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| Shirley Ze Yu |
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| Paul Gillis |
The U.S. environment is getting increasingly hostile for China-related IPOs.
Earlier this month, a bipartisan group of lawmakers, including Republican Senator Marco Rubio and Democratic Senator Bob Menendez, introduced a bill that would require U.S.-listed Chinese firms to comply with increased financial oversight–such as providing access to auditing–or face delisting. The Public Company Accounting Oversight Board (PCAOB) in the U.S. routinely inspects the accounting practices of U.S.-listed firms, but China, citing national security concerns, has barred overseas regulators from examining the companies’ audit and financial records.
Whether the bill would become law probably depends on trade negotiations between the U.S. and China, as it could likely be resolved as part of any deal that comes out of those talks, says Paul Gillis, professor of practice and co-director of the IMBA program at Peking University's Guanghua School of Management. He warns that “there is likely to be no more listings” from China on U.S. markets if the bill is passed because no China-based accounting firm is currently inspected by the PCAOB and Chinese law forbids them from handing financial records over to foreign regulators.
“It [passing the law] would be troublesome for U.S. stock exchanges and investment banks,” he says.More in Forbes.
Spinoffs are typically business transactions where the total of all entities increase their value by splitting up their existing business. But not so for Chinese companies, listed in the US, argues Beida accounting professor Paul Gillis. Not the shareholders or the company gains, but mostly management, he explains at his weblog.Spinoffs are situations where a corporation disposes of part of its business by giving shares in the business to shareholders. When they work, the value of the parts is greater than the value of the whole. “Spinoffs” of US listed Chinese companies work differently.
A favorite transaction of US listed Chinese companies is to "spin off" parts of the business in a new entity in an IPO transaction. Shareholders of the parent company are not distributed shares of the company that does an IPO although they may benefit if the value of the underlying shares is recognized in the stock price. There have been a number of these transactions and several in the pipeline.
I have observed, however, that the biggest winners in these transactions appear to be members of management. Management typically ends up with a big chunk of these deals which are structured in a way that does not report as expense the value transferred to them.
Rather than point to a specific transaction, I am going to examine these transactions through a straw man. When I look at specific transactions, I find the public documents obscure what is going on and add bells and whistles that do not alter the essence of the transaction while providing arguments to counter any attacks on the structure. So, the transaction I describe below is fictitious, although I think fairly represents what is going on. I leave it to others to apply this to specific transactions. I apologize, but this simplified example is still complicated as hell.The full case at the Chinaaccountingblog.
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| +Sara Hsu |
China’s stock market is the third largest in the world by market capitalization, weighing in at $3.7 trillion in 2013. However, despite recent reform proposals for a streamlined registration-based listing system that would allow companies that meet criteria for making a public offering (instead of the current system in which the China Securities Regulatory Commission approves IPOs), China’s stock market remains one of the poorest-performing in the world. This can be seen in the MSCI Index, calculated by Morgan Stanley, and even in the Shanghai Composite Index.
The Chinese stock market has often been criticized for channeling funds to state owned companies and their subsidiaries, via other state-owned companies that purchase shares. This does not reflect a market-based environment, but rather is reminiscent of earlier practices of earmarking bank loans for state enterprises that have been part of China’s state led development model. Insider trading and accounting fraud are also problems for investors. A recent crackdown on “rat trading” has sought to eradicate fund managers’ practice of purchasing shares using personal accounts and selling them for a profit once they gain in value. Accounting fraud presents investors with incorrect information, including incorrect revenue recognition and fraudulent asset information, among other abuses.China’s stock market does have potential to improve. Despite being branded early on, by Chinese economist Wu Jinglian and others, as a “casino” in which speculation, accounting fraud, and stock price manipulation play a large role, Carpenter, Lu, and Whitelaw (2014) show that stock prices are now informed by real indicators of risks and returns. China’s stock market has been relatively limited in scope and therefore has weathered the Asian financial crisis and the recent global crisis despite casino-like speculation in earlier years. Meanwhile, the stock market does not contribute to financial deepening due to the same limitations. In addition, Ya, Ma and He (2014) find that herding behavior, in which investors mimic the behavior of others by making the same stock purchasing choices, is not a significant issue in Shanghai’s and Shenzhen’s A-share stock markets.
These findings show that while the companies that list on China’s stock market may be inefficient or distorted in their financial reporting, and the process that lists the companies may be slow and cumbersome, the market itself is “efficient” in its pricing of risks and returns. Poor performance can likely be chalked up to the underlying companies themselves. Although subject to further rigorous analysis, this conclusion has important implications.
This means that if stock market reform improved the quality of companies that list, performance might improve. This resonates with research that shows that listed non-state owned firms perform better on China’s stock markets than do state-owned firms. Enhancing accounting and auditing standards of listed companies and encouraging the listing of innovative companies over more static state-owned companies would increase the quality of China’s stock markets and prevent the financial “brain drain” that China has recently experienced—as the most innovative companies have listed outside of the country, drawing financial pools and returns from the nation.
As China restructures, it is critical that innovative companies have sufficient access to funding. Further reform of mainland stock exchanges will benefit both the listing companies themselves and China’s financial economy. If, indeed, the stock market is now becoming efficient in pricing risks and returns, then deepening capital markets through the stock market should not be an impossible task.More in TripleCrisis.
