China’s Surprising Insider Tip

When it comes to China, it is hard to understand a company’s business in depth without having a personal connection to the managers and owners. That is a statement that applies to almost every emerging market, and that investors generally accept as the price of operating in less transparent and rule-based environments.

Such a self-evident proposition may hardly seem worthy of academic proof, though a group of researchers has now sought to quantify it. More surprisingly, they conclude that such selective and limited dissemination of information can actually be good for companies and the market.

In the latest research by T.J. Wong, Choh-Ming Li Professor of Accountancy and Director of Centre for Institutions and Governance at The Chinese University of Hong Kong Business School and his collaborators, it states that “emerging markets firms face a tradeoff where greater transparency may lead to a lower cost of capital, but at the cost of revealing proprietary information in their relational business practices.” Companies could get cheaper capital if they told everyone how they got the contract to build that stadium, but if they did so they might be shut out from future deals. Instead, they tell a few trusted analysts, who pass it on to their circle of investors, and the information gradually makes its way through the market.

Prof. Wong shares in an interview with Bloomberg Gadfly’s Singapore-based markets columnist Christopher Langner that ideally everyone should get the information at the same time, something that even regulators in the United States struggle to enforce. Such a goal may be impractical in environments such as China, where the legal and regulatory environments are more opaque and where personal connections, or guanxi, consequently play a bigger part in greasing the wheels of commerce.

Prof. Wong explains that if you’re investing in one of these companies you want to know whether they have the guanxi to get their plans and projects rubberstamped. The company can hardly include a note in its annual report stating that “in the course of the past year we acquired an important connection with a senior regulator who will ensure our projects continue to get approved.”

Selective disclosure to trusted analysts allows the information to be disseminated, in coded form, through published reports without jeopardizing the company or its connections. Examining data on 2,460 firms and 6,099 analysts from 2005 to 2014, Prof. Wong and his coauthors found that when a firm is followed by more “connected” analysts, the consensus forecast of all analysts becomes more accurate.

Fiercer enforcement of insider dealing is unlikely to be effective, because the problem isn’t who gets the information so much as what Prof. Wong calls “relationship-based contracting,” a cultural tradition that runs much deeper than stock market norms. Until companies stop needing connections to do business in these countries, investors will continue to need those relationships to get the full picture. Those who don’t like it may just have to stay away… Read More (PDF)

CUHK Business School’s Marketing and Communications Office disseminated the China Business Knowledge (CBK) feature article titled “How China’s Firms Use Analysts to Communicate Externally” to more than 141 journalists/12,564 distribution points in the United States and across 21 countries in Asia Pacific. The working paper “The Dyadic Ties of Managers and Financial Analysts and their Externality on a Firm’s Information Environment” is originally penned by Prof. Wong, Prof. Gwen Yu at Harvard Business School and Prof. Zengquan Li at Shanghai University of Finance and Economics.

As a result of this successful media campaign, the article has been widely picked up by the media around the world, with at least 254 clippings generated. Publications that have picked up the story include Bloomberg News, The Times of India (PDF), Global Banking and Finance Review (PDF), Computerworld Malaysia (PDF), Computerworld Singapore (PDF), Regulation Asia, Yahoo! Finance (screen capture), Sina Hong Kong (PDF) and more. More importantly, the campaign has successfully drawn media attention on the topnotch research conducted at CUHK Business School. One of the positive media responses came from Bloomberg Gadfly.

Gadfly is Bloomberg’s newest editorial initiative which was launched November 2015 as an extension of the existing Bloomberg View opinions section, with a sizable roster of editors and columnists drawn from other news organisations as well as from within Bloomberg.

Source: Bloomberg Gadfly
Date published: 9 June, 2016