Tesco: Every Little Does Not Help

How important are Ethics to You? 

Hello everyone! Welcome back to Pretty Little Business, and I hope your week has been delightful. And it’s now December! Yipeee!! However exciting December is, there are still lots of other exciting things that need to be discussed in today’s blog post. I want to focus on ethics today, since ethics is an ever growing topic, particularly with the ever changing climate.

Of course ethics in business is extremely important, reputation, goodwill, loyalty, trust and teamwork are just a few of the benefits that businesses come to pass when dealing with good ethics. But we alllll know that not all businesses are ethical. Like seriously, do you guys read the news? Volkswagen scandal? How ethical was it to lie about emissions? And take BP oil spill 2010 for example complete gross negligence and recklessness, was this really ethical behaviour?

Not all companies are unethical though, don’t forget the likes of Lush and The Body Shop who are fair traders, against animal testing, use ethical buying, and comply with laws. See businesses aren’t all bad.

I want to focus on accounting scandals for the rest of this blog post. If anything is unethical it is altering accounts to hide figures.

Let’s take Tesco for example. The supermarket with the highest market share in the UK. Market domination was once a daily thing for Tesco, ever growing sales and profits and diversification. However, in 2014 £10bn was wiped off the market value. Why do you ask? Because Tesco had overstated their profits by £263m. Ethics? What ethics?

How did this happen? How did PwC (auditors) miss such unmissable figures? Deloitte asked to conduct an independent review and that is when the scandal was revealed.

Tesco accelerated revenue which was breaching the revenue recognition principle, Tesco brought forward revenue, Tesco paid money back to suppliers, but all of which were not accounted for.

Is there a simple, humane explanation for this though? At the beginning and the end of this problem there is a human who made a mistake. Pressure from shareholders could have been a primary motivation for Tesco, Tesco diversifying away from Tesco could have built pressure. Think of it like a pressure cooker about to pop. There must have been so much angst for things to have gotten that intense so quickly. Of course, shareholder value is the main goal, so not living up to their standards and the decreasing profit was just more pressure for them to worry about.

Not in any way do I think what Tesco done was ethical. However, it must be remembered that we are all human who make mistakes. But then maybe the right person wasn’t in the job. All the people who knew about the accounting scandal knew it was wrong, they all know pressure will build. So maybe they weren’t fit for the job in the first place?

This sort of scandal definitely makes you think. Tesco was the supermarket with the most loyal, and trusted customers. But now? Profits are quickly declining, along with shareholder value and customer retention. Is there a way out for Tesco? Because at the minute it seems to be one scandal after the other, all proving their unethical practices. Tesco really need to step up their game and act in line with PIPCO – professional behaviour, integrity, professional competence and due care, confidentiality and objectivity. Hopefully with main focus on the first two!!

What do you think about Tesco accounting scandal? I think it is not over yet, and Tesco are still hiding figures.

Do you think Tesco have been showing ethical practices? Do you think it was just a ‘mistake’? Or was it malicious?  Let me know about how you feel towards ethics, and how important it is. And if it even effects where you decide to shop? That would all be very interesting for me to hear!

Thanks for reading guys,

Blog Soon, Laura.

Olympus Accounting Scandal

To be ethical, or not to be ethical? That is the question.

Welcome back to my blog guys, I hope you have all had a very good week. For this blog post I want to look at accounting scandals and ethics. They are very interesting to watch and read about so hopefully you will find this interesting. I am going to discuss a scandal that look place in 2011 by Olympus.

Olympus is a huge technical giant that is based in Japan, they manufacture things such as cameras, medical systems, life science solutions and industrial solutions. It was 2011 when the accounting scandal came to light and Olympus was facing $1.2billion investment losses that they had kept on the down-low. How did people find out? You may ask. There was a whistle-blower in the firm. Surprisingly enough it was Michael Woodford, the former president.

Being the first non-Japanese president, Michael Woodford did immediately occur some problems. The most important issue was the clear cultural differences between Woodford and the other Directors of Olympus. Woodford had a very rocky start, which I believe was completely down to cultural differences. Do you think cultural differences are that important? They were proven to be significantly important when Woodford was dismissed due to ‘differences in management styles’. But why did they appoint him? Surely they would have known he was from a different culture before they appointed him? Surely they wouldn’t have expected him to be EXACTLY the same? Or was this a ploy? Did they dismiss Woodford to stop him from getting too close? Did they dismiss Woodford because they were scared he would reveal their secret? There are so many questions to ask but still to this day, there are not many answers.

However, unfortunately for Olympus, Woodford did not keep their secret safe. In fact, the dismissal probably spurred him to whistle-blow even more so! Woodford was always suspicious yet never 100% certain about what was going on.

Until, a magazine in Japan was the beginning of a downwards slope for Olympus. The article questioned Olympus’ acquisitions just like Woodford had done, yet neither of them got the answers they wanted. When Woodford was dismissed he ordered a British Auditing Firm (PwC) to audit their accounts. Maybe dismissing him was not the best of ideas, because what this audit revealed was exactly what Woodford assumed; a scandal.

Losses in the books were hidden, profits overstated, things written where not appropriate. Basically the accounts showed lies and fraud and definitely not as much money as Olympus were claiming they had.

Enough about the nitty gritty of the documentary. Do you think it was ethical for Woodford to whistle-blow? Do you think he would have done it if he was still president? Do you think it was ethical for Olympus to dismiss Woodford? Do you think they dismissed him to keep the secret? Would you have done the same if you were in Woodfords position? Would you have done the same as Olympus?

Good business ethics leads to good reputation, goodwill, loyalty and trust. Do you think this scandal has impacted on customers? Because people still buy from Olympus…

Personally I think is shows complete integrity from Woodford. But from Olympus? No way. They completely breached professional competence and due care. They breached integrity. They breached professional behaviour. It is very surprising that Woodford did not feel intimidated to keep his mouth shut!

On one hand, Olympus were trying to keep shareholders happy. But on the other? No way would they have gotten away with it. I do praise Woodford for whistle-blowing as I think it takes a lot of courage and integrity. As, let’s be honest, he was in an ethical dilemma. To whistle-blow and risk colleagues going to jail, or to keep quiet to keep everyone sweet.

I do think that Woodford made the right and best decision. He choose ethically and professionally. This I think he should be awarded for, it takes a brave man to stand up to what he believes is right.

Please tell me your thoughts on this. What would you have done if you were in Woodfords situation? Are you brave enough?

There are some links below, more about the Olympus scandal!

• http://www.bbc.co.uk/programmes/b054f7qp
• http://edition.cnn.com/2012/02/15/business/japan-olympus-prosecutors

Blog soon, Laura. 

Merging and Acquiring

How much would you be willing to pay?

Welcome back to my blog! This post we will be diving straight into the topic of mergers and acquisitions. Personally, I think they are verrrry interesting. Companies are willing to pay millions to get with or take over other companies. But is it always worth it? Does it risk the shareholder value? Is it worth the risk? Can it be good? Can it go wrong? Hopefully I will answer all these questions below so keep reading!

Lets start with the basics…

To merge with a company consists of two company’s well…merging. They come together as one on mutually agreed terms to (apparently) benefit the companies. To acquire a company in basic terms means to takeover a company, this can either be friendly or hostile. 

I bet now you are thinking a merge or an acquisition sounds like a great idea, right? The answer to that is not an easy one. There are so many drawbacks to M&A’s and shareholder value is a significant one. Surely shareholder value should ALWAYS be a priority for businesses. M&As are often sought to have emerged from managerial motives. This could be down to more money, status, power, even the excitement of the process itself! The agency theory displays conflicts of interest between managers and shareholders and the separation of control and ownership! Do managers really care about their shareholders or are managers happy when something is in it for them? M&As can even lead to job losses and uncertain futures for employees. Do you think this represents managers acting morally?

I hope you are all with me. So after that rant, let’s try and put this thing into perspective.

In February 2015 it was announced that BT were to acquire EE for £12.5billion. BT is the UKS biggest supplier of broadband and EE is the country’s largest mobile operator. This merge is huge. It was argued that the takeover would create a dominant company, unfair on competitors. However it was approved by the Competition and Markets Authority (CMA) in October.

Do you think £12.5billion is the right amount to pay? Will it be a threat to competitors? Will it create market inefficiency? Well since the news was out BT shares have increased by 4.7% and their main competitors Talk Talk has fell 5%. Is this an efficient market? Of course BTs CEO Gavin Patterson would welcome the merge, it will mean more money and more power. But is he concerned about shareholder value? At the time it might have seemed like a good idea. However, the second quarter after the news, BT posted flat results.

Personally, I think that this M&A could go disastrously wrong. The deal was worth a lot of money but there hasn’t been much talk about shareholder wealth. I think there will be conflict between competitors over market share. I think that this will show market inefficiency. Then I think that this will decrease the value of the company. And therefore defeat the object of the merge.

But these are, as always, just my thoughts. How do you feel about this deal being given the go ahead? I would love to know your thoughts and opinions, so please leave them in the comments below!

If you want to read up more about merging and acquisitions of companies then I highly recommend reading,

Haleblian, J., Devers, C. E., McNamara, G., Carpenter, M. A., & Davison, R. B. (2009). Taking stock of what we know about mergers and acquisitions: A review and research agenda. Journal of Management

This paper examines antecedents (motives, why we do it), moderators (how it’s done, how it happened), and outcomes (what happened was value created). 

I also have some links below if you want to read more into BT and EE:

• http://www.theregister.co.uk/2015/10/29/bt_posts_flat_results_ahead_of_ee_merger/
• http://www.ft.com/cms/s/0/e5f5bff4-7d42-11e5-98fb-5a6d4728f74e.html#axzz3sJcqlacR

Blog soon, Laura.

Valuing Shares and Companies

Were corporate principles even practiced? 

Welcome back to Pretty Little Business, I hope an exciting week has occurred for you. Prior to this post I watched a fictional movie called Margin Call, and I found it really enjoyable and interesting. It gives you an insight into an investment bank and the Financial Crisis. Although this is a fictional movie, I believe that it definitely has elements of real life. (The link to the trailer is at the bottom of this post.)

Corporate valuation: the value of shares and the company is going to be the main focus of this blog post. I am going to look at this with regards to the movie (Margin Call), and to the literature.

The movie is based around a firm which realises that their assets are worthless. It shows the decisions, the attitudes and the consequences of the financial crisis from an investment bank perspective. Insider information was found and this reflected a completely inefficient market that was running on next to nothing with MINUS days of survival.

The product that they were selling (which was now completely worthless) was the product that made them rich, completely drew by money. I thought that a great thing about this movie was that it doesn’t go through the technicalities of the Financial Crisis, it examines psychological causes – greed, egoism, selfishness, ignorance and money, money, money orientated. The characters were under pressure and stress but at the end of the day, the bonus was the goal. Traders were offered more than $1.3 MILLION per person if the whole floor hit the quota which would also mean destroying the market, yet they all were willing to do it because…money.  Focused on short term gain for people who quote, ‘need the money’.

In the movie all risk was placed in mortgage securities which are all liquid. Relying on one product is the same as putting all the risk into one product. Markowitz believed that a good portfolio is a diversified portfolio. If investors were to spread their risk, the risk would be reduced. If the company in the movie were to diversify risk then the outcome may not have been as disastrous.

What I thought represented a shocking truth in the movie was that some of the CEOs did not even understand the figures and charts that were displayed in front of them. Surely they should know best? Surely CEOs should have the deepest understanding of their company’s situations? Does this show lack of communication? Lack of skill? Lack of actual care in the business? Does this yet again represent only the care of the outcome - money? It definitely doesn’t represent the perceived value of the company.

It was made quite clear at the start of the movie that they had over leveraged itself. This makes me think that maybe they are believers of the Modigliani and Millers theory of increasing gearing and having a lower WACC. Do you think this is a good idea? Is that really moral? It harmed the market in the movie just like it did during the Financial Crisis of 2008! Maybe the theory is not so good after all?

Don’t even get me started on the salaries of the CEOs! In the movie one CEO made $86 million a YEAR! And on top of that he still ‘needed the money’?! Do you think this salary is fair? Does he really deserve that much? The lack of morals and human values is unreal. He was selling bogus products to people who work hard, who don’t have millions, just so he could make even more millions! Which isn’t even over-stated to real life situations considering…

• ·         Ralph Lauren - $66.7m
• ·         Antonio Horta-Osorio (Lloyds) - £11.5m
• ·         Sir Martin Sorrell (WPP) - £40m+
• ·         Howard Schultz (Starbucks) - $29.21

Really though, do you think this is fair? Do they deserve this much money? I think high salaries are important as then it attracts the right people, but for reckless investors? By people driven by money? Of course it isn’t fair. They should be after doing a good job and doing well for the business and shareholders. Money should not ever be the be all and end all in the eyes of CEOs and I personally think that this is where businesses are going wrong. What do you think?

Corporate principles should ALWAYS be practiced. This way things like the Financial Crisis might be averted. 

Please leave comments below of what you think of this. And I would definitely recommend watching the movie for a deeper understanding into investment banks and their lack of human values. Thanks for reading!

Blog soon, Laura. 

Margin Call Trailer

Dividends

Research, policies and reality

Welcome back to my blog! This week’s finance blog post is going to look at dividends. Can it get any more exciting?! I am going to delve deeper into Modigliani and Miller’s (1961) theory of dividend irrelevance. And yes I know, M&M again you say, but they just have so many good ideas.

Let’s start at the basics for those who have no idea what I am talking about. 

Dividends, in basic terms, is a payment made by the company to its shareholders. Companies must find a way to finance the dividend particularly in a way that will create the most wealth. Companies (usually the big ‘uns) pay a dividend twice a year. Interim dividend which is worth pennies, kind of like a trial run to the real thing. And then there is the final dividend which is where shareholders get their sum money at the end of the year.

With me so far?

There is also something called share repurchase. This is quite similar to the dividend however, for dividends tax is paid, and for share repurchase tax is not paid until the share is sold.

Studies show (e.g. Rooj and Renneboog 2009) that dividends are vitally relevant and extremely important to companies, shareholders and stakeholders.

Can you guess who did not agree? Modigliani and Miller believed in dividend IRRELEVANCE.  They argued (like they usually do) that share prices are determined by future earning potential not by dividends paid now. They suggest that the value of shares are determined by investment policies, and investment policies only.

To make it very clear though they did not argue that dividends are completely irrelevant just that concentration should be instead focused upon investments to maximize shareholders wealth. Companies would do this by investing into positive NPV projects which would increase the positive NPV cash flows, which would increase share price which would increase shareholder wealth and value. A chain of goodness. 

I do actually find myself agreeing with M&M though. The success of investments is obviously important to the value of a company compared to what dividend policy they choose. Surely shareholders would rather the firm invest their money into projects with a positive return, which will create long-term profit and a higher overall result. Rather than just receiving a small dividend today just to have the money in your hand with no investment in the future. Which one would you rather?

Shareholder maximization should be a sole focus for businesses, ALONGSIDE dividend policies. Maybe they are both important? Do you agree with M&M? Are they equally important? Does one outweigh the other?

Yet again though with M&M their theory has flaws. Quite substantial flaws that really question the point in it! Perfect capital markets are assumed (just like they assumed for the capital structure theory!!) There is no such thing as a ‘perfect’ market. There is a cost to create dividends. M&M have not considered the issue cost for securities even! The most important point to take away about this theory is that it requires no tax. But there are substantial amounts of tax implications involved in dividends.

Companies do however, despite the flaws, follow M&Ms theory of dividend irrelevance. The graph below shows 15 SUCCESSFUL businesses that do not pay dividends yet they still find themselves with a large market value. This just goes to show that businesses all have different views and perspectives of dividends and they try and alter things to fit best into their own business.

(source http://finance.yahoo.com/news/biggest-companies-dont-pay-dividends-180000561.htm) 

There are many many more theories regarding dividends (e.g. bird in the hand, agency costs, firm life cycle theory etc) and I will not bore you by delving into them all. However, they are all equally as important and together they have the power to enable good decisions and successful business.

What do you think? Do you agree with M&M? Do you have your own opinions? I would love to know what you think of dividends. Please leave comments below of your own ideas.

Blog soon, Laura 

Capital Structure

Modigliani and Miller, 1963 v Trade off model - Kraus & Litzenberger, 1973

I hope you have all had a fun week! This week’s post is going to focus on capital structure, with main references to Modigliani and Miller (1958). How much do you know about company’s capital structure? Probably not much, so read on!

What is the most efficient, effective and relevant way for a company to structure its capital? Does it change between companies? Does it depend on the size of the business? Is that even of relevance to the capital structure?

Businesses have the choice to either be financed by debt or by equity, or by a bit of both. What do you think is the best way to finance a company?

Modigliani and Miller theorem (1958), also known as ‘capital structure irrelevance principle’ highly believed that it did not matter if a company was financed with either debt or equity. They believed that the value of the business depends on its risk.  However this was at first a highly rejected theory. Many limitations were found with this theory in 1958: no taxation mentioned, no perfect information is always available and markets were assumed to have strong form efficiency - the theory was not uniform enough to make complete judgements from. However, they realised this and in 1963 Modigliani and Miller added taxation to their theory to make it a normative and unified. The 1963 theory was way more accepted as it was a ‘real world’ approach.

(Modigliani and Miller theorem, 1963).

Surely this would have swayed people to agree with them? Many did, many didn’t. Modigliani and Miller (1963) assume that it doesn’t matter what the gearing (debt/equity) is, what really matters is the firm’s value which is determined solely by business risk.

Modigliani and Miller advice companies to always finance through debt, is this sustainable? High gearing can negatively impact the economy and businesses.

However the trade-off model (Kraus & Litzenberger, 1973) contrary to Modigliani and Miller, assumes that companies choose the amount of debt and equity finance to use by balancing benefits and costs. Do you think this model is better than Modigliani and Miller? I think so. Having both debt and equity finance allows tax benefits, which increased the gearing to a safe level and having half debt, half equity allows a discount rate for potential projects the company may want to invest in.

The trade-off model assumes that weighted average cost of capital (WACC) will initially fall and at some point will hit rock bottom. Decreased WACC = decreased risk. But we must ALWAYS consider financial distress costs. A high level of debt will equal to a high level of financial distress, is this another factor against Modigliani and Miller? At high levels, financial distress cannot be ignored. Particularly when there is uncertainty in supplier’s minds. High financial distress can lead in bankruptcy costs. 

                                 (Trade off model - Kraus & Litzenberger, 1973)                                                

To me I think that the trade-off model represents a more realistic view of capital structure. Modigliani and Miller seems too good to be true, and does not represent the world that we live in which is definitely not a perfect one. Trade off model takes into account that things can change, and that companies should only borrow as much as they can afford (AKA reasonable level).

What do you think? Which model do you think is more sustainable? Thanks for reading this blog post, and I hope you found it interesting! Please leave your comments and opinions below and let me know what you think. Until next week.

Laura

The Madoff Hustle: Small Investment, 'Low Risk'.

I hope you have all had an exciting week! This blog post is going to focus on international cost of capital, but with ultimate target on the Madoff scandal that happened in 2009 and shocked hundreds of customers, shareholders and even family and friends throughout the world.

How many people trust their grandparents? Because all of the people I know do, so how is it that one man described as a 'caring, friendly family-man who acted like a grandpa' became the limelight of the 'biggest scandal the world has ever seen'?

So ask yourself this, would you have paid into an investment that was low risk, steady return with a promise of 1% return every month each year? Many of you will say no because you know of this scandal, but before the scandal, I know that I would have said yes. A low risk investment with a promised return, why would you say no? 

Bernie Madoff was a highly respected and trusted financier who was also chairman of NASDAQ market, where he had built up contacts, trust and personal friendships with many. This was a huge advantage for Madoff as the more people that invested the more money he was making for himself to fund his four luxurious homes. But unfortunately when the going got tough, all of these people lost thousands and thousands of dollars with many people not receiving even a cent. This makes the extent of losses extremely hard to estimate.

Madoffs main selling point was that he was an ‘exclusive club’. Making people feel lucky if they got into the club making it feel more personal as he got to know his clients. Having personal relationships with his clients worked as a great advantage to him as they committed more and more money with him as trust built with friendships.

Certain returns were promised however in hard times during the credit crunch clients were pressing about getting their money back. But at this point the scheme was getting out of control, too big for him to manage.

However he remained confident, reassured his clients, and promised them their money. But a week later it was revealed - he was a fraud.

A Ponzi scheme is what the scandal entailed. ‘Everyone wants something for nothing, you just having to give someone nothing for something’. Madoff was basically paying clients returns with their own money and saving the rest for himself.

People throughout the world were shocked, out of every one of Wall Street, Madoff was not the man who would ever have even been suspected of such a crime. But Harry Markopolos informed securities in 2005, and again in 2009 where authorities finally investigated the loss of billions of dollars.

The scandal had many consequences for clients, loss of money, homes, and possessions and for one man, (Madoffs brother) even his life.

Bernie Madoff knew his way into the hearts and lives of customers. This retrospectively gained him many clients all of which were affected by the scandal in the U.S. His clients were eager for money and the low-risk investment sounded like the perfect opportunity for them to gain money and not lose any. This was not the case and lives have been turned upside down after the news erupted.

Was it all really Madoffs fault though? Could some of the blame go onto his partners, accountants, financers, family? And even the clients themselves. A good portfolio is a diversified portfolio (Harry Markowitz, 1959) but investors unfortunately did not spread their risk to reduce it. Madoff was convicted and he pleaded guilty, resulting in a 150 year imprisonment.

I think that Madoff deserved his sentence of 150 years imprisonment, he ruined many clients lives, had been unethical in his decisions, manipulated clients, charged for theft, fraud, perjury and money laundering. However, I do not think it is fair that his accountant and lawyer only faced upto 30 years in prison when they were aware of what was happening! Do you think this is justice?  Or at least, fair justice? Madoff cheated clients out of $65 BILLION dollars. But he was not the only person who cheated the system, people knew what was going on. Maybe this requires for higher legislation, more open transparency and a better form of judgement.

I stick to thinking that there was not a sufficient conclusion to this scandal. People are still owed thousands of dollars, trust is lost and may never be returned. Did the convictions make people feel better? Probably. Did convictions make their money appear? No. Let me know what you think of this scandal.

Blog soon. Laura.

Madoff Scandal Explained: http://www.businessinsider.com/how-bernie-madoffs-ponzi-scheme-worked-2014-7?IR=T