A Lack Of Transparency Is Coming Back To Haunt Chinese Firms

Ghost

The roller coaster ride for China stocks on Wall Street continues, with some firms subject to intense sell offs based on nothing more than rumours that unfavorable reports from research firms are in the offing.

You’ve seen the names in the news: Sino-Forest, Yurun Food Group, Spreadtrum. Seems like there’s a new story every day with fresh accusations that are later vehemently denied by the companies in question, who are often armed with reams of financial data. In a summary piece out today, Reuters reports:

The accounting troubles and short-selling attacks hitting China-based companies are creating fertile ground for the rumour mill to flourish, with some shares hammered by chatter rather than actual evidence.

Such stock swings have created a dangerous climate for even strong Chinese companies and put regulators on high alert for market manipulation.

How did this happen? One can go through the list of companies that have been “outed” by analysts in recent months, but taking a step back and looking at the trends, I think it all comes down to transparency. (Apologies for stating the obvious, but although I have written about this subject several times, I have yet to sum up how we actually got here.)

I’ve been writing a lot recently about suspect legal structures and the way that investors tend to ignore potential risks. Yes, the onus was on the investors to investigate those structures before pulling the trigger on deals, but to be fair, these listed companies did whatever they could to obscure these (and other) risks in their disclosure documents. U.S. securities laws grant firms a decent amount of wiggle room in that regard.

Add to that murky accounting practices and inadequate corporate governance, and you can see why many investors were suckered in, desperately wanting to cash in on the China growth story.

At this point, let me throw out a few cliched sayings/quotes: you live by the sword, you die by the sword; hoist on his own petard; what goes around, comes around. Enough?

How about this: if you give an optimist a box and tell him there is a surprise inside, he will conjure up images of all sorts of goodies. If you repeat the exercise with a pessimist, he might imagine what sort of dangerous creature might leap out to attack him once it is opened.

The market has recently gone from being wild-eyed optimist to skittish pessimist.

These companies have benefited from being opaque, with China bull optimists helping to push some valuations to laughable territory. But the market’s confidence was based on imperfect information, on data and opinions that were not sufficiently researched.

Now that questions are being asked, that lack of transparency is coming back to haunt these firms.

This too shall pass, and an equilibrium will be reached that is hopefully more in line with reality than the current psychology of the China optimists and pessimists. In the long run, though, only greater transparency will protect these firms from this sort of volatility, which is based on nothing more than the hopes or fears of what’s inside that box.

This post originally appeared at China Hearsay.

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