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Earnings Forecasts: Voodoo Science, Pt 2 of 2

Even in very corrupt countries, for example, India, corruption isn't always condoned. The odds of the 2008 2G telecom licenses being cancelled due to shocking revelations of public sector profiteering by India's world-beating backlogged judiciary were negligible. Surprise.

In 2012, India's Supreme Court ordered the cancellation of 122 cellular permits. Caught in the ruling were six foreign telecom companies that had been spending hundreds of millions to build up their presence in the Indian market. One license holder Etisalat (ETEL.AD) of the United Arab Emirates has already shut down its joint venture and taken an $827 million write-off.

This incident stunned the world on a number of levels: Eye-popping corruption, a judicial action that caused billions of foreign investment dollars to sit in limbo, and the fact that the Indian government did something. Thousands of foreign investors who flocked to the second most populous country have had to scale back expectations because India's world-beating bureaucracy can't get anything done -- like building out the infrastructure that is needed for commerce to grow.

Fortunately, there are financial auditors. Unfortunately, they too can be caught up in unusual developing country environments. In December 2012, the SEC initiated proceedings against the China-based Big 4 accounting firms and BDO because they refused, indeed were prohibited, from providing audit data on China-based companies.

In this situation, the securities of these companies are/were sold on U.S. stock exchanges, but the "state secrets" the accounting firms are obliged to conceal are also present in the audit documents of thousands of U.S.-China joint ventures, because they too rely on state-secret-holding party members to get things done. Subsequent refusals should be expected.

China is ranked by the World Bank 100th for investor protections. More sobering news, there are 85 countries that are ranked as having less shareholder protections than China.

If audits and law enforcement can't be counted on, at least the bums can be thrown out -- as in terminated. This will send a clear message to others. Not so fast. In some countries, terminating an employee requires government and/or labor union, and/or Works Council approvals -- which are not always granted.

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