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Issue Report

Collection of full-length papers and in-depth analysis of economic and management issues.

Emergence of Hedge Fund Activism in Korea

Emergence of Hedge Fund Activism in Korea

KIM Yong-Ki

July 10, 2007

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Abstract

Hedge funds are engaging in shareholder activism as a basic strategy to increase returns over a relatively short time span. Their action, which has sparked several disputes over corporate governance and M&A issues, differs markedly from the traditional “Wall Street rule” of “put up or sell out” (i.e. passive shareholding), as well as past generations of individual shareholders, who raised post facto objections to management.

Today, an activist hedge fund is highly likely to take a pre-emptive approach by acquiring a 5% stake and then raising objections and marshalling support from other institutional investors to pressure for steps that would increase share prices. In a 2003-05 study of 155 cases where activist hedge funds purchased a 5% stake in listed US companies, management and the other shareholders either accepted or were compelled to accept the proposals of hedge funds in 93 cases, or 63% of the total.

Korean companies have unique circumstances: 13 out of 20 of Korea’s top businesses have foreign ownership of 40% or more. Combined with the country’s weak systems for protection of managerial rights, Korean businesses are exposed to hedge fund-led activism. The only policy tool keeping activist hedge funds in check is the nation’s regulatory filing system, but this too suffers numerous weaknesses. In particular, the nation’s “5% Rule,” which applies to shareholders who attain over 5% equity to make a regulatory filing, falls short.

The rule is intended to allow incumbent investors and management to adjust to sudden changes in the ownership structure. However, as is evident in the cases of Sovereign Asset Management and a consortium led by Carl Icahn, who bought a major stakes in SK Corp and KT&G, respectively, Korea’s regulatory filing system has several major weaknesses. In particular regulatory loopholes allow private investors to continue to purchase shares for 7 days after attaining 5% equity. Korea's regulatory system also does not easily pinpoint the source of capital used in stock purchases. Under such conditions, the overall economy, as well as individual companies, is negatively affected by the excessive influence of foreign hedge funds. Accordingly, both the government and the private sector need to consider urgent measures to keep domestic businesses safe from undue threats from hedge fund activism.

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