Corporate Finance – Al (Aloke) Ghosh

Category: Corporate Finance

Bavarian Book-Keeping: Cash-in-out

Wirecard, a high flying publicly traded fintech company from Munich, Germany, has attracted major investors around the globe including SoftBank. In about a year, the stock price of the company rocketed from €41 in 2017 to €192 in 2018.

Recently, Wirecard has admitted to book-keeping or accounting fraud. The company declared that the $2.1 billion cash on its balance sheet is “missing” (a quarter of its Balance Sheet value). It is not that the company received cash (cash-in) and then the cash was stolen (cash-out). The company never acquired that cash! By recording fictitious revenues/profits, the company accumulated a mammoth “paper” cash balance of $2.1 billion. Welcome to Alchemy Accounting.

Regrettably, the investors are left with the hefty bill—the stock is trading today around one euro!  

WireCard Business

Wirecard specializes in digital payments. The company offers its customers electronic payment transaction services, risk management, and physical cards. Initially known for processing payments in controversial markets, the company evolved into a full-service global financial payments player from 2006 following the acquisition of a bank. The company became publicly traded from 2005 following a “reverse merger” with InfoGenie, a Berlin-based company.

Over the past decade Wirecard fueled its expansion through aggressive acquisition of smaller payment processing businesses including a major acquisition of 20,000 merchant clients of CitiBank in Asia-Pacific region.

What is Fintech

Fintech encompasses any kind of technology in financial services industry linking businesses with consumers through software or other technology/apps (from payment apps to cryptocurrency). Fintech has been used for many of the newest technological developments – from payment apps like PayPal, Venmo, and cryptocurrency.

Cooking the Books

As part of investigations of potential financial fraud, Financial Times (FT) concluded that there were reasons to suspect that Wirecard’s units in Singapore and other Asian countries may have engaged in accounting fraud. According to FT, one of Wirecard’s “third-party acquirer” (licensed by Visa and Mastercard to help retailers accept credit card transactions), a Dubai-based intermediary called Al Alam Solutions, contributed half of the German company’s worldwide profits in 2016. This third party acquirer had only six-seven staff members despite processing vast sums of transactions for 34 of Wirecard’s most important clients in the US, Europe, Middle East, Russia and Japan (around E350 million between 2016 and 2017). Neither Visa nor Mastercard have any record of a relationship with Al Alam.

Investigations raise doubts whether the sales and profits recorded by Al Alam were invented. For instance, Wirecard says the US payments processor CCBill was a multimillion-dollar-client of its partner company Al Alam Solutions but CCBill says it had no business with Al Alam. Similar cases of fraud may have been perpetrated by Wirecard Dublin office.

Wisecard and Big 4: E&Y is the external auditor

As the audit firm of Wisecard for nearly a decade, E&Y GmbH, the German affiliate of E&Y Global Limited (global umbrella organization for E&Y firms) issued unqualified opinions every year until 2018 despite increasing questions from journalists and short sellers over the company’s accounting practices. 

In 2019, Wirecard hired KPMG to investigate allegations raised by some in the media and sophisticated investors that a large share of Wirecard’s reported revenue-profits between 2016 and 2018 originated from a trio of third-party partners. In April, KPMG released a 74-page report saying it couldn’t verify the arrangements with the third parties because of lack of cooperation.

During its 2019 audit, E&Y concluded that it could not verify the cash balance of $2.1 billion held by trustee-controlled bank accounts in Philippines. Why would a German company hold cash in Asia that too in a trustee-controlled account? Wisecard’s explanation for such an unusual arrangement was that they were following risk management strategies and were reserving cash to process refunds and chargeback. Ironically, Germany’s central bank could not confirm that the money had entered its financial system.  

On Friday, a German shareholder association filed a criminal complaint to the prosecutors’ office in Munich accusing E&Y auditors of missing the alleged fraud.

Political Fallouts

In Germany, Financial Reporting Enforcement Panel (FREP), a quasi-private entity, supervises the financial statements of companies traded on the German stock exchange. Germany’s lead financial regulator BaFin often relies on the investigations initiated by FREP to supervise companies. Following the Wisecard accounting scandal, Justice and Finance Ministries decided to sever ties with FREP.

BaFin President Felix Hufeld is scheduled to testify behind closed doors to German parliament members.

Expect even more fallout!
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Amazing Amazon, Inc., is an electronic commerce and cloud computing giant based in Seattle, Washington. The company was founded by Jeff Bezos on July 5, 1994. More than 20 years after going public, Amazon has a market cap of over $900 billion. In August it became the second company, after Apple, to join the $1 trillion-dollar club. According to Bloomberg, Jeff Bezos, the CEO of the company, has net worth more than $150 billion, which makes him the richest person in modern history.

Hedge-Fund to Amazing-Fund

After graduating from Princeton, Bezos began his career in D.E. Shaw, a hedge fund. He became a senior vice president after four years. However, he left the cushy job to start his own company By the end of the first month, Amazon sold books to customers in every state within the US and to customers in 45 diverse countries.

Jeff Bezos continued to diversify Amazon’s offerings into the sale of CDs, videos, clothes, electronics, toys and more through major retail partnerships. The company went public in 1997.

Amazing Acquisitions

In August 2013, Amazon bought the coveted newspaper “Washington Post” for $250 million. His space company Blue Origin made history in 2015 when it became one of the first commercial companies to successfully launch a reusable rocket. His rocket company, Blue Origin, aims to reduce the cost of getting into space.

In August 2017, Amazon officially acquired Whole Foods for $13.7 billion.

Earlier this year, Amazon, Berkshire Hathaway and JPMorgan Chase delivered a joint press release in which they announced plans to pool their resources to form a new healthcare company for their U.S. employees. According to the release, the company will be “free from profit-making incentives and constraints” as it tries to find ways to cut costs and boost satisfaction for patients, with an initial focus on technology solutions.

Amazing Story: Rags-to-Riches

In July 2017, Bezos became the world’s richest person for the first time, surpassing Microsoft founder Bill Gates. At the time, his net worth was more than $90 billion. While Gates reclaimed his top spot shortly after, Bezos became No. 1 again after Amazon released its Q3 2017 earnings in late October. Now, he’s holding steady as the richest person in modern history.

Even though he is the founder and CEO of the company, Jeff Bezos’ salary is negligible—his annual salary in 2017 was around $1.69 million (salary was $81,840 and other compensation was $1.6 million). In contrast, the annual compensation of the CEO of Apple in 2017, a comparable company in size, was a staggering $102 million (salary was $3.06 million, bonus was $9.33 million, and stock compensation was $89.2 million).

Despite his dominant position in the company, as the CEO of Amazon, Jeff Bezos was making only 1.65% of what his counterpart was making at Apple.

Amazing Stock

In early 2010, Amazon stock was trading around $100. In September 2018, the stock is trading around $2,000. In a sort span of 8 years, the stock has sky-rocketed by 2,000%. Imagine that for a moment. If you had invested $10,000 in 2010, your investment today would be worth a staggering $200,000!!!

Is Amazon still a “buy” given the amazing run up of the stock? Wall Street experts believe so. Analysts’ consensus forecast for the stock is around $2,500 by 2020. Some Wall Street heavy-weights predict that this target might be achieved much sooner.

An amazing American account!

September 30, 2018Facebooktwitterredditlinkedinmailby feather

Bite of the Big Apple

New York City or the “Big Apple” is the financial capital of the world—the city that never sleeps. Walk down the streets of Broadway, and you can hear someone humming the tune “New York, New York” immortalized by Liza Minnelli and Frank Sinatra. With access to Central Park, I believe a more appropriate label for New York City is the “Garden of Eden.” The trees in this Garden sustain life, support knowledge, and generate forbidden fruits. One serpentine bite of the forbidden apple and we are at the cross roads with Genesis!

Why was New York City baptized as the “Big Apple?”

Big Apple

In the early 1920s, “Big Apple” was a nickname for large monetary awards associated with horse racing contests, many of which were organized in and around New York City. The name was commercialized by prominent writers from the New York Morning Telegraph reporting on the City’s horse-racing. Because the city hosted important races, rewards associated with the races were substantial, which may explain the term Big Apple.

Big Apple was subsequently adopted by the City’s jazz musicians. An old saying in show business was “there are many apples on the tree, but only one Big Apple.” New York City being the premier place for jazz musicians to perform made it customary to designate New York City as the Big Apple.

The City in 1971 started a campaign to increase tourism and officially adopted the nickname Big Apple. The campaign featured red apples as reminder of the bright and cheery side of the City, in stark contrast to the common belief that New York City was dark and dangerous. Since then, New York City has officially been designated as the Big Apple.

Jobs’ Apple

What if a bite of the Big Apple eludes you? There is a solution to this biblical dilemma—own a piece of Steve Jobs’ Apple. Apple Inc. designs and manufactures computer hardware, software and other consumer electronics. The company is best known for its Macintosh personal computer line, iTunes media application, the iPod personal music player, and the iPhone.

The original logo of the company, which portrays a man sitting under an apple tree, draws on the Newtonian inspiration from a falling apple. Subsequently, Apple redesigned its logo depicting a bite of an apple. I believe the bite taken out of the Apple represents the story of Adam and Eve from the Garden of Eden with apple representing knowledge.

  • Holy Cash Cow

The company today is a colossal holy cash-cow. Based on data from the most recent financial statements, i.e., April 2017, the company has a cash balance including short term marketable securities of around $67 billion. If you add long-term marketable securities, the balance increases to nearly $260 billion, which is larger than the GDP of Greece!

What is the genesis of the cash balance? iSimple, high margins. The company’s gross profit margin is around 40%, which means for every $1 of sales, the company generates 40 cents of profit after deducting the cost of sales. The operating margins are equally staggeringly high (around 27%). Even after netting out all operating costs, the company generates $27 of profits for every $100 of sales. The sales for the first quarter of 2017 alone was $52 billion, a mind- blowing number.

  • Investments and Acquisitions

Apple is all about organic growth. The company is very frugal with its investments and acquisitions. Much of the excess cash is heavily invested in marketable securities (parking the cash and generating returns on those dollars). Its corporate investments, i.e, purchase of other companies or fixed assets, is rather modest at less than 5% of total assets.

  • Giving Back

What does the company do with its surplus cash balance? It pays dividend and buys back its own stock. Over the 6-months period ending April 2017, the company paid $6 billion as dividend. Over the same period, it repurchased $18 billion of its common stock. Thus, the cash returned to its shareholders was around $24 billion over a period of six months only.

No wonder shareholders are elated and appear flying on Elon Musk’s spaceship to the red planet. Over just under a year, the stock price of the company has increased from around $93 to $155, which translates into a 67% annual return. No legal business in the world can come close to generating these holy numbers.

If you cannot get a bite of the Big Apple, I suggest you consider a bite of the Apple company. Apple’s history is being cooked with a hint of exotic spices by its own “Cook.” The taste is simply divine.

Bon Appétit!

May 16, 2017


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Hamiltonian Hip Hop: Broadway to Wall Street

Giddy up! At more than 21,000, the Dow Jones Industrial Index has soared by 1,200 points or about 13% since January 2017. If you consider the run-up since February 2016, the stock market has delivered a staggering return of about 30%. The stock market has been on the best winning streak in 25 years.

One fundamental reason for the stock market rally is linked to the growth of Exchange Traded Funds, or ETFs, as retail investors have poured in $124 billion into this type of an investment vehicle in 2017 alone.

State Street Corp.’s SPDR S&P 500 ETF is the market’s oldest, largest and the most-traded security in the world.

Love Thy ETF

Introduced in 1993, ETFs, or Exchange Traded Funds, trade on an exchange like stocks. An ETF is a marketable security that tracks an index, a commodity, bonds, or a basket of assets like an index fund. Unlike actively traded mutual funds, an ETF trades like a common stock on a stock exchange. ETFs experience price changes throughout the day as they are bought and sold.

ETFs typically have lower fees than mutual funds, making them an attractive alternative for individual investors. Shareholders do not have any direct claim on the underlying investments in the fund, instead, they indirectly own these assets.

According to research firm XTF, there are around 1,800 ETF investment vehicles holding stock worth more than $2.7 trillion. There are no SEC rules governing ETFs which means ETFs are regulated via mutual fund regulation. Just three firms

—     BlackRock Inc.

—     State Street Corp.’s State Street Global Advisors

—     Vanguard Group

manage 80% of ETF assets.

ETF vs Actively Managed Funds

  • ETFs try to track the performance of a particular market benchmark, or “index,” as closely as possible. In contrast, Actively Managed Funds (AMFs) try to outperform their benchmarks and peer group average.
  • ETFs buy all (or a representative sample) of the securities in the benchmark, while AMFs combine research, forecasting, and experience/expertise of a portfolio manager or management team.
  • Index funds tend to be more tax-efficient and have lower expense ratios than actively managed funds because they trade less frequently than AMFs.
  • Although AMFs attempt to beat the market, quite often they may also miss their targets which results in losses for the funds’ investors. In contrast, ETFs are only undertaking the underlying risk of the market benchmark.
  • Most importantly, AMFs typically charge between five and twenty-five times what ETFs charge their investors.

Not surprisingly, the pace of ETF inflows bodes negative news for asset managers. Investors have started pulling their investments from AMFs to ETFs. The largest providers of ETFs have started reducing management fees to attract even more funds. The average annual fee of ETFs bought this year is only $23 for every $10,000 invested, sharply lower than last year. Some ultralow-cost iShares Core funds cost as little as $4 a year for a $10,000 investment, which is can be about 1/25th fraction of the fees charged by most mutual funds.

Given the low-cost structure of ETFs and the raging bull market, $7.5 billion has moved into the iShares Core S&P 500 ETF and $5.4 billion into the Vanguard S&P 500 ETF in January 2017 alone!

Hamiltonian Hip Hop and ETFs

Lately, the US stock market has generated staggering returns unmatched by almost any other country. Take for instance the returns generated from an investment in S&P 500 stocks in the last eight years.

  • 2009                26%
  • 2010                15%
  • 2011                2%
  • 2012                16%
  • 2013                32%
  • 2014                14%
  • 2015                1%
  • 2016                12%

If you invested in the S&P 500 from 1928 to 2014, the per annum compound rate of return was 9.8%. Thus, if you invested $100 in 1928, your nest egg would become $346,261 in 2014.

Join and celebrate the US goldilocks economy and consider becoming an ETF shareholder.

Vermont, February 10, 2017Facebooktwitterredditlinkedinmailby feather

Van Guarding your Assets: US Market The Best Bet

sp_chartThe annual return for investing in the U.S. stock market over the last 50 years has been around 7-8%. How can one explain this remarkable growth in the U.S. stock market? The Sage from Omaha, Warren Buffett, has a lucid and precise response. The U.S. economy, as measured by gross domestic product (GDP), has been growing, and is expected to grow, at an annual rate of about 3%. The inflation is about 2 to 3% which pushes nominal GDP growth to 5-6 %. Stocks pay about 1-2 % of dividend which increases the growth rate to about 6-8 %.

If you were fortunate enough to have invested during the bull market, i.e., 1982 to 1999, the S&P 500 Index, a common benchmark for U.S. stocks, would have crowned you with returns of about 18 percent per year. You surecannot beat these numbers unless you happen to be the humanitarian George Clooney with the reliable Ocean’s Eleven to back you up!


So where is the risk if you make 6-8% each year when the period is dull and about 18% during the bull period, which is no bull.

While these numbers are average returns, for some decades you could have easily lost money (e.g., 1970s and 2000s). Sadly, more than half the adult American population gets deprived of the “vintage bourbon” offered by the US equity market. Only 48% of adult Americans have a claim on the returns offered by the US stock market, which is such a travesty. A considerable majority has foregone the benefits of the goldilocks economy.

The Best Bet

The stock market remains the best bet for growing and preserving your financial assets. If you invested in Certificate of Deposits (CDs) with banks, you would earn about 7% in the early 1990s and about 1-2% in the last 5 years. If you invested in government bonds, which is only possible via an authorized stock broker, you would have earned between 2 and 6% in the last 30 years. If you had invested in AAA corporate bonds, you would have earned between 3 and 6% per year.

Clearly, the US stock market offers the best returns in the long run with very little risk when the investment horizon is sufficiently long.

The Van Guard(ing) your Assets

The million-dollar question for your million-dollar investment is what stocks do you pick or what fund/portfolio-manager do you choose?

The relatively safest and least costly method is to pick an index mutual fund. Instead of hiring fund managers to actively select which stocks or bonds the fund will hold, an index fund buys all (or a representative sample) of the securities in a specific index, like the S&P 500 Index. The goal of an index fund is to track the performance of a specific market benchmark as closely as possible, which is why index funds are also referred to as a “passively managed” fund.

The all-time favorite financial company offering index funds happens to be Vanguard Group because they charge very little commission or administrative fee for managing your assets. Vanguard’s 500 Index Fund started business with $11.3 million in assets. Today, the same fund holds more than $252 billion, i.e., the Fund’s assets grew by around 23,000 times.

By investing in the Index Funds like the S&P 500, you must calibrate your expectations. You should not expect staggering returns from investing in a few darling stocks like Tesla or Amazon or Apple. Why? Because those are much riskier bets. You sure make money when the market loves those stocks, but you could also lose your shirt when the market turns its roving eye towards other more attractive beauties. By investing in the Index Fund, you have committed yourself to getting whatever returns the market offers which, in this case, happens to be returns on the S&P 500 index.


Some would advise that you seek “alphas” by investing your money in hedge funds or mutual funds choreographed by “superstar” portfolio managers. While this seems like an attractive proposition, chasing these types of funds or portfolio managers can be akin to making a million through lotto tickets. The odds are heavily stacked against you; you might as well give your money to some charity.

There is another caveat. Superstar managers and high profile mutual funds will charge you a bulky administrative fees (> 1%). In addition, you must pay about 20% performance fees, especially to hedge funds.

Possible because of the realization that it is impossible to beat the market consistently over the long run (academics have been saying this for more than 30 years), or for the fear of paying exorbitant fees, index funds have grown in astounding popularity. From their start at $11 million in 1976, index funds grew only to $511 million by 1985, and thereafter expanded more than 100-fold over the next decade to $55 billion in 1995. Their assets hit $868 billion by 2005, and the future still looks very bright so you need wear shades.

Are you ready to invest in the stock market and Index Funds to help grow your financial assets. It sure beats any other form of legitimate financial investment.

Chatham, September 20, 2016; 11A feather

Equestrian Polo Designer Fails to Score

198_Polo_Ralph_Lauren_logo_profileThe stock price of Ralph Lauren, an upscale apparel company renowned for its Polo brand, has taken a thrashing lately. The stock has declined by about 50% over the past one year because of sluggish demand in the US and a decline in the value of its overseas sales from a strong dollar. In the third quarter of this year, the company reported a colossal 39% drop in  earnings.  The company also lowered its fiscal 2017 guidance numbers. Investors fear that the company may be at the vortex of a long-term slump.

End of an Era

To energize the polo pony, Mr. Ralph Lauren, the iconic designer-founder of Ralph Lauren and its sole Chief Executive Officer (CEO) and Chief Creative Officer, finally decided to step down as the CEO after being at the helm for almost 50 years. Mr. Lauren is hoping to inject some youthfulness into the septuagenarian polo team. Stefan Larsson, who is a former H&M executive and president of Old Navy, was hand-picked by Mr. Lauren to take charge of a company that is under attack.

Mr. Larsson will report to Mr. Lauren, although Mr. Lauren characterized their relationship as a “partnership” which is understandable considering that Mr. Lauren is the largest individual shareholder in his company and is expected to play a role in major decisions. Essentially, the company is separating the roles of the professional manager from that of the creative manager. The separation of the two roles will help assure Wall Street that the creative aspirations do not bleed the financial foundations of company.

Brutal Cost Cutting

Under the new strategy labelled as “New Plan Forward,” the incoming CEO intends to slash costs to fashion a reversal in downward profits. The company intends to close 50 stores, lay-off about 1,000 employees (or 7% of its workforce), and remove three of the nine layers of management that stand between the CEO and sales team.

The clothing production lead times will be amended from 15 to 9 months. Certain clothing lines will be on a hyper fast production time whereby it will be moved from the development stage to the shop floor within eight weeks.

The cost cutting strategy is bold and brutal, the Swedish CEO intends to slash costs by about $180 million to $220 million per year which is in addition to the $125 million in cost cutting completed last year.

Restructuring Costs

According to the plans, the company is projecting $400 million in restructuring charges and additionally the company intends to write off as much as $150 million in inventory that is scheduled to be liquidated. Evidently, near term earnings numbers are going to take a big hit before increasing.

Uncertain Prospects

The reasons for Mr. Lauren giving up some operational and financial control of the company after 50 years are notable and praiseworthy. Once a founder-owner company becomes sufficiently complex, the natural economic progression for the company is to retain a high quality professional manager who is responsible for supervising day-to-day operations, mange investments, and make optimal financing decisions with the objective of maximizing firm value. The advent of a professional managers also assures investors that the financial aspects of the company are not being compromised as creative side blossoms.

However, some of the restructuring plans are hard to assess. Some immediate concerns include,

  1. Why hire a CEO from outside the company? Why not hire an insider who understands the value of the brand?
  2. Can young CEO render value while being under the influence of a powerful founder-owner?
  3. Why pick a CEO from a low-priced apparel designer company that is not a direct competitor?
  4. Why are the business models that helped revive the fortunes at Old Navy and H&M likely to be useful for Ralph Lauren?
  5. Cost cutting strategies can only render value up to a point, eventually the principal driver of earnings is revenue growth.
  6. Too much cost cutting can also harm the brand value because of a loss in human capital.

Considering all these questions, the future of Ralph Lauren remains highly uncertain.

Helsinki, June 21, 12.48P.Facebooktwitterredditlinkedinmailby feather

The Mexican Wall (Mart) Spectacle

walmartWal-Mart Stores, the leading private employer in the world, operates in 25 countries with a strong presence in Mexico. Roughly about 20% of Wal-Mart’s 11,500 locations are based in Mexico. Over the last three years, the Justice Department has been investigating allegations that Wal-Mart paid bribes in Mexico to obtain permits. 

A group of beneficial Wal-Mart owners filed a complaint with the Securities and Exchange Commission (SEC) and the Public Company Accounting Oversight Board (PCAOB) that Wal-Mart’s auditor, Ernst & Young (E&Y) was aware of the bribery long before the company disclosed this irregularity to U.S. authorities in 2011. According to the complaint letter, E&Y as the independent auditor should have reported the suspected bribery to the SEC as soon as it became aware of such improprieties in 2006.

Bribery Act

The Foreign Corrupt Practices Act of 1977 (FCPA) makes it unlawful for persons and entities to make payments to foreign government officials to assist in obtaining or retaining business. The Act was amended in 1998. The anti-bribery provisions of the FCPA now applies to foreign firms and makes it illegal for foreign companies to pay bribes in the U.S.

The Act levies criminal and civil liability for paying bribes to foreign government officials. The Justice Department has jurisdiction over the FCPA.


The Justice Department launched an investigation following a 2012 New York Times article about the alleged Mexican bribes. According to the article, Wal-Mart Mexico unit paid middlemen to obtain permits and that Wal-Mart executives chose not to pursue an internal inquiry into the suspicious payments.

Although the three-year investigation remains incomplete, according to Wall Street Journal, the case could be resolved with a fine and no criminal charges against Wal-Mart executives because the charges may not be as severe as previously anticipated.

Auditor’s Obligations

According to the auditing standards (AU section 317), auditors have a responsibility to design procedures that provide reasonable assurance of detecting illegal acts. In cases of bribery, the auditor is also implicated because bribing a foreign government official is illegal in the US and also because any bribery is likely to have a material effect on a company’s financial statements.

Companies that pay bribes generally record the underlying transactions in their accounting books as legitimate operating expenses to avoid detection. Since bribes often involve disbursements of cash, recording a bribe as a legitimate operating expense results in false reporting of expenses on the income statement.

What are the duties of the external auditor when it becomes aware that its client is suspected of violating FCPA provisions?

The answer may surprise you.

  • If an outside auditor discovers an illegal act, it is required to notify responsible authorities within the company including the company’s board and audit committee.
  • The external auditor is not required to notify the government.
  • Only when the company refuses to take corrective actions or the company’s books are compromised is the auditor obligated to notify the government.

Essentially, the rules and obligations are suggesting that the company has the obligation to correct improper acts and also inform appropriate government authorities.

Top Gun: Tom (Cruise) Ray

According to Chief Tom Ray, past Chief Auditor of PCAOB and my colleague at Baruch College,  external auditors are not legally obliged to inform outside regulators about potential scandals except in limited circumstances. Auditors are required to report those acts to management and the board’s audit committee, which is responsible for monitoring financial reporting and disclosure practices. The accounting firm also needs to evaluate whether the bribers would have a material impact on financial statements.

Top gun in auditing, Tom states that only when the company doesn’t take appropriate actions, an outside accounting firm may be legally required to report the problem to a federal agency,


Needless to say, Wal-Mart will become target of lawsuits. E&Y, with its deep pockets, is also likely to become a prime target. However, if the norm is to pay bribes to secure contracts, especially in developing and emerging countries, U.S. companies are at a disadvantage relative to almost all other countries that do not have anti-bribery provisions.  

Maybe it is time to have an anti-bribery world statute.

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Predatory Pricing and Oil Games

Graph_-_Predators_pricingPredatory pricing (undercutting) is a pricing strategy whereby producers lower their prices with the ultimate intention of driving out some competitors from the market. Because high cost producers are unable to sustain production at unusually low prices, they must exit the market which shrinks competition. Predatory pricing is illegal in most countries because it intends to choke competition which hurts consumers as they must pay higher prices. One might ask whether predatory pricing is illegal in the global market place. The answer will not surprise you.    

Saudi Arabia and Russia recently have engaged in a brand of “predatory pricing” by refusing to cut back on their production levels despite falling global demand. The net result of the overproduction is unusually low oil prices. The fundamental question is why are Saudi Arabia and Russia, historically the largest producers of oil, adopting such an aggressive production-strategy when they too suffer from lower oil prices? The answer not surprisingly is predatory pricing strategy. By not cutting-back on their production, the major oil producers are playing a long-term strategy of forcing high cost producers out of business. Their ultimate aim is to drive US oil producers out of business, at least the high cost producers. 


Oil production has been an oligopolistic market with a few large producers controlling the global market share. Saudi Arabia has traditionally controlled the largest market share with Russia being the second major producer. Largely because of the discovery of shale oil, the US has become a major oil producing country. In 2014, the US toppled Saudi Arabia and now has the distinction of being the largest producer of oil with a global market share of 13%.


Oil prices have precipitously declined from around $80 per barrel to around $40 per barrel in less than a year because of the oil glut. Not surprisingly, the biggest casualty has been the U.S. energy industry. A great example of this struggle has been Chesapeake Energy Corp., an icon of the U.S. energy boom. In 2012, 54% of Chesapeake’s projects did not generate a single penny of profit. To compound its problems, hundreds of lawsuits and investigations challenged the company’s business practices.

Some activist investors including Carl Icahn forced out its charismatic co-founder/CEO Aubrey McClendon. Under the new CEO, Chesapeake has slashed spending by more than half compared with 2012, and pared its staff by 67%. Its drilling footprint is nearly 5.5 million acres smaller. Antitrust allegations against the company in Michigan have been resolved, as have about two-thirds of the lawsuits filed against Chesapeake over past business practices. Despite all these aggressive cost cutting measures, Chesapeake’s future remains precarious.

The company’s stock price has fallen from a high of around $30 in 2014 to about $5.41 last week, a nearly 85% decline. Chesapeake has written off $15.6 billion in holdings, and its cash flow continues to shrink. In the past several months, the company has suspended its dividend and laid off 740 employees. As the incumbent CEO Mr. Lawler said, “the biggest challenge is external. Chesapeake has been hampered by the low natural gas and oil prices.


Presently, the major players are playing a “game of chicken” or a “hawk-dove game.” The principle of the game is that while each player prefers not to yield to the other, the worst possible outcome occurs when both players do not yield. As State-owned enterprises, Saudi Arabia and Russia are immune to market pressures or cost considerations, which is why they have continued to produce oil at past levels ignoring the negative information in prices. While US oil producers are much more sensitive to market pressures and cost considerations, many have refused to exit the business or cut-back on their production so long as current prices have covered their variable costs. US oil producers are expecting a rebound in oil prices in the near term.

What defines as the near term is hard to predict. While most economists agree that oil prices are unsustainable at $40 a barrel in the long run, we are left with the Keynesian question, what defines a “long-run.”

December 4, 2015; 1.14A feather

Closing the GAAP on Leasing

lease_vs_buy_1_.56003548643f9The Financial Accounting Standards Board (FASB) voted earlier this month to require companies involved in leasing arrangements to record all future lease obligations on the lessee’s balance sheets regardless of whether the leasing arrangement is deemed as operating or capital.

Lease Accounting Background

Under the current accounting standards, companies involved in leasing arrangements can account for a leasing transaction as a ‘capital’ or ‘operating’ lease. If a leasing-arrangement qualifies as a capital lease, the lessee must record on its balance sheet: (1) a liability representing the present value of the future obligations/payments related to the lease (i.e., capitalize the lease obligations), and (2) an associated asset (i.e., capitalize the lease asset). All leasing arrangements that do not qualify as a capital lease must be reported as an operating lease. Under an operating lease, all lease payments are treated as a rental expense and no asset or liability is recorded on the lessee’s balance sheet.

New Accounting GAAP for Leasing

As before, under a capital lease, companies would record a lease obligation and lease asset on their balance sheet. Companies would also recognize and present the interest on the lease liability separately from the amortization of the right-of-use asset on their income statement

The key accounting innovation is that companies with operating leases must now record a lease liability and a lease asset as in the case of a capital lease. Most other accounting treatments of operating leases would remain unchanged, i.e., the lessee would recognize a single lease expense, which combines the interest on the lease liability with the amortization of the right-of-use asset on a straight-line basis.

Thus, the new lease accounting potentially affects the lessee’s balance sheet composition without invoking much changes to the income statement. FASB is expected to finalize the new lease accounting by the end of 2016 and public companies must adopt the new lease standard starting from 2018/2019.


A key advantage of the current lease accounting is that companies with operating leases can keep their obligations “off-balance-sheet,” or hidden, which means they underreport their financial leverage or indebtedness relative to other companies with capital lease arrangements. However, under the new rule, companies can no longer keep their lease obligations off-the-books which could adversely impact their debt ratings, ability to borrow cheaply, and investors’ risk perceptions.

As of 2014, the top ten companies with the largest lease rental expense (i.e., operating leases) include

Name of the company                                              Million dollars
VODAFONE GROUP PLC                                     3,420
WAL-MART STORES INC                                      2,800
SPRINT CORP                                                              2,600
FEDEX CORP                                                               2,443
FEDERAL EXPRESS CORP                                  1,418
HITACHI LTD                                                               1,338
GAP INC                                                                         1,323
TJX COMPANIES INC                                            1,322

Assuming these rental payments are contractual obligations requiring payments over multiple years, we can expect trillions of dollars in historically off-balance-sheet leases to now get recorded onto the companies’ books.

While lately economies and companies have been emphasizing “de-leveraging,” accounting is motivated to undo that effect by requiring re-leveraging! A crucial question is whether the accounting ruling will have an economic effect on the leasing business. The accounting motivation for companies to prefer leasing over buying has been negated.

November 28, 2015; 8.06P feather

Organizational Structure of the largest U.S. Banks

BankThe largest U.S. banks are constantly under regulatory pressure to simplify their organizational structures especially following the 2010 Dodd-Frank Act. How complex are their operations?


  • JPMorgan Chase & Co., the largest U.S. bank by assets, has 3,400 subsidiaries as of March 2014, which is relatively stable from the number in 2012.
  • Morgan Stanley, the sixth-largest bank, has 2,900 units as of 2013, the same number as two years ago.
  • Bank of America Corp. had 1,736 subsidiaries at the end of last year, 86 fewer than in 2013, which was unchanged from 2012.
  • Wells Fargo & Co. has 1,273 subsidiaries as of December 2013, the fewest of the six largest banks.
    These  subsidiaries can often be interconnected through complex connections. For example, Banc One Capital Holdings LLC, a wholly owned subsidiary of JPMorgan, owns BOCP Holdings Corp., which in turn owns Tax Credit Acquisitions LLC. Tax Credit is the owner of Banc One Housing Investors GTC-1A LLC, which owns a 50 percent stake in BOTCF I LLC. That company owns a 48 percent stake in ORC Tax Credit Fund 1 LP, which in turn has eight subsidiaries, including one named Faith Village LP. Faith Village is a low-income housing project in Columbus, Ohio.
    Overhauling Plans

Resolution Plans

JPMorgan, Bank of America, Citigroup, Goldman Sachs and Morgan Stanley, along with six other firms, submitted resolution plans to simplify the holding company structure of their respective banks but their plans were deemed insufficient last August by the Fed. According to the Fed, the new blueprints needed to ensure that banks can be wound down without systemic contagion.

For more, read the following article in Bloomberg. feather