Ethical or not?

Why does financial scandal happens all the time, especially involving large multinational companies that has already been listed in stock exchanges with good reputation.  Has greed took over all the rationality when making a decision?  In relation to business ethics, we look at Olympus scandal which happened in the year 2012. 

Olympus is founded in Japan in 1919, and has become a leading manufacturer of innovative optical and digital equipment for the healthcare and consumer electronics sectors.  Olympus are committed to develop new technologies, products and services to increase safety, security, quality and productivity.  But however, due to misleading accounting scandal have led Olympus to lose the share value. It happened when Michael Woodford that the company staggered 1 billion USD of shareholder value moving 678 million USD accounted as an agent fee to a British company called Gyrus.  When Woodford found out about this, he was quickly dismissed by the board chairman, Tsuyoshi Kikukawa.  Because Kikukawa moved the loss to Gyrus, investments made by the company suffers a loss as well, leading to devaluation of shareholders. 

Following the case where Kikukawa tried to cover the loss from investments by transferring almost 1.2 billion USD to Gyrus.  And the accounting book has shown Woodford that the company is covering the loss and overstating the profits-an action Woodford portrayed as a whistle-blower to ask PricawaterhouseCoopers (PWC) to audit Olympus’ account. 

But the question is, was it ethical for Woodford bring down Olympus’ image?  Was it ethical for Kikukawa to alter the account books?  Besides these two questions, is there any other way for Woodford to solve this problem?  However, in my opinion, Woodford may have done the right thing because he is no longer a staff in Olympus, and it was not fair for him that Olympus dismisses him because he was questioning the accounts of the company.

Let me know what you think of Woodford’s action and what would you have done if you were to be in such situation!

LIBOR Scandal

To those who have been in the financial industry for many years, or to those who actually keep up with the financial health across the countries, I'm sure you have heard about the Libor rate being rigged in 2012. LIBOR stands for the London inter-bank offered rate which is actually an interest rate benchmark set for many other rates, from commercial loans to mortgages.  Besides that, it serves to be an important index for derivatives and it is also the most widely used interest rate in the world.

On every business day, the major banks in London will give information as at which interest rate would they expect to pay on a loan from another bank to Thomson Reuters and Thomson Reuters collect rates from panel banks, and the highest and lowest 25% of value will be eliminated. Then, an average is calculated from the 50% remaining mid values to produce the official LIBOR rate.

Why is LIBOR rate so important?

• A benchmark in the world for short-term interest rates.
• It is used as the base rate for a large number of financial products.
• Also used as a base rate to set the interest rates such as loans, savings and mortgages

Back to the scandal.

The scandal happened in 2012 where Barclays Bank revealed significant fraud and collusion by member banks connected to the rate submissions, leading to the scandal.  Because Libor rate is used in the US derivatives markets, an attempt to manipulate the Libor rate means an attempt to manipulate the US derivatives markets.  The manipulation of submissions of interest rates can have negative effects on consumer and financial markets globally.  Due to this scandal, many authorities have started investigating when did banks started rigging the rate and some mentioned it happened 10 years ago or some said it was as early as 1991.  It was not only Barclays Bank who was involved in the scandal, but there were other major banks involved too, such as, Royal Bank of Scotland (RBS), JP Morgan, UBS, Citigroup and Bank of America, which they had been fined over $9bn.  

What do you think about the idea of rigging the Libor rate which it was such an important rate that many banks in the world use it as a base rate?  I personally think it was really unethical of these banks to manipulate the Libor rate.  Shareholders' values in these banks definitely have gone down and it definitely takes time to regain their value as this scandal has a big impact in those who are involved, as it was not fair to consumers that they are using an inaccurate interest rate that was being charged.  Banks definitely have breached the core values and objectives of the companies itself. 

Let me know what you think about the LIBOR Scandal in the comments below!

Does M&A create shareholder value?

What do we know about mergers and acquisition (M&A)? M&A gives a company a chance to enlarge their company when it seems that their company cannot grow further or is dependent on the company to expand its existence. It can be a threat to other company as if another company wants to merge and takeover your company, you lose your independent existence.  Here are some of the reason why M&A is an important role in a company.  It can be an entrance to new market, to eliminate inefficient management and to increase market power and share.

M&A happens mainly because of synergies between two companies which give a higher value when the transaction cost is lower than the gain.  Royal Dutch Shell is an Anglo-Dutch multinational oil and gas company and is the fourth largest company as of 2014.  Shell is vertically integrated because it has combination between firms at different stage and is active in area related to oil and gas.  Shell has the decision to take over BG Group. BG Group is also a multinational oil and gas company but is not as big as Shell.  Shell believes that taking over BG Group will benefit in terms of economies of scale, where larger size leads to lower cost and savings from the sharing of central services. 

When two companies are joined together, it gains cost efficiency because M&A will be a new and bigger company now, so the production is done on a much larger scale. So, when output production increases, cost of production of output may be reduced.  The merging of Shell and BG Group could be known as a horizontal merger because they are of the same production which is oil and gas. 

But what if this merging and acquisition is not successful?  This leads to the confidence level of CEO of Shell because many shareholders and stakeholders are doubtful of the takeover.  If the CEO of Shell over-estimated their ability to generate returns, it means that Shell is destroying the value of merging the two companies where it destroys the value of Shell and BG Group as well. 

As a conclusion, many companies think that M&A plays an important role in the company, but is it really good for the company against the little decision that has been made throughout the whole process? Despite the many benefits of M&A, there are drawbacks as well. For example, the overconfidence of CEO.  In my opinion, the pros can only be benefitted if CEOs considered all aspects of M&A before getting the real deal and should not be overconfident as it might worsen the company’s image hence lowering shareholder’s value.

How greedy can you be?

Wall Street: Money Never Sleeps, definitely a fictional movie that is worth your time to watch.  As a person who hasn’t watched any finance-related fictional movie, this interests me as a finance student.  After watching this movie, it made me think if greed is really good? What kind of person are you displaying if you were to be seen as a greed? Honestly, greed is no crime but it does hurt people as well as the economy if your greed has overpowered you.  Not only that, greed may cause you what money cannot buy.

At the beginning of the movie, it was seen that Keller Zabel (KZI)’s share price had dropped due to rumors that was being spread by James Bretton.  Due to rumors which caused the public to sell their shares, KZI’s shares price dropped from $79 to $2 in just a month’s time. If Louis Zabel does not sell the company, it is only going to lead to bankruptcy.  And obviously, Louis doesn’t want that to happen.  In such condition, to save his company, Louis went to the US treasury at the Federal Reserve and asked for a bailout.  Because Bretton had been eyeing on Keller Zabel, Bretton had block Louis’ bailout and offered to buy Keller Zabel at $3 per share which humiliated Louis very badly.  Due to such circumstances, Louis committed suicide because he couldn’t handle such failure. Bretton’s greed had hurt so many people along the way. 

Jacob Moore, who was an apprentice of Keller Zabel, was more than upset to hear the news of the death of his mentor.  Jacob worked in Keller Zabel and tried to raise funds for a fusion research project but was rejected by many.  He attended Gordon Gekko’s lecture where Gekko was selling his book “Greed is Good”, was also talking about the next financial crisis which was going to happen.  As the movie goes on, Gekko told Jacob a private offshore hedge fund, Lotus Fund that was betting against Keller Zabel at the time of the crash of Keller Zabel.  Jacob obviously did some research about it and found out that James was the one behind it all.  As an apprentice of Louis, Jacob wanted to avenge his death.

Then James offered a job placement to Jacob.  As Jacob’s goal was to raise funds for the fusion research project, he took the job.  At some point, James told Jacob that the Chinese was going to throw the funds into fossil fuels and not the fusion research project, Jacob called it quit. 

As for Gekko, he manipulated Jacob to persuade Winnie Gekko who is Gordon’s daughter, to take out the money as for the research.  But what Jacob didn’t know was, Gekko took the money to run a new company with the $100million from Winnie’s bank account.  At this point, Gekko had lost Jacob and Winnie’s trusts and Winnie lost trust in Jacob.

However, Jacob tried to make it up to Winnie by putting every single piece of information that he had of Bretton James that led him to find his private offshore hedge fund and asked her to publicize it and the result caused Bretton’s company.  Because of his greed, Bretton was sent to jail and had to testify for his crime.

As a conclusion, is greed good? In my honest opinion, I think that greed is good, everyone loves money.  But if you were to destroy your virtues and values because you want to be more than greedy, then you have to be prepared to lose things and people that you care about along the way. Greed drives people to become irrational.  You may be good in investing in any stocks, but you may have just lost what is really important to you and concerns you most.  

Investing in stocks, is dividend payout a factor that you would consider before investing?

Paying dividend can fulfill a company’s objective in achieving maximization of shareholder’s value.  In shareholder’s perception, it is definitely a positive thing that a company pays dividends.  This leads to an increase of shareholder wealth. A company has the right to pay dividends or not due to its forthcoming new project. A company will choose not to pay dividend it needs to finance a new project.  However, paying dividend can be seen as the company is active. Are shareholders actually okay with the company not paying dividend?

Again, in the context of Modigliani and Miller (1961), they argued that dividend is irrelevant in terms of corporate earnings and also concluded that share valuation is independent of the amount of dividend paid by a company. In order to understand Modigliani and Miller’s theory, we have to assume that there are no transaction costs, firms can issue shares without incurring floatation, no tax paid and capital markets are perfectly efficient.  Because of these assumptions, investors who are rational pointed out by M&M, prioritize maximization of market value by adopting an optimal investment policy.

Looking at the some of the biggest companies in the world, i.e. Google Inc. and Amazon.com, they stopped paying dividend for years because these companies are aggressively investing in future growth initiatives in their bid to conquer the technology landscape. But why do shareholders of these companies still buy their shares even if they do not pay dividends? In my opinion, many companies, especially companies that are still growing, will choose to reinvest their capital gains for further developments and researches.  It is cheaper to reinvest their stock because it can generate higher capital gain.

However, there is also dividend relevance that was proposed by Lintner (1956) and Gordon (1959) which is also known as the Bird in the hand argument.  It was argued that dividend is preferred to capital gains due to their certainty as some investors would prefer to be certain of receiving dividend rather than not receiving dividend at all.  In this theory, dividends are seen as a signal to investors whether the company is progressing positively or not.  For example, if a company pays low dividend, investors might think that the company is not giving any good news to them, hence, selling off their shares.  And if a company pays high dividend, it means that the company is doing greatly in their businesses and activities – giving positive results/good news to investors.

Both dividend policies have been quite a controversial topic to many because, in my opinion, it is mostly based on investor’s point of view.  At the end of day, it is up to the investor whether or not they want to continue investing their money into stocks that will pay dividend or stocks that are uncertain of their dividend payment.  It is all based on investors’ attitude and considerations towards the stock that they want to invest. 

If you are an investor and you have invested in some stocks, would you rather be paid with dividend or wait for the company to issue dividend? 

Let me know in the comments below what your answers are and why? :)!

Debt wins, why?

How does a company realize what is good for their company? Financing through debt or through equity?

As we all know, debt is always cheaper and also riskier because through debt financing, the debt interested is deductible. Also, through debt financing, however, if you hold a lot of debt, you will be seen as a risky company, showing investors that if you have problems regarding your cash flows, you will have trouble paying back the loan.

Financing through equity, on the other hand, has a major advantage which a company do not need to repay the money that investors have invested in the company, but, of course in investors' point of view, they hope to regain their investment through future profits from the company.

Weighted average cost of capital (WACC), can be difficult to calculate because it considers both cost of debt and cost of equity. While cost of debt is easier to be calculated, cost of equity is a harder way to calculate because it has various forms of calculating where different company will use different methods to calculate it.  Companies can either use capital asset pricing model, dividend growth model or bond yield plus risk premium method to calculate cost of equity. The main problem of calculating cost of equity is that there are at least one component in these formula which is an estimate, hence, giving a different result of estimates of cost of equity which is not accurate.  

Question is, are these businesses confident that their cost of capital estimates are correct on their decision on strategic investments? A survey was generated from 424 responses back in 2013 and the response was, many were not confident with their cost of capital estimates which can define the future of their company.  

Why weren't those businesses confident? 

• Small fluctuations in the cost of capital actually affect the discounted cash flow and strategic decision of the future investments and acquisitions.
• Weighted average cost of capital were not used by businesses to be calculated.
• Many organisations are using cap or floor on the risk-free rate 
• Many organisations prefer to use Capital Asset Pricing Model (CAPM) to estimate cost of equity.

In the context of Modigliani and Miller (M&M) in 1958, they argued that capital structure has no impact on WACC because they assumed that there are no transaction costs, no taxation and have perfect capital markets.  But in the real world, these are impossible.  

However, many financial managers have used WACC in decision making because it lowers the cost of equity by lowering the beta of the company, thus, increasing shareholder value.  Besides that, by lowering cost of debt, it lowers the gearing level to avoid financial distress.  Also, by issuing bond, companies are exempted from tax interest because it is deductible. And finally, increasing optimal leverage by lowering credit spreads and cost of equity, resulting an increase in relative tax shield. An increase in leverage increases shareholder values.

We all love money, don't we?

The Love of Money

Lehman Brothers' was one of the largest investment banks in the United States.  The investment bank filed for bankruptcy in year 2008 as the former CEO of the company, known as Dick Fuld, had thrown a large amount of borrowed loans into investments such as housing-related assets, making it at risk to a downturn in the market.

Lehman Brothers collapse due to rushing into subprime mortgage market while the U.S housing market fall tremendously. The subprime mortgage crisis happened in the year 2007 to year 2009. The crisis was triggered by a large decline in housing prices which led to mortgage error and the devaluation of housing-related securities.  However, during the housing boom in the U.S. in year 2003, Lehman acquired 5 mortgage lenders, including subprime lender.  Lehman definitely made a huge profit out of this as the housing value was at an inclined rate at that moment.

As Lehman continued to borrow more money, Lehman is left with small amount of capital as to the amount that they owed which was at a ratio of 20:1.  Lehman used borrowed money to play with the property market. It is true that they were earning from it, but as the housing market fall, they made losses.  So, is it true that Dick Fuld was too greedy for his own good at that moment?

As for the Federal Reserve, Hank Paulson as the U.S. Secretary of the Treasury, made it clear that the government is not going to bailout Lehman.  Is it true that there was nothing the Fed could have done to bailout Lehman, or if there was, did the Fed make the right decision for not bailing Lehman out? It could be a lesson to large investment banks or companies that no matter how big of a company you are, you will still fail, without the help of other banks or government.

Merrill Lynch, on the other hand, made a great deal by cutting off a deal with Bank of America, which led Lehman Brothers being unable to fund themselves.

We all love money, don't we? Any financial intermediaries/institutions are bound to take on higher risk as all they care about is gaining profits.  As they may say it is to increase shareholder value, but in my opinion, they are just gambling with the public's money, to increase net income.  As at the end of the documentary, the attorney of Lehman Brothers said "you don't finance long-term investment with short-term money," which is really true, because what comes out of it was the collapse of Lehman Brothers.

How efficient markets are?

Money is expected to generate when investor invest their money into stock market.  It is known that many investors do not only aim for profitable return, but they, too, try to outperform the market. Market efficiency will always be reflected on all available information on a particular stock or market at any given time.  Companies do not reveal all information, or no one can actually have access to all information that a company has to take advantage in predicting a return of a stock.  We know that there are 3 forms of efficiency which are weak form efficiency, semi-strong form efficiency and strong form efficiency which were identified by Fama (1970).

Earlier this month, Glencore announced to cut zinc production by a third has effectively boost up zinc's price as well as its share price. Previously, commodity prices were falling so badly that Glencore, as one of the biggest commodity company, was battling with the fall of the price too.  With its announcement of cutting zinc production, Glencore's share price increased to 133p.  The sudden announcement caused investors to invest in this stock because zinc's price has always been low for few years and its sudden production cut have increased the zinc's price which increases its share value.

Heath Jansen, who is an analyst at Citigroup, believes that Glencore is protecting its value by cutting production which is not profitable.  Personally, I think that Glencore has made the right decision in cutting zinc production as it is trying to save the company from falling to its ground and that decision has definitely covered some of its debts, although not entirely. 

So, how did this news affect the market efficiency? 

As we can see, the announcement of cutting zinc production has led to an increase in Glencore's share price.  Due to this, can we conclude that investors are acting and responding rationally?  However, in my opinion, I think it is based on how investors perceive and interpret the news in their own ways.  There are rights and wrongs in making decision, but at the end of the day, it all comes down to investors' piece of mind of looking at it.  The 'random walk' prices was discussed in class that price changes in random fashion and share prices reflects all known information by the public at any time; which includes a few factors such as government, international transactions, speculation and expectation and supply and demand.  

Digby Jones : The New Troubleshooter

Based on the documentary of Digby Jones: The New Troubleshooter, Digby Jones was seen helping out Hereford Furniture to their current situation which they made a loss of  £80,000 in the previous year's sales.  The main reason for Hereford Furniture's downfall was Mike Muxworthy, as the managing director, are doing three businesses at the same time.  The company was unable to cope with this challenge as the management was poor and disorganized as well as the company's accounts and cash flows.

As Hereford Furniture was looking at three businesses together, which was importing, retailing and manufacturing, it has made the company to lose its focus. And how Digby wanted to help them was to make them refocus on what Hereford Furniture is able to do, which was to focus only on one business.  In the video content, Mike said "why not?" to handling three businesses because he thought he could do it, which was wrong because I personally think it would make him lose attention at some point.  Because Hereford Furniture is a medium-sized company, its competition in the furniture industry is going to be definitely large and all the medium-sized company will find its way to go further, and if Hereford Furniture is unable to cope with so many ranges of business that they are doing, they will get to nowhere; therefore, making a loss in their revenue. That's why, to beat the foreign brands of furniture, companies like Hereford has to work harder to attract UK customers. However, after many discussions, Mike was willing to take advises that were given by sir Digby, which was to scale down their ranges of stock and only build for stock.

Another issue that was brought up in the documentary was Mike and the team were unable to provide proper accounts that Digby wanted to see.  Mike only assumed that by cutting down ranges of products, it would increase 40% of the stock but are unable to do the accounts that can prove it. Also, they are unable to show Digby a proof of financial implication because they do not have enough accounting resources in the company.  But as they move on, they realized that they need this financial implication to implement their project, whether or not this work can be done. The figures that they will be getting will be sufficient enough for them to work things out.

Also, the issue of communication between workers were shown in the workplace, and the employees were saying that this department does this and that department does that, but nobody was doing it as a whole, which I think it has made the workplace to be a little inefficient.  As Mike realizes this problem, the company has made a small activity among the employees to build a better relationship and to communicate between one another, to create a new stamp which could be a symbol of the new brand.  In my opinion, building a good relationship among employer and employees will definitely be a plus point for the company as they can communicate better instead of being inferior to their boss and being reluctant to voice out their opinion.

At the end of the documentary, it was shown that Mike has done all the necessary changes that was mentioned by Digby and it is good thing because I see that Mike is willing to let go his old methods of doing things to ensure a better future of this company and for the betterment of his employees.