Is Socially Responsible Investment still possible nowadays?

This week in the lecture I’ve been introduced to SRI, or Socially Responsible Investment. Those are nice word, very ethical, but what does it really mean? Why is everybody suddenly talking about that now?

For most people, making investment, and expecting a lot of returns, is anything but social or responsible. However, this is not how SRI is defined. Indeed, to fully understand this post, it is to be understood that when we talk about Socially Responsible Investment, we are actually talking about how companies use money, and not how they get it. I don’t think that these two points should be dissociated. Do you think it is possible for a company to be “socially responsible” on how it spends its money, and not on how it gets it? Therefore, would it be possible to be “half-ethical”? I really don’t think it is!

On the other side, before taking too “black or white” position, we all need to think about where these rules come from. Indeed, when we know that making Socially Responsible Investment is about having a head above regulations and rules, then who decides what is and is not SRI? As soon as any action becomes mandatory, it not a socially responsible investment anymore. This definition then means that companies willing to invest in a social and responsible way are to spend some time to find some other kind of investment to do so. Is it fair to them? They are already spending their money in a social and responsible project, why would they have to spend their time trying to find other projects because a new law says it now mandatory to do what they were doing in the first place?...

Speaking of fairness for these companies, I think it is worth underlining the next point. Once a law is promulgated in company’s home country, the company then have to abide by this rule, even in its foreign subsidiaries. That means, for example, that a company which has to pay its “home employees” at fair price, will have to do it also in its foreign subsidiaries. And this could seem as a good thing, I agree. But, let’s see the issue from the other side. That also means that a company having a subsidiary in China, for example, will have to pay its Chinese workers at fair price, when its competitors will be allowed to pay them less, because they won’t have to abide by the same laws… It is still fair to the first company? How is it supposed to be competitive with the local companies then? And if the companies are not competitive, then they will leave the country, closing their subsidiary, and that will imply the loss of several jobs for the local population.

In my opinion, it is very important that everybody is treated in an equal way. However, I think that if this situation continues all the different players in that matters will have to find a compromise between having jobs for local population paid less than if employees were to work in the company’s “home country”, and no job at all if the company closes its foreign subsidiary.

To conclude on this subject, I don’t think that SRI should have anything to do with any rules, and I don’t think that we should stop calling socially and responsible investment SRI just because a new law says it is now mandatory to do it.

Whose fault is it?...

“Economic crisis”, “recession”, “inflation”, “buying power”… We all hear these words several times a day. We do for about four to five years now!! The 2007 crisis, as we usually call it, impacted the world economy and still has impact now. Why? What happen? Could it have been avoided? What can we do to prevent it to happen again? Is it possible to prevent such crisis to happen? Whose fault is it? These are the points I’ll try to deal with in this post.

First, I’d like to start by a “historical part”. Starting from the beginning, a vast distribution of mortgages was made, notably by American banks. This made most of their assets “illiquid”, which is in my opinion a pretty bad thing, especially for a bank! Indeed, let’s take the example of a bank according a loan of $100,000 to an individual to buy his house. In a way, it can be argued that there is no real importance if the bank owns the $100,000 “liquid” (the cash) or “solid” (the house, until the individual repay the bank). However, if the house price drops while the individual is repaying for it, then there will be a problem for the bank. The 2007 crisis started with too many mortgages accorded to too many people who weren’t able to repay the banks. And this led to the destruction of bank assets value.

There were a few signs that a recession will show before 2005, but then why these signs weren’t noticed by anyone? There are a lot of different organisations and people working in the financial sector, all of them scrutinizing the market, hopping being able to predict what will happen!! But then whose fault is it? Is it exclusively one person’s fault? I don’t think so! The problem in this kind of crisis is that they are international… when it started in the US, the “western countries” were not touched yet, and then probably thought they wouldn’t be touched by it… (Could this reaction be an ego matter? Maybe!). However, the bank system being touched in the first place, and banks being interrelated worldwide, how could we have missed it? Indeed, relations between banks are based on confidence on each other, and once this is broken, it is then very hard to fix!...

This diagram highlights quite well how a crunch starting in the United States can affect the United Kingdome.

On another hand, it might not be only the bank’s fault. Other players were also “in the game”. They could have interfered before leaving the situation becoming that bad. Whether it is government, rating agencies, experts, companies… everybody could (should?) have seen it coming. Some companies saw it coming and tried to protect themselves by securitising. This works like described in the diagram below.

To conclude, I think it is not a “one person fault”. This economic situation is very closely linked with politic choices, more than usual, if I dare say so. I think that the situation is what it is now, and instead of looking for someone to blame for it, we should all together (banks, governments, companies, experts, citizens…) to find a solution to finally get over this crisis.

Do mergers and acquisitions really create shareholder value?

Mergers and acquisition can be considered as different types of Foreign Direct Investment (for more information about FDI, please see the previous post). Mergers and Acquisitions are two different things, but since they work in a similar way, I will consider for the purpose of this blog that they are similar enough to be dealt with together.

To find an answer on whether or not mergers and acquisitions create shareholder value, I think it is primordial to understand at least partially the theory: how could mergers and acquisitions create shareholder value? According to Markides and Oyon (1998), value creation depends on different factors such as governance characteristics of the acquiring companies, the “competitiveness of the market for corporate control in different countries”, and, of course, the specificities of the mergers or acquisition.

For example, a few years ago, Procter and Gamble Co’s share (US company) lost 5% in one day after the company announced they acquired Crush Canada. On the other hand, when Viatech (US company) announced they acquired Dixie Union Verpackungen GmbH (German company), its shares’ price increased by 20%. I don’t think these differences are due to hazard. I think that the opinion (right or wrong!) people have about other countries have a major role in whether or not there will be shareholder value creation or destruction.

However, mergers and acquisitions are very complex procedures and very risky for the company. Indeed, they are most of the time very expensive: Kraft acquisition of Cadbury cost them about $19m! There are also numbers of risks to consider when acquiring another company going from financial risks to integration risks. But then, isn’t there other easier way for companies to create shareholder value, without being that risky, and towards which shareholders would be more satisfied with? Because let’s not forget that the costs for a merger or an acquisition are money the shareholder won’t receive… Of course there are other ways, but they probably are not that profitable…

On the other hand, people can argue that mergers and acquisitions are the only way or the easiest for a company to diversify, and therefore give its shareholders better dividends. I don’t think that when a company diversify, the first thought of its manager is the shareholder value. This is a more a strategic matter than a financial one in my opinion. Besides, if shareholders really want to diversify their share in different sector, they won’t ask the direction to buy another company in the new sector and take all these risks. I think they’ll probably just buy share from another company in the new sector…

We can also consider the question about mergers and acquisitions under a different angle. Should creating shareholder value be the only aim or mergers and acquisitions? I think it would be a bad idea to think that mergers and acquisitions are not good to anything if they can’t create shareholder value. Indeed, mergers and acquisitions, despite the risks highlighted before, can provide lots of advantages: overcome entry barriers, acquire core competence from other business, vertical/horizontal integration… However, commissions are here to prevent companies to become too dominant.

To conclude, I don’t think that it is possible to say if mergers and acquisitions really create shareholder value, or destroy it. I think that each merger and each acquisition should be considered independently. There are too many different factors to determine a general rule.

Aurelie, 11/03/12.

Is FDI a solution or a problem?

A Foreign Direct Investment, or FDI, is a “category of international investment made by a resident entity in one economy (direct investor) with the objective of establishing a lasting interest in an enterprise resident in an economy rather than that of the investor (direct investment enterprise)”, according to the OECD (1999). The difference between FDI and Portfolio management is that FDI implies a “lasting interest”, which often indicates a long term relationship and an influence on the way of management on the “direct investment company” by the “direct investor company”.

According to the literature, there are several reasons why companies engage in FDI instead of portfolio management. Most of them highlight the long term partnership between the companies and the benefits brought by the direct investor company to the direct investment company. But is that all? Do you really believe that multinational companies like Tesco or Apple are just investing in FDI in foreign countries because they want to help local populations to develop? I certainly don’t!... Those companies invest in FDI because it will be better for them at some point whether it is for cutting production costs or using cheaper call centre. Is it too cynical to just say that like that?

Indeed, companies invest in FDI principally in Asia at the moment. Whether it is China, or India, their labour cost is cheaper than in west countries, even considering transportation costs.

However, it is not all bad for the direct investment company. Since the two companies are in a long term partnership, the companies “exchange” their knowledge. I see that more like that: the direct investor company offer its knowledge and experience to the direct investment company, and in return, the last one offers a way to enter a new market to the first one. But what’s next? What will happen when all the knowledge will have been transferred and the market will be mature?

Considering FDI, the direct investor company has to think through different risks occurring when investing in a foreign country. According to Moffett, Stonehill and Eitman (2012) there are three major risks: transaction risk, translation risk and economic risk. Let’s take the example of Tesco. The company is investing in FDI in America under the brand “fresh and easy”. They want to open 40 stores by then end of 2014, and already have 26. In this case, Tesco will have to consider:

Ø  The transaction risk: this could affect profits the company is making when they are sent back to the UK as well as the investment the company will have to make to keep the FDI going. However, this risk could be diminished by “netting”.

Ø  The translation risk: this could affect the value of the company’s asset or at least their value in the balance sheet. This could therefore affect shareholder value or at least the perception of it…

Ø  The economic risk: this could affect the long term competitiveness. The perfect example of this risk could be what happened with the “Shwinn” company, creating two of its major competitors by sharing too much of their knowledge.

In conclusion, I think that FDI is a solution for now, but could be a problem in the future.