Regulators at China’s two biggest stock markets have asked more than 70 companies to explain why they made large provisions for the effects of the pandemic, with industry observers expressing concerns that China’s strict zero-Covid policy may have been used as a cover for earnings manipulation.
Since mid-January, the Shanghai and Shenzhen stock exchanges have queried companies with a combined market capitalisation of Rmb398bn ($57bn) over why they wrote down the value of assets last year in earnings guidance. Staff at the exchanges also questioned more than two dozen companies about large goodwill impairments.
The regulatory scrutiny comes as a record 859 listed groups have said in recent weeks that they expect to report big losses in 2022, due in part to asset write-offs in the fourth quarter. That compares with 743 guiding for losses in 2021 and 680 in 2020.
The Shanghai and Shenzhen stock exchanges did not reply to requests for comment on the probe, which was revealed in company filings on the stock exchanges’ websites.
As the Chinese economy begins to recover from its worst downturn in decades, listed companies have been booking large losses on underperforming assets in spite of many months of steady performance. Many of them blamed the writedowns on the pandemic and the toll of Beijing’s stringent zero-Covid policy on their performance.
Industry observers warn the provisions could be subject to manipulation and may distort the real picture.
“Some listed companies may use the pandemic as an excuse to make big provisions so they can cover up losses that should have been disclosed earlier,” said Dong Yizhi, a lawyer at the Zhengce law firm in Shanghai. “That is a very bad practice as it may lead to a misunderstanding of corporate performance and inflated stock prices in the future.”
Property developers have led the pack in making provisions, even though home sales are starting to recover in many cities. Public records show more than half of China’s listed developers booked large writedowns in the fourth quarter for underperforming projects that had for many months been labelled as safe, even though sales were weak at the time.
“Companies make large provisions on an asset when its ability to generate future cash flow deteriorates dramatically,” said Mike Zhao, a Shanghai-based fund manager. “That’s not the case for real estate, since the worst days are over.”
Xue Yunkui, an accounting professor at the Cheung Kong Graduate School of Business, said it was difficult for outsiders, including regulators, to distinguish between normal and “malicious” asset writedowns because of a lack of information.
Yet large provisions, such as those worth one or several years of sales or profits, are enough to raise red flags, as the accounting treatment may “greatly” change how companies are perceived by investors, according to Xue.
“It is not normal for a company to report a big loss due to a Rmb1bn writedown, when investors expect it to make a Rmb50mn profit,” he said.