Chinese Firms Facing Heat On Governance

Hong Kong

Photo: jgaerlan via flickr

Chinese corporate portfolios are currently under review after a ‘spate of allegations’ reveals that Hong Kong-listed companies are engaging in fraudulent accounting practices, according to a report released by Fitch Ratings on Monday.The credit rating agency says Chinese companies have an above average risk of facing fraud allegations and warns of ‘widespread weaknesses’ in Chinese corporate governance practices. The report suggests fraud hasn’t improved since a study released in 2009 by the World Bank’s Perception Indicators, which showed China with a Control of Corruption ranking of 36 (where 100 is the best).

Investor concerns about fraud and US accounting firms’ questioning of managements’ representation of audit numbers have turned up the heat on Chinese companies to improve governance. ‘It seems that overseas investors are currently undertaking the job that China’s underdeveloped capital market is not doing: that of challenging Chinese management to adopt higher standards,’ the Fitch report says.

The report, which screened 35 companies, contends that the flow of ‘accusations and investigations’ is not expected to decrease any time soon because audit committees face challenges in ensuring a ‘fully transparent view.’

‘Some of the accusations will be legitimate; some will be erroneous; many will be a mixture,’ Fitch claims. ‘All have the potential to present liquidity problems for an individual issuer and its closest peers.’

Chinese companies using auditors from the Big Four accounting firms (Deloitte Touche Tohmatsu, PricewaterhouseCoopers, Ernst & Young and KPMG) are more likely to have higher governance standards and less possible fraud as a result.

But some companies that use the Big Four have also received fraud allegations. Additionally, ‘Companies which adhere to international financial reporting standards (IFRS) – and the audit trail that lies behind such scrutiny – would have more difficulty in perpetuating fraudulent statements compared with [those adhering to] domestic standards,’ the report points out.

The Fitch report comes just a week after Moody’s ratings released a report indicating ‘red flags’ at 61 Chinese mainland firms with probable governance and accounting risks. Moody’s says these companies were evaluated in five categories: weak corporate governance, risky business models, fast-growth strategies, poor earnings quality and audit concerns.

[Article by Aarti Maharaj, Corporate Secretary]

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