Of Accounting Fraud and China

The Great Wall might well symbolise
the accounting veracity barriers
in China
Image: www.crystalinks.com

Those looking to play the China mega trend would do well to read this from Reuters. Singapore-based investors would be familiar with the tale of the remiss S-chips even though Reuter's perspective is of those listed on the American bourses.

It talks about accounting irregularities bordering on outright fraud, and how even international accounting firms have seem to fail to detect these, leaving it to certain smaller research firms to investigate and then short the companies profitably (which also spells another conflict of interest and gives potential room for abuse). 

1: For any firms (including those outside of China) where the financial statements cannot be depended upon to be reliable, the only thing  for an investor to do is to avoid it like the plague, regardless of how profitable the trade might seem. The reason might be obvious, but let me say it loud and clear: If the financial statements are not reliable, there is no means of knowing what is going on in the business, unless you are an insider.

2: Reputation is actually worth something. This doesn't mean that one should only invest in well-known firms, indeed great opportunity might lie in small unknown firms. But then there might be a need for a larger discount factor to take into account any unknown risks. Or to put it another way, the expected profits from such less known investments should be fairly large, to compensate for the higher "risks".

3: Another point to note from the Reuters' article is, for those Chinese firms that are formed out of reverse mergers, they did not undergo the rigours of the American IPO process, which thus give rise to such abuses. 

4: There are other ways to play China than to invest directly in the country's companies. International firms doing business in China, or selling their products in China (or for that matter the other countries in rapidly growing countries), can be a safer way to get the China exposure, without the Chinese accounting issues.