Shareholder Engagement in East Asia

Little has been written in the legal literature about hedge fund activism in major East Asian markets such as China and South Korea. To fill this literature gap, this chapter entitled ‘Shareholder Engagement in East Asia’, forthcoming in Board-Shareholder Dialogue: Policy Debate, Legal Constraints and Best Practices (Luca Enriques and Giovanni Strampelli eds, Cambridge University Press), aims to take an empirical and comparative approach to examining hedge fund activism in the three major East Asian markets of mainland China, South Korea and Japan.

They are all civil law countries that follow a German-centric civil law legal tradition. In recent years, they have also transplanted corporate governance mechanisms from the US, such as derivative actions and outside directors. Moreover, they share similar cultural characteristics in terms of the remnant influence of Confucianism, respect for hierarchy and preference for amicable rather than confrontational engagement, all of which have found their way into modern-day corporate governance. Furthermore, the listed companies in these jurisdictions have a similarly concentrated shareholding structure; even in Japan where the phenomenon is perhaps less so, ownership there is still more concentrated than in the United States (US) and the United Kingdom (UK). Looking at corporate control and ownership concentration across the world in 2020, the mean percentage of voting rights held by the three largest shareholders in mainland China (52.7%), Japan (41.2%) and South Korea (47.7%) is generally larger than that in the US (34.2%) and the UK (37.4%).  Their similarities aside, these three jurisdictions display varying degrees of openness to and regulatory control over hedge fund activists, adding to the scope and nuances of this study.

Based on my dataset and the reported cases, activist hedge funds in the three studied East Asian countries targeted companies that have one or more of the following characteristics: (1) relatively more dispersed ownership with no controlling shareholder; (2) undervalued; (3) low profitability; (4) inefficient use of free cash flow in balance sheets; (5) under public criticism due to events such as ongoing criminal or administrative investigations; and (6) controversial agenda pending, such as a restructuring. The target companies found in this sample are also mostly listed companies that are well-known, at least within their local markets, and command a respectable market presence. While activist campaigns have generally targeted large-cap firms, there has been a growing number of campaigns targeting small-cap and micro-cap firms in recent years.

The common objectives of the activists in China, Japan and South Korea are generally aimed at: (1) pay-out policies (e.g. special dividend, share buyback), (2) corporate governance and representation (eg dismissal of chairperson, directors or executives and/or appointment of their proposed candidates), and (3) business strategies (eg objection to a proposed merger, spin-off, or diversification plans). In about one-third of the studied campaigns, the activists demanded some form of corporate governance and representation, including the dismissal of the chairperson and directors, replacement by their preferred candidates, and the establishment of an independent audit committee or remuneration committee. Sometimes, board representation is sought concurrently with other objectives. This is because with their candidates sitting on the board, the activists have greater room to advance their positions and gather support from other shareholders.

Regarding activism strategies, the findings in this study are largely similar to those conducted in the US and the UK. The first port of call for activist hedge funds in East Asia is private engagement. When that fails, they attempt to issue public letters criticising the alleged poor practices and gather support from other shareholders. Only in very exceptional circumstances would they resort to severe measures such as lawsuits or takeover bids. This is largely in line with industrial practices elsewhere.

Nevertheless, there are distinct differences in the patterns of hedge fund engagements within China, Japan and South Korea. In particular, the frequency of activism in China is much lower than Japan and Korea over the years, due to the controlled entry of foreign hedge funds in China and its government-centered approach towards corporate governance.

In China, there is a limited number of foreign hedge funds as a result of regulation. Foreign funds’ entry into the Chinese market is tightly controlled. Foreign institutional investors and hedge funds must be approved by the China Securities Regulatory Commission (‘CSRC’) as a Qualified Foreign Institutional Investors (‘QFII’) or RMB Qualified Foreign Institutional Investors (‘RQFII’, raising RMB directly) in order to trade Renminbi-dominated ‘A’ shares of Chinese companies on the Shanghai and Shenzhen stock exchanges. Foreign investors qualified as QFII are also required to comply with the shareholding limit for domestic securities investments. Moreover, foreign investors, including hedge funds, have to comply with the Catalogue of Encouraged Industries for Foreign Investment before they make investments in Chinese markets (‘the FI Encouraged Catalogue’). Unlike China, there is no such approval system for foreign hedge funds in Japan and South Korea. Foreign hedge funds that find it difficult to make their way into the Chinese markets to pursue opportunities for activist interventions play a major role in catalysing activism in South Korea and Japan.

Last but not least, it is found that hedge fund activism is on a growing trajectory in Japan and South Korea. The promulgation of the Japanese Stewardship Code and the Korean Stewardship Code have catalysed a rapid increase in activism in Japan and South Korea as institutional investors are encouraged to play a more active role in corporate governance. However, the future trajectory of hedge fund activism in China remains uncertain as the heavy state control on institutional investors make it more challenging for hedge funds in China to gather momentum and effectively carry out their activist campaigns. In this respect, the Japanese and Korean markets have been and will likely continue to be more receptive towards aggressive hedge fund activism as compared to China.

Lin Lin is Associate Professor at the Faculty of Law of National University of Singapore.

This post is part of an OBLB series on the Board-Shareholder Dialogue. Previous OBLB series are available here.