Manipulation of the interbank lending rate Libor... Where can we see ethics in this?

Welcome back my followers! Its slowly coming to an end, I hope you all enjoy my last few posts. Keep your eyes open they will be rather interesting ones! Another week of an unethical company will be discussed, this week it will be Bob Diamond? Does his name sound familiar? Keep reading!

"In doing so we damaged our ability to make long-term sustainable returns"

Bob Diamond should be famous for installing high-quality risk management in the group to dodge the worst of subprime crisis! Barclays bank has been hit with record fines totalling £290m by financial regulators on both sides of the Atlantic after staff were found to have attempted to manipulate the benchmark Libor rate which ultimately governs the rate at which banks loan money. How shocking right? It means that millions of holders or mortgages, credit cards and small business loans may have been charged more than was necessary. How would you feel if you were part of one of those small businesses? Would a red flag be risen for unethical behaviour?

Right let's get on...

Ethics played second fiddle to self-interest. First a number of senior executives including the CEO Bob Diamond reacted to the media criticism by announcing they would forgo their bonuses. Is this right? Then, as the scandal escalated, the Barclays Chairman, Marcus Aguis announced his resignation. Was this to hide from the unethical behaviour they have been perceived through? Barclays either pushed the Libor rate up at the behest of traders who needed a higher rate to return profit, or squeezed the rate lower to reduce its costs and make the bank appear better and safer than it actually was, (lower Libor rates being a sign of good health). Can we see this as a ethical dilemma within in the company? Or an ethical issue?

I believe the banks suspended normal ethical standards and were selling products that were profitable for the investment banks, not well understood by the banking staff that were introducing them, and not at all understood by the customers who were buying them. Can we agree to this? Leave a comment below in the comment section with your opinion of this scandal! The ethical boom has been driven by a perceived lack of ethics in the policies of the biggest banks but going ethical is not always straightforward. What are your views of unethical behaviour in the banking industry? Is the industry holding the loyalty of customers and stakeholders? Where funds are managed by trustees or spread widely, as with most local authority pension schemes, it can be often be very difficult to prevent investments that run contrary to strongly held an often very personal ethical standards.  

Ethical investors not only need to watch which companies are being invested in by their funds but also who is investing on their behalf. Barclay has been fined for falling foul of regulators and anti-money laundering rules.  In many ways an ethical bank is much the same as any other bank. Of course we know this has affected the loyalty of customers, investors, and so on... How much can we put our trust in the banking industry? Until next time...

Hit me up with your comments below!

It's a wrap!

RS.

Olympus Scandal & Ethics!

Welcome back to my page followers. Have we been keeping up to date with the unethical companies out there? Even the companies we adore? Are they working towards an ethical strategy? Let's just say not all companies are ethical! Today I will be bringing you a company that has behaved unethically. To find out more read on... 

International optics manufacturer Olympus became a target or major suspicion towards the end of 2011, after a suddenly shift in management. Michael Woodford president of Olympus corporation that removed himself from the high office of the company disclosed that his removal stemmed from no fault of his own, rather he was asking questions. Fingers started pointing towards Olympus. It was discovered that the case was a tobashi scheme. Third party was helping Olympus, by illegally organizing their portfolios in a manner company where losses would be hidden. Is this ethically right? How would you feel if you were a shareholder of this company? Would you feel valued? 

FAKE accounts were developed to hide this money, and to allow their account to look successful! Olympus acquired three smaller Japanese companies. A year after the acquisition, the assets were recorded at a value of $721 million less than the acquisition value. As such, they avoided huge tax expenses in the activity. From what I have told you so far we can completely see how unethical Olympus was!

Now let's talk more about the ethical/unethical side of things.

Based upon these concepts, individualism is viewed as egoism. Can we say this was seen as selfishness? From a individualist point of view Olympus was seen to be making a large profit, even if they were doing so unethically. Before the scandal Olympus was seen to be a success. Potential investors saw their huge profits and lack of mistakes or large expenses financially. Profits were there, the management was just greedy. Once you start unethical and even illegal practices, it now seems more decent to do it again. Am I right?

Utilitarianism combines the ideas from egoism. A utilitarian would argue that Olympus actions were intended to emit happiness in all involved. What do you all think? They were putting their reputations on the line, for them to feel happy, for stockholders to feel happy, and for customers to feel happy. I think this completely ruining the loyalty they have with their customers and stockholders as surely they knew a lie will always be revealed? Costs included distrust in the performance of the business following the scandal. Stockholders had difficulty trusting their dividends would be paid out. Clearly, the greatest number of society did not get the greatest good in this case.

I believe that Olympus acted for a specific purpose and reason, as selfish as it may have been. Agree? With false audits, reports, and records Olympus was lying to its investors, many of whom ended up losing a great deal of money following the scandal. Virtue theory I believe can come into this case. In business, philosophers use four main virtues. They are courage, honesty, temperance and justice. Olympus is a great example of one extreme end of the spectrum, the one business attempt to avoid. It begins with courage, which involves taking risks and standing up for the right ideas and actions. Clearly, the right ideas and actions were not supported by Olympus, because they themselves did not even practice them. Honesty is possible the most obvious, because they admitted to filing false audits! The next is temperance, which was not demonstrated by Olympus because they did not have reasonable expectations of their potential profit, both short-term and long-term. Lastly, part of justice includes fair practices, which once again was a large part of the scandal.

Overall, I think the company have affected the reputation , goodwill, loyalty and trust of the company. I also feel like Olympus has created false economic standing. Investors were essentially lied to, and they are people that trusted the company with their investments. This untruthfulness hurts the company, stockholders, and its reputation with customers. I do agree that they created "feelings of happiness" for these stakeholder groups, but it is only imaginative and not backed by real figures! Until next time...

Hit me up with your comments below!

It's a wrap!

RS.

Synergy & managerial motives towards Mergers and Acquisitions: Can it be seen as value adding to shareholders?

Welcome back my lovely followers! This week we will not be talking about a rather long movie, let's keep it short and snappy. This week's topic will be focussed on mergers and acquisitions and the value (if there is any) effects on shareholders. How well do you think mergers and acquisitions are when it comes to value adding?

What is a merger and acquisition?  

Lets first talk about the relationship of mergers and acquisition and managers. Well, many of the ethical issues related to mergers and acquisitions stem from managerial conflicts of interest which is known as agency problems. Mergers and acquisitions can be seen to provide managers with more discretion in their jobs as well as reducing risk to their careers. Can we say this is true? If these are the primary reasons for engaging in a merger or acquisition as opposed to maximising shareholder value then I believe this can be seen as unethical? Study by Mckinsey & Co. found that approximately 60% of the acquisitions examined failed to earn returns greater than the annual cost of capital required to finance the acquisitions. What do my fellow readers feel about this?

Mergers & acquisitions based on managerial self-interest is targeting unrelated business to acquire. I feel there is less potential synergy in the acquisition of an unrelated business and therefore I think lower potential to enhance shareholder value with such an acquisition. Sorry guys, you are probably wondering what a synergy is? Let me explain... A synergy is the concept that the value and performance of two companies combined will be greater than the sum of the separate individual parts. Basically when value is created from a merger when the gain is greater than the transaction costs. Michael Jensen, showed that shareholders of the acquired firms often earn above-average returns from the acquisitions but that shareholders of the acquiring firms earn returns, on average, close to zero.

Let's talk about a real life example! Lloyd's & Cheltenham & Gloucester oh wait and TSB...

It seems a ruthless approach is the key they were not afraid to wield the cost-cutting scalpel. I personally believe, the shareholder 'value' delivered by sacking workers and closing branches has to be offset against the price of the acquisition to assess how much money has really been made.

"When they don't work, the two key management groups do not blend well together."                      

Past Mergers & Acquisition 

Another example of a merger and acquisition that did not benefit shareholder value is Italy based telecom company with Germany based telecommunications company Deutsche Telekom. When this merger was being discussed there was great talks about two executive officers working side by side. So little did we know shareholders opted for the rival from Olivetti's Roberto Colaninno, Telecom Italia's chief executive Franco Bernabe had to leave. Failure to create value can be down to "poor preliminary auditing of the target company" as well as "inadequate post-acquisition goals". Do we agree?

"More than half of mergers ultimately fail to create value."

Can we argue that mergers do not create value because if we go back to 1998 one of the largest announced mergers was the marriage between Citicorp and Traveler's Group estimated at approximately $77 billion in value and Exxon's acquisition of Mobil for an estimated $79 billion. SBC and Ameritech valued at approximately $61.8 billion and between Nations Bank Corp. and BancAmerica Corp. valued at approximately $60 billion. So this whole concept of mergers not creating value? Where do we go after seeing such value being created in the past.   

What about MARKET POWER?

I believe market power can also be gained when the firm acquires a company competing in an industry that is highly related to the acquiring firms industry.  strong example of this is when France's Suez Lyonnaise des Eaux S.A. paid $4.5 billion, including the cost of assuming some debt, to acquire U.S. based Nalco Chemical Company. Suez had received positive responses from this acquisition gaining a strong position in the critical US market while paying no more for the company than 11 times earnings before interest, tax and depreciation.

Lets wrap this all up my fellow readers!

Mergers & acquisitions may seem a great way to grow your company but this may not always be the case. Different motives come in the way when it comes to thinking about this. We can often overvalue what we have leading to failure.

Let me all know what you think in the comments below!

It's a wraaaaap!

RS.

"You're selling something you know has no value"

Welcome back my lovely followers! I hope my posts have been keeping you entertained. This week we will be focussing on value of shares and the company? Sounds good right? Well I hope so! This week I will be blogging about a fictional movie I had my eyes glued to, Margin Call! Guys I highly recommend you to watch this movie, I found it particularly interesting! If you would like to see how an investment bank was portrayed during the early stages of the financial crisis, click the link below!

http://bobnational.net/record/282204/media_id/282476

"Rather a mix of dread, disgust, pity, and confusion."

Corporate finance theories and practices have evolved since the 50's from normative to positive approaches to explain why and how investors react to companies decisions and announcements with respect to companies financial investment decisions. The ways and methods used to estimate companies values are essential issues in corporate finance. Several events during last years have changed the validity of the models and methods of corporate valuations.

Example: The case of Enron is one of these events that make us re-evaluate the classical and neoclassical methods. Anyhooo... let's not go there! This blog will be focussed on Margin Call & Margin Call only.

We can say corporate valuation depends on purpose of valuation, stage of business, past financials, expected financial results & industry scenario. Now we need to ask ourselves was this Wall Street investment bank revising these valuations? Hmm...

     

I understand that the subject matter of mortgage-backed securities (MBS) is a bit dry and complicated but the cast is full of well known Hollywood stars! The fictional head of a Wall Street firm "John Tuld" ( a composite character resembling Merrill Lynch's John Thain and Lehman Brothers Dick Fuld and played by the wonderfully villainous Jeremy Irons) is told that the firm is drowning in toxic mortgage- backed securities. The firm had eventually realised the assets they held were penniless. The movie I felt portrayed a set of psychological causes rather than the stages of the financial crisis, which I personally feel is important. Companies setting their minds on greed & money? I feel this is exactly what happened in this movie. Trader Peter Sullivan, discovers that the firms exposure is potentially greater than the entire value of the firm, meaning bankruptcy if the market goes not improve markedly.

Tuld, realised that its only paper money they were talking about. The figures did not end up any more? Can we blame the CEO's for not understanding the basics? Appalling! I feel that the CEO's did not evaluate the company as well as they should. Did they have a look at the expected financial results? or even the past financial results? I don't think so! What do you all think? You would think that with the CEO's being at the top of the business chain this would all have been embedded. Lack of corporate valuation and valuing shares! I just think this was just a bunch of investing banking psychopaths and greedy CEOs!

What interests me about the investment-bank role in the 2008 financial crisis is that how banks sold high risk MBS securities- which they knew were junk - to institutions and claimed with a straight forward face that these MBS securities deserved a triple-A credit rating. Like how could they do this deliberate act? I am disgusted! I personally feel that they did not value the company at all or even think about valuing the shares! Sure, in passing the characters mention that the MBS securitization process was "very lucrative" for the investment bank and the bank's risk manager has "warned" higher-ups that the firm was over leveraged? Did anyone consider this in the movie? Bollocks!

Corporate Valuation Model

In conclusion, the fictional investment bank decided to unwind its MBS position because the value of the securities fell outside the bank's value-at-risk computer-model parameters. Nobody outside of the firm was demanding cash and the firm was not suffering from a liquidity crisis like real-life Lehman Brothers experienced before it went under. Considering the Markowitz portfolio theory by not investing your all your eggs in one basket would be clever right? So can we say the bank considered its corporate values? I think we all know the answer to that!

Hit me up with your comments below!

It's a wraaaaap!

RS.

Dividend Relevance or Dividend Irrelevance?

Welcome back everyone! I hope my last few posts have kept you all in tack with everyday finance and questions that may crop up in the finance world. This week I am bringing you another view from Modigliani & Miller. Stay tuned...

Lets first talk about what are the meanings behind dividends then we will on to see if we companies should pay dividends or reinvest. Paying out dividends shows that the company provides certainty about the company's financial well-being. Some see this as a reward but other companies can show this in different ways such as increasing wealth to use cash or retained earnings and to invest this back into the company for growth and innovation. As much as dividends can be seen as a pretty picture of course Modigliani & Miller did not agree to this. M&M declared dividends to be irrelevant because investors could home brew their own dividends by selling from or borrowing against their portfolios, (Easterbrook, 1984). They argued that dividends represents a residual payment after investing in projects with positive NPV projects. How do we all feel about this? How would you like to be paid as a shareholder?

Modigliani and Miller believe that dividend irrelevance leads to companies spending a great deal of time pondering an issue about which their stockholders are indifferent. Let's talk about a company that support the M&M  theory. Google a large company that have used their earnings to invest into the company. 2014, Google invested $9.8 billion into research and development which lead to a constant increase in revenue but yet no dividends paid out. How do we all feel about this? Do we support the M&M dividend irrelevance theory? Has this left Google in the deep end? No! Google's share price has risen about $65 billion! Recently having a 16.3% jump. Its $468 billion market capitalization makes it the second most valuable U.S. stock. This was all done through investment policy theory? Can we finally say M&M theory may be realistic? 

Large companies such as Amazon do not pay dividends as they invest a lot more. This takes us back to the way M&M support 'dividend irrelevance'. Let's talk about Berkshire Hathaway... They have now generated more than $10 billion in free cash flow in each of the past four years, after never having generated more than $7.2 billion in free cash flow in any prior year in its history. The company's gross cash balance reached $47 billion at the end of 2012. Companies such as Google, Amazon, aggressively are investing in future growth initiatives. There are companies out there such as Gilead Sciences that have rising free cash flow that now exceed capital spending, that do not pay dividend then we ask our self why? BUT soon they shall be... In the past few years, Gilead has taken advantage of a weak stock price to buy back more than 300 million shares. So can we see the M&M theory to be a positive theory? What do you all think?

As much as the Modigliani and Miller theory of dividend irrelevance may seem positive it also has its flaws. Shareholders will have to be waiting for long term awards such as capital gains? Can we see this as a risk of uncertainty? hmm... I think so! Markets can be seen as not perfect, meaning we will not always know what a company may face next. Companies pay out dividends in cold, hard cash. These are not paper profits that can disappear just like that. Dividends are money in your pocket, and after they're paid they can't be taken from you. So would we not want the cash in our pockets? rather than the M&M theory of dividend irrelevance. Investors gain confidence in the consistency and growth of the company when they are paying out regular dividends which then leads to an increase in the share price of the company.

Ok people lets wrap this up enough of Modigliani & Miller. There are supports for both arguments of dividend relevance and irrelevance. As we have been proven large companies out there are investing can increase shareholder wealth and other companies in the world that pay dividends can also do the same. I personally think it depends on the business sector itself, as you can see there are a lot of large successful companies out there that do not pay dividends but maybe this is the best theory for their particular company? I feel there is not a right or wrong way of dividends as both have been proven to be successful in different ways. Companies need to decide whether paying dividends would be the best option for the company or not!

Invest or Dividends?

It's a wrap!

RS.

Comment below with your views & questions!

Grainger & it's 'realistic' capital structure?

Welcome back followers! I hope my last post was an interesting one for you guys. Today I am bringing you something different... Grainger & there new capital structure? Is it realistic?

Capital structure refers to the way a corporation finances its assets through some combination of equity or debt securities. A firms capital structure is the composition or structure of its liabilities. Debt and equity are ways which companies can raise capital but really companies have to think which is the best way to finance the company?

 Debt is usually cheaper than equity:

- Lower risk

- Tax relief on interest.

Therefore we might expect that increasing proportion of debt finance would be a good idea and reduce WACC (weighted average cost of capital).

But hold on...

Increasing levels of debt makes equity more risky right?

- Fixed commitment paid before equity = finance risk.

So really increasing gearing (proportion of finance in the form of debt) increases the cost of equity and that would increase WACC!

Modigliani and Miller, 1958 created a theory of Capital Structure in a perfect market.

Capital Structure shows how a company's assets are built out of a debt and equity.

The theory of business finance in a modern sense starts with the Modigliani and Miller (1958) capital structure irrelevance proposition. Before Modigliani and Miller, there was no generally accepted theory of capital structure. Modigliani and Miller strongly believed that it does not matter if a company was financed with debt or equity. Their view based on the belief that the value of a company depends upon the future operating income generated by its assets. Therefore, the total value of the firm will not change with gearing, and neither will its WACC? Agree or disagree? People have argued that the M&M theorem does not provide a realistic description of how firms finance their operations, and it has been said that it provides reasons why financing matters. What do we all think about the M&M theory? Do we believe it is a realistic approach?

Grainger debuted its new capital structure this week. Supposedly promising higher returns? Its debt capitalization ration jumped to 31% from 12% but remains relatively low. The company beat second-quarter earnings expectations, though it lowered its per-share 2015 earnings view for the second time since January. Grainger issued $1 billion debt last month? So has Grainger reduced risk for the company? or made equity more risky? I personally feel the company has used the capital structure rather than the M&M theory. Debt is seen to lower risk as lenders require a lower rate of return. Can we see Grainger pleasing lenders?

A number of practical criticisms were levelled at M&M's no tax theory. Since debt interest is tax-deductible the impact of tax could not be ignored. M&M therefore revised their theory. In 1963, M&M modified their model to reflect the fact that the corporate tax system gives tax relief on interest payments. Can we say that Grainger is increasing innovation as this is the effect that tax relief has! M&M said the value of a company is independent of its capital structure. Also the cost of equity for a leveraged firm is equal to the cost of equity for an unleveraged firm. If capital structure is irrelevant in a perfect market, then imperfections which exist in the real world must be the cause of its relevance.

Kraus & Litzenberger 1973 Trade Off Theory:

Equity is seen to be a higher risk therefore shareholders demand higher returns, making equity more expensive. the marginal benefit of further increases in debt declines as debt increases, while the marginal cost increases, so that a firm that is optimising  its overall value will focus on this trade-off when choosing how much debt and equity to use for financing. This is when Kraus & Litzenberger 1973, trade off model comes in. This theory assumes that companies choose the amount of debt and equity finance to use by balancing benefits and costs. This theory provides a classic statement of the theory that optimal leverage reflects a trade-off between the tax benefits of debt and the deadweight costs of bankruptcy. The theory assumes WACC (weighted average cost of capital) will not always be standing. According to the trade off theory the present value of the resulting gains from choosing debt over equity, the so called tax shield, increases a firms value, (Baker & Martin, 2011).

Kraus and Litzenberger 1973 model

So guys lets wrap this up. Which theory shows a realistic view of capital structure? Personally, the trade off model (Kraus and Litzenberger) seems more fair to me. The trade off model thinks into the future and sudden changes that may happen whereas Modigliani and Miller does not take in real world aspects. The essential point made by M&M is that a firm should be indifferent between all possible capital structures. Should company use as much debt as possible what do you guys think? I believe that as gearing increases so does the possibility of bankruptcy? Do we want that? hmm...

Modigliani and Miller or Kraus and Litzenberger?

It's a wrap!

RS.

Comment below with your views & questions!

Hustle is mentality, not a business plan! How did Madoff use his mentality?

Trusting a man like Madoff was a huge mistake people made. This man was responsible for masterminding the biggest con the world has seen, netted billion of dollars and ruined thousands of lives. Madoff convinced thousands of investors to hand over their savings, falsely promising profits in return. 

Chairman of NASDAQ market was gaining a lot of trust from different people and building up this huge scandal. The way Bernard Madoff played his game was clever, people parted with their money because he was exclusive. People put their trust and savings into Bernie Madoff and it all turned out to be one of the largest U.S. scams! Appalling right? Madoff used a so-called 'Ponzi Scheme', which lures investors in by guaranteeing unusually high returns. Ponzi schemes are run  by a central operator let's just say Madoff  in this case, who uses the money from new, incoming investors to pay off the promised returns to older ones. This makes the operation seem profitable and legitimate, even though no actual profit is being made. Meanwhile, Madoff pockets the extra money and to expand his scheming game? A big LIE! In Madoff's case, things began to deteriorate after clients requested a total of $7 billion back in returns. Unfortunately for Madoff, he only had $200 million to $300 million left to give.  

The number of victims from Bernard Madoff's alleged Ponzi scheme that was affected was immense. This man came across as an influential honest and caring man towards his clients. Although he did not promise high returns to his investors he still managed to win their hearts with his promise of steady returns. Showing low risk to his clients but how long can one lie before they get caught? Clearly not forever... How would you guys react if you were in the shoes of Madoff's investors? 

Bernard Madoff with his sons Mark (left) and Andrew (centre) in 2001 

Was Madoff in this scam alone? or did he have back office workers? With a large family and some of the members working for him I personally feel at least one of the family members had an insight on this large scam! Could we describe the Madoff scam as a double act? His brother Peter ran the office on a daily basis as well as his niece Shana, who was the compliance officer for the company? Did they have any clue? A year after disgraced financier Bernie Madoff pleaded guilty to a $65 billion Ponzi Scheme and was sentenced to 150 years in prison. Both sons of Madoff's Andrew & Mark ran the trading section, surely they could have picked up the red flags? hmm... In March 2014, five of Madoff's employees were found guilty for their part in the Ponzi Scheme. Most recently, Madoff's accountant and lawyer is also facing up to 30 years in prison for his role. 

As much as Madoff's investment sounded attractive would you really put all your eggs in one basket? Markowitz, 1959 theory suggests a good portfolio is a balanced whole, providing investors with protections and opportunities with respect to a wide range of contingencies. Can we say Madoff provided these points to its investors? Yes but with lies! Agree? Can we partially blame investors for not digging deeper? Investors should have a diversification strategy this way it will reduce risk.

I personally believe Madoff's investors should have done this instead of seeing Madoff as a pretty picture. What do you guys think? Investors should have looked into business and its growth. Therefore putting life savings into the hands of Madoff was clearly not a good idea.  Or maybe they did not measure the success of their portfolio instead they just wanted to see the return? I believe investors should have allocated different asset classes then diversify within each asset class. Investors gone wrong?

Eventually, the scam fell. Madoff's clients were panicking pleading for their own money back but all Madoff's plan was to reassure his clients hoping for the best. 

Andrew died in September, blaming his cancer relapse in 2012 on stress and shame he suffered from the colossal scam, while his older brother Mark hanged himself in 2010 on the two-year anniversary of his dads arrest. 

The real hustler?

It's a wrap!

RS.

Comment below with your views & questions!

I have added some interesting links below following up the Madoff hustle:
http://www.ft.com/cms/s/0/f724f0fc-36ab-11e5-bdbb-35e55cbae175.html#axzz3pVintmW6