Paul Gillis – “Does it add up?: The US-China Auditing Dispute”

Paul Gillis was a partner with Pricewaterhouse Coopers, one of the “big four” accounting firms, for twenty-eight years. He first went to China sixteen years ago to help the company build its business there and subsequently became a professor at Peking University, where he’s taught for six years. Gillis edits the widely-read China Accounting Blog and is frequently consulted by the business press. His book on how the Big Four came to dominate the accounting business in China and the push back against that will be published in fall 2013.

In this short interview, Gillis discusses the role accounting has played in China’s economic rise. First, China’s leaders in the 1990s, including Zhu Rongji, understood that socialist era accounting approaches borrowed from the Soviet Union didn’t allow those outside a company to understand what was happening inside a company. Accounting approaches from the West were better suited to evaluating efficient resource utilization and other issues. Second, for Chinese firms to be able to raise capital on foreign exchanges, they would need to be audited by recognized firms, the global Big Four. These were sometimes challenging undertakings. Gillis says that the audit of one major firm took millions of hours to complete.

Gillis notes that the Big Four accounting firms (PricewaterhouseCoopers, Ernst & Young, Deloitte, and KPMG) received licenses to operate in China in the early 1990s. They struggled to find able local hires. Initially, because of the importance of being able to conduct business in English, many of those hired came not from accounting background but from the hospitality industry and from foreign l language departments. Now, however, the English language skills of those in singing programs is such that most new hires have studied accounting or business. Gillis describes his own students as energetic, able, and committed. He notes, though, that experience makes a big difference in managing an audit and that it will take some time before current students and recent graduates have accumulated that experience.

Even with strengthened auditing however, investors in many public Chinese firms have taken a beating. Gillis notes that some Chinese firms gained access to American capital via reverse mergers, essentially through the purchase of a defunct American company’s listing. Such companies were not subject to the usually scrutiny required of firms listing on American exchanges. A number of these firms were found to be misrepresenting their activities and finances and some were clearly fraudulent. The value of most Chinese firms listed in the US, as a result, have suffered. Gillis mentions a July 2013 McKinsey report that found the value of Chinese firms listed on US exchanges fell 72% in 2011-2012 and that one firm in five was delisted.

Gillis argues that the problems associated with some listed firms has justifiably shaken investor confidence. He says that some audits were flawed due to fraud on the past of the companies, differences in business culture, and mistakes by the auditors.

Because of its obligations to try to protect investors from fraud and to promote transparency and accountability, two U. S. Regulatory bodies, the Securities and Exchange Commission (SEC) and the Public Company Accounting Oversight Board (PCAOB) have sought access to audit records. The firms doing those audits, however, have been forbidden by the Chinese government to turn over those materials to the SEC or PCAOB. As Gillis puts it, the Chinese see foreign investigation of Chinese in China as an infringement on their sovereignty. The Chinese authorities, however, recognize that it is in China's interest to affirm the credibility of Chinese audit regulators and to be seen as cooperating with others in stamping out fraud. So, as Gillis notes, the Chinese have agreed to cooperate with U.S. investigators on a case by case basis.

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