Moran (2005) argues, "We audit and we regulate when we cease to trust", and personally I think it's evident that this is the case. After every big scandal or crisis the rules and approaches to auditing and governing change significantly in the hope of preventing similar things from happening. But are we missing a fundamental issue? Why is auditing and regulating not stopping further scandals from occurring?
I can understand the argument as to why we regulate and audit when we loose trust. We do it so that over time we can rebuild that trust we had and be assured that people are acting how we want them to. But it seems that every time we rebuild our trust, we loose it again. So what are we missing? Well to me it seems like we're failing to understand why we're loosing our trust. Something must be causing this recurring cycle of gaining and loosing trust that we find ourselves in, and I believe that something is Culture.
Culture is arguably one of the most important things in an organisation. Communicated in the right manner, a good culture can encourage employers and managers to work together to meet the needs of the business. A bad culture on the other hand can destroy an organisation. But what makes a good and bad culture? Well, that's open to interpretation. From my experiences, a good culture is one in which everyone is encouraged to grow to their full potential. A bad culture on the other hand is one in which you're seen solely as a worker and not as a person.
In the banking industry, it appears to me that managers operate in a culture where you're encouraged to take risky short term decisions in order to maximise short term shareholder wealth, rather than do what is best for the employees and the organisation in the long term. To me this is a bad culture. Yes you need to keep your shareholders happy, I dont dispute that, I just think that risking a lot to do that is the wrong message to promote. If I was a shareholder I'd be more interested in having a stable income for ten years than having a few years with large payments and a few with little to no returns. But that's me.
If I was in a position now where I could make a difference in the banking industry I'd be seriously questioning whether the culture being promoted is the right one. And fundamentally I'd be asking whether banks should be running in the interests of shareholders or stakeholders.
Nothing's going to fix the banking crisis over night, especially not a change in culture. But maybe if someone was to take this into consideration, it might prevent more problems in the future.
Sunday, 24 March 2013
Saturday, 16 March 2013
Are Auditors to Blame for the Credit Crunch?
In 2007, the world began to feel the effects of the global credit crunch. A credit crunch we are still struggling to recover from 6 years later. A number of groups and organisations have been blamed for the cause of the crisis, but one such group which has received criticism is that of the auditors. In 2008, Prem Sikka (a Guardian journalist) wrote "Each collapse shows that highly paid directors had little idea of the value of company assets, liabilities income, costs, profits and financial health. This has been accompanied by one constant factor: the silence of the auditors. Auditors collected large amounts in fees and dished out clean bills of health." But are the auditors really to blame?
In some sense yes. As an auditor your job is to search for evidence to enable reasonable assurance to be given on the truth and fairness of financial and other information provided. Therefore the hidden and undervalued assets on the balance sheet should have been raised as issues as they don't provide a true and fair representation of the real situation. But what is key within the description given of an auditor's job is the words "reasonable assurance". In my opinion reasonable assurance is a subjective term and one person's view on whether they can reasonable assure that something is correct will differ from that of another. So can the auditors be blamed for being reasonably assured that what they is seeing is right?
In my opinion, no they can't. As Sikka said many of the companies being audited didn't know the value of their own assets so how can the auditors know whether, based on the information they've been provided or have requested, the assets are valued correctly? Yes they probably could have dug a bit deeper than they originally did but if the information isn't there within the company for them to dig into how are they supposed to give an accurate judgement?
This leads me to believe that despite a number of groups, organisations and individuals being blamed for the crisis the fundamental cause of the problem was the banks themselves. With a culture and reward packages based around becoming the biggest and best bank in their market it is no wonder that many organisations manipulated their accounts, didn't value their assets properly etc. They were being rewarded extremely large bonuses for doing well, who wouldn't adapt things slightly to suit them better if you were going to get an additional £1 million in bonuses?
So yes, auditors should have been a bit more proactive and aware of tricks being played, but fundamentally the issues lie within the banks and their corporate governance structures and it needs addressing so as to prevent anything like this happening again.
Thankfully, I'm not the only one to realise this. Since the crisis banking corporate governance (BCG) has been investigated and it has been found that typical corporate governance and BCG differs in some ways. Realistically, since the global banking industry is the biggest industry in the world you'd have thought this would have been looked at long before now, but no it was only as a reaction to the crisis that BCG was looked at. Hopefully measures will now be introduced to improve BCG and prevent another crisis in the future. And hopefully, the auditors will take into consideration the lessons they have learnt and be a bit more cautious in the extent that they are reasonably assured the information is correct.
Thankfully, I'm not the only one to realise this. Since the crisis banking corporate governance (BCG) has been investigated and it has been found that typical corporate governance and BCG differs in some ways. Realistically, since the global banking industry is the biggest industry in the world you'd have thought this would have been looked at long before now, but no it was only as a reaction to the crisis that BCG was looked at. Hopefully measures will now be introduced to improve BCG and prevent another crisis in the future. And hopefully, the auditors will take into consideration the lessons they have learnt and be a bit more cautious in the extent that they are reasonably assured the information is correct.
Sunday, 10 March 2013
Vodafone and Verizon Merger
Last week I discussed FDI, today I will consider one possible type of investment opportunity: Mergers and Acquisitions. Mergers and acquisitions (M&A) involve the buying, selling, dividing and combining of different companies and legal entities. M&A trends tend to occur in a cyclical pattern in line with changes in domestic and world economies. The last cyclical trend began in 1999 during the tech boom with a significant increase in the number of M&A activities, and their values, compared to previous years. When the tech-bubble burst and economies began to slow, the level of M&As fell. 2004 is believed to be the end of the downturn, and the start of our current cycle.
Despite being in the downturn of our cycle, there are still M&As occurring. Today, the focus is not on the trends of M&A activity, but on the merger of Vodafone and Verizon. Vodafone currently possesses a 45% stake in Verizon, but this week it has been announced that Vodafone hopes to up it's stake and fully purchase the company. The deal, worth $160 billion, will potentially result in the largest M&A activity on record. But what can both parties expect during and after the merger, and is it a good idea?
In Anglo-American organisations, the fundamental principle is to maximise shareholder wealth. But to what extent will this occur? The answer is dependent upon how you view the acquisition. Theoretically, the shareholders of the target company (i.e. Verizon) are likely to see their wealth maximised as their share prices rise by 30%. However, for the shareholders of the bidding company (i.e. Vodafone) they are likely to experience little or no gain on their shareholder wealth. Why? Because investing into Vodafone at that moment in time would be too risky as the success of the activity cannot be predicted. So the question is raised, if the wealth of Vodafone's shareholders is not being maximised then why is the activity being performed?
In my opinion, the reasoning behind the Vodafone and Verizon transaction is to provide synergy between the two organisations. This basically means that the two organisations together are worth more than they are separately. It is argued, that if the merger occurred 70% of Vodafone's total earnings would be from Verizon, a significant increase from the 40% it had in 2010. I believe that by entering into this merger, Vodafone will see an increase in market power and presence, allowing them to receive better economies of scale and easier entrance into new markets and industries.
However, a worrying thought is that there could be some managerial motives behind this merger. It is speculated that Vodafone's management are also pursuing other possible acquisitions and mergers if the Verizon one was to work successfully. Could this be an indication that Vodafone's management are looking to increase their own status and power, and possibly build their own empire? If so, this is very concerning for all parties and stakeholders involved.
For me however, I feel that the most worrying and concerning aspect of this merger is the reaction from Verizon's management, the press and some stakeholder groups. There are a lot of criticisms regarding these discussions, and a lot of reluctance from Verizon to agree to the takeover. This strongly suggests to me that if the acquisition was to occur, it would not occur easily and may damage shareholder wealth in the future.
Studies have found that there are three key reasons why mergers fail; misguided strategy, over-optimism and failure to integrate management. If the Vodafone Verizon transaction was to fail, my bet would be on failure to integrate management being the reason behind it. I feel that there is already too much resistance to the news now, and this will only get worse as talks continue. This is likely to result in damaged morale for the takeover company and won't provide the synergy and savings Vodafone are hoping to benefit from.
Personally, I can see why Vodafone would want to enter into this deal, and I can understand some of the reasons behind why Verizon are against the deal. I don't think there's an easy resolution and at some point one side will have to compromise. For the time being this is a news story I will be closely interested in and hope that whatever happens, it happens successfully. These are two good companies, who need to focus on maintaining their good relations with each other if they hope to continue working together in any way in the future.
Despite being in the downturn of our cycle, there are still M&As occurring. Today, the focus is not on the trends of M&A activity, but on the merger of Vodafone and Verizon. Vodafone currently possesses a 45% stake in Verizon, but this week it has been announced that Vodafone hopes to up it's stake and fully purchase the company. The deal, worth $160 billion, will potentially result in the largest M&A activity on record. But what can both parties expect during and after the merger, and is it a good idea?
In Anglo-American organisations, the fundamental principle is to maximise shareholder wealth. But to what extent will this occur? The answer is dependent upon how you view the acquisition. Theoretically, the shareholders of the target company (i.e. Verizon) are likely to see their wealth maximised as their share prices rise by 30%. However, for the shareholders of the bidding company (i.e. Vodafone) they are likely to experience little or no gain on their shareholder wealth. Why? Because investing into Vodafone at that moment in time would be too risky as the success of the activity cannot be predicted. So the question is raised, if the wealth of Vodafone's shareholders is not being maximised then why is the activity being performed?
In my opinion, the reasoning behind the Vodafone and Verizon transaction is to provide synergy between the two organisations. This basically means that the two organisations together are worth more than they are separately. It is argued, that if the merger occurred 70% of Vodafone's total earnings would be from Verizon, a significant increase from the 40% it had in 2010. I believe that by entering into this merger, Vodafone will see an increase in market power and presence, allowing them to receive better economies of scale and easier entrance into new markets and industries.
However, a worrying thought is that there could be some managerial motives behind this merger. It is speculated that Vodafone's management are also pursuing other possible acquisitions and mergers if the Verizon one was to work successfully. Could this be an indication that Vodafone's management are looking to increase their own status and power, and possibly build their own empire? If so, this is very concerning for all parties and stakeholders involved.
For me however, I feel that the most worrying and concerning aspect of this merger is the reaction from Verizon's management, the press and some stakeholder groups. There are a lot of criticisms regarding these discussions, and a lot of reluctance from Verizon to agree to the takeover. This strongly suggests to me that if the acquisition was to occur, it would not occur easily and may damage shareholder wealth in the future.
Studies have found that there are three key reasons why mergers fail; misguided strategy, over-optimism and failure to integrate management. If the Vodafone Verizon transaction was to fail, my bet would be on failure to integrate management being the reason behind it. I feel that there is already too much resistance to the news now, and this will only get worse as talks continue. This is likely to result in damaged morale for the takeover company and won't provide the synergy and savings Vodafone are hoping to benefit from.
Personally, I can see why Vodafone would want to enter into this deal, and I can understand some of the reasons behind why Verizon are against the deal. I don't think there's an easy resolution and at some point one side will have to compromise. For the time being this is a news story I will be closely interested in and hope that whatever happens, it happens successfully. These are two good companies, who need to focus on maintaining their good relations with each other if they hope to continue working together in any way in the future.
Saturday, 2 March 2013
Foreign Direct Investment
In Anglo-American organisations is it argued that the overall aim of the company is to maximise shareholder wealth. One way to do this is through foreign direct investment (FDI). FDI is the purchase of physical assets or a significant amount of a company's ownership in another country so as to gain a measure of management control. But, why do companies choose FDI over other options such as exporting or licensing?
Truthfully there is no simple answer to this question. It depends on the circumstances of the organisation. If I was a UK based organisation looking to expand my target market, and sell my products in Europe the sensible choice would be to export. It would be relatively low cost and wouldn't require any large levels of financing or transferring of knowledge. But if I was the same organisation looking to expand my target market, and sell my products in Latin America, licensing and FDI would be more sensible choices than incurring large transport costs through exporting. The choice lies solely with the organisation. But that does not mean we can't speculate why an organisation has opted to do something the way they have.
Let's take Kraft, for example. Kraft Foods Group Inc are a US based food conglomerate who in 2012 announced their acquisition UK based chocolatier, Cadbury. The reason? So they could expand into the snack business of emerging markets, in particular India. But why, if their sole aim was to expand into new markets, did Kraft choose to invest into the UK?
In FDI theory there are a number of reasons discussed as to why organisations choose FDI over exporting or licensing. A lot of these theories, such as market imperfections, transport costs and eclectic paradigm, could be easily applied to Kraft if they had opted to invest in India, or another developing market, rather than the UK. But the question is not why India, the question is why UK? Why Cadbury?
I think the answer to that is in the question itself. Kraft have not chosen to invest in the UK for it's location, it's easy access to other locations, it's stable economy etc. They have chosen to invest in the brand, Cadbury. And who could blame them? Cadbury as a brand name was known in over 50 countries worldwide and was the industry's second largest globally. Having Cadbury in their brand portfolio was not only going to provide Kraft with an easy way into new developing markets, it was going to allow them to enter existing markets with minimal effort, develop upon existing product ranges and ultimately maximise their shareholder's wealth. Cadbury had the skills and knowledge needed to operate on their own so Kraft was not risking any knowledge transfers and was minimising it's exporting costs to some places in the process.
The Kraft takeover wasn't as smooth as Kraft would have probably liked. There was a lot of negative press regarding the takeover, especially in the UK, and Cadbury themselves weren't keen on the acquisition in the first place. Up until now I've never really had an opinion on the Cadbury takeover, but it's seems to me that Kraft's reason for acquiring Cadbury isn't as transparent as the reason they gave to the press. Yes saying you're buying Cadbury so as to reach new developing markets may be true, but it just seems that there are a number of other ways FDI options that could have been explored which would have made more sense, theoretically anyway. In my honest opinion, the whole purpose behind this method of FDI was to maximise shareholder wealth by buying into the brand. And since I've already said that is the main aim of an organisation, I can't really argue against the decision.
Truthfully there is no simple answer to this question. It depends on the circumstances of the organisation. If I was a UK based organisation looking to expand my target market, and sell my products in Europe the sensible choice would be to export. It would be relatively low cost and wouldn't require any large levels of financing or transferring of knowledge. But if I was the same organisation looking to expand my target market, and sell my products in Latin America, licensing and FDI would be more sensible choices than incurring large transport costs through exporting. The choice lies solely with the organisation. But that does not mean we can't speculate why an organisation has opted to do something the way they have.
Let's take Kraft, for example. Kraft Foods Group Inc are a US based food conglomerate who in 2012 announced their acquisition UK based chocolatier, Cadbury. The reason? So they could expand into the snack business of emerging markets, in particular India. But why, if their sole aim was to expand into new markets, did Kraft choose to invest into the UK?
In FDI theory there are a number of reasons discussed as to why organisations choose FDI over exporting or licensing. A lot of these theories, such as market imperfections, transport costs and eclectic paradigm, could be easily applied to Kraft if they had opted to invest in India, or another developing market, rather than the UK. But the question is not why India, the question is why UK? Why Cadbury?
I think the answer to that is in the question itself. Kraft have not chosen to invest in the UK for it's location, it's easy access to other locations, it's stable economy etc. They have chosen to invest in the brand, Cadbury. And who could blame them? Cadbury as a brand name was known in over 50 countries worldwide and was the industry's second largest globally. Having Cadbury in their brand portfolio was not only going to provide Kraft with an easy way into new developing markets, it was going to allow them to enter existing markets with minimal effort, develop upon existing product ranges and ultimately maximise their shareholder's wealth. Cadbury had the skills and knowledge needed to operate on their own so Kraft was not risking any knowledge transfers and was minimising it's exporting costs to some places in the process.
The Kraft takeover wasn't as smooth as Kraft would have probably liked. There was a lot of negative press regarding the takeover, especially in the UK, and Cadbury themselves weren't keen on the acquisition in the first place. Up until now I've never really had an opinion on the Cadbury takeover, but it's seems to me that Kraft's reason for acquiring Cadbury isn't as transparent as the reason they gave to the press. Yes saying you're buying Cadbury so as to reach new developing markets may be true, but it just seems that there are a number of other ways FDI options that could have been explored which would have made more sense, theoretically anyway. In my honest opinion, the whole purpose behind this method of FDI was to maximise shareholder wealth by buying into the brand. And since I've already said that is the main aim of an organisation, I can't really argue against the decision.
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