For years I have been pointing out the problems with information in emerging markets. Much of the information especially about securities is simply false. This is not because the managers of companies in emerging markets are any less venal than their counter parts in the developed world. Certainly in the US we have recently seen our share of fraudulent financiers. The difference is a question of a law.
In law and economics there is a function as to the probability of a law being obeyed. The function is the probability of getting caught versus the severity of the punishment. For example, in many states in the US the penalty for murder is death which should be a good deterrent. It isn’t because less than 50% of the murderers are ever caught.
The same is true with information provided by companies. Information has value and is only disclosed for consideration or if required by an enforced law. In the US we have strict laws that are supposed to require disclosure. Still, many companies either fail to disclose or do not give timely, accurate or completed disclosures.
The situation is much worse in emerging markets because the legal disincentive is much weaker. Last week we had an excellent example. According to Asia Times, the Chairman of CNOOC (CEO), Fu Chengyu, the Hong Kong and New York listed unit of China’s biggest offshore oil producer, China National Offshore Oil Corp, admitted that information provided in the company’s annual report was not correct. According to the annual report for 2008, Fu earned 12.047 million yuan (US$1.77 million). On April 13 a spokesman for the China National Offshore Oil Corp. said that the compensation for Fu including an incentive scheme was only a show designed to give Western investors the idea that CNOOC had adopted measures that were similar to other multinational oil companies. On April 19th, at the Boao Forum for Asia annual conference, Fu confirmed that his salary was set by State-owned Assets Supervision and Administration Commission of the State Council and that his pay listed in the report was inaccurate.
So far, to the best of my knowledge, there has not been any reaction from the regulators. Although this appears to be a violation of Rule 10b-5 as a failure to disclose a material fact, the SEC at this time has taken no action. Neither have either Chinese watchdogs, the Hong Kong SFC or China’s CSRC.
Many people might not feel that failure to disclose information about compensation is important. In fact, some investors might rightfully point out that Fu was most likely getting paid less than his western counterparts, so the shareholders actually benefitted. Still, it leads one to wonder that if a Chinese state owned company made a show of their compensation package just to please western investors, what other parts of their annual report might just be there to please western investors?
It is also not just China. With inadequate or economically inefficient legal infrastructures, emerging markets are replete with organizations typical of relationship based systems. Many of these firms are either state owned or family owned. State owned companies are managed ultimately by politicians, who manage for political reasons, not for profit. If those reasons require the suppression of information, it is suppressed.
Although majority family owned companies are managed for profit, the agent managers are obviously going to be more responsive to the needs of the majority owners. Where there are insufficient protections of minority shareholders, which is in most of the world, there will be insufficient legal disincentive for full, complete and timely disclosure. What does eventually appear may not accurately reflect reality.
For those investors who believe that audited financial statements are adequate protection, let me point out that CNOOC is listed in New York, and so should be subject to audited statements as required both by US federal law and the rules of the exchange.
This web site is often filled with charts and numbers about companies all over the world. There are also economic projections and forecasts. The hope is that these numbers will bear some relationship to reality and help investors control their risk. But before investors put too much faith in any numbers they should ask themselves whether the economic incentives to refrain from providing complete, accurate and timely information exceed the legal disincentives from doing so.
