Ethical Business vs Maximizing Profits

Come to the last week of blog!

This week, I’m going to discuss a topic which regard on an issue related to the financial ethical. As we can observe that tons and ton of scandals have been reveal each year which majority are due to unethical conduct in the business. Taking example such as the recent Volkswagen emissions scandal, Enron, American Insurance Group (AIG), Lehaman Brother, Bernie Madoff's ponzi scheme and etc etc. The fun facts is that, ended with the scandal those culprit which are resulting the fraud did not get into punishment. For instance,  AIG rewarded themselves with over $165m in bonuses after posting the largest quarterly corporate loss in history in 2008 and getting  bailed out with taxpayer.

What causes the unethical conduct happened?

Looking though the recent Volkswagen, the car were built with a software device that detects when the vehicle is undergoing emissions tests and activates full emissions control measures to produce results far better than those achieved in real-world driving. The net result is that cars pass strict US emissions limits under laboratory conditions, but when unplugged from the testing rigs, the EPA states that the diesel engines emit nitrogen oxides (NOx) up to 40 times. Perhaps, the company were to edger to gain much profit which resulting them to have pay for the price of scandal!

Almost one in five of the stories about the financial sector – which includes insurance and payday lenders – was about the bonus culture and pay, followed by almost one in five on fraud and theft – a reflection mainly of the manipulation of Libor. Then, each with fewer than 10 per cent, came mis-selling, the treatment of stakeholders, tax avoidance, bribery and money-laundering.

The issue in retail was mis-treatment of stakeholders, mainly treatment of staff. It was followed by supply chain issues, notably sweatshop labour and poor working conditions. Mining, in contrast, was criticized mostly for bribery and corruption. 

In conclusion, business man and company should not be doing unethical conduct in order to for short-term gain. Looking into the consequences that the tax-payer or consumer have to suffer for the wrongdoing of the company. This unhealthy habit and ethical should be eliminated in every company especially financial industries. 

Accounting For The Olympus Fraud

Spending my weekend to watch the Olympus: 1.7 Billion Dollar Fraud, which is talking about corporate corruption scandal on how the well-known Japanese optical company hide up losses and kept the secret for more than two decades. This documentary is about the corporation dismissed its president and CEO, Michael Woodford over culture differences in management style. Despite there being minimum coverage, media reported an alleged scandal where board members of the company voted to get rid of Woodford for whistle blowing on $1.7 billion dollar fraud.

Former chairman Tsuyoshi Kikukawa and two other former executives pleaded guilty in September 2012 for covering up losses at Olympus for 13 years starting in the 1990s. The $1.7 billion fraud was revealed by the company’s former president Michael Woodford in 2011. Perhaps, the reason behind for the former executives to cover losses probably is to make a healthy book of account which will resulting the increasing of shares prices, thus lead to the corporate to pay more bonuses. According to Pawel Bilinski, director of the Centre for Financial Analysis and Reporting Research at Cass Business School, claimed that the accounting scandal will be arise is due to the  pressure to meet short-term market expectations in terms of financial and share price performance.

“Bonuses and share options are often linked to hitting particular targets and these pressures may entice executives to engage in creative accounting. Companies can also manage their operations by delaying investments or selling assets to reach certain goals. As long as there are market pressures, we can expect some firms to resort to creative accounting to shore up their performance.”

Michael Woodfrod blew the whistle on a 1.7bn dollar fraud at Olympus and resulting in dismissed from his position after he confronted senior executives about the scandal. It demonstrates that even people at the top of an organisation can find themselves in a "whistle-blower" role. He stands tall as an example of leadership. Would you do the same thing—or would you just shut up and go on?

Inside Job: the story behind our economic collapse

Looking into "Inside Job’’ which is a documentary discussing on about the head of finance and government selling the world in to  global financial crisis, filming by Charles Ferguson. It is explaining about the global financial crisis of 2008 by following a chain of cause and effect beginning in the 1970s. Inside Job" exposes how that since the Sept. 15, 2008, crash that resulted in government bailouts, huge bonuses for the perpetrators continued. It shows the collusion of academia and finance and, finally, that the officials in the Bush Administration who should have had oversight and failed are now officials in the Obama Administration who are supposedly trying to save the U.S. and global economy.

What’s remarkable about the financial crisis isn’t just how many people got it wrong, but how many people who got it wrong had an incentive to get it right. Journalists. Hedge funds. Independent investors. Academics. Regulators. Even traders, many of whom had most of their money tied up in their soon-to-be-worthless firms. “Inside Job” is perhaps strongest in detailing the conflicts of interest that various people had when it came to the financial sector, but the reason those ties were “conflicts” was that they also had substantial reasons — fame, fortune, acclaim, job security, etc. — to get it right. And ultimately, that’s what makes the financial crisis so scary.

The main cause of financial crisis was deregulation and to give financial industry full freedom, as a result, they acted in their own interest and made millions of dollars at the cost of taxpayers and general public investment. So It is recommended that strong actions are need to be taken against those who are responsible for this crisis, but it is unfortunate to see that those people and institutions are still in power. The Government need to bring reforms in financial industry

One of the major concern arise after watching the film is accountability, can we still trust on those who are in powers?

Merger and Acquisition

AB InBev makes formal £71bn bid for SABMiller November 11, 2015 5:27 pm

Talking about merger and acquisition, the acquisition of SABMiller by AB InBev is one of the larger and significant m&a recently. Anheuser-Busch InBev formally offered £71bn for SABMiller which happened to form the world's largest brewing takeover in the history. SABMiller share prices just pop over 8% over the news of m&a, through this it shown that it is once again a strong market efficiency which react a news quickly!

Is taking over the SABMiller is the right decision for AB InBev?

According to brewers association, SABMiller's trading statement showed a significant increase of the revenue in the second quarter of the year, meanwhile, ABInBev beer sales are stagnant in North America. This deal will lead to the 1/3 of market shares with brands such as Stella Artois, Grolsch, Miller Corona and Peroni under one company.

All the M&A activity tends to expand their business by joining forces which will result in favor of advantages of economic of scale and scope and thus lead to a greater profits. However, there are no guarantees of benefit over m&a activities!

With the such huge amount GBP71bn who is really benefits?

Such merger and acquisition for both brewer definitely causes a huge economic of scales. this lead to a cheaper cost to produce a range of products compare to a limit range of production. Futhermore, the combination bound both to enjoy a synergy gain in production, marketing and also distributions. With all these gain, it might bea ble to hike up the shares prices to maximize shareholder wealth. However, the reduce in the operation/manufacturing /personnel cost does not really brings advantages on consumer. it is not necessary for the dominant brewer to lower down the price. Drinkers will probably find that the chances for this deal to resulting in cost saving is way to diminish.

Pay-out or NOT? (Dividend Policy)

After an investment decision have been made, the firm probably is starting to concern with the dividend policy in order to retain and satisfy the investor. In order words, firms should consider the amount of earnings to be retained and the amount to be pay out to compensate investor for delaying their spending by investing in the firm.

A controversial theory according to  Modigliani and Miller (1961) claimed that the dividend is irrelevance proposition to shares value, it is meaning that investors are indifferent with the capital gains and dividend pay out. M&M assume that in the perfect market it is fine for firm not to pay out divided when it is positive NPV project on hands. In the perfect market condition such as no taxes, no transaction cost and etc etc, investor indifferent with holdings the present value of $100 and the future value of $105 one year later with the annual inflation of 5%. 

I could not agree more with Modigliano and Miller (1961) theory of dividend irrelevancy if only the current market is in the perfect market situation because it is definitely not any different with holdings the FV which have the value with the PV now! However, we have to accepted to true that the perfect market is only seem to be appear in the M&M theory. We as a investors are just having a little or no information of company practice and  insider information, it is not easy to completely trust the firm judgement or valuation on the investment project. 

This is similar to the Linter and Gordon (1962) "Bird-in-the-hand" theory which argue that dividends are preferable to capital gains because of uncertainty. Perhaps the future is just way  unpredictable and from the empirical study past history doesn't be the best indicator to predict the future movement. Furthermore, one of the significant issue should be questioned is what kinds of markets are we currently investing at. The market is full of emotion, selfishness, cost, etc etc, therefore, investors rather get the dividend pay out now instead of later to minimize the risk. In addition, majority of investors have lost the trust buy putting their hard earn money with the firm due to the various scandal have been reveal to the market. Thus, it create a more preferable dividends gains to capital gains.

On the other hands, by having read thought the clientele effects, pay out or not or the dividend policy of the firm should also be concern on the type of shareholders. It is utterly crucial for company to understand who is their investors, by doing that it helps the firm to working on dividend pattern which is either more to a income investor or a capital gains investors. 

Different investor might be have different preference on the dividend pay out policy, some rather the firm invest on more project to gain higher return, some prefer a steady income pay out.

Leave me comment tell me what type of shareholder you are and why? :)

"Optimal Capital Structure"

Knowing the company's capital structure is one of essential financial theory that required for both investor and company, its shows how much debt and equity a company currently posses. The combination of both cost of debt and cost of equity is normally known as weighted average cost of capital which allow funds managers to identify a hurdle rate that a fund manager must overcome before it can generate income and value to the company.

The allocation of the debt and equity for the company bring significant effect to the company value as the lower's of company wacc the higher the market value. In order to lower the wacc, one of the solution is to increase the cost of debt, meaning that the company is going to issue more debt to the investor, but with the higher debt  it might be causes a financial distress to the investor and lead to a fall of share prices and therefore lower the value of company. Hence, it is crucial for the fund manger to identify the optimum cost of capital or financing mix in order to generate greater value to company in the mean time not to lead any financial distress to investor.

Modigliani and Millar have came out with a alternate theory for the company's capital structure in 1958. Both of the claims that capital structure has no impact on the wacc and therefore no optimal structure exits. In Modigliani and Millar II, they amended their earlier model by recognizing the existence of corporate tax. Their they claim that the optimum capital structure for a company gearing is to be 100% of debt and therefore able to enjoyed the tax advantage. However, this is perhaps not applicable in practical due to the existing of bankruptcy cost, agency cost, tax exhaustion and etc etc. Undeniable, with the increase of debt capital it definitely will also enhance the default risk and the chances of not financial strong enough to pay back debt which lead to a bankruptcy. Looking into the largest bankruptcy in history Lehman Brothers with holding over $600 billion in assets, this is probably due to the inefficient of the capital structure with substantially high amount of debt.

After all, with the additional of debt, the benefit of tax deduction will be realized, but once it exceed the so called of  ''optimal capital structure " it will not create any advantage to the firm. In defining the optimal capital structure, i strongly believe that it is vary form different industry due to the ability of the constant cash flow from industry. For instance, the utility industry debt to equity ratio is definitely higher than the internet and social media industry due ability of generating cash in the industry.

Libor Scadal

Manipulation of the London Inter-bank lending rate is one of the significant financial crisis to the global market back in recent year. Libor is serving as the primary indicator for the average rate at which banks that contribute to the determination of short-term loans in the London inter-bank market. It is unlike the base rate which is provide by the bank of England the libor is calculated by the Britsh Banker's Association (BBA) from estimates submitted by the major international banks based in London. 
Barclays Bank one of the well-known international banks which was underreporting its rate to prevent the public speculation about the bank's risk and credit profile during the crisis in 2007-2009, through manipulation of the libor submissions it does helps to provide a healthier picture of the bank's credit quality and ability to raise funds, thus, it helps the bank to stimulate the profit.

This misconduct related to the daily setting of the Libor and the Euribor directly influence the value of trillion of dollars of financial deals between banks and public on the mortgage deals.

How does this manipulation of libor rate affected the global mankind in the daily life?

During the manipulation of libor rate, the rate was actually being pushing downward, thus, it affected the saver badly. Depositor tends to receive a lower interest rate in the riskier investment tools. However, small saver like us does not being affected much because the interest rate given is base on the base rate that provided by the Bank of England instead of the libor rate.

In the video, a statement has been mentioned saying that finance is there to be a utility to simply serve the economy or it should be a business as profit seeking enterprise for his on right? 3 principle by the founder of Barclay Quaker, integrity, honesty and plain dealing in the banking sector. What do we want from the bank? Banks serve as a crucial institution  to promote the economy growth of a nation, A scandal from a bank might be lead to a global market issues which affected million of people on the earth. The bank definitely have to do somethings in order to restore investor trust toward the bank. I'm totally agree with the saying that a major culture change shall be take in to account for the banks which involving in the scandal. The resignation of the CEO and a huge fine from regulators do not really ensure the banks out of the scandal again. Bank should have to internalize the 3 principle (integrity, honestly and plain dealing), so that i will be able to affect how banks behave in the future.

However, in my opinion, the unhealthy culture way of doing business have been implanted deeply in business man as we can observe from the volume of the business scandal  has been reveal in pass. This might take generation to change the corrupted culture. Hoping that the banks can be scandal-free in the future, if not it is going to hurt the tax payer badly!