The Missing Ingredient

In this part of the module I have learned ethics for the finance professional. This subject is relevant for myself in three areas which is why I am really interested in it. Firstly, over the past 6 months, I have been writing a dissertation on how there is hope that new audit regulation will improve audit quality and I have looked into accounting scandals and what it means to be ethical in the audit profession. Secondly, I am going to be an auditor (far flung from when I wanted to be a fireman when I was a child) when I leave university, so I need to understand that ethics are really important. And finally, in semester 1 of this year, we learnt about ethics and normative ethical theories (Kant, Rand etc) and it is interesting to be able to apply that thinking to real case studies.

I myself have been aware of a lot of ethical scandals and news reports over the past few years and further into the past which really bring to light a couple of things. After each scandal, new regulation is passed to stop it from happening again (but it always does) and that business leaders are not learning from past mistakes. I have noted a few scandals below:

In the table above, you can see that scandals will happen, then a series of regulation will be passed, then it will happen again. This will continue to go like this probably forever. I did some investigation and it was clear to see what I am talking about. So, in 2001 (Enron) and 2002 (Worldcom) scandals happened, then the Sarbanes-Oxley (SOX) Act 2002 was passed. Then in 2010 (Lehman Brothers), the financial crisis was happening, more regulation e.g. Financial Services Act (FSA), and then a few years later we have more scandals. When will it stop?

Many columnists and accounting professionals who look into scandals report that scandals are still increasing year-on-year, with one saying that there was an increase of 46% in account fraud from 2013 to 2014. This is worrying because new regulation such as SOX was passed to try and protect stakeholders from accounting errors and fraud. I would like to ask a question to whether any regulation could be passed to stop it? or will businesses just try and find new loopholes?

What I found when doing my dissertation and which I have also learned from the lectures is that there are certain reasons to why accounting scandals happen between businesses and financial professionals. I have learned about the PIPCO acronym (Professional Behaviour, Integrity, Professional Competence, Confidentiality and Objectivity) which shows a few reasons (I am sure there are more) why finance professionals may fail their duty. The one thing I find when conducting my research was that Objectivity was the main reason into why finance professionals did a poor job. If they become to familiar with the client (known as lack of independence, such as going on holiday together or being 'mates' at the pub) then they are more likely to let things'slide' as it is said. I do believe that this is the biggest risk and probably the reason why a lot of scandals happen. 

For example, I read an article about how Arthur Andersen auditors of Enron were treated 'as if they were employees of Enron' and they were invited to company picnics and so on. If this is not a lack of independence then I do not know what it; and we all know how that turned out.

My belief is that being ethical in your role as a finance professional is the most important factor in being successful, and not about how much money you earn or how big your bonus is. If you cannot be ethical, you may be jepardising someones pension or rainy day fund which could cause a lot of harm and unhappiness. In relation to ethics being the missing ingredient, I think that the finance professional (a minority rather than a majority) sometimes misses thinking about ethical considerations.

One final note that I was really interested in when listening to this lecture was a question the lecturer mentioned was "should white collar crime be punished as harshly as murder?". This was interested and provoked a lot of thought because of a video of Dennis Kozlowski (former Tyco CEO) who for his crime may be in prison for 25 years (longer than some murderers). My thoughts to the question are that murders should obviously face more time in prison, but white collar crime can hurt people in different ways and can cause a lifetime a distress and suffering for some people, so definitely should be treated more harshly than it currently is. I feel CEOs of these companies are not put off because they see the rewards (bonus etc) outweighing the risk (prison).

Buying, but for the Big Boys

The topic of Mergers and Acquisitions (M&A) is probably one of my favourite subject areas in business. I think it is because it would be so exciting to spend millions of pounds on another company then have the challenge of trying to integrate them to create the synergies and culture you have promised the shareholders (that might be crazy to hear I want to face the challenges). I remember in my GCSE and A-Level studies learning about some notable M&As:

Creating wealth for shareholders through M&A activity must be really difficult, you can do all the due diligence in the world and look at all financial indicators, but areas such as culture and employee motivation (which you can not physically see) may be your downfall which would be really unfortunate. Research conducted as far back as the 80's such as by Jensen and Ruback (1983) show that the target firms gains more than the bidding firm. I would be angry if my management based on hubris, their own self-preservation and hunger to build an empire would enter into a merger and then I wasn't gaining as much as someone who probably was not bothered.


One thing I remember from my business teacher at school was, she always stressed about culture, culture, culture (dare I go on?) was the single most important factor that could lead to the failure of M&A activity. In a sense I believe that, because you can not physically see the culture, but the financials are the starting point. My last blog (Blog 5) focused on culture which you can take a look at if you get time.


What I find really exciting (well exciting in my head) in this topic is the defence tactics that target firms can put down to stop firms bidding on them (the names are strange too). These poison pills in my head feel like they would be a little petty war like we would play at school such as flicking elastic bands at each other. How fun these poison pills may be, they can cause significant damage if a bidder does not spot them. Say a target decides to make a 'scorched earth' policy; load the firm up with debt, sell key assets to disrupt efficiency; if the bidder still goes for them they will ruin their shareholders value. I have learnt many poison pills; Pac Man Defence (who even makes up these names?), Greenmail, White Knight.


It is quite pertinent that today's blog is on M&A activity when there are two big ones in the news; Deutsche Boerse - London Stock Exchange and Three - O2 . From learning the material in this module and reading publications such as the FT, BBC to try and get all sides of the argument, I have seen that there are good and bad points for myself as a consumer and a member of the EU economy.


Firstly, the good. The Deutsche Boerse and LSE 'merger of equals' I believe will help the economy by providing better opportunities for European Companies to gain capital as well as companies from the US and Asia as London, Germany and Spain merged could help compete. However, how will the UK's EU referendum affect the benefits of this merger? I am undecided, but will continue to look.


Secondly, the bad. Three (CK Hutchinson) are looking to merge with O2, basically making the UK market for Telecom shrink to Three, EE and Vodafone (creating an oligopoly situation). Three want to pay £10.5bn for the merger (that is an exciting amount as I said before). How will it affect myself and you the consumer? Well, I think it really could, shrinking the market may lead to increased prices for the same service. When I go to look for new contracts, I currently think that there a lack of differentiation, so this will surely decrease more? Surely if they are creating better cost synergies they will reduce the prices (well this is what should happen), but I really do not think they will.


I never understood how a company would pay for the acquisition either (transfer through the banks Iphone app? Set up monthly instalments? Pay in 10p's?). But let me get serious, so the company will either pay using cash or shares. If I was a shareholder, I think I would the company to pay through cash as I would have to same amount of control and my shares won't be diluted. But if I was the target firms shareholder, cash may mean I pay a hefty sum of tax if I own a lot. Tough choice right?


As there will always be hungry managers, there will always be M&A activity in the market. Whether these are successes or failures will depend on how much research the company has done and whether they can integrate cultures. As consumers we will always be put as risk through M&As that we could be forced to pay more for the same service through lack of choice, however, we can only hope such mechanisms such as the Takeover Panel and Competition and Market Authority (CMA) regulators will help protect us.


Empty Vaults - The RBS Collapse

The Royal Bank of Scotland (RBS) which found notoriety in 2008 when it was apparently '2 hours away from running out of money' and losses of £24.1bn (I can't even comprehend this figure). It was clear from my own viewing that I could conclude RBS had serious problems which included to rate of acquisitions, due diligence of these acquisitions and Fred Goodwin's leadership. As you can see below, this is the result of RBS management decisions.

RBS Share Price (Yahoo! Finance)

Acquisitions
RBS I feel really fell down on their rate of acquisitions, I think they over expanded too quickly and this can't be good as they ultimately had 'a finger in too many pies'. They were involved in Insurance, Hospitals, Airports, second-hand cars and asset finance (I can't see where some fit into banking). I thought that these acquisitions were a waste of money and there was no need to diversify from their core business of banking. The acquisition of ABN-Amro was obviously their biggest downfall. They had no idea about the level of sub-prime mortgages ABN held and therefore I do feel I can reach a conclusion that this was why they failed.

Fred Goodwin said "we don't do acquisitions for fun", but I thought that them buying a second-hand car company, this did not seem like it was done to 'better the core business'. RBS was not the only company undertaking failing acquisitions; HSBC's acquisition of Household (2003) fell victim to the sub-prime collapse and AOL's acquisition of Time Warner took less than 2yrs to fail.

Due Diligence
Watching the part where Fred Goodwin said that there was no real scrutiny of ABN-Amro's books really made me annoyed. I would have thought someone with all that business knowledge wouldn't have gone with the 'we did Natwest well, so this will be fine' mentality. Even myself, a final year business student looks into everything I buy; if I purchase a TV, I will be looking into it for a week at least to see if it is worth it (and that only costs £300 not £49bn).

Due Diligence is key when acquiring a business. It makes sure you're not buying 'junk' and will reassure you that you are not paying over the odds. I am currently looking to buy a car for work, I wouldn't want to pay £10,000 for something that is actually worth £6,000 or a car that has been written-off in the past. This is why you undertake due diligence. Anglo American mining is another example, they have really underestimated the challenges they would face when going to Brazil in 2009 and other projects where now their share price has dipped below 1999 listing level and have been given 'junk' bond status by credit firms such as Moody's (FT, 2016) (would they have been more successful if undertaking more due diligence?).

Leadership
One thing that was apparent when watching the documentary to me was Fred Goodwin's management style. Morning meetings were called 'morning beatings' and managers were intimidated to say if they believed something was wrong. I don't think you can run an organisation like that. Listening to others is the most important thing, especially when dealing with a public interest sector.

When I was in my placement working in the audit department, listening to what I was doing wrong and what I could do better was important to help me do a quality job and make sure every part of the audit was correct. This helped shareholders/stakeholders base decisions on true and fair information. If not, I could have been misreporting values and making wrong decisions which may have lost people money. This is exactly what Fred Goodwin did with RBS and definitely I believe another reason for their demise.

A Final Note
I think what really hit me the most when watching the documentary was that ordinary people (which I probably know a few) who have saved for years and were unfortunate enough to invest in RBS (where they thought their money would be safe) lost around 90% when RBS collapsed. These are the people who I really feel for.

References
Financial Times. (2016). Anglo American’s credit rating downgraded to junk, retrieved from http://www.ft.com/cms/s/0/1f989c28-d409-11e5-829b-8564e7528e54.html#axzz40cHUmspG 
BBC. (2011). RBS - Inside the Bank that Ran out of Money (documentary).

Aspects of Diversification - A Case of Ebac-Norfrost

Aspects of Diversification - A Case of Ebac-Norfrost

Acquiring a new business can lead to so many problems, such as what Ebac found when they bought Norfrost for £1million. A bankrupt chest freezer business once given the go-ahead to make Coke-Cola freezers for the Olympics in need of a re-brand and a new lease of life. Well, this is what Ebac saw anyways. 

However, one of the main problems when acquiring a new business is the fact that the acquirers (already being successful), think that they know it all. Successful in dehumidifiers and water coolers isn't the same as being successful in a fridge/freezer market worth £600m. Indesit (Italy) and Beko (Turkey) have market dominance and can compete on price with anything British made. So how do you become successful in a new market?

In the case of acquiring a new business, what needs to be done first is called Due Diligence! Without this (basically checking to make sure everything seems okay), millions of pounds (or dollars to appeal to an international crowd) can be wasted in buying a business, only to find out the machines you bought do not work or the business had huge debts you didn't know existed. This will cost you money through productivity lost and in general monetary terms. I implore you to take a look at the lack of due diligence that was undertaken when RBS acquired ABN Amro and how much ultimately it cost them.  

Secondly, research, research, research (do I need to emphasise my point?). There is no point going into a new market on the basis of 'I am already successful and know everything' or 'We will go with whatever the company we acquired have done'. You need to make sure you have the most up-to-date data possible. This involves primary research (or I guess you could look at Mintel reports as a start) by going to your customers and asking what do they want? What are their drivers to buy the product? These opinions will either make you a success or a failure. Many in business know, if you do not know your customer, you are destined to fail like so many before you. This has been so apparent in other industries, such as where Nokia did not react to what their customers wanted and rapidly declined when Apple and Samsung released their smartphones. 

Leading on from your research, the company needs to make use of their marketing abilities to get the brand out and known to consumers. Create that USP (unique selling point) that is not generic like 'affordable' or 'quality'; make it something to do with your long heritage or simply 'Made in Britain' (which is becoming fashionable again nowadays). In the case of Ebac, they were held back by the fact that they didn't know the uses of social media as a marketing tool or even what their USP was. Once they embraced it, they flourished. This brings me onto my next point with marketing. Whatever the product, marketing can be done successfully. Ebac wanted to go into chest-freezers. Interesting right? It's not an enlightened fact that chest-freezers are not the most widely searched term daily, therefore traffic would be low. However, knowing their key customers through research, they could identify the people who bought the product and then cater marketing towards them; in this case it was recipes which millions of people search for daily.

However, the key to everything (whether acquiring a business, undertaking market research or marketing itself) is planning. You must plan to succeed. As the old saying goes, Fail to Plan, Plan to Fail (oh how I hate cliche's).