have emerged around the world. One fear in many jurisdictions is that "independent" directors may not be genuinely independent due to interpersonal connections with other board members and management. A new proposed amendment to the Korean Commercial Act would address this by requiring a procedure to elect the audit committee separately from other directors.
Several lawmakers from the ruling party and the government proposed legislation, which is now pending with the National Assembly. Most of the proposed items aim to keep in check the controlling shareholder. Among them, management and controlling shareholders in Korea are most concerned about the separate election of directors who would be audit committee members because it could serve as a blow to the controlling shareholders and management. Under the current law, in the annual general meeting, shareholders can elect directors and then elect audit committee members out of the elected directors. However, if the proposed legislation passes, the directors who would serve in the audit committee should be separately elected under a certain voting restriction from those not audit committee members.
This procedure change is extremely important because the current Commercial Act also requires the controlling shareholder and other major shareholders to exercise only up to three percent of their voting rights when electing an audit committee member. Thus, if the separate election provision is adopted, then the three percent rule would apply to audit committee members' election. The likelihood that the candidates nominated by institutional investors or minority shareholders are elected as directors who would serve in the audit committee dramatically increases.
The current Korean government and the ruling party have been pushing this amendment. They believe that it is hard to maintain "board independence" in the true sense of the word, especially in a relationship-centered society like Korea. They argue that the amendment would make the board "more independent" from controlling shareholders and management. On the other hand, controlling shareholders and management believe that the change will substantially increase company information leakage and expose companies to various types of threats from activists. For example, suppose an activist forms an alliance with different institutional investors or with another activist. In that case, they can easily win the election of audit committee members even in the case when they battle with controlling shareholders who, on average, own about 43 percent of shares in Korea.
Korea's case may be the first one globally, which, under the restriction on major shareholders' voting rights, requires the separate election of the audit committee from other directors. The potential benefits would be that this procedure may strengthen a board's independence and increase transparency by providing more opportunities for non-controlling shareholders to participate in the board. However, the move would also increase the threat from hostile activists. Moreover, the "up to three percent" restriction on the voting rights applied to major shareholders when electing audit committee members is against the "equal treatment" principle of the Commercial Act, which states that shareholders have one vote for each share they hold. Interestingly, the government has opposed the introduction of dual-class shares that Korean companies have long demanded, claiming that it is against the "equal treatment."
Should audit committee members be elected independently of other directors? If your country adopts the same provision and if you are a corporate director, what would you do?
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Myeong (Mike) Cho is currently professor of strategy and corporate governance at Korea University Business School and senior executive advisor at the Korea Corporate Governance Service (KCGS). He has published numerous academic papers on corporate governance in prestigious journals such as Journal of Financial Economics. He was the president of the KCGS. He has also worked as a board director at Samsung, Korean Air, SK, Lotte, and ICGN. Dr. Cho has served as a member for various Korean government bodies such as the National Economic Advisory Committee and Financial Policy Advisory Committee. Before joining Korea University, Dr. Cho was a professor at Owen Graduate School of Management, Vanderbilt University. Dr. Cho earned his bachelor's degree from Seoul National University, MBA from Essec Business School in France and Ph.D in Economics from Cornell University. He is a Fellow of Salzburg Global Seminar.
The Salzburg Questions for Corporate Governance is an online discussion series introduced and led by Fellows of the Salzburg Global Corporate Governance Forum. The articles and comments represent opinions of the authors and commenters, and do not necessarily represent the views of their corporations or institutions, nor of Salzburg Global Seminar. Readers are welcome to address any questions about this series to Forum Director, Charles E. Ehrlich: cehrlich@salzburgglobal.org To receive a notification of when the next article is published, follow Salzburg Global Seminar on LinkedIn or sign up for email notifications here: www.salzburgglobal.org/go/corpgov/newsletter