In August 2019, the Wаll Street Jоurnаl published аn article regarding the rampant accоunting fraud, financial repоrting improprieties, and securities violations that occurs in the Chinese capital markets. Many companies in China have structures that are not transparent with tightly held shareholder and management control, which is a consequence of the greater proportion of family-run companies. Many of these family-owned companies have major shareholders filling senior management positions, and it is not unusual for the largest such shareholder to be both chief executive officer (CEO) and Chairman of the company. Independent directors are often not independent but are friends of the family. Sometimes, members of the family management team will even be on the audit committee. In addition, it is also common to find that suppliers and customers have close relations, providing substantial opportunity for improper conduct. Most disturbing is that, sometimes, the attitude of the Chairman has is that this is his company and he can do what he wants with it, usually to the detriment of other lenders, creditors or shareholders. The maximum fine for false financial disclosures is 600,000 yuan ($87,000), while the top criminal punishment for hiding or destroying accounting records is a prison term of five years and a fine of up to 200,000 yuan ($29,000). Required: Janet Brown, a graduate from UF tells you she is thinking of investing in some Chinese stocks because these stocks appear to be “super cheap.” Required: Using the information discussed above, (i) explain to Janet why you believe Chinese stocks are selling at low prices (ii) select from among the corporate governance participants listed below the one participant you believe can potentially have the greatest impact on improving corporate governance in Chinese companies. Defend your choice. [Board of Directors, External Auditors, Internal Auditors, Institutional Investors, Regulators and Standard-setters, Financial Analysts]
Bаckgrоund:Between 2011 аnd 2015, Biglаri Hоldings (BH) accumulated a significant оwnership stake in Cracker Barrel Old Country Store (CBRL), eventually exceeding 19.9%. BH repeatedly argued that CBRL underperformed and sought board representation. CBRL, in turn, implemented defensive measures—including a shareholder rights plan (“poison pill”)—to prevent BH from increasing its ownership beyond a specified threshold. Throughout this period, the market closely watched changes in the value of BH’s investment as CBRL’s stock price rose substantially. At the time, BH accounted for its investment in CBRL using the fair value method, even though its ownership was just under the 20% threshold associated with equity-method accounting. BH consistently argued that it should be allowed to account for the investment using the equity method. Assume the following simplified data for BH’s investment in CBRL: BH purchased 4.7 million shares of CBRL for $200 million total. At year-end, the shares trade at $275 million fair value. CBRL reports $150 million of net income during the year. BH owns 19.9% of CBRL’s voting shares. BH has no board seats, and the poison pill prevents increasing ownership further. Required: Using the data above, explain why BH prefers equity method accounting for its investment in Cracker Barrel, even though the income statement effect appears more favorable if fair value method is used.