Who services VIEs? | China Accounting Blog | Paul Gillis

Who services VIEs?

This is another guest posting by my former student Fredrik Oqvist.   I find it unsurprising that PwC has a dominant market share among accounting firms since this firm invented the use of the VIE structure in China. 

As we move along the trove of VIE data another thing that I think is interesting to look at is who is servicing the VIEs? VIEs are usually not set up by the companies themselves but by advisors in legal and sometimes accounting. 

Traditionally a lot of focus has been placed on the accounting firms, which is natural as the VIE entity itself is something of an accounting creation. Spawned in the aftermath of the Enron scandal to prevent accounting shenanigans, it was the reinterpreted to allow for the listing of Chinese companies in restricted sectors.

But since it is primarily the work of advisors, it seems prudent for us to have some idea of who these advisors are, and how they rank among themselves. In order to do this I looked at both who audits VIE’d companies and who the legal advisor is. 

If we start out with a classic and look at who audits the VIEs we find that the field really is dominated by two players: PWC and Deloitte, who together audit 60% of the companies. Even if we change things up and look at the combined market cap that they’re currently auditing they come out comfortably on top. EY and KPMG, who round out the big 4, have significantly less exposure to VIEs, and we then also find some of the smaller firms, who unsurprisingly mainly audit smaller companies.

In general VIE disclosures tend to be quite good across the board, but there is a definite difference between the larger auditors/companies and the smaller ones. While the sample size here is too small to meaningfully feed into statistical models to corroborate a general view is that you will find the worst disclosures (mainly missing disclosures of financial data etc.) among the smaller firms. Whether this is to do with the size of the company or the size of the auditor is not something I’ve delved into.

Moving on from the auditors I also collected data on something I haven’t seen discussed as much, the law firms signing off on the VIEs in the annual reports. Here I have just used the latest legal opinion from the annual reports, and as such there is no guarantee that the company giving the opinion actually drew up the structure, so do keep this in mind.

Still it’s interesting to see how the market for this breaks down among the listed companies, and who the major players in the sphere are.

As we can see we once again have two major players, with the others playing a little catch-up. It should be noted that the general risk exposure for investors in the structures vary quite a bit even with structures signed off on/set up by the same law firm. This is quite interesting as it implies there’s no great niche being carved out currently for creating and managing structures in a more investor-friendly manner, and this general hypothesis is also borne out when we look at the quality of recently IPO’d structures, which in general score higher on standard risk factors than the norm among already listed companies.

In general, I think this might be the result of the very fact that these structures are set up by advisors, usually in conjuncture with the imminent listing of a company. What happens then is that the VIE structure itself becomes part of the “IPO paperwork”, and as such once it’s done it’s quickly forgotten about. Because no one in the company actually set it up, no one in the company is actually responsible for it.

Law firms could really do with selling their clients on the importance of viewing VIEs as something that requires regular management and maintenance. This might push companies towards taking up more investor friendly structures benefitting investors, and as an entirely unintended consequence create a good amount of high-level recurring work for the firms themselves.

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