Accusations of accounting fraud and profit warnings have led to sharp falls in Chinese companies' stock prices and dampened foreign investors' enthusiasm for the overseas IPOs of Chinese companies.
US short seller Citron Research accused 21 Chinese companies of fraud between January 2006 and September 20 of this year, which led the shares of some of these companies to drop by more than 80 percent. Short sellers such as Citron sell shares with the hope of buying them back at a lower price. Some Chinese analysts say that US short sellers have targeted Chinese companies because US auditors cannot properly monitor Chinese companies' operations in China and, therefore, the Chinese companies cannot prove the veracity of their domestic finances or accounting practices.
Under Chinese law, it is illegal to remove audit papers from China and Chinese authorities do not allow foreign auditors or regulators to conductinspections of Chinese compan i e s domestically. US-based auditors, the US Public Company Accounting Oversight Board and the US Securities and Exchange Commission have all sought to investigate some US-listed Chinese companies to allay investors' concerns about these companies' accounting practices, but Chinese authorities have stymied these efforts.
Auditors and regulators inability to independently verify Chinese companies' domestic accounting to the satisfaction of investors has led to a fall in the stock prices of these companies. According to data from Bloomberg, the stock prices of 53 Chinese companies that completed IPOs in the US between January 2010 and April of this year were down by an average of 38 percent on April 30 compared to their offer prices on listing. In contrast, other USlisted companies that had IPOs within the same period had gained an average of 9.9 percent by April 30.
Hong Kong listed Chinese companies are faring slightly better, although they too are seeing decreases in their stock prices. The 110 Chinese companies that listed in Hong Kong between January 2010 and April of this year had their stock prices fall by an average of 15.8 percent from the initial offer prices from the time of their listing until April 30. In contrast, non-Chinese companies that had IPOs in Hong Kong between January 2010 and April of this year had gained 6.5 percent between the time of their listing and the end of April.
Domestic Companies Reconsidering Overseas IPOs
Listing overseas may not be the best method to satisfy Chinese firms desire to find growth opportunities abroad or expand their foreign sales. Research by Luo et. al. published by the Journal of Multinational Financial Management in July shows that Chinese firms listed in the US generally underperform the US benchmark stock indices and their industry peers in the long run. In addition, the research shows that Chinese companies that list in the US generally experience significant drops in operating performance after their IPOs. Furthermore, US-listed Chinese firms do not seem to enjoy better net income growth or greater returns in capital expenditure compared to their domestically-listed peers.
Many Chinese entrepreneurs are recognizing the pitfalls of listing abroad in the current environment and are choosing to shelve or delay their IPOs. As a result, the pace of overseas IPOs by Chinese companies has slowed down significantly in 2012. A total of 24 Chinese companies went public in overseas markets between January and June 2012. In contrast, 40 companies listed abroad between January and June 2011. Financing for Chinese companies that choose to list abroad has also fallen sharply as foreign investors have become more wary of domestic firms. The total amount of money that Chinese companies raised from listing abroad in the first half of this year was $2.98 billion, much lower than the $8.53 billion that domestic firms raised from overseas IPOs during the first half of 2011.
Of the 24 companies that listed abroad during the first half of this year, 19 companies listed on the Hong Kong Stock Exchange's Main Board, raising $2.88 billion or 96.4 percent of the total financing amount raised by Chinese companies that listed overseas in the first half of this year; three companies listed on the Frankfurt Stock Exchange, raising $10.41 million; one listed on the New York Stock Exchange, raising $71.53 million; and another listed on the Hong Kong Stock Exchange's Growth Enterprise Market, raising $25.77 million.
Incomparison,among the 40 companies that listed abroad during the first half of 2011, 22 companies listed on the Hong Kong Stock Exchange's Main Board, raising $6.34 billion or 74.2 deals between January 2011 and August of this year.
Chinese authorities are supporting domestic companies' delisting from US stock exchanges. Zhou Qinye, deputy general manager of the Shanghai Stock exchanges, said overseas investors are short-selling Chinese companies for profit and US regulators have politicized company accounting issues when only a few Chinese companies have serious accounting issues.
"We know that many overseas-listed Chinese companies are not bad. So we welcome those China stocks to return home," Zhou said.
Hope Remains for Successful Overseas IPOs as Regulation Tightens
There may still be hope for companies that want to list abroad, however. A group of Chinese entrepreneurs, including, Lee Kai-Fu, a former senior Google executive, have launched a website, www. citronfraud.com, which aims to expose short sellers or analysts who publish false accusations against US-listed Chinese companies for financial gain. The efforts of Lee and the group of entrepreneurs he works with may reduce the incidence of legitimate US-listed companies being brought down by unverified claims of accounting malpractice. This would make investors more receptive to Chinese companies, ultimately leading to more Chinese companies being able to list on US stock exchanges.
In another move expected to allay investors' suspicions of accounting fraud by US-listed Chinese companies, the US Public Company Accounting Oversight Board announced September 21 that it had reached a tentative accord with Chinese authorities that would allow American accounting inspectors to observe audit activities in China. Lewis Ferguson, a board member of the Public Company Accounting Oversight Board, said the plan to allow U.S. observers in China would be a "trust-buildingexercise" that could lead to more regulatory cooperation.
Ferguson added that the Public Company Accounting Oversight Board had been trying to gain access to China to address the accounting scandals plaguing US-listed Chinese companies. The board efforts were spurred by Americans loss of billions of dollars invested in China-based companies listed on U.S. exchanges after questions were raised about the companies' accounts. Allowing US auditors in China should do much to ally concerns about US-listed Chinese companies' accounting practices, making it easier for Chinese companies to gain financing by listing on US exchanges.
As such, local entrepreneurs who want to list abroad still have some hope, but they should be careful to prevent accounting and legal problems from developing in the first place.
Scott Cutler, executive vice president o fNYSE Euronext ,said that the significant decline of Chinese IPOs has a lot to do with a general lack of trust and confidence in financial markets and a lack of confidence in the companies' own financial statements.
"Unfortunately, the mistakes or fraud by a very few number of companies has impacted the perceptions that the investors have on all companies from China."
Cutler, who is also a co-head of US Listings and Cash Execution at NYSE Euronext, said the only way that the companies will be able to restore that trust and confidence is by being more transparent and more communicative with investors and regulators.
Improve Accounting, Disclosure, and Corporate Management Before IPOs
Preparation for IPOs may span several months based on the structure of the company and the time needed to make the company compliant with the regulations of the exchange on which it will list. In preparing to list overseas, Chinese companies should pay particular attention to regulating their accounting systems, improving their corporate management structures and improving their information disclosure systems. These practices should be established well before the company plans to list. Improving corporate management structures through making the actual controller of the company accountable to the directors of the company is a first step that domestic companies have to take before listing. Many domestic companies have a structure in which the actual controller of the company has limitless power and the board of directors or board of supervisors has little or no influence on the actual controller. Such a system, in which decisions are made by the actual controller without input from supervisors or directors, can lead to situations in which shareholders' interests are not adequately representedafter the company lists. Assuch , companies that are preparing to list should strengthen and empower the board of directors and improve the quality of directors and the ratio of independent directors.
As investors have the right to timely and thorough knowledge about all aspects of a publicly-traded company, companies that plan to list abroad should ensure that information is provided in an accurate, complete and timely manner.
Familiarize with Listing Laws, Regulations, and Requirements
Companies planning to list abroad should make themselves familiar with the domestic and overseas laws, regulations and requirements governing IPOs.
Chinese companies can only issue shares (domestically and abroad) only after they receive the approval of the China Securities Regulatory Commission. According to the Securities Law of the People's Republic of China, a company can only embark on an initial public offering abroad if it has "complete and welloperated organization," has "the capability of making profits continuously," and has "no false record in its financial statements over the lasts 3 years." The CSRC can also impose other requirements as it sees fit. In addition, the State Council has a set of regulations governing listing and issuing shares abroad.
Choosing where to list depends on a number of factors. Entrepreneurs should not only consider costs and regulations, but should also consider how listing in a particular location will help them achieve their corporate goals, what access they have to investors in the location they plan to list and the perceptions investors in those locations have towards their companies or industries.
Comparatively, the US imposes fewer pre-listing requirements on companies that plan to list in the US. The US securities' regulator, the Securities Exchange Commission, has no formal listing requirements. Different US exchanges have their own requirements. For example, non-US companies listingon the New York Stock Exchange are required to have at least 5,000 shareholders worldwide, 2.5 million publicly held shares worldwide and at least a $100 million market capitalization.
The financial requirements of the New York Stock Exchange mean that only relatively large companies can list on the New York Stock Exchange. The Nasdaq Stock Exchange listing standards, on the other hand, allow slightly smaller companies to list. The Nasdaq has four sets of standards among which companies that plan to list may choose to meet. One standard requires market capitalization of at least $160 million, total assets of $80 million and stockholders' equity of at least $55 million before companies may list, among other requirements.
The listing requirements of the Hong Kong Stock Exchange's Main Board are more formidable than listing on the New York Stock Exchange or the Nasdaq. The Hong Kong Stock Exchange requires Main Board applicants to choose among three sets of listing criteria. One set requires applications to have market capitalization of at least HK4 billion ($516 million) and at least HK$500 million in revenue for the most recent audited financial year. On the other hand, listing on the Hong Kong Stock Exchange's Growth EnterpriseMarket, which provide nascent companies with the opportunity to raise capital, has lower financial requirements. Growth Enterprise Market applications must have a market capitalization of at least HK$100 million ($12.9 million) and a positive cash-flow totaling at least HK$20 million ($2.6 million) for the two financial years immediately preceding the application for listing.
Germany has also emerged as a popular destination for Chinese companies that want an efficient and fast IPO process, with lower minimum financial requirements compared to listing in Hong Kong or the US. The vetting and approval process of listing on the Frankfurt Stock Exchange can be completed in as little as 20 days. Chinese companies are also choosing to list on the Frankfurt Stock Exchange because the high transparency and corporate governance requirements in Germany underline these companies' credentials and help with brand building in China. Requirements for listing in the Prime Standard Segment of the Frankfurt Stock Exchange include a minimum market capitalization of
