There appears to be a lack of corporate governance awareness among many of them
By MAK YUEN TEEN 28 October 2008
On October 20, Citic Pacific announced an estimated loss of US$1.9 billion as a result of wrong foreign currency bets that were allegedly made by finance executives without proper authorisation. The stock price promptly fell by more than 55 per cent.
If we look at analysts’ recommendations on Citic Pacific as reported in Reuters.com as of Oct 24, there were two ‘buy’, four ‘outperform’, two ‘hold’, two ‘underperform’, one ‘sell’, and one ‘no opinion’. Such diversity of analysts’ recommendations is extremely common, even for a stock that has just tanked badly.
Of course, some analysts expect things to get better, and hence their ‘buy’, ‘outperform’ and ‘hold’ recommendations. If we go back one month ago, before the losses were revealed, the distribution of recommendations was remarkably similar - three ‘buy’, four ‘outperform’, two ‘hold’, two ‘underperform’, one ‘sell’, and one ‘no opinion’. Going back two months and three months, the distributions of recommendations were also very similar.
In the meantime, over those months, the stock price has fallen from above HK$30 to just over HK$5.
Of course, different analysts will have different views about a stock at any particular time, based on their own research and methodologies. However, an investor must wonder which analyst’s recommendations to follow, given that at any one time, the recommendations will often span the entire range of possibilities. According to Reuters.com, the mean ratings for the analysts for Citic Pacific were consistently just over 2.50, based on a range of one to five over the last three months up to now - which translates into something between a ‘hold’ and an ‘outperform’.
Therefore, the analysts’ recommendations were generally on the positive side, while the stock sank by more than 80 per cent.
Contrast this lack of accountability for analysts’ recommendations with the issue of an opinion by an auditor. If an auditor issues a clean opinion and the company implodes shortly after, fingers will usually be pointed at the auditor. To be fair, an auditor is paid a not insignificant fee to conduct an audit and issue his opinion, so it is reasonable to expect a high quality of work, although the auditor is also heavily reliant on the information provided by management.
It is right that auditors should be held accountable if they are shoddy in their work. It may be useful to also make analysts more accountable for the quality of their recommendations. Perhaps the track record of analysts should be made more transparent to the market.
What is perhaps more disappointing is that in making their recommendations about a company, few analysts seem to consider its corporate governance, which can affect the quality and sustainability of the earnings of the company, or even whether the earnings are real or illusory.
Last year, I was invited to chair a panel discussion on corporate governance at a major conference organised by an investment bank and attended largely by analysts and fund managers. It was a surreal experience.
In our session, we were discussing concerns about corporate governance in Asia and were rather critical. However, the mood of the other sessions was consistently upbeat and corporate governance was hardly mentioned. I felt like I was attending a wake but had accidentally stumbled into a wedding dinner.
Let’s now look more closely at the case of Citic Pacific from a corporate governance perspective. Once we go a little beyond the company’s proclamation in its annual report and website that it upholds high standards of corporate governance - which must now be one of the most widely abused and misleading statements in annual reports and websites of many companies - it is easy to see that the company has poor governance. This is not the benefit of hindsight. One does not even need glasses to see it.
Citic Pacific has a board of 19 directors based on its last published annual report. This may be fine if the board is governing a country. However, it is way too large for governing a company. Of these 19 directors, 12 are executives. The chairman is an executive chairman, so even though the company has a managing director, the chairman is the de facto chairman-cum-CEO. The chairman’s son is also an executive director, and his daughter is a member of the senior management team and holds a finance position. The 12 executive directors included the two finance executives who executed the foreign exchange bets and who have now resigned.
Independent directors
Among the seven non-executive directors, four are independent. The Hong Kong listing rules require at least three independent directors, so the company meets this requirement. The Hong Kong Code of Corporate Governance recommends at least one-third of the board to be made up of independent directors. Citic Pacific does not meet this recommendation, as independent directors make up less than a quarter. Of the four independent directors, two are brothers (although apparently not related to the chairman’s family). It should be fairly evident that the board would not be able to effectively oversee management because the board is essentially management. It is unrealistic to expect internal controls and risk management to be effective in such a company where there is no real check and balance on management.
Let’s now turn to the incentive scheme in the company. There is extensive use of share options. The executive chairman - already a significant shareholder - has 102 unexercised million share options as at Dec 31, 2007. This represents 4.6 per cent of the company’s issued share capital. In total, the 12 executive directors, including the chairman, have share options totalling almost 5.5 per cent of the issued share capital.
The two executive directors who were responsible for the foreign exchange bets had around four million unexercised options and about one million shares. They had significant upside exposure, and more limited downside risk at least on the basis of the share incentives. Of course, they now have plenty of downside as they have lost their jobs. However, prior to this, they would probably have figured that if the currency bets were correct, the stock price could increase significantly and they could benefit substantially. Share options and derivative trading are a dangerous concoction.
Citic Pacific clearly has a low governance and high risk culture. This is like having a bomb factory next to a petrochemical plant - and hoping that nobody smokes. Everything mentioned above can be gleaned easily from the annual report. The red flags are all over the place. Perhaps the analysts who were making the bullish recommendations believed that the poor corporate governance can be sustained indefinitely without the company imploding. More likely, they did not look. And investors who blindly followed recommendations are now paying for it.
Discussions about corporate governance have been going on in this region for at least 10 years. Most directors and senior executives now have some appreciation of corporate governance, although implementation of good corporate governance practices remains patchy.
Throughout this period, it seems that this same awareness has not reached most in the analyst community - at least not when they actually make recommendations about companies. It almost seems they are living in a parallel universe. It may be time for them to come back down to earth.
The writer is co-director of the Corporate Governance and Financial Reporting Centre at the NUS Business School. The views in this article are his own
If you are feeling buffeted by the global financial deep freeze, which is going to get worse before it thaws, consider the fortunes of once "Australia's richest man". Since James Packer took control of the family corporate empire, he made a huge bet on the future of the empire. Like father like son. This is the score:
* The value of Packer's flagship company, Crown Limited, in which the Packer family has a controlling interest, has fallen from $15 a share since it was listed last year to $6.66 (the devil's number).
* Shares in Packer's billion-dollar gambling play in Macau, Melco Crown Entertainment, have gone into free-fall, dropping just over 85 per cent, from $US22 to $US3.18, since their peak 20 months ago.
* In April Packer was offered $4.80 a share, or $3.3 billion, for the media company CMH, by another media heir, Lachlan Murdoch. Packer declined, wanting a higher price. The shares have since plunged 60 per cent, to $1.94, closing on Friday at $2.02. Almost $2 billion in value has evaporated since the bid.
* Shares in the Packer-controlled investment company Challenger Financial Services Group have fallen from $6.58 to $1.785 in the past year, a 73 per cent plunge for a company with a large number of small investors attracted by the Packer name.
* Australia's biggest mortgage fund, Challenger Howard, 20 per cent owned by Packer's CPH, suspended investor redemptions last week, freezing $2.8 billion because it said the Federal Government's pledge to guarantee bank deposits had caused a run on the fund.
* Crown's plans to build the tallest tower in Las Vegas in a multibillion-dollar casino-hotel development have been abandoned, with a $44 million write-off in development costs.
* Seek Limited, the online company in which Packer holds a 27 per cent interest, has had a run on its shares, which have fallen 40 per cent since September from $5.60 to $3.65.
Packer's net worth is now less than half what it was a year ago. His self-worth might be similar.
It could be worse. Macquarie Bank, known as "the millionaires factory" for the exorbitant rewards its executives paid themselves, was savaged for years by scathing assessments by analysts aghast at the size and secrecy of its fee structure. Now the bill has come due, paid for by its shareholders. Macquarie Group's share price has plunged 71 per cent from a peak of $98.50 last year, to $28.75 on Friday.
Even more blood has been shed at its reckless imitator, Babcock & Brown, whose market value has been destroyed since it peaked last year at $33.90. It closed at $1.40 on Friday, having lost 96 per cent of its market value and 100 per cent of its reputation.
How many little people have the big boys taken down with them? It was so easy to turn comfort into excess. At the height of the good times, the Howard-Costello government made the generous offer of allowing people to put as much as $1 million into their superannuation by June 30 last year, thus avoiding lump-sum taxes before the super rules were changed.
I was advised by a very wealthy friend to borrow the full $1 million and put it into super. The cost of servicing the debt, he said, would be covered by tax-free dividend payments, and the rising value of the super would be free money. He made it sound so simple, and inevitable, perhaps because he had done so well for so long by borrowing to the hilt.
That was 18 months ago. Since then his company has collapsed. He has sold his waterfront mansion. He has left the country, with no plans to return for the foreseeable future. I did not take his advice. I borrowed nothing. Rather than leverage up, I de-leveraged down. I have no debt, no mortgage, not even a car. What I wanted was the ultimate luxury good, something invisible but palpable - peace of mind.
Peace of mind only goes so far when you are watching the unravelling of the greatest run of gambling and speculation in human history. Like James Packer's towering ambition in Las Vegas, this gigantic global casino, in which investors bet on property, companies, commodities, currencies and derivatives, all the time, all over the world, is in the process of being wound back (perhaps to be replaced with a state-run bingo hall).
In September we were agog at giant financial houses falling like dominos. That is old news. Now it's economies, not companies, that are freezing up. The entire euro zone, the currency union of 15 advanced economies, is about to go into recession. So is the US, and Japan, our biggest export market, and Korea.
At the International Monetary Fund, countries are lining up for rescue packages, including Austria, Hungary, Ukraine, Belarus, Kazakhstan, Serbia and Pakistan. In Argentina, the Government is raiding the pension funds to find cash. The fall of the Aussie dollar has been accompanied by even more violent raids on every currency propped up by excessive foreign debt, with the conspicuous exception of the US dollar. What was supposed to stabilise the world was the "BRIC", the boom economies of Brazil, Russia, India and China, but the boom is over in Brazil, Russia is in serious trouble, India's rupee has plunged and China has gone into stress.
Amid all this, the Rudd Government, which overreacted when it committed to splurge half the budget surplus on a $10 billion stimulation package, has lowered its growth forecast for 2009 from 4 per cent to 2 per cent. That already looks optimistic. The big freeze could send growth down to zero.
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The Irrational Exuberance of Analysts
There appears to be a lack of corporate governance awareness among many of them
By MAK YUEN TEEN
28 October 2008
On October 20, Citic Pacific announced an estimated loss of US$1.9 billion as a result of wrong foreign currency bets that were allegedly made by finance executives without proper authorisation. The stock price promptly fell by more than 55 per cent.
If we look at analysts’ recommendations on Citic Pacific as reported in Reuters.com as of Oct 24, there were two ‘buy’, four ‘outperform’, two ‘hold’, two ‘underperform’, one ‘sell’, and one ‘no opinion’. Such diversity of analysts’ recommendations is extremely common, even for a stock that has just tanked badly.
Of course, some analysts expect things to get better, and hence their ‘buy’, ‘outperform’ and ‘hold’ recommendations. If we go back one month ago, before the losses were revealed, the distribution of recommendations was remarkably similar - three ‘buy’, four ‘outperform’, two ‘hold’, two ‘underperform’, one ‘sell’, and one ‘no opinion’. Going back two months and three months, the distributions of recommendations were also very similar.
In the meantime, over those months, the stock price has fallen from above HK$30 to just over HK$5.
Of course, different analysts will have different views about a stock at any particular time, based on their own research and methodologies. However, an investor must wonder which analyst’s recommendations to follow, given that at any one time, the recommendations will often span the entire range of possibilities. According to Reuters.com, the mean ratings for the analysts for Citic Pacific were consistently just over 2.50, based on a range of one to five over the last three months up to now - which translates into something between a ‘hold’ and an ‘outperform’.
Therefore, the analysts’ recommendations were generally on the positive side, while the stock sank by more than 80 per cent.
Contrast this lack of accountability for analysts’ recommendations with the issue of an opinion by an auditor. If an auditor issues a clean opinion and the company implodes shortly after, fingers will usually be pointed at the auditor. To be fair, an auditor is paid a not insignificant fee to conduct an audit and issue his opinion, so it is reasonable to expect a high quality of work, although the auditor is also heavily reliant on the information provided by management.
It is right that auditors should be held accountable if they are shoddy in their work. It may be useful to also make analysts more accountable for the quality of their recommendations. Perhaps the track record of analysts should be made more transparent to the market.
What is perhaps more disappointing is that in making their recommendations about a company, few analysts seem to consider its corporate governance, which can affect the quality and sustainability of the earnings of the company, or even whether the earnings are real or illusory.
Last year, I was invited to chair a panel discussion on corporate governance at a major conference organised by an investment bank and attended largely by analysts and fund managers. It was a surreal experience.
In our session, we were discussing concerns about corporate governance in Asia and were rather critical. However, the mood of the other sessions was consistently upbeat and corporate governance was hardly mentioned. I felt like I was attending a wake but had accidentally stumbled into a wedding dinner.
Let’s now look more closely at the case of Citic Pacific from a corporate governance perspective. Once we go a little beyond the company’s proclamation in its annual report and website that it upholds high standards of corporate governance - which must now be one of the most widely abused and misleading statements in annual reports and websites of many companies - it is easy to see that the company has poor governance. This is not the benefit of hindsight. One does not even need glasses to see it.
Citic Pacific has a board of 19 directors based on its last published annual report. This may be fine if the board is governing a country. However, it is way too large for governing a company. Of these 19 directors, 12 are executives. The chairman is an executive chairman, so even though the company has a managing director, the chairman is the de facto chairman-cum-CEO. The chairman’s son is also an executive director, and his daughter is a member of the senior management team and holds a finance position. The 12 executive directors included the two finance executives who executed the foreign exchange bets and who have now resigned.
Independent directors
Among the seven non-executive directors, four are independent. The Hong Kong listing rules require at least three independent directors, so the company meets this requirement. The Hong Kong Code of Corporate Governance recommends at least one-third of the board to be made up of independent directors. Citic Pacific does not meet this recommendation, as independent directors make up less than a quarter. Of the four independent directors, two are brothers (although apparently not related to the chairman’s family). It should be fairly evident that the board would not be able to effectively oversee management because the board is essentially management. It is unrealistic to expect internal controls and risk management to be effective in such a company where there is no real check and balance on management.
Let’s now turn to the incentive scheme in the company. There is extensive use of share options. The executive chairman - already a significant shareholder - has 102 unexercised million share options as at Dec 31, 2007. This represents 4.6 per cent of the company’s issued share capital. In total, the 12 executive directors, including the chairman, have share options totalling almost 5.5 per cent of the issued share capital.
The two executive directors who were responsible for the foreign exchange bets had around four million unexercised options and about one million shares. They had significant upside exposure, and more limited downside risk at least on the basis of the share incentives. Of course, they now have plenty of downside as they have lost their jobs. However, prior to this, they would probably have figured that if the currency bets were correct, the stock price could increase significantly and they could benefit substantially. Share options and derivative trading are a dangerous concoction.
Citic Pacific clearly has a low governance and high risk culture. This is like having a bomb factory next to a petrochemical plant - and hoping that nobody smokes. Everything mentioned above can be gleaned easily from the annual report. The red flags are all over the place. Perhaps the analysts who were making the bullish recommendations believed that the poor corporate governance can be sustained indefinitely without the company imploding. More likely, they did not look. And investors who blindly followed recommendations are now paying for it.
Discussions about corporate governance have been going on in this region for at least 10 years. Most directors and senior executives now have some appreciation of corporate governance, although implementation of good corporate governance practices remains patchy.
Throughout this period, it seems that this same awareness has not reached most in the analyst community - at least not when they actually make recommendations about companies. It almost seems they are living in a parallel universe. It may be time for them to come back down to earth.
The writer is co-director of the Corporate Governance and Financial Reporting Centre at the NUS Business School. The views in this article are his own
The Packer share meltdown
Paul Sheehan
October 27, 2008
If you are feeling buffeted by the global financial deep freeze, which is going to get worse before it thaws, consider the fortunes of once "Australia's richest man". Since James Packer took control of the family corporate empire, he made a huge bet on the future of the empire. Like father like son. This is the score:
* The value of Packer's flagship company, Crown Limited, in which the Packer family has a controlling interest, has fallen from $15 a share since it was listed last year to $6.66 (the devil's number).
* Shares in Packer's billion-dollar gambling play in Macau, Melco Crown Entertainment, have gone into free-fall, dropping just over 85 per cent, from $US22 to $US3.18, since their peak 20 months ago.
* In April Packer was offered $4.80 a share, or $3.3 billion, for the media company CMH, by another media heir, Lachlan Murdoch. Packer declined, wanting a higher price. The shares have since plunged 60 per cent, to $1.94, closing on Friday at $2.02. Almost $2 billion in value has evaporated since the bid.
* Shares in the Packer-controlled investment company Challenger Financial Services Group have fallen from $6.58 to $1.785 in the past year, a 73 per cent plunge for a company with a large number of small investors attracted by the Packer name.
* Australia's biggest mortgage fund, Challenger Howard, 20 per cent owned by Packer's CPH, suspended investor redemptions last week, freezing $2.8 billion because it said the Federal Government's pledge to guarantee bank deposits had caused a run on the fund.
* Crown's plans to build the tallest tower in Las Vegas in a multibillion-dollar casino-hotel development have been abandoned, with a $44 million write-off in development costs.
* Seek Limited, the online company in which Packer holds a 27 per cent interest, has had a run on its shares, which have fallen 40 per cent since September from $5.60 to $3.65.
Packer's net worth is now less than half what it was a year ago. His self-worth might be similar.
It could be worse. Macquarie Bank, known as "the millionaires factory" for the exorbitant rewards its executives paid themselves, was savaged for years by scathing assessments by analysts aghast at the size and secrecy of its fee structure. Now the bill has come due, paid for by its shareholders. Macquarie Group's share price has plunged 71 per cent from a peak of $98.50 last year, to $28.75 on Friday.
Even more blood has been shed at its reckless imitator, Babcock & Brown, whose market value has been destroyed since it peaked last year at $33.90. It closed at $1.40 on Friday, having lost 96 per cent of its market value and 100 per cent of its reputation.
How many little people have the big boys taken down with them? It was so easy to turn comfort into excess. At the height of the good times, the Howard-Costello government made the generous offer of allowing people to put as much as $1 million into their superannuation by June 30 last year, thus avoiding lump-sum taxes before the super rules were changed.
I was advised by a very wealthy friend to borrow the full $1 million and put it into super. The cost of servicing the debt, he said, would be covered by tax-free dividend payments, and the rising value of the super would be free money. He made it sound so simple, and inevitable, perhaps because he had done so well for so long by borrowing to the hilt.
That was 18 months ago. Since then his company has collapsed. He has sold his waterfront mansion. He has left the country, with no plans to return for the foreseeable future. I did not take his advice. I borrowed nothing. Rather than leverage up, I de-leveraged down. I have no debt, no mortgage, not even a car. What I wanted was the ultimate luxury good, something invisible but palpable - peace of mind.
Peace of mind only goes so far when you are watching the unravelling of the greatest run of gambling and speculation in human history. Like James Packer's towering ambition in Las Vegas, this gigantic global casino, in which investors bet on property, companies, commodities, currencies and derivatives, all the time, all over the world, is in the process of being wound back (perhaps to be replaced with a state-run bingo hall).
In September we were agog at giant financial houses falling like dominos. That is old news. Now it's economies, not companies, that are freezing up. The entire euro zone, the currency union of 15 advanced economies, is about to go into recession. So is the US, and Japan, our biggest export market, and Korea.
At the International Monetary Fund, countries are lining up for rescue packages, including Austria, Hungary, Ukraine, Belarus, Kazakhstan, Serbia and Pakistan. In Argentina, the Government is raiding the pension funds to find cash. The fall of the Aussie dollar has been accompanied by even more violent raids on every currency propped up by excessive foreign debt, with the conspicuous exception of the US dollar. What was supposed to stabilise the world was the "BRIC", the boom economies of Brazil, Russia, India and China, but the boom is over in Brazil, Russia is in serious trouble, India's rupee has plunged and China has gone into stress.
Amid all this, the Rudd Government, which overreacted when it committed to splurge half the budget surplus on a $10 billion stimulation package, has lowered its growth forecast for 2009 from 4 per cent to 2 per cent. That already looks optimistic. The big freeze could send growth down to zero.
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