Samsung Electronics' Silence on Treasury Share Cancellation, Why?

He raised suspicions that this silence is not a simple financial issue or a management mistake, but rather a deeply rooted reason related to maintaining the control of Chairman Lee Jae-yong's family. He criticized that despite the amendment to the Commercial Act explicitly stating the fiduciary duty to shareholders, it is not functioning properly in reality.

The fiduciary duty to shareholders refers to 'Fiduciary Loyalty,' meaning loyalty to shareholders, and Korea is the only country in the world to explicitly stipulate it by law. This adopted the case law of the Delaware Court of Chancery in the United States and garnered significant expectations from the capital market at the time of its enactment. However, Director Kim Kyu-sik pointed out that Samsung Electronics' announcement of a 110 trillion won shareholder return policy without clarifying whether treasury shares would be canceled led to a sharp drop in stock prices, and that such behavior is far from the legislative intent of the fiduciary duty to shareholders. He argued that this incident is a significant corporate governance issue and a factor exacerbating the Korea Discount.

Director Kim Kyu-sik explained that a company's stock price cycles through growth and distribution phases, and failure to announce a clear policy during the distribution phase can cause stock prices to plummet. In fact, Samsung Electronics' stock price has more than halved from its peak, representing a discount of over 50%, which he identified as a cause of the Korea Discount, where the company is valued lower than competitors like Micron.

A company's fair stock price is determined by net profit and its multiple (PER), which is determined by three factors: growth rate, discount rate, and shareholder return rate. If treasury shares are not repurchased and canceled when the stock price is undervalued, it sends a reverse signal that management does not consider the stock price undervalued, negatively affecting investor sentiment.

Director Kim Kyu-sik presented a model where PER (Price-to-Earnings Ratio) is determined by the shareholder return rate in the numerator and the growth rate minus the discount rate in the denominator. That is, the fair stock price is calculated by multiplying net profit by the shareholder return rate and dividing it by the growth rate minus the discount rate. He explained that net profit is 'shareholder profit' after excluding facility investment and R&D funds, and thus, American companies, in principle, return 100% of net profit to shareholders. He emphasized that this shareholder return rate directly impacts the multiple (PER), and its importance grows as a company matures and its growth rate slows. Therefore, a low shareholder return rate inevitably exacerbates the Korea Discount.

Director Kim Kyu-sik explained that although the shareholder return rate is calculated based on net profit, actual shareholder dividends are made from free cash flow. He believed that during a high-growth phase, the company's growth rate (G) is high, leading to multiple expansion, so the shareholder return rate is not a significant issue. However, he emphasized that when a company enters maturity and its growth rate slows, the impact of the shareholder return rate on stock price becomes very significant. He criticized that many Korean companies, despite reaching maturity, are conservative about shareholder returns, stuck in the mindset of the past development-dictatorship era. This can cause the stock price of mature companies to halve and ultimately lead to shareholders not being rewarded, turning the market into speculation.

Treasury share repurchase and cancellation has the effect of increasing earnings per share (EPS) by reducing the number of shares. Director Kim Kyu-sik explained that this automatically enhances the growth rate. He also emphasized that it sends a strong signal to the market that management believes the current stock price is undervalued. On the other hand, if only dividends are paid without treasury share repurchase and cancellation, the market suspects that management does not view the stock price as undervalued or that there are problems with business prospects. He criticized that the Korean market becomes speculative due to the lack of clear shareholder return policies, which can be interpreted as a refusal to reward shareholders who provided capital.

Treasury share repurchase and cancellation should be implemented when the stock price is low to maximize shareholder value. Financial theory generally holds that the more undervalued the stock price, the more treasury shares should be repurchased and canceled. Director Kim Kyu-sik cited Apple's case, where it actively implemented treasury share repurchase and cancellation during its growth slowdown period from 2016 to 2019, expanding its PER from 10x to 20x and more than doubling its stock price. However, he criticized that Samsung Electronics maintains silence on treasury share repurchase and cancellation despite its stock being undervalued, calling it a typical example of the Korea Discount. He raised suspicions that Samsung Electronics' behavior might not be a simple management mistake but driven by other intentions.

Director Kim Kyu-sik argued that Samsung Electronics' silence on treasury share repurchase and cancellation poses problems that could violate five laws. The first is the Commercial Act stipulation that repurchased treasury shares must be canceled within one year. If treasury shares are canceled, the shareholding percentage of the remaining shares increases. The shares of Samsung Electronics held by Samsung Life Insurance and Samsung Fire & Marine Insurance would also increase. These are key stakes for maintaining the control of Chairman Lee Jae-yong's family, but under the Financial Industry Separation Act, financial institutions cannot own more than 10% of voting shares in non-financial affiliates. Thus, an increase in shareholding could lead to a violation of the Financial Industry Separation Act. Currently, Samsung Life Insurance and Samsung Fire & Marine Insurance are very close to this limit, meaning they might have to sell some of their holdings if treasury shares are canceled.

This regulation limits major shareholder affiliates from holding more than 3% of their total assets in securities of a specific company. Currently, Samsung Life Insurance and Samsung Fire & Marine Insurance comply with the 3% rule by calculating Samsung Electronics shares at their acquisition cost (book value). However, if some Samsung Electronics shares are sold according to the Financial Industry Separation Act, this transaction would be valued at market price. This could lead to criticism that the remaining shares should also be market-valued. If the 3% rule of the Insurance Business Act is switched to market valuation, Samsung Life Insurance and Samsung Fire & Marine Insurance might have to sell a large number of Samsung Electronics shares, which could weaken Chairman Lee Jae-yong's family's control over Samsung Electronics.

Director Kim Kyu-sik explained that this regulation is not applied to all shares of a specific company but specifically to shares of major shareholder affiliates. This is widely interpreted as aiming to prevent insurance companies from misusing customer funds to secure control. He also criticized Samsung Life Insurance and Samsung Fire & Marine Insurance's stance of considering Samsung Electronics shares as 'strategic assets not to be disposed of,' arguing that holding strategic assets is inconsistent with the essence of the insurance business.

The third issue is the Fair Trade Act. If Samsung Life Insurance sells 9% of its Samsung Electronics shares at market value according to the 3% rule of the Insurance Business Act, Samsung C&T would become Samsung Electronics' largest shareholder. Under the Fair Trade Act, a largest shareholder whose subsidiary's stock value exceeds 50% of its assets is automatically incorporated into a holding company. Becoming a holding company entails an obligation to hold more than 30% of subsidiary shares, which for Samsung Electronics would amount to hundreds of trillions of won, making it practically impossible. Failure to comply with this obligation can result in stock disposal orders, fines, and criminal penalties. Director Kim Kyu-sik argued that Samsung Electronics' silence on treasury share repurchase and cancellation stems from these issues, and criticized this as a violation of fiduciary duty to shareholders and neglect of stock undervaluation to maintain the control of Chairman Lee Jae-yong's family.

If Samsung C&T is converted into a holding company under the Fair Trade Act and cannot fulfill its obligation to hold 30% of subsidiary shares, it will face two options. First, Samsung C&T must sell all its Samsung Electronics shares, relinquish its position as the largest shareholder, and become the second-largest shareholder. Second, Samsung C&T must be completely spun off from the Samsung Group, severing its control. Director Kim Kyu-sik mentioned that such holding company conversion issues have arisen in the past and warned that selling Samsung Electronics shares held by Samsung Life Insurance and Samsung Fire & Marine Insurance could lead to serious problems. He criticized that the Samsung Electronics board of directors is violating its fiduciary duty to shareholders and neglecting stock undervaluation for the benefit of the chairman's family.

He explained that while it is difficult for shareholders to win direct lawsuits for damages, they can replace the board of directors through exercising voting rights at shareholder meetings. That is, directors who fail to clarify their stance on treasury share repurchase and cancellation or make decisions that infringe on shareholder interests can be dismissed, and new directors can be appointed. He emphasized that if Samsung Electronics' stock price is currently undervalued and shareholders are suffering, the board has a duty to clearly state its shareholder return policy. He also pointed out that announcing shareholder return policies at each earnings release is a global standard.

It was pointed out that while Samsung Electronics' stock price rose even when it remained silent on treasury share repurchase and cancellation during its past high-growth period, the situation has now changed. Director Kim Kyu-sik explained that during high-growth periods, the impact of shareholder return policies on PER expansion was small, so problems did not surface. However, he emphasized that the market looks ahead 12 months, and while growth rates were high until the first half of this year, largely preventing shareholder return issues from being highlighted, expectations for specific shareholder return policies are growing from the second half. Samsung Electronics announces its shareholder return policy every three years, and there were expectations for treasury share repurchase and cancellation until this year. However, the current announcement failed to provide guidelines on whether to opt for dividends or treasury share repurchase and cancellation, exacerbating market disappointment.

Director Kim Kyu-sik diagnosed that the Korean capital market has entered a new phase due to the enactment of the fiduciary duty to shareholders last year and the increase in global investors' investment in the domestic market. He emphasized that leading companies like Samsung Electronics and Hynix are now expected and obligated to present new capital and shareholder return policies that meet global standards. He stated that simply paying dividends and remaining silent on treasury share repurchase and cancellation is no longer acceptable. Management must explain why the stock price is undervalued and specifically clarify why they choose dividends over treasury share repurchase and cancellation. He pointed out that this lack of information makes objective analysis difficult for analysts and prevents the issuance of sell reports, leading to a vicious cycle.

Developed country companies, even when paying dividends, explicitly explain why they choose dividends over treasury share repurchase and cancellation, dispelling market misunderstandings. Director Kim Kyu-sik cited Broadcom's recent earnings announcement as an example, emphasizing that overseas companies announce capital and shareholder return policies in great detail and specificity. Such transparent information disclosure allows analysts to accurately estimate corporate value and conduct various analyses, including sell reports. In contrast, Korean companies are reluctant to disclose information, fostering investor distrust. He pointed out that if undervaluation persists, advanced countries allow and applaud active capital market activities like public tender offers, but Korea does not.

Micron recently announced that it would return 100% of its excess cash to shareholders, and if this method is treasury share repurchase, it means management believes Micron's stock is undervalued. Director Kim Kyu-sik criticized that he cannot understand why Micron actively repurchases and cancels treasury shares despite trading at a PER of 7x, while Samsung Electronics, at a PER of 4.5x, remains silent. He warned that Samsung Electronics' behavior goes beyond the strangeness of the company itself and could lead to a discount for the entire nation. Foreign institutional investors would invest in Micron instead of Samsung Electronics in such a situation, and he mentioned that Hynix attracts more foreign investment despite Samsung Electronics having better long-term fundamentals.

Family businesses in advanced countries like Wal-Mart and Wallenberg establish family trusts or family companies to facilitate business succession. These companies receive benefits such as inheritance tax exemptions on the condition that they separate management and ownership. That is, they create a structure where family members do not directly participate in management as CEO but only own shares. Director Kim Kyu-sik explained that some European listed companies, like Louis Vuitton, are directly managed by families, but they hold more than 50% of the shares with their own money to secure management legitimacy. In Samsung's case, the shares held by Samsung C&T and Chairman Lee Jae-yong are small, and a large portion of shares are held by Samsung Life Insurance and Samsung Fire & Marine Insurance using customer funds, which differs from these overseas examples, he pointed out.

The Wallenberg family uses a public interest foundation to entrust management to professional managers of affiliates, and the foundation exercises voting rights, thus separating ownership and management to receive inheritance tax exemptions. He emphasized that if founding families want to be exempt from inheritance tax, they must separate management and ownership. He argued that for Korea to advance to a developed country, it must resolve these deadlocked governance issues and adopt a separation of ownership and management structure suited to its circumstances, so that founding families, the public, and shareholders all benefit.

That is, a structure is needed where the founding family does not practically interfere with management, the CEO independently manages the company, and if the board of directors commits dereliction of duty when necessary, the court actively intervenes to hold them accountable. He believed that if such a practice is established, the board of directors will function independently, and management will diligently fulfill its fiduciary duty to shareholders. He also argued that the courts should actively interpret the fiduciary duty to shareholders and hold them accountable for dereliction of duty, so that the entire social system changes.

Director Kim Kyu-sik pointed out that despite the fiduciary duty to shareholders being clearly codified in Korean commercial law, there is still much room for interpretation, leading to ongoing acts of dereliction of duty. He emphasized that to resolve these issues, a social consensus on the separation of ownership and management and a system upgrade are necessary. That is, in addition to active interpretation by the courts, a culture where management makes independent decisions and the board of directors properly performs its oversight role must be established. He explained that this would prevent the board and management from committing dereliction of duty, and create a structure where shareholders can actually hold them liable for damages through lawsuits for conflicts of interest. He argued that these changes are an important step in elevating the Korean corporate governance system to the level of developed countries.