Stock Manipulation by China's Pangang Group case study deals with how a university professor of accounting and finance discovered that there may exist a manipulation of Pangang's earnings to achieve a much higher stock price. The professor was concerned about making the decision of whether to report this suspicious activity to the country’s regulatory authority or not. In order to decide, the professor conducts a financial analysis of the Pangang V and T and compares the results with other companies that are in the same industry.
Xin Chen; Michael R King
Harvard Business Review (W16074-PDF-ENG)
February 22, 2016
Case questions answered:
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- In this case, students should focus on these major issues. What is (are) the ethical issues facing Dr. Chen? Is Pangang V&T over-valued relative to its peers, if so does this mean definitively that management engaged in stock price manipulation? If the firm appears to be over-valued, what are the estimated losses on the put options written by Angang Steel? What would be the professional approaches to properly report the financial condition of Pangang V&T?
- This is the start of more corporate financial analysis in our case studies. The discussion and recommendations should be centered on a suggested course of action(s) supported by relevant financial analysis. From your knowledge of accounting and financial incentives, do you think earnings management frequently occurs in public companies? If investors are using solid estimates of cash flows, should earnings management fool sophisticated investors?
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Case answers for Stock Manipulation by China's Pangang Group
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Introduction – Stock Manipulation by China’s Pangang Group
The professor of one of the leading universities Shanghai Jiao Tong University of China; Professor Xin Chen who has also achieved a Philosophy of Doctorate Degree in the field of Finance; was analyzing the financial statement of Pangang Group Vanadium and Titanium Company (Pangang V and T). Professor Xin Chen was concerned about the rise of 60 percent in the share price of Pangang V and T Company.
Furthermore, Professor Xin Chen found the various discrepancy in the financial statement of the Pangang V and T Company, which was the subject to suspicious activity that was conducted by the company. Therefore, the professor was concerned about making the decision of whether to report this suspicious activity to the country’s regulatory authority or not. Hence, this decision will be taken by the professor after conducting the financial analysis of the Pangang V and T, and the comparative analysis of the company with its peer companies that are also conducting operations in the same industry.
The announcement of restructuring by the Pangang Group to consolidate the three subsidiaries into one subsidiary raised the concern for the minority shareholders to protect them from the decrease in price after the restructuring phase if things don’t go well. Ansteel, which was one of the largest steel manufacturing company acts as a third party for Pangang Group to offer the put option to the Minority shareholders in order to protect them from downside risk of the share price. Soon after the issuance of put options in 2007, Lehman brother’s credit liquidity issue arose, which led to the downfall of the financial market around the world.
Furthermore, the liquidity crisis negatively affects the stock market of China and the Share price of Pangang Group’s subsidiary decreased considerably below the put option. In the money, put options could result in exercising the put options by the shareholders, and Pangang Group could face severe losses.
Moreover, to cope up with the situation, the innovative strategy adopted by the company is that the company offered put option of greater price in comparison to the previous put options, and announced that the put options of greater price can be redeemed only by those who would not exercise the current put option. Hence, the deal seemed attractive to shareholders, which preferred the high priced put option that was exercisable in the year 2011 and provided a short term relief to the company from losses if the shareholders exercised the current put options.
Financial analysis of the various components of the company is conducted by the professor to determine the rise in the share price of Pangang V and T which are discussed in detail below.
The discounted cash flow analysis of the company was analyzed by considering the number of assumptions on the components of the financial statement of the company. The five-year projections form the year 2011 to 2015 was conducted on the free cash flows of the company by considering assumptions of growth in revenue and expenses of the company. The weighted average cost of capital of 9.6 percent was used as the discount rate to discount the future cash flows of the company and the perpetual growth rate of 3 percent was used for the calculation of terminal value.
The analysis of the company’s operational activities, revenues, and expenses; it is identified that the current value of the company appears to be 8.57 per share according to the discounted cash flow analysis but the current closing price of the company is 14.26 which clearly indicates that the share price of the company is overvalued.
Discounted Cash Flow Analysis
Relative Multiple Analysis
In multiple relative analyses, various ratios and components of the financial statements of the company are analyzed to determine the correct share price of the company or…