“So Mr Chairman, just how many passports do you have?” A question such as this may not seem the typical opening line when shareholders sit down with management, but in China such inquiries are increasingly common.
Holding a second country passport is barred by Chinese law but can prove handy for executives should they one day need to skip beyond the long arm of Beijing.
China’s anti-corruption drive has felled hundreds of government officials and as it has evolved has moved beyond the corridors of power and deeper into the boardroom. Investors are taking note.
“If there’s one thing you don’t want as a portfolio manager, it’s to wake up and see one of your companies’ chairmen on the front pages,” says Francois Perrin, chief investment officer for greater China at BNP Paribas Investment Partners.
The most recent example of a business hobbled by an anti-corruption investigation was Kaisa, the Hong Kong-listed developer. As a result of an inquiry into a local official, Kaisa has been the subject of a sales ban in its home market of Shenzhen.
Events have since moved quickly, with the company ultimately seeking a white knight rescue and a restructuring of billions of dollars of debt.
Other listed companies have been forced to explain why a member of senior management is no longer taking investors’ calls. The chairman of Agile, a developer, was detained temporarily last year as part of a corruption inquiry; the chief financial officer of China Southern airline resigned last month for a “ job-related crime”; and the president of Minsheng Bank has become one of the first financial sector executives to be investigated.
“It’s very difficult for investors to know who is next,” says one Asia-based investment banker. “It’s a bit opaque as to how certain companies have come into the spotlight.”
China is not considered the worst offender when it comes to corruption in emerging markets. Last year it ranked 100 out of 175 countries in Transparency International’s corruption perceptions survey, putting it above countries such as Argentina, Indonesia and Albania.
But Beijing’s drive to tackle official corruption has changed the way investors view the potential risks associated with graft.
In most cases, the company in question or its executives have had ties to specific individuals in government who have been removed as part of the anti-graft purge.
In Minsheng’s case, the link appears to be to Ling Jihua, a former aide to Hu Jintao, China’s president until 2013, while Kaisa had business ties to the family of Zhou Yongkang, the former security chief.
The ousting of Mr Zhou, the most senior figure indicted for corruption in China since the founding of the Communist government in 1949, also led to a sweeping examination last year of state-backed oil companies.
For investors, the campaign poses two important questions: can you insulate yourself from the risks, and do such investigations really matter to the underlying business?
Mr Perrin believes investors are far from powerless when it comes to gauging the dangers posed by corruption investigations.
“There is nothing surprising once you try to have a high-level, big-picture view,” he says. “It may not get you to the individual company names but it gives you a framework to analyse the dynamics of a sector.”
Perhaps more pertinent is whether it really matters. Aside from Kaisa, corruption inquiries have rarely had a lasting impact on the share price of listed companies or on their operations.
According to Bernstein Research, the potential for lapses in corporate governance is baked into the valuations given to Chinese stocks. Hong Kong-listed Chinese companies trade at an average of 8.4 times forward earnings compared with 12.4 times for MSCI’s Asia ex-Japan index.
“Instead of punishing companies when instances of corruption or other corporate malfeasance are revealed, the market appears to punish Chinese-domiciled stocks beforehand,” says Michael Parker, strategist at Bernstein Research, in a report. “The stocks don’t sell off so much as trade at a permanent discount.”
While in western markets serious corporate governance failures tend to snowball as shareholders, customers and suppliers cut their ties, in China the offending individuals are simply removed and replaced.
As a result, reckons Mr Parker, investors are more likely to suffer losses from accounting fraud in the US than they are from corruption investigations in China.
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