Rampant corruptions and Chinese firms

Prompted by an article on Business Week, I started looking into a Chinese firm (China Sky One Medical Inc)( CSKI) purely out of curiosity.  It lasted for a short while because I concluded that I understood in a general sense what was going on, and nothing new of any significant could be learned.  It is classical book model of a firm operating under a corrupted totalitarian regime where cheating is normal and often necessary for survival. Their stock price was about $5 then (down from its peak of $25), but is $0.27 now.  Its trading was suspended on March 08, 2012, and was delisted from NASDAQ on March 14, 2012.  The company is facing multiple lawsuits.

Though people in the West know that the Chinese regime is a corrupted totalitarian regime, and the lack of a free press in China, but they generally have very limited appreciation of the ramification. When it comes to the economy and firms of China, people are full of illusions.

When they see cheating, corruptions, they blame the Chinese culture.  This is ludicrous.  Imagine that if the American press and media were controlled or censored by one governing party (Republican or Democratic), and the party officials had intricate relationships with businesses, would American culture keep the government free of rampant corruptions and maintain high integrity of businesses?  There is no historical evidence to support the possibility of having a clean government and trustworthy businesses without a free press.

The problem of CSKI and other Chinese firms have nothing to do with the Chinese culture.  Taiwan has the Chinese culture, Singapore has the Chinese culture, Hong Kong has the Chinese culture, but all of them have a free press. None of them have rampant corruptions.

Bribing hence cheating government agencies is normal or necessary in a country without a free press. Cheating requires book cooking. If cheating the native country’s government is normal, why should cheating a foreign agency be surprising? Would it be more consistent and convenient to use the same book cooking to deal with all regulatory bodies instead of having an honest one and a cooked one? Investing in any country without a free press has to pay extra for the risk regardless of its culture.

The details of CSKI remain to be unveiled.  Here are some of my points that I expressed before:

• CSKI is a real company with many real employees selling real products generating real revenues, and most likely real profits.  Their hotly debated lease is real too.
• Frauds have been committed.  This is a meaningless statement about any business in a country without a free press. The question is how many and how severe.  In terms of revenue and earnings, there is book cooking.  In terms of the lease, there may be some backroom dealings not to the best interest of shareholders but to the great interest of a few.
• The theoretically ideal solution is to have a thorough cleaning of the book with the help of a reputable auditor. Even if all the numbers (revenue, earnings, and book value) came out to be a fraction of what has been claimed, the company would still be able to survive.
• Taking it private would defeat the purpose of all the RTO (Reverse Takeover) effort.  Being listed on NASAQ and headquartered in LA, USA still means a lot in China.
• The consequence of admitting fraud may be too much or too uncertain for some key players to handle.  That may be the biggest burden for the company to come out clean.
• The board of directors is a semi-joke. Even in the US, boards are often clubs of the friends of CEO’s.  It is even more so in a country with little transparency.
• The end of the drama could go either way. CSKI can come out with a clean book and reestablish its reputation and regain the fair market value. Since they do not have any products without plenty of competitions, they compete by reputation and price. The damage of reputation can cause a plunge of revenue. Sometimes the government does step in for various reasons to punish someone who has committed a fraud though frauds are ubiquitous.  For example, bribery is normal in China, but the government does send people to jail for that reason sometimes. The highly publicized Rio Tinto bribery scandal is an example.  Shutting down the company is possible though not probable.