Early-warning system debuts to pick risky companies

By Kim Tae-gyu

A listed company’s accounting reports must be thoroughly reviewed by accounting firms and regulators also need to keep an eye on them to prevent irregularities such as window dressing.

But the conventional monitoring system fails often, as amply demonstrated by the Enron debacle in the United States and the now-defunct Daewoo Group in Korea. The most recent case would be the embattled Daewoo Shipbuilding & Marine Engineering (DSME).

Kim Sang-kyung, CEO of the Korea International Finance Institute, says that there is a loophole in the traditional way of overseeing corporate financial reports.

“In the past, we focused on liabilities of a company’s balance sheets to check whether or not its debts are too great,” Kim said on Sunday. She doubles as a founding chairwoman of the Korea Network for Women in Finance.

“Such an approach has a loophole and we should plug it by shifting our focus from credit to debit,” she said. “Then, we will be able to pinpoint the new-type bad companies, which tend to inflate their assets to hide their problems or exaggerate their profits.”

Under this belief, Kim’s institute worked together with local consultancy DMG to come up with a unique product this July called the E-Warning System, oriented to analyzing assets’ portfolio.

The system compares any firm’s asset values adjusted through a weighted format to its stock price. If there are substantial gaps between the two, a warning flag will be raised for investors.

Kim said that the new scheme will make it very tough for corporate con artists to rig a company’s accounting.

“A retrospective analysis shows that DSME balance sheets included a rising amount of problematic assets in 2008. Matters are similar with STX Offshore & Shipbuilding,” said Kim, who is well-known for being the country’s first female foreign exchange dealer.

“Back then, our ratings agencies gave top ratings to STX but our system shows a clear sign of downward risks in its analysis of the 2008 accounting report. If we could have dealt with the risks preemptively beginning in 2008, we would have been able to save a substantial amount of taxpayers’ money.”

STX Offshore was the world’s fourth-largest shipbuilder but eventually filed for bankruptcy this year despite years of being in expensive court receivership ― up to 6 trillion won in taxes were channeled to revive it.

Kim said that the E-Warning System would also be helpful for investors.

“The Gini coefficient of our system is around 80 percent between 1995 and 2016, which is around 20 percentage points higher than other global contenders. That means our tool is second to none in predicting which corporations will collapse.”

“Along the same lines, its hit ratio is 99.6 percent. In other words, corporations that receive good investment ratings under our system hardly ever go under.”