Korea’s Treasury Stock Policy: A Landmark Examination of the “Discount” Hypothesis

Korea’s Valuation Gap: A Shifting Investment Narrative

For a long time, Korea’s stock market has been defined by its persistent undervaluation, with the KOSPI’s price-to-book (P/B) ratio consistently below 1—meaning investors valued Korean firms at less than their net asset value. This phenomenon, often called the “Korea discount,” has been widely linked to governance shortcomings and limited focus on shareholder interests. Recently, a strong market rally has pushed the P/B ratio up to 1.87, with leading indices now above 2. Despite this progress, Korean equities still trail behind international benchmarks: the KOSPI’s 1.7x book value lags Japan’s Topix at 1.9x and China’s CSI 300 at 1.8x. As one industry expert observes, the gap has narrowed, but Korea’s market remains undervalued compared to peers.

Legislative Reform: The Next Catalyst

The current optimism is fueled by the narrowing discount, though it hasn’t disappeared. The next potential turning point is a major legislative proposal: the third amendment to the Commercial Act, which would require companies to retire newly acquired treasury shares within a year. This move is designed to enhance shareholder value by reducing outstanding shares, thereby lifting earnings per share (EPS)—a key valuation metric. Proponents believe the law will promote transparency and shift influence from dominant shareholders to the broader investor base. Its prioritization in the National Assembly highlights both its political significance and the market’s anticipation.

Governance Reform in Context: Lessons from Abroad

This legislative push echoes previous efforts to address Korea’s valuation gap, but the current environment is different. The recent rally has already elevated market valuations, supporting the argument that governance reforms can be effective. The treasury stock bill represents a concrete step to accelerate this process. If enacted, it would directly target a structural cause of the discount, potentially paving the way for further re-rating.

Quantitative Strategy Spotlight: Absolute Momentum (Long-Only)

A quantitative momentum approach for the KOSPI involves entering positions when the 252-day rate of change is positive and the price closes above the 200-day simple moving average (SMA). Exits are triggered if the price falls below the 200-day SMA, after 20 trading days, or if a take-profit (+8%) or stop-loss (−4%) threshold is reached.

• Entry Condition: 252-day ROC > 0 and close > 200-day SMA
• Exit Condition: close < 200-day SMA, or max holding days = 20, or TP +8%, or SL −4%
• Instrument: KOSPI
• Risk Controls: Take-Profit: 8%, Stop-Loss: 4%, Max Hold: 20 days

Backtest Results

• Strategy Return: -3.1%
• Annualized Return: -1.53%
• Maximum Drawdown: 4.84%
• Profit-Loss Ratio: 0.67
• Total Trades: 3
• Winning Trades: 1
• Losing Trades: 2
• Win Rate: 33.33%
• Average Hold Days: 9
• Max Consecutive Losses: 2
• Average Win Return: 1.64%
• Average Loss Return: 2.34%
• Largest Single Gain: 1.64%
• Largest Single Loss: 4.49%

The market’s response will reveal whether this policy is sufficient to close the remaining valuation gap.

International Experience: Insights from Japan and Taiwan

Korea’s debate over mandatory treasury share cancellation is not without precedent. Japan’s corporate governance reforms in the 2000s, which limited treasury stock and aimed to improve shareholder returns, did lead to higher price-to-book ratios over time. However, as analysts note, the valuation gap persisted, largely due to broader economic stagnation and deflation. This suggests that governance reforms alone may not be enough to overcome deeper macroeconomic challenges.

Taiwan’s recent amendment to its Commercial Act, which also mandated treasury share cancellation, faced strong business opposition—similar to the resistance now seen in Korea. This pattern highlights a recurring challenge: reforms aimed at boosting shareholder value often meet pushback from entrenched interests that use treasury stock as a defensive tool. The historical takeaway is clear: while such legislation is important, it is rarely sufficient without accompanying reforms, such as changes to inheritance tax and enhanced protections for minority shareholders.

Korea’s current bill is narrowly focused on share cancellation. For it to have a lasting impact on the “Korea discount,” it may need to be part of a broader package of reforms. History warns that a single policy, no matter how well-intentioned, is unlikely to fully close a valuation gap that has persisted for decades.

How the Bill Works and Its Market Implications

The proposed law requires listed companies to cancel newly acquired treasury shares within a year, and to dispose of existing holdings within 18 months of the law’s enactment. Exceptions for employee compensation and stock ownership plans require board and shareholder approval, adding oversight. This represents a direct intervention in corporate capital management. The market’s initial reaction has been increased volatility, especially among companies with high treasury stock ratios. For example, ShinYoung Securities, which holds treasury shares equal to 53.1% of its issued stock, has seen its share price fluctuate sharply ahead of the vote. This volatility reflects investors’ efforts to identify winners and losers as the bill’s passage appears increasingly likely.

Business leaders warn of a significant trade-off. The ruling party presents the bill as a means of protecting minority shareholders and ending the use of treasury shares by controlling owners to consolidate power. However, critics argue that the law removes a key defense against hostile takeovers, creating uncertainty around corporate control and capital planning. Companies that have relied on treasury stock as a strategic buffer must now rethink their defensive strategies and long-term financial plans.

Politically, the bill’s passage is nearly assured. It cleared committee and was brought to the floor on February 24th. Although the opposition attempted a filibuster, the ruling party’s majority made its failure likely. With the legislative process nearly complete, attention now turns to implementation and market adaptation. The bill’s approval eliminates a major political risk, but also locks in a structural change. The market will soon test whether this shift is enough to drive further valuation gains or if it introduces new governance challenges.

Valuation Outlook and Future Scenarios

Korea’s market valuation has surged, with the KOSPI’s P/B ratio reaching 1.87, its highest in 18 years. This jump validates the reform narrative, as the ratio has more than doubled in a year and finally surpassed the symbolic 1.0 mark. Still, the gap with the U.S. market—where the P/B ratio exceeds 5—remains wide, suggesting further upside if reforms continue and earnings improve.

This positive outlook is underpinned by robust earnings, especially in the semiconductor sector. According to Shinhan Investment Corporation’s AI model, the probability of market gains over the next three months is as high as 78%, indicating that the expansion phase may not be over.

However, passing the treasury stock bill is only part of the solution. To fully eliminate the discount, broader governance reforms are needed. As one manager notes, the gap has narrowed, but Korea’s market remains undervalued. Closing it will likely require deeper changes, such as adjusting inheritance tax to net assets, which would reduce the incentive for family-controlled conglomerates to accumulate cash and shares. Without such reforms, the new law may boost EPS and sentiment, but may not be enough to achieve the “Korea premium” that policymakers desire.

Ultimately, the market’s direction is being driven by earnings growth, not just policy changes. The AI model’s high confidence in further gains suggests that the expansion is ongoing, but future advances will depend on whether governance reforms can keep up with profit momentum.

Key Catalysts and Risks Ahead

Passing the bill is just the beginning—the real test will be in its execution. The immediate catalyst to watch is how quickly major companies cancel their treasury shares once the law takes effect. The speed and scale of these cancellations will directly affect EPS and, by extension, share prices. Early moves by firms like ShinYoung Securities will be closely watched. Swift, widespread cancellations could provide a tangible boost to EPS and validate the reform’s effectiveness, while delays or resistance would suggest a more limited impact.

Another crucial development would be regulatory action on inheritance tax. As seen in Japan and Taiwan, treasury stock rules alone rarely close the valuation gap. Addressing inheritance tax could reduce the incentive for conglomerates to hoard cash and shares, tackling the root of the governance issue. Whether there is political will for such reforms remains to be seen, but they could be key to finally closing the gap.

In the near term, the main risk is increased volatility and potential capital outflows. While the bill is positive for governance in the long run, it removes a key defensive tool against hostile takeovers, creating uncertainty for companies’ capital structures. Firms that have used treasury stock for defense may see investors pull out as risk profiles change. The business community’s warning that the law removes a vital defense is a real concern, and could lead to turbulence in stocks with high treasury stock ratios, even as the broader market rallies on reform hopes.

In summary, the market must now distinguish between the policy’s intent and its actual impact. Data on share cancellations will reveal the law’s effectiveness. Broader reforms, especially on inheritance tax, will determine whether the valuation gap is truly closing. Meanwhile, investors should be alert to both headline developments and the subtler shifts in corporate behavior that may follow.