South Korea has generally been underperforming other emerging markets recently, but the KOSPI, a broad measure of South Korean equities, hit a three-year high in anticipation of higher dividend payments1.

Newly appointed finance minister Choi Kyung-hwan announced tax measures that will incentivize corporations to unlock billions of dollars in cash reserves and redistribute them in the form of dividends and capital expenditure (capex). Choi stated “The goal of the plan is to help encourage companies’ profits to be spent more in the form of investments and dividends.”2

Additionally a $40 billion stimulus package, which is close to 3% of gross domestic product (GDP), was rolled out to help stimulate a languishing economy that grew at its slowest pace in more than a year.

Why the Emphasis on Higher Dividends?

The South Korean equity market has one of the lowest dividend payout ratios in the world.

Choi stated, “When a company makes a profit, the funds have to flow into households in the economy through investments, salaries or dividends for the economy to be functioning properly.”3 Below we detail the new economic team’s proposals to facilitate higher dividend payouts.

Raising dividend payouts potentially can be a stimulant for asset prices, attracting a new range of market participants looking for the cash flows from those equities. Growth in valuations can help boost domestic demand and subsequently improve economic growth.

The policies aiming to increase dividends:

New tax on undistributed earnings: The government plans to introduce a 10% tax on undistributed net earnings to encourage investments, dividends and wage hikes in South Korea. This tax will be assessed on large companies if the combined impact of dividends, capex and wage increases is below 60% to 80% of the company’s net profits. The tax is charged on the shortfall at 10%, and this is effective for earnings in 2015, 2016 and 2017.

– One need not look far to understand the economic implications of these taxes. Taiwan introduced a similar tax on undistributed earnings in 1998, and today its equity market has an average dividend payout ratio of 48%. In contrast, South Korea’s payout ratio is 14%4. These tax incentives clearly have an impact.

– Michael Na, Nomura’s Korean strategist, argues, “If Korean firms start paying out 50% of earnings, which would be 5.2% of dividend yield. That could spark a wave of buying and see the KOSPI rise to 3,000.” The potential for a 5.2% dividend yield is highly alluring, given that current dividend yields in South Korea stand at 1.1%5.

Lower tax on dividend income: The government has also proposed lowering withholding tax rates for both large and minority shareholders who are currently subject to a dividend income tax of 38% and 15%, respectively. The proposal would allow large shareholders of qualified listed companies to pay a withholding tax of 25%, from a consolidated income tax of 38%.