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Those with foreign residency right more willing to commit corporate fraud

The number of emigrants from China has risen from four million in 1990 to more than nine million in 2013. According to a 2014 report by Barclays Bank, 47 per cent of China’s wealthy plan to move abroad within five years, double that of Singapore (at 23 per cent) and three times that of Hong Kong (16 per cent).

According to CNN Money, Chinese nationals account for more than 80% of visas issued in the US. Photo: Reuters

According to CNN Money, Chinese nationals account for more than 80% of visas issued in the US. Photo: Reuters

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The number of emigrants from China has risen from four million in 1990 to more than nine million in 2013. According to a 2014 report by Barclays Bank, 47 per cent of China’s wealthy plan to move abroad within five years, double that of Singapore (at 23 per cent) and three times that of Hong Kong (16 per cent).

They leave for several reasons: To escape China’s high-pressure, exam-based school system, and to pursue better job prospects and economic opportunities overseas.

One path to foreign citizenship is through investor immigration programmes, which have proven to be popular. In 2014, the quota of visas set aside for Chinese nationals under the United States’ Immigrant Investor Programme was maxed out by Chinese millionaires. According to CNN Money, Chinese nationals account for more than 80 per cent of the visas issued — or 6,900 visas. Similarly in Australia, a year after it launched its Significant Investor immigration scheme in 2013, some 90 per cent of the 545 visa applicants were Chinese nationals.

Designed to attract high net-worth individuals to migrate and support the hosting country’s economic growth, the minimum investment for these programmes is between US$500,000 (S$679,000) in the United States and A$5 million (S$5.1 million) in Australia. This is no deterrent to ultra-wealthy Chinese.

In a collaboration between the National University of Singapore Business School, Nanjing University and Renmin University of China, my research colleagues and I studied non-state-owned Chinese firms listed on the Shanghai and Shenzhen Stock Exchanges, and included in the China Securities Market and Accounting Research (CSMAR) database.

As China requires firms to disclose their controlling persons’ foreign residency information in their annual reports, we could identify who has or does not have foreign residency rights. Corporate fraud data such as fraud type was also obtained from the fraud database in CSMAR.

We found that those with foreign residency rights were more likely to be associated with corporate fraud than those without foreign residency rights. Some 11 per cent of the 2,924 controlling shareholders who have foreign residency could be white-collar criminals. In contrast, of the 2,659 without foreign residency rights, 7 per cent committed corporate fraud.

With foreign residency rights, a fraudulent business person avails himself of an exit route that enables him to flee and live abroad, and possibly go scot-free.

Interestingly, the fraud committed by those with foreign residency rights is more disclosure-related, such as manipulating reported numbers of earnings or assets, rather than the more severe form such as illegal speculation or hyping up stock prices.

This suggests that such business people are not fraud-driven in seeking foreign residency. If they were, they would have committed more severe fraud.

Since our research showed that less-severe fraud was committed, it is more likely that only after acquiring foreign residency status did these business people begin to engage in fraudulent activities. A lower chance of getting caught may incentivise these controlling shareholders to be more aggressive after they acquire foreign residency status, yet severe forms of fraud can lead to extraditions. Therefore, the logical outcome is that owners with foreign residency rights tend to “cheat at the margin”, a concept introduced by psychological researchers.

Were there internal and external governance mechanisms that could mitigate such business people’s motivation to commit corporate fraud when they have foreign residency rights?

We measured share ownership by executives of the business as a form of internal governance mechanism. When the percentage of shares owned by executives is high, it implies that managers’ incentives are similar to those of minority shareholders, and hence would deter the controlling persons’ expropriation activities. External governance mechanism was measured by way of analyst coverage as financial analysts can help enhance firms’ governance by providing effective monitoring.

We found that the association between foreign residency rights and corporate fraud disappears when firms have high executive ownership or high analyst coverage. So, such governance mechanisms deterred fraud associated with foreign residency rights.

Finally, we examined the impact of foreign countries’ institutional qualities on the association between foreign residency rights and corporate fraud. If residency rights in countries with strong institutions signal a business person’s commitment to better investment protection laws and enforcement, then we expect the association to be less significant for those with residency rights in these countries.

But we found the reverse. Only residency rights in countries with strong institutions are associated with corporate fraud. It may be that the high quality of life and better property rights protection associated with such countries were critical in the migration decision.

Our findings bear implications to the Chinese and foreign governments, and investors. It is important for the Chinese government to pay attention to high-profile business people who have acquired foreign residency rights. Our findings suggest that they are more likely to commit corporate fraud.

The recent regulation that the Chinese government will not appoint or promote officials who have direct relatives with foreign residency rights appears to be aligned with our findings. Also, recent actions of the Chinese government seem to be consistent with our assertion. In 2010, the Chinese government began to investigate government officials whose family members reside in foreign countries and restrict their political promotions.

Foreign governments should also be more careful in setting residency qualification requirements and screening applicants, as some may have hidden fraudulent agendas.

ABOUT THE WRITER:

Oliver Li Zhen is Musim Mas Professor in Sustainability from Department of Accounting at National University of Singapore (NUS) Business School.

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