Short arms and deep pockets

For my last blog this week I’m going to be discussing CEO pay. CEO’s have always been paid a lot and I believe CEO’s should be paid a lot for several reasons – the job is tough and often short lived due to very difficult challenges and impatient Boards of Directors and because people in organizations need a highly paid position they can aspire to in order to help motivate them to want promotions. However I don’t agree that CEO’s should be guaranteed enormous compensation packages or astronomical pay regardless of the performance of the organisation. CEO’s are one of the first to say employee pay should be based on performance, claiming it’s the fairest way to pay employees. So why should CEOs, Chairman or anyone else be exempt? And how has the pay got so out of hand?

No rule as yet is in place in the UK but in 2010 the US passed the Dodd-Frank Act. This act means public companies are now legally obliged to publish the ratio which compares the pay of their CEOs to that of their median employees. This act should hopefully educate the general public on just how much CEO’s earn and give an understanding of which CEOs are focused on personal greed.

Ironically this push for CEO salaries to be public and more transparent could be to blame for benchmarking. When hiring a CEO every company wants the best and most of the time the best isn’t just waiting around to get picked he/she will already be a CEO somewhere else at a successful company. To poach a CEO you naturally have to offer them a better deal than anyone else in the industry and thus this Dodd-Frank Act has made this easier to do. Myself like others would want a considerably better package if it means leaving a good position and taking a risk with an unfamiliar company. This increase in pay every time a new CEO is hired and the fact that CEO’s on average are fired every three years; it takes a significantly short period of time for CEO’s packages to get at ridiculous levels. This doesn’t just happen with CEO’s it happens in the sports industry and this is the reason why footballer’s salaries have gotten out of control. To regulate this NFL set a wage cap, but would this work for CEO pay? I believe for it to work in England a salary cap of the same amount would need to be enforced globally. If it’s not, the best CEO’s in England will go chasing the money and move elsewhere, it’s just human nature!

What other things can be done to control CEO’s salary? Peter Drucker created the 20 to 1 ratio in 1984 basically stating that CEO pay should be no more than 20 times the average worker’s pay. Rick Wartzman in an article for business week stated “Widen the pay gap much beyond that, Drucker asserted and it makes it difficult to foster the kind of teamwork that most businesses require to succeed”. Following Ducker’s idea Starbucks CEO Schultz  in 2014 earned a total pay valued at $21.5 Million this would have to mean that the average Starbucks worker earns just over $1 million for 2014. A little over the going baristas rate don’t you think? Based on analysis results from 2014 only 4% of US companies would meet Drucker’s standard! And CEO’s at FTSE 100 Company earn 149 times more than the average worker; which is a pretty disgusting figure.

I’ll stop being so negative for a minute and I’ll just mention a couple of organisations which have actually started to consider Drucker’s theory. The CEO of Grant Thornton, Sacha Romanovitch has capped her pay at 20 times higher than her average worker. Although not as low TSB’s CEO Paul Pester salary is capped at 65:1. Yes companies that use this can be seen as a publicity stunt but the more companies that use this ratio can only be a good thing. Imagine all the money saved that could be used for CSR activities or used to increase all employee salaries.

These two examples are of companies where the average worker’s pay is relatively high but sometimes large pay gas could just show the nature of the industry. Companies like Primark are obviously going to have a higher ratio than accountants employing smaller numbers of highly skilled staff.

Another option to try and control this increase is to company CEO compensation to the value they bring to the corporation. To many this may seem the best way to pay CEOs there pay rises and bonuses would be set to how successful the company has been throughout the year. Helping CEO’s think more about how to use the company’s money and how it affects performance. However just to be devil's advocate not all value is directly reflected in financial impact and a company’s financials can fluctuate with the market in ways that simply does not reflect the quality of the CEOs leadership.

To finish even though I agree that CEO’s salaries should be high I don’t believe it is right that in the US the average CEOs earned $11.7 million in 2013 and the US president earner $400,000. Above I have given examples of how we can look at correcting this but not one of these policies will work alone. Multiple policies will need to be in place and it would need to be a global agreement. I know that the likely hood of this ever happening is extremely rare but what do we do? Sit and watch as the CEOs fill their deep pockets?

Thank you for reading  and as always feel free to leave any comments?

Idiots and Samurais

Watching the Olympus: 1.7 Billion Dollar Fraud documentary, I feel almost ashamed that I knew nothing about this scandal. Before discussing this case I’ll just give you a brief overview of this scandal. Woodford became president of Olympus in 2011. He was an unusual choice for Olympus as he didn’t speak Japanese and has often been reported that Woodward was an outsider, who would be easy to control. I bet Kikukawa and the board regretted the decision to put Woodward in power! As after only a few months Woodford became aware of accounting fraud when an anonymous employee leaked the story in an article for Facta. He wanted these claims to be investigated but the board dismissed these claims and wouldn’t let the issue go any further. The fraud in question started back in the 1980s and built up over the years to cover Olympus’s loses. Olympus realised the companies loses through acquiring three defunct companies for $700 million and another $680 million for ‘advisory fees’. In all Olympus hid $1.7 billion in loses. After much disagreement Woodward got dismissed from Olympus and the whole story came to light.

If you are reading this and thinking was Olympus’s fraud really that bad? There’s no personal hidden agenda and no personal enrichment from this. The perpetrators were motivated purely to save the company and the thousands of people working there. So I guess it was a victim less crime? I believe different; for one the shareholders were misled. I wouldn’t have wanted shares in the company when they dropped from the equivalent of over £15 to less than £3 when the scandal broke.

If I was a shareholder I would want to why wasn’t a fraud that started in the 1980’s caught earlier? Olympus pays for an external audit by an independent body so why did they not report this? Because of this I looked into who were Olympus’s auditors. It seems a mystery why one of the biggest accounting firms KPMG signed off on Olympus’s accounts in 2009. Even though they mentioned to Olympus that they disagreed with the way they accounted for the acquisition of Gyrus. After this Ernst & Young replaced KPMG as external auditors and yet the fraud was still never caught!!! So did the auditors follow the code of conduct? Did the auditors do their duty in good faith to ensure that the books gave a true and fair view of the state of affairs at the company? I believe they didn’t. If the auditors had worked more diligently and questioned the accuracy of accounting, the alarm bells would likely have woken up Japanese regulators years earlier.

I feel the main reason this scandal never broke until Woodward become whistleblower is the Japanese culture. After spending a year living in Asia I understand how proud the Japanese are of their culture but with corporate governance this seems to have turned into stubbornness. The Olympus fraud brought to light the lack of independent board members at many of the big Japanese companies. Only 3 out of 15 board members were independent when the scandal broke in 2011 and the main concern being these figures are high for Japanese companies! Woodward has said his self that the Japanese closed-rank corporate culture needs to change and I couldn’t agree more!

But I can’t just pick on the Japanese culture here; globally we never seem to learn. Olympus is another company with financial manipulation, management abuse, special purpose entities, conflicts of interest, and complicit auditors. From Olympus to Enron and now Volkswagen this abuse of power continuously occurs and as I mentioned in my first blog they consider themselves untouchable. And like many others I am fed up of these scandals.

As always thanks for reading and feel free to leave any comments

Third time is the charm?

So on this weeks blog I’m going to look at mergers and acquisitions and the current story that caught my attention this week is the LSE and Deutsche Börse deal. These talks aren’t even the first or second time but the third time these two companies have tried to merge together. Below are just three of the problems that LSE and Deutsche Börse will have to deal with in this merger.

This current deal will see the two largest European exchanges working on an all-share “merger of equals”. Is it even possible for mergers to be equal? At present Deutsche Börse is the bigger of the two companies and will end up with 54.4% of the merged company. It will be based in London but will have headquarters in London and Frankfurt.  It’s strange to me that businesses can think that a merger will be completely equal when previous examples have shown that it can’t work. Forbes states that these corporate marriages of equals ‘in which two firms of roughly similar size combine, with neither a buyer nor a target and typically no cash changing hands—account for a disproportionate share of disastrous failures’.  

One examples of the “merger of equals” failing are the union of Daimler and Chrysler. After two years of the merger Jürgen Schrempp managed to see off the former CEO of Chrysler and was the only person running the new company.  The former CEO of Chrysler later stated the term “merger of equals” was just used by Jürgen Schrempp to get Chrysler to merge with him. 9 years after the merge it fell through and the companies went their separate ways. Another failed "merger of equals" was Maurice Lévy with Omnicom. Thus with this is LSE and Deutsche Börse deal really a “merger of equals”?

With the current uncertainty of whether the UK will stay in the EU the present Deutsche Börse CEO has stated “a decision by the United Kingdom electorate to leave the European Union would put the project at risk”.  Both companies believe that whatever the results of the referendum the merger makes strategic sense and wouldn’t be a condition of the merger. However if the UK leave the EU it would have huge effects for the merger and it seems logical that most of the operations would move back to Frankfurt.

Their first failed attempt was back in 2000, where Deutsche Börse were in talks of a merger but the deal was gatecrashed by Sweden’s OM Exchange who tried to gain LSE through a hostile takeover. And this could be a huge worry for this current merger. The ICE and CME may both decide to acquire a key part in the European market; and so they could both place an offer for LSE. As much as these two competitive offers have been rumored, I feel if they decide to bid neither of these two companies will be successful. Merging with a company across the North Sea is a lot more feasible than across the Atlantic with one set back being time zone differences. But if nothing else this could be classed as a pac man defense and will drive up the price Deutsche Börse will pay.

With all of these factors and Jensen and Ruback’s research showing that on average the bidding company makes no gain with a merge is all of this hassle with LSE and Deutsche Börse merger worth it?

Thank you for reading it and I would love to hear your thoughts on the merger.

“Money is a she. She sleeps in the bed with you with one eye open. Next thing you know, she might be gone forever” - Gordon Gekko

So for this week’s blog I spent the evening watching Wall Street- Money never sleeps. Although I’ve never seen the first film, Gekko’s character to me is based on the crooks of the 80’s like Michael Milken who’s insider trading and rigged deals were the fashion back then. After Gekko was sent to prison most people probably  presumed there wouldn’t have been a sequel but 23 years later here we are.

The writer definitely decided to cash in on the 2008 financial crisis and essentially stole the whole movie script from real world events. The film tackles the issues of MBS, CDOs and distressed debt through two Wall Street firms Keller Zabel and Churchill Schwartz  (basically Lehman Brothers/ Bear Stearns and JP Morgan Chase/ Goldman Sachs).

Keller Zabel gets caught with far too much debt, is targeted by merciless short sellers, and runs out of cash within a week. Which leads to meetings at Federal bank, discussions on credit-default swap, collateralized debt obligations and whether the government should bail out banks. Does this all sound familiar? YES!! Because I talked about this exact thing in my blog a few weeks ago discussing the Lehman brothers case. I enjoyed this film when I first watched it in the cinema; that’s why I decided to watch it again for this blog. But this time all I could do was make these comparisons and wondered did the writers actually do any work!?

The comparisons don’t just stop there; Bretton James, the CEO of Churchill Schwartz who comes across as a mix between CEO of JPMorgan and CEO of Goldman Sachs. There is no bigger example of the similarity than the fact Goldman Sachs  betting against the housing market at the same time it was creating mortgage deals; which is similar to what Bretton James was doing in the film.

The area that struck me the most was Gekko’s quotes in the film; "You're all fucked, you’re the Ninja Generation.  No income.  No job.  No assets.” As I suppose I am part of this Ninja generation this worried me. Why are we the Ninja generation? Can I blame the likes of Wall Street? Why are people like Lloyd Blankfein getting away with betting against the housing market, and how can Gordon Gekko get sent to prison for insider trading yet as soon as he is released he starts trading on the London stock exchange (I know Gekko is fictional but  I bet it has happened). 

‘The mental stumbling block, for most Americans, is that financial crimes don't feel real; you don't see the culprits waving guns in liquor stores or dragging coeds into bushes. But these frauds are worse than common robberies. They're crimes of intellectual choice, made by people who are already rich and who have every conceivable social advantage, acting on a simple, cynical calculation: Let's steal whatever we can, then dare the victims to find the juice to reclaim their money through a captive bureaucracy.’

Whilst researching this area I found a great article in The Rolling Stones, which ends with the paragraph above. This article perfectly sums up my feelingsto how they have managed to get away with these financial crimes (article link: http://www.rollingstone.com/politics/news/why-isnt-wall-street-in-jail-20110216).

So after reading this article and watching the film the questions I’m left with this week include:

Are we being too soft with the stock market and financial crimes?

Who's responsible for our NINJA generation? And why are they never called to account?

Thank you for reading please feel free to leave any comments.

The confusing world of dividends

‘The harder we look at the dividend picture, the more it seems like a puzzle, with pieces that just don’t fit together’. This a great quote by Fischer Black represents my feelings towards dividends, a company that pays the most dividends is the best on to invest in right? There are so many theories on the correct way for businesses to give dividends it’s hard to see the wood from the trees.

I’m only going to briefly discuss a couple of these theories otherwise I’d probably be able to write a book with them all. The first theory I’ll mention is my two least favorite people I talked about last week Modigliani & Miller and their theory of dividend irrelevance. It completely fathoms me that their theories are still talked about because each one I have come across so far can’t be related into the real world (again this theory doesn’t count tax!!!!) so in reality is completely and utterly useless. Their idea with this theory is that dividends is a residual payment after NPV projects are financed, basically to assume each year a businesses opportunities completely change to the previous year and will fluctuate for good to bad. Thus with this policy shareholders don’t know the level of dividends (if any) they will receive each year.

Now after I’ve just insulted Modigliani & Miller, I’ll just mention the thing I like about this theory. I like that it takes into consideration the fact that paying dividends is wasting money that could be used within the company for R&D. For example Google don’t pay any dividends to their investors and share prices still continuously rise. However people know that when they invest into Google they won’t receive dividends; with M&M’s approach it changes every year and for a shareholder the unknown of what’s coming next sits uncomfortably with most.

The other theory I’ll talk about in this blog post is signaling; this is where investors see dividends as giving information on company’s performance/prospects. Following this theory high dividends= good news and low dividends= bad news.

An example of this theory work is with Barclay’s earlier this week they announced a cut in dividends to put the money towards restructuring and capital resilience. A chief analyst at Cenkos even say’s the cuts are justified for the success of the company in the restructuring. However investors have seen this slash as a negative and thus led to share prices falling by 8%. This situation is proving that signaling is used in the market and even with analyst saying that this cut is helping build the future of Barclay’s, investors have automatically taken the slash as there must be bad news coming soon.

However an example of this working against the investor is last summer BHP Billiton announced their worst profits in a decade but still increased their dividends by 2%. This lead to the share price rising 5.5% this looked like BHP Billiton was sending the signal of ‘don’t worry we will turn things around’. In reality they were up shits creek without a paddle and have now scrapped dividends. BHP Billiton’s example shows how signaling can be manipulated to give a certain impression of the company.

So back to the question that Fischer Black’s quote left me with, I don’t necessarily think that the bigger the dividends the more successful the company is. I believe that a lot of shareholders have an extremely short-term view when it comes to investment and businesses try to appease this. Taking the dividends might seem great at the time but surely receiving a smaller dividends, letting the company spend some of that money within the business and in the long term having a greater return on the share price is better. Companies that pay’s higher than average dividends leaves me with a question of why aren’t they investing that money?

It’s a hard area making sure the company has the correct dividends policy, the main thing to remember with these theories is non of them are mutually exclusive and so a business can use a mix to find the best policy for themselves.

Thank you for reading my ramblings please feel free to leave any comments.