The Panama Papers: Perfectly Acceptable or Just Simply Unethical?!

The terms “tax evasion” and “tax avoidance” are often used synonymously, but as I found recently the two terms appear the name but are completely different. It seems rather bewildering to me that if one evades a tax they are liable to face criminal charges, but if one avoids a tax then this is perfectly acceptable. To put this into perspective, consider the government definition of tax evasion: ‘exploiting a tax advantage that parliament never intended.’ Despite this, offshore tax funds are still considered perfectly legal under UK jurisdiction.

It really is quite remarkable how much of a grey area this is.

Remember the Wiki Leaks scandal of 2010?! The Panama Papers make that look like a 

 

 

 

 

 

 

 

 

Some 11.5 million documents have been released by the whistle-blower “John Doe,” including 200,000 companies. This has sparked recent discussion: Is the use of tax avoidance schemes ethical?

Personally, I think schemes such as those used through the Panamanian law firm Mossack Fonseca are unethical due to the fact they completely undermine the integrity of the tax system which we are all a part of. Taxation is vital for society to function; schools, public services, healthcare ect are all funded through tax, yet it appears those who are due to contribute the most are tending to contribute the least, as they are rich enough to employ accountants and lawyers to mastermind tax-avoidance schemes.  As well as depriving the public of much needed funds, offshore funds can also harbour corruption for world leaders, due to the banking secrecy laws tax havens inhibit. Take Russia’s president for example. He has been heavily linked to hiding nearly $1bn through Mossack Fonesca. To briefly summarise an extremely complex process, he basically used Mossack Fonesca to set up a number of offshore companies under name of his best friend, Sergei Roldugin, who was then able to control the assets by giving out loans through a bank, which, coincidentally, his friend Yuri Kovalchuk owns!  You couldn’t make it up, could you?! The implications of this compromise democracy as anonymous transactions can be made to fund corrupt activities like bribery.

I’ll leave you with my suggestions on remedies the UK government should take. Firstly, I believe the government should place more emphasis on making corporate tax less onerous, as this would make investment in the UK more attractive and minimise the need for tax havens. Secondly, I think a review of the current tax legislation is required to prevent massive corporations like Amazon, Starbucks and Google from avoiding tax through loopholes.

Do you think my remedies would be appropriate to address the issue?! I look forward to reading your comments! 

 

BBC,. (2016). Panama Papers: Source breaks silence on Mossack Fonseca leaks - BBC News. BBC News. Retrieved 8 May 2016, from http://www.bbc.co.uk/news/world-latin-america-36232142

Harding, L. (2016). What are the Panama Papers? A guide to history's biggest data leak. the Guardian. Retrieved 8 May 2016, from http://www.theguardian.com/news/2016/apr/03/what-you-need-to-know-about-the-panama-papers

 

Was it all just an Inside Job?

 “Inside Job” – The quirky movie title perfectly describes the theme the film highlights: the fact everyone on Wall St appeared to be involved in the financial disaster. The film focuses on the changes which took place to the finance industry in the 10 years running up to the crisis, for example the political movement towards deregulation. 

I found it inconceivable that the very bodies which were supposed to be regulating the industry were all involved. The film documents the pressure from the Wall St bosses on the political process to avoid regulation which controls systemic risk. This allowed risk taking managers to maintain an unerring focus on their bonuses, with little concern over the potential risk of the products. Lenders were pushed to sign up for mortgages without regard to risk, or even favouring higher interest rate loans, since, once these mortgages were packed together, the risk was disguised. As these products were branded with AAA ratings (the safest rating possible), equal to US bonds, they could be used by investors such as pension funds.

The film focuses on changes in the financial industry in the decade leading up to the crisis, the political movement toward deregulation, and how the development of complex trading such as the derivatives market allowed for large increases in risk taking that circumvented older regulations that were intended to control systemic risk. In describing the crisis as it unfolded, the film also looks at conflicts of interest in the financial sector, many of which it suggests are not properly disclosed. The film suggests that these conflicts of interest affected credit rating agencies as well as academics who receive funding as consultants but do not disclose this information in their academic writing, and that these conflicts played a role in obscuring and exacerbating the crisis.

A major theme is the pressure from the financial industry on the political process to avoid regulation, and the ways that it is exerted. One conflict discussed is the prevalence of the revolving door, whereby financial regulators can be hired within the financial sector upon leaving government and make millions.

Within the derivatives market, the film contends that the high risks that began with subprime lending were transferred from investors to other investors who, due to questionable rating practices, falsely believed that the investments were safe. Thus, lenders were pushed to sign up mortgages without regard to risk, or even favouring higher interest rate loans, since, once these mortgages were packaged together, the risk was disguised. According to the film, the resulting products would often have AAA ratings, equal to U.S. government bonds. The products could then be used even by investors such as retirement funds who are required to limit themselves to the safest investments.

LSE – Deutsch Börse Merger – A “merger of equals?!

 

It was announced last week that the London Stock Exchange and Deutsch Börse. I was left rather astonished that the deal was being branded as a ‘merger of equals’ by both parties, and I couldn’t help but feel a sense of inquisitiveness with regard to a) It being a good deal for both parties  b) it actually being a merger of equals.

It has emerged that each LSE share currently owned will equate to 0.4421 shares in the combined group, whilst each Deutsch Börse share will equate to 1 group share. This is the first sign that this isn’t really a ‘merger of equals’ as this is evidenced by the statistic LSE will own 45.6% of the combined group whilst Deutsch Börse shareholders will own 54.4% (Stafford & Massoudi, 2016). Furthermore, the stock market reaction to the proposed merger suggests that LSE would be getting a good deal out of the transaction, as they are significantly less profitable that DB. This is consistent with Arik & Kutan (2015) find comprehensive evidence regarding the response of target firms’ stock returns in M&As in twenty emerging markets, including a number in Eastern Europe. Employing standard event-study methodology for a sample of 1,648 M&As from 1997 to 2013, they find significant abnormal returns for target firm stocks in emerging economies around M&A announcements, suggesting that M&A transactions create value for the target firm’s shareholders in the short run.

If it is actually going to be a merger of equals then it is questionable whether the two firms will successfully integrate. Segil (2004) suggests that the main reason for M&A failure is the inability to conjoin the two firms corporate cultures successfully. This could be the case in the merger as it is common in so called merger of equals that the merging firms boards clash and there is a significant lack of cohesiveness between them that enables the projected synergies to be achieved. Take the merger between the two largest cement producers as an example: the firms predicted cost savings of 1.4billion euros but in reality the clash of French and German cultures in the firm appears too significant, and this is illustrated by the 2015 fourth quarter loss of $2.91billion (Akram, 2015); (Revill, 2016).

 

 

 

 

 

 

 

 

Source: Ft.com

As illustrates above, the deal will, however be a good opportunity to create a European exchange which is large enough to compete on a global scale against the likes of ICE, CME and the Hong Kong stock exchanges. For this reason I believe the deal is wise for both sets of shareholders, as the combined portfolio will allow a significant amount of synergies to be achieved.

 

 

 

Massoudi, A. & Stafford, P. (2016). Deutsche Börse lines up swoop for LSE. Financial Times. Retrieved 8 May 2016, from http://www.ft.com/cms/s/0/7b77d95c-da33-11e5-a72f-1e7744c66818.html#axzz484TNvU7T

Revill, J. (2016). LafargeHolcim Turns More Bullish on Cement Demand Despite Hefty Loss. WSJ. Retrieved 8 May 2016, from http://www.wsj.com/articles/lafargeholcim-pushed-to-hefty-loss-by-write-downs-1458197341

Segil, L. (2004). Measuring the value of partnering. New York: AMACOM.

Akram, I. (2016). LafargeHolcim: Becoming Reality – Part One. World Cement. Retrieved 8 May 2016, from http://www.worldcement.com/special-reports/03082015/LafargeHolcim-Becoming-Reality-Part-One-256/

Arık, E., & Kutan, A. (2015). Do Mergers and Acquisitions Create Wealth Effects? Evidence from Twenty Emerging Markets. Eastern European Economics, 53(6), 529-550. http://dx.doi.org/10.1080/00128775.2015.1099445

Mr Buffett: Is it plausible to try and copy-cat the world’s greatest Investor?!

 

Introduction

After watching the documentary ‘Warren Buffett: The world’s greatest money maker’ one gets an empowering sense they too could replicate the success of the ‘Oracle of Oklahoma’. This feeling came about due to the sheer simplicity in which he explains his investment strategy; in the documentary he states he follows the three criterion for all investments he makes:

·        Investment Philosophy

·        Security Selection

·        Psychology of Investing

 

I decided to investigate this in more detail to determine why, if it is so simple, others have struggled so much to replicate his success.

 

It is evident from the documentary that Buffett disagrees with the concept of debt financing; arguing “borrowed money has no place in the investor’s tool kit”. He highlights the dangers of highly leveraged firms, explaining that no-one can predict what is going to happen in markets. This is the first major lesson I learned:

 

1.      He doesn’t borrow to invest

 

Instead of amassing capital from bank loans he, rather intelligently, uses the float from the premiums his insurance business customers pay to invest. This is worth around $77 billion and carries an extremely simple but important advantage over traditional debt finance: It allows Berkshire to borrow at a cost averaging 2.2% (Worstall, 2013). The fact this figure is more than three percentage points below the average short-term financing cost of the American Government over the same period means Buffett is able to borrow at a rate which is below the market, therefore if his stocks make only market returns he will still outperform the market.

 

Even before Buffett acquired enough capital to implement this technique with his insurance business, he followed the same principal when making investments in small to medium sized businesses. This is the second lesson I derived from Mr Buffett:

 

2.      Use Profits to fund Operations

 

This is interlinked with the first lesson, but also carries extreme significance. He suggests that if he believes profit from one business could be put to better use, then this should be done. This point surprised me, as it reveals he does not agree with the idea that an optimum capital structure should be pursued. He is implying that trying to lower the WACC is risky because any slight changes to the WACC impact a manager’s decisions dramatically. This is the basis for arguments against Kraus and Litzenberger’s trade-off theory.

 

 

Although it may not be feasible for the vast majority of investors to imitate Buffett’s investing technique due to the enormous float generated from his insurance business, we can still learn some lessons from the ‘Oracle of Oklahoma’.

-          Use profits to fund operations

-          Sell off parts of the business if you think you could reinvest it better

 

Worstall, T. (2013). Explaining The Secret Of Warren Buffett's Success: Double Leverage. Forbes.com. Retrieved 15 April 2016, from http://www.forbes.com/sites/timworstall/2013/02/08/explaining-the-secret-of-warren-buffetts-success-double-leverage/#7d94b8767ba9

Dividend Policy: Are Global Miners BHP Billiton digging themselves into a deeper hole?!

This week BHP, the largest global mining company, announced they are to scrap their progressive dividend policy, comically only 6 months after their CEO Andrew Mackenzie made the contradicting statement “over my dead body sounds a little strong but it’s almost right”! In light of this news returns us once again to the age old question: Is dividend policy relevant?

An interesting point to begin with is the fact BHP vowed to maintain their progressive dividend policy by increasing the annual dividend by 2%, despite their share price and first half profits tumbling 92%! (Stringer, 2016). It is clear that the directors disagree with Modigliani and Miller’s (1961) dividend irrelevance theory. This is congruent with the popular view that dividend policy is important, as evidenced by the large amount of money involved and the attention that firms, security analysts, and investors give to dividends (Baker & Weigand, 2015). Personally I believe their decision to initially raise the dividend was to try raise investor confidence even though the market conditions are in a state of turmoil, with the price of a barrel of oil falling from 114.83p per barrel on april 01, 2011 to just 26.05p on feb 01, 2016 (Kumar, 2016). In a rather fitting quote, Andrew Lapping, deputy chief investment officer for South Africa-based fund Allan Gray Ltd., recently described miners promising ever-rising dividends as a “joke.” (Hoyle, 2016). It is likely BHP took Linter (2007) and Gordon’s (1959; 1962) “Bird-in-the-hand theory” into consideration when deciding to continue their progressive dividend policy. In their research, Linter and Gordon argue that dividends are preferable to capital gains due to uncertainty, and that investors would rather have the money now rather than leave it tied up in uncertain investments. This approach is likely to raise concerns amongst BHP’s investors.

Personally I agree with the dividend relevance theory, due to the fact Modigliani and Miller’s theory was based upon a number of assumptions, such as the reliance of perfect capital markets, no issue cost for securities and no tax. In reality, these factors have to be taken into consideration. Unfortunately we do not live in strong form markets, and there are transaction costs and hefty taxation implications.

 

 

 

 

 

 

 

Source: (Wsj, 2016).

BHP’s decision to scrap the policy has largely been influenced by the rest of the market’s attempts to improve their financial position by also cutting dividend.  All the main players have now cut their dividend, including Rio Tinto and Anglo-American. From this ordeal it has been made clear to myself the implications dividend policy has on the shareholder’s perceptions of the company. This dividend cut, which BHP were forced to do to try and savour their credit rating, even though this has been downgraded by Barclays and HSBC to “underweight,” has resulted in BHP’s stock falling significantly.

 

 

 

 

 

Source: (Cunningham, 2016). 

 

From this ordeal it has been made clear to myself the implications dividend policy has on the shareholder’s perceptions of the company. This dividend cut, which BHP were forced to do to try and savour their credit rating, even though this has been downgraded by Barclays and HSBC to “underweight,” has resulted in BHP’s stock falling significantly, as illustrated below.  This highlights how short term the market is, because now the short term returns have been cut a lot of shareholders have began to sell, hence the price drop.

 

Baker, H., & Weigand, R. (2015). Corporate dividend policy revisited. Managerial Finance, 41(2), 126-144. http://dx.doi.org/10.1108/mf-03-2014-0077

Cunningham, T. (2016). BHP Billiton tumbles amid fears of dividend cut. Telegraph.co.uk. Retrieved 14 March 2016, from http://www.telegraph.co.uk/finance/markets/marketreport/12095897/BHP-Billiton-tumbles-amid-fears-of-dividend-cut.html

Hoyle, R. (2016). BHP Billiton Slashes Its Dividend. WSJ. Retrieved 14 March 2016, from http://www.wsj.com/articles/bhp-billiton-slashes-its-dividend-1456177003

Kumar, D. (2016). Oil plumbs new lows below $27 as oversupply woes persist. Reuters. Retrieved 14 March 2016, from http://www.reuters.com/article/us-global-oil-idUSKCN0UY04U

Stringer, D. (2016). BHP Cuts Dividend for First Time in 15 Years on Profit Drop. Bloomberg.com. Retrieved 14 March 2016, from http://www.bloomberg.com/news/articles/2016-02-22/bhp-cuts-dividend-as-first-half-profits-fall-92-on-price-rout