As a new “silicon curtain” crashes down between the technological infrastructure of America and some of its allies and China and the countries in its sphere of influence, there has begun to be talk about restricting flows of capital as well as goods between the two nations. Some have fretted that China might dump its holdings of US treasuries in retaliation for escalating tariffs. Other analysts have speculated that U.S. financial institutions might soon be prohibited from investing in securities in mainland China’s state-owned enterprises. And now Senator Marco Rubio has put the nuclear option on the table with a bill and editorial in the Wall Street Journal, “You Can’t Trust a Chinese Audit,” proposing to potentially boot hundreds of Chinese companies off of U.S. stock markets.
The role of a Chief Financial Officer for a Chinese company listed on the U.S. stock market is intensely challenging. While the job of CFO generally has become increasingly complex due to the growth in regulatory oversight and the pressure from institutional shareholders, Chinese CFOs need to also bridge two very different business and legal cultures.
Tencent Music’s (NYSE:TME) $1.1 billion IPO on the NYSE last week put a shiny bow on a banner year for Chinese IPOs on U.S. stock markets, with over $8 billion raised year-to-date, twice the IPO haul for Chinese companies in 2017. With 30 Chinese companies having listed on NASDAQ or NYSE it’s the best year since 2014, when Alibaba’s (NYSE:BABA) $25 billion IPO broke all previous records. What’s more, there is a sizable pipeline of China “unicorns” with multi-billion dollar private valuations hoping to score listings in the near future.
Given the deteriorating trade relations between China and the U.S., why are so many of China’s most innovative and valuable private companies still seeking to ring the opening bell in New York? And can this blistering pace of new IPOs be sustained?
NYU accounting and finance professor Baruch Lev is one of the most incisive contrarian critics of current accounting practices. In his recent book, The End of Accounting (written with Feng Gu) and his blog, Lev argues that current accounting methods have become hopelessly out of step with how value is created in the modern economy, and that an accumulation of new accounting regulations have only made things worse. Professor Lev backs up his critique with reams of market data and regression analyses to demonstrate how flawed accounting measurements have caused earnings and book value to become nearly meaningless to investors and now create very serious managerial biases and errors in how capital is allocated.
MarcumBP’s Drew Bernstein met with him to understand his views on where the principles of accounting went awry and how the structure of accounting might be reformed.
"If the trade war continues to escalate as Trump has threatened, there's going to be a big impact on the capital markets... I expect that we're going to see a winter in IPOs next year."
Paul, you've gotten to this point where you've become this guru for all issues related to accounting in China. How did that journey come about?
I came to China 21 years ago. I was transferred here by the international accounting firm PriceWaterhouseCoopers. It was Price Waterhouse at the time. I was in China with them for seven years. Then I took early retirement from PwC and I tried playing golf for a while, but got bored with that. So I went back to school. I first studied theology. I enjoyed the academic side of it, so I decided to get a PhD in accounting. I chose, as my topic for my dissertation, the development of the accounting profession in China.
One of the things that I discovered in my research was that there were gaps in the regulation of Chinese companies that were starting to rush to U.S. stock exchanges in the early 2000s. Those gaps in regulation were likely to lead to an environment where there might be a lot of fraud. I predicted it would happen in my doctoral dissertation. About the time I finished it, it all came true. There were over 100 cases of fraud brought against overseas-listed Chinese companies. My work came to the attention of the Public Company Accounting Oversight Board (PCAOB), which asked me to serve on their standing advisory group. And also a lot of hedge funds and other market participants got interested in what I had to say.
My blog, The China Accounting Blog, got quite a bit of attention. After a while, basically, everybody who was following the China stock market was reading what I was writing. That has led to me being, probably, the leading Western expert in Chinese accounting and auditing problems for overseas -listed Chinese companies.
Effective July 10, 2017, the Securities & Exchange Commission ("SEC") began allowing all companies to submit non-public, draft registration statements for initial public offerings ("IPOs"). Why make this significant change? In altering the disclosure requirements, the SEC hopes to reduce organizations’ exposure to market fluctuations while going through the IPO process, rationalize the filing process so that compliance is less burdensome and expensive for small organizations, and further streamline disclosures to make them more meaningful and useful to investors.
The SEC’s new rule is largely an effort to reverse the decline in IPOs, encourage more public offerings, among both U.S. and foreign companies, on U.S. exchanges, and provide investors with access to a wider range of small, successful companies in which to invest. While this ruling may encourage more companies to consider (or reconsider) listing within the U.S. market, for foreign issuers, numerous complexities remain that should be considered.