JIAR China 2016 Flashcards
Companies who use U.S. GAAP are not allowed to
report property, plant, and equipment (PPE) at amounts greater than historical cost
Companies in the European Union (EU) and other countries using International Financial Reporting Standards (IFRS) may choose to report assets on
the balance sheet at either historical cost or fair value
Those Chinese companies following Chinese GAAP must use the
direct method in preparing the statement of cash flows, whereas most companies in the United States and the EU use the indirect method.
Both U.S. GAAP and Japanese GAAP stipulate that research and development costs must be
expensed as incurred, whereas IFRS requires development costs to be capitalized as an intangible asset when certain conditions are met.
In a typical reverse merger (RM), a private operating company, either from the U.S. or abroad,
merges with a “shell” U.S. company
Upon consummation of the merger, the private company becomes
a wholly owned subsidiary of the shell company; can be traded in the U.S. securities market if the shell company is publicly listed.
Since an RM avoid an underwriter, it could potentially allow companies to
go public in the U.S. more quickly and in a a less expensive manner than a traditional IPO
Critics point out that RMs allow companies to go public with
less scrutiny of their financial situations, exposing investors to risk
Concerns on RMs
-the use of small audit firms that might not have the resources to meet auditing obligations when all or substantially all private company’s operations are in another country; causing them to miss non compliance with relevant accounting standards.
-audit quality
In 2011 the SEC passed
new rules tightening the standards that RMs needed to meet for listing on the major exchanges that would provide greater protections for investors
SEC New Rules
- require RMs to be traded in the U.S. over the counter or on another regulated U.S. or foreign exchange for at least one year and
-meet minimum share price requirements before it can be publicly listed on the NYSE, NASDAQ, or NYSE Amex
A comparison of domestic and foreign firms that undertake RMs reveals
no systematic difference in earnings management between the U.S. and non-U.S. RM companies
Risk considered with RMs
-Domestic RM firms show potentially questionable accounting practices
-Focus on foreign firms as risky investments has been too narrow and ignored Domestic RM firms
-caution should be expanded
-Domestic and foreign RMs engage in Earnings Management
RMs that use Big 4 auditors (higher quality auditors) are associated with
lower Earnings Management
RM firms that use Big 4 auditors are associated with significantlly
lower rates of failure (delistin) in the years following the reverse merger; equal to almost half of the failure rate of RM firms that do not employ a Big 4 auditor
RM firms intending to issue equity within the year of a reverse merger are more likely to
manage earnings than firms undertaking a reverse merger alone
The firm-level characteristics of the identity of the auditor and the desire to raise equity capital in the U.S. are more important indicators of
earnings quality than the geographical location of the RM firm
The most common type of RM is conducted as a
reverse triangle merger, whereby a public shell company forms a new wholly owned, empty subsidiary and then merges this subsidiary into a company that wishes to go public through a reverse merger
Once a reverse triangle merger is completed, the company’s
shares are converted into shares of the public shell and constitute a majority stake in the public company.
at this point the firm operates as a wholly owned subsidiary of the company
is used more often than an RM because it has few transaction costs
RMs have been conducted since the
1950s
RMs are considered ______ investments
risky; due to their relatively unregulated status
The SEC adopted a rule change in 2005 affecting the use of
S-8 and Form 8-k by shell companies
new rules clarified the definition of shell companies as those with little to no operations and assets other than cash, prohibited the use of Form S-8 by shell companies
required shell companies to file additional information on 10-K forms.
Currently all RM companies that trade on the NYSE, NASDAQ, or OTC Bulletin Boards are required to
file Forms 10-K and 10-Q disclosures and provide audited annual financial statements
Under new SEC rules NYSE, NASDAQ, NYSE Amex are required to
impose a one-year “seasoning period” for firms going public through RMs, where they must first trade in the OTC market or other regulated U.S. or foreign exchange following the reverse merger
during this period, firms must file audited financial statements before being listed on the major U.S. exchanges
the price for sustained period of time and stays at this price or above for at least 30 of the 60 days prior to listing application with the major exchange
The most commonly cited reason for choosing and RM is
the cost; it is lower
Companies wishing to issue equity would have less incentive to use a reverse merger as the cost of a reverse merger that includes an SEO ( Seasoned Equity Offering), is approximately
equal to the cost of an IPO
Reasons companies choose RMs
lower cost
raise capital
lower speed
higher likelihood of completion
Management typically cites one of seven categories as the primary reason for conducting and RM
growth
diversification
organizational depth
taking advantage of economies of scale
capitalizing on firm strengths
expanding into complementary lines of business
desire of a private firm to be publicly listed
Firms that undertake RMs are typically
smaller, younger, and low-performing before the merger than firms that undertake an IPO
Disadvantages of RMs for smaller firms
smaller firms do not get provided with liquidity and marketing
they typically see shares more thinly traded post-reverse merger
RMs do not require support of underwriters serving as a signal of low quality
low-quality firms are less likely to raise capital after completion of the RM
Firms involved in RMs are generally
unprofitable prior to the merger
shareholders receive significant gains at the announcement of the merger
there is little to no post-merger improvement in operations or profitability for the RM firms
2 yrs following the merger,
firms continue to have higher debt,
higher volatility,
lower profitability,
lower growth opportunities,
lower trading liquidity,
lower institutional ownership than conventional IPO firms
more than 40% are delisted or bankrupt by the end of the 2 yr period
Due to issues with quality of the firm and accounting transparency, RM firms are typically characterized by a high
high degree of information asymmetry and high asymmetric information environment has been found to encourage earnings management behavior
