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Investment
Implications
Significance of the Research
Chartered Accountants:
Inappropriate Role as Financial Analysts And Management
Consultants?
Pakistan
is facing an industrial crisis for the past several years. CA's
lack of expertise in fixed income mathematics, international asset
returns and competitive strategy will result in failure of sick
units revival attempts of the government. Of more general interest
is that this problem is prevalent in Bangladesh and we suspect is
an important factor in more Asia and emerging markets nations.
Pakistan
is in the midst of an industrial, banking and economic crisis. This
has resulted from a lot of industrial failures and defaulted loans.
Whatever may be the reason for the crisis ranging from inappropriate
debt structuring, over invoicing, bad management, over taxation,
large government budget deficit, one thing is for certain
that bad financial decision have been made. Even if the
crisis is entirely the fault of the businessman or the State Bank
or the Government of Pakistan one very interesting analysis comes
forward.
Wharton
Partners has previously identified the inappropriate structuring
of debt to be a major cause of industrial sickness. One thing we
pointed out was that financial and business analysis done as part
of due diligence of project financing or as part of feasibility
analysis is quite faulty.
What
we have noticed is that a few very well regarded principals of investing
were ignored which resulted in the mess we are in. Firstly no one
had any idea what the effects of an economic liberalizing
policy mixed with a high budget and trade deficit would effect industrial
profits. Had any analysis been done of business returns
of any other countries one would have come up with the conclusion
that the abnormal profits would subside in a hurry especially in
the context of a mounting budget and trade deficit which would require
financing and hence increase in Rupee interest rates and taxation.
The
point being to do this analysis one needs financial experts
whose training is in Finance. People who are well versed
in the efficient market theory, capital asset pricing models, debt
markets, equity markets, international asset allocation and business
returns. Similarly to understand competitive pressures it
is essential to understand business policy and competitive strategy
in detail. This last factor would have resulted in fewer
and more efficient textile mills and fewer cement plants, more value
added industries and would have resulted in a less serious crisis.
The
question then arises who are the financial experts, management consultants,
and preparers of feasibility reports? The answer is by and large
chartered accountants. Not only do they operate as accountants
and maintain books and conduct audits but are regarded as both financial
experts and management consultants. Their role as financial experts
and as management consultants is extremely inappropriate.
While
CA's were acting as the financial experts and management consultants
and were responsible for making feasibility reports, something went
drastically wrong. So much of the industry went sick and the banking
sector close to disaster. The question arises, if there was a very
serious debt structuring problem in Pakistan, why did not the financial
experts catch it. Here if we think about it lets look at who is
considered a financial expert in Pakistan or more specifically a
debt expert. By this I mean, when there is talk about reviving the
sick industries or the banking sector who are sought for their opinion
about the problem. Primarily the Chartered accountants. But
chartered accountants are supposed to be primarily accounting book
keepers and auditors. Their training does not go into debt financing
in detail nor are they made aware about international asset returns.
So
who are the financial experts and management consultants in the
USA? It is interesting to look at the perspective of a typical Harvard
or Wharton Business School Graduate. His training is very general
he would understand the basics of Accounting, Finance, Management,
Marketing, Statistics. He would be concerned about competitive advantages
and how businesses he analyzes would be effected by changing government
policy. If he concentrates in international finance or fixed income
finance, he would understand the issues. Further training as a CFA
would entail being trained in such areas as fixed income securities
(bonds), equity markets and other diverse areas of finance in detail.
Thus a CFA (Chartered Financial Analyst) is more prototypical of
a qualified financial expert than a CPA. And this explains why there
are both CPA's and CFA's (and financial analysts) in the USA each
having expert but very different roles. As far as management consulting
is concerned, top firms like McKinsey & Co. hire people from
the top business schools from America.
On
the contrary the CA's wear all these different hats. The typical
CA in Pakistan is just not trained for such analysis. Sure the business
environment in Pakistan is extremely volatile and very few business
graduates from even the top US Schools would be able to effectively
model and predict what to expect. A CA in Pakistan, well trained
in accounting as he may be, is inadequate in terms of his expertise
in debt structuring, strategic analysis etc., which a CFA or a top
business school graduate would be. Granted, the Accounting expertise
of the chartered accountant may be quite substantial.
The
fact is that project financing decision taken in Pakistan have been
detrimental for Pakistan's economic future. A large part of
this is due to a lack of proper research into the hidden competitive
advantages that Pakistan holds in the supply of products.
This has been due to a lack of vision on part of the entrepreneur,
banker, and the chartered accountants responsible for preparing
feasibility reports. This has, for example, resulted in
the stagnation of the engineering and value added industry in Pakistan.
What is worse is the implications of this to the future of industrial
revival in Pakistan.
We
believe the current approach for reviving industry based on State
Bank and the Sick units committee has a high probability of failure.
The primary reason for the failure is that a number of crucial issues
have been missed by the committee. A big reason for the mishap as
well as the industrial sickness in the first place was due to the
inappropriate role of chartered accountants. Their inclusion as
financial experts and management consultants is inappropriate. Their
being made to act as such has resulted in flawed analysis and extreme
detriment to the Banking system and the industry. This crucial lack
of expertise include the following.
1.
Insufficient training in competitive analysis from the point of
view of industrial returns projection.
2.
Lack of understanding of international asset returns. Not understanding
the relevance of international asset returns.
3.
Lack of training in fixed income (debt) mathematics and finance.
These factors are crucial in the development of the banking and
industrial crisis
Chartered
Accountants by training are not trained in the above mentioned areas
which are absolutely crucial for optimal capital resource allocation
in form of investment. It is interesting to note that ACCA qualified
chartered accountants are to a much larger extent trained in competitive
analysis. Also the State Bank, the chief regulatory body for the
banks lacks the above mentioned expertise. The whole project appraisal
process must be rethought in order to avoid a complete industrial
and consequently economic collapse. If this is not done, the sick
unit revival plans will fail.
Top
Investment
Implications
- Be
extremely careful about analysis you get in Pakistan and Bangladesh
in particular keeping in view the areas we have identified as
areas of weaknesses.
- Be
extremely careful regarding generic systematic problems arising
in these countries.
- Contact
Wharton Partners for a test for your financial analysis firm and
also for getting guidelines of exposing weaknesses in analysis
you get prepared.
- Look
out for similar problem arising in other emerging markets countries.
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Significance of
the Research
A
few reasons why it is important to understand the significance of
this research piece is to understand that in countries like Pakistan,
the entire establishment including the Central Bank, Ministry of
Finance, Bankers, Chamber of Commerce and Businessman were completely
unaware about this problem for several decades. No economic revival
package can work without realizing this factor. Hence expect bad
investment opportunities in countries where this problem exists.
A devastating debt structuring problem existed in Pakistan for decades
without any of the financial experts finding it until Wharton Partners
uncovered
this problem in 1996.
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