61 | P a g e Even though the use of stock options is becoming greater, not all Chinese employees will necessarily be familiar with them. Furthermore, even if they are familiar with them, they still may not necessarily be interested as the compensation is delayed. The year-end bonus has traditionally been the way of rewarding employees (Chiu et al., 2002), and thus Chinese employees may prefer shorter vesting periods.
The use of stock options however is continuing to gain ground overall. Depending on the employee, stock options can be a useful method – among others – to encourage employee performance and improve retention (Gross and Minot, 2008). Evidence suggests that stock options are now being received more favourably amongst Chinese employees. (Xiu and Ming, 2008) have found that especially amongst overseas listed SOE’s, barriers to exercising stock options have been overcome and some senior managers have received substantial rewards and have been cashing in on them. One major mainland Chinese company that has implemented options is CITIC Securities43
It is clear that the Chinese authorities recognise the importance of executive compensation as an incentive mechanism and consider it an important element of enterprise reform. Conyon and He (2008) have found CEO equity incentives in China to be positively correlated with firm size and risk profile. These findings imply that China’s corporate governance regulations have succeeded to some extent in aligning managerial interests with those of shareholders.
(Gross and Minot, 2008). The Chinese government has also initiated a new plan which allows (with prior approval of the government) for foreign exchange purchases for the purpose of stock options in foreign companies. Procter & Gamble China was the first to participate in this new program in February 2008 (Gross and Minot, 2008).
62 | P a g e necessary for these reports to be made available on the internet. In addition to the mandatory information disclosure requirements, companies are also encouraged to disclose other information in a timely manner. This includes details of management and supervisory board members compensation packages, executive performance assessments, executive compensation and the holding of the controlling shareholder. It is also a CSRC requirement that a company seeking listing must have three years of financial statements prepared prior to being listed.
In an effort to improve the information disclosure level of listed companies, the CSRC released
“Regulations on Information Disclosure of Listed Companies” in February 2007. The new regulation specifically addressed the required disclosed content, disclosure procedures, responsible persons on disclosure, and the punishments on the violation of disclosure rules.
Furthermore, the new regulation not only applies to the listed company and its directors, supervisors and management, but also other stakeholders such as the controlling shareholder, potential buyer of the companies, investment advisory companies and the media, who may play a role in the listed company’s information disclosure process. In order to ensure true and complete disclosure, the 2007 regulation has specified that the Chairman, CEO and board secretary together are responsible for the authenticity accuracy completeness, immediacy and fairness of the disclosed information. The new regulation also introduces a ‘fair disclosure’ principle, meaning that the listed company cannot selectively disclose information to particular investors or the media. In relation to ownership disclosure in particular, the new regulation also attempts to disentangle the complex pyramidal ownership structures of Chinese listed companies by requiring that the controlling structure must be made available in a diagram which clearly identifies the controlling shareholder or shareholder group.
The Chinese government has also released a series of disclosure standards and ordinances aimed at improving the quality of accounting practices. The Finance Ministry has for example issued 38 new Basic Accounting Standards for Business Enterprises (ASBE) which is applicable to all listed companies from February 200644
44 See details in:
. The new ASBE standards are designed to improve the quality of financial information, to be in line with International Financial Reporting Standards (IFRS). Furthermore, the Finance Ministry has also issued 48 new Auditing Standards for
63 | P a g e Certified Public Accountants (CPAs). These in turn are expected to bring China’s audit rules more in line with International standards, and improve the overall quality of domestic CPA’s.
Investors are willing to pay a premium for companies with sound governance, and full and timely information disclosure is the best way of ensuring investors that this is the case.
Information disclosure in China’s capital markets is however still in relatively short supply to both investors and analysts. As a result, markets are not well-appointed to monitor auditing and accounting professionals, or the disclosure practices of listed companies. The CFA survey shows the information disclosure practices of Chinese listed companies to be incomplete. More information relating to business segments and cash flows should be disclosed in the company’s financial reports. The survey also finds companies disclosure practices are more geared towards meeting the requirements of the authorities, rather than the needs of private investors.
Consequently, this may increase the risk of the falsification of financial information.
Figure 4.3 Information disclosure: changes for the three years prior to 2007
Source: CFA Institution Centre survey (2007)
Figure 4.3 shows the development of information disclosure practices in China over the three year period. Unsurprisingly, it is the completeness of information disclosed that received the lowest rating. This indicates only a slight improvement over the three year period. Although the CSRC has issued new regulations and standards pertaining to information disclosure, these ratings are relatively low and suggest there remains much room for improvement.
64 | P a g e The multiple standards that are currently in use for the preparation and auditing of financial statements in China also affect the quality of disclosure. Some listed companies follow the International Accounting Standards (IAS), some the American General Accepted Accounting Principles (GAAP), and yet others follow domestic standards such as ASBE or industry-specific rules (Tenev et al., 2002). It is even the case that some parent companies follow ASBE principles, whilst their subsidiaries use industry-specific accounting systems. The same problem also exists regarding auditing standards. As a result of using multiple accounting and auditing standards, it is often difficult for investors and analysts to compare financial information between companies.
China has worked to improve both the standards of Accounting education and the number of students that study accountancy, however despite this the country is still presently lacking a large number of qualified accounting professionals45
Market competition within the accounting industry in China is also fierce. There are approximately 5000 accounting firms competing to service around 1500 listed companies in China
, with most domestic accountants working without formal education or training. Many Chinese accountants therefore lack knowledge of International accounting standards and practices. In relation to the large International accounting firms, the quality of China’s Certified Public Accountants (CPA’s) is much lower, especially amongst the smaller firms. Chinese CPA’s are well below International standards in areas such as management, qualifications of personnel and services offered. Furthermore, they have no proper process to perform risk assessments, and rarely carry out any internal control assessments as part of their audit work.
46
45 Info from:
. Intense competition as a market characteristic does not encourage firms to improve on professional quality. Many firms instead compete on price in order to increase their market share, instigating a ‘race to the bottom’ in terms of audit quality. CPA’s have been known to collaborate with listed companies in producing financial statements, and there have been many cases of fraud in China involving the questionable practices of CPA’s (Lin, 2004). As with many other industries in China, the accounting industry has not been fully opened up to international competition, however the government does encourage cooperation between foreign and domestic
46 Data from:
65 | P a g e accounting firms. Many Chinese listed companies hire international firms as their external auditor, in spite of their charges being far in excess of domestic Chinese firms. These are primarily overseas listed companies where the presence of a reputable auditing firm is essential in order to raise capital internationally.