Connecting the classroom to the "real world"
Blocher Ch 19
Wall Street: Inside the Collapse – 60 Minutes
2 years ago
60 Minutes ran an interesting piece last night featuring Michael Lewis, the author of a book called The Big Short set to be released this week. One of his contentions touches on something we discuss to varying degrees throughout the course: the behavioral aspects of business and incentives. His feeling (which seems to be strongly supported) is that Wall Street companies and individuals within those companies are given such incentive to produce short-term results (which result in big bonuses to the employees) that they do not consider the long-term implications of their actions. And the fact that the government bails out people that make poor decisions increases the moral hazard that this behavior will continue.
Asked what happened, Lewis said, “The incentives for people on Wall Street got so screwed up, that the people who worked there became blinded to their own long term interests. And because the short term interests were so overpowering. And so they behaved in ways that were antithetical to their own long term interests.”
“Wall Street is able to delude itself because it’s paid to delude itself. I mean one of the lessons of this story is that people see what they’re incentivized to see. If you pay someone not to see the truth, they will not see the truth. And, Wall Street organized itself so people were paid to see something other than the truth. And that’s one of the central messages of this story. You have to be very careful how you incentivize people, ’cause they will respond to the incentives,” Lewis explained.
You can read more at CBS News: http://www.cbsnews.com/stories/2010/03/12/60minutes/main6292458.shtml
Or watch the two-part video I’ve embedded below.
View From Hong Kong: Lessons From Singapore on Bank Bonuses
2 years ago
We’ll get into compensation strategies at the very end of the semester, but this article is illustrative of the kinds of approaches companies, in this case banks in Singapore, are taking to better match pay with performance and with the idea that people need to take a longer view when it comes to things like bonuses. If you focus bonuses on short-term results you end up getting short-term thinking. That concept isn’t revolutionary but it does seem to be one that has gone by the wayside in many different industries the last several years.
The View from Hong Kong: Bonus Plan? Take a Look At Singapore. Peter Stein. Wall Street Journal. (Eastern edition). New York, N.Y.: Jan 25, 2010. pg. C.3
Veritas Scores a Major “Transfer Pricing” Victory – Tax – CFO.com
2 years ago
As mentioned in class, transfer pricing is becoming an increasingly complex and confrontational issue as tax authorities around the globe are struggling to collect as much money as possible. Companies, meanwhile, are increasingly operating in multiple jurisdictions and have certain leeway with regard to pricing internal transfers, which tax authorities (including the IRS) may disagree with.
CFO.com profiled a transfer pricing case earlier this week involving Veritas, a software firm that is now part of Symantec, and the IRS.
Veritas Scores a Major Transfer-Pricing Victory. The tax court sides with the software company against the IRS. Robert Willens – CFO.com. December 21, 2009
A Better Way to Fix Bankers’ Pay
2 years ago
Here is a thoughtful article discussing the benefits of linking risk, performance, and compensation. In order to prevent banking collapses in the future there needs to be goal congruence between the managers and the companies so that managers are not pursuing goals to earn higher pay that turn out to be bad for the firm. Of course this should have always been a goal but it seems that things got out of whack and that, at least partially, is why the financial system experienced such chaos in the last year.
The implicit response seems to be that they were distracted by their greed. According to this view, these villains exploited the financial system for their own gargantuan end-of-year bonuses, got bailed out, and have every reason to do it again. Given this inherent moral hazard, it’s no wonder that so many political leaders in the U.S., Europe, and elsewhere are eager to rein in bankers’ compensation.
The moral hazard is a real concern. But the plans to limit compensation will not work, because they do not address the core problem: the disconnect among bank capital, risks (borne by both banks and society), and compensation structures (particularly the way traders are paid). If the financial leadership of the Group of 20 (G-20) can follow a “triangle principle” — building a tight regulatory connection among those three factors, making them interdependent at a granular level — they will get closer to mitigating the moral hazard. And they won’t have to regulate bonuses directly.
A Better Way to Fix Bankers’ Pay. Instead of bashing bonuses, let’s put in place the incentives we need: linking compensation to risk and capital. Shumeet Banerji. strategy+business. November 2, 2009.
Companies make deals on transfer pricing
2 years ago
Here is another in recent pieces I’ve come across that deal with transfer pricing and taxing authorities. This article explores the expanding use of “Advanced Pricing Agreements” where companies gain taxing authority approval of their transfer prices in advance of using those prices internally. Theoretically it saves time/money to do this work on the front-end.
Indeed, tax authorities are increasingly insisting that they get their piece of the pie as they step up enforcement efforts over transfer pricing, or the pricing of sales and services between a company’s subsidiaries. These transactions in particular have caught the eye of international tax authorities whose coffers have dwindled as the global economic crisis shrunk the revenue of multinationals and, subsequently, their taxable income.
How to Get on the Same Page as the Taxman. More companies are looking to make deals with tax authorities on transfer-pricing terms to avoid unexpected penalties, tax advisers report. Sarah Johnson – CFO.com. October 20, 2009
Tax Authorities Demand Transfer Pricing Evidence
2 years ago
As luck would have it, just as we are beginning to cover transfer pricing in class I came across a new posting on WebCPA that looks at the increased enforcement activity being seen with regard to how companies handle transfer pricing internally. As I mentioned in class, with tax collections down nearly everywhere around the globe I expect there to be more scrutiny on transfer pricing in the near future.
Ford Strips Vans it Imports to Get Around Tariffs
2 years ago
In Chapter 22 we deal with transfer pricing issues where goods and/or intermediate products are bought/sold between divisions of a larger legal entity. In that context, we look at times where companies can purposefully set up circumstances that allows them to pay less tax than they would otherwise have to. A great example of a company doing just that is on the front page of today’s Wall Street Journal. Ford Motor Company imports some small cargo vans into the United States that are manufactured at its own factory in Turkey. Because of the way taxes are set up on imported cargo vans, Ford ships the vans with seats and windows so that they appear to be passenger vans (which are subject to a much lower tariff) and then has its employees at a factory on the east coast rip out the seats and windows to turn these vans back into cargo-carrying vehicles. The seats are then shredded and recycled into landfill cover.
The primary motivation for doing all this is that the entire process is still considerably cheaper than paying the tariff. But imagine if Ford were just allowed to import the vans intact as cargo vans in the first place? Wouldn’t there be greater efficiency and less waste? This is a fine example of unintended consequences that occur when governments engage in protectionism of tariffs and other restrictions. Companies will find a way around some of these through means that are not the best use of resources for anyone involved.
To Outfox the Chicken Tax, Ford Strips Its Own Vans — Logic Takes a Back Seat — and Windows, As Auto Maker Plays Tariff Games. Matthew Dolan. Wall Street Journal. (Eastern edition). New York, N.Y.: Sep 22, 2009. pg. A.1
Engagement is Key to Meeting Strategic (and, therefore Financial) Goals
2 years ago
Throughout the course of Acct 320, we come back time and again to the Balanced Scorecard model and the idea that improvements internally in things like employee relations and internal business processes eventually “bubble up” to improve the customer experience and the financial measures of a company. Reinforcing that concept is a great piece that I found today at chiefexecutive.net that focuses on employee engagement and the impact that improving it can have on a company’s bottom line. The article specifically mentions Best Buy in an example of this concept.
Best Buy was able to demonstrate that an increase in engagement among its store employees of 0.1 percent on a 5 point scale resulted in an annual profit increase of $100,000 for their store. If you really believe that your employees are the lifeblood of your company then your employees are an integral part of your brand equity.
In fact, employee engagement can be a piece of the puzzle in terms of differentiating your company/product from that of others. As I have mentioned in class, with the vast amounts of information available to us as consumers via the internet, nearly every product trends toward becoming a commodity. Something needs to be done to stand out in this environment so that you are able to charge the premium necessary to have brick-and-mortar operations when companies operating in the virtual world obviously have lower costs…employee engagement can help with that.
Aren’t you interested in growing the value of your customers, and in so doing increasing profitability? Engaged employees make a positive contribution to the bottom line. Disengaged employees with no emotional connection to the business or the customers negatively impact profitability.
The internet has created a global marketplace where much of what businesses produce can be commoditized. Today customers are just a click away from access to a number of alternatives if they are unhappy with a brand experience. In addition, social networks and blogs allow unhappy customers the ability to broadcast their unhappy experiences to consumers around the world.
Read more of this excellent piece including some discussion about aligning compensation with strategy at the link below:
Targeting Supply Chain for Savings & Revenue Growth
2 years ago
This article uses the term “supply chain” but I think the concepts are just as valid in terms of the “value chain” principles that we discussed in class. Working outside the legal framework of our own organization is one of the main ideas behind the importance of value chains and Cricket Communications, the company profiled in this article, is a perfect example of the benefits that can be gained by doing so. One of the things I found most interesting was that this piece pointed out the importance of aligning compensation of employees with the strategy to make sure that there is goal congruence.
One of the biggest innovations reached all the way to the end customer. Analysis revealed huge hidden costs in Cricket’s “reverse logistics” process, through which phones are returned for replacement and repair. The main problem was a mismatch in incentives. Salespeople were rewarded for satisfactory customer transactions. If an out-of-warranty phone broke down, the sales rep found it hard to tell the customer that he or she was simply out of luck. So the rep accepted the phone for repair and the customer received a new phone free of charge, with Cricket bearing the entire cost. Absent the innovation imperative, a rules-based solution might have been devised that brought costs under control but left customers even more dissatisfied. Instead, the team came up with a more creative solution, and acted quickly to implement it.
There are many good examples in the rest of the article. I encourage you to check it out at the link posted below.
Debugging the Supply Chain. By Keith Buckley and George Appling. strategy+business. July 14, 2009.
McDonald’s to Move European Headquarters
2 years ago
Following some other companies including Kraft and Yahoo!, McDonald’s has announced that they will move their European headquarters to Switzerland. The McDonald’s spokesman denies that the move is for tax reasons, but other firms have been quite vocal that high taxes in the U.K. and elsewhere compared to the lower tax rates in Switzerland have been behind their moves.
Some homegrown companies have also been making the same switch. While the U.S. companies have usually been discrete about their complaints about high U.K. taxes, the homegrown companies that move out of the U.K. to Switzerland or sometimes Ireland have been more vocal in saying high taxes have been the reason for the move.
We’ll discuss multinational issues including tax rate discrepancies in Chapter 23 when we discuss transfer pricing. With more companies operating in multiple countries the practice of choosing to locate in tax-favorable locations is sure to increase. The same thing happens, by the way, when states in the USA raise their taxes too much in comparison to neighbors or even distant states.
McDonald’s Base in Europe Shifts to Switzerland. Martina Cruz Riquet. Wall Street Journal. July 13, 2009.
