Recently news came out that SM Entertainment had been paying large amounts of money to Like Planning, a company owned by Lee Soo Man, who founded SM but left the company in 2010.
When the news came out, SM shares took a dive, and there’s been a lot of back-and-forth about what that means and if the company is doomed to collapse into ashes, or alternately is a perfect entity run by benign divine beings.
So, I’m going to put in my former-business reporter two cents. First, though, I should note that I have no special insider knowledge of SM’s situation, or even not-so-special knowledge of Korean securities law.
What it appears SM did is something that actually happens quite a bit, and it’s important to be aware of it if you ever plan to invest in stocks: They put the interests of a company insider before the interests of investors.
This happens all the time, and in fact is one of the great conundrums of corporate management: How do you prevent the people inside the company from running it to benefit them instead of investors? A lot of common business practices, like awarding shares of stock to upper management, are designed to align management’s personal interests more closely with that of shareholders (and then these practices get abused, and new ones are adopted, and then they get abused…).
This is a particularly thorny issue when a company goes from being a private firm (fewer owners, who likely know each other and may even be related) to being a public company (many, many owners, who have no personal connection to the people running the firm). That is a very difficult transition for companies to make, and it results in all kinds of controversies.
For example, Rupert Murdoch founded News Corp, which was long criticized in corporate governance circles for being dominated by him and his family. Google is another example of a company where the founders don’t want to give up control (although at least they don’t seem to be using it as a personal piggy bank). Although they didn’t technically found Archer Daniels Midland, the Andreas family’s domination of that company was quite controversial even before Michael D. Andreas went to jail.
As you can see from the above examples, putting an insider’s interest first isn’t necessarily illegal. It also doesn’t necessarily mean that the company isn’t being run well as a business–it might be quite profitable.
What it does mean is that investors are getting the short end of the stick. SM doesn’t pay cash dividends to investors, and it probably never will because it’s paying enormous amounts of cash to Lee Soo Man instead. In addition, because of the high cost of these payments to Lee, SM’s profits are going down the tubes, meaning that the value of their shares is likely to decrease–which, generally speaking, is not what investors want. (What about the artists and all? Well, stuff like this is why you always want a share of the revenues, not a share of the profits.)
So, it makes total sense for investors to sell their shares in SM, even if they don’t suspect that something illegal happened and aren’t worried that regulators are going to swoop in and shut the company down. The simple fact that this arrangement exists is an announcement to investors that their interests are coming in dead last. If you think of the money SM makes as a pie, it’s just become public knowledge that Lee is getting a huge slice–which means investors are only going to get a small helping of crumbs.
Additionally, this arrangement doesn’t really speak well of SM’s management, even if it’s not some company-killing illegality. The money SM’s management is giving to Lee could instead be used to expand the company or just put aside for a rainy day. It’s a bit like Murdoch’s insistence that his sons be his successors, when there were potentially far more talented executives available–this kind of favoritism doesn’t benefit the bottom line. Investors in public companies aren’t interested in whatever sentimental attachment SM’s management has to Lee–they’re interested in making money, and if that doesn’t appear to be high on SM’s agenda, they will take their money elsewhere.