’Poison pill’
Korea Times, Seoul
’Poison Pill’
By Kim Yu-ho
18 March 2010
South Korea has signed free trade agreements (FTAs) with many nations since 2003. In the past few years, it has sought to tear down trade barriers and open its market wider to the world’s major economies on a reciprocal basis.
The country struck a free trade deal with the United States in 2007. And the FTA between Korea and the European Union (EU) is likely to take effect in 2010.
The Ministry of Justice has recently proposed a revision of the commercial law provisions, including the introduction of a poison pill,'' which is one of the common tools to enable local firms to defend themselves against hostile takeovers.
The termpoison pill’’ refers to the tactic of discouraging hostile mergers and acquisitions (M&A). Generally, two types of poison pill strategies are used.
One poison pill strategy is to grant existing shareholders, excluding the acquirer, the right to purchase new shares at a discounted price. The other approach is to allow shareholders to purchase the acquirer’s shares at a discounted price after a hostile takeover.
The introduction of the poison pill and dual-class recapitalization has been controversial in Korea ever since the Monaco-based Sovereign Asset Management’s threat to take over the management of the SK Corporation, the American investor Carl Icahn’s acquisition attempt of KT&G, and the buyout of the Korea Exchange Bank by Lone Star Funds, a U.S. private equity fund, in 2003.
Dual-class recapitalization is another anti-takeover method which establishes two classes of common stock with unequal voting rights, granting more voting rights to the current majority management shareholders.
With both the poison pill and dual-class recapitalization, a target company may be able to defend itself by diluting the number of shares held by the acquirer, making the takeover attempt more difficult.
The discussion of anti-takeover methods, including the poison pill, has shifted into high gear since fall 2008. The Fair Trade Commission (FTC) previously opposed the introduction of the poison pill and dual-class recapitalization.
After the justice ministry’s proposal for a revision of the commercial law, the FTC has now stated that it will not oppose the poison pill.
The FTC has reasoned that, in order to facilitate foreign investment in Korea, it is necessary to stabilize the management of a company proactively, and that the poison pill has a relatively lesser adverse effect than other defense methods such as dual-class recapitalization.
The FTC further stated that the use and effects of the poison pill has been tested by the current implementation in other developed nations such as the United States, France and Japan.
The poison pill has beneficial effects. With the poison pill, the management of a company can be focused on the running of the business while relieving management from having to spend an exorbitant amount of time and resources on the prevention of attacks from hedge funds or green mailers.
This also saves a business the expense of defensively buying its own stock shares and frees up the use of such spending for investment in the business itself. Even in a hostile M&A situation, a company has the advantage in negotiations with an anti-takeover acquirer which, in turn, is beneficial for minority shareholders.
On the other hand, the poison pill has possible adverse effects. Due to the strengthening of the management, the poison pill may lead to moral hazards for the management, majority shareholders and owner, ultimately causing shrinkage of foreign investment by those opposed to the primary purpose for the poison pill and its initial introduction.
This, in turn, may lead to a decrease in the stock price as the lowering of the valuation of shares held by the acquirer through the issuing of new shares also lowers the value of shares held by the existing shareholders.
Korea may not be ready for the introduction of the poison pill. This is primarily because many large Korean corporations, also known as ``chaebol,’’ are run by the owners and the owners’ family members.
As such, large corporations in Korea are not free from the absolute influence of the owner, and the board of directors, in many cases, serves for the owner’s benefit rather than in the best interests of the corporation.
This structure of corporate governance is a bit distorted, making the risk of moral hazard quite considerable. The running of a company by owners and the owners’ family members does not mean it is flawed, so long as such a management practice can maximize the corporate sustainability and profits.
However, under the unique corporate governance structure of Korea, there is a high risk of further distortion of the corporate governance structure associated with the poison pill. Furthermore, M&A, or even a hostile takeover, is not necessarily without merit.
M&A functions as a solution to market failure, thereby giving companies another opportunity to succeed. Generally, in the Korean business culture, entrepreneurs who sell their company are criticized, as it may appear that their original intent was to establish such a company only to profit through selling it later, rather than due to a genuine interest in ownership and entrepreneurship.
Conversely, active M&A can be an indicator that the market is healthy and functioning well. If the poison pill makes it more difficult to do an M&A, it is likely that the competitiveness of a company will be weakened and the market itself will be at high risk for losing vitality. In the end, this will adversely affect the economy as a whole.
Historically, hostile takeovers do not occur often because they are very complex and pose a more severe financial pressure on not only the target company, but also on the acquirer than other types of takeovers.
Considering that the Korean government has expanded the signing of FTA with many countries and encouraged the opening of the Korean market, the introduction of the poison pill may lessen the good effects of these Free Trade Agreements.
Moreover, the poison pill may be seen as a discrimination against foreign capital; foreigners may see the introduction of the poison pill in Korea as protecting only a particular set of major shareholders or companies. If so, the introduction of the poison pill will likely discourage future foreign investment in Korea.
The poison pill has both advantages and disadvantages. However, considering the unique corporate governance structure and the business culture in Korea, the introduction of the poison pill appears to have more shortcomings than benefits.
The Korean government must be very careful with the introduction of the defense mechanisms for hostile takeovers. Even after implementing the poison pill in Korea, the government should adopt other mechanisms to minimize the ill effects of the poison pill and to promote a foreign investment-friendly culture.
It is doubtful that the poison pill will derive more foreign investment in Korea. Investment depends not only on the system itself, but also upon the overall economic environment of an entire country. It stands to reason that one will not invest if one does not stand to make a profit.
Kim Yu-ho is a U.S. certified attorney working for the Seoul head office of LOGOS Law LLC, which is a full-service international law firm with offices in Beijing, Hanoi, Ho Chi Minh City, Incheon, Moscow, Phnom Penh and Songdo. He has also worked in Vietnam, Hong Kong and the U.S., and traveled to over 30 countries.
