Accounting for the Korea Discount with Book-to-Market Ratios above One

The historical average book-to-market ratio (BTM) of Korean listed companies is above one, and often used as evidence for the Korea discount. This paper asks whether the BTM reflects either risk inherent in Korean businesses as claimed in the popular press, or a bias in market expectations. Analyzing data of Korean listed firms from 1995 to 2019, we first confirm that stocks with BTM above one consistently outperform the rest, consistent with the empirical findings documented in prior studies. When we compose three summary indicators that are allegedly associated with the Korea discount (i.e., fundamental factor, geopolitical factor, and governance factor), we find that only governance factor is positively related to BTM as alluded to in the business press. In our subsequent analyses borrowed from Ohlson and Bilinski’s (2015) specification, we find that BTM above one is associated with a higher probability of positive extreme returns, but a lower probability of negative extreme returns. The finding indicates that BTM above one is more likely to reflect characteristics associated with stock mispricing. We further explore why such systematic bias persists over time and report some evidence that governance factor plays a crucial role. This paper highlights the importance of recasting the underlying cause of a phenomenon.