Corporate tax evasion- The arguments from both sides!

Would you pay less tax if you could get away with it?

One goal a company strives towards is reducing costs; many achieve this through tax evasion. They can use many methods to reduce the cost of taxation which contributes to their overall company objective to maximise shareholder wealth, discussed in blog post 1. When a company decides it needs to reduce costs the main question is how?  Tax is a huge cost for large corporations and while tax avoidance is illegal, evasion is perfectly within the law, whether morally correct or not! However, a large proportion of the public point out, why should we pay tax and large corporations who turnover millions of pounds evade paying towards the society they reside in?

Well one company who felt the need to evade tax is the much loved household name, Cadburys. Cadbury’s was taken over by the American firm Kraft in 2010. However with the sale of the company to Kraft, the US owners decided they wanted to move Cadburys headquarters from its historical base in the UK over the Switzerland which benefited from a 15% corporate tax, a major deduction when compared to the 28% tax Cadburys paid in the UK.  Although Kraft argues that it’s not evading tax, it’s only trying to integrate Cadbury into the Kraft Company. The public was still outraged as it believed the move was not only costing the UK $60bn but moving a well known British company from its routes:

‘The great British public will question Kraft’s commitment. The public will say this is just tax avoidance and the public will be right.’ (Daily Mail, 2010)

Yet when it comes to corporations, should it be their goal to be ethical? Or should it be to make as much money as possible, cut costs as much as they can and therefore create the competitive market that Britain has? If Cadburys wants to remain competitive they have to take advantage of this strategy, other companies do it around the world and while the government has promised to try to reduce the chance of companies doing it, while the option is there companies will continue to take advantage.

When it comes down to it, why wouldn’t Cadburys restructure to take advantage of the lower tax rate? They aim to maximise shareholder wealth and this is one way of doing that! Many countries offer tax escapes to corporations such as Ireland, the Cayman Islands and as Cadburys has proven Switzerland. Don’t companies and their managers have a responsibility to maximise shareholder wealth and if that is their role then surely tax evasion is an effective way of doing this. The main issue comes down to corporations Vs the public!

Although everyone has to pay tax including corporations, there is nothing to state that a company can’t relocate or restructure their business so that they pay less tax. Countries that offer zero or low tax rates are a major temptation for companies. Managers aim to reduce costs, in the hope of achieving positive results for their company, increasing dividends and as a result improving and securing the bonus they receive. The public on the other hand expect companies to pay tax as a social duty towards the company they reside in; therefore when a company restructures its business to a low tax country, such as the Cadbury Switzerland move, the public is outraged.

The question many people are asking when it comes to tax avoidance in this way, are the companies behaving ethically and should tax evasion be legal?

So a major question being asked, Is it ethical to evade tax? Well the answer is probably not! Corporations should contribute to the area and country they reside in, as they are not only contributing to the wider society but the tax they pay will help their employees who live in that country. However, although the public are generally outraged by British corporations avoiding tax, if they had the chance to reduce the amount they paid, would they? And if they could reduce the amount of tax they paid, they probably wouldn’t consider the ethical implications of doing this.

In the end, Cadburys move to Switzerland is costing the UK around $60bn a year; however that is $60bn that will more than likely go to one of two things. The money will either be paid out to shareholders, which are more than likely UK based, in the form of pension funds and insurance companies. The other option would be going towards investment in the company to make them more competitive; this could potentially create more jobs or reduce the prices, which again would benefit the public.

Although tax evasion is probably not the most ethical thing a company can do their goals and aims can’t all be ethical as their main responsibility is to their shareholders not to the general public. As with any business practice the question is what the most important consideration is, and usually shareholders win!

Sources used: Daily Mail, BBC News

http://www.dailymail.co.uk/news/article-1335774/Cadburys-Swiss-avoid-British-tax-cost-Treasury-60-million-year.html

http://www.bbc.co.uk/news/uk-11919248

Raising finance for the company…Equity Capital or debt finance?? Choices Choices!

When it comes to companies one important factor they have to consider is how they are going to raise capital to fund projects and activities that will generate wealth and value for the company. They have the option of debt finance, funding from bank loans, bonds and syndicated loans (for large sums of capital). However, another option for companies to raise capital is equity finance. This form of funding can come from listing on the stock exchange through an initial public offering of company shares. The problem is, with so many options which one do they take? Which one has the most benefits and drawbacks? 

Facebook is a prime example in the current market of a company who has made its decision to raise money through equity finance. The economist (February 4^th 2012) reported that Facebook announced its IPO on February 1^st, which could value the company between $75-$100bn. This seems like an astronomical amount of money, however as the Jones, R (2012) from the BBC reported the shares were trading privately at $80bn last week and with the IPO being announced it looks as though the price will climb to $100bn. When considering the excitement and price tag that has been placed on Facebook it does appear to be an excellent option for raising capital. However, did they have other options? Was this the right one? 

http://www.youtube.com/watch?v=vjkXNcyDvQI (video about Facebooks IPO)

When it comes to large corporations, who are reporting good revenue figures and net profit, as Facebook has, ‘Last year it generated $3.7billion in revenue and $1billion net profits.’ The choices for generating capital would appear to be endless, so why have Facebook chosen to list on the stock exchange and publically offer shares? When raising capital, all forms of funds have their benefits and drawbacks, so it is understandable therefore, that listing on the stock exchange will also have pros and cons. When a company decides to list, one major drawback is the high costs such as the cost of issue; the yearly fee to the stock exchange e.g. NYSE and also the required rate of return for shareholders once the company is listed. In addition, to these high costs, companies also have to consider that there will be a loss of control, as they are effectively selling ownership (this is only a major issue with concentrated shareholders). However, this form of financing hosts a major advantage over debt finance, the company doesn’t have any obligation to pay back the money or to pay dividends, sounds like a good idea to me! 

Although debt finance contains both advantages and disadvantages, listing on the stock exchange does seem incredibly desirable. Yes there are high costs but in the end the finance the company raises doesn’t have to be paid back, as it would if it was a bank loan. Although debt financing can be a great way to raise capital, such as through bonds, an IPO does seem like the best option for such a large firm, because debt finance is still an available method to raise additional capital while they are offering shares, therefore the company really has nothing to lose by raising capital through an IPO.

With so many choices for companies in terms of raising capital, any form of either debt or equity would be an acceptable choice. However, when companies are doing so well and are wanting to increase in size and profitability such as Facebook, listing on the stock exchange is an excellent and logical form of raising capital, not just because it raises so much but because it allows the company to become more recognised on a worldwide basis and it borrows the prestige of that stock market.

 Facebook, if the IPO goes the same way as Google, will raise an unprecedented amount of money which will allow them to invest in projects that help the company grow. Although Facebook will have no obligation to pay dividends to shareholders, I have complete confidence that they will because it is such a highly desirable business with a massive level of popularity across the globe. This IPO isn’t to raise finance for a company who is in trouble, it’s to raise finance for a company that is clearly becoming one of the largest websites in the world with huge amounts of users and companies advertising there, this money will help them grow and hopefully generate larger profits and as a result reward its shareholders with generous dividends. Good choice Facebook! 

Sources used: The economist (February 4th-10th 2012) and bbc.com (http://www.bbc.co.uk/news/technology-16835116) http://www.youtube.com/watch?v=vjkXNcyDvQI

Stock Market efficiency: Can you predict the market or is it random chance and what does that mean for efficiency?

Stock market efficiency is a topic that has various theories and ideas surrounding it. The main focus in this area is the efficient market hypothesis with the main focus being on pricing and looking at how we get it right. It is argued that in order to test the efficiency of the market, there needs to be an event or news to determine how the market moves in relation to this occurrence.  If a company released their quarterly report which showed good results, the share price would go up (this is in a perfect world with a perfectly efficient market). So basically simply put ‘In finance, the efficient-market hypothesis (EMH) asserts that financial markets are "informationally efficient," or that prices on traded assets (e.g., stocks, bonds, or property) already reflect all known information, and instantly change to reflect new information.’ (Miller, 2009) However, we don’t live in a perfect world and therefore it is likely that we don’t have a perfectly efficient market. If the market isn’t perfect (which anything rarely is) can we actually predict what is going to happen?

The BBC news reported on February 9th that Rolls Royce had seen its profits rise by 21% this year, increasing to £1.16bn! My first thought was, we should definitely see the market reacting positively to this information, especially when their orders rose 5% as well reaching £62bn, a substantial amount. However, the London Stock exchange, reported something completely different from expected as the share price for Rolls Royce had gone down from the 8th Feb by 18.5. This would highlight that markets are completely random, as who could have predicted the price would go down after such a positive result?  This leads to the belief that Kendal (1953) is correct and that the stock market is completely random, with price and movements reacting in an unpredictable way.  However, Kendal (1953) also argues that ‘changes occur when new news enters the market’ and ‘share prices at any time reflects all known information’. This seems to be untrue in the case of Rolls-Royce because surely the market would react positively to profits rising to 21% this year. However, profits don’t mean everything when it comes to the market, what about the dividends and other factors that could influence people’s reactions?

When looking at Fama (1970) argument, the likely form of efficiency for the UK market is the semi-strong theory, which states that share prices do reflect the information available both publically and historically, he also argues that the market ‘reacts quickly and rationally to new information.’ However, how can this be the case when Rolls Royce shares have gone down after releasing information that shows huge profits and good increases in orders? This brings us back to the fact the some information may not affect the share price as dramatically as others. If Rolls Royce released that it was not going to pay out any dividends this year, it would most likely be predicted that the market would react very negatively to this information. However, as stated above, profits aren’t the main basis of interest for those buying and selling shares, although important, there are other more essential results that may be more likely to impact the market. If this is the case, then is the market semi-strong in terms of efficiency? It would appear when looking at the recent case of Rolls Royce, that the market doesn’t react as dramatically as is expected over every piece of information. Therefore its level of efficiency is questionable, because it would be expected to see fluctuations and rises over the trading day, however on a day like February 9th 2012, a more dramatic movement would be expected because of the news coverage of Rolls Royce. This highlights that the market isn’t predictable, saying it is portrays the fact that we can read the future! No one can predict what things will happen to a company on a day to day, month to month or year to year basis, we can guess but to know for sure would be impossible. Therefore it is impossible to know definitely how the market will react; of course we can make educated guesses but that’s about as far as we are able to go. This then raises the question, if it is so unpredictable, is it efficient? 

Sources used: BBC news, The Financial Times, Fama 1970, Kendal 1953, Miller 2009, Arnold: Corporate Financial management 2008.