The risks of being a foreign investor
Before you invest in an international company, you need to consider the political stability and property rights of the country it calls home. You can't always assume that every country has effective protections for shareholders' rights -- especially for foreign shareholders.
In the U.S., there's a tendency in some circles to vilify foreign capital. Consider the gnashing of teeth that took place in the early 1990s, when it seemed that the Japanese were "buying up the country." If anything, this tendency might be magnified elsewhere on Earth. As a foreign investor, you're not likely to rank high on the list of sympathetic characters in case there's malfeasance by a corporation or, more ominously, a government.
As shares of companies from less-free countries like Russia and China become more common on U.S. exchanges, questions about the risks of expropriation and nationalization of foreign companies have grown increasingly relevant to individual investors. With YUKOS -- the former oil giant -- the Russian government was more than happy to send tens of billions in shareholder value up in smoke as it pursued ownership of the company. It wasn't the first instance, and it won't be the last.
Don't cross the Kremlin
When YUKOS filed for bankruptcy late in 2004, it happened not in Moscow, but in Houston. It was part of the company's desperate attempt to stop the Russian government from expropriating its key oil-producing subsidiary, Yuganskneftegas (called Yugansk), in a sham auction, which ended up taking place undeterred. The events that led to YUKOS shareholders losing virtually their entire investments might seem unbelievable to an American. Whatever your misgivings about the U.S. market, and whatever your memories of shareholder disasters like Enron, you'd hardly expect the American government to steal from shareholders for political reasons.
Frankly, until the YUKOS situation (and one in 2003 in Kazakhstan), some had assumed that government nationalization of businesses was a thing of the past. If anything, governments everywhere have been selling off formerly state-controlled assets. Many of these companies, like Telecom New Zealand (NYSE: NZT ) , are available to American shareholders. Yet these events in Russia all too clearly refuted that opinion.
Naturally, the risk of another YUKOS-like scenario varies from place to place. There's a better chance of government expropriation happening in California than there is in Canada or Singapore, for example. But as the inexorable -- and mostly healthy -- trend of international investing accelerates, so do its overall risks.
Five years ago, ADRs on the U.S. exchanges tended to be companies like Finland's Nokia (NYSE: NOK ) and Japan's Sony (NYSE: SNE ) , from countries with strong commercial codes and property rights. But the more recent ADRs have come largely from less-developed countries with murkier limits on government power. ADRs' rapid rise in popularity makes it easier than ever to buy and sell international firms without even recognizing their foreign status or country of origin, which could lead to trouble in a less-free country, not to mention the possibility of these companies partaking in questionable practices. As with domestic companies, it goes without saying that a Fool would be wise to look deeper into a foreign company before investing.
Shareholder rights? Riiiiiiiight.
One doubts it's a coincidence that Russia grabbed for YUKOS in the same year that human rights and democracy watchdog Freedom House downgraded the country's rating to "Not Free" from "Partly Free." The Russian government's heavy-handed actions harm more than just the companies in the Kremlin's crosshairs. How much less likely would you be to run out and buy a company if you knew that the government under which it's incorporated has shown a tendency to essentially destroy companies by nationalizing them? At that point, what's the additional margin of share-price safety you'd demand before you bought any Russian security?
Russia's not alone. In the past few years, China -- also classified as "Not Free" by Freedom House -- has been the big dog among new listings on the American exchanges. It has brought dozens of partially privatized government entities to the market, including China Telecom (NYSE: CHA ) and CNOOC (NYSE: CEO ) . More distressingly, China has shown a tendency to use its government ownership, multiple share classes, reciprocal holdings, and other confusing and tangled elements to muck with the shareholder equity of Chinese companies' overseas owners.
Getting the numbers straight
The likelihood of misinterpreting a foreign company's financial statements is an ongoing risk, though not necessarily a catastrophic one. When most American investors buy internationally and view company financials, one suspects that they often assume that local standards provide a "good enough" proxy to U.S. generally accepted accounting principles, and they may simply -- and erroneously -- accept these statements at face value for comparison purposes.
As more investors around the world buy foreign stocks, the International Accounting Standards Board has sought to harmonize the various accounting regulations from country to country. It's working toward an international standard that companies can follow in their financial statements, alongside their own domestic accounting principles. In addition, some companies help American investors by also providing their financial statements in U.S. generally accepted accounting principles. Investors should expect this harmonization to continue.
Though international investment is a growing trend overall, politically unstable countries don't always welcome foreign ownership of domestic industries. You should assume that, as YUKOS investors discovered in Russia, your right of recovery in some places is nil. If that's not a risk you're willing to take, then investing in many developing countries is simply not for you. So before you jump ship into foreign waters, make sure your investments will remain afloat.
This article has been updated and was originally published on Nov. 17, 2005 by Bill Mann.
For more Foolish international words of wisdom: