We penalise companies where investments in affiliates account for a large portion of shareholders’ equity. This raises a number of corporate governance concerns: First, companies can shift profits by trading with affiliates on terms that suit management and do not reflect market conditions, thereby creating a false market. Second, the level of financial disclosure at affiliates is limited.
Around half of all companies have investments in affiliates although these are typically small, equating to just 3% of equity. In general, property companies have higher exposure to affiliates than other sectors, presumably to reflect collaboration on large projects.
Under our accounting screen a red flag is triggered when affiliates/equity exceed the 80th percentile relative to global peers (13% of equity). A red flag is also triggered when affiliates/equity increase at an unusually large rate over 1 and 3 years. Again, this is when the increase exceeds the 80th percentile relative to global peers.