Corporate Tax

Maximising shareholder wealth has always been at the forefront of objectives for managers that run publically listed companies. Improving financial performance generates wealth for shareholders. One method of improving financial performance is to cut costs, a more controversial way of achieving this is for companies to alter their tax structure. Why pay 25% corporation tax in the UKwhen taxation loopholes can be exploited, reducing this figure to, in some circumstances 0%. Companies are able to take advantages of such scenarios due to the introduction of double taxation treaties.

Double taxation treaties are agreements drawn up between two states to:

* ‘Protect against the risk of double taxation where the same income is taxable in two states’
* ‘Prevent tax discrimination against UK business interests abroad’(HMRC, 2012)

However,companies can exploit this by “relocating” their company to a tax haven (an area with low corporate tax rates) and therefore only have to pay the corporate tax rate implemented by their state of residence. For example, there has been much speculation in the news over the last year regarding Northern Ireland’s corporate tax rate. The country shares the same tax rate as the UK, around 25%.However, the Republic of Ireland’s corporate tax rate stands at just 12.5%. As a result Northern Ireland’s economy has become heavily reliant on its public sector with private companies simply moving over the border into the Republic of Ireland to benefit from the country’slow tax rates. Many MPs are in favour of granting Northern Ireland with responsibility to determine its own tax rate, lowering it significantly would help to regain competition with the Republic of Ireland. However, Chancellor George Osborne believes Northern Ireland’s government ‘will lose about £200-300m from the NI block grant if the business tax is cut’ (BBC News, 2011).The decision regarding altering Northern Ireland’s corporate tax rate is still pending.

However, it is not only Northern Ireland that is seeing companies from its private sector moving out of the country to benefit from lower corporate taxrates…

Boots the high street retailer is a common culprit for avoiding tax. Founded by John Boot in Nottingham during the 1860s, the firm has always been considered a national corporate treasure. The firm paidout roughly about a third of its profits in UK tax every year and the UK treasury could expect this amount coming in, usually around £100m annually. However, in June 2007 the company was bought by KKR an American venture capital giant for £11.1bn, of which £9.3bn was raised through debt. In 2007 the huge interest payments on the debt (a tax deductible expense) acted as a ‘taxshield’ for the company, wiping out any tax to be paid in the UK.

In 2008 the Boots group was moved to Zug, a tax haven in Switzerland. Although little activity actually takes place at the Zug offices the company can take full advantage of the locations low corporate tax rate, currently around 19%. Although 19% is still quite high when considering other tax havens (for example, the Cayman Islands 0% or the Republic of Ireland 12.5%) it is believed that ‘the chances are good that the officials in Zugwill cut you a deal--something like a 10% rate for a decade’ (Robinson, 2009). Significantly reducing their tax will have a positive effect on the company’s financial performance and potentially increase the wealth of shareholders. Boots aren’t the only companiesto do this, Zug currently has 30,000 companies registered to the location andthis number is increasing by 800 every year.

To understand the extent at which tax evading is present in the UK, a Sky Newsreport suggests that ‘All But Two FTSE 100 Firms AvoidPaying Tax' (Sky News, 2011). Back in 2010 American food giant Kraft bought the British chocolate manufacturer Cadbury’s for £11bn. Under instruction from the new owners the company is to be moved to Switzerland, again, to take advantage of the country’s low corporate tax rates, a move that is said to cost the UKtreasury £60million a year.

An additional way of avoiding paying high tax rates is through ‘transferpricing’. Globalisation of companies allows them to shift profits over borders into countries with low corporate tax rates. For example, a company is situated in a tax haven with corporate tax rates of 12.5%, their subsidiary is located elsewhere with a higher corporate tax rate of 20%. The subsidiary is where manufacturing takes place however once the goods are ready the subsidiary under-invoices their goods to the parent company. Theoretically, the subsidiary hardly turns a profit due tothe low price they charge the parent company and therefore avoids the large corporate tax rate. The parent company however makes large profits but only pays 12.5% tax on them. Roughly about ‘60% of world trade’ (Sikka, 2009) consists of multinational companies trading internally. This provides the opportunity to ensure that profit is shifted to a state with low corporate tax rates resulting in companies paying less tax and retaining more profit.

This strategy of relocating to avoid paying high tax rates is perfectly legal, is the move then just good business?

I imagine my fellow students looking to pay £9,000 tuition fees as of September would argue not. I imagine their argument would be supported by the thousandsof public sector workers made redundant during the cutbacks or any of 2.67million people in Britain currently unemployed. Ultimately it is the British economy and taxpayers that lose out to such controversial behaviour. In December 2011, Britain’s total debt figure reached £1003.9 bn. Many companies that generate their sales and profits in the UK pay their corporate tax elsewhere, to foreign governments, bad business ethics considering the current state of our economy and it is often the taxpayer that has to pick up the bill. I believe businesses owe a moral duty to pay taxes in the countries they generate sales; finding loopholes or ways of evading paying tax is simply exploiting UK society.


Sources Used:

BBCNews. (2011) ‘Chancellor gives 'serious consideration' to tax cut’, BBC News Website, [Online]. Availableat: http://www.bbc.co.uk/news/uk-northern-ireland-13800048(Accessed: 25/02/12).

HMRC.(2012) ‘Double Taxation Treaties’, HMRevenue & Customs Website, [Online]. Available at: http://www.hmrc.gov.uk/taxtreaties/dta.htm(Accessed: 25/02/12).

Oxlade, A. (2012) ‘£1trillionborrowed: So how bad is Britain'sdebt problem?’, This is Money Website, [Online].Available at: http://www.thisismoney.co.uk/money/news/article-2091113/1trillion-debt-How-big-Britains-debt-problem.html(Accessed: 25/02/12).

Robinson, P. (2009) ‘Cutthe Corporate Tax Rate!’, Forbes Website,[Online]. Available at: http://www.forbes.com/2009/09/17/taxes-corporations-business-globalization-opinions-peter-robinson.html(Accessed: 25/02/12).

Sikka, P. (2009) ‘Shiftingprofits across borders’, The GuardianWebsite, [Online]. Available at: http://www.guardian.co.uk/commentisfree/2009/feb/11/taxavoidance-tax(Accessed: 25/02/12).

Sky News. (2011) ‘All But Two FTSE 100 Firms 'Avoid Paying Tax', Sky News Website, [Online]. Availableat: http://news.sky.com/home/business/article/16086749(Accessed: 25/02/12).

CBS News. (2011) 'A look at the world's new corporate tax havens', CBS News Website, [Online]. Available at: http://www.cbsnews.com/stories/2011/03/25/60minutes/main20046867.shtml (Accessed: 25/02/12). 

Raising Finance - You need money to make money

Companies are always looking at possible ways of raising capital at the lowest possible cost. In order to minimise debt many firms are keen to shares on stock exchanges, selling equity of their corporation to investors. However, this method does have its disadvantages. For example, entrepreneurs can lose some control over their companies and must begin to satisfy the needs of sharegolders. Regardless of this, selling equity does offer an opportunity to raise a large volume of capital without incurring any debt. The company holds no liability to repay the capital invested by shareholders nor is there any legal obligation to distribute dividends.

As an alternative a company can raise finance through debt in various forms, for example: bonds, bank loans etc. Unlike equity finance, debt holders have no control over the firm. However, the corporation is legally obliged to repay the borrowed sum plus interest, usually with regular cash payments, these must be made regardless of the company’s financial situation. From an investors viewpoint this is the less risky alternative. Interests payments are always paid to bondholders before dividends to shareholders, in the absence of interest payment, bondholders have the ability to take action against the firm forcing them to sell assets or even enter liquidation to cover their debts. However, the potential wealth of a lender is capped to the interest payment amounts outlined in their contract whereas the potential of a shareholder’s wealth has no restriction.

There is however, a recent case regarding a company that is set to list on the stock exchange against its will…

The social networking site ‘Facebook’ is the fairy-tale of every investor’s dreams. The company was started by 19-year old Mark Zuckerberg in his university dorm room in February 2004 and is set to be publically listed on a stock exchange later this year. The networking site currently has approximately 850 million active users and made $1bn profit last year. There is currently an on-going heated battle between the two American stock exchanges NYSE and NASDAQ over which will be given the opportunity to list Facebook.

Zuckerberg in his Harvard dorm room, birthplace of Facebook

Being offered the ability to list the internet giant would be hugely beneficial to either stock exchange, both of which are looking to ‘jump-start’ their equity markets after being ‘hamstrung by the European fiscal crisis’ (DeCambre & Sloane, 2012). The company is suggested to raise a $5bn initial public offering, this is the sales figure generated by Facebook stock as it becomes listed. Obviously either stock exchange would welcome such investment with open arms.

In preparation for going public Facebook must fulfil some of the regulations required by companies looking to list. For example, the company has recently released some financial statements regarding its performance. The firm’s growth is phenomenal, with revenue up from $153m in 2007 to $3,711m in 2012! I can’t calculate the company’s weighted average cost of capital at the moment as there are currently no figures for the market value of the firm’s equity or debt.  However, I can see that the firm is sitting on a solid balance sheet in a very strong financial position producing a total liabilities to total assets percentage of just 22.6%, low debt means higher profits and greater returns for investors.

Why then does Facebook want to raise more finance through equity? The company already has huge growth and is very strong financially holding cash reserves on their balance sheet of $3,908m. The actual reason for the company going public is that, it doesn’t have a choice. According to the Securities and Exchange Commission rule from 1964, ‘any private company with more than 500 "shareholders of record" must adhere to the same financial disclosure requirements that public companies do’ (Sloan, 2012). This is a situation Facebook reluctantly finds itself in, passing the 500 shareholders figure at the end of 2011. As a result, Mark Zuckerberg (Facebook CEO) is eager to give the smallest volume of equity away to the public, he ‘is reportedly planning to sell just 10 percent of the company’ (Sloan, 2012) retaining the majority of control within his team. This is where the rules between the American stock markets and the LSE differ; if Facebook were being launched on the LSE Zuckerberg would have to make 25% of his shares available to the public.

In addition to losing equity and a level of control over the company Mark Zuckerberg will now have a greater volume of shareholders to appease creating more tension regarding key business decisions. The company must maintain strong financial consistency to keep investors happy and share price high. The majority of the company’s revenue is generated through advertising; increasing financial performance may mean selling greater volumes of its user’s information to advertisers. The site currently has over 800 million active users; these users are essentially the company’s product. Advertisers use the information provided by Facebook to specifically channel advertis to their target markets. Facebook must therefore manage to develop a system in which financial performance is improved to keep shareholders happy without damaging the user’s experience.

Floating on the stock exchange will allow Facebook access to a large volume of capital. This can be used to develop new ways of maintaining its lead in the social networking market, a lead that needs to be carefully maintained, particularly as Google+ has had significant growth recently producing statistics such as: ‘62 million users, adding 625,000 new users per day. Prediction: 400 million users by end of 2012.’ (Allen, 2011).

Despite Facebook’s strong financial performance the revenue generated from the stock market floatation will allow the company to grow. By only giving away a small percentage of equity Mark Zuckerberg and his team will have still maintain majority control. Had the company not had the opportunity to float on the market raising $5bn through debt would prove to be difficult, if they managed to raise the sum through loans and bonds the interest payments would be excessive. In addition, the company’s profit figures would take a hit as they would be legally obliged to pay off the enormous debt putting huge pressure on the company. I think that, had Facebook not been forced to float on the market this is a move that should be taken anyway, receiving $5bn in exchange for a 10% equity sounds like a ‘no-brainer’ decision it will allow the company the funds to continue funding growth, a necessity to maintain their dominant position in the market.

In addition to raising capital Facebook will benefit from some of the non-financial advantages of listing on the stock exchange. For example, it will enhance the company’s status, increasing public awareness and demonstrate the company is capable of meeting the rules and regulations enforced by listing authorities for example ‘company’s board of directors is required to have a majority of independent directors’ (Nasdaq, 2010).

The Facebook case represents every investors dream and demonstrates from the viewpoint of the shareholder one of the main advantages of purchasing shares as oppose to lending money through bonds. The bullet points below display some of the company’s main shareholders, the value at which they purchased equity and the value their stake is currently worth:

• Accel partners, purchased a 15% stake in the company back in 2005 for £12.7m, their current stake is currently valued at $12.75bn.

• Dustin Moskovitz, lucky enough to be Zuckerberg’s roommate at Harvard, co-founder, has retained a 6% stake currently valued at $5.1bn.

• Peter Thiel, purchased a 10.2% equity share of the company in 2004 for $500,000 currently retains a 3%share valued at $2.55bn.

It depends on an investor’s goal on which sort of finance they decide to invest their savings. An investor looking for a steady, relatively risk-free return should opt for bonds and debt finance. Whereas, the more daring should choose to invest in shares with unlimited potential returns, the earlier investors of Facebook could only dream of the possible success of the company, fortunately for them, that’s a dream that became reality.



DeCambre, M. & Sloane, G. (2012) ‘ NYSE, Nasdaq battle for Facebook Listing’, New York Post, [Online]. Available at: http://www.nypost.com/p/news/business/not_so_friendly_ChdwVK0UaV1krE1J3k0FoI. (Accessed: 17/02/12).

Sloan, P. (2012) ‘Three reasons Facebook has to go public’, C Net News, [Online]. Available at: http://news.cnet.com/8301-1023_3-57368449-93/three-reasons-facebook-has-to-go-public/. (Accessed: 17/02/12).

Allen, P. (2011) ‘Google + Growth Accelerating’, Google + Website, [Online]. Available at: https://plus.google.com/117388252776312694644/posts/ZcPA5ztMZaj#117388252776312694644/posts/ZcPA5ztMZaj. (Accessed: 19/02/12).

Nasdaq. (2010) ‘Regulatory Requirements’, [Online]. Available at: http://www.nasdaq.com/about/RegRequirements.pdf. (Accessed: 19/02/12).

Stock Exchanges and Stock Market Efficiency

Stock Exchanges and Stock Market Efficiency

Stock markets are platforms that allow companies to list and sell shares to investors. Shares are issued to raise capital for the organisations and in return, the now, ‘shareholders’ own a percentage of the corporation. Despite owning the company shareholders are secured by limited liability, this ensures that owners of shares are not held liable for debts incurred by the organisation. Once investors have purchased shares they are not responsible to contribute any more capital regardless of the firms financial situation, they risk only the cash they have chosen to invest.

Established stock exchanges now operate in over 100 different countries across the globe and in March 2010 the world stock market valuation reached highs of $49.1 trillion.

Investment markets are essential to increase cash flow in a modern economy. The capital raised by selling shares to investors is assigned to projects by the financial manager of the corporation. Ideally, these projects generate profits increasing share price and allowing the firm to produce dividends and inflate share price for its shareholders, generating wealth for investors. However, there are many factors that can contribute to the ‘efficiency’ of the market.

An efficient market can be described as one in which share price fluctuates both rationally and quickly to reflect any new information released regarding an organisation. The importance and impact of the news will determine the size of the fluctuation. However, is the theory of an efficient market hypothesis actually a reality on the stock exchange?

An example against the theory was evident on June 24^th 2010 when Apple Inc launched their new product the iphone 4. The success of the iphone 3gs, selling over 1,000,000 models within three days of its release suggested the iphone 4 would have similar success. On the morning of June 24th people were queuing outside apple stores read to get their hands on the new iphone. The product launch was the company's most successful yet, selling 1.7 millions units worldwide by June 26^th. Sales surpassed analysts expectations, Apple were struggling to keep up with such relentless demand for the product, the device was ‘sold out in the majority of the apple stores in the United States the day after it went on sale’ (Carew & Madway, 2010).

Such positive news and soaring sales should be well received by investors that hold apple shares, in an efficient market, theoretically, share price should increase and yet, the opposite occurred. This trend is consistent with the launch of Apple products, the graph below displays the share price fluctuations regarding Apple product announcements:

As we can see the iPad 2 is the only product launch that appears to have had a positive effect on the company’s share price. Why then do Apple shares behave in such a manner?

There are theories that suggest reason for this trend. For example, anticipatory price movements due to information leaks. Leading to the launch of a product, share price often ‘creeps up’ anticipating the launch. This anticipation can exaggerate the value of shares leading to an overreaction of share price followed by deflation. However, Apple is renowned for maintaining secrecy of their products until the launch. An app developer was entrusted to test one of the first ipads before the products official launch. In an interview he states ‘Apple drilled a hole in a desk and chained the prototype to it using bicycle cables’, ‘Apple even went so far as to take pictures of the wood grain of the desk so that any leaked pictures could be traced back’ (Dhebar, 2011). He was forbidden to tell anyone about the product and had to use it in a room with no windows and new locks.

Such strict criteria suggest that very few people are aware of an Apple product prior to its launch, eliminating the possibility of anticipatory share price inflation.

It could be argued that Apple is simply unfortunate with its timing, that overall market shares drops on the day they launch their products. The circled area on the image below indicates the date at which the iphone 4 was released into stores. As we can see the Apple share price mimics that of the Nasdaq, suggesting the fall in share price may simply be due to a drop in the market.

This theory is reinforced with the image below. The circled area here indicates the day on which the iphone 4s was launched, again the Apple share price roughly mimics that of the Nasdaq:

The ‘random walk’ theory developed by Kendal could be another option to suggest why Apple shares act in such a manner. Kendal suggested that there is no link between subsequent share price movements, no consistency. Metaphorically similar to the path a drunken man may take when placed in the middle of a field. Many theorists believe this is incorrect. I believe there is some truth to Kendal’s theory when attempting to achieve short-term financial gain on the stock exchange. If share price movements are affected by news and new information arising, then each subsequent piece of news should be independent of the last, therefore shareholders never know whether the next release of information will be good or bad. In addition to this, as shown in the Apple case even if what would appear to be good news is released, share price may still fall!

I think that although there is no ‘secret formula’ for making short-term financial gains on the stock market educated guesses may be made by analysts that are well informed and experienced. These recommendations from top analysts may be correct more often than not but the volatility and inefficiency of stock exchanges means that nobody can ever be sure.

Shareholder Wealth Maximisation – ‘The sole guiding principle for corporate action?’

It is suggested that throughout Anglo-American corporations the primary objective for publically owned companies is to maximise shareholder wealth. As a result, managers must continually devise strategies that promote wealth for their investors. However, this if often not the case as outlined by Jensen and Meckling (1976). They believe that ‘managers are “self-utility” maximizers and often look for opportunities to increase their own financial gain at the expense of the shareholder. For example, John Thain former CEO of Merrill Lynch spent $1.22m of shareholder’s investment refurbishing his office for his own personal gains, this form of behaviour is described as ‘Agency Theory’.

It is important that management intention remains aligned to fulfilling shareholder needs. However, where does management draw the line? Should social and ethical principles be abandoned to satisfy shareholder greed? Does law apply to managers that are simply fulfilling their corporate objectives?

Management must ensure they do not abandon the needs of other key stakeholders. A greedy approach to achieve short-term financial gain can often become the long-term demise of a corporation.

In 1985 Kenneth Lay merged the two natural gas pipeline companies Houston Natural Gas & InterNorth to form Enron. According to many financial analysts the company was in quite severe debt. In an attempt to pay their liabilities Lay sold many of Enron’s profitable assets. The CEO then set up several ‘sleeping partnerships’ with companies such as: Enron Oil Trading, Enron Exploration & Enron Cogeneration.

In 1987 Lou Borget head of Enron Oil Trading was convicted of laundering money through bogus foreign accounts. His selfish actions were an example of ‘agency theory’, acting in his own interest and not that of the shareholder. His conviction cost Enron’s shareholders $64m.

In 1990 Jeff Skilling joined Enron, he hired Andrew Fastow a previous employee of the failed Continental Illinois National Bank and Trust Company. In 1996 Fastow begins to create ‘off-the-book’ entities. In an attempt to cover growing debt Enron starts to dispose of their poor performing assets and projects to Fastow’s subsidiaries. As a result, Enron appears to have a more positive balance sheet, hiding their debt and inflating profit. During the 90s the company’s share price rose by 311%.

From 1996-1999 Enron continue to enter into ventures that financially perform poorly creating more debt. As a result, Andrew Stow created LJM, (that stands for Lea, Jeffrey, Michael the names of Stow’s children) a company that is used to purchase Enron’s poorly performing stocks and assets.
Due to their positive appearance, high profits and strong balance sheet the company’s shares hit highs of $90 each during the year 2000.

In 2001 Jeffrey Skilling resigned from his position and sold 450,000 company shares for $33m. Shortly after, the company’s huge debt and unethical accounting principles were uncovered. By November their shares had dropped in price below $1 each, costing shareholders millions in investment. Enron, once valued at $64.3 billion, filed for bankruptcy on December 2nd 2001.

The company were able to hide their huge debt due to a conflict of interest held by their auditors. The firm Arthur Andersen applied reckless standards and did not properly review Enron’s financial performance. This may be due to the influential $25million received annually by the auditors in fees.

The Enron case demonstrates how managers must maintain focus on increasing shareholder wealth whilst in keeping with the law and basing their strategies on achieving long-term financial goals. An emphasis on short-term financial gains can create future problems for organisations.