University of Otago Professor in accounting David Lott, Dr Tom Scott from the University of Auckland and Otago honours student Ella Douglas have completed a study which shows  annual reports and other public disclosures contained enough information to predict more than 80% of New Zealand’s finance company failures.

They looked at 31 finance companies that failed between 2006 and 2009 and an equal number that did not fail.

“Our result suggests that failures were predictable and so the financial information was more useful than some believed. This is important, as our research suggests that warning signals were available prior to the failure of these companies, thus contradicting the overall media impression in the wake of finance company collapses, which often focused on CEO fraud and that financial reporting was unreliable,” Lont said.

The researchers found that failed finance companies had lower capital adequacy, inferior asset quality, more loans falling due, and a longer audit lag - a possible indicator of audit/client disputes.

Trustee monitoring was also a risk factor and the authors have suggested further research to better understand why that was the case.

Lont said financial advisers had a crucial role to play in providing advice to clients about the finance companies. “Clients weren’t understanding the risk of the underlying finance company but were attracted by interest rates and good marketing.”

He said advisers needed to have research capabilities within their businesses or to buy research that was doing the sort of analysis that would indicate problems.

“Everyone involved needs to take a hard look at the checks and balances in their systems,” he said.

Lont said some people would blame trustees, auditors or regulators or say that the companies office oversight was not adequate.

“But analysts and advisers were one of the voices. Were they getting commissions clients were unaware of that was tainting their advice? Were they aware risks were increasing but biased in the advice they were giving? If they were, that’s a serious issue.”

He said if it was merely ignorance to blame, advisers should look at their ability to access research to give them sufficient information. “If they had done that analysis there would have been up to three years’ warning. If you can nip the problem in the bud earlier, there’s a much great chance of survival.”