Dividend Policy – To pay or not to pay

For as long as there have been dividends there have been questions raised regarding their relevance and necessity to shareholders. Managers face a difficult decision when deciding what proportion of profits should be retained within the company for future growth and what amount should be paid out to shareholders in the form of dividends.

There are a number of solutions to the issue all that can have direct effects on share value and shareholder wealth.  Managers may choose to pay out a high volume of profits, nicely lining the pockets of shareholders, hopefully increasing share price?


Or could this demonstrate that the firm has a lack of potential, positive NPV projects in which to invest and therefore has no better use for the capital that to distribute it amongst shareholders. Such an impression could possibly have a negative effect on share price. 

Modigliani and Miller (1961) argue that dividends are irrelevant in determining share value. The authors believe that share price is based upon the forecasted growth and availability of positive NPV projects.  Unfortunately for the proposition to be accurate there are several conditions that must be made, for example, there are no taxes, there are no costs associated with buying and selling shares etc.

If Modigliani and Miller's theory were true then if a company that produces consistently high dividends every year were, to one year, simply declare that all cash was being retained and therefore no dividend was being distributed, the share price wouldn’t even flinch due to the irrelevance of dividends...

One of the major dividend issues reported in the media recently was BP’s decision not to pay a dividend for three of the four quarters during 2010. The company usually pays dividends consistently every quarter of the year, however in 2010 this pattern was broken. In June 2010 the decision came to ‘suspend its quarterly dividend as part of its commitments to compensate victims of the Gulf oil spill’ (ABC, 2010) .


The direct effect of a potential dividend cut was evidently reflected in the company's share price:

Share in BP fell 6 percent on Wednesday as investors saw it increasingly likely the oil major would suspend dividend payments under the US political pressure due to its oil spill in the Gulf of Mexico (Reteurs, 2010). 

 

This demonstrates the relevance of dividends and the effect it can have on share value, constructing an argument opposing that of Modigliani and Miller (1961).

However, in retaliation only recently Apple declared 'it would pay a quarterly dividend of $2.65 per share from July' (BBC News, 2012). This will be the first dividend the firm has produced since 1995, however, this doesn't seem to have had much of an impact on the growth of company's share price...

The Apple case suggests that dividends may not be so relevant with creating value as the firm has achieved significant growth since 1995 despite never distributing a dividend.

However, I feel the more traditional outlook on the significance of dividend policy provides a more accurate picture of how the distribution/retention of dividends can affect shareholder value.

Shareholders might require a dividend to reassure them that the company is performing well; reducing a dividend to re-invest in future projects could have adverse effects on share price. Shareholders that aren’t receiving a frequent cash return on their investment may choose to sell up and purchase shares in company that produces strong, consistent dividends. In this circumstance obviously dividend policy has had an effect on share value and is therefore very relevant in contributing to shareholder wealth, counteracting the former argument outlined by Modigliani and Miller (1961).

Like most things in business then dividend policy is another complex decision to be made by managers, constantly weighing up the opportunity costs of their firm’s capital. Several things can affect dividend policy, for example: changes in the market, the firm’s financial position, clientele effects etc.

One of the other approaches toward dividend policy that I consider to be reasonably suitable it to treat dividends as a residual. This approach ensures that all future positive NPV investment projects receive the retained capital required and after all channels of investment that encourage future growth are exhausted then the residual capital should be distributed through dividends. During a boom or period of financial success I believe this approach would be favourable as the future investment opportunities receive the capital required and shareholders receive a dividend. The knowledge of further investment in positive NPV projects is also likely to drive up the share price. 

You have both a bird in the hand AND two in the bush.

However, this method typically produces a fluctuating dividend that can often discourage shareholders.

Producing consistently stable dividends year-on-year is usually considered an important factor with regards to dividend policy as it suggests financial stability and translates the least amount of risk to shareholders. Furthermore, producing consistent dividends can help companies safeguard themselves by producing the same dividend regardless of financial success; managers can retain capital from years of significant profitability and then potentially use this capital to pay dividends if they were to make a loss the consecutive year. 


This blog demonstrates yet another issue managers must take into account when determining the best ways to enhance shareholder wealth.

To pay or not to pay, that is the question.

Sources used:
Bergin, T. (2010) 'BP shares drop as dividend cut seen more likely', Reuters [Online]. Available at: http://uk.reuters.com/article/2010/06/09/uk-bp-shares-idUKTRE65838Q20100609 (Accessed: 26/04/12).

ABC (2010) 'BP: No dividend to be paid this year', ABC Website [Online]. Available at: http://abclocal.go.com/ktrk/story?section=news/national_world&id=7501374 (Accessed: 26/04/12).

Roberts, D. & Pratley, N. (2010) 'BP Dividend - To pay or not to pay', The Guardian Website [Online]. Available at: http://www.guardian.co.uk/business/2010/jun/10/bp-dividends-for-and-against (Accessed: 26/04/12).

BBC News (2012) 'Apple to pay dividend and buy back shares', BBC News Website [Online]. Available at: http://www.bbc.co.uk/news/business-17434328 (Accessed: 26/04/12).

Capital Structure and the three bears

Throughout previous weeks a theme that has been common throughout some of these blogs is the idea of maximising shareholder wealth. It has been made apparent, throughout this weeks lecture that utilising capital structure can be an effective method of contributing to this objective.

Capital structure can be defined as the method at which a firm finances its operations and growth by using different sources of capital. For example, one of my previous blogs covers the idea of equity vs. debt, well; capital structure is the method at which managers use both of these capital sources to achieve their optimal capital structure.

Traditionally it was believed that simply increasing the gearing of a firm, i.e. the debt would be most beneficial as this would produce the cheapest rate of borrowed funds, creating the lowest WACC and therefore enhancing shareholder wealth. Debt is considered cheaper than equity due to the fact that: lenders usually expect lower rates of return than shareholders, debt can actually be paid off before the business’ profits are taxed, resulting in less tax being paid by the firm and finally, the transaction costs associated with debt are usually less expensive than those incurred by equity.

However, unfortunately raising capital through debt does have its disadvantages. As gearing increases, so do the annual interest repayments and unlike dividends, firms are required by law, to pay the interest. As a result, interest repayments that get too large can result in a firm being unable to pay dividends to shareholders, lowering shareholder wealth and opposing the aim of optimising capital structure in the first place. In more extreme scenarios firms may have to enter liquidation to pay off their debts and could even end up having to declare bankruptcy!

There is a way of achieving this optimal debt to equity ratio; if the gearing is too low then the benefits of low cost borrowing are lost, whereas if debt is too high then the company could be deemed a very risky investment.

The idea reminds me of the story Goldilocks and the three bears, it’s all about finding that perfect bowl of porridge…

However, finding the optimal capital structure can be difficult, particularly if your firm is largely affected by changes in the market. For example, if a firm has a capital structure that relies heavily on debt, it can often find itself in trouble during times of turmoil.

Companies with this sort of capital structure have been hit worse by the economic recession. As stated previously, companies that raise capital through debt must pay their interest repayments regardless of their financial performance whereas companies that have raised finance through equity can choose to avoid paying out dividends, retaining the capital to sustain future operations and growth.

Many companies that have been hit hard by the recession have found themselves struggling to pay interest repayments on their debt. One of the largest UK companies to buckle under the weight of their debt as a result of the recession was Woolworths. In November 2008 the high-street chain went into administration after struggling to cope with repayments of its £385million of debt (BBC News, 2008). The firm had been described as a “lame duck” by the BBC, a term usually used to refer to politicians that were known to be in their final term of office. Woolworths had been losing market share to intense competition over the previous years and a vicious cocktail of declining sales and heavy debt repayments were the cause of its demise.

In its final days, the 'company had tried to sell itself for the nominal price of £1' (BBC News, 2008) with the new owner taking on the company's huge debt. Unfortunately, the desperate plea for someone to inject life back into the firm, fell on deaf ears.

Perhaps if the firm had re-structured its capital, taken a more equity focused approach it would’ve been able to weather the storm of this recession. Retaining any cash reserves, withholding dividend payments until things began to look up.

Although, are shareholders likely to hold onto shares that aren’t offering any returns? What use is holding equity in a firm that’s bleeding market share? Ridiculed by the media as a “lame duck”, hardly screams great investment. Maybe then this end was unavoidable for Woolworths; a strategic re-structure of capital may simply have delayed the inevitable. 

Sources used;

BBC News (2008) 'Woolworths set for administration', The BBC News Website. [Online]. Available at: http://news.bbc.co.uk/1/hi/7751064.stm (Accessed: 01/04/12). 

Corporate social responsibility - It's not all about the money? Right?

Corporate social responsibility is becoming an increasingly important objective for businesses. It refers to the efforts made by a company to behave ethically and contribute to the welfare of society.

In addition to contributing to the welfare of the state, acts of corporate social responsibility can grant companies with lots of positive publicity, however, alternatively acts of unethical business practice can have adverse effects on a company’s public persona.

A company that has recently suffered lots of negative press as a result of its unethical practice is Primark. The clothing retail giant has been reported throughout the media regarding the poor working conditions in some of its manufacturing facilities overseas.

‘Primark tops list of unethical clothes shops in poll that shames high-street brands’ – (Brand Republic.com, 2005).

An article on the CSR European website suggests that corporate social responsibility is becoming increasingly more important in the eyes of the investors, apparently CSR is significantly effecting many people’s investment decisions. Corporate social responsibility is therefore an element of business that must be considered to those wishing to maintain a positive image in the public eye, although, as stated in the Primark example, a firm’s CSR may not have as significant effects on a company’s financials as previously thought...

In 2008, the firm was targeted by BBC Panorama who produced a documentary on the company’s use of sweatshops abroad. The documentary sparked lots of negative media attention to be focused on the company and yet, despite this, the unwanted publicity doesn't seem to be enough to deter people from shopping there..

‘Primark profits soar 35%’ – (The Guardian, 2010).

In a seminar I attended recently, hosted by Niamh Brennan regarding her new paper; ‘the dirty laundry case’ she explained the efforts made by Greenpeace to stop the use of toxic chemicals in the production of sporting attire by some of the major sporting brands. Public displays and press releases carried out by Greenpeace to create awareness of the issue obviously had the desired effects as all of the manufacturers targeted withdrew the use of such chemicals within weeks of the campaign.

However, had the companies failed to comply would the company have suffered financially?

Everyone can show disgust and pass judgement on such poor manufacturing standards but if it keeps the cost a new outfit to below £10, do people really care?

‘Primark sales rise despite cost pressures’ – (BBC News, 2011)

Apparently not.

In 1994 John Elkington designed a system that could be used to provide full measure of the ‘financial, social and environmental performance of the corporation over a period of time’ (The Economist, 2009). He called the model the triple bottom line. The model focuses on the three ps:

- Profit
- People

- Planet

 

The models aims to evaluate the ‘people’ and ‘planet’ factors using measures such as: the excessive use of hydrocarbons and the exploitation of cheap labour.  Although these factors can prove difficult to measure, an increasing awareness of the social and environmental impact of business practice has led to many companies improving their ethical and environmental standards.

Nike and Tesco have been amongst some of the bigger firms that have been made to improve their ethical standards, particularly in countries like Bangladesh and Mexico where labour conditions are largely unregulated often leading to exploitation of workers.

I agree that such practices are very difficult to measure, for example; BP has recently had huge issues measuring the extent of the spill in the Gulf of Mexico. Obviously, there’s the cost of oil that was wasted but then also environmental damage, damage to wildlife, to the welfare of the fishermen and other people that make their living from working in the Gulf, the cost of the 11 men that lost their lives, the list goes on…

Although you cannot really put an accurate calculation to such factors, the increasing transparency and responsibility firms are taking regarding the ethical implications of their operations is leading to a fairer and more environmentally friendly world.

Hopefully this increasing awareness will lead to the growth of more organisations such as: The Fairtrade movement that focuses on giving farmers and suppliers from around the world a fairer wage. The group was started in 2006 and has shown promising growth ever since. I understand there’s a long way to go to significantly reduce the amount of exploitation and corruption of workers and environmental standards in the world, but at least the examples shown here indicate quite a promising start.

Sources used:


Whitehead, J. (2005) 'Primark tops list of unethical clothes shops in poll that shames high street brands', The Republic.com Website, [Online]. Available at: http://www.brandrepublic.com/news/532319/ (Accessed: 24/03/11).

The Guardian. (2010) 'Primark profits soar 35%', The Guardian Website, [Online]. Available at: http://www.guardian.co.uk/business/2010/nov/09/primark-profits-up (Accessed: 25/03/12).


BBC News. (2011) 'Primark sales rise despite cost pressures', The BBC News website, [Online]. Available at: http://www.bbc.co.uk/news/business-12237010 (Accessed: 24/03/12).


The Economist. (2009) 'Triple Bottom Line', The Economist Website, [Online]. Available at: http://www.economist.com/node/14301663 (Accessed: 24/03/12).

The Credit Crunch

Since 2007 terms such as; recession, economic depression, the double dip, the credit crunch, the downturn, the business cycle, have been on the lips of the nation but what actually is a recession?

In economic terms a ‘recession’ refers to a period of two consecutive quarters of negative economic growth. However, over the past few years the UK has seen a period of economic contraction for ‘a record six consecutive quarters’ (The Telegraph, 2010).

So where did it all go wrong?

There is much disagreement amongst economists regarding when signs for the recession officially started with some people believing the cracks were beginning to show way back in 2001, others specify the date to be 9^th August 2007. On this date the French Bank BNP Paribas halted withdrawal from three of its largest investment funds because it couldn’t accurately calculate the value of their securities.

The announcement knocked 3.4% off of BNPs share price and 1.9% off the European stock index (Bloomberg, 2007).

Economists believe on that date the first domino fell.

For years prior to 2007 lending from banks had been on the increase, loans, mortgages and credits were given out far too easily, often to people that couldn’t afford the repayments. The turn of the millennium saw the dot-com bubble burst and a terrorist attack on the world trade centre. As a result the US Federal Reserve reduced interest rates making credit cheaper, this resulted in an increase in public borrowing in the forms of mortgages and loans.

These loans were then securitized by the banks, pooling all of the loans together to form collateralized debt obligations (tranching). These “CDOs” appeared to be an attractive investment and were given credit ratings that did not truly reflect their risk of investment. Many were given AAA credit ratings which, according, to the Moody credit rating agency deems the investment: prime, maximum safety, high grade, high quality. As the CDOs began to default and become worthless, banks stopped leading to one another, in some US market segments liquidation completely evaporated, this made it ‘impossible to value certain assets fairly regardless of their quality or credit rating’ (Bloomberg, 2007).

One of the first major signs in the UK of the recession was the Northern Rock fiasco. Due to the reduction of lending amongst banks Northern Rock couldn’t secure any loans and as a last resort took financial backing from the Bank of England. As this information seeped through the media it triggered a run on the bank with thousands of savers heading to their nearest Northern Rock to essentially, empty their accounts. ‘Faith in British banking was being destroyed’ (BBC News, 2007).

Since then things simply got worse, UK manufacturing starts to decline, house prices fall, in April 2008 the UK announces its officially in a recession after ‘a run of 63 successive quarters of growth stretching back to 1992’ (Telegraph, 2010), we began to see many household brands buckle under the weight of heavy losses:

Even now, five years down the line some high-street giants are struggling to survive, HMV is set to close an addition 60 stores throughout 2012 in response to declining sales, Game announced to its shareholders just this week that it is desperately struggling to survive and on the 12^th March the company’s shares fell a shocking 65%!

So what now?

The Bank of England predicts that there is a 1 in 10 chance of the country entering a double dip recession, this would have shocking effects on the economy and could de-rail any recovery plans outlined by the government. I fail to see any solution presenting itself in the near future, the record figures for unemployment in the UK means there’s a significant lack of spending and the economy is suffering as a result.

However, in February 2012 the UK services sector (that makes up two thirds of the UK economy) has seen significant growth indicating that dreaded ‘double-dip’ could be avoided. Furthermore, we have seen a lot of stores on the high-street closing down but there are many that have thrived despite the recession, Primark for one has seen an increase in share price regardless of the state of the current economy, Dominos Pizza has also seen growth as families are cutting back on going to restaurants, opting for this cheaper alternative.

Regardless of these few anomalies the future is looking bleak; economists believe it could take up to 2016 before the country manages to haul itself out of recession. George Osbourne believes were in an economic crisis equal to, if not even more severe than the crisis suffered during the 1930s.

Could the recession have been avoided? Perhaps if the rating agencies had scrutinised and justified the credit ratings given to CDOs more thoroughly, even prior to that surely the banks should’ve implemented stricter codes of conduct when allocating loans and mortgages? I understand these were not the sole principles that got us into this mess but they certainly contributed and somebody has to take blame, if anything just to ensure that it doesn’t happen again.

Sources used:

The Telegraph (2010) 'The Story of the Recession', The Telegraph Website, [Online]. Available at: http://www.telegraph.co.uk/finance/recession/7077504/Story-of-the-recession.html (Accessed: 18/03/12).

Bloomberg (2007) 'BNP Paribas Freezes Funds as Loan Losses Roil Markets', The Bloomberg Website, [Online]. Available at: http://www.bloomberg.com/apps/news?pid=newsarchive&sid=aW1wj5i.vyOg (Accessed: 18/03/12).

Mergers and Acquisitions –Is bigger always better?

Over recent years it appears that the use of mergers and acquisitions is becoming a popular strategy for companies looking to; grow, achieve economies of scale, diversify, increase the value of the firm or even simply feed the egos of CEOs. However, despite the good intentions of M&As, research suggests that the majority usually have depreciative effects on a firm and often result in a decline of shareholder value. What is it then that causes this negative impact? Surely an increase in growth and market power, partnered with the additional motives for M&As would improve business performance?

Take Daimler-Benz and Chrysler for example, Chrysler at the time dominating the American market deemed ‘the most profitable automotive producer in the world’ (Dartmouth Business School, 2002). Meanwhile, Damiler-Benz on the other side of the Atlantic, one of the biggest car manufacturers in Europe, struggling however to penetrate the American market.

The idea was perfect, a $37bn deal; a “merger of equals” American and German engineering giants united under one banner. The company were listed on the NYSE under the symbol DCX, the Chrysler CEO predicted “Within five years, we'll be among the Big Three automotive companies in the world” (Martelin, 2008).

However, unfortunately for them business is never that simple and it wasn’t before long that the cracks began to show…

The main reason believed for the downfall of the firm was the clash of cultures between the two. The autocratic Germans, relentlessly issued orders from Stuttgart to Detroit on all business matters, constantly trying to dominate. It was often believed that the Germans saw the ‘merger’ as more of a ‘takeover’.

Tensions ran high between workers, the Americans often earned up to four times the amount compared to their German counterparts. As the cracks deepened executives became more open about their opinions.

Daimler-Benz executives had been reported to utter snide comments about their partners; “I’d never drive a Chrysler” (Dartmouth Business School, 2002). The Americans retaliated with equally petty jabs all channelled through the media, directly in the public eye.

The cultural differences between the firms were obvious. Although both had the same goal, each had their own way of achieving it. The Germans ran a very tight ship, focusing on precision and uncompromised quality at any cost. Whereas the Americans were more focused on keeping costs low, as a result both had very different ideas on manufacturing standards.

I think the firms were simply incompatible; both were part of the same industry but operated in different markets. To use Warren Buffet’s metaphor of the princess and the toad in this circumstance we had two princesses, neither of which was willing to act the toad. Had either company identified the significant cultural differences between the two before the merge perhaps the multi-billion pound loss may have been avoided.

When considering a merger it essential to consider the human integration factors. Simply adding A+B doesn’t always equal C, on paper, from a financial view it may look an obvious choice but in reality are the firms really compatible?

However, mergers and acquisitions are not all doom and gloom and if thoroughly researched with a strong post-merger strategy both parties can benefit significantly. Take Disney and Pixar for example, Disney bought the animation studio back in 2006 for $7.4 billion a figure believed by a lot of analysts to be significantly overpriced. However, since the acquisition Disney’s stock price has climbed 28% generating wealth for its shareholders (The NY Times, 2008). The new company has gone on to produce films that have made staggering figures in the box office with the film ‘Cars’ hitting $460m in ticket sales.

I believe the success of the acquisition is down to the level of detail and dedication the management team took in carefully uniting the two corporate cultures. Strong communication between management and employees was essential to the success ensuring that everyone had a voice. Pixar even went to the extent of drawing up a list of elements that it would not have changed, for example the company’s health care, employee’s e-mail addresses etc. a list of which Disney were happy to oblige.

Sources used:

Finkelstein, S. (2002) ‘The DaimlerChrysler Merger’, Dartmouth College Website, [Online]. Available at: http://mba.tuck.dartmouth.edu/pdf/2002-1-0071.pdf (Accessed: 09/03/12).

Martelin, N (2009) ‘Daimler-Chrysler Merger Case: Rationale of a failure’ GRIN Verlag oHG: Munich

Barnes, B. (2008) ‘Disney and Pixar: The Power of the Prenup’, The New York Times Website, [Online].  Available at: http://www.nytimes.com/2008/06/01/business/media/01pixar.html?pagewanted=all (Accessed: 09/03/12).

FDI - Corporate tool or exploitive device?

It is common for companies in the modern business world to trade on a global scale. Improvements in travel and technology, a reduction of trade barriers and increase in foreign direct investment have all contributed to the success of globalisation.

The term foreign direct investment “FDI” simply put; refers to the process in which a company invests in a foreign country. These foreign investments can be categorised into two forms:

Greenfield investment – This literally refers to a company purchasing a “green field” in a foreign country and building new operational assets from the ground up on their newly acquired land. This is seen as very beneficial to the host country particularly if it’s a developing country as often large sums of capital are injected into the foreign economy to purchase or expand facilities. An example of this is the Hyundai case. In 2006 the company purchased land in Nosovice a village in the Czech Republic and built a brand new manufacturing plant, the first ever Hyundai plant to be constructed in Europe, creating 3,000 jobs for local people. The investment cost the company approximately €1bn, obviously such a large investment had a positive impact on the Czech economy. It apparently helped curb unemployment ‘by up to 2.5%’ (EIROnline, 2006) in the region and triggered significant growth in the country’s GDP.

International Mergers and Acquisitions – This method refers to the purchase of assets already owned by a foreign company. According to an article in the FT; companies in Northern Asia are set to ‘lead the way’ with this form of FDI due to ‘limited growth opportunities and higher costs’ (FT, 2011) in their home regions. An example of this occurred in 2011 when Japan’s largest pharmaceutical company Takeda purchased Germany’s Nycomed for $13.7bn. The acquisition of the German firm displays Takeda’s interest in global expansion, providing a ‘ready-made’ doorway into European markets, ‘Takeda said the deal would make it the world’s 12th largest drugmaker globally’ (FT, 2011).

Due to the economic and trade benefits of FDI, governments are often creating policies to encourage it. For example, the North American Free Trade Agreement ‘NAFTA’ was an agreement made between the United States, Canada & Mexico to remove barriers of trade between the three regions in order to encourage FDI. FDI then obviously has huge benefits; creating jobs, improving economies, providing opportunity for companies to grow on a global scale. However, it is not without its problems…

The growing trend of FDI is that it usually occurs between more economically developed countries. This is due to a variety of different reasons; less developed countries often have poorer infrastructure, weak market strength and unstable political problems. As a result, many avoid investing in these countries; however for some firms this cannot be avoided. Shell the oil and gas producers for instance must invest in operations in countries they identify significant oil reserves. Throughout previous years there have been several incidents of the kidnapping of Shell employees in Nigeria by armed groups claiming ‘to be fighting for a fairer share of Nigeria’s oil wealth’ (Donovan, 2010). The victims are usually released after a few days often after a ransom has been paid by the firm. It is examples such as this one that makes companies reluctant to invest in less developed countries despite the fact that it is these countries that would benefit most from FDI.

However, there have been some circumstances where corporations have opted to invest in less developed foreign countries to exploit cheap labour; this has often raised large ethical issues. In 2000 a case arose regarding the use of child labour in a Nike and GAP manufacturing facility in Cambodia. An investigation team discovered girls as young as 12 (three years younger than the legal working age of 15 in Cambodia) were working in these facilities, this unethical practice goes against the corporations’ strict code of conduct and yet it is occurring in their foreign factories. When the girls were questioned on their working conditions they stated that ‘they all work seven days a week, often up to sixteen hours a day’ (BBC News, 2000) receiving pay well below the minimum wage. However, it appears that these children have become reliant on this wage, one of the girls interviewed states: “I didn't want to come here - But we're very poor so I had to come” (BBC News, 2000).

Places like Cambodia are therefore in need of foreign direct investment but with stricter policies that encourage better working hours and decent wages for all employees. These changes could significantly improve their employee’s way of life. In addition, reasonable wages would lead to an increase in public spending, boosting the economy. However, unfortunately it is not that simple, for example, if companies like Nike and GAP were forced to pay a decent minimum wage etc then perhaps there would be no financial gain in investing in Cambodia in the first place.

The advantages of FDI are evident in the case of Botswana. The country’s economic policies promoted a ‘free market’ as a result, foreign direct investment was one of the key driving factors that boosted the country’s economy and allowed it to increase from the status of less developed to middle-income country. Economic growth has lead to a reduction in poverty within Botswana. In addition, throughout previous years the country was ranked the least corrupt country in Africa by ‘Transparency International’ (a non-government organisation that monitors political corruption) and achieved the highest credit rating for an African country by Poor and Moody’s investment services.

FDI is a powerful tool that can vastly improve a region’s economic growth, help reduce unemployment and allow investment in factors such as infrastructure. All these factors will lead to further FDI as the host country becomes more appealing to investors, providing mutual benefits to both parties. However, as demonstrated in the Nike and GAP case, often human rights have been exploited at the hands of FDI and all for what? So people in Western markets can enjoy cheaper trainers and hoodies, company executives can get richer, all whilst the poor, remain poor.

Sources used: 

EIROnline. (2006) ‘Hyundai plans major Greenfield investment’, European Industrial relations observatory on-line website, [Online]. Available at: http://www.eurofound.europa.eu/eiro/2006/04/articles/cz0604029i.htm. (Accessed: 01/03/12).

Whipp, L. & Jack, A. (2011) ‘Takeda Completes Nycomed Purchase’, The Financial Times Website, [Online]. Available at: http://www.ft.com/cms/s/0/cf277228-81a1-11e0-8a54-00144feabdc0.html#axzz1nsq1ydNC. (Accessed: 01/03/12).

Donovan, J. (2010) ‘Three British workers kidnapped in Nigeria’, RoyalDutchShellPlc.com website, [Online]. Available at: http://royaldutchshellplc.com/2010/01/13/three-british-workers-kidnapped-in-nigeria/. (Accessed: 01/03/12).

BBC News (2000). ‘GAP and Nike: No Sweat?’, BBC News Website, Available at: http://news.bbc.co.uk/1/hi/programmes/panorama/970385.stm (Accessed: 01/03/12).

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).