Chinese Style Accounting and Shareholder Management
A staggering 18.47% of the world’s population lives in China, and by some measures, the nation makes up 18.2% of all global economic activity. This compares to the U.S. who has 12.4% of global economic activity. Yet with only 5% of the world’s population, the MSCI All-World Index that is designed to capture the total world investment opportunity set, you find that the United States makes up just under 60% of the total market allocation. Meanwhile, China makes up just 3.3% of the total market allocation.
How is this possible?
One reason for this is the total share value of U.S. public companies is much higher than those domiciled in China. Another key reason is that China’s biggest companies, in the biggest industries, are largely owned and controlled by the Chinese Communist Party, which is far more concerned with achieving its political goals than achieving profits and shareholder value.
A recent example of stagnation came when three-fifths of the Hang Seng index of state-owned enterprises missed their earnings-per-share estimates. This means that the utilities, telecommunications, and consumer staples firms were in decline with no clear sign of improvement. Making things even more troubling to current and potential investors, the Chinese government basically dictates what will and will not be reported about these companies, using accounting “principles” which could be fairly described as “making stuff up to keep our bosses happy.”
The Chinese government is also reportedly telling state-owned companies to focus on restoring overall growth and job creation. However, this is not necessarily the path to building shareholder value. One sign that perhaps the country will break free from the heavy hand of Beijing bureaucrats, came when China moved to streamline stock market listing rules by (according to the announcement of the policy) getting the government out of the business of approving new initial public offerings. Investment bankers in China hoped that this would give a boost, and a semblance of freedom to the economy’s private sector and introduce the kind of capitalistic entrepreneurship that is a mainstay of the U.S. economy. Under the new system, China’s stock exchanges will vet the IPOs, with the stated goal of focusing on improving corporate information disclosure.
Recent enthusiasm has been tempered a bit by the fact that the stock exchanges, fearful of angering their masters in Beijing, have been impossibly rigorous in their “investigations” of would-be new publicly traded companies. Any decision will have to be cleared through the China Securities Regulatory Commission, which, you guessed it, is the same heavy hand of the government. The Commission’s stated role will be to make sure all listings are in line with Beijing’s broad industrial policy. One investment banker, who had hoped to foster IPOs in China, noted that all the applicants are being screened based on national policies, and hundreds of would-be new public companies have now abandoned their plans to be listed on the various exchanges.
Last year, the government reported 3% growth after the abrupt end of the stultifying Zero-Covid policy. However, almost nobody believes the actual economic growth was that high. This year, the Chinese leadership has set a target of 5% total GDP growth. Regardless of what actually happens in the Chinese economy between now and the end of the year, it’s a pretty good bet that the government’s statistical economists will be reporting that this goal was roundly achieved.
With this lack of transparency and goals completely at odds with delivering shareholder value, the low percentage of Chinese companies in the global indices starts to make sense.
Sources:
https://www.nytimes.com/live/2023/03/04/world/china-congress-xi
https://www.worldeconomics.com/Share-of-Global-GDP/China.aspx
https://www.theglobaleconomy.com/USA/population_share/
https://www.msci.com/documents/10199/b93d88ef-632f-4bdb-9069-d7c5aecd9d6
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