9 - The use of debt finance

As covered in the blog of week 3, there are two methods that companies can raise finance, which are equity and debt. Equity finance is to issue shares by various ways, this means it is more risky compare to debt finance, and expecting a higher return as it requires a higher amount of funds to issue shares. Furthermore, through debt finance companies enable to find it lower cost and cheaper, as it is lower transaction cost and tax deductibility of interests, this means the company use debt finance expects lower returns with less risk.

In a contemporary business environment, there are many companies are using equity to raise their finance as equity finance is earlier to gain funds through issue shares in the stock market. However, there are still a number of companies using debt finance, for example, Japan based company of Sony, Sharp and Panasonic, they has announced that losing over billions due to technological edge and mass appeal and their share prices are also declining since 2009. They are well-known multinational businesses in the worldwide, and also a major employers and exporters in Japan. If these three companies collapse, it will cause a huge effect to Japan economy. Therefore Japanese government requested these three companies to borrow huge amounts of debt funding to keep them afloat.

Doubt these three companies were through equity finance to raise their capital, and the past evidences showed that their share prices has dramatically dropped since 2009, which demonstrates that if these three companies cannot perform well in next few years, the consequence of these companies will  collapse and cause Japan economy to downturn. Although using debt finance although companies need to repay interests of it and may cause a fall in share price, the debts take a number of years which determine it is a low risk compare to equity finance when facing to this situation. Also, debt finance enable to decrease the WACC over the time in order to generate a higher NPV profits as debt finance is cheaper than equity finance. As a result, Sony, Sharp and Panasonic’s share price may suffer an unoptimistic situation when using debt finance, but they may able to take advantages to changes their company’s capital structure.

8 - The impact of family business financing decision

Family business will be discussed in this weekly blogger. As covered in blogger 5, there was a banking crisis occurred in 2008. This will cause a huge effect to whom are doing family businesses. Firstly, economy recession appears while the banking crisis existed, it causes small-medium businesses face a difficult challenge to survive in their industry. Secondly, as banking crisis occurred, credit crunch will be existed, this means businesses are harder to gain bank loans, especially to small-medium businesses. Above factors indicate a problem that family businesses may face, raising capital.
 
Although most family businesses aim to grow faster, the recession left a impair mark, which causing some family businesses are either unable or harder to source finance and capital. There are two different situations that family businesses can choose. For example, if a family business is public companies, this means the business is able to raise capital through issuing equity to shareholder, which listing on stock market. Although it sounds like easier to get fund from public, the family business need to be transparency, which means that they requires producing documentation to public. In contrast, if a family business is private company they only can raise their capital through bank loans. However, due to the influence of recession, small-medium family businesses are remained restricted for availability of loans from bank.
 
 
Normally, family businesses do not produce any documentation as they are closed environments and protective of family secrets. In contrast, for those larger family businesses, although they are able to gain fund by issuing equity, they may need to aware of agency problems. Investor may not trust the family businesses with their wealth as the founding members or managers of family businesses may only server their own needs, which effect the growth of the business. However, in the situation of small-medium family businesses, they found borrowing loan harder as many banks feel business confidence was declining, which means the aim of growing and expanding their family businesses are not achievable .
 
 
The effect of recession has a huge impact to family businesses, and what will be the best method for those family businesses to run in contemporary business environment? As most of banks are restricted to lend funds to small-medium business, and the result of survey shows over 40% of applicants have been refused in each quarter this year, which means family businesses are not able to grow and invest, and it is frustrating that bank finance is still difficult to get.

7 - The failure of banking industry

To recall back to 2008 USA bank crisis, Banking industry was successful before 2008, it was determents as much profitable compare to other potential industries, such as oil, gas and coal, and global banking industry revenues were 6% of global GDP. However, there was no emphasis on corporate governance measures for financial institutions, and caused a banking crisis in 2008 which originated by Lehman Brothers. As a result of this, there were more than 465 banks have failed after 2008 banking crisis, some of banks are either nationalised, takeover or collapsed.

There are a number of reasons why causing the bank crisis happen. The management of  interconnection between the inherent business risk and remuneration was collapse. This was causing a problem between remuneration structures and bonuses, which encouraged excessive short-termism rather than focus on maximising shareholder's welfare, and also lack of prudent risk management and weaknesses in reporting on risk were serious problems as there were no one care about the risk. Therefore this indicates that banking industry was lack of corporate governance, and it was a main contributor to the financial crisis.

From a personal perspective, this is a question that why global banking industry revenues were 6% of global GDP, this is a strange issue that there was a lack of corporate governance measures for financial institutions. There should be more corporate governance compare to non-financial institutions. If there was existed a strong corporate governance in banking industry, people who working in banking industry cannot easier to achieve personal welfares (easier to let businesses and citizen to get bank loan in order to take more remunerations).

10 - The use of dividend policy

In this weekly blogger it will explore dividend policy.  There is a question, what is dividend policy? Dividend policy is to determine the proportion of profits that paid out to shareholders. Shareholders usually buy share from stock market, and the share of the company usually pay out dividend periodically. Most of people think that the reason why companies need to pay dividend back to shareholder is to return money back to shareholder to maximise their wealth.

However, this is an interesting question to everyone. Do a company want to maximise shareholder wealth? The answer is yes, but they may have other purposes when paying dividends, such as to keep shareholders buying their shares. Indeed, there are two different situations that the company may face, which are obtain attractive investments and a project that difficult to obtain or too expensive. If a company is paying a small amount of dividend which represents the company is using the amount of money to invest into a project. On the other hand, if a company is paying a huge amount of dividend to shareholders, it may be a signal that the company does not have any project to invest to.

When a company decide to pay a dividend, what do they need to consider? Modigliani & Millar (1961) suggest that company should determine by investment policy, not the amount of earning distributed, which means the amount of paying dividend has no effect to company value. The dividends represent a residual payment and therefore it is irrelevant to pay more dividends when the company try to increase their value.  However, Modigliani & Millar assumption only applies in a perfect capital markets, no issue cost for securities and no tax.

Looking at a warehouse club company Costco, the announcement that Costco will spend 3 billion USD to pay a special dividend to shareholder, as higher tax rates that may kick in come January, from this announcement Costco share price rose 6.3% dramatically.

It can be seen that Costco is based on a tax issue to raise dividend to shareholder, which cannot apply Modigliani & Millar (1961) assumption. However, the amount of the dividend, a low dividend is considered bad news to the company. Costco spent $3 billion on special $7 dividend per share, which demonstrates this is a good new to Costco as they have performed well previous year. Through this action it will display an unstable dividend compare to last few years, it will lead investors who aims for short team may intend to sell their shares when the company drop their amount of dividend in times. Therefore to all companies are willing to pay dividend should be stabilize their dividend in order to lost potential investors.

6 - Failure of Merger and Acquisition

Last week, I discussed about how firm could gain advantages by using FDI, and this week is something seminar to FDI, as this is one of method in FDI, Merger and Acquisition (M&As). To those multinational enterprise who seek for competitive advantages in their industry, sometimes they do not have a competitive advantage or even a competitive disadvantage, and thus they will use M&As to cover it. The concept of M&As is to help company grow quickly in their industry, or enter a new market, without using joint venture or create a subsidiary. According to Arnold (2012), he defines that there are a number of M&As motives, such as market power, entry to new markets and industries, risk diversification, acquire superior management skills, and technological innovation. From above we could see that M&As lead an enterprise to a successful model.

Although M&As has a lot of advantages to lead a company to success, it still have some factors to consider with, for example, company A may merger with a fake performance of company B, once they merger, the overall of the business maybe doing badly, and also when they merger, it will exploit company A share price increase, however when the news come out with the overall of their business has no increase as the market expected, their share price will drop afterward.  

The example was HP, HP made a deal with Autonomy which bid 12bn USD. The company was planning to move away from making computer industry into the software business. Although this would be a market power for HP as Autonomy is a existed player for over 10 years and they are the industry-leading technology in the industry and this could lead HP more profitable, Autonomy had misled HP which provided a fake report to HP, which causing HP over bid to the company. When the news came out, HP share price dramatic dropped around 12%, this was the 10years lowest point.

From this case, HP was overbid Autonomy as they think the position of Autonomy in software industry was essential, however Autonomy through falsify, conceal, and other techniques to conceal the company's financial position, and misled HP acquisition valuation, which causing HP loss over bid fund and damaged their share price value.

To sum up, enterprise could gain advantages from Merger and Acquisition which lead company increase their profit, and improve their management skill. However, they also need to aware of the company to merger that they are choosing, as they could conceal and mislead the bidder and as a result it could damage to their company.

 

5 - Foreign Direct Investment

Foreign Direct Investment (FDI) is now a common activity over the world, the reasons why many companies seek to FDI is to increases their sales and profits, enter a global market, reduce costs, gain a foothold in economic blocs, protect and remain their substantial domestic markets and foreign market, and acquire technological and managerial know-how.  Furthermore, some developing countries also encourage FDI as it can obtain overseas resources, increase access to return markets, increase local capital markets, and drive economic growth. This makes me remind an example of how a developing country encourages FDI in the past, China.

China was a developing country in 20th century and Chinese economy was in a depressed situation, as there had no government policy liberalisation in China to allow foreign fund inflow and outflow. However, Chinese government started to encourage FDI inflow into their country and established a policy called “Open door policy”, which allows inflow FDI into China and drive Chinese economy growth, and also gain resource transfer from overseas firms. After that, during a period of inflow FDI into China, Chinese firms are able to outward FDI to foreign country, and Chinese government also intend to create a global leading Chinese firms. Therefore Chinese government intervene to this and established a policy called “Go global policy”, which enable Chinese firms outward FDI to foreign country, and also encourage and support national firms in order to enhance international competitiveness of domestic firms , obtain overseas resources, and improve Chinese economic growth.

On the other hand, back to the attractive of companies to FDI. As mentioned in the first paragraph, there are many reasons that companies seek to FDI. The recent example of a well-known multinational enterprise called Ikea, the company has already allocated in many countries worldwide, and now the company seeks to FDI into the Indian market. From this FDI both Ikea and India would be benefit to itself, for Ikea, they can enter India market to increases their sales and profits, and also gain a foothold in economic blocs and protect domestic markets and foreign market. For India, they could increase local capital markets, and spur their slowing economic growth.

From this case we could use FDI theory “Dunning Eclectic Paradigm”, which to explain the nature and direction of FDI in Ikea. Dunning Eclectic Paradigm has identified three conditions which the firm must engage with. These are location advantage, ownership advantage, and internalisation advantage.   For location advantage, India may have its existence of raw material and low labour costs which Ikea can obtain. For ownership advantage, Ikea is a well-known trademark, and also has its own production technique, it could define as greater competitive advantages to Ikea which lead to the reason engage in their foreign production. For Internalization advantages, they are not licencing to other firms to operate their business, which is the advantages by own production.  

To sum up, the idea of FDI could benefit to both firms and inflow FDI to the country, to concern of firm FDI, they need to look at Dunning Eclectic Paradigm to see do they engage any of these conditions, which allow them to see could they obtain any competitive advantage when they FDI into a foregin country.

4. Corporate Tax and transfer pricing

As a business management student, I believe that many businesses emphasise that expense is the most important factor they will consider with, such as spending more time and focus on how to reduce cost in all areas of their business, because all industries are very competitive and all businesses try to cut costs to get a competitive advantage in order to survive and maintain their position in the market. From last decade, many companies are seeking a strategic way to minimise their taxation, and there are many multinational enterprises that strategically avoid taxation legally, this will be explained further in later sections.

Few days ago, I attended a finance lecture and heard about a case study, a company based UK called Shire, the company wanted to pay less tax and used a method to minimise tax strategically, the company would usually need to pay corporation tax in UK of 28%, and Shire knew that the tax in Ireland is less than UK by 15.5%, the tax in Ireland is 12.5%. Therefore, Shire management team decided to allocate an office in Ireland and gather their monthly board meetings in Ireland. Through this action, Shire show that they have followed through legally and have also helped the company save lots of expenses. From this case, it reminds me that many foreign enterprises register offices in Hong Kong, it is because they know Hong Kong corporate tax rate is lower than their home countries, and thus they are using this method to minimise their tax expenses.

There is also a common method to minimise tax expense through transfer pricing. Take, for example, a enterprise based in Europe and manufactures products in Asia (e.g. Malaysia) and ships the products back to Europe to sell. Through using transfer pricing the enterprise can gain more profit as Asian countries has lower taxation, compare to European countries. The enterprise could make use of higher transfer prices, from Asian manufacture to Europe retailer division. As a result, Europe division will report high cost and low profit and Asian manufacture division will report higher profit, and thus the company could minimise their tax expense and generate more profit. However, as transfer pricing is very common, and now many countries now set a law to control transfer pricing, such as China's tax authorities are now focusing inspection and execution  of rules to prevent companies who are using transfer pricing to avoid tax liabilities, a news reported that China retrieved $398milion tax after investigations of using transfer pricing on 178 companies.

Moreover, a famous company Apple inc. is one of a company that keeps their taxes expense low by stashing cash offshore. The strategy that Apple used is to set up subsidiaries and subsidiaries of subsidiaries in countries with low corporate taxes and transfer funds between them in order to minimise its liabilities. As a result,  this makes Apple that pay less tax compare to  35 % rate in U.S.

Also, Google CEO announced that they are proud of avoiding tax, saving 1.5 billion euro by transferring 7.6 billion euro in revenues to a Bermudian tax-haven.  This makes me very struggle with a question. Do a company need to think of their ethical behaviour? Or just play a rule of the game, and maximise shareholder wealth  and company profit?