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Challenging Management
Myths II
Accounting & Finance Research
The
spring issue of Notre Dame Business magazine featured research
by Mendoza marketing and management faculty that challenges conventional
wisdom. We again bring you research that challenges conventional thinking.
But this time we focus on accountancy and finance research. Mendoza
faculty tackle issues ranging from how businesses can reduce state income
taxes by moving their company's Internet servers to states with lower
rates to how trading through Electronic Communication Networks can save
time and money. If you'd like to share your thoughts, please click here
to post your response.
To
save money on state income taxes, some businesses move their company's
Internet servers to states with lower rates. After learning that a number
of companies had moved their Internet servers to Indiana where taxes
are up to 5% lower than in other states - Pennsylvania, Wisconsin, Minnesota
and New York to name a few - Accountancy Professor Ken Milani began
to look more closely into this phenomenon.
To take advantage of lower tax rates, says Milani, a company can move their servers to a low-tax state and create what is called "nexus" - proof that the company has established a physical and/or economic presence there. A physical presence in the state could take the form of a warehouse, sales people, or a customer service or training center. After a company has taken these steps, it has the right to file income tax on the e-commerce-based portion of their profits in the state. For example, a Wisconsin-based firm with Internet-based profits of $1.5 million could save $43,500 by establishing nexus in a lower tax state, such as South Carolina.
However, Milani warns, watch out for hidden costs. "Some states, such as Indiana, have hidden fees that make the effort of relocating less worthwhile," he says. "And don't forget that state tax laws can - and do - change over time."
"Imagine if this practice becomes the norm. Companies would become more fragmented, with some functions, such as customer complaint centers, located outside the state where the company is head-quartered. And high tax states such as Pennsylvania, Wisconsin and New York may suffer if companies begin to opt out of paying taxes in those states." What does this mean for the company that moves part of its business out of one of these high-tax states? There will be less money for infrastructure-such as highway repair or support for local schools. "Employees in the home state may also suffer as funds available for social and other services decline," says Milani. "The ethical dimensions of this situation are considerable."
Milani's advice? Look before you leap. "Moving part of the company may be a quick way to save a buck, but things are rarely so simple."
Executive
compensation in the U.S. has skyrocketed over the past two decades,
with top executives earning a staggering 531 times that of the lowest
level worker in 2000-up from 85 times that of the lowest level worker
in 1980, according to a 2000 Business Week poll. Shackell-Dowell
decided to take a closer look at executive compensation packages. She
wanted to see what effect new laws have had on capping executive salaries.
"In 1992, the U.S. government took away a company's right to deduct executive pay if it exceeded $1 million and was not sensitive to company performance," said Shackell-Dowell. "However, the law had unforeseen side effects: companies began to see the $1 million level as the floor, not the ceiling."
Shackell-Dowell and two colleagues researched more than 170 companies with executive pay in excess of $1 million. These include Anheuser-Busch, Bristol-Myers Squibb, Goodrich Corporation, Johnson & Johnson and 3M. They discovered that the 1992 law had not ameliorated the problem; it actually helped to widen the executive pay gap. "Companies previously paying less than $1 million experienced the most dramatic increase in executive salaries. Unwittingly, the government set a standard in 1992 just by associating a number with executive pay," she said. "One million dollars became a base amount; and companies paying executives less than this felt they had to sweeten the deal to compete for executive talent."
And what about those companies already paying major league salaries to senior management? According to Shackell-Dowell's study, in 1993 and 1994, companies often met the new law's requirements, but found loopholes. "Traditional methods of regulating pay are still the most effective," she says. "Gaps between the highest paid and the lowest paid workers in a company tend to be smaller when pressure from stakeholders (such as members of the company's board and major stockholders), firm performance, firm size, prior compensation levels and pay-for-performance measures act as regulators on salary."
Accountancy
professor Paquita Friday wondered why international companies that use
International Accounting Standards seemed to be more frequent targets
of mergers and acquisitions than those which adopt domestic accounting
standards.
Friday and a colleague looked at the merger activity of 219 international companies over a four-year period and found that those companies adhering to International Accounting Standards were roughly twice as likely to be targets of mergers and acquisitions as those which adopt domestic accounting standards. "International Accounting Standards require companies to disclose more information about profits and financial position in their financial statements - the same statements that companies review when contemplating a merger or acquisition," said Friday. "Before International Accounting Standards were adopted, acquiring companies had no way to obtain such detailed information."
So why aren't CEOs of international companies up in arms about being taken over? "Because," says Friday, "According to a recent article in the Journal of Finance, if you are a top manager in an international company, most likely you own significantly more stock than a typical upper-level manager of a U.S. company. When the acquirer buys the international company's stock, for more than it is currently selling, that money is going straight to the top managers."
Is
how you invest your money as important as where you invest it?
According to Roger Huang, Meyer Chair in Global Investment Management,
it is.
"Technological advances have opened up huge opportunities for traders, " says Huang. "The Nasdaq and the U.S. Stock Exchange have dominated for years. But now there's another way to invest: through Electronic Communication Networks (ECNs)."
Think of an ECN as an electronic trading platform with some very important perks. In a traditional market, such as the Nasdaq, investors' orders pass through the hands of various middlemen before stock is actually bought or sold. Not so with ECNs. They bypass human intermediaries completely by posting stock orders electronically. What does this mean for investors? Extended trading hours and no hidden fees. Buyers purchase stock directly from the seller.
Huang analyzed more than 14.8 million bid and ask quotes offered through ECNs and the Nasdaq over a two-year period. His conclusion: ECNs are an extremely attractive trading venue to both institutional investors and daytraders. "ECNs already control up to one-third of the total share of volume traded on the Nasdaq because of tighter spreads" (a spread is the difference between the buying and the selling price), says Huang. And there's another reason investors trade through ECNs: ECNs are completely anonymous. For certain investors anonymity can be key. "In a traditional marketplace, informed buyers (typically institutional traders such as TIAA-CREF, Fidelity Investments and those purchasing stocks for hedge funds) can end up paying more for their trades," says Huang. "But, because ECNs are anonymous, everyone is placed on a level playing field."
For
more information about Electronic Trading Networks (ECNs),
contact your broker. In the meanwhile, here are a just a few ECNs to
check out: Island.com, Archipelago,
Instinet Corporation, or Redibook.
Note: this is for information only; none of the above ECNs are
endorsed by Notre Dame's Mendoza College of Business.
When
Finance Professor Tim Loughran began charting the average "first day"
returns of Initial Public Offerings (IPOs) over the past two decades,
he noticed an interesting trend. He discovered that investment bankers
who facilitate the distribution of company shares tend to undervalue
stock. One result is that the company "nets" significantly less money
from the initial offering.
"When firms go public, they hire an investment banker who markets the company and facilitates the distribution of shares," says Loughran. "Investment bankers advise the company on a fair stock price. This price is usually undervalued in order to help the company get its foot in the door on opening day."
However, the recent escalation of underpricing - from 7% undervalued in the 1980s to 65% in 1999 and 2000 - has taken underpricing to a new level, he says. "When stock is undervalued, it tends to favor the investment bankers who are hired to facilitate the stock transaction."
Loughran's advice to companies going public: "Determine a reasonable price for your stock, then drive a hard bargain with the investment bankers."