Aloke Ghosh

Fulbright Distinguished Chair Professor of Accountancy Baruch College, CUNY

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Spirits of East India Company

January 15, 2017 / / 0 Comments

Beer is the third most consumed drink after water and tea and its production can be traced back 10,000 years. This popular beverage serves as the esprit de corps for almost every human emotion. We drink beer to rejoice, to recollect, to champion ball games, to forget, to relax, or just to get rowdy.

The production of beer is relatively straightforward—some form of starch is converted into alcohol through a fermentation process using yeast. The most common variation of starch used is malted barley, which is dried germinated barley. Hops are added during the brewing process to inject flavor and bitterness to the drink while acting as a natural preservative. Hops are dried flowers from the same family of vines as cannabis so beer may have some medicinal properties as well.

Lager versus Ale

The two overarching beer categories include ales and lagers. The crucial difference between two beer categories is the quality of yeast used in the fermentation which in turn imparts a distinctive character.

Ales are produced using “top-fermenting” yeast strains, which ferment at the top of the fermentation container. Lagers are generated using “bottom-fermenting” yeasts, which ferment at the bottom of a fermentation container. Ales are traditionally fermented at warmer temperatures (55 to 70 degrees Fahrenheit), while lagers are fermented at much cooler temperatures (38 to 50 degrees Fahrenheit). The dissimilar yeast types and the differential temperatures are a key reason why ales are bitter, darker and fruitier and while lagers are less fruity with a refreshingly clean and crisp taste.

The younger sibling Lager is a modern creation with a maturation age less than 300 years. Ale happens to be the older, more traditional and the distinguished sibling.

British East India Company

In the 18th century, British merchants set up East India Company to trade spices, fine cotton and silk from India. Although the British stationed in India may have preferred darker and sweeter ales, the wealthy traders of British East India Company wanted a more refined and lighter/paler version of the traditional ale to accompany their long voyages to India.

To quench the thirst of the industrial revolution, British beer-producers started a new “pale ale” assembly line with a heavy injection of hops to add a bitter counterpoint to the sweetness of the malt. The added advantage of hops was that it also served as a natural preservative, which meant that the pale ale could last the long voyages to India.

As British interests in India grew, so did the beer market in UK. More and more brewers started making “Ales for the Indian Market” or just “India Pale Ale (IPA).” As IPA conquered taste buds in India, it also spread around the world, turning up in America, Australia and South-East Asia.

IPA in the US

Today, IPAs are particularly popular in the US. Craft brewers are increasingly making IPAs as part of their medley. Bars are also happy to stock an assortment of IPAs. Not surprisingly, to satisfy the discerning palate of the consumer, beer producers and suppliers are able to charge a hefty premium for IPAs. Because of the distinct flavor, a unique bitter taste, a discrete sweetness and color, brewers are able to distinguish their products from other beer selections, which allows them to charge a hefty premium for “differentiated products.”

Get ready to recall the spirits of Jack Sparrow from the Indian Ocean and not from the Caribbean. Cheers!

Helsinki, January 15, 2017

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Mardi Gras Float in Trouble: First NBC

October 30, 2016 / / 0 Comments

mardigrasIn the absence of major national banks in New Orleans, regional banks have floated the NOLA (New Orleans, Louisiana) economy. Through its wholly-owned subsidiary First NBC Bank, First NBC Bank Holding Company provides a wide range of financial services in New Orleans, Florida, and Mississippi Gulf Coast with 39 banking offices.

Following Hurricane Katrina, First NBC invested heavily in New Orleans construction projects that included generous tax credits established by federal and state governments. These investments collectively helped propel First NBC to become the city’s largest bank based on assets under the leadership of CEO Ashton Ryan.

Halloween Scare: Stress Test

The Federal Reserve Bank of Atlanta and the Louisiana Office of Financial Institutions informed First NBC on Oct 11 that the bank is under “troubled condition.”  As troubled bank, it must seek regulatory approval before adding any new directors or senior executives or changing the responsibilities. The bank is also prohibited from increasing its debt, distributing interest on subordinated debt or paying dividends on its stock.

To add to the stress, the Federal Deposit Insurance Corp. (FDIC) recently declared that First NBC is no longer “well capitalized,” restricting its ability to take on certain deposits and pay interest. First NBC was recently downgraded to junk status by Kroll Bond Rating Agency Inc., which specializes in rating smaller lenders. HoldCo Asset Management, which owns the banks’s debt has shorted the bank’s stock and as a way to hedge its risk against a bank default has also publicly questioned the bank’s accounting policies.

Uncle Sam’s Subsidies: Tax Credits

First NBC invested heavily in New Orleans in construction projects following Katrina and thereby benefited from the generous tax credits from federal and state governments. Because the tax credits received by First NBC were more than the taxes being paid, the bank was able to use the unused portion of the tax credits to reduce future tax payments by offsetting future taxes against the unused portion. For instance, if the government gives a $1,000 tax credit to a single parent for raising a child alone, and the parent must pay $800 as federal income taxes based on his/her income, the parent does not pay any taxes for the current period because the tax credit fully offsets the $800 taxes payable for the current year. More importantly, even after the tax offset, the remaining $200 tax credit balance can be used to reduce future taxes.

Accounting rules allow this $200 future tax benefit to be capitalized (i.e., treated as an asset) and booked as a deferred tax benefit. As of the first quarter of 2015, the bank’s deferred tax assets—the benefits from reduction of future taxes—are $247 million, up from $95.8 million a year earlier.

In 2014, the company reported $28.6 million as income before taxes yet it reported a net income of $55.6 million because it had an income tax benefit of $27 million (instead of having an income tax expense which normally reduces net income).

Mardi Gras Float in Trouble: Recanting Previously Issued Statements

First NBC announced in August 2016 that it expects a delay in filing its 2015 Form 10-K (annual report filing with the SEC) because of restatement of previously issued financial results! The prior results included errors because of the following reasons:

  • Use of an inappropriate amortization method in accounting for investments in tax credit (Halloween Hullaballoo)
  • Consolidation of certain investments in Federal Low-Income Housing Tax Credit entities because such entities were determined to be variable interest entities in which the Company was the primary beneficiary (Enron Phantom).
  • The result of the consolidation has adverse effect on the financials (Hurricane)

Following the error corrections, the 2014 net income was now being restated (or reduced) by 20% ($55.6 million being revised to $44.7 million). Similarly, the 2013 net income was being restated (or reduced) by 18% ($40.9 million being reduced to $33.6 million). Accumulated earnings for 2012 and prior periods was being reduced by 16% from $59.8 million to $50.3 million. The company in its 2015 10-K stated “We determined that we had insufficient qualified personnel at both the executive management and staff levels with appropriate knowledge, experience and training on accounting and reporting matters, which contributed to the material weaknesses that resulted in the restatement, as well as the inability to timely file this report.”

To make matters worse, the bank was in violation of NASDAQ listing rules because it had not filed its 2016 quarterly statements. To avoid delisting from NASDAQ, First NBC submitted a plan to regain compliance with Nasdaq’s listing rules.

In a time-span of less than a year, the stock price of First NBC declined from a high of about $40 to around about $5.30, which is a cyclonic decline of around 86%. More than $600 million in shareholder wealth was destroyed because of the accounting related aggression.  

Grateful Dead Sings Aiko Aiko Ande

Ernst & Young (E&Y), a Big 4 auditor with international reputation and stature, has been the independent auditor of First NBC leading up to the 2015 financial statements. First NBC’s restatement is likely to bring considerable negative publicity, media scrutiny and regulatory intervention for E&Y. It will not be surprising to see class action lawsuits initiated by shareholders to recover losses.

In September 2, 2016, Ernst & Young declined to stand for reappointment as the company’s independent auditor for 2016. Is it a case of too little too late? A restatement is considered an audit failure.

Did E&Y fail the shareholders of First NBC? Only courts and the SEC can render a verdict on this matter. Until then, the accounting profession sings “Aiko Aiko Ande” in Cajun style.

 My spy boy saw you spy boy sittin by the bi-yo

My spy boy told your spy boy, Im gonna set you flag on fi-yo.

I said, hey now, hey now, Aiko aiko all day, jockomo feeno na na nay, jockomo feena nay.

My grandma and your grandma were sitting by the fire

Said my grandma to your grandma, gonna get your tail on fire.

Chatham- Helsinki; October 30, 2016

 

 

 

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Drugs and the Land of Lords

September 30, 2016 / / 0 Comments

fdaIndia has become a dominating player in the production of generic-drugs particularly targeting the large U.S. market. Indian drug manufacturers account for 40% of generic drugs sold in the U.S. While most Indian pharmaceutical companies continue to make their money selling inexpensive generic drugs, there is a visible change in their strategy over the last few years. Indian generic-drug manufacturers have started competing intensely to develop their own products through heavy R&D spending and finding solutions to many illnesses and diseases.  

Motivated by the desire to produce innovative and patented drugs, Indian pharmaceutical companies have started applying for drug approvals with the U.S. Food and Drug Administration (US-FDA) at an unprecedented rate. Approximately, a third of all FDA applications in the last year were submitted India’s multibillion-dollar pharmaceutical industry. A year ago, the growth in application was only 19% which means the growth rate between the two consecutive years has almost doubled.

Why the Change in Strategy?

Generic drug business (production and sales) entails making money through large volume. Margins are low because there is heavy competition from other generic drug producers. Think of grocery stores as an analogy. In contrast, patented drugs generate high returns for the producer because they are the only producer, i.e., volume is high, and margins are high because they act as a monopolist (sole producer). Think of the diamond business and DeBeers as a parallel.

Medical innovation in drugs requires considerably investments in R&D with initial outlays exceeding millions, and sometimes billions, of dollars. However, following the successful development of a drug, a pharmaceutical company must first procure a patent before the drug can become a commercial product.

Patent

The economic idea behind a patent is simple. The government wants the private sector to invest and innovate in the field of medicine and find cure for illnesses. However, because the cost of finding a cure for human ailments can be prohibitively costly, the government offers through a patent a “protection period” for a drug company to sell its drug over a certain period, which is typically 20 years in the U.S.

As a result of the patent, only the pharmaceutical company holding the patent can manufacture the drugs being approved by the FDA. Therefore, in essence the drug manufacturer with a patent is akin to a monopolist, which means it can charge an exorbitant price (think of the recent Mylan case). High prices result in high profits because the cost of production is generally low. The higher profits allow the drug manufacturer to recover the initial investment in R&D and thereafter make a ‘healthy,’ and sometimes super-healthy, return.

Humans benefit, we get to live longer and are able to become more productive, which means that society benefits but all this comes at a step price. Some drugs can cost between $10,000 to $30,000 per dosage (e.g., cure for AIDs or cancer)!

Prominent Manufacturers

India’s largest drugmaker by sales, Sun Pharmaceutical Industries Ltd., received approval for an eye drop to treat swelling and prevent pain in patients undergoing cataract surgery. In 2014 it received approval for a new injection to treat a rare blood disease known as myelodysplastic syndrome. However, to receive these patent approvals, the company had to invest heavily in R&D. The company’s R&D outlay increased from about $50 in 2011 to about $261 million in 2015, which is more than a 400% increase in a span of 4 years or about 100% annual growth.

Dr. Reddy’s Laboratories, India’s second-largest drugmaker by sales, received FDA approval for a spray for treating a skin condition called plaque psoriasis, as well as an injection for migraine headaches. The company similar increased in R&D from $50 in 2011 to $253 million in 2015, which again translates into a 100% annual growth.

Lupin increased its R&D spending by 17% to $168 million in 2015. The company is  developing an injection to treat less common cancers and a nasal spray to better deliver off-patent drugs to treat some types of pulmonary diseases. The company’s U.S.-based laboratories in Florida and New Jersey are also working to improve AllerNaze, according to Wall Street Journal.

Cost versus Benefit

Dr. Reddy’s Lab spent about $25 million in developing its migraine injection and was able to get it from concept to market in less than five years so the gestation period can be long. However, the company predicts that it expects to earn more than $100 million in annual sales from the migraine injection and skin spray.

A 20-year patent period means that the sales over the duration of the patent period would generate about $2 billion sales. The “bottom line,” it pays to invest in R&D for a company and switch from generic production to patented products. But, the company must first succeed in its innovation efforts otherwise all the investment is lost, which is the typical risk associated with R&D investments.

Chatham, Feb. 29, 2016; 11.22P

http://www.wsj.com/articles/indian-drugmakers-target-niche-markets-1461024100

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The Joy of Being Wise

August 17, 2016 / / 0 Comments

joyconnolyJoy Connolly,1 a Professor of Classics and the Dean for Humanities at New York University, has been appointed as the Provost of the Graduate Center of the City University of New York. As the Dean for the Humanities at New York University, Professor Connolly was responsible for about 400 faculty in 30 departments, programs, centers, and institutes. Her primary research interests include Roman republicanism, rhetoric, civic discourse, classical reception, and the role that aesthetic experience plays in the formation of political judgments.

With immense pride and excitement, we welcome Professor Joy Connolly to Graduate Center and to the City University of New York.

The City University of New York (CUNY)

The City University of New York, or CUNY as it is popularly known, is the largest urban university in the United States. CUNY is an integrated system of senior and community colleges, graduate and professional schools, research centers, institutes and consortia. The City University of New York receives funding from New York State and the City of New York. Presently, the CUNY network of colleges and schools provides high-quality, accessible education for more than 274,357 degree seeking students at 24 campuses across New York City.

CUNY faculty includes recipients of the Nobel Prize, the Pulitzer Prize, the National Humanities Medal, the National Medal of Science, the National Endowment for the Humanities, the Rockefeller Fellowship, the Schock Prize, the Bancroft Prize, the Wolf Prize, Grammy Awards, the George Jean Nathan Award for Dramatic Criticism, Guggenheim Fellowships, the New York City Mayor’s Award for Excellence in Science and Technology, the Presidential Early Career Awards for Scientists and Engineers, and memberships in the American Academy of Arts and Sciences and the National Academy of Sciences. For example, Paul Krugman, the Nobel Laureate in Economics, is a Distinguished Professor of Economics at the Graduate Center of CUNY. Professor Krugman was awarded the Nobel Memorial Prize in Economic Sciences for his contributions to New Trade Theory and New Economic Geography.

CUNY alumni includes an awe-inspiring list of individuals. Some prominent examples include Colin Powell (Former Secretary of State), Barbara Boxer (U.S. Senator from California), Max Kupferberg (Manhattan Project physicist), Ray Romano (TV actor and comedian), Joy Behar (comedian and writer), and Matthew Goldstein (Former Chancellor of CUNY). Refer to the website below for a comprehensive list of CUNY alumni.

http://www2.cuny.edu/alumni/fields-of-excellence/education/

Graduate Center, the City University of New York

Residing within the City University of New York (CUNY), the Graduate Center (GC) is an advanced teaching and research center. With over 35 doctoral and master’s programs of the highest caliber, and 20 research centers, institutes, and initiatives, the GC benefits from highly ambitious and diverse students and alumni. Through its public programs, the GC enhances New York City’s intellectual and cultural life. A distinct advantage for the Graduate Center is that it can draw upon its more than 1,700 faculty from across the CUNY college-campuses and scientific institutions dispersed throughout New York City.

Devoted exclusively to graduate education, the Graduate Center provides rigorous academic training in the humanities, sciences, and social sciences. GC remains the principal doctoral-granting institution of the CUNY system. As of June 2013, the CUNY PhD in Business is offered jointly by the Graduate Center and Baruch College.

Baruch College, the City University of New York

If you want a business degree, graduate or undergraduate, you must walk about 10 blocks south and head for the CUNY’s crown jewel, or its Kohinoor, Baruch College. Baruch College has about 18,000 students with around 80% majoring in business, which makes Baruch College the largest business school in the U.S.

With a legislatively mandated mission, the CUNY education system acts “as a vehicle for the upward mobility of the disadvantaged in the City of New York … ensuring equal access and opportunity.. to students, faculty and staff  from all ethnic and racial groups.” 

In spirit, the CUNY education-system embodies the much revered Finnish education system!

 Helsinki, August 17, 2016.

 1Irish meaning of the name Connolly is wise or brave.

 

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Academics and Central Banks

July 25, 2016 / / 0 Comments

raghuram_rajan--621x414A central bank is a public institution charged with managing a country’s monetary policy and regulating member banks. The main objective of a central bank is price stability. By statute, many countries also require their central banks to support full employment. Governments often appoint influential academics as the Chair/Governor of the Central Bank. Ben Bernanke, Professor at Princeton University, served as the Chair of the Federal Reserve, the Central Bank in the U.S., from 2006 to 2014. Stanley Fisher, a prominent macro-economist from MIT, served as the Governor of the Bank of Israel from 2005 to 2013. An academic staff at Trinity College Dublin, Philip Lane was appointed the Governor of the Central Bank of Ireland in 2015.

In 2013, India’s then Prime Minister, Dr. Manmohan Singh, invited Raghuram Rajan, a high profile financial economist and a Professor at the Chicago Booth School of Business, to become the Governor of the Reserve Bank of India for a three-year term. When Dr. Rajan took over the reins of India’s monetary policy, India was grappling with high consumer price inflation, industrial slowdown, a free falling rupee, and a widening current account deficit.

Key achievements

During his short tenure span of three-years, Dr. Rajan is credited to have

  • Strengthened the Indian currency.
  • Boosted investor sentiments.
  • Contained the current account deficit from around 5% to around 1.9% by levying added import duty on gold.
  • Reduced inflation to 8% from 11%.
  • Established the “Joint Lenders Forum” to foster greater coordination among bankers and discuss every loan decision above Rs. 5 Crore in forum so that bad loans can be prevented.
  • Forced the recognition of non-performing loans (bad loans).

Non-Performing Loans

Mr. Rajan’s priority was to purge the banking system of bad loans by forcing banks to remove non-performing loans from their balance sheet. The de-recognition of bad loads forebodes bad news for banks because they would need to recapitalize the balance sheet if their equity cushion fell below the mandated levels. Moreover, banks would be forced to call out the bad players.

In country that wants to open up the economy, India has 27 government-controlled banks which account for 70% of the country’s banking assets. Much of the bad bank loans are confined to India’s state-owned banks. According to the Economist, nearly 17% of all loans need to be written off. Therefore, the problems of bad loans are quire severe.

Colliding Politics and Personalities

The Modi government, which came to power with a huge mandate in 2014, has had major disagreements with Dr. Rajan’s economic policies. The current government is more ‘dovish’ and prefers a low interest rate environment to spur domestic investments while electing to ignore the risk of higher inflation from pursing an aggressive monetary policy. In contrast, Mr. Rajan was more ‘hawkish’ on inflation and, as a result, he was more focused on controlling inflation by keeping the interest rates high even at the cost of choking potential investments. Also, the Central Bank’s aggressive policy to recognize bad loans may have contributed to the disagreement between the government and the governor of central bank.

The current BJP party is led by a charismatic leader who is predisposed to governing with an iron hand. The top gun of India’s Central Bank was also a high-powered intellectual, a renowned economist, and a man with strong economic convictions. Fireworks are inevitable!

The Outcome

After some modest ideological confrontations with the BJP party, Dr. Rajan abruptly decided to step down as the Governor of the Reserve Bank of India and not seek a second term. CNBC deems Mr. Rajan as the world’s best central banker because of his commitment to structural reforms and because of his ability to stabilize prices and exchange rate during his short term. Did he deliver? The market believes so!

Unfortunately, India is the big loser in this Bollywood-style drama. The country is deprived of the services of a financial superstar who could have guarded financial markets and helped the Indian government pursue pro-market reforms.

Helsinki, July 25, 3.36P

http://www.economist.com/news/leaders/21699911-proposed-reforms-indias-financial-system-are-welcome-insufficient-banks-and-bureaucrats

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Can Migration Explain Britain’s Decision to Exit EU?

July 1, 2016 / / 0 Comments

BrexitNearly 52% of British citizens (17.4 million) voted in the ‘referendum’ on Thursday to exit the European Union. The outcome is startling because, from all accounts, the economic cost to Britain in the short- and long-term is expected to be staggeringly high. In less than 3 days, the global financial markets lost more than $3 trillion. During this period, the FTSE lost more than 100 billion pounds. The British pound, which was trading at an exchange rate of around $1.7 about a year ago is trading today at around $1.35.

The worst may not be over. Many sophisticated analysts believe that the pound could fall to as low as $1.10 within a year and it is projected that the U.K economy might hit a recession with a precipitous decline in property prices.

Why did the majority of the voting electorate elect to exit the EU and embrace large economic costs? One common explanation is linked to the sustained inflow of migrants from other EU countries.

Migration Statistics

Statistics disproves this theory. In 2015, the inflow of foreign nationals into Great Britain was 630,000. The increase in foreign population in 2015 as a percentage of Britain’s population, which is around 65 million, is less than 0.01%. Most economists would consider such an increase as a rounding error.

Between 1990 and 2015, Britain’s population grew from 57 million to 65 million, which translates into a modest increase of less than 1% per annum. Again, this small magnitude of the inflow of foreign nationals into Britain is unlikely to drum up mass hysteria among British citizens. Granted, the politicians have exploited the foreign migration issue to harness their individual political careers. However, the migration numbers from the census bureau do not support the casual observation that migration is a key factor driving the British anger.

If the scale of ‘legal’ migration fails to provide a compelling narrative why the majority of British nationals, principally the English, chose to exit the EU, there must be other persuasive economic explanations why 17 million rational British individuals didn’t hesitate to marry into an economic uncertainty.

Factor Price Equalization Theory

The Nobel Laureate in economics, Paul Samuelson, wrote his theory of “factory price equalization” in 1948. His theory might provide deeper insights into Britain’s current dilemma.

The Theory: According to factor price equalization theory, the prices of identical factors of production (typically labor and capital) will be equalized across countries as a result of international trade in commodities. Thus, when two countries have a free trade agreement, even without free mobility of labor, any differential in wage rate (price of labor) and rent of capital (interest rate) between two trading countries is expected to slowly dissipate. With the advent of free mobility of labor, as in the case of EU-Shengen countries, the factor price equalization process converges rapidly.  

Wage Disparity

Anecdotal evidence suggests that much of the migration of EU nationals into the U.K. has been mostly from Eastern Europe, which is typically identified as having depressed wages. For instance, according to World Bank statistics, the average monthly wage rate of Poland is €430, for the Baltic States (Lithuania, Latvia and Estonia) it is €380, for Hungary it is €358, for Romania it is €279, and for Bulgaria it is €215. For some Western European countries like Spain and Portugal the wage rates are also quite low (around €600).

In sharp contrast, the average monthly wage rate of Great Britain is around €1,550. Thus, the average wage rate of U.K is about 3 to 5 times larger than the wages of the migrant countries.

Economic Outcomes

  • Negative outcomes
  1. Wages in the host country are expected to decline as new migrants from lower wage-rate countries provide their services at a lower price in the U.K. The influx of competition injects considerable downward pressure on the wage rate of the host country. Unfortunately, U.K. workers must bear the brunt of this cost. In the absence of any barriers to entry in the labor market, i.e., specialized degrees or technical skills, wages of the host country will decline. Typically, “blue collar” workers who do not have a comparative advantage are most affected by migration. In contrast, “white collar” workers remain unaffected because migration does not affect competition in this sector.  
  2. Depending on sector specific labor migration, the abundance of labor force will also lead to some loss of jobs. Again, the job loss is expected to be confined to the blue collar working class because of fierce competition and limited growth opportunities in this sector.

The combination of job losses and a decline in wages gives rise to public discontent, anger, and resentment. This resentment is likely to be confined to working class. This is a strategic reason why the voting pattern in the referendum can be explained by the level, or lack, of education. The more affluent people or the more educated people would vote against an exit while those with lower levels of education or having less financial security would vote in favor or an exit.

  • Positive outcomes

Economists often underscore the gigantic economic benefits of migration. Yes, wages/rates decline with migration but it spurs investment, which in turn leads to more jobs. Consumers always benefit from migration and trade because of lower prices.

The Politics of Winner and Losers

A fundamental human natural law is that there are winners and losers in any society. An optimal and emancipated society aspires to minimize the number of losers while maximizing the number of winners. Judging from the referendum, a disproportionally small segment of the U.K population appropriated much of the gains from being part of the European Union, while a large segment of the population lost because of the union.

The U.K experience is a reminder that gains from trade, or common markets, must accrue to all strata of society. Otherwise, there will be social unrest or perverse outcomes that are to the detriment of the country’s long term economic welfare.

Migration issue is a sensitive topic in the U.S. as well where the discussion centers around illegal immigration. Whether the benefits of migration accrue to the majority of the citizens of the host country will decide whether ultimately host countries become more welcoming towards migration (illegal or legal).

At the end of the day, we are all migrants. Some migrated recently, while others migrated a while back.

Helsinki, July 1, 2016; 9.59P

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Chatham Professor Earns Distinguished Fulbright Award

June 25, 2016 / / 0 Comments

Indian Express, North America Edition

New York – March 1, 2016 – Aloke (Al) Ghosh, Professor at Baruch College has been chosen as a recipient of the prestigious Fulbright Aalto University Distinguished Chair Award for research in Finland and other European countries.

 Ghosh is a Professor of Accountancy at the Zicklin School of Business. Starting in the summer of 2016, he will engage in scholarly activities, conduct research, give lectures, conduct seminars for doctoral students and faculty, and consult with senior administrations at Aalto University.

“I feel extremely honored to be receiving this prestigious award,” said Ghosh. “Consistent with the Fulbright goals and objectives, my endeavor would be to exemplify the power of international academic exchange, share my knowledge and understanding of cultures with the intention of bridging the academic and cultural gaps between the U.S. and Finland and with the ultimate goal of a more peaceful and prosperous world.”

Professor Ghosh graduated from Tulane University, in New Orleans, where he earned his Ph.D. in Accounting and Economics. His Master’s degree, which is in Economics, is also from Tulane University. Speaking about his expertise and how it has contributed to his selection of the Fulbright Honor he said, “I graduated from Tulane in 1993, which was 23 years ago. Because my academic training includes Economics, Accounting, and Finance, I am able to use an interdisciplinary lens to provide unique and distinctive insights on business subject matter rather than use a specialized lens derived from one area of expertise.”  He continued, “My endeavor would be to engage in high quality scholarly research with faculty at Aalto, give lectures on my subject matter of expertise, conduct seminars for doctoral students and faculty, and consult with senior administrations at Aalto University.”

Ghosh has published numerous articles relating to topics in financial reporting and analysis, capital markets, auditing and corporate finance. These articles have appeared in The Journal of Accounting and Economics, The Accounting Review, Review of Accounting Studies, Contemporary Accounting Research, Journal of Finance, Auditing: A Journal of Practice and Theory, Journal of Corporate Finance, Financial Management, Journal of Management Accounting Research, Journal of Business Finance and Accounting, and many others.

With the support of the United States government and through binational partnerships with foreign governments, especially the Fulbright Center in Finland, the Fulbright Scholarship Program sponsors U.S. and foreign participants for exchanges in all areas of endeavor, including the sciences, business, academe, public service, government, and the arts and continues to increase mutual understanding between the people of the United States and the people of other countries. Currently, the Fulbright Program operates in over 155 countries worldwide.

Chatham Professor Earns Distinguished Fulbright Award

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How Mobil(e) is ExxonMobil?

June 11, 2016 / / 0 Comments
Losing Triple A Credit Rating

Losing Triple A Credit Rating

ExxonMobil Corp. had the honor and distinction of having a gold-plated AAA credit rating since the post WWII period. However, fortunes can change abruptly when one is trading products of mother nature. Last week, Standard & Poor’s (S&P) downgraded Exxon Mobil’s credit rating for the first time in almost 70 years from the coveted “AAA” rating to a “AA+” rating citing expectations of continuing low oil prices. ExxonMobil joins two other US companies with S&P AA+ credit ratings; General Electric Co. and Apple Inc. The two remaining US companies with the highest possible corporate AAA debt ratings are Johnson & Johnson and Microsoft Corp.

Exxon Mobil History

ExxonMobil is an American multinational oil and gas company based in Texas. It is the largest direct descendant of John D. Rockefeller’s Standard Oil Company. Exxon Mobil was formed in 1999 by the merger of Exxon (formerly Standard Oil Company of New Jersey) and Mobil (formerly the Standard Oil Company of New York). ExxonMobil is also the Fifth largest publicly traded company by market capitalization. ExxonMobil was the second most profitable company in 2014.

Downgrade Reasons

S&P stated that the “company’s debt level has more than doubled in the recent years, reflecting high capital spending on major projects in a high commodity price environment and dividends and share repurchases that substantially exceeded internally generated cash flow.”

S&P also said that while Exxon made efforts to reduce capital spending, the maintenance of production and replacing reserves will ultimately require the company to spend more. Because the company is returning cash to shareholders, instead of building cash or reducing its debt, the company faces limits on credit improvements even when oil prices recover.

S&P cautioned that it could further lower its rating on Exxon if the company is unable to sufficiently adapt to a prolonged period of low commodity prices. The downgrade is not a complete surprise. In February, S&P downgraded rival Chevron Corp and warned that such a move was also possible for Exxon.

Shareholder Payments

ExxonMobil paid out $325 billion as dividend and share repurchases over the last 11 years which exceeded its outlays for new property, plant and equipment of $272 billion over the same period. During the fourth quarter of 2015, the company paid out $3.6 billion in dividends and share repurchases, which is more than it earned in that quarter.

In February, Exxon Mobil changed its strategy and declared that it would only repurchase shares to offset dilution, and not pay back cash as dividend.  

Why Repurchase Over Dividend

Many companies prefer stock repurchase over dividends. One explanation is accounting based therefore cosmetic and the second explanation is more economic.

Investors tend to focus on accounting earnings, mostly earnings per share (EPS), which is computed as net income divided by number of shares outstanding. When a company buys back (repurchases) its own stock, it reduces the shares outstanding and thereby increases its EPS. This type of an increase in reported EPS is cosmetic (nip and tuck). Shareholders care about the pie (earnings) and not how the pie is being shared (EPS). So stock buyback initiated to increase EPS is a akin to a magician’s show intended to circumvent reality.

The advantage of stock buyback is that it is a one-time cash payout unless the company elects to announce future buybacks. Dividends, on the other hand, are more permanent in nature and investors expect continuation of dividend payments when one is announced. Therefore, companies wanting to preserve future cash prefer stock buyback over dividend.

ExxonMobil wants to buyback stock to offset the stock price decline from declining oil prices. Given the low oil prices, it has cut back on its planned investments or production capacity. However, when oil prices bound back, it wants to preserve cash to fund its future growth which is why it prefers stock buyback over dividend.

Stock Price

ExxonMobil’s stock price went down from a high of around $103 in 2014 to a low of $72 in 2015. The stock is back at around $90. With oil prices trending up, we can only expect ExxonMobil’s stock price to continue its upward trajectory.

Chatham; June 11, 2.11P

http://www.reuters.com/article/us-exxon-mobil-ratings-s-p-idUSKCN0XN26L?feedType=RSS&feedName=businessNews&utm_source=feedburner&utm_medium=feed&utm_campaign=Feed%3A+reuters%2FbusinessNews+%28Business+News%29

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The Mexican Wall (Mart) Spectacle

May 30, 2016 / / 0 Comments

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.

Investigations

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,

Solipsism

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.

http://www.wsj.com/articles/shareholder-group-ctw-says-ernst-young-knew-about-wal-mart-mexico-bribery-allegations-1432580954

 

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Cookin’ Apple Strudel with Some Cinnamon

May 20, 2016 / / 0 Comments

apple-ceo-tim-cook-has-dataApple Inc. recently reported its first-ever revenue decline in 13 years. The stock price of Apple has declined by about 30% over the past 12 months. The high flying stock was trading at a high of $135 around May of last year but today it trades around $95. The billionaire investor Carl Icahn announced last week that he had sold his entire stake in Apple citing China’s economic slowdown. He also worries that the government could make it very difficult for Apple to conduct business.

Some financial gurus disagree with the market’s negative assessment of Apple and the company’s future prospects. The Sage from Omaha, the Financial Guru Warren Buffet, does not share the market’s adverse outlooks on Apple. Buffett’s Berkshire Hathaway Inc. declared on May 16 that it had invested $1 billion in Apple Inc. stock earlier this year. Apple stock went up the same day by about 4% which created value of more than $18 billion.

China

Among various Apple products, the iPhone business is the prime driver of Apple’s profitability and global growth. Apple iPhones account for almost two-thirds of its global revenues. China plays a crucial role in propelling Apple’s business. Following the U.S., China is Apple’s second-largest market in the world. Tim Cook, the CEO of Apple, has visited China 8 times since taking up the reigns of the company.

Many investors have serious doubts whether China can contribute towards Apple’s growth. With a slowing Chinese economy, phone sales have declined in China which is a key reason for Apple’s deceleration in revenues. To confront the decay in revenues, Mr. Cook visited China earlier this month and met with senior government and Communist Party leaders. Apple also announced that it would invest $1bn in Chinese ride-hailing app Didi Chuxing to better understand the Chinese market.

Is the China commentary likely to lead to “one bad apple?” Carl Icahn seems to believe so.

Cookin’ With Spices

The solution for Apple is to replicate the Chinese success story with another country with comparable population and one that is hungry for smartphones. Low and behold, Cook landed in India this week just in time for a monsoon wedding. Mr. Cook is hobnobbing with the Indian Prime Minister, meeting with key industrialists, and boogying with the Bollywood starlets. Mr. Cook is cookin’ Apple strudel with a hint of cinnamon!

India accounts for only 1% of iPhone sales. Why? The answer is simple. India’s market is dominated by phones under $75, while Apple’s models start at around $500. As a price sensitive market, it is not surprising that Apple with its expensive iPhones has been unable to make a dent on the smartphone market in India. Apple is now aiming to grab the Indian smartphone market share and resurrect its growth story.

Bilateral Trade  

Apple has announced major investment in India. It plans to set up the first development Centre in India in Hyderabad. Apple also announced a “design and development accelerator” in Bangalore. Although, Apple is expected to continue to have its manufacture hub in China, the company had announced last year that it plans to invest $5bn in India to make Apple devices.

But what does Apple want in return for its massive investments in India? According to the Economist, Mr. Cook is hoping that the Indian government will allow Apple to sell its refurbished phones in India, which has the dual advantage of finding an outlet for its used phones and also meet the lower price barrier of smartphones in India.

Future of Apple stock?

Hard to say, but winners like Apple have a way of figuring out how to win even when the odds are stacked against them. They defy all odds, which is why we call them winners.

It is safe to ride the apple wave with the King of Omaha.

New York, May 20, 2016; 12.12P

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