Failure of Corporate Governance - Essay Example

?Section A Using an example of a real world company discuss and analyse a failure of corporate governance in which the financial goals of a company were not met. Your answer should consider both the internal and external pressures upon the company and the components of the corporate governance system that should have prevented the crisis or failure? Corporate governance is the collection of procedures, civilization, rules, regulation and institution influencing the method a business is expressed, managed Controlled. Corporate governance is mainly analyzed as equally the arrangement and the relations which decide corporate way and presentation. The Enron Corporation before its collapse was one of the largest global company which had its hands in the sales of natural gas and electricity, commodities like bandwidth internet connection and provided other financial and management services. Failure of corporate governance can be due many reasons. In financial terms if a company owes more than it earns over a significant time period and is not able to carry out trade then it faces a corporate failure. Failure can also occur due to institutional failure in which a group of managers fails to tackle major issues of the company. An important factor behind the collapse of corporate governance is the financial crisis. “The Enron failure demonstrated a failure of corporate governance, in which internal control mechanisms were short-circuited by conflicts of interest that enriched certain managers at the expense of the shareholders.” (Enron: Corporate Failure, Market Success, 2002). A complete reevaluation of corporate governance practice in the United States became important after the fall of Enron. The financial goals of a corporate sector are mainly maximization of share holder’s wealth and the maximization of corporate wealth. The wrong financial decisions taken by the authorities leading to a ‘dubious’ financial transaction also contributes to the failure of corporate governance. The free market situation which emerged as a result of liberalization and the process of privatization of public sector got questioned after the breakdown of the Enron. “The failure of the corporate governance system should be viewed as the failure of the corporate internal control system” (Dewan, 2006, P. 51 An effective system of corporate governance has both internal and external aspects that have to be sufficiently responsive if governance is to succeed. “Different internal and external influences address different issues within an organization” (Hafner, 2010, P. 6). Absence of an appropriate internal governance system which leads to an inefficient financial and management performance may also contribute to the breakdown of corporate governance as happened at Enron. Failure of External governance system which has the responsibility to warn the company about the future market situations to do its duty may also contribute to the failure of the corporate governance. The power in the hands of the company given by the corporate rules to influence the policy makers and hence the government has been another reason for the corporate failure. The collapse of corporate governance was not just rooted in poor managerial performance but the entire corporate department plays a major role in ruining the corporate ethical values and principles. But the primary responsibility for the failure of corporate governance lies with the executives and the managers. If the operations management were allowed to work according to the corporate norms then the tragedy of the Enron collapse might not have occurred. Effective regulation and oversight, restrictions on campaign financing, and an arms length approach of government in dealing with business may have prevented the breakdown of Enron. “Enron situation taught a lesson about the main reasons for such failures and not to repeat the same mistakes in the future. The Enron situation was the focus of a massive investigation that led to significant changes in corporate governance, accounting rules and auditing procedures” (Hermanson, et al, 2011). 2. Using a real world company operating mainly in an emerging market as an example, you are to consider and discuss whether cost of capital is really a relevant factor in the competitiveness and strategy of that company. What effect (if any) does the emerging market the company is from have on the calculation of the company’s overall cost of capital? The term cost of capital refers to the maximum rate of return a firm must earn on its investment so that the market value of company's equity shares does not fall. The concept of cost of capital provides useful guidelines for determining the optimal capital structure. Optimal capital structure is the one where overall cost of capital is minimum and the overall valuation of the firm is maximum. The cost of capital is always a factor in considering a company’s competitiveness. There are three classic symptoms of corporate failure- low profitability, high gearing and low liquidity. Petroleo Brasileiro S.A. (Petrobras) was the national oil company of Brazil. It was integrated oil and gas producer which was publicly traded but 33% of its ownership shares were still owned by the Brazilian government. “Until the 1990s, Petrobras performed so poorly that its nickname was “Petrosaurus.” Its workers were 25% less productive than the average for the industry and Brazil needed to import nearly half the oil that the country needed” (Purcell, 2007). International diversification was not followed in its operations which is clear from its limited operations within the country. Due to lack of diversification and following the economic history of Brazil, the cost of capital of petrobras was relatively higher than most other major oil and gas companies all over the world. Globally oil and gas are priced in U.S. dollars. In 2002 the cost of capital of most of multinational oil companies was between 7.6% and 9.0%. But the cost of capital of petrobras was 15.0%.. “For a company like Petrobras, operating in one of the world’ most capital-intensive industries, the cost of capital is considered critically important.” (Petrobras of Brazil and the Cost of Capital, 2009). To make Petrobras more transparent and accountable, changes were incorporated in the corporate structure of the company. An independent board of directors was created including the leading Brazilian corporate executives. Above all the government abolished the monopoly of the Petrobras on oil drilling in Brazil and floated the company shares in New York. “Since 1953, Petrobras had been responsible for supplying the domestic market with petroleum products, fuel alcohol, and natural gas and, until recently, had a monopoly on imports and exports of crude oil and petroleum products. However, it did not have complete control of the country's refining capacity” (Brazil's Restructuring of the Oil and Gas Industry1, 2005). The share prices of Petrobras had shown a high correlation with the EMBI? sovereign spread for Brazil. As long the spread is used by investors in calculating the company’s cost of capital, it would seem to be reflecting changes in the exchange rate, regardless of its theoretical validity. Petrobras has its command in foreign countries like South America, West Africa and Gulf of Mexico. Petrobras is famous for its technology in deep-water exploration. The effective steps taken by the government and the company reduced the cost of capital and hence prevented the company from destruction. Section B: 1. You are to examine a real world international joint venture in an emerging market and discuss, using appropriate theory regarding the aims of international foreign investments, how you can measure or estimate the “success” of such a joint venture (financial or otherwise). (500 worlds) International Joint Ventures are becoming more and more popular in the business world as they help industries to form tactical alliances. These tactical alliances permit companies to gain competitive advantage through admission to a partner’s capital, including technologies, markets, people and capital. Foreign Investment defines to the net inflows of investment to obtain a lasting management interest in an organization working in an economy other than that of the investor. It is the total of reinvestment of earnings, equity capital, other long-term capital, and interim capital as shown in the balance of expenses. It generally contains involvement in joint-venture, management, expertise and transfer of technology. The FDI has two types; there are outward foreign direct investment and inward foreign direct investment, ensuing in a net FDI inflow and stock of foreign direct investment, which is the cumulative amount for a specified period. The company GM-AvtoVAZ is a joint venture in Russia connecting AvtoVAZ and General Motors set up in 1999. This company makes the GM-AvtoVAZ Chevrolet Niva, derived from the GM-AvtoVAZ Chevrolet Viva and the Lada Niva, founded on 1998 Opel Astra notchback. “A joint venture is a business partnership or consortium between two or more companies foe a special purpose” (Tata Mcgraw-Hill, 2011, P. 85). They contain two types of joint ventures, cooperative joint ventures and equity joint ventures. Cooperative joint venture is a contractual deal whereby responsibilities and profits are allocated to each party according to terms in a contract. Equity joint venture is economically and legally separate organizational entity formed by parent associations that jointly invest financial in addition to other resources to follow certain objectives. The main aim of foreign direct investment are sustaining a high level of investment, technological gap, exploitation of natural recourses, Undertaking the initial risk, Development of basic economic infrastructure, Improvement in balance of payments position. Sustaining a high level of investment reveals the underdeveloped states want to developed themselves within a small period of time; it turns into essential to raise the level of savings substantially. This requires, in revolve, a high level of savings. “In the context of an emerging market, these synergies and related economic benefits” (Yadong Luo, 2002, P. 216). Its can be outcome of knowledge acquisition, risk reduction, rationalization and economies of scale, improved local acceptance, competition mitigation, and market entry. The technological gap through mainly in three ways, there are Provision for expert services, Training of Indian personnel, training institution and Education research in the country. The risk of savings in host countries and thus gives the much-needed motivation to the procedure of industrialization. Economic infrastructure has been observed that the home capital of the under urbanized countries is often too insufficient to make up the financial infra structure of its own. Thus these states require the assistance of foreign capital to take on this task. “GM will reportedly invest some $141 million in the AvtoVAZ venture for a 41.5 percent ownership stake.” (Hill, 2011, P. 311). The joint venture policies to create concerning 75000 Nivas a year, all selling the car locally, there are policies to export the Nivas to the Latin America, Asia, and Middle East. Altogether, the venture expects to make some 3500 fresh jobs. GM has also invested $125 million to buy the residual 50% of Saab, laid out $2.4 billion for a 20% risk in Fiat. $1.3 billion for 20% of Fuji heavy businesses, and $653 million to twice its 10% point in Suzuki motors. Current years such familiar American MNCs as chevron, Avon products, Citicorp, Colgate Palmolive, coca-cola, Du Pont, Exxon mobile, Gillette, eastern Kodak, Gillette, McDonald’s, Hewlett-Packard, Ralston Purina, Texaco, Xerox, and the 3m company have all deserved more annual income in the global arena than they have stateside. These growing businesses will require being concerned with global management if only to progress their capacity to interact and work well with MNCs that they are supplying them on a limited basis. 2 Using an example of a real world company’s trade or sourcing from a low manufacturing cost emerging market, you are to analyze the sorts of political, ethical, brand name and competitiveness risks involved in this type of international trade. Your analysis should come to judgments regarding who is ultimately responsible and accountable regarding the quality and safety of products, and what resultant issues should international company’s consider when sourcing from emerging markets. (500 words) International trade is a risky dealing, particularly when it requires North America and countries outside Europe. Among a lot of the risks contained in it, the political ones are the most complex to measure, while having the possible. China has turn into the main supplier of manufactured goods in the globe. Its export development has been mainly based on the growth of low cost manufacturing. The company Mattel in the year 2007 illustrated that the concentrate on low cost manufacture could be vast risk for MNC’s if quality values are not met. “In china alone, Mattel had contracts with approximately 37 principal vendors who made toys for the company.” (Ireland, et al, 2008, P. 153). The principal vendors further used smaller companies for the full or partial production of toys.” Therefore, the supply chains in china were lengthy and complex. According to some approximation, concerning 3000 Chinese firm’s made Mattel products. Mattel had straight contact only with the chief vendors. The US undertaking had to recall above 20 million toys for the reason that products were manufactured with lead paint and slack, potentially risky magnets. “Mattel announced that the recall would cut its pretax operating income by $30 million and lead the MNC into huge trouble.” (Andreas van de Kuil, 2008, P. 47). Businesses are very weak to changes in the political circumstances. International trade can expand a financial system, but at the similar time certain domestic company can be outperformed by monetarily stronger multi nationals and strained to get merged. Sometimes these international companies turn into so powerful, especially in less important states, that they can dictate political conditions to the government for their profit. Chinese producers were the source of 65% of Mattel’s toys. Of those 65%, one half was possessed by Mattel and one half manufactured for the firm under qualified manufacturing contract. All of the businesses in the complex supply chain were facing the same competitive cost pressures in china, it increasing wage rates, a scarcity of skilled labor in coastal regions, rising material and commodity prices some of which may have been the incentive for suppliers to cut costs and corners. “Mattel effectively hedges against political and currency risk by sourcing in many different countries.” (Lee & Lee, 2007, P. 133). The political, ethical, brand name and competitiveness risks are involved the Mattel international trade. “The rising anxieties over Chinese products and their associated risks and returns in 2007 reflected a multitude of different political, economic and business difficulties” (Czinkota, et al, 2008, P. 127). The price of manufacturing growth had far exceeded the capacity of the Chinese government on all levels to direct the growth. Regulatory deficits are health, safety and environmental. While Mattel and further firms were now admitting their own product risks, the Chinese management were scuttling to close regulatory gaps and defend not only the sell overseas consumers who were not defensive themselves, but trying to maintain the reputation of Chinese manufacturing and evade growing trade barriers or restrictions to their products in foreign markets. Section C - International Trade: 1. Using an example of a real world multinational company, you are to come to a judgment regarding if foreign exchange gains and losses have a significant impact on corporate performance. Your answer should include a discussion of the relationship between actual spot exchange rate, the budgeted spot exchange rate, the forward rate, and the expectations of currency rate changes which may occur in a country the real world company is involved in, with a analysis of the methods of hedging that your real world company could engage in to protect itself from transaction exposures. (500 Words) Using the case study of Xian-Janssen Pharmaceutical (China) and the Euro” case study the judgment that can be made is that the foreign exchange gains and losses have a significant impact on corporate performance. Xian-Janssen Pharmaceutical (XJP) made most of its product purchases from J&J Europe therefore the price involvement was transfer prices which means prices were set internally within the company. The transfer prices that XJP was paying were quite high which increased the profits of the European business while increasing the Chinese costs. Since all the purchases were invoiced in Euro therefore the Euro rose while the Chinese Rmb which was fixed to dollar fell against the Euro. The most critical years for XJP were 2003 – 04 where there were high foreign exchange losses thereby the operating earnings of the firm suffered due to foreign exchange changes. It is important to set budget rates for a firm as it can lead to the development of the firm’s hedging process and also it’s pricing process. Foreign exchange is the result of a number of factors like the limited availability of the foreign exchange derivatives, regulatory restrictions in china on the use of derivatives. The budget rate is used for planning and purchasing activities. The forward rate is calculated from the current spot rate and interest differentials. The Chinese currency of Rmb was fixed to dollar at the time when XJP was purchasing from J & J Europe there was appreciation of the Euro over dollar which affected XJP’s financial results negatively. Thus the case study of XJP shows that foreign exchange gains and losses have a significant impact on the corporate performance of a firm. There was a high difference between the actual spot rate and predicted spot rate. The actual spot rate was high as compared to the firm’s predicted spot rate. Similarly there was difference between the actual budget rate and the predicted budget rate. The budgeted spot rate was lower than the actual rate. The forward rates in the foreign exchange of the XJP also showed an increase. “Spot exchanges are where currency is delivered straightaway, while in forward exchanges the exchange rate is fixed now but for delivery of currencies at sometime in the future” (Fell, L., 2000, P. 194). There is difference between the spot and budget exchange rates. “If there is a major difference between the spot and budget exchange rates, either the hedging or the pricing strategy may have to be reconsidered” (Henderson, 2006, P. 154). When XJP operates independently from its parent company J&J Europe, they have the sole responsibility for providing appropriate hedging methods in order to offset the future uncertainty of the foreign exchange rates. “There are two ways to hedge against exchange risk: one is to take out forward cover; the other is to borrow or lend abroad. Interest rate parity tells us that the cots of the two methods should be the same” (Brealey, 2011, P. 776). According to the expectation theory of exchange rates the forward rates should be equal to the expected spot rate but the forward rates include a risk premium. There is always currency risk in overseas operations but the hedging facility in companies makes the risk of currency forecasts less. An average rate can be set up as a budget rate to smoothen the hedging process. The case study of Xian-Janssen Pharmaceutical (China) and the Euro” case study leads to the judgment that foreign exchange gains and losses have a significant impact on corporate performance. 2. Using an example of a real world multinational company you are required to discuss and give examples of how pricing, currency of denomination, and trade financing are interrelated in the market penetration of an emerging market economy. Your discussion should include coverage of the use that instruments of trade financing such as letters of credit, drafts and related trade financing alternatives could have to the company. Pricing, currency of denomination and trade financing are interrelated in the market penetration of an emerging market. There are three choices of pricing that a firm has which are mainly local currency pricing, the producer currency pricing and the vehicle currency pricing. Through the process of herding a firm decides its currency of denomination which is on the basis of an unwavering unit between the exporter’s price and the proportional price in the importing country. It is necessary to choose an appropriate Currency denomination because currency denomination choices by exporting firms can affect the collective price level in the importing country. When the exchange rate is highly volatile then the firm can either change its currency denomination or the frequency of price adjustments. The Exporting firms which practice producer currency pricing change their price more often than the firms which use local currency pricing. “The desire to “herd” is based on denominating the firm’s price in a basket of currencies that is similar to the basket of currencies that affect the targeted price index in the importer’s market” (Witte, 2006, P. 6). Noteworthy and wide inconsistencies between the currency denominations of the exporting and the importing country led to different assessments concerning price discounts. This can be evaluated through the example of American currency which is low in denomination. When the Americans travel abroad they are more likely to be influenced away by the price discounts in countries with high denomination currencies than by price discounts in countries with similarly low denomination currencies. Australia has a low denomination currency as that of America while Turkey has a high denomination currency. Therefore the Americans will be more influenced with the Turkey than Australia. For example an American will choose a price discount of 10000 lira over Australian 10 dollars. When there is no proper infrastructure for trade finance then there occur trade barriers which hamper international trade. Trade financing instruments are the financial tools and packages that are designed to facilitate the financing of trade transactions. Some of the main types of trade financing instruments are documentary credit, counter trade, factoring, and pre and post shipping finance etc. “the documentary credit arrangement offers an internationally used method of attaining a commercially acceptable undertaking by providing for payment to be made against presentation of documentation representing the goods, making possible the transfer of title to those goods” (United Nations. Economic and Social Commission for Asia and the Pacific. 2002, P. 59). Taking the case study of Croswell diapers for a successful market penetration, an emerging company like Croswell needs to hit the customer market at such a low price below the high preliminary cost. The currency risk present for Croswell is because the product is being imported from the United States on a dollar-cost basis, and there are a large number of competitors. Therefore the cost of local made diapers is less than the imported diapers due to which high prices had to be charged from customers. Letter of credit is an important trade document where the importer’s bank extends the credit facility to the importer and takes up the responsibility to pay the exporters. “Counter trade is a movement away from free multilateral trade. It is a slow, expensive, and convoluted Way of conducting trade that often forces firms to set up operations to deal in products very remote From their expertise” (International Trade Finance, 2007, P. 22). Reference List Andreas van de Kuil., 2008. Strategies of Multinational Corporations in the Emerging Markets China and India. [Online] GRIN Verlag, P.47 Available at: http://books.google.co.in/books?id=sO8iI91z9WoC&printsec=frontcover&dq=Mattel%E2%80%99s+Chinese+trade+or+sourcing+from+a+low+manufacturing+cost+emerging+market&hl=en&ei=CVS_TY6gJYWGuQOO5tGlBA&sa=X&oi=book_result&ct=result&resnum=1&ved=0CEYQ6AEwAA#v=onepage&q=Mattel&f=false [Accessed 3 May 2011]. Brealey, RA., 2011. Principles of corporate finance. [Online] Tata McGraw-Hill Education, P.776 Available at: http://books.google.co.in/books?id=8PQfXfUlscoC&pg=PA777&dq=relationship+between+actual+spot+exchange+rate+and++the+budgeted+spot+exchange+rate&hl=en#v=onepage&q&f=false [Accessed 11 May 2011]. Brazil's Restructuring of the Oil and Gas Industry1, 2005. [Online] Center for Energy Economics. Available at: http://www.beg.utexas.edu/energyecon/new-era/case_studies/Brazil_Restructuring_of_the_Oil_Gas_Industry.pdf [Accessed 3 May 2011]. Czinkota, M. et al., 2008. Fundamentals of International Business. [Online] Wessex Publishing, P.127 Available at: http://books.google.co.in/books?id=_X-l25srIYkC&pg=PA126&dq=Mattel%E2%80%99s+Chinese+Sourcing+Crisis+of+2007&hl=en&ei=R1O_TfvjNYSivQPaprG1BA&sa=X&oi=book_result&ct=result&resnum=1&ved=0CDwQ6AEwAA#v=onepage&q=Mattel%E2%80%99s%20Chinese%20Sourcing%20Crisis%20of%202007&f=false [Accessed 11 May 2011]. Dewan, SM., 2006. Corporate governance in public sector enterprises. [Online] Pearson Education India, P.51Available at: http://books.google.co.in/books?id=Nbf4ZqYlhi0C&pg=PA51&dq=failure+of+corporate+governance&hl=en#v=onepage&q=failure%20of%20corporate%20governance&f=false[Accessed 11 May 2011]. Enron: Corporate Failure, Market Success, 2002. [Online] International Swaps and Derivatives Association. Available at: http://www.isda.org/whatsnew/pdf/EnronFinal4121.pdf [Accessed 3 May 2011]. Fell, L., 2000. An introduction to financial products and markets. 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[Online] Tata McGraw-Hill Education, P.311 Available at: http://books.google.co.in/books?id=FtDRz1uBxekC&pg=PA311&dq=GM-AvtoVAZ+joint+venture+in+an+emerging+market+the+aims+of+international+foreign+investments&hl=en&ei=xD2_Tdu7BIqovQPRjpHJBQ&sa=X&oi=book_result&ct=result&resnum=3&ved=0CEwQ6AEwAg#v=onepage&q&f=false [Accessed 3 May 2011]. Hafner, C., 2010. Building a Framework for an Efficient IT Governance. [Online] GRIN Verlag, P.6 Available at: http://books.google.co.in/books?id=jmAuiqi0FSMC&pg=PA6&dq=internal+and+external+influences+on+corporate+governance&hl=en#v=onepage&q=internal%20and%20external%20influences%20on%20corporate%20governance&f=false [Accessed 11 May 2011]. Ireland, RD. et al., 2008. Understanding Business Strategy: Concepts and Cases. [Online] Cengage Learning, P.153 Available at: http://books.google.co.in/books?id=jX7RXTi8MTEC&pg=SL3-PA153&dq=about+Mattel%E2%80%99s+Chinese+company&hl=en&ei=Vl6_Te7sNInIvQPo14i1BA&sa=X&oi=book_result&ct=result&resnum=2&ved=0CGwQ6AEwAQ#v=onepage&q=about%20Mattel%E2%80%99s%20Chinese%20company&f=false [Accessed 3 May 2011]. International Trade Finance, 2007. [Online] pearsoned, P.22 Available at: http://www.pearsoned.co.nz/LinkedFiles/Free/9780733980848/Eiteman-CH21.pdf [Accessed 11 May 2011]. Lee, HL. & Lee, CY., 2007. Building supply chain excellence in emerging economies. [Online] Springer, P.133 Available at: http://books.google.co.in/books?id=BuwFF2JLw1MC&pg=PA132&dq=issues+of+Mattel%E2%80%99s+Chinese++consider+when+sourcing+from+emerging+markets&hl=en&ei=DI_TayhD43qrQfFstX7Aw&sa=X&oi=book_result&ct=result&resnum=1&ved=0CFEQ6AEwAA#v=onepage&q&f=false [Accessed 3 May 2011]. Mehta, MS. & Srivastavaare, MR., 2009. Reasons for Corporate Governance failures. [Online] Indian MBA. Available at: http://www.indianmba.com/Faculty_Column/FC974/fc974.html [Accessed 3 May 2011]. Petrobras of Brazil and the Cost of Capital, 2009. [Online] Pearson Prentice Hall. Available at: www.cba.nau.edu/faculty/download_proc [Accessed 3 May 2011]. Purcell, SK., 2007. The Lesson of Petrobras. [Online] CADAL. Available at: http://www.cadal.org/articles/nota.asp?id_nota=2112 [Accessed 3 May 2011]. Sridharan, UV. et al., 2010. The Social Impact of Business Failure: Enron. [Online] America Journal of Business. Available at: http://www.bsu.edu/mcobwin/majb/?p=199 [Accessed 3 May 2011]. Tata Mcgraw-Hill., 2011. Question Bank in Business Studies for Class Xi. [Online] Tata McGraw-Hill Education, P.85 Available at: http://books.google.co.in/books?id=qJa_eTEhnXAC&pg=PA85&dq=joint+venture+meaning&hl=en&ei=f1G_TcfEN46evgPQvIzBBA&sa=X&oi=book_result&ct=result&resnum=2&ved=0CGoQ6AEwAQ#v=onepage&q=joint%20venture%20meaning&f=false [Accessed 3 May 2011]. United Nations. Economic and Social Commission for Asia and the Pacific. 2002. Trade facilitation handbook for the Greater Mekong Subregion. [Online] United Nations Publications, P.59 Available at: http://books.google.co.in/books?id=1PcN7LUyhzkC&pg=PA59&dq=instruments+of+trade+financing&hl=en#v=onepage&q=instruments%20of%20trade%20financing&f=false [Accessed 11 May 2011]. Witte, MD., 2006. Currency Invoicing: The Role of “Herding” and Exchange Rate Volatility. [Online] University of North Caroline Chapel Hill, P.6Available at: http://www.unc.edu/depts/econ/workshops/witte.pdf [Accessed 11 May 2011]. Yadong Luo., 2002. Multinational enterprises in emerging markets. [Online] Copenhagen Business School Press DK, P. 216 Available at: http://books.google.co.in/books?id=G_RlwpxlBVwC&pg=PA215&dq=international+joint+venture+in+an+emerging+market&hl=en#v=onepage&q=international%20joint%20venture%20in%20an%20emerging%20market&f=false [Accessed 3 May 2011]. Read More