Corporate Social Responsibility

Corporate social responsibility (CSR) has become a much more dominant objective for many companies in recent times. Whereas once profit maximisation at whatever cost seemed to be the priority of many businesses, now there seems to be much more consideration taken into account of how a company effects all stakeholders that are influenced by it's operations, not just shareholders. This blog aims to affirm the theory that profit maximisation does not need to be sacrificed by a business in the pursuit of operating in a socially responsible manner.

My previous blog regarding foreign direct investment briefly touched on the subject of CSR. Nike and Apple and their controversial operations in their Asian factories were discussed, highlighting the bad publicity that was gained when the poor working conditions in which many of their workers were subjected to, was discovered.

There have several other instances of firms that have hit the headlines for all the wrong reasons. One notable example is that of Body Shop. For a company that prided itself on being a ideal model of a social responsible company, it came a shock to many when certain discoveries showed that in fact they weren't such a leading example. The Body Shop had tried to maintain the image of a cosmetic company that only used natural products, yet it was revealed in a groundbreaking article in 1994 that many of their products contained extensive amounts of artificial colourings. Furthermore, the company had insisted that it gave much of it's profits to charity, but it was later discovered that this was not that case and that during the first 11 years of trading it donated nothing, with very insignificant amounts given after that period. The misleading image shown by the company had a very negative effect on it's share price, with the market value of the shares dropping by 50% once the story broke. This is a perfect example of the increasing importance of companies having to consider how they operate, not focusing purely on making healthy returns. It is clear from this example that indeed not operating in an ethical manner can have a dramatic effect on the image and value of a company.

The company has since dramatically transformed it's image, to be known as a prime example of a company that holds CSR as an integral part of it's strategy.

From an investment point of view, there is some ambiguity regarding what is considered as social responsible investing (SRI). Differing opinions as to whether a company operates in an ethical manner or not can often be an issue. Additionally, there maybe differences in opinion as to what extent a company is responsible for operations in which it is involved with. For example, an investor who maintains strict principles against investing in tobacco companies because of the obvious health implications that are associated with smoking may face a dilemma when considering whether or not to invest in a company that sells tobacco products despite not being involved directly in the manufacture of them. I think it ultimately relates to personal opinion, and some decisions regarding investing in social responsible companies will easier to make than others.

An example of a company that has undoubtedly shrived from maintaining a social responsible stance is Pret a Manger. This company considers the impact of every level of its operations, from using recycled materials in its packaging to shipping ingredients as opposed to using air freight in an attempt to cause less damage to the environment. Pret's popularity has without doubt been effected by it's socially responsible efforts. It is fair to suggest that if they tried to cut costs by operating in a less ethical manner that they would notice an negative effect on sales. This again goes to show that considering CSR is something that companies will clearly benefit from, as well as having an obvious positive effect on many other stakeholders in the process.

Credit Crunch

Since 2007 stories of the 'credit crunch' have been continually been headline news. The BBC defines the credit crunch as 'a severe shortage of money or credit' and this phenomenon has had a profound effect on the world economy. The start of the crisis has been pin pointed to the 9th August when "French bank BNP Paribas told investors they will not be able to take money out of two of its funds because it cannot value the assets in them, owing to a "complete evaporation of liquidity" in the market" (BBC). This news resulted in a sharp rise in the cost of credit. But was this the actual start of all the trouble? It is believed that the 'borrowing culture' particularly in western countries has lead to the economic downturn. In the years leading up to 2007 levels of borrowing were very high. A particular problem was the ease in which people were able to arrange mortgages, sometimes far bigger than the actual value of the property in question. Mortgage lenders were given attractive financial incentives to sell mortgages, resulting in not much consideration regarding whether or not repayments would be met. Since the crisis began mortgages have been increasingly difficult to obtain. Today's situation is very different to the years leading up to the crisis. Today banks are much less keen to lend money, causing problems particularly for first time home buyers who are finding it increasingly difficult to get on the property ladder. Following the dot.com bubble bursting and the terrorist attacks of 9/11, the US Federal reserve tried to stimulate the economy by reducing interest rates to just 1%. The cheap available credit encouraged borrowing and in many cases people were borrowing more money than they were able to pay back. As mentioned before, mortgages were offered to people who were unable to make repayments. These are known as sub prime mortgages and these were ultimately what caused the economic downturn. Banks would pool these loans together, creating collateralized debt obligations (CDOs). It soon became apparent that these CDOs were not worthy of the AAA credit rating attached to them. Once this was realised banks became unwilling to lend to each other. Subsequently many banks faced tremendous difficulties. In the UK, Northern Rock had to be bailed out by the bank of England after it became unable to pay back loans from the money market. Northern Rock's business model was heavily reliant on the inter-bank market so once other banks stopped lending money it had a dramatic effect on the fortunes of the company. Northern Rock used this short term method of finance to fund lending of mortgages. Following the announcement of the bail out, depositors withdrew £1bn in one day in what was the biggest bank run in over 100 years as they were fearful that they would lose their savings. The UK government responded by guaranteeing their savings but the damage was already done.

There was also a dramatic turn of fortunes for many other companies, particularly in the retail sector. Even today, many well known high street retailers are falling into administration. In recent news, companies such as HMV and Game have announced their problems and have been drastically reducing their operations in an attempt to survive.

It seems a stark contrast to the seemingly trouble free years the proceeded the credit crunch. It is not the first time a 'bubble' has burst and it will undoubtedly not be the last but looking back it seemed quite obvious that there would be problems associated with the heavy borrowing culture that engulfed the western world. Despite the credit crunch starting over 5 years ago, the world is still greatly affected by it and many leading economists suggest that it could be until as late as 2016 before the UK can officially say it is out of 'recession'. So the future still looks bleak and I have no doubt that we will see the demise of even more well established businesses. Hopefully a valuable lesson will be learned from all the events that have occurred and perhaps people will more cautious about borrowing money which they are unable to pay back.

Mergers and Acquisitions

Mergers and acquisitions involve two separate companies combing to make one company. As the names suggest, a merger relates to two companies often of similar size combining to make one bigger company. Acquisitions on the other hand involves one company taking over another company which will then cease to exist. There have been several notable mergers and acquisitions in the past, and M&A activity often finds itself in the news headlines. But is the process of making a bigger company by combining two smaller companies always a good thing? Most mergers and acquisitions take place with the aim of increasing total revenue by combining two companies together and also reduce expenditure. Savings can be found in the form of reducing the total wage bill by decreasing staff numbers as many job roles will have two people fulfilling them since two companies have now become one. It is also hoped that the newly formed, bigger company will have more purchasing power and therefore be able to negotiate lower prices from suppliers, again a form of cost cutting. Such economies of scale are perceived as being a significant benefit of merging with or acquiring another company. Additionally this process could allow for a greater share in the market for the new, bigger company which now might find it has significant competitive advantage as one large entity. Furthermore, merging or acquiring a new company is often used a method of gaining access to new markets. For example, in 1998 Tesco purchased the Lotus chain of supermarkets from the Charoen Pokphand group to create Tesco Lotus, Tesco's first Asian Venture. This is an example of one method of Foreign Direct Investment (FDI) as mentioned in the previous blog, and allowed Tesco to quickly establish itself in the Thai food retailing market.

So the advantages of M&A seem plentiful but at what cost? Financially speaking, the cost of acquiring another company can astronomical. Typically a company wishing to buy another company will pay a 30% premium on the share price. Examples of large deals include the acquisition of Mannesmann by Vodafone in 2000 for around $185 billion and America Online (AOL) acquiring Time Warner in 2001 for over $180 billion. Following the acquisition of Mannesmann, Vodafone's share price dropped quite noticeably. Taking into account the general theme of these blogs, the maximisation of shareholder wealth, it could be argued that an M&A activity that decreases the value of a company's share price is certainly not in the interest of increasing shareholder wealth and therefore a bad idea. It has been argued that acquisitions have occurred based on a number of different decisions not related to increasing shareholder wealth. The status of the management of the acquiring company is likely to improve following an acquisition, and this fact alone may be enough of an incentive for a CEO to orchestrate a takeover. Although this may benefit the CEO personally, making him a better known business leader, acquiring a company for this reason alone is certainly not considering the interests of the shareholders. CEOs of smaller companies may also decide to acquire another company in the hope that this will prevent their own company being subject to a takeover. Being acquired by another company is likely to lead to the dismissal of much of the existing management, on average within two years of being taken over. Although it is easy to identify motive for acquiring another company to avoid being taken over yourself, this again is not in the interests of the shareholder. Such conflicts of interest  can allow for acquisitions to occur for the 'wrong reasons' in the eye of perhaps everyone other than the CEO of the company!

Quite often mergers and acquisitions are seen as anti competitive processes and are prevented from occurring by governing bodies. In a recent case, the purchase of airline BMI by IAG (who also own British Airways) came under scrutiny for being potentially anti-competitive. Rival airline Virgin argue that the deal will create a monopoly especially on routes between Heathrow and Scotland and north-western England. Virgin say that such dominance over these routes will result in increased prices and reduced services which will be against the interests of consumers. In response to the deal, the UK's Office of Fair Trading (OFT) has announced that it will not make a review and that the European Commission will be left with the decision of whether or not to approve it.

So overall it appears that M&A activity is not necessarily always a good thing. It can result it job losses, decreased competition, higher prices for the consumers and a reduction in shareholder wealth for investors. The desire to create a bigger company purely to become more powerful is not the right reason to conduct a merger or acquisition in my opinion. With so many other stakeholders being affected, it is crucial that such activity takes place for the right reasons.

FDI - a plan for world prosperity or an exploitative tool for MNCs to become more powerful?

Foreign Direct Investment (FDI) refers to the purchase of physical assets or a significant amount of the ownership of a company in another country to gain a measure of management control (Wild, Wild & Han 2004). Over the past few decades FDI has occurred much more frequently due to a number of factors including increased international trade, closer financial links developing between countries and the removal of capital controls. Overall the world economy has become much more interdependent and FDI is seen as a process that is mutually beneficial to both the companies investing abroad as well as the country receiving investment. It can allow companies to reach and enter new markets, potentially reaping a host of benefits such as lower production costs and access to new technology as well as access to new capital and a skilled workforce. On the other side, the countries receiving foreign investment can benefit from a boost to their economy. Multinational Corporations (MNCs) who conduct FDI can offer thousands of new jobs within the countries they invest in, many of which historically have had high unemployment rates.

Overall it is suggested that FDI is a win-win situation for all involved, but is this really the case? In theory, trade and investment between countries should be a good thing. Open markets create wealth, bind nations together and help create a more prosperous world. Some may argue that large companies should provide more employment for the country in which they originate instead of outsourcing work abroad in pursuit of cheaper production costs. There are many examples of companies who do this, including Apple who outsource the production of their products to Foxconn (a Chinese company) and also Nike who outsource the production of many of their products to Asian countries, benefiting from cheap labour.  

When asked if he would consider increasing production of Nike products in the U.S, co-founder Phil Knight famously went on record to say that U.S workers would not want to make shoes for a living. So what is the problem? The countries receiving investment can benefit from more jobs being available to their population and the company involved can benefit from having access to a low cost labour force who are happy to take the jobs, unlike their local workforce. In theory it is a win-win situation, but what has happened in reality for both Nike and Apple seems to be a stark contrast.
Nike has been criticised on a number of occasions for the poor working conditions that their workers face in their Asian factories. Despite claiming that this no longer occurs, evidence from as recent as 2001 suggests that workers are still being exploited. In a documentary featuring the existence of child labour, the BBC revealed girls working up to 16 hours a day, 7 days a week in Nike shoe factories. More recently Apple has received a lot of negative attention regarding the Chinese company to which they outsource the production of many of their products. Again it is alleged that the workers are over worked, under paid and exposed to poor working conditions. Shockingly there has also been reports of Foxconn employees committing suicide whilst at work in response to the poor conditions they have to deal with. Is this really what FDI is all about? Rich, powerful multinational businesses exploiting poorer countries and their populations in order to increase profits and gain even more power? To me this is not a mutually beneficial situation.

Another concern is the seemingly obvious trend of FDI occuring mostly between countries with developed economies. The world's largest economy, the USA, is also the country which has received the largest amount of FDI. Other countries receiving a large amount of FDI include Hong Kong, the UK and other wealthy European countries including France and Germany. MNCs seem to be reluctant to invest in countries which could benefit most from investment, particularly countries in sub-Saharan Africa. Quite often the opportunity to enter these new markets with a potentially very low cost work force is heavily outweighed by the negative factors associated with these particular countries. A lack of adequate infrastructure is often a a major problem. Political instability is also a common feature of these countries. In the example of Zimbabwe, which would clearly benefit from FDI, Robert Mugabe's regime allows for a particularly unpredictable environment for potential investment in the country. When you look at FDI in this way, it suggests that rather than helping to create a more prosperous world, it actually could result in increasing the gap between the rich nations and the poorer ones.

There are many examples which display the positive effects of FDI, even in Africa. Botswana benefited significantly from FDI, mainly in its diamond mining industry. Between 1970 and 2000 it was the worlds fastest growing economy and saw a big shift in the major source of it's GDP from agriculture to mining. In recent news India has announced that it will open it's doors to FDI in it's food retailing industry which will be good news for many large retailers such as Tesco who have already successfully invested in several other countries including Thailand, South Korea and the US. However, this news has been met by severe opposition from traditional local businesses who are dreading the prospect of such large, powerful organisations being allowed to compete in the market.
I think that this could be a big problem for much of the local population particularly those who currently sell groceries. If food retailing trends in India follow what has occurred in the UK for example, local businesses may be forced to close as a result of being unable to compete with large supermarkets.

Overall I think the idea of FDI is often different to the reality. Although there is much to gain from internationalisation, open markets and increased trade between nations, there are also many problems that can occur. If MNCs strive to keep the interests of the local population as a high priority I think that FDI can indeed increase the overall prosperity of the world.