Capital Structure and Shareholder Wealthy

There is a strong argument on the exist of the optimal structure. Some people suggest that there is an optimal structure in the capital structure, which could help the organization to create more shareholder wealth; while others believe that there is no optimal structure as the change of the capital structure has no effect on the company’s WACC so it do not exist. However, since this was based on the assumption, it only could be used under certain condition. Therefore, it is still difficult for the manager to control the capital structure. From my personal view, I do believe that the capital structure has kind of relationship with the shareholder wealth, which could be proved through the case below.

Like the company Peacocks, which is a clothing retail has gone into administration because of the unsuccessfully to restructure its £240m debts from its total debts. Moreover, based on the figure of the year 2010, it could be found that the debts becomes a burden for the company. It used to make operating profits of £27m, however that was reduced to a pre-tax loss of £56m as a result of £77m in bank loans and overdrafts. Therefore, the high cost of finance make the company go administration. The reason for Peacocks has so much high finance cost is because of the change of capital structure at wrong time. The manager choice to management buy out through the bank loan, which make the company has £460m bank loan in order to reduce the share capital to increase the power of manger. Since the recession continue, it could be found that the bank loan is high interest which make the company has overall debts stands at £750m in 2011. As we know that, during the recession, it could be better to choice the share equity, since the company has no need to give the dividend and the higher bank interest based on the higher risk. Hence, it could be more wise for the company to choice go for the share equity. 

Moreover, the Peacocks now sold to Edinburgh Woollen Mill since the company could not going concern with such high debts. From this case, it could seen the shareholder wealth has been destroyed by the wrongly choice on the capital structure. Moreover, it tells that we need to taking the environment into consideration, if the timing is good, it could be found that sometimes it is more cheaper to choice debt finance like when the government trying to encourage their economic it reduce their bank loan interest, which for the company is a good news to reduce their cost of finance. However, during the financial crisis, as it could be know that the credit crunch, the credit was so high as people are not willing to lend their money and the government bank also increase their rate of reserve. In this time of period, lending is at a extremely high cost.

Therefore, it could be found that in the economic growth period, the debts finance is better and during the recession period the equity and debts finance need to be carefully considerate.  The manager need to careful balanced the capital structure in order to create more shareholder wealth. As the lower cost of finance could reduce the expense,which in some extent is increasing the shareholder wealth and the unhealthy capital structure might the company go administration the the company Peacocks.

http://www.bbc.co.uk/news/uk-wales-16733819

http://www.bbc.co.uk/news/uk-wales-16737580

http://www.bbc.co.uk/news/uk-wales-16580309

http://www.bbc.co.uk/news/uk-wales-south-east-wales-16621080

Social Responsible Investment - New Fashion

Nowadays, the socially responsible investing has become a new fashion for investors.The socially responsible investing (SRI) is invest the money only based on non-financial factor especially the factor that related environment and ethical principles and regarding the profit. The reason for this is based on the improving awareness on the environment. It is used to be based on the different religious like the different culture has their belief on dealing with money. However, now it is more based on personal and social ethical convictions of the investors. Moreover, there are many SRI funds for the investors to chose in current position. 

However, people might wonder that if the fund will not invest based on the financial factor than how could it make money? This is could be answered by the definition of the SRI, the fund manager will chose to invest in those for profit business like tobacco, alcohol, gambling, nuclear power, firearms and military weapons; and chose some other company which more environmental friendly, such as the lush or the body shop. 

The reason for people still have problem on SRI is whether it will make return annually? This could be found through the figure announced by the company. The Appleseed fund, one of the largest SRI funds in the US has produced an annualised return of 6.2% in the five years. Moreover, it could be based on compare the difference of total returns between the MSCI KLD Social Index and the MSCI KLD USA. From the figure, it could be found that based on the graph, the total returns of the SRI is higher than the total average return. 

(Source from: MSCI Inc, 2010)

Moreover, the specific details could be found as follow:

                                                                                                                                                                   (Source from: MSCI Inc, 2010)

From those data above, it illustrates more detail information about the performance and the return for the SRI and the USA. It enhance the pervious figure about the SRI is higher than average return. 

Overall, it could be found that SRI is a good choice for the investor, because of it combines the high ethical investment and the good return. However, some people might still insist that the belief of high risk and high return. To some extent, this was true, however, like the current situation in some industry, it could be found that it was not so ture. This could be seen from the co-manger of Appleseed said that the largest bank are operating in the massive risks, where they making profit and it more like to be a recipe for corruption, cronyism and economic disaster. If one day the risk fail, the bank will going to close or take over by the government. Therefore, as the shareholder, the value of the share might disappear, which could be worse than they expect. Hence, from my point of view, I want to make notice the benefits of the SRI will far more than other investment and it is becoming increasingly popular. 

http://online.wsj.com/article/SB10001424052970204542404577158791058719100.html?KEYWORDS=Socially+Responsible+Investment

MSCI KLD 400 Social Index

http://www.mscibarra.com/products/indices/thematic_and_strategy/esg_indices/MSCI%20_KLD_Factsheet_Nov2010.pdf

The shareholder wealth and the financial crisis

With the financial crisis continuing, people begin wondering about the cause of the financial crisis. Many arguments suggests that the reason for this is the greed of the managers. However, some believes that it more related to the shareholder wealthy. 

This could be found from the company of HBOS, which illustrated as follows. The HBOS plc is a banking and insurance company, it used to be a well know company in the UK. During the financial crisis, the company meet the problem of credit crunch, which is a suddenly tightening of loan condition. The reason is because of the manager of HBOS use their bank loan invest in some high risk projects. However, suddenly the project failed and then the debtors worry about their money could not come back, so they are careful with their money and not willing to lend any of their money. This problem lead the company’s share price fell down 17 per cent in March 2008. Moreover, it fluctuated between 88p to 220p per share during the September 2008. Finally, in order to avoid another Northern Rock style collapse, this company was took over by Loyds TSB at 232p per share, which is much lower than the BBC estimated 300p per share. 

From this case, it could found that how the shareholder’s wealth has been destroyed through the financial crisis. From my point of view, after taking this into further consideration about the reason of the financial crisis, it could be found that the reason of financial crisis might be the greed of the shareholder. In order to create more shareholder wealthy, the manager uses all he could to make more profit of the shareholder, such as invest in some high risk project. For example, the manager of HBOS choose to provide their loan to some low creditworthy in order to make more profit. However, once the bad debts increased to a great level and met the problem of credit crush, the company in the position of bankrupt or take over by other company.

Therefore, I believe the purpose of the shareholder wealth sometimes lead some kind of misbehaviour like the financial crisis. Instead of creating more shareholder wealth, it destroy the shareholder wealth. However, all of those are depends on the manager’s operation. Hence, it back to the pervious problem that the manager should choose the right direction to create more shareholder wealthy instead of destroy it.

Does M&A destory shareholder wealthy?

Angwing (2007) point out that during the period of 1996 to 2005, the total amount of global mergers and acquisitions (M&A) is more than $23.4 trillion. The increasing amount and size M&A arose public attention about whether the M&A is really good for the organization and increase the shareholder wealthy. In particular, sometimes it destroys the shareholder’s wealthy, such as the case of the Time Warner and AOL. The merger of two companies seems to be great news to the industry in 2000 and the share price move up to $34.75, however, after the annual loss has been announced after the merger, the share price decrease immediately and in 2002 it has reported $98 billion loss, which destroyed 97% shareholder wealthy.

Moreover, it could also be found in the case of the Lenovo & IBM. In 2005, Lenovo take over the PC department of IBM by $1.25bn (£668m). As the failing PC price and squeezed profit margin in China, Lenovo using the way to take over IBM to develop the overseas market. After the acquisitions, Lenovo become the third computer manufactory. However, the bad news comes is the continue loss in IBM PC. In 2006 Lenovo announce a net loss of $116m compare with $21m profit in previous year. Moreover, although the operation become well in recent year, the overseas market still the loss part of Lenovo.

(Source from: Lenovo 2010 annual report, the segmental report)

(Source from: Lenovo 2009 annual report, the segmental report)

According to the case of Lenovo, it illustrates that the M&A did not success, because it did not achieve the primary aim of the Lenovo. Moreover, it becomes a burden of Lenovo. Therefore, it might found that the M&A sometime destroy the shareholders’ value. Then why do many managers still go for M&A? Most of people argue that it is because of the market power, survival problem, or egoism. From my point view, in the case of Lenovo, it should be market power. Although it was not their primary aim, it now becomes their advantage in China market. After it takes over IBM, it has more competitive computer manufactory in China (17.6% increase in profit in China market in 2010). This also could be found that Lenovo becomes the third computer manufactory just after Dell and HP. Therefore, although M&A sometimes destroy the shareholder value in the first stage, it will brings other benefit to the organization in the future such as the market power.

http://news.bbc.co.uk/1/hi/business/5015776.stm

http://news.bbc.co.uk/1/hi/business/7871664.stm

http://www.bbc.co.uk/news/business-11023642

Lenovo 2009 annual report and 2010 annual report

Whether India should apply FDI in its retail chain

The Foreign direct investment (FDI) is quite welcome for the developing countries such as China. The reason is because of the FDI encourage the local economic and create more working opportunity for the local residents. However, it is not always good for the local economic, because of the strong competitive multinational company might also become a threat to the local industry. 

The recent argument about wether the India should choice FDI in retail chain brings public notice. The reason is the India government trying to reform its FDI plan in India’s retail chain. The reason for the government to reform the economic might from several reason. Firstly, the repaid decline in FDI in India, FT (2011) has point out that the overseas investment decrease annually to $14bn for the first eight months of the fiscal year. Additionally, the messy current situation in India’s retail sector, the low efficiency and decelerating annual growth in domestic product (BBC, 2011). Thirdly, it will provide millions of new jobs.

However, this was resist by some small shopkeeper, they believes this will destroy their benefit event led them lose their job. This is because it is difficult for them to competitive with the supermarket giant like Tesco and Wal-mart. Furthermore, this also worried by the local farmers, because of the multinational companies might squeeze out their profit by drive down their price. Nevertheless, this has been argued that introduce the large companies will not reduce the local supplier’s profit and on the other hand, it will brings more benefits to customer and supplier by reducing the retail chain and improving the market efficiency.

Overall, from my point view, I strongly agreed with the opinion that it is time for India to introduce FDI. This is not only because of the huge benefit that the FDI will bring for the countries but also it is a global trends. The reason for me to suggest this opinion that although FDI will increase the market competition in India and left small market share for the local business. However, the competition will also bring the efficiency to the countries. What is more, the India government really want from FDI is to improve the current situation in the retail sector-- too much wholesale trader and small retailers not only low down the market efficiency and the lack of adequate cold storage and refrigeration in deliver chain. This will boost up the economic in India. As it is general knowing, china was a successful example for FDI. From the Bloomberg (2011) it states that the FDI in China in 2010 has reach to $105.7 billion (17.4% increased from last year). The huge inflow invest boosted up the economic in China as in 2010 it surpassed Japan becomes the second-biggest economy in 2010 (Bloomberg, 2011). According to  the case of China’s FDI, it could be found that the FDI will boost up the country’s economic and brings more benefits than drawbacks. 

However, some arguments about the multi-national company will be too power to be a threaten to government. This warns the government although it will brings lots of good for the country, the well regulation still need to be complete in order to achieve the original goal of the country. In other words, for india, it need to well monitor the FDI and apply the adequate regulation to control it develop towards the mutual benefits.

http://www.bloomberg.com/news/2011-01-18/foreign-direct-investment-in-china-in-2010-rises-to-record-105-7-billion.html

http://www.youtube.com/watch?v=AwsD1tBHg-o&feature=relmfu

http://blogs.ft.com/beyond-brics/2011/02/16/india-fdi-what-fdi/#axzz1nuKjz0oa

http://www.bloomberg.com/news/2011-12-07/india-s-reform-by-stealth-derails-wal-mart-choudhury.html

http://www.bbc.co.uk/news/business-16046394

http://www.bbc.co.uk/news/world-asia-india-15869378

Time for Goverment's Action

Recently, the news about the US government proposing about lower the top corporate tax rate and make it up by using the lost from the reducing the tax break like the loopholes that business organization was trying to avoid the tax.

The reason for the government in doing this, is the effective corporate tax rates were decreasing annually. This brings the government’s notice.

This was not only happens on the US as well as in the UK. But, since the high corporation tax, the business organization was using different way to avoid tax. The most popular way for Multinational Corporation is restructuring the organization to reduce their tax amount. Normally, organization can restructure their organization based on three ways in avoiding tax- ownership, transaction and transfer pricing.

From the case of Nabors Industries, it could be found that,  organization using the ownership method to restructure its company by moving their head office in to Bermuda. Nabors Industries was used to be an American corporation, while the high tax rate in the US, force the Nabors Industries move to the Bermuda, which is a zero tax rate country. The company was still trading their business in US (on shell). In the year 2005, the company announced generates $428.4 million in profit and based on that it ought to pay $86 million on tax, but the company only paid $30million in actual.  And, this was the reason why so many corporations want to avoid tax. It simply means that, by reducing their tax cost, it creates more shareholder wealth.

However, every coin has two sides, the bright sight brings more dividend to the shareholder and makes the company become more profitable and competitive, while in the opposite side, it reduces the government income. The same reason is applying in  US government in trying to rearrange their tax regulation to reduce that shell off game to improve their effective of corporate tax. 

From my personal view, I think it is time for the government to take some measures to reduce this phenomenon. Firstly, it is unfair for the small organization, as the multinational company will make use of their advantage in avoiding tax, which may leads unfair competition. Additionally, this will also encourage the small organization using other methods to avoid their tax in order to compete with the large company and this would not good for the government. Furthermore, as the large multinational companies using this method, it will also bring a kind of wind to follow, which might also has huge negative impact for the government economic, especially in this recession period. However, it is true that it is difficult to measure the taxes for multinational company and different countries have their own regulations. As a result, US government need to consider more when they trying to rearrange its tax.

(Annual report of Nabors Industries, daily mail, CNN news

http://www.dailymail.co.uk/news/article-2057306/Thirty-biggest-U-S-companies-paid-zero-income-tax-years-despite-making-combined-profits-160billion.html

http://www.focus.com/fyi/10-big-businesses-that-have-moved-abroad/#)

Debts finance or equity finance

Since the variety source of finance for corporation to choose, it has been a big problem for them to make decision. The debts finance and equity finance are two major methods of financing. Although they are quite similar in some way, they still have some unique advantage. Some small firm prefer to finance from debts finance, because it can provide the company needs with the low interest cost. In terms of the equity finance, although the company can get large number of capital from the capital market, it lose the control about the company. Moreover, it will cost a lot for them to make the initial public issue from the capital market.

However, most of the company more prefer to financing from the capital market. This is because not only the capital assets will not need to pay back but also the liquidity risk will no be a problem for the company. Especially, it was very suit for the large corporation, which always need to finance a large sum of money. This could be seen by Tullow, who is an international oil and gas company (Tullow.com).

After Tullow has noticed the natural decline production from the main exploration area, Tullow has changed its strategy and mainly focus on its exploration programme. Moreover, based on its new strategy, its new finance strategy is financing from the surplus cash flow or equity. Hence, it could be found that the company issue the shares annually, which leads the gearing ratio decreasing significantly. However, the ratio did not dropped dramatically in 2010 because of the company also bank loan to support the programme of acquisition of 50% stake in Uganda, which could be found from the cash flow. The reason for Tullow did not follow its finance strategy, because of the unexpected event of delayer finalising transaction in Uganda, which increase the needs of financing. Moreover, the reason for Tullow did not finance from the equity again is the amount of share issue in 2010 is larger than the pervious issue and the liquidity ratio is quit health in Tullow. Therefore, Tullow have to choose debt finance.

Overall, from the case of Tullow, it could be found that priority financing method is finance from the equity. The major reason for this is the company did not need to pay back the capital and the company only has to pay the annual dividend as the interest cost, which is a great deal for the large company. On the contrast, the bank loan always be the last choice for the big company like Tullow. This is because of the bank loan will increase the company’s liquidity risk and if there is any unexpected event happened, the company will meet the problem of bankrupted. However, from my personal view, the decision about whether to issue from the equity or debts more depends on the current situation of the company. For the small firm only small sum should go for the debts finance and the large sum which are more than 500,000 pounds than the company could consider joint venture. The equity finance are more suit for the large firm because of the equity finance needs large sum of transaction cost. Moreover, it is vital for the corporation to take the liquidity risk into consideration before they go for the debts finance.

(All the information are based on the website and the annual report of Tullow)