Tax Avoidance: Business Ethics

Though tax avoidance isn’t illegal, it is certainly unethical. It is in this grey area of uncertainty that tax avoidance exists and it is this uncertainty that exploits it. So the question is, avoiding tax might be legal, but can it ever be ethical? At times where governmental spending cuts have a real impact upon the every lives of people, it does confuse me as to how multinational firms would avoid paying their fair share of taxes like the rest of us. Avoiding tax is avoiding a social obligation and it is in the greed of businesses, which damage its reputation.

In a recent story, McDonald’s is currently facing fines as part of the European union initiative to stop tax avoidance in Europe. Unsurprisingly, US officials are accusing the EU for picking up on American companies rather than their European rivals. Forgive me but is America even part of the EU? The cheek.

In today’s global environment, it seems as though companies are intoxicated by this idea of shareholder value maximisation. With this, it is in their best interest to make as much profit as possible through diving through the nearest loophole in tax avoidance. Don’t get me wrong, from a purely business point of view, why wouldn’t you to save money. Through doing so, this would provide your business with a tax advantage, saving much money, which can be reinvested back into the business. After all, it is in the government’s failures, which are being exploited.

Just to be clear, I’m not defending tax evasion, which should be stopped and prosecuted for. The point of my argument is that tax avoidance happens everyday. Have you ever bought something from the airport that was ‘tax free’? Essentially, this is also tax avoidance although is considered perfectly acceptable. I guess in reality it depends upon the scale of the damage.

Rather than hiding from tax avoidance, both the governments and companies need to be transparent about tax negotiations and the stance on the law. Through doing so, this would to an extent, restore some public trust.

What was considered a Merger of equals, turned to be a massacre?

There can be a huge problem with internationalization with M&A and companies need a global strategy to manage operations. However implementation can be a challenge, especially when multiple nationalities and countries are involved. Enter Daimler Chrysler. The horizontal $36 billion merger of American carmaker Chrysler and Germany’s Daimler-Benz is a powerful demonstration of the globalization of the world economy.

The first problem that exists here is that both companies aspire fierce national pride in their homelands, which both companies thought could be put aside for progress in a highly competitive car industry. The first question that should be asked with internationalization with M&A is, do we have a global strategy to manage worldwide business leverage? And if so, can we implement it despite there being challenges with differences in nationalities and countries? Though this is a significant issue between the firms, the main problem causing the failed merger or takeover is that the terms of the transaction were misrepresented as a ‘merger of equals’ to close the deal.

When Shrimp went to Bob Eaten (Chrysler CEO) over potential merger, the meeting lasted 18 minutes before an agreement was made. How on earth in an 18-minute meeting could anyone decide on a merger? It takes me 18 minutes to decide on a filling for my sandwich!!! Never mind a $36 billion deal. The answer behind this could be due to the CEO’s overestimating the potential synergies between the firms as well as overestimating their ability to generate returns and as a result, have engaged in a value-destroying merger.

I guess in some cases this merger would be a brilliant idea, as when looking at both corporations they have something huge to offer. Daimler-Benz for instance is a strong luxury German brand with high-end cars, whilst Chrysler targets the low-end consumer in America. Joint together, they could take a large proportion of the market share and become a powerful force in the automobile industry. If only things were that simple. As mentioned above, culture can be the demon in all companies and in order for a successful merger, their needs to be synergies between firms. In order to minimize the culture clash, Schrempp decided to allow both firms to maintain their existing cultures. Can you identify the problem here? At first, it looks as though Chrysler have been given the freedom they want, however within 19 months two American CEO’s were dismissed and German management took over. This looks like complete ignorance if you ask me. Later it was only then that Schrempp admitted that the merger of equals was actually a takeover. Instead of gaining a competitive advantage, the merger was pushed into a deep crisis. This global ambition between he two firms triggered one of the most devastating law suits in corporate history, lasting up to 10 years before being sold for a mere $7.4billion.

  

If we look at how M&A’s has changed today, unlike the Daimler-Benz failure, Deloitte states that 2015’s deals have promised annualised $150-$200 billion in cost savings. Although like the Daimler-Benz merger, synergies are somewhat poorly reported and updates on cost savings may be provided for a year or two, but past this as it dry’s up. The question then, if management were acting in the best interest of shareholders, then shouldn’t M&A’s be successful? Even today, the idea of shareholder value maximisation is a grey area for management because managers are known to act in their own best interests, whether that is for power (Daimler-Benz) or greed. As a result, even today, shareholders are still paying for the deals many years after the event. Managers need to start proving there worth. 

Is human nature the flaw in our financial system?

“There are three ways to make a living in this business: be first, be smarter, or cheat”.

The film Margin Call gives an insider’s look into this unknown Wall Street firm and reveals the human nature of it and the distressing aspect regarding the emotions that drove decisions. The plot really narrows down to an accommodation of factors including; people who were gambling, people who were taking advantage of deregulation and people who were all about the short term rather than the long gain.

I ask the reader, what is the role of emotions in financial decision-making? Do emotions effect how decisions are made? This echoing theme throughout the film explicitly sets out to examine how our emotions, both those which are conscious, and more importantly, those unconscious, play a key role in financial decision making. To me, it seems to be apparent in Margin Call indefinitely as we see how the senior management prepare to do whatever it takes to mitigate the debacle to come even. The reality is, the company held a massive position in an illiquid market, decided to stop chasing profit and were lucky to have cut their losses. At times we find ourselves rooting for the firm's survival despite the fact that its executives are actively promoting worthless assets.

What I found to be a little unrealistic about the movie was the fact that they were able to accomplish the unloading of these illiquid positions as cleanly as they did. In a semi-strong market, you’d assume that regulators would identify this flaw in the formula, although it can be argued that regulators can have an oversight of the big picture here, which relates to my blog regarding Bernard Madoff’s scam. 

Were they acting in the best interest of the shareholders, or even themselves? Most certainly there is a clear indication for delivering shareholder value, although I’d argue at what cost. The bank had insider information regarding its flawed formula and refused to let it bring the company down. Was the bank wrong to sell off its worthless assets? I’d argue not, they’ve implemented a hedge strategy to save their own company from extinction. Ultimately, you’re selling something that you *know* has no value, but quite correctly you are selling to ‘willing’ buyers at the current fair market price. Although the economy may suffer, it’s the markets late reaction, not necessarily the company’s inside knowledge. After all, staying alive is animal instinct, it’s a dog eat dog world. Its human nature to survive, which is why I believe emotions were the basis of decisions making.

On the other hand, could shareholder value be destroyed from potentially losing all their current and future customers from a ruined reputation? The firm may survive from this although they’ll destroy their reputation at the very least, whilst also destroying the economy. One could argue that had they not taken the initiative to sell off their junk, someone else would have. This brings me back to this idea of ‘one man’s gain is another man’s loss.’ The underlying issue here could be the corporate culture of the company, which relates back to my second blog.

The ultimate unsatisfying conclusion of Margin Call is that there may be no final fix for the problem; that, to a large extent, the financial crises is unavoidable and will continue to happen in any economy that resembles free market capitalism. The message is conclusive: Human nature does not change and the crisis will happen again. The question is not whether we should reform our financial and economic system to prevent another crisis. The question is whether we can at all.

CALL OF DUTY meets Candy Crush!

How long before you can judge the company you have acquired? That will be the question going into 2016 for Activision Blizzard CEO Bobby Kotick who has bought King Digital Entertainment for ……hold on I think I have my sources wrong….HOW MUCH?? $5.9billion, are you mad! Considering that Candy Crush has been on the decline for the last few quarters and that mobile phone games have one of the shortest lifespans in the world, was it worth it? Arguably to a certain extent I can agree because the app rakes in $1 million a day in micro transactions, which although has gone sown slightly, still is huge cash inflows. Activisions current business model is based around hit based games such as the COD titles and World of Warcraft selections, which although are huge profit makers, do not bring in a steady inflow. This is where King can help. Activision need to be balanced around regular steady streams of income, which is why Blizzard bought King and the deal is expected to increase Activision Blizzard expected revenue in 2016 by 30%. A huge motive behind this venture would be society’s addiction to mobile phones, which has progressed immensely over the years. Furthermore, with Blizzard controlling already a huge part of the console market, it makes sense to invest into the app industry in order to diversify the business and sustain its competitive advantage.

Having played Candy Crush, though addictive for the first week or so, I can’t see how the valuation is at $6 billion. Part of me wants to believe this is due to CEO overconfidence from both companied and maybe even complete arrogance in taking over something just because the funds are there to do so. With a transaction this big, I’d expect thorough due diligence to have been taken when completing this overall valuation figure. Firstly, if the market were efficient, it would be safe to say that the market valuation represents a true intrinsic value of the firm. In determining whether the investment is likely to return a profit, it is worth also noting that King produced cash flows of $600 million in cash last year. Considering the value of the company is said to be higher than its cash flows, its definite good news for the gaming brand.

Despite the valuation, I would have said that the company itself has been over evaluated big time, with the biggest contributor to this being management resistance to sell for less. 

BHP Billiton - Progressive Dividend FLOP

 "Big business should re-balance demands of shareholders with wider issues"

BHP made 61% less in pre-tax profits, yet still made decision to increase dividends by 2%. Why, despite the fact that BHP didn’t make as much profit as it thought it had, would the company increase dividends by 2%?  The words I’m looking for here are ‘progressive dividend policy’, which involves management committing to a rising dividend year-on-year for the company. The company plans to do so by accelerating cuts in operating and capital spending to ensure this pay-out, although I question whether this pay-out would be sustainable in the future and secondly, is it wise cutting spending. BoE’s chief economist Andy Haldane argues that if BHP commits itself to this policy, is the company potentially running the risk of eating its own business by not being able to invest in new products and services. In this article, he also accuses business leaders for “serving the short-term interest of shareholders at the expenses of the wider economy.”

Looking back at MM’s theory of dividend irrelevance (Residual Dividends Policy) dividends should be paid from retained earnings after meeting investment needs from positive NPV projects, MM argued that if all projects can’t be met, then a company should alter its capital structure to finance these projects (i.e. bank loans) but ultimately, TAKE ON MORE DEBT. This was apparent in their theory against an optimal capital structure which I discussed in my previous blog on American Apparel.

So the question remains, does dividend policy help to maximise shareholder wealth? 

Not surprisingly, the finance literature poses considerable debate on whether dividend policy plays a role in achieving this goal and whether it affects firm value. One view, attributed to Miller and Modigliani (1961) and echoed in Black (1976), suggests that dividends are irrelevant for firm value and possibly value-destroying, which is evident in BHP’s case because the company is serving the short-term interests of shareholders. BHP have a progressive policy of dividends, however is willing to decrease investment in growth to fulfil its yearly claim. While dividend policy may not maximise shareholder wealth, it can certainly destroy it. So, should BHP drop its dividends? I would say so, as dividends should relate to performance increases in profits, rather than temporary. With the money returned from dividends, this should mitigate their loss.

Another perspective, represented in the classic works of Williams (1938), Lintner (1965), and Gordon (1959), considers dividends as an important determinant of firm value. Arguably, I would also agree with this statement because to an investor, dividend pay-outs can be seen as a way of assessing the company’s performance, for example; BHP’s sustaining dividend increase is to signal to shareholders that the drop in earnings is only temporary, which is a reason why share price has increased, because more people are buying the shares, and perhaps the best time to. Although I believe if the company would reinvest, likelihood that investors would still prosper from new project and therefore also increased share price.

No universal set of factors is appropriate for all firms because dividend policy is sensitive to numerous factors including firm characteristics, market characteristics, and substitute forms of dividends. The Dividend Puzzle remains an important topic in modern finance. Despite extensive research, considerable debate exists on whether dividend policy plays a vital role in achieving shareholder value.

I had my thoughts on the topic….what’s yours?

Just how will American apparel avoid a Halloween fright?

‘Trick or Treat’ has long been a tradition for going from house to house searching for goodies until you’ve taken on too much to carry, which in this case it exactly what American Apparel have done, in the form of debt. As a general principle, companies that have stable sale figures, assets that make good collateral for loans and a high growth rate can use the advantages of debt more heavily than other companies. Recall that the main benefit of increased debt on the capital structure is the increased benefit from the interest expense as it reduces taxable income. Given this statement and American Apparels situation, wouldn’t it make sense to maximize their debt? My answer is no.

In general, using debt keeps profits within the company, increases returns on equity for owners and helps secure tax savings, as well as retaining control of the company.  However, with an increased debt load, interest expense increases and this idea of financial distress becomes apparent. Debt issuers become nervous that company cannot cover its financial responsibilities and this comes no surprise to investors of AA as the company have filed for bankruptcy protection as substantial doubt surrounds the business and investors could incur big losses. So where did it go wrong for the retailer?

AA has high gearing and tried to take on as much debt as possible to increase the value of its company in the long run. As a result, its debt pile grew to 11.6 times its annual earnings before interest, tax, depreciation and amortisation as of March this year, an increase from 8.6 times in 2014. Consequently, it struggled to implement a turnaround fast enough to stem the sharp decline in its stock price, closing at 11 cents on Friday October 2^nd.

Why do you think that the management would allow such a highly leveraged capital structure? In 1963, Modigliani and Miller revised their original theory of capital structure to take into account a more real world approach and incorporated tax into it which showed a substantial benefit to borrowings. On one hand, I can understand why management at American Apparel would highly leverage its capital structure, mainly because the after-tax cost of debt is usually less expensive than equity; so firms will add debt up to the point where the risk of bankruptcy raises the WACC. As a result, the company will favour using debt as a source of its financing when it enjoys a tax shield.

On the other hand, I would look at my first question, how can we know when we’ve maximised our debt? American Appeal should have looked into the market conditions and its own financing before taking on too much debt. MM argues that in the presence of bankruptcy costs, firms should be concerned about having too much debt, this I would agree with. AA could have realised its capability in static trade-off models, which it could have used to maintain its optimal capital structure in the face of market imperfections such as bankruptcy, taxes and debt tax shields.

The current status of Capital Structure research and theory is perhaps best summarised by Baker et al. (2010) “The status of our understanding of how managers actually make capital structure decisions does not appear to be anchored by any of the extant academic theories. Despite several decades of theory development and refinement, none of the normative capital structure theories indicating how managers should act seem to fit the survey data.” This I would agree with as in the real world, managers decisions are altered by the several circumstances. In the case of AA, It depends on various factors such as the type of economic conditions and the time period. In light of the AA situation, maybe it’s time companies actually paid attention to theories, maybe they’d learn a thing or two.

The magician who made $65 billion disappear

Berard Madoff: The Madoff Hustle

‘The closer you look, the less you see’ is a great line for a magic trick, but an even better line for a fraudster, and in this case, Bernard Madoff nailed it. In his $65billion Ponzi scheme he ruined thousands of lives, from small time investors to sophisticated money managers in what is the largest stock fraud in history. So how did he do it? Once Madoff managed to revive his scheme, it required a constant influx of additional funds. On its surface, the fraud looked real enough to attract interest from new investors to help pay off client’s doubts and make the scheme look profitable for everyone.

So what went wrong? IT WAS A SCAM PEOPLE! Even for me, a young upcoming financial student this fraud sounds ludicrous, how does a man of Madoff’s background not only convince over 1000 wealthy people to invest but also manage to nutmeg regulators? Unbelievable tekkers if you ask me. Some could argue that Madoff was a trustworthy person and a huge credible man, promising returns of around 10% annually, which isn’t much, but is steady. Others could argue that because of the steady return, Madoff could have a source for insider information to help beat the market consistently.  I would argue that all people did was dump money in, do no due diligence and count their money, why did they think it was plausible? 

In my opinion, the fault is not with Madoff, rather with the investors who didn’t look beyond the promised rate of return and were gimmicked into this personification of wealth. Some of Madoff’s investors had been investing in his fraud for 21 years and as a result lost everything. I feel that through investing in one particular stock makes these people very vulnerable, I say ‘people’ because most weren’t real investors rather people wanting a good return.  

Portfolio theory suggests that it is possible to construct an "efficient frontier" of optimal portfolios, offering the maximum possible expected return for a given level of risk. The theory suggests that it is not enough to look at the expected risk and return of one particular stock, which is what most investors did in Madoff case. If the investors were to invest in more than one stock, the investor can reap the benefits of diversification, particularly a reduction in the riskiness of the portfolio. Therefore, not putting their eggs in one basket and risking all of their investments falling at once. If they were to have created a portfolio of shares, investors wouldn’t have lost everything, rather just one stock, which is what I would have done as an investor.

The real scam in this is market manipulation, an inefficient market, which potentially could affect investor confidence in the future. The regulators in my opinion were responsible for the colossal amount of the scandal. Tighter regulations need to be put in place to prevent Ponzi schemes from ever happening through more thorough searches.

Seven years on from the scandal, it looks as though the majority of Madoff’s victims are going to get a big pay-out (Popken, 2015). I’m guessing along with his houses, they also sold Madoff’s winter clothes; he won’t need them in prison.

Until next time, I leave you with a quote from Harry Houdini, ‘My professional life has been a constant record of disillusion, and many things that seem wonderful to most men are the every-day commonplaces of my business.’

Leave a comment if you have something to add, whether agree or disagree!

Avengers Assemble

Financial Times: Fantasy Sports: Rule-playing games

Goooooooood morning Newcastle! In today’s rant of the week, I welcome you to a scandal which has erupted in the industry of fantasy sports, an online and apparent ‘regulated’ market. Sports enthusiasts build and assemble their elite avengers ahead of the national football league season, evidentially the busiest time of the year for fantasy sports.

In the last few weeks, the industry has attracted the interest from many law firms and government officials regarding its inefficient market over the controversy of a DraftKings employee winning $350,000 playing on its rival site FanDuel. This has led to the suspicion of misusing insider information for personal gain. A question that comes to mind - how and why are employees of the two companies allowed to participate in a pay to play league with the general public? Questionable corporate culture if you ask me. If more rules were in place and employee involvement was banned, the market would certainly be more efficient and this idea of ‘insider trading’ wouldn’t exist (perhaps). Moreover, if there was a separate area where employees from both DraftKings and FanDuel could compete with one another, this would allow the use of insider trading, just not against the public. Then again, what’s to stop employees from playing on other people’s accounts (say a friend)?

 “The single greatest threat to the daily fantasy sports industry is the misuse of insider information,” (New York Times).  

This industry is under real scrutiny unless real safeguards are put into position to make it more market efficient for investors of the industry. I myself as a huge fantasy enthusiast ponder on the idea of insider trading, especially when my own money is at risk. Withholding information from the public is unacceptable; again, questionable corporate culture. After all, the two companies are built on a shaky legal foundation, declaring their games “100% legal”. But an interesting question, if online-gambling is ‘illegal’ in America, what exempts fantasy sports, which is a form of online-gambling?

The Efficient Market hypothesis states that a market is ‘informationally efficient’, which means that it is good at pricing assets based on the information that is currently available. I’m going to look at the concept of EMH from a different angle, applying it to fantasy sports. In this scenario, NFL drafts are the market, although a market that trades in players instead of companies. For example, NFL franchises, like investors, have a strong financial stake in ensuring their valuations are as accurate as possible. Similar to investors, NFL franchises are gorgers for information, seeking information that might be relevant to a player’s future to make informed decisions. Furthermore, while investors might not be perfect at pricing the assets, the NFL draft involves an open competition between different agents who are looking to buy players when their price falls, or sell players if another team is willing to pay more than they’re worth. I believe that this market shares common characteristics with the stock market for this reason.

My questions to you, the reader, just like the stock market, how can we be sure the NFL draft is an efficient market?  Unlike the stock market, which is heavily regulated, fantasy sports have loopholes which need filling. If the NFL draft was an inefficient market, you would expect individuals would outperform the market consistently, compiling many strong drafts against a few weak over a long time period. If it was an efficient market however, despite recent successes, they’d perform no better.  This relates to this idea of a ‘random walk’.

In regards to my question, considering no individual is capable of judging a player at a rate that outperforms the market consensus, i’d like to say the market is efficient. Just like there is a weak form, a semi-strong form and a strong form in finance, I believe this can be related to the NFL draft, or fantasy sports.

“How can you build a brand when you value it so little?”

Digby Jones: The New Troubleshooter: Episode 1

In Great Britain over 180,000 people make, build and sell furniture. The marketplace accommodates for over £7 billion spent yearly by consumers, the equivalent of £100 for every person in the UK. Within this competitive environment is Hereford, a manufacturing furniture company questioning its survival among other major players in the industry. Having made a loss of £80,000 for the first time last year, there are questions that need answering.  Lord Digby Jones is first to the scene to transform a wounded business into a strong sustainable competitor.

As a generic principle, no business can succeed without understanding its customers, its products and services and the market in general. Competition in the furniture industry is often fierce, especially for a family run business like Hereford with no real financial backing from investors to help fund operations and growth. Within the industry, major players such as IKEA have a commanding presence and market share due to their resilience and constant need for innovation. In Hereford’s case, the market around them is contracting due to the influx of players in the market. IKEA for one have dominated through their ‘flat-packed’ products, offering customers affordable furniture. A major concern for Hereford is the huge product lines they offer, currently at 2,000 products in their portfolio, which is thought to be ‘killing the business.’

A question to be considered, 'how could the management at Hereford Furniture allow its company to approve over 2000 products into its portfolio and have no financial implications to the effect this would have?' It can be seen that managing production and range has had a dramatic impact on profits, perhaps a reason for an £80,000 loss last year. A solution to the company’s problems would be to cut its products down a sizable amount in order to cope with orders and to reduce costs. Such an operation would involve indicating which products are bestselling to worst selling. Unilever in the late 90’s had the same issue and cut 700 brands and saved over £1billion in the process, certainly something Hereford should consider. Certainly a lack of communication can be considered here between management and employees. Lord Digby’s response was to trim the products down considerably and focus on a small number of products and implement a make-to-order system. This is one way the company can cut back on costs and improve its profits for next year.


On first impressions of the workforce, the systems in place were not conducive to productivity enhancement, as departments were working independently from one another with no cohesion. Immediately a concern area here as a problem in one area could potentially stop all other operations. Digby’s response was to consult all departments in the business, only to find that everyone was unhappy with management decisions due to lack of factory floor appearances and lack of communication. Meetings were scheduled with managers from every department and also from top management in order to talk over improvements. A fun morale boost was to shut the factory for the day to organise a staff trip to an art college to build team cohesion through designing a new stamp for the furniture. Although only a few changes were made, it’s certainly a step in the right direction.


In terms of value management, the future of Hereford will depend upon its ability to diversify and innovate. Currently, the company doesn’t put its name on any of its products therefore not creating any value for its brand, which is why I named the title of my blog ‘How can you build a brand when you value it so little.’ Reflecting back to earlier in this blog about the importance of understanding customers and products and services, I don’t believe Hereford has a full understanding of its marketplace. The strategy seems to be focusing on profit maximization, hence three different business channels. This strategy has been beneficial in the short term; however the company has ignored the long term financial implications, another reason for its £80,000 loss.

Reflecting upon the operations of the company, Hereford had managed to over complicate it through operating three different channels; manufacturing, importing and retailing. Although Digby said to focus on one area (manufacturing), it can be argued that importing from China would be a route to take; UK manufacturing is still booming, but arguably it is cheaper to outsource. With the rise of IKEA and its flat packing, this can be considered an obvious concern for Hereford as they cannot be as competitive in their pricing as IKEA, therefore reducing their profitability and consequently, market share. From a shareholder wealth perspective, Hereford should be exploiting the opportunity to expand, however first must consider if it has the resources to continue operating three businesses, or whether one is more logical. Having researched into what the company is today in 2015, its original idea of changing the brand name to ‘Hygge’ has collapsed due to the brand already being owned by a Thai furniture store and Instead has become Oak Furniture Solutions. In terms of its products, there seems to be no indication of a decrease in its product portfolio however the company has decided to innovate with alternate colours and designs.

Overall I would rate Oak Furniture Solutions 5/10 for its little improvements.