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? :)!