An article published in the New York Times in January 2016, states :
“The veracity of China’s economic data has been increasingly questioned as the slowing pace of the country’s growth has startled the world. And a new investigation into the official who oversees the numbers is unlikely to inspire confidence.”
In the light of a likely and imminent economic confrontation between the US and China, it is interesting to contribute to the discussion on the credibility of China’s economic data and, in particular, to shed some light on reliability of Balance Sheets are reported by major Chinese corporations.
In our recent blog, we have introduced the Balance Sheet Credibility Index, or the BCI, which measures, on a scale from 0 to 100%, the degree of veracity, or reliability, of a given Balance Sheet. We have computed the index for over 700 Chinese public companies and compared it to some of their US counterparts. In particular, we have analyzed Balance Sheets of 40+ companies from the Dow. The results, illustrated below, are startling, but not totally unexpected.
Average BCI for US companies: 58.6%
Average BCI for Chinese companies: 44.4%
This means that on average, US companies produce Balance Sheets that are nearly 15% more credible than those of Chinese companies. The distribution of US BCIs is illustrated in the chart below.
What is surprising, however, is that there is one company, which is currently listed on the Dow, which has a BCI of a mere 27%! There is only one Chinese company which has a Balance Sheet with a lower degree of credibility of 19%. The above chart – which is negatively skewed – suggests that, as a rule, US companies tend to produce high-quality Balance Sheets.
The distribution of Chinese BCIs is depicted below.
It is evident, examining both charts, that the most likely BCI in the case of China is in the 40-45 range while for the US it is around 70. This chart suggests that, as a rule, Chinese companies produce Balance Sheets of moderate degree of reliability.
The comparison in terms of worst/best credibility is as follows:
Best BCI for US companies: 72%
Best BCI for Chinese companies: 61%
which yields a difference of 11%
Worst BCI for US companies: 27%
Worst BCI for Chinese companies: 19%
with a 12% difference, again, in favour of US companies.
Another interesting finding is that all fourteen Chinese banks we have examined have a BCI between 43% and 50%. In the case of US banks the spread is far more pronounced. This points to a ‘tighter’ relationship between the Chinese banks and their central bank.
A separate comment on a group of twelve systemic European banks. Almost all banks involved in scandals (e.g. Libor manipulation) have low BCIs, around 52%-54%, versus significantly higher BCI values of those that weren’t. A coincidence?
It is important to mention that in our analyses of hundreds of public companies, we have never seen a BCI higher than 80%. This appears to make sense. First of all, coming up with a Balance Sheet is not what one would call an exercise of science. The highly discretionary nature of the process is what A) opens the door to fraudulent practice on the one hand and B) what guarantees that there is no perfect Balance Sheet. Experience suggests that 80-85% may be some sort of physiological limit of the BCI.
Stay tuned for more.