Introduction

The effectiveness of corporate boards in monitoring management and protecting shareholder interests is a central question in corporate governance. Policymakers and scholars have proposed two broad approaches to improve monitoring: strengthening the legal accountability of directors and enhancing the representation of minority shareholders in boardrooms. While both aim to improve oversight, their economic consequences may differ substantially. The first approach uses liability as a disciplinary device, forcing directors to internalise the costs of poor monitoring. The second approach focuses on board composition, allowing minority shareholders to elect directors through proportional voting mechanisms to provide an independent voice against controlling interests.

This research exploits a unique regulatory setting in Korea to disentangle the effectiveness of these approaches. Historically, the Korean corporate sector has been dominated by large business groups (chaebol) with concentrated ownership, leading to persistent concerns about investor protection. Following the inauguration of President Lee Jae Myung in June 2025, a series of reforms were implemented through amendments to the Commercial Code to improve board monitoring and enhance shareholder rights.

Related literature and hypothesis development

A large body of research suggests that strong investor protection is a key determinant of financial market development. Legal accountability ensures directors owe fiduciary duties of care and loyalty to shareholders. However, excessive legal exposure may induce overly conservative strategies or discourage qualified individuals from serving on boards. In environments where investor protection is weak, the benefits of increased accountability may outweigh these potential costs.

Regarding proportional representation, mechanisms like cumulative voting allow minority shareholders to limit ‘tunnelling’ — the transfer of resources out of firms for the private benefit of controlling shareholders. While some studies find positive market reactions to minority representation, others highlight potential costs. Board effectiveness depends on coordination; when directors represent different constituencies, conflicts of interest may arise, reducing the efficiency of deliberations and interfering with managerial information sharing.

Recent regulatory changes regarding investor protection in Korea

The study examines two sequential amendments to the Korean Commercial Code (KCC) enacted in 2025. The first amendment, promulgated in July 2025, expanded the scope of directors’ duty of loyalty to include shareholders in addition to the corporation. Previously, directors could favour controlling shareholders without liability if the corporation itself suffered no harm. The second amendment, enacted in September 2025, introduced mandates for ‘large-scale’ listed companies with assets exceeding 2 trillion KRW (approximately 1.3 billion USD). It made cumulative voting mandatory and increased the number of directors elected under the ‘3% rule’ from one to two, capping individual voting rights to limit the power of controlling shareholders in audit committee elections.

These reforms occurred against a backdrop of rising retail participation. The number of individual investors in Korea increased from 6.18 million in 2019 to 14.40 million by 2022. Following the 2025 presidential election, the KOSPI index rose by 2.66 percent on 4 June, and increased by 13.8 percent between 2 June and 30 June, reflecting market anticipation of these governance changes.

Data and methodology

The sample consists of all non-financial firms listed on the Korean stock market. Financial firms are excluded due to their distinct regulatory and accounting frameworks. To ensure quality, the study requires firms to have positive book value of equity and at least 100 trading days of return observations. The primary firm characteristic analysed is the price-to-book ratio (PBR), as governance reforms are expected to matter more for firms with weaker valuations and potentially more severe agency conflicts.

The researchers conducted an event study using the market model to estimate expected returns. For the first amendment, 4 June 2025 was used as the event date. For the second amendment, 25 July 2025 — the date of committee approval — was selected. Cumulative abnormal returns (CARs) were calculated across several windows, including (0,0), (0,1), (-1,1), and (-2,2).

Empirical results

For the first amendment, the average event-day abnormal return was positive and statistically significant, with CAR(0,0) equalling 0.193%. This indicates that investors responded favourably to increased legal liability. Cross-sectional analysis revealed that low-PBR firms reacted substantially more positively than high-PBR firms, suggesting that the market prices this reform as most beneficial where monitoring problems are severe. Larger firms and holding companies also showed more favourable immediate reactions.

In contrast, the market response to the second amendment was significantly negative across all multi-day event windows. CAR(0,1), CAR(-1,1), and CAR(-2,2) were all negative, suggesting that investors did not interpret proportional board representation as an unambiguous improvement. The negative reaction was concentrated among low-PBR firms and those above the 2 trillion KRW asset threshold. This implies that in firms where governance frictions are already pronounced, investors worry that introducing minority-appointed directors may intensify internal conflict rather than resolve it.

Conclusion

The findings reveal a clear contrast in how capital markets evaluate governance mechanisms. Investors perceive stronger director accountability through legal liability as an effective tool for improving governance, particularly in environments with weak investor protection and high tunnelling risk. However, the market reacts negatively to reforms that expand minority representation on boards. Such reforms may introduce new frictions that complicate strategic decision-making, delay corporate actions, and reduce board cohesion. The evidence suggests that in the Korean institutional environment, the market places greater value on reforms that improve director discipline than on those that reconfigure boardroom representation.