Levelling the playing field

Dean Katselas

Finance lecturer Dr Dean Katselas is interested in the effects of inequality of information in capital markets – how those with access to better information have a potentially unfair advantage over their less knowledgeable counterparts. A new research project looking at the efficacy of reporting regulations in the mining sector has given him an interesting new avenue for his research. By Stephen Green

It is often said that you have got to spend money to make money. Nowhere is that truer than in the mining industry, for so long the driver of Australia’s economic success. The rewards may be high, but the costs are proportionally astronomical.

“These types of firms require particularly large amounts of capital,” explains finance lecturer Dr Dean Katselas. “It’s really how they make their money. Firms may generate growth via capital expenditure, but for these firms it’s absolutely imperative, so the ease with which they can raise capital is of particular importance.”

Moreover, a significant proportion of the costs that demand capital expenditure in the mining cycle occur long before any revenue can be generated from the resources themselves. The business of exploration, geological surveys, and research and development is time-consuming and expensive. Crucially, it is unlikely that the full extent of the natural resource to be mined will be known until quite late in this process. 

Typically, at the stage when capital investment is first sought, companies cannot provide investors with as much information as they would like on the likely return on their investment. All investment is by its nature speculative, but there is a difference between shooting in the dark, and taking a calculated risk. So what is it that the capital investors really need in these circumstances?

The key word here is credibility. Investors need to be able to give credence to a company’s public disclosures about its future assets – the natural resources to which it has access.

“The real value behind mining companies is the extent to which they have resources available…” says Dean. “From an investor’s perspective, if a firm announced that they had conducted research which revealed significant, previously unknown mineral resources under their control, that’s good news, because it positively affects firm value.”

When public announcements like this are made, though, as has occurred on a number of occasions in the past, they may prove to be either gross exaggerations, or even worse, totally unfounded. This not only creates a lot of market volatility, but can significantly damage the ability of companies to raise capital in the future. For such reasons, Australia instituted the JORC code in 1989. Under the auspices of the Joint Ore Resources Committee, from which it gets its name, the code, which is mandatory for ASX listed companies, requires minimum standards in the public reporting of exploration results and mineral and ore resources.

“Its main objective is to instill a greater sense of credibility into the information that can be disclosed about these particular firms,” says Dean. “We’re talking about high risk, low probability outcomes. There may be research conducted which reveals the presence of mineral deposits, but in the early stages, their quality and quantity are highly uncertain. Nevertheless, these are still assets of potentially significant value.”

Whilst the JORC code is well established in Australia, there has been little research into how successful it has been in its primary purpose of enabling mining companies to continue to secure capital.

Dean Katselas is co-researcher on a University of New South Wales led project, which will investigate just that, and the overall impact the code has had on investor confidence in the last couple of decades since its inception.

“This is particularly topical now”, says Dean. “Not just because the mining industry is, of course, very important to Australia, but also other countries are now modeling their standards on what the Australian JORC principles contain. There is a lot of reliance being placed on it.”

The project, which secured research funding from the Centre for International Finance and Regulation (CIFR), will also investigate the usefulness of employing similar reporting regulations in analogous industries (for example technology firms) where innovation forms a significant component of wealth generation, and therefore presents capital investors with similar challenges.

For Dean, the project has provided an interesting new setting to explore his main area of research: information asymmetry in capital markets.

“In brief, you generally have two types of investors: informed and uninformed. The informed investors have more precise information about a firm’s value. The uninformed investors will lose against the informed investors because they are transacting at values which are inherently mispriced, in favour of the informed trader. The very perception of this can damage the integrity of capital markets.”

Within the context of the JORC code, whilst the main issue is the credibility lent to headline statements about future assets, a second consideration which is certainly on the agenda for future research is the degree to which the information supplied is actually understood by investors. Much of the disclosures required by the code contain technical geological information, the full implication of which may take expensive expert opinion to understand. But how important is this information?

“My interest is very much in examining these issues in capital markets – and the mining industry fits quite well – you have a transparency problem generally and an information asymmetry problem in particular. There are those within the firm, or with close interaction with the firm, who have clearer information on matters affecting firm value, relative to the rest of the market. The JORC Code was developed to credibly address these matters, and we look forward to quantifying its outcome as our research progresses.”

Updated:   14 October 2014 / Responsible Officer:  CBE Communications and Outreach / Page Contact:  College Web Team