Corporate tax: Are companies right to avoid it?

Keeping costing to a minimum has always been a philosophy in the business world, after all why would anyone want to pay more out than they should? However in these challenging economic times this has become the vital issue for businesses whose structure must operate in the most cost effective manner.

The concept of tax avoidance comes in here - this must not be confused with tax aversion which is illegal! Tax avoidance however is completely legal and so has prompted many companies to tax advantage of lower tax rates offered around the globe by restructuring their business and locating their headquarters in countries which will benefit their operations. With countries like Bahrain, Bermuda and the Cayman islands offering 0% tax rates, is it surprising so many companies are choosing to go down the restructuring route?! From a manager point of view if maximising shareholder wealth should be their priority then isn’t this a method of achieving this? It would certainly seem that way, by reducing their tax bill in some cases by billions, this will help improve profits and increase capital available for dividends.

I am going to use the case of Google again in my blog this week - the company was mentioned in my second blog in terms of stock market efficiency. Here however the company has received scrutiny over its tax-avoidance techniques with payments as low as £1.2million for the UK operation revealed despite its parent company in the US making massive profits! Matt Brittin who heads up the UK subsidiary of the company said: “We have an obligation to our shareholders to set up a tax-efficient structure, and our present structure is compliant with the tax rules in all the countries where we operate" (London Evening Standard, 2011).

According to Bloomberg (2011) Google managed to reduce its tax bill by $3.1billion over the past 3 years by using techniques which divert profits through Ireland, the Netherlands and Bermuda. Through this shifting of income they have managed to take advantage of an average overseas tax rate of 2.4% despite operating in some of the world’s highest taxed countries! Google’s ability to achieve this relies on transfer pricing which allows income to be allocated in tax havens, like Bermuda, and expenses allocated to the countries with higher tax rates. It is estimated this costs the US government as much as $60billion every year!

However is this really ethical? I certainly don’t think so - after all isn’t it the company’s duty to contribute to the society in which it operates? By avoiding tax the home government whether it be the UK or elsewhere  is missing out on vast amounts of income which will have a detrimental effect on the country we live in, with the only option left for them to make cuts or attempt to generate the money from elsewhere – probably our pockets! In this respect I think it is unfair for multi-million pound companies to avoid what it is their moral duty to pay!

On the other hand, thinking about this from a manager’s point of view allows me to see why this happens. As I brought up in my first blog, bonus culture in today’s business world is often linked to maximising shareholder wealth - tax management is seen as a wealth generating strategy. So if I was managing one of these firms pressure to perform and meet targets would make it almost impossible to avoid such strategies!

So, it is clear tax avoidance is a popular strategy in the business world. The UK government has assured public it will do more to try and put a stop to big companies abusing the system. It has also been claimed that some large corporations have developed ‘unduly cosy’ relationships with HMRC; with the public accounts committee claiming around £25billion of tax is currently outstanding (BBC, 2012).

Goldman Sachs faced legal proceedings from UK Uncut last year over claims that HMRC waivered the banks interest payment on their tax bill - this claimed ‘error’ was estimated at between £5-8million by the National Audit Office (BBC, 2011). If this is the case it’s no wonder the public are becoming increasingly frustrated about the situation!

Raising capital!

Last week my blog focused on stock markets, a key way for companies to raise much needed capital, however alternative methods to equity finance are out there… namely debt finance!

To start up new business as an individual or even to expand an existing company funds will be needed. So how can individuals/companies find these funds? If we didn’t have options like this for raising finance then we’d have far fewer companies out there and I think the business world would be a different place!

I will first touch on the equity finance market. A trend amongst stock exchanges in recent times appears to be mergers, with exchanges across the globe competing to become the champion. To do this lowering their prices is important and mergers are seen by the exchanges as a way to achieve this.

In the news this week has been talk of the failed attempt at merging the NYSE Euronext and Deutsche Borse stock exchanges. The deal was brought to a halt by European competition regulators who believed the combined exchange would have hold too much financial power in the trading world. It was claimed it would create a near monopoly, which was seen as unfair on competition grounds with the exchange covering around 90% of trade across the globe (BBC, 2012). This would make it hard for it European competitors to retain their competitiveness (Huffington post, 2012). The following video displays these concerns:

http://www.bbc.co.uk/news/business-16838854

In response both exchanges announced they will now focus on smaller acquisitions to boost their existing business. Although it has been a disappointing result for the stock exchanges themselves, I feel the news will be well received by shareholders wanting the financial markets to remain competitive allowing them to take advantage of the best prices. Linking back to last week’s blog which brought up the theory that in an efficient market share prices will rise in response to positive news, this was reflected in the 4.6% rise in NYSE share price (Yahoo! Finance, 2012).

i will now turn to debt finance, this has been on the rise over the past few decades. It has an advantage over equity finance in that it’s less expensive due to a lower rate of return and the tax deductibility of interest. However this form of debt must be repaid over a certain time period (Arnold, 2008).

For larger companies out there, one method of raising finance through debt is using a syndicated loan. This type of lending is becoming more popular and it’s easy to see why… it allows for companies to borrow large amounts which one bank alone may be unwilling to provide. Here, a number of banks group together and contribute towards the total required funds. So, while it is benefitting the companies in that they can acquire the funds they desire it is also helping the banks by allowing them to spread the risk (Arnold, 2008).

A recent company in the news regarding its syndicated loan debt is Xstrata. The company has asked banks to keep its $6billion of existing syndicated loans in place throughout its $90billion merger with Glencore. This will allow the companies to wait until the merger has gone through before having to consolidate its loans into a new syndicated loan (Reuters, 2012). It would seem banks are keen to cash in and become a part of this merger with Barclays winning an equity advisor role at last minute. The bank already lends to Xstrata along with underwriting many off the company’s bond issues and yet it was originally left of the list of institutions involved in the merge (Telegraph, 2012).

Between them Xstrata and Glencore are among the biggest borrowers or syndicated loans, as banks attempt to reduce their individual exposure to the company which has in the past been reliant on their loans. The company will have to restructure its debt finance upon merging as together loans will exceed the lending limits set by the banking industry.

Glencore has a net debt of $12.9 billion, with Xstrata just behind at $8.1 billion of net debt. So would these companies be able to pull of such a merger without the availability of debt finance? I think it is unlikely as it was only through the banks waiver terms for throughout the merger that the companies were able to maintain sufficient working capital. One positive however it that if they pull it off no new debt will have been created, which has surely got to be a benefit for the shareholders?

Stock market efficiency - Predictable or game of chance?

According to Stratman (1999) market efficiency has two meanings. Firstly ‘that investors cannot systematically beat the market’ neither with technical or fundamental analysis, and secondly ‘that security prices are rational.’ In this sense he refers to the fact that prices are based on fundamental issues such as risk rather than psychological tendencies like regret. So, bearing in mind these definitions how efficient are stock markets?

Efficiency can come in three different forms – operational, allocational and pricing, for the purposes of this blog I am going to focus on price based efficiency. In this view if markets are efficient then share price should rise on receiving positive news and should fall in response to negative news, but in reality does this always happen?

Google recently proved that markets don’t always react in the way we might expect! Despite the company’s revenue exceeding $10billion dollars for the first time, a 6% increase in profits was below the expectations of the market and led to a 9% dip in their share price wiping billions of the market value (Mail Online, 2012). How can this be? Have expectations become too high when a company yielding $2.7billion in one quarter is facing a share sell off. Or are investors being extremely cautious due to the current economic conditions? Analysts have been weary of increased spending on developing ideas, particularly its expansions into the social networking sector.

 A similar situation emerged on February 9^th 2012; Diageo announced positive half year results with a 15% rise in profits (BBC, 2012). This information however did not impact the company’s share price at all reflecting the under-reaction of markets. 

So, should we be paying more attention to the theories of Kendal (1993) he suggested that the way in which prices rise and fall has no systematic pattern and branded financial analysts as being irrelevant! The concept of ‘random walks’ comes in here, this is due to the fact that share price reflects all available information at one point in time and will only change when new information is published (Arnold, 2008). Like a stumbling man not knowing which way to turn, looking at past information will not help predict what might happen in the future. This is due to the fact price fluctuations are based on new information being released and the market reactions to this… until it happens we cannot possibly know whether it is going to be positive or negative information!

So is investing in the stock markets merely just a game of chance? Would we be better of blindly picking a company to invest in out of a hat? Might this be just as successful as if we’d spend valuable time and effort assessing all the available information relating to possible investments? Surely not?!

If this was the case then why do we still have analysts? Someone must believe we still need their expertise and knowledge to help guide us. If I was looking to invest I’d certainly value this information, but maybe that’s just me wanting not wanting to feel as though I’m taking a huge risk with what little money I have! Perhaps the gamblers amongst us would like the risk?

Fama (1970) on the other hand identified that efficiency of markets can come in three forms: Weak form, semi-strong form and strong form. In an ideal, perfect world everyone would expect markets to be strong form – efficient, but examples like the ones above show this is not always the reality. That is not saying in some companies it can’t happen… but is this just down to chance?

As always people have contradicted this concept, Warren Buffet for example suggested that share price only reflects people’s emotions such as regret which are not always logical. The concept of ‘regret aversion’  (Baker & Nofsinger, 2010) means that although an investment might be losing money people are likely to keep it until they break-even again just so that they don’t have to admit they made the wrong decision – if this is the case then no wonder stock markets don’t operate in the manner we expect them to!

As a final point, I feel the IPO of Facebook will be an interesting one to watch out for in the future. As anticipation builds over the availability of shares pushing the price up to premium levels will this result in an over-reaction of the market? I guess we’ll have to wait and see!

Shareholder Wealth Maximisation – Does the lavish bonus culture developing in the banking industry need to be stopped?

If the suggested primary objective of organisations is to make decisions which maximise value for its owners – the shareholders, then could companies who are indulging themselves in lavish bonuses potentially be in trouble?

Barclays for example have been in the spotlight recently as investors warn they will not tolerate lavish bonuses for the company’s executive directors. As the backlash from the public continues the board is being urged to end the company’s excessive bonus culture. It has been claimed by a top 10 investor in the firm that ‘if the bank doesn’t exercise real restraint then it faces a shareholder rebellion.’ (Financial Times, 2012) So is this right?

The company’s share price over the past year has fell below both the FTSE all share and the banking industry, is this a sign that the shareholders will not stand for the company’s practices any longer?

Contractual theory leaves shareholders, despite arguably being the most important for corporate success, with incomplete contracts. This means that if they feel the company is not acting in their best interests they can walk away and sell shares whenever they want. Our capitalist market system means they are then free to invest in a company which might prioritise the shareholders needs over other factors.

Many people adopt the view that since investors have took the risk to invest in the company and showed support for their strategies that any left over capital should be directed their way. However, some people may have the opinion that directing funds elsewhere is perfectly fair… Can shareholders really be so angry with a company’s financial decisions when from the start they were characterised as the residual risk takers?  The company stated from the onset that they have no obligation to pay out, after all wasn’t it the shareholders personal choice to invest their savings in the company knowing this?

Another example is former Lloyds boss Eric Daniels; he was the man behind the company’s disastrous HBOS takeover. Yet he received a salary of £1.1million plus bonuses of £1.45million in 2010 (Mail Online, 2011). He was ousted from the company in early 2011 however remained on the payroll until September 2011 racking up hundreds of thousands a month – Of shareholders money!! This is an example of ‘managerialism’ and how individuals within companies can be out to indulge their interests rather than those of the shareholders.

It also displays how mergers and acquisitions if not managed carefully can lead to shareholder value destruction. This can happen relatively quickly in comparison to the many years taken to create value. Lloyds TSBs £12.2billion takeover of Halifax Bank of Scotland (HBOS) led to Lloyds share price declining 17.7% to 253p (BBC, 2008).

So, with all this in mind should we avoid too much focus on incentive schemes for CEO’s? If companies did this we could risk losing some of our countries most talented and knowledgeable directors, who may be poached by firms who will offer them the financial incentives they feel entitled to! An alternative could be to offer share option schemes to managers therefore aligning the objectives of both the company and its shareholders. It could also help reduce the effects of short-termism and help managers focus on long term prospects of the company.

To round up, it clearly doesn’t seem right that in current market conditions such huge bonuses are still being received... Shouldn’t pay schemes be adapted to fit in with the current financial conditions? In the case of Lloyds especially, who received government bail-outs to support them through the financial crisis, how can these huge pay outs to executives be justified?! Does their commitment and quality of work justify this or are these managers just plain greedy!